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Welcome to the Fisher & Paykel Healthcare's Results Conference Call. My name is Cynthia, and I will be your operator for today's call. At this time, everyone except the guest speakers' will be in a listen-only mode. Later, we will conduct a question-and-answer session. We ask for your assistance in keeping the call to a maximum of one hour. [Operator Instructions] Please note this conference call is being recorded.
I would now like to turn the call over to Marcus Driller, VP Corporate. Please go ahead.
Thank you, Cynthia. Good morning, everyone, and welcome to Fisher & Paykel Healthcare's 2023 financial year results conference call.
On the call today are Lewis Gradon, our Managing Director and Chief Executive Officer; Lyndal York, Chief Financial Officer; Paul Shearer, Senior VP of Sales and Marketing; and Andrew Somervell, our VP of Products and Technology. Lewis and Lyndal will first provide an overview of the results, 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 2023. We have earlier today provided our 2023 annual report, including financial statements and commentary on our results to the NZX and ASX. These documents can be accessed on our website at fphcare.com/investor.
With that, I'd now like to turn the call over to Lewis.
Okay. And thanks, Marcus, and welcome, everyone. So today, I'm going to be referring to the investor presentation pack that we released to the NZX and the ASX this morning. We do have limited time and our roster of analysts is continuing to grow. So I'm very conscious of leaving plenty of time to get to all your questions. We are thinking that we will try to move through these initial slides a little faster than we normally do today.
And for this audience, we think it's a little more meaningful to focus on our second half performance. So let's start on Page 4, our second half results. And we are coming out of three years that were impacted by COVID-19. And we think this result is encouraging as we can see market conditions progressing towards more of a normal state over the last six months.
Operating revenue for the second half was $890.5 million, that's up 14% on the prior corresponding period or 12% in constant currency. Net profit after tax for the half was $154.4 million, which is flat compared to the prior corresponding period, and it's a 3% decline in constant currency.
So let's turn now to Page 6 for hospital. Hospital operating revenue was $584.8 million for the half, that's up 9% or 7% in constant currency. For the full-year, hospital hardware sales were down 53% in constant currency compared to the 2022 financial year. And that is a year that was much more heavily impacted by the global COVID-19 surges.
Hardware sales have still benefited from surges during FY2023 in some locations. But in those countries or regions that did not experience COVID-19 surges, hardware sales look to be tracking somewhat close to pre-pandemic patterns throughout the year.
New applications consumables revenue for the second half was up 14% on 2022. That's 13% in constant currency. And given that we are lapping a period significantly impacted by COVID-19, we think this is a very pleasing result, and we believe it indicates steady progress in increasing use of our therapies. Overall, in hospital therapies, we would say we are beginning to see periods of stable ordering patterns in the second half of the 2023 financial year and into the early months of this year FY2024.
But turn now to Page 8. Homecare operating revenue was $303.9 million. That's up 25% on the second half of 2022 or 22% in constant currency. I would say, mask revenue was particularly strong at 28% or 24% in constant currency. Now we launched our Evora Full mask in the U.S. in May 2022, and it's been a significant contributor to mask revenue. That is one of the most positive mask launches we have ever experienced, both in terms of customer feedback and sales performance to date.
Now I will pause there and hand over to our CFO, Lyndal York, for more details on the financials, and then I'll speak to guidance after that. Over to you, Lyndal.
Thanks, Lewis, and good morning, everyone. On Page 9, gross margin for the year was 59.4%, down 325 basis points from last year, or 369 basis points in constant currency. The cost of freight continues to be elevated and compared to pre-COVID-19 rates impacted our constant currency gross margin by approximately 230 basis points for the year. This is a similar impact as we saw last year.
We saw hospital customers destocking leading into the year, and in response, we reduced our production volume. This resulted in manufacturing inefficiencies due to under-recovery of overhead costs, which are largely fixed and labor costs. We have also started to see the impact in our margin of labor and materials inflationary cost increases.
As anticipated, we saw an improvement in our second half constant currency gross margin, which was up 179 basis points over the first half, driven by lower freight rates and price increases. We have shown over the decade prior to COVID that through our regular focus on efficiency, continuous improvement and cost out, we've been able to achieve an annual average of around 125 basis points improvement in our gross margin.
Over the last three years, our focus and effort has been on increasing production, sourcing materials and getting our product to customers to treat patients at all costs, if and when they needed it. Our usual operational focus on margin maintenance saw improvement was secondary. This is reflected in the decline in gross margin you can see over the last three years.
We've returned now to our usual practice of working on efficiency, cost out and margin improvement. However, we are also facing significant inflationary pressures on our input costs. We are confident we will return to our target of 65% as we've shown we can do. We are aiming for annual improvements of around about 150 basis points on average to return to our target.
For FY2024, we anticipate an improvement of approximately 200 basis points in constant currency from FY2023 with ongoing improvements from freight rates, price increases and manufacturing efficiencies more than offsetting inflationary increases in labor and materials. At May exchange rates, that would translate to about a 100 basis point improvement in our reported gross margin.
Moving on to Page 10. Total operating expenses grew 11% or 7% in constant currency. Operating margin was 21% as we continued our focused investment through the demand fluctuations over the last few years. R&D expenses grew 13% to $174 million as longer-term projects accelerate. R&D expenses were 11% of revenue for the year. We have estimated that approximately 60% of our R&D spend will be eligible for the 15% R&D tax credit this year and expect about the same level of eligibility for FY2024.
