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ResMed Inc. (NYSE:RMD)

F4Q09 (Qtr End 6/30/09) Earnings Call Transcript

August 6, 2009 4:30 pm ET

Executives

Kieran Gallahue – President and CEO

Brett Sandercock – CFO

Analysts

Joshua Zable – Natixis

David Low – Deutsche Bank

Alex Smith – JPMorgan

Ben Andrew – William Blair

Peter Bye – Jefferies & Co.

Andrew Goodsall – UBS

Jason Mills – Canaccord Adams

Joanne Wuensch – BMO Capital Markets

Michael Matson – Wells Fargo Securities

David Simpson – RBS

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2009 ResMed earnings conference call. I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator instructions)

The company has asked me to address certain matters. First, ResMed does not authorize the recording of any portion of this conference call for any purpose. Second, during the conference call, ResMed may make forward-looking statements, such as projection of future revenue of earnings, new product developments or new markets for the company's products. These statements are made under the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.

Risks and uncertainties exist that could cause actual results to materially differ from the forward-looking statements. These factors are discussed in ResMed's SEC filings such as Forms 10-Q and 10-K, which maybe accessed through the company's website at www.resmed.com.

With that said, I will like to turn the call over to Kieran Gallahue, ResMed's President and CEO. Mr. Gallahue, please go ahead, sir.

Kieran Gallahue

Thank you. Well, good afternoon and welcome to ResMed's fourth quarter and year-end earnings call.

As with our previous calls, I'm begin with some summary remarks and then turn the call over to Brett Sandercock, our CFO to go through the numbers in more detail. We will then both take your questions.

Well, as any of you that have seen the press release, you know the we had another very solid quarter and a phenomenal year that once again demonstrated the power of being a well balanced, geographically diversified company with a well accepted, high quality diverse mix of products.

We are pleased to report the global revenue in the fourth quarter of 2009 grew 7%, or up 15% on a constant currency basis. Revenue growth in the Americas grew by 20% year-over-year.

ROW revenue declined by 4% but in constant currency terms grew 10%. As expected, currency had a significant effect on ROW revenue. For the year, we are approaching that billion dollar mark with 921 million in global revenue. GAAP EPS increased a remarkable 55% to $0.59. Excluding amortization of acquired intangibles, EPS was $0.02 better at $0.61.

We projected that we would be able to grow gross margin and are pleased to report that gross margin improved over 62% in Q4, benefiting from the depreciation of the Australian dollar from last year's highs, and increase in sales of our higher margin masks, sales of high-end flow generators as well as continued success in leveraging cost efficiencies across our global organization.

Again we had very strong performance in operating cash flow, which came in at $70.2 million demonstrating our commitment to strong operating performance and a commitment to working capital control. Our balance sheet remains extremely strong with the cash and cash equivalent balance at the end of Q4 of about $416 million.

We also experienced balanced growth across product categories with global flow generators up 8% or 17% in constant currency, and mask segments growing at 6% during the quarter, an 11% increase on a constant currency basis.

We saw significant growth in the profitable segments of our flow generators. Globally the growth was mainly driven by strong sales of our high-end sleep devices, especially the S8 AutoSet II and VPAP Auto 25 where we had a big advantage in both noise and in comfort.

Our Easy-Breathe technology is now available across the entire sleep device platforms from CPAP to APAP and through to our VPAP SV devices. The whisper-quiet comfortable performance of Easy-Breathe is truly being recognized as best in class. Easy-Breathe technology has set a new standard in the industry and it's helping to differentiate ResMed from our competitors with improved comfort and reduced noise.

Sales of America’s flow generators were up 22% year-over-year in Q4 and sales in ROW improved to 30% in constant currency terms. As a result of changing product mix in the sleep device category towards higher-end technology, our gross margins are improving. There continued to be tremendous interest in our wireless compliance technology, ResTracks GSM. We still remain the only company that provides wireless transfer of sleep apnea data to an Internet system.

Once again we posted double digit growth in the mask segment globally during the quarter and continue to increase market share. We believe we are taking market share in both the new patient population and the installed base. Mask sales grew 18% in the Americas and in constant currency terms grew 4% in ROW. Mask sales in the Americas were strong across all product lines, with our full face masks, such as the Mirage Quattro contributing significantly, but also Mirage Activa LT, the Swift LT and Swift LT for Her doing particularly well. With their ease of use they are some of the best selling masks in the marketplace. As a reminder, these redesigned LT masks are smaller, lighter and more streamlined versions of their predecessors.

The Swift LT for Her product fills a gender need and space not addressed by other companies. We listened to the voice of the customer and we responded. And the Activa LT is a less obtrusive mask, which gives patients superior performance and potentially fits 90% of all patients. With these new masks in the global marketplace, we remain focused on growing market share with high margin industry leading products.

Looking forward over the next 12 months, we plan to launch a series of new masks and flow generators. In July as promised, we introduced the ApneaLink Plus, our type three home diagnostic device that will meet the existing reimbursement and physician requirements.

As we have been saying this year, we will be watching home testing carefully throughout 2009 and expect home testing to be piloted in various forms. It was proven that HST was here to stay in 2008 and in 2009 as we expected, multiple healthcare providers began piloting HST in various models. We are working closely with our sleep physician partners to make home testing a reality that can improve patient access to appropriate therapy.

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

Although sleep disordered breathing affects people of all ages, weights, genders and races it is becoming widely recognized that heart disease and diabetes particularly tend to go hand in hand with sleep disordered breathing, and treatments for sleep disordered breathing can not only improve health, but dramatically lower medical costs associated with these populations. I think that point deserves more thought and consideration.

