ResMed Inc. (RMD) Earnings Call Transcript & Summary

Good morning, everyone. I'm Sean Laaman, the Australian Healthcare Analyst here at Morgan Stanley. I'm joined on stage from ResMed, Mick Farrell, CEO; and Brett Sandercock, CFO. So welcome, gentlemen, and thank you for your time today.

Maybe just to kick things off, pandemic, hopefully, well in the rear vision mirror by now. So how would you describe the patient volumes and the market growth compared to 2019 as a jumping off point?

Yes, good question. And -- so we're looking very much at the patient flows, and using 2019 as the base of pre-COVID, and we're seeing triple digits. So 105%, 109%, 115%, all the 140 countries that we're operating in. China, we had the most recent shutdown part, which was sort of 6, 9 months ago now, but even that's sort of flowing through the system. So across the 140 countries we're at, we're actually at a patient flow level, that if you took the market growth rates that we are seeing in 2019, which was mid- to high-single-digit growth of market demand for flow generated devices and high single-digit growth rates of market growth rates of the masks, we're seeing that or slightly above that across the markets. Obviously, given our #2 competitor still out of the market right now, we're achieving higher double-digit growth. But the market growth is still solid in that single -- mid-single digits for devices and high-single digits for masks. And with the replenishment work we're doing, actually seeing a little bit above that.

Sure. Thanks, Mick. You have, as you mentioned, some very solid growth numbers over the last few quarters. And it's been a little difficult for us to define what true market growth is given that there's probably some growth in some of the smaller competitors to fill in the void vacated by Philips and -- so there are how many quarters of -- really of that excess growth do you think might be left before you're facing tough comps and you're back to whatever the market growth is?

Yes. Well, I mean, if you look at the sort of the S-curve of the share taking that we primarily and others have taken, it's been over the last number of quarters. It's hard to say exactly, where that levels out, but it will be over -- during this fiscal year as we get towards the end of it, that we'll get back to market level growth. But the patient flow is the part that we really look at and adherence and replenishment. So those three factors are really important. And we've actually, on the demand gen side, been investing in social media and driving patients into the funnel. Actually, some of the competing therapies and some of their work and advertising actually drives patients into our funnel as well. And even the -- all this work around pharma and their work on obesity drugs is driving patients into the funnel. Markets laser-focused on, will that impact 2030 or 2040 TAM? We're actually seeing patients get activated into the health care system. And when a patient shows up with symptoms of -- questions about a sleep apnea therapy, the low-cost, high efficacy noninvasive therapy is the primary focus. And so we actually, I think, can benefit from demand gen across some of these alternative therapies and new drugs.

Sure. Sure. Thank you, Mick. And maybe just to move away from the top line a little bit. So last quarter, there was a small miss on gross margin compared to consensus expectations, which Street seem to over-obsess upon. First, when we think it's probably a transient issue and we kind of put it down to two main areas, with the [indiscernible] high cost of our components are procured, when there were shortages around and still running trailing off of that inventory. And the second one is you've done such strong growth in devices over mass, that they've had that adverse mix effect. So how should investors think about those two threads and the outlook for margin going forward?

