Fisher & Paykel Healthcare Corporation Limited

Welcome to the Fisher & Paykels Health Cares Results Conference Call. My name is Cynthia, and I will be your operator for today's call. At this time, everyone except the guest speakers will be in a listen-only mode. Later, we'll conduct a question-and-answer session. We ask for your assistance in keeping the call to a maximum of one hour. If assistance is required at any time, please press the star followed by zero on your phone and wait for a coordinator. If you require further assistance, you should redial into the call. Please note this conference call is being recorded. I would now like to turn the call over to Marcus Driller, VP Corporate. Please go ahead.

Thank you, Cynthia. Well, good morning, everyone, and welcome to Fisher & Paykel Healthcare's 2023 Financial Year Results Conference Call. On the call today are Lewis Graydon, our Managing Director and Chief Executive Officer, Lyndall York, Chief Financial Officer, Paul Shearer, Senior VP of Sales and Marketing, and Andrew Somerville, our VP of Products and Technology. Lewis and Lyndall will first provide an overview of the results, and then we'll open up the call to questions for the team. We'll be discussing our results for the year ended 31 March, 2023. We've earlier today provided our 2023 annual report including financial statements and commentary on our results to the NZX and ASX. These documents can be accessed on our website at fphcare.com forward slash investor. With that I'd now like to turn the call over to Lewis.

Okay and thanks Marcus and welcome everyone. So today I'm going to be referring to the investor presentation pack that we released to the NZX and the ASX this morning. We do have limited time and our roster of analysts is continuing to grow. So I'm very conscious of leaving plenty of time to get to all your questions. We're thinking that we'll try to move through these initial slides a little faster than we normally do today. And for this audience, we think it's a little more meaningful to focus on our second half performance. So let's start on page four, our second half results. Now we're coming out of three years that were impacted by COVID-19 and we think this result is encouraging as we can see market conditions progressing towards more of a normal state over the last six months. Operating revenue for the second half was $890.5 million. That's up 14% on the prior corresponding period or 12% in constant currency. Net profit after tax for the half was $154.4 million which is flat compared to the prior corresponding period and it's a 3% decline in constant currency. So let's turn now to page 6 for hospital. Hospital operating revenue was $584.8 million for the half, that's up 9% or 7% in constant currency. For the full year hospital hardware sales were down 53% in constant currency compared to the 2022 financial year, and that is a year that was much more heavily impacted by the global COVID-19 surges. Hardware sales have still benefited from surges during FY23 in some locations, but in those countries or regions that did not experience COVID-19 surges, Hardware sales look to be tracking somewhat close to pre-pandemic patterns throughout the year. New applications consumables revenue for the second half was up 14% on 2022. That's 13% in constant currency. And given that we are lapping a period significantly impacted by COVID-19, we think this is a very pleasing result, and we believe it indicates steady progress in increasing use of our therapies. Overall in hospital therapies we'd say we are beginning to see periods of stable ordering patterns in the second half of the 2023 financial year and into the early months of this year, FY24. I'll turn now to page 8. Home care operating revenue was $303.9 million. That's up 25% on the second half of 2022. or 22% in constant currency. I would say mask revenue was particularly strong at 28% or 24% in constant currency. Now we launched our overall full mask in the US in May 2022, and it's been a significant contributor to mask revenue. That is one of the most positive mask launches we've ever experienced, both in terms of customer feedback and sales performance to date. Now, I will pause there and hand over to our CFO, Lyndall York, for more details on the financials, and then I'll speak to guidance after that. Thank you, Lyndall.

