Masimo Corporation (MASI) Earnings Call Transcript & Summary

All right. Good morning, everyone. We'll get started here with our next fireside chat. I am Jason Bednar, I cover med tech here at Piper. I'm really pleased to have with us here the team from Masimo, Masimo's interim CEO, Michelle Brennan; CFO, Micah Young on the end over there; and COO, Bilal Muhsin. Also in the audience, we got Eli Kammerman from IR. Just thanks a lot for being here all of you. I was joking before you brought the [ Calgary. ] So really happy to have you all. But why don't we get right into Q&A, a lot to talk about probably the most dynamic story I have on my list here over the last couple of years.

So -- but I think dynamics, again, I mean that in a nice way, but also like -- there's a lot -- not just a lot to talk about, but it's also now getting to be dynamic, and that's -- I think it's a cleaner story going forward. So we'll probably bring a lot of that out here during the discussion. But Michelle, I did want to start with you. You are the newcomer here among the group. You also have the freshest set of [ ideas ] to bring to Masimo. You've been on the Board in the past 18 months. But I guess, what have you seen as interim CEO here in the past couple of months? What are some of the most obvious takeaways you've had that you didn't fully appreciate from your Board seat?

Well, I'd say the first one was really getting to know the team beyond the management team and really seen how strong they are across sales, engineering, operations, and then in talking with them to understand that, that team already saw where the changes had to happen. They were on board the day we walked in. And when we sat down as a board and shared with them our focus areas were to prioritize that pipeline on big opportunities of growth to address our cost structure and then to find the right home for Sound United, they were on board and engaged and very eager to start driving that change. The other thing was you couldn't appreciate from the Board that this $1 billion-plus company as its scaled in revenue didn't scale key processes. So being able to now come in and hire the capability of strategic marketing to be able to address the innovation process and put in stage gates to be able to really take launch excellence and execute it so that when we bring innovation to the market, we really get the most out of it will be a really fun thing to do together and build off of where they are. I think those are probably the 2 most obvious.

Okay. All right. Great. And then Micah and Bilal, just to kind of give you some intro comments here, but it's no secret, I think, for everyone in the room that there was concern that one or both of you might depart Masimo after the recent board vote in September. But 2-part question for each of you, and Bilal, you can go first. I guess, why did you choose to stay is number one? And then number two, what are the early changes you've seen from your seats in the past couple of months because you have kind of the experience prior to the vote and then experience after the vote?

Yes. Well, I'll speak for myself, but truly excited about the future of Masimo and what we could do here. That's really what the passion that the team brings and the products we build are amazing products and now being able to really focus on getting those out, which is part of what our core is and not really expanding to the consumer, but focusing on what we do in hospitals is what makes me excited and what made me stay at Masimo and focusing on that. The second part to your question was related to -- sorry?

Yes. Just the change you've seen before to today?

Yes. So the biggest focus, I think, is the alignment with the Board that we've had. What you've noticed is within a very short period of time, we were able to execute quite a bit, and we have a lot more to go. But really having that trajectory alignment with the Board is really the biggest change I've seen personally and I think what the company is seeing in terms of how we can move forward.

Yes, for me, Jason, it's a couple of things. So one is there's no other company out there I'd want to work for than Masimo in terms of where we are today and the potential we have for the future. And I think not only do we have an incredible business model that drives that recurring revenue stream, but also we have great opportunity to continue to expand, drive profitability, drive earnings power over the next 5 years. And that's what I see in front of us. And number two is we've had a lot of work that Bilal and I have done over the past year or so, and we knew where we wanted to go. We knew the opportunities where we could drive that earnings power and also sustain that top line growth. And we're doing it very deliberately. We're being very thoughtful about that and measured, and we have a Board that's been very supportive. Within a couple of months, it's pretty incredible. While we've already been able to work with the Board on and come to a conclusion on how we're looking about 2025 and how we're looking at the next several years and how we're going to drive that earnings power with really a focus around optimizing our return on invested capital and driving shareholder value. So that's what excites me. That's why I'm here.

