Resmed Inc (RMD) — Q2 2017 Earnings Call Transcript

Thank you, Marianna, and thank you for attending ResMed’s live webcast. Joining me on the call today are Mick Farrell, our CEO, and Brett Sandercock, our CFO. Other members of the management team will also be available during the Q&A portion of the call. If you have not had a chance to review the earnings release, it can be found on our website at investors.resmed.com. I want to remind our listeners that our discussion today may include forward-looking statements, including, but not limited to, statements about future expectations, plans, and prospects for the company, corporate strategy, integration of acquisitions, and performance. We believe that these statements are based on reasonable assumptions, but actual results may differ materially from those indicated. Important factors, which could cause actual results to differ materially, are in the forward-looking statements detailed in filings made by ResMed with the Security and Exchange Commission. I will now hand the call over to Mick Farrell.

Thanks, Agnes, and thank you to all of our shareholders, as we summarize our results for the second quarter of fiscal year 2017. We achieved solid double-digit global revenue growth this quarter, led by sales from Brightree and continued strong growth in our device platforms. We also saw the start of a steady ramp of our latest mask technologies. For the call today, I will review top level financial results, outline some regional highlights, and discuss key announcements this quarter. Then, I will hand the call over to Brett, who will walk you through our financial results in further detail. We achieved strong device sales due to our leadership in digital health and connected care. The number of patients managed on the AirSolutions platform and the number of daily uses of our Brightree platform continue to grow rapidly. This quarter, we announced that we have reached a milestone with more than 1 billion nights of sleep data in our cloud-based physician and provider solution called AirView. We have well over 2 million 100% cloud-connected medical devices. We are liberating data and unlocking value for physicians, providers, and patients like never before. Midway through the quarter, we commenced the launch of our new AirFit range of masks, the AirFit N20 nasal mask and the AirFit F20 full face mask. Both of the products leverage new step-change technology called Infinity Seal that provides significant advances in fit and comfort to patients. Earlier this month, at the JPMorgan healthcare conference, I announced that we had received FDA clearance for the ResMed AirMini, our world leading, travel-friendly sleep app technology. I will talk more about that a little later. At the bottom line, in terms of non-GAAP net operating profit, we grew at 13% on a year-over-year basis in Q2. Including financing costs, our diluted earnings per share or EPS was $0.73 on a non-GAAP basis. We continue to balance revenue growth and gross margin improvements as well as ensuring an appropriate investment in both R&D and SG&A, so that we can maximize the success of multiple product launches across our global markets. Now for some regional highlights. The Americas region produced double-digit revenue growth. These results were fueled by Software-as-a-Service revenue from Brightree and 13% growth in devices. Device growth was particularly remarkable given that we were up against a 24% year-over-year comparable. The mask and accessories category in the Americas grew 4% in the quarter. This is up sequentially and reflects the fact that our sales team that received products around the Thanksgiving timeframe has started showing the new technology to physicians and providers. There is clearly a long way to go in the ramp of these products in Q3, Q4, and into fiscal year 2018. Growth in devices was driven by the continued support for the AirSense 10 systems by our customers. These are powered by the cloud-based AirSolutions software platform, including the myAir patient engagement app that has over 1,000 new patients sign up every day. We achieved good growth in our respiratory care device platforms in the Americas, particularly our cloud-connected life support ventilation platform called Astral. We earned strong growth in our combined EMEA and APAC regions this quarter, primarily driven by Flow Generator sales, with some outstanding performance from our combined Curative and ResMed China businesses. We have now completed the earn-out, and the integration is going very well. As we enter the Chinese New Year, we have truly formed one ResMed China team with one vision, one mission, two brands, and many varied customer channels; things are really coming together well. Mask, accessory, and other sales in the combined EMEA and APAC regions were down year-over-year due to a couple of factors. One, we had some international licensing revenue from the comparable quarter a year ago in the region, and two, the N20 and F20 were only released in a few countries, and as we know uptake of new masks is a lot slower in EMEA and APAC than the U.S. market. We expect this mask category to return to public growth in EMEA and APAC as we continue to launch the N20 and F20. Feedback from patients, physicians, and homecare providers on the fit range and comfort of the N20 and F20 is very positive. This is a great indicator for stronger mask growth in Q3, Q4, and into FY 2018. Looking at our Software-as-a-Service revenue, Brightree continues to grow strongly and in line with our acquisition model in the low-to-mid teens. We are on track with our work to integrate Brightree software functionality into the AirSolutions portfolio. We are truly creating end-to-end software solutions for our customers, and Brightree is achieving strong double-digit growth, with high levels of customer satisfaction and customer workflow efficiencies gains. Let me now take a few minutes to update you on the progress against each of the three horizons in our 2020 growth strategy and then I’ll hand the call over to Brett. In the first horizon of growth which focuses on our core sleep apnea business, we are making significant advances with the smallest, quietest, and most comfortable products, catalyzed by digital health and connected care solutions. We launched our new AirFit F20 