瑞思邁 (RMD) 2013 Q3 法說會逐字稿

Welcome to the Q3 2013 ResMed Inc.

earnings conference call.

My name is Trish and I will be your operator for today's call.

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

Later we will conduct a question-and-answer session.

Please note that this conference is being recorded.

I would now like to turn the call over to Constance Bienfait, Director of Investor Relations at ResMed.

Constance, you may begin.

Thank you, Trish, and thank you all for joining us today.

The Company has asked me to address certain matters.

First, ResMed does not offer 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, new product launches, or new markets 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 actual results to materially differ from forward-looking statements.

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

Please limit your questions to two at any one time.

If you have additional questions, please return to the queue.

Speaking on the call today are Peter Farrell, Executive Chairman; Mick Farrell, CEO; and Brett Sandercock, CFO.

There are also other members of the management team present that will be available to answer questions.

I would now like to turn the call over to Peter Farrell.

Peter, please go ahead.

Okay.

Thank you, Connie, and thanks to everyone for joining us.

After this call I will turn over responsibility for the handling of future quarterly earnings calls to Mick, who the Board appointed as CEO, which most of you would have [be across] last month and, as an aside, let me point out that we had a two-year search, which the Board conducted under the auspices of Spencer Stuart and we examined both internal and external candidates and the decision was made, as I said last month.

So I'll review the quarter and then Mick, who is currently in London, will join the call and make some brief remarks before we hand over the call to Brett Sandercock to go through the numbers in more detail.

So, first, the financial summary, as you would have seen from the press release.

We finished another solid quarter.

This represents the 73rd consecutive quarter in which we've grown the top line and, obviously, we are extremely pleased about that.

Global revenue in the third quarter grew 10%, in both actual and constant currency numbers, to $334 million.

Revenue in the Americas grew 13% year over year to $215 million, and ROW revenue increased 6% compared to the year-ago quarter.

And that also was in both actual and constant currency terms.

And that was to $168 million.

We believe that these results were as a result of both superior product quality and full solution offerings.

And these two aspects continue to drive our growth.

Net income for the quarter increased 31% to $85 million, while GAAP EPS increased 32% to $0.58 per share for the quarter.

Excluding amortization of acquired intangibles, EPS was a record $0.59, which showed excellent operating performance.

The global growth in flow generators this quarter was primarily driven by our high-end devices with strong sales of order set bilevels, and adaptive server ventilation, as well as in respiratory care with the Stellar.

We believe we continue to take share in the AutoSet space and we are also gaining share back in bilevels.

In short, our respiratory products are being well received.

And there is plenty of room for us to continue to grow in all these areas.

For example, in the Americas where flow generator sales were particularly strong this quarter, we had the S9 AutoSet bilevels and VPAP Adapt, which of course is our adaptive [survey] ventilator in the US.

All did particularly well.

And we attribute a lot of the share gains in mix shift to both the positive responses to EasyCare Online and to increases in home sleep testing which I will discuss in a little more detail.

Turning to the rest of the world, there was still a lot of uncertainty in Europe.

However, we were gratified with the results in both the UK and Germany.

So despite the challenging economic climate throughout Europe, as well as fiscal constraints, the focus is still on treatment that keeps patients out of hospital and healthy.

AutoSet CS, again, our ASV offering in Europe, VPAP ST and Stellar products did well again this quarter in most parts of Europe.

The Asia-Pacific region also had a solid quarter with strong sales in Japan and India, although as we have explained on a number of occasions, Japan's sales are inconsistent from quarter to quarter and, in this particular quarter, Japan was a little softer but not unexpected.

Japan ended this fiscal year-end and these distractions -- that is [Tasian], ended their fiscal year on March 31 and those distractions tend to affect their sales during this quarter.

And, as I said, they are a little softer, but not unexpected.

As I mentioned, EasyCare Online, the Compliance Management System, continues to be well received and we are seeing solid uptake from both existing as well as new accounts.

And the EasyCare Online, I should point out, is also now available for bilevels.

In this challenging environment, where there are changes in government reimbursement, coupled with mandates to bring down the cost of health care, products and programs which provide superior therapy, and better compliance are what bring the most value across the board to patients, customers, and payers.

Now, with respect to interfaces to masks, our growth moderated due to -- and I think a number of you referred to these new entrants into the marketplace.

However, mask parts and accessories did very well in all geographies, but complete mask systems sales were in fact a little softer.

But Phillips and F&P have two new masks as most people are aware and, as expected, they are being trialed by various customers.

This is not a new experience for us, but, as you know, we have been experiencing particularly good performance in market share gains in all of our mask categories for quite some time.

So things do tend to change.

But, more recently, the new competitive offerings, as I've already mentioned, are being tried by some of our customers.

We are of the view, however, that these new entrants are not nearly as good as ours, but they are gaining traction as HMAs are willing to, as I said, try them.

But perhaps equally importantly, or arguably more importantly, we faced a top comparison to last year's third quarter where growth in the mask category in the Americas was 21% and, globally, it was 16%.

