ResMed F2Q10 (Qtr End 12/31/09) Earnings Call Transcript

| About: ResMed Inc. (RMD)

ResMed Inc. (NYSE:RMD)

F2Q10 (Qtr End 12/31/09) Earnings Call

February 4, 2010 4:30 pm ET

Executives

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

Brett Sandercock - Chief Financial Officer

Peter C. Farrell Ph.D. - Executive Chairman of the Board

David Pendarvis - Sr. Vice President - Organizational Development, Global General Counsel, Corporate Secretary

Analysts

Joshua Zable - Natixis Bleichroeder

Benjamin Andrew - William Blair & Company, LLC

David Clair - Piper Jaffray

Andrew Goodsall – UBS

Saul Hadassin - Credit Suisse

Matthew Prior - Merrill Lynch/Bank of America

David Low - Deutsche Bank

Peter Bye - Jefferies & Co.

Natalie Kelly - COMMSEC

Presentation

Operator

Good day ladies and gentlemen and welcome to the second quarter 2010 ResMed Earnings Conference Call. My name is Jennifer and I will be your operator for today. (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 Gallahue, ResMed's President and CEO. Mr. Gallahue, please go ahead, sir.

Kieran Gallahue

Thanks, Jennifer. Well good afternoon and welcome ResMed's second quarter Earnings Call, as with our previous calls I'll be in 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.

Well, we are very pleased to report today that we just achieved an important milestone at ResMed by crossing the billion dollar mark in trailing 12 month revenue, and reporting our 60th consecutive quarter of revenue growth with another very solid quarter. We are pleased to report that revenues in the second quarter of 2010 grew 23% or up 17% on a constant currency basis.

Revenue in the Americas grew by 20% year-over-year, ROW revenue increased by 27% and in constant currency terms grew 14%. In contrast to recent quarters, currency movement has a positive impact on ROW revenue this quarter. GAAP EPS increased 36% to $0.60. Excluding amortization of acquired intangibles, EPS was two pennies better at $0.62 per share.

We're pleased to report that in the face of the strengthening Australian dollar, gross margins were 59.7% or approximately 60% in Q2 benefiting from the continued success in leveraging manufacturing and logistics cost efficiencies across our global organization, and offset primarily by the depreciation of the Aussie dollar. Cash flow from operations was $11.6 million, operating cash flow for the December quarter was adversely impacted by the timing of the $61.7 million income tax payment that we mentioned would be forthcoming during our last quarter conference call.

We expect cash flow to return to robust levels as we continue to demonstrate our commitment to strong operating performance and earnings, and a commitment to working capital control. Our balance sheet remains extremely solid with the cash and cash equivalent balance at the end of Q2 just over $451million. We also experienced balance growth across product categories with global flow generator sales up 29% or up 21% constant currency, and mass segments growing at 17% during the quarter a 13% increase on a constant currency basis.

Sales of America's flow generators were up 24% year-over-year in Q2 and sales in ROW, improved to 17% in constant currency terms. Globally the growth was mainly driven by strong sales of our high-end sleep devices, once again led by our AutoSet CS and BiPAP Auto, where we have a large advantage in both noise and comfort. The whispered quite comfortable performance of the Easy-Breathe continues to be recognized in best in class and is truly helping us differentiate ResMed as best in class from our competitors.

In the mask category we believe we continue to take market share in both new patient populations and the installed base. Mask sales were quite robust this quarter growing 16% in the Americas and in constant currency terms 8% in ROW. Our newly launched soft-gel mask is off to an encouraging start in its early days and we've had a fabulous response from both physicians and from patients. We expect to continue launching various sizes in the Americas and broadening our launch to other geographies throughout this year. The market is telling us that they appreciate the value and the comfort of quietness that this mask demonstrates.

The Swift FX the newest member of the Swift family and our lightest mask to-date launched outside the Americas during Q1 and has just launched in the Americas, so it is just now going global in all sizes, just as with the soft-gel mask the feedback has been outstanding. So with these new masks in the marketplace we remain focused on growing market-share with high margins, industry leading products. Last March we indicated that we would have a very active 18 or so months on product launches, as you can see from the past month we are well on track to meeting that commitment. Today we are officially announcing the release of our newest generation of flow generators, the ResMed F9 series.

The initial introduction will be the F9 AutoSet and the F9 Elite products expanding to other flow generators over time. We expect the launch to begin first in Europe and then expand to the Americas later this quarter. We're extremely proud and excited about the unique advantages of the F9 and what they will bring to the market. The F9 will have a new look and feel that will integrate within the bedroom while delivering advanced and improved feature such as (inaudible) and heated circuit or hose for improved patient comfort, a simplified user interface, and an enhanced AutoSet algorithm, it is absolutely going to be an outstanding product.

A quick update on home sleep testing, the home sleep testing continues to be piloted in various forms. It is proven that HST was here to stay in calendar year 2008 and in calendar year 2009, just as we expected, multiple healthcare providers began piloting HST in various models. We're working closely with our sleep division partners to make home sleep testing a reality that can improve patient access to appropriate therapy. We've heard that a growing number of commercial payers are in discussions on recommending and perhaps even requiring HST as a first line diagnostic.

We also expect growth results to continue to improve the awareness and validation of the critical role that sleep disorder breathing plays in a very serious most rapidly growing, most costly diseases in the world, cardiovascular disease and diabetes. Although sleep disorder breathing affects people of all ages, weights, genders and races its becoming widely recognized that heart disease and diabetes particularly tend to go hand-in-hand with sleep disorder breathing and that treatment for SDB cannot only improve health, but 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 will represent a large opportunity within occupational health and safety and the transportation business for diagnosis and treatment of sleep disorder breathing.