All right. Excellent. And I think I want to pick up on something that Bilal you alluded to, really focusing the business on professional health care. We've seen you already take some early actions, right? You shut down Bridge, you shut down Opioid Halo recently, set out communications around shutting down Stork. I guess can you talk about -- and maybe bring Micah into the discussion on this, too, but were those easy decisions, one, then also, like, I think they're mostly pretty close to 0 revenue or very low revenue, maybe put it better. What are the financial savings from shutting down products like these? Or how much marketing spend or financial support were they getting now?

I'll start. Okay. I think it was a process we went through, right? So it's easy to make decisions when you have a good process in place, right? And with the help of Michelle coming in, we put processes in place where we're evaluating all the programs we have out there today that already have an associated marketing budget, a sales team and so on. We're looking at the ROI that we've had from them actually. It's easy to calculate backwards now that they've been launched for a while without much revenue. So those were easier decisions. But we're not stopping there. So looking forward is we're seeing what we have coming in the pipeline, right? And now refocusing that pipeline on what we see is going to be the most impactful into the market. And instead of having 15 releases a year, you're probably going to see Masimo launch 2 to 3 products a year, but these products will be meaningful products, both from a revenue standpoint and from a strategic standpoint. And I think the future, you'll see more of a predictable outcome with these products as they come out to market.

I want to build on was it an easy decision? Yes, because -- and I'm going to state the obvious, but both the Sound United team couldn't figure out why they were in a health care company and the health care company couldn't figure out why we had an audio business. And so when I said the teams knew where the changes needed to make -- be made, the day we walked in, that was very clear. And I think there was a lot of relief in being able to focus the Sound United team back on their strength and focus the health care team on the core and really deconflict and get the prioritization, right, that we are a health care company, we're going to lead with our innovation. And a nice observation moving from the Board to the interim CEO was we have all those products to build the next-generation patient monitoring in our pipeline. But they got deprioritized and lost as we moved into consumer as we tried to do some of the feasibility testing in glucose or oncology. So those were really easy decisions to come back and say we're going to go back to what made us successful in the first place.

And then just to add to the other part of your question on how to quantify that, I think the best way to put it is we've laid out plans for next year to get to at least 26% operating margin. That's all -- those decisions that are incorporated into those plans. So we want to do that to really show the earnings power of this business as we move into next year, and we're not stopping there. We're still working through, as Michelle and Bilal mentioned, the rationalization of the project portfolio, how we're launching products and what those are going to be that scale us to the next level of growth over the next 5 years. So once that work is done, there will be more output that comes from that, but we're working through that right now.

Okay. And then what's left at this point within consumer health care? I mean, we've seen a lot that's been pulled out, I think anything direct-to-consumer OTC has more or less been pulled out. Correct me if I'm wrong. But is it just W1 that's left? And if so, is that like a signal, hey, we're still doing this hospital the home strategy using like the home as an extension of kind of the professional health care setting? Or do we need to reconsider kind of the future for W1 as well?

No. I think you're right. We -- it's not just W1, by the way, as a product, but our focus has shifted away from anything going to consumer to really the health care segment. And when we look at the Healthcare segment, that hospital to home is a big portion of that in the future. So any devices, wearable or disposable devices that we're introducing to the market, including our cloud and computing, is going to help 2 patient categories that are either exiting the hospital early, think of postoperative exits, right? So you want to reduce cost in hospitals by pushing monitoring to the home early. That's one segment of the patient population we're going to focus on. The second one is going to be chronic care management. So think of your diabetics, think of your heart failure patients. Each of these 2 categories, we believe, is a large enough business and a growing business in terms of monitoring at home, and we plan to be the leader in that, just like we are in hospitals today.

And you can do that all internally? Or do you have to look outside the walls of Masimo?

