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Executives

Kieran T. Gallahue - President, Chief Executive Officer, Director

Brett Sandercock - Chief Financial Officer

Analysts

David Clair - Piper Jaffray

Saul Hadassin - Credit Suisse

Joshua Zable - Natixis Bleichroeder

Joshua Jennings - Jefferies & Co.

Joanne Wuensch - BMO Capital Markets

Michael Matson -Wells Fargo Securities

Natalie Kelly - CommSec

David Stanton - RBS

Jamar Ismail - Canaccord Adams

Dan Hearn - UBS

ResMed Inc. (RMD) Q1 2010 Earnings Call November 5, 2009 4:30 PM ET

Operator

Good afternoon ladies and gentlemen my name is Marsha and I will be your conference operator today. At this time I would like to welcome everyone to the ResMed Incorporated Fiscal First Quarter 2010 Earnings Conference Call. (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 projections of future revenue or earnings, new product development, or new markets for the Company's products. These statements are made under the Safe Harbor Provision of the Private Securities Litigation Reform Act of 1995. Risks and uncertainties exist that could cause actual results to materially differ from the forward-looking statements. These factors are discussed in ResMed's SEC filings, such as Forms 10-Q and 10-K, which you may accessed through the Company's website at www.resmed.com.

With that said, I will like to turn the call over to Kieran T. Gallahue, ResMed's President and CEO. Mr. Gallahue, please go ahead, sir.

Kieran Gallahue

Thank you Marsha and good afternoon and welcome to ResMed's First Quarter Earnings Call. I am certainly glad that we’re having it today and not competing with the New York Yankees and Joe Burke and the World Series celebration tomorrow.

As with our previous calls, I will 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 take your questions.

We had another very solid quarter and we’re pleased to report that global revenue in the first quarter of 2010 grew 13%, or up 16% on a constant currency basis. Revenue in the Americas grew by a very encouraging 19% year-over-year. The rest of the world revenue increased by 8%, but in constant currency terms it grew 13%. Europe and Asia Pac sales were quite solid this quarter. As in previous quarters currency had some effect on ROW revenue.

GAAP EPS increased a remarkable 53% to $0.55 per share. Excluding amortization of acquired intangibles EPS was a penny better at $0.56 per share. We projected that we’d be able to sustain gross margins in the 60% to 62% range in the face of the strengthening Australian dollar and we are pleased to report that gross margin was in fact 60.8% in Q1 benefiting from favorable product mix due to an increase in sales of our high margin masks and high-end flow generators as well as continued success in leveraging manufacturing and logistics cost efficiencies across our global organization.

Again, we had a very strong performance in operating cash flow which came in at $64.1 million demonstrating our commitment to strong operating performance and earnings and a commitment to working capital control. Our balance sheet remains extremely solid with cash and cash equivalents balance at the end of Q1 of around $478 million.

We also experienced balanced growth across product categories with global flow generator sales up 12%, or up 15% in constant currency and mass segments growing at a robust 15% during the quarter, a 17% increase on a constant currency basis.

Sales of Americas flow generators were up 14% year-over-year in Q1 and sales in ROW improved to 15% in constant currency terms. Globally the growth was mainly driven by strong sales of our high-end sleep devices, once again led by the strong sales of our AutoSet category where we have a big advantage on noise and comfort. 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 is helping to differentiate ResMed from our competitors with improved comfort and reduced noise.

Once again we posted double-digit growth in the mask segment globally during the quarter and continue to increase market share. We believe we’re taking market share in both the new patient population and the install base. Mass sales were extremely strong this quarter and grew 23% in the Americas and in constant currency terms grew 8% in ROW.

Mass sales in the Americas were strong across multiple segments, including excellent progress with our Mirage Quattro Full Face mask, our Mirage Activa LT nasal mask, and Swift LT and Swift LT for Her nasal pillow interfaces. 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 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 remained focused on growing market share with high margin, industry-leading products.

To add to our offerings of small lightweight masks we recently launched the Swift FX nasal pillow mask in Europe, our lightest mask to date. We also just launched our first ever gel mask with the Mirage SoftGel. We showed the mask at Medtrade and have had a fabulous response both at the show and in our early days of the market.

In October we announced that we acquired Laboratoires Narval. Based in France Narval manufactures and distributes the Narval ORM, an innovative mandibular repositioning device that offers a solution to patients for snoring and mild obstructive sleep apnea. With this acquisition we add another therapy to complement our existing positive airway pressure based solutions. In the near term we plan to commercialize this device primarily in France where it is presently the only device with established reimbursement. Over time we will evaluate other markets and expand into other geographies as it makes sense.

