瑞思邁 (RMD) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2011 ResMed Inc.

earnings conference call.

My name is Jeff and I'll be your operator for today.

(Operator Instructions).

As a reminder, this conference is being recorded for replay purposes.

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 markets for the Company's products.

These statements are made in the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995.

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

These factors are discussed in ResMed's SEC's flings such as Forms 10-Q and 10-K which you may access through the Company's website at www.ResMed.com.

Finally, when asking questions, please limit yourself to no more than two questions and if you have more place yourself back in the queue.

With that said, I would like to turn the call over to Kieran T.

Gallahue, ResMed's President and Chief Executive Officer.

Mr.

Gallahue, go ahead, sir.

Thanks, Jeff.

Well, good afternoon, everybody, and thanks for joining us on the call today.

As with our previous calls I'm going to begin with some summary remarks and then turn the call over to Brett Sandercock our Chief Financial Officer to go through the numbers in more detail.

We will then take your questions.

Well, if any of you have seen the press release we've had another solid quarter.

Global revenue in the first quarter grew 14%.

We are up 17% on a constant currency basis.

Revenue in the Americas grew by 16% year-over-year.

Rest of world revenue increased by 13% and in constant currency terms grew by 19%.

We had a very robust quarter in Asia Pacific and the growth in Europe was remarkable as well.

Gross margin was 61.7% in Q1 benefiting from the continued success in leveraging in manufacturing and logistical cost efficiencies across our global organization and also due to positive ForEx impacts.

Our focus over the past several years of continually improving our costs while also maintaining our market leading innovation has been paying dividends.

We reported very strong bottom line results, GAAP EPS increased 33% to $0.36.

Excluding amortization of acquired intangibles EPS was $0.37.

Cash flow from operations was $59.1 million.

Demonstrating our continuing commitment to strong operating performance and earnings.

And a commitment to working capital control.

We also experienced growth across all product categories.

Global flow generators sales were up 15% or 19% in constant currency and the mass segment grew 13% during the quarter, a 15% increase on a constant currency basis.

Globally, the sleep therapy devices was mainly driven by strong sales in our new S9 Autoset and S9 Elites.

Sales of Americas flow generators were up 14% year over year in Q1 and sales in ROW were particularly strong, growing at 22% in constant currency terms.

Led by growth in France, Germany and Japan.

S9 Autoset and S9 Elite, as well as the Autoset CS2 products, saw solid growth in these countries during the quarter.

Toward the end of the quarter, we launched the S9 Escape and the Escape Auto to round out the offerings from basic to enhanced CPAP and APAP with our S9 series.

It appears that the value proposition focusing on comfort, appearance and design that fits the bedroom is having an effect in the marketplace.

In addition sleep labs in the US and Europe continue to install the VPAP TX and TX link systems, ResMed's all in one solutions for sleep labs.

During the quarter, we announced the results of a 50 patient clinical trial which demonstrated that patient's compliance with sleep therapy increases when using the S9 series.

The study showed an improvement of 30 minutes in average daily usage from a mean of 6 hours 35 minutes on a patient using their usual CPAP device to 7 hours 5 minutes when using the S9 series.

These data may be critical to customers who need to get patients over the 4 hour a night compliance criteria from payers such as Medicare.

The clinical data was statistically significant when combined with customer feedback showing that the S9 series helps customers drive increased adherence to positive airway pressure therapy.

In the mass category, we believe we continue to take market share in both new patient populations and the installed base.

Mass sales grew 17% in the Americas and in constant currency terms 13% in ROW.

The Swift FX is doing very well.

Feedback from the market has been outstanding.

It is particularly popular in combination with the S9 as a combination where the slim tubing and a comfortable interface is focused on improving compliance.

During the quarter we launched the Swift FX for her, drawing on the strengths of the Swift LT for her, the Swift FX for here is even lighter, softer, and is more streamlined than ever.

Its gentle fit and size range is customized to suit women.

It has soft wraps that enhance comfort at the cheeks and a minimal design creates a feeling of freedom and yet it is extremely stable even at high pressures.

We also launched a Quattro FX full face mask this quarter in Europe.

A new and smaller model, Quattro FX provides an effective alternate to conventional full face masks.

Only covering the patient's mouth and nose the Quattro FX mask offers unrestricted view giving patients a clear line of sight.

New technologies incorporated in the contoured cushion membranes of the spring air cushion and the spring frame enables the same level of stability and angular adjustment as provided by the forehead support of conventional full face masks.

New headgear design featuring a contoured crown strap at the top of the head further contribute to patient comfort by avoiding the sensitive area around the neck.

With respect to home sleep testing, ResMed continues to be committed to supporting and partnering with our sleep physician partners as they evolve through this transition phase.

The IDTF's and a few well funded independent firms remain the primary early adopters of HST and we expect them to continue to invest in expanding this category.

Insurance companies continue to pilot programs as well.

The number of lives covered under HST reimbursement now has reached about 83% of lives.

Some major payers are beginning to experiment with HST mandates by requiring preauthorization on a regional level.

We believe that HST will play a major role in future market penetration.

We also expect growth result from the continued improved awareness and validation of the critical role that sleep disorder breathing plays in the very serious, most rapidly growing and most costly diseases in the world, cardiovascular disease and diabetes as well as stroke and obesity.

