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. [Operator Instructions]. I'm pleased to introduce Eli Kammerman, Masimo's Vice President 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.

Thank you, Eli. Good afternoon, and thank you for joining us for Masimo's Second Quarter 2023 Earnings Call. As we discussed 4 weeks ago, we are disappointed with the level of sales we achieved in the second quarter in both segments of our business and have reduced our revenue and earnings outlook for 2023. Micah will provide a detailed review of the quarter and our updated guidance shortly, but I want to share our view of prevailing trends in our key markets. How Masimo is doing in this environment and how we are responding to them. In health care, 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. The time we provided our guidance, we also had large new product orders in the pipeline that we hope would help us exceed our guidance. And 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 2 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 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, but now I will ask Micah to review our second quarter results in more detail and provide an update on our 2023 financial guidance.

Thank you, Joe, and good afternoon, everyone. For the second quarter, we achieved consolidated revenue of $455 million and non-GAAP earnings per share of $0.62. For our Healthcare segment, second quarter revenues were $281 million, reflecting a 21% decline. Please recall that our second quarter 2022 revenues benefited from the shift of approximately $25 million to $30 million of revenues from the first quarter of 2022 into the second quarter due to supply chain delays in the first quarter of 2022, making the year-over-year comparison more -- even more difficult. For the second quarter 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 is related to large orders that had been expected that have not closed yet. The remainder was attributable to lower 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 delayed purchases, and our OEM partners managed their order backlog and inventories. As of the end of the second quarter, we estimate that our installed base grew by 6% over our installed base at the end of the second quarter 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 expect to significantly reduce…

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 on 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 second quarter, and 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 and sales for the products are likely to be above our initial forecast formulated earlier in 2023. In addition, we received many inbound requests by new retailers to carry PerL. We are 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 1 percentage point to health care segment revenues with these products. We want our W1…

[Operator Instructions]. Your first question comes from the line of Matt Taylor with Jefferies.

So I wanted to ask kind of a 2-part questions related, but basically wanted to understand from you how transient these issues are? And you referenced in your prepared comments, the ability to get back to kind of your normalized growth rate in Healthcare in' 24. I guess I'm wondering if these comps are easy and some of the sales are getting pushed, do you think 2024 could actually be a stronger than normal year? Or why would it just go back to a normalized growth rate?

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 pressures hospitals have for inpatient care? Or is that what surgeons and patients prefer. If it's an anomaly, that would be another reason next year will be a better growth here than normal for us. But assuming it is not, we believe this is our baseline. And at least, if we get the normal couple of percentage increase in census beginning 2024 compared to 2019 then we should do well. And the final point I want to make is we have the bulk of pulse oximetry monitoring into ambulatory surgery centers, but they use reusable sensors and reusable sensors are unfortunate, even despite the best efforts to clean them in between surgeries carrying bacterias that are dangerous to patients. So we plan to make it more concerted efforts in educating the ambulatory surgery centers on the advantages to patients and maybe their businesses by using single-patient-use sensors.

Okay. Could I ask maybe just one follow-up. Just would want you to stretch ahead a little bit because normally, 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 second quarter and the downward revision on the guidance. Maybe help us understand the bridge, the different components, if you can estimate and how much was caused by Census versus OEM delays and orders? Just to give us a better picture of what's going on underneath the hood?

Sure, sure. We'll try. I'll give you a high level, then maybe Micah can get more granular. We came into 2023 with incredible momentum in all the over the normal new contracts that we had in 2022 and 2021. And 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 not 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. So some of the revenue shortfall was because of that. But probably the biggest factor was lower purchase of sensor by our customers that 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 because they push those pent-up procedures to outpatient setting but they ordered less from us. Census and inpatient went down. So we could have anticipated that. And I think one of the things that I had hoped because when you're doing these projections, you're always wondering, especially in a dynamic situation would come out of COVID. You wonder what do you have as a backup plan in case some of your assumptions don't pan out and for our backup plan, we had several large business that we anticipate at least one of them would close. And unfortunately, all of them got delayed, most of the things out of our control. I think one of them is due to fear of shakeup at Masimo because of the proxy war. But nonetheless, all of these factors that we had hoped would either help us flow our numbers out of the water like we'd like to but a minimum save us from maybe bad assumptions that we're making at the beginning did not materialize. And as 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. So I hope that helps. Micah, do you want to add anything to that?