So in short, a pretty big mountain to climb.

However, as always, we plan to stay ahead of the game by constantly innovating.

We're going to provide in the very near future mask products that are smaller, quieter, and more comfortable and which we believe will keep us well ahead of the game.

Our product pipeline is actually quite full and we are releasing two considerably improved mask products this quarter with more to come during the remainder of fiscal 2014.

In fact, we are extremely optimistic about these new interface innovations.

Now coming back to home sleep testing, the number of commercially covered adult lives requiring preauthorization for PSG continues to roll out, steering providers and patients towards HST.

It is now well over 50% of covered lives and heading north.

We estimate that -- well, we estimated that at the end of calendar 2012, approximately 25% of all tests were HST and we believe -- or our numbers are showing -- that this will be around about 40% at the end of our fiscal year, June 30.

We continue to see a steady increase in the number of sleep labs involved in HST, averaging approximately 38% during the last 12 months with a rise to around 47% in January in response, again, to preauthorization.

We are also participating in primary care physician awareness initiatives as HST continues to advance.

In fact, PCPs are becoming more evolved in the diagnosis and management of the sleep apnea patient and are also starting to drive momentum in the whole of the sleep business.

The sleep market is not just about selling equipment to treat sleep disorder breathing.

It is very much about forming partnerships with both customers and payers.

A combination of our range of high-quality flow generators, the most comfortable and effective masks and accessories, and easy to access robust data through the EasyCare Online makes us an excellent value proposition.

Not only do we have a robust pipeline of new masks, we have future technology innovations planned for both sleep and respiratory care.

In short, we are at the forefront as leaders in innovation in the sleep space and we have every intention to continue to bring to market the best possible solutions for sleep disordered breathing.

Finally, as I have said before, given recent data which suggests that SDB, sleep disorder breathing, affects approximately 25% of the adult population at some level and that the treatment -- the diagnosis and treatment of SDB firstly improves quality of life; secondly, slows comorbid disease progression; and, finally, reduces health care costs.

It is, as I have said before, the Holy Grail of healthcare delivery.

With that, I'll turn the call over to, Mick.

Are you ready to make some comments, Mick?

I am.

And, thank you, and hello from London.

This is a really exciting time for our team here at ResMed and not just because we had a Q3 revenue of $384 million, which represented 10% topline growth and 31% net income growth.

However, with the fast growth of the global healthcare spend and its growing share of the GDP burdening many major global economies, both governments as well as private payers are looking for answers to reduce the cost of their health care and to improve patient outcomes.

We believe that, at ResMed, we have the answer to these questions in the fields of sleep disordered breathing as well as chronic obstructive pulmonary disease, or COPD, and in other cardiorespiratory areas, particularly heart failure.

I'd like to take just a couple of minutes to discuss three major growth horizons that we see in our future here at ResMed.

The first growth horizon for ResMed is in our core SDB business.

In the last 12 months alone we have impacted many millions of lives in this space, resulting in around $1.5 billion in revenue.

We will continue to grow the number of lives we impact each year along with our revenue.

We are the global SDB market leader.

We've talked before about SDB as a solid growing market and one that is incredibly underpenetrated.

At most, it is 5% to 15% penetrated, meaning that 85% to 95% of the opportunity in our core business is still in front of us.

As a global SDB market leader, we are in a great position to drive new market penetration and new market growth, geographically and to other comorbidities, as you just heard.

We have said it before.

Our biggest competitor is not one of the other SDB manufacturers.

It's a lack of education and awareness of the signs and symptoms of SDB, as well as the ability for physicians, particularly PCPs, to have practical medical action pathways.

We are investing in changing that and ensuring that we have sustained strong growth in our core SDB market.

The second growth horizons for ResMed is our respiratory care business.

This fast-growing business include diseases such as COPD, which I mentioned before, neuromuscular diseases, such as ALS, also called Lou Gehrig's disease.

This respiratory care opportunity includes hospital and home care ventilation as well as hospital and home care humidification.

We have a leadership position in Western Europe with home care ventilation.

However, in the US market, we have significant room for share growth.

Combining respiratory care opportunities in the US with those significant ones in Asia Pacific, as well as Latin America, we have revenue growth potential in the multiple hundreds of millions of dollars.

And there are many, many millions of patients with COPD and neuromuscular disease whose lives can be significantly changed with innovative ResMed technology.

In that vein, we have just announced today, as you saw another press release in these last 24 hours, that we are launching the first and only bilevel device cleared by the FDA, specifically for the treatment of COPD, one of the top five killers in the Western world.

COPD sufferers now have the weapon in their fight to stay out of hospital.

One of the biggest challenges for COPD patients, as well as their payers and physicians, and for the healthcare providers that we serve, is to keep these patients from returning to the hospital after a COPD exacerbation event.

More than one in five COPD patients are re-hospitalized within 30 days.

VPAP COPD has all of the features of our higher and noninvasive ventilation devices, including access to our cloud-based software system, EasyCare Online.

