Masimo Corporation (MASI) Earnings Call Transcript & Summary

Moving on to our last meeting in the morning. It is always a pleasure to welcome the Masimo team. Bilal Muhsin, Chief Operating Officer; and to Bilal's left, Micah Young, Chief Financial Officer; in the audience the distinguished Eli Kammerman, VP of Business Development and Investor Relations. Great to have all of you here with us today. Thank you so much for joining us.

It's a strange place to start. I haven't asked anybody yet today and somehow I'm inspired to ask you. We just had a major election in the United States. And I thought to ask you just because of your connection to the hospital and you're impacted in so many ways by the hospital environment and -- just preliminary thoughts or reactions, Bilal or Micah or whoever just about what any of this means to you, whether it's manufacturing or patient flow or health care?

Yes. I think the biggest focus is tariffs right now based on kind of all the news that's coming out now. We're going to be patient. We know it's a lot of posturing at this moment. But I think China is going to be a big focus for this administration. Thankfully, I think we've prepared well for that from that perspective just because of the years we've had with the China tariffs already. So I think we're set up well there. Now, we are using the exemption for the medical side of things, if that doesn't change, and we hope it doesn't change, then we feel pretty good. In terms of what's going to happen in Mexico, it's a wait-and-see now for us. But we've kind of focused our manufacturing now into Malaysia, which seems to be a good location for us, and it looks like it will pay off even with the tariff situation between China and Mexico moving forward.

I'd just add to that. I mean, we face -- all companies face the tariffs situation several years ago was implemented. There's a lot of opportunity. As Bilal mentioned, the exemptions that we saw with pulse oximetry was one of those. And just the fact that we had opportunities to navigate it, how we work with vendors and moving manufacturing capabilities or raw materials. And we've put a lot of time and effort into even here recently just trying to make sure we get out in front of it, and we're -- we've got a lot of flexibility, as Bilal mentioned, on the Malaysia, moving a lot of our production there. We have very minimal exposure in terms of China. We don't do -- in terms of manufacturing, we don't -- we only manufacture in China for a small portion that is sold in China. So a majority of our high-volume manufacturing has moved to Malaysia from Mexico. And we still have some equipment that we manufacture down in Mexico and some products down there. But the majority of our finished goods in terms of sensors are moved over there. So it gives us a lot of flexibility to navigate in the future.

And obviously, you folks are very sensitive to China exposure. But remind us sort of once the consumer separation occurs, today's core health care business China is what percentage perhaps of that?

Well, I mean, where we're exposed -- because there's a lot of exemptions, right, in terms of medical goods. Cables is a good example. There's cables -- patient cables that we have in terms of raw materials there. Again, it wasn't -- it's not something that was really that meaningful in terms of overall impact in the past, and we've been able to navigate it and put plans around it. So that's really what's -- what we've been is more on the cable side.

The next question, given the change -- all the changes at Masimo, you brought this up, I think, Bilal, you talked about it on the third quarter call, that it's wonderful attrition actually lower after the change rather than it had been before. Are all these management and corporate governance changes helping motivating exciting folks at Masimo? How would you characterize it, Bilal?

Yes. I think, proxy was difficult, right? Two years of proxy battle was difficult and working on the consumer products within the health care team was also difficult for them. So they were stretched very thin. I think we've transitioned now very quickly, I would say, from a timing standpoint, probably ideally I couldn't see us doing this any faster, but Micah and myself had put a plan together even before this all happened. And you guys are seeing executed today is the plan we had put together. We got the clearance from the Board. We're aligned with the Board, both on the vision and the plan. And the team is seeing that, right? And when the team sees that, okay, there is a vision, there is a plan and they get to go back to what they love doing most, which is serving patients in hospitals and our telemonitoring space. I think we're able to retain all the talent we needed to retain and lower attrition and have everybody focused on moving forward.

Yes. Micah, you want to say something? And I don't want to put you on the spot in any way, shape or form, and I know you're only going to say what you can say. But I'm always fascinated -- just first of all, I'm just fascinated about change whether -- it's in the world or at companies. And I mean this is a significant change. And I would think for you personally a significant change. What are you free now to do or dream or imagine or act on in a way, at a high level, Bilal, that you and the team that, again, answer it as you will.