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

So, in summary Q2 once again demonstrated the strength of our global reached and balanced business while providing very positive signals for sustained industry growth as we look forward. Our new product flow is robust and customer meaningful and demonstrates that our commitment to innovation is paying dividends.

Before I turn over the call to Brett, I just want to remind everyone, or inform those of you who haven't heard, that we'll ring in the closing bell at the end NYSE on Monday February 8th. We'll be hosting an investor relations meeting at the exchange beforehand, if you'd like to attend or leave details, please contact Connie Bienfait, our Director of Investor Relations.

Now I'll turn the call over to Brett to provide some additional details. Brett?

Brett Sandercock

Thanks, Kieran. So I'll briefly run through our December quarter results, revenue as mentioned for the December quarter was $275.1million, an increase of 23% over the prior year quarter. We did have favorable currency movements that increased second quarter revenues by approximately $13.3 million. In constant currency terms revenue increased by 17% over the prior year quarter.

Income from operations for the quarter was $57.9 million an increase of 34% over the prior year quarter and net income for the quarter was $46 million an increase of 36% over the prior year quarter. Diluted earnings per share for the quarter was $0.60 an increase of 36% over the prior year quarter.

Gross margins for the December quarter was 59.7%, down sequentially from Q1FY10, largely attributed to an unfavorable currency impact resulting from the depreciation of the Australian dollar relative to the US dollar. Looking forward exchange rate volatility will continue to manifest in our gross margins. In particular a recent depreciation of the Euro against the US dollar together with the strong Australian dollar will impact our gross margins.

SG&A expenses for the quarter were $84.1 million an increase of 20% over the prior year quarter. In constant currency terms SG&A expenses increases by a modest 10% over the prior year quarter. The increases in SG&A reflects expenses to support sales growth as well as activities targeted at increasing the awareness and diagnosis of sleep disorder breathing. SG&A as a percentage of revenue improved to 30.6% compared to the year ago figure of 31.4%. Looking forward and subject to currency movements we expect SG&A as a percentage of revenue to be in that 31% range for the balance of the fiscal year 2010.

R&D expenses for the quarter were $19.1 million, an increase of 28% over the prior year quarter. In constant currency terms R&D expenses increased by 1% over the prior year quarter. R&D expenses as a percentage of revenue was 7% consistent with the prior year quarter. Looking forward and again subject to currency movements we'd expect R&D expenses as a percentage of revenue to be in that 7% range for the balance of the fiscal year. We continue to devote significant resources to product innovation and clinical study activities.

Amortization of acquired intangibles were $2.1million for the quarter and stock-based compensation expense for the quarter was $7.3 million. During the quarter we also donated $1 million to the ResMed Foundation.

Our effective tax rate for the quarter was 27.1% and we estimate our fiscal year 2010 tax rate will be in the vicinity of 27%.

Turning now to revenues in more detail, overall American sales were $148 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 APAP devices, full face masks, and incremental revenue from our recently launched gel mask.

Sales outside the Americas totaled $127.1 million, an increase of 27% over the prior year quarter. As expected, sales outside the Americas were positively impacted by currency movements. In constant currency terms, sales outside the Americas increased by 14% over the prior year quarter.

Breaking out revenues between product segments, in the Americas, flow generator sales were $75.9 million, an increase of 24% over the prior year quarter. Masks in other styles were $72.1 million, an increase of 16% over the prior year. Fr revenues outside the Americas, flow generator sales were $86.2 million, an increase of 32% over the prior year quarter, or in constant currency terms, an increase of 17%. Masks and other sales were $40.9 million, an increase of 18%, or in constant currency terms, an increase of 8% over the prior year. On a group basis and constant currency terms, flow generator sales increased by 21% while masks and other increased by 13%.

Cash flow from operations was $11.6 million for the quarter. The operating cash flow was impacted by the timing of income tax payment totalled $61.7 million during the quarter. Our underlying cash flow remains very strong.

Capital expenditure for the quarter was $14.5 million. Depreciation and amortization for the December quarter totalled $15.6 million. We continue to buy back shares as part of our capital management program. During the quarter we repurchased 606,000 shares for consideration of $30.1 million as part of our ongoing buyback program. As of today we have repurchased approximately 1.5 million shares out of a total authorized buyback of 10 million shares.

Our balance sheet remains strong and conservatively geared. For December 1, total assets stored at $1.6 billion and net equity was $1.3 billion. Group external debt was $145 million while cash and cash equivalents totalled $451 million. I'll now hand the call back to Kieran.

Kieran T. Gallahue

All right. Thanks, Brett. Jennifer, let's open it up for questions.

Question-and-Answer Session

Operator

(Operator's Instructions) Our first question comes from the line of Joshua Zable with Natixis Bleichroeder.

Joshua Zable - Natixis Bleichroeder

Hey, guys. Congrats here on a really impressive quarter and thanks for taking my questions. I have a bunch, but I'll try to keep it brief here. First, just market commentary. I know we always ask that just kind of what you see out there and anything picking up, slowing down, or pretty status quo?

Kieran T. Gallahue

The market remains robust. We still think the market growth is around what we've experienced this past year. The indications out there at this point, our physician awareness, clinical awareness, continues to grow. And from the Americas perspective, HST continues to be piloted. We continue to good progress in that space. I'd hesitate to say that it's material yet in the results. I think that's probably more ahead of us than behind us seeing the impact of HST.

Joshua Zable - Natixis Bleichroeder

Great. And then a lot of people obviously talking about the competitive landscape. With the announcement of the S9 obviously concerns will be less, but can you just give us a little bit of color? I mean, this quarter constant currency growth actually accelerated. I know it takes a while to ramp up the S9, so should we see some trialing maybe next quarter as that would be the peak of the trialing and then coming back in your fourth quarter we see you guys fighting back or are you guys just not feeling it at all?

