Masimo Corp (MASI) 2009 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Masimo Corporation Third 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) I would now like to turn the call over to your host for today, Mr. Mark De Raad, Executive Vice President Finance, and Chief Financial Officer of Masimo. Sir, you may begin your conference.

Thank you. I would like to welcome you all to Masimo's third fiscal quarter 2009 earnings release conference call. Our press release was distributed about 30 minutes ago. If you've not seen the release, and you'd like to, a copy is posted on the Investor Relations page of our website at www.masimo.com.

Joining me today on the call is Joe Kiani, Masimo's Chairman and Chief Executive Officer.

In just a few moments, Joe and I will deliver remarks on our financial results for the 2009 third fiscal quarter and general comments regarding our business. After we complete our prepared remarks, 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 and detailed 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, Mark. And thank you, ladies and gentlemen, for joining us today. Our third fiscal quarter product revenues increased 14% to $75.1 million, up from $66.1 million in the same prior-year quarter and up sequentially from $70 million in the immediately preceding second quarter 2009.

Despite the still-challenging business environment for new product procurement, we were able to ship 26,200 new Masimo SET and Masimo Rainbow SET monitors during the third quarter and our Rainbow revenues doubled to $6 million compared to $3 million in the third quarter 2008.

In our second quarter earnings call, we expressed confidence that our third quarter and fourth quarter product revenues would grow sequentially. Nothing has happened to change our expectations for sequential growth in the fourth quarter.

Despite a rough market, our business is growing. The fact our direct business grew by 22% year-over-year due to strong demand for Masimo SET and Masimo Rainbow SET. These results underline both the power of our innovations in non-invasive monitoring, which is helping our customers improve to save lives and our business model.

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

Thank you, Joe, and hello, good afternoon to everybody. Earlier today we reported total fiscal 2009 third quarter revenues of $87.4 million, which consisted of product revenues of $75.1 million and royalty revenues of approximately $12.3 million. This represented a 12% year-over-year increase in total revenues, and a 14% increase in year-over-year product revenue growth.

The beneficial impact of foreign exchange rates on third quarter fiscal 2009 revenues as compared to the prior-year quarter was relatively insignificant at $179,000.

For the nine-month period ended October 3, 2009, total revenues rose to $256.5 million, up 15% from $224 million, while total product revenues rose 17% to $219.7 million, up from $188 million in the same prior-year period.

Also in the fiscal third quarter, excluding handheld monitors, we shipped 26,200 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 621,000 drivers, up from 540,000 drivers, or about 15% just one year ago.

We have recently completed an internal review of the useful field life of our products, and based upon input from both our OEM and direct customers, we believe that the appropriate range of the true useful field life of our pulse oximeters and pulse co-oximeter monitors is from seven to 15 years. As you recall, we have traditionally assumed a seven-year life.

As a result of this recently completely analysis, beginning in the first quarter of 2010, we intend to change our useful field life assumption from seven years to 10 years. In the first quarter, we will provide a revised set of historical driver data reflecting the new 10-year life assumption. This change will have the impact of both increasing the number of drivers in the field and, at the same time, decreasing the average dollar per driver, which is a measurement used by many of our analysts in their models.

We are providing this notice now so that when we provide the revised driver data in Q1 2010, the rationale for the change will already be understood.

The year-over-year growth in product revenues came primarily from Masimo's SET revenues, which rose to $69.1 million in the Q3 2009 quarter from $63.1 million in the Q3 2008 quarter. This increase is primarily the result of our continuing expansion of Masimo SET technologies into new hospitals.

Included in our Q3 2009 product revenues, was approximately $3.4 million in previously deferred revenue, which we recognized as the result of the elimination of obligations to provide upgrades under two long-term sensor agreements. In comparison, in the same prior-year quarter in 2008, we recognized approximately $2.6 million in deferred revenues related to the establishment of vendor-specific objective evidence of a product tied to a long-term sensor agreement.

During the third quarter of 2009, Rainbow revenues totaled $6 million, up from $3 million in the comparable prior-year quarter and from $4.5 million in the immediately preceding quarter. The increase was due primarily to strong year-over-year demand for our Rainbow license parameters, especially SpCO and SpHb, as well as increased Rainbow consumables.

Third quarter 2009 product revenues generated from our direct business, which includes sales through our Just In Time distributors totaled $60.1 million, or 80% of total product revenues, while OEM revenues totaled $15 million, or 20% of total product revenues. In the prior-year period, direct sales were $52 million, or 79%, while OEM revenues totaled $14.1 million, or 21%.

