Masimo Corp (MASI) 2012 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to Masimo's fourth-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 Aronson, Masimo's Vice President of Investor Relations.

Hello, everyone. Joining me 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-Q and the Form 10-K to be filed later today. You will find these in the Investor section of our website.

I'll now pass the call to Joe Kiani.

Thank you, Sheree. Well, first, let me wish everybody a Happy Valentine's Day. Thank you for joining us and becoming our Valentine. We are very happy with our progress, while we always wish for more and we hope to deliver more. We're happy to be sharing with you our progress in 2012 and talk about our plans in 2013. But as they say, love is in the eyes of the beholder, so we hope you will enjoy what you're hearing.

So, good afternoon, and thank you for joining us for a financial and strategic update on Masimo. We delivered a strong finish to 2012 in many respects, including a 20% rise in fourth-quarter product revenue, a 31% constant currency increase in fourth-quarter international revenue, fueled by strengths in nearly every outside US region, especially Europe, Middle East and Africa, Japan and the rest of Asia.

We also experienced a 24% rise in fourth-quarter driver shipments, bringing 2012 driver shipments to 146,000, and expanding our global installed base by a net of 11% to 1.09 million units. And we saw a 13% rise in year-over-year earnings per share, finishing the fourth quarter at $0.26 a share compared to $0.23 a share in the prior-year period. During the quarter, foreign currency losses and an ability to benefit from a 2012 federal research tax credit, as we had planned, reduced fourth-quarter EPS by $0.03.

During 2012, we generated approximately $75 million in operating cash flow, which, along with our strong balance sheet, allowed us to complete two strategic acquisitions, repurchase $26 million in Masimo's stock, and pay a $57 million dividend to stockholders in December 2012. And today, we announced that the Board has authorized the repurchase of up to 6 million shares of our common stock during the next three years, underscoring our confidence in the power of our technology platform, global franchise, and business model, to take full advantage of our growth potential over the long-term.

We've entered 2013 fully focused on advancing our strategy, which is to grow our core SET business by increasing our presence in Critical Care and the general ward, while leveraging our rainbow platform to pursue new opportunities in and beyond the hospital, and continuing to execute on our long-term plan.

I'll discuss our 2013 plans in a few minutes, but first, Mark will review fourth-quarter and full-year 2012 financial performance, and provide 2013 financial guidance. Mark?

Thank you, Joe. Hello, everybody. Fourth-quarter 2012 product revenue was $125.3 million, up 20% versus the fourth quarter of 2011, due primarily to strong growth in our SET Pulse Oximetry sales to hospital customers and growth in international markets.

Fourth-quarter product revenue included approximately $1 million in revenue from Masimo's semiconductor, which we acquired in March 2012, and $2.8 million in revenue from PHASEIN, which we acquired in July 2012. Excluding these, total product revenue rose 16% versus the year-ago period.

Movements in foreign exchange rates reduced fourth-quarter 2012 product revenue as compared to the prior-year quarter by approximately $800,000. Rainbow product revenue grew 13% in the fourth quarter to $11.1 million. The growth reflects primarily increased licensing and consumable sales, primarily related to our SpHb and RAM technology. Total hemoglobin sales rose 8%, and RAM sales rose nearly 300% in the fourth quarter versus the year-ago period.

Although we achieved near-record quarterly total rainbow revenues, the quarter was slightly less than we expected, due to a large international order which was delayed into the first half of 2013, and lower-than-expected revenue from our US physician office distribution channel.

Our worldwide end-user or direct business, which includes sales through just-in-time distributors, grew 18% in the fourth quarter to $106.8 million versus $90.2 million in the year-ago period. Our direct business representing -- represented 85% of total product revenue in the quarter versus 86% one year ago. OEM sales, which made up the remaining 15%, rose 28% to $18.5 million compared to $14.5 million in the same period of 2011. Excluding the impact of acquisitions in 2012, our direct and OEM businesses grew 17% and 12%, respectively, in the fourth quarter.

By geography, total US product revenue rose 16% to $84.4 million in the fourth quarter, compared to $72.9 million in the same quarter of 2011. Additional hospitals gained during the year and higher consumable sales drove this growth.

Product revenue outside the US totaled $40.9 million, up 29%, or as Joe mentioned, 31% on a constant currency basis compared to $31.8 million in the same period last year. The increase reflects solid double-digit growth across all major international regions, especially, as Joe noted again, in Japan, EMEA, and the rest of Asia. In fact, international product revenue hit a new all-time high in the fourth quarter, representing 33% of total product revenue compared to 30% in the fourth quarter of 2011.

Our fourth-quarter product gross profit margin was 64.1% compared to 63% one year ago. Our 2012 acquisitions combined to reduce fourth-quarter 2012 product gross margin by approximately 180 basis points. In addition, the ongoing incremental cost of our X-Cal technology reduced fourth-quarter 2012 product gross margins by an additional 130 basis points when compared to the year-ago period.

