Eli Kammerman - Masimo Corp. Joe E. Kiani - Masimo Corp. Mark P. de Raad - Masimo Corp..

Tao L. Levy - Wedbush Securities, Inc. Lawrence Keusch - Raymond James & Associates, Inc. William R. Quirk - Piper Jaffray & Co. Brian David Weinstein - William Blair & Co. LLC Christopher William Lewis - ROTH Capital Partners LLC.

Good afternoon, ladies and gentlemen, and welcome to Masimo's 2016 Year-End Earnings Conference Call. The company's press release is available at www.masimo.com. At this time, all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

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

Thank you. 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, including certain of our expectations regarding fiscal 2017 financial performance.

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 good afternoon and thank you for joining us for Masimo's 2016 fourth quarter and full-year earnings call. We are happy to report another strong quarter with top-line revenues in excess of our expectation and operating income at a new record level. As seen throughout 2016, we again experienced strong U.S.

product revenue growth due to a combination of higher utilization, new customers and incremental revenues from our new product such as Nomoline capnography, O3 regional oximetry, SedLine Brain Function Monitoring, and Root patient monitoring and connectivity hub.

We attribute our strong quarterly and full-year performance to our technologically-advanced product portfolio and its proven value to improve patient outcomes and reduce costs, as well as the exceptional abilities of the Masimo team. Our Q4 product revenues grew to $175.7 million, a 10% increase.

In fact, we achieved double-digit product revenue growth in each quarter in 2016, resulting in full-year product revenue growth of almost 11% to nearly $664 million. We shipped 48,600 oximeters in Q4, a new quarterly record, producing total shipments for 2016 of 186,000 oximeters, excluding our handheld and finger pulse oximeters.

In fact, our Q4 driver shipments allowed us to reach an important milestone as we now estimate our total global installed base to be just over 1.5 million oximeters, further illustrating the value of our SET and rainbow technologies to our customers.

Our Q4 2006 (sic) [2016] GAAP earnings per diluted share were $3.97, which includes $3.37 in net benefits related to some special items, which Mark will discuss in more detail in a moment. Excluding those items, our adjusted Q4 GAAP earnings were $0.60, including $0.09 from the new stock option accounting rule.

For the year, our GAAP earnings per diluted share were $5.65, which includes $3.43 in net benefits related to the same special items. Excluding those items, our adjusted year-to-date GAAP earnings were $2.22, including $0.24 from the new stock option accounting rule.

Earnings per share, excluding the new stock option gain accounting rule, was $1.98, a 33% increase from the prior year adjusted earnings of $1.49 per share. These results, we believe, continue to demonstrate effective execution on our 10-year plan. The other major event in the fourth quarter was the announcement of our partnership with Philips.

While I will speak to this in more detail later, this agreement will provide both companies with an ability to help clinicians keep their patients safer as we expand the reach of Masimo rainbow, SedLine, Nomoline and O3 to more hospitals around the world.

As a reminder, fiscal 2017 represents the final year of our 10-year post-IPO plan and we are confident that the momentum we have built will allow us to finish this 10-year plan strongly. Given that this is the last year of our prior plan, it is time for us to begin discussing our next long-term plan.

And to that end, I'm happy to let you know that we will be hosting an Investor Day on May 9, 2017 at our corporate headquarters in Irvine, California. We hope that you'll be able to join us for what should be an exciting and informative event as we discuss the key drivers with our new five-year plan.

Today, of course, our focus is on providing you with additional information on our fourth quarter 2016 financial results and then to share with you our new fiscal year 2017 financial guidance. To that end, I will ask Mark to review both items with you.

And afterwards, I will provide you with some more detail on both, our 2016 accomplishments and some expectations for 2017.

Mark?.

Thank you, Joe, and good afternoon, everybody. Our Q4 product revenues rose to $175.7 million, up 10% or 9.6% on a constant currency basis versus the $159.8 million posted for the fourth quarter of 2016. The strength was the result of all of the factors that Joe just previously mentioned.

