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ResMed Inc. (NYSE:RMD)

Barclays Global Healthcare Conference

March 13, 2013 1:30 pm ET

Executives

Michael J. Farrell - Chief Executive Officer and Director

Analysts

Matthew Taylor - Barclays Capital, Research Division

Matthew Taylor - Barclays Capital, Research Division

Thanks for joining us for this afternoon session. I'm Matt Taylor, the medical device analyst, and we're pleased to be joined by ResMed and CEO, Mick Farrell. Also have Connie Bienfait from -- the Head of Investor Relations.

And ResMed is a leader in respiratory therapy, truly have a leading position in the sleep apnea space, and that's been growing nicely over the last couple of years. They have a lot of new products in the pipeline and are also looking to move into new therapy areas, and so we're certainly looking forward to hearing more about that. But I think this is going to be all Mick, so I'm going to step aside and let you take it away.

Michael J. Farrell

Yes. Thanks, Matt. And we're going to have Q&A afterwards so this is a -- presentation session's 25 minutes and then we're going to have Q&A, I think in Ponciana 4 straight afterwards.

So our global general counsel tells me that I have to read this page. So forward-looking statements, I've done that, they will be made and you can check the SEC for all the risks associated with ResMed.

We believe that at ResMed, we are grasping or about to grasp the Holy Grail of health care. And the Holy Grail of health care has 3 elements: Firstly, that what we do in treating respiratory medical conditions is prevent other disease progression from cardiovascular disease to COPD to type 2 diabetes, to other ailments I'll talk about.

Additionally, we improve quality of life. We make people participate more in their life, be more present at work, not get fired from work, not get divorced from their spouse. We'll talk a little bit about the aspects of quality of life from respiratory therapy.

And then thirdly, and not least importantly, we know, we don't believe, we know that we reduce the costs of health care, and we'll talk about some real hard economic data and then the much more challenging task, which is to get that real hard economic data across to every payer in every country of the 70 countries that ResMed is in.

So who we are; I'm looking around the room, I'm seeing a lot of faces either from the general or from the one-on-ones, so I think a lot of you know who we are. For those of you who don't, we're a global -- we're the global leading manufacturer, developer and marketer of medical devices for respiratory medicine. That includes our primary and core market, which is sleep-disordered breathing, and we love our acronyms at ResMed so that's SDB, so that's our core market. But it also includes COPD, neuromuscular disease, Cheyne-Stokes respiration, central sleep apnea and others that I'll talk about.

So since we're in a financial conference, I'll start off with the numbers. We've just -- well, not just, about 2.5 months ago, we announced our 72nd quarter since we went public. We IPO'd on NASDAQ in '95 and then moved to NYSE in '99. But since we've been public, we've had 72 quarters of consecutive revenue -- year-on-year revenue growth. We did it again. We were $376.5 million, which is about 14% in constant currency. The headline was around 13% because of ForEx. Net income, the bottom line was $77.9 million, which was up 24% year-on-year. Our earnings per share were $0.53 per share and that was up 26% year-on-year.

Importantly, our operating profit was strong too. Our operating performance is a big part of who we are. And we'll talk about continuous improvement, the importance of quality and what we do in that space later in the presentation.

Additionally, another area that we're very proud of, even though we're a public company not owned by a private equity, is cash flow. $93.6 million worth of cash flow in Q2, which we think was a good number. And we look to use that cash and we'll talk about that later. And another important one is our gross margin. We're maintaining that at 61.8%, and our guidance was somewhere in the 60% to 62% range, so we sort of hit the top end of that from Brett Sandercock, our CFO.

So putting that in perspective, from 1 quarter to looking back over 5 years here, our compound annual growth rate on the top line on revenue is a nice double-digit 14% over that 5-year period. That's in a market that we believe is growing at 6% to 8% roughly. So we have been taking share on a consistent basis and that's our core market of sleep-disordered breathing, and I'll talk about the new markets in a second.

Switching to bottom line, our compounded annual growth rate on a 5-year period is a nice double-digit 19%. And really importantly as well, with EPS, we're at 20% on the 5-year picture for sustained earnings per share growth.

So how do we do it? How do we produce numbers like that for 5 years? Well, we do it through innovation. We are an innovative medical device player. We raise the bar for compliance and efficacy for our patients. We look at the answer per metrics of a face and design products that are specifically designed for segments such as the female segment, or categories such as the low end, the mid end and the high end segments.