Therefore, excluding the impact of 2012 acquisitions and X-Cal, our year-over-year fourth-quarter product gross margin would have been approximately 310 basis points higher, or 67.2%, which, at least on a pro forma basis, would have resulted in the highest quarterly product gross profit margin in our history.

Throughout 2012, we have noted the negative gross profit margin impact of these items, so that the offsetting positive results from our product cost reduction efforts could be recognized. These efforts, which we began discussing in late 2012, began to turn into realized benefits -- excuse me -- which we began discussing in 2011, began to turn into realized benefits in 2012, and have included improved manufacturing processes, supply chain efficiencies, and other cost improvement initiatives.

Our fourth-quarter total gross profit margin, including royalties, was 66%, compared to 65.5% in the same period last year. Fourth-quarter 2012 operating expenses were $64.9 million, up 21% from $53.5 million in the fourth quarter of 2012. Excluding the impact of 2012 acquisitions, operating expenses rose 17%. SG&A expenses increased $7.6 million or 17% to $51.6 million in the fourth quarter compared to the year-ago period. Excluding the impact of 2012 acquisitions, SG&A expenses increased 14%, due primarily to higher staffing levels as well as higher year-over-year legal, marketing and tradeshow expenses.

Total R&D spending rose 39% in the fourth quarter to $13.3 million from $9.6 million in the year-ago period. Again, excluding the impact of 2012 acquisitions, R&D expense rose 32%, due primarily to the higher staffing levels and engineering project expenses associated with the large number of new product initiatives, such as ROOT, iSpO2, Universal ReSposable Sensors, SpfO2, the SuperSensor, new SpHb centers, and additional products yet to be announced. In total, our R&D spending was approximately 10% of fourth-quarter 2012 total revenues.

Fourth-quarter 2012 operating income was $22.3 million, up 11% compared to $20.1 million in the year-ago period. Excluding the impact of 2012 acquisitions, operating income was approximately $24.3 million, which would have been up 21%. Nonoperating expense was $1.3 million in the fourth quarter compared to $468,000 in the year-ago period. The increase reflects the recognition of realized and unrealized losses on foreign currency denominated transactions, due almost entirely to the late Q4 2012 strengthening of the US dollar against the Japanese yen.

Our fourth-quarter 2012 effective tax rate was 29.3% compared to 27.7% in the same period last year. The increase was due primarily to the suspension of the Federal Research Tax Credit in 2012. In early January 2013, this tax credit was extended retroactively to 2012, and prospectively through the end of 2013.

Because this extension occurred in 2013, we were unable to recognize the benefit in 2012, but will recognize the full-year 2012 benefit in the first quarter of 2013. Had the Federal Research Tax Credit been reinstated before our fiscal year-end, as we expected, our fourth-quarter 2012 effective tax rate would have been 24.6%, reflecting the full 2012 R&D tax benefit in the fourth quarter.

Fourth-quarter 2012 net income was $15 million or $0.26 per diluted share compared to $13.8 million or $0.23 per diluted share in the same period last year. As Joe mentioned at the outset, higher FX-related nonoperating expense, and the inability to benefit, as we had expected, from the 2012 R&D tax credit, combined to reduce fourth-quarter EPS by $0.03. In addition, and as expected, our fourth-quarter 2012 results included a $0.03 per-share loss attributable to the 2012 acquisitions.

In the interest of time, I'll abbreviate my review of 2012 results, and direct you to today's press releases and the Form 10-K, which will be filed later today for more information. In 2012, total revenue rose 12% to $493.2 million, including product revenue of $464.9 million, up 14% versus 2011, or 15% on a constant currency basis. Excluding 2012 acquisitions, product revenue grew 13%. Total 2012 royalty revenues declined from $32.5 million to $28.3 million as a result of the decline in the royalty rates.

Product gross profit margin was 64.1% in 2012, down slightly from 64.4% in 2011, reflecting primarily the negative impact of X-Cal and the lower gross margin models of the businesses we acquired in 2012. Operating expenses totaled $241 million, up 16% from the $207.6 million in the prior-year period, due to the impact of the 2012 M&A activity, higher staffing levels, and increased marketing and legal expenses. Excluding M&A activity, total operating expenses increased 14%.

The 2012 tax rate was 26.1%, relatively flat with 26% in the prior-year period. Net income for 2012 was $62.3 million or $1.07 per diluted share compared to $63.7 million or $1.05 per diluted share in 2011. As expected, and discussed throughout the year, our 2012 acquisitions reduced full-year 2012 EPS by approximately $0.06. In addition, the primarily Q4 2012 FX-related nonoperating expense, and once again the inability to benefit from the extension of the R&D tax credit in 2012, reduced our total 2012 EPS by another $0.03.