The year-over-year impact of the foreign exchange rates was relatively small, adding approximately $0.5 million to total revenues in the quarter.

Q4 total revenues, which include royalty revenues, were $183.2 million, up 9.5% from $167.3 million in the prior-year period, rainbow product revenues for Q4 totaled $16.9 million, down by 11.6% from $19.1 million in the prior-year period.

The decline in rainbow sales was related entirely to a decline of $2.7 million in rainbow revenues from a large customer in Saudi Arabia due to the country's current economic difficulties. Adjusting for the impact of this customer, our year-over-year rainbow revenues would have been up by 3%.

Encouragingly, again excluding the impact of this customer, our single-use rainbow adhesive sensor revenues and unit volumes were both up approximately 23%. Our Q4 SpHb revenues were $4.3 million, down by 30% from $6.1 million in the prior-year period, with $2.4 million of this decline due to the same large Saudi Arabia customer.

Importantly, if we exclude the impact of this large customer, our total Q4 2016 SpHb single-patient-use sensor sales were up 51%. For the entire year, our total SpHb revenues rose 13% to a record of nearly $20 million accounting for 30% of total fiscal year 2016 rainbow revenues.

Our worldwide end-user or direct business, which includes sales through just-in-time distributors grew 10.8% in the fourth quarter to $152.8 million versus $137.9 million in the year-ago period. Our direct business represented approximately 87% of total product revenue in the quarter versus 86% in the prior-year period.

OEM sales comprised the remaining 13% and rose by 4.8% versus the prior-year period to $22.9 million. By geography, total U.S. product revenue increased by 13% to $120.5 million compared to $106.7 million in the same prior-year quarter. Our Q4 O-U.S.

product revenues of $55.2 million rose by 3.9% versus $53.1 million in the same prior-year period and were up 3% on a constant currency basis. Excluding our business related to the one large customer in Saudi Arabia, our O-U.S. business in Q4 grew by approximately 12% or 11% on an FX-adjusted basis compared to the same year-ago period. Q4 O-U.S.

revenues represented approximately 31% of total Q4 product revenues. Our fourth quarter 2016 GAAP product gross profit margin was 66.5%. Our Q4 product margins were stronger than we expected due to a favorable product mix, continued benefits from our value engineering efforts, and favorable foreign exchange rates.

Importantly, if you compare to the prior year Q4 gross profit margin of 63.6%, adjusted for both the impact of a Q4 2015 inventory adjustment and the deconsolidation of our VIE, variable interest entity, we had a near 290 bps point year-over-year improvement in product gross profit margins.

Of this amount, nearly 60 bps was due to foreign exchange rates, but the remaining 230 bps improvement was due to the combination of the factors that I just noted.

Reported fourth quarter 2016 total operating expenses included a $270 million benefit from the Philips agreement as well as a $5 million donation to the Masimo Foundation, and therefore, resulted in our operating expenses being reported as a credit of $186.1 million.

Without the Philips payment and the donation, adjusted operating expenses were $78.9 million, which was up 3.4% versus an adjusted $76.3 million in the prior-year quarter. This lower-than-expected spending level was due primarily to lower than previously-forecasted legal expenses.

We believe that these modest increases in operating expenses continue to demonstrate our commitment to controlling the absolute level of total operating expenses. I also wanted to take a moment to point out that although we did receive a $300 million payment from Philips, we recognized only $270 million in the Q4 profit and loss statement.

The remaining $30 million will be recognized in the future as non-recurring engineering revenue, as Masimo continues to deliver on its remaining product integration milestones related to our settlement agreement with Philips. SG&A expenses were $69.4 million, including the $5 million charitable contribution donation that I previously mentioned.

Without that donation, our SG&A expenses would have been $64.4 million, which was up a very modest 1.3% versus an adjusted $63.6 million for the prior-year period, again in line with our efforts to control expense growth.

R&D spending of $14.5 million increased by 14.2% versus the year-ago period due to the higher engineering project-related expenditures.