SG&A expenses increased 10% to $432 million or 4% in constant currency. We have set a target operating expense growth for FY2023 based on approximating an 11% compound annual growth rate from FY2019. While we exited FY2023 with pretty much the number of people we were targeting, it took us longer than hoped to bring them on board. This 9% increase in people during FY2023 will lead to a higher expense growth next year, reflecting the lower-than-target growth in FY2023.
We are anticipating operating expense growth of approximately 12% in FY2024 at May exchange rates. This is largely driven by the full-year cost of the people added during FY2023 with a small increase in people in FY2024.
Moving to Page 11. Operating cash flow this year was $238 million, reflecting the lower profit. Our working capital also increased in the year as receivables grew, reflecting the phasing of sales at the end of each year. Payables reduced reflecting timing of purchases from suppliers. Virtually all of our operating cash flow was generated in the second half of the year as we reduced inventory by $33 million in the second half. Capital expenditure, which includes purchases of intangible assets, was $211 million for the year. The increase of $42 million from last year is primarily due to land and buildings.
We completed our third building in Mexico and continue to progress our East Tamaki campus development, including earthworks for our fifth building. In September, we paid a deposit of $27.5 million for the acquisition of land for our second New Zealand campus. The second payment of $190 million was made on the 11th of May. Capital expenditure for FY2024 is expected to be approximately $450 million including the payment made this month for the land.
The balance sheet remains strong. Net cash at the 31st of March was $38 million, and our gearing ratio was minus 2.3%. During the year, we put in place net additional borrowing facilities of $450 million to have sufficient funding for our strategic acquisition of land and completion of our East Tamaki campus building works over the next few years.
With the $190 million paid this month for the land and the continued infrastructure investment, we expect to have higher debt and interest levels and have a gearing ratio over our target range of minus to plus 5% for the next three to four years. For FY2024, we are expecting net interest expense of approximately $16 million, up from $4 million this year.
Turning to Page 12. We've declared a fully imputed final dividend of $0.23 per share. This represents a 2% increase on the final dividend declared last year and continues our track record of increasing our dividends to shareholders. It will be paid on the 7th of July. This brings the full-year dividend to $0.405 per share, up 3% on last year. Our dividend reinvestment plan remains available for eligible shareholders with a 3% discount to the market price.
Looking now at foreign currency on Page 13. Foreign currency movements positively impacted our profit after tax by approximately $10 million compared to the last year primarily due to the New Zealand dollar being weaker on average through the period.
Now back over to you, Lewis.
Okay. Thanks, Lyndal. So now let's turn to guidance on Page 14. We have provided revenue guidance of approximately $1.7 billion for FY2024, and that's at May exchange rates. Almost all parts of our business have had a myriad of influencers during FY2023, and they've got quite disparate and distinct impacts on each half. So rather than trying to normalize those effects, revenue guidance for consumables is based on the recent ordering patterns during stable periods, and that's territory by territory. The assumptions incorporated in that guidance for our hospital business are a normal flu season, no hospitalization surges during the year and anesthesia is growing strongly off a fairly small base.
For hospital respiratory consumables, our assumption is that we continue to see the steady progression that we've seen through FY2023 of increasing usage. And that's been prescribing physician by prescribing physician, respiratory therapists by respiratory therapists, department by department and patient presentation by patient presentation, and they all overlay.
At the moment, our sales efforts are focused on consumables growth on the installed base of hospital hardware rather than on incremental hardware sales. And hospital hardware is difficult to forecast at the best of times with no clear or stable patterns being normal. And it's even more so at present. So we used a different approach for hospital hardware in our guidance compared to consumables, and as a result, we called it out, although we don't feel it's particularly material to the year's result compared to the rest of the business. And we specifically called out $115 million of hospital hardware is what's included in our revenue guidance total. And in the absence of those stable ordering pattern, this number is approximately in line with historical growth rates of pre-pandemic levels.
Now homecare is largely driven by OSA masks, and we are lapping a very strong FY2023, where we benefited from the very successful introduction of our Evora Full OSA mask in the North America and a reduction of the CPAP supply backlog and potentially some competitor issues.
As we move through FY2024, we see market conditions continuing to return to more of a historical norm. And then overall, these assumptions would result in approximately similar revenue growth rates for hospital and homecare product groups for FY2024 at May exchange rates.
Now Lyndal has already provided an outline of our expectations for gross margin and operating expenses. But just let me reiterate that during the pandemic, we had a responsibility to get as much product as possible into the hands of our customers. And now as demand progresses towards more of a normal state, we are shifting from a supplier-all-cost mentality to supplying in a sustainable profitable manner. And as we do so, we are confident in our ability to return to our long-term gross margin target of 65% within a three to four-year time frame.
And our FY2024 operating expense guidance is largely driven by the full-year cost of the people that we added during FY2023. So in my remarks there, I think we can now open the line to questions, Marcus.
Yes. Thanks, Lewis. Cynthia, if I could ask you to please open up the lines for questions. And before we begin, can I please ask everybody to limit your questions to two. This is to ensure that everybody has an opportunity to participate. If you do have further questions, you are welcome to rejoin the queue, and we can do our best to cover everything off within the hour.
