Good afternoon, everyone, and welcome to the Morgan Stanley Healthcare Conference 2020. As we wrap up our last medical device presentation of the fourth day, one very exciting half day tomorrow. We've been sticking with the same theme all day, which has been growth. It's a pleasure to have Masimo with us today and their EVP CFO, Micah Young. Obviously, I'm David Lewis, medical device analyst at Morgan Stanley, as I've been saying all day. Make sure you report what you gain when you go to the Morgan Stanley Research Disclosures website backslash Research Disclosures and see fun facts about me. Micah is kind enough to give us a brief overview of Masimo real quick, and then we're going to jump into Q&A. Micah, the floor is yours.
All right. Thank you, David. Yeah, I just want to give a brief overview. So we have a strong history here at Masimo of innovation, and it really started with our SET Pulse Oximetry. That's our signal extraction technology. That's basically an LED sensor technology that shines light through the finger or the tissue to measure the level of oxygen in the blood. It really changed the way pulse oximeters worked. At the time, there were 70%-90% false alarms given by oximeters due to their inability to measure through motion when a patient moves or low blood circulation, what we call low perfusion. Masimo SET, what we did was we separated the arterial signal from the venous signal because you would get a false low oxygen read from the venous signal. So we separate that in real time, and we're able to measure through that noise.
We're the first company to get an accuracy specification for motion. And at the time, it was plus or minus 3%. We've improved that recently to plus or minus 1.5%. And what's happened is hospitals learn to trust our technology, the accuracy of it. And SET's been an expandable platform for us. We've been able to expand that technology portfolio. We've gone from two LED sensors to eight LED with over a dozen measurements when you start to look at Rainbow, capnography, SedLine O3, all those different parameters that we can measure. And hospitals, we've been able to expand that platform across the continuum of care, whether it's OR to the general floor, from the hospital, and now recently into the home. We have a very strong business model that really is kind of a razor-razor blade model.
We have a large and growing installed base of what you could quote call razors, which is our monitoring equipment and technology boards that go into our OEM monitors as well. And that installed base grew 13% last quarter to over two million drivers. Historically, that's grown mid-single digits in terms of the installed base. And of course, we've been increasing our revenues per driver over time with more and more technologies coming out. We have a durable recurring revenue stream. We typically contract alongside of the capital sales, five- to seven-year contracts for the sensors, and we have a high retention rate, over 98% on those contracts. We're in over 150 countries now, monitoring over 100 million patients per year. And we've seen tremendous growth, especially this year with COVID and the need for our technologies to treat a severe respiratory illness like COVID-19.
Just a quick overview on the markets we serve. We kind of break it down into three categories, which I'm sure we'll talk about here, David: core parameters where we have SET pulse oximetry, Rainbow, total hemoglobin monitoring continuously, as well as our advanced parameters like capnography and gas monitoring and brain monitoring, so SedLine and O3. That's about a $3.5 billion market opportunity with all those parameters growing. We believe to $4.5 billion by 2025, and our long-range plan has us growing about 8%-10%. We've been growing here recently closer to 12% so far, and there's multiple opportunities here for upside with what we can do with hospital automation. That's another large market. That's about a $1.5 billion market that provides upside opportunity for our long-term plan.
As well as here recently, you've seen us launch a lot of products in our home-based care in terms of telehealth, so kind of hospital to home. And we believe that that's at least a $4 billion market opportunity when you think about treating opioid patients who are prescribed post-surgery or for long-term chronic pain patients alone. And there's some other things we can do with that platform. So I want to turn it back to you for some Q&A, but I just want to give an overview there.
Great. Thanks, Mike. Very helpful, specifically for the audience members who are not as familiar with the story. So you started with COVID or talked about COVID, and that's obviously been the theme of this conference. Product revenues were up, I think, 30% second quarter. Boards were up 200%, 175% in that quarter. So the question is, that's pretty significant demand. What have you seen in sort of that demand post the quarter as it kind of progressed through the summer?
Yeah. So in July, we mentioned on our last earnings call for the month of July, we saw our worldwide sales orders up 40%, driven by another 150% increase in capital orders. So that was very strong. Again, as we're heading into Q3, we're expecting last quarter, we shipped over 165,000 Drivers. This quarter and third quarter, we're expecting at least another 140,000. So we can see our installed base probably grow based exiting this year about 15%. So strong demand for monitoring equipment, especially around pulse oximetry. We also saw some very strong demand for our Root and vital signs. That was up nearly five times last quarter as well. And we saw an increase in installations of Patient SafetyNet up about 10%, which is very good for not only hospital automation, but also the opportunity for general floor monitoring.
