Masimo Corp (MASI) 2014 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen and welcome to the Masimo's third quarter 2014 earnings conference call. The company's press release is available at www.masimo.com.

(Operator Instructions)

I'm pleased to introduce Eli Kammerman, Masimo's Vice President of Business Development and Investor Relations.

Hello, everyone. Joining me today are Chairman and CEO, Joe Kiani and Executive Vice President of Finance and CFO, Mark de Raad.

This call will contain forward-looking statements which reflect Masimo's 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 investor section of our website.

I'll now pass the call to Joe Kiani.

Thank you, Eli. Good afternoon and thank you for joining us for Masimo's third quarter earnings call.

I would like to begin by noting just a few highlights from the third quarter. We're happy about the overall growth of our SET pulse oximetry business which rose back to the 10% level in the past quarter and a sequential increase over Q2 product revenues, which we have not seen since 2010.

Despite the typical seasonal related outside the US business slowdown in the summer quarter, we are also pleased with the relatively strong year-over-year revenue growth in our international business, which grew by 15% or 17% FX adjusted, led mostly by growth in Europe.

We had another solid quarter for oximetry shipments at 42,600, representing the sixth quarter in a row of shipments in excess of 40,000 units. As a result, our global installed base grew to an estimated 1.289 million, up 9% year-to-year and once again exceeding the market growth rate for pulse oximetry.

As evidence of the Board's and Management's optimism in Masimo's long term outlook, during the quarter we repurchased approximately 2.4 million shares. This repurchase in addition to the 2 million shares we purchased in the second quarter 2014 brings our 2014 year-to-date total stock repurchase to 4.4 million shares. And if you include the 1 million shares we purchased in 2013, a total of 5.4 million shares over the past seven quarters, only 600,000 shy of the 6 million share repurchase program we announced over a year ago. In fact, I am happy to share with you that just last week the Masimo Board of Directors authorized the repurchase of up to another 3 million shares.

I want to also highlight how proud we are of the continuing rollout of new technologies and products during this past year, which now includes O3 Regional Oximetry, iSpO2 mobile health pulse oximetry for Android, transflectance adhesive forehead pulse oximetry sensor, Radius-7 wearable wireless rainbow pulse Co-Oximeter and respiration monitor, BCI mini SpHb for infants and small children, (inaudible), the MX-5 rainbow SET OEM circuit board and with it the new ORI or oxygen reserve index monitor, which has been received very favorably.

We believe that all of these new technologies and related products will, over time, continue to add to the potential for additional revenue growth and more importantly, help save lives and costs for our customers. In addition, with the late Q2 FDA clearance of our Root connectivity hub and open architecture monitor with SedLine brain function monitor and airway gas monitoring including capnography, we are now already beginning to see additional customer interest in this exciting new product line.

Against these highlights, our Q3 rainbow revenue increased by only 10%. Our Q3 results were impacted by our inability to close a sizable $4.5 million international rainbow order we had expected in the third quarter and as a result, referenced in our second quarter press release and earnings call.

While it is encouraging that our pipeline of noninvasive hemoglobin opportunities continue to increase, we also continue to find the hospital purchase environment for new technology including SpHb to be challenging and therefore unpredictable.

I'll provide additional comments about our business and the rest of 2014 in a few minutes. But first, Mark will review our third quarter financial performance and as a result, also provide you with an update to our 2014 financial guidance. Mark?

Thank you, Joe and hello, everyone. Total revenue and total product revenue for the third quarter was $144.1 million and $137.1 million, respectively. Third quarter 2014 total revenue including royalties increased by 9.6% versus the third quarter of 2013, while third quarter 2014 product revenue rose by 10.1% or 10.5% on a constant currency basis which actually represented about $0.5 million in revenue versus the third quarter of 2013.

rainbow product revenue grew 9.6% in the third quarter to $13.2 million. This slower than hoped for growth, quarterly revenue growth was due primarily, as Joe just mentioned, to the large international order we expected but were unable to recognize in the quarter. In the quarter approximately 47% of total rainbow revenues were consumables, which was up from 41% a year ago. In a moment, Joe will add some additional perspective on the rainbow business.

