Eli Kammerman - Vice President of Business Development and Investor Relations. Joe Kiani - Chairman and CEO Mark de Raad - Executive Vice President of Finance and CFO.

Tao Levy - Wedbush Rick Wise - Stifel Larry Keusch - Raymond James.

Good afternoon, ladies and gentlemen, and welcome to Masimo's Second Quarter 2017 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. Sir, you may begin..

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 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 2017 second quarter earnings call. We are happy to report product revenues and earnings per share that once again exceeded our expectations.

We were able to achieve double-digit product revenue growth, which provides solid evidence that our technologies and systems continue to be adopted by more hospitals focussed on improving patient care and reducing costs.

Encouragingly, we are steadily gaining new customers for our core technology platforms and also beginning to see higher revenues from our newer products including Root, normal and [Indiscernible] cerebellar oximetry and SedLine brain function monitoring. Our Q2 product revenues grew to nearly $183 million an 11% increase.

We are very proud to have achieved a new milestone for our oximetry shipments which reached a record 50,000 units producing a new estimated installed base of 1,545,000 oximeters excluding handheld and finger oximeters. Our Q2 2017 GAAP earnings per diluted share were $0.83 up from $0.57 in the same prior year period.

In a moment I will review some important business updates. But for now, I’ll ask Mark to review our Q2 results in more detail and provide you with an update on our 2017 financial guidance.

Mark?.

Thank you, Joe, and good afternoon everybody. Our Q2 product revenues rose to $182.8 million which was up 11.1%, or nearly 11.8%, a difference of approximately $1.3 million on a constant currency basis, versus the $164.6 million posted for the second quarter of 2016.

The strong growth was attributable to demand for our core technologies in OUS markets as well as increased contributions from some of our new products Joe just alluded to including Root. Our Q2 OUS revenues benefited from higher than expected follow on orders from our prior citing tender award as their demand has continued to increase.

And encouragingly, we just received word this week that we have been successful in securing a new tender which will cover the July 2017 through June 2018 period.

In addition to the strong OUS growth, we realized 30% growth in our Nomoline capnography business as well as more than a 200% in revenues per Root and at associated measurements, such as O3 cerebral oximetry and SedLine Brain function monitoring.

Q2 total revenues which include royalty revenues were $192.9 million which was up 11.8% from $172.6 million in the prior year period. In the second quarter, we were able to recognize approximately $1 million in our Phillips in our e-revenue [ph] related to the completion of work again related to one product.

Due to some new technological testing requirements we now expect to recognize the remaining $3.4 million in Q3 that we had originally expected to be able to recognize in the second quarter. Rainbow product revenues for Q2 totaled $17.1 million, an increase of 14.6% compared to $14.9 million realized in the prior-year period.

The year-over-year growth was due primarily to the strong Saudi order volume which I just noted and which we now expect to recur over the next 12 months. Our Q2 SpHb revenues were $5.8 million, up by 62% from $3.6 million in the prior year period.

Our worldwide end user or direct business which includes sales to just in time distributors grew 13.8% in the second quarter to $160.4 million versus a $140.9 million in the year ago period. . Our direct business represented approximately 88% of total product revenue in the quarter, versus 86% in the prior-year period.

OEM sales totaled approximately $22.4 million, representing 12% of product revenue, as compared to $23.7 million in the year-ago period, a decline of approximately 5%. By geography, total U.S. product revenue increased by 8% to $126.5 million, compared to $117 million in the same quarter of 2016.

Our Q2 OUS product revenues of $56.3 million rose by 18.5% versus $47.6 million in the same prior-year period and were up 21.1% on a constant currency basis. Q2 OUS revenues represented approximately 31% of total Q2 product revenues. Our second quarter 2017 GAAP product gross profit margin was 64.8% versus 65.1% in the prior year period.

Our Q2 product gross margins were in line with our expectations based upon our ramp up of our new manufacturing facility. Ironically, we achieved our expected Q2 product gross profit margins, despite incurring for the first time in many years an approximate [Indiscernible] negative FX impact due to the recent strength of the peso versus the U.S.

dollar. Reported second quarter 2017 total operating expenses were $81.6 million an increase of 3.6%, due primarily to higher staffing levels. Partially offsetting this increase was the capitalization of selected R&D expenses related to the Phillips NRE efforts and some marketing expenses that have now been deferred into the second half of 2017.

