Good afternoon ladies and gentlemen and welcome to Masimo's Fourth Quarter 2018 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'm 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 Chief Financial Officer, Micah Young. This call will contain forward-looking statements which reflect Masimo's current judgment including certain of our expectations regarding fiscal 2019 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 periodic filings with the SEC. You will find these in the Investor Relations section of our website.

Also this call will include a discussion of certain financial measures that are not calculated in accordance with Generally Accepted Accounting Principles or GAAP. We generally refer to these as non-GAAP financial measures.

In addition to GAAP results, these non-GAAP financial measures are intended to provide additional information to enable investors to assess the company's operations in the same way management assess its operations.

Management uses non-GAAP measures to budget evaluate and measure the company's performance and sees these results as an indicator of the company's ongoing business performance. The company believes that these non-GAAP financial measures increase transparency and better reflect the underlying financial performance of the business.

Reconciliation of these measures to the most directly comparable GAAP financial measures are included within the earnings release and supplementary financial information on our website.

Investors should consider all of our statements today together with our 10-K for the fiscal year 2018 to be filed with the SEC in order to make informed investment decisions.

In addition to the earnings release issued today, we have posted a quarterly presentation within the Investor Relations section of our website to supplement the content we will be covering this afternoon. I'll now pass the call to Joe Kiani..

Thank you, Eli. Good afternoon and thank you for joining us for Masimo's fourth quarter 2018 earnings call. 2018 was a dynamic year for Masimo as we saw strong momentum in our business. Our global organization executed on our strategy to deliver above market growth and drive operational efficiencies throughout the business.

We're extremely happy to report fourth quarter and full year results that exceeded expectations. For the fourth quarter, our product revenue increased 13% to $221 million and our non-GAAP EPS grew 54% to reach $0.83 per share.

We also shipped a record 60,300 non-invasive technology boards and monitors during the quarter which exclude our handheld and finger oximeters. I'll discuss more in the call today. Now, I will ask Micah to review our fourth quarter and full year results in more detail and provide you with an update to our 2019 financial guidance.

Micah?.

Thank you, Joe and good afternoon everyone. Before we get started, let me remind you that many of the financial measures covered in today's call are on a non-GAAP basis unless noted otherwise.

Please refer to today's earnings release, supplemental financial information, and the quarterly investor presentation on masimo.com for further information regarding our non-GAAP reconciliations. As Joe mentioned, we're very happy with the strong momentum that we are seeing in our business.

Our results for the fourth quarter reflect another sequential step-up in our product revenue growth, continued operating margin expansion, and more than 50% growth in our non-GAAP earnings per share. During the quarter, we shipped 60,300 noninvasive technology boards and monitors, which reflects growth of 11.5% over the prior year quarter.

For the full year, our driver shipments increased 14.1% to reach 231,700. The growth is attributable to strong customer demand in both our direct and our OEM business. For the fourth quarter of 2018, we reported total revenue including royalty and other revenue of $223.1 million.

Our product revenues were $221.4 million for the quarter, which reflects growth of 12.8% or 13.5% growth on a constant currency basis. Royalty and other non-recurring engineering revenue was $1.7 million for the quarter compared to $11.6 million for the fourth quarter of 2017.

Our fourth quarter results included $1.1 million in royalties compared to $7 million in the prior year period. In addition the fourth quarter included approximately 600,000 of non-recurring engineering revenue compared to $4.5 million in NRE revenues in the fourth quarter of 2017.

Despite the expiration of the royalty on October 6 of 2018 and the significant year-over-year reduction in NRE revenues, we still experienced very strong growth in both revenue and earnings for the quarter. Now, let's turn to the rest of the P&L.

For the fourth quarter, our non-GAAP total gross margin including royalty and NRE revenue was 66.5% compared to 66.7% in the prior year period. Our product gross margin for the fourth quarter increased 130 basis points to 66.4% compared to 65.1% in the prior year period.

Once again, the improvement was driven by increased manufacturing efficiencies, favorable mix benefits from customers upgrading to our new sensor line, as well as additional cost reduction activities we've implemented to improve margins.

Non-GAAP selling, general, and administrative expenses were 33.4% of total revenue for the fourth quarter compared to 37.3% in the prior year quarter. If you exclude the impact of royalty and NRE revenue, our SG&A expenses decreased 590 basis points to 33.6% of product revenue compared to 39.5% in the prior year period.