Our worldwide end user direct business, which includes sales through Just In Time distributors, grew 9.1% in the third quarter to $116.1 million versus $106.4 million in the year ago period. Our direct business represented 85% of total product revenue in the quarter, level with the prior year period. OEM sales comprised the remaining 15%.

Our sequential and year-over-year Q3 SET revenue strength was due to a combination of slightly improved US hospital census, the deployment with various new US hospital customers and the benefit of stronger OEM revenues related partially to the purchase of new RoHS-compatible products for products shipped into the European Union associated with the new EU standard that went into effect this quarter.

By geography, total US product revenue increased by 8% to $95.3 million compared to $88.3 million in the same quarter of 2013. The improvement compared to the first half 2014 results was attributable to the factors that Joe previously noted as well as the reduced negative year-over-year impact from the record 2013 contract renewals that has now fully anniversaried.

In international regions, product revenues of $41.9 million rose 15.4% in the third quarter of 2014 or 16.8% on a constant currency basis versus $36.3 million in the same period last year. The increase was due primarily to strong growth in Europe. International revenues represented approximately 31% of total product revenue, a Q3 record compared to 29% a year ago. Our third quarter 2014 product gross profit margin was 65.1% compared to 64.7% in the year ago period.

The year-over-year and the sequential quarterly improvement in our product gross profit margin was due primarily to the continuing benefits of our ongoing value engineering program. Our third quarter total gross profit margin including royalties was 66.8%, up by 20 basis points versus the year ago period. Third quarter 2014 consolidated operating expenses were $74 million, an increase of 10.8% versus the year ago quarter.

Included in our $74 million in consolidated operating expenses was the net benefit of a $2.4 million litigation award, net of defense costs, received by our variable interest entity, Cercacor. Without this adjustment, total operating expenses would have been $76.4 million, up 14.5% from the prior-year period. Of the total adjusted year-over-year operating expense increase of $9.7 million, approximately $3.5 million was due to the previously discussed and therefore anticipated higher legal expenses resulting from both the Q3 Philips trial and other ongoing legal matters.

SG&A expenses rose by 16.9% versus the year ago period to $62.1 million. As I just mentioned, excluding the impact of higher year-over-year legal expenses, our SG&A expenses rose by 10.3%.

R&D spending of $14.2 million rose by 4.2% as spending on clinical studies and other new project related costs grew more modestly in the quarter. Third quarter 2014 operating income was $22.3 million, up 7.4% compared to $20.7 million in the year ago period. Non-operating expense was $565,000 in the third quarter, primarily due to the negative translation impact of movements in foreign exchange rates.

This compares with non-operating expense of $676,000 in the year ago period, which was also the result of the negative impacts of changes in foreign exchange rates. As anticipated, our third quarter 2014 effective tax rate was 25.7%, up from 22.8% in the same prior period last year. The lower prior year tax rate was due to a favorable conclusion for a prior-year tax audit.

Third quarter 2014 net income was $14.9 million or $0.27 per diluted share, compared to $15.6 million or $0.27 per diluted share in the same prior-year period. Just to remind you, the after tax benefit of the unusual $2.4 million settlement, net of legal expenses of our variable interest entity, Cercacor has been, as usual, eliminated from our reported net income attributable to Masimo Corporation stockholders. This can be seen clearly on our consolidated P&L statement on the line entitled net income attributable to non-controlling interest.

Our average shares outstanding for Q3 was 54.6 million, reflecting a benefit from the repurchase of 2.4 million shares during the quarter at an average price of $21.95. As of September 27, 2014, our days sales outstanding was 49 compared to 51 in the same prior-year quarter end. Inventory turns were 3.0, which was also consistent with the same prior-year quarter.

