Masimo Corp

NASDAQ:MASI

Earnings Call Analysis

Masimo Q2 Growth Spurs Increased Revenue and Earnings Outlook

Masimo reported a 23% year-over-year increase in health care revenues for Q2 2024, driven by strong hospital conversions and rising sensor demand. The company achieved a gross margin of 62.5% in health care, benefiting from cost reductions and operational efficiencies. New contracts added $134 million in value, boosting confidence for sustained growth. Masimo updated its 2024 guidance, projecting consolidated Q3 revenues of $495-515 million and non-GAAP EPS of $0.81-$0.86. Full-year guidance was raised to $2.085-$2.135 billion in revenue and $3.80-$4 per share in earnings, reflecting the robust performance and strategic focus on high-margin products. The company also plans to separate its consumer business to enhance shareholder value.

Steady Healthcare Growth Amidst Challenges

Masimo's second quarter for 2024 showed a strong performance in its healthcare segment with revenues of $344 million, marking a 23% increase compared to the previous year. The company's consumables and service revenues experienced a 29% growth, while its capital and other revenues dipped by 9%. Notably, SET pulse oximetry consumables and capnography consumables both saw growths of 35%. However, there was a slight decline in rainbow consumables by 5%, which was attributed to timing issues in shipments outside the United States.

Non-Healthcare Segment Faces Headwinds

In contrast, Masimo's non-healthcare revenues were $152 million, an 11% decline year-over-year, closely aligning with the lower end of guidance. This segment's performance has been negatively affected by a sluggish luxury consumer market and a weak housing market, influencing both product installations and upgrades. Despite this, Masimo maintains a stable gross margin of 54% across the company with higher margins in healthcare at 62.5% compared to 35% in non-healthcare.

Strategic Moves for Long-term Goals

To improve long-term operating margins to 30%, Masimo has made strategic decisions such as relocating sensor manufacturing to Malaysia, resulting in healthcare gross margins improving by 240 basis points year-over-year. This move, along with ongoing cost reduction initiatives, aims to stabilize and grow profits. Presently, the consolidated non-GAAP operating profit stands at $73 million for Q2, with a 15% operating margin, slightly lower year-over-year due to normalized performance-based compensation in 2024.

Guidance and Future Projections

For the full year of 2024, Masimo projects consolidated revenues between $2.085 billion and $2.135 billion, with healthcare pulling in $1.385 billion to $1.405 billion, marking 9% to 10% growth. Non-GAAP EPS is expected to rise to a range of $3.80 to $4, reflecting substantial year-to-date progress. Q3 projections include consolidated revenues of $495 million to $515 million and non-GAAP EPS between $0.81 and $0.86. The healthcare segment alone is projected to generate $335 million to $345 million in revenue for Q3.

Plans for Business Separation

Masimo contemplates separating its consumer business from its healthcare operations. This strategic split aims to enhance shareholder value by allowing clearer market valuation of its thriving healthcare sector, which has been overshadowed by weaker consumer sales. They are considering various options, including joint ventures (JVs), outright sales, or spin-offs. The potential separation could improve non-GAAP operating margins by 610 basis points to 21% for healthcare or by 260 basis points to 24% if combined with Consumer Health, aligning with Masimo's goal of achieving a 30% operating margin.

Operational Efficiencies and Debt Management

Masimo remains committed to rigorous operational efficiency and managing debt. A $75 million operating cash flow in Q2 improved working capital and enabled a debt pay-down of $93 million, reducing total debt to $782 million. With the anticipated cash proceeds from any consumer business transactions, the company aims to further reduce debt, potentially retiring it within the next 3 to 4 years.

Outlook and Focus Areas

Looking forward, Masimo is optimistic about further growth in its healthcare segment, driven by strong hospital conversions, enhanced sales, and backlog fulfillment. They highlight an aggressive push towards innovation, cost reduction, and healthcare product penetration into new markets. Additionally, they aim to mitigate economic and market headwinds affecting their non-healthcare sales, particularly in their luxury consumer products.

Earnings Call Transcript 2024-Q2

[Operator]

Good afternoon, ladies and gentlemen, and welcome to Masimo's Second Quarter 2021 Earnings Conference Call. The company's press release is available at www.masimo.com. [Operator Instructions] After the speakers' 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, executive]

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 2024 and 2025 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.

This call will also include a discussion of the potential separation of our consumer business and a preliminary estimate of the financial impact of a potential separation. However, the estimate is being provided solely for illustrative and informational purposes. The company is currently evaluating the structure of any potential separation of its consumer business and the method, structure, timing and terms of any such potential separation are still under consideration and have not been determined, approved or finalized.

Please refer to Slides 2 and 3 of our earnings presentation for additional factors to consider in evaluating and reviewing the information relating to the potential separation of our consumer business.

