Masimo Corp (MASI) 2011 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Masimo's fourth quarter and full year 2011 earnings conference call. The Company's press release is available at www.masimo.com. At this time, 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 am pleased to introduce Sheree Aronson, Masimo's Vice President of Investor Relations. Please proceed, ma'am.

Hello, everyone. Joining me today are Chairman and CEO, Joe Kiani, and Executive Vice President of Finance and CFO, Mark de Raad. This call will contain forward-looking statements which reflect Masimo's best current judgment. However, they are subject to risk and uncertainties that could cause actual results to differ materially. Risk factors that could cause our actual results to differ materially from our projections and forecasts are discussed in detail in our SEC filings, including our most recent Form 10-Q. You'll find these in the investor section of our website. With that, I'll pass the call to Joe Kiani.

Thank you, Sheree. Good afternoon, and thank you for joining us for Masimo's quarterly review and update. We finished 2011 with fourth-quarter product revenue up 12%, including a strong 17% rise in our direct business. This performance was driven primarily by strong double-digit sales growth in both our US acute care channel and our international business as well as a 60% increase in rainbow sales. We shipped 34,400 new drivers in the quarter, excluding hand-held devices, bringing our worldwide installed base to 979,000 at year end, up nearly 15% versus 2010.

Underscoring our belief and optimism in Masimo's growth potential in 2012 and beyond, we also repurchased approximately 1.8 million shares of our common stock in the fourth quarter as part of the stock repurchase program we implemented in 2011.

And 2012 got off to a strong start with FDA clearance and full US commercial release of Pronto-7, our palm-sized hand-held device designed for quick and easy noninvasive spot-checking of total hemoglobin, Sp02, pulse rate and perfusion index. The Pronto-7 is now available to clinicians in much of the world and our sales efforts are in full swing. I'll talk more about our future prospects in a few minutes, but first Mark will review our recent financial performance and provide you our 2012 guidance. Mark?

Thank you, Joe, and good afternoon, everybody. Masimo's fourth-quarter 2011 total revenue rose 6% to $112.3 million versus $105.6 million in the year-ago period. We achieved this growth despite a 35% decline in royalty revenue from $11.8 million to $7.6 million reflecting the change in the Covidien royalty rate from 13% to 7.75% effective March 15, 2011. Fourth-quarter product revenue rose 12% to $104.7 million due primarily to accelerated growth in our acute care channel as installed base expansion translated into increased sensor sales to hospital customers. Encouragingly, rainbow sales rebounded in the quarter, rising 16% versus one year ago to $9.8 million on higher instrument and consumables sales.

Our worldwide end user or direct business, which includes sales through just-in-time distributors, grew 17% in the quarter to $90.2 million versus $77.4 million one year ago. In total, our direct business represented 86% of product revenue versus 83% in the year-ago quarter. Fourth-quarter 2011 OEM sales were down 12% to $14.5 million from $16.4 million in the same period last year due to both lower board and sensor revenues.

By geography, total US product revenue rose 9% to $72.9 million in the fourth quarter compared to $66.8 million last year as double-digit growth in US acute care sales was partially offset by lower US alternate care and US OEM sales. Product revenue outside the US totaled $31.8 million, up 18% compared to the fourth quarter last year. Every major international direct sales region contributed to the growth which was primarily offset by a 20% decline in international OEM sales. Excluding OEM revenue, our direct OUS product revenue grew 29%.

International product revenue represented approximately 30% of total product revenue in the fourth quarter versus 29% in the year-ago period. Favorable year-over-year currency exchange rates added approximately $580,000 to fourth quarter international totals. Fourth quarter gross profit margin was 63% compared to 66.5% one year ago. During the fourth quarter, we were required to write down previously capitalized deferred costs related to one specific contract.

Without that impact, our Q4 product gross margins would have been approximately 40-- 64%, a bit higher than we had originally projected in our updated full year guidance we provided in our October earnings call. The remaining year-over-year product gross margin declines were due to the result of expected higher total deferred cost amortization expenses, as well as the initial Q4 2011 cost impact of our X-Cal Technology introduction, which we noted in our October earnings call, and a slightly less favorable product mix versus the same prior-year period. Total gross profit margin including royalties was 65.5% in the quarter versus 70.2% in the same prior period last year. In addition to the items I just mentioned, the remaining decline was due entirely to the $4.2 million decline in Covidien royalty payments.

Operating expenses were $53.5 million versus fourth quarter 2010 operating expenses of $52.5 million which included approximately $1.8 million in one-time marketing expenses. Excluding these year ago one-time items, our fourth quarter 2011 operating expenses rose about 6%, reflecting slightly higher staffing levels, worldwide marketing trade show and program expenses and increased sales commissions associated with record contract bookings in the quarter. Fourth quarter 2011 operating expenses also included $9.6 million in R&D spending, which was up 16% from $8.3 million in the year-ago quarter, reflected primarily increased staffing levels and increased engineering supplies-related expenses related to new product development activities. Foreign exchange rates also increased fourth quarter 2011 total operating expenses by approximately $340,000 compared to the same period last year.

Fourth quarter 2011 operating income was $20.1 million compared to adjusted operating income in 2010's fourth quarter of $23.4 million which excludes the one-time expenses in the year-ago quarter. Our fourth quarter 2011 effective tax rate was 27.7% compared to 23.5% in the fourth quarter of 2010, which included the full-year benefit of the December 2010, enactment of the R&D tax credit and other one-time adjustments. The fourth-quarter rate was up slightly from our prior year-to-date rate expectations due to a shift in the mix of income generated within our various international jurisdictions.

