Masimo Corporation (MASI) Earnings Call Transcript & Summary

My name is Jayson Bedford. I cover medtech here at Raymond James. Thank you for attending the 45th Annual Raymond James Institutional Investors Conference. With us today from Masimo, we have Eli Kammerman, VP, Business Development and Investor Relations. This is going to be full fireside, but please, if you have any questions, I can -- just raise your hand, and I can kind of paraphrase the question here without the mic there. So Eli, for those who are new to the Masimo story, just describe the business model, the core drivers and how the business has evolved over time.

Okay. Sure, Jayson, and thanks for inviting Masimo to the conference this year. At Masimo, we have 2 sides to our business, health care and non-health care. The health care side is primarily focused on hospital monitoring products and other medical technology products used in alternate care settings, the non-health care business is focused on consumer audio products, mostly related to listening to music. For the health care business, we have a razor-razorblade business model that works off of an installed base of monitor technology that uses our disposable sensors. So our main business is sensors. We sell those sensors directly to hospitals ourselves to work with monitors either made by us or made by our OEM customers, the large hospital monitor manufacturers such as Philips, GE, Drager and Nihon Kohden. Our largest product segment is pulse oximetry devices that measure the amount of oxygen in the blood. We also have measuring technologies or monitoring parameters to measure oxygen in the brain, exhaled carbon dioxide, brain wave activity as well as other components of the blood like hemoglobin, carboxy hemoglobin and methemoglobin. We've been in business since 1989, commercial since 1998, and we are gradually and consistently gaining market share in our core market of pulse oximetry. Our contracts are typically 5 to 7 years long, and they are for sensor supply to hospitals. And we have a very, very high renewal rate with our customers and a very low churn rate. We're constantly innovating. We're coming out with new technologies every year. This year, we intend to launch a new hemodynamic monitoring system that will measure cardiac output as well as other hemodynamic parameters, especially one that's quite important called delivered oxygen. On the non-health care segment, the main products are amplifiers, speakers and hearables, which are headphones and ear buds. The hearables category is the fastest growing one, and it's a focus area for us. That business owns 4 major brands, Bowers & Wilkins, Denon, Polk and Marantz. So there's a quick snapshot of our overall business.

That's a great synopsis. How do you envision the normalized growth profile of the business?

Sure. Well, when we look at growth for the business, we like to look at it as the 2 separate reporting segments. For health care, this year, we see growth of 6% to 9% on the top line, and that will be driven by market share gains in pulse oximetry, continued adoption of our advanced parameter technologies as well as continued gains of users for our rainbow technologies to measure other blood constituents. We are seeing very good growth overseas, about 1.5x our domestic growth and the growth profile boils down to growth for the core business of 6% to 8%, 2x the market growth rate of 3% to 4%, as we gain share. Growth for the rainbow category where we're the only player of at least 10% a year. That category comprises 15% of the segment today. And then finally, growth of 20% at a minimum for those other 3 technologies I mentioned, which comprise 8% of the health care segment. On the non-health care side, the growth profile is basically demographic type growth for the traditional audio components, speakers and amplifiers, but much, much faster growth for the hearable segment that I mentioned before, we expect to see that category grow by at least 50% this year after more than doubling last year.

Okay. So not knowing the exact mix of hearable in the consumer business, consumer is low to mid-single digit. Is that fair?

Well, on a long-term basis, a low to mid-single digit is a good way to characterize it. We won't see that kind of growth this year because we're coming off some very difficult comps related to momentum during the COVID area when there was a lot of pull forward of demand as people upgraded systems in their home. But we are disclosing the contribution from the hearables products of headphones and earbuds, they comprise about 10% of the non-health care segment today.

Thanks for pointing out that. I didn't know that. That was a joke. Just if you could recap last year, meaning last year was a challenging year, a lot going on. I'd love for you to, in your own words, just kind of recap what went on for the audience.