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. 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, executive]

Thanks, Eli. Good afternoon, and thank you for joining us for Masimo's Second Quarter 2024 Earnings Call. I'm happy to report that our health care revenues rose sequentially and grew 23% versus last year. Our health care business is seeing increasing momentum driven by excellent execution by our health care team and our robust hospital census.

We saw strong demand for Masimo sensors due to the combination of strong hospital conversions over the past few years, normalization of installations and, after a tumultuous post-COVID environment, rising hospital admissions.

Our sales team once again secured a record level of new hospital conversion contracts amounting to $134 million in true incremental value for the quarter, representing a 28% increase versus last year. Not too long ago, we contracted $130 million of TI in the entire year. We believe our exceptional hospital conversion contracts point to a very bright multiyear future.

Another standout item for the quarter was a substantial increase in gross margins. We committed to investors that this would be a key area of focus for us and the team is delivering. Our health care business continues to benefit from initiatives to reduce product costs, including the recent relocation of most of our sensor manufacturing to Malaysia, which continues to be executed extremely well and ahead of schedule.

In addition, we have an engineering team that focuses each year on product updates that reduce our cost of goods and increase margins. We have filled this team with some highly skilled talent and the benefits are currently flowing through the P&L.

The combination of strong conversions, new equipment installations and increasing hospital census gives us the confidence to significantly increase our full year guidance for health care revenues and earnings.

I'm particularly proud of how well our global organization is performing. We remain committed to separating our consumer business. As previously announced on July 8, we received preliminary terms from a potential JV partner, and we have extended exclusivity until August 15 to accommodate their needs. We believe this option could offer shareholders the best outcome, but the completion of the transaction is not entirely in our control.

In addition to the potential JV, we are considering all strategic options, including the sale of or spin-off of the audio business, either alone or together with the consumer health business. We will act decisively to execute on the option that best maximizes value for shareholders and puts us on the path to achieve our long-term goal of $8 earning per share, which would effectively double our EPS in 5 years.

With that, I'll pass it over to Micah to review our second quarter results in more detail and provide an update on our 2024 outlook.

[Micah Young, executive]

Thank you, Joe, and good afternoon, everyone. For the second quarter, our health care revenues were $344 million, which were above the top end of our guidance range and represented 23% growth versus last year.

Our consumables and service revenues grew 29%, partially offset by an expected decline of 9% in capital and other revenues. Within consumable and service revenues, our SET pulse oximetry consumables grew 35%. Capnography consumables grew 35%, and brain monitoring consumables grew 19%.

Partially offsetting this growth, rainbow consumable revenues declined 5% due to the timing of shipments outside the U.S. We expect rainbow consumable revenues to reach our double-digit growth target for the full year based on continued growth outside the U.S. and adoption of rainbow sensors in the U.S. following the FDA clearance of Oxygen Reserve Index late last year.

Our ongoing focus on expanding our footprint with existing customers and winning new customers has built a solid foundation for growth in the second half of 2024 and beyond.

As shown in our slides today, the incremental value of new contracts was $134 million this quarter, increasing 28% versus last year and rising 34% sequentially. This clearly demonstrates Masimo's strong market share gains through contracting with our hospital customers and has contributed to a 16% increase in unrecognized contract revenues, which have reached $1.6 billion as of the end of the second quarter. You'll be able to see the benefits from these new contracts and our revenue growth as the equipment is installed over the next 6 to 9 months.

On a related note, driver shipments for the second quarter were 59,000 and were above our expectations. We believe that driver shipments will steadily rise over the remainder of the year and are being fueled by the excellent level of conversions that our team is achieving.

Non-health care revenues were $152 million, which was at the low end of our guidance range and represented an 11% decline versus the prior year. This business continues to be affected by the weakening environment for luxury consumer purchases as well as slowness in the housing market, which affects product installations and upgrades.

Now moving down the P&L. For the second quarter, our consolidated non-GAAP gross margin was 54%, which included gross margins of 62.5% for health care and 35% for non-health care. Health care gross margins improved 240 basis points year-over-year and rose 20 basis points sequentially, which is attributable to the relocation of sensor manufacturing to Malaysia, combined with increased operational efficiencies and a favorable mix benefit from higher consumable sales.

Our progress on this front gives us confidence in achieving our long-term goal of 30% operating margins for the health care business in 5 years.

For our consolidated business, non-GAAP operating profit was $73 million. Our operating margin of 15% improved sequentially from the first quarter, but declined modestly versus last year due to the return of performance-based compensation to normalized levels in 2024.

Excluding the impact of performance-based compensation, our operating expenses decreased 4% versus the prior year period due to cost reduction initiatives. Even with the return of performance-based compensation, we delivered 13% earnings growth to achieve non-GAAP earnings per share of $0.86 for the second quarter.

