Masimo Corp (MASI) 2009 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Masimo Corporation Second Quarter 2009 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions)

Thank you. I would now like to turn the call over to your host for today, Mr. Steve Moran, Executive Vice President and General Counsel of Masimo.

Thank you, Christina. I would like to welcome you to Masimo's Second Fiscal Quarter 2009 Earnings Release Conference Call. Our press release was distributed about 30 minutes 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 Chairman and Chief Executive Officer, and Mark De Raad, Executive Vice President Finance and Chief Financial Officer. In just a few moments, Joe and Mark will deliver remarks on our financial results for the 2009 second fiscal quarter, general comments regarding our business, and an update to our 2009 financial guidance. After Joe and Mark offer their comments, there will be a question-and-answer session in which they 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'd like to turn the call over to Joe Kiani, Chairman and CEO.

Thank you, Steve, and thank you, ladies and gentlemen, for joining us today. Prior to this quarter, we had witnessed strong sequential product revenue growth despite an economy that began to decline significantly in the summer and fall of 2008. The impact of the recession and its impact on our customers materialized in the second quarter.

As we had highlighted in our earlier calls this year, we were particularly concerned over our OEM partners' larger ticket multi-parameter devices sales. In Q2, we generated only $12.5 million in OEM revenues, which was down from $13.8 million in the same prior-year period and down from $15 million in the immediately-prior Q1 2009 period. It's important to note, however, that we believe our OEM market share for new pulse oximeters did not decline in Q2.

In addition to the Q2 weakness in our OEM channel, we also saw some softness in our direct US business in Q2 due to what we now believe was the balancing of inventory from Q1 to Q2. We believe the sequential decline between Q1 and Q2 was due to the end user customers reducing their higher than normal inventory in Q1 and being more cautious with carrying inventory in Q2, as well as customers benefitting from our industry-leading durable reusable sensors and patient cables introduced over a year ago and lower capital purchases.

Yet, despite what is the worst recession since the Great Depression, we had a good quarter. While total worldwide product revenues were down quarter-over-quarter, they grew at 13% year-over-year and direct end user business grew 20% year-over-year thanks to continued strong Masimo SET growth and even stronger Masimo Rainbow SET growth. These results underline both the power of our business model and the power of our innovation in noninvasive monitoring, which is helping our customers improve and automate patient care.

We are also happy to report that we continue to place new Masimo Set and Masimo Rainbow SET monitors at a pace consistent with our norm, despite the macroeconomic pressures and healthcare reform discussions in the US, which has caused some healthcare providers to pause some purchases and investments.

We shipped over 27,000 new drivers into the market. We had a nice increase in our international direct monitor placements, which helped offset the lower OEM [board] placements. We expect that these placements, as usual, will contribute to further revenue growth.

Also, we were encouraged by our second quarter Rainbow revenues, which rose to $4.5 million from $2.9 million in the prior-year quarter. This increase was due to Rad-57 handheld pulse co-oximetry devices and growth in all our Rainbow parameter revenues, including our recently released continuous noninvasive hemoglobin measurement. We believe that we have seen the low point in product revenues for 2009 and based on our updated projections, we expect both Q3 and Q4 product revenues to rise sequentially.

Next, Mark will provide you with a more detailed summary of our Q2 2009 financial results. After Mark's review, I would like to share with you some important recent milestone events during the second quarter. We will then be happy to answer your questions. Mark?

Thank you, Joe. Hello and good afternoon, everybody. Earlier today we reported total second quarter revenues of $83.6 million, which consisted of product revenues of $70 million and royalty revenues of approximately $13.5 million. This represented a 13% increase in year-over-year quarterly total product revenue growth.

In the second fiscal quarter, as Joe just noted, we shipped 27,100 new pulse oximeters and pulse co-oximeter monitors into the marketplace. And based on these shipments, we now estimate that our total worldwide installed base, net of estimated retirements, to be at least 605,000 drivers, up from 515,000, or about 18%, from just one year ago.

The year-over-year growth in product revenues came primarily from Masimo's SET revenues, which rose to $65.5 million in the Q2 2009 quarter, up from $59.2 million in the same prior-year period. This increase is the result of our continued expansion of Masimo SET technology into new hospitals.