Yes. Look, clearly, we had in the last quarter in Q4, we had outperformance of our U.S. sales. We're taking a lot of share and competitor out there. And very -- so on the geography mix side, we had outweighted into the U.S. And then on the product mix side, we had a lot of CPAP and APAP, which is our lowest-margin device versus the bilevels, ST, ST-A, or noninvasive ventilators or adaptive server ventilators, or life support ventilators have significantly higher margins. And so the outperformance in the U.S. geography, outperformance in the product mix did dampen gross margin. But it was interesting. The delta in that quarter was only 30 basis points, but the delta that I think investors were laser focused on was actually 30 basis points of foreign exchange from parts and pieces we bought just the Singapore to the euro to the Aussie dollar to the USD in 9, 12 months ago that was flowing through the excess inventory we bought to deal with the excess demand that we were seeing over this period of time. But yes, as you said, those are all going to mitigate the excess freight costs and component parts, particularly on electronic components, semiconductors that we work desperately to get and did get and get to the market to achieve 30% year-on-year growth in devices in Q4, those costs were flowing through the system. So that hit the GM percentage. But I want to say really clearly, it was great gross profit dollars that we have and free cash flow that we generated, that we're reinvesting in the business, reinvesting in R&D, and reinvesting in marketing and SG&A to get patients and keep that demand gen going, when we're post the recall phase. And the other thing is, obviously, we had the low comps that a year ago people weren't in New York at conferences, people weren't traveling around the world and costs are through the roof to get people. And so I think all of those factors came in. And as we look through fiscal year '24 that we're just through out halfway -- well, just over halfway through our first quarter here, we see GM leverage opportunity to come back into the business. We're going to have costs go down on our COGS. We're going to be better at controlling the SG&A growth and R&D growth, and we're also going to see, I think, really strong demand for ResMed products and get the mix shift back to more masks on replenishment to keep our vents driving through there and continue the growth.

Sure. Thank you, Mick. And are there still any restrictive influences in the supply chain, whether it's procurement of...

Yes, not really in terms of limiting our ability. We've got the capability to take care of the whole market demands right now, and we are taking care of the whole market demand in the device side and on the mass side. So we don't see any particular supply chain constraints that -- the costs that were there and were excessively high 9, 12 months ago are not there either. And so on the spot buys and what we're getting for forward contracts on freight are very good. But we still have the high cost of components that we bought 9, 12 months ago in contracts we signed 9, 12 months ago, when no one could get semiconductor. So those are working their way through the system. So there's still some sort of hangover, if you like, from the crisis of the supply chain crisis post-COVID. But the patient flow is back. The costs are coming down, and we see GM leverage opportunities as we go through the fiscal year.

Sure. Sure. Thanks, Mick. And still on the product mix. So you've seen this really strong growth in the installed base, due to not on your own growth, but to tell us recalling the opportunities afforded there. Is it realistic to expect that at some point, we're going to see a significant up sweep in consumable sales off the back of that expanded installed base?

Well, I mean, if you look at our mask growth over this last fiscal year, there was no major competitor out of masks. We've been competing in a 3- or 5-horse race in the mask side throughout the whole post-COVID supply chain crisis and on. And we didn't have a supply chain issue with the LSR that goes in to make our masks. And so, I actually think we've been achieving some pretty solid mask growth rates, and that is due to us, yes, being there with the installed base, being there to provide the devices, but then setting up sustainable long-term replenishment models with patients. And in the U.S., we're using Brightree. We're using myAir to engage the patients directly. We're using AirView. So our cloud-based solutions to engage either the physician through AirView, the patient through myAir and the HME through Brightree. And I think that sort of digital engagement of the whole ecosystem has driven really good replenishment levels and it's sustainable. I think another -- and in other markets around the world, outside the U.S. where maybe it's a cash pay market or a different type of reimbursement model, we're optimizing how that looks as well. And it's interesting to see that in consumer-driven subscription markets, patients engage just as well or even better than in reimbursed markets. And we're getting more sophisticated as to how we reach out and leverage myAir, the direct communications tool, to a patient, particularly in a cash pay market to engage them in replenishment. And the final factor I'll talk about is that the COVID for all the awful sufferings that the world had through, the blessings that we saw in the respiratory medicine industry was people care about respiratory health and respiratory hygiene. They are engaging more with their replenishments, understanding the importance of treating their sleep suffocation, but also replenishing that tubing, that masks, that it can get dirty could have infections. And I think that sort of secular uptick in replenishment is there. So there's a secular uptick, people caring about respiratory health, respiratory hygiene. Subscription roles are engaging more. The digital is engaging them more. I do think that our replenishment and masks business is going to be very sustainable as we move forward.

Thank you, Mick. Shift gears a little bit to the card-to-cloud strategy, which worked very well for you in response to chip shortages in the market and more so in the U.S. that probably led to some softness in some of the other markets like France, I think maybe Korea. So you could maybe talk us through the way out, what does the curve look like? Where are inventories sitting on card-to-cloud? Chips freely available? And have markets like France rebounded now that there's access to direct-cloud connectivity?