As of December 29, 2012, our DSO was 49 versus 50 in the year-ago period. Over the same period, inventory turns rose slightly from 3.4 to 3.8, in fact, marking the highest level of inventory turns since early 2007. Total cash and cash investments as of December 29, 2012 were $71.6 million compared to $129.9 million as of December 31, 2011.

The change reflects primarily net cash generated from operations, offset by $7.2 million in cash used to purchase the assets of Spire Semiconductor in Q1 2012, $26.2 million in cash used to repurchase shares of our common stock in the first half of 2012, $30.4 million used to purchase PHASEIN in Q3 2012, and $57.3 million used to pay a $1 per-share dividend to stockholders in Q4 2012.

Now I'll turn to our 2013 guidance, which is based on the best information we have available to us, and in general, assumes no significant changes to the worldwide macroeconomic environment or to the environment in which our primary customers, hospitals, operate. Also, these projections assume certain FX rate assumptions at the start of the year. And to the extent these differ significantly from the actual exchange rates, our guidance could be impacted.

So with those caveats, we are projecting 2013 total revenue of $548 million, including product revenue of $520 million, and royalty revenue of $28 million. Included within this $520 million in product revenue, we are projecting rainbow revenues of $50 million. We expect our 2013 product gross profit margin to be approximately 64.5%, reflecting a continuation of our gross profit margin expansion efforts, offset by the full-year negative product gross profit margin impact of the businesses that we acquired in 2012.

We expect our core operating expenses to be approximately $265 million. Also, including the full-year operating expense impact of our 2012 acquisitions, and the incremental costs associated with the buildout of a new SpHb dedicated sales force, which Joe will discuss in more detail later. In addition, we are projecting an estimated medical device tax of approximately $6.5 million, which we intend to report in SG&A expense. Therefore, including the medical device tax, our total 2013 operating expenses are expected to be approximately $271.5 million.

We expect our 2013 effective tax rate to be approximately 28%, which includes the benefit of the retroactive 2012 and perspective 2013 benefits of the Federal Research Tax Credit, offset by a slightly less favorable US OUS operating income mix. As a side note, as a result of the 2012 R&D tax credit being a discrete Q1 2013 item, we expect our Q1 2013 effective tax rate to be approximately 24% to 25%, while each of the other quarters should be approximately 28% to 29%.

As previously noted, we are assuming constant FX rates during the year, and as a result, are not projecting or attempting to forecast any foreign exchange gains or losses within our 2013 nonoperating expenses. As a result of these assumptions, we are now projecting 2013 GAAP earnings per share of $1.13 based on approximately 59 million weighted shares.

Unfortunately, as we've discussed in the past, our $6.5 million in 2013 medical device tax projection will have the effect of reducing our 2013 EPS guidance by approximately $0.08 per share. Of course, the total amount of shares outstanding could be lower, based upon the impact of the stock repurchase program that we announced today.

With that (multiple speakers) --

(multiple speakers) Thank you. I think, Mark, you said $1.13 instead of $1.14.

Oh, excuse me, yes, you are right. $1.14 should be the 2013 GAAP's earnings per share.

Thank you, yes. Thank you, Mark. We played out our 2013 financial guidance with confidence and the tremendous potential of our technology platform to drive meaningful sales growth and margin expansion over the long-term, and with the belief that targeted investments are essential now to achieve our goals.

Our 2013 plans will focus on four key priorities -- achieve continued above-market growth in the worldwide pulse oximetry and emergent general ward monitoring markets; capitalize on SpHb's potential to dramatically lower hospital's blood management costs and save lives; expand our presence in non-hospital markets; and heighten our R&D focus on existing growth drivers.

As you can see from our fourth-quarter and full-year performance, demand for the superior clinical performance of Masimo's Measure-Through Motion and Low-Perfusion pulse oximetry technology, remains strong. Setting the course for future growth, we've also continued to renew our partnerships with existing hospitals while converting new ones to Masimo throughout 2012.

Some notable 2012 additions include Yale, New Haven Health System, Cleveland Clinic System, Seattle Children's Hospital, Great Ormond Street Hospital in London, King Fahd Medical Center in Saudi Arabia, and Charite, the largest University Hospital in Europe, and Erasmus, the largest medical center in the Netherlands.

Our expanding presence through 2012 was also underscored by the pace of our 2012 new driver shipments, which exceeded 145,000 for the third year in a row. We expect the trend to continue, with driver shipments targeted to be above 150,000 for 2013. Contributing to this growth is the movement of continuous patient monitoring beyond critical care and onto the general ward, especially for patients receiving opioids and at increased risk of respiratory depression.

