Masimo Corp (MASI) 2012 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to Masimo's Third Quarter 2012 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.

I'm pleased to introduce Sheree Anderson, Masimo's Vice President and 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 the most recent Form 10-Q. You will find these in the Investor section of our website. With that, I'll pass the call to Joe Kiani.

Thank you, Sheree, and thank you all for joining us today, especially our friends and investors who are joining us from the points that have been hit the hardest by Hurricane Sandy. We're sorry you had to go through that and we hope for you a speedy recovery, but we also thank you for being diehards and joining us today.

We finished the third quarter with 15% year-over-year growth in product revenue, fueled primarily by our direct business in the US and abroad. We shipped 33,100 new pulse oximeters and pulse CO-Oximeters in the quarter, and now estimate our worldwide install base to be 1,056,000 monitors, representing an 11% year-over-year increase and demonstrating continued adoption of our technology by hospitals worldwide.

Importantly, sales of Rainbow products topped 11 million in the third quarter, representing a 41% year-over-year increase. This was fueled primarily by a 92% jump in total hemoglobin revenue as more care providers recognized the potential of our continuous aspacha (ph) hemoglobin monitoring to help reduce unnecessary blood transfusions, identify occult bleeding, and detect anemia.

Also during the quarter, we strengthened our future growth potential with the introduction of new breakthrough products which we displayed and announced at the recent American Society of Anesthesiologists annual meeting. And with the acquisition of PHASEIN, a developer and manufacturer of best-in-class capnometry and anesthetic agent monitoring solutions.

Reflecting our confidence in Masimo's long-term potential, the Board has declared a special cash dividend of $1.00 per share, payable on December 11, to stockholders of record as of November 27. This action demonstrates our commitment to enhancing stockholder value. And by making the declaration now, Masimo stockholders can take advantage of current dividend tax rates, which may increase in 2013.

This is the fourth instance of a special dividend being paid by Masimo in the past six years, and it's the third since we became a public company in 2007. Including the dividend announcement today, since becoming a public company, Masimo will have returned approximately $220 million to stockholders in the form of special cash dividends, and anther $62.5 million in the form of purchases of our common stock.

Together, these represent approximately 88% of the cash generated from operations between 2008 and September 2012. Our ability to do this underscores the power of our innovation and recurring revenue model to generate strong cash flows, a healthy balance sheet, and expectations for future growth.

I will provide additional perspective on our business and strategy in a few minutes, but first, Mark will review the details of the third quarter financial performance. Mark?

Thank you, Joe, and good afternoon, everybody. In the third quarter, product revenue rose 14.8% to $112.1 million, reflecting primarily increased sensor sales to hospital customers.

Movements in foreign exchange rates resulted in a decline of approximately $1.1 million in Q3 2012 product revenue compared to the prior-year quarter. On a constant currency basis, product revenues, therefore, rose 16%.

Third quarter product revenue also included approximately $900,000 in revenue from Masimo Semiconductor, which we acquired in mid-March 2012, and $1.5 million in revenue from PHASEIN, which we acquired in late July 2012. Excluding the impact of these acquisitions, our total product revenue rose 12.4% versus the year-ago period, or 13.5% on a constant currency basis.

Masimo's third quarter 2012 total revenue, including royalties, rose 14.4% to $119.1 million, versus $104 million in the year-ago period.

Rainbow product sales grew 41.3% in the third quarter, to $11 million. Encouragingly, we saw significant year-over-year growth in Rainbow consumables, which suggests to us that utilization of our Rainbow products continues to increase. Specifically, as Joe mentioned, SpHb was a standout performer in the quarter, and it was up 91.6%.

Our worldwide end user or direct business, which includes sales through just-in-time distributors, grew 15.2% in the quarter to $95.2 million, versus $82.6 million in the one year-ago period.

In total, our direct business represented 84.9% of product revenue in the third quarter, consistent with year-ago levels. OEM sales, which made up the remaining 15.1%, rose 12.9% to $16.9 million, compared to $15 million in the same period of 2011. Excluding the impact of acquisitions in 2012, our direct business grew 13.7%, while OEM revenues grew 4.6%.

By geography, total US product revenue rose 12.6% to $79.2 million in the third quarter, compared to $70.3 million in the third quarter of 2011. Once again, this growth is due primarily to higher consumables sales.

