Good afternoon, ladies and gentlemen, and welcome to the Masimo Corporation's second quarter 2009 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions) Thank you. I would now like to turn the call over to your host for today, Mr. Steve Moran, Executive Vice President and General Counsel of Masimo. Please proceed, sir.

Thank you, Christina. I would like to welcome you to Masimo's second fiscal quarter 2009 earnings release conference call. Our press release was distributed about 30 minutes ago. If you have not seen the release and would like to, a copy is posted on the Investor Relations page of our website at www.masimo.com. On the call today are Joe Kiani, Masimo's Chairman and Chief Executive Officer; and Mark de Raad, Executive Vice President in Finance and Chief Financial Officer. In just a few moments, Joe and Mark will deliver remarks on our financial results for the 2009 second fiscal quarter, general comments regarding our business, and an update to our 2009 financial guidance. After Joe and Mark offer their comments, there will be a question-and-answer session in which they will answer as many questions as time permits. Before we begin, let me remind you that this call may contain forward-looking statements. While these forward-looking statements reflect Masimo's best current judgment, they are subject to risks and uncertainties that could cause our actual results to vary. Risk factors that could cause Masimo's actual results to materially differ from our forecast are discussed in detail in our filings with the Securities and Exchange Commission. With that, I would like to turn the call over to Joe Kiani, Chairman and CEO.

Thank you, Steve, and thank you ladies and gentlemen for joining us today. Prior to this quarter, we had witnessed strong sequential product revenue despite an economy that began to decline significantly in the summer and fall of 2008. The impact of the recession had its impact on our customers materialize in the second quarter. As we had highlighted in our earlier call this year, we were particularly concerned over our OEM partners’ larger ticket multi-perimeter devices sale. In Q2, we generated only $12.5 million in OEM revenues, which was down from $13.8 million in the same prior year and down from $15 million in the immediately prior Q1 2009 period. It is important to note however that we believe our OEM market share for new Pulse Oximeters did not decline in Q2. In addition to the Q2 weakness in our OEM channel, we also saw from softness in our direct US business in Q2 used to what we now believe was a balancing of inventory for Q1 to Q2. We believe the sequential decline between Q1 and Q2 was due to the end-user customers reducing their higher than normal inventory in Q1 and being more cautious with caring the inventory in Q2, as well as customers benefiting from our industry-leading durable reusable sensors and patient cables introduced over a year ago and lower capital purchases. Yet despite one of the worst recession since the Great Depression, we had a good quarter. While total worldwide product revenues were down quarter-over-quarter, they grew 13% year-over-year and direct end-user business grew 20% year-over-year. Thanks to continued strong Masimo SET growth and even stronger Masimo Rainbow SET growth. These results underline both the power of our business model and the power of our innovation in noninvasive monitoring which is helping our customers improve…

Thank you, Joe. Hello and good afternoon everybody. Earlier today, we reported total second quarter revenues of $83.6 million, which consisted of product revenues of $70 million and royalty revenues of approximately $13.5 million. This represented a 13% increase in year-over-year quarterly total product revenue growth. In the second fiscal quarter, as Joe just noted, we shipped 27,100 new Pulse Oximeters and Pulse CO-Oximeter monitors into the marketplace. And based on these shipments, we now estimate that our total worldwide installed base, net of estimated retirements to be at least 605,000 drivers up from 515,000 or about 18% from just one year ago. The year-over-year growth in product revenues came primarily from Masimo’s SET revenues which rose to $65.5 million in the Q2 2009 quarter, up from $59.2 million in the same prior year period. This increase is the result of our continued expansion of Masimo’s SET technology into new hospitals. During the second quarter 2009, Rainbow revenues totaled $4.5 million, up from $2.9 million in the comparable prior year quarter and from $3.1 million in the immediately preceding quarter, a growth of 56% over the prior year period. This increase was due primarily to Rad-57 handheld Pulse CO-Oximetry devices and growth in all of our Rainbow parameter revenues including our recently released continuous noninvasive hemoglobin measurement. Second quarter 2009 product revenues generated from our direct business which includes sales through just-in-time distributors totaled $57.5 million or 82% of total product revenues, while OEM revenues totaled $12.5 million or 18% of total product revenues. This compares to $48 million or 77% in our direct and distributor channel, while OEM revenues totaled $14.1 million or 23% in the same prior year period. This decline in OEM as a percent of total revenues is due primarily as Joe noted to our lower…

