Masimo Corporation (MASI) Earnings Call Transcript & Summary

All right. Good morning, everybody. I'm Jason Bednar. I cover med tech here at Piper. Our next fireside chat is with Masimo. Very happy to have with us today from Masimo, SVP of Finance; Mike Lazinski; and VP of Investor Relations, Eli Kammerman. Thanks a lot for being here, both of you. I really appreciate having you both with us today.

So why don't we just dive right into Q&A. And Eli, Mike, I really like to start around on the messaging around margins coming out of last quarter, if we could. It was a big focal point on the call. It seems like the message was pretty direct on gross margins, continuing into '23 at the level that we're probably exiting '22. I don't know if you want to add any color on top of that or if I misunderstood that. But that's how I interpret it. And then maybe we get some improvement on that gross margin as we get into the second half of the year. But then it seems like there's some fluidity around the OpEx spending and maybe there was -- that wasn't totally, I guess, thought through on the budgeting side yet, and maybe we'll get a little bit more at the Investor Day here in a couple of weeks. But is that how they get the right way to be thinking about margins with all the information we have here today?

Yes. I think largely, that's right. I think -- in the Q3 earnings call, I think, Micah, was very thoughtful in terms of messaging the margin pressure we saw in the Q3 results in terms of how that's coming through and then how we contemplate in Q4 guidance. And so there's really 2 factors there, I think, are similar to a lot of other companies in the space. One is the foreign currency headwinds, right? So we've definitely seeing that hit us more in the second half of the year. A lot of companies have -- were exposed most to the euro and the yen. And so that foreign currency headwind for us really, really kind of flows through as we think about Q3 actuals and Q4 guidance really hits us about $0.57 on the dollar into op profit. And so that's a meaningful impact to our gross margins there. And so we really just wanted to make sure that, that was kind of being contemplated through something similar we talked about coming out of Q2 with our second half guidance. We want to reiterate that. And then secondly, really on the supply chain pressures, right? So we felt it really all throughout the year. We're obviously going into COVID and all the disruptions there. And our team has done a really nice job of managing those pressures for us. But really, those costs are starting to roll through our P&L. They kind of get out of hung up in inventory and roll out over a 6-month period. So really starting to feel those costs more acutely here as we look towards Q4 and those going through. So I think one of the things in terms of that pressure and how we manage that is also wanted to make sure as we looked at the 2023 budgeting and we'll get into more of that at Investor Day in 2 weeks, probably be a common refrain here. But as we get into that budgeting, we're looking at kind of where people were at noticed that really, especially on the foreign currency, in fact, we want to make sure we were communicating the fact that based on how we saw the rates and we kind of look at rates going into the quarter as we think about our guidance for Q4, thinking about that rate profile and then our revenue mix, but there will be a $70 million of additional currency headwinds in 2023 that Micah discussed on the call there, too. And again, similar profile, think about that $0.57 on the dollar flowing through their op profit. Again, continued drag and certainly, those FX headwinds will be felt more acutely in the first half of the year on the comp to the first half of 2022. And so definitely see that margin picture going through there. And then on the supply chain, that's -- it's something that we're obviously constantly looking at. We feel like it's stabilized for us, but it really -- hasn't really improved, right? And so we kind of news every different day. We hear some good news and then some other things here, too. So really, see those pressures continuing. Again, those are delayed about 6 months when we incur, those expenses are incurred, those inefficiencies until they roll through the P&L. So again, as we look at the first half of 2023, definitely from a profile standpoint, kind of see those pressures going through. And then for the second half, we'll see, right, we'll see in terms of how that corrects and it really depends for us on the core supply chain of the beginning of the supply chain of us getting components or raw materials from our suppliers not having to expedite them in. If we can get a steady supply of those materials. We can kind of do our normal freight. It won't kind of disrupt some of the manufacturing processes of having kind of lumpy inputs in the process. And then finally, a lot of the expecting we've had to do customers to get the product to them on time. So -- in terms of the overall profile, I think, Jason, that's something that we continue to look at. And I think we just say it's a balancing act for us, but it's something as we have those gross margin pressures, we're not going to be able to offset all the foreign currency. I think that's just something that it's just too big of an impact for us, but we'll continue to work it all across the P&L.

