Earnings Call Transcript - MASI Q2 2023

Operator, Operator

Good afternoon, everyone, and welcome to Masimo's Second Quarter 2023 Earnings Conference Call. The company's press release can be found at www.masimo.com. I’m pleased to introduce Eli Kammerman, Masimo's Vice President of Business Development and Investor Relations.

Eli Kammerman, Vice President of Business Development and Investor Relations

Thank you. 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 results as an indicator of the company's ongoing business performance. The company believes that these non-GAAP financial measures increase transparency and 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.

Joseph Kiani, Chairman and CEO

Thank you, Eli. Good afternoon, and thank you for joining us for Masimo's Second Quarter 2023 Earnings Call. As we discussed four weeks ago, we are disappointed with the level of sales we achieved in the second quarter in both segments of our business and have reduced our revenue and earnings outlook for 2023. Micah will provide a detailed review of the quarter and our updated guidance shortly, but I want to share our view of prevailing trends in our key markets, how Masimo is doing in this environment, and how we are responding to them. In health care, we believe inpatient volumes this year remain close to flat relative to 2019, while our original 2023 guidance contemplated a step-up in inpatient volumes above those pre-COVID levels. At the time we provided our guidance, we also had large new product orders in the pipeline that we hoped would help us exceed our guidance. If patient census growth was lower than expected, these large orders would offset the lower-than-expected growth. Unfortunately, we did not see the inpatient census growth, and those large orders have not come in yet. The forecast we are giving you today assumes we will not get most of the large orders and that inpatient census growth will not return in the second half of 2023. If the rebound in inpatient census growth does not return, then we have reset our baseline this year and will expect our normal growth to return in 2024, given our strong hospital wins over the last two years. If inpatient census growth does return, then we could exceed our updated guidance this year. In the meantime, we're taking action to mitigate the impact of the shortfall in revenues. Notably, we will reduce our expenses by over $100 million. We're also refocused our field resources to speed up new customer conversions as customer scheduling and OEM equipment availability improves. On the consumer side, we are refocusing the team on Hearables, Wearables, Stork, and HEOS, while we continue to support iconic brands such as Marantz, Denon, Bowers & Wilkins, and Polk. This focus should help us grow the business despite the challenges in the consumer audio markets. I'll provide you with updates on some of these new products, but now I will ask Micah to review our second quarter results in more detail and provide an update on our 2023 financial guidance.

