ResMed's Management Presents at Citi 2013 Global Healthcare Conference (Transcript)

| About: ResMed Inc. (RMD)

ResMed Inc. (NYSE:RMD)

February 26, 2013 10:20 am ET

Executives

David Pendarvis - Chief Administrative Officer, Global General Counsel and Secretary

Analysts

Alexander Evans Smith - Citigroup Inc, Research Division

Question-and-Answer Session

Alexander Evans Smith - Citigroup Inc, Research Division

The latest with regards to the impact that you're expecting, how that will flow through to the distributors, and then what follow-on effects there might be on ResMed. I think that's one of the continuing risks of the story, and I'm always curious to hear your thoughts.

David Pendarvis

Sure, great. So the -- to sort of size the issue, which really hasn't changed for us, the U.S. represents about 55% of our sales and Medicare, which is the segment that competitive bidding applies to, is about 20% to 25% of our U.S. sales, are ultimately reimbursed in a -- by Medicare. So Round 2, which is the round that was just bid and the bids announced, I think, overall, would be probably at least 1 and 2 together would be roughly 65%. So 2/3 or so or to 70% of the overall Medicare market. You sort of run those numbers in and you're talking about 15% or so of our overall sales would be ultimately subject to reimbursement by competitive bidding. So it's not all of our business. It's a small segment of our business and it's also an indirect impact because the impact was falling on our customers rather than directly on us so just to sort of size it up for a second. Round 1, we saw relatively little impact to us as a result of competitive bidding, and that's in part because of this size issue that I just kind of went through. And secondly, because the dynamic in the U.S. market has been that the commercial pay reimbursement insurance companies have been consistently reducing reimbursement over the years. So our customers have been living in an environment where reimbursement per sleep as well as many of the other DME products that they sell have been consistently coming down year over year over year. We've been helping our customers live in that environment and prosper in that environment in part by reducing the cost of our products year over year over year. So we've been having an environment of SKU declines on a like-for-like basis in the kind of mid-single digits over the past several years. We've been able to still do well with that because we have been able to reduce the COGS of our products so that we can maintain our margins in the U.S. and we've also had some wins in terms of the competitive dynamics with our competitors, so we've been increasing market share over time. And then in addition to that, more recently in particular, we've had some significant mix shifts, both in terms of the increasing use of automatic devices and in terms of the increasing benefits and market share gains on the bilevel side for us. So those have been sort of more recent offsets. But when you look back at what happened in sort of Round 1, in part because what was happening was the Medicare reimbursement was coming down closer to the private pay reimbursement, the world that our customers have been living in didn't change all that much. And certainly, from -- in the sleep perspective, we're roughly, as I've said before, there's a 80-20 mix with 80% of the patients being commercial, 20% being Medicare. That mix didn't change. Whereas, for the customers, the impact's bigger frankly because a lot of their business is more heavily weighted towards oxygen. So for our customers, the whole competitive bidding thing has a big impact because a lot of their revenue is subject to competitive bidding even if a lot of their sleep revenue is not subject to competitive bidding. So we try to work with our customers, make sure that we're finding out what our customers need and what we found in Round 1 was a lot of them are looking for opportunities to offset whatever revenue loss they were looking at. And one of the opportunities that they had was to work on things like mask replenishment, where there's still opportunity for growth, adding new patients in sleep where there's still opportunities for growth. So what we try to do is work with our customers on finding growth opportunities to offset whatever the negative impact they might be seeing on sort of the oxygen side or on the Medicare sleep side from the reimbursement changes. So Round 2, we would expect more of the same. The cuts were a little deeper than we had expected, although, interestingly, this sort of being our government, they changed the accounting or they changed how they want to report things. And so as we understand it, when we sort of calculate it on a non-weighted basis, what the reductions were sort of equally weighted average, the reduction was about 41% compared to the 32% across-the-board. Reduction that you saw in Round 1, they reported it, I think, higher, at 47% to 48%, but that's on a weighted average basis. So apples-for-apples compared to Round 1 and it's 32% in Round 1 and 41% in Round 2, so a deeper cut, but still not hugely different than it was. And so we would expect to work with our customers to -- we're continuing to reduce prices as we have over the last several years. We've worked with our customers to try to find ways that they can grow their sleep business, and use that to offset whatever impact they may have on the reimbursement side, and then work with our customers to make sure that we're continuing to be good partners to them and help them to prosper overall. It's very early days, right? I mean, these sort of headlines came out less than 1 month ago. We still don't know and it won't be announced till later this spring sort of who won contracts in certain markets and who didn't win contracts in certain markets. Those new reimbursement amounts go into effect July 1, and then you've got a rebid of Round 1 that goes into effect in January, I believe, of next year. So this is an ongoing process that we'll be living with on that 20% kind of the U.S. market Medicare side for some time, and the same things that we've always done which is to work with our customers we expect to be doing as we go forward. So we don't expect to have a huge impact on our business, but we're obviously going to work with our customers to make sure that we do what we can to help them win and prosper. Yes? Just hang on for the microphone. I think they're trying to webcast it.