Total cash and cash equivalents as of September 27, 2014 were $119 million compared to $95.5 million as of the end of December 28, 2013. The increase in nine-month cash levels represent the combination of net cash generated from operations supplemented by $125 million draw-down on our credit line. And offset by the acquisition of our new corporate and development headquarters building for approximately $56 million as well is $98.7 million for year to date stock repurchases.

Now, I'll discuss our updated 2014 financial guidance, which is based on our year-to-date financial results and is the best information we have available to us. Our new fiscal 2014 annual financial guidance is as follows. As a result of the large international rainbow order no longer being expected for fiscal 2014, we are now lowering our fiscal 2014 rainbow revenue guidance from approximately $60 million to approximately $55 million.

At the same time, we are increasing our FY14 royalty revenue expectations up slightly from $28 million to $29 million. As a result of these two changes, we are lowering our total revenue guidance from our previous 2014 range of $588 million to $593 million to approximately $585 million, including approximately $556 million in product revenues and $29 million in royalty revenues.

As we do expect to see continued improvements in our Q4 product gross profit margins, we are not revising our prior annual product gross profit margin guidance of approximately 65%. We expect our Q4 total operating expenses, including approximately $1.9 million in medical device taxes, to be approximately $80 million. We continue to expect that our Q4 and full-year effective tax rate will be in the range of approximately 25% to 26%.

And as a result of our stock repurchasing activity, we now expect our Q4 weighted shares outstanding to be approximately $53.5 million. As a result of these changes, we now expect to report fiscal 2014 earnings-per-share of approximately $1.28, within the prior range of $1.24 to $1.30 per diluted share. With that, I will turn the call back to Joe.

We see great potential for our business as our breakthrough technologies continue to gain traction in the market. And while I'm not sure when we will hit the steep part of the adoption curve with some of our new breakthrough technologies, we are confident that they will. We saw similar challenges when we introduced our breakthrough SET pulse oximeter, but now enjoy seeing that technology become the standard of care across the globe.

In early October, one of the two major court trials this year for Masimo was held. The trial was related to our 2009 patent infringement suit against Philips and their counter claim against us. We were gratified to have the jury verdict returned in our favor with respect to the two patents asserted by us in the first phase of litigation with the jury awarding us damages of $466.8 million.

The jury also found that Masimo did not infringe the Philips patent tried in this phase of the litigation. While there's a possibility for Philips to overturn the verdict through appeal, we see a high probability of winning this case and anticipate that the remaining portions of the case will go well for us as well.

Looking at our Q3 results, our installed base in Q3 grew by 9%, which was again faster than the overall market, another good indicator that Masimo is increasing its share in hospitals across the world. During the quarter, we observed a slight easing of pressures seen on hospital census during the first half of the year. Our higher unit volume for sensors are correlated to the census shifts and we are optimistic that these trends will persist through the end of this year.

We were gratified to see a 10% increase in our core SET business, a rebound from the sluggishness we saw in the first half when our growth was obscured by pricing headwinds related to 2013 record contract renewals. We are seeing sales growth that more closely mirrors the growth we have been achieving in our installed base. Our run rate for new contracts remained high.

During Q3, we again increased our market share with several noteworthy contract wins such as Miami Children's Hospital, Regional One of Memphis, and Mount Sinai Hospital, Toronto. Our Q3 sales for rainbow were $13 million and a 10% growth rate, certainly less than we had forecasted, in part due to the absence of the large international orders that we previously mentioned. Growth for our noninvasive hemoglobin devices was also more modest than expected in Q3 at 9% with SpHb revenues rising to $4.3 million.

The SpHb revenues include continuous measurement as well as spot check tests and devices. Our SpHb sales force focused on increasing the number of acute care hospitals that are evaluating the technology, leading to a potential sale after purchase approval processes are completed.

Echoing what I noted earlier, we have met our goal this year of introducing one new clinically significant product per month. Our most recent innovation, Oxygen Reserve Index, was launched with receipt of the CE Mark.