Last March we indicated that we would have a very active 18 or so months of product launches. As you can see from the past few months we are well on track to meeting that commitment. As noted earlier we began taking orders for the SoftGel mask in the US during October and we’ll commence product shipments, in fact we have commenced product shipments, in November. In addition, we launched the Swift FX in Europe during October. We expect that each of these products will be launched on a global basis over the course of the remainder of this fiscal year. Additionally, in July, as promised, we introduced the ApneaLinkTM plus our type III home diagnostic device that meets 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 home sleep testing was here to stay in calendar year 2008 and in calendar year 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 results from continued and improved awareness and validation of the critical role that sleep disorder breathing plays in the very serious, most rapidly growing, and most costly diseases in the world, cardiovascular disease and diabetes. Although sleep disorder breathing affects people of all ages, weights, genders, and races, it’s becoming widely recognized that hear disease and diabetes particularly tend to go hand in hand with sleep disorder breathing and that treatments for sleep disorder breathing could not only improve health, but may also dramatically lower medical costs associated with these populations. We also know that SDB can have a substantial effect on presenteeism, as well as absenteeism and represents a big opportunity with occupational health and safety in the transportation business for diagnoses and treatment of sleep disorder breathing.

It seems almost sadly routine that we hear of airline or trucking mishaps that are linked to sleep issues. In addition, just recently the US National Safety Board stepped up its campaign to test all drivers for sleep apnea. The NTSB has written to the US Coast Guard and Federal Motor Carrier Safety Administration recommending screening for all pilots, bus, and truck drivers for sleep apnea. The NTSB recommendation follows a string of transport accidents in which sleep apnea was identified as a factor in driver and pilot performance.

Finally, as part of our strategy to improve awareness of sleep disorder breathing in the physician community we are embarking on a series of branded and unbranded medical education programs. In fact, we just announced the collaboration with Phillips to support the sleep communities efforts to educate primary care physicians funded with educational grants. This is just a part of our continued commitment to raising the awareness of the dangers of sleep disorder breathing within the medical community.

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

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

Brett Sandercock

Thanks, Kieran. I will just briefly run through our September quarter results. Just to recap our revenues for the September quarter were $247 million, an increase of 38% over the prior year quarter and as expected unfavorable currency movements reduced our first quarter revenues by approximately $5.3 million. In constant currency terms, revenue increased by 16% over the prior year quarter.

Our income from operations for the quarter is $52.7 million, an increase of 44% over the prior year quarter and net income for the quarter was $42.1 million, an increase of 50% over the prior year quarter.

On a diluted earnings per share basis for the quarter it was $0.55, an increase of 53% over the prior year quarter.

Our gross margin for the September quarter was 60.8%, down sequentially from Q4 ‘09. We did benefit from favorable product mix, but this was offset by unfavorable currency impact and some unfavorable geographic mix.

Looking forward, the recent depreciation of the Australian dollar will have a negative impact upon our gross margin, however assuming current exchange rates we still expect our gross margin to be around 60% for the balance of fiscal year 2010.

SG&A expenses for the quarter were $76.8 million, an increase of 8% over the prior year quarter. In constant currency terms SG&A increased by $0.11 over the prior year quarter. The increase in SG&A reflects expenses to support sales growth as well as activities targeting the increasing awareness and diagnosis of sleep disorder breathing. 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 broadly in the range of 31% for the balance of fiscal year 2010.

R&D expenses for the quarter were $70.9 million, an increase of 4% over the prior year quarter. In constant currency terms R&D expenses increased by 9% over the prior year quarter. R&D as a percentage of revenue was 7% compared to 8% in 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 the balance of fiscal year 2010. We continue to devote significant resources to [inaudible] 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 $6.5 million. During the quarter we also donated $1 million to the ResMed Foundation.

Our effective tax rate for the quarter was 27.3% and we estimate our fiscal year 2010 tax rate will be in the vicinity of 27%.

Turning now to revenues in more detail: Overall Americas sales were $134.7 million, an increase of 19% over the prior year quarter. This was driven by strong growth in both flow generators and masks with strong contributions from our high-end APAP devices, new range of bi-levels and the full-face masks. So that side of the Americas totaled $112.3 million, an increase of 8% over the prior year quarter. As expected, sales outside of the Americas were impacted by currency movements, in particular the depreciation of the euro against the US dollar. In constant currency terms, sales outside the Americas increased by 13% over the prior year quarter.

Breaking out the revenues between product segments, in the Americas flow generator sales increased by 14% over the prior year quarter, while masks and other increased by 23%. For revenues outside the Americas and in constant currency terms, flow generators increased by 15%, while masks and other increased by 8%. On a group basis in constant currency terms, flow generator sales increased by 15%, while masks and other increased by 17%.

