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

Welcome to Fisher & Paykel Healthcare's Results Conference Call. My name is Amil, and I will be operator for today's call. [Operator Instructions] Please note that this conference call is being recorded. I would now like to turn the call over to Marcus Driller, VP Corporate. Please go ahead, sir.

Thank you, Amil. Good morning, everyone, and welcome to Fisher & Paykel Healthcare's 2022 Financial Year Results Conference Call. On the call today are Lewis Gradon, our Managing Director and Chief Executive Officer; Lyndal York, Chief Financial Officer; Paul Shearer, 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 will be discussing our results for the year ended 31 March 2022. We have earlier today provided our 2022 annual 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. Well, thanks, Marcus, and welcome, everyone. So today, we're going to be referring to the investor presentation pack that was released to the NZX and ASX this morning. But we would like to begin by thanking our customers and our clinical partners who have been relentless in their efforts to respond to COVID-19 over the last few years is inspiring. We also want to thank the people at Fisher & Paykel Healthcare for their hard work this year. They have to manage through another disruptive year and deal with lockdowns, higher rates of absenteeism because of COVID-19 and the global supply chain issues. And through all of this, our people demonstrated that we could deliver to our customers. We also want to thank our suppliers who came through for us yet again. They too are operating in a difficult environment. They've had to adapt and change along with us. Our suppliers are critical to our success, and we're very grateful for these relationships. So let's start now on Page 3. During the 2022 financial year, we continued to respond to waves of COVID-19 driven demand across the globe. And our products were used by clinicians to treat approximately 20 million patients around the world. At the same time, we've stayed focused on the long year. And today, we announced the launch of 2 new applications that expand the market opportunity for Optiflow into anesthesia. We also unveiled our new Airvo 3 device, and we'll tell you more about those opportunities shortly. We've continued investing in our sales force and to support -- all that -- to support all our hospital hardware placements globally and to deliver on the opportunity in anesthesia. And as always, we continued growing our manufacturing and supply chain capacity. So let's turn to Page 4. So just to put this into perspective, our full year operating revenue for FY '19 before the pandemic was just over $1 billion. For FY '20, it was over $1.2 billion. And revenue increased to nearly $2 billion for FY '21 last year. Off the back of that extraordinary year, FY '22 was another year of high demand and performance was once again strong. Operating revenue for FY '22 was $1.68 billion, and this was a decline of 15% from the previous financial year or 14% decline in constant currency. Net profit after tax for FY '22 was $376.9 million, and that's a 28% decline from the previous financial year, a 30% decline in constant currency. Again, for context, this result was strong. Operating revenue for the 2022 financial year was 33% above the pre-COVID-19 2020 financial year. So turning now to Page 5, our hospital product group. This includes the devices and systems used with invasive and noninvasive ventilation, nasal high flow and for surgery. And I'd like to spend a little more time on this slide this time. One of the strengths of our business is that we offer a continuum of care for respiratory patients and that's across an entire hospital and for nearly all modes of respiratory therapy. Hospital hardware includes our range of humidifiers and Airvos. Our humidifiers are used with invasive ventilators for intubated patients in ICU, intensive care units. Most modern invasive ventilators are also capable of delivering noninvasive ventilation and nasal high flow therapy, and they do that in conjunction with our humidification systems. Our humidifiers are also used with noninvasive ventilators, and modern noninvasive ventilators are also capable of delivering nasal high flow again that's in conjunction with our humidification systems. And these humidifiers can also be used with flow sources such as blenders and flow meters to deliver nasal high flow therapy. Our Airvo system is used exclusively for delivering nasal high flow therapy. So our consumables can be used with all of these hardware arrangements I just mentioned. This flexible range of applications and consumables means we don't have an installed base for a particular therapy. We have an installed base for respiratory care. And the therapy is supported by our hardware largely driven by nasal high flow increasingly utilizing more parts of the hospital. So application of our installed base is flexible and usage patterns vary depending on the location in a hospital, the different clinical practices between and within hospitals and how a hospital chooses to deploy their hardware. So this all impacts how we think of utilization and what's beyond just a simple terms ratio for a particular specific therapy. For us, the indicator of change in clinical practice is the number of patients treated with a therapy. The number of patients treated is best represented by consumable volume. And because patient sensors varies for all sorts of reasons, that needs to be over a period of time. So now that we've been through that, I hope it's been illuminating, let's look more closely at our results on Page 6. In the Hospital product group, revenue was $1.21 billion for the full year, a decline of 19% from FY '21, and that's 19% in constant currency. Of total Hospital product group revenue, 27% was from the sale of hardware. That's the range of humidifier and Airvos and 73% was from the sale of consumables. Sales from new applications consumables increased 3% in constant currency over the prior financial year, and that growth was across the respiratory therapies in that category. Hospital hardware was very strong at $323 million for the year, and that's more than triple a pre-COVID year. So I move on now to our Homecare product group on Page 7. 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. On Page 8. Homecare revenue was $469.5 million for the full year, which was a 1% increase over the previous financial year or 2% in constant currency. Reported revenue for OSA mask is up 3% or 4% in constant currency for the year, and that's 6% for second half. Growth in OSA masks is dependent on new patient diagnosis rates. And in FY '22, mask revenue continued to be impacted by reduced new patient diagnosis due to COVID-19 as well as the limited supply of the treatment hardware. Our Evora Full mask for OSA has been one of the most positive new mask launches we've ever experienced, and that's based on customer feedback and initial sales performance to date in the regions where it's been available. And we just launched it in the United States in May this year. So let's turn to Page 9. So this is our aspiration slide. And before the pandemic, our long-term goal was to sustainably double our constant currency revenue every 5 to 6 years. And you can see that over the different time frames, we're expecting a progression of different applications to contribute to the longer-term costs. So now if you turn to the next page, Page 10. This is still a graphic. It's not a graph but it's to illustrate how we're thinking about the potential impact of the pandemic on our long-term growth aspirations. Our aspiration doesn't change, but we have an opportunity to bring forward our progress. Now as you know, we've had a steep increase in revenue over FY '21 and FY '22 of COVID-driven demand, and that's placed about 10 years' worth of hospital hardware in only 2 years. So we're representing that by the bump which is not to scale and marks COVID-19 on that graphic. And I think it's also fair to say that we can't be exactly sure where we are on the up just yet. But as we change clinical practice, transitioning hospital hardware to a broader application for respiratory insufficiency, our cost moves above where we were before COVID and that puts us ahead of where we were before COVID. And the size of that step-up depends on the time it takes to transition that hospital hardware. Because we've moved ahead, we need to bring forward the release of new products and applications, invest sooner in clinical research, accelerate the growth of sales teams and continue growing our manufacturing and distribution facilities compared to before COVID. So this is something else that we started working on over the last 2 years. So on that note, move on to Page 11. Today, we announced the launch of 2 new hospital products, Optiflow Switch and Optiflow Trace. These interfaces are designed to facilitate the use of nasal high flow in anesthesia applications. In procedures with much heavier sedation where a patient will need a machine to breathe for them, Optiflow Switch lets the anesthesiologists, make sure the patient has full of oxygen before they stop breathing and then also while the artificial ventilation is being put in place. Compared to the current practice, Optiflow Switch could give the anesthesiologists more time to intubate the patient and that can help in preventing the saturations. That's not enough oxygen in the plant. Optiflow Switch, the anesthesiologist swap to their normal anesthesia mask at any time quickly and efficiently so they can check the airways or they can add pressure to assist breathing whenever they need to. Now in procedures with lighter sedation, where the anesthesiologist expects that the patient will be able to make a breathing effort themselves throughout the procedure, Optiflow Trace helps measure the exhaled CO2, carbon dioxide so that they can check that the patient is breathing throughout the procedure. Now if we move on to Page 12, we also announced the launch of our new Airvo 3 for nasal high flow therapy today. Airvo 3 makes it easier for more patients to be treated in more parts of the hospital and by more health care practitioners. There's quite a bit of technology that comes together to enable all of that, which you can see here on Page 12. So we're going to spend some time on that at our Investor Day tomorrow. So with that, I'll turn you over to our CFO, Lyndal York to give you more details on the year. Lyndal?

