Masimo - Q2 2023

Transcript

Operator (participant)

Good afternoon, ladies and gentlemen, and welcome to Masimo's second quarter 2023 earnings conference call. The company's press release is available at www.masimo.com. At this time, all lines have been placed on mute to prevent any background noise. After the speaker's remarks, there'll be a question and answer session. I'm pleased to introduce Eli Kammerman, Masimo's Vice President of Business Development and Investor Relations.

Eli Kammerman (VP of Business Development and Investor Relations)

Thank you. Hello, everyone. Joining me today are Chairman and CEO, Joe Kiani, and Executive Vice President and Chief Financial Officer, Micah Young. This call will contain forward-looking statements which reflect management's current judgment, including certain of our expectations regarding fiscal year 2023 financial performance. However, they are subject to risks and uncertainties that could cause actual results to differ materially. Risk factors that could cause our actual results to differ materially from our projections and forecasts are discussed in detail in our periodic filings with the SEC. You will find these in the investor relations section of our website. Also, this call will include a discussion of certain financial measures that are not calculated in accordance with generally accepted accounting principles or GAAP. We generally refer to these as non-GAAP financial measures.

In addition to GAAP results, these non-GAAP financial measures are intended to provide additional information to enable investors to assess the company's operating results in the same way management assesses such results. Management uses non-GAAP measures to budget, evaluate, and measure the company's performance, and sees these results as an indicator of the company's ongoing business performance. The company believes that these non-GAAP financial measures increase transparency and better reflect the underlying financial performance of the business. Therefore, the financial measures we will be covering today will be primarily on a non-GAAP basis, unless noted otherwise. Further, we will also be referencing pro forma financial measures, which include historical results for Sound United prior to the acquisition date of April 11, 2022. In our presentation today, we will once again be referring to this business as our non-healthcare segment.

Reconciliation of these measures to the most directly comparable GAAP financial measures are included within the earnings release and supplementary financial information on our website. Investors should consider all of our statements today, together with our reports filed with the SEC, including our most recent Form 10-K and 10-Q, in order to make informed investment decisions. In addition to the earnings release issued today, we have posted a quarterly earnings presentation within the investor relations section of our website to supplement the content we will be covering this afternoon. I'll now pass the call to Joe Kiani.

Joe Kiani (Chairman and CEO)

Thank you, Eli. Good afternoon, and thank you for joining us for Masimo's Q2 2023 earnings call. As we discussed four weeks ago, we are disappointed with the level of sales we achieved in the Q2 in both segments of our business, have reduced our revenue and earnings outlook for 2023. Micah will provide a detailed review of the quarter and our updated guidance shortly, I want to share our view of prevailing trends in our key markets, how Masimo is doing in this environment, and how we're responding to them. In healthcare, we believe inpatient volumes this year remain close to flat relative to 2019, while our original 2023 guidance contemplated a step up in inpatient volumes above those pre-COVID levels.

At the time we provided our guidance, we also had large new product orders in the pipeline that we hoped would help us exceed our guidance. If patient census growth was lower than expected, these large orders would offset the lower than expected growth. Unfortunately, we did not see the inpatient census growth, and those large orders have not come in yet. The forecast we are giving you today assumes we will not get most of the large orders and inpatient census growth will not return in the second half of 2023. If the rebound in inpatient census growth does not return, then we have reset our baseline this year and will expect our normal growth to return in 2024, given our strong hospital wins over the last two years. If inpatient census growth does return, then we could exceed our updated guidance this year.

In the meantime, we're taking action to mitigate the impact of the shortfall in revenues. Notably, we will reduce our expenses by over $100 million. We're also refocused our field resources to speed up new customer conversions as customer scheduling and OEM equipment availability improves. On the consumer side, we are refocusing the team on hearables, wearables, Stork, and HEOS, while we continue to support the iconic Marantz, Denon, Bowers & Wilkins, and Polk brands and products. This focus should help us grow the business despite the challenges in the consumer audio markets. I'll provide you with updates on some of these new products. Now I will ask Micah to review our Q2 results in more detail and provide an update on our 2023 financial guidance.

Micah Young (EVP and CFO)

Thank you, Joe, good afternoon, everyone. For the Q2, we achieved consolidated revenue of $455 million and non-GAAP earnings per share of $0.62. For our healthcare segment, Q2 revenues were $281 million, reflecting a 21% decline. Please recall that our Q2 2022 revenues benefited from the shift of approximately $25 million-$30 million of revenues from the Q1 of 2022 into the Q2 due to supply chain delays in the Q1 of 2022, making the year-over-year comparison even more difficult. For the Q2 of 2023, we missed expectations by approximately $66 million. Of this amount, approximately half was related to lower than expected sensor orders. Roughly 40% of the shortfall was related to large orders that had been expected that have not closed yet. The remainder was attributable to weaker demand for capital equipment from hospitals, as well as slower than expected installations.

