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Executives

Kieran T. Gallahue - President and CEO

Brett Sandercock - CFO

Analysts

Andrew Goodsall - UBS Securities

Jason Mills - Canaccord Adams

David Clair - Piper Jaffray

Joshua Zable - Natixis Bleichroeder

Benjamin Andrew - William Blair & Company

Paul Choi - Merrill Lynch

Michael Matson - Wachovia Capital Partners

Joanne Wuensch - BMO Capital Markets

ResMed Incorporated (RMD) Q4 FY08 Earnings Call August 5, 2008 4:30 PM ET

Operator

Good day, ladies and gentlemen and welcome to the Fourth Quarter 2008 ResMed Incorporated Earnings Conference Call. My name is Marsha, and I will be your coordinator for today's call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session toward the end of this conference. [Operator Instructions]. As a reminder, this conference is being recorded for replay purposes.

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 market for the company 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 access through the company's website at www.resmed.com.

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

Kieran T. Gallahue - President and Chief Executive Officer

Thanks, Marsha. Well welcome everybody to ResMed's Q4 2008 results call. I am very pleased, very optimistic about our performance and about the recent industry developments. And I look forward to reviewing those with you today.

So we set new records for performance and results during the quarter and I will open the call up by making some introductory comments, then I'm going to turn the call over Brett Sandercock, our Chief Financial Officer to go through the financials in a bit more detail. And then it will come back to me for... me and the team actually for your questions.

Well we finished 2008 on a high note. Global revenue was 23% in the fourth quarter coming in at a record $235 million. As we continue our focus strategy of launching new and innovative technologies into the global marketplace.

In particular I was very pleased to note that the growth was stimulated by regions across the globe. Every region for ResMed played a critical role and contributed to our success. It's also important to mention that the company generated a record $56.8 million in operating cash flow during the current year... quarter. And that was driven by solid working capital management and operating performance. And we put those funds to good used by repurchasing almost $52 million of company's stock during the fourth quarter.

The outside U.S. business continues to fire on all cylinders posting a 32% growth in revenue. France and Germany were the main drivers in Europe and we expect to see continued success on the leadership of Lasse Beijer and his team in fiscal year '09.

We're also very pleased to see the American's region return to mid-teens growth with a 14% increase in revenue year-over-year. We launched the number of new products in Americas in Q4 and a feedback on those products has been absolutely phenomenal.

The flow generator segments grew 17% worldwide and we're pleased to see how the U.S. flow generators segment return to growth in the high single-digits due to the introduction of the S8 II platform with our innovative Easy-Breathe technology.

In particularly the high-end or auto in the lead products performed exceptionally well with AutoSet leading the way as the fastest growing flow generator in category from a percentage terms.

NASS segment, posted another banner quarter with 29% global growth, due to new product introductions led by the new smaller low noise nasal pillows products with Swift LT. This product has been received exceptionally well in the marketplace.

We believe the new products have much more to run and we're confidence that continued innovation in NASS Technologies will bring additional growth as we launched several new products in fiscal year '09.

For the year ended June 30, the company grew revenues 17% to $835.4 million while generating a record $143 million in operating income and $110.3 million in net income.

We ended the year with an exceptionally strong balance sheet. We had $321 million in cash and we demonstrated our confidence in this industry and in our company by repurchasing $2.6 million shares this fiscal year, representing a total investment at share repurchase of nearly $100 million.

As we entered at fiscal '09 I think it's useful to step back and reflect a bit on the industries prospects for growth. In summary, this industry has never been poised more for expansion of a growth. We need only to look the developments within the past few months to demonstrate that this under penetrated market remains robust and remains one of the most attractive segments in the medical device industry.

For example, home testing; it's been early encouraging signals related to home sleep testing. Approvals from private insurers like Anthem the largest insurer the U.S. will help open up the diagnosis of sleep disorder breathing to many more patients. I personally believe that as we look back on home sleep testing, we'll look at this as a single biggest inflexion point in this industry's future.

Competitive bidding was delayed for 12 to 18 months providing some certainty to the HME's so they can plan their expansion strategies. We formed to join marketing agreement with Johnson & Johnson LifeScan Division, the largest provider of glucose meters in the Americas to promote awareness and education of sleep disorder breathing in the diabetic population.

New clinical literature and medical guidelines including the International Diabetes Federation statement on sleep apnea and type 2 diabetes were released. And a review article in the ACC, AHA on sleep disorder breathing and cardiovascular disease which was published in circulation and jacked just a few weeks ago.

In fact just last week, MSMBC picked up an update from Dr. Terry Young's latest data, which showed a six-fold increase in the risk of death for severe sleep disorder breathing patients. We are clearly serving a population of patient that need our help and that are costing the healthcare systems around the globe billions of dollars. And we are doing it with a therapy that is incredibly safe. Safer than an Aspirin and yet is in incredibly efficacious.

In summary, we just completed a record breaking quarter for ResMed. We experienced growth throughout the globe. We rebounded in the Americas, we have a series of new products that are either in the launch process or soon to be there. We generated a record breaking $56.8 million in cash during the quarter and we are confident about our ability to grow the market in the short and the long-term and about out opportunity to grow shareholder value throughout fiscal year '09.

Now over to Brett and then back to your questions. Brett?

Brett Sandercock - Chief Financial Officer

Thanks, Kieran. I'll briefly run through the June quarter results.

Our revenues for June quarter was a record $235.2 million, a 23% increase over the prior year quarter. Favorable currency movements added approximately $14.1 million to our Q4 revenues. Our income from operations of $37 million for the quarter and net income for the quarter was $29.6 million.

During the quarter we recognized an additional charge of $3.1 million for asset recall, staying at throughout of our original accrual and reflecting more thoroughly on actual cost incurred as we approach the conclusion of the recall.

We do not anticipate any meaningful incremental expenses associated with recall in fiscal year 2009. Excluding recall expenses and amortization requiring tangibles our income from operations was $42.2 million and net income for the quarter was $33.2 million. While diluted earnings per share for the quarter was $0.42, an increase of 14% over to prior year comparable quarter.

Our gross margin for the quarter was 58.3%, down sequentially from Q3 reflecting product mix changes, foreign currency movements and ISP declines. The product mix impact was attributable to the strong recovery in flow generated sales in the U.S. this quarter. While the strength of Australian dollar, relative to the U.S. dollar continued to negatively impact our gross margins.