Now cash flow from operations was $64.1 million for the quarter reflecting strong underlying earnings and working capital management. In the next quarter our operating cash flow will be significantly impacted by an expected Australian tax payment traditionally made in the calendar fourth quarter; it should return to robust levels after that.

Capital expenditures for the quarter was $14.1 million, including $4.3 million in completion costs associated with our new global headquarters in San Diego. Depreciation and amortization for the September quarter totaled $14.1 million.

We continue to buy back shares as part of our capital management program. During the quarter we repurchased 789,000 shares for consideration of $35.7 million as part of our ongoing buy back program. As of today, we have repurchased 994,000 shares out of a total authorized buy back of 10 million shares.

Our balance sheet remains strong and conservatively at September 30 total assets stood at $1.6 billion and net equities $1.2 billion. Group external debt was $163 million, while cash and cash equivalents totaled $478 million.

I would now like to hand the call back to Kieran.

Kieran Gallahue

All right, thanks Brett and Marsha we will now open the call up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Clair from Piper Jaffray.

David Clair - Piper Jaffray

I was hoping you could give us some color on your ROW performance. We saw a pretty nice acceleration here, what was driving that and should we expect that to continue?

Kieran Gallahue

It was really a balanced performance across the ROW regions. You’ve seen that the last couple of quarters, we have had some strong performance and I just think the team has a lot of good things going for it right now. It is executing extremely well. The leadership teams under Stein Jacobsen and under Rob Douglas are both performing extremely well. The product line up is very well suited to the marketplace and stacks up well from the perspective of competitive alternatives. So, all in all I think it is no silver bullet here, it is not just one single item, it is strong performance across multiple geographies and we’re feeling good about their performance.

David Clair - Piper Jaffray

Okay and then can you give us your take on, there was a launch by a competitor of yours and I’m just wondering If you are seeing any kind of impact in the field from that and maybe your take on how you’re line up stacks up against their refreshed line up.

Kieran Gallahue

You are speaking specifically about the launch of flow generator series by our primary competitor and so to date I am not hearing a whole lot. I mean obviously any new product is going to get trial and there is going to be a lot of sort of conversations around the products. I will say that we are mainly hearing back from customers is the feeling that it is an attempt to compete with the SA II, to try to basically play catch up with that product series.

There are a couple of nice features that we appreciate which is some investment in algorhythms and informatics, which we think is good for the industry. Overall, I would say the summary is there are some feature sets in there which will be good for raising the awareness of the industry; it is good to have more than one player that is focusing on some of these high end algorhythms, but when you look at our product line up versus the competitive, I guess my summary would be we remain very comfortable with our product line up and we remain even more comfortable with our product pipeline.

David Clair - Piper Jaffray

Brett, can you give us the foreign exchange impact on EPS?

Brett Sandercock

It is round about the $0.05 to $0.06 mark positive there. It is worth noting though, even if you sort of strip that out we still had a really strong quarter. We would have growth on EPS of over 35% even without that sort of currency impact. But, overall that was sort of the region of the impact.

Operator

Your next question comes from Saul Hadassin from Credit Suisse.

Saul Hadassin - Credit Suisse

I want to ask you about competitive bidding in the US. We are seeing some updates coming out of CMS the processes that kicked off. I would like your thoughts on the outlook for the Medicare part of your business in terms of price.

Kieran Gallahue

Again, just a sort of benchmark here, just a reminder, from a global sales perspective we estimated somewhere around 10% of the global sales that are associated with US Medicare related patients, so that is point one.

Point two, no real surprises. I mean the updates that have been provided over the last year about how this thing is going to roll out; the fact that they have moved it from 10 MSAs down to 9 MSAs, just really there are no changes. There is obviously a lot of activity at the HME level; they have been working on it for a number of months, although not a lot of chatter at if from a customer perspective. If I compare this to two years ago and the amount of chatter when it was the first time through, I think there was almost sort of a feeling of panic. This time it is much more of a businessman like sort of approach to it. They kind of know the drill and they are going to go through it.

It is still unclear, even after the betting, what’s going to happen. If it continues to roll through it doesn’t get impacted for what another year, 14 months, as we get into calendar year 2011, and no clear understanding about whether it will roll out after that.

My summary would be business as usual at this point.

Saul Hadassin - Credit Suisse

Then I would like to hear your thoughts on US healthcare reform and particularly in regards to the medical device industry. Have there been any updates since we spoke last week and what is your expectation around the final build of the merge?

Kieran Gallahue

That would be one for Las Vegas, I think, at this point. As you know those bills are all over the place and our feeling is you just step back and you look at it and you say what are the fundamentals that they are trying to drive towards and to the extent that there is an attempt to try to become more efficient in healthcare, the extent that there is a desire to increase the access to bring more patients into the system, both of those trends actually could be very positive from our perspective. Certainly by increasing the number of covered lives, sleep disorder breathing is a disorder that affects people of all walks and all sorts of economic classes; in fact you could argue that those in some of the areas that they are not being covered today by insurance may have the highest prevalence rates.