We were encouraged by the sequential rebound in OEM revenues, which resulted in 20% of Q3 2009 OEM revenues, up from 18% in the immediately preceding Q2 2009 quarter.

During the third quarter, our US product revenues totaled $57.4 million, or 76% of total product revenues compared to $50.1 million, or 76% in the prior-year period. As a result, the international product revenues as a percent of total product revenue remained flat at approximately 24%. Year-over-year third quarter OUS revenues grew by 11%, although on a current currency basis, they grew only 9%.

Our 2009 third quarter royalty revenue increased slightly to $12.3 million from $12 million in the prior-year period. Our 2009 third quarter product gross profit margins rose to 66.5% from 66.1% in the same prior-year period. The year-over-year increase was due primarily to the beneficial impact of higher sensor and Rainbow revenues. Adjusted for the impact of foreign exchange rates, our Q3 margins would have been 66.4%.

Total gross profit margin, including royalties for the 2009 third quarter, declined to 71.2% from 71.3% in the same prior-year period due to the mix impact of higher royalties representing a lower percent of total revenues.

Our third quarter engineering expenses were $7.7 million, up approximately 28% 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 third quarter selling, general, and administration expenses rose to $33.5 million, up approximately 15% from $29.2 million in the prior-year period. Higher expenses were due primarily to the combined result of a $3 million increase in payroll, payroll-related, and stock-based compensation costs associated with the increase in worldwide selling; general, and administrative staffing.

Our 2009 third quarter effective tax rate increased to 37% from 36.6% in the same prior year, and from 35% in the immediately preceding second quarter of 2009. This higher tax rate is due to our revised revenue and profitability forecasts, which now assume lower OUS revenues and profitability.

Based upon that reassessment, we now believe that our year-to-date effective tax rate will increase from 33.9% to 35%. As a result of this change in forecast, we were required to adjust our Q3 effective tax rate sufficiently to adjust our year-to-date tax rate to the new 35% rate for the year. This cumulative year-to-date tax adjustment resulted in approximately $400,000 of additional Q3 2009 tax expense, or slightly less than $0.01 per share.

Weighted average shares outstanding for the third quarter 2009 were $60,157,188, and $60,376,739 for the same prior-year period.

In summary, the combination of our 14% year-over-year increase in product revenues, relatively flat royalty revenues, higher gross profit margins, and increased operating expenses, and a slightly higher effective tax rate combined to generate a Q3 2009 operating profit of $20.8 million compared to $20.5 million in the same prior-year period. As a result, our Q3 2009 earnings per share was $0.22, the same as in the prior-year period.

Now I'd like to make just a few quick comments about our balance sheet. At October 3, 2009, total cash increased to $174.7 million, up from $146.9 million at January 3, 2009. This nine-month increase of $27.8 million was the result of generating $29.7 million in cash from operations despite making a special $11 million tax payment in Q1 2009 related to our international reorganization.

During the nine-month period ended October 3, 2009, we also generated approximately $3.4 million in cash from the tax benefit and cash associated with the exercise of stock options and purchased approximately $4 million in capital equipment.

As I noted in our last call, the statement of cash flows, which we are now including in our press release financial statements, should provide you with any other noncash expenditure information that you might require.

At October 3, 2009, our day sales outstanding declined to 47 from 50 in the immediately preceding June quarter but were up from 40 at the end of the fiscal 2008. Our inventory turns remained relatively flat at 3.2 as of October 3, 2009, compared to 3.3 as of January 3, 2009, and 3.2 in the immediately preceding quarter.

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

Thank you, Mark. We are happy to report stronger third quarter results, which, despite the still-difficult economy, represented a nice rebound from Q2 and, in fact, represented a record product quarter for Masimo.

I am also happy about our ability to double our Rainbow revenues in the third quarter of 2009 versus Q3 2008. As we look forward, we continue to believe that we will again be able to grow sequentially in our final quarter of 2009. Our perspective is based upon seeing, one, a more active customer base as customers are reengaging on projects, which they put on hold in the first half of 2009 as they tried to manage through a very difficult economic period of time for hospitals; two, an indication that more hospitals are beginning to move towards continuous monitoring of their patients in the general ward; and, three, more customers wishing to implement Rainbow, especially SpHb and SpCO, which is non-invasive continuous hemoglobin and non-invasive continuous carboxyhemoglobin monitoring -- as they are seeing the clinical and lifesaving impact of these breakthrough non-invasive measurements.

