ResMed Inc. (RMD) Earnings Call Transcript & Summary

Good afternoon, everyone. Welcome to the KeyBank Life Sciences and MedTech Investor Forum. My name is Matt Mishan. I'm a senior Medtech Analyst. I'm pleased to be joined by ResMed, who is represented today by Rob Douglas, President and COO. I'm going to start us off, but this will be 100% Q&A and questions can be submitted directly to me by typing into the box below under your video screen and then I can relay. Rob, welcome. Thank you very much for joining. Very much appreciate it.

Thank you.

I'll start us off a little like with a broader question, just how would you compare the current environment and your level of visibility for the start of 2023 to the last couple of years?

Yes. Well, in comparisons to the last couple of years of quite interesting and have been an interesting few years. The whole COVID pandemic when the world needed our ventilators, and we had incredible demand for that. Then as that normalized, we saw cyclical typical challenges in supply chains, which actually our usual inventory and risk management policies would have seen us through just fine if it hadn't been for a significant increase in demand that came about when one of our competitors withdrew from the market while they conducted a recall. So it has been challenging. And really, our business changed from being a long-term demand-driven business, where our core strategy was create awareness and demand of the risks and need for treating sleep apnea. And in meeting that demand, we turned into a supply-driven company, where basically what we could manufacture, particularly in devices was what we would sell. And that's a big change. And at this stage, we're hoping, during calendar '23, that we'll see an end to that and we'll have -- we expect to have capability and capacity to meet all customer demand wherever it comes from as we've reached the end of the calendar year. And we should be able to reset ourselves back to being a long-term demand-driven business that we've been in.

Could you provide an update around supply chain headwinds with semiconductors and other component availabilities? I think you previously stated that AirSense 10 was off allocation in the first quarter in the U.S. Kind of where are you able to sustain that?

Yes. Earlier in the quarter, we were able to take the Air 10 off allocation. Predominantly what drove that for us is that our engineering efforts to validate alternate components worked and then the suppliers of those components as well as the suppliers of the previous components all started being able to provide more volumes to us. We've also seen really sort of the outlook or our visibility improve and the rate of what we call decommits, which were always a fact of life in any supply chain, occasionally suppliers can't do what they promised, we saw the rate of that really normalize back to what we normally would expect. And so, as I mentioned earlier, our usual risk management policies, we always have risks in supply chain and our usual risk management policies of inventory and alternate components are really starting to see us through where we have still only minor problems now.

Have you been able to move to an unconstrained supply of connected devices in additional markets outside the U.S.?

Yes. On a whole, that's predominantly where we're at, it's not quite so simple. The U.S. is a very strong market, and we have 1 SKU per product category in the U.S., whereas in other markets, we need of these often market-specific SKUs with appropriate labeling and things like that and then separate regulatory processes. And so we have to go through all of those. So on a whole where our Air 10 connected is fully available, but there are still some smaller markets where you might hear that we haven't quite got the volumes yet or the regulatory approvals, but they're all in progress and won't be too far away.

Can you help us understand like the difference in availability between AirSense 10 and kind of AirSense 11? Like why AirSense 10 is available, but AirSense 11 is still somewhat constrained? And then how you're choosing to strategically launch 11 in various markets?

Yes. So the AirSense 11 still is on allocation. And what that means is we're in the unfortunate situation of having to tell our customers what they can order from us of that and based on our planning. The AirSense 11 doesn't have quite as many alternative options for [ com strips ]. It's also a slightly later generation of electronic components, which sort of have a different demand profile and different competition profile from other industries in the older Air 10, which was first launched in 2014. And so it's just different dynamics. We just have to work through it. Our engineering projects for alternatives will come through as appropriate. And as I say, we should be able to meet all demand by the end of the calendar year. The -- last year, we were able to drive volumes of the AirSense 10 card to cloud because, as I mentioned earlier, that connection modules were some of our key constraints. So the card to cloud let us get around that. But once the Air 10 is connected devices off allocation, there wouldn't be a lot of reason for many customers to want to order the AirSense 10 card to cloud.

Do you think it makes sense to keep the AirSense 10 and the AirSense 11, both in the marketplace at 2 distinct price points?