EasyCare gives physicians, payers, and HMEs the opportunity to monitor COPD patients as well as our core SDB patients -- it's the same platform -- and intervene if there is a problem and potentially reduce costs and reduce re-hospitalizations.

Our third growth horizon is in the field of cardiorespiratory disease, but specifically cardiology and, even more specifically, heart failure.

As many of you know, we are running a live multinational randomized controlled trial or RCT in the heart failure space, called SERVE-HF.

Serve as in a tennis serve and HF for heart failure.

SERVE-HF is evaluating approximately 1,300 patients and is wrapping up enrollment over the coming weeks and months.

In this two-year follow-up study, we are looking at two primary outcomes -- mortality and morbidity.

We are cautiously optimistic that the data from SERVE-HF are going to show that ResMed's proprietary technology can save both lives and money.

So, to reduce the mortality and to reduce the morbidity.

This is an enormous opportunity in the market space where heart failure and SDB intersect.

At ResMed, we believe we have the best products, the best team, and a winning strategy.

We care about the health and quality of life of our patients.

We care about disease prevention, we care about improving outcomes, and we care about improving the economics of our somewhat broken healthcare systems.

We are more excited than we have ever been that, despite the challenges of current healthcare market dynamics, we at ResMed have the capabilities and the product pipeline to really make a difference.

You will hear me echoing many of the same things you have heard from Peter Farrell over the last couple of decades.

Our belief in ResMed's people.

Our world leading product quality.

Our laser-like focus on innovation as well as solid science and clinical validation.

Most important, though, is our shared vision for these three growth markets.

We are proud to be leaders in SDB.

And as you heard earlier, there is still so much room for growth in that space.

I'm really looking forward to partnering in the office of the CEO with Rob Douglas, our COO, and with the rest of our CEO operations team, as well as with the almost 4,000 strong ResMed global team as we continue to drive increased value for our shareholders.

The bottom line is that we have defined business plans, specific identified investments, and key ResMed business leaders who are accountable for driving success in these three growth horizons that I talked about -- SDB, respiratory care, and cardiology.

So, with that, I'll turn the call over to Brett, who is in Sydney, to review Q3 in more detail.

Brett?

Thanks, Mick.

As we mentioned, revenue for the March quarter was $383.6 million, an increase of 10% over the prior year quarter and also 10% in constant currency terms.

Income from operations for the quarter was $96.1 million, an increase of 26% over the prior year quarter.

Net income for the quarter was $84.9 million, an increase of 31% over the prior year quarter.

Diluted earnings per share for the quarter were $0.58, an increase of 32% over the prior year quarter.

Gross margin for the March quarter was 62.4%, up sequentially from Q2 FY 2013.

On a sequential basis, our gross margin benefited from a favorable product in geographic mix and manufacturing and logistics improvements.

Looking forward, we expect our gross margins for the balance of fiscal year 2013 to be in the range of 61% to 63%, assuming current exchange rates.

We continue to execute on initiatives targeted at improving our global manufacturing supply chain and logistics cost structures.

SG&A expenses for the quarter were $109.6 million, an increase of 8% over the prior year quarter.

In constant currency terms, SG&A expenses also increased by 8%.

And SG&A expenses, as a percentage of revenue, improved to 28.6%, compared to the year ago figure of 29.2%.

Looking forward in the subject of currency movements, we expect SG&A as a percentage of revenue to be in the range of 28% to 29% for the balance of fiscal year 2013.

R&D expenses for the quarter were $31.2 million, an increase of 10% over the prior year quarter.

In constant currency terms, R&D expenses increased by 11%.

R&D expenses, as a percentage of revenue, were 8.1%, consistent with the prior year quarter.

Looking forward, we expect R&D expenses as a percentage of revenue to be around 8% for the balance of fiscal year 2013, reflecting ongoing investment in our product pipeline.

Amortization of acquired intangibles was $2.5 million for the quarter, while stock-based compensation expense for the quarter was $10.2 million.

Our effective tax rate for the quarter was 21.4% compared to the prior year quarter effective tax rate of 23.1%.

The lower tax rate reflects the benefit of lower effective tax rates in our Singapore and Australian operations.

We currently estimate our effective tax rate for fiscal year 2013 will be in the vicinity of 21%.

Turning now to revenue in more detail, overall, sales in the Americas were $215.2 million, an increase of 13% over the prior year quarter.

Sales outside the Americas totaled $168.4 million, an increase of 6% over the prior year quarter.

In constant currency terms, sales outside the Americas also increased by 6% over the prior year quarter.

Breaking out revenue between product segments.

In the Americas, flow generator sales were $95.4 million, an increase of 21% over the prior year quarter, reflecting strong growth in our APAP and bilevel devices.

Masks and other sales were $119.8 million, an increase of 8% over the prior year quarter.

For revenue outside the Americas, flow generator sales were $114.6 million, an increase of 9% over the prior year quarter and in constant currency terms, also an increase of 9%.

Masks and other sales were $53.8 million, consistent with the prior year quarter.

Globally, in constant currency terms, flow generator sales increased by 14%, while masks and other increased by 5%.

