Good afternoon, ladies and gentlemen, and welcome to Masimo's Fourth Quarter and Year-End 2019 Earnings Conference Call. The company's press release is available at www.masimo.com. [Operator Instructions]. I am pleased to introduce Eli Kammerman, Masimo's Vice President of Business Development and Investor Relations.

Thank you, and hello, everyone. Joining me today are Chairman and CEO, Joe Kiani; and Executive Vice President of Finance and Chief Financial Officer, Micah Young. This call will contain forward-looking statements, which reflect Masimo's current judgment, including certain of our expectations regarding fiscal 2020 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. 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 Fourth Quarter and 2019 Year-End Earnings Call. We achieved many important objectives in 2019, including another year of double-digit revenue and earnings growth. 2019 was a record-breaking year in nearly every category. And to our delight, we saw promising acceleration in the adoption of Patient SafetyNet in postsurgical wards, together with hospital wide adoption of SpHb in prestigious leading hospitals. Our ability to help our customers improve outcomes and significantly reduce overall cost of care has enabled us to achieve these records. Clinical studies have shown that only SET reduces ROP in neonatal intensive care units, reliably detects CCHD in newborns in maternal wards, and in combination with Patient SafetyNet, saves lives from opioid overdose while dramatically reducing ICU transfers and rapid response team activations in postsurgical wards. In addition, studies have shown that rainbow SpHb and PVI help clinicians reduce blood transfusions. And a recent landmark study in France showed SpHb and PVI decreased mortality by 30%. We are seeing hospitals actual experience with our SET and rainbow technology reinforce these objectives and independent clinical study findings. At the same time, our worldwide team continues to succeed in improving our operational efficiencies, while expanding our portfolio of life-saving products. We are happy to report fourth quarter and full year results that exceeded expectations and set the stage for a promising year ahead. For the fourth quarter, our product revenues increased 12% to $247 million, and our non-GAAP EPS grew 12% to reach $0.91 per share. And for the full year, we delivered nearly 14% constant currency product revenue growth and 22% non-GAAP EPS growth. I'll discuss more in the call today. Now, I'll ask Micah to review our Q4 and full year results in more detail and provide you with an overview of our 2020 financial guidance.

Thank you, Joe, and good afternoon, everyone. Before we get started, let me remind you that the financial measures I will be covering today will be primarily on a non-GAAP basis unless noted otherwise. Please refer to our website for today's earnings release, supplemental financial information and the quarterly earnings presentation, as well as the Form 8-K we filed with the SEC for further information regarding our non-GAAP financial measures and reconciliations. Throughout 2019, we saw steady growth in our business across multiple product segments and multiple geographies. In addition to another quarter of double-digit revenue growth, our fourth quarter results also included significant margin -- operating margin expansion and double-digit growth in our non-GAAP earnings per share. During the quarter, we shipped 61,400 noninvasive technology boards and monitors, which is consistent with our expectations of 60,000-plus drivers per quarter. For the fourth quarter, our product revenues were $247.4 million, reflecting growth of 11.8% or 12% growth on a constant currency basis. Please note that our product revenues for the quarter included approximately $3 million of monitoring equipment revenue recognized under ASC 842, which contributed roughly 1 percentage point to our revenue growth this quarter. Moving down the P&L. Our non-GAAP product gross margin for the fourth quarter increased 110 basis points to 67.5% compared to 66.4% in the prior year period. This improvement was primarily driven by favorable customer and product mix, increased manufacturing efficiencies, and other cost reduction activities we've implemented to improve margins. Our non-GAAP selling, general and administrative expenses as a percentage of product revenue decreased 90 basis points to 32.3% compared to 33 point -- 32.3% compared to 33.2% in the prior year quarter. And our non-GAAP research and development expenses as a percentage of product revenue increased 10 basis points to 9.5% compared to…