I'd like to now give you a few topical highlights. First, I'll start off with the clinical study update. Several new studies were presented at this year's American Society of Anesthesiologists meeting. I will highlight a few of them for you.

The first was accuracy of non-invasive hemoglobin measurement by pulse co-oximetry in hemodilution subjects. A clinical study led by Dr. Martin Allard at Loma Linda University in Loma Linda, California, compared SpHb measurements to 165 invasive laboratory measurements in 20 healthy adult patients undergoing hemodilution. Masimo SpHb had a bias of 0.15 g per deciliter and precision of 0.92 g per deciliter, leading researchers to conclude the SpHb measurement accuracy was unaffected by perfusion index levels and offers an acceptable alternative to invasive hemoglobin tests in many clinical scenarios.

Another study, validation of a new non-invasive hemoglobin albumin in patients undergoing liver transplantation, which was a clinical study led by Dr. Klaus Torp at the Mayo Clinic in Jacksonville, Florida, compared SpHb measurements to 55 invasive laboratory measurements in five patients undergoing liver transplantation and found significant agreement between the two methods.

The study showed that spHb using the new Masimo resposable sensor had a bias of 0.2 g per deciliter and precision of 0.8 g per deciliter. Researchers concluded that the accuracy of non-invasive SpHb measurements obtained by the pulse co-oximeter with new resposable sensors was high.

Additionally, two studies presented at the ASA highlights the importance of understanding the variation in invasive arterial and venous hemoglobin measurements. The study of 471 paired invasive hemoglobin measurements from 33 patients on two different invasive laboratory devices, one by Beckman Coulter hematology analyzer and other Novo Biomedical co-oximeter, showed a bias of negative 0.97 g per deciliter and a precision of 0.58 g per deciliter. The authors noted that the different devices using different principles of operations can produce consistent differences and to absolute value measurement.

Another study comparing hemoglobin measurement in 107 subjects from [time match] arterial and venous blood samples on the same invasive laboratory device found average differences as high as 0.5 g per deciliter and noted that arterial and venous hemoglobin values from the same individual are not interchangeable.

Other third quarter product and customer highlights -- first, I am proud to say Medtronics video control, who was one of our first OEM partners to launch Rainbow in the US, had robust sales of Rainbow parameters sold within their new LP-15 defibrillator. Nearly 70% of the LP-15s were shipped and are being ordered with SpCO or SpCO and SPMet. SpCO and SpMet are the first Rainbow parameters Medtronics is offering to their customers.

In Q3, we submitted, for FDA clearance, the Pronto 7, our new spot check SpHb measurement device. Depending on the timing of FDA clearance of Pronto 7, we expect to begin limited market release of Pronto 7 in the first half of 2010 with a new physician office salesforce.

We launched enhanced Masimo Patient SafetyNet system to help hospitals reduce preventable deaths on the general floor and are seeing relatively strong growth. 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 low false-alarming pulse oximeters and Patient SafetyNet system as outlined in the Dartmouth Hitchcock study. And even more encouraging is the fact that the early adopters are becoming repeat customers.

I'd like to now -- speaking of PSN, I would like to now give you some update on Acoustic Respiration Monitoring. We have made good progress with the development of another revolutionary new product, which we call ARM. To remind you, in second quarter of 2009, we submitted ARM for FDA clearance. We have recently begun beta site testing of ARM, and depending on the successful results of our beta tests and timing of FDA clearance of ARM, we hope to begin limited market release either before the end of this year or early next year and commercially launch ARM in the second half of 2010 if not earlier.

Recently, we announced in a press release, the 9th Circuit decision -- 9th Circuit District Court of Appeals decision, which affirmed that Covidien engaged in anti-competitive tactics. And based on what the 9th Circuit has written, we believe it should curtail Covidien's sole source market share-based pricing and bungling when mixed with either sole source or market share-based pricing.

The prior court ordered damage figure was $14.5 million, trebled to $43.5 million and included attorney's fees. At the same time, I would like to remind you that this engagement was contingency-based, and that our legal counsel will receive 50% of the net proceeds, which should be over $25 million -- half and half.

