Masimo Corp (MASI) reported earnings of 27 cents per share in the third quarter of 2014, which beat the Zacks Consensus Estimate by a couple of cents, but remained flat on a year-over-year basis.

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Quarter Details

Revenues in the quarter scaled up 9.6% to $144.1 million, slightly above the Zacks Consensus Estimate. Product revenues grew 10.1% to $137.1 million while revenues from Royalty inched up 0.7% to almost $7 million in the quarter.

Direct product revenues (85% of product revenues) increased 9%, while OEM sales jumped 16% in the quarter. Masimo Rainbow revenues climbed 10% to $13.2 million, which suffered due to the company’s inability to win an international deal worth $4.5 million. Approximately 47% of total Rainbow revenues comprised consumables, which was better than 41% in the year-ago quarter.

SET pulse oximetry and rainbow Pulse CO-Oximetry unit shipments totaled 42,600. Per Masimo, worldwide installed base as of Sep 27, 2014 was 1,289,000 units, up 9% over the last 12 months.

Year-over-year growth of 9% in non-invasive hemoglobin devices was modest than expected in the quarter, while SpHb revenues increased to $4.3 million. The SpHb revenues included continuous measurement, as well as spot-check tests and devices.

U.S. product revenues increased 8% from the year-ago number to $95.3 million. International revenues grew 15% or 17% at constant currency led mostly by growth in Europe.

Masimo continues to introduce new products like O3 regional oximetry, iSpO2 Mobile health pulse oximeter for Android, transflectance adhesive forehead pulse oximetry sensor, Radius-7 wearable wireless Rainbow Pulse Co-Oximeter and respiration monitor, DCI-mini SpHb for infants and small children SpHb monitoring.

The MX-5 Rainbow SET OEM circuit board and the new oxygen reserve index monitor (ORI) received favourable customer interest. ORI provides insight into a patient's oxygen reserve when he/she is receiving supplemental oxygen.

During the quarter, Masimo’s market share increased on several noteworthy contract wins, such as Miami Children's Hospital, Regional One in Memphis and Mt. Sinai Hospital, Toronto.

Gross margin expanded 20 basis points (bps) on a year-over-year basis to 66.8%, due to higher product gross margin based on cost structure improvement from ongoing value engineering program.

Selling, general and administrative (SG&A) expense as percentage of revenues increased 170 bps, while research and development expense declined 50 bps on a year-over-year basis. The R&D decline is attributable to lower spending on clinical studies and other new project-related costs.

Adjusted operating margin decreased 200 bps on a year-over-year basis to 13.8% due to a reasonably high 200 bps jump in operating expenses.

At the end of the third quarter, Masimo had cash and cash equivalents of $119 million as compared with $97.1 million at the end of the previous quarter. In the first nine months of 2014, Masimo has borrowed $125 million on its line of credit.

Through the first nine months of the year, Masimo has repurchased approximately 4.4 million shares for $101.9 million. The company has approximately 0.6 million shares remaining from its original 6.0 million share repurchase program. In addition, Masimo recently authorized the repurchase of up to an additional 3.0 million shares.

Guidance

Masimo revised its fiscal 2014 guidance. Revenues are expected to be approximately $585 million, down from the earlier outlook of $588–$593 million. This includes product revenues of approximately $556 million (down from $560 to $565 million) and royalty revenues of approximately $29 million (up from $28 million).

Masimo expects fiscal 2014 GAAP earnings to be approximately $1.28 per share, as against the prior range of $1.24 to $1.30. However, product gross profit margin guidance of approximately 65% was reiterated.

For fourth quarter, total operating expenses, including approximately $1.9 million in medical device taxes, are expected to be approximately $80 million.

Our Take

We believe Masimo’s innovative product line will continue to drive top-line growth going forward. The upcoming Root connectivity hub, an open architectural monitor with SEDLine brain function monitor and airway gas monitoring, including capnography (received FDA clearance in second quarter), is a significant addition to the overall product portfolio.

However, reluctance of hospitals on buying new technology remains a major headwind. Moreover, lowered product revenue guidance will serve as an overhang on the stock.

Currently, MASI carries a Zacks Rank #4 (Sell). Better-ranked stocks in the medical instruments sector include Alphatec Holdings (ATEC), Cynosure (CYNO) and Electromed (ELMD). All these stocks hold a Zacks Rank #2 (Buy).

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