Masimo Corp (MASI) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Third Quarter 2008 Masimo Corporation's Earnings Conference Call. My name is Stephanie and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will facilitate a question and answer session towards the end of the conference. As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to your host for today's call, Mr. Steve Moran, Executive Vice President, General Counsel of Masimo. Please proceed, sir.

Thank you, Stephanie. Welcome to Masimo's third fiscal quarter earnings release conference call. Our press release was distributed about an hour ago. If you have not seen the release and would like to, a copy is posted on the Investor Relations page of our website at www.masimo.com.

On the call today are Joe Kiani, Masimo's President and Chief Executive Officer, and Mark de Raad, Executive Vice President and Chief Financial Officer. In just a few moments, Joe and Mark will deliver remarks on our results achieved during the 2008 third quarter and general comment regarding our business, including an update of our fiscal 2008 financial guidance. After Joe and Mark offer their comments, there will be a question and answer session in which we will answer as many questions as time permits.

Before we begin, let me remind you that this call may contain forward-looking statements. While these forward-looking statements reflect Masimo's best current judgment, they are subject to risks and uncertainties that could cause our actual results to vary. Risk factors that could cause Masimo's actual results to materially differ from our forecast are discussed in detail in our filings with the Securities and Exchange Commission.

With that, I would like to turn the call over to Joe Kiani, Chairman, President, and CEO.

Thank you, Steve, and thank you ladies and gentlemen for joining us on our third quarter 2008 business update and earnings call. Earlier today, we announced our financial results for our third fiscal quarter. We are happy with the continued adoption of our Masimo SET and Masimo Rainbow SET technology as evidenced by the shipment of an additional 30,700 new drivers into the marketplace either our new Masimo SET or Masimo Rainbow SET Pulse oximeters and Pulse Co-Oximeters and excludes our handheld monitor sales.

In fact, for the first nine-month period ending September 27, 2008, our unit shipment on an annualized basis grew 25% from the total net installed base at the end of December 2007. Given the current challenging economic environment, we are happy by the strength in our third quarter product revenues and in general with our overall financial results, including our reported $0.22 per share earnings, which is well above our expectations.

In addition to our strong third quarter financial results, which Mark will review with you in more detail, the third fiscal quarter also included some very important business and operational milestones, including; one, in September 2008 Masimo received FDA clearance for Noninvasive Total Hemoglobin Adhesive Sensors.

Two, late quarter three 2008 we initiated a limited release of our hemoglobin parameter for our Rainbow platform. As we have explained before, this limited release is not the commercial launch of hemoglobin. We limited the release because, as with the release of other Rainbow parameters, we are able to improve the robustness of the device for the many different conditions in which it is used, based on testing that is done in a limited release [phase].

We also obtained valuable feedback to the adjustments to the way we instruct users on the proper use and operation of our device, given the various models of use our devices are subjected to in the various clinical settings. We still expect to move to commercial release of hemoglobin in early 2009, hopefully in Q1 2009.

Three, more independent and objective studies are demonstrating Masimo PVI to be highly predictive of patient fluid responsiveness as presented at the American Society of Anesthesiologists Conference which was held last week. Four, Shaklee and NIR dismissed all claims against Masimo with prejudice for no consideration.

And five, addition of executives and changes to adjust to our new opportunities. In Q3, Mr. Jon Coleman has joined us as President of International Business. David Goodman has joined as Executive Vice President of Business Development. Rick Fishel, whom has been with us for several years, will be leading our Worldwide OEM business, in addition to his other responsibilities.

And lastly, we have sharpened the focus on our sales management of US acute care sales, as well as physician offices with one promotion and one new hire in leading those two responsibilities.

Now Mark will provide you with a summary of our Q3 2008 financial highlights, including and update of our 2008 guidance. After Mark's review, I would like to spend a few moments updating you on the general business. We will then be happy to answer you questions. Thank you.

Thank you, Joe. Hello, everybody. Please keep in mind that all my comments will relate to financial results on a GAAP basis. As a reminder, in fiscal 2007, prior to our initial public offering, Masimo was required to report GAAP earnings per share under the two-class method. For the benefit our investors, we have included to include in our quarterly earnings releases, as we did today, the non-GAAP 2007 financial statements, with 2007 earnings per share computations, as if the current method had been used in the prior periods.