Unknown Analyst

Sorry about that. I was just curious with the discussion on the impact that you saw in Round 1. How did the CMS cuts impacts the behavior of the commercial -- the commercially reimbursed piece of the business? Did you see prices for that piece of business try to come down underneath the CMS cuts? Or was there more stability and how does that impact your thinking about how Round 2 will play out?

David Pendarvis

We don't really have differentiated pricing, right? So we don't give one price to customers for that portion of their patient flow that's going to be reimbursed by the commercial side and then a different price to our customers based on those patients who are getting reimbursed on the Medicare side. So our pricing is unitary. And if you have whatever your patient flow is and you need a certain amount of our products, that's a negotiation, and we're going to give you kind of one price. In terms of what we can see of what happened in the marketplace of the reimbursement, we didn't see -- I think we're not as close to it because we don't get reimbursed, right? So we kind of hear about this anecdotally from our customers, but we didn't hear of any substantial commercial insurance companies in the U.S. changing their reimbursement as a result of something that happened on the Medicare reimbursement side. Now, again, as I said earlier, because the commercial reimbursement was significantly lower than that Medicare reimbursement, Medicare is sort of moving down to be closer within the mix of the commercial pay reimbursement rates, which are all over the map. It didn't really change the landscape, I would think. So we didn't see it, but again, we're not as close to it. And in terms of pricing, we offer sort of unitary pricing for our products and they're not differentiated by the reimbursement source.

Unknown Analyst

Do you expect that mid-single-digit price decline to continue in the future?

David Pendarvis

That's the world we've been living with, and we would expect -- we certainly plan for prices to continue to go down. We -- our pricing is largely driven by competitive activity, right? So it's -- we need the competition. We try to stay competitive. We believe we've got the best products in the market and we believe those products ought to command a price premium. We think they deliver cost savings to our customers, and we think that they deliver benefits to our customers in terms of increased compliance for patients. So we think that there will always be a premium that we'll have. But on the other hand, we plan for a world in which prices will continue to go down. So on a product -- new product introduction basis, we might necessarily bring new products in at sort of a level of parity to where the previous generations of products were priced. So in an SKU basis, yes, we expect prices to come down in a category basis, and you might find prices being a little more stable than that within that sort of -- that's a U.S.-based phenomena. Outside the U.S., again, we traditionally reduced our prices as well, but in different markets those fluctuations might be at different levels.

Unknown Analyst

And so my second question, in terms of the masks and certainly, historically, you've had a big advantage over your competitors in your mask technology. Do you feel that's being eroded recently? Or do you still feel you've got the lead?