Masimo is uniquely positioned to help hospitals reduce avoidable adverse events through implementation of our breakthrough Masimo SET Pulse Oximetry and Patient SafetyNet systems that facilitate patient safety. We offer the only general ward monitoring solutions shown to help clinicians improve outcomes, let alone also lowering costs -- an advantage that helped us grow 2012 sales of our Patient SafetyNet remote monitoring system by 50% compared to 2011. Moreover, we continue to see an increasing number of our long-term sensor contract bookings include some component of general ward monitoring with Patient SafetyNet.

In conjunction with Patient SafetyNet growth, the adoption of Masimo RAM or Respiratory Rates from Acoustic Sensor, RRa, is also on the rise. In 2012, RRa revenues, albeit from humble beginnings, rose more than 300%. Used to detect respiratory depression by noninvasively and continuously monitoring a patient's respiration rate with a sensor that's been attached on the neck, RRa is easy for clinicians to administer, and has been shown in independent studies to be well-tolerated by patients, and as accurate as capnography.

In 2012, we broadened our ventilation monitoring offering with the PHASEIN acquisition, which complements our RAM technology, RRa, with a full range of not just ventilation monitoring options with capnography, but gas and anesthetic agent monitoring for our customers.

Turning now to SpHb, on our plan to capitalize on SpHb's potential to lower blood costs and save lives, SpHb is a revolutionary technology that provides continuous real-time hemoglobin trending and identifies significant changes in hemoglobin levels. It has been shown to help clinicians reduce transfusions, detect occult bleeding, and lower hospital blood costs.

Since the debut of SpHb in 2008, we have been working to build a market through our global acute care sales organization, which has sales responsibility for all Masimo products used in hospitals. Given the expanding awareness of the risks and the costs associated with unnecessary blood transfusions and occult bleeding, as well as the favorable reaction we're getting from clinicians, we believe the time has come to make a more focused push to establish SpHb as the standard of care measurement, by investing in the creation of an SpHb-dedicated sales and clinical specialist team.

Therefore, as we have previously suggested, we have already begun to build out a new SpHb blood management sales and clinical team that will eventually include nearly 60 people throughout the world. The team's singular focus will be to drive awareness of SpHb's compelling value proposition to hospitals, and grow adoption among current and prospective hospital customers. This heightened sales focus complements our continuing efforts to refine the SpHb technology. We won't stop refining it until it is as good as our SET Pulse Oximetry.

And buildout of this new SpHb sales team now also ensures we have it in place by early 2014, when we anticipate a significant increase in the number of rainbow OEM partners and SpHb products becoming available.

Leading the new SpHb sales and support team will be Rick Fishel, a proven sales and business development executive with 10 years of senior level experience at Masimo. As President of Worldwide OEM Business and Corporate Development, Rick has played the principal role in establishing rainbow OEM partnerships with leading patient monitoring companies. Under Rick's leadership, we have continued to increase the number of OEMs who are currently selling or are planning to introduce rainbow-enabled multiparameter monitors to the global market.

At year-end 2012, more than 40 OEMs had active rainbow integration efforts in place, including 17 with released products. Recall that roughly 70% to 80% of our drivers into the market as part of an OEMs multiparameter device, which makes conversions of the OEM community to rainbow SET technology an essential component of our SpHb growth strategy.

Jon Coleman will be running the rest of the Worldwide Sales, Marketing and Clinical Research team. Rick and Jon will be working closely to maximize Masimo's overall potential.

The use of SpHb monitoring to help clinicians make optimal transfusion decisions was underscored again recently with a new award-winning study, which is the first to report the impact of SpHb in high blood loss surgery. Doctors at Cairo University in Egypt conducted a prospective cohort study in 106 neurosurgery patients, and found that SpHb monitoring helped clinicians achieve a 56% reduction in the frequency of multi-unit RBC transfusions, and a 47% reduction in average number of RBC, which is red blood cells, units transfused.

Moreover, once clinicians determine transfusion was needed, they were able to initiate transfusion 82% faster using SpHb monitoring. The researchers estimated that SpHb monitoring could save roughly $470,000 to $1 million per 1000 surgeries performed. These compelling results complement the previous Mass General Hospital study of 327 lower blood loss orthopedic surgery patients, which also showed that SpHb monitoring helped clinicians reduce red blood cell transfusion frequency, and average red blood cell units per patients by nearly 90%.

To help hospitals reduce the risk and costs associated in validating SpHb's ability to lower their blood costs, we offered the Better Care guarantee. For hospitals that replace their Pulse Oximetry Adhesive Sensors with Masimo ReSposable rainbow Pulse CO-Oximetry Sensors, we guarantee that their blood transfusion-related savings will exceed the incremental cost of the ReSposable Sensors, or we will refund the difference.

