Masimo Corporation (MASI) Earnings Call Transcript & Summary

Well, good afternoon, everyone, and welcome to the Morgan Stanley Healthcare Conference 2020, as we wrap up our last medical device presentation of the fourth day. One very exciting half day tomorrow. We've been sticking with the same theme all day, which has been growth. And it's a pleasure for us to have Masimo with us today and their EVP, CFO, Micah Young. Obviously, I'm David Lewis, medical device analyst at Morgan Stanley, and as I've been saying all day, make sure before we begin, you go to Morgan Stanley research disclosures website, /researchdisclosures and see fun facts about me. Micah is kind enough to give us a brief overview of Masimo real quick, and then we're going to jump into Q&A. Micah, the floor is yours.

All right. Thank you, David. Yes, I just want to give a brief overview. So we have a strong history here at Masimo of innovation, and it really started with our SET pulse oximetry, that's our signal [ extraction ] technology. That's basically an LED sensor technology that shines light through the finger or the tissue to measure the level of oxygen in the blood. It really changed the way pulse oximeters work. At the time, there are 70% to 90% false alarms given by oximeters, due to their inability to measure their motion when a patient moves or low blood circulation, what we call low perfusion. Masimo SET, what we did was we separated the arterial signal from the venous signal because you would get a false low oxygen read from the venous signal. So we separate that in real time, and we're able to measure it through that noise. So we're the first company to get an accuracy specification for motion. And at the time, it was plus or minus [ 3% ]. We've improved that recently to plus or minus 1.5%. And what's happened is hospitals learn to trust our technology, the accuracy of it. And SET's been an expandable platform for us. We've been able to expand that technology portfolio, we've gone from 2 LED sensors to 8 LED with over a dozen measurements. When you start to look at rainbow, capnography, SedLine and O3. All those different parameters that we can measure. In hospitals, we've been able to expand that platform across a continuum of care, whether it's OR or the general floor from the hospital and now recently into the home. We have a very strong business model that really is kind of a razor or razor blade [ model ]. We have a large and growing installed base of what you could quote call "razors", which is our monitoring equipment and technology boards that go into our OEM monitors as well. And that installed base grew 13% last quarter to over 2 million drivers. Historically, that's grown mid-single digits in terms of the installed base and of course, we've been increasing our revenues per driver over time with more and more technologies coming out. We have a durable recurring revenue stream. We typically contract alongside of the capital cells, 5 to 7-year contracts for the sensors, and we have a high retention rate, over 98% on those contracts. We're in over 150 countries now monitoring over 100 million patients per year, and we've seen tremendous growth, especially this year with COVID and the need for our technologies to treat a severe respiratory illness like COVID-19. Just a quick overview on the markets we serve are -- we kind of break it down into 3 categories, which I'm sure we'll talk about here, David, is as core parameters where we have SET pulse oximetry, rainbow, total hemoglobin monitoring, continuously, as well as our advanced parameters, like capnography and gas monitoring, and brain monitoring, so SedLine and O3. And that's about a $3.5 billion market opportunity with those -- all those parameters, growing, we believe, the $4.5 billion by 2025. And our long-range plan has us growing about 8% to 10%. And we've been growing here recently closer to 12% so far. And there's multiple opportunities here for upside with what we can do with hospital automation. That's another large market. That's about a $1.5 billion market that provides upside opportunity to our long-term plan. As well as here recently, you've seen us launch a lot of products in our home-based care in terms of telehealth. So kind of hospital to home. And we believe that, that's at least a $4 billion market opportunity when you think about treating opioid patients who are prescribed post surgery or for long-term chronic pain patients, alone. And there's some other things we can do with that platform. So I want to turn it back to you for some Q&A, but I just wanted to give an overview there.

Great. Thanks, Micah, and very helpful, specifically the audience aren't as familiar with the story. So look, you started with COVID, or we talked about COVID, and that's obviously been the theme of this conference. Product revenues were up a 30% second quarter orders were up 200% or 175% in that quarter. So the question is to you that's pretty significant demand. What have you seen in sort of that demand post the quarter as you kind of progressed through the summer?

Yes. So in July, we mentioned on our last earnings call, for the month of July, we saw our worldwide sales orders up 40%, driven by another 150% increase in capital orders. So that was very strong, again, as we're headed into Q3. We're expecting -- last quarter, we shipped over 165,000 drivers. This quarter, in the third quarter, we're expecting at least another 140,000. So we can see our installed base probably grow at least exiting this year about 15%. So strong demand for monitoring equipment, especially around pulse oximetry. We also saw some very strong demand for our group in Vital Signs. That was up nearly 5x last quarter as well, and we saw an increase in installations of patients taking that up about 10%, which is very good for not only hospital automation, but also the opportunity for general for monitoring. In terms of our sensors, we've seen that -- the trends there we've seen, we were down as much as 20% at one point during the last quarter. We ended up settling in. Our worldwide sensors were down 8%. U.S. was down a little further than that. July was down about 11%. So we've seen a nice, steady trend back in terms of our volumes compared to pre-COVID volumes. I would say in July, we think it's probably about an 80%, 85% of the volumes that we saw pre-COVID levels.