Okay. And unfortunately, I mean, it seems like currency has probably worked a little bit in your favor since we had the last update. I mean the dollar weakened a little bit. But -- and I know we'll get more detail here in a couple of weeks. But when you -- when you're able to speak pretty confidently on the gross margin side, but it still seems like there's again, some fluidity around the OpEx spend for next year. Is that simply because like you have that visibility on gross margin? And you want to make sure that you have the budgeting process fully in place before speaking to the OpEx spend?

Exactly right. And I think that's something we're still working through that process. We'll definitely speak to it more in 2 weeks here in the Investor Day in terms of how we're looking at that. And we just want to be thoughtful about how we're looking at gross margins, right? So definitely, it's something that's been a pressure for us. And again, until we have that underlying operational improvement in what we're seeing and can feel more comfortable about it, then I think we'll pick a little bit differently. May be in the OpEx piece, but really just want to be thoughtful about that, knowing it's a headwind and knowing it's something we're still battling with every single day. And just make sure we're contemplating that as we think about the rest of the P&L.

Okay. All right. Maybe since we're on this topic, and again, I'm trying to get ahead of myself here through the Investor Day. But I guess, how do you think philosophically about supporting these consumer launches that we have coming, you've got right now, market release of W1, your smartwatch, you have Freedom that's coming. I think you've hinted at something in the hearable space that's probably coming. I think there's maybe even another launch that's coming next year in a different category. So multiple new product launches, all in different categories. How do you think philosophically about supporting these launches appropriately so that they're successful as -- in their first year, first -- at least first months and the first year of launch, is that DTC spending? Is it marketing? Is it branding? I mean, how do you think about that as we look forward and start preparing for 2023?

Right. I think that's certainly in terms of the details on that, again, continue the same refrain in terms of Investor Day in a couple of weeks, but I think philosophically, it's a balancing act, right? It's something that I think in order, as we think about some of these products and whether it's development of some of these products that are maybe a little bit longer term or the launches of some of these products that are more near term, it's a balancing act, right? And definitely, we'll need to do some justice in terms of supporting those products with the right amount of spend, but we've got to balance with the overall P&L and overall profitability, right? So then we think about that. In terms of the DTC, I think one thing that we have, certainly in our favor here is leveraging the consumer audio side of the business, right, in terms of both their relationships with the 20,000 points of distribution, the established retail relationships that they have, but also the DTC channel that they've built off here with Bowers & Wilkins and Denon and really leveraging those channels to help us kind of be more thoughtful and efficient with some of that spend that we otherwise would have had to probably be a little bit higher on.

Okay. Okay. I might come back to margins if we have time, but I don't want to belabor the point because I know there's only so much, we can talk about ahead of the Investor Day. Maybe shifting over to the health care business. The driver shipment trends have been pretty strong, I think, pretty resilient just in the face of some uncertainty out there with hospital CapEx spending. So I guess, why has that just been very buoyant, what has protected that those driver shipments are giving you so much confidence on remaining at 75,000 boards or better when a lot of other hospital CapEx companies, a lot of your OEM partners, I'd say, are having more of a mixed message around like kind of the budget visibility for hospitals and hospital capital spending.

The advantage we have is that monitoring and especially pulse oximetry is the standard of care. So hospitals have to do it for every critical care patient that's out there. Now they can stick with the old monitors they have. But because of the addition of advanced features like networking and data management, a lot of hospitals are still very interested in upgrading their monitors. So through that upgrade cycle, we're able to maintain our shipments of our drivers, meaning the circuit boards, 3/4 of which go to the OEM companies. Keep in mind that 25% of the drivers are housed in Masimo brand monitors, and we're seeing very good adoption of our multifunction platform route, which typically carries our pulse oximetry technology along with It. So we're feeling very good about the driver shipments. We're continuing to gain share against our main competitor, and that's another good source of demand for us.

