Masimo Corp Q1 FY2023 Earnings Call

Good afternoon, ladies and gentlemen, and welcome to Masimo's First Quarter 2023 Earnings Conference Call. The company's press release is available at www.masimo.com. At this time, all lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. I am pleased to introduce Eli Kammerman, Masimo's Vice President of Business Development and Investor Relations.

Thank you, and hello everyone. Joining me today are Chairman and CEO, Joe Kiani; and Executive Vice President and Chief Financial Officer, Micah Young. This call will contain forward-looking statements, which reflect management's current judgment including certain of our expectations regarding fiscal year 2023 financial performance. However, they are subject to risks and uncertainties that could cause actual results to differ materially. Risk factors that could cause our actual results to differ materially from our projections and forecasts are discussed in detail in our periodic filings with the SEC. You will find these in the Investor Relations section of our website. Also this call will include a discussion of certain financial measures that are not calculated in accordance with generally accepted accounting principles or GAAP. We generally refer to these as non-GAAP financial measures. In addition to GAAP results, these non-GAAP financial measures are intended to provide additional information to enable investors to assess the company's operating results in the same way management assesses such results. Management uses non-GAAP measures to budget, evaluate and measure the company's performance and sees these also as an indicator of the company's ongoing business performance. The company believes that these non-GAAP financial measures increase transparency to better reflect the underlying financial performance of the business. Therefore, the financial measures we will be covering today will be primarily on a non-GAAP basis unless noted otherwise. Further we will also be referencing pro forma financial measures, which include historical results for Sound United prior to the acquisition date of April 11, 2022. In our presentation today we will once again be referring to this business as our non-healthcare segment. Reconciliation of these measures to the most directly comparable GAAP financial measures are included within the earnings release and supplementary financial information on our website. Investors should consider all of our statements today together with our reports filed with the SEC including our most recent Form 10-K and 10-Q in order to make informed investment decisions. In addition to the earnings release issued today we have posted a quarterly earnings presentation within the Investor Relations section of our website to supplement the content we will be covering this afternoon. I'll now pass the call to Joe Kiani.

Thank you. Thank you, Eli. Good afternoon and thank you for joining us for Masimo's first quarter 2023 earnings call. We started the year with solid performance and are excited about the many new products coming out of our research and development pipeline this year. Our consistent focus on life-improving innovation continues to drive growth in our professional healthcare, consumer health and consumer markets. And now supported by the scale and infrastructure of our Masimo consumer business, our health and healthcare innovation is going to reach people from all walks of life. Our consolidated revenues for the first quarter reached $565 million. We delivered healthcare revenues of $347 million and consumer revenues of $218 million. New customers in our pulse oximetry business and increasing traction for rainbow and advanced parameter products strengthened our healthcare revenues this quarter. In fact, this was the best first quarter in our history for new conversions of hospitals to Masimo. In addition to rainbow blood constituent monitoring, which has now become over 10% of our healthcare revenue, we had solid growth in our SedLine and O3 brain monitoring and Normal line capnography and gas monitoring products. Robust growth for hearables led the performance of our consumer business along with the strong market reception for recently launched AV products. Despite many consumer-facing companies struggling post-COVID, our consumer business remains on track. Meanwhile, we're leveraging our unique combination of signal processing physiological monitoring audio and automation technology capabilities to launch a series of new and innovative products to revolutionize consumer health. On that point, later in the call, I'll update you on the recent launch of our STORK baby monitor and opioid Halo, as well as some of the other new products planned for this year that we expect will contribute to our long-term success. With that, I'll pass it to Micah to review our first quarter results in more detail and provide an update on our 2023 financial guidance.