Earlier today, we reported record total third quarter revenues of $78.1 million, which consisted of record product revenues of $66 million, and royalty revenues of $12.1 million. This represented an approximate 29% increase in year-over-year product revenue growth.

As Joe just alluded to, we shipped 30,700 new pulse oximeters and Pulse Co-Oximeter units into the marketplace and based on these shipments, we now estimate that our total worldwide installed base, net of estimated retirements, to be approximately 540,000 units.

Importantly, this is up 25% from the estimated 448,000 net installed units just one year ago. As many of you know, the shipment of new pulse oximetry units is important because once installed, these units generate future sensor sales which continue to represent the most significant component of our total product solution revenues.

During the third quarter of 2008, in accordance with our revenue recognition policy, we deferred approximately $672,000 of product revenue related to selected long-term sensor purchase agreements and, at the same time, recognized approximately $1.9 million of previously deferred product revenue due to the establishment of vendor-specific objective evidence related to an undelivered element in one of our long-term sensor agreements.

Similarly, in the third quarter of 2007, we also deferred approximately $888,000 of product revenue related to selected long-term sensor agreements, and recognized approximately $2 million due to the delivery of a previously undelivered element in one of our long-term sensor agreements.

Our revenue recognition policy will require that we continue to defer revenue on selected contracts until certain delivery criteria have been met. However, to date, we have been required to recognize deferred revenue for selected contracts in only the third quarters of both 2008 and 2007.

During the third quarter of 2008, we generated approximately $3 million in Rainbow-related product revenues, compared to $1.6 million in the prior year quarter. This represented an approximate 85% increase in year-over-year Rainbow growth.

Of the record $3 million in Rainbow revenues, Rad-57 revenues accounted for approximately $1.6 million, and other Rainbow revenues, including sales of Masimo Rainbow SET MX-1 boards, carbon monoxide, methemoglobin, and PVI totaled approximately $1.4 million. Our Q3 total hemoglobin revenues from our limited release were not significant.

Third quarter 2008 product revenues generated from our direct business, which includes sales through our distributors, totaled $52 million, or 79% of total product revenues while OEM revenues totaled $14 million, or 21% of total product revenues. This compares to approximately 70% and 30%, respectively in the prior year periods, and is the result of our multi-year investment in our expanding worldwide direct sales force, as well as a decline in third quarter 2008 OEM revenues as compared to the same prior year period.

During the third quarter, our US product revenues totaled $50 million, or 76% of total product revenues, compared to $40.5 million, or 79% in the prior year period. The increase from 21% international revenues in the third quarter of 2007 to 24% in the third quarter of 2008 was primarily due to improved shipments into our European region with notable gains in Germany, France, the United Kingdom and, in addition, notable strength in Japan.

Of the three percentage point increase in year-over-year international revenues as a percent of total revenues, approximately one-third of this increase was due to the favorable impact of foreign exchange rates.

Our third quarter royalty and license fee revenues decreased to $12.1 million from $13.3 million in the prior year period, due to the anticipated lower royalty rates associated with our 2006 settlement agreement with Nellcor, now part of Covidien. As a reminder, our settlement agreement with Nellcor included a 15% royalty rate in 2007, and a 13% rate in 2008.

Our total third quarter gross profit margins rose to 66.1% from 63.2% in the same prior year period. The year-over-year increase was due primarily to the beneficial impact of improved manufacturing efficiencies resulting from higher production levels, a lower US dollar, as well as increased Rainbow product sales.

Total gross profit margin for the third quarter increased slightly to 71.3% from 70.8% in the same prior year period, due to the previously noted contributors to higher product gross margins, despite the $1.2 million decline in year-over-year Covidien royalty revenues.

Our third quarter engineering expenses were $6 million, compared to $6.5 million in the same prior year period. The year-over-year decrease was due primarily to approximately $450,000 in capitalized software development expenses, and a one-time $250,000 research and development refund. Excluding these credits, engineering expenses would have been $6.7 million, up slightly from the prior year quarter due to slightly higher stacking levels.

Our third quarter selling, general, and administrative expenses rose to $29.2 million, up from $21.6 million in the prior year period. Higher expenses were a combined result of a $3.8 million increase in payroll, payroll-related, and stock-based compensation expense, consistent with an increase in our SG&A staffing from 350 people at September 2007 to 410 people in September 2008.

