All right, so good afternoon, everyone. I'm Mike Matson, Medical Device Analyst here at Needham & Company. I'm pleased to introduce Masimo. And sitting over there, we have Eli Kammerman. He's Vice President of Business Development and Investor Relations. So we're going to be doing a fireside chat here today. So I'm kind of broken out by your different kind of product lines and some other more general questions. So I guess I just wanted to start with your SET measurements. So can you talk about whether or not you're still capturing share in the core oximetry market? And if so, what's allowing you to capture that share?
Yeah, yeah, well, first off, thanks, Mike, for having us, and we're really pleased to be here and share our story. I think we've got a great story to share and a great opportunity ahead of us, so you talk about SET, and maybe before I jump into SET, I can lay out our-.
Yeah, sorry. I should have asked if you wanted to do a brief intro.
I can give you a little intro. So we're guiding $912 million of revenue, product revenue, here in 2019, which is about 10.7% in constant currency growth over 2018. Our guide for EPS is $3.08, and it implies about a 24% operating margin, which is about a 200 basis points improvement over the non-GAAP product operating margin percentage of 2018. Our revenue is really kind of we think about it in three primary components. We think about SET, which is about 85% of our business, which is core SpO2, or the measure of the blood oxygen level, or the oxygen level in the blood. And SET stands for Signal Extraction Technology. It's kind of our proprietary technology for measuring the SpO2 levels in a patient. That's about 85% of our business. And our total company revenue guide is about 8%-10% over the long run.
And in that context, SET is growing at 6%-8%. 10% of our business is Rainbow. So talk about non-invasive measurement and monitoring of hemoglobin levels, Oxygen Reserve Index, as well as a number of other non-invasive measurements. That product line is growing at about 10% a year. And then we have advanced parameters, capnography, SedLine, brain function monitoring, and O3 Regional Oximetry. Those are about 5% of our total revenue, is growing at 20%. It's another point of growth. So that's kind of how we get to our 8%-10% growth. When we dig in a little bit deeper in SET, we are definitely having good experience and good uptake there. We've been taking share at about a point or two a year over the last 20 years or so.
When you look at that market, we believe that market's growing about 3%-4% a year. We're growing at twice the rate of the market at 6%-8%. When you look at our technology as compared to our nearest competitor, Nellcor, it is significantly better clinical outcomes. Those clinical outcomes mean better outcomes for patients. It's fewer missed true alarms and fewer false alarms. That's good for patients, but it's also good for the nursing and the clinical staff in the hospital who have to bear the brunt of those false alarms. That technology benefit or relative performance improvement over Nellcor and other competitors is really the backbone of why we can continue to take share at the rate that we have in our core SET products.
Okay. And just given that you—it sounds like you clearly have a better mousetrap in that category. So I guess, why are hospitals even using the competitive products when you have something that seems to be clearly superior?
So a lot of times, it kind of comes down to price and the competitiveness of the offering and what hospitals and customers are looking for. But when we do lose, we typically lose on price.
Okay. And have you seen anything new from a competitive perspective in the oximetry market? And I guess more specifically with regard to Medtronic, have you seen them doing anything differently now that those patents expired and they're not having to pay the royalties anymore?
So as you know, the patents expired in October. The royalty ceased in the first week of October as well. And we thought we might see something at ASA. It would have been a perfect opportunity for them to kind of come out with something new. But they didn't. And we really haven't seen much since. That said, we take our competitors really seriously and are always trying to continuously improve ourselves. In fact, we did launch an improvement in our clinical accuracy and results as well on our SET technology in the second half of 2018. So we continue to innovate. We continue to improve and raise the bar because we're always very, very sensitive to the fact that competitors never stop.
Yeah. Okay. And then moving on to the Rainbow category, can you talk about the utilization of the different Rainbow parameters within the measurements that are available?
Yeah. So I think the two primary areas where we're focused on is ones with SpHb and PVI. And SpHb is the non-invasive measurement of hemoglobin. And the other one is ORI, which is Oxygen Reserve Index. ORI is not approved in the U.S., but it is approved outside the U.S. And we have some really good pockets of success there. One happens to be with one of our Middle East customers. And we find that where customers are building out new facilities and really committed to the leading technology, they are adopting our products wholesale and having great success with that. In addition, we're seeing great success or good success in penetration and utilization with ORI in Japan as well.
