Masimo Corporation (MASI) Earnings Call Transcript & Summary

Good afternoon, everybody. I'm Travis Steed, the BofA medical device analyst. And next up on the medical device track, we have Masimo. And so Micah Young as CFO; and Michael DeFries, Head of FP&A. Is that right?

Yes.

Welcome. Thank you. I guess just opening up kind of big picture, it's kind of a turning point right now for MASI. It's got a new CEO change and some things, selling the Sound business. And what's kind of the vision kind of going forward here, I think at this turning point for MASI and just kind of how you see the business shaping up going forward?

Yes. Thanks, Travis. So in the fourth quarter last year, we did a lot of realignment of the business, really trying to realign and optimize the cost structure, but also really focus back on our core -- kind of our core areas of growth. And that's all within the 4 walls of the hospital. Looking at, of course, SET pulse oximetries, our flagship that represents over 70% of our revenues, getting more and more focus around rainbow, hemodynamics, that's another big area of growth for us, as well as brain monitoring, capnography and gas monitoring, all the key monitoring platforms we have. And then automation, how do we continue to automate workflows in the hospital, manage data throughout the hospital. And that's our core business. I mean that's the focus we want to get back to. We took a little detour into consumer health, and now we're refocusing back on the core, and that's really what drives our growth algorithm. When we talk about our long-range plan, we expect to grow 7% to 10% top line growth with good operating margin, high profitable growth, and we're aspiring to reach 30% operating margins over our long-range plan. So just getting back to focus there, that's the biggest change. And we've got new leadership with Katie coming on. She brings a wealth of experience with working with the -- leading the Edwards Critical Care business. And we're already seeing some of that with some of the focus she has on commercial excellence, how we're really focusing on launching products in a more meaningful way and again, concentrating on those core areas of the business.

Kind of double-click on Katie joining. How has it been working with her since she's joined and kind of the things she's focused on? And what do you think she's going to bring to the business? And when are investors going to get to spend more time with Katie?

Yes. So Katie will be out with me on the road for the next -- I mean, I think we're planning to go out all through May, June. So we'll be out there on roadshows, visiting different conferences. So that's -- that will be coming. A lot of our time right now is being spent with a lot of the sales teams, both in the U.S. as well as international. She's traveling and seeing a lot of different sites. And the focus with her right now has been, again, it's on commercial excellence, launching products, focusing on -- she brings a lot of experience in the area of AI and how we're -- we've been doing a lot of development around advanced algorithms for decision support in hospitals. And that development has had -- we've done that development over the last 5, 10 years. And it's really -- she brings another view on how we can monetize that, how we can launch those products with AI capabilities, and that's another area of focus for her.

Great. I wanted to touch on Q1. Revenue was more or less in line with expectations, but the composition was a little different. I'm just trying to clarify what happened versus the capital. Which was stronger this quarter? And then I'll touch on consumables next, but...

Yes. So our capital growth this quarter, I mean we came into the year expecting capital growth of flat to mid-single-digit growth, modestly improving environment from what we experienced in the last few years. And then consumable growth, we always expect that to be kind of that high single-digit, low double-digit growth rate. And that's kind of been the guidance coming into the year. Q1, we saw capital growth of 32%. A lot of that was a contribution from just the configuration of a tender order that we had. It's the same customer. It's a customer we've had for many years. It's a large OUS public health system, but it's under the tender contracts, and those can be very lumpy. So we've received an order for -- a large order of capital in the quarter. The consumable orders have been -- are always lumpy through from quarter-to-quarter. We didn't receive a full order on that in Q1. But if you adjust for that and look at kind of the underlying growth in the business, we saw double-digit consumables growth. So it was a strong quarter. We expect the timing of that. We'll see the delivery of the consumables in the next 3 quarters under that contract, and that's all intact for the full year. But the capital is delivered upfront, which is not a bad thing because the more drivers we put out there, the more it's consuming sensors and driving utilization at those hospitals. So it's more of a timing issue. We'll see capital kind of be lower in the next 3 quarters, but consumable sales will be higher.

Was there any pull forward on the capital side, especially with tariffs out there?

