Masimo Corp (MASI) 2013 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to Masimo's fourth quarter 2013 earnings conference Call. The Company's press release is available at www.masimo.com. Again, that is www.masimo.com.

(Operator Instructions)

I am pleased to is to introduce Eli Kammerman, Masimo's Vice President of Business Development and Investor Relations. Please go ahead sir.

Thank you. 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 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 and Form 10-Q. You will find these in the investors section of our website. I will now pass the call to Joe Kiani.

Thank you, Eli. Good afternoon and thank you for joining us today.

We closed 2013 with clear evidence of both underlying business and operational strength in many areas, including fourth quarter driver shipments of 42,000, bringing our 2013 driver shipments to a record 168,200 SET Pulse Oximeters and rainbow Pulse CO-Oximeters; an annual increase of 15% over 146,400 in 2012, and ahead of our expectations.

We also had a 34% increase in rainbow revenues. For the full year, our rainbow revenues reached nearly $49 million for 2013, up 21% for the full year.

Although this was slightly below our $50 million expectation, had we been able to ship the complete SpCO orders I referenced in the Q3 call, we would have exceeded the $50 million. We also had a 9% constant currency increase in fourth-quarter worldwide product revenues, which contributed to total fiscal year 2013 product revenue of $517.4 million, up 13% on a constant currency basis.

We believe that the operational improvements we have been working on for the past number of years will become even more apparent in 2014. A combination of continued positive results from our ongoing of value engineering and manufacturing, and a continuation of the moderation in our operating expense growth, gives us confidence in our earnings potential as we enter 2014.

FY14 will mark our 25th Anniversary, which we hope to celebrate with a variety of new product introductions. We have already announced the first of several products we plan on introducing in 2014.

This first product is called O3, and it allows Masimo to deliver its first tissue and regional oxygen saturation monitor. This product, which I will speak about in more detail later, has many clinical advantages to the existing products, and what we believe to be $100 million market opportunity.

In a few minutes, I will provide some additional perspectives on what we expect in 2014, and highlight some key achievements from both the fourth quarter and 2013. But first, Mark will review fourth quarter and full-year 2013 financial results, as well as share with you our 2014 financial guidance. Mark?

Thank you, Joe. Hello, everybody.

Fourth quarter 2013 total revenue, including royalties, was $142.4 million, or up 8%, or 9% on a constant currency basis, versus the fourth quarter of 2012. Product revenue was $134.7 million, up 8%, or again 9% on a current currency basis, versus the fourth quarter of 2012.

The impact of unfavorable foreign exchange rates lowered our year-over-year Q4 2013 revenues by a record $2.3 million, and $7 million for the entire year. This was due primarily to the weakening of the year-over-year Yen versus US dollar.

As I will note later, this material foreign exchange change impacted not only our top line, but also negatively impacted both our product gross profit margins as well as our operating income. Rainbow product revenues were a record $14.8 million, up approximately 34%.

We saw continued strength in our consumable sales, including very strong Q4 SpCO orders from our international business. Consumable revenues accounted for nearly 47% of total rainbow revenues in the quarter, up from 37% in the prior-year quarter.

Our worldwide end-user, or direct business, which includes sales through our just-in-time distributors, grew 9% in the fourth quarter to $116.3 million, versus $106.8 million in the year-ago period. Our direct business represented 86% of total product revenue in the quarter, slightly higher than the 85% one year ago.

OEM sales, which made up the remaining 14%, declined slightly to $18.4 million, compared to $18.5 million in the same period of 2012. By geography, total US product revenue rose 6% to $89.3 million, compared to $84.4 million in the same quarter of 2012. Growth was primarily driven by an increased SET Pulse Oximetry sensor sales to hospital customers, resulting from the strong shipments of drivers this year.

This growth was less than we expected and due, we believe, to a few specific reasons. While we ended the year with a record number of hospital contracts, which is excellent news for the business long-term, when these new contracts are renewed, they are done so at pricing lower than the prior five-year contract pricing. In addition, we believe that overall US shipments were also impacted by lower year-over-year Q4 hospital admissions, which were down by approximately 4%.

International product revenues rose 11%, or 16.5% on a constant currency basis, to $45.4 million in the fourth quarter of 2013, versus $40.9 million in the same period last year. This increase is due primarily to growth in EMEA and Latin America.

Unfortunately, we were not able to shift the full rainbow SpCO order that we noted in the Q3 call, and had two other large international orders that did not materialize in the quarter as we expected. But despite these specific orders, our international revenue represented approximately 34% of total product revenue for the fourth quarter of 2013, which was up from 33% a year ago, and represented the highest OUS percent of revenue in our history.

