Masimo Corp (MASI) 2010 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Masimo Corporation first quarter 2010 earnings conference call. The Company's press release is available at www.Masimo.com -- that is W-W-W dot M-A-S-I-M-O dot com.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. If you would like to ask a question during this time, simply press star and the number one on your telephone keypad. If you would like to withdraw your question, press the pound key.

I am pleased to introduce Sheree Aronson, Masimo Vice President of Investor Relations.

Good afternoon. Joining me are Chairman and CEO Joe Kiani and Executive Vice President Finance and CFO Mark de Raad, who will each make prepared remarks and then take as many of your questions as time permits.

Please note this call contains forward-looking statements. While these forward-looking statements reflect Masimo's best current judgment, they are subject to risk and uncertainties that could cause our actual results to vary. Risk factors that could cause our actual results to differ materially from our forecast are discussed in detail in our filings with the FCC. You'll find these in the investor relations section of our website.

With that, I'll pass the call to Joe Kiani.

Thank you, Sheree, and thank you, ladies and gentlemen, for joining us today. Masimo delivered strong first quarter results, with total revenues up 15%. Product revenues also rose 15%, including a 71% increase in Rainbow revenues. We also achieved a solid 34% increase in shipments of Masimo SET and Masimo Rainbow SET units. These results prove once again the superiority of our technology and strength of our mission, which is to improve patient outcomes and reduce the cost of care by taking non-evasive monitoring to new sites and applications.

Our first quarter progress can be summed up by four key points. First, our core SET business outpaced both market and competitor growth with a 13% year-over-year rise in revenues. This performance signals additional revenue share gain by Masimo, coupled with our strong OEM board and Radical-7 and Rad-87 shipments, it makes clear that hospitals are increasingly turning to Masimo SET pulse oximetry not only for deployment in acute care, but also on the general ward, where our patient safety net monitoring system connects caregivers to patients, resulting in improved patient safety and reduced cost.

Second, our Rainbow platform continued to advance, with year-over-year sales up 71%. We experienced growth in both licensing and sensor revenues, and in general are happy with the progress in all Rainbow categories. The only exception are Rad-57 revenues, which were down slightly due to cannibalization by our OEMs, specifically Medtronic Physio-Control and [Zoll] defibrillators with Rainbow, and continued EMS market weakness tied to local and municipal budgets.

Importantly, in the EMS market our year-over-year Rainbow SpCO and SpMET unit sales grew by over 75%. Unfortunately, because our license fees are significantly lower than our standalone Rad-57 unit ASPs, total revenues were slightly down year-over-year.

During the quarter we also prepared for the launch of two new Rainbow products -- Rainbow acoustic monitoring and respiration rate monitor and Pronto hemoglobin spot-check device. We remain enthusiastic about the long-term prospects of Rainbow and expect sequential and year-over-year growth for the balance of 2010.

Third, we continue to invest in our future. Our first quarter R&D spend equaled 11% of product sales again this quarter, as we pushed forward on our new product roadmap. Also, we moved closer to completing a multi-year initiative to expand our global sales organization and structure. We believe that our robust 44% rise in international revenues, 37% in constant currency in the first quarter, is testament to the value of this initiative.

Thinking more broadly of ways to benefit patients and caregivers and make a positive long-term impact on the strength and vitality of the healthcare market, we also established the Masimo Foundation for Ethics, Innovation and Competition in Healthcare.

Lastly, our strong financial position allowed us to return significant capital to stockholders. On March 31st, 2010 we paid out $117,500,000 to stockholders through a special $2 per share dividend, which is our second dividend in the past four years. This dividend reflects our healthy balance sheet, expectation for continued positive cash flow, and confidence in future growth.

Despite the dividend payment, we finished the quarter with $112 million in cash and short-term investments, and no debt. Overall, the healthcare market remains challenging, but as our first quarter results illustrate, we're seeing positive signs as more and more hospitals engage in contract discussions and appear more willing to upgrade to Masimo technology.

We believe the superior performance of our core SET technology and the broad clinical advantages of our Rainbow platform combine to form a powerful message to hospitals -- that we can help them deliver better care at a lower cost.

I'll provide an update to our strategy and highlight some of the new opportunities we see for Masimo in more detail in a few minutes, but first Mark will review our first quarter financial results. Mark?

Thank you, Joe, and good afternoon, everyone. First quarter 2010 total revenues rose 15.5% compared to the same prior year period, to $98.8 million. This included a 15.3% rise in product revenues to $85.9 million and a 17.3% increase in royalty revenues to $12.9 million.

The increased year-over-year royalty revenues were based on Covidien's higher-than-expected Q1 2009 royalty payments, which we received in Q2 2009 and have factored into our Q1 2010 estimated royalty revenues.

Favorable year-over-year foreign currency exchange rates added approximately $1 million to the first quarter international revenue totals. Note that this positive foreign exchange benefit to revenue was offset to a large extent by approximately $600,000 in increased year-over-year operating expenses.