Thank you. We will now begin the question-and-answer session. [Operator Instructions]
Thanks, Cynthia. The first question in the queue comes from Gretel Janu at Credit Suisse. Please go ahead, Gretel.
Thanks. Good morning, everyone. Just to start with the guidance. So you have OpEx growth faster than sales growth. I understand that's what to do with the sales force. But when do you expect to actually see a return on that investment you are making in the sales team? And when should we expect the revenue growth to exceed OpEx growth looking out past FY2024? Thanks.
Sure. Thanks, Gretel. I think we need to go back to our fundamental strategy in FY2023 – FY2022 as well actually, which was to make sure we have salespeople in place to support the hardware that our customers have acquired. That was step one. Step two, grow the anesthesia sales force. And then the next strategic target was to advance our R&D product pipeline. So that's what we've done through 2022 and 2023. I think going forward, if we need to – or I think probably the next comment is we're always going to have our eyes on that operating margin target of 30%. That's probably the fundamental driver. And if over time, we need to take operating leverage to get to that operating margin target, that's what we'll do. And that has been our history prior to FY2019.
Understood. So we should basically think of FY2024 then as kind of the new reset and then after FY2024, things should return back to that kind of normal margin improvement story. Is that correct?
Yes. In the sense of – historically, we've been able to make gross margin improvements year-on-year. We would expect to get back to that style of operating. And also, historically, if we need to take operating leverage to get to an operating margin of 30%, that's what we'll be doing.
Great. And then just secondly, just in terms of hospital consumables and the stocking, destocking issues that you had impacted in the last six to 12 months. Has that now been completely resolved? Or buying patterns vaccine kind of pre-COVID normal now?
So yes and no answer to that. We think that in the major markets, it probably has been resolved. Typically, when you have a COVID surge, there's a bit of an overhang of destocking, and it's really, really hard to estimate that because it overlaps so many other movements. But we think on the whole, there might be a little bit of residual destocking in FY2024. But at the moment, anyway, we are thinking probably not material.
Great. Thanks very much.
Thanks, Gretel. Next questions come from David Low at JPMorgan.
Thanks very much. Lewis, if you could just start with the utilization trends. I mean, I heard what you said there about doctor by doctor and department by department. But if you could perhaps shed a little bit more light on what you've seen, we're obviously pretty interested in new applications growth. Just wondering if you could sort of flesh out what you're seeing on the ground and what the trends could be over the next 12, 24 months?
Yes. Let me start with that, and then I might pass over to Paul for some color. But I think that is the summary. It is doctor by doctor, therapist by therapist, department by department, patient by patient. And I think that probably shouldn't come as a surprise to us. That's been the history of the business. We haven't really seen any sort of spontaneous change anywhere. It's really just that steady progression. And I think we're seeing it in all regions. I would say that probably all salespeople have seen evidence of that steady progression. We do see evidence when we're working with an account, we get a result. And then if you think what kind of result and what kind of evidence, there's a bit of everything, I would say, every scenario you can imagine is in there. Paul, do you want to add some color?
I can't read add much more, Lewis. But David, I just echoing everything Lewis has said, just been away for the last couple of weeks around the various sales teams. He is just hearing from everybody, they're making progress. We're making – we're getting Airvo's into departments, into emergency room, obviously in ICU, into the wards. We are getting patients put on some of those Airvo's. We're working with commission-to-commission. We're just making good steady progress.
I think maybe one final comment, David, is if you look at new apps second half constant currency, 13% growth. I mean that's lacking a global Omicron spend up. So we think that's a pretty good result. And we think that's evidence of that steady progress.
Okay. I mean we're very used to kind of measure it on a utilization number of consumable setups per annum per device. Is that a data point that you track? Can you give us any sense as to where you think things are now versus where they were pre-pandemic, please?
Yes, I'd really like to get you off that metric if I could. And I'll give you a couple of the complications. First of all, we've got a very flexible installed base, right? Most ventilators in intensive care for invasive use these days, they're going to deliver nasal high-flow non-invasive ventilation or invasive ventilation. Most non-invasive ventilators and there will be an intensive care, that will be in emergency departments, they'll be in respiratory awards, they're going to deliver nasal high-flow and they're going to deliver non-invasive ventilation. So when we go to a metric like that for our installed base, the installed base is quite flexible.
Then the second reason that makes that metric not so useful for us is that very different patterns of usage that you see throughout a hospital, right? In a ED, you might have three or four patients a day on a piece of hardware in a surgical unit, may be one in an ICU. Average patient stay might be three or four days. And when you get to a ward, a patient could be there for a week or longer. They've got really different patterns of usage. I think 10, 15, 20 years ago, the metric was fine for us. We were largely ICU. We are largely one therapy, and we're largely one set of hardware. So I think at that time, it made sense. Now, it just doesn't add up for us because of those different patents of usage.
And as I said before, we see kind of every variation on this thing. We can see hospitals pretty well penetrated – or better penetrated in wards and in EDs and vice versa and so on. And then thirdly, there's another phenomenon going on there, David. And that is – and we tried to illustrate this a little bit on one of the slides in the pack this time around, somewhere in the 30s, I think. But as a hospital gets more penetrated, as they get more hardware, apparent utilization can drop.