Okay. So do you think the post-COVID demand, the reason why that's still -- I'm just trying to get a sense of the underlying demand for the business, underlying driver placements versus COVID, most cap equipment companies, [indiscernible] beds, ventilators and we have some exposure to ventilator boards as well. We can talk about. I'm just trying to get a sense of other cap equipment companies that had a cheap pandemic response are seeing pretty significant shortfalls or just [ about ] resting of their momentum. I wonder, are you also seeing that, or you're seeing more downstream demand as hospitals realize that we don't need a new bed? But we need a better way of monitoring acute care patients across the broader organization. So we can add pulse ox to med-surg beds, not just buying in the rights to new beds. So how do we understand underlying demand versus any risk that we're going to have to see in acute normalization of trends?

Absolutely. We've been very close with our customers, especially with the ones we're selling the equipment in directly with. And what we're hearing is, even though they're working to increase capacity, going from lower acuity beds to higher acuity beds for potential surge in patients who -- treating that backlog of demand of the disease load that's out there, more broadly. They are still looking and saying, well, we've got an opportunity to move and do more monitoring on the general floor. And that's kind of what we're seeing in the trends. It's what we're seeing in the ordering patterns of the equipment that they're ordering. The other thing we're hearing, too, is even though hospitals have lost significant cash flow with procedures being deferred for a period of time, that's put a lot of strains on the capital budgets. And I think what we're hearing, though, is that there's still a demand for pulse oximetry. They may be shaving back on budgets elsewhere. But this is a respiratory disease. We've got a flu season coming in and combined with COVID, and they're preparing for that. I think the demand is still there for pulse oximetry.

Okay. You did lower your outlook for boards for ventilators a little bit on the second quarter. And then since that time, you've seen more public announcements about sort of ventilator demand shortfall. It's not a very big business, to be honest with you. But is that an incremental risk?

No. Because I mean, if you look at the revenue tied to those boards, it's very -- it's very immaterial from a revenue standpoint on what we get per board. And we've seen that pull back. What we've been saying all year long, though, is we believe that the core boards, the 450,000, whether or not we get that additional 50,000 of ventilator orders, that should give us that increase in our installed base that where we'll exit this year at 15%. So that's kind of what we've focused on because we believe that -- those are the boards that are going to be consuming sensors moving forward.

Okay. And one of the other companies that was at this conference, their CEO Steve MacMillan and Hologic. He's obviously benefiting also from COVID-related dynamics, specifically diagnostics. So their debate is he's placing a lot of new [indiscernible] or molecular diagnostic systems and people say, "Hey, once you place these systems, we're going to have to demand pull-through? Look, you're placing a dramatic number of drivers here. And you'd like to believe, at some point, there's going to be pull-through, how have you started the work to sort of quantify what the full impact could be? I mean, you can say, " Look, you're only going to use these things as a acute respiratory distress, but that's actually not necessarily true. In some cases, you're just going to democratize pulse oximetry across a hospital system that perhaps wasn't using it as often. And Maybe now that they have it, they're just going to use it. So how have you worked to quantify what the downstream SET opportunity could be based on the significant its stock-based improvement?

Yes. I mean, what -- we have a lot more visibility into our direct business. So if you think about the drivers where we have 20%, 25% of our drivers that we ship, are tied to our direct sales to customers. And we've been staying very close. We hear that the utility will be there as they're looking at the used case as monitoring continuously with pulse oximetry for patients who are post -- after surgery, they're prescribed opioids, and they're on the general floor. And if you look at that, I mean, today, the general floor is very underpenetrated. Probably -- it's about 10% penetration because it's not the standard of care today. So what we're seeing is we think that there's going to be a greater shift there, and we're hearing it from our direct customers. What we don't know yet is we're still working through the OEM side of the business because we, typically, are on the front end of that demand, where we provide the technology board that goes into their multi-parameter monitor. And I think we're going to learn more about that as we go alongside our OEM partners and sensor side of the business with those customers. So I think we've got good line of sight on the direct business. And I think that, that's where we are seeing a shift more towards monitoring on the general floor.

Okay. So it sounds like that this COVID-driven demand is durable, at least for the near term?

We believe so. Yes.

And then like a [ Beebe ] and a Baxter, you also are exposed to what we call patient or hospital census. If you have less people in the hospital you have to sell less pulse ox sensors. So that business is coming back. It sounds like similar to how a MedTech procedure company would come back. Is there a kind of concern that's going to come back to a certain level, you, I think, you said sort of 80%, 85%. It's going to sit there for a while. But how do you think that business recovers? And when would you expect that core business to get back to normal?