As Joe indicated, product revenue growth was driven primarily by Masimo's SET revenues, which rose approximately 13% to $80.5 million in the quarter, as we continued to extend our reach into more hospitals worldwide. First quarter 2010 revenues generated from our end user or direct business, which includes our sales through our just-in-time distributors, were up approximately 14% to $68 million, and represented 79% of total product revenues.

OEM revenues made up the remaining 21% at $17.8 million and represented a strong year-over-year increase of nearly 19%. This strong increase is due, we believe, to some pent-up demand carried over from 2009, and our ability to continue to garner a higher percentage of our OEM partners' pulse oximetry sales due to hospitals continuing to demand Masimo's SET and Rainbow SET technology.

First quarter Rainbow revenues were $5.3 million, up approximately 71% compared to the same period last year. The rise reflects higher year-over-year sales of license parameters and sensors, offset, as Joe mentioned, by significantly lower Rad-57 sales due to the cannibalization by Physio-Control and Zoll-related products, as well as the continued constraints on state and municipal EMS budgets. As a side note, lower Rad-57 sales were also the primary factor in the sequential decline in Rainbow revenues versus the fourth quarter of 2009.

Looking at the first quarter product revenues by geography, US revenues totaled $60.9 million, up approximately 6% compared to $57.2 million in the same period last year. This increase, which is lower than our historical norm, is due, we believe, to a combination of factors, including longer installation periods, a higher mix of OUS versus US-OEM revenue growth, and the impact of some pricing pressure, especially related to some unique contracts that we signed in 2009.

Through the first quarter of 2010, however, we see signs of a more stable pricing environment and we are very encouraged by the strong first quarter US drivers shipments, which should continue to add to additional quarterly increases in year-over-year US revenues.

Product revenues outside the US were $24.9 million, up approximately 44% or 37% on a constant currency basis. Importantly, each of our international regions contributed double-digit growth. This was the second consecutive quarter that total OUS product revenues reached 29% of product revenues, which we believe is an indication that our past and continuing multi-year investment to build an international sales organization is working.

As we previously noted, we achieved strong growth in our worldwide installed driver base in the quarter. Excluding handheld devices, we shipped 37,100 new pulse oximeters and pulse co-oximeters compared to 27,700 in the same period last year, and 30,400 in the immediately preceding fourth quarter of 2009.

We now estimate our total worldwide installed base at the end of the quarter, net of estimated retirements, at about 757,000 drivers. That's up 16% from 651,000 drivers one year ago.

Continuing with the income statement, our gross profit margin was 66% in the first quarter compared to 66.8% in the same period last year. The slight year-over-year decline is due to a combination of higher OEM board sales, which carry lower margins, along with unfavorable manufacturing variances due to the transition of production to Mexicali, and selected first quarter 2010 inventory reserves we took related to our SBHB sensor improvement and transition.

These additional inventory reserves reduced our first quarter gross profit margin by approximately 50 basis points. Total first quarter gross profit margin, including royalties, stood at 70.4% compared to 71.1% in the same period last year. The decline is due primarily to the same factors that I just noted.

On a GAAP basis, our first quarter 2010 operating expenses were $28.8 million, which included a $30.1 million, one-time gain related to the resolution of an antitrust lawsuit against Covidien, offset by $10.9 million in related one-time marketing expenses. This one-time spending is included in our SG&A expenses and reflects approximately $10.3 million to fund the new Masimo Foundation, with the remainder used to fund various educational programs, grants and some clinical research designed to accelerate Rainbow awareness and adoption.

As we discussed in last quarter's conference call, we had planned to deploy approximately $15 million of the gain for various marketing initiatives, including the possible establishment of a foundation. We continued to evaluate other one-time marketing-related expenses and depending on our review, we may or may not incur the additional $4 million later this year. However, should we continue to incur any of these additional one-time marketing and clinical research expenses, we will identify them and discuss them separately in future quarterly calls.

Excluding the one-time items, our first quarter total operating expenses were $47.8 million, up 17% from $40.7 million in the prior year quarter. This increase was due primarily to $4.1 million in higher payroll and payroll-related expenses associated primarily with our continuing worldwide sales force expansion.

Legal expenses also rose by approximately $800,000. As I previously noted, nearly $600,000 of the increase in expenses was due to foreign exchange conversion rates.

Finally, as you will recall, in the fourth quarter of 2009, we invested approximately $3 million in SEDLine, a newly formed private company focused on neuromonitoring technologies. Also, pursuant to ASC topic 810, Masimo is required to consolidate SEDLine, and as a result our first quarter, 2010 statement of operations included nearly $787,000 in operating expenses from SEDLine.

It is important to note that although we are required to consolidate SEDLine's net operating loss in our consolidating income, we are not required to include SEDLine's net loss in our EPS calculation. As a result, SEDLine's net loss is removed from our EPS calculation in the line item entitled net income or loss attributable to non-controlling interests.

Our first quarter 2010 research and development expenses totaled $9.4 million, which was a 21% increase from $7.8 million in the first quarter of 2009. The rise is due primarily to increased engineering headcount as well as higher clinical engineering, project-related and supplies expenses.

