Masimo Corporation (MASI) Earnings Call Transcript

All right. Good afternoon, everybody. Welcome to the last -- almost last presentation of the day. We're glad to have Masimo Corporation. I'm Travis Steed, Bank of America research analyst. And we have Joe Kiani, Chief Executive Officer of Masimo; and Micah Young, Chief Financial Officer. So thanks for joining us today.

Thanks for having us.

Yes, of course. So you just reported Q1 a couple of weeks ago or last week and came in slightly ahead on revenue and margins. And just maybe kind of think about the trends in the quarter and how the core business kind of played out.

Yes, we're happy to see the business stabilize. And we went through this incredible period during COVID, where I think we grew 20% revenue. Our drivers went up from 240,000 to 480,000, and pulse oximetry became a household name. We introduced the COVID product that allowed people to send patients home and bring them when they need them. And just was a really exciting, terrifying period. And then afterwards, it was a little weird, right, because I think a lot of customers have hoarded products, and there was these gyrations in the market. We're feeling that we're finally in a steady-state situation. We started feeling that way Q3 last quarter -- last year, Q4 last year. And now Q1, as you noticed, not only we did really well from a great hard quarter to beat Q1 of 2023. We beat it in sensor revenue and volume. And the TIs were incredible. We did $100 million of TI. And remember, TI is true incremental. So it's the new contracts we gain with new hospitals minus anything we've lost. So when we say we did $100 million of TI, that means we're gaining market share probably 2 to 3x the normal rate. This is after a year where we did $400 million in TI where we normally did $150 million to $170 million in the past. So all in all, we feel really good about the business, and we feel like things are going to get better. The comparables are going to get a lot easier. And yes, we're looking forward to a strong 2024.

I think one area of focus has been kind of the weaker driver shipments. And my understanding, it's not really affecting the kind of the cadence of installation. So maybe kind of talk through that a little bit.

Yes. First of all, the drivers that we report are the OEM boards we ship and the monitors we ship. Obviously, the monitors we ship, we ship directly to hospitals. So those are going to soon consume sensors. The boards we ship, it's up to the OEMs when they ship it out to the customers. Some of our OEMs, you may have seen their report. They're public companies. They've had good quarters. So our softer driver quarter to them means they were hoarding some of our OEM boards, and they have been shipping them to our customers now. And from the report we're getting, as Micah had already told folks in the Q4 earnings call, Q1 was supposed to be the trough. It feels like it is at 50,000 drivers. We think Q2 will be 55,000, and Q3, Q4 will be back to the 60,000 level. But I think we began telling our stockholders the true incremental numbers because at the beginning, every driver was a new sensor driver. Now as we become the #1 market leader, not every driver is a brand-new sensor driver. Some of them are replacement. So we thought the TI, which is the growth, is the way for you to be able to know how we're doing in market share gains.

And when you think about utilization for drivers kind of back above pre-COVID levels at this point, what's driving that?

That's the good news. The fact that sensor utilization per driver is -- and the revenues are better than ever, it means 2 things. Not only the big bolus of drivers we shipped in 2020 didn't get all put in the closet. It looks like a lot of them are being used. But it also means hospital census is up, and they're utilizing our products, which we're very happy about.

Yes. I think one thing to add is back in 2019, we were about 1.8 million drivers. We're -- today, we're sitting at about 2.6 million. So we've seen about a 50% increase from where we were back in 2019, but our consumable revenue per driver is higher than it was in 2019. So we're still -- despite shipping 2x back in 2020, we shipped an extra 240,000. That's about 10% of our installed base today. And even those may be lower utilization, if they're going into general floor or other care areas, we're still seeing very good utilization overall in the installed base.

If you think about the drivers of the high single-digit growth, can you walk through the components of that a bit more? The high single-digit revenue growth.

Yes. So if you look at kind of how things are playing out right now, we've seen good growth even in a very tough comp for Q1. Our consumable revenues were up 2% in the first quarter against a very, very tough comp. Capital was down 21%. So if you kind of play out for the year, we're guiding 6% to 9%, but all that -- the growth is coming from consumables. So what we're seeing is if you go out and look at some of the things we put out in some of our recent earnings presentation, the consumables within each category, whether it's rainbow, it's capnography, SedLine, O3, all those consumables are driving good revenue growth that's above our long-term growth rate. So the trend is there. And all that's coming off the strong contracting. And keep in mind the contracts we do, customers typically don't sign up for 100% of volume. They sign up for minimum volumes. So we typically outperform on those contracts, and that's what we show as a minimum commitment. So as you start to see that 100 million that Joe referred to in Q1 and say that's -- let's just say simplify it and say it's 5 years on average of the contract life, that 20 million a year starts to layer in. So that's where we're seeing good strong growth coming off of winning new customers. We're also seeing our -- we're able to get into install equipment into customers where if you go back a year ago, it was difficult to get into the hospitals. Some were short nursing staff, and we were getting delayed with equipment going in from OEM partners, and we had our own challenges. So today, that's stabilized. We're getting in more. We're able to install and start driving the revenue growth.

Is this high single-digit growth algo kind of back on track for second half of this year and then into 2025?

Yes, yes, especially when you look at consumables. I mean over -- 80% to 85% of our business is consumables today, 15% is capital. So we're not a capital-intense company. We focus on the recurring revenue stream of consumables. We feel very good that we're on track to that high single digit, 8% to 10% type of growth for consumables. Capital is a little tricky just because of where the environment is. The patient monitoring was a key area of focus for capital budgets during COVID. A lot of hospitals were deferring the higher intensive capital, the larger capital items. And now they're probably refocusing of those budgets towards those as well. But we feel very good about where we're positioned with -- again, driver shipments is not the best indicator right now. Contracting is, and we believe the drivers are going to come back.

