Good morning. Welcome to this session with Masimo. I'm Matt Taylor, the U.S. Medical Supplies and Devices Analyst here at Jefferies, and I'm really pleased to be joined here by Masimo management, including Micah Young, the CFO, and Eli Kammerman, who runs Investor Relations and Strategy. So we'll have about 25 minutes for Q&A, and let me kick things off, Micah. I just want to start high level. For anyone who's not familiar with Masimo, maybe you could just talk about the evolution of the company. There's been a lot of changes from going from just SET to more parameters and different kinds of business models, including some foray into consumer where you're looking to make some changes. So maybe talk about the current state, the portfolio, and the type of growth investors could expect from that.
Absolutely. Thank you, Matt. So kind of going back, looking at our history as a company, I mean, our flagship product was centered around what we call SET pulse oximetry. It's Signal Extraction Technology. We have the ability to measure through motion and low perfusion. So patients who are very sick, we can measure through that state for patients. So that's been our—that's what the company was founded on. It's revolutionized how pulse oximeters work in hospitals. There used to be 80%-90% false alarms. And we've been able to reduce those rates in the hospital and improve outcomes in patient care. And that's been a steady growth product for us. It used to be the majority of our revenues. Today, it's about low 70%, probably about 73% of our revenues today. And we've evolved beyond the core SET pulse oximetry.
Now, we take that platform, and that platform's used in a lot of the other platforms that we've been rolling out as we think about streamlining care in hospital. We call it hospital automation, but before I get into that, the mature markets we're in are the pulse oximetry market, and like I said, that's about 73% of our revenues today. We have capnography and gas monitoring, and that's a large market as well. Pulse oximetry is about $2 billion-$3 billion when you include the general floor opportunity. That's grown about 6%-8%, or the market's grown about 3%-4%. We've been growing about 6%-8%, taking significant share capture over the past 20-plus years. But capnography and gas is another mature market area for us. It's also a standard of care in hospital, similar to pulse oximetry.
That's about a $1 billion market. It's about 4% of our revenues today. We expect to grow about 10%-20%. And these growth rates are about 2x what market growth is. So we're continuing to take share in that market as well. The third one is brain monitoring. And that's combining our SedLine, which is sedation monitoring, and combining that with also our O3, which is cerebral oximetry. So being able to measure oxygen saturation in organs like the brain. So that market's about a $300 million market, growing about 10%-20% for us in our long-range plan. And then those are kind of the mature categories. Now we start to look at the next phase of growth as far as wave two, three, and four for us. Wave two is Rainbow and combining that with hemodynamics.
And that's what we call our hemodynamics platform, is combining Rainbow continuous hemoglobin measurement with carboxyhemoglobin, methemoglobin, and bringing that together with cardiac output. And that gives us the ability to measure oxygen delivery. And that's a big market opportunity for us. We believe that's around a $600 million market just for the hemodynamics side of it. Rainbow has been about a $2 billion market opportunity when you think about being able to work with hospital systems on blood management programs, reducing blood transfusions with our products. So that's a big opportunity. That's grown 10% + per year. And then the last two waves of growth is hospital automation, continuing to connect. We have one of the largest device libraries in the industry, which is we can connect over 1,000 devices in hospitals, take that data, and we are very good at managing patient data throughout a hospital.
We can do it in real time. We have an architecture that allows us to manage in real time in terms of delivering data to any endpoint in the hospital so clinicians can make the best decisions, and it's continuing to advance that capability by we're working on advanced algorithms to help clinicians with decision support, making better decisions real time, establishing the data, the baseline data with a patient, and know if that patient's going to be deteriorating or not, or if they have markers that are going to indicate sepsis or infection. Those are things that we can help improve care in the hospital. That's kind of the third big wave of growth for us.
And then the last one is taking that capability of connectivity, our cloud platforms that we can leverage in the hospital systems, and connecting patients and their data as hospitals discharge with our technologies into the home. And that's the last big opportunity for us in terms of growth. So telemonitoring, taking our software, our hardware solutions, we've got wearable technology, some of the best wearable capabilities in the hospital, and bringing that into the home and continuing to manage those patients. So if they ever come back into the hospital, we want to reduce readmission rates. We want to reduce the length of stay in the hospital by being able to help clinicians discharge patients home earlier. And that's helping improve and lower the cost of care for hospitals.
Great. So maybe with all that explained, can you talk about how your growth algorithm could look the next few years? You've talked about high single-digit growth and 100 basis points. I'll call it a core margin expansion a year, which is a nice algorithm, but also next year with some cost cutting and some changes that have been made, bumping op margins a couple hundred basis points. Maybe tie that back into how you were talking about some of these different areas. Where is that growth going to come from? What gives you the confidence in that?
