2024 The Annual Needham Healthcare Conference. I'm Mike Matson, and I lead the MedTech and Diagnostics Equity Research Team at Needham & Company. I'm pleased to introduce Masimo with us today. We have Vice President of Investor Relations, Eli Kammerman. Instead of a standard presentation, we are going to do a Q&A session. If you do have questions you'd like to ask, you can submit them electronically through the conference Needham website, or feel free to email them to me at mmatson@needhamco.com, and I'll do my best to fit them in. With that, we're going to get started here with the Q&A. Thanks for joining us, Eli. I guess let's just start with some product-related questions.
I know in the past, Masimo used to talk about this growth paradigm with SET growing high single digits, Rainbow growing 10%, your advanced parameters, including Nomo Line, O3, and SedLine growing by 20% for combined kind of high single digit growth. Does all those growth rates still apply?
Yes. Thanks for inviting us, Mike, and I'm glad to be here today. I can answer yes. Those growth rates do still apply. I can confirm those expectations and shed a little more perspective on them. For our pulse oximetry business, which we refer to as the SET business, SET is our trademark. It means signal extraction technology. We have a combination of market growth and market share gains, both contributing about equally to that 6-8% growth rate. We have been consistently winning market share for over two decades now and are very much on track to keep doing that. For the Rainbow technologies, which we are calling co-oximetry and hemodynamics as we expand the breadth of products in that area, we have been outperforming our long-term expectation of 10% growth, and we still have 10% as our minimum expectation there.
We should see some sort of boost to that as we launch our new hemodynamic system later this year with contributions coming in 2026. For the advanced parameter group, yes, that 20% growth is accurate for our long-term expectation as we gain market share. Our market share in capnography and brain function monitor is substantially lower than it is in pulse oximetry, so we do have a lot of runway there. One other element that you did not mention, and that is our hospital automation and services revenues, which we are now seeing very healthy growth in. That is in the range of 3-4% of our total sales growing at at least 20%. We do expect to achieve long-term growth of 7-10% based on that composition.
Okay, got it. The hemodynamic system, maybe, you know, I don't know if you've talked about that before. I don't remember hearing about it, so I apologize if you have, but can you maybe just tell us more about that and kind of when you're planning to launch it and how it fits with Rainbow?
Yeah, sure. Our new hemodynamic system is an expansion of the technology that we acquired when we bought LiDCO, a U.K. company a few years ago. This is a product that will provide the standard hemodynamics measurements plus one highly differentiated measurement. We will have cardiac output, we will have stroke volume, stroke volume variation, but we will also have DO2, delivered oxygen, which we are uniquely qualified to provide because of having the total hemoglobin sensor that gives hemoglobin concentration in grams per deciliter. That is a technology nobody else has.
When you know how much hemoglobin is in the blood and you know how much blood is being pumped, you combine that with the amount of oxygen saturation of that hemoglobin, that's the pulse ox value in %, then you can get DO2, delivered oxygen, which is a very valuable thing to know and should make us very competitive against the other hemodynamics monitor competitors out there like Becton Dickinson, which owns the old Edwards critical care business, as well as the Baxter Cheetah Medical product and a product made based on ultrasound from a company called Uscom. We expect to be able to gain market share by using our presence in pulse oximetry as an entree to present the value of our hemodynamics measurements, including DO2.
To get the DO2 measurement, they'd have to use your Rainbow sensor, correct?
Yeah, that's correct.
Okay. There are some kind of synergies there where maybe you pick up some hemodynamic monitoring, but you also pull through the Rainbow sensors. All right. I think you already answered my question on SET. You said you are gaining a fair bit of share there still, but I guess maybe you could talk about what's driving the share gains. I believe you have better technologies and that's part of it, but maybe just tell us more there.
Yeah, sure. There are two main factors driving our market share gains in pulse oximetry. First, it's that we have a better performing product in terms of accuracy and reliability. That means lower false alarms, better true alarm rate, as well as the ability to get around two major problems in clinical monitoring. That is low blood perfusion as well as motion of the hand and feet. That's where we get our tagline: measure through motion and low perfusion. It's especially valuable in the NICU, the Neonatal Intensive Care Unit, where we have our largest presence in hospitals. We typically expand to other critical care areas like the adult or pediatric ICU and the operating room from there. Better performance in terms of the overall reliability of the values we provide.
