Cochlear Plc Ord

by and welcome to the Cochlear Limited Half Year 25 Result 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 would like to ask a question you'll need to press the star key followed by the number 1 on your telephone keypad. I'd now like to hand the conference over to Mr. Dick Howitt, CEO and President. Please go ahead.

Good morning everyone and thanks for joining for our Half Year Results presentation. So here with me today have Stu Sayers and Sarah Tom. And Stu, who was our CFO until the end of December and is now President of Asia Pacific and Latin America, will talk about the result because it's the result for the last half. Sarah, as our new CFO, is here with me as well. Okay, so thanks for joining. Let's get underway. And we have our mission up front because... That does guide all that we do at Cochlear and it also sets out our longer run ambition and underpins our long-term strategy for growth. So looking back at the first half of this year, overall we were pretty happy with the outcome but clearly as you look into it, there's some mixed results in there. So strong cochlear implant revenue growth at 13%, acoustics revenue very strong at 22%, and services, which we'll obviously talk more about, declining by 12%, but all of that giving us a net sales increase of 6% in constant currency. Our underlying net profit moved pretty much in line with sales on a reported basis, with our profit up 7% to $206 million. Gross margin that Stu will talk more about in line with our targets and our operating expenses up 10%, so a bit faster than sales and that's not unusual for us early in the year as we continue to invest into R&D and very much into driving growth. Balance sheet remains strong with $383 million in cash. Now, that's come down a bit as we've been building up inventory ahead of new product launches, and Stu can talk a bit more to that. And the dividend up 8% to $215 and just short of our 70% payout ratio. And we're maintaining our guidance range, but do expect to come in at the lower end of that range. And two contributors, which we'll talk more to, the lower services revenue and outlook for the year, and we've increased our cloud spending in this year as we move into the final phase of our cloud transition. So let's go into these in a bit more detail. So cochlear implants first up. So sales revenue up 13% and unit growth of 6%. Now developer 5%. Development market's going 6%. And remember here we had a 15% growth in the first half of 24. We saw a good growth across the US and Asia Pacific in our developed markets, but a lower rate of growth in Western Europe. Importantly, adults and seniors grew at 10% for the half, whereas our children declined modestly. And we're actually pretty pleased with that outcome for children because if you remember back to the first half of 24, we had strong growth, actually had double-digit growth for children, which we said was a one-off. We thought some share gains, and in the US, with the FDA changing its indications from 12 months to nine months, we had a pull forward of younger children getting surgeries earlier. So we were pleased to see that actually, rather than settling to a lower level, actually that children have started hasn't grown it that way and stayed pretty strong. And I think it's a good indication of our competitive position in children in paediatrics. But we do continue to work on the core of this, obviously, our long-run strategy for growth in adults and seniors, which is by far the biggest opportunity that we have, and we continue to invest in our strategy for growth. We continue to see good adult referral rates And we do continue to see some of the bottlenecks in a few places, as we've talked about, particularly at the full year for 24, particularly around audiology. But equally, we're seeing increasing engagement and uplift of more efficient paths for audiology, fewer appointments in the first year. We still have a long way to go, but it is pleasing to see increasing adoption of fewer appointments based on the evidence showing that outcomes are equally as good. Now, in emerging markets, this was a bit behind where we had hoped to be in the first half, but recognising that emerging markets always has some volatility to it. We said at the full year that there were A number of markets, including India, where tenders hadn't come out at the rate that we had seen in the past or expected. We did expect those to come back through this year. We haven't seen as much of that in the first half. But the demand is clearly there and the governments have funded before, so we do expect that to come back. And we did see a lift, you know, that gap between the revenue and the unit growth rate. largely driven out of emerging markets and it's a reflection of lower tender volumes, a positive country mix, obviously countries have different prices and some stronger growth rates in private pay segments and the premium segments in China and in India. So certainly pleasing to see the the growth in those premium segments and that's supported stronger growth in cochlear implant revenue overall. Now if we move on to services and to our upgrade business, so clearly down 12%, that wasn't where we expected. We did expect it to come off given the 29% growth in the equivalent half last year. We saw that growth come off in the second half of 24. We didn't expect it to come off by as much as it did. Now, there's a few factors underneath that. One of the significant ones that we are seeing is this cost of living pressures, particularly in the US, that we are seeing a higher rate of cancellations or inquiries that don't follow through. when people see they're out of pocket. We were actually asked about this at the half, at the full year, and then we said we were monitoring it, but we hadn't seen an impact from inflation and higher cost of living in this half. We have seen, particularly in the US, an impact of inflation, higher cost of living, pressures of people deferring upgrades when they see the co-pay. Further on that, and part of the reason I'll do that is because Nucleus 7 is such a good product. Nucleus 8 is a better product than people who switch, recognising the benefit that we have these two pieces of Nucleus 7 being very strong in cost of living pressures, having people defer upgrades. In this area we do, and as part of our cloud transformation, putting a new CRM and implementing a new cloud-based marketing automation system, which will enable us to much better segment our customer base and be able to therefore better target people on upgrades. Because while there's barriers around co-pays, one of the biggest barriers to upgrades still is awareness of eligibility. And We have made good progress but there is more progress for us to make in actually being able to segment eligibility and where we are able to make people aware of their eligibility and the benefits of new products and we're building the platforms to enable us to do that. So let's move on now from services and going on to acoustics and a very strong half in acoustics. recognising that it was a little bit weaker in the first half of last year because we introduced the OSI 300 in that half and we saw some surgeries held in the US which led to a 50% increase in surgeries half on half for the OSI, for the Osseo system. Baha continues to perform well, but Ossia is absolutely the driver of growth, and as we have talked about for the last few years here, we see a huge opportunity, long-run opportunity for growth in acoustic implants. With Ossia, we clearly have the right product to do it, delivering great power output in high frequencies, simple to implant, very good MRI compatibility. and extremely good feedback from virtually all of our OSSEA recipients. So we've got the right product. We've got a huge opportunity. We continue to expand into new countries. So we are reflecting the quality of the product by asking for a higher price, which is appropriate, and that means it does take time for us to roll out country by country. Having added France and Italy recently and a number of emerging markets, we see good growth in those as we roll out. But lots more opportunity to come in acoustics and very confident of our product portfolio there in that competitive position that we hold and our activity to drive growth. So with that, I will now hand over to Stu to talk through the P&L and the balance sheet and I'll come back to talk about the outlook.