In addition, professional fee expenses increased $1.8 million due to higher patent litigation expenses, including the previously noted Shaklee case which, as Joe noted, has been resolved, as well as increased tax, audit, and other professional fees associated with the costs of being a public company, including our ongoing Sarbanes Oxley's compliance activities.

Third quarter 2008 net income before taxes was $20.6 million, increased from $17.5 million in the prior year quarter. This increase is due to the stronger product revenue and gross margin results, despite lower Covidien royalties and higher operating expenses.

Our 2008 third quarter effective tax rate declined to 36.6% from 39.7% in the prior year quarter, due to selected, one-time third quarter adjustments for foreign taxes payable and the cumulative benefit of research and development credits.

In summary, despite the decline of nearly $1.1 million in third quarter 2008 royalty revenues, our strong product revenues, higher product gross margins, and lower than expected operating expenses combined to generate third quarter 2008 net income of $13.1 million or $0.22 per common share, compared to net income of $10.6 million, or $0.16 per common share in the same prior year period.

Now, I would like to make just a few comments on our balance sheet. For the three month period ended September 27, 2008, total cash increased to $122.6 million from $96.7 million at December 2007. During the nine months ending September 27, 2008 we have generated $52.6 million in cash from operations, and approximately $10.9 million in cash from the tax benefit and cash associated with the exercise of stock options.

These sources of cash were partially offset by the repayment of approximately $30.3 million in debt, about $27 million in the first quarter of 2008, and $5.3 million in capital equipment purchases. As of September 27, 2008, our day sales outstanding have declined to 41 from 44 as of December 2007.

During the same periods, our inventory turns have declined to 3.1 from 3.5 at the end of 2007. The slight decline is the result of our stated intention of insuring that our inventory levels are always sufficient to meet our customers' demands, as well as building inventory related to new product introductions.

Now, I would like to make just a few comments on our updated 2008 financial guidance. On our July 2008 earnings call we updated our Fiscal 2008 financial guidance to indicate that we expected our 2008 product revenues to increase to approximately $253 million and total revenues, including royalties, to be approximately $300 million. We also indicated that we expected our earnings per common share to be approximately $0.64 per share, up from the prior guidance of $0.52.

Based on our third quarter financial results, and the information available to us as of today, we are updating our guidance for the remainder of 2008. We now expect our 2008 product revenues to be $256 million and total revenues, including royalties, to be approximately $303 million.

We now also expect our earnings per common share to be approximately $0.71 from share, up from the prior guidance of $0.64 per share. To reiterate, while we believe this guidance to be appropriate, these are projections and our actual performance could be different.

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

Thank you, Mark. As a reminder, and especially for any new investors, or potential investors that may be on this call, I want to reiterate a couple of important messages regarding Masimo and our position within this marketplace, both today and in the future.

Number one, in 1996, we revolutionized noninvasive patient monitoring with our measure through motion and low perfusion Masimo SET pulse oximetry technology. Today Masimo SET is helping caring clinicians save numerous lives and eyes, and Masimo SET is considered the gold standard for pulse oximetry.

Number two, our market share for new pulse oximetry sales are noticeably higher than our market share of pulse oximetry revenues. This is due to the time it takes to have the installed base of pulse oximeters catch up with the annual rate of pulse oximetry shipments. Within five years, due to the accumulation of installed base, our revenue market share should start approaching our annual shipment percentages.

Number three, we have revolutionized noninvasive patient monitoring again with Rainbow SET. Masimo Rainbow SET allows clinicians and emergency professions to measure carbon monoxide, methemoglobin, PVI, and now hemoglobin and oxygen content continuously and noninvasively for the first time along with oxygen saturation, pulse rate, and perfusion index, which are considered the gold standard in the pulse oximetry marketplace.

Number four, analysts have projected that noninvasive hemoglobin, which we refer to as SpHb, will be a $1 billion or higher market, bringing Masimo's total potential market opportunities to between $3 billion and $4 billion. But, Rainbow is exciting beyond what it will do for us in terms of growth. With it, we hope to help caring clinicians save and improve the lives of even more people.

But, as I explained, we are currently in a limited release state with SpHb. The response to SpHb has been encouraging, to say the least. We hope to release SpHb commercially in early 2009. And, with that said, I want to end my talk with a couple of closing thoughts.