full-size masks and our new AirFit N20 nasal masks in the second quarter. The Infinity Seal technology is a step change in comfort for patients, with fit ranges of 97% to 99% of patient populations, proving a winning value proposition with respiratory clinicians. We are seeing exceptionally strong demand for the N20 and F20 products, and for some of the mask SKUs, demand is in fact outpacing supply as we ramp up our production capabilities for these new technologies. We will continue to ramp up our supply and expect to be outpacing demand as we go through Q3 and into Q4. At the JP Morgan Healthcare Conference in San Francisco earlier this month, we announced the FDA clearance of the world's smallest CPAP called the ResMed AirMini. It's a tiny portable travel PAP with all of ResMed's best-in-class comfort features. AirMini is intended to be a secondary device for travel, and it truly complements our world-leading AirSense 10 platform. AirMini is an amazing technology, and we expect to launch this product commercially before the end of the fiscal year. I have personally been using a prototype of the ResMed AirMini for over 12 months. It has traveled with me to Asia, all over Europe, and throughout the Americas. For those listening to this call, who may also be CPAP patients, feel free to go to airmini.resmed.com and sign up. We’ll make sure that you’re amongst the first to know when the product is fully launched through our Homecare Channel Partners. We continue to lead in the field of connected care, one of the key foundations of our growth strategy. We have reached, as I said earlier, 1 billion nights of sleep data, and are focusing on algorithms to convert big data into actionable information. The ultimate goal is to unlock even more value for physicians, providers, payers, and most importantly for patients. This quarter, we announced results from a European study published by PricewaterhouseCoopers, analyzing data from more than 23,000 patients in Germany and the UK. The study shows that myAir patients, when compared to controls, used their CPAP devices for longer durations and have significantly higher adherence rates. This adherence study was executed in our core sleep apnea vertical, and we are extending this cloud-based coaching algorithms to our ventilation and oxygen technologies; watch this space. This is a great transition for the second horizon of the ResMed 2020 growth strategy. We know that COPD is the number three cause of death and the number two cause of re-hospitalization in the western world. The spectrum of cloud-connected respiratory care products across our ResMed portfolio will play a big role in reducing costs for providers and improving outcomes for patients with this debilitating disease. Connected Care in ventilation can reduce costs and improve patient outcomes in COPD and beyond. We continue to see portable oxygen concentrators, or POCs, as an important addition to our spectrum of respiratory care products. Our integration of the Inova acquisition has focused on quality improvements to the current Activox POC platform. We are gradually ramping the launch of this technology to our global sales team as we continue to improve quality and functionality of the product. We will ultimately add cloud connectivity to our POC platform, which will help drive adherence for patients, fleet management for providers, and activity tracking for physicians. Our third horizon of growth encompasses a portfolio of long-term opportunities, including sleep health and wellness as well as clinical adjacencies, such as atrial fibrillation and heart failure with preserved ejection fraction. Another key area of horizon three growth is our work in chronic disease management algorithms, including population health models, healthcare analytics, care coordination, and Software-as-a-Service models for home health, home nursing, and hospice. In the area of sleep health and wellness, we are making good progress with our new joint venture called Sleep Score Labs, with capital investments from ResMed, Pegasus Capital, and Dr. Mehmet Oz. We started the partnership last quarter with an entire Dr. Oz show dedicated to the field of sleep wellness. Dr. Michael Bruce and Dr. Oz leveraged the S+ by ResMed, the world's first non-wearable sleep device, and Smartphone app designed to help people track, better understand, and improve their sleep. The sleep awareness campaign encompassed anonymous sleep data from a database with over one million nights of sleep. Sleep Score Labs calculated America's overall sleep score, and Dr. Oz announced the results at the Consumer Electronics Show or CES in Las Vegas earlier this month. Dr. Oz reported that people are not sleeping as well as they should; we're getting less than what the National Sleep Foundation recommends, which is seven to eight hours plus of sleep. We are about one hour behind the minimum with around six hours of sleep. People say they're tired, and people say they want to understand their sleep better. Sleep Score Labs will do just that; they will truly quantify sleep and help people objectively determine which sleep solutions are best for them. For ResMed, this is about driving the importance of sleep awareness and sleep health. We will be helping people realize that they need to go see their doctor if they have any risky breathing at night or any shortness of breath, day or night. These and other signs and symptoms of sleep apnea and COPD impact overall health. We will continue to drive sleep health and sleep awareness and our ResMed brand as a leader in the field. Let me close with this: we are incredibly excited about the ongoing launch of our N20 and F20 mask technologies and our pipeline of products in 2017, including the new ResMed AirMini. We continue to lead in connected care with enhanced solutions that lower costs for providers and improve outcomes for patients. We are leading the industry, driving consumer awareness of sleep so that undiagnosed consumers go to see their doctors and healthcare providers. We continue to bring our strategy into action for the benefit of physicians, providers, payers, and most importantly to improve the lives of tens of millions of sleep apnea and COPD patients around the world. With that, I will turn the call over to Brett for his remarks, and then we will go to Q&A.

