ResMed Inc. (RMD) Q1 2014 Earnings Report, Transcript and Summary

Constance C. Bienfait - Director of Investor Relations Michael J. Farrell - Chief Executive Officer and Director Brett A. Sandercock - Chief Financial Officer and Principal Accounting Officer James Hollingshead - President of Americas Robert Douglas - President and Chief Operating Officer David Pendarvis - Chief Administrative Officer, Global General Counsel and Secretary

Andrew Goodsall - UBS Investment Bank, Research Division Ben Andrew - William Blair & Company L.L.C., Research Division David Low - Deutsche Bank AG, Research Division Saul Hadassin - Crédit Suisse AG, Research Division Steven David Wheen - JP Morgan Chase & Co, Research Division Matthew Prior - BofA Merrill Lynch, Research Division Joanne K. Wuensch - BMO Capital Markets U.S. David C. Clair - Piper Jaffray Companies, Research Division Ian Abbott - Goldman Sachs Group Inc., Research Division Dan Hurren - UBS Investment Bank, Research Division Jeffrey Chu Anthony Petrone - Jefferies LLC, Research Division

Hello, and welcome to the Q1 2014 ResMed Inc. Earnings Conference Call. My name is Maisha. I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Constance Bienfait, Director of Investor Relations at ResMed. Constance, you may begin.

Thank you, Maisha, and thank you, all, for joining us today. The company has asked me to address certain matters. First, ResMed does not authorize recording of any portion of this conference call for any purpose. Second, during the conference call, ResMed may make forward-looking statements, such as projections of future revenue or earnings, new product development or new markets for the company's products. These statements are made under the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Risks and uncertainties exist that could cause actual results to materially differ from the forward-looking statements. These factors are discussed in ResMed's SEC filings, such as Forms 10-Q and 10-K, which you can access through the company's website at www.resmed.com. [Operator Instructions] Speaking on the call today are Mick Farrell, CEO; and Brett Sandercock, CFO. There are also other members of the management team here present that will be available to answer questions. I would now like to turn the call over to Mick Farrell. Mick, go ahead.