Thus far, we have secured accounts related to the Better Care Program at hospitals in Japan, Holland, and in the US, including the fourth-quarter addition of UCLA, which is in our own backyard. Encouragingly, we have continued to increase the number of customers with whom we are discussing ID'ed implementation of a Better Care Program, or in some cases, just moving directly into the actual purchase and deployment of SpHb technology within the operating room, recovery room, intensive care unit, and other critical care areas of the hospital.

We've also made progress in our plans to expand our presence in non-hospital settings with news that Libya will become the first country to begin using the Pronto-7 to screen potential blood donors for low hemoglobin levels in all of its major blood donation centers. We see the blood donation market as a key opportunity for the Pronto-7, which provides quick, noninvasive spot-check hemoglobin, SpO2, pulse rate, and perfusion index measurement.

In order to enter the US blood donation market, we are pursuing specific regulatory clearance from the FDA Center of Biologics Evaluation and Research. We also continue to work with major US distributors, PSS World Medical and Henry Schein, to penetrate the physician practice market. We are unhappy with our initial results, and as a result, have reiterated our performance expectations to them. We will be monitoring this carefully over the first half of 2013.

Finally, we were happy with the response in our new iSpO2 at the Consumer Electronics Show in Las Vegas last month. Indeed, for aviation -- intended for aviation and sports use, the iSpO2 is a commercially available consumer pulse oximetry for the iPhone, iPad or iPod touch. It includes our board and cable technology, which is SET technology, and downloadable app, which also lets consumers trend measurements and email trend data.

Innovation is the central Masimo competency. Our track record of introducing first-ever technologies has earned us the reputation as the industry's innovation leader. In 2013, we will continue to invest approximately 10% of our total revenue in research and development. Later this year, for example, we will introduce ROOT, our new open architecture connectivity-based platform that includes a radical docking station with large touchscreen display, rich connectivity options, and additional ports for other sensors.

I'll close by saying that few companies have a base business that is as sticky as ours, and still grows by double digits. And probably even fewer companies have growth potential within their existing product portfolio that could rival Masimo's opportunities. Today, we have a robust global franchise deploying breakthrough technologies that are helping clinicians improve patient care, save lives and reduce costs. With the proper support in the market, our newer technologies are capable of having an enormous impact over time on patient safety and the practice of medicine.

I am confident that we are making the correct and necessary investments now, including creation of a global SpHb dedicated sales team to ensure we realize our potential and also achieve our long-term financial goals. Beginning in 2014, we expect our SpHb and clinical support team to be largely in place. And accordingly, we expect to begin to deliver higher levels of operating leverage.

We've come a long way since our IPO five years ago, and we look towards -- we look forward to reporting our progress as we execute the second half of our long-term plan over the next five years. We are optimistic it will be an exciting and rewarding journey.

With that, I'll open the call to questions. Operator?

(Operator Instructions). Bill Quirk, Piper Jaffray.

So first question is regarding rainbow, and I guess specifically thinking about the rainbow guidance, we're looking at -- it's actually an acceleration in -- over the fourth quarter's performance. And so help us think a little bit, guys, how, I guess, what would drive that? And perhaps folding into this discussion, maybe you could just expand on your comments regarding Pronto and how to accelerate that. Thanks.

Thank you, Bill. I think it's a combination of factors, including a dedicated sales force for hemoglobin, including a customer base that has begun using our technology in a wider way; some Better Care accounts that will start implementing. And some of them we'll be able to measure the cost savings within the fiscal year, so that we can hopefully recognize the additional revenues from rainbow. So I think it's a combination of things, and we're hoping to meet and maybe even beat the number.

And so, Joe, should we read that to mean then, with the exception of the larger order that we should see in the first quarter, I guess the move from the fourth to the first, that the business should essentially accelerate over the years? Is that the right way to think about the pacing?

Yes, and just to correct you, we think the business actually will happen in the second quarter that we lost in the fourth quarter. It did just slip in one quarter; it slipped into the second quarter. So it should happen in the first half, maybe in the first quarter, but right now, we're expecting it -- actually an April time frame.

So (multiple speakers) having said that, yes, that's what we're expecting. We think the acceleration will happen in the fourth quarter, somewhat in the third, but given that the third quarter usually, because of the vacation season, kind of takes a dip, I'm not sure how much of it you'll witness then. But we really think we have a nice fourth-quarter ramp.

Okay, got it. And then perhaps, Joe, you could just talk a little bit about Pronto. And I guess specifically, I guess I'm thinking more of your feedback from your partners, what are they telling you in terms of the uptake and why it wide isn't going faster than perhaps you'd initially expected? Thank you.

Sure. With Pronto and Pronto-7, one of the things we expected, we expected the sales force of our distribution partners to be proactively selling it, given the discussions and the contracts we have. And what we had witnessed in the first two quarters in doing business with them, they really were not doing that. And in some ways, were even impeding our sales process, because we're no longer selling direct.