In terms of our sensors, we've seen that the trend there, we were down as much as 20% at one point during the last quarter. We ended up settling in. Our worldwide sensors were down 8%. US was down a little further than that. July was down about 11%. So we've seen a nice steady trend back in terms of our volumes compared to pre-COVID volumes. I would say in July, we think it's probably about an 80%-85% of the volumes that we saw pre-COVID levels.
Okay. So do you think the post-COVID demand, the reason why that's still, I just kind of get a sense of the underlying demand for the business, underlying driver placements versus COVID, most cap equipment companies, Hillrom and BD's, ventilators, and we have some exposure to ventilator boards as well. We can talk about. I just try to get a sense of other cap equipment companies that had achieved pandemic response are seeing pretty significant shortfalls or just resting of their momentum. I wonder, are you also seeing that, or are you seeing more downstream demand as hospitals realize that we don't need a new bed, but we need a better way of monitoring acute care patients across the broader organization so we can add pulse ox to med-surg beds versus just buying into the ICU beds?
Help me understand underlying demand versus any risk that we're going to have to see in acute normalization of trends.
Absolutely. We've been very close with our customers, especially with the ones we're selling the equipment indirectly with. And what we're hearing is, even though they're working to increase capacity, going from lower acuity beds to higher acuity beds for potential surgeon patients, treating that backlog of demand of the disease load that's out there more broadly, they are still looking and saying, "Well, we've got an opportunity to move and do more monitoring on the general floor." And that's kind of what we're seeing in the trends. It's what we're seeing in the ordering patterns of the equipment that they're ordering. The other thing we're hearing too is, even though hospitals have lost significant cash flow with procedures being deferred for a period of time, that's put a lot of strains on the capital budgets.
And I think what we're hearing, though, is that there's still a demand for pulse oximetry. They may be shaving back on budgets elsewhere, but this is a respiratory disease. We've got a flu season coming combined with COVID, and they're preparing for that. I think the demand is still there for pulse oximetry.
Okay. You did lower your outlook for boards for ventilators a little bit on the second quarter. And then since that time, you've seen more public announcements about sort of ventilator demand shortfall. It's not a very big business, to be honest with you. But is that an incremental risk?
No, because I mean, if you look at the revenue tied to those boards, it's very immaterial from a revenue standpoint on what we get per board, and we've seen that pull back. What we've been saying all year long, though, is we believe that the core boards, the 450,000, whether or not we get that additional 50,000 of ventilator orders, that should give us that increase in our installed base that we'll exit this year of 15%, so that's kind of what we focus on because we believe those are the boards that are going to be consuming sensors moving forward.
Okay. And one of the companies who was at this conference, so there's Steve MacMillan at Hologic. He's obviously benefiting also from COVID-related dynamics, specifically diagnostics. But their debate is he's placing a lot of new Panther or Molecular Diagnostic Systems, and then people think, "Hey, once you place these systems, we're going to have demand pull through." Well, if you're placing a dramatic number of drivers here and you'd like to believe at some point there's going to be pull through, how have you started to work to sort of quantify what the forward impact would be? I mean, you can say, "Look, you're only going to use these things if there's acute respiratory distress," but that's actually not necessarily true.
In some cases, you're just going to democratize pulse oximetry across a hospital system that perhaps wasn't using it as often, and maybe now they have it, they're just going to use it. So how have you worked to quantify what the downstream SET opportunity could be based on this significant installed base improvement?
Yeah. I mean, we have a lot more visibility into our direct business. So if you think about the drivers, where we have 20%-25% of our drivers that we ship are tied to our direct sales to customers. And we've been staying very close. We hear that the utility will be there. They're looking at the use case as monitoring continuously with pulse oximetry for patients who are post after surgery, they're prescribed opioids, and they're on the general floor. And if you look at that, I mean, today, the general floor is very underpenetrated. It's about 10% penetration because it's not the standard of care today. So what we're seeing is we think that there's going to be a greater shift there, and we're hearing it from our direct customers.
What we don't know yet is we're still working through the OEM side of the business because we typically are on the front end of that demand where we provide the technology board that goes into the multi-parameter monitor, and I think we're going to learn more about that as we go alongside our OEM partners and sensor side of the business with those customers, so I think we've got a good line of sight on the direct business, and I think that that's where we are seeing a shift more towards monitoring on the general floor.
Okay, so it sounds like this COVID-driven demand is durable, at least for the near term.
We believe so.
Okay. And then like a BD and a Baxter, you also are exposed to what we'd call patient or hospital census. If you have less people in the hospital, you're going to sell less pulse ox sensors. So that business is coming back, it sounds like, similar to how a med-tech procedure company would come back. Is there a kind of concern it's going to come back to a certain level? I think you said sort of 80%-85%, and it's going to sit there for a while. I mean, how do you think that business recovers, and when would you expect that core business to get back to normal?