Fourth quarter 2011 GAAP net income was $13.8 million, or $0. 23 per diluted share compared to fourth quarter 2010 GAAP EPS of $0.26. Also remember that EPS in the year-ago period included approximately $4.2 million, or almost $0.05 per share in higher royalty revenues. In addition, in the fourth quarter our weighted average number of shares declined to 60.2 million due to the weighted impact of our repurchase of 1.8 million shares during the quarter. As you will recall, under this current repurchase plan we have the ability to repurchase a total of 3 million shares subject to Board approved criteria through August 2013.

In the interest of time, I won't go through the 2011 results in detail, but rather hit the highlights and direct you to today's press release and the Form 10-K which will be filed later this week for more information. In summary, 2011 revenue grew 8% to $439 million including a 14% rise in product revenue to $406.5 million. Our SET business grew 15% to $372.4 million in 2011, while rainbow grew about 4% to $34.1 million. Recall, however, that excluding the $4 million US Marine order from 2010, our rainbow revenues would have increased by 18%. Revenue from our direct and distribution channel rose 21% to $342.9 million while OEM revenue fell by 13% to $63.6 million.

The 2011 gross profit margin of 64.4% was below the 66.4% product gross profit margin in 2010 due primarily to the previously noted increased amortization costs, the Q4 2011 write-down of deferred equipment costs related to the one contract I previously mentioned, the Q3 inventory charges that we incurred related to the product redesign and transition activities, and as we noted in our October call, the incremental costs associated with the introduction of the new X-Cal Technology into our sensors beginning in Q4 2011.

We finished 2011 with operating expenses of $207.6 million, up 6% compared to adjusted operating expenses of $195.5 million in 2010, which excluded the Covidien anti-trust award and related one-time marketing spending. Our 2011 operating income was $86.5 million compared to 2010 adjusted operating income of $90.1 million which excludes the anti-trust proceeds on onetime spending in 2010. Our full-year 2011 effective tax rate was 26% versus 31.8% in 2010, reflecting primarily a change in the California effective tax rate and a change in the geographic composition of pretax income in jurisdictions where we do business. That brought fiscal 2011 GAAP EPS to $1.05 compared to 2010 GAAP EPS of $1.21 and adjusted 2010 EPS of $1.03. Keep in mind that our 2011 EPS reflects a reduction of more than $16 million in royalty revenue which was roughly equal to $0.20 per share.

As of December 31, 2011, total cash and cash investments were $129.9 million compared to $88.3 million as of January 1, 2011. The $41.6 million net increase was due primarily to cash generated from operations, apparently offset by approximately $36 million used to repurchase our shares in the fourth quarter. As of December 31, 2011, our DSO was 50 versus 48 on January 1, 2011, and over the same period our inventory turns rose to 3.4 from 2.8.

Now we'll turn to our 2012 financial guidance, which assumes stable industry market conditions and foreign exchange rates consistent with year-end 2011 levels. We expect fiscal 2012 total revenue to be approximately $483 million including product revenue of $455 million and royalty revenue of $28 million. Included within the 2012 product revenue guidance is a rainbow revenue expectation of $45 million.

We expect our annual 2012 product gross profit margin to be in the 65% range, although we may experience quarters that are outside of this annual gross profit margin estimate. For example, we expect the first half of 2012 product gross profit margin to be below 65% due to the rollout of unfavorable capitalized manufacturing variances in the period. However, we also expect our second half 2012 product gross profit margins to be higher than 65% due to the positive impact of various supply chain optimization strategies that will be in place beginning in the second half of 2012.

We expect 2012 operating expenses to be approximately $227 million, and our full-year effective tax rate to be between 27% and 29%. The high end of this tax rate range excludes any benefit from the R&D tax credit as we await Congressional action for 2012 and beyond. Finally, we expect 2012 earnings per share to be approximately $1.20, assuming a share count of approximately 60.5 million for the entire year. With that, I'll turn the call back to Joe.

Thank you, Mark. Clearly 2011 was a year of contrasts for Masimo. There were numerous high points including the successful completion of two major new whole system installations at Kaiser Permanente and Banner Health along with the acquisition of many other new hospital customers which helped us deliver 50% growth in both our global installed base and core SET business. For a second year in a row, we shipped approximately 150,000 drivers up from previous annual ranges of 100,000 to 120,000 drivers indicating the strength we saw in 2010 was not due to catch-up purchases from 2009, but to fundamental and continuing shifts in the number of customers that are migrating to Masimo SET and Masimo rainbow SET technology.

We extended our royalty agreement with Covidien until at least March of 2014 which avoided potential costly IP litigation. We launched multiple new products further strengthened the body of clinical evidence validating our technology's benefit and signed a record number of new rainbow OEM agreements including one with Phillips, the world's largest patient monitoring company. Also as promised, we were able to continue our growth while dramatically cutting the overall rate of operating expense growth to less than 7% adjusted for one-time spending in 2010.

In addition, in 2011 the US Department of Health and Human Services recommended critical congenital heart defect screening using motion tolerant and low perfusion pulse oximetry, which we invented, and nation wide newborn screening standards that we expect to drive a lot of benefits from. We expect our technology play an ever-important role in saving newborn lives as these screening protocols are put in place.

At the same time, 2011 brought some setbacks, including declines in US hospital admission rates, a significant unanticipated decrease in sales to one of our long-time OEM partners, the lengthy delay in FDA clearance of Pronto-7, the absence of the repeat rainbow order from the US Military and the delay of our rainbow-centric Radical-7 bedside device, which create an inventory charges. All of this led to the worst product revenue growth rate we have ever had at just 14%.