ORI is the first noninvasive and continuous parameter to provide insight into a patient's oxygen reserve when they are receiving supplemental oxygen. By providing an analog to the continuous measurement of PaO2, ORI represents a true breakthrough that was previously only possible with an invasive arterial line sensor.

ORI represents the 11th noninvasive parameter we have introduced using rainbow technology and is another reason why clinicians will want to use rainbow sensors along with SpHb measurement. ORI can help clinicians improve patient outcomes by keeping patients in the optimal oxygenation zone to help reduce the risk of hypoxia and hyperoxia. ORI data obtained in real-time can enable proactive interventions by clinicians via visualization of trends or alarms that indicate critical changes in a patient's oxygen reserve.

A few weeks ago, Masimo technology was the subject of multiple presentations at the annual American Society of Anesthesiology meeting in New Orleans. We were excited to see positive clinical data presented about our PVI, SpHb and ORI technologies.

In one study involving a retrospective review of an enhanced recovery after surgery program called ERAS in colorectal surgery patients, Masimo's PVI was used to help guide fluid therapy resulting in reduced length of hospital stay, significantly reduced hospital costs, lower fluid administration, lower morphine administration and earlier return of bowel function.

A clinical study evaluating Masimo's latest noninvasive patient monitoring parameter oxygen reserve index, ORI, showed that ORI can provide advanced warning of potential hypoxia and may help clinicians optimize oxygenation before and during prolonged intubation. The study presented by Dr. Peter Szmuk of the University of Texas Southwestern and Children's Medical Center in Dallas was among 12 selected from more than 1,000 as one of the best abstracts at the ASA. A key conclusion was that ORI is useful as an advanced indicator for impending desaturation.

Lastly, a study involving our SpHb hemoglobin parameter was presented by Dr. Edmundo Souza Neto of the University of West Paulista in Brazil. The study showed that SpHb has similar absolute and trending accuracy as an invasive blood gas analyzer for hemoglobin when both the SpHb and the hemoglobin from the blood gas analyzer were compared to hemoglobin from a laboratory hematology analyzer. This study included data from the Radical-7 with a Rev K SpHb adhesive sensor.

Our product portfolio holds multiple products with the potential for a broad adoption including [Rad]/capnography, SpHb as well as our more recent introductions including Root, Radius-7 ORI SedLine, mobile health products and O3. Like I said before, while the timing of a rapid ramp of the sales for these products is uncertain, we are confident that the clinical value they provide will be acknowledged broadly over time leading to widespread use. Summing up, our third quarter revenue growth and consistent level of [drive] replacements illustrate the steady gains we are realizing in the marketplace as our advanced technologies provide superior clinical benefits.

We are now about 70% through the 10 year plan that we described at our IPO as a two-part strategy to first build the business through investment, then to realize significant earnings leverage as our build-out levels off. We believe that our Q3 results show the early signs of the benefits of this strategy, as our earnings growth exceeded expectations despite the small shortfall in our revenues, thanks in part to improved gross margins stemming from our value engineering investment.

We're optimistic that our financial performance will continue to improve as we reap the rewards of providing patients with breakthrough technology while we focus on raising our operational efficiency. Our emphasis on disciplined control of our operating expenses will yield earnings leverage over the next few years that should benefit shareholders.

With our guiding principles, including the guiding principle to always do what is best for patient care, our leadership and advanced noninvasive monitoring technologies allow us to contribute to improving the practice of medicine and will continue to propel the growth of Masimo.

With that, we will open the call to questions. Thank you. Operator?

Thank you.

(Operator Instructions)

Tao Levy with Wedbush Securities.

Hi, good afternoon. A couple questions, obviously the rainbow a little light in the quarter. The shipments that you took out of the guidance, were all of those the same ones from the second quarter or were there any new ones that you are expecting into the third quarter that also didn't materialize? And are all of these international orders?