During the second quarter of 2009, Rainbow revenues totaled $4.5 million, up from $2.9 million in the comparable prior-year quarter and from $3.1 million in the immediately preceding quarter, a growth of 56% over the prior-year period. This increase was due primarily to Rad-57 handheld pulse co-oximetry devices and growth in all our Rainbow parameter revenues including our recently released continuous noninvasive hemoglobin measurement.

Second quarter 2009 product revenues generated from our direct business, which includes sales through our Just In Time Distributors, totaled $57.5 million, or 82% of total product revenues, while OEM revenues totaled $12.5 million, or 18% of total product revenues. This compares to $48 million, or 77%, in our direct and distributor channel while OEM revenues totaled $14.1 million, or 23%, in the same prior-year period. This decline in OEM as a percent of total revenues is due primarily, as Joe noted, to our lower OEM revenues resulting from the economic pressures that our OEM partners are experiencing.

During the second quarter, our US product revenues totaled $51.2 million, or 73% of total product revenues, compared to $45.4 million, or 73%, in the prior-year period. As a result, international product revenues as a percentage of total product revenue remained flat at approximately 27% for both the current and prior-year period. Year-over-year second quarter OUS revenues grew by 19%, although on a current currency rate basis they grew 24%.

Our 2009 second quarter royalty revenue increased to $13.5 million from $12.7 million in the prior-year period. This increase was primarily due to the higher than anticipated Covidien Nellcor royalty payments related to the January through March 2009 reporting period.

Our 2009 second quarter product gross profit margins rose to 66.3% from 65.5% in the same prior-year period. The year-over-year increase was due primarily to the beneficial impact of higher sensor and Rainbow revenues as well as continued improvements in manufacturing efficiencies.

Adjusted for the impact of foreign exchange rates, our Q2 margins would have been 66.6%. Total gross profit margin, including royalties, for the 2009 second quarter rose to 71.8% from 71.4% in the same prior-year period, primarily due to the higher year-over-year royalties. And adjusted for foreign exchange rates, the second quarter total gross profit margins would have been 72%.

Our second quarter engineering expenses were $7.3 million, up 21.3% compared to $6 million in the same prior-year period. The year-over-year increase was due primarily to increases in payroll and payroll-related costs associated with increased research and development staffing levels and engineering supplies expense.

Our 2009 second quarter selling, general, and administrative expenses rose to $32.8 million, up approximately 7.9% from $30.4 million in the prior-year period. Higher expenses were due primarily to the combined result of $2 million in increased payroll, payroll-related, and stock-based compensation costs consistent with an increase in worldwide selling, general, and administrative staffing.

Our 2009 first quarter effective tax rate declined to 34.8% from 39% due to the beneficial impact of our new international structure and lower overall tax rates on our foreign-source revenues. This increase in the effective tax rate was due primarily to the increase in anticipated income in jurisdictions in which we do business with lower effective tax rates. I would like to point out that the 34.8% rate is higher than the 33% from the prior quarter and this was the result of our new expectations for both our international and operating income organization for the rest of 2009.

Weighted average shares outstanding for the second quarter of 2009 were 60,184,802 and 60,050,622 for the same prior-year period. In summary, the combination of our 13% year-over-year increase in total product revenues, higher royalties, higher gross profit margins, increased operating expenses, and a lower effective tax rate, combine to generate Q2 operating profit of $19.9 million, compared to $16.7 million in the same prior-year period. As a result, our Q2 2009 earnings per share were $0.22 versus $0.18 in the prior-year period, an increase of 22%.

Now I'd like to make just a few comments on our balance sheet. At July 4, 2009, total cash increased to $156.6 million, up from $146.9 million at January 3, 2009. During the six months ended July 4, 2009, we generated $11.1 million in cash from operations, including $11 million in tax payments related to our international reorganization and approximately $2.4 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 purchases of approximately $2 million in capital equipment.

In today's earnings release, we have now included the Company's statement of cash flows, which should provide you with any additional non-cash-related expense data. So as a result, I'll avoid repeating that here.

At July 4, 2009, our days sales outstanding were 50, up from 40 on January 3, 2009, while our inventory turns remain relatively flat at 3.2 as of July 4, 2009, compared to 3.3 as of January 3, 2009.

Now I'd like to make just a few comments on our updated financial guidance for the remainder of fiscal 2009. While we are maintaining our EPS guidance in the range of $0.83 to $0.87 per share, based upon our second quarter product revenues and our expectation for stabilized but continued economic challenges throughout the remainder of 2009, our new 2009 product revenue guidance is $295 million to $300 million.

