Masimo Corporation (MASI) Earnings Call Transcript & Summary

So I'm Matt Taylor, the U.S. medical supplies and devices analyst here at Jefferies, and please to host the management team here from Masimo, including Micah Young, the CFO; and Eli Kammerman, who runs the Investor Relations function and business development. So I'll have about 25 minutes here for a fireside chat. And maybe 1 question or 2 at the end from the audience. So I guess to start out, we always like to do some high-level questions, Micah, maybe you can talk a little bit about Masimo's history, but really focusing on the last couple of years, there's been a lot of transition, and you've moved into consumer now we're talking about potentially segmenting that off in some way. So -- maybe bring us up to speed on where the healthcare business is today, what we should think about in terms of options to separate Consumer and the time frames around that and the progress that you made on some of the combination initiatives between Healthcare and Consumer.

Yes. Thanks, Matt. Yes. I appreciate the opportunity to be here with you at the Jefferies conference. Kind of stepping back and looking at the evolution of Masimo. The core business is still the core business. I mean, we're making great inroads, continue to make great inroads and taking share in pulse oximetry. Big market for us, we still have a lot of runway there with that -- those share gain opportunities. And I'll kind of hit on the healthcare side and then we'll talk a little bit more about consumer health, but health care -- we look at that as -- the pulse oximetry is our flagship product, $2.5 billion market, give or take, maybe $3 billion market. And we're still a lot of runway ahead. If you look at our business today, our revenues for healthcare, I think the midpoint of our guidance this year for core health care is about $1.365 billion. 70% to 75% of that revenue is SET pulse oximetry. Rainbow is about -- around 15% of the revenues and growing 10%. And then if you start to look at some of the other categories of markets, we have capnography and gas monitoring, another large market, growing double digits, and that's been very strong growth for us. And we have, of course, brain monitoring, and those are some of the core parameters that we have. And the high-growth markets are rainbow capnography and brain monitoring for us. SET continues to kind of pace it. We look at that growth is about a 6% to 8% growth rate for the business. And overall, we still see the business as a high single-digit low double-digit grower as we move forward. And it's exciting that we're kind of getting back to focusing on that core business and the growth and the margin expansion story, which I'm sure we'll talk about here in a minute. But over the past several years, not only have we got -- went deeper into automation hospital and more into wearable devices in the hospital that can make patients mobile, but we've also moved more into the home through telehealth, telemonitoring, and that's going to be a nice growth area for us moving forward as well. And that's led us into getting into more consumer health. And and devices like the Freedom watch, the Freedom band, some of those products that are going to be coming out. We also launched the STORK baby monitor here recently. And we see some big markets ahead for that business in terms of the consumer health opportunity getting into very large and growing markets there. So we've kind of evolved over the years. We completed an acquisition of consumer company a couple of years ago, that wasn't received well by investors, and I think we've come around and I know that we've been on the road a lot listening to investor and finally decided to separate. And I know the commitment originally was 3 years. I think we've heard from top investors, and we are willing to separate it earlier. So we've been evaluating that. We're looking at a separation, either a sell or spin and that will be the next steps in terms of -- we put some of those numbers out there on what the remaining part of the business looks like and getting back to the core getting back to that 30% operating margin profile of the business and we're working diligently through 2 different pathways, which is spinning off into a new publicly traded company or selling the business to a third party.

And I guess as you listen to shareholders and heard them say that they want you to do something different with Consumer, I guess, how have you incorporated that into your value creation thesis for Masimo? Meaning just how do you think a spin or a sale is actually going to create value through the mechanism that you're choosing.

Yes. I think we still see great value in the ecosystem that can be created between home to hospital and back to home. We also think there's opportunities through a separation to drive value for shareholders. There's 2 different options on the table. One is to spin it off into to a new publicly traded company, like I mentioned, the only challenge with that is it does take probably 12 months to complete a spin. It's a longer time horizon, and it also would require some operating cash. You want to make sure the capital is properly capitalized to begin. You don't want to have to go back out to the capital markets within the first few years of separation. So that's part of it. The other side is if we can complete a sale of the company, and we're looking at a potential sell majority stake of the business. So we would essentially deconsolidate the full business. We'd no longer have to report it in consolidation with our healthcare business. But the great thing about that would be getting proceeds from the sale to be able to pay down debt. That's our #1 priority in terms of capital use for any proceeds that we get. Today, we have about $0.63 of earnings tied up into debt. So that would be immediate opportunity to boost earnings if we can complete a sale. And it's a shorter time frame. I mean we're looking at probably 3 to 6 months to complete that transaction versus the year it would take for a spin.