And as Joe previously noted, I'm very pleased to again highlight that the combination of our strong Q4 product revenue performance are stronger-than-expected Q4 gross profit margin results and our continued operating and expense control, all combined to allow Masimo to report our highest-ever operating income at 24.8%.

Non-operating expense in Q4 2016 was $2.9 million compared to non-operating expense of $1.9 million in the prior-year period. During the fourth quarter, due to the significant movement in the U.S. dollar versus the yen, euro and other currencies, we recorded an unrealized $2.5 million re-measurement loss in Q4.

While this re-measurement loss was partially offset by favorable FX impacts on our revenues, cost of sales, and operating expenses, the net foreign exchange loss was still approximately $1.2 million and reduced our Q4 earnings per share by $0.02.

Also impacting this line item with the lower interest expense related to our decision to use part of the proceeds from the settlement payment to repay our entire outstanding line of credit in the quarter. Our fourth quarter 2016 tax rate was 30%, up from 28.4% in the same period last year.

There are a number of impact – items impacting this quarterly rate that are worth noting. First, due to the stronger-than-expected U.S. business growth that is relative to our O-U.S. business, our prior estimated annual effective tax rate of 30.3% had to be increased to 31.5% by the end of the year.

Consequently, we were forced to record a Q4 catch-up tax provision adjustment, which caused our final Q4 effective tax rate to be 35.6%.

This year-to-date related catch-up adjustment effectively reduced our Q4 earnings per share by $0.04 In addition, the combined effective tax rate applied against the Q4 $270 million and the $5 million charitable contribution donation was 31.1%.

And finally, we were also able to reduce our Q4 tax expense by $5.2 million or $0.09 per share, which when combined with the other items that I just noted resulted in our final Q4 tax rate of 30%.

Our average shares outstanding for Q4 rose to 54.2 million, an increase of 2.5% from the 52.9 million shares in the year-ago period and up from 53.6 million in Q3 2016.

The sequential increase in our weighted share count was due to the exercise of stock options and the dilutive impact that a higher stock price has on the value of stock options outstanding. Fourth quarter GAAP net income was $215.3 million or $3.97 per diluted share.

Of this amount, $3.43 per diluted share was related to the benefit from the Philips settlement and $0.09 per diluted share came from the discrete Q4 2016 accounting stock option gain-related item. This was partially offset by an expense of $0.06 per diluted share from the charitable donation.

Adjusting for these three items, our adjusted earnings per share would have been $0.51, a 27.5% increase compared to the adjusted earnings per share of $0.40 in Q4 2015. Fiscal 2016 GAAP net income was $300.7 million or $5.65 per diluted share.

I wanted to be sure to point out that the full-year EPS benefit of the settlement payment of $3.49 is different from the quarterly benefit of $3.43 due to the different weighted average shares in the year versus the quarter. In addition, like in the fourth quarter, the full-year EPS results included the $0.06 charge for the charitable donation.

Finally, the full-year results also include a benefit of $0.24 per diluted share from the new stock option gain accounting rule. Adjusting for these three items, our fiscal year 2016 earnings per share would have been $1.98, which is a 32.9% increase compared to the adjusted earnings per share of $1.49 for 2015.

As of December 31, 2016 our day sales outstanding was 53 compared to 54 at the end of October and compared to 46 at the end of January 2, 2016. Inventory turns were 3.3 times compared to the October level of 3.4 times and the prior year-end level of 4.2 times.

Total cash and cash equivalents as of December 31, 2016 were $306 million compared to $132.3 million as of January 2, 2016. During 2016, excluding the $300 million settlement payment, we generated approximately $117 million in cash from operations and received $37.3 million from the exercise of stock options.

During fiscal 2016, we repurchased a total of 1.4 million shares at a cost of $63.4 million. Now, I'd like to discuss our fiscal 2017 financial guidance, which is based on the best information we have available to us.

And having said that, the business and overall economic uncertainties surrounding the future of the Affordable Care Act as well as the administration discussions about potential U.S. tax reform, including possible border tax considerations, make projections at this point in time very dependent upon these unknowns.