Included in these new product revenue ranges, we now expect our full year 2009 Rainbow revenues to be between $16 million to $18 million. As a result of the higher than expected Q1 royalties, we are narrowing our 2009 royalty revenue forecast to $44 million to $46 million. We are also updating our effective tax rate guidance to approximately 34%, based upon our current expectations for the mix of our future US and international revenue and profitability streams.

Thank you for your time. I'd like to turn the call back to Joe.

Thank you. This was the first quarter in more than five years that we didn't see sequential product revenue growth. However, as I noted before, our direct product revenue grew by 20% and our total product revenue grew by 13%. During the second quarter, we continued to invest in the growth of our sales force and research and development team. We intend to continue to invest in these areas in order to deliver growth in our core and emerging businesses, especially when the market rebounds.

The good news is that we believe that we have seen the low point for 2009 and based on our updated projections, we expect both Q3 and Q4 product revenues to rise sequentially. An encouraging sign is that we are seeing more activity and excitement around our suite of revolutionary noninvasive measurements. Our gold standard pulse oximetry and the recently launched hemoglobin, SpHb, as well as PVI, SpCO and SpMet.

Our pipeline for SpHb, or noninvasive continuous hemoglobin business, has growth nearly twofold to over 500 hospitals being quoted, but an average of five hemoglobin licenses per site, but not all are capital sales. We now have three different ways we provide these hemoglobin licenses -- through capital purchases, through the 90-day loan with increased sensor price, and through the hospital-wide conversions with hemoglobin licenses.

Just recently, we announced FDA clearance of our Rainbow Resposable Sensor, which can reduce the cost of pulse co-oximetry and, specifically, noninvasive hemoglobin monitoring by 50%. In addition to lower cost, we believe the new Resposable Sensor will resonate with hospitals that are trying to be environmentally conscious or green.

Just to remind you, we believe the market for SpHb, noninvasive hemoglobin, will be as big as pulse oximetry, if not bigger, even if all our customers were to use the new Resposable Sensor. We believe SpHb may help clinicians manage blood transfusions much better due to its ability to show trends of hemoglobin continuously.

In fact, two new independent clinical studies released in the second quarter -- one conducted in patients undergoing general surgery and published in the Journal of American College of Surgeons, and another conducted in a patient undergoing cardiac surgery and published in the Anesthesia and Analgesia Journal -- added to a growing body of evidence that suggests more restrictive blood transfusion practices could improve patient outcome.

These studies concluded that transfusions and their associated risks could be largely avoided through implementation of better blood management techniques and more appropriate indicators for transfusion. And commenting on these studies, Dr. Aryeh Shander, Clinical Professor of Anesthesiology, Medicine, and Surgery at Mt. Sinai School of Medicine in New York, said, "Continuous and noninvasive hemoglobin monitoring has the potential to greatly improve clinical decision making and reduce patient exposures to allergenic transfusion, reduce complication, preserve the precious resource, and reduce cost.

Moving on to our other measurements -- PVI. Three new independent studies demonstrating the clinical accuracy and utility of Masimo PVI as a noninvasive and continuous measure of patient's flow status and responsiveness, were presented at the European Society of Anesthesiology Annual Congress in June in Milan.

These studies conducted at leading medical schools in Japan are important because they confirm what previous results have shown -- that PVI's accuracy at predicting fluid responsiveness is better than traditional measurements and similar to the newer invasive monitoring technique at fraction of the cost and complexity.

We believe that because PVI is noninvasive and is available from the same sensor used at Masimo SET or Masimo Rainbow SET devices, it has a strong potential to expand and improve fluid monitoring and management in patients who would otherwise not be monitored with the newer invasive techniques.

As for general care floors, Patient SafetyNet System. We have seen consistent growth since the introduction of our Masimo Patient SafetyNet System in the fourth quarter of 2007. Masimo Patient SafetyNet includes gold standard Masimo SET pulse oximetry and pulse co-oximetry devices, which dramatically reduce false alarms at the bedside, with direct communication to Masimo RadNet, a wireless monitoring and clinician notification system with industry-leading product features.