Got you. And I guess, whether you sell or separate into ConsumerCo, HealthcareCo, I guess how much of the Masimo trademarks IP, et cetera, will be at ConsumerCo in those scenarios. I think 1 question I've had, especially the last couple of days is, how does Masimo avoid competing with itself with the SpinCo?

Well, first of all, we're hoping to get out details of what's in front of us in terms of the sale opportunity of the majority stake. Hopefully, we'll get to a point here. We're working through diligence to where we can disclose more details around that because I think shareholders will be excited once they see the full view of what the transaction could look like. But that being said, in terms of the IP, really, the way it would work is we would have with a core business, RemainCo or core healthcare, legacy Masimo would essentially license the right to use technology and to sell and target to consumers. So it's really limiting that license to the end market all the core technology of healthcare stays with Healthcare. Only IP that would really move is the Consumer Audio, of course, that goes with the whole business, that core audio as well as Hearables. And then the only 1 that's kind of where there's some crossover would be the IP around the sensor module. So if you think about the sensor module goes on the back of the watch or the band that's also tied to the Apple litigation. So that's what we're working through right now. If that were to go with the new company, then there would be a right of use license to use the sensor module IP back into healthcare for W1 and telehealth telemonitoring. So it's really just right-of-use licenses, very similar to kind of what we have today with other areas of our business where we provide right of use with, for example, OEMs to use SET in the OEM devices. So it should be a very clean structure. And I know that there's been a lot of noise out there. But I think once we nail down the terms and get all the details out there, I think it will calm people down a little bit on kind of how the licensing would work.

Great. Maybe I'll transition and ask you about what things could look like in a separation. You gave us a preview of that on the last earnings call with the slide really showing kind of a pro forma first look at new HealthcareCo, ConsumerCo. And 1 of the things I think investors were excited to hear about again was the longer-term margin potential and laying out this new [ 66-30 ] goal that you have for gross and operating margins. So that's the longest question ever. So I guess just framing that. Maybe you could talk about a I guess any puts and takes in that initial separation? Like how close is that to what we would actually see? Are there things that could flex up and down? And then b, in that longer-term plan to get to [ 30 ] how long would that take? Or what would the cadence of OMX be like annually going forward from here?

Yes. Great question. So what we did was we put out in the investor deck, the earnings deck this last quarter, as Matt's referring to is we showed basically what the separation could look like. What are the costs and the changes in the P&L to get back to a core healthcare P&L. So if you look at it, we went with a range because we're still working through the perimeters of the deal, whether it's a spin or a sale. Basically, what we put out there is kind of what it would look like in terms of operating margins for either a spin or a sale and given us a range. So when you kind of carve out those costs, it could range from an operating loss you're backing out of $28 million or $51 million because there's -- we have been investing in R&D. There's been marketing dedicated resources that we announced at the time of the acquisition that we were put out there. So once you kind of strip out the loss there. It gets to core healthcare margins of about 23.2% at about 24.8%. So call it, 24% at the midpoint and it's going to be, give or take, depending on what assets go, what costs go, and we're working through all that. So hopefully, we'll start to narrow that down as we go through this process. But that gives you a pretty good range that wraps around kind of where we think we're going to land. If you look at the 30% operating margin, your question was really around the cadence. And the cadence, we've always kind of delivered a very strong operating margin expansion about 100 basis points per year. And I think that, that's a cadence. Now what things that could cause us to get there a little quicker could be is if we start to see even greater efficiencies in Malaysia, some of that happening earlier than we expect. We just recently raised our gross margin 60 basis points. We're already seeing the cost benefit of moving to Malaysia this year. And I think we still got a lot more opportunity there. And hopefully, we'll see some of that even earlier. But I feel very good about a cadence of 100 basis points a year. It's really driving 350 basis points of gross margin improvement. And we'll get there through efficiencies in manufacturing as we move to Malaysia. We should be fully transitioned by the end of this year. Start to leverage efficiencies moving forward. We've had a lot of turnover workforce in Mexico because of the competition going down there. And of course, the government has been raising minimum wage for the past 4 or 5 years. So that will start to roll through inventory and through the P&L next year. And then we've got a lot of focus around cost reductions with our engineering teams that are laser-focused on driving costs out of products and improving product margins over time, especially as we get into higher volumes with some of those higher growth product lines that have been kind of a smaller scale, but they're starting to get as a much larger size in terms of our revenues. And then, of course, the last is leveraging our installed base. Today, despite seeing some softness in driver shipments here recently just because of the inventories that the OEMs have taken -- we've got a large installed base out there that we continue to leverage over time because we provide that equipment free of charge and the return for the recurring sensor revenue. So that becomes a very high leverage model for us. So that's another path to achieving that 66% margin we're targeting.