Great. Thanks, Connie, and thank you, all, for joining us today. I'll review the highlights of our fiscal Q1, and then hand the call over to Brett to go through the quarter in more detail. So first, the financial summary. Global revenue in Q1 of fiscal 2014 grew 5% year-on-year, to $358 million, that's up 4% on a constant-currency basis. Americas revenue grew 4% to $202 million. Europe, Asia and the rest of the world headline revenue increased 7% for the quarter, which is 5% growth in constant currency terms. We believe the overall global growth of the industry remained steady at 6% to 8%, with global flow generator growth in the 4% to 6% range and global Mask category growth at approximately 8% to 10%. Net income for the quarter increased 14% to $81 million, while earnings per share increased 14% to $0.56 for the quarter. This bottom line result demonstrates strong global operating performance from the team. I'm going to start with an overview on Europe, where we saw a strong regional growth, with solid performance in many countries, including France -- particularly France, the U.K., as well as Switzerland. Both our German homecare business and our German dealer business also grew strongly. The European results were driven by strength in both flow generators and Masks. One of the main drivers of flow generator growth in Europe was the AutoSet CS product. This product includes the proprietary PaceWave algorithm that is designed for congestive heart failure patients with cardiorespiratory disorders, including Cheyne-Stokes respiration, amongst others. We also saw strong growth in our Respiratory Care products throughout Europe, including continued adoption of our Stellar ventilation platform. Mask growth was also solid across the European region, with both the Quattro Air and the Swift FX Nano masks being well received across the region. In France, the government confirmed during the quarter that its telemonitoring requirements would take effect right at the start of this quarter, on October 1. We believe that this announcement during the quarter dispelled any confusion in the homecare provider space in France, and will help ResMed grow its share in both the flow generator and the emerging healthcare informatics space in France, as well as across Europe. We are starting to see success in the way we position EasyCare Online solutions for monitoring requirements, not only in France, but also in other parts of Europe. Building on the strength in the U.S., this is becoming a global trend. We expect that success to continue. We announced on our website today that we have acquired an Eastern European-based distributor of sleep-disordered breathing, as well as respiratory care products. The acquisition is in Poland, the country with a population of around 40 million, and a gross domestic product of around USD 490 billion. This acquisition strengthens our presence in Eastern Europe, allowing us to expand ResMed's reach to help more patients with access to comfortable and effective treatment for respiratory disorders and also, to be able to more closely support the local homecare provider networks in developing respiratory care, as well as cardiorespiratory markets. This acquisition is an element of our ongoing global emerging market growth strategy. In the Asia Pacific region, sales were lumpy, influenced by our business primarily in Japan. The long-term opportunities in this region remain incredibly strong, especially in our emerging markets -- growth opportunities in this region, with a focus particularly on China, as well as India. In the Americas, we saw steady 5% flow generator growth, knowing that we were up against a very tough prior year comparison. Flow generators were up 17% in Q1 fiscal 2013, and we hit 5% in Q1 2014. This 5% increase is in line with market growth, which we said is around 4% to 6%. We are holding share in this category. The strong mix shift from CPAP to APAP was evident again as the trend to home sleep testing continues to drive this mix shift. The S9 AutoSet remains our flagship product in this region, and it is growing well. We're seeing a trend that new patient growth is very solid in the U.S. And we attribute some of the growth that is part of that trend to the increased availability of home sleep testing. We estimate that approximately 35% of all U.S. sleep diagnostic tests are now with HST. This is driven primarily by payer mandates. We also think that HST will grow in the next 12 months to around 40% to 45% of all tests done within the U.S. Additionally, we continue to see a steady increase in the number of sleep labs involved in HST. We think it's around 55%, based on our latest sleep lab survey data, but sleep labs are really engaging in HST and looking to offer it as a choice to patients. And we're partnering with our sleep labs to help provide our ApneaLink services, our VPAP Tx services and other services that can help them diagnose patients. In terms of Respiratory Care devices in the Americas, we are seeing positive early trends with our VPAP ST-A and our VPAP COPD products. You'll remember VPAP COPD was just recently launched. Both of these are now on the S9 platform. These products have a long lead sales cycle, and we expect this growth to continue over the coming quarters and beyond. We are taking share in the respiratory care space, and these products are positive margin contributors. We believe regulatory approval of the Stellar product in Brazil is imminent, and we expect that this will be a great geographic market for growth, given its particular homecare ventilation needs in that geography. We are making good progress on our Respiratory Care pipeline, and we plan to launch a new Respiratory Care platform for patients in fiscal year 2014. Masks in the Americas were up against a tough year-on-year comparison. Masks, if you remember, grew 13% year-on-year in Q1 fiscal 2013. We acknowledge that we lost share in this quarter due to a competitive product cycle, particularly in the nasal category and, to a lesser extent, in the pillows category. We held share in the full face category, helped by initial momentum from the launch of Quattro Air. It was released late in the fourth quarter. As I stated in our press release, the Quattro Air is on its way to being one of our best mask product launches ever. And there's lots of runway left for that product. We're only 90 days in. We also launched the Swift FX Nano in the U.S. during September, which is just a couple of weeks ago, the last month, obviously, of the quarter. The Nano has a low-profile nasal cushion, minimal headgear, and we expect the Nano to help get us back on the front foot in the nasal category. We have had a leading position in the masks space for many years and we will maintain that. We obviously expect competition in this space, and we expect customers to sample new competitive products. The increasing competition, in fact, in the nasal and pillow categories demonstrates that the market continues to look for, and reward, new product innovation, despite the ongoing reimbursement pressures. We think that's good for our business because innovation is our strong suit. We have an incredibly exciting pipeline of innovative new masks across all the categories coming out over the next 3, 6, 9 months and beyond, with one mask launch, literally, just around the corner. There's been a round of competitive bidding launched on July 1, the first day of the quarter that we're talking through here, Q1. And that caused some distraction, as we've talked about, for our U.S. channel in the quarter. Our HME customers had new reimbursement rates that were announced in February but went into effect on July 1. Remember, CB 2 is a significant part of Medicare, which is around 25% of the HME payer portfolio in the U.S. market. HMEs who won new CB 2, or competitive bidding 2 -- I'll use CB 2 as an abbreviation in this call, contracts in geographies where they didn't have a brick-and-mortar presence now have to set up subcontracts. HMEs who won CB 2 in areas where they have an established presence now have to collect paperwork on the new Medicare patients and establish replenishment programs for those new patients. HMEs who lost contracts in CB 2 are now working on driving new referrals for commercial payers, which is the other 75% of their payer portfolio, and on subcontracting partnerships for the 25%, that is CB 2. It looks to us that CB 2 has temporarily impacted volumes in the U.S. market, but as that distraction clears, volumes will pick up to meet the ongoing growth in patient demand. As I said earlier, we have seen new patient growth that is solid, and the underlying fundamental patient dynamic of home sleep testing is driving that. And the fact that 85% of this most penetrated of our markets, which is the U.S., 85% of the patients still need to be diagnosed and treated. That's a lot of runway ahead of us. We continue to see the trends that sleep-disordered breathing and COPD prevalence, awareness and patient referrals are all growing. It's notable that in the Round One Recompete bid that was announced during Q1, the reimbursement rates for sleep and respiratory care products increased versus CB 2. We believe this is a very good indicator. With CB 2 rates and contracts now in effect, and have been in effect for over 90 days, we're encouraged that uncertainty is receding and customers are focusing on how to succeed in this new environment. We're partnering with our HME customers and helping them take cost out of our mutual supply chain and out of the system. Our solutions include EasyCare Online, U-Sleep, electronic data interchange, replenishment optimization, drop ship programs, PCP awareness, and patient engagement programs and more in the healthcare informatics space. As a particular example in the healthcare informatics management space, we announced an alliance at Medtrade during the quarter with Brightree. Brightree is a cloud-based software development company. The ResMed online store will now be integrated with Brightree's HME management solutions, simplifying the ordering process for our mutual HME customers. So HME customers who use Brightree's systems will be able to order ResMed products with a single login and access to inventory availability data directly in their own management systems. This makes it easier to do business with ResMed and it makes it more cost efficient to do business with ResMed. Brightree's share of the healthcare informatics space is somewhere in the 30% to 40% range, we believe, in the HME management solutions based in the U.S. As an example of patient engagement programs, we just crossed over the 1-year anniversary mark for our Wake Up to Sleep offering. Wake Up to Sleep is ResMed's comprehensive sleep apnea support community. It's intended to help people along their entire sleep-disordered breathing journey from awareness, to diagnosis, to treatment, to ongoing adherence. There are already multiple tens of thousands of people signed up for the program, which focuses on the lifelong value to the patient. Once engaged, Wake Up to Sleep helps patients through their journey, and helps them maximize adherence. This benefits the patient, but it also benefits the physician, the HME provider and the payer. Finally, on the intellectual property front, we were just designated by an independent IP firm, Intellectual Asset Management, as the leading global company in the Asia Pacific region with, in their words, "world-class IP functions and strategies and strong IP protection." So ResMed is seen by them as a truly global IP player committed to asserting its IP rights. We've demonstrated this by defending and protecting our intellectual property and our solid R&D investments over the years, with lawsuits against both APEX and BMC. Let me wrap up with this. Our respiratory medical market is no longer just about selling equipment to treat sleep-disordered breathing. It's about forming partnerships with our customers and offering full-service solutions for patients, providers, physicians and payers to help manage outcomes of chronic disease. This solutions approach applies in our core market of sleep-disordered breathing, but it also applies in our growing Respiratory Care business, as well as in our fast-growing cardiorespiratory business. For these 3 horizons of growth, the combination of our world-leading quality flow generators, as well as the most comfortable and effective patient interface systems on the planet, as well as easy-to-access, robust and actionable software solutions, makes ResMed the leading value proposition for our customers. We have a robust pipeline of new products in both devices, as well as in masks, as well as in future business process innovations that are planned for sleep, Respiratory Care and cardiology. We are laser-focused on bringing these innovative solutions to our market, and we're managing the fundamentals of our business. Those fundamentals are that we continue to improve patients' quality of life, we continue to prevent disease progression, and we continue to reduce the burden of health care costs for critical, chronic diseases, such as sleep-disordered breathing, COPD and heart failure. Now I'll turn the call over to our Chief Financial Officer. Brett?