Moving to cash flow. We generated operating cash flow of $75 million due to strong earnings and working capital improvements. As a result, we were able to pay down $93 million of debt in the second quarter, bringing our outstanding debt to $782 million.

Increasing cash flow and reducing debt are key priorities for the organization, and we are succeeding with both objectives.

Now I'd like to provide an update on our 2024 financial guidance. For the third quarter of 2024, we are projecting consolidated revenue of $495 million to $515 million and non-GAAP earnings per share of $0.81 to $0.86, representing 8% to 15% earnings growth.

For the Health care segment, we are projecting revenue of $335 million to $345 million, representing 9% to 12% revenue growth. Robust hospital census, along with our record-breaking hospital conversions, new equipment installations and strong sales order backlog increases our confidence in achieving a growth rate that exceeds the 9% revenue growth we saw in the first half of the year.

For the non-health care segment, we are projecting revenues of $160 million to $170 million.

Now turning to our full year 2024 financial guidance. We are now projecting a consolidated revenue range of $2.085 billion to $2.135 billion. For our Health care segment, we are now projecting revenues of $1.385 billion to $1.405 billion, representing 9% to 10% revenue growth for the year and an increase of $25 million at the midpoint versus the prior guidance range.

With regard to driver shipments, we expect to see shipments increase to more than 60,000 in both the third and fourth quarters, representing a sequential step-up from the first half levels.

For the non-health care segment, we are now projecting revenues of $700 million to $730 million, which represents a decrease of $25 million at the midpoint versus the prior guidance range.

For the full year, we are now projecting consolidated non-GAAP gross margin of 53%, which includes health care gross margins of 62.5% and non-health care gross margins of 34%.

Finally, we are now projecting non-GAAP EPS range of $3.80 to $4 per share, which represents an increase of $0.28 at the midpoint versus the prior guidance range, demonstrating our year-to-date progress and our strong commitment to increasing operating leverage and driving sustainable earnings growth.

In summary, our health care business is solidly back on its expected growth track, and we foresee the potential for even faster growth combined with expanding margins over the remainder of the year.

Our hospital conversions have grown substantially over the past 12 months, and those contracts can drive higher sensor volumes for the next 5 years.

Now I'd like to provide you with an update on the progress we are making on the separation of our consumer business from our health care business. While we continue to see long-term potential for the consumer business, we believe that separating into 2 stand-alone businesses will maximize returns for Masimo shareholders and ensure the market can recognize the full value of our thriving health care business.

As Joe mentioned, while the JV offers a uniquely attractive solution for separating the consumer businesses while retaining some upside, the Board is considering all options to separate the consumer audio business regardless of the outcome of the JV negotiations. We are committed to executing on a full de-consolidation of the consumer audio business from our financial statements.

Our thriving health care business is being obscured by the weaker consumer market and increases our desire to separate the 2 businesses. We are committed to this goal, whether it is through the JV, a sell, or a spin-off of audio alone or audio combined with consumer health. Our decisions on the structure that any separation will be predicated on providing maximum value to our shareholders.

To that end, we've provided a preliminary estimate of the financial impact of 2 different alternatives for a separation on Slide 9 of our earnings presentation. Notably, assuming an outright sale of just the consumer audio business is completed as outlined, we estimate that Masimo's non-GAAP operating margins would improve by 610 basis points to reach 21%.

Alternatively, if the audio business is divested in combination with the Consumer Health business as contemplated in the proposed JV, we estimate that Masimo's non-GAAP operating margins would further improve by 260 basis points to reach 24%. This structure would result in significant progress towards achieving our long-term goal of 30% operating margins for the healthcare business.

If a transaction results in cash proceeds to Masimo, we plan to use those proceeds to pay down debt and reduce interest expense, which currently amounts to $40 million in our guidance this year.

Either way, with our strong cash flow, we expect to retire our debt within 3 to 4 years. With that, I'll turn the call back to Joe.

[Joe Kiani, executive]

Thank you, Micah. Before we go to Q&A, I want to thank our team for their unrelenting effort and consistent focus through a disruptive time that is unprecedented. Our last few quarters clearly demonstrate that the post-COVID disruptions are behind us, and we are back on track to meet or exceed expectations.

Our main objective continues to be driving our revenue growth towards double digits by providing our customers with clinically relevant innovations and achieving or exceeding 30% operating margins. We see a clear pathway to reach that margin target within the next 5 years and expect the planned business separation to have an immediate positive impact on the profitability of our professional health care business once finalized.

Our future is brighter than ever as we execute our mission to improve lives, improve patient outcomes and reduce cost of care and taking noninvasive monitoring to new sites and applications.

With that, we'll open the call to questions. Operator?

[Operator]

[Operator Instructions]

Our first question comes from Jason Bednar.