Yeah, and you're talking about the volumes of the 80%, what we saw in July, the 80%-85%.
Yes.
Yeah, so we're hopeful based on what we're seeing, the way it's trending, that we believe it'll get back to at least 90%. The question is going to be that last 5% to 10%. I think it's going to come down to patients' confidence going back into the hospital, and I think the trend would tell you that we're heading back there. I think that you've seen some other companies. I've seen some of the other presentations, and they're seeing similar trends in the data points, so I think there was a company two days ago that showed a trend line on medical device procedures that was improving even in August over July, and I think those are some of the trends that we're seeing as well.
Okay. So you're including pretty much similar trends we're seeing across the conference, which is encouraging. One other thing I've done with one of my companies' conferences is looking at talking just very loosely about '21 versus 2019. I don't have a model on your company, so I can really go crazy. But look, your striking census numbers from Masimo are kind of 22% above '21, which is 22% above 2019. And at a first blush, I said, "Look, this is a business that's been growing." You say 8%-10%, but let's be honest, you've been doing better than that these last couple of years. So 22% above, kind of 11% per annum on an underlying basis. I say, on one hand, that seems very achievable.
Then I don't know because I feel like you have this underlying demand that's going to pull through next year, but then you have these awkward comps. So how should investors sort of think about next year? Should we be overly concerned about this very challenging comparable?
I think the most important way to look at this is we will have some tough comps on capital, no question, because once capital gets back to normal levels, and normal levels for us are about 60,000 drivers per quarter. And we think that that's kind of where it'll go back to normal placement cycles there next year, but it's still early. We're still trying to figure out the puts and takes there. But the most important thing is we are going to exit this year with installed base growth of 15%. So if we can get sensor volumes back to the pre-COVID levels, and then you've got an installed base that's up 15%, even if utilization is a little lower to start out, we should see an acceleration in our sensor growth that is in a much better position than we were at pre-COVID.
I think that's what's important for the long-term growth of this company.
And then, Mike, you're kind of saying you could see some capital headwinds, but with this downstream sensor demand we talked about earlier, you kind of net out. It's not insane to think this business can continue to grow kind of on the underlying trend it's been growing prior to COVID.
That's right. Yeah, that's the way to look at it.
How do you feel about margins? Same kind of dynamic. I mean, I forget the core GM on your sensor business. Obviously, I know it's higher than hardware. But does that give you kind of a positive mix shift as you head into 2021 as well? So I think about GMs and that upper 60s range. I thought there should be some upper mobility there as well.
Yeah, absolutely. We came into the year guided to 68%. We've seen a lot of pressure on margins due to that high capital mix with sensors being down and capital being up, probably impact us about 400 basis points last quarter. So if you were to normalize that mix, we would have been around that 68%. Now, we've also had some challenges with keeping our workers safe, providing the right social distancing, and that's impacted some of our costs in the manufacturing plant as well as across the company, just like every other company. But we believe that we can still get back on track as we go into next year in those high 60s and continue to get back on track in terms of the margin profile we're trying to expand, which is gross margins back in that 68%, going about 50 basis points per year.
Okay. Well, let's transition to one of the big businesses. I came down to the analyst day as well, and hospital automation was a huge focus of that day, as was hospital to home. What kind of traction were you seeing? I know it wasn't that much time to build out that business, but what kind of traction were you seeing in things like Root prior to COVID? And then what has COVID done to that hospital automation business?
Absolutely. I mean, one of the biggest things we saw here just more recently in the second quarter was that Root sales were up five times what they were last year and nearly what we sold all of last year. So we've had strong demand in addition to the installations we've seen on Patient SafetyNet. Last year, as we exited the year, we had about 20 customers who had deployed our full automation suite. So we just deployed that starting last year. So we've made some very good inroads and traction there. And then, as you know, we acquired the Connected Care business from NantHealth, and that's given us some acceleration of that footprint and given us some opportunities to pull through more revenue opportunities as well as the full automation suite. So we acquired just over 400 customers from that acquisition.
We also acquired a very capable sales team and implementation team. We were trying to build that out ourselves, and we were able to acquire it through the acquisition. So strategically, that was a great fit for our company. And there's a lot of synergies in terms of the opportunity to pull through into that customer base, other parameter revenue for us because we had very little overlap there. So we're making progress there on the hospital automation front. And now that hospitals are starting to contract again, we're excited about the opportunity to gain some more momentum on some of those implementations.