Thanks, Lewis, and good morning, everyone. On Page 13, gross margin decreased by 59 basis points to 62.6% for the year, down 147 basis points in constant currency as our costs increased as expected to appropriately reflect the level of production volume growth we experienced last year. Because of the challenges with global supply chains, we have been and continue to use air freight to bring in raw materials and to deliver product to our customers quickly. . The cost of freight continued to be elevated during the year. The increased proportion of air freight and elevated rates compared to pre-COVID-19 rates impacted our constant currency gross margin by approximately 240 basis points for the year. Freight rates are likely to remain elevated for at least FY '23. We also expect air freight in FY '23 to remain a high proportion of rates than it was pre-COVID-19. If freight impacts remain the same as they are now, we expect our constant currency gross margin for FY '23 to be in line with FY '22. Moving on to Page 14. Total operating expenses grew 3% or 4% in constant currency. Excluding the donations of $25.6 million last year, which includes the $20 million to the Fisher & Paykel Healthcare Foundation, operating expenses grew 9% in constant currency. Operating margin was 30.1%, in line with our long-term target, assisted by the strong hospital hardware sales this year. R&D expenses grew 13% to $154 million reflecting continued growth and timing of R&D projects. R&D expenses were 9% of revenue for the year. We've estimated 65% of our R&D spend is eligible for the 15% R&D tax credit this year and believe that that's a reasonable estimate for the next year. SG&A decreased 1% to $393 million for the year or a 1% increase in constant currency. Excluding the donations, we grew SG&A by 8% in constant currency. We will continue to grow our investment in R&D as longer-term projects accelerate. We will also continue growing our sales teams to support the increased hospital hardware that has been sold over the last 2 years and deliver on our anesthesia opportunity. Activity in many of our locations is increasing, and we anticipate travel and sales event costs for the next year to be approaching the normal expected level, up from less than half of the normal expected level that we experienced this year. Targeting and operating expense constant currency compound annual growth rate of 11% from FY '20 would result in FY '23 operating expenses growing around about 13% over FY '22 in constant currency. Moving to Page 15. Operating cash flow this year was $324 million. The final tax installments for FY '22 profit were paid this year, with total tax payments of $250 million this year compared to $131 million last year. Our working capital increased as inventory grew to ensure we can manage any surge demand from our customers and supply chain disruptions. Capital expenditure, which includes purchases of intangible assets, was $170 million for the year. Our third building in Mexico is nearing completion, and earthworks have commenced on our fifth building here in New Zealand. Once that building is complete, we'll be at maximum capacity on our Auckland campus. Work is progressing well on identifying and acquiring a second campus in New Zealand as well as a new offshore manufacturing location outside of New Zealand and Mexico. We expect our investment in land and buildings to be approximately $700 million over about a 5-year time frame. The balance sheet remains strong. Debtor days were in line with the prior year at 41 days. Inventories increased in both raw materials and finished goods to manage supply of products through potential surge demand and supply chain disruptions. The $20 million donation to the foundation committed to last year was paid during this year. Tax payable decreased $120 million as the final tax installments, particularly in New Zealand, which reflects our FY '21 taxable income was paid in May '21. Net cash at the 31st of March 2022, was $222 million, and our gearing ratio was minus 16.3%. Interest-bearing debt was $68 million with 92% of it being noncurrent. As of 31st of March 2022, we had available liquidity of approximately $474 million between undrawn facilities and cash and investments. Turning to Page 16. We've declared a final dividend of $0.225 per share. This represents a 2% increase on the final dividend declared last year and is payable on the 6th of July. This brings the total dividends declared for FY '22 to $0.395 per share, an increase of 4% over FY '21 and continues our record over the last 8 years of increasing our dividends to shareholders. Looking now at foreign currency on Page 17. Foreign currency movements negatively impacted our profit after tax by $2 million compared to the same period last year primarily due to the New Zealand dollar being stronger on average throughout the period. This includes the results of our hedging program, which contributed a gain of $30 million after tax for the period. At current rates, we would have an after-tax gain from hedging of approximately $29 million during FY '23. The net impact on profit from movements in foreign currency will depend on revenue for the period and the currency mix of that revenue. Now it's back over to you, Lewis.

