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 in 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 are 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 U.S. business slowdown in the summer quarter, we're 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 1,289,000, up 9% year-to-year, and once again, exceeding the market growth rate for pulse oximetry. And as evidenced of the board's and management's optimism in Masimo's long-term outlook, during the third quarter, we repurchased approximately 2.4 million shares, this repurchase in addition to the 2 million shares we purchased in second quarter 2014, brings our 2004 [sic] (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 7 quarters. Only 600,000 shy of the 6 million share repurchase program we announced over 1 year ago. And 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…

Thank you, Joe. 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%, 1 year ago. And in a moment, Joe will add some additional perspective on the rainbow business. Our worldwide end user or 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 U.S. hospital census, the deployment with various new hospital customers and the benefit of stronger OEM revenues related partially, to the purchase of new RoHS compatible products, for product shipped into the European Union associated with the new EU standard that went into effect this quarter. By geography, total U.S. 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…

Thank you, Mark. We see great potential for our business as our breakthrough technology continue to gain traction in the market. And while not sure when we will hit a steep part in 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 the technology become the standard of care across the globe. In early October, one of the 2 major court trials this year for Masimo was held. The trial was related to our 2009 patent infringement suit against Philips and their counterclaim against us. We are gratified to have a jury verdict return in our favor with respect to the 2 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 based 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 pressure seen on hospital census during the first half of the year. Our higher unit volume for sensors are correlated to the census shift, and we are optimistic that these trends will persist through the end of this year. We are gratified to see a 10% increase in our core SET business, a rebound from the…

[Operator Instructions] Our first question comes from the line of Tao Levy of Wedbush Securities.

Just a couple of questions. So obviously, the rainbow, a little light in the quarter. The -- I guess, the shipments that you took out of the guidance, were any of those -- were all of those the same ones from the second quarter? Or were there any sort of new ones that you're expecting in the third quarter that also didn't materialize. And are all of these international orders?

Tao, the answer is essentially yes in the sense that the 1 large order to be 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, that as we noted today we had expected, obviously, to come through in the quarter. The good news is that we actually added a number of other smaller scale, not quite of the same size of this order, international rainbow orders that did, we expected to materialize, and in fact, did materialize in the quarter.

Okay. And obviously, the non-rainbow business did nicely in the quarter. And Joe, I don't know if -- you obviously, have gotten a lot of new products approved internationally in the U.S., and it's tough to, I guess, figure out what the contribution, if any, from those products were in the quarter? Any sort of help on that front, in terms of the contribution from the new products?

Yes, we saw very little help of contribution for those new products. First of all, except for Root that received clearance towards the end of Q3 in the U.S. The rest of them have only been cleared outside the U.S., in countries like Europe. And given the summer season in Europe and how Europeans take good advantage of that, we've not seen the benefit of those new product sales. We hope to see that in Q4 from international. And then as we -- from the international markets and as we gain FDA clearance in the U.S., hopefully, it will follow in the U.S.

Great. And just the last question on the litigation front. The Masimo, the Phase II part gets geared up again. The main difference between sort of the patents that you're asserting in that case versus what you just went through, I don't know if there's a couple of key highlights that you can provide to kind of summarize those patents?

Sure. I think mainly -- well first, it's still some of our measures through motion patents that are engulfed in the Phase II, just like in Phase I. But I think the difference is in the Phase II, we also have the patent, we call it the Radical patent, which covers the high-end Philips monitors called the X2. And that has, I think, implications that maybe even more material to Philips because besides damages, which may not be that great, is that 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's coming into Phase II.

And just actually, just 1 quick one. Since the jury verdict, any thoughts or possibility of a settlement between the 2 parties? Or are you guys just too far apart still at this point?

Well, I guess, if there were any settlement dialogue, I couldn't even talk about it. But what I can say to you is that both parties would like to settle this case. We'll 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. So we'll have to see, Tao.

Our next question comes from the line of Larry Keusch of Raymond James. Lawrence S. Keusch - Raymond James & Associates, Inc., Research Division: Mark or Joe, could you -- 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 will be versus $13 million in the third quarter. So I guess, I wanted to get some sense of what's your visibility on that, if that math is largely correct? And are there any, again, sort of one-time big orders that you are anticipating that helps you get there?