So for the most part, today, from the monitoring technology, it's all internal. We are already partnering in our hospital or in our monitoring at home program with other partners, not on the cloud or the computing part but on some of the devices that we integrate. So we're an open platform when we monitor at home. So we do a lot of the wearable devices, but for example, if we're adding a scale or something that already exists in the market, we're partnering with other companies to bring that in. And you'll hear some more about that coming in the future, some exciting partnerships there as well.

But I think you'll see our hospital to home is going to be anchored from the hospital where a physician or a surgeon needs to monitor the patient in their home. We're not going to go through a wellness or a consumer channel anymore.

Got it. All right. So Micah, you and I have talked about this quite a bit. But one of the criticisms that is out there, kind of maybe the -- I want to call it the bear thesis that's out there on your stock right now is you've got the 7% to 10% top line growth profile that's out there. And that's unhittable because you're cutting back so much on spending, you're pulling back on spending, cutting some of these like newer product launches. So what's the argument against that thesis? So I have my own view, I think 7% to 10% is doable. But from -- I want to hear from you, like how do you get to 7% to 10% knowing that one of the parts of the growth algorithm, the installed base growth has -- is slower today because you're off of a bigger base. So how do you get to the 7% to 10%?

I would actually say it's the opposite. I think we've got a tremendous opportunity right now with focus on the right projects that we're trying to deliver to the market over the next several years to really double down on those efforts. And I think that gives us an opportunity with that focus to drive hopefully some accelerated growth. But if you look at our core set of some of our mature growth areas or some of our mature markets, set pulse oximetry, you've got brain monitoring, you've got capnography and gas. Those are steady growers. And you've seen the growth algorithm for those. And we've still got a lot of runway for share gains there. And those are more sustaining for us. So we sustain those through engineers, engineering efforts. If you look at rainbow and Hemodynamics, that's something that we expect to grow 10% plus, and that's a lot of runway still with rainbow and Hemodynamics. But if you look at some of those higher growth areas like automation and telehealth, that's where the focus is going to be that could give us some upside opportunity to that long-term growth profile. So 7% to 10% is kind of that core growth profile we expect, and we've seen through our contracting this year in the last several years, we've been able to sustain that kind of underlying growth profile. So we feel very good about where things are heading and we think with focus and getting back there. And again, the cost reduction, margin is the output, not the input. And I think you'll hear us talk a lot about that. We're trying to be very deliberate and thoughtful about where we're cutting costs. Everything we've done so far to delay out what we're doing in 2025. And we think we still have some additional opportunity there to optimize the cost structure while not sacrificing the top line. All this has been minimal impact on revenue so far, and that's what we're trying to be very thoughtful of.

Okay.

One comment just on the driver base. I think it's confusing because of the drivers. You're seeing them slow down and the assumption is that means we're not gaining market share. It's quite the opposite. If you look at the true incremental that we've been pointing out, I think, in the last few calls, you see that continuing to increase, which is a true gain of market share of new contracts. The reason why drivers have been kind of looking like they're shrinking is because that's a sell-to model, not a sell-through model, right? So we're seeing what our OEMs are picking up, which stocked up quite a bit during COVID. So it's not a true indication of what's happening in hospitals. Today, it's more of an indication of how the channel looks like from a driver standpoint with our OEM partners.

Yes. Where do you think share sits today?

In terms of worldwide?

However you want to cut it, 45% to 50%...

Yes. 45% to 50% is how we see it in our core, which is Masimo SET and growing, and that market is also growing. So there's 2 elements that we're growing share against our competitor and we'll continue to do so. But also the pulse oximetry market is continuing to grow as you see more and more unmonitored beds moving to monitored beds and at home as well.

And we're very anchored in anesthesiology. So as we bring in new parameters, connectivity and wearables, you'll see us move to different areas and different floors like cardiology, the emergency room, where we're not playing as strong today. So that allows us to expand our share and grow.

Especially on the monitoring side devices.