Right, thanks Mick. In my remarks today, I'll provide an overview of our results for the second quarter of fiscal year 2017. As Mick noted, we had a solid quarter. Revenue for the December quarter was $530.4 million, an increase of 17% over the prior year quarter. In constant currency terms, revenue increased by 18%. Excluding acquisitions in constant-currency terms, organic revenue increased by 10% over the prior year quarter. Taking a closer look at our geographic distribution and excluding revenue from our Brightree acquisition, our sales in the Americas were $293 million, an increase of 9% over the prior-year quarter. Sales in combined EMEA and Asia Pacific totaled $203.6 million, an increase of 10% over the prior year quarter. In constant currency terms, sales in combined EMEA and Asia Pacific increased by 13% over the prior year quarter. Breaking out revenue between product segments, Americas device sales were $154.3 million, an increase of 13% over the prior year quarter. Masks and other sales were $138.6 million, an increase of 4% over the prior year quarter. For revenue in combined EMEA and Asia Pacific, device sales were $146.7 million, an increase of 19% over the prior year quarter, and in constant currency terms, an increase of 21%. Masks and other sales were $57 million, a decrease of 7% over the prior-year quarter, or in constant currency terms, a decrease of 4%. Globally, in constant currency terms, device sales increased by 17%, while masks and other increased by 2% over the prior year quarter. Brightree revenue for the second quarter was $33.8 million, with growth on a prior year comparable basis continuing to track in the low to mid-teens. During the rest of my commentary today, I will be referring to non-GAAP numbers. The non-GAAP measures adjust the impact of amortization for acquired intangibles, acquisitions-related expenses associated with additional contingent consideration, restructuring expenses, and litigation settlement expenses. The prior year comparable excludes amortization of acquired intangibles, restructuring expenses, and the release of the SERVE-HF accrual. We have provided a full reconciliation of the non-GAAP to GAAP numbers in our second quarter earnings press release. Our gross margin for the December quarter was 58.3%. On a year-over-year basis, our non-GAAP gross margin increased by 20 basis points, reflecting manufacturing and procurement efficiencies and the favorable impact from our Brightree acquisition. These were partially offset by product mix, typical declines in average selling prices, and unfavorable currency movement. Due to current exchange rates and likely trends in product and geographic mix, we expect gross margins to continue to be in the range of 58% to 60% for the balance of fiscal year 2017. Moving on to operating expenses, our SG&A expenses for the quarter were $139.3 million, an increase of 18% over the prior-year quarter, and in constant currency terms, also an increase of 18%. Excluding the impact from acquisitions and in constant-currency terms, our SG&A expenses increased by 10%. SG&A expenses as a percentage of revenue were 26.3% compared to 26% that we reported last year. Looking forward and subject to currency movements, we expect SG&A as a percentage of revenue to be in the range of 27% to 28% for the balance of fiscal year 2017. This reflects expected marketing expenses associated with product launches and ongoing legal expenses. R&D expenses for the quarter were $38.2 million, an increase of 32% over the prior-year quarter, or on constant currency basis, an increase of 28%. This increase largely reflects the impact of our recent acquisitions and incremental investments across our R&D portfolio. Excluding the impact from acquisitions, our R&D expenses in constant currency terms increased by 11% over the prior year. R&D expenses as a percentage of revenue were 7.3% compared to the year-ago figure of 6.4%. Looking forward and subject to currency movements, we expect R&D expenses as a percentage of revenue to be in the range of 7% to 8% for the balance of fiscal year 2017. Amortization of acquired intangibles was $11.7 million for the quarter, an increase of $7.3 million over the prior year, reflecting the additional amortization associated with our recent acquisitions. Stock-based compensation expense for the quarter was $10.8 million. Non-GAAP operating profit for the quarter was $131.6 million, an increase of 13% over the prior year quarter. Non-GAAP net income for the quarter was $103.3 million, an increase of 1% over the prior year quarter. Net income for the quarter was $76.7 million. Non-GAAP diluted earnings per share for the quarter was $0.73, consistent with the prior year quarter, while GAAP diluted earnings per share for the quarter were $0.54. Note that our prior year earnings per share comparable was restated as a result of the adoption of accounting standard ASU 2016-09, whereby we recorded a tax benefit of $5.1 million in Q2 FY16. In the current quarter, under the standard, we recorded a tax expense of $25,000. Excluding this impact, non-GAAP earnings per share would have increased by 6% over the prior year quarter. Additionally, foreign exchange movements negatively impacted second quarter earnings by $0.03 per share, reflecting the unfavorable impacts from the weaker euro and stronger Australian dollar relative to the U.S. dollar. On a non-GAAP basis, our effective tax rate for the quarter was 21.1%. Looking forward, we estimate our effective tax rate for the fiscal year 2017 will be in the range of 20% to 22%. During the quarter, we recognize restructuring expenses of $4.4 million associated with the rationalization of our European R&D activities. Additionally, we recognize an expense of $10.1 million for additional contingent consideration associated with the acuity acquisition. The additional accrual was the result of the business achieving performance milestones that result in the investment contingent consideration payable under the purchase agreement. Finally, we recognize an expense of $8.5 million as part of the global settlement of all litigation between ResMed, BMC, and 3B. Cash flow from operations was $119.9 million for the quarter. This reflects strong underlying earnings offset to some extent by a modest increase in net working capital balances during the quarter. Capital expenditure for the quarter was $14.7 million. Depreciation and amortization for the December quarter totaled $27.7 million. Our Board of Directors today declared a quarterly dividend of $0.33 per share, an increase of 10% over our prior year quarterly dividend. As previously announced, we have temporarily suspended our share repurchase program due to recent acquisitions. At present, we expect to recommence the buyback in fiscal year 2018. At December 31st, we had approximately $1.2 billion in gross debt and $380 million in net debt. Our balance sheet remains strong with modest debt levels. At December 31st, total assets were $3.3 billion and net equity was $1.7 billion. And, with that, I will hand the call back to Agnes.

