瑞思邁 (RMD) 2007 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2007 ResMed, Inc.

earnings conference call.

My name is Eric, and I will be your coordinator for today.

At this time, all participants are in a listen-only mode.

We will be facilitating a question and answer session towards the end of the conference.

(OPERATOR INSTRUCTIONS)

The company has asked me to address certain matters, First, ResMed does not authorize the recording of any portion of this conference call for any purpose.

Second, during the conference call, ResMed may make forward-looking statements, such as projections of future revenue or earnings, new product development or new market for the company's products.

These statements are made under the Safe Harbor Provision of the Private Securities Litigation Reform Act of 1995.

Risks and uncertainties exist that could cause the actual results to differ materially from the forward-looking statements.

These factors are discussed in ResMed's SEC filings, such as the forms 10-Q and 10-K, which you may access through the company's website at www.resmed.com.

With that said, I would like to turn the call over to Peter Farrell Ph.D., ResMed's Chairman and CEO.

Dr.

Farrell, please go ahead.

Farrell, Eric, but thank you very much.

I apologize to everybody for the initial delay, and for this delay now for which I'm not really sure quite what happened.

I want to try to spend most of my comments on three matters.

One is the recall discussed in detail, the results as reported and then talk a little bit about the future.

I'll go through in bullet point form as I normally do and then make some comments, probably a little more detail than previously and then throw it open to Q&A.

Revenue for the quarter was $183 million a 13% increase over the year-ago quarter.

Pro forma income from operations and pro forma net income were $44.3 million and $31.1 million, increases of 5 and 3% respectively.

Pro forma diluted earnings per share were $0.39.

GAAP with the addition of the recall, shows an operating loss of $22 million, and that, obviously, is impacted by the approximately $60 million $60 million, $41.8 million net of tax, for a voluntary product recall, which I'll discuss in a few moments.

Gross margin for the quarter, excluding the recall issue, was 62.3%, consistent completely with the year-ago quarter of 62.2%, and obviously the gross margin is impacted negatively by the recall.

Pro forma SG&A for the quarter was $57.4 million, an increase of $7.3 million, or 15%, over the year-ago period.

Pro forma SG&A costs were 31% of revenue for the March quarter, again, consistent with the year-ago quarter.

And GAAP SG&A was $61.3 million.

Pro forma R&D for the quarter was $12.6 million.

GAAP R&D was $13.1 million, or 7% of revenues, and that was an increase of 43% over the year-ago quarter and going forward we expect R&D expenses to be in the 7% range.

Amortization of acquired intangibles was $1.7 million or $1.1 million net of tax.

Stock-based compensation incurred during the quarter was $4.7 million or $3.5 million net of tax.

And as you all noticed, we've-- noted-- we have announced, and it's in a separate press release, we are going to conduct or are in the middle of conducting a voluntary recall, affecting approximately 300,000 S8 flow generators.

These are the early batches.

We're currently in discussions with the FDA and other regulatory authorities regarding this action.

The estimated cost is almost $60 million, and it has been recognized as a charge to cost of sales in this quarter.

Things can change, but we think we are being suitably conservative with this number.

For the nine months ended March 31, 2007, revenues were $525 million, an increase of 20% over the $436 million for the 9 months through to March 31, '06.

For the nine months ended March 31, '07, pro forma income from operations and pro forma net income were respectively $131.9 and $93.6 million, increases of 19 and 21%, respectively.

On a GAAP basis, income from operations was $51.1 million, while net income was $38.6 or $0.49 per diluted share.

Inventory at approximately $157 million increased by $15 million.

Accounts receivable days' sales outstanding at 73 days increased marginally from the 72 in the December quarter.

Third quarter for the Americas increased by 10%.

However, if we exclude the ResMed motor technology or our motor division, sales increased by 13% over the year-ago quarter.

Sales growth for the Americas were impacted by quite a challenging quarter, and there were four things that I would like to point to.

First of all, we had extraordinarily tough comparables.

The U.S., for example, was up 50% in the year-ago quarter.

ROW, Rest of the World, was up 36%, and combined it was 45% quarter.

So tough comparable.

The second point is we saw competitor discounting that we have never seen before.

In fact, not only was there discounting, there was in fact give-aways.

Not just mask samples, but, in fact, it has been reported back to us that there were in fact boxes of masks being delivered to customers.

If your are getting free masks, even if you don't particularly like the quality of the mask, you are unlikely to be paying for a new mask.

The third point is that-- and by the way, on the discounting, as you can see from our gross margin being maintained at 62.3%, there was business that we just simply walked away from because we just thought it was crazy to do business at some of the pricing being requested.

And again, that was obviously catalyzed by competitor activities.

The thing third is that ResMed Motor Technologies, last year-ago quarter we did $3 million, this quarter we did $.5 million.

This was expected, but it is a chunk of change.

I guess very importantly and finally, neither this quarter nor the previous quarter, but this quarter in particular, there was no new product flow.

I'm pleased to say it's not all bad news, and let me finish the comment about product flow by saying that later this week at the Medtrade meeting in Las Vegas we will be introducing five new products.

The Tango -- the C-Series Tango, which is our value CPAP device, was in fact released right at the end of March.

So it had no impact whatsoever on the quarter just finished, but we have got a full-scale press on the Tango, which is an excellent product, robust and field trials have been extraordinarily encouraging.

We'll also be releasing another device, the VPAP Malibu and this can be summarized as a auto-setting, bi-level unit.

We expect initially the sales to be incremental from this product, but also we expect as people get experience with it, that it will be taking market share.

And in the mask area, we have the Swift II Nasal Pillow System.

This is a great product.

It is much quieter and easier to use than the Swift I and that was a home run, but we're really excited about the Swift II release in the domestic market.