So our expectation is, as we continue to see success in different markets, that we can then take that and leverage that and use that to support the commercialization and broader adoption.
I think you're still waiting on U.S. clearance or approval for.
For ORI.
For ORI. Okay.
That's correct.
What's the latest update with regard to timing on that?
We don't really like to handicap when FDA is going to come back. We're in active dialogue with them about clinical data and about the index. It's a reserve index, Oxygen Reserve Index, that nobody else has. So it is taking a little bit of extra work and partnering with FDA to ultimately get them over the hump.
Okay, and then what are you doing to try to drive more Rainbow adoption in both the U.S. and outside the U.S.?
Yeah. So I think it kind of comes back to pointing to our existing experience with existing customers who are having success, as well as leveraging the clinical data that we have and are working towards to essentially prove the efficacy and the clinical value of the product.
Are there any clinical trials that you would point to specifically?
We've talked about both NACHO and Big 10, which are multicenter trials that are assessing the value of non-invasive hemoglobin.
Okay. And can you talk about the pricing of the Rainbow sensors relative to SET?
Yeah. The Rainbow sensors, kind of depending on which parameters you choose, can range anywhere from kind of $20 to $50 a sensor as compared to our SET sensors, which typically range in the $8 to $10 range.
Okay. And just moving on to the other measurements, can you just talk about what they are and the market opportunity with NomoLine, SedLine, and O3?
Yep. So our advanced parameters in total are about $800 million of market opportunity. Capnography is about $500 million of market opportunity. That market, we believe, is growing at about a rate of 15% a year. So it's pretty healthy market growth. Our share today is kind of mid-single digits in that market. And we are, in aggregate, across all three product lines, projecting 20% growth. So applying that growth rate to capnography gives us a little bit of share taking and share gain across the coming years in capnography market. SedLine is about a $150 million market. That market is growing kind of mid-single digits, 5% to 7%. And our share is mid-single digits at a rate of 20% growth. We're capturing share at a pretty good clip there.
O3 Regional Oximetry is a market that also is about $150 million, growing a bit faster, like 7%-10%, where we have mid-single-digit share and continuing to capture share there. We feel very good about our three products in our advanced parameter SET, growing at a rate faster than the markets that they're in.
You mentioned that several of them are gaining share. So what's enabling that? Is there something differentiating about the products themselves? Or is it just a matter of you have a large presence because of your oximetry install base?
I think it's twofold. One, it is definitely built on the foundation of our competitive advantage technologically, and they all three have different advantages over competition, and then as you take that product and you kind of leverage it across our broad footprint commercially, we're definitely seeing broader commercial uptake in those areas. We're bringing more focus on it and a little bit more disciplined approach to targeting our customers and accounts and utilizing our strong presence in the OR and surgical wards in the critical care space to drive adoption and sell more products.
Can you talk about the pricing on these sensors? I think some of them are considerably more expensive than the other oximetry sensors, including Rainbow.
That's correct, so the SedLine is equivalent to our Rainbow pricing, and O3 and capnography are more equivalent to our SET pricing.
Okay. And then moving on to the Philips agreement, can you just give us a quick overview of the Philips agreement and how it will affect your growth over the next five, say, years or so?
Yeah. So broadly speaking, we partnered with Philips to do co-marketing of our Rainbow products and integrate our technologies into their multiparameter devices. So broadly speaking, it's a co-marketing agreement where they agreed to invest in integrating Rainbow into their products. And when we signed that deal, we said our long-term growth horizon, rather than 8%-10%, was 7%-9%. And so we said that Philips would add about a point of growth to our long-term growth rates. So as we look at that relationship, we say, well, what's a leading indicator? And we say, well, we know that the boards we sell to Philips or drivers are a leading indicator. And we know that in 2018, we grew our drivers at about 14% over 2017. And that's about twice our long-term growth rate of drivers, which tend to be 7%-8%.
So a lot of that growth delta or improvement in growth rate was due to the Philips arrangement and driver shipment to Philips. So that's a good leading indicator that says, yes, the Philips arrangement is starting to bear some fruit. Now, does that turn into revenue? And what I can tell you is that every Wednesday or every Friday we have a discipline of looking at our sales funnels and going through that. And we're definitely seeing more sales deals attributed to Philips customers than we have in the past. And as a result, we feel good based on those two metrics that the Philips deal is resulting in kind of the commercial outcomes that we wanted. And there's really two shots on goal there. One is the fact that when you look at the multiparameter market, Philips is about half of that market.