Kieran T. Gallahue

Well, I think it's important to recognize that some of the competitive launches that have occurred here in the last couple of months are, in our view, attempts to catch up to what has been in the marketplace now for the last 18 months. The S8 II series of products that were underpinned with this Easy-Breathe motor technology and the wave forms that are associated with the Easy-Breathe wave forms have been extremely well received within the marketplace and they create a fundamental sort of base for us to compete against new products. So the new products that have rolled out, they're going to get trial. We assume that the completive products got a good trial, but I got to tell you, our field sales forces felt very comfortable walking into those same accounts with the high quality ResMed products, the quiet ResMed products with the algorithms that are associated with it and we still feel very comfortable competing with the S8 II. In our opinion, you look at the S9, that's a bonus on top of that.

And when you look at the product and people get the ability to physically look at this product and then be able to experience its ease of use to be able to look at some of the feature sets that are very patient meaningful and they're going to be customer meaningful as well because they are oriented towards improving compliance and simplifying the ability for patients to adapt to therapy. In addition to providing additional revenue streams for some of the customers there is a lot of good things that are going to come out with this S9.

Now, our intention is to launch it like we have sort of the classic ResMed way if you will, so rolling it out first in Europe, then we are going to be rolling it out towards the end of this quarter in the US. You're absolutely right in your comments that it takes several months for you to get around and start seeing that ramp and really feel that materiality as we get into fiscal year 2011. So we're excited about that launch process.

And just as in sort of our classic way we're going to start with the AutoSet and the Elite and then over time we'll fill out the CPAP area as well as move over to the bio levels. So we're feeling good at what we're at and we'll be rolling it out through the rest of this fiscal year.

Joshua Zable - Natixis Bleichroeder

Great, and then I'll let other people have a chance, but just to be clear, you have not yet launched outside the US, but you will be shortly? And then I guess are we going to get to see a sample, if you will, at the investor day next week?

Kieran T. Gallahue

All right, great. So actually we've begun the early shipments in Europe, but again like I'm saying, these things kind of ramp up, but we're absolutely delivering product and have been for about a week or so. I'm looking at (inaudible), but yeah that last week or so, and yes you'll absolutely be able to see a device during the investor day next week.

Operator

And your next question comes from the line of Benjamin Andrew with William Blair & Company, LLC.

Benjamin Andrew - William Blair & Company, LLC

Good afternoon. I wanted to follow up on a couple of things briefly. Brett, could you give us some sense of the impact of currency on gross margin if you could isolate it? And then how did that flow throughout the bottom line once you back out hedging gain and what not?

Brett Sandercock

If you looked at that sequential decline, the vast majority of that would have been impact that's currency related is basically the real driver on that.

Benjamin Andrew - William Blair & Company, LLC

So the sequential decline in the gross margin percentage of over a full point was just currency?

Brett Sandercock

Yeah, predominantly. I mean, as you know there's plenty of factors that impact the geographic mix, product mix, manufacturing and so on in the mix, but if you look at it and say what's the predominant driver it was currency and it was the appreciation of the Aussie.

Benjamin Andrew - William Blair & Company, LLC

Okay, great. And then the lag effect in terms of that flowing through, are we right to think of that as maybe two or even as long as three quarters when — because now we have had a recovery a bit in the dollar so it wouldn't look like gross margin based on currency is going to recover for a couple of quarters?

Brett Sandercock

Yeah. It's certainly not as long as three quarters. It'll be around that one-and-a-half-quarter mark, that lag impact. So still some of that to flow through, but you're right, the Aussie — well, you know how volatile currencies are at the moment but the Aussie has come off from $0.925 to about I think under $0.87 within the last three weeks. So clearly that's coming down. It'll take a little while to flow through, but we'll get that benefit down the track for sure.

Benjamin Andrew - William Blair & Company, LLC

Okay. Two other quick questions. Kieran, you mentioned you've had kind of a minimal impact or benefit from the gel mask so far. I mean, is that $10 million or something that we should look for or even that that we should look for a substantially different dynamic in the next couple of quarters?

Kieran T. Gallahue

Yeah. You know, Ben, we don't get into that sort of line item detail when we break out revenues just because it's sort of a slippery slope over time of detail, but what I intend to say is that the product has been very well received. The way a product like this launches is that not all sizes are available Day 1. So you get out the predominant sizes and then over the course of several months you fill out the rest of the SKUs, you fill out your sampling packages, et cetera. So the initial shot over the bow came during Q2, and what you'll see throughout Q3 is exactly what I just described, filling out of the rest of the SKUs. We expect by the end of the quarter we'll be shipping all the SKUs in that product and we'll be fully up on the samples and then we'll be full steam ahead.

And I got to tell you, the early feedback has been fantastic. It's really encouraging. And not only on the gel, the gel and the Swift FX. When you look at some of the customer testimonials and the patient testimonials that have been coming in, these are darn good products. So we’re looking forward to them. And by the way, as you know mass products tend to be on the side of gross margin contributors. So we’re certainly looking forward to that continued expansion as well.

Benjamin Andrew - William Blair & Company, LLC

And last structural question, I mean, one thing we’ve noticed in the last several, really probably couple of years, has been the mix shift in Europe changing substantially in favor of generators. And particularly this quarter you grew generators quite a bit faster than masks, it looks like worldwide. I mean, that supposedly in the face of a new competitive launch. Now you’ve got all these new products. Is that going to balance out where we’ll see more balance growth from your perspective the next four quarters with all of these new launches?

