Masimo Corporation (NASDAQ:MASI) Q3 2023 Earnings Call Transcript

Masimo Corporation (NASDAQ:MASI) Q3 2023 Earnings Call Transcript November 7, 2023

Masimo Corporation misses on earnings expectations. Reported EPS is $0.1967 EPS, expectations were $0.59.

Operator: Good afternoon, ladies and gentlemen, and welcome to Masimo’s Third Quarter 2023 Earnings Conference Call. The company’s press release is available at www.masimo.com. [Operator Instructions] I am pleased to introduce Eli Kammerman, Masimo’s Vice President of Business Development and Investor Relations.

Eli Kammerman: 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.

Joe Kiani: Thank you, Eli. Good afternoon and thank you for joining us for Masimo’s third quarter 2023 earnings call. Our performance for the third quarter was within our guidance range communicated last quarter and was highlighted by record market share gains in hospitals with a record level of new customer contracts for our SET pulse oximetry and other solutions. That said, our healthcare business is navigating a clear transition away from COVID era conditions. Despite sequential improvements from the second quarter, sensor utilization remains below prior trend and hospital budget pressures have continued to slow the pace of equipment installations. This is keeping sensor utilization below our expectations for the second half of the year.

As we continue to gather more data on hospital utilization of our sensors, we are beginning to see that customer behavior and sensor purchasing patterns are transitioning back to the pre-pandemic growth trend line we saw from 2017 to 2019. Micah will have more to say about these observations later in the call. But together with our record contracting performance this year to date, this data reinforces our conviction and the underlying long-term growth rate for our healthcare business. On the consumer side, we continue to realize strong growth for hearables, which remains a key focus area for us. The rapid uptake of our hearables products is helping to partially offset the challenging consumer environment that our premier audio brands are facing for audio components and home entertainment systems.

I will share updates on some of our exciting new products and opportunities later in the call, but now I will ask Mike to review our third quarter results in more detail and provide an update on our 2023 financial guidance.

Micah Young: Thank you, Joe. For the third quarter, we achieved consolidated revenue of $479 million and non-GAAP earnings per share of $0.63. Our performance for the third quarter was within our guidance range communicated last quarter with revenue at the low end of the range and earnings at the high end of the range. For our Healthcare segment, third quarter revenues were $308 million, reflecting a 6% year-over-year decline. As with last quarter, the decline was driven by lower sensor utilization, which continues to suppress growth from our record level of new customer conversions. In addition, the elevated backlog of new equipment installations by our OEM partners and constrained capital budgets at hospitals also impacted sales.

We shipped over 63,000 drivers during the quarter, which was in line with the second quarter level. During the third quarter, we saw a slower-than-expected pace of recovery and sensor utilization. Further, the pace of equipment installations from new hospital conversions remains slower than expected, leading us to reduce our guidance for the healthcare business for the year. Despite these near-term headwinds, we did see a 10% sequential increase in revenue in what is normally our seasonally slowest quarter due in part to a rebound in sensor orders from customers who have been working down inventory. This dynamic bolsters our confidence that customer behavior and sensor purchasing patterns are returning to pre-pandemic trends. As we move past the difficult comparisons, we expect sensor purchasing patterns to ship back to the growth trend line we saw from 2017 to 2019 and believe our healthcare business will resume annual growth from our updated guidance level for 2023.

Let me take a few minutes to share some additional data that informs our perspective. As you can see in our supplemental slides for today’s results, when you step back and look at the longer-term growth trends we are seeing healthy on-trend line performance from our products on a year-to-date basis. From 2017 to 2023, our average annual growth rate for total consumables revenue is 10%, which is in line with the pre-COVID growth rate. Further, the average annual growth rate for rainbow and Hemodynamics revenue is 20%. And the average annual growth rates for our brain monitoring and Capnographyne gas revenues are 27% and 16%, respectively. This longer time frame makes the distortions of the COVID years clearer and together with the recent rebound in purchasing from our customers, who previously had elevated inventories supports our belief that the business is tracking well with its pre-COVID growth rate and that our targeted long-term growth rate remains achievable.