We've got about 10%-15% share of that market. To the extent that we can just get SET sockets up to a higher level, we can get additional SET revenue. Then Rainbow parameters turned on and the sensors associated with that, it's kind of the second shot on goal associated with the Philips arrangement.
Just to give folks maybe a better understanding of how this business works, can you just talk about the fact that Philips makes their monitors and then you put a board in? And the analogy I think that helped me kind of understand, I was thinking about the car analogy where you buy a luxury car and you can get the base stereo or you pay more and get the Harman Kardon stereo or something like that.
Yeah. So essentially, our products, our pulse oximetry typically is part of a multiparameter monitor in a hospital. And so every 10 years or so, a hospital will buy or refresh its multiparameter monitors. In that process, because we're in the hospital kind of regardless, or probably nine times out of 10, we have already got the NICU space and we're trying to broaden our footprint in the hospital. We know that a multiparameter monitor contract is coming up. So we'll pre-sell and engage the decision makers on helping them or decision makers to say, hey, use Masimo in your next purchase of a multiparameter monitor. And so as the hospital then works with Philips or they work with GE or whomever it is, they say, great, I want Nellcor, or I want Philips SpO2, or I want Masimo. And they choose Masimo.
What happens then is Philips will then go back to their manufacturing and they'll pull a Masimo printed circuit board off the shelf and they'll stick it into the multiparameter monitor. And that's how Masimo technology gets put into the monitor. It's more complicated than that, obviously. But simply put, that's how that gets put in there. And then we will, in parallel, negotiate the sensor contract with the customer, the hospital customer. So when those multiparameter monitors are placed in the hospital, our products will be available for use consistent with that. The second way we can have our technology implemented in the hospital is every five years. So if you think about a 10-year cycle of the capital equipment, in the middle of that, the hospital typically renegotiates its sensor contract to drive down price or whatever it is.
And if we don't have a customer, we can then go into that customer and say, "Hey, why don't you use Masimo technology?" And they'll say, "Well, we're not going to refresh our capital equipment." And we could say, "Well, we could defray some of that cost and help you help fund that for you." Or if it's a Philips installation, we can then just say, "Well, we will just swap out the boards, the printed circuit boards." And then we can actually enable that capital deployment to be Masimo enabled for SpO2 monitoring.
All right. And then I guess the next phase of the Philips agreement will be to get the NomoLine, SedLine, and O3 parameters integrated.
Correct.
Can you talk a little bit about that and how big of an opportunity is that relative to the rainbow opportunity at Philips?
Yeah. I think the Rainbow opportunity is really, really big. It's very meaningful for us. The integration of capno, SedLine, and O3 into the Philips monitors is also a significant tailwind for us to get a multiparameter monitor to have all three of those attached in the hospital. And that way, it's easy for us to then kind of just expand the bag, if you will, for a Philips installation much easier than it is today, so it's a good tailwind for us. Certainly gives us confidence in our ability to deliver around the 20% growth rate that we've committed in the advanced parameter section.
Yeah. Okay. And moving on to the opioid opportunity. So Masimo is one of a handful of winners in the FDA's opioid device challenge. Can you give us a quick overview of the program itself and what it means to be a winner of that?
Yes.
Thanks.
That's good. I always like being a winner. There was about over 250 companies that applied to be part of this opioid challenge that FDA kicked off. And we were chosen to be one of eight. And what's important, I think, to recognize is that each of the eight addresses a different part of the opioid challenge. So our part of it is to be a monitoring company, essentially to ensure the safe use of an opioid when you have one on a prescription. So the idea there is to continuously monitor patients who are on an opioid with SpO2. And why is that important? It's important because the opioid will essentially cause respiratory depression, which essentially is a physiological response to the opioid that creates a shallower breath. And as that breathing becomes more and more shallow, you get less and less oxygen.
