Cochlear Limited (COH) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Cochlear Limited HY '22 Results Analyst and Media Briefing. [Operator Instructions] I would now like to hand the conference over to Mr. Dig Howitt, CEO and President. Please go ahead.

Good morning, everyone, and thanks for joining and welcome to our results presentation. I'm going to give an overview of our results and progress during the last half, then hand over to Stu to talk through the P&L and balance sheet and back to me for the outlook and then on to questions. Let's get going, starting with our mission. Our mission is important in terms of always guiding the business and our people right around the world and what it is that we're seeking to do and how it is that we help our customers here and improve their lives. And onto the result. This last half was a really strong result from a revenue perspective, especially considering that the half started with the Delta variant of COVID and finished with the Omicron variant, and we dealt with varying degrees of operating theater capacity constraints through hospital staff shortages right around the world through that half. So I'm very pleased to see that sales growth given those constraints. Also very good from a profit perspective, and that profit increase was driven by the strong sales growth that we saw. Our gross margin improved from last year back to where we expected to be at the time around 75%, and there was some benefit from lower operating expenses. And simply, we spent less than we set out to do largely because of some of the COVID restrictions that were in place around the world. But despite those restrictions, we were able to continue to invest significantly in our market growth activities and in our R&D to support our long-term product pipeline. We finished the half in a strong financial position. Continue to be a very strong cash balance, 35% left in the dividend. And our net profit guidance with that range of $265 million to $285 million that now includes the cloud computing costs, and we'll talk more about that at the end. But certainly, overall, very strong part to sales profit and strong financial position. Now to go into a little bit more depth in each of the areas. In the Cochlear implants, we saw a 7% unit growth. And you can see that, that split between developed markets, which were down slightly, and emerging markets, which were up strongly. If we look at developed markets first, importantly, belt market units are tracking ahead of pre-COVID levels, which is very important. We did see that decline, and it was largely the U.S. that pulled down the decline relative to the last half. And that's remembering that the last half of the U.S. was a very strong comparable, in part driven by catch-up surgeries from the April, May hospital shutdown in the U.S. and also now restrictions on hospital operating theater capacity, which we've clearly seen in the U.S. through the last half and particularly at the end of the half. We continue to have a very strong market share position both in the U.S. and around the world, and that's on the back of our customer service and the strength of our product portfolio. In Western Europe, pleasingly, we've seen a good recovery. If you remember back to the full year, we've said Western Europe was recovering, but it was still overall below pre-COVID levels. It's now above pre-COVID levels. Still, there continues to be variability by country. The U.K., for example, while recovery is still not back to the strength that it was pre-COVID, but its trajectory, we're confident that, that recovery will continue. In emerging markets, we've seen a good recovery there. And our stronger markets like China continue to grow. We've seen in markets like India and Brazil that were very, very affected by COVID. A good recovery, although still below the pre-COVID levels, but it's really pleasing to see the recovery coming through in the emerging markets. Now if we look at Service, and actually very strong result. There's a couple of important points that sit behind the strong Services result. The first of those is that the growing installed base is the biggest driver of our opportunity to grow Services. And with Services, as we've talked before, that it's -- the demand doesn't go away. People want an upgrade, they'll get an upgrade. They may be delayed. As we saw through COVID, there were some delays through clinic capacity being reduced. What this result shows is that the clinics are open back up, people are getting into clinics, being able therefore to get upgrades, and that's driven that strong performance. And it's also in part showing the constraints on operating theater capacity, that clinics do have a choice on how they spend their time. And if there are fewer surgeries, then they spend more time on upgrades. So there's sort of a shock absorber in the upgrades in a sense on the CI unit numbers, and we've seen that happen in the half. It's certainly a pleasing result for Services. It shows the strength of Kanso 2 and the attractiveness of Kanso 2. And remembering, we're nearly 5 years since the launch of Nucleus 7, so to have that stronger Service results and we're 5 years on from -- of launch of BTE, certainly also is pleasing and encouraging for the long run opportunity we have in Services and access to that recipient base and being able to continue to grow in this area. Onto Acoustics. Acoustics, also a very strong result. We've been saying for a while that we thought with the product portfolio we were developing with Acoustics, there was real opportunity to grow. There's very clearly a market opportunity for growth in Acoustics and competition with hearing aids and reconstructive surgery. And we're starting to see some of this come through with $100 million of sales, a 40% uplift in constant currency in Acoustics, albeit off a COVID-affected base, but it's still a record half for us. With Osia, we continue to see a very good and strong response and uptake in the U.S. We have started to roll out through Western Europe following CE mark there and seeing some good early-stage growth in some Western European countries. Knowing that Osia, and we've said this over time, too, that Osia is a new product. It's a new category. We need to do the work to get reimbursements and acceptance at an appropriate level country by country to make sure that we get a price that reflects the value in the product. We continue to do that work. And therefore, it will take us a few years to roll Osia out to the extent that -- of the opportunity and to really get the game. It's certainly very pleasing to see this. And obviously, Baha 6 Max is very well accepted. And remembering in our Acoustics numbers, it contains upgrades. So the strength here again shows the strength of Baha 6 Max Processor, but it also shows the same point that I made on Services. If the clinics are open, people are coming into clinics and they are, in this case, getting upgrades of Baha products, and that gives us good confidence as operating -- surgery operating theater capacity opens up. People are coming through clinics and we'll see that lift in CI over time and Acoustics surgeries over time as well. Okay. So moving on from the revenue lines to our strategy and a quick update on our strategic priorities. So in terms of retaining market leadership, our share has remained very strong through the last half. And we said when COVID hit, that this was a real opportunity for us to consolidate and strengthen our competitive position to enable us to continue to invest in growth in the long run. Two years on, we do have a very strong competitive position with 9 new products approved by the FDA. Over -- of the 2-year COVID impact, that shows the benefit of continuing our R&D investment and the strength of our R&D and regulatory teams around the world. The opportunity to accelerate connected care. And connected care, like Osia, is something that is new to market, will take time to roll out to get reimbursement in places to get adoption. We continue to push that forward. The addition of Cochlear Remote Assist with FDA approval is an important addition. It allows live video interaction and adjustments through a personal assistant through the app, which is -- that live interaction is important for reimbursement of procedures like this in some markets. So continuing to work on remote care over time. And I talked about Osia and the opportunity there. You can see across the bottom here the range of products that we have had approved over the last 2 years really strengthened our competitive position. We also know that our market leadership depends very importantly on world-class customer service. That customer service is driven by a combination of things. It's both our product technology and the impact on customers. And Kanso 2 and Nucleus 7 and 22 is an example of it, that particularly showing the lifetime support for our implant recipients with Nucleus 7 and 22. But it's also about building out the Cochlear family. So a 20% increase there. Again, nearly 240,000 Cochlear family members around the world. And the strength of our field teams, the customer service, clinical sales around the world and their connection direct to recipients, but also their connection to hospitals and hearing care professionals is a very important part of our share. And we've switched most of that connection virtually. And we've been able to do that very effectively, and that helps strengthen our leadership position. And with CoPilot and SmartNav Custom Sound Pro continuing the portfolio of services for recipients, for audiologists and to serve the surgeons, again, to make us easy to work with, to strengthen our competitive position and improve their experience as providers of implant services or as receivers of cochlear implants or acoustic implants. And [ off to great ] obviously, retaining market leadership is very important because it enables us to have the financial capacity to invest in growth and investing in growth and really competing for attention of people with severe to profound hearing loss who are otherwise getting hearing aids or who are frustrated with their hearing loss and stopping to seek any solution is a very, very important part of our growth. So we have been able to continue to expand in our direct-to-consumer marketing activities. And the pipeline of recipient candidates we have is strong, awaiting the expansion of that operating theater capacity. And we continue to work on referral activities in increasing number of developed countries to build this consistent and clear clinical path from hearing aids through to Cochlear implant. That all plays into building out Cochlear implants as a standard of care for adults with severe to profound hearing loss. And the work the World Health Organization has been doing over several years and most recently with hearing screening considerations for implementation and publication, which recommends hearing screening for adults, is an important part of addressing the extent of hearing loss and the underserved nature of hearing loss right across the world. And clearly, continue to work on guidelines with professionals with recipient groups around the world, with health authorities is very important on building out standard of care. And our market access work to expand indications, to expand funding is important. A good example of that in the last half is the FDA approval of single-sided deafness on people more than 5 years of age. And that's a significant expansion in the potential market in the U.S. and so an important step forward in continuing to expand access into people the best hearing care that they can. Okay. And then moving on to just our -- third, our strategic priorities of consistent revenue and earnings growth, and remembering that this is in the context that we are aiming to achieve long-run growth, consistent revenue and earnings performance over the very long run. And we did continue to invest to grow in the half, and it was a strong -- we do have a very strong financial performance. And we continue to work from an operational perspective on improving the business, the opportunity to gain leverage and to get that leverage invested in growth. And we have [ a vast ], and Stuart will talk more on this, in our major process and systems transformation, the cloud computing work, which obviously now comes through the P&L rather than through CapEx, so it does have an impact on our profit margin, and Stuart will talk more to that. [ That counts for me then. ] I think we've got a strong half. I'm going to hand over to Stu to talk a bit more through the P&L and the balance sheet and cash flow.

