Thank you for standing by and welcome to the Cochlear Limited HY22 Results Analyst and Media Briefing. All participants are in a Listen-Only Mode. There will be a presentation followed by a Question-And-Answer session. If you wish to ask a question, you will need to press the star key followed by the number one on your telephone keypad. I would now like to hand the conference over to Mr. Dig Howitt, CEO and President. Please go ahead.
Good morning, everyone, and thanks for joining, and welcome to our results presentation. I'm gonna give an overview of our results and progress through the last 1/2, then hand over to Stuart to talk through the P&L and balance sheet, then back to me for the outlook, and then on to questions. Let's get going, starting with our mission.
Our mission is important in terms of always guiding the business and our people right around the world in what it is that we're seeking to do and how it is that we help our customers hear and improve their lives. On to the result. This last 1/2 was a really strong result from a revenue perspective, especially considering that the 1/2 started with the Delta variant of COVID and finished with the Omicron variant.
We dealt with varying degrees of operating theater capacity constraints through hospital staff shortages right around the world through that 1/2. Very pleased to see that sales growth given those constraints. Also very good from a profit perspective, and that profit increase was driven by the strong sales growth that we saw.
Our gross margin improved from last year back to where we expect it to be over time, around 75%. There was some benefit from lower operating expenses, and simply we spent less than we set out to do, largely because of some of the COVID restrictions that were in place around the world. Despite those restrictions, we were able to continue to invest significantly in our market growth activities and in our R&D to support our Long-Term product pipeline.
We finished the 1/2 in a strong financial position, continue to be a very strong cash balance, 35% lift in the dividend, and our net profit guidance with that range of AUD 265-AUD 285 that now includes the cloud computing costs. We'll talk more about that at the end. Certainly overall, a very strong 1/2 to sales, profit and strong financial position.
Now, to go into a little bit more depth in each of the areas. In the Cochlear implants, we saw 7% unit growth, and you can see that that's split between developed markets, which were down slightly, and emerging markets, which were up strongly. If we look at developed markets first, importantly, developed market units are tracking ahead of Pre-COVID levels, which is very important.
We did see that decline, and it was largely the U.S. that pulled down the decline really for the last 1/2. That's remembering that the last 1/2 in the U.S. was a very strong comparable, in part driven by Catch-Up surgeries from the April-May hospital shutdown in the U.S. and also no restrictions on hospital operating theater capacity, which we've clearly seen in the U.S. through the last 1/2 and particularly at the end of the 1/2.
We continue to have a very strong market share position both in the U.S. and around the world, and that's on the back of our customer service and the strength of our product portfolio. In Western Europe, pleasingly, we've seen a good recovery.
If you remember back to the full year, we said Western Europe was recovering, but it was still overall below Pre-COVID levels. It's now above Pre-COVID levels. Still there continues to be variability by country. The U.K., for example, while recovering, is still not back to the strength that it was Pre-COVID. Looking at its trajectory, we're confident that recovery will continue. In emerging markets, we've seen a good recovery there and our stronger markets like China continue to grow.
We've seen in markets like India and Brazil that were very affected by COVID, a good recovery, although still below the Pre-COVID levels. Certainly pleasing to see the recovery coming through in the emerging markets. If we look at services, actually very strong result.
There's a couple of important points that sit behind the strong services result. The first of those is that the growing installed base is the biggest driver of our opportunity to grow services. With services we've talked before that it's the demand doesn't go away. It's people want an upgrade, they'll get an upgrade. They may be delayed, and we saw through COVID there were some delays through clinic capacity being reduced.
What this result shows is that the clinics are opened back up. People are getting into clinics. They're able therefore to get upgrades, and that's driven that strong performance. It's also in part showing the constraints on operating theater capacity, that clinics do have a choice on how they spend their time, and if there are fewer surgeries, then they spend more time on upgrades.
There's a shock absorbing the upgrades in a sense on the CI unit numbers, and we've seen that happen in that 1/2. Certainly a pleasing result for services. It shows the strength of Kanso 2 and the attractiveness of Kanso 2. Remembering we're nearly 5 years since the launch of Nucleus 7.
To have that strong a service result nearly 5 years on from a launch of a BTE certainly also is pleasing and encouraging for the Long-Run opportunity we have in services, access to that recipient base and being able to continue to grow in this area. On to acoustics. Acoustics also a very strong result.
We've been saying for a while that we thought with the product portfolio we were developing with acoustics, there was real opportunity to grow. There's very clearly a market opportunity for growth in acoustics in competition with hearing aids and reconstructive surgery. We started to see some of this come through with AUD 100 million in sales and 40% uplift in constant currency in acoustics, albeit off a COVID-Affected base, but it's still a record 1/2 for us.
With Osia, we continue to see a very good and strong response and uptake in the U.S. We have started to roll out through Western Europe following CE mark there and seeing some good early-stage growth in some Western European countries.
Knowing that Osia, and we said this over time too, that Osia is a new product, it's a new category, we need to do the work to get reimbursements, and acceptance at an appropriate level country by country to make sure that we get the price that reflects the value in the product. We continue to do that work, and therefore, it will take us a few years to roll Osia out, to the extent that, or the opportunity and the revenue that we gain. It's certainly very pleasing to see this. Obviously, Baha 6 Max are very well accepted.
Remembering in our acoustics numbers, it contains upgrades, so the strength here again shows the strength of Baha 6 Max processor, but also shows the same point that I made on services, is the clinics are open, people are coming into clinics, and they are, in this case, getting upgrades of Baha products, and that gives us good confidence as surgery operating theater capacity opens up.
