Oct 27, 2008
Executives
Steve Moran – EVP and General Counsel Joe Kiani – Chairman, President and CEO Mark de Raad – EVP, CFO and Secretary
Analysts
Bill Quirk – Piper Jaffray Sara Michelmore – Cowen & Company Matthew Dodds – Citigroup Philip Legendy – Thomas Weisel Partners Tao Levy – Deutsche Bank Joanne Wuensch – BMO Capital Markets Spencer Nam – Summer Street
Operator
Good day ladies and gentlemen, and welcome to the third quarter 2008, Masimo Corporation earnings conference call. My name is Stephanie and I will be your coordinator for today.
At this time all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of the conference.
As a remainder this conference is being recorded for replay purposes. I would now like to turn the call over to your host for today’s call, Mr.
Steve Moran, Executive Vice President, and General Counsel of Masimo; please proceed sir.
Steve Moran
Thank you, Stephanie. Welcome to Masimo’s third fiscal quarter earnings release conference call.
Our press release was distributed about an hour ago. If you have not seen the release and would like to, a copy is posted on the Investor Relations page of our website at www.masimo.com.
On the call today are Joe Kiani, Masimo’s President and Chief Executive Officer, and Mark de Raad, Executive Vice President and Chief Financial Officer. In just a few moments Joe and Mark will deliver remarks on our results achieved during the 2008 third quarter and general comments regarding our business including an update of our fiscal 2008 financial guidance.
After Joe and Mark offer their comments there will be a question-and-answer session in which we will answer as many questions as time permits. Before we begin, let me remind you that this call may contain forward-looking statements.
While these forward-looking statements reflect Masimo’s best current and judgment they are subject to risks and uncertainties that could cause our actual results to vary. Risk factors that could cause Masimo’s actual results to materially differ from our forecast are discussed in detail in our filings with the Securities and Exchange Commission.
With that I would like to turn the call over to Joe Kiani, Chairman and President and CEO.
Joe Kiani
Thank you, Steve. And thank you ladies and gentlemen for joining us on our third quarter 2008 business updates and earnings call.
Earlier today we announced our financial results for our third fiscal quarter. We are happy with the continued adoption of our Masimo SET and Masimo Rainbow SET technology as evidenced by the shipment of an additional 30,700 new drivers into the marketplace with our new Masimo SET or Masimo Rainbow SET, Pulse Oximeters and Pulse CO-Oximeter and exclude our handheld marginal sales.
In fact for the first nine month period ending September 27, 2008, our unit shipments on an annualized basis grew 25% from the total net installed base at end of December 20, 2007. Given the current challenging economic environment, we are happy by the strength in our third quarter product revenues and in general with our overall financial results, including our reported $0.22 per share earnings, which well of our expectation.
In addition to our strong third quarter financial results, which Mark will review with you in more detail; the third fiscal quarter also included some very important business and operational milestone including. (1) In September 2008, Masimo received FDA clearance for our noninvasive total hemoglobin adhesive sensors.
(2) Late quarter three 2008, we initiated a limited release of our hemoglobin parameter for our Rainbow platform. As we have explained before this limited release is not the commercial launch of hemoglobin.
We’d limited the release because as with the release of other Rainbow parameters, we are able improve the robustness of the device for the many different conditions and which that it used based on testing that is done in a limited release stage. We also obtained valuable feedback about adjustments to the way we’ve instruct users on the proper use and operation of our device given the various models of use or devices are subjected to in the various clinical setting.
We still expect to move two commercial release of hemoglobin in early 2009, hopefully in Q1 2009. (3) More independent and objective studies are demonstrating Masimo PVI to be highly predictive of patient fluid responsiveness as presented at the American Society of Anesthesiologist conference, which was held last week.
(4) Shaklee and NIR dismissed all clients against Masimo with prejudice, for no consideration and (5) addition of Executives and changes just for our new opportunities. In Q3, Mr.
Jon Coleman has joined as President of International Business, David Goodman has joined us as Executive Vice President of business development, Rick Fishel, whom has been with us for several years will be leading a worldwide OEM business in addition to his other reasonability and lastly we have sharpen the focus on our sales management of U.S. secured care sales as well as position officers with one promotion and one new higher in leading those two responsibility.
Now, Mark will provide you with the summary of our Q3, 2008 financial highlights including an update of our 2008 guidance. After Mark’s reviews I would like to spend a few moments updating you on the general business.