Fantastic. Thanks, Dig. As you've heard a lot about the sales revenue already, if we jump to gross margin, you'll see that we've moved up back into that target range of 75%, which is where we'd like to be longer term at the gross margin line. That change, not so much a function of mix. The gross margin we get across all the different lines is roughly the same. It's really a function of 3 things. One, bigger volumes. So we're spreading the overheads across a large number of units. There was a significant FX move that was washing through our inventory at this point 12 months ago. And then a couple of big one-off negatives that were hitting a year ago, in particular, having to run the manufacturing site at a much lower rate for at least 1/4 a year ago and also some significant stock write-offs we took a year ago as well. So not seeing those reoccur has seen that margin improve back to where we would like to see it. If we jump down to then the operating expenses at $400.5 million in the first half, just a bit of context on that. So the $353 million prior year, that really was very COVID-depressed spending levels, no trouble at all globally, and a bunch of other cost actions we took at the time to really slow down the cost there, so coming off a very low base. If we look at half 2 '21 OpEx, that was $400 million as well. So we're basically flat half-on-half leaving '21 and coming into '22. And so within that, I guess the significant most to call, that admin expense line growing at about 20%. There's really 2 things behind that, ongoing insurance premium increases and that's also where the IT expenses that are not related come in. And a lot of the growth activity that we are investing in is either enabled by or in part involves IT change and so that's where that's showing up. The cloud line, you've heard quite a bit about it through the results today. So we're $5 million for the first half. As you remember, this is a function of that accounting standard interpretation change. We flagged at the full year results, we expect the full year impact of this to be in or around $20 million, and we're on glide path for that. We're at the beginning of the shift to cloud, and so that number is going to ramp up in half 2. And we really think this is a 4- to 5-year journey where we think the total bill will be in that range of $100 million to $150 million. Jumping down to net profit, 19% for the half, that's slightly ahead of where we would like to be longer term. We aim for that 18% mark pre the cloud computing adjustment. The combination of revenue running higher than we expected in the first half and costs running slower than we expected has enabled that 19%. We will be looking to land the full year number. Again, we're in that range of 18% pre-cloud, and cloud's going to be about a 1%-ish impact on that going forward. If we jump on to capital employed on the next page, top 3 lines are all the changes out here. The receivables, they're up $22.7 million, that's entirely in line with trading. We sold more, so we're -- receivables have gone up. So it's a pleasing result. Inventory is up 21.9%. Again, deliberate decision to invest in 2 things: One, holding more finished goods stock in the supply chain so that we're better prepared in case there's any sort of logistics issues or last mile issues and also investing in raw materials and particularly components to make sure that there's no risk that we run out of supply of anything and we keep our recipients on the air. So that's deliberate investment -- and particularly things like electrical components where if we've needed to, we've actually done a lifetime buy, so literally buying all of the products we think we're ever going to need of serving components and make sure that supply is secure. And then lastly, the trade payables, a $33 million shift. It's really $169.8 million is where we'd expect it to be given our trading. The $202.9 million last year was somewhat inflated -- sorry, last half was somewhat inflated. We had done a couple of significant lifetime buys in June that we ended up paying for in July. So that's the reason for the change there. If we go on to cash flow, obviously with the strong revenue, the nice rebound in gross margin and slower OpEx, that's delivered a very strong number in the EBIT line. Income tax, pretty much exactly where we'd expect it to be. CapEx, $38.1 million. Again, we're on glide path there. We think we're likely to end in at around $70 million for the full year, and so happy with where that is at this point in the year. And we've invested $42.3 million in the innovation fund investments. That's really 2 significant ones there, an additional injection into Nyxoah as part of their capital raise and then a new investment in Precisis. Onto net cash, not a lot of news here. We're still obviously sitting on a very strong balance sheet position. It's worth remembering, we did the capital raise 18 months ago now to really remove any risk that COVID could impact the business materially on the longer term. We want to make sure we're here for 100 years' time for the [ challenge that's being ] implanted today. And so we're comfortable still with that level of cash holdings right now given that the coverage risk is not behind us yet. And then lastly on to the dividend. So we aim for full year dividend payout ratio of 70% of NPAT. We will target that for this year again. We normally are more 50-50 in our NPAT split half 1 to half 2. Because we're going to be more weighted to half 1 for the reasons we've talked about, we have decided to moderate the payout ratio for the first half slightly. So we're going to be paying at 65% for half 1, which delivers a dividend of $1.55, and as I said, we will be aiming to pay out for the full year at 70%. And with that, I'll hand you back to Dig to talk through the outlook.