It is well known that government and payers across the globe are looking to reduce healthcare costs, while improving outcomes. Let us remember that NICE, the National Institute of Clinical Excellence, which is the UK health economic experts, just over a year ago, released the results of their evaluation of sleep disordered breathing.

The net outcome, NICE concluded that it is economically advantageous to identify and treat patients suffering from sleep disordered breathing. Given that countries around the globe are looking to develop similar healthcare economic analysis arms, many based on the model that NICE established, this bodes well for ResMed and for the sleep industry moving forward.

We also know that sleep disordered breathing can have a dramatic effect on presenteeism as well as absenteeism and represents a significant opportunity with occupational health and safety in the transportation business for diagnosis and treatment of sleep disordered breathing. As a matter of fact, there was the story just recently that pilots on a Go Airlines flight from Honolulu overflow the international airport by 50 km last year because the pilots fell asleep.

The US National Safety Board confirmed an initial finding a few weeks ago that the captain and first officer inadvertently fell asleep, while the plane was on autopilot. The board said that the contributing factor was the captain's previously undiagnosed severe obstructive sleep apnea. This focus on occupational health and safety and the comorbidities such as diabetes and cardiovascular disease are still in their early days of impact. The data is compelling and we have not yet began to feel the full impact on this industry.

This market remains highly under penetrated, a fact that bodes well for the future growth prospects.

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

Brett Sandercock

Thanks, Kieran. Let's briefly run through our June quarter results. As Kieran mentioned, revenue for the June quarter was 252 million, which is an increase of 7% over the prior year quarter.

As expected unfavorable currency movements reduced our fourth quarter revenues by approximately 17.3 million. So in constant currency terms revenue increased by 15% over the prior year quarter.

Income from operations for the quarter was 57.9 million, an increase of 57% over the prior year quarter and net income for the quarter was 45.4 million, an increase of 53% over the prior year quarter.

Excluding amortization of acquired intangibles, diluted earnings per share for the quarter was $0.61. Gross margin for the June quarter was 62.2%, up sequentially from Q3, reflecting favorable currency impact, and traction from our manufacturing and supply chain improvement initiatives.

Our fourth-quarter gross margin now reflects the full benefits associated with this initiation of the Australian dollar relative to the US dollar. As you look forward, should the more recent appreciation of the Australian dollar be sustained, we will have a negative impact on our gross margins over the course of fiscal year 2010. However, subject to further currency volatility, we still expect our gross margin to be broadly in the range of 60% to 62% over the course of fiscal year 2010.

SG&A expenses for the quarter were 77.6 million, consistent with the prior year quarter. The flat price in headline SG&A expenses reflects the impact of the depreciation of international currencies against the U.S. dollar. In constant currency terms, SG&A expenses increased by 11% over the prior year quarter. SG&A as a percentage of revenue improved to 31%, compared to the year ago figure of 33%. Looking forward, and again subject to currency movements, we expect SG&A as a percentage of revenue to be in the range of 31% to 33% for fiscal year 2010.

R&D expenses for the quarter were 17 million, a decrease of 4% over the prior year quarter. The lower R&D expense reflects the depreciation of the Australian dollar against the US dollar as the majority of our R&D expenditure is denominated in Australian dollars. In constant currency terms R&D expenses increased by 14% over the prior year quarter. R&D expense as a percentage of revenue was 7%, consistent with the prior year quarter. Looking forward, and subject to currency movements, we expect R&D expenses as a percentage of revenue to be in the 7% range for fiscal year 2010.

We continue to devote significant resources to product innovation and clinical study activities.

Amortization of acquired intangibles was 1.8 million for the quarter and stock-based compensation expense for the quarter was 6.6 million. During the quarter, we also had donated 2.5 million for the ResMed Foundation.

Our effective tax rate for the quarter was 27.3%, and we estimate our fiscal year 2010 tax rate to be in this vicinity of 27% as well.

Turning now to revenues in more detail, overall America’s sales were 134.2 million, an increase of 20% over the prior year quarter. This was driven by strong growth in both flow generators and masks with strong contributions from our high-end CPAP and IPAP devices, our new range of bilevels and Swift and Quattro mask ranges.

Sales outside of the Americas totaled 117.8 million, a decrease of 4% over the prior year quarter. As expected sales outside the Americas were impacted by currency movements, in particular depreciation of the euro against the U.S. dollar. In constant currency terms, sales outside the Americas increased by 10% over the prior year quarter.

If you break those revenues up by product segments Americas flow generator sales increased by 22% while masks and others increased by 18%.

For revenues outside the Americas and in constant currency terms, flow generators increased by 13% over the prior year quarter, while masks and other increased by 4%. On a global basis in constant currency terms, flow generator sales increased by 17%, while masks and other increased by 11%.

Cash flow from operations was 70.2 million for the quarter, reflecting strong underlying earnings and improved working capital balances. Capital expenditure for the quarter was 25.8 million, including 9.8 million in building construction and fit out costs for our new global headquarters in San Diego.

I am pleased to note that the building was completed on schedule and within budget, and we have relocated to our new headquarters on May 11, 2009. There is approximately 4 million in payments remaining on the building and they should be paid during our first quarter of fiscal year 2010. Depreciation and amortization for the June quarter totaled 14.9 million.

We continue to buyback shares as part of our capital management program. During the quarter, we repurchased 349,000 shares, a consideration of 13 million as part of our ongoing buyback program. For fiscal year 2009, we repurchased approximately 1.8 million shares at a cost of 65.7 million. During the June quarter, our board of directors authorized a share buyback program for up to 10 million shares and this buyback program replaces our previous program. As of today, we have repurchased 79,000 shares out of the new total approved buyback of 10 million shares.

