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Executives

Steve Moran – Executive Vice President and General Counsel

Joe Kiani – Chief Executive Officer

Mark de Raad –Chief Financial Officer

Analysts

Bill Quirk – Piper Jaffray

Tao Levy – Deutsche Bank

Sara Michelmore – Cowen & Company

Matthew Dodds – Citigroup

Joanne Wuensch – BMO Capital Markets

Spencer Nam – Summer Street Research

Masimo Corporation (MASI) Q4 2008 Earnings Call March 3, 2009 5:00 PM ET

Operator

Good day ladies and gentlemen, and welcome to Masimo Corporation’s fourth quarter and full year 2008 earnings conference call. My name is Lindsey, and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of the conference. As a remainder this conference is being recorded for replay purposes only.

I would now like to turn the call over to your host for today’s call, Mr. Steve Moran, Executive Vice President and General Counsel of Masimo.

Steve Moran

Welcome to Masimo’s fourth fiscal quarter and full year 2008 earnings release conference call. Our press release was distributed about an hour 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 of Finance and Chief Financial Officer. In just a few moments, Joe and Mark will deliver remarks on our results achieved during the 2008 fourth quarter and full year 2008 and general comments regarding our business including an update of our fiscal 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.

Joe Kiani

Thank you ladies and gentlemen for joining us today. Earlier today we announced our financial results for both our fourth fiscal quarter and full year 2008. As I noted in our press release today, we are happy that despite the difficult economic conditions, we continued to see strong demand for Masimo SET and Masimo Rainbow SET technology and products. In fact, the 31,700 drivers that shipped represented a record quarter for Masimo, and we now estimate that our total installed base of Masimo SET and Masimo Rainbow SET sockets excluding handheld devices has increased to 567,000 net drivers, up from 470,000 drivers just a year ago.

We believe that this strong shipment level in the face of very difficult economic conditions is further evidence that hospitals continue to recognize the superiority of our technology allowing hospitals to both improve their patient care as well as reduce their overall cost of care. In addition to strong fourth quarter and full year financial results, which March will review with you in more detail, the fourth fiscal quarter of 2008 also included some important business and operational milestones that I would like to briefly mention.

Late in Q3, we initiated a limited market release of continuous noninvasive hemoglobin parameter for our Rainbow SET platform. As we’ve explained before, this limited release was not the commercial launch of hemoglobin, but we limited the release because as with the release of our other products, we’ve found that with limited marketing testing, we can sometimes significantly improve our product before we commercially release the product. The limited market release also allows us to obtain valuable feedback on how we can best develop and deliver our training programs for our new products.

In our Q3 earnings call, I mentioned that we hoped to have from 10 to 20 limited market release to customers by the end of fourth quarter. I am pleased to report that we finished the fourth quarter with 23 such limited market release to customers and clinical sites, and we believe we may be up to 50 limited market release sites by the time we commence our commercial release of Hemoglobin which we are still expecting will be before the end of this quarter, Q1 2009. Later in this call, I will provide you with some additional observations on the progress we have made in our Total Hemoglobin limited product release.

Other important events included Masimo Rainbow SET SBCO and SB MET, which is our noninvasive carbon monoxide and noninvasive methemoglobin measurements, received CPD codes and Medicare reimbursement for outpatient care. Nihon Kohden also expanded the integration of Masimo’s SET Pulse Oximeter technology worldwide. Zoll, one of our long term OEM partners, entered into a multiyear agreement to add Masimo Rainbow SET technology in their E series defibrillator.

We launched the first non-adhesive pulse oximetry sensor designed for extremely low birth weight babies, focusing on the less than 500-gram babies. Also in Q4, we successfully completed the realignment of our international operations, which will allow us to better serve our non-US customers by centralizing all our international sales, marketing, support, planning, and logistics and administrative activities in one location, in Neuchatel, Switzerland.

Although no major additions in Q4, the fiscal year 2008 represented a significant year in our ability to add talented, experienced, and knowledgeable executives to our team. To quickly refresh your memories, I wanted to touch just briefly on these key new hires.

Jon Coleman has joined as President of International Business. As you can see from our press release today, we are realigning our international business under the direction of John including the establishment of a new international headquarters in Neuchatel, Switzerland.

David Goodman has joined us as Executive Vice President of Business Development. David is focused on expanding our business development activities allowing us to consider a variety of opportunities that may present themselves as Masimo continues to consider other technologies that may contribute to our long term mission of improving patient care and reducing their cost of care by noninvasive monitoring to new sites and applications.

