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Edited Transcript of FPH.NZ earnings conference call or presentation 27-May-18 10:00pm GMT

Preliminary 2018 Fisher & Paykel Healthcare Corporation Ltd Earnings Call

Auckland Jul 16, 2018 (Thomson StreetEvents) -- Edited Transcript of Fisher & Paykel Healthcare Corporation Ltd earnings conference call or presentation Sunday, May 27, 2018 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Antony G. Barclay

Fisher & Paykel Healthcare Corporation Limited - Consultant

* Lewis G. Gradon

Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director

* Marcus Driller

Fisher & Paykel Healthcare Corporation Limited - General Manager of Corporate

* Paul N. Shearer

Fisher & Paykel Healthcare Corporation Limited - SVP of Sales & Marketing

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Conference Call Participants

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* Andrew Goodsall

* Brian Bourdôt

* Chelsea Arna Leadbetter

Forsyth Barr Group Ltd., Research Division - Senior Analyst of Equities

* Elyse Miriam Shapiro

Wilsons Advisory and Stockbroking Limited, Research Division - Equity Analyst

* Marcus Curley

UBS Investment Bank, Research Division - Executive Director and Head of New Zealand Research

* Stephen Ridgewell

Craigs Investment Partners Limited, Research Division - Deputy Head of Research

* Steven David Wheen

Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst

* Tristan Joll

First NZ Capital Limited, Research Division - Research Analyst

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Presentation

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Operator [1]

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Welcome to the Fisher & Paykel Healthcare's Results Conference Call. My name is Melinda, and I'll be your operator for today's call. (Operator Instructions) Please note, this conference call is being recorded.

I would now like to turn the call over to Marcus Driller, General Manager, Corporate. Please go ahead.

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Marcus Driller, Fisher & Paykel Healthcare Corporation Limited - General Manager of Corporate [2]

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Thank you, Melinda. Well, good morning, everyone, and welcome to the Fisher & Paykel Healthcare 2018 Financial Year Results Conference Call.

On the call today are Lewis Gradon, our Managing Director and Chief Executive Officer; Paul Shearer, Senior VP of Sales and Marketing; Tony Barclay, Chief Financial Officer; and Andrew Somervell, our VP of Products and Technology. Lewis will first provide an overview, followed by some specific comments from Tony. And then we'll open up the call to questions for the team.

We will be discussing our results for the year ended 31 March 2018. We have earlier today provided our 2018 annual report, including financial statements and commentary on our results, to the New Zealand and Australian stock exchanges. These documents can be accessed on our website at www.fphcare.com/investor.

With that, I'd now like to turn the call over to Lewis.

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [3]

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Well, thank you, Marcus, and welcome, everyone. We're pleased to report a strong result for the 2018 financial year. This year, we estimate that our products were used in the treatment of more than 13 million patients in over 120 countries.

Overall, operating revenue for the year grew 10% to a record NZD 980.8 million or 9% growth in constant-currency terms. That's comprised of 13% constant-currency growth in our Hospital product group and 4% constant-currency growth in our Homecare product group. Operating profit grew 12% to NZD 269.8 million, and reported net profit after tax was up 12% on last year at NZD 190.2 million.

This result was at the top end of our November guidance of NZD 185 million to NZD 190 million. And given that positive result, our Board of Directors has approved and increased fully imputed final dividend of $0.125 per share, taking the total dividends for the year to $0.2125 per share, an increase of 9% on the previous year.

In the Hospital product group, our devices and systems are used in invasive ventilation, noninvasive ventilation, nasal high flow therapy and during surgery. Growth in revenue from our Hospital products was strong at 13% in constant currency for the year and 15% for the second half. A highlight was the robust second half constant-currency revenue growth of 25% from new applications consumables. This was driven primarily by our Optiflow nasal high flow therapy, which is benefiting from a growing number of clinical studies pointing to its effectiveness in reducing the need for higher acuity therapies and the length of hospital stay for patients.

In 2017, there were 259 studies published on nasal high flow therapy across adult, neonatal and pediatric patient populations. The amount of clinical interest in this therapy is extraordinary, and it's encouraging for us to see more research being conducted on nasal high flow in patients that have a broader range of conditions.

We are also starting to see a number of studies exploring the effectiveness of this therapy in areas of the hospital outside of intensive care units, which traditionally is where most usage has been.

During FY '17, we had a number of new product launches and we have continued the global rollout over the last year. Optiflow Junior 2, a nasal high flow system for infants, is now available in the U.S., Canada, Europe and India, in addition to New Zealand and Australia. Our F&P 950 respiratory humidification system for adults is continuing its global rollout, and the infant version was recently launched in New Zealand and Australia.

On noninvasive therapy, the Nivario mask was introduced into the U.S. in the second half of this financial year, and we are pleased with the very positive response we have received from customers on this innovative mask. There was a strong Northern Hemisphere flu season, which we estimate contributed between 1 and 2 percentage points to constant-currency Hospital revenue growth. Given the low global penetration of nasal high flow therapy, we believe we can continue to grow the new application segment of our Hospital business strongly for years to come.