The answer is essentially yes in the sense that the one large order that we called out today that we were unfortunately not able to recognize in the quarter was in fact the large order that we were referring to in our prior earnings call. But as we noted today, we had expected obviously to come through in the quarter. The good news is that we actually had a number of other smaller scale, not quite of the same size as this order, international rainbow orders that did -- we expected to materialize and in fact did materialize in the quarter.

And obviously you have the non-rainbow business did nicely in the quarter. Joe, you obviously have gotten a lot of new products approved internationally and in the US and it's tough to figure out what the contribution, if any, from those products were in the quarter. Any help on that front, the contribution from the new products?

Yes. We saw very little help of contribution from those new products. First of all, except for Root, that received clearance towards the end of Q3 in the US, the rest of them have only been cleared outside the US in countries like Europe.

Given the summer season in Europe and how Europeans take advantage of that, we've not seen the benefit of those new products' sales. We hope to see that in Q4 from international markets and then as we gain FDA clearance in the US, hopefully they will follow in the US.

Last question, on the litigation front, the Masimo, the phase II part gets geared up again. The main difference between the patents that you are asserting in that case versus what you just went through, I don't know if there is a couple key highlights that you can provide to summarize those patents?

Sure. First, there's still some of our measure to motion patents that are involved in phase two, just like in phase one. But I think the difference is, in the phase two, we also have a patent, we call it the Radical patent, which covers the high-end Philips monitors called the X2.

That has, I think, implications that may be even more material to Philips because besides damages, which may not be that great, if we win that patent then there's an injunction phase potentially that will ensue for the Philips product. So that's probably the main differences in what is coming in the phase II.

One quick one, since the jury verdict, any thoughts or possibility of a settlement between the two parties? Or are you guys just too far apart still at this point?

If there were any settlement dialogue, I couldn't talk about it, but what I can say to you is that both parties would like to settle this case. We will just have to see when Philips is ready to provide a settlement that is tangible and it matches to the kind of verdict we received.

Got you. Great, thank you very much.

Thank you. Larry Keusch of Raymond James.

Thank you, good afternoon. Mark or Joe, on rainbow, if this math is correct, I think the implied fourth quarter rainbow number is about $17 million on your revised $55 million for the year. And that would be versus $13 million in the third quarter. I wanted to get some sense of, what is your visibility on that, if that math is largely correct and are there any, again, one-time big orders that you are anticipating that helps you get there?

Your math is right, Larry, and I don't believe there is any one-time big orders that's part of it. I think we get the $17 million with a lot of smaller orders as well as our efforts with the hospitals and what we used to call the blood management team which is the noninvasive hemoglobin team.

Okay. Then on hemoglobin, and then I have one after this, maybe you could give us an update, Joe, on where we stand with the spot check product? And how those distributor relationships are going these days and what do you think needs to be done to continue to increase the magnitude of the revenues there?

Well, on the spot check program, our revenues have been very small with the distributors. We still think the right thing to do is to maintain these two large distributors despite the less than expected business that we are getting from that market.

We really see that it makes sense to put greater emphasis on the continuous noninvasive hemoglobin product, given that one of the key attributes of SpHb is the trending information it gives versus spot check information. If and when we get broader abilities to claim more of what hemoglobin can do for our physician office customers, we don't think it's prudent to push that harder than the way it is right now.

Okay. Perfect.

Last one, on the royalty, obviously no change in, at least at this point, relative to Covidien continuing to pay the royalties on those US sales. I think at the beginning of the year you had incorporated, not only for this year, but the next three years, I want to say was the level. Just wanted to see if there was any further insights that you've had now that we've gone a couple quarters past that March 14 timeframe and are you still thinking about this as a multi-year, pretty sustainable revenue driver for you guys?

Yes. I think nothing has changed since then, Larry.

I think given our patents that go until October 2018 that we believe cover Covidien's products, I believe Covidien has probably made the decision that it's the best thing for Covidien, its customers and shareholders to continue paying that until October 2018. I may be wrong. Maybe after Medtronic buys them things will change, but that's the best information -- or the best guesstimate I should say, I have of the situation.

Okay, terrific. Thanks very much, appreciate it.