We also spend a lot of time and effort battling our #1 competitor, and our #1 competitor is not Philips, it's not Fisher & Paykel. Our #1 competitor is ignorance or lack of education and awareness about sleep-disordered breathing and how it impacts medical morbidity. So we spent quite a lot of time and effort driving social media and direct marketing campaigns around awareness for sleep apnea. And hopefully, in your cocktail conversations or talking to cab drivers, you get asked what you do.

I join ResMed in 2000 and probably about 2, maybe 3 out of 10 taxi drivers or people at a cocktail party, when I said, well, we stop sleep suffocation, said, "Oh, you mean sleep apnea?" Now it's more like 7 or 8 out of 10, and these are not just mix review of taxi drivers. This is some clinical data and review data of what we have of awareness out there. But we're not done at awareness. We had to then switch from awareness to action and I'll talk a little bit about that later.

Additionally, another important area for us is our noninvasive ventilation solutions. It's really our second horizon of growth. Why don't I spend a moment on that now; we've got 3 horizons of growth. The first is our core market of sleep-disordered breathing, and that core market is growing at 6% to 8%. We plan to grow in the double digits in that space, but while doing that, we plan to take that cash flow and reinvest in the other 2 horizons.

So our second horizon of growth is in respiratory care, including the diseased states of COPD, chronic obstructive pulmonary disease, neuromuscular disease. We're also looking at ALS or Lou Gehrig's Syndrome and all of these are covered by our respiratory care strategy.

In addition to that, we have a third horizon which is cardiology and specifically the heart failure market; the 5 million patients with heart failure here in the U.S.; in the Americas, it's more like 7 million. We start going over to Europe, you add another 7 million, and then we look around Asia Pacific, you have another 10 million. So we're talking 24 million to 25 million patients around the world that we've got some amazing therapies in the cardiology space. Both screeners and diagnostic, but also therapeutic, and I'll talk a bit about each of those.

Well, let's switch back to that first horizon in our core market of sleep-disordered breathing, what's the market size? So there's some very solid data of out there from Terry Young and the University of Wisconsin group. It's called the Sleep Heart Health Study. For those of you who follow stocks in the cardiac space, this is our Framingham. This is our Framingham study, so we switch from Massachusetts to Wisconsin. But Terry Young runs this. And the prevalence in the adult population of sleep apnea, the primary type of sleep-disordered breathing is 20%. 7% of that is moderate to severe. And when we say moderate to severe, that means you suffocate 15 to 30x per hour for every hour of sleep. So you could suffocate 50, 80, 100, 200x a night.

Mild, which is that 13% component, means you suffocate between 5 and 15x per hour. So if you sleep 8 hours, that's 40 suffocation events at a minimum, could be up to double that, 80 or more. We'll talk about what that does to your system. You don't die immediately because you have this response called the fight or flight response. The surge of neurohormones sympathetic nerve activation and you sort of do this and then you go and you breathe in because your body says, "Oh, shit, I'm about to die." And literally, sends you into a state where you don't actually consciously wake up but you snore and respond, and your heart rate jumps from wherever you were at your resting heart rate, maybe in the 40s, 50s, 60s, 70s up to the high 80s, 100, 120. And this happens 80x a night. This is not triggered at all.

So sleep-disordered breathing, there's 3 main aspects to it. There's obstructive sleep apnea, central sleep apnea and Cheyne-Stokes respiration. Obstructive sleep apnea, which I badly just demonstrated right then is the primary one. And that's where you got snoring, sorting and literally the uvula and the upper airway collapsing upon each other. Then the central sleep apnea, which is where the brainstem, so the back of your brainstem actually measures the CO2, carbon dioxide in your blood, and that's how it determines whether you breathe or not, have a respiratory drive or not. When the CO2 gets out of sync or the receptor gets out of sync, you can have central sleep apnea. So about 80% of SDB is obstructive sleep apnea, about 20% is central sleep apnea. And there's 2 different therapeutic elements for that. I would say it's treated by what you probably hear as CPAP, the standard CPAP. It's also treated by APAP, which is for automated positive airway pressure.

Central sleep apnea is treated by more advanced technologies, and our advanced technology is called adaptive servo-ventilation or ASV and I'll talk about that in a moment. You can't read this from the back of the room. It's meant to be an iChart. What it's talking about is the prevalence of sleep apnea in various comorbidities. And for us, a comorbidity is anything -- any disease state that we touch that gets worse when the obstructive sleep apnea or the central sleep apnea is untreated.