I wouldn't say freer. I would say, look, I think -- with Joe Kiani at the helm, it was a company that was based on innovation and everybody loved that. But we were doing a lot. And I think at the end, we were stretched too thin. And I think today, the way I would answer it is a lot more focus is going to bring us a lot more gains. And I think the biggest change I see is allowing us to focus on what's going to get us the biggest returns and put a process in place now whether it's on existing programs that we have out there or on the pipeline that we're going to be introducing and putting a process now to really say these are the projects we should be focused on. These are the projects that are going to get some biggest returns, within a certain period of time that we believe is necessary. And I think that's the biggest change that I feel today that I feel like, okay, this is now going to generate -- I don't want call it Masimo 2.0, but the next generation of products and everything we introduce are going to be much more meaningful both to our revenue and to patients and to the company.

We'll drill into that. There's plenty to talk, I think we'll come back to that. Just to say it and move consumer to the side, it's only been 2 weeks since you reported. I doubt anything radical has changed or shifted. I'm looking at Micah, assuming you're going to answer this. Where are we from last update, it sounds like Masimo is evaluating, of course, all separation pathways, spin, sell pieces -- bits and pieces. Anything incremental to add there about the approach, the timing, Micah, anything you want to update us today?

No. I mean, the plan has been to separate our -- the consumer business. The Board, it's a new board. Again, we've worked very well with them in terms of aligning on the path forward. We have their full support on the plans we've laid out. In terms of the -- there's a strategic review, though, that the Board has to go through. And I think that's important that they go through the process as we have a lot of new Board members to make sure that they get to the conclusions that we were getting to. There's evaluating whether you sell the audio business -- the consumer audio business alone, combine it with consumer health or look at a spin-off into a separate company. And they've got to pursue all those options and evaluate them and I think come to the right conclusion. If the business continues into next year, and I mentioned this on the earnings call, if it continues into 2025 and we have not separated it, then at that time, if the Board decides to only sell a certain part of the business and put the parameters around that, we will move that into discontinued operations as we hold it for sale. And right now, we've laid out a plan that getting back to the core, getting back to the focus on the great business model we have. And it is a tremendous business model in terms of the opportunities we have with just the core product lines, whether it be SET pulse oximetry, capnography and gas monitoring, brain monitoring, those are kind of in our more mature markets. The standard of care is in those markets already. And that's a big wave of growth for us because we are growing very well, high single digit, low double digits in those areas. But to really start to, as Bilal mentioned, take a lot of the focus and put back into things like our hemodynamic monitoring platform that we're rolling out, combining that with rainbow to be able to measure oxygen delivery, that's going to be a big area we can drive in the near term. Another one is the hospital automation and telemonitoring, getting the focuses and more resources back into those areas to launch new product introductions over the next several years. And I think we can accelerate some of that because we're able to refocus, and that's going to help us with our top line growth as well. So -- but that recurring revenue stream, we have a razor-razor blade model. And we've come off a couple of years of very strong contracting. So we're positioned very well to really drive earnings next year regardless of carving out some of the earnings we were getting from the consumer audio business. And that's where I was going with it is we've laid out a plan for Healthcare to be 26% operating margins. Top line growth of 7% to 10% is what we felt good about laying out into that long-range plan, and we feel good about that going into next year. And if you do the math all the way down through, the earnings power of the business is tremendous. And even if we strip out the consumer audio business, it's still cash accretive. So they're still generating profitability and cash flow. So it's not like we're going to lose that in the meantime as we're selling it. And -- but the main thing is getting focused back on the core.

Micah, I haven't asked you in a while. Take us through just on the 7% to 10% top line. You've -- over the years, I've asked you since you've gotten there and you talk about market growth, innovation, price, whatever the mix. How are you getting -- how do you want us to think about that 7% to 10% at a high level?