Product revenue outside the US totaled $32.9 million, up 20.5%, or 24.7%, on a constant currency basis, compared to $27.3 million in the same period last year. Every major international region delivered double-digit revenue growth in the quarter, with international product revenue representing approximately 29.3% of total product revenue in the 2012 third quarter, versus 28% in the year-ago period.

Our third quarter product gross profit margin was 63.7%, compared to 63.5% one year ago. As we expected, and indicated in our previous earnings call, the Masimo Semiconductor and PHASEIN acquisitions combined to reduce third quarter product gross profit margin by approximately 140 basis points.

In addition, the ongoing incremental costs of our new X-Cal technology reduced the Q3 2012 product gross margin by more than 150 basis points.

So importantly, excluding the impact of acquisitions and the cost of the X-Cal technology, our pro forma Q3 2012 product gross margins would have been approximately 67%.

As you'll recall, beginning last quarter we indicated that we expected various cost improvements related to new manufacturing processes, automation activities, and other supply chain improvements, to result in increased overall gross profit margins. The Q3 pro forma product gross product margin indicates that we are making progress with these initiatives.

Our third quarter total gross profit margin, which includes royalties, was 65.8%, unchanged versus the same prior period last year.

Third quarter 2012 operating expenses were $60.4 million, up 22% from $49.5 million in the third quarter of 2011. SG&A expenses increased $8.2 million, or 20.2%, to $48.3 million in the third quarter compared to the year-ago period.

Excluding Masimo Semiconductor and PHASEIN, SG&A expenses increased 17.6%. This increase was due primarily to increased payroll and related costs associated with higher staffing levels, and higher legal fees as a result of additional patent litigation activities, which we indicated in Q1 2012 as we expected to occur in the latter part of 2012. Higher marketing, advertising, and professional fees also contributed to the increase in year-over-year SG&A.

The rise in total operating expenses also reflects a 29.3% increase in R&D spending, to $12.1 million from $9.4 million in the year-ago period. The increase reflects primarily increased payroll and related costs associated with higher R&D staffing levels, costs associated with new projects and engineering supplies, and the addition of Masimo Semiconductor and PHASEIN R&D expenses.

Third quarter 2012 operating income was $18 million, compared to $18.9 million in the year-ago period.

Non-operating income was $912,000 in the third quarter, compared to non-operating expense of $240,000 in the year-ago period. The change reflects primarily the recognition of net realized and unrealized gains on foreign currency-denominated transactions.

Our third quarter 2012 effective tax rate was 28.1%, compared to 20.7% in the third quarter of 2011. This year-over-year increase was due primarily to a lower-than-normal Q3 2011 effective tax rate. As you'll recall, this was the result of a change in our 2011 expectations for the mix of 2011 income in jurisdictions in which we do business and, to a lesser extent, the suspension, in 2012, of the federal research tax credit.

Third quarter 2012 net income was $13.8 million, or $0.24 per diluted share, compared to $14.8 million, or $0.24 per diluted share in the same period last year. Note that in our third quarter 2012 operating results, they included a $0.02 per share loss, which we attributed to our 2012 acquisitions of PHASEIN and Spire Semiconductor.

As of September 29, 2012, our days sales outstanding was 51, versus 50 at year-end 2011. Over the same period, inventory turns declined slightly, to 3.3 from 3.4.

Also at September 29, 2012, total cash and cash investments were $113 million, compared to $129.9 million as of December 31, 2011, reflecting primarily net cash generated from operations offset by $7.2 million in cash used to purchase the assets of Spire Semiconductor and create Masmio Semiconductor in Q1 2012; $26.2 million in cash used to repurchase shares of our common stock in the first half of 2012; and $30.2 million used to repurchase PHASEIN in Q3 of 2012.

The payout of the special cash dividend announced today is expected to be about $57.2 million, based on current shares outstanding. This dividend, which will be reflected in our fourth quarter and full-year 2012 financial statements, represents only a portion of our cash reserves, which the Board believes is sufficient to cover our operational needs and fund R&D investments and strategic initiatives.

I'll close by reminding you that, consistent with our prior practice, we intend to provide 2013 guidance in mid-February, when we release our full-year 2012 results.

In the meantime, please note that if the medical device excise tax does not get repealed or delayed, we expect the majority of Masimo's US product revenue to be subject to the 2.3% tax beginning in January 2013. Like many other companies, we are still working with advisers to determine the appropriate accounting methodology regarding how the tax will be computed and how it will be reported on the income statement. We nevertheless, though, believe it's important that these incremental tax costs be included as a line item in any financial modeling of the Company's expected operating results for 2013 and beyond.