The lower SG&A spending was primarily due to operational improvement of 50 basis points and a favorable year-over-year comparison of 540 basis points related to an asset write-down that we recorded in the prior year quarter.

If you recall from our earnings call last year, we recorded an asset write-down of $10.5 million in the fourth quarter of 2017 which was related to an unpaid balance from our former agent in connection with a foreign government tender. Non-GAAP research and development expenses were 8.9% of total revenue compared to 7.7% in the prior year quarter.

If you exclude the impact of royalty and NRE revenue, our R&D expenses increased 70 basis points to 8.9% of product revenue compared to 8.2% in the prior year period. The higher R&D spend was primarily due to increased staffing levels and higher project-related costs as we continue to invest in delivering innovative technologies to the marketplace.

For the fourth quarter, our non-GAAP total operating margins were 24.3% compared to 21.7% in the prior year quarter. If you exclude the impact of royalty and NRE revenue, our non-GAAP product operating margins increased 640 basis points to 23.8% compared to 17.4% in the prior year period.

Our product operating margin expansion was driven by operational improvements of 100 basis points and a favorable year-over-year comparison of 540 basis points related to the asset write-down that we recorded in the prior year quarter. Moving further down the P&L.

Non-operating income on a non-GAAP basis was approximately $2.9 million for the quarter compared to $700,000 in the prior year period. The increase is primarily driven by an increase in net interest income due to having a much stronger cash position and the higher interest yield associated with the invested cash. Turning to taxes.

Our non-GAAP tax expense in the fourth quarter was $10.5 million resulting in a non-GAAP effective tax rate of 18.3% compared to non-GAAP effective tax rate of 34.9% in the prior year period. The lower tax rate once again reflected the recent changes in U.S.

tax laws as well as the favorable mix of profits as we continue to scale our international business. In addition the U.S. government issued proposed regulations in November 2018 which provided some further clarification on the methodology for determining foreign tax credits.

This resulted in a $1.6 million reduction to our tax provision for fiscal year 2018 of which we recorded the full impact in the fourth quarter. Our weighted average shares outstanding for the quarter was 56.4 million compared to 55.6 million in the prior year period.

Fourth quarter 2018, non-GAAP total net income was $46.6 million or $0.83 per diluted share. In comparison, fourth quarter 2017 non-GAAP net income was $29.8 million or $0.54 per diluted share. This reflects total EPS growth of 54% or $0.29 over the prior year quarter.

If you exclude the impact of royalty and NRE revenue, our non-GAAP product net income was $45.5 million or $0.81 per diluted share. In comparison fourth quarter 2017 non-GAAP product net income was $22.6 million or $0.41 per diluted share. This reflects product EPS growth of 98% or an increase of $0.40 per share over the prior year quarter.

Our earnings growth was driven by another strong quarter of product revenue growth, significant operating margin expansion and a favorable year-over-year comparison of approximately $0.18 related to the asset write-down that we recorded in the prior year quarter. Turning to our non-GAAP -- turning to our GAAP results.

GAAP net income for the fourth quarter of 2018 was $46.9 million or $0.83 per diluted share. In comparison for the fourth quarter of 2017, we reported a GAAP net loss of $7.7 million or $0.14 per diluted share which was primarily driven by nonrecurring charges related to the asset write-down and U.S.

tax reform which were both recorded in the fourth quarter of 2017. Adjusted EBITDA margin which excludes the impact of non-cash share-based compensation was 29.9% for the fourth quarter of 2018. This represents a 280 basis point improvement compared to 27.1% in the same quarter last year.

Our days sales outstanding was 45 days in the fourth quarter which improved 10 days to the end of last year. These strong results are primarily due to improved cash collections outside the U.S. where we typically have longer payment terms.

Our inventory days on hand was 113 days in the fourth quarter which improved 10 days compared to the end of last year. As a result of our strong earnings performance and working capital improvements, we generated $222 million of free cash flow for the full year 2018.

This represents a significant improvement in our cash-generating power of our business as we converted 26% of our revenue into cash during the year. Furthermore, our cash and short-term investments increased to $552.5 million at the end of the fourth quarter compared to $315.3 million at the end of 2017.

Looking back, 2018 was an incredible year for Masimo as we delivered product revenue growth of 12%, non-GAAP total operating margin improvement of 100 basis points and non-GAAP total EPS growth of 32%.