We’ll then be happy to answer your question. Thank you.
Mark de Raad
Thank you, Joe. Hello everybody.
Please keep in mind that all my comments will relate to financial results on a GAAP basis. As a reminder in fiscal 2007 prior to our initial public offering, Masimo was required to report GAAP earnings per share under the two class method.
For the benefit of our investors we have continued to include in our quarterly earnings releases as we did today, the non-GAAP 2007 financial statements with 2007 earnings per share computations as if the current method had been used in the prior periods. Earlier today we’ve reported record total third quarter revenues of $78.1 million which consisted of record product revenues of $66 million and royalty revenues of $12.1 million.
This represented an approximate 29% increase in year-over-year product revenue growth. As Joe just diluted to, we shipped 30,700 new Pulse Oximeters and Pulse CO-Oximeter units into the marketplace and based on these shipments, we now estimate that our total worldwide installed base net of the estimated retirements to be approximately 540,000 units.
Importantly this is up 25% from the estimated 448,000 net installed units just one year ago. As many of you know, the shipment of new Pulse Oximetry units is important because once installed these units generate future sensor sales which continue to represent the most significant component of our total product solution revenues.
During the third quarter of 2008 in accordance with our revenue recognition policy, we deferred approximately $672,000 of product revenue related to selective long-term sensor purchase agreements, and at the same time recognized approximately $1.9 million of previously deferred product revenue due to the establishment a vendors specific objective evidence related to an undelivered element in one of our long-term sensor agreements. Similarly in the third quarter of 2007, we also deferred approximately 888,000 of product revenue related to selected long-terms sensor purchase agreements and recognized approximately $2 million due to the delivery of our previously undelivered element in one of our long-term sensor agreements.
Our revenue recognition policy will require that we continue to defer revenue on selected contracts until certain delivery criteria have been met. However, today we have been required to recognize deferred revenue for selected contracts in only the third quarters of both 2008 and 2007.
During the third quarter of 2008 we generated approximately $3 million in Rainbow related product revenues compared to $1.6 million in the prior year quarter. This represented an approximate 85% increase in year-over-year Rainbow revenue growth.
Of the record $3 million in Rainbow revenues, Rad-57 revenues accounted for approximately $1.6 million and other Rainbow revenues including sales of Masimo Rainbow SET MX-1 boards, carbon-monoxide methemoglobin and PBI totaled approximately 1.4 million. Our Q3 total hemoglobin revenues from our limited release were not significant.
Third quarter 2008 product revenues generated from our direct business which includes sales through our distributors totaled $52 million or 79% of total product revenues while OEM revenues totaled $14 million or 21% of total product revenues. This compares to approximately 70% and 30% respectively in the prior year periods and is the result of our multi-year investment in our expanding worldwide direct sales force as well as a decline in third quarter 2008 OEM revenues as compared to the same prior year period.
During the third quarter our US product revenues totaled $50million or 76% of total product revenues compared to $40.5 million or 79% in the prior year period. The increase from 21% international revenues in the third quarter of 2007 to 24% in the third quarter of 2008 was primarily due to improved shipments into our European region with notable gains in Germany, France, The United Kingdom, and in addition notable strength in Japan.
Of the three percentage point increase in year-over-year international revenues as a percent of total revenues approximately one-third of this increase was due to the favorable impact of foreign exchange rates. Our third quarter royalty and license fee revenues decreased to $12.1 million from $13.3 million in the prior year period due to the anticipated lower royalty rates associated with our 2006 settlement agreement with Nellcor, now part of Covidien.
As a reminder our settlement agreement with Nellcor included a 15% royalty rate in 2007 and a 13% rate in 2008. Our total third quarter profit margins rose to 66.1% from 63.2% in the same prior year period.
The year-over-year increase was due primarily to the beneficial impact of improved manufacturing efficiencies resulting from higher production levels, a lower US dollar as well as increased Rainbow product sales. Total gross profit margin from the third quarter increased slightly to 71.3% from 70.8% in the same prior year period due to the previously noted contributors to higher product gross margins despite the $1.2 million decline in year-over-year Covidien royalty revenues.