And this is kind of if we – if you had three or four Airvo's in your 50-bed ED, you're using them flat out all day, every day, and utilization looks really high. If you bump that up to 20 Airvo's, it looks like utilizations drop, but that's actually a great outcome. And if you go to the extreme example there, if we had a hospital with Airvo in every single bit, that would be the lowest utilization we would ever see, and it would be the greatest success we could ever have. So a long-winded answer to your question, David, but I just really want to explain that we're not being coy about it, it's just not a number that has any utility for us.
All right. My question were asked. Thanks very much. I would like to understand what metrics we could look at as an alternative, but we can perhaps touch on that another time. Thanks.
I think just will go there. Look, it's really about patients treated. That's the goal. That's what we're after, and that's the measure of progress, and that is reflected in consumables.
Thanks for your questions, David. Really appreciate that. Next questions come from Matt Montgomerie at Forsyth Barr. Please go ahead, Matt.
Hi there. Good morning. Maybe just a question on OpEx, Lyndal, you made the comment in your remarks just so you're expecting a small increase in people in FY2024 on the back of a 9% increase in 2023. That seems low to me. Are you, therefore, saying that you're currently comfortable with the headcount within the business to drive utilization of your installed base sort of doesn't really align with strategy in prior commentary?
Yes. Let me take that one, Matt. No. So the small increase in people is largely in the sales team. That's the main driver, and it's continuing to build out the anesthesia sales team, and it's continuing to support the hardware that we placed in our geographic expansion.
Okay. That's fine. And then maybe just further on David's question, before. Slide 37, I appreciate this improved color and disclosure. Can you maybe just talk to these numbers in terms of usage in locations in a pre-COVID world? I suppose it’s just another way of asking sort of the uptake trends that the other analysts have asked?
Yes, let me just get to Page 37. Yes. So look, we really are trying to illustrate that point of – you've got different usage, different apparent utilization or different turns rates depending on where you are in a hospital. And we have taken – this is actual data from a hospital, it's at the pretty good end of Optiflow adoption. So that's an excellent example. And I think if you start the point there is, if you look at where are Airvos on the right-hand pie chart, you've got three quarters of the installed base, is in wards. And in this case, that's generating about half of your consumables. It's probably underpenetrated.
We've got 11% of our hardware in intensive care that's generating about quarter of our consumable, intensive care in this case, and this would be quite common. It's pretty well penetrated with Airvos, that's generating quarter of our revenue. And then you look at the other 13% of the installed base that's in emergency departments, that's generating the other quarter of the consumables consumption in this case. And that's quite underpenetrated ED. So I think all we're trying to illustrate here is that 10, 15 years ago, this was largely an ICU. And if you look at a more advanced adapter case study, you can see a very clear trend to usage outside ICU. And you can see really there's a significant opportunity outside ICU that's being realized there. That's all we're trying to illustrate on that slide.
Okay. No, that's good. That's my two. Thank you.
Thanks, Matt. Next question comes from Craig Wong-Pan at RBC. Please go ahead, Craig.
Good morning. My question was just on the gross margin improvement, sort of expectation of getting back to that 65% over three to four years. Should we think about that as like a gradual improvement up to that level? Or is there going to be step changes as you get sort of volume increases and manufacturing efficiencies?
Yes, Craig, thanks. It's going to be a gradual change and it's not going to be linear. So it will be sort of that’s why we said, on average about $150 million basis point improvement per year. We're looking at a bit higher than that in constant currency for FY2024 as we will be able to get a stronger improvement in the efficient – in the manufacturing inefficiencies that we had in 2023 as we move into 2024. The exact timing of that and the quantum will be a bit dependent on the inflationary cost increases that we're seeing and mitigating in our usual practice of improvements.
When we're working on gross margin improvement, there's so many levers that are all being matched, there's so many moving parts there.
Okay. And then my second question, just on the hospital hardware sales that came from COVID. Are you able to give some color on how much that was in FY2023?
Yes. Look, the sum we do may be right or wrong. But to answer the question, we take FY2019 as a base year, and we've put 3% to 4% growth a year off that. And we'd call that normal. And there's not a lot of – there's no other rationale to that. So if you apply that to FY2023, you get around about $40 million coming out of due to COVID.
Thank you.
Thanks, Craig. Next questions come from Dan Hurren at MST Marquee.
Hi, good morning. Thanks very much. One for Lyndal. I just wanted to ask about that 12% OpEx growth. And some comments you made in the past that's getting harder or it's been hard to spend up for that spend than you might expect. Can you just talk about the operating environment and the risk that you might underspend that number in 2024?
Yes. We were talking about that mainly last year where we were aiming to add quite a lot of people through FY2023, and that's what we were really referencing and why in 2023, we were saying, look, we're targeting this sort of growth, but it is dependent on adding a lot of people. And as I mentioned, we have actually managed to add them through 2023. It just has taken us a bit longer to get them in place. They're actually largely in place now. So that's why we're seeing that growth into 2024, which is largely baked in now.
Got it. Okay. Thanks. And just a follow-up – a second question, just I think, follow-up with some other questions about COVID and the operating conditions. You mentioned China COVID and the U.S. flu season in the January update, and you're guiding to basically no COVID and a normal flu season FY2024. So I was just trying to get an idea of what that second half hospital level would have looked like under normal conditions? And perhaps if we look at your pre-January revenue guidance, is that a fair assumption of what it would have looked like if those two events hadn't occurred?