With that, I'll turn the call back to Joe.

Thank you, Mark. Before I begin, let me say what a pleasure it was to see many of you at our inaugural Investor Day in New York the 20th of September. We enjoyed the opportunity to give you an in-depth overview of our key growth strategies and technologies and explain why we have a strong belief in Masimo's future.

If you were unable to join us for the event, we hope you'll take the time to visit our website and listen to the archived webcast, particularly the clinical panel discussion, which offered enlightening perspectives on how doctors and respiratory therapists use our technologies every day to enhance the care they provide patients.

For us, it was a proud reminder of the importance of our mission and guiding principles, especially our drive to always do what is best for patient care.

To that end, we made good progress in the third quarter on a number of financial and operational fronts. As a result, year-over-year growth in our product revenue and install base continue to be significantly above industry growth rates. We view this as proof that we are cementing a market position as the clear technological leader known for providing products that help clinicians solve clinically challenging problems while also helping to usher in practices and standards that improve patient care, save lives, and reduce costs.

Our focus on prudent and superior performance and innovation was on full display earlier this month at the American Society of Anesthesiologists annual meeting in Washington, DC. Masimo's technologies were the subject of 18 clinical studies, many of them highlighting the positive clinical outcomes and patient safety impact of total hemoglobin PVI, acoustic respiration rate, and SEDLine brain function monitor.

In addition, more than 200 clinicians attended a symposium to hear leading anesthesiologists discuss their experience with SpHb, PVI RAM, and Patient SafetyNet, and thousands of ASA attendees jammed the Masimo exhibit to see a host of new breakthrough products.

For example, we announced during ASA that our Rainbow platform is expanding once again with the addition of fractional arterial oxygen saturation measurement, which will be delivered through the new Rainbow supersensor. Previously, pulse oximeters could only measure and display functional oxygen saturation, or SpO2. So when patients had elevated coboxyhemoglobin and/or elevated methhemoglobin, the display functional oxygen saturation overestimated the actual oxygen saturation values.

Masimo's new fractional arterial oxygen saturation measurement, or SpfO2, will be, for the first time, noninvasively measure oxygenation in the presence of dishemoglobin.

To illustrate the importance of this, consider this example. In a patient who has an SpO2 of 98%, coboxyhemoglobin level of 12%, and methhemoglobin level of 1%, SpfO2 would be displayed at 85%. It's highly likely that clinicians treating this patient would frequently make different diagnostic and therapeutic decisions at an oxygenation of 85% versus 98%, which is SpO2 would display. Both SpfO2 and the Rainbow universal resposable supersensor are pending FDA clearance, but are available in CFR countries.

At ASA, we also demonstrate the new SED pulse oximeter universal and resposable sensor. As we have done every year since our first ASA, we also showed how our pulse oximeters and pulse CO-oximeters can measure through motion and low profusion while our main competitor's products can't. That difference is what has brought us here and what has helped transform patient care with reliable, accurate monitoring when patients need it most, whether it's neonatal patients in the neonatal intensive care unit or any patient on the general floor.

The pace and substance of our new product releases telegraphed to the market our continued commitment to investing in important advances that benefit hospitals and patients, both in terms of leading-edge parameter and platforms and in finding ways to improve existing modalities.

Our universal resposable pulse oximetry sensor and progressive sensor configuration that combine the performance, accuracy, and comfort of a single-patient use Masimo SED sensor with the cost-effectiveness and environmental advantages of a reusable sensor, is a good example. More than ever, hospitals are under pressure to reduce costs and implement green initiatives. With Masimo universal resposable sensors, hospitals' material management departments can meet cost-reduction edicts while helping the hospital advance environmental and safety goals; and, most importantly, ensure that their patients are provided with accurate monitoring when they need it most.

We also demonstrated the recently FDA-cleared uSpO2 universal pulse oximetry cable with GE Healthcare's ApexPro telemetry system. This unique technology is a boarding cable pulse oximetry solution that invented a Masimo SED circuit board within a completely self-contained cable, providing a simple way for hospitals to add Masimo SED pulse oximetry to devices that weren't designed with SpO2 integrated inside the device.