In our Homecare group, our products are used in long-term care facilities and home settings assisting in the treatment of obstructive sleep apnea or OSA and chronic obstructive pulmonary disease or COPD as well as other chronic respiratory conditions. We have reported constant-currency growth of 4% in our Homecare product group for the year, with OSA mask constant-currency revenue growth of 5% and 2% for the second half. This is lower growth than we have experienced over the last few years as competitors introduced new masks to the market.

Our product pipeline is full, and we expect our range of innovative and popular OSA masks to expand later this year. We do understand that there's interest in the specific dates of release for this new product, but for competitive reasons, we don't think it's wise to provide that level of insight. What we can say is that we are expecting to introduce new products this year. And given the timing and the rigorous recycle, we expect contribution from new products in the FY '19 year will be muted. We are pleased with the strong performance of our most recently released mask, the F&P Brevida nasal pillows mask. This gives us a competitive mask offering in each of the 3 major mask product categories.

OSA flow generator revenue declined 8% for the full year, but we saw 10% growth in constant-currency terms for the second half. Our SleepStyle CPAP device, which was launched last year, is now available in Australasia, Canada, U.K., some European markets and has been very well received by customers. We've also received great feedback on our SleepStyle patient engagement platform, an app and website connecting patients with their SleepStyle device and with their therapy. Through this platform, patients are able gain insights into their therapy progress. We're also able to identify common therapy issues and provide guidance on how to solve these.

These tools complement our InfoSmart web system, which offers health care providers exception-based patient management, comprehensive reporting and a simple user experience. And for customers that want more flexibility with their data, InfoSmart offers an extensive set of APIs, enabling seamless integration into health care providers' systems. Our CPAP and related informatics systems position us well to continue our emphasis on masks and the COPD opportunity in the home in the future.

Our myAIRVO system, which is used to deliver Optiflow nasal high flow therapy in the home for patients with chronic respiratory conditions, continued to grow strongly. Two research papers in particular were published this year which showed considerable benefits of our therapy. These included positive data around number of exacerbations, hospital admissions, quality of life, hypercapnia and progression of the disease. These new studies add to the small but growing body of evidence relating to the use of Optiflow nasal high flow therapy in the home with patients with COPD. We expect these studies will help drive clinical change and assist with the adoption of our myAIRVO system.

We again generated significant revenue from recurring consumables and accessories this year, accounting for 87% of operating revenue in the year and 87% in the second half. Gross margin increased by 31 basis points to 66.3%. In constant-currency terms, gross margin for the year increased by 34 basis points and 22 points for the second half, primarily as a result of favorable product mix.

Mexico manufacturing at 34% of output for both FY '17 and FY '18 made a lower contribution to gross margin improvement this year compared to previous years.

In Homecare, average selling prices declined as expected, generally within a 35% range. We expect FY '19 constant-currency gross margin improvement will be similar to FY '18 as the benefits of new products and product mix continue, and we expect to have manufacturing lines commissioned in our second Mexico facility near the end of this financial year.

Moving on now to operating expenses. This year we have again increased our investment in R&D, with expenditure growing 10% to NZD 94.7 million for the year, which represents 10% of revenue. We have a strong new product pipeline, including new humidification systems, flow generators, masks, consumables and information solutions all under development.

Selling, general and administrative expenses increased 8% to NZD 290.9 million for the year or approximately 7% growth in constant-currency terms, largely due to the continuing expansion of sales teams and promotional activities around the world and building out our global logistics network.

We have included an update on the patent ligations proceedings in the press release and in Note 3 and Note 19 of the financial statements included in our annual report.

We incurred expenses of $15.6 million in FY '18 in relation to the patent litigation, which is net of $3 million of costs recovered in relation to legal proceedings in Europe. Assuming a continuation of current actions, we expect to incur these costs at a similar run rate during FY '19, which is included in our earnings guidance. We anticipate that in constant-currency terms our operating expense growth for the FY '19 year will be broadly in line with underlying revenue growth.

Now before passing the call over to Tony to discuss our balance sheet, cash flows and foreign exchange position, I'd like to acknowledge that after delivering over 30 of these results conference calls, this will be Tony's last given that he's retiring at the end of this month. Tony has been a key member of our leadership team for 22 years and he's been instrumental in the growth of this business.

So Tony, my friend, over to you.

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Antony G. Barclay, Fisher & Paykel Healthcare Corporation Limited - Consultant [4]

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Thanks, Lewis, and good morning, everyone. Looking first at cash flow.

Operating cash flow was strong as expected at $248 million, reflecting good cash conversion and a modest reduction in working capital requirement, principally through supply chain optimization of inventory holdings. We expect operating cash flow to continue to track closely with earnings for FY '19.

CapEx including intangibles was $99 million for the year, somewhat below our forecast. However, this is primarily due to the timing of spend on our 2 building projects. The majority of CapEx for the current year was for increased manufacturing capacity in new product tooling, with $40 million spent on the building projects. Costs associated with the SAP projects are included in intangible expenditure. SAP has now been implemented in our New Zealand and Mexico manufacturing facilities and a number of our global sales offices, with the rollout to continue over the next 2-and-a-bit years.

We expect CapEx for FY '19 to be higher than FY '18 as a substantial proportion of the New Zealand building for expenditure will incur in FY '19. Our expectation for FY '19 CapEx is approximately $160 million to $170 million.