If you exclude the impact of royalty NRE revenue, we delivered non-GAAP product operating margin improvement of 340 basis points and non-GAAP product EPS growth of 53%. And last, but certainly not least, we drove significant working capital improvements which allow us to convert 26% of our revenues into cash in 2018.

Our strong performance in 2018 demonstrates the significant progress that we are making to drive operational efficiencies throughout the business and take further steps towards achieving our long-term goal of 30% operating profit margins.

Most importantly, we are making this progress on the profitability front while at the same time increasing our R&D investment and accelerating the growth profile of the overall business. Now I'd like to update you on our full year 2019 financial guidance.

As a result of the royalty expiration on October 6 of last year, we are not anticipating any additional royalty in other revenues for 2019. So I will be focusing the guidance discussion around our product operating performance which excludes the impact of royalty and NRE revenues from prior periods for comparison purposes.

Due to the strong finish in 2018, we are now increasing our 2019 product revenue guidance to $912 million which reflects year-over-year growth of approximately 9.9% on a reported basis or 10.7% on a constant currency basis. This represents an increase of $2 million above our prior guidance issued in January which was $910 million.

Our non-GAAP product gross margin guidance remains unchanged at 66.8% and our non-GAAP operating expense guidance remains unchanged at 42.8% of revenue. Based on these assumptions, we're continuing to project non-GAAP operating profit margins of 24%.

Excluding the impact of royalty and NRE, this represents a 200 basis point improvement in our operating margins in 2019. Moving further down the P&L, we expect to generate approximately $12 million in non-GAAP non-operating income in 2019 which is primarily comprised of interest income.

And we are now projecting a non-GAAP tax rate of approximately 23% compared to our prior guidance of 24%. This improvement in our tax rate is primarily due to a favorable mix of OUS profits as well as the impact related to the recent clarification of the U.S. tax law changes which I had mentioned earlier.

Also, we are still estimating that our weighted average shares outstanding for the year will be approximately 58 million which does not reflect any additional share repurchases in 2019.

Based on all of these assumptions, we are now increasing our non-GAAP EPS guidance to $3.08 which represents an increase of $0.03 above our prior guidance issued in January of $3.05.

Excluding the impact of royalty and NRE revenue, our non-GAAP EPS is projected to grow 16% in 2019 And from a GAAP perspective we are now projecting a GAAP tax rate of approximately 20% and GAAP earnings per share of $3.19 for the year up from our prior guidance of $3.17.

For additional details on our full year 2019 financial guidance for GAAP and non-GAAP earnings per share please refer to today's earnings release and supplemental financial information within the Investor Relations section of our website at masimo.com. With that I'll turn the call back to Joe..

Thank you, Micah. Thank you. Our fourth quarter results illustrate growing adoption of our unmatched clinical products and systems solutions for improving patient care.

We are realizing more success as our newer products gain traction while we continue to win customers for our SET pulse oximetry technology that's been shown to make a significant financial and more importantly a significant clinical difference in the care of patients from neonates to adults.

During the fourth quarter, we experienced very positive reactions to our initiative for hospital automation.

This initiative involves the unique ability of Masimo Root to not only connect a variety of different devices such as ventilators anesthesia machines infusion pumps and patient monitors in the OR ICU and general ward so that the data from all of these devices can be sent to the EMR but also to use UniView so that clinicians can11 see all of relevant data on a single large display screen by the patient or remotely from anywhere with Replica.

The integrated and customizable display is designed to reduce the cognitive overload caused by having to scan multiple screens on various devices for seeing critical settings and patient measurements.

Our suite of innovative software applications for hospital automation such as UniView and Replica were on display at ASA Arab Health, HIMSS and SCCM and were greeted with enthusiasm by the attendees of these conferences.

We look forward to working with our customers to optimize the flow of critical information to aid clinicians, to improve patient outcomes. The second major initiative for Masimo which has recently intensified is our program to improve opioid safety via innovative monitoring technology for both post surgical wards and home use.

As many of you have heard from us over the years we are committed to reducing unexpected deaths and resuscitation events in patients who are prescribed opioids for postoperative pain control. In the post-surgical wards and hospitals these opioids typically include morphine and fentanyl administered via IV dosing.

