Masimo Corporation (MASI) Q2 2013 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and welcome to Masimo's Second Quarter 2013 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. Please go ahead, sir.

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'll now pass the call to Joe Kiani.

Thank you, Eli, and welcome to the team. Hello, everyone. Joining me -- thank you for joining us today to review our second quarter results. We are happy to report total worldwide product revenues that were up 12% versus the year-ago period. Our second quarter SET revenues rose 12%, while rainbow revenues rose 19%, including approximately $3.6 million in SpHb revenues, a normal increase over the immediately preceding first quarter of 2013. We're also happy to report on Q2 Pulse Oximetry and Pulse CO-Oximetry shipments, which rose 14% to 42,600 units, signaling both the continued global adoption of our breakthrough technology and positive prospects for long-term growth in consumables sales. As of June 29, 2013, we now estimate our global installed base to be approximately 1,148,000, up 11% versus the year-ago period. Our Q2 earnings per share was $0.30. This was equal to the $0.30 per share in Q2 2012, although the 2012 second quarter included a $0.03 per share benefit from a tax audit settlement. The improvement in year-over-year earnings would have been even more significant if not for the negative impact from the medical device tax and foreign exchange movements. I'll provide a brief operational overview of the quarter and highlight some new market developments in a few minutes. But first, Mark will provide some additional details on our second quarter financial performance. Mark?

Thank you, Joe, and hello, everybody. Second quarter 2013 total revenue, including royalties, was $137.4 million, up 12% versus the second quarter of 2012. Product revenue was $129.6 million, up 12% versus the second quarter of 2012. This growth is despite negative movements in foreign exchange rates, almost entirely due to the weakening of the yen versus the U.S. dollar, which reduced second quarter 2013 product revenue by $1.9 million versus the year-ago quarter. Rainbow product revenue grew 19% in the second quarter to $11.5 million, due primarily to increased SpHb product sales, as Joe just alluded to. Encouragingly, approximately 45% of our total rainbow revenues were consumables. In a few moments, Joe will provide some additional information on our Q2 2013 SpHb revenues. Our worldwide end-user or direct business, which includes sales through just-in-time distributors, grew 10% in the second quarter to $108.1 million versus $98.4 million in the year-ago period. Our Direct business represented 83% of total product revenue in the quarter versus 85% 1 year ago. OEM sales, which made up the remaining 17%, rose 27% to $21.4 million compared to $16.9 million in the same period of 2012. By geography, total U.S. product revenue rose 8% to $89.8 million compared to $83.2 million in the same quarter of 2012. Growth was driven primarily by increased SET Pulse Oximetry sensor sales to hospital customers, resulting from strong driver shipments this year. International product revenue rose 24% or 30% on a constant currency basis to $39.8 million in the second quarter of 2013 versus $32.1 million in the same period last year. The increase is due primarily to growth in both EMEA and Asia. International revenues represented approximately 31% of total product revenue in the second quarter of 2013 compared to 28% 1 year ago. Our second quarter product gross profit margin was 64.4% compared to 64.1% 1 year ago. As previously mentioned, the significant unfavorable year-over-year FX movement also resulted in lowering our Q2 2013 gross profit margin by 70 basis points. Adjusting for the impact of FX, the underlying improvement in our product gross profit margins are due primarily to the continuing benefits of our ongoing cost reduction efforts and SET Pulse Oximetry sensor ASP market stabilization. Our second quarter total gross profit margin, including royalties, was 66.4%, essentially level with the year-ago period. Second quarter 2013 operating expenses were $68.1 million, up 16% versus the year-ago quarter. Contributing to the increase was $1.5 million for the medical device tax, which went into effect at the beginning of 2013. Without this impact, operating expenses rose 13%. SG&A expenses increased 14% versus the year-ago period to $54.2 million. Excluding the $1.5 million in medical device excise tax, our SG&A expenses rose 11% from $47.6 million to $52.6 million. This increase was due primarily to higher year-over-year staffing levels, higher legal fees and various marketing-related expenses and a $2.4 million increase in costs associated with the build-out of our new worldwide blood management sales force. R&D spending rose 25% to $13.9 million in the second quarter compared to $11.1 million in the year-ago period, primarily due to increased staffing levels, engineering project and new product development-related costs. Second quarter 2013 operating income was $23.2 million, up 2% compared to $22.7 million in the year-ago period. Non-operating expense was $200,000 in the second quarter compared to $500,000 in the year-ago period. Our second quarter 2013 effective tax rate was 36.2%, up from 20% in the same period last year. Included in the income tax provision for the Q2 2013 period was a $2 million provision for the establishment of a valuation allowance against deferred tax assets of Cercacor, which you'll recall is a separate company we'd spin off to stockholders in 1998 but we continue to consolidate within our financial statements. During Q2 2012, we recorded a $2 million income tax benefit from the favorable conclusion of an international tax audit that Joe alluded to earlier. Excluding the establishment of the $2 million valuation allowance and the favorable audit conclusion impact, our provision for income taxes was $6.3 million or an effective tax rate of $27.4 million for the second quarter of 2013 compared to $6.4 million or an effective tax rate of 29% for Q2 2012. Second quarter 2013 net income was $17 million or $0.30 per diluted share compared to $17.7 million or $0.30 per diluted share in the same prior year period. As Joe previously mentioned, it's important to recognize the results for the year-ago period included a benefit of approximately $0.03 per share from the onetime benefit related to the favorable conclusion of the international tax audit, while the current year period includes a $0.02 additional cost related to the new medical device tax. As of June 29, 2013, our days sales outstanding was 47 versus 49 at December 29, 2012. Over the same period, inventory turns declined from 3.8 to 3.3, due primarily to our decision to increase consumable inventory levels to better serve our customers and to improve our disaster recovery mitigation strategy. Total cash and cash investments as of June 29, 2013, were $78.1 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. As part of our current share repurchase program, we acquired approximately 222,000 shares during Q2. In total, since the board approved the most recent stock repurchase plan in February 2013, we have repurchased a total of 1 million shares. And with that, I'll turn the call back to Joe.