Although 2011 was a tough year that we're glad to put behind us, we know that we've laid important groundwork over the past 12 months that gives us confidence about a brighter 2012 and beyond. While we have put many initiatives in place to achieve top line and bottom line growth in the high teens or better, we have to remain conservative with our financial outlook until we have proven to ourselves and to you that we can grow at those levels. So for now, assuming no further hospital census declines, we are forecasting product revenue growth of approximately 12% including 32% rainbow growth and earnings growth of approximately 14%. We expect to achieve this performance, if not more, by remaining true to our vision for Masimo, which is to build the strong proprietary recurring revenue franchise with breakthrough products to solve unsolvable clinical problems and advance the standard of care.

Among the reasons for our optimism in 2012 are the continuing global growth potential for our core Signal Extraction Technology business. Two, the momentum building across the OEM community behind our rainbow platform. Three, the novel and bold sale of the marketing programs like Better Care that we're rolling out to accelerate rainbow growth. Four, the competitive strength of our current product line up and new products we have on deck for debut in 2012. And finally, the ability for a global Masimo team to execute our strategy.

I'll review each of these in a bit more detail starting with growing our core SET business. This begins the continuing to increases the volume of sensor sales by expanding our relationship with existing hospital customers while attracting new ones. Our progress is evident in the recent expansion of our installed base. We have shipped more than 300,000 new drivers in the last two years and believe we can ship another 15,000 this year, taking our existing installed base well above the $1 million-- excuse me, the 1 million unit driver mark by the end of 2012.

Our confidence is based in part on the recent performance of our acute care sales team which set a new Company record for the total dollar volume of contract bookings and the second highest new hospital contract booking quarter in the history of Masimo in the fourth quarter of 2011. These contracts set the stage for new driver installations throughout 2012 and ultimately new sensor sales and improved patient care.

We're also focused on maximizing our opportunity in the international markets where our revenues rose 20% in 2011 with the direct portion of our international business up 31%. Moreover, the mix of our international direct revenues continues to skew more heavily to consumable sales due in large part to the strength in our international contract bookings which were up on $1 basis by more than 50% in 2011 versus 2010 and a record for Masimo. And it's important to note, the numbers I mentioned earlier about the contract bookings were in the US only which set not only a record for the Company but also as far as new contracts, the second highest quarter ever for the Company.

This is not only a foreteller of future OUS revenue recurring but also shows how our prior investments to expand our international presence have established the foundation for continued growth and profitability. Of course, higher sensor volumes enhance our ability to improve manufacturing efficiency. During 2011 we said we would be making investments in 2011 and into 2012 in initiatives to lower future product and manufacturing costs. We are moving closer to implementation of some of these supply chain initiatives which will include automation, vertical integration, vendor localization and inventory management realignment initiatives. As Mark indicated earlier, we expect to begin to see some of the early benefits of these initiatives in our product gross margins in the second half of the year.

Remember that the majority of our SET revenues are generated through long-term contracts that fix sensor price and volumes, or minimum volumes, for an average of five years which minimizes price volatility and gives us the opportunity to reduce our costs over the contract term. While prices have moved down from 2008 levels, the ASPs on our single-use Sp02 sensors have held relatively steady over the last two years. We maintain a disciplined approach to pricing which is grounded in the added value we offer hospital customers, including the Masimo set gold standard pulse oximetry, an efficient and effective general award monitoring solution, and upgradeable rainbow platform that provides access to a host of breakthrough proprietary technologies and measurements.

Our SET technology has been proven to reduce excessive sensor usage, invasive procedures, ICU days, rapid response team activation and oxygen therapy. And our rainbow technology has been proven to reduce blood transfusion-related costs, and most importantly, together rainbow SET saves lives and eyesight.

I'll turn now to rainbow where our confidence for 2012 is rooted in activities under way on multiple fronts to increase utilization and grow revenue. Critical to achieving broad adoption of rainbow is ensuring its availability across the range of multi-parameter OEM devices. Remember that roughly 80% of Masimo drivers shipped into the market get there through the OEM channel. We began 2012 with over 40 OEM rainbow agreements in place, more than double the number one year ago and dramatically above our original target of 30. Most importantly, the list includes Phillips, which has nearly 50% market share of the worldwide patient monitoring market.

About half of these OEM partners have already released rainbow-capable products or made public announcements about the rainbow integration. Among those already selling rainbow-enabled devices are Physio-Control, Welch Allyn, ZOLL and Drager. In addition to Phillips, companies with announced rainbow integration programs underway include Adam Medical and CareFusion to name just a few. We're now turning our attention to supporting our existing rainbow OEMs, doing all we can to ensure the successful and on-time delivery on the rainbow-enabled product road maps.

We're also implementing new sales and marketing programs, including a 2012 sales compensation plan that takes sales reps heavily on achievement of rainbow goals. Last month, we brought our global sales organization together for three days of training. We rolled out this 2012 plan as well as some new SpHb initiatives including revise and expand it's financial modeling tools to help hospitals conduct individualized return on investment and operational budget analysis associated with adoption of SpHb.

A new pricing strategy that we just announced today which reduces the per patient cost of a ReSposable SpHb sensor to $30, representing a roughly 50% discount for hospital customers who make certain volume commitments. We also announced today an SpHb risk-sharing program for hospital customers called Better Care. The program will guarantee that blood transfusion-related cost reduction called Better Care will exceed the incremental price of SpHb sensors. We plan to identify a select number of accounts who are interested in working with us to validate what many of our customers and independent researchers have found. Namely, that the deployment of SpHb will not only reduce mortality and morbidity but will dramatically reduce blood usage costs.