Our first quarter 2010 operating income was $40.8 million, including $19.2 million related to the benefit of the $30.1 million in proceeds for Masimo's antitrust litigation against Covidien, offset by $10.9 million in one-time marketing expenses.

Our first quarter 2010 effective tax rate was 35.3% compared to 34.3% in fiscal 2009. The slightly higher tax rate is primarily due to our inability to benefit from R&D tax credits in the first quarter of 2010 and the impact of the net gain from the Covidien litigation, which is all US-based income. If and when the US government enacts the R&D tax credit legislation in 2010, we expect to be able to benefit from that, which will result in a tax rate more commensurate with 2009.

First quarter 2010 net income was $26.7 million, or $0.44 per diluted share. As we've discussed, this included approximately $0.20 associated with the net $19.2 million one-time gain. Excluding the one-time items, our diluted EPS would have been $0.24. This compares to $0.22 in the first quarter last year.

Weighted average shares outstanding for the first quarter were 60.5 million compared to 60.2 million for the same prior period.

Now turning to a few quick balance sheet items, at April 3rd, 2010, total cash and cash equivalents and short-term investments were $112.1 million compared to $189 million at year-end 2009. This $76.9 million decline is due entirely to the $117.5 million dividend payment we made at the end of March. Excluding the impact of the dividend payment, cash rose by $40.6 million, due primarily to the $19.2 million in net cash received from the combination of the $30 million in antitrust litigation receipts less the $10.9 million in associated market expenses. In addition, we generated $5.4 million in proceeds from the issuance of common stock, while the remainder was generated from operations.

At April 3rd, 2010, our day sales outstanding stood at 49 compared to 44 at year end 2009. Inventory turns were 3.5 versus 3.4 as of January 3rd, 2010.

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

Thank you, Mark. As you've all heard me say many times before, I believe Masimo is still in the early stages of executing an exciting, long-term growth strategy.

We are riding three technology adoption curves--first, Masimo SET pulse oximetry and the $1 billion critical care market, where we are in the steep part of the S-curve; second, Masimo's SET pulse oximetry in the general ward, also estimated to be a $1 billion market, where we are just beginning to enter what we believe will be a fairly aggressive S-curve ramp; and third, Rainbow, estimated to be a $2 billion market, with most measurements just beginning to form the S. This is a tremendous opportunity that we are addressing by continuing to maintain our technology leadership by inventing new measurements and improving our current measurements, and establishing a critical mass sales force in hospital and alternate care markets worldwide.

What inspires and drives the Masimo team to deliver against these objectives is the chance to make a meaningful and lasting impact on patients' lives by providing caregivers the resources they need to make better and faster decisions.

We made some important strides in the first quarter, which I'd like to review briefly before opening the call up to your questions. Based on our double-digit SET revenue growth and our 34% year-over-year increase in new driver shipments, we're confident that we grew our share of the pulse oximetry market during the first quarter, both in the US and internationally.

We're seeing better demand, not only in acute care but also in the general ward, where the combination of our Masimo SET technology and patient safety net monitoring system, is capturing the attention of caregivers and administrators for its ability to cost effectively enhance response times to patients in distress and ultimately reduce sentinel events.

In fact, with the Masimo SET and patient safety net groundbreaking general floor study by Dartmouth-Hitchcock, I believe we have reached a tipping point in the adoption of Masimo SET pulse oximetry on the general floor. For the first time, hospitals see that they can provide better care for patients and reduce costs.

We believe that combining the general floor study with what has already been proven to date about Masimo SET, including reduction of retinopathy of prematurity in the neonatal ICU, detection of congenital heart disease, reduction in sensor waste, reduction in ventilation amount and reduction in unnecessary blood gas could yield total annual US healthcare savings of roughly $5 billion if all US hospitals implemented Masimo technology to its maximum potential. Given the bright spotlight now being focused on healthcare spending, we believe these numbers establish a timely and compelling rationale for adopting Masimo technology by all hospitals.

To further extend our impact on the general floor, we continued in the first quarter to prepare for the full market release of Rainbow Acoustic Monitoring, which we call RAM. In the second half of this year, we hope to begin the full market release. RAM non-invasively and continuously measures respiration rate via an adhesive sensor and integrated acoustic transducer applied to a patient's neck. Continuous monitoring of breathing status is especially important for post-surgical patients receiving patient-controlled pain medication -- so much so that the Anesthesia Patient Safety Foundation recommends continuous oxygenation and ventilation monitoring in all patients on opiate-based pain medications.

We expect the introduction of RAM to represent a significant step forward in hospitals' ability to comply with this recommendation, given its advantages in terms of ease of use and patient comfort and compliance. Using Masimo Rainbow pulse co-oximetry and RAM, we will allow clinicians to follow not only a patient's oxygenation but also circulation through Masimo SET pulse rate, ventilation through RAM respiration rate monitoring, bleeding through SpHB, and fluid responsiveness through PVI.

Together, these measurements provide immediate and critical information to aid decision-making and action, which often revolve around when and whether to give fluid or transfuse blood.

