Masimo Corp (MASI) 2012 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen. Welcome to Masimo's first-quarter 2012 earnings conference call. The Company's press release is available at www.masimo.com. (Operator Instructions) After the speakers remarks, there will be a question-and-answer session. I am pleased to introduce Sheree Aronson, Masimo's Vice President of Investor Relations.

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 risks 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-K. You'll find these in the investor relations section of our website. With that, I'll pass the call to Joe Kiani.

Good afternoon, and thank you for joining us for Masimo's quarterly review update. Before I get started with our comments on the quarter, I wanted to share with you the importance of today's date which is the twenty-third anniversary of our incorporation. From our very humble beginnings in 1989, I believe we have truly revolutionized pulse oximetry, making it a clinically useful tool and a foul-weather friend. And in so doing, provided the best technology in the world to both our hospital customers and the patients they serve. Of course, we remain focused on expanding the pulse oximetry business, as well as continue to push our new equally revolutionary rainbow parameters. We still have much to accomplish but we are proud of what we have delivered over the past 23 years. So if we sound chipper this afternoon, this is part of the reason.

In Q1 2012, we achieved 11% growth and product revenue compared to Q1 2011. We have double-digit growth in both our direct US acute care and international business coupled with a 14% rise in worldwide rainbow sales. We shipped 33,300 new Masimo SET and Masimo rainbow SET Pulse Oximeters and Pulse CO-Oximeters in the quarter. And now estimate our worldwide installed base, for the first time ever, to be just over 1 million units, representing 13% year-over-year growth and obviously achieving a significant Masimo milestone.

Other major developments include -- the debut of our rainbow and clinician-centric Radical-7 bedside device, which we sometimes call the 2012 Radical-7; the addition of GE, the world's second largest patient monitor provider, to the ranks of OEM partners; converting the Masimo rainbow SET; the acquisition of the assets of Spire Semiconductor, a foundry for custom LEDs and photodetectors; the completion of our 3 million share buyback program; regulatory clearance and commercial launch of Pronto-7 in the US, China and South Korea, and the introduction of novel healthcare initiatives called Better Care, designed to demonstrate SpHb's clinical and cost saving benefits to hospitals. In a few minutes, I will talk more about how each of these is advancing our growth strategy. But first, Mark will review the first quarter financial performance. Mark?

Thank you, Joe, and good afternoon, everyone. Masimo's first-quarter 2012 total revenue rose 6% to $119 million versus $113 million in the year-ago period. We achieved this growth despite a 39% decline in royalty revenue from $11.5 million to $7 million reflecting the reduction in the Covidien royalty rate from 13% to 7.75%, effective March 15, 2011. First-quarter product revenue rose 11% to $112.2 million as recent installed base growth translated into higher consumable sales to hospitals. A rise in Pronto-7 and consumable sales drove rainbow sales higher, up 14% in the first quarter to $8.5 million. In addition, the March 12 acquisition of the assets of Spire Semiconductor, now known as Masimo Semiconductor, added approximately $300,000 to product revenue in the quarter. Our worldwide end user or direct business which includes sales through just-in-time distributors grew 12% in the quarter to $95.9 million versus $85.3 million one year ago. In total, our direct business represented a 85% of product revenue versus 84% in the year-ago quarter. First-quarter 2012 OEM sales were virtually unchanged at $16.3 million from, excuse me, from $16.2 million in the same prior last-year period.

By geography, total US product revenue rose 12% to $80.8 million in the first quarter compared to $72.4 million in the first quarter of 2011. This growth reflects primarily strong US care sensor sales coupled with the US OEM sales increases and higher sales to physician offices following our Q1 launch of Pronto-7. Product revenue outside the US totaled $31.5 million, up 8% compared to the first quarter last year. Excluding OEM revenue, our direct OUS product revenue grew 15% with higher sales in both Europe and Asia. This growth was offset by a 15% decline in our OUS OEM business. International product revenue represented approximately 28% of total product revenue in the first quarter, versus 29% in the year ago period. Foreign currency exchange rates had virtually no impact to international revenue totals in the year-over-year period.

The first-quarter product gross profit margin was 64.4%, unchanged from 64.4% one year ago and up sequentially from 63% in the fourth quarter of 2011. Our Q1 2012 product gross profit margins were negatively impacted by approximately 30 basis points, due to the impact of the Masimo Semiconductor cost of sales of approximately $400,000. Compared to our own internal expectations, which were reflected in our updated product gross profit margin guidance which we provided on March 12, 2012, our Q1 product gross profit margin was slightly better than we had expected, due primarily to a higher mix of consumable revenues than we expected.

Q1 2012 product gross profit margins also continue to be negatively impacted by the ongoing incremental costs of our new X-CAL technology which, beginning in Q4 2011, is now incorporated into every Masimo adhesive sensor we ship. In the first quarter of 2012, the full incremental cost of adding this new technology reduced our Q1 2012 product gross margins by more than 100 basis points. Recall that we introduced X-CAL technology in order to both ensure the integrity and reliability of our technology while at the same time reduce customer complaints and loss of revenue due to sensors sold to our installed base by knock-off manufacturers internationally and by third party re-processors in the US. We believe that in the long-run, this investment in protecting our technology and ensuring our customers of the quality and reliability of Masimo products is worthwhile.