We shipped over 64,000 drivers in the quarter, which is below our expectations for shipments of 75,000. We believe that orders for replacement monitors from hospitals to our OEMs have slowed as hospitals facing budget pressures, delay purchases, and our OEM partners manage their back-order backlog and inventories. As of the end of the Q2, we estimate that our installed base grew by 6% over our installed base at the end of the Q2 of 2022. However, we would like to point you to our record-breaking level of new hospital contracts, as those will bring new sensor cells and are better predictors of our future growth. Coming into this year, we felt good about our healthcare revenue outlook due to strong contracting with hospitals in the prior year, in combination with some large new opportunities within patient monitoring and telehealth.

Further, we expected to significantly reduce the equipment installation backlog associated with new hospital customer contracts as supply chain issues abated for Masimo and our OEM partners. We also projected sensor volumes to improve substantially, with inpatient volumes rising well above pre-COVID 2019 levels. In fact, we saw data showing sequential improvements in inpatient admissions exiting last year, and we expected those trends to continue this year. Based on data we've seen and feedback from customers, we believe that inpatient admissions have remained roughly flat versus 2019 levels, and inpatient surgeries are still down from 2019. To be clear, outpatient surgeries have increased versus 2019 levels, but even though we are in the vast majority of ambulatory surgery centers, where the bulk of outpatient procedures occur, they predominantly use reusable sensors today.

The procedure shift from hospital to ASCs, therefore, limits our consumable revenue growth, even though those patients are still being serviced with Masimo technology. We do believe there are opportunities to move ASCs to single patient use sensors over time as we educate them on all the benefits of single patient use sensors. Sensor orders were lower than expected across most of our customers in the Q2. We have also seen extended lead times for equipment installations, which also affected sensor sales. Therefore, we are rebaselining our healthcare revenue level for 2023 and still see our long-term growth rate targets as achievable, assuming that inpatient volumes grow annually at historical levels in the low single digits going forward. For our non-healthcare segment, Q2 revenues were $174 million, representing a decline of 17% on a pro forma and constant currency basis.

This business is grappling with reduced discretionary spending on high-end audio systems and a return of competitors who had previously been hampered by supply chain interruptions, now being aggressive with price cuts as they get back into the market. Although we are unable to raise prices to the level we had planned coming into this year, we did not reduce our prices and have put discipline in place to sell based on our features and advantages. While non-healthcare was hampered by the change in consumer behavior and competitive pressures, a bright spot in the segment was the hearables category, including headphones and earbuds, which we scaled up in the second half of 2022 with the introduction of the Bowers & Wilkins Pi7, Px7, and Px8 headphone models.

The steady growth we are realizing was boosted by the June launch of Denon PerL earbuds, with automatic customization of the sound spectrum for a personalized listening experience. Hearables revenues represented more than 7% of our non-healthcare revenues this quarter, compared to 3% last year. Moving down the P&L. For the Q2 of 2023, we realized consolidated non-GAAP gross margin of 50%. This includes gross margins of 60% for the healthcare business and 34% for our non-healthcare business. Gross margins were negatively affected by the deleveraging impact of lower sales against our fixed overhead costs, a difficult pricing environment for consumer audio products, as well as an unfavorable segment mix- segment and product mix.

For our consolidated business, our non-GAAP operating profit was $59 million versus $107 million in the prior year, due to the revenue shortfall and its deleveraging impact, partially offset by a reduction in accrued expenses for performance-based compensation. Our non-GAAP earnings were $0.62 per diluted share, which included an increase of $7 million in interest expense over the prior year period related to the debt incurred for the acquisition and share buyback in 2022. Again, we are disappointed in our Q2 results, but encouraged by the strength in the underlying fundamentals of our business. We see good potential for a rebound in our healthcare and consumer businesses, buoyed by hearables and the soon to be launched consumer health products with our consumer team.

We are committed to preserving profitability by implementing a variety of expense control measures that should provide benefits beginning with our Q3 earnings. Our expense control measures include reductions in payroll costs as we slow down our hiring activities, as well as significant reductions in performance, compensation, and other measures. Further, we have reduced marketing and promotional expenses within our consumer audio business to help offset the shortfall in those revenues. Now, I'd like to provide an update on our 2023 financial guidance. For the full year 2023, we are reducing our guidance range for consolidated revenue to $2.1 billion-$2.2 billion, down from our prior guidance range of $2.415 billion-$2.46 billion.