ResMed ended fiscal year 2009 in excellent financial shape. Revenues for the year were a record 920.7 million, an increase of 10% over the prior year or a 15% increase in constant currency terms. Net income was a record 146.4 million an increase of 33% over the prior year, and earnings per share was $1.90, an increase of 36% over the prior year.

Our balance sheet remains strong and is conservatively geared. At June 30, total assets stood at 1.5 billion and net equity was 1.1 billion. Group external debt was 162 million, while our cash and cash equivalents totaled 416 million as of June 30.

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

Kieran Gallahue

Thanks, Brett. All right, operator, why don’t we start the questions? Thanks.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Joshua Zable with Natixis. Please proceed.

Joshua Zable – Natixis

Hi, guys. Congrats on a great quarter here, and great year. Thanks for taking my questions, and thank you for officially making me afraid to get on an airplane ever again. Just a couple of quick ones, just the first a breakdown of revenues, I know you gave it on constant currency, but can you give us just the numbers there for flow generators and masks?

Kieran Gallahue

Sure, Brett, you want to answer that.

Brett Sandercock

Yes, I will break it down. For flow generators in the US, it was 69.7 million; the rest of world was 79.6. And for masks other in the US 64.5, and the rest of world 38.2.

Joshua Zable – Natixis

Great, okay. And then just one follow-up, just on the market in general, obviously clearly you guys are taking share. I know your competitors haven't had quite the success you have had, and I know Kieran you kind of brought up some things that we have heard you talk about before; obviously it seems like it is getting more awareness. The market growth has been pretty solid and stable. Is there a sort of sense that there is the kind of reenergy here in the market that the market kind of maybe is reaccelerating in any way, shape or form or is this really a lot of market share gains, and we're just kind of steady or still growing [ph]?

Kieran Gallahue

Well, I think you know, the market has remained healthy all during this time period when so many other industries have suffered incredible challenges. That includes many part of the healthcare business. You know, we haven't seen a dramatic change in the business. Early in the January timeframe, we said that maybe there is a couple of points that were carved off the market or so. We are seeing that basically flat. We are seeing a lot more interest and talk about increasing capacity. We are seeing a lot of excitement about the comorbidities.

And in areas for instance, with home sleep testing we are seeing the pilots begin to play out just as we expected. And I think that is creating a general excitement about this area, and a recognition that this is the kind of market that even in difficult times still has the ability to be growing in double digits. And I think that that has opened the eyes of many of the players in the marketplace, has given them comfort and given them renewed energy. So I think there are just a lot of good things that keep happening in this marketplace.

Joshua Zable – Natixis

Great. Well, congrats, I will get back in queue here.

Kieran Gallahue

Thanks. And by the way, you should also feel uncomfortable on the roads because truckers have it at even at a higher rate than pilots.

Joshua Zable – Natixis

Thanks.

Operator

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

David Low – Deutsche Bank

Thanks very much. Just a question about – along the similar lines. I guess with the economy being tough and hospitals particularly investing less, we see signs that investments in sleep lab beds have slowed down. I was just wondering if you see similar signs, and whether you're seeing that impacting on market growth?

Kieran Gallahue

You know, we didn't see or feel anything different this quarter than we had in the last quarter. And from that perspective, I would say that there is not a lot of change out there. What you are saying is that there is an increased emphasis on, for instance, HME’s part, where they recognized the ability to monitoring the installed base. As things get difficult across-the-board what they look for is where the growth opportunities are. And this is the same thing that happened three years ago when oxygen in neb-med reimbursement got cut, and suddenly everybody recognized that the sleep market has been underserved.

So what you're hearing from HME is a renewed emphasis on looking at compliant users, making sure those compliant users are appropriately followed up with, that to the extent that they deserve have accessories and masks, to the extent that their payers will support the patients in those, that these patients should be better served. So there is multiple ways of growing a marketplace. Some as the fundamental diagnostic capacity, some of it is how you use that capacity in other words, the mix between split nights versus a dual night studies. And finally there is the means of mining that compliant user base, and I think that we are seeing customers in all those cases focus on getting more from what they have.

David Low – Deutsche Bank

Great. Thanks very much. This is another question, national contracts and movements there, is there something else we are trying to break out, and I know you don't want to comment on particular contracts, but could you give us a sense as to whether there were any changes there that had any influence on this quarter?

Kieran Gallahue

No, I think you are right. I don't think it is useful to break out by customer type. We are doing very well across the board. We have been working very hard not only from a product perspective in bringing innovative technologies to market, but also whenever possible making it easier to do business with ResMed, because we believe that helps support the goals of the HMEs and improves their profitability and perhaps most importantly helps them improve patient care.

You may have different techniques from time to time, but the same underlying fundamentals work with both the independents and with the nationals. And so as a result, we are seeing wins in all categories.

David Low – Deutsche Bank

Okay, great. Thanks very much for taking my questions.

Kieran Gallahue

You bet.

Operator

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

Alex Smith – JPMorgan

Thanks guys. Just – maybe a question for Brett on the gross margin outlook for 2010, you said 60% to 62%. So if it hits a headwind, are there offsets that you are thinking about to arrive at that number as well from the cost side?

Brett Sandercock

Yes, Alex. This is Brett. Definitely, basically as we have been saying for a little while now, we're working a lot on the cost side, and on the cost of the business, and there is many – not just a silver bullet, but across – basically right across the board on many initiatives. And the expectation really is that those ones will start to kick in and mitigate any of the currency headwinds that we will have as we move through the fiscal year. So if you think about Singapore manufacturing for example, some work on logistics, on their freights and warehousing, materials purchasing. New products, obviously as we roll through the fiscal year, will have an impact, and then overlying that we have a continuous improvement program, which had excellent engagement down here in Sydney. So it is a combination of all those factors that makes us confident we can – that they will actually expand the margin, even though that currency will obviously be a negative for us.