We have two new full-face masks, one being the Quattro, which has an adjustment where the mask is fitted and the patient is set up and if there's even a minor leak, an adjustment on the forehead will completely eliminate the leak.

And, finally, the Liberty which is based on our Nasal Pillow System, upgraded, but this time with a full face mask, so it's a hybrid mask, which we are extremely excited about.

Let me finally refer to sales outside the U.S.

These were -- the sales were $88.4 million, which was a 16% increase over the year-ago quarter, and operating cash flow was an encouraging $20.3 million.

As can be seen from the numbers, the real impact on the quarter came from the U.S., and I have already described the four major factors that impacted there.

Happily these factors, with the exception of RNT, are not likely to be around to the same extent in this quarter that we're currently in.

Let me spend a couple of seconds or a minute or so on the volunteer recall.

The irony is that the overall reliability of the S8 product line is even better than the S7 product line, and the reliability of that product range was excellent.

The problem was the nature of some of the failures.

Now, the units that failed, there was a .2% failure rate in 300,000 units over a two-year period.

Now this .2%, if we drill down, there are actually seven devices where there was thermal damage.

We recently became concerned about that in the last few weeks.

We took -- we dealt with our own internal people in terms of drilling down to try to understand what was going wrong.

And then finally, we brought in external consultants in a rage of areas, and our conclusion was that there was a very remote possibility of any adverse affect.

However, we didn't think that customers would like it.

Of course, our statistical analysis, the so-called (Inaudible) Analysis, based on the data that we had in hand, albeit extraordinarily limited.

I mean, you're dealing with a failure rate of 0.002%, but we -- in terms of the thermal damage.

This is extraordinarily small, but when we looked at overall failures in the devices, and the nature of the failures, the (Inaudible) Analysis suggested that there may be a risk that the failure rate would accelerate going forward, and we didn't want to be faced two, three, four, five years down the pike with an accelerating failure, and leaving us with an embarrassment.

But not only that, leaving us potentially with dissatisfied customers, and more importantly, dissatisfied patients.

I'm saying it's only a potential, that's what the statistics told us, and we were faced with a very tough decision.

Do we just let this simmer along, and hope that things turn out all right?

And we decided, sitting down around a table, we said, "What would people expect from us?" and we decided that the right thing to do was to do a complete product recall, and even though we're looking at a large number, it was, we felt, the best for customers, the best for patients, the best for our own employees, who we've garnered respect from over many, many years, and we've faced nothing like this before, but we decided to take it head on and bite the bullet and just get the job done and get it put behind us.

We are using external people for this recall.

We think we're being very conservative with the number.

We are in discussions with the FDA and there's likely to be more there, but, so far, we're satisfied that we're working through this very professionally with that body.

So that's all on the product recall, although, I suspect some of you might have some questions about that.

The external body we're using is very experienced in this area.

We expect minimal disruption to the business.

We have worked through, we think, all of the issues, albeit in a very, very tight timeframe and I've got to say that the team of people within ResMed here have just been absolutely spectacular, working all through this weekend in Australia, the U.S.

and Europe.

Working out individually how to do things properly and efficiently in the various markets.

And more on that later, but we're actually happy the way things are going, if one can be happy.

I think, with that, I'll throw it open to questions.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Ben Andrew with William Blair.

Please proceed.

Good afternoon, Peter.

Ben.

Few questions on the recall first.

The charge you are taking, is that the actual cash charge or cash cost, I should say?

That is our estimated cost for the whole kit and caboodle.

Ben, it's overheads and things that we think we need to do, plus replacement of the units as estimated.

So, that is out-of-pocket cash?

Brett?

Ultimately that will be probably spent over the next six months or so.

Ultimately it will be cash outlay.

Okay.

And Peter, do you have supply of S8s, or how quickly do you think you can replace the units that are affected?

We, believe, Ben, we're pretty good shape on that.

We have looked at the supply chain, and it's all very doable.

In fact, we don't think that that is going to be a limiting factor.

The limiting factor is going to be getting to people and doing the switch out.

We're very confident about our ability to produce.

Okay.

And then on the timing front, just kind of walk us through your awareness of this issue.

It sounds like there was a component change, I think May of '06.

Was there something evident there or this really only came up just recently?

No, there was nothing -- it was like when you launch a new product, there are always improvements you can make.

And we noted that there was some improvements that could be made there, and these were made, but it wasn't until -- I mean, the products were first put out in '04, and it wasn't -- given that the failure rate was even better than the S7, there was nothing really there that raised its ugly head.

It was only more recently with some thermal damage associated with the connectors.

These were very early units.

In fact, the first cut was around 40,000, and we thought it was only there, and it looked like it was only there, but further digging down by the engineers, suggested there might be a risk in another approximately 260,000, and we're just being excessively, excessively cautious on this.

Has there been any patient injuries or other damage that you might ultimately end up being responsible for?

That people could come after you for?

No.

Okay.

We have seen nothing there that -- you can conjure up all sorts of things in your mind as to what can go wrong, but the data are pretty clear there.

Good.

Then, just turning to the market, what do you think changed this quarter that caused this acceleration in discounting by the competitors?

Well, it looks as though we saw a little bit of this early in the quarter, but it looked as though there was a full-court press by a competitor, who will remain nameless, but it was an extraordinary -- just level of discounting on the one hand, that's for devices, and launching a new product with a massive give-away.

I mean it was-- we normally have quarters (and we have been trying to work around this, in fact probably about three or four years), there's a bit of a hockey stick to it.

It was flattish in the first couple of months, and we normally have a big finish and we did have a reasonable finish, but it took a while for us to work out what the heck was going on here.

If you are getting boxes of masks as give-aways, you're not going to turn around and say -- if you don't know the product.