Yes. And you're talking about the volumes of the 80 -- what we saw in July, the 80%, 85%?

Yes.

Yes. So we're hopeful, based on what we're seeing, that the way it's trending, that we believe it will get back to at least 90%. The question is going to be that last 5% to 10%. I think it's going to come down to patients' confidence going back into the hospital. And I think the trends would tell you that we're heading back there. I think that you've seen some other companies, I've seen some of the other presentations, and they're seeing similar trends in the data points. So I think there was a company 2 days ago that showed a trend line on medical device procedures that was improving even in August over July, and I think those are some of the trends that we're seeing as well.

Okay. So you're improving pretty much. There's similar trends that we're seeing across the conference, which is encouraging. And one other thing I've done with my company at this conference is looking at, talking just very loosely about '21 versus 2019. And I don't have a model on your company, so I can really go crazy. But look, your -- the Street consensus number from Masimo are kind of 22% above. 21% is 22% above 2019. And at a first plus, I said, look, this business has been growing. You say 8 to 10, let's be honest, you've been doing better than that these last couple of years. So 22% of at best, kind of, 11% per annum on an underlying basis. I say, on one hand, that seems very achievable. Then I don't know because I feel like you have this underlying demand that's going to pull SET pull-through next year, but then you have these awkward costs. So how should investors sort of think about next year, should we be overly concerned about this very challenging comparable?

I think, the most important way to look at this is we will have some tough comps on capital. No question because once capital gets back to normal levels, and normal levels for us are about 60,000 drivers per quarter. And we think that, that's kind of where it'll go back to normal placement cycles there next year, but it's still early. We're still trying to figure out the puts and takes there. But the most important thing is we are going to exit this year with installed base growth of 15%. So if we can get sensor volumes back to the pre-COVID levels, and then you've got an installed base that's up 15%. Even if utilization is a little lower to start out, we should see an acceleration in our sensor growth that is in a much better position than we were at pre-COVID. And I think that's what's important for the long-term growth of this company.

Sure. So net-net, Micah, you're kind of saying, we could see some capital headwinds over this downstream. Sensor, what we talked about earlier, kind of net out. It's not the same to think like this business can just continue to grow kind of on the underlying trend. It's been growing [indiscernible].

That's right. That's one way to look at it. Yes.

How do you feel about margins? Same kind of dynamic, I mean, I forget the core GL on your sensor business. Obviously, I know, it's higher than hardware. But does that give you kind of a positive mix shift as you head into '21 as well. So I think about GNs in that upper 60s range. I felt that there should be some upward mobility there as well.

Yes, absolutely. We came into the year guiding to 68%. We've seen a lot of pressure on margins due to the high capital mix with sensors being down and capital being up, probably impacted us about 400 basis points last quarter. So if you were to normalize that mix, we would have been around that 68%. Now we've also had some challenges with keeping our workers safe, providing the right social distancing, and that's impacted some of our costs in the manufacturing plan as well as across the company, just like every other company, but we believe that we can still get back on track as we go into next year in those high 60s and continue to get back on track in terms of the margin profile we're trying to expand, which is gross margins back in that 68%, growing about 50 basis points per year.

Okay. Well, let's transition to the -- one of the big businesses that I came down at the Analyst Day as well. And automation -- hospitalization is a huge focus of that day as was hospital to home. What was -- what kind of traction were you seeing? I know it wasn't that much time to build out that business, but what kind of traction were you seeing in things like Root prior to COVID and what has COVID done to that hospital automation business?

Yes, absolutely. I mean, one of the biggest things we saw here, just more recently in the second quarter was that Root sales were up 5x what they were last year and nearly what we sold all of last year. So we've had strong demand in addition to the installations we've seen on patient SafetyNet. When we were -- last year, as we exited the year, we had about 20 customers who had deployed our full automation suite. So we just deployed that starting last year. So we've made some very good inroads and traction there and then as you know, we acquired the Connected Care business from NantHealth, and that's given us some acceleration of that footprint and given us some opportunities to pull-through more revenue opportunities as well as the full automation suite. So we acquired just over 400 customers from that acquisition. We also acquired a very capable sales team and implementation team. We were trying to build that out ourselves, and we were able to acquire it through the acquisition. So strategically, that was a great fit for our company. And there's a lot of synergies in terms of the opportunity to pull-through in that customer base, other parameter revenue for us because we had very little overlap there. So we're making progress there on the hospital automation front. And now that hospitals are starting to contract again, we're excited about the opportunity to gain some more momentum on some of those implementations.

And this 5x number you gave us, Micah, is this that hospitals were realizing they need more connected information to manage patients in these kind of acute pandemic times? Or is this just you sold dramatic amount of peripherals that have to get tied together? Or is it just reflective of the underlying momentum you've had in the COVID, it's pretty hard for me to tease out those 3 trends within that 5x number.