With that caveat, we're projecting total 2017 revenues of $752 million, including $721 million in product revenues, of which – excuse me, $720 million of total revenues and $31 million in royalty revenues. Included in our product revenue projection is approximately $74 million in rainbow revenues.

As always, our product revenue expectations are based upon certain foreign exchange assumptions. For fiscal 2017, our projected product revenues are based on an assumption of the Japanese yen/U.S. dollar foreign exchange rate at approximately ¥115, the euro at $1.05, and the British pound at $1.25.

We expect our GAAP 2017 product gross profit margins to be approximately 65.7%, which reflects a 50 basis point improvement over the final fiscal year 2016 gross profit margin of 65.2%.

We expect our 2017 total operating expenses to be approximately $327 million and we expect to generate approximately $1.3 million in net interest income as compared to net interest expense in 2016. Based on our outlook for the fiscal year 2017 mix of U.S. and O-U.S.

income, including the impact of the foreign exchange rate assumptions, we expect our effective tax rate to be approximately 30.5% to 32.5%. And based on this range, we have used 31.5% in the financial guidance that we are providing today.

As you're aware, the new stock option gain accounting rule that we elected to adopt in fiscal 2016 is now required GAAP as of the first quarter of 2017. In fiscal 2016, we received a $13 million or $0.24 per share benefit from this new rule.

In today's 2017 financial guidance, we are including a $3.4 million benefit or $0.06 per diluted share, based on stock option gains we have already realized at the time of our new 2017 financial guidance. As a result of this $3.4 million benefit, we expect our first quarter 2017 effective tax rate to be approximately 23.5%.

Because we're unable to project future stock option exercise gains, our effective tax rate for the Q2 to Q4 period will remain at the 31.5% rate that I noted earlier. We're projecting our average weighted shares outstanding for the year to be between approximately 55 million and 56 million.

And based on all of these assumptions, we're now expecting that our 2017 GAAP earnings per share will be approximately $2.30. And with that, I'll turn the call back to Joe..

Thank you, Mark. Just to maybe clarify, we're projecting total 2017 revenues of $752 million, including $721 million in product revenues, of which $4 million is attributed to the non-recurring engineering revenues and $31 million in royalty revenues..

You're right (23:01). Thanks..

So, thank you so much, Mark. As I mentioned in the introduction, 2016 was a significant year for Masimo with one important achievement being the Q4 formation of the new partnership agreement with Philips that settled all prior litigation and, more importantly, created a new partnership.

We anticipate a measurable impact from this agreement that builds over the succeeding years the positive effects on the adoption of our innovative technologies and improved outcomes for patients. Including in the agreement are our rainbow products, Nomoline capnography products, O3 tissue/cerebral oximetry, and SedLine Brain Function Monitoring.

As we have noted in the past, a key factor in the adoption rate of rainbow will be availability of rainbow within the monitors of major patient monitoring company. We believe that Philips has twice the market share of the next patient monitoring company in the world.

Consequently, over the next few years, we anticipate an acceleration in growth for rainbow and a boost to the adoption rate of our other technologies. Having Philips as a truly cooperative business partner in this effort is exceptionally valuable, and we believe we should have a constructive working relationship with Philips moving forward.

This agreement is part of the reason why we elected to increase our estimated product revenue growth rate in 2017, as Mark just noted. Over the coming years, we expect Philips agreement to continue to result in increased deployment of our technologies all over the world.

With increasing acknowledgment of the clinical value of our measurements, we are making significant inroads. We are happy to report that another major U.S. hospital group recently has decided to upgrade to Masimo SET pulse oximetry. We expect to be able to disclose more information on this new customer in the near future.

2016 was a great year for major hospital organizations converting to Masimo SET, including Cedars-Sinai Hospital in Los Angeles, Stanford Health Care in Palo Alto, and Walter Reed Army Hospital in Washington DC.