Thank you.

Chris Lewis of ROTH Capital Partners.

Hi, guys. Good afternoon.

Hi, Chris.

Joe, you mentioned it earlier, but going back to the core SET business, that had a nice pickup versus the past three quarters. You mentioned that the anniversarying of the contract renewals. With that, is the third quarter growth rate for that core SET business around 10%? Can we think of this as a more normalized, sustainable level going forward?

I'm going to let Mark answer that. I don't want to get myself in trouble. Go ahead, Mark.

Chris, I think the way I'd answer that is we believe that's in the range of a more consistent, appropriate growth level than maybe what we've seen over the past couple of quarters. Having said that, obviously, as you've seen from the past couple of quarters, the overall growth rate has hovered I would say on average about 4%, 5%, 6% or so.

We are very busy, obviously, looking at our projections for next year so it's a little preliminary at this point to provide any kind of official guidance, but I think the right zone is probably somewhere between those two numbers. As we highlighted in some of the comments today, a little bit of the additional strength in the quarter that we benefited from most recently had to do with some of these additional OEM products that were part of an additional purchase in the current quarter.

Something that we don't expect to continue in the next couple quarters and certainly helped to a certain extent, accelerate the year-over-year growth in the third quarter. So I think there was that one unique item that helped us climb up to a 10% number for the current quarter. But longer-term growth rate for that SET business, without giving away too much, is I would say somewhere between ultimately about the 5% and 6% that we seen and 10% that we saw this quarter. That's probably the right range going forward.

Okay, great and then international continues to outperform the US, maybe even despite some rainbow order choppiness there. Can you talk more broadly about what is driving the continued strength there? Sounds like Europe continues to be strong so maybe if you could elaborate on that.

Yes, I think first of all Europe and the international market was an area that we began investing in to increase the sales force size and the clinical specialists over there. I think we are seeing some benefit of that.

Secondly, outside the US, the norm is for hospitals to purchase things departmental wide instead of hospital wide and to actually purchase them instead of expecting the giveaways with the equipment and then entering the sensor contract.

So I think that environment is good for some of the new rainbow parameters that we've introduced as well as some of the new technologies like Root that we introduced about a year ago that we just received FDA clearance for in the US. So I suspect the US will continue growing and we believe especially in areas like Europe, the Middle East, we'll continue having good growth in the coming years.

Great, and then on gross margin, I may have missed it, but maybe Mark can you walk us through gross margin expectations for the fourth quarter? Then any type of elaboration on the trend into 2015 would be helpful. Thanks.

Sure. I think as I alluded to in our prepared remarks, and obviously implied by our holding the line on our 65% gross profit margin guidance for the full-year, that implies a marked improvement in the fourth quarter in product gross profit margins.

The good news is that what we have seen enough even through the third quarter, in the sense that some of these favorable variances that are coming through our financial statements, as you probably know, are variances that are required to be flown out with or rolled out with the related inventory. So even at the end of the third quarter, we've seen some very nice, favorable variances that will flow into our fourth quarter. And we expect to continue to see those kind of favorable variances in the fourth quarter as we roll into next year. Sitting here today, we're actually fairly confident about the ability to see a notable improvement in our fourth quarter product gross profit margins.

In terms of what does that portend for 2015, as I said before, a little too early to start providing that kind of guidance. However, we are very optimistic about the trends that we are seeing right now related to projects that were put in place anywhere from one to two years ago. And even more encouragingly, there are a number of new initiatives that we have identified recently that we think over the next couple of years will give us the opportunity to see more dramatic improvements to our overall product cost structure.

So we are very, very enthused about what we have seen recently and that should portend for some improvements to overall product gross margins in 2015 and beyond.

Okay, thanks for the time.

Thank you.

Joanne Wuensch of BMO Capital Markets.

Thank you very much for taking the questions. The hospital census environment, is that getting any better or is that about the same?

I think we saw it look a little bit better in Q3.

All right. And is that ACA patients coming through or do you have an explanation or thought on that?

