Cochlear Limited ($COH)

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

Thanks, everyone, for joining on short notice this morning. As I said, we're going to make a few comments to open. What I'd like to do is talk through what are the issues that are impacting the business that have led to a lower sales and lower profit. What are the short-term implications of them for the P&L? And then I think perhaps most importantly, what are the implications for our longer-term strategy and how we implement strategy. So I want to make some comments on each of those, and then we'll open up for questions. So starting off just with sort of what's happened more recently and what do we see that might be sitting behind that. And I'll start -- talk through each of the segments. I'm going to talk with developed market cochlear implants first and spend most of my time on that because it is the most significant piece. So as we went into the second half, we had expectations for growth based on market growth and our Nexa share gains and share gains from Nexa. The contracting for Nexa is now complete. It's gone well, and we are seeing some of the share we talked about having lost in that contracting period being regained. We regained that share. However, the market growth is much lower than we expected. We're not sure for the -- obviously, for the year yet, but we think certainly below 5% for the year. And particularly, I want to focus on the Adults and Seniors segment, which is the biggest part of the developed markets and our biggest growth opportunity. And there, we're seeing a range of things across the world that I wanted to talk about. And I'll start by talking about the U.S. So as we said in the half, we saw some strong momentum in Q2 and good growth in November and December. That growth continued through into about the middle of February. And then from the middle of February, sales fell off. There were some weather events in February, which sort of possibly explains some February. But then from March, we saw a dip compared to -- a decline compared to March last year, which is obviously very unusual for us, and we'll get a bit under what do we think is going on there. Then in Europe, hospital systems in Europe are under pressure. And we're seeing that manifest itself in a few different ways. In the U.K. with the NHS is the most obvious example there. We've had significant success in lifting referrals, but we're not seeing that translate into more surgeries in the NHS. And the NHS has really struggled as have many healthcare systems since COVID. But what we're seeing is growing waiting list, not only at surgery, but also at audiology. And we're also seeing quite frequent cancellations of CI surgeries. So that is within the NHS, cochlear implant surgeries are getting deprioritized relative to other surgeries. Also, similarly in Germany, hospital systems under pressure. We're seeing growing waiting lists and a lower priority in some hospitals there with that economic pressure. And then also in strikes in Italy and strikes in Spain in the hospital systems cutting surgical capacity. What we see there is that's a different manifestation of a hospital system under pressure. And we do run into surgical slots access from time to time. So that's not necessarily new, but what we've seen over the last few months is where in the past, it perhaps been a bit patchy, it's happened across all of the major European markets over the last few months, and that's put real pressure on just the total number of CI surgeries and consequently onto our sales. If I then go back to just want to look back a little bit further at this Adults and Seniors segment and what we've seen since COVID and what we saw before COVID. And I'm going to link all these bits together and what the implications are for our strategy in just a minute, but I want to give you a bit more background first. If we look back before COVID, we saw Adults and Seniors growing at 10% to 11% per year year-on-year very consistently. What we've seen since COVID is the Adults and Seniors growth rate has gone from probably lower than 5% this year, which will be the lowest to over 20%. And obviously, it bounced back strongly out of COVID, which was a catch-up. But then even in '23, we saw 19% growth in Adults and Seniors. So we've seen much more variability in the Adults and Seniors growth since COVID. As we've looked back at that and tried to understand it, we've also seen that, that Adults and Seniors growth rate has some correlation with what's happening in the hearing aid sales in developed markets. It had a similar burst of growth, high growth coming out of COVID. But if we look across the hearing aid companies and what they're reporting, we have seen that sales growth slowing year-on-year for the last few years. So it looks like there is a correlation between our sales to Adults and Seniors and hearing aids. And that -- as that segment becomes a bigger part of our business, we are seeing that correlation or that variability is having more of an impact on our overall revenue. We then take that back to the U.S. As we said at the half year, we have seen year-on-year growth in our referrals from hearing aid channel. We have seen that decline in the first half, and that's continued into this quarter. And we've also just seen then that U.S. consumer sentiment is the lowest on record. And we've got records going back just over 50 years, and U.S. sentiment now is lower than it's been at any time over that period. And so what we see -- what we're concluding from that, and we're still exploring is that our Adults and Senior sales is more correlated with sentiment and macroeconomic conditions than we've seen in the past. And that's only being tested with the extremes of consumer sentiment that we have at the moment. So I want to do this obviously in the U.S. -- in Europe, we're seeing significant financial pressure on hospitals, leading to ways of surgery schedules getting cut or disrupted in the U.S. We see some of that pressure on hospitals, but very much more pressure on the individual, and we're seeing individuals pull back from getting their hearing treated. We think there's a core theme that sits under both of those, and that just gets to the importance of our strategy. That core theme is that hearing loss isn't being seen as a high priority intervention when either people become under pressure financially or when hospital systems come under pressure, they are deprioritizing hearing loss. Why that's important for our strategy, which I'll come back to a little bit later, is the core of our strategy is actually to medicalize hearing loss and to use the evidence out there to get up lifted both from a hospital priority perspective, but also from a consumer perspective. And again, what we're seeing in the U.S. is people know they've got to pay out of pocket for hearing aids when they see this in our consumer research, when they think about a cochlear implant, I think that's got to cost more. So if I'm concerned on cost, people are more likely to pull back. We need to change that. So let me come back to that, but we think there's a core theme that sits under what's going on across both those markets with quite different healthcare systems, which to do with how people and how society more broadly views hearing loss and the importance of treating it. Let me go then just to the other segments. So in cochlear implants or across emerging markets, there, setting up through February, our sales were on track and in line with our expectations, and we were seeing good growth. The war in the Middle East is having a significant impact on us there. Our sales in the Middle East are always weighted to the last 3 or 4 months of the year. That's just a quirk of timing in that part of the world where we're typically selling into distributors or to government hospital systems in sort of bulk rather than sort of a run rate with surgeries. So with the war in the Middle East, we are seeing some order cancellations. We are seeing reduced surgeries in a range of countries, and there are access issues, just getting logistics in terms of actually getting products into some countries is constrained. That's having an impact already. We're not sure of how big that impact