Traditionally, we haven't been able to do that. When we've launched new platforms, we've taken the view that everyone would want to switch to the new platform as soon as possible. And in fact, people used to try and track our launches by watching closely our inventory levels because we'd have to build out risk management inventory of the new product prior to stopping the old product, and then we have to manage that inventory was quite a challenge. And actually, for us, it was good opportunity for us to be able to launch the Air 11 while the Air 10 was still going strongly with that price differential. Long term, our aspirations would be to get back to a single platform and be in a mode where we're maximizing the volume of that platform and able to really optimize both our ability to supply that platform and for our customers for them to be able to optimize all the workflows they have around the benefits and features and the connectivity of the AirSense 11 platform.

Okay. Thanks for the hint on how to do detail checks on new product launches now for everybody.

Well, it used to be -- that's how we used to do it, not how we'll be doing it in the future.

Hopefully. Is it reasonable to think Europe is and other international markets are poised for an inflection in device growth like similar to what you saw in the U.S. when you were able to get availability?

Yes. I mean you would -- you could expect that there's been constraints and as those constraints ease and growth will accelerate. But there are numerous other factors that make it different. In many of these markets, we had tender markets where there were sort of predefined contracts for volumes and products and so they don't change quickly. Many of the other markets are government or public funded or have some sort of effectively capitation type model in terms of how many patients flow through. And then the big challenge in all markets that we've seen since the pandemic is with staffing, and having staffing able to actually treat and activate the patients and get the patients back in and manage them become bottlenecks. So there are other bottlenecks in the system that probably have had less obvious impact in the U.S. system. So I wouldn't particularly be looking out to that.

I mean the U.S. seems to have its own bottlenecks. Did you happen to listen to the Adapt 4Q call?

Yes, we had a look at the transcript, and I understand it, and it's impressive, impressive the digital strategy that they're adopting and the approach that they're driving their business. We're really impressed with them.

What did you make of their near-term commentary though? I thought it was interesting around sensitive to the all-time highs, but 4Q could have been better, costs are higher for like to catch up, but we think we're going to get there by 2Q. And sort of -- it seems a little mixed.

I think like everyone in the industry, and us included, we all have the challenges where we've been through some very dynamic times. The -- being able to get really high-quality insight into the supply chains is challenging. There's clear patient demand. We're in a -- particularly in the sleep business, we're in an industry where there's just a huge pool of patients that as we activate or as they get activated, they're going to come into the system and then there are constraints and bottlenecks at all points of the patient pathway. So we think about the patient pathway from awareness through the primary care referral, the sleep specialist referral to testing capacity and then HME provider capacity for short-term and long-term management are all potential bottlenecks. And we actually think that our settings around digital solutions to optimize through those bottlenecks and activate and engage and manage patients across that journey are really key. And I think Adapt's -- many of the Adapt's commentary, I think, are really aligned up on that. In the short term costs are an issue. And when you have such uncertainty and sort of volatility in your supply chains, continuous improvement, cost optimization and volume leverage business, which I think we're all in, are actually harder to run to.

Would you generally agree with them that the full patient backlog could be abated by 2Q? Or it's just -- is Adapt like ahead of the rest of -- a lot of other players in the space?

I think everyone has slightly different parameters around that and certainly provide us, or including ones that we were unable to support because remember, we had our principled approach of putting patients first and business relationships with people who do a good job of looking after patients led us to have an allocation process that we allocated products to in terms of historical business levels. And so many of the people who weren't really using our products much, we were unable to support them through the -- those.

Okay. I just wanted to shift over to Philips at this point. I guess just as an organization and a management team, are you guys just ready for clarity on this situation?

I haven't talked to anyone who's not ready for clarity. The likelihood of getting it I'm a little uncertain of. I think, that's a very difficult situation. Their commentary around waiting on consent decrees and negotiating with the FDA and all of those I think probably mean they don't have clarity themselves. Our view of it is we look at different scenarios. The industry is different now. We're a much bigger player. There are other players in there. We think as we -- we've taken share, and we think it's defendable share, and we'll actually do everything we can to hold and drive that share and by doing the right thing by patients and providers, we should do that. So I think it's -- your question, probably it would be great to have clarity, but I think 2 points. One is unlikely to happen and be regardless of the scenario output, we think our business will be strong through it.

Okay. Any recent updates made since your last call that on Philips I think people -- they're incremental?

Nothing particularly strong. Personally, I thought when they quoted a growth rate over the next few years, it seemed fairly modest to me in terms of their expectations. I think it's just a very challenging situation for them.

Regarding your commentary that you'll be able to supply the entire market by the end of like calendar year 2023, I mean does that assume a worst-case scenario for them with the consent decree into 2024? And I guess how much flexibility do you have with your supply chain if things were to resolve more favorably for them?