You also have the opportunity to look a bit more holistically at the cost of care and it is very clear that hospital systems around the planet, not just in the US, are trying to keep people out of hospitals, trying to keep them out of acute care settings, and trying to manage them in a more cost effective way. They are also trying to deal with the rising costs of managing chronic disorders.

You look at sleep disorder breathing; we are sitting in the middle of some of the most costly co morbidities, or chronic disorders on the planet. We have a very cost effective way of helping to treat patients and increasing access for patients can only be a good thing.

I think the best proof statement on that is if you look at the National Institute of Clinical Excellence that supports the National Health System in the UK. I mean, you can argue that the UK is one of the more frugal healthcare environments on the planet and they have some very good outcomes data as well. The National Institute of Clinical Excellence has really been sort of the granddaddy of health economic bodies around the globe and 18 months ago they analyzed the sleep apnea space and their recommendation was that it was cost and official in order to identify and treat more patients with sleep disorder breathing.

So, when you look at those kinds of indicators and you say if we move anywhere in the direction towards that level of frugality and then there is some common sense put in place as NICE has demonstrated, there could be some very positive aspects that come out of this.

Operator

Your next question comes from Joshua Zable from Natixis Bleichroeder.

Joshua Zable - Natixis Bleichroeder

I know you broke out the US generators in mass on a constant currency basis, but can you give us the numbers for everyone’s models?

Brett Sandercock

For the US the flow gens was $64.8 million, masks and other was $69.9; Tiger $34.7; for the rest of the world flow gens was $75.8; masks and other $36.5, for $112.3 total.

Joshua Zable - Natixis Bleichroeder

Perfect and then on the gross margin I know you gave a range, you sort of talked about 60%, just because I know there is a lot of stuff going on with gross margins as far as product mix and the new products higher and currency, I mean from this range should we sort of see it dip first and then come back up, should it be kind of constant over the year, can you just give us any color on how we should think about it? I know you guys don’t like to give quarterly guidance, but kind of moves it around a lot just to give us some sort of gauge?

Brett Sandercock

As you said there is a lot of things impacting on the geographic mix, the product mix, new product releases and so on and then obviously currency as well. If you look at it, we get benefit from the euro, which has been appreciating at the moment, so that is going to help us and I hope it is on a headline basis in terms of revenue as well. The Aussie dollar depreciating will hurt us also and that has been coming from a low, probably around six months ago, of about $0.66 and it has been steadily climbing through the quarters. We felt some of that impact clearly this quarter. We will feel some more of the impact through Q2 and it will still be manifesting in Q3 as well, but then I would expect that that would then start to improve as we went through Q4 and we’re pretty much through those sort of year-on-year currency impact. So you think of it like that, if that makes sense.

Joshua Zable - Natixis Bleichroeder

Yes, no that is actually very, very helpful.

Kieran Gallahue

Part of that is you get sort of the temporary effects on the currency side, but the lasting effects are the things that are associated with product mix, with new product flow, with operational improvements that we’ve been engaging in throughout the globe and structural changes such as increasing manufacturing in our Singapore facility. So there is sort of the temporary sort of things that are really hard to forecast and then there are the longer trend items that are quite positive for us.

Brett Sandercock

That is exactly right and we have been working hard on the cost initiative on the manufacturing and so on. You guys know that we did move to Singapore, we established a factory there to enhance the factory down here in Sydney, so there is a lot of activity that goes on beneath the surface here that we’ll continue to work on, really just a sustained reduction in that overall cost base and we will continue to do that and new products, obviously, will help as well.

Joshua Zable - Natixis Bleichroeder

Okay great and then Kieran I know you commented about the competitive launch and I know you don’t want to knock the products and you made your comments already, but I am just wondering have you really seen them out there yet/ I know typically when Respironics launch it is some sort of limited release and I am just wondering obviously they are still sampling in that limited release, but have you really seen it out there yet to the point that your guys could come back and evaluate, or it is not really out there yet and it is just sort of trickling into the market?

Kieran Gallahue

I think, as you noted at Medtrade, I think they did an excellent job, as they always do, in trying to establish awareness about the new product flow and I’m sure that transcends into the sales force and into their call patterns. You are absolutely right that any product launch from any competitor or from ResMed for that matter, you go through a process where you get an initial trial and then the real question mark is after that initial trial what are your reorder rates like and then how does it stack up competitively. At the same time you have sort of a push through of some of the older inventory that you try to make sure that you don’t get caught with any obsolescence on that.