I'm going to focus for today's talk just on the top 5 here and I'll read them out for you. The top one is drug-resistant hypertension. 80%, that's 8-0, 8 out of 10 drug-resistant hypertension patients have obstructive sleep apnea. Obesity, 77%, that's logical. CHF, heart failure, 76%, 7-6% CHF. And I'm going to talk about heart failures. It's a very important opportunity for us. Type 2 diabetes, 72%. A little higher in males, more like 78% in males and 60-something percent in females, and also stroke, 63% of stroke patients have obstructive sleep apnea.

So is it the chicken and the egg? Is it causality or correlation? I'm going to go a little bit into the mechanics of this as we drill down in some of these disease states. We have 5 strategic areas of focus for ResMed including cardiovascular and cerebrovascular disease. We have type 2 diabetes; peri-operative risk, so in dead in bed, patients literally dying in hospital with sleep-disorder breathing; occupational health and safety and COPD.

Today, we've only got 25 minutes and I'm almost halfway through. We don't have time to focus on all. I'm only going to focus on 3; cardiovascular disease, Occ-Health and COPD.

So firstly, we're talking about cardiovascular disease, what are the data? Does OSA have an impact on this and does CPAP treatment, our primary treatment, impact those disease states? The answer is yes and yes. In studies, CPAP on -- in randomized-controlled trials on a diagnosed and treated arm versus a diagnosed and untreated arm has an improvement of between 4 and 10 millimeters of mercury reduction in blood pressure, which is equivalent to a drug from a major pharmaceutical company. And we're talking about a noninvasive therapy that you can remove every morning and doesn't impact the rest of your body that's unaffected.

Another really important aspect for us in cardiovascular disease is our investment in this space. ResMed is sponsoring the largest and the pivotal trial in this disease space. This trial is SERVE-HF, as in serving heart failure. And we are looking at 1,200 patients with class 2, 3 and 4 heart failure. And those patients have to have sleep-disordered breathing as well as a comorbidity, and the sleep-disordered breathing has to be about 50%-plus central sleep apnea and Chyne-Stokes respiration.

Within those group of 80 centers in France, Germany, U.K., Nordics, Australia and so it's a global trial, we are pleased to announce that we are on the way to finishing completion of the enrollment for that. We have between 1,200 and 1,300 patients, and we're going to announce that in the next 2 or 3 weeks with a press release to show that we are fully enrolled in that.

It's important to note that it's a 2-year follow-up trial, so each patient has to be followed up for 2 years. So if we complete enrollment here in the first half of 2013, we'll finish the last patient in the first half of 2015, get through peer review, publication, submit and then present at major conferences late '15, probably early '16 to 2016.

But we think this style -- this study is going to show some pretty important things. There's 2 major outputs of the study: one, mortality and; two, morbidity, right. And our goal which I'm sort of quick to hit here, is to show that ASV does those 2 things, right. It lowers mortality, so it saves lives and it lowers morbidity or, of course, hospitalizations and so that we save money for the health care system. We think both of those are pretty important and we think it's very important for our industry to have this type of information out there.

Switching from heart failure to occupational health, one of those other 3 areas I want to focus on today. There are many accidents from a New York Harbor ferry accident, from a Tokyo bullet train accident, from a plane over flying Minneapolis airport or worse still flying over Honolulu airport where there aren't many airports to land in. In all these incidences, the occupational health driver, pilot, had obstructive sleep apnea and was untreated. They had obstructive sleep apnea, they'd been prescribed and they were not wearing their device. We think getting these patients diagnosed and getting them on therapy and tracking them on therapy, we'll talk about our cloud computing compliance technologies in a second, but this capability is incredibly important.

There are a number of trucking companies, one that's gone public, a leader in the space called Schneider Trucking, who has made it compulsory that their drivers diagnosed for OSA and if they're diagnosed, they're on treatment and that they're using the treatment. They have a centralized nursing facility that calls you up if you're not using it. And she's got EasyCare Online, ResMed's database in front of her showing green, yellow, red. If you're red, it means you didn't wear your device. Guess what, you're not on the road today. So some companies are taking this incredibly important.

Take another company in this space, that has a lot of drivers. Waste Management. They ran a trial and they published this, so it's okay for us to share it. There are many that we're running with Occ-Health partners that we can't share, but this one we can. Waste Management has published theirs. They showed in just 1 year that there was a 37% reduction in total medical costs for their patients, their drivers who were OSA patients who were on therapy and compliant with the therapy. It was compared to a control group who had OSA and were not on therapy. This is incredibly important, 37% reduction in the health care bill for a self-employed -- self-insured employer. Huge potential savings in Occ-Health. And we've got many other examples and as we are allowed to and as those company share them with the public, we will share them with you at investor conferences like this.