Cash flow from operations was $107 million for the quarter, reflecting strong underlying earnings and working capital management.

Capital expenditure for the quarter was $19.9 million, while depreciation and amortization for the March quarter totaled $20.7 million.

Our share buyback continues to play a major role in our capital management program.

During the quarter we repurchased 1.5 million shares for consideration of $67.3 million.

For the first nine months of fiscal year 2013, we have repurchased 2.8 million shares for a consideration of $115.3 million.

At the end of March, we had approximately 6.1 million shares remaining under our authorized buyback program.

During the final quarter of fiscal year 2013, we intend to purchase at least 1 million shares under our share buyback program.

In addition to our share buyback, our Board of Directors today declared a quarterly dividend of $0.79 per share, consistent with our previously advised dividend policy.

Our balance sheet remains very strong.

Net cash balances at the end of the quarter were $[673] million.

And at March 31, total assets stood at $2.4 billion and net equity was $1.8 billion.

I'll now hand the call back to our operator for your questions.

(Operator Instructions).

David Clair, Piper Jaffray.

The first one for me, just on competitive bidding, just wondering if you could give us some color on conversations you've had with DMEs following the rate announcements?

Yes, David, that's a great question and I'll probably hand over to Jim Hollingshead, the President of our Americas Group, to talk in more detail about the conversations as he took over the Americas during the last quarter.

But to lead out on it, competitive bidding conversations have been ongoing with our customers over the last two years through round one that we are two years into and into the conversations on, and into round two, which, as you said, the announcements came out around about with an apples to apples number, low 40% reduction versus expectations in the 30s.

We've had lots of conversations with our customers over these last 90 days as we have over the last two years.

And the conversations really aren't any different than they were before, which is how do we work together.

How do we find ways to get deficiencies efficient these out of the system that we can link up together to take cost out of the system to link with our electronic data in the [phases our EDI] to get drop shipped to inventory sites, to work together to understand how we can help Medicare understand the return on investment from diagnosing and treating sleep disorder breathing patients.

And, of course, the topic of price comes up, but that comes up in every discussion with our partners.

To frame this, as we always do on this call, and many of the analysts who are listening to this call around the mathematics on this, and we are talking about 20% to 25% of our Americas payers are included in competitive bidding.

So somewhere between 10% and 12% of our global revenue could potentially be impacted by this.

So there's a lot of other elements that go into the price discussion for the other 80% to 90% of the business.

But, Jim, do you have any further detail you might want to share with David with regard to conversations about competitive bidding round two?

Sure, Mick.

Thanks very much for the question, David.

I don't have a lot to add to what Mick said.

We're obviously talking to our customers about the issue of competitive bidding round two frequently.

And nobody is happy with the extent to which reimbursements have been cut and it does represent a cut in reimbursement in portions of their business.

But I do think it is fair to say that the more sophisticated HMEs out of the market understand that -- understand a couple of things.

The first thing they understand is that there is a volume opportunity if they want contracts.

The second thing they understand is what they need to do is drive efficiencies into their business.

And so that tends to be the kind of conversation we are having with customers, is how we can we can help them as Mick alluded to -- how we can help them by providing solutions and services so that they can run more efficiently.

Okay.

Thank you very much for that.

And then, just a quick one on the new mask launches that you talked about briefly on the call.

Do you think that these address the Phillips and Fisher and Paykel products that took a little bit of share in the quarter?

And any additional details on are they nasal pillow, nasal full face, anything you want to share there?

So David, that's a great question and one that the Phillips and F&P and other competitors who are listening to this conference call with love to hear lots of details on.

I don't think we're going to give a lot of detail on that.

I think we have said a lot in that our pipeline is very solid.

We plan to launch two masks in this quarter and there is a lot more in the pipeline to come.

I'll hand it over to Don Darkin, maybe, to give a little bit of color as to how our FX series is holding up.

Our Mirage FX, Quattro FX.

These masks -- and Swift FX -- have had incredible success for a sustained period of time and we know that the market is sampling some of the competitive masks from our two major competitors.

And we think that's a healthy competitive environment to have in the market.

We are very proud of our number one patient preferred market position in the mask space and we plan to defend it by innovating further and getting further ahead of where we were, which was in the lead.

But, Don, any further color that you might want to provide David on the masks?

Thanks, Mick.

David, we are pretty confident that what's coming out in the next few months is going to be more than adequate to cover what we need.

I think, more importantly, the actual pipeline itself over the next months, you're going to see pretty much what we've been planning on for some time now and I think the competitive position for us will be more than adequate as we go forward.

Okay.

Thank you.

Congrats on the quarter.

Ben Andrew, William Blair.

Two questions, if I might.

First, on the COPD opportunity, how should we think about that in terms of revenue generation for you all in terms of magnitude and time frame?

Yes.

Great question, Ben.

And we have a large focus on COPD and I'm going to hand this question for further detail on to Geoff Neilson, who is the President of our Respiratory Care Group.

But just to lead out there, the COPD market opportunity is huge.

It's the top five killer in the Western world.

