I think we're ready to start our next session, and I'm really pleased to be joined by management from Masimo. On the stage we have Micah Young, the VP and CFO, and we're going to have about a 25-minute Q&A session with some audience feedback. Micah, to get started, maybe you could just talk about some of the trends in the core business, and you laid out some product guidance this year for 9% growth, driven by both the SET business but also a lot of new products that have been really taking off in the Rainbow platform. Maybe we could start there if you want to outline some of the key drivers.
Yeah.
And then we'll move on.
Yeah. Thank you, Matt. Good afternoon, everyone. Appreciate the opportunity to be here with you today. Some of the key drivers are growth, and if you think about our 8%-10% range that we give as far as our long-term growth rate, and we're, of course, guiding 2018 at kind of the midpoint at 9%. If you think about how that breaks down, our core SET pulse oximetry business is about 6%-8% contribution to that growth rate. Then if you start to look at some of our newer products like SedLine, O3 organ oximetry, and NomoLine capnography, those are a big market opportunity called a $700 million-$800 million market opportunity as well, in addition to the SET market or the pulse oximetry market. It's a fast-growing market, and we're starting to really take off on those products.
Those products grew in aggregate over 40% in the fourth quarter last year. So that's adding another point to growth. And then if you think about Rainbow, which represents approximately 10% of our business, that's growing in the double digits as well. So there's another point. So to get to that 8%-10%, 6%-8% core pulse oximetry business, add in a point of Rainbow and then a point of some of those newer products.
Good. And maybe on the SedLine business, we can give a little context for people who may not be as familiar, but you've been gaining share there and was basically a duopoly for years, and it doesn't seem like there's anything really slowing that down based on the most recent trends. Can you talk about why that is and maybe just some of the core problems that SET really solves and what you expect in terms of future market growth and share gains?
That's right. So going years back, I mean, there's always a problem with the accuracy of pulse oximetry, and we solved that with what is Masimo's SET, SET extraction technology. And we found a way to measure or to read oxygen saturation and measure it through motion and low perfusion. So there was 70%-90% of pulse oximetry that was generating false alarms. So you could imagine the chaos that created for hospital systems and clinicians. So to respond to those, there's alarm fatigue. What we did through solving that problem with SET was we reduced false alarm rates to less than 5%, and we increased true alarm detections by over 98%. So that's a big differentiator in our core technology.
We've continued to grow at two times the market ever for the past, I don't know how long, but we've been growing at that multiple and continue to take share. And if you look at 2018, I think this is the year that we take over as the leader in pulse oximetry, so we've continued, it's a very sticky business where we have a large installed base of about 1.5 million-1.6 million drivers out there just in total. And also, it's a business that has long-term contracts, so five to seven years, so it's a very sticky business model.
You have kind of a watershed event this year with the agreement with Philips.
That's right.
Philips is one of the biggest installs out there in terms of the boxes. Could you talk about what that partnership now entails, what you're doing together, and then go through some of the framework and the numbers in terms of what the Philips install base could mean for your future placement?
Yeah. So we've moved into what used to be a little contentious relationship between us and Philips to what's now a very collaborative partnership. And it starts all the way from the top down and all the way through our sales force. And the opportunity is a great opportunity for us. So this past year, we worked on integrating our Rainbow technology and our boards into their devices. And now we're working on some of those newer product lines, which is a big opportunity as well, so SedLine, O3, and capnography. The opportunity there is Philips represents, of course, 50% or so of the global patient monitoring market. And if you look at prior to our agreement, we were doing very little business with Philips. And we work with about over 70 OEM partners around the world.
Typically, we're doing business that represents maybe 60%-70% of that OEM's business. You can imagine if we can take Philips and get to those type of levels, the opportunity that gives us to really take more and more share of the market.
And I guess in 2017, you actually had a little bit of a pickup in the Philips business kind of even before you got started. Can you talk about that? And then how specifically the Philips sales force is going to be incented or help to focus on selling Masimo and selling Rainbow products?