Our third quarter engineering expenses were $6 million compared to $6.5 million in the same prior year period. The year-over-year decrease was due primarily to approximately 450,000 in capitalized software development expenses and a one-time 250,000 research and development refund, excluding these credits engineering expenses would have been $6.7 million up slightly from the prior year quarter due to the slightly higher staffing levels.
Third quarter 2008 net income before taxes was $20.6 million increased from $17.5 million in the prior year quarter. This increase was due to the stronger product revenue and gross margin result despite lower Covidien royalties and higher operating expenses.
Our 2008 third quarter effective tax rate decline to 36.6% from 39.7% in the prior year quarter due to the selected one-time third quarter adjustments for foreign taxes payable and the cumulative benefit of research and development credits. In summary despite the decline of nearly $1.1 million in third quarter 2008 royalty revenues, our strong product revenues higher product gross margins and lower than expected operating expenses combined to generate third quarter 2008 net income of $13.1 million or $0.22 per common share compare to net income of $10.6 million or $0.16 per common share in the same prior year period.
Now I’d like to make just a few comments on our balance sheet. From the three month period ended September 27, 2008 total cash increased to $122.6 million from $96.7 million at December, 2007.
During the nine months ending September 27, 2008 we have generated 52.6 million in cash from operations and approximately $10.9 million in cash from the tax benefit and cash associated with the exercise of stock options. These sources of cash were partially offset by the repayment of approximately $30.3 million in debt about $27 million in the first quarter of 2008 and $5.3 million in capital equipment purchases.
As of September 27, 2008, our day’s sales outstanding of decline to 41 from 44 as of December 2007; during the same periods, our inventory turns have declined to 3.1 from 3.5 at the end of 2007. The slight decline is the result of our stated intention of ensuring that our inventory levels are always sufficient to meet our customers demand as well as building inventory related to new products introductions.
Now, I’d like to make just a few comments on our updated 2008 final guidance. On our July, 2008 earnings call, we updated our fiscal 2008 financial guidance to indicate that we expected our 2008 product revenues to increase to approximately $253 million and total revenues including royalties to be approximately $300 million.
We also indicated that we expected our earnings per common share to be approximately $0.64 per share up from the prior guidance of $0.52. Based on our third quarter financial results and the information available to us as of today, we are updating our guidance for the remainder of 2008.
We now expect our 2008 product revenues to be $256 million and total revenues including royalties to be approximately $303 million. We now also expect our earnings per common share to be approximately $0.71 per share, up from the prior guidance of $0.64 per share.
To reiterate, while we believe this guidance to be appropriate, these are projections and our actual performance could be different. Thank you for your time and now I’ll turn the call back over to Joe.
Joe Kiani
Thank you, Mark. As a reminder, especially for any new investors or potential investors that maybe on this call, I want to reiterate a couple of important messages regarding Masimo and our position within this marketplace, both today and in the future.
(2) Our market share for new pulse oximetry sales are noticeably higher that our market share of pulse oximetry revenues. Business due to the time it takes to have the installed base of pulse oximeters catch up with the annual rate of pulse oximetry shipment.
Within five years due to the accumulation of installed base, our revenue market share should start approaching our annual shipment percentages. (3) We have revolutionized noninvasive patient monitoring again with Rainbow SET.
Masimo Rainbow SET allows clinicians and emergency professionals to measure carbon monoxide, methemoglobin, PVI, and now hemoglobin and oxygen content continuously and noninvasively for the first time along with oxygen saturation, pulse rate and perfusion index, which are consider to gold standard in pulse oximetry marketplace. (4) Analysts have projected that noninvasive hemoglobin, which we refer to SpHb will be $1 dollar or high-end market bringing Masimo’s total potential market opportunity to between $3 billion and $4 billion, but Rainbow is exciting beyond what it will do for us in terms of growth.
With that we hope to help caring clinicians save and improve the lives of even more people. That as I explained, we are currently in our limited release stage with SpHb, the response to SpHb has been encouraging to say belief we hope to release SpHb commercially in earlier 2009.
With that said, I want to end my talk with couple of closing pulse. Our clinical contribution in business model as a lot us to build the solid business with our breakthrough measure through motion pulse oximetry with room to grow as we bridge the gap between our new pulse oximetry shipment and installed base, which drives or sensor sales, which makes of most of our revenue.
We expect Rainbow SET Pulse Oximetry, it have a great impact on patient care and our growth. However, as I have stated before the timing of when we will be in the steep part of the growth curve with any new technology introduction in the patient monitoring field little alone medical field is hard to predict.