This change includes reductions in expected revenues for our healthcare segment and our non-healthcare segment. For our healthcare segment, we are maintaining the low end of our guidance range of at $1.3 billion this year, as stated in our press release last month, and introducing a new high-end guidance range of $1.35 billion, compared to our original 2023 guidance of $1.45 billion-$1.465 billion. The lower end of our guidance range assumes inpatient admission levels and capital sales trends seen in the Q2 continue through the remainder of the year. For the higher end of our guidance, we are assuming that some of the large orders expected in the first half will be realized in the second half.

Further, we are assuming the pace of equipment installations from hospital conversion wins will steadily improve, leading to increased sensor volumes from new customer conversions in the second half. For the non-healthcare segment, we are maintaining our previously stated revenue guidance from our July pre-announcement of $800 million-$850 million, down from our previous guidance range of $965 million-$995 million. Our new guidance range reflects continued weakness in the premium and luxury audio categories for the remainder of the year, partially offset by continued growth in the hearables category, driven by our new product introductions.

We are accordingly lowering our guidance for 2023 non-GAAP operating profit to $296 million-$312 million, compared to prior guidance of $400 million-$405 million. As we experience deleveraging of our business, partially offset by a variety of cost control measures. At the midpoint, we are lowering our operating profit guidance by roughly $98 million. This is comprised of a $168 million impact from lower revenues, a $32 million impact from lower gross margins, and a $15 million impact from increased litigation costs. We expect to partially offset these headwinds with $117 million in expense reductions, which is comprised of $46 million from expense control measures and $71 million from performance-based compensation.

Lastly, we are now estimating 2023 non-GAAP EPS to be $3.35-$3.55, down from our prior guidance of $4.70-$4.80. Turning briefly to our Q3 outlook, we are projecting consolidated revenue of $475 million-$525 million, with healthcare revenue of $305 million-$335 million, and non-healthcare revenue of $170 million-$190 million. Further, we are projecting non-GAAP operating profit of $50 million-$60 million and non-GAAP EPS of $0.50-$0.64. Please reference the earnings presentation on our investor website for further details.

In closing, although we are rebalancing our healthcare revenues this year following the large expansion in our business since 2019, the fundamentals of our healthcare business remain strong. Notably, new hospital customers continue to switch to Masimo technology faster than ever, increasing our share of the hospital market, and we achieved record contracting in the first half of the year, which has contributed to a 12% growth in our unrecognized contract revenue versus the end of the Q2 of 2022. With that, I'll turn the call back to Joe.

Joe Kiani (Chairman and CEO)

Thank you, Micah. Masimo is an innovative, mission-driven, adaptive, and resilient company. In addition to the short-term actions to adapt to changing market conditions that we've already discussed, innovation to drive profitable growth from products that improve lives across all our businesses remain a key focus and source of vitality. Our data informs us that our business remains very strong. Starting with consumer health and wellness, we launched the first new hearables product based on our adaptive acoustic technology during the Q2. It has been very well received in the marketplace. These next-generation earbuds are being marketed as the Denon PerL and PerL Pro to leverage Denon's heritage of world-class acoustics. We've seen nearly 200 positive press reports on PerL since the launch in June.

Initial demand from existing retailers for Denon PerL has been very strong, sales for the products are likely to be above our initial forecast formulated earlier in 2023. In addition, we have received many inbound requests by new retailers to carry PerL. We're nearing the launch of our Stork baby monitor with some very large, well-recognized, mass-market retailers. Stork should be on the shelves soon. The retailers that carry Stork will be displaying the product in prominent locations. In addition, Stork will be available from one of the largest online baby registries. Our expectations for Stork are based upon its superior feature set and value to new parents, as well as the high visibility the product will have in marquee stores and online stores.

We are not changing our 2023 sales guidance for our consumer health and wellness products at this time, but we have increased confidence in our ability to reach our target of adding one percentage point to healthcare segment revenues with these products. We want our W1 watch and the Stork baby monitor to have FDA clearance. A 510(k) clearance for Stork will open the door for promotion of the product for healthcare. A 510(k) clearance for W1 will allow us to execute on our hospital-to-home strategy in the U.S., including preoperative and postoperative monitoring at home, as well as monitoring patients with chronic diseases such as congestive heart failure and COPD, similar to our current efforts outside the U.S. In Q2, we received two long-awaited and important FDA clearances for Radius VSM, wearable vital signs monitor, and Opioid Halo for detecting opioid overdose.