It actually, I think, just jumped up to number three, ahead of stroke, which dropped down to number four in terms of how many people it kills in the Western world.

But apart from that, it also costs the system a heck of a lot of money.

And that rehospitalization, as many of you know, particularly in the US market, there are serious penalties to hospitals for within 30-day rehospitalization events.

We think we can help hospitals, but also really help the patients and physicians who have trouble with these exacerbation events with our VPAP COPD product.

And the market opportunity is in the triple digits, but I will hand over to Geoff to provide some more color for you there, Ben.

Ben, thanks for the question.

I think, if you look at the number of COPD exacerbations, which are hospitalized every year, there is getting close to 100 million -- I'm sorry -- 1 million patients every year hospitalized for COPD.

Around 400,000 of these are hypercapnic COPD patients, which means that they would be suitable for an IV treatment post discharge.

Unfortunately, because of the qualification criteria here in the US, not all of them can be qualified for NIV therapy.

So we were estimating the market, given the current qualification criteria in reimbursement, to be in the order of $100 million annually in the US.

And this product is really focused at what the requirement is in the US.

As far as the time frame does, obviously we've got to change some practices in terms of discharge, prescribing behavior.

These patients can qualify direct from the hospital rather than going to the sleep lab and so that's not a short-term activity.

And we do have a sales force on the ground, now, that we are building up who is calling on hospitals and the discharge planners with the discharge guidelines and education material to try and change that.

But it's going to be a multiyear activity to build up our fair share of that $100 million market.

Okay.

So from a revenue per patient opportunity, is it the typical pricing for the VPAP plus kind of a mask replenishment model?

Or is there a different reimbursement model that allows different pricing?

No.

So this is going to be reimbursed under [EO] 470, which is a standard bilevel without a backup rate pricing.

So this device is specifically designed to meet the FDA criteria for a respiratory insufficiency device, which has -- so the device is indicated for COPD.

But for the first time, it's possible to prescribe on label a bilevel device for respiratory insufficiency and do that straight from the hospital.

It's going to be at a premium to your existing bilevel devices, but it's not going to be priced as a ventilator type pricing.

Okay.

And last question since I have another track I wanted to go on, but how high is the bar for another company to get a similar indication?

I think we could expect to get our fair market share of this.

Clearly, it's possible for other companies to get these indications and we have optimized our product specifically around treatment for COPD, but it's not impossible for others to do the same thing in time.

What I would add to that, Ben, is that there is some level of sustained competitive advantage from the VPAP COPD, not necessarily just in the device, but also in -- as you saw in the press release, and you heard in the remarks we just made, it's linked to EasyCare Online.

Having a cloud-based compliance and adherence and management system that already has its market share growing in the core SDB, linking the VPAP COPD, not only with the whole S9 platform.

So all the humidifiers tubing connectivity, but also the cloud-based connectivity is there.

We think that can provide some level of sustained competitive advantage.

And, as Geoff said, we expect to get more than our fair share of this large opportunity in COPD.

Okay.

And then lastly --

If I could just add to what Mick said, so many of these patients are on oxygen.

With our new ClimateLine Oxy tubing we allow oxygen to be fed in there.

That means we are optimizing humidification and therefore comfort for these patients, which means that we enhance compliance and that also means that we are reducing exacerbations and reducing re-hospitalizations.

And maybe you could add a little bit more, Geoff, in the sense that we've also altered some of the characteristics for inhaling and exhaling.

We won't go into the details there, but we have really optimized the way the unit functions.

Yes.

So we have optimized the parameters and so on in the device specifically for COPD to make it easy to set up, because we want this to be set up directly from the hospital and not have to go through the sleep lab.

Got you.

And then, briefly, the other topic I guess is back to competitive bidding.

And without getting too specific relative to fiscal 2014, you've talked in the past about structural pricing being kind of in the 3% to 4% and then last couple of years maybe it went to 6% to 8%.

Is that sort of the level of expectation we should be looking at as this shakes out or is there a likelihood of a step function kind of dynamic as we go through the resetting of some of these contracts a la 2007 that we could think about as people try to model both what pricing and ultimately mix will do under competitive bidding?

Well, that's a good question, Ben, and I think you somehow got three questions in there by asking some sub questions around COPD.

But the third question, competitive bidding, yes, look, absolutely there are potential impacts on pricing.

I think what we've said in past calls and at conferences and so on is that there has been a traditional 3% to 5% annual reduction, like for like reduction on products within the market.

Could this push it to the high end of the range or even a little bit beyond it?

Yes, certainly.

I mean that 5% year on year reduction in prices is something that we would present -- expect and predict and plan for.

Our job -- and this is something our team is working incredibly well on -- is to take more than that 5% or 5% to 6% out of COGS supply-chain delivery.

And we talk about the supply-chain meaning all the way from our factory to the delivered patients.

So looking at the efficiency of the HME as well.

So there could be some increased significant pressure, but it's not -- nothing different to what we've seen before and nothing that we weren't expecting and weren't planning for and having executing on, I think, quite well through these first rounds of competitive bidding.

