Masimo - Q3 2023

Transcript

Operator (participant)

Good afternoon, ladies and gentlemen, and welcome to Masimo's third 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 will 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 11th, 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 third quarter 2023 earnings call. Our performance for the third quarter was within our guidance range, communicated last quarter, and was highlighted by record market share gains in hospitals with a record level of new customer contracts for our SET pulse oximetry and other solutions. That said, our healthcare business is navigating a clear transition away from COVID-era conditions. Despite sequential improvements from the second quarter, sensor utilization remains below prior trend, and hospital budget pressures have continued to slow the pace of equipment installations. This is keeping sensor utilization below our expectations for the second half of the year.

As we continue to gather more data on hospital utilization of our sensors, we are beginning to see that customer behavior and sensor purchasing patterns are transitioning back to the pre-pandemic growth trend line we saw from 2017 to 2019. Micah will have more to say about these observations later in the call, but together with our record contracting performance this year to date, this data reinforces our conviction in the underlying long-term growth rate for our healthcare business.

On the consumer side, we continue to realize strong growth for hearables, which remains a key focus area for us. The rapid uptake of our hearables products is helping to partially offset the challenging consumer environment that our premier audio brands are facing for audio components and home entertainment systems. I will share updates on some of our exciting new products and opportunities later in the call, but now I will ask Micah to review our third quarter results in more detail and provide an update on our 2023 financial guidance.

Micah Young (EVP and CFO)

Thank you, Joe. For the third quarter, we achieved consolidated revenue of $479 million and non-GAAP earnings per share of $0.63. Our performance for the third quarter was within our guidance range, communicated last quarter, with revenue at the low end of the range and earnings at the high end of the range. For our healthcare segment, third quarter revenues were $308 million, reflecting a 6% year-over-year decline. As with last quarter, the decline was driven by lower sensor utilization, which continues to suppress growth from our record level of new customer conversions. In addition, the elevated backlog of new equipment installations by our OEM partners and constrained capital budgets at hospitals also impacted sales. We shipped over 63,000 drivers during the quarter, which was in line with the second quarter level.

During the third quarter, we saw a slower than expected pace of recovery and sensor utilization. Further, the pace of equipment installations from new hospital conversions remained slower than expected, leading us to reduce our guidance for the healthcare business for the year. Despite these near-term headwinds, we did see a 10% sequential increase in revenue in what is normally our seasonally slowest quarter, due in part to a rebound in sensor orders from customers who have been working down inventory.

This dynamic bolsters our confidence that customer behavior and sensor purchasing patterns are returning to pre-pandemic trends. As we move past the difficult comparisons, we expect sensor purchasing patterns to shift back to the growth trend line we saw from 2017 to 2019, and believe our healthcare business will resume annual growth from our updated guidance level for 2023. Let me take a few minutes to share some additional data that informs our perspective.

As you can see in our supplemental slides for today's results, when you step back and look at the longer-term growth trends, we are seeing healthy on-trend line performance from our products on a year-to-date basis. From 2017 to 2023, our average annual growth rate for total consumables revenue is 10%, which is in line with the pre-COVID growth rate. Further, the average annual growth rate for rainbow and hemodynamics revenue is 20%, and the average annual growth rates for our brain monitoring and capnography and gas revenues are 27% and 16% respectively.

This longer time frame makes the distortions of the COVID years clearer, and together with the recent rebound in purchasing from our customers who previously had elevated inventories, supports our belief that the business is tracking well with its pre-COVID growth rate, and that our targeted long-term growth rate remains achievable. Our strong performance in converting new customers also reinforces our optimism about our long-term growth trajectory. We achieved another record-breaking level of new hospital contracts in the third quarter. These new contracts include sensor sales for new customers that reflect our continued market share gains. In fact, our unrecognized contract revenues for the third quarter increased 16% over the prior year period, and was up 4% sequentially from the prior quarter to reach $1.4 billion.