Yeah. So if you look at an early indicator of the opportunity that lies ahead is really looking at our driver shipments or what we call our sockets. So it's either our devices, our monitors that we put out, or it's the boards that go into our OEM devices. So we saw a very strong number of shipments in Q4 as well as Q3. And we saw our oximeter shipments grow by about 12% in just year-over-year shipments in both quarters. And the lead indicator that we're seeing is there was a contribution from Philips, although it's not in our total revenue. It's not a big impact right now in our total revenue because a lot of our revenue comes from the sensors that are consumed by those drivers.
But we are seeing that we're putting more and more out there, and it's helping drive the growth in our installed base. And that's a good indicator of the revenue that's to come. But in terms of answering your second question on the incentives, I can't really get into how they're incentivized. But Rainbow brings a lot broader opportunity of revenue per driver and per account because you can also gain revenue for those additional parameters that Rainbow brings. So in terms of you're almost incentivized by all the different parameters you can bill for with Rainbow as well as the software you can bill for as well.
Maybe just one follow-up on that. I've gotten this question a little bit in trying to understand the stickiness of your business. Can you just cover a little bit more about the sales cycle and how much of your revenue is driven by capital versus those recurring components and just maybe some metrics on how sticky that is?
Yeah. So as I mentioned before, we have a very large installed base, approaching 1.6 million oximeter devices that are out there. And if you look at our, as I mentioned before, we contract for periods of five to seven years. And if you look at our devices, those are just consuming the sensor revenue. So sensor revenue, if you think about the sensors and the consumables, those represent a majority of our revenue. And these devices are consuming those. So we put them into accounts, and we'll put them on contract to contract the sensor revenue for five to seven years. And what we've experienced over, and what we've seen historically, is about a 98% renewal rate with customers. So we have a very sticky business. I think a big part is our technology is so differentiated and so, it's a superior technology.
But also, it's hard to break into that installed base because there is a cost to try to set up and enter into contracts and gain share in this business. So I think there's a few barriers or kind of moats around that revenue.
Okay. With that, let me pivot to the audience, and we'll ask them a question about your growth prospects for 2018. So this first question just asks whether they think your growth guidance is conservative, middle of the road, or more aggressive. So please key in your favorite answer, and then we'll talk about 2018 guidance. Okay. So we have a little bit of a range here. We have some very conservative, modestly conservative is the most popular answer, and then a few that are a little bit higher, middle of the road, and even up to aggressive. So I guess to start out, you've laid out the 9% product growth in the range of the 8%-10% and the LRP. Can you talk about the factors that build up the building blocks to get to the 9%?
Yeah.
Maybe relative, you already laid out the core business versus the pipeline, but maybe relative to 2017 where you grew 12%, can you talk about what the puts and takes are for 2018?
Yeah. I mean, we ended the year, and we grew 12% for 2017. We did have some contribution from our Saudi business, so that was definitely a contributor to the growth. As we move into looking at 2018, we're basically looking at it as we want to basically put out guidance that we believe is achievable in terms of we want to drive credibility in those numbers and make sure that it's something that we can put out there and that we feel good, and we're going to drive towards exceeding those expectations. And when you look at kind of how that builds up, it goes back to kind of how we have historically driven about 6%-8% in our core business, and then those new products contributed more.
And we're hoping that some of the tailwind opportunities that we have this year, let's say the Philips partnership becomes a bigger contributor and it accelerates and we have opportunities to really drive Rainbow, those would be tailwinds that would provide upside to our guidance. And there's a lot of different opportunities that we have that are out there that could see the same results. I mean, if you go back to last year, we guided 8%, and we delivered 12%. And our goal is to drive towards that higher end again and drive beyond.
When you mentioned the NomoLine, SedLine, O3 products, they've been growing really strong double digits the last couple of quarters. Is there anything one-time in there, or is this kind of strong growth that you continue to see off of a small base?