Thanks, Stu. I'll finish up with the outlook before we go to questions. So our guidance range is still $265 million to $285 million. However, that does now include the cloud computing cost. It's effectively a 5% lift in our guidance range, and that reflects the strength of performance in the first half. In terms of the assumptions underlying that, so we expect to see in the second half given the operating theater constraints that the growth is weighted towards Services and Acoustics. We do see continuing impacts on our Cochlear implant revenue from either region-specific or country-specific COVID-related shutdowns or restrictions and the hospital staffing shortages. And what we do see is we do see a strong pipeline of candidates. When we say pipeline of candidates, we see surgeons that are keen to operate as they get access. So we remain very confident of the medium- and long-term outlook here. And just got to work through, as do many other companies, work through this hospital staff shortage and capacity issue that we have at the moment. From an OpEx perspective, as Stu said, we're going to continue to invest in our growth activities. As he said, OpEx will be weighted to the -- towards the second half. And the guidance does now include $18 million to $20 million in cloud expenses. It's obviously $5 million in the first half and then $13 million to $15 million in the second half coming through. And our net margin will stay just below the 18% this year and next year, and that's largely due to the cloud computing impact. But certainly, our long-run target of 18% remains and we will get back to that. So while there is the prospect of a more material disruption from COVID, obviously the longer we go on, I think the likelihood of that reduces, but it certainly is still a factor outside of this guidance. But that said, we certainly remain confident. With good pipeline of recipient surgeons keen to operate some restrictions on operating theater capacity, in the medium term, very confident of what we see in terms of potential demand. So with that, we will move on to questions.

[Operator Instructions] Your first question comes from David Stanton from Jefferies.