Thanks, Lewis, and good morning, everyone. On page nine, gross margin for the year was 59.4%, down 325 basis points from last year, or 369 basis points in constant currency. The cost of freight continues to be elevated and compared to pre-COVID-19 rates impacted our constant currency gross margin by approximately 230 basis points for the year. This is a similar impact as we saw last year. We saw hospital customers destocking leading into the year and in response we reduced our production volume. This resulted in manufacturing inefficiencies due to under recovery of overhead costs which are largely fixed, and labour costs. We've also started to see the impact in our margin of labour and materials inflationary cost increases. As anticipated, we saw an improvement in our second half constant currency growth margin, which was up 179 basis points over the first half, driven by lower freight rates and price increases. We've shown over the decade prior to COVID that through our regular focus on efficiency, continuous improvement and cost out, we've been able to achieve an annual average of around 125 basis points improvement in our gross margin. Over the last three years, our focus and effort has been on increasing production, sourcing materials and getting our product to customers to treat patients at all costs if and when they needed it. Our usual operational focus on margin maintenance or improvement was secondary. This is reflected in the decline in gross margin you can see over the last three years. We've returned now to our usual practice of working on efficiency, cost out and margin improvements. However, we're also facing significant inflationary pressures on our input costs. we are confident we will return to our target of 65%, as we've shown we can do. We are aiming for annual improvements of around about 150 basis points on average to return to our target. For FY24, we anticipate an improvement of approximately 200 basis points in constant currency from FY23, with ongoing improvements from freight rates price increases and manufacturing efficiencies more than offsetting inflationary increases in labour and materials. At May exchange rates, that would translate to about a 100 basis point improvement in our reported gross margin. Moving on to page 10. Total operating expenses grew 11% or 7% in constant currency. Operating margin was 21%. as we continued our focused investment through the demand fluctuations over the last few years. R&D expenses grew 13% to $174 million as longer term projects accelerate. R&D expenses were 11% of revenue for the year. We have estimated that approximately 60% of our R&D spend will be eligible for the 15% R&D tax credit this year and expect about the same level of eligibility for FY24. SG&A expenses increased 10% to $432 million or 4% in constant currency. We have set a target operating expense growth for FY23 based on approximating an 11% compound annual growth rate from FY19. While we exited FY23 with pretty much the number of people we were targeting, it took us longer than hoped to bring them on board. This 9% increase in people during FY23 will lead to a higher expense growth next year, reflecting the lower than targeted growth in FY23. We are anticipating operating expense growth of approximately 12% in at the FY24 at May exchange rates. This is largely driven by the full year cost of the people added during FY23 with a small increase in people in FY24. Moving to page 11, operating cash flow this year was $238 million, reflecting the lower profit. Our working capital also increased in the year. as receivables grew reflecting the phasing of sales at the end of each year. Payables reduced reflecting timing of purchases from suppliers. Virtually all of our operating cash flow was generated in the second half of the year as we reduced inventory by $33 million in the second half. Capital expenditure which includes purchases of intangible assets was $211 million for the year. The increase of $42 million from last year is primarily due to land and buildings. We completed our third building in Mexico and continue to progress our East Tamaki campus development including earthworks for our fifth building. In September we paid a deposit of $27.5 million for the acquisition of land for our second New Zealand campus. The second payment of $190 million was made on 11 May. Capital expenditure for FY24 is expected to be approximately $450 million including the payment made this month for the land. The balance sheet remains strong. Net cash at 31 March was $38 million and our gearing ratio was minus 2.3%. During the year we put in place net additional borrowing facilities of $450 million to have sufficient funding for our strategic acquisition of land and completion of our East Tamaki Campus building works over the next few years. With the $190 million paid this month for the land and the continued infrastructure investment, we expect to have higher debt and interest levels. and have a gearing ratio over our target range of minus to plus 5% for the next three to four years. For FY24, we're expecting net interest expense of approximately $16 million, up from $4 million this year. Turning to page 12, we've declared a fully imputed final dividend of 23 cents per share. This represents a 2% increase on the final dividend declared last year and continues our track record of increasing our dividends to shareholders. It will be paid on the 7th of July. This brings the full year dividend to 40.5 cents per share, up 3% on last year. Our dividend reinvestment plan remains available for eligible shareholders with a 3% discount to the market price. Looking now at foreign currency on page 13. Foreign currency movements positively impacted our profit after tax by approximately $10 million compared to the last year, primarily due to the New Zealand dollar being weaker on average through the period. Now back over to you Lewis.

Okay, thanks Lyndal. So now let's turn to guidance on page 14. We've provided revenue guidance of approximately $1.7 billion for FY24, and that's at May exchange rates. Almost all parts of our business have had a myriad of influences during FY23, and they've got quite disparate and distinct impacts on each half. So rather than try to normalise those effects, revenue guidance for concern bills is based on the recent ordering patterns during stable periods, and that's territory by territory. The assumptions incorporated in that guidance for our hospital business are a normal flu season, no hospitalisation surges during the year, and anaesthesia growing strongly off a fairly small base. For hospital respiratory consumables, our assumption is that we continue to see the steady progression that we've seen through FY23 of increasing usage, and that's been prescribing position by prescribing position, respiratory therapist by respiratory therapist, department by department and patient presentation by patient presentation and they all overlay. At the moment our sales efforts are focused on consumables growth on the installed base of hospital hardware rather than on incremental hardware sales and hospital hardware is difficult to forecast at the best of times with no clear or stable patterns being normal and it's even more so at present. So we used a different approach for hospital hardware in our guidance compared to consumers and as a result we called it out although we don't feel it's particularly material to the year's result compared to the rest of the business. We specifically called out $115 million of hospital hardware as what's included in our revenue guidance total and in the absence of those stable ordering pens this number is approximately in line with historical growth rates. of pre-pandemic levels. Now home care is largely driven by OSA masks and we're lapping a very strong FY23 where we benefited from the very successful introduction of our Evora Full OSA mask in North America and a reduction of the CPAP supply backlog and potentially some competitor issues. As we move through FY24 we see market conditions continuing to return to more of a historical norm. And then overall, these assumptions would result in approximately similar revenue growth rates for hospital and home care product groups for FY24 at May exchange rates. Now, Lyndall's already provided an outline of our expectations for gross margin and operating expenses, but just let me reiterate that during the pandemic, we had a responsibility to get as much product as possible into the hands of our customers. And now as demand progresses towards more of a normal state, we're shifting from a supply-at-all-cost mentality to supplying in a sustainable, profitable manner. And as we do so, we're confident in our ability to return to our long-term gross margin target of 65% within a three- to four-year timeframe. And our FY24 operating expense guidance is largely driven by the full year cost of the people that we added during FY23. So in my remarks there, I think we can now open the line to questions, Marcus. Yeah, thanks, Lewis.