The market conditions are rough and we are hearing that the hospital census maybe down, but you can be assure that we will continue to focus on our mission and Improving Patient Care and Reducing Cost of Care by Taking Noninvasive Monitoring to New Sites and Applications regardless of market condition. We run our business for the long-term horizon outlook, we have a great innovation engine and we are eager to solve more of the remaining problems initiative and care provided states and before I turn it back to the moderators, so that we can start taking your questions.
I just would like led you know of one thing that we’ve been discussing, but I think it was time to implement, which is we will not be accepting any calls from our investors and analyst after the end of the fiscal quarter and prior to the quarterly earnings release. We just take that period as the no mans land period and we’ll gutter off waiting to this call and after this call, we’ll be happy to obviously take calls from our dedicated shareholders and analysts.
So with that, back to Stephanie for you.
Operator
(Operator instructions) Your first question comes from the line of Bill Quirk with Piper Jaffray.
Bill Quirk – Piper Jaffray
Joe, first off, thanks for the, for you updating color on total hemoglobin, is there are any feedback from the early access users that you can share with us at this point?
Joe Kiani
Well, yes the feedback has been positive. We’ve obviously have also run to some issues where we have been expecting, but overall I can say that the Limited Release has gone well and has met our expectation.
Bill Quirk – Piper Jaffray
Joe, it sounds from your earlier comment that you should maybe expect to release kind of tail end to the first quarter maybe early second quarter, anything in particular that for the more cautious language? Or is this just kind of everything as expected?
I know you guys that always expected to do to make tweaks, if necessary as they came along?
Joe Kiani
No, this is just I think moreover the same in that we’ve seen this Limited Release goal as expected and we expect both from things we’ve planned to do before our commercial launch as well as the feedback we’ve gathered from our customers in the Limited Release space, we’re going to take that feedback as well and add them all together and a hopefully in early 2009 as do commercial launch.
Bill Quirk – Piper Jaffray
Okay, very good, a couple of questions for Mark. Mark, really strong operating margin performance, if you exclude the royalty it frankly looks like you doubled it sequentially, where there any one-time items in SG&A?
Or are we just trying to see the leverage from the sales force ads in 2007 and into our first part 2008?
Mark de Raad
For build the two items that I mentioned in engineering certainly were one-time items that impacted SG&A in the aggregate, but specifically in that category, no there is nothing unique, I think the one thing that we did not do as we had initially expected was the rate of hiring during the quarter and so that we did not bringing as many people had a contribute in impact on the overall lower than expect G&A expenses.
Bill Quirk – Piper Jaffray
Okay guys, so nothing other than the two items you mentioned engineering.
Mark de Raad
Correct.
Bill Quirk – Piper Jaffray
Okay great and then last question from me and then I’ll jump on your is the in term of the tax rates we expect that you go back to about 39% in the fourth quarter.
Mark de Raad
From what we can now yes, that would be right, that’s why I noted at they were onetime true up adjustments in the third quarter.
Operator
Your next question comes from Sara Michelmore with Cowen & Company.
Sara Michelmore – Cowen & Company
I guess just a couple of question. Joe, if you kind of gone through this prelaunch activity.
What are your latest thoughts in terms of pricing of the total hemoglobin product and what type of data have you kind of look that are footprint the customers in terms of kind you have discussion some of about pricing. Thanks.
Joe Kiani
First of all there has been no change in our pricing thought as I think guys even though a kind of an extension of our development phase limited release. The limited release customers have been paying customers and so nothing really have happened on the limited release front or nor our contact with our customers let us believe that we need to change our pricing that we shared with you on the last earnings call.
Sara Michelmore – Cowen & Company
Okay and could you give us a quick progress report general on methemoglobin and CO? I know that there secondary to the total hemoglobin opportunity, but just give us a sense where you are with those products and actually true in that PVI or relative.
Thanks
Joe Kiani
Sure. As Mark, I think he mentioned then we added in our press release, we had a really good Rainbow quarter.
We grew, I believe 85% compares to the same quarter last year. A lot of that actually was from sale of CO methemoglobin and PVI to the cute care market, not just EMS market.
So, we are happy to see the traction that these measurements are having in the hospital of obviously that you can imagine then maybe we have the hemoglobin excitement is more, but CO and meth and PVI are doing a great job kind of coming up on that S-curve that I mentioned several quarters ago.
