Call Start: 20:00 January 1, 0000 9:14 PM ET

Dig Howitt - President & Chief Executive Officer

Stu Sayers - Chief Financial Officer

Andrew Goodsall - MST Marquee

Steven Wheen - Jarden Securities

Gretel Janu - Crédit Suisse

Sean Laaman - Morgan Stanley

Lyanne Harrison - Bank of America

Chris Cooper - Goldman Sachs

David Nayagam - E&P

Jackson Lee - Insignia Financial

Good morning and thank you all for joining for our 2022 Results Presentation. We'll go straight in, as I said and then we'll have questions at the end. We'll start with our mission. As always, our mission has been a wonderful guide for us over the history of Cochlear but particularly over the last 2.5 years, where obviously we have seen waves of COVID come through the impact of COVID on hospitals, in terms of hospital waiting lists, restrictions on immigration which caused shortage -- staff shortages in hospitals restricting access to care, supply chain disruption which we all have heard and seen and more recently inflation.

And despite all those things we had as we set out to do 2.5 years ago emerged from this period with a stronger organization with our long-term strategy intact. And not only intact but strengthened and strengthened because of increased awareness of the importance of treating hearing loss. And that's come both from mask wearing and people -- many people realizing they were subconsciously lipreading and it's also come from the impacts of isolation from people and the importance of we got to communicate and connect with others. So we have -- our long-term strategy is strengthened and intact.

Our competitive position has also strengthened. Our market share has risen since pre-COVID and we continue to hold high share, particularly across developed markets. And our organization is also stronger. Our organization is critical. We're a knowledge business, the capability and skill of our people is important, as is the culture which is really how we work together. We've strengthened our people and our culture over the last 2.5 years. The result of all of that is that we've been able to deliver record results in '22. So record sales revenue up 10% and record revenue on each of the revenue lines, cochlear implants, Services and Acoustics.

Our net profit is also a record $277 million and that's after including cloud-related costs. And if we look a bit further into the P&L, we had managed our costs with the gross margin back at 75% and our net profit margin before cloud expenses at 18%, both in line with our long-term targets.

And clearly, our balance sheet is very strong, both the cash position and the strong cash flow that we saw in the last year. And in terms of the outlook for '23, we expect the strong performance to continue as we see hospitals continuing to reopen and open up more capacity. But we'll get to the details of the guidance a bit later.

I'll now step through each of the revenue lines, cochlear implants. We saw 5% unit growth as we continue to recover from COVID. In developed markets, we saw good growth in the second half. Remember, in the first half, developed markets were a bit soft and the emerging markets were strong. In the second half, we saw developed markets recovering and emerging markets more stable.

And now as we look across the world, across the developed markets, we are well above pre-COVID levels, the U.S. leading at 20% above pre-COVID levels. We did see a very strong recovery in '21 which was in part some surgery delayed from '20 into '21 which led to a small decline in surgeries in the U.S. in '22 but half-on-half in '22, we saw growth in the U.S. We also see a number of clinics in the U.S. with patient backlogs and we expect those patient backlogs to work down through the year as hospital capacity opens up.

Western Europe has also recovered strongly and particularly strongly through '22. There was a longer impact of COVID through Western Europe, was very pleasing to see the recovery through '22. We still do see some variability across country with the U.K. still below, only just getting back to COVID level -- pre-COVID levels. And in emerging markets, we've always said that we expected emerging markets to take longer to recover. That continues to be true. We have seen very strong performance in China and through the Middle East. And whereas in India and Brazil, we saw good recovery through '22 but they are still below pre-COVID levels.

On to Services; you can see here in this chart, we've seen a very long run growth in Services which were interrupted by COVID as clinic capacity was curtailed but looking at both halves of '22, we saw our clinic capacity reopening and very good growth in Services and -- obviously driven by upgrades. And as we said, the driver here is the growing recipient base and that growing recipient base wanting to upgrade to the latest technology. So certainly pleased to see this level of sales and services and that being 5 years after the launch of Nucleus 7. It's good to see that strength.