Another important market expansion opportunity for us is to go after the 85% to 90% of patients who are not yet diagnosed from obstructive sleep apnea. So we're here in Miami, so 40 million to 60 million Americans have sleep-disordered breathing, and we've got somewhere between 4 million and 6 million of them on treatment. So we're somewhere between 10% and 15% penetrated. This is after 20 years in business.

We're happy with our growth and the numbers we showed you, but we're not happy with the fact that we're not penetrating that group faster. Another way to get after those undiagnosed patients is to give them an easier way to get diagnosed. Home sleep testing is just such a way and the example product up here is ApneaLink. We're kind of agnostic to the diagnostic. We don't mind if you use someone else's diagnostic device. We're very partial to the therapeutic. We'd like the prescription to be a ResMed therapeutic device because that's where we focus our efforts.

But we created this diagnostic product actually from an acquisition we made in Germany in the early 2000s and brought the ApneaLink product to market. An important part of this market is now 60% of the lives, the covered lives in the United States have preauthorization for the lab test, which is called polysomnography or PSG. That means that there's a lot of paperwork you have to do to go through the more expensive lab tests, and it means that therefore, there's an incentive to drive more patients to the home sleep testing. And home sleep testing is very sensitive and specific to 4 PSG and it's been shown in peer-reviewed published articles to be just as effective in diagnosing core obstructive sleep apnea.

For the more sick patients, the central sleep apnea patients, they're always going to go to a sleep lab. And so a good 20% of the market will always be there for the sleep labs and that's very important because the sleep labs are a big part of our business. But for the garden [ph] variety, obstructive sleep apnea, a lot of these patients are now being diagnosed in the home. And this is driven by the payors. It's driven by CMS, Medicare and it's driven by the private payers as well.

Just as an example, this is a global health care conference looking at other countries. In France, 80% of the diagnoses are done in the home. In the U.S., right now, it's 25%, so 25%. But a year ago, it was only 15%. So we're projecting that within 12 months, it'll be somewhere between 35% and 45% of the studies being home sleep tests in the United States and it could be higher. We have one person at about 4,000 that happens to be our founder and chairman and he believes that it will be 50% by the end of this calendar year. He's on the aggressive side.

So talking a little bit about costs. So here on the y-axis, we have the average life expectancy for the country, and on the x-axis, we have the total expenditure in U.S. dollars per capita on health care. I don't know if you can see the trend line from the back of the room, but I'll read it out. Mexico's sort of in the bottom left with the life expectancy of around 75, 74 and around USD 1,000 per person per year per capita. And this is on a PPP basis. U.K., the life expectancy's around 79, and the average cost per person per year is around $3,000. Japan, the average life expectancy is 83 and the average cost is around $2,700 per patient per year. I don't know if you can notice the outlier. I was born in Seattle; I've lived here the last 16 years. I'm a taxpayer, but I'm upset that the U.S.A. is out here, a life expectancy of 77 and total cost per capita per person -- per patient per year of $7,200, be better from the OECD.

So I look at this and I say, I think there's opportunity to save costs in our system. And I think our system is actually a sick care system not a health care system. And the sick care system waits until you to get to the ER, CCU the ICU and then charge to treat you. We believe at ResMed that treating patients at the home is more cost-efficient and will save lives because you'll keep patients who might develop hypertension and prevent them from doing that, but it also saves money. Even for that heart failure patient, we'll be able to reduce hospitalizations and reduce the number of visits to the ICU and CCU. We hope to move that curve to the left.

So big costs in that -- this is all U.S. data now, just drilling down to say why is that expense so high. Cardiac and stroke, $403 billion a year, completion to require, you guys know this; asthma, $20 billion a year; diabetes, $132 billion a year; obesity costs the U.S. health care system $148 billion a year. Where do you think sleep-disordered breathing lies? $165 billion a year.