Cynthia, if I could ask you to please open up the lines for questions. And before we begin, can I please ask everybody to limit your questions to two? This is to ensure that everybody has an opportunity to participate. If you do have further questions, you're welcome to rejoin the queue and we can do our best to cover everything off within the hour.

Thank you. We will now begin the question and answer session. If you wish to register a question, please press star followed by one on your phone. And if you wish to cancel your registration, you may remove yourself from the queue by pressing star followed by two on your phone.

Thanks. Cynthia, the first question in the queue comes from Gretel Janu at Credit Suisse. Please go ahead, Gretel.

Thanks. Good morning, everyone. Just to start with the guidance, you have OPEX growth faster than sales growth. I understand that's to do with the sales force, but when do you expect to actually see a return on that investment you are making in the sales team, and when should we expect the revenue growth to exceed OPEX growth looking out past FY24? Thanks.

Sure, thanks Gretel. I think we need to go back to our fundamental strategy in FY22 as well actually, which was to make sure we have sales people in place to support the hardware that our customers have acquired. That was step one. Step two, grow the anaesthesia sales force and then the next strategic target was to advance our R&D product pipeline. So that's what we've done through 22 and 23. I think going forward if we need to, I think probably the next comment is we're always going to have our eyes on that operating margin target of 30%. That's probably the fundamental driver and if over time we need to take operating leverage to get to that operating margin target, that's what we'll do. And that has been our history prior to FY19.

Understood. So we should basically think of FY24 then as kind of the new reset and then after FY24 things should return back to that kind of normal marginal improvement story. Is that correct?

Yeah. Historically we've been able to make gross margin improvements year on year. We would expect to get back to that style of operating and also historically if we need to take operating leverage to get to an operating margin of 30% that's what we'll be doing.

Great. And then just secondly, just in terms of hospital consumables and the stocking, de-stocking issues that you had that impacted in the last six to 12 months, has that now been completely resolved? Are buying patterns back to pre-COVID normals now?

So yes and no answer to that.

We think that in the major markets it probably has been resolved. Typically, when you have a COVID surge, there's a bit of an overhang of destocking, and it's really, really hard to estimate that because it overlaps so many other movements. But we think on the whole, there might be a little bit of residual destocking in FY24, but at the moment anyway, we're thinking probably not material.

Great. Thanks very much.

Thanks, Gretel. Next questions come from David Lowe at JP Morgan.

Thanks very much.

Well, so if we could just start with the utilization trends. I mean, I heard what you said there about going doctor by doctor and department by department. But if you could perhaps shed a little bit more light on what you've seen. We're obviously pretty interested in new applications growth. Just wondering if you could sort of flesh out what you're seeing on the ground and what the trends could be over the next 12, 24 months.

Yeah. Let me start with that, and then I might pass over to Paul for some color. But You know, I think that is the summary. It is doctor by doctor, therapist by therapist, department by department, patient by patient. And I think that probably shouldn't come as a surprise to us. That's been the history of the business. We haven't really seen any sort of spontaneous change anywhere. It's really just that steady progression. And I think we're seeing it in all regions. I would say that probably all salespeople have seen evidence of that steady progression. We do see evidence where when we're working with an account, we get a result. Then if you think what kind of result and what kind of evidence, there's a bit of everything I would say. Every scenario you can imagine is in there. Paul, do you want to add some colour?

Can't read much more, but David, I'm just echoing everything Lewis has said. I've just been away for the last couple of weeks around the various sales teams and you're just hearing from everybody they're making progress. We're getting EVOs into departments, into emergency room, obviously in ICU, into the wards. patients put on some of those EVOs, we're working with commission to commission, we're just making good steady progress.

I think maybe one final comment David is if you look at new apps, second half, constant currency, 13% growth, that's lapping a global Omicron spend up, so we think that's a pretty good result and we think that's evidence of that steady progress?

Okay, we're very used to trying to measure it on a utilization number of consumable setups per annum, per device. Is that a data point that you track? Can you give us any sense as to where you think things are now versus where they were pre-pandemic, please?

Yeah, I'd really like to get you off that metric if I could. And I'll give you a couple of the complications. First of all, we've got a very flexible installed base. Most ventilators in intensive care for invasive use these days, they're going to deliver nasal high flow non-invasive ventilation or invasive ventilation. Most non-invasive ventilators, and they'll be in intensive care, they'll be in emergency departments, they'll be in respiratory wards, they're going to deliver nasal high flow and they're going to deliver non-invasive ventilation. When we go to a metric like that for our installed base, the installed base is quite flexible. The second reason that makes that metric not so useful for us is that very different patterns of usage that you see throughout a hospital. In an ED, you might have three or four patients a day on a piece of hardware. In a surgical unit, maybe one. In an ICU, average patient stay might be three or four days. When you get to a ward, a patient could be there for a week. or longer. You've got really different patterns of usage. I think 10, 15, 20 years ago the metric was fine for us. We were largely ICU, we were largely one therapy and we were largely one set of hardware. I think at that time it made sense. Now it just doesn't add up for us because of those different patterns of usage. As I said before, we see every variation on the scene. we can see hospitals better penetrated in wards than they are in EDs and vice versa and so on. Thirdly, there's another phenomena going on there, David, and that is, and we tried to illustrate this a little bit on one of the slides in the pack this time around, somewhere in the 30s I think, but as a hospital gets more penetrated, as they get more hardware, apparent utilization can drop. If you had three or four EVOs in your 50-bed ED, you're using them flat out all day, every day, and utilization looks really high. If you bump that up to 20 EVOs, it looks like utilization's dropped, but that's actually a great outcome. The extreme example there, if we had a hospital with an air vent every single bed, that would be the lowest utilisation we would ever see and it would be the greatest success we could ever have. So long-winded answer to your question, David, but I just really want to explain that we're not being coy about it. It's just not a number that has any utility for us.