Thanks, Mark. Our second quarter 2013 results demonstrated, once again, the clinical value of our breakthrough SET and rainbow SET technology and the strength of our recurring revenue and innovation-driven business model. This combination positions Masimo for sustained double-digit product revenue growth well into the future. Market share gains were clearly visible in our new driver shipments and in our sales performance, reflecting the effectiveness of our sales and marketing efforts. Over the past year, we are realizing steady increases in the number of new Pulse Oximetry agreements with hospitals that also include advanced rainbow measurements, general ward patient monitoring systems or both. Our Renewal business with existing customers is also increasing as our existing customers continue to recognize the benefits of our monitoring solutions for both patient safety and lowering their overall costs. We have continued to increase our list of premier hospital customers worldwide. In fact, as we announced this morning with the recent addition of Mayo Clinic in Minnesota, we are happy to be able to now report that 8 of the top 10 ranked U.S. hospitals are now our customers. These well-regarded institutions also include Johns Hopkins, Massachusetts General, Cleveland Clinic, UCLA Medical Center, UCSF Medical Center and Brigham and Women's Hospital in Boston. As you know, Masimo's key competitive advantage and most significant long-term growth opportunity lies in our ability to provide customers with SET Pulse Oximetry. SET Pulse Oximetry is the first and the best measure-through motion and low perfusion pulse oximetry in the world and is the only pulse oximetry technology that has been proven to reduce retinopathy of prematurity in neonates, detect critical congenital heart defect in newborns and reduce cost in preventable death in the general ward. In addition, with rainbow SET, clinicians get a host of unique breakthrough rainbow parameters, which have been shown in multiple independent studies to help clinicians improve patient care, save lives and reduce costs. During the second quarter, we made good progress on our efforts to grow adoption of the rainbow platform as evidenced by the 19% year-over-year rainbow sales increase, driven by strong SpHb sales. We believe that SpHb has the potential to become a standard of care based on its ability to help reduce blood transfusion rates and associated costs and mortality, as well as its ability to help detect occult bleeding. In the second quarter of 2013, total hemoglobin sales were $3.6 million, representing an 87% improvement over the immediately preceding first quarter 2013 SpHb sales. As I said previously, the timing for when we'll be on the steep part of the technology adoption curve in SpHb sales is uncertain. However, I'm confident that our efforts to build a dedicated sales team, increase rainbow OEM partners, continually improve the technology and at the same time, educate through clinical research and novel marketing programs, will all combine to make SpHb a standard of care. Encouragingly, our list of OEM partners offering rainbow-equipped monitors is growing, including many new patient monitors that will provide a significant increase in the number of OEM solutions offering SpHb and rainbow Acoustic Monitoring. We continue to expect the 2 largest companies in the global patient monitoring market, Philips and GE Healthcare, to introduce rainbow-enabled products within the next year. To date, more than 50 OEMs have executed agreements to integrate rainbow technology into their devices, including more than 20 companies that have already released rainbow-enabled products. For the acute care hospital setting, Dräger is marketing the Infinity Acute Care monitor system incorporating rainbow SET. Dräger is the first patient monitoring company to offer a high acuity patient monitor with Masimo Rainbow SET technology. For lower acuity settings, Welch-Allyn is the first to market rainbow SET technologies. I'll close with a few thoughts on Masimo's commitment to improve patient care, which is the cornerstone of our success thus far. First of all, 30 states have now passed legislation that requires the screening of newborns for critical congenital heart defect, a condition that often leads to infant mortality. The screening for CCHD is effectively enabled with Masimo's breakthrough and allowing for accurate SpO2 measurement during motion and low perfusion. CCHD screening may soon be required in an additional 11 states, which either have legislation pending or active pilot screening programs now in place. In fact, just 2 weeks ago, the New York State Legislature submitted a bill to Governor Cuomo for signature, which would require CCHD screening for all newborns in New York. Governor Brown has already signed into law similar legislation for CCHD screening in California. Another example of how we continue to improve patient care is through our new breakthrough open architecture monitor and connectivity platform named ROOT. ROOT is designed to provide unlimited applications from the operating room to the general floor. The ability of ROOT to accept new functionalities from third-party developers increases its utility. Also, ROOT has a feature called IRIS. IRIS gives ROOT the ability to act as a hub in each room, allowing hospitals to collect data from all devices on the patient in the room and send the data to their electronic medical record and for the future use with Halo, our predictive algorithm to assess the overall patient status. We have begun the premarket release of ROOT in many countries outside the U.S., with SEDLine brain function monitoring, ASA capnography and, of course, radical rainbow SET Pulse Co-Oximetry and rainbow Acoustic Monitoring. We are encouraged by the reaction ROOT has received thus far. Just to let you know, ROOT with WiFi and IRIS is still pending FDA clearance in the U.S. With the guiding principle to always do what is best for patient care, our innovation engine continues to position Masimo at the leading edge with multiple opportunities to advance medicine and propel Masimo's steady and fast growth. With that, we'll open the call to questions.