Thanks, Dick. Morning, all. So you've heard Dick talk to the sales line, that 6% change year-on-year constant currency. I won't add further to that. If you look at gross margin, that's 75%. That's slightly better than we had expected, and that's really the tailwind of some higher ASPs in emerging markets, offsetting what we knew was coming in terms of a little bit of a headwind Whereas Chengdu is still very much in ramp-up stage, that Chengdu site, we are manufacturing and selling sound processors out of that site now. We've just got approval to manufacture and sell implants out of that site. They come through in December. So while that plant is in ramp-up, and that'll be for the next year or two, we'll still see a slight headwind there. We are expecting to be at about 74.5% at the full year. Good growth in the sales marketing general line, and that's really us continuing to invest in medium to long-term growth. So that's standard of care, that's direct-to-candidate activity, really all of the activity around expanding access and awareness, and we continue to see good progress and good wins in that space. R&D, as we often say, we aim to keep that at 12% of revenue, and it is there again for the half. It's up slightly more than that year on year, and that's really just a function of sort of timing more than anything, being slightly below that 12% mark and slightly fractionally above it at the end of the half. Again, 12% of revenue is the set point we're aiming for there. Dick mentioned the cloud investment. H1 at 11.7 was slightly lower. Again, that's a timing thing. We are... accelerating that program. We're going to be spending more in half, too. We still expect to be at around 40 mil for the full year, and I think we'll talk to more of that acceleration into FY26 as well. And lastly, underlying profit, both pre- and post-cloud, given the slightly smaller cloud spend, 18%, and again, that's that set point we're aiming for. So on to the balance sheet. A key change here is a pretty significant move in inventory. You can see that 69.5 mil increase in H1 in inventories, driving the 97 mil change in working capital. That's really a function of two things. The biggest one, a build-up of inventory ahead of some major new product launches coming later in the year. And then also, again, some deliberate choices to hold higher levels of safety stock on a And again, that just makes us more confident that there's no chance we ever run out of stock. That stock level, as I said, it's ahead of new product launches. We do expect it to stay at those elevated levels through the end of the financial year, and it should start to moderate towards the end of calendar 25. Property plan and equipment up 18.6%. That's continuing investment in the Lane Cove site capacity expansion and the same in Malaysia in our KL operations. And the net cash line coming down 130, really that's a function of the inventory build and the higher inventory line. Obviously, we're still doing the share buyback and remembering that H1 is always a bit heavier on cash use versus H2, because that's also where the STI payments for the prior year come out. And then lastly, on to cash flow. Operating cash flow is down 47. Again, that's a function of those inventory movements. We did get stronger cash coming in through the underlying business. CapEx, very much in line with last year and where we expected. And as previously mentioned, where the 19 mil on share buyback, that's the amount we've spent since June, and that program is set to continue. And with that, I'll hand you back to Dick.