Thank you, Joe, and good afternoon everyone. For the first quarter, we achieved consolidated revenue of $565 million and non-GAAP earnings per share of $0.87. For our healthcare segment, first quarter revenues were $347 million, representing 16% constant currency growth. Recall that our first quarter 2022 revenues were adversely affected by supply chain challenges that produced a shortfall in that period and resulting growth of only 3%, which was subsequently recovered in the second quarter of last year. We shipped over 77,000 drivers in the quarter and we are on track to ship over 300,000 drivers this year. At the end of the first quarter, we estimated that our installed base has grown by 7% over our installed base at the end of the first quarter of 2022. As Joe mentioned, our healthcare revenue growth was driven by strong performance from our rainbow blood constituent monitoring, SedLine and O3 brain monitoring, and Normoline capnography and gas monitoring products. For our non-healthcare segment, first quarter revenues were $218 million, representing an expected decline of 9% on a pro forma and constant currency basis. This was in line with our guidance as this business faced a tough year-over-year comparison due to the fulfillment of backordered products in the prior year quarter that drove 22% constant currency growth, right before the acquisition closed. Hearables including headphones and earbuds remain a key category for growth. Hearable sales more than doubled in the first quarter versus the prior year period, primarily driven by the Bowers & Wilkins headphone franchise. While we're pleased with the strong growth we're seeing in this category, we expect the launch of the Denon Pearl, AAT earbuds later this year to further elevate our hearables business, as we bring truly differentiated technology to our consumer audio brands. Now, moving further down the P&L. For the first quarter of 2023, we realized consolidated non-GAAP gross margin of 52%. This includes gross margins of 62% for our healthcare business and 36% for our non-healthcare business. Consistent with our guidance, we expect to see gross margin steadily rise over the course of 2023, as our supply chain continues to stabilize. For our consolidated business, our non-GAAP operating profit increased 8% to $76 million, which was a solid result despite year-over-year currency headwinds and the elevated litigation costs associated with the trade secret misappropriation trial against Apple. And our non-GAAP earnings were $0.87 per diluted share, which included an increase of $11 million in interest expense over the prior year period related to the debt incurred for the acquisition and share buyback. To summarize, we delivered first quarter results at the high end of our guidance as our healthcare business again realized steady gains in market share across the portfolio. In our non-healthcare segment, we saw impressive growth from our hearables products despite a difficult year-over-year comparison. And we have an exciting lineup of new products rolling out this year, that will help us advance our strategy, drive long-term growth and improve lives whether in the home or in the hospital. Now, I'd like to provide an update on our 2023 financial guidance. For the full year 2023, we are maintaining our previous guidance ranges for consolidated revenue of $2.415 billion to $2.460 billion, non-GAAP operating profit of $400 million to $405 million, and non-GAAP EPS of $4.70 to $4.80. As we discussed last quarter, we are taking a disciplined approach to our product launches and leveraging our Masimo consumer capabilities and channels to maximize the impact of the incremental 100 basis points of promotional investment we are making. For our healthcare segment, we are maintaining our previous revenue guidance of $1.450 billion to $1.465 billion, representing 8% to 10% constant currency growth. For the non-healthcare segment, we are maintaining our previous guidance range of $955 million to $995 million, representing 2% to 5% growth on a pro forma and constant currency basis. Please reference the earnings presentation on our investor website for further details. In conclusion, our outlook for 2023 reflects solid growth in our business, while incorporating prudent investments to support the new products we will launch this year. With that I'll turn the call back to Joe.