[Operator Instructions] Your first question comes from the line of Bill Quirk with Piper Jaffray.

It's actually Dave Clair here for Bill. First question for me, I was just curious, can you give us some more details on what drove the SpHb growth over last quarter? And is this the rate that we should think of going forward? And are you still comfortable with the $50 million rainbow guidance for the year?

The primary driver behind the strong sequential performance was in our Pronto area of the product segment, primarily related to WIC-related market opportunities in the quarter. So we're very pleased about that, even more pleased that we think some of that demand will continue for the rest of the year. So that was the primary reason there. And then in terms of the overall question on the annual guidance, yes, we still believe that our original guidance back in February of $50 million of total rainbow revenues is obtainable. Clearly, it requires an acceleration towards the second half of the year, which was always part of our expectation. And as Joe mentioned, with the continued build-out of the new blood management team, along with some of the additional momentum that we've seen recently in areas like WIC that I just described, we're feeling very confident about the ability to achieve that number as we head towards the end of 2013.

And is that kind of the run rate to think of going forward, like increasing from this? Or is it still going to be kind of variable?

Well, I think, certainly, given the number -- given that the number is in that $50 million range, we could still obviously see some volatility quarter in, quarter out. But overall, our high-level expectations for rainbow growth over the next couple of years continues to be in that 20% to, hopefully at some point, 40% revenue growth ranges that we've spoken to about in the past.

Okay. And then on the blood management team that you guys are pulling out, where are you right now in terms of numbers of reps? And how long do you think it'll take to get these reps fully productive?

Well, currently, we stand here in the U.S. at very, very close to the original target of almost 40 reps and clinical technical specialists supporting those reps. Our OUS original goal was around 20, and we're in the neighborhood of about half that number. We always expected that part of the build-out to take a little bit longer, but we're still real hopeful that we're able to complete that by the end of this year. Sorry, what was the second part?