Rick Fishel, who has been with us for several years, will as of this quarter be focusing entirely on our worldwide OEM business and in driving our new business opportunities in the areas of alternate care including the emergency medical systems and physician’s offices. Also in the most recent quarter, we have announced that Steve Paul who was previously our US Area Vice President for the West will be assuming responsibility for all of our US hospital business. Steve brings a deal of experience, knowledge, and energy to this extremely important role, and we look forward to the contributions that we know Steve will be able to provide to our company.

Earlier in the year, we added additional key resources including Steve Moran who is our new Executive Vice President of Legal and Human Capital as well as our General Counsel and Secretary. Steve brings a tremendous amount of legal experience in both corporate contract and general business law. Steve is also responsible for our human capital development which by the way we expect to continue to add over 100 new professional physicians over the next year in the US alone.

Dr. Michael O’Reilly who joined us in early 2008 as our Executive Vice President of Medical Affairs is a practicing anesthesiologist and has already added tremendous benefits to our organization by ensuring that we continue to always have the clinicians’ perspective in mind when we design, develop, and deploy our new technology.

As today’s reported Q4 and full year 2008 financial results show, we had a strong year with product revenues growing by nearly 30%, and our earnings excluding the $0.25 one-time Q4 2008 tax charge rising to $0.78, even though at the beginning of the year we had forecasted 23% product revenue growth and an EPS of $0.52.

Now, Mark will provide you with a more detailed summary of our Q4 and full year 2008 financial highlights including our 2009 financial guidance. After Mark’s review, I would like to spend a few moments updating you on the general business, our products, and some of the key 2009 areas that we will be focusing on during the year. We’ll then be happy to answer your questions as Steve Moran alluded to.

Mark de Raad

Please keep in mind that all my comments will, except when I note otherwise, relate to financial results on a GAAP basis. As a reminder in fiscal 2007 prior to our initial public offering, Masimo was required to report GAAP earnings per share under the two class method. For the benefit of our investors we have continued to include in our quarterly earnings releases today the non-GAAP 2007 financial statements with 2007 earnings per share computations as if the current if-converted method had been used in the prior periods.

Earlier today, we reported record total fourth quarter revenues of $83.1 million which consisted of record product revenues of $71.4 million and royalty revenues of $11.7 million. This represented an approximate 29.4% increase in year-over-year fourth quarter product revenue growth. As Joe mentioned, we shipped 31,700 new Pulse Oximeters and Pulse CO-Oximeter drivers into the marketplace, and based on these shipments, we now estimate that our total worldwide installed base net of the estimated retirements to be approximately 567,000 drivers. Importantly this is up 21% from the estimated 470,000 net installed units just one year ago.

As we’ve noted in the past, the shipment of new Pulse Oximetry units is important because once installed these units generate future sensor sales which continue to represent the most significant component of our total product solution revenues.

During the fourth quarter of 2008, we generated approximately $4.7 million in Rainbow related product revenues which was up 161% from $1.8 million in the comparable prior year period. Our stronger than expected Rainbow revenues were related to a large OEM MX board order as well as very strong US demand for the RAD-57 related, we believe, to the end of year budget related purchase.

Included in the $4.7 million of Rainbow related revenue were our initial total hemoglobin revenues derived from our limited market release of Total Hemoglobin. Fourth quarter 2008 product revenues generated from our direct business which includes sales through our distributors totaled $56.1 million or 79% of total product revenues, while OEM revenues totaled $15.3 million or 21% of total product revenues. This compares to approximately 76% and 24% in the prior year period and is the result of our multi-year worldwide direct sales force expansion as well as a decline in our year over year OEM revenues. Importantly, however, while our year over year fourth quarter OEM revenues were down, the number of Masimo OEM boards were up year over year by approximately 3%.

During the fourth quarter, our US product revenues totaled $54 million or 76% of total product revenues, compared to $41.4 million or 75% in the prior year period. The slight decrease from 25% international revenues in the fourth quarter of 2007 to 24% in the fourth quarter of 2008 was due primarily to the strong US fourth quarter assisted by the recognition of some previously recognized deferred revenues.

On a year to date basis, US and international direct and distribution revenues rose by 37% and 50% respectively. Our 2008 fourth quarter royalty and license fee revenues decreased to $11.7 million from $14.1 million in the prior year period due to the expected lower royalty rates associated with our 2006 settlement agreement with Nellcor, now part of Covidien. As a reminder, our settlement agreement with Nellcor included a 15% royalty rate in 2007 and a 13% rate in 2008.

Our 2008 fourth quarter product gross profit margins rose to 65.6% from 63.9% in the prior year period. The year-over-year increase was due primarily to the beneficial impact of improved manufacturing efficiencies related to higher production levels, as well as increased Rainbow product sales.