For our non-healthcare segment, third quarter revenues were $171 million, representing a year-over-year decline of 24% on a constant currency basis. A difficult environment for consumer discretionary purchases is adversely affecting the market for high-end audio systems. With non-healthcare overall, while non-healthcare overall is suffering from the negative macro environment, we again realize strong growth for our hearables category, which increased by more than 130% year-over-year, and now represents 10% of segment sales. The positive momentum in hearables has helped to partially offset the macro conditions weighing on the market for high-end audio systems. Now, moving down the P&L. For the third quarter of 2023, we realized consolidated non-GAAP gross margin of 50%. This includes gross margins of 60% for our healthcare business and 33% for our non-healthcare business.

As we saw in the second quarter, gross margins were again affected by the deleveraging impact of lower sales on our fixed overhead costs and an unfavorable segment and product mix. For our consolidated business, our non-GAAP operating profit was $57 million versus $81 million in the prior year, as decreased profits from lower revenues were partially offset by the benefits realized from reducing operating expenses, including performance-based compensation. Our non-GAAP earnings were $0.63 per diluted share versus $1 per share in the year ago period. Despite the year-over-year decline in our third quarter results, our record levels of hospital contracting and continued traction in high growth categories are positive signals for sustainable growth over the long term. In addition, we are partially offsetting lower revenues in 2023 with the expense control measures we have implemented.

Now, I'd like to provide an update on our 2023 financial guidance. For the fourth quarter, we are projecting consolidated revenue of $526 million-$576 million, with healthcare revenue of $320 million-$345 million, and non-healthcare revenue of $206 million-$231 million. Further, we are projecting non-GAAP operating profit of $65 million-$79 million and non-GAAP EPS of $0.74-$0.94. For the full year, we are projecting consolidated revenues of $2.025 billion-$2.075 billion. For our healthcare segment, we are projecting revenues of $1.255 billion-$1.28 billion, which now includes $6 million of year-over-year currency headwinds.

This represents a 3%-5% reduction from our prior guidance on a constant currency basis. For the non-healthcare segment, our full year revenue guidance is now $770 million-$795 million, which now includes $9 million of year-over-year currency headwinds. This represents a 2%-5% reduction from our prior guidance on a constant currency basis. We've incrementally reduced fourth quarter revenue guidance to reflect softer demand. Our guidance range also reflects a seasonal sales step-up typically seen in the fourth quarter. We are now projecting non-GAAP operating profit of $256 million-$270 million, compared to prior guidance of $296 million-$312 million.

At the midpoint, we are lowering our operating profit guidance by $41 million, which is comprised of a $51 million impact from lower revenues, a $9 million impact from incremental currency headwinds, and a $3 million impact from increased litigation costs. We expect to partially offset these headwinds with $22 million in cost reductions. Excluding the incremental currency headwinds, our revised operating profit guidance represents a 10% reduction from our prior guidance at the midpoint. Lastly, we are now projecting non-GAAP EPS of $2.85-$3.05, down from our prior guidance of $3.35-$3.55. In summary, although this has been a challenging year, challenging post-COVID transition year for our business, we believe there are many reasons to be positive about our long-term outlook.

Over the last quarter, we have gained a better understanding of the transition in customer behavior and ordering patterns. We've had consistent success in winning new customers over the last three years, and Joe will share more about the exciting potential of recent FDA clearances and upcoming new product launches to extend that track record. Our market share for patient monitoring in hospitals is steadily rising as we win new customer contracts at a record pace. We believe a return to long-term growth rate targets for our healthcare segment will be more visible next year as we complete the transition back to pre-COVID trends. With that, I'll turn the call back to Joe.

Joe Kiani (Chairman and CEO)

Thank you, Micah. As you just mentioned, our innovative new products are driving our record contract wins and sustaining our ability to grow over the long term. Masimo has built a track record of achievements over the past 30 years that is unsurpassed in the field of patient monitoring. We're extending these accomplishments with a combination of innovation and responsiveness to patient needs that enables us to create high-value products that truly make a difference. A great example is one of our fastest-growing products, our Oxygen Reserve Index parameter. The Oxygen Reserve Index parameter, ORi, has accounted for over 20% of our worldwide sales of rainbow products year to date, despite the fact that it has not been available in the U.S. We just received FDA clearance for ORi last month and are launching it in the U.S. this quarter.