Thank you. This was the first quarter in more than five years that we didn’t see sequential product revenue growth. However as I noted before, our direct product revenue grew by 20% and our total product revenue grew by 13%. During the second quarter, we continued to invest in the growth of our sales force and research and development team. We intend to continue to invest in these areas in order to deliver growth in our core and emerging businesses, especially when the market rebounds. The good news is that we believe, that we have seen the low points for 2009 and based on our updated projections, we expect both Q3 and Q4 product revenue to raise sequentially. An encouraging sign is that we are seeing more activity and excitement around our suite of revolutionary noninvasive measurements, our gold standard Pulse Oximetry and the recently launched hemoglobin SpHb as well as PVI, SpCO and SpMet. Our pipeline for SpHb or noninvasive continuous hemoglobin business has grown nearly two folds to over 500 hospitals being quoted with an average of five hemoglobin licenses per site but not all our capital sales. We now have three different ways we provide these hemoglobin licenses through capital purchases, through the 90 days loan with increased sensor price and through the hospital wide conversions with integrals and licenses. Just recently we announced the FDA clearance of our Rainbow Resposable Sensor, which can reduce the cost of Pulse CO-Oximetry and specifically noninvasive hemoglobin monitoring by 50%. In addition to lower cost, we believe the new Resposable Sensor will resonate with hospitals that are trying to be environmentally conscious or green. Just to remind you, we believe the market for SpHb noninvasive hemoglobin will be as big as Pulse Oximetry if not bigger, even if all our…

(Operator instructions) Your first question comes from the line of Bill Quirk with Piper Jaffray.

Good afternoon.

Hi, Bill.

Hi, Bill.

First off, Joe, thanks for all the color certainly around everything is going around vis-à-vis the economy and in your business. You expressed a lot of optimism about growing the business sequentially here both for 3Q and 4Q, but also mentioned that obviously there is a – there at least was in the second quarter a bit of an inventory issue at the hospital level, how confident are you that that levels have been worked down to where the end user feels comfortable with that, what mechanisms are you looking at in terms of being able to track that, if you could just add a little bit color there?

Sure, Bill. We have looked at not only what is in the inventory of our just-in-time distributors, but we’ve also looked at the sales it had in our top US hospitals in terms of sensor sales. And first of all, we’ve noticed on the just-in-time distributors for the most part a dramatic reduction in the inventory compared to Q1. Secondly, what we have noticed is in Q2, while some of our US hospital customers had lower sensor purposes from us, Q1 was higher. And when we averaged the two together, we kind of gotten into the same historic numbers that they have with us a year ago. So it’s really those two factors along with of course the first $30 million in this quarter that makes us believe that perhaps the worst is behind us.

Okay. Very good. And then just a quick hemoglobin question, if you are willing to give us a number that would be great, if not, can you comment a little bit about the sequential growth that it perhaps stay at the same pace that we saw 1Q over 4Q?

Yes, the pace was the same with revenue wise. What changed that was I think maybe more dramatic was the amount of I guess the pipeline for us at the new quotations being given to customers worldwide. And that seemed to have doubled since last quarter and we will have to see in the next quarter whether that pace will continue giving that it may have again been due to pent up demand given that we released the product on March 23rd.

Okay, very good. And Joe just one clarifying question and I will jump in the queue here. When you said that the pace grew similar sequentially and you mentioned the dollar amount – the dollar amount essentially – the delta between 1Q or 4Q is roughly the same as 2Q over 1Q or are you referring to the growth rate in a percent terms?

I was referring to – really this dollar amount is growing the same way between Q2 and Q1.

Understood and quote activities up. Okay. Great. Thanks guys.

Thank you, Bill.

Your next question comes from the line of Tao Levy with Deutsche Bank.

Good afternoon.

Hi, Tao.

Hi. Joe, I just want to go back to the inventory reduction question. I just want to make sure, in the last quarter, you guys have indicated seasonality as a reason why the first part of the second quarter looked a little bit softer. Is it now, if not necessarily seasonality, it’s more this inventory issue you’re talking about?

