Fisher & Paykel Healthcare Corporation Limited (FPH) Earnings Call Transcript & Summary

Good day, everyone. Welcome to Fisher & Paykel Healthcare's Results Conference Call. My name is Kelly Ann, I'll be your operator for today's conference. [Operator Instructions] Please note that today's call is being recorded. At this time, I'd like to turn things over to Marcus Driller, Vice President, Corporate. Please go ahead.

Thank you, Kelly Ann. Well, good morning, everyone, and welcome to the Fisher & Paykel Healthcare First Half 2021 Results Conference Call. On the call today are Lewis Gradon, our Managing Director and Chief Executive Officer; Lyndal York, Chief Financial Officer; Paul Shearer, our Senior VP of Sales and Marketing; and Andrew Somervell, our VP of Products and Technology. Lewis and Lyndal will first provide an overview of the results, and then we'll open up the call to questions for the team. We'll be discussing our results for the 6 months ended September 30, 2020. And we have earlier today provided our interim report, including financial statements and commentary on our results to the NZX and ASX. These documents can be accessed on our website at fphcare.com/investor. With that, I'd now like to turn the call over to Lewis.

Okay. Thank you, Marcus, and welcome, everyone. Today, I'm going to be referring to the investor presentation pack that was released to the NZX and ASX this morning. We're going to start on Page 3. But before getting into details of our financial results, I really want to start by thanking some people who are very important to us. First, I'd like to express my thanks and admiration for the thousands of health care providers around the world who have responded to the COVID-19 pandemic with such care and such courage. Second, I want to thank everyone across our entire business, but especially our families and partners for the contribution you have made this year, supporting the single-minded focus of our people, either working from home or the long hours at the manufacturing and distribution sites, and all of this for extended periods of time and all of this at a time when you may have had other major concerns as well. Our families and partners have made a big contribution to Fisher & Paykel Healthcare's results this year, and we really want to acknowledge that. And thirdly, I want to thank our suppliers all around the world. They've all gone above and beyond to provide the raw materials, the components and the services we need to answer the global call for our products. So thank you. So now turning to Page 3. I'd like to acknowledge some of the highlights for the half year. Our biggest achievement by far was ramping up production on a number of our hospital hardware and consumable products to meet that customer demand. We accelerated production in the new Daniell Building, and we commenced planning for our third manufacturing facility in Mexico all in the half. We also developed a wealth of new online resources to support health care providers who are treating patients with COVID-19. So turning now to our results on Page 5. For the first 6 months of the 2021 financial year, Fisher & Paykel Healthcare delivered extremely strong financial performance. Overall operating revenue for the first half of 2021 was $910.2 million, and this was a 59% increase compared to the first half of the 2020 financial year and at 61% in constant currency. Net profit after tax was $225.5 million, that's up 86% on the first half of last year or 87% in constant currency terms. Growth continued to be driven by hospital hardware and that increased 383% in constant currency. In short, the world needed our AIRVO, our Optiflow and our humidification systems, and we have delivered. Our consistent practice has been to pay a dividend to shareholders. Given the positive result, our Board of Directors has approved a fully imputed dividend of $0.16 per share, that's an increase of 33% on the first half of the previous financial year. Now achieving these results has required an extraordinary effort from our entire team. And to acknowledge the way our global team has gone above and beyond, the Board has doubled the discretionary profit sharing bonus our people will receive for the first half of the financial year. This total bonus is equal to approximately 3.1% of annual base pay for each person, and it's a total profit share of about $12 million. So now looking more closely at our product groups, starting with hospital, Page 6. So these are products and systems used for invasive and noninvasive ventilation in nasal high flow therapy and during surgery. And this includes the AIRVO devices and the therapies like Optiflow that are being used to treat COVID patients. On Page 7, our reported revenue for hospital products was $681 million, up 93% or 94% in constant currency, and that's over the first half of the 2020 financial year, of course. Sales and hardware and consumables continue to track surges in COVID-19 globally, and that's as the virus moved across Europe, North America, South America and South Asia. Revenue growth in new applications consumables was strong at 43% over the first half of the previous year in constant currency terms. So now if we move on to the Homecare product group, starting on Page 8. So this includes products used in the treatment of obstructive sleep apnea or OSA and chronic obstructive pulmonary disease or COPD as well as other chronic respiratory conditions. So heading to Page 9. In our Homecare product group, operating revenue grew 5% to $226.2 million or 6% growth in constant currency. The first half was challenging for our sales team and obstructive sleep apnea. Many sleep clinics around the world were closed or operating at reduced capacity, and that resulted in a reduction in new patient diagnosis. Having said that, customers have responded positively to our Evora and Vitera mask for OSA, our newer masks, and we're confident that these are great products and that they've yet to reach their full potential. So now I'll turn over to our CFO, Lyndal York, to give you some more details about the financials. Lyndal?