We have installed approximately 1000 Patient Safety Net Systems in hundreds of hospitals with incredible results many lives saved and significant reduction in cost as the seminal Dartmouth-Hitchcock study showed in 2010.

However patients are frequently discharged after surgery with a prescription for oral opioids such as Vicodin, Percocet and OxyContin.

These drugs carry similar risks of causing respiratory depression at home as the IV forms of opioids administered in a hospital setting tragically resulting in the death of tens of thousands of people while they are sleeping.

Respiratory depression takes the form of slower, more shallow breathing that can lead to reduced blood oxygen levels, which can be reliably detected via Masimo SET pulse oximetry measurement technology without the false alarms that made these monitoring attempts futile in the past.

We now have a great opportunity to deploy our SET technology after discharge at home, where we believe it will provide an early indication of respiratory depression due to opioids.

In fact, the state legislature of Utah recently issued a resolution that recommends consideration of home pulse oximetry monitoring for all patients receiving a post-operative prescription for opioid upon discharge.

I'm happy to inform you that Masimo was recently selected by the FDA as one of eight companies out of an applicant pool of more than 250 companies for the FDA innovation challenge to develop products, to prevent and treat opioid use disorder.

This program is similar to the FDA breakthrough devices program in terms of encouraging innovation for the public good and ensuring that it reaches the marketplace quickly via an expedited approval process.

We're currently engaged in an active dialogue with the FDA to achieve an eventual expedited approval of a novel system we have developed for detecting respiratory depression in the home setting.

While the details of this device are still confidential, I can tell you that the device will have valuable features such as alarm notification that can alert a family member, remote caregiver or even a first responder to awaken patients and potentially administer antidote for an opioid overdose.

Of course, the key to the success of our opioid SafetyNet at home or Patient SafetyNet in the hospital is our SET pulse oximeter the only technology proven in objective and independent studies to accurately monitor oxygen saturation and pulse rate during motion and low perfusion.

While during the fourth quarter, our performance advantage in pulse oximetry increased as we received FDA clearance for improved SpO2 accuracy specification for our RD SET sensors for use with all patients over 3,000 grams.

The new RD SET sensor's SpO2 accuracy specifications during patient motion improved for adults, pediatrics and infants to 1.5% at one standard deviation, compared to previous accuracy specifications of 3% at one standard deviation.

Even with our prior performance, which was unmatched, SET was the only technology proven to reduce retinopathy or prematurity in neonates, detect CCHD in newborns and save lives and costs in the general ward. We are also gratified to see increased recognition of the value of our rainbow SpHb continuous hemoglobin monitor.

In November 2018, a new consensus statement on postoperative anemia management was published in the journal anesthesia by an international panel of clinicians specializing in patient blood management, which included clear guidance on the use and benefit of noninvasive hemoglobin measurement.

The authors state that the reliability of noninvasive hemoglobin monitoring devices or dynamic changes over time may permit detection of occult bleeding and response to therapy. This new consensus statement shows a meaningful acknowledgment of the value of Masimo's noninvasive SpHb measurement by clinicians in the international settings.

I spoke of strong momentum at the beginning of our call. One of the highlights in 2018 was successful conversion of new customers to Masimo SET and renewal of our existing SET agreements. We had our second most successful year in our entire history for winning new customers and renewing our existing customers.

One of the significant new customers, who upgraded to SET pulse oximetry in 2018 is Community Health System, who's upgrading their 39 hospitals to SET. We also expanded our business with the Mount Sinai Health System in New York. They are now standardizing their whole system on Masimo SET technology.

While at UCLA, we renewed our contract in the fourth quarter amongst many others. Overseas, we won significant new business with the Turkish Ministry of Health to include more than 1,000 monitors with Masimo technology. Other important outside the U.S.

wins include the Leeds NHS pediatric hospital in England and the UMCG Groningen Hospital in The Netherlands. In closing, as we enter 2019, the 30th anniversary of our founding, we are confident in our abilities to fulfill our mission to improve outcomes and reduce the cost of care with our innovative products and systems.

We hope to see you all on May 16 in Irvine for our Investor Day, which will include a comprehensive demonstration of our hospital automation technologies as well as overview of our business and financial outlook. With that, we'll open the call to questions.

Operator?.

Thank you. [Operator Instructions] And our first question comes from the line of Matt Taylor with UBS. Your line is now open..