People are coming through clinics, and we'll see that lift in CI over time and acoustic surgeries over time, as well. Okay, moving on from the revenue lines to our strategy and a quick update on our strategic priorities. In terms of retaining market leadership, our share has remained very strong through the last 1/2.
We said when COVID hit that this was a real opportunity for us to consolidate and strengthen our competitive position to enable us to continue investing growth in the long run. Two years on, we do have a very strong competitive position with 9 new products approved by the FDA over the 2-year COVID impact.
That shows the benefit of continuing our R&D investment and the strength of our R&D and regulatory teams around the world. The opportunity to accelerate Connected Care, like Osia, is something that is new to market, will take time to roll out, to get reimbursement in places, to get adoption. We continue to push that forward.
The addition of Cochlear Remote Assist with FDA approval is an important addition that allows live video interaction and adjustments to a person's system through the app, that live interaction is important for reimbursement of procedures like this in some markets. Continuing to work on remote care over time. I talked about Osia and the opportunity there.
You can see across the bottom here the range of products that we have had approved over the last 2 years really strengthen our competitive position. We also know that our market leadership depends very importantly on World-Class customer service. That customer service is driven by a combination of things. It's both our product technology and impact on customers, and Kanso 2 or Nucleus 7 for CI22M is an example of that.
That particularly showing the lifetime support for our implant recipients with Nucleus 7 for CI22M. It's also about building our Cochlear Family. A 20% increase there. Again, we have 240,000 Cochlear Family members around the world.
The strength of our field teams, our customer service, clinical, sales around the world, and their connection direct to recipients, but also their connection to hospitals and hearing care professionals, a very important part of our share. We've switched most of that connection virtually, and we've been able to do that very effectively and that helps strengthen our leadership position.
With CoPilot and SmartNav Custom Sound Pro continuing the portfolio of services for recipients, for audiologists, and for surgeons, again, to make us easy to work with, strengthen our competitive position, and improve their experience, as providers of implant services or as receivers of cochlear implant or acoustic implants. Onto growth.
Obviously, retaining market leadership is now important because it enables us to have the financial capacity to invest in growth, and investing in growth and really competing for attention of people with severe to profound hearing loss who are otherwise getting hearing aids or who are frustrated with their hearing loss and stopping to seek any solution is a very, very important part of our growth.
We have been able to continue to expand in our Direct-To-Consumer marketing activities, and the pipeline of recipient candidates we have is strong, awaiting expansion of that operating theater capacity. We continue to work on referral activities in an increasing number of developed countries to build this consistent and clear clinical path from hearing aids through to cochlear implant.
That all plays into building out cochlear implants as a standard of care for adults with severe to profound hearing loss. The work the World Health Organization has been doing over several years, and most recently the Hearing Screening: Considerations for Implementation, which recommends hearing screening for adults as an important part of addressing the extent of hearing loss and the underserved nature of hearing loss right across the world.
Clearly continue to work on guidelines with professionals, with recipient groups around the world, with health authorities, is a very important part of building out standard care. Our market access work to expand indications, to expand funding is important. A good example of that in the last 1/2 is the FDA approval of single-sided deafness for people more than 5 years of age. That's a significant expansion in the potential market in the U.S., so an important step forward in continuing to expand access and give people the best hearing care that they can. Okay. Now moving on to just our...
third of our strategic priorities of consistent revenue and earnings growth, and remembering that this in the context of we are aiming to achieve Long-Run growth and consistent revenue and earnings performance over the very long run. We did continue to invest to grow in the 1/2, and it was a strong. We do have a very strong financial performance, and we continue to work from an operational perspective on improving the business, the opportunity to gain leverage and to get that leverage and invest it in growth.
We have advanced and Stuart will talk more on this in our major process and systems transformation, the cloud computing work, which obviously now comes through the P&L rather than through CapEx, so it does have an impact on our profit margin, and Stuart will talk more to that. Karen, with that, I think we've got a strong 1/2. I'm gonna hand over to Stuart to talk a bit more through the P&L and the balance sheet and cash flow.
Fantastic. Thanks, Dig. You've heard a lot about the sales revenue already. If we jump to gross margin, you'll see that we've moved up back into that target range of 75%, which is where we'd like to be longer term at the gross margin line. That change, not so much a function of mix with the gross margin we get across all the different lines is roughly the same. It's really a function of 3 things. One, bigger volumes, so we're spreading the overheads across a larger number of units.
There was a significant FX move that was washing through our inventory at this point 12 months ago, and then a couple of big One-Off negatives that we're hitting a year ago, in particular, having to run the manufacturing site at a much lower rate for at least a 1/4 a year ago, and also some significant stock write-offs we took a year ago as well. Not seeing those reoccur has seen that margin improve back to where we would like to see it. If we jump down to the operating expenses at AUD 400.5 in the first 1/2. Just a bit of context on that. The 353 prior year, that really was very COVID-depressed spending levels.
Almost no travel at all globally, and a bunch of other cost actions we took at the time to really slow down the cost there. Coming off a very low base. If we look at H2 2021 OpEx, that was AUD 400 as well. We're basically flat half-on-half, leaving 2021 and coming into 2022. Within that, I guess the significant moves to call out, that admin expense line growing at about 20%, there's really 2 things behind that, ongoing insurance premium increases, and that's also where the IT expenses that are not cloud-related come in. A lot of the growth activity that we are investing in is either enabled by or in part involves IT change, and that's where that's showing up.