My questions are up. Thanks very much. I would like to understand what metrics we could look at as an alternative, but we can perhaps touch on that another time.

Thanks. I think I will go there. Look, it's really about patients treated. That's the goal. That's what we're after, and that's the measure of progress, and that is reflected in consumables.

Thanks for your questions, David. Really appreciate that. Next question's come from Matt Montgomery at Forsyth Bar. Please go ahead, Matt.

Hi there, good morning. Maybe just a question on OpEx, Lyndall. You made the comment in your remarks just that you're expecting a small increase in people in F24 on the back of a 9% increase in 23. This seems low to me. Are you therefore saying that you're currently comfortable with the headcount within the business to drive utilization of your installed base? It sort of doesn't really align with strategy and prior commentary.

Yeah, let me take that one, Matt. So the small increase in people is largely in the sales team. That's the main driver and it's continuing to build out the anesthesia. and it's continuing to support the hardware that we've placed in our geographic expansion.

Okay, that's fine.

And then maybe just further on David's question before, slide 37, appreciate this improved colour and disclosure. Can you maybe just talk to these numbers in terms of usage and locations in a pre-COVID world. I suppose it's just another way of asking sort of the uptake trends that the other analysts have asked.

Yep, let me just get to page 37. Yeah, so look, we really are trying to illustrate that point of you've got different usage, different apparent utilisation or different turns rates depending on where you are in a hospital. And we have taken, this is actual data from a hospital. It's at the pretty good end of OptiFlow adoption. So that's an actual example. And I think if you start, the point there is if you look at where are the EVOs on the right-hand pie chart, you've got three-quarters of the installed base is in wards. And in this case, that's generating about half your consumables. That's probably under-penetrated. We've got 11% of our hardware in intensive care. That's generating about a quarter of our consumables. Intensive care in this case, and this would be quite common, is pretty well penetrated with EVOS. That's generating a quarter of our revenue. And then you look at the other 13% of the installed base. in emergency departments, that's generating the other quarter of the consumables consumption in this case, and that's quite an under-penetrated ED. So I think all we're trying to illustrate here is that 10, 15 years ago this was largely an ICU, and if you look at a more advanced adopter case study, you can see a very clear trend to usage outside ICU and you can see really there's a significant opportunity outside ICU that's being realised there.

That's all we're trying to illustrate on that slide. Okay, now that's good. That's my two. Thank you.

Thanks, Matt. Next question comes from Craig Wongpan at RBC. Please go ahead, Craig.

Good morning. My question was just on the gross margin improvement, the sort of expectation of getting back to that 65% over three to four years. Should we think about that as like a gradual improvement up to that level or is there going to be step changes as you get sort of volume increases and manufacturing efficiencies?

Yes Craig, thanks. It's going to be a gradual change and it's not going to be linear so that's why we said on average about 150 basis point improvement per year. We're looking at a bit higher than that in constant currency for FY24 as we will be able to get a stronger improvement in the manufacturing inefficiencies that we had in 23 as we move into 24. The exact timing of that and the quantum will be a bit dependent on the inflationary cost increases that we're seeing and mitigating in our usual practice of improvements.

When we're working on gross margin improvement there's so many levers that are all being nudged, there's so many moving parts there.

And then my second question, just on the hospital hardware sales that came from COVID, are you able to give some colour around how much that was in FY23?

Yeah, look, the sum we do may be right or wrong, but to answer the question, we take FY19 as a base year and we'd put 3% to 4% growth a year off that and we'd call that normal. And there's not a lot of... There's no other rationale to that. So if you apply that to FY23, you'd get around about $40 million coming out due to COVID.

$40 million. Thank you. Thanks, Craig.

Next questions come from Dan Hurren at MST Marquis.

Good morning. Thanks very much. One for Lyndal. I just want to ask about that 12% OPEX growth. Some comments you made in the past, it's been hard to spend up for that spend than you might expect. Can you just talk about the operating environment and the risk that you might underspend that number in 24?

Yeah. We were talking about that mainly last year where we were aiming to add quite a lot of people through FY23, and that's what we were really referencing and why In 23, we were saying, look, we're targeting this sort of growth, but it is dependent on adding a lot of people. And as I mentioned, we have actually managed to add them through 23. It just has taken us a bit longer to get them in place. They're actually largely in place now, so that's why we're seeing that growth into 24, which is all largely baked in now.

Got it. Okay, thanks. And just a second question, just I think following up with some other questions. about COVID and the operating conditions. You mentioned China COVID and the US flu season in the January update, and you're guiding to basically no COVID in the normal flu season, FY24. So I was just trying to get an idea of what that second half hospital number would have looked like under normal conditions, and perhaps if we look at your pre-January revenue guidance, is that a fair assumption of what it would have looked like if those two events hadn't occurred?