I think -- a few comments around that. We -- our manufacturing business is a relatively low CapEx business in a sense investing in export capacity is out of the question for us at all, and it doesn't hurt us too much. And in fact, our typical settings is we have significant burst capacity over our run rate capacity. And you need that because things go wrong and you want to be able to recover quickly. And provided we have really headwaters of enough components into our own systems, we can run at very sustained rates for extended periods of time, and that's really what our capacity is. And as our components come in, and you'll see our inventory balances have really gone up a lot, that's been deliberate to make sure that as we fix one bottleneck, we don't run into another one. We'll have a lot of parts and a lot of capacity. What we'd like to see is that, that all normalizes and we have enough outlook and reliability and enough backups all working well that we can get back to a more normal setting of optimizing our inventory to our traditional days on hand levels, and also start optimizing our costs and driving that volume leverage cost process improvement benefit that we typically run our business to it.

Okay. So generally speaking, I mean you -- when you say you could supply the entire market, your supply chain is fairly ready to do that if necessary. And then you have the flex capacity that's coming to that. Is that...

That's right. As the parts become available, and we have the right supply chain relationships, and we've put in place a lot of long-term commitments, which, frankly, has a low risk for us given the growth profile of the business and the number of untreated patients over there.

Interesting. Directionally, how should investors think about mask and accessories growth normalizing in the U.S. and Europe as kind of patient demand is kind of more fully met?

Yes. I think -- so masks haven't been through that bust and boom shortage cycle. There have been various spot challenges around materials and stuff. But typically, we've managed that and competitors have stayed in the market. We would say that both going back a few years, when the sleep labs shut down early in COVID, that was a headwind for new patients, which becomes a headwind for mask growth. We recovered from that. Competitor exiting the market probably reduced the number of new patients in the total market. And we take a significant share of masks of other competitors when they put their products out into the market. And so that was a slight headwind for growth on there. But I think, beyond that, as we've come back, you've seen mask growth normalize. And we'd expect long term the sleep business to be a solid mid- to high-single-digit growth business and masks doing better because of the issue if you improve compliance, you improve the number of patients that stay on treatment number who need masks better. And then also our other digital strategies that are coming up for sort of as -- we're not doing it yet, but as we get back to driving demand, we'll have a lot of opportunities around there driving patients through that, and that will reflect into masks as well.

Okay. So then, in essence, you -- with the mid- to high-single-digit growth rate, you expect a sort of a mid-single-digit growth rate or mid-sort of some level of growth in CPAPs of generators with excess growth in the mask and accessories as in -- yes?

I think we expect solid growth in CPAP and then excess in masks. Yes.

Okay. And are you -- I mean, what do you think the growth for CPAPs is? I mean if you can drive upfront compliance and have a lower dropout rate over time because your penetration rate is still fairly low.

That's right. There's nearly [ been ] in untreated patients around the world. The U.S. is probably our most penetrated market, but there's still heaps of room to do that. And so that sort of gets back to our digital strategy and the types of digital solutions and the tools. And then also as we have data come available out of these systems, and we can anonymize it and protect it properly, then we can use it in sort of machine learning type algorithms for very targeted optimization processes. Our earlier study showed that these digital solutions, in various configurations could show a significant uptick in adherence from the sort of the 60% range to close to 90% range. We can sort of improve the average through that and even go higher and beyond the 90% as well with these solutions. So there's a lot of future technology come to play.

And then how much more room do you think is there in better optimizing the level of recurring revenue, like per device in your installed base?

Same issue. We've talked a bit about the resupply programs, and we published data showing that if you have a patient on a resupply program, where you have a some systematic way of reaching out to patients at the appropriate time in that whatever their usage of the mask is and whatever their insurance is, then you can really keep those patients engaged, keep their masks in really top shape, and you actually get better outcomes in terms of staying on treatment for patients. I think we've got many opportunities in that in many markets, and we still have a lot of optimization to do there. And then we barely even started thinking about that in terms of the device life cycle as well.

What's the patient pushback to that? If you get notification saying it's time to get a new mask, you either like click a button or do a quick phone call and you're there? Is it just that extra step necessary for them because you have to acknowledge at least that you would like -- you want that additional...

That's right. You have to acknowledge it and often there's a co-pay involved as well so you need to be prepared for that. But our data would suggest that it's very positively received and that having really high-quality, fresh, clean masks is really a good thing for patients.