From what we understand, both the in-hospital patients as well as the outpatients census improved and we believe it's people finally getting some of those procedures done that they had been delaying in getting done, which is what has, I think, increased the census.

Remember, Joanne the last three or four quarters the comparables were actually down anywhere from about 3% to 4% to 5%. So this quarter actually, as Joe just said, having been up just a little bit, I think most of the numbers were somewhere between 0% and 2%. But simply being up is obviously a nice improvement from the kind of traffic that we've seen the prior three quarters.

I agree. One of the things that I thought was interesting was the SG&A level went up year-over-year. Is that all litigation costs? Should it come down next quarter now that Philips is over?

The answer to the first part of your question is yes, Joanne. In fact I called out in our prepared remarks that year-over-year we've actually had almost a $4 million net increase to our total operating expenses coming from our legal expenses. Unfortunately, that's something we were aware of and it's part of the reason why we changed our guidance a couple quarters ago, recognizing that that higher level of legal expense was coming our way.

The answer to your second question is, at least as of right now, we don't think the total level of legal expenses for other ongoing litigation matters will change all that much as we head into the fourth quarter. Having said that, we should see a reasonable amount of legal expenses decline, specifically related to the Philips trial, because obviously that trial took place in September.

So there was a fairly large spike in our Q3 operating expenses because of that. Sequentially in total our legal expenses should come down, but they won't come down dramatically, primarily because of the other ongoing litigation matters that continue.

And because Philips still continues even though we won the jury verdict, there is now the process of (J-Mal), appeals, court that we'll be going to probably. But also the phase II, the trial judge has said he will not schedule the phase II until the completion of phase I. So once that's done, we expect some time toward the end of next year to go to trial on the phase II.

My last question, what are you going to do with the Philip's cash?

We are going to give it away. No (laughter). I heard some mythology on that.

We're obviously, as you can see, are happy buying back our shares especially at these kinds of prices. So we'll have to see when the money comes, what's the best thing to do with the money? It either will go into our bank account or share buyback, we will have to see.

Okay, thank you.

Thanks, Joanne.

Brian Weinstein of William Blair.

Hi, guys. This is Matt Larew in for Brian today. Thanks for taking my question.

Just wanted to dig in a little bit on what you are seeing with the total hemoglobin product. We just recently had the patient blood management forum at ABB and it's pretty clear that the acceptance of blood management as a practice has certainly increased relative to the last couple of years. You've spent a lot of money on bringing this blood management sales force on, but haven't really seen the results spike up quite like we would have liked.

Could you help us understand, is it that the from trial to contract win is taking a little longer? Are you having a harder time helping people understand the product? Anything you can do to help us understand the disconnect between what you are seeing in terms of results and the end markets embracing the practice of blood management. Thanks.

Sure. I think this environment that we are in along with the fact that any new product takes years of persistence before it takes off. As I said earlier in my prepared remarks, we saw the same thing when we introduced SET pulse oximetry. For different reasons there was a lot of inertia against it.

With noninvasive hemoglobin, what I can tell you is that where I'm getting great reports from our head of that business, Rick Fishel, hospitals, from big brand names to local community hospitals are evaluating it, getting great results, moving forward with the part about purchasing the equipment and then the sensors that follow. They get snagged at that level with more and more proof being demanded by administration regarding its cost savings potential, not about its clinical life-saving potential, but its cost saving potential.

So I'm really happy with what we are seeing. I'm not happy with the revenues. I hope soon revenues will catch up with what this technology can do for patients.

I can tell you without a doubt, had we introduced noninvasive hemoglobin maybe eight years ago instead of four or five years ago, it would have had a different uptick. It is just the environment we are in.

Okay, thanks for that, Joe. Mark, I wanted to, maybe you said it on the call and I missed it, could you characterize how much in the quarter were those one-time OEM orders? How much did those make up?

You mean the question about the existing rainbow revenues?

No, remember you mentioned the 10% growth was partially because of additional OEM revenues we got because of the EU.