Alex Smith – JPMorgan

Okay, terrific. And maybe for Kieran, can you give us any idea of whether that will be new product launches during the next quarter?

Kieran Gallahue

So we're not going to get into that fine into details for obvious competitive and customary reasons, but let me just say then that the next 12 months is going to be an incredibly busy 12 months, and we will be busy even before the end of this calendar year. So this is going to be a very exciting year for us across both masks and flow generators.

Alex Smith – JPMorgan

Okay, terrific. Thanks for that.

Operator

Your next question comes from the line of Ben Andrew with William Blair. Please proceed.

Ben Andrew – William Blair

Great, Kieran, maybe just following up on that last question, can you characterize how significant a change kind of the next-generation platforms from you, and if you can to some extent your competitors will be versus where we are. Are we talking about a modest improvement in technology or there is something more dramatic we can point towards?

Kieran Gallahue

And you are talking flow generators or are you talking masks?

Ben Andrew – William Blair

Primarily generators, but if you want to comment on masks that will be great.

Kieran Gallahue

well I think that there are opportunities across the board. I obviously cannot speak in detail for my competitors. That will be questions that are better targeted towards them. I will say as an industry overall, there is still a lot of innovation to be brought to bear in this marketplace as the technology continues to progress and some of that has to do with the use of informatics, and how these devices, these therapeutic devices fit in not only as a therapeutic device in and out of itself, but also as a node within a system of care. There is – and you can kind of get a feel for that with, for instance, the ResTracks data systems and the continued evolution that you would expect to see with those informatics systems.

I think there is continued opportunity to improve on noise levels, on algorithms that are applied to patients in order to improve comfort or either reduce or deskill the labor that is applied. And I think those are important points by the way, because if you look at health care across the globe and what we seeing certainly over the last decade is that health care systems are trying to contain costs and in part by either reducing the amount of labor applied or deskilling the labor that is supplied in the care process. And they are also trying to move people out of expenses settings into the home settings. Both of those play to half strength, and there is innovation that could be brought to bear that simplifies the administration of the therapy and making sure people are compliant, while increasing the efficacy. So there is a significant amount of opportunity for us to continue to innovate in multiple ways.

On the mask side of the business, it is still about how do you make it easy for the care providers to set the product upon the patient, how do you improve the comfort, the immediate comfort and the long-term comfort of the patient. How do you improve the efficacy through managing leak, and how do you wrap that whole thing into a system cell. And then finally when you look across both of those platforms there is opportunity for bit of Moore's Law, where we can improve the functionality while addressing the cost of goods. So we're going to be hitting on all those cylinders as we go through this year.

Ben Andrew – William Blair

Maybe just one other question on generators, you talked about mix being very positive for you, can you characterize where we are as a percent of mix as we look at the different, maybe three or four different broad areas, and you have even often talked about present auto setting in the past, where maybe is that now?

Kieran Gallahue

So when you look at from a percentage perspective, I guess we can look at it from a number of different ways. We continue to be under penetrated in the bilevel category, and we have an incredible platform that is underpinned by the Easy Breathe motor technology that makes our devices far quieter, in some cases up to 90% quieter, while being more comfortable for the patients. So the first thing is major mix shifts within that. We have a significant opportunity for continued growth because our products are simply market standard and it has been an area that we have been under penetrated in the past.

We do see continued growth on the Autoset side of the business, and even the Escape II, where we have put in additional functionality with the EPR. So we're seeing it across the boundaries, and we are comfortable with the growth in each of these categories, not only from what we have achieved to date, but with further penetration in the future. As far as specific percentages on the mix of Autosets, Brett do you have the current figures on that.

Brett Sandercock

Yes, it is probably in the order of 25%, somewhere around that mark. Certainly, Autoset continues to be the strongest growing category.

Ben Andrew – William Blair

Okay. And is Europe still kind of a 60ish, or has it moved higher as well?

Kieran Gallahue

That has been more of an autosetting market. It is probably around that, about 60% to 70% mark.

Ben Andrew – William Blair

And then last question, I will hop off. If you think about the 10 MSA that are going to be bidding in October, have you guys looked at what percentage of the market that might represent and then what the next group of MSAs that bid in the eleven might represent the market, and how we might anticipate lead through?

Kieran Gallahue

Yes, I think first of all I think it is 9 MSAs now. They eliminated Puerto Rico. So I think – it is clearly a minority of the marketplace as far as what percent is covered directly by that. I couldn't give you the percent, but it is a small percent of the total market. I think more than anything else when you talk to HMEs, many of them feel that the last round of competitive bidding was just so poorly implemented that the likelihood of this being implemented well is a challenge and many of them feel that, even to the extent that this delayed process, because it is obviously been delayed again, right? Or it was delayed several months ago, and that redelayed, but delayed several months ago. That there is a feeling that if it is not administered properly, and if there is a significant push back from the community that it may make full rollout of competitive bidding very challenging as well. So I think there is a lot of water to go under the bridge before we forecast what the impact of that will be or won't be.

Ben Andrew – William Blair

Thank you.

Kieran Gallahue

You bet.

Operator

Your next question comes from the line of Peter Bye with Jefferies & Co. Please proceed.

Peter Bye – Jefferies & Co.

Hi. Thanks guys. A couple just on the home sleep testing, I mean you mentioned airlines and truckers, what is the – for some of these occupational groups to develop models for sleep testing instead of sending their members to sleep labs, are you hearing anything there. We notice the Aetna CareCore National deal here in New York sort of a trial there. And I think (inaudible) is playing around with it too. Is there anymore color you can see about programs going on out there?