That’s a good question, Tao. We do obviously see seasonality really the peak of our sensor volume sales and I think although and obviously Q3 should be lesser in terms of sensor volumes than Q1 and Q2, what we were referring to in Q1 was kind of the uncertainty of why we saw less sensor sales. But then when we went back and looked at the inventory which we didn’t get to do until the end of Q2, really the sensor sale had not changed much between Q1 and Q2, a lot of the sensors happened to be in the inventory of our distributors with the adjusted time distributors which they weren’t buying from us in Q2 at the beginning of the quarter. So to – I guess to sum it up, yes, there is going to be obviously seasonality issues, but some of that was already expected and really the bulk of what we saw was increased inventory at the hands of the just-in-time distributors in Q1. And another thing I want to say is that, it ended up at the flu season wasn’t as bad as the previous flu season, so I think some of the inventory our customers must have taken it in anticipation of that and perhaps even a swine flu that they were worried about ended up being for naught and that’s why I think in Q2, we began seeing kind of cleaning up of the inventory at the end-user level as well.

Perfect. And when you look at the US sensor business, you have a pretty good visibility on that, because you get the Covidien royalty. Is your sense that that Covidien also was down sequentially in your US sensor business or do you think maybe you could have lost a little bit of share sequentially in the US?

Well, we actually don’t believe we have lost any market share. In fact, the converse – first of all, I want to remind you that Covidien unlike Masimo doesn’t do a sell through model. So in Q1, while all the inventory was being built, they ended up probably just booking it as revenue, we did not – we ended up putting it aside and then at Q2, we took some of that it. And based on kind of the royalty number that we have seen, we can’t be certain because we don’t have all the information. But it looks like we are continuing to out broaden as the same pace as we ever had, but just the delta. The delta is the same but the numbers are different.

And the last question, when I do this metric, product revenue per install, obviously that took a bit hit here in the second quarter. So when you talk about Q3 being sequentially up, should we be thinking about that product revenue per install trending up versus the 2Q number?

Yes. We looked at that and all we can tell you is it’s difficult to understand based on one quarter what the actual sensor revenue for socket is. I think you got to kind of look at it annually. But I think if you were going to – if we were going to give any guidance, we would probably say, probably should be around the 450 number not where it is looking at this quarter.

Okay, great. All right, thank you very much.

Thank you.

Your next question comes from the line of Sara Michelmore with Cowen and Company.

Thanks for taking my question.

Hi, Sara.

Let me first start, Joe, thanks for the color on the quote activity. I know last quarter you had said that I think there were several hundred hospitals that were requiring quote. Can you just give us a sense of what the quote to kind of conversion timeframe is or do you have a better sense of the sales cycle here in terms of the length of time and takes a quote to convert into a sale at this point?

I don’t get – no, Sara, I will have to venture out there. I don’t typically for the industry – it’s typically about three to one ratio of what you quote and what you end up bringing in. If I had to say I think we should expect to see some of those activity mature in Q3 and the bulk of it Q4.

And I know you’ve come up with some changes to at least making some different options in terms of acquisition or how customers can acquire the technology. What do you expect to be the kind of predominant model going forward in terms of the hemoglobin adoption, in terms of capital cost versus the financing of those after sales, et cetera?

It’s too early to tell. What I can tell you right now, we are having activities in all the three different scenarios, capital purchases, the 90-day loan with increased sensor price or the hospital wide conversion with the hemoglobin licenses. And I prefer to hold off a little bit till we have a little bit bigger trend in just one quarter.

Okay. And lastly, I just want to make sure I understand on the guidance. I mean you’ve reduced it by about – it looks like $15 million for the product revenue and can you just give us a sense in terms of how much of that is SET versus Rainbow in terms of the reduced expectation, and maybe in the SET, if you could go one layer deeper and talk about the direct versus the OEM sales expectations. I am just trying to figure out what really changed in terms of that $15 million versus your prior view?

Sure. I believe our previous guidance on Rainbow was about $23 million to $25 million and today Mark mentioned $16 million to $18 million. So I think it’s really about half-and-half, half on Rainbow reduction, half on SET reduction.