will be through the rest of the year, and that's one of the reasons for a pretty broad guidance range is that there remains a fair bit of uncertainty over what we will sell into the Middle East through the next 3 months. And then on to China. We've talked about the impact of VBP, and that was in our forecast. What's happened in the last quarter is that we -- there are special zones in China where we're able to sell premium product where we've been selling Nexa. There was a level of reimbursement into those special zones that was withdrawn in Q2, and that will have an impact on our premium tier sales into China as well. Go back to Service and Acoustics. Both of those performing in line with expectations. We said we see growth in the second half, and we've given the 13% and 11% constant currency growth rates that we saw in Q3. So they seem to have been largely unaffected by what's going on so far. So that's sort of the -- if I run through the segments, what's happening. If I then just go quickly to what's the implications of that on the P&L. So just to quickly summarize in that. In Adults and Seniors, we've got weaker demand. In emerging markets in the Middle East, we've got the war, which is defer our -- defer -- canceling and possibly deferring some sales. And further to that, given what's going on, there are some questions over the collection of some of our receivables in the Middle East. We just don't know at this stage. I don't think anyone can know at this stage as the state that some of those governments will be in because all government payers will be into the future. And so we have been cautious to signal that we may need to provide for some of our receivables into the Middle East. And of course, we had the rising Australian dollar, which we already took -- already factored in, but does have an impact on our profitability. So that's led to lower sales. It's led to that guidance range. That guidance range is wide. We acknowledge that, and that is because there is a range of uncertainty that we still see even over the next 10 or 11 weeks. We're in quite an unusual situation across the world in terms of what we're seeing. The final component of the impact on the P&L is reduced manufacturing output. So we have lowered our manufacturing output. We have lowered it by more than the fall in sales, and that's a consequence of the inventory levels that we are carrying. When we do, do that, there is manufacturing overhead that doesn't get recovered and it goes straight through the P&L. Obviously, we had a choice there. We could have kept production running at the rates that we had planned, which would have pushed those costs into inventory and then through the P&L in subsequent years. And obviously, we made a sensible decision to slow our production down, and that means that there is a P&L impact in this year from that. So that's the short term. Before I turn over to questions, let me then just go to what does this mean for our strategy, which I think is actually the most important question of all of this. Just touching on market leadership first and then on to growth, which are the core elements of our strategy and then how we -- and then on to costs in terms of how we -- so Nexa continues to be well received. Now it is out there. We've got lots of interest in the potential of Nexa and to explore potential Nexa to improve hearing outcomes over time. But we also have a very broad product pipeline. And we talked about TICI, drug-eluting electrodes. We have great confidence in the specification of the products that we're building there. The progress of the trials and the experience we're seeing is very positive. They will come to market over the next few years and the products we have are built on long experience and give us confidence of those products as they come to market. In terms of our growth opportunity and our growth strategy, first of all, that medium to long-term opportunity is unchanged. The clinical need is significant. We have very effective products. The products are very cost effective from both the society and the healthcare system. The clinical evidence supporting why treating hearing loss is really important for healthy aging, particularly around cognition and lowering the risk of dementia is significant and it's growing. And we need to continue to prosecute to build that evidence and to use that evidence to prosecute the case for standard of care for cochlear implants and to medicalize hearing loss. I think all the data that we can see says that's certainly what that would be beneficial for society, for healthcare systems for that to be the case. But as always, with a therapy, it does take time for that to happen. And perhaps just a quick example of the time it takes. Back in 2018, 2019, we set out -- we helped facilitate a group of professionals around the world to develop a consensus statement on cochlear implants, which is a standard thing for a therapy to do. It's what does all the evidence say about what should be the treatment process, treatment path and treatment criteria for an intervention. As a result of having a consensus statement, you can then start to build guidelines and have those guidelines adopted country by country. Just in the last few months, the U.S. has adopted a set of clinical guidelines based on this consensus statement and available evidence for the treatment of hearing loss and particularly cochlear implants. How this helps is that as we talked about at the half go into the medical channel to build a referral base. We're not just there saying, do you know about cochlear implants and how can we educate them on you. We can go in and say, are you aware of the latest guidelines for -- adopted by the U.S. professional bodies for the treatment of hearing loss. And let's talk about -- you can talk about those guidelines because it also starts to put some professional obligation to follow guidelines when they are approved by the leading professional body. So just one example, but it was 7 or 8 years from starting that consensus statement to getting the guidelines actually adopted in the U.S. And now we've got to build -- the guidelines approved. Now we've got to build out adoption and awareness of those guidelines. So it does take time to build towards that standard of care in medicalizing hearing loss. And I think then what does this mean? So we're confident our strategy is on the right track, and we've got to learn as we implement. What we've also seen is we've got to invest more in this strategy, and that's why we are reshaping our cost base. We flagged at the half year that we've been working on the organization through the last few years to get more flexibility to redirect more resources to growth. What we're doing with the program that we are undertaking now is to accelerate that process given the lower sales growth, that's what we need to do to make sure that we can provide the funds and still manage our margin to invest in growth. We're also nearing the end of replacing our core systems with cloud-based systems and consistent data structure and standardized processes across the world, which sets us up to build scale and efficiency and particularly to be able to more easily leverage AI and generating that scale and efficiency. So it's the right time for us to accelerate. And because we are accelerating that program, we have called out that we'll see somewhere between $25 million and $35 million in costs that are going to come through in this half in terms of accelerating the restructuring that we will be undertaking to accelerate that program. That will all go above the line. It is really pulling forward expenses that we would have taken up in '27 and '28 as we worked to the plan we originally had, but we are accelerating that plan. And I say let me finish before going to questions to say, there are a range of issues hitting us right now, which have had a significant impact on this year's performance. We remain confident in the long-term growth outlook and the core of our strategy. What we see we do need to do is to free up more money within the organization, which we -- and we see we can do that to invest more in that growth to accelerate the execution of the growth programs. And with that, I will hand over to questions.