Okay. Thanks, Lyndal. Turn to Page 19. On Page 19, our Evora Full mask, I say launched in the United States in May this year. It's performed very well in the countries where it's been available. But growth in OSA masks will be dependent on new patient diagnosis rates and how the availability of treatment hardware plays out over the year. And on all those fronts, we're expecting some level of growth in the 2023 financial year. So now moving on to the hospital part. For our Hospital product group, over the last 2 financial years, we've placed about $880 million of hospital hardware, both humidifiers and Airvos. That's the equivalent of more than 10 years of placements prior to COVID-19. It's been driven by health care systems and hospitals around the world gearing up to treat COVID patients. So we're not expecting FY '23 hospital hardware sales to continue at that pace. To give you a context of the opportunity for consumables growth presented by that incremental hardware, we've estimated a range of scenarios in the table on the right-hand side there. First, we estimated that for FY '22, average hardware utilization through the year across the therapy options was somewhere between 60% and 70% of a pre-COVID-19 midpoint. Then we modeled the revenue impact of different time frames to convert 85% of that incremental FY '21, FY '22 hardware to a historical normal utilization, taking FY '22 as the base. And the only question all we had for that 85% number in this model is that it seems conservative. Then on that basis, the implication is that if it took 4 years, their activity alone would represent an equivalent compound annual growth rate of about 13% for our hospital consumables for the full year period going from that FY '22 starting point. If the transition was completed over 3 years, the compound annual growth rate would be equivalent to 18%, and it was 5 years, 10% net average complete period. Now that's without selling any additional hardware during that period. When we model placing additional hardware over these time frames at half of our pre-COVID-19 levels. And we assume that, that will be driven by a change in clinical practice so it has historically normal utilization. And that adds another 2 to 3 percentage points to the hospital consumables compound annual growth rate. So this is all for context. We can't forecast the pace of that clinical change and even less so on an annual basis or even shorter basis. And this is an equivalent compound annual growth rate that we're talking about over a period of time. Over the journey, we expect to be impacted by surges and declines in hospitalized COVID-19 patients as well as the resulting increases and reductions in our customers' demand and their stockholding choices. And these surges and COVID hospitalization also impacting our customers' bandwidth for adopted clinical change. Many of them are tired and many of them are on [ start ]. The take-home points of all this commentary and estimates and modeling that the installed base of hospital hardware driven by COVID-19 provides a strong underlying base of growth in hospital consumables for several years to come as and when COVID-19 hospitalizations abate or stabilize. Secondly, as a growing body of clinical evidence supporting the use of nasal high flow and other respiratory therapies to improve care and outcomes, and that's beyond COVID-19 patients. And then finally, we have a proven 50-year track record of changing clinical practice. And never before in our history that we change clinical practice with the significant advantage that our customers already have the hardware. I already have the clinical experience of it, and they already have access to have such a huge amount of clinical evidence. So now with that, I think we can open the call to questions.