Our reported fourth quarter gross profit margin was 61.5%, compared to 64.1% one year ago. At the end of the fiscal fourth quarter, based on decisions we made to accelerate our transition to more efficient and lower cost boards and LED components made by Masimo Semiconductor, and to concurrently write-down the value of certain other terminated automation project-related expenses, we took an approximate $4.6 million charge.

Importantly, excluding this charge, our Q4 gross profit margin would have been 64.9%, marking a continuation of the improvements we have seen in our overall product gross margins for over a year now. Our fourth quarter total gross profit margin, including royalties, was 63.6%, down from 66% in the year ago period. However, excluding the impact of the Q4 charges I just mentioned, our adjusted total gross profit margins would have been up to 66.8%.

Fourth quarter 2013 total operating expenses were $77.9 million, up approximately 20% over the year ago period. Included in this total was an $8 million charge related to the arbitration award and associated legal fees, $5.4 million of which we noted in our 8-K filed on January 22, 2014. The incremental $2.6 million charge was the result of a decision to accrue the potential legal expenses which had previously been covered by insurance.

Importantly, without the impact of this $8 million charge and the $1.4 million in medical device taxes, our total operating expenses were $68.5 million, which represented only a 6% increase over the prior year period. The overall increased spending was due primarily to costs associated with new blood management sales team, other legal expenses, and various marketing tradeshow-related expenses.

Fourth quarter 2013 operating income was $12.7 million, down by 43% compared to $22.3 million in the year ago period. However, once again, the $9.6 million decline in operating income was attributable entirely to the $12.6 million in charges reported in the quarter, as we previously mentioned. In fact, without these charges, operating income would have risen by 14% to $25.3 million.

Nonoperating expenses were $752,000 in the fourth quarter, and were due primarily to the impact, again, of unfavorable foreign exchange rates on the translation of our foreign currency balance sheets. This compares with nonoperating expense of $1.3 million in the year ago period.

Our fourth quarter 2013 effective tax rate was 22.8%, down from 29.3% in the same period last year. This decline was entirely due to the impact of the $8 million arbitration and related legal expense award, which are all US-related expenses. In fact, without the $8 million arbitration award and related legal expense charge, our Q4 effective tax rate would have been 28.5%.

Fourth quarter 2013 reported net income was $9.2 million, or $0.16 per diluted share, compared to $15 million, or $0.26 or diluted share, in the same prior year period. However, once again, the two special Q4 charges, reduced Q4 EPS by $0.09 and $0.06, respectively. Therefore, without the special charges, our Q4 earnings per share would've been approximately $0.31.

The impact of the new medical device tax reduced Q4 EPS by an additional $0.02 per share, compared to the prior year. As a result, without these impacts, our Q4 EPS would've been $0.33, up from $0.26 in the prior year.

Now I will provide a brief review of our 2013 full-year results, but also direct you to today's press releases and the Form 10-K, which will be filed later today, for more detailed information on our full fiscal year results. For FY13, total revenue rose 11% to $547.2 million, from $493.2 million, including product revenue of $517.4 million, which was up 11% from $464.9 million. Importantly and significantly, for the entire year, product revenues would have been up 13% on a constant currency basis, a year-to-date difference of $7 million in total product revenues.

Total 2013 royalty revenues rose 5% to $29.8 million, from $28.3 million in 2012. Reported 2013 product gross profit margins were 63.6%, down slightly from 64.1% in 2012. However, once again, adjusted for the Q4 2013 inventory and equipment charges, the adjusted 2013 product gross profit margins would have been 64.5%.

Total 2013 operating expenses were $279.1 million, which was up 16% from $241 million in the prior year. Excluding the special charge of $8 million in Q4 2013, and the $6.3 million in medical device taxes this year, our adjusted operating expenses would have been $264.8 million, up approximately 10% from 2012. And, without the impact of the new worldwide blood sales management team, our 2013 operating expenses would have increased approximately 7%.

The 2013 tax rate was 26.4%, which was slightly above the 26.1% in the prior year. Again, without the Q4 arbitration award and related legal expenses, our adjusted 2013 tax rate would have been 27.5%.

Net income for 2013 was $58.4 million, or $1.02 per diluted share, compared to $62.3 million, or $1.07 per diluted share, in 2012. As discussed earlier, the one-time charges in our Q4 results, reduced our full-year 2013 EPS by approximately $0.15, while the medical device reduced 2013 EPS by another $0.07.