And this 5x number you gave us, Mike, is this that hospitals are realizing they need more connected information to manage patients in these kind of acute pandemic times, or is this just you sold a dramatic amount of peripherals that have to get tied together, or is it just a reflection of the underlying momentum you had into COVID? It's pretty hard for me to tease out those three trends within that 5x number.
Yeah, I think hospitals, number one, they're trying to increase bed capacity, and an economical way of doing that is with Root because it serves as a single interface in the room. It can be a monitor and display, and it can bring all the data from everything together, and it can also, within the cradle of Root, you have your pulse oximeter, so we have a Radical-7 where we can do all the measurement of vital signs information, so that's a way for if you're increasing bed capacity, Root is an incredible way of doing that because it really serves as that single connectivity hub, and it increases the power of the data through the hospital system, so they're looking at it twofold.
Increasing to be beds, and Root drives that capability, as well as on the back end, they can start to connect that in with Patient SafetyNet, monitor more patients on the general floor, and start to increase their capacity there as well.
Okay. Mike, I forget at the analyst day if you map this out. If I take these three segments of the business that you started this conversation on, the core SET business, SedLine, capnography, hospital automation, obviously hospital to home. If you go out five years, how does the mix of your business shift? These two major segments, your biggest TAMs are sort of the smallest or very large TAMs are the smallest part of the P&L right now. What do those things look like in five years?
Yeah. I mean, I think we'll see a bigger shift towards Rainbow. We'll see a bigger shift towards some of those advanced parameters like capnography, SedLine, O3. Hospital automation, we have a tremendous opportunity to take share in what we look at as about a $1.5 billion market. So you could see a bigger shift or a more material shift towards revenues that have more of a service component as well. And then if you think about the opportunity we have in the home, especially with Opioid SafetyNet, that's over a $4 billion market opportunity for us. So that could be a sizable shift in mix towards Opioid SafetyNet. Once we get reimbursement, once we get the product approved, get the reimbursement, which that could be out that kind of that three-year time horizon.
Okay. I mean, I've covered some of your prior competitors in capnography. How big do you think that capnography market is, and what kind of share opportunity do you think is realistic for investors to think about the next few years?
Yeah. We've sized the capnography market at about $550 million, and we believe it's growing anywhere from 10%-15%, and so strong growth there. We have probably 5% share of that market today, so in our long-term plan, we plan to grow the next percent in that category, so this will be a great opportunity for us. If we could take our share of capnography alone and get that up closer to our pulse oximetry, that's a 40% market share gain opportunity for us, and that's pretty sizable when you look at that $550 million market opportunity.
Okay. When you place, maybe early, but when you place Root into a hospital system and start to envision a system about automation, do you have any evidence in terms of in the robotics field, there was a dynamic where you could place a robot, obviously, or implant share is going to go up. But I wonder if you can get a Root system in, if you have SET in a hospital plus Root, your share of capnography in that particular hospital, I mean, if you have 5% share, your share is going to be a lot higher in some hospitals and lower. What are the elements of places where your share is a lot higher? Is it tied to a broad suite of products, a bundling solution?
Yeah. So Root is basically kind of the, it's the enabler as far as capnography, SedLine, and O3 because everything can tie into Root, the platform that it ties into. So the more we put out there in terms of connectivity with Root, the opportunity we have for pull-through. So if you look at the accounts we're placing Root, that's where we're gaining the most traction on pulling through the capnography business.
Okay, understood. Okay. Then just two, there's a bunch of stuff going on, obviously, in patient monitoring. I don't know. There's a lot of different areas there. I think opioid got a lot of attention at the analyst day, but there obviously was safety net. Can you just help me size, just to start out before we get into specifics, size the relative markets within patient monitoring across some of these key areas: safety, opioid? I guess we could start with those two.
Yeah. I'll start with Opioid SafetyNet. So we've sized that up as a $4 billion market opportunity. Really looking at, and it's in excess of there, but we've kind of conservatively viewed it that way. We've sized it up as about 45 million prescriptions. We've tied those really to the volume from patients who are prescribed opioids post-surgery as well as long-term chronic pain patients. And 191 million prescriptions of opioids a year. So we've taken kind of a more conservative approach on really targeting those two segments to start out. So that's a big market opportunity for us. Masimo's SafetyNet, we took the Opioid SafetyNet, which is still we're working through with the FDA to get approved one. We've given them a tremendous amount of clinical data, especially the data that we've seen in hospitals where we're monitoring patients on the general floor using opioids.