Total gross profit margin, including royalties, was 66.5% in the quarter versus 68% in the same period last year, reflecting primarily the 39% year-over-year decline in royalty revenue, as well as the 30 basis point impact from Masimo Semiconductor that I just mentioned. On a sequential basis, our total gross profit margin rose by 100 basis points from 65.5% in the fourth quarter of 2011 due to the same factors I previously noted. Operating expenses were $57 million, up 11% from $51.4 million in the first quarter of 2011. This year-over-year increase was due largely to the impact of both our annual sales meeting which was not held in Q1 2010, as well as the Q1 2012 World Congress of Anaesthesiologists conference in Buenos Aires, which is held only once every four years. Other more moderate spending increases occurred in payroll and related costs, commissions, and marketing and clinical studies costs. Partially offsetting these increases were lower Q1 legal expenses compared to the prior-year period. Adjusting for the higher sales training and conference expense and the lower legal expenses, our year-over-year operating expenses would have increased by approximately 9%.

I did want to take this opportunity to reiterate what we mentioned in our March 12, 2012 press release and updated guidance. Namely, that we do expect our legal expenses to begin increasing more significantly as we move through the rest of 2012. First-quarter 2012 operating expenses also included $10.5 million in R&D spending, which was up 5% from $10 million in the year-ago quarter, reflecting primarily increased payroll and related costs and project related expenses associated with increased staffing levels. Masimo Semiconductor, for the last three weeks in the quarter, also added approximately $100,000 to our total operating expenses in the quarter. Movements in foreign exchange rates had virtually no impact on first-quarter 2012 operating expenses as compared to the same prior-year period.

First-quarter 2012 operating income was $22.3 million compared to $25.4 million in the year-ago period. This year-over-year decline, as previously noted, was due entirely to the $4.5 million reduction in royalty payments over the same comparable periods. Nonoperating expense was $600,000 in the first quarter compared to income of $200,000 in the year ago period and reflects primarily the recognition of the net realized and unrealized losses on foreign currency denominated transactions. The expense in the first quarter of 2012 resulted primarily from the strengthening of the US dollar against the Japanese yen, offset by the weakening of the US dollar against the euro and the British pound. Our first-quarter 2012 effective tax rate was 27.5%, compared to 29% in the first quarter of 2011. The improvement is due primarily to the mix of income in jurisdictions in which we do business and partially offset by a rate increase resulting from the suspension of the Federal R&D credit. First-quarter 2012 net income was $15.8 million or $0.27 per diluted share compared to first-quarter 2011 EPS of $0.30 per share. As I just previously noted, from an earnings per share perspective, the decline in year-over-year royalties was the equivalent to almost $0.06 per share.

As of early April 2012, we completed the two-year, 3 million share repurchase program authorized by our Board of Directors in August 2011. We repurchased approximately 1.8 million shares in Q4 2011, approximately 1 million shares in March 2012, and the remaining approximately 200,000 shares in early Q2 2012. As a result, our weighted average shares outstanding in Q1 2012 declined to 59.1 million. As of March 31, 2012, total cash and cash investments were $128.8 million compared to $129.9 million as of December 31, 2011. The change reflects primarily cash generated from operations, offset by $14.4 million to repurchase our stock and $7.2 million used to acquire the assets of Spire Semiconductor. At March 31, 2012, we also owed an additional $6.9 million for repurchased shares and this obligation is reflected in accrued liabilities on our March 31, 2012 balance sheet. As of March 31, 2012, our DSO was 49 versus 50 on March 31, 2011. Over the same period, inventory turns declined slightly to 3.3 from 3.4.

Let me close with a quick reminder about our policy regarding annual financial guidance. We provided updated 2012 revenue and EPS guidance in a March 12 8-K filing related to the Spire Semiconductor transaction. It is our policy not to update annual guidance unless there are material developments which cause us to believe that either revenue or EPS will be materially outside the numbers we previously provided. Based on our first-quarter results and currently available information, we are not providing any update to the annual guidance we issued in March. However, as I have noted before, we would encourage investors to review both our original February 14, 2012 annual financial guidance as well as our updated March 12, 2012 guidance resulting from the acquisition of the assets of Spire Semiconductor, the addition of an estimated for $3.5 million in legal expenses and the impact of lower shares outstanding on our original February 2012 annual financial guidance. With that, I will turn the call back to Joe.

Thanks, Mark. Our performance in the quarter showed the positive momentum that continues to form behind the Masimo growth strategy, which is to build a strong proprietary recurring revenue franchise with breakthrough products that solve unsolvable clinical problems, advance the standard of care, and lower health care costs. The foundation of this strategy is our core signal extraction technology pulse oximetry business, which again this quarter posted revenue and installed base growth rate significantly above competitor and market levels, giving us confidence that our global market presence is hitting new highs. The accuracy, reliability, and cost effectiveness of our Masimo SET Pulse Oximeter technology, along with our efficient and intuitive Patient SafetyNet solution for the general award are helping us to strengthen existing hospital customer relationships and win new business. This was apparent in the brisk pace of long-term sensor contract bookings with new prestigious hospitals in the first quarter which were up significantly from one year ago and followed the record setting booking levels we delivered in the fourth quarter of 2011.

The prime motivator for hospitals to choose Masimo over competing systems is to be at the standard of care level for pulse oximetry monitoring and the ability to access our upgradable rainbow SET platform, the first and only technology to noninvasively and continuously monitor total hemoglobin, carbon monoxide, methemoglobin, fluids responsiveness, and respiration rate. Consequently, an increasing number of our customer relationships now include deployment of one or more rainbow measurements. While rainbow grew less than we had expected, the slower growth was not due to SpHb which grew 70%, or to Rad, which more than doubled compared to Q1 2011. Rather it was due to softer sales of SpCO and SpMet which is predominantly purchased by EMS customers. Unfortunately, ever since the 2008 great recession, municipalities have not had the tax revenues that fueled EMS product sales. We expect, after recession ends, that business will begin to grow faster in the EMS environment.