Our clinical contribution and business model has allowed us to build a solid business with our breakthrough measure-through-motion pulse oximetry, with room to grow as we bridge the gap between our new pulse oximetry shipments and the installed base, which drives our sense of sales, which makes up loss of our revenue.

We expect Rainbow SET Pulse Co-Oximetry to have a great impact on patient care and our growth, however, as I have stated before, the timing of when we will be in the steep part of the growth curve with any new technology introduction in the patient monitoring field, let alone medical field, is hard to predict.

The market conditions are rough and we are hearing that hospital census may be down, but you can be assured that we will continue to focus on our mission in improving patient care, and reducing cost of care by taking noninvasive monitoring to new sites and applications regardless of market condition.

We run our business with a long term horizon outlook. We have a great innovation engine, and we are eager to solve more of the remaining problems [in the] clinicians and care provided space.

And, before I turn it back to the moderator so that we can start taking your questions, I just would like you to know of one thing that we have been discussing, but I think it is time to implement, which is that we will not be accepting any calls from our investors and analysts after the end of a fiscal quarter, and prior to the quarterly earnings release.

We just think that period is a no-man's land period, and we are better off waiting to this call. And after this call, we will be happy to obviously take calls from our dedicated shareholders and analysts.

So, with that, back to Stephanie, please.

(Operator Instructions)

Your first question comes from the line of Bill Quirk with Piper Jaffray.

Thanks. Good afternoon, and a great quarter, guys.

Thanks.

Joe, first off, thanks for the updated color on total hemoglobin. Is there any feedback from the early-access users that you can share with us at this point?

Well, yes, the feedback has been positive. We obviously have also run to some issues where we -- had been expecting, but overall I can say that the limited release has gone well and has met our expectations.

Joe, it sounds from your earlier comment that we should maybe expect a release kind of tail end of the first quarter -- maybe early second quarter. Anything in particular for the more cautious language, or is this just kind of everything as expected? I know you guys had obviously expected to do, to make any tweaks, if necessary, as they came up?

No, this is just, I think, more of the same in that we have seen this limited release go as expected. And we expect both from things we have planned to do before our commercial launch, as well as feedback we have gathered from our customers in the limited release phase. We are going to take that feedback as well and add them all together and, hopefully, in early 2009 do a commercial launch.

Okay, very good. A couple of questions for Mark. Mark, really strong operating margin performance. If you exclude the royalty, frankly it looks like you doubled it sequentially. Were there any one-time items in SG&A, or are we just starting to see the leverage from the sales force ads in 2007 and first part 2008?

Well, Bill, the two items I mentioned in engineering were one-time items that impacted SG&A in the aggregate, but specifically, in that category, no, there is nothing unique. I think the one thing that we did not do as we had initially expected was the rate of hiring during the quarter. And so, that fact that we did not bring in as many people had a contributing impact on the overall, lower than expected G&A expenses.

Okay, got it. So nothing lower than the two items that you mentioned in engineering.

Correct.

Okay, great. And, then, last question from me and I will let somebody else jump on here. In terms of the tax rates, will you expect that to go back to about 39% in fourth quarter?

From what we can see now, yes. That would be right. That is why I noted that they were one-time, true up adjustments in the third quarter.

Perfect, thank you.

Thank you.

Thank you, Bill.

Your next question comes from the line of Sara Michelmore with Cowen and Company.

Good afternoon.

Hi, Sara.

I guess, just a couple of questions. Joe, as you have kind of gone through this pre-launch activity, what are your latest thoughts in terms of pricing of the total hemoglobin product? And what type of data have you kind of looked at, or put in front of the customers in terms of trying to have discussions with them about pricing? Thanks.

Sure. Sure. Well, first of all, there has been no change in our pricing thoughts. As I think you guys know, even though this is kind of an extension of our development phase -- limited released, the limited release customers have been paying customers. So nothing really has happened yet on the limited release front, nor are contact with our customers, who led us to believe that we need to change our pricing that we shared with you on the last earnings call.

Okay. And could you give us just a quick progress report, Joe, on the hemoglobin and CO? I know that they are secondary to the total hemoglobin opportunity, but just give a sense of where you are with those products, and actually throw in PVI while you are at too. Thanks.

Sure. As Mark, I think, you mentioned, and we had it in our press release. We had a really good Rainbow quarter. We grew, I believe, 85% compared to the same quarter last year. A lot of that actually was from sale of CO, methemoglobin, and PVI to the acute care market, not just the EMS market.