Recall that the recent MGH study to evaluate the impact of SpHb monitoring showed a 90% reduction in blood units transfused. When you consider that the typical hospital's blood transfusion-related costs are roughly 10 times their annual Sp02 sensor costs, we feel confident that this risk-sharing program will make it abundantly clear that the higher sensor costs can be more than offset with even a modest improvement in blood management costs and shifts the entire discussions about even pulse oximetry to a new level.

We also know that SpHb has the potential to dramatically improve patient care and save lives. Clinicians who use it tell us it helps them identify undetected bleeding earlier in surgical, intensive care, trauma and obstetric patients, and it helps them identify anemia more rapidly and efficiently. Our objective with these new programs is to motivate more clinicians and more hospitals to use SpHb because we are confident that once they do they'll become ongoing customers who are convinced of its value and benefit.

As an example, we recently learned of a case in Dallas where an 8-year-old girl was undergoing a unique and complex craniofacial surgery. The patient was monitored with Radical-7 with SpHb during her surgery. After the surgery, as the patient was being prepared for transfer to the recovery room, clinicians noted that her SpHb level had dropped significantly from 9.2 grams per decilitre to 6.5 grams per deciliter in just 5 minutes. When lab results came back at the critically low level of 5 grams per deciliter, confirmation was received for what Masimo SpHb has already helped clinicians conclude, that the patient was suffering from occult internal hemorrhage.

Without this early warning, the child would likely had been transported out of surgery in a hypovolemic and critically anemic state. A delayed response may have resulted in tissue hypoxia, acidosis or even cardiac arrest. Afterwards the pediatric plastic surgeon in this case told us that SpHb helped prevent a potentially life-threatening event and that he is now using SpHb for all of his major craniofacial procedures. We expect the new SpHb initiatives, particularly the Better Care program, to allow more hospitals and doctors like this one to experience the technology's benefits firsthand and incorporate it into their routine practices.

We're also very excited to be in full commercial release of Pronto-7, which was cleared by the FDA last month and represents another medical, excuse me, another Masimo medical first. Pronto-7 provides completely non-invasive and fast spot check measurement of hemoglobin, Sp02, pulse rate and perfusion index all from the palm of your hand. All Masimo direct sales reps are now selling the device with our 20-person physician practice sales team targeting doctors' offices in the US concurrent with our recent FDA clearance for the Pronto-7.

And we have implemented a guarantee program for our Pronto-7 device with a minimum sensor purchase commitment. This program will allow physician offices to work with a device for 30 days, and if they are not completely satisfied, they will receive a refund for the unused portion of the SpHb sensors they purchased during that period. In addition, we're in the process of finalizing our physician practice distributor agreements and currently anticipate that we will have one or more US distributors engaged and shipping Pronto-7 product by mid-year.

Pronto-7 is an excellent example of the compelling cutting edge innovation that defines and differentiates Masimo. Innovation is the foundation of our Company and future success, which is why our R&D investment is typically towards the high end of industry averages. While our current product offering is robust, we plan to be introducing some exciting new products that we expect to be important contributors in 2012 and beyond. They include a rainbow-centric Radical-7 called Radical-7 2012.

Our Rad revenue grew significantly in 2011 which was it's first full year on the market, and we expect RAMs availability on our flagship Radical-7 launch in 2011 bedside device to fuel increased utilization in 2012. As an aside, although one of our competitors recently revealed what they considered a new technological deployment of respiratory rates from the plethysmographic waveform, Masimo has had CE Mark approval for same measurement of respiration rates via changes in the plethysmographic waveform from the pulse ox signal since Q1 2011. And in fact, we've even sold some. We have just decided not to make this a major marketing focus due to the superiority of RAM.

Besides RAM and SpHb, we're also excited about the potential of the Halo Index, our dynamic wellness indicator that produces a specific numeric value designed to help clinicians better assess the patient's overall condition and predict deterioration. While we wait FDA clearance, we are introducing the Halo Index to customers outside the US. For example, a major hospital in Singapore began using Halo Index a few months ago as part of their patient safety net deployment in the post surgery ward. Clinicians there tell us they can already appreciate it's sensitivity and usefulness in providing the combination of physiological measurements in a single number and for its ability to help recognize possible underlying problems for patients. This institution continues to work with us to collect clinical feedback. As I said before, as more clinical evidence is collected on Halo Index, we expect it's clinical utility in a variety of carriers and patient types to become more specific.

Other new technologies helping to drive growth include the Masimo E1 trauma sensor, the industry's first single-patient use ear sensor which enables faster detection of oxygen saturation changes during low perfusion while avoiding the challenges and complexities of reusable ear sensors. And our new MS-2040, a Masimo circuit board that uses about a third of the power, less than 45 milliwatts, and is about half the size of our standard SET boards. This compact board is already enabling OEMs to develop a broad range of small, lightweight, hand-held and wearable portable medical devices and will, we believe, lead to an expansion of the number of OEM board shipments over the coming years. Finally, we're also on track to introduce a new rainbow measurement in 2012 that we believe will mark another Masimo industry first.

To summarize, Masimo has entered 2012 in an excellent position. We have superior technology and efficient goal infrastructure to continue to achieve profitable growth in our core SET business. And we're building momentum behind our breakthrough rainbow platform while developing new technologies that extend our innovation leadership. Importantly, we also have a dedicated and talented global team with the experience, industry knowledge and drive to execute our strategy. We all continue to be-- to focus our energies and resources on helping hospitals and clinicians improve the quality and cost of patient care believing that this is the surest way to achieve much faster growth and enhance Masimo's value over the long term. With that, we'll be happy to take your questions. Operator, would you please tell us who the first questioner is?