So I've had discussions with the senior management people at both of these organizations. And we want to be patient, hoping that it's just a learning curve issue, especially given that PSS went through an acquisition. They had some distractions. But our patients -- it's not going to be forever -- and if we don't get to the target that we had all established, then we're going to make some changes.

Now we don't want to get rid of our distributors, but we may agree to sell in parallel with them. That's a change that may come if we don't get to the results that we hope to get to without that effort.

Understood. And then just last one for me and I'll jump back in the queue. Mark, can you talk about the 2013 earnings guidance as it relates to the buyback? What does it assume there about the pacing of that? Thank you.

Sure. I think as I mentioned, that the current assumption is a weighted average of about 59 million shares, which given where we are at the end of the fourth quarter, essentially does not include any specific assumptions of stock repurchase.

So given the announcement we made today, and, of course, depending upon these purchases, that number could obviously move down throughout the year. But since we've not committed to any specific time frame for those purchases -- because as most stock repurchase programs stipulate, we'll do it when market conditions are appropriate -- we didn't feel it was appropriate to include some of those assumptions in that EPS guidance number.

Perfect, thanks guys.

Thanks.

Joanne Wuensch, BMO Capital Markets.

Thank you very much for taking the question. Let's talk a little bit about X-Cal technology and how that's going to help your gross margins increase next year -- or maybe I should re-word it differently. What is helping you increase your gross margins next year?

Well, the X-Cal, you're right, does not increase the gross margin. What it should do is increase the user perception of our products, and minimize some of the knock-off business that happens around the globe because of generic sensors being sold to our installed base, and so forth.

But their cost reductions come from a line of initiatives that have begun several years ago, that we expect to see a benefit from continuing throughout this year, as we did see some of it last year, but even throughout 2014 and 2015. We are putting a lot of emphasis in our engineering team working on redesigns of products, redesigns of manufacturing equipment, to better manufacture products at higher efficiency.

Okay. And is this more a back-end loaded thing? Or should we see a slow ramp throughout the year, as your engineering pieces of the puzzle go into place?

Joanne, I think from a projection stand, probably a slow ramp is the right way to think about it, given the 64.1% that we ended the fourth quarter with. So a number probably somewhere in the 64% to 64.5% range for the first half of the year, and then 64.5% to 65% would probably be the right range for the back-end of the year, with the overall blend being at that 64.5%.

Okay. And then a lot of people have asked me what might happen to your business with healthcare reform. And do you have a view on that?

Yes, I think healthcare reform is going to have some snakes and it's going to have some ladders. (laughter) I think the ladders, I think as hospitals turn from independent hospitals to more these Accountable Care organizations, which eventually will be, in our opinion, maybe 100s of Kaisers -- 100 Kaisers instead of 5000 independent hospitals and several Kaisers.

The ownership of the quality and the safety of the patients will mean a lot to these customers. So we believe our technologies and products for long-term view customers is ideal. So we think that will help create more traction for solutions.

On a negative, of course, we don't expect -- the medical device tax was a negative, which we're trying to suck up as best we can through cost-cutting measures and instead of layoffs and things like that. And some of it, unfortunately, translates to our bottom line as well. So that's a definite negative. And then the other, I think, negative is that we don't anticipate additional procedures and, therefore, sensor volume from the hospitals, because of the increase in the patient population.

So if we're fortunate, the volume will stay steady for our product to potentially slightly going down because of what we experienced in Massachusetts. In Massachusetts, when we look at what happened before and after their Affordable Care Act, our growth rate in Massachusetts was less than the neighboring five states. So, if that was to be a gauge of what could happen, it could mean lower volume for some of our products -- like the disposable products, that is.

Thank you very much.

But I want to emphasize, not lower than where they are today, lower than what they could be without the changes. So -- but what Massachusetts didn't have to go through is the accountable care organization, so that is the wild card, which is to see in that mode will the volume actually be less than what we would like to see over the next five years.

Brian Weinstein, William Blair.

Thanks for taking the question. Question is on the SpHb sales force. Can you maybe talk specifically about what they're going to be doing differently than what your reps were doing today? Is it a different call point? Is it a different -- just different level of focus? What are the specific changes that you're going to see from that sales force versus what your reps were already doing?

Well, on focus, I think, really, the call points will be mostly the same, although there is a higher C-Suite pull for SpHb than there is for SpO2, our pulse oximetry business. So there will be some more of that, but really it's just a focus, Brian.

Because when you have a sales force that has the responsibility of hospitalwide conversions, of Patient SafetyNet into the hospital they have right now, and new hospitals that are getting, and you put on top of that hemoglobin, I think what will happen, it will go towards whatever is easier, instead of going and doing the pioneering work, the missionary work that you have to do with a new technology that promises to improve the standard of care.