Thank you, Micah. At the beginning of this call, I mentioned the great record-breaking year we had and discussed some of the highlights. Further in 2019, we contracted the most incremental new business in our history, thanks in part to SpHb. Some of the significant new customers we can discuss from the fourth quarter of 2019 include Baptist Health in the U.S. and hospital Virgen de las Nieves in Spain. In addition, we won new business in Turkey and in Saudi Arabia from 3 new hospitals under construction. We also captured a significant renewal with MHH Hannover Hospital in Germany and renewed and expanded our contract with Seattle Children's Hospital. Our proprietary rainbow platform achieved full year revenue growth above our long-term growth goal of 10%. Also, 2019 was a record year for our U.S. business in terms of winning new customers for SpHb technology, which measures total hemoglobin continuously and noninvasively. This technology is being more broadly adopted by hospitals that see the clinical benefit and expense reduction from continuous hemoglobin monitoring. For 2019, our SedLine Brain Function Monitoring, NomoLine Capnography and gas monitoring and O3 organ oximetry monitoring grew well above our long-term growth goal of 20%. We're seeing strong adoption of these 3 technologies. In the fourth quarter, we also installed 5 more customers for our hospital automation systems, bringing our total customer installs to 13 since we launched this category of products in 2019. Our suite of innovative software applications for hospital automation, such as UniView and Replica, are being well received by potential users because they streamline workflow and contribute to better patient management. One of our strategic priorities is through hospital automation to reduce cognitive overload for physicians and reduce errors of omission. Through the high-veracity SET pulse oximetry and our unique noninvasive measurements,…

[Operator Instructions]. Your first question comes from Rick Wise from Stifel.

It's actually Drew on for Rick tonight. Just wanted to start on the long-range plan first. Just Masimo's consistently delivered towards the upper end of your LRP, and you have another year of high-end LRP growth on tap, excluding the acquisition. Just putting aside maybe some of the initiatives you have like hospital automation and opioid safety for a moment, just as you look at the business today, why shouldn't 10% plus be the new kind of growth baseline for Masimo going forward?

Yes. Drew, yes, as we think about our core business, without even layering in our initiatives for hospital automation or Massimo SafetyNet, we've been -- we have been delivering at the upper-end of that range or better. As we think about -- you've got a couple of years of how -- understanding how our guidance philosophy is, and we also don't -- it's a long-range plan, so we don't want to get ahead of ourselves. And we want to provide guidance that we're -- we have a high confidence in, both going into the year, but also over a multiyear plan. And we drive the business to a much higher growth rate number internally. But as far as how we prepare guidance and provide guidance, we want to be thoughtful and prudent about it and give guidance that we have a high confidence in achieving.

Got it. And then just touching on capital allocation for a moment. You just closed the recent acquisition. The balance sheet still remains very solid. How are you thinking about approaching capital allocation priorities in 2020? Could we see additional M&A? And just on M&A for a moment. Should we think potential deals could mirror the recent transaction that you just did, or maybe even something larger?

I think thinking about 2020, we see more things in our pipeline similar to the size and type of a deal you just saw with the NantHealth acquisition. We have a few things in the pipeline. I think they will be complementary and digestible. But we're also looking at things slightly bigger. I don't think it's a 2020 thing. It could be 2021. But it's early stages, so it's hard to tell what's going to happen to something like that. But yes, we're -- we think the best way to use our capital is currently towards M&A.

Got it. And then just with hospital automation, you mentioned the new -- the recent transaction should accelerate initiatives there. You have 13 -- it sounded like you have 13 in your pilot program now. So does that double in 2020? Just kind of what are your expectations for your hospital automation program in 2020?

One of the fun things preparing for this call was that I wasn't given a count. We have so much in our product pipeline, there wasn't an easy number to just quickly grab and give to me. But it's really strong. Both the new deals we've signed up that haven't been installed as well as the pipeline of business that our team is working on closing. We are really excited about the success we had in the first year and the reaction we get every day from people that come through and see the discovery lab where we showcased what hospital automation can do for hospitals.

Your next question comes from the line of Matt Taylor from UBS.

Just wanted to ask you, now that you have submitted the opioid product. Any difference in your thoughts about how that could develop this year? Do you feel -- still think it could be cash pay? Or is it possible you'd get reimbursement for it?

Matt, we think the same way. We think, number one, we're excited about what we submitted. We hope the FDA finds its adequate. We are -- through our data collection for the FDA, more confident about what this technology can do for people on opioids at home. As far as reimbursement, there's some discussion that breakthrough technologies may get reimbursement immediately, and then relooked at in 3 years, but we haven't seen that yet become concrete. So therefore, our first line of revenue expectation is from cash patients. And then second line, from some reimbursement for telepresence, telemonitoring reimbursement codes that were developed last year that we hope we can use. But the more specific reimbursement for our product, until something gets concrete, we have to assume it's going to take 2 to 3 years.

Got you. I was hoping you could just talk about how material these hospital automation contracts are, and could they grow?