We have, as normal, included $5 million of other income in our income statement and cash flow from the Callaghan Innovation Growth Grant. The current grant expires at the end of September 2018, and there has been a recent announcement by the New Zealand government proposing a change to the way R&D in New Zealand is incentivized. We understand the intention is for our Callaghan Growth Grant to continue through the end of March 2019 while, at this point the exact mechanism to do so has not been made clear.

A discussion paper on the R&D tax incentive has been circulated by government, and we will shortly submit our views on the paper. If we assume the incentive will work in a similar way to 2008, the incentive should provide more assistance to the Callaghan grant for FY '20 and beyond. However, it is too early to quantify the size of that additional assistance.

We also recently made a submission to the Tax Working Group on their paper Future of Tax. We submitted that the fundamental challenge to the New Zealand tax system is to remain competitive and to continue to attract and retain investment in New Zealand in the face of lowering corporate income tax rates globally. We await developments with interest.

The recent U.S. tax reforms did have a -- did not have a material impact on the wider operations of our business. While there was a reduction in the headline U.S. federal income tax rate from 34% to 21%, once state taxes are added to the equation, our effective rate will now be very similar to New Zealand. We did benefit modestly from a lower blended U.S. tax rate from 1 January this year.

Our effective tax rate for the year was 29%, down very modestly from 29.1% for the prior year due in part to the lower U.S. federal income tax rate just mentioned. We estimate that, ignoring currency movements, the effective tax rate for the group should continue to be around 29% for FY '19.

Looking now at the balance sheet. The balance sheet is in very good shape, with working capital well managed. Debtor days are again at the lower end of our normal range, being 45 days, a modest improvement on the prior year. Inventory value has decreased, as described earlier, through the efforts of the supply chain team to optimize global holding levels. The proportionate manufacturing in Mexico remains largely unchanged in the mid-30% area.

Interest-bearing debt increased by approximately $20 million, principally due to the land purchase and building program in Mexico. Overall, we had a net cash balance of $50 million at the end of the year, and gearing was minus 7%. With the larger building program in FY '19, we expect to end the year back within our target gearing range of minus 5% to plus 5%.

We hold cash balances and short-term investments, mainly in New Zealand dollars, of approximately $130 million at the end of the year. This balance will decrease upon payment of the final dividend and as payments for our new building in Auckland increase during the year. No New Zealand dollar debt was held at year-end, with the majority of debt held in U.S. dollars and euros as a balance sheet hedge, also benefiting from lower costs of borrowing.

Net property, plant and equipment increased by approximately $50 million from the end of last year, mainly as a result of the land and building CapEx. Depreciation expense for the year was $35 million, and amortization was $10 million. EBITDA for the year was $314 million compared to $279 million last year, an increase of $0.13.

Looking now at foreign currency. Over the last 6 months, we've continued to add longer-dated Kiwi-euro hedging from an average spot rate of EUR 0.585 as forward points have remained beneficial. If we continue to see Kiwi-euro here or slightly lower, we have the ability and intention to hedge a portion of our net exposure in the 6- to 10-year period at very favorable outright rates.

Recent Kiwi-U. S. weakness has allowed us to add a little more hedging in years 1 and 2. However, at current spot rates and with forward points being a cost, we currently have no real opportunity to hedge beyond 2 years forward. We also have been able to top up our hedging levels on other currencies in the 1- and 2-year buckets.

Our policy remains unchanged. And when there are opportunities to extend our hedging position, we're able to do so up to 5 years forward and, in some circumstances, up to 10 years forward. The cover levels and the rate of that cover in relation to the U.S. dollar and euro has again been provided in today's disclosures as are the FY '18 average conversion rates.

Our hedging program again proved valuable in reducing earnings volatility and providing earnings support. Our pretax hedging gain is approximately $15 million a year.

For the year, earnings were favorably impacted by less than $1 million from the New Zealand dollar being lower than last year. At the current exchange rates, we would expect to record a hedging gain, again pretax, of approximately $6 million for FY '19. Based on the FX rates used for guidance today, we forecast that FY '19 earnings will be favorably impacted by approximately $2 million compared to FY '18.

Ownership of the company continues to be a similar holding as previous, with 70% of shares held by institutional and 30% by retail investors. The most recent analysis of investor domicile has seen New Zealand and Australian holdings decrease. New Zealand holding now sits at 41% of shares on issue and Australia at 27%. The main increase has occurred in relation to investors in North America now holding 20%, up another 3%. Shareholders from other countries hold the remaining 12%.

As Lewis mentioned previously, we'll be paying an increased final dividend of $0.125 per share payable on the 6th of July. The company will again be offering eligible shareholders the option to take all or a portion of their dividend in the form of fully paid ordinary shares under the dividend reinvestment plan. No discount will be offered again for this dividend. The dividend will be fully imputed, and a supplementary dividend of $0.022 per share will be paid to nonresident shareholders.

So before handing the call back to Lewis, I would like to thank the team here at Fisher & Paykel Healthcare for a great 22 years. We have achieved a huge amount over my time here, and I know the company is well placed to execute on the exciting opportunities we have ahead.