Okay, thanks, Jude. So let's go through the outlook. So we still aim to help over 50,000 people here with one of our implants, cochlear or acoustic implants this year, and we remain on target for that guidance range 410 to 430, but we'll be at the lower end, and that is driven by services revenue coming in lower than our expectation for the year and the higher cloud investment that Stu just talked to. So for cochlear implants, we do expect to end up with a unit growth rate of around 10% for the year. We will be launching the next generation cochlear implant around the middle of the year. Obviously, that's dependent on the regulatory approvals. Just to head off questions on that, so we are saying that we are launching the product around the middle of the year, but we're not going to go into any details on what's actually in that product. For that, we need to wait until, and our customers need to wait until we are ready to launch and we do launch the product. but obviously we expect that to be available through FY26. Our activities to drive growth that I've talked about and Stu talked about, part of our longer-run strategy, particularly to focus on adults and seniors in developed markets, remains intact and we continue to see good signs of raised awareness, more people being referred. and therefore more demands coming through in that very important segment. And that's supported by the ongoing increase in evidence showing the importance of treating hearing loss as people age and particularly the links between hearing loss and cognition that continue to strengthen with a number of research programs around the world exploring that. So on services and on upgrades, we did, as you said, saw a really strong uptake of Nucleus 8 when we launched in financial year 23. We did – we saw the growth slow in the second half of last year. We still didn't expect modest growth for 25. We're now expecting a single-digit decline. I've talked about there that impact of – out-of-pocket definitely being a factor there. And we certainly have more work to do to build, increase our ability to connect with recipients and to promote the benefits of Nucleus 8 over Nucleus 7. But there still is a significant unmet demand or unmet need for upgraded and new processes. but we have still a large proportion of our recipient base on processes older than Nucleus 8 and actually still on older than Nucleus 7. So the opportunity is there and we're working hard through a range of activities to lift the upgrades as we go into the second half. And certainly as we go into 26, we have an increasing eligible recipient base and we'll have Our new off-the-ear processor, Kanso 3, which will be part of this mid-year launch available both for upgrades and obviously as part of a new implant system. Acoustics, I've talked about the outlook there, the continued geographic expansion and also continued work on raising awareness of the benefits of acoustic implants in the markets where we've already launched, building patient pipelines, building the clinical evidence showing how good the outcomes are with Ossia and the benefits that patients and healthcare systems see from people taking an acoustic implant over doing nothing or alternative therapies. And then finally on the cloud investment. So as you know, we've been investing in working on our operating model on upgrading core and aging business systems to cloud-based systems over the last four years. All of this aims to improve our efficiency and agility as well as make sure that we are capable and able to support a growing and larger customer base. So we've increased the amount that we're going to spend by $100 million to $250 million from our previous estimate, and that is directly as a result of expanding the scope. As we've gone into this final phase of replacing our core ERP and manufacturing systems, we have found that we want to do more from a data perspective to make sure that we are set up to leverage the benefits of having clearer data and particularly with AI and to make sure that we can support our customers very well. From a manufacturing perspective, as we grow, we are adding a new manufacturing execution system that actually wasn't in the original scope, and that's to make sure that we can meet all of the regulatory requirements for traceability around our manufacturing processes. But we're also going to accelerate that program so that we will finish it in 27 with the majority of that balance spent in 26. And so given that materiality of that increase from the rate we've been running at year on year, we will report it as a significant item for 26 so that our underlying performance of the business is clear. Okay, so that's a summary of the outlook. I'm happy now to switch over to questions.

Thank you. If you'd like to ask a question, please press star 1 on your telephone and wait for your name to be announced. If you would like to cancel your request, please press star 2. If you are on a speakerphone, please pick up the handset to ask your question. Your first question today comes from Andrew Goodsall from MST Marquee. Please go ahead.

Oh, good morning. Thanks very much for taking my question. Just asking, first question, asking around that second half, you're obviously expecting quite a big second half. I've sort of calculated about 15% unit sales growth. So, yeah, just trying to get you to characterise sort of what sort of movement you've seen in these first couple of months of the half and sort of, I guess, what that's pinned on. And maybe throw China contracts in there. Perhaps that's a tailwind for you.

So, Andrew said, yeah, first up on the outlook more broadly, yeah, we do expect to get to around 10% and therefore a lift over the first half into the second half. That's what we're seeing, good momentum across key countries. You know, Europe was a bit slower in the first half and Europe always has a bigger second half than first half anyway just because of the... Northern Hemisphere summer and impact through July and August. And on emerging markets with only 3% growth in the first half, we do expect significantly stronger growth there in the second half. And you mentioned China, so talk a little bit about that because I'm sure that there's going to be questions and that's really around what's the impact of the volume-based pricing mechanism that the Chinese government has been bringing in across a whole range of therapy areas. So where I want to go there is first talk about more broadly what are China trying to do with volume-based pricing. Secondly, what's, you know, from a competitive or relative perspective, what's China mean for Cochlear? And thirdly, what's the future look like? And the third of those is the hardest. It's actually the most uncertain. But first of all, just very briefly on volume-based privacy, the Chinese government have been doing this across a range of therapy areas, and their goal is really to both lower price and expand access. So they run a competitive process to try to bring the price of devices or of drugs down. At the same time, they effectively expand reimbursement, expand medical insurance, so that there is still an out-of-pocket component, but there's a smaller out-of-pocket component and far more people eligible. So it's trying to manage costs, but also expand access is the goal of the program. In terms of us and China, we don't disclose how big China is as an individual country. Clearly, that's very sensitive from a competitive perspective. What we can say is we are least exposed to China than any of the cochlear implant companies around the world. China forms part of our Asia Pacific region which you can see is less than 20% of our sales and it is a big region. Now the part of the China volume-based or part of the market that is affected is surgeries done through the public hospital, so it excludes the special zones. So that's a significant portion of the business, but it is certainly not all of our China business. So in terms of then the process, so there's been a bidding process that's gone on. Out of that, we've come out with a price that – Is it a premium to our international peers? We exercise some good discipline on managing where we priced. We will lose a little bit of volume in the short run. But as I said, the intent of this is actually to expand the volume significantly. And we think we're very well positioned to, as that volume expands, to pick it up. Now, how this all plays out is still very uncertain. It hasn't been implemented yet. But it's a long way around saying we still believe in the significant long run growth opportunity in China. We'll be working on that growth with a price that's a premium to our competitors. I hope that answered your question, Andrew. Sorry, long answer.