We have finally launched these products in the US. We're seeing great customer excitement for these new products. Lastly, we recently secured a multimillion-dollar contract for our Centroid body position sensor with a large healthcare system that sees the high potential of Centroid to help reduce the incidence of costly pressure ulcers with their patients. To conclude, while we regret disappointing our investors with a large revenue and earnings miss in Q2, we are happy to report strong market share gains in our healthcare business and customer excitement around PerL, Opioid Halo, Radius VSM, and W1. We will soon launch Stork and begin to execute our consumer health business plan. Masimo has faced challenges in the past and has always overcome them to evolve into a stronger company.

We are confident that we will move past the recent shortfall and achieve great results for patients, clinicians, and our shareholders alike as we continue to pursue our mission to improve life. With that, we'll open the call to questions. Operator?

Operator (participant)

Thank you. At this time, I'd like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. We will pause for just a moment to compile a Q&A roster. Your first question comes from the line of Matt Taylor with Jefferies. Please go ahead.

Matt Taylor (Managing Director and Senior Equity Research Analyst)

Hi, guys. Thanks for taking the question. I, I wanted to ask kind of a two-part question. It's related, but basically wanted to understand from you, you know, how transient you view these issues are. You referenced in your prepared comments, the ability to get back to kind of your normalized growth rate in, in healthcare in 2024. I guess I'm wondering, you know, if these comps are easy and some of the sales are getting pushed, do, do you think 2024 could actually be a stronger than normal year, or why would it just go back to a normalized growth rate?

Joe Kiani (Chairman and CEO)

Well, 2024 should be a strong year for us, maybe even stronger than normal, because of the availability of some of the new products and our push into telehealth and also the consumer health. We see that as a very promising business. On the census side, what we don't know whether the shift to outpatient surgeries at the Ambulatory Surgery Centers are an anomaly due to shortages of nurses and the pressure hospitals have for inpatient care, or is that what surgeons and patients prefer? If, if, if it's an anomaly, that would be another reason next year will be a better growth year than normal for us. Assuming it is not, we believe this is our baseline.

At least, if we get the normal couple of percentages increase in census beginning 2024 compared to 2019, then we should do well. The final point I want to make is we have the bulk of pulse oximetry monitoring in the ambulatory surgery centers, but they use reusable sensors. Reusable sensors are unfortunately, even despite the best efforts to clean them in between surgeries, carry bacteria that are dangerous to patients. We plan to make a more concerted effort in educating the ambulatory surgery centers on the advantages to patients and maybe their businesses by using single-patient use sensors.

Matt Taylor (Managing Director and Senior Equity Research Analyst)

Okay, thanks. Thanks, Joe. Could I ask maybe just one follow-up? You know, just that's what scratching our heads a little bit, 'cause normally your, your business is very stable, and you have this volatility here. Could you help us, you called out a number of factors that impacted the Q2 and the downward revision on the guidance. Maybe help us understand the bridge of the different components, if you can estimate, you know, how much were caused by census versus OEM delays and, and orders, just to give us a better picture of what's going on underneath the hood.

Joe Kiani (Chairman and CEO)

Sure, sure. We'll, we'll try. I'll give you a high level, then maybe Micah can get more granular. You know, we came into 2023 with incredible momentum in all of the over the normal new contracts that we had in 2022 and 2021. We expected as we finish our installations of those, we will push our normal business up by several percentage points. Some of those got delayed despite our best efforts. Those installations did not occur. We're now going to even a higher gear, calling all of our clinical specialists to support the installation, given, at least at this point, it looks like the hospitals are ready to do them finally, and the OEMs can deliver the monitors. Some of the revenue shortfall was because of that.

The, probably the biggest factor was lower, purchase of sensor, by our customers than we anticipated. We not only anticipated a return to normal growth off of 2019 due to the pent-up surgeries, but we also thought, they're not going to order less. They ended up not only returning to the increased demand because of the pent-up procedures, 'cause they pushed those pent-up procedures to outpatient setting, but they ordered less from us. Census and inpatient went down, we could have anticipated that. I think one of the things that I had hoped, 'cause, you know, when you're doing these projections, you're always wondering, especially in a dynamic situation, we've come out of COVID, you wonder, what do you have as a backup plan in case some of your assumptions don't pan out?