No, we're not seeing that. Demand is pretty strong and pretty steady right now. If you were -- if you kind of pull out that -- the large tender and the capital with that, we still had delivered drivers well above our range of 60,000 to 65,000 drivers that we place into the field each quarter. So critical systems up, making sure operations are up, but we have been operating below optimal levels. So we're going to be playing catch-up here as we bring those systems online.

Is the expectation that you might see Q2 impact and recoveries in Q3, and that's why there's no full year impact?

It's still too early to tell, but we feel good about where orders are and where we are for the year, which is why we didn't change anything with guidance or pull off of guidance. And we'll know a lot more in the coming weeks in terms of can we catch up and try to minimize any impact for the quarter.

Anything to kind of help to assure us that there won't be an impact in the quarter? I think prior situations, there have been some short-term impacts.

Yes. I think looking with where we are with getting critical systems back up, I think we're -- every day is getting better. We're getting better line of sight into getting up and operational. So there's companies that have faced this where it's been weeks or months. And I think it's a different situation based on what we're seeing so far. But again, I haven't been through this before. So we're kind of navigating it day by day.

How do you think about the cost impact on the expense side?

On the cost impact, I mean, we're quantifying it as we go. We do have insurance that will cover a large portion of any impacts. We look at this as onetime in nature, so it wouldn't impact -- it's more of -- it would be removed from -- adjusted out of our earnings for the quarter. But again, we're trying to minimize that cost impact as much as we can.

Okay. When you think about Q2 and the full year guidance, anything else to call out on Q2 normal seasonality and just think about sequencing throughout the year.

Yes. We look at this year as normal seasonality. The only thing different this year is we do have an extra week of revenue in the fourth quarter. Every -- based on our financial close calendar, we have an extra week every 5 or 6 years. This year happens to be that year. So if you back out, call it, 1 point of revenue for the year out of the fourth quarter and kind of normalize seasonality. Typically, we have about 24.5% of our revenues in the first 3 quarters, give or take, and then we have 26.5% in Q4 because the seasonality of the business is stronger. Respiratory season, flu season usually impacts us more as well as surgeries in the fourth quarter.

And capital for the remainder of the year is still strong. I know '24 was a challenging year. So...

Yes. I mean we're still -- implied in our guidance is that flat to mid-single digits. If we see capital continue the way it did in Q1, that could be a source of -- or a tailwind for us this year.

Okay. So and average revenue per board, I think low single-digit growth in Q1. Is that kind of the fair way to think about it going forward?

Our installed base grew. It was up 3% in Q1. If you look at our consumable revenue per driver, I think it was up about 5 points in the quarter. Again, that was softer just because of the timing of that tender order. So we look at the full year being kind of 3% -- 2% to 3% installed base growth with 5% to 7% consumable growth per driver.

Okay. And then the tariffs, you've called out $35 million in 2025. How do we think about the impact of the China bill over the weekend?

Yes. So if you look at China, we source our patient cables from there, a lot of the raw materials as well as the subcomponent assembly that comes through on those patient cables. About 5% of our cost of goods is basically the raw materials and cables out of China. So it's roughly $20 million or so a year. If you look at it, the rate -- it looks like the tariff rate is coming down 115%. So you can kind of do the math on that and see that, that's going to -- it's half of the impact of our tariff exposure. So if that sticks, that could be a meaningful reduction in what we guided to for the year.

And how are you thinking about like reinvesting that versus letting it flow through?

We let it flow through. Yes, we're continuing to drive margin expansion this year. We guided 28%, 28.5% operating margins. And we look at this really trying to continue to drive that in the core business. And if tariffs start -- the pressure starts to come off on the tariff and exposure starts to reduce, then we'll let that flow through.

So if I adjust for China and kind of get a new '25 impact and -- is taking that Q4 run rate and annualizing it kind of a good way to think about the gross impact in '26?

I think on a gross impact, but of course, as I mentioned on the call, I wouldn't -- I think it's too early to annualize, especially with the rates moving around, with trade negotiations happening as well as we have a lot of mitigation plans we're working through right now. Some are no-regret actions that we're taking that we would do regardless of kind of where things shake out on the tariff side. So that's stuff that will -- it will come more in focus over the next probably 90 days as far as those action plans, and we'll communicate that. We expect to communicate more of that on the next earnings call. So...