And although we have discussed the significant impact of the unexpected, unfavorable foreign exchange rates this year on our revenues and gross profit margins, we have not really attempted to also determine the quarterly impact and, now, full-year impact on our earnings per share. However, for the full year, the cumulative impact of the unfavorable 2013 FX rates on our revenues cost of sales in operating expenses, was approximately $0.09 per share, while the translation impact reflected in our other expense line item on our profit and loss statement was reduced 2013 EPS by another $0.06.

As of December 28, 2013 our day sales outstanding was 52, compared to 49 as of the same prior year period, and over that same period inventory turns declined slightly to 3.7 and 3.8. Total cash and cash equivalents as of December 28, 2013 were $95.5 million, compared to $71.6 million as of December 29, 2012.

The change reflects net cash generated from operations, offset by capital expenditures, and $19.8 million in share repurchases in the first half of the year. We did not repurchase any additional shares in the fourth quarter, but for the full year, we repurchased a total of 1 million shares.

Now I will discuss our 2014 financial guidance, which is based on the best information we have available to us, and in general, assumes no significant changes either to the worldwide macroeconomic environment, or to the environments in which our primary customers, our hospitals, operate. In addition, as usual, we make various pricing assumptions, including the overall rate of ASP reductions, the level of new contract renewals, and the impact of third-party reprocessing on our sensor business.

Should any of these assumptions prove to be incorrect, our overall revenue guidance could be impacted. Also, these rejections assume certain foreign exchange rate assumptions at the beginning of the year, and to the extent that these assumptions differ significantly from actual exchange rates, our actual results could vary from our guidance.

We are now projecting a 2014 revenue of $578 million, including product revenue of $570 million, and royalty revenue of $8 million. Included within the $570 million in product revenue, we are projecting rainbow revenues of $60 million.

Currently, we anticipate that we will see slightly lower overall year-over-year first half 2014 growth rates, with higher year-over-year growth rates materializing in the second half of 2014, especially as usual with a strong fiscal fourth quarter. We believe that the second half of 2014 strength will be due to the positive impact we expect from the blood management sales team, the installation and use of additional drivers, and the impact of new products.

We are also projecting a 2014 royalty rate range of between $8 million to $28 million. Because we have not had any dialogue with Providian on this matter, we are going to assume that Providian will abide by the current royalty agreement, which does require Providian to provide Masimo with at least 60 days' notice of its intention to terminate the current agreement.

Of course, as you know, this agreement provides Providian with a covenant not to be sued for patent infringement of their Pulse Oximeter, in exchange for a 7.75% royalty payment. Because we have not been notified of their intention to terminate the agreement, for now, we are assuming that Providian will continue to pay the royalty agreement through at least April 14, 2014.

As a result, the lower end of our royalty rate assumes approximately $8 million in Q1 and Q2 royalties. However, beyond April 2014, we are still not certain as to Providian's intention, and so in order to provide the broadest range possible, we are also suggesting that if Providian elects to continue to operate within the terms of the current royalty agreement, that the full-year royalties could approximate $28 million. As a result of this uncertainty, we are providing a 2014 range of royalty revenues from $8 million to $28 million.

We expect our full-year 2014 product gross profit margin to be approximately 66%, reflecting a continuation of our ongoing focus on overall product cost reduction efforts throughout the year. We expect our gross profit margins to be lower than this overall range in the first half of 2014, but higher in the second half of 2014, as the impact of our cost reduction efforts are implemented into production during 2014.

Assuming only $8 million in 2014 Providian royalties, we expect our total operating expenses to be approximately $287 million, including $2 million for incremental IP legal expenses with Providian. This operating expense projection also includes the additional remaining incremental costs associated with the complete buildout of our new SpHb dedicated sales force, and assumes flat year-over-year other legal expenses.

If our assumption on legal expenses related to the timing of various potential dates proves incorrect, our total operating expenses could increase. Assuming that the Providian royalties continue and reach approximately $28 million for the year, we expect our operating expenses to increase to approximately $292 million, due primarily to our ability to of invest in additional 2014 business, product, and marketing initiatives, to support our new product rollouts, as well as make certain charitable contributions. In addition, to this operating expense guidance, we are also projecting an estimated medical device tax of our approximately $7 million, which we intend to continue to report in SG&A expense.

We expect our 2014 effective tax rate to be approximately 27% to 29%, depending on the percentage and level of royalties we will receive. As previously noted, we are not assuming -- we are assuming constant FX rates based on the beginning of the year FX assumptions, and as a result, we are not projecting or forecasting any foreign exchange gains or losses within our 2014 product revenues, cost of sales, operating expenses, as well as within our nonoperating expense section of our P&L.

As a result of these assumptions, including royalties, at $8 million and $28 million, we are now projecting 2014 GAAP earnings-per-share of approximately $1.13 to $1.28, respectively. This is based on a weighted share assumption of $58.5 million for the year.