We're very comfortable, by the way that our products-- the quality is there, and we have got the history, and the experience that's there and we think that this is likely to be very much a blip.

But it was just -- this was clearly a concerted effort, and it was a full-court press, and we just didn't think that it was actually happening because you sort of stare in disbelief when you look at what is going on.

I mean, if you are in a business, presumably you want to sell product.

Well that's our approach, and you can see that our gross margins, which hold up, we just simply walked away from business, we said this is not good for the marketplace.

It is not good for anybody.

Last question and I'll jump off, but did you see a big disconnect between generator growth and mask growth that would kind of support that there was good patient growth?

Or did you see the market for patient volumes decline in the quarter?

Well, initially we thought it was like over Niagara Falls, like a drop in the rate of market growth.

But as we looked at it more carefully, we are comfortable that the U.S.

is growing around the 20% and ROW 10 to 15%.

We don't think there has been any change whatsoever there.

Clearly there was a change in terms of he process being charged per per unit.

No question about that, but I think, we think the market is incredibly healthy and we are fairly convinced this is a aberration, and we're actually feeling fairly comfortable, fairly confident with the new product offerings.

We think this, is as I say, an aberration.

The Tango is a great product.

It's going to allow us a lot more flexibility to be creative in that value space, and our mask offerings, are just really, really extraordinarily good.

So we're actually pretty optimistic.

Disappointed that this is happening, but hey, it is what it is, and we'll get through it, and we'll be back on track very quickly.

We're fully confident about that.

When we look out at areas such as cardiology, diabetes, occupational health and safety, anesthesiology, and [JCo] coming out saying there should be perioperative screening of patients now.

That's all good stuff.

And, finally, the ventilation, and we're getting on top of that.

It is a work in progress, it doesn't happen overnight, but those five areas where we are putting stakes in the ground, we are very, very optimistic about those.

OK.

Thank you, Peter.

Thank you, Ben.

Your next question comes from the line of Paul Choi with Merrill Lynch.

Please proceed.

Good afternoon, Peter.

Paul.

Perhaps if you could walk us through the usual breakdown of U.S.

and Rest of World for everyone's models, please.

Right.

Well Ben Andrew asked about the mask issue, and I didn't really complete his question, but let me say that the mask and accessories in the Americas were only up 8%, but if we take into account the ResMed Medical Technology, which is an aberration, that is the OEM stuff, motors from the Motor Division, it was actually a 14% growth.

And so this definitely was impacted by the give-aways that we were seeing in the marketplace.

Flow generators were up by 12%, and then ROW there up by 12%, and the masks and accessories ROW were up by 24%.

So overall, we're up 13%.

And it was -- overall flow generators were 12%, the masks and accessories were up 14%, but that would have been closer to 20% if you throw out the RNT, the ResMed Motor Technologies, but overall 13% of 183, but organic growth 15%.

Okay.

Great.

Thank you for that.

Just to return to the issue of pricing for a little bit and you mentioned one of your competitors giving away substantial quantities in masks.

Is there point at which you are going to either announce that you are going to stick to your guns as is, or is there a point where the strategy will cause you guys to adjust your plans going forward to some degree?

If you care to quantify it to the degree that you can.

We're a great believer that if you are running a business, and you've got a value proposition that people should pay for that, I don't think it makes sense for the long term to have a supply-driven price reduction, where the customers are not even really requesting it.

But I'm going to throw that question over to Keith Serzen, who is the Chief Operating Officer for the Americas, and Keith is the one who has been wrestling with these very issues.

So, Keith, do you want to comment?

Sure, Peter, thanks.

As Peter said, we were a bit surprised for the first part of the quarter about where the pricing was going and where the give-aways was going.

By the way, that was primarily one competitor, but there were a couple of other competitors that were clearly in there attempting to buy market share with new products.

We didn't respond through the first couple of months of the quarter, because, bottom line, we just couldn't believe what was going on.

When we did realize what was going on, we did respond, and we will continue to respond as necessary to make sure that we continue to grow our business, continue to grow our market share, and continue to respond to the pricing pressures that are out there.

Albeit, we still will always be the price leader in this market, and we will continue to sell on value, but we will respond to pricing pressures to continue to grow our business, and we did at the end of the quarter and responded very, very well.

Our team had one of the best months in the month of March that we've ever had as we did respond.

Thank you for that Keith.

Lastly, in terms of the new products you are going to launch coming up here at the Medtrade.

Can you just comment on where you stand in terms of training with those products with your sales force?

How much have they been exposed it to, how many more, or if any additional processes or recessions are required at this point, for the launches to proceed?

Well, that's relatively easy, Paul, because these are not -- these are evolutionary products.

The Malibu, which we said is initially going to be incremental, is an auto-setting bi-level.

It is a very good product.

It's being targeted mainly at the non-compliant, OSA patients.

It will probably be used beyond that, but we believe that we have got adequate training across the sales force.

We are in very good shape on that.

There's not likely to be any hiccup in that regard.

As I say, these are really evolutionary products, albeit adding significant value, but they are evolutionary.

Then supplies for each of them are ready to address, you think, demand at this point?

We have been caught -- but you never want to launch a product and go in to immediate back order.

We have been there, done that several years back and we didn't like it.

And customers didn't like it.

Now we have adequate supplies of all those.

And if you are at Medtrade and you need to load up on any of those products, Paul, we're there to take your order.

But we're not giving you cases.

Thanks a lot guys, I'll jump back in queue.

That's right.

No give-away cases.

We think the product will sell itself.

Your next question comes from the line of Tim Lee with Caris & Company.

Please proceed.

Hey, guys, good afternoon.

Tim.

How are you?

Just a couple of (Inaudible) questions on the recall side.