Our strong performance in converting new customers also reinforces our optimism about our long-term growth trajectory. We achieved another record-breaking level of new hospital contracts in the third quarter. These new contracts include sensor cells for new customers that reflect our continued market share gains. In fact, our unrecognized contract revenues for the third quarter increased 16% over the prior year period and was up 4% sequentially from the prior quarter to reach $1.4 billion. For our non-healthcare segment, third quarter revenues were $171 million, representing a year-over-year decline of 24% on a constant currency basis. A difficult environment for consumer discretionary purchases is adversely affecting the market for high-end audio systems.

With non-healthcare overall – while non-healthcare overall is suffering from the negative macro environment, we again realized strong growth for Hearables category, which increased by more than 130% year-over-year and now represents 10% of segment sales. The positive momentum in Hearables has helped to partially offset the macro conditions weighing on the market for high-end audio systems. Now moving down the P&L. For the third quarter of 2023, we realized consolidated non-GAAP gross margin of 50%. This includes gross margins of 60% for our healthcare business and 33% for our non-healthcare business. As we saw in the second quarter, gross margins were again affected by the deleveraging impact of lower sales on our fixed overhead costs and an unfavorable segment and product mix.

For our consolidated business, our non-GAAP operating profit was $57 million versus $81 million in the prior year. As decreased profits from lower revenues were partially offset by the benefits realized from reducing operating expenses, including performance-based compensation. And our non-GAAP earnings were $0.63 per diluted share versus $1 per share in the year ago period. Despite the year-over-year decline in our third quarter results, our record levels of hospital contracting and continued traction in high-growth categories are positive signals for sustainable growth over the long-term. In addition, we are partially offsetting lower revenues in 2023 with the expense control measures we have implemented. Now I’d like to provide an update on our 2023 financial guidance.

For the fourth quarter, we are projecting consolidated revenue of $526 million to $576 million with healthcare revenue of $320 million to $345 million and non-healthcare revenue of $206 million to $231 million. Further, we are projecting non-GAAP operating profit of $65 million to $79 million and non-GAAP EPS of $0.74 to $0.94. For the full year, we are projecting consolidated revenues of $2.025 billion to $2.075 billion. For our Healthcare segment, we are projecting revenues of $1.255 billion to $1.280 billion, which now includes $6 million of year-over-year currency headwinds. This represents a 3% to 5% reduction from our prior guidance on a constant currency basis. For the non-healthcare segment, our full year revenue guidance is now $770 million to $795 million which now includes $9 million of year-over-year currency headwinds.

This represents a 2% to 5% reduction from our prior guidance on a constant currency basis. We’ve incrementally reduced fourth quarter revenue guidance to reflect softer demand. Our guidance range also reflects a seasonal sales step-up typically seen in the fourth quarter. We are now projecting non-GAAP operating profit of $256 million to $270 million compared to prior guidance of $296 million to $312 million. At the midpoint, we are lowering our operating profit guidance by $41 million, which – this is comprised of a $51 million impact from lower revenues, a $9 million impact from incremental currency headwinds and a $3 million impact from increased litigation costs. We expect to partially offset these headwinds with $22 million in cost reductions.

Excluding the incremental currency headwinds, our revised operating profit guidance represents a 10% reduction from our prior guidance at the midpoint. Lastly, we are now projecting non-GAAP EPS of $2.85 to $3.05, down from our prior guidance of $3.35 to $3.55. In summary, although this has been a challenging year, challenging post-COVID transition year for our business, we believe there are many reasons to be positive about our long-term outlook. Over the last quarter, we have gained a better understanding of the transition and customer behavior and ordering patterns. We’ve had consistent success in winning new customers over the last 3 years, and Joe will share more about the exciting potential of recent FDA clearances and upcoming new product launches to extend that track record.

Our market share for patient monitoring in hospitals is steadily rising as we win new customer contracts at a record pace. We believe a return to long-term growth rate targets for our Healthcare segment will be more visible next year as we complete the transition back to pre-COVID trends. With that, I’ll turn the call back to Joe.

Joe Kiani: Thank you, Micah. As you just mentioned, our innovative new products are driving our record contract wins and sustaining our ability to grow over the long-term. Masimo has built a track record of achievements over the past 30 years that is unsurpassed in the field of patient monitoring. We’re extending these accomplishments with a combination of innovation and responsiveness to patient needs that enables us to create high-value products that truly make a difference. A great example is one of our fastest-growing products, our oxygen reserve index parameter. The Oxygen Reserve Index parameter, ORi, has accounted for over 20% of our worldwide sales of rainbow products year-to-date. Despite the fact that it has not been available in the U.S., we just received FDA clearance for ORi last month and are launching it in the U.S. this quarter.

I’m excited about the prospects for ORi in the U.S. because it has clear and well-established clinical benefits and is the first noninvasive technology for analysis that are currently done through invasive procedures. ORi has great utility for detecting moderate hyperoxia. ORi is useful for determining when to stop the intubation involving a difficult airway, provide additional supplemental oxygen and attempt to intubation again prior to surgery. ORi is also useful to avoid over oxygenating patients in the ICU and other places, where oxygen is prescribed. We expect to realize similar traction for ORi in the U.S. as we have overseas, which should boost rainbow revenues over time. For context, the U.S. market typically accounts for two-thirds of our global healthcare product sales.

In conjunction with the U.S. clearance of ORi, we have introduced our 4 LED rainbow sensors. In some countries where the 4 LED rainbow sensors have been available, many customers have switched from our 2 LED sensors to our 4 LED rainbow SET sensors. We also have combined SpHb with LiDCO cardiac output monitoring to provide for the first time indication of oxygen delivery of patients to care providers. Both ORi and oxygen delivery were received incredibly well at the American Society of Anesthesiologists Conference in October and we expect both to help improve patient care and drive our rainbow sensor revenues. Building on our precision measurements, hospital automation solutions and telemonitoring platforms, Masimo is empowering clinicians with Halo, our AI-powered clinical decision support tools designed to drive transformation from episodic and reactive care models to care enriched by continuous and predictive insights.

Deterioration prediction tools will proactively prompt clinicians helping them make more informed decisions and navigate their clinical pathways more effectively. Our AI-powered clinical decision support tools are helping clinicians improve care across a multitude of disciplines, including respiratory care, cardiovascular care and neurology and brain health. And soon, Halo will help clinicians improved care and infectious disease treatment, hemodynamics and hand hygiene compliance. In Consumer Health, we launched our STORK Baby monitor in late August in both brick-and-mortar and online retailers, including Target, Best Buy, Amazon and babylist.com. We are ramping up distribution and will be in 250 outlets by year-end with plans to quadruple that in 2024.

And in consumer audio, the Denon Pro Earbuds continue to see strong demand as we head into the holiday season. In telemonitoring, we continue to wait for FDA clearance of W1. In countries where we have been able to offer W1 for hospital to home telemonitoring, we have seen strong interest in using a W1 telehealth programs making us believe that the availability of W1 will improve patient care in the U.S. and advance our hospital-to-home strategy. Finally, I want to comment briefly on the landmark ITC victory, we won over Apple. The decision validates our ongoing efforts to hold Apple accountable for unlawfully misappropriating our intellectual properties. Just as importantly, it advances our mission to improve lives by protecting the incentives to innovate and ensuring that products that really work are able to compete on a level playing field.

To conclude today’s comments, we are encouraged by the stabilization of sensor orders and record new hospital customer wins, which reflect the superiority of our products, and give us confidence in the long-term growth trajectory for our healthcare business. We have a healthy portfolio of new and rapidly growing products and are excited about the potential contributions they can make, not just to our business, but to people’s health and reducing the cost of care. We remain dedicated to pursuing our mission to improve life, improve patient outcomes, reduce the cost of care and take non-invasive monitoring to new sites and applications. With that, we will open the call to questions. Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from the line of Rick Wise with Stifel. Rick, please go ahead.

Rick Wise: Good afternoon, everybody. Apology for the background noise. I am in the airport. Let me start talking about the order stabilization that you’re seeing. I just want to be clear in my mind, how – where are inventories now from your perspective relative to the last time you spoke to us 3 months ago. And when you’re talking about this order stabilization, is this something that you’ve seen throughout the quarter or you felt that for the last month? And – or is it something you’re just starting to see now as you head into the fourth quarter?

Joe Kiani: Well, this Rick, even though we have a really good relationship with our customers, they don’t share their inventory levels with us. So what we consider as order stabilization is the increase we’re seeing in sensor purchases. And that has continued through today. Micah, do you want to add anything to that?

Micah Young: Yes. So Rick, we’ve been monitoring. We’ve got another 3 months of data points here to look at purchasing patterns. We’ve been monitoring it very closely. The trends are encouraging. They are heading in the right direction. I think the slope of that recovery, we thought was a bit a steeper recovery and that we’ve returned back, and that’s why we’re lowering guidance for the year. But in terms of where we are today and what we’ve seen through the first 5 weeks of this quarter, the trends are heading in the right direction. We are seeing things stabilizing to more kind of that pre-COVID utilization trend and things are recovering. It’s just not the pace of recovery that we expected with the data that we were looking at in the last quarter.

Rick Wise: And Micah, I know how conservatively you will approach things, and I’m sure you thought in giving us the prior guidance range for the year that you were being thoughtful about the low end and the high end of the range. Why are you feeling today in giving this new range that you’ve – now you’re getting it right? Or why should we hope you’re getting it right? Is it because of this pickup in orders? Is it just that straightforward?

Micah Young: Yes. I think it’s multiple things. I mean, first of all, we’ve gained market share through a strong contract and that continues. So that’s encouraging. We haven’t kept pace with the in terms of equipment and installations with the gains we’ve had on contract, we’re still behind on getting those cut up. But we still have strong numbers in terms of installations that we are going to help us grow not only in Q4 but grow into Q4, but also as we move into next year. The biggest thing that we see, though, right now is, like I said, we’ve been monitoring those weekly revenue trends. We’ve got another 3 months of data points and especially when you look at October, we’ve got a lot more clarity today than we did last quarter.

We – like you mentioned, we gave you the best guidance range we could with the data we had at the time. Now that we’ve got another quarter of data, we believe that we have a very – we’re back to providing a high confidence guidance range as we move into Q4.

Rick Wise: And just last for me. What’s – I mean, I apologize for asking, but I have to ask about the year ahead, thinking about 2024, Micah, if you’re – if you’ve got the right picture right now, it seems to be, one, you’ve got relatively easy comps, two, back to trend line base business growth, and you’re launching all these new products. Can you sort of help us think through, I’m not asking for guidance today, but just we have to come up with numbers, how would you frame a reasonable starting place for us? So to help you set the stage for or start to set the stage for expectations for the year ahead. Thank you very much.

Micah Young: Yes, absolutely. So Rick, I mean, we will share more details on our expectations for 2024 on the year-end call. But as I mentioned before and even in my prepared remarks, based on the underlying trends we’re seeing in the business with the new customer conversions, we expect return to annual growth next year. And there will be some comps that change in the first half. I mean we’ve got some tougher comps in the first quarter, easier comps in the second quarter and those comps start to normalize in the back half. So we expect a return to growth. We will have to work through and finalize our plans for next year. But we believe we’re back on that growth trend heading into next year.

Rick Wise: Thank you.

Joe Kiani: Next caller, please.

Operator: Your next question comes from the line of Matt Taylor with Jefferies. Matt, please go ahead.

Matt Taylor: Hi, thanks for taking the questions. So I guess I wanted to try to work through some of the disconnect between what you’re talking about with sensor utilization – but obviously, your contract wins showing the backlog and the growth there and helping us understand how those things come together to actually recognize revenue next year and grow strongly over this new baseline? So that’s the setup for the question. But the real question is, a, are you seeing any success with some of the actions that you’ve taken to activate folks to actually get installations into the recognized sensor revenues so that we can see that rev rec going forward? And when do you think you could call this new trend, a real trend? It seems like a bit of a divergence from last couple of quarters in terms of how people are using sensors? And I guess what more do you need to know to know whether that’s durable or just kind of a short-term change?

Joe Kiani: Well, we have seen more of our installations, just not at the level that we had hoped by this time. We also did go back to the ambulatory surgery centers that are seeing more surgeries now than before and have been successful in getting many of them to switch to single-patient use sensors. As I’ve indicated before, we believe roughly 70%, 80% of the ambulatory surgery centers use Masimo. So they have just been historically using reusables. So we think we can hopefully make that change because it’s better for everyone, especially the patients. So yes, we believe as we look into 2024, we believe the worst is behind us. We believe the – even if trends in sensors growth doesn’t occur, we believe it should be stable, and because of our increase in market share, we should be growing anyway. And that’s why I think Micah in his prepared remarks stated that we think we will be seeing normal growth next year.

Matt Taylor: Got it. And maybe as a follow-up, just as a separate question. Congrats on the ITC win. Can you help us understand what this could actually mean in some different scenarios for you going forward, assuming that does get finalized, and there is an injunction, you’ll have some leverage. But what can you do with that in the context of some of the other, I guess, battles that you’re going to have with Apple going forward?