Of course, the total amount of shares outstanding will be impacted by normal treasury stock valuation factors, new option grants, and any additional stock repurchases. With that, I will turn the call back to Joe.

Thank you, Mark. As you just heard, Masimo has grown into a company with sales approaching $600 million annually, and significant growth prospects.

We began 2014 with mixed feelings. On one hand, we see positive business trends, such as high driver shipments, strong rainbow growth, significant product introductions, and the prospects of GE and Philips entering the market with rainbow products this year.

But we also note the weak census in the US hospitals, which has resulted in lower-than-expected revenue growth rates in the first six weeks of this year. Overall though, we remain optimistic, and believe that any sluggishness in the first half will be more than offset by a strong second half in 2014.

Last year, we achieved appreciable market share gains as seen in our new drivers shipments and in our sales growth. The 11% increase in our install base is directly attributable to our breakthrough Pulse Oximetry, Pulse CO-Oximetry, and patient safety net technologies.

These technologies enable us to consistently win competitive Pulse Oximetry agreements with new and existing hospital customers. In fact, in 2013, we had a record year for such new contracts with new hospitals around the world, including: the Mayo Clinic; St. Joseph's Hospital systems; Children's Hospital of Atlanta; St. Darío's Healthcare; Oklahoma University Medical Center; Resurrection Healthcare; University of Colorado Hospital; Crumlin Hospital, in Ireland; and Papa Giovanni XXIII Hospital, in Italy.

Further, we continue to gain new installation into the general ward of the hospitals, as the values of continuous monitoring for all patients become more apparent. For the past seven years, we have focused on building a strong and knowledgeable worldwide sales and marketing organization, capable of expanding both our SET and rainbow businesses.

In 2013, we made another incremental investment in our new worldwide business blood management team, which will be primarily focused on our SpHb technology and related products. While we continue to make strategic incremental staffing investments throughout our worldwide organization, we believe that we have now reached a level of staffing needed for our sales, marketing, engineering, and other organizations to be capable of supporting higher product revenue growth.

Also, as we have noted, our engineering and operations organizations are continuing to focus a large percentage of their efforts on reducing the cost of our products, both devices and sensors, while improving them for our customers.

As an example, the investment we made in acquiring Spire Semiconductor, now Masimo Semiconductor, has -- this acquisition has allowed us to make our own high-performance low-cost light-emitting diodes for our rainbow sensors, which will dramatically reduce the cost of goods for sensors while enhancing their performance. In summary, with the good start we had in 2013, in both improving product gross margins and lowering our operating expense levels, we are now ready to continue to drive business and financial leverage through the financial model in 2014 and beyond, without sacrificing our future.

Also as I discussed earlier, 2014 is a symbolically important year for us, as Masimo becomes 25 years old. We have planned many important new product rollouts this year. As one example of these new products and technologies, a few weeks ago we announced receipt of the CE Mark for a new O3 regional tissue oximeter and pulse oximeter compatible with our Root monitor.

This sensor broadens our reach in the operating room, enabling the measurement of cerebral oxygen and is synergistic with our SEDLine brain function monitor. All three, for the first time ever, measures simultaneously, with the same sensor, the regional and core oxygen saturation with 4% and 2.5% accuracy, respectively, which will help clinicians assess their patients status better.

We anticipate filing for FDA 510(k) clearance for O3 during Q1 this year, but the duration of the FDA review process is uncertain. Our Root monitor continues to gain interest in hospitals due to its expanded information display and expandability potential.

We have now launched three Masimo MOC-9 modules for expanding the functionality of Root, SEDLine grade function monitoring, Phasein capnography and O3 regional tissue oximetry. The Phasein capnography and O3 regional tissue oximetry modules are currently available only in CE marked countries, which take additional launching capabilities for Root to be launched from our internal research efforts as well as from the efforts of third-party developers.

The full-featured version of our Root monitor, which includes Iris connectivity capabilities is CE marked and is currently pending FDA 510(k) clearance in the US. With the Iris Gateway, Root can connect to other devices such as IV pumps, ventilators, and other patient monitors, and send the information to electronic medical records.

We ended 2013 with SpHb revenues of $12.8 million, which accounted for roughly a quarter of our total rainbow sales. SpHb revenues for Q4 were $3.3 million, and continue to reflect the lumpiness associated with smaller scale revenues affected by seasonality within certain alternate care markets and periodic large orders. While quarterly growth comparisons are still subject to such distortions, it is important to know that SpHb revenues for the second half of 2013 rose by 31% over the revenues for the first half of 2013.