Okay. All right, thanks, Joe. I will get back in the queue.

Thank you, Sara.

Your next question comes from the line of Gregory Hertz with Citi.

Hi, Joe. Hi Mark. It’s Greg calling for Matt, who – he is away out of the office right now, so he couldn’t make the call. Quick question for you, just wanted to get understanding on the headcount outlook for the year. Are you still targeting the 220 or did the results this quarter give you some pauses as far as your outlook for expansion specifically with the doctors’ office?

Hi, Greg. We have not slowed down our growth of our sales force or our R&D team. And we have stopped giving exact numbers due to competitive reasons. But I can tell you we are going as fast as we can. And as far as doctors’ offices, we are preparing for hopefully 2010 launch into the doctors’ offices.

So the project Pronto timing at Q4 still holds?

It does. We are basically looking at Q4 over the Q1 timeframe for Pronto into the doctors’ offices.

Okay. And maybe a couple of questions for Mark; Mark, the deferred revenues were down a bit sequentially, can you just give a little color on that.

Yes, actually the primary reason was what Joe had alluded to earlier to the fact that as you know, we defer our revenues that are shift into our distribution channel, because those inventory levels were higher at the end of March than they were at the end of June. That deferred revenue was essentially reversed in the second quarter, so that’s essentially why that number came down.

Got you. And then could you maybe just give a little – this is I guess for both of you, if you could just give a little color as to where you stand right now in the quarter, how sales performed in August, maybe just sensor volume wise, how it’s tracking and how that kind of pulled into your outlook for further confidence with the sequential gains for the reminder of the year? That’s it from me. Thank you.

Well as I said earlier Greg, we based on many factors including how big that we go into first 30 days of this quarter, we are feeling like the – kind of the low point of the year behind us and we are expecting a sequential growth Q3 and Q4.

All right, so from a sensor volume standpoint, you already seeing the turn specifically in August versus July?

I don’t know if I can get that granular with you. But yes, I can just tell you overall just about on every front, things were looking better. Maybe one of the benefits of fitting low at 70 is that everything goes better after that.

All right thanks very much.

Thank you.

Your next question comes from the line of Raj Denhoy with Thomas Weisel Partner.

Hi, good afternoon.

Hello, Raj.

Hi, Raj.

Wonder if I could ask a little bit about the reduction in Rainbow guidance. Relative to the base business, it was sort of a large percent of reduction. I am curious, where are you seeing the softness, is it – are your expectations for hemoglobin maybe a little lower they were, are you seeing more softness in the Rad side of the business with the other perimeters, just maybe some more thoughts around that?

Well, as we indicated last quarter, we are seeing EMS softening where all the budgets locally have been cut. In addition, we – the good news is our first OEM partner with Rainbow technology released its products in Q2. The bad news is we get about half the revenues when they sell things compared to if we sold it direct. So I think when we see softness in our EMS side of business compared to what we would expect and because of those issues. But also I think with the rollout of hemoglobin, the whole environment where cost cutting is en vogue does not bode as well for brand new measurement like that. So all those taken together has what made us feel that conservatively we need to redo our forecast for Rainbow and we feel very good about meeting the numbers we’ve given now.

Okay, fair enough. On the hemoglobin front, is it cost – is that the major pushback you are hearing from institutions or is it data related or just generally how is that – how is that receptivity out there?

I think it’s cost, it’s people getting for – with new measurement, it’s expectation. I think something – that the ratio between invasiveness and efficacy and cost plays a bigger role in that than before. So overall, we are very happy with what hemoglobin is doing for our customers in the OR, in the ICU, and we believe it’s the word of mouth gets out as the studies come out. And of course, as we have reduced our cost by offering another option which is the Resposable Sensors, we hope with type and those new parameters, hemoglobin will start to rise. And I have always said trying to forecast the brand new measurement that isn’t doesn’t fall under reimbursement and it is really difficult to do. But one thing we are confident about is that it is going to get there and just going to be when do we get that inflection point and I guess you will know when we get there.

Sure. Did you mention that – I think it was just asked, I want to make sure it was right that you said you had 500 hospitals with an average of five licenses for hemoglobin per site.