Also, thank you to all of those in the investment community for your attention, engagement and good humor most of the time when discussing the business with me. I will see many of you on the upcoming Australasian post results road show and look forward to that. It has been a pleasure.

Now back over to Lewis, who will provide some more comments in relation to guidance for FY '19. Lewis?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [5]

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Well, thanks, Tony. On behalf all the team here at Fisher & Paykel, I'd like to acknowledge the outstanding contribution you've made over the last 22 years. We wish you all the best in this next phase of life and I can assure you, you will be missed.

So turning now to guidance. Our strategic direction remains consistent as we continue to develop new and innovative products, utilize our expertise to develop new therapies and change clinical practice and grow our international presence. We expect similar constant-currency revenue growth in our Hospital product group for the FY '19 year. And in our Homecare product group, we expect constant-currency growth rates similar to the second half of FY '18. At current exchange rates, we expect full year operating revenue to be approximately NZD 1.05 billion and net profit after tax to be approximately NZD 210 million.

So with that, I think we can now open the call for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

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Marcus Driller, Fisher & Paykel Healthcare Corporation Limited - General Manager of Corporate [2]

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All right. Thanks, Melinda. Our first question comes from Chelsea Leadbetter at Forsyth Barr.

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Chelsea Arna Leadbetter, Forsyth Barr Group Ltd., Research Division - Senior Analyst of Equities [3]

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Just if I can start with the Hospital segment. And can you provide a little bit more detail on sort of the -- I guess, the breakdown between some of the new applications and how -- I guess, what growth rates we're seeing particularly for Optiflow and noninvasive, given you called it out a bit in the first half results?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [4]

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Yes, I did. So with regard to noninvasive, in the second half what we can say there is Nivairo was released in the U.S. in November, so it's there for most of the second half. Overall, in the second half, Nivairo made a positive contribution to growth within new apps.

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Chelsea Arna Leadbetter, Forsyth Barr Group Ltd., Research Division - Senior Analyst of Equities [5]

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Okay. And I guess, some clarity on maybe what we're seeing as the growth rate for Optiflow in -- I mean, should we assume it's higher than what you're suggesting for the overall new apps growth rate?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [6]

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Yes. So we really don't want to dig much deeper into that category than we have, Chelsea. But Nivairo -- or noninvasive ventilation was fairly flat in the first half. It's made a small positive contribution in the second half. And so you can assume that the remainder is Optiflow.

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Chelsea Arna Leadbetter, Forsyth Barr Group Ltd., Research Division - Senior Analyst of Equities [7]

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Okay. And I guess, just a quick point of clarification with respect to the ligation cost. When you're suggesting and carrying cost at a similar run rate for FY '19, should I be assuming that, that's compared to the $18.6 million of costs, i.e., without the $3 million benefit that you got in FY '17? [Is it fair to think so]?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [8]

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We would think -- yes, we were thinking the net costs, so closer to the $15.6 million.

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Chelsea Arna Leadbetter, Forsyth Barr Group Ltd., Research Division - Senior Analyst of Equities [9]

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Okay. And I guess, just last question before I hand over to someone else. Just a little bit of clarity on how you're thinking about the manufacturing facilities when they open and how we think about the initial cost drag, I guess, in Mexico in particular given that's going to be fairly soon in this year and maybe into FY '20.

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Antony G. Barclay, Fisher & Paykel Healthcare Corporation Limited - Consultant [10]

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Chelsea, Tony here. Look, the Mexico facility is due to be opened relatively late in the financial year, so there really isn't much impact at all in the guidance today. So I think that it's more in the rounding than anything else at this point, and it will be an FY '20 question.

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Chelsea Arna Leadbetter, Forsyth Barr Group Ltd., Research Division - Senior Analyst of Equities [11]

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Okay. And do you have any sort of, I guess, initial indications on what FY '20 -- what quantum of drag that could be -- we could be thinking about?

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Antony G. Barclay, Fisher & Paykel Healthcare Corporation Limited - Consultant [12]

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I think we probably prefer to line that up with guidance as we kind of get closer to that.

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Marcus Driller, Fisher & Paykel Healthcare Corporation Limited - General Manager of Corporate [13]

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Thanks, Chelsea. Next question comes from Elyse Shapiro at Wilsons.

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Elyse Miriam Shapiro, Wilsons Advisory and Stockbroking Limited, Research Division - Equity Analyst [14]

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I was just wondering what sort of pricing power do you have for new applications, in particular Optiflow and AIRVOs. And was growth in that segment driven by price or volume or a combination of the 2?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [15]

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Well, first of all, driven by volume rather than price. In terms of pricing power, I mean, we do have a unique product offering. So relative to other products, it tends to be on the right side of our average gross margin.

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Elyse Miriam Shapiro, Wilsons Advisory and Stockbroking Limited, Research Division - Equity Analyst [16]

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And do you see price increases for Optiflows and AIRVOs going forward at all?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [17]

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No, probably not. We think we're at about the right place now.

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Marcus Driller, Fisher & Paykel Healthcare Corporation Limited - General Manager of Corporate [18]

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Next question comes from Tristan Joll at First New Zealand Capital.