So, I would expect since the launch and for a few months that there will be sort of that blend of their new product coming in, cleaning out the old inventory, and what not. But, the awareness is there, there is no doubt. I have a lot of respect for them and their communication capabilities and there is no doubt that there should be very few customers that don’t know about that new product yet.

Joshua Zable - Natixis Bleichroeder

Pricing is being maintained while they’ve launched their new product?

Kieran Gallahue

Yes, I will say that from the beginning of the integration of the Respironics and the Phillips team we’ve felt they’ve been very good competitors. I think we all recognize that there is tremendous amount of value that is brought to bear and I won’t limit that to Respironics, I will say that throughout the industry that there is a tremendous amount of value that we bring to customers and I think we all know that price competition is a short-term gain and that we all need to be focusing on higher value opportunities and how to reduce the costs to our customers. You reduce the costs by simplifying their supply chain. You reduce the costs by helping to drive more volume into the marketplace. You reduce the cost by this focus on informatics or algorhythms or what not.

That is why we, at this point, feel pretty comfortable with the state of where the industry is at.

Joshua Zable - Natixis Bleichroeder

My ResMed count down clock to your new generator launch is hitting 9 months now I think. Is that correct, are we on time with that or do I need to change it?

Kieran Gallahue

We said the beginning of last March that we were going to have a very active 18 months or so of product launches and the team has done a very good job of living up to that. We started in the first quarter with the ApneaLinkTM plus, we now have the Swift FX which was launched in Europe and before the end of this fiscal year we’ll be global. We’ve got the gel product which has only been launched in the US and we expect that before the end of the fiscal year it will be launched on a global basis and certainly we have noted that we have a flow generator platform coming, but for competitive reasons and for customer reasons it is simply not appropriate for us to get specific on the timing.

Operator

Your next question comes from Peter Bye from Jefferies & Co.

Joshua Jennings - Jefferies & Co.

It is actually Josh Jennings in for Peter who is traveling today. Could you give a little bit more color in terms of the home sleep testing pilots that are ongoing in terms of maybe numbers and how they are faring? Then when do you expect home sleep diagnostics to become more of a meaningful impact to your sales base?

Kieran Gallahue

First of all I think there are certain home sleep testing pilots that we’re involved with and there are many that are ongoing that are really led by the customers themselves and experimenting. So, as we expected throughout this year there is going to be activity really across a wide range of customer types. Seeing primary care physicians try their hand at it, the independent diagnostic testing facilities, or the IDTFs that are getting involved, sleep physicians, other types of specialists, so there are a number of different types of customers or healthcare providers that are getting involved in understanding what their role in home sleep testing could be, or should be, and you are almost seeing the first echo, if you will, in that process where there has been a learning and an iteration in it.

What I mean by that is there are certain groups that seem particularly interested in it and I would say the IDTFs working with the HMEs seem particularly interested and capable of providing support and very encouragingly we see more and more sleep physicians, who we certainly enjoy working with in this category, who are beginning to understand the benefit of integrating home sleep testing along with their traditional diagnostic techniques. And, you see many of the sleep physicians who maybe a few months ago, and I mean that literally, just a few months ago may have been quite reticent to think about the adoption are beginning to learn a bit more, experiment a bit more, and to gain substantially more comfort with the idea of home sleep testing in their professional hands being able to be administered quite well and in a quite balanced way.

In addition, you are seeing more and more payers get engaged in this. We, on a regular basis, get feedback from payers, local payers, national payers, of their interest in either supporting customers that have been working in home sleep testing or somehow encouraging the use of home sleep testing and much of this we get from feedback from the physicians themselves who have been working with those payers.

So, it is progressing. I would say that the effect on results to date is not yet material. We hadn’t expected it to be material and in fact is not material and that is sort of the way that you would expect these things to roll out, which is to have people gain comfort, understand the three Ps, process, payment and politics. The process and payment have been progressing quite well. Then as I note that the politics, which were probably a bit more intense six, nine months ago, are beginning to ease a bit, but certainly by no means have disappeared and I wouldn’t expect that to happen over night.

So, good progress and I would say nothing has happened yet that is different than we had anticipated and articulated certainly earlier in the year.

Operator

Your next question comes from Joanne Wuensch with BMO Capital Markets.

Joanne Wuensch - BMO Capital Markets

Your Americas number is on supplier. I know you are introducing some new products there, but is there anything else that helped shift that quarter?

Kieran Gallahue

The US organization under J.C. [Corellas] and supported by our SBU leaders, Farrell and Don Darkin have been just doing an excellent job of continually improving the experience that we have with our customers, trying to make it easier to do business with ResMed. They have an excellent product line up and an excellent team.

Again, I will say just as I said with the ROW piece, it is not one silver bullet. It is execution across multiple areas and they are just doing a great job.