Yes, I think so. I'm still trying to process the question. So what are you asking?
Sorry, I always ask complex questions. So look, I'm just trying to figure out how much benefit there was from that strong flu season and the China COVID that you mentioned in January. And the way I'm thinking about it is that your pre-January guide – revenue guidance, is that kind of indicative of where you would have been had you not had that COVID surge in China and the strong U.S. flu season?
Yes. That's kind of – well, let me take that one by one maybe. So when we look back at FY2023, we've got a whole range of competing myriad of effects going on there. We've got destocking running through probably abating but maybe still in the second half. We've got some potential overstocking here and there in buckets running through the year. As you mentioned, you've got your seasonal flu impact, we've got seasonal RSV impact. And those are all happening at the same time as you've got some underlying growth in clinical usage. So – and they all overlap of it. We don't have a fundamental data point for any of those things. So what we have tried to do for you is try to have a look at exactly your question, how could you potentially normalize that? The only way we can really do that is look at the recent stable trends, have a look at our normal historical sales trends and overlay them. So when we do that, we get a net benefit to the second half of somewhere around about $35 million in FY2023.
But then on the flip side, we would have a penalty, if you like, to our first half of around about $45 million. So I think I just want to emphasize those are kind of rough analytical sums the topline, I'm talking about hospital consumables at the topline. And probably the number I'd be going with would be the net impact is about a benefit of about $10 million for the year. You would add about $10 million to the year that is a rough sum.
Okay. That's helpful. Thanks very much
Thanks, Dan. Next questions come from Tom Deacon at Macquarie.
Good morning guys. Thanks very much for taking the question. Maybe just the first one on GP margin recovery. Can you just give us a bit of color in terms of where you see that coming from compositionally in 2024 freight and manufacturing and efficiencies? And maybe a second part, what kind of hospital revenue performance do we need to see to see upside to the GP margin recovery guide in FY2024?
Yes. Thanks, Tom. So for those improvements in 2024, we're thinking that we probably get about 100 from freight, about 50 from price increases and about sort of 150-odd for manufacturing efficiencies. And then that sort of adds up to the 300 that we're facing cost increases of about 100 basis points coming in and offsetting that in there. Actual sales of hospital consumables next year, shouldn't materially impact that because we can sort of either build or deplete inventory depending on what revenue does. So it's slightly less dependent on revenue. But obviously, it could have an impact depending on how materially different that is.
Understood. That's helpful, Lyndal. Thank you very much. Maybe just going up to the top line for my second one, and you kind of alluded to a couple of points here, but just to get some clarity. What are you thinking in terms of respiratory hospitalizations and that profile in 2024? And how does that feed through into your hospital revenue guide? Are we expecting lower COVID, a little bit of a lower sort of more normal flu season this year? Can you just give us a bit more color there?
Yes. I just want to give you one insight. This guidance does come from country-by-country, territory-by-territory, region-by-region. We add it all up, and then we try and analyze it, what it might mean at the topline. So these are kind of implications of this guidance. And I think the implication is comparable flu season 2024 to 2023. That's one of your questions. COVID, I mean, we've got COVID bubbling along in 2023. It's probably going to bubble along in 2024. I think the implication is probably pretty similar in terms of hospitalization taking out the surges. Does that help?
That's helpful. What about sort of RSP, would you assume a similar RSV season given that we might see the imposition of some vaccines in the latter part of this year with the FDA approvals of – with the clients [indiscernible]
Yes. So when we go region-by-region, RSV was mostly material in North America. We haven't seen great data, but we haven't seen much evidence or data based evidence out of Europe. And then also, when we look at influenza or the flu season, again, you see probably a pretty normal-looking U.S. number. Europe looks a little bit light. So when we try and analyze it and we aggregate that all up, it all kind of comes out to about normal. So I think that's the assumption and guidance. It's normal, and it's – if you aggregate that all up, you're potentially lapping normal.
Okay, that's helpful. Well, thank you very much.
Thanks, Tom. Next question comes from Saul Hadassin at Barrenjoey Capital. Please go ahead, Saul.
Yes. Thanks, good morning. Just a couple of questions from me. Just in terms of the revenue guidance in fiscal 2024, Lewis, are you able to give a bit of more detail regarding your thoughts on traditional app sales growth versus the new app sales? Are you effectively thinking new app sales will drive all of that growth, just noting traditional consumables were a bit flat through FY2023?
So we typically think of traditional in the mid-single digits. We think it probably is impacted by COVID surges overstocking and destocking. But we think to a much, much smaller extent than new apps. So think there's an effect going on in there. But when we're doing our analysis, we kind of assume that effect is less material than the new apps effect. So we assume it kind of trucks along in that mid-single digits.
And does that translate to maybe a teens type growth for new app consumables?
Yes, exactly, yes. So mid-teens for new apps.
Great. Thanks. And then just one more, just on that commentary around recovery of the EBIT margins back up to that sort of 30% target. So is it right to assume that if you reach the gross margin target within the next three or four years, would that EBIT margin naturally inflate back to 30%? Or are you expecting OpEx growth to remain robust over the next few years, in which case you would have to assess those levers around OpEx to get that margin back up to that 30% level?