Okay. Another favorite topic of mine. The margin outlook here, just to maybe baseline everyone, I think most appreciate it, but you're finishing this year 24% operating margin. In health care alone, next year, you're guiding 200 basis points of expansion to 26% for health care alone. And I think you've committed to saying, hey, we're going to deconsolidate anything associated with consumer and say it's discontinued operations, right? So I guess my -- kind of with that is like the kind of the intro, the question here that I've gotten from some people is like -- but the Politan had led with a 500 basis point year 1 margin improvement. You're guiding to 200 basis points. What happened to the 300 basis points? Like why isn't it better? Now I like that you've set the expectation that you have. So I don't have a problem with it, but what's the response to saying they said 500, we're only doing 200.

Yes. I think it goes back to margin is the output, not the input. And I think we've got to go through our process. And I think when I look at what we're doing right now, think of it more broadly as we're focused on optimizing our return on invested capital, just in general. One of the first things you can do is divest a business that's earning lower margins in your core, and that's what we're doing. So that's step 1. So getting rid of the consumer business is step 1 to optimizing our return on invested capital. Step 2 is trying to optimize the cost structure in ways that aren't going to impact our top line growth, and that's what we're doing right now and what we've been working through. Three is going to be that portfolio of project rationalization, making sure we have all the key resources focused on the right projects going forward so we can not only improve margin as an output, but also drive more focus and execution on the top line and our revenue growth. So -- because return on invested capital is not just a margin exercise. It's also top line growth and continue to grow profitably as an organization. So those are all the things we're doing to try to focus on that. But I think you should look at it as we are going to continue our efforts and work through this, but we're trying to be very thoughtful about how we do it.

Okay. All right. Well said. Maybe shifting gears, zooming out a little bit, new administration coming in, a lot of discussion about tariffs, everyone -- I mean this is going to be a topic in almost every fireside chat this week. But I guess, how do you see it impacting your business. Feel free anybody to respond, but you've got manufacturing in Malaysia, still a little bit in Mexico. You're a global player, but mostly U.S. revenue player. So is there an impact and direct impact on you or indirect with respect to some of your OEM partners?

Well, I think right now, it's so early. It's too early to tell exactly how it's going to impact Masimo or just broadly across the industry. Right now, there's a lot of this is really to be a leverage to change behavior in certain countries and how they work on border protection and some of those policies and how they work together with the U.S. to manage that. I think we'll see where that goes because it depends on what the tariff rate, which countries are impacted. We know Mexico and Canada and China seem the ones to be the ones targeted. Thank goodness, we moved our high-volume manufacturing to Malaysia when we did. Not only we had a lot of headwinds from labor inflation down in Mexico over the last 5 years, but also the currency moved the wrong direction on us over that time period as well. And now we're in a much more stable labor environment in Malaysia. It seems to be very effective in terms of how efficient our manufacturing processes are. So we're seeing some good operational efficiency and seeing a more stable currency there as well. So I think we made the right moves there. We will continue to navigate it. We're going to monitor the situation closely, and we do have some raw materials that we've had to pay some tariffs on in China or coming out of imports from China. And we do have some manufacturing still in Mexico for some of our monitors and low-volume sensors, but all of our high-volume sensors have moved over to Malaysia. So we're going to stay on top of it, and we've got a great team of engineers that are focused on cost reduction efforts right now that's going to bring this into the fold and make sure we stay on top of it.

We have a lot more expansion in Malaysia. So the capability in Malaysia is we can continue to expand there, which is nice.

Okay. Yes, right. Perfect. We have about 5 minutes left. A couple of things I definitely wanted to cover. So when we think about kind of cadence of events here, maybe focusing first on guidance. This is kind of a -- I'd like to call Masimo 2.0 or new Masimo, even though it's really like almost like old Masimo. But anyways, are we going to see the kind of the typical prelim results when we get to early '25? So I already feel that you're going to...

Yes. So typically, since I've been here, I think we started when I first got here, we started announcing the following year guidance and kind of our preliminary revenue result the second week of -- around the second week of January. So we still plan around that time to kind of frame out the guidance and hopefully give a little bit more color on next year.