Well, I believe they are material and that they are happening all around the world, from North America to Europe, Middle East, even Africa. And they are significant, in that hospitals are not just -- I mean, obviously, they're piloting in a way because they haven't done the entire system in most of these locations. But they're investing in it, and they expect to invest more heavily into it. And just about every other customer we've met with about it wants to do it. So we think this is going to become significant. Now we've not taken approach of a capital-based model. We've taken more of a SaaS model, which means you're not going to see bolus revenue. But hopefully, that you're going to see a stable, growing revenue base like we've built with our pulse oximetry technology.

Your next question comes from the line of Bill Quirk from Piper Sandler.

So I guess, first question is, I guess, anything, I appreciate that the situation in China may be -- at least there's some news that suggests that we may be settling down a little bit. But is there anything to worry about with respect to supply chain over there? And then conversely, given the products that you're providing, are you seeing any potential lift from that situation?

On the supply chain side, we do worry about it. However, we're not seeing any problems yet. Just in case there might become problems in the future, we're planning to build up more inventory from things we get from China. Fortunately, what we get from China is very limited, and it really is just our cables and enclosure for some of our monitors, the plastic. So -- which we've already made plans to do the plastic internally anyway here. But nonetheless, just to be safe, we are getting additional inventory. As far as revenue enhancements from what's happening there, we've not seen any. We know of some of our OEMs who have seen that, but we have not seen any yet. Our business is just the normal business we see in the flu season.

Okay, got it. And then secondly, a question for Micah. I appreciate the comments around the Connected Care and the slight dilution to '20 earnings. I appreciate you don't want to get too far ahead of ourselves here. But is there any way to think about the magnitude of the accretion in '21? Is this breakeven, Micah? Is this something that can help move the needle for the company? Just trying to get a rough idea of how we should think about that in our models.

Yes, Bill. So as we think about it, we look at -- we mentioned the 50 basis points of headwinds on operating margin, slightly dilutive on earnings per share. And that's in this year, year 1. But we believe that it's going to be neutral to positive as we move into 2021. So we will have an opportunity to drive some additional leverage there as we grow that business.

Your next question comes from Larry Keusch from Raymond James.

Joe, you mentioned SpHb multiple times in the prepared script. And so it certainly stood out that, that's gaining traction. Can you talk a little bit about what do you think is driving that? And can you give us some sense of growth? Because it -- again, it did from your comments, sounded like things are starting to pick up there.

Yes. Yes, they are. We are -- it's been 10 years, I think, maybe more since we launched hemoglobin, and it's great to see hospitals commit to it, especially those who've studied it nearly for 10 years as well as new ones that are looking at it. I think what's nice that we're seeing is hospitals are signing up for their operating rooms, recovery rooms and in ICUs to be fully equipped with SpHb and be used on practically every patient versus at the early days where they were buying a handful of devices and using it on patients they thought they might need it for. To why this phenomena is occurring now, I think part of it is the industry we're in. It takes about 10 to 15 years for adoption of a technology that's been proven earlier to make a clinical difference. And I think, secondly, it has to do with our -- some of the additional, maybe body of evidence that's come about. I mentioned earlier the study in France, where it was a pleasant surprise. We've seen -- we've heard reports of people using SpHb and saving lives because they caught bleeding that was hidden. But Limoges, who used it for 1 year on practically every patient, saw a 30% reduction in mortality 30 and 90 days after surgery. And then when they dis-installed or de-installed the technology because they didn't have budget to use it clinically for the future, the following year, mortality and morbidity -- mortality shot up back to where it was. And so I think that data that was published last year probably has had an impact. We're repeating that study at several additional hospitals to hopefully confirm its magnitude of results. But yes, I think it's just, finally, time is catching up, and people are beginning to see this is real and they need to use it.

Okay. Perfect. I guess, two other ones. First off, just coming back to hospital automation. Again, I caught from your comments that the installations have been a variety of the feature sets that you guys offer. But if you come back to the one, I think, in your local neck of the woods, that was the first installation, I think that was more comprehensive. Maybe you could talk about sort of the experience to date. It's probably approaching 6 months now, if not longer. So just that question. And then, I guess, for Micah, again, you indicated your confidence in the 30% operating margin over the long term. But again, I just want to sort of get a sense of, is that five years out? Or just any brackets around how we should be thinking about when you might achieve that 30% margin.