Hi. Thanks for taking my question. And congrats on a lot of good developments here. I guess, one thing I wanted to ask about was you talked about the new disclosures around this FDA program and your development of a system to address the opioid issue, which is great.

I guess, I was wondering if you could be a little bit more detailed about what you would expect to come from that commercially in terms of the size of the opportunity or the timelines or if you can give us any parameters to help think about how to incorporate that to our model?.

Sure, Matt. I'll do my best. Given that it's a new product and a new category that has not ever been done before, there's a lot that we have to assume right now. We'll know, I guess, better within a year or two into the business. But just imagine that of 72,000 deaths that occurred last year due to opioid overdose 20,000 were from prescription opioids.

And last year, 92 million prescription of opioids were filled. So the opportunity is at least 92 million prescription opioids and possibly a list of use of opioid with users, assuming we're allowed to get over-the-counter clearance by the FDA for this new system that is under review and discussions with the FDA..

And Matt, this is Micah. I just want to add to Joe's comment. We're continuing to size this up as far as the opportunity and learn more and more about it especially, over the next 90 days that we've been working with the FDA.

But we'll have also a little bit more of an update as we look at May Investor Day, if you're out here on May 16, and hopefully, provide you with an update on kind of what we see on the landscape. And again this is a new market opportunity for us, so..

Thanks.

And just on the timelines, you're going to be working out here in the near term, could you have something like out there commercially toward the end of the year? Or is it going to take longer?.

Well, it depends on obviously not just our efforts, but the FDA's work. While we're really excited and proud to have been selected by the FDA to look at this on an expedited review, I know the FDA is eager to make sure there are safeties and all the proper precautions. If things go well, this will hopefully come out in 2019.

We have not projected it in our revenues in 2019. And I think we'll see our first real year of revenue probably in 2020. And it's a business that might be very digital. We'll have to see. It could either be extremely successful or not. So, we're excited about it. We're working hard on it. Obviously, third-parties are excited about it.

But we'll know more after the launch and hopefully we'll launch it this year..

Great. Well, thanks for the color. I’ll jump back in the queue..

Thank you, Matt. .

Thank you. And our next question comes from the line of Rick Wise with Stifel. Your line is now open..

Good afternoon, Joe. Hi, Micah. Let me just start off with the top line. Driver growth is very impressive. It seems like your -- the new products and everything that you talked about Joe, you're seeing broad adoption across the entire portfolio.

How do we think about the -- how should we be modeling and thinking about drivers, driver numbers in 2019? I mean, this 60,000-ish kind of run rate now, is that the level that's going to continue? Would you be disappointed if you didn't exit the year more than the mid-60s kind of range? Just help us you know, think about the numbers and maybe some of the drivers of the drivers, if you will..

Yeah, Rick. This is Micah. I would look at it as we've seen this level the high 50s, even reached about in the 60s this quarter. We -- before we were saying in the low 50s and I think we expect it will be somewhere in that high 50s range now. We're seeing more -- getting more confident and seeing that for three quarters now.

And I think you could expect high-50s around that 60,000 range..

Okay. And turning to the P&L, Micah, to you. I mean, clearly, the volume mix were really helpful in gross margin. But cost reduction manufacturing efficiency, operating improvements very visibly helped gross margins and SG&A part of which seems like you redeployed into R&D.

So what inning are we in, in terms of that efficiency cost reduction side of things? Still early inning and should we assume that you'll continue to focus some of the excess opportunities to spend more in R&D?.

Yeah. I think Rick, we're having around 9% investment in R&D, which we believe is a very good level to kind of maintain it. You've seen it rise this year.

We were able to accelerate some improvements in gross margin, also accelerate improvements and leveraged our SG&A expenses over the course of the year through some cost reduction efforts there as well. We would like to maintain our investment R&D at that level, so we've always said that 8% to 9% range.

And we expect that that 9% will continue through at least 2019. And I think the way you think about our cadence is we've always said 100 basis points of improvement per year as we try to drive towards that this 30% margins. Of course, we're actually guiding 200 basis points of improvement in 2019.

And some of the cost reduction efforts that we had in place in 2018 have given us the confidence to put a number out of 24% operating margins next year and grow 200 basis points. If you think about that it breaks down 80 basis points of improvement in gross margin and 120 basis points of improvement in our operating expenses.