Great. Thanks, Mick. Revenue for the September quarter were $357.7 million, an increase of 5% over the prior-year quarter. In constant currency terms, revenue increased by 4%. Income from operations for the quarter was $96.9 million, an increase of 20% over the prior-year quarter. And net income for the quarter was $80.9 million, an increase of 14% over the prior-year quarter. Diluted earnings per share were $0.56 for the quarter, again, an increase of 14% over the prior-year quarter. Gross margin for the September quarter was 63.7%, an increase of 230 basis points compared to Q1 FY '13. On a year-on-year basis, our gross margin benefited from favorable currency movements, favorable product mix and manufacturing improvements, partially offset by ASP declines. Looking forward, we expect our gross margin to be in the range of 62% to 64%, assuming current exchange rates. Additionally, we continue to execute on initiatives targeted at improving our global manufacturing, supply chain and logistics cost structures. SG&A expenses for the quarter were $101.3 million, an increase of 3% over the prior-year quarter. And in constant currency terms, SG&A expenses increased by 4%. SG&A expenses, as a percentage of revenue, improved to 28.3%, compared to the year-ago figure of 28.9%. Looking forward, and subject to currency movements, we expect SG&A as a percentage of revenue to be in the vicinity of $0.28 for fiscal year 2014. R&D expenses for the quarter were $27.4 million, an increase of 1% over the prior-year quarter. While in constant currency terms, R&D expenses increased by 9%. R&D expenses, as a percentage of revenue, were 7.7% compared to the year-ago figure of 8%. Looking forward, we expect R&D expenses, as a percentage of revenue, to be in the range of 7% to 8% for fiscal year 2014. This reflects an ongoing commitment to investing in our product pipeline, tempered somewhat by the depreciation of the Australian dollar, as the majority of our research and development is undertaken in Australia. Amortization of acquired intangibles was $2.4 million for the quarter, while stock-based compensation expense for the quarter was $10.8 million. Our effective tax rate for the quarter was 20.7%, compared to the prior-year quarter effective tax rate of 21.6%. The lower tax rate this quarter reflects the ongoing benefit of lower effective tax rates associated with our Singapore manufacturing operations. We currently estimate our effective tax rate for fiscal year 2014 will also be in the vicinity of 21%. Turning now to revenue in more detail. Overall, sales in the Americas were $201.5 million, an increase of 4% over the prior-year quarter. Sales outside the Americas totaled $156.2 million, an increase of 7% over the prior-year quarter. In constant currency terms, sales outside the Americas increased by 5% over the prior-year quarter. Breaking out revenue between product segments. In the Americas, flow generator sales were $88.6 million, an increase of 5% over the prior-year quarter, reflecting solid growth in our APAP and bilevel devices. Masks and other sales were $112.9 million, an increase of 3% over the prior-year quarter, reflecting a very competitive market, particularly in the nasal and pillow segments. For revenue outside the Americas, flow generator sales were $103.2 million, an increase of 7% over the prior-year quarter, or in constant currency terms, an increase of 4%. Masks and other sales were $53 million, an increase of 9% over the prior-year quarter, or in constant currency terms, an increase of 7%. Globally, in constant currency terms, flow generator sales increased by 4%, while Masks and other also increased by 4%. Cash flow from operations was $90.4 million for the quarter, reflecting strong underlying earnings and working capital management. Capital expenditure for the quarter was $16.8 million, while depreciation and amortization for the September quarter totaled $17.9 million. Our share buyback continues to play a major role in our capital management program. During the quarter, we repurchased 432,000 shares for consideration of $21.1 million. At the end of September, we had approximately 4.1 million shares remaining under our authorized buyback program. We plan to repurchase at least 2 million shares during fiscal year 2014. In addition to the buyback, our Board of Directors today declared a quarterly dividend of $0.25 per share, consistent with our previously advised dividend policy. Our balance sheet remains very strong. Net cash balances at the end of the quarter was $616 million, and at September 30, total assets stood at $2.3 billion, and net equity was $1.7 billion. I'll now hand the call back to the operator for your questions.