There's nothing really one-time. We had, as compared to Rainbow where we had some of the tender business helped in Q3 last year with the growth rate. In terms of those newer products, it's just a matter of just continuing to drive adoption. We saw broad strength across the board last year in the fourth quarter. We think that there's good momentum there. That could provide a tailwind this year if we can continue to see that kind of penetration and market share gains in those categories.
When you're thinking about the pipeline trajectory from some of those products, what are some of the best leading indicators to look at? Is it the new sockets or the Rainbow placements? What are some of the things that investors could kind of point to to portend what the new products could do?
I think it's still good to look at the driver numbers. I think whenever we put out that data. Also, we'll talk more and more about the integration that we're doing with Philips. I think that's another thing that is probably underappreciated. A lot of people think it's just Rainbow integration, but we are integrating those new technologies, and those are going to be something that we could see a nice uptick in our growth rates for those product lines with the partnership with Philips as well, so.
Let me ask the audience another question. I want to talk about more medium-term growth. And this just asks what your organic figure could be over a three-year period. So please key in your favorite answer, and then we'll talk a little bit more about some of the long-range growth plans that you put out there. Okay. So the most popular answer looks like 10, which would be kind of at the high end of the range of your LRP. And then we have some 7s, 8s, and 9s. And then one person or two people are above 12.
I like the number.
Yeah. I like the 12. That's good. That's good. One of the things we haven't touched on is at the Analyst Day, you laid out kind of the five secret TAMs or the new opportunities that Masimo has in development, including one in consumer. So maybe we could just talk about that first one. I know the other ones are kind of state secrets at this point. But what are the main capabilities that Masimo can bring to bear in these new TAMs that you could leverage?
Well, I mean, some of the newer products we've talked about are coming out with the integration of those newer products with Philips. And those are going to be delivered throughout the year. In terms of there's also pneumonia screening with Rad-G. We've talked a little bit about that. That's an opportunity that's going to be in more underdeveloped countries in terms of healthcare and being able to provide access to care for the pneumonia screening. And then the bigger opportunities are the things that are truly in the pipeline that are definitely out of our core business. And those are opportunities that we haven't disclosed, but we've talked that they're very sizable market opportunities. And I think you'll start to hear more about those in the future.
I think right now, the thing that gets me excited about the opportunity of the company and isn't really in our current run rate of growth is the opportunity that we have for driving hospital automation with Root and its connectivity, serving as a connectivity hub within a hospital system. We're already working with hospital systems to look at completely automating the hospital to where you bring in Root, where it can connect anesthesia machines, ventilators, infusion pumps, all kinds of third-party monitors. And all these things are not very well integrated. And Root basically connects those all in together and then sends the information centrally and then onto the electronic medical record. So it's a way to integrate the whole hospital system into the EMR, where hospitals have made significant investments over the years.
But if they can't connect everything and be able to bring the data together and send that into the EMR, it's going to be they're not recognizing the full value of that investment. So I think hospital automation, we recently announced telehealth for home monitoring with Rad-97. We're excited about that. That's been a couple of months since we talked about or came out with that release as well. We're working with some large hospital systems to really look at how can they discharge patients earlier to home and still have the communication similar to Root. They can take the smaller scale device, which is Rad-97, to the home, and it creates a connectivity hub similar to how Root connects to anesthesia machines and all those devices. It can connect through Bluetooth or Wi-Fi to weight scales, glucometers, thermometers, and then feed that information back into the EMR.
And then also, the clinicians can monitor now via their phone based on the new Replica that we announced. They can monitor that data. And then also, there's a camera built into that system to where they can have live audio feed and video feedback to the clinician. So those are some things that we're really excited about as far as opportunities for us that are more immediate that we can talk about. And then there's some other things in terms of internal floor expansion if you want to get into those, so.
With Root, maybe it's worth spending a second talking a little bit about the open architecture too. You have some applications that have already come on board, but this could potentially be an area. You've talked about it as kind of the iPhone of operating room connectivity. So could you expand a little bit on that idea and talk about the outside agreements that have come in on the platform?