Very comprehensive, but it probably means it wasn't China, because I think that contract starts in March, or that process starts in March. It tends to start in March, yes. Just to follow on more, just maybe one for Sarah or Stu, just thinking about the hedge at second half, always trying to nail this down a bit more, a bit better than I do. But with the drop in the $8 versus US spot rate, what's your sort of just broadly sort of rough impact for the second half hedge effect?

Yeah, not a huge amount. So we averaged 66 cents US in the first half. I think we think we'll be in and around 65. We're planning about 65 on balance for the second half. And obviously it's a little bit lower than that on the spot rate. But, you know, the rates we're living in now were hedged six, 12, 18 months ago as well, so that moderates that a bit.

But probably still to come in with a slight negative, though, if your head's above the spot?

Yeah, somewhere in sort of 5 to 10 mil.

Okay, got it. Thank you very much. Appreciate it.

Thanks, Andrew.

Thank you. Your next question comes from David Lowe from J.P. Morgan. Please go ahead.

Thanks very much for taking my questions. Can we start with the service revenue? And I hear the explanations, but I guess some of the feedback we get is that it's much more difficult these days to show a clinical or a hearing outcome benefit with the latest processor, and that being the case, insurers or payers are more reluctant to pay for the next generation, certainly quite as quickly as in the past. I'm just wondering, one, do you think that's a factor? Two, what can be done about it?

Yes, so the first one is that you don't see that as a significant factor. Insurance, navigating insurance in different countries requires some knowledge and some challenge, and we do get insurance rejections, but we are not seeing many for lack of benefits. and we've got some good clinical evidence showing the gains in hearing and noise on Nucleus 8 over Nucleus 7. It's a core part of our design philosophy is to improve hearing outcomes, and so we've done it with Nucleus 8, and we think there is clearly headroom to go further, and that's part of our development of future sound processors.

Thank you. And just on it related, I see the hearing aid companies are introducing AI-supported devices and claiming better hearing outcomes. Can you talk at all about where Cochlear's at with similar development?

Yeah, we've been aware of the opportunity for deep neural networks to do even better in hearing and noise. and so clearly that would be part of our future is to make sure that we keep across technology. One of the things we've done for a long time is monitor what's going on in hearing aids from a technology perspective and to make sure that we incorporate those sorts of things into our products. Apart from a competitive perspective, our growth comes from getting people to move from high-powered hearing aids to cochlear implants and they all do better when they do that but part of the assessment going in is do they get all the features that they were getting on the implants. We were first in iPhone and Android phone connectivity in cochlear implants. We did that on the back of our relationship with GN ReSound but we did that because there's a clear benefit. for our customers, but also because they were used to that from a hearing aid and trying to get someone to switch from a hearing aid and say, yeah, but you lose this benefit, makes that task much harder. So yeah, well aware of the opportunity there. And if it proves to be successful, it certainly will end up in our products.

Right, and just one other. I mean, going back to Andrew's question on unit sales, so an uplift in the second half, yet you've announced a new product is coming. How much have you allowed for the fact that there will be some postponement? I mean, frankly, I would have thought potential recipients who become aware that there's a new version, a next-generation version coming, are likely to postpone, and that will have a detrimental impact on sales this half. Just wondering how you've thought about that.

Yeah, absolutely. We think that will be pretty muted. Most people who end up getting a cochlear implant have not heard anything about cochlear implants until they have had hearing loss for a long time and are really struggling with hearing loss. And they get significant benefit off from switching over. Not like people on this call are monitoring what we're doing regularly. Tens of thousands of people out there are going to get cochlear implants completely in the field. The other factor there is that hospital and audiological capacity is tighter and they're giving up of a surgical slot and hoping that it can be made up later. and we're just not seeing hospitals do that. Even now, forget about a new product, but when surgeons have surgical slots, they want to use them. So, look, there is some risk there, but we don't see it as significant. And the other thing is that we have a couple of regulatory approvals. It's not too broad yet. and we haven't in the past seen people hold when there's not regulatory approvals in place.

Understood. Thank you very much.

Thanks, David.

Thank you. Your next question comes from Saul Haddison from Baron Joey. Please go ahead.

Thanks. Good morning. Can I just ask you about the upgrade sales again? Noting you've flagged again the Canso 3 release. These sort of mid-upgrade cycle releases, can you talk to your thoughts about the recovery in services and revenues beyond FY25? I guess what I'm trying to work out is to what extent do you think N8 will continue to be a drag on the basis of a very strong first 12 months I assume an N9 is not due out for several years. So to what extent do you think the Kanso 3 can resolve some of that softness as you head towards the mid and late part of the N8 upgrade cycle?