Yes. I mean we -- if you look at our kind of 4 -- we've talked about 4 waves of growth this past year. And the one wave was that the one I mentioned, which was capnography and gas monitoring, SedLine and O3, our brain monitoring products and SET pulse oximetry. If you look at SET pulse oximetry, we are gaining -- continuing to gain share at a rapid pace. You've seen it in the strong contracting we've put out there and the true incremental value of new contracts. And those just waterfall into growth each and every year as we gain share. We expect that to grow 6% to 8%. If you look at then capnography and gas, we expect that to grow 10% to 20% range. So that's additive to growth. And then you look at brain monitoring, another area that we expect to grow 10% to 20%, those are sizable markets. Those add up to -- you got $3 billion market, $2 billion to $3 billion for SET pulse oximetry. You've got a $1 billion market for capnography and then about $300 million market for brain. That's the kind of the wave of growth we've been in for a long time. Then you shift to looking at rainbow and hemodynamic monitoring. That's, call it, a $2 billion-plus market opportunity, especially when you're bringing in the hemodynamics platform. And that we expect to grow 10% plus per year. And we're still early stages in terms of penetrating the opportunity there. The next wave of growth, the third wave is the automation platform. And today, that represents -- when you look at automation and telehealth, telemonitoring, those are about 4% of our revenue. So still a lot of runway ahead that we expect that's where we're going to focus a lot of that NPI effort, the R&D, the project effort is around those areas. And that's what we expect to grow, and that's going to augment our growth rate even further out in the future.

And why am I not raising my top line growth based on that to 40% -- I'm sorry. No, it's exciting. The underpinnings are strong, obviously. And just briefly, just to touch on it probably, it seems like I don't -- just going through the third quarter, broadly speaking, it seems like hospital census volumes are stable and going well, tracking, I think, your 2.5% to 4% kind of -- so steady as she goes as we're halfway through the quarter kind of thing.

Yes. We'll start to get the impact of the flu season probably in December and then...

Positively.

Yes, positively, -- and then we'll see how that will impact early next year as well.

Got you. And nothing new competitively here, as you said, Micah, with SET continuing to gain share?

Yes. We're seeing very strong contracting. Like I said, I mean, last year was a record year for us in terms of winning new business and contracts. We approached about $400 million of net incremental new contract revenue. And that kind of waterfalls in over, call it, a 5- to 7-year period. So this year, we're tracking ahead of that so far. I mean we're up even versus last year. So everything is -- the foundation of this business is very strong going into next year.

One lagging area has been the capital, the OEM side of the business. And since COVID, and I understand all the reasons why and probably everybody here does. Any signs of life? What can you do to get that going again? Or you just have to wait around until they start buying again?

No. So I think there's 3 impacts to our capital business. And I think they should all be favorable now moving the favorable direction next year. First, it is our OEMs. They did purchase inventory during COVID. And it didn't impact the sell-through, but sell-to to them slowed down, right? So the sell-through is still happening into the market, but the sell-to to our OEM slowed down, and that should now recover in the fourth quarter and start to recover all through the next. In terms of capital at hospitals, they overloaded on monitors during COVID. And then when they got their capital budgets back, they went to things like imaging and so on that they've been waiting to do. But we should start to see that come back into monitoring next year. That's our expectation. And the third one, I'll hand to Micah, which is a financial issue with F-42.

Yes. So I don't know if you remember, Rick, but when the rules change for how to treat operating versus capital leases, and that was really -- we enter into these long-term contracts that are 5 to 7 years, and we really go into them where we'll place equipment and return for the recurring revenue of sensors and service revenue. Those become kind of -- go into the lease accounting rules. Well, those rules changed over the last few years, they've changed them back and forth. And kind of we've been going -- it feels like we've been whipsawed a lot here in the last few years. That started moving us into away from capital leases where we accelerate the capital revenue on the contract by allocating a portion of that recurring revenue to the capital in the period that you ship it and install it to more operating leases -- now recognizing that capital revenue over the term of the 5 to 7 years instead. We no longer accelerate it. That's created a headwind for us the past couple of years, and that's starting to bottom out, and we should start to see that stabilize as we move into '25 and beyond.

And to talk about with the focus -- operational focus and product focus and manufacturing focus, talk about gross margins especially as it relates to the Malaysia sensor manufacturing transition. Where are we in all of that? How much more to go? And what does it all say about gross margins?