[Operator Instructions] Your first question today comes from David Low from UBS.

Could I just start with a sort of high-level question? I mean is it -- it seems clear from what you said that this adjustment is not about the war or that effect or the Middle East lost sales. This is about the developed markets and you're seeing a slowing down in Adult and Senior sales versus what you expected.

Yes, David, it's actually both those things. There's absolutely an impact from the Middle East on our sales. So the last 4 months our emerging market sales in the last 4 months of the year are disproportionately skewed to the Middle East. That's just the nature of the timing there. So there is an impact of that. But there absolutely is a piece of this that comes from much slower Adults and Seniors growth in developed markets than we had expected and that we have seen over the last few years.

Okay. And when we look at the situation in Europe, it strikes me as that's going to be more of a challenge because it's a system issue rather than a demand issue. So you've talked about the strategy in broad brush sense and need to ensure adequate prioritization of surgery. How quickly can you have an impact on those sort of systems?

Yes, good question. It is going to take some time. And because we are not going to solve the problems in those healthcare systems. What we want to do is get a higher priority. So when the scheduling happens, ENT and particularly cochlear implants isn't seen as way down the list. Yes, we can't solve the problem, but what we can do is work on the priority. We think the evidence is there to strongly support that, particularly things like the data that came out of South Korea last year showing that for people with severe to profound hearing loss, cochlear implants -- those people who got cochlear implants had a 70% lower rate of dementia than people had hearing aids with the same level of hearing loss and 120% lower than people with no hearing treatment. That sort of data that I think we can get in front of the right people in terms of healthcare systems, should lead to say, yes, this actually is a more -- this is not a discretionary. It's nice for all the people to hear, it's actually saving the healthcare system money. That's a skill we are building and we need to get better at is that payer government and policy influence. And as we look to reshape our cost base, that's one of the areas that we will be strengthening is that our government affairs and that ability to work at the policy level.

All right. And just last one for me. Cochlear had this long-term policy of 18% after-tax profit margin. What's the plan going forward on the -- post this year?

Yes. Look, our intention is still to get back there. As we said at the half, it's going to take us a few years to do that. The currency makes that harder. The lower sales growth makes that harder. So we're still holding that but it will take us a few years to get there. And we've got some impact on the gross margin that we've talked about, and we'll talk more about them in August.

So for the next couple of years, we should certainly assume that it's going to fall short of that. Can you -- I mean like this year's number is going to be dramatically short of the 18% margin. Can you give us a sense to get back to 18%, what's the pathway?

Not more at this stage than it will take a few years. When we come out in August, we'll have our outlook for '27, and that will give some insight into '27, but I don't want to get more specific on that now. We need to go through the right process to have a solid outlook.

Your next question comes from Andrew Goodsall from MST Marquee.

Just on those restructuring charges, I'm not sure I picked up what would flow into FY '27 or are they all going to get done in the second half?

So the amount we called out in the release is to hit in '26. There will be some costs in '27 likely too, but there were in '24 and '25, and we just absorbed them in the OpEx. We're just calling this out because this is a bigger one, and it is an acceleration.

Okay. So no distinct -- nothing distinct in '27?

Not at this stage. Look, when we're going to give our outlook for '27, if there is another bigger piece, we will certainly call that out. But at this stage, we're not sure -- we know what we're going to do now. There will be some more in '27, and we're just -- whether that's big enough to call out or whether we absorb it as normal, we will tell you then.

And just in China and the special access tones, what percentage of contribution to the total cost would reimbursement have been presumed for it to impact the market is quite materially?

Yes. It actually it was -- I won't go into the full detail because that sort of end up showing what our price was too, but it was a pretty significant contribution to the total. So we've certainly already seen a drop-off in demand.

And just...

Entirely out of pocket.