Thanks, Lewis, and good morning, everyone. On Page 10, gross margin decreased by 534 basis points to 61.7% for the half, down 420 basis points in constant currency. As Lewis discussed, there has been a sustained high level of demand for our respiratory products. Because of the challenges with global supply chains, we have been and continue to use air freight to bring in raw materials and deliver product to our customers quickly. The cost of air freight and expediting the supply of raw materials has been significant, with the cost per cubic meter of air freight averaging 4 to 5x higher than normal. However, we have opted not to increase prices to our customers, and this has impacted our gross margin. Excluding the additional freight costs, gross margin was in line with the same period last year in constant currency. The amount and cost of air freight has reduced from the early months of the pandemic, but are still at elevated levels. We have assumed that the freight costs will continue at these current levels for the remainder of the year. Moving on to Page 11. Total operating expenses grew 17%. As this was significantly lower than the revenue growth, the operating margin increased 489 basis points to 34%. There was a negligible net impact on our operating expenses from COVID-19. Higher costs, such as personal protective equipment, well-being, cleaning and security were largely offset by reduced travel and sales event costs. R&D expenses grew 20% to $64.6 million, reflecting continued growth and timing of R&D projects. R&D expenses were 7% of revenue for the half. We have a strong new product pipeline, including new humidification systems, flow generators, masks, consumables and information solutions, all under development. SG&A increased 15% to $118.1 million for the half or a 16% increase in constant currency. We anticipate that our constant currency operating expense growth for the second half will be slightly lower than the growth rate in the first half. Moving to Page 12. Operating cash flow was $218.1 million. Our working capital increased, primarily reflecting the growth in the business and rebuilding our inventory, including the sea freight pipeline, which were lower than usual at the end of March. Capital expenditure, which includes purchases of intangible assets, was $94.5 million for the half, compared with $86.6 million last year. Our fourth New Zealand building, the Daniell Building, was completed this half, and we have been accelerating our investment in manufacturing capacity to ensure we have an increasing supply of our products. We are still expecting to spend approximately $185 million in CapEx for the full year. Our free cash flow, which is operating cash flow, less capital expenditure and lease payments was $118 million for the half. From this free cash flow and our short-term deposits, we paid $89 million in dividends during the half. The balance sheet remains strong. Debtor days are within the normal range at 44 days and in line with the prior year. Inventory has increased with business growth and rebuild from lower levels in March. Net property, plant and equipment increased by $42 million from the 31st of March, mainly as a result of the acceleration of manufacturing capacity. Net cash at 30th September, 2020 totaled $78.1 million, up from $42.2 million at the end of March, predominantly as a result of higher sales driven by the COVID-19 demand. We had cash balances and short-term investments, mainly in New Zealand dollars of NZD 158.3 million at the end of September. Interest-bearing debt was $80.2 million, with 26% of it being noncurrent. The USD 30 million facility that matured on the first of November and was classified as current, has now been replaced with 2 NZD 30 million multicurrency facilities maturing in September 2025. Most of the debt is held in U.S. dollars as a balance sheet hedge. Turning to Page 13. Our gearing ratio at 30th of September, 2020 was minus 7.1%, which is below our target gearing range of minus 5% to plus 5%. Based on our guide assumptions that Lewis will go through shortly, we are projecting to be around the bottom of our target gearing range at the end of FY '21. As Lewis mentioned previously, we will be paying an increased interim dividend of $0.16 per share payable on the 16th of December. This represents a 33% increase on the interim dividend declared last year and enables us to make the accelerated investment manufacturing capacity that we are currently doing and expect to continue over the next year. The dividend will be fully imputed and a supplementary dividend of $0.0282 per share will be paid to nonresident shareholders. Looking now at foreign currency on Page 14. Profit after tax for the half declined by $4.9 million compared to the prior period, primarily due to the New Zealand dollar being stronger than at the 31st of March, 2020. This includes the results of our hedging program, which contributed a loss of $1 million after tax for the first half of this year. Our policy remains unchanged. And when there are opportunities to extend our hedging position, we are able to do so up to 5 years forward, and in some circumstances up to 10. At current rates and the assumptions used in our guide, for the second half this year, we would have an after-tax gain from hedging of approximately $10 million. These rates and assumptions would result in a decline of our H2 net profit after tax compared to the second half of last year by approximately $13 million due to net currency impacts. Now I'll pass back over to Lewis, who will outline our full year guide assumptions. Lewis?