At some stage, you get not enough oxygen that it starts to affect your brain. And ultimately, you stop breathing. So it kind of becomes a do loop at some stage. And so quite simply put, they die because they don't breathe anymore because of the opioid's interference with the breathing mechanism. We also know that when you're on an opioid and before that decompensating event, there is a period of physiological instability that continuous monitoring of SpO2 can catch and can see. So the idea is that we would have some sort of consumer-friendly device that can continuously monitor a patient while they're on an opioid at home. And so you might be familiar with our Radius-7 device, which is an ambulatory SpO2 monitor in the hospital use. Kind of same concept, but a version that is much more consistent with home use and more consumer-friendly.
A device that could alarm the patient or more likely a caregiver or a partner who's near them while they're sleeping that could then wake up because of the alarm, arouse the patient, revive the breathing, and then eliminate or avoid a respiratory depression event or avoid death. If that isn't successful, then be able to wirelessly communicate with a local EMT who could come and administer Narcan as an antidote to the opioid.
And so part of the FDA's program, I think, is that they're accelerating the approval pathway or clearance pathway. So can you talk about that and what that means in terms of timing? I know you're not probably going to give specific timing. But how much time can that save from the process?
It can be pretty significant. I mean, I guess it all depends on what you're doing and all of that, which we're really not going to get into too many of the details at the moment. Suffice to say, we're working very closely with the FDA. They've been great partners with us on this. We're hopeful to have something out in the marketplace by the end of the year. That kind of gives you a sense for the turnaround time and when we might see something in the market.
Okay. And I think there's around 200 million opioid prescriptions per year in the U.S. I think you've talked about maybe in terms of unique prescriptions or unique patients getting the prescriptions is maybe in the 90 million range. So we think our math, rough math indicates this could be in the hundreds of millions, if not a billion or more in terms of the opportunity. I mean, are we thinking about this the right way? I know you're not going to put a hard number on it right now. But I mean, are those numbers way off base?
Yeah. No, I think those are the right numbers. We see those same numbers, 191 million, I think, prescriptions. I think 92 million people in the U.S. in 2015 took an opioid. And from some of the research we've looked at, you can probably look at the prescription opioid users in two camps. One who are chronic users or who are users to address chronic pain over longer periods of time, like years, and people who are taking an opioid maybe post-discharge from some sort of painful surgical procedure. Some literature would say that post-surgical discharges, 80% of people get an opioid. You can kind of maybe 20-25 million surgeries. You can do that math. Or you can kind of triangulate it and say how many orthopedic surgeries, spine surgeries, invasive cardiac surgeries. You can kind of get to a 15 million number there.
And then I think we've seen from the research we've done maybe about 10 million chronic users. So that's 25 million patients. And you can do the math on what that would equate at different price points. But I think north of $1 billion is certainly how we see it. And we'll give more insight and detail around this as we get into the topic at our investor day.
Okay. And I have some more questions. I don't know how many of them you're going to be willing to answer given that you're going to talk more at the investor day. But I'll try. So is the device intended to be something that's kind of a disposable one-time? When I say one-time use, I guess maybe one patient use. In other words, a patient gets it, uses it, and then gets rid of it versus something that's more like a capital equipment item like the Radius-7 or something where they borrow it and then they would have to return it or something.
Yeah. I think in the way we're envisioning it, it would be something that the patient would have and kind of keep. It wouldn't have to be returned.
Okay. And do you have any thoughts on who would be expected to pay for this? I see several possibilities. You could have the insurers pay for it as a typical type of medical device. Or you could have maybe FDA says, hey, the drug companies are making a lot of money off these opioids, but they're causing a lot of problems. Maybe you force them to provide this with every prescription. Or maybe the patients have the option of buying it out of pocket. But if it's the patient, I think that would probably limit the market to some degree because not everyone's going to want or be able to pay for this, want to or be able to pay for the thing.
So we're certainly pursuing all paths. And when you think about it in terms of reimbursement, typically that has to follow the indication you get. And we won't know what indication we get, whether it's over-the-counter or prescription until after it gets approved and the labeling around the product. So some of that is dependent on timeline with FDA and approvals and the indications for use. But we're definitely pursuing a reimbursement pathway. Also, some of the research we've done, some of the customer research would suggest that there is appetite to do private pay in different situations. So in terms of how we might do a limited market launch, you might envision something that focuses on the private pay, learn the process, learn what you can, and then move out and scale from there.
Just to be clear, when you say private pay, you mean the patient paying out of their own pocket?