I hope so. How should we think about share gains in masks versus competitors at this point?

Well, I think one thing to point out is that the share dynamics in masks and devices are quite separate. And it's not an issue that a gain in device share automatically leads to a gain in masks share or vice versa. Our view is we've historically been the market leader in masks, and we are the market leader in masks. And whenever someone goes on, we're more likely than not to get that mask treatment regardless of who supplied the mask. So then the share really depends on the quality of the mask and the experience of the provider in setting up the patient and their ability to predict which patients are going to work well on which masks. And we have a great portfolio of masks, and we've got a lot more ideas in the pipeline as well as to how to continue to improve that. So we expect that to keep going.

And then just one last one on sleep here. How do you think about the innovations that are going on in kind of sleep apnea? Like the innovation pipeline outside of what ResMed is doing in CPAPs, where you have Inspire in the back end, you potentially had Apnimed in the front end. As more people look at this market and say, we're going to try and enter with some different solutions.

Yes. Look, our view is that -- well, firstly, ResMed is a sleep therapy company amongst other things, and so we're not just a CPAP company. We actually have a really good business in Europe doing mandibular repositioning devices. We haven't really pushed that in the U.S. just for structural reasons in the way the market works. I'll go back to, as I said before, there's nearly 1 billion patients in the world. Most of them are untreated. The best way to get them treated is to have options and ways of getting people into treatment and awareness and all of that. And we actually think all of these alternatives actually all help and are synergistic with each other between the businesses. And I actually think that the advertising campaigns that you see on some of the -- where they're sort of using it to put down one form of treatment is not the right strategy, not a good strategy. In addition to owning really good mandibular repositioning device, we also have public record as an investor in a stimulated device as well. Usually, we've had lots of small investments in future therapies that we don't have to make public, but this -- they went public. So they listed so we ended up on their share register became known. But no, we think all of these treatments have a role and they're sensible. Most of them have in their clinical work at an end point saying a 50% reduction in AHI. AHI is the index of hypopneas and apneas that you have per hour, the number of times you suffocate per hour, if you like. And our view is if you have a -- if you suffocate 30 times an hour and you have some treatment that takes that to 15 times an hour, that's great, and you'll be a lot better off. But we still think that people suffocating 15 times an hour should be treated. So there's sort of different levels of the actual effectiveness of it. And then there's a patient selection issue in that many of these treatments will work in a subset of patients that need to be identified and the quality of those businesses depends on the ability to identify those. So we think they're all valid businesses and complementary.

Okay. Shifting to gross margin. Now that the emergency is coming close to being over as far as being able to supply, we can talk about gross margin a little bit more. Theoretically, would it largely drop through to EPS and free cash flow if you were to be able to pick up a couple of hundred basis points of gross margin improvement? I just don't get the sense that you guys are holding back on sales, R&D or capacity investments.

Yes. No theoretically, it would. It absolutely would. And as you said, there are things like mix and stuff that -- and currency that we take through there. The one thing we have talked about is that we haven't really unleashed our demand gen programs over the past 18 months because why spend money generating demand when you can't meet the demand you've got. But we have been running the experiments and being prepared, and we've got a lot of great data and that IP won't last forever in a sense. So we will want to get going on those. But I don't think they'll change ratios or anything like that in terms of it. And we see a fairly good outlook for our ability to return the business to the volume leverage business that it has been for so many years.

Yes. I mean assuming that like a lot of those -- I'm assuming a lot of those demand levers are digital...

That's right.

The stuff you're doing with like Primasun and stuff that it doesn't necessarily require us again, another layer of cost.

That is correct. Yes.

I thought it was interesting on the last call that you said that you've done a whole lot of work on volumes. But optimization and continuous improvement efforts have kind of largely been on hold. Do you know when you can refocus on that?

Some of the examples around that is, typically, we'd be negotiating with suppliers. And we'd say, look, we've got a very good outlook for our volume growth, and this is what it will be next year. And we'd love to give you the business, but we'll need a per unit cost reduction for the volume growth in there. When you're in a critical component shortage and supply chain shortage when you're actually begging for deliveries, it's not the time to make that argument. And so really, I guess you're seeing the effect of that. Then there are other challenges. When you've got a bit of chaos in terms of components coming in and you're not sure whether your next week's volume is going to be half year average or 5x your average, and you're not actually sure which parts you're going to have, it's very hard to do the long-term process optimization that's been a hallmark of what we'd normally do. So as we -- the earlier comment saying, we should meet the industry and customer demand by the end of the calendar year, then we'll be able to start getting that regular systemization thing. Another thing to watch for is as our inventory trajectory as we go through that. And as we would also be looking to have our inventory back to and sort of traditional days on hand type levels as we can optimize.