Yeah, I think so. I'm still trying to process the question.

Sorry, I always ask complex questions. So, look, Bryce, I'm just trying to figure out how much benefit there was from that strong flu season and the China COVID that you mentioned in January. And the way I'm thinking about it is that your pre-January revenue guidance, is that kind of indicative of where you would have been had you not had that COVID surge in China and the strong US flu season?

Yeah, that's kind of... Let me take that one by one, maybe. So when we look back at FY23, we've got a whole range of competing myriad of effects going on there. We've got destocking running through probably abating, but maybe still in the second half. We've got some potential overstocking here and there and some markets running through the year. As you mentioned, you've got your seasonal flu impact, you've got seasonal RSV impact, and those are all happening at the same time as you've got some underlying growth in clinical usage. So, you know, and they all overlap a bit. And we don't have a fundamental data point for any of those things So what we have tried to do for you is try to have a look at exactly your question, how could you potentially normalise that? The only way we can really do that is look at the recent stable trends, have a look at our normal historical sales trends and overlay them. So when we do that, we get a net benefit to the second half of somewhere around about $35 million in FY23. But then on the flip side, we would have a penalty, if you like, to our first half of around about $45 million. So I think I just want to emphasise those are kind of rough analytical sums at the top line. I'm talking about hospital consumables at the top line. and probably the number I'd be going with would be the net impact is about a benefit of about $10 million for the year. That's helpful. Thanks very much. You would add about $10 million to the year as a rough sum.

Thanks very much. Thanks, Dan. Next questions come from Tom Deacon at Macquarie.

Good morning, guys. Thanks very much for taking the question. Maybe just the first one on GP margin recovery. Can you just give us a bit of colour in terms of where you see that coming from compositionally in 24A, trade and manufacturing inefficiencies? And maybe a second part, what kind of hospital revenue performance do we need to see upside to the GP margin recovery guide in 2524?

Yeah, thanks Tom. So for those improvements in 24, we're thinking that we probably get about 100 from freight, about 50 from price increases and about sort of 150 odd for manufacturing efficiencies. Then that sort of adds up to the $300, but we're facing cost increases of about 100 basis points coming in and offsetting that in there. Actual sales of hospital consumables next year. shouldn't materially impact that because we can sort of either build or deplete inventory depending on what revenue does. So it's slightly less dependent on revenue, but obviously could have an impact depending on how materially different that is.

Understood. That's helpful, Lyndal. Thank you very much. Maybe just going up to the top line for my second line. And you kind of alluded to a couple of points here, but just to get some clarity, what are you thinking in terms of respiratory hospitalisations and that profile in 2024, and how does that feed through into your hospital revenue guide? Are we expecting lower COVID, a little bit of a lower sort of more normal flu season this year?

Can you just give us a bit more colour there?

Yeah, I just want to give you one insight. This guidance does come from country by country, territory by territory, region by region. We add it all up and then we try and analyse it, what it might mean at the top line. So these are kind of implications of this guidance and I think the implication is comparable flu season, 24 to 23. That's one of your questions. COVID, I mean, we've got COVID bubbling along in 23. It's probably going to bubble along in 24. I think the implication is probably pretty similar. in terms of hospitalisations taking out the surges. Does that help?

It's helpful. What about RSV? Would you assume a similar RSV season, given that we might see the imposition of some vaccines in the latter part of this year with the FDA approvals of waxes with clients of a 60-class vaccine?

Yeah, so when we go region by region, mostly material in North America. We haven't seen great data, but we haven't seen much evidence or data-based evidence out of Europe. And then also when we look at influenza or the flu season, again, you see probably a pretty normal-looking US number. Europe looks a little bit light. So when we try and analyse it and we aggregate that all up, it all kind of comes out to about normal. So I think that's the assumption in guidance. It's normal and if you aggregate that all up you're potentially lapping normal.

That's helpful both. Thank you very much.

Thanks Tom. Next question has come from Saul Hadasson at Baron Joey Capital. Please go ahead Saul.

Yeah, thanks. Good morning. Just a couple of questions from me. Just in terms of the revenue guidance into fiscal 24, Lewis, are you able to give a bit of more detail regarding your thoughts on traditional app sales growth versus the new app sales? Are you effectively thinking new app sales will drive all of that growth, just noting traditional consumables are a bit flat through FY24? Sorry, through FY23?

So we typically think of traditional in the mid-single digits. We think it probably is impacted by COVID surges, overstocking and destocking, but we think to a much, much smaller extent than new apps. So I think there's an effect going on in there, but when we're doing our analysis, we kind of assume that effect is less material than the new apps effect. So we assume it kind of trucks along in that mid-single digits.

And does that translate to maybe a teens type growth for new app consumables?

Yeah, exactly. Yeah, so mid-teens for new apps.

Great, thanks. And then just one more, just on that commentary around recovery of the EBIT margins back up to that sort of 30% target. So is it right to assume that if you reach the gross margin target within the next three or four years, would that EBIT margin naturally inflate back to 30% or would Are you expecting OPEX growth to remain robust over the next few years, in which case you would have to assess those levers around OPEX to get that margin back up to that 30% level?