Bill Quirk with Piper Jaffray.

Hi, good afternoon, everybody, it's actually Dave Clair here for Bill. The first question from me-- hi, how are you guys doing?

Good.

The first question, I was just hoping to get some more details on the new ReSposable price, how did you determine that $30 is the right level to drive total hemoglobin adoption?

Good question. First of all, we looked at what is the minimal cost of blood to hospitals. And at what level would modest savings in blood transfusion given a certain sensor price for hemoglobin would save the hospital money above the cost of the sensor. And $30 was that minimum number. Now, some hospitals' cost for blood is maybe five, six X that cost. But we wanted to be sure that this is the price that makes the Better Care program work, and hopefully even outside the US, it's a price that we've been told by many customers that if you price it there, the threshold of jumping over would be minimized and they would come over.

But one of the ways we could actually achieve this goal of $30 was through enhancements of our ReSposable design that we've been working on for about two years that we were able to go from 5 disposable optical sensors for reusable optical sensors to 20. So we were able to get four times as many usages from the ROS DOS system than we could just a few months ago. So with that advent of this new performance enhancement, as well as where we felt the cost needs to be for both Better Care program as well as international input, we chose $30. Now that is not our list price, that is the price that we're willing to give at reasonable volume commitments from customers.

Okay, thank you. And then just another question here, this one on guidance. So I was just hoping to get a little bit more detail behind the $45 million rainbow guidance. So what needs to happen to hit that number?

Well, I think one of the things that helps us increase our guidance for rainbow was the clearance of Pronto-7. So we believe there is hopefully some upside in there. But we believe with modest growth in our normal business and now availability of Pronto-7 and the fact that we're going to be bringing on major physicians office distributors, we can drive to the $45 million revenue for rainbow.

Okay. And then can you give us an update on Phillips, when do you think we should see rainbow as an option on Phillips' products?

Well, they have many products from sold in the US to sold in China and Brazil and all over the world. We believe the earliest some of their products will come out will be end of this year. But we believe by -- well hopefully within 2013, we'll have most if not all of their major products out with rainbow.

Okay, thank you.

Thank you.

Joanne Wuensch with BMO Capital Markets.

Hi, thanks for taking my question and good afternoon. When I run the math here to get $45 million in rainbow, that means that your SET revenue is increasing in the high-single digits when you've been increasing nicely in the double digits, why would that be?

Go ahead, Mark.

Well Joanne I think as Joe sort of alluded to in his overall comments, I mean we are looking forward next year in a -- to an environment in which we're trying to be reasonably conservative in the outlook given all the various economic headwinds that we do have in place. And as you can also see, while we're really pleased with the amount of drivers that we had towards the end of the year, they were actually a little bit lower than the driver -- same driver numbers in the previous year. So as you roll those new place drivers forward, ultimately that results in a little bit lower year-over-year SET revenue growth. So that was a factor in the overall determination.

Okay, I have two other questions. One is, how much do you have in there for Pronto-7, and does that include a distributor which is being signed?

Well, as you know, we never give out specific individual revenues for individual products within the rainbow umbrella. But I think as Joe mentioned, yes, the answer to your second part of your question is that that $45 million does assume that we are successful in introducing the Pronto-7 with either one, or as Joe said, maybe even a couple distributors by the middle part this year.

And then the second follow up is $1.20 is a very specific number, usually Managements give a range. Does that mean your managing expenses and share count et cetera for that $1.20?

No, no, we're hoping to do that if not better. But we just did not feel comfortable this year providing a range.

Okay. Thank you very much.

Thank you, Joanne.

Brian Weinstein with William Blair.

Hi, good afternoon. Question on gross margins. Mark, can you give us a little bit more detail on that first half, second half? Specifically I didn't quite catch what you guys were talking about as far as first half weakness there. And then any commentary you can give on base business pricing. And then, Joe, longer term, you've talked about a 70% gross margin target for the Company, is that sill reasonable, and how do you get there? Thanks.

So Brian, let me take the first part of the question dealing, I think, with margins throughout the year. As we indicated, we-- our best projection right now is that for the full year we'll be around the 65% gross profit margin level. As I indicated, we think it'll be lower than that in the first half of the year, primarily as a result of some of the things that we began talking about in our call in October. Most specifically, if you recall, the introduction of our new X-Cal Technology that will add incremental costs to our sensor. And that we just began to introduce and, therefore, we began to see some of the impact of that in the fourth quarter of this year. We'll see more of that, and in fact on a continual basis, it will always now be part of our cost of those sensors.

But offsetting that incremental increase cost in the first half of the year will be the benefit from some of the supply chain initiatives that Joe called out in his prepared remarks. And we expect the benefit from those initiatives to begin materializing in the second half of the year. So that's essentially why we expect lower margins in 65% in the first half of the year, and we believe we'll see higher margins in the second half of the year with the overall blend at 65%.

And I guess that also hopefully lets you know that we do believe we're going to get back on track on margin growth and that 70% gross margin, Brian, is still realistic and a goal which we expect to attain.

Okay. And then real quick, you-- last quarter you talked about a $3 million-- payment of around $3 million with a major US hospital system that you had signed that wasn't able to recognize. Did you recognize anything from that? Because you had said that you expected to have that resolved by the end of the year. What's the status of that, and was there any of that in the Q4 number? Thanks.