Thank you, Micah. I'm delighted to report that we received de nova FDA approval for Masimo opioid Halo, a revolutionary product for the detection of opioid-induced respiratory depression in people taking opioids at home. The listed opioid-related deaths are at an all-time high and unexpected death from opioids even in patients who are complying with recommended dosages are a significant problem in the U.S. Over 80,000 people died due to opioid overdose. We intend to play an active role in reducing these deaths by alerting patients and their loved ones when opioid-induced respiratory depression occurs. The alarm functionality of opioid Halo provides an early warning of depressed respiratory function that should result in vulnerable patients being woken up and saved from a terrible fate. And if not, then an alarm with location is sent to the nearest ambulance. On May 1, we began marketing opioid Halo to drugstores and addiction treatment centers. We are going to do our best to make sure there is awareness of opioid Halo as we believe if used it could save people from opioid-induced respiratory depression. With the transition of naloxone brands to over-the-counter status, large retailers are creating display areas that promote opioid safety and awareness within their stores and we expect opioid Halo, which has over-the-counter and prescription clearance to become part of that initiative. On May 3, we launched STORK at the 2023 Kids Expo in Las Vegas. We had very strong interest from major retailers, including one of Masimo consumers' largest customers, which will carry STORK and give it a very prominent display location in stores. We're currently selling different configurations of STORK on the masimostork.com website and expect to announce important retail channel presence as well as large online baby registries for STORK over the next six months. The marketing team at Masimo consumer is doing an excellent job of gaining attention for STORK both online and in traditional retail channels. These efforts should accelerate adoption of the product in the second half of this year. As one of our first consumer health product launches, STORK is creating a great template for how our teams can leverage our integrated global brand and marketing framework, which we will rapidly refine and replicate as we learn from the STORK rollout and launch more consumer health products. We will also soon launch our first hearables based on our adaptive acoustic technology platform. The AAT platform creates personalized listening profiles for each user, customizing the sound spectrum for each person's unique ear architecture and tearing sensitivities to ensure that no instrumental detail or sound goes unheard. These next-generation earbuds will be marketed as Denon Pearl and Pearl Pro to leverage Denon's heritage of world-class acoustics and we have already received very strong interest from retailers that gives us confidence in a rapid sales ramp. Shifting to wearables, our W1 watch is gaining traction as Cambridge University Hospital in the U.K. and Charité German Health Center in Berlin have expanded their telehealth programs with Masimo W1. Last but not least, Masimo Freedom Watch with Android operating system is slated for sale in the second half of the year. We showed Freedom at the BNP Paribas Tennis Tournament in March and have begun presales on our e-commerce site. In addition, Freedom sleep band will round out our portfolio of wearables, which addresses a range of distinct consumer health needs at various price points and can be displayed together in retail stores for marketing synergy hopefully, prior to the Christmas holiday season. We also continue to make progress in building our home-based medical data ecosystem that connects our wearables and remote monitoring products and services to HEOS devices allowing us to feed data from the wearables into our secure Health Cloud. We grew the number of HEOS connected devices by approximately 180,000 in the first quarter. We intend to grow Masimo by making a real difference in people's lives, in hospitals and at home. But we can't do that without the dedication and commitment of our team and the support of our shareholders. For the first time since we took Masimo public in 2007, we will be engaged in a proxy contest. We encourage all of our shareholders to book. The outcome will be consequential for our company's mission, strategy and guiding principles, which have been incredibly important to our success. With that, we'll open the call to questions.

Our first question comes from Marie Thibault with BTIG. Your line is open.

Hi. Thank you so much for taking the question and congrats on a very strong start to the year.

Thank you, Marie.

I wanted to start here with just a basic question about the healthcare business. I think last quarter you mentioned that there had been some encouraging pricing trends and contract renewals. Just wanted to hear what drove some of the strength that you saw in healthcare. I know you mentioned some of the parameters, but I wonder if there are other sustainable trends that you can also point to?

I’m not sure if we can maintain this momentum, but Q1 was our largest quarter ever for converting hospitals to new customers of Masimo SET Pulse Oximetry, achieving double the typical conversion rate. This is very encouraging. Pricing and cost of goods have both stabilized. Additionally, we are pleased with the traction that rainbow is gaining with noninvasive hemoglobin and PVi outside the US, as well as our capnography O3 and SedLine businesses. Overall, these developments are positive. The best estimate we have indicates that hospital census has returned to 2019 levels without growth, whereas typically we see growth of 1% to 3% annually. From what we observe, we have finally reached the 2019 level again. All of this looks promising; we hope that as COVID-related deaths decrease, particularly among elderly patients who frequently use hospitals, we will start to see a new normal. With the significant conversions we’ve had this quarter and over the last couple of years, we believe we will be in a favorable position overall. I hope that clarifies things.

Yes, it does. Thank you. It sounds like it's heading in the right direction. I wanted to ask my follow-up here then on opioid Halo. Congrats, very much on getting through the FDA with that and great timing with the naloxone going OTC as well. I wanted to sort of understand how you think about your go-to-market strategy. You mentioned that some drug stores will offer Halo as part of the over-the-counter naloxone effort. Is there a plot to try to get reimbursement at some point? I think I recall out-of-pocket costs of $250, which is more than most people spend in the drugstore. So curious about the business model, longer term here then.