I'll kick it off and then Bilal jump in. So we laid out a plan back in June to really drive doubling our earnings in the next 5 years. And we're making very good strides already. As you can see with what -- how we're talking about next year. Part of that was about 70 basis points per year on average of expanding gross margin to try to get that up to 66%. We want to go above and beyond that, but that's kind of our more near-term targets. If you look at that, so 70 basis points of improvement is what we're expecting kind of a cadence in the next year. We're hoping to do like we did this year where we're able to exceed those initial expectations, but that's kind of where we're at today. The Malaysia transition has really helped us advance the ball this year in terms of moving up the gross margins throughout the year. We saw about 62.9% in Q3. That was ahead of 62.5% guide. We're progressing ahead of that. 63% we're expecting in Q4, and that's setting us up to really start to move that into next year. And we're only getting about half the year benefit from Malaysia this year. So that's going to set us up well and give us a lot of confidence on delivering that gross margin expansion next year of 70 basis points. And we're becoming very efficient there. The operations have been very efficient. We've had lower attrition rates. It's much more stable than what we've seen down in Mexico, where we've seen the government raising wages about -- minimum wages by about 25% a year over the last 5 years. We're now 30% to 40% lower labor costs in Malaysia than we are in Mexico. So that push is going to help us to continue to drive margin improvement. And we've got a lot of team of engineers. Bilal's got them back reenergized and refocused on what we call cost reduction projects within gross margin and trying to reduce our cost of goods sold for products. So a lot of initiatives to really drive that.

That's exactly what I want to tackle. And I apologize, I don't remember whether Micah has said or you said it to me at one point recently, but I was sort of surprised that I always think of Masimo is an amazing manufacturer and very efficient. And I think Bilal runs that, right, especially because of that. But my sense is that there's actually a fair amount of opportunity to get after COGS in certain areas. Why don't you talk about that.

We approach it a little bit differently than everybody instead of just looking at the operational side or any of that, we actually look at the product from the getgo. And we consider high-volume manufacturing from the beginning. And every few years, technology advances and we get to reinnovate and we get to look at our product lines and say, how could we redesign this entire product line to reduce its cost and improve its manufacturing and so on. So we take it -- just like we take any innovation-type product -- project. We take that very seriously at Masimo. We prioritize those what we call co-red projects, but they're cost reduction projects, very seriously. And we put our top engineers on it to be able to do that. And it's really a pleasure to be able to see innovation come through with cost reduction to be able to impact patients, improve patient care and reduce the cost of care at the same time.

So again, a lot more to go from that perspective. And just last on the cost side, maybe. Micah, one of the joys of knowing you over the years is we've had a lot of fun talking about -- I was thinking of it as sort of an operating kind of a CFO. You've got all excited about getting transportation cost down. There've been a lot of projects like that. Are there opportunities like that remaining. Do you have the bandwidth to get after that?

I think the focus is key. And I think we're excited, Bilal and I to have the support that's coming along right now with the aligning on these initiatives at the Board level. And I think there's a lot of stuff we want to get after. I mean how are we leveraging our distribution centers, how are we optimizing our transportation costs. All those things are coming into play. Right now, we're really attacking the cost structure from a standpoint of how do we -- it's not a -- this is not trying to target a margin number. This is trying to become the most efficient we can to contain it to drive top line growth because we know that we can. And we -- maybe there's opportunity to as we focus to even accelerate and we're hopeful of that. But we're trying to be very thoughtful and focused on how do we drive costs out of -- the cost structure improvements that doesn't impact the top line. So there's a lot of things we're looking at now. And I think we're excited about what we've already done, and we expect at least 26% operating margins next year, and we're going to continue to drive that and see where we can get to. But that's a good starting point within just call it a few weeks of working with the new Board, and we'll see where this goes.

No, that's exciting. And I'm glad you're thinking about at least 26% margin. When I hear a thoughtful financial guy like yourself talked about, at least I say, well, hech, he's being conservative. What -- but seriously, I mean -- and I'm trying to think how to ask this without putting you on spot too much. But I mean, is there a lot more room over years where you can get these efficiencies, increase the volume and drive operating margins meaningfully higher or no you'd want to invest it back in R&D or something else? I don't know.

Well, the great thing about our business model is it's a high leverage model. And we expect to continue to expand margins over time, even beyond the efforts we're doing between now and next year. So getting back to that nice cadence of expansion. What's great about it is we -- with that recurring revenue model with driving that through the contracts and how we install. It leverages our sales force. We get -- every year, we're getting better and better productivity because it's not a high intensive model in terms of we've got the sales structure in place to really leverage that. We can continue to leverage other areas throughout the P&L and our infrastructure, and we feel like we've got the investments where they need to be. Now it's just a matter of refocusing those resources.