So, beyond next year though, we're continuing to commit that improvement of 100 basis points per year as we drive towards 30%. But we are seeing acceleration because of the efforts from this year..

Okay. One last one for me, quickly. Free cash flow generation is really impressive. How do we think about your increasingly sizable cash priorities -- cash use priorities in 2019 at this point? Thanks so much and congrats on the excellent quarter..

Thank you. Yeah, Rick, just to answer that question as we think about it, we're going to continue -- we're trying to continue to maintain flexibility on the balance sheet, but also be opportunistic about share repurchases whether it be through 10b5-1 plan. We're open market purchases.

And we're just -- we're looking to be opportunistic in terms of where the share price is and also relative to what we can invest in our cash. We basically look at different things like the return on investment and also -- we're also trying to be flexible in terms of M&A opportunities.

If those things -- if those arise, we continue to evaluate more digestible smaller type companies that have come across. And we want to make sure we're being flexible as we move forward into 2019..

Thanks so much..

Thank you. And our next question comes from the line of Bill Quirk with Piper Jaffray. Your line is now open..

Great. Thank you. Good afternoon, everybody..

Hi, Bill..

Hi, Bill..

Hi. First question is following-up on -- it was Matt's question initially. In terms of -- if we think about the commercialization of the opioid monitoring device, Joe, can you help paint maybe some scenarios for us? You mentioned OTC which would suggest maybe cash pay.

Is there an opportunity here for some sort of reimburse device, or tying it in with ultimately kind of writing the prescription, you would write a script for the device as well? How are you guys thinking about the longer term kind of commercialization track or payment scheme, if you will?.

Sure. First of all, consumer health business is relatively new for us. As you know, we've had MightySat and iSpO2 which we have been marketing for athletes. But marketing to consumers for healthcare it's a new thing for us.

And one reason I mentioned earlier, it's to me in my -- feel more like a digital business because in the consumer world things seem digital either it's an incredible success and it just catches on or it doesn't.

To answer your question about how we're thinking about the model, well, first of all, things are kind of coming kind of towards us in a positive way. There's now and the new bill that just passed, there's reimbursement for whole monitoring that we might be able to take advantage of for prescription opioids.

Secondly, if we can get OTC, we're hoping this new system would develop and will be cost-effective and affordable so that many people can afford to buy it. Right now, in Utah, they're buying a Rad-97 which is a hospital grade device that costs a couple of thousand dollars and they're sending to home with one or few of our adhesive sensors.

And they're doing that because they had some very high profile opioid related deaths. There was a young man Parker, 21 years old, six foot four goes in for a tonsillectomy was given opioids to go home with for pain. He took half of the pill and went to bed and never woke up.

So that case along with a few others pushed the community to say we got to do something different. And ever since they've been prescribing our technology there they -- an outcome was they have not had another opioid related death except for a woman who refused to be monitored which unfortunately she did pass away which was terrible.

So, looking at that, looking at the consumer side of things, we think if we can make it at a price that keeps us on our normal margin, but makes us affordable and we have this new revolutionary design that we're hopefully going to be able to show you when we see you all in May.

We think it can be done, it can be done really in a cool cost-effective way..

That's great. Thanks for the color Joe and certainly appreciate there's a couple of different commercial avenues here in front of you.

Separately, so staying on kind of new commercial products or products in development anyway, what's the latest on ORI? Certainly, I know that you guys are awaiting FDA approval, but maybe you could give us some additional details into kind of the back and forth with FDA? And then also maybe just kind of a bigger picture is how should we think about the pace of adoption upon approval? Thank you..

Thank you, Bill. We are in communication with the FDA over ORI. We submitted the 510(k) application for it after a couple of years of dialogue with them. And we recently received comments on it. We're working on our response to those comments. So, we'll keep our fingers crossed. Outside the U.S. where we are marketing ORI, it's going very well.

We're getting a lot of traction. For example, in Japan already a nice chunk of our business has switched to this new rainbow Lite sensors for LED version of rainbow or SET sensors that allows not just SpO2 measurement, but ORI measurement.

And all of the states to-date have been amazingly positive on ORI, where it's giving between 30 seconds to minutes of warning before a hypoxemia event occurs, which is a big issue for anesthesiologists, especially in the OR, but people are beginning to think it could be very beneficial in the intensive care unit as well both for adults and neonates where you're trying to optimize oxygen, but not getting to oxygen toxicity overdose..