[Operator Instructions] Our first question is Andrew Goodsall with UBS.

Could I, perhaps, just dig in a little bit to the U.S. flow generators, of course, and just ask you to clarify your comments or elaborate on your comments around volume and price? You mentioned it being weaker sort of in volumes or disruption, I think, through the bidding process?

Yes, Andrew, so there was some temporary distraction that we talked about from the CB 2 rates that we saw in Q1. The Americas' flow generators growth was 5% year-on-year, which is in the middle of that 4% to 6% range that we think is around that. So reasonably solid growth from us, but in looking at our partners, our HME's business and working with them, we noticed some distraction in, as we said, the contracts from the winners, the subcontracting from the nonwinners and the relationships that have to happen in terms of getting both prescriptions and referrals for patients who were on the replenishment programs for -- who transferred from nonwinners to winners. So all that together caused some temporary distraction during the quarter, and we think that's had some effect on the flow generator growth of the market. And we did reasonably well, I think, in terms of holding our share in a pretty tough quarter for that, where we hit 5%.

And just when we look at that 5%, can you elaborate any further on mix, on what was price versus volume? Because you have spoken to the impact of price on the group before?

Yes. So I mean, as we talked about on our last call in the intervening period, around 5% to 7% is the sort of year-on-year price reductions that we've seen. If you remember, last call, we talked about 4% to 6%. So that's a delta of 100 basis points. We think that is temporary and associated with the distraction that happened particularly in the U.S. market. And that 5% to 7% can possibly go back to the 4% to 6%. And we think that will happen as the distraction clears. So without, Andrew, breaking out the specifics of exactly what unit volumes are, which we never do here, and we just talk about revenue growth, that 5% number has sort of all those factors weighed into it.

Our next question is Ben Andrew with William Blair. Ben Andrew - William Blair & Company L.L.C., Research Division: The question I guess, for me, first off, is talk a little bit about the revenue that you might be getting from ventilators and ventilatory kind of masks in the quarter in the United States? And kind of break that out, if you can, to give us a kind of raw sleep number, if that's relevant. And then second, just on the currency side, for Brett, if rates hold steady, what do you expect for the quarter and the year?

So I'll take the first part and Brett will take the second. But it will be a quick answer, Ben, we're not going to break out Respiratory Care versus sleep. We're just going to keep flow gens versus masks. Brett, do you want to take the second part?

Yes, I do. I mean, the currency impact obviously benefited on the gross margin with the currency this quarter. And if I look -- if you look through from Q1 into Q2, I still think we'll see some favorable benefits there, and I'd estimate probably -- it's probably going to be in the order of 70 basis points, if currencies hold. Go in [ph] with caution, as all these crept up a bit over the quarter. If you looked in -- for the gain in the Q2, Q3, then you'd see something like half of that 70 basis points reversing back into -- in Q3. So we're going a long way out in terms of predicting on currencies. But if you think about it, Q2 will still see some favorable benefits from currency, then if you watch into Q3, that'd probably, on a sequential basis, reverse a little bit. But looking -- kind of underlying theme of favorability from currency movement, I think we're still going to see that play out on the bottom line in the next few quarters.

Our next question is David Low with Deutsche Bank.

Just touching on masks. I mean, mask resupply and the growth in the number of masks per patient has been a big trend in recent years. I was wondering if you could, one, comment on that; and two, just comment on whether you're seeing much brand change or seen patients changed the mask model they use once they already establish the user of CPAP?

Thanks, David. The mask resupply has been, and will continue to be, a strong element of growth long-term for the industry. We partnered very closely, particularly in the U.S. market, with our customers to help drive replenishment programs, really, over the last 3, 5 years, and even beyond that in terms of helping them access their patients, understand adherence rates, understand the importance of that for keeping the patients out of hospital, saving money for the health care system. And that is good for the patient, it's good for the payer and it's good for the provider. So there's a good incentive for all the parties involved. And we've seen that grow really well, as you have, over the quarters. We think that trend will absolutely continue and we will be a part of it. Clearly, in Q1, we did not grow as fast as we'd like to in the nasal and -- particularly, the nasal category but also somewhat in the pillows category. With the launch of the Swift FX Nano, we're back on the front foot in the nasal category. And that's got an S-curve to go up. But as I said in my opening remarks, we have 3 great masks coming out across the categories over the next 3, 6, 9 months. And we believe that those will get us on the front foot for the new patient setup. On the second part of your question about switching patients, masks tend to be like those really comfortable pair of jeans or those really comfortable pair of shoes where it's hard to get someone to change. And if they change, they often buy the same pair of jeans or the same pair of shoes that they were wearing before. And it's difficult to get patients to switch. We think that fundamental is still there. And that's why it's all the more important for us to get these great new masks out and get back on the front foot for new patient setup because there's a trailing revenue opportunity and a trailing opportunity to really help the health care system by keeping those patients with masks for their lifetime.