Micah Young, Executive Vice President and Chief Financial Officer

Thank you, Joe, and good afternoon, everyone. For the second quarter, we achieved consolidated revenue of $455 million and non-GAAP earnings per share of $0.62. For our Healthcare segment, second quarter revenues were $281 million, reflecting a 21% decline. Please recall that our second quarter 2022 revenues benefited from the shift of approximately $25 million to $30 million of revenues from the first quarter of 2022 into the second quarter due to supply chain delays in the first quarter of 2022, making the year-over-year comparison even more difficult. For the second quarter of 2023, we missed expectations by approximately $66 million. Of this amount, approximately half was related to lower-than-expected sensor orders, roughly 40% of the shortfall is related to large orders that had been expected but have not closed yet. The remainder was attributable to weaker demand for capital equipment from hospitals as well as slower-than-expected installations. We shipped over 64,000 drivers in the quarter, which is below our expectations for shipments of 75,000. We believe that orders for replacement monitors from hospitals to our OEMs have slowed as hospitals facing budget pressures delayed purchases, and our OEM partners managed their order backlog and inventories. As of the end of the second quarter, we estimate that our installed base grew by 6% over our installed base at the end of the second quarter of 2022. However, we would like to point you to our record-breaking level of new hospital contracts, as those will bring new sensor sales and are better predictors of our future growth. Coming into this year, we felt good about our Healthcare revenue outlook due to strong contracting with hospitals in the prior year, combined with some large new opportunities within patient monitoring and telehealth. Further, we expect to significantly reduce the equipment installation backlog associated with new hospital customer contracts as the supply chain issues abate for Masimo and our OEM partners. We also projected sensor volumes to improve substantially with inpatient volumes rising well above pre-COVID 2019 levels. In fact, we saw data showing sequential improvements in inpatient admissions exiting last year, and we expected those trends to continue this year. Based on data we've seen and feedback from customers, we believe that inpatient admissions have remained roughly flat versus 2019 levels, and inpatient surgeries are still down from 2019. To be clear, outpatient surgeries have increased versus 2019 levels. But even though we are in the vast majority of ambulatory surgery centers, where the bulk of outpatient procedures occur, they predominantly use reusable sensors today. The procedure shift from hospitals to ambulatory surgery centers therefore limits our consumable revenue growth, even though those patients are still being serviced with Masimo technology. We do believe there are opportunities to move ambulatory surgery centers to single-patient use sensors over time as we educate them on all the benefits of single-patient use sensors. Sensor orders were lower than expected across most of our customers in the second quarter. We have also seen extended lead times for equipment installations, which also affected sensor sales. Therefore, we are rebasing our Healthcare revenue level for 2023 and still see our long-term growth target as achievable, assuming that inpatient volumes grow annually at historical levels in the low single digits going forward. For our Non-healthcare segment, second quarter revenues were $174 million, representing a decline of 17% on a pro forma and constant currency basis. This business is grappling with reduced discretionary spending on high-end audio systems and a return of competitors who have previously been hampered by supply chain interruptions, now being aggressive with price cuts as they get back into the market. Although we are unable to raise prices to the level we had planned coming into this year, we did not reduce our prices and have put discipline in place to sell based on our features and advantages. While Non-healthcare was hampered by the change in consumer behavior and competitive pressures, a bright spot in the segment was the Hearables category, including headphones and earbuds, which we scaled up in the second half of 2022 with the introduction of the Bowers & Wilkins PI7, PX7, and PX8 headphone models. The steady growth we were realizing was boosted by the June launch of Denon PerL earbuds with automatic customization of the sound spectrum for a personalized listening experience. Hearables revenues represented more than 7% of our non-healthcare revenues this quarter compared to 3% last year. Now moving down the P&L. For the second quarter of 2023, we realized consolidated non-GAAP gross margin of 50%. This includes gross margins of 60% for the Healthcare business and 34% for our non-healthcare business. Gross margins were negatively affected by the deleveraging impact of lower sales against our fixed overhead costs, a difficult pricing environment for consumer audio products, as well as an unfavorable segment and product mix. For our consolidated business, our non-GAAP operating profit was $59 million versus $107 million in the prior year due to the revenue shortfall and its deleveraging impact, partially offset by a reduction in crude expenses for performance-based compensation. And our non-GAAP earnings were $0.62 per diluted share, which included an increase of $7 million in interest expense over the prior year period related to the debt incurred for the acquisition and share buyback in 2022. Again, we are disappointed in our second quarter results, but encouraged by the strength in the underlying fundamentals of our business. We see good potential for a rebound in our Healthcare and consumer businesses, buoyed by Hearables and the soon-to-be-launched consumer health products with our consumer team. We are committed to preserving profitability by implementing a variety of expense control measures that should provide benefits beginning with our third quarter earnings. Our expense control measures include reductions in payroll costs as we slowed down our hiring activities, as well as significant reductions in performance compensation and other measures. Further, we have reduced marketing and promotional expenses within our consumer audio business to help offset the shortfall in those revenues. Now I'd like to provide an update on our 2023 financial guidance. For the full year 2023, we are reducing our guidance range for consolidated revenue to $2.1 billion to $2.2 billion, down from our prior guidance range of $2.415 billion to $2.416 billion. This change includes reductions in expected revenues for our Healthcare segment and our Non-healthcare segment. For our Healthcare segment, we are maintaining the low end of our guidance range at $1.3 billion this year, as stated in our press release last month, and introducing a new high-end guidance range of $1.315 billion compared to our original 2023 guidance of $1.450 billion to $1.465 billion. The lower end of our guidance range assumes inpatient admission levels and capital sales trends seen in the second quarter continue through the remainder of the year. For the higher end of our guidance, we are assuming that some of the large orders expected in the first half will be realized in the second half. Further, we are assuming the pace of equipment installations from hospital conversion wins will steadily improve, leading to increased sensor volumes from new customer conversions in the second half. For the Non-healthcare segment, we are maintaining our previously stated revenue guidance from our July pre-announcement of $800 million to $850 million, down from our previous guidance range of $965 million to $995 million. Our new guidance range reflects continued weakness in the premium and luxury audio categories for the remainder of the year, partially offset by continued growth in the Hearables category, driven by our new product introductions. We are accordingly lowering our guidance for 2023 non-GAAP operating profit to $296 million to $312 million compared to prior guidance of $400 million to $405 million as we experienced deleveraging of our business, partially offset by a variety of cost control measures. At the midpoint, we are lowering our operating profit guidance by roughly $98 million, this is comprised of a $168 million impact from lower revenues, a $32 million impact from lower gross margins, and a $15 million impact from increased litigation costs. We expect to partially offset these headwinds with $117 million in expense reductions, which is comprised of $46 million from expense control measures and $71 million from performance-based compensation. Lastly, we are now estimating 2023 non-GAAP EPS to be $3.35 to $3.55, down from our prior guidance of $4.70 to $4.80. Turning briefly to our third quarter outlook. We are projecting consolidated revenue of $475 million to $525 million, with Healthcare revenue of $305 million to $335 million. And Non-healthcare revenue of $170 million to $190 million. Further, we are projecting non-GAAP operating profit of $50 million to $60 million and non-GAAP EPS of $0.50 to $0.64. Please reference the earnings presentation on our investor website for further details. In closing, although we are rebalancing our Healthcare revenue this year following the large expansion in our business since 2019, the fundamentals of our Healthcare business remain strong. Notably, new hospital customers continue to switch to Masimo technology faster than ever, increasing our share of the hospital market, and we achieved record contracting in the first half of the year which has contributed to a 12% growth in our unrecognized contract revenue versus the end of the second quarter of 2022. With that, I'll turn the call back to Joe.