Okay. Thanks, Lyndal. So I'll move now to Page 16. We've had a strong first half to the year, and we've continued to expand our installed base of hardware and hospitals. And since the last trading update we gave in August, we've maintained the same level of hardware and consumables revenue in our hospital group for the half year. And in our Homecare product group, OSA mask revenue also continued at similar levels to the first 4 months of the financial year. Now we cannot predict the course of COVID-19, the effectiveness of preventive measures, the adoption of preventive measures, the progress of a vaccine, outcomes of vaccines, the impact of any of those on future hospital rates or investments that countries may choose to make and treatment measures. So consequently, we really had no basis on which to provide traditional guidance for the full 2021 financial year. So what we're doing is providing a guide to the full year results based on the following assumptions, which I'll list. So first, we assume that hospital hardware sales returned to normal levels from January 2021. Second, we assume that the use of our hospital hardware returns down to approximately normal rates for the second half of the financial year. And third, we assume that OSA diagnosis rates are reduced for the second half of the financial year, and that's due to limited access to patients. And finally, we assume that freight costs remain elevated, resulting in a reduction in gross margin of approximately 200 basis points in constant currency terms for the full financial year. So now based on these assumptions and reflecting the sustained stronger hospital hardware sales to date, on that basis, full year operating revenue would be approximately $1.72 billion, and net profit after tax would be in the range of approximately $400 million to $415 million. And this guide is based on exchange rates of $0.69 for the New Zealand dollar to the U.S. dollar and EUR 0.58 for the New Zealand dollar to the euro. Just to be clear, our assumptions used in providing this guide, they're not a prediction or a forecast of the course of COVID-19 around the world or its impact on us, and they don't impact our production planning. We are continuing to grow the manufacturing capacity of those hospital respiratory products for the rest of the 2021 financial year, and that's because we think the world is counting on us and we think it's the right thing to do. Now while the efforts to contain COVID-19 remain uncertain, we believe the exposure clinicians around the world have had to hardware bodes well for treating respiratory patients and hospitals over the long term. Now with that, I think we can now open the call for questions.

Thanks, Lewis. And operator, Kelly Ann, if I could ask you to please open the lines up for questions. [Operator Instructions]

[Operator Instructions]

Thanks, Kelly. I think we have our first question, and it's from Andrew Goodsall at MST Marquee. Please go ahead, Andrew.

Congratulations on a great response to the COVID and the great result. I was just going to quickly ask just if you could add any comments around third quarter trading to date, just with the Northern Hemisphere second wave and lockdown?

Well, yes, I can. But before I do that, Andrew, I want to point out, one, really, really big thing, and maybe could relate to all the questions we're about to get. And that is when we look back on that first half, we have massive variability from month-to-month in both our hardware and our consumable revenue. If we look at a region over the 6 months, we have really big variability from month-to-month. It tends to track COVID hospitalizations. If we just take a snapshot of 1 month from time and we look at the world, again, we have really big variability. And I think that if we took the last 3 months, and we tried to forecast the next 3 months of that, we'd be changing our forecast on a monthly basis. So I don't think there's a lot of value in doing that or going there, Andrew. There's just such massive variability. Having said all that, and with that caveat, it's looking pretty strong.

All right. Anything else you want to add to that? Or just strong?

Well, again, it's impossible to draw a trend of what looks like a pretty random graph. It doesn't look to us like anything is going away.

Okay. And then the second question, just curious around your outlook comments on OSA and the comment on diagnostics in the second half. I was just going to see if you could expand on that because, I guess, I'm reading it as you're seeing a slowing of new patients in the second Northern Hemisphere lockdown because of lack of access to diagnostics?