Thanks, Brett. We will now turn to Q&A, and we ask that everyone limit themselves to one question and one follow-up question. If you have additional questions after that, please get back into the queue. Mariana, we are now ready for the Q&A portion of the call.

If we could just start with the mask rollout. Mick, you mentioned that you've had some issues with keeping up with demand, and you've also talked about the rollout into other countries outside the U.S. I was wondering if you could just expand on those two issues, and wondering particularly whether that production issue means that the rollout internationally might take a little longer.

Thanks for the question, David. Look, the patients and providers and clinician acceptance of the mask has been great. The Infinity Seal technology particularly and its ability to reach 97% to 99% of the patients that come to a sleep lab or through a clinic - and so the acceptance has been great and certainly exceeding what we had thought it may be. And so what we're finding with the new production technology that we're using for this Infinity Seal is that, as we ramp across the different stock keeping units, that in some of those SKUs, we are not keeping up with very high demand, but as we look forward over Q3 and Q4, we will start to catch up and we expect by certainly the end of Q4 that we'll be well ahead of the demand for the product. Rob, do you want to add something on that?

Regarding the rest of the world rollout, the volumes in the U.S. are much larger than elsewhere in the world, and we really don’t see a big impact on the rest of the world rollout. That will continue slow and steady progress as we reported previously.

Great. Yes, looking at it obviously, it seems like a good problem to have if you can't keep up with demand. Just the other question I had, Brett, you mentioned in the SG&A commentary, you've given us guidance, which I think is above what we've just seen, and I think you made a comment about legal expenses. Just wondering if that relates to the settlement that's already happened or are we talking about other ongoing legal expenses?

No, that’s really the ongoing legal expenses, Dave. I mean, we're obviously into legal action with S&P, so that's not inexpensive.

Probably a follow-on question from David, just trying to get a bit more granular on the N20 series. Just the 4% mask growth you saw in the U.S. Just if you're willing to characterize, was that mainly the N20, I guess, after a sort of flat growth elsewhere? And just also any feedback from the pilots that you guys ran on those masks?

Thanks, Andrew. Both the N20, which is mask, and F20, which is the full-face mask are doing very well. They both have the Infinity Seal technology this year, single-layer technology that provides excellent fit and comfort for patients. I personally wear a CPAP mask, and the N20 is particularly comfortable for me, but those products are going very well and doing well in the U.S. market, and that’s what got us to the sequential uptick in U.S. mask growth. We expect that as we go through Q3 and Q4 and pick our production up to continue to grow quite strongly there and turn back to positive growth in EMEA and APAC.

Any new feedback from the pilot? Did it meet your expectations in terms of the way the DMEs are thinking about this mask ahead of other masks?

Yes, certainly as the DME or HME home care providers, as we call them in Europe, start to see this product, that fit range fitting 97% to 99% of the patients that walk through the clinic has just been a real winning value proposition for the respiratory technicians. The N20 is the go-to mask for nasal now for them. And the F20, we believe is a go-to mask for them on full-face, and its early days in the rollout, the U.S. team got this at the week of Thanksgiving; they’ve really only had half a quarter and one with the bunches of Thanksgiving and Christmas holidays. But we do expect as we look for Q3 and looks to Q4 and starting to ramp the production up, there’ll be a slow, steady gradual increase in both the U.S. and in other regions through Q3, Q4, and of course beyond FY 2018. These technologies have a lot of legs.

A couple of things. You mentioned the impact of lower ASPs and mix on the expense structure. Could you expand upon that just a little bit?

Brett, you want to take that?

Yes. Just on that, it was really truly the gross margin year-on-year that kind of ASP product mix is probably the biggest one year-on-year. We’re still seeing - well, we’re seeing that really strong device growth continuing and unfavorable FX impacts was quite a bit too. If you just look at it sequentially, Joanne, it was 60 basis points, but we had unfavorable FX of 40 basis points. So those were probably the drivers.

Okay. That's very helpful. Share repurchases, when are you likely to restart those, given your cash flow in the quarter?

Yes, we’re still of the view that we’ll commence that in FY18.

Brett, the first question is really what drove the acceleration in Ameriсas devices and the number was pretty big. The question is, is it sustainable, and can your mix of new products and ASV offerings really keep that revenue growth profile for ResMed in the low double-digit or teens range?

Thanks for the question, Margaret. It's Mick here. So we did have very strong growth in devices in the Americas, it's 13% on a constant currency basis. We think that was primarily fueled by AirSolutions, the portfolio of AirView and myAir capabilities to lower the labor costs for setting up a CPAP by 50% to 60% for a home care provider. Also the ability for engagement apps like myAir to drive adherence from previous industry standards of 50% to 60% up to 80% to 87% in some of the data that we have talked about publicly. So we think all that comes together to drive good sustainable growth and that does of course include some of the growth in the respiratory care line, our Astral ventilation, our life support ventilation line. Look, we talk in terms of the industry growing in the mid to high single digits. Clearly, we were taking some share in devices in this quarter, and as we look forward, we expect to see good mid to high single-digit growth of the industry, and we'd like to lead or beat that, and clearly we beat that this quarter.