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Tristan Joll, First NZ Capital Limited, Research Division - Research Analyst [19]

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Just following on from the Mexico questions, I guess. Just in terms of working capital, would we expect to see a bit of an inventory build towards the back end of this year? That's the first one. And then the second one, just in terms of gross margins for this year. I think we expected only 47 basis points of expansion in the first half, and I -- and we've ended up a touch lower than that for the full year. But I think we probably thought back and knew that, that would improve. Can you kind of characterize what has been going on in the cost base or in the mix that sort of stopped that sort of going up to what you might have expected?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [20]

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Sure, Tristan. With regard to the first question on inventory build, that will be new and additional lines going into our second plant, so we wouldn't expect any inventory build related to that. Insofar as gross margin for FY '18 goes, there's a lot of moving parts there. There's no real single material effect to call out. In the past, we've got gross margin improvements from product mix from Mexico and the supply chain. If you look at product mix, I mean, things like lower OSA mask growth, CPAPs swinging the other way to 10% growth in the second half, reduced the magnitude of that mix shift contribution. Our OSA masks also -- they're mostly in Mexico, so a smaller positive contribution this year from Mexico than we've normally experienced. We had a strong flu season in the second half in the Hospital part of the business so that did mean there was a small amount of effect to some of the Hospital products. So supply chain contributed a bit to this as well. We've had an inventory improvement, which was a bit of an impact as well. But I think the summary, Tristan, is nothing big, nothing material or pretty small effects across the board.

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Tristan Joll, First NZ Capital Limited, Research Division - Research Analyst [21]

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And then just one other question, I guess, which is just on the masks maybe, too, 2% growth in the second half. And I heard your comments around the contribution of new products being muted this year. Would you care to sort of give us some sense of what you factor again to your guidance? I mean, it certainly feels [that, that] should increase, [it's just that] a negative rate might be a possibility. What will be headlines on that?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [22]

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Well, what we're guiding to is a pretty similar number to our second half of FY '18.

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Tristan Joll, First NZ Capital Limited, Research Division - Research Analyst [23]

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Okay. So (inaudible) constant-currency guide through the year. So you think probably that their, I guess, performance or market share -- (inaudible) market share are probably kind of static now, you're not losing share from here.

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Paul N. Shearer, Fisher & Paykel Healthcare Corporation Limited - SVP of Sales & Marketing [24]

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Tristan, Paul here. I think the answer to that is that there were a lot of -- there were some new product offerings in FY '18, mainly in the second half. A lot of the homecare providers are sampling those. So it had an effect on our second half performance. I think that's starting to become more clear for us. Dealers of samples aren't continuing with their products and rebounding back to our products. So when we did miss on it, we think we're going to hit a very similar run rate into the -- into FY '19 and (inaudible).

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Marcus Driller, Fisher & Paykel Healthcare Corporation Limited - General Manager of Corporate [25]

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Next question comes from Andrew Goodsall at MST Marquee.

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Andrew Goodsall, [26]

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I was just going to quickly, I guess, carry on from Tristan's question on masks. Just if you could give me a sense of, I guess, what's important in that marketplace. We've got other -- some of your competitors saying that connectivity is a pretty big piece of that market now, and that might be helping their mask effort. Just wondering how you're sort of thinking about that piece.

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [27]

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Yes. We don't think so. We think the mask's independent of the CPAP, it's independent of connectivity and it's independent of the data. And I guess we've seen that play out over the last 5 years or so when we've had very strong market share gains in the face of that phenomena. You kind of see a little element of that now in second half, where CPAPs grew more than masks as well. So we don't think there's such a connection.

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Andrew Goodsall, [28]

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And what about -- over to the flow generators in that Homecare space, would that -- do you think that has more relevance for flow generators?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [29]

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Connectivity, yes, we think that's pretty important for flow generators. I mean, there's a couple of things there and we think it's important for our machines to connect to any healthcare system anywhere in the world with any dealer or any institution. So it's one of our primary goals with what we do.

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Andrew Goodsall, [30]

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And just on the R&D outlook, I think you were up about 10% this year. Just in terms of how you see that -- the pace of that for next year, would it be similar sort of levels to this year?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [31]

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Well, we have grown R&D in constant-currency terms above revenue growth for the last few years. We've given an indication that we sort of expect that to revert to the mean over the next few years. And if you have a look at the first half, second half numbers for R&D growth, you'll see that coming off a little bit in the second half. So going forward for the next year or so, we are expecting R&D growth to be a little lower than revenue growth.

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Marcus Driller, Fisher & Paykel Healthcare Corporation Limited - General Manager of Corporate [32]

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Next question comes from the line of Stephen Ridgewell at Craigs Investment Partners.

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Stephen Ridgewell, Craigs Investment Partners Limited, Research Division - Deputy Head of Research [33]

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Just if I might ask a couple of questions on the new apps and the 27% growth in the second half. I mean, would a reasonable read from that be that the pick up from the first half we saw was -- there's a little bit of flu season in the year, also Optiflow 2 Junior and perhaps a bit of the 950, the incremental growth cycle and the nice use. Will you make any broad brush comments on it?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [34]

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Yes, so the 950 won't be new apps. New app growth for the second half was 25% in constant currency. And otherwise it's all the things you mentioned. It is flu season kicking in. It is Optiflow Junior kicking in. It is 950 where it's released probably has helped -- that's primarily Australia.