So we think there will be reasonably steady sailing through it, but we are ready for alternate weather reports.

Thank you.

And, Ben, just to add a little bit to that, maybe I've been smoking too much dope, but I don't recall any discussion of 6% to 8%.

I mean, maybe somebody else has talked about that, but there is no way we ever talked about 6% to 8% reductions --

(Operator Instructions).

Michael Matson, Mizuho Securities.

So I guess I've heard some rumblings of some price or I guess reimbursement cuts in Germany from a couple insurance companies over there.

And I guess they were sort of doing tenders or something, sort of similar to competitive bidding here in the US.

So I just wondered if you could comment on whether or not you have seen that and whether or not you have won any of those tenders.

Mike, thanks for the question, and I'll hand over to Rob Douglas, our President and COO, to add more color.

You know, he and I have been spending a lot of time over here in Europe with our European operations team.

Just as sort of a prequel to that, tendering or competitive bidding in different European countries happens on an ongoing basis.

So we have tenders in places like Norway and the Nordic region that we participate in on an ongoing basis.

And there has been some tendering in Germany.

I wouldn't sort of put it as akin to competitive bidding.

I would put it akin to the other tendering processes that we've been managing and executing on for many years in Europe.

But, Rob, do you want to provide some more detail on the specific question around tendering in Germany?

Sure, Mick.

Yes, Mike, you know, the Germany insurance industry is pretty fragmented.

There's about 130 insurers.

Even though they have been consolidating, that's still quite a lot.

Recently a couple of them put out requests for tender and they went through.

Our competitors won those tenders.

They won them at pretty low prices that don't seem to include requirements for compliance monitoring or good patient service.

We actually don't think that's very good care of the patients and we don't think it's going to be a major trend in Germany.

So we are keeping a careful eye on it but we don't think it's the main thing for Germany for us.

Okay.

That's helpful.

And then, as the market in the US moves more toward home testing, and the primary care physicians get increasingly involved in -- with those tests, and writing prescriptions for CPAP, is there a risk that that's going to sort of erode a portion of these prescriptions that are branded and maybe give the HMEs a little more flexibility in determining what products they use on these patients?

Yes, that's a good question, Mike.

Certainly, with home sleep testing going from 25% of the tests to we think starting to approach 40% in the coming quarters, and then, through the calendar year, there will be an increased influence, if you like, on the process of primary care physicians.

Often, a specialist physician still doesn't read the study and often may make a recommendation on therapy.

So the impact that specialists have in this field will not go away, but it will increase for the primary care physicians.

This isn't something that is new to us and we have been interacting with primary care physicians regarding sleep disordered breathing for many years.

We have actually some very specific programs -- and I don't want to go into too much detail on this call.

I don't know, Jim, if you want to provide some highlights of that, but we are working with primary care physician groups to make them aware not only of the disease state of sleep disordered breathing, but also of the very important factor that if you're going to go from home sleep testing to positive airway pressure therapy, you're going to need to choose an algorithm that you can trust to deliver all night, every night, for the rest of that patient's life.

And you want to put your bet on an algorithm that has a lot of clinical validation, a lot of science and technology behind it, because if you're saving money for the healthcare system by getting them to something that's going to keep them out of hospital, you actually want to keep them out of hospital.

And the right technology is able to do that and part of that technology is not only with the algorithm, but also the data that can be taken from that algorithm, the information that can be taken to the cloud that can be used to manage that patient.

And I think that's an area in terms of what I'm talking about, specifically as our AutoSet algorithm and our EasyCare Online or healthcare informatics infrastructure.

I think both of those are credibly important factors that will weigh into the specialist, but also the primary care physicians decision.

And it is our job to educate them about the availability of both of those.

Jim, did you have any further input or thoughts on the primary care physicians and our work with them going forward?

Only a couple of things to add to that, Mick.

I think that there will be a number of different models as different insurers shift PSG to HST in different geographies and with independent physician groups, et cetera.

So it's complicated landscape.

I don't think there's going to be a world where a primary care physician who is utterly ignorant of sleep apnea is writing scripts for sleep apnea.

There will always be some sort of influence model in there, whether it is coming from an insurer or from a specialist who has read the study and is recommending the therapy and so on.

And, as Mick says, we have a number of programs underway right now and I would say that some of them are early stage and we are experimenting.

But we have a number of programs underway right now to drive awareness and brand awareness into the PCP space, but I don't think there's a huge risk associated with PCPs ending up as sort of arbiters in this space without knowing anything.

It's really our job to educate the PCPs.

I would say it's less a risk and really an opportunity, Mike.

And something that we've not only planned for, but are starting to execute on as Jim said.

Okay.

And just -- sorry to go back to the Germany question, but I just -- just one quick follow-up on that is, so is this -- you mentioned that there has been tendering in other countries in Europe.

Is this the first time that there has been tendering in Germany or have you seen that happen over the past?

I think this is a first -- Rob, do you want to address that?

Sure.

I'll go, Mick.

Thanks.

It has been going on in the past for quite a while.