Compared to quarter two 2008 and the second quarter of 2009, we sold four times more new PSN customers covering eight times more general care floors. We believe Masimo Patient SafetyNet growth is due to more and more customers recognizing the urgent need for general floor monitoring and value of Masimo's Patient SafetyNet Systems as outlined in the Dartmouth-Hitchcock Study, which showed a 70% decrease in distress code and rapid response team activation, 50% decrease in patient transfers to ICU, for a total of 163 ICU days saved annually. So one of the other interesting points is that earlier doctors of Masimo's Patient SafetyNet System are becoming a repeat customer as they're expanding into other floors.

Also in June, we launched our new compact, lightweight Rad-8 Masimo SET pulse oximeter at the 23rd annual meeting of the Associated Professional Sleep Society in Seattle. Newly redesigned with greater clinical efficiency and the alternate care setting in mind, the new Masimo Rad-8 has a streamlined look and a host of easy-to-use special features that enable sleep clinicians to more effectively and efficiently monitor, diagnose, and care for patients with sleep disorders.

Turning to this hemoglobin monitoring. A new, independent clinical study funded by the National Institute of Health and presented at the American Thoracic Society in May, shows that the noninvasive measurement of carboxyhemoglobin, SpCO, and methemoglobin, SpMet, with Masimo Rainbow SET pulse co-oximetry is accurate and may help clinicians better detect hypoxemia, a potentially life-threatening lack of oxygen in the blood in children with sickle cell disease.

And finally, on new products -- ARM, Acoustic Respiration Monitoring. We have made good progress in the development of our ARM. In the second quarter, we submitted ARM for FDA clearance. We expect to begin beta site testing of ARM in the second half of 2009 and depending on the results and FDA clearance timing, we expect to begin limited market release late Q4 and commercially launch ARM in the first half of 2009.

So despite the current challenging environment, we remain optimistic about our future, the role of Rainbow measurements such as SpHb, than what it will have on our future, as well as the impact that all our new measurements -- noninvasive measurements -- will have in improving patient care. And while we can't speak about all of them now, the product pipeline is full and we expect to be introducing even more exciting products over the next five years, including ARM.

We're also optimistic that once the uncertainty around healthcare reform is over and the overall economic begins to recover, some of the issues that have weighed on our growth, such as OEM partner business, will be resolved.

In closing, the Masimo SET pulse oximetry is considered the gold standard and has room to grow as we bridge the gap between our new pulse oximetry shipment market share and in installed base market share, which drives central sales and most of our revenue. We believe our annual shipment market share of pulse oximeters is twice our installed base market share. And therefore, we remain confident about our ability to grow our revenues as we bridge this gap.

We expect Masimo Rainbow SET to have a great impact on patient care. However, as I've stated before, the timing of when we will be on the steep part of the growth with the new technology conduction is hard to predict. We will continue to focus on our mission of improving patient care and reducing cost of care by taking noninvasive monitoring to new sites and applications. We run our business for the long-term outlook. We have a great innovation engine and we are eager to solve more of the remaining problems clinicians and care providers face.

I would now like to turn the call back to our moderate and begin to take any questions you may have. Thank you.

(Operator Instructions). Your first question comes from the line of Bill Quirk with Piper Jaffray.

Good afternoon.

Hi, Bill.

Hey, Bill.

First off, Joe, thanks for all the color, certainly, around everything that's going on vis-a-vis the economy and our business. You expressed a lot of optimism about growing the business sequentially here, both for 3Q and 4Q, but also mentioned that obviously there at least was in the second quarter a bit of an inventory issue at the hospital level.

How confident are you that levels are going to work down to where the end user feels comfortable with that? What mechanisms are you looking at in terms of being able to track that? If you could just add a little color there. Thank you.

Sure, Bill. We have looked at not only what is in the inventory of our Just In Time Distributors, but we've also looked at the sales we've had in our top US hospitals in terms of sensor sales. And first of all, we've noticed on the Just In Time Distributors, for the most part, a dramatic reduction in inventories compared to Q1.

Secondly, what we have noticed is in Q2 while some of our US hospital customers had lower sensor purchases from us, Q1 was higher. And when we averaged the two together, we kind of got into the same historic number that they had with us a year ago. So it's really those two factors, along with, of course, the first 30 days of this quarter, that makes us believe that perhaps the worst is behind us.

Okay. Very good. And then just a quick hemoglobin question. If you're willing to give us a number, that would be great; if not, can you comment a little bit about the sequential growth? Did it perhaps stay at the same pace that we saw 1Q over 4Q?