Just in terms of productivity, when do you think they'll get fully ramped?

There is obviously an initial training period for those individuals and then time in the field as well. And unfortunately, this segment for us, to a certain extent, is not all that indifferent or different than our existing Pulse Oximetry business, meaning that, in some cases, the transaction cycle here will be one that involve multiple quarters and maybe even more. So directionally, we think it'll be 2014 before we begin to see much of a significant impact from this new team.

Your next question comes from the line of Matthew Dodds with Citi.

A couple of questions. First, Mark, on the gross margin, you quantified the foreign exchange impact. Did the higher inventory run help at all? That's one question on gross margin. The second one is, does the mix hurt you a little bit when the OEM grows faster than the direct?

Let me -- the first question regarding inventory margins, no. I mean, there's obviously not really any correlation between the growth of inventory on our balance sheet and the cost of the product that we happen to sell in any particular quarter. So...

Actually, that makes the margin worse. So when inventory grows, the margin looks...

Well, no, it just lowers your overhead of the plant, but it shouldn't -- it's not that much, that's what I was wondering.

Yes. No, I -- you mean from an absorption standpoint?

Right.

You're right, there wasn't -- it does theoretically contribute to that, but there wasn't a big impact relative to our overall margins for that. And then in terms of the product mix on the OEM side, there is a little bit of a counterbalance there between our traditional OEM products, which obviously are heavily influenced by board sales, which are typically at lower gross profit margins. But remember, within those OEM numbers are also revenues from our no acquisition last year, PHASEIN, and some of those margins in the aggregate are actually improving a little bit relative to where they were about a year ago.

Okay. And then just one other question. On SG&A, when you back out the med tech tax, you did show improvement again year-over-year this quarter as a percent of sales. Not as much as Q1 but still an improvement. It still looks like in the back half, you've got to get a little more leverage. Is that still realistic?

Well, I think in general, if you look at the overall operating expense guidance that we provided at the start of the year, that implied in that guidance is some additional leverage, primarily, honestly, in Q4 because typically Q4, as we all know, is our softer quarter and we're expecting that to occur again this year. But yes, by Q4, we would expect to see some additional leverage in the model, courtesy of the higher Q4 revenues that we're expecting.

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

A couple of questions. Acquisition revenue in the quarter, is there a way to quantify that impact?

Yes. The total impact of acquisition revenue for the quarter was slightly over, and I'm now including both acquisitions last year, was slightly over $4 million versus about $1 million in the prior year period. So the incremental increase was about $3 million.

Okay. And then the royalty was, and I'm nitpicking here, I'm telling you in advance, was a little bit higher than I expected. Any particular reason or anything to read into that?

Well, I think what we read into it, remember that the way that we handle our royalty accrual accounting is that we make our estimates based upon the best information we have available. And then when we receive the royalty payment, usually about 2 months after the end of the quarter, if we receive more than we accrue, we actually put that into the following quarter royalty numbers. And that's exactly what happened this quarter. So what that means, of course, is that our original accrual for royalties in the Q1 period turned out to be a little bit light, which obviously meant that the total royalties we received from Covidien was a little bit higher than what we had expected and accrued in Q1. And so therefore, that difference rolls into Q2. And fundamentally, we assume that, that's due to the fact that just like Masimo, Covidien actually enjoyed a fairly strong start to the year in the first quarter, and that's reflected in those royalty numbers.

Okay. And then my last question is when GE, and I think it's Siemens, gets the rainbow system into their systems, how long does it take for it to be deployed and to start generating revenue for you?

Well, GE and Philips, when they deploy, it should be -- listen, I mean, the date we're giving isn't when their engineering will be done but rather what we think they'll have products in the marketplace. So it should be within the next 12 months.

And then you should start resuming ReSposables relatively quickly thereafter?

Well, it's hard to predict what they're going to do. But whatever they do, yes, we'll be able to recognize that immediately.

Your next question comes from line of Brian Weinstein with William Blair. Brian Weinstein - William Blair & Company L.L.C., Research Division: Quickly, noncontrolling interest is a little bit higher than what we've typically seen. I'm not sure if you mentioned this during the prepared remarks, but can you quickly go through kind of why that was up to $2.4 million?