Patient pay, yeah.
Okay.
Correct.
All right. And then this is the home setting. But I believe there's an opioid monitoring opportunity within the hospital setting as well. So can you maybe talk about that?
Yeah. So if you kind of think about patient safety and why you have sentinel events in the hospital, a lot of times they are connected with opioids. So we know that if you're on an opioid in the hospital post-surgical, maybe you've had a knee replacement or a hip, and you're on some sort of morphine drip or fentanyl, that does cause higher risk for death in bed or sentinel events. And we know that before those decompensating events happen, there is a period of physiological instability. If you continuously monitor the SpO2 or the blood oxygen level of those patients while they're on an opioid in the hospital, you can essentially see when that physiological instability happens before the event happens. And you can then intervene earlier. Because ultimately, what typically happens is that either they fail to rescue or they do rescue, but they rescue late.
It ends up in an ICU step-up. That ends up being obviously bad for patients, but also bad for the hospital from a cost perspective as well. It doesn't take sophisticated math to see that whether we do some sort of broad monitoring in the general ward or the step-down units post-surgery, that that makes a lot of sense for patient safety as well as for the financial incentives of the institution. Our products obviously SET as well as what we call Patient SafetyNet that allows or enables the nurse to see that from the nursing station and to monitor multiple patients who are being continuously monitored on SpO2. To do that from the nursing station is a great opportunity to address that particular issue.
To what degree is this being done currently? I guess the penetration, if you will, is the difference for that.
Yeah. So broadly speaking, we think of the $1.7 billion SET pulse oximetry market in the U.S. to correlate to the 125,000 critical care beds in the U.S. We then say there's about 450,000 general ward beds. Of those 450,000 general ward beds, we think we're about 10% penetrated in that space. What we haven't really put our finger on exactly is how many of those beds need to be continuously monitored in the scenario that I've previously described. But suffice it to say there's a lot of opportunity to continue to continuously monitor patients in a post-surgical environment.
Is opioid use the main reason? Or are there other reasons why you'd want to do the monitoring in the general ward?
The opioid is the primary reason, and I think given the publicity and essentially the awareness of the topic, it's an opportunity for us to really address that in a meaningful way.
Okay. And I think there was an unfortunate death of a young person in Utah.
Correct.
And so is there some legislation or something that they're passing? And what does that mean for Masimo on your monitoring technology?
Yeah, so it was a resolution, so not a binding law or anything. But it's Parker's Bill. And Parker was a young man who simply had a tonsillectomy, was sent home with an opioid for the pain, took half the dose, and sadly passed away in his sleep because of respiratory depression. And so that obviously was a tragic event. And that led to Parker's Bill, which was the resolution that the Utah Senate passed to essentially say if you're going to have an opioid at home, you should also be continuously monitored for blood oxygen levels.
So does that mean that it's required in Utah? Or it's just a recommendation?
Yeah. It's a non-binding resolution that says this is what we believe should happen. So it's awareness. It's, I think, momentum. But it's not a requirement per se.
And then what about illicit use of opioids? I mean, is there a market opportunity there? Not that you want to be supporting that. But I mean, if it's an over-the-counter product, I mean, would there be people that are abusing opioids that choose to get this as a safety measure? Or they're just already not concerned enough about their safety if they're abusing the drug to begin with?
Well, again, I think some of the customer research we've done would suggest that some of these folks are living at home or living with loved ones. And it's known that the abuse is going on. And you can imagine that the loved one would be incented or want to use this device for the person who's abusing the opioid. How the economics of that work out, how big that is, very difficult to tell. But I think the human side of this is that people are dying. And they ought not to be dying because of respiratory depression. And we have a device and a product that can avoid that. And so whether it's illicit use or prescription use, both lives are valuable.
Okay. I have a few financial questions. But I guess I wanted to see if there are any questions in the audience before I move into those.
Is there anyone else you know trying to do something similar to opioid monitoring?
Not that we're aware of. Eli, you want to?
It would be very difficult for another company to develop an opioid monitor for home use to detect respiratory depression because we're the only company with a Measure-through Motion technology feature, which means we won't give a false alarm when a person is turning in bed or just moves their arm, and so consequently, if another company were to develop it, the competitive product would be so bothersome that the person would probably just throw it away, so we think we have a unique position.