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Stephen Ridgewell, Craigs Investment Partners Limited, Research Division - Deputy Head of Research [35]

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And so just more broadly, is it fair to read there has been a bit of a pick up or do you feel it has been an underlying pick up in Optiflow demand in the adult market?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [36]

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Other than the seasonality of the flu effect, no, we think it's pretty consistent.

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Stephen Ridgewell, Craigs Investment Partners Limited, Research Division - Deputy Head of Research [37]

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And are you able to talk to any signs of traction for myAIRVO?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [38]

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Well, sure. As I've said, it's a small part of the Homecare business that's growing strongly. Yes, we do think the 2 studies that I called out are going to be very helpful and very instrumental over the next few years, the Storgaard study, 200 patients in the home over 12 months. I mean, that's really our second set of randomized controlled hardcore outcomes data in that area, so we're very pleased that that's being published. And the results are probably even little better than we're expecting. The significantly reduced exacerbation rates and modeling lower hospital readmissions is kind of everything we were hoping for.

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Stephen Ridgewell, Craigs Investment Partners Limited, Research Division - Deputy Head of Research [39]

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And just in terms of the comment on OSA and new masks planned for this year, was that a reference to this calendar year or to the FY'19 fiscal year?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [40]

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Yes, good question. I think I can safely say calendar year.

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Stephen Ridgewell, Craigs Investment Partners Limited, Research Division - Deputy Head of Research [41]

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And given this is Tony's last call, I couldn't sign off without asking a few questions. And before I do, just wanted to take the opportunity to thank you, Tony, for your efforts and engagement with the investment community over the years and wish you all the best for future. And I guess the point...

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Antony G. Barclay, Fisher & Paykel Healthcare Corporation Limited - Consultant [42]

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Terrific.

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Stephen Ridgewell, Craigs Investment Partners Limited, Research Division - Deputy Head of Research [43]

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I guess the points of clarification were the guidance for -- 210 impact refers to approximately current exchange rates. Just wondered if you could clarify exactly what that means in terms of the US dollar and euro, so you took 69 or is it higher than that?

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Antony G. Barclay, Fisher & Paykel Healthcare Corporation Limited - Consultant [44]

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We were talking 69 and 69.5 -- sorry, 59.50 and 59 for the euro. While we're about the same one side or the other -- this or the other side or another this morning, so here or thereabout.

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Stephen Ridgewell, Craigs Investment Partners Limited, Research Division - Deputy Head of Research [45]

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Yes, pretty close. And I guess also I'm just interested is, typically at this point of the year you would give a range and this year you have gone for a point estimate. I am just curious as to why the change in approach. Do you feel you've got that much more certainty on the outlook compared to prior years?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [46]

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No, you're probably ascribing...

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Antony G. Barclay, Fisher & Paykel Healthcare Corporation Limited - Consultant [47]

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Too much weight.

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [48]

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Yes, too much weight into that, Stephen. No, the key word is approximately, right?

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Stephen Ridgewell, Craigs Investment Partners Limited, Research Division - Deputy Head of Research [49]

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And then if we look -- so within that guidance, could you please clarify what hedging profits are included within that?

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Antony G. Barclay, Fisher & Paykel Healthcare Corporation Limited - Consultant [50]

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Sure. There's NZD 6 million approximately of hedging profits. And the other comment I made was that year-on-year the overall impact of currency would be, with these guidance exchange rate, a tailwind of $2 million before tax.

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Marcus Driller, Fisher & Paykel Healthcare Corporation Limited - General Manager of Corporate [51]

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Next question comes from Marcus Curley at UBS.

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Marcus Curley, UBS Investment Bank, Research Division - Executive Director and Head of New Zealand Research [52]

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Just a couple from me. And excuse this one if you already mentioned at the beginning, but did you call out what you thought the impact of the flu season was in the second half?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [53]

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Yes, we did. We think between 1% and 2% -- well, it's an estimate, Marcus, and it's our best estimate. I think between 1% and 2%, but that's for the full year, to Hospital.

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Marcus Curley, UBS Investment Bank, Research Division - Executive Director and Head of New Zealand Research [54]

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And so then when you look at your guidance for the Hospital business being on the constant-currency level pretty similar to last year -- obviously, you're swallowing up the flu season benefit. Could you talk to a little bit about what you think accelerates to offset that impact in FY'19?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [55]

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Yes, I can. It's a little bit complex, but in our guidance we modeled a moderate flu season versus what we've just had, which is a strong flu season. But it's not just the magnitude, we also took account of the timing of the flu season. So FY'17 was a little bit later and sharper decline than other years. Maybe to summarize it: so we think in the guidance as a moderate after an FY'18 strong, but with timing of the relative flu seasons, we think it comes out at about same rate.

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Marcus Curley, UBS Investment Bank, Research Division - Executive Director and Head of New Zealand Research [56]

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Does that mean you give it back in '20?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [57]

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No, it's kind of the other way around. It's a historical event. Look, the phenomenon is this: flu seasons have a peak and then they have a decline. During that decline phase, our customers will generally -- naturally be overstocked as the stocking lags the decline. And if that decline falls into our first half, it can have a negative impact on first half. And that's what we experienced in FY'18 because of the FY'17 timing. So we think '17 was later than most seasons.