[Jason Bednar, analyst]

Nice quarter here. Joe or Micah, feel free to respond here. But the core business performance appears to improve quite a bit. We're seeing in the driver numbers. We're seeing the productivity and installed base and see in the gross margin of the health care franchise. So look, there's understandably a little skepticism from investors out there regarding maybe a repeat of what we saw last year ahead of the shareholder vote. So really just hoping you could comment on maybe what's different this time around? What kind of visibility are you going to offer to lend confidence to the investment community that the underlying improvements are sustainable into the back half of the year and that there wasn't any pull forward of revenue or margin contribution?

[Joe Kiani, executive]

Well, maybe I'll start off high level, Jason. First of all, as you've seen from some of the public hospitals that have reported, the census is very strong. I think HCA and Tennant reported 5% increase. And our business is driven a lot by the consumables, which is driven by hospital admissions, in-hospital admissions. So that's one.

The second to address directly what you're saying, we have not had this level of backlog for many, many quarters. The backlog going into Q3 is extremely strong. And that's one of the reasons besides the census and the successful conversions of hospitals to Masimo at a really rapid rate has made us feel comfortable in updating our guidance and giving such a strong guidance for the rest of the year.

[Jason Bednar, analyst]

All right. Very helpful. And I just want to double check because I know -- and there's already questions that -- that have surfaced since the preannouncement, but that's super helpful, Joe.

And then I wanted to come back to some of the comments you made. And just maybe help us with the JV situation, the JV partner situation. You referenced the August 15 exclusivity period that you've extended it to this partner. I think that was in the 8-K that that you provided a month ago.

But you also mentioned that things are outside your control. I'm not sure if you're suggesting that's in the control of the JV partner or if the agreement that you have is interrelated with the upcoming shareholder vote. I'm curious if other players may have entered the discussion with that original JV partner or if you've received other definitive inbound interest beyond what was originally outlined.

So really just trying to get a sense of where things stand, if you can give us an update on whether or not we should expect anything ahead of the AGM or after the AGM.

[Joe Kiani, executive]

Well, first of all, given some of the innuendos and comments that were thrown out, we made it clear that we will not do any JV unless the activist board member agreed to it.

Secondly, when we mentioned it's not in our control, it's because unlike a sale or a spin, this requires a JV partner to also do what they say they're going to do. And as you know, they had -- we reported this before, is they wanted to get 1 or 2 other more partners in the JV -- so that's, I think, one of the reasons they asked us to give them to August 15. That's what they're currently working on. And we should know soon what they're going to do, and we will report to you what they're going to do.

But I think Micah and I wanted to reiterate, regardless of what the JV partner does because -- or doesn't do, we still think the JV proposal was the best proposal compared to the other options. But if those -- if that option doesn't come true, we still will do a separation, and nothing is off the table, whether it's just separating the audio business or separating the audio and the consumer health business. We'll do whatever we believe is best for shareholders.

[Jason Bednar, analyst]

Okay. And maybe just a quick follow-up, Joe, should we expect like a, I guess, a more definitive path forward than after we hear what that JV partner decides as of August 15? Or do we need to sit tight until after the shareholder vote to maybe have a better clarity on what that looks like?

[Joe Kiani, executive]

As soon as we have something that we can do, we will take it to the Board, assuming we have that. If the Board approved it unanimously, then we can get it done. I don't think it needs to wait for the shareholder meeting.

But clearly, it has to be unanimous bought by the Board, which hopefully, it should mean everyone is happy with it. But if we don't get a unanimous vote, then we're not going to do it, regardless of whether it's before or after the shareholder meeting.

[Operator]

Our next question comes from Marie Thibault.

[Marie Thibault, analyst]

I wanted to ask a straightforward one here on the Q3 guide. If I think back to Masimo Healthcare pre-COVID, I'm very used to Q2 and Q3 revenue being very similar, the health care revenue being very similar and often quite flat sequentially between Q2 and Q3. Just curious if there's anything to think about when we look at the Q3 guide. The midpoint's just $5 million or so below what you achieved in Q2? And how to think about maybe the puts and takes on that guide?

[Micah Young, executive]

Yes. Thanks, Marie. So the way we're thinking about that is we are seeing, of course, strong contracting. Installations seems to start to normalize now. We're not seeing the length of the delays that we've seen in the past. So that's helping us to -- more to the positive as we look into Q3 and Q4, and that strength should come through revenues.

We are also being mindful, though, of census. We saw a very strong census in Q2. I think it was reported out by some of the large public companies, as Joe mentioned, 5% in patient growth in Q2. I think that was following 4% growth in Q1. So we're also being cautious there in terms of the -- how we think about that.

So -- and I think a lot of those public hospitals are also guiding to a full year growth of around 3% to 4%. So they're being cautiously, I guess, cautiously optimistic in the back half of the year as well. So strength from contracting installations.