Our next question is Saul Hadassin with Crédit Suisse. Saul Hadassin - Crédit Suisse AG, Research Division: Mick, just a question on -- you mentioned the temporary disruption that you've seen post company, can you talk to how long you think that disruption's likely to last?

Thanks, Saul. Yes, it's a temporary distraction in the U.S. market associated with CB2, right? So the U.S. market, which is 50% of the global, it's within that 25% that's [indiscernible] as Medicare. That temporary distraction -- how long is a piece of string? We don't have 100% knowledge on how long it'll take, but we believe it's a matter of months. It's not a matter of weeks. But it's not a matter of quarters. This is a matter of months and we think the U.S. customers have been dealing with this for, now, 90 -- across 20, we're talking about 110, 114 days now. It's not new to them, we've been partnering with them over this period. They know what the challenges are and they're working hard at getting all the paperwork sorted out, getting the subcontracts sorted out, getting the new prescriptions, getting the patients on their databases and working with them. And we are partnering with them -- as we said, with things like the Brightree to make it single order entry, single approach to 1 health care infomatic system to be able to order and resupply. So we think that, over the next number of months, we'll be able to help them through that process, and we're pretty confident in that. Jim, I don't know if you want to add a couple of comments, Jim Hollingshead, who is our President of the Americas, might add a couple of comments. He's closer to this.

Sure. I mean, to give you guys a sense of the scale of it, roughly half of competitive bid to contracts were won by HMEs who did not have physical facilities in the place where they wanted, right? And so as Mick referred to in the opening comments, that means that there's a lot of subcontracting arrangements that have to be worked out. And so if you just think that side of it alone -- just think of the contracts that had to be set up -- and the subcontracting model is actually new, for the most part, in the HME world. So there's a big administrative burden. Once you've figured out a model, you've got a lot of paperwork you've got to do and you've got arrangements, you have to set up around who owns the inventory and how does it get shipped and things like that. It creates an extra burden on top of, and parallel to, the reimbursement cuts. And so, how long will it take to work through? We see people working through it already. Our customers are very good business people. They have historically shown real resilience in dealing with administrative burden created by both government payers and, well, by Medicare and private payers. So we think we seen working through it now and we think it's probably months and not weeks, but it's not an all year thing. We think they'll clear it and we think they're working through it right now. Saul Hadassin - Crédit Suisse AG, Research Division: Again, just a follow-up question for Brett. Just wanted to ask where you are in terms of manufacturing production out of Singapore and where you think that might get to over the next 12 months or so?

Yes, we're around the 60% mark. We're a little bit more on the Flow Gens, a little bit less on the Mask, but you can sort of blend it around the 60%, And I think, as we said before, I think we just progressively kind of lift that as our production increases. So, also, we predict exactly where we'll be, but that will certainly become a larger percentage of our manufacturing over time.

Our next question is Steve Wheen with JPMorgan. Steven David Wheen - JP Morgan Chase & Co, Research Division: Just on your rest-of-world numbers and Asia Pacific you referred to as being lumpy. Could you sort of give it a little bit more color as to what's happening there, and in particular, your reference to Japan? What is going on in that market?

Yes, thanks for the questions, Steve. I'll hand that to Rob Douglas, our Chief Operating Officer.

The Japan market has always been lumpy for us. Probably you're aware we've got just a few large customers there that run very significant home care businesses, and they replenish their fleet periodically. Tracking the underlying patient numbers and the whole progression of the sleep business there is progressing well. But order, timing and that just meant that we were in a low part of the lumpy run in Japan. We're very confident of the business there. We've got great relationships with our customers and our teams are working well together in serving those markets. That was really the main issue. The other smaller markets in Asia-Pac all did pretty well and we saw good growth through the emerging markets in there, but they're not yet material enough to show up on these numbers. Steven David Wheen - JP Morgan Chase & Co, Research Division: Okay. And then just also on France, the formalization of that, I guess, compliance regime. What sort of response are you seeing from the buyers in that market?

Okay, Steve. So we're 110 days in, and we think it's months away on CB2 lineup. We're 23 days in to the French announcement of the telemonitoring, and so 3 weeks -- Anne Reiser, who's our President of Europe, is all across this. She's actually our previous President of France, and ran that business since we hired her from Medtronic for almost a decade in sales and laying it [ph], so she knows the French market intimately. And we have good relations with both the authority and excellent relationships with our customers in France. And we have seen this coming and have been planning for it. We have had great learning from our U.S. market, with EasyCare Online now becoming the leader in healthcare informatics for the sleep disorder breathing space, and we have been able to scale that business very well over the last number of years in the U.S. So we have the systems, the tools and the scalable capabilities that we have now taken, literally, to within the country of France and availability now across the European Union. So it's early days. We think the customers are starting to get to grips around it and understanding how to work with us. We think it's going to be a benefit for the S9 order set, for the S9 order set with wireless capabilities and for our EasyCare Online solution in France. But, Steve, it's too early days to say how quickly that S-curve will start to happen, but the starting gun just went off.

Our next question is Matthew Prior with Bank of America.

