Cochlear Limited (COH) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Cochlear Limited announcement. [Operator Instructions] I would now like to hand the conference over to Mr. Dig Howitt, CEO and President of Cochlear Limited. Please go ahead.

Thank you, and thank you all for joining the call. So what I would do is just give you a brief overview of the announcement and then open it up for questions. So just starting with the announcement. What we've obviously seen is that the Chinese Lunar New Year extended until Monday. We've been talking to hospitals right across China, and we're seeing that CI surgeries also is the reason the surgeries are being delayed and many hospitals not taking appointments for new surgeries. So we, at this stage, don't know how long this will go on. So we've looked back at our experience of SARS as a guide to try to estimate the impact that this could have on our business in Greater China. There are, obviously, pretty -- still pretty significant travel restrictions in place in China. Many of our China team are working from home. That has resumed after the Chinese New Year. So with all of that as background, we've had to estimate or have estimated an impact this could have on our revenue and therefore, on our profit in the second half. We've done that thinking about a few things. One of those is that we will not be making any changes to our cost base in China. So we've been investing in China heavily over the last few years to build out our market presence. We are leaving our people and that cost base in place as they continue to talk to candidates and support our customers up in China. Also, March is typically the biggest month of the year for sales in China. It's a month -- [indiscernible] a month. It's a month where there's significant promotional hearing loss and awareness of hearing loss, and it has always been the largest month for sales that we have. And we had assumed at this stage that there is no impact on -- from the coronavirus outside of Greater China. That's what -- we haven't seen any impact over the last few weeks and at this stage, we don't expect one. And as we said in the announcement, from a supply chain perspective, at this stage, we're confident that our supply chain won't be affected by the coronavirus. In terms of the guidance range, what we've done obviously is reduce the net profit range by between $10 million and $20 million. And that's been done thinking about -- solely thinking about what is the potential impact on our sales in China and therefore, on our net profit. Keeping in mind that the vast majority of our sales in China are in private pay, that we have, as you can see in our accounts, a pretty strong gross margin across the board and China is not far different from that. So I'm thinking about the net profit impact we're looking at. What's the gross margin impact of lower sales, net of tax, and that's where we come with the $10 million to $20 million range, with the bottom of that range, the $20 million being a very, very significant reduction throughout the rest of the financial year in China. So I think with that background, I might open it up for questions.

[Operator Instructions] Your first question comes from Sean Laaman from Morgan Stanley.

Dig, hope you're well. Talk about the capacity within the channel to sort of catch up on these surgeries, once some people stop being afraid of going to hospitals, would be the first question.

Yes. Look, it's hard to know, Sean, at this stage. There's normally excess capacity. What's a little unclear though is quite a lot of elective surgery is going to be delayed. And so won't to just be catching up cochlear implants when things resume to normal. So we certainly expect to see, when things resume to normal, a rebound and a catch-up. What's very hard to know right now just is over what period that catch-up would take.

Sure. And one quick follow-up. I just noticed that there's no FX assumption in today's guidance. Is there an FX assumption? And if so, what is it?

No. Look, no, we haven't put an FX assumption in there. I mean we've restricted this announcement rightly to just what has happened in China. Obviously, with all our results next week, you get -- you know there will be details there on what's happening with FX. And I think to clarify that, obviously, that we've made -- we've assumed an FX rate and converting China sales back to Australian dollars, but that's not material in our thinking of the magnitude.

Your next question comes from David Bailey from Macquarie.

Just a couple of quick ones to start with, just the relative contribution of China to group revenue. And then also within China, you mentioned a high proportion of private pay. Just that number as a proportion of total would be useful to start with.

Okay. So [indiscernible] are not numbers we disclosed. I mean China is, as we said, is a top 5 market. It's part of our Asia Pacific business, and you can see what proportion of our Asia Pacific business is of our total revenue. In terms of private pay, that we've been saying for a while now, the vast majority of our revenue in China comes from private pay or with some level of provincial or city level reimbursement versus the national tender, which used to be a significant part of the business. It's now a very, very small part of our overall China business.

Okay. Just working backwards through some of the changes in [ contri ]. If I look at $295 million being the midpoint of the previous range, $280 million now, it implies a second half impact from China being $15 million. If I gross it up for a full year, it'd give me $30 million. $30 million on $295 million gives me a contribution of around $10 million. Is that math kind of right in terms of relative contribution of China to the group earnings?

Let me sort of take you through it. I can say, again, let me take it to a slightly different way. So we've taken, obviously, $10 million to $20 million of our guidance, and that is the range that we think the net profit impact from the reduction in sales, range of production in sales in the second half. So very clearly, in doing that, we're assuming that we will be losing money in China through the second half because we're taking our cost base in [indiscernible] and have a very significant -- expecting a very significant reduction in revenue.

Okay. I'm trying to give how that relates back to the commentary around gross margin and things similar to the group, but that could just be a bit of timing issue.

So in normal -- in terms of thinking about the impact, respectively, the gross margin impact, which we then would pay tax on. Yes, yes. Sales and marketing and distribution costs all continue -- to perform on the ground in China.

Your next question comes from David Low from JPMorgan.

Just a quick one. So would it be right to assume that there's not a material difference between the revenue impact and the volume impact given we're going to see unit sales as well as dollars? Are they broadly going to be in line?

Broadly in line. Look, in China compared to the rest of the businesses, typically lower services revenue and higher CI system revenue.

Right. So I presume making some allowance at pricing differentials. We're going to see more of a volume impact to unit volume impact than we would have a revenue impact but not tremendously different?

Not tremendously different, but that's -- given the proportion of our sales that our services in China is lower than the average around the world. That's a reasonable assumption.

Okay. And I presume upgrade sales, et cetera. You've obviously alluding to it there, but we're not assuming much of an impact there because they're not material or not significant anyway?

It does -- so in China, upgrades are typically done through the hospital. So we do expect an impact on our upgrade sales in China for the half because hospital outpatient services have been significantly reduced that you'd expect. And that -- I mean focusing on the coronavirus, not on hearing care in many, many hospitals.

Yes, understood. Changing topics a little bit. The new plant that's currently being constructed, any thoughts on the implications of the coronavirus on that project?

Not at this stage. We don't see any significant disruption to our plans there. That's still in the construction phase. But here, yes, we're not seeing any significant disruption at this stage.

Okay. And the SARS experience versus the coronavirus experience is obviously rather early days, but could you talk through what happened in terms of the way at which patients came back? I mean were they back in a flood because everything was -- there was an all-clear given? Or did it take time for confidence to have a...

Once sort of the things cleared up, it ramped up reasonably quickly, but the volumes, we're going back 7, 9 years. The volumes were much, much smaller.

Okay. And just last one there, just moving into speculative territory. If the coronavirus becomes more widespread, so we see more of an outbreak in the west, any reason to think that the implications would be any different in Western markets?

Look, I think at this stage, we just don't know. We're certainly not seeing any impact and it's very hard to speculate on what to...

No. I understand. I thought I'd try. I'll leave it at that.