So, we are happy to see the traction that these measurements are having in the hospitals. Obviously, as you can imagine, then maybe we have parlayed, that the hemoglobin excitement is lower, but CO, and Met, and PVI are doing a great job, kind of coming up on that S-curve that I have mentioned several quarters now.

Okay. And lastly, a question for Mark. Mark, you had talked a little bit about the impact of foreign exchange on the P&L this quarter with the rates kind of going a different direct here. Can you just talk us through any considerations in terms of how a little stronger dollar affects the P&L? Thanks.

Sure. We are actually uniquely situated in the sense that the foreign exchange exposure that we have on our revenue line is essentially offset by the same exposure on our operating expense line. So, in reality, what we gain or lose on the revenue line, we offset on the operating expense line, in general.

This particular quarter, obviously the last four to six weeks have been significantly volatile in the foreign exchange marketplace. The strengthening of the US dollar against the euro would, in most cases, result in a negative impact on our revenues. However, the corresponding strength of the yen against the dollar in this particular case is going to, in a sense, act as a natural hedge for us as long as those kind of movements and rates continue for the rest of this quarter.

So, the summary is that we are actually, despite not having any active hedging strategy in place, our core business is essentially hedged from an operating income standpoint basis.

Thanks.

Okay.

Your next question comes from the line of Matthew Dodds with Citigroup.

Good afternoon, a couple of questions. Joe, first, when you look at the potential for slow down in CapEx in the hospitals, because with your long term contracts, do you feel you get lumped into CapEx decisions outside of major renovations, or building on the smaller scale for your direct placement? That is one. And then, for Mark, on Rad-57, is it too early to say that was off a little bit potentially because also of economic exposure?

Yes, let me take your first question. Is this Matt, or is it Greg?

No, it is Matt this time, Joe.

Ooh, I am honored, Matt. Hi, Matt.

I would not go that far.

But, to answer your question, no, the CapEx issue does not at all -- or, has not to date, I should say, affect the hospital contracts that we sign up since all of that comes from the operating business of the hospitals. And you wanted Mark to answer the second question?

Sure.

Yes, and I think Matthew, the answer to your question on the Rad-57, in the sense that it was a little bit low where we were last quarter, I think is certainly, on the one hand, related to the economic environment. Our sales organization that on occasion they are running into situations where budgets have been impacted.

However, more importantly, what we know is that the summer quarter for this product has traditionally been the lightest quarter for us. And, having said that, we are already beginning to see some very encouraging signs for Q4. So those are the two primary reasons for the quarter-over-quarter reduction in Rad-57 revenues.

Great, thanks, Mark. Thanks, Joe.

Thank you, Matt.

(Operator Instructions)

Your next question comes from the line of Philip Legendy with Thomas Weisel Partners.

Good afternoon, gentlemen.

Hello, Phil.

Hi, Phil.

I would like to drill down on the hemoglobin sensor. I am sure you are not surprised. You mentioned that the final version of the sensor will incorporate some improvements over the beta version. Maybe you could lay out for us sort of specifically what you are focused on in those improvements.

Well, I cannot get into all of the technical details for good reasons, but I can tell you that the product that we think is commercially viable from a Masimo perspective, is not what is being trialed today at limited police accounts. They have known that, yet they were anxious to get their hands on it and to assist us with the refinements before we launch it.

I think, you know, in your report, you had mentioned that we were expecting to go from a perfusion limit of about 0.5 to 0.25. That is correct. However, I think in your report you had reported when you were doing the non-scientific observation, that you noticed about 20% of the time -- let me just make sure I get it right, that basically you said, our anecdotal experience based on watching, not counting many times this number of customers testing the product over two days is that roughly 20% had a perfusion index reading too low to generate a hemoglobin signal.

As we discussed, obviously you do not mean by that that we did not pick up, but rather, then those times where perfusion were one or less, and -- our sales rep, I think I told you that when perfusion was one or less, you might get a low constant message.

I do not know if I answered your question, but I think -- maybe just one thing I will share with you, although the perfusion became an issue of discussion, the first pulse oximeters ever launched were in 1980s -- maybe 1981, 1982, 1983 time frame, their perfusion limit actually is the same as what we have in this limited release beta phase. And it was not until about 10 years later, maybe even 15 years later, that their perfusion limit improved to about the same amount that ours will be when we launch it actually commercially for the first time.