However, I would note that recently the Australian dollar has declined from its high than any sustained decline in the Ausi dollar will be positive for the gross margins.

Additionally and importantly, we expect initiatives currently in progress in areas such as supply chain, manufacturing and product development to have a positive impact on margins as we look forward.

SG&A for the quarter was $77.4 million, an increase of 19% over the prior year quarter. In constant currency terms, SG&A increased by more modest 10% over the prior year quarter. SG&A substantial revenue improved to 33%, compared for a year ago figure of 34%.

R&D expense for the quarter was $17.6 million, an increase of 24% over the prior year quarter and again in constant currency terms R&D increased by 9% over the prior year quarter. R&D as percentage of revenue was 7% consistent with the year ago figure.

With our ongoing commitment to innovation, solid product pipeline and clinical trial activity, we expect R&D expense as a percentage of revenue to continuing in the 7% range for the fiscal year 2009.

Amortization of the acquired intangibles was $2.1 million for the quarter and stock-based compensation expense for the quarter was $5.3 million.

Turning to revenues in more detail. Overall Americas sales were $112.2 million, an increase of 14% over the prior quarter. So, outside Americas probably $123 million, an increase of 32% over the prior year quarter.

Breaking out revenues between product segments. In the Americas, flow generators increased by 8% over the prior year quarter, well Masks and other increased by 18%. The growth reflects the continuation of strong sales in our new product introductions, including encoring traction from recently introduce, S8 II flow generator.

For revenues outside the U.S., flow generators increased by 24% while Masks and other increased by 49%. Again driven by strong new product sales across key international geographic markets. On a group basis flow generator sales increased by 17% while Masks and other increased by 29%.

Cash flow from operations as Kieran had mentioned was a record $56.8 million for the quarter, reflecting strong underlying earnings and improved working capital management.

Capital expenditure for the quarter was $18.2 million and these included $7.8 million in building construction cost, predominantly associated with the constructions of our new headquarters in San Diego.

Depreciation and amortization for the quarter totaled $16.5 million. We continued to buyback shares as part of our capital management program. During the quarter, we repurchased $1.4 million shares for consideration of $61.7 million as part of our ongoing buyback program.

For fiscal year 2008, we have repurchased $2.6 million shares or approximately 3% of shares outstanding. As of today, we have repurchased approximately 5.5 million shares out of the total approved buyback of 8 million shares.

We ended the fiscal year financial in very good shape. Our balance sheet remains strong, with total asset of $1.4 billion and net equity $1.1 billion. Cash and cash equivalents net of external debt were $183 million at the end of June.

I'll now hand the call back to Kieran.

Kieran T. Gallahue - President and Chief Executive Officer

Thanks Brett. Well with that why don't we open up the line for some questions?

Question And Answer

Operator

[Operator Instructions]. Your first question comes from the line of Andrew Goodsall [UBS Securities]. Please proceed.

Andrew Goodsall - UBS Securities

Good morning guys. Thanks very much and very good results. Perhaps if I can just ask a couple of housekeeping questions, just I guess on FX, total FX impacting perhaps just give a sense of what plan through from you're the stronger account you got there but also in terms of cost as well?

Kieran T. Gallahue - President and Chief Executive Officer

Sure. Yes thanks for the question Andrew. And Brett you want to take the FX, please?

Brett Sandercock - Chief Financial Officer

Yes, Andrew if you looking at that on total net basis including some of the foreign currency hedging gains we've made this quarter which around $1.2 million, you probably... if you look through on EPS its $0.01 to $0.02 actually positive impact year-on-year from currencies.

Andrew Goodsall - UBS Securities

And perhaps could you sell through... I just presumably the euro was obviously contributing quite strongly top-line?

Brett Sandercock - Chief Financial Officer

Correct. So the euro... they're troubling on their revenues obviously there was $14 million or touch over and the euro has contributed obviously offset largely by the increase or appreciation the Australian dollar relative to the U.S. dollar.

Andrew Goodsall - UBS Securities

Okay. And you're saying that net is about 1.2?

Brett Sandercock - Chief Financial Officer

Yes, $0.01 to $0.02, including the hedging gains for this quarter.

Andrew Goodsall - UBS Securities

Okay good. And perhaps just drilling down to the performance just perhaps if you could... maybe just expand here a little bit more on, what's the contribution in new products has been and perhaps maybe Kieran if you could just give on what driving and have a result or the having surcharge this quarter?

Kieran T. Gallahue - President and Chief Executive Officer

Yes, absolutely. It was a great product or I should a great quarter for wins across the board from new products to new customers vendors or penetration within current accounts. So, during the third quarter we had launched the VPAP Auto and the Mirage Micro. So we have full quarter in the fourth quarter.

And then during this past quarter we launched the S8 II Auto and the S8 II Elite, part of the way through the quarter in the U.S and then very late in the quarter we launched the S8 II Escape. And then of course in the math side the Swift LT. The products have been received exceptional well.

I guess, tell you this Easy-Breathe Technology that is the under pinning of the new VPAP products as well as the S8 II series. And importantly, just remind ourselves, this Easy-Breathe Technology is a motor technology where it's a double ended blower. It's incredibly efficient, it allows for massive sound reduction. I mean some of the new buy levels we're going to launching are 90% quieter than the competitive alternative. And yet they are more responsive than any other motor on the marketplace.

So what you have is, benefit from noise allowing you to reduce the size of the instruments. But also improved performance, all of which yield benefits on the compliance side and that that's where we're trying to drive compliance, because flow generators lead to complaint patients, which means they use more Masks which there would be the highest profitability segment we have overtime.

So it's a very sort of good trend that we see from that perspective. So as far as this quarter, the S8 II Elite and Auto contributed well. We saw particularly in the AutoSet side of the business in the Americas that whether it's a consequence of home sleep testing or other develops in the market, we just saw a very, very significant up-tick on those types of products. We really haven't seen the impact yet of the Escape too, that would probably come in this year or I should say this quarter.

Andrew Goodsall - UBS Securities

Okay.