Yes. I think, Matt, in the prepared remarks, 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. If you look at the -- your question was, can you break down the lower-than-expected sensor orders, it's very difficult from that standpoint. Just one, we -- number one, we came in the year expecting much higher-than-expected inpatient volumes stepping up well above pre-COVID levels. So we had some assumptions that were incorrect. But also, 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.

But Matt, one thing I just want to emphasize because 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. But what was kind of similar for me is here, we had, again, another record quarter in contracting with new hospitals and lack of any loss to our competitor. So here, we're growing, again, unfortunately, our revenues decline, unfortunately, it was a perfect storm, and I know it's probably an overuse terminology, but it really was 3, 4 factors came together and unfortunately blew out our revenue target, but the business is strong because we are gaining over the competition by much larger slope than usual.

Can I just add one thing, Joe. Matt, we are looking at monitoring closely the order competitor to customers. Over the first 4 weeks, we are seeing that improve. And that gives us more confidence in the new guidance range we have. We'd like to see them improve even further, but give us confidence in that guidance range we just put out today.

Your next question comes from Marie Thibault with BTIG.

I'm going to continue along the guidance path here and see if I could try to understand a little bit more about your margin expectations and also the cadence throughout the year for revenue. It does look like we're expecting 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. But if you can help us kind of figure out that cadence a little bit more, that would be helpful.

Micah, do you want to take that?

Yes. Yes, Marie. So I mentioned -- I walked through kind of how we're thinking about the guidance range and that lowering the guidance, we're assuming the inpatient admissions and capital sales trends kind of seen in the second quarter continue through the year with a modest improvement there. And then on the high end of the range, we're assuming that some of the large orders that we expected are going to be realized in the second half. And we've got a large portion of these orders more in Q4, on the mix there. So if you look at the kind of the forecast of Q3 and Q4, the large orders are contributing probably about 1% in that upper end of the range and those are assumed out further in Q4.

Okay. And 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?

Yes. So you'll see some of those come through in the third quarter. We're already taking action on those. And then you'll see a bigger impact as we move into Q4 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. So those have been pulled out to offset the lower revenues. So we've given you guidance on the third quarter, and then you have the full year, so you should be able to model right into the fourth -- what we're expecting for the fourth quarter.

Yes. Yes. Okay. Understood. And those cuts, the expense reductions will stay in place even if revenues rebound better than you're assuming at this point?

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 RSU grants, all that kind of stuff. So 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.

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

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 sort of next steps for corporate strategy, what might be next in terms of expanding the Board to 7 members? Any clarity you can give us on what's next here.

Yes. The Chairman of our Nominating Committee is working on that. Unfortunately, due to the loss of our prior Chairman of Nominee Committee, we are kind of starting a little bit from scratch. But yes, we're eager to expand the Board and hopefully get more thoughtful people around the table.

All right. Our next question comes from Rick Wise with Stifel.

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 fourth quarter, what you're assuming? And maybe just remind us if you're thinking about the opportunity even looking ahead to '24 and beyond what Stork could do if it all unfolds as you hope?

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 a breathing problem, but it's got a thermometer, 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 going to keep being added to it. So having shown that at one of the major baby conventions, many retailers and online retailers wanted it. And in fact, some of them have moved mountains to get under shells immediately. Normally, what would take a year, 1.5 years is happening in a matter of 2 to 3 months. One of our major retailers are very proud that we're going to bring on to Target. Target will be carrying Stork. So we are feeling that Stork could become a business that should be a couple of hundred million dollars a year. I know the potential might be $1 billion. But let's see. Let's see if -- once we get the $200 million, we could now plan for the rest. So the demand has been strong, 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 historic, I think it will happen. But a huge element, too, for how we want to market it in the U.S. because some of the things I just said to you, I can't say in the U.S. is getting to FDA clearance. Right now, in the U.S., we can't help parents, this can help the tech sits because of oxygen monitoring. We have to be careful how we raise things. We can't be open about all its capability. But once we get the FDA clearance, we can really go to time and really take the covers off.