And if you really look at the business historically, our health care revenues have had years where they've kicked down in Q2 to Q3. And that -- if you go back pre-COVID, and kind of look at the 3 years leading up to 2019, we averaged a step down from Q1 or Q2 to Q3, a slight step down there. So that's why we put at the midpoint, $345 million of revenue -- or sorry, $340 million of revenue. On the high end is $345 million, which would keep it flat to Q2. Okay.

[Marie Thibault, analyst]

That's really helpful, Micah. And then maybe my follow-up, I heard a quick mention of it. Oxygen Reserve Index, that's one of the newer products in health care that should come with a revenue uplift. And I know a standard of care in some countries where it's been available for a few years. So can you tell us how that's doing in the U.S., what the early feedback is on that? And are you indeed seeing any revenue tailwinds from that?

[Joe Kiani, executive]

Thanks, Marie. Yes. That's gone really well. We are seeing an uptick in the U.S. with the adoption of rainbow. I think the combination of Oxygen Reserve Index, as well as now offering the cardiac output with rainbow that gets us measurement of oxygen delivery. I think it's helping our rainbow business tremendously. We should see great results in the second half. And that's why I believe Micah mentioned we expect for the year to grow double digits and rainbow, not just based on OUS but U.S. conversions.

[Operator]

Next question comes from Rick Wise.

[Frederick Wise, analyst]

I was hoping maybe first talk you could talk a little bit more about the implied rest of your consumer outlook. Obviously, you're going through the separation. But just help me better understand, obviously, yesterday, there was a lot of concern about a softening or more softening of the economic environment. I think if I'm doing it correctly, the guidance is implying sequential consumer sales improvement in the second half. Help us understand your thoughts or your optimism on your confidence that consumer sales will, in fact, increase sequentially as the year unfolds?

[Joe Kiani, executive]

Sure, Rick. The growth this year should come from our hearables. These are the over-the-air headphones and inner ear earbuds, like the Bowers and Wilkins headphones and earbuds and the Denon PerLs. So we -- as you remember, last year grew about 100% compared to year before that business, and we expect to see strong growth this year as well.

But those products are typically shipped in Q4. It's kind of a holiday gift, Christmas thing. So we expect a very strong Q4. And even though we think the high-end audio -- both the speakers and the AVRs -- may be continuing to be muted because of the economic pressures, we think the earbuds and headphone business will grow, and that's why we're optimistic about the second half of the year.

[Frederick Wise, analyst]

And Micah, maybe you could -- or Joe -- could expand on your comments about 2 things related to gross margins and therefore, operating margins. You said that Malaysia is ahead of schedule going well. And if I'm remembering correctly, last quarter, you said it was 2/3 of the way through that sensor manufacturing transition. In those 3 months, where does it stand today? When is it going to be done? How are you thinking? What are you baking into the guidance?

And maybe just separately, but related what's -- you talked about some of the cost reduction initiatives. Maybe you can help us better understand what those are. And again, your confidence in the second half outlook based on the programs that are clearly helping out so far.

[Micah Young, executive]

Absolutely. Thank you, Rick. Well, just to kind of step back and provide some context. We came into the year and I believe our guidance for health care was 61.9% gross margins. We took that up about, I believe, 60 basis points -- 50 to 60 basis points last guide, where we're taking up another 10 basis points for the year to get to 62.5% for the year. So we're seeing good traction so far.

Last quarter, we were about 2/3 of the way there with Malaysia manufacturing. Keep in mind that a lot of that early on is more of the high-volume runners that we're getting up and running first with sensors. The next phase that we're working through now between now and the end of the year is going to be some of the lower volume parts and more complex parts. So it will take a little time, but we plan to be there by the fourth quarter as we exit this year.

We're already seeing good efficiencies coming out of Malaysia in that workforce. They're doing an incredible job so far. That's starting to roll through the P&L. We should start to see an uptick in margins -- gross margins in Q4. We're expecting gross margins to be relatively flat to Q3 from the first half, but then stepping up closer to 63% in the fourth quarter. So progressing well there.

We also have our team that's dedicated on cost reductions to your second point of your question. The engineers continuously look to take costs out each and every year. It's where we've historically gained good margin expansion and trying to fight the offset of the inflationary cost that we've seen over the years.

But I think we're seeing that progress very well. They're taking costs out of anything from our technology boards, our cables that attach -- to bring the attachment to the sensors. Also, we're seeing mix benefits from some of the prior cost reduction efforts that they did to reduce the cost of sensors from moving from links to RD. And I think we're close -- we're probably over 50% now with the lower-cost sensor now with its higher margins. So that's progressing well.

And we're continuously trying to take costs out of our Masimo-branded equipment as well and some of the advanced parameter lines like NomoLine.

[Frederick Wise, analyst]

And if I could ask a quick follow-up, I apologize. You expect a lot of confidence in your 30% operating margin goal. Just in the simplest of terms, Micah, is this sales driven, mix driven? What are the -- why are you confident that that's the right goal and that you have the tools in the hand to make it happen?