Total gross profit margin from the 2008 fourth quarter decreased to 70.5% from 71.2% in the same prior year period primarily due to the anticipated decline in year over year Covidien royalty payments. Our fourth quarter engineering expenses were $7.2 million, up 31%, compared to $5.5 million in the same prior year period. The year-over-year increase was due primarily to a $1.2 million increase in payroll and payroll-related costs associated with increased research and development staffing levels, higher stock-based compensation charges, and higher year over year clinical trial expenses.

Our 2008 fourth quarter selling, general, and administrative expenses rose to $31.2 million up approximately 15% from $27.2 million in the prior year period. Higher expenses were due primarily to the combined result of a $4 million increase in payroll, payroll related, and stock-based compensation costs consistent with an increase in worldwide SG&A staffing from 360 people at December 29, 2007 to 415 people at January 3, 2009.

Our 2008 fourth quarter effective tax rate increased significant to 102.7% from 31.3% in the prior year quarter due primarily to a new international business organization and structure designed to better serve and support Masimo’s growing international business. By centralized our international operations, including sales management, marketing, customer support, planning, logistics, and administrative functions, we expect to be able to develop a more efficient and scalable international organization capable of being even more responsive to the business needs of our international customers, all under one centralized management structure.

As a result of this realignment in Q4 2008, we incurred a one-time tax charge of $14.9 million or $0.25 per share related to the expenses for sharing in the costs of our ongoing R&D efforts as well as the prepayment of licensing commercial rights to utilize pre-existing intangibles. Importantly, as a result of this new international business structure, we expect that our future tax income tax rate will decline, although future income tax rates will depend on various factors including profits or losses before taxes, changes to tax law, and the geographic composition of our pre-tax income.

Absent this implementation, our fourth quarter pro-forma tax rate would have been 28.1%. This Q4 2008 rate was lower than the Q4 2007 rate due primarily to increased 2008 R&D credits which have in the past two years been recognized in our fourth quarter tax provision.

In summary despite the decline of nearly $2.4 million in fourth quarter 2008 versus 2007 royalty and license revenues, our strong year over year product revenue growth, higher product gross margins, and lower than expected operating expenses have combined to generate fourth quarter 2008 operating profits of $20 million as compared to $17.6 million in the same prior year quarter. Because of the previously mentioned 2008 Q4 tax charge related to the realignment and consolidation of our international business, we incurred a $14.9 million or $0.25 per share earnings charge which resulted in a $0.01 GAAP loss for the fourth quarter of 2008. Without the one-time tax charge, our pro forma earnings per share in fourth quarter of 2008 would have been $0.24, up from the $0.20 in the fourth quarter of 2007.

Now I’d like to make just a few quick comments on our balance sheet. For the 12 months ended January 3, 2009, total cash increased to $146.9 million from $96.7 million at December 29, 2007. During this 12-month period, we generated $78.2 million in cash from operations and approximately $28.8 million in cash from the tax benefit and cash associated with the exercise of stock options. These sources of cash were partially offset by the repayment of approximately $30.4 million in debt and $6.9 million in capital equipment purchases. Depreciation and amortization expense for the 12-month period was $5.7 million.

At January 3, 2009, our days sales outstanding had declined to approximately 40 from 44 as of the prior year period, while our inventory turns increased slightly to 3.6 from 3.5 in the same prior year period.

Now, I’ll just share just a few comments regarding our 2009 financial guidance. Clearly, providing financial guidance in today’s economic and political environment is difficult. Although the conventional wisdom has been that the medical industry and medical device industry has been relatively immune to economic downturns, it is apparent that our customers are facing a growing level of uncertainty including their ability to obtain the necessary access to capital, the lower overall hospital census for pain patients data, and the impact of lower overall census on hospital budgets. Additionally, recent budget proposal and health care reform discussions have created additional levels of uncertainly regarding hospital spending, Medicare reimbursement rates, and other related issues.

The majority of Masimo’s direct US business model is based on long term sensor agreements that do not require upfront capital commitments. As a result, a large part of our US business has not and continues to not be restricted by our customer’s ability to fund capital purchases. However, our OEM customers are impacted by the capital purchase, and there are portions of our US business including the sale of Pulse Co-Oximetry including carbon monoxide and the soon to be released Total Hemoglobin that are tied to a capital sales model. To the extent that the current economic uncertainty and budgetary reductions cause our potential customers to delay and/or cancel new capital equipments, our ability to generate revenues could be impacted.