SG&A expenses were $66.4 million, up by 3.9% versus $63.9 million for the same prior-year period, while R&D expenses totaled $15.2 million, up approximately 2.5% from $14.8 million in the prior period.

We're pleased that the robust revenue growth coupled with moderate growth in operating expenses result in a Q2 operating margin of 24.3%, an improvement of 320 basis points versus the 21.1% in the same prior year period.

Non-operating income in Q2, 2017 was approximately $200,000 compared to non-operating income of approximately $500,000 in the same prior-year period. During the second quarter, we reported net interest income of approximately $700,000 and a $400,000 FX [ph] re-measurement loss.

This compares to prior-year interest expense of $1.1 million offset by $1.5 million re-measurement gain. Our second quarter 2017 effective tax rate was 0.7%. This number is a combination of a Q2 tax provision of approximately $15.4 million or approximately 32.8% on our pre tax income of approximately $47 million.

This was offset by an approximate $15.1 million tax benefit associated with the new accounting rule regarding the reporting of gains from stock option exercises.

By comparison, in the same prior-year period, we reported a realized tax rate of 18.6%, which was the net result of a 29.7% effective rate reduced by a $4.1 million tax benefit associated with the same new stock option accounting rule.

Our average shares outstanding for Q2 rose to 56.2 million, up from 52.7 million in the year-ago period, and up from 55.5 million in the first quarter of this year.

The 6% year-over-year increase in our weighted share account is due both to the impact of stock option exercises and the dilutive impact that a higher stock price has under the treasury stock method. Second quarter GAAP net income was $46.7 million or $0.83 per diluted share, compared to $0.57 in the prior-year period.

The $0.83 per diluted share includes a net $0.24 benefit related to the high level of Q2, 2017 stock option exercises so that without the benefit the Q2 earnings were $0.59. Similarly, this compares to our prior year $0.08 benefit such that without that benefit prior year Q2 earnings per diluted share were $0.49.

In the current quarter, the net $0.24 benefit was due to a combination of a final $0.27 per diluted share benefit, partially offset by a $0.02 negative impact due to higher payroll taxes and a $0.01 impact due to the higher shares outstanding again related to the higher stock option exercise activity.

To be clear, this net 24 per share benefit compared to an estimated Q2 net benefit of $0.16 per fully diluted share which was included in our Q2 financial guidance.

That $0.16 net estimate was the combination of a previous assumption that we would see a benefit of $10.1 million or $0.18 per diluted share tax benefit that would be partially offset by an expected $0.01 reduction for higher payroll taxes and a $0.01 reduction due to the higher weighted shares outstanding.

Also please recall that in our update annual guidance at the end of Q1, we did as I previously noted already assume a net benefit of $0.16 in the Q2 period related to the net impact of the new stock option accounting gain as compared to the final $0.24 net benefit that we realized during the quarter.

Therefore approximately $0.08 of our higher than expected Q2 earnings per share was related to the higher than projected net benefits from the new stock option accounting rule and approximately $0.04 was related primarily to our stronger than anticipated Q2 product revenues.

As of July 1, 2017 our days sales outstanding was 52, down from 53 as of April 1, 2017 while our inventory turns were 2.9, compared to the 3.3 for the period ended December 31, 2016. Total cash and cash equivalents as of July 1, 2017 were $331 million, compared to $306 million as of December 31, 2016.

During the second quarter, we expanded approximately $13.5 million in cash from operations, actually its rounded closer to 14, including a $71.4 million tax payment related to the $270 million gain from the Phillip settlement that we had recognized in our Q4, 2016 financial results.

Now, I'd like to discuss our updated for fiscal year 2017 financial guidance, which is based on the best information we have available to us.

Note that we are providing this updated financial guidance in an environment that continues to be characterized by significant uncertainties related to the overall general business and economic conditions, including the future of the Affordable Care Act as well as potential changes in U.S. corporate tax policies under consideration in Congress.

