Masimo Corporation (MASI) Earnings Call Transcript & Summary

Chief Financial Officer. Is Micah here? I don't know, Eli Kammerman, Vice President, Business Development, Investor Relations, man about town, many other good things. Thank you both for being here.

This is a great time to talk to you about the reaction to the third quarter sort of fundamentals generally. We're going to talk about the fourth quarter trends, early thoughts about the outlook. And of course, I know you said, Micah, you can tell us all the details about the Analyst Meeting and the bottom line, and so we can all be ready. But seriously, let's start with the reaction to the quarter. I think people were, I don't think it's too much to say, shocked and surprised at the early -- some of your early commentary about currency pressures on the '23 top line margin performance. I just assumed right or wrong $0.50 of FX impact and $0.15 of interest -- extra interest. Did -- do you think -- how can I put this? I feel like you've always set up the next year in the 5 years you've been there, 6 years conservatively, carefully, thoughtfully, prudently. Is this Micah being Micah? Did Eli make you do this? I mean it's like talk to us about the factors behind your input and the setup for next year.

Yes. So Rick, when we came out of the second quarter, so we had our second quarter results laid out. A lot of the margin -- or the FX headwinds. If you go back and look at our investor presentation coming out of Q2, I laid out -- the guidance was changing about $44 million of headwinds incrementally from Q2 guidance to Q3. And that was dropping through. We were seeing a drop-through rate of about 57%, so about $25 million on the $44 million. What I was concerned about when I exited Q2 and we started seeing consensus numbers rolling in was -- and I started looking out at '23. And I was concerned that things weren't being considered as far as FX headwinds as they annualize out next year. And we saw even -- throughout this past year, we've seen the dollar strengthening against our major currencies. If you get the euros probably as our top currency, it's strengthened about 10% against the euro over the past year, and it's -- the dollar strengthened about 20% against the yen, which is probably our second major currency. And that got even more persistent as far as those headwinds as we got into Q3 -- throughout Q3. We saw the dollar strengthen more. So the one thing I want to make sure was if you look at this year's revenue mix, and we're still working through the plans for next year, but based on this year's revenue, the mix, those headwinds were significant, and I was concerned that those were not being factored into next year. So I was very intentional on the earnings call. I had in my prepared remarks that we -- based on current FX rates that they hold where they are today and where revenue mix is today, we see about $70 million of headwinds next year on the top line. And if that drops through at the rate that we saw going from our prior guidance to current guidance, we felt that, that was -- got to see about $0.57 on the dollar, which is a big impact on next year. So I want to make sure that those were being thought through because we still see good results on a constant currency organic growth of the business, but we felt that those headwinds were not being factored in. So that was one thing. Number two, we've had a year of supply chain challenges. I think we've done a great job of navigating the team. The global team has done a great job navigating those headwinds in the past through COVID, some of the most challenging years that I've seen. But they navigated through them, but we're now starting to see some of those costs playing into the -- into our P&L. And I want to make sure that those are being thought through as well. So one thing I signaled was, if you look at our Q4 guidance, which really didn't change a lot from a gross margin standpoint from the prior guidance, but I didn't feel like those were being factored in as well. So those -- the gross margins we see in Q4, we think that those are nearing the bottom. If you look at health care, it's about 63%. I think overall, consolidated gross margin is about 51% for Q4 guidance. And those will continue into the first half of next year. A lot of this takes time to turn through the inventories, and those roll out over a 6-month period. We are hoping -- we're doing everything we can right now. We've got initiatives internally to try to improve that. But it's going to take time to work through those inventories and start to impact the back half of next year. And hopefully, we'll start to see some of those -- we're seeing it stabilize. It's still -- it's not improving as far as the supply chain challenges that we're seeing and the inefficiencies. But they are -- we're seeing them stabilize, and they're not getting better. They're not getting worse, but we need to start seeing those getting better before we start to see that path back to the margins we saw pre COVID.

I think the confusing part for me or one aspect of confusion was you really had a good third quarter, both part aspects of the business across divisions of the business performing extremely well. Sound United, really third quarter in a row significantly beat. It seems like demand is strong. Performance is excellent. And so to what extent, Micah, did you incorporate, again, based on what the current realities are sort of a worst-case currency scenario but not really fully reflect the kind of momentum in both parts of the business, irrespective of whatever new products we're going to hear about?