So, obviously our -- I guess, expectation of what a product should do is different than what successful products in the marketplace have done. We hold ourselves to a higher measure, but I hope that answers your question.

That is helpful and, yes, that is true. We had a little bit of a glitch in the text there. It should have been below a limit of one, and no signal. Wonder if you could lay out for us as well the strategy of how you are going to physically get the hemoglobin sensors into sites that do not already have Rainbow-ready hardware? Is it going to be an adapter, or a box on top of a box, or -- just logistically how will that work?

Well, Phil, the places that today have Radicals, or Radical-7, we will probably replace those with a new Radical-7. The places that -- it depends on the vintage, by the way -- sometimes we will be able to just do a software upgrade. If it is Radical, we will have do a replacement, if it is Radical-7, we can do a software upgrade.

The places that do not have any Masimo devices at all, we will have to place a brand new Radical-7. And as I mentioned in our previous calls, we have not seen a pattern where one of our customers had a software upgradeable device or not, we are not seeing that to be a driving factor of interest for hemoglobin.

I guess what I am focusing on is for those customers who have -- who use Masimo as part of a larger monitoring unit, who have an OEM system, how will those -- how will you make that --. That is about 80%, I believe, of the installed base. How will you be making hemoglobin available to that hardware infrastructure?

I see. I see. Thank you. I understand your question better now. Phil, we have two excellent distribution channels. One of them is our direct distribution channel, which includes our distribution -- our distributor network. The other is our OEM, and we pride ourselves on both. We have seen interest of all of our OEMs.

I don't think I am exaggerating, but I think of all of our OEMs, a keen interest of having Rainbow, of having hemoglobin, and we have today signed up over ten companies that are going to be providing that. We are in negotiation with all the rest.

However, I believe that, unlike pulse oximetry, which not having it as an OEM option, meaning inside other companies products, was a detriment that was significant to the adoption of our SET SpO2 technology. I do not believe that is the case with Rainbow. So, until we do sign up with OEM companies, which we hope to, and intend to as long as we get commercially good terms that we think is fair, given the value we are bringing in, until then, we are going to be offering Radical-7.

It has a very flexible way of mounting other equipment to make it seem like it is part of the overall system in the OR, or the ICU, as well as it has very flexible connectivity that allows it to share the data that it has to the systems that it needs to share it with.

Okay, that is helpful. And, then last question. I guess either Mark or Joe, would you remind us how the arrangement with Masimo Labs affects the economics of the Hemoglobin sensor to Masimo -- mother Masimo, if you will?

Would you?

Sure. You mean from a financial statement standpoint, Phil?

Or perhaps -- not necessarily from a technical accounting perspective, but what it the royalty? I think there is a sliding scale, just kind of how does that work?

Sure. Well, if we go back to the beginning, in 2006 the royalty rate -- well the royalty rate exists between Masimo Labs and Masimo Corp. at about 10% of the value of Rainbow technology that is sold by Masimo Corp. So, that is a royalty that is in essence paid back to Masimo Labs, and that royalty rate is subject to certain minimum royalty commitments in each year. And for the first couple years, we have been operating at the minimum royalty rate level.

Okay. And that hemoglobin will fall directly under that same kind of arrangement?

Correct.

Same type of arrangement? Okay.

Yes.

Thanks.

Thank you, Phil.

Your next question comes from the line of Tao Levy with Deutsche Bank.

Hi, good afternoon.

Hello, Tao.

Hey, can you hear me okay?

Yes, we can hear fine.

Okay, good, thank you. A couple of questions on my end. Joe, you have done the limited release of hemoglobin now for the past few weeks and maybe you could give us a sense of how that launch is going with some specific -- what are your doctors seeing that they have not been able to see before?

Have there been any, sort of maybe just anecdotal evidence of better patient care? And, also, anything that can give you, at least us, some clues as to how the uptake of hemoglobin is going to pan out once you launch it, based on what you have seen in the limited release so far?

Okay, sure. First of all, the anecdotal response has been that overall it has been clinically very valuable. We have some people get very excited and in fact, in one of our accounts in Sri Lanka, there is whole press about it, and the Prime Minister has gotten involved in it. So, it is exciting.