We move on to Acoustics. Record revenue again in Acoustics, too. Both halves were strong. And in Acoustics, again, we said that there is a significant growth opportunity. One of the keys to getting that growth opportunity is for us to build scale and get scale, getting the product portfolio right. And then we're using that scale now to raise awareness and build the clinical evidence to support the long run growth of Acoustics and the opportunity for acoustic implants is in competing with both hearing aids and reconstructive surgery. To build the evidence and awareness, we need scale to do that. So it's certainly pleasing to see that growth in Acoustics.

We continue to be pleased with the success of the Osia 2 System. We've said with Osia 2, that the roll-out will take a number of years because we are going carefully country-by-country, getting regulatory approval, making sure that we can get reimbursement at a price that represents the value in the system. That takes time but we have seen good progress in Western Europe and the U.K. and Germany. Particularly over the last year, we continue to see good performance in Osia. And through '23, we will expand the markets where we are offering Osia. Baha 6 Max Sound Processor has also driven upgrades and new Baha implants and we continue to see great opportunity for more traditional Baha system moving forward.

So, if we now move to looking at the business through how we create value. So we restructured last year how we present and are going to present in line with our value creation opportunity this year, what our goals are and what we have achieved. But importantly, our mission drives what we do is why we started the presentation with it. Our strategy which is based around the growth opportunities, strategic priorities of making sure that we retain our market leadership position, we grow the hearing implant market and that we deliver sustainable revenue and earnings growth over time, all supported by the strength of the organization and continuing to build and strengthen the organization to support our customer base and to support future growth.

So, I'll now step through each of the areas of value creation, starting with healthier and more productive society. And clearly, that's an area where we do create significant value for people and to society as a whole. And this year, we've been able to quantify that value. So we know that cochlear implants and acoustic implants are cost effective. There's an increasing number of studies on the effectiveness -- cost effectiveness of cochlear implants. This year, there's also been some study on the societal value created from enabling people to hear with cochlear implants. And over the last year, we've helped more than 40,000 people hear with either one or 2 implants acknowledging that, obviously, the number of implants we shipped is higher than that across Acoustics and cochlear but a number of people get bilateral solutions.

But the net -- I think a conservative estimate of the net societal benefit of hearing or providing hearing to those people is over $6 billion across the lifetime of the recipients. And that comes through lower cost education, better educational outcomes, improved employment and productivity opportunities and the value of improvements in quality of life.

To support this growth and the value that we create, we continue to work on our growth segment strategy -- our developed market growth strategies which is very much about raising awareness, increasing access and building a clinical path from hearing aids through to implants, made good progress in that regard in the last year with the World Health Organization continuing to advocate for the treatment of hearing loss in both children and adults and advocating for adult hearing screening and an initiative that we're driving on Living Guidelines, where 50 professionals from around the world, 21 countries around the world are building on the work that was done in the consensus statement, to get clear and consistent guidelines for indications for cochlear implants treatment and post-surgical treatment and care for people.

Again, taking that to country-level guidelines helps build this clear and consistent treatment pathway which is critical to our work on standard of care. Market access continues to be important and we continue to work around the world on broadening indications, broadening reimbursement. And you can see here some of the examples of the successes in the past year. And we continue to work in many countries on in this area. And in the last year, the Cochlear Foundation announced a partnership with the Malala Fund aimed at children in emerging countries and the importance of hearing loss to -- through good education and obviously, good education being critical for society and for future economic success.

If we now move on to empowered customers. We do -- that's why people want to be able to hear and will get their hearing back is be empowered to live their life to the fullest and one of the important things there is providing care, particularly through a chronic phase in a more convenient way. And our remote care solutions do that, we're the first implant company to offer remote care solutions, both cochlear and acoustic implants and adding remote assist this year which enables clinicians to connect by video through smartphones to recipient and giving the clinician the ability to change some of the parameters in the processor, again, saves clinic appointments, frees up clinic capacity and clearly is far more convenient for recipients right around the world.

And we continue to expand Cochlear Family with now the 20% increase in membership to 260,000 members, more than 260,000 members and recognizing that we shipped over 700,000 implants over the last 41 years, we've still got scope to continue to grow the Cochlear Family membership.