Yes. I think we feel very good about the business. I mean Q3, we saw our health care business deliver 10% constant currency growth above that midpoint of our guidance range. We saw the consumer audio business deliver above the high end of the range. We are being cautious right now just because there are a lot of challenges right now in the macro environment. We're trying to be thoughtful about the -- if you look at the consumer audio side, for example, our luxury brands like Bowers & Wilkins, brands continue to perform very, very well in a tough environment. Denon performing -- it's stable, it's performing well. We have seen some challenges in our Polk brand, which is more price near the mass consumer pricing. That's been challenged throughout this year, and we've got that contemplated in our guidance. But we want to kind of continue to see how things are playing out. Do we see any more erosion that works its way up through maybe into some of those other premium brands? We haven't seen it yet, but we're trying to be conscious of that. So that's more on the consumer audio front. But we've had strong performance. We're guiding to 5% to 10% constant currency growth for that business in Q4. And so that's a strong growth outlook for Q4 versus what we're seeing in the market. They're outperforming the rest of the market. So they are taking share in the markets they play in. On the health care front, we're continuing to take share there in a big way. We're guiding to 7% to 11% growth in the fourth quarter, 9% constant currency growth at midpoint. We're being thoughtful about the challenges right now. We have had challenges this year installing under contracts. We've got a contract backlog that's up to about $1.24 billion right now at the end of Q3. It's up 25% year-over-year. We haven't been able to get the installations done as fast as we want. And once we do, we'll start recognizing the census on those contracts. But there's also been very choppy census we saw in Q3. And I mentioned that on the earnings calls. We've seen softer census than we expected. We're being thoughtful about the hospital buying patterns because we recognize our revenue on sell to the customer. And we're just being cautious there just because we came out of a soft quarter. We are expecting that to tick up for normal seasonality of the business. And then there's also a -- what we're seeing is a pretty heavy flu season starting. So if those can -- if what we're seeing on the CDC -- for example, if you go to a CDC website, you'll see the flu data, it's ticking up pretty strong right now. The question is how much of those outpatient volumes that they're seeing there or the diagnosed flu volumes, how much will those translate into in-patient admissions. Our sensors track to in-patient admissions as far as the volumes. So we got a wider range there, but it's contemplating some of that softer census but also a potentially stronger flu season, plus we do believe that there is some backlog of surgeries that are still out there. That could pick up in Q4 as well. So that's kind of how we're thinking about Q4. And we still are encouraged by the growth in both businesses right now. And as we head into next year, and the health care business has some very strong -- great opportunities and tailwinds behind it in terms of the contract backlog, and we're seeing a growing installed base. It's up 7% year-over-year as well.

I think you've won -- the last 9 months have been a period of record contract wins. Your major competitor is spinning off its business sort of throwing the talent, it feels like a little bit. So it does seem like the setup is encouraging. One thing I don't understand, you were talking about the $1.2 billion in contract backlog. Help us understand that better. A couple of simple questions. One, how quickly do you expect that to be worked through? What's a normal level? What -- I mean I assume that there's always something in that backlog. But what could the implications be for '23?

Well, it's a good tailwind going into '23 and our outlook for next year as well as beyond because a lot of our contracts, as you know, those are, call it, 4- or 5-year terms as far as length of the contract. So the backlog, when we talk about that, and you see it in our quarterly filings, that backlog represents undelivered equipment under contract as well as undelivered sensors. So that will give a nice tailwind over the next 5 years start to install under those contracts and roll out the equipment.

So it's always going to be at sort of these levels, but it's just a steady, consistent, predictable.

Yes, we're seeing I think what we're seeing is I mentioned on the call about the first 9 months of the year, we've got record contracting. It's going to be tough to top what we did last year because we had such a strong fourth quarter of contracting, but we're tracking very well this taking share. We're seeing that in our contract -- the new contracts, winning new customers to Masimo. We're also seeing strong renewals as well. So all those things are lining up very well for -- as we move into next year.