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Marcus Curley, UBS Investment Bank, Research Division - Executive Director and Head of New Zealand Research [58]

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Secondly -- again, you probably mentioned this, but were you calling out 2 new OSA masks in the calendar '19?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [59]

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Well, I fairly carefully said product, new product.

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Marcus Curley, UBS Investment Bank, Research Division - Executive Director and Head of New Zealand Research [60]

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I'll put that down as one. And then finally, just on Mexico, can you talk a little bit about where you think the percentage of manufacturing goes to the '19 and over the medium-term once the new factory is up and running?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [61]

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Yes. Look, I just want to refresh our strategy there. The strategy is we put our first line in process in New Zealand, then the growth goes in Mexico. And we do it that way because we think it's the most efficient use of our R&D and manufacturing resources. So what goes in Mexico, when, is kind of an output of that strategy. We don't drive the business by putting stuff in Mexico. So if you look at FY '17, '18, we've had quite a few new product introductions, first line, first processes in New Zealand. OSA masks are largely in Mexico and we've guided to lower growth there. So when we look at all that, we see Mexico -- Mexico FY '17 was about 34% of output, FY '18 was 34%. We think FY '19 as a proportion of output it doesn't really grow that much either. Then looking into FY 2020, we probably do see a pickup in Mexican output as a proportion of our growth as we get some of the faster growing products there kind of with that natural evolution.

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Marcus Curley, UBS Investment Bank, Research Division - Executive Director and Head of New Zealand Research [62]

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And long-term where do you see that settling?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [63]

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Well, it steadily climbs with that algorithm that I described, the first line, first process in New Zealand. I mean, most -- and that's a lot of products, that's maybe 20% of what we make, yes, in New Zealand. So I was staring at Andrew. Yes, so long-term you might be heading to, if we stick to that algorithm, towards 80% or something like that. Yes. And it's just like offshore rather than just Mexico.

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Marcus Driller, Fisher & Paykel Healthcare Corporation Limited - General Manager of Corporate [64]

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Thanks, Marcus. Next question comes from Steve Wheen at Evans & Partners.

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Steven David Wheen, Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst [65]

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I just had a question. I wondered if you could provide some color around Optiflow, in particular just around its usage outside of the ICU and what that experience was like in the half?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [66]

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Yes, that's a great question. Thanks. That's been something we've been working on for quite a few years, is spreading Optiflow outside of intensive care. And we're feeling pretty pleased with that over the last 12 months. We think globally maybe up to 20% of our Optiflow patients are being treated outside intensive care and that's a proportion that continues to grow. So we are very encouraged by that.

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Steven David Wheen, Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst [67]

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And that's across both adults and children?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [68]

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It would be similar across both, yes.

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Steven David Wheen, Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst [69]

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Secondly, is there any sort of geographic color you can provide just across your Hospital business as to certain geographies that may be doing better than others?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [70]

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Well, if we put aside New Zealand and Australia as -- well ahead of the curve, we see pretty similar, very similar penetration rates per capita between North America and Europe. Rest of the world lagging per capita, but there's other reasons for that. But in the 2 major geographies, we'd say very similar penetration rates.

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Steven David Wheen, Evans & Partners Pty. Ltd., Research Division - Senior Research Analyst [71]

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And just lastly from me just on SG&A -- and this I guess is consistent with your peers. There is that leverage that was obvious in the second half of the year, earnings leverage. Can you talk to any particular items within the SG&A bucket that's providing that? And I just noticed that going into FY '19, you're expecting that SG&A growth will come back into line with revenue unlike what happened in second half?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [72]

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Yes. Well, actually your explanation for the second half is largely in the litigation and costs being significantly lower in FY '18 and FY '17 in the second half. If you take litigation out of it completely, SG&A is in constant-currency terms running along at a similar rate to revenue growth for FY '18.

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Marcus Driller, Fisher & Paykel Healthcare Corporation Limited - General Manager of Corporate [73]

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Next question comes from Brian Bourdôt at New Zealand Super Fund.

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Brian Bourdôt, [74]

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A few questions, please. Just basically on the OpEx guidance for growth to be in line with underlying revenue growth for FY '19, can you just clarify if that's including or excluding legal? I assume it's including. Second question is on Slide 32 of the presentation, you have an ambition for operating margins of 30%, but you're not quite there. I'm just wondering if you can sort of outline how you hope you'll be able to close that gap. And I guess lastly, Optiflow has grown very strongly and making a great contribution on what you described as extraordinary interest. Just wondering if you have any sense or can provide any color of the proportion of sales that are being generated by customers who are I guess trying the product out versus customers who have changed the standard of care in their hospitals and are kind of recurring customers. That might be a bit tricky, but worth asking.

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Antony G. Barclay, Fisher & Paykel Healthcare Corporation Limited - Consultant [75]

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Okay, Brian, I'll start with the first one. You might need to remind me about the other 2. So I think the first question is that our guidance, we have built in our expected litigation costs, is I recall the first question. Second question was operating expenses -- you might have to remind me -- target 30% -- yes, so we're targeting 30%. If we look at our operating margin without the litigation costs, we're running around 29%. So that would be getting close. With litigation, I think it's 27%, 28%, something like that. So we think we've got a bit of room to go. And we're thinking of the primary contributor to that being more and more efficient sales force, so selling more and more per person. And we think that will be driven by better and better clinical evidence in Optiflow as it gets closer to mainstream practice, being a more efficient selling process.