Sure. Well, the first part of the answer is pretty easy. Difficult macroeconomic conditions have created challenges in consumer discretionary. These conditions mainly relate to high interest rates and lower housing transaction volumes, which have depressed demand for integrated home entertainment systems. So that is a big part of the explanation for the performance of the non-health care segment last year, along with the difficult comparisons against 2022 when stay-at-home work was still driving a lot of upgrades for home entertainment. On the health care side, we had a number of cross currents last year. Firstly, there was a transition from all patients going to the hospital being monitored because they were all suspected of potentially developing COVID to going back to the typical practices of the most relevant and appropriate patients being monitored continuously for blood oxygen levels. That transition absolutely depressed pull-through for our pulse oximetry sensors, and that was one of the reasons why we had a bumpy year last year. In addition to that, we also saw some inventory elevated at some of our customers from a combination of overly enthusiastic buying during 2021 and 2022 as well as some inventory related to discounted sensor pricing that was offered to a select group of customers. That inventory has now been vastly worked down and is not presenting a challenge to us anymore. Another key aspect of 2023 was that there was a lot of momentum still carrying orders of our circuit boards which are put into our OEM customers' monitors, which created some excess inventory for them to work down, and that relates to our board shipments volume, which has been a big focus after our fourth quarter report. So in 2023, I guess you could say it was somewhat of a bumpy year with some challenges to overcome, but those are now behind us. And we've re-baselined the business and think we're well positioned to get back on our normal growth trajectory this year once we get past the first quarter and second quarter comps, which are respectively difficult and easy because of the gyrations related to those factors I just mentioned.

Let's dig in a little bit more on the health care business, 60%, 65% of sales. You mentioned just the inventory build, are you -- that occurred last year. Is it a pretty clean kind of sell-in, sell-through right now and normalized ordering patterns? Can we say that's behind us?

Yes, we can.

Okay. And then you also had talked last year at one point about the move to the outpatient from the inpatient and that having a negative impact on your volumes. Can you just explain that dynamic? And how can you adjust the business for that inevitability effectively of moving to the outpatient?

Yes, sure. Last year, we saw a bias towards having more surgical procedures done in an outpatient setting, moving from the inpatient setting, mainly because nursing staff was very stretched in hospitals. So capacity was a real issue. And the growth rates for those 2 subsets were very different from each other. Last year, inpatient admissions rose by only about 1% to 2%, while outpatient admissions were rising by 7% to 9%. Those trends have started to moderate now for outpatient and that growth rate has settled back to mid-single digits range. What's been happening is the hospitals wanted to retain the patient traffic, but they just couldn't do it on an inpatient basis. So they were able to move those procedures to outpatient facilities that were owned by the hospital and the revenues were still captured that way. This year, we haven't seen the growth rates equilibrate yet, but they're headed in that direction. For us, it's kind of a mixed bag because we have a very large market share in the outpatient setting, but most of those patients are getting reusable rather than disposable sensors. We have an active strategy now to convert those ASCs, ambulatory surgery centers to disposable sensor usage by offering them a value-added package that includes both sensors as well as productivity enhancement software, things that will allow a nurse to see the status of all the patients all at the same time. And at the same time, we're stressing the value of disposable sensors for reducing infection risk, especially from skin-borne bacteria. So things are moving in the right direction there. It does represent upside for us because our technology is already broadly in place in the ASCs. It's just a matter of generating that conversion from reusable to disposable.

And what's the difference in economics to Masimo?

Well, for us, we get about $150 for a reusable sensor that will last about 6 months. On the other hand, we get about $10 from a disposable sensor that's used with a single patient. So if the reusable is used on 300 to 500 patients, you can see the cost per patient for monitoring is dimes rather than dollars.

Do you have any idea as to outpatient versus inpatient mix of your business today?

No, I can't speak to that because we have no way of knowing where the sensors are being used in the hospital once we deliver them.

Okay. But seemingly, you have a disposable sensor versus the reusable sensor, right?

Right.

Okay. Okay. I guess just how do you define your health care markets in terms of kind of size and potential penetration that's left?

Well, our main market is for inpatient admissions for surgery. That's about 26 million people per year in the U.S. and about 2x that number OUS. All patients getting general anesthesia will always be monitored for blood oxygen levels during their procedure, and they'll always be monitored after the procedure, if they're in the ICU, the intensive care unit. That's about a $2.5 billion market today, as I mentioned, growing at about 3% to 4% per year. The other markets we're addressing for our rainbow technologies to measure things like hemoglobin or carbon monoxide in the blood, that's a $2 billion market opportunity by our calculation, and we're the only player there. We have no competition, and we're about 10% penetrated into that today. For the advanced parameter group of capnography, brain function monitoring and cerebral oximetry. In aggregate, those 3 add up to about an $800 million to $900 million market today, growing at 8% to 10%, and we've got roughly 8% share overall in that area. So there's considerable upside for us if we're able to match our share in those markets to the share we have in pulse oximetry today.