SpHb continues to gain recognition as a valuable tool for blood management and detection of occult bleeding in the hospitals, with documented benefits of improving outcomes and lowering costs for hospitals. SpHb visibility is expected to grow with the impending launch of rainbow-enabled products by our largest OEM partners, Philips and GE, expected in the second half of 2014.

This year, we anticipate a notable contribution to our product revenues from our new blood management team. In fact, I am happy to announce that one of our first better care customers, Del Sol Hospital, a held-trust hospital located in El Paso, Texas have successfully completed their better care program.

Despite already having a successful blood management program in place which had reduced blood transfusions, implementation of the Better Care Program with SpHb further reduced blood transfusions that was sufficient to more than offset the cost of the deployed SpHb. And now, Del Sol has chosen to deploy SpHb across many more departments.

We are proud of our efforts to improve patient care around the world last year, which resulted, in addition to the other placements, in the installation of the largest Patient SafetyNet system in Germany at Children's Hospital of St. Elizabeth in Newburgh. We now have over 250 hospitals that are deploying Patient SafetyNet, and there are many more in our pipeline.

In the fourth quarter we launched the prescription version of our mobile oximeter, the ISP O2 RX, in CE marked countries and Japan, and initiated collaboration with the Newborn Foundation for making birth oximetry routine for newborns, the Born Program. The Born Program is an effort to increase early detection of life-threatening congenital heart disease and incidents, so that corrective measures can be prescribed before severe illness occurs.

With our guiding principles, including the guiding principle to always do what is best for patient care, our portfolio of breakthrough monitoring technologies positions us as the clear leader for improving patient care, and will continue to propel Masimo's steady and fast growth. With that, we'll open the call to questions. Operator?

Tao Levy, Wedbush.

Good afternoon.

Hello, Tao.

First, just a couple quick questions. Joe, you mentioned the hemoglobin number, you are sequentially a little bit lower. I know things are still lumpy there. But on the flip side, you had brought on -- you did bring in a bunch of new sales reps there.

How should we think about how that unfolds throughout 2014? And when do you get a better sense of whether that was a good investment, in terms of resources, in terms of expanding that group of sales reps?

Thanks Tao. Well, we have that sense already that, that was a good investment and I'll tell you why. From throughout the history of noninvasive hemoglobin, we have nine hospitals that have implemented across multiple departments noninvasive hemoglobin. Five of them being the better care accounts.

But I can happily tell you that, because of this group, we now have 35 new hospitals that have decided to deploy SpHb across multiple departments. And I'd say probably 1 out of 7 or 1 out of 10 times, they require a better care type of a guarantee. And that's because, while a year or two ago, we had to have the guarantee to get hospitals interested and the cost was a major factor, I believe through the efforts of the sales force, through the education of the clinicians, they're beginning to see the value of noninvasive hemoglobin to not just be a way to reduce costs through blood transfusion reduction, but to help with patient safety through detection of occult bleeding.

So we're feeling pretty bullish about noninvasive hemoglobin's growth, and especially because of this new team that's been deployed. Mostly in the US, but worldwide.

Great. And you'd mentioned a date regarding the Covidien royalty, obviously you can't really say too much about that, but you mentioned April 2014? What's important? Why the April of next -- I guess of this year, in terms of -- what do you expect to learn more about?

We are supposed to get a 60-day notice from the date that Covidien wishes to stop making the payments. So today is April -- today is February 13. We haven't gotten such a letter, so we have 60 days from tomorrow and that gives us until April 14, 2014.

Got you. And would you guys put some notice out if you get a check and it has more royalties then you expected? Or we won't find out until May when you report numbers?

Well, that's a good question. We'll have to think about that, but I think right now, we're giving you a range and while I was being maybe more pessimistic and I still should be prudent about that, from what we're seeing out there were not expecting it to and in Q2 either.

Whether it will go for the full year, who knows? Again, it's all a guesswork for us. We'll just have to see and I guess one thing for sure if we do get the letter, that says they're going to stop paying it, that we will do an 8-K on.

Okay. Great. Thank you.

Thank you.

Bill Quirk, Piper Jaffray,

Hello. Good afternoon everyone. It's Dave Clair in for Bill. First question from me, I'm just hoping you can give us a little bit more details on what's included in the rainbow guidance. What needs to happen for you guys to hit that number?

Well, I think, A, the blood management team needs to deliver, and we are being very conservative compared to what they have in their pipeline and they have in their quotas. Secondly, we expect a repeat of the SPC order that we got last year towards the end of the year that we talk to you about. We think that will continue to happen.