Our ability to convert hospitals to Masimo SET extended around the world, and 2016 was a year of substantial growth for the company in many international regions. Our global strength was evidenced in Q4 with growth of 20% to 40% in many outside the U.S.

regions, for fiscal 2016, total international sales for Masimo rose by nearly 12% with very strong growth in both Latin America and Asia. Additional evidence of our market strength is seen in the fact that we are realizing higher utilization across our installed base with a growing number of customers adopting our new rainbow technology and sensors.

Other Masimo technologies are now gaining traction with clinicians, based upon their innovative and unique capabilities.

Our ability to innovate has led to the introduction of many new products over the past 12 months such as MightySat, Root with vital signs, O3 organ oximetry or regional oximetry, second-generation SedLine Brain Function Monitoring, second-generation SpHb, ORI and Rad-97.

Our new Rad-97 monitor has received a CE Mark and is well positioned for success as a compact and highly versatile choice for the outpatient setting and for deployment in developing regions of the world. The Rad-97 has a smaller form factor than our established Radical-7 monitor.

In addition to a rotatable screen, this monitor also has extensive communication abilities, including Wi-Fi, Bluetooth, nurse call interface, Ethernet, and optional built-in camera for telemedicine and tele-presence with Patient SafetyNet. The Rad-97 should allow more patients to have access to our life-saving technologies.

As we extend continuous monitoring to the general floor setting, our Root with vital signs monitor is an important component of the strategy.

Root with vital signs enables clinicians to capture blood pressure, temperature, oxygen saturation and pulse rate with a single monitor unit that is also upgradable to incorporate rainbow and other Masimo measurements.

Further, we have now entered into multiple collaborative agreements with third-party for some novel measurements that can be plugged into Root. We expect to see market introductions of at least two of these technologies within the next six months.

Another important new product in the early stages of adoption is our O3 organ oximetry, tissue and cerebral oximetry monitor. This measurement is unique in that it can be hosted on an existing Root monitor and is responsive to changes in cerebral oxygen saturation.

O3 sensor is usable with Root and further extends the utility of the device for monitoring patients during surgery or in the critical care setting.

Early adoption of O3 has been encouraging, and this product is helping to drive sales of Root, which can be used to incorporate other Masimo monitors such as Nomoline capnography or SedLine Brain Function Monitoring, and take advantage of its connectivity hub to connect legacy devices in every room to the EMR and make the data flow and more useful.

Our SedLine Brain Function Monitor was upgraded significantly last year to Version 2.0 and is being sold outside the U.S. SedLine 2.0 includes advanced capabilities for filtering out motion artifact using methods similar to our SET technology and with the ability to work on geriatric patients.

As with O3, SedLine works with Root, which can be useful in the OR as well as other settings.

Finally, our newest measurement, Oxygen Reserve Index, or ORI, is a relative index that correlate with changes to PaO2 for patients on supplemental oxygen and can provide an early warning for imminent desaturations, which can be very valuable in many situations including the anesthesiologists performing intubation and extubation procedures.

All of these newer products have significant growth potential as clinicians become more familiar with their benefits for improving patient outcomes.

The specific example of Masimo technology improving outcomes has been seen in the results of the recent large 18,000 patients study at University Hospital Center of Limoges, France, involving the entire hospital, which investigated the value of a combination of PVI and SpHb monitoring for improving mortality.

For this study, Masimo Radical-7 rainbow SET Pulse Co-Oximeters were installed in all operating rooms, recovery rooms and intensive care units. In addition, the Radical-7s were connected to Masimo Patient SafetyNet for trend data collection.

The study showed results of a 30% and 25% mortality reduction at 30 days and 90 days after surgery, respectively, for the group that had SpHb and PVI monitored.

The researchers concluded that monitoring SpHb and PVI integrated in a vascular filling algorithm allowed earlier transfusion and reduces mortality at a scale of a whole hospital with different clinical practices and unselected patients.

If these results can be repeated at other institutions, it should create a standard-of-care argument for SpHb and PVI. Regarding our outlook, now that we are on the final stretch of our 10-year plan, we are rolling out a new five-year business plan, which as I noted earlier we will share at our upcoming Investor Day here in Irvine on May 9.

The day will also include a product fair and demonstrations of our advanced technologies. In closing, our 2016 financial results exceeded our projections and have provided us with confidence as we entered 2017. We're excited about our new five-year plan and look forward to sharing it with you all in May.

We're excited about fulfilling our mission to improving patient outcomes, and reduce the cost of care with our breakthrough noninvasive monitoring technologies. We hope to see you in Irvine in May. With that, we'll open the call to questions.

Operator?.

Thank you. Our first question comes from Tao Levy with Wedbush Securities. Your line is now open..

Thanks. Good afternoon, everyone..

Good afternoon..

Hi, Tao..

Hi. So maybe we could touch on the guidance on the revenue side.

What are you assuming in there regarding sort of rainbow sales? And also how should we think about how the agreement with Philips rolls out? How much of that agreement you feel like is contained within your 2017 guidance? And the question is kind of related to, if it's just a little bit, are we going to see potentially more of a benefit from that agreement in 2018 and following years?.

Yes. Sure. First of all, we're projecting about a 10% increase in our rainbow revenues. And as for Philips, while we delivered better than 10% growth in 2016, you may recall we had projected 6% to 7% increase in our revenues in 2016.

So because of Philips, we actually increased our projections in 2017 where we're now projecting an 8% increase in revenues. So, we increased our revenue projections by 1%. We hope to beat that, but conservatively these are numbers we feel good about.

And I think, Tao, as far as your final question, the Philips agreement should hopefully accelerate as the years continue, because of not only roll out of new products with the technology, but also roll out of other technologies.

So, while Philips has rainbow now in their high-end monitor and one of their low-end monitors, rainbow is going into many other products. And then with a strong partnership, we expect further penetration into market than we've had historically with them.

And yet, we have a new opportunity too with Philips integrating SedLine Brain Function Monitoring, O3 regional oximeter and the Nomoline capnography technology. So, we think hopefully we can increase the pace and the growth rate over the next few years..

Perfect. Great. Thanks a lot..

Thanks, Tao..

Our next question comes from Larry Keusch with Raymond James. Your line is now open..

Great. Thank you. Good afternoon, everyone..

Hi, Larry..

Hi, Larry..

Hey. So, Mark, I want to touch on product gross margin. And I think if I caught this correctly, you said you're looking forward to increase 50 basis points in 2017.

Could you just help me? So, A, is that correct? And then B, can you just help me bridge if you were to take out the FX benefit from product gross margin in 2016, what the actual underlying gross margin expansion is that you are looking for? So, that's question one. And then, question two, DSOs, you did 54 days in the third quarter.

I think you said you did 53 this quarter. I know in the 2Q, it was down around 47, so still a little bit elevated from where we were kind of at the midpoint of the year.

So again, if you could provide any color as to where you think that can go and why it is elevated?.

Sure, Larry. Let me take the first one first, on gross profit margins. As I said earlier, we ended up – even though the fourth quarter was obviously a very, very strong 66.5%, the full-year number was 62.5%. And if you look at that full-year number of 62.5%, approximately 40 bps of – was included relative to favorable FX rates.

So, if you exclude that, you walk back down to about 64.8% versus the 65.5% guidance that we talked – sorry 65.7% guidance that we provided today. So excluding FX, we're actually looking for about a 90 bp increase year-over-year..

Okay. Perfect..

And then on the days sales outstanding question, yes, if you remember, the last couple of quarters we've highlighted the increase, essentially, from the high 40s to the low 50s was as a result of the large customer in Saudi Arabia that we alluded to in the prepared remarks today. And so, we constantly are monitoring that situation.

The good news is the days have not increased at all, and we're certainly hopeful that things will come to some positive outcome in the next couple of months or quarters in that part of the region of the world, so that we will get repaid on some of the receivables that we have outstanding.

Our situation, obviously, is no different than the rest of the world. And we're still very, very confident that ultimately things will get resolved there and that ultimately we will receive payment on those receivables. It's somewhat analogous to four, five years ago, we had the same situation with the countries of Southern Europe.

If you remember, they were going through some very difficult times. They ultimately told us they weren't sure when they were going to pay us, but they would pay us, and sure enough, two to three years later we ended up getting paid.

So, we don't know when that payment will come relative to the Saudi customer, but we're hopeful that we'll see something soon..

Okay. Perfect. And if I could just sneak one last one in here quickly. Just obviously flu has been spiking up here lately.

How are you thinking about that relative to the first quarter? I believe there is a fairly easy comp versus a year ago, but just hoping that you can help calibrate us a little bit on kind of what you're building in for flu?.

Well, if you're talking about the relatively easy comp relative to the flu season, I think you might be right, because last year, there was a late flu season, where I think this year people would categorize it as more of a normal flu season. And you're also right that the data that we've seen has suggested a very strong flu season this year.

In general, as you know, Larry, that provides some anecdotal support to our numbers, plus or minus a little bit. But really our core revenue strength continues to come from the successful utilization of those 1.5 million drivers all over the world, plus the impact of new customers that Joe alluded to in his comments.

So, the flu season, again, is helpful or hurtful essentially on the fringe. It really doesn't drive the overall movement of our top-line revenues that much..

Okay. Very good. Thank you guys..

Thank you, Larry..

Our next question comes from Bill Quirk with Piper Jaffray. Your line is now open..

Great. Thanks. Good afternoon, everybody..

Hi, Bill..

Hi, Bill..

Hi. So, first question, I guess, is just picking up off of one of Larry's. So, Mark, the FX-neutral 90 basis point gross margin improvement in 2017.

I guess, should we read into that combined with your favorable mix comments that the RD sensor roll out is going at least as well as expected, perhaps better than expected?.

In essence, not really, that's the good news. We have just begun, in fact, the roll out of the RD product that we've been talking about. And we expect that product to continue, obviously, much more sizable influence on our 2017 numbers. But having said that, we're not – we're expecting a relatively modest transition in the first year.

We think that will accelerate in years two, three and four. So, certainly, there is a little bit of benefit of the RD transition in the product gross margin numbers that we just provided to you, but it's not, honestly, a huge part of that.

Most of that increase comes from the collective continuing benefits of our value engineering efforts as well as other cost reduction initiatives that we have going on around the world in that area of cost of sales delivery..

Okay. I appreciate the color. Thank you. And then on the remaining $30 million from Philips, I think Joe, I think I heard you say at the tail end of your comments that I think $4 million of that will be recognized in 2017.

So, I guess, one, could you just clarify if I heard you correctly? And then, secondly, if I did, how should we think about, I guess, the pace of the $30 million? Is it going to be fairly ratably over the next several years, or are there any boluses here that we should know about? Thanks..

Well, I think – yeah, I think, we expect the $30 billion over the next three years, and it won't be linear. Obviously, we have $4 million that we believe will come in this year and we're still looking at what it will be for 2018 and 2019, but it will be over the next three years..

Okay. Got it. Thank you..

Thank you. Thank you..

Our next question comes from Brian Weinstein with William Blair. Your line is now open..

Hey, guys. Thanks for taking the question. I apologize for any background noise here. I'm just curious about the utilization per driver this year. It looks like the installed base was up about 6% or so. And from the best we can tell, it looks like utilization was up closer to maybe 10% or so.

I'm just trying to understand the difference there, why do you think you guys are seeing an increase in utilization per driver, (44:04)? Thanks..

Sure. I believe, it's a mixture of items. One is a census increase that we saw in 2016 in the U.S. compared to 2015. The other is we think customers are recognizing the limitations of reprocessed sensors from third-parties and purchasing more of their sensors from us, and also new customers with higher consumable business orientation..

Okay. That's helpful. And then sorry to go back to something that you might have said before on a rainbow (44:51), but there are minimums in the Philips agreement, as I recall. Is that what's assumed in your guidance are the minimums? And it looks like rainbow and SpHb specifically was down sequentially.

I believe the Saudi Arabia comments were year-over-year, but not – was there anything that impacted kind of the sequential comp on rainbow? Thanks..

Yeah, Brian, I think excluding Saudi Arabia, our rainbow revenues were up and SpHb specifically was up, if you look at it from a revenue percentage about 23%; if you look at it from a sensor volume basis, about 50%..

Yeah. I was referring to sequential. I thought that they may be down sequentially, but we can go over that, I guess, offline.

But is what's assumed in the rainbow guidance for next year, does that reflect the minimum contractual royalty that you – the contractual amount that you have from Philips or is there something above that that you're assuming in your rainbow number?.

Well, we really don't have a minimum contractual obligation. This is a partnership and Philips sees the value of rainbow and they really want to get the value out to the customers.

Philips has been working diligently on informatics and algorithms that can bring all the data together to give a more holistic warning to clinicians and the rainbow parameters are essential to it, because many of the measurements are orthogonal to the other measurements they had before. So, no, we – I don't know if I answered your question.

The bottom line is we overall see about a 1% increase in our revenue year-over-year because of Philips. We think much of that actually will be rainbow related. We'll be conservative with our forecast on rainbow, given that it's not a market that's out there, it's a market that's being developed.

But we hope there's optionalities and hope we project it..

Okay. Thanks..

Thank you so much, Brian..

Our next question comes from Chris Lewis with ROTH Capital Partners. Your line is now open..

Hi, Chris.

Hey, guys. Good afternoon. Thanks for taking the questions..

Of course..

Joe, you mentioned in your prepared remarks about another large major hospital group potentially upgrading. I was wondering if you could provide any additional color on how big that opportunity may be and the expected impact we can see from that upgrades this year..

Yes. First of all, they're not the size of Kaiser, but not too far behind. Out of the respect for them, for their permission to announce their name, we didn't mention it, but hopefully very soon we will. But it's not just the sizable hospital system on the Eastern front of the United States, but one of the top-10 hospitals in the U.S.

news report, a very, very high quality of business. And 2016 was a record year for us for new hospitals as well as renewing with hospitals. And this particular system was probably about 15%, 20% of at least the new business that we contracted. So, it's quite exciting and we're hoping to announce the entity very shortly there..

Okay. Congrats on that. And then, in terms of the installed base, grew about 6% in 2016 over 2015.

As we look ahead, kind of how should we think about that, the growth rate of the installed base going forward?.

Well, we believe our installed base, hopefully, will be exceeding 200,000 units in the future due to both the partnership with Philips as well as many other OEMs around the world integrating Masimo technologies. So, I think the growth rate will hopefully sustain, if not increase.

And the only reason I say that is because we have an assumption which may not be exactly right, and that is that we retire whatever we shipped 10 years ago. So, we know a lot of our OEMs product remain in use for 15 years or more.

So as we retire the prior 10 years, and those numbers starting to look higher and higher, it makes our installed base growth seem smaller, and which may not be true, but it is what we set out to do and we don't want to change the way we measure it.

But it might end up doing, Chris, over time it may make the unitization look stronger, because maybe the installed base isn't shrinking as fast as we think historically..

Understand. And then just one more for me, given you paid down all of your debt in the quarter and you ended the year with over $300 million in cash. Can you talk about kind of cash deployment strategy, whether it's potentially getting more aggressive on the M&A front or continuing on the stock buyback plan or other avenues? Thanks..

Yes, of course. While I don't have an imminent deal, we haven't taken a deal to the board, we are, as part of our new five-year plan, looking at M&A more strongly. Despite expecting strong organic growth that we've been having and we think we'll continue, we think we're in a situation where acquisitions might be good for us.

So, to the best of my projections, I think we'll be using the cash toward acquisitions, but again nothing imminent and it's just the strategy for the next five years..

Okay. Thanks for the time..

Thank you so much. Thank you all for joining us. I wish you all a happy Valentine's Day..

Ladies and gentlemen, thank you for participating in today's conference. You may all disconnect. Everyone have a great day..