In terms of the manufacturing capability or capacity, do you have enough capacity to supply the recall quantities of the S8 in addition to supply any commercial demand for that product?

Yes, we have done the sums, Tim.

Obviously it doesn't happen overnight, but frankly we have got a third of them.

We've -- based on expectations in the last few weeks, we have got to Rob Douglas who is Head of Operations.

Rob has done all the shaking of the trees that he needs.

We have basically 100,000 on hand as we speak, and we can meet normal demands and we can crank up production to the levels we need to.

So we do not think that that's going to be a critical path in this process.

Okay.

Thank you.

And then is there any recourse on your part to the third-party vendor that supplied this component, or is this $60 million tab on your guy's books and there's no recourse whatsoever?

We expected that we will be able to -- Well, first of all our contract with the supplier is a fairly tight contract.

If there are any faulty components, they are honor-bound to replace those components.

No question that that is their responsibility.

The irony is that we saw something like 4 million power supplies from this vendor, and this is the first time that we have noticed anything that's slightly untoward.

They are a small outfit.

We certainly don't want to jeopardize them.

And they're making power supplies for all of our units.

We don't want to jeopardize our relationship.

We think they owe us something.

It's too early in the game.

We didn't wait to negotiate with them before we decided to do this voluntary recall.

Maybe David Pendarvis, who is our legal counsel, who is sitting beside me.

Dave, I don't know if you want to add anything, but we will be going back to them.

We haven't decided exactly what we're going to require from them, but it's likely to be something like 300,000 power supplies.

But Dave.

Thanks, Peter.

I think you adequately stated it.

Obviously, our first priority is to get adequate measures of supply and conduct this recall as quickly as we can and efficiently as we can throughout the process.

So our first order of business is to work with our suppliers to make sure that we've got adequate components and adequate supplies.

But we have a long history with this supplier.

We expect that we can have reasonable discussions with them to work all of the issues out as matter of course.

Just one last one, if I may.

I know in your comments you noted you didn't expect this recall to have any type of meaningful impact here in the fourth quarter.

I guess, how reasonable is that?

Is your sales force involved in any of this process, or are they completely hands off and their responsibility is to just go out and get sales?

I'll try that question to Kieran, but obviously our sales force is involved.

But the message to them, is, "Guys, we want to do this professionally, but we have a third party that's going to handle all of the logistics," and we're paying for that to be done.

So we want to minimize any disruption to the sales force.

No gold-plated guarantees on that, of course, but we feel that these guys have been apprised, obviously the word has only just gone out in the last day or so and, in fact, discussions and communications are going on as we speak.

I just sent out -- well, Kieran and I sent out a joint email on what the game plan is, but, we're anticipating minimal disruption, but Kieran do you want to say a few wording on that?

I think you accurately stated it.

Look, any of these kinds of exercises have to have an element of disruption.

The way that we plan on conducting this is the standard ResMed way, which is of the highest quality, focused on patient care.

We're really going above and beyond to support our customers and our patients.

Our anticipation is, sure, there might be a little disruption upfront, but we're going to try to minimize that through the use of external parties and we fully expect that this will have a long-term positive impact, because it basically demonstrates our commitment to quality and our commitment to the customers and patients.

Great.

Thank you very much.

Okay, Tim.

Your next question comes from the line of Joshua Zable with Natexis Bleichroeder Inc.

Please proceed.

Hey, guys.

Thanks for taking my question.

Couple of quick ones, first of all -- can you just give us a quick currency stat?

The [Talwin]?

Yes.

Yes, the order of 6 million.

Okay.

Cool.

And then can you just -- I know sometimes we get a little excited about product launches, so just help me understand, obviously of the new products at Medtrade (and I'm looking forward to see ing them) I know with Tango you were very up front about controlling market release.

Now it seems to be out there full blown.

Are all these new products, obviously launched at Medtrade, are they going to be in a controlled release or full-blown release, and is there any sort of staggering of the launches?

Obviously, you have a number of products coming out.

What is your sales peoples' focus?

Is it sort of a stagger effect or are you kind of throwing them all out there and saying this is what we have got, and we have got a lot of good stuff out there?

Well, the launch date -- we'll be showing them on April 24.

The launch date is a week later.

Main one is the kickoff.

We have adequate supplies of all of them, and we anticipate that the Swift Is are not going to be around for much longer, when you have the Swift II at basically the same price.

With the full face mask, these two products-- When you come up with a new product, it's hard to predict exactly how they're going to go.

But we are anticipating very good receptions, based on our clinical trials for both the Quattro full face mask, and the hybrid Liberty.

So we're ready to go with these three mask products, and masks are relatively easy to sell.

That's not a major league issue.

The Tango, as you said, has already been out there on controlled market release.

We're ready to go with a full-court press on that product on May 1.

And the same is also true of the VPAP Malibu, but obviously the numbers associated with the VPAP Malibu, the auto-setting bi-level, are going to be much, much smaller, and therefore much more manageable than the Tango in terms of that sort of volume.

Great.

Thanks.

And then in terms of .

Just one second, Joshua.

Keith might want to add something.

Peter and Josh, the only thing I wanted to add is that the Liberty full face mask, the hybrid mask is going to be a tremendously exciting mask.

It is in full release at this point in time and full ability to supply any demand that comes at us.

The only limiting factor with that product is that the reimbursement will -- is not yet clear.

The reimbursement under a K-code will be issued in June/July time frame by CMS.

That will establish the right level of reimbursement for that product, and right now there's a little bit of confusion in the marketplace regarding that and as a result we are asking our sales force to go out with that in limited places where people want the product, want to buy the product, but not in such a way that we confuse them or cause them any problems from a reimbursement standpoint.

That reimbursement will be cleared up at the end of this quarter or the early part of Q1.

Great.