I'm excited about the prospects for ORi in the U.S. because it has clear and well-established clinical benefits and is the first non-invasive technology for analysis that are currently done through invasive procedures. ORi has great utility for detecting moderate hyperoxia. ORi is useful for determining when to stop the intubation involving a difficult airway, provide additional supplemental oxygen, and attempt intubation again prior to surgery. ORi is also useful to avoid over-oxygenating patients in the ICU and other places where oxygen is prescribed. We expect to realize similar traction for ORi in the U.S. as we have overseas, which should boost rainbow revenues over time. For context, the U.S. market typically accounts for two-thirds of our global healthcare products sales. In conjunction with the U.S. clearance of ORi, we have introduced our 4-LED rainbow sensor.

In some countries where the 4-LED rainbow sensors have been available, many customers have switched from our 2-LED SET sensors to our 4-LED rainbow SET sensors. We also have combined SpHb with LiDCO cardiac output monitoring to provide, for the first time, indication of oxygen delivery of patients to care providers. Both ORi and oxygen delivery were received incredibly well at the American Society of Anesthesiologists conference in October, and we expect both to help improve patient care and drive our rainbow sensor revenues.

Building on our precision measurements, hospital automation solutions, and telemonitoring platforms, Masimo is empowering clinicians with Halo, our AI-powered clinical decision support tools designed to drive transformation from episodic and reactive care models to care enriched by continuous and predictive insights. Deterioration prediction tools will proactively prompt clinicians, helping them make more informed decisions and navigate their clinical pathways more effectively.

Our AI-powered clinical decision support tools are helping clinicians improve care across a multitude of disciplines, including respiratory care, cardiovascular care, and neurology and brain health. Soon, Halo will help clinicians improve care in infectious disease treatment, hemodynamics, and hand hygiene compliance. In consumer health, we launched our Stork baby monitor in late August in both brick-and-mortar and online retailers, including Target, Best Buy, Amazon, and Babylist.com. We are ramping up distribution and will be in 250 outlets by year-end, with plans to quadruple that in 2024. In consumer audio, the Denon PerL Pro earbuds continue to see strong demand as we head into the holiday season. In telemonitoring, we continue to wait for FDA clearance of W1.

In countries where we have been able to offer W1 for hospital-to-home telemonitoring, we have seen strong interest in using the W1 in telehealth programs, making us believe that the availability of W1 will improve patient care in the U.S. and advance our hospital-to-home strategy. Finally, I want to comment briefly on the landmark ITC victory we won over Apple. The decision validates our ongoing efforts to hold Apple accountable for unlawfully misappropriating our intellectual properties.

Just as importantly, it advances our mission to improve lives by protecting the incentives to innovate and ensuring that products that really work are able to compete on a level playing field. To conclude today's comments, we are encouraged by the stabilization of sensor orders and record new hospital customer wins, which reflect the superiority of our products and give us confidence in the long-term growth trajectory for our healthcare business. We have a healthy portfolio of new and rapidly growing products and are excited about the potential contributions they can make, not just to our business, but to people's health and reducing the cost of care. We remain dedicated to pursuing our mission to improve life, improve patient outcomes, reduce the cost of care, and take noninvasive monitoring to new sites and applications. With that, we'll open the call to questions. Operator?

Operator (participant)

Thank you. If you would like to ask a question, please press star, then the number one on your telephone keypad. Your first question comes from the line of Rick Wise with Stifel. Rick, please go ahead.

Rick Wise (Managing Director and Medical Technology and Supplies Analyst)

Good afternoon, everybody. Apologize for the background noise. I'm in an airport. Let me start by talking about the order stabilization that you're seeing. I just wanna be clear in my mind, where are inventories now, from your perspective, relative to the last time you spoke to us, three months ago? And when you're talking about this order stabilization, is this something that you've seen throughout the quarter, or you've felt that for the last month, or is this something you're just starting to see now as you head into the fourth quarter?