Yes. I think that's a fair comment. And we're trying to take account of the impact of COVID on sleep labs being open, whether they can pivot to home diagnosis where the patients want to be engaged in treating sleep apnea, where the patients have the money to contribute to that. So trying to take account of a whole lot of things. We've kind of landed on it's almost impossible to try and predict those impacts. So we've taken an arbitrary number to put in our guide. And that arbitrary number we just assumed that 80 -- we would have 80% of last year's new patient starts. Our second half would be 80% of that this year. I just want to emphasize, we've used that. It's relatively arbitrary number. Fair comment to say, I think, from what we're seeing. We know it's reduced, but to what extent and how long in the future, we just picked the number.

So next question comes from Marcus Curley at UBS. Go ahead, Marcus.

I just wondered if you could talk to what you think the benefit from COVID has been across invasive ventilation versus new apps or high flow. I suppose, it looks like the growth in consumables in invasive ventilation was stronger. Obviously, the average consumable price there is lower, so it would suggest quite a large skew in terms of COVID patients towards your traditional business versus your new app business?

Yes, that's a complex question, Marcus. So remember that we've given you new apps growth rate. And in new apps, you've got -- also got noninvasive ventilation that's running a bit under the average rate. And you've also got surgical, which has pretty much disappeared during the last 6 months. So you've got some drags on the new apps rate, that would be the first comment. Second comment to your question would be that we're fairly confident that all these intensive care ventilators that have gone out, not all, but a large proportion of these ventilators that have gone out. We've managed to supply them with humidifiers and humidification products. And then I guess the third caveat is, typically, in a normal year, when we talk about utilization, we're talking about our revenue. And in a normal year that kind of makes sense. But what -- we don't actually have visibility to utilization. So what we have visibility to is our sales. So there's another variable there that we can't put a number to, and that is how much of this is being utilized, and how much of this is customers, hospitals, supply chains rebuilding their inventory.

Could you talk a little bit to what you think your installed base has increased by across invasive ventilation and high flow?

No, that's not a place that we're comfortable going. You can see certainly the numbers for the half. So you can draw the conclusion that it's increased substantially.

Okay. And secondly, just on the flu season, is that an influence on why you are suggesting for the second half? Or assuming, I should say, that utilization in the hospital space falls back?

So we're not really thinking about the flu season this year. We think it's just been completely not only swamped by the other flu, the COVID-19 one. So that really hasn't played into any of the assumptions. Again, it's kind of an arbitrary number that we've chosen to say, well, we'll assume normal utilization for the second half. I spoke about all the variability in the first half. And on a month-to-month basis, it's all over the place. But if you take the average over the first half, it doesn't look too unusual. So that's kind of the only thought that's gone into that assumption for the second half of averaging about normal utilization.

Next question comes from Lyanne Harrison at Bank of America.

I know you've mentioned you can't speak exactly to the October and November trends. But can you give us some indication? And if we look at the hospital revenue, if we look at the hardware, are you still seeing demand on hardware come through from all the geographic regions, such as U.S., Europe, APAC, and other? Or are there specific regions that you can call out that is still demanding hardware?

I think the answer to your question, Lyanne, is yes. And it's all regions. With the caveat that we're talking about 2 months, what's been a very variable -- well, you're up to 8 months now. Very, very variable 8 months. Those last 2, I'd say, across all regions, and hardware demand continues.

Okay. And would that hardware demand be stronger or less strong than what you experienced through the first wave, particularly for the United States?

Again, I'd caveat that with the very, very variable, taking 2 months out of something. Just to try and put a color on it, we can go -- we can have a month that's utilization looks like maybe double normal to months where it looks like half. So you're talking big variation, which I think it's very, very dangerous to focus in on 2 and a bit months, 1.5 months. 1.5 months, really dangerous. And going with that caveat, the last couple of months -- look, you could pick a couple of months that looked like that out of the first half. But for any region, actually.

So sorry, so just to clarify that, if I looked at the first, say, 1.5 months of third quarter compared to April and May or April and the first half of May, would that demand be -- the hardware demand be stronger or less stronger than that period? I guess, what I'm trying to understand is...

What I'm telling you is I could find 2 months in the first half -- I could find 2 months in the first half that look for these 2 months. So I think we are just on such dangerous ground, trying to draw any extrapolation out of the 2 months. I really want to caution you on that. It's dangerous.