I'm going to ask an odd question. One of the challenges of following Masimo is like what number can we focus on our track and people, I think, overfocused is bad thing on the driver shipments. So I'm going to ask you a mundane question first. I mean, it seems like we're stabilizing around 60,000 drivers shipped per quarter level. Is that 60 or 60, 65 range, just the way it's going to be for the future? And sort of go back to the start of my question as you think about answering it. It's like -- so in the new Masimo, what do you want us to focus on? I mean that we can track the business. I hope you've got some exciting new ways to think about it so we can stop talking about drivers.

We're working on that. We're working to figure out what is the best metric to track our business. And hopefully, we come up with something for you guys that gives you a true indication. Drivers were good. when we were looking at just SpO2 and growing that base, right? So that was a nice way of saying that we continue to penetrate the market. Today, we release other numbers out there like our TI, right? Our true incremental business. That's a new contracted committed business that we're seeing. That's to give you a little bit more insight that even though drivers have slowed down for many different reasons, whether it's capital or so on, it's not impacting the amount of disposable or consumable sensors we're pushing out there based on our contracted commits. And remember, those are always understated by like 20% to 30%, right? They always achieve on those, right? So we've exposed that. Now we're looking at how we're growing our business in the hospital automation world and the telehealth or telemonitoring world. And we're trying to figure out how can we come to a number to tell you what is our revenue per bed, right, is what we're trying to get to. We're seeing if we can get to a number like that, that we can see, okay, are you seeing an increase of revenue per bed eventually. Now we hope we can get there. We're working on it, and we hope we can extract that at a stable rate for you guys in the future.

And when you think about new markets, there's been a lot of the home over the years or what's -- is there a focus there that now that you're maybe reenergized and freed from all the change to focus, are you returning to some of these markets like home?

Yes. I think our two focus areas are going to be our monitoring platform in hospitals that we know we can win and continue to win there and the telemonitoring space at home. We believe that space is prime for a company like Masimo to own it because we own that patient data, and we own -- not on the data, but on accuracy of the data that's delivered for that patient for care in hospital, and it should be the same level at home in order to receive the same type of care and outcomes. So we're primed for that, and we plan to deliver on that promise.

Yes. And what are the catalysts there? Bilal mean your counts of milestones over the next year or two, where would you hope to be or...

Yes. I think in the next couple of years, what we're going to see is mainly focusing on postoperative patients, right? And there's both the chronic care management and postoperative patients, but the postoperative patients really are -- is a cost factor to hospitals today because they're staying in the hospital for multiple days postoperatively to be monitored. If we can move those patients to be monitored at the same accuracy at home and same outcomes at home, then that would be a massive cost reduction for hospitals and a massive win for patients and clinicians and so on. So I think the biggest thing is we're going to start to see that shift over the next 1 to 2 years, and we hope to be leading in that space.

Yes. I spoke to a hospital a year or so ago, he was 2 years ago now, we had a pilot program. And every patient that left the year they were discharged with the Masimo system. Are programs like that happening under the surface? And is that the kind of thing we might dream about?

Yes. We've been -- I don't want to call it limited market, but we've been kind of working with a few hospital systems, one of them is UC Health out of Colorado, kind of refining that program, right, to a point where we can launch it broadly with the latest 510(k) clearance we got for the W1 allowing it to now provide notifications on our cloud solution, now we're planning to now focus on that next year and deploy it more broadly as hospitals systems in the U.S.

When I think about -- there's a ton, we could have another hour going through each product, each topic here. But -- in the early days, actually, when you just joined, I really believed in the Masimo story I kept saying this is a sleep at night stock. And I mean with 85% of revenues recurring, amazing stability, steady margin improvement. I really believed in Micah's pitch about operating efficiency. Are we almost back to those days of telling that kind of story?

I think we definitely feel like we're back. And we definitely feel like you're going to recognize Masimo as a stable growing company and hopefully start to see more innovative products come out, not at the same rate or maybe at a slower rate, but hopefully more impactful into the market in the future.

With Profitable growth.

Yes. That's more profitable, more predictable, more information for aging analysts like me. But no, it sounds like a great thing. Thank you so much for being here today. We really appreciate all the insights.

Thank you for having us.

Thank you, Rick. Appreciated.