Yeah. I mean, we've continued to deliver strong growth in terms of top-line growth. Our history has been double-digit growth on top-line. That's where we aspire to be. It's where we incentivize our teams to be at. We've looked at a long-range plan as we want to make sure we have high confidence and high conviction around that. And that's a 7%-10% growth. And that's what we're expecting as we think about next year as well. And the growth algorithm is, what I mentioned before was about, call it three-fourths of our revenue coming from SET. That's about 6%-8% growth. You think about Rainbow and hemodynamics, that being a 10% + grower. And then capnography, gas, brain monitoring, all those contributing somewhere between 10%-20% growth.
And then, of course, we're starting to roll out some new product introductions in some of those categories, like Radius VSM. That's going to help as we start to roll that out in our connectivity platform in the next phase of patient monitoring in hospitals. And then, of course, W1 with the 510(k) approval there. We've been doing a lot of pilot programs, so that's going to help to start augmenting our growth rate as well. But as far as it's kind of steady, it's that steady growth algorithm that we've had in the past. And we believe that the strength of the business, what we're seeing in contracting with hospitals, we had a record year last year. We measure a couple different ways of measuring contracts. We have our renewals of contracts, and those are five- to seven-year long-term contracts with hospitals.
What we do is we contract to place our equipment in return for the recurring sensor and service revenues. So it's a very sticky model for us. And it's kind of that razor-blade model where we place the drivers in the hospital in return for that sensor revenue. And coming off a strong year last year, we're pacing faster this year through three quarters. And we're hoping to see another record year for contracting. But if you think about that, our baseline revenue, the easiest way to put it is if we're doing $400 million a year of true incremental contract revenue, you can take that and divide it by, call it, five, six years. And that's the incremental revenue you have going into next year in terms of revenue growth on top of your baseline.
That gives us the confidence coming into the next year and even being on the third-quarter call to be able to come out and start to lay out that kind of plan. 7%-10% growth next year top-line. We've laid out a plan of going from 22% healthcare margins, including the investment in consumer health. If you kind of back that off, we've got about 200 basis points of investment there. But we are planning for 26% operating margins at least next year. It's a pretty strong expansion. We're just still working through a lot of that, but we feel very good about delivering at least 26% up margin next year.
So on the 3Q call, there was a lot of talk about the transition and some of the changes at the company. And you called it a seamless transition in the press release and on the call. Maybe talk about some of the changes that have happened with the new board and management. You're in a search for a CEO right now. How has that changed the focus of the organization in terms of the margin changes and some of the different areas of investment?
Yeah. I think what you're seeing is us getting back to the core, the core healthcare business. We have such an incredible business model in healthcare and just the technologies that we've rolled out over the years and how innovative we've been. I think what I've called it here lately is we've been an innovation-driven company, but I think now we're getting innovation-focused, and what I mean by that is we have a lot of launches. One year, we rolled out, I think, a new product every month. But what I want to see us get back to, and this is some of the plans that I've been working on with Bilal, and we've been pitching to our new board, and just really getting back to focusing on the core platforms and technologies we're rolling out the next two to three years.
What we want to do is make those rollouts. We may reduce the number of individual products coming out, that we're going from more products, launching just individual elements of our platforms to really rolling out the platform in a holistic way. So as we roll out the new products, really focusing on platform launches that are more impactful to revenue. So not dribbling things out and not seeing that turn into all these products that are out there and you may hit on one or two. We want to get laser-focused to really drive the return on investment of what we're doing in terms of new product introductions. So we've been working on focusing all the resources back into some of those core platforms. Think about our next generation with Root and our next generation of patient monitoring. That's a key one for us.
Telemonitoring, really rolling that out in the right way. We've got a lot of resources we want to put towards the hemodynamics, how we're launching that, how we're marketing that as we start to roll that platform out as well. So what I'd say is margin's been an output for us. It's not the input. We're not saying we need to be at this margin percentage. What we're saying is we want to get the company focused on continuing that long-term growth algorithm we have on the top line. We don't want to compromise that, but we want to double down on the things that are going to give us the biggest returns in the biggest markets. And that's where the focus is. Now, margin is a beneficiary. Our margins improve as a result of that because we are getting more focused.
We're reducing resources in certain areas where we're not getting the right returns. For example, I mean, to get to 26% operating margins, there's areas of corporate overhead costs that we're cutting right now, rationalizing spend there. We're cutting certain marketing spend with products that are just not generating the right returns, and doing facility rationalization, a lot of these plans we've been wanting to really focus on, but we've had a lot of distraction with what we were trying to do in the consumer space, and now we're separating the consumer business, and like I said on the earnings call, I mean, that will move into if the board decides on the exact parameters, they're working through the strategic review. We're also in parallel trying to sell the audio business.