Kieran T. Gallahue - President and Chief Executive Officer

Because it was launched late in the quarter. And the Swift LT came out like a shot. I mean it is a really differentiated product, smaller, it's quieter. We've got part of a quarter impact on that, probably about two thirds of the quarter. So... and we're looking forward to that rolling out through the rest of the part of year.

So from a product perspective, what we've launched has been received very well in the marketplace. And by the way we've got a couple of new products that are launching as I speak in the bilevel category. And we've got some new Mask in the pipeline throughout this year. So very good from a product perspective.

From a customer perspective, we've continued on wins. We made progress at the large accounts, obviously, I am not going drill too much in the detail on any given customer in respect for their privacy. But we have done well with some of these new competitive wins and I... we quite frankly haven't gotten all that I expect to get from it. So we're still in the early cycle, I'd say on some of these competitive wins and gaining share and I expect continue to do so throughout the year.

Andrew Goodsall - UBS Securities

Okay. Perhaps we out missing the line, any particular customers move that material... was it material to this result?

Brett Sandercock - Chief Financial Officer

One of us is being breaking. So I couldn't really understand you. Could you say that Andrew?

Andrew Goodsall - UBS Securities

I am sorry. Sorry, was it Aprea material to this result?

Kieran T. Gallahue - President and Chief Executive Officer

So Aprea has always been a large account for us. And obviously, it's going to get, we believe it's gone get larger and it has been getting larger, given that we're now playing on a level playing field. I am not going to speak directly to the numbers other than to say there was increase that was due to them. But it was certainly not the majority of the increase that we experienced. We had experienced and wins across the board at multiple accounts and in the accounts that we're in because of the products that we released.

Andrew Goodsall - UBS Securities

Okay. So that's probably fair to say that it will soon ramp up?

Kieran T. Gallahue - President and Chief Executive Officer

Absolutely.

Andrew Goodsall - UBS Securities

Yes, I'll get back in the queue. Thank you.

Kieran T. Gallahue - President and Chief Executive Officer

Great, thanks.

Operator

And our next question comes from the line of Jason Mills. Please proceed.

Jason Mills - Canaccord Adams

Thanks, Kieran. Congrats on a good quarter.

Kieran T. Gallahue - President and Chief Executive Officer

Thanks.

Jason Mills - Canaccord Adams

So, U.S. business bounced back perhaps a little bit better and sooner than we expected and perhaps you could comment to Andrew's question following on as to really how much impact we saw in the quarter from sort of unit growth in the U.S. relative to what pricing did?

And then I was curious, with respect to the gross margins, clearly we all sit in the room here when I talked investors as where gross margins are going to do, so I would like to understand better how currency impacted gross margins specifically? And what otherwise is a great quarter across the board. We saw gross margins come down a little bit and I feel like some of the really great things in the quarter could get lost unless we understand sort of where that could drop going forward and if in fact Kieran, we could start to see that with a little bit more of a stable currency tick back up sequentially here in the first quarter of fiscal 2009?

Kieran T. Gallahue - President and Chief Executive Officer

Yes, great, great question Jason. Look, we had the results that you saw that come of out of the Americas, we were very pleased with we are very proud of that it came back very strongly. And the answer is across it was across the board. That was driven by new products, it was driven by execution, it was driven by new customer win.

So, there were a number of factors that came into play, all of which were very important. But let me just see at the specifically the gross margin question. So yes, we did see a tick down to 58.3% and I think there is a number of things that you want to keep in mind with that. For those of you who've been following ResMed for number of years which you've seen is that we normally take a tick down in Q4, it's sort of a historical trend that we've normally experienced during the fourth quarter.

And as you know, Americas came back strong, very strong. We jumped from up to 14% growth from where were at which is 5% in the prior quarter and our flow generators went to from negative 5% all the way up to plus 8% on the back of some fantastic product releases.

And in addition to the currency, and the currency did absolutely play a role in it. We've long known the geographic mix in the U.S. and product mix the flow generators had some impact on the gross margin percent. I mean it's very good for cash flow, it's very good for gross margin dollars and it puts a little bit of pressure on the percentage, the gross margin percentage.

But if I drill down that a little bit more, lets talk about what we're doing about margin expansion as we're moving forward. What are we doing from the fundamentals, not only for this continued growth that we've seen, but also to look at the margin line. And there is a couple of different things that we're engaged in right now that I think are going to start paying dividends. So let's go through them.

One is the pricing, alright. So we feel the product pricing has stabilized. We made some adjustments over the past couple of quarters to get us back in line with market pricing and we now feel that we're price correctly for the market. Approx we have a seller year of product launch ahead of us. And importantly a number the products that we have that are on the launch cycle yield strong margins and that's not an accident. Several years ago, we substantially increased our R&D focus on products such as Masks and such as Bilevel and we're just now in the middle for instances of those Bilevel launches that I mentioned before the VPAP SC and VPAP Auto 25.

Both of them use this Easy-Breathe technology, up there are 90% quieter and the competitive alternative, there are in the smaller box and they've got ResMed quality. We've got the Swift LT rollout which we only saw a partial quarter, last quarter, we're going to see a full quarter of this quarter and as we move forward. And I got to tell we've got a year that we're going to be rolling out additional Masks throughout the year. So between the Bilevel in the Mask, we've got a good product flow ahead of us. Alright?

Supply chain, alright? So this is our third area that we're focused on. We are actively engaged in this for margin expansion in the supply chain leveraging the volume growth that we've seen over the last couple of years. As we grow volume we grow opportunity. And what we've done is we've gone outside the company, we've looked to... in fact we've gone outside the industry, we looked to the automotive industry and said, hey, how can we do things better? We've hired in some of that talent, we're actively engaged in it now and I fully expect that to be showing dividends.

And finally manufacturers, now in addition to our very strong comfortable presence in Australia we're gone be adding capacity in a lower cost region. Where we can still maintain our high expectations for quality, we will not drop on quality sides. But we do see opportunities for augmenting our current manufacturing strategy with lower cost locations. Alright? And we expect to be doing that in the coming six months or so.

So in summary, totally agree with you I think ForEx absolutely have some impact on it. We have natural sort of cycle in Q4 as well and we had very result in the Americas and as I look forward be it from the supply chain, be it from product introduction that we're in the mid to rolling out, be it a stabilization in market pricing to the manufacturing I see very good opportunities on the margin side as we look forward.