And just the 3% to 4% market growth in pulse ox that's a little above census just thinking around of what's left in terms of penetration, how deeply are you penetrated into that market?

Well, when you talk about penetration, you have to look at 2 different subsegments in the hospital. Today, the critical care area is fully penetrated, and it's been that way for years. Every operating room table and every ICU bed has a monitor next to it. So that's 100% coverage. On the other hand, in the low-acuity area, like the general floor or the med-surg floor, only about 35% to 40% of those beds have monitors next to them today. But not all of those patients are monitored all the time like in critical care. So there is considerable upside for equipment in the low-acuity area. And in the high-acuity area for us, it's really a market share gain as well as geographic expansion to drive our growth at 2x the market growth rate.

And just you mentioned international growth in health care, like 1.5x your U.S. growth. What is the rough mix of your health care business, U.S. versus OUS?

Yes. For health care, domestic sales account for 65% while OUS is 35%.

Okay. And you alluded to kind of the razor-razorblade model. We've all been kind of conditioned to think drivers as the leading indicator of future demand. Drivers at one point were running last year at 65,000, 75,000 a quarter. This year or '24 starting closer to 60,000. So can you just explain the dynamic as to why you're seeing the slowdown and what gives you the confidence that, that can accelerate?

Yes, sure. Firstly, for the audience out there, when Jayson says drivers, what he's talking about are the circuit boards that we sell to OEMs and the circuit boards that we put in our own brand of monitor that allow those boxes out in the field to use our sensors. Driver shipments have declined for 2 main reasons over 2023. The first is the one I mentioned earlier, which is our OEM customers and the monitoring business got overly aggressive with their ordering. The second reason is we have other types of OEM customers, including customers that make products that use very few, if any, sensors. These are products that have reusable sensors attached that are used very infrequently. They are the vital signs console devices that are carried by ambulances and fire rescue vehicles, sometimes they're combined with defibrillator technology. And that is a significant portion of our driver business that had a decline last year as our customers in that particular category had lower product volumes for different reasons. So the key message there is that drivers are really not the best indicator of growth of the sensor business for us, the best indicator is new contracts, which we are now quantifying every quarter and which more directly relate to the expected volume of sensor shipments going forward.

I guess just -- I do want to touch on the contracted revenue. Just in terms of -- in any given quarter, new versus replacement drivers, what's the rough mix?

Well, we assume a usable life of 10 years for our installed base, and that is a finance-based assumption, not a field audit count. So you could say that 10% of the base is turning over every year. Now, if you're looking at how we gain business, we're looking at a couple of percentage points of market share gain each year and a hospital bed universe in the U.S. of about 900,000 beds. So I guess you could try to convert that using those numbers. But when we sell a driver to an OEM customer like Philips or GE, we don't know where in the hospital their monitor is going to be placed. So it's very difficult to quantify exactly how many of our drivers are brand-new customers versus replacements of old monitors.

That's helpful. In terms of contracted revenue. Can you just talk about the importance of that? And you are seeing some very good growth there. Just talk about the visibility you have and when you recognize revenue?

Yes, sure. Well, 2023 was another record year for us for winning new contracts. We won close to $400 million in new contracted business last year. Those contracts have an average duration of about 6 years. So if you apply that lifespan to the amount, you can see that based on last year's number, we'd be gaining about $70 million a year in brand new business from those contracts. That's not our only source of growth though, but it is the main source in the U.S. OUS, most of our business is done more on either a tender offer basis or a spot ordering basis.

Consumer health care, it's kind of a newer business to you. I think you've talked about 1% of total health care revenue in '24 from consumer health care. Can you walk through the key products there and the contribution from each of these products?

Yes. Well, 1% of our health care segment revenue this year is not a huge number. It's only about $14 million. So we're not talking big numbers, but the main contributor to that would be our Stork baby monitor that is now available in retail as well as online. That's a baby monitor that measures heart rate, respiration rate, body temperature and blood oxygen levels. And it's very useful for parents who are worried about the health status of their children and also want to keep an eye on them, both literally and figuratively because the monitor does come with a full color high-resolution camera that also has night vision so that parents can watch their baby remotely. So that would be the biggest contributor to that figure. Other products that will contribute to the figure include our W1 vital signs watch and then some new introductions that are planned for later this year, our over-the-counter hearing aid as well as a next-generation watch that we've named Freedom, which will be a higher-end product that also has vital signs functionality combined with smart watch functions.