GE Healthcare is the first to integrate this low-power Masimo SED platform into patient-worn monitors designed for use in ambulatory patient care settings. Clinicians are very excited to have this capability, which will help them to enhance work flow due to improved monitoring and reduction of false alarms on these more active patients.

Late in the third quarter, we received FDA clearance for Masimo SED pulse oximeters, Rainbow SED pulse CO-oximeters, and neonatal sensors with labeling for screening newborns for critical congenital heart disease. This marked the first time the FDA has cleared specific labeling indicating the use of pulse oximeters, in conjunction with a physical exam, to screen newborns for CCHD. CCHD affects five to 10 of every thousand newborns, resulting in 3% of all infant mortalities. Improving early detection and treatment is critical because up to 30% of all CCHD-related deaths in the first year of life are due to failure to detect the condition.

Following the action last year by the US Department of Health and Human Services to add measure through motion on low-profusion pulse oximetry, CCHD screening for newborns as part of the recommended uniform screening panel, California recently became the latest state to mandate such screening.

We are proud of the role our technology has played in helping clinicians save babies' lives and are actively engaged in efforts to educate current and prospective hospital customers treating patients in labor and delivery, well-baby nurseries, and neonatal intensive care units about the importance and proper method for conducting CCHD screening with motion and low-profusion tolerant pulse oximetry.

A fundamental component of our growth strategy is continuous monitoring on the general ward with our Patient SafetyNet remote monitoring system. Masimo Patient SafetyNet tracks the underlying physiological conditions of patients and detects changes and abnormalities that signal declining health status in real time. When a patient's condition deteriorates, the system automatically sends wireless alerts directly to clinicians, prompting a potentially life-saving response to the bedside of the patient.

In the third quarter, the joint commission issued a sentinel event alert on safe use of opioids in hospitals, and recommended better opiod dosing, along with oxygenation and ventilation monitoring in post-surgical patients. Opiod analgesics rank among the drugs most frequently associated with adverse drug events. In fact, of opiod-related adverse drug events, including deaths, that occurred in hospitals that reported to the joint commission sentinel event alert database between 2004 and 2011, 29% were related to improper monitoring of the patients, second only to dosing medication errors.

To help hospitals comply with the joint commission edict and similar recommendations from the Anesthesia Patient Safety Foundation, Masimo has a one and above, if not the, most comprehensive continuous monitoring offering, including measure through motion and low-profusion pulse oximetry, acoustic respiration rate monitoring, and a full suite of side stream and mainstream capnography options, which we added in July with our acquisition of PHASEIN.

Roughly three months following the acquisition, we couldn't be more satisfied with the strength of the technology and the team. Integration is progressing on schedule and includes a reassessment of manufacturing activity, the identification of period when we will expand PHASEIN's R&D efforts through 2013 to address additional market opportunities.

The addition of capnography to our product offering ensures that we can provide customers a full range of respiration- and ventilation-monitoring choices. However, it is our belief that Rainbow acoustic respiration rate monitoring, RAM, will ultimately surpass other forms of ventilation monitoring because it is entirely noninvasive, easy to administer, well-tolerated by patients, and as accurate as respiration rates from capnography.

Evidence of this continues to build with new clinical studies that confirm RAM's performance. At the recent ASA, three separate studies showed that respiration rate measured with RAM displayed similar accuracy and precision to capnography. One of these was a study conducted in anesthetized patients under sedation at Stanford University School of Medicine, when researchers concluded that the use of RRA, or RAM, could be a good alternative for the perioperative period, as most patients will have received sedation during surgery and need to be monitored in the post-anesthesia care unit and, later on, the patient wards.

RAM's, of course, a primary growth engine within our Masimo Rainbow SED platform, which delivered solid 41% year-over-year growth in the third quarter. Importantly, consumables represented roughly 45% of total Rainbow revenue in the third quarter, which is similar to the second quarter of 2012 levels and an encouraging indication that adoption is on the rise.

Leading Rainbow's growth in the third quarter was SpHb, which grew 92%, due primarily to higher consumable sales, indicating that SpHb continues to gain traction among our customers. As you know, in 2012 we increased our commitment to educate clinicians and hospital administrators regarding the problems associated with unnecessary blood transfusions and the ability of SpHb to help reduce unnecessary blood transfusions by providing continuous real-time hemoglobin trending.