We continue to focus on products and programs that enhance rainbow's accessibility of an ease-of-use for clinicians and hospitals. For example, during the first quarter, we debuted the 2012 Radical-7 bedside monitor which is clinician and rainbow centric and provides a variety of features designed to simplify the clinician's life. This new monitor, now in pre-market release, offers exceptionally easy operation, view of all rainbow parameters, and instant adaptability to change displays and settings on-the-fly. With a quick touch, drag, and drop, clinicians can move any parameter to and from the center and bottom of the display, never losing track of any vital signs and yet seeing boldly what they want to see. The instant-trend feature provides the ability to view one or two parameters at once and with a simple finger motion, clinicians can move, expand or collapse parameter trends for real-time analysis. It is versatile in multiple care areas with an automatic rotational screen for either horizontal or vertical display and it can be used in a standalone device at bedside, as a detachable, untethered wireless wearable device or as a multiparameter monitoring interface with SatShare.

I know Steve Jobs' biographer, Walter Isaacson, noted in his book that while at Methodist University in Memphis, Tennessee, Jobs remarked that he hated the oxygen monitor they put on his finger and told his caregivers it was ugly and too complex. I can confirm that this hospital was not a Masimo customer at the time so Jobs was obviously not referring to our Radical. I'm curious what Jobs would have thought about our Radical, even the old one, but I wish he was alive and we could have shown him the clinician and rainbow centric Radical. I think he would have liked it. The clinicians of the World Congress of Anaesthesiologists certainly did. We unveiled it there in March and the reception was overwhelming. Clinicians from around the world were excited by its functionality and ease-of-use and told us they had never seen a device quite like it. The clinician centric Radical-7 is first part in a series of system solutions that we will ultimately introduce to improve the process of care.

We're also excited about customer's response to our innovative blood transfusion related cost reduction guarantee, or Better Care program, a risk sharing initiative we rolled out in Q1 that guarantees blood transfusion related cost reductions for participating customers will be greater than the additional cost of the rainbow ReSposable sensors. Under the program, Masimo guarantees that when a hospital replaces its standard pulse oximetry adhesive sensors with ReSposable rainbow Pulse CO-Oximetry adhesive sensors and begins monitoring noninvasive hemoglobin in addition to other rainbow SET Pulse CO-Oximetry measurements, it will experience a reduction in blood transfusion costs well in excess of the incremental price paid for the rainbow Pulse CO-Oximetry sensors. The Better Care guarantee program is quickly capturing the attention of key clinicians and C-suite level hospital executives. We're actively engaged in discussions with a number of interested customers and are confident the program will help to not only validate SpHb's ability to improve patient care, but also its ability to lower costs.

A new study from Johns Hopkins Hospital, published in the April issue of Anesthesiology, spotlights the fact that many surgeons transfuse more blood than necessary, putting patients at risk. The 18-month study, which collected data on more than 48,000 surgical patients, revealed significant variation in the frequency of blood transfusions among the institutions' surgical services and surgical procedures and among its individual anesthesiologists and surgeons. Transfusions, of course, are inherently risky and can cause a range of adverse reactions which often translate into longer hospital stays, slower recovery and higher medical bills, if not mortality and morbidity. As more and more hospitals begin to focus on improving their blood management programs, we expect SpHb, with its ability to monitor and trend hemoglobin in real-time, to become an essential part of clinical decision-making on when and how much to transfuse.

Paramount to achieving broader utilization of rainbow is assuring its availability in OEM multiparameter patient monitoring devices deployed in hospitals around the world. We are achieving this through expanded agreements with our OEM partners incorporate Masimo rainbow SET into their patient monitors. This effort took a major step forward in the first quarter when we announced an agreement with GE Healthcare, the world's second-largest patient monitoring company, to incorporate Masimo rainbow SET into many of their monitors. You will recall that Philips, the world's number one patient monitoring company in terms of market share, signed a similar agreement with us last year. So with these two leaders, along with approximately 40 other agreements already secured, we now have the vast majority of the global patient monitoring providers in some stage of converting to Masimo rainbow SET technology. This isn't a transition that happens overnight. In fact, we estimate that it can be one to two years between the time an agreement is signed and rainbow SET equipment from each OEM enters the market. Nevertheless, we are well on our way to making rainbow broadly accessible to hospitals, clinicians, and patients everywhere.

At the same time, the body of clinical research continues to expand, demonstrating rainbow's accuracy and efficacy in a range of care settings. At last count, we had over 100 studies completed on rainbow and over 100 active rainbow studies. A major study that we are anxious to see begin is being conducted by the Society for the Advancement of Blood Management with principal investigator, Dr. Aryeh Shander, a world leading authority on blood management. The study is named NACHO, especially appropriate for upcoming cinco de Mayo celebrations. But in our case, stands for noninvasive and continuous hemoglobin monitoring, with an O at the end instead of the M, for surgical blood management is a randomized controlled trial of several hundred patients in at least four centers in three countries, US, Germany, and Japan and is set to start by the third quarter. Half the patients will be treated by clinicians who will use SpHb monitoring on a Radical-7 to supplement their blood transfusion decisions. And the other half will have the SpHb data collected but it will be blinded to the treating clinicians.