The cloud line, you'll hear quite a bit about it through the results today. We're AUD 5 million for the first 1/2. As you remember, this is a function of that accounting standard interpretation change. We flagged at the Full-Year results, we expect the Full-Year impact of this to be in or around AUD 20 million, and we're on glide path for that.
We're at the beginning of the shift to cloud, and that number is gonna ramp up in 1/2 2. We really think this is, you know, a 4- to 5-year journey, where we think the total bill will be in that range of AUD 100 million-AUD 150 million. Jumping down to net profit. 19% for the 1/2. That's slightly ahead of where we would like to be longer term.
We aim for that 18% mark pre the cloud computing adjustment. The combination of revenue running hotter than we expected in the first 1/2 and cost running slower than we expected has enabled that 19%. We will be looking to land a Full-Year number. Again, we're in that range of 18% Pre-cloud, and cloud's going to be about 1%-ish impact on that going forward.
If we jump onto capital employed on the next page, top 3 lines are where all the changes are here. The receivables, they're up AUD 22.7 million. That's entirely in line with trading. We've sold more stuff, receivables have gone up, so that's a pleasing result. Inventory is up AUD 21.9 million. Again, deliberate decisions to invest in 2 things.
One, holding more finished goods stock in the supply chain so that we're better prepared in case there's any sort of logistics issues or last mile issues, and also investing in raw materials and particularly components, to make sure that there's no risk that we run out of supply of anything and we keep our recipients on the air.
That's deliberate investment and particularly things like electrical components, where if we've needed to, we've actually done a lifetime buy, so literally buying all of the products we think we're ever going to need of a certain component to make sure that supply is secure. And then lastly, the trade payables, AUD 33 million shift. It's really AUD 169.8 million is where we'd expect it to be given our trading.
The AUD 202.9 last year was somewhat inflated, sorry, last 1/2 was somewhat inflated. We had done a couple of significant lifetime buys in June that we ended up paying for in July, so that's the reason for the change there. If you go onto cash flow, obviously with the strong revenue, the nice rebound in gross margin, and slower OpEx, that's delivered a very strong number at the EBIT line.
Income tax pretty much exactly where we'd expect it to be. CapEx AUD 38.1 million. Again, we're on glide path there. We think we're likely to end in and around AUD 70 million for the full year, and so happy with where that is at this point in the year. We've invested AUD 42.3 million in the innovation fund investments. That's really 2 significant ones there.
An additional injection into Nyxoah as part of their capital raise, and then a new investment in Precisis. Onto net cash. Not a lot of news here. We're still obviously sitting on a very strong balance sheet position. It's worth remembering we did the capital raise 18 months ago or so now to really remove any risk that COVID could impact the business materially on the longer term. We wanna make sure we're here for 100 years' time for the child who's being implanted today.
We're comfortable still with that level of cash holdings right now, given that the COVID risk is not behind us yet. Lastly, onto the dividend. We aim for full year dividend payout ratio of 70% of NPAT. We will target that for this year again.
We normally are more 50/50 in our NPAT split 1/2 one to 1/2 2. Because we're gonna be more weighted to 1/2 one for the reasons we've talked about, we have decided to moderate the payout ratio for the first 1/2 slightly. We're gonna be paying at 65% for 1/2 one, which delivers a dividend of AUD 1.55. We will be aiming to pay out for the full year at 70%. With that, I'll hand you back to Viv to talk through the outlook.
Thanks, Stuart. Okay, finish up with the outlook before we go to questions. Our guidance range is still AUD 265-AUD 285. However, that does now include the cloud computing costs, so that's effectively a 5% lift in our guidance range, and that reflects the strength of performance in the first 1/2. Our temporary assumption's underlying that.
We expect to see in the second 1/2, given the operating theater constraints, that the growth is weighted towards services and acoustics. We do see continuing impacts on our cochlear implant revenue from either region-specific or country-specific COVID-related shutdowns or restrictions and the hospital staffing shortages. However, what we do see a strong pipeline of candidates.
When we see a pipeline of candidates, we see surgeons that are keen to operate as they get access. Now, we remain very confident of the medium and Long-Term outlook here. Just gotta work through, as do many other companies, work through this hospital staff shortage and capacity issue that we have at the moment.
From an OpEx perspective, as Stuart said, we're gonna continue to invest in our growth activities. As we've said that, you know, OpEx will be weighted towards the second 1/2, and the guidance does now include AUD 18 million-AUD 20 million in cloud expenses. That's obviously AUD 5 million in the first 1/2 and then AUD 13 million-AUD 15 million in the second 1/2, coming through.
Our net margin will stay just below our 18% this year and next year, and that's largely due to the cloud computing impact. Certainly our Long-Run target of 18% remains, and we'll get back to there. While there is the prospect of a more material disruption from COVID, obviously the longer we go on, I think the likelihood of that reduces.
It's certainly still a factor outside of COVID, outside of this guidance. That said, we certainly remain confident with good pipeline of recipient surgeons keen to operate and restrictions on operating theater capacity. Medium term, very confident of what we see in terms of potential for demand. With that, we will move on to questions.
Thank you. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press star 2. If you're on speaker phone, please pick up the handset to ask your question. Your first question comes from David Stanton from Jefferies. Please go ahead.
Good morning, team, and thanks very much for taking my questions. Firstly, if we could talk about services, do you think the Catch-Up is done in services in terms of, you know, compared to the lockdowns that we saw in the first 1/2 or, sorry, during COVID, or will we see all that level of ongoing growth in the second 1/2, please?