Yes. So we are through the communications semiconductor crisis there, and we're able to get 4G, 5G chips as we need it. And actually some of the reduction in electric vehicles and consumer product sales has freed up some capacity there. Obviously, we're using 45, 60-nanometer. We're not using the 1, 2 and 5 nanometers that you're seeing on the consumer products and electric vehicles. But the upstream capacity of wafer and so on has been freed up. And -- so yes, we're not constrained there at all. The card-to-cloud was really a pivot during the last fiscal year. We were able to pivot quickly, primarily for the U.S. market, with this excess demand, take care of patients. And yes, so we've passed that, and we are, I would say, down to de minimis number of sales being from the card-to-cloud. So that it's good because it was a tactical pivot. The strategy for us is to have 100% connectivity into every device we sell. We're back to that and we have that engagement. And it's interesting to see -- I used to get up with these banking conferences and talk about the 7 million patients that use myAir. And they're using it every day and they're really into it. We know when they're clicking on it. We know when they open the app, but where they really engaged in it. We had a little outage just during this last quarter. And I have never been so hammered in social media on Twitter and LinkedIn because people needed their therapy, and they weren't getting it every day. So that gamification of the consumer into their therapy, they're treating it like the Fitbit or a Whoop device that they want to see after that exercise. But for us, it's sleep. We've gamified sleep for the consumer. And they want to see their data every day. So when we talk about engaging the consumer and engaging the patient in their therapy, it's really there. So I think that 100% connectivity being back there on the chipset available globally there is really important for us. And it's really back to our 2030 strategy and what we're trying to achieve, which is help people sleep better, breed, better and live better lives well away from the hospital.

Still related to that question and maybe you extend it a little bit. So could you spell out to our investors the differences between the S-10 and the S-11? And how are you going through that launch phase? And what have been the market experiences so far?

Yes, sure. So the AirSense 10 platform we launched in 2016, so it's 7 years old, still the second best platform in the market, head-to-head with competitors during this crisis. So we're running the AirSense 10 as well as the brand new AirSense 11 that we launched just in the last 12 months in the U.S. and just in the last quarters to some markets in Europe. And I see, I think Australia and New Zealand launched a couple of weeks ago. And so we're getting through Europe and Asia Pacific as we roll forward. And we're in 140 countries. They will have different regulatory cycles and launch cycles. But for the major markets, we have launched the AirSense 11, and we're selling both platforms in parallel. We used to pretty rapidly ramp down. Like the S9, we pretty rapidly ramped down when we launched the AirSense 10. This time, we're actually keeping both platforms going in parallel. The differences are the AirSense 11 is lower cost and higher price, if you look at the economics for those in the room. But if you think about it from the customer perspective, it's far more engaging. It has a touch screen. It has engagement. It talks to the consumer. It talks to the patient. It walks them through the setup process. It has a care check-in. It has a concierge. It engages and communicates with the consumer. And we think -- and also has the ability for pretty engaging over-the-air upgrades, if we want to upgrade the software to the firmware and engage with the patient. So I think that level -- certainly, the economics are beneficial, and we're going to launch that. But far more important than that, we think, is the clinical benefit. We're seeing -- so I was talking about myAir before the patient app. The uptake rates on that in our AirSense 10 platform was sort of 20%, 30% of patients would download the app, get the QR code, engage in their therapy every day. We're seeing more than double that rate of consumer engagement with the AirSense 11. So we think it's not only good for the economics of the business, it's far better for the long-term clinical outcomes for the patients. which will lead to lower costs, better quality of life, lower cost to the health care system and benefits. So it's a win for the patient, the provider, but also the payer and ResMed. So we're going to be launching that throughout this fiscal year and the year after into every country. And I think that's a tailwind in terms of GM. I think it's also a tailwind in terms of our ability to have long-term sustainable mask growth rates with that level of engaged -- consumer engagement leads to consumer adherence, which leads to better outcomes, but also greater trailing revenues.

