Thanks everyone for joining us for the last presentation of the day. I'm Kristen Stewart, the Medical Supplies and Devices Analyst here at Barclays. And it is my pleasure to host Masimo here at the conference. With me on stage, I have Todd Koning, who is the SVP of Finance, and then also Eli Kammerman, who you might know, is the Investor Relations Officer of the company as well. So I want to just kind of talk probably pretty high level just in terms of the growth profile of your company. I think your longer-term goals are to grow the top line 8%-10%.
Yeah, that's right.
See gross margin improvement up to, I think it's 70%, and then getting to operating margins of about 30%. So how should we just think about the comfort level that you guys have on each of those metrics? Maybe let's start first just from a top line, the 8-10. How do you get comfortable that that's the right number? Certainly seems like you've been able to do that in the past.
Yeah, well, thanks for having us.
Extrapolating trend.
Thanks.
Pretty good.
Thanks for having us.
Yeah.
And we're really pleased to be here and partner with you on this. As you said, our long-term revenue growth is 8%-10% long-term. And that's really made up of three components. One is our core SET business, which is kind of equivalent to the pulse oximetry, global pulse oximetry market of $1.7 billion, kind of correlates to about 125,000 critical care beds in the U.S. It's the place where SpO2 is the standard of care. And that's about 85% of our business today, growing at about 6%-8%. Rainbow is about 10% of our business. We believe the rainbow opportunity is upwards of $1 billion. We believe that is growing at about 10%, our 10% growing at 10%. So that's another point of growth.
Then finally, our capnography, SedLine, and O3 businesses being about 5% of our revenues, growing at about 20%. And combined, the market opportunity in those three is about $700-$800 million, where we have kind of mid-single digit share. And so as you mentioned, we've been doing fairly well in the top line growth. Q4, we exited at about 13.5% constant currency growth. And for the full year, I think we did 11.9% constant currency growth on $829.9 million of product revenue. And so as we look at where that growth came from, we feel really good about the fact that we had broad strength across all of our product platforms, if you will. There wasn't really one that was driving all of the growth.
And so by and large, that gives us a lot of comfort that as we go into 2019 and we look at our $912 million guide, which is about 9.9% reported or 10-point, yeah, 10.7% constant currency growth, that we've got the right kind of, I think, momentum going into the year. We had a particularly good year relative to new customer acquisition and capital sales in 2018. So we really feel like our commercial model's working, working well, and feel quite good about where the business is at.
Just kind of on the core business, the end markets, I think you said that was like a 6%-8% growth. The end markets are maybe about half of that?
Yeah, they were growing about twice the rate of the market in core SET.
So how do you get comfortable that you're going to continue to gain share in that market? What's kind of the level of visibility that you have on that?
Yep. So I think there's a couple of things. One is, given the length of our contracts, five to six years, we come into the year with a fair amount of that under contract, and we have decent visibility too. And then competitively, we renew about 99%-98% of all of our existing customers and win probably one out of every two new contracts that we go after. So historically, we've seen one to two percentage points of share over the last 20 years. So we've demonstrated that ability. And we really believe that's on the basis of our superior technology and the fact that it really makes a difference to patients and makes a difference to the clinicians in their day-to-day lives, who oftentimes are part of the decision-making team. And that's really what has fueled our growth.
And then you can think about the fact that we have our co-marketing agreement with Philips. And that really should accelerate our penetration into or enable our penetration into the installed base of the Philips opportunity. And so Philips has about half of the market of multi-parameter monitors, and we're probably in that 10% range penetration of their base. And therefore, if we get our share up to kind of our core or the share of our other OEMs, that's another 40% share on half the market, which is about 20 percentage points. So we think we've got a lot of upside with a tailwind of the Philips agreement enabling that.
Yep. So that would suggest certainly a very, very high level of visibility in terms of really sustaining that level of growth. Is the Philips what would be reasons why you couldn't achieve comparability in terms of market share? It seems pretty straightforward.