Also, while our long term sensor agreements provide for minimum annual sensor purchases, if hospital census levels fall, that would over the short term impact the volume of sensors being purchased by our customers, and as a result impact our ability to generate consumable revenues. Despite this very challenging economic environment, we intend to move forward with our 2009 launch of Total Hemoglobin, and towards the end of 2009, our limited market release of acoustic respiration monitoring or ARM. Both of these products, as well as all existing Rainbow parameters do require our customers to purchase a one-time license fee as well as more complex and therefore higher cost sensors. While we are encouraged by the initial response we have seen for our Total Hemoglobin product, we do not know what impact the economic environment including lower budgeting levels will have on our ability to generate additional Rainbow revenues including Total Hemoglobin.

While these risks are present, we also recognize that pulse oximetry which continues to constitute the bulk of our business is a standard of care in all critical care settings, and as a result, we believe that demand for pulse oximetry technology is likely to continue. Given these macroeconomics, Masimo’s business model one typically referred to as the razor-razor blade model does allow us as a result of our long term sensor agreements to forecast a large percentage of our future revenues. In addition, our strong fourth quarter driver placements coupled with the 567,000 drivers now in place throughout the world provide us with a reasonable level of confidence to provide the following forecast for 2009. However, these are only projections, and our actual performance could be different.

Masimo expects that 2009 total product revenues will be between $310 million and $315 million. Masimo also expects that total Rainbow revenues including revenues from the 2009 commercial launch of Total Hemoglobin will range between $23 million and $25 million, or 7.5% to 8% of total product revenues, which is up from 5.2% in 2008 and 3.7% in 2007. Masimo also expects 2009 royalty revenues to be between $42 million to $46 million, down from over $48 million in 2008. This reduction is expected to be due primarily to the assumption that Covidien’s total US pulse oximetry revenues will decline in 2009 versus 2008 as a result of both the impact of the economic environment as well as Masimo’s continued market share expansion.

As a result of these ranges, Masimo expects total 2009 revenues to be between $352 million and $361 million. For the full year of 2009, we believe that our consolidated gross margins will be approximately 66%. We believe this improvement from our 65.4% in 2008 will be due to a higher level of sensor revenues versus total product revenues, increased sales of rainbow products, and the benefits from our continued transition of manufacturing activity from Irvine, California, to Mexicali, Mexido.

For the full year of 2009, Masimo expects its total operating expenses to be in the range of $172 million to $176 million, compared to $146.3 million in 2008. This increase is expected to be due to the anticipated expansion in our US sales force including the creation of a new sales force targeted at the physician’s office as well as growth in engineering, marketing, and administration. Internationally, as part of our new business realignment, we plan to continue to expand our sales, marketing, and other support organizations necessary to expand our growing non-US market place. Also included in these 2009 operating expense estimates are $11.6 million in stock-based compensation compared to $7.4 million in 2008.

Given the current economic environment, low interest rates, and uncertainly over the direction of foreign exchange movements, we are projecting a $1 million figure in other income primarily from interest earned on our invested cash, and this is consistent with the $1 million in 2008. Importantly the previously guidance on revenues, gross margin, and operating expenses are all based on foreign exchange rates that we have established at the start of the year for our own internal budgeting purposes. To the extent that foreign exchange rates move dramatically, our financial results could differ.

Primarily as a result of our new international business structure, we expect our 2009 tax rate will decline to the 32% to 33% range, down from our recent historical tax rate range of 38-39%. Although we are not providing any additional financial guidance beyond 2009, we do expect that our future income taxes will remain at these levels or move lower depending upon a variety of factors including our profits or losses before taxes, changes to tax laws, and the geographic composition of our future pre-tax income.

We are projecting a weighted shares outstanding figure of approximately 61 million to 61.5 million for the full year. As a result of all these projection, Masimo expects 2009 earnings per share to be in the range of $0.83 per share to $0.87 per share. This guidance includes the expected reduction in 2009 royalty revenues, the increased stock-based compensation expense, and our new lower tax rate. To reiterate, while we believe this guidance to be appropriate as of March 3, 2009, these are projections, and our actual performance could be different.

Thank you for your time, and I’ll turn the call back to Joe.

Joe Kiani

As a reminder, and especially for any new investor that may be on this call, I wanted to review some important messages regarding Masimo.

In the mid-90s, we revolutionized pulse oximetry with our measure-through motion and low-perfusion Masimo SET Pulse Oximetry technology. Today, Masimo SET Pulse Oximetry is helping caring clinicians save numerous lives and eyes, and Masimo SET is considered to gold standard for pulse oximetry. Our market share for new pulse oximetry sales is noticeably higher than our market share of pulse oximetry revenues. This is due to the time it takes to have the installed base of pulse oximeters catch up with the annual rate of pulse oximetry shipment. Within five years, due to the accumulation of the installed base, our revenue market share should start approaching our annual shipment percentages.