Secondly, we have a broader monitoring technology portfolio than we've ever had, which makes us more competitive in terms of being able to match the capabilities of our main competitor, Medtronic, who we're now competing against with four different technologies.
Okay, got it. Just keeping in that line of thought around competition, some of the core SET patents have expired. I guess I got this question from an investor, but why have not they been able to more effectively copy some of your core technologies with the IP having expired? Maybe you are just kind of a moving target because you keep innovating and adding new features and things that are architected.
Yeah, I'd say there's an external and an internal reason for that. Internally, Medtronic was blocked from innovating next-generation versions of their pulse ox technology for many years by virtue of the settlement from the patent infringement case we went against them way back in the mid-2000s. Secondly, we did not disclose the nature of all the IP, especially the SET algorithms in our patent filings. Some of it was withheld in trade secret form, and that IP is actually contained in encrypted chips on our circuit boards. So it's not accessible in any way that would allow for copying. That's how we've maintained our competitive advantage. At this point, pulse oximetry is not a very fast-growing market like some of the other markets that are being targeted by our main competitor. The appeal of investing in R&D there may have limited value for them.
Yeah. Okay. That makes sense. Where do things stand in terms of hospitals expanding oximetry into the general ward? I think there was an expansion kind of coming during the pandemic and coming out of the pandemic. Has that continued? What are you seeing there in terms of utilization of those systems that were placed in that part of the hospital?
Yeah, we're seeing a steady expansion of bed coverage with monitors next to them in the low acuity area, meaning general ward or Med-S urg floor. It really spiked upward during COVID. It leveled back off to its prior growth rate where you're only seeing low single-digit % increases in bed coverage with hardware. The traditional method for monitoring patients in low acuity has been for a nurse to wheel a monitor from room to room periodically. With some of the productivity enhancement tools that we've integrated into our monitors, like Root with vital signs, we're able to automate the data capture of all the vital signs, which acts to streamline the recording and record-keeping processes for nurses. They no longer have to write down that information on a clipboard, then type it into a computer. That's helped to increase the presence of monitors next to beds.
Now, we've been pushing for many years to monitor all patients who are receiving opioid pain control drugs postoperatively because they have the risk of causing respiratory depression where a person can slip away and die without anybody noticing if they're not on a monitor. If they are, then the drop in blood oxygen that is linked to respiratory depression will trigger an alarm, and the nurses can do something before it's too late. We're still pushing for that. One of the main missions of our new CEO, Katie Szyman, is to increase the frequency of monitoring in the hospital because of its value to improve outcomes. We're going to see a continued push in that regard.
Part of that involves getting the hardware out there, but we're also developing new form factors of monitoring, including our Radius VSM product, which is a fully wearable monitoring system, which should help to facilitate that increased bed coverage. That's because the capital equipment investment for this small wearable system is substantially lower than it would be for a big box next to the bed.
Okay. Then moving on to Rainbow, maybe you could give us an update there just kind of on the penetration, how many of your customers have adopted Rainbow. I guess why has not it happened even faster, I guess? Is there any kind of killer out there? Is it the hemoglobin or monitoring, I think it was, that really was the most appealing part of it?
Yeah, with Rainbow, it's actually grown to a pretty substantial portion of our sales now. It's about 15% of our revenues. That's still growing faster than our pulse ox business, so it will continue to rise in proportion to the whole. The two more successful parameters out there in terms of critical care adoption have been the total hemoglobin measurement, which gives you hemoglobin in grams per deciliter and helps to guide blood transfusion decisions intraoperatively. The other measurement is ORI, Oxygen Reserve Index, which has been very valuable for anesthesiologists as they do their preoperative prep and intubation of patients, helping them to know when they're starting to run out of time to complete the intubation, getting the breathing tube into the lungs to allow gas exchange. Sometimes there's a difficult anatomy or the patient has some other complications, which makes the intubation process difficult.