In contrast to the Massachusetts General Hospital randomized control trial that focused on surgical patients with low expected blood loss, which showed a 90% reduction in blood transfusion, the NACHO study will focus on surgical patients with high expected blood loss and is powered for a 25% reduction in blood transfusion. In patients with a higher absolute blood loss, a 25% reduction would actually result in a higher savings of unnecessary blood transfusion than the 90% shown in the Mass General study. If the study meets its primary endpoint, the clinical community will have two randomized control trials showing SpHb monitoring technology reduces blood transfusions as significant clinical and financial endpoint. Most new monitoring technologies never show any outcome differences in randomized controlled trials. While these study results could ultimately be profound, we hear today that continuous SpHb monitoring is saving lives in the intensive care units and delivery rooms.

Related to rainbow, Pleth Variability Index or PVI, a new study was recently published in the April issue of peer reviewed journal BioScience Trends which showed that noninvasive and continuous monitoring of maximal PVI helped clinicians assess fluid responsiveness during major abdominal survey. It confirms that PVI results were similar to invasive more expensive stroke volume variation or SVV, from a flow track catheter. Researchers concluded that monitoring fluid responsiveness using a noninvasive device may be helpful for fluid optimization in the operating room, especially in some patients who do not need invasive artery monitoring. Multiple studies have shown PVI helps clinicians assess fluid responsiveness in surgical, mechanically ventilated patients, helping clinicians improve fluid management to reduce patient risk. Although fluid administration is critical to optimizing patient status and enabling an organ preservation, unnecessary fluid administration is associated with increased morbidity and mortality.

Consistent with our strategy to make Masimo measurements beyond the hospital and take it to other care settings, our full commercial launch of Pronto-7 is now in full swing. Of course, we started the quarter with good news about the FDA clearance of this breakthrough handheld device, which conveniently and noninvasively measures total hemoglobin, SpO2, pulse rate, and perfusion index in a minute. Today all of our direct acute care sales reps are selling the Pronto-7 and our 20-person physician practice sales team is targeting US physicians' offices. We are working to finalize Pronto-7 agreements with one or more US physician practice distributors, which will dramatically expand our reach to more than 200,000 physician offices nationwide. Our goal is to be shipping via a distributor by midyear. Moreover, just a few weeks ago, we announced regulatory clearance of Pronto-7 in China and South Korea, expanding our growth opportunities in key emerging markets.

The Pronto-7 and other technologies that make up the Masimo rainbow platform require anywhere from 8 to 15 specialized light emitting diodes in order to gather the optical data necessary to produce the Pulse CO-Oximetry rainbow measurements. To ensure the availability of these sophisticated optical electronic chips, we recently acquired the assets of Spire Semiconductor, an advanced semiconductor device foundry service business. Now a wholly owned subsidiary called Masimo Semiconductor, this New Hampshire-based organization has developed groundbreaking LED and photo detection technology with applications in solar cells, photodynamic therapy, oxygen sensing, and infrared imaging. We researched virtually all the manufacturers in the space and selected Spire because we were most impressed their capability and expertise and with the way we saw their focus on breakthrough innovations complementing Masimo's vision.

With Masimo Semiconductor, we will be able to stabilize our rainbow LED supply chain for expected future demand, develop and manufacture custom components, accelerate our R&D cycles, and optimize future development costs. We expect the acquisition of the assets of Masimo Semiconductor to be mostly dilutive to 2012 earnings which we incorporated into our revised March 12 guidance at the same time we announced the transaction. However, we expect the impact of the Masimo Semiconductor business earnings to be neutral in 2013 and accretive thereafter.

Let me close by reminding investors that since 2004, Masimo has delivered annual revenue growth in the $40 million to $60 million range which translated into a range between 56% to 14% annual growth over the seven-year period. We have achieved this organic growth by continuing to convert hospitals to our gold standard SET technology. And while the percentage growth we expect from Masimo, which is north of 20%, will not happen without dramatic growth in rainbow, we believe our first-quarter results speak to the underlying strength of our business model, the value of our technology to the practice of medicine, and the fact that we continue to convert as many new hospitals to Masimo as we always have. Customer enthusiasm continues to build for our breakthrough technology such as SpHb, Rad, Patient SafetyNet and Pronto-7. Of all of these, if just one was to become the standard of care, I am convinced that SpHb will become the standard of care because it is saving lives by detecting occult bleeding in places like the intensive care unit and labor and delivery and it's the first monitor since the introduction of Masimo SET Pulse Oximetry to show improvement in outcomes in a randomized control trial as evidenced by the Mass General study.

We also continue to push the envelope with new innovations like our 2012 Radical-7 bedside device and the Halo Index, our dynamic wellness indicator, which is still pending FDA clearance. The swift completion of our 3 million share stock repurchase program underscores our confidence in our future. As I have said many times before, new Masimo breakthrough measurements like SpHb, follow an S curve-like pattern of adoption and it is hard to predict when we will reach the steep part of that growth curve. We remain fully focused on the opportunities ahead of us and believe we are in an excellent position to achieve solid top and bottom line growth for years to come. With that, we will be happy to take your questions.

(Operator Instructions).

Bill Quirk, Piper Jaffray.

Thanks. Good afternoon, everybody, and congratulations on the anniversary.

Thank you, Bill.