Kieran Gallahue

Sure. I would look at those two things independently, although one can be supportive of the other. There is the opportunity in occupational health, which is certainly not dependent on HSD coming in, but rather the entire marketplace has the dynamics that is associated with HSD, which anything that lowers the cost of diagnosis and simplifies it, will not only help it in the occupational health area, but it will also help in all aspects, whether it is looking at the comorbidities, whether it is looking at you garden variety, sleep disordered breathing patient. So if we segment those two different things there are a number of companies, HMEs or start-ups that have tried to focus on the occupational health category, and there is no doubt that the introduction of HST has us even more excited looking at different models, because particularly those categories of transport workers where there are moving to a different location every night.

The idea of a mobile screener if you will, a mobile diagnostic tool certainly makes diagnosis even more simple, and so there is a number of start-ups that we have heard about out there or other HMEs that are looking to get engaged in that process. And that is good. The more noise there is, the more opportunity to address the big players and transport more likely that we will get to a tipping point sooner.

With HST overall, just sort of general update on that, we are the one who said that the last calendar year was the year that really was established whether or not home sleep testing was here to stay or not. And clearly from the fact that CMS and the largest payers have jumped on board with it, it is very clear that home sleep testing is here to stay, and it is just a matter of how it rolls out and the speed. This year as we have said is the year of the pilot. And it is really working out the three Ps. It is looking at the pricing. So what are people going to get paid from their different payers. What are the processes? So how do different healthcare providers integrate home sleep testing into the way that they do business, and what are the various flows associated with that. And the last one is politics, which is, what is the interaction among the channels, among the different physicians. And that is always the hardest one to predict the timing of when that is going to play out.

We have heard of, we have seen a number of pilots that in fact have started as we have anticipated and they range from HMEs to sleep physicians to primary care physicians to independent diagnostic testing facilities. So you have a number of different players that are testing the three Per share, if you will, of home sleep testing. And they are using a variety of devices. Certainly many are finding the simplicity and cost effectiveness of ApneaLink and ApneaLink Plus is very convenient for them. And there are other solutions out there, which is fine because what this is all about is opening access to the markets.

So our intention as we go through this is to continue to support our sleep physician partners and the sleep community and our long-standing relationships, and be able to do the best we can to help them provide quality patient care and open up access to more patients. So it is moving and it is moving right along the pace that we had anticipated.

Peter Bye – Jefferies & Co.

Okay, and then a couple of more. Just on Washington, what are you hearing from your DME customers in the sense of compliance mandates for follow-up with the physician, risk of not getting that and not getting paid by Medicare. How much panic is there among some of the guys or the smaller guys on accreditation? Is that going to affect on October 1 if at all, and any thoughts about any interim cuts in 2010, until we get competitive bidding starting in 2011?

Kieran Gallahue

So, the major buzz is in a couple of categories. One is with compliance monitoring, and you know that ruling, which came out almost a year ago now. That is when the starting gun went off, and that is when we started to see a huge up-tick in interest for the ResTracks GSM and in some of the higher-end systems that work particularly well with ResTracks GSM and also help support patient compliance.

So, I think the community has reacted or we saw the first wave of reaction to that and what they realize is that with all those data that they now need to manage and with the importance of gaining compliance, I think there is a renewed emphasis on compliance, and that this good for the patients. That is good for the industry. That is certainly good for ResMed because of the nature of our products. And because this is a chronic disorder where people are treated for decades, every patient that can be captured that can be – that we can keep compliant in those early days represents a long-term annuity stream and good health care. So this renewed emphasis, I think the HMEs have sort of taken it on board. They are taking the actions. It is leading to very good conversations at the field level – to act as consultants in the selling process, and we have the technologies that can help make them more successful.

The other buzz from the Washington side there is just a lot of interest on HMEs really around oxygen. That is where the primary emphasis is. There is a desire to keep oxygen out of the competitive bidding to remove the 36 month cap. So, there is a lot of action. Their focus tends to be more on the O2 side, and I think there is a greater level of comfort and security on the sleep side, because they know that it is a highly under penetrated market and in any case represents significant growth opportunities.

Peter Bye – Jefferies & Co.

Okay, and just one last follow-up, the VS-3 [ph] ventilator had sort of the first full quarter I think on the full supply that you have, and you know, any leverage on the H1N1 stuff going on, especially overseas?

Kieran Gallahue

So, VS-3 is a great product and it is doing quite well. As far as bump up from the flu, no, we're not seeing at this point. We are hearing a lot of discussion around it, obviously as you know with the – it is mainly the southern hemisphere at the current time and there is the expectation that it could quite a spread in the Northern hemisphere. At this point, we are not seeing any thing like bumps we got out of bird flu and that sort of thing. Not yet.

Peter Bye – Jefferies & Co.

Okay, thanks, guys.

Kieran Gallahue

You bet.

Operator

Your next question comes from the line of Andrew Goodsall with UBS. Please proceed.

Andrew Goodsall – UBS

Thanks for taking my call guys. I was just going to ask just in terms of Singapore, what sort of percentage of volume do you think that is going to start contributing in the 2010 year?

Brett Sandercock

Andrew it is Brett. If you look say FY09, it is probably in the order of 10% to 15% up there. I think as we move through fiscal 2010, it is probably more like the order of 20% to 25% of the total. So it certainly will progressively ramp up through the fiscal year, and there is a meaningful amount there now. And that will build, and obviously that will help us on the manufacturing or cost front. The other thing it does is it also diversifies a little bit out of the Aussie dollar. To the extent the [inaudible] there has been seeing dollars. We need a little more position now, the Aussie a bit stronger in terms of our cost base. So for example the Singapore dollar over the last three months was up about 3%. If you compare that to the Aussie, which was close to 50, you can see there is quite a bit of difference there. So that decision to diversify risk mitigation et cetera is also going to support us on the cost base as well.