Okay. Okay. That makes sense. No, that's probably where I was going. So it's total cash, so okay. And then just with -- just more just trying to get a sense of proportion, but there's been some quite good articles talking about global hospital slowdown. On top of that, you've got the consumer. Do you have a sort of sense of sort of where that split is? Are the hospitals picking up any capacity? Or just any color you can add on that would be great.

Yes. Look, I've been reading those articles on as many as I can see on hospital, we all have. Yes, look, I think healthcare systems around the world are under significant pressure. And we are a tiny part of any hospital system. Our goal, as I said, is to change the priority, not change the system. I'm not sure if that answers your question. Ask more if I haven't quite.

Consumer gets excited through -- not excited. Consumer takes -- you get a call to action, particularly around dementia and so on, just where the capacity is...

Yes. Yes. So again, part of us -- yes, part of us using the data that's there is to make consumers aware of the importance of treating hearing loss. I mean the best way to get a waiting list deal with it is for the patients themselves to be saying and their family saying, look, this is essential treatment, look what you're not providing me or look at the implications of not getting treated and particularly in socialized healthcare system, that is what gets action on waiting list. So patient advocacy is an important part of raising the priority. And that's something we've been working with advocacy groups around the world for a few years now, and we do want to again strengthen that along with the work we do on policy and payers.

Your next question comes from David Stanton from Jefferies.

Look, it's more a longer-term question, my first one. Given what you called out as sort of public and private insurer pressure plus discretionary spend pressure that we're seeing particularly in the developed market, how long is this sort of low growth in developed market environment likely to continue? Should we be thinking that this is a story for at least 2 to 3 years, and then we might see volume growth as things hopefully improve across the systems? Or can we see a faster bounce back than that or a slower bounce back than that?

Yes. Doug, good question. I don't think we can say at the moment. We've got -- I mean what we're seeing from a consumer sentiment perspective is extreme based on history, particularly in the U.S. How that changes? I think we can't say how quickly that's going to -- I don't know if anyone knows certainly not us on how quickly that's going to change. The advocacy work that we need to do on policy, we are on to them. We are going to -- with this reshaping data we spend more to accelerate that. So again, we're confident in the medium to long term of the opportunity and our strategy. It's hard to know over the next couple of years, just given the range of factors and how that's going to turn out.

Okay. So just a follow-up then, we shouldn't necessarily -- it sounds like you're not really saying there's an immediate bounce back here.

I don't have to do that, I'd be able to predict consumer sentiment.

Yes. And my second and last question. Can you give us some more color about this cost base reshaping? I'm just frankly, a little bit perplexed as to why in this kind of soft environment, you feel you have to spend more? Can you help sort of explain exactly as much as you're willing to do so, the increased costs you're putting into the business, firstly? And then second, how that's going to pay off over the medium to long term?

Yes. So we're not spending more. We are reallocating the costs that we've got. So we are -- we're taking cost out, and there's a cost of taking cost out because our biggest cost is people. So to reduce costs, we've got to have fewer people in the business, and we've called out the cost of doing that. With that cost that comes out, some of that will go to building the margin and some of that will go to further investments in growth.

Understood. So a follow-up from me. So building the margin happens over the medium to longer term, though?

Yes, it will be part of that next year. But yes, we will build it over -- we're aiming to build back over the next few years.

Your next question comes from Saul Hadassin from Barrenjoey.

Just the first one, Dig, I wonder if you're willing to give us what you think Cochlear implant unit sales will look like for second half '26? And in particularly, do you think you can actually increase the number of units sold in the second half versus first half '26?

So I don't want to try and go into that now. We've given -- we've said we can get, we think, between 2% and 6% revenue growth in the second half. There's a range of variables that go into that, but I don't want to try and give a more specific data than we've given in the release on that now. Obviously, you'll see in August. And when we've seen the full year, we'll be able to make more in-depth comments.

Okay. Second question, Dig. Just in terms of the impact on consumer that you're talking to, particularly in the U.S. consumer sentiment. I think you flagged that historically is actually impacting on processor upgrades as well. You're noting now that upgrades actually seem to be doing tracking quite well. So I guess, is the -- is what you're seeing on processor upgrades due to the obsolescence of the N7? And I guess my question is, as that obsolescence impact washes through, for example, into FY '27, is there a risk that, that sentiment starts to impact on processor upgrades again? Or is that -- I'm trying to reconcile the impact on the consumer of upgrades versus units.

Yes. No, I was waiting for this question because, yes, it's the -- why isn't upgrades affected by the sentiment. And we haven't seen it so far. And yes, we think it's because once now it's retired, it takes this upgrade from discretionary to essential. And insurers will pay for it. If someone's processor breaks, they got to pay their co-pay, the insurer will pay the difference. We are watching through the fourth quarter. It's one of the potential variables just to see do we see a higher rate of cancellations. Certainly, to your point, that the impact of the retirement will take some time to flow through because we have quite a lot of people out there in the U.S. still on Nucleus 7 and they don't all come in on the day we retire. So it will take some time to get them through. But as they've moved through, then yes, I'd expect to see consumer sentiment have some impact on upgrades. Now who knows where consumer sentiment will be then. And obviously, at some point in the future, we will have the next generation of upgrade, which starts that cycle again.

And just lastly, you say you may need to take that provision for Middle East receivables. So is that incorporated into the range of guidance? And if you do have to take that provision, do we assume then the range would be skewed to the lower end?