And we basically repositioned it when a lot of the focus became on COVID-19. So we took the wearable wireless Radius PPG device that we had as well as our clinician portal where you can communicate those vital signs as well as it ties in with a smartphone, and it's got Bluetooth connectivity to get the data back into the hospital. So we positioned that to treat COVID patients. So the way to look at Masimo's SafetyNet right now is more for COVID patients. The opportunity that's bigger here is when we can start to monitor other disease states for patients. So things like chronic respiratory disease, COPD, emphysema, asthma, or chronic heart conditions like CHF. Those are the things that we can expand on that SET platform because it's the most accurate technology out there.
And because of its ability to limit false alarms, that gives us the ability to go into the home and expand on that category. But we're still early in sizing that market opportunity up.
Okay. I have two follow-up questions here. First, on opioid, look, big opportunity. There's some barriers to kind of access here. When does this business start becoming material at the P&L? Is it 18 months away? Is it 36 months away? Obviously, there's reimbursement elements and other access issues. But materiality was the question I have about the analyst day.
Yeah. It's a great question because we've always said the gating factor here is reimbursement. We thought that we're looking at it would probably take about two-to-three years to gain reimbursement once we have approval of the device and before any material revenues. The one thing that we're trying to look into right now is the MCIT. It's a proposed rule that came out from CMS about a week or so ago where it's a Medicare coverage for innovative technology, so they're providing a temporary reimbursement of up to four years for breakthrough technologies, and as you know, we were one of eight technologies that were considered breakthrough technology for the opioid crisis challenge of the FDA, so we're hopeful. We're working through that. I think it's something to stay close to because we're trying to work through, do we qualify under that new proposed rule?
That could give us some temporary reimbursement pathway that could help us as early as next year. I would say more material revenues would follow probably the year after.
Okay. I want to push you on something on Masimo's SafetyNet. I mean, if you Hillrom bought this big company Welch Allyn years back, and Welch Allyn's core product is basically a mobile wheeled solution that just does two things. It's basically blood pressure and temperature, right? Even they have tried to develop wearables to get after those two things because the cost savings to the hospital from a human capital perspective and then cost and workflow management, if you can just do blood pressure and temperature, it would be something. So what's the opportunity for Radius T? I mean, it just seems to me if that can work post-blood pressure, you could dramatically reduce the pressure on patient management and inside hospital systems.
Absolutely. I mean, Radius T, we can do continuous core body temperature measurement. So now it gives us the capability to where we can measure now oxygen saturation, respiration rate, pulse rate, and now temperature. So that gives us great utility in the hospital. We think there's better outcomes as patients can become more mobile in the hospital system. And all these wireless devices that you're starting to see that common theme from us can make some big improvements there and drive some value in those hospitals. The other thing I want to add is we also have Centroid, which is basically a wearable wireless sensor that monitors a patient's position, and it helps clinicians reduce pressure ulcers or bed sores. And we recently came out with that. Recently, it was cleared by the FDA.
As you know, I mean, pressure ulcers affect nearly 2.5 million patients per year, and we've seen where 60,000 of those patients die as a direct result. The other thing is that bed sores are defined as a never event by CMS. So there can be penalties for reimbursement there. So there's a lot of these devices that we're coming out with. You're seeing the common theme of wearables, and I think we've got a great opportunity to drive value in the hospital as well as in the home if you think about Radius T combined with what we can do with Radius PPG.
Okay. What is the total? How did you define the TAM, Micah, for safety net?
For Masimo's SafetyNet?
Yeah.
Or the opioid product?
Masimo's SafetyNet, sorry.
Masimo SafetyNet, we're working on defining the TAM with a more broader view, and that's because we can expand on the different disease states. The way to look at it right now, it's still only focused around COVID patients because we got emergency use authorization. It's over a certain period of time. We've got right now about 120 hospitals that have fully deployed it, and we have about 1,500 in our pipeline right now. And we typically sell that at about $150 per kit. But it's not quite the waterfall that we get from normal disposable sensor contracts. Just keep that in mind. It's more of hospitals are piloting it. They start to use it and reorders. And it's more of a stocking-type revenue sale.
Why would that not turn into a per-patient pulse ox-like business model?
We think it will. We think that it definitely can get there longer term, but I think what's going to be critical for us is to expand that for the indications of it as well as expand it to other disease states.
Okay. Yeah. I think that could be a home run. Okay. Hold on. One more, Micah, we're out of time, unfortunately. But I really appreciate anything that we've missed that we should be hammering here at the end here?
No, I think we touched on everything. All the big hot topics right now, especially with COVID and kind of where utilization is in the hospital. So appreciate the time, David.
All right, sir. Thanks so much for joining us. I really appreciate you spending time with us.
All right. Thank you. Take care.
Thank you.
Bye.