Well sometimes, sometimes I guess compromise and being nice to your customers is the best thing to do. So despite us feeling very strongly that we were owed that plus some, we did resolve our issues. But unfortunately, we ended up not collecting any extra revenues.

Next question.

Matt Dolan with ROTH Capital Partners.

First, I want to just to finish up on the rainbow guidance. You talked about Pronto-7, how are you thinking about military orders this year? And then I guess as a follow on to that, how is the new hemoglobin pricing model play into the revenue trends that we should expect for rainbow throughout the year?

Well I think we have -- we expect very little to any growth on the military business this year from 2011 given that there are normally uncertainties around those businesses anyway. But ever since the discussion about cutting back defense spending, that has put a lot of spending on hold. So that's on the military side. Maybe, Mark, you can take on the second part of the question that Matt had.

On the pricing, Matt?

Yes, just the rainbow trajectory through the year considering the change to hemoglobin pricing.

Yes, the programs that we announced today, the overall ASP impact of those are essentially embedded within the guidance that we provided today, as well, on the revenue side.

So but we-- should we assume a dip in the first half of the year as you work through the change?

Maybe a dip in ASP, but not a dip in revenue, because to get to the prices we're offering, either you have to do it under Better Care program, which is a hospital-wide switch to rainbow which will be very large increases in our rainbow revenue, or you have to meet a minimum quantity commitment which by meeting will not create a dip in our rainbow revenues.

Matt, and I would also highlight just to recall that we've for a couple years now had a bit of a seasonality factor dialed into our rainbow revenues. So once again this year, we would expect to begin the year a little bit more softly, similar to what we've done the last couple of years. And then accelerate rainbow revenue growth sequentially throughout the year.

Okay, that helps. And then Joe, maybe to touch on what you're seeing from the OEMs. I know I think on the last call you touched on some softness early in Q4 and it looks like that category was down maybe 10% in 2011. How are you thinking about OEM growth versus direct growth in the backdrop of today's purchasing environment?

Well, we believe the OEM growth is ahead for us, and at least we're going to continue meeting the 150,000 drivers a year through the OEM growth that we anticipate. But the OEM revenue has had pressure because as I mentioned earlier one of our long-time OEM partners had a huge drop in their revenues and driver numbers which was not anticipated, and we're not happy about it. We are investigating it, and you'll see more about that soon.

Okay.

But setting that aside, our relationships have become even stronger with the rest of our OEM partners, very big OEM partners. And because of some of the things we've done in the last year that hopefully we'll start manufacturing itself, including the Phillips agreement as well as the new low power MS-2040 board, we expect OEM business to continue to grow.

Okay. And then finally on the buyback, that was a pretty aggressive quarter, could you just walk us through the plans there into 2012? Is there a price trigger for you, and do you expect to expand the program as obviously your pace would require?

Well, we were fortunate that we saw a bigger price pressure on our stock than we had anticipated, so we took advantage of it. And I think given we've been in a blackout period, we've got to come out of our blackout period, and once we feel like we are out of our blackout period, then we can discuss the next steps. So sorry that I can't say more about that, but we felt 1.8 million out of 3 million is a good chunk, which was a three-year program in the first half of the year in through the three-year program. But I personally think our stock price is a bargain. And our-- as an entrepreneur, many good advisors told me I should annually divest some of my stock in Masimo, but just the prices are so low that even I personally bought Masimo shares. So we'll have to see what happens.

Great. Thanks a lot.

Thank you.

Lawrence Keusch with Morgan Keegan.

Hi, good afternoon. Joe, can you -- when do you expect to have the new sensor, the X-Cal fully rolled out? And I guess the question behind that is, what's the strategy for turning that on?

Well, I don't want to get into that, it's not a good idea for us to get into the details of what we're doing. But I can tell you that it has upped Q4 2011, everything we shipped was with X-Cal.

So I'm sorry, so everything in Q4 '11 was with X-Cal?

Yes.

Okay. And then I guess, Mark, just to carry on with that, does that now -- I know that you've talked about the first half 2012 product gross margin being lower than your anticipated number for the full year, but as we sort of calibrate ourselves for the first quarter, do you think that that-- we should be thinking about a lower sequential number and then it kind of builds through the year? How should we think about that, I just want to make sure we're thinking about this first quarter correctly?

Well we believe the full year is going to be in the 65% gross margin range. But we do believe the first half of the year will be less than 65%, but it will be offset by a second half of the year where we're going to be over 65% and therefore, deliver on the 65% range for the year.

Larry, were you speaking sequentially to our Q4 63% gross profit?

Yes, exactly. I just want to-- again, I understand the first half versus the second half, but I just wanted to make sure I kind of understand how we should be thinking about the progression through that first half.

Yes, we don't -- right now our projections would not have us sequentially lower in first quarter than where we were in the fourth quarter.

Okay, perfect. And then just the last one for me is obviously the topic of reprocessing has come up over time, as well as counterfeit. Can you just give us a little sense on, again, how you thought that was playing out in the fourth quarter?

Well, I think it's still not a significant part of our losses, I should say. I think it's probably 5% or less of our revenues lost to reprocessors. I don't know what it is with counterfeiters because that's kind of rest of the world kind of numbers, and that's harder for us to get our arms around. But the biggest problem with the counterfeiters and the reprocessors is that their products risk patient care.

We tested 1,000 reprocessed sensors from Stryker, and 91% of those sensors did not meet our performance specification. And we have tested knock off sensors internationally, and they're just as bad if not worse. I mean they can't even desaturate if a patient is losing his oxygen. So I think we get called into a lot of places thinking our product doesn't work, then they notice to see their reprocess sensor or a knock off, poor knock off sensor, and what we hope by the things we're doing, we're going to help not only enhance patient care but also protect the business that we have been promised by our customers.