Joe Kiani (Chairman and CEO)

Well, Rick, even though we have a really good relationship with our customers, they don't share their inventory levels with us. So what we consider as order stabilization is the increase we're seeing in sensor purchases, and that has continued through today. Micah, do you wanna add anything to that?

Micah Young (EVP and CFO)

Yeah. So, Rick, we've been monitoring. We've got another three months of data points here to look at purchasing patterns. We've been monitoring it very closely. The trends are encouraging. They're heading in the right direction. I think the slope of that recovery we thought was a bit, you know, a steeper recovery than in and that we'd return back, and that's why we're lowering guidance for the year. But in terms of where we are today and what we've seen through the first five weeks of this quarter, the trends are heading in the right direction. We are seeing things stabilizing to more kind of that pre-COVID utilization trend. And things are recovering. It's just not the pace of recovery that we expected, you know, with the data that we were looking at in the last quarter.

Rick Wise (Managing Director and Medical Technology and Supplies Analyst)

And Micah, I know how conservatively you approach things, and I'm sure you thought in giving us the prior guidance range for the year, that you were being thoughtful about the low end and the high end of the range. Why are you feeling today in giving this new range that you've now you're getting it right, or why should we hope you're getting it right? Is it because of this pickup in orders? Is it just that straightforward?

Micah Young (EVP and CFO)

Yeah, I think it's, it's multiple things. I mean, first of all, you know, we've, we've gained market share through strong contract, and that continues, so that's encouraging. You know, we haven't kept pace with the, you know, in terms of equipment and installations, with the gains we've had on contract, and we're still, you know, behind on getting those caught up. But, you know, we still have strong numbers in terms of installations that we are gonna, are gonna help us grow, not only in Q4, but, you know, grow into Q4, but also, as we move into next year. The biggest thing that we see, though, right now is, like I said, we've been monitoring those weekly revenue trends.

We've got another three months of data points, and especially when you look at October, you know, we've got a lot more clarity today than we did last quarter. We, you know, like you mentioned, we gave you the best guidance range we could with the data we had at the time. Now that we've got another quarter of data, we believe that we have a very high confidence guidance range, you know, as we move into Q4.

Rick Wise (Managing Director and Medical Technology and Supplies Analyst)

Just last from me, I mean, I apologize for asking, but I, I have to ask about the year ahead. Thinking about 2024, Micah, if you've got the right picture right now, it seems to me, one, you've got relatively easy comps, two, back to trend line base business growth, and you're launching all these new products. Can you sort of help us think through? I'm not asking for guidance today, but just we have to come up with numbers. How would you frame a reasonable starting place for us, so to help you set the stage for or start to set the stage for expectations for the year ahead? Thank you very much.

Micah Young (EVP and CFO)

Yeah, absolutely. So Rick, I mean, we'll share more details on our expectations for 2024 on the year-end call.... but as I mentioned before, and even in my prepared remarks, based on the underlying trends we're seeing in the business with the new customer conversions, we expect to return to annual growth next year. And you know, there will be some comps that change in the first half. I mean, we've got some tougher comps in the first quarter, easier comps in the second quarter, and those comps start to normalize in the back half. So, you know, we expect a return to growth. You know, we'll have to work through and finalize our plans for next year. But we believe we're back on that growth trend heading into next year.

Rick Wise (Managing Director and Medical Technology and Supplies Analyst)

Thank you.

Joe Kiani (Chairman and CEO)

Next, caller, please.

Operator (participant)

Your next question comes from the line of Matt Taylor with Jefferies. Matt, please go ahead.

Matt Taylor (Managing Director and Senior Healthcare Analyst)

Hey, thanks for taking the question. So I, I guess I wanted to try to work through some of the disconnect between what you're talking about with sensor, sensor utilization, but obviously your, your contract when showing the backlog and, and the growth there, and helping us understand how those things come together to actually recognize revenue next year and, and grow strongly over this new baseline.