David Pendarvis

We still think we've got the best masks on the planet. In fact, we recently did some surveys to try to put some science behind that, and we were able to do survey work, find out we were the #1 mask brand preferred by patients in various of the large markets. So we asked patients and found that when the patients expressed a preference for masks, these are patients who would -- been on both our mask as well as competitors' masks, they're able to draw the comparison, and when patients expressed a preference for one brand over another, they express that preference for ResMed more than any other brand. So we believe that we're the #1 mask brand preferred by patients in the large markets across the world. And when we look at feature for feature, how our masks match up against our competitors, our competitors are always getting better, but our products are getting better as well. So that's good for patients across the spectrum. But yes, we believe that we still got an advantage in terms of our products because they're preferred by patients. We think they do better for our customers. They're easier to set up, and it leads to more compliant patients. And obviously, in the end, compliant patient is going to be good for the patient. First of all, they're getting effective therapy. They're going to be reducing their overall health care cost because if you're compliant with your sleep therapy, you're going to be having fewer cardiovascular instance, having lower instance of stroke and then really catastrophic expenses. And lots of health care economics data is out there showing that you're going to be lowering the costs of your overall health care being provided to the patient. That only works if you're compliant. If the mask and the flow generator's sitting in the closet behind your desk or your drawer besides the bed, you're not getting those benefits. So if you can get that patient compliant, the overall health care system is going to benefit. And then in addition, you're going to find that the compliant patient who needs a resupply of mask is going to benefit, our dealer is going to benefit. So it's really triple win, and we think having that mask lead is going to continue to pay those advantages for the whole system definitely.

Unknown Analyst

May be shifting to the positive side a little bit.

David Pendarvis

We think it's all positive.

Unknown Analyst

What are the incrementals for the positive opportunities over the longer term? I think you've touched on compliance as one of them, increased mask replacement. Can you give us an update with regards to home testing as well as incremental evolution of the products that could be significant growth drivers in the longer term?