Increasingly there is evidence coming to light that early intervention and the treatment of STB may slow or prevent the progression of these comorbidities.

On the clinical study front, we have enrolled 600 patients in our SERVE-HF trial in Europe.

We are halfway to our enrollment goal of around 1,100 to 1,200 patients.

The end points of this study are reduction in mortality and hospitalization in heart failure patients.

Externally, a recent study by Dr.

Ian Wilcox, Department of Cardiology at the Prince Alfred Hospital in Sydney, demonstrated that the most serious complications from STB are cardiovascular.

Including arrhythmias, systemic and pulmonary hypertension, coronary disease, heart failure, stroke, and sudden death.

As reported on newyorktimes.com just this October, a 60-year-old woman with dementia under the care of Dr.

Ronald Petersen, an Alzheimer's specialist at the Mayo Clinic started STB therapy.

She rapidly improved and her neurophysiological tests returned to normal.

There are other studies that are being done to investigate whether STB therapy might help reduce the cognitive damage from Parkinson's Disease and even relieve migraines.

As a reminder, in the past two quarters we shared with you that the NIH data demonstrated increased risk of stroke in patients with OSA and the Gottlieb study showing the association of OSA and the increased risk of incident heart failure.

What that means is we have continued evidence that is being generated in the public press and in the general press that supports the continued expansion of the STB market place.

We also stepped up our initiatives in the education of primary care physicians.

Cephalon has recently joined ResMed and Phillips in an investment in primary care education on sleep apnea.

The programs are designed to help primary care, family practice, internal medicine physicians, nurse practitioners, and physician assistants better understand how to identify and treat patients with OSA.

Participants learn about symptoms of sleep apnea, screening, implementation, diagnostic pathways, therapy and the latest research on mortality and morbidity with untreated sleep apnea.

This is the second year of investment for Phillips and ResMed.

Cephalon's participation is new and it's exciting because it allows our investment to reach up to 10,000 physicians.

The program's goal of educating 7,200 clinicians was surpassed in the first year with more than 7,800 participants.

Prior to participating in the program 40% of the surveyed clinicians felt confident in recognizing the signs and symptoms of sleep apnea.

After attending the CME program, 85% felt confident in their ability to assess and recognize sleep apnea signs and symptoms.

In summary, Q1 once again demonstrated the strength of our global reach and balanced business while providing very positive signals for sustained industry growth as we move forward.

Our product flow is robust and customer meaningful and demonstrates that our commitment to innovation is paying dividends.

Now, I will turn the call over to Brett for some additional detail on the financials and then we will take your questions.

Brett.

Thanks, Kieran.

Let's briefly run through our September quarter results.

The revenue for the September quarter was $292 million.

That's an increase of 14% on the prior year quarter.

Unfavorable currency movements reduced our first quarter revenue by approximately $7.7 million.

In constant currency terms, revenue increased by 17%.

Income from operations for the quarter was $66.4 million.

An increase of 26%.

And net income for the quarter was $56.7 million, an increase of 35% over the prior year quarter.

Diluted earnings per share for the quarter was $0.36, an increase of 33% over the prior year quarter.

Gross margin for the September quarter was 61.7% up sequentially from Q4 FY '10.

On a sequential basis our margin benefited from favorable currency movement, favorable product mix and margin improvements from new products.

Looking forward it's joined by an impact on the gross margin.

It should be relatively neutral in Q2; however, the impact from the recent appreciation of the Australian dollar will be reflected in our cost of sales in Q3.

And this will have a negative impact on our gross margin.

Of course, this could change if there are no further significant movements in either the euro or the Australian dollar.

In the meantime, we will continue to execute on initiatives targeted on improving our global manufacturing and logistics cost structure.

SG&A expenses for the quarter were $84.8 million, an increase of 10% over the prior year quarter.

In constant currency terms, SG&A expense have increased by 12%.

The increase in SG&A reflects expenses to report sales growth as well as activities targeted at increasing the awareness and diagnosis of sleep disorder breathing.

SG&A as a percentage of revenue improved to 30.1%.

Compared to the year ago figure of 31.1%.

Looking forward and subject to currency movements, we expect SG&A as a percentage of revenue to be in the range of 30% for fiscal year 2011.

R&D expenses for the quarter were $19.7 million, an increase of 10% over the prior year quarter.

In constant currency terms, R&D expenses increased by 6%.

R&D as a percentage of revenue was 7% compared to the year ago figure of 7.3%.

Looking forward in a current exchange rate we expect R&D expenses as a percentage of revenue to be in the 7% to 8% range for fiscal 2011.

Amortization of acquired intangibles was $2 million for the quarter.

And stock based compensation expense for the quarter was $8.4 million.

During the quarter, we also donated $1 million to the ResMed foundation.

Our effective tax rate for the quarter was 25.9%.

We estimate our fiscal year 2011 tax rate will also be in the vicinity of 26%.

Turning now to revenue in more detail, overall sales in the Americas were $155.6 million, an increase of 16% over the prior year quarter.

This was driven by strong growth in both flow generators and masks with strong contributions from new product releases.

Sales outside the Americas totaled $126.4 million.

An increase of 13% over the prior year quarter.

As expected, sales outside the Americas were negatively impacted by currency movements.

In constant currency terms sales outside the Americas increased by 19% over the prior year quarter.