As part of this, we rolled out the Better-Care Guarantee, which is designed to stimulate customer adoption by reducing the risk at up-front costs. Under the program, a customer replaces their pulse oximetry adhesive sensors with Rainbow pulse CO-oximetry sensors, and Masimo guarantees that the reduction in blood transfusion-related costs will exceed the incremental price paid for Rainbow sensors or Masimo will refund the difference.

Our first Better-Care Guarantee program is now underway at a prestigious academic medical center in the US. Interestingly, some customers, after considering SpHb and the Better Care program, decided in the third quarter to bypass the Better Care Guarantee altogether and move directly to full adoption of SpHb. These include prestigious hospitals in Japan and Europe.

As we noted last quarter, we continue to see increasing levels of interest in our Better Care program, and now have more than 50 hospitals throughout the world who are actively engaged in discussions with us regarding the program. We expect to see more customers take advantage of this program in Q4, with even stronger adoption as we move into 2013.

The body of SpHb clinical evidence also continues to expand. At ASA, researchers from Fujisawa Municipal Hospital in Japan represented a study indicating that SpHb monitoring contributes to effective ultra-filtration and stable blood purification. And researchers from Seoul National University Hospital in Korea presented a study concluding that SpHb monitoring, with the Radical-7, can be useful as a trend monitor in children during an operation, even immediately after volume expanders are administered.

Late in the third quarter, our new distribution partners, Henry Schein and PSS World Medical, commenced sales of Pronto and Pronto-7 devices and sensors in a physician-practice market. We're excited about this opportunity because total hemoglobin is one of the most frequently ordered laboratory tests in hospitals, urgent care centers, physicians' offices, and public health clinics. Existing point-of-care testing methods are time-consuming for the clinician and expose the patient, clinician, and healthcare facility to potential contamination and blood-borne pathogens.

Conversely, Pronto and Pronto-7 offer noninvasive and quick total hemoglobin testing, along with SpO2 pulse rate and profusion index, with no needle sticks, contamination risk, lab consumables, or waste disposal.

A study published recently in Postgraduate Medicine confirmed that not only did the study show Pronto SpHb measurement to be equivalent to the bias and limits of agreement of the HemoCue 201-plus, the most commonly used invasive point-of-care total hemoglobin analyzer, in a outpatient setting, but these researchers also said that because SpHb measurement is noninvasive, it has the potential to confer the additional benefits of patient comfort, decreased complexity, and increased safety for healthcare professionals.

SpHb is the cornerstone of our Rainbow platform for its long-term potential to improve the practice of medicine, reduce costs, and ultimately become the standard of care. Recent favorable trends in total revenue, new customers, consumable sales, adoption by our OEM partners, and clinical evidence are giving us confidence that our years of work to build the Rainbow market are starting to translate into sustained growth.

In closing, our third quarter financial results demonstrate our ability to take full advantage of our recurring revenue business model and innovation leadership to seize multiple growth opportunities across a variety of patient care settings.

Our core SED business grew 10% and our global install base grew 11%, continued to outpace market growth. Our Rainbow product sales were among the most robust yet, at 41% growth, fueled by a strong 92% hemoglobin SpHb growth.

We enhanced our competitive position with strategic acquisitions that added capnography and anesthetic agent monitoring to our product lineup. We introduced a series of important new innovations, sensors, parameters, and platforms all designed to address clinically relevant problems while lowering healthcare costs. And strong cash flows helped us maintain a healthy balance sheet, providing flexibility to do what is in the best interests of stockholders, including returning cash to stockholders with the special dividend announced today.

With that, we'll be happy to take your questions. Thank you. Operator?

(Operator Instructions) Bill Quirk, Piper Jaffray.

Hi. Good afternoon, everybody. It's actually Dave Clair, here for Bill. First question for me -- I didn't hear an update on guidance. Does your prior guidance still apply?

Yes.

Yes; okay. That was easy. And then, I was hoping for a couple more details on the Better Care Program. What kind of conversion rates have you experienced in the program to date?

Well, as we mentioned, we are now in advanced discussions with 50 hospitals worldwide and we have converted at least three hospitals, one directly under the Guarantee program and two -- like I said, they just decided they were just going to do it. So that's where we are today.

Okay. And then, any updates on GE and Philips? When should we expect to see Rainbow-enabled monitors?

While I can't be sure of the answer I can give you because it's a lot of work by OEMs and they are the ones that have to kind of be the owners of the date, our expectation is by this time next year, we should have Philips out with Rainbow and soon after, GE. I think you already know that many other companies, from Welsh Allyn to Zoll and Physio-Control already have Rainbow in their products today.