Your math is right, Larry. And I don't believe there's any one-time big orders that's part of it. That's -- I think we get to $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. Lawrence S. Keusch - Raymond James & Associates, Inc., Research Division: Okay. And then just on hemoglobin, and then I have 1 after this. But maybe you could just give us an update, Joe, on kind of where we stand with the spot-check product and how those distributor relationships going these days. And what do you think needs to be done to continue to increase the magnitude of the revenues there?

Well, we -- 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 2 large distributors despite the less-than-expected business that we're getting from that market. We really see that it makes sense to put a greater emphasis on the continuous noninvasive hemoglobin product, given that one of the key attributes of SpHb is the trending information it gives versus the spot-check information. And I think until we get -- 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. Lawrence S. Keusch - Raymond James & Associates, Inc., Research Division: Okay, perfect. And then just last one. On the royalty, obviously, no change in at least, at this point, relative to Covidien continuing to pay the royalties on those U.S. sales. I think at the beginning of the year, you had incorporated not only for this year, but for the next 3 years I want to say, was the level. And, again, just wanted to see if there was any further insights that you've had now that we've gone a couple of quarters past that March '14 timeframe. I know you're still sort of 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 till October 2018 that we believe cover Covidien's products. I believe Covidien has probably made the decision that its the best thing for Covidien, its customers and shareholders to continue paying that till October 2018. I maybe wrong. Maybe after Medtronic buys them, things could change. But that's the best information -- or the best guess in that, I should say, I have of the situation.

Our next question comes the line of Chris Lewis of Roth Capital Partners.

Joe, you mentioned it earlier, but just going back to the core SET business. That had a nice pickup versus the past 3 quarters. You mentioned that the anniversary-ing of the contract renewals. With that, is the third quarter growth rate for that core SET business around 10%? Can we think of this is as a more normalized sustainable level going forward?

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

Chris, I think that 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, and obviously, this is -- 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're 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 2 numbers. And 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 of quarters, and certainly helped, to a certain extent, accelerate the year-over-year growth in the third quarter. So I think there was that 1 unique item that helped us climb up to a 10% number for the current quarter. The longer-term growth rate for that SET business, I guess without giving away too much is, I would say somewhere between, ultimately, about the 5% and 6% that we've 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 U.S., maybe even despite some rainbow order choppiness there. Can you just talk more broadly about what's driving the continued strength there? It sounds like Europe continues to be strong, so maybe just -- if you could elaborate on that.

Yes. I think -- first of all, Europe or international market was an area that we began investing in to increase the sales force size and the clinical specialist group there. And as I think we're seeing some benefit of that. But secondly, outside the U.S., the norm is for hospitals to purchase things departmental-wide instead of hospital-wide. And they actually purchase them instead of expecting the giveaways with the equipment and then enter into sensor contracts. 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 1 year ago that we just received FDA clearance for in the U.S. So I suspect OUS will continue growing and we believe, especially in areas like Europe, 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? And then any type of elaboration on kind of the trend into 2015 would be helpful.

Sure. Well, 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. And the good news is that what we've seen enough EBIT 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 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. So 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're seeing right now related to projects that were put in place, anywhere from 1 to 2 years ago. And even more encouragingly, there are a number of new initiatives that we've identified recently that we think, over the next couple of years, will give us the opportunity to see more dramatic improvements to overall -- our overall product cost structure. So we're very, very enthused about what we've seen recently, and that should portend for some improvements to overall product gross margins in 2015 and beyond.

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

The hospital census environment, is that getting any better or is that about the same?

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

All right. And is that ACA patients coming through? Or how's -- do you have an explanation or thought on that?

Well, I -- from what we understand, both the patient -- the in-hospital patients as well as the outpatient census grew. 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.

And remember, Joanne, the last 3 or 4 quarters, the comparables were actually down anywhere from about 3% to 4% to 5%. So this quarter, actually, as Joe just said, actually, 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 in the prior 3 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? And should it come down next quarter now that Philips is over?

The answer to your 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 is part of the reason why we changed our guidance a couple of 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 that 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. And so there was a fairly large spike in our Q3 operating expenses because of that. So 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's now the process of [indiscernible] appeals court that we'll be going to, probably. But also the Phase II, the trial judge had said he will not schedule a Phase II until the completion of Phase I. So once that's done, we expect some time toward end of next year, to go to trial on the Phase II.