David Pendarvis

Sure. So the home sleep testing again is pretty much a U.S. phenomenon so it's really affecting that kind of U.S. business. A lot of the testing that's done on the rest of the world is already predominantly home sleep testing. So it's really a U.S. trend, but it's an important trend. And the last sort of survey work that we did to give us an estimate of the number of tests that were done in the market, listed about a quarter of those tests. Maybe 25% of them were being done in a home environment, and that has been increasing. And we expect that change will continue to increase so that home sleep tests will represent a larger percentage of the tests that are being done in the market when we get to the end of the year. Now will it be 30%, 35%, 40%, 50%? We don't know. It's hard to project a trajectory, but it's definitely a positive trajectory. It's being driven by a lot of the insurance companies requiring preauthorization. So now we'll say the AASM, American Academy of Sleep Medicine, have some guidelines for when they believe you should or shouldn't have a home sleep test. And so a lot of insurance companies now are saying, "Okay, if you're going to order a sleep test, tell me why this doesn't qualify for a home sleep test under those guidelines. And if it doesn't, if you think it doesn't, you persuade me, then I'll authorize you to have a laboratory polysomnography. If it doesn't, then you still have the home sleep test. And if you don't ask me for authorization, then you can go have a home sleep test regardless. So it's an easier path to home sleep test, and that's really what's driving it is the adoption of those preauthorization requirements, and we're still seeing those preauthorization requirements get broader. So certain systems, certain large insurance companies are broadening those preauthorization requirements to more regions of the U.S. and then more payers are adopting those preauthorization requirements. So as we see those trends broaden and deepen, you'd expect to see more home sleep testing. More home sleep testing tends to drive more use of our automatic devices because in home sleep test, you don't have that second night. A typical laboratory test either has a second night or in a split night, the second half of the night in which our patients actually have a mask put on them and then pressure is applied, and the technician will try to determine what's the right pressure that the patient needs to keep their airway open. There's no way to perform that second night test in a home sleep test environment so you need an automatic device, which automatically sets the pressure. We believe the automatic device is a better device for a patient to be on anyway because it's constantly adjusting the pressure. So those -- that trend of increasing preauthorization leading to a trend of increasing home sleep testing, leading to a mix shift of positive, more automatic pressure device, we think, is good for us and that will be an incremental benefit. We also think that if you look at some of the other benefits in terms of the overall health care market again in the U.S., but some of this is true outside of the U.S. as well, is this view towards more, say, in the U.S. would be accountable care organizations or another census looking at the overall cost to a system of what the patient's health care costs, and we've developed a lot of health care economics data around the fact that you're saving money, I referenced this earlier, you're saving money for an overall patient's health care if you treat, effectively treat their sleep apnea. We think that's a trend that will continue to have positive for us. In terms of some of the new product introductions so we came out about a year and a bit ago with our bilevel products and our bilevel products and the S9 platform had a significant benefit in terms of the increased -- certainly, all of the S9 benefits that we have in terms of reduced noise, increased humidification, some of the data analytics that they have, were all now present on our bilevel product. So our higher end products, which are providing a little bit more ventilatory support have those S9 benefits. They were much more competitive products. They were at the same -- we have the same benefits of having the same platform for S9 and for humidifiers across the line so it was a real beneficial uptick to have that and that's been a market share gain for us, an opportunity to sell the bilevel products and the S9, particularly with you get -- with the benefit that we get on our ASV devices or adaptive servo-ventilator, which is one of our highest end product to treat combination of central sleep apnea and obstructive sleep apnea. That product went from the S7 to the S9 platform. So it's a big leap. So it's almost a golf analogy. If a new club would give you an extra 5 yards, this club would give you an extra 10 yards. So it's a much more significant incremental benefit that you might get from a new driver, say -- and so going from that S7, S9 in the ASV platform made the ASV a significant competitive advantage for us, and so we've seen increasing sales of that -- it's a great price with a high ASP product, high margin product and does wonders for the patients. So we've really been able to invest in a global phenomenon of having that product be very successful, and then we've brought new products out in the ventilation range. The Stellar 100 and Stellar 150 done very well. Again, it's a segment for us with non-invasive ventilation. The Stellar 150 can also be used invasively as well, but it's primarily in that home care ventilation segment. The segment has done very well in Europe, and we think it's got some good opportunities for us in the U.S. in the long run, but that product has done very well for us. And then there's an overall new product and new service offering that we have which is really in the software space. So we came out with EasyCare Online, which is a cloud-based data management solution. It's primarily based in the U.S. at the moment for dealers who need to maintain records of their patient's compliance. So we've always had a compliant system, but it was a system that wasn't a cloud-based system and wasn't as easy to upgrade on our end. It wasn't as easy to access for both the physicians and the DMEs and others who might need access to that data. Coming up with that system and then rolling that out over the course of last year was an opportunity for us to have incremental gains with our Flow Generators in the U.S. That has been very well received by our customers, and very well please with that. And so it's a preference, a preference for our flow generators work with EasyCare Online. That is now being rolled out in France, and so you're seeing EasyCare Online migrate to, certainly, to France and could well migrate to other areas of Europe where there's a customer need for managing that kind of data. It's a very robust system, and provides us with a lot of opportunities. We made an acquisition awhile back of a company called Umbian, and Umbian has U-Sleep product, which is actually a non-brand specific data management system. So if you look long-term trends, the data and the management of data is becoming much more important in our industry. And we believe that we're on the cutting edge there, and we'll continue to incrementally improve that product. But in addition to that, we've always got R&D that's working in sort of additional masks, upgrades for our Flow Generators line, and those will continue over time.

Unknown Analyst

You touched on the bilevel devices. Could you just give more detail in terms of percent of share within the generators themselves in which the bilevels are? I've never quite understood because I appreciate it's a higher-margin product, but how much of a driver is that at the end of the day for us to think about?