The anesthesiologist can know from the ORI value when they have to abandon the procedure temporarily and basically re-oxygenate the patient manually using the insufflation bag before they try the intubation again. That parameter has been adopted very successfully OUS, and now we're starting to win contracts for it in the U.S. after getting approval for it last year. Those are the main things driving Rainbow today. At this point, it looks like the % of customers who have adopted it are somewhere in the mid-single-digit range. There is still a lot of upside there because that's just scratching the surface for us. As the data continues to accumulate, showing a net savings in terms of reduced blood transfusions and expenses, we expect that adoption to continue to rise.
Yeah, okay. Can you just remind us the pricing, the sensor pricing differential between SET and Rainbow?
Yeah, our pulse ox sensors or SET sensors are typically priced in the $8-$10 range. That's for the single patient use or disposable sensors. For rainbow, it really depends on the configuration and the volumes, but those sensor prices can range anywhere between $30-$100, depending upon how many LEDs and how many measurements are achievable with those sensors. At the high end, we have all of the measurements integrated in. That includes hemoglobin, methemoglobin, ORI, and carbon monoxide, for example. We have variations on that all-in-one sensor with versions that only have a subset of the measurements. That's where the price variation comes in.
For Rainbow, are the sensors actually different, or is it just that you're charging more when they enable more of the different parameters?
The sensors are actually different. The way they differ is in the number of LEDs or wavelengths of light that they contain. We have a four-LED sensor, an eight-LED sensor, and a twelve-LED sensor. Because they have more components, they cost more as you go up that scale.
Okay, got it. Got it. All right. Back years ago, when I picked up coverage, there was a lot of attention paid to this Philips agreement. I know that you subsequently kind of updated that until 2020. Where do things stand with that now? Is that something, I mean, is it still adding to your growth, or has that kind of run its course now?
Yeah, the Philips agreement is an evergreen agreement. We are looking at expanding the terms of that. We are actively in negotiations with Philips. It has been very productive for us because it led to an increase in our penetration in their installed base on a run rate basis, very substantially. On a full installed base basis, our penetration is gradually improving because of that increased presence on a run rate basis. We will definitely pursue a continuation of that. Philips committed to integrating four different Masimo technologies into their monitors as a customer option. Those were the Rainbow measurements, as well as our capnography, our brain function monitoring, and our cerebral oximetry technologies. With all those readily available, it provides the customers with a lot more choices for adopting Masimo, which works to both companies' advantages.
Since Rainbow is available from other big OEM companies, it only makes sense for Philips to also offer it. The end result is that the hospital customer benefits because our technologies are superior and they can achieve better patient outcomes with them.
All right. And then just on the advanced parameters, the capnography, brain monitoring, organ monitoring, maybe can you tell us about kind of where your share is with those and what's driving the growth, I guess, points of to the degree you're differentiated versus some of the competitors?
Sure. For that advanced parameter group of capnography, brain function monitoring, and cerebral oximetry, we estimate our share is in the 8-10% range overall. There is still a lot of upside there. For capnography specifically, we sell disposables in the form of cannula that carry the exhale breath up to the monitor that will fit many different brands of capnography devices, not just Masimo brand. That is different than all of our other sensors, which only work with our own hardware. As a result, we have seen very rapid growth in the sales of those disposables to the point where they now represent a very substantial portion of our total capnography sales. That is going very well. We expect to see continued growth there because capnography has been broadly acknowledged as a very valuable measurement in hospitals.
It measures exhaled carbon dioxide, which is a great indicator of lung function to make sure that oxygen and CO2 are being effectively exchanged for good oxygenation of tissues. We see a lot of upside here as we continue to leverage the pulse ox presence to gain share for these other smaller revenue products.
Okay. I just wanted to get a similar update on hospital automation. I think you said it's 3-4% of your total sales, if I remember correctly. It's kind of one of those things that's kind of hard to, I think, for investors to get their arms around or understand because it's not like a single product. There's a service component. Maybe just talk about the business model there, how the deals are sort of structured, how much revenue per hospital per year you could potentially generate from that.