Yeah, I think we feel really good about where we're at with Philips, frankly. And we're seeing the driver growth. We grew 14% drivers last year, which is above our long-term average. A lot of that growth is attributable to Philips. So that's one anecdote. And then as we look at the new contracts and our contract and our deal funnel process, we're seeing those contracts come into fruition in terms of Philips placements and the customer contracts associated with that. So we feel like it's working the way it's meant to.
Yep. And you mentioned Rainbow, 10% of the business. And Rainbow has been something that you guys have talked about for a very long time. A $1 billion market opportunity. So how do you really, I guess, get or achieve the kind of full opportunity that you see? What were the drivers to kind of drive Rainbow even more than it is today?
Yeah. So I think ultimately it's really getting the clinical data, the multi-center clinical data. It's continuing to get customer traction with both our hemoglobin sensors as well as our ORi and PVi sensors. And ORI is not approved here in the U.S. at the moment, but we're hoping for approval late this year in the second half. But ultimately, we do expect that that clinical data and as we get customers and more experience, that we can drive the change in behavior and really develop the market and have that become standard of care.
And then can you maybe just update us on what you see the opportunities with the general ward? Because I know that's something that you guys have also talked about.
Yeah. So we've talked about the $1.7 billion pulse oximetry market. And that kind of correlates to 125 critical care beds where pulse oximetry is the standard of care. There's another 400,000-450,000 general floor beds in the U.S. where pulse oximetry isn't the standard of care. And it is an opportunity, though, to create a standard of care for a portion of those beds. Perfect opportunity for that is in the post-operative pain management where opioids are given to a patient to manage the pain, whether it's post a cardiac surgery or knee or hip replacement of some sort. And we know that those patients are at risk of opioid-induced respiratory depression.
We know that if you monitor those patients consistently or with SpO2, that you can predict and you can see the physiological instability that precedes the decompensating event that would lead to a rescue team call out of some sort. So that's a perfect opportunity for us to kind of install our pulse oximetry monitoring on a continuous basis. Then to do that with our Hospital Automation and Patient SafetyNet solutions as well. Because that enables better management of those patients from the nursing station. It also helps reduce the amount of data transcription errors and the workflow for the nurses.
Can you maybe just expand a little bit upon the hospital automation initiatives and then also how big the opioid monitoring could be? Obviously, that's a big topic out there, and there are a lot of hospitals that clearly are interested in that type of technology. So maybe just some more additional thoughts.
Absolutely. So we're really excited about both hospital automation opportunity and the opioid opportunity. Hospital automation, think about it in three ways. One, it really takes all the data, our data as well as third-party device data in the operating room or in the ICU or the general floor. And we can bring that into our Root device. And then we can take it from there and bring it to the EMR, integrate it there, which reduces transcription errors and helps workflow. So that's kind of one value driver. The second value driver we have is presenting that data in a clinically supportive way that helps the clinicians make good decisions in how they view the data. So that might take the form of software called UniView, which you would have in the operating room.
So you'd have a big screen where you can take the infusion pump data, the ventilator data, the multi-parameter data, and you can put it on the screen in the same place no matter which operating room you're in and in the same way. Because what we found is that physicians get cognitive overload where they've got the different user interfaces. So maybe the same machines, but different manufacturers from operating room to operating room. And so it's just overload, if you will. And so our solution solves that problem. And then we can also do remote monitoring and alarm management through Replica. Or Patient SafetyNet installation on the general floor, you might have all of your installations of continuous monitoring pulse oximetry in the different rooms on the general floor with a big screen at the nursing station that's got a little box for every installation.
Then we can do decision support, which is the third arm of hospital automation, which really enables better decision-making and easier decision-making through presentation of early warning scores or the Halo Index, or you can imagine where we could take all that information, do predictive analytics that would further enable clinical decisions.
Okay.
Talk opioid?
Yes.