Thanks, Lewis. Amil if I could ask you to please open the lines up for questions. [Operator Instructions] And we can do our best to cover everything off within the hour.

[Operator Instructions]

The first question comes from the line of Chris Cooper at Goldman Sachs. Please go ahead, Chris. Chris, just checking if you can hear us. We will go on to the next question. The next question comes from the line of -- we can hear you now.

Sorry, I think the operator just took a little while to unmute my line here, sorry about that. So just if I could start on Slide 19, if you don't mind. So the scenario analysis you provided there is helpful. I note you've given some different sensitivities based on how many years it will take to convert to the incremental installed base, but you haven't done so for the amount of additional installed base that will be used, that 85% number that you referenced there. So just curious, I mean you commented there Lewis as well that the 85% number was conservative. Can I ask what gives you that degree of confidence at this stage in the cycle? I mean our sense just speaking to people on this matter quite regularly is there's still quite a few expectations out there, which are below that 85% level.

Yes. Chris, so those numbers in the years are based on converting 85% of the volume -- hardware volume sold during FY '21, '22. So it's in all those numbers. I was having a bit of trouble hearing that all of your questions due to the quality of the call there. I mean as far as the 85% goes, I mean look, there's no signs in that. We've just said 100% seems optimistic. 15% -- maybe 85% seems conservative. There's no more sites other than that. The whole point of that table there is really just to give a sense of what the opportunity is and a sense of the impact of the time frame that it might take to convert it.

Understood. I mean it's just interesting to me that you sort of can say with some confidence today that 85% is conservative because, yes, like I said, the expectations, I think, generally, on average, probably a tough below that. But just interested to hear why you think 85% is the number and not higher or lower than that at this stage.

Well, really, look, we think that -- if only 80% was utilized, that's 1 in 5. 20% of the hardware we've sold not utilized, the job's not finished as far as we're concerned if that's the case. So it's going to be better than that.

And it's also...

And just -- sorry, yes, okay. Understood. And then the -- on the commentary on consumables growth. Obviously, we understand that you peaked in December, you troughed in February. You're now seeing a slower recovery from there. But presumably, we're still closer to the sort of trough level than the peak, I would imagine. First of all, is that true? And secondly, if that rate of recovery continues that you've seen some factory, would hospital consumables revenue still decline year-over-year in fiscal '23? Or is there a scenario where you could grow that number?

Look, I think the point here is that in the short term, in 6-month periods and in 12-month periods, we've got other influences. You've got COVID surges. And one of the influence of COVID surges is a big overstocking phenomenon and destocking phenomenon. So you picked up on that. We think we're seeing that. We're entering into FY '23, probably with a destocking phenomenon going on with our customers. I think the short version is we're a lot more confident saying over several years, yes, it increases. Trying to pick 6 months and 12 months, I think, is a bit more challenging because of all the COVID hospitalizations and then the stocking, destocking playing into year-end and year beginning and that kind of thing.