Firstly, if we could talk about Services. Do we think -- do you think the catch-up is done in Services in terms of -- compared to lockdowns that we saw in the first half -- or sorry, during COVID? Or will we see that level of ongoing growth in the second half, please?

Yes. Dave, thanks for your question. We expect Services to moderate in the second half. I think there's a bit of catch-up in there. The deeper we get into the cycle since Nucleus 7, sort of the harder it is to keep that growth rate going. So longer run, great opportunity in Services is sure. We obviously think that this will moderate in the second half.

And if we switch to costs, you mentioned you saw COVID restrictions on costs in the first half. Given the lockdowns that we're still seeing in some areas in the world, can you explain to us why we'll see COVID restrictions on costs into the second half -- or a decline in those, I guess, into the second half going forward, please?

What we're seeing is the world starting to open up and we're starting to see some conferences come back in. There's a couple scheduled for this half. I would go overseas next week for the first time in 2 years. So we think that access -- so it's basically travel in confidence, but it's also just access to clinics and the ability to get out. We've had some of our clinical studies go a bit more slowly than would happen and that delays cost. So we could be wrong on that, but I think we're certainly seeing increasing optimism and real evidence of opening up. And so that's why the expenses will lift as we go into the second half, and we're lifting in R&D and in investments in growth.

Understood, understood. And final one for me. How are you going in terms of penetrating into audiologist networks, particularly in the U.S., that don't currently follow up Cochlear implants? And can you give us any metrics on changes that you've seen half-on-half, please?

Yes. So we continue to work there through, for example, the Cochlear Provider Network, CPM. And there, we've given numbers of clinics in the past, sort of a 400 range, and that's still about where it is. What we're focusing on now is more how do we get more out of each of these clinics rather than necessarily expanding the network at that rate. We think -- we do want to expand the network, but it's more about the productivity of each of these and the opportunity to refer than it is about expansion. So that opportunity still exists. As I said, we're doing work on referral activities right around the world and how that -- there's slight differences. The intent is the same, but there's slight differences in how we do it depending on local market conditions and setup, but it's a very important part of our future growth.

Sorry, just a quick follow-up on that then. So how do you get more out of these clinics going forward?

It's all about awareness and education. So we know that clinics are seeing implant candidates. They're referring some but not all, and so it's making sure that they see the benefits of the ones that they do refer. It's continuing to educate on the indications and the benefits that people get. And there's no -- what we're seeing is there's no shortcut to that education. It takes time. It takes some enthusiasm from the clinic. And we're getting better at targeting there, picking the clinics more likely to refer on. And then we continue to build our field team that supports these clinics.

Your next question comes from Andrew Goodsall from MST Marquee.

I was just going to ask you to characterize the U.S. market at the moment. I guess what you're saying sort of implies there is a bit of a backlog building up, and I guess you've talked about disruption to surgeries and so on. Just whether you could see perhaps by midyear that, that's sort of moved on or just what perspective you might be able to bring to that and whether indeed there's a backlog?

Yes, Andrew. Good question. There certainly is. We're seeing good demand for surgeries. We're seeing people come into clinics. So there is a backlog there. I think the second half of your question, we don't know how long will that take to clear. And what we saw, I don't think it's going to happen the way it happened in the first half of '21 when, after the COVID restrictions, there was a rush back to surgery. That -- because the constraints are different now, the constraint is availability of nurses particularly, that will take sort of -- it won't open up the way it did then. So I expect it will take longer to clear, so it will be a less obvious bump. But I think -- look, I think this will take a while. It's an issue that's pretty widely reported. But it is -- this is [ partly shape ] of hospitals to deal with their incentive in terms of [ note ]. Hospitals make money from getting through these operations, so a hospital's incented to solve this problem pretty strong. So I think it will get solved. It just might take some time.

And I presume it's -- kids are getting done with -- or at the top of the list and adults at the back or?

Yes. Yes, certainly. Typically, yes, when there are constraints, children get priority as much [ you would do ].

Next question. You mentioned that in '17, your 5-year mark. I know you don't like to be drawn on when the next upgrade to the process is coming through, but is there any reason that we should think your sort of normal 5-year innovation cycle has changed or COVID had any sort of disruption to the way you like to launch and promote and things like that?

Well, I think if you look back out, we've launched actually a BTE every 4 years from 2001 through to 2017. In 2016, we launched Kanso and then 2019 Kanso -- 2020, sorry, Kanso 2. So the addition of an OTE allows a little bit more space between BTE generations, and that's all about getting -- maximizing the benefit we get from our investment in R&D and continue to provide a range of options to our customers, which is an important competitive feature. So I'm not going to comment on what the future is other than the addition of successful off-the-ear processes are going to help space it out, but the timing on it behind the year is consistent.

And final one for me, just the balance sheet looks a little lazy. Just any sort of capital management initiatives that you've got in your thoughts or what you might have planned for that?

We think we're, as Stu said, happy to have quite a lot of cash right now in -- as we come through this, which we are. It's more cash than we need. So we're thinking about what's the right thing to do there, but we're in no rush. We've got lots of -- we can invest significantly through the P&L that gives us terrific returns. We're very focused on that. But over time, we're looking at options for that cash, but it's not a -- it's important, but it's not a high priority right now.