Exactly, Joe. Thanks.

Sorry, Matt. That number on, just to give you a sense, was a number probably about $0.5 million.

Okay, thanks. That's all I have, guys. Appreciate it.

Thank you. I think we have time for another question.

Bill Quirk of Piper Jaffray.

Yes, thanks. Good afternoon, everybody.

First up is, it didn't really come up in the quarter, guys, but any delta or anything changing with respect to the impact of reprocessing?

Time to reprocessing? I'm sorry I didn't hear the last part.

The overall impact on the SET revenue, Joe. You mentioned in the last quarter that you'd seen, I don't know if I'd necessarily say a bit of a re-emergence on the reprocessing issue, but it certainly had impacted your 2Q results. I'm curious what the feel is right now in the field.

Yes, I think reprocessing is something that has been there for several years. I know once in a while I highlight it just so you guys don't forget. But it's not because it's rearing its head up any uglier than before. So I think we have the same amount of reprocessing in Q3 as we saw in Q2 percentage wise.

But it is really hard to calculate what it is. It's something we don't really quite understand, what percentage of our business is leaking out due to reprocessing.

As you know, we have put out several initiatives including the new X-Cal technology in our products. As more and more of our OEMs grow that product out along with us, there will be less and less ability for third parties to reprocess our sensors. We still will and we still will offer it, but less and less the third parties will be able to do it reliably.

Understood. On the rainbow order, I realize this topic's come up quite a lot here in the Q&A, but to be clear, this isn't -- it's not a lost order, it's just a question of timing. So in other words, you would expect that you are going to recognize this in 2015?

So one, I just wanted to clarify that. And then two, if you had to put any odds on it, are you willing to take a stab at the potential that you are able to capture this here by the end of the fourth quarter?

You are right that we haven't lost the order. From what we understand, this government agency, they're going through an audit. They said to us they think the audit will end in November and then they should be able to proceed.

But given that, we've been at that 11th hour with them for quite a while. We finally felt and we wished, even last quarter we had not even included it in our numbers, but we thought it would be prudent to take it out and let that be a positive bluebird when it does happen.

Very good. Lastly for me, you talked a little bit about Root on the call.

Help us think a little bit, Joe, about the longer opportunity here. How large or how much of a revenue contributor could this be, call it two or three years down the road?

Did you ask about Root specifically?

Yes, about Root specifically.

I think Root should do to this industry what PC did to basically home and the distributed computing. I think Root, with its connectivity powers, with its open architecture to take any third-party sensors as well as our own innovation and this very rich user interface, and now with Radius-7. And maybe even more importantly, the price that we're willing to charge for it, which is very low. I really think it should become ubiquitous and I think it will be very exciting to see all the cool things we can do with it.

I can tell you we have numerous customers that are looking at very large scale deployments of Root. We look forward to those maturing and having it become a big part. I just recently watched this movie, There Will Be Blood. It's about these oil wells. I think we've got several oil wells that we're digging, Root being one of them, hemoglobin being another one ORI certainly becoming another one, [Patient SafetyNet] yet another one.

I'm expecting they will all hit. It would be nice if they all hit together, but I'm expecting they will eventually all hit. I really don't think there's any dry wells we are digging. I hope we will all be around to appreciate when those products hit.

Got it, okay. Then sorry, I guess I misspoke, if I can sneak one last one in for Mark. Mark, any color on the makeup of rainbow between hemoglobin, CO, Met, et cetera?

Really no dramatic change, Bill in terms of the overall makeup. I think obviously we called out the actual SpHb number at about $4.3 million in the quarter.

But amongst the other parameters, not a dramatic change. Interestingly, we have seen of recent quarters, interest in PVI re-accelerating, which is a positive trend and something that we are actually very enthusiastic about and expect to see much more of that in 2015.

Perfect, thank you.

Thank you so much everybody. We appreciate you joining us, wish you guys all a happy Halloween. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Have a great day everyone.