So takeaways from this 9th Circuit decision -- we believe Covidien, as a result of this ruling, should curtail these illegal acts against Masimo; two, Masimo does not seek out litigation, however, we are also not willing to accept violations of our intellectual property or what we believe to be unfair and illegal monopolistic practices; and, three, with our legal victories in the patent infringement and antitrust suits and settlements including with Nellcor, Shaklee, and Respironics, we believe our business practices and legal challenges are on a firm foundation, and we remain committed to protecting our business and legal interests to the fullest extent.

So I would like to just leave you with some closing thoughts before we go to the question-and-answer session. Despite the current challenging economic environment, we remain optimistic about our ability to continue to expand our worldwide customer base, utilizing Masimo's gold standard pulse oximeter technology and excited about the important role that Rainbow measurement, such as SpHb, that will have on our future. Not to mention the impact that all our new parameters will have in improving patient care.

And, as we have noted in the past, while we can't speak about all of them now, our product pipeline remains full, and we expect to be introducing more exciting products over the next five years starting with ARM and Pronto 7 in 2010.

We are also optimistic that once the uncertainty around the health care reform is over, and the overall economy continues to recover, some of the issues that have weighed on our growth, such as our OEM partner business, will be resolved. However, we are very concerned over the recent proposals, which suggest that an excise tax on medical device manufacturers may be part of a final health care reform act.

Although we can't anticipate what may or may not occur, we believe that any such excise tax will simply result in higher health care costs as these taxes are either passed on to customers or stifle innovation.

I also would like to remind you of the fact that we continue to place normal levels, over 25,000 new pulse oximeters and pulse co-oximeters in the third quarter, which some analysts have said is 40% of the pulse oximetry shipments in the US. And yet our revenues continue to represent approximately 25% of the total $1.1 billion pulse oximetry marketplace and, as a result, we remain very confident regarding our ability to continue to grow our revenues into our increasing share of the worldwide pulse oximetry market.

We expect Rainbow to have a great impact on patient care in a broad way. We hope that by the time our pulse oximetry business will start to slow down, Rainbow will ramp up to the same part of the S curve. We will continue to focus on our mission of improving patient care and reducing cost of care by taking non-invasive monitoring to new sites and applications, and we will continue to run our business for the long-term growth. And with our great innovation engine, we will continue to solve more clinical problems and make Masimo a great company.

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

(Operator Instructions) Bill Quirk, Piper Jaffray.

First off, could we get a hemoglobin account update? Last quarter, I seem to recall you gave us both the current account number, as well as indicated that there were approximately 500 accounts that had requested a proposal. Any update on either one of those metrics, guys?

Yes, we will, Bill, but I think we've gotten you guys used to some granularity that we are regretting now. Don't forget, we have a business to run and competitors to potentially deal with. But I will, one more time, give you an update, and I hope maybe in the future we can just look at the overall growth of Rainbow and not get into these fine details.

But to answer your question, there are now 145 hospitals with SpHb, and this is up from 68 worldwide hospitals that we had end of Q2. And the 500 "activity" I mentioned last quarter, has now grown quite strongly. Since this is the last time I have to give it, I will let you know that it's about 800 now.

Outstanding. A second question from me is, if we think about your comments, Joe, around -- expect 4Q to be up sequentially because, obviously, you didn't update your formal guidance, should we read the no update on guidance to essentially mean that you are reiterating the targets that you gave us during the second quarter conference call?

Yes, that's correct, and if things continue the way we think, it will probably be towards the higher end of the guidance.

Okay, very good. And then if I can just sneak one last one in here -- thinking about the Pronto 7 introduction -- can you just give us an update -- how much have you built out on that salesforce now and how much more should we expect and, obviously, what should we be thinking about in terms of the SG&A impact? Thank you.

Sure. We have built a salesforce close to 20 people for the physicians' offices, and right now they are mostly doing training in the hospital environment, and we hope to turn their attention to the physicians' offices fully beginning of next year.

And as far as guidance on revenues and earnings -- we'll provide that at the end of this fiscal year next year.

And so is the 20 the right number to think about next year, Joe, or should we thinking about that going to 40 or 50 or -- ?

The sales reps?

Yes.

It should go to 40.

Tao Levy, Deutsche Bank.

Since, Joe, this is the last time you're going to be providing some of this granularity, I figure I'd ask on hemoglobin. So the sequential increase in the number of hospitals close to 80, quarter-over-quarter -- how many of those came from that 500 leasing test program that you had announced a few months ago?