Yes, the pace was the same revenue-wise. What changed, I think maybe more dramatic, was the amount of the pipeline, as far as the quotation being given for customers worldwide. That seats have doubled since last quarter and we'll have to see in the next quarter whether that pace will continue given that it may have again been due to pent-up demand given that we released the product on March 23.

Okay. Very good. And Joe, just one clarifying question and I'll jump in the queue here. When you said that the pace grew similar sequentially and you mentioned the dollar amount, the dollar amount essentially -- the delta over 1Q over 4Q was roughly the same as 2Q over 1Q, or are you referring to the growth rate in percent terms?

I was referring to really the dollar amount growing the same way between Q2 and Q1.

Understood. And quote activity is up. Okay, great. Thanks, guys.

Thank you, Bill.

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

Good afternoon.

Hi, Tao.

Hey. I just want to go back to the inventory reduction question. I just want to make sure -- in the last quarter, you guys indicated seasonality as the reason why the first part of the second quarter looked a little bit softer. Is it now -- it's not necessarily seasonality, it's more inventory issue you're talking about?

Well, that's a good question, Tao. We do obviously see seasonality. The flu season is really the peak of our sensor volume sales. And I think although obviously Q3 should be lesser in terms of sensor volume than Q1 and Q2, what we were referring to in Q1 was kind of the uncertainty of why we saw less sensor sales. But then when we went back and looked at the inventories, which we didn't get to do until the end of Q2, really the sensor sales had not changed much between Q1 and Q2.

A lot of the sensors happened to be in inventory of our distributors, which the Just In Time Distributors, which they weren't buying from us in Q2, at the beginning of the quarter. So to sum it up, yes, there's going to be obviously seasonality issues, but some of that was already expected. Really, the bulk of what we saw was increased inventory in the hands of the Just In Time Distributors in Q1.

That's very helpful.

And I think the other thing I wanted to say is that it ended up that the last flu season wasn't as bad as the previous flu season, so I think some of the inventory our customers must have taken in in anticipation of that, and perhaps even the swine flu that they were worried about, ended up being for naught and that's why I think in Q2 we began seeing kind of cleaning up of the inventory at the end user level as well.

Perfect. And when you look at the US sensor business, because you have a pretty good visibility on that because you get Covidien royalty, is your sense that Covidien also was down sequentially in their US sensory business? Or do you think maybe you could have lost a little bit of share sequentially in the US?

Well, we actually don't believe we've lost any market share; in fact, the converse. First of all, I want to remind you that Covidien, unlike Masimo, doesn't do a sell-through model. So in Q1, while all the inventory was being built, I think they ended up probably just booking it as revenue. We did not. We ended up putting it aside and in Q2 we took some of that in. And based on kind of the royalties number that we've seen -- we can't be certain because we don't have all the information -- but it looks we are continuing to outgrow them at the same pace as we ever have. The delta's the same, but the numbers are different.

And the last question. When I do the metric -- product revenue per install, obviously that took a big hit here in the second quarter. So when you talk about Q3 being sequentially up, should we be thinking about that product revenue per install trending up versus --

Yes.

-- the 2Q number?

We've looked at that and all we can tell you is it's difficult to understand based on one quarter what the actual sensor revenue per socket is. I think you've got to kind of look at it annually, but I think if we were going to give any guidance we'd probably say it probably should be around the 450 number, not where it's looking at for this quarter.

Okay, great. All right. Thank you very much.

Thank you.

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

Thanks for taking my question.

Hi, Sara.

Let me first start -- Joe, thanks for the color on the quote activity. I know last quarter you had said that I think there were several hundred hospitals that have required quote. What -- can you just give us a sense of what the quote to kind of conversion timeframe is? Or do you have a better sense of the sales cycle here in terms of the length of time it takes a quote to convert into a sale at this point?

I don't get -- no, Sara, I would have to venture out there. I know typically for the industry it's typically about a 3:1 ratio of what you quote and what you end up bringing in. If I had to say, I think we should expect to see some of that activity mature in Q3 and the bulk of it in Q4.

And I know you've come up with some changes to at least making some different options in terms of acquisition or how the customers can acquire the technology. What do you expect to be the kind of predominant model going forward in terms of the hemoglobin adoption in terms of capital costs versus the financing of the after sales, et cetera?

It's too early to tell. What I can tell you right now, we're having activity in all the three different scenarios -- capital purchases, the 90-day loans would increase sensor price flow at the hospital by conversion with the hemoglobin licenses. I'd prefer to hold off a little bit until we have a little bit bigger trend than just one quarter.