Okay. Not burning a hole in your pocket.

Your next question comes from David Low from JPMorgan.

Dig, if you could just start, I mean you've talked about the U.S. challenges with staffing. Just wondered if you could talk a little bit more about Western Europe. I would have thought with the Omicron wave, et cetera, going through some of your bigger markets there, you might have seen more of a hit. I understand it was an easy comp, but just sort of characterize how things are in Western Europe today and over the rest of this half, please.

Yes, David, no problem. So okay, Western Europe is certainly hit by Delta, hit by Omicron, has some hospital staffing shortages, I think not to the degree of the U.S., but it's not plain sailing. As we said, Western Europe -- Continental Western Europe is now back above pre-COVID levels, which is great to see. So there is more capacity than there was pre-COVID, which is good, but it's not back at the -- there's opportunity for more capacity and for further capacity. In the U.K., I think it's widely reported -- well, it is widely reported that the surgical backlog in the U.K. is very significant on the NHS side. We also see to try to work through that. So certainly, I think better -- so it's recovered well, but there's still more to go. And -- but I'm getting confident that, that will -- it will resolve and we'll continue to see that recovery come through in Western Europe.

Okay. Just a quick one on the cloud computing costs. So $5 million in the first half, closer to $15 million give or take in the second half. Is that the run rate that we should be thinking about going forward? I mean, $30 million a year rather than $20 million?

Yes, Stu here. Yes, broadly. Like I said, it's -- we think it's a 4- to 5-year journey. We're at the beginning of it. We're doing it in sort of deliberate stages. Obviously, we've got a lot more visibility over the first stage. The latter stages are still -- we're still forming up the scope and expectations around those, but broadly speaking, yes.

And just one bit to that, too, is obviously if we were capitalizing this in sort of a few years, we start to see the depreciation coming through, which we would manage within our margin. So sort of the worst impact on our margin is the front end of this where there's no -- the full impact of what we spend and there's no offset in depreciation savings. So it's sort of as we get into '24, we start to see -- in normal times, we would be depreciating. So we expect to see that the margins start to recover from there forward.

Understood. Look, last one for me. We've heard some fairly positive -- had some fairly positive feedback on Advanced Bionics' offering. I'm sure you don't want to particularly comment on competitors, but very interested in your thoughts there and whether you've seen any market share movements in major markets, please.

Yes. Look, Advanced Bionics have a very good offering with the Marvel processor. They're also coming back from the recall. So you saw that in their last result. Coming back from the recall, obviously your sales start to lift. We think, overall, they have regained some of the share that they have lost. We don't see that they're gaining that share from us.

Your next question comes from Steve Wheen from Jarden.

I just also wanted to just touch on the Services business. It's -- clearly, there would be an expectation, particularly in the U.S., around the Nucleus 8, so it is kind of curious that you've been able to achieve that conversion to the Nucleus 7 during this period. I just wonder how much of it's the -- of the driver for those sales is from the deductibles issue in the back half of the calendar year? Has that been a major driver, considering a lot of those recipients might not have qualified in the previous 2 years because of COVID issues?

It's certainly a partial driver on timing. When this deductible issue became more prevalent a few years ago, we saw bigger swings sort of from December to January in terms of our upgrade sales. It's become more muted as people have gotten used to it. So I think it's a partial factor, but it's definitely not the majority cause of the uplift.

And so your comments around the moderating of that, is that more because we're going into the half where the deductibles issue isn't as prevalent? Or is it more we're getting closer to people's expectations around the Nucleus 8 launch?

I think it's really both. I wouldn't count it as expectations of Nucleus 8 launch. I just will say it's lots of people have upgraded to Nucleus 7. And the more that do, the fewer there are to upgrade. And the Kanso 2 is still a very strong prospect. So I think now we'll see a good number in service, but certainly wouldn't expect the level that we saw in the first half.

And also we know there will be a degree of almost sort of natural hedge in that, particularly in Western Europe where you've got cap funding markets where we anticipate they're going to be more focused on CI in that second half, but that's going to naturally then depress the level of spending they can put towards upgrades as well.

Yes, right. Understood. The second question I had was just in the emerging markets space. China, India, Brazil obviously showing a good recovery and good sales. And is that largely all tender-based? Or what's -- could you just sort of help characterize those sales in those regions?

Yes, yes. Certainly, we've seen the public -- it's the public markets, which are typically tender-based, that were the biggest hit from COVID because it's government money versus private money and the government stopped their spending pretty quickly. So the recovery, certainly in India, Brazil, is a return of the public market, but what we have seen is the private market actually grow strongly through all those countries. And in part, that's just the natural growth with the economy, I think in part as the government pulls back people and parents are more inclined to spend their own money on their child than wait for the government to step back in. So we've seen a bit of an expansion in the private markets in those areas.

Next question I had was around your reinvestment in the business. And it would appear that, I guess, given the backdrop with Delta and Omicron during the first half, you're able to sort of pull back on some of that reinvestment until you get the confidence. And so the fact now that you're suggesting you're going to be stepping that up in the second half, that -- does that sort of highlight that you have much more confidence in the second half given what you're seeing so far?