Yeah, David, thanks for your question. We expect services to moderate in the second 1/2. I think there's a bit of Catch-Up in there. You know, the deeper we get into the cycle since Nucleus 7, sort of the harder it is to keep that growth rate going. Longer run, great opportunity in services. Shorter run, we think that this will moderate in the second 1/2.
Thank you. If we switch to costs, you mentioned you saw COVID restrictions on costs in the first 1/2. Given you know the lockdowns that we're still seeing in some areas in the world, can you explain to us why we'll see COVID restrictions on costs into the second 1/2? Or no, a decline in those, I guess, into the second 1/2 going forward, please?
I think what we're seeing is the world starting to open up. You know, we're starting to see some conferences come back in. There's a couple scheduled for this 1/2. I go overseas next week for the first time in 2 years. We think, you know, that access. It's both sort of travel and conference, but it's also just access to clinics and the ability to get out.
You know, we've had some of our clinical studies go a bit more slowly than would happen, and that delays cost. We could be wrong on that, but I think we're certainly seeing increasing optimism and real evidence of opening up. You know, that's why the expenses will lift as we go into the second 1/2.
You know, we're lifting in R&D and in the investments in growth.
Understood. Final one from me. You know, how are you going in terms of penetrating into audiologist networks, particularly in the U.S., that don't currently follow up, you know, cochlear implants? Can you give us any metrics on changes that you've seen, you know, 1/2 on 1/2 please?
As we continue to work there through, for example, the Cochlear Provider Network, CPN. There, we've given numbers of clinics in the past that sort of the 400 range, and that's still about where it is. What we're focusing on now is more how do we get more out of each of these clinics rather than necessarily expanding the network at that rate.
We think we do wanna expand the network, but it's more about the productivity of each of these and the opportunity to refer than it is about further expansion. That opportunity still exists. As I said, we're doing work on referral activities right around the world and how that there's slight differences.
The intent is the same, but there's slight differences in how we do it depending on local market conditions and setup. It's a very important part of our future growth.
Sorry, just a quick Follow-Up on that then. How do you get more out of these clinics going forward?
It's all about awareness and education. We know these clinics are seeing implant candidates. They're referring some, but not all. It's making sure that they see the benefits of the ones that they do refer. It's continuing to educate on the indications and the benefits that people get. You know, what we're seeing is there's no shortcut to that education.
It takes time. It takes some enthusiasm from the clinic, and we're getting better at targeting them, picking the clinics more likely to refer on. You know, we continue to build our field team that supports these clinics.
Thank you.
Thanks, Stanton.
Your next question comes from Andrew Goodsall from MST Marquee. Please go ahead.
Good morning, and thanks very much for taking my question. I was just going to ask you to characterize the U.S. market at the moment. I guess what you're saying sort of implies there is a bit of a backlog building up, and I guess you've talked about disruption to surgeries and so on, just whether you know you could see perhaps by midyear that that's sort of moved on or just you know what perspective you might be able to bring to that and whether indeed there's a backlog.
Yeah. Andrew, good question. There certainly is. We're seeing good demand for surgeries. We're seeing people come into clinics, so there is a backlog there. I think the second 1/2 of your question, we don't know, is how long will that take to clear? I mean, what we saw, I don't think it's gonna happen the way it happened in the first 1/2 of 2021, when after the COVID restrictions, there was a sort of rush back to surgery.
That's because the constraints are different now. The constraint is, you know, availability of nurses particularly. It won't open up the way it did then, so expect it to take longer to clear. It'll be a less obvious bump.
I think, you know, look, I think this will take a while. It's an issue, you know, that's pretty widely reported. It is, you know, this is an important issue for hospitals to deal with. Their incentive in terms of, you know, hospitals make money from getting through these operations, so hospitals' incentive to solve this problem is pretty strong. I think it will get solved. It just might take some time.
Presume it's kids that are getting done with or at the top of the list and adults at the back, or?
Yeah. Certainly, typically, yes. When there are constraints, children get preferred priority. Yes, that's true.
Next question. You've mentioned the N7 hitting 5-year mark. I know you don't like to be drawn on when the next upgrade to the processor is coming through, but is there any reason that we should think your sort of normal 5-year innovation cycle has changed or has COVID had any sort of disruption to the way you like to launch and promote and things like that?
I think if you look back, we've launched actually a BTE every 4 years from 2001 through to 2017. In 2016 we launched Kanso, and then 2019 Kanso, 2020, sorry, Kanso 2. The addition of an OTE allows a little bit, you know, a little bit more space between BTE generations, and that's all about maximizing the benefit we get from our investment in R&D and continuing to provide a range of options to our customers, which is an important competitive feature. Yeah, I'm not gonna comment on what the future is other than, you know, the addition of successful off-the-ear processors.
You know, I got spaced out, but the timing on it behind-the-ear processor.
Okay. Final one for me, just, balance sheet looks a little lazy. Just any sort of capital management initiatives that you've got in your thoughts or, what you might have planned for that?
Well, I think we're, as you said, happy to have quite a lot of cash right now. You know, as we come through this, which we are, it's more cash than we need, so we're thinking about what's the right thing to do there. We're in no rush. You know, we can invest significantly through the CapEx, through the P&L. It gives us terrific returns. We're very focused on that. You know, over time we're looking at options for that cash. It's important, but it's not a high priority right now.
Okay. Not burning a hole in your pocket. No problem. Thank you very much.
Thanks, Andrew.
Thank you. Your next question comes from David Low from JP Morgan. Please go ahead.