Great. Micah, you talked about implementing expense control starting in the third quarter and you talked about some of the factors. But could you give us a little more in-depth perspective there, quantify a little bit what some of the biggest actions are? And how quickly we're going to see it in the second half, how significantly. And maybe the implications of some of these actions as a set up for '24 and beyond for gross margin and operating margins.

Yes, Rick. So some things I had mentioned were -- keep in mind, our performance comp was about $71 million out of $117 million for the reductions for this year. Some of that -- that's all tied into this year's performance comp. So as we perform, that was -- some of that would come back if we perform better and improve. And the other expense reduction, the $46 million is true cash expense reduction. So those should carry into next year. And the majority of that is 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.

Okay. And just sneaking in one last one, if I could. Just maybe any update on the litigation with Apple. And just any new perspectives or time lines you want to share at this point?

Yes, of course. We have 3 cases. 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 17. They pushed it out to October 10. We think hopefully that will stick. And assuming they go with the ALJ's 300-plus paged decision, we should get an injunction borrowing President Biden's ability to stop it, which he has 60 days to do so. They did not stop the Lifecore's injunction, so we don't expect those arms. On the trade secret and patent case in California, as you remember, the trade secret case, we unfortunately had a hung jury, and we just met with a judge. It looks like we will not go to trial until next year on that again, hopefully February, March time frame. And then on the Delaware case that Apple brought against us, they brought a patent against us, I think, 10 patents. And then we responded with patent case against them, I think, 10 patents, but we also had 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 speed to the fire. And that might go to trial next year, which will be unheard of. So that's where we're at.

Okay. Our next question comes from Jayson Bedford with Raymond James.

Maybe just a couple. Just getting back to the lower sensor sales, the $30-plus million in the quarter. Micah, you kind of alluded to it in answering your question, but I didn't hear much 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 you implemented any better processes here to gauge inventory levels going forward?

Yes. So Jayson, what I mentioned -- a little bit earlier, I touched on it, but it's difficult to identify inventory levels with our customers just because we don't have that visibility. But what we are watching very closely is customer order patterns. The first 4 weeks, so call it, July, those order patterns have improved substantially from Q2. So they're heading in the right direction. They're not where we want to be completely yet, but they do support that new guidance range that we just put out today. So that's how we're monitoring it closely. We're continuing to put some -- try to get more and more information as we can. But that's -- the focus right now is just to continue to monitor those new order patterns.

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

Well, discounting wide startup that we're still trying to understand that. But what I can tell you is deep we're not discounting at the time of contract, we were discounting post contract. And we -- once I became aware of it, I stopped it and the reason I stopped it is because the censor revenue is part of razorblade. It's part of the razor-razorblade strategy. And while we -- I have given 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, so we need to be disciplined on that. So I've asked it to be stopped. I've asked from hereon, if anyone ever want to discount our sensors, they have to get my approval. So that this hopefully won't ever happen again. But bottom line, it wasn't being done for a long time. We've done for a short time. They thought they were free to do it because they had been allowed to discount capital and sometimes cables and so anyway, that's what happened. And what's I think positive is that going forward, it should help our gross margins too because we're not offering these discounts anymore.

Okay. Okay. That's helpful. Maybe just last one here. Has your view of the market opportunity changed in any way here, meaning upon reflection after 2Q, is there a sense to, hey, maybe the market is more penetrated than we thought? Or does the opportunity still exist that you outlined back in December?