Breaking out revenue between product segments, in the Americas, flow generator sales were $74 million and increase of 14% over the prior year quarter.

Masks and other sales were $81.6 million, an increase of 17%.

For revenue outside the Americas, flow generator sales were $87.8 million, an increase of 16% over the prior year quarter or in constant currency terms an increase of 22%.

This growth was driven by strong sales of our S9 flow generator platform particularly in our pre French and German markets.

Additionally we experienced robust growth in the Asia Pacific region, particularly in the Japanese market.

Masks and other sales were $38.6 million.

An increase of 6% or in constant currency terms an increase of 13%.

Globally in constant currency terms flow generator sales increased by 19% while masks and other increased by 15%.

Cash flow from operations was $59.1 million for the quarter reflecting strong underlying earnings and working capital management.

Capital expenditure for the quarter was $15.3 million.

And depreciation and amortization for the September quarter totaled $15.6 million.

During the quarter we also acquired certain business assets and intellectual property from our existing mask head gear supplier.

This acquisition will enhance our ability to develop and integrate our headgear technology, streamline our supply chain and improve our cost structure.

We continue to buy back shares as part of our capital management program.

During the quarter we repurchased, on a post split equivalent basis, 592,000 shares for consideration of $17.9 million.

As of today we have approximately 13.8 million shares remaining under our current authorized buyback program.

Our balance sheet remains strong and conservatively geared.

We increased our cash balances during the quarter to $540 million at September 30.

This was the result of our strong operating cash flow together with a favorable impact from exchange rates changes on our cash balances.

This impact alone increased our quarter end cash balances by approximately $59 million.

At September 30, total assets stood at $1.8 billion and net equity was $1.5 billion.

I'd now like to hand the call back to Kieran.

Great, thanks Brett.

Jeff, why don't we open up for questions.

Absolutely.

(Operator Instructions) Our first question comes from the line of Andrew Goodsall with UBS.

Please proceed sir.

Thanks very much guys.

That is a terrific quarter.

And good leverage coming through.

Could I perhaps ask on the leverage, just with the currency headwinds Brett was taking us through coming up in the third quarter, how much space, I guess you have got to match that up against?

And I guess second part of the question, just obviously some of those growth numbers we were directly correlating with the launch of the product.

So just how closely the growth is tracking those launches and I am leading into what you are seeing with this new entry level product?

I am sorry, Andrew, I didn't really understand the first part of your question.

Can you--?

Yes.

I just, Brett said, obviously currency, the third quarter has some margin headwinds.

And just trying to understand how much leverage you have got with the -- with transferring manufacturing to Singapore?

And with the lower costs of manufacturing?

Got it.

How much can you match that off, I guess?

Well, look, I think what you have seen us do over the last couple of years has been to continually focus on a number of things.

Trying to drive operational efficiencies throughout the entire business, trying to create some business continuity opportunities by expanding footprint in manufacturing.

And trying to do the design products that not only bring greater advantages to both patients and to customers but also, have the ability to design cost out of the system.

Either in the product itself or in the way that we manufacture the product or the way that we distribute the product.

And it has been a -- and I think the team has made an enormous amount of progress in each of those areas.

Singapore itself, it is not like we get a tremendous amount of cost of good reductions by balancing the production in Singapore.

You get a lot of profitability improvement because as you can see from our effective tax rate over the last several years we've been able to have a substantial improvement in our effective tax rate.

So it becomes a very profitable exercise while at the same time leading to the strategic advantages of diversifying the manufacturing base and also having a base of operations to manage the aging supply chain.

So I think there's a lot of things that are in there as part of your question I think it is important to highlight.

Our focus on designing products to improve value, of improving margin, have all been the part of our ability to drive improvements on the gross margin line.

Certainly, there is some periodic offsets one way or the other.

Either headwinds tailwinds coming out of FX, not a lot you can do about it.

Although I will say that over the last couple of years we reduced our exposure.

Certainly with the -- some of the costs that are in Singapore being a little bit more closely aligned with the US dollar.

And a lot of our contracts that we've purchase products in we have also moved towards US dollar denomination on those contracts.

There is multiple aspects to that have given us flexibility and allowed us to carry through as we look forward.

Brett, do you have anything to add to that?

No, you summarized that well, Kieran.

To my mind, the key is for us to continue to work on our cost out initiatives.

We're taken a fairly holistic approach and really attacked it across the whole spectrum of those cost initiatives through manufacturing, logistics in a lot of areas.

And we're working through on a continuous, improvement basis.

Certainly from a currency and a headwind perspective it will have an impact for sure, the strengthening Australian dollar at that sustained level.

Some offsets though, obviously, the euro has strengthened recently over of that period of time so that will help to mitigate that impact to some extent.

We'll look to drive our cost structure as hard as we can feasibly do that and help mitigate some of those headwinds on currency.

And as you've seen over the last few years.

It tends to ebb and flow.

And a headwind turns into a tailwind pretty suddenly sometimes.

We just keep doing the fundamentals--.

--and the currency will look after itself.

Sorry.

While I have got you, Brett, the hedge contribution to this quarter?

Yes, you'll see that coming through other income on some gains we made on our hedging structures which we do mark-to-market.

So that basically brings those gains forward if you like when you mark-to-market.

That was $5 million this quarter.

Okay.