Joanne Wuensch - BMO Capital Markets

Okay, you have a nice amount of cash building on the balance sheet, other than stock repurchases what should we think about uses for that cash?

Kieran Gallahue

We do have a very strong balance sheet. It is one that we are proud of and certainly one that has held us in very good position throughout this last year and allowed us to focus on our business and growing the business and growing awareness and continuing to fund our product pipeline where perhaps other businesses needed to spend time worrying about their financial condition.

We have traditionally been a conservatively geared company and we feel very good about continuing that process. We will selectively look at opportunities to invest those dollars. I think a good example of that was the Narval acquisition that we completed in this last quarter, which is our first sort of toe in the water and to a complimentary therapy to pap and one that we feel very good about and the execution of that French team, which by the way has already begun its integration; an excellent team and one that we welcome with open arms into the ResMed team. We also had the opportunity to buy back our own stock and that continued too, as Brett noted, another $35 million was invested in this last quarter and that is on top of a substantial amount of share buybacks over the last 18 months, because we feel that ResMed was a very worthy investment.

Joanne Wuensch - BMO Capital Markets

With this shift in foreign exchange environment, does it make sense to change your head in policies?

Brett Sandercock

What has happened over the last two or three years is in fact volatility on exchange movements increased significantly really. I think that you still need to continue to hedge and I think you look at what you do there within derivatives. I mean we take it pretty simple. The majority is options, for example, where you are not impacted; you are not going to lose your premiums sort of thing. We hedged the cash flows coming back to the factory and then we looked to naturally hedge a lot of our exposures around the group as well, just basically leveraging our global reach, I suppose, so we do a lot of that natural hedging as well.

And we do spend time looking at where our international revenues are and where our international expenses are and how balanced they are and they are reasonably well balanced; so you end up looking to hedge relative out performance or under performance of some of the major currencies such as the euro and the Aussie, but I still think there is a place for hedging, but you just have to do it in a very measured way and really look for natural hedging and offsets where ever you can and just use that global base to your advantage. I think so far we have done pretty well. We managed a high currency environment, low currency environment, and still generated great results over many years.

Operator

Your next question comes from Michael Matson from Wells Fargo Securities.

Michael Matson -Wells Fargo Securities

I know you have talked quite a bit about the positive impact you’ve seen from Medicare’s compliance requirements, given that you are probably selling more of the ResTraxx units and things like that. But, when I was at Medtrade I did hear some chatter from some of the HMEs about having problems getting the Medicare patients to A. show that they are compliant and B. go back for that follow up visit that they’re required to do. Is there any risk that that could actually turn into a negative to the degree that those folks don’t end up being compliant and the HME pulls that equipment back and then gives it to a new patient thereby trimming the demand for new equipment?

Kieran Gallahue

I think that the key here is that the opportunity for improving compliance has always existed. What the Medicare ruling did was to focus the HMEs very strongly on the opportunity to improve compliance, and that is something that we have long wanted for many, many different reasons. One, because that is the only way you help the patient, that is the primary reason. We are here to help support healthcare providers in helping patients. But, it is also good business because a compliant user obviously over time represents a renewal stream for many years of very high value products.

The idea of the ResTraxx types of units in the world is to help solve the problem. It is to be able to help those HMEs be more efficient in the way that they address the opportunities of improving compliance. It is a management by exception tool. So, we don’t expect the challenges associated with the compliance to ever fully go away. That is why HMEs play such an important role in the channel. They are service providers and payers need to recognize the value that those HMEs are bringing to patients.

Our job is to provide technology enablement that allows them, whenever possible, to either lessen the labor that is involved in getting patients compliant, or deskill the labor that is being applied to it. Many, many of the things that we do, regardless of whether it is Medicare or non-Medicare, because everyone has the same opportunity for improvement. So, whether it is ResTraxx and this fantastic management by exception tool; whether it is the Easy Breeze wave form and designing wave forms that are more comfortable for patients; whether it is EPR and having the ability to make the introduction to therapy more comfortable; whether it is the wide range of masks that we provide, everything from nasal pillows to full face masks; from liquid silicone rubber all the way over to gel masks now; it is all about making the experience better for the patient and we believe in the long run the healthcare providers, the payers, including Medicare, win in that process and the HMEs will win in that process.

I think we think that the focusing that Medicare has done could always create a few bumps in the road, but net, net it should be a positive for this industry.

Michael Matson -Wells Fargo Securities

Okay, so you see a positive factor of compliant patients replacing masks more frequently and also more sales of the ResTraxx units sort of offsetting a kind of negative factor of some patients kind of giving up their equipment and having that come back into the pool?