Thank you very much. Dig, if we could just start, I mean, you've talked about the U.S. challenges with staffing. Just wonder if you could talk a little bit more about Western Europe. I would have thought with the Omicron waves, et cetera, going through some of your bigger markets there, you might have seen more of a hit. I understand it was an easy comp, but just sort of characterize how things are in Western Europe today and over the rest of this 1/2, please.
Yeah, David, no problem. Western Europe certainly hit by Delta, hit by Omicron, has some hospital staffing shortages. I think not to the degree of the U.S., but it's not plain sailing. As we said, Western Europe, continental Western Europe is now back above Pre-COVID levels, which is great to see. There is more capacity than there was Pre-COVID, which is good, but it's not back at the.
There's opportunity for more capacity, you know, for further capacity. You know, in the U.K., I think it's widely reported that the surgical backlog in the U.K. is very significant, and the NHS are working with all the seniors to try to work through that.
I think better, you know, so it's recovered well, but there's still more to go. I can get confident that it will resolve and we'll continue to see that recovery come through in Western Europe.
Okay, thanks for that. Just a quick one on the cloud computing costs. Five in the first 1/2, you know, closer to fifteen, give or take, in the second 1/2. Is that the run rate that we should be thinking about going forward? I mean, so AUD 30 million a year rather than AUD 20 million?
Yes, you hear, yes, broadly. Like I said, we think it's a 4-5-year journey. We're at the beginning of it. We're doing it in sort of deliberate stages. Obviously, we've got a lot more visibility over the first stage. The latter stages are still. We're still forming up the scope and expectations around those. Broadly speaking, yes.
Okay. Thank you.
I think just add one bit to that, too. Because obviously, you know, if we were capitalizing this in sort of a few years, we'd start to see the depreciation coming through, which we would manage within our margin. Sort of the worst impact on our margin is the front end of this, where we have the full impact of what we spend, and there's no offset in depreciation savings. As soon as we get into 2024, we start to see, you know, normal times we would be depreciating. You know, we expect to see the margins start to recover from there forward.
Yeah. Understood. Look, last one from me. We've had some fairly positive feedback on Advanced Bionics' offering. I'm sure you don't wanna particularly comment on competitors, but very interested in your thoughts there and whether you've seen any market share movements in major markets, please.
Yeah. Advanced Bionics have a very good offering with the Marvel processor. They're also coming back from the recall. You know, we saw that in their last result, that they're coming back from the recall. Obviously, your sales start to lift. We think overall they have regained some of the share that they had lost. We don't see that they're gaining that share from us.
Perfect. Thank you very much.
Thank you. Your next question comes from Steve Wheen from Jarden. Please go ahead.
Yeah, good morning, Dig. I just also wanted to just touch on the services business. You know, clearly there would be an expectation, particularly in the U.S., around the Nucleus 8. It is kind of curious that you've been able to achieve that conversion to the Nucleus 7 during this period.
I just wonder how much of it's the driver for those sales is from the deductibles issue in the back 1/2 of the calendar year. Is that been a major driver, considering a lot of those recipients might not have qualified in the previous 2 years because of COVID issues?
It's certainly a partial driver on timing. You know, when this deductible issue became more prevalent a few years ago, we saw bigger swings sort of from December to January in terms of our upgrade sales. It's become more muted as people have got used to it. I think it's a partial factor, but it's definitely not the majority cause of the uplift.
Your comments around the moderating of that, is that more because we're going into the 1/2 where the deductibles issue isn't as prevalent or is it more we're getting closer to people's expectations around the Nucleus 8 launch?
I think it's really both. I wouldn't count it as expectations of Nucleus 8 launch. I just will say it's you know lots of people have upgraded to Nucleus 7 and you know the more that do the fewer there are to upgrade. You know the Kanso 2 is still a very strong prospect. I think you know we'll see a good number in service but we certainly wouldn't expect the level that we saw you know in the first 1/2.
We know there'll be a degree of almost sort of natural hedge in that, particularly in Western Europe where you've got cap-funded markets where we anticipate they're gonna be more focused on CI in that second 1/2, but that's gonna naturally then depress the level of spending they can put towards upgrade as well.
The second question I had was just in the emerging market space, China, India, Brazil, obviously showing a good recovery and good sales. Is that largely all tender-based or what's... Could you just sort of help characterize those sales in those regions? Yeah, yeah. That certainly we've seen, the public markets which are typically tender-based that were the biggest hit from COVID, you know, government money versus private money and the government stopped their spending pretty quickly.
So the recovery certainly in India, Brazil is a return of the public market. But what we have seen is the private market actually grow strongly through all those countries. And in part that's just the natural growth with the economy.
I think in part as the government pulls back, people, you know, parents are more inclined to spend their own money on their child than wait for the government to step back in. We've actually seen a bit of an expansion in the private markets in those areas.
Next question I had was around your reinvestment in the business. It would appear that, I guess given the backdrop with Delta and Omicron during the first 1/2, you were able to sort of pull back on some of that reinvestment until you get the confidence. The fact now that you're suggesting you're gonna be stepping that up in the second 1/2, that does sort of highlight that you have much more confidence in the second 1/2 given what you're seeing so far?
Well, we've definitely got more confidence, you know, as time goes on. The first 1/2 wasn't so much we pulled back, we just were unable to spend because of restrictions. It wasn't so much a deliberate choice as we just didn't have the opportunities that we think will be there in the second 1/2.
Okay. Just one final question, a clarification on the cloud software. If we're doing sort of AUD 30 million OpEx or expensed going forward for the next sort of 4 years, that would suggest there's nothing that's been capitalized from this accounting standard. Is that the correct interpretation? I remember last result you were saying that there would be a split between what is CapEx and what is OpEx from that spend.