It is in the range of guidance. I don't want to comment now on whether that would take us to the low end or not. There's several moving parts at the moment that goes into that outlook of which the receivables is one, but it is included in the guidance range.

Your next question comes from Chris Cooper from JPMorgan.

Dig, so beyond the 18% net margin guidance, which has been in place for some time and remains in place by the sounds of it, the other long-term guidance you've had is 10% revenue growth on a long-term go forward. So today, you've called out quite a number of headwinds on implants, some of which hopefully are sort of short term in nature, many of which sound a little bit more structural. Is 10% revenue growth over the long term still the right number to be anchored to?

Yes. We see that it is. And you're right, there are a bunch of headwinds right now. Some of those I think will come off over time. We said we're working on the policy level and the evidence level to get hearing loss is a high priority. But the opportunity is there. The effectiveness of the products is there. The cost -- both effectiveness in terms of the patient outcome and the cost effectiveness for society and healthcare systems is there. As we communicate that more clearly to the right people, we do see that, that opportunity to grow at 10% is there. When we look to our future product pipeline there, too, we see further opportunities to drive growth.

Just a follow-up. If the revenue opportunity is sort of over the longer term as attractive as it has been in the past, why is now the right time to be thinking about changes to the cost base and becoming a lower cost to serve business as you described today?

Yes. Why is the right time now? So two things. One is what we are seeing and I took out, we're seeing more variability in our sales than we saw pre-COVID. And just that on its own says we need to get more variability into our cost so that we can better deal with that variability. And part of that is you've got to pull fixed costs out to get to that point. Second one is that we do believe we have the right strategy. We do have that opportunity I just talked about, and we talked about this before. In terms of building out standard of care, it's effectively -- you can think about it like trying to build an asset. And the faster you invest in that asset, the faster it gets built. So if we can create more capacity to invest, we build that asset, which is standard of care faster and we get to that more consistent growth faster. And we see in the organization with the work we've been doing over the last few years that the time is right that we can do this. We think the opportunity is there in changing how we work and leveraging AI and leveraging the new platforms we've put in. So we've been building towards this. We're now just accelerating what we're doing because the opportunity is there. And there's nothing like the imperative of lower growth to reinforce all across the business. We had a call with -- a global call this morning with the business on this is a situation we're in, and here's how we need to respond. These are -- we don't like being here, but this is an opportunity to galvanize people even more strongly around our outlook and our strategy and our mission.

Okay. And just one quick specific one on the Middle East. Forget '26 for a second, but just over the last couple of years, how much revenue contribution from that region through '24, '25, just rough numbers?

Yes. We -- look, we haven't called that out. Emerging markets overall is now a bit over 20% of our revenue, of which China is the biggest component. The Middle East would follow China as being a significant part of that. So we don't call it out explicitly, but it is a reasonable part of the business. It's quite a profitable part, and it's particularly overweighted in the last 4 months of any year, again, just due to timing of how orders work in that part of the world.

Your next question comes from Steve Wheen from Jarden.

Just my question is around the Nexa launch. Just trying to understand, particularly in developed markets, whether you've been able to achieve the price premium as you've been recontracting some of these hospitals and if that's part of the issue here with regards to the earnings impact or the surprise relative to your previous guidance?

No. So there's nothing in the change in guidance that's related to price. So we have achieved the price outcomes that we set out across the world. We did a bit better in some places and a bit behind. But overall, we've got where we wanted to get to. But there's no change there that's had an impact on the change in outlook for the year.

I mean I might just push a little bit harder on that because some of the channel checks that were done, it would suggest that hospitals, particularly in the U.S., have not seen a price increase. They've been able to negotiate no price increase relative to the 600 series. So just trying to understand, I mean, is that just -- we've just chosen the ones that you were able to -- that were able to achieve that? Or is that a bit more commonplace in the U.S. and you're getting price improvements elsewhere in the world?

So the pricing -- average price increase we achieved in the U.S. was above our expectation. It looks like you've spoken to a few small subset. And I'm not -- I'm intrigued on which ones because there's very few. There are some that have contracts that aren't up for renewal yet, possibly spoken to them, but anyway.

Yes. I mean the issue that hospitals are saying in the U.S. is that with an absence of features in the Nexa platform and no change to the reimbursement for the implants, then it's difficult for them to accept a price increase. And I'm just...

So first of all, there was an increase in the CMS reimbursement. So that part of what they told you wasn't accurate. And there are features in the Nexa. So that wasn't accurate either. But it is the argument we hear, right, yes.

So what are the Nexa features that we expect -- I mean this is the big question that we're trying to understand is when will we see these differentiated sort of software that you can on the...

Yes. So we've got -- so the one that is there right now, which has a direct impact on clinic profitability is Smart Sync. So people don't need to come into the clinic if they lose or break their process so we can ship them a blank one. And so that takes unbillable time out of the clinic. So that one has a direct impact on hospital profitability now. We have -- that said, we've got premarket research that we -- that has been done on Nexa. We will soon -- very soon start to show the results of that. We are also working on regulatory approval for some research tools, which will enable a range of clinics to be able to start exploring the features of Nexa. So certainly getting plenty of interest, and we're getting closer -- we are getting closer -- much closer to showing some results and getting closer to enable a range of clinics to actually get in and experiment with the potential.

In terms of timing that we can expect to see some sort of benefit in terms of take-up rate?