Sure. Remember, in the prepared remarks, I talked about the unusually high effective tax rate due to Cercacor's decision to write off or at least create a value allowance for their deferred tax assets. That rolled through -- because we consolidate, that rolls through our effective tax rate on the P&L. However, because it's essentially an additional loss for Cercacor, as you know, that gets added back in that noncontrolling interest at the bottom of the P&L. So what you're seeing there primarily is the offset to the negative impact that you see in the effective tax rate line. Brian Weinstein - William Blair & Company L.L.C., Research Division: Got it, okay. And then on the Pronto and Pronto-7, last quarter, you said it wasn't better. By the end of the quarter, you've made certain changes, but it sounds like it did improve there. So are you happy with your distribution status at this point with that product?

We are feeling better about our distribution partners, and we're still watching it over the next couple of quarters. But we think things are looking better. Brian Weinstein - William Blair & Company L.L.C., Research Division: All right. And my last question is, as far as the last quarter, Joe, can you give us an update on Better Care? You haven't signed any as of the last quarter and you pointed to hopefully something kind of in the back half of the year. How are you thinking about that program? And are you continuing it? And where does it stand?

We are continuing it. To my understanding, we may be up to 5 Better Care customers now. What I'm hearing from our head of, I guess, typical from sales, the blood management team, is that while Better Care is something that they'll use from time-to-time, a lot of customers are saying, "Look, we see the value. We just want to move forward with technology. And people typically have their own unique way they want to do it." So we're hoping that Better Care is a tool that we'll have for customers who need that guarantee. But going forward, it will be less and less an ingredient to get the pump primed for the SpHb usage. Brian Weinstein - William Blair & Company L.L.C., Research Division: Would you reprise customers that are up and signed and are active?

No, we have 5 hospitals that have signed up for Better Care and I think 2 are up and active.

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

So maybe I could ask on the SpHb. $3.6 million a quarter, good total number, but you did say that the -- most of the increase or big chunk of the increase came from Pronto. And I was just curious more on the hospital side of SpHb, whether -- what that looked like in the quarter. Is that similar to the $2 million you posted in the first quarter?

Well, what we can say, Tao, is that the -- and I think this would be very encouraging, that the adhesive sales grew dramatically in second quarter compared to Q1 and even in the past. So I don't think -- we're already breaking down a very small part of our business of being SpHb. We don't want to get further breaking it downwards or going, with all due respect, because then you'll want to ask us every quarter about it. And it's just too choppy to look at everything and draw conclusions, and that's why we don't think it's a good idea to do that. But I hope that answers your question.

Yes. So definitely, it sounds like more hospitals adopting SpHb, more sensors being used in the hospital setting.

Yes. And like I said earlier in our prepared statement, we really believe in the future for SpHb, especially in hospitals. We believe that just even from recent visits to customers around the world, Europe, U.S. The demand is palpable and people are very interested, and we think the future is bright.

And then on patient safety, in that side, I think in the last quarter you had mentioned you had around 200 hospitals that were kind of in contract, I think, is the term you used. How many actually have the technology installed? And how are they using it? I assume it's all, obviously, for the general floor setting, but I'm not exactly sure and look to get any likes, dislikes, sort of areas for improvement.

Well, if I got all these questions, you're referring to the Patient SafetyNet and how they're used?

Yes, and sort of how many you have out there sort of installed. Last quarter, I think you said you had over 200 contracts that had been signed.

Yes, I think that's correct. And the usage is mainly in monitoring patients after surgery, usually orthopedic or cardiac, patients that are likely to be on drugs that can affect their respiration rates -- respiration, and therefore, they're being monitored.

And as long in the general...

I think you know that the Joint Commission and APSF have issued similar alerts, as well as recommendations to continue to monitor patients after surgery that are on drugs that can affect respiration with both Pulse Oximetry and ventilation monitoring. So that's where we're seeing the usage happen, and we expect it to expand.

Got you. And then just the last question on the share buyback, is that still a good use of cash going forward?

Well, not immediately. As we sit here, we don't see that because we've got some opportunities we're looking at for the long term, perhaps acquisitions, perhaps our future home, so we're analyzing it. But I don't expect this to be in the market, buying shares in the immediate future.

Your next question comes from line of Chris Lewis with Roth Capital Partners.