Yes.

So there is roughly 2,500 places you could plug hemoglobin sensor into right now.

Yes. 2,500 units.

Right, right. Okay. So I guess as we look forward as far as a way to kind of build a hemoglobin sort of an adoption, I mean that’s a nice pace to be building up?

Yes. And mostly next quarter, if I can tell you, it’s grown again at a good rate that will be terrific and that’s what we are hoping for.

Okay. And when you look at that number of sort of 2,500 places out there, do you have a rough expectation for how many sensors for each of those might be used or have you seen any sort of even early anecdotal data on how this is going through?

We do have it. Obviously, we don’t count our whole 2,500. As I mentioned earlier, we counted about a third of that as we look at our pipeline. And as far as sensors are concerned, I think in the OR, when they’re being used in the OR, we can at minimum predict a 100 sensors per unit per year and ICU probably 50. But it could be in upwards of 300 sensors or 400 sensors per unit per year in the OR. So we will just have to see how they’re going to use the product, they use it only every patients or they try to use it on the high-risk blood loss patients.

Okay, fair enough. Thank you.

Your next question comes from the line of Joanne Wuensch with BMO Capital Markets.

Thanks for taking the question. You talked about hospital capital purchasing decisions, but anything regarding hospital sensors and how that maybe impacting your business?

Joanne, at the end of Q1, we were more worried about sensors than today. Today, all of the normal places we go to get a feel for sensors. It looks like it’s either up or it’s flat. So we don’t – we think sensors have kind of come back. Now maybe not all of those people are carrying insurances like they used to, but for our world, sensors seems not be an issue.

One of the things we hear when we do our field checks is that to some of the hospitals are looking for to quote independent kind of a data on hemoglobin. And could you sort of address that and tell us when you think that maybe presented at some stage?

Yes, that I believe at the ASA, American Society of Anesthesiologists Conference few papers are going to be presented. I believe they are already – there is already independent data from both Loma Linda and I think Mayo Jackson will, but certainly will be more at the ASA and hopefully that data will start satisfying people’s curiosity.

Helpful. Finally, can you give us an idea, you have several different ways of going towards the average selling price for hemoglobin and you have now added the Resposable product. What should we think of a sort of blended ASP for the sensor? Thank you.

I would say maybe for the probably $50 is the right way of maybe doing it.

Very helpful. Thank you.

Thank you.

Your next question comes from line of Sean Lavin of Lazard Capital Markets.

Hello, Sean.

Just a couple of quick questions, the first one is, in terms of hemoglobin, am I correct in the fourth quarter, you were in – about 25 hospitals, about 50 in the first quarter and now 500?

No, no, no. The 500 what I was referring to was how many hospitals have requested quotes for hemoglobin, whether it’s part of a capital purchase or a 90-day loan with increased sensor price or the hospital conversion with SpHb. As far as how many hospitals we were in, we went from 50 to I believe as of the end of Q2, we were at 68 hospitals.

And then my second question is we have heard from a number of physicians that you are making ongoing improvements to the algorithm and the sensors. Could you talk a little bit about those?

Sure. We believe in continuous improvement and we – when we launched the product, we believe that it was at the same performance level as second generation Pulse Oximetry were introduced in the mid 80s to late 80s. However, our goal does not to weigh 10 years to go by to make enhancements, but we are constantly improving it and we – we’ve already made some nice improvements in the past couple of months, we expect another release towards the end of this month and we have tight release for end of Q4. We are constantly improving both the sensor and algorithm. Our goal is to – eventually the goal – I am not saying we are going to get there, but the goal is to get the accuracy down to 0.5 grams per deciliter and haven’t work for fusion levels of well below 1 or 1.1.

All right, that’s all I have. Thank you.

Thank you.

Your next question comes from the line of Ben Forrest with Summer Street.

This is Spencer Nam. Thanks for taking our questions. I just I have a quick question here. We were getting some feedback from some of your OEM customers that things were looking more positive in the second half into 2010. Are you guys getting any sense from OEMs in terms of the demand pattern and how they are planning out the rest of the year end going forward?