Yeah, I'm certainly confident of seeing a lift with Kanso 3. There is a good proportion of our users who prefer off-the-ear processor and the opportunity to go from Kanso 1 or Kanso 2 to Kanso 3. is important for people, so we'll see an uplift there. And also remembering that we certainly do see these cycles of a jump on launch and then tails off over the life of a product until we launch the next one. Still the biggest driver of our services over any cycle is the increasing number of people who are eligible for an upgrade. So as we look out over 2020, 26 and 27 and into 28, we're cycling good high growth in our cochlear implant and first time cochlear implants in terms of people being five years out from getting their first, their implant. And so that lift in the eligible base, we expect to see that continue to drive upgrades into the future. And if you go back and look at the chart, I think on our third slide you do see long run growth there but you do see half on half some variability.

Thanks Deegan. If I could just one question for Stu. Stu, just to get the other income for the half, just noticed a couple of items in there. Can you talk to what the other in other income is? Is that gain on investments or just that doubling of that profit this half versus PCP?

Yeah, it's definitely not going on investments. Anything that goes to the P&L comes in underneath underlying. The only real material reveal we've had this year of this half spend Excel, but that goes for the balance sheet. In terms of that other line, there's about six, seven mil of FX gains, which is actually It's about 3.2, but it's off a negative of 3.6 last year, so it's about a 6.8 swing on FX on balance sheet items. That always goes through that line. There's been no change in what's in that line this half versus others. The other two things that are in there are, again, things that we're always doing. They're grants. So R&D grants where we can apply for funding or co-funding from payers or other philanthropic institutions for R&D research we do. So that's what we do every year. And then a small amount of collaboration income, and that's where we might offer contract services to small players who we think have aligned interests. So that's the nuts and bolts of it. It's largely rats and mice.

Great, thank you.

Thank you. Your next question comes from David Stanton from Jefferies. Please go ahead.

Good morning, team, and thanks very much for taking my question. In terms of... Perhaps start with one for Stu and or Sarah. In terms of gross margin, you talked to the fact that Chengdu will impact this... this year, but into next year, should we be thinking that gross margin will get back to its long-run average? Is that the way to think about it?

Look, I think there's likely to have an impact for at least another year or two. We started production really in the last six, 12 months. It'll take a couple of years to get up to full capacity. So until you get there, you have that higher overhead per unit drag. So it's at least a couple of year phenomenon, I think.

Understood. And then just want to confirm you're still targeting a circa 18% impact margin over the longer term for the business? Yes, definitely. Understood. Okay, very good. And then I guess two competing things in terms of that, what we're all talking about, that circa 15% growth in the second half in terms of unit sales. How much of that is going to be driven positively by visibility of referral rates? Do you get a you get a better look at what's in the pipeline than perhaps you did even two, three years ago. And if so, what's the reason? Versus, you know, the impact of, we continue to hear, in the developed world at least, you've got lower surgical support staff, which is sort of somewhat alluded to a little bit, I guess. You know, how do you sort of offset the two of those going forward?

So, yeah, I think first on the... Visibility, we do have better visibility than we had, but we still want more. The majority, we talked about this in the last few results, the majority of people who get a cochlear implant, we still don't have visibility of them until they get to a clinic. But the proportion that we are engaged with or in touch with is certainly growing. So it's improving, but there's still room for us to do more. And then on the surgical capacity, it's actually still really audiology that we do that's more of an impact. There are cases of surgeries rescheduled or at least to stop being available, but the audiology piece is more of a constraint than the surgical one. And there, I think we are seeing some better adoption of... lower – fewer post-surgery appointments, which is helping to be more capacity for evaluation. Thanks.

It's very clear.

Thank you.

Thank you. Your next question comes from Steve Wayne from Jarden. Please go ahead.

Yeah, thanks very much. I just had a quick question on the new implant. Just wondering whether or not that's been approved by the FDA yet to give you the confidence to announce the launch date. Probably asking mainly from the point of view they've been looking for signs of clinical trials on this and have came up with not very much. So just wondering where it stands from an approval point of view.

Yeah, so, Steve, we don't have FDA approval yet, so I'm happy to answer on the FDA, but don't want to... And I know you're not going there to do a country-by-country where it's approved and not approved.

But the FDA approval, when it happens, is reasonably public, so you'll be able to find it. And the clinical trial's been complete?

Well, we don't... We don't necessarily need to do a clinical... trial to get an implant approved. So they're independent functions in this case of us doing clinical trials and regulatory approval processes.

Okay. Just switching to the nucleus A, I'm not sure if I missed this, but do you quote a number as to what sort of penetration you've already achieved with the eligible cohort for upgrading?

No, we haven't quoted a number. The penetration in the last half is, we haven't quoted a number on it, but it has fallen from where we were and that's our opportunity to lift that back up, as I said, but part of that is the cost of living this year.