SpHB plays an important role in helping clinicians continuously identify stable and safe hemoglobin levels that prevent unnecessary blood transfusions, especially during surgery. This has the potential to reduce patient morbidity and mortality while also lowering costs.

In fact, a study published in the April issue of Transfusion estimated that the actual fully loaded cost for a unit of blood was up to nearly $1,200 per unit -- higher than previous estimates. This study prospectively analyzed more than 20,000 surgical patients, mapping all activities involved in the transfusion of blood in real-world surgical settings.

The research not only showed that total annual blood costs are largely driven by transfusion rate, but also provided a roadmap for institutional administrators to evaluate hospital processes in order to reduce and optimize blood usage. We believe Masimo SpHB can play an important role in this effort.

Another study conducted at Cincinnati Children's Hospital and Medical Center showed that SpHB provided total hemoglobin accuracy, comparable to point-of-care invasive measurements versus standard invasive laboratory tests. This was the first SpHB study presented in pediatric patients, and the anesthesiologist in chief at Cincinnati Children's Hospital said the results indicated that SpHB has the potential to replace the need for invasive blood draws in infants and children undergoing surgery.

We expect these and other studies, along with customers' real-world experience using Rainbow, to continue to spur new demand and allow us to build on the 71% year-over-year Rainbow sales performance we posted in the first quarter, delivering nice growth rate throughout the rest of the year.

In terms of furthering Rainbow adoption, we're also enthusiastic about the prospects of Pronto -- the first-ever handheld device for non-invasive hemoglobin spot-check testing.

Hemoglobin is among the most commonly ordered tests in both in and outside the hospital, in part because it is critical to assessing anemia. Until Pronto, the only way to assess hemoglobin status in the physician's offices has been through a needle stick and invasive, time-consuming blood tests.

Conversely, Pronto provides a painless hemoglobin reading in a couple of minutes. We see applications across various healthcare settings and are targeting our sales and marketing efforts towards physicians' offices, clinics, blood donation centers and hospital emergency departments.

We also have a new product called Pronto 7 that has been designed specifically for spot-check SpHB, and is capable of measuring SpHB in 45 seconds. We expect to begin a limited market release in Europe in the second quarter, with full market release in the second half 2010.

Recall that in the US our hemoglobin spot-check measurement will be reimbursed at $7.19 per test for eligible patients for the 2010 CPT code designations. We expect this to help provide a financial justification for office physicians to deploy the device in their practices.

Pronto and soon to come out Pronto 7 is emblematic of our constant focus on breakthrough innovations with market-changing potential -- solving the unsolvable problems. This focus forms the foundation of our success thus far and is the key to maintaining our technological leadership moving forward. Equally important to pursuing excellence within Masimo is doing our part outside the Company to promote a healthcare environment that thrives on competition, provides paths for new ideas and strives to make better care available to more patients at a lower cost.

With this in mind, we have formed the Masimo Foundation for Ethics, Innovation and Competition in Healthcare. This nonprofit foundation will facilitate Masimo's philanthropic efforts. As announced last week, we funded the foundation with $10.3 million from the Covidien antitrust award, which seems to us a worthy and fitting use of these dollars, as well as another way for us to demonstrate our commitment to do what is right on behalf of patients.

We hope this gift begins a long and impactful effort by the Masimo Foundation and others to support programs and research that improve patient safety and deliver advanced healthcare to people worldwide, find better and most cost-effective healthcare solutions and protocols, and create an environment of healthy and ethical competition, which we believe is the ultimate answer to lowering healthcare costs across the US and throughout the world.

With that, Mark and I will take your questions.

(Operator instructions.)

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

Good afternoon, everyone.

Hello, Bill.

Hi, Bill.

So Joe, you had a comment in I think it was your first set of prepared remarks talking about expectations for sequential year-over-year growth through the balance of the year. Were you referring to the overall business or specifically Rainbow?

Both. Both. We believe we should continue to enjoy sequential growth as well as obviously stronger year-to-year growth with both SET and Rainbow. Now, while the Rainbow may not be happening at 71%, we expect it to be at healthy levels and makes us feel good about the present and the future.

So just to get a better sense, Joe, as to the impact of Rad-57 on that metric during the quarter, can you help us think, at least in rough terms, what the overall mix of Rainbow is between sensors and license fees, et cetera?

Yes, let me try to do that for you. First of all, our unit sales of Rainbow licenses was up over two times compared to same quarter last year. But because some of that now is happening by our OEMs, like Medtronic Physio-Control and Zoll, the overall revenue from that business, from that license sale, has been slightly down.

Our total Rainbow sensor sales have seen a very nice increase -- again, unit-wise -- but again, because of the mix that is shifting from the disposables to the resposables is the reason we saw the kind of growth we did. Otherwise, the growth unit-wise, it was very robust, much more than the numbers we gave you for the total revenue growth quarter-to-quarter, year-to-year.

Okay, very good. Then just last one for me, you guys didn't touch on it but in terms of the overall 2010 guidance, do you still feel comfortable with the numbers that you put out after the fourth quarter call?