Sara Michelmore – Cowen & Company
Okay and lastly a question for Mark. Mark you had talked a little bit about the impact of foreign exchange on the P&L this quarter with the rates kind of going a different direction here.
Can you just talk us through any considerations in terms of how would strong dollar effects P&L? Thanks.
Mark de Raad
Sure, we’re actually uniquely situated in the sense that the foreign exchange exposure that we have on our revenue line is essentially offset by the same exposure on our operating expense line. So, in reality what we gain or lose on the revenue line, we offset on the operating expense line in general.
This particular quarter, obviously the last four to six weeks have been significantly volatile in the foreign exchange marketplace. The strengthening of the U.S.
dollar against the euro would in most cases result in a negative impact on our revenues. However, the corresponding strength of the yen against the dollar in this particular case is going to in a sense act as a natural hedge for us as long as those kinds of movements and rates continue for the rest of this quarter.
So the summary is that we’re actually, despite not having any active hedging strategy in place, our core business is essentially hedged from an operating income standpoint basis.
Operator
Your next question comes from the line of Matthew Dodds with Citigroup.
Matthew Dodds – Citigroup
Joe Kiani
Let me take your first question. Is this Matt or is it Gregg?
Matthew Dodds – Citigroup
No, it’s Matt this time Joe.
Joe Kiani
Who I’m honored man, to answer your question, no the CapEx issue has not does not at all or has not to-date I should say effect the hospital contracts that we sign up hence that all of that comes from the operating business of the hospital and you want to Mark answer the second question.
Matthew Dodds – Citigroup
Sure.
Mark de Raad
Yes and I think Matt, the answer to your question on the Rad-57 in a sense it was a little bit below where we were last quarter. I think is certainly on the one hand related to the economic environment our sales organization is telling us that on occasion they are running into situations were budgets have been impacted however, more importantly what we know is that the summer quarter for this product has traditionally been the lightest quarter for us and having said that we are already beginning to see some very encouraging science for Q4.
So, those are two primary reasons for the quarter-over-quarter reduction in Rad-57 revenues.
Matthew Dodds – Citigroup
Right. Thanks, Mark; thanks, Jeff.
Mark de Raad
Thank you.
Operator
(Operator instructions) Your next question comes from Philip Legendy with Thomas Weisel Partners.
Philip Legendy – Thomas Weisel Partners
Good afternoon gentlemen. I’d like to drilldown for a moment on the hemoglobin center, so you are not surprised.
Maybe you mentioned that the final version of the sensor will incorporate some improvements over the data version maybe to layout for us sort of specifically what you’re focused on in those improvements?
Joe Kiani
Well, I can’t get into all the technical details for good reason, but I can tell you that the product that we think is commercially valuable from a maximum perspective isn’t being, what’s being trial today at limited to least accounts. They have known that yet they were anxious to get their hands on it and to assist us with the refinement before we launch it.
I think in your report, you had mentioned that we were expecting to go from a perfusion limit of about 0.5 to 0.25, that is correct. However, I think in your report you would mention, when you were doing the non-scientific observation that in orders about 20% of the time.
Let me make sure I get it right. Basically this whole anecdotal experience is based on watching, but not counting many times this number of customers testing the products over today is that roughly 20% had perfusion in that leading two load to generated hemoglobin single as we discussed obviously you don’t mean by that we didn’t pickup at rather than those were time where perfusion were one or less and our sales reflecting, I told you that one perfusion is one or less, you might get a little comp message.
Philip Legendy – Thomas Weisel Partners
I think may be financial question, but I think maybe just one think I’m share with you although, the provision became an issue of decision. The first pulse oximetry they were launched in 1980s like 81, 82, 83 timeframe, their profusion limit actually with the same as what we have in this limited release database and it wasn’t until about 10-years later maybe even 15-years later that their Perfusion limit improved to about the same amount that ours will be when we launched it actually commercially for the first time.
So obviously, our – I guess expectation of what a product should do is different than what successful products and the marketplace have done. We have beheld of the higher measures, but I hope that answers your question.
Philip Legendy – Thomas Weisel Partners
That’s helpful and yes that’s true. We had a little bit of gulch in the text there it should have been below the limit of one and knock that no signal.