Okay, and then maybe a similar question on the international side. Obviously, you had strength in the international generator. So was there anything specific to this quarter? And then I hate to sneak one more in, but the constant currency of mask growth - what was it excluding the licensing fees that you referenced at the beginning of the call?

Yes, so Margaret, the factors driving the international sales are similar to the ones driving U.S. sales, just that the ramp has been different as the takeout from the whole process of explaining AirView and getting the myAir going is a longer process. Then the other really significant thing in the rest of the world data, outside of the U.S. data is China had a big impact, and so we had a very strong quarter in China, really related to the teams getting together and our integration plan going really well. And the team all pulling together focusing on new channels, really getting the sleep business and also really driving our respiratory care business in China. And then of course, you know Q2 is sort of like the end of the year in China, it's traditionally a strong quarter for us.

Hi, thanks for taking the question. Can you hear me okay?

Yes, got you loud and clear, Matthew.

Okay great. So one question I wanted to ask is you announced the settlement of all your litigations with BG. And I just wanted to know if you could help us understand what the ongoing impact is going to be in terms of the licensing royalty revenue that you could see and the lower legal expense that you could have, now that you have this settlement.

I'll hand that question to Dave Pendarvis, our Global General Counsel, Dave.

Thanks, Matt. First of all, we're really pleased with the settlement. We think that it is helping to validate the strength of our IP that we're now going to get paid royalty on sales in the U.S. by our competitor for the products that are covered by the deal. The reality is, those royalty streams will not likely be material to us going forward, and you know that's fine. They don't have a large market share in the U.S. market. We don't expect that to change anytime soon. So we don't expect it to be material. Obviously, there is a reduction in the ongoing litigation costs that were associated with that case and really a number of cases around the world, but as Brett mentioned earlier, we continue to have really, frankly, a larger case against F&P and some other ongoing legal expenses. So there still will be significant legal expenses going forward. But obviously, one of the reasons you settle cases is to avoid the further ongoing expense, and that was one of the reasons that motivated us to reach this settlement with BMC that we did, but we're very pleased with it.

Great, and then just a follow-up on an earlier question. I mean, it’s a little bit surprising that late and kind of the flow gen launch to see such a big acceleration; was there any kind of stocking order or anything else that was abnormal that you would call out, or was this just a good execution quarter?

Yes, Matthew, I think this was really about good execution. The value proposition of AirSolutions has proven to be very sustainable and compelling for customers. Reducing therapy setup costs by 50% to 60% has become integrated into the workflow of our home care provider partners, who prefer working with a cloud-based system that is cost-effective and promotes adherence. As Rob mentioned, we saw good acceleration in China, with our local team performing well. Globally, the AirSolutions platform is having a positive impact, and the integration of Astral into the cloud-connected system is gaining traction. Additionally, the Adaptive-Servo Ventilation technology is contributing positively. All these factors have resulted in strong growth for flow generators, and we anticipate continued strong growth. While we expect market rates to fluctuate, we project mid-single to mid-high single-digit growth and aim to meet or exceed that.

I've a question on Brightree. So good revenue number there ahead of us. I was just wondering, Mick, if you could give us a sense of, I guess, some of the CPAP share dynamics and some of the resupply dynamics you've seen amongst new adopters of Brightree? That's the first question.

Thanks, Sean. I think I'll hand that question over to Jim Hollingshead, who runs the Americas. I'll just start off with, yes, the low to mid-teens growth from Brightree is strong, again, it's a compelling value proposition for our home care providers, and they like it incorporated into their workflows. Jim, any further color with regard to ongoing resupply sales associated with Brightree?

Yes, the Brightree platform serves as an extension of process automation for the core sleep business. There is a strong connection between new Brightree customers and users of the AirSolutions platform, which facilitates smoother operations. Despite having separate commercial and sales teams, the two businesses support each other in the market. Brightree customers generally enjoy their experience with ResMed sleep products, and the Brightree software platform for resupply, known as Connect, is seeing increased adoption. This platform is beneficial for customers and patients alike, as it promotes regular resupply, leading to better therapy experiences, and this is becoming a growing part of their offerings.

Sure, thank you. And just as a quick follow-up, when might we see the P20?

Sean, we don't talk about future pipelines to a great extent. We did open up a little bit on this call about the ResMed AirMini, the world's smallest travel CPAP that we got FDA clearance on, that was a public FDA clearance, but we won't be talking about the pipeline of future masks. But thank you for the question.

Just firstly on pricing in the U.S. I think you mentioned a few quarters ago that you had gone early with customers in reducing price prior to the introduction of competitive bidding on July 1. Not all customers, but some I remember you saying. Just wondering when you might cycle those price reductions, and you might see maybe a more favorable pricing environment in the U.S.?

Will, I think you're referring to something maybe 18 plus months ago, where there were some changes around competitive bidding round two. So 18 almost 24 months ago when there were some resets.

I'm referring to the latest round of competitive bidding.