Mick, just a question, just peeling back the layers on CB a little bit further, the 100 basis points of discounting or price pressure that you saw since the last update. Can you give us a sense as to whether that was pressure from private insurers or payers? Or is that driven more from a competitive element, given that volumes are depressed from the distraction factor and various manufacturers fighting for volume?

Matthew, we don't have visibility into the exact per-customer, per-payer knowledge of our customers and so what we do is look at it as a portfolio. Clearly, globally, we saw 100 basis points with the 5% to 7% year-on-year price declines. So there's some impact there, but breaking it out between public and private is very high. What we know are the facts. The facts are that CB2 was announced in February, and went into play in July 1, and that's the main impact that's happened across that payer portfolio. There have been very minor changes in private payers that are not out of the ordinary in and what was happening over the last, not just 5 quarters, but 5 years. So I'm affected by CB or CB1 or CB2. So I'd say that you could deduce that, primarily, price changes were driven by CB2, but we don't have true visibility into it. So it's an assumption, but a pretty good one, based upon the data that we have in hand.

And just a follow-up question, I guess, for them all. Have you seen any change in competitive behavior, to the extent that, again, lower volumes from the distraction factor? Are all various manufacturers still behaving in the same manner which they've behaved, and that it gets around 1 in previous near quarters, given this backdrop of low-volume growth?

Yes, look, I think the pricing behavior has been pretty steady in that 5% to 7% range. I mean, clearly, the new product introduction behavior is that there have been a number of new products introduced by, primarily, our 2 major competitors. Without going into detail, we talked about the nasal category and the pillows category being where they are looking to enter and the customers are sampling those products. We're very confident that not only the Quattro Air's success but Swift FX Nano's great start. And without going into detail, the pipeline that we have coming in the next 3, 6 to 9 months will get us back on the front foot for that first-time setup. So if I was to summarize competitive behavior, I'd say it's about innovation and it's about competition through small, acquired and more comfortable, and better for the patient. Because everyone is starting to realize that adherence is the outcome that matters. That's what saves money for the payer, it's what saves money for the employer and it's what benefits the patient directly each night. That level of competitive behavior of innovating on value, is something that we think is healthy for the industry, but we also think plays to our strong suit over the last couple of decades, and something that we are absolutely confident we can get back on the front foot.

Our next question is Joanne Wuensch with BMO Capital Markets.

Can we spend a moment on gross margins? Which were pretty spectacular this quarter. How sustainable is that? And what drove almost 100 basis point uptick sequentially?

Brett?

Yes. I mean, the big one, sequentially, would have been FX impact. So, sequentially, that contributed around 90 basis points. So you think on that, that's basically most of that expansion, if you like. I mean, but if you're still looking at trend buys, we're still getting product mix benefits and things like CPAP to APAP, the Respiratory Care business, all those provide, if you like, sort of a bit of tailwind for us on the gross margin. And some geographic mix, there's some benefit around geographic mix this time around, which -- generally, we probably don't get to the same magnitude we got this time. So there's a few things playing out. The other one is on -- I mean, we're working really hard in the manufacturing and the cost outside of the business as well. And you're seeing that sort of manifest pretty consistently now through the gross margin, and we're absolutely committed to those programs. So, again, you'll see them flowing through as well. And what we're looking to do is -- and you've probably seen it here in the last year or 2 is really do enough through the product mix, through manufacturing logistics to offset the ASP decline.

Okay, now I know you don't like to give revenue guidance, but given all of the pushes and takes that are happening in the first quarter, and quite frankly, the constant currency growth rate which is a meaningful step down from where you have been, can you comment on what you think your revenue may grow at, even if it's a range, for 2014?

No, Joanne, we don't give guidance on revenue. I'll reiterate our market guidance, that we believe that the global market will grow at 6% to 8%, Flow Generators will grow at 4% to 6%, and Masks will grow at 8% to 10%.

Next question is David Clair with Piper Jaffray.

I guess, just kind of a bigger picture one for me, but how do you defend your market share from lower-cost manufacturers and kind of the post-competitive bidding environment? At Medtrade that seems like a lot of kind of fringe players who are talking about this as an opportunity to take some share.

David, low-cost competition is nothing new in our industry. It's been around for over a decade. Many of the players at Medtrade are players who have been trying to enter this market and/or other markets. When I say this market, the one you're at, at Medtrade, the U.S. market and/or other markets around the world, for many years. And the way I'd look at it is if supply was unable to enter the Chinese market or the Brazilian market and their levels of focus on quality and cost trade-off, what are their chances in the U.S. market? So I think it comes back to the fundamentals. The fundamentals here are that health care systems are growing at a fast rate, relative to GDP, for every major developed country. And the U.S. is at 18% of its GDP on health care. Most of western Europe is somewhere in the 10% to 12% of its GDP on health care. Every healthcare system around the world is looking for outcomes and value, and that's driven by long-term adherence and reduction of cost with improvement of quality of life of the patient. We have focused very closely on this, and every new product we bring to market, every new solution we bring to market, looks to take cost out of the system and improve adherence rates for the patient, and reduce the long-term costs for payers and for employers. So, in that environment, with all that going on, I don't think a low-cost solution that has low value has a great opportunity to get into the market. We have great value, our products, at good value prices. So this is happening on a global scale. But I guess you were in the U.S. at Medtrade, maybe I'll hand it to Jim Hollingshead to give some detail on what's happening in the U.S. market with those new entrants.