So free cash flow improvement on top of that as well?

Consequently, yes.

Okay. And what is the right way to look at the gross margin trajectory over a multiyear period as kind of mix, especially the mix of accessories and masks sort of improves?

Yes. So Brett, in our last call, he said that the outlook for the next few quarters is pretty flat. And there are puts and takes on that, as we've talked a lot about product mix of more devices at lower than the company average margin is a headwind, but it's still great for over the bottom line and all of that. I think as we get back to those longer-term optimization, will certainly be our ambition to get back to margin expansion through the pricing environment in terms of the long term of it. With 1 billion patients to be treated, it's probably not going to stay a price increase market as we would see it, but we should be able to run our volume leverage at a faster rate than that. And really, the sort of fundamental thing is if we're going to treat all those patients, I think the insurance companies and public health systems will want to see the per patient cost trend down. Now our biggest believer on that is our digital solutions and the efficiencies and workflows and better outcomes that we can provide and so that's why we'll be focusing on those.

Interesting. Okay. A follow-up on the next time we do that. Very interesting. SaaS business has quietly returned to growth, 7%, 8% for the last like 6 quarters. What are you seeing from an end market dynamics perspective in SaaS, particularly around patient census and staffing?

Yes. I think you've caught a couple of issues. Obviously, our SaaS business has had a big development with the acquisition of MEDIFOX DAN. And we're really excited about that and how that's looking in the -- in German business. And we're excited that, as a global company, we now have our SaaS business also on the pathway to being a global business. I think in all health care provider situation staffing is sort of the 1, 2 and 3 issue just at the moment. And the challenge, particularly in many of these out-of-hospital care settings is we've got sort of really looking at using unskilled labor people in situations where we have to provide all the training. We're looking for them to deliver really good patient service and then having them in relatively unsupervised situations. And so those are big staffing challenges. And then just getting people is a big challenge. And we actually think our digital solutions can help with all that. If our solutions make basically the staff's life better because they're not spending so much time doing paperwork and going through crazy processes, we can make the training easier, so it's easier to onboard people. And while we keep their life better, they're less likely to leave and then be more efficient while they are there, then we're solving that problem on many fronts. And that really is part of the big opportunity of the SaaS businesses.

I know we'd be short on time, so I did a question like this because there's a couple of things I do want to ask. Can you place in order of kind of time frame to materiality turning on Primasun, high-flow therapy and Propeller?

They're all incredible opportunities for us further out. They're all in experiment stage and trying things out and building up new relationships and building models that create value in many different ways, that set our core sleep business and our SaaS business grow strongly, particularly our North America sleep business. So timeframe for materiality against that moving target is a very tough one, very tough one to lay out. So it's a good way to [ cover ] them. We're excited about high flow is where that's going, but we have to generate the evidence, that takes time. So they're all great opportunities.

Okay. Next time, we'll ask you what your favorite is. And they're all my favorite. I can...

I will say how we go, yes.

On Propeller, can you touch on the EMR integration with Epic and Cerner? And why that was an important milestone for that platform?

Yes. So there's lots of -- Propeller creates value in all sorts of ways, and it creates value for the providers. It creates value for patients getting them on treatment, that creates value for pharma companies. It creates value for insurers as to getting the better patient outcomes. But if we can make it -- if any of these -- to the extent that you can make it simple to prescribe and simple to manage and having the Propeller system on the EHR system that you're already using, which is a potential source of prescriptions is really valuable as well. So it's really more to the same thing. It just means that less clicks and less work and less intellectual efforts needed to get the patients on treatment and that should be a help driver of the business.

Okay. And I'll squeeze in one more. What is your appetite for additional acquisitions this year following MEDIFOX?

We've always described that our M&A strategy is very much focused around, is it aligned with the ResMed strategy, and do we see companies that we can be a better manager of and are going to be part of a ResMed culture and add to the ResMed culture? And as those come up, we have the capability to do that. But we would -- we do like having it sort of steady as she goes and getting a significant acquisition in a good shape before doing the next one. So -- but you don't always get to control the timing.

Okay. Excellent. Rob, thank you very much.

Okay. Thanks, Matt.

You were just fine. Yes. Thank you.

Thanks, everyone.