Look, we assess it on a year-by-year basis. We would certainly be expecting to sort of start taking some operating leverage over, you know, not in 24, as we're seeing, because we've got the people from 23 that we've added that has that impact into 24. But look, we'd probably expect the operating margin to follow once we hit the gross margin by a year or two maybe. But we sort of assess that every year sort of based on what we're doing in the business, what we need to do from an operating perspective really for the long term. We don't focus as much on an annual margin.

I think it's our assumption and our history is that we'll be able to generate efficiencies in OPEX. And you've seen us do that for decades. And then the question is, do we want to take them as operating leverage and get to the operating margin target, or do we want to invest them in the business?

Yeah.

Great. Thanks, guys.

Thanks all. Next questions come from Stephen Ridgewell at Craigs Investment Partners.

Good morning guys. Just firstly on Evo 3, as far as we can see it hasn't yet got FDA clearance for the US. Does the FW24 guidance for $115 million of hospital device revenue assume FDA approval for Evo 3 comes through and any material revenue from the US or other key markets, please?

The short answer to that is no. We're not assuming anything material in FY24 from Evo III in the US. That'll probably be much later in the year, and we're not expecting it to be material.

Okay, thank you. Just on anaesthesia, Lewis, you mentioned the revenue guidance assumes strong revenue growth off a low base. In the past, the companies kind of talked to a surgical anaesthesia washing its face in terms of profitability, but just interested, given the new sales hires in that space, is that segment expected to lose money in FY24 and give us a rough quantum? Would it just be useful to get a sense of the scale of investment perhaps in that segment which is perhaps weighing down the overall guidance books?

It will at least be washing its face Stephen. No concerns there. That's kind of the algorithm we use to ensure it does when we add people. Once we generate enough revenue to support the person we do. So that's that part. That's probably the best advice I can give you.

You know, that's helpful. Okay, so that's good to hear. And then would you, I guess, as you have the plan that's washing its face this year, that you might start to see any contribution kind of into next year and beyond? What's your thinking in terms of the medium term for anaesthesia, please?

Well, washing its face means, you know, all the way through, you know, Stephen, we focus on the profitability country by country, region by region. So washing its face means it's making the right contribution that we expect it to make. So maybe just to clarify that one for you. And then I think probably where you're going is at present you're looking at maybe a bit over 5% of new apps growing really strongly. That's probably the sum.

Okay, that's helpful. Thanks, Lewis. I can just think one more on China. Can you talk a little bit further about the revenue benefit to China that was a major driver of the upgrade in January. Did that market perform in line with your expectations that you had in January for the balance of the year? And then can you perhaps talk a little bit to whether you're seeing repeat business for the devices that were placed at this point, or like other markets, do you think you've got to get your sales reps in there to really improve utilization of those installed devices?

Let me start with China.

So look, we've kind of netted China out in the second half number I gave you of 35 odd million benefit. It's in there because we can't really call it out. When you get to China, you've got all the same old things going on that we have in every other market. You've got impacts of COVID surges. You've got overstocking, you've got destocking at You've got all the same phenomena. In China we've got another phenomena going on, or two more really, three more really, and that is we do have about a dozen competitors in China and they are building hospitals at an astonishing rate. They have been over the last few years. They are continuing to build hospitals at an astonishing rate so that makes it even harder to do the analysis and then when you put that together with a dozen competitors and an intense national interest in local capacity, probably the best I can give you is that we've wrapped it up into that $35 million second half benefit.

That's helpful. Thank you.

Thanks, Stephen. Next questions come from Marcus Curley at UBS. Please go ahead, Marcus.

Good morning. Lewis, I just wondered if we could start on the hospital business. It sounds like the guidance implies around 10% consumable revenue growth. Is it right to assume that business is normal in terms of how you're thinking about it at the moment? And if that's the case, to sort of get that division back up to, let's say, the traditional target of 13, we'd need to see new products added or anaesthesia

start to be a much bigger part of the business?

Well, depending on your time frame, right? As your time frame stretches out, you're expecting anesthesia to be a bigger and bigger part of the business. If your time frame's the next couple of years, I would say no, you're not really relying on new products or anything like that. We're relying on the steady progression of increase in use across more patients, more departments, more hospitals.

And so the anticipation is that the 10% you're seeing this year, you could look to accelerate over the course of the next few years through high flow in the hospital?

Well, I guess that's always possible, Marcus.

I'm not sure where you're getting your 10% from, but we'll just take that off the table. I think probably the fundamental here is the guidance we've given you is a reflection of the recent stable trends, and that's what it is. Then to go further than that, we'd be speculating.

Okay, the 10% is just, if you talked about, it's about 8% revenue growth in the guidance. You've called out the device number, so the difference is the consumer's number, which is obviously a little higher than 8%. Anyway, let's move on. Second question, just on home care, you obviously talked to a lower growth number this year. It's been a while since you've had a new mask. Obviously, the last mask was very successful. What's the pipeline like? Do you think you're overdue something in that space, or how are you thinking about product launches there?

Yeah, we are due a couple of product launches in the very near future there, Marcus. That's about all I'm going to give away on that.

But I suppose on a basis, it's unlikely to be material this year.