There's, I guess, a couple of comments. We have taken some small write-offs, adjustments in this 1/2 to reflect things that were being CapEx historically, but that's pretty minor. Going forward, there will be a small amount of CapEx spend here, but you know, not material. There's a couple of things. It's really when you're making investments in cloud assets that you own. We have a couple that fall under that category, but the bulk of the spend is more on platforms that are owned by third parties like Salesforce and other things.
Great. Thanks very much.
Thank you. Your next question comes from Gretel Janu from Credit Suisse. Please go ahead.
Thanks. Good morning, all. Just firstly on the guidance and outlook commentary. You stated that the revenue growth will be weighted to services and acoustics in the second 1/2. I guess just focusing on Cochlear implant revenue, does the outlook actually assume growth at this point and given the restrictions currently that you're seeing?
Yeah, Gretel, look, we do expect there to be growth in cochlear implants in the second 1/2, from what we've seen. The point we're making here is, well, it won't be complete access to operating, sort of unfettered access to operating theater capacity. We do expect some improvement in the 1/2.
Okay, great. That's clear. More of a medium term question, just on the FDA approval for single-sided deafness that you recently achieved. Can you give us a bit of detail in terms of how much you expect that to add to market growth in the short to medium term?
There's not much in the shorter run, because the reality is some people have been getting implants for single-sided deafness. There's still a bit of work to get all the insurance companies on board with funding. The FDA approval is an important step, but it's not the last step there. It's important sort of medium term rather than a shorter term impact.
Okay. Understood. Then just 2 quick housekeeping questions. The other income that you recorded, the AUD 5 million, what was that? And the FX contract gains, what do you expect in the second 1/2? Thanks.
The other income, there's a small amount of income we generate from effectively licensing R&D technology. Again, it's very small in the grand scheme of things. The FX outlook, yeah, I mean, very small. We're not seeing significant fluctuations in FX right now. Right now, little impact in the outlook.
Great. Thank you very much.
Thank you. Your next question comes from Sean Laaman from Morgan Stanley. Please go ahead.
Thank you. Good morning, Dig. Good morning, Stuart. I hope you're both well. Dig, just like to tease out your view on the growth potential in the U.S. You know, it sort of was flatish or down, I think you called out, and one of the main reasons was, you know, the staff shortages. I mean, many of the hospital execs we talk to, you know, call this out at the top of the list as one of the potential sort of midterm, potentially longer term problems. I'm wondering if you have a view whether, you know, staff shortages are more transient and it...
As it pertains to the pandemic or, you know, if you think that essentially there hasn't been enough or strong enough recruitment of nurses into the beginning of the funnel, compounded by nurse fatigue and retiring. You know, this could have a more profound structural impact going forward on surgeries. Any view you can share there, Dig, would be very useful.
Yeah, Sean, that's some good questions. I think what we're hearing is that, you know, this is very much a factor, a COVID-driven factor of fatigue, rather than necessarily a structural shortage. I mean, I think that said, you know, if you look at sort of Western world and aging population and growth in healthcare, there is an increasing demand for nurses everywhere.
You know, I think education systems and training systems need to keep up with that. I think there are 2 pressures there. One is there's a growing need for nurses and so that, you know, that intake does need to keep growing.
I think what we're seeing now is mostly driven by a, you know, the impact of COVID and fatigue and, you know, part of what we're seeing is here in the U.S. too particularly, is that nurses aren't necessarily, well, not necessarily giving up, but what they're seeing is they can quit their full-time job and go to part-time nursing as a casual basis and earn higher rates, so they can earn the same amount of money working fewer hours.
That to me sounds like a market anomaly. I think things like that normally get resolved, you know, just through the economics of it. Look, I think this will recover, but it's obviously an issue a lot of people are looking at.
Great. Super helpful. Thank you. I might have missed it, but just the currency assumption in guidance. I think you called out 74 cents at the full year result last year for fiscal 2022 looking forward, just the rate if that's changed.
Yeah. We think we're gonna land somewhere probably closer to 72, 73 for the full year. Obviously that's been coming down through the course of the year. It's probably a cent or 2's impact in there.
Awesome. Thanks, Stuart. That's all the questions I have.
Thank you. Your next question comes from John Deakin-Bell from Citi. Please go ahead.
Thanks very much. Dig, perhaps just to look at the acoustics business, an excellent result there. Can you just give us a sense of, you know, whether you think over the medium term that your products, you know, it's quite a differentiator product can grow that market materially and whether I think the size of the U.K. has been a big bone anchored market. Is that still kind of negatively impacted and should we see a bounce back in that market over time as well?
John, I think good questions. We do expect that the Osia 2 product has the potential to grow the segment. The vast majority of people with mixed and conductive hearing loss get hearing aids, processor aids, another type of hearing aid or reconstructive surgery. A very small minority get either a Baha or now an Osia product.
The results that we're seeing from Osia, and we're turning to the clinical studies and the evidence to support this show that it is a very effective solution with very good outcomes with very few complications. I think as we can put that evidence together, there's a real opportunity to grow this segment that or grow the implant segment as it competes with reconstructive surgery and hearing aids.
That was certainly a big part of our intent of putting Osia together, was not just to replace Baha, but actually to grow the segment. In the U.K., you know, it is a big Baha market and Osia's now launched there. There's different price point as there should be for Osia over Baha. We think that means that, you know, both products will stay in the market over time because of the sort of, you know, the pricing difference, but we would expect that the Osia segment to grow relative to the Baha segment. Your point on, yeah, that the U.K. is still catching up. Yes, there is still a catch up in acoustics and in CI in the U.K.