The next question comes from John Deakin-Bell at Citi.

I mean the first question, I guess, is Lewis, you just sold 10 years of hardware in a 2-year period. What was the strategy in launching the Airvo 3 right now? Surely, you're not going to get the full impact because there's so much hardware out there.

Well, the general strategy with product launches is to try and launch everything as quick and as soon as possible. That's kind of what we do with everything. So really, no impact there. I mean I think the point of Airvo 3 is it sits alongside Airvo 2. And it provides some features that we think our customers are going to be really keen on.

Okay. But if I just bought an Airvo 2 in the last 2 years, is it likely that they'll buy an Airvo 3 in the next 1 to 2 years?

I could chip in here, John, it's Paul here. Who knows. I mean Airvo 3 is a great product. It's got a lot of features Airvo 2 doesn't have. We're going to sell it into other parts of the hospital, we transport some [indiscernible]. We think this we can upgrade users from Airvo 2 to Airvo 3 so we can sell in different parts of the hospitals to people have previously used high flow. So we think that over time is a great opportunity for Airvo 3.

I think this is also against the backdrop of -- we don't really have many customers that are fully penetrated with hardware. There's still plenty of headroom. And if we've got someone where the hurdle is, I need to move patients around the hospital and the way we work, I need to move them with the hardware, they want Airvo 3 to grow their hardware fleet. And if we've got customers that are saying, well, I want to use it in my general ward, but that's too much training for my general staff and my traveling nurses. Well, we've got Airvo 3 that will help with that. So I don't know. I think it's going to help with some of the hurdles to increasing penetration.

Okay. And just -- maybe just for context, anecdotally, if the -- if you pick a big hospital system in the U.S. or in Europe, wherever, if the COVID patients continues to decline dramatically, and you've already been in the intensive care. What are the 1 or 2 areas in the hospital that you expect will pick up that slack and be the real driver of growth if not in the next 6 or 12 months beyond that to take the place of the COVID patients?

Well, it's kind of already there in these places because of COVID, but you're talking pulmonology wards, emergency departments and in many cases, general wards.

Next question comes from Gretel Janu at Credit Suisse.

So just going back to that hospital hardware utilization of 60% to 70% on average through FY '22. What was your exit run rate? Are you able to give us an estimate of where you're tracking as you exited FY '22 on that?

Well, we haven't really done that to arrive at this number, we've looked at the entire year. We think year-by-year, there's enough variation. So it's probably not -- it's not something we've done. It's not something we really can do. And I don't think -- if you're trying to, I don't think it would make a lot of sense will be helpful.

Sure. Okay. Then how about via each of the regions? Are we seeing any significant trends between Europe, U.S. and APAC?

So as far as we can tell, no, we think it's fairly in a pretty tight range through FY '22.

Okay. And then just in terms of inventories, like large dumping inventories. I know you said that's partly because you're trying to manage your supply chain and respond to any potential surges. I guess when do you expect your inventory levels to normalize? And how much of that jump in inventory is also because you're seeing at the customer level some significant destocking happening here and not normalized buying patterns?

Gretel, it's Lyndal here, I'll take that. Whilst we're still seeing supply chain disruptions and particularly lead time of sea freight continuing to get longer and longer and once it gets to a port, you then have to say how long are going to take to clear and get into a warehouse as well as potential likely surge demand from customers and raw material constraints and supply, we might be looking to reduce inventory materially from where we are now until we see all of those things stabilize or settle down. But we would anticipate when they do settled down, we would look to probably reduce that inventory a bit by far the most important thing for us is making sure that if a patient needs it, then they get the product as opposed to keeping very high levels of inventory. We try to -- we're very conscious of that and the capital tied up in inventory, but the priority is ensuring patient treatment.

Yes. And then as far as our customers' inventory goes, we've seen this effect all through COVID with the COVID hospitalizations rapidly increasing. They practically fill their warehouses with stock of consumables. And then the number of COVID, they dropped just about as quickly. So then, when the COVID hospitalizations drop, our customers got a warehouse for the consumables, and we just have to write that out for a few months.

Next question come from Dan Hurren at MST Marquee.

I just want to ask, of the $880 million in hardware sales that you're talking about there, what has been the split between humidifiers and new applications and by other words, splitting up in the high flow?

Well, we don't really break that out. I mean I suppose the commentary is that Airvos, which only is for nasal high flow have been a higher growing component, but off the smaller base.

Right. Okay. I guess why -- what is the hesitation to actually explain what's the installed base is? I mean clearly, you want to talk about that and you're talking about patient numbers rather than term. But why the hesitation to let us know what the installed base of the equipment is or what is the complication?

Well, there's 2 really. We do think it's commercially sensitive. And in what trying to giving more color how the hardware is used and how flexible. It doesn't really help us with modeling and predictions on how we manage our business and the strategies that we generate.

But I mean clearly, your sensitive analysis has that installed base in there. So it would be helpful to us surely.

Sorry, you're phasing in and out on that question.

Yes, okay. Okay. I'll have to leave that to tomorrow at the Investor Day. Just Lyndal, could we just start, cash flow looking a little unusual. Can you just talk to break out the elements there?

We can't hear what you're saying, Dan.

Hearing you, it's really challenging.

We can't hear what you're saying.

Sorry, repeat that.

Yes. Sorry, Lyndal, just the cash flows look a little unusual. Could you break out the elements there, please?

Yes. The big item in the cash flow was the payment of the third or the final installment of tax related to the FY '21 year. Here in New Zealand, which the bulk of our profit comes to because this is where we've got all of our manufacturing assets, et cetera, at risk. The first 2 installments for a tax year are paid within that tax year, and that's using a prior year's taxable income with an uplift of 5%. So for FY '21, when we had that big jump up in profitability, the 2 tax payments within the FY '21 were at only a 5% uplift from FY '20. The final catch-up of that happened in FY '22, so we had a payment of about $140 million in May 2021. So this financial year relates to last year's profit. And then last year's tax payments were really just about 5% uplift compared to the profit and the cash flow generated out of the business that year. So it's just really a timing difference between the 2 years.

Next question comes from Tom Deacon at Macquarie.

Just in terms of GP margin outlook. Just wondering given that freight prices and other COGS price increases, particularly looking more structural now sticking around for longer. Does that mean that you'll look to take some price increase across the product range in FY '23?

Yes, we're back in kind of a normal pricing cycle now. We are increasing pricing when we were able to and kind of in line with local CPIs and everybody else.

That's great. And just maybe a second one for me. Just in terms of the device utilization estimate that you provided for FY '22. Can you just provide a little bit more color on how the team came to that range, given the challenges we've discussed previously around coming to an accurate device utilization estimate?

Yes, absolutely. So we took the 5 years before COVID, and we looked at the relationship between incremental hardware and incremental consumables over those 5 years, and then we averaged it. And we called that normal. So that was our starting point and then we applied that ratio to FY '22.

Next question comes from Stephen Ridgewell at Craigs Investment Partners.

I just wanted to touch on what you're seeing in the emerging markets in a bit more depth. You previously called out a large portion of the $880 million of devices sold over the past couple of years have been placed in emerging markets such as India, Brazil, Russia, et cetera. Are you seeing consumables demand currently will come off in those emerging markets, consistent with kind of the decrease in COVID hospitalizations in recent months? Or is there some evidence that hospitals and emerging markets like India are starting to transition to using that installed base to treat non-COVID patients? Or is it just too early?

I think you landed on it, it's too early. For FY '22, it doesn't look much different than anywhere else, but you've got the COVID surges going on. So I think it's too early to say. I think also fair to say we think that emerging markets are probably going to be more challenging for us to convert that usage in U.S. and Europe.

And just following up on that, Lewis, could you just elaborate on that last comment as to why your emerging markets have been more challenging?

I'm going to ask Paul to have a go at that, Steve.

Stephen, so in '22, in lot of those emerging markets, we would sell consumables with the hardware together with -- now together. So they've largely been used for treating COVID patients. So we're able to do that because they're hardware and they had the consumable sales. Clearly, a lot of these markets are probably bought these products to treat COVID patients. So the opportunity for us now is to go and educate them into non-COVID applications. So I think it will be more time consuming to put people into some of those markets, someone who work with distributors. Sometimes funding may not be available for the consumable sets. So it will be more challenging to do that in the emerging markets with more developed markets high-flow, Airvo, Optiflow is understood people using already. So that will be an easier transition.

Cool. And maybe just a second question for me. We haven't talked too much about myAIRVO on the call so far. You saw that big spike really in the pandemic and then the growth rate kind of [ age ]. Can you just call out or give us some flavor on the trends you've seen in myAIRVO during the year? Some suggestions that some of myAIRVO units I think were kind of -- I think you may have made on a previous call, Lewis, that some of those units have been kind of rented sort of to hospitals during the peaks of the pandemic. Just interested in what you're seeing in that part of the business, please?

Yes, totally on the money there. And we think what's happened with myAIRVO in FY '21, some of that was making its way to COVID patients either in hospitals or at home. So FY '22 looks a bit backwards compared to '21. But if we look at '22 versus '20, we're kind of just on a similar trend, if we skip that '21 kind of COVID-related jump out of it.

Okay. Just to be clear, Lewis, that was kind of in that 20% range from memory there, that kind of organic growth rate in Airvo from pre-COVID?

It's off a small number. So it's pretty bouncy, but it is something, yes.

Our next question comes from Saul Hadassin at Barrenjoey Capital.

A couple of questions. Just on hospital hardware. Just looking at the second half revenues, it looks like the run rate is still running at about double the sort of the pre-COVID levels of sales. I'm just wondering as you move into FY '23, the decline in hardware sales this fiscal year, I mean, do you expect to be able to still maintain hospital hardware sales above a pre-COVID level? Do you think we're heading back to that more circa $45 million, $50 million per half or is it too early to say?

Well, yes, we really don't know how to predict that one. I think it's all I can say. Do you want to add anything, Paul?

I think it's hard to predict. But I think it's starting to settle down to more normalized levels.

Yes. Well, you can see the trend over the last like 4 halves.

And I guess, again, is it -- are you still seeing pull-through sales for hardware in some regions, where COVID is still a bit of an issue?

Yes, we are. I think -- and I think the reason we're saying that it's probably heading back to more normalized levels over time there, it's really hard to pick it as a lot of customers now have bought hardware as COVID surges. So as and when there are additional surges, probably many of those customers have already purchased hardware they need. But of course, there's still going to be people around the planet that are going to need hardware if there's more COVID -- by the time COVID surges.

Sure. And just one other one for me. Just looking at the -- your guidance you've given around the number of years to convert for that hardware and the growth of hospital consumables. Lewis, what -- I mean how much influence do you guys have on reaching that -- those targets based on those years? In other words, if you were to accelerate your SG&A expense, could that get you to an earlier time frame and hence the higher rate of growth? In other words, is there a drop through to EBIT, if you reach, if you achieve that? Or does it -- is there an offset through having to expense a lot more SG&A to get you to 3 years versus, say, 5 years? I'm just trying to work out what assumptions you've made as to what would get you to those 3 years, 4 years or 5 years of conversion?

Yes. So I just need to make one comment for the record, that's not guidance technically that we provided there. That's a range of scenarios that we modeled. So -- and then to your question, well, the numbers are derived, they are model. They're not guidance. They're -- the strategy and what we are doing is we're putting the people in where there's been the increases in hardware. It's kind of that simple. And whether it's 3 years, 4 years or 5 years kind of isn't part of it, that's a medical model.

But we think we've made a balanced investment in our [ services ].

Essentially, we're just -- we're putting the people in proportionate to where the hardware is gone, and we expect over time that will give a result proportionate to where the hardware is gone. That's a whole different question.

Next question comes from Marcus Curley at UBS.

I just wonder if we could start with cost of goods sold. You're obviously flagging flat gross margin. But within cost of goods sold, the largest component is labor. So are you managing your labor costs down this year? And if so, how are you planning on doing that?

Well, large component materials. But to your labor question, with the occasional exception, I'll touch on, we matched labor to the output rate. It is quite that simple. And the exception has been COVID when we're trying to accommodate ebbs and tiers due and to COVID up to 20% or 30% at times. We run a bit heavy on the labor force that's on board for manufacturing. But we're probably through that now, we think.

So in other words, as your inventory build requirement lessens, you're just drop down your labor force numbers here in Auckland?

Yes. Yes, that's the case, yes, absolutely. And we coped with that demand and there's rapid increase in demand with our temporary staff.

And over time, as well. So it's -- it was not just the number of people, it's how hard and how long they're working. So we can ratchet that back with keeping head count the same.

And within -- second question, within your commentary, obviously, within the hospital consumables, yes, obviously, the third quarter was much stronger than the fourth quarter. Can you give us any color on what the fourth quarter was as a reflection of, I suppose, COVID sort of outcomes?

What we've really got going on there is a great big COVID surge that picks up in November, peaks in December, January is still pretty big, and then February falls off the cliff. And March is still somewhere around the bottom of that cliff. That's what you got going on in the quarters.

Okay. Another word -- have it another way, if we looked at the second half, on a complete basis. Is there a -- would you describe there being a COVID tailwind collectively still in that second half hospital consumable number?

Look, I don't know. It's still kind of tracks COVID hospitalizations. If you overlay a hospitalization curve on our consumables, they've got a pretty similar shape. So I have to go back to -- to answer that question, Marcus, I go back to the beginning of the half and what happened prior to that. My recollection is we enter the -- we need a bit of destocking, I think. I can't remember that actually, Marcus. You've got the stocking, destocking plan and do we -- does it average out for the half or not?

And sorry, maybe another way of answering the question. When do you think you'll be in a position to provide some sort of commentary or guidance in terms of where you think hospital consumable sales are going for the year? Do you think it's going to be all the way through to possibly the first half result? Or do you think it could be earlier than that?

Yes, that is a good question. I think we're going to want to see a bit of stability that we can forecast off of -- we're going to want to see stability that we can say there's a base that we can project from instability that's going to need to be 2 things, but COVID hospitalizations, because of stocking, destocking a bit of stability in our volumes as well.

Next question comes from Adrian Allbon at Jarden.

Just the first question. Maybe this is for Paul. Can you -- and it's related, I guess, to the consumables. Can you just give us a sense maybe in the U.S. and Europe, just what sort of access your sales force has actually now got to the hospitals? And what sort of activity is going on?

Sure, Adrian. I think we might have some commentary earlier on. It's been relatively spotty the access to hospitals over this whole period. And again, over the last surge, especially so for Omicron in the third quarter, that really affected our ability to get into hospitals. So getting to hospitals, about now, we've been getting recently unrestricted access to hospitals, both in Europe and the U.S. So it's getting on really for us now that we can generally get under most people, most institutions who want to see. And that's only been in the last month or 2. With the...

Okay. And just that was...

You go ahead, Adrian.

Sorry, no, I missed the last part of your question, sorry -- sorry, answer.

I was really just wanting to make sure that -- Adrian that was -- I was answering the question that you asked. The second answer is yes.

So the -- so just to put that back, you're now getting sort of unrestricted access in the hospital and you're sort of in the U.S. and across Europe. And is there any sort of development just related to this question on the clinical practice evidence? Like is it still sort of a couple of key papers that you've mentioned over the last period? Or is there new stuff which you're able to use as well?

Well, the clinical -- yes, clinical papers coming out all the time. And obviously, now our whole emphasis is to making sure that our customers actually understand the value of the investment. They can use it for wider applications than just COVID. So all kinds of respiratory insufficiency. So we use whatever clinical data is available at the time and depending on who we're talking to and what kind of application that they're seeing as an opportunity. So we're using a lot of clinical data and all the latest clinical data that supports...

The clinical practice guidelines probably the most compelling.

Yes, and the clinical practice guidelines are definitely the most -- well, very compelling too.

Okay. That's helpful. And then second question, just if I just come back to, I think in the presentation, you've got -- you've, I guess, expanded your total addressable market from sort of in $20 billion plus to $25 billion. Is it right to assume that the anesthesia is kind of like the key component within the hospital, like sort of $5 billion within that?

Yes, that's good assumption.

And then related to that, as I think somewhere else in your slides, you also sort of made the point that the nasal high flow, the general respiratory sort of use is about the same size. Is that also kind of fair? I presume that's where Airvo 3 is targeting as well?

Yes. So we think it's a similar opportunity, absolutely. Airvo 3 is kind of a different story. Airvo 3 is more respiratory-oriented than anesthesia.

Yes. No, sorry, I understand that. I just -- I think in one the slides, you made the point that nasal high flow and a general respiratory setting is kind of around the same size of anesthesia.

Yes, that's right.

From a patient perspective.

Yes, the number of patients that would benefit, yes.

Given the time, we will just take one last one. I realize there are others in the queue. You can feel free to call Hayden or me following the call. But last question is from David Low from JPMorgan. David, are you here? We haven't had some good luck of technology today. What we might do is we might conclude the time now for questions. As a reminder, we're holding an Investor Day tomorrow. So if you reached it for the event, you'll have the opportunity to hear from more of our team and to learn more about our new products, but hand it back to Lewis to conclude.

Okay. Thanks, Marcus. In summary, FY '22 has been another remarkable year for our company. And as a whole, we've showed our customers that they can rely on Fisher & Paykel Healthcare and that we're doing all we can to create the best possible outcomes for patients whenever they come. Going forward, we haven't wavered from our long-term sustainable profitable growth aspiration. We've got an exciting opportunity to apply our 50 years of experience and changing clinical practice to what is now a customer base that already has the hardware and already has the clinical experience. That enables us to bring forward new products and applications and global sales, manufacturing and distribution investment. We want to thank everyone who has supported us, and we're all looking forward to the years ahead. Thank you to all the participants for joining us on the call today as well. Thank you.