Kieran Gallahue

I say we have been very pleased with the ramp up of the Singapore facility, and also want to note that we remain very committed to our facilities down in Australia. We have got fantastic employees down there. We are in a very fortunate position with the growth in this market and the growth in volume, and that we can remain committed to a given geographic region, and at the same time have the ability to expand elsewhere.

Andrew Goodsall – UBS

Can I just – just looking at rest of world masks, there were sort of 4%, can I just ask you characterize how we should be thinking about those?

Kieran Gallahue

Yes, I mean, you know, the ROW masks tend to grow at a slower rate than you will see in the US. And it tends to be a little bit lumpier. In this case we had some pretty challenging base year comps. So I just think it is sort of a timing issue.

Andrew Goodsall – UBS

Okay. There is nothing particular regulatory changes in your paying countries or anything?

Kieran Gallahue

There are zero fundamental changes.

Brett Sandercock

Just to put the tough comp in perspective, I think we grew 30% the year before in that category. Kieran said that it tends to be a little bit lumpy.

Andrew Goodsall – UBS

Okay, terrific. Thank you very much. I will get back in the queue.

Kieran Gallahue

You bet.

Operator

Your next question comes from the line of Jason Mills with Canaccord Adams. Please proceed.

Jason Mills – Canaccord Adams

Thanks guys. Congrats on a good quarter.

Kieran Gallahue

Thanks.

Jason Mills – Canaccord Adams

Kieran, I will start with going back just to your commentary about the US market, sorry if I missed it, I am bumping between calls. Just wondering what you saw in the first half of this calendar year, the last half of your fiscal year, as it relates to US market growth, and it is hard to tell what Respironics is doing, specifically I suppose, but obviously you guys gained share, and I'm just wondering sort of what you are looking for going forward in terms of market growth here in the United States?

Kieran Gallahue

By all indications, the US market continued to grow in double digits. We saw probably in the January timeframe as we discussed earlier, there might have been a bit of a tick down, maybe a couple of points, but we haven't seen that regress any further than that. This last quarter felt very similar to the quarter before that. So that was a very comforting feeling that we are in good shape in the marketplace.

I think you are right. I think we're gaining share. I will say we still have very worthy competitors. I think Phillips is a very strong competitor and one we respect and think that they are good for the industry. We have been doing well both at large customers and smaller customers, and I think we are benefiting from a couple of things, I think both very significant differentiation in our technologies both on the mask and the flow generators side and that is something I think we will see continuing through the new product launches that we have in the next 12 months. And I think just fundamental execution at the field level.

Jason Mills – Canaccord Adams

Thanks, got it. So as you look forward over the next two or three quarters, you're looking for market growth in the US in that double-digit range. You guys also are going to be comparing against some really nice quarters in the second half of last calendar year. At the same time you're planning to launch some new products which I'm sure you hope will sustain your growth. So, could you maybe discuss the juxtaposition of the difficult comps with the new products launching relative to where you are sort of expecting the market to grow, and I guess the bottom line is do you continue to expect to gain share or hold your share during the time you're competing in some earlier quarters last year?

Kieran Gallahue

Yes, I mean you know that we never talk in you know, single quarters because one of the things that we are very adamant about it not managing a business quarter-to-quarter, and I think that gets very dysfunctional over time. So, you know, let's talk about the way that we always talk about things, which is we look over the next 12 months, we look over the next 18 months, et cetera. Do I think that we have the ability to continue to gain market share? You bet. Do I think that we are in a market that's going to continue to grow in the double digits? You bet. I think that we're in very good positions. No doubt, you're right. We've got certainly tougher comps coming up than we had in the past and I think that you know, that's recognized and that's a good thing. You know, keeps the sales force focused, and we continue to enjoy the benefits of those wins that we have had in the past.

Jason Mills – Canaccord Adams

That's very helpful. Thank you very much. Couple of just follow up questions. I'm wondering what your thoughts are and update as it relates to comorbidities and typically what you're doing or thinking about in terms of partnerships to explore further comorbidities with sleep disordered breathing?

Kieran Gallahue

Well, you know, the blessing and curse of being involved in – and being a leader in the sleep disordered breathing marketplace is that it seems we overlap with every with every costly comorbidity on the planet. You know, whether you're talking about heart failure, whether you're talking about diabetes, whether you're talking about drug-resistant hypertension, whether you're talking about obesity and our ventilation business, we are square in the middle of COPD. You know, so the opportunity is enormous. But life is about execution and execution is about focus, and so we are – we try to be relatively disciplined about how we approach each of these comorbidities and they are at various stages of development.

You know, some of them where the knowledge, let's say in hypertension as example, it's well known and understood ever since the JNC seven guidelines that sleep disordered breathing is a major cause of hypertension and treating the sleep disordered breathing can bring down blood pressure. Now, we still have education to do, and I think you'll see a much greater focus on primary care physicians in the coming year as we help them understand sleep disordered breathing and we work as an industry to help them understand sleep disordered breathing, and the role that CPAP can play in treating that.

You have other comorbidities where we are at a little bit earlier stage. The data is fantastic, but we probably have even more opportunities for education. So, you know, we try to balance the investment. We try not to try to, you know, bore the ocean all at once, but we try to focus, use partnerships where it is appropriate, use internal business development resources when it's appropriate and then we get to critical mass stage, we spread it out to the sales force to try to strengthen relationships with their contacts. So, you know, it's a matter of having the opportunities but focusing specifically where we think the best pay back is.