Thank you. Perhaps just a longer-dated question. I think last time, and even a year ago, you called out the kind of knowledge level around hearing loss have increased as people were wearing masks through the pandemic. I know since we caught up last, the Over-the-Counter Hearing Aid Act in the U.S. has kind of progressed a bit. I mean, is that part of your build-up of candidates being driven by those things, or are those issues going to be on a longer-dated and allow you to continue growing beyond the immediate bounce back?
I think a few things. There certainly is increasing awareness of hearing loss. You know, that's things like the World Health Organization promotion of hearing loss and drawing attention to hearing loss is part of that. Mask-wearing has definitely highlighted, continues to highlight for many people that their hearing is worse than they thought it was.
Certainly at a macro level, there is absolutely growing awareness, and growing awareness is essential to our growth and growth in Segment. To OTC, that legislation is specifically aimed at reducing the barriers to people getting hearing care and to open up the market. The more people, again, that get hearing care, they will realize the benefits. It raises awareness, and I think it will make it more of those people, I think, will.
People will then more expect their hearing to be looked after, and I think that definitely helps the implant segment as, you know, as people's hearing loss progresses through their lifetime. Look, I think the macro level, there's a number of very positive features in the outlook and moves going on that give us confidence in our Long-Term strategy and the Long-Term opportunity for growth.
Thanks very much.
Thanks, John.
Thank you. Your next question comes from Chris Cooper from Goldman Sachs. Please go ahead.
Morning. Thank you for taking my question. Dig, can I just start on the guidance? I recall when you first set the guidance, it was predicated on the assumption that COVID impacts generally improved from that point. Despite, you know, Delta and some of the Omicron surprisingly to the downside, you've really been able to upgrade the guidance today.
Just looking at the wording, I mean, you anticipate continuing COVID impacts for the rest of this year. Can you just outline for us how you've thought about continuing impacts? What does that look like to you? I'm just trying to get a sense of how much room there is to deliver ahead of this guidance 'cause you know, you've given yourself a bit more room than you ordinarily would at the outset of that target. Thank you.
Yeah. Chris, thanks for that. Yes, look, certainly going into the year, you know, the Delta variant was the dominant issue. We were seeing impacts. We were in our outlook thought that, like previous waves, we'd get through the Delta impact, and we'd see sort of surgeries expand again and sort of see that recovery through the year.
I mean, what happened was that happened with Delta, but then there were the hospital staffing shortages and the Omicron variant. I think that outlook of early issues in the year then recovering, what we're seeing is, well, we had a really good first 1/2 despite those issues and driven by Service and Accessories. There are still impacts in the second 1/2 on surgery.
As I said, we expect the surgeries to lift a bit in the second 1/2, but certainly not at the level we'd anticipated earlier in the year, which is why we say our outlook's weighted to Service and Accessories. All that does, you know, in the Long-Term view is say, look, that opening up recovery and the working through of the demand that we see is there is just pushing out a little bit further. In the meantime, we think that, you know, Service and Accessories can fill some of that, some of the opportunity there.
Okay, thanks. Stuart, maybe following on from that, the sort of drivers you ran through on the gross margin improvement, it doesn't sound like there's any sort of mix tailwind going on here at all. Any reason to think that we don't remain at this kind of 75% targeted level, as we continue through the rest of the year and perhaps beyond?
Yeah, certainly not as a result of mix. Like I said, the gross margin is very similar across all the different product lines. Look, you know, 2 things we keep a close eye on, certainly on FX. But you know, obviously haven't seen much volatility there recently. We are just continuing to look at every single component, and we'll see, you know, some small lumpy costs coming through in terms of lifetime buys. But yeah, at a macro level, not a lot to see that being radically different in 1/2 2.
Got it. Just a quick final one, just on the net margin guidance. You've had this 18% level for quite some time. You now have a chunk of costs that didn't exist through the P&L previously, which you quantified at a one percentage point headwind. Are we to interpret the fact that you're keeping 18% as a message that the underlying business is in a slightly more profitable state? Or should we just be thinking that you know, these cloud costs are kind of a wash and sort of get lost with everything else going on?
The cloud cost will reduce our margin this year and certainly into 2023. Our 18% take was prior to the cloud cost being an issue. As I was saying earlier, the cloud cost is a temporary issue. But the further we go into it, the more it just solves itself in terms of the cost being offset by depreciation further on. Our goal is to get back to 18%, inclusive of the cloud cost, but it's not gonna happen in this year or in 2023.
Got it. Thank you.
Happy to.
It is. Cheers. Thank you. Your next question comes from Saul Hadsassin from Barrenjoey. Please go ahead.
Good morning, Dig. Good morning, Stuart. Dig, just one question from me. Just on the upgrade cycle. You mentioned sort of an extended upgrade cycle, I guess, you know, on the back of Kanso and Kanso 2 coming out. Do you have any sense of what percentage of the recipient base is eligible for an upgrade in this current sort of 5-year window has actually upgraded? Historically, Cochlear used to talk to sort of a 50% sort of peak upgrade percentage of that population. Is that higher? Can you give us any sense of where that is now?
Yeah, look, I'll take that. Broadly speaking, yes. I think we're seeing some signs that it's still pretty early days, that investments in things like Cochlear Family and connectability with that recipient base are helping there. Certainly the combination now pretty much always having an off-the-ear and an on-the-ear option. Those 2 things combined, I think have given us some confidence that we might get a push beyond that historic level, but it's still pretty early days.