So that's the setup for the question, but the real question is, A, are you seeing any success with some of the actions that you've taken to activate folks to actually get installations into the recognized sensor revenue, so that we can see that rev rec going forward? And, you know, when do you think you can call this new trend, you know, a real trend? It seems like a bit of a divergence from last couple of quarters in terms of how people are using sensors, and I guess, what more do you need to know to know whether that's durable or, you know, just kind of a short-term change?

Joe Kiani (Chairman and CEO)

Well, we have seen more of our installations, just not at the level that we had hoped by this time. We also did go back to the ambulatory surgery centers that are seeing more surgeries now than before, and have been successful in getting many of them to switch to single patient use sensors. As I've indicated before, we believe roughly 70%-80% of the ambulatory surgery centers use Masimo.

So they've just been historically using reusables. So we think we can hopefully make that change because it's better for everyone, especially the patients. So we believe as we look into 2024, we believe the worst is behind us. We believe the... Even if trends and census growth doesn't occur, we believe it should be stable, and because of our increase in market share, we should be growing anyway. And that's why I think, Micah, in his prepared remarks, stated that we think we'll be seeing normal growth next year.

Matt Taylor (Managing Director and Senior Healthcare Analyst)

Gotcha. And maybe as a follow-up, it's just a separate question. Congrats on the ITC win. Can you help us understand what this could actually mean in some different scenarios for you going forward? Assuming that does get finalized and there is an injunction, you know, you'll have some leverage, but what can you do with that in the context of some of the other, I guess, battles that you're going to have with Apple going forward?

Joe Kiani (Chairman and CEO)

Well, I think the most important and maybe most consequential result that a patent holder looks for is an injunction. So if indeed the injunction goes into place, I think we'll be benefited no matter what. If we can't come to a deal with Apple, where we can work together for the benefit of their customers, we will do better as a result of having a monopoly over our intellectual property, while that monopoly lasts, which isn't that long. It's got maybe five, four years left in it. So we think it's very positive, and we hope to share good news regarding either one moment in time or hopefully many moments in time in the future.

Matt Taylor (Managing Director and Senior Healthcare Analyst)

Great. Thanks, Joe.

Joe Kiani (Chairman and CEO)

Thank you.

Operator (participant)

Your next question comes from the line of Jason Bednar with Piper Sandler. Jason, go ahead.

Jason Bednar (Managing Director and Senior Research Analyst)

Hey, good afternoon. Thanks for taking my questions, guys. Joe and Micah, I want to pick up a bit on Rick's question, looking at 2024. And really, you know, ask about some of the commentary in your release today, some of your remarks, really focusing on the, the element where you're setting- you say you're setting the stage for a strong 2024.

You know, not, not just revenue, as Rick asked, but what about EPS as well, as we consider some of those variable comp items normalizing higher next year? I think you're also shifting some manufacturing out of Mexico over to Malaysia. Mike, I don't know if you want to comment on, you know, what we should think about for, like, duplicative costs or what that means for gross margins next year. I'm just trying to understand, you know, is this—does that 2024 strength extend not just to revenue growing, but also EPS growing year-over-year?

Micah Young (EVP and CFO)

Yeah. So, Jason, let me kind of step through that. You know, in terms of... We talked about the revenue growth, you know, we're gaining a lot more confidence going into next year to return to annual growth year-over-year, barring some of those comps throughout the year. But, if you look at where we're at today, the opportunity we have in front of us is to drive gross margins, and that's been something we're very focused on as we exit this year and move into next year.

And we've got several initiatives around that, including shifting more and more volume to Malaysia and some other cost reduction initiatives that we have for certain products. The other thing is our consumable growth that we're seeing now and carrying into next year, even though capital continues to be suppressed, we should see some good mixed benefits that flow through in gross margins as we move into 2024.

In terms of your comments on or question around, you know, operating expenses, I think, you know, where we expect to get the margin improvement's gonna be mostly through gross margin. We're trying to do everything we can to offset the add back of variable comp to try to deliver good bottom line EPS growth. We still have a lot to work through our planning process that we're gonna be wrapping up in December and as we exit the year and provide guidance early next year. But, you know, we're trying to take the right expense actions. We've been taking that through the last two quarters to try to offset that add back on variable expenses.