Kieran T. Gallahue

Well, I think if you go historically, you’ve tended to see in Europe that actually on a consistent basis you tend to see the flow generators do represent a larger percentage of the revenues in Europe. And you do tend to see higher growth rates in those categories, right. So, and remember also in Europe you have the ventilation line which is a flow generator heavy part of what we do. And you don’t have that in the US. So, as we look forward, I think we’re very much in a reasonably balanced phase of the product launches. Certainly as we look at some of the new mask launches that gives us continue, hope to, to grow those categories and to continue to penetrate them. But I’d say we’re in a pretty classic mix. Brett, do you have anything to add to that?

Brett Sandercock

Yeah, I mean, I think, some of that European, I think it’s turning to really good consistent results coming out of Germany out of the last (inaudible). And some of the mix that we had in Germany we’ve passed that now completely, getting good growth out of that. And as you know in Germany it’s time care, so it’s really quite generator driven. Nice that in fact that the cost of that business sort to speak. So I think some of that driving through is waiting for those nice out performance and flow generators in Europe. Been throwing in the mix also, we’ve got the S-9 launch which is a new platform. So I think over time you’ll get back to historical levels where (inaudible) will grow stronger than flow gen. But with some many new product launches that some of that mix might change a little over the short term.

Benjamin Andrew - William Blair & Company, LLC

Okay. Thank you.

Operator

And your next question comes from the line of David Clair from Piper Jaffray. Please proceed.

David Clair - Piper Jaffray

I guess the first question here, just a quick one on the soft gel. When do you think we should expect that OUS?

Kieran T. Gallahue

Soft gel OUS? Outside of the US.

David Clair - Piper Jaffray

Sorry, IOW.

Brett Sandercock

We’re expecting to launch in France early March. And then we’ll progressively roll out over the next four to eight weeks on country by country.

David Clair - Piper Jaffray

Okay. Great. And then, Brett, just kind of with where foreign exchange rates are, where they’ve been over the last couple months here. What do you think we should expect from a gross margin perspective, say in the next quarter here? Will we be above the 59% or how should we think about it?

Brett Sandercock

Just on the exchange rates through the volatility at the moment, the quarter to quarter estimate is just not making sense at the moment. Give you a lot of color on that. I mean, you know what exchange rates are doing as well as I do. And you know that they’ll be short term, there’s probably some head wins with the Euro. The lag on the Aussie, but that’ll held at – by the next few quarters after that. But I think what I would say, the FOREX we can’t really control. But I’m really confident and comfortable with our ability to expand the GM through strong – when you put out the flow for example, limiting our cost structure which we’ve been doing, managing cogs and continuous improvement programs. We’re working hard to do all that. And we’re looking at (inaudible) as well. And part of innovation and the product flow we’ve designed to do that.

So I think we’re doing everything we can and working pretty hard to withstand the margins. But in short terms we will be subject to some of the volatility around those currencies. And we’ll just have to deal with that and keep doing what we need to do.

The only other thing I’d say, we have been working pretty hard over the last few years to diversify our prospect away from the Aussie dollar. And we have been relatively successful. We’ve done through materials purchasing, Singapore manufacturing, for example. And just trying to contain those operational costs. So we’ll continue to do that as well. And it doesn’t mean to say we won’t be impacted because we will. Just not as bad as it was, for example, two years ago. But I don’t want to dismiss the currency impact that’s there. But it’s short term as well as (inaudible) and the underlying sustainable margin improvement we’re absolutely working on.

David Clair - Piper Jaffray

Okay. Then that was sort of good lead in for my next question. Just an update on Singapore? Where are we in terms manufacturing?

Kieran T. Gallahue

Singapore has been a very successful venture for us. The plant came up to speed quite rapidly. We’ve now celebrated what our 13-14 months of operations. We’re already producing about 20% of our volume our of Singapore. So we’ve been just very pleased with the quality of the work force with their ability to integrate our products into a quality system to be able to mirror the success that we’ve seen in Sydney. And at the same time be able to provide some of the costs and tax advantages that are associated with Singapore. So we’re very pleased with where we’re at.

We continue to build capabilities there. The initial phases were really about, what’s called assembly type work. Over the course of these year we’re going to continue to build out some of the capabilities and for instance manufacturing of motors. So that we can not only produce in the LA area but we can also have a secondary source within a company. And Singapore, we look at building some capabilities on the LSR, so the moving capabilities, etcetera, itself. We’ve got a very strong foundation. It ramped up quickly. And we’re feeling very comfortable with the ability to continue to ramp that.

We’re not giving any specific estimates what we want to produce there. But I can tell you we feel very comfortable with our ability to ramp.

David Clair - Piper Jaffray

Okay. Great. Congratulations on a great quarter.

Operator

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

Andrew Goodsall – UBS

Could I perhaps just ask you to just detail the features (inaudible) of S9 a little bit more. And I guess in particular just some of the smarts that you’ve added in this time around that are really going to differentiate you from your competitors?

Kieran T. Gallahue

Yeah. Let me throw the ball over to McFarrell who runs (inaudible).

Peter C. Farrell Ph.D.

Andrew, there are many benefits that would take the length of this conference call to cover. But obviously you’re not really there to that level of detail on investor relations a bit like this. If I could summarize the three major benefits, I’d focus on the three Cs that it brings, comfort, compliance and connectivity. There’s more including cost effectiveness and others. But the comfort that you can get from this product from the new climate line system that provides a heated wire circuits. We’ve closed loop control of temperature and humidity. Incredible. The enhanced (inaudible), which brings even low (inaudible) and more comfort and low worker breathing for the patient. Which all leads to greater compliance. Which is what the patient wants. It’s what the provider wants. And it’s what the insurance company wants as well.