Very Good. And so you talked there about definitionally kind of a medium-term plan, a 6-year cadence, you got from 24% to 30-ish. I guess things. So 1 is, if you did see some upside from Malaysia or some of these other sources that you talked about, how much flex could there be? That's one. And then, I guess, longer term, you could probably will stop at 30%. What are the best margins could get in kind of a longer-term plan?

Yes, I think as we think about -- as you mentioned, 6 years getting to 30%, I think we continue to see good leverage it's ultimately going to be is we've got to come back with some new initiatives around cost reduction that will continue to take us beyond 66% gross margin. And I think we'll -- and then you always have the leveraging in the installed base. So those will continue. Will we see 70%, I mean we would love to get to 70%. I think that's going to be our ultimate goal is to get there. But going beyond 6 years, I mean, I can see margins getting to a 35% operating margin, and then you're probably getting close to 40% EBITDA margins over time. So still a lot of leverage in this business. But you've got to do it through scale. I think our innovation and our ability to grow the top line, high single digit, low double digits is critical as well to getting that leverage story.

And you mentioned before, you have some confidence in healthcare going back to being a more consistent high single-digit to low double-digit grower kind of 8% to 10%. Could you talk about the halfway this year as you are expecting sales growth to ramp through the year, even though we did see a slightly weaker board number in Q1. So maybe first explain the board piece in Q1 and talk about the catalyst for higher growth through the remainder of the year?

Yes, absolutely. So drivers in Q1, I mentioned on the fourth quarter earnings call that we -- I think we were sitting around 57,000 or 58,000 in Q4 last year. And I signaled that Q1 would be a low point, and I thought it would be in the low 50s. And then we'd start to rise back up to 55,000. And I mentioned that on the most recent call was we'd step up to 55,000 in Q2 and then be back to our normal pre-COVID kind of level, 60,000 a quarter in the back half. The dynamic that's happened is OEMs -- our OEM partners have taken a lot of additional inventory of our technology boards over the last several years. So they're working still through shipping out of their inventories. And that's kind of created a near-term kind of air pocket for us that if I were to guess, we're probably shipping over 60,000 into the end customers as we ship through to the final customer. But into our OEMs, it has pulled back because the inventory levels they were maintaining. So I'm not concerned that it's a short-term issue, and it's going to come back. It's temporary. The reason I'm -- our best leading indicator for growth is really what we're doing on our contracting of new incremental revenue, whether it's new customers or expanding existing customers in terms of revenue on contracts. And last year, we had a record year in terms of -- we were around $400 million of new incremental value on contracts. And those contracts are about 5 to 7 years. So you can kind of see how that revenue waterfalls in each year. Plus Keep in mind that when we talk about our contract revenues or our contract backlog, our unrecognized contract revenue that's up 11% year-over-year from last year. That is only at probably somewhere between 70% to 90% of the contract -- the committed volumes in hospitals. So they're doing much higher volume, but hospitals will not always commit to the volume they're doing, so they're lowering the minimums. So that's another reason why we're seeing very strong revenues that should be coming in. And if you look at our guidance, Q1 is a tough comp. Q2, I think our implied guidance is about 17% to 21% growth in Q2. And I hope Medtronic does the math on that in terms of market share because if they're doing the same math they did in Q1, we'll gain 400 basis points. But if you look, though, year-to-date and then full year, we're guiding 6% to 9% with a down capital year, and capital is down about double digits. So that implies with capital being 15% of our revenues, you've got at least 1.5 points headwind. So our 6% to 9% growth we're growing much faster on consumables, which that's where we get our recurring revenue, and that's the core part of our business. So we're still tracking very well, which gives us confidence in that long-range growth plan because capital is going to turn around. It's just -- we plan for a down year.