To-date, we have only filled about the half the orders that we have received for hemoglobin and we intend to, over the next couple of months, to expand our limited release, as we have mentioned. So, we were planning to do ten to 20 hospitals, and my expectation is that will be what we will do during the limited release phase.

There is a possibility we might expand that up to 50 hospitals, but it is just going to depend on kind of the timing between when we are feeling good enough to [get ready] for commercial launch, versus how we feel about further expansion into hospitals without the commercial product.

And when you talk about limited release, is the hospital free to order as many as long you are part of one the selected hospitals, or even within those hospitals, do they only get a small percentage of what they would like to have?

Good question. Once a hospital is a limited release hospital, we allow them to order as many as they want. The reason we are kind of keeping it tighter in terms of number of hospitals, because we want Masimo personnel to be there so that we can firsthand observe the usage of the product, as well as get immediate feedback of any issues so that it can be addressed in the upcoming release of new software and sensors that we expect to be the commercial product.

And right now, you are currently just -- I think the one that is out there is the reusable version -- when do you expect to have the disposable, sort of out there in the marketplace? And is that going to be, are you going to do a limited release of that version, of that device as well?

Yes, we expect to do a limited release of that version as well. The adhesive sensor should be available to our limited release accounts in this quarter.

Great, thanks. And then just a final question for Mark. On the tax rate, I think since your prior question you talked about the tax rate going back up in the fourth quarter. I thought it would have gone down with the R&D tax credit being passed. And also, I assume in your guidance, and I do not know what type of sales you might see, but I think you have an extra selling week in the fourth quarter. And how should we think about that as it relates to your business?

Sure, as I said earlier, there were a couple -- there are actually three specific items that helped drive down the effective tax rate in the third quarter and that is why I suggested to Bill earlier that our best estimate is it is going to climb back to about the 38% to 39% level in the fourth quarter, which to your point, is still down from a year ago and it would be down because of what you mentioned, the finalization of the R&D tax credit. So we will still see a benefit of that in the fourth quarter relative to the year-ago quarter, but it will be up a little bit, most likely from the third quarter.

In terms of the -- I'm sorry, the second question --?

The extra selling week, because --

Well, yes, the irony of that is if you actually look at the number of shipping days in the quarter, while on the calendar there is actually an extra day, the number of shipping days for us actually comes to about one extra shipping day over the prior year, so we do not expect that to have a dramatic impact on year-over-year numbers.

Okay, great. Thanks a lot.

Okay.

Thanks, Tao.

Your next question comes from the line of Joanne Wuensch with BMO Capital Markets.

Hello.

Hello.

Thank you very much for taking my question. Can we get into gross margins, which improved considerably year-over-year? Is there something in particular which helped the product line in the third quarter? And should we think of this as sort of base case going forward rate?

Hi, Joanne. The answer is there are really multiple elements that impacted the strong gross margin performance. But the ones that I mentioned before, primarily the efficiencies that we are seeing from higher volume levels, obviously there is a certain element in our COGS structure that is fixed, and so clearly as revenues continue to accelerate, we are seeing that benefit of those fixed expenses drop to the bottom line, so that component certainly should continue.

The other element that I mentioned before, was that we did have, again, courtesy of exchange rate movement. We have actually had a bit more positive impact on a year-over-year basis in terms of the gross margin because, of course, the revenues are more valuable in US dollar terms against a fixed US dollar cost structure.

So, we had a little bit of benefit of that in the third quarter. And then the last element was, yes, just the increase of Rainbow revenues that Joe alluded to before. The fact that nearly half of our Rainbow revenues this quarter were from what I would call non-traditional Rainbows for us.

Traditionally it has been the Rad-57, which of course is a handheld device that has a more normal margin structure to it versus, of course, the introduction now of many of the Rainbow parameters including Met, CO, and PVI, and of course those are primarily software-like margins for us. So, the fact that that increased dramatically this quarter was another element that contributed to the higher margins.

Okay. When I think about next -- after hemoglobin, acoustic respiratory monitoring, could you give us an update with that technology iteration?

Hi, Joanne -- Joe. Yes, acoustic respiration monitoring. The plans have not changed. We hope to make that product available on a limited release to our customers in Q3 2009.

And then a final question, and this may just be a knowledge gap for me, which is when I take a look at the pulse oximetry units which are retired in the quarter, they are relatively flat with the previous quarter, but down about 16% year-over-year. Is there a pattern to those being retired and taken off the shelves?