We definitely got more confidence as time goes on. The first half wasn't so much we pulled back. We just were unable to spend because of restrictions. So it wasn't so much a deliberate choice as we just didn't have the opportunities that we think will be there in the second half.

Okay. Just one final question, a clarification on the cloud software. If we're doing sort of $30 million OpEx or expense going forward for the next sort of 4 years, that would suggest there's nothing that's being capitalized from this accounting standard. Is that the correct interpretation? I remember last result, you were saying that there would be a split between what is CapEx and what is OpEx from that spend.

So there's, I guess, a couple of comments. So we have taken some small write-offs -- adjustments in this half to reflect things that were being CapEx historically, but that's pretty minor. And going forward, there will be a small amount of CapEx spend here but not material. So there's a couple of things. It's really when you're making investments in cloud assets that you own. And so we have a couple that fall into that category, but the bulk of the spend is more on platforms that are owned by third parties like Salesforce and other things.

Your next question comes from Gretel Janu from Credit Suisse.

Just firstly, on the guidance and outlook commentary. And you stated that the revenue growth will be weighted to Services and Acoustics in the second half. I guess just focusing on Cochlear implant revenue, does the outlook actually assume growth at this point and given the restrictions currently that you see?

Yes, Gretel, we do expect there to be growth in Cochlear implants in the second half. From what we see, the point we're making here is we don't see that there -- we won't be complete access to operating -- sort of unfettered access to operating theater capacity. We do expect some improvement in the half.

Okay, great. That's clear. And then more of a medium-term question, just on the FDA approval for single-sided deafness that you recently achieved. Can you give us a bit of detail in terms of how much you expect that to add to market growth in the short to medium term?

Not much in the shorter run because the reality is some people have been getting implants with single-sided deafness. There's still a bit of work to get all the insurance companies on board with funding. The FDA approval is an important step, but it's not the last step there. So it's important sort of medium term rather than a shorter-term impact.

Okay. Understood. And then just 2 quick housekeeping questions. The other income that you recorded, the $5 million, what was that? And the FX contract gains, what do you expect in the second half?

So the other income, it's a small amount of income we generate from -- I think we're licensing R&D technology. Again, it's very small in the grand scheme of things. The FX outlook, yes, we're not seeing significant fluctuations in FX right now. So right now, a little baked in the outlook.

Your next question comes from Sean Laaman from Morgan Stanley.

Dig, just like to tease out your view on the growth potential in the U.S. So it sort of was flattish or down. I think you called out one of the main reasons was the staff shortages. I mean, many of the hospital execs we talked to call this out at the top of the list as one of the potential sort of midterm, potentially longer-term problems. I'm wondering if you have a view whether staff shortages are more transient as it pertains to the pandemic or if you think that, essentially, there hasn't been enough or strong enough recruitment of nurses into beginning of the funnel compounded by nurse fatigue and retiring. So this could have a more profound structural impact going forward on surgeries. Any view you can share there, Dig, would be very useful.

Yes, sure. A set of good questions. I think what we're hearing is that this is very much a factor -- COVID-driven factor of fatigue rather than necessarily a structural shortage. And I think, that said, if you look at sort of western world and aging population and growth in health care, there's going to be -- there is an increasing demand for nurses everywhere, and our education systems and training systems need to keep up with that. So I think there's been 2 pressures there. One is there's a growing need for nurses, and so that intake does need to keep growing, but I think what we're seeing now is mostly driven by the impact of COVID and fatigue. And part of what we're seeing is, during the years too particularly, is that this is not necessarily -- well, not necessarily giving up, but what we're seeing is they can quit their full-time job and go to part-time nursing on occasional basis and earn higher rates. So they get the same amount of money working fewer hours. That to me sounds like a market anomaly, and I think things like that normally get resolved just through the economics of it. So look, I think this will recover, but it's obviously an issue a lot of people are looking at.

Super helpful. And I might have missed it, but just the currency assumption in guidance. I think you called out $0.74 at the full year result last year for fiscal '22 looking forward. Just the rate, if that's changed?

Yes. So we think we're going to land somewhere probably closer to $0.72, $0.73 for the full year. Obviously, that's been coming down through the course of the year. So it's probably a $0.01 or $0.02 impact on that.

Your next question comes from John Deakin-Bell from Citi.

Just to look at the Acoustics business, an excellent result there. Can you just give us a sense of whether you think, over the medium term, that your products, it's quite a differentiated product, can grow that market materially and whether -- I think historically, the U.K. has been a big bone-anchored market. Is that still kind of negatively impacted? And should we see a bounce back in that market over time as well?

Yes, John. I think -- good questions. And we do expect that the Osia 2 product has the potential to grow the segment. And the vast majority of people with mixed and conductive hearing loss get hearing aids, [ cross aids on top of a ] hearing aid or reconstructive surgery. A very small minority get either a Baha or now an Osia product. The results that we are seeing from Osia, and we are building out the clinical studies and the evidence to support this, show that it is a very effective solution, gets very good outcomes with very few complications. We can put that evidence together as a real opportunity to grow this segment -- that will grow the implant segment as it competes with reconstructive surgery and hearing aids, and that was certainly a big part of our intent of putting Osia together. It was not just to replace Baha. It's actually to grow the segment. In the U.K., it is a big Baha market. And Osia is now launched there that -- there's a different price point as there should be for Osia over Baha. And we think that, that means that both products will stay in the market over time because of the sort of the pricing difference, but we would expect that the Osia segment to grow relative to the Baha segment. And your point on here that the U.K. is still catching up, yes, there is still a catch-up in Acoustics and in CI in the U.K.