Joseph Kiani, Chairman and CEO

Thank you, Micah. Masimo is an innovative, mission-driven, adaptive, and resilient company. In addition to the short-term actions to adapt to changing market conditions that we've already discussed, innovation to drive profitable growth from products that improve lives across all our businesses remains a key focus and source of vitality. Our data informs us that our business remains very strong. Starting with consumer Health and Wellness, we launched the first new Hearables product based on our adaptive acoustic technology during the second quarter, and it has been very well received in the marketplace. These next-generation earbuds are being marketed as the Denon PerL and PerL Pro to leverage Denon's heritage of world-class acoustics. We've seen nearly 200 positive press reports on PerL since the launch in June. Initial demand from existing retailers for Denon PerL has been very strong, and sales for the products are likely to be above our initial forecast formulated earlier in 2023. In addition, we received many inbound requests from new retailers to carry PerL. We are nearing the launch of our Stork baby monitor with some very large, well-recognized mass market retailers. Stork should be on the shelves soon. The retailers that carry Stork will be displaying the product in prominent locations. In addition, Stork will be available from one of the largest online baby registries. Our expectations for Stork are based upon its superior feature set and value to new parents, as well as the high visibility the product will have in marquee stores and online stores. We are not changing our 2023 sales guidance for our Consumer Health and Wellness products at this time, but we have increased confidence in our ability to reach our target of adding 1 percentage point to healthcare segment revenues with these products. We want our W1 watch and the Stork baby monitor to have FDA clearance. A 510(k) clearance for Stork will open the door for the promotion of the product for Health care. The 510(k) clearance for W1 will allow us to execute on our hospital-to-home strategy in the U.S., including preoperative and postoperative monitoring at home, as well as monitoring patients with chronic diseases such as congestive heart failure and COPD, similar to our current efforts outside the U.S. In Q2, we received two long-awaited and important FDA clearances for Radius VSM, Wearable Bioscience Monitor and Opioid Halo for detecting opioid overdose. We have finally launched these products in the U.S. We are seeing great customer excitement for these new products. Lastly, we recently secured a multimillion dollar contract for our Centroid body position sensor with a large healthcare system that shows the high potential of Centroid to help reduce the incidence of coccyx pressure ulcers with their patients. To conclude, while we regret disappointing our investors with a large revenue and earnings miss in Q2, we are happy to report strong market share gains in our Healthcare business and customer excitement around PerL, Opioid Halo, Radius VSM, and W1. We will soon launch Stork and begin to execute our consumer health business plan. Masimo has faced challenges in the past and has always overcome them to evolve into a stronger company. We are confident that we will move past the recent shortfall and achieve great results for patients, clinicians, and our shareholders alike as we continue to pursue our mission to improve life. With that, we'll open the call to questions.