Okay. And lastly, I just want to make sure I understand on the guidance. When you reduced it by about -- it looks like $15 million for the product revenue. Can you just give us a sense in terms of how much of that is SET versus Rainbow in terms of the reduced expectation? And maybe on the SET, if you could go one layer deeper and talk about the direct versus the OEM sales expectations? I'm just trying to figure out what really changed in terms of that $15 million versus your prior view.

Sure. I believe our previous guidance on Rainbow was about $23 million to $25 million, and today Mark mentioned the $16 million to $18 million. So I think it's really about half and half -- half on Rainbow reduction and half on SET reduction.

Okay. All right. Thanks, Joe. I'll get back in the queue.

Thank you, Sara.

Your next question comes from the line of Gregory Hertz with Citi.

Hi, Joe. Hi, Mark. It's Greg calling in for Matt, who -- he's away out of the office right now, so he couldn't be at the call. Quick question for you. Just wanted to get understanding on the headcount outlook for the year. Are you still targeting the 220 or did the results this quarter give you some pause as far as your outlook for expansion, specifically within the doctors' office?

Hi, Greg. We have not slowed down our growth of our sales force or our R&D team. And we have stopped giving exact numbers due to competitive reasons, but I can tell you we're going as fast as we can. As far as doctors' offices, we're preparing for hopefully a 2010 launch into the doctors' offices.

So the project, Pronto, timing in Q4 still holds?

It does. We're basically looking at Q4, hope the Q1 timeframe for Pronto into the doctors' offices.

Okay. And maybe a couple of questions for Mark. Mark, the deferred revenues were down a bit sequentially. Can you just give a little color on that?

Yes, actually the primary reason was what Joe had alluded to earlier. The fact that, as you know, we defer our revenues that are shipped into our distribution channel, because those inventory levels were higher at the end of March than they were at the end of June. That deferred revenue was essentially reversed in the second quarter. So that's essentially why that number came down.

Got you. And then can you maybe just give a little -- this is for both of you -- could you just give a little color as to where you stand right now in the quarter or just how sales performed in August, maybe just central volume-wise how it's tracking and how that kind of folds into your outlook for further confidence with the sequential gains for the remainder of the year? That's it for me. Thank you.

Well, as I said earlier, Greg, we, based on many factors including how things have been going the first 30 days of this quarter, we're feeling like kind of the low point of the year is behind us and we're expecting sequential growth Q3 and Q4.

So from a sensor volume standpoint, you're already seeing the turn specifically in August versus July?

I don't know if I can get that granular with you. But yes, I can tell you overall just about on every front things are looking better. Maybe one of the benefits of hitting low at 70 is that everything looks better after that, so yes.

All right. Thanks very much.

Thank you.

Your next question comes from the line of Raj Denhoy with Thomas Weisel Partners.

Hi. Good afternoon.

Hello, Raj.

Hi, Raj.

Wonder if I could ask a little bit about the reduction in Rainbow guidance? Relative to the base business, it was sort of a larger percent of reduction. I'm curious, where are you seeing the softness? Are your expectations for hemoglobin maybe a little lower than they were? Are you seeing more softness on the Radical side of the business or the other parameters? Just maybe some more thoughts around that.

Well, as we indicated last quarter, we're seeing EMS softening. Really, there's -- all the budgets locally have been cut. There's addition. The good news is our first OEM partner with Rainbow technology release its products in Q2. The bad news is we get about half the revenues when they sell things compared to if we sell it direct.

So I think kind of still we see softness in our EMS side of business compared to what we had expected because of those two issues. But also, I think with roll-out of hemoglobin, the whole environment where cost cutting is en vogue does not bode as well for brand new measurement like that. So all those taken together is what made us feel that conservatively we need to review our forecast for Rainbow and we feel very good about meeting the numbers we've given that.

Okay, fair enough. On the hemoglobin front, is it cost? Is that the major push-back you're hearing from institutions or is it data related or just generally how is that receptivity out there?

I think it's cost, it's people getting familiar with new measurements, expectation. I think something -- the ratio between invasiveness and efficacy and of course these plays a bigger role in that than before. So overall, we're very happy with what hemoglobin is doing for our customers in the OR, in the ICU, and we believe that the word-of-mouth on that gets out and studies come out, and, of course, as we have reduced our costs by offering another option, which is the Resposable Sensors, we hope with time and those new parameters hemoglobin will start to rise.