Jason Mills - Canaccord Adams

Thanks Kieran, that was very, very robust and very helpful it sound like you --

Kieran T. Gallahue - President and Chief Executive Officer

Jason you're going to get me in trouble being provoked.

Jason Mills - Canaccord Adams

Well, it was quite good. Lets put it that way. And if you were obviously well prepared for that question expecting perhaps to receive a question about gross margins. So you maybe perhaps... hopefully you would answer this question which would be, could you give us some comfort that you... ResMed may show us sequentially up gross margins assuming we are at sort of the currency levels that we saw exceeding the quarter.

Can you at least go that far as to say that this could be as we look two quarters back... two quarter ahead looking back the top in gross margins given all that you said about the improvement you expect to make in those four or five areas?

Kieran T. Gallahue - President and Chief Executive Officer

Jasonlook I would never get into that shorter term of discussion when it comes to the complexities of geographic mix and product mix and everything else. So we have always stayed away from very short term discussions on gross margins, I am not... continue to stay away from that, but I will reiterate that we feel very comfortable with the action plan ahead of us and we do feel very comfortable with everything from product introductions schedules to lay down through the market situation on pricing.

Unidentified Analyst

Okay so, but generally over this, over a longer period of time, you would be, you would expect to see gross margins at a higher levels sort over a longer period of time than where you exited 2008 fiscal year.

Kieran T. Gallahue - President and Chief Executive Officer

Absolutely, we are really [ph] targeted on that.

Unidentified Analyst

Okay and last question, I'll get back in queue, as it relates to the Americas region, your flow generator sales certainly improved dramatically, but is lower than where I think market growth is did generally. Would you expect a launch... full launch of the escape here this quarter to have an impact on taking your flow generator sales sort of back in to that low to mid teens level like you showed for the total Americas business this quarter.

Kieran T. Gallahue - President and Chief Executive Officer

Yes, we're feeling very good, where we are in our product cycle, where the S8 2 has a very good contributor. Let's not forget outside the U.S. and the growth that we've seen over the last several quarters, not only from execution, but also because we launched product like the S8 II earlier outside the U.S. and we have seen same growth from that. I fully expect that that the Escape II will be receive well in the marketplace. It already has been received well in it's early days. I fully expect that the bilevels that we launching over the course of this quarter will be received well in the marketplace. So I think that we're in a good place in our product launch side.

Unidentified Analyst

Thank you very much, Kieran great quarter.

Kieran T. Gallahue - President and Chief Executive Officer

Thanks.

Operator

Your next question comes from the line... one moment. Your next question comes from the line of David Clair. Please proceed.

David Clair - Piper Jaffray

Hey, guys. Can you hear me?

Kieran T. Gallahue - President and Chief Executive Officer

We can, David.

David Clair - Piper Jaffray

Okay, well first of all congratulations on a great quarter. Well, it's very impressive results. I just was wondering if you could may be discuss the pipeline that you had, it sounds like fiscal '09, it's going to be pretty good year from a product launch perspective, I mean. What should we be looking for and is it more kind of a back half '09 waiting or is it a kind study throughout the year.

Kieran T. Gallahue - President and Chief Executive Officer

We've got various products that are launching throughout the year. I'll talk specifically with the products we're midst of launching now. And for competitive reasons, I'll stay away specifics on some of the other products and very specific timing. But, we are, you think about this quarter, it looks to be the first quarter that we will have full Swift LT, full S7 Elite, full S8 Auto, full S8 II in the Americas. And we've got the bilevel side, we have the VPAP FT and the VPAP Auto 25, both are literally in the midst of launching as we speak now. So I think that product lineup is a very exciting product lineup from the flow generator side, as well as with the Swift LT.

From the mass perspective, you can expect several mass that will come out at various times throughout the year. So it's not all loaded to one part of the year or the other. So I think it's a good mix bag right across the product line.

David Clair - Piper Jaffray

Okay, great. And, if we could just talk, you actually kind of hit this a little bit earlier but you said that you think that pricing has stabilized at this point, I mean what's kind of your estimate of price pressure in the quarter in North America, I mean is it still a low single-digits that we are looking at or if you could just talk about it real quick, that will be great.

Brett Sandercock - Chief Financial Officer

I think when you look at a lot of the genesis of some of the price movements, it really is about a year ago or so that may be, actually little bit more than that, probably 15 months ago or so that this started and of course, our believe as market leaders is that we should be slow to respond on the pricing side. We would like to maintain a premium pricing strategy, we think it's healthy for the industry over the long haul. And we think we deserve it, because were believe we have the best technologies and there the most efficacious for patients and the best of customers, form a quality perspective. What we have seen is last couple of quarters that we need to adjust some pricing to get back in line with market pricing, we made those adjustments.. We have not seen significant movement at all from a competition since field just come in from the marketplace and acquired. And we are very hopeful that discipline will maintain going forward, and I think we have a couple of large competitors that are quite reasonable that compete on quality, that compete on innovation, that compete on market growth. And that's certainly where we're focused and we feel that right now we've made the adjustments for the necessary.

David Clair - Piper Jaffray

Okay, well thanks a lot. Thanks again and great quarter.

Kieran T. Gallahue - President and Chief Executive Officer

Great. Thank you.

Operator

And your next question comes from the line of Joshua Zable. You may proceed.

Joshua Zable - Natixis Bleichroeder

Hey, guys congratulations on the great quarter here.

Kieran T. Gallahue - President and Chief Executive Officer

Hi, Joshua.

Joshua Zable - Natixis Bleichroeder

Thanks for taking my questions. I'll be quick I'm sure there is a long line but Kieran just talking about U.S. market growth I know you talked about pricing being stable. Can you just sort of obviously there is some push back about people talk about the law of numbers in this market and I know you talked about the positive dynamics out there whether be no, co-mobility or what not. Obviously there is been some confusion in the marketplace over the past year. Can you just give us some sort of sense of volumes if you can believe sort of volumes out there are healthy? Right now we're going forward kind what you're seeing?