And, as I said, it's quite a fragmented insurance industry and while they operate to a common set of top-level rules, there are different practices in different companies and they have maintained those over the years there and we have seen them come and go in the past as well.

Okay.

Thanks a lot.

That's all I have.

Matthew Pryor, Bank of America.

First question in regards to US flow generator strength and the backdrop competitive bidding.

We have seen commentary out of Phillips and their first-quarter results they talked to a pretty tough year landscape and you guys have done quite well.

Can you talk about share gains, whether they've been driven off the back of these schematics that you are pushing through and is that obviously fading into obviously the backdrop of competitive bidding?

And if I can just ask one sub question to competitive bidding, do you think you'll take your medicine up front in terms of the private payers in terms of national accounts looking to negotiate now?

Or do you truly see it staggered in line with the phasing of competitive bidding in both a CMS and a private payer sense?

Well, great, Matthew.

So you got your two questions all up front there, so let's address them in order.

So firstly, the flow generation and then we will get to the competitive bidding and upfront staggered.

So, flow generator share gains, again, I think Don Darkin might want to add some color after this, but just to start off, I think there are three major factors that are influencing our flow generator share growth.

The first is home sleep testing is driving growth in the APAP category.

ResMed has a leadership position in the APAP category with the S9 order set device.

So we are growing share in a growing category.

That's point one.

Point two, our S9 bilevels are now available across-the-board and as you heard from Geoff Neilson, who in his press release in the last 24 hours, we've added another S9 bilevel and they are available all across the same platform.

We think that we've had very strong growth across the high-end bilevels because the efficiencies that generates for our distributors, our customers, and frankly the value delivers to the patient in terms of quiet, comfortable, and efficacious therapy.

And that has helped us on the VPAP ST, the VPAP Adapt, the AutoSet CS, the VPAP STA, and we believe it will help us on the VPAP COPD.

The third point, as you alluded to, Matthew, is the healthcare informatics side, EasyCare Online and the cloud-based software that links into the VPAP COPD.

We think that EasyCare Online, in our core sleep disordered breathing market, is driving added value for our customers that is leading to a preference for ResMed devices.

And an important point on that is that that is a sustainable competitive advantage and it takes a long time to build up the capability.

And once you are ahead, you can continue to lead from the front.

Don, any further thoughts or ideas on the flow gen share gains?

No.

I think you have covered it, Mick.

Okay.

So the second question was around competitive bidding and this, I won't answer up front, and I'll let Jim get to whether it's going to be upfront or staggered.

I think there will be negotiations that happen on a daily basis with accounts with regard to pricing.

As the numbers came out, over 30 days ago, we've already had many discussions with customers about -- for those who were winners, which those data only came out a number of weeks ago.

So that's all public now.

We know who the winners are.

We can sit down and talk to them.

We can bring out the playbook that we did in competitive bidding round one where we worked with winners, we helped them grow, and we partnered with them on driving their ability to deliver with economies of scale.

Jim, any thoughts on the question there with regard to medicine upfront or staggered, Matthew's question on competitive bidding?

Yes.

I think it's a good question and I actually think it's a very difficult question to answer.

As you say, Mick, negotiations are happening daily and the bid rates when they came out obviously created a ripple through the market and all of our customers are concerned about reimbursement from CMS.

And we are negotiating.

One thing that works very strongly in our favor is that our products drive better compliance and that is still a very important thing to the business model of all of our customers.

So, now, we are going to continue to negotiate and work with our customers, both on pricing, but on other things that we can do for their business.

And we'll have to see how it plays out.

I think we are very strongly positioned and I think our customers recognize the value that our products bring to them as well as our solutions like ECO.

And we'll manage it as we can and we will see how it goes.

All right.

Thanks, guys.

Ian Abbott, Goldman Sachs.

I was wondering -- I had a follow-up question on EasyCare Online.

I'm just wondering how much of a direct revenue driver is that or is it more -- you actually almost give it away and then it drives the uptake in APAP and CPAP, as you've talked about?

Yes, Ian, that's a good question, and, Don, I'll hand this over to you before going too far.

EasyCare Online is a software provision that gives customers chances for efficiencies, the ability to remotely manage adherents in a way that is kind of unique and certainly a serious value add.

I do think there is a very strong indirect influence on their choice of flow generator because of that.

And so that indirect strength is there.

There are some direct revenues associated with the overtime air fees, and so on, that we put through there, but we are really focused on the innovation part that ResMed brings to the game, which is in the medical device field.

But, Don, maybe you want to talk to some of the other areas like our [Ambien] acquisition and the opportunities that we have with You Sleep as well.

It is a difficult one to try and understand whether there is actual revenue directly as we add people on ECO.

Clearly, it has many functions that enable us to keep those customers in a position where we need them.

With Ambien, it's a slightly different situation where we are, in fact, getting revenue from the use of Ambien.

And as that software package grows, there will be other opportunities for us to see and measure.

But at this point, it's a very difficult one to track.

If that's answering your question.

Yes.