Yes, okay. Thank you.

Thank you, Dave.

Joanne Wuensch, BMO Capital Markets.

Joanne?

Can you hear me?

Yes, we can now.

Wonderful. We have next year from the med-tech tax about $5.5 million, $6 million net of tax. Does that sound about right for what you're thinking?

In general, Joanne, I think our answer would be yes. The problem is, as I said in our prepared remarks, that we, too, are still evaluating the specific rules of the tax and so therefore we can't be exactly sure what kind of revenue will ultimately be associated with the tax. There is some product that's includable, there's some product that's not includable.

But directionally, I think in your model you've got, as you said, after tax about $6 million, if I remember.

Correct.

Implying something in the range of about $8 million, $8.5 million gross. I think that would probably be on the high end of our expectations today, but it's close.

Okay. And could you give us an update on how the initial Pronto-7 with your two distributors went in the quarter?

Not well. (Laughs) We're going to be short in answers, I guess. Mark started with yes. Not well, but we're hopeful that's just at the beginning of them getting up to speed. Some of them did not have their sales meeting. As you noticed, one of them got acquired by another company, so that could have had something to do with it. So we're watching that carefully.

Okay. And then, just -- when I take a look at your operating margin, I know there were several pieces of the puzzle in the quarter which pushed that down lower than I would have expected. How do I think about a recovery in margins over next coming quarters?

Well, let me start by just saying that implied in my answer to the first question about guidance -- obviously since we're not changing our guidance, that implies that we're looking forward to a rather robust Q4 period. Historically, the Q4 period for us is relatively strong as we enjoy the seasonality that typically occurs as we move into the fourth quarter.

And so because of that, you can infer that given our year-to-date results that we announced today, we're expecting some pretty sizeable sequential growth on the product revenue side. And as hopefully my comments included some inference of we hope continuing improvement on the product gross margin side.

Operating expenses -- as you know, Joanne, the fourth quarter for us is typically our high quarter in operating expenses because of various items, primarily our increased trade show activity. So we would expect our overall operating expenses, as they usually do, to rise as we go from Q3 into Q4.

Having said all that, from an operating income standpoint, I think that will get us to a higher operating income number, certainly in the fourth quarter, than we had in the third quarter. And for the whole year, obviously it should get us very close to where the original guidance and expectations were.

Unfortunately, for next year, since your question alluded to a couple of quarters, I think it's a little too early for us yet to get into some estimates of where we think next year's numbers will be. But directionally, we would hope to continue to see improvements in those same areas that I just mentioned for Q4.

Thank you very much.

Brian Weinstein, William Blair.

Hi, good afternoon. Thanks for taking the question. Question is on the competitive dynamic. The royalties have ticked up a little bit. Just curious if you're seeing any more traction from Covidien in the market.

And then the follow-up to that would be, can you comment a little bit on pricing trends and if things have stabilized at all there? Thanks.

Sure. I think first of all, as our competitor has been bragging about a handful of accounts they've taken from us -- in the past 10 years -- that did affect our revenues, maybe have affected our expectation on the royalties a bit. I just want to remind you all that in the past 10 years, we're one for 100. For every 100 contracts that we convert, they've converted about one.

And as far as pricing is concerned, we saw our ASPs stabilize the last couple of quarters, compared to the same period a year ago.

Okay. And then Mark, you had talked about some of these cost improvements in automation and what not. You talked about that about a year ago. Where is that versus where you expected it to be at this point? Is there any kind of quantification that you can give us to give us an idea about what kind of contribution that provided? Thanks.

Sure. I think, implied in the comments that I went through earlier, was really our attempt to provide everybody with some directional guidance in terms of what the impact of those kind of programs have essentially already had on our margins, if you exclude the negative impact of the X-Cal cost increase that, again, I alluded to before.

If you think through those numbers, I think you can get a pretty good sense of the kind of impact that those changes have already had for us this year. The good news is that we think we're well on our way to realizing some of those benefits. But our expectations are, as we go into 2013, that we'll continue to see an improvement in those kind of operational changes, ultimately resulting in incrementally higher gross profit margins.

So the good news is we've already seen a fairly sizeable contribution relative to the numbers that I mentioned earlier. The even better news is that we expect those kind of improvements to continue increasing -- and I would say, frankly, over the next couple of years.