For our backup plan, we had several large business that we anticipated. At least one of them would close, and, unfortunately, all of them got delayed. Most of them, things out of our control. I think one of them due to fear of shakeup at Masimo because of the proxy war. Nonetheless, all of these factors that we had hoped would either help us blow our, our numbers out of the water like we'd like to, but at minimum, save us from maybe bad assumptions we were making at the beginning, did not materialize. Like I said in our prepared remarks, at this point, we're kind of tightening down, expecting the worst, that not only census won't return, but those large orders won't happen this year. I hope that helps. Micah, do you want to add anything to that?

Micah Young (EVP and CFO)

Yeah, I think, Matt, in the prepared remarks that I mentioned, the large orders are about 40% of the miss, 50% was due to the lower than expected sensor orders, and then the remainder is due to capital and installation impact. Your question was, can you break down the lower than expected sensor orders? It's very difficult, from that standpoint, you know, number one, we came in the year expecting much higher than expected in patient volumes, stepping up well above pre-COVID levels. We had some, some assumptions that were incorrect, but also, you know, it's difficult to separate the census from how customers are ordering.

We don't have good visibility into the inventory levels, how they're managing those inventory levels, and it's hard to break out the impact separately in those buckets.

Joe Kiani (Chairman and CEO)

Matt, one thing I just want to emphasize, because I've, I've been around software companies. Sometimes software companies have great contracting, but their revenues that they can account for that quarter doesn't hit quite right. Obviously, that's not our situation. What was kind of similar for me is here we had, again, another record quarter in contracting with new hospitals and, and lack of any, any loss to our competitor. Here we're growing, and yet, unfortunately, our revenues declined. Unfortunately, it was a perfect storm.

Micah Young (EVP and CFO)

Can I just add one thing, Joe? The Matt, we are looking at monitoring closely the ordering patterns of customers. Over the first four weeks, we are seeing that improve. You know, that gives us more confidence in the new guidance range we have. We'd like to see them improve even further, give us confidence in that, that guidance range we just put out today.

Matt Taylor (Managing Director and Senior Equity Research Analyst)

Great. Thank you, guys.

Joe Kiani (Chairman and CEO)

Thank you.

Operator (participant)

Great. Your next question comes from Marie Thibault with BTIG. Please go ahead.

Marie Thibault (Medical Technology and Digital Health Analyst)

Hi, good evening. Thanks for taking the questions. I'm going to continue along the the guidance path here and see if I could try to understand a little bit more about, you know, your margin expectations and also the cadence throughout the year for revenue. It does look like we're expecting a bit of a bit of a step up in Q4 for both sales as well as operating margins, and I'm assuming most of the OpEx cuts will be coming in Q4. If you can help us, you know, kind of figure out that cadence a little bit more, that would be helpful.

Joe Kiani (Chairman and CEO)

Micah, do you want to take that?

Micah Young (EVP and CFO)

Yeah. Yeah, Marie. I mentioned, I walked through kind of how we're thinking about the, the guidance range and, you know, that lower end of guidance, we're assuming the inpatient admissions and, and capital sales trends kind of, seen in the Q2 continue through the year with, with, modest-

Marie Thibault (Medical Technology and Digital Health Analyst)

Okay, I think I was also asking about the expectations for those OpEx cuts, the $100 million in expense reductions, and how we should think about over Q3 and Q4.

Micah Young (EVP and CFO)

Yes. You'll see some of those come through in the Q3. We're already taking action on those. Then you'll see a bigger impact as we move into Q4 as, you know, with all the reductions we're making. Also, some of the marketing and promotional investments that are tied to the consumer audio business, some of those are heavier in Q4 as well. Those have been pulled out to offset the lower revenues. We've given you guidance on the Q3, then you have the full year, you should be able to model right into the fourth what we're expecting for the Q4.

Marie Thibault (Medical Technology and Digital Health Analyst)

Yep. Yep. Okay, understood. Those cuts, the expense reductions will stay in place, even if revenues rebound better than you're assuming at this point?

Joe Kiani (Chairman and CEO)

Not all of them. A big portion of the cuts is we're taking away the bonuses for the executives and many of our people and the RSU grants, all that kind of stuff. If for some reason we deliver what we had projected at the beginning of the year, those will come back. But assuming we don't, they will be gone.

Micah Young (EVP and CFO)

Yeah. To answer that question, too, Marie, is, you know, we've taken some cuts to really size our expense profile with our, with our revenue profile this year as well. You know, we are still trying to make the investments we need to grow this business and balance that, but we're making the right, taking the right actions to offset the lower revenues.

Marie Thibault (Medical Technology and Digital Health Analyst)

Okay, that's well understood. One last question, if I could. Just sort of high level now that we have the shareholder vote behind us, what can we expect on, on sort of next steps for corporate strategy? You know, what might be next in terms of expanding the board to seven members? Any clarity you can give us on, on, on what's next here? Thank you.