Okay, let me get to my lawyer's cheat sheet to answer your question on that. Basically, as you know, we provided guidance for 2010 in our earliest release, issued on February 16, 2010. It is our policy not to update annual guidance unless there are material developments which cause management to believe that our revenues, or earnings per share, will be significantly outside the range previously provided.

Based on currently available information, we're not providing any update to our annual guidance issued in February.

Said another way, if you thought you guys were going to meaningfully exceed or meaningfully miss it, you'd say something, but since you're not saying anything it's reasonable to assume that things are generally going to be in line?

I think that's a good conclusion.

Very good, thanks, guys.

Thank you.

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

Hi, good afternoon. This is actually Imron Zafar in for Teo. Thank you for taking my question. Just a follow-on to Bill's question, and sorry to be nit-picky here, but in terms of your confidence in the sequential growth in Rainbow over the balance of the year, does that include contribution from RAM and Pronto in the back half of the year, and an increase in EMS spend? Just trying to get an apples-to-apples sense of how we should think about growth within the Rainbow portfolio.

Yes, yes, it certainly does include Pronto and RAM in it, but I would say to you that we would see sequential growth even without those [patient option rates].

Okay. I'm sorry. Then just a little more detail on the non-invasive -- the SpHB launch. Can you just talk to me, even in qualitative terms, Joe, about the interest level from hospitals? I know you've commented on this in the past. How is that looking from a qualitative perspective?

It's looking very good. We like what our customers are seeing with the product, both its performance and the clinical utility it's providing them. We like the increased word-of-mouth that's going around about successful usage of the product, and the overall demand for SpHB.

Okay, great. Then once you place the hemoglobin technology in a hemoglobin, those within your current installed base, how are the utilization trends tracking in terms of over the last couple of quarters, those early adopters? Are you seeing an increase in usage within that institution?

I don't have institution-by-institution numbers, but what I can tell you is we are getting usage based on the macro level of sensor increase that I alluded to earlier and my own personal contact with the number of customers I've been in contact with.

No one's put it back on the shelf. Everyone is using it. In fact, they're using more, they're wanting to buy more, so we're feeling very good, especially for a new product that hasn't had routine usage. For it to find its way in normal use day to day, it's very reassuring.

Now, as I said earlier, we are on the S-curve technology adoption, so we're at the beginning of that. obviously, we're dealing with early adopters. We hope to get to the steep part with the mass market, so I don't -- by answering your question I also don't want you to think that we think everything is perfect.

It should be perfect, but you can't tell until you move from early adopters to the mass market.

Okay, and then one last quick question on procedure volume trends intra-quarter. We've seen some conflicting commentary from the procedure-sensitive med tech companies. Can you just give us some observations on what you saw intra-quarter on procedure volumes, and maybe what impact the light flu season had on sensor volumes? Because you did post a very good sensor number, notwithstanding the light flu season. Thanks.

Sure. Obviously, Q4 of the year and Q1 of the year is the flu season. I don't think we -- fortunately, we did not see an epidemic swine flu problem like we had worried about, but my belief is we did see some seasonal increase in our sensor volume.

But given the strong drivers that we shift in Q1, I'm not expecting that seasonality to cause an issue for us going forward. I don't know if I'm clear, but I think we should be able to maintain the growth because of the strong placement of the 37,000 Masimo SET and Masimo Rainbow SET units

Okay. Thanks so much.

Thank you.

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

Great, thank you. Joe, you mentioned it a few times, I saw it called in the press release as well, but just wondering if you can just give us a little more color on what you're seeing in the general ward and how that patient safety net product is driving things.

Is this something that you think is going to be a substantial part of the revenue contribution or growth contribution going forward, or how should we think about that? Thanks.

I'm going to give you my best answer, but it may not be the right answer. My best answer is that we feel like we've hit the tipping point with general floor monitoring, and we're not yet at the revenue level at the steep part of the S-curve, but we certainly are at the demand level and interest level at the steep part of the S-curve. It looks like the combination of the Dartmouth-Hitchcock study showing the value of patient safety net as well as word of mouth at other institutions that have been using it is not only driving -- I want to say just about every customer in the US that I've been in touch with to want to move into general floor monitoring, continuous monitoring, which is very exciting.

But even the ones that we've been working with in the past, expanding beyond what they thought they were initially going to do, which for some of them was okay, we're just going to do post-orthopedic surgery ward, and they're going just about to every bed in the ward.

So it is a very exciting time. We're actually working hard to keep up with the demand, and we don't want that to ever be an issue. But hopefully, I'm right and the next several quarters and years we'll be able to look back and see that it really was the tipping point.

That's helpful, Joe. Then on the OEMs, it's nice to see you have a good quarter there. Seems like it might have been a little bit of pent-up demand. How sustainable is that trend going forward? Do you think you've kind of -- was this a one-off quarter or are you back to maybe more normal ordering patterns? Thanks.

Again, the best information I have, this is not a one-time event. It looks like we're heading towards a good year. Now, we've heard from some of our very larger OEMs who employ economists and the like telling us the second half may not be as strong for them as the first half, so I can't really tell you about Q3 and Q4 all that well.