I assume at the Analyst Day, we're going to hear more about the -- on the health care side, the new product pipeline, among other -- many other topics. But this does not seem -- that major core health care product launches. Am I wrong? Could that pace pick up as well next year on the internal organic innovation front?

Absolutely. We've got a lot of projects internally focused around our health care business and continuing to really focus around -- we've got a great hospital automation platform, and we're looking to continue to innovate in that space. Where you're starting to see things play out in our telemonitoring. We just launched the W1. that's going to be more geared towards telemonitoring. We're also making it available to consumers, but that's where the focus is because we think we can provide the solution for patients who are -- whether it's discharged from surgery and they're going home to be monitored for a few weeks and maybe that's Radius PPG, which is our wearable wireless sensor; or they can use the W1, which hospital systems can basically monitor patients with long-term chronic conditions like COPD and CHF.

We're going to talk about this more later, but talk about the W1 launch. It's challenging for me to explain it to people in the sense that, I mean, you're being very clear about your idea about the W1, and I know it's a first step into this market. What are your expectations? What do you want us to look for in terms of the W1 and say as you will in terms of revenues or incremental growth? Are you dialing into your guidance for next year? I mean help us -- give us some perspective.

Yes. As far as how -- our view on W1 and my personal view is this is going to be a great product, like I mentioned, for telemonitoring. We do have some pilot programs we're working through in the Middle East and Saudi, the Saudi market. That's going to be something to stay tuned on is how do those turn into -- translate into contracts for us. Right now, there are pilots, Joe mentioned on the call, that we're looking at starting out with hundreds of units, and that has a potential to get into ten thousands of units. So it's going to continue to be an opportunity to expand from there, but we want to see that turn into contracting. And I think that's going to be a great opportunity. It's also going to be a reference point for us as we try to expand on that platform and the capabilities there. The other thing I'd like to see is we're starting to do some early work with some of the large hospital systems here in the U.S. And we're pending 510(k) approval on the watch. Right now, we submitted -- I believe, it was in September. We submitted the 510(k) application. So that's pending review with the FDA. And that's going to be kind of a key milestone for us is getting approval for that because we're basically using this as -- it's a medical-grade technology that can be used for patients with those long-term chronic diseases. So that's what -- we'd like to see some of those pilots and those programs play out in the U.S. and translate into a contract with a large system, and that will be a good reference site for us as well.

And I just want to make sure, when do you expect FDA clearance in the U.S.? I mean, is it 3, 6, 12?

I wish I could predict FDA time lines. We've had a lot of challenges there over the years, but this one should be a faster pathway, but we'll keep our fingers crossed.

So hoping for '23 approval. The -- talk about, if you would, the Sound United side of the business. I mean I know we're going to hear more at the Analyst Day, but this sort of -- there's the sort of everyday consumer business. You've touched on it. But I'm guessing we're going to hear more about how we should imagine Sound United accelerating your wearables. I like to phrase this following the consumer wherever they go, strategy. Is that the way -- is that the right expectation?

Yes. I mean we look at it as -- and we'll talk a little bit more about this at Investor Days. They've got a strong retail channel, over 20,000 points of retail distribution but they also are building a good channel for their direct-to-consumer. And that's -- you can go out there and look at some of the websites like bowersandwilkins.com, denon.com. They've got the presence. They know how to market to consumers, and that's -- they've got a very capable team. So we want to leverage that channel, both the retail as well as their direct-to-consumer channel, and that's going to be a great opportunity for us to take some of these medical grade technologies into the home and to consumers.

Yes. The Freedom Watch is -- I don't know whether is it the next-gen version of W1.

That's right.

Is it still on track for launch next year? Any additional details you can share? And maybe you should tell us is -- you're wearing W1? What's the experience like? And do you get a free upgrade to the...

No, it's a great watch. I mean the technology we have with the vital signs with -- if you think about it, a lot of our core SET pulse oximetry measurements are in here. So you've got blood oxygen saturation, pulse rate, respiration rate, perfusion index and Pleth Variability Index. So you've got a lot of the key -- the core measurements. And this is going to be the first continuous medical grade type technology that's on the market in terms of wearables. And this is going to be a learning experience for us with W1. We're making it available to consumers. We're hoping to learn as much as we can, trying to continuously improve the user interface, the design, software applications in preparation for the launch of Freedom. And that's going to -- that feedback loop is happening now, and that's going to work through the course of next year. We'll probably touch more on timing of the next generation Freedom watch at Investor Day, but we're excited. It's -- you're probably looking at it within the next 12 months or so.