Wonder if you could lay-off for us as well the strategy of how you’re going to physically get the hemoglobin sensors into the side SET don’t already have Rainbow ready hardware, is it going to be an adaptor or a box on top of a box or just logistically how will that work?
Joe Kiani
Well, Philip that place is dead to-date have radicals or Radical-7, we will probably replace those with the new Radical-7. The places that, it depends on a vintage of other way, sometimes we’ll be able to just do the software upgrade its just radical, we all have to go replacement of this Radical-7.
We can do a software upgrade the place as that don’t have any Masimo devices at all, we will have to place the brand new Radical-7 and as I’ve mentioned in our previous call, we have not seen our patterns where whether our customers had a software upgradeable radical device, or not we’ve not seen that to be a driving factor of interest for hemoglobin.
Philip Legendy – Thomas Weisel Partners
I guess what I’m focusing on is for those customers who have use Masimo as a part of a larger monitoring unit, who have an OEM system, how will you make that, that’s about 80% I believe if the installed base and how you’ll be making hemoglobin available to that hardware infrastructure?
Joe Kiani
I see, thank you. I understand your question better now.
So we have two excellent distribution channel, one of them is our direct distribution channel, which includes our distribution, our distributor network, the other is our OEM and we’ve pride ourselves on both. We have seen interest of all of our OEMs, I don’t think I am exaggerating, but I think of all of our OEMs a lot of a keen interest of having Rainbow having hemoglobin and we have to-date signed up over 10 companies that are going to be providing that; we’re in negotiation with all the rest.
However, I believe that unlike of Oximetry, which not having it as an OEM option, we meaning inside other companies product was a measurement that was significant to the adoption of our SET SpO2 technology. I don’t believe that’s the case with Rainbow, so until we do sign up with the OEM companies which we hope to an intent as long as we get commercially good terms that we think is there given the value of bringing in until then we are going to be offering Radical-7.
It has the very flexible way of mounting other equipment to make it seem like its part of the overall system in the OR or the ICU as well as they has very flexible connectivity it allow us to share the data that it has to the systems that I need to share it with.
Philip Legendy – Thomas Weisel Partners
And then last question I guess either Mark or Joe would you remind us how the arrangement with Masimo labs affect the economic of the hemoglobin sensor to mother Masimo if you will?
Mark de Raad
You mean from a financial statement standpoint Philip.
Philip Legendy – Thomas Weisel Partners
Perhaps, not necessarily from a technical accounting perspective, what’s the royalty I think there is sliding scale just kind of how does that work.
Mark de Raad
Sure, if we go back to beginning in 2006 the royalty rate while the royalty rate exist between Masimo labs and Masimo Corp at about 10% of the value of Rainbow technology that sold by Masimo Corp. so that’s a royalty that is an essence paid back to Masimo labs and that the royalty rate of subject to certain a minimum royalty commitments in each year and for the fist couple of years we have been operating at the minimum royalty rate level.
Philip Legendy – Thomas Weisel Partners
Okay, and that hemoglobin will fall directly under that same kind of arrangements?
Mark de Raad
Correct
Operator
Your next question comes from Tao Levy with Deutsche Bank
Tao Levy – Deutsche Bank
Hi, good afternoon. A couple of questions on my end, Joe so you’ve done the Limited Release of hemoglobin now for the past few weeks and maybe you could give us a sense of how that launch is going with some specific?
What you’re doctors seeing that they haven’t been able to see before, has there been any even just anecdotal evidence of better patient care and also anything that can give you any at least us some clues us to how the uptake of hemoglobin is going to pan out once you launch it based on what you’ve seen in the limited released so far?
Joe Kiani
Okay, sure. Well, first of all the anecdotal response has been that overall as been clinically very valuable.
We have some people get very excited and in fact in one of our accounts in Sri Lanka there’s a whole press about it and the Prime Minister has gotten involve in it so it is exciting. Today we have only build about half the orders that we’ve received for hemoglobin and we intend to over it to the next couple of months, to expand our Limited Release as we’ve mentioned.
We were trying 10 to 20 hospitals and my expectation is that will be what we will do. During the Limited Release stage, there is a possibility we might expand that up to 50 hospitals, but it’s just going to depend on kind of the timing when were feeling good enough for commercial launch versus how we feel about further expansion into hospitals without the commercial spot.