What are some of the strategies? Is it more like pricing or shifting manufacturing?

Yes. I mean we're looking at everything from pricing levers. We're -- of course, we're a heavy-contracting business where we enter into 5- to 7-year contracts with customers, give or take. And those contracting cycles take time to work through, and they're long contracts. So you may have 20% of your contracts come up in 1 year, and we'll see what we can do to start to mitigate some through pricing. In terms of cost mitigation, we're working through -- last quarter, our exposure in Mexico is about 25% of our cost of goods were subject to tariffs. We brought that down to 10% now. A lot of that work was just qualifying under USMCA exemption, doing all the paperwork, working with legal teams to try to get through that. And all of our sensors, consumables that are down -- that manufacture out of Mexico are now under USMCA exemption. The last piece is just the instruments. So we're working through to see what -- how we -- how those would potentially qualify. That will be some things we work on in the coming months. We're also evaluating sensor manufacturing, seeing what we can do there. We've got some mitigation plans we're working through there to see if we can impact that. The longest process that would take us is really around the patient cables out of China. So that one is kind of longer term, call it, 12, 24 months to try to move things out of there.

Okay. And I know Malaysia is kind of a big part of your gross margin expansion plans. Does the tariffs change your strategy there? Are you considering moving more back to Mexico or anything like that?

Yes. I mean we're looking at it on a -- we're doing the math. I mean, on one hand, you've got Malaysia where you've got a 30%, 35% lower labor cost component to manufacture there. But then on the other hand, you've got a tariff that could be -- if it goes reciprocal and moves back to that 24%, that's on the whole cost of the finished goods versus just the labor component. So there's going to be some math we're going to do to evaluate if tariffs go back higher. There could be potential where we may end up moving some back to Mexico. But again, we want to continue to benefit from the operations that we've seen in Malaysia. It's been -- that was a great move for us as a company in terms of lowering cost, but also becoming more operationally efficient. And we're trying to do mitigation strategies that can hopefully avoid having to bring anything back. But if those don't work out, we may have to consider some products.

That makes sense. And margins have been a bright spot for you guys beyond Malaysia. When you think about some of the growth margin drivers kind of beyond Malaysia, whatever, like how are you thinking about the progress on gross margin over the next few years?

Yes. Well, we still have -- we have sensors that we sell, we have a lower cost sensor and it's very high quality, but it's an RD sensor. We manufacture what's called a link sensor. We've been shifting more and more to RD, which has helped us to drive margin expansion. We took a lot of cost out of that. It was a project we worked on years ago. So that's continuously giving us a benefit in mix there. We also have engineering teams that are very focused on taking cost out of products each and every year. So that's always been a good lever for us. We've seen good leverage out of leveraging our installed base. We have over 2.6 million monitors and boards that are out in the field that are consuming sensors, and that's a high cost of that installed base to put out there. And every year, we're continuing to leverage that with more consumable revenue coming off those drivers. So there's a lot of different levers we have in gross margin still. And we're -- the goal is to get up -- the long-range plan is to get up closer to 66%. We're not giving up on ultimately getting to 70%. But I think COVID, going through that, with the inflationary costs that we saw during COVID, it set us back off that target a little bit.

The OpEx in Q1, is this kind of the new lower baseline?

Yes. So Q1, we delivered operating margins of 28.8%. I think -- like I said, we're guiding 28%, 28.5%. We're trying to balance to where we've done a lot of optimizing of the cost structure in the fourth quarter of last year. You saw the benefits of that in Q1 and how we're guiding this year. I think year-over-year, we're improving margins by over 400 basis points on the full year. So -- but we're also trying to balance investment. We want to continue to invest for top line double-digit growth and continue to deliver over the long term. So that's a balance for us. I would say that we've come down in Q1. There's some timing of investment we've made in terms of sales and marketing that's going to hit more in Q2 and through the rest of the year. So that's kind of how we're balancing and trying to continuously deliver on margins as well.

Does tariffs change your kind of outlook from the 30% operating margin goal? Will you still get there with tariffs?