Joe Kiani (Chairman and CEO)

Yeah. The chairman of our nominating committee is working on that. Unfortunately, due to the loss of our prior chairman of the nominating committee, we're kind of starting a little bit from scratch. Yes, we're, we're eager to expand the board and hopefully get more thoughtful people around the table.

Marie Thibault (Medical Technology and Digital Health Analyst)

All right. Thank you both.

Joe Kiani (Chairman and CEO)

Thank you, Marie.

Operator (participant)

All right, our next question comes from Rick Wise with Stifel. Please go ahead.

Rick Wise (Managing Director and Senior Equity Analyst)

Good afternoon, Joe. Hi, Micah. If I could start off, Joe, maybe you could just expand on your Stork comments a little bit. Obviously, very positive sounding, exciting product, as we all know. Maybe just talk about the kind of incremental revenue potential, especially as we move into the Q4, what you're assuming. You know, maybe just remind us of your thinking about the opportunity even looking ahead to 2024 and beyond, what Stork could do if it, if it all unfolds as you, as you hope.

Joe Kiani (Chairman and CEO)

Sure. Well, I think, there are probably over 10 million births, in developed countries annually, and many people feel uncomfortable, taking their baby home, given the risk of SIDS and other issues. Stork not only can measure oxygen saturation and detect if, if a breathing problem, but it's got a thermometer, a real-time thermometer, that continuously measures the baby's temperature for fever spikes and has an amazing camera technology with lots of cool features that are gonna keep being added to it. Having shown that, at one of the major baby conventions, many retailers and online retailers, wanted it. In fact, some of them have moved mountains to get them on their shelves immediately. Normally, what would take a year, a year and a half, is happening in a matter of two to three months.

One of our major retailers that we're very proud, that we're gonna bring on is Target. Target will be carrying Stork. We are feeling that Stork could become a business that should be $200 million a year. I know the potential might be $1 billion, you know, let's see. Let's see if, once we get to $200 million, we can now plan for the, for the rest. The demand has been strong, and we're, we're hoping, once it gets in the hands of consumers, the way PerL has gotten in the hands of consumers and has generated a lot of positive feedback from consumers as well as people who report on it. If those things happen with Stork, I think, I think it'll happen.

A huge element, too, for how we wanna market it in the US, 'cause some of the things I just said to you, I can't say in the US, is getting the FDA clearance. Right now in the US, we can't tell parents this can help detect SIDS, because of oxygen monitoring. We have to be careful how we phrase things. We can't be open about all its capability. Once we get the FDA clearance, we can really go to town and, and really, take the covers off.

Rick Wise (Managing Director and Senior Equity Analyst)

Great. Micah, you, you talked about implementing expense control, starting in the third Q3, and you talked about some of the factors, but could you give us a little more in-depth perspective there, quantify a little bit, you know, what some of the biggest actions are and, you know, how quickly we're gonna see it in the second half, how significantly, and maybe the implications of some of these actions, as a setup for 2024 and beyond for gross margin and operating margin?

Micah Young (EVP and CFO)

Yeah, Rick. Some things I've mentioned were, to keep in mind, our performance comp was about $71 million out of $117 million for the reductions for this year. You know, some of that is, that's all tied into this year's performance comp. As we perform, that would, some of that would come back if we perform better and improve. And the other expense reductions, the $46 million is true cash expense reduction, so those should carry into next year. And the majority of that is, you know, reduction in payroll costs. That's about $28 million, and then there's about $18 million associated with the marketing and promotional spend for the consumer audio business.

Rick Wise (Managing Director and Senior Equity Analyst)

Okay, and just, I was thinking one last one, if I could. Just, maybe any update on the litigation with Apple, and just any, any new perspectives or timelines you want to share at this point? Thank you.

Joe Kiani (Chairman and CEO)

Yes, of course. We have three cases, really. one is the ITC, which we should hopefully have the soonest results. As you remember, we were supposed to get the commission to give us a decision on July 17th. They pushed it out to October 10th. We think hopefully that will stick. Assuming they go with the ALJ's 300 plus page decision, we should get an injunction, barring President Biden's ability to stop it, which he has 60 days to do so. They did not stop the AliveCor's injunction, so we don't expect they'll stop ours. On the trade secret and patent case in California, if you remember the trade secret case, we unfortunately had a hung jury, and we just met with the judge.

