Wednesday 10th December 2003
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SC: Your results obviously get badly knocked about by the New Zealand dollar and the company, before it was split from Fisher & Paykel Appliances, has got into trouble with its hedging policies in the past. Can you explain the current hedging policy?
Managing director, Mike Daniell: Because a large part of our revenues are generated in US dollars and Euros and quite a chunk of our costs are in Kiwi dollars, we do hedge actively. We have a formalised hedging policy in place. Depending on exchange rate conditions, it requires us to hedge up to five years. In the short term, that's primarily with foreign exchange contracts. Further out, it's with foreign exchange contracts and options. We hedge a declining percentage of our net exposure. In year one, it's 100%, in years two and three, it's 75% and in years four and five, it's 25%. In order to go out longer term, we have a test that the New Zealand dollar has to be less than 10% below the long-term average. Two years ago we put hedging in place out five years and we still have hedging in place for 2 ½ to 2 ¾ years looking forward. Currently those hedging instruments, a mix of contracts and options, are by today's spot rates very beneficial. They average 45 cents to the US dollar and 41 cents to the Euro (the New Zealand dollar is currently trading at 64.22 US cents and 53.66 Euros.)
SC: Do the currency's fluctuations make your life difficult?
MD: It's the nature of the business. We measure ourselves mainly in US dollars because that's the primary currency we sell in. It can create different impressions in two different currencies. Our experience is that investors can look through the New Zealand figures to see what the business is really doing. We don't see foreign exchange as a problem. It's just something we need to manage.
SC: Analysts were disappointed with your sleep apnea sales. Can you explain what the problem was?
MD: Our sleep apnea sales growth was pretty strong at 15%, although that's less than the growth we have experienced. It was really due to passing through a transition. The market was anticipating the launch of our new flow generator. Sales were up 28% once that was launched. Our business is moving more to core products. Less of our business is in add-on humidifiers which was the product that was used to enter that market some years ago. Flow generators and masks are currently 57% of sales. Those higher growth rates are pulling overall OSA product sales back to the higher levels.
SC: Is the second quarter sales growth (28%) of OSA products the kind of growth rate we can expect in the second half?
MD: We're still passing through that transition from the majority of our business being in add-on humidity. We've indicated to the market that we expect growth to be anywhere between 15% and 28%. The market's growing about 20% currently. We would certainly be aiming at that figure which is the mid point of that range.
SC: Why are OSA product prices falling?
MD: They have been falling modestly for many years. It's a rapidly growing market. Most of the companies involved are probably seeing economies of scale - (the market is) several million patients around the world now. The people paying for those patients, both governments and insurers, are looking to reduce the cost per patient. Price decreases over the last few years have been fairly modest at about 3% to 5% per year.
SC: Are these products becoming commodities?
MD: The market's growing rapidly enough and there's a lot of technology in this area. The challenge is to be able to provide devices for treating OSA which the patient is very happy to use every night. Traditionally, over half of patients have given up on their treatment because of discomfort. We see there being a lot of opportunity to continue to improve the devices, the flow generators, the humidification and the masks. That's not typical of a commodity type business. It's still a technology-based business.
SC: You said the SARS virus contributed about $2 million to sales. Is this a one-off or are there lasting benefits?
MD: We hope that SARS was a one-off. It's a pretty nasty condition. It has meant hospitals in Asia, particularly in China, have purchased a lot of respiratory care equipment, both from us and other companies in the field. Our feeling is that will raise the capability of treating people with these conditions. In the US, about 30,000 people die each year from complications associated with flu. China has now equipped itself at a higher level for treating respiratory illness. We will have to wait and see how it develops. We have an office in China which we opened early in the year. Certainly, our people there are optimistic.
SC: You say you're spending 6.5% of revenue on R&D. How does that compare with the rest of your industry?
MD: If you measure it as a percentage of revenue, we're probably at the mid to higher end of similar companies. Some are down at 1% to 2% and others are up to 8%. It's a bit of a misleading figure because most of our sales are generated in US dollars and Euros while most of our R&D is in New Zealand. We can do a lot more R&D at a competitive cost than we could for the same money in the US. If we moved the R&D team to, say, California, that figure would be closer to 15%. We've got a competitive advantage.
SC: Your balance sheet looks exceptionally lazy, especially given your cash flow generation. Do you have any plans to fix that?
MD: Our pre-tax return on shareholders' funds is 40% or better, which is high by any measure. Certainly, we do have some cash on the balance sheet. We did announce at the time of our half-year profit result that we were intending, that we had the capacity to pay 90% of tax paid profit in dividends looking forward. We're in the fortunate position that we can do that while still having the capacity to grow.
SC: Would you return capital to shareholders?
MD: Some would argue we should have some debt on the balance sheet. We haven't yet been able to identify a tax efficient method to get into a debt position. We've certainly got our eyes open of opportunities arise that would allow for that.
SC: Are there any potential acquisitions that would allow you to gear up?
MD: For many years, our primary growth strategy has been organic. That's worked very well for us. We have made very small acquisitions - we acquired a distributor in Germany about three years ago. If an acquisition was available that could help expand our sales around the world or provide new technology, it's certainly something we would pursue.
SC: How likely is that?
MD: It's unpredictable.
SC: Can you give any clues as to this new technological application you're working on?
MD: One plank of our growth strategy is to find additional groups of patients that we can apply our technology to to improve their care. That's what drives our competitive advantage. For competitive reasons, we would prefer to talk about that one closer to it being available.
SC: Given the hiccup in OSA sales in the first quarter, are you pleased you no longer report quarterly?
MD: We were reporting quarterly for about a year and a half which was long enough. It's a very short period for a business like this. Everything we do is long term. Twelve weeks is a very short time period and it's also very time consuming. We're pleased to be back to six monthly reporting. You could argue that quarterly reporting increases volatility.
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