We have revolutionized noninvasive monitoring again with Rainbow, or what we call Rainbow SET. Masimo Rainbow SET allows clinicians and emergency professionals to measure carbon monoxide, methemoglobin, PVI which is a measure of slowed responsiveness, and now hemoglobin and oxygen content continuously and noninvasively for the first time. Analysts have projected that hemoglobin will be $1 billion market opportunity bringing Masimo’s long term potential market opportunity to over $3 billion. As I explained earlier, we are currently in our limited release phase for Hemoglobin. The response to it has been very encouraging, and we hope to release noninvasive Hemoglobin commercially in late March.

While we are very excited about Hemoglobin and its long term future, we can’t determine the level of demand that will occur in 2009. For example, when pulse oximetry was introduced in the early ‘80s, the growth didn’t happen overnight. You guys can look at that model, and we’d be happy to point you to it, but we do believe we will get to significant growth with it. It’s just a matter of when that will happen.

Rainbow is exciting beyond what it will do for us in terms of growth. With it, we hope to help caring clinicians save and improve the lives of even more people. With that said, I’d like to end some closing thoughts on 2008 and 2009. For 2008, the fiscal year marked Masimo’s first full year as a public company. In general, we were happy with our business and financial results, which included significantly exceeding our original 2008 product revenue and earnings per share forecasts. We continue to expand at a near 30% product revenue growth rate in a market which most suggest grew at about 6-8% rate, despite an increasingly challenging economic environment. We introduced Hemoglobin in March 2008 at the World Congress of Anesthesia Meeting, received FDA clearance for Hemoglobin in 2008, and for the family of single patient adhesive Rainbow Hemoglobin sensors, we received FDA clearance in September 2008. At that time, we initiated a successful limited market release of the product that resulted in over 20 limited market release accounts and we’re on target to deliver the product commercially in late Q1 2009. We also realigned all our international operations into a new structure designed to allow us to even better and more responsively meet the needs of our non-US customers.

As for 2009, we have good things to look to forward to. We obviously expect to shortly launch Hemoglobin commercially for the hospital market, with out hospital bedside devices. We also hope that we’ll be introducing a new Rainbow sensor system that will provide lower cost alternative to hospitals subject to regulatory clearance. Also we hope to have a portable hemoglobin device that we call Pronto for the physicians’ office. We hope to begin limited market release of this product in 2009 and be hopefully commercial in 2010.

Mark mentioned earlier acoustic respiration monitoring. We expect that product to hopefully be launched in the second half of 2009, similar to the way we launched Hemoglobin in 2008. We will continue to invest in our worldwide sales expansion. We hope that by the end of the year we will have 200 sales reps and continue to see an expansion of our international revenues as a percentage of total product revenues resulting from Europe, Japan, Canada, Latin America, Australia, and the rest of Asia, and continue to focus on our product quality and customer service.

From an M&A standpoint, we will be evaluating a variety of technologies that we believe may fit into our longer term product strategy, and most importantly continue the Masimo model. Our clinical contribution and business model has allowed us to build a solid business with our breakthrough measurement through motion pulse oximetry with room to grow as we bridge the gap between our new pulse oximetry shipments and the installed base which drives our sensor sales and most of our revenues.

We expect Masimo Rainbow SET Pulse Co-Oximetry to have a great impact on patient care; however, as I stated again earlier, the timing of when we will be on the steep part of the growth with the technology is hard to predict. We will continue to focus on our mission of improving patient care and reducing cost of care by noninvasive monitoring to new sites and applications regardless of market conditions, and we will run our business with a long term horizon outlook. We have a great innovation engine, and despite the current economic headwinds, we are eager to solve more of the remaining problems clinicians and care providers face.

I would now like to turn the call back to our moderator and begin to take any questions that you may have.

Question-and-Answer Session

Operator

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

Bill Quirk – Piper Jaffray

Mark, the first question is for you. The sequential decline in gross margin, I assume that was pretty much tied to the strength in the driver business, i.e., it was kind of a mix shift with some lower margin products?

Mark de Raad

Yes. That was one of the reasons. There are a couple of small minor reasons, but the change you’re talking about is 0.4%, nothing overly dramatic. Nothing worth mentioning.