[Micah Young, executive]

Yes. I think what's given me a lot of confidence is we do believe that we can get back up. I mean we're -- we're assuming just to get to 30%, that gross margins get back to 66%. We've been as high as 67% and maybe even 68% before a lot of the inflationary costs that sprung from COVID -- the COVID years, with -- over the past 4 or 5 years, we've had a lot of inflationary cost increases in labor costs down in Mexico.

And now that we're moving that manufacturing to Malaysia, that's going to give us good benefits not only on the labor cost reduction, but also improving efficiencies as we're seeing a much more stable workforce and lower turnover.

We've had a lot of currency headwinds with the peso, although it's head in the right direction again, finally, but much more stable currency situation there with Malaysia, as well. So that's giving us more confidence on top of all the cost reduction initiatives we've laid out.

And we've -- the team is aggressively pursuing those product cost reductions that I just mentioned.

The other thing to your question on revenue, revenue leverage is very important. I mean to grow, let's say, 7% to 10% is what we're really going after to deliver that $8 EPS and doubling EPS in the next 5 years. Revenue leverage is important that the innovation of this company is critical to drive -- continue to drive revenue growth. And we also are set up well with the contracting we're doing over the next several years.

So I think that's going to give us the leverage to leverage those fixed costs and gross margin, leverage our installed base and then -- and also leverage a lot of our fixed SG&A costs for the company as well in R&D.

So when we look out 5 years at 30%, our performance this year, seeing the growth on the top line and where the strength of the business is, we're getting a lot more confident towards achieving that 30% margin goal and $8 earnings per share.

[Operator]

Our next question comes from Michael Polark.

[Michael Polark, analyst]

The health care driver base in the deck, I'm seeing the installed base is up 2% year-on-year. I'm also hearing about record contracting and a tick-up in installation activity. Is it fair to say is that as new accounts get onboarded and you expect that 2% growth rate to reaccelerate here over the next year?

[Micah Young, executive]

Yes. I think we're going to see continued step-up in driver shipments throughout the rest of this year, especially as we exit going into next year. I'd expect next year is going to be a strong year for driver shipments as we step up on the exit.

The other thing is we only need we're replacing a lot of the existing drivers in our installed base today. We've got about 2.6 million drivers that are out there. A lot of the shipments we're doing, half of those are replacing existing drivers because we've gotten to a significant market share already within pulse oximetry. So we really only need 50% of that kind of 60,000-plus run rate to be new drivers going out in the field, and that's what we're seeing.

And that's why we're starting to see it step back up because of the contracting we're doing. But our consumable revenue per driver is going to continue to expand. We're seeing this year, on a year-to-date basis, consumable revenue per driver is up 11%, 11% to 12%. Our installed base is up 2%. We're delivering about 14% growth on consumable revenue in the first half of the year. So that's coming off -- that's the strong contracting installations and just the momentum that we're seeing in the business.

[Michael Polark, analyst]

If I can ask a follow-up on this. Let's say, your goal, core health care is to grow 10% round numbers. At this level of scale and kind of market share, what would you hope is the mix between kind of growth in the driver base versus growth in revenue per driver to get to 10%, say, next year or beyond?

[Micah Young, executive]

Yes. I think of it being somewhere around probably 4% to 5% maybe on driver or installed base growth and the other, call it, 3% to 5% coming from our consumable revenue per driver.

[Michael Polark, analyst]

Yes. Okay. If I can ask then the last one on Apple. Could we just get an update on the Apple litigation, where it stands, what milestones might be upcoming?

[Joe Kiani, executive]

Certainly. We have probably 2 or 3 trials left. There is a litigation we brought against them in the federal court for patent theft and trade secret theft, and those 2, we were hoping to have them being 1, but it might get broken in 2 pieces.

Right now, we're looking at a schedule in November to have the trade secret trial and then later the patent trial. I'm still hoping they'll get combined. We'll see.

Then Apple brought a litigation against us in Delaware. And that first part of it should go to trial late October. And then our part, where we brought patent and antitrust case against them, that should go to trial hopefully next year.

If we win our trade secret and patent case that's remaining even in federal court here in California, we should be able to broaden our injunction, not just limited SPO2 to photoplethysmography, which will include pulse rate and other related parameters to photoplethysmography, as well as, hopefully, with the trade secret lawsuit broadened injunction beyond the U.S. So that's where we're at.

There is some activity at customs and border where Apple has gone back to try to basically get around the ITC's injunction. We should hear back soon on that. We're hoping customs and border will not give them what they're asking for. But if they do, we'll have to go back to the ITC to make it clear what the injunction was supposed to be about. So that's where we are.

I think we probably have another 2 to 3 years left and we should be done.