Yeah, sure. Hospital automation refers to our suite of products comprised of both hardware and software, which are designed to automate information-based processes. We can automate the capture, transmission, display, and analysis of all the information coming from all the devices around a patient, no matter what brand they are. At the front end, we've got our connectivity hub known as Root. That serves as a collection station for all the data coming from different devices like monitors, ventilators, anesthesia machines, IV pumps. All those things can serve as sources of data that flow through Root and then go to a second hardware component known as Iris Gateway, which is a dedicated server to translate that data stream into the HL7 or other similar programming languages that can allow the data to be inserted into the EMR, the electronic medical record.
From there, the data can also flow back out into the operating room and be reconfigured and reformatted in a very easy-to-read and comprehend style using a software module called UniView, which provides one integrated view of all the different values from all those different machines on a single video screen. That allows doctors and nurses and technicians to all be on the same page at the same time in the surgery suite so that they can manage the patient more effectively. At the furthest back end, we have our most advanced software. These are the decision support and analytics modules, such as the Halo Sepsis Index, which looks for signatures or patterns in vital signs and care history that can indicate developing sepsis.
If you can flag that early, even before you get a confirmation from a blood culture, you can have the medical team consider administration of antibiotics early, which may save the patient's life because sepsis can develop quickly and become life-threatening. That is what hospital automation is. As far as the way the business is structured, we are selling it as a subscription. It is a SaaS type of service where we can charge a certain amount per bed per year. We are looking at fees that range anywhere between $500-$5,000 per bed per year, depending upon the setting. It would be lower in low acuity because they are using less software and higher in high acuity. At this point, most of our service revenues are based on service and maintenance plans that allow for periodic upgrades of the software. They are at the low end.
Okay. All right. Just in terms of the kind of the mix of the products that you're selling, your board shipments have sort of slowed down a bit. I know there was kind of a boom and bust there during the pandemic or coming out of the pandemic, but maybe just talk about what's driven the two-year decline that we've seen there and what you're expecting for 2025.
Yeah. In 2023 and 2024, hospitals basically were recovering from the very high enthusiasm levels that they had for obtaining new monitors to improve bed coverage related to fears of running out of ICU space from COVID patients. There was a lot of monitor purchasing going on, and things kind of came back into balance last year. Now in 2025, we're expecting to see our driver shipments grow again as any excess stock that the OEM monitor companies had in their components inventory has been successfully worked down. We are expecting to see growth this year with the driver shipments coming in anywhere between 240,000-260,000 against the 235,000 we sold last year. Things are definitely on track there. That relates to the expansion in our installed base, which now is running at a rate of about 3%.
That's not the best indicator of growth for us. The best indicator of growth is the new contract wins that we quantify each quarter. We show those as incremental new contracts, which means it's either new business with brand new customers or expanded business with old customers. You can see those amounted to over $430 million last year, and we're up 11%. That's a good proxy for the kind of growth that we can achieve. Our typical contract is about five to six years. You can look at those revenues flowing in on that type of apportioned basis. We also give our total unrecognized contract value in aggregate, which includes renewal business, as opposed to that incremental contract value. In the total aggregate, we've got $1.77 billion in unrecognized contract value that represents product yet to be shipped.
You can see there's quite a predictable stream there of revenues that will accrue to us as we fulfill the shipments for those contracts.
Yeah. Okay. All right. I just want to move to a different topic. I want to ask about the consumer separation. I think with the management change and the new board and everything, that shifted from this JV effort to just an outright, an attempt to do an outright sale of the business. Is that still right? Is that still what you're aiming for, I guess, at this point?
Yeah. We're only looking at an outright divestiture involving a sale. We're no longer considering the other two options, which would have been a joint venture or a stock dividend to shareholders to spin the business out to holders. We're concentrating on a sale. We're talking to potential buyers actively now. They're conducting their diligence. Our objective is to get to a transaction by mid-year. Timing of a close could be a little bit hard to predict, depending upon whether it's a strategic buyer or a financial buyer, because a strategic buyer may have to go through significant antitrust reviews in various countries, which could slow the process down getting to a close. At the very least, we're aiming to have a definitive agreement in place by mid-year.
Okay. Has all this tariff turmoil and whatnot weighed on this or slowed this down at all?