David Pendarvis

Yes, so we don't break out the specific percentages for competitive reasons, but let me see if I can at least size it for you a little bit, which would be to say from the overall sales of our Flow Generators, we would sell on a volume basis many more Flow Generators on -- that are CPAP or APAP than we would our bilevels. The dollar volumes will be greater for CPAP and APAP than they would be for bilevels. So it's a smaller portion of our business from that perspective, but it's one that we believe has a lot of opportunity for growth because, at least, in certain segments of that business, we have less market share than we do in the CPAP and APAP side. So we think we have opportunities to gain share. Then if you remember, there was an event about I guess, maybe 1.5 years ago or so where we got a little out of sync. So we had upgraded the CPAP and APAP to our S9 platform. We didn't yet have the bilevels out on our S9 platform so we had issues where like, remember, we had a humidifier that work with the S9, and so if our customers needed to stock our bilevels, they had to stock S8 bilevels and the S8 humidifiers and the S9 CPAPs, and the S9 humidifiers, and so there was a complexity to doing business with us, and we got hurt in bilevel share during that period of time. By introducing the S9 bilevels, that enabled us to gain that share back, but even traditionally, we think we have had lower share there than we think our products deserve. So we're actively pushing now to continue to try to drive share with bilevels, and so that's in part why it's an opportunity because we think we've got a higher growth trajectory that we can have there simply by gaining market share than we would necessarily have by growing the overall bilevel market. So it's a lower volume product, lower dollar total contribution, but it's a significant product opportunity for us. And because it's at the high end, it's a positive mix shift for us, which has been a little bit of a driver of our success. Is that helpful?

Unknown Analyst

[indiscernible] diagnostic [indiscernible] helping bilevel volumes?

David Pendarvis

So the question is whether the home sleep testing or other diagnostic changes has been helping bilevel volumes, not really, not really applicable. I don't think those would be changing because bilevel would be something that you would tend more in the U.S. It's got a couple of different categories. One category is really used for patients who don't become compliant with the traditional products and they have sleep apnea. So it's really still treating sleep apnea. It's only treating patients who are sort of for whatever reason can't tolerate the pressures or otherwise of CPAP. But then at the higher range, the sort of ST and ST-A range, they're really providing more ventilatory assistance and ventilatory support for patients who have neuromuscular disease or other specific issues that are not going to be picked up by a home sleep test. So it's really being driven in a different direction.

Unknown Analyst

Do you think there's going to be much more consolidation in the market?

David Pendarvis

Well, if you looked at the state of the channel, and I assume you're referring to the U.S. market, right? Basically, if you look at the U.S. market, it's certainly more fragmented than the market would be outside of the U.S. So that would suggest to you that there's opportunities for consolidation there. There's a small number of very large dealers and then there's a huge number of very small dealers. So you've got a lot of dealers in the U.S. that are sort of 1 and 2 locations. And any time you've got a business where scale can provide you with some advantages, you think there'll be opportunities for consolidation, and certainly, if you talk to customers, they believe that one of the impacts of competitive bidding will be to lead to more consolidation. Again, I think less so because of sleep, but more so because a lot of their business is oxygen and primarily, the oxygen -- the Medicare component of oxygen is enormous. So if you win or lose an oxygen contract, you can change the dynamics of your business overnight. So we think there's probably opportunities for consolidation in that space, but that will be determined by our customers, not by us. And as it happens, one of the things that I think is a barrier overall though is -- and you have to realize, this is an industry where there's still in probably 9 times out of 10, maybe more than that, there's a face-to-face interaction between the dealer and the patient with mask fitting and an initial setup of the device. And hopefully, it's an education and training to get that patient compliant. It's not like Amazon.com, where you're just sort of shipping your book to someone, and I guess now you can get your book downloaded on a Kindle, right? Or so back to my golf analogies, I've got a taylormadegolf.com and I say ship me the new R1 Driver and it arrives, and I know how to use that driver. If I don't, I should go see my pro and get some lessons, right? But to get that mask, how does that mask fit the first time and how do I make sure I've got the right size, small, a medium or a large? Do I have a -- do I need a -- if I can use a nasal mask, do I need a nasal mask or nasal pillows? That a lot of times requires an interaction with a technician, and that technician's at a dealer. That's a bricks and mortar location in an individual city, maybe an individual neighborhood. So unless you're providing that bricks and mortar or you're providing that interaction through some other means, you kind of -- there's an irreducible minimum level of infrastructure you got to have to be able to get those patients compliant. So we're concerned of that model that go towards -- I'm shipping you the product because it's easy for me. If those models don't lead to good patient care and good patient compliance because in the end, it's all about compliance. Now we're making our products easier to set up, more intuitive. The whole advent of EasyCare Online allows for the interaction to be remote, dataflow to be remote and real-time and instant. So we're certainly doing things that can enable a patient setup and compliance to occur with less interaction, if you will, but I think we're still a ways away from the Amazon.com consolidation of the sleep industry.