Okay; thank you, guys.

Thank you, Brian.

Matt Dolan, Roth Capital Partners.

How are you?

Hi, Matt.

So just to follow up on two components of the guidance comment, Rainbow needs to step up, so I know you said that the Pronto office distribution program didn't go as well as you'd hoped. Is there some of that baked into Q4 for Rainbow?

Yes; absolutely, Matt. As you point out, we didn't change our original $45 million for the year. Obviously, in order to achieve that we're going to need a very strong fourth quarter. And implicit in that assumption is a fairly sizeable increase in the amount of revenue associated with those two new distribution partners.

As Joe said, Q3 was a little bit underwhelming, but we're still very hopeful that the pieces are in place now so that Q4 will actually see a very notable increase in overall activity. And clearly, that's part of the reason why we're sticking by the original start-of-year guidance.

Okay. And the other general comment was on placements, and I think you'd hope the second half of the year to exceed the first half. Can you just walk through what the environment is in getting drivers installed out there?

Sure. The 33.1 that we reported this quarter, I think we would consider probably just a little bit light from where we'd expected. We'd expected maybe 34 or 35.

Given that, we always expected that in order to achieve our second half of the year driver guidance, that we would have to have a very, very strong fourth quarter. The good news is that sitting here today, we're very encouraged about what we're seeing from a driver standpoint, both our OEM drivers as well as our direct drivers.

And then, as Joe alluded to in his comments, the new technology, the new board-in-a-cable technology, is going to allow us, for the first time ever, to put those type of new drivers into the marketplace in the fourth quarter. And so we're actually counting on that new technology to be part of the reason why we expect a very strong fourth quarter driver number which should, we believe, get us very, very close to that second half of the year driver guidance. And in fact, the entire full-year guidance that we provided back in February of up to 150,00 drivers for the year.

Okay.

Matt, we would have achieved our own internal volume of drivers in Q3 had it not been for a mistake in border crossing. We had a couple thousand units that unfortunately got stuck in the border because of improper labeling by one of our vendors. So we actually had orders to achieve what we had expected, but couldn't because of inability to manufacture the products.

Okay, so those will pull onto Q4. All right, that's helpful. If I could sneak two more quick ones in -- Mark, on the X-Cal, on the resposable, can you just tell us where you are as a percentage of total sensor volume today, and how that plays out going forward as that becomes a bigger percentage of sensors as it relates to gross margin?

You mean, Matt, in terms of volume shipments?

Yes, what percent of sensors are either X-Cal or resposable? And if it's 10%, do we have more of a drag on gross margin coming, or vice versa? Or have you already seen it be the majority of the business so far.

No. Let me start with X-Cal. Remember, we started shipping X-Cal in the fourth quarter of last year, which essentially meant that every sensor from that point forward contained the X-Cal technology. In other words, the incremental cost to those sensors was already embedded in the shipment cost of those drivers.

And since we've been essentially shipping every one of our sensors since then with the X-Cal cost, essentially all of that cost is already, if you will, embedded into our model. Certainly in the first, second, and third quarter results this year. And that's one of the reasons we've been calling out the impact of those additional costs this year.

So to your question, those costs are already essentially embedded in our model. The only reason they would theoretically increase from here is courtesy of increased sensor volume. Then obviously, as I just implied, we're working feverishly to reduce the cost of that incremental technology and over time, we think we will bring it down.

But essentially, every sensor that's been shipped since early Q4 last year, really has contained the incremental X-Cal cost.

The amount of resposable sensors that we're shipping, still a very, very small percentage of our total sensors. So really not even impacting, if you will, the overall cost equation so far.

Okay, great. And then Joe, it sounds like with the dividend, we know how you think the election will go. Can you give us your perspective on the device tax, and Masimo's philosophy in terms of managing profitability relative to that extra burden next year? Is that something you're going to try to offset or do we just live with it and grow out of it? Thank you.

Well, I think the administration is going to be driven by data, and I think that just like the Constitution had 27 amendments, there's nothing wrong with the Affordable Care Act having a few. So we're working very hard with the administration and people on the Senate and Congress to at minimum delay the tax, if not, I guess, repeal the tax or dramatically reduce it.

I appreciate the inquiry; I know you know all about that. But as far as what Masimo's going to do to deal with the tax, we're just going to have to have it be part of our expenses. We don't want to cut back on any of our strategic initiatives; we just think it's the wrong time to do that, and long-term, value will be lost.