Just extending that a little bit, could you talk more about the underlying fundamentals this year, how you feel about the market health. You mentioned on prior calls that and patient trends have been really supportive and is basically above your guidance so far. And it sounds like even though this board dynamic is a little wonky that you're saying -- you're seeing good trends in the end markets in terms of what your OEMs are doing in other words they're shipping the boards, right?

That's right.

So I guess any comment on the current state, has anything changed? Do you still feel really good about the fundamentals?

Feel great about the fundamentals. And like I said, the biggest leading indicator I look at is how strong we are contracting with hospitals and that's really how we measure share gains. We don't look at it year-over-year on 1 quarter and say we're gaining share. We look at it on what we're taking on new contracts and how we're retaining our existing business. But if you look at just kind of how things are playing out going forward, I mean, we're seeing good growth across all categories. I mean everything is coming in where we expected in terms of kind of where set growth has been, where it is this year and how we expect it to go going forward. Rainbow has been really strong over the past 5 years, and it continues to be on a good pathway. The other thing is we've -- our rainbow, even though it's gotten to 15% of revenue, and I think it's around $200 million last year in revenue, ORI has been a big product line for us that gives us a lot of confidence moving forward. That's only been available outside the U.S., and we're just now launching that in the U.S. under 510(k) approval. And that product has gotten to a point where it's about 20% of our rainbow revenues, so about $40 million last year. So there is great potential now that we're launching it in our biggest market to take over to that next level, and that will be a good tailwind for growth as well. In all our other categories, they're hitting the expectations that we set out there. The installed base growth 1 thing that we're going to start sharing more of is our consumable revenue per driver because our utilization on the installed base has been very strong. We were at 1.8 million drivers back in 2019 pre-COVID. Today, we're sitting about 2.6 million drivers. So our installed base has grown 50% over the last 5 years. Our revenue per driver on consumables and service is just as high as it was in 2019 on an installed base that probably has 10% extra drivers in it. Because if you remember back in 2020, we shipped 480,000 drivers, and we typically ship about 240,000 a year. So we're seeing good utilization per driver. That's another thing that's giving us confidence. As we move forward, if the installed base is kind of mid-single digits, that will be plenty to support the growth of high single-digit, low double-digit growth for the company.

I have time for 1 more -- maybe I'll just ask you on the last call in the Q -- there are disclosures about the FDA looking at the timing of a recall disclosure and then also and SEC looking at an accounting issue in that investigation. Is there anything you can say about those now in terms of trying to help investors understand -- risk there.

Let me hit the SEC, if you want to hit the product recall. So on the SEC side, I've been very close with this. We had an employee from Sound United that basically came to me shortly after the acquisition. And raise some issues with some accounting practices with intercompany transactions with the consumer business. At the time, immediately, I knew the complexities because I've dealt with those at prior companies, in that area with foreign currency and how those things impacted it. So I had 1 of the big 4 firms look at it and review. They came back and concluded everything looked like it was working properly. Fast forward to the end of 2022, the year that we acquired the company, and I do a quarterly sub-certification process and this employee raised additional issues again. So I had our internal auditors, external auditors review it. We all concluded that there is no material misstatement of the financials. And of course, we did that all ahead of our filing of our 10-K that year. And I have to get comfortable because I'm signing off on the 10-K every year. So that was a very thorough process we went through. What we learned at that time as well is that employee also sued a former employer prior to coming to our company. So we weren't surprised to get a whistleblower inquiry from the SEC. We knew it was coming, but it's just a matter of time. But I feel very good about our position. We did all the right things and no concerns at all about any restatement. You like to...

Yes, sure. On the recall and the DoJ investigation, it involves a handheld monitor called the Rad-G, which is a product that's been sold primarily in developing countries for field use to diagnose childhood pneumonia. In the U.S., we sold a very small number of units and the recall is a Class II voluntary recall. We have a protocol designed to detect whether or not the units in the field are defective in the U.S. It's less than 100 units. So we don't expect a very large impact from this and we do have a resolution for it now. So we do expect that it'd be resolved satisfactorily.

Great. I think we have to end there.