Okay. And then the last one, just trying to think about how we treat this cloud increase in the investment. There obviously was a balance of that spend, which was you were previously absorbing into the underlying numbers for FY26. So when you give guidance for 26, will you be taking all of that out and putting it below the line or leaving the amount that was originally in and just putting the extension of your project below the line. No, we'll put the whole amount below the line. Because otherwise it'll get confusing. So we'll get an upgrade in the underlying. We'll get a big upgrade in the underlying, you know, relative to the way we're expecting or forecasting it. And then the total amount will go below the line. Yes. Yeah. Okay. Got it. All right. That's all from me. Thanks. Thanks, Steve.

Thank you. Your next question comes from Darwin from Goldman Sachs. Please go ahead.

Thanks. Hi, Dick and team. Just a question on, I guess, your implant market share. There's a bit of feedback from the channel suggesting that some of your competitors have released new features, have managed to shift some of that share to their business. Curious on your thoughts there in light of the number that you've put in the half, you know, just your ability there to sort of either hold your long-term market share. And then the next question on that would be with the new implants that you are launching, just the ability to, I guess, innovate ahead of the field. Thank you.

Thanks, Davin. Good questions. So first of all, we're confident of our long-run position on share. we hold a very strong share across the world and certainly in developed markets. And that's on the back of the strength of our product portfolio, our history and reputation and the strength of our local sales and field clinical teams. Yeah, competitors are always going to try and find things that we don't do and aren't doing and try to differentiate themselves on that. So we see that from both our competitors. Look, as they do that, they'll have some successes here and there, but we're not seeing that happening at a material level. And remembering one of our competitors is coming back from a pretty significant recall, and the further that fades into the distance, that sort of helps their share a little bit. But as we look forward to our... our product portfolio and the future, we are very confident that we will be able to not only hold our share but lift our share as we look forward, knowing what we have in the pipeline. We spend a lot of money on R&D and I think we're spending it wisely and that means that we do, as we've said in the past, we've got a full pipeline of products coming out over the next several years and we don't see that our competitors have the financial capacity to keep up with what we're doing.

Okay, thanks. And the next question is on the cloud. spend that you've increased quite materially by about $100 million relative to the baseline. Could you give us some better sense of what you're spending that on? I saw the release was on core ERP data and manufacturing systems. Could you just elaborate further on why you've lifted the spend there? And then secondly, the expected benefits that you would expect out of that spend? That would be very helpful. Thank you.

Yeah, so go back first on the why we've lifted what it's going on to and then to the benefits. So when we set out on this in 2020, 2021, at that point we're actually going to capitalise what we spent and there was a clarification of interpretation of accounting laws which meant that all investment in cloud computing and transformation had to be expensed rather than capitalised. So we had an estimate at that time, and that was done sort of looking forward, but without detailed scoping. So now four years on, we've gone and we've implemented a new human capital management system. We've implemented a new CRM. We've put some supporting systems around those. And now we're going into replacing... Our core ERP, we have a 20-plus-year-old ERP. This is something that we expect to do about every 20 years. So as we've gone in and scoped this in depth, we want to make sure we get it right. We want to make sure we're building a platform for a much larger business. We have gone into more depth, which enables us to get a better estimate. cost of putting these things in has not been immune to inflation over the last four or five years. So just the actual cost effectively per day of implementing these things is considerably higher than it was. And we've added a manufacturing execution system. When we went into this, we hoped that we would be able to use sort of an off-the-shelf ERP for our manufacturing, given they've developed quite significantly over the years. As we've gone into further detail, we realised we need to put – manufacturing system over the top of the ERP to have the level of visibility and control that we have and that we need. And so that's an additional cost that we didn't have at the start. And we're doing much more on data than we were initially, and that's looking forward to, obviously, the value of data, but also the potential that not only these new systems bring, but also with AI into the future and making sure that we get the foundations for that future. So it is a material uplift and it's driven by that going into more detail and we deliberately left this part to last so that we would learn as we went through the first few phases.

Okay. Thanks, Nick.

Thanks, Damon.

Thank you. Your next question comes from Matthew Chevrier from Citi. Please go ahead.

Thank you. Good morning, gents. Thanks for taking my question. My first one was just on cochlear implants, the ASP benefit that you have in the first half. And I guess that was from the mixed shift. How do you see that evolving in the second half? And then how do you see the new implant impacting that in 26 and onwards?

Yeah, Matthew, thanks for the question. So we expect that, particularly as emerging markets, we get more of that tender volume coming back with the ASP will come off. So it was higher in that first half. As we look forward to new technology, we will certainly be seeking price increases in the markets where we have the opportunity to do that on the back of the benefits that the new technology brings. The magnitude of that, we're not going to get, we think we can get at this stage.

Yeah, okay. And then in terms of how you're thinking about the potential penetration rate of upgrades, you know, over time, has what happened in the last kind of six, 12 months made you reconsider where that could land over time?