Operator, Operator

Your first question comes from the line of Matt Taylor with Jefferies.

Matthew Taylor, Analyst

So I wanted to ask kind of two-part questions related, but basically wanted to understand from you how transient these issues are. And you referenced in your prepared comments, the ability to get back to kind of your normalized growth rate in Healthcare in '24. I guess I'm wondering if these comps are easy and some of the sales are getting pushed, do you think 2024 could actually be a stronger than normal year? Or why would it just go back to a normalized growth rate?

Joseph Kiani, Chairman and CEO

Well, 2024 should be a strong year for us, maybe even stronger than normal because of the availability of some of the new products and our push into telehealth, and also the Consumer Health. We see that as a very promising business. On the census side, what we don't know is whether the shift to outpatient surgeries at the ambulatory surgery centers is an anomaly due to shortages of nurses and the pressures hospitals have for inpatient care, or is that what surgeons and patients prefer. If it's an anomaly, that would be another reason next year will be a better growth year than normal for us. But assuming it is not, we believe this is our baseline. And at least if we get the normal couple of percentage increase in census beginning in 2024 compared to 2019, then we should do well. And the final point I want to make is we have the bulk of pulse oximetry monitoring into ambulatory surgery centers, but they use reusable sensors and reusable sensors are unfortunate, even despite the best efforts to clean them in between surgeries, carrying bacteria that are dangerous to patients. So we plan to make more concerted efforts in educating the ambulatory surgery centers on the advantages to patients and maybe their businesses by using single-patient-use sensors.

Matthew Taylor, Analyst

Could you provide some clarity on the recent volatility in your normally stable business? Specifically, can you break down the various factors that affected the second quarter and the revised guidance? It would be helpful to understand how much of the impact was due to Census issues versus OEM delays and orders to give us a clearer view of the situation.

Joseph Kiani, Chairman and CEO

Sure, sure. I'll give you a high level, then maybe Micah can get more granular. We came into 2023 with incredible momentum in all of the new contracts that we had in 2022 and 2021. We expected as we finish our installations of those, we would push our normal business up by several percentage points. Some of those got delayed, despite our best efforts those installations did not occur. We're now going into a higher gear calling all of our clinical specialists to support the installation. Given at least at this point, it looks like the hospitals are ready to do them finally, and the OEMs can deliver the monitors. So some of the revenue shortfall was because of that. But probably the biggest factor was lower purchases of sensors by our customers than we anticipated. We not only anticipated a return-to-normal growth off of 2019 due to the pent-up surgeries, but we also thought they're not going to order less. They ended up not only returning to the increased demand because of the pent-up procedures but also ordered less from us. Census and inpatient went down. So we could have anticipated that. And I think one of the things that I had hoped because when you're doing these projections, you're always wondering, especially in a dynamic situation would come out of COVID. You wonder what do you have as a backup plan in case some of your assumptions don't pan out, and for our backup plan, we had several large businesses that we anticipated at least one of them would close. Unfortunately, all of them got delayed, most of the things out of our control. I think one of them is due to fear of shakeup at Masimo because of the proxy war. But nonetheless, all of these factors that we had hoped would either help us flow our numbers out of the water like we'd like to but a minimum save us from maybe bad assumptions that we're making at the beginning did not materialize. And as I said in our prepared remarks, at this point, we're kind of tightening down, expecting the worst that not only Census won't return, but those large orders won't happen this year. So I hope that helps. Micah, do you want to add anything to that?