Bill Quirk – Piper Jaffray

Secondly, Joe, I understand that you don’t necessarily want to commit to a hemoglobin number for ’09. I want to push on this one a little bit. Can you help us think a little bit about that in the context of the guidance? Obviously you guys assumed something when you put the numbers together.

Joe Kiani

Yes, we did, and I think as we looked at it, we just didn’t look at what the appetite we thought was for our product by the number of clinicians and customers who had contacted us, but rather we also looked at the historical growth for pulse oximetry when it was introduced, and when we looked at that, we basically saw that within about 5 years, pulse oximetry came from of course nonexistence to about $100 million in revenues. So, it’s difficult for us to tell you what we’re going to do this year. Obviously things are different. The economic is different. The whole environment of how products get paid for is different. Masimo is not a brand new company like many of those companies were when they were introducing pulse oximetry, so we do have a good reputation and a team that can on a positive take it forward hopefully in a fast way, but we feel comfortable giving you our Rainbow revenue numbers, but given the newness of the product, we’re just not prepared to give you a number for Hemoglobin by itself.

Bill Quirk – Piper Jaffray

Given how guys have decided to price the product, i.e., close to about $100 a sensor and then obviously the license fee, have you guys given any thought to changing that strategy at all? For example, taking away the license fee for a big order or that type of thing?

Mark de Raad

We are flexible in that as long as overall price of the sensors or the price of the equipment is amortized in one or the other, we can look at that. So far, we’re dealing with early adopters, so it’s hard to make grand statements about what it will mean to others. So far, we haven’t seen pricing as a major issue towards our success with Hemoglobin, but one of the things I mentioned, we also hope in 2009 to introduce this new sensor system. We coined it ‘risposable’ which is the combination of reusable element and a disposable element that reduces the cost of goods for the disposable element, so we’re looking to introduce that, and we hope to have that be roughly about half the price of the single sensor disposable model. When we did our market survey, we had noticed based on the survey, assuming the survey was correct, that a good percentage, I think 30% or 40% of our customers that we surveyed felt that $100 price on the sensors was enough of a price for them to jump forward given the cost savings and the care improvements that they expected, but I think the number jumped up to 60% or 70% when the price fell below $60, so we hope with the introduction of this new risposable sensor system we’re coming out with, we’ll also be able to reach a broader audience.

Bill Quirk – Piper Jaffray

Joe, timing on some ARM data or rather second generation ARM data?

Joe Kiani

The timing of that data in terms of clinical results I would guess the earliest would be January 2010, short of some of the other maybe international forums, so that’s what I’m expecting right now.

Operator

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

Tao Levy – Deutsche Bank

You mentioned at the end of the quarter you had 23 hemoglobin customers. Can you give us a sense of how many monitors were at those customers?

Joe Kiani

I think probably 60 to 70, I would say.

Tao Levy – Deutsche Bank

On average 2 to 3 then?

Joe Kiani

Yes. Roughly.

Tao Levy – Deutsche Bank

You talked about the timing of ARM being similar to hemoglobin. Is that going to be 510K, I assume, and when do you expect to file that?

Joe Kiani

Yes. We expect it to be a 510K. Before we actually acquired the technology from Andromed, they had 510K clearance already on it, so we expect to be doing an update of 510K, and we hope to have something submitted, I guess, towards the middle of the year.

Tao Levy – Deutsche Bank

As I look at your basic and your SET business, again we are still seeing amount of revenues generated per socket going up. What’s driving that, and should we just extrapolate what you did here in the fourth quarter going forward or is there a reason why that might move down in 2009?

Joe Kiani

That’s a good question, Tao. In Q4, we started hearing that census had dropped, and therefore we had anticipated that maybe sensor per driver would potentially drop, but we did not see that happening. Again, our best estimate is that potentially two things happened. First of all, outpatient type of surgeries dropped which normally don’t use disposable probe and maybe paying patient census dropped, which unless things really got bad, it should not affect our business because pulse oximetry is a standard of care in every surgery, every ICU, every recovery room. I don’t have a better crystal ball than you do, but I would just think that things should be where they have been. I wouldn’t expect a big change.

Tao Levy – Deutsche Bank

Joe, you mentioned briefly on M&A. What are you thinking there? Are you thinking that you could easily plug in, say it’s a monitor out there? You obviously have a bunch of cash on the balance sheet.

Joe Kiani

We are mostly at this stage of our company interested in new technology that we think is a good fit for our mission, so if we think there’s an opportunity for us to bring some of those technologies in, that wouldn’t be companies that have necessarily revenues, although it could but would allow us to maybe continue to improve our product pipeline over the next several years.

Operator

Your next question comes from the line of Sara Michelmore with Cowan & Company.

