Cochlear Limited

Thank you for standing by and welcome to the Cochlear Limited FY25 results, analyst and media briefing. All participants are in a listen-only mode. There will be a presentation followed by a question and answer session. If you wish to ask a question, you will need to press the star key followed by the number one on your telephone keypad. I would now like to hand the conference over to Mr. Dig Howitt, CEO and President. Please go ahead.

Good morning, everyone, and thank you for joining our results presentation. Let's get underway. And as always, we are starting with our mission. And our mission serves as a guide across the company, but there's two important points. One is the purpose that sits in our mission enables us to attract outstanding people. And the other thing it reminds us of is the long-term nature of our business and the long-term nature of our strategy to help more people hear and be heard. And so I wanted to start the presentation today with a look at our 25-year financial history. And I'm doing that to put in context the F25. So as you've already seen, our sales were below our expectations for 25. And then it's really a question of how do we respond and I want to put the how do we respond to lower sales in the context of history. So if you look at these charts and starting on the left with our R&D, the investment in R&D, that's the most consistent chart on this page. So R&D has increased year on year. When sales have gone down, that R&D investment has continued to lift. So our first response when our sales are not where we expect them to be is to make sure that we protect R&D, and we do that because it's the core of the business. It enables us to retain our market leadership position, but it's also the performance of our products that sets us up to get the evidence to drive growth, and I'll come back to that. And we think about NEXA, which I'll also talk about being a 20-year development. It's that consistent investment in R&D over 20 years that enables us to produce a product like NEXA. Now, OPEX after R&D is then the next least variable chart on this page. Again, pretty consistent growth. But you can see we do pull OPEX back further than we do R&D. And we lift OPEX more than we do R&D too when sales are going well. And I think you'd expect that. So when we do moderate our spending, but we do try to protect in the OPEX is the investment in growth. So protecting that investment in R&D, protecting the investment in growth, leads to the two charts in the middle, which is the long-run history of growth in cochlear implants and the long-run history of growth in revenue. Now, a consequence of protecting... The growth spending and the R&D spending are the charts on the right, where there's more variability in profit, which is what you'd expect, than there is in our spending and then there is in our sales. And so that response to lower sales, which we saw this year, than our expectation, is to protect investment in the core parts of our strategy that drive our long-term growth. And we do that because we've got a market that's less than 5% penetrated, but we do that because we have confidence in our future. And I want to talk to two key aspects of our confidence in our future before we get into the detail of 25. So the first of those is the nexus system. So launching now around the world it is. We started the development of Nexa from Concepts in 2005. It was early in Chris Roberts' tenure. Yarn Yarnson had just taken over R&D at that time and Yarn shepherded this product over the last 20 years. And it's absolutely a breakthrough product. The world's first and only smart cochlear implant. in our view, perhaps one of the most sophisticated neural stimulators in any therapy. What does it bring to our patients and our professional partners? We want to make sure we have benefits up front as well as potential into the future. I'll get to the potential into the future in a minute. But right up front, because we've been able to, with new electronics, make the power transmission more efficient, We can have a smaller battery on Nucleus 8 and it gives a full day of battery life. So Nucleus 8 was already the smallest processor on the market by quite a margin. It's even smaller again. We know that consumers are very interested in cosmetics and the size of the processor and we have extended our advantage in terms of having the smallest processor with a full day of battery life. And then the map on the implant, which we call Smart Sync, the ability to get back on air quickly, is important both for recipients and for clinics. So what happens up to now is if someone's processor breaks, they either need to schedule an appointment with the clinic, go into the clinic, they get a new processor, the clinician loads their map, and the map is the unique settings that encode sound for their auditory nerve, and it's different for each person. They load that onto the processor and the person goes away hearing again. Or in some parts of the world, we've got the map in the cloud, so they call us. We load the map in our warehouse onto a processor and ship it back out to them. But there is a process that takes recipient time, takes valuable clinic time. It is often not reimbursed. You can think about this from when people go on holidays, for example, particularly with children. They're worried that the processor could break, they could lose the processor, so they go into the clinic and they get a spare. They get a loaner just in case. So you think about all this clinic time that is taken up, even when processors are reliable, They're not billable and adds no value. Now with the map on the implant, all someone needs is a blank processor. So we can ship a blank processor, clinic can ship a blank processor to them, no clinic time, appointment time needed. People going on holidays can take a new spare with them. They've got an emergency, if they don't need it, they send it back afterwards. So savings in clinic time. and savings for recipients. And one