Tao Levy – Deutsche Bank
And when you talk about Limited Release as a hospital, free order as the many as long your part of one of the selected hospitals or even within those hospitals they only get a small percentage or what that like to have?
Joe Kiani
A good question. Once the hospital is a Limited Release hospital, we allow them to order as many as they want.
The reason we’re kind of keeping it tighter in terms of number of hospitals, is because we want maximum personnel to be there so that we can first hand observe, the usage of the product as well as get immediate feedback of any issues so that it can addressed in the upcoming release of new software and censors that we expect to be the commercial part.
Tao Levy – Deutsche Bank
And when are you currently just – I think the one that’s out there is the reusable version? When do you expect to have the disposable sort of out in the marketplace and is that going to be, are you going to be a Limited Release of that version of that devices alone?
Joe Kiani
Yes, we expect to do a Limited Release of that version as well that adhesive sensors should be available to our Limited Release account in this quarter.
Tao Levy – Deutsche Bank
Just final question for Mark. On the tax rate, I think since your product question you talked about the tax rate going back up in the fourth quarter.
I thought it would have gone down with R&D tax credit being past and also I assuming in your guidance and I don’t know what type of sales you might see, but I think you have an extra selling week in the fourth quarter and how should we think about that as it relates to your business?
Mark de Raad
Sure, as I said earlier that we’re a couple there are actually three specific items that help drive down the effective tax rate in the third quarter and that slides of suggested to build earlier that our best estimate is going to climb back to about the 38% to 39% in the fourth quarter which to your point is still down from a year ago and it would be down because of what you mentioned the finalization of the R&D tax credit, so we will still see a benefited out in the quarter relative to the year ago quarter, but we will be up a little most likely from the third quarter. The second question, the irony of that is if you actually look at the number of shipping days in the quarter while on the calendar, there is actually an extra week the number of shipping days for us I think it actually comes to about one extra shipping day over the prior year, so we don’t expect that to at to have a dramatic impact on year-over-year numbers.
Operator
Your next question comes from the line of Joanne Wuensch with BMO Capital Markets
Joanne Wuensch – BMO Capital Markets
Do we get to gross margins, which improved considerably year-over-year, is there something in particular which help the COGS line in the third quarter and should we think of this is sort of base case going forward rate.
Joe Kiani
The answer is they are really multiple elements that impacted the strong gross margin performance that the one thing I mentioned before primarily the efficient fees that we are seeing from higher volume levels obviously there is a certain element in our COGS structure that’s fixed and so clearly as revenues continue to accelerate we’re seeing that benefit of those fixed expenses drop to the bottom-line so that component certainly should continue. The other element that I mentioned before was that we did have again curtsey of exchange rate moment.
We’ve actually had a bit more positive impact on a year-over-year basis in terms of the gross margin because of course the revenues are more valuable in U.S. dollar terms against a fixed U.S.
dollar cost structure. So, we have a little bit of benefit of that in the third quarter and then the last element was the just the increase of the Rainbow revenue that Joe alluded to you before.
The fact that nearly half of our Rainbow revenues this quarter were from what I would call non-traditional Rainbows for us, traditionally its been the Rad-57, which of course is a handheld device that has a more normal margin structure versus of course the introduction of many of the Rainbow parameters including Met, CO and PVI and of course those are primarily software like margins for us. So, that the fact that increased dramatically this quarter was another element that contributed to the higher margins.
Joanne Wuensch – BMO Capital Markets
Okay. When I think about next after hemoglobin if it’s respiratory monitoring; could you give us an update, where you are with that technology iteration?
Joe Kiani
Hi, Joanne; this is Joe. The respiration monitoring the plans have not changed, we hope to make that product available on a limited release to our customers in Q3, 2009.
Joanne Wuensch – BMO Capital Markets
And then a final question, and list me the same my knowledge gap for me, which is when I take a look at the pulse oximetry units, which are retired in the quarter, they’re relatively flat with the previous quarter, but down about 16% year-over-year. Is there a pattern to those being retired and taken-off the shelves?
Mark de Raad
Not really Joanne, we actually track our shipments back seven years and so what you’re seeing in a fact every quarter is the retirement of what we’re shipped seven years ago. So, obviously seven years ago there were some fluctuation in our quarterly driver shipment and so you just essentially seeing that unwind now, but I think I’m safe in saying that the average rate of actually would have fallen off each quarter or probably if you’re in about the 5,000 to 6,000 per quarter range you’re probably in about the right zone and most of our historical data suggests that that’s about where we’ll be.