Because you can imagine that in home use, false alarms would be a gigantic nuisance, and so that's ultimately what Eli is saying.
All right. So just I wanted to touch on your gross margin goal. I think you set a target product gross margin, to be clear, of 70% this year. And that's up about, I think, from 67% last year. So that's a pretty healthy increase. And maybe you can talk about the factors that are influencing that.
Yeah. So our 70% goal is in the context of a 30% operating margin goal. And we expect to get to that 30%. And our guide this year is for 24%. So basically at 100 basis points a year from 24 to 30. About half of that coming from gross margins, half of it coming from SG&A leverage. Our path on the gross margin front is really threefold. One is really to get overhead leverage as we drive more volume through our plants. We built a new factory in 2017. And we're continuing to see that leverage come through. The second is our shift to RD. RD is a Red Diamond, which is a new sensor. It's cost advantaged over LNCS and M-LNCS. Its predecessors.
And so as we bring on new customers and contract RD with those new customers, and as the existing customers turn over, we expect to get some cost benefit and savings from that transition. And that transition is probably another five years of tailwind for us. We're kind of in the mid to late teens in terms of our adoption on RD today. And then the third piece is kind of cost reduction. So we have a team of engineers whose job it is to really focus on reducing the cost of our products. And so that might come through productivity improvements, yield improvements, or driving material costs on the product design.
Okay. And the RD sensor, you mentioned that huge cost benefit there. Is there potential to wring out more costs? I mean, you mentioned engineers. But I mean, that's such a big improvement. Is there room for additional savings with future generations? And can you remind me, is that just for SET? Or is it Rainbow?
It's for SET and Rainbow.
For both? Okay.
And so the improvement is significant. I guess what I'd say is that our core RD process doesn't really draw constraints. It kind of looks at all of our cost basis and then tries to prioritize and look at where the biggest opportunities are. And then we put our resources at what it should be. So not just a standard, hey, 2%, 3% a year, but what should it be in the future? And let's put the resources at the biggest returning projects. And so if we found projects that affected RD, we would absolutely go after them. And certainly, RD is part of our funnel as we look at opportunities to improve cost.
Okay. And what can we expect to hear from you guys at your investor day? I mean, I'm not talking about the numbers. But I mean, will there be longer-term targets set? Or I assume you're going to talk more about the opioid home monitoring opportunity and things like that.
Yeah. So as we look at our investor day, we certainly want to give an update on our longer-term goals. Today we say 8%-10% long-term revenue growth and 30% operating margins. Speak more specifically around how we size up those markets, our competitiveness in those markets, and why I believe we can continue to take share in those markets. Put some firmer numbers around hospital automation in terms of market sizing, market opportunity, our offering, as well as opioid kind of market size, our offering, so that we can really help you understand how we see those opportunities materializing as we go forward in the future.
Additionally, we've got an innovation lab where we have fully installed multiple different versions of our hospital automation solution so that we can really communicate the value and its breadth of offering and how it addresses really multiple challenges in that space and how we do that very uniquely with our solution.
Okay. And then just balance sheet question. You're sitting on quite a bit of cash. I think it was over $500 million or so. I know you always get questions on this. So what's the plan there to deploy the cash, if anything? And to the degree you're looking at M&A, I know you've hired someone to do more business development work. So what types of things would you be looking at?
So on the M&A front, we have a pretty broad filter. And we're pretty active in the targets we look at and assess. And at any given time, we're probably looking at 10 or 15 different targets. And then we really kind of put that against our strategic filter of areas that are either non-invasive monitoring or they may be adjacencies. Maybe it's a therapeutic, but it's an adjacent space, whether it's kind of oxygen-related or blood-related. And then places where we can leverage our Signal Extraction Technology, places where we can leverage our clinical and our sales footprint. So those are kind of the strategic filters we put it through. And then from a financial standpoint, we're looking at targets that will deliver north of our 8%-10% revenue growth and be supportive of our 30% operating margin target.
And that would be ROIC accretive in five years. So we're really putting out, I think, good strategic and financial filters out there. And at the end of the day, that's kind of how we're looking at it.
Okay. So that's it for my questions. I'll give the audience one more chance to ask anything that they want. All right. If there's no questions, I think we'll stop there. Thank you.
Thanks, Mike.