But I can tell you it's been a combination, as you said, pent-up demand as well as an increase in the percentage of demand within those companies for Masimo technology versus competitive technology. More hospitals are seeing the benefit of our technology and asking the OEMs to deliver Masimo by name and specifically demanding Masimo.

Okay. Thanks for the color, Joe.

Thank you, Sara.

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

Good afternoon.

Hello, Matt.

Mark, for the revenue split, this is the second straight quarter the OUS has grown a lot faster than the US. I know you're putting more resources there, but can you give us any color if any region is outsized growth versus some of the others? I guess there's three I'd highlight -- like Western Europe, Japan and then kind of all other. Just any color you can provide us on one of those regions?

Well, Matt, as I said in the prepared remarks, the good news is we had double-digit growth in every region throughout the world. Your question more specifically on which specific region, certainly we saw strength in our EMEA region, Japan was very strong for us, and then I'll call out a couple of sub-elements of the rest of the world.

We had a very nice quarter in Canada and also some nice activity that we're seeing in Australia.

Do you think a lot of that relates to the expansion you've made in the sales force internationally or do you feel the growth internationally has been stronger, in terms of pulse oximetry market?

Well, the investment, certainly, that we've been making over the last two, three years and continue to expect to make for the rest of the year this year we believe is the primary reason. We've got today probably about four times the number of feet on the street that we had in these regions about three years ago. A lot of that hiring was done the early part of last year.

So we believe that as we said in the earlier remarks, that the investment that we've made, and you know this is a business that unfortunately requires a bit of a longer sales cycle than most, so we think the investments over the last couple of years are beginning to pay off in all of these regions around the world.

Thanks, Mark.

Your next question comes from the line of Peter Lawson with Thomas Weisel.

Mark, I wonder if you could just comment upon the negative manufacturing variances and whether those are going to be disappearing in 2Q?

Sure. Well, I think if you go back to the prior maybe three or four calls that we've had, we've occasionally mentioned the fact that some of our positive margin movement quarter-over-quarter has been due to favorable manufacturing variances.

This quarter marked what we essentially believe is sort of the final major push of our production activity from Irvine down to Mexicali, and so as a result there was a bit of a overlapping hiring process that went on in this quarter, where we had to hire people in one location and get them transitioned as quickly as possible, obviously, before we could make the appropriate adjustments at the other location.

So that's primarily what generated the event in this quarter, and we don't think it's something that will continue.

Thank you, that's helpful. Then I wonder if you could elaborate on the pricing pressure you talked about in North America. What was responsible for that?

Well, the comment that we made, I think, was in a reference to 2009, and obviously 2009, the year we all just came out of, was an extremely difficult one economically. We had, throughout the year, the challenge of convincing customers to complete contracts with us in an environment where they were unsure of their own financial situation.

So as a result, as you can imagine, pricing pressure was such that on occasion we entered into certain deals last year at price points that at least historically were lower than what we had seen.

As I alluded to in the comments, the good news is we believe that sort of unique economic environment that was precipitating some of those larger-than-usual pricing adjustments has ended, and that we're looking at a much more stable pricing environment going forward.

So those should roll off this year, basically.

Well, remember, most of those contracts could be contracts anywhere from three, four, five years, so the impact of any one-off pricing deals that we would have done in 2009, those will continue with us for a while. My comments are more in relationship to the new contracts that we'd be signing, and of course those new revenue streams would be laid upon the building revenue streams from the over 700 long-term sensor agreements that we have today.

Okay, thank you so much.

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

Thank you so much for taking my question. A couple of things. You had commented that the litigation expense was about $800,000 higher than you had expected. Anything in particular there?

No, we didn't say it was higher than expected, we just said it was the reason for the increase year-over-year. Remember, we went into this year, and actually we went into the back end of last year highlighting the fact that the litigation that we had ongoing at this stage was something that was front and center as we looked at our operating expenses, and clearly, it was a risk to our total operating expenses.

But I wouldn't say actually the number that we called out as a reason for the increase wasn't necessarily a surprise to us.

Okay, so maybe it was just a surprise to me. My second question has to do with is it fair to say that the hemoglobin revenue, while you won't break it out, is sequentially increasing?

I would say in general that our hemoglobin total revenue levels over the last couple of quarters have been in a fairly consistent range. Some quarters up, some quarters a little bit down, but very, very consistent.

Is it that you're still in the new adopters and haven't gone broader yet? And if that's the reason, what does it take to go broader?

I really believe it's the transition of customers from disposables, which had an [ASV] of over $100, to resposables, which have an ASV of about $50, because the actual volume is up --

75?

The actual volume is up 400%.

That's very helpful. Thank you very much.

Yes.

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

Good afternoon. Just hoping to get a little bit of clarification on Pronto. Is it fair to say that you will not really launch the product until you get approval of the Pronto 7? In other words, that the first generation product will not be what's really launched here in the US?