Sometimes a little bit lower, maybe as low as 4.5 or so and sometimes as maybe as high as 6.5, but that’s the range of retirements that we see.
Joanne Wuensch – BMO Capital Markets
Okay, very helpful. Thank you.
Operator
Your next question comes from Spencer Nam with Summer Street.
Spencer Nam – Summer Street
Thanks for taking my questions. I just have a couple of good questions; this limited launch sites, are they paying for these hemoglobin test right now?
Joe Kiani
Yes they are.
Spencer Nam – Summer Street
And do we have a pricing information on that?
Joe Kiani
Yes, we provided with the last conference call, but basically the stock where at still just one the limited release. It could been between 28,000 with my estimate that these customers are getting in force $8,000 within the volume and even that were at this point only selling you Rainbow SET to the useable sensors not (inaudible) I believe those are selling for about $1,000 each, so I hope that helps.
Spencer Nam – Summer Street Research
Great this is helpful and can we assume that once the national launch takes place for the hemoglobin test that these are initial sides would the customers?
Joe Kiani
Yes, just I think so, we need their customers that…
Spencer Nam – Summer Street Research
They have basically signed up to be a full time customer?
Joe Kiani
Yes, this is not just a temporary customer site, these are regular customers that are willing to be part of our last pace of the product development before we launch.
Spencer Nam – Summer Street Research
Okay and than just looking at the guidance couple of questions may be I missed on this, you raised the EPS guidance for the rest of the year, what is driving that?
Mark de Raad
I think it was the combination number one of our confidence and looking-forward that our fourth quarter revenues and as I alluded to earlier we surprised ourselves actually what the level of operating expenses of this quarter and so, what we except the usual significant increase as we had into the fourth quarter in terms of operating expenses. We’re going to stating at a lower base, so the combination of those two factors are really gave us the opportunity to adjust at guidance upward.
Spencer Nam – Summer Street Research
Great and than if I remember from the beginning of the year that the way that you, the management was guiding for the – in explaining the guidance was that you would make one update on the guidance and unless there is a – in a substantial reason to update the guidance you would not make any updates during the year and then we’ve seen any guidance update last quarter, which I think it was appropriate. We are also seeing on this quarter in terms of revenue line, which is somewhat a minor.
It appears to be in $3 million, which is material, but not significant. I was just wondering, If whether we should expect sort of the quarterly updates on guidance for upcoming quarter or the upcoming year whether what this should be considered as a sort of a standard, the operating procedures for you guys?
Joe Kiani
Well, Spencer I think the answer to that frankly is it all depends and clearly in this quarter with only one quarter left in the year and the fact that we had a very strong third quarter, put us in a position where obviously if we didn’t change our guidance the implications would have been that we expected a less robust fourth quarter, which certainly we don’t. So given that situation we thought it was prudent for us to come out and update to avoid any perception that the fourth quarter might be down form the third quarter and so that why we came out with that guidance, but philosophically we have not changed our position and that is that we will come out with one guidance for the entire year.
Obviously that typically occurs at the start of the year and at the start of the year there is a little bit more time for events to occur throughout the year. As we head towards the fourth quarter that window is dramatically reduced and so I think we will continue to the stick basic premise of annual guidance, but when appropriate and when we feel we need to, we will make an update.
Operator
Your next question is a follow up from Bill Quirk with Piper Jaffray
Bill Quirk – Piper Jaffray
Mark just a real quick housekeeping question, can you tell us what the CapEx expense as well as the depreciation amortization were?
Mark de Raad
In just the quarter?
Bill Quirk – Piper Jaffray
Yes, please just the third quarter.
Mark de Raad
Now let me I don’t know if I have got that right handy, why don’t I get back to you on that.
Bill Quirk – Piper Jaffray
That’s fine.
Joe Kiani
Stephanie, I think maybe we have time for one more question.
Operator
(Operator instructions)
Joe Kiani
And if there are no other questions, then we are going to say good bye and we look forward to our next call in 2009. Thank you so much all for joining us today.
Operator
At this time, there is no further questions.
Joe Kiani
Thank you, bye-bye.
Operator
Thank you. This concludes today’s conference call.
You may now disconnect.