Okay. Would you say that your position or pulse oximetry's position and monitoring within the hospital has been relatively more insulated for -- with respect to like replacement CapEx?

Well, because the monitors tend to be lower-priced items, they're not nearly as vulnerable to cut back on capital budgets as the larger pieces of equipment like imaging products. So we are somewhat insulated in that regard.

Okay. All right. When -- and I'll try and to give a bigger picture view if we're taking like a 3- to 5-year view. I mean, is it -- is this a new good run rate? Or can we still grow off of the 75,000 as we think forward? I mean I know it's tough to predict, but the installed base has been growing pretty rapidly. I think definitely faster than the overall market. I think to maintain that growth, you probably need a little bit more growth -- maintain the growth in the installed base, you need more growth in that 75,000 per quarter. Is that attainable? .

It is. I mean, if you look at our installed base today, it's approaching 2.4 million monitors. So with that number getting larger and larger, of course, it gets harder to maintain the overall growth rate. Even so, our market share gains have accelerated somewhat. So we should still see mid-single-digit growth in the installed base over the midterm.

Okay. All right. Maybe on more of a macro view on hospital volumes and some of the things that are being widely discussed today. I mean I just would love your perspective on things like staffing and bed utilization, there's talks of tripledemic that's taking place here in -- this winter in the U.S., COVID and the flu, RSV. I mean, maybe help us all understand where does Masimo benefit or not benefit with respect to, again, some of those bigger picture items, again, staffing and then the bed utilization that's probably elevated right now.

Well, our observations through the third quarter and into the early part of the fourth quarter, still show some negative impacts on hospitals from COVID as well as problems with scheduling because of nursing shortages. This has made the census growth kind of soft. And of course, selfishly, we think there will be a rebound in census with the spike in flu much earlier than usual. RSV still an open question. So we can't really comment on the net impact for the fourth quarter at this point because it's still somewhat early, and we're mid-quarter. But it looks like things are getting very close to approaching normal schedules in terms of elective surgeries. And it's somewhat of a wildcard right now because in the third quarter, the vacation season for medical personnel was much stronger than usual as people finally got freed up and we're able to take some time off. That is likely, but not definitely going to have an effect on pushing procedures out of the third quarter and into the fourth, where there's a little bit of pent-up demand. . So the fourth quarter looks like it's getting very close to normal. Hopefully, these nursing shortages will abate, but it looks like in the community hospitals, especially, they're feeling a lot of pressure because of the stress on the budget for paying these traveling nurses. And in the large academic centers, that problem has largely been alleviated, but there's still kind of a tail effect in the smaller hospitals.

Okay. All right. That's really helpful. Moving over to the unrecognized contract revenue of $1.2 billion, it's a big number. I know Micah has started talking about this more, I think, a couple of quarters ago, it's a really healthy number, but then also the growth has been pretty impressive. I think we're at something like 25% growth year-over-year as far as that total contract backlog. And I know a function of all the new contracting wins that you've had. So that's all fantastic. I'm going to get a testament to the business and the success you've had. But I think in the same thing you've also talked about maybe some -- that backlogs remained maybe a little elevated because there's been some delays on installations. You haven't had access to hospitals. Could you help us with what -- maybe -- how much of those delays on installations, what has that impacted health care growth by? Is it material where growth would have been 50 -- 100 -- 150 basis points better if those installations would have gone into place?