I think short of some disaster occurring, I think the number that we've given you is quite conservative and we should be able to meet it. Some of the positive signs that are out there that makes us feel better, for example, with SpCO, we see the cities and the states becoming more solvent and have more financial wherewithal, which should eventually trickle down to the fire department, which should trickle down to us in the purchase of SpCO. So, I think there are some good things so far that makes us feel that, that $60 million number we gave you is one that we can achieve.

Okay. Thank you. And then in terms of the blood management sales force, are you at that 60 headcount level? And then what percent of these reps would you say are kind of fully up to speed and fully ramped at this point?

We are about 50 with another 10 to go. We believe, by middle of the year, they will all be quota-carrying and at full capacity.

Okay. Thank you.

Thank you.

Joanne Wuensch, BMO Capital Markets.

Thank you for taking the questions. I'm a little bit confused by something. There was a lot of discussion about taking out the royalties for 2014 because it was unknown. And now it sounds like you are putting back the royalties in some way for 2014, given your range.

And I just want to know if there's something that has shifted in your conversations or your thought process? And then, the secondary question is, how do you budget quarter by quarter, not knowing when this money is coming in? Would you let it just flow through to the bottom line should it arrive?

Well, Joanne, unfortunately we don't -- we can't give you anything more that we've already said, but let me repeat what we have. They need to give us a 60-day notice, we haven't gotten one yet. From reading from the tea leaves, both what they've said in their earnings calls, and what we're hearing on the street, we are not expecting that should change dramatically, and that's why we're thinking these might continue and at least through Q2, not for the whole year at least through Q2. But again, like I said earlier if we do get a notice, we'll make an announcement of that so you'll know.

But as far as the second part of your question and how were managing the business, we are assuming we're not going to get those royalties beyond what that $8 million that Mark mentioned. So therefore we are managing our business assuming we're not going to get it. And if we do get it, while we're going to let the majority of it fall to the bottom line. And that's why you see a big earnings difference between with and without. We are going to spend a little bit more than we had planned in things like sales, marketing, and maybe do some philanthropic nature.

Okay. And then my second question is, you are talking about gross margins expanding a fair amount between 2013 and 2014, call it 130 basis points. How do you get there from point A to point B?

Well, we had decided a little while ago, maybe a couple of years ago, that, in preparation for the royalties ending, to do -- take our very best people -- not all of them but a lot of them -- and our engineering department and manufacturing group, and have them go through a full value engineering from our sensors to our devices. And the team has done an amazing job.

We are seeing some amazing differences in our costs going forward and, as we bring in line the newly-value engineered products into our production, we expect to see dramatic drops in our cost of goods. And given that we believe our sensor pricing Pulse Oximeter pricing have stabilized, we expect that improvement in the cost of goods to help both bolster our margins.

Okay. Thank you.

You're welcome.

Brian Weinstein, William Blair.

Hello, guys. Good afternoon.

Hello, Brian.

My question is on operating expenses. Can you let us know what the incremental cost is of the new reps in the 2014 numbers? And, sort of what the underlying growth rate is excluding those reps?

It seems as if you are operating expense growth has expected to slowdown pretty dramatically over where things were in prior years, if you back that out, if my math is correct. So can you give us any kind of insight on that? Thank

Sure, Brian. This is Mark. Directionally, on an incremental basis, to complete not only the buildout but of course next year we'll have that new entire sales force onboard for the entire year, whereas they were hired throughout 2013, of course. Our best guess is that will add incremental $4 million-ish range to our spending in 2014. So that's part of the additional operating expense, that guidance that we provided.

And frankly, you're right. If you remove that, if you look at the core underlying operating expense growth without that, we'll be hovering at the lower end of the numbers we talked about a little bit before, in about that 7% range. Which historically, obviously for Masimo, is very much at the low end of the range. But again, very consistent with the overall direction that Joe just articulated in terms of the focus of delivering overall leverage in the model.

Okay. And then, I might have missed it, but when you gave the guidance for rainbow for next year, did you provide, or could you please provide what you expect the percent from consumables to be, and then specifically what the contribution is expected to be from SpHb? Thanks.

Well, the SpHb portion, we expect our revenue to go to $18 million from the $12.8 million that it was 2013. As far as the contribution of the consumables, I know this year we ended up with what, 47%?

In the quarter.

In the quarter. So, I think that run rate is probably the right rate, so I'd say about 50% will be consumables.

Okay. Thanks, guys.

Thanks, Brian.

Matthew Dodds, Citigroup.

Good afternoon. On the product revenue guidance for 2014, the last couple of years, it's been pretty consistent in the growth between US, OUS. I know Joe, your comments about the US volume in the fourth quarter. Directionally, is that going to be the same in your estimation for 2014 or is there more of a spread in the guidance?

Mark?