Helpful. On the margin side, on health care, at one point, it was 65-plus-percent gross margin. Now I think you're at 61% gross margin. What's the plan to get back to 65%? And where can that go from there?

Yes, sure. We have a very clear plan to get back to the mid-60s for gross margin in the health care segment. The main step in that is to move most of our manufacturing for sensors to Malaysia, out of Mexico. Right now, we're planning to move 80% of the sensor manufacturing, and that project is well underway, we'll be about halfway done with it by the middle of this year and all the way finished by the middle of next year. We should be able to capture about 200 basis points of margin improvement when that program gets fully completed, and we see a full year benefit from it. So that wouldn't be until 2026. But looking at gross margin expectation this year of close to 62%, you can see we can get back to that mid-60s range in a period of 2 to 3 years.

And remind us the weight? The 400 basis points, if you're going from 65% to 61% over the last couple of years?

Yes. The main negatives that were driving that down were increased manufacturing costs at our facilities in Mexico related to 3 factors: One, the minimum wage climbing annually for 3 years in a row by at least 20%. Two, high turnover in the labor force down there, which created inefficiencies as we had to keep retraining new people. And then three, the strength of the peso against the dollar, which, of course, worked against us with higher costs.

The non-health care business, it's still a sizable chunk at 35%, 40%. The guide implies that revenue is down year-over-year in '24. What causes that to turn in '25 and '26?

Well, there are 2 things that could lead to a rebound there. One, of course, would be an improvement in macroeconomic conditions where more people are either installing fancy home entertainment systems for the first time or upgrading their existing systems. And the second one would be continued rapid growth of the hearables segment, which could fully offset any weakness in the traditional components area of speakers and amplifiers. So those things should both come into play as we start to move into a lower interest rate environment and our traction in the hearables area continues to work as it has over the past year.

Can you talk about the margin profile in the non-health care piece? And what can you do -- in the case of revenue coming down, what can you do to stabilize the profit profile?

Yes. For the health care segment, we're looking at gross margins this year, likely somewhere in the 31% to 33% range. We think we can drive that back up into the mid-30s where they were when we first acquired the company, but some things have to go right there and one would be the return of pricing power, which doesn't exist today, but has existed in 2021 and 2022 as well as the first part of '23. We've had to hold back on price increases, but we likely will reinstitute those as things firm up.

And I guess just big picture, when we think of -- you've got 2 core businesses, how do these businesses work together? And do they make sense together?

Okay, sure. It makes sense to have the 2 businesses together because there's exceptional value in combining the brand equity of some of these famous brands like Bowers & Wilkins and Denon with the power of Masimo technology as it relates to health and wellness. We think there is a very savvy sales and marketing team at Sound United, the former name of our Masimo consumer business, and they've been instrumental in helping us to generate successful launches of products like Stork and we expect big things from them when we're ready to launch our over-the-counter hearing aid under one of those well-known brands later this year. In addition, they will be instrumental in helping us to engineer a successful launch of our Freedom watch coming out later this year. They've got the channel access. They've got the expertise and we bring the competitive advantages of superior technologies. So putting those 2 together, should lead to successful ramp-ups and revenue generation for these new consumer health products.

And just to be clear, because it's a common question, you're fully committed to this strategy, both with non-health care and health care?

Yes, we are fully committed. And the measure of success there will be the magnitude of sales at the 3-year anniversary. So in mid-2025, we'll look at how much we've achieved and then make a decision about whether we've hit our target or not.

And again, I apologize if I missed this, but the magnitude of sales and the target, has that been disclosed numerically? Or do we have to go back to the investor event?

No. We've been pretty public about the threshold of success there. It's getting to a point where you're looking at annualized sales of $200 million. And that's for the consumer health and wellness products specifically.

Okay. I think we're bumping up against our time here. So Eli, thank you. I've enjoyed the conversation. Thank you for coming. The breakout is downstairs in [ Amarante 1 ].

Thanks Jayson.