The minority came from that. Basically, we have three different ways that we are providing hemoglobin to our customers -- either a straight purchase where they get the sensors at a discount, or we do this 90-day program where they get the hemoglobin monitor for free for a period of time in return for higher-priced sensors. And a third is part of our hospital-wide conversion when we provide some amount of hemoglobin to our customers. But the minority are in the 90-day program. The majority are actually -- as far as the number of hospitals -- are purchasing the software license, the parameter.

And it is still roughly out of the ones who have purchased it around five installations per hospital?

Roughly, yes.

And maybe if you can comment on the new hospitals that came on board with hemoglobin -- were they all prior Masimo pulse ox customers or did you pick up de novo accounts -- not only picked up the pulse ox but also Rainbow?

They were both. I don't know the exact percentage but, for example, we announced Mainz, which is a very prestigious university hospital in Germany -- that was a brand-new customer. We are currently not doing pulse oximetry with them, and they decided to put hemoglobin in every OR, ICU, and, I believe, ED bed.

And then there were customers like Children's Hospital of Oakland, who had been a Masimo customer that had decided to use pulse co-oximetry and hemoglobin throughout the hospital. So based on just sitting here, I would guess that it's probably half and half.

Okay, and if I could sneak one last one in -- Mark, you mentioned sequential increase, or maybe it was Joe, in revenues, as it's kind of the expectation. Shall we think of gross margins also improving sequentially just because of the higher volumes?

I would suggest, Tao, that the range that we're in right now -- as you know, our guidance for the whole year was at 66%. We've achieved a little bit better than that in the last couple of quarters, so I would stay within that general gross margin percent range. I don't think you should be looking for anything dramatically higher in the next quarter.

Sara Michelmore, Cowen & Company.

Just looking for a little more color, if you could, on some of the OEM partner trends. It does sound like some of the inventory loosened up in the quarter, and I'm just curious what your visibility was in terms of what was going inbound to those OEM folks, thanks.

Mark, would you like me to answer that? Yes, basically, our OEMs do not generally like to carry inventory. So our estimate has always been when we ship products to them, that they are just in time, and they manufacture them and send them out to their customers. We, from time to time, do have some obsolescence-related purchases, which I believe this quarter was very minimal. So, really, nothing has changed the way the OEMs have been purchasing.

I think you may be referring to the discussions we've had before with the Just In Time distributors in terms of inventory management and how, in Q1, they may have put too much inventory on their shelves. Is that right, Sara?

Yes, basically, I'm referring to the part of the business that is not direct -- so everything, I guess.

We don't see any difference. If there is some, we're blind to it. But with the Just In Time distributors, these are the Cardinals and Owens & Minor, it looks like their inventory is continuing to come down. So we don't think there is any inventory-related sales. In fact, with our business, it wouldn't matter because we only report sell through revenues, not what they do in their inventory.

Okay. Any trends, though, on the sell through side that are helpful in terms of just trying to model this, going forward?

Sara, as Joe alluded to, at the end of the June quarter, we talked about, through our distributor channel, the fact that they had, in general, brought their inventory levels down to much more historically normal levels. In the September quarter, we actually saw, in most cases, that continuing. And, in some cases, we actually saw even lower inventory levels, suggesting the distributors continue to do whatever they can to manage their inventories as effectively as possible.

So, if anything, the inventory levels held by our distributors at the end of September were at a lower level than they were at the end of June.

Okay, that's helpful. And maybe a little bit of a longer-term question -- we're getting closer to the March 2011 timepoint which, if we're being conservative here, is when the Covidien royalty would roll off. I assume you don't have any better visibility on that today than the last time you updated. So if you could just comment on that -- and just talk a little bit about a lot of these staffing increases you're making and a lot of the investments that you are making this year and probably next -- things like Pronto 7, physician office salesforce, et cetera, and how should we think about your ability to make those investments in the context of having this royalty potentially come off in March 2011? Thanks.

Sara, I have to first say, yes, we don't have any more visibility than we have had in the past regarding what Covidien may or may not do. We suggest that our shareholders, investors, take the conservative viewpoint that those royalties will stop, and that Masimo will be forced to sue for intellectual property, so there will be some additional expenses as well. We hope those things won't happen, but I think that's how you have to model it.