Okay, terrific. Thank you very much.

Thank you.

Thanks, Larry.

John Putnam with Capstone Investments.

Yes, thanks very much. Joe, in the fourth quarter I think-- or I'm sorry, in the third quarter, one of the reasons for weakness was a flattish kind of hospital surgical procedure. And I wondered if what it was like in the fourth quarter and what it's been here in the first quarter?

Well, I've been talking to some of the CEOs, the CEOs of hospitals, and they all said that last year obviously there was a big census drop. The number that one COO of a very prestigious hospital told me recently shocked me. They said census drop was 8% below the previous year in 2011 and that was according, he said, to the AHA surveys and Premier surveys. So that's the paths, and if it was that high, then it's bigger than a lot of analyst numbers I've seen.

But so far they've also said to me that it looks like it's stabilized. It's too early for them to say it's going up because obviously there's a seasonal period that's come in because of the respiratory complications that happen during the fall and winter time. So I think the real sign of the business-- for hospitals improving and therefore for us improving, will come after the season where a lot of the elective surgeries are done. And hopefully if the economy continues to regain, maybe we'll see some increase. But at least we're assuming there won't be a decrease compared to last year given how low it seems like it has gone.

Okay, thanks. And what are you seeing overseas in Europe? Are you seeing pushback, reimbursement pushback as strong or growing, or has that stabilized as well?

Well there are countries like the UK where they're having a lot of financial problems. But mostly OUS is growing very rapidly, and we don't see the same kind of pushback we saw in terms of price pressures in the US the last couple of years. Now the good news is, like I said earlier, while the prices are below where they were before the recession hit in 2008, the last two years, even in the US, the prices have been stable. Our ASPs have been stable despite the fact we've signed some unbelievably big contracts. I mentioned this last quarter in the US was our, not only our record contract booking, but it was the second biggest contract, new contract booking for new hospitals. And unlike the biggest one we ever had, which included Kaiser, this one didn't have one big system, it was a lot of hospitals. So despite getting a lot of hopefully businesses that have come our way that will continue to come our way, we haven't had to reduce prices from where they've been the last couple of years. Hopefully that answers your question.

Yes, thanks very much, Joe.

Thank you.

Sara Michelmore with Brean Murray.

Hello, good evening, thanks for taking the question. Mark, I was hoping you-- just another follow up on gross margin, you talked about mix being a negative gross margin dynamic in 2011, although it was on the lower end of a laundry list of items that you went through that are likely to be transitory or not occur, and I'm just wondering if you would give us some sense for what that impact of mix was? What exactly you're seeing in terms of mix and what your expectations are for 2012? And then just a clarification on the stock buyback, your average shares for the quarter were 60.2. Where did you end for the quarter, and it seems like you're -- I just want to, again, clarify that you're assuming 60.5 in your guidance for 2012? Thanks.

Got it. Well let me start with the mix question and just to rehash a little bit, remember when we started the year, we called out the fact that we knew entering 2011 versus 2010 we were going to see a fairly sizable impact because of the increased amortization of deferred COGS. And so-- and that remember, was the result of a record number of equipment value placed in hospitals in 2010. So that expectation that we had earlier in the year pretty much ran through the entire year. And directionally, that number now that we've ended the year was about-- it's worth about 100 basis points in year-over-year gross margin decline. In addition to that, I called out, as you said, the other two what we consider to be somewhat unique charges that we had to occur in the second-- in the third and fourth quarter.

On the mix question, the mix question really has to do a little bit more with the overall migration between consumable revenues for us versus board revenues versus monitor revenues and ultimately versus parameter revenues. Of course, parameters being the license revenues that as you would surmise come in at very, very high margins. So on a year-over-year basis, you'll recall that 2010 total rainbow revenues rose pretty dramatically. And as a result, we benefited from a lot of the mix within that rainbow pool of revenues. This year, year over year, our rainbow revenues were up just 4%, and therefore, we didn't quite see the same benefit that we had in the prior year. So that's the reason primarily why we -- that's the reason we were referred to when we talked about the mix impacting gross margins. Then on the --

Go ahead, Mark. Go ahead. And I'm just -- we do get asked the question about SET ASP differences, a mix change to ReSposable sensors versus single-use only, was that a factor?

Not a dramatic factor, no.

In fact, in ReSposables, we've been in pre-market release mode under Sp02 SET side, we haven't launched ReSposables yet.

Okay. And you can continue, Mark, thanks.

So then following up on your stock buyback question, the impact that we experienced this quarter -- of course, as Joe said, we repurchased 1.8 million shares. Obviously we purchased that through out the quarter and, therefore, the weighted benefit of that is what got us to the 60.2 million for the fourth quarter. We should see the additional benefit of the rest of that repurchase included completely, if you will, in the first quarter number. And then the way we're looking at our motto, we expect a traditional amount of additional stock options to be granted throughout next year. Those will bring the weighted number back up again. And then our models also assume a number of different variables, as you know, related to things like volatility and stock price, as well. And so we do the best we can to guesstimate all of those different variables and ultimately that yielded a net 60.5 for the year. It may turn out to be a little bit -- it's probably a little bit conservative at this stage, knowing that we will get the benefit of that entire 1.8 million share buyback certainly in the first quarter of next year.