It seems a reasonable assumption. I can't say definitively because I haven't been involved in the deal team. If there are changes in the potential profitability of the audio business related to the imposition of tariffs, of course, that would make a buyer reconsider the valuation. If that's happening, it's likely unfolded in the past two weeks. I'm not sure how it's affecting the process overall, but at the very least, you would expect people to rework the numbers.
Yeah. Okay. Putting that aside, the numbers you're reporting or the guidance for this year, I mean, it's essentially with that business already excluded. When you do sell it, you've said, I think you're going to use any proceeds to repay debt. It seems like almost regardless of what the valuation is that you end up getting, it should be accretive, right? Because you're going to pay some amount of debt down. We just do not know how much that's going to be, and that's going to lower your interest expense. I mean, is that a fair summarization?
Yeah. What we're going to have to do is pay down the loan that's associated with the audio business that we took on when we executed the acquisition. That's the first thing we need to do. We can refinance that loan if we want and use the proceeds from that refinancing to buy back shares. The original loan needs to go away, but we can still have leverage on our balance sheet that we can use to do a buyback. Okay? The magnitude of that is up in the air depending upon the actual sale price of the business. That's about all I can say at this point. We're looking at the share buyback as our true intention for use of proceeds.
Okay. That makes sense. I guess what I'm getting at is, is there any scenario in which, based on the numbers that you guys have guided to for this year, that this could end up somehow being dilutive to the current guidance EPS range you've given? It seems like to me it can only be accretive, but maybe I'm missing something.
The guidance we've given does not incorporate any assumption based on proceeds from the audio business sale whatsoever. Okay?
Yeah.
I guess if we get to a completed transaction, we would revise guidance at that point. I think the answer to your question really depends on what you're assuming for a sale price as well as interest rates for refinancing that loan. It is very difficult for me to give you a definitive answer here. Sorry about that.
Yeah. No, no worries. I appreciate it. Maybe we can talk about it offline. Okay. Just on the, so the consumer health products that you had, like the Freedom Watch and the Stork, those have just basically been shut down. They're dead. Those aren't going to be sold separately or part of this consumer audio sale, correct? Could you end up selling those if you found a buyer, or is that not happening?
No. We have shut down the baby monitor, Stork, as well as the development work on the Freedom Watch, the smartwatch. There was one project that was in motion to develop an over-the-counter hearing aid based on an adaptation of music earbuds. That's one thing that could go with the audio business sale, but it's very much up in the air. The majority of the consumer health effort has now been completely shut down.
Okay. Got it. All right. I want to move on to some financial questions. I'll start with one on the tariffs. I mean, obviously, fluid situation. We had news today that they're rolling them back to some degree, I guess, 10% with the exception of China. Just from a high level, regardless of the specific amounts, I just want to understand where your exposure is. I think you do do manufacturing. You have some manufacturing in Mexico. You have some manufacturing in Malaysia with the sensors that you move there. What else do you have? Is any of your supply chain or manufacturing coming from China at all?
Okay. We have two main manufacturing sites, Mexico and Malaysia. In Mexico, we've got exposure of 25% of our COGS. About a third of that is related to low-volume sensors and cables, and two-thirds is related to monitors and circuit boards. There is going to be different treatment there related to what's eligible for USMCA exemption and what's not. With Malaysia, we're producing most of our high-volume sensors, which are pulse ox sensors. Of course, the tariff situation there, as you said, is very fluid. We're working on assessing exactly what the financial impact could be there based on all the different factors that go into that calculation, which include not only just Malaysia production, but also the various geographic sources of raw materials and components and how the final product gets treated.
Lastly, keep in mind that we have a significant portion of our revenues from OUS customers. Some of the Malaysia production does not even come to the U.S. All right? As far as China, we do source some components and raw materials from that country. I can't really comment any further than that on the tariff treatment because those things could be shipped to different locations.
Yeah. Okay. Yeah. Because you have plants in Mexico and Malaysia. If they went there. Okay. All right. Let's see. You did talk a little bit earlier about the contracts. I think you said on the fourth quarter call, new contracts are $432 million. How should we think about the timing of when that converts to revenue? I mean, maybe you already answered this because you said the contracts last five to six years. I mean, does that imply take that and divide that by five or six, and that kind of gets you to an annual number, or is that oversimplifying it?