And then as far as with salesforce investment, expansion, and same with R&D -- we decided years ago, when we first won our intellectual property lawsuit, and we also realized that we are going to be doing an agreement with Covidien, which -- where we gave them a covenant not to sue for the current product in return for ongoing royalties, that maybe the best thing to do with those monies is to invest ahead of time that normally we would have. And maybe we got our idea one day flying out of Orange County -- from those who have flown out of Orange County -- basically, you put the foot to the metal, and when you get over the nice houses in Newport Beach, you throttle back and hope you won't make too much sound, the plane continues going.

So, basically, we have been increasing our expenses, roughly, at about a $30 million a year pace, year after year, with the anticipation that, in 2011, we will back off from increasing our expenses that much. But we will have benefited from reaching critical mass in both sales personnel as well as research and development personnel, so that we can continue to grow our business the way we'd like.

And my expectation, it may take a couple of years, if not longer, before we'll feel the need to invest again. Under the norm, which, for Masimo, has been to invest after you absolutely need to invest in growth so that we can be prudent in the way we do our business, which, all said and done, should hopefully make 2011 smoother than otherwise.

But what should really set us up for a wonderful 2012, and so forth, as we start to reap from the investments we made without this -- maybe "artificial" is the wrong word, but this accelerated growth that we've been doing up until that date.

Matthew Dodds, Citigroup.

A couple of questions -- Joe, when you talk about -- or, I guess, Mark -- the useful driver life -- I don't want to jump the gun too much here -- but when you talk about seven to 15 years versus seven -- counting-wise, are we talking a middle point there of 11, or is it still closer to seven?

And then on that side, just looking historically at what you estimated the driver retirements to be -- I don't think we're talking about an increasing of that 600,000-plus over, say, 50,000 total when you do make this change, are we?

Let me answer your first question first -- the range that we received -- and that is a range, it was a low of seven to a high of 15. We also looked essentially at the median of where most of this data was coming in at, which suggests that 10 to 11 years is the right range for us, and that's why we selected 10. So that's the basis upon which we're going, from seven to 10.

In terms of what to expect as a result of that change, I think directionally -- I haven't looked at the numbers recently, but I think, directionally, the kind of range that you threw out in terms of gross number of drivers is probably about right. I think we might even be a little bit higher than that in terms of where we think the adjustment for this change will come in.

So, for example, if we are in the low 600,000 range right now, we expect that when all the numbers are completed, that that number will probably be in the high 600 range when we make this transition in the first quarter. So that's the order of magnitude of change that you should expect.

Conversely, as I said in the comments, the impact of that will obviously be to reduce the amount of dollars per driver, simply because there are going to be more drivers in the calculation.

Thanks, Mark, that's helpful. Then one other quick housekeeping number -- can you give the Rad-57 number for the quarter?

Well, as you know, this whole year, we have focused on one Rainbow revenue number, so we're not going to change that right now. We can say, in terms of Rad-57 that it was another reasonably strong quarter for us. We've had essentially three very decent quarters in Rad-57 sales this year. They continue to be impacted, of course, because of the impacts that we continue to face in state and local government budget environments. So on a year-over-year basis, we haven't seen the kind of growth that maybe we would have expected at the start of the year and that, of course, was factored in our reset of guidance in our last earnings call.

But in terms of just sequential Rad-57 revenues for the last three quarters, it's actually been a very decent number for us.

And I'd just like to add, also, keep in mind with Medtronics that you control launching their defibrillator. A lot of our customers like having the Rad-57 measurements, which is carbon monoxide, hemoglobin, pulse oximetry inside the same monitor defibrillator. So if you look at the combined LP-15, CO and Met shipments with the Rad-57, it's been a very, very strong year for us.

Got it. I think, going forward, it's better to combine the two in terms of a commentary, correct?

Well, we're not sure what to do here, but -- because some people think of it as OEM business, some people here think of it as EMS business. So we're still grappling with that, and I think -- you know, one day when the numbers start getting really big, we're going to break out the different measurements. But I think right now, while we get there, we just prefer to report all that is Rainbow revenue.

Peter Lawson, Thomas Weisel Partners.

I wonder if you could give us further details on that really strong jump in Rainbow revenues -- what were the components there by parameter or US versus non-US? And were there any bulk orders in there or any revenues that were delayed from the first half?

No delays, Peter, but I can tell you that it was strong all the way through -- carbon monoxide, hemoglobin, and, of course, it helped to have Medtronics video control jump in with their monitors and much better-than-expected percentage of their defibs going out with our parameters. So I hope that helps.