of the things we've been able to do with the amount of data that we now collect on clinical practices, we can see that over half the appointments that are made in clinic are for people after the first year of having their implant. And those appointments are really about just routine checking and maintenance. The more we can reduce them, the more clinic capacity we create for future growth. The other point I want to make on Nexa for the future too is we often talk about how full our R&D product pipeline is. Nexa is an example of this, a 20-year development that we didn't say anything about, I think for obvious reasons, until 2023, until we were getting very near the end of the development, we started to talk about new stimulation modes. And new stimulation modes to improve hearing outcomes is one of the potential future possibilities of NEXA. And it's the last one on the list on the right here. It's really one of the core reasons for developing NEXA with this upgradable firmware is to be able to now experiment with different ways of stimulating the auditory nerve, getting potentially more precise stimulation and therefore better hearing outcomes. A bit over the last year we have been running four small studies to experiment with new techniques. Those studies will wrap up over the next year which will give us real insights into the possibility with this end plan and then enable us to undertake further development. Some of the other future possibilities shown here, even more power efficiency which could lead to smaller externals. Earlier activation, so with the map on the implant, we can actually load a map in surgery, and we're going to start running some experiments on this, which means that someone, when they go home from surgery, once the bandages come off, they can put a processor on and they'll be able to start hearing. But now, it'd be some number of weeks later, they've got to come back to the clinic for another appointment or set of appointments to get that map set up. So again, that's saving clinic time, easier for recipients. There's a whole bunch of potential for diagnostics. Already some of those are active. There is more to come. Again, we think about half of clinic appointments being routine maintenance and follow-up. The more we can do on a diagnostic front saves clinical capacity into the future, but also gives both clinicians and recipients confidence in the performance of their system. And then the last one here is neural health. One of the biggest drivers of variability in outcomes for people with cochlear implants is neural health, the quality or health of their auditory nerve. At the moment, that quality can only be inferred, and at some time after implant, we're very confident that what we can do with the implant is be able to measure that neural health, which will mean much more target, potentially much more targeted expectation setting and much more targeted rehabilitation or habilitation to enable people to reach their potential. So a very quick view of just some of the potential for Nexa. The second reason we're confident, so Nexa really puts us in a really strong competitive position. It's a significant step above our competitors and those benefits come from the SlimModiola electrode, which is also unique to us. Second reason for being confident in the future is the work that is going on across the world to explore the link between cognition and hearing loss. This is all about medicalising hearing loss. We've talked about this a lot. Hearing loss is one of the most prevalent medical conditions in the world and it's one of the least treated conditions. And it's one of the least treated because people don't see it as a medical condition. They don't see that there is other health consequences from not treating it, so they don't see the need to treatment. And through our awareness campaigns, these people actually don't know of the potential solutions and their effectiveness. So what we've seen and we've talked about over the last five or six years is people a whole range of studies, starting with Spranklin actually in 2011, showing the correlation between hearing loss and cognitive decline. The Lancet publishing that hearing loss was the single biggest midlife modifiable cause of cognitive decline. The Saran study in Melbourne showing people with cochlear implants' cognition improved after getting a cochlear implant. And then on the right here, there are several more studies coming over the next few years looking at hearing loss and cognitive decline, looking at the different treatments between CI hearing loss and effectiveness, both in terms of hearing and to some degree effectiveness in terms of cognition. And it's this emerging data that gives us a growing pool of data on this link that gives us confidence of medicalising hearing loss and increasing motivation for professionals to refer if the people don't want to treat their hearing. I wanted to just call out one study in particular. This comes from Korea. It was just published a couple of months ago. And this study, in Korea they've got population-wide data from people's health records. So this study tracked over 50,000 people with severe to profound hearing loss for 14 years. It was an observational study, so it didn't track them. It looked back at their medical records. And then what it looked at was the incidence of dementia across these 50,000 people over 14 years. then looked at that incidence by type of treatment. So if we go to the chart here, the black line there is the incidence of dementia from people with normal hearing. There was over a million people that they tracked over those time. The blue line is the incidence of dementia for people with severe to profound hearing loss who got a cochlear implant. It's about 640 people, so a reasonably significant number for us. There is no statistical significance, the study concluded, in the incidence of dementia for people with a cochlear implant versus people with normal hearing. We then go to the green line and