[Operator]

Our question comes from Mike Matson.

[Michael Matson, analyst]

First, just on the guidance, given what you did in the same quarter where you're guiding for the third quarter, you can kind of back into what it means for the fourth quarter for revenue and EPS growth. And it seems like the -- that's really where the raise is effectively falling both for revenue and for EPS, at least relative to where consensus was for the third quarter.

So the fourth quarter looks kind of aggressive to me assuming the third quarter comes in, in line with the guidance. So I don't know if you had any comments there. I know, Micah, you did say something about gross margins maybe being -- expecting them to be stronger in the fourth quarter, so maybe that explains part of it.

[Micah Young, executive]

Yes, absolutely. So a couple of things there. So if you look at kind of our guidance now versus our prior guidance, top line, we're increasing $25 million for health care at the midpoint. It's really distributed that increase pretty evenly between Q3 and Q4 in terms of percentage increase. If you look at Q3, the midpoint is around -- just a little over 10% for Q3 growth. We're about 9% growth in Q4.

And so we -- I don't view it as more risk on that Q4 guide. I feel like we've put a reasonable range around that for the fourth quarter.

If you look at our earnings per share, we're up about $0.20 at the midpoint. And -- we do have a little bit more coming from the fourth quarter. Some of that is though -- is we're seeing a better tax rate in the fourth quarter and full year as well. So that's driving some of the earnings there.

But gross margin improvement from last guide is up about 110 basis points in Q3 and Q4 for the consolidated business. Q4 is 90 basis points. So I think we're -- when I look at the guidance, you can see an increase pretty consistently with both Q3 and Q4. The only difference there would be more the tax rate benefit that we're seeing and expecting for the fourth quarter.

[Michael Matson, analyst]

And then just looking into next year, and I know you're not giving guidance, but one of the things I think that has talked to gross margin this year in addition to Malaysia is just a mix shift where you've had more sensor growth and your boards have been, boards and capitals have been. So I would imagine that, that kind of reverses next year. So is that -- could that be sort of a material headwind to gross margin in '25, if that does play out that way?

[Micah Young, executive]

Yes, Mike, I don't expect that to be a big headwind. I think we do believe that the capital environment is going to stabilize rather than being down double digits like it was this year, especially with our drivers are starting to pick up, and they're stepping back up from the low point we saw in Q1. But we still expect very strong growth in consumable revenues.

So -- and then any of the headwind that would be on mix, we're trying to offset that with cost reduction projects that we're working on with taking costs out of products, as well as the full year benefit of Malaysia transition. So there's going to be some puts and takes in there, but we still feel very good that we'll be on track to that cadence of margin expansion going into next year.

We also -- we don't have the year-over-year headwinds of performance-based comp like we did this year. This year, if you look at our operating margins, we are actually flat year-over-year. We're 15.3% guidance this year versus last year, we landed at 15.3% operating margin despite about 400 basis points of headwinds in performance-based comp. So that headwind will no longer be there, and we should get back on to a good margin expansion cadence going into 2025.

[Operator]

Our next question comes from Jayson Bedford.

[Jayson Bedford, analyst]

Maybe just a couple. Micah, maybe just to an earlier line of questioning on drivers, and I may have misheard it, but of the, what, 59,000 drivers you sold this quarter, are you implying that half of them were new, meaning not replacing legacy drivers?

[Micah Young, executive]

Yes. So to grow our top line, half of those drivers are new incremental drivers. And that's what's required to grow that top line, somewhere between 25,000 to 30,000 drivers is what we need to deliver the top line growth that we're seeing this year.

So that's -- the rest of it is literally replacing our existing installed base due to the size we are in the market today.

[Jayson Bedford, analyst]

Okay. Have you seen any on the capital side, any changes in ordering patterns from OEMs? I know that's been a little sluggish of late.

[Micah Young, executive]

The question was ordering patterns from OEMs?

[Jayson Bedford, analyst]

Correct.

[Micah Young, executive]

Yes. So the OEMs last year, as we talked about before, they had excess inventory. And they -- we feel like they burn through a lot of that down in Q1, which was a trough of our driver shipments. Their -- Q2 is stepping up, and we believe that we'll be back up above the 60,000 a quarter in the back half of the year. And we think that we should see that back in to normal ordering patterns, either by Q4 or early or Q1 of next year.

[Jayson Bedford, analyst]

And just last one for me. Just in terms of the potential separation and just disclosure around that August 15 date, should we expect the public announcement either way in and around that August 15 date?

[Joe Kiani, executive]

Well, the August 15 is the time we've given them exclusivity. Whether or not they will have something final that the Board can approve or not could come before or after. So there's really no magic date about August 15, except that you would think if they want to do something, it would come before then or they would ask for another extension.

So I don't know if we'll have an announcement or not, we'll have to see.

[Operator]

Our next question comes from Vik Chopra.