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [76]

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So in the meantime carry on.

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Paul N. Shearer, Fisher & Paykel Healthcare Corporation Limited - SVP of Sales & Marketing [77]

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Yes. Yes, I just think it's just -- yes, I think you get efficiencies just as -- we've seen a lot of -- we're developing this kind of marketplace, Brian, and the literature supports what we're doing. As you get adoption of a therapy, it just starts to spread in the zone and you start getting a wider customer base with the same number of distribution and sales force.

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Antony G. Barclay, Fisher & Paykel Healthcare Corporation Limited - Consultant [78]

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That's certainly what we've seen over the last 5 or 6 years anyway. And there was a third question, proportion of customers trialing versus regular users or proportion of new users. I don't know if I can give that color.

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Paul N. Shearer, Fisher & Paykel Healthcare Corporation Limited - SVP of Sales & Marketing [79]

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Well, I think that -- I'm not sure this answer your question, but I think if you look around North America and Europe, we've got many, many users that have been utilizing Optiflow, AIRVO for certain patient types, groups in different parts of the hospital, that is starting to expand their usage -- so starting to use that in some cases of standard care and in other cases just using more of it, and other situations, they are using other parts of the hospital in more markets outside North America and Europe, which is getting a lot of -- a lot of hospitals, commissions are starting to use the product, get some experience with it. So it's a combination of those factors.

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Antony G. Barclay, Fisher & Paykel Healthcare Corporation Limited - Consultant [80]

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One of the difficulties with answering your question, Brian, is if you go country by country in terms of ICU penetration, how many ICU's are using it, it probably varies somewhere between 50% and 100%. So it's very dependent on the -- the answer to your question is very dependent on the region.

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Operator [81]

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(Operator Instructions)

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Marcus Driller, Fisher & Paykel Healthcare Corporation Limited - General Manager of Corporate [82]

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Okay. Next question comes from Marcus Curley at UBS.

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Marcus Curley, UBS Investment Bank, Research Division - Executive Director and Head of New Zealand Research [83]

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Just one follow-up. Can you just talk a little bit about the SleepStyle in terms of where it's at, in terms of its rollout and your expectations for that over the coming year?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [84]

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Sure. So the expectation -- the guidance we gave over the coming year was similar growth to second half of FY '18. In terms of rollout, in our FY '18 numbers you got New Zealand, Australia, Canada. As we sit here today, it's released in I think 22 countries of the world, something like that. And then of course for the major market, the U.S., there is a regulatory cycle that we're still going through.

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Marcus Curley, UBS Investment Bank, Research Division - Executive Director and Head of New Zealand Research [85]

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And so into the U.S. this financial year?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [86]

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I would expect this financial year, yes.

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Marcus Curley, UBS Investment Bank, Research Division - Executive Director and Head of New Zealand Research [87]

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I suppose what's the broader feedback and sort of expectations for the product?

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Paul N. Shearer, Fisher & Paykel Healthcare Corporation Limited - SVP of Sales & Marketing [88]

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Well, Paul here, Marcus. The feedback is very, very good. I mean, it's a brand new CPAP. It's got great features. It's got a great user interface, so it's very easy to use. It's got some very good informatics surrounding it. Again, they are getting -- people are feeling very good about the informatics side of the business. So it's a very good product. The feedback has been very good.

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Marcus Curley, UBS Investment Bank, Research Division - Executive Director and Head of New Zealand Research [89]

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And so do you think it becomes a bigger feature of the sales force effort in the next 12 months or is there still a preference to be focusing on masks over the SleepStyle?

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [90]

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Yes, exactly that. Look, it varies from market to market of course, but the reality is CPAP is important to us. It will get a lot of attention. But our focus really is, is making sure we're growing our mask business. And it's the focus of the sales force.

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Antony G. Barclay, Fisher & Paykel Healthcare Corporation Limited - Consultant [91]

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In the therapy, the opportunity.

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [92]

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In the therapy, the opportunity.

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Marcus Driller, Fisher & Paykel Healthcare Corporation Limited - General Manager of Corporate [93]

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That's the last question, Melinda. I don't think we've got anyone else in the queue. If there any follow-up questions, by all means please give me a call. I'm conscious as well that we've had a few people who have had issues with the webcast, so we'll get a replay of this call -- full call up on the website as soon as we are able. But I hand it back over to you, Lewis.

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Lewis G. Gradon, Fisher & Paykel Healthcare Corporation Limited - MD, CEO & Executive Director [94]

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Thanks, Marcus. Look, in summary, I'd like to acknowledge the hard work and dedication of our global team. It's over 4,000 people now. Our outlook is exciting and we look forward to another year of positive revenue and earnings growth. And also thank you to our shareholders for their continued support and thanks to all the other participants on the call for joining us today. We do appreciate your time and attention, so thank you.

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Operator [95]

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And that does conclude today's conference call. We thank you all for joining us.