Thank you, Mick. Change gear a little bit again. So a major competitor having a recall, and a lot of inbound that I get on what day are they going to be back in the market? Well, I don't know. But what would be your response to that question? When do you think that major competitor might be back? And what do you think that the market -- or how will the market be shaped? Do you think you'll retain share? Do you think there'll be an impact on price? How do you think it plays out?

Yes. So look, [ Philips ] has been out for 2 years and 3 months roughly of the market. So we've annualized any sort of initial sort of part of that [indiscernible]. We're now working through between us and the other players, who are actually in the market, we are the market. So they have to sign a consent decree and then they have to work with the DOJ on that, but then they have to work with the FDA as to when they're allowed to sell new product into the market. And I think it will take a long time. Historically, even if the starting gun was, well, you can go and sell Monday, they've got -- they don't have a sales force. They don't have a group, so they've got to build that back up again and work their way through. And I think it will be a slow S-curve to come back from the #5 position, if you like, to #4 to #3 and #2 to even think about challenging #1. And I look at it, we were winning this battle with them in 2019. We are taking share and growing faster than them. We've now had 2 years to further embed AirView physicians, myAir with patients. And just show that we lower costs, we improve outcomes. We are the best partner of choice. And we have the #1 and the #2 platform in the market. So as they come back, they'll have to earn their share from the bottom up. And I don't know when that's going to be. 2 years ago, they said it would be 3 months, 6 months and kind of just kept rolling. New CEO came in and said, "It will be 6 months." And now he stop saying. So I don't know. But I think it's a good question for them. But from our perspective, I'm almost -- it's almost irrelevant because we're looking forward between the 936 million people worldwide or those data from 2019, let's call it, with aging and growing populations, just over 1 billion patients worldwide with obstructive sleep apnea at a clinically significant level. We're less than 20% penetrated in the U.S., less than, 10%, 15% in Europe and less than 5% penetrated in Asia. Our competitor isn't one of those other players. Our competitor is ignorance, lack of awareness and education about the importance of sleep suffocation. And I know we're going to get on to the drug therapy stuff, but I actually think it's great to see new drug therapies coming after the metabolic syndrome, whether it's obesity, diabetes, or cardiovascular disease because it brings patients into the funnel and gives them a chance to be treated for all their comorbidities, including obstructive sleep apnea.

Sure. Thanks, Mick. So on to obesity then. So we know in medical literature that OSA is often associated with obesity. We have a bunch of clinical studies in progress with one specifically examining I think [indiscernible] OSA and the impact on the severity of OSA through weight loss by that drug. So how do you think that might shape the way that OSA is diagnosed and treated? And how do you potentially swim that tide of uptake of such drugs?