[Dino Weinstock, analyst]

You previously noted that your guidance assumed a 0% to 1% in patient growth? I know you mentioned a couple of comments that some public hospitals have made. What are you now expecting in your guidance for 2024?

[Micah Young, executive]

Yes. Great question. So right now, we're somewhere around 2.5% to 4% is implied in the guidance for the year. And that's pretty consistent with what we're hearing out there in the market with what we're seeing with reported admission growth and expectations that are laid out for the year. And that's implied in the back in Q3 and Q4 as well.

[Dino Weinstock, analyst]

Oh, and I think I forgot [inaudible] Dino Weinstock on for Vik Chopra.

Just a follow-up from me, on the guidance, what gets you to the low versus the high end of your guidance range?

[Micah Young, executive]

Well, a lot of it is really driven by census. We've already kind of modeled in the new hospital conversions. We're layering those in, also with the timing of installations through the rest of the year. So a lot of it is really dependent around the inpatient census growth inpatient surgeries.

We've seen positive trends on inpatient surgeries. I think those were up about 3% is what one of the large public hospitals quoted this past quarter, whereas actually outpatient was down, I think, a couple of points. So I think trends are going in our favor. But I'd say it's really around the -- the spread on the -- our expectations on inpatient census.

Capital, we've pretty much -- we've seen a drop in capital year-over-year. I think it's down close to -- on the full year, we're expecting down close to 15% with consumables up around 14%, 15%. So that's kind of where -- what's implied in the guidance range.

[Joe Kiani, executive]

I think we have time for one more question.

[Eli Kammerman, executive]

Operator, next question, please.

[Operator]

And the next question comes from Matt Taylor.

[Matthew Taylor, analyst]

I did want to ask you about the estimates of the separation that you put in this presentation versus the prior one. So really 2 clarification questions. Firstly, is the difference between the profitability with and without consumer health, is that really just spending on some of the projects in consumer health and the new presentation?

And then, Micah, I was hoping you could provide any other comments to help us bridge from the prior representation to the new one. If there are any other assumptions that were different or obviously, some of the core assumptions have changed, but I just wanted to get your take on that.

[Micah Young, executive]

Yes, it's pretty consistent with what we showed. I mean we're focused more around the midpoint. I think that's where we're kind of dialing in. Previously, we were putting some ranges around it. But our best estimate, we want to show to simplify the reconciliation between the 2 scenarios. We want to simplify that.

So we're expecting about $37 million of adjustments if you were to separate out consumer health in addition to the audio business. That's about 260 basis points improvement to get us to about 24% at the midpoint for professional health care, which is kind of where we expect to land. And that's where we've been showing a lot of the -- when we showed our long-range plan, we were jumping off of that midpoint. So everything is pretty much in line there.

If you look at the $37 million, we have reduced some cost for consumer health spend this year to drive some margin improvement there. But that assumes cost of goods sold or R&D expenses, selling and marketing expenses and certain other corporate overhead expenses into that number -- of the $37 million that we carve out as an operating loss.

So that's pretty consistent with prior -- what we showed previously, just a few tweaks there on the operating expenses for the year, but it's still getting us to the right end point of 24% margins for professional healthcare.

[Matthew Taylor, analyst]

Okay. And just, is there any change in tax or below the line to get to these new numbers? Or is that all consistent?

[Micah Young, executive]

No, this is -- nothing really below the line other than the guidance range and the raise.

The other thing would be is we're seeing closer to a 25% tax rate as opposed to 26%. And -- and I think that we have an opportunity to continue to see a tax rate there going forward for the professional health care business. Before we were showing about 26%.

So that would give us an upside or more confidence to achieve that $8 per share in 5 years.

[Matthew Taylor, analyst]

And maybe I could just ask you seem very keen on this plan with the JV versus just separating consumer -- sorry, separating the audio business. Could you articulate more about why you like that plan so much better seemingly what do you think that does for you strategically or financially that you wouldn't get with just separating audio?

[Joe Kiani, executive]

Well, I think we -- one, we get a lot more cash than we probably could get for the audio business alone, but also, two, we would get an upside into the future that we had envisioned. While we understand short-term the consumer health business is hurting our EPS due to the investment we're making in that, we believe, long term, it has a potential of becoming really successful.

That's why, to us, we acquired Sound United because we thought we needed that consumer group to sell the Freedom Watch, to sell our hearing aid and hearables. And if we don't have that team, it's going to be very tough to really make a success out of the wearables and the hearables from a health care company, and can unfortunately add risk to the health care business because it defocuses the team that's delivering on the health care business to also try to do something with the consumer health business.

Thank you so much, everyone. We appreciate you joining us today. We look forward to reporting our Q3 numbers and wish you a great end of your summer. Thank you.

[Operator]

The meeting is now concluded. You may now disconnect.