And the net effect after the negative $7.5 million, I think it was.

Yes, if you look -- if you roll through all the currency impacts throughout the lines of P&L and you come down to EPS, even on net basis including those gains.

It was adverse.

Year-on-year impact is by about $0.03.

Okay.

Terrific.

Thanks very much, guys.

Our next question comes from the line of Ben Andrew with William Blair.

Please proceed, sir.

Good afternoon, guys.

So thinking through a couple of things in terms of following up with the currency.

It was a $0.03 then headwind to the bottom line, Brett, is that right?

That's right.

If you think about currencies holding steady here.

Do you have any projection for what it would do in the second quarter or for the balance of the fiscal year?

If you look at what currencies, where they are.

And you look through, Q2 would be relatively neutral, Q3, with the Australian dollar up around that AUD0.98 level and through the quarter it is AUD0.97, AUD0.98, I think it has been reasonably significant.

And if you look forward to that it is probably 100 basis point impact, if you look forward through the back end of the year.

That is assuming both year-end and all are pretty consistent through the period.

100 basis points where?

In the gross margin or?

In the gross margin.

Okay.

So, you have obviously been doing a pretty good job of late offsetting those dynamics with mix and like you said before manufacturing efficiencies, et cetera.

Kieran, is there further to go on that front because I think everybody is worried about mix and competitive bidding and all those things Are you seeing any pressure on mix at all?

Or do you anticipate that or a slowdown on some of those efficiency gains over the next several quarters?

Not at this point.

It's always hard to forecast the future right?

But the -- we have seen continual interest in our high end devices, particularly the AutoSet range and the Elite range.

Because you have offsetting factors, right?

I mean I think the primary drivers over there are people are focusing on compliance.

They like the ability to have devices with communication with data.

There is the sense and feel as I mentioned in that study that we have done internally, which would suggest the S9 is leading towards greater usage per night which for people that are on the bubble of are they compliant or are they not, it could be meaningful for an HME to get paid.

So I think at this point, we've certainly have been helped a bit by mix, and let's not just focus on the US too.

We can look around the world and I think it's important for us to always remember that we're a balanced business.

And I think this was a great quarter to demonstrate that because we had really fantastic growth in markets around the globe.

And some of that growth was S9 related.

Some of it was Mask related.

Some of it was ACS2 related.

We have markets like Japan where we are making really significant strides and we're seeing things like cardiologists that are using adaptive servo-ventilation and they're putting them on heart failure patients in acute care settings and that's in Japan.

And obviously you're not seeing that yet in other parts of the world.

So there's multiple factors that have led to benefits that we see in the mix.

Just briefly on the competitive bidding dynamic.

Any additional insights versus your comments historically?

Are you assuming that you are going to see a negative mix through that or some additional price.

I know you don't guide.

But is that just a realistic thing to think about as we get into 2011 or is there just no way to forecast at this point?

I think it is real hard to forecast it.

Because it is like for instance, when the original compliance requirements came out.

There was a lot of is this going to be a challenge for you?

Is this going to cause problems?

Is this going to slow the markets?

When in fact, it was one of the better things that happened.

Many times, you have these unintended consequences and we still have home sleep testing which is rolling out and as that continues to it spread itself throughout the country then the opportunity for improved mix associated with that because AutoSets will likely be an important part of the mix there.

So at this point competitive bidding.

You probably have heard that they haven't gone through the full strokes of implementing it.

There were some delays.

We still model and figure that those 9 MSAs will go live.

But you have a lot of push back.

You probably have seen the economists including nobel laureates that have written and said that the competitive bidding process is flawed.

So there is probably going to be a lot of water to flow under this bridge before we get through the next two years and it extends to test markets number two.

A lot of things have to happen in the market.

Great.

Thank you.

All right.

Our next question comes from the line of David Stanton with Nomura.

Please proceed.

Good morning, guys.

Thanks for taking my call.

Just wanted to ask Brett a bit more about the other income.

Can he explain what is driving that high and unexpected, for us anyway, increase in other income and what we should be thinking going forward?

Thanks.

Sure, David.

So and the other there -- around $5 million is on currency gains and predominantly on our hedging structures which we, under US accounting, we mark-to-market.

So that was gain was really driven by the strong appreciation of the Australian dollar late in the quarter.

If you looked at it, if currency stayed, and if you looked at it going forward if currency stayed exactly where they were, then our mark-to-market would be pretty similar amount and therefore, the gain or loss on that would be negligible running through the next quarter.

Great.

Thank you.

Yes, if you want it to continue to go up, then obviously we would continue to gain on our hedging structures.

Right.

Thank you.

And then finally, just was wondering if you could perhaps give us more color on the split it between mix and currency and manufacturing efficiencies that has led to that gross margin increase of 193 basis points sequentially?

Thanks a lot.

Brett, you want to take that?

Yes, on the fact that we mentioned there.

They all contributed to that margin expansion.

Yes, so I think to give a little bit more color to that.

We saw that each of the categories, whether it is mix, whether it was cost improvements that we have seen in the manufacturing process and the way that we are negotiating contracts as we gain scale and gain volume all of those across the board have their own impact and carry through in the margin lines.

So we're real pleased with the way it seems performing and driving towards protecting and growing margin.

Just a quick follow up.

So you think it's about -- they are all equal?