Broadly, ResMed has always been about long-term health. And Professor William Dement from Stanford, may he rest in peace in heaven, but he was the founder of the field of sleep medicine in the '50s and '60s and '70s at Stanford, and he called it the triumvirate of health, good sleep health, good nutritional or diet health and good cardiovascular health, those three together and how linked they were together. And ResMed's always been focused on all three of those areas and looking for partners to help with that. And so, I see this new class of drugs, the GLP-1s, I think we're 2 years into the launch of Wegovy, right. You've had an obesity drug out there for 2 years. I look at it and say, "If they're able to achieve 10%, 15%, 20% weight loss with a new therapy, that's a really good thing for the world. I think that actually could be a really good thing." If you believe the MACE study, the 600 patient MACE study showed some cardiovascular improvements, that's really good as well. So I actually think these are good things for the world. And we've been watching that for 2 years with Wegovy on obesity. By the way, we haven't seen any slowdown of patients coming into the funnel for last 2 years with those obesity drugs out there. We've actually got a registry that we're following. Over 17,000 patients, who are using GLP-1s and positive airway pressure. We haven't seen changes in adherence. We haven't seen dramatic changes in lack of replenishment revenue. But we're watching very closely that cohort, and making sure that there's a partnership there. But I look at it and say, "Well, if it's good, you want patients engaged and caring about their chronic diseases, you want them thinking about weight, you want them into the system." So if a patient shows up at a primary care physician's office and says, "Hey, I saw this new drug out there, I want to get treated for this weight-loss drug or this weight-loss drug." They're activated into the health care system. The 80% patients in the U.S., the 90% in Europe and 95% in Asia that we are not getting yet, the undiagnosed patients, they're not activated into the health care system. So a new class of drugs to get patients in, I think, is actually a net benefit for us. We've been watching the 2-year experiment with one of those drugs. Look -- and the other part -- the analogy I look at this and say, "I've been with the company 23 years this year." So when I was just 3 or 4 years in, I was running the new business development group. We're looking at cardiovascular disease, neurological disease. And there was this brand-new surgery, which is coming out in the early 2000s, bariatric surgery. It was an existential threat for ResMed. Bariatric Surgery is going to kill the business because everyone's going to get stomach staples and take these Roux-en-Y was the nonstable one, and it was going to takeover. We're like, "Okay, well, let's focus this." We partnered with bariatric centers. We're just launching AutoSet, which was our adjusting positive airway pressure versus CPAP, continuous positive airway pressure. And so we think, well, this is a new way to launch AutoSet into these bariatric surgery markets. What we found is the patients had 40%, 50% weight loss reduction. So 400-pound male to 200-pound male, BMI of 35 to 29 post-surgery. Pressures on the device, right? They want to say pressures. We're tracking them before and after and tracking clinical sleep apnea before and after. By the way, after surgery, 50% weight loss, BMI, high-20s. The prevalence of obstructive sleep apnea on post-treatment patients, 6, 12 months after, was triple in the general prevalence in the market. So very high prevalence still post surgery. Because the causes of sleep apnea are craniofacial. It's the distance between your tongue and your uvula. Its aged. We all lose some level of soft tissue, which is the uvula and muscle, which whether it's your bicep or your tongue muscle. It loses some strength over time. So age is the third risk factor. And the fourth is gender, sex, if you are male, you have a high propensity, all the way through your life until menopause and in the female prevalence catches up and is the same. So gender is a factor, and then obesity as well. But look, I look at that and say, with 50% weight loss reduction, triple general market prevalence, if you think of the 1 billion and the 8 billion in the world that we have seen post those surgeries, I think this is about half as good as surgery in terms of the weight loss, but far more convenient to take a pill or have an injection versus to go through an invasive surgery. So I think it will be lots more people taking it, but lower weight loss reductions. The only actually published study on this is a study called scale. So it's 2016, and it's with the GLP-1, and they were specifically looking at obstructive sleep apnea and AHI in that study. And they had a reduction in the AHI, but the clinically significant obstructive sleep apnea in the residual pool post-GLP-1s, at the end of the study was 94% of the patients that had obstructive sleep apnea at the start, also had at clinically significant level at the end. So we look at it as -- actually a net positive for the company because it's going to activate the 80%, 90% of patients, who aren't in the health care system. It's the duty of a primary care physician to assess when a patient shows up, who's overweight and is at risk for hypertension for cardiovascular disease in general for diabetes and for sleep apnea to look to treat those. And to treat them with the lowest cost, most effective, least invasive device, I actually think that, net-net, as we look to 2030, 2035, this will be a positive for us. If you look at the market, they're not agreeing, right? The last 45 days, there's a 30% reduction in our value. I think there's 20% upside overnight just if you run the numbers on those analyses. But look, go run the numbers, do your own models. We're going to go. We're going to keep growing. We're going to keep driving patients into the funnel. We're going to keep growing our device revenue, mask revenue and our Software-as-a-Service revenue and keep leading the market and getting the 1 billion people worldwide who need our help. And if you think 5% or 10% of them might get treated by a drug, okay, there's 20% upside.

Sure. Thanks, Mick. And maybe just to move forward to the -- if I can tease out of you, the upcoming [ SEMA ] OSA study and yes, trying to give us a feel how we should interpret that when the study results come out. So for example, like, clearly, we don't know yet which way it's going to go. But assume that 15 AHI is a level of we get reimbursed and you had someone with an Apnea Hypopnea Index in 20 and they go on drug and it falls to 10. So still a clinically significant level of sleep apnea. But how do you think insurers might think about that kind of outcome?