And then can you give us an update on VPAP Adapt?

What it contributed, if you don't mind?

And how that up-take is going?

The up-take is significant.

What I can say is that 20% of the sleep labs in the country have now have exposure to it, have now had training.

We are very excited about this product.

The Mayo clinic.

Tim [Morganfowler] at The Mayo Clinic has just had an article published, I think it was in Sleep, where Tim put the VPAP Adapt through its paces and he basically concluded it was superior to all other pap modalities in the treatment of centrals and complex sleep disorder breathing.

So we are extremely excited by that.

We haven't broken it out as a separate item.

I mean we have, we know what it is.

But when you start with small numbers, and you start talking about hundredths of percent, it doesn't give you a true understanding, because the numbers are so small, but it's selling like a hot cake.

Okay.

Great.

And then just -- can you give us a quick update on the [SEM], on what is going on with the [SEM].

Yes, it's still a work in progress.

We've sent over a very senior operations guy from Sidney, [Gregg Lang].

Don [Darken], who was in charge of all product development was over there in the initial phases, working out what needed to be done, getting it, if you like, a checklist together.

Don did that and the checklist has been passed to Gregg Lang.

I haven't had a recent report from Gregg, but he is one smart, capable individual, and we are still -- we still haven't pushed the boat out to the extent that we can't to on those ventilator products, but we're certainly getting there.

It's going at the pace we expected.

There haven't been any scorpions under the rocks.

Kieran is probably closer to it than I am.

Kieran, do you want to add to that?

No.

We're making very good progress.

We've had very good, positive feedback from our customers.

The quality continues to improve.

We released the new bill standard.

All things moving in the right direction.

Very comfortable with the progress.

It's a blocking and tackling exercise, and you just got to get through it, and bring all of the people you're working with there in the French operation along at the right pace.

Great.

Well I'm looking forward to seeing the new products in a couple of days.

Okay.

Take care.

Thanks, Josh.

Your next question comes from the line of Michael Matson with Wachovia Securities.

Please proceed.

Hi.

Thanks for taking my question.

I guess I just want to push back a little bit on your explanation of the discounting.

I guess I'm just wondering, you are kind of saying it won't continue.

What leads you to believe that it won't continue from some of these competitors?

Mike, discounting is probably -- I mean we have already, always expected falling ASPs, it's just that they are falling at a slightly greater rate at this point.

I think, in fairness, a couple of things are happening.

When we're saying falling ASP, it's more, if you-- if you buy five you get two free, that sort of thing.

In other words, if you ask if the ASP is being changed, you probably get a response, "No it's not," or "Only marginally." So that sort of free goods type thing happening.

With the masks, normally if you are launching a new product or you interest people in using it, you might give a few samples away.

You don't give boxes away, and the reason I'm saying is that I think that changes.

If you are in a business, you got to sell product.

You can't just run a sample outfit.

And so, at some point there's got to be an understanding.

I think it would be probably said to be a seeding process.

We'll give a few away to seed the market, because we're confident this will be accepted as a really valuable product.

Our assessment is that that's not the case, so we think on a price equivalent, if you like a level playing field, we're very comfortable we're going to get more than our fair share of business.

If somebody's giving you something free, well, why pay anything for a better product?

Particularly if you are not going on it yourself.

So I think aggressive sampling is going to -- that will disappear.

If you're running a business, you can't just give stuff away as I just said.

And we think there will be some continued discounting, but we don't think it'sgoing to be at the same level.

Keith, I don't know .

Peter, I would just add that I don't believe, Mike, that we said we didn't think that there was going to be a stop to the discounting, but we believe there will be discounting as Peter said, and we just want to communicate very, very clearly that we will respond accordingly if we have to.

And these give-aways that you are talk about, I had picked up on some of that back in the December quarter actually.

Is this something that was happening in the March quarter as well, or it is just sort of a spill over that maybe there were things given away in the December quarter and they just had things left over in their inventory from that period?

Well, we saw the impact in January, February.

It's very much -- we saw marginal amount in the December quarter.

These are current deals going on.

These are current deals.

All right.

Okay.

And then with the Tango, are there any plans -- I know you have been asked this in the past, but I just want to get an update, any plans to go after some of the larger national firms there, that you maybe haven't done business with, or had limited business with, because of pricing concerns, with that-- with the Tango product?

Well, we would be crazy if we didn't.

I mean, that's the whole raison d'etre for the Tango, was to be price competitive in that sort of value area, where we traditionally haven't played.

We haven't had the cost structure to justify our doing that.

With the Tango, we're in the sweet spot.

So we will-- it doesn't mean you get it.

I mean, but we will certainly be aggressively pursuing some of that business.

Okay.

And then just for modeling purposes, it is possible for you to give us the motor sales for the next several quarters -- the year-ago motor sales for the next several quarters so we can factor that in to our models?

In terms of assuming it effectively goes to zero for the next several quarters.

Mike, I'm not sure what information you are seeking.

Could you repeat that?

The motor sales in the masks and accessories category, the motors that are going away, what were those in the June, September, and December quarters for fiscal 2006?

Okay.

Well, you know, it's interesting when you look at Q3 '07, if we look at the mix between CPAP, APAP, and bi-levels and masks and accessories, basically it's the same as Q2 '07 and it's the same as Q3 '06, in terms of the breakdown, almost identical.

In other words 52% of devices, masks and accessories, 48%.

Q3 it was-- you want--

I understand that, but I guess what I'm getting at is that you said that, for example, the year-ago quarter from the March quarter, there was $3 million in motor sales and this quarter it dropped to $0.5 million, if I'm correct.

Yes, sorry.

There will be a little bit of holdover from that --

Brett, do you have the base year comps for coming up --

For next quarter the comp before would be around sort of the $2 million mark, something like that, and then it sort of tails off through the quarters after that.