Okay. And then back on the gross margin, just what are the mix considerations for 2012 and again, if you can just address any notable changes in average ASPs for the Pulse Ox sensors and increasing mix of ReSposables that you may or may not anticipate? Thanks.

Sure. Well within our revenue modeling and, therefore, obviously the guidance that we've provided today, we, too, make assumptions about overall ASP movement. However, we don't share those assumptions publicly. But we've got enough history here over the last five, six, seven years to make some pretty reasonable guesstimates at where we think the blended average ASPs will head. And so we've continued to make similar assumptions that have proved to be true in prior years on traditional Sp02 sensor sales.

In terms of the mix of product between traditional adhesive versus ReSposable, we've continued to assume a pretty ratable allocation between those two individual product lines. Historically again, they have not changed dramatically. The only other obvious mix delta included in the overall revenue or margin expectations are the fact that we, given our guidance of $45 million in rainbow revenue, we do expect an increase from the $34 million in rainbow revenue this year. So that mix, if you will, would also be included within both the revenue numbers that we've generated, as well as the gross profit margin guidance.

Great. That's very helpful, Mark. Thanks for the color.

Ben Haynor with Feltl & Company.

Thanks for taking my questions, just a couple quick ones here. Did I hear that correctly in response to Sara's question as far as stock-based compensation, did you say it would be similar to this year next year?

No, we weren't talking about stock-based comp. We were just talking about the amount of weighted shares and what -- I think what had alluded to was that part of that calculation or future prediction is the amount of stock options that would be granted in any particular year. And so as we usually do, we make an assumption of how many of those options we will be granting in 2012, and those played a factor in the overall 60.5 million average annual weighted shares outstanding number that we provided today.

Sure, okay, that makes sense. And then where are you in the process with the FDA on the Halo Index?

We -- we're still working with them, and I can't predict when they're going to clear it, but we're hopeful that it'll get cleared the first half of this year.

Okay, great. Thank you very much, guys.

Thanks.

Tao Levy with Collins Stewart.

Just three quick ones, maybe can you provide any sort of metrics around the adoption of rainbow from the OEMs so far? I know it's just a handful that have launched products, but any metrics would be helpful.

Well I think the ones that have already launched rainbow have been Physio-Control and ZOLL in the EMS environment with their defibrillators. And on the high acuity end, Drager has just launched rainbow outside the US and they're waiting for FDA clearance for the US. And in the low acuity market, Welch Allyn had launched rainbow worldwide. We are waiting-- there was plenty of more, excuse me, there are plenty more companies that have launched, but smaller companies around the world. So we're waiting for some of the majors like now Phillips and others to enter.

Okay, great. And in terms of the new hemoglobin price program that you talked about, at $30, with the ReSposable, what type of gross margins would that generate?

Well I can't get--

Not the exact number, but versus--

What I can tell you, it's the reason we feel confident about long term hitting our 70% gross margin for the total business because rainbow does have a better margin than our current business.

And that factors this $30 --

Yes.

Into that thinking, great? And then the final question, when you talked about the respiration rate, the RAM and getting the CE Mark approval in Europe already, how-- what's the accuracy of using Pulse Ox to determine the respiration rate versus RAM? I mean, is it good enough to get an FDA approval?

Yes, we believe it's good enough to get FDA approval. But it's not nearly as good as RAM. RAM's available now worldwide, we have FDA clearance, we have Japanese clearance, obviously it's available in Europe. And respiratory rate from the Pleth it's convenient, but it's not as reliable as the RAM sensor.

Got you. Okay, thanks a lot.

Thanks.

Lennox Ketner from Bank of America, Merrill Lynch.

Hi, guys, thanks so much for taking the questions, just two quick ones. First on the SpHb, Joe I know you had talked in the past about doing some additional clinical studies there, is that something that you're still planning to do or still planning to present at some point, or is your sense that the pricing change will be enough to drive adoption there?

No, no, we don't think the pricing change or the Better Care program is going to be enough, we think we need more evidence. So we're definitely working on those. I'm aware of nearly 100 studies that are underway with SpHb, and so hopefully a lot more will be coming out to weigh in on the value of SpHb.

Okay, is Masimo still funding studies there, as well, or --

Well we really only fund -- to my knowledge, we've only funded one major study. I think the rest of the studies are -- we're supporting researchers that are wanting to study the product. We're funding a multi-center, multi-country trial on benefits of SpHb, or maybe not, and that study I believe is starting hopefully this quarter, but definitely the first half of the year. And we hope that early results will be available in 2013.

Okay, great. And then just last one, sorry if I missed this, but I think in the past you had talked about rolling out a ReSposable line for the Pulse Ox business rather than just the hemoglobin, is that still something that you're planning to do?

Yes, yes, as I mentioned during the Q&A part when Mark was speaking, we had been working on a ReSposable line for the Sp02 business, it's been in the pre-market release stage. We hope to begin limited market release of it very soon. And that line as you know has all the benefits of lowering costs, yet keeping our margins intact while providing the best green product. Because it not only doesn't have any mass compared to disposable product, but since you don't have to recycle it by packaging it and shipping it and cleaning it and refixing it, the carbon footprint on it is much lower than even new sensors. We've discovered by the way, I know I'm rambling a bit, but we discovered that reprocessing of disposable sensors has a higher carbon footprint than brand new sensors. And this was all validated by third party. So hopefully that answers your question.

Okay, great. Thanks so much.

I think that said, given that some of you on the east coast and Valentine's Day is here, maybe we ought to end it here. Wish you all a happy Valentine's Day. Thank you.

This concludes today's Masimo's fourth quarter and full year 2011 earnings conference call. You may now disconnect.