No, it hasn't. We said at the full year, the question was raised on cost of living and inflation, what impact? And we said that we haven't been through with upgrades of volume to see what impact that has. And we have seen some impact. Given inflation is coming off and hopefully cost of living pressures moderate, that should fall away. And as I said, we are working with our new platforms, the ability for us to segment and target costs to make more people aware of their eligibility will lift and people's awareness of their eligibility is still the biggest factor in lifting up penetration. So I do think that there is opportunity to lift the penetration, certainly back to where it was, but as we've been talking about for a while, lift it further still, and the underlying base of recipients just continues each year to grow in volume. Okay.

Thanks very much. Thanks Matthew.

Thank you. Your next question comes from Craig Wong Pan from RBC. Please go ahead.

Thanks and good morning. In services, which region experienced the largest declines or was it a fairly broad-based fall in services revenues by region this half?

Yeah, Craig, I can give you a little bit of detail on that. I don't want to go too far, but certainly the US where probably most exposed to co-payers had the most significant falls. There were a couple of other countries where we saw falls equally. We had some countries where we grew. but the US was the most affected.

Okay. And then you mentioned about the cloud systems and the benefits of that allowing you to target patients to greater target them for an upgrade, but the full benefits of that aren't sort of there yet. I mean, when do you expect to see the benefits of those cloud systems helping you drive upgrade services revenues?

So we think certainly in 26, the next financial year, we will be able to get some of those benefits. We'll get some through this year. We have a number of activities underway. So these things don't tend to happen in a step change. They have gradually as build functionality changes. and learn how to use that functionality. So it will happen gradually, but starting this year and certainly into 26. And I realised just on that, I didn't say to answer Matthew's question just on the broader benefits. And there are, particularly with the ERP and manufacturing, significant efficiency gains that we will get in manufacturing. A reasonable portion of time now is spent on recording that we can automate with a new system. So we'll get just straight out efficiencies in our manufacturing line. And similarly from the ERP, we have a lot of transactional, manual transactional processing, which is inherent in a 20-year-old system that we will be able to automate. So there are efficiency gains that we will see after we put the new ERP in.

And then my last question, just on the capex at your full year result last year, you guided to capex of 110 to 130. Just wondering whether you're still expecting that level of capex this year?

Yes, we're holding to that range.

Okay, thank you.

Thanks, Greg.

Thank you. Your next question comes from Sasa Crenn from Evans and Partners. Please go ahead.

Good morning. Thanks for taking my questions. First question just on developed market paediatric implants. Just wondering if you can talk a little bit about the outlook there. Do we sort of expect growth to plateau or penetration, I should say, to plateau? Are there still opportunities for further penetration and possibly increases in bilateral implantation as a proportion of surgeries?

So pediatric implants, we expect that to grow at a couple of percent a year, largely in line with the growth in birth rates. The penetration across most markets is very high and the uptake of bilaterals is very high, certainly across developed markets. There are countries like the US where there is still an opportunity to lift the penetration. Japan is another one. So there are some Smaller opportunities for more penetration but largely we're expecting just growth in line with birth rate.

Okay, second question. We're hearing about some good outcomes on residual hearing out of some trials in Melbourne. I'm just wondering if there's an opportunity to expand that more broadly and achieve better outcomes on that globally?

Yes, so residual hearing is certainly one of the areas of research and product development that we are working on. You know, it's one of the barriers to people getting a cochlear implant is they can hear a bit. It's not really very functional hearing, but people rightly are concerned about losing that hearing. Now, whether they lose it or not, they still get extremely, extreme, significant lift in... in hearing performance. But having, be able to make stronger claims around residual hearing would help remove barriers to people getting an implant. We have made some progress on a couple of, or aiming to make progress on a couple of fronts. One is that with our SlimModiola electrode, there's a number of surgeons around the world who are reporting good hearing preservation with that electrode. because often the loss of hearing is often caused by trauma from the electrode being inserted into the cochlea. With the slim modiola, it actually should stay away from the walls of the cochlea and therefore not cause trauma. So that's encouraging. We think there's more in future in design opportunity there. And the other one is... drug-eluting electrode. So if there's trauma, if there's a drug or steroid that can minimise the reaction to that trauma, the inflammation from that trauma, then there's potential to improve residual hearing. So we've done some, we are in the middle of doing some trials with drug-eluting electrodes. Some early indications there are showing some interesting indications on hearing preservation, certainly not at the scale and the volume to make any claim, but you wouldn't expect that at this stage of the trial. But there's definitely some opportunity there that we will continue to explore through our clinical work.

Okay, thank you. And just one clarification question on the Chengdu ramp-up. Just wondering what capacity you're talking to when you talk about the ramp-up. Is that the 10K that's being quoted?

Yeah, so it'll happen in stages. So we've got capacity for at least that at the moment. We'll want to, obviously, building to use that capacity, and then we can add further capacity over time by adding extra equipment. So we've got plenty of floor space for a lot more capacity than that, but obviously we'll add equipment and people as demand grows.

Got it.

Thank you.

Thank you.

Thank you. Your next question comes from Laura Sutcliffe from UBS. Please go ahead.

Hello. Thank you for taking my question. The first one is just a bit of a revisit on the unit growth expectation for the year. Is there anything that you're expecting in the second half that you wouldn't class as underlying? And what should we think about as a kind of fair runway? Is it going to look Is the third half more of a fair run rate or is the second half more of a fair run rate or is it something in the middle?