The third area has been a lifetime of hearing solutions. This very much gets to our innovation. We're spending over $200 million on R&D this year at 13% of revenue, a little above our long-term target of 12%. And clearly, we have the opportunity to increase our R&D spend within the parameters we set for the P&L. We will want to do that because we have so many things that we are building into our portfolio and continue to develop our products and service portfolio.

We have got just very recently approval CE Mark for Cochlear Nucleus 8 Sound Processor. This continues our long history of advancing the development of sound processors. We will launch processor later in this half in Europe and we expect to launch in other countries through this half as we receive regulatory approvals. Today is not the launch of Nucleus 8. So we're not going to go into the details of the features today, just to anticipate some questions for later on.

And we continue to expand the access to Baha 6 which is very well accepted and driving some of that growth that we're seeing in Acoustics and through the year, we launched the Nucleus 7 S and the Nucleus 7 SE. These variants of Nucleus 7 aimed at tiered offering in emerging markets. And this both increases our competitiveness in these markets and also reduces the cost of offering our portfolio in these markets, both clearly important in terms of succeeding in emerging markets over the long run.

Our people are critically important to the organization. We are a technology business. Therefore, the knowledge and skill of our people is critical to our success. So we continue to grow the organization to build the capability in the organization and very deliberately shape our culture as we grow to make sure that we are positioned for future growth and supporting our customers into the future. As we continue to shape our culture, we want to maintain a high level of employee engagement and we have that. People are very passionate about our mission, about the work we do to help people with hearing loss.

We've expanded also the range of incentives for employees across the year, broadened the base of incentives, increased the number of people and consistency of how reward is offered right across the businesses is important for global alignment and global execution of our strategy and we continue to work hard on diversity and inclusion.

We set ourselves a target of achieving at least 40% women in senior management roles. We set a target of achieving that by June '23 and we've achieved that 18% -- sorry, 18 months ahead of what we expected to do. But clearly, we are not finished on that front and we continue to work hard on diversity and inclusion and that applies to the Board as well with 33% of our Board women and transitioned to Alison as Chair this year as well.

Here in Australia, too, we have formalized our commitment to recognition and reconciliation through our first reconciliation of action plan in the year.

And then, the final area of value is very important. It's about delivering sustained value over time. Clearly, this gets to our financial performance but it's also about our contribution to the environment more broadly. And we are announcing today emission reduction targets that we are targeting net zero emissions from our operations, Scope 1 and 2 by 2030 and across our whole value chain. So Scope 1, 2 and 3 by '50. These targets are aligned with science-based target initiative. This builds on the travel reduction targets that we have previously announced. We've done a lot of work in the last year converting our manufacturing facilities to renewable energy which is an important part of our Scope 1 and 2 emissions. Bear in mind that we are very small, better overall but it's still critically important that we play an appropriate role in the global effort to reduce carbon emissions.

And Stuart, I'll now hand over to Stu to talk about our financial position but clearly strong profitability, strong management of costs. And we are reporting our profit with and without the cloud computing expenses. We've talked previously about this change, accounting change. It's very important that we upgrade our platforms, build alignment and consistency across the organization to support future growth and to support our customer base and provide them the service that they expect. And as we said, we will spend $100 million to $150 million over 4 or 5 years going through this process of upgrading our platforms and processes.

And I'll come back to Oticon Medical at the end but now I'm going to hand over to Stu.

Thanks, Dig. Good morning, everybody. We jump to the P&L. Dig's already spoken to revenue, so I won't add anything further there.

We've got a gross margin. You'll see we're -- happily we're back at 75%. That's our long-term target, up 2 points from last year. You might remember last year, we had a few headwinds impacting that line, specifically knocking out around the plant at full speed due to COVID. We had some stock write-offs and also some Kanso 2 launch costs that all hit in '21. We've had a much cleaner year on that front in '22 and that's why we're back at that 75%. We do anticipate being there or thereabouts in '23. We can see at least about 0.5% headwind coming in '24 as the Chengdu commissioning costs start to roll through.