Look, we assess it on a year-by-year basis. We would certainly be expecting to sort of start taking some operating leverage, not in 2024 as we're seeing because we've got the people from 2023 that we've added that has that impact into 2024. But look, we'd probably expect the operating margin to follow once we hit the gross margin by a year or two maybe. We sort of assess that every year sort of based on what we're seeing in the business, what we need to do from an operating perspective, really for the long-term. We don't focus as much on an annual margin.
Well, I think it's – our assumption and our history is that we will be able to generate efficiencies in OpEx, and you've seen us do that for decades. And then the question is, do we want to take them as operating leverage and get to the – get to the operating margin target? Or do we want to invest them in the business.
Great. Thanks guys.
Thanks, Saul. Next question comes from Stephen Ridgewell at Craigs Investment Partners.
Good morning guys. Just firstly on Airvo 3. As far as we can see – we got FDA clearance for the U.S. Does the FY2024 guidance for $115 million of hospital device revenue assume FDA approval for Airvo 3 comes through? And any material revenue, therefore, from the U.S. or other key of the markets, please?
The short answer to that is no. We're not assuming anything material in FY2024 from Airvo 3 in the U.S. That will probably be much later in the year. And we're not expecting it to be material.
Okay. Thank you. And just on anesthesia, and Lewis you mentioned the revenue guidance assumes the strong revenue growth off a low base. In the past, the companies kind of talked to surgical anesthesia washing its face in terms of profitability. But just interested, given the new sales hires in that space, is that segment expected to lose money in FY2024. And could you give us a rough quantum? It would just be useful to get a sense of the scale of investment perhaps in that segment, which is perhaps weighing down the overall guidance.
It will at least be washing its face, Stephen. No concerns there. That's kind of the algorithm we use to ensure it does when we add people, once we generate enough revenue to support the person we do. So – that's that part – that's probably the best advice I give.
But then – okay, so that's good to hear. And then would you – I guess, as you plan that’s washing its face this year that you might start to see any contribution kind of into next year and beyond? And what's your thinking in terms of the medium term for anesthesia, please?
Well, washing its face means all the way through, Stephen, we focus on the profitability country-by-country, region-by-region. So washing it's face means it's making the right contribution that we expect it to make. So maybe just to clarify that one for you. And then I think probably where you're going is at present, you're looking at maybe a bit over 5% of new apps growing really strongly. That's probably the sum.
Okay. That's helpful. Thanks, Lewis. And if I can just sneak one more on China. Can you just talk a little bit to the revenue benefit to China that was a major driver of upgrade in January? Did that market perform kind of in line with your expectations that you had in January for the balance of the year? And can you perhaps talk a little bit to whether you're seeing – business for the devices that were placed at this point? Or like other markets, do you think you're going to get your sales reps on there to really improve utilization of those installed devices?
Let me start with China. So look, we kind of netted China out in the second half number I gave you of $35-odd million benefit. You've got – it's in there because we can't really call it out. When you get to China, you've got all the same old things going on that we have in every other market. You've got impacts of COVID surges. You've got overstocking, you've got destocking it. But you've got all the same phenomenon. In China, we've got another phenomena going on or two more, really, three more, really, and that is – we do have about a dozen competitors in China. And they are building hospitals at an astonishing rate. They have been over the last few years. They are continuing to build hospitals an astonishing rate. So that makes it even harder to do the analysis. And then when you put that together with a dozen competitors in an intense national interest in local capacity, probably the best I can give you is that we've wrapped it up into that $35 million second half benefit.
That’s helpful. Thank you
Thanks, Stephen. Next question come from Marcus Curley at UBS. Please go ahead, Marcus.
Good morning. Lewis, I just wondered if we could start on the hospital business. It sounds like the guidance implies around 10% consumable revenue growth. Is it right to assume that business as normal in terms of how you're thinking about it at the moment? And if that's the case, to sort of get that division back up to, let's say, the traditional target of 13%, we'd need to see new products added or anesthesia start to be a much bigger part of the business?
Well, depending on your time frame, right, as your time frame stretches out, you're expecting anesthesia to be a bigger and bigger part of the business. If your time frame is the next couple of years, I would say no, no, you're not really relying on new products or anything like that. We are relying on the steady progression of increasing use across more patients, more departments, more hospitals.
And so the anticipation is that the 10% you're seeing this year, you could look to accelerate over the course of the next few years? Yes, through high flow in the hospital.
Well, I guess that's always possible, Marcus. I think – I'm not sure where you're getting your 10% from, but just take that off the table. I think probably the fundamental here is the guidance we've given you is a reflection of the recent stable trends. And that's what it is. And then to go further than that, I would be speculating.
Okay. And then the 10% is just – if you talked about, it's about 8% revenue growth in the guidance, you've called out the device number. So yes, the difference is the consumables number, which is obviously a little higher than eight?
Anyway, let's move on. So second question, just on Homecare, you obviously talked to a lower growth number this year. It's been a while since you've had a new mask. Obviously, the last mask was very successful. What's sort of the pipeline like? I sort of – do you think you're overdue something in that space? Or how are you thinking about product launches there?
Yes. We are doing a couple of product launches in the very near future there, Marcus. That's about all I'm going to give away on that.