When I think about the math, whether it's the $500 version or the $1,000 version, I don't know whether -- it doesn't sound like a lot to me to say, 10,000, 25,000 units really add 25 to 50 bps to top line growth. Is that the right kind of math?

You're really working on the area.

Yes, I really am.

Keep in mind , the main milestones here is going to be in the telemonitoring side. So what's going to be the catalyst for revenue growth and contribution is going to be those contracts. So if we start to see that play out in the Middle East and some of those in the U.S., that's -- that will move the needle. But in terms of the consumer health side, which those can have a quicker uptake on revenue, that's going to be more dependent on the timing of our Freedom launch.

Got you. Micah, you've done an amazing job since you got there, I've been very conscious of it, in terms of driving efficiency, focused on cash generation, all sorts of things. COVID and supply chain have made your life -- I mean I won't say hell, but I hope not, but it's been tough.

Yes.

What are your priorities for next year, again, beyond integrating -- and rolling out the strategy or whatever that we're going to hear about. But from just running the company and doing what you've done outstandingly getting it that back to basics, if you will?

Yes. I mean our priority is our revenue growth and earnings growth. And we've got to put together plans right now, and we can't fully overcome currency, right? So currency is going to be a headwind for us. But if you look at the organic growth in the business, we want to drive top line revenue growth and earnings growth. We also need to be balanced in the investment that's going to be required to successfully launch some of these products. So we are working through that. I mentioned on the earnings call, I think I got a question on all the marketing investment and how we're thinking about it. And we're trying to be as balanced as possible to deliver the earnings growth. It's important to me. It's important to Joe. It's important to our leadership team. So I think we're going to be measured. We got to figure out how to balance that and make the right investments because it is important to get to successfully launch these products.

No question about it. It's hard for me to not ask you about your active investor. I'm guessing it's challenging to comment. I'm sure that there are other people involved in this discussion. But -- so I'm not asking about specifics, but what do you want the investors in the room to know? What do you want me to know about some of their ideas and thoughts? What Masimo's response to this? How are you going to respond?

Well, I mean, right now, it's in the hands of our legal teams. I can't talk a lot about it, but what I can say is there's -- the complaint has been filed. You can go read that. We've also had a press release with our response back on that complaint. And I think the thing for us is I'm hoping we can get this behind us soon. And probably looking at right now, it's in the Delaware court, and we're hopeful that there will be some resolution by maybe March of next year.

Okay. Turning to Analyst Day. I'm sure you're going to have some good surprises -- I trust. But -- and that you'll only commit there. But what are your priorities -- this is the first Analyst Meeting, Eli, in 3 years 4 years?

3.

3 years. So it's that's an event in itself. What are your key priorities to accomplish at this meeting?

I think from my standpoint, I mean we want to give an outlook into next year into 2023. We want to lay kind of the foundation for how we're looking at our outlook beyond '23 and over the next 5 years. We want to hit on a lot of the -- some of the things we're working on. There will be some consumer-related products, and we'll also get into more telehealth, telemonitoring, kind of what we're doing in that space. I know Bilal Muhsin, who is our Chief Operating Officer for health care, he's going to focus a lot around kind of similar to what we did with hospital automation back in our 2019 Investor Day, talk a lot more about telehealth, telemonitoring, W1, the capabilities we have there. There's tons of opportunity that we have in that space to be a great solution provider for hospital systems. And then we'll hit on some of the consumer health products that are coming out. Touch on some of the time lines there. And then Blair Tripodi, who's our Chief Operating Officer for the Consumer division. He'll hit on some of the -- their core business, the consumer audio business as well as some of the go-to-market plans for our consumer health business.