I think as we start to show -- we're already seeing some benefit of that as we start to show some of these results, I think that will -- does reinforce the opportunity for NEXA and the take-up that we'll see. As people start to do research, it should help even further, but I'm not going to put times publicly on when those things, part of it is subject to regulatory approval, but both of those things are getting closer.

Okay. I might just talk to guidance overall. I mean we've had a number of disappointments relative to guidance over the last few halves. Just trying to understand, is this guidance now, is it -- is there any ambition in there? Or have you approached this with a lot more conservativeness so that we can sort of at least establish a new base?

I think, we all try to learn as we go and make sure that we're getting better in all of the things that we do. So the guidance we've put out there is based on our collective view and our experience. It is a broad range because there is a fair bit of uncertainty. There's a number of dimensions to it, which we're calling out, and there's a bit of a range on each of those.

Yes. Okay. And sorry, one final just point of clarification. At the first half result, you guided the gross margin down to 73%. Is this the commentary about another -- the 100 basis points? Is that now suggesting 72%? Just wanted to clarify that.

Yes, that's right.

Your next question comes from David Bailey from Morgan Stanley.

Just on the U.S. hearing aid channel, wondering if you could help us just size that in terms of how material that is in terms of referral base. And I suppose the extension then is if you're seeing more discretionary behavior, does that mean that fewer people going in for the initial consult? Is that a thematic? And/or do you think that maybe the audiologists are referring a little bit less if they're under pressure financially, they make a bit more money on hearing aids, maybe they're referring less for cochlear implants? So just some of the observations around the hearing aid channel in particular, if you can.

Yes. No worries. I think it's all of those things. And obviously conscious talking about the hearing aid channel. We have some insights through the cycle data. And then we have sort of anecdotes and what we read in the hearing aid manufacturers public reporting. So certainly, there has been slower organic growth across the hearing aid companies year-on-year for the last few years. We see in the cycle data that there is a bit less traffic in hearing aid clinics, and that's obviously a segment. It's not all. We're also seeing a bit that people are sort of trading down a model. So people who are replacing their hearing aids are not necessarily buying the same tier. And these are I'm speaking cautiously because this is a sort of macro look at a lot of data and obviously, hearing aid companies know this way better than we do. But I think all of that suggests that people are being more cautious on what they're spending on hearing aids. That means less hearing aid retailers are probably seeing less revenue than they were and our lower referral suggests that they are holding on to people more so than in the past.

Yes. No, that's helpful. And just how significant is that channel? If you did a pie chart, how would hearing...

So in the U.S., sort of 30%, 35% of our business -- about 35% of our business comes from our DTC and our hearing aid referrals. We actually don't break out which of those two -- what's the split in those two, but it's in that segment where we're seeing the reduction in referrals. But we also know in the other sort of 65%, about half of those referrals come from the hearing aid channel, other half come from the medical channel. So we have visibility of a proportion of the referrals from the hearing aid, but not all. The proportion we got visibility of we can see has declined. So we suspect that decline has gone into the proportion we can't see. There's no reason to believe why it wouldn't be different in the part we can't see.

And just a quick follow-up -- sorry, an extra question. First half, you sort of said there was some -- a bit of discounting from competitors. Just want to understand the competitive dynamics subsequently. It sounds like you're winning share, but can you just talk through what you sort of -- you think -- if you think the trends are more macro driven as opposed to share dynamics at the moment?

Yes. So certainly, what we're seeing in terms of sales is a macro -- an overall market issue, not a share loss. We've seen -- we've been gaining share. We did lose some share, as we said, we've regained that share. Note that one of the competitors recently publicly reported increased competitive intensity and hinted at a poor outlook than expected on their CI sales.

Your next question comes from Craig Wong-Pan from RBC Capital Markets.

Could you talk about what growth you've been seeing in the pediatric markets in the U.S. or Europe during the third quarter?

Yes. It's -- for pediatrics, I don't want to give -- try to give a quarterly number because there is a delay in registration. So the best we could do is only give you about half a quarter. What we did say at the half is we had seen, particularly in the U.S., a decline in the pediatrics. But remembering this is a smaller and smaller part of our developed market business. It's now less than 30% of our developed market sales are in this pediatric segment. But given that the U.S., we said at the half had been -- we had seen a decline.

Okay. And within Europe, have you been seeing similar activity there?

In Europe, I can sort of look back to the first half, and it looked pretty flat. But yes, I don't want to -- again, given the lag on registration, I don't want to go into what's happened in Q3, so we wouldn't be able to do it accurately.

Okay. No problem. Second question, just the hospital capacity issues that you mentioned in Europe, has that transpired in the U.S. as well? Or is it more just the adults and seniors the consumer activity and cost of living pressures having any impact there?

Yes. So it's more stark in Europe. I think socialized healthcare systems, I suspect -- I have no data, but I suspect they have less able to get a sort of efficiency in their hospitals, whereas the U.S. with the commercial hospital system are pretty clear --- clearer rather on their overall financial state. There's no doubt the U.S. healthcare system is under pressure as well. Some of the changes being made by the administration to Medicare, Medicaid has the potential to impact some hospital funding. Where -- what I called out is we just -- we see in the U.S. more of an impact from consumer than we do broadly across the hospital, but there's no doubt that there are hospitals that are under pressure and there are hospitals where it's been tough for doctors doing CI to get surgery slots in the U.S. It's just less of a theme than we see in Europe, where it's pretty consistent.