the red line. The green line is people with hearing aids. The red line is people who had no treatment for their severe profound loss. What that shows is that for people with used hearing aids, The incidence of dementia was significantly higher than those with a cochlear implant and those with normal hearing, but it was better than people with severe to profound hearing loss who didn't have any treatment. Now, this is an observational study. There are some limitations on it, but it is evidence like this that gives us confidence of our future growth because of this growing link between hearing loss and cognitive decline. and that being the motivation for people to refer, for professionals to refer, but in time for people to get their hearing loss treated as well. Okay, so now let's move into the detail of the results. You'll have seen the headlines already, that 4% revenue growth, 1% net profit and dividends. So let's get into the detail. So first into cochlear implants. And so cochlear implant, the result overall is a pretty good result, 9% growth in cochlear implant revenue, 12% growth in We saw stronger growth in the systems in the second half, which is one of the things we said would happen at the half. We look into developed markets first. Their units were up 6%. Adults and seniors growing around 10%. Again, pretty slower than we've seen in the last two years, but still pretty strong growth. And the key bit there is we continue to see ways for us to activate people on their hearing loss journey. We've collected a lot more data over the last year on referrals, on what happens to those referrals. For instance, we know now that about... people actually get referred for a cochlear implant, only about a third are actually getting to get an implant. And there's a whole bunch of reasons that they drop out along the way, but by us understanding those reasons, it's the opportunity for us to go in and to help those people back into their funnel, because only a small number are dropping out because they are not in indications. Most it's about not enough information or conflicting information or just not sufficient follow-up. So we've learned a lot more about that path. I talked about the medicalization of hearing loss and cognition. That all helps us build confidence into the future. And our DTC programs continue to be a very important part of driving growth around the world. We did lose a little bit of share, we think, through that half in a couple of countries and coming into the product launch, you know, competitors know that's coming. They have responded as you'd expect. They're very good companies. We expect to more than regain any share that we have lost with the launch of Nexa. And a slight decline in children. Again, we said that the half was surprised children was continuing to We wouldn't be surprised by a decline in children just because we have seen such strong growth, which we knew was out of line with the rate of incidence, that there should be a reversion to the more normal rate, and I think that's what we're seeing. Very strong growth in emerging markets, so up over 20%. And remember, we had two different halves on emerging markets. In the first half, we had a smaller volume, but a very strong mix towards the premium tier, which lifted our overall ASP on lower volumes. In the second half, we had far more volume going through, but it was low tier volume, and that was across a range of countries. Obviously, the volume-based pricing in China, which started in March, has been a factor in this, and we are seeing strong growth there, but that growth is in the lower-priced lower tier. And that, given the comparison between 26 and 25, the VBP in China will be a headwind for us, both on revenue and on profit. Okay, let's move on to services. Services for us is the down 10% is obviously the most disappointing part of the result. We talked about this at the half. We've seen some stabilisation of our services sales and we do expect to see growth going into 26%. But there does remain some uncertainty because there's a few factors in 25 which are unique to 25 and then there's some ongoing factors. So one thing unique to 25 is we are cycling, particularly the second half of 25, the impact of COVID and we know the biggest driver of services over time is growth in the recipient base and particularly the eligible recipient base. Five years ago in COVID, we saw a reduction in sales and a reduction in upgrades, and we are starting to cycle that, and we can see that in the eligible base. Now, that eligible base grows again as we get into 26, and particularly into the second half of 26. The other thing that we talked about at the half that we have not seen... for over time is the impact of cost of living and particularly in the US where there's just significant economic and consumer uncertainty. We look at some of what the hearing aid companies are saying. I think they're saying something similar to this. But that's where we do have an out of cost payment. The US was the largest fall in upgrades over the last year. We talked about putting payment plans in place, which we have done, and even that we are seeing is not, at this stage, sufficient to get people to take upgrades. And we do know upgrades for many people is discretionary. So if someone's processor is broken out of warranty in the past five years, they'll get an upgrade. But if it's discretionary, then we do see people delaying. So, again, at some point those people will upgrade, but right now we are seeing more hesitancy, particularly online. Part of that is Nucleus 7 is a fantastic product. And people saying, well, Nucleus 7 is pretty good. Why would I switch? And we've got really good clinical evidence that shows that Nucleus 8 is better. The other thing that we have done through the half is survey people who have gone from Nucleus 8 to Nucleus 7. Nine out of 10 of them. are saying that they would recommend switching, and 7 out of 10 are saying they're hearing better. And we will use that evidence