We'll still feel that similar impact next quarter.

Okay.

All right.

So roughly a $2 million inorganic drag there from that?

Yep.

Yep, that sort of number.

All right.

That's all I have got.

Thanks.

Thanks.

Your next question comes from the line of Alex Smith with JPMorgan.

Please proceed.

Peter, just want to comment on this product discounting.

How long -- you mentioned that you think it's a bit of a blip.

How long do you think it's going to stay around in the market for?

And can I just confirm that you -- when you say ResMed are willing to respond, that means you are willing to have a bit of a price war or give-away war, or whatever it may?

Alex, we don't think you need to give stuff away.

I mean, I think we're in just a much more solid position now with the Tango.

As Keith said, you can't just ignore discounting, and we weren't really in a position with our other devices to do heavy discounting, or be as price competitive as maybe we needed to be in the device area.

We can be very competitive in the mask area if we need to be, but, I guess, the point I was making is that if you are giving away samples, and you are giving away boxes of samples, at some point you have got to start selling them.

It costs you to make stuff, and it's very well to seed the market.

My feeling is that that seeding process is going to go away, the discounting will be there in some form, and that will wash through.

But Keith, you want to add any more to that?

Peter, what I would say that we do not -- a price war is really a silly thing for this entire industry.

We do not want a price war.

We think it's bad for all of the reasons that you talked about.

What we want to clearly communicate, though, is if somebody out there thought that we were going to lay down and not respond, we will respond.

Right.

And that's different than a price war, but we will respond as appropriate.

Okay.

And do you think that launching impacts the launch of the new products, in terms of the price that you may be able to achieve on those products, or is that not such an issue?

I don't believe it's an issue.

I mean, all you can do is make a value judgment there.

Look, I think these products-- we feel they are so good that -- we're not the sort of company that launches a new product and immediately goes into a discount mode.

And we know competitors that do that.

I just don't understand that.

It could be -- it could reflect the fact that they are concerned that their products won't be adopted at all.

Maybe that's a concern.

I don't know.

But we don't launch new products with discounting.

We never have.

We haven't done that in 18 years.

I don't expect that we'll start.

Okay.

Thanks, guys.

Okay, Alex.

Your next question comes from the line of Glenn Novarro with Banc of America.

Please proceed.

Hi, thank you.

Couple of things.

First, I want to clarify, Peter, I think you said that the global -- your global mask and flow generator revenues were up 20%, excluding OEM.

That's right.

Yes, 24%, Glenn.

Okay.

So that's what is giving you confidence that the market is still very healthy?

Yes.

Well, the ROW?

Yes.

Yes.

Yes.

Okay.

And then what was the U.S.

market up then?

The organic growth for the masks and accessories was up 14%.

Okay.

Previously, that's half to a third of the growth rates that we have experienced traditionally.

And as I explained, this was an unusual quarter in that area with the promotional activities, and some new products coming up, where we didn't have any.

The last couple of quarters we have been bare in the cupboard in that area, and others have come up with new products with significant give-aways, and that obviously impacted the growth in that space.

We don't anticipate that continuing at anything like that level.

But, overall, in your travels in the quarter and talking to DMEs, talking to physicians, talking to sleep labs, you are seeing no slow-down in patient flow in to the sleep labs?

It's still very robust?

We are seeing no slowdown whatsoever.

Keith, do you want to comment on that?

Peter, there are surveys done by some of the folks that are on this phone of the sleep centers to predict what the future growth is going to be at the sleep labs, and I think that those numbers are well-known, and those numbers are indicative of continued robustness in this marketplace.

We have done our own surveys as well of sleep labs and the results that we have gotten back of the surveys support the information that has come from the surveys done by the people on this phone.

The fundamentals are all there.

This is a strong market and it is a market that still has huge growth associated with it.

And we don't see any changes to the fundamentals of what is going forward in the marketplace.

What we see is we didn't react to a competitor and their tactics quite fast enough here in this particular quarter.

Just to add to Keith's comments, you -- it's just -- the general feeling -- I don't know, I would say today -- I was looking at emails this morning and there's another truck driver there talking about there he was caught, sleep apnea, wasn't getting treated etc.

Everything we see, the data that we're getting back from our diabetes surveys and the data that we've collected ourselves.

We're looking at something like 80% of type 2 diabetics with sleep disorder breathing, and if you treat it, you treat both the hypertension and the diabetes itself.

I mean, all the signals are extremely positive.

In the heart space area what we're seeing-- our data suggests that one out of every two heart patients has sleep disorder breathing.

If you don't treat it -- you can't treat the congestive heart failure, you can't treat the atrial fibrillation, and so on and so on.

And the occupational health and safety, we just signed up another trucking group, that's Prime.

You know that we've been working with Schneider Trucking.

We're expecting to add more and more people.

The [JCo] data on the anesthesiology, the perioperative sleep disorder breathing concerns, and finally, ventilation is showing no signs of abating in terms of its growth.

So we remain extremely optimistic about the whole area.

May I ask you two questions on reimbursement?

First, what is your anticipation of reimbursement for home diagnosis?

And do you expect that to help accelerate the market as we kind of pull through more patients into the system?

That's question one.

And then, as we talk to our contacts on the competitive bidding front, particularly on the DME side, most are saying that they don't see how the government can implement the first round of competitive bidding, by, I believe it's next March or April.

What are your expectations?

Let me address the competitive bidding first.

The new rates are going to apply in ten selected metropolitan areas (MSAs), and the only step we implemented, as you correctly indicated, is April 2008.

And if the cost reductions are met, and there's no guarantee that they will be, the program will be expanded to 80 MSAs by April 2009.