We hear the same things, but we have not seen a dramatic increase in orders for our board and we don’t believe like I said earlier, our market share has been reduced in those products. So we will still waiting to see, but so far, doesn’t look like it’s pointing downwards anymore. So hopefully, we have seen the bottom and hoping both for our OEM partners as well as ourselves that they will have a nice Q4 finish.

Great. And then the second question is, in terms of your hemoglobin test, total hemoglobin test right now, what it would be – if you had to describe, what it would be your biggest challenge at this point in terms of adoption?

I want to say the economy is – but I don’t it’s just a combination of I think economy, I think it’s the price of our product. I think and somewhat as far as where we want to take it into spot check world, into the emergency department and doctors’ offices it’s improving upon its accuracy in those environments and trending is not so important there, we need the absolute number. So I think it’s the combination of things and maybe one that will always be with us is how long it takes for a new technology, monitoring technology to be adopted. And I think as I told you before, the most successful companies when they introduced Pulse Oximetry in the early 80s, the first unit they introduced, they did $2 million dollars in revenue. And clearly we are going to do that more of it. So I think, it’s just growth it’s gone from $2 million in the early 80s to today a $1 billion market, but unfortunately it’s not like a new drug or some device. It has reimbursed and associated with it which causes overnight shifting of the market.

Thanks very much.

Thank you.

Your next question comes from the line of Brian Weinstein with William Blair.

Hi, good afternoon. I apologize for the background noise here. How should we think about drivers for Q3? I want to make sure that I am clear on this. Are you expecting a number of drivers that are placed to the markets also be up sequentially Q3 and then also Q4?

I don’t think so. I think from now we are kind of targeting that same 25,000 to 30,000 drivers per quarter for Q3 and Q4.

But, up sequentially from what you did potentially in Q2.

Well, Q2 was 27,000, so potentially slightly but nothing dramatic. I think where we see the sequential growth is, first of all, we see it in the health of the sensor business is coming back. Secondly because of inventory issues that we were dealing within Q2, we see it in Rainbow measurement software sales. We see it in handheld devices that we don’t include in our driver numbers. So it’s a combination of those issues, not particularly a dramatic increase in drivers.

Okay. Can you give us an update on what you are seeing in Europe and what your strategy is there?

Well, Europe, they are having the same roles as we have in the US economically. We had a wonderful driver quarter in Europe. I think it was in about 2x the same quarter last year in Europe. So we – Europe, we have been in rapidly increasing our sales force there and they typically do purchases of a department by department level which should be less resistance to decision versus in the US where we do hospital license stuff. And same also with parameters like hemoglobin and PVI. Historically Europe is earlier to adopt those kinds of measurements.

Okay. And then my last question, how many accounts have actually converted and wind up paying the license fee of those who were paying the higher sensor price from the marketing program that you initially started a couple of quarters ago?

I don’t have that number.

Can you kind of ballpark it. Is it more than 50%?

I don’t know. Mark, can you ballpark it?

I think it’s just around there Brian.

Okay. Great. Thank you guys very much.

Thank you.

(Operator instructions) Your next question comes from the line of Bill Quirk with Piper Jaffray.

Just quick housekeeping question, Mark I noticed and you commented on the call that the DSO has picked up. What was the information for that, was just a timing issue around collections or anything off there?

Well unfortunately Bill, it’s really a reflection of our other comments on the environment in Q2. We have seen a variety of our direct hospitals extend their payment cycles to us. We don’t believe there is any deterioration in the quality of our receivables, but we have certainly seen our customers who are all struggling with their own cash flow requirements, tried to push out as long as they possibly can in payments. So that’s really the driving force behind the increase in DSO.

Understood. Thank you.

There are no further questions. I would now like to turn the call over to Joe Kiani for closing comments.

Thank you all for joining us this afternoon. I am looking forward to reporting Q3 numbers to you. I expect them to be better. As you can see, while we had a couple of great quarters in Q1 and Q4 and historically, we were worried about what Q2 would potentially is going to be like and we’ve tried to put some measures out there for you. You can see we are feeling much better now about going forward with Q3 and Q4 and look forward to the longer term with Masimo. So thank you all for joining us. Have a wonderful evening.

This concludes today’s conference call. You may now disconnect.