I think that's tough to quantify. I mean I think we certainly looked at what that impact would be. I think probably the most meaningful piece is exactly what you said in terms of -- it's really a function of that strong contracting that we've had as a business. Really, in 2021 had a really strong year in 2022. It will be tough to beat last year, but the team is working through it. But we have seen the delays on the installs, both from the OEM available equipment and just availability of getting in the hospitals. And as Eli mentioned, in terms of staffing shortages and trying to prioritize where they're going to put their resources again, a lot of times that doesn't make the mark at least right now. So definitely working to get that installed. But again, as we get those drivers installed into the hospital and kind of pull through that sensor revenue on those committed contracts that really makes up that backlog number that should help us going forward. But in terms of quantifying for this year, it's tough to tell because it really depends on which contracts there are, what the duration is, how big they are. So kind of -- there would have been kind of scenario is tough for us to do that. But I think overall, again, as you mentioned it's 25% growth in the backlog, it's something we look at in terms of really being a function of that strong contracting that we have.

Okay. Is the visibility on installations getting to need better or kind of the -- where are the hurdles to installing that equipment? Have those -- are those getting lower being removed?

I'd say it's pretty consistent to where we've been this year. I think it's something we continue to look at. I wouldn't say it's been a material change that it's gotten better. Again, it's not -- it certainly isn't getting worse there, but certainly something we want to get those into the hospitals. Number one, especially on those competitive wins where we've taken share and have been able to flip accounts, we want them to feel the impact and the benefit of Masimo's technology.

Okay. All right. And then maybe I think last topic on health care for me. I do want to leave some time for Sound in your consumer pipeline. Maybe on pricing, how much power do you have to pass along price in this environment, in this market? I would say a lot of companies are talking about taking price. Everybody wants to try to offset inflationary pressures, so it makes a ton of sense. I think half of your business is tied to GPOs. So maybe help us out just with how the contracts and contract negotiations typically run, specifically with sensors. And are there like medical CPI, inflators that might be built into some of these contracts?

Right. We do. We've done a good job over the last few years of getting the CPI escalators into the contracts. And we have -- have been able to enact some of that. We're currently enacting some additional price actions as well too. So again, we're doing it where we can that we've talked about before, we do bump up against the GPO pricing, again, with some of our larger customers where they have been able to get a discount. We can bring that up based on the CPI escalator but we do bump up against it. But it's certainly something we're looking at, especially as we talk about those margin pressures that we talked about earlier in terms of being able to offset that. So it is -- and regionally, there are some areas we can have more impact on price versus others. But in the U.S., you are right, we do jump -- bump up against the GPO, but we're working through for sure.

Okay. And I mean my sense has been with a lot of hospital supply companies, that 2023 pricing could be even better than 2022. And I don't know that's something you won't to comment to, but it feels like as these contracts reset and you are able to, again, take advantage of some of those escalators. I mean, is that a reasonable outlook as we think about the business?

I think certainly in pockets, I think overall -- I think that will be the question in terms of what the overall impact is, but we certainly look at where we're renegotiating contracts, looking at just the broader landscape of specially contracts that are coming up that are 5, 7 years old in terms of what pricing looks like. Just to understand the broader landscape and the pressure we're feeling is a business that other businesses are feeling as well, too. And we wanted -- we tried to be thoughtful with our customers, especially through COVID. And -- but now I think we're feeling this pressure. So it's certainly something we're looking into for next year.

Okay. All right. Shifting over really quick to Sound. And really just I'd say one key question for me is just, just how are you -- the business has just done, I think, phenomenally well considering the environment. It's been much more resilient than I expected, and I think a lot of investors expected. So kudos to you all at Masimo for getting this done. The question I have, though, is like maybe how resilient this is, this business continues to be, if consumer demand does soften, like it seems like it might going into a recession or maybe we're on the front end of a recession here. How do you think about that element and just maintaining this momentum in the business in spite of the macro economy and the consumer sensitivity?

Yes. I think so far, again, given the premium brands with Denon and McLaren and Bowers & Wilkins, we haven't quite seen that erosion yet. We've seen a little bit in poke, and that's contemplated in our guidance and our outlook. We haven't quite seen it yet. I think it's something we're thoughtful on and we're keeping a close eye on. Certainly hope it remains here, too. But I think it's just -- it's something we'll continue to work through with our experienced team that have lived with those brands for years and manage through it, but we're not quite seeing it yet, but certainly so -- we'll be thoughtful on and thinking through our 2023 outlook.