But I suppose on a basis that's unlikely to be material this year?
Correct. Yes, that's right.
Thank you.
Thanks, Marcus. Next questions come from Sean Laaman at Morgan Stanley.
Good morning everyone. Hope all is well. You mentioned the gross margin upside, past year due to price on the outlook. I was wondering if you could characterize the pricing environment for us and particularly as it references OSA mask. So we're thinking low single digits, mid-single digits here, just a bit more characterization on your thoughts on price, it would be great?
Well, we're all looking at one another on that one. I'll take one thing I'd point out is for the hospital business, most of our customers will be on some kind of supply contract. They might typically be three years. They might be four, two would be a short one. So you've kind of got on average, maybe a bit over a three-year cycle as you roll through the hospital pricing. Homecare or mask pricing, Paul, do you want to...
Yes. Well, that's always I mean, it's relatively stable. We think of pricing in Homecare because new product introductions that may be at a different price point to some of the masks that you've been traditionally selling. And so we kind of think of average selling prices for our mask is relatively stable in the Homecare care environment.
Great. Thank you. And second question, just on labor inflation. So you talked about adding new heads. But what about the unit increase on unit labor inflation, if that makes sense?
Yes, Sean. Look, we're seeing that across the business and that's sort of what's been incorporated in here as well. And that's part of also why in the OpEx, whilst we've added 9% people during FY2023, there's the cost of them plus the inflationary rate of salaries and wages built into that as well as we see it in the COGS line too.
Great. Thanks so much for answering my questions.
Thank you, Sean. Next questions come from Adrian Allbon at Jarden.
Good morning, team. My first question is like on Optiflow. If I go to your Slide 35, I think you're calling out that you've treated like roughly six million patients on Optiflow. If I sort of go back to FY2020, I think the same callout was around about 4%. And then the sort of the bridge in between, I think from memory, you kind of said – you might have treated up to sort of 3 million with Optiflow on for COVID applications. So is the way to think about the 6 million that you've sort of replaced almost two-thirds of that COVID peak with underlying growth over that period?
I think not really. I mean there is something I will point out here is the patient numbers are based off our volume. So you've got the overstocking, destocking phenomenon going on there. But I think on the whole, we probably treat – I haven't got it in front of me, mate, just let me find the slide.
Adrian, this is Marcus here. I don't think we called out that we knew the number of patients that were treated with Optiflow during COVID. I mean you mentioned a number there of three. I don't think we even would have had a guess at that. So that was a – that's a very difficult number for us to try and ascertain.
Okay.
Do you have a follow-up, Adrian?
Sorry, I was just waiting to see if Lewis was coming back on that. I guess my follow-up then.
I found the slide. Sorry, go ahead.
Sorry, did you have any follow-up on that? Like are you able to give us some sort of I guess what you've done earlier in the call, which I understand as you tried to orientate us away from utilization into patients treated. I guess you've given a patient's treated number here, and we had a patient treated number like pretty much on the eve of COVID, like the delta feels like 2 million was 2 million in circa across three years. There's been COVID in between. I'm just trying to get a sense of what the underlying replacement of COVID patients rate is. As you've had guidelines and push that versus the therapy and stuff like that, and you've placed hardware?
Right. The best place I could probably point you out there would be second half FY2023 versus FY2019. Look at something like that, which I haven't done.
In terms of patients treated?
Yes. Using consumables as a proxy.
And Adrian, we can't know how – what patients were treated because they had COVID versus anything else. So that how many of the patients treated in the last couple of years were COVID versus anything else. We really can't tell that.
Okay. I understand. Can I just ask a follow-on question then like – you obviously made strong guideline progress for high flow? And I think you've got a slide in here that sort of demonstrates its, yes, there's still room to move in respiratory and general in terms of a hospital setting. And I understand you're strong in hypoxic strong and post situation. But how much of the R&D spend is sort of focused on you like clinical trials, I suppose, and specific applications to sort of broaden out the underlying patient demand. Can you give us a sense of that? And then maybe a question slightly before that, like what's the sales force sort of doing now with this guideline support?
Sure. Let me take the R&D spin one. So as far as respiratory Optiflow goes, you've got hundreds of papers a year. We're not really part of that. It's got a life of its own. It's the research community, exploring the questions. Our R&D clinical spend seems to be much further out into the future, and we tend to be doing the early work, if you like, in our clinical studies that we're funding. We tend to be the venture capitalists of the clinical study world.
And then the second question was about guidelines or things. So Adrian, obviously, we're using the guidelines to advantage and talking to our customers about them. And what we're trying to do from the guideline is to try and get commissions to put protocols into place. So that they are adopting those guidelines. And then the real key thing from there just because you've got protocols in place is making sure that those protocols are actually being used and it's what we call adoption. So there's quite a process we go through from guidelines of protocols to adoption of those protocols. Just one step on the steady progress.
Yes. But just, Paul, are you seeing the efficiency of your sales force effort now start to build like – because obviously, that processes was going on before, but you didn't have the guideline necessarily recognition?
Absolutely. And I mean we're always fundamentally trying to be efficient and improve our efficiency. And the guidelines are very helpful because there are guidelines, and it's something that commissions take notice of. So yes, it does help us, and it will help us become more efficient.