Selling, marketing and general. We're up 12%. We're getting back closer to a normal level of spend here. That activity is very much focused on either growth now driving people into the referral channel or future growth sort of underwriting that channel to try and make it stronger and more likely that someone comes out at the end with a cochlear implant and that's things like standard of care and market access work that Dig's just referred to.

R&D, we aim to be 12% of revenue. We slightly exceeded that in '22 coming in at 13%. Significant jump in admin expenses, you'll see up 22% there. There's 3 factors. The biggest one is just continued investment in non-cloud IT. That's very much customer-focused IT investment. It's things like some of the back-end work on connected care. It's things like cybersecurity and privacy as well as FTE-related IT costs. We don't anticipate that rate of growth to be as high next year. We're also seeing growth in insurance costs. We saw growth in insurance costs in '22. Again, looking forward, we expect that to moderate a bit into '23. And we also had some Oticon transaction expenses in that line this year as well.

Cloud, 21.6%; as we flagged this time last year, we're just over one year into about a 4-year or 5-year journey. We're still on track for $100 million to $150 million total cost of that journey as we transform the core systems and the processes that run on them. And if we look forward to '23, we expect that spend to go up to about $36 million. That will be about $25 million after tax and it will stay there in '24 before it starts to come down again as we get through the bulk of that journey. Because the accounting standard change only came in about a year ago. We are not changing our ultimate focus which is that 18% net profit margin but we will be reporting that as a pre-cloud number. We're not going to be changing anything just due to the accounting change. So we'll keep reporting a pre- and post-cloud number for the next 3 or 4 years while we go through that journey.

Last thing I want to call out on this page is just the growth rate in the underlying net profit number. You'll see that the reported change is 18% and the constant currency change is only 10%. The reason for that delta is we're cycling about $16 million of FX losses in '21 related to balance sheet items. That was a strong Aussie dollar appreciation in '21. That wasn't repeated in '22 but that's why those numbers are as different as they are.

If we jump to the balance sheet, capital employed pretty stable across the whole year. You see working capital up. That's partly a function of just selling more, the best reason and also some deliberate choices to invest more in inventory, raw materials, componentry and finished goods in the warehouse and closer to the customer, just making sure that we maintain that absolute surety of supply to our customers and the manufacturing and logistics guys have done a stellar job in the last 2 years, navigating a whole bunch of hurdles and making it pretty much invisible to the customer. We will continue to take the opportunity where they presented for strategic buys to make sure that we always are in stock.

You'll also see the innovation -- sorry, investment and other financial assets line there, the minus $38.9 million. That's a net number which includes both us putting more cash into some innovation fund investments, specifically Precisis, Epi-Minder and Nyxoah but then also devaluation and the largest of those, the devaluation in the Nyxoah value. You may recall, we own 18% of Nyxoah, it's listed in the U.S. It's a small med start-up that's listed. That whole category was pretty heavily impact -- or has been pretty heavily impacted this year with financial market headwinds. We don't see any company-specific issues to be concerned about with Nyxoah given where it is in its journey, it's entirely in line with our expectation.

And overall, we're still sitting on -- sitting very comfortably on $580-odd million of cash. And most pleasingly, that was $22 million up versus last year.

So if we jump to actually the cash flow in a little bit more detail. Again, best driver of that is just stronger trading results. Hence, the $56 million contribution from higher EBIT in the first line there. We did also, again, make some more investments in working capital. Again, that's all about putting more stock into the manufacturing system to make sure that supply stays strong.

I think it's worth calling out on the income tax line, we did get a second tax refund. We got a similar size one last year and again, one in '22 of about $62 million. That's based off over payments from prior years. We were expecting one more year of large tax return or refund, should be about $40 million in '23. And then after that, we should be back to a more normal tax incurred tax paid scenario.

And last thing I'd note here is the $61.7 million of the other net investments line. Again, that's us putting cash into Nyxoah, Epi-Minder and Precisis. That's an abnormally high level of spend for us on innovation fund investments. Next year, we expect that to be much more back to sort of normal levels in that sort of $20 million to $30 million range.

