Okay, who decided to host this conference here anyway? So, I'm Matt Taylor, the U.S. Medical Supplies and Devices analyst here at Jefferies, and pleased to host the management team here from Masimo, including Micah Young, the CFO, and Eli Kammerman, who runs the investor relations function in business development. So, we'll have about 25 minutes here for a fireside chat, and maybe a question or two at the end from the audience. So, I guess to start out, we always like to do some high-level questions. Micah, maybe you can talk-
Mm-hmm
... a little bit about Masimo's history, but really focusing on the last couple of years. There's been a lot of transition, and you've moved into consumer. Now we're talking about potentially segmenting that off in some way.
Mm-hmm.
Maybe bring us up to speed on, you know, where the healthcare business is today, what we should think about in terms of options to separate consumer, and the time frames around that, and the progress that you've made on some of the combination initiatives between healthcare and consumer.
Yeah. Thanks, Matt. Yep, appreciate the opportunity to be here with you at the Jefferies Conference. Kind of stepping back and looking at the evolution of Masimo, the core business is still the core business. I mean, we're, you know, making great inroads, continuing to make great inroads and taking share in pulse oximetry. Big market for us. We still have a lot of runway there with those share gain opportunities. And, you know, I'll kind of hit on the healthcare side, and then we'll talk a little bit more about consumer health. But, you know, healthcare is... We look at that as the pulse oximetry is our flagship product, $2.5 billion market, give or take, maybe $3 billion market. And we're, you know, still a lot of runway ahead.
If you look at our business today, our revenues for healthcare, I think the midpoint of our guidance this year for core healthcare is about $1.365 billion. 70%-75% of that revenue is SET pulse oximetry. Rainbow is about, you know, around 15% of the revenues and growing 10%. And then if you start to look at some of the other categories of markets, we have capnography and gas monitoring, another large market, growing double digits, and that's been very strong growth for us. And we have, of course, brain monitoring, and those are some of the core parameters that we have. And the high growth markets are Rainbow, capnography, and brain monitoring for us. SET continues to kind of pace it.
We look at that growth as about a 6%-8% growth rate for the business. Overall, we still see the business as a high single-digit, low double-digit grower, as we move forward. And it's exciting that we're kind of getting back to focusing on that core business and the growth and the margin expansion story, which I'm sure we'll talk about here in a minute. But over the past several years, not only have we, you know, got, you know, went deeper into automation in hospital and more into wearable devices in the hospital, that can make patients mobile, but we've also moved more into the home through telehealth, telemonitoring, and that's gonna be a nice growth area for us moving forward as well.
And that's led us into getting into more consumer health, and devices like, you know, the Freedom Watch, the Freedom Band, some of those products that are gonna be coming out. We also launched the Stork Baby Monitor here recently, and we see some big markets ahead for that business in terms of the consumer health opportunity, getting into very large and growing markets there. So we've kind of evolved. You know, over the years, we completed an acquisition of a consumer company a couple of years ago. You know, that wasn't received well by investors, and I think, you know, we've come around and I know that we've been on the road a lot listening to investors and just finally decided to separate.
I know, you know, the commitment originally was three years. I think we've heard from top investors and we are willing to separate it earlier. So we've been evaluating that. We're looking at a separation, either a sell or spin, and that'll be the next steps in terms of, you know, we put some of those numbers out there on what the remaining part of the business looks like, getting back to the core, getting back to that 30% operating margin profile of the business. We're working diligently through two different pathways, which is spinning off into a new publicly traded company or selling the business to a third party.
I guess as you, as you've listened to shareholders and, and heard them say that they wanted you to do something different with consumer, I guess how, how have you incorporated that into your value creation thesis for Masimo? Meaning just-
Mm-hmm
... how do you think a spin or a sale is actually going to create value through the mechanism that you're choosing?
Yeah, I think, you know, we still see, you know, great value in the ecosystem that can be created between, you know, home to hospital and back to home. But, you know, we also think there's opportunities through a separation to drive value for shareholders. You know, there's 2 different options on the table. One is to spin it off into a new publicly traded company, like I mentioned. You know, the only challenges with that is, you know, it does take probably 12 months to complete a spin. It's a longer time horizon, and it also would require some operating cash. You'd wanna make sure the capital, it's properly capitalized to begin. You don't wanna have to go back out to the capital markets within the first few years of separation.