Just looking at the unit driver shipment number, this is really the third quarter in a row you showed solid year-over-year growth there. So I was hoping you could just provide some more color around what is driving that placement growth at that level? And then going forward, is this mid- to high-teen growth rate a sustainable type of growth rate we should think about in terms of unit shipments as we head -- as we look into the second half of the year?

Well, what I can say on that is, obviously, we believe the growth is due to the demand for our technology, both direct and through our OEMs. We're getting a lot of hospitals and premier hospitals around the world that are adopting our technology, and this is just really wonderful to see. As far as what's expected for the growth, it's probably easier if I kind of said maybe in a different way that the normal for Masimo used to be 25,000 to 30,000 drivers a quarter and we feel like the normal is now getting to that 35,000 to 45,000 drivers or Pulse Oximeters and Pulse Co-oximeters per quarter. And I don't know when we'll see that grow again to that next level, but at least we feel like that's kind of where it's stabilizing at for the foreseeable future.

Okay. And then is it safe to say you expect that with the higher unit placements, we can expect that to translate into kind of an acceleration of the related pull-through sensor revenues as we look ahead as well?

Yes, absolutely. As I said earlier, one of the things that's exciting about the record driver shipments we've had from -- I think maybe the second largest ever is that not only shows what the market's thinking about us and how we're doing in the marketplace, but how that sets up -- us up for a nice growth in our Sensor business looking forward.

Great. And then can you -- Joe, can you just talk a little bit about -- maybe just give an update on what you're seeing with the general ward and what type of traction you've got since the last update?

Yes. There's, unfortunately, many gaps usually between best practices and what really gets done in many parts of our environment, including hospitals. This is definitely one of those gaps that is eventually going to fill up and it's going to fill up quickly like the way the Berlin Wall fell. Clearly, there are people dying on the general wards due to lack of continuous monitoring. Most hospitals today, the patients, they're lucky they get seen every hour, once an hour, in the ward. It's not every 2 to 3 hours. And as you know, the drugs that they're taking stops them from breathing. In a few minutes, they'll die. So just checking once an hour, once every 2 hours is really not adequate. So fortunately, we've now made a technology that's robust enough that you can have continuous reliable monitoring in the ward as the Dartmouth-Hitchcock study and the editorial that accompanied it proved in the Journal of Anesthesiology a few years ago. So I can't tell you every customer we talk to they're in the process of either doing it or already doing it, it's not translating as fast as we had expected in hospitals, hundreds at a time converting and doing it, but I think it's just a matter of time and it will happen.

Your next question comes from line of Lawrence Keusch with Raymond James.

This is actually Konstantin for Larry. So I guess, I just want to start off with just looking at the first half of the year in terms of EPS and where your guidance is, I'm just wondering as why are you guys not increasing your guidance given EPS guidance, given that through the first half of the year, you already achieved more than 50% of your targeted EPS.

It's Mark. Well, I think, as we've always said, we do our best to provide what we believe to be appropriate annual guidance at the start of the year. And then our basic premise is that unless we see a material change to those numbers, whether it's the top line, bottom line or any of the other numbers that we provide guidance to, that really, we don't feel that on a quarterly basis, it's appropriate to make small changes. And at this stage, only halfway through the year, while we're really pleased with what's happened so far this year, there's still a long way to go. And as I said before, the third quarter is traditionally a lighter quarter for us. And so we don't know what that means in terms of just how light. We don't expect anything, any unusual numbers, but there's always that uncertainty. And then as usual, we expect a very robust fourth quarter. But again, that's so far out right now and there are so many unknowns that we just don't think it's the appropriate time to be making any changes -- or I should say, any material changes to the guidance that we provided back in February.

Understood. And then maybe for Joe. Joe, maybe can you remind us just your philosophy on just acquisitions, the kind of your criteria?

Well, ideally, the acquisitions we would like to do would be ones that fit well either technologically or in our distribution channel. As far as the size of acquisition, we don't like doing big acquisitions unless we fall in love with the -- what's to be acquired, so much that we think it's better than what we're doing because it's really going to take that kind of effort to make sure that such big acquisitions are done properly. So you have to really like what you're buying. So then, that normally then leads us back to smaller, tuck-in acquisitions like we did last year with PHASEIN with their capnography and gas monitoring that fit well with our distribution channel or with Spire Semiconductor for the vertical integration and a way to improve rainbow's performance by focusing better on to the light emitting diodes and photodiodes that we were manufacturing and receiving. So having said all that, we remain open to anything and everything, maybe to some people's chagrin, but we're -- and at he end, we're very picky with what we end up choosing to acquire.