Kieran T. Gallahue - President and Chief Executive Officer

Yes, we seen a lot of good signals I think for market expansion over the last three months, six months I think that something comes up, either in clinical side from the awareness side et cetera that should be very positive in the long-term growth in the market. We've long said this market should be round at 10% to 15% ex-U.S. in the U.S. 15% to 20% to sort of blending around that 15%. And our feeling has been that is a sustainable figure, different drivers over different times. But it's a sustainable figure and our objective is always been to grow at and above market rate. The... if you look at where the markets growing now in the Americas previous question, I think we're about that market growth, I think the revenue growth rate is probably around that 13%, 14% or so volume growth is probably a few points above that probably around lets call 16% or so, so it remains a good robust marketplace.

When you look at some of the drivers that have come out recently, they both well for the future and they both well for recognition that this market remains hugely, hugely under-penetrated. So let's just get a few examples, International Diabetes Federation statement. I don't think there is enough time and attention that is paid or understood about this because this is where you had leaders in the diabetes community coming together with terminologists or erotologists coming together with cardiologists.

Looking at the clinical literature and saying there is absolutely a huge overlap between these orders, I mean some of the figures are up to 70% of diabetics have the disorder and it appears that we're not appears, the data shows that the primary issue the diabetic suffer from that they die from cardiovascular complications or exactly where the treatments sleep disorder breathing can support, can help, that means lowering of blood pressure, the treatment being used in heart failures, this is we're doing in our clinical study within Europe with survey chest, these things all tied together and say that is good medical practice and this is what the recommendation was it is good medical practice for type to diabetics to be squeal for sleep disorder breathe, that's never happened before this opens up a massive market opportunities in front of us, to bring people into the pipeline.

There were just with view article and that was a co published in circulation inject, looking at the vast amount of clinical literature on cardiovascular disease and sleep disorder breathing now these things move to held stand accord. A very young stated that was again picked by MSMBC showing a sixth fold increase in risk, immortality if you got severe sleep disorder breathing, this is a massive issue that is costing healthcare systems around the globe billion of dollars and it remains under penetrated.

Even it the home sleep testing like with all these different pieces that move with home sleep testing during the quarter. There is no way to look at home sleep testing other than say positive, positive, positive because anyway you look at it, it opens up the doors to more people being diagnose to simplifying the diagnostic process. Right, it is a positive step forward for this industry and will continue to be as we move forward.

So we remain very, very optimistic about it. I think all these things when if that having multiple shots on goal right, not all of them have to hit all at once, each one can hit overtime and that's what feeds into this continued regular growth that we seen in the industry, this would happen in the past and it goes very well for what we believe is going to happen in the future.

Joshua Zable - Natixis Bleichroeder

Okay. And then, I mean you touched upon that was sort of my follow up, just at home diagnostics, I mean a lot of people have sort of looked at these LCD's as a negative. I totally agree with you that having home testing is obviously better than not having it, anywhere you cut it, but you made a point to say that you seem to see them... see it in the market already as having some sort of impact, given that may be it's, Medicare is obviously a small part of it, so that's why the LCD's don't really matter or may be can you just kind of talk a little bit, I know it's early and I know LCDs kind of just came out, but sort of a what you are seeing on a home testing, I know you have alluded that fact that's helping, but can you just add a little bit more color there on the specifics?

Kieran T. Gallahue - President and Chief Executive Officer

Yes, sure. I mean we negative a good point, Joshua which is which is always important for us to remind ourselves that in Americas, the Medicare population is only 20% of the population being addressed. That being said, I was very encouraged to see that and some right sort of country's largest insurers [ph] jumped on Board with home sleep testing. Of course, there is a lot of movement in the early days with the LCDs. Even if these things are coming out, some of them still point back to the old national coverage decision, right? I mean, for this... where we get these government bureaucracies, there is always a little bit of confusion in the early days. There is a little bit of too and fro.

But anyway you look at it, what is it's doing, it's validating that home sleep testing is a valid way in addition to PSG and in addition, and in combination with the sleep test because we still remain firmly partnered with the sleep community and we see some very innovative sleep physicians who are at beginning of the early days of home sleep testing, where they are reaching out to some other physicians in their community, some of them are CMS related, many of them quite frankly are more private payroll oriented and saying, hey, can we increase the diagnostic capacity.

So, look, I think early days on these changes are always a little bit balancing. The think is to take the step back, look at it and say is the ball moving down the court or not and the answer is firmly, yes. The ball is moving firmly down the court and we believe it's going to continue to move that way.

Joshua Zable - Natixis Bleichroeder

Great, well interesting. Congrats and thanks again guys.

Kieran T. Gallahue - President and Chief Executive Officer

Great, thanks Joshua.

Operator

Your next question comes from the line of Ben Andrew from William Blair. You may proceed.

Benjamin Andrew - William Blair & Company

Hi, good afternoon. Just wanted to follow-up, I am sorry Kieran.

Kieran T. Gallahue - President and Chief Executive Officer

I said hey Ben.

Benjamin Andrew - William Blair & Company

Hey, I was trying to follow-up with a couple of things about sort kind of tying into things. The DME activity, are you seeing any shift in behavior, versus in the last six months as a result of some resolution on the local coverage decisions or the home testing, etcetera that are moving the needle here, because I think you're talked about volume growth picking up a bit.

Brett Sandercock - Chief Financial Officer

Yes, right. In some ways it's a little hard to segment out, because at the same time all these changes we are occurring, we're launching the S8 II platform with Easy-Breath. And so we have seen a very significant up-tick, particularly again in the auto setting part of that business. Part of that is clearly attributable to people preparing themselves for home sleep testing that's part of feedback that we get. And part of that is clearly attributable to the fact that were, we are gaining share in that category. So I think --

Benjamin Andrew - William Blair & Company

Can you tell what's what or you just can't?

Brett Sandercock - Chief Financial Officer

I think it will be really hard for us to guesstimate at that.

Benjamin Andrew - William Blair & Company

Okay, but clearly there's been a significant shift in your volumes?

Brett Sandercock - Chief Financial Officer

There's clearly been a... we are growing clearly growing more quickly at that high end and that leads to mix shift, yes.

Benjamin Andrew - William Blair & Company

Okay, are you seeing growth in the low end of the product line, is that stabilizing where units are back up and even lower mid-single digits now?

Kieran T. Gallahue - President and Chief Executive Officer

We're seeing more stabilization in that category. And I will also say in that category we haven't yet seen the impact of Q4. We didn't see impact of the Escape II, it was launched towards the end of the quarter, at the end of fiscal year. So the reality is that sales force is now custom [ph] a lot attention on it. I expect that we will see that moving forward.