Just to clarify the contribution to the strong services revenue growth, is it a combination of increasing penetration of the installed base as well as increased numbers of the installed base? Or is it still more weighted just to the actual numbers of people or recipients in that installed base itself?
Biggest driver is the size of the base and the growth in the base. Increasing penetration is helping, but the biggest driver is the increase in the size of the base. Actually then the double whammy of surgical capacity constraints, meaning that in CAP-funded markets, there's a bit of an incentive to then shift some of that focus to upgrades.
Great. Thanks, Stuart. That's all I had.
Thank you. Your next question comes from Lyanne Harrison from Bank of America. Please go ahead.
Hello, Dig. Hello, Stuart. Can I just come back to Acoustics? Obviously very good growth there. Can you give us a sense of, you know, what proportion of that growth was either driven by implant revenues and what proportion is processor growth?
Hi, Lyanne. Thanks for the question. So short answer is no, we won't split out sort of the implant or upgrade part of that. We just haven't ever done that. It's important to competitive information. Given that it's, you know, overall it's 12% of our sales, we don't think there's a lot of insight to be gained. But we can say that there has been a lift in both the number of implants and the upgrades in that accessories product.
Another way to ask that, can you expect, you know, similar rate of increase in second 1/2, or do you expect that to moderate slightly?
We certainly expect that sort of level of sales and that unit sale.
Mm-hmm
... dollars, too, should continue somewhere around there. You know, then the comparable in the second 1/2 is a little bit better than the comparable first 1/2. You know-
Yeah
in terms of the percentage, that will flow through.
Okay. Just another question, just trying to understand the pipeline a little better, particularly for the North American seniors market. Do you get a sense that that pipeline flow remains, is fairly robust, or do you get a sense that given some of the clinics are shifting to upgrades, that there might be some softening there?
Now what we're seeing is that there is good demand. You know, there are people who want surgery and really can't get in. There's also been a lot of rescheduling of surgeries going on, either from, you know, the doctor gets COVID, the nurse gets COVID, the patient gets COVID. So there is, again, with unconstrained operating theater capacity, there would be more surgeries being done.
Okay. Thank you very much.
Thank you. Your next question comes from Shane Counihan from Morningstar. Please go ahead.
Yes. Good morning. Just on Services and Acoustics still. Wondering how much of the growth you think was attributable to high average prices given the newer products? Just thinking about how the growth potentially moderates from here, as it sounds like it's being buoyed by surgery delays. Thank you.
Yeah, there's really nothing in underlying pricing that's driven the first 1/2 result. That's the only thing on that line is that as we've said, Osia price is higher than Baha. We, you know, but there's not a lift in unit pricing.
The average prices, it sounds like, Osia's been doing pretty well. Would it be fair to assume that some of the growth's attributable to that?
Only at the margin. If you look, it's been 12% of our revenue, and then that's split between upgrades, Baha implants and Osia implants. Even if you think about a premium for Osia over Baha and work through the weighted average, you're gonna end up with a very small number.
Okay, understood. With the 75% gross margin just previously flagged a negative effect from commissioning costs for the China manufacturing side, how much of an impact did that have? Do you think there's any further upside if freight costs for these as well?
Minimal impact of that in the first 1/2 number. We're not anticipating significant movement on the prices of freight in the second 1/2.
Is there more cost for commissioning to come?
Yep. That plant is ramping up. As we go through that learning curve effect, that will have a lag for a couple of years as we get up the yield curve in production in Chengdu, but then ultimately it becomes a net benefit.
Okay, thanks. If I could also please clarify 2 things real quick. The AUD 20 million cloud computing for this year, that's included in the AUD 100 million-AUD 150 million guidance range. Is that right?
Yes.
Great. Lastly, with the same sort of guidance and PAT margin of 18% for this year and next year, would it be fair to say the stronger U.S. dollar is sort of more or less offsetting the higher cloud computing costs, and so the guidance hasn't changed too much?
No. We said 18% next year is 18% target excluding cloud, and we said that the cloud will bring our margin down in the balance of this year and through 2023. We don't see that the FX outlook is gonna change significantly. It may do, but in terms of our forecast, we don't see it changing significantly through next year.
Okay, great. That's all. Thank you.
Thank you. Once again, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. Your next question comes from Ray Tollefson from Team Invest and Shareholder. Please go ahead.
It's actually the afternoon now. Good afternoon, Dig and Stu. Just a couple of items I'm curious about. What is actually going to the cloud? Is it all of the corporate enterprise stuff or what? Is it everything possible? And also, there was just a brief mention of the Chinese factory. I may have missed it, but when is that likely to actually start producing product? Thanks.
Okay. Ray, on the first one, we are in terms of what's going to the cloud, we are implementing a Salesforce product across our sales and customer service. That'll be in the cloud. We'll then work through our human capital management systems and finance systems and they'll go to the cloud, and we're having a look at what we do with manufacturing. And that's a pretty typical trend across all large businesses now. And the second one on that, the factory in China. As we've said that commissioning is in progress. We'll start production in terms of you know supply from the plants. We said we need regulatory approvals and that will still take us a...
You know, they are still, you know, at least 18 months away for the first ones there. So it's still some time to go before, well, approaching production before we're actually distributing product from the plant.
Okay. Thanks very much for that. That's all from me.
Thank you.
Thank you. There are no further questions in the queue at this time. I'll now like to hand back to Mr. Howitt for closing remarks.
Okay. Thanks all for joining for the call. Thanks for the questions. Look forward to talking to you again in 6 months' time.
Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.