So it's a fair way down the pike, and lots of things as you pointed out, Glenn, can go wrong, but the overall impact for us is 10% of total revenues, even if and when the program is fully implemented.

So it's not something that we-- I don't get up in the morning and worry about competitive bidding, put it that way.

Plenty of other things to worry about.

With respect to home diagnosis.

As you are aware, we are in the throes of CMS looking at a national coverage decision, about whether or not they should include home diagnosis and pay for that.

My guess is that it will happen.

My guess also is that it is going to take a while for that to get traction.

I mean, people will continue doing what they are used to doing.

I think the growth in hybrid units should make people fairly secular about what procedure they use for diagnosis.

In other words, if you have downstream business, which is treatment business, you are selling masks, you are selling devices, so and on so forth, why would you care about home diagnosis?

If you didn't get reimbursed for it, you might just be tempted to send everybody through the sleep lab, but if you get even a modest level of reimbursement behind a diagnosis, why wouldn't you do it?

It's easy.

Because we know -- and this is a very important point -- we're only 10% penetrated, by our estimates, at best into this market, so that's 90% of the market untapped.

So you know the business is out there.

How do you access truck drivers, for example?

You are going to get these guys who are working seven days a week to take a day off to go to a sleep lab?

It's just not going to happen.

So here with the home diagnosis, you can do the guy in the truck and get him fitted up during his off-period for a CPAP device, and he can be back at work immediately, because we know the effect is instantaneous.

But look, when you look at this area, what sort of restrictions are there going to be on home diagnosis?

This is all in the lap of the gods.

We have no idea.

If it's made too restrictive -- and a lot of people would like it to be made restrictive, you can see in some of the submissions -- my feeling is we'll be somewhere in the middle, and I think it will be go through and I think it will hugely help the market, but I don't think it's going to be in the short term.

Over the longer term it's a going to be a burn.

Peter, when do we expect the final decision from CMS?

October I believe is when it is expected, Glenn.

Thank you, sir.

Okay.

Your next question comes from the line of Joanna Wuensch with BMO Capital Markets.

Please proceed.

Thank you and good afternoon.

Hi, how are you?

I'm curious how the recall of the S8 was communicated to the DMEs and the home-care providers, and if the patients are hearing about it through you or through them?

Well, we-- Kieran is on top of all of this, but we, concurrently with the press release, we have sent out an all-points bulletin: an email has gone out to everybody.

There will be blocking and tackling that needs to be done, but Kieran do you want to address that?

Yes, so we're working very closely with our customers and partners in order to help them understand the best way to enact the recall and how we can do this in the least disruptive manner.

We'll work with them to contact patients.

We've offered up the services of a third party to make it easier for them.

Basically we're going to do this in concert with our customers.

And as Peter mentioned, it's happened in concert with the announcement today and throughout the rest of this week we'll be in constant communication with them, helping them through the process.

Okay.

I know you guys don't like to give quarterly guidance, but given that this one is somewhat of a surprise to people on the street, do you want to comment given guidance and/or where street consensus is.

Well, I think it's fair to say that the quarter we're in will be a challenge.

I mean, there will be some holdover from the quarter just finished.

But when we look into the future, and I said a little bit about that in a strategic sense, like the 30,000 foot view, but I remain pretty optimistic, that we'll be back where we need to be in '08, Q1 going forward.

'08 -- we -- this market is not going away.

There's been some -- I think an aberration that's occurred here.

There might be a little bit of carry-over in to this quarter, but we're looking very confidently going forward.

We've got not go reason not to.

My final question is just a follow-up on something somebody asked before.

When you talked about responding at the end of the quarter and that you will respond appropriately, can you just explain a little more?

You're not going to get into a price war, you don't want to lie down at the same time and let people walk over you, but where is it in the middle?

Well, Joanna, let me respond to that by sort of a couple of anecdotes, but similar.

We lost a very large account with some discounting, and they came back to us, and we said, sorry, we just can't go there it's -- we -- see, the -- what we're trying to sell is value, and as you look forward, this is a business which is an annuity business.

It's not a one by one transactional business.

In other words, you're better off paying $50 more and putting the patient on an order-setting device, where we -- we pay for the clinical studies to be done.

We're getting better compliance with auto-setting devices, particularly at a level of ten centimeters of water or above, and we're saying, look, your real business is an annuity.

The patient can get a mask every quarter and you are doing the right thing by the patient.

By contacting the patient, first of all you find out if they are still using the product, that's kind of important.

And second, if they are, they can now get a new mask paid for, and it's better to put people on a new mask so that -- masks, don't last forever.

You might get a year out of it, but you are far better off renewing the mask, and that's where the real business is and we're trying to get people to understand that.

Some of them do and get it in spades.

Others seem more reluctant to pay the extra money.

But what we found that is successful in certain instances.

In this particular case, when we lost the business, because of the terrible experience they had in compliance going forward, the business came back to us within a period of six months.

There was another case, and it was a more recent case where we were dealing with a large potential customer.

There was a visit set up to come out and see us.

They called up and said, "Oh, look, by the way we have just been offered the following prices," and Keith, you can talk to this, and he said we're coming out to you for a strategic meeting, and Keith said "Don't bother coming.

Save your plane ticket.

There's no way we can go anywhere near this.

But if you want to partner with us and build the business and turn it in to a proper annuity and get all of the support and infrastructure that we can provide at a very, very high clinical level, then fine." and the people decided to come out.

And we have the business.

And we have the business.

So this is not an impossible thing, but people do respond to value.

And we sell value propositions.

It's no point coming us to and saying, "What's your best price on a Swift?" If you came to us and said what is your best price and we want 100,000, that's different.

But if you want just 50 or 60 Swifts or whatever, we say here is the price.

Terrific.

Thank you very much.

OK, Joanna.