Finally, on to dividends. Final dividend, we're going to be at $1.45. That's $3 for the whole year and that's 18% up entirely in line with the underlying net profit. The $1.45 is going to be 40% franked as we rebuild our reserves and the total payout ratio for the whole year, just a slight hair above our long-term target of 70%, we'll be paying out 71% for F '22.

And with that, I'll hand you back to Dig for the outlook.

Thanks, Stu. So just finishing with the outlook before we go to questions. So our guidance range for net profit is $290 million to $305 million. That number is obviously inclusive of the increase in cloud computing that Stu talked about. When we take that and we back out the cloud computing out of both years, that increase is between 8% and 13%. And that guidance, obviously, anticipates strong sales growth and maintaining an underlying net profit before cloud computing about 8%.

We do expect the net profit to be weighted towards the second half this year for 2 reasons. One is we expect hospitals to open up through the year as we've seen happened over the last 6 months. We expect that to continue to happen through the year. Therefore, surgery rates increasing through the year. And secondly, with the availability of Nucleus 8 coming in starting in Q2, we expect to see some of our sales pushed into the second half and obviously launch costs hitting us in the first half. So that will be quite different to the split that we saw this year in '22, where we had a strong first half profit. We had that because remember, we had delta variant starting in '22 and we held back our spending earlier in '22, while we waited to see what impact we had in sales, we're pleased to see strong sales performance early in '22. And then we obviously lifted our spending in the second half and our investment in R&D and in growth. That takes at 18% net profit margin.

So we will continue to invest in R&D and growth activities. Stu has spoken about cloud computing. We do give guidance on the currency and we've added the euro in this year just given the volatility and change in the euro over the last year. It's always important to guide there as well. Also on CapEx, around $80 million, in line with this year. And our dividend policy, again, we're targeting 70%.

Now guidance doesn't factor in the acquisition of Oticon Medical. Obviously, that's going through a process with competition regulators. Expected that process will be completed and closing before the end of the calendar year. But obviously, we need to wait for that to happen before we say anything about the broader impact on our performance. And also our guidance doesn't include a more material disruption from COVID or to hospital capacity. Clearly, there is still some risk of that. In the world at the moment, there we continue to see waves of COVID, there continues to be some uncertainty. And so clearly, there are still some risks out there and flagging that more significant impact of those risks does not fall in hard on our guidance.

So with that, we'll close off on the presentation and move over to questions.

[Operator Instructions] The first question comes from Saul Hadassin from Barrenjoey.

Dig, just a question on cochlear unit sales for fiscal ‘22. If we go back and look at the last half before COVID hit and just annualize those units, it looks like units for this year about in line with where that would have been back in FY ‘20, assuming COVID hadn’t arrived. I guess, the question is, do you still think there’s a significant amount of patients who are still waiting as part of backlog to be implanted into FY ‘23? And then a separate part to that question is, what do you think -- what do you estimate the unit sales growth rate to do globally over the next 12 months, assuming COVID doesn’t, is not as disruptive as it was, say, in FY ‘21?

Yes. So couple of -- we expected the overall unit growth to increase this year from the 5% that we -- occurred in '22. What we have seen is -- and the drivers of that, there are still some backlogs. I said there's some clinics in the U.S. with backlogs, the NHS in the U.K. has backlog, I think, of just about every surgery. Australia, there is some backlogs to come through as well. But the majority of that uplift will come from growth as it should do and that's a consequence of our growth strategies of the opportunity and of clinics reopening and freeing up. I think -- also, we expect to see continued growth in emerging markets, both growth and recovery. But just also flagging, as we've said many times, that there is less stability in emerging market sales and less predictability. They do move around more. But we're confident of that outlook and as you said, just with the caveat, obviously, there's a more material disruption than that changes. But our sales, as we said, well above where we were in '19, the last full year and expect to see good growth in cochlear implant units this year.

If I could just push you on that, what's your expectation -- say, medium to long term, what's your expectation as to how quickly the industry can grow in terms of that unit sales? Historically, I think, the range has varied from anywhere as low as maybe 5% up to as high as 15% based on some of the commentary from your competitors in the past. What do you think is a sustainable rate of CI unit sales for the next 5 years?