But we’ve also added increased expansion of conductivity. So we’ve taken our S9 wireless capability that we have really worked on these last five years on the S7 and S8 range to the next level. And we’ve added other ways to get connectivity. So I don’t want to go into too many more details on it. Other than to say that the initial reception from our internal sales teams, the French national sales team earlier this quarter got it and they launched at the national pneumology conference this last weekend in France. Amazing reception from the physicians and from customers.

So early days but seeing great response in Europe and looking forward to the full data of the quarter, taking it to the rest of the world.

Kieran T. Gallahue

It is a fantastic product series. This is going to be – just as SA2 and the easy breeze motor technology established a new level within the market place, this certainly has the potential to do the same. And again, we haven’t released it yet in the US. So we’re waiting later in the quarter and the availability and the access to everyone is going to be quite easy.

Andrew Goodsall – UBS

We were hearing one of the features was, I guess, feedback to the patient that they could measure how good a night of sleep they were getting. Could you perhaps expand on that if that’s one of the features?

Kieran T. Gallahue

Sure, Andrew, I’ll talk about that too. You seem to know quite a lot about this. I love to talk about it. And it ties into my second C there, which is compliance. Having that sort of bio feedback mechanism where a patient can – the day after their therapy, at the discretion of their provider and physician mind you, have access to the hours of use that they had that night. And the (inaudible) given to the patient by a smiley face or a frowny face depending on the (inaudible) is up and above the 0.4 maybe the second sort of gradient that’s accepted standard for acceptable mouth rates. I spoke potentially, again, at the discretion of the provider or the physician, an efficacy measure such as AHI.

And the patient can have access to those. What we’ve seen in our clinical trials of this device and in the early market acceptance in our controlled product launches is that patients who have access to data get more engaged in therapy. And that’s sticking it through the therapy in those first seven days leads to months and years and years of trailing revenues for the provider in masks and accessories and for the homecare provider or the HME involved, but also on going compliance reduction of chronic health care and disease problems, such as Type II diabetes and cardiovascular recurrences and others that can be improved by ongoing care. So it's a great combination again for the patient, the physician, the provider, and ResMed as well as we contribute to that.

Andrew Goodsall – UBS

Yeah. That's a really nice feature. Maybe just in the interest of time can I just ask a final question just in terms of your growth outlook? Maybe just help me understand what you're seeing in terms of home sleep testing? I know you've talked to the insurers sort of requiring that as the first line, and then perhaps you also mentioned in the release, just transport safety. If I could just ask sort of on both those camps where things are progressing?

Kieran T. Gallahue

Sure. So the home sleep testing is progressing right along the schedule that we predicted a couple of years ago. First year it was out there, first calendar year, it was really about is it here to stay or not and clearly it is. Last year was about the initiation of pilots in different types of providers; some HMEs, some primary-care physicians, some independent diagnostic testing facilities, and certainly sleep physicians. And there were a number of pilots that we're aware of that have used, by the way, various types of diagnostic devices and have tried different processes to accomplish it. And as you might expect, some of the business models flushed out and others are doing quite well. So that's progressing well.

And what's very interesting and encouraging actually is in the last — oh G-d, it's probably about 14 weeks or so, we've heard a very different voice even among the sleep physicians where the understanding the acceptance that home sleep testing is here to stay and it makes most sense to understand how to integrate that within your practice . The number of questions, the interest in getting involve in pilots and acquiring home sleep testing devices has increased substantially. So I think that's a good signal for the market to say look, the pilots are working and it's time to move forward with greater acceptance.

Now, there was the three Ps we've always talked about; it was process, it was payment, and it was politics. The process and the payment we've really figured out. People are getting paid for it and the process is what I just mentioned. The politics is really driven by the payers moving from a you can do HST to a you must do HST, and that's what we referred to. There's some insurance companies in certain parts of the country that are piloting with that, but it's a little bit harder to predict exactly when they're going to flip to that you must phase, although we do know that some large insurers are considering it. They have put together teams to look at it and it certainly wouldn't be surprising if before the end of this calendar year, again hard to predict, but it wouldn't be surprising if one of the large ones moves and starts requiring that. And then that just opens up the gate towards further enhancement.

So this is a good process for the industry to follow. You don't want it happening all at once because things fall apart then. This process of the gentle boil, of working out the pilots, of getting it integrated, and showing that it actually promotes good care and it's not going to promote some overuse or overutilization has been very positive.

That does roll into occupational health and safety. The interest within the transportation sector in the trucking community, the airline pilots, boat riders and what not, there is a number of companies that have sprung up to try to serve those and there are some large customers that are already in the HME business as an example, or in the sleep diagnosis business, which are trying to integrate that into their practice. So I'd say that that foundation continues to be built. It always takes a little longer than you think it's going to take, but all the signals are positive.

Andrew Goodsall – UBS

That's terrific. Thank you very much, great quarter. I'll get back in the queue.

Operator

And your next question comes from the line of Saul Hadassin with Credit Suisse.

Saul Hadassin - Credit Suisse

Good morning, guys. Just had two questions, the first is just on the balance sheet. Your cash balance is starting to look quite large, just wondering if there were any comments you could give particularly on the buyback and whether you might look to accelerate that or any other type of capital management? The second question is maybe for Kieran, you moved with the Narval purchase outside of CPAP, just wondering if you could expand your thoughts on or give us some commentary on how you're looking at the mild to moderate sleep apnea market going forward? Thanks.