Were there any stocking orders from Medtronic?

No. No. These Rainbow parameter sales that we are enjoying, and the percentages I gave you, are basically software. In fact -- well, I'll leave it at that. But, no, there was no stocking.

Okay, and then I wonder if you could talk about the traction on their resposable product?

I guess it's too early to tell, but I have to tell you, people like the sensor. Yet, when we talked to our customers who have been using our hemoglobin monitors, they are happy to see that the lower-cost sensor is out there, but not every one of them is jumping on it -- "Oh, my God, I couldn't wait to have the price reduction that I get with resposables."

So we still believe resposables will probably become the lion's share of the sensor purchases, but let's just say old habits die hard. The people who started with the disposable, the one piece, are still, for the majority of them, buying that. New customers are buying resposables.

I wonder if you could just give, just finally, an update on Europe, the traction you're getting there, and any commentary upon the driver growth of Europe?

Yes, I can give you some. Europe, it seems that our market share has not been as strong as it is in the US. I was just there, and I -- overall, I'm talking about -- all around with the Masimo revenues -- but when I look at Rainbow, of the 145 hospitals I mentioned that have gone with hemoglobin, 91 of them are outside the US; 57 in the US. And a majority of that is in Europe because, for example, countries like Japan, we still are waiting for approval.

So the strategy, or the thought, that we like to have a direct salesforce for countries in Europe that -- if it was just for pulse oximetry, we wouldn't have put a salesforce together for, seems to be, at least early on, correct. And that about 60% of this new Rainbow revenue hemoglobin is coming from Europe, 40% from the US -- or -- international 60%, 40% US -- and that's kind of what the norm should be. Whereas, typically, with pulse oximetry it's been the other way around to actually -- a bigger extreme.

You had a similar strength in 2Q for ex-US versus US for hemoglobin?

I don't have that data, so I don't know. I'm sorry, Peter.

Joanne Wuensch, BMO Capital Markets.

You're getting a nice number of cash on your balance sheet. Can you discuss uses of it?

Large (inaudible) on the Ethernet. No, just joking. Well, for now, we're feeling good about growing our cash, and I think ultimately while we believe we can be the company we want to be with organic growth from our own product roadmap, we are also going to be looking at acquisitions, and at least for a short while, we don't see our stock as a cheap way of buying companies. We like to use the cash to potentially buy companies.

So -- we like to grow the cash and hopefully buy either technology companies that we find interesting, or buy product revenue stage companies with the cash.

Could you remind us what the Acoustic Respiratory Monitoring opportunity -- the size of that market could be?

Yes. We believe, based on the Anesthesia Patient Safety Foundation recommendation of monitoring oxygenation and ventilation on patients on the general floor who are on any kind of pain medication that could affect respiration, we believe that market could be as big as -- unit-wise -- as big as the current pulse oximetry units by sales. So if the ASPs were even the same as pulse oximetry, we think ARM could be as big as pulse oximetry.

And then, of course, there are surgeries that are done without ventilation -- or intubation, excuse me -- those are called "MAC" surgeries, and in those kind of cases, we see a need for a product like ARM. Because currently, capnography works very well on patients that are intubated, but is not regarded highly on non-intubated patients. So we think a product like ARM, that's easy to use, gives hopefully the same, if not better, accuracy and reliability as capnography. It should do very well on the general floor.

And then just a final question -- you mentioned that hemoglobin is not approved yet in Japan -- could you please remind us of the commercial pathway for that product there? Thank you.

Sure, Joanne. We filed our application for approval for hemoglobin over a year ago in Japan. So typically it takes about 18 months to get approval. We hope this will be typical. So assuming that happens, hopefully, in the second half of 2010, we expect to be able to sell hemoglobin freely in Japan. Right now, we do have some customers in Japan that want the hemoglobin badly enough that are doing applications directly to the Ministry of Health for Wednesday, Tuesday orders for their hospitals. And that's not a lot of orders, but it just shows to us that there is a pentup demand there. So, hopefully, the second half of 2010 we'll be free to sell in Japan.

Brian Weinstein, William Blair.

On the new Pronto product, the Pronto 7, there's a lot of different places that you could take that -- OB-GYN, pediatrics, family docs, oncology, blood collection centers, and others. Can you talk how you're going to address that with an initial salesforce of 20 going to 40? Where are you going to actually focus first and how are you going to make the determination on where you're going to focus?