Look, look, it's in that range. It's -- if you think about what are we trying to do is we want to...

[Indiscernible] with the lower end of that range or the...

Yes, I’m getting there, I’m getting there. We want to aim broadly around 10% revenue growth and we expect see, as we’re saying, a bit faster growth in Acoustics and in Services. And therefore, that implies slightly less than that in CI growth rates.

The next question comes from David Low from JPMorgan.

I mean if we could just start with the N8 launch. Could I just get you to talk through previous experience, I mean, I think we can see back to what happened to sales of the N7 when it came out. But if I could just get you to touch on likely timing for U.S. launch and likely implications this year and should we expect a bulge in services revenue next year as you see the full benefit, please?

So I'm going to go -- I'm going not to go into specifics of country launch times. And we said Q2 for Europe, said we expect other markets to come in through this half as we receive further regulatory approvals. Typically what we do see, if you look back in the past, is we do see a lift in Services revenue when we put a new product out there. Equally, new products has historically been good for share. New system sales as well, we'll have that benefit. We're anticipating that benefit for at least through the second half of this year and the full year in '24. So that does create a good opportunity for us in '24.

Equally, if you look at the Services growth rate, it's been pretty consistent over the last 10 years, just backing out the COVID impact. And as we've talked before, we used to see bigger swings in Services upgrade revenue on new product launches than we do now. And I think that's just part the size of the base and scale and part people understand upgrades and know when they come about and know when they're eligible. I hope [ph].

Okay. Just my other question -- yes, that was helpful. The other question is on cloud computing. I mean I hear the comment that the range of spend will be $100 million to $150 million. That’s quite a large range. I think also this -- the FY ‘22 numbers came in a little bit above what was been guided, if I understood correctly. Just sort of wondering how you think we should think about that $100 million to $150 million, what period it will be fully spent. It sounds like ‘23, '24. Just a little bit more sort of detail on that would be helpful, please.

We can provide a little bit more. We're in line with what we expected to see in '22 and should go up to $36 million pretax in '23 and hold down '24 and then start to roll off from '25. And that sort of add up what that gets you, that gets you in between $100 million and $150 million. That's where we expect to come in.

And we're 1-year into a 4-year or 5-year journey and we are doing it. It's not like we've agreed to a lump sum price upfront. We are doing it a system at a time. And again, that's largely to not be taking on too much risk. We can't afford to be doing anything that's going to impact customers. And so we -- this is not in first place we want to take a lot of risk.

So, it’d be fair to say it’s not particularly easy to predict. And hence, you’ve given us a pretty wide range.

Yes. No, I think that's fair. And the other reason for this, too, is this is whether it's $100 million or $150 million is immaterial to our long-term value. What's material is the changes that we -- and transformation that we get out of this and the ability to scale the business, the ability to be more agile and to support a much larger customer base and have much better data for driving growth. That's where the value comes in on this.

The next question comes from Andrew Goodsall from MST Marquee.

The first one, just looking at the next 3 years plus, you’ve got the N8, you’ve got Oticon, you’ve got an R&D pipeline that looks pretty busy with the multi-channel implant and you’ve got China commissioning, just looks like some of your busiest sort of execution period. And just trying to get your thoughts on, I guess, from our perspective, what we should expect over those next few years. And am I on the right track here that it’s just going to be a busy execution period and your capacity to do that.

Yes Andrew, good question. And certainly, it will be a busy execution period and that's good. That's what we want. We've got -- we've had a long journey of R&D investment with some projects that take a long time to come to fruition. So we have a very full pipeline and we've talked about before that the longer we go, the more of that comes to market and it's always busy to launch new products. It's also very exciting to do it as well. So we're very confident in our future pipeline. And I think we've shown over time that we have a very good ability to execute. And I think just what we've done in the last 2 years, having the gross margin back at 75% despite all the supply chain issues and costs and disruptions were capable from execution front and we like the challenge of bringing brand new products to market and we expect to continue to do that over the next few years.