All right. So opioids, a lot of talk about that. I'd say on the market size and the market opportunity, there's a lot of information. We're working through that. We're optimistic that we'll not optimistic. We're going to bring more clarity to that market size in our investor day on May 16. But there's about 195 million opioid prescriptions in the U.S. every year. So a lot of those are in the hospital. A lot of those are outside of the hospital. There's 72,000 deaths due to opioids, of which about 20,000 are associated with prescriptions. So there's a lot of use out there. We would see our use case being post-operative discharge opioid use for short-term pain management or for people who are managing their chronic pain through an opioid.
And so imagine a device that is very user and consumer-friendly, that's wearable, that would be connected so you could have remote monitoring or wireless communication to your physician, or you could do notifications to other caregivers. So what it would do is it would monitor your SpO2 level, and once it got low enough, it would alarm. And that alarm might be audible, so maybe it wakes up the person who has it on, or maybe it wakes up to their partner who's sleeping next to them who can then wake them up, or maybe it notifies an emergency responder who's down the road.
Okay. Great.
Anything you want to add to that, Eli?
No.
I wonder if we could just move a little bit on to talk about the P&L. So you guys have the goal of 70% gross margins. What's the path forward there? And can you maybe just talk a little bit about the long-term kind of pricing trends for some of these contracts as well? Because we're talking in for 7 to 10 years, I'd imagine you have a pretty high level of visibility then on that.
Yep. So we've maybe just addressed the pricing first. So pricing, we see maybe 1% on average.
Positive or negative?
Pressure.
Pressure. Okay.
Pressure. But by and large, we've been able to keep pricing where it's at. We price at a pretty significant premium to the competitor, which really reflects the technological advantage that we have. We don't compete on price. And as a result, we've got pretty good top-line consistency on the pricing. Relative to our 30% operating margin target, we've guided to 100 basis points of improvement on our path towards 30%. And broadly speaking, I've talked about 50 basis points or 50 basis points of that coming from gross margin, 50 basis points coming from SG&A leverage, keeping our R&D investment at 9%. And so if you kind of look at where we're at here in 2019 guide, where we're guiding to 24% operating margin improvement or 24% operating margin, that's about 80 basis points of that's coming out of gross margin and 120 basis points coming out of SG&A.
The gross margin story has largely been a threefold story. One is leveraging our fixed overheads in our manufacturing facilities. The other is our move to a lower-cost sensor called RD or the Red Diamond sensor. And then the third is the efforts we put around our engineering teams to just lower the cost, higher yields, higher productivity, those types of things, which have yielded and certainly yielded in 2018 and will continue to yield benefits in 2019 and expect to moving forward as well.
Is there any kind of mixed benefits as well that you see in the portfolio as some of these other categories may grow a little bit faster? I think you mentioned the capnography, SedLine, O3 oximetry, or.
I think from a disposables perspective, we have pretty similar profiles. So there's not a ton of mixed benefit. I think the biggest mixed benefit is associated with our Red Diamond SpO2 sensor.
Okay. And then what about capnography and SedLine? Can you maybe just speak to those areas? Because I think you had said it's a $700 million-$800 million market. You only have mid-single digit share. And that strikes me as being an area of a lot of opportunity.
Yeah. So capnography, we think it's about a $500 million market growing at 15%. So it's a real lucrative and good opportunity for us. We continue to invest there. I think we've got a new cannula coming out later this year, which should drive growth as well. And so we're optimistic about that. And SedLine and O3, both of those are about $125 million-$150 million of market opportunity each, kind of growing mid-single digits market-wise. All of those, we've kind of mid-single digit market share. And I think one of the catalysts or one of the tailwinds we'll have there is all three of those will be integrated into the Philips monitors by the end of this year. So that should also enable adoption and uptake in those products as time goes on. And we'll support our long-term 20% growth guidance.