Understood. Thanks for the color, Joe. And then just last one for me. Is there anything about the Japanese market that would make it kind of less applicable from an adoption curve standpoint to some of your other larger markets like the U.S.

for example?.

I don't believe so. First of all, I think you'll remember when Masimo first started we actually began in Japan first, because again FDA clearance issues as well as the time of exclusionary GPO contracts that were keeping us out of the market. And eventually what happened in Japan, happened in the U.S.

Now Japan doctors are more in control of what happens and they are in the U.S. And they are more capable of getting the technology they want. So -- but that to us just needs an early indicator kind of like neonatologists in general around the world are more easily adopt new technology and have more voice in what gets used under patients.

But eventually everyone follows. So we think Japan actually is a healthy example. Japan happens to be the second largest country after the U.S. in terms of our market for our products. So it's always been following the U.S. quite closely..

Very good. Thanks guys..

Thank you..

Thank you. And our next question comes from the line of Mike Matson with Needham & Company. Your line is now open..

Hi, Joe and Micah. This is David Saxon on for Mike. Thanks for taking our question. So first, I think the expectation was that you'd be able to integrate NomoLine, SedLine and O3 parameters into the Philips monitors by mid-year.

Is this still the expectation? And can you talk just about the market opportunity there?.

Yes. It's still the expectation by middle of this year those will be out and Philips being that they have at least 50% if not 60% of the market for patient monitoring we think it's a huge opportunity both for uptake in their markets as well as recognition of those measurements by other hospitals as well.

So we're excited we're working very closely with them on the launch of those products. So hopefully there will be no snags or delays and it will be out hopefully in the middle of 2019..

Okay. Thanks. And then in your prepared remarks you said this year was the second most successful year for converting customers and renewing existing ones.

Can you just talk about what contributed to that and how repeatable it is?.

Well, first of all, you don't have access to all that data. But if you did you'd be happy to see that it's been growing nicely since 2002 I think we're keeping track of it, when we were first allowed contracts in the U.S. post the New York Times articles regarding GPOs and so forth.

But except for the year, we've won Kaiser and except for the year we renewed Kaiser really this is the biggest year ever. And what is aiding it, I believe it's the continued recognition of what we've done for our other customers. I've said before, our renewal rate is over 98%.

And whenever we've lost the customer it's never been due to performance, it's been due to a very aggressive pricing and sometimes what we think is not good business practices of our competitor on a monopolistic morally level, but things like bundling, where they're bundling unrelated products with the pulse oximeter.

But bottom-line, the studies are undeniable. There are hundreds of independent studies that prove our technology not only just -- not only saves lives and improves eyesights in babies, but reduces costs -- dramatic cost reduction.

The Dartmouth study that I mentioned in the call, they -- in 2010, they showed for just one postsurgical ward, they saved over $1.5 million a year in reduction of ICU transfers and reduction of rapid response team activation.

And after they converted their investment in postsurgical wards to our Patient Safety Net System with Masimo SET, they said they saved $7 million a year. And so anyway I think it's just a lot of good stuff.

Obviously, I'm grateful to our team, our salesforce, and clinical specialists who are doing a phenomenal job both servicing our existing customers and introducing our technology to new ones..

Great. Thank you. And congrats on the quarter..

Thank you..

Thank you..

Thank you. And our next question comes from the line of Lawrence Keusch with Raymond James. Your line is now open..

Good afternoon Joe and Micah. It's John Hsu on for Larry..

Hi John..

Hey guys. So, first question just going back to the shipments, obviously, a little bit higher than you were expecting.

But can you just talk about was there any pull forward or I guess front-loading from the DoD contract? And if so what was that in the quarter? And do you expect that trend to continue in maybe the early part of 2019?.

Well, we have never known what the DoD volumes were going to be. When you the DoD was planning to replace all of their existing monitors with a combination of monitor/defibrillator from ZOLL, a company we've been working with since I think 1996. ZOLL has gone very strong they've -- not only with the DoD, but their EMS business their hospital business.

So, obviously, ZOLL has been a big help with our improvement in our drivers. But if I was going to guess I think the DoD would have been a couple of thousand units at most for us in the quarter. Their volumes would have not been tipping the scale.

I think it's all of our OEMs doing well such as Philips who's doing more and more with us these days, GE doing more and more, and our own direct business which is going very strong..