And I've always said, trying to forecast a brand new measurement that doesn't fall under reimbursement is really difficult to do. But one thing that we're confident about is that it is going to get there and it's just going to be when do we get to that inflection point, and I guess you'll know when we get there.

Sure. Did you mention that -- I think I read this and I just wanted to make sure it was right, that you said you had 500 hospitals with an average of five licenses for hemoglobin per site?

Yes.

So there's roughly 2,500 places you could plug a hemoglobin center into right now?

Yes.

Okay. And I guess --.

2,500 units.

2,500 units. 500 hospitals, 2,500 units. But he means 2,500 places in the hospital, correct?

Right, right, okay. So I guess you know, as we look forward, as far as a way to kind of build a hemoglobin adoption, that's a nice base to be building off of.

Yes, and hopefully in the next quarter if I can tell you it's grown again at a good rate, that will be terrific and that's what we're hoping for.

Okay. And when you look at that number of sort of 2,500 places out there, do you have a rough expectation for how many sensors for each of those might be used or have you seen any sort of even early anecdotal data on how this is flowing through?

We do have it. Obviously, we don't count our whole 2,500, as I mentioned earlier. We count it about a third of that as we look at our pipeline. And as far as sensors are concerned, I think in the OR -- when they're being used in the OR, we can at minimum predict 100 sensors per unit per year and ICU probably 50. But it could be upwards of 300 sensors or 400 sensors per unit per year in the OR.

So we'll just have to see how often do they use the product? Do they use it on every patient or do they try to use it on the high-risk, blood-loss patient?

Okay, fair enough. Thank you.

Thank you.

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

Thank you for taking the question. You talked about hospital capital purchasing decisions, but anything regarding hospital census and how that may be impacting your business?

You know, Joanne, at the end of Q1 we were more worried about census than today. Today, all of the normal places we go to get a feel for census, it looks like it's either up or it's flat. So we think census has kind of come back. Now, maybe not all of those people are carrying insurance like they used to, but for our world, census seems not to be the issue.

One of the things we hear when we do our field checks is that some of the hospitals are looking for "independent clinical data" on hemoglobin. Could you sort of address that and tell us when you think that may be presented at some stage?

Yes. I believe at the ASA, American Society of Anesthesiologists, Conference, a few papers are going to be presented. I believe there already is independent data from both Loma Linda and I think Mayo Jackson will, but certainly there will be more at the ASA and hopefully that data will start satisfying people's curiosities.

Helpful. Finally, can you give us an idea -- you have several different ways of going towards the averaging selling price for hemoglobin and you've now added the Resposable product. What should we think of as sort of a blended ASP for the sensor? Thank you.

Well, I would say maybe for the -- probably $50.00, the right way of maybe doing it.

Very helpful. Thank you.

Thank you.

Your next question comes from the line of Sean Lavin with Lazard Capital Markets.

Hello, Sean.

Hello. Just a couple of quick questions. The first one is, in terms of hemoglobin, am I correct, in the fourth quarter you were in about 25 hospitals -- about 50 in the first quarter and now 500?

The 500 -- what I was referring to was how many hospitals have requested quotes for hemoglobin and whether it's probably a capital purchase or a 90-day loan with increased sensor price or the hospital conversion with SpHb license. As far as how many hospitals we were in, it went from 50 to, I believe as the end of the end of Q2 we were at 68 hospitals.

And then my second question is, we've heard from a number of physicians that you're making ongoing improvements to the algorithm in the sensors. Could you talk a little bit about those?

Sure. We believe in continuous improvement, and when we launched the product, we believed that it was at the same performance level as second-generation pulse oximeters were introduced in the mid 80s to late 80s. However, our goal is not to wait 10 years to go by to make enhancements, but we're constantly improving it and we've already made some nice improvements the past couple of months. We expect another release towards the end of this month and we have planned release for end of Q4.

We're constantly improving both the sensor and the algorithm. Our goal is to eventually --. The goal -- I'm not saying we're there -- but the goal is to get the accuracy down to 0.5 grams per deciliter and have it work at perfusion levels of well below one -- or should be 0.1.

All right. That's all I have. Thank you.

Thank you.

Your next question comes from the line of Ben Forrest with Summer Street.