And just a longer-dated question. I think last time and even a year ago, you called out the knowledge level around hearing saw an increase as people were wearing masks through the pandemic. And I know simply [ bought up lastly ] over-the-counter hearing aid act in the U.S. has kind of progressed a bit. I mean is that part of your buildup of candidates being driven by those things? Or is that -- are those issues going to be kind of longer-dated and allow you to continue growing beyond the immediate down stack?

I think a few things. So there certainly is increasing awareness of hearing loss. There's things like the World Health Organization promotion in hearing loss, and drawing attention to hearing loss is part of that. Mask-wearing has definitely highlighted -- continues to highlight, for many people, that their hearing is worse than they thought it was. So certainly, at a macro level, there is absolutely growing awareness, and growing awareness is essential to our growth and growth in CI. So to OTC, that legislature is specifically aimed at reducing the barriers to people getting hearing care and to open up the market. The more people, again, that get hearing care, they will realize the benefits. It raises awareness. And I think more of those people, I think, will -- people will expect their hearing to be looked after, and I think that definitely helps the implant segment as people's hearing loss progresses through their lifetime. So I think at the macro level, there's a number of very positive features in the outlook and moves going on that give us confidence in our long-term strategy and the long-term opportunity to grow.

Your next question comes from Chris Cooper from Goldman Sachs.

Can I just start off with the guidance? I recall when you first set the guidance, it was predicated on the assumption that COVID impacts generally improve from that point. Despite Delta and probably Omicron surprising you to the downside, you've really been able to upgrade the guidance today. Just looking at the wording, I mean you anticipate continuing COVID impacts for the rest of this year. Can you just outline for us how you've thought about continuing impacts? What does that look like to you? I'm just trying to get a sense of how much room there is to deliver ahead of this guidance because you've given yourself a bit more room than you ordinarily would at the outset of that target.

Yes. So Chris, yes, look, certainly going into the year, the Delta variant was the dominant issue. We were seeing impacts. We were, in our outlook, thought that like previous waves, we'd get through the Delta impact and we'd see sort of surgeries expand again and sort of see that recovery through the year. I mean what happened was that -- what happened with Delta but then there were the hospital staffing shortages and then the Omicron variant. So I think that outlook of early issues in the year then recovery, what we're seeing is, well, we had a really good first half despite those issues driven by Service and Acoustics. There are still impacts in the second half on surgeries. As I said, we expect the surgeries to [ relatively ] in the second half, but certainly not at the level we'd anticipated earlier in the year, which is why we say weighted to -- our outlook is weighted to Service and Acoustics. So I think all that does [ bring in ] our long-term view is, look, that opening up, recovery and working through of the demand that we see is there. It's just pushed out a little bit further. And in the meantime, we think Service and Acoustics can see some of the opportunity there.

Okay. And Stu, maybe following on from that, the sort of drivers you run through on the gross margin improvement. It doesn't sound like there's any sort of mix or a reason to think that we don't remain at this kind of 75% targeted level as we continue through the rest of the year and perhaps beyond.

Yes, certainly not as a result of mix. Like I said, the gross margin is very similar across all the different product lines. Look, we have 2 things we'll -- we keep a close eye on [ what's having on effects ]. We're not -- we obviously haven't seen much volatility there recently. And then we are just continuing to look at every single component. And we'll see some small, lumpy costs coming through in terms of lifetime buyers, but yes, at a macro level, not a lot to see that being radically different in half 2.

Yes. Got it. And just a quick final one, just on the net margin guidance. You've had the 15% level for quite some time. You now have a chunk of costs that didn't exist through the P&L previously, which you quantified at a 1 percentage point headwind. Are we to interpret the fact that you're keeping 18% as a message that the underlying business is in a slightly more profitable state? Or should we just be thinking that these cloud costs kind of awash and sort of get lost with everything else going on?

The cloud costs will reduce our margin this year and certainly into '23. So our 18% target was prior to the cloud cost being an issue. As I was saying earlier, the cloud cost is a temporary issue, but the further we go into it, the more it just resolves itself in terms of the costs being offset by depreciation over time. So our goal is to get back to 18% inclusive of the cloud cost, but it's not going to happen in this year or in '23.

Your next question comes from Saul Hadassin from Barrenjoey.

Dig, just one question for me, just on the upgrade cycle. You mentioned sort of an extended upgrade cycle, I guess, on the back of Kanso and Kanso 2 coming out, but do you have any sense of what percentage of the recipient base is eligible for an upgrade in this current sort of 5-year window has actually upgraded? Historically, Cochlear used to talk to sort of a 50% sort of peak upgrade percentage of that population. Is that higher? Can you give us any sense of where that is now?