First question for Mark, really nice gross margin improvement here over the last couple of quarters. Mark, you mentioned that a fair amount of that was mix. Can you give us a little extra color here? Obviously, there was fewer drivers and you've been pushing a few initiatives. Can you walk us through a little bit I guess mix of lower drivers versus some of the new initiatives? Thanks.

Sure. Let me start by saying that the impact of the new initiatives was still very, very minor in the first quarter. As you'll recall, Bill, we spoke about those improvements throughout the second half of last year and in fact, we are expecting those improvements to really become more visible towards the second half of this coming year. So not a lot of the current quarter improvements were related to that. In terms of the mix issue, that simply is a reflection of the amount of total revenues as a percent -- the total amount of sensor revenues as a percent of the total revenues. We obviously make certain assumptions when we are building our plans for the year and in this particular quarter, we actually did a much higher percent of our total revenues through the actual sensor, adhesive sensors, than some of the other product lines that we had assumed. And because those -- that specific product line actually does, in general, come in at a higher gross margin that had the positive impact that we referred to in the comments today.

Got it. Understood, thank you. And then, secondly, just thinking about the competition, they noted a couple of days ago that they felt that market share was starting to stabilize within the space. And just coincidentally looking at your drivers numbers which were obviously off year-over-year, any truth to that? Where do you think you are in terms of share within the pulse oximetry market?

Well Bill, I don't think that is accurate. And I think we saw the statements and I think if you look at it carefully, they said that their pulse ox business really was flat. So if you remember, we generally used to be shipping 25,000 to 30,000 drivers a quarter, and the past year or two have been moving up to be a little bit over that, maybe more like 30,000 to 40,000 drivers. And last year, it was the year that we did a lot of installations, this time in places like Kaiser and Banner, which were two major installations. But no, in fact the point I made earlier, you know we've been growing at this $40 million to $60 million for several years. And that has been the organic growth mainly out of the pulse oximetry business and it continues to grow that way. In Q1, we converted I think almost a record for the Company for the first quarter. Maybe it was the second or third biggest ever in terms of new bookings for the quarter, new customers. So I don't think that is accurate.

Okay, that's good to hear. And then lastly for me. Are we starting to see any traction? I realize it is still early days but are we starting to see traction on the bulk $30 hemoglobin sensors, Joe? Thank you.

As I mentioned, hemoglobin grew more than 70% this quarter and a lot of that was due to Pronto-7 shipping, as well as increase in adhesive sensors. But what I can tell you is that I personally have had many conversations recently with CEOs or COOs or CFOs and CMOs of different hospitals and there is a lot of excitement about hemoglobin. More than I have sensed before. We hope those will materialize in major conversions and the kind of exposure we would like to see to fall into that steep part of the S curve.

Very good. Thanks a lot.

Gregory Hertz, Citi.

Hi, gentlemen. Thanks for taking my question. Just one quick one. Obviously, the results out of the US were solid, but it was certainly one of the weaker quarters for OUS sales. And you mentioned that the OEM channel was weaker in the OUS versus US. I was just wondering if you could maybe provide a little bit more detail there on the direct channel, as well as whether any particular areas within the OUS where things were soft? Were there any initiatives there? Did you maybe pull out of any particular countries?

What actually threw it off a little compared to last year, was a lack of repeat of a big one-time cash order we got from Canada last year that didn't happen this year. And most of the world, that is not our model, these one-time cash deals. We usually place devices for sensor contracts. So if you take that out, actually we had really robust growth, similar to the numbers that we have seen in the past.

Okay, that helps. And also just another question as it relates to X-CAL. I'm just wondering if you've noticed in any reduction in reprocessed sensor use within your customer base to date? And also, just want to make sure that I have a proper understanding of how the technology works. And does it require a software upgrade to the drivers as well, to activate the technology in the sensor? And where that process stand, if that is the case, as far as upgrading that? And thanks.

Well, this is a topic that I don't want to get too deep in to, because it can be misconstrued. I can just tell you that we planned this for several years, and no -- there will be no software upgrade necessary. And the purpose of this whole X-CAL is to protect the system integrity of our solutions and minimize the copycat products that are being sold, mostly into international markets. But it will also impact of reprocessors which we are not too upset about, given the testing we have done with reprocessed sensors and seeing how poorly they behave. I mentioned I think on the last call, that we brought in 1,000 new reprocessed sensors, and found I think, if I am not mistaken, about 90% of them not meeting our functional test requirements.

Thanks very much. I appreciate it.

Joanne Wuensch, BMO Capital Markets

Good afternoon, and thanks for taking the question. You noted that X-CAL weighed on gross margins by about a 100 basis points. Is that sort of a consistent level, or is there still a balance of volume mix that that damage should sort of be minimized as the quarters go by?

Joanne, in general, that number as a percent of total gross margin will obviously move as the total amount of sensor shipped volumes increase in the future. The good news is that the cost we have seen so far, relative to this new technology, we believe today are essentially at the peak of their cost. We will be working over the next year as we always do, to continue driving costs out of that incremental component related to X-CAL. So over time, we expect it to be a smaller impact as a percent of total. But if you look over the next year or so, that is probably a pretty good gauge, except for whatever may happen to volume. As volume increases, there is a potential that the overall impact will actually be larger.

Okay. And then Covidien purchased during the quarter Oridion. And my memory is that you either had or have some kind of agreement with them? Is that something you can comment on?

Sure. We do have an agreement with Oridian. They do have our technology in their products and we also connect their device to Patient SafetyNet. We don't believe, from our perspective there's no reason for us not to continue that, but we will need to see how the companies behave after the integration.