There's been some technologies. We've had a company come in with technology that can go through what we call as Masimo Open Connect. So it's a MOC portal, and it allows third-party devices to connect their innovative technologies into Root and be connected through the hospital system. So we'll probably have a lot more coming out on that, but we're seeing companies start to come out with products that can connect into it and also give us a good way to evaluate opportunities on technologies that we may be interested in as well as a company, so.
And let me ask the audience another question. This is just on different areas that you could focus on as a management team to improve stock price performance. So revenue growth is in here. But then also, there's a few margin areas that people can choose or cash flow growth. And this will give us an opportunity to talk about some of those. So please choose your favorite answer here, and then we'll talk about some of the different choices you can make around focus in these places. So revenue growth is the winner, but when we have EBIT expansion and cash flow growth tied for two. And we've talked a lot about revenue. So why don't we talk a little bit about your margin goals this year and in the plan and what really are the key drivers of operating margin?
Yeah. Great. So just to kind of break down, our operating margin goals are 30%. So trying to achieve 30% long-term margin goals and then also achieving 70% gross margin goals. So I'll start with gross margin. Today, we're guiding to if you just strip out the growth and NRE on all these numbers I'm talking about, but look at just core product margins where 65.8% is what we're guiding to. And that's about an 80 basis point improvement from last year. And we are committed to driving 50 basis points per year as we drive towards 70% gross margin. So some of the big levers for the gross margin expansion are one of the biggest ones that really doesn't require us to continue to take costs out today would be just driving more and more mix to our RD sensor line.
We've done a lot of the engineering effort around taking costs out of our sensors. And we now have an RD sensor line that's a higher quality line of sensor, and it's also much lower cost. So if we continue to shift our revenue mix toward that sensor line over time, and we're still in the very early innings, that's going to drive significant margin improvements to support that 50 basis point of improvement. So that's one that's a lower-hanging fruit. It says contracts renew, we'll start to bring them on, or new contracts, we'll start converting those on the new sensor line. The other ones are optimizing our manufacturing supply chain. This past year, we vertically integrated a second facility down in Mexico and put automation into that facility.
But there are inefficiencies as you're putting that in place that's going to help us deliver into 2018 and give us some leverage opportunity there. And we'll continue to vertically integrate and become more efficient and productive in that facility. So that's another margin expansion opportunity for us. And then just looking more beyond the gross margin improvement, delivering 50 basis points there to get the 100 basis points of operating margin improvement year-over-year, we also have the opportunity to really drive through our international growth in our business. We've made significant investments over the past several years. It's going to give us the opportunity to leverage those investments and drive profitability as we scale internationally. If you look at our revenue mix today, 30% is international revenue, but our mix of profits is much lower than 30%.
So we'll continue to use that as an opportunity to drive operating margin leverage. But also, we have a lower tax rate outside the U.S., so that's going to also help us bring down the tax rate over time.
And on the RD sensor, you mentioned you're kind of early in. Can you talk about two things? One, what's kind of the absolute margin differential if you can help frame that? And is there any reason why your customer wouldn't want to use an RD sensor? What are the pushbacks to driving adoption there?
Yeah. In terms of sizing, I mean, you should think of it as maybe 10%-20% lower cost than our current products, and some are in that ballpark. So as we convert, you can imagine the savings that we'll get over time, and that really gives us confidence to put out the ability to deliver 50 basis points a year. In terms of getting people to convert, it's actually a better quality sensor, and it's a lighter feel sensor. It's easier, too. You can get better patient compliance with the sensor as well. So it's almost a no-brainer in terms of it's a higher quality and lower cost. And as new contracts come up, as we renew contracts, we even think that we have an opportunity to convert existing contracts. We may have to offer some cables to get that conversion because there's a conversion cable.
But there's opportunity to convert more meters as well.
Okay. I think we're about out of time, so I think we'll have to end there. But, Mike, thanks so much for your time, and thanks for your interest in Masimo.
All right. Thank you.