Yes. And if I could add, the Q2 projections we just gave when we announced our Q1 numbers, it's about a 20% increase to sensor revenue. So even if you look at the first half with 2%, we're going to be more than double-digit growth the first half of the year. So we feel like it's come back. When we first gave our projections for the year, we assume the low end was a 0% census increase. The high end was 1%. And it looks like Q1 was about 2% to 3% census increase. So that's really helping us meet and beat what we guided at the beginning of the year.

And how are you feeling about Q2 in that range? Second quarter.

Yes. Second quarter, we're thinking we're going to do like nearly 20% growth. And so we're -- and so far, it's tracking that way. And we have this tool sales summary. We get to look at the sales on an hourly basis. And the sensor volumes are finally coming in, in an orderly way, not lumpy like it was for a few quarters before.

Yes. I think Q2 implies somewhere between 16% to 20% growth on the range. So -- and then on the year-to-date, things kind of normalize out for the first half and then normal comps in the back half of the year.

Got it. And then on gross margin, kind of raised the gross margin guide 60 basis points in the kind of the core business. But what gave you the confidence kind of in the Q1 to raise the full year by that much?

Yes. We're seeing good traction on our transition in Malaysia. As you know, we've had a lot of headwinds over the years with inflationary costs with the workforce down in Mexico. The peso has been a headwind for us. But we've been watching Malaysia very closely over the past few years, and it's a much lower cost in terms of direct labor costs. It's probably close to 30% to 40% lower today. So we've been transitioning that. We've -- at the end of March, we were around 2/3 of the way there. So we're on track to actually have a full transition of sensors by the end of this year, so if not earlier. So we're on track. Originally, we thought that would take through middle of next year to get to that point. So that's tracking well, and we believe the labor cost is going to give us 60 basis points, and we will then focus on driving the efficiencies as we start to get more stable volumes going through that plant.

Especially with Malaysia, how much upside could there be kind of left in '24 on the margin side?

Yes. I mean we brought it up originally. I mean we're ahead of schedule, so we brought up 60 basis points. So we're getting the direct labor starting to come in, but it's going to get us in a good trajectory as we go into 2025. We're trying to get back on that path to get back up in the high 60s gross margin. Ultimately, we want to get up even higher than that. But we only need to get to 66% to be a 30% EBIT margin business. And that's another 350 basis points based on where we're guiding today. And 1/3 of that is going to probably come from those efficiencies we're seeing in Malaysia. And we've got a lot of other cost reduction initiatives that we have in place that we're putting in place today that's going to set us up for the rest of that path to 66%.

Yes, I want to get into the longer-term margin in a minute. But before we do, there's kind of a couple of items I'm going to check the list on kind of post Q1 that came up. I think first is the Rad-G recall. And I don't know if there's a way to kind of size that.

Yes. Let me -- I'll take that one. The Rad-G is a project that the Gates Foundation funded. It was meant to be a very low-cost pulse oximeter developed for mainly detecting pneumonia in children in developing countries. 5 million children were dying of pneumonia every year. And the Gates Foundation was trying to fix that. They narrowed down to 4, 5 pulse oximeters. They took them -- including us. They took it to those countries, 5 of them, tested on 5,000 children. And we had a 3% error rate. The next best product at 30%. So they came to us saying, we want you to develop this, we'll pay for it, but make it low, low cost. So to make it low, low cost, we took away some of the redundancies we normally put in our instruments. And secondly, we saw an opportunity where there's no pulse oximetry during surgery for 5 billion of our population. So we also made it a continuous mode, not just spot check. Some of the countries in Africa couldn't buy it unless we had FDA clearance. So we sought FDA clearance so they could buy it. Then some of our sales people noticed the product was the lowest-cost product. They began selling it. We got one notification that a child had died that had come from hospital as a newborn with terrible illness and a year later died. The parents, when they got to the child, they said the product was flashing, which is what it's supposed to do. Nothing to do with the recall reason, the best of our knowledge. Then the recall happened because to be RoHS compliant, you can't use LED anymore for soldering. But part of the process, the board has to be clean before you put the components on. The supplier that was shipping us those boards didn't do the right steps. So some of the boards came with that contaminant still on. What that did, it caused the pulse oximetries to turn on and off, on and off, just would not work. So the team met last August when they learned about it. They did an HHE. They decided to recall it. And then it was given to one of the individuals, a high-level individual, to do the recall. That individual, knowing the mass majority of these products are in Kenya and all kinds of places where it's hard for people to replace things, was working on a software solution to give to them and did not immediately do the recall, waiting for the software, knowing these products either work or they don't work. So it's not a risk to the patient. Bottom line, we learned about it on February 14 that the recall hadn't still happen. I said, do it right away. We did it that day. But the DOJ began investigating on why did we delay the recall, and they're right. We shouldn't have delayed the recall. And we have been very forthcoming. We're working with them. We apologized. Tell us what we need to do. But no patient was harmed because of this because the product just won't work from the beginning. And we need to -- we've improved our process that someone can't sit on the recall that long. But that's the whole thing. And we don't think it's going to be a problem. Very few units were ever sold in the U.S. So we think it's going to be okay. But we'll see. We'll see what DOJ wants to do. We're working with them.

So no real financial impact to talk about?

No. We took a recall reserve. So I think it was around $3 million in the quarter. Nonrecurring type of reserves. So that was already booked we took a more conservative view on that. So we think the financial impact has already been covered. We don't expect it to impact revenue or any financial results going forward.