Sara Michelmore – Cowan & Company

Back on hemoglobin Joe, I think you used the word hope to release in late March. I’m just wondering what exactly are the gating factors here in terms of when you’d be able to do a commercial release and assuming that it’s just a couple of weeks away in terms of what your target is?

Joe Kiani

I think the hope has come to my language recently because of the new Obama administration, but we are expecting to launch end of this quarter, and short of something that I can’t foresee right now, all looks good.

Sara Michelmore – Cowan & Company

In terms of the limited release customers, what have you learned in terms of how they are evaluating the product? What has their process been, how are they looking at cost savings, potential and clinical improvement potential in terms of how they would incorporate that product?

Joe Kiani

We are seeing customers use it mostly in the operating room, some in the ICU, trying to better administer blood transfusions and basically avert occult bleeding or hemorrhage that’s not seen.

Sara Michelmore – Cowan & Company

In terms of this international commercial change that you are making or expansion you are planning on, are there particular geographic areas that you are focused on there and does it impact at all some of the markets that you currently go through distributors?

Joe Kiani

We are planning to go direct in a few additional countries this year, but mostly it’s increasing our presence in the countries that we are already direct in. We hope that by the end of the year we will have reached critical mass in every country that we are direct in, including the US.

Sara Michelmore – Cowan & Company

Lastly, could you give us an update on the business in Japan, Joe?

Joe Kiani

The business in Japan under the leadership of Jon Coleman is going very well. It’s grown to what we had expected, maybe even better. I don’t think we’ve done a breakout for Japan, but it’s grown. I think Mark had mentioned international grew this year by 50%. Certainly, Japan contributed to that and was head of that pack.

Operator

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

Matthew Dodds – Citigroup

Joe, first on the sensor contracts, I know a lot of it is razor blade focused. Can you just state broadly if that is different in the US versus OUS, are there actually some capital sales for you OUS? Two, how does your model compare with Covidien and some of the other players? Do you have a higher percentage of long-term disposable contracts?

Joe Kiani

First of all, OUS does far less adhesive sensor sales than in the US, both in total and percentage. Our market share we believe is the same. It’s not even potentially higher OUS, but certainly they are sensor revenues or the revenues wouldn’t make you think that due to the lesser purchases of sensor, and had it not been for Rainbow the fact that we can sell hemoglobin and CO and met and PVI at a good margin and what we believe will be a healthy revenue stream, we may have not even gone direct in many of those countries. The other piece that I just want to say before I answer this second part of your question is that the Hemoglobin does allow us to maybe turn some of the international markets into the disposable or risposable sensor customers in that it’s much more sensitive to sensor placement and therefore really makes a reusable sensor not practical in the long-term care settings like OR and ICU, so over time we hope that international will grow more in line to other medical companies rather than what pulse oximetry companies do in general. What was the second question?

Matthew Dodds – Citigroup

How are you different in your percentage of long-term contracts versus Covidien or some of the smaller players? Would this have an advantage for you given what’s going on with the economy?

Joe Kiani

I’m not sure I understand that question.

Matthew Dodds – Citigroup

Covidien, are they mostly razor blade contracts as well in the US or the OUS when you compete with them?

Joe Kiani

Of course, I don’t know. If I was going to give you a guess for that answer I would say we have a larger percentage of our sensor business under contract than they do.

Matthew Dodds – Citigroup

One last question for either you Joe or Mark. The physician office expansion, of the 200 sales reps you talked about for Hemoglobin in general, is there some rough idea on what that physician group could be?

Joe Kiani

Well, that doesn’t really include the physician office sales reps. With it, we could be up to 220 by the end of the year.

Operator

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

Joanne Wuensch – BMO Capital Markets

That 200 number, what does that compare to at the end of 2008?

Joe Kiani

Joanne, that was about 135, I believe, 138 maybe.

Joanne Wuensch – BMO Capital Markets

And did you give of your Rainbow SET revenue guidance number, how much of that you think is Hemoglobin?

Joe Kiani

No. We did not.

Joanne Wuensch – BMO Capital Markets

Can you give that or give us an idea of a range?

Joe Kiani

Not now, maybe in the future we will. We are comfortable breaking down our business between Masimo SET Pulse Oximetry and Rainbow, but we are not yet ready to talk about Hemoglobin, CO, MET, PVI independently.

Joanne Wuensch – BMO Capital Markets

Since you’ve had a couple of Obama commentaries, I need to ask the question is there anything in the budget that you saw that you think may be impactful to your business?