to promote, along with upgraded marketing capabilities, to promote upgrades in the half. Sorry, through 26, and we have Kanso 3 as well, which will help us get modest growth in upgrades into 26. And then finally, acoustics, 6% revenue growth, so slower than we expect the long-run trend for acoustics. Osseo growing 30%, very happy with the Osseo growth. It was really Baja 7 coming and Baja 7 being slow. Visible later in the half, we saw a pullback on Baja 6. We expect to pick that back up this year with both Aussie continuing to grow in countries and with more geographic expansion and Baja 7 lifting Baja plus Baja upgrades through the year. Onto our strategy. Now, our strategies are unchanged, so I'm going to move pretty quickly through and over the other strategy because I did talk about our strategy up front. As we go into a lifetime of hearing solutions, our product portfolio investment in R&D continues, like I said. The Kanso, sorry, Nexa is a whole system, new software, as well as Kanso 3, and the drug-eluting electrode trials. Two pivotal studies well underway, recruiting well this important product for our future portfolio. Moving on to thriving people. Again, people, there are two parts to this. Our people and our leadership development are one of the key enablers of our growth. We continue to work hard on leadership development, particularly in the lifting capabilities of our leaders so that they are capable to lead in a growing and larger organisation. and the investments in replacing our core systems. We are in the final stages with replacing our core ERP. And what we will get here with both new data, new systems that will automate many processes, giving us efficiencies, but more importantly than that, data and clean data and consistent data, which will enable us to be making better decisions and enable us to be able to use AI as we look forward. And then a picture of Stephen Dine, one of our first next recipients meeting people in manufacturing. So just one of the things Stephen said, we talked about our mission and hearing solutions. One of the things he said is this is not a hearing solution, it's a living solution and a good reminder of the impact of what we do. And again, reinforcing our confidence for growth. And then on environmental responsibility, we continue to meet our targets. We're a very small emitter and we continue to reduce our emissions. And with that, I am going to hand over to Sarah to take us through the P&L and balance sheet in more detail.

All right. Thanks, Dig. And good morning, everyone. Let's go through the numbers. So we'll start with P&L. You can see on there sales revenue was up 3% in constant currency. Now, Dig's taking you through that, so I won't go through those details. You see, the gross margin declined by one percentage point to 74%. There are two parts to this. First, there's a shift to lower margin emerging markets in the second half. And second, we started to scale up production at the Chengdu manufacturing facility. Until December last year, we'd only been manufacturing sound processors. Now, we have regulatory approval for implants, and we've started to increase production rates. That site will continue to be a gross margin headwind for another year or so. Operating expenses increased 5% for the year, just a little ahead of revenue growth. We continued to invest in activities to support long-term sustainable growth and in R&D. We moderated the rate of growth in the second half. With softer sales, we prioritized our growth investment on the highest value activities. Total operating expenses also includes an approximately $50 million reduction in the employee short-term incentive provision. This was the result of below-target revenue and profitability outcomes. Our cloud computing related investment was around the same levels as last year at 33 million. We continue to expect our overall transformation investment to be about 250 million total. The final phase of that program focuses on our core ERP, our underlying data, and our manufacturing systems. The balance of approximately 130 million will be incurred in FY26 and FY27. Given the materiality of this investment, we'll report it as a significant item from FY26. And the increase in other income is primarily collaboration income from our innovation fund investments and revenue from various government grants. And then the final thing to note on here is the net margin pre-cloud was 18%, in line with last year. All right, let's move on to the balance sheet on the next page. Key change to the balance sheet that you'll see is the increase in working capital. That was up around $200 million on last year. A big part of that was inventory levels, which... ahead of major new product launches, and to build higher safety stock levels for critical components. We expect inventory to sales levels to start to moderate by December. The $90 million increase in trade receivables reflects a relatively stronger fourth quarter sales that we had, including in emerging markets. You can see property, plant, and equipment increased $28 million, and this is mainly investment in capacity expansion at our Lane Cove and Koala Lumpur manufacturing facilities. You see the $50 million increase in intangible assets that reflects increased IT system development, acquired technology and software development, and some impact of foreign exchange. Any increase in the other net liabilities includes the approximately $50 million reduction in the employee short-term incentive provision that I mentioned before. All right, on to the cash flow on the next page. You'll see operating cash flows declined $150 million on last year. That's driven down by the working capital, which we just went through, and a bid on higher income taxes paid. That's due to timing of tax installment payments. Finally, the capex of $103 million includes the capacity expansion that I mentioned, that investment in Lane Cove and Kuala Lumpur, and our stay-in-business capex. But now back to Dick for the Outlook.