And just in terms of the follow-up, just with Oticon, just any clarity on sort of how you’re seeing those costs? I know you gave us a pretty big number to start with up to 60. So just how you think those costs will fall through our forecast?

I think just to stick with that range for now. We're in that detailed due diligence phase and we don't anticipate putting any update on that until we get through closing.

The next question comes from Steven from Jarden.

Just wanted to ask around the launch of the Nucleus 8. What sort of launch costs you’ve factored into your guidance in the first half and again, on the guidance, what sort of shortfall as people sit on their hands waiting for that launch to come into the market, what you’re anticipating the impact of that will be in your guidance?

Steve, I think that's more detail than we want to give out and perhaps more detail than we could accurately forecast. We've obviously got plans around how we think the year will play out. We always manage to a full year set of numbers. All we're doing is just signaling that the second half will be stronger than the first half and that will be different to '22. I think that's as far as we want to go or I think as far as we can accurately go at this stage.

Even with regards to launch costs?

Launch costs -- and again, it's sort of what's the -- we have an idea of what the launch costs are. We don't want to -- don't want to disclose exactly what they are. Again, in terms of the year, we'll see an impact in the first half. But in terms of sort of materiality over time, it's not lumpy.

Yes. Okay. Just moving to sort of more broader question. CMS is obviously proposed to expand the eligibility criteria for cochlear implants which there seem to be no -- in terms of the public commentary, no aversion to that. I just wonder from your perspective how this might ultimately look. Is it a big expansion for eligibility in terms of your ability to target an expanded market going forward?

Yes. Steve, it's a good question. So CMS change which is in processing consultation is to lift the hearing test score from less than 40% to less than 60% in best stated condition in the U.S. That's obviously a significant change in terms of the level of hearing. It's certainly more in line with the performance that people get with cochlear implants and the point at which they are best to transition to a cochlear plant. So it's an important change to come through. Now it's not an automatic issue of as soon as their approval all of these extra people roll up at clinics. Still the big challenge is getting people out of the hearing aid channel and getting them into implant clinics. One of the things this change helps us do is be clear on the criteria that hearing aid clinics should think about when they're assessing candidate. So it's certainly helpful in terms of the pipeline, helpful for longer run rate but it's not a step change on approval.

And I'll put this in the -- it's in the category of standard of care which is a long run program to get adults with significant hearing loss access to the best product for them. The indications are a critical piece of it and that's where this comes in. Awareness of -- and evidence showing the cochlear implant, the best available solution is important. And that's where the COACH study that is being run in the U.K. That's a head-to-head randomized study between cochlear implants and hearing aids [indiscernible]. And the work that Frank Lin and team are doing at Johns Hopkins and many others now around the world on the importance of healthy hearing to healthy aging. All of that -- all of these things go together to build out standard of care over time as does the work on Living Guidelines.

So, this is one element of an important and comprehensive strategy and driving standard of care over time and really opening up access to hearing implants for adults and seniors.

Yes. Great. And can I just ask one more, just on the implants that you've done in the second half of '22. What the prevalence of single-sided deafness was? If you could just give any sort of high-level commentary around the success you're having now that you have that label expansion.

Yes, you don't have specific numbers to hand here, Steve but certainly important. As we've said in the past, this was -- seeking this approval in the U.S. was very much a competitiveness issue that [indiscernible] had an indication for asymmetric hearing loss single-sided deafness that meant that they were picking up some candidates that we thought we should get. And so us getting that indication is important in the first instance from competitiveness. I guess, we said in the announcement, we think there's about 60,000 people a year in the U.S. who suffer from single-sided deafness.

So, certainly a good pool to have and it increases the magnitude of the clinical opportunity but I go back to the standard of care. Our work has got to be turning that clinical opportunity into genuine demand which is people lined up at clinics. And that’s all of the things I talked about in standard of care apply equally to single-sided hearing loss as they do to bilateral loss. These indication expansions are really important but they’re not the single feature in driving growth.

The next question comes from Gretel Janu from Crédit Suisse.

Just firstly, on cochlear implant. So just looking at the ASP, it looks to have slightly weakened in second half relative to first half despite the sound things where for a much more improved developed market environment in that second half. So can you comment on these dynamics and what’s happening with the ASP?