It looks like we will not go to trial till next year on that again, hopefully February, March timeframe. Then on the Delaware case that Apple brought against us, they brought a patent case against us, I think 10 patents, and then we responded with patent case against them, I think 10 patents. We also added an antitrust complaint and an unfair competition false advertising claim, and that is going a lot faster than we expected. The judge has been incredible and has been really holding all of our feet to the fire, and that might go to trial next year, which will be unheard of. That's, that's where we're at.

Rick Wise (Managing Director and Senior Equity Analyst)

Thank you so much.

Joe Kiani (Chairman and CEO)

Thank you, Rick.

Operator (participant)

Okay, our next question comes from Jayson Bedford with Raymond James. Please go ahead.

Jayson Bedford (Managing Director of Medical Technology)

Good afternoon. Maybe just a couple. Just getting back to the, the lower sensor sales, the $30+ million in, in the quarter. Mike, you, you kind of alluded to it in answering a question, but I, I didn't hear much in the, in the prepared remarks around inventory dynamics. Can you just talk through what you've learned maybe in the last month around inventory levels at the customer level, and have you implemented any kind of better processes here to, to gauge inventory levels going forward?

Micah Young (EVP and CFO)

Yeah. Jayson, what I mentioned a little bit earlier, I touched on it, but, you know, it's difficult to identify, you know, inventory levels with our customers just 'cause we don't have that visibility. What we are watching very closely is, is customer ordering patterns. The first four weeks, so-called July, those, those, those ordering patterns have improved and substantially from Q2. They're, they're heading in the right direction. They're not where we want 'em to be completely yet, but they do support that, that new guidance range that we just put out today. That's how we're monitoring it closely. We're, you know, continuing to try to get more and more information as we can.

That's, that's the, the focus right now, is just continuing to monitor those, those new ordering patterns.

Jayson Bedford (Managing Director of Medical Technology)

Okay. Maybe just on a semi-related topic, price. I think last month you mentioned discounting. Can you just talk about, why the, the discounting started, and then kind of where we are from a pricing standpoint?

Joe Kiani (Chairman and CEO)

Well, the discounting, why it started, we're, we're still trying to understand that. What I can tell you is, these were not discounting at the time of contract. These were discounting post-contract, and we, once, once I became aware of it, I stopped it. The reason I stopped it is because the sensor revenue is part of a razor blade. It's part of the razor, razor blade strategy. While we, I've given a lot of, a lot of freedom to the sales force to discount our capital, even give away our capital, I never intended them to reduce our sensor pricing. We need to be disciplined on that, so I've asked it to be stopped.

I've asked from here on, if anyone ever wants to discount our sensors, they have to get my approval so that this hopefully won't ever happen again. Bottom line, it was, you know, it wasn't being done for a long time. It was done for a short time. They thought they were free to do it because they had been allowed to discount capital and even sometimes cables. Anyway, that's, that's what happened. What's, I think, positive is that going forward, it should help our gross margins, too, because we're not offering these discounts anymore.

Jayson Bedford (Managing Director of Medical Technology)

Okay. Okay, that's helpful. Maybe just last one here. Has your view of, of the market opportunity changed in any way here? Meaning, upon reflection after Q2, you know, is there a sense that, hey, maybe the market's more penetrated than we thought, or does the opportunity still exist that you outlined back in, in December? Thanks.

Joe Kiani (Chairman and CEO)

No, no. Like I said, it's really in the press release, I think I put in there, it's a tale of two realities. One reality is that our market penetration is increasing, our market share is increasing. I think there's a slide in your, the PowerPoint presentation that was put out in time for the earnings call that shows that. Unfortunately, the revenues decreased. I'll tell you, if there's one thing it made me believe, is we had the right strategy in getting into telehealth, telemonitoring, and consumer health. Because as unbelievably reliable as our set sensor business has been over the past couple of decades, this quarter, it wasn't, and the patterns changed. They went from inpatient to outpatient. I know when we first put out our pre-announcement, people kind of disputed that.

I know our competitor disputed that. It's showing that we were right. Outpatient census did increase, and we said that, but inpatient re-reduced, went down, decreased, and that hurt us. No, I, I think the, what we thought about the overall market and the overall future of Masimo is intact. I, I'm, I apologize, I, I regret that we missed our numbers in Q2. It is not indicative of the health of our business.

Jayson Bedford (Managing Director of Medical Technology)

Thank you.

Joe Kiani (Chairman and CEO)

Thank you.

Operator (participant)

Okay, your next question comes from Mike Matson with Needham & Company. Please go ahead.