Benjamin Andrew - William Blair & Company

Okay. So, but volume growth overall for the business unit growth, rather is turned distinctly positive,

Kieran T. Gallahue - President and Chief Executive Officer

Absolutely.

Benjamin Andrew - William Blair & Company

At versus where it was.

Kieran T. Gallahue - President and Chief Executive Officer

Yes.

Benjamin Andrew - William Blair & Company

Okay, and then the underlying kind of concept of the competitive bidding dynamic and now they are going to delay the implementation and implement whatever, it is a 9% or so cut. And they list the demonstration areas and that goes national. Have you seen the impact of that already in the business, or is it that something that we are going to stare down later in the year?

Brett Sandercock - Chief Financial Officer

Well, a couple of points to make on that. First I think the, what we heard from the industry was a collect sigh of relief, when that comprise was met. And the reason is it takes a lot of uncertainty at as of HME were feeling. They weren't sure exactly what they prep for. In other words many of the HMEs that won the bid didn't have a presence and the communities where they had won the bid there was a confusion around how they are going to care for those patients, is patient care going to be maintained in all that. So I think that in the first step was there was a really a collective sigh of relief that alright this is good compromise. I think the second part of it is I think you remember the CMS was the high priced player in the marketplace. Right so, most of private insurers will also already priced well below where we had seen the CMS side of the business.

So and the final pieces is just to remind ourselves that 9.5% cut as I understand not implemented to January 1. So its gives people the time to sort of work through the strategies for growth in one hour.

What... I will say one side, if we look back was about three years ago when there was significant option in that net cuts in the industry, and I remember distinctly of the time of having a conversations around what that going to mean is this a real negative industry. And the reality is the proceeded a significant growth in the sleep industry because HME are businesses and the HME need to look for avenues of growth and what they saw at that time, there is an area we can grow and its sleep and in fact where they tend to really grows in the compliant user side, we're getting more efficient to that the supply of mass, the patient because realized that they had under-penetrated that market but they under serve that marketplace and so the consequence is very different, that was anticipated. It was instruct able to look back on history to see how some of these things are played out.

Benjamin Andrew - William Blair & Company

Certainlyclarity goes a long way, the other side of this I guess is the gross margin because other than that issue in the quarter this is a strong result, if you think about your opportunities that you laid you out previously, are we talking hundreds of basis points, are we talking stabilization in 12 months?

Kieran T. Gallahue - President and Chief Executive Officer

So we've got different line items that are going to contribute different levels in that I think that and there are going to come at various times, that's good part of this right, again its not a single shot on goal we got multiple ways of addressing the opportunity for margin expansion, I think it's going to be a continuing, it's not going to be overnight one step, it's going to be improvement that we're going to see over the months and over series of time right.

So some of those things are going to happen quickly like the Bilevel products right and they're launching and right the middle of launching those now and the Swift LT out for the full quarter, we'll be right in a mid there, that's for the shorter-term. All those products that we have in the pipeline will be hitting during the year, the manufacturing in Asia that will be coming more in towards the back of the year where we see the improvements. Supply chain, we've already begun that process in a number of months ago, so we're already starting to see some of the dividends that'll be playing. It's going to play itself out I think all the time.

Benjamin Andrew - William Blair & Company

But again if we look at 12 months, you've got... you probably don't want to give specifics about the impact of going into a lower cost environment but are those going to be offset overall by continued price declines are we looking at absolute improvements in gross margins from the 58% or from the 68% level, or 60% level?

Kieran T. Gallahue - President and Chief Executive Officer

I think when we look at all that 12 month horizon we should be able to see improvements.

Benjamin Andrew - William Blair & Company

Versus the 58 or the 60?

Kieran T. Gallahue - President and Chief Executive Officer

Certainly versus the 58% and 60% possibly.

Benjamin Andrew - William Blair & Company

Okay. I mean, we all crystal balls, but you get a little bit more information. So that's very helpful. Thank you.

Kieran T. Gallahue - President and Chief Executive Officer

Yes. No, no, I guess my summary on that is we feel very confident with the actions that we're taking, the product pipeline and with the very specific actions that we're taking on margin expansion.

Benjamin Andrew - William Blair & Company

Thank you.

Kieran T. Gallahue - President and Chief Executive Officer

Right. Thanks.

Operator

And your next question comes from the line of Paul Choi from Merrill Lynch. Please proceed.

Paul Choi - Merrill Lynch

Thanks guys, can you hear me?

Kieran T. Gallahue - President and Chief Executive Officer

Yes.

Paul Choi - Merrill Lynch

Okay, great. Maybe, I can just start with some shop keeping questions. Kieran, I think you gave us the U.S growth rate for flow generators, but I may have missed the number from masks and the U.S. numbers?

Kieran T. Gallahue - President and Chief Executive Officer

I want to Brett was actually the guy, he went through all the details, he's got closest line there.

Brett Sandercock - Chief Financial Officer

For the Americas flow generators increased by 8%.

Paul Choi - Merrill Lynch

Yes.

Brett Sandercock - Chief Financial Officer

And masks and other was 18%.

Paul Choi - Merrill Lynch

Great.

Brett Sandercock - Chief Financial Officer

Then for the South Americas [ph] that flow generators was up 24% and masks and other was up 49%.

Paul Choi - Merrill Lynch

49%, great and then I think you said by that your net income excluding amortization and the recall charge was at $33.2 million which if my math is right gives you a tax rate of about 29.1% which was about 140 basis points drop versus the previous quarter. Is that reckon what would you guys have?

Brett Sandercock - Chief Financial Officer

Yes, it's was around 29% for the quarter pretty close to that and if you look at the full year rate was little over the 33 mark.

Paul Choi - Merrill Lynch

Okay, I see.

Brett Sandercock - Chief Financial Officer

Going forward and that 30% mark probably realistic...

Paul Choi - Merrill Lynch

Okay. 30%. Can you just help us understand what the any particular items were, perhaps here in the fourth quarter, that help you guys that are on the bottom line with the tax rate, just provide a little clarity in terms of what's driving that tax rate here in the quarter, please?