How many times does your primary care physician ask you, "Are you tired?" Have you been told, "Do you suffocate at night? Do you snore?" Incredibly rarely. So our awareness at the primary care physician level is a really important opportunity for us to drive this awareness, that's it's a high-cost disease and that it's easy to screen for and relatively easy now with home sleep testing to diagnose and get the patients on therapy. So we've got a 3 pronged attack on this and we have a payer team that calls upon -- we try to lobby Medicare as best as you can in Washington these days. We call upon Aetna, CIGNA, BlueCross BlueShield to show them these data that this high-cost disease state for you can be easily diagnosed and treated. And the goal here is to get to care management and move away from utilization management, which is sort of what's happening in some of the markets with CMS pushing competitive bidding. It's all about lowering nickeling and diming on line items rather than saying, "We understand that $1,000 spent on sleep-disordered breathing care will save us a net present value $3,000 to $6,000 on costs to the health care system." So it's taking a bigger picture point of view. And we're working through that.

Another way of how we innovate is through making better products, small, quieter, cheaper, more comfortable. Our devices have to be worn every night for the rest of your life, so that device better be light, small, comfortable, as comfortable as it can be, right. You're going to this every night. The devices that we have are on the bedside table -- we own the most expensive real estate in the world. Your bedside table, right. It's not -- it's a tough place to get on and a lot of companies would die to be on 1 million bedside tables with 24-hour access to power. We're there and we also have the capability to send the data through 2.5G or 3G, GPRS to the cloud and share that data with the payer, share that data with the provider, share that data with the physician so they know which patients to follow up on.

40% of the patients now showing up to the diagnosis, to the sleep lab or the home sleep testing are female. Up until just this last couple of years, it was thought of as an obese, male, elderly, centrally obese disease. It can be a woman in her 30s. And I've seen this. I've been to ENT clinics and to pulmonary clinics and seen young women with just a slightly recessed jaw, so just where the uvula and tongue is positioned to the back of the upper uvula, can drive obstructive sleep apnea. And she won't know about it because she doesn't necessarily snore as much. But these patients need different products and different approaches, and the anthropometrics of the face of a female are different to that of a male.

Another really important innovation that we've brought to the marketplace and we led in this space 7 years ago with cloud data from CPAP and APAP devices in the early 2000s is EasyCare Online. So these data now are coming from millions of node sources across the U.S. and now actually we're starting this up in France are able to share data so that a payer who knows they're saving money when a patient is using this device that stops them suffocating and stops their heart surging and stops the hypertension developing. We can track it on a daily basis, weekly basis and prove that the patient is compliant.

What pharmaceutical company can tell the payer that the patient's taking the pill? Now I know there's no one innovation Eric Topol talks about a lot, when you take the cap off, it knows and sends data to the cloud. But how do you know they didn't take the cap off and give that to the dog or put it -- flush it down the toilet? You don't know. You don't know where it's going. Our device, you know when it's turned on, you know that it's at pressure, you know that's it's on the patient because there's a different respiration platform if it's on the patient or not. We're able to send incredibly secured data to show that this therapy works and that the patient's adherent to it.

We also have a dental device. We're not just a CPAP and mask company in that sleep space. There was a substitute therapy coming up which is a dental device which attaches to the rear teeth and the upper teeth. It's called an MRD or mandibular repositioning device, pulls the jaw slightly forward. We bought that company in France 2009 and that product is going in France, Germany, Sweden, Canada and we just launched in the U.S.

A really important space for us is the respiratory care opportunity. This is the COPD neuromuscular disease, high acuity disease state. We bought a company in France in 2005 called Saime. We're #1 or #2 in every European home ventilation market. But in the U.S., we're #6, 7 or 8. If we bring all the mechanical and electrical engineering capabilities from our sleep business over to this respiratory care business, we have a huge multi-hundred million dollar opportunity in the U.S. and other parts.

The bottom line for these products is these are ventilators that you use not just at night. And it can be, like Johanna here, using an Elisee 150 that literally, she wouldn't be able to leave the house without her ventilator. And we're able to bring that type of ventilation technology across Western Europe, why can't we bring that to the U.S., why can't we take it to Asia-Pac and we've got the distribution channels to do it and we're going to make that happen over the coming years.

We're not going to talk much about our capital management, I see I'm at time. We've got about $950 million on the balance sheet; market cap's about $6.2 billion. We understand what that ratio means. We instituted a dividend. We are doing a share buyback process. Our CFO could go into a lot more detail. And if you want more detail about our capital management, Connie and I will cover those in the Q&A.

I'm going to close where I started. ResMed, we believe, is grasping the Holy Grail of health care here. We're preventing disease, we're improving the quality of life for our patients and we're potentially improving that we're reducing the cost of care. Thanks for your time.

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