Joe Kiani

Well, I’m entrepreneur, so I will give you that disclosure. I’m optimistic that his plan will actually help release capital spending for our OEM partners and maybe also for ourselves in areas like Hemoglobin. There’s a package that’s going to be an investment in healthcare infrastructure. I think that’s going to free up other dollars that would have been spent there that may come towards our way indirectly, plus I like the fact that the Obama campaign is pushing for quality because we believe that our customers are getting higher quality of care, better patient outcomes with our technology, and therefore there will be more impetus to do best practices across different hospitals in the country.

Joanne Wuensch – BMO Capital Markets

When you talk about international expansion, what does that entail in terms of cost to build it?

Mark De Raad

In general, Joanne, there really isn’t anything truly incremental to the numbers that we’ve already provided. As you know over the last couple of years, Masimo has invested heavily in our international expansion, and I think this is just sort of a reaffirmation of that just under a different structure, as I said before, primarily to allow our management team to consolidate all of their international sales activity under one structure, and everything from a spending standpoint that will be required to achieve that is in the numbers that we talked about earlier.

Operator

(Operator Instructions). Your next question comes from the line of Spencer Nam with Summer Street Research.

Spencer Nam – Summer Street Research

I just wanted to get a better sense of how your conservations with hospitals are going on in terms of both your pulse ox products and also the hemoglobin tests. How are these hospitals with the budget crunch responding to the hemoglobin tests and potential of ramping that up, and also in terms of your discussions with pulse ox, clearly so far things have been very smooth in terms of demand flow, but are you seeing maybe the sales cycle increasing a little bit or hospitals thinking a little bit more about as they prepare to upgrade their pulse ox for the coming years?

Joe Kiani

Yes. Let me try to answer that Spencer. First of all, in the US, we are seeing nervous customers. They are of course worried about anything that has to do with capital spending, and therefore even when they’re looking at our contracts where we place the capital for free in return for sensor contracts, they want to make sure it doesn’t look like capital item in their numbers because I think it changes their standing about future capital spending and access to capital. I think some of those things we have to be sensitive about. We do have some customers that, just like at one point maybe investors were doing their irrational exuberance, now customers have potentially irrational fear of any change, so yes, we are seeing some of that, but I think the good news I can give you when it comes to pulse oximetry at least is that given that the model that we have is all positive for them, rationality does come back as you can see from the numbers we have been producing, and the model is such that they get a much better product that potentially can help reduce eye damage with neonates, improve patient care, capture patients that could be in trouble they can avoid which actually increases cost as well. But they do that without having to pay more than what they were paying before, so in fact in more circumstances they end up paying less operational budget-wise because they are paying nothing for the capital equipment but less operational budget wise than before, and then when you include in that the performance of our product had been shown to minimize invasive procedures such as blood draw, increased time on ventilation, and even reduction in senor usage, in general, this is no more challenging business for us than it was a year ago or two years ago.

Now on Rainbow, on Hemoglobin, that is new territory for us. Although we could change our model and not sell the parameter and sell sensors like before, even if we did that, the customer is still seeing a new product, but they have to get comfortable with the fact that our product is going to help offset invasive tests that we’re doing before, blood transfusions that are not necessary that also has not just cost implications but care implication, and get themselves comfortable to those kinds of purchases. The good news is we never projected that we were going to get hospital wide conversions to Rainbow like we do with pulse oximetry. Instead the projection is that the ORs will buy a handful first and try it. ICUs will buy a handful and try it. Similar to the way pulse oximetry was introduced to US hospitals and abroad, so we think that smaller rate of purchase done broadly over many hospitals is going to be key to over time the clinicians and hospitals seeing the true value of what noninvasive hemoglobin measurement, methemoglobin measurement, PVI and CO will do for them, so I’m sorry for the long answer, but I just want to get you at least the picture that we see since I can’t give you an easy answer.

Operator

Your next question comes from the line of Bill Quirk with Piper Jaffary.

Bill Quirk – Piper Jaffary

Mark, I know you mentioned, at least I think you mentioned, there was an incremental contribution in the fourth quarter from Hemoglobin. Did you disclose the specific number there or maybe I just misheard you?

Mark De Raad

No. I did not disclose the Total Hemoglobin.

Bill Quirk – Piper Jaffary

So there was a contribution, you didn’t disclose it. Okay.

Operator

At this time, there are no questions. I’ll now turn the call over to Joe Kiani for closing remarks.

Joe Kiani

Thank you so much all for joining us this afternoon. We look forward to our next call, and hope that we can continue delivering on what we have promised you.

Operator

This concludes today’s Masimo Corporation’s fourth quarter and full year 2008 earnings conference call. You may now disconnect.

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