Kieran Gallahue

Look, first of all ResTraxx is an enabler, so it is not a huge revenue driver, or a profit driver. We provide that mostly as a service to our HMEs to help them become more efficient, but when push comes to shove in this industry it is about creating awareness and it is about engaging healthcare providers, including across all the various medical silos and right down to the primary care physicians and most importantly it is about providing the support to those patients, because when they get treated we all know, and the data has shown, that their healthcare costs get reduced holistically. The improvements in cardiovascular disease, and the improvements in diabetes, we talked about occupational health and safety and the danger of these truckers when they are not treated appropriately. We read about these pilots that over shoot airports like in the Go Airlines case. There are a lot of opportunities for well treated patients, when they have sleep disorder breathing, to be able to reduce healthcare costs overall, including if you want to look at it on a micro basis, or if you want to look at it on a macro basis.

Michael Matson -Wells Fargo Securities

Okay and then can you just quantify what the impact of currency was to your bottom line, to your EPS number this quarter? It sounded like it was pretty minimal, but…

Brett Sandercock

On the EPS it is around $0.05 or $0.06, including there is some hedging gain as well.

Kieran Gallahue

As Brett noted, even if you back that out the EPS was still up over 35%.

Michael Matson -Wells Fargo Securities

It looked like your international mass growth even on a constant currency basis was a little bit on the weak side. I am just wondering if you have really started to see the impact from the Swift FX or did that kind of come later in the quarter, or even after the quarter, so it didn’t really have an effect?

Kieran Gallahue

Swift FX really was not material in those results and just as the question that came up before about the impact of new products, whether it is us or others you don’t tend to see the full impact in that first quarter over time, it tends to grow over time, but just in general it is not unusual for two things to be on the ROW mass line and I know you have tracked us for awhile, which is A. in general it tends to grow slower than the US line items and there tends to be a little bit more lumpiness on the ROW line items than you will see in the Americas.

Operator

Your next question comes from Natalie Kelly from CommSec.

Natalie Kelly - CommSec

Looking in the past you seem to have made several vertical acquisitions picking up quite a few independent distribution companies, whereas the Narval acquisition seemed to be a little bit of a shift for you. I am just wondering whether you see many opportunities sort of in this space of complimentary therapy?

Kieran Gallahue

You are right we have actually done both. We have done acquisitions within the channel. The latest one was our Indian distributor as an example and we have also done acquisitions of technology where we believe it’s strategic. Two examples would be the motor business that now under pins so much of the innovation that we’re capable of. Other examples would be the ventilation business in France and now, of course, this Narval, as you noted.

To answer your question, we are broadly about complimentary technologies. We are very open-minded when we look at opportunities in the marketplace. We strongly believe that we’re here to serve patients and patient care and that it is not unlikely over time that more than one solution can be appropriate.

With that said, I will say we have never seen anything that is as efficacious and as safe as positive airway pressure CPAP and APAP, but that is a whole PAP therapy and that remains, we believe, the gold standard and we believe to be the core of the opportunity in treating sleep disorder breathing patients. But, we absolutely keep our eyes open for other opportunities, but we are data driven. We look at these solutions and we want to see opportunities where it is demonstrated that it helps patients. We want to see opportunities to see that it is good medicine, that it is something that’s acceptable by the medical community and acceptable by our standards for patient care. We also need to see a pathway to profitability with those. We need to see where ResMed can benefit from investing our time and attention and that.

So, those are some pretty high hurdles, but every now and again there is a company, or a technology, that that makes sense and quite fortunately we have the resources to be able to take advantage of those when we see them.

Operator

Your next question comes from David Stanton from RBS.

David Stanton - RBS

Can you give us an update on home diagnosis and whether you think the volume of diagnosis, particularly in the US, is increasing due to this?

Kieran Gallahue

At this point the net net answer is we do not believe there is a material impact yet from home sleep testing. That is totally consistent where we thought this would be at this point. This is really the year of piloting. It is the year where the three Ps are being worked out, the payment, the process, and the political situation that surrounds home sleep testing. There has been substantial movement forward as various healthcare providers that range from IDTFs to sleep physicians, to HMEs, to primary care physicians, each of those areas have had certain players that have experimented or are experimenting with home sleep testing and over time we would expect the smoke to clear and there to be certainly more than one solution that will be in the marketplace that is associated with home sleep testing.

So, it is progressing quite well. I think as we look out over the future we still believe that home sleep testing has the potential to have a very major effect on this marketplace over time and as we have been saying and we continue to believe we don’t believe that is a one night or an over night kind of process, it is the kind of thing that gets introduced and grows over time and signals very positively for the long-term health of this industry.

David Stanton - RBS

Have you gotten any feedback from home sleep doctors, in particular, that they can make good money out of home sleep testing at the moment compared to further investment in the sleep labs and perhaps they are?