Kieran T. Gallahue

So on the capital management side yeah, we do have a very strong balance sheet. We mentioned the cash balance and of course we've got about $140-$150 million in debt that offsets that. We're very comfortable with the position we've taken to date. You know that we again acquired about $30 million of our own stock back during this last quarter and that's in addition to what we've done over the prior two years so we feel comfortable continuing to participate in those stock buybacks at an appropriate basis, and as Brett mentioned, we still have about 8.5 million shares left in that authorization for the buyback program.


And we're always looking at other appropriate uses for cash, but we're very careful to let it burn a whole in our pocket and to look to do, for instance, M&A that is not appropriate or that we think is not going to add value to the business or that we think doesn't leverage the strength of the ResMed team. So we feel comfortable with what we've done to date.

As it relates to Narval, that acquisition is now complete. The team is in the midst of integration. It was a low risk way of putting a toe in the water of complimentary technologies for the treatment of mild sleep disorder breathing and particularly of obstructive sleep apnea. It is, just to remind those on the phone, a company that's based in Leon, France which is great because it's right next to where our commercial headquarters is in France and in fact we're going to be combining those facilities shortly. We've already begun integrating the teams. It is one of two players — only two players in the market within France that have reimbursement for these MRD devices, and they already had a running start. They have a reputation within the industry, and maybe most importantly for us, we saw a pathway to profitability by participating in this category. They use CAD/CAM technology for much of their manufacturing and we saw that as a technology that allows scalability and allows the device manufacturer to actually make a return on these, and we can leverage our experience, our history, our relationships within the sleep community and be able to appropriately promote these technologies, again for the appropriate uses.

So it's an experiment at this point that's going well and as appropriate we're going to investigate other countries to expand into and we'll look at everything you'd expect us to look at. We're going to look at the distribution that's required in those marketplaces, we're going outlook at the price points in those marketplaces, and we're going to look at our strengths in those marketplaces, and then market by market we'll make a business decision about expansion. So early days, but we're very pleased with that acquisition.

Saul Hadassin - Credit Suisse

Okay. Thanks very much, guys.

Operator

And your next question comes from the line of Matthew Prior with Merrill Lynch/Bank of America.

Matthew Prior - Merrill Lynch/Bank of America

Yeah. Good afternoon, guys. Just a quick question on the S9 if I can. You talked a lot about management by exception in the last quarter focusing on compliance, and compliance certainly seems to become an increasing issue for the industry. Can you talk about ResTraxx at all and whether that feature is within the S9 or whether we're persisting with it or increasing its emphasis with the S9.

Peter C. Farrell Ph.D.

Yeah, Matthew. We will have the ability to do management by exception with the S9 system and there will be an S9 wireless module that will connection the back of the S9 devices that takes the data from the device to the cloud and allows the home care providers, HME, and physicians, to have access on a protected basis to that information and so they can go and manage their patients and choose how, where, and when to get back to their patients to encourage them to increase their therapy or participate more in their therapy or address mask leak or look at say a central apnea index going up and maybe the patient doesn't need just the basic CPAP and APAP, maybe they need an upgrade to a VPAP adapt or some other sort of adaptive server inhalation technology and need to get back into the sleep channel on that front.

So we will have the capability on the S9 platform and it's actually a great advantage for us. No other industry on the S8 II platform had that and we look forward to continuing that on the S9.

Kieran T. Gallahue

And just add a little color as well, you did mention the management by exception and one of the things that Mick had highlighted earlier were a number of the feature set that are designed for improved comfort and improved compliance. So our true objective here first of all is to produce the exceptions to make it easier for people to get compliance, and then certainly using our leadership positioning in our wireless monitoring to be able to make those few exceptions that do exist then or for those exceptions that do exist to certainly be able to treat them in the most cost effective way.

Matthew Prior - Merrill Lynch/Bank of America

Thanks. And just one quick followup question; obviously you have access to that data, does that assist you with product development given that the data would be quite powerful seeing what age, what profile, what combination of equipment, is leading to compliance?

Kieran T. Gallahue

We're very careful about the use of patient data. That's proprietary to the physicians and to the care providers and so we are very careful about that. We have other ways of gathering that data. We have very strong relationships in the sleep community and our innovation team is very successful. We don't need to look at those avenues for data. It's a good question, but that's not what we want to use the data for.

Matthew Prior - Merrill Lynch/Bank of America

Great. Thanks, guys.

Operator

And your next question comes from the line of David Low of Deutsche Bank.

David Low - Deutsche Bank

Thanks very much. Kieran, just a question on market. I mean, I know the question was asked before, but I guess if you could talk about the fact that you've clearly taken some market share, what do you think the underlying market growth is? And I guess my question really is centered on the fact that from what we understand or the feedback that we're getting is that volume of patients going through sleep centers, it doesn't seem to be as strong as it has been in the past, and with home testing, by your own sort of commentary still sort of a story for next year, I mean do you see any concern that the underlying market is declining? I'm trying to understand where your market share has been going in that environment.

Kieran T. Gallahue

Yeah. These are the same questions that have really been coming up for the last year, year and a half, and I'm pleased that we can say that it's been consistent that we remain very positive that you have double-digit growth. The Americas, we had said about a year ago we thought it would come off maybe a couple of points, but it was still up around the 12% or so range. I think we continue to feel comfortable that that's about right, perhaps a few points ahead of that on volume, but that would be on a revenue basis. And in Europe in the high single digits, and so for a blended growth rate in the double-digit ranges.

So I think we still feel the underlying strength in that market. I think you have to be careful when you're looking at these proxies. Part of what you're missing sometimes when you look at just one indicator of potential growth, let's say number of beds is first of all there is still bed growth and sometimes you have better bed utilization. So for instance you have people that were doing two-night studies that will go to a split-night study. So instead of doing a study one night and the next night a titration, they'll get the patient all in one night or they're working at how to reduce their no-show lists, et cetera.