Board shipments is a topic we haven't talked about a ton in this year, a lot of topics have been on the table. But this is the fifth consecutive quarter, the third quarter -- it was the fifth quarter where -- plus minus, you've been delivering 75,000. Last year, it was more like 60,000. Is 75,000 drivers the new norm? And talk about the drivers of the drivers.

Yes, absolutely. So yes, new driver levels, what we're forecasting now is at least 75,000 a quarter. Installed base, as I mentioned earlier, is up about 7% year-over-year. I think a lot of concerns coming out of COVID. I mean we saw almost double the amount of drivers of the year of 2020. A lot of concern was is the installed base going to slow down and is it going to -- or could it even contract. What we're seeing is good stability in the installed base. It's continuing to grow. It's back, it's growing at the pace it was even pre COVID, which is pretty incredible. So up 7%. And as you know, we tend to drive that double-digit growth with pulling through more and more revenue on those drivers over time. So we've got a great foundation for growth as we move into next year. And yes, driver shipment's up 75,000 now. I think pre COVID was below 60,000. So we're seeing good demand out there.

Yes. That's great. And good demand from your OEM customers as well. Have they retrenched at all in any way that you have performed?

No, it's been pretty consistent. We've always had a split of about, call it, 75% to 80% as OEM drivers that go into our installed base. And 20%, 25% is Masimo-branded equipment. So those drivers have stayed pretty consistent as far as the demand.

Great. Back to Sound United. I mean it's -- and again, it's been -- I would not have predicted that they would have outperformed 3 quarters in each of the 3 quarters reported this year. That says to me in a simple-minded way that things are going well. But talk about the integration. There was some noisy leadership transitions. Is it fully integrated? Is -- are they on track? Where are we now? What's the thing to do, maybe?

Right now, we've got -- it's -- right now, we're going through collaboration among our R&D and development teams. So those projects are underway. They're working together. A lot of those projects are 2-year-plus type contracts or projects. The back office, we've been integrating more to the back office. That's been driving some efficiencies there for us. We're through the majority of the integration. So we still have some systems integrations that we need to work through, but it's going very well so far.

All right. pricing and price and cost inflation is a topic I've been bringing up a lot lately. To what extent are you, at this point, able to talk to your customers and raise prices to offset some of your costs? Is that underway? How significantly? Any color there?

Yes. We're in the process right now of enacting price increases. We've been in -- we've been putting in place the CPIs under contracts. We've been enforcing those. We did take a little bit of time off during COVID just because customers were challenged. I mean they were suffering in terms of cash flows. And I talked to several CFOs during that environment from the hospitals. And it was a challenging environment for them. But we did take a pause, but now we're enacting those CPIs in the contracts. We do kind of butt up against some of the GPO pricing and contracts. So a lot of times, whenever we enter into contracts with larger customers, there are some levels of discounts there, and we can raise price over time, but then you're kind of capped out with the GPO contracts. So we can't go higher than that. So that does limit our ability somewhat to continuously raise prices there. But outside the U.S., you tend to get more off-contract type business there. So that's -- those are the same things we're trying to raise prices to offset some of the inflation.

During the quarter, we saw that, on the Apple litigation front, we saw the administrative -- ITC administrative judge delayed his preliminary decision, I think, twice, if I remember correctly. It's now expected December 19. I haven't been able to catch up with our litigation expert yet, but what are you thinking and hearing about this case now? Is delay good? Does it mean something? Is it concerning?

I think it's a complex case. And I think that, that's what's being delayed right now. If you look at the ITC for us, this is originally supposed to be October. That's now moved to, I think, December 19 or 20. And that's where the [ ALJ ] will make a decision whether or not to ban the watch within the U.S. So I think it's gotten more complex. I think there's -- you've seen that complexity shake out even in the LiDCO case. That's been delayed as well, and that's actually sitting with the International Trade Commission as we speak. So I think there's a lot of complexity that's been moved back more by the judge just due to the time needed to work through this. And then, of course, if that moves on, then it goes to the International Trade Commission, which will be a review. Probably that'll be -- we'll hear more about probably next March if it keeps moving through. So -- and then the final step would be on to the President for signature if it keeps moving all the way through.

Got you. On that note, we have to stop. Thank you very, very much, Micah. Appreciate you being here.

All right. Thank you.

Thanks, Rick.