I think I referred to last quarter that we had around $74 million, $74 million or so of a variable comp add back coming back into the P&L. So, but we've also been very diligent on getting after expenses to try to offset some of that, but where you'll see a more outweighed benefit will be through gross margins than it will in OpEx.

Jason Bednar (Managing Director and Senior Research Analyst)

Okay. So maybe just to put a finer point, I mean, do margins expand, EPS grow next year? And then the follow-up would be, you know, kind of a separate topic here. You know, when we think about sensor utilization, and trying to model that forward, you know, coupled with the massive amount of boards that we've seen placed or installed over the past few years during the pandemic and immediately after the pandemic, you know, what's the right utilization level we should be considering as board use normalizes? And I guess, as I think through those driver shipments over the past few years, you're covering a lot of general ward beds that you weren't covering before. They have lower utilization per driver, presumably.

So does the average consumption per driver actually need to be lower than the 2017-2019 trend you're quoting? I guess I'm just trying to figure out, you know, kinda, kinda how Rick was like, how do we model forward, you know, considering that we're looking at a different Masimo today than we were in, like, 2018 or 2019?

Micah Young (EVP and CFO)

Yeah. So, Jason, I would say that, you know, through some of the COVID years, we saw a step-up in terms of the revenue per driver. I think we're seeing it settle back into to kind of the utilization from 2019. But we also believe that we'll be able to grow that and improve the revenue per driver, move, you know, back again going forward. So I think we're seeing a settle back in to kind of what we were seeing back in 2019. But again, as we start to, you know, drive additional revenues from these new customer conversions, we've got a lot of equipment installations we've done that we're not fully leveraging at this point, so we should see improvements moving forward.

Joe Kiani (Chairman and CEO)

As we mentioned early on the call, with the launch of the four-LED rainbow sensor, which will carry about a 50% premium to our standard two-LED SET sensor, that many customers are wholesale switching to. Hopefully, with the more sales of rainbow hemoglobin sensor, not just to track hemoglobin, but to allow for measurement of oxygen delivery with our cardiac output monitor, we think, as Mike has said, while the volume of sensors per socket per year might be the same as it used to be in 2019, the revenue per socket will be greater.

Jason Bednar (Managing Director and Senior Research Analyst)

Okay. I'll hop back with you guys. Thank you.

Operator (participant)

Your next question comes from the line of Marie Thibault with BTIG. Marie, please go ahead.

Marie Thibault (Managing Director and Medical Technology and Digital Health Analyst)

Good evening. Thanks for taking the questions. Wanted to check in on one of the headwinds that you had discussed earlier this year. I think it was, you know, you had a number of large orders that didn't come through on the time that you'd hoped. Where are we with those? Did we see any of those recognized in the quarter, or could we see those in Q4? And then as part of that, can you help me understand exactly why the equipment installation backlog has gotten so bad with the OEMs? Are they short on labor? Is it just sort of too much workload? Is it something the hospitals are telling them? Any more detail on that?

Joe Kiani (Chairman and CEO)

Sure, Marie. So, first of all, I just wanna say on the hospital installations, the OEMs are loosening and giving us the pieces we need for the installation, but the hospital's nursing shortage, staff shortage, is delaying some of our installations. I think your first question was on-

Micah Young (EVP and CFO)

Large orders.

Joe Kiani (Chairman and CEO)

Large orders. Yeah. Yeah, I've already forgotten about those. Yeah, the large orders did not come in again in Q3, and we're not projecting them in our Q4 numbers. We haven't lost them. They're still there, but it's getting frustrating as quarter after quarter, we anticipate them, and they don't come in. So, no, they did not come in.

Marie Thibault (Managing Director and Medical Technology and Digital Health Analyst)

Okay. And just to be clear, are they included in the Q4 guide?

Joe Kiani (Chairman and CEO)

They're not included in the Q4 guidance, no.