Yes. Longer term, we do hope to get reimbursement, but that might take a few years. In the meantime, we are doing a multipronged sales approach from over-the-counter drugstores to reaching out to the kind of physician offices that do surgeries, in their offices and send people home with opioids, to make them aware of it. And we're reaching out to states that have received settlement money from the opioid companies that want to use that money for the greater good of people that are potentially addicted to opioids already. So I think hopefully, with all of that until we do get reimbursement we should have strong adoption of sales.

All right. That all makes sense, Joe. Thank you so much.

Thank you.

Our next question comes from Matt Taylor with Jefferies. Your line is open.

Hey, thanks for taking the question and congrats on a good start to the year here. So I guess I was open to ask a little bit about the current state of litigation. Obviously, we saw the mistrial. So I was hoping you could update us on what you think ultimately happens there? And maybe just remind us about what's coming up here with the ITC and the other trials you have in the future?

We currently have five separate lawsuits involving Apple. It began with our patent and trade secret lawsuit filed in Orange County, which split into two cases: a trade secret case and a patent case that will resume after the PTAB ruling and appellate court decisions. We also initiated an ITC case to prevent the importation of foreign products that violate our patents. In response, Apple filed a patent infringement suit against us in Delaware, and we countered with claims of patent infringement, antitrust, and unfair competition. Regarding the ITC case, we won the first stage and are now awaiting the commission's ruling, which has been delayed. We expect a decision by mid-July, and if it is favorable, and not blocked by President Biden, we could see an exclusion of the Apple Watch with pulse oximetry by September. As for the trade secret case, we recently had a three to four week process in Orange County where we presented strong evidence showing that Apple decided in 2012 to develop a watch focused on health sensing with pulse oximetry. They realized they needed expertise in pulse oximetry, leading them to look at companies, ultimately selecting Masimo, where my trusted VP and I were instrumental. Apple recommended acquiring Masimo for our technology and expertise, which Tim Cook later rejected, stating they do not pursue acquisitions of that nature. They then considered a joint development while recruiting our team, despite internal warnings. Eventually, the CTO at Circle Cor, who was my confidant, showed interest in joining Apple under certain conditions, which halted their business development plans with us. Instead, Apple initiated a confidential project to delve deeper into pulse oximetry, recruiting our engineers and executives, which the jury witnessed as evidence. The jury also learned that Apple launched their pulse oximeter in 2020, despite it not being sufficient for FDA approval, motivated by the COVID situation to gain market share from Fitbit. Unfortunately, around 100 million users now have a non-functional pulse oximeter on their watches, achieving only 37% of their target for daily measurements. All this evidence was presented to the jury before they reached a decision. The judge removed our business trade secret case from the jury's consideration, which we disagreed with and will appeal. Ultimately, the jury did not reach a unanimous decision. While it's been reported as a 6:1 split, the details are more nuanced. Nevertheless, we will get another chance to retry this case, and we are optimistic about achieving different results next time given the strength of our case.

Thanks for that great answer. Any thoughts on the timing of that coming back around?

No. We don't know. It's up to the judge. It could be two to three months to another year. We don't know.

Okay. Cool. Thanks very much for that answer.

Our next question comes from Michael Polark with Wolfe Research. Your line is open.

Hi. Good afternoon. Thank you for taking the questions. Maybe a guidance question. I see the affirmation for the year on face. As I look through the deck I see a modest reduction to the consumer gross margin input. That's the standout. I guess for Mike any other twists and turns within the guidance affirmation we should be mindful of here?

No. The only thing we maintained is guidance on top-line, bottom-line, EPS, and operating profit. However, if you look at the full year for the consumer business, we have a slightly lower gross margin. This is mainly due to some lingering spot buys that affected that business in the first quarter. We didn't change the outlook for the last three quarters, allowing it to flow through the year. Additionally, we managed expenses well in the first quarter to offset that impact. Therefore, while you will notice slightly softer gross margins, there is also an improvement in lowering operating expenses for the year as reflected in our guidance. Overall, we're observing stabilization in the supply chain. The trends we are seeing as we exit the first quarter signal positive changes for us. We still anticipate a steady increase in gross margins for the remainder of the year, with Q1 being the lowest point.

If I can follow up another guidance question or modeling question. 2Q any feel for 2Q modeling? Specifically, I guess both segments but also kind of want to make sure we're all understanding of the unusual year-on-year comps given kind of the supply chain snafu last year in 1Q and then getting all caught up in healthcare in 2Q. So kind of just sequentially Micah how do you think about revenue progression? Thank you so much.