Hi, this is Spencer Nam. (inaudible) questions. I have a quick question here. We were getting some feedback from some of your OEM customers, that things were looking more positive in the second half into 2010. Are you guys getting any sense from OEMs in terms of the demand pattern and how they are planning out the rest of the year and going forward?

We hear the same things, but we have not seen a dramatic increase in orders for our board and we don't believe, like I said earlier, our market share has been reduced in those products. So we're still waiting to see, but so far it doesn't look like it's pointing downwards anymore. So hopefully we've seen the bottom and hoping both for our OEM partners as well as for ourselves that they will have a nice Q4 finish.

Great. And then the second question is, in terms of your hemoglobin test -- total hemoglobin test right now, what would be -- if you had to describe -- what would be your biggest challenge at this point in terms of adoption?

I want to say the economy. But I don't know, it's the combination of, I think, the economy; I think it's the price of our products; I think it's somewhat as far as where we want to take it into [spot-check] world into the emergency department and doctors' offices. It's improving up on its accuracy in those environments and trending is not so important there; you need the absolute number.

So I think it's the combination of things and maybe one that will always be with us is how long it takes for a new technology -- monitoring technology -- to be adopted. I think I told you before, the most successful companies, when they introduced pulse oximetry in the early 80s, the first year they introduced it they did $2 million in revenue. And clearly, we're going to do that, if not more.

So I think it's just -- the growth has gone from $2 million in the early 80s to today a $1 billion market, but unfortunately, it's not like a new drug or some device that has reimbursement associated with it which causes overnight shifting of the market.

Thanks very much.

Thank you.

Your next question comes from the line of Brian Weinstein with William Blair.

Hi. Good afternoon. I apologize for the background noise here. How should we think about drivers for Q3? I want to make sure I'm clear on this. Are you expecting the number of drivers that are placed in the markets to also be up sequentially Q3 and then also Q4?

I don't think so. I think for now we're kind of targeting that same 25,000 to 30,000 drivers per quarter for Q3 and Q4.

But up sequentially from what you did potentially in Q2?

Well, Q2 we did 27,000. So potentially slightly, but nothing dramatic. I think where we see the sequential growth is -- first of all, we see it in the health of the sensor business coming back. Secondly, because of inventory issues that we were dealing with in Q2. We see it in Rainbow measurements, software sales. We see it in handheld devices that we don't include in our driver numbers. So it's a combination of those issues, not particularly a dramatic increase in drivers.

Okay. Can you give us an update on what you're seeing in Europe and what your strategy is there?

Well, Europe, they're having the same woes as we have in the US economically. We had a wonderful driver quarter in Europe. I think we did about, what, 2x the same quarter last year in Europe? So we -- Europe, we've been rapidly increasing our sales force there and they typically do purchases at a department-by-department level, which should mean less resistance to decisions versus in the US where do hospital-wide stuff.

And same also with parameters like hemoglobin and PVI. Historically, Europe is earlier to adopt those kinds of measurements.

Okay. And then my last question, how many accounts have actually converted and wind up paying the license fee of those who were paying the higher sensor price from the marketing program that you initially started a couple of quarters ago?

I don't have that number.

Can you kind of ballpark it? Is it more than 50%?

Well -- I don't know, Mark. Can you ballpark it?

I think it's just around there, Brian.

Okay. Great. Thank you guys very much.

Okay.

Thank you.

(Operator Instructions). Your next question comes from the line of Bill Quirk with Piper Jaffray.

Just a quick housekeeping question. Mark, I noticed in your comments in the call that the DSOs ticked up. What was the explanation for that? Was that just a timing issue around collections or anything else there?

Well, unfortunately, Bill, it's really a reflection of our other comments on the environment in Q2. We have seen a variety of our direct hospitals extend their payment cycles to us. We don't believe there's any deterioration in the quality of our receivables, but we have certainly seen our customers, who are all struggling with their own cash flow requirements, try to push out as long as they possibly can in payments. So that's really the driving force behind the increase in DSO.

Understood. Thank you.

There are no further questions. I would now like to turn the call over to Joe Kiani for closing comments.

Thank you all for joining us this afternoon. I'm looking forward to reporting Q3 numbers to you and I expect them to be better. As you can see, while we had a couple of great quarters in Q1 and Q4 and historically, we were worried about what Q2 was potentially going to be like and we tried to put some measures out there for you. As you can see, we're feeling much better now about going forward with Q3 and Q4 and look forward to the longer term with Masimo.

So thank you all for joining us. Have a wonderful evening.

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