With that said, here is our updated 2017 financial guidance. We are now projecting total 2017 revenues of $769 million, compared to $759 million, including $736 million in product and other revenues compared to $727 million. We are now also projecting total royalties to be approximately $33 million as compared to $32 million in our prior guidance.

We now expect our full-year product gross margins to be approximately 65.2% down slightly from the prior guidance of 65.4% due primarily to the new unfavourable peso U.S. dollar FX rate issue and higher amortization cost associated with a record amount of equipment that we were able to place in the field during the first half of 2017.

We continue to expect our total annual operating expenses to be approximately $329 million. We are increasing our estimate for our effective tax rate slightly from 31.5% to 32% for the year due to a slight shift in our overall level of U.S. profitability.

And based on all these revised estimates, we are now projecting our full year GAAP EPS to be $2.80, up from our prior guidance OF $2.65. And with that, I’ll turn the call back to Joe..

Thank you, Mark. As you just heard our strong second quarter results have given us the confidence to once again move our full year guidance. As we achieve double-digit growth for product sales once again, we were able to post growth for adjusted earnings per share, which was more than one and a half times our sales growth a 20% growth year-over-year.

Our other accomplishments during Q2 included a number of clinical and commercial success that I’ll now describe in more detail. One important milestone is the announcement of our first the Masimo Open Connect partnership with the Root patient monitoring and connectivity hub.

The MOC-9 and MOC-C program represents a great value opportunity for our customers who can get access to innovative technologies developed by third parties for our Root Patient Monitoring and Connectivity Hub. The MOC-9 announcement with Mdoloris is only the first of many formal MOC-9 and MOC-6 collaboration for Root which are now underway.

Watch for more announcements in the future about these MOC-9 and MOC-C offerings. By partnering with Masimo these emerging innovators gain quicker access to the hospital market while our customers benefit from an ever expanding measurements and applications for Root that increases Root’s clinical value to clinicians and hospitals.

Masimo has now executed formal agreement for seven partnerships with our MOC-9 or MOC-C technologies and later stage discussion with an additional 20 companies for such agreements.

As I stated at the beginning of the call today, we are encouraged that Root and two Masimo parameters that are used with Root, 03 and SedLine have had aggregate sales in the quarter which were more than three times the year ago level.

We anticipate continued rapid growth for our Root Monitoring and Connectivity portfolio as additional parameters in future from Masimo and our MOC-9 and MOC-C partners are introduced.

In the clinical arena, we are happy to report that multiple studies were published during the quarter that supports the value of various Masimo measurements such as ORi, PVi and SpHb. For example, a study investigating the clinical utility of ORi led by Dr.

Leonard Lee at UC Davis demonstrated the potential utility of ORi as an advanced warning of arterial oxygen saturation and as an adjunct to SpO2.

The study involved 40 adult critically ill patients who are scheduled for elective surgical procedures and found that the average time from the start of ORi alarming to 94% oxygen saturation was 80 plus or minus 38 seconds providing an average increase in warning time with ORi of 34 plus or minus 23 seconds.

This additional warning time can translate to improve patient safety by allowing earlier calls for help, assistance from a more experienced person or modification of airway management. ORi hasn’t yet been approved for sale in the U.S. and we are hopeful about its potential based upon the accumulating positive data that supports utility.

Our optimism is based upon our success today with ORi in Japan, but we had already seen ORi being used by four hospitals and there are an additional 50 hospitals actively planning to implement ORi in the near future. In a recent multi-parameter – in the recent multicenter study of our SpHb parameter led by Dr.

Richard Applegate and Patricia Applegate of UC Davis and Dr. Klaus Torp of the Mayo Clinic in Jacksonville Florida showed that SpHb appear to provide similar intraoperative guide as arterial blood gas measure of hemoglobin and point-of-care hemoglobin measurement regarding HP increase or decrease.

More and more hospitals are seeing SpHb as a useful tool added to their other information and tools available to them in making decisions during surgery. As evidenced by 75% increase in sensor volume in the U.S., a multimillion dollar increase in sales of disposable SpHb sensors worldwide.

An updates from other clinical studies related to SpHb the big five studies has confirmed participation from six centers and they are in the process of securing the IRB approval to start this multicenter study.