A third, a third, a third, mix, currency, and manufacturing?

In each of those.

Yes.

If you looked at -- I wouldn't put it quite simplistically like that.

But if you look at each contributing in a meaningful way to that expansion and separating them out, some of them, the margin improvements in the product mix, some of that will be as a result of new products as well.

So it's a whole bunch of factors there, David, to try and tease out.

So but certainly they each contributed in a meaningful way to that margin expansion.

Thanks a lot guys.

Thank you.

Next question comes from the line of Joanne Wuensch with BMO Capital Markets.

Please proceed.

Thank you very much for taking my question.

I am sorry to beat a dead horse here.

But of the 61.7%, did you say 70 basis points can be attributed to FX?

Joanne, we don't get into specific detail of breaking it out.

Because when we look forward, there's always a lot of contributors to gross margin.

What we can say is that when you look across -- and this is in the same way we've always answered this question by the way, and we need to be consistent on that.

Is that when we look across it, there was positive contributions from mix.

There was positive contributions from cost savings.

There was from the design of the product.

We really felt it across the spectrum.

And Brett, do you have anything more beyond that?

I mean, that's right, Kieran.

It is really the whole bunch and in the mix.

And they get geographic mix as well, clearly, highest pay is an impact and so on.

So there's a lot of factor that go into that gross margin and really those ones that we spoke about today are the ones that were driving the expansion this time around.

Forgive me if I missed this.

You said SG&A for the year would be about 30%, R&D about 7% to 8%.

Did you say what you thought gross margin for the year would look like?

No, I don't think we got to that level of detail.

We are in that range, that 60% to 62% range that we have stated in the past.

I think we continue to feel comfortable with that.

Shifting topics if that's okay.

Home sleep testing, you talked about some progress being made there.

Do you think you are at a tipping point on that?

Yes, that's a good question.

It is always hard -- I think tipping points are usually best identified in arrears.

I think that we are very comfortable with the way it's been rolling out.

And we still feel that the way it has progressed has been really the way that we'd anticipated and the way that we are comfortable, quite frankly.

So we're seeing across the country, that sleep physicians are more and more becoming engaged in asking questions and seeing that home sleep testing can be a viable pathway for them to integrate within their patient care models.

The real disrupters, I suppose you would say it, has been the IDTFs and these independently, and well funded home sleep testing providers that are on their own track.

And some of which are addressing or -- speaking directly with primary care physicians is an example, either directly or through distribution.

So they're creating greater awareness within the medical community.

They're creating greater engagement among the medical community.

And that really filters back to the sleep community, and I think the sleep community rightly wants to maintain a heavy amount of involvement because they are very important members of treating patient population.

So, I think you are seeing that shift.

I don't know how I define tipping point other than I think when some of the big payers get to the point where they say that home sleep testing as moved from a you can do it to a you must do it, then I think that would probably be the biggest definition of the tipping point.

Right now, they're experimenting with it.

They've got pilots that some of the large ones had in different parts of the country.

For however long they want to run those pilots, they will tweak them a bit and they'll make their decisions about rolling them out more broadly.

So it's all progressing well.

I would say that the growth that we will experience from home sleep testing is ahead of us, not behind us.

Terrific, thank you.

Great.

Next question comes from the line of Matthew Prior with Merrill Lynch.

Good morning, Kieran and Brett.

Just a first question in terms of competitive bidding, and the nervousness that you guys receive questions on daily from the DME channel.

Do you think that growth presently is somewhat depressed by that nervousness and if there was more clarity and certainty around competitive bidding going forward?

That you'd actually see a high industry growth rate that you could benefit from?

That's a really good question.

And whenever it gets to questions around industry growth rates.

It is just such a hazy area to make specific assertations on it.

But you do get the anecdotal feedback, you do get the gut sense from spending a lot of time in the field and in these conversations.

Competitive bidding is on the minds of some and not on the mind of others.

And this is a market that we are always dealing with some level of opportunity to grow volume and also where you are going to get into negotiations with HMEs.

So sometimes it's brought up more than anything else just as today's negotiating tactic works versus tomorrow, they will use some other negotiating tactic.

So, I would say, the industry, you don't feel a panic out there at all.

I think people recognize it is only in test markets and if full implementation comes and that is certainly an if, that it won't happen until 2015.

And I think when they think about it, they tend to think more about the parts of their businesses that are dominated by Medicare.

We, in the US a good 80% or so of the market is non-Medicare for sleep versus for oxygen or for other types of the devices that they may sell, it is a higher percentage.

So what you tend to have is, certain players will express concern and in fact, it may slow their desire to expand or think through what they're doing, it is quite possible.

And others look and say if it is going to get difficult, I need to grow my way out of this.

How am I going to grow and that leads to a good business discussion.

And that's what we train our reps to do, is to take the discussion towards what are you going to do about it.

And how are we going to grow our way out of it.

Because really the only ways to address it are to reduce labor content.

Which is why we always position our products appropriately as having benefits and non-value-added costs because it is easy to get people compliant, et cetera.

As well as talking to them about replenishment and supply.

And how do you provide better patient care in a way that also happens to have an economic advantage for the HME?

It really opens the door for a business conversation.

Right.

And just the second question, if I may.

Just in terms of the S9 Escape being launched late in the quarter.