Thanks, Adrian. Conscious, we're at the one hour mark. We've still got two more people in the queue, so we will take those. So next questions come from Mathieu Chevrier at Citi. Please, go ahead, Mathieu.
Yes. Good morning. Thanks for taking my question. My first one is on hospitals. What are you seeing in terms of access to hospitals and hospitals budget for hardware?
Yes. I'll take that question, Paul, here. Access to hospitals are improving all the time. Obviously, it's been difficult during the COVID period, but we're getting more access from hospitals as we go. One of the problems we are facing is just clinician burnout. Sometimes a lot of the clinicians have just wanting to take a bit of a breather. But all in all, we're getting better access to hospitals and commissions. And then it's very spotty in terms of hardware budgets in areas where there's been a lot of hardware bought for COVID, probably there's not a lot of thought or budget available for hardware. And other areas where there weren’t COVID surges, it's pretty much business as usual.
Thank you. And then just in terms of the OSA business, and maybe one for Lewis, do you think that not selling a device, an OSA device in the U.S. puts you at a disadvantage longer term as Philips will eventually return to the market and they may be more aggressive to try to regain share not only in devices, but our mask as well?
Yes. No, we don't. But there is a key component as long as we've got a mask that performs better than anything else the patient can get or a dealer can get or a sleep lab can get we think we're going to do pretty well. And that is what we have been doing for over 10 years now. So I think the model is proven.
Thanks for your questions Mathieu. Really appreciate it. Last, lucky last from the queue, Chris Cooper from Goldman Sachs. Thanks for waiting Chris. Please go ahead.
Thanks, Marcus. Good morning. So Lewis, I heard your comments around the challenges of assessing the productivity of the installed base. Perhaps, I can just ask it slightly differently. How are you incentivizing the new sales staff you've employed in the year? What would you consider to be a good quarter or a good year for one of the new reps? And how are you measuring that?
Yes, we do it a bit differently country-by-country, but the general principle, I mean, as you pointed out, because it is so hard to measure. And because we are long-term, we can be working with an account for four or five years. Some of the success rates we've had since COVID been accounts that we've been working with since before COVID. So it is a long-term plan, and it's a long-term process. So incentives where we have them specifically tend to be around, projects, project based, what we agree, what a salesperson agrees, what their manager agrees with the sales manager is, is their objectives for the year.
Chris, we're very project based and obviously that, the ultimate result of sales, but I mean, we are tracking what each salesperson by, by project, what we're trying to achieve, and the progress we're making throughout that, that project.
Okay. And just secondly, on the EBIT margin, I mean it maybe somewhat related, but I just want to get a sense of how important that 30% target is to you. It sounds very much like you're running the business primarily for a gross margin target. But you've mentioned a couple of times on this call, you sort of can squeeze additional operating leverage when you choose. I guess the question is, when would you consider that necessary to do and what levers are you referring to when you talk to operating leverage in that way?
Yes. So look, I think it goes back to a philosophy of sustainable profitable growth over the long-term. And to be sustainable, profitable over a very long-term, you grow OpEx at the same rate you grow revenue. So that's the first concept. The second concept is, we chose these targets of 65% gross margin, 30% operating margin has been great performance over a very long-term. Companies certainly do better than that from time-to-time, but if you can sustain it and maintain it, you're doing a great job.
So prior to COVID, we had our eyes on those two margin targets and steadily worked our way towards them because they kind of go hand in hand, gross margin, operating margin. We steadily worked our way towards them. And we move towards them, as I said, kind of by taking efficiencies that we generate in our sales operation and our manufacturing operation, we can either use that as leverage to get towards target or we can decide to keep it in the business. And that's an ongoing process making that trade-off. It's something we look at frequently, but always we are working towards those margin targets. And always we are expecting to gain efficiencies in what we do. It's more about where we put it.
Very good. Thanks for your questions, Chris. That brings us to the end of the Q&A. Before I pass over to Lewis for the final word, just a reminder that we have our Investor event planned for the 14th and 15th of September in Tijuana, Mexico and Irvine, California. I know a number of you have registered already. We are looking to see many of you there, and it's a great opportunity to reconnect and see our operations in Mexico and to hear from some of our customers and our U.S. team. And you can register for the event on the Investor page of our website.
So with that, over to you, Lewis, just to conclude the call.
Okay. Thanks, Marcus. Thanks, everyone, very much for the questions. Now before we close, I would like to just zoom out a little bit and recap the last year and the opportunities in front of us. So when we look at it, our hospital salespeople are describing a steady progression of increasing usage of our therapies. Hospitalization rates are beginning to stabilize in most regions. We launched a very successful OSA mask in Evora Full. Gross margin is beginning to revert to our historical pattern of steady improvement. We've invested in R&D and salespeople to fully realize our opportunities, and that's over both the short-term and the medium-term. And for the long-term, our response to COVID has advanced our infrastructure investments.
Looking at – going forward, we've got a unique pattern of alignment for our business. We continue to have underpenetrated markets. We've expanded our sales teams. We've expanded our geographical reach. We've got a growing body of clinical evidence for our newer therapies, and we've got a very promising pipeline of new products and our infrastructure developments are well underway. And we think all these factors line up in our favor and they all leave us with confidence in the long-term. So thank you very much to everybody for your time today. Thank you.
This concludes today's call. Thank you for your participation, and you may now disconnect.