Jason Mills – Canaccord Adams

It's helpful as well. Last question from me, Kieran. Trends in the market as it relates to you mentioned your customers are focusing on mining their customers, and I'm wondering if you've seen any change in trend as it relates to patients using masks. I think the last time we asked it was still hovering around one mask per patient per year, notwithstanding the reimbursement for more than that. Wondering what you guys are doing to drive that higher and whether or not we've seen some benefits from anything you're doing to do that.

Kieran Gallahue

Yes, so I can answer that mostly from an anecdotal basis and then I can from a specific number which is, you know, it is always very difficult to get out anyway just because of the ability to segment replacement from new user masks, but the – but in our dialogue with our customers and their request for things like drop ship directly to patients and their request to support their resupply to learn about how to set up resupply initiatives. What we feel very comfortable in saying is that the HMEs continue to increase their focus on that very valuable segment of compliant users, and you're also seeing new players get in to the mix, who may have let's say previously focused on other disease states that see the opportunity in sleep, and may have particular skill sets and direct consumer marketing as an example that are trying to stimulate greater use. You know, I think we talked down in the last conference call, in the last six months you started to see direct consumer advertising on TV for compliant users. I mean, that is just an indication of what's going on in this industry, and when you have one player that's doing that I can assure you that the other leaders in the industry look at that and try to understand how they either defend against that or leverage that – those kinds of activities to stimulate their own growth. So it's a good sort of dominoes affecting dominoes process, where the HMEs recognize the attractiveness of serving the compliant users.

Jason Mills – Canaccord Adams

Great. Great quarter, guys.

Kieran Gallahue

All right, thanks.

Operator

Your next question comes from the line of Joanne Wuensch with BMO Capital Markets. Please proceed.

Joanne Wuensch – BMO Capital Markets

Hi, may I also say great quarter. Couple of little things, capital expenditures in 2010 now that you've completed the new facility in San Diego, what might that be?

Brett Sandercock

Joanne, it is Brett. With the Aussie dollar appreciation in Euro, it will probably be around when I look forward about 12 million to 15 million a quarter on CAPEX and it will be predominantly operational CapEx because we have as you know, finished out a booming cycle.

Joanne Wuensch – BMO Capital Markets

Okay, is there any way to quantify of the 62% gross margins a quarter, how many basis points came from foreign exchange? You can start trying to peel away the onion a little bit to understand it.

Brett Sandercock

I mean, if you look at that there's a lot of factors that impact the margin, geographic mix, product mix, FX, manufacturing efficiencies, et cetera. If I look at sequentially, manufacturing efficiencies or improvements in logistics and so on, and FX had a similar impact and those were the key drivers.

Joanne Wuensch – BMO Capital Markets

Okay, so just sort of take the improvement sequentially and divide it in half?

Brett Sandercock

Well, they are the key drivers. We have slightly better product mix, slightly worse geographic mix and, you know, ISP were always there, but the two big drivers were FX and then the manufacturing efficiencies or improvements.

Joanne Wuensch – BMO Capital Markets

Okay, helpful. Thank you. Res products have recently had a recall. Is there anything you can comment on that and what it may mean for your position in the market? Did you see anything from that in the quarter?

Kieran Gallahue

You know, we've heard buzz, but you know, one of the things where we ask our sales force to be disciplined and focused on positive selling, and focus on the benefits that our products can bring to market. So, you know, it's not something that we talk about a lot and it's not something that we promote within our commercial organization.

Joanne Wuensch – BMO Capital Markets

Okay, will we be seeing some of your new products at Medtrade this fall?

Kieran Gallahue

Maybe. It was a great try Joanne. Great try.

Joanne Wuensch – BMO Capital Markets

Okay, thank you very much.

Kieran Gallahue

You bet.

Operator

Your next question comes from the line of Michael Matson of Wells Fargo Securities. Please proceed.

Michael Matson – Wells Fargo Securities

Hi, just sort of related to Joanne's question. I think last quarter you all said that you saw a net $0.05 positive impact on your EPS from currency. I was wondering if you could quantify what the overall impact from currency was this quarter.

Kieran Gallahue

Yes, Michael. It was pretty strong this quarter. I estimate in the order of $0.10.

Michael Matson – Wells Fargo Securities

Okay. And then with regards to the increased compliance documentation requirements from Medicare, are you seeing that from other private payers as well, and then sort of a follow-up to that what happens with the CPAP units, when patients are not compliant or they don't go back to check in with their doctor after they've been using it and the HME isn't able to collect all the reimbursement. Are they able to pull those products back and put them back into service?

Kieran Gallahue

So, with regards to the first question, we are seeing some interest but I'm not hearing about it any broad scale adoption of changes in the compliance monitoring world. With regards to what are they doing with the units, they've always had a certain amount of units that have come back and they usually – different players use them differently. Some of them put them in loaner [ph] pool so that they can have – use them with the initial patients, and then once they are compliant they'll put out new units on them. So some of them sort of have these loaner pools they use during the introductory phase, some of them donate to charity.

I mean, there is a lot of different uses. I think the key emphasis on this though, what the HMEs are really driving towards is improving compliance, and so I think that this regulation, although certainly none of the HMEs would necessarily ask for it. I think what their finding is that there is a significant unintended benefit or maybe it is intended benefit. Let's give it the benefit of doubt that there is more emphasis on compliance, and that it appears that there may be an improvement in compliance, which means you'll have less units coming back anyway, and you'll have better long-term prospects with these compliant users.