Okay. And then on the general floor opportunity there, how do you measure progress here? How can we measure the progress there? Do you have any idea in terms of where driver placements are going, so that 150,000 next year, how we should think about what percent might be going into more of a general floor opportunity versus the critical care? And what the contribution can be from that? Thanks.

Sure. First of all, on the 150,000 drivers, we are assuming a very small -- like 2%, 3% of the drivers to be from the general ward market opportunity. And we do track those through installation of Patient SafetyNet and monitors that are connected to it. But that's going off of a growth rate that we have seen in the recent past, but doesn't take into account of what happens when the wall really falls down.

APSF, which is an Anesthesia Patient Safety Foundation, for a few years has been recommending continuous monitoring of patients on the Pulse surgical general floor beds. And the traction is happening, but it still is being resisted by people who are worried about cost and worried about monitoring. But JCAHO, this last summer, also issued their recommendation for monitoring a patient's pulse surgically. So we see a tremendous push to make that a reality.

So when that happens, we don't know exactly when that dam will break, the general ward market is actually bigger than the critical care market. We estimate, in the US, for example, there are about 120,000, 150,000 critical care beds, including the OR recovery room and ICU, but there's at least 450,000 general floor beds. So even if one-third or half of them began doing continuous monitoring, which frankly eventually we believe all of them will, you will see a much, much bigger driver of growth than what we're projecting.

(Operator Instructions). Matt Dolan, ROTH Capital Partners.

I wanted to follow-up on the rainbow topic, and maybe approach it from a different angle. You were able to add more than $10 million to that business last year in 2012. So I'm curious what's embedded into your assumptions for -- let's call it only a $10 million increase in 2013. Joe, I think you mentioned you hope that maybe you can beat that, so I'm trying to understand with Pronto-7 and this new hemoglobin initiative, what's included in that $50 million target?

Well, first of all, my memory, if I'm right, Mark, please correct me, I think we grew from $34 million to $41 million. So we grew by --

$40 million.

$40 million. So we grew by about $6 million, not the $10 million. But so we're expecting to grow faster than last year. So we're expecting now to grow by $10 million, as you put it. But in addition, I'm pretending I'm the new CEO of Masimo, and I get to reset expectations. (laughter) So, I'm trying to set expectations, so that we can hopefully, not meet, but beat. So I may have to eat these words, but that's what this forecast is -- it's a conservative forecast and hopes to meet and beat.

Okay, great. And you also mentioned leverage in your prepared remarks, and if we adjust out some of the issues in 2012, we're not seeing a ton on the earnings side. I know you have the medical device tax in-your-face, but maybe just walk -- and I know you have the investment of the hemoglobin group. Can you walk through the pacing of those investments? And then layer in your thoughts on how leverage expands once this investment year is passed?

Sure, Matt. I think, as you pointed out, part of what's embedded in our 2013 total operating expense guidance is what I would refer to as sort of a continuing incremental cost of the M&A activity that we kicked off in 2012. Because, obviously, those acquisitions were done in different periods throughout the year. So this year we, of course, have the full-year impact of those additional operating expenses.

So those are an incremental part of our year-over-year growth in operating expenses. As you pointed out, we also have now the incremental SpHb sales management team cost that we've got layered into that projection. And so, in reality, when you back those two incremental expenses out, the overall true net operating expense increase for Masimo next year -- again, excluding those two variables, is actually back in the single digits.

So while it's not clearly apparent this year, because we do have those two other contra expense items, there is some underlying operational benefit that we're beginning to build into the model this year -- and, as Joe suggested earlier, we think setting the stage for even better operating leverage performance in 2014 and beyond.

And, Mark, just to sneak one more in, did you give what the core growth rate was -- you know, and you stripping acquisitions out in '12 and '13, what the product revenue guidance implied in terms of core growth? Thank you.

We didn't, but we can suggest that it is in the range of about 10% or so, if you look at the core Masimo SET product revenue growth, excluding the impact of the acquisitions, as the benefit of those acquisitions roll into 2013.

Okay, thanks again.

Ben Haynor, Feltl and Company.

Now how quickly do you think you'll be able to add those 60 people on the SpHb side of things?

We actually think it's going to be rather quick. As Joe alluded to, we began this process in the fourth quarter, of the 60 total worldwide positions, directionally, we're looking for about 40 in the US, 20 OUS. And we believe there's a very good chance that we'll have very close to 40 of that team here in the US built by the middle part of the year.

The OUS portion will probably take a little bit longer, probably extending throughout the rest of the year. But that's why I think we've called out the impact of this SPH build out into our numbers. Because we actually think it can occur relatively quickly, certainly the majority of it in the first half of the year.