Not really, Joanne. We actually track our shipments back seven years. And so what you are seeing, in effect, every quarter is the retirement of what was shipped seven years ago. So obviously seven years ago there was some fluctuation in our quarterly driver shipment, and so you are just essentially seeing that unwind now.

But, I think I am safe in saying that the average rate of actual units that have fallen off each quarter are probably -- if you are in the 5,000 to 6,000 per quarter range, you are probably in about the right zone, and most of our historical data suggests that that is about where we will. Sometimes a little bit lower, maybe about as low as 4.5 or so, and sometimes maybe as high as 6.5, but that is the range of retirements that we see.

Okay, very helpful. Thank you.

Okay.

Your next question comes from the line of Spencer Nam with Summer Street.

Thanks for taking my questions. I just have a couple of quick questions. These limited launch sites -- are they paying for the hemoglobin tests right now?

Yes, they are.

And, do we have pricing information on that?

Yes, we provided that last conference call, but basically the software is sold, at this point, a limited release. It could be between $2,000 to $8,000, but my estimate is that these customers are getting between $4,000 to $8,000, given the volume. And given that at this point we are only selling Rainbow reusable sensors, not the adhesives, I believe that those are selling for about $1,000 each. So, I hope that helps.

Great. It is helpful. And can we assume that once the national launch takes place for the hemoglobin test, that these initial sites would be customers?

Oh, yes, I think so. These are customers --

They have signed up -- they have basically signed up to be full time customers?

Oh, yes, yes, this is not just a temporary customer site. These are regular customers that are willing to be part of our last phase of product development before we launch.

Okay. And then, just moving on the guidance, a couple of questions. Maybe I missed it on this. You raised the EPS guidance for the rest of the year. What is driving that?

I think it's -- well it is a combination number one, of our confidence in looking forward at our fourth quarter revenues. And as I alluded to earlier, we surprised ourselves actually with the level of operating expenses this quarter. And so, while we expect the usual significant increases as we head into the fourth quarter in terms of operating expenses, we are going to be starting at a lower base. So the combination of those two factors really gave us the opportunity to adjust that guidance upward.

Great. And then, if I remember from the beginning of the year -- the way that the management was guiding, or the -- explained the guidance was that you would make one update on the guidance. And unless there is a substantial reason to update the guidance, you would not make any updates during the year.

And then, we have seen a guidance update last quarter, which I think was appropriate, but we have also are seeing one this quarter. In terms of revenue line, which is somewhat minor it appears to be, $3 million, which is material but not significant, I was just wondering whether we should expect sort of quarterly updates on guidance for upcoming quarter, or the upcoming year. Or, whether this should be considered as a sort of a standard -- the operating procedure for you guys?

Well, Spencer, I think the answer to that frankly is it all depends, and clearly in this quarter, with only one quarter left in the year, and the fact that we had a very strong third quarter, put us in a position where obviously if we did not change our guidance, the implications would have been that we expected a very, or a less robust fourth quarter, which certainly we don't.

So, given that situation, we thought it was more prudent for us to come out and update to avoid any perception that the fourth quarter might be down from the third quarter, and so that is why we came out with that guidance. But, philosophically we have not changed our position, and that is that we will come out with one guidance for the entire year.

Obviously that typically occurs at the start of the year, and at the start of the year there is a little bit more time for events to occur throughout the year. As we head towards the fourth quarter that window is dramatically reduced. And so, I think we will continue to stick to the basic premise of annual guidance, but when appropriate, and when we feel we need to, we will make an update.

Great. Thank you very much.

Your next question is a follow-up from Bill Quirk from Piper Jaffray.

Thanks, guys. Say, Mark, just a real quick housekeeping question. Can you tell us what the CapEx expense, as well as the depreciation and amortization were?

In just the quarter?

Yes, please, in just the third quarter.

Well, I do not know if I have that right handy, Bill. Why don't I -- can I get back to you on that?

That's fine.

Okay.

Thanks.

I think maybe we have time for one more question.

(Operator Instructions)

And if there are no other questions, then we are going to say goodbye, and we look forward to our next call in 2009. Thank you so much, all, for joining us today.

At this time there is no further question.

Thank you. Bye-bye.

This concludes today's conference. You may now disconnect.