Kieran Gallahue

Over the last couple of months there has been a reasonably significant shift in many of the conversations where sleep physicians are approaching us and whereas they may have been a bit concerned, or more concerned maybe nine months ago, typically with either the economics or the politics associated with it, they seem to be getting to a point where many more of them are getting more comfortable with the idea of integrating home sleep testing. Some of them are a bit more advanced than others. We certainly have some of our customers which have said they’ve been able to grow their business by using home sleep testing and the way that they are viewing it is, and again it varies by the individual, but is looking at many of the patients who, for whatever reason, may not show up at the lab, so they get a referral into the sleep lab. A good 30% of those patients historically have never showed up.

Clearly some of those people either are not showing up either because of the expense or because of the inconvenience associated with the over night sleep test. 70% do show up, but 3% is a big number and so you have some of those sleep physicians who are looking at that and saying hey, this is not a matter of replacing somebody who would have been in a bed anyway, this is a matter of getting somebody who we would not have been able to reach. So, it is truly a new patient or an incremental patient that they wouldn’t have been able to reach.

In addition, what they are finding is that some of those patients, once they test them with the home sleep testing device, still require either because they are borderline, or because there is something very unusual about them, they still require a full PSG. So, those are the ones that are getting more comfortable more quickly and obviously you’ll have some of those faster movers in the marketplace and you will have some that will lag behind that and may take a bit longer to feel comfortable and may need to see the sleep physician across town and see how they have adopted it before they feel comfortable in the adoption phase.

It is a very interesting process that they are going through, but the more data they get it seems the more comfortable they get.

Operator

Your next question comes from Jason Mills from Canaccord Adams.

Jamar Ismail - Canaccord Adams

This is Jamar for Jason. First on the EPS effect for foreign exchange, what are you guys thinking about in the upcoming quarters? I mean $0.05 to $0.06 is fairly high this quarter and going forward talking about different hedging strategies do you see the same effect next quarter or a little bit lower?

Brett Sandercock

If you look at this quarter we are in the Q1 we had a positive impact there. As the country swings around particularly the Aussie and it works its way through inventory into our cost of sales, I would expect the next quarter, for example, you are probably looking around $0.04 or $0.05 negative impact on EPS all things being equal.

Jamar Ismail - Canaccord Adams

Okay changing gears to the US market, you talked a little bit about the US market being a little bit lower than you had seen in the past. What are you thinking now?

Kieran Gallahue

We haven’t really seen a significant change in these last nine months. So, you need to go back to the beginning of the year and as we said at the time we thought that maybe there was a couple of points that were shaved off, but it was still double-digit growth on the revenue side and the volume side was still close to that range of around the 15% or so. We continue to feel that the market is growing at quite a healthy clip. Then when we look at the fundamentals of awareness building, of diagnostics simplification, about just in general look at the various very positive signals in this marketplace, it still looks very, very good.

So, we remain very, very comfortable about the marketplace. We continue to invest both in the short term and the long term because you don’t take market growth for granted, so these efforts on the industry side to raise awareness and educate primary care physicians are very important. The advent of home sleep testing is very important. This just flood of data that continues on the link between sleep disorder breathing and heart failure, and cardiovascular disease and diabetes is just very, very encouraging as we look out over the medium and the long term in market expansion.

Operator

Your last question comes from Dan Hearn from UBS.

Dan Hearn - UBS

The trend that you are seeing with the mix shift toward the higher end of [inaudible] and the flow generators, is that a trend that is slowing, or stable, or accelerating?

Kieran Gallahue

We see a continued trend it is certainly not slowing. There was a period there were it was accelerating and it continues to grow above market rates, so let’s just call it a stable, continuing positive shift mix that we’ve seen in this industry. Again, I think that bodes well for the future, because many of these higher end feature sets are oriented towards patient comfort, which can improve compliance, and they are oriented towards the reduction of labor that ‘s required by the HME or the sleep physician in helping patients get acclimated to their therapies.

So, good, solid, positive trends and they continue.

Kieran Gallahue

Thank you everybody for your participation in this call. As always I want to thank our employees all over the globe in their various functions, because once again, these results are the result of their passion and their hard work and their efforts. So, fantastic job by the ResMed team across the globe.

I can tell you this that we on the back of a fantastic Q1 we remain excited about our future. We have high margin exciting new products that are rolling out over the year. The market for sleep disorder breathing is still highly under penetrated. We have new policies that are simplifying the diagnostic process. We have a stellar balance sheet, significant operating cash flow, and as I noted we have an absolutely stellar team.

Thank you very much for your attention and we look forward to continuing to update you as we move through the fiscal year.

Operator

Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation. (Operator Instructions).

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Source: ResMed Inc. Q1 2010 Earnings Call Transcript
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