Okay. All right. It's kind of in the same vein of Sound. But I very the remainder of the time to talk about the pipeline that I know you probably can't talk much about. But we'll do the best we can here. So first on W1, that's the first product we've seen here. I know you introduced it over in the Mid-East and now you're working through the 510(k) clearance. You've launched in the U.S., you have the 510(k) yet. What happens when we get the 510(k)? What does that trigger for you? .

When once W1 gets the 510(k), which should be sometime early next year, we'll then be able to sell it as a B2B product to hospitals and payers in the U.S. It will be truly positioned as a medical device and will be useful for 2 purposes. One is getting additional monitoring for patients who are leaving the hospital and don't need to be retained for monitoring an observation and instead can be monitored at home for a few days. Then secondly, for people with chronic diseases like CHF or COPD where continuous monitoring will help keeping tabs on their drug regimens to make sure the efficacy is in place and the dosages don't need to be adjusted. So that will give us a nice leg up in terms of expanding the marketability of that product in the U.S. from just consumers today.

Okay. And what's the right corollary, Eli, when thinking about W1 and the contribution or the impact it could have to the business? I mean is it something along the lines of SafetyNet or hospital automation or could potentially be bigger than those items? .

Well, it should be substantially bigger than SafetyNet, which today we have deployed in about 650 hospitals overall. The addressable market for W1 for chronic disease patients is in the tens of millions of patients. So we see substantial opportunity there with multiple customers across the country. And that product really does have great potential to optimize disease management programs.

Okay. But to be clear, this is I think -- and this is where I think the challenges in talking about W1 is like it's a sale to a hospital for a product that's not directly reimbursed. So the reimbursement benefit is like on not having those patients readmitted, right, those frequent fliers in the hospital. I mean, do you have like economic model, economic studies to justify that point to hospitals? Or do they see the benefits without even needing that?

Well, we don't have the economic studies. However, the data is pretty straightforward. If a watch costs $500 at list price or lower than that in bulk volumes, you don't have to save more than 1 hospitalization day to pay for 20, 40 units of watches.

Okay. Okay. So you -- I don't want to put words in your mouth, if you think it's more or less sells itself. It's an obvious purchase for hospitals.

Exactly. So it should be easily integrated into disease management programs as another component of overhead.

Okay. So staying on the smartwatch theme here, you got Freedom that's probably coming next year. What's the hit factor. This is your mass market consumer watch. What is going to compel someone to buy Freedom over, say, any other competing watch?

Well, the main advantage of the product is continuous, highly accurate, very reliable vital signs measurements. That's in contrast to the other watches out there that have the ability to get vital signs only on a spot check basis with the accuracy very much in question. So we see a good addressable niche with pro and amateur athletes with people who are strong fitness enthusiasts as well as with people who have recently recovered from some kind of illness and are very interested in keeping tabs on their vital signs because they're worried about some sort of relapse. That is the differentiation that we're going for. The Freedom watch will be a true smart watch with an android operating system. That's very different than the W1, which is strictly a vital signs capture tool. And consequently, the Freedom watch will be priced as a premium product. And we see it competing directly against Garmin and Fitbit and, to a much lesser extent, against the Apple watch.

Okay. And there is a -- for W1 and Freedom, there is a service element as well, correct? I mean the plan that you have with W1 right now is to -- because you do have the subscriber, there's a subscription model that you're going -- the plan is to keep that as well with Freedom, correct?

Yes, that's right. We will have a service plan, which will help with data analytics for people who want to track their improvement over time. .

Okay. All right. Perfect. Well, we have about 10 seconds left, and I don't think that's enough time to talk about Apple or any of the other topics that I easily could go on for another half hour, but I really do appreciate the time here. Mike and Eli, thanks so much for joining us, and thanks for everyone else for joining us as well today. Thank you.

Thank you, Jason.

Thank you. Appreciate it.