Brett Sandercock - Chief Financial Officer

Yes, so I would say the quarter some of that relights to some of the R&D concessions we get down here in Australia. We had a particularly strong quarter here lock in R&D spend for the quarter that will manifest it self in the effective tax rate, because of some of the tax concessions we get. And a continuation of the German tax rates which are kind of down at the beginning of the year, that's off to around 10% and Germany is doing well in those profits are coming through as lower tax rates. So, I mean there's a myriad of them, but there might be the two major ones.

Paul Choi - Merrill Lynch

Okay, then one down in north [ph] and then the German tax rate being the two big drivers here in the quarter. Great.

Kieran T. Gallahue - President and Chief Executive Officer

Yes and as the Germany would have been with us for the full year that we continue to get that impact quarter-on-quarter.

Paul Choi - Merrill Lynch

Great, Kieran you guys have given some pretty good details on some what you think the drivers can be on the gross margin line. I was wondering if you could speak a little bit to operating expenses?

You've given some guidance to us on the R&D lines, but with respect to the SG&A line, can you may be comment a little bit on how you're feeling about the need to invest over the upcoming fiscal year '09, with the sales force in terms of market development activities for either their home testing opportunity to help out your DME customers or alternatively some of the areas, if you like you need to perhaps bone up on when, it comes to getting some more feet on the street to help with the new products that you have coming out here?

Kieran T. Gallahue - President and Chief Executive Officer

Yes, so I've been first of all, I've been very pleased with the performance of the global team and controlling operating expense, growth particularly during the time when as you know, there is foreign currency impact has been a challenge in controlling that headline.

But we are looking on a constant currency basis. It's been just some very good cost control. Part of that is activities that we are engaged in throughout the globe, as an example that we described as an ops of the continuous improvement down in Australia, we are doing the same thing in Americas here using lean techniques in order to reduce efficiencies. I should say increase efficiencies, reduce elements that are interfering with our efficiencies.

So a good standard operating procedure that gives me comfort that as we move forward that the dollars that we spend, will be spend in a right place which is market expansion, which is feet on the street, which is the ability to grow market share. Alright?

So I think that we're doing the right things and have been doing the right things about focusing on efficiencies and focusing on market expansion opportunities. I think when at the operating cost as a percentage of revenues, you've seen we gained a little bit of leverage here in the last quarter.

And I expect to continue that, but we are spending about the right level. We are not going to take our foot off the accelerators or too many good things happening in this industry. There is too much opportunity to try to reduce that to some level that would start critical initiatives. So I think we are going to continue the balanced approach, picking up efficiencies and some leverage as move forward, but making sure that we invest appropriately and expanding this highly and underserved marketplace.

Paul Choi - Merrill Lynch

Okay, great. Thank you for that Kieran and then something that's been off the radar for a little bit is Simi [ph] or ResMed Paris, can you perhaps give us an update as to where those sales stand perhaps in terms of your U.S. markets and maybe when we can potentially look forward to some of these things... these products from the same acquisition looking coming into the U.S. market here?

Kieran T. Gallahue - President and Chief Executive Officer

Yes, so we continue to make good strides with the ventilation product line and the organization here is just seems to improve by the day. We continue to invest in them and they continue to respond to that investment. They've got a very a good product pipeline, a part of what we've done is gone in and done some significant product pipeline reengineering which is going to, we think going to significantly up-tick or increase our ability for market penetration overtime, it also delays a little bit.

So our thought there is if we are going to swing we are going to swing the best, we are going for the big impact, as opposed to simply trying to make incremental changes or improvements. So we are doing well, that business doing is quite well ex-U.S. it's not yet time to bring it into the U.S. and we are not giving any specific timelines on that. But I can I can tell you I'm very pleased with the progress.

Paul Choi - Merrill Lynch

And maybe if you can just give us a sense of where that business is going in terms of sales for the run rate?

Kieran T. Gallahue - President and Chief Executive Officer

We historically have not broken out to that level of details. So I feel little bit uncomfortable getting too much detail.

Paul Choi - Merrill Lynch

Okay.

Kieran T. Gallahue - President and Chief Executive Officer

But just to say that it's positive and it's doing well and we're pleased with the performance.

Paul Choi - Merrill Lynch

Okay, great. I'll take [indiscernible] out of that. And, a last one, just in terms of the U.S sales force, you said, you've laid out a very clear strategy here in terms of that putting the feet on the street. In terms of... and obviously had a very nice results here in the U.S. Is that the sort of result do you want to expect and given the nice product cycle you guys have coming here and that we can potentially expect going forward for over the next couple of quarters here with the U.S growth rate and, is there something you feel like will start to generate returns more in the near term or is it just to help us understand the timing of these investments and spending coming through. Thank you and I'll turn back into queue

Brett Sandercock - Chief Financial Officer

Okay if I understand the question correctly Paul, with that prospect in the near term I think that there are number of factors which are signals of encouragement, to my perspective to the Americas. Certainly the products flow as you know had been very strong I mean we hit the market. People care about compliance and in fact some of legislative changes moving forward probably are just going to increased the emphasis on compliance and with flow generators if you got the right algorithms and we absolutely have a market leading algorithms when you can reduce noise and on some products up to 90%.

I really think about that up to 90% in a market at this point. They're important for the individual and they're important for the partner and help to buy this plan [ph] another things that makes me feel very comfortable that we have a seller U.S sales of course that is executing very well and I feel that if we speculate their executing even better their well trained with testing [ph]

Kieran T. Gallahue - President and Chief Executive Officer

I think we've got a lot of opportunities to [indiscernible]. Marsha?

Operator

Okay. Your next question comes from the line of Michael Matson from Wachovia Capital Partners. Please proceed.

Michael Matson - Wachovia Capital Partners

Hi.

Kieran T. Gallahue - President and Chief Executive Officer

Hello.

Michael Matson - Wachovia Capital Partners

I guess first of all I know you talked a little bit about the cut that facing your customers on due to the competitive bidding '08 just wondering how much if any of that 9.5% cut you think you'll end up having to bare?

Brett Sandercock - Chief Financial Officer

Yes it's always hard to say, this is marketplace where every year people are coming with cup and hand and kind of things and I don't expect that to change in this year then in another year. But I think one of the positive things that is happened is we've absorbed a lot of the price compression over this last year, right, so there was some pretty significant movement and I think that has taken a lot of pressure of the HME's that might have otherwise been there.