As far as the margin contribution from flow generators and what we can expect from the second quarter and I think you can tell from the question, that I'm going to try to sniff out what that trajectory is as far as the second quarter being stronger gross margin and then tapering in Q3 and Q4 with FX pressures.

With the launch with the S9 Escape which would be -- and I am happy to take guidance here as far as the dominant product in any S9 category and clearly at a superior margins of prior products in the flow generator space.

I guess with more growth coming from flow generators what surprised me in this quarter was that mask sales are also holding their own without necessarily massive product releases as being comparatively as the S9 is in a flow generator sense?

Can you talk about how that mix is holding so well in masks and whether or not you expect the S9 Escape's contribution in the second quarter to be accretive to margin.

As far as the Escape being accretive to margin, it is really tough to get into any level of detail.

It is depending on what country.

And what is the mix between that and some of the other flow generators and a whole bunch of things.

There is a margin improvement with the S9 line versus prior.

So there is benefit that's associated with it.

As far as the mask is concerned, we have got darn good mask products and we have an organization that is experienced at selling those mask benefits as we roll out products like the new full face mask.

As we roll out products such as the FX for her.

These are meaningful products.

They are differentiated, they're targeted toward benefits that can be experienced both by the patient and by the healthcare provider.

Whether it is a sleep lab or an HME because they help in gaining compliance and acceptance of the technology.

And we are having those business discussions.

We are talking to them.

And we have got a whole group that is focused on resupply that helps provide consulting services if you will.

Helps provide guidance to customer to help them build their resupply.

Because we want them to be successful, because it helps patient care and it helps all of us as we move forward.

I am not surprised to see the mask holding there strong.

Because I think the team does a good job on them.

So you're happy the S9 and the S9 branding if you will, also has a cool-off effect on the market category.

Because of the noise around the new flow generator platform.

I don't know.

It is always hard to measure that.

But I will say that normally when you grow through a successful launch, it does help across the product categories.

So, it is possible you get a little lift out of that too.

Sure.

Thank you.

Our next question comes from the line of Ian Abbott with Goldman Sachs.

Thank you very much for taking the question.

Just had a question around pricing.

Each period you do talk to some price deflation, just wondering what you are seeing this perios and what the outlook for that is?

Well, as we normally say.

We expect in this marketplace on an annual basis, you see somewhere around 5% price in the market and sometimes it is a little hotter and sometime it's little softer.

I'd say we continue to see that across the marketplace.

It tends to be spotty.

You will find some reasonable customers here, maybe a large customer there, a series of small customers where you will start seeing price movement and then it will tend to spread across the market.

That is pretty typical.

This marketplace has relatively inefficient pricing.

You don't normally see everything switching overnight.

You tend to see it in a wave.

And that's why we tend to talk in those rounded numbers.

Sure.

And is it particularly not particularly hot given competitive bidding or is there any impact from that?

I don't think that competitive bidding is driving anything hugely abnormal.

We've got some accounts where it is pretty price aggressive and we respond when we need to and with we have other accounts, where they have been holding steady.

Price is always one of the things where you are in negotiations on a constant basis.

That is not going away.

Are we feeling some price pressure?

Yes.

I probably would have said the same thing a year ago if you asked.

Can I also ask around just in Europe?

You mentioned you've called out a couple of good results from Germany and France.

And certainly, there is a lot of talk around austerity measures in western Europe what has een your experience there?

We are very pleased with the performance that we are seeing out of the team in Europe and we are very proud of the team for what they have been able to accomplish.

And how they have been able to address customer needs.

We are seeing that right now the market seems to be holding itself in most of those countries.

Maybe smaller countries in our marketplace such as the UK, you might be feeling it a little bit more.

But it is a small country for us really.

The reason we key on the Germany's and France's are those are by far the largest markets that we have over there.

And I think in part, it is -- with the exception of the part of our business in Germany.

And it is part of the business where we are an HME, we sell to intermediaries, right, we sell to HMEs, and so what we tend to see is that there can be a decoupling of what we experience versus what they experience.

And sometimes what we experience is more driven by developments within the industry and competitive activity than it is directly from the payers.

And then you mentioned, also, just in some of the other markets, you called out Japan, are there any other newer markets outside of western Europe and US that you've seen particularly good growth?

Absolutely.

It is just that the materiality of them at this point is not great.

We are very active in India, we're very active in China, we're very active in Brazil.

In India, we have three different business models that we are working on and experimenting with and growing.

We have got a real solid team in China.

Our Latin America team is just excellent.

So, absolutely.

We are in developing economies.

Or developing markets around the world.

Iit is just that from a materiality at this point, you can get really big percentage growth numbers and it doesn't really move the total bottom line of the Company in the short term anyway.

I would say we're very excited.

As we look to the future of those marketplaces, we are very excited about it.

Both in sleep and in ventilation.

Because in ventilation, particlarly you are going to see in a lot of those marketplaces, they build out the infrastructure.

We think there is substantial opportunity to grow both during the time period of infrastructure development.

But also you look at the prevalence of diabetes.

Let's say in India.

And you find that SBB tracks those diabetes numbers, could be very closely.

You find COPD, in these areas where you have heavy smoking where your occupational health standards are certainly not what we would consider safe.

They are certainly going to lead to some long term respiratory issues.

These are big opportunities as we look forward.

And so we are taking it seriously.