So there's a lot of different avenues that can contribute to growth on that side, and then in addition you continue to have HMEs were are working at maintaining compliance. The stick, if you will, that CMS put out there a year and a half ago could very well be the best thing that happened for patient care because what it said is you the HME need to spend more time making sure these patients are compliant or else you don't get paid in the short run. And we know that once you get those patients compliant in not only the short run, but they represent very significant opportunity in the longer run with continued accessory sales, continued market sales, and eventually continued CPAP sales. So that's been a positive contributor as well that as people maintain their focus on compliance it's a good situation for the industry and it helps the focus on trailing annuities.

David Low - Deutsche Bank

Are you able to measure internally as to what level of repeat sales or how much of your revenue base is coming from the sales to existing patients versus new patients?

Kieran T. Gallahue

It's very difficult to get that level of granularity. You have HMEs which are very protective of their data and it's the same SKU, if you will, that goes to a new patient versus an existing patient. So we have some proxies where we have certain customers that do their compliant user replenishment through certain locations so we get a sense for their focus, but I think more importantly it's in our customer relationships where we get feedback from the sales force and know that patients are instituting these replenishment programs.

So I can't break it down to the figures and I certainly couldn't do it on a short-term basis, but I think we do feel comfortable that that focus on generating compliance and then mining the compliant users continues to expand.

David Low - Deutsche Bank

Okay, and just one final question on that. So the growth rates or the market growth that you've talked about this year end and last, if we talk about home testing starting to become material over the next few years, is that on top of that growth rate do you think? I mean, is this a boost coming in the next couple of years?

Kieran T. Gallahue

Yeah look, I think there's no reason that home sleep test can't improve the volume of patients going through this market. Again you never get into sort of the quarter-to-quarter stuff, but if you look at it over the medium term, if you look at it over the longer term, and you look at what home sleep testing brings, it stops or it eliminates some forms of leakage. So let's just talk about two of them as an example. 30% of the patients who get a referral to a sleep lab never show up, and why don't they show up? They don't show up maybe because it's a several hundred dollar co pay, they don't show up because they've got to be away from their family for a night. They don't show up because they don't want to be wired up like Gulliver's Travels with a camera on them all night. It's not very comfortable when you think about it.

Now, lots of people still do it which tells you how important this disorder is and how important treating this disorder is, but still, 30% don't show up. If HST does nothing other than take that 30% number to 15%, you're talking about a 20% increase in the flow of patients that get diagnosed at that point, right? Then there's a secondary form of leakage which is — now again, put yourself in the place of a primary-care physician and you are looking at a patient and trying to determine whether to send them to a sleep lab or have a sleep test. If they have an expensive test that's very inconvenience, your index of suspicion has to be pretty darn high before you send them to that test. Now you have a test that's simple to use, that can be used in their own home, but is still highly accurate — that borderline case that maybe you weren't going to send for a sleep test before, now you're going to be willing to send.

So if you just strip away everything else and just focus on the facts and the common sense piece of it, the ability for this to contribute to growth I think I quite significant and I think as a company we're very comfortable with that.

David Low - Deutsche Bank

Right. That's very helpful. Thanks very much.

Operator

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

Peter Bye - Jefferies & Co.

Thanks, guys. Just a couple of ones on a lot of concern on pricing in the market over the years and we noticed Invacare just raised their oxygen concentrator prices to the homecare dealers about 4%-5%. I know it's a different market, but I guess does that say anything to you about the reception out there what's coming in competitive bidding or sort of any takeaway for the sleep market?

Kieran T. Gallahue

Well, I don't know about a direct corollary with that action, but I will say in general the market remains healthy. We got into this with the questions before on gross margin and I think as Brett very well articulated, we feel just real comfortable with our product flow. We feel very comfortable with our ability to reduce our cost per future set that we're delivering, and we feel comfortable with the ability to continue to provide premium products with new feature sets that can allow us to have customers trade up within the marketplace, just as we've seen with the auto setting devices because of the data capabilities and because of the Easy-Breathe motor technology. And as we've seen in the bilevel category which historically we've been very underpenetrated and we've been able to, with what we believe is a superior product, 75%+ quieter than the competition, very responsive — we're able to move in there and trade them up.

So we see the market. Certainly price pressures won't go away tomorrow. The ability to significantly raise prices I think would be difficult to forecast that, but I think through product mix on one side, through delivering feature sets that are meaningful that can drive compliance, can reduce cost of delivering the product for the customer — we have, I think, a very strong value proposition.

Peter Bye - Jefferies & Co.

Okay. And just on the Bill in Washington, HR7390 to essentially get rid of competitive bidding, I think they're having a lobbying event in your neck of the woods in California pretty soon. Do you have any thoughts on one, do you get involved in lobbying for this? Do you care? I mean, you care, but do you feel that it's worth your time to lobby for potentially adding more sponsors to this bill? I think they're up around 140 in terms of sponsors, so just any thoughts on that?

Kieran T. Gallahue

We feel it's important to support industry efforts that are geared towards recognizing the value that HMEs provide, the service that they provide to the industry, and to recognize the advantages that home care brings to the health care system. I mean, when we think about what health care systems around the globe are struggling with, they're trying to keep people out of a lot of these expensive hospital settings, but at the same time they're trying to manage chronic disorders and they're trying to get more predictive in care . Categories like the treatment of sleep disorder breathing or the use of adaptive server ventilation in treating heart failure that is big — we have a large study that is ongoing right now in Europe and we're very, very optimistic about the results that we expect to see in a couple of years in that category.

Those things we think are important for people to know about. Now, we don't do a lot of direct lobbying, but we certainly support several industry groups that are engaged and are involved in getting the word out.