Michael Matson – Wells Fargo Securities

Okay, and then you know, your cash is now more than 10% of your market cap, and I guess just doing some rough math of 10 million shares that you have been authorized to repurchase would eat up pretty much all the cash you have right now. Can I infer from that that you're not going to really be looking at acquisitions, or are you active kind of in the business development area, and are there things out there that you could actually buy that would fit with your business model?

Kieran Gallahue

So, I wouldn't directly associate either our gross or our net cash position with – entirely be in the buyback. I mean that's certainly one use of cash and obviously we've – if you look over the last 18 months we've used that $140 million in cash buying back shares. So it's certainly one of the uses of cash. You know, are we looking at potential acquisition targets or investment in various forms. Absolutely, we always do that and, you know, one of the things that we changed organizationally a year ago is we went to a strategic business unit structure that allows us to look at the way that we develop and acquire technologies in a different way, and that certainly opens up the avenue for us to be a bit more proactive in our sort of appearance or the way that we look at different opportunities.

I would say this though. We remain disciplined and one of the strengths I think of ResMed over time has been the fact that cash does not burn a hole in our pocket that we do not go out and try to chase the next deal. We are in a very, very attractive under penetrated market. We are market leader within that segment and so our thresholds for looking at acquisitions is quite high. You know, we want to make sure that it either helps us in our core business or represents a significant upside growth opportunity, and we are rather disciplined when we look at those things. So it's not going to burn a hole in our pocket. The feel that we are in a very strong financial condition. It holds us in great stead during the times when other companies may feel challenged and we feel good about that.

Michael Matson – Wells Fargo Securities

Okay. And then, just one quick question on the guidance ranges that were given on your operating expenses, did those include your stock-based compensation expense, the SG&A in particular the 31% to 33% I think as well as the guidance?

Brett Sandercock

Yes, they do.

Michael Matson – Wells Fargo Securities

Okay, thanks.

Kieran Gallahue

You bet.

Operator

Your next question comes from the line of David Simpson with RBS. Please proceed.

David Simpson – RBS

Hi, good morning guys. Thanks for taking my call. Look, I just want your impressions of the potential for US healthcare reform and then the impact of that on ResMed going forward?

Kieran Gallahue

Sure, I mean I think it's anybody's guess at this point what kind of healthcare reform takes place. I mean it'll be hard to believe that there will be no legislation in the area and the question is just how far-reaching it is, and what the both the intended and unintended consequences of that are. I will say that I think we feel ourselves well positioned, whether or not healthcare reform comes through, and the reason is when you look at the fundamentals of what we do, we are sitting in the middle of a metabolic syndrome and sleep disordered breathing touches on the most costly chronic disorders in the planet. And so whether you're talking about diabetes, whether you're talking about heart failure, whether you're talking about COPD with our ventilation business, we have the ability of providing very cost-effective care, and, you know, what are they trying to do is we discussed earlier today, you know, healthcare systems across the globe have been trying to either eliminate or deskill labor in order to take cost down and they're trying to take people out of costly care settings such as the hospitals and put them in lower-cost settings, and guess where that is.

That's the home, that's the most cost-effective way of providing care. So, we are I think very, very strategically positioned, regardless of which side things come down on, and you know, I mentioned before the National Institute of Clinical Excellence, and nobody would disagree I believe that the NHS is probably one of the most frugal healthcare systems in the planet, and they were certainly ahead of the curve in the establishment of National Institute of Clinical Excellence to look at a health economic situation and to make sure that there is an economic balance in the care process, and I think it's very important to note.

I mean they came out with a study after looking at the data and said it is cost advantageous to identify and treat more people with sleep disordered breathing. So the extent that you know, prepared effectiveness comes out let's say to the extent that that is based on the NICE standards, which you would imagine at least in part it would be. To me that bodes well. So you know, we are not so concerned about the whole changes that are forecasted here. You know, could it put more people into the system? You bet. Is that a benefit to us? Yes. Could it be more focused on cost controls? You bet. Do we position ourselves very well as a category that helps control costs in the healthcare systems? You bet. I think we are at a very unique and a very well positioned part of the industry.

David Simpson – RBS

Thanks for that and just as a follow-up, just like a bit of color I guess in terms of the rest of the world, you know, the relative performance of Asia versus EU in the quarter?

Kieran Gallahue

Yes. So, for us, Asia-Pac represents 1% to 10% of our business and it tends to be a very lumpy business. So quarter-to-quarter trends are really hard to pick out. If you look at over the last year, you know, not talking about any given quarter it was very, very good, strong growth and you know, we tend to still be dominated first by Japan and second by Australia and New Zealand, and the other markets though they certainly represent significant long-term upside, opportunity remains on the smaller side.

David Simpson – RBS

Okay, thanks guys very much.

Kieran Gallahue

You bet.

Operator

I would now like to turn the call back over to Kieran Gallahue for closing remarks. You may proceed.

Kieran Gallahue

Thank you. And thank you all for joining us as always and as always I also want to thank all of our employees across the globe in their various functions because ResMed is a collection of its individuals acting as a team, and we have fantastic team members in all the functions and across the globe and these results, these stellar results are really a result of their efforts and their dedication to patient care. I can say that we are excited about our future. We've got high margin, exciting new products rolling out over the course of the next year. The market for our sleep disordered breathing is still highly under penetrated. New policies approving the use of home testing are going to reduce the barriers for accessing patient care. We've got a stellar balance sheet, significant operating cash flow, and as I mentioned an absolutely first-rate team to assure and focus on execution. So thank you very much, and I look forward – and we look forward to updating you as the fiscal year 2010 progresses. Thanks.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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Source: ResMed Inc. F4Q09 (Qtr End 6/30/09) Earnings Call Transcript

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