In India, we brought our distributor last year in order to really get them out of the channel so that we can experiment with these different business models.

We spent time in those markets.

We've got very talented individuals.

So we are excited about the future of those developing economies.

Thank you very much.

You bet.

Our next question comes from the line of David Clair with Piper Jaffray.

Please proceed.

Good afternoon, everybody.

I guess, a lot of the questions have been asked already.

But maybe you can give us a little bit of color on the headgear acquisition that you made.

And is that what we should think of as far as the use for the cash stockpile that you have now?

Is it primarily looking at vertical integration and just talk about that?

Sure.

Classically, well, first of all, we don't put boundaries on the M&A side.

We have always been very clear that we have a high bar when we make acquisitions.

We recognize a lot of M&A could be very distracting and when we look to opportunities we look to see if we can more quickly expand our current markets or be able to enjoy the benefit of adjacencies where we can bring something to bear.

And where we get something significant out of that acquisition.

So what we've said and we continue to believe is that patience is critical.

When we move, we will move with great consideration.

And with great deliberation.

And, but, we are very careful not to let money burn a hole in our pocket.

This acquisition, I think in some ways you can think of it similarly to the way that when we acquired our motor manufacturer back eight years ago.

We bought the assets of a significant portion of this company in order to gain strategic control over an important asset.

There is an element here where it is certainly very controllable because it's within our supply chain and something we are very familiar with.

It's the technology we are very familiar with.

What this is going to allow us to do is to better integrate the design of those products with our design teams.

So, that we can with the objective of accelerating innovation and improving innovation that we can bring it to the marketplace.

And again, we reflect back on the motor acquisition, we said that's exactly what happened.

Our competitive advantage on the flow generator side is multifaceted but certainly the Easy-Breathe motor technology that the initial versions that underpin the SA2 and developed through into the S9 series have allowed us to have a competitive advantage.

I can assure you it was the integration of the design teams both on that component as well as the full system which were a key element of enablement.

Our objective is to bring that same enablement to the headgear and the mask category.

Then on the two new masks that were launched, I think the Quattro FX is just in Europe, is the Swift FX for her is that worldwide.

And when are we going to see the Quattro FX in the States?

We will periodically launch a mask in a certain region of the world and then we'll extend it over time, particularly as we build capacity.

For competitive reasons we are not giving a specific date on the Quattro FX.

It's a great product.

It's rolling out well.

We're very, very pleased with how it is coming out of the gates.

And it is not it going to be too distant in the future that you are going to see it on a global basis.

We are not going to get more specific on that as I am sure you can appreciate.

And yes, on the Swift FX, it is a great product that has worldwide application.

Congratulations.

Next question comes from the line of Saul Hadassin with Credit Suisse.

Please proceed, sir.

Good morning Kieran and Brett.

Kieran, a question for you.

Last few quarters you seemed to be growing well ahead of system or industry growth.

Can you talk about competitive dynamics and any responses that you are seeing from either Respironics, and indeed, Fisher Paykel with their new platform due to be released or released?

I think a lot of the industry dynamics, in some ways I call it classic, flow in the market so if I start with the second part of your question first.

F&P is launching their new device series.

And that has been in fits and starts over the last couple of years and we saw it roll out in other parts of the world quite some time ago and now, it seems to eventually be here in the other markets.

Products like that, I would expect they will get some trial in the marketplace.

I think most customers like to dip their toe in the water, different things, and give it a try.

I don't like to speak too definitively about competitor products.

I think that's for them to talk about.

I will say that we remain very, very comfortable with our product line up and our sales force remains very, very comfortable with our products and technologies.

So, I think enough said on that.

As far as other dynamics, Respironics or Phillips remains a worthy competitor and collaborator.

We appropriately work together where it's on industry growth initiatives, such as with Cephalon in this PCP education.

Which we're all very excited about.

We think it is the right thing to do to engage more primary health care physicians, help them understand the therapy, help them know what to look for in the diagnostic process.

And it makes more sense to have a common message.

So we are not confusing and in fact, we can build on each other's investment.

And that helps everybody.

All the competitors in the marketplace and all customers.

That is the right thing to do.

Other than that, you see the standard industry things.

You are fighting daily battles, you have different positioning and counter thrusts on positioning.

You have pricing discrimination on different accounts.

You have -- I would say the classic way of looking at the market.

If I can, just one question to follow.

You didn't mention anything about the ventilator space.

I'm wondering if you can give us an update on what is happening in that sub-category of the market with the same product?

Well, it is almost getting to the point where we are referring to the system product is outdated because it has been far enough integrated with -- I appreciate what you are saying, but it is far enough integrated into the business that internally we don't refer to it that way any more.

It is another series within the ResMed's product line.

Those products are doing well.

And the teams are doing well as we continue to continually improve them.

Our quality levels in that segment have improved dramatically.

When we first took over that business, there was substantial challenges that would be very natural for a Company of the size that was acquired.

And I'd say in a lot of ways they've been ResMedized.

We are seeing very positive improvements and quality therefore, in the customer response associated with it.

We're building the capabilities of the organization in different parts of the world.

Japan being an example.

And we have a good pipeline of products that we'll take it to the next generation that will be as we get closer to release of different flavors that we will give more guidance on.

So we are feeling good about that sector.

It is an interesting sector.