So, okay. Well if it’s related to that, then you know that what we’ve been saying, which is the reality around the competitive bidding round three and the national expansions and the rebids going on now is that it’s a pretty steady pricing picture; in fact, no step change at all. Industry normal price changes year-on-year in a steady pricing environment. Obviously, we’re seeing a lot of competition amongst the innovation. Innovation in the masks and innovation in the cloud connectivity and connected care side. So, it’s been complication for us and our competitors in masks and digital offerings. But in terms of price, it’s been a very steady environment these last four, eight, plus quarters. Sure. Rob, do you want to address?

We don’t typically provide a detailed breakdown, but as I mentioned earlier, the value proposition of AirView and its connectivity is consistent across European countries and the U.S. However, the way people perceive and realize that value varies, and it has taken longer to establish in these regions. Specifically, in France, there was legislation that aimed to introduce differential reimbursement for devices monitored wirelessly. That legislation faced a legal challenge but has since been reinstated, and we anticipate seeing differential reimbursement become standard in France this year. This change could significantly boost our volume in that market. Overall, we are still experiencing increases in volume, and the adoption of myAir remains strong, with many patients in Europe eager to access their data to enhance their treatment and health outcomes.

I guess, I just wanted to start with your manufacturing operations. I think they are pretty much all outside the U.S. One, I want to know if that’s correct, and two, how do you think you’d be affected by some of these border tax proposals that the Republicans are talking about?

Listen, Mike, currently, we have a very strong global supply chain footprint that manufactures in many countries, and we talk a lot about Singapore and Sydney as being a major part of that supply chain. What we don’t often talk about is that we do have manufacturing in the U.S. as well, and our ResMed motor technology subsidiary is based in the Los Angeles area. And we also manufacture some in the U.S. in our Atlanta facility. And so we’ve actually got the capability to respond to what is needed on a tax basis as needed, and we'll keep an eye out and be flexible with it.

Yeah, Mike, it’s Dave here. One thing we can all agree on about U.S. politics today is that it's going to be hard to predict. There are many discussions about tax reform and its implications, so we will have to wait and see what the actual proposals, details, and implementation timelines look like. As Rob mentioned, there are opportunities for us. If incentives arise to increase manufacturing in the U.S., that could be a significant opportunity for us given our large customer and patient base there. We prioritize the interests of all our stakeholders, including shareholders, customers, and employees, and we consider all these factors in our decision-making. However, it may take a few years for things to stabilize, and we will do our best to make informed decisions based on the details available.

Okay. Thanks. And then just curious for AirMini, I think there is one other product out there that’s a big part of that segment of the market. So I was just wondering if you had a feel for how big that market is currently, I guess in the U.S. at least, if not globally?

Thanks for the question, Mike. The current travel PAP is a very small niche segment, and what our goal at ResMed, as the global leader in sleep apnea therapy, is to bring the world’s smallest, the world's most comfortable, the world’s quietest, and most engaging travel CPAP to the market. And so we think we will actually expand on what is currently a very small travel CPAP niche and create a sizable segment of travel CPAP users that are willing to pay retail cash and work with our home care providers who access those products and really make it as part of their care so that you can have the same experience when you’re traveling around the country or around the world as you do at home. So that’s the goal of the ResMed AirMini, and as we launch that between now and June 30, you'll see us talk about how we're going to drive awareness, create that niche, and make sure that patients the world over have the opportunity to have ResMed therapy with them wherever they are.

Thanks. Can I squeeze one more in? Just curious if the liquidation of AirStart devices had any kind of material impact on your U.S. flow generator growth in the quarter.

Thanks, Michael. I’ll hand that over to Jim. Any thoughts on AirStart?

It is a very small part of sales in the quarter. Not material.

So, Mick, I have a couple of questions. First, you mentioned that you expect AirMini to be cash-pay for customers, especially in the travel market. Can you provide some insight on how you plan to segment this market in the U.S.? I'm trying to get a better understanding of how things might develop given your lead in this area. That's my first question. My second question is how you view the potential confirmation of Tom Price as the head of HHS? Our information suggests he is supportive of DME. Any insights from your perspective would be appreciated.

Thanks, Suraj. I’ll take the second one first and then I’ll hand to Jim maybe to talk a little bit about AirMini and how we're looking at segmenting the cash-pay market and working with our provider customers. But the second part first, Tom Price was a congressman from Georgia who spoke at the Mid Trade Conference in Atlanta last fall. And I don’t think anyone in the room knew or thought that he might become HHS Secretary, but when he got off on the floor and made a very passionate speech about the importance of home care, and the importance of keeping patients out of hospitals and taken well care of in the home. He’s an orthopedic surgeon, and I think he understands the economics of the broken sort of sick care system where patients are frequent fliers in the ICU and CCU with COPD, and we believe also sleep apnea is a big impact on that. I think he will be a big supporter, and if he puts in place some of the policies that he was advocating for on behalf of the homecare industry as HHS Secretary, we think it could be beneficial for our industry. But look, you know, as Dave said earlier, there are a lot of things going on in Washington right now, a lot of changes, and we're going to wait and hope to see some more homecare friendly policies out of Washington, but we'll wait till we see them and then we'll act on them. But that’s sort of the early take on Tom Price; I’d say it's a positive for our industry. Jim, on the AirMini, thoughts?