Unknown Analyst

Internally the -- you mentioned earlier, the waiting, I believe, is different than what we saw in Round 2 in terms of the actual individual code. I think oxygen and CPAP are now 1 category and each code is weighted differently. I'm just curious internally for the codes that matter for you, the device code, the EO-61 [ph] I think, in the fullface masks and those -- with the difference in waiting, do you guys have any expectations in terms of less for more, in terms of the absolute cut?

David Pendarvis

No, I really -- you're talking about the round 1 rebid, right, or recompete -- whatever, yes, okay. So no, we don't -- I mean, my understanding is you'll have to win or lose. And so in some ways, it might be more stable to someone if someone's business is heavily weighted towards oxygen and less weight towards sleep, and they won on sleep and they lost on oxygen, they may not be a financially stable participant. So in some ways, there would be some more stability, but whether or not that means someone might bid differently in our category as compared to how they did before, I don't think we have enough information to be able to see that. And again, we're not really -- those bids really aren't visible to us. We don't talk to our customers on which we're bidding. They don't share them with us, and so we just kind of wait and see. We just have a little bit more time, maybe one more question.

Unknown Analyst

If I understood right, EasyCare Online that you were talking about earlier is the system that allows the distributors to monitor patient compliance?

David Pendarvis

Correct.

Unknown Analyst

Is that something that you see as a sort of significant switching cost once all of your distributors are using that software platform? Does it make it harder for Respironics or Fisher & Paykel or the fourth and fifth players to do business if they're requiring that distributor to learn another software system? And can you talk about how many of your patients are on monitoring systems currently and what the potential is there?

David Pendarvis

We think -- so we certainly think it is a switching cost issue. If nothing else other than the opportunity to have staff trained on how the system operates, one of the great things, if you think about EasyCare Online, is it's an amazingly intuitive system. So it doesn't require a lot of training and the training's easy. But we think once you get up and running with the system, then you probably don't need a proliferation of other systems. A lot of times in the U.S., to the extent it's only being used for that first 90-day monitoring so you'd find a patient compliant, it's not as if that one patient is continually monitored for the lifetime of their therapy. So from that sense, it's not as sticky as it would be otherwise, but one of the things that we do is through U-Sleep we actually provide a solution that is -- that crosses over multiple manufacturers. So actually, if you want to have a unitary system, usually, it's the way to go. So we think we've got a differentiated offering. We've got an offering that can provide this sort of crossover monitor all my patients, no matter what equipment they're on, and we provide the ResMed specific proprietary system as well. So we can meet our customer whichever way the market goes. But clearly, we think it is a switching cost and more importantly, we think it's a way to enable our Flow Generators to certainly provide the most data in the most accessible fashion so it gives us -- it should give us an advantage in terms of preference.

Unknown Analyst

[indiscernible] penetrates the market?

David Pendarvis

So I don't -- the question is how penetrated is the market, and I don't think we've got a strong sense for that at the moment. In terms of customers, it's certainly being adopted by most of our customers. But in terms of how frequently they're actually using that system with what percentage of their patient population base, we don't really know.

Unknown Analyst

Great. Well, thanks, very much. Thanks to Citibank in absentia for having me here, and we look forward to seeing you all down the road. Thanks very much.

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