Well, so in the U.S., the clinically significant level is over 5 for treatment. So if you're over 5 with any symptoms, you can get treated. And yes I know, if you look at that study, my bet, if you look at that drug, they're achieving, I think, on the weight loss side, 15%, 20% weight loss reduction. So if you run the bariatric analysis, they may achieve some reduction in AHI, probably a reduction in the positive airway pressure that's required to keep the airway open, but the probability of eliminating -- clinically eliminating and treating and curing sleep apnea is going to be very low. It's going to be -- I don't know. We'll wait and see. The data will come out within the next year. But maybe if it's half the weight loss, you could -- it's not exactly linear, you could say it's half the reduction that bariatric surgery achieves in the OSA. So the residual was triple the prevalence of a general market population. What will the residual be on treated patients? Will it be slightly above that? Probably. Will it be in line with it? Possibly. But well I look on that is there's still a huge number of patients that are out there to be treated. If the 936 million is the prevalence from 2019. If it's 1 billion to 1.1 billion now, and that gets reduced by 10%, stretch at 15%. So there's only 850 million to 900 million people worldwide, we have to engage and get into the system. And if coming in for that drug means they're in, and then there's a residual prevalence of triple the general patient population, that's an activated person in the health care system. So look, the drugs have been out for obesity for 2 years. And during all the COVID crisis and all this, we haven't seen a reduction. We're back above 2019 levels of patients coming in the funnel. So I look at it as, I think the activations above the reduction in TAM and over the next 15, 20 years, you'd never see us getting to that end TAM because it's just so hard to get to the 1 billion people worldwide. It's activating the patient. It's helping them realize because they're an unconscious state that they're suffocating, getting them to believe their bed partner, when they tell them, you snore, you stop breathing. And all those -- all that work we're doing to activate consumers and patients. I actually think if you believe the $1 trillion in value that's with these pharma companies they invest at in D2P advertising, get in the channel, get treated from -- we're going to see patients come into the funnel. And if it's as effective as Bariatric Surgery or some of the alternatives like dental, the hypoglossal nerve stem that we're investing and we already have a dental product. We've invested in -- actually, the drug therapy Apnimed, which is targeted at ResMed's investor in that, a different approach, but a drug therapy as well. Amarin investor and hyperbole's nerve stem. ResMed stands for respiratory medicine. It doesn't stand for CPAP company. And if we can get you treated with one of those alternatives, if you fail and say that, we're going to do that. And we have 2 million patients a year coming into our funnel. The best adherence we get, when the doctor uses AirView, the patient uses myAir and you fully engaged in the digital health care ecosystem. The published data is 87% adherence, which is awesome. I mean you talk to a pharmaceutical company, you talk about 87% of patients taking that pill. That's off the charts, all the digital engagement are doing. But let's round it up. Some patients are -- some customers are better, let's call it 90% adherence. That's still 10% of our patient flow. So we can't get adherent to the lowest cost, low security, most effective therapy. We have then a patient flow that we can direct over to dental. We can direct over the drug therapy. You can direct over the hyperbole's nerve stem. That's, I think, an opportunity that's not even -- people aren't even thinking about, but we are -- and we're investing in those substitute therapies. But my net-net on this is, I think it's a net positive for patients into the funnel and there will be another alternative treatment from big pharma with their big advertising dollars. And the more noise, the better about obesity, cardiovascular disease and sleep apnea because these three chronic diseases are incredibly impactful in the world, and I think there can be a lot of patients, who have better quality of life, longer lives and are treated better when they come through the medical system.

Yes. Thank you, Mick. I did have a couple of questions for Brett, but we're out of time. So maybe I'll take these offline. My apologies, Brett.

No problem.

But that might be time to wrap it up. Is there any comment that you'd like to leave us with? Or you happy parking it right there?

I'm happy parking it right there. Thanks a lot everyone. Enjoy the rest of the conference. Thank you.