Well, I feel good without tariffs. We're tracking very well without tariffs. The longer out with our long-range plan of trying to continue to drive margin expansion, I mean, it's going to give us time to get a lot of those mitigation actions in place. So we'll have time to respond over the longer term, but it's a challenge in the near term. I mean it's just a very fluid dynamic environment, and it's hard to speculate and tell you today that we can get to 30% by x date. But we're feeling very confident in the core business when you kind of back out the tariffs and look at where we're tracking.

Okay. That's fair. And then on tax, your tax rate was a few hundred basis points lower before Sound United. Does the tax rate kind of go back to that point now?

Yes. We've already -- we've lowered it a little bit more this year. As we came into the year, I think we were guiding closer to 25%. We're getting down -- I think our latest guidance has us around 24.5%. What's impacted us from where we were back in 2019, if you go back 5 years ago and well before Sound United, we were sitting probably around 22% for a few years. Pillar Two has been an impact on us because we've been setting in our OUS business. We've offshored IP to put us in the best, most tax-advantaged structure outside the U.S. So we have a very low tax rate structure. The Pillar Two, though, started to lift that above where we were, and everything is minimum 15%. So that had an impact on us in terms of our tax rate. But if you look over the long term, I mean, with where we're set up and with that the tax structure we have in place today, the more profitable we become in terms of mix of profits that are outside the U.S., the more -- the lower the tax rate can go. So there's opportunity to leverage that as we become more profitable outside the U.S.

Makes sense. And capital deployment, I think you said share repurchases is kind of what you're going to be doing with the Sound United proceeds. What about going forward? And how are you thinking about capital deployment? Is it still buybacks at this point?

Yes. I mean we always evaluate kind of where share price is relative to where interest rates are. If you kind of do that math in the near term, it's probably pretty close to neutral. But we believe in the business, and we think that earnings power is going to be a lot greater in the next 2 to 3 years. So we probably lean more and prioritize share buybacks. And we'll probably balance it. It will be a combination of share buyback, debt paydown. We also want to improve our liquidity, continue to improve liquidity. And that will set us up in a good spot, too, as we start to look at tuck-in technologies that we want for our core business going forward and how we deploy capital. But we're always doing the math, making sure that we're optimizing capital deployment and -- but we're definitely leaning more in on share buybacks right now.

And it sounds like even with tariffs, like the plan is to grow earnings.

Yes. That's right. Yes. We want to continue to invest for that double-digit top line growth and try to deliver strong earnings growth that outpaces that top line.

So the plans for earnings growth next year, it sounds like...

That's the goal. But again, it's early to talk about next year just with all the environment with tariffs right now.

Yes, that makes sense. Any updates to provide on the Apple litigation kind of next steps and milestones that you're looking for?

Yes. So the -- going back to kind of where it started with the ITC case, we got an injunction on the Apple Watch with using our pulse oximetry. Apple has continued to appeal that and going through the appeal process. In terms of the trade secret theft case against Apple that was tried last year, we still haven't heard a final decision. It was a bench trial with a judge. We're still waiting the decision on that. And then the last piece is really the 2 big cases for us, which is the patent infringement cases. One is going to be in Delaware, one is in California. The one in California will be in November. The Delaware case has not been scheduled yet. So I think that's -- we're excited to move into this next phase in terms of the patent infringement cases. Those are going to be important to us.

Okay. And kind of a similar question on the Joe litigation?

Yes. I mean I don't have a lot to comment on litigation, employment litigation there. I'm not really that involved with it. So yes.

That's fair. All right. Anything else that you think is important to talk about at this point that I didn't ask?

No, I think we're excited to kick off the year. It's a very strong start to the year. I know there was a little noise with the tenders, but we feel that it's -- we're in a very good position for this year to deliver on the plan -- to the guidance as we came into the year. Fundamentally, we're as strong as ever. Margin expansion story is intact. A lot of the cost actions we took were really things that need to be done and to really optimize the business as we move forward and help us to continue to grow. And we can -- by optimizing margin, we can reinvest more back into the business to drive growth. And I think we're set up very well as we move forward.

Yes. Great. Thank you. I mean, that's all the questions I had.

All right. Thank you, Travis.

Thank you.

Thanks, Travis.