Mike Matson (Managing Director and Senior Equity Research Analyst)

Thanks. I just wanted to go back to the kind of quarterly sequencing implied by the guidance. I think if you take kind of the midpoint of the Q3 EPS range and the midpoint of the annual EPS range, it's implying something like $1.39 of EPS in the Q4, which is a pretty big sequential step up, as well as it's up, you know, year-over-year versus last year. You know, the Q3 number seems believable, but that seems like a pretty, you know, tough number to reach, I guess. I don't know, maybe you can explain, like, how you're gonna, you know, see, you know, kind of make that ramp.

Joe Kiani (Chairman and CEO)

Yeah. Mike, if you look at the, it, you know, cost actions we're taking, it's gonna be more of a step up in the Q4. Plus, we're expecting, you know, stronger revenues in Q4, based on how we planned out the year and, and, and rebaseline our forecast. The combination of the, the strength in revenues that we expect in Q4, some large, you know, some of those large orders coming in and that, and that guidance range, as well as the expense reductions taking hold.

Mike Matson (Managing Director and Senior Equity Research Analyst)

All right. Then, just wondering if there's any kind of second thoughts on the Sound United deal here, just given what's happened. I understand the consumer health strategy, but the way you're talking about Stork, for example, it sounds like there's a tremendous amount of retailer interest there. I'm not really convinced that you need a billion-dollar speaker company to get that product into the, onto the shelves at these retailers. Your competitor, Owlet, they're, you know, I know Best Buy sells their products. They, they don't want a billion-dollar speaker company. Just wondering if you'd consider maybe exiting that business, and focusing back on the healthcare business.

Joe Kiani (Chairman and CEO)

Well, look, reasonable minds disagree, and Masimo has a lot of parents, and I, I understand people have different views on things. When we bought Sound United, we said, "Hey, give us three years. If we haven't proven this thing is gonna really do what we say it is, we'll get out of it." Not only that, that thought hasn't changed, everything today tells us it was the right move. Secondly, you know, we have a thriving healthcare business that I did not wanna take our eyes off of. I wanted to make sure the current management team runs that optimally. We needed a new team to optimally run the consumer health, and the Sound United team has done a great job. All these, all these contracts we have now for Stork, for PerL, that's all done by them.

Yeah, well, maybe my team could have done that, but it may have distracted them from the healthcare business. Lastly, you know, the fact that we got in and refocused Sound United on the hearables, which is about a $50 billion-$85 billion business, depending how far you go into it, whether you're just streaming music and voice calls, or you want to improve hearing for people that have lost hearing at a low level to moderate level, that's a huge opportunity, and already it's working. No, I'm sorry you still feel like I should get rid of it, but, but we don't. We still think it was the right decision, and we're gonna do our best to prove it. We're not gonna, we're not gonna be foolish about it.

If we're wrong, we'll back out, but we're not done yet.

Mike Matson (Managing Director and Senior Equity Research Analyst)

Okay, I understand. Thank you.

Joe Kiani (Chairman and CEO)

Thank you. We have time for one more question.

Operator (participant)

All right. Our final question for today comes from Vik Chopra with Wells Fargo. Please go ahead.

Vik Chopra (MedTech Equity Research)

Hey, good afternoon, thanks for squeezing me in. Just two questions to me.

Joe Kiani (Chairman and CEO)

The W1 is a pulse ox with ECG, it's going through the normal channel that these products go through. Stork is a pulse ox-based product that's going through the normal channels with the FDA that look at oxygen desaturation, like Opioid Halo or pulse oximetry in the healthcare side. We believe they're all under the 510(k) procedure, and we believe we're having great communication with the FDA about it, you know, hopefully, in the next 60 to 90 days, both of them will get cleared. We've been, we've worked with the FDA successfully over now three decades, and sometimes some products get cleared in 30 days, and some products get cleared in one decade. Let's hope those two are not going that direction.

Vik Chopra (MedTech Equity Research)

Thank you for the color. Then on my follow-up question, you know, I heard your comments earlier about expanding the board from five to seven. Can you put a finer point around that? Sort of, you know, when do you expect to get the two, the two additional board members in? Is it by end of the year or, potentially earlier or later? Thanks for taking my questions.

Joe Kiani (Chairman and CEO)

Sure, sure. We're gonna try to get them in as soon as possible. Thank you so much, everyone. Again, I hope from here on, we don't have to have a bad quarter to report, and that the fundamentals of the business match the revenues from the business. We appreciate your time, and we'll talk to you hopefully in a quarter. Thank you.

Operator (participant)

Thank you, ladies and gentlemen. That concludes today's call. Appreciate you all joining. You may now disconnect.