Yes, that's a great question. If you look at the first half of last year, there were significant supply chain disruptions, and on the consumer side, we saw some improvements with the fulfillment of backorders. I believe that the second half will present more normal comparisons. In Q1 of last year, as noted in my prepared remarks, our healthcare business grew by 3%, while Q2 saw a growth of 19%. Typically, our healthcare business experiences a seasonal drop alongside the non-healthcare business in Q2, followed by growth in Q3, with Q4 being our strongest quarter. It's important to keep in mind the 19% growth comparison for healthcare in Q2. Additionally, for the non-healthcare segment, we had 22% growth in Q1 last year and 10% growth in Q2, which was above trend due to the fulfillment of backorders. Therefore, in the first half of this year, we will be facing challenging comparisons, particularly in Q2, but those comparisons should ease and normalize in the second half of the year.

Our next question comes from Jason Bednar with Piper Sandler. Your line is open.

Hi, guys. Good afternoon. Joe or Micah, I wanted to start on maybe some of the new products as we think about Halo STORK W1. I know this is a funding year for a lot of these new products, really a building year to get these products off the ground. But can we talk about maybe an immediate-term economics on the hardware help us with how you're thinking about margins and what volumes need to reach with Halo or STORK or W1 in order for those offerings to be breakeven? And then maybe from a timing perspective, should we be thinking about breakeven in 2024, or is this more of a multiyear process to get that part of the business profitable?

We expect all of the business to be profitable from the day we launched them. We're not seeing margin limitations despite manufacturing the W1s right here in Irvine, and we anticipate good margins on those. Micah, do you want to add anything to that?

Yes. No, I think Jason, we would expect that the margins on those products should support our overall gross margins for the company. So to Joe's point, we don't expect those to be dilutive. In fact, if we can start to drive some subscription-type revenues around those products over time, we could see steady improvement above the corporate average. We are making some investments, and I mentioned in my prepared remarks about 100 basis points of promotional investments this year. We will be very prudent and thoughtful about that going forward, and we want to see good results while continuing to make the right investments to grow that business.

Okay. As we consider this, we might be viewing profitability differently. To say they are profitable in the first year, we are discussing more than $20 million in revenue from these products this year, which may not align with your perspective, Micah. Please, go ahead.

No, that's not what we're saying. I think what Joe is referring to is that it would support our gross margins. In terms of breakeven, we'll have to see how that plays out, but we're making about 100 basis points of investment this year and we have high expectations for these products. We believe we'll see some meaningful revenues going into next year that could drive some leverage in that business. Hopefully, we can achieve profitability within the next year or so.

Yes, it's important to point out that we've advertised regularly since our product launch. Advertising for a specific product tends to positively impact other areas as well. For instance, during COVID, while promoting our COVID product, it actually contributed to Masimo's growth. So, I believe we are not expecting to incur losses from this.

I understand that it's difficult to determine the nuances at this point since we are venturing into entirely new categories and channels for marketing and sales. I'm trying to assess the sensitivity regarding our spending and its impact on uptake, but it seems that there are currently no anticipated issues or problems. I'd like to move on to a different follow-up now.

Well Jason, it may not be a bad thing that you're raising this point as there seems to be some confusion. Remember, we acquired Sound United for this reason. They have 400 to 500 salespeople who were there when we took over, and they will be helping with these new products. So although this is a new category for Masimo and the combined entity, we are not hiring additional personnel to support these launches. That's why we acquired Sound United.

Understood. Yes, I'll address any additional questions offline. From a competitive standpoint, I’m curious if you've noticed any shifts in practices or strategies from your primary competitor in patient monitoring. Are they exploring alternatives to their business? I’m not suggesting anything negative about them, but have you observed any distractions within that group, or have they become more aggressive? Is there any change in their behavior in light of their asset potentially being up for sale or being spun off?

Well, it never helps to underestimate your competitors. But on the healthcare side, I think they tried everything. They can't slow us down. I hope to when they say that about the consumer side.

Our next question comes from Jayson Bedford with RJ. Your line is open.