Okay. No problems, why don't I move on and let's talk about consumables revenue. Would you say that there is possibly increase -- likely to be increased consumables growth, given that you've got a high install base now and then also a second wave of coronavirus, particularly through the United States?

Well, yes, we do think that's likely. And if you look at the guide we gave to the second half, that is kind of built-in there. We're assuming that the hardware base is utilized. So that gives you consumables growth. And then the only additional comment to make to that was once we get to our second half, we're lapping February and March. February and March, we had already begun to see the pandemic response in our consumables revenue.

Thanks, Lyanne. Our next question comes from David Low at JPMorgan.

Lewis, could we start with just talking a little bit about how much pull forward sales you think you've received as a result of the recent period. So where did the AIRVO nasal high flow sales end up versus where you perhaps would have predicted they would have been a year ago? I'm just trying to get a sense as to how much additional equipment has been sold into the market on the hardware side.

Well, the best sense we can give is that 383% hardware growth of what's happened. In terms of trying to estimate what's been pulled forward, I wish we could. But at the moment, we have -- I'd just say we couldn't. We can't interpret what's being pulled forward at all. We don't think this is pulled forward. So far, looking at data, we see -- it looks like what we're placed is being utilized.

Okay. Yes. I guess what I was trying to get a sense as to how far ahead of plan are you in terms of rolling out the nasal high flow? And then of course, the real question, I think, for the business is where to after the pandemic, are we -- have we just stepped forward a number of years and growth continues from there? Or have we seen a whole lot of hardware sales into the market, which will now take a little bit of time for the underlying normalized demand to catch up. Any thoughts on that?

Yes, you're right. That is the question. So I think in terms of Optiflow and AIRVOs, we had such low global penetration prior to the pandemic. We don't think we're anywhere near saturating that market whatsoever. We think the challenge and what our job is, what our opportunity is, is to ensure it continues to be used post-pandemic for -- as a default therapy for respiratory support. That's what we'll be working on, and that's what we'll be aiming for. So if we achieve that, or then you're right, we would have just managed to roll progress forward several years depending on how long these rates go on for.

So we saw a lull in the COVID cases, particularly in the U.S. I'm wondering if there's any anecdotes that came through from that period as we pass the peak and there was a lot of this, the hardware, Fisher & Paykel's hardware in some of these hospitals. And I'm thinking in some regions, obviously, more -- had earlier peaks than others. And what happened to utilization in those periods that follow, perhaps that's possible to say, but just any thoughts or anecdotes on that front?

I think during the lull, it was mostly about trying to replenish inventory. So it's a bit hard to say from any data what was actually going on there. People were trying to build inventory. And that might have impacted their treatment decisions also. And also bearing in mind that our salespeople haven't had great access to hospitals that's been really essential access only during this whole period. I'm wondering if, Paul, wants to add some color?

Yes. Well, just -- it's been lumpy for a whole variety of reasons, David. And then -- and of course, COVID is kind of started in New York and spread in other states and things, so that has an impact, too. It's too much variability there to about to be able to draw any real conclusions.

And no real anecdotal that I feel talking to the guy.

All right. I think there's only one other thing I would say, what has been very helpful is that we've got a whole lot of new customers that are now gaining exposure and interest in AIRVO and Optiflow. And I think that bodes really well for the future.

Yes. No, look, I gather it's an impossible question, but it's also the crucial question. If I could squeeze in one more. Just the Homecare business, there's a comment there about myAIRVO sales being strong. Can we just talk to how much demand you saw for treatment of patients at home, presumably COVID patients at home with myAIRVO?

So we don't know what the myAIRVO product is being used for in the home. I don't -- we can't give you any data around that. I think 3 or 4 months ago, myAIRVO has been growing strongly for a while. It was sitting on a similar trajectory 3 or 4 months ago, and I'd say probably it's picked up. It's been accelerating over the last 3 or 4 months. What's being used for, harder to say.

Thanks, David. Our next question comes from John Deakin-Bell at Citi.

Okay. I was just trying to get a little more -- just to ask that question a little differently around the geographic demand. So we've got your general geographic growth, North America 44%, Europe 70%, so quite a big difference, but we don't have any color between the businesses and also between the hardware and the consumables in the hospital side. Can you just try and give us a bit more color on where the demand geographically has come from?