No, that is not correct. We have launched Pronto, full market release, earlier this quarter in the US. We have not launched it internationally because we have a predictable path to launching Pronto 7 internationally since we don't have to wait for FDA clearance.

So the plan is to launch Pronto 7 in a limited market release in this quarter, and then by second half of the year do a Pronto 7 full market release, and we don't know when we're going to get FDA clearance, but when and hopefully if and when we do, obviously we'll launch it full market release in the US at the same time.

But Pronto is selling in the US, physicians' offices, and we've gone from limited market release of that to full market release.

Can you remind us when you submitted Pronto 7? I think it was in the fall, is that correct?

Yes, it was. It seems like a long time ago. I think as you may be aware, everything is taking longer with the FDA. We've had some dialogue back and forth with them about the application, and we have been waiting, but there's no assurance of when and if we're ever going to get the clearance.

So we have as a result launched the Pronto just to make sure we get started, and hopefully when Pronto 7 gets released, it's a better product and we're anxious to launch it in the US as well.

Great. My last question is when you guys are talking about patient safety net and really getting through the S-curve here pretty quickly and moving along that curve, it seems like it's quicker than what you originally thought. Was this what you were thinking when you guys provided your guidance back three, four months ago, or have things really -- it seems like things have really accelerated since then.

Well, yes, things have accelerated further than we expected. However, I want to caution you that there's a long cycle of installations for patient safety net, so while we have a lot of interest and a lot of contracts, a lot of them have not been deployed yet. So the revenues, it's going to take a little time for them to start adding up.

Okay. Great, thanks.

Thank you.

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

-- taking my questions. Just have a couple of questions. Just have a couple of questions here. So I think it may have been you, Joe -- you mentioned that looking at the S-curve adoption of the hemoglobin test, that we may be at the steep part of the demand cycle, if you will, but adoption may be a little bit behind.

What brings the gap closer? What do you think is -- why are these physicians who may be interested in the device still kind of waiting on the sideline?

Well, I believe I mentioned that we're in the steep part of the interest and demand in talking about patient safety net systems on the S-curve. With Rainbow and hemoglobin specifically, I didn't call it out but I said Rainbow measurements, I think we're at the beginning of the S-curve, although we're seeing great interest, great demand, but obviously the numbers are not that big yet.

But I think still, to answer your question, what's bridging the gap between what we believe ultimately is going to be a very successful product commercially to where it is today, I think it's a combination of us understanding the first killer market, killer app market, for this technology as well as clinical studies and research coming out and validating what some early studies have shown. And of course user word-of-mouth, acceptability, I think those all kind of go together.

I appreciate that. Second question I have is is there any update on the discussions between -- I don't know if you guys are even having a discussion with Covidien about the royalty issues beyond the first quarter of next year.

No. As you can imagine, we're not on daily speaking terms, so no, there isn't any, and unfortunately I have nothing new to report to you on that.

Okay, thank you.

You're welcome.

Your next question comes from the line of Matt Dolan with Roth Capital.

Hi, guys, good afternoon. Just a couple of quick follow-ups. Mark, first, can you talk about where you are on your infrastructure build this year, relative to the pro-forma operating spend we saw in Q1? How should we think about continued investment going forward?

I think, Matt, from a calendar standpoint, obviously we've completed one-fourth of that calendar, so I think even from a headcount standpoint the assumption should be that you'll see additional headcount increases throughout the rest of the year, which will, at least sequentially, cause expenses to continue to climb as we move out into the next couple quarters.

Having said that, there are always a few expenses in the first quarter that are somewhat unique, so we expect some of those expenses to decline a little bit as we move forward.

So overall, we're still comfortable with the guidance that we provided back in February in terms of our operating expense range and the build-out of our infrastructure should fit within that.

Okay, great. Then looking to the foundation and some of the special marketing initiatives using the Covidien antitrust money, what are you expecting from -- is there any numerical impact you're anticipating, or some type of fundamental benefit, particularly from the marketing programs, that they are looking for later this year?

Yes, well I can tell you that obviously we wouldn't do it if we didn't expect something to come out of it, but using the money we're investing in more clinical research activities than before and maybe some advertising or unique marketing work with the hope that the combination of all these is going to increase the awareness of the benefits of our technology.

But as you can imagine, in marketing, you never know what part is going to work, and the timing of it, my guess, it won't be immediately felt, it'll be more slowly felt.

Sure. Okay, and then finally, on a little bit of a longer-term question, you paid out the dividend in March. Can you touch on any business development plans in the future for the company, and also maybe the new measurement pipeline? When should we think about the next product coming?

Business development wise, we're constantly looking at new opportunities and we to date have not seen anything that we have felt was worth the risk of taking our eyes off the current ball that we have in our hands that we think has got a lot of room for growth.

One of the exciting things at Masimo is that our revenue run rate is let's say, I don't know, $350 million, but our total market potential is somewhere around $4 billion. So we feel that we have a lot of head room for growth and as far as new parameters are concerned, I'm not sure we'll deliver on this but our hope is to deliver a new parameter or a new measurement every year. so we're feverishly working on several exciting fronts with the hope that they'll start coming out like they've been coming out the last few years, year after year.