That's part of it. The other side is if we can complete a sale of the company, you know, and we're looking at a potential sale of majority stake of the business. So we would essentially deconsolidate the full business. We would not [audio distortion] we'd no longer have to report it in consolidation with our healthcare business. But the great thing about that would be getting proceeds from the sale to be able to pay down debt. That's our number one priority in terms of capital use for any proceeds that we get. And today we have about $0.63 of earnings tied up in debt, so that'd be immediate opportunity to boost earnings if we can complete a sale.
So that's, you know, and it's a shorter timeframe. I mean, we're looking at probably 3-6 months to complete that transaction versus the year it would take for a spin.
Gotcha. And I guess whether you sell or separate into Consumer Co, healthcare co, I guess how much of the Masimo trademarks, IP, et cetera, will be at Consumer Co in those scenarios? I think one question I've had-
Yeah
... especially the last couple of days, is: How does Masimo avoid competing with itself, with the-
Yeah
... with the SpinC o?
Well, first of all, we're, we're hoping to get out details of what's in front of us in terms of the sell opportunity of the majority stake. Hopefully, we'll get to a point here. We're working through diligence to where we can disclose more details around that, 'cause I think shareholders will be excited once they see the full, full view of what the, the transaction could look like. But that being said, in terms of the IP, you know, really the way it would work is we would have, with the core business for Masimo or core healthcare, legacy Masimo would essentially license a right-to-use technology and the consent to sell and target to consumers. So it's really limiting that license to the end market. All the core technology of healthcare stays with healthcare.
The only IP that would really move is the consumer audio, of course, that goes with the whole business, that core audio as well as hearables. And then the only one that's kind of where there's some crossover would be the IP around the sensor module. So if you think about the sensor module, it goes on in the back of the watch or the band, that's also tied to the Apple litigation. So that's what we're working through right now. If that were to go with the new company, then there would be a right of use license to use the sensor module IP back into healthcare for W1 and telehealth, telemonitoring. So it's really just, you know, right of use licenses.
Very similar to kinda what we have today with, with other areas of our business, where we provide right of use with, for example, OEMs to use SET, in the OEM devices. So it's, so it should be a very clean structure, and I know that there's been, you know, a lot of noise out there, but, but I think, I think once we nail down the terms and, and get all the details out there, I think it'll, it'll calm people down a little bit on, on kind of how the licensing would work.
Okay, great. Maybe I'll transition and ask you about what things could look like in a separation. You gave us a preview of that on the last earnings call, with the slide really showing-
Yeah
... kind of a pro forma first look at new Healthcare Co, Consumer Co.
Yeah.
And one of the things I think investors were excited to hear about again was the longer-term margin potential-
Yeah
... and laying out this new 66/30 goal that you have for gross and operating margin.
Yeah.
So, that is the longest question ever. So I guess just framing that.
Oh.
Maybe you could talk about, I guess, any puts and takes in that initial separation, like how close is that to what we would actually see? Are there things that-
Yeah
... could flex up and down? And then, B, in that longer-term plan to get to 30, how long would that take, or what would the cadence of OEM be like annually going forward from here?
Yeah. Yeah, great question. So what we did was we put out in the investor deck, the earnings deck, this last quarter, as Matt's referring to, is we showed basically what the separation could look like. What are the, the costs and the, you know, the changes in the P&L, to get back to a core healthcare P&L? So if you look at it, we went with a range because we're still, we're still working through the parameters of the deal, whether it's a spin or a sell. Basically, what we've put out there is kind of what it would look like, in terms of operating margins for either a spin or a sell and giving us a range.
So when you kind of carve out those costs, it could range from an operating loss you're backing out of $28 million or $51 million because there's, we have been investing in R&D. There's been marketing, dedicated resources, that we announced at the time of the acquisition that we were put out there. So once you kind of strip out, you know, the loss there, it gets to core healthcare margins of about 23.2%, at about 24.8%. So, you know, call it 24% at the midpoint. You know, and it's gonna be give or take, depending on, you know, what assets go, what costs go, and we're working through all that.
So hopefully, we'll start to narrow that down as we go through this process, but that gives you a pretty good range that wraps around kind of where we think we're gonna land. If you look at the 30% operating margins, your question was really around the cadence. And the cadence, we've always kind of delivered a very strong operating margin expansion, about 100 basis points per year, and I think that that's a cadence. Now, what things that could cause us to get there a little quicker could be is if we start to see even greater efficiencies in Malaysia, some of that happening earlier than we expect.
We just recently raised our gross margin 60 basis points. We're already seeing the cost benefit of moving to Malaysia this year, and I think we still got a lot more opportunity there. Hopefully, we'll see some of that even earlier. I feel very good about a cadence of 100 basis points a year. It's really, you know, driving 350 basis points of gross margin improvement. And, you know, we'll get there through efficiencies in manufacturing as we move to Malaysia. We should be fully transitioned by the end of this year, start to leverage efficiencies moving forward. We've had a lot of turnover in workforce in Mexico because of the competition going down there and, of course, the government's been raising minimum wage for the past 4 or 5 years.
So that'll start to roll through inventory and through the PNL next year. And then, you know, we've got a lot of focus around cost reductions with our engineering teams that are laser-focused on driving costs out of products and improving product margins over time, especially as we get into higher volumes with some of those higher growth product lines that have been kind of a smaller scale, but they're starting to get a much larger size in terms of our revenues. And then, of course, the last is leveraging our installed base.
You know, today, despite you know, seeing some softness in driver shipments here recently, just because of the inventories that the OEMs have taken, we've got a large install base out there that we continue to leverage over time because we provide that equipment free of charge, and then in return for the recurring sensor revenue. So that becomes a very high leverage model for us. So that's another path to achieving that 66% margin we're targeting.
Very good. And so you talked there about definitionally kind of a medium-term plan, a six-year cadence you got from '2024 to 2030-ish. I guess two things. So one is, if you did see some upside from Malaysia or some of these other sources that you talked about, how much flex could there be? That's one. And then I guess longer term, you probably will stop at 30. What are the best margins could get in-
Yeah
... kind of a longer term plan?
Yeah, I think as we think about, as you mentioned, you know, six years, you know, getting to 30%, I think we continue to see good leverage. It's ultimately gonna be we've gotta come back with some new initiatives around cost reduction, that'll continue to take us beyond 66% gross margin. And I think we'll, you know. And then you always have the leveraging the install base, so those will continue. You know, will we see 70%? I mean, we would love to get to 70%. I think that's gonna be our ultimate goal is to get there.
But, you know, going beyond six years, I mean, I can see margins getting to a 35% operating margin, and then you're probably getting close to 40% EBITDA margins over time. So, still a lot of leverage in this business, but, you've got to do it through scale. I think our innovation and our ability to grow the top line, you know, high single digit, low double digits, is critical as well to getting that leverage story.
You, you mentioned before you have some confidence in healthcare going back to being a more consistent, high single-digit to low double-digit grower kind of 8-10. Could you talk about the pathway this year, as you are expecting sales growth to ramp through the year? E ven though we did see a slightly weaker board number in Q1.
Yeah.
So maybe first explain the board piece in Q1 and talk about the catalyst for higher growth through the remainder of the year.
Yeah, absolutely. So drivers in Q1, you know, I mentioned on the fourth quarter earnings call that we, I think we were sitting around 57 or 58 thousand in Q4 last year, and I signaled that Q1 would be a low point, and I thought it would be in the low 50s. And then we'd start to rise back up to 55,000, and I mentioned that on the most recent call, we'd step up to 55,000 in Q2, and then be back to our normal pre-COVID kind of level, 60,000 a quarter in the back half. The dynamics that's happened is OEMs, our OEM partners have taken a lot of additional inventory of our technology boards over the last several years. So they're working still through shipping out of their inventories.
And that's kinda created a near-term kinda air pocket for us that, you know, if I were to guess, we're probably shipping over 60,000 into the end customers, as we, you know, ship through to the final customer. But into our OEMs, it has pulled back because of the inventory levels they were maintaining. So I'm not concerned that it's a short-term issue, and it's gonna come back. It's temporary. The reason our, our best leading indicator for growth is really what we're doing on our contracting of new incremental revenue, whether it's new customers or expanding existing customers in terms of revenue on contracts. And last year, we had a record year in terms of we were around $400 million of new incremental value on contracts, and those contracts are about five to seven years.
You can kinda see how that revenue waterfalls in each year. Plus, keep in mind that when we talk about our contract revenues or our contract backlog, our unrecognized contract revenue, that's up 11% year-over-year from last year. That is only at probably somewhere between 70%-90% of the committed volumes in hospitals. So they're doing much higher volume, but hospitals will not always commit to the volume they're doing, so they're lowering the minimums. That's another reason why we're seeing very strong revenues that should be coming in. And if you look at our guidance, you know, Q1 is a tough comp. Q2, I think our implied guidance is about 17%-21% growth in Q2.
I hope Medtronic does the math on that in terms of market share, 'cause if they're doing the same math they did in Q1, we'll gain 400 basis points. But if you look though, year to date and then full year, you know, we're guiding 6%-9% with a down capital year, and capital is down about double digits. So that implies, you know, with capital being 15% of our revenues, you've got at least a 1.5-point headwind. So our 6%-9% growth, we're growing much faster on consumables, which that's where we get our recurring revenue, and that's the core part of our business. So we're still tracking very well, which gives us confidence in that long-range growth plan, 'cause capital's gonna turn around. It's just, you know, we've planned for a down year.
Just extending that a little bit, could you talk more about the underlying fundamentals this year, how you feel about the market health? You've mentioned on prior calls that inpatient trends have been really supportive-
Yes, yeah
... and basically above your guidance so far.
Yeah.
It sounds like even though this board dynamic is a little wonky, that you're saying you're seeing good trends in the end markets in terms of what your OEMs are doing.
Yeah.
Not putting words in your mouth, but they're shipping the boards, right?
That's right.
So, I guess any comment on the current state? Has anything changed? Do you still feel really good about the fundamentals?
Feel, feel great about the fundamentals. And like I said, the biggest leading indicator I look at is how strong we are contracting with hospitals, and that's really how we measure share gains. We don't look at it year-over-year on one quarter and say we're gaining share. We look at it on what we're taking on new contracts, and how we're retaining our existing business. But if you look at, you know, just kind of how things are playing out going forward, I mean, we're seeing good growth across all categories. I mean, everything's coming in where we expected, in terms of kind of where SET growth has been, where it is this year, and how we expect it to go going forward.
Rainbow has been really strong over the past five years, and it continues to be on a good pathway. The other thing is we, Our Rainbow, even though it's gotten to 15% of revenue, and it, I think, it was around $200 million last year in revenue, ORI's been a big product line for us that gives us, like, a lot of confidence moving forward. That's only been available outside the US, and we're just now launching that in the US under 510-k approval. And that product has gotten to a point where it's about 20% of our Rainbow revenue, so about $40 million last year. So there's great potential now that we're launching it in our biggest market to take ORI to that next level, and that'll be a good tailwind for growth as well.
All our other categories, you know, they're hitting the expectations that we set out there. The installed base growth, you know, one thing that we're gonna start sharing more of is our consumable revenue per driver, because our utilization on the install base has been very strong. You know, we were at 1.8 million drivers back in 2019 pre-COVID. Today, we're sitting about 2.6 million drivers, so our install base has grown 50% over the last five years. Our revenue per driver on consumables and service is just as high as it was in 2019 on an install base that probably has 10% extra drivers in it. 'Cause you know, back in 2020, we shipped 480,000 drivers, and we typically ship about 240,000 a year.
We're seeing good utilization per driver. That's another thing that's giving us confidence. As we move forward, if the install base is kind of mid-single digits, you know, that will be plenty to support the growth of high single digit, low double-digit growth for the company.
We might have time for one more. Like, maybe I'll just ask you on the last call in the queue, there are disclosures about the FDA looking at the timing of a recall disclosure, and then also an SEC looking at an accounting-
Mm-hmm
... issue in that-
Yeah
... investigation. Is there anything you can say about those now in terms of trying to help investors understand?
Yeah
... the risks there?
Let me hit the SEC if you wanna hit the product recall. So on the SEC side, I've been very close with this. You know, we had an employee from Sound United that basically came to me shortly after the acquisition, and, you know, raised some issues with some accounting practices with intercompany transactions with the consumer business. At the time, I immediately knew the complexities 'cause I've dealt with those at prior companies in that area with foreign currency and how those things impacted it. So I had one of the Big Four firms look at it and review. They came back and concluded everything looked like it was working properly.
Fast-forward to the end of 2022, the year that we acquired the company, and I do a quarterly sub-certification process, and this employee raised additional issues again. So I had our internal auditors, external auditors review it. We all concluded that there's no material misstatement of the financials, and, and of course, we did that all ahead of our filing of our 10-K that year. And I have to get comfortable because I'm signing off on the 10-K every year. So, so that was a very thorough process we went through. Fast-forward, you know, what we learned at that time as well is that employee also sued a former employer prior to coming to our company. So, we weren't surprised to get a whistleblower, you know, inquiry from the SEC.
We knew it was coming, but, you know, it's just a matter of time. But I feel very good about our position. We did all the right things, and no concerns at all about any restatement.
Great.
Um, Eli?
Yeah, sure. On the recall and the DOJ investigation, it involves a handheld monitor called the Rad-G, which is a product that's been sold primarily in developing countries for field use to diagnose childhood pneumonia. In the U.S., we sold a very small number of units, and the recall is a Class II voluntary recall. We have a protocol designed to detect whether or not the units in the field are defective. In the U.S., it's less than 100 units, so we don't expect a very large impact from this, and we do have a resolution for it now, so we do expect it to be resolved satisfactorily.