Correct. Yeah, that's right.

That's right.

Thank you.

Thanks, Marcus. Next questions come from Sean Lamarne at Morgan Stanley.

Good morning, everyone. Hope all is well. You mentioned the... gross margin upside past due to price on the outlook. I was wondering if you could characterise the pricing environment for us and particularly as it references OSA, Marce, are we thinking low single digits, mid single digits? Just a bit more characterisation on your thoughts on price would be great.

We're all looking at one another on that one.

One thing I'd point out is for the hospital Most of our customers will be on some kind of supply contract. They might typically be three years. They might be four. Two would be a short one. So you've kind of got, on average, maybe a bit over a three-year cycle as you roll through the hospital pricing, home care or mask pricing.

Paul, do you want to? Yeah, I mean, it's relatively stable, what we think of pricing in home care, because with new product introductions, that may be at a different price point to some of the masks that you've been traditionally selling. And so we kind of think of average selling prices for our masks as relatively stable in the home care environment.

Great, thank you. And second question, just on labour inflation. So you talked about adding new heads, What about the unit increase on unit labour inflation, if that makes sense?

Yeah. Yeah, Sean. Look, we're seeing that across the business and that's sort of what's been incorporated in here as well. And that's part of also why in the OPEX, whilst we've added 9% people during FY23, there's the cost of them plus the inflationary rate of salaries and wages built into that, as well as we see it in the COGS line too.

Great, thanks so much for answering my questions.

Thank you, Sean.

Next questions come from Adrian Orbon at Jarden.

Sweet. Good morning, Tim. My first question is like in OptiFlow. If I go to your slide 35, I think you're calling out that you've treated like roughly 6 million patients on OptiFlow. If I sort of go back to FY20, I think the same call out was around about four. And then the sort of the bridge in between, I think from memory, you kind of said you might have treated up to sort of three million with OptiFlow for COVID applications. So is the way to think about the six million that you've sort of replaced almost two thirds of that COVID peak with underlying growth over that period?

I think not really. I mean, there is something I will point out here is the patient numbers are based off our volume, so you've got the overstocking, destocking phenomena going on there. But I think on the whole, we're probably treat... I haven't got it in front of me, mate. Just let me find the slide.

Adrian, this is Mark. I don't think we called out that we knew the number of patients that were treated with with OptiFlow during COVID. I mean, you mentioned a number there of three. I don't think we even would have had a guess at that. So that's a very difficult number for us to try and ascertain.

OK. Did you have a follow-up, Adrian?

Oh, sorry, I was just waiting to see if Lewis was coming back on that. I guess my follow-up would be then— Oh, I found the slide. OK.

Sorry. Go ahead.

Oh, sorry, did you have any follow-up on that? Are you able to give us some sort of— I guess what you've done earlier in the call, which I understand, is you've tried to orientate us away from utilization and to patients treated. I guess you've given a patient's treated number here, and we had a patient's treated number pretty much on the eve of COVID. The Delta feels like 2 million, or is 2 million in circa, across three years. There's been COVID in between. I'm just trying to get a sense of what the underlying replacement of COVID patients' rate is.

As you've hit guidelines and pushed the therapy and stuff like that, and you've placed hardware,

Right. The best place I could probably point you at there would be second half FY23 versus FY19. Look at something like that, which I haven't done.

In terms of patients treated?

Yeah, using consumables as a proxy.

We can't know what patients were treated because they had COVID versus anything else so that sort of how many of the patients treated in the last couple of years were COVID versus anything else. We really can't tell that.

Okay, I understand. Can I just ask a follow-on question then? You obviously made strong guideline progress for high flow and I think you've got a slide in here that sort of demonstrates it's there's still room to move in respiratory in general in terms of a hospital setting. And I understand you're strong in hypoxic, strong in post-situations. How much of the R&D spend is sort of focused on clinical trials, I suppose, and specific applications to sort of broaden out the underlying patient demand? Can you give us a sense of that? And then maybe a question slightly before that, what's the Salesforce sort of doing now with this guideline support?

Sure. Let me take the R&D spend one. So as far as respiratory OptiFlow goes, you've got hundreds of papers a year. We're not really part of that. It's got a life of its own. It's the research community exploring the questions. Our R&D clinical spend tends to be much further out into the future, and we tend to be doing the early work, if you like, in our clinical studies that we're funding. We tend to be the... the venture capitalists of the clinical study world. And then the second question was about guidelines and things.

So Adrian, obviously we're using guidelines to advantage and talking to our customers about them. And what we're trying to do from the guideline is to try and get clinicians to put protocols into place. so that they're adopting those guidelines. And then the real key thing from there, just because you've got protocols in place, is making sure that those protocols are actually being used, and that's what we call adoption. So there's quite a process we go through from guidelines to protocols to adoption of those protocols. Just one step in the steady progress. Yeah.

But just, Paul, are you seeing the efficiency of your Salesforce effort now start to build? Because obviously that process is, was going on before but you didn't have the guideline necessarily recognition?

Absolutely and I mean we're always fundamentally trying to be efficient and improve our efficiency and the guidelines are very helpful because they are guidelines and it's something that clinicians take notice of so yes it does help us and it will help us become more efficient

Thanks, Adrian. Conscious we're at the one hour mark, we've still got two more people in the queue, so we will take those. So next questions come from Matthew at Citi. Please go ahead, Matthew.