Micah Young, Executive Vice President and Chief Financial Officer

Yes. In the prepared remarks, I mentioned that large orders account for about 40% of the miss, with 50% attributed to lower-than-expected sensor orders, and the remainder due to the impact of capital and installation. Regarding your question about breaking down the lower-than-expected sensor orders, it’s quite challenging. Initially, we entered the year expecting significantly higher inpatient volumes, exceeding pre-COVID levels, which led to some incorrect assumptions. Additionally, it's hard to distinguish between customer census and ordering behavior. We lack clear visibility into inventory levels and how customers manage them, making it difficult to isolate the impacts in those areas.

Joseph Kiani, Chairman and CEO

But Matt, one thing I just want to emphasize because I've been around software companies. Sometimes software companies have great contracting, but their revenues that they can account for that quarter don't hit quite right. Obviously, that's not our situation. But what was kind of similar for me is here, we had, again, another record quarter in contracting with new hospitals and lack of any loss to our competitor. So here, we're growing, again, unfortunately, our revenues decline. Unfortunately, it was a perfect storm, and I know it's probably an overused terminology, but it really was three, four factors came together and unfortunately blew out our revenue target, but the business is strong because we are gaining over the competition by much larger slope than usual.

Micah Young, Executive Vice President and Chief Financial Officer

Can I just add one thing, Joe? Matt, we are looking at monitoring closely the orders coming from our customers. Over the first four weeks, we are seeing that improve. And that gives us more confidence in the new guidance range we have. We'd like to see them improve even further, but it gives us confidence in that guidance range we just put out today.

Operator, Operator

Your next question comes from Marie Thibault with BTIG.

Marie Thibault, Analyst

I'm going to continue along the guidance path here and see if I could try to understand a little bit more about your margin expectations and also the cadence throughout the year for revenue. It does look like we're expecting a bit of a step up in Q4 for both sales as well as operating margins, and I'm assuming most of the OpEx cuts will be coming in Q4. But if you can help us kind of figure out that cadence a little bit more, that would be helpful.

Joseph Kiani, Chairman and CEO

Micah, do you want to take that?

Micah Young, Executive Vice President and Chief Financial Officer

Yes, Marie. I discussed how we're approaching the guidance range. By lowering our guidance, we are factoring in that the inpatient admissions and capital sales trends observed in the second quarter will continue through the year, with some modest improvement. On the higher end of the range, we anticipate that some large orders we expected will materialize in the second half, particularly in Q4. If we examine the forecasts for Q3 and Q4, these large orders are likely contributing around 1% to the upper end of the range, with most of them expected in Q4.

Marie Thibault, Analyst

Okay. And I think I was also asking about the expectations for those OpEx cuts, the $100 million in expense reductions and how we should think about over Q3 and Q4?

Micah Young, Executive Vice President and Chief Financial Officer

Yes, you will see some of the effects in the third quarter. We are already implementing actions on those. A more significant impact will come in Q4 due to the reductions we are making, as well as some marketing and promotional investments linked to the consumer audio business, which are more concentrated in Q4. Those have been reallocated to counterbalance the lower revenues. We have provided guidance for the third quarter, and you should be able to project into the fourth quarter based on our expectations.

Marie Thibault, Analyst

Yes. Yes. Okay. Understood. And those cuts, the expense reductions will stay in place even if revenues rebound better than you're assuming at this point?