It is still obviously very respiratory related but it's an overlap and extend policy for us that gets us into other areas within the marketplace.

It plays well with our bilevel products and just above it and it starts to help address not only obesity hyperventilation but gets us into some of the areas of COPD where it gives us a great opportunity to learn and continually develop solutions for what is one of the most costly comorbidities or morbidities on the planet.

One that we think over time we are going to be able to bring some really both clinically and economically advantageous solutions to.

Thank you.

You bet.

Our next question comes from the line of Joshua Zable with WJB Capital.

Congrats on a nice quarter.

And thanks for taking my questions.

Most of them have been answered but just a couple of follow ups.

I've been jumping around here on calls and I know people were asking about the gross margin.

I am just trying to get it clear on it just as far as the guidance for the year, are you just effectively -- I know you are trying to give us the right way to think about it.

And we appreciate that.

But just in terms of gross margin for the year, is it effectively the same, it's just moving around in different ways?

Yes.

This is always a tough thing because there is so many different influences in gross margin.

We've always said that you've got geographic mix, you've got product mix, you've got currencies, and there are a lot of different things that go into how the gross margin moves a little bit up or a little bit down.

Which is why, as Brett said before we just focus on the fundamentals and just keep driving improvements in product mix, improvements in our cost profile and in our manufacturing base.

So getting more specific than I think what we said.

In the past, we've said we think we are on that 60% to 62% range.

We are still comfortable with somewhere in that range so at this point I don't think that we can give any more definitive guidance on that.

Brett, would you agree?

I agree, Kieran.

A lot of the factors are somewhat out of your control.

And just trying to forecast that out, it is just it very difficult to do.

I think a range like that is where we feel more comfortable.

Fair enough.

Then, just in terms of market growth here, guys.

I mean, there is obviously a lot of dynamics going on.

You have a new product.

There is competitive gains, market share gains I should say, and I am trying to get a gauge, if you have a sense of home sleep testing in there, what the market growth is like.

Obviously, times are tough out there, so to speak.

It is just hard for us to gauge where the market is growing.

And obviously you guys seem to be doing well here in a seasonally weak quarter.

I am just wondering if that is more new product or more market share, more underlying market growth or maybe it's all three combined.

If there's any color that you can provide, it would be helpful.

You think gross margin is difficult.

Market growth is one of the things, it is always very difficult to get very specific on.

Because unlike, I don't know, consumer products, where you have -- you are scanning data or even some of the medical businesses where you have got 99% of the market that's publicly traded companies that report specifically on those things where you can aggregate it.

In our marketplace, it is a lot more difficult and you do a lot of gut feel kind of stuff, and anecdotal information back.

What's clear is that we're very fortunate.

We are in a marketplace that is highly underpenetrated.

It's clear we're in a marketplace that adds significant amount of value to the health care system.

So we are growing at 16% in the US, are we gaining market share?

I think I would feel very comfortable saying that we are gaining market share at that rate.

We hear the other medical device companies just like you do reporting spine, and orthopedics and they are talking about very low growth profiles, even negative.

Are we impacted like that?

No.

We have been very fortunate that this market is growing well above that.

Is there some impact to the economy?

Is there some impact of unemployment or Obama care to consider?

Yes.

I would assume there's got to be some impact that those kind of things play into it.

But we remain bullish.

We look at this marketplace.

We look at the penetration rates.

We look at the advent of home sleep testing.

We look at the clinical data that is associated with sleep disorder breathing and we look forward -- we think this market has a bright future.

Great, that is helpful.

Just last, you have seen a move towards product mix over the last year or two at this point as people go to the higher end products for monitoring purposes and obviously better treatment so to speak.

You are releasing the S9 Escape.

I guess I am just trying to understand now how important a launch that is.

And in the past, obviously, the last line or last launch was pretty important just in terms of -- because most people weren't buying the auto devices and things like that, and higher end, there was a lower mix.

As you're mixing here, you guys have any sense?

Is this launch any less important than it might have been a couple of years ago now that people are moving up the scale here?

Or is this still a pretty impactful launch?

That's a really good question.

Clearly as the market moves more up scale or more to the autosets, just by the numbers perspective, it becomes a less, the potential would be less impactful just from a pure numbers perspective.

We think it's important because it rounds out the bag and you can sell across the line when you are into the marketplace.

But if you are going to use that comparative versus a few years ago I'd say that you are probably right, the more percentage you get in the higher end, the less percentage is on the other side.

But it's still an important launch and one we're very comfortable with and one we're very excited about.

Great guys.

Thanks for taking my questions.

Congrats again.

Ladies and gentlemen, we are at the one hour mark.

I will turn it over to Kieran Gallahue for his final remarks.

Thanks very much, Jeff, and thank you everybody for joining the call as always and of course, as always, I would like to thank our employees, our ResMed team members from across the globe and the various functions because those team members are what drives ResMed and we are certainly very proud of their efforts and most importantly, their results.

As I noted, we are excited about the future.

We've got some exciting new products that are rolling out.

We are excited about the prospects of sleep disorder breathing and it's through the relationship with the comorbidities.

We've got very strong cash flow and a strong balance sheet.

So the future continues to look bright.

Thank you once again and we look forward to updating you in future calls.

Ladies and gentlemen, that concludes today's conference.

Thank you for your participation.

You may now disconnect.

Have a wonderful day.