Well, the first thing -- I think it's a great question and I completely agree with Mick's answer. But if I just think, with our customers, right? The basic equation for our customers is they need products to work. So they need to be able to easily set up a patient. They need to be able to track the compliance of that patient, make sure the patient gets compliance and then create a resupply model. And so the better the product works, the better off they are. And our products work better than other products on the market. We have the best products on the market. Most of the low-cost sort of Asian entrants are producing products that really are not in that class. They don't work that well. They create cost at setup, they create lower compliance rates, et cetera. It's not a very good value proposition. Having said that, we're very mindful. I mean, we're watching the competitive set. And the key thing for us, over time, is to be able to continue to innovate with great product, which we have a great track record of doing, right? So that's it. Now, one of the things we found, and I was actually going to suggest we might turn to Dave to comment is the other issue was around our intellectual property. So, in this space, intellectual property is very strong. And as you guys know, we've defended our intellectual property against a couple of Asian entrants. And that's another way we defend. But I think that the basic way we defend is we have the great products that work that create more revenue for our customers.

Yes, it's a good suggestion. Dave, you want to address the IP side and also to APEX and BMC deal?

Sure. So the key here is, when people come in to compete and they compete with using our intellectual property, we're not going to let it happen. So, whether that's a small competitor or whether it's a large competitor, we intend to enforce our intellectual property. And that's a different question from a small competitor who comes in and tries to compete using their own R&D, which obviously they've got to get off their own merit. But we're not going to hesitate to continue to enforce our intellectual property against market entrants who want to use the innovation of our hard working employees. And that's something we're continuing to fight with APEX and BMC on. We expect to continue to win those battles. And then at the same time, we expect to be able to be prepared to launch them if we need to. We prefer to see competitors respect our intellectual property and battle on the field. But if we need to battle in court, we won't hesitate to do that.

And then in terms of the temporary distraction that you guys saw during the quarter, how would you -- would you kind of say that things started out badly in early July and it kind of got progressively better as the quarter rolled on or was it just kind of depressed throughout the quarter?

David, we have daily conversations with our customers. It's hard to get a read on this at that level of detail, but what I can say is the temporary distraction is receding, and it's a question on how fast it recedes. We're 111, 114 days in. It's better than 100 days in, it's better than 90 days in. And it's going in the right direction and we believe it will resolve over a matter of months. The exact kinetics of it, during the quarter, is something that we just don't have visibility to. But the needle is moving in the right direction.

Our next question is Ian Abbott with Goldman Sachs.

Just wondering, in bilevels, whether you can talk to some of the initiatives you're doing to perhaps broaden the channel and the class of patients that use those products.

Yes, absolutely. And we are very focused on our VPAP ST-A, our VPAP COPD and across our pipeline in the COPD space. So that's the first market that we have huge opportunities for our bilevels. The VPAP COPD product was just launched in the end of Q4. So it's initial part of its S-curve. It involves some interaction through the pathway, with the sleep lab, where we have excellent channel access and channel control. And we have our VPAP Tx titration devices available in sleep labs across the country, and so we're really excited about the opportunities in COPD. Secondly, in the bilevel side, long-term, there's a huge opportunity in heart failure. And as you saw, we talked about our European growth being very strong during the quarter. That is helped by the fact that we are running SERVE-HF in France, Germany, the Nordics, as well as the U.K., as well as sites outside Europe. But we're seeing a halo effect from that trial, in the cardiorespiratory space. So, the order set CS product, which is an adaptive servo-ventilation product, an extension of those bilevels, saw some incredible growth. Not just during Q1, but over the last number of quarters. That is a long S-curve, and as we get to the end of results from SERVE-HF, which is mid-2015, there could be an inflection point in really accelerating those cardiorespiratory sales. So I'd summarize, Ian, by saying we've got great initial movement on our S9 bilevels, but there's a heck of a lot of runway ahead for us, particularly in the cardiorespiratory space.

For my second question, can we -- just changing topics to DMEs. Just wondering, if you look at your U.S. business and breaking the DMEs into some of the large nationals, and then obviously you've got the regionals and then some of the smaller single-person operator. If you look at, say, your business last year and then projecting your business -- maybe not this year, but maybe another year out -- to what extent do you see the percentage of your business changing across those sort of various classes of DMEs, is it going to be material or is it going to be relatively gradual?

Yes. We have good relationships with all those segments of customers from large nationals to regionals, to mom and pops. As to the exact change of it over time, I'm going to hand it to Jim Hollingshead for some thoughts there. Jim?

Thanks, Mick. The consolidation has been a gradual tectonic move in the channel over the last several years. And I think it will continue at that. Logically, you might expect a little bit of acceleration to consolidation because of CB2, but right now, we're not seeing a massive step change on that basis. And bear in mind, too, that DME is such a local business, that in many cases the local setup shall still be done by DMEs who are now subcontracting, right? So I continue to see it as a more gradual movement.

Partnerships like our partnership with Brightree really help the regionals. We've got EDI partnerships which really helped the nationals. We've got PCP awareness which helps the mom and pops, the regionals and the nationals. So we're willing to partner across the segments and across the categories of customers and products, and we see it as a pretty solid and steady move going forward, would be my summary there.