Marie Thibault (Managing Director and Medical Technology and Digital Health Analyst)

Okay. That's really helpful. Thank you for that. And then one kind of high-level question. You know, we've seen a competitor of yours in the headlines for potential spin-out of the business unit or possibly an acquisition. Are you seeing any impact at this point in the field? I know that, you know, there's kind of been ongoing discussions, but curious if that's helping with market share at all?

Joe Kiani (Chairman and CEO)

Well, Marie, we have been getting market share against the Nellcor division of Medtronic for, I think, a couple of decades, and nothing has changed. And sometimes I hear them saying something to the contrary, and it is not true. As far as their transition or spinoff, I've heard rumors that the buyer can't get the money together to buy them, so I don't know even if it's happening. But assuming it happens, we think it should be positive for us, and not negative.

Marie Thibault (Managing Director and Medical Technology and Digital Health Analyst)

Okay, very interesting. Thank you for it.

Joe Kiani (Chairman and CEO)

Thank you.

Operator (participant)

Your next question comes from the line of Michael Polark with Wolfe Research. Michael, please go ahead.

Michael Polark (Senior Equity Research Analyst in Medical Devices)

Thank you. Another one of the call-outs from last quarter was excess inventory at certain customers. Micah, it sounded like in your prepared remark that, you know, you're seeing order patterns there return towards normal. And I know the visibility on your end is not super high, but can you say confidently now that you feel like the channel is feeling more correct and that these customers that had excess might no longer... Any other color that you can provide on that topic would be great.

Micah Young (EVP and CFO)

Yeah. Yeah, Mike. So from the ordering patterns that I see of the customers, I feel like we've got the worst behind us. Can I predict every customer and how they manage inventories in this tight environment with capital budgets and constrained operating budgets, and how they, you know, utilize their sensors and their inventories? It's not easy to do that. So, but I can say that where things are trending, it's—I'm more encouraged than, a lot more encouraged this quarter than I was last quarter, just because we had limited data points. And I think, you know, it gives us the confidence for this new guidance range.

Last quarter, like I mentioned, we just did not have as much of a view as what I would have liked. And now that we do, and the trends are continuing to step up and improve sequentially, you know, it's given us the confidence that we're through the worst of it. And I think now, you know, we're encouraged that we can get back to growth. So yeah, I feel much better at this moment.

Michael Polark (Senior Equity Research Analyst in Medical Devices)

And then the follow-up for Joe, perhaps just kind of a fresh reflection on Sound United. Is it, you know, relative to your expectations, how do you feel about it? Is it proving a distraction? Is it creating opportunities that or do you think it's still positioned to deliver the opportunities that you saw in it as you move the consumer products closer to prime time? Just how you're feeling about running that business today would be great. Thank you.

Joe Kiani (Chairman and CEO)

Thank you. As we announced, when we announced we were going to acquire Sound United, I said, "Give us three years, and if in three years it's not working, we'll, we'll get rid of it." Since then, it has been constantly reminding us that what a good thing we did to acquire it. Because one, it has allowed our healthcare business to stay focused on the healthcare business as we make this attempt for consumer health. Which isn't something that I think we could ever ignore, because health is moving to the home, healthcare is moving to the home. And so it's something we had to do, but I didn't want to lose focus in our normal hospital business. Secondly, the other positive is that the management team, the employees, they're excited about the consumer health products that we're getting into.

We did not hear from them, "Hey, leave us alone. We just want to sell speakers and AVRs." On the contrary, they're excited about being part of Masimo, helping people live better lives. In addition, our focus on their business has put them in the segment where the market is growing, where they have a good reason to be there, which is the hearables, that has grown over 100% since a year ago. And last but not least, the launch of Stork into the stores. We wouldn't have known who to call, where to start, and hearing some of the stories we heard firsthand on how those were done, it would have taken us years to figure that stuff out. So, no, I more than ever believe in it.

There's some important products that have to get rolled out, like Freedom. Obviously, we're-- that was the, the biggest reason. The hearables was the second reason, and Stork, which was the third. So, please, please hang in there. I really think this is the right thing for Masimo. I really think it's the right thing for people and for even payers. It's going to help bend the cost curve of, hospital and patient care.