Yes John just to add to Joe's we're definitely seeing more broad shipments across more of our OEMs as opposed to concentrated with a handful like we've seen in some other quarters. So, things are going very well with the -- both our OEM and direct business in terms of driver shipments..

Great. And then maybe one on the 2019 revenue outlook.

Can you help us think about maybe some of the growth aspirations or I guess assumptions rather underlying for maybe core versus SedLine O3 capnography which you've talked about as some pretty nice opportunities in front of you and then perhaps rainbow as well? Just help us think about maybe some of the sub-components of that growth..

Well, you're going to have to come to the Analyst Day to get that.

I don't know Micah do you want us to talk about that?.

No, I can add to that. John we just want to be consistent with how we talked about earnings. I mean We're seeing strong growth across our neuro products, of course, with SET and rainbow as well this year. Our long-term plan as we talked about it was at it's an 8% to 10% long-term plan.

And this is how we've described it as you've got the core SET business which we said in our long-term plan is 6% to 8% growth. And then you've got rainbow which has been roughly about 10% of our revenues growing 10%. So, you get another point of growth there.

And then our newer categories like capnography SedLine and O3 are about 5% of our business and we said that those are growing 20%. So that adds another point of growth. That gets you to 8% to 10% range. And 2018, we saw growth pretty consistently ahead of all those categories. For 2019, I would just say that we're guiding to 10.7%.

So, we're seeing broad-based strength that's putting us above that 8% to 10% growth rate in those categories. I think that's probably the easiest way I can put it without getting into all the details..

No that's definitely helpful. And maybe just one more on some of the growth differentials there, I believe it was actually at the analyst -- your last Analyst Day that there was a slide showing the potential growth in revenue for Root and some of the newer parameters actually surpassing the rainbow parameters.

So I guess is that still a fair way to think about maybe the near-term prospects say over the next few years for some of those new parameters with Root versus rainbow?.

Yes. Yes I think it is. And if anything, if hospital automation is released, hopefully Root is going to continue that climb to probably bypass rainbow. But we also have as you remember from that slide, we expect rainbow to grow to a serious business as well..

That's right..

Okay, great..

And John, we'd love to have you on May 16 here for our Investor Day because we're going to dive a lot more into those categories especially hospital automation. We'll have a live demonstration. And then we'll discuss more about opioid safety in our base business..

Excellent!.

And I believe you remember at the last Analyst Day, we gave you five new areas that we were -- we had in our pipeline in R&D. We'll be able to share more on where those things are and some of them we'll be able to talk about..

Great, thank you for that. We'll definitely make sure that the date is circled on our calendar. And I guess last one, if I could, just shifting gears a little bit. Following up on Rick's earlier question for uses of cash, just wanted to take your temperature on M&A and maybe any color on the pipeline there? Thank you..

Yes. Let me just summarize. So when we talk about uses of cash of course, I mentioned being opportunistic about share repurchases, of course we want to maintain our investment in R&D and innovation.

And then third is M&A and how we are looking at that and we continue to have a very strong vetting process for things that are coming through the pipeline for M&A. As you know we have financial targets that we use to assess different opportunities as well as strategic targets.

So as we evaluate acquisitions we look at from a strategic standpoint, we want to leverage our signal processing algorithm capability. We feel like that's one of our core strengths our manufacturing capability and then just our clinical presence that we have such a strong clinical presence across the U.S. and globally in the hospital settings.

And as we think about the financial we've talked about, we wanted to find companies that are growing at or better than our long-term growth rates. So they have to be at least 8% to 10% growth on the top line.

We look for things that are going to be accretive to our long-term operating margin goal of 30% and give us a good return on invested capital that's greater than our WAC for over a three to five-year period. So those are some of the things we look at financially strategically.

And a lot of things that are coming more across our desks are more -- are smaller type opportunities. But Joe, go ahead..

I think maybe also as we're seeing our efforts on hospital automation and opioid safety take form and look very, very exciting as potential ways of getting to our goal and our earnings per share target we've discussed before and our operating margins as Micah said we're being more selective on what we're looking at..

Excellent! Thank you for all the color..

I want to thank you all for joining us today and I know I made a hard pitch for you to come in May. We just look forward to seeing you. I hope you can come. Thank you. Thank you for your support and look forward to seeing you all..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone have a wonderful day..