Okay. And then my final question is -- my memory was that your Pronto-7 into the physicians office was going to require some type of agreement, a distributor to help do that, that you didn't have a sales call point. Has that changed, or is there some type of an announcement that would lead to a contribution from physician offices this quarter?

No, that has not changed. We still would like to have distribution help us with reaching over 200,000 physicians offices in the country. We clearly can't cover them with 20 or even 40 or 50 sales people, so we expect to forge a relationship like that. But it also doesn't mean the day that we sign up with them is the day that they will get the product and run with it because we also want to make sure with our own sales force, we have answered a lot of questions that are going to come up, so that the largest sales force will be carrying thousands of products, will have a smoother sales cycle.

Okay. Thank you very much.

Brian Weinstein, William Blair

Hi, good afternoon. Thanks for taking the question. A question. I think you answered the one the OUS OEM. But the revenue growth or lack thereof in the US with OEM, that has been kind of an ongoing situation for the last several quarters. And I think you reported it roughly flat this quarter. Can you just give us some explanation as to what is going on with the revenues through the OEM channel? Because I don't think I'm completely clear on what the rationale is behind the trend there. Thanks.

I think, Brian, as last year, actually as you will recall, we typically were talking about sequential year-over-year declines as we were seeing some of the OEMs continue to transition away from the reselling of the consumables as part of their business model. That kind of changed a little bit, depending upon whether not you are talking US or OUS. On the US side, we actually saw that decline begin to mitigate a little bit more, whereas on the OUS in the first quarter at least, we saw a continuation of it. And that helped contribute to the lower year-over-year OUS OEM revenues that we mentioned before.

The good news really is that I think for the first time in a long time, at least on a sequential basis, we have actually seen sort of a flattening of that decline. And we are actually hopeful that as we look forward over the next three quarters of this year, that we have seen the bottom. And that from this point forward, we should be beginning to see a slight upward tick in total OEM revenues. So that year-over-year decline we were experiencing last year, we don't think is going to reappear this year. Okay. And then, if you can comment at all on what the pricing environment looks like on the base SET technology at this point? Are you experiencing anything other than kind of -- the typical kind of -- down a couple percentage points year-over-year, and what your outlook is for pricing going forward? Thanks. In general, I would say yes. We have not seen any dramatic change relative to this quarter versus, say, we saw in 2011. Having said that, it still is a very competitive pricing environment, but not any more dramatically on then what we have seen over the last three or four quarters. Looking forward, as you know, Brian, we always make some assumptions as to the overall direction of the pricing environment and historically for us, that has meant on average, modeling ASP reductions of somewhere in the range of about 3% to 5% per year. That is what we have assumed for this year. And there's nothing in the first quarter that we have seen that would change that, as we look through the rest of this fiscal year.

Matt Dolan, ROTH Capital Partners

Hi, this is Chris Lewis on the line for Matt. Thanks for taking the questions. First question is around your rainbow guidance for the year. You came in at $8.5 million. I know there is some seasonality here at the beginning of the year. But it still leaves you little bit of work to do, to get to the $45 million that you have guided to. Just wanted to know how you see rainbow sales tracking throughout the year and what you need to do to get to that $45 million? Thanks.

Well, as we mentioned, or Joe mentioned in the prepared remarks, the $8.5 million of the first quarter was a little bit lighter than what we had hoped for internally. Having said that, our planning all along assumed that the first quarter of the year would be the lowest quarterly revenue for rainbow. And even though rainbow, in general, has only been around for a couple of years now, we certainly believe that the seasonal pattern that seems to be developing is that the first quarter of every fiscal year seems to be the low point of our total rainbow revenues.

So to your point, we do expect sequential increases in rainbow revenue, essentially for each quarter as we look through the rest of 2012. And if we are able to achieve that, then we certainly think the $45 million that we provided as guidance at the start of the year is certainly still achievable. And there's no reason sitting here today, why we don't think that is achievable, especially in light of the distribution agreement that Joe was just mentioning.

Great, thank you. And in your last earnings call, you mentioned that you had a long-time OEM partner had a large drop their revenues and driver numbers that you weren't anticipating. Can you provide an update on that, and what you have seen thus far from that OEM partner for this year? Thank you.

Sure. Part of that made the OEM numbers look better in the US, I believe, is that particular OEM coming back, and we are still investigating what is going on. It is not an issue that we are done with, but we will keep you posted.

Great. And then my last question. Can you just provide any more color on Halo FDA status, and what type of feedback you're getting from your OUS customers? Thanks.

With the FDA, unfortunately, we don't know when we're going to get clearance. It's been, I think now a year since we submitted Halo, so it is kind of getting on the long side of things. But that has become typical these years. As far as feedback we are getting internationally, we had some notable customers using Halo. And one of them in particular in Singapore, we are getting a lot of great feedback on how they are using it to improve their process of care, both in identifying patients at risk, as well as using Halo to know how to best spread out the resources. For example, you don't want one nurse to have several high Halo number of patients. If you can, you want to spread the high Halo patients evenly amongst the nurses. So we are quite excited about Halo, and we can't wait to get FDA clearance because we think the US market is probably most ripe for something like a Halo, and there is some pent-up demand for it. But we are going to have to wait.

Thank you.

Larry Keusch, Raymond James.