Joseph Kiani, Chairman and CEO

Not all of them. A big portion of the cuts is we're taking away the bonuses for the executives and many of our people and RSU grants, all that kind of stuff. So if for some reason, we deliver what we had projected at the beginning of the year, those will come back. But assuming we don't, they will be gone.

Micah Young, Executive Vice President and Chief Financial Officer

To answer your question, Marie, we have made some adjustments to align our expenses with our revenue this year. We are still focused on making the necessary investments to grow the business while managing this balance. We are taking the appropriate actions to compensate for the decline in revenues.

Marie Thibault, Analyst

Okay. That's well understood. One last question, if I could. Just sort of high level now that we have the shareholder vote behind us. What can we expect on sort of next steps for corporate strategy, what might be next in terms of expanding the Board to seven members? Any clarity you can give us on what's next here?

Joseph Kiani, Chairman and CEO

Yes. The Chairman of our Nominating Committee is working on that. Unfortunately, due to the loss of our prior Chairman of the Nominating Committee, we are kind of starting a little bit from scratch. But yes, we're eager to expand the Board and hopefully get more thoughtful people around the table.

Operator, Operator

All right. Our next question comes from Rick Wise with Stifel.

Frederick Wise, Analyst

If I could start off, Joe, maybe you could just expand on your Stork comments a little bit, obviously, very positive sounding, exciting product, as we all know. Maybe just talk about the kind of incremental revenue potential, especially as we move into the fourth quarter, what you're assuming? And maybe just remind us if you're thinking about the opportunity even looking ahead to '24 and beyond what Stork could do if it all unfolds as you hope?

Joseph Kiani, Chairman and CEO

Sure. I believe there are over 10 million births in developed countries each year, and many parents feel uneasy bringing their baby home due to the risk of SIDS and other concerns. The Stork can measure oxygen saturation and identify breathing issues, and it also features a real-time thermometer that continuously monitors the baby's temperature for fever spikes, along with impressive camera technology that will receive ongoing updates. After showcasing it at a major baby convention, we received significant interest from retailers, some of whom have expedited their processes to stock it right away. What typically takes a year or more is now happening in just two to three months. We are excited to announce that Target will be carrying Stork, and we believe this product could generate a couple of hundred million dollars annually. While the potential could reach $1 billion, we need to achieve the initial $200 million first. The demand has been robust, and we hope that once consumers use it, it will generate positive feedback similar to what PerL has experienced. However, we must navigate marketing carefully in the U.S. as we await FDA clearance. Currently, we cannot assist parents in detecting issues through oxygen monitoring. Once we obtain FDA clearance, we will fully launch the product.

Frederick Wise, Analyst

Great. Micah, you talked about implementing expense control starting in the third quarter, and you talked about some of the factors. But could you give us a little more in-depth perspective there, quantify a little bit what some of the biggest actions are? And how quickly we're going to see it in the second half, how significantly? And maybe the implications of some of these actions as a setup for '24 and beyond for gross margin and operating margins.

Micah Young, Executive Vice President and Chief Financial Officer

Yes, Rick. Some points I mentioned included that our performance compensation was approximately $71 million out of $117 million for the reductions this year. This is related to this year's performance compensation, so if we perform better, some of that may come back. The other expense reduction, amounting to $46 million, is an actual cash expense reduction, which should carry over into next year. The majority of this is a decrease in payroll costs, around $28 million, along with about $18 million related to marketing and promotional expenses for the consumer audio business.

Frederick Wise, Analyst

Okay. And just sneaking in one last one, if I could. Just maybe any update on the litigation with Apple and just any new perspectives or timelines you want to share at this point?