I was just trying to get a sense of whether -- you know, you've had a very strong flow gen number this -- for this quarter in the US.

I'm just trying to get a sense of whether the EasyCare or the Ambien was a contributor there or is it more just the underlying (multiple speakers)?

It certainly seems that way.

But to actually put an exact track number on it, it's quite difficult at this point and I think longer term it will be easier to make a call on it.

But at this stage, difficult.

So directionally as having an influence, which is hard to quantify it, Ian, I think is the short answer.

All right.

Thank you.

And my second question is around gross margin.

I was just wondering if we could get an update on how much of your production is now in Singapore and also if you could perhaps break out or give some idea of the gross margin improvement during the quarter.

How much was product mix and how much was manufacturing mix?

So I'll hand it over to Rob, and then, he may hand it over to Brett to give some more details on gross margin contribution for the quarter.

Thanks, Mick.

Yes, we continue to work on product cost, both on the incremental improvements and operating costs through the manufacturing system.

The shift to Singapore continues to help our Malaysian factory producing headgear is working well.

And of course, then the product design teams really had a big impact on the cost of the products through as well.

In terms of the exact mix of margin, I think I will hand that over to Brett.

So if you kind of looked at that year on year, then both product mix and the manufacturing logistics improvements were both significant contributors.

So we kind of don't break that down in a blow-by-blow, but both of them were meaningful contributors to that gross margin expansion this time.

And the mix of -- how significant is Singapore now?

Is that getting up to two thirds or 70%?

No, it's on a blended basis, it would be approaching 60%.

Great.

Thanks very much.

Anthony Petrone, Jefferies Group.

Thanks.

One on EasyCare Online, I am wondering how penetrated EasyCare Online is among the installed base?

Is that only S9 and is there a way to transition S8 users into EasyCare Online?

Somebody want to take that?

Yes.

I'll have a crack at it.

It's a difficult one to actually answer in a sense of what penetration we have today.

We've got several hundred thousand patients in the system, but when it comes to reverting back to S8, we don't intend to do that.

Going forward obviously we will be covering all about new products as they come out.

But I guess it's just a tough question to answer that in this period.

Again, as we go forward it's going to become clearer where we're at, but today it's quite a difficult one to answer.

But there are no plans to go back to as S8s and (multiple speakers).

No, no.

There's no need.

I mean, EasyCare Online is about the present and the future.

And of course, you know, some governments such as in France are starting to mandate that you need to have compliance there and even CMS where there's this 90 day rule where you're going to show 30 days continuous usage.

That's also part of the influence EasyCare Online is meeting or is addressing.

And the S8 is being phased out, if you like, or almost has been phased out.

Jason Mills, Canaccord.

This is Jeff Chu, filling in for Jason.

Thanks for taking the questions.

I wanted to focus on your operating margins for a moment.

With regard to operating margin leverage, what is the Company's medium-term target for operating margins on an organic basis and do you see M&A as a viable driver of operating margin expansion for the next two to three years?

It looks like Mick has dropped off in London, so, Rob, do you want to --?

Yes, I think the operating margin leverage question we will hand over to Brett because.

Okay.

It's a bit of a ping-pong here.

So, Brett --.

You're being thrown under the bus.

Yes, there's operating metrics and targets and so on that we have.

It's not something that we publicly go out there with.

But I would say, I mean, clearly, we will look for operating leverage over time.

You're certainly seeing that with, for example, SG&A spend.

And you're seeing some margin expansion coming through as well.

So they've really been driving out operating ratios and so on, which are in very good shape.

And we'll continue to do that.

R&D, a little bit different.

We'll absolutely invest in the product pipeline and we'll invest on merits, really, from the ground up in terms of where we think gaps in the market and opportunities.

So that one we look at it much more differently, if you like.

But certainly, we are absolutely committed for initiatives that they're going to drive those operating ratios.

But we are not out there on public record disclosing what they are.

Okay.

Great.

And one last question.

Did you pay the medtech tax during the quarter and what are your expectations for the tax burden going forward?

Yes.

Jeff, yes, we are paying a small amount, but really -- I think I mentioned a quarter or two ago, really that number, if you look at it annually, will be less than $1 million.

Most of our products fall into the device tax.

Basically it's a hospital issue and some of our products (multiple speakers) direct to hospitals will fall under the medical device tax -- the 2.3% on revenues, but it's -- happily it's not material for us.

Great.

Well, I think maybe --.

I apologize.

We are at the one-hour mark, so now I'll turn the call back over to Dr. Peter Farrell, for his final remarks.

Thank you.

Thank you very much.

I'd just like to thank the team for their efforts and, once again, we have some first-class employees backed up by some first-class products and we are very optimistic about the future and so thank you for joining us today and I'll leave you in very good hands with Mick and Rob, operating within the office of the CEO.

We have an extremely strong, productive, and excellent team across the globe and so thanks to all for their efforts.

And that completes the call and we look forward to keeping you posted on our progress.

Thanks, guys.

Thank you.

Ladies and gentlemen, this concludes today's conference.

Thank you for participating.

You may now disconnect.