Hi, good afternoon. Joe or Mark, I'm wondering if you could -- and this was sort of touched on earlier relative to the drivers and the OEMs. But you had targeted 150,000 for the year and I just wanted to check in and see how your feeling about that target? And if it is still intact, what causes the acceleration from the levels that we saw in the first quarter?

Larry, the answer is yes. We still believe that the number is intact. We believe, as you recall, we said approximately 70,000 was our best estimate for the first half of the year, followed by 80,000 in the second half of the year. Looking at our activity so far this quarter, we think we are in a good position to be able to support that 70 number for the first half of the year. And the acceleration in the second half of the year, to your question, is actually primarily related to an acceleration of OEM rainbow board adoption. Again, speaking to some of the comments that Joe mentioned earlier, as we begin to see some of these additional OEM partners begin to actually deliver our technology within their new product cycles.

Okay.

Still feeling very good about the 150 number.

Okay, great. And then, relative to the gross margin, I think if my memory serves me correctly, you had a 100 basis points or a one-timer in the fourth quarter. So you kind of sequentially went up 40 basis points, and certainly I understand the impact of Spire in there. I guess my question is, with a full quarter of Spire coming in on the second quarter -- I think you mentioned it was only in on three weeks, in the first quarter. How should we think about the sequential change in that product gross margin with the Spire lower gross margin now in the mix?

Good question. You are correct. We, obviously, indicated with those numbers today, that we had about a 0.3% or a 30 basis point impact for this current quarter. When we provided the annual guidance for the year, there was actually about a 50 basis point reduction in our overall gross margins. If you do the math, of course, that suggests that our best estimate right now, is that we will probably be looking at a reduction anywhere in the range of about 0.6% to maybe 0.7% of -- or 60 or 70 basis points on a future quarter basis. So in other words, another sequential 30 to 40 basis points is what we would expect as we look forward to Q2, Q3 and Q4. And when you add that collectively, you get very close to the 50 basis points that we assumed in our guidance back on March 12.

Okay. So does that imply that gross margin on a sequential basis should be flat to up? Is that the right way to think about it?

Well, as I said today, we haven't changed our overall annual product gross margin guidance number, which as you recall in March, we reset that from 65% to 64.5%. So we're still looking at over the next couple of quarters, even though there will be a higher negative impact as a result of the Masimo Semiconductor activity, there were other gross margin improvements that we expect and still expect, to be seen over the next three quarters that should offset that negative impact, so that the annual guidance that we suggested earlier is still appropriate.

Okay. I understand. And then one last one for you, and again -- I'm -- it may be for Joe or for yourself, Mark. But obviously you have now completed the share repurchase and you, as indicated, still have significant cash levels and I anticipate you will generate additional cash throughout the year. The stock price has not moved in any major fashion in that time period with the share repurchase. So I guess what I'm really sort of curious about is, how are you thinking about your capital allocation at this point? And quite, frankly, why not buy back more stock?

Well, that's a good question, and we have actually discussed this recently with the Board. We have a couple of acquisitions that we are looking at and if we can come to terms with either or both, we are going to need cash for those acquisitions. And there are other things we were thinking of doing. So right now, we think there's better things to do with the cash. If that changes, and stock prices have not moved much, obviously, we would probably jump in and buy more shares.

Okay, terrific. Thanks very much for the color. I appreciate it.

John Putnam, Capstone Investments

Thanks very much. I was wondering if you could give us an update on your OEM relationships in China? And I was wondering, is X-CAL a major tool for, I guess combating piracy of your technology, particularly in a place like China?

It is of the pirating of the sensor technology. We do have now at rainbow, encryption that should minimize pirating of the rainbow technology itself, not just the sensors. So we hope that the combination of X-CAL and the rainbow platform of, the things we have been doing since 2005, will be hard for people to just knock off in China.

Okay. And have you signed any other additional OEM agreements over there, Joe?

I believe we have a handful of OEM agreements there. I think they are all rainbow related, and I believe even one or two of them have begun selling rainbow-based devices in China. At least one has. And really, the major players there are Philips, Mindray, and with Philips, we already have a rainbow agreement, but with Mindray, we are going to have to see.

Great. Thanks very much.

Sara Michelmore, Brean Murray.

Hi, thanks for taking my question. I guess just two very unrelated ones, if I could. Just back on rainbow, Joe, in your prepared comments, you did say that the SpCo and SpMet continued to be a little slower than your expectations. And I was just wondering if you could contextualize for us what you had assumed for the full year? Certainly, relative to 2011, if you can just kind of give us directionally what had been in your assumptions, just so we can have an idea of how that is tracking? And then since you brought it up, I would be curious just to hear your thoughts on M&A framework. Obviously, Spire was a small deal, but did include a little dilution it sounds like. If you have some other things you're looking at, just in terms of, if you can give us any just, big picture context for how you are thinking about these things? What your priorities are when you're looking at these deals, et cetera? Thanks.

Sure, sure. SpCO and SpMet, we started selling those as Rad-57 devices (technical difficulty). And then in a matter of two or three years, four out of the five major associations recommended monitoring of carbon monoxide. In fact, the National Fire Protection Agency, NFPA 1584, recommends it. So it should become a standard in every fire truck and paramedic vehicle to make these measurements. Unfortunately, one negative thing occurred. And not unfortunate, but another thing occurred, which minimizes the revenue of CO and Met. The unfortunate thing that is definitely all bad is the recession. And it has basically reduced local revenues, so really a lot of the sales that are happening right now out there with our devices are through grants that are provided either by federal or private institutions.