Saul, I'll take that. Broadly speaking, yes, I think we are seeing some signs, but it's still pretty early days. The investments in things like Cochlear family and contact ability with that recipient base are helping there. And certainly, the combination now pretty much always having an off-the-ear and an on-the-ear option, those 2 things combined I think has given us some confidence that we may see a push beyond that historic level, but it's still pretty early days.

So just to clarify the contribution to the strong Services revenue growth, is it a combination of increasing penetration of the installed base as well as increased numbers of the installed base? Or is it still more weighted just to the actual numbers of people or recipients in that installed base itself?

Biggest drivers are the size of the base and the growth in the base. Increase in penetration is helping, but the biggest driver is the increase in the size of the base. And actually then, the double whammy of surgical capacity constraints, meaning that in cap fund marketing -- cap funding markets, there's a bit of an incentive to then shift some of that focus to upgrades.

Your next question comes from Lyanne Harrison from Bank of America.

Can I just come back to Acoustics? So obviously, very good growth there, but can you give us a sense of what proportion of that growth was either driven by implant revenues and what proportion is processor growth?

Yes, Lyanne. So short answer is no. We won't split out sort of implant or upgrade part of that, and we just haven't ever done that. It's important for competitive information. And given that it's -- overall, it's 12% of our sales, we don't think there's a lot of insight to be gained, but we can say that there has been a lift in both the number of implants and the upgrades in that Acoustics product.

Okay. And so another way to ask that, can you expect a similar rate of increase in second half? Or do you expect that to moderate slightly?

So we certainly expect that sort of level of sales and in absolute dollars to -- should continue somewhere around there. And then the comparable in the second half is a little bit better than the comparable first half so -- in terms of percentage of that flow through.

Okay. And so just another question, just trying to understand the pipeline a little bit, particularly for the North American seniors market. Do you get a sense that, that pipeline still remains fairly robust? Or do you get a sense that, given some of the clinics are shifting to upgrades, that there might be some softening there?

Now what we are seeing is that there is good demand. There are people who want surgery and really can't get in. There's also been a lot of rescheduling of surgeries going on either from the doctor gets COVID, the nurse gets COVID, the patient gets COVID. So there is -- again, with unconstrained operating theater capacity, there would be more surgeries being done.

Your next question comes from Shane Ponraj from Morningstar.

Just on Services and Acoustics still, wondering how much of the growth you think was attributable to higher average prices given the newer products? Just thinking about how the growth potentially moderates from here as it sounds like it's being buoyed by surgery delays.

So Shane, there's really nothing in underlying pricing that's driven the first half result. Perhaps the only thing on that in that line is that, as we've said, Osia price is higher than Baha, but we -- but there's not a lift in unit pricing.

But the average prices, it sounds like Osia has been doing pretty well. So would you -- would it be fair to assume that some of the growth is attributable to that?

Only at the margin. If you look at Acoustics being 12% of our revenue and then that's split between upgrades, Baha implants and Osia implants -- even if you think about the premium for Osia over Baha and work through the weighted average, you're going to get up with a very small number.

Okay. Understood. With the 75% gross margin just previously flagged a negative effect from commissioning costs for the China manufacturing side, how much of an impact did that have? And do you think there's any further upside if freight costs [ surveys ] as well?

Minimal impacts of that in the first half number. And we're not anticipating significant movement on the basis of freight in the second half.

Is there more cost for commissioning to come?

Yes, so that plant is ramping up. And as we go through that learning curve effect, that will have a lag for a couple of years as we get up the yield curve in production in Chengdu, but then ultimately, it becomes a net benefit.

Okay. And if I could also please clarify 2 things real quick. The $20 million cloud computing for this year, that's included in the $100 million to $150 million guidance range. Is that right?

Yes.

Great. And lastly, with the same sort of guidance and NPAT margin of about 10% for this year and next year, would it be fair to say that stronger U.S. dollar is sort of more or less offsetting the higher cloud computing costs and so the guidance hasn't changed too much?

No. So we said 18% next year is -- 18% target is excluding cloud. And we've said the cloud will bring our margin down in the balance of this year and in through '23. We don't see that the FX outlook is going to change significantly. We've made -- in terms of outlook where that's -- with our forecast, we don't see it changing significantly in through next year.

[Operator Instructions] Your next question comes from Ray Tollefsen from Teaminvest and shareholder.

Just a couple of items I'm curious about. What is actually going to the cloud? Is it all of the corporate enterprise staff or is it everything possible? And also just a brief mention of the Chinese factory. I may have missed it, but when is that likely to actually start producing product?

Okay. Ray, yes, on the first one, we -- in terms of what's going to the cloud, we are implementing a Salesforce product across our sales and customer service, that will be in the cloud. We'll then work through our human capital management systems and finance systems, and they will go to the cloud. And we're having a look at what we do with manufacturing, and that's a pretty typical trend across all large businesses now. And the second one on that factory in China, so we've said that commissioning is in progress. We'll start production -- in terms of supply from the plant, we said we need regulatory approvals and that will still take us -- they are still at least 18 months away for the first ones there. So it's still some time to go before -- well, [ approximately ] production before we're actually distributing product from the plant.

There are no further questions in the queue at this time. I'd now like to hand back to Mr. Howitt for closing remarks.

Okay. Thanks all for joining the call. Thanks for your questions. And we look forward to talking to you again in 6 months' time.

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