Okay. And then just the production volumes being lowered to reflect what you're seeing with demand. I mean volumes do seem to have been fairly volatile. I guess, just wondering how quickly you can ramp up production if needed?

Yes. So we do -- we can ramp production. We carry an efficient -- we have an efficient way of carrying some headroom in production so that we can lift output by at least 10% quite easily.

Okay. And then just my last question on the TICI. You've mentioned that as some studies underway. Just wondering if you could give any rough timing for when how that might come through?

Yes. So cautious to give timing because -- largely because of the regulatory process. So we do have pivotal studies, so studies for regulatory approval running in Europe and in the U.S. Those studies are recruiting. The surgeries are going, and then there is a follow-up period and then the regulatory submission. So it's still a few years away and the regulatory cycle for a new product like that is certainly less predictable than an iteration of a conventional implant. So we're cautious on giving timing for that reason. We're also cautious that just from a -- we don't want to signaling to people to hold back getting a cochlear implant now in the anticipation of a TICI.

Your next question comes from Paul Grace from Evans & Partners.

Actually, Sacha Krien here. Look, a couple of questions on the guidance, first of all. Just wondering if we should still be expecting the $50 million STI provision rebuild or whether that has now been reversed?

Yes. So in our outlook, there is an allowance for the STI made, an appropriate allowance for STI. Obviously, STI is subject to a Board's decision at the end of the year, but there is an allowance in there in that guidance.

In that guidance. Okay. I think you previously spoke to $50 million there. Is that the allowance that we should be thinking about?

No, that's slightly different. So that was what we took out of our STI potential last year. So we have an STI pool. That pool was reduced by $50 million because of performance last year. And when you look at the OpEx this year, assuming 100% STI, $50 million of the OpEx or whatever it will be this year would have to be STI 100%. That makes sense. But it's fully covered in the guidance. And when we get to the end of the year, the Board will look at our performance and make a decision on what size pool that should be.

Okay. So just to be clear, I'm not 100% following this. So you've got all of it, all 100% covered within the current guidance and some of that may not be paid out, and therefore, the guidance may change a little bit. Is that the message?

No. We have sufficient in that guidance to cover the range of outcomes that we can see for this year. So whatever -- yes, the STI will not take us outside of guidance, yes.

Yes. Okay. You've given guidance for second half constant currency sales growth, 2% to 6%. I'm just wondering if you can share third quarter -- the third quarter constant currency sales growth. You've given some of the component parts, but...

Yes. No, I don't want to share more detail. We think we've shared enough details as much as we're comfortable with, we think makes sense.

Okay. And just on the U.S. market, just wondering, I mean, you mentioned a couple of times that you've regained share with the Nexa. Are you actually meeting your expectations for share gains? Or is it a bit hard to say in the current environment?

I think it is hard to say in the current environment. We remain based on feedback we get, optimistic on the outlook for Nexa and the potential of the product and therefore, the potential for further share gains, but it is hard to -- as always, it's hard to be too specific on share over a short period of time.

Yes. Okay. And then just last one for me. I just wanted to dig a little bit more into your comments about deprioritizing hearing. I'm just wondering, are you saying that U.S. hospitals are deprioritizing cochlear implant surgeries to a degree given the economics of those surgeries?

We're certainly seeing it in Europe, more from a -- but deprioritized more on the basis of what's perceived as the most important therapies or conditions to treat. There certainly are cases in the U.S. As they look at profitability, they'll schedule something that they see as more profitable than a cochlear implant in. But it's not -- it's certainly not a dominant driver of the -- not a driver of our sales being below forecast.

Yes. And you're not seeing any change in sort of reimbursement knockbacks for cochlear implant surgery?

We're watching insurance approvals carefully. We are hearing of some anecdotes of some insurance rejections, which almost always get overturned on appeal, but the data is anecdotal rather than comprehensive at this stage.

Your next question comes from Stuart Thomas Welch from Alphinity.

Can you hear me?

Yes, can.

Excellent. Just I just want to focus in on that cost-out initiative that you got underway. I guess my understanding is you guys have been adding sales reps to help deal with some of the customer or the patient interactions to take the weight and load off some of the audiology clinics to give them a bit more space and time. Given that's where a large part of the investment has been, like where can you take cost out to reinvest?

The short answer is across the board. But we're very -- we will be surgical as we do this. We will make sure that we are protecting revenue growth. We'll protect things like -- obviously, things like product quality, but there still is a range of things that we've got across the business. There's certainly an opportunity -- there's an opportunity to improve efficiency everywhere through the better use of information and through the use of our systems and through the redesign of some of our work. So now worries off limits, but we're also being very careful not to damage or put out risk core parts of our growth or core parts of our competitive advantage as we do this.

Yes. And how -- what's been the competitive sort of landscape, if you like, on the ground vis-a-vis Model and AB with that strategy? Have you sort of seen -- like how have they evolved as you've been adding more salespeople in the field?

Yes. I mean they're strong competitors. They certainly compete very hard. Model are a good company. They're clear on their messages and on how they -- the rationale for why they think their product is best and they prosecute that well. Advanced Bionics have a couple of features around bimodal and around remote programming that they get from Sunnova. And again, that's -- they're their differentiator. So they do a good job of selling those. Now coming back to, we have the most complete system, the most comprehensive system with the broadest set of features and benefits. And that's why we hold the share we do, and we make sure we sell that well and our competitors are good.