No, that's a really good simplistic way of looking at it. As you take the 430, divide it, say, by five and a half. That means year one post-signing, you'd be looking at $80 million-$85 million in incremental new revenues flowing into the P&L. In year two, it would be the same $80 million-$85 million. It would be flat year over year. In year two, you'd be adding in the new contract revenues that you just signed in year one. It keeps building on itself. That's how you should look at that.
Okay. Got it. Just a couple of things in terms of the P&L here. Starting with gross margin, you've seen a nice improvement from moving the sensors to Malaysia. Besides that, and putting aside any tariff impact for now, what's the outlook for gross margin? Is it just a matter of volumes growing, and that's just driving more fixed cost absorption, or are there other tailwinds there from things like product mix or geographic mix or anything else that can help your gross margins?
Yeah. Putting aside tariff impact, we expect to see gross margin improve anywhere between 50 and 80 basis points this year. That was based on continued improvements in processes and component selection based on deliberate efforts of our cost reduction team, as well as the benefits of scale. Gross margin is something that we expect to see steadily improve year by year with a long-term target in the upper 60s. All right? We did see a nice improvement in gross margin when we moved manufacturing of our high-volume sensors out of Mexico into Malaysia because labor costs were lower. Now we have to assess whether or not we're going to keep that manufacturing in Malaysia in view of the potential tariff situation, or if we're going to consider moving it back to Mexico. That's an analysis that's actually ongoing.
Yeah. Okay. The day-to-day changes, I'm sure, aren't making that easy, but okay. Then operating expense, similar question there. Outlook for the two kind of line items, SG&A and R&D. I'd imagine that we're going to see SG&A grow more slowly than your revenue, probably more like low to mid-single digits or something, more at inflationary levels. I mean, is that fair? Are there any other factors to consider for OPEX?
Yeah. Firstly, for R&D, we're aiming to reduce that from its historical levels recently in the 10-11% range down to something more in the 8-9% range, which is still very competitive against our peers. You're exactly right. On the SG&A line, we do expect to see leverage accrue there as those expenses grow more slowly. We had significant reductions in R&D last year as we eliminated some programs as well as some staff. The benefits of that cost reduction will flow through all of this year. You got your first view of it in our fourth quarter results. That's where you're seeing a significant improvement in our operating margin this year.
We're expecting to see a 400 basis point improvement in operating margin this year as a result of that portfolio optimization, both on the product and project side, as well as lower expenses in the operating expense area related to discretionary expenses, as well as things linked to the Office of the CEO. Finally, we've eliminated the spending for those consumer healthcare products that you mentioned before, which further adds to margin expansion.
Okay. I think you had talked at one point about some five-year EPS target of, I think it was, I want to say it was like $6 or something, but it almost looks like you're going to be close to that maybe next year, at least based on where people are modeling things. I guess where do we go from there? I know you haven't said guidance for next year, but let's just say that's the number where it ends up. I guess what I'm getting at with this question is you're getting a pretty massive improvement in margins this year, which is great. To what degree?
I mean, what I'm worried about is that pulling future margin improvement forward so that maybe 2026, 2027, 2028, you're not going to be seeing, not to say your margins will be down, but maybe they're going to be growing more slowly than they might have otherwise been.
We still have the same targets long-term, and we're approaching those faster than we had anticipated. We should be able to reach the endpoint more quickly, which is very good news. All right? As far as additional margin expansion, our objective is to see operating margin improved by 100 basis points per year after this year. That is a combination of both gross margin improvement as well as leverage on the OPEXs. I would not say that there is any reason to expect us to plateau. If anything, what you should expect is once we reach our long-term targets, we will come up with new targets. That is something that we fully intend to do, but we do not want to get ahead of ourselves with that.
Yeah. Okay. Let me just see if we have any, it does not look like we have any questions from the audience. I think we are going to have to wrap up there. Thank you, Eli. Hope you have some good news at our conference.
All right. Thanks a lot, Mike. Take care. Bye.
Bye.