And just my last question. What are you going to do with the Philips cash?

We're going to give it away. No. I don't -- I've heard some mythology on that. No, we've obviously, as you can see are happy just 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. Either it will go into our bank account or share buyback. We'll have to see.

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

This is Matt Larew in for Brian, today. Just wanted to dig in a little bit on what you're seeing with the total hemoglobin product. We just recently had a patient blood management forum at ABB. And it's pretty clear that the acceptance of blood management in sort of practice has certainly increased relative to the last couple of years. And you spend 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've liked. So can you maybe help us understand? Is it that the -- from trial to contract win is taking a little longer, do you have a harder time helping people understand the product? Anything you can do to help us understand sort of the disconnect between what you're seeing in terms of results and the end markets embracing the practice of blood management.

Sure, sure. I just think, this environment that we're 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's 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 and getting great results. Moving forward with the part about purchasing the equipment and then the sensors that follow. And they get snagged at that level with more and more proof being demanded by administration regarding its cost savings potential, not about its clinical lifesaving potential, but cost saving potential. So I'm really happy for what we're seeing. I'm not happy with the revenues. I hope, soon revenues will catch up with what this technology can do for patients. And I can tell you, without a doubt, had we introduced noninvasive hemoglobin maybe 8 years ago instead of 4, or 5 years ago we would have a different uptick. It's just the environment we're in.

Okay. And Mark, I just wanted to that maybe you said on the call and I missed it. Could you characterize how much in the quarter were those one-time OEM orders, how much those make up?

You mean the question about the existing rainbow revenues?

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

Exactly, Joe.

I'm sorry -- sorry, Matt. Yes, that number, just to give you sense, was a number probably about $0.5 million.

I think we have time for another question?

Our next question comes from the line of Bill Quirk of Piper Jaffray.

So first off is, I guess it didn't really come up in the quarter, guys. But any delta or anything changing with respect to the impact of reprocessing?

With time to reprocessing, I'm sorry, I didn't hear the last word.

No, no, just I guess the overall impact on the SET revenue, Joe, from -- yes, you mentioned in the last quarter that we'd seen -- yes, I don't know if you'd say a bit reemergence on the processing issue. But it certainly had impacted your 2Q results. I'm just curious kind of what the -- I guess kind of what the feel is right now the field.

Yes. I think reprocessing is something that's 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 got the same amount of reprocessing in Q3 that we saw in Q2 percentage-wise. But it is really hard to calculate what it is. It's just something that we don't really quite understand what percentage of our business is leaking out due to reprocessing. As you know, we put out several initiatives, including the new [indiscernible] technology in our products. As more of our OEMs roll 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. And then just on the rainbow order, I realize it's a topic that's obviously come up quite a lot here in the Q&A. But just be clear, this isn't -- it's not a lost order, just a question of timing. So in other words, you would expect that you're going to recognize this in 2015 so, I guess, one, just want 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 this -- that you're able to capture this year, by the end of the fourth quarter?

You're 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 have not even included in our numbers. But we thought it would be prudent to take it out and let that be a positive Bloomberg when it does happens.

Very good. And then just lastly for me. You talked little bit about Root on the call. Help us think little bit, Joe, I guess about a longer-term opportunity here. I mean how large or how much of a revenue contributor could this be, call it 2 or 3 years down the road.

Did you ask about Root, specifically?

Yes. About Root, specifically.

Yes, I think Root should do to this industry what's PCs did to basically home and a distributed computing. I think Root, with its connectivity prowess, with its open architecture to take any third-party sensors as well as our own innovation and this very, 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'll 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. And we look forward to those maturing and having it become a big part. What I -- maybe because I just recently watched this movie, what was it called -- "And There Will be Blood." So it was this oil well. I think we got several oil wells that we're digging Root, being one of them. Hemoglobin being another one. ORI becoming recently another one. Patient safety that's in the general floor is yet another one. That I'm expecting they will all hit, it we'll be nice if they all hit together. But I'm expecting they will eventually all hit. I believe, don't think there's any dry wells we're digging, and I hope we'll all be around to appreciate when those products hit.

Got it. Okay, and then if I can -- sorry I guess, I misspoke, if I could sneak 1 last one in for Mark. Mark, just any color on the makeup of rainbow between hemoglobin CO, MED, 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 quarter's, 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.

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