Your next question is from Davin from [indiscernible].

It's Davin from Goldman Sachs. Just thinking about the U.S. market, Dig, and I guess the question really is relative to your previous expectations and previous guidance range. You had sort of flagged a slowing referral base from the hearing aid channel. So I don't think that's necessarily, in my view, anyway, the real reason why the U.S. market has probably underperformed to your previous guidance range. So what else is happening? Do you sort of feel like people have gone through the pipeline, gone and had a referral and ultimately just not gone ahead and converted to get an implant?

Yes. So a couple of comments. One is -- that decline in referrals is definitely part of this. But as I said, it's more than that. It is -- we are seeing -- yes, people who are getting referrals not going ahead. That's part of it, too. What we are hearing from clinics is they are just -- they are seeing fewer people coming in more recently, and that I think links back to -- again, we're sort of triangulating this, but that links back to the fewer referrals, but also a sentiment issue of this is a discretionary treatment, and it might cost me something. So I'm just going to hold off at least for now.

Yes. I'll leave you with a point because clearly, there's a question here about whether it's cyclical, i.e., discretionary impacts on the consumer versus more structural questions on your referral base. My understanding in this space has been it takes more than 2 months for someone to be referred and ultimately get put on an implant. So your guidance 2 months ago, which was based on some visibility you had in your pipeline to what you're putting out today, what's been the key change really?

Yes. Good question. So you're right, it does take more than 2 months for people to come through the system. I think a couple of things to that. People can withdraw from the process at any time, and so that does happen. Secondly, we don't have full visibility of that pipeline. As we talked about before, we got visibility in the U.S. of about 35% of the surgeries. The 65%, we don't have visibility. So we actually -- we don't know. We get feedback from clinics, but we don't have numbers on how many people were turning up 6 months ago for assessments. So you're right, 2 months isn't enough time, but equally, we didn't have -- we never have perfect information.

Yes. Okay. And just sort of a follow-on question on this. You've talked about making some changes to your cost base. And I assume part of it will be to sort of pivot referral sources. Could you sort of help us understand some more tangible changes you can make on that point and if that can start contributing to some better outcomes in FY '27?

Yes. So certainly, the work that we are doing in the medical channel, which is now well underway. We have -- we're working in 4 cities in the U.S. to build a referral base. That's progressing very well. We do see it, as we said at the half year, is a significant opportunity that about half our referrals come from medical channel already, and that's without us doing a lot of work to stimulate referrals. I think it has -- is potentially a bit of a buffer to sort of economic conditions impacting hearing aid referrals because it is a medical channel. It's more used to what's your condition. I know where to send you rather than I have a treatment for you, the hearing aid where there's a financial incentive not to refer in some -- in many instances. So that's an example where it both can insulate from the macroeconomic and it is definitely a growth opportunity. The other part which we talked about, which is more for Western Europe, but has a role in the U.S. as well is working at the policy and the payer level on the evidence of the effectiveness of treating hearing loss and the -- particularly around cognition, what happens if you don't treat it, and therefore, what costs are avoided if you provide the right level of treatment and therefore, why it should be a higher priority in terms of the prioritization process that goes on in hospitals of what procedures to undertake.

Yes. And just one last one.

And just building on that, too, that work we're doing in the U.S. for the sort of the direct-to-professional referrals is something that we are working out. We are expanding that one into Germany and into Australia and then some of the other Western European markets to build out that medical channel referral.

Yes. Okay. And just one last one on your cost base and the restructure initiatives that you've highlighted today. Just if you didn't think about adding more costs or just investing in further headcount. So if I just think about it being the headcount you've reduced from your restructuring initiatives, just how much of reduction in SG&A and R&D costs from a year-on-year would that yield in FY '27 versus FY '26, please?

Yes. We don't want to give that out at this stage. As we get into '27, we'll work out what we want to say about where we are. We are, as I said, taking costs out broadly across the business and a significant part of that, we will reinvest. We'll keep you informed as we go through the process, but I don't want to put numbers up now of this is what's coming out and this is what's going back in. We'll get further down the track before we do that.

[Operator Instructions] Your next question comes from Shane Ponraj from Morningstar.

Just one from me, please. I just want to clarify the guidance for the cost base reshaping, you've called out up to $25 million today. But it sounds like some of that is accelerating the cloud investment you're already planning. Am I correct in that thinking?

No, no. So this is separate. So no, that $25 million is related to the taking costs out of the business. We do what -- in terms of the reference to accelerating the cloud, it's not accelerating the cloud program. That's nearing completion. It's accelerating the realization of benefits from that program.

Great. So just as a follow-up, if I remember correctly, at the half, I think you called out $80 million this year for cloud expenses as a significant item. That guidance hasn't changed at all. It remains -- roughly about $20 million remaining for '27?

Yes. Sorry -- yes, that's the envelope that we had given.

Your next question comes from Trent Crawley from Copia Investment Partners. Your next question will be from David Grace from Noventia Group.

We're finished with the questions, I think.

Yes, unfortunately, there seem to be some technical difficulties with their lines. As there are no further questions, I'll now hand back over to Mr. Howitt for any closing remarks.

Just to say thanks all for joining this call at short notice, and thanks for your questions.

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