Sure. Let me deal with the first question. And I'll have Micah deal with your second question. The experience on the initial customers that have installed hospital automation has been excellent. In fact, they have agreed to be reference accounts and customers -- we just had customers here yesterday that are visiting some of these installations. So in -- so it's been so far, so good. Now we're, obviously, all over this because it's an important initiative for us, to make sure it stays good. And as we expand to more and more hospitals, the experience improves. And from the products that continue coming out of that group, it continues enhancing the product, making it more useful for the clinicians and more useful for the patients. So I have no doubt about -- that it'll continue delighting our customers.

Okay, great. Larry, the second question in terms of getting to 30% operating margins over our long-term plan. We still look at that as committing to 100 basis points per year. Of course, we had -- we had originally -- the existing business build up to about 120 basis points for 2020, and that was offset by the acquisition of the Connected Care business by about 50 basis points. So that puts us at 70-basis-point improvement this year. But as we think about marching towards that 30%, we still are committed to that 100 basis points of improvement per year. And we may see some tailwinds coming from the Connected Care business as we go into 2021. As I mentioned earlier on Bill's question that what was headwinds this year, should start to flip and become more of a tailwind as we move into 2021.

Your next question comes from the line of Mike Matson from Needham & Company.

I guess just back to hospital automation with these deals, can you maybe just walk us through how the revenue sort of works with that? Is there an upfront capital purchase and then subsequent service or subscription fees on an annual basis? Or is it all just kind of on the back end in terms of these fees?

Well, we give options to our customers so they can do a capital acquisition of it, or we provide them the SaaS model. So generally, obviously, the capital is an upfront more to the customer. But over time, the SaaS model ends up being more to us, more revenues for us, but we take an initial investment in getting that rolling. And what we charge for it, I don't want to say it because we have competitors. Although no one yet has told us there's a direct competitor to what we're doing. I can tell you, it seems like we're charging a very reasonable price because from low-resource countries to high-resource countries, no one has bought at what we were asking for.

Okay. That's helpful. And then just the Connected Care acquisition. Can you maybe just talk a little bit more about how that sort of fits with the hospital automation business? Is it giving you some products that you didn't have? Or is it getting you into some new accounts or goal?

Well, first of all, iSirona was the second largest Connected Care device out there. So in that sense, it's nice to have that business. Secondly, they have a device that's a stand-alone small device for connecting things, where we do are connecting to a route which, of course, has other features from monitoring to being a hub for UniView and so forth. So that in itself, for certain installations, it might make sense to have in the OR and the ICU, a root device, and other areas, maybe just the small hub device. But really, the biggest reason we found ourselves wanting to buy that business was the team that was there. We are scaling very rapidly with hospital automation. And frankly, we could have more customers if we could have more people to help us support those customers. So what we got from the iSirona NantHealth acquisition is a fantastic team of installation experts, sales and marketing people that can help us not only with their previous products, but our total product portfolio with hospital automation.

Okay. And then finally, Joe, I saw you were on CNBC kind of supporting these proposed HHS rules about giving patients increased access to their health data. Just from a business perspective to Masimo, what does that really mean? And does that create some kind of additional opportunities for new products and revenue for Masimo?

Well, first of all, for us all to benefit, and ultimately, the patients to benefit, we all have to do a little bit of data philanthropy. If we don't share data, then none of us can really create the type of decision support that could help patients. So yes and no. Yes, we think it will ultimately help us in -- especially with our hospital automation business. And yes, we may have been able to sell our data before, and now, we can't. But I think it's the right price to pay given that we are in the business of health care.

Your next question comes from the line of Ravi Misra from Berenberg Capital.

So just one on rainbow, and then another, maybe a couple on automation. Joe, also call me another -- in the line of someone who heard you speaking a little bit more confidently about the SpHb opportunity, I'm just curious, full year above your long-term growth prospects of about 10%, yet there's still kind of a level of guidance conservatism, I think, embedded in the questions we're all asking here about 2020. So help us maybe think about the pushes and pulls with rainbow, if that keeps going over 10%, kind of the rest of the business stays within those historical targets. What kind of upside are we looking at in the model on the top line? And then kind of related to that, are we looking at kind of the gross margin uptick as there's some mix shift over to that? And then I have one on the automation one after that.