Regarding a natural [ph] trial study sponsor [Indiscernible] reported that the study needs about 50 more subjects to complete the recruitment based upon their recent review of the recruitment goals. They now expect to complete recruitment and start data analysis in Q4, 2017.

Also a significant was the Anesthesiology News publication of the favorable results from the Limoges study of PVi and SpHb showing a 30% reduction in mortality.

As was presented in abstract form at ASA in October 2016, we expect the full manuscript of this 18,000 plus patients study to be submitted soon for publication by Professor Nathan and colleagues at the Centre Hospitalier Universitaire de Limoges.

These positive studies on rainbow along with next-generation SpHb introduction, and Philips partnership makes us feel optimistic about the adoption of rainbow, in particular SpHb and PVi.

Regarding our expanded partnership with Phillips, we remain confident about the short-term and long-term potential for our partnership to propel not only sales of rainbow technology but other Masimo technologies such as SedLine, 03, and Nomoline.

As we described at our Investor Day in early May our views on the magnitude of the opportunity to increase our market presence in 2018 and beyond with Philips increased contribution is resolutely positive.

Lastly, a recent positive study conducted by researchers at University Medical Center Groningen Netherlands compared the performance of our next-generation SedLine Patient State Index, PSI-2 to the original PSI during anesthesia.

Our next-generation SedLine enhances PSI to make it less susceptible to electromyographic interference and to improve its performance in low power EEG cases, as seen on geriatric patients. The investigators concluded that PSi-2 has enhanced signal stability and a better description of the dose-response relationship.

The next-generation PSi showed reduced population variability and improved baseline stability as well as lower inter-individual variability. And therefore has improved capacity as a pharmacodynamic monitor of anesthesia compared to PSi-1 quotation close. During the second quarter we announced the market release of some important new products.

In June, we announced the availability of the Rad-67 Rainbow Pulse Co-Oximeter with next-generation SpHb measurement. The Rad-67 offers patient motion tolerance and censor to finger stability considerably improving accuracy in the clinical settings and providing faster time to display SpHb results.

In addition, field performance has been enhanced in lower hemoglobin ranges with next-generation SpHb technology. In late May, we announced FDA clearance of our 03 cerebral oximetry device for pediatric patients. Expanding the addressable market for this important new technology for Masimo.

03 adoption is rising rapidly that clinicians appreciate the superior performance of the technology against competitor, as well as its utility as part of the Root connectivity system.

The availability of 03 for patients as young as three months old will serve to broaden 03’s potential to help clinician better care for their patients especially for infants at risk. Two other significant new products that we announced in second quarter are the Rad-G Pulse Oximeter and the Kite supplemental display system for Root.

The Rad-G is a pulse oximeter design primarily for use in pneumonia screening as well as spot-checking of oxygen saturation in low resource settings. Its development has been supported in part by a grant from the Bill and Melinda Gates foundation.

We are hopeful that enhanced screening for pneumonia with the Rad-G can empower millions of healthcare provider in developing countries by supporting informed decisions related to diagnosis and treatment with potential improvements in the appropriate administration of antibiotics and oxygen therapy when needed.

Separately the new Kite system for Root expands use and visibility of patient data for clinicians by allowing data from Root to be wirelessly displayed on large view screens and customize configurations and operating room, intensive care unit, cardiac theater emergency departments and other venues.

The Kite display system can be customized to enable clinicians to view the monitoring parameters, waveform and other data they require and in a configuration that they prefer. The increased user-friendliness of data displayed the Kite should enhance clinical decision-making in multiple hospital settings.

In closing, our quarterly performance again exceeded our expectation, increasing our optimism about the potential results we can achieve for 2017. We remain committed to our mission to improve patient outcomes and reduce the cost of care. With that, we’ll open the call to questions.

Operator?.

Thank you. [Operator Instructions] And our first question comes from Tao Levy with Wedbush. You may proceed..

Hi. Good afternoon..

Hi, Tao..

Hi. So, congratulations on a great quarter. I just have few questions on my end.

Any sense to tease out or just still the Philips contribution to the number of higher Socket placement that you had in the quarter, or is there no real contribution yet?.