Sure. You are correct, that there is a lot of opportunity. We calculate about 200,000 physicians' offices that could be -- in the US alone -- that could be good targets for Pronto 7. And, clearly, we wouldn't expect, with 20 or 40, even, salespeople to reach them appropriately.

However, we think it's important we start selling that product ourselves to make sure we understand all of the idiosyncrasies of selling such a product, and at the right time we anticipate bringing on board, most likely, on an exclusive basis, one of the large physicians' office distribution groups, such as PSS or Henry Schein or McKesson, and we are in dialog with them. There is interest on both sides, and we're going to have the challenge of choosing one.

But, again, we probably would not do it at the beginning. We would wait until we feel like we understand how to best to do this on a large scale.

And then on the accuracy of the product, I think you had mentioned at a dinner we had with you, that you want us to get it down to -- I think it 0.7. Is this where we should expect the product to be when it gets FDA approved?

Well, I try to think about what our accuracy claims were when we submitted it. I think -- just to let you know, we -- to keep things simple, we are seeking FDA clearance for accuracy of 1 g per deciliter, which is no different than where our current continuous non-invasive monitoring product is today, which is 1 g at 1 standard deviation. But the goal is to have it perform better than that, even if we don't make that claim. So that the overall experience of the user is more adjusted to what they expect than rather what you specify.

What I am saying by that is when you say accuracy is 1 g per deciliter at 1 standard deviation, that means it's 2 at 2 standard deviation and 3 at 3 standard deviation. So that means somebody could be off by 3, plus or minus, when they are doing a spot check.

So the goal we've had is to try to make that be, hopefully, closer to 1, no matter -- well, no matter what standard deviation, but even at 2 or 3 standard deviation, so that, again, the user experiences a better -- to what they expect rather than what we tell them.

Spencer Nam, Summer Street.

Just a couple of quick questions here -- among those 140-some-odd hospitals where the SpHb is already in, I'm curious whether you could share with us the usage pattern or the behavior of users with respect to SpHb? Is it concentrated amongst a few hospitals that have more experience? Or are we seeing a lot of interest from the new customers who have adopted recently?

Well, you are giving me the [second] question for an entrepreneur. So I'll try to hold myself back. We are excited about the hemoglobin, because we are seeing it's being used in a lot of great places. For example -- now I'm going to get into anecdotal data -- as I talk to our customers, they are using it in an operating room for better management of blood transfusion, and they're using it in intensive care units for basically detecting bleeding before it happens.

One of the surgeons that we are working with told us -- over time, he put it on 10 patients, and he believed one out of those 10 patients' lives were saved because of our device since he detected internal bleeding 30 minutes before they would have normally detected it.

So -- we are hearing news from OB-GYNs, especially outside the US where they are saying it's helping to detect the mom bleeding during delivery much sooner and, as a result, has helped reduce death, mortality.

So -- to answer your question, of the 145 hospitals that have hemoglobin, there is nothing particular about them. There is no sensitivity. People are using it in the OR and ICU and some even in the ED for trauma.

That's helpful. And then looking forward, you mentioned that there is a good pentup demand in Japan right now in some cases. I am wondering how you describe the US market in terms of demand. Are you seeing a lot of hospitals being interested in hemoglobin tests or is it still very much you guys trying to push this out to hospitals and have them take a shot at it, if you will?

We are seeing the latter -- well, maybe I should make sure I understand -- we are seeing strong demand in the US, as well, and in Europe. For example, the American Society of Anesthesiologists meeting this last October in New Orleans, I was impressed by how excited the clinicians were about hemoglobin. So you remember, we launched it at the ASA last year in Orlando, Florida, and that was the first time people were becoming aware of it.

At this conference, people were coming to our booth and wanting to learn more, wanting to have it in their hospital. From what I've been told by our marketing people, we had the most robust lead generation ever, and mostly it's around hemoglobin.

So, no, I think the message is out there. People appreciate the value of non-invasive hemoglobin. They're coming up with some really unique ideas of what else they could do with it besides just continuous monitoring hemoglobin. But, no, I think it's looking very positive.

There are no further questions. Mr. Kiani, do you have any closing remarks?

No, but I just want to thank you all for joining us. I appreciate your questions and your interest in our Company. I look forward to our next earnings call, which will be, hopefully, in February. We're going to try to do it sooner. So have a wonderful holiday season. Thank you.

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