Micah Young (EVP and CFO)

Operator, next question, please.

Operator (participant)

All right. Your final question comes from the line of Jason Bedford with Raymond James. Jason, please go ahead.

Jayson Bedford (Managing Director and Senior Analyst in Medical Devices)

Good afternoon. Maybe just a few cleanup questions here. Just on sensor utilization, you've mentioned normalization post-COVID a few times during the script here. But it didn't seem like COVID was much of a factor last year. So why don't you think you experienced lower utilization in sensors last year?

Joe Kiani (Chairman and CEO)

Well, I think, first of all, there are certain provisions that went into effect with insurers that pushed patient care from the hospitals to surgery centers. Secondly, as our sales force was, I think, trying to react to a lower census that was occurring, they did certain volume orders that, by discounting our sensors to some large customers. So that, I think, helped continue our growth during that period. When I became aware of it, I stopped it because, we're a razor blade business, and providing discounts on sensors just did not make sense to me. From what I'm seeing out there, like everyone saw during COVID, we saw tremendous growth. We normally have grown $100 million a year.

During COVID, we grew $200 million, the first year of it. The next year, we still grew over $100 million, and, and now we're kinda catching up with that, bolus of growth, and, we're hopefully at a point where things should be as bad as it gets with, purchasing patterns of sensors. And because of our increase in, market share, we should see growth next year regardless.

Jayson Bedford (Managing Director and Senior Analyst in Medical Devices)

Okay. And you have pretty good visibility. You've mentioned market share a few times. You have pretty good visibility that these are competitive wins?

Joe Kiani (Chairman and CEO)

Absolutely. Our whole business for the last, since 1998, has been to target hospitals that don't have Masimo and fully convert them to Masimo. If you look at the graphs that Micah put out there today, you can see kinda where we were for the first nine months of the year, for the past several years. And we've seen incredible record growth in COVID 2020, 2021, 2022, and this year, it's more than ever. So it is definitely a market share gain, it's definitely competitive wins, and I can't remember when we lost a customer. So it's not like we're winning some or we're losing some. The numbers we're giving you is what we believe to be the normalized wins and losses in terms of new incremental business.

Jayson Bedford (Managing Director and Senior Analyst in Medical Devices)

Okay. Was there a contribution from Stork? And if not, maybe you can just kinda reframe the potential revenue contribution here.

Joe Kiani (Chairman and CEO)

I think it was minor, but yes, there was. Micah, do you wanna speak to that?

Micah Young (EVP and CFO)

Yeah. So, Jason, we launched Stork in late August. Sales today have been modest. We're continuing to build out the distribution of Stork with the expansion of retailers over the next year. I think we mentioned in prepared remarks that I think we're in 250 stores with Target. That's gonna expand significantly over the course of the next year. We're also in Best Buy and Amazon retail as well. So, sales today have been modest, but we're still excited about this product and believe it'll achieve great success, especially when we get the regulatory clearance and we're able to really differentiate this product in the marketplace.

Jayson Bedford (Managing Director and Senior Analyst in Medical Devices)

Okay. And then just maybe lastly, I may have missed it, but your thoughts on expanding the board?

Joe Kiani (Chairman and CEO)

Yeah. Actually, today, we did an 8-K. We're happy to announce that Mr. Ralph Lawson will be joining our board.

Jayson Bedford (Managing Director and Senior Analyst in Medical Devices)

Okay, so you've added one. Or, is it just one, or are you adding two?

Joe Kiani (Chairman and CEO)

Well, we're gonna add one, at least one more, but we're working through it. The nominating committee has changed. The chair of the nominating committee is new. We have new members, and they're vocal, and we're trying to, we're trying our best to manage a process in the midst of all of it, but we're eager to add more.

Jayson Bedford (Managing Director and Senior Analyst in Medical Devices)

Okay. Thank you.

Joe Kiani (Chairman and CEO)

Thank you very much. I think that was our last call. We appreciate your time and look forward to good days where we're back to, I think, meeting, beating, and raising. So thank you.

Operator (participant)

Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect.