ResMed Inc. (RMD) Earnings Call Transcript & Summary

Good afternoon, everyone. Suraj Kalia, senior medical device analyst at Oppenheimer. Pleased to have so many of you join us this afternoon for a fireside chat with Rob Douglas, Chief Operating Officer of ResMed. Rob, it's a pleasure to have you here. I'll let you take the floor for a couple of minutes for some introductory comments, and we'll jump into the meat of the matter.

Great. Thanks, Suraj. Great to be here, and thanks, everyone, for joining. For those of you who don't know, ResMed, we're a world-leading digital health company. Our sort of -- the digitization of our entire therapy platform has really made a huge difference to the company. And at this stage, we have well over 16 million cloud connected devices treating people every day. We also have a software business. We have over 115 patient accounts in that software business, providing management of patients in the out-of-hospital care market. In terms of therapy, we're best known for treating sleep apnea. This is a terrible condition. We call it sleep suffocation, where people stop breathing in their sleep. And it really affects all parts, all aspects of physical well-being and mental well-being as well. We believe there's over 930 million people around the world with sleep apnea, and most of those are undiagnosed and unaware. So we still have this massive opportunity in our core business to promote awareness and improve the pathways to getting people under treatment. We also have solutions for COPD and asthma emerging. As I mentioned earlier, our cloud software is really looking at all aspects of out-of-hospital care. And we believe that the future of care is to really extend care beyond the hospital and to provide solutions that help people stay healthy and remain out of the hospital longer. It's just much more efficient for health systems. Our strategy long term is to -- target is to improve 250 million lives by 2025. So we're on a very strong growth trajectory. We've got a really great operating and operating excellence culture in the company, which is overcoming the externalities. And I'm sure today we'll be talking about 3 of those major externalities, mainly the recovery from COVID is ongoing. There's a very significant competitive recall in our industry that's really changing things a lot and also the supply chain challenges, which in the short term are more of a headwind. So just to reiterate, we've got really strong growth opportunities, and we're really just getting started. So look forward to answering any specific questions, Suraj.

Perfect. So Rob, thank you for that overview. And having covered ResMed or written sell-side research investments for ResMed almost a decade, it's amazing to see how you guys have adapted to market conditions. And you and I remember in the 2010, '12 time frame where there was so much a pressure of reimbursement, U.S. reimbursement. So you guys -- for a big company, you'll adapt like a smaller company pretty quickly. That having said, Rob, the front and burning question right now is, how are you all adapting to the Philips situation? And the reason specifically, if I could go one layer deeper is, look, you have X number of patients, right? Let's say, I'm on a DreamStation I was using Philips in. It's a mess right now. We all know that. But the fact that I need a product doesn't mean necessarily I will get it either from ResMed or Philips. Help us just sort of understand how the logistics -- and it doesn't seem like there is a 1:1 correlation of business being lost by Philips to business being gained by ResMed. Just kind of walk us through what's going on because that's the burning question that keeps coming up from investors all the time.

Yes. Well, Suraj, you're right about adapting. And you noticed in my earlier comments, our long-term mission and vision in the sleep apnea market, the sleep suffocation market really has been to work on awareness, work on the sort of the pathways by which patients get treated and work on the ways in which their treatment is managed. And so we've always thought in terms of the long-term patient pathway that goes from awareness, referral of primary care -- by primary care to sleep specialist to a lab for a test to treatment from a provider in HME or whatever in other countries and then ongoing management of that. And our stance has been to create awareness and demand and meet that demand. And so to switch to an environment where there's an industry shortage -- and in fact, we've had to have allocation processes. It has been a big switch. But we have done it in a very agile fashion. And the first thing we did was establish the guiding principles by which we were doing that. And that #1 guiding principle is to focus on patient activity. So the resources that we have available, we've focused really on the higher acuity patients. Patients needing ventilators, adaptive servo ventilators, APAPs and then CPAPs in that order. We also focused on business relationships that we've spent a long time developing. And we know that by working with the providers who really care about the ongoing management of the patient and they do that by adopting digital solutions to be more efficient and do it better, that they were the right customers that we should continue to support. So that's been our priority. And then what's left over, we're really trying to help the rest of the industry as we go forward. But as I said, it has been a big change for us into that allocation process. And at the moment, we're basically shipping and supplying to the market, whatever our supply chain can get through. You mentioned that it didn't sound like a zero-sum game of what Philips was losing in terms of market. We weren't able to pick that up. We actually always said that, and we were very clear about that last year when that recall first came out -- first was announced. And by the way, the scope of the recall seems to continue to change and the challenges and it's not progressing smoothly or in a linear fashion. And the timing of it is actually quite uncertain, notwithstanding public statements being made. But I would reiterate that our preference would be that the recall is over sooner rather than later because with the industry shortage, patients are not getting treated. That's not good for patients. We'll certainly have all the right settings to -- recovering those patients as the recall goes into the past and making sure they do get access to treatment over time. But at the moment, we're not in that stage. And I think you recall that Philips, in some of their earlier commentary, said they estimated while they're out of the market for a year during the recall, that it cost them around EUR 800 million of sales. And in the normal course of events, our supply chain would be able to pick that up. But in a period of shortages for electronics and all the challenges around chips, commits and those types of things, we wanted to be clear that we are unlikely to be able to pick all of that up. And that's why we actually gave out some guidance last year that we thought in fiscal year '21, we'd be in the area of $300 million to $350 million, plus or minus, of additional revenue, beyond that otherwise underlying growth rate.

So Rob, if I were -- if you could quantify, if I could press you on that, how does the pie chart correctly -- currently look? These -- specifically for the Philips patient. I don't know, 30% transferred -- or 50% transferred to ResMed, 20% -- how does our sort of SOL, they don't have a choice. These many are still on Philips. Or how does that pie chart right now -- for sure, how does it look like now?

I mean I think you're going to say -- yes, I mean, again, we don't have particular insight into Philips' actions or other competitive actions through that. We understand our views of market shares and where they're changing. But we're not able to share those publicly because they're really pretty rough estimates through that. But -- and really, patients don't have a choice. One of the fundamental issues -- and the FDA, I think, commented on this in one of their fighting three letters to our competitor was that the recall didn't, to me, look like they've been done with the appropriate risk assessment. And so just saying that people stop using your treatment for this particular problem, there's a risk of stopping using it and there's a risk of using it. And you've got to weigh up and balance those risks. And information was not presented to allow that risk assessment to be done. And in fact, it should have been done as part of the recall process. But out of that, many patients were advised to continue using their device, and I believe they are. And -- it's not my call to call the actual technical risks of the Philips products, but I assume that was an appropriate call. It was actually often made by regulators around that to continue using it. So, many patients will stay on treatment. Other patients will wait longer for treatment, just as we go there. We're doing everything we can to get as many devices onto the market as possible. And we're pulling out all stops there as to what we can. But unfortunately, there still will be a shortfall of treatment. And then there are other smaller manufacturers that are coming into the market with their particular solutions picking up in there. Now some of those products have varying levels of performance. And their levels of connectivity really are nowhere near in the region of our sort of end-to-end solution with the really strong connectivity on the Air 10 and the Air 11 and the effects of the system AirView, which enables really good management of the patients and the myAir solutions, which allow patients to stay on treatment. We were in a good -- our timing was actually good. We actually had long-term development that are nearing its end last year with the launch of the -- with the development of AirSense 11 platform coming up. And so we were able to accelerate that. And actually in having 2 different platforms, they do share many components, but they've got many separate components. And actually, that's enabled us to manage our volumes through this as well. So that's been helpful.

So Rob, you brought up AirSense 11. I'd love to get the latest and greatest in terms of penetration, allocation, how you are thinking about it. You just -- there are constraints everywhere in the supply chain, right? Obviously, in 2014, '15 when you came out with AirSense 10, we saw -- you all started picking up share. But right now, there is a lot of noise in the system. And I'd love to get your perspective. On one hand, you have a smaller, quieter, better system. But another mitigating factor is the macro backdrop. So help us understand how AirSense launch is going. If you could quantify that for us to the extent that you can at this stage?

Sure. It's unprecedented times for us to have what virtually looks like unlimited demand for our products. And so we could sell as many Air 10s as we can make and as many Air 11s. Usually, in the past, and this is true for AirSense 10 and the S9 and previous products as well. When we develop a new platform, we have a strategy of really trying to switch the market from the old platform to the new platform as quickly as possible. That's just because people want the new platform. And so you don't want to get stuck with too much of the old platform. So we build up inventory in a sense of both products, try and run one down and then snap and launch to the other one. And it's quite a juggle of logistics and operational juggle for that. With the Air -- with this situation of infinite demand, we're actually in a situation where we're able to sell both products at the same time with no concerns around that. So we actually accelerated the AirSense 11 launch ahead of where we otherwise would have done it. So we can have both platforms in the market at the same time and gradually switch over market by market. We're still only selling the AirSense 11 in the U.S. market because that's our best way to maximize volumes of total CPAPs to do that. If that wasn't the case, we actually wouldn't be launching it into Europe. And in a normal course of events, you wouldn't want too long in other major market, knowing that there's a new-generation product out before you get it to that market. But that's not an issue. So in a sense, the current circumstances have made product launches easier for us to -- scheduling dynamic without having to take those larger inventory risks. It's still very difficult actually to the allocation process, which I should say is one of the toughest jobs that our teams have to do. And we need to make sure we're maintaining the right relationships and communicating and being as transparent as possible with all of our customers on that.

So Rob, what does AirSense 11 penetration look like in the U.S. right now?

We haven't broadly communicated, but it's gone really well. It's probably -- in terms of the products, we're selling the majority of them.

Okay. Most of it...

Not most of them, but it's more than half.

Rob, one of the other things, obviously, that is in the minds for all investors that keeps coming up in conversations, just as the supply cost inflation, Mick also made comments on the last quarterly call about the ability -- or I shouldn't say ability. You were not trying to pass through the cost. Just kind of walk us through how the component time lines look like, how the supply chain inflation is looking like to you guys. And ultimately, there will be a threshold where you guys will say, "Screw it. I'm going to pass this cost on either in renegotiated contracts or whatever." Just kind of walk us through the supply chain and the pass-through environment, how you all are looking at it for the next...

There are two bits of background to that. One is, clearly, we have a long-term history of getting volume leverage in our business. And because we've always -- because of those 930-plus million untreated patients, we know there's a strong volume growth in the future for the whole business. And so we have no problems with CapEx and really putting in place the volumes. And actually in the normal course of events, our new factory in Tuas, combined with our other factories, would be able to supply the whole industry if we could have all the incoming ones. So we've always had that view that we're going to get volume and we're going to get a lot of cost leverage out of that. The other factor in that all is that freight is very, very challenging for our supply chain, mostly in Southeast Asia. So we're really -- that's added a lot of cost that turns up into our COGS as well. And that's not likely to simplify and change overnight. There are other factors in there. Whenever we launch a new platform, one of the missions of our design team is to simplify the design and take cost out of it. So the AirSense 11 has sort of cost out benefits and the future benefits of that, that we can continue to optimize in it. But again, in the chip world, in the electronics world, where typically, we'd be negotiating ongoing cost improvements, in times of shortage, you can't -- you don't make any headway in doing that. So in a sense, our customers are probably in the same circumstance. You probably won't be able to give a lot of cost out type of stuff to that. The other important background thing, as I mentioned earlier, our guiding principles around this, what are we doing in this allocation in time of industry shortage and focus on the acuity of patients and business relationships. And also in that, we've also said we'd be pretty -- we'd be very disciplined in pricing and all that. We're concerned about the long-term health of the industry and the viability of the providers and all of that and their ability to do well by patients as well as run excellent businesses, which is in part why we invest in the out-of-hospital software to help them do that as well. So that said, you can't swallow cost increases forever through there. We did introduce a surcharge in January that we mentioned was sort of a sharing of some of the cost increase. It was actually only a fraction of the cost increase in there. Launching the Air 11 also was a help because that is a premium product with additional value-adding features. And so we see extra value in that. And we will continue to be, again, thoughtful and disciplined about how we approach pricing for the long term. But we do have to run a business that can afford to invest in R&D and afford to invest in future market development. You might understand, we're not spending anything on -- in sort of demand generation at the moment. But we're still running the experiments and the programs that are setting up so we know what to do when we need to restart those programs.

So if I could press you on that. So AirSense 11, you guys are getting a lift because of higher ASPs. We obviously look in the marketplace. And it's no secret, freight, especially shipping, it's pretty well documented in the news that shipping costs have gone up 1,000%, right? It depends on how much you're shipping and all those dynamics. So how much should we think about, hey, I got 200 bps lift in margins because of higher ASPs of AirSense 11, but then I lost 210 bps or whatever because of -- how should we think about the puts and takes there?

I think you're thinking about it right as a headwind/tailwind story. And obviously, in the current environment, pricing is not going to be the usual headwind that it has been. And I mean the whole issue sort of underpinning this whole discussion is what does our business look like in an inflationary environment and how do we manage that? And particularly what does it look like in a reimbursed -- sort of capped reimbursement market and how long? So we will -- our teams will still be running for the leverage as we can. It's definitely going to be harder to get there. So in terms of tailwinds, what was usually a tailwind in our ability to get leverage has got that headwind of freight and some component cost increases in there as well that we'll have to manage around. There are product mix issues in there as well and our higher acuity patients, meaning ventilators and adaptive servo ventilators, typically sort of above the device average margin. So that is a helpful contributor to the gross margin in terms of that product mix as well. And then all the other usual stuff around currencies and things like that are factors in there as well.

Rob, in terms of -- I think one of the key components of your business, right, when reimbursement hit in 2013, '14, core business went down, CAGR went down. You guys supplemented it with software. Software basically picked up a lot of the slack on the margins on the growth side. And more recently, I would say for the last 4 quarters, 5 quarters, Brightree in software or the SaaS component seems to be slowing down. Help us understand what gets it back to double-digit CAGR. Is this a macro headwind? Or is this just sort of growing pains with your current mix?

Yes. I think sort of for us going forward in terms of the growth rates of those businesses, Brightree is a market leader. It's an innovation leader in its space. And its growth trajectory is sort of driven by adding increasing value to that customer set there. And I think we've got a really good trajectory there. MatrixCare has got different market positions in its different segments. And then obviously, some things like the issues around skilled nursing during COVID have really affected centers or headcounts in those facilities, which directly affects our growth in there as well. That has been a factor. We really think those businesses should be able to grow faster than what they have been. And we believe that we're making really good progress on the execution issues that we need to optimize and improve in order to get to those growth rates. A lot of room for innovation. We have extremely strong relationships with customers. We're really essential to their business and are able to make huge differences to the outcomes and performance of those businesses as we fine-tune the solutions and fit them in. So we continue to believe that they're good investments. And as you correctly said, we didn't want to be only a sleep apnea company. We want to have these other things that made sense and added on value into the hospital care setting. Of course, the sleep apnea or the sleep suffocation market has grown very strongly through all of that. And the actual benefit of the digital solutions that we've put in there, which, by the way, one of the main benefits of that is once a patient sort of is nominated for treatment, they're much more likely to get on to treatment and actually much more likely to stay on the treatment long term if the digital solutions are being used. So in a sense, we've really raised the lifetime value of the patient quite a bit through that. And so that's been a big factor as well. And so that's all growing really strongly, meanwhile the SaaS businesses continue to execute to their rhythm.

I know we are coming up on time. I have to ask the 800-pound gorilla question in the room, so to speak. What are the -- you obviously see the geopolitical tensions, right? I'm not asking for an opinion on which side of the fence, but there is a spillover effect for everyone, FX, supply chain, air routes, there's that. How do you all see the acute, i.e., the next 3 to 6 months impact, specifically on ResMed and its operations outside the U.S.?

Yes. I mean, just first of all, answering the longer-term question, our business has grown continuously through many economic shocks over the years. And basically, the underlying issue of these medical conditions need to be treated and patients need care fundamentals. So probably not going to see a lot of sort of demand shocks or anything like that in our business at all. In terms of what's happening in the Ukraine at the moment, we don't do much business in that part of the world. And we really don't have significant suppliers in that area at all. Long term, it probably isn't going to help the chip shortages. But all of the actions we're taking to manage that are as appropriate as ever for that, including trying to create options for different components and have a very agile engineering team that can get around shortages quickly as well as continuing to manage how we make sure we get the best available products into the right people's hands at the right time and be efficient through that. So we're not -- we have no particular insight into that. In terms of what could happen in the environment in Europe, where obviously, we've got very significant businesses in many good -- really strong businesses in many European countries. But you wouldn't expect those to be affected and if they are, there will be a lot of other bigger challenges around that. So our view is actually that the challenging supply chain environment remains challenging. It is uncertain and it's actually -- this week's problems can get solved, but we don't know what next week's problems will be. And so things keep coming up, and we're relying on the sort of the agility and strength of our team to really jump on and improve things. Longer term, that -- those teams will often be working on future generation products. So but they have huge insight and great capability to really manage these short-term issues. So we continue to do that, and we suspect that, that won't -- it's not helpful, but it won't be a major factor for us.

Rob, quickly. Any material exposure to Russia?

No, very little.

Rob, we're up on the time. We do appreciate you walking us through some of the key components. And there are various factors at work here. I wish you guys all the success as you work through some of these things that have just been dropped, I'm sure in your lap. And kind of, like you said, you want to innovate. But it seems like you're blocking and tackling right now on some of the -- we completely respect that and hope all of these issues get mitigated in due times. Thank you very much. It's been a pleasure.

Thanks, Suraj. Thanks for your questions. Appreciate it. Thanks, everyone.