Because the fire departments are facing layoffs and much, much bigger issues, and they're really not paying attention to the standards. Then the fortunate but maybe somewhat unfortunate for revenues in the short term, is both our good partners Physio and ZOLL integrating rainbow for CO and met measurement into their defibrillators. So immediately that took our revenues down by half at least. But fortunately this increased the number of units that people were purchasing because many do prefer the integrated approach. So you asked what do we predict, we predicted more, of not just our own sales force that calls on EMS, but our OEM partners, and unfortunately, in the US, we fell short of it. OUS we didn't, but the numbers are much smaller to begin with outside the US. So all in all, Mark correct me if I'm wrong, but I think CO and Met grew, what 7%, or some very small level. Yes, 7%. And that is kind of -- because of what we started off with in 2005, which is kind of the base of rainbow it's -- even though hemoglobin grew 70%, rainbow in general grew only 14%.

But it is -- yes -- so it is up. And then, when you just talked deviation off the line, I mean you obviously knew what the environment was coming into the year. And I'm just trying to get a sense of how far -- I mean the numbers sound like they are fairly small. But just how far are you off, that's I guess what I am trying to get at. Thanks.

Well, we are not that off much. I think we're maybe -- total dollars maybe $1 million off. So it was not like we predicted much more, given that we understood the environment that we are in. But I think that led to less than what we had estimated in our forecast for our shareholders.

For this quarter?

For this quarter.

Yes. Okay.

Sara, I think -- you may have already realized it, but I do think the important part of the comment that Joe had made earlier was that the two new -- call them elements in the rainbow family, both SpHb and RAM, the growth rates in those particular parameters were very, very strong year-over-year. So we're actually very encouraged with what is going on in those new areas and as Joe alluded to, those are really going to be the drivers for rainbow revenues over the next five years. So the fact that CO and Met are not growing at the levels we would like is certainly a fact, but it is also not a complete surprise to your point. But the real important point I think of the comment that Joe made before, is that the other components of rainbow really are growing very nicely now.

Okay, that's great. And then, Joe if you could just address my question on how you kind of think about M&A, and what you're hoping to achieve? Thanks.

Well, our philosophy on acquisitions is two things. One, acquisitions by cash versus acquisitions that are either so large in cash that we have to borrow or buy stock. When it comes to the acquisition by big amounts, that either we have to borrow or give our stock for, we will only look at acquiring something that we think is better than our current business model. Something that we have already. And so far, we have not seen anything like that yet, because I don't want to make a big bet like that, and not love what we are acquiring more than what we have today, because otherwise I fear that, will be not a prudent investment, since we may not integrate it properly. So that is what we think about big acquisitions. So really for us, the other category where we are acquiring technology like we did recently with Spire or we did with Andromed or we did before with Vital Insight, the hurdle is smaller but it has got to be an acquisition for either -- mainly for technology that has got to be revenue -- something that we can pay with our own cash that we have generated. So right now, the two acquisitions we're looking at, both should be things we can do with our cash, so they are not big acquisitions that are going to game changing, but things that we think are good to have for the long-term.

Okay, thanks the color.

We have time for one more question.

Lennox Ketner, Bank of America

Hi, and thanks so much for fitting me in, and congratulations on the anniversary.

Thank you.

I guess, Joe, I was trying to reconcile on the drivers placed. You talked last quarter and this quarter about seeing record contract bookings. And yet, as people mentioned, the driver shifts were down meaningfully year-over-year, so I am just trying to reconcile that. Are you saying basically that you booked a record number of new hospitals in the quarter? But they may be smaller than some of the large contracts, the Kaisers and Banners that you booked before? Is that the right way to think about it? Or how can we reconcile those two things?

Well first of all, a couple of ways. One, 80% of our drivers come from the OEM. So our OEMs had a softer quarter than we had expected, but we don't think that is going to continue for the year. We think we are going to get more of it in the second half, and even in the second quarter. The second part is our own direct business. And we don't want to get to detailed, but we had some major installations that unfortunately got delayed. So a few thousand of our devices that normally would have been installed in Q1, got pushed into Q2. So that is a big part of it.

But to answer more specifically your question regarding the new contracts we converted in the new year, in Q1, there weren't actually a lot of contracts. There were some major contracts, with some really significant names, top hospitals in the country and some outside the US. So we're very happy with the quality, as well as the quantity of the new customers we are attracting. If that answers your question?

Okay. So it is just more of a timing issue at some of the installations, some of those contracts that were booked, were pushed out?

Yes.

Okay. And then, last question, just are you still to planning to launch a line of ReSposable sensors for the Pulse Ox business, and if so, is there any update on the timing for that?

Yes, we are. That's a great question. We have been in a prolonged -- what we call a pre-market release, make sure everything is good, before we run with it. We are really close. So if its not in the second quarter, I expect in Q3 we are going to launch a very exciting ReSposable line of sensors for Pulse Ox, and some additional ones for rainbow that is going to really create a better environment for hospitals that are A, trying to go green, and B, and trying to both use rainbow and SET in different departments, yet want have the same adhesive kind of go with the patient, no matter where they go.

Great. Thanks so much.

Thank you. I want to thank you all for joining us. We really appreciate the support. Of course, yes, we are excited about our twenty-third anniversary. One that started us with -- in a garage. And while we feel like we have a lot of places to improve, and a lot of places to go, we are happy about the history. And hopefully, in the next five or six years, we will dwarf where we have come from over the last 23 years. So with that, I want to thank you, and wish you all a great week and weekend.

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