Okay. And then just in terms of capital allocation, I have a question on, I think, question number three. You could just skip up there. I know there's not a ton of you in the room, but I'm going to make you work. So where do you see the greatest opportunity for Masimo to add value? Increase R&D, special dividend, repurchase shares, tuck-in bolt-on M&A, transformational M&A, or you can opt out and say, "I'm short, but I'm hoping that you guys have one of the five." So countdown, use your clickers. Eli, you can't click.
No voting for you.
All right. Thank you guys for participating. Definitely seems like there's a fair number that wants you to do M&A. So you've got plenty of dry powder for it. You certainly generate a lot of cash each year, and you've got a lot in the bank. So how should people think you're going to deploy it?
Yeah. So we look at M&A. We've got a pretty broad filter on that front. And from a strategic perspective, we're looking for areas that can leverage our signal processing technology, markets that are adjacent to the ones that we're in, and also places where we can leverage our commercial footprint. And then from a financial perspective, we look at opportunities that'll help us to accelerate our 8%-10% top-line growth objectives and be supportive of our 30% operating margin target over time. And then something that'll exceed our weighted average cost of capital in the next three to five years.
So is the preference from your perspective more to do smaller bolt-ons, or do you see the opportunity to do something more transformational to maybe bring it even into a little bit different area?
Yeah. I see our focus really being on the bolt-on and the tuck-ins and technologies that are kind of in a little bit of the pre-commercial or early commercial stage, something that we can really integrate into our offering and then commercialize with our existing sales force.
You've been with the company now for a year. We were talking earlier. I'm just interested if you could just share with us your perceptions on Masimo and what you've been really kind of pleasantly surprised by, and then where you see kind of some of the opportunity.
Yeah. So I tell you, I've been really pleasantly surprised by the durability of the revenue. I think that's one of the things that I did not appreciate coming into the company. And the fact that, again, in any given year, we've got a pretty good line of sight to what's going to be coming on from a contractual perspective. And the fact that 85% of our revenues are in a space where it's standard of care, and we are by far the clinical leader in that, which just all leads to continued share taking and a strong tailwind to growth. And I think that gives a lot of confidence in our ability to kind of manage the business, make investments, and deliver the kind of results that we expect.
And then in areas of opportunity, I think it's really generating the kind of investment priorities and leverage that we can outside the U.S. as we grow our business outside the U.S., aligning our investments, bringing a real profit and loss perspective to the different countries and regions so that we can hold ourselves accountable to the investments we make. And also, I think over time, that will help us align our investment profile outside the U.S. so that we can focus on both top-line and bottom-line growth.
Okay. And I guess in the final moments, I know you have an investor day coming up on May 16th. What should we be expecting from you? Are you going to update the long-range plan? Is it just kind of technology overview? How should we not so front-run the meeting, but?
You want to hit that, Eli?
Yeah. Sure. We're going to provide a comprehensive overview of our portfolio as well as our major new initiatives in hospital automation and opioid safety. We're going to frame out the market opportunity for those two initiatives to try to give people a rough idea of how large they could be and what the various adoption curves might look like depending on various variables. And then finally, we'll talk about our financial objectives for the long term and show people the path wherein we hope to get there, including gross margin expansion, operating leverage, as well as payback from R&D investment.
Perfect.
And also our lab.
Oh, of course. There will be one special feature, which will be the interactive tour of our real-world hospital room facility where we have all of our equipment set up in a real-world setting so people can see exactly how automation works and how we connect our devices to third-party devices to get that integration.
We've taken a couple of investors through that so far, and we've found it to be really, really helpful and beneficial in helping communicate the opportunity and the value we can create with hospital automation.
Are a lot of the third parties very willing to kind of integrate? Have you integrate them into the system or have you had to?
Oh, definitely. Because when they become integrated into the hospital information network, it makes their business more sticky as well.
Yep. Okay. Perfect. Looking forward to May 16th. Thanks, everyone, for joining us here in the room. We will have an additional breakout session as well. For those of you who have additional questions, feel free to stick around. Thank you.
Thank you.
Thanks, Kristen.
Okay.