Understood. And last one for me is just your comments regarding GE and Philips. And are they going to begin selling rainbow systems with rainbow capabilities in the next 12 months? I'm just wondering if you can maybe just pinpoint a little bit, I guess, more fine-tuning it, in the first quarter of 2014, we should expect that? Or is it really second quarter of mid next year, something mid next year that should occur?

I would really like to do that, Konstantin, but I think it would be disrespectful to Philips and GE. They're very protective about the timing of what they're going to do things. And that's why we gave kind of this 12-month window that we felt would be okay with them. And I apologize, but I can't give you more.

[Operator Instructions] Your next question comes from the line of Spencer Nam with Janney Capital.

So my first question is on the increase in driver sales. We've been seeing this for the last 2 or 3 quarters. I was wondering if given that Covidien all seems to be doing well, I'm just curious whether you guys view this as maybe some sort of a pent-up demand that's being addressed or that -- is there a sort of spending increase from hospitals and in adding more drivers here? What's really driving this sort of rebound, if you will, that we've been seeing over the last 6-plus months?

Well, to my -- to the best of my knowledge, I don't know really if our competitor has had a big driver increase. We know what we're doing, and I think we believe our increase in driver sales is due to our market expansion, as more customers are switching to us, whether it's the Mayo Clinic or the Cleveland Clinic or hospital in Ireland and hospital in Vienna. I mean, that's -- so it's just really happening all around the globe and it's putting good demand on both our direct products, as well as our OEM products, to fulfill those major conversions.

That's helpful. So in terms of spending then at the hospital level, are you guys feeling comfortable that there's no sort of a cautious approach or behavior seen at the hospital level with respect to these monitoring devices at this point?

Well, I think if you say that relative to the sub-2008, 2009, yes, we feel like the hospitals are getting back on the saddle and they're riding once again. We're feeling that the Affordable Care Act is actually a good thing for us because hospitals are now looking very, very sharply at how to maximize patient care and reduce their costs. Because in the old days, if you had to get a patient back in again or have them there for a few more days or something kind of went wrong and then went right again, the hospital would get reimbursed for it. Now as you kind of go through this accountable care model, there is going to be more demand on getting it right the first time. And surgeries were once were considered revenue generation or considered a liability. So I think that bodes well for our technology, both our Pulse Oximeter technologies that's been proven to do really amazing things, as well as our noninvasive hemoglobin technology and the like. So I think if there's any macroeconomics or macro things going on out there, it's perhaps hospitals becoming more deliberate about the decisions they're making with their whole process. For example, some of the things that we're selling them before were being handed down to people that were not as clinically astute. Clinicians are now becoming more part of that team in deciding what they're going to do for the future. So because they're seeing that the technologies are an important element to the process changes, they're planning to make to try to lower their costs and improve share and minimize patients needing second or third visits and surgeries and so forth.

Great. And then I -- that's -- I appreciate the detail there. Next question is on X-Cal, which you guys haven't talked much recently, but wondering if there's any feedback on how -- is it -- does the whole program doing what it's supposed to be doing? Kind of where are you in terms of rolling that out across your customer base?

Well, it's maybe why we didn't bring it up, it's just running smooth. There's really nothing to report on it. We really had done, I think, a really good job for nearly a decade planning for it and executing and it doesn't mean we got everything right, doesn't mean we can't make things better. But overall, things are running smoothly.

Great. And final question is, there's 2 out of the top 10 hospitals who haven't converted yet, why are they holding back? And do you think you guys could get them over the line in the next near term?

Well, we don't want to jinx our process. But really, there's no reason all 5,000 U.S. hospitals shouldn't be using Masimo and same for the rest of the world. So we're -- we see it as not just good for our business but good for patients to have all hospitals be our customers. So we're not giving up on 10 out of 10, and hopefully, we'll get there. Thank you so much all, and I really appreciate you all joining us this afternoon. Enjoy your summer, and we'll get back to you after Q3. Thank you.

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