Okay, great. That's helpful. And then this might be a little bit further off, but about a year from now, you've got the Covidien royalty agreement due to expire. Have you guys had any discussions with them on possibly extending it yet?

We have not.

Is there anything on the schedule?

Just so you know, the way the agreement is written, it doesn't expire on 2014. Covidien can choose to stop paying it in, I think, what -- March 2014? And if they do, then we have the choice of potentially bringing legal patent litigation against them. So they can keep paying and nothing happens. So we're in no reason to have discussions with them.

Okay, so we find out in March 2014, I guess.

Roughly. (laughter)

(laughter) All right, that's all I had. Thank you, gentlemen.

Thanks, Ben.

(Operator Instructions). Lennox Ketner, Bank of America Merrill Lynch.

Thanks so much for taking the question. I just wanted to come back to rainbow for a second. Joe, I'm wondering if you can just give an update on when you expect the Philips and the GE contracts to come online?

And, also, I just want to clarify, because I'm just a little bit confused on this, for customers that do buy products through Philips and GE, or through other OEM starts like rainbow right now, those customers still have access to rainbow, but they would have to buy it -- they would have to use it through a separate Masimo driver rather than having them combine? Is that correct?

Let me first answer your first question, and then maybe you could repeat your second, because I got distracted and I didn't hear it.

Okay, sorry.

So the first question is, why we can't be sure, because it's GE and Philips that have to produce the products. We signed the contracts, and we expect to have Philips and GE out, if not by the third quarter of this year, certainly by Q1 2014. And that's our best estimate. Again, we don't know for sure. And like any engineering project, it can slip. But so far, that's the horizon we have.

And your second question?

Okay. Oh, my second question, I'm just trying to understand for customers that purchase their monitoring systems through Philips and GE, can they still get rainbow right now, except that they would just have to have a separate Masimo driver? Or do those customers really not have access to rainbow right now?

I see. They don't have access to rainbow right now. They will need a new hardware as well as a new software to allow them to have access to rainbow. Because, I mean, think about it -- up until now, there has never been a noninvasive hemoglobin carbon monoxide, methemoglobin PVI measurement.

So the work that GE and Philips have, and our other OEMs, especially them because of their expansive electronic medical records work, if they have to create the field for those measurements and pretty much all of their products. And, secondly, you need the special hardware that has the rainbow board in it that can then work with our regular sensors to deliver the measurements.

Okay, I guess my question was whether they could just have a separate Masimo driver with rainbow. (multiple speakers) But we can talk offline.

(multiple speakers) You're asking could they somehow get rainbow today? They can, but the way they would have to do it is to purchase, for example, a Radical-7, and that unit would bolt on their device or somewhere near their device. And then that device would be doing the rainbow measurement. And they could get the SpO2 and pulse rate shown on the screen of their Philips or GE monitors, and in some cases, even the rainbow parameters.

But to get all that data into electronic medical records, they would have to then connect our device, the Radical-7, to some type of interface that then sends the information directly to their electronic medical records, which we have that capability. But that's how they would do it.

Okay, okay, that's helpful. Thank you.

It's kind of clean. I mean, the issue is, imagine on your automobile, if you have an embedded navigation system versus you buy an external navigation system. That's probably the best analogy.

Okay. No, that's very helpful. And then, Joe, on the royalty agreement with Covidien, I know you said there's been no discussions there, but in my conversations with investors, there just seems to be some confusion over whether the royalties that are -- those -- sorry, the patents that those royalties are based on expire in 2014, or not until 2017. Or whether it's some expire in 2014 and some in 2017. I'm just wondering if you can maybe clarify that for people?

We have patents that go to 2017 that covers Measure-Through Motion and Low-Perfusion pulse oximetry. It really depends on what their products do today and what they might do in March 2014. So, so far, their products that they have today, we believe, would violate our patents till 2017.

Okay. And then just last question for me, is just on the ReSposable launch, which I think you initiated a few months ago. Could you maybe just talk about what percentage of your customers are choosing to go with the ReSposable sensors?

Well, on the rainbow side, it's 50/50. On the pulse oximetry side, it's near 100% standard sensors versus ReSposables. It's something that we're just getting customers launched on. It's been a limited market release phase, so we hope soon to go to a full market release where that percentage might change.

And our whole focus with ReSposables, the reason for introducing it, was to give choice to customers who truly want to be green. So I think the customers that appreciate the ReSposables the most are customers that are not just trying to get the cost savings of being green, but really get a true carbon footprint and mass filled reduction green part of it.

So we have some customers that are very interested in that. And we're working with them. And we think it will be a great product for them. So (multiple speakers) --

Okay, thanks very much.

My pleasure. So I think that's our last question. So if there are no other questions, we're going to adjourn this call. I want to thank you all for joining us, and wish you a Happy Valentines evening. Thank you.

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