On the AirMini, we see a couple of opportunities with the AirMini. One for patients and one for HME customers. Patients, we believe have a strong pent-up demand for a good travel solution for CPAP. And right now, there are some solutions on the market that we think are not up to snuff. We think our offer is going to be very superior, and actually as Mick was saying earlier, we'll grow demand in the category because patients really want to take our full-featured CPAP with them when they travel. And so we see an opportunity for patients to have better care and a more convenient life with their CPAP as they travel. For customers, it's an opportunity because we know that our HME customers, especially in the U.S., are trying to grow their cash-pay business. There is more and more healthcare spend that's out of pocket in the U.S. because the way insurance is increasingly shifting the landscape. Our DME customers, HME customers are looking for and often exploiting cash-pay out of pocket opportunities. We intend to take this product through our dealers, which will allow them to service patients and that pent-up need for a good travel PAP experience and also create cash-paying opportunities to grow their businesses.

Just a couple on underlying device growth in the quarter, and it sounded like there's some moving parts there. I'm just wondering if you have the combined contribution for Astral and Nova and ASV. And then maybe just a revisit on underlying sleep margins, where they sit today, just getting all the moving parts with pricing and mix versus Americas or U.S. and masks flow gens? And then one follow-up question. Thanks.

Right, Anthony. Well look, the underlying device rate - we don’t split up sleep versus respiratory care and then respiratory care down to ventilation and oxygen. But as you saw in the Americas, a really strong 13% constant currency growth in devices and in EMEA and APAC very strong 21% with the global 17% growth. We think that growth is strong and sustainable, but there are elements, as we've said earlier with regard to China where there were some things that were kind of onetime and there were other more sustainable parts such as the AirSolutions platform and its ability to continue to drive AirSense 10 and AirCurve 10 sales along those lines. But with regard to margins, as we look forward, I think other than the foreign exchange impact, it was pretty reasonably good quarter in terms of margins. Any color there, Rob, you'd like to add?

Well, I think, as I said, some of the drivers around margins in the sleep have to do with product mix, so while machines grew stronger as the headwinds for margins, sales strong in the U.S. compared to our lower volume markets in Europe and in Asia will generally also be a headwind to margins as well. Offsetting that, our efficiency improvements in our supply chain and as we really crank the production for the AirSense 10 and in other products, we see ongoing improvement, and it’s a continual headwind to our win rates, so we run neck and neck too. Brett, I don't know if you have any other comments?

No, everyone thinks you've articulated it pretty well. I guess we try to take it all into account as best as we can, and so we're still looking at the guidance of 58% to 60%, and then it’s just contingent on how the product meets the geographic mix, FX plays out during the quarter.

That's helpful. And then a follow-up would just be, did you quantify the benefit from China, and then just any comments on the Cures Act, with that passing? Obviously, that pushed out some of the reimbursement cuts. How does that play out? Our checks are suggesting there's sort of one-time payments that DMEs will get at some point in 2017, but that it could be scattered throughout the year. Thanks.

Right, thanks Anthony. I think somehow you managed to get four questions in there, but we don’t quantify the breakdown there. Rob was talking qualitatively to the curative ResMed China combination and its impact on the quarter, so we're not going to break all that out. Dave, do you have any comments with regard to the 21st Century Cures and impacts for ResMed?

Sure, it's really well done by the industry to get this through. You know, it's been a long time coming. You remember we were a while back and we were about to have some relief for the rollout of the national expansion of rates, and it was stopped by a protest on the floor of the house for gun controls. Just goes to show you, crazy things can happen when you're trying to go through the legislative process. So the industry worked very hard, really across the board and was able to ensure that this time around it stuck and they got some relief, that was six months of relief. And there are still some issues with competitive bidding rates and how competitive bidding is determined. But the industry, I think on the whole, feels good about having gotten a win and feels like, as Mick was saying earlier, that if Congressman Price is confirmed as Secretary of HHS, there should be at least a sympathetic ear for perhaps some further regulatory relief. And as the industry moves forward, you got some stability now. The rates are set with Medicare for the next two years, till January of '19, and Congressman Price has bill to add in binding bids, so that now anyone who bid in an area has to put up a bond; that's a benefit. And so I think the industry is feeling like it’s a better environment with some more predictability and some more stability, and that's a positive.

Maybe first question, Mick, any more color on just what the production issues involved with regards to those SKUs on the masks? In other words, is it a matter of adding more manufacturing lines, for example, or is it just simply putting more product through the existing lines and the demand has maybe caught you by a bit of surprise versus the production capabilities?

Thanks, Saul. Well, yes, clearly the market acceptance has been ahead of our expectations. Rob, you want to go into some detail with regard to the manufacturing?

Any new product sold has new tooling and new things to learn about it, and really new fine-tuning to do on the process, and it's really just a matter of mixing that fine-tuning and matching that fine-tuning and process building, plus capacity building, which is predominantly driven by tooling and supply chain management. Matching that with the take-up of demand, we should see that sort of match up, as we said earlier, through the quarter.

Great. Thanks. Just a follow-up for Brett maybe. But just on the cash flow from operations, for the half, again looks like it's reasonably weak versus the PCP. You did flag the inventory build. Should we expect that to recover second half as you start to clear this product that you've been building up, particularly on the mask side for the launch?