I'd take the annual run rate. We're aiming to grow cochlear implants around about 10% per year. We have grown faster than that for the last couple of years, but we've been continuing to talk about 10% being, I think, a sustainable rate when we look at the work to drive demand and to make sure that there is capacity through the system.

Okay, that's clear. Thank you. And then just secondly on bottlenecks in the system and trying to tie together a few of the comments that you've made around maybe waiting times and things like that over past sets of earnings. Is it the case that some of the greater visibility that you've got into the pipeline, if I can call it that, of patients can help you be part of the solution to people falling out of the funnel, waiting too long? getting around some of these bottlenecks or is it really a case of just sit back, wait and see, let awareness increase and then sort of the benefits will come in time?

No, we can definitely play a role and we are playing a role now working with, in two ways. One is working with clinics to take them through the evidence that shows that the optimum number of post-surgery appointments just and we continue to see a reduction in the average number of post-surgery appointments, which frees up capacity on the front end for evaluation. We also do work from a technology perspective, so our remote care and remote assist enables audiologists to check the status of people's processor and implant and map and do that remotely and do that in a shorter time than a full programming session, whether that's a face-to-face session or a remote session. So with technology, we can take time out of appointments and we're making progress there. Again, that takes some time. But also the weight of demand is an important factor. Clinics having waiting lists is an important motivator to either the to increase capacity, whether that's through hiring more people or through changing practice, but having those waiting lists is a very important part of the motivation.

Yeah, and if I could just add to that, I think a big continued focus has been identifying candidates earlier in the funnel, being able to see more of them before they get to surgery, because still a lot of the patients, the first time we know about them is when they're being implanted. And certainly that data and that access is very helpful in, as you said, being able to do everything we can to make sure those patients make it all the way through the funnel and don't fall out. And I think our capability is getting better, one, at identifying and bringing them in initially, and two, at holding them in the funnel and sort of holding their hand through to surgery.

Thank you very much.

Thanks, Laura.

Thank you. Your next question comes from Leanne Harrison from Bank of America. Please go ahead.

Hi. Good morning all. Just to continue on Laura's line of questioning, with those bottlenecks in audiology, are they getting worse or is it a matter of just has it been stable over the last, you know, six to 12 months but still seeing bottlenecks?

So capacity has been increasing but there are still bottlenecks. So I think it has been getting better but there is more work to do.

Okay. But effectively we're starting to see more people move through the funnel as you continue to do your work there as well as the audiologists. Yes. Okay. And then if I could move on to the emerging markets. We saw private pay. There was a good tailwind in this half. Can you comment on what's really driving that and do you expect that to continue over the next six months?

So From private pay or it's premium tier private pay, yeah, there continues to remain a good and actually growing opportunity there because it's largely related to wealth and to a little bit to if there is any local reimbursement. So across emerging markets as wealth grows, we continue to see a good opportunity in the premium private pay, but also recognising that the In emerging markets, like in developed markets, the long-run opportunity is a level of government funding and government support to really significantly increase access.

Okay. And then if I could come back to services, obviously some challenges there with services revenue, but given what you're trying to do more around creating awareness and working out who's eligible for an upgrade, are we likely to see an increase in the sales and marketing spend as you target those customers over the next six months?

No, not outside the boundaries that we set of having the 12% into R&D and the 75% gross margin will be a little bit lower with Chengdu and 18% net profit. So You know, we've got an envelope there to spend. You know, and part of putting these systems in is it doesn't really cost us more to market. It's more effective. It's the effort we put in can be done, can be more effective.

Okay. And just one last question around the cloud costs. You know, about $120 million balance for 26, 27. How will that be phased over those two years?

We're still working through the detail of that as we go into the detailed design, but the majority of it we anticipate will occur in 26. Okay.

Thank you very much.

Thanks, Leanne.

Thank you. Once again, if you would like to ask a question, please press star 1 on your telephone and wait for your name to be announced. Your next question is a follow-up from Steve Ween from Jarden. Please go ahead.

Hi, Steve. Hi. Thanks very much. G'day, Stu. This is a question for Stu. I'm just following up on the comment about Nick Sower. I was looking at your annual report for FY24 and it talks to the fair value going through the comprehensive income line. I'm only raising it because the stock's up like 22% in the half. So just trying to understand where that sits in the P&L from a mark-to-market perspective.

That's definitely it, Steve. It's definitely on the balance sheet and it is through that investment line.

Do you know what the other side of it is? We've got the one side on the balance sheet. Do you know what the other side of that entry is or where it is?

Yeah, why don't we get back to you on that one, Steve?

Okay. Thank you. That's all for me.

Thank you. Your next question comes from Eric Johnston from The Australian. Please go ahead.

Hi, Eric.

As he appears to have his phone on mute, that does conclude our conference for today. As there are no further questions at this time, I'll now hand back to Mr Howitt for any closing remarks.

Thanks everyone for joining today and look forward to talking to you all at the full year. Thank you.

Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.