Sure. Well, I've always wished for Christmas for a conservative CFO, and God gave me one. So you can thank him or blame him for the conservatism. It's appropriate, because, obviously, we do our best to forecast. And by nature, we're optimists, so -- but we want to make sure we deliver. As far as our confidence in the business and the upside, I think the same kind of upside you've seen before is probable. I think our confidence in SpHb, these revenues we gained in 2019 did not even reflect the contracts we've signed up for SpHb that I'm so happy about. You're going to start seeing them in 2020. And there's an acceleration of that. Now we just have to keep making sure our customers get what they expected because word of mouth is the most important factor in our business. So I'm -- as I said, I think in my prepared comments, I can't help but be optimistic about the future. And we hope to continue delivering beyond what we promised. So I think that's the last question -- is there a second?

Yes, there's one more.

One more, sorry.

Just one follow-up , if you don't mind.

Not at all.

The kind of -- the customer installed base. Up to 13 now, you said 3 in the fourth quarter. Can you just walk us through how long that process takes to onboard? Not only onboard when you sign up a hospital and then onboard them. And if I could just sneak one last one. That $3 million of monitoring revenue, Micah, that you mentioned. Is that related to these automation contracts? Or if you could just kind of define what's in that bucket, that'd be great.

Well, I can tell you that the installations were ahead of what we had expected for the year. And I said earlier, the pipeline of contracts that we signed for it is deep, and the number of customers that want to go on hospital automation is deeper. As far as your question about the $3 million, Micah, do you want to?

Yes. So Ravi, on the $3 million, that's really tied to any time that we provide equipment to customers on contracts that are long-term sensor-based contracts, under ASC 842 we could sell -- we have revenue that matches that equipment in terms of the cost. So that's really all that's changed this year, and it's caused us to recognize some revenue -- accelerate some revenue within the quarters. And that's why we kind of lay that out every quarter to investors so they can understand that you really strip that out to look at the core growth rate in the business. So for example, this year, this past year, growing 13.6% on a constant-currency basis in 2019, and you had about 1 percentage point of contribution from ASC 842. And that's really what that is. It's not necessarily tied directly to hospital automation. Hopefully, that answers your question.

[Indiscernible] in the past, the accounting rules were not to take the capitalized version, a portion of their revenue. And now, you have to. Now given in 2020, it's going to continue being that way, or we're going to still...

Now we'll have similar comps. So year-over-year comps, the ASC 842 revenues will be in both 2019 as well as we report going forward. And right now, just so you know, we're expecting that revenue to be relatively flat year-over-year or a slight growth out of that revenue. But it should be consistent.

And given that the comps are now the same, going forward, we may or may not even call them out. But we call them out in 2019 because it was a new standard in 2019 compared to the prior years. I think we have time for one more question.

And your next question comes from the line of Marie Thibault from BTIG.

Great. Thanks for sneaking me in here. I appreciate it. In the fourth quarter, you shipped -- you shipped 61,400 boards and monitors. And I know that last year, you set out the goal of at least 60,000 or more shipments each quarter. Do you have a goal that you'd like to set out for 2020? And along the same lines, should we continue to see that trend of higher ASPs with those shipments due to the popularity of your advanced parameters?

Yes, yes and yes. So yes, thank you for that question. We believe any quarter for 2020 that we do 60,000 more -- boards or more is a good quarter, so that's what we're forecasting. And yes, we expect the ASPs though to continue increasing per socket because of the rainbow parameters from the 4 LED sensor that does ORI and RPVi, to the 8 and 10 LEDs that do hemoglobin and CO; and SedLine, Nomoline and O3 that are higher ASP products.

Joe, can I just add one thing? Marie, one thing to add there when we think about our installed base as well, our installed base has been growing this past -- in 2019, roughly 8%. And that's up about 2% from a few years ago. And then our revenue per driver is contributing growth that we're seeing in the business in 2019 of about 4% to 5%, which is -- gets you into that 12% to 13% growth we saw last year. So that used to be around 3% to 4% before. So it's -- we're continuing to see more and more revenue per driver as we move towards those advanced premium-based sensors. And that's why we're seeing that step-up in the growth rates. We're continuing to drive growth through those advanced parameters and rainbow sensors.

That's great to see. That's great to see. And if I could, I'm surprised it wasn't asked yet. On the flu season, we're seeing kind of a second peak, a double hump to the season. I'd love to hear any color you have so far on how that's looking this year.

Yes, I've often said we should be the ones disclosing the -- how the flu is going because we did one-for-one almost with the sensor volume. Yes, it has been a bad flu season. And yes, the sensor volumes are tracking higher than normal. So we'll see that impact in Q1, which we'll be announcing for April, April time frame. Thank you so much. Thank you all for joining us. We look forward to our next call.

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