Great, okay. Thanks a lot, guys.

Thank you.

Thanks, Matt.

Your next question comes from the line of Larry Kush with Morgan Keegan.

Hi, good afternoon, guys.

Hi, Larry.

Just a couple questions. Joe, just to make sure that I understand this, in terms of pushing out pulse oximetry into the general floor areas, it sounded like you're saying that interest is growing, perhaps at a rate better than you guys had been thinking. A lot of that's being driven by the Dartmouth-Hitchcock study. It also sounded like you indicated that there are some contracts being signed that haven't necessarily translated to revenues yet.

But I just wanted to make sure that I'm getting that. It feels like there's some increasing momentum under this.

Yes, you are correct. Again, like I said, I'm giving you the best answer I can at this point, and at this point we feel that that market is happening. It's right now, it's alive and we are the company that people are coming to most, but it is happening and we believe it's a $1 billion market that is barely penetrated and it's about to go.

Got you, okay. Then you used the word, when you were talking about your expectations for the launch of RAM in the second half of 2010, I think you had in your prepared comments that you said that you hope to launch it in the second half of 2010. So I just wanted to again make sure I'm understanding correctly what you're saying. Is there something that would cause that not to happen?

Well, if we got any negative reaction to the product, things that we felt that we couldn't complete in time, yes, but I can tell you, so far we've done limited market release at a few sites and the reaction has been very positive. In fact, I know at least one of those sites has now gone all over their place with RAM.

So no, I used the word hope because, well, it is the word of the year, maybe the decade. But I used the word hope because until it's out, it's not out.

Got you. I just wanted to make sure I understood that. Then lastly, just for Mark, two questions here. Just kind of help us -- and you kind of touched on this earlier -- but again, what are the targets for the sales force expansion for this year, and then secondly, your DSOs were up. I'm assuming part of that is driven by your OUS sales, and also you had about a $2.5 million increase in your deferred revenues in the quarter. I just want to make sure I'm clear on what's happening on those metrics.

Sure. So first of all, in terms of where are we on the sales force expansion, you're right, I alluded to that before, but just more specifically, today throughout the world we're probably at about 160, 165 direct sales reps. 200 is the number that we have been articulating, really for the past two years or so. That still is the number that we're headed toward.

Okay.

On the DSO question, you're absolutely right. The two factors that contributed to that increase, number one, were the increased level of revenues outside of the US, and as you probably are aware, in general terms, outside of US are a bit more lengthy than here in the US, and we've actually experienced some collection issues in some parts of the world, as you can imagine, that are struggling -- Spain being a good example.

So some of our DSO numbers internationally have expanded a bit over the last quarter, and then the other portion of that, you correctly pointed out, was an increase in deferred revenue that we had this quarter as a result of a contract that we closed during the quarter, and are going to have to recognize that revenue over a period of time.

So that accounts receivable goes onto the balance sheet and it becomes an element in the computation.

Got you. Okay, terrific, thanks very much.

Okay.

Your next question comes from the line of John Putnam with CapStone Investments.

Yes, thanks very much. Joe, I was wondering if you could give us a little color on the foundation in terms of staffing and expenses, ongoing expenses, and perhaps the need to contribute to the foundation at some point greater than the initial contribution.

Well, are you guys going to invest in it? Is that --

We don't have any staff, per se. We really want to keep it at a board level that does most of the work. We do have one part-time person that's going to take care of the back office for it, and I think the point of it is we want to make sure the money gets to the right people instead of to a staff.

But secondly, as far as the future, whether we're going to put more money into it, it's possible. I think there might be other nice events that are outside our normal business that may come in that will prompt us to want to put more money into it. But we feel very good about the current funding of it and I think it can do some real good for healthcare as it is right now.

Thanks very much.

Thank you. Now just if you don't mind, we're doing a time check here, it's about 2:30. Maybe we'll take one more question.

Your final question comes from the line of Greg Brash with Sidoti & Company.

Good afternoon, guys, thanks for squeezing me in. I know you're not changing your guidance here, but do you still -- with some of the trends you're seeing in Rainbow, Rad-57, you may see more cannibalization through the year and you may see more conversion to resposable from disposable sensors. Are you still comfortable with the guidance you outlined of $30 million to $35 million in Rainbow for 2010?

Yes, Greg, I think as we said earlier, all we can really do today is just reiterate what we said back in February, and as Joe alluded to before, that's essentially what we're doing today.

Okay, fair enough. Then the general floor and the demand you're seeing there, is that primarily a US phenomenon?

Yes. Yes, we're seeing some pockets of interest in other countries, but really, this tipping point that I've mentioned is happening here, not anywhere else.

Great. Thanks for taking my questions.

Thanks Greg.

Thank you all. I want to thank you all for joining us this afternoon, and I'm happy that unlike last year, which this time we had a wonderful quarter to report but we had to caution you about the future. We don't have to do that. We hope to speak with you all one-on-one, and hopefully together very shortly. Thank you for your time.

Thank you. This concludes today's conference call.