I think in general, Matt, our expectation is that, as I alluded to in the fourth quarter, we were happy with a record 34% OUS mix. Looking forward to next year, on a comparable basis to 2013, we do expect on a percentage basis again, to have a higher contribution of total revenues from our OUS business. Can't put a specific number on it, of course, but directionally we expect that OUS percentage of total revenues to continue climbing.

And then just one follow-up. For the total number of install base into the year, the $1.205 million, it looks like that equated to about 17,000 retirements in the quarter, which is higher than the recent run rate, is that right? And, is that a change or is that kind of a blip when we think about 2014?

Matt, no. Your number is right. It was actually about 16,500 units. Directionally we do not think it's really a blip. We think, as we head towards the next couple of years, that based upon our standard 10-year life assumption, if you obviously dialed the clock back 10 years, those were years in which there were significant additional drivers being put into the marketplace by Masimo. And so it stands to reason that, that number will continue to grow.

And this was -- you are right in the sense that this was a marked increase from about the 12 to maybe 14 range that we had seen before. But directionally, it's probably the right range to be thinking about for the next year.

Thanks, Mark. Thanks, Joe.

Thank you, Matt.

Chris Lewis, Roth Capital Partners.

Hello. Chris?

First, on the general award opportunity, Joe I was just hoping you would talk about the interest levels and overall adoption rates you are seeing from the field there, and how that layers into the growth outlook for 2014?

Sure. First of all, maybe it's the circle I run in, but in the circle of hospitals I am talking with, it feels like general ward monitoring is going to go from this 5%, 10% penetration, to 80% to 100%. There are some whispers even at CMS where they're going to recommend monitoring of patients who are on opioids -- let's just say not continuous, pretty close to continuous basis. So we're feeling really good about that market becoming real.

Short of some solutions that stop using drugs, like opioids that affect respiration rate, that the monitoring is going to become ubiquitous there. So we had a great year in terms of number of new hospitals that implemented Patient SafetyNet, and we think we have a good momentum to increase that in this year.

Great. And then for your guidance, I think last year when you introduced 2013 guidance you kind of talked about taking a more conservative approach. Can you talk about the methodology used this year and maybe how that's changed or evolved since a year ago?

Yes. We have the same approach this year. We really have tortured the numbers.

We've taken what our heads of sales and their managers have given. And we have dialed it back to numbers that we believe should be more than achievable. But things kind of got to go right.

I mean, we've had this whole headwind with the FX in Japan that cost us $7 million of revenues in 2013, which we didn't anticipate when we rolled out the numbers. And in Q4, a few things didn't go quite our way, from multiple orders that didn't happen, to the big [SPC] order that we couldn't fulfill fully, to the census drop. So, you can never say for sure, but we believe we have made it conservative and we hope we'll meet these numbers that we are giving you.

And then, on the M&A front can you just provide an update on your appetite there and anything worth talking about?

Yes. We are constantly looking. We have a couple of -- we have three but I think now maybe two, companies on our radar. None of them are big acquisitions.

These are all [tuck and tuss] acquisitions like [Sphasin] and SEDLine, and Masimo semi conductors. So those kinds of level of acquisitions.

Okay. Thank you.

Thanks, Chris.

Larry Keusch, Raymond James.

Hi. Good afternoon. Joe, just as you were mentioning earlier, the general floor seems like a really substantial opportunity and it feels like it's starting to gain some traction. And certainly you -- it sounds like you are seeing it in the business. But I'm curious, given that it could be a significant opportunity for the company, it's sort of right in the core of what you guys do, is this something that you think you could accelerate the uptake of this in the general floor if you threw more money at it?

I guess where I'm going -- I'm thinking about your SpHb guidance for the year going up to about $18 million, so up about 40%. Which is good. But it seems to me or I guess the question is, could that money be spent elsewhere and perhaps throwing it on general floors. I'm just trying to understand, if you can influence the growth rate on the general floor if you could invest more there?

Yes. Great question. Certainly, I think we would get more if we did have a dedicated sales force that did nothing but call on the general floor section of hospitals. I don't believe though we would get a good return on that investment, because, one, we have the ideal technology for the general floor. The noninvasive pulse of Pulse Oximeter that we made due to its reliability, sensitivity, and specificity, really has no match and it is what is enabling general floor monitoring.

So with that and with some of the cool tools -- these bodies that we created like Patient SafetyNet system, the Root, the Radical 7, and some new products we are going to be introducing, we believe we got the right vehicles, right technology. And, we have this big sales and clinical specialists sales force in the US that are calling on hospitals regularly. And the people that are making the decisions to implement monitoring the general floor, our anesthesiologists, which is our main call point our regular hospital business.