Okay. And that was going to be my follow-up, but I think you answered it. You're going to guide as well in early '25.

That's a goal.

Okay. Even though there's still -- there's going to be some unknowns with possible tariffs that could go into place the following week, like...

Yes, I think we're going to give some -- if there's something we can't guide to, then we'll definitely discuss that. But we're going to give you as much as we can. It's probably the best way to put it.

Okay. Okay. All right. Fair enough. Maybe related to that, Micah, I mean, some of the -- I've gotten some questions already for -- I mean, investors are already asking like for the next thing, are you going to provide recast financials for health care come here soon?

Yes. So think about it as we go through the year because no matter what happens, whether we sell Sound United before the end of the year or next year or whenever that happens, if Sound United remains with the business in Q1, we will most likely move that in discontinued operations. But no matter what we're going to remove from non-GAAP earnings and no longer guide it. So -- and it's cash accretive -- cash flow accretive. So it's not like it hurts the quality of our earnings in terms of removing it. So we'll pull that out and provide more context around it. In terms of look back, as we go throughout the year, we'll show more of a comparable view in 2024 by removing out and showing just an isolated health care business as we move through 2025.

Okay. So that won't be something we get at any like -- when you guide, it's not going to change...

No, but you have an idea of -- I mean, when we talk about the guidance, you have an idea of kind of the comparables in terms of key metrics.

Okay. It's going to be fun. Looking forward to that.

I don't want to overcommit.

Yes, I hear you. I agree it's a lot of work. Michelle, I think from your seat, the Board and I know Quentin had committed to saying, hey, we're going to provide updates as we go through various organizational reviews, reviews of the consumer audio business. When do you -- I was asking Micah kind of on some of the cadence of events around prelim announcement and guidance. What about some of the outputs of these reviews? Do we get that at the same time? Do we get these before year-end, early next year? How do we think about that?

So everything is active. So when we're looking at the strategic review process with the consumer business, that's going and ongoing. So when we have an update, we will update. So we won't wait. We will do that. Same with cost structure, like what we've just been doing announcing our first steps of that pipeline prioritization and addressing costs. So as these processes move through, we'll update you appropriately when we have the decisions made based on the data. Yes.

Okay. All right. No time line, but as -- okay. Got it. Maybe on -- we've got about 1.5 minutes left here. And Micah, free cash flow, I remember when I first started covering your business, I was just amazed that like how strong your cash flow was, your free cash flow yield was very impressive, like top of class. It's going to get a lot better here as margins improve. What do you do? It's kind of like this embarrassment of riches, what do you do with all that cash? Because your leverage isn't huge right now. Do you -- how do you think about that?

Yes, we're levered about 2x right now. But our main focus is going to be -- there will be a few things. Number one, I mean, we will prioritize share buybacks over probably debt paydown because I don't mind having some debt out there, and we also just want to make sure we're financially flexible though, too. So we've got a revolver in place that can allow us if something came up that we went -- that we saw some investment opportunity, then we can do that. But the priority right now is really optimizing the core. So that's step one. before we ever get back to doing any M&A. Business development is coming back under me now. So that will be my responsibility going forward. And my focus will be really around once we optimize the core, working with Michelle, the Board and Bilal and the team just really focusing on where is our gaps. So as we look at our high-growth areas like hospital automation, telehealth, next phase of patient monitoring platform in the hospital, is there any gaps in that technology portfolio that we need to fill. And that would be more tuck-in acquisitions, not looking to do another large deal. It will be tuck-in in nature. So that's kind of -- that will be where the focus will be in terms of capital deployment going forward.

We're very aligned that our growth strategy needs to be both inorganic and organic. So when that time is right, and we know where we can invest our capital and drive value creation, we'll do it, but it's probably not next year.

Take care of some of the internal efforts and then start and then reevaluate the external.

Yes.

Okay. Well, I think that's it. Our time is up. That's a great place to call it. Thanks so much, all 3 of you for being here. Thanks, everybody.

Thank you.

Thanks.

Thank you.