Joseph Kiani, Chairman and CEO

Yes, of course. We have three cases. One is the ITC, which we should hopefully have the soonest results. As you remember, we were supposed to get the commission to give us a decision on July 17. They pushed it out to October 10. We think hopefully that will stick. Assuming they go with the ALJ's 300-plus page decision, we should get an injunction barring President Biden's ability to stop it, which he has 60 days to do so. They did not stop the Lifecore's injunction, so we don't expect those arms. On the trade secret and patent case in California, as you remember, the trade secret case, we unfortunately had a hung jury, and we just met with a judge. It looks like we will not go to trial until next year again, hopefully February, March timeframe. And then on the Delaware case that Apple brought against us, they brought a patent against us, I think, 10 patents. And then we responded with a patent case against them, I think 10 patents, but we also had an antitrust complaint and an unfair competition, false advertising claim. And that is going a lot faster than we expected. The judge has been incredible and has been really holding all of our cases to the fire. That might go to trial next year, which will be unheard of. So that's where we're at.

Operator, Operator

Okay. Our next question comes from Jayson Bedford with Raymond James.

Jayson Bedford, Analyst

Maybe just a couple. Just getting back to the lower sensor sales, the $30-plus million in the quarter. Micah, you kind of alluded to it in answering your question, but I didn't hear much in the prepared remarks around inventory dynamics. Can you just talk through what you've learned maybe in the last month around inventory levels at the customer level and you implemented any better processes here to gauge inventory levels going forward?

Micah Young, Executive Vice President and Chief Financial Officer

Yes. Jayson, I mentioned earlier that it's challenging to pinpoint inventory levels with our customers due to a lack of visibility. However, we are closely monitoring customer order patterns. In the first four weeks of July, those order patterns have significantly improved compared to Q2. While they're not yet at our desired level, they do align with the new guidance range we provided today. We're focused on keeping an eye on these new order patterns and are working to gather more information as we can.

Jayson Bedford, Analyst

Okay. Maybe just on a semi-related topic of price. I think last month, you mentioned discounting. Can you just talk about why the discounting started and then kind of where we are from a pricing standpoint?

Joseph Kiani, Chairman and CEO

The discounting began, and we are still trying to fully understand it. However, I can say that we weren't discounting at the time of the contract; it occurred after the contract was signed. Once I became aware of this, I put a stop to it. I halted it because the sensor revenue is integral to our razorblade strategy. While I've given the sales team flexibility to discount our capital and even give it away, I never intended for them to lower our sensor prices, and we need to maintain discipline in this area. I've made it clear that moving forward, any discounts on our sensors will require my approval. I hope this situation does not occur again. To clarify, this practice was not happening for an extended period; it only took place briefly. The team assumed they had the freedom to do this because they had been allowed to discount capital and sometimes cables. The positive takeaway is that going forward, it should benefit our gross margins since we are no longer offering these discounts.

Jayson Bedford, Analyst

Okay. That's helpful. Maybe just last one here. Has your view of the market opportunity changed in any way here, meaning upon reflection after 2Q, is there a sense to, hey, maybe the market is more penetrated than we thought? Or does the opportunity still exist that you outlined back in December?

Joseph Kiani, Chairman and CEO

No, no. As I mentioned, it's really in the press. I believe it can be described as a tale of two realities. One reality is that our market penetration and market share are increasing. There is a slide in the PowerPoint presentation released in conjunction with our earnings call that illustrates this, but unfortunately, revenues decreased. This makes me more confident that our strategy in entering telehealth, telemonitoring, and Consumer Health is correct because, despite the strong performance of our sensor business over the past few decades, this quarter was not as successful. The trends shifted from inpatient to outpatient care. When we initially announced our three initiatives, some questioned our assessment, including a competitor. However, the data confirms we were correct; outpatient numbers increased while inpatient numbers declined, which has a negative impact. Thus, I believe our outlook for the overall market and the future of Masimo remains strong. I apologize for not meeting our expectations in Q2, but this does not reflect the overall health of our business.

Operator, Operator

Okay. Your next question comes from Mike Matson with Needham & Company.