Good afternoon. Just a couple of questions. I guess just on the pipeline here where do you stand with the timing of FDA clearance from both W1 and STORK? And then just walk through the decision to launch STORK without clearance?

We don't know and we don't want to guess on when they're going to approve things. We're delighted that we got opioid Halo cleared and we hope the rest will clear as well. But the decision to launch STORK is because it's a baby monitor. If you notice we are not making alarm monitoring claims or things like that. And there's a significant business out there without making or needing to make those claims. So, we decided to begin the sales of these products given that we were seeing high interest from the retailers that we're talking to without making those claims. But of course, as soon as we get the FDA clearance we will announce that and I think it should help as well.

Okay. Just off topic here or a different topic. Is there any way to parse out the incremental cost related to the Apple suite in 1Q? And then just on the retrial from an expense standpoint are most of these costs sunk, or would you expect a similar spend on round two?

We're not new to defending our IP, but we are new to people just exercising the hell out of the court with motions. I think the number of motions Apple filed that was leading up to this trade secret trial we're about three times what we're used to. So, it's funny you say that because I've been asking Micah can we non-GAAP this extra stuff that's really related to Apple not our standard stuff. Whether he gets comfortable with that or our auditors get comfortable with that, I don't know. But it is really not normal.

Is there any way to quantify it?

I believe we have incurred $55 million so far in the Apple litigation, as mentioned in the Wall Street Journal article. This involves not just a trade secret case but also the ITC case and the patent case, among others. Overall, there are five cases, and we have only just begun two of them. Unfortunately, I anticipate that our total expenditure on these litigations will exceed $100 million.

And Jayson, just to clarify, that's over the entire duration of the cases, which spans multiple years, approximately three years.

All right. thank you.

Our next question comes from Mike Matson with Needham & Company.

Yes, thank you. I have a few questions about the Freedom watch and the bands as well. I noticed on the website that it is priced at $1,000, which seems quite high compared to similar products on the market. I would like to hear your thoughts on that, especially considering it likely requires a subscription. Additionally, you mentioned significant interest from retailers and stores. What has the interest level been for the bands and Freedom?

We have three price points for our wearables. The most expensive product is the Freedom at about $1,000, followed by the W1 at around $500, and the Freedom band, which will likely be priced at about $250. All these products offer the same biosensing technology. The choice will depend on the features customers desire and their willingness to pay for them. I’ve noticed strong interest in the privacy switch, which is unique to our products. Our target customers are individuals with chronic illnesses who need reliable monitoring that is unobtrusive. We are also working to manufacture these products in the US, which does raise production costs compared to manufacturing in China. However, we have been conservative in our revenue projections for these products, so we will see how it unfolds.

Are you seeing any signs of traction with W1 in the healthcare setting and that product channel?

Well, W1 right now is being really marketed by our hospital sales force outside the US. In the US we're still waiting for FDA clearance. We had not begun putting W1 into the consumer channel because we didn't want the consumers to think that is the watch we have in mind. We want them to first know Masimo as Freedom that is a much more beautiful design and has a lot more features. So now that we have begun the presales on Freedom we're giving our consumer business team, the ability if they want to begin selling W1 to their channel. So that may start happening towards the second half of the year.

Okay. Can I ask one more question about the quarter? I know there was an earlier question, but I want to be more specific. The consensus I see is $591 million in revenue and $1.11 in EPS. Are you comfortable with that? Do you believe the analysts have accurately modeled it for the second quarter?

I think when I look at the numbers right now, it appears that there was consideration for the seasonality of both businesses, as they traditionally decline in Q2. The comparisons from last year show that healthcare faced a 19% growth rate in Q2, while non-healthcare had a 10% comparison in the same quarter last year. It's important to take that into account, along with the significant year-over-year currency headwinds we are experiencing, similar to what we saw in Q1. However, I believe this will shift to being more of a tailwind in the latter half of the year regarding currency. So it's essential to keep that in mind as well.

Yes. But we reiterated the full year guidance. So while the quarters might not be exactly the way you guys have put out there we feel really good about the whole year.

Yes.

I think that was our last question. We thank you for joining us today and I know you guys are going to be spending a lot of time with Micah and Eli. Look forward to talking to you next quarter.

This concludes today's call. You may now disconnect.