Good morning. Thanks for taking my question. My first one is on hospitals. What are you seeing in terms of access to hospitals and hospitals' budget for hardware?

Yep, I take that question, Paul, here. Access to hospitals is improving all the time. Obviously, it's been difficult during the COVID period, but we're getting more access in hospitals as we go. One of the problems we are facing is just clinician burnout. Sometimes a lot of the clinicians are just wanting to take a bit of a breather, but all in all, we're getting better access to hospitals and clinicians. And And it's very spotty in terms of hardware budgets. In areas where there's been a lot of hardware bought for COVID, probably there's not a lot of thought or budget available for hardware. In other areas where there weren't COVID surges, it's pretty much business as usual.

Thank you. And then just in terms of the OSA business, maybe one for Lewis, do you think that not selling a device I know I say DeVos in the U.S., puts you at a disadvantage longer term as Philips will eventually return to the market and they may be more aggressive to try to regain share, not only in DeVos, but in our mask as well.

Yeah, no, we don't. But there is a key component. As long as we've got a mask that performs better than anything else a patient can get or a dealer can get or a sleep lab can get, We think we're going to do pretty well. That is what we have been doing for over 10 years now. I think the model's proven.

Thanks for your questions, Matthew. Really appreciate it. Lucky last in the queue, Chris Cooper from Goldman Sachs. Thanks for waiting. Chris, please go ahead.

Thanks, Marcus. Morning. So, Lewis, I heard your comments around the challenges of assessing the productivity of the installed base. Perhaps I can just ask it slightly differently. How are you incentivizing the new sales staff you've employed in the year? What would you consider to be a good quarter or a good year for one of the new reps, and how are you measuring that?

We do it a bit differently country by country, but the general principle, as you pointed out, because it is so hard to measure, and because we are long-term, we can be working with an account for four or five years. Some of the success rates we've had since COVID have been accounts that we've been working with since before COVID. It is a long-term plan and it's a long-term process. Incentives where we have them specifically tend to be around projects, project-based, what we agree, what a salesperson agrees with their manager or agrees with the sales manager is their objectives for the year.

Chris, we're very project-based and obviously the ultimate result is sales, but we're tracking each salesperson by project, what we're trying to achieve. and the progress we're making throughout that project.

Okay. And just secondly, on the EBIT margin, it may be somewhat related, but I just want to get a sense of how important that 30% target is to you. It sounds very much like you're running the business primarily for a gross margin target. But you've mentioned a couple of times on this call, you sort of can squeeze additional operating leverage when you choose. I guess the question is, when would you consider that necessary to do? And what levers are you referring to when you talk to operating leverage in that way?

Yeah. Look, I think it goes back to a philosophy of sustainable, profitable growth over the long term. and to be sustainable, profitable over a very long term, you grow OPEX at the same rate you grow revenue. So that's the first concept. The second concept is we chose these targets of 65% gross margin, 30% operating margin as being great performance over a very long term. Companies certainly do better than that from time to time, but if you can sustain it and maintain it, you're doing a great job. So, you know, prior to COVID, We had our eyes on those two margin targets and steadily worked our way towards them. Of course, they kind of go hand in hand, gross margin and operating margin. We steadily worked our way towards them. And we move towards them, as I said, kind of by taking efficiencies that we generate in our sales operation and our manufacturing operation. We can either use that as leverage to get towards target or we can decide to keep it in the businesses. That's an ongoing process, making that trade-off. It's something we look at frequently, but always we're working towards those margin targets. Always we're expecting to gain efficiencies in what we do. It's more about where we put it.

Very good. Thanks for your questions, Chris. That brings us to the end of the Q&A. Before I pass over to Lewis for the final word, just a reminder that we have our investor event planned for the 14th and 15th of September in Tijuana, Mexico, in Irvine, California. I know a number of you have registered already. We're looking to see many of you there, and it's a great opportunity to reconnect and see our operations in Mexico and to hear from some of our customers in our U.S. team. and you can register for that event on the investor page of our website. So with that, over to you, Lewis, just to conclude the call.

OK, thanks, Marcus. Thanks, everyone, very much for the questions. Now, before we close, I would like to just zoom out a little bit and recap the last year and the opportunities in front of us. So when we look at it, our hospital salespeople are describing a steady progression of increasing usage of our therapies. Hospitalisation rates are beginning to stabilise in most regions. We've launched a very successful OSA mask in Aurora Fall. Gross margin is beginning to revert to our historical pattern of steady improvement. We've invested in R&D and salespeople to fully realise our opportunities, and that's over both the short term and the medium term. And for the long term, our response to COVID has advanced our infrastructure investments. Looking at going forward, we've got a unique pattern of alignment for our business. We continue to have under-penetrated markets. We've expanded our sales teams. We've expanded our geographical reach. We've got a growing body of clinical evidence for our newer therapies. And we've got a very promising pipeline of new products. And our infrastructure developments are well underway. And we think all these factors line up in our favour, and they all leave us with confidence in the long term. So thank you very much to everybody for your time today. Thank you.

This concludes today's call. Thank you for your participation and you may now disconnect.