Our next question is Dan Hurren with UBS.

We've noticed, when we're talking to the market, that there's a range of deals out there -- as we'd expect for sort of discounts of volumes and those sorts of things -- just wondering how they impact the P&L over time, and the other discounts. Upfront or is there a count-back? Does a customer have to do a certain volume before they get the rebate? So will that hit the P&L later on? Just wondering how that flows through over time.

Brett, you want to talk about how we count for our deals?

I mean, they'll be a combination of all those, Dan, really. And on things like volume rebate and so on, what you do there is you have to be -- it's pretty dynamic in terms of estimating where you think volume is going to be. And then if we think they're going to hit those, then we certainly accrue as we go. So it's not like you're just going to get lumped with them all of a sudden. That will be spread out through the course of the year or whenever the volume contract is over. And then, of course, you have to make a call on what you think's really sticking and what you think that particular customer will achieve in terms of volumes.

So, I guess what I'm trying to understand is that are we seeing sales today that will actually result in lower sales when the rebates gets headed back in future periods.

No. No, because we'd be accruing or offsetting an accrual for that rebate as we go.

Our next question is Jason Mills with Canaccord Genuity.

This is Jeff filling in for Jason. Wanted to switch gears a bit and ask about the termination of the distribution agreement with CareFusion, which I think you announced about this time 1 year ago. First off, is this timing correct? And secondly, I was hoping you'd quantify the U.S. Flow Generator business during the quarter that were from products that were part of this distribution agreement. I'm just trying to understand the impact over the next several quarters, as you anniversary this termination of this agreement.

Jeff, the distribution agreement with CareFusion was immaterial 1 year ago, and it remain immaterial now. How we're distributing the Stellar range of products which were involved in that agreement is that we have our own respiratory account managers across the U.S. market, which is where that bill is focused. And our respiratory account managers and our respiratory clinical specialists, who are part of our core sales force, have picked up this product. And we did better in our first quarter with our team selling our product than another team trying to sell our product over 1 whole year. So we're seeing some good momentum with Stellar, which has done incredibly well in France and Germany, where it was primarily designed for. But some really good upside opportunities that have come to us in the U.S. But, particularly, as I mentioned in my introductory remarks, Stellar is a great product in the Americas geography, for Brazil, where we see the need for home care ventilation. And in some of those emerging markets, our products that are in the value space in respiratory care, have a great opportunity in that geography. So, in the Americas, I'd say one of the best geographic opportunities is right there in Brazil. But here in the U.S., we've taken over that distribution and we've started to move pretty well in it. And there's more, as I said in my opening remarks, in this market, through the end of fiscal '14, we're going to see some very interesting platform launches in the respiratory care space.

Our next question is Anthony Petrone with Jefferies Group.

One on mix and one on the overall U.S. market. On mix, I know you don't tend to give mix on Flow Generators, but certainly, APAP over CPAP has been a driver. It seems that, that was a driver in gross margin in this quarter as well. So I'm wondering if you can just give us an update on the runway there is still left in that mix shift as we move more towards APAP over CPAP.

Yes, so we won't break it out, Anthony. But what I'll say is that, with 35% of the diagnoses in the U.S. market being home sleep testing, pretty much every prescription that comes from a home sleep test requires some type of APAP device. And so there's a sort of good relationship between us. It's not necessarily one for one, because physicians get to see products like the S9 order set and get to love it and want to use it for many of their patients and prescribe it for [indiscernible] from the lab as well as from HST. But if you're looking for an indicator, that may be one that can help you in your calculations for working the downstream split between APAP and CPAP. But one thing remains, is that there is a positive mix shift from CPAP to APAP. Why? Well, of course there's the HST trend in the U.S. market. But if you look at other markets around the world, APAP, and particularly the S9 order set, has gained share because it's better for patients. It adjusts during the night, it adjusts night to night and it is very good long-term care. And so we're seeing good outcomes from that. There's people focused more on the outcomes and the value of therapy. We're seeing products like the S9 order set get more and more attention.

That's very helpful. And then just on the U.S. market, just going back to reimbursement trends overall. I know in the past you've touched on private reimbursement relative to CMS. Is there an update as to where they stand relative to CMS at this point? And perhaps, again, as you look forward, is there any indication of direction or where private pays may be going?

Yes, sure, Anthony. Well, as I said earlier in the Q&A here, CMS announced CB2 in February, it went into effect in July and we saw some effect in Q1. But private payers, during the last 90 days, did what they've done over the last 9 years, which is the steady reductions over time, by geography, by state. There's been business as usual as we look across the private payer space within the U.S. market.

We are now at the 1 hour mark, so I will turn the call back over Mick Farrell for his closing remark.

Great. Well, thanks, everybody, for coming and listening in on this call. I'd like to say thanks to our investors, to the analysts and our many customers who listen to this conference call. Importantly, I'd like to take this opportunity to say a special thank you to the 4,000-strong global ResMed team, from Asia-Pac, Europe and the Americas, for your hard work, dedication and continued excellence. Together, we are improving, literally, millions -- multiple millions of lives in respiratory medicine, 1 breath at a time. Thank you.

Thank you, ladies and gentlemen. This concludes the Q1 2014 ResMed Inc. earnings conference call. Thank you, all, for participating. You may now disconnect.