Your next question come interests the line of Andrew Goodsall with UBS.

Please proceed.

Good morning, Peter.

Andrew, how are you?

Can you hear me?

Not too bad.

Not too bad.

Can I just ask, just with this recall -- obviously Respironics have also been through a recent recall themselves and I think they had about 170,000 units.

Just, I think they indicated the impact was sort of something below $5 million, but I think that might be earnings as opposed to the direct costs of the recall.

Could I just ask whether you think there's going to be some sort of earnings impact here, because certainly with Respironics we could see slower growth rate coming through from those guys, just -- I guess as an impact beyond the direct cost.

Andrew, their growth rates have traditionally been significantly lower than ours.

The market sort of expects around a 13%, 14% -- which traditionally where they have been.

We have been traditionally, at least in the U.S., significantly higher.

In the mid-20s or even mid-30s.

In fact, a year ago this quarter we were up 50%.

But in terms of slowing the business, their recall was 172,500 or whatever, but they were --

Yes.

So humidifiers as opposed to CPAP devices.

In this case, we're replacing the CPAP devices, we're not replacing humidifiers or anything else other than the device itself.

I don't know.

I mean, I'd have to sit down with them and talk about it.

I'm not sure they would be happy to do that.

I don't think something like that is going to impact the business significantly.

And you asked about earnings.

We're taking the full hit now.

Now it may -- my guess is we're being conservative.

We may have overprovisioned.

Time will tell on that.

We have done the numbers as accurately as we could.

We think that's it.

So, it's just this quarter and we're not anticipating any expenses going forward other than the charges we have taken on them.

Maybe just another way to look at it, do you think there will be much distraction for your sales force as a result of this?

Is it entirely banged out with by third party?

I guess just depending on when they're out there with their sales calls?

You can't expect zero distraction.

Because customers are going to want to know, "Listen, how are you guys going to handle this?

" We have a very robust communication procedure going.

We have already sat down with the third party who is going to help us on these recalls.

They have done them -- they have done bucket loads of these before.

We're dealing with -- we've sought advice from people who have done the DELL, Sony battery, so this, in fact, what we've been told they said' "Oh, this is sort of a Mickey Mouse recall, only 300,000." And we're thinking, gosh, how much bigger would you want it?

It's not as though recalls are unknown.

In the medical device industry, last year there were 600 of these, and at some point you stub your toe.

Bear in mind, this wasn't us.

This was something that was served up to us by a vendor.

Is your phone working there?

Yes.

Yes.

Can you hear us?

Yes.

I think so.

Is the phone on?

Hello, can you hear us?

Your speaker line is working into the main conference.

Oh, it is.

Okay.

Is your phone working, sir?

Yes, the phone is working.

Mine is just frozen.

Eric, you may want to disconnect him at the moment and debug that and move on to the next question.

We can come back to Andrew Goodsall.

I was in the middle of a conference call--

You may want to disconnect Andrew.

He's got a problem with his phone.

I don't think it's ours.

Your next question comes from the line of David Low with Deutsche Bank.

Please proceed.

Thanks very much.

You talked about responding to the pricing pressure from the competitor in the latter part of the quarter.

Just impressed to see that your gross margins actually improved on -- certainly the previous quarter.

Wondering if you could comment on what the drivers of gross margin were, whether it's because we saw Rest of World sales stronger.

I'm presuming when you respond to a competitors pricing pressure, you tend to reduce your ASP as well.

Right.

Well if you look at the geographic mix.

It was pretty much consistent.

Last quarter, the previous year-ago quarter, etc.

So, it wasn't associated with that.

It was more the mix -- we've got the Adapt SV is in there.

That just shows you that that's going quite well.

Wee tend not to-- if somebody comes through and says, "Look, we're being offered this price.

What do you guys --" we don't automatically say, "Oh, yes.

Okay.

We'll meet that.

Let's move forward." We sit down and talk to the customer and try to understand their value proposition and how we can add value.

While we do know that we're going to have to compromise to a certain extent, but it's not like -- we just don't go out and meet the price.

As you can see, we did do pretty well with the Adapt SV.

But still, at 62.3% gross margin, you can tell that we're not playing [doggo] here and just giving people any price they want.

Keith, you want to say anything?

No --

Over the three months, would it be fair to say that your gross margin in the last part of the quarter was weaker because you had to respond?

If we talk about gross margins going forward, I know you have given some guidance.

Is there any reason, given the experience we have seen with discounting over the last quarter or so, that you would be changing your views there?

We don't expect to fall out of the 60% any time soon.

63, 60 to 62%, we believe that that's a realistic -- being in the low 60s is realistic.

And we don't believe we're going to have to take any big haircuts to continue our business.

Okay.

Great.

Just one other question on the Tango, just wondering you talked about it being designed to take on the national accounts.

Would you be prepared to give us any feel as to what the time frame is to win an account there?

Is this something which i s purely in the lap of the gods and we might hear about next week.

Or are they specific contract ranges where you know the date that the Apria contract, or whatever is coming up?

No, it's a work in progress.

I mean, none of these things happen overnight.

We're not in any immediate negotiations for a big sale.

It's just normal part of business.

We'll be-- when contracts come up for bidding, we'll be in there.

That's how we always do business.

I guess the point that I would make is that with the Tango we're in a much better position to be much more creative with respect to price.

Because we developed the device knowing that we could be very competitive.

All right.

Thanks very much, Peter.

Okay.

Thanks, David.

This concludes our question and answer session.

We would like to turn the call back over to Dr.

Farrell for closing remarks.

Please proceed.

That's it.

I think I have talked myself out already, Eric.

Thanks very much for your help.

Thank you for your participation in today's conference.

This concludes our presentation.

You may now disconnect.

Have a good day.