I believe that our Q2 cash flow of around $120 million was quite strong, and we experienced a modest gain in working capital. When comparing this to the previous year, working capital was definitely moving in our favor, and we managed to reduce it significantly, leading to substantial cash flow last year. However, Q1 was somewhat low; I was pleased with Q2, which brought in $120 million. We anticipated new product flow and recognized the need to catch up. Overall, I expect only a modest increase in working capital moving forward.

Just to start with on the core sleep business, by my calculations - and there's a lot of inputs here - looks like it increased, the gross margin increased by about 80 basis points. First of all, is that fair sequentially? And then is that strictly - it looks like it's mostly manufacturing driven, maybe a little bit of mix on the generator side, but would love to hear your thoughts on that.

I am uncertain about that. Looking at the numbers sequentially, Q1 was 58.9 and this quarter is 58.3. I previously noted that unfavorable effects impacted around 40 basis points, which is slightly higher than we anticipated due to the deterioration of the euro throughout the quarter. Overall, if you examine it sequentially, the rest looks relatively stable. Year-on-year, it has increased slightly from 58.1 to 58.3.

Hey Brett, excluding Brightree.

Yes, so excluding that, we've got - I mean the bigger impact there is on product mix, and we're still seeing really strong device growth. I think as we go forward and we get some improvements in mask growth with the new products and so on, then you'll see that impact moderate, but at the moment, it's still a headwind for us; so that's kind of if you like, kind of offsetting this to a large extent on the Brightree. And had typical ASP decline, and there was FX also year-over-year which was unfavorable, but as we mentioned earlier in manufacturing procurements so on, we've driven that and we've got efficiency there as well, which more than offsets those other elements.

Okay. I'll follow up a little bit offline on that. As far as Inova goes, I think when you bought that about this time last year, you said it would take about 18 months to refine the product, feel more comfortable in rolling that out to your broader sales force. Just based on the comments from earlier in the call, is it fair to say that you're a little bit ahead of schedule, and you could be a little more aggressive in rolling that out throughout the course of 2017?

I’ll take that. Matt, I’d say we’re pretty much on schedule for that sort of 18 months, I'd get it to where we think ResMed's quality and functionality should be. Look, the Activox product is a great POC. It’s light and very portable, but it can improve in some areas, and we’re really working on the improvement of those areas in terms of oxygen delivery and sustainability of that over the many months that they’re out there helping patients get freedom back. And so I’d say, I don’t track, and we’re looking forward to gradually ramping that Inova product out there. And as we said in the prepared remarks earlier, adding communication capability onto that and pulling it as part of the whole AirSolutions portfolio, we think we'll allow home care providers to do better fleet management of all these POCs that are out there, but really engage the patients in terms of adherence for the product as well. So the conclusion is, I think we're just pretty much right on track with the versus the timeline that you talk about.

Look, my phone dropped out before, so if I'm going to be repeating something, I apologize. I just wanted to understand the rest of the world masks; I think, from the questions, you've been saying that supply outstripped demand on this. Can you just confirm that? And why did the masks in the rest of the world decline 4% post launch, and what are we expecting there?

Thanks, Victor. So, I mean, I’m sure you heard the prepared remarks and what we talked about. There are two factors behind EMEA and APAC on the masks. Number one, we had a big comparable; what was about around 8% constant currency growth in the quarter a year ago in EMEA and APAC. So we had some licensing revenue in there and some really good sales to particular customers. And we just launched the N20 and F20 at the ERS. And so it’s the first quarter out there, and as you know, you’ve been following our stock for a long time, mask launches in EMEA and APAC; you're talking hundreds of countries and you go country-by-country and they see the masks, they don’t immediately buy the masks. It can even slow down the purchases of current masks because they see the next generation technology, and they put it through their systems; they have it as their frontline setup, and they work out how to put it into the protocols and start to get launch through. So as we said earlier, we expect a gradual improvement of masks growth not only in the Americas but also in EMEA and APAC. Certainly the positive in that region, and then through Q3 and Q4, we really think the impact N20 and F20 are going to be there and sustainable throughout fiscal 2018. Okay. Great. I wanted to ask about pricing and whether there has been a significant return of end-of-quarter bulk discounts, which have been absent for some time. Has that reemerged in the market? How are you seeing pricing in that context? We’re seeing pricing, as I said earlier, in the pretty steady state these last six to eight quarters. Back to industry standards on year-on-year in terms of price. So the competition is fierce, but it’s around innovation. Who's got the best fit, the best comfort, the quietest device and now best informatic solution to really improve quality of care for patients and provide us to improve their workflow efficiencies. Thanks for your questions, Victor. We are now at the one-hour mark, so will turn the call back over to me. Yeah, thanks. In closing, I want to thank the 5,000 strong ResMed team from around the world for their commitment to changing tens of millions of lives. We remain laser-focused on our long term goal of improving 20 million lives by 2020, and we look forward to executing on everything we talked about this last 60 minutes and driving this innovation and great products throughout 2017. Thanks for your time today. And we’ll talk to you again in about 90 days. Thanks.

Thank you everyone for joining us today. If there’s any additional questions, please feel free to contact me. The webcast replay will be available on our website at investor.resmed.com. Marianna, you may now close the call.