Once they define the final parameters of that transaction, that'll most likely move into discontinued operations as we hold it for sale of that business in 2025.
Yeah. I wanted to talk a little bit more about the value creation pathway for consumer as you sort of pivot back to core. Certainly, you've talked about a sale. At certain times, you've also talked about a JV potential. Is that still on the table, or what are sort of the range of options of what could happen with the consumer business?
Yeah. There's different options. I mean, we did evaluate a potential transaction with a JV partner. That's been out there. And it's not completely dead, but it's one of those where they ask for an additional period of exclusivity, and we wanted to open this process up more and not let it drag on any further. So we're still open to that option as far as how those parameters were defined, but we're also moving on. Our main priority is getting back to refocusing on our core healthcare business. So whatever transaction opportunity gets us there, that's what we're pursuing right now. So it could be a sale of just the audio. It could be a sale of audio plus consumer health. And of course, the third option was a spin-off to a public company or a publicly traded company. I still believe that's not the right option.
I don't think our healthcare shareholders want to hold on to a stock that's just a consumer stock post-spin. But the board's got to go through that process as well. And once they define the final parameters, we'll continue to move forward. So right now, we've opened it up. We're pursuing the sale of the audio business, and we're driving as fast as we can, so.
I guess I know there's different scenarios, but talk about some of the consumer or basically crossover assets that you'll keep in any of those scenarios. You still have the watches and the ability to do telehealth and those sorts of things, so could you just be clear about what's going to stay and what's going to go away?
Yeah. So the next phase, and I talked about some of the early kind of low-hanging fruit to get to what we've put out there in terms of the margin profile for next year. But we're going through what's our really R&D project portfolio rationalization. So we're looking at everything we're doing across whether it's consumer health, it's healthcare projects as well. But in terms of your question is more on how are we evaluating consumer health and how that will play in the role or in healthcare in the future. One of the things that is a key part of it is hospital to home and telemonitoring. Now, we aren't going to be consumer-facing. That's not the goal. It's going to be more discharge for patients, post-op, post-operative surgery into the home, and what are the right monitoring-type capabilities there that we're trying to build out.
That's where W1 will continue. And that's more on chronic pain as far as chronic disease management. So if a patient has a heart disease or COPD or respiratory, W1 will play a big role there or some type of wearable, whether we use the band. And we've talked about doing a band as well. So that would be used for telemonitoring. So that is going to be transferable. We also have the ability for post-surgical patients to use our just wearable wireless sensing as well because that's more of a disposable. And that makes more sense when you've got a very short-term monitoring post-op. So there's going to be different elements that we'll look at. But as far as the Freedom watch and the consumer-facing, that will probably, that's something that we're evaluating right now. We'll probably lean more into the OEM opportunity there.
I think you heard about we were working on a partnership with Google, and so that's probably where we'll lean more into in terms of the consumer opportunity, but there is some utility out of some of those consumer health products, but I think the biggest change is we are not focused on marketing those products directly to consumers. Those will be more focused on the telemonitoring capability.
You talked about the strong contract trends. This year, you've also had good census and really healthy capital environment.
Yeah.
Is there anything one-off that's helped the last two years, or do you expect more of a continuation of that into 2025?
Yeah. I mean, our contracting has been strong the past two to three years, and that's what's given us that strong, sustainable growth. And you can see this year, I mean, through three quarters, our consumable and service revenue has grown about 15% this year. Now, we've had a nice benefit from higher census this year, two and a half to four points of growth. If you look at our 7%-10% algorithm, that long-term algorithm, we only assume very low single-digit growth, so maybe one, one to two percent growth from census. So that's been a tailwind, but the biggest thing has been our contracting, and that's been very strong. And that's despite what's been a more difficult capital environment over the past, I'd say, two years, three years.
During the COVID years, we had years where we shipped twice as much in terms of the drivers that are consuming our sensors in terms of the monitoring equipment or the boards that go into OEM multi-parameter monitors. And that was very strong during those years. And then it dropped off a bit on the capital side. And I think what happened was capital budgets turned towards patient monitoring during the COVID period. And then post-COVID period, they turned back towards some of the other higher cost of capital, which is, think of imaging or MRI machines. Those are the normal capital budgets there as well. So I think now it's starting to settle back in to where patient monitoring, there will be funding that comes right back, and it starts to normalize out. And I think that's a period we're going to be going into now.