Peter Bye - Jefferies & Co.

Great. Just two more followups, do you have any thoughts on the upcoming audit on prepayment rates as it concerns the CPAP that's coming out of Jurisdiction B? I think they're focused a little bit on the documentation requirements on the post-four month range, and I know you've got the compliance software on that front, but it's also going back and documenting they saw a doctor. Have you heard any — is that a concern at all, I guess, in terms of the —

Kieran T. Gallahue

Well, certainly not material, but let me throw it over to Dave Pendarvis.

David Pendarvis

Yeah, Peter. We're aware of it. We rely on these areas mostly on our HME partners. Obviously they're the ones who have to supply the appropriate documentation. This is a Medicare issue. It's not the overall issue, but it's our expectation that our customers have been following the proper paperwork, they've been getting the right forms now. In any situation when you're kind of putting in a new requirement there are always some slips and downs, but it's our expectation that by and large this won't have an impact on the operations. There might be some minor distraction to a particular customer who gets under an audit, but it's our expectation that the HMEs are compliant with all the requirements and there shouldn't be any long-term issues.

Peter Bye - Jefferies & Co.

Thanks. Maybe just one last one, any comments on Qnexa's data on sleep apnea? It's coming up for obesity approval, obviously it could have some off-label usage. And just on what their dataset compares to the gold standard here on CPAP and is it maybe an opportunity to copromote if these guys are maybe just going after mild candidates to just identify more sleep apnea patients?

David Pendarvis

Yeah. We obviously track developments on it in the pharmaceutical industry just as we track developments on the surgical area and device areas looking at potentially if there's any substitutes for something that can impact our markets in a positive or a negative way.


As you know, there tends to be a lot more sizzle and noise then there tends to be depth when these early data come out, and so as we look at this now the idea that there's going to be a single drug that's going to cure obesity, I guess you can make your own bed on that. I'm not sure that that's a bed that I'd be comfortable making in the short term, but that's the basic focus that these guys are driving towards.

We don't see, at this point, a risk and at this point we don't see a material opportunity for partnership. That being said, things do evolve and if we feel that it is appropriate, just as we've demonstrated with our alliances with LifeScan and alliances with Guidance when we were first entering the heart failure space, alliances with appropriate — Philips even when we're talking about public relations or we're talking about education. We're very comfortable with reaching out and finding mutual WIFMs, what's in it for me, in these cases. And if we see it we'll do it. But at this point I think we're comfortable in sort of a watching brief.

Peter Bye - Jefferies & Co.

All right. Thanks a lot, guys.

Operator

And your next question comes from the line of Natalie Kelly with COMMSEC.

Natalie Kelly - COMMSEC

Thanks a lot. I was just wondering if you could give some color on any (inaudible) improvements that you're getting from your two recently released masks and also that you expect to get from the new S9 series?

Kieran T. Gallahue

Yeah, great question. So as you know, when we enter an area that we're already in, I think a good example would be the Swift FX or the S9 which are basically replacements for existing products, and it's true with other products as well, but I think it's always easier to sort of calculate that delta on the things that exist. Our belief and our direction to the R&D team, and it's a very, very capable team, is to design products that can improve the feature sets, so it can improve the efficacy or improve the aesthetics or have some meaningful benefit to patients and to customers, but to do it at a lower cost basis. And that's particular enabled when you go through generational leaps.

When you go through the normal learning curve you certainly have some substantial benefits that you can provide, but when you do generational leaps, and I think a good example will be the S9, it gives you the ability to take advantage of developments that have occurred within the electronics industry as an example, or within the computing industry, or in the communications industry. And we can apply some of those improvements to new platforms. So absolutely, we will look at examples within the mask category, we will loo at examples within the flow generators, and I mention just two right off the top of my head. Both of those would represent opportunities for not only enhancement of performance, but also offer cost of goods reduction.

Natalie Kelly - COMMSEC

Great. And just one more question, just wondering what feedback you're getting from the DMA's intensive compliance levels? Are we starting to see compliance levels in the US sort of increase to European levels as the markets shift across to the APAPs and the BiPAPs, those higher end products just really sort of concerning those trends?

Kieran T. Gallahue

Well it's always hard to give you accurate or specific figures on compliance and the reason is any HME you talk to is between 85%-95% compliant. They're always the best at it and it's the guy down the street that has the problem. But I will say that we feel comfortable that because of the change in the technology that is being used and because of the informatic capabilities of those devices — Mick mentioned before that customers and patients who have access to data and they engage in the use of that data, that it demonstrates a focus that improves compliance. And the nature of what we are delivering today and the increase in the number of auto set devices as an example, the use of ResTraxx as an example, and maybe even forgetting all those and just say the focus of the HME; understanding and knowing the importance of compliance and reinforcing of that, all of that leads to greater touch points with patients which will inevitably lead to higher compliance. So I think we can feel comfortable saying directionally it is moving in the right direction. I think it will be a little bit harder to get more specific on the numbers in the short term.

Natalie Kelly - COMMSEC

Thanks for that.

Operator

We are now at the one-hour mark so I will turn the call back over to Kieran Gallahue for his final remarks.

Kieran T. Gallahue

Well great, thank you, everybody, for your time and attention. As always, we would like to thank our employees all over the globe in the various functions for their stellar efforts that drive ResMed's performance. I think you can see that in not only the results of this quarter, but you can see it in the product flow that we have begun launching throughout this year and the pipeline that we have to follow. So it's a very exciting time for ResMed. We're very pleased with the efforts and the results of the team throughout the globe and we look forward to updating you as we move into the next quarter. Thanks, everybody.

Operator


Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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