No, no. Like I said, it's really in the press. I think I put under is a tale of 2 realities. One reality is that our market penetration is increasing, our market share is increasing. I think there's a slide in your -- the power point presentation that was put out in time for their earnings call that shows that but unfortunately, the revenues decreased. I'll tell you, if there's one thing it may we believe is we have the right strategy and 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 patterns change, they went from inpatient to outpatient. And I know when we first put out our 3 announcement, people kind of disputed of that. I know a competitor disputed that. But it's showing that we were right, outpatient census did increase, and we said that, but inpatient reduced, went down, decreased and that hurts. So no, I think what we thought about the overall market and the overall future of Masimo is intact. I apologize. I regret that we missed our numbers in Q2, but it is not indicative of the health of our business.

Okay. Your next question comes from Mike Matson with Needham & Company.

So 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 third quarter EPS range and the midpoint of the annual EPS range, it's implying something like $1.39 of EPS in the fourth quarter, which is a pretty big sequential step-up as well as it's up year-over-year versus last year. So the third quarter number seems believable, but that seems like a pretty tough number of reach, I guess. So I don't know maybe you can explain like how you're going to kind of make that ramp?

Yes. So Mike, if you look at the cost actions we're taking, it's going to be more of a step up in the fourth quarter. Plus we're expecting stronger revenues in Q4 based on how we planned out the year and re-baseline our forecast. So the combination of the strength in revenues that we expect in Q4, some large -- some of these large orders coming in, in that guidance range as well as the expense reductions taking hold and having a full quarter of expense reductions is how we expect to get to that guidance.

Okay. All right. And then just wondering if there's any kind of second thoughts on the Sound United deal here just given what's happened. Look, 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 retail interest there. I'm not really convinced that you need billion-dollar speaker company to get that product in the some of the shelves at these retailers. For example, your competitor, [indiscernible] sold their products. They don't own a billion-dollar speaker company. So just wondering if you'd consider maybe exiting that business and focusing back on the Healthcare business?

Well, reasonable minds disagree, and Masimo has a lot of parents and I understand people have different views on things. When we bought Sound United, we said, "Hey, give us 3 years. If we haven't proven this thing is going to really do what we say it is, we'll get out of it." Not only that thought hasn't changed, everything today tells us it was the right move. And secondly, we have a thriving healthcare business that I did not want to take our eyes off of, I wanted to make sure the current management team runs that optimally. So we needed a new team to optimally run the consumer health. And the Sound United team has done a great job, all these contracts we have now for Stork, for PerL, that's all done by them. Again, well, maybe my team could have done that, but it may have distracted them from the Healthcare business. And lastly, the fact that we got in and we focused Sound United on the Hearables, which is about a $50 million to $85 million business, depending how far you go into it, whether you're just doing streaming music and voice call 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. So no, I'm sorry, you still feel like I should get rid of it, but we don't, we still think it was the right decision, and we're going to do our best to prove it. But we're not going to be foolish about, if we're wrong, we'll back out, but we're not done yet. Thank you. We have time for one more question.

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

Just two questions for me. So I guess on W1 and Stork, can you talk about the regulatory pathway for approval? And then I had a follow-up, please.

Yes, of course. The W1 is pulse-ox ECG and it's going through the normal channels 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, Opioid Halo or pulse oximetry and the healthcare side. We believe they are all under the 510(k) procedure, and we believe we're having great communication with FDA about it and hopefully, in the next 60 to 90 days, both of them will get clear. But we've been -- we've worked with the FDA successfully over now 3 decades and sometimes some products get cleared in 30 days and some products get cleared in a decade. So let's hope that those 2 are not going in that direction.

And then on my follow-up question, I heard your comments earlier about expanding the board from 5 to 7. But can you put a finer point around that sort of when do you expect to get the 2 -- the 2 additional board members in? Is it by end of the year or potentially earlier or later?

Sure. Sure. We're going to try to get them in as soon as possible. Thank you so much, everyone. Again, I hope from here on, we have the best quarter to report and that fundamentals of the business match the revenues from the business. We appreciate your time, and we'll talk to you hopefully in the quarter. Thank you.

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