I see that what I'm seeing now is we've kind of stabilized on the capital. We've probably reached a low point this year, and now it's going to be stable to improving as we move into 2025 and beyond. But capital's been probably about a three percentage point headwind to us in our growth this year. And that's going to start to, I think that's going to be no longer a headwind as we move forward and start to turn, so.
So, in a simple way to think about it, if everything sort of steady-state, the two variables changing, you had a tailwind from census this year. Maybe that rolls over a little bit, but capital was a headwind, and maybe that improves.
That's right. Yeah. Absolutely.
And then as far as, I guess, the ability to continue growing at these high rates, can you talk about the competitive environment? There's been a lot of chatter from your main competitor and pulse ox that they're improving, doing better. They've said they've taken market share. I'm not sure that's true, but maybe you want to address that and talk about anything changing on the competitive front.
I didn't know they were growing double digits, but I'd say on the competitive front, we've seen pretty much the same in terms of pulse oximetry. They always tend to be very aggressive on pricing and how they bring together other products to price against us. But in terms of the innovation front, we've seen them come out with a new monitor that's more kind of in line with what we have with Root as far as in that kind of category. But as far as innovation, we continue to extend that kind of lead in terms of innovation. So we have so much more to offer in terms of bringing together not just our SET pulse oximetry, which is much more accurate technology, combining that with all the different parameters that we can use in hospitals with what is our proprietary Rainbow technology.
And that brings together a lot more parameters. So on one fingertip sensor, we can take patient monitoring from five core parameters to now 12. So that brings a whole different set of opportunities for patient monitoring platforms in hospitals. And then if you think about just the capabilities of what we can do in terms of managing data in hospitals, we bring together, what's different about us is we bring the whole ecosystem. It's not just pulse oximetry, but it's all the capabilities that we can bring to hospitals. And they want to partner with somebody that's driving innovation. If you think about wearable technologies, we can have wearable wireless sensing capabilities, and we're continuing to build that out and advance it. There's nobody playing in the space that can offer that capability in hospitals what we can. So that's where we continue to separate ourselves.
We've been innovating around those technologies and the way we manage data, our cloud capabilities, and how we can connect that data and manage it through that kind of connectivity and be able to distribute. We have AI software engineers. We have algorithm engineers. And we have a lot of AI capabilities that we're starting to roll out. And you'll see more of that in the coming years as we start to roll out those technologies. So that's a difference that we have is where we're taking patient monitoring in the hospitals. And it's the future of what we're going to do as we move into the home as well.
It's just a couple of minutes left. I think I'd end with two questions. One is, when you think about your growth algorithm this year, you're going to have something like at a gross level, low single-digit installed base growth. But what's been impressive is that the revenue per driver has gone up a lot this year. So could you talk about the sources of that, and how would we split between the two to get to your high single-digit growth going forward?
Yeah. I mean, if you look at, I mean, here this year, I mean, looking at the fourth quarter, we're going to ship about 60-65,000 drivers. So whenever we look at our drivers and the contracting we're doing, and again, we have very strong contract. All we need to do is ship about 20-25,000 drivers out per quarter. And then on an annual basis, growing the install base about 2%-3%. Because what we're seeing now is the revenue per driver growth has been continuing to climb each and every year. And that's because we are going from, for example, a two-LED SET sensor to a four-LED, which brings on ORI and some of those Rainbow parameters. That takes you up on a premium upsell about 30%-40% per patient. And adds so much more technology and capability.
So as we start to advance from the SET sensor and work our way up into all the capabilities we can do in terms of measuring parameters and providing that sensor capability, that's a big upsell. So that brings in more revenue per driver. Then you think about what we're doing on the service side, the connectivity, the data management. You can start to bring in service revenue. And that's another recurring revenue for us. So you can think about on one patient, you could have maybe $500 per driver per year. And then you bring in the service capability, and that's usually starting at around $400 or $500 per driver per year. So that's what you're going to see more of is we are mature now. Because we have a higher share in the marketplace today.
We're getting close to 50% in terms of the SET pulse oximetry market. And we're replacing a lot of our existing installed base as well. But we're continuing to grow with putting new drivers in place as well. So the revenue per driver is going to be more meaningful. And I think one of the things we've been talking a lot about internally is how do we start to really define that so investors can understand that growth algorithm moving forward? Because I think there's been so much focus around the installed base. And I think it's really about what can we do with expanding that revenue per driver going forward.
Gotcha. I think we have to end there a little bit over. So we'll get the last question. Cliffhanger. So you have to come back next year. Thanks, guys. Thanks a lot for your time. And thanks for your interest in Masimo.
Thank you.