Great question. Yes, Philips definitely helped us achieve this record number. The Philips year-over-year quarter volume increase in sockets were over 50%, and I can tell you from a historical volume perspective we’re on a run rate to do twice as much as we’ve done historically with them.

So already we’re seeing incredible cooperation, credible results from our new Philips agreement,.

Okay, great. And I don’t know if I’m – you talked about this before, but in terms of the rainbow revenues and the guidance, I don’t think provided guidance or you didn’t update the rainbow guidance. Given that you now have more confidence around the Saudi Arabia customer payments.

How should we think about the movement in rainbow sales throughout the year?.

Well, I think given that rainbow is still relatively a small portion of our business. It’s a lumpy business from quarter-to-quarter. So while, we’re very happy with Saudi Arabia’s second quarter orders and what we expect for the next 12 months.

Given the ebbs and tides – ebbs and flows that comes with small tide here, we feel good about the years guidance, but don’t feel good about increasing at this point..

Got you. Okay, And then just lastly, when I look at my model and analyze sort of product revenue per install, that continues to trend higher.

Should our expectations be that trend continues as long as you introduced new products and adoption continues to move favorably?.

Yes.

We have had a wonderful run with increase in Socket shipments, increase in sensor volume shipments, and on top of that with the new products, and I think they are kind of feeding into each other, but I mean, if you know the last few years, beginning with our 25th Anniversary, we’ve been introducing about a dozen product – new products per year and three to four of them each year brand new market product, where we’re opening ourselves to new opportunities.

As we’ve said in the Analyst day, we are very bullish about the future, in fact, increased our projections of our revenue growth to between 8% to 10% per year because of one, Philips, and two, these new products..

Perfect. Thanks a lot. .

Thank you, Tao..

And our next question comes from Rick Wise with Stifel. You may proceed sir..

Good afternoon, everybody. Hi, Joe..

Hi. Good afternoon. Welcome to our call..

Thank you very much and I apologies in advance for my occasionally naive question here as I learn more about Masimo. I’d like to come back to Philips if I could, obviously you’re making progress. You gave us some good comments there and good data.

When I go back and look at some of the comments in the Analyst Day, can you talk to us in little more detail and sort of lay out a roadmap of the agreement and the joint initiatives.

What should we expect in terms of joint selling, joint marketing, market development, development pipeline? How do we think about what’ coming next over the next 6, 12, 24 months?.

Well, I have to be careful here, because I don’t want to disclose anything that’s confidential and I know our partners sensitivity to that.

There was a lot of redlining I think to the contract because of that, but what I can say to you is one, we’ve increased – we’ve seen this increase volume with Philips without even to rollout of the marketing programs.

We expect that marketing programs to rollout in Q4 and we’ve seen this improved volume dramatic volume increase without even some of the new products that are suppose to come up, for example product with SedLine, Nomoline and 03.

So, we remain really optimistic, it’s been a fantastic role we have and incredible relationship from the CEO of the company, Chairman of the company to the key stakeholders in the business and it’s really wonderful to see how our relationship has turn around and blossom for into a good friendship, partnership agreement with them.

So forgive me for not disclosing more, I’m just hesitant because I don’t know – I was not involve with the redlining, so I don’t know what’s in there, what’s not. So, maybe if sense maybe Eli and Mark are more familiar with that. If you guys want to add anything more to what I just said, please free to do so..

Rick, I just want to add that in general the co-marketing agreements plan for both companies to make rather notable financial commitments to those programs. And as Joe said that’s been in development now for the last couple of quarters. And hopefully we’ll begin to see some of those efforts rollout towards the end of this year.

Ideally having an impact as we’ve been saying mostly 2018 and then 2019, so I mean, there is a real hard dollar commitments that have made by both companies to support the kind of partnership that Joe was just alluding to..

That’s great. Turing to Root, just curious at Root account how quickly you’re seeing pull-through for other parameters. And just where are you having beyond the Saudi tender where do you feel like you’re seeing the most success with Root placements? Current Masimo users you’re opening up new accounts? Again any more color would be really welcome..

Certainly. Truly it is all around. We’re seeing demand for it in U.S., Europe, Asia, Middle East, and the usage is really; right now focus in two areas; the operating room and general floor. Operating room because they like features such as Kite. They like the connectivity hub.

It provides and they like some of the parameters like Sedline, O3 and Nomoline. And in the general ward before surgical ward mainly they like the fact that it has vital science capability for spot-checking like blood pressure and temperature.

They also have like the new early warning systems scoring that we introduced for it, and that is really is ideal for the general floor because one, that hubs connect everything in the room back to the AMR, two, it gives them the ability to either have tethered or untethered monitoring because of the Radius 7 that can be use with it instead of Radical-7.

So, we’re seeing really a nice across the board pattern of interest and sales and also as been told by my sales team, sales leadership that actually Root is so exciting to customers is pulling in Masimo [Indiscernible] conversations. So, it really just like rainbow, it just not doing good for itself, its doing good for our core business..

And just last from me if I could, any update in your thinking Joe, as that you made really compelling and proactive comments at the Analyst Day about your cash usage potentially for M&A, any updated thinking on your part and how we should be thinking about the potential there? Thank you so much and congrats on the good quarter..

Thank you. Thank you so much. First of all again, welcome, we’d love having you covering us and we appreciate you being on this call.

But as far as M&A is concerned I think I have said at the call -- at the meeting, excuse me, that we’re looking as M&A because we can grow organically, in fact we have 8% to 10% growth pattern trajectory for the company, all based on organic growth, all without even the five new products that have reach feasibility that we haven’t announced yet.

And we’re seeing double digit earnings growth on top of that, great operating margins growth 30%, so why the M&A? Well as M&A one is because we think we can handle it. Two because we want to create diversification for Masimo, I jokingly said, I don’t want the Kodak movement.

We’re somehow which we not anticipating, but somehow your core business gets obsolete because of changes, disruption and the new things coming out and you’re left with nothing. So we think it’s prudent upon as to M&A opportunities, not adjacent to our business but totally separate from our business.

Of course, we always tuck-ins like we had for last few years, thing that are adjacent, but we’re looking for opportunities in big markets where more than $3, $4 billion size growing either double-digit or near double digit growth and strong preference where the customer get to the close to the choice or what they’re going to use, because we’re confident whatever we’re going to do we’re going to be best at it and therefore we want people to chose us faster than kind of the time lines that we have with our current model.

So, but -- because we feel so good our organic growth we’re not interested in buying things that are going to dilute Masimo. We’re not looking for this $1 billion, $2 billion type of acquisition.

We’re looking for what I call fixer-uppers in great neighborhood which should mean by definition two things, one, one cost us very much, we can pay for it with our own cash.

But two, it means, they’re going need fixing and upping, and therefore it might for a while be a little of a downer on our earnings, but we’d only do it, if we we’re totally confident that its going to pay dividend as we optimize the value of Masimo in a new five to seven year plan.

So long story short, yes there were some companies we’re talking with actively, but I can’t say there’s anything imminent given where we are with our due-diligence space..

Very helpful. Thank you so much..

Thank you so much. Thank you..

And our next question comes from Brian Weinstein with William Blair. You may proceed sir..

Hey, guys. This is Andrew in for Brian today. Real question I had was on utilization per driver and sorry if you already talked about it, but just quickly doing the math it looks like utilization is again growing faster than kind of the overall installed base.

You guys still see this kind of being equate mostly to reprocessing or is there something else out there that we should be thinking about? Thanks..

Brian, first of all thank you for the question. I’ll first start off by saying we’re not sure exactly, but I can tell you the reasons we think the business is doing better than the drivers with 0.2. We think number one is probably increased in outpatient sensors.

In some days I wish we could report our sensor volume on a daily basis for you, but I think it’s probably the best indicator of sensors, because as you know mostly single patient use product and hospitals in the U.S. So think that’s number one.

I think reprocessing mostly it's failing on its own because of customers realizing, while they might be paying a lower price. They're getting higher volume purchase. They have to buy more because it doesn't work well and they’re recognizing, the reprocessors [ph] are adulterating the product. They're not making the motion claims that we make.