So I feel that, while we could get more, if we invested more, I think the return wouldn't be there. I think what needs to happen now is, if not this grassroots effort of saying enough is enough. We're tired of having people dead in bed because they weren't being monitored and they were giving opioids and stuff for breathing. We need something like maybe the joint commission or CMS or people like that to say enough is enough.

We've got to do it. This is something we're going to check for and every hospital that they have implemented this continuous noninvasive monitoring on the general floor. So I think if that happens, we're there to collect the business.

We are already in thousands of hospitals as the Pulse Oximeter, only Pulse Oximeter company in those hospitals. And then, the other one that we're not in, I can tell you, we get calls from them, even though they're a Nellcor account, that says, Look, we want to do general floor monitoring and even though we have Nellcor for the rest of the hospital, when it comes to general floor monitoring, we want to talk with you, are you willing to work with us just on the general floor area?

Which, of course our answer is, yes. So, I think, while spending more could get us more, I don't think it's a good investment.

Okay. That's helpful. And then one of the question and then one very quick one.

Again, on the timing of the GE and Philips introductions of their rainbow compatible products, you are now saying second half of 2014. You know, obviously that's sort of been moving around over the course of the last 12 months, and so I get the obvious question is, how much visibility do you truly have into the timing of those launches?

We work really closely with them. We have regular meetings with them. But, unfortunately, as you know with engineering projects, I've never seen a project delivered on time. Maybe it happens.

But, unfortunately, I've seen many times when projects do get pushed out, and that has happened here. Some for good reasons. For example, RoHS, which is something that every medical company has to comply with, is going to be live this June, July. If you are not RoHS compatible, you cannot sell your monitors, so that has distracted some of our OEMs, and even us, in those efforts. But I feel pretty good about second half of 2014.

And at don't forget, these companies are integrating rainbow in not just one platform, but multiple platforms. I think you are going to start seeing some of the platforms from both GE and Philips come out maybe beginning of the second half, but some of the other ones towards the latter part of the second half.

So we're getting close. We're getting close but we're not quite there yet. And I'm sorry that the days have pushed out a bit, but I think everyone's working in earnest and it's coming soon.

Okay. That's really helpful.

And then Mark, just quickly, the $8 million to $28 million on the royalty that you indicated for the year, just so I understand, is that just purely the lower end is if it ends in April, and the high end is if it continues through the full year? Is that kind of what we are thinking about here?

Exactly.

Okay. Thanks very much, guys. Appreciate it.

Thank you, Larry.

Ben Haynor, Feltl and Company.

Gentlemen.

Hello.

You mentioned that had the SpCO order shipped during the quarter you would hit the $50 million in guidance for rainbow. Could you perhaps tell us how much it would have gone above the $50 million and also has that shipped so far in 2014?

Yes. It would've probably hit over $51 million, and we do attempt to ship the rest of it this quarter. And we actually had meetings with this customer and we expect more orders along that same level in 2014.

Okay. That's helpful. Great. And then on, this might be kind of an odd one, but with Apple picking up some guys from you from C8 Medisensors closing up their [assant] up in Canada. Some of these raman spectroscopy plays, what do you suppose they are up to there, and do you have anything that's in development on the raman side?

Well, first of all I do not think Apple has picked up C8 raman technology. We had some insight into that, and, while it's an interesting technology, we don't think that's the optimal way to go. Did I answer your question?

Well, and do you guys have anything in development on the raman side?

Not at Masimo, but Circacore is developing, or trying to develop, other noninvasive measurements, and we do have an agreement with Circacore that, if they do, we have the right to exercise those licenses and those measurements. In fact, I think you'll notice in our 10-K, in Q4 we exercised five new measurements.

These are brand-new noninvasive measurements, unfortunately they do not include glucose, but they are important measurements. When we exercised that, we believed that they had reached feasibility on those five measurements, so we are hoping sometime in the future we'll be introducing five additional new noninvasive measurements. As far as glucose, they're still working on it and will have to see if ever they get to a point where we think what they've done is useful for our marketplace.

Okay. Great. And should we expect any of those measurements to be the ones that are product introductions that might hit in 2014?

No. Those will probably be 2015, 2016 time frames. The 2014 ones, these are products that we're near completion with, we've been working on for several years, and we hope to, on May 2, if not sooner or later, we should 25th anniversary of our incorporation to introduce them. Or, at least announce them.

Good. That's all I have. Thank you very much.

Thank you.

At this time there are no further questions.

Well, thank you all for joining us today. We look forward to talking with you on our next call and as we meet you out in your neck of the woods or when you come out here. Thank you very much. Have a great day.

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