Michael Matson, Analyst

So I just wanted to go back to the kind of quarterly sequencing implied by the guidance. I think if you take kind of the midpoint of the third quarter EPS range and the midpoint of the annual EPS range, it's implying something like $1.39 of EPS in the fourth quarter, which is a pretty big sequential step-up as well as it's up year-over-year versus last year. So the third quarter number seems believable, but that seems like a pretty tough number to reach, I guess. So I don't know; maybe you can explain how you're going to kind of make that ramp?

Micah Young, Executive Vice President and Chief Financial Officer

Yes. So Mike, if you look at the cost actions we are implementing, we anticipate a significant increase in the fourth quarter. Additionally, we are expecting stronger revenues in Q4 based on our year planning and updating our forecast. The combination of the anticipated revenue strength in Q4, including some large orders, along with the impact of expense reductions taking effect throughout the quarter, is how we plan to meet that guidance.

Michael Matson, Analyst

Okay. I'm curious if you have any second thoughts about the Sound United deal given recent developments. I understand the consumer health strategy, but when you speak about Stork, it seems like there is significant retail interest. I'm not convinced that you need a billion-dollar speaker company to get that product on the shelves at these retailers. For instance, your competitor sold their products without owning a billion-dollar speaker company. So, are you considering exiting that business to refocus on Healthcare?

Joseph Kiani, Chairman and CEO

Well, reasonable minds disagree, and Masimo has a lot of parents, and I understand people have different views on things. When we bought Sound United, we said, 'Hey, give us three years. If we haven't proven this thing is going to really do what we say it is, we'll get out of it.' Not only has that thought not changed, everything today tells us it was the right move. Secondly, we have a thriving healthcare business that I did not want to take our eyes off of; I wanted to make sure the current management team runs that optimally. So we needed a new team to optimally run the consumer health. The Sound United team has done a great job; all these contracts we have now for Stork and for PerL, that's all done by them. Again, maybe my team could have done that, but it may have distracted them from the Healthcare business. Lastly, the fact that we got in and we focused Sound United on the Hearables, which is about a $50 million to $85 million business, depending on how far you go into it, whether you're just doing streaming music and voice calls or you want to improve hearing for people that have lost hearing at a low level to moderate level. That's a huge opportunity. And already, it's working. So no, I'm sorry you still feel like I should get rid of it, but we don't; we still think it was the right decision, and we're going to do our best to prove it. But we're not going to be foolish about it; if we're wrong, we'll back out, but we're not done yet. Thank you. We have time for one more question.

Operator, Operator

All right. Our final question for today comes from Vik Chopra with Wells Fargo.

Vikramjeet Chopra, Analyst

Just two questions for me. So I guess on W1 and Stork, can you talk about the regulatory pathway for approval? And then I had a follow-up, please?

Joseph Kiani, Chairman and CEO

Yes, of course. The W1 is pulse-ox ECG and it's going through the normal channels that these products go through. Stork is a pulse-ox based product that's going through the normal channels with the FDA that look at oxygen desaturation, Opioid Halo, or pulse oximetry in the healthcare side. We believe they are all under the 510(k) procedure, and we believe we're having great communication with the FDA about it and hopefully, in the next 60 to 90 days, both of them will get cleared. But we've worked with the FDA successfully over now three decades, and sometimes some products get cleared in 30 days and some products get cleared in a decade. So let's hope that those two are not going in that direction.

Vikramjeet Chopra, Analyst

And then on my follow-up question, I heard your comments earlier about expanding the board from five to seven. But can you put a finer point around that sort of when do you expect to get the two additional board members in? Is it by the end of the year or potentially earlier or later?

Joseph Kiani, Chairman and CEO

Sure. Sure. We're going to try to get them in as soon as possible. Thank you so much, everyone. Again, I hope from here on, we have the best quarter to report and that the fundamentals of the business match the revenues from the business. We appreciate your time, and we'll talk to you hopefully in the quarter. Thank you.

Operator, Operator

Thank you. Ladies and gentlemen, that concludes today's call. Appreciate you all joining. You may now disconnect.