They're not making neonatal claims in the neonatal sensors use on neonatal patients. So yes, we’re processing might be slowing down but we’re not a 100% on that. The best thing we can look to is really the outpatient sensors increase..

Great. Thanks guys..

Thank you. I think we have time for one more question..

And our next question comes from Larry Keusch with Raymond James. You may proceed..

Good afternoon everyone. Yes, I’m sorry about that, I had the mute on. So, just couple questions. Joe or Mark maybe just starting off, I’m actually thinking ahead and just thinking about 2019, and could you talk to you again for philosophically how you’re thinking about filling in the royalty gap that occurs when the royalty expires.

Are you still sort of planning to grow through that?.

Great question, Larry. We of course are doing everything we can, so that the feel the depth, but as you know that royalty, most people have [Indiscernible] discount; it has full value to them. So it’s not really being part of our multiple in our earnings.

So therefore even if earnings from the royalties drop from 2018 to 2019 we are not expecting that to change our valuation or maybe even more importantly given – compared to 2006 when the royalty started and there were more than 50% of our income, by 2019 they’re going to be, I don't know, maybe 10%, 15% of our income, so I think they because a far less important component.

But at the meantime as you know because of our 10-year plan and the painful investment we went through with the use of the royalties and the days we couldn’t just let it drop earnings and feel good, we’re now are much more formidable competitor with much broader product portfolio and feel like it won't really matter much.

So – but Larry, we are going to do our best to bridge it, but even if we don't I guess my response is, so what?.

Okay. That's really helpful. And then just two other ones. On the Saudi tender which sounds great that they’ve come back and they’re now purchasing again.

As you look at the remainder of this year in the guidance is there, is there additional Saudi revenues in there or are you treating it as upside if it comes in?.

Well, our business has a lot of optionality and ups and downs, so with the guidance we’ve given you, you could say, they’re in there. Obviously if other things come in the number could be better. If other things don’t in, we’ll meet those numbers.

As we look towards this second half of the year we see more optionality in Q4 than in Q3 given the summary season.

So all-in-all our instinct about the business and how it’s going is the same, it feels good but we don’t want to get ahead of ourselves and you know we’ve been raising our guidance every quarter for almost three years and while we hope we can keep doing that, we don’t go into the quarter expecting that.

We are not padding, we are doing our best to give you the best picture we have. So I hope that answers your question....

Yes that’s really helpful. And then lastly, you know last quarter you guys gave some indication of what you anticipate at the stock option benefit would be the EPS. I’m wondering if you could help us think about that in the third quarter.

And then on the R&D side, it sounds like there was some capitalization, so just wondering how we should be thinking about R&D spend for the year?.

I'll let Mark answer these questions.

Mark?.

Sure. So Larry [ph] on the stock option your first question, as you know the first couple of quarters it was relatively a new phenomenon and because we had insight into some pretty large activity, we provided some initial guidance in each of the quarters.

As it turned out, I think that ended up to be a little bit more problematic at the end of the day because there was always a portion of our guidance that included some of those numbers.

So to eliminate that, and to be honest partly because the activity this quarter has been a lot lower than it was in the prior two quarters, we decided just not to attempt to guesstimate that number for Q3 and Q4. We’ll just lay that number into the final quarterly results when we get to the end of the quarter.

I think it will be a lot simplier and easier to understand for everybody. And then in terms of R&D spending, I think you know directionally as you know R&D is the lifeblood of Masimo. As a result, we’ve always spent on a relative basis a higher level, with most of our competitors. There is no reason to assume that’s going to change.

The numbers as I said this quarter a little bit lower because of some of those reclassifications that we took where we had to reclass some of our R&D expenses related to the Phillips NRE revenue numbers, but over the next couple of years we fully expect to continue to see the kind of investments in R&D that we’ve historically had and in general that puts us in a range of about 8,9 sometimes even 10% of our total operating expenses in R&D..

Okay, very good. Thanks for the clarifications..

Well thank you. Thank you all for joining us today. We really appreciate everyone’s interest and support and we wish you the rest of the summer to be happy and safe. Thank you so much..

Ladies and gentlemen, this does conclude today’s’ conference. And you may all disconnect. Everyone have a great day..