Okay; thanks very much.

Thank you, Matt.

Larry Keusch, Raymond James.

Could you talk a little bit about how you're thinking about the cash that you have on your balance sheet? Obviously, with the special dividend you still have very healthy cash levels -- certainly north of $60 million. And just how you think about allocation to M&A and share repurchase.

Well, on the M&A front, I think as I stated in the inaugural analyst meeting, there was one acquisition we were very close to pulling the trigger on that we decided against. So we don't anticipate any sizeable acquisitions in the next six to 12 months. So therefore we didn't think we needed the cash for that.

And as far as stock buyback, we're considering it. But I think given the likelihood of dividend taxes that we're going to be dealing with next year, we thought this was the right time to do a dividend instead of stock buyback. But we're going to monitor that and as you know, as I mentioned earlier in my prepared statements, we have given back 88% of our cash flow to stockholders, and we'll continue to be driven in that fashion.

Okay, terrific. And then, two other ones. Joe, I just want to make sure I'm understanding this. So you've been shipping X-Cal for this year -- all your sensors going out. The capabilities within those sensors to protect from reuse and counterfeiting, are those capabilities now being recognized within all those sensors going out the door?

Yes.

Okay, perfect. And then lastly, just on Rainbow. I wanted to just check -- were there any military or sort of one-time big orders in there?

There was a military order, but it wasn't a one-time big order, it was kind of a routine amount.

Okay. Would you expect that sort of level of military order to reoccur in the fourth quarter?

No. We get kind of routine order -- this (inaudible) throughout the year, and really end of the fiscal year for the government, so September is usually a fun month for us with them. But it wasn't a big number. It was a nice order, but it wasn't anything like we had a couple of years ago where we got a $4 million additional amount than the normal amount we would get from the military.

Okay, great. Thanks for the clarification.

Thank you, Larry.

(Operator Instructions) Lennox Ketner, Bank of America.

Hello, Lennox?

So Mark, first, I just wanted to make sure I understand the guidance for Q4. I know you're not changing your overall guidance, but if I use your revenue guidance for the year, to get to the dollar 11, I have to assume some fairly meaningful operating margin improvement in Q4. But it sounds like you are say that you expect operating expenses as a percentage of sales to go up, or were you just saying you expect them to go up on a dollar basis -- that you expect to see margin (inaudible)?

Yes, it was the latter, Lennox. I was talking about the aggregate dollar amount. I was just pointing out that sequentially, our spending is typically in a year the highest in the fourth quarter, primarily because of all of our trade show activity.

Okay, but you still expect to see some leverage there.

Yes.

Okay. And then Joe, you talked about the fact -- and I know you talked about this analyst day, too, but the fact that you expect over time your customers will prefer RAM over capnography. I'm just wondering, in light of that, how we should think about modeling the PHASEIN business going forward. Do you feel like that could still see double-digit growth, even if your customers prefer RAM, or should we not see modeling as meaningful growth for that business?

Well, I think -- it's a small business, both of them. So I guess they're all going to have better than double-digit growth for a while. I just believe for you, the best thing to do is to continue to think about capnography growing double digits, but that's not going to be long term. I think it's going to be probably the next year or two. We see, long term, for RAM to take off and keep growing at really healthy levels for the next 10 years.

Okay. But so in the near term, you still think (inaudible) can see double-digit growth.

I'm sorry, I didn't hear your question.

Oh, I'm sorry. So in the near time, you still think PHASEIN can see double-digit growth?

Yes.

Okay. And then, last question is on the -- I know you rolled to the resposables for pulse ox. One, are you still expecting to see similar operating profit on that on a dollar basis on your regular pulse-ox sensors? And two, are you still expecting only a small percentage of your customers to just use that product?

Yes, we expect operating profit to be the same amount as our normal sensor sales. It's still too early to tell how customers are going to choose between that sensor and the new one -- and the existing one; excuse me. We are seeing, with new customers, strong interest in the resposable. If I had to get my crystal ball out, I would say over time, that could be 20%, 30% of our volume.

Okay, thanks so much. I'll let someone else hop on.

Thank you. I think that's our last question. Thank you again for joining us. I know some of you have been through a lot. So for you to be on this call means a lot to us. Wish you all the best, and talk to you in the new year.

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