And we're hearing from the HME's this point is looked they're looking for quality products they at a competitive price that we've been able to make the adjustment necessary to be in that competitive price range and they're also looking for future that going to make their life easier because many of them recognizing that this is about the cost not just about the price that they buy something with.

It's about quality and we by far have the market leading quality products in this industry and that has a big effect on their ability to serve and I mean one of the funny things about rising oil prices is these guys run a lot of trucks and if they have got to go out to patients homes and they have to go for multiple calls because of quality issues that's going to cost their money, they don't want to deal with that, they think the same way on the masks side.

So I think that we have been on one side very fortunate but I think it's on the other side it's been part of our very specific strategy that people are recognizing the cost advantages of the cost savings associated with quality products.

Michael Matson - Wachovia Capital Partners

Okay. Aand then I was wondering if you've noticed or heard of any dollar reports of an economic impact on the demand for sleep studies and or CPAP equipment.

Kieran T. Gallahue - President and Chief Executive Officer

Yes, it's really no new news on that; I think the last couple of quarters have been no real significant development that we're not here to lot about it.

Michael Matson - Wachovia Capital Partners

Okay. And then given that year-to-date or you've launched the Escape II or sorry, S8 Escape... S8 II Escape, is there any risk that that's going to drive a negative mix shift, now that you're pushing some features down onto the lower end units?

Kieran T. Gallahue - President and Chief Executive Officer

I think what we are doing is, we have taken a lower cost platform and we have been able to take the EPR, the Esptr [ph] the expletory pressure release function and be able to put it on that lower cost platform by doing some, I think some very innovative things. So, one of the things that refused to compromise on was quality of care and in that pressure release category, the different solutions are different and we feel very comfortable as though our customers that the EPR feature offers the most efficacious treatment and for that category of pressure relief, the secret though here was the ability to take that mode of care or therapy and be able to put it over to a platform that costs less fro us to make and allows us to be more price efficient in the marketplace.

Michael Matson - Wachovia Capital Partners

Okay, and then just a question on your stock-based compensation. Can you give us out of that $5.3 million of how much of that was in... went into the SG&A category, how much that went in the R&D category?

Kieran T. Gallahue - President and Chief Executive Officer

Brett, do you want to handle that.

Brett Sandercock - Chief Financial Officer

Yes, the most of it was in the SG&A. It's around, half a million, three-quarter of million in R&D and the balance is in SG&A, it's high bidding cost is up.

Michael Matson - Wachovia Capital Partners

Okay. And is the $5.3 million number I assume is before tax?

Brett Sandercock - Chief Financial Officer

Correct.

Michael Matson - Wachovia Capital Partners

Okay, can you give me what number would be net of tax?

Brett Sandercock - Chief Financial Officer

Yes, the tax rate around there is roughly the 30% mark touch on that.

Michael Matson - Wachovia Capital Partners

Okay, alright. That's all I've got. Thank you.

Kieran T. Gallahue - President and Chief Executive Officer

Great, thanks very much. Marsha, I think we've time for another question.

Operator

And our last question comes from the line of Joanne Wuensch with BMO Capital Markets. Please proceed.

Joanne Wuensch - BMO Capital Markets

Thank you very much for taking my question. I am sort of a pattern girl. And you broke two patterns in this quarter, and it's been a topic of most of questions, but I want to another second or two on it, you went from16% revenue growth to 23% revenue growth.

You went from 60% gross margin to 58.4%gross margins. How do we think about without giving guidance? Where do we go from here, is this the new starting point? Do I think about revenue growth again revenue growth again in the 20% plus range for ResMed and recovering gross margins. How do we think about that?

Brett Sandercock - Chief Financial Officer

Joanne, you're absolutely right. We don't give specific guidance on that. So I'll go back to our statement we made earlier which is to say that we feel that on from a market perspective that the outside the U.S. we feel comfortable with long-term sustainable growth of 10% to 15% in the U.S. and the Americas we feel comfortable with the 15% to 20%.

So market growth that is sustainable in that mid teens and we feel we can grow at and above as we have historically market growth so I'd say on what our prospects moving forward are... we feel very comfortable that we can get back to and are back to that level of growth. There is lot of things that impact both of those line items and a single quarter doesn't make a trend certainly in anyway but we're feeling very comfortable with where we're out in our life cycle.

Joanne Wuensch - BMO Capital Markets

Okay.Any change in the competitive landscape with respond extreme part of Philips?

Brett Sandercock - Chief Financial Officer

No I think, no we are very hopeful that Philips has a reputation for competing in marketplaces by focusing on innovation and market expansion. That's the way we like to compete in a marketplace and we think that help us for these long-term growth of the marketplace. And there is nothing that gives us pause at this point.

Joanne Wuensch - BMO Capital Markets

And is there are reasons you're taking the $3.1 million charge for the S8 recall now in the fourth quarter?

Kieran T. Gallahue - President and Chief Executive Officer

This was... we felt at this point that it was predictable amount, but I remind everybody that's within 5% of our original estimates. And we felt it was time an appropriate to give the true up.

Joanne Wuensch - BMO Capital Markets

Okay. And Kieran you're anticipating future troops?

Kieran T. Gallahue - President and Chief Executive Officer

At this point is as Brett had mentioned earlier we feel that this should be up.

Joanne Wuensch - BMO Capital Markets

Okay. Thank you very much.

Kieran T. Gallahue - President and Chief Executive Officer

Thank you for your questions.

Operator

And I would now turn the call back over to Mr. Kieran T. Gallahue for his final remarks. Please proceed, sir.

Kieran T. Gallahue - President and Chief Executive Officer

Well, great thanks Marsha and thank you all for your time and attention. I think as many of you have noted this was a very strong quarter for ResMed from the top-line growth that was we think quite exceptional to these strong results that came out of Americas across the board right on down to the record breaking cash.

So we were very pleased with performance. I'm very proud of our employees throughout the globe and through all functions in the company who've all contributed to that. And I look forward to updating you on the next conference call.

Operator

Thank you for participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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Source: ResMed, Inc. F4Q08 (Qtr. End 06/30/08) Earnings Call Transcript
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