Our ASP has been pretty flat through the year. I think it was about a 1% decline across the year. So no, we're not seeing anything new or anything different from -- Gretel, from an ASP perspective.

But I would have thought second half you would have seen slightly stronger ASP given the growth was skewed to developed markets.

No, actually, part of this, too, is that what we've seen in the recovery in emerging markets is little bit less in government tenders and a bit more in private pay. So in the first half, we saw a rise in ASP in emerging markets.

Understood. That makes sense then. And then secondly, just in terms of the inventory build in the second half, I guess, how much of this is just purely building safety stock as opposed to getting ready for the N8. And then a bit more of longer-term questions about inventories. They’re now roughly 30% higher relative to pre-COVID levels. So is this now the new normal? Or do we expect further increases from here?

Yes. Good questions, Gretel. Look, the bulk of the uplift is more safety stock driven. And is it the new normal? It's certainly the new normal for now. I think until we get through COVID and the disruptions that we continue to see there, I think it's safe to assume that, yes, this is a good level. And as I said, we'll continue to look for opportunities to further underwrite safety of supply. We'd much rather have a bit more stock and make sure we're never letting a customer down.

So we should expect a little bit more of an inventory build in FY ‘23?

I think current numbers about -- feels about right. It will be somewhat driven by circumstance in the year.

The next question comes from John Deakin-Bell from Citi.

Just a clarification, if you can. You talked about in the cochlear implant side that there was some impact from access to operating theaters but the Acoustics business grew and didn’t seem to be the same problem. Can you just kind of explain to us how -- why the acoustics patients had access to theaters and the cochlear implant patients didn’t? Is it just more a country mix issue?

Yes, John, good question. Remember, in Acoustics, we have 2 things. One is that we include -- the acoustics upgrades go through the Acoustics line. So a lot of the Baha 6 sales are actually upgrades that feed in there. And the second thing is that just Osia is growing and that's helped lift that number. That said, as Acoustics has more challenge on operating theater capacity than CI does in most countries. So there are certainly constraints through there but it's masked by Osia being new and by the significant upgrades on Baha 6 Max.

And maybe just back to that question about ASP but asking in a slightly different way. I mean if there’s a recession in the U.S. and Western Europe and then if inflation continues to be a problem, can you just talk about how do you think about your business being impacted on the cost side, costs will go up but can you actually put prices up? Or does that challenge your margins?

Look, I think managing through inflation is new for anyone who's joined the workforce in the last 30 years. So I think it's hard to be too prescriptive on what will happen. We do have -- in markets where we do have the opportunity to move price, then we will look to do that. Clearly, there are a number of markets where -- and it's particularly more specialized health care where we don't have that opportunity. So that does put some pressure on us. Clearly, we've got to manage costs and manage more efficiently and that's the nature of any business. We've got to get better operationally every year. We've got to be finding ways of getting efficiency. The work that we're doing on transformation will definitely provide us with the opportunity to get scale over time.

And remember that the biggest part of our cost is people. So to the extent inflation hits us, it's mostly going to be through what happens with remuneration across the countries in which we operate and what we're seeing at the moment, certainly I think pay costs rise faster than they have in a while but we're still at a quite manageable level.

So the kind of that 18% net profit margin target regardless of the inflation environment, you’re comfortable that, that can be maintained?

Yes, certainly, from what we can see at the moment, yes. As I said, inflation is new and if inflation sits at high levels for a number of years, that might be different but that's a new situation for us that we'll see but we're certainly confident from what we can see now of maintaining that margin through '23.

The next question comes from Sean Laaman from Morgan Stanley.

I hope you’re both well. Yes. My question also on costs. The gross margin pretty good today. OpEx is a little high than what I thought. But certainly in the noise that given what we are observing across many subsectors of health care with respect to staff and componentry and global supply chains, those impacts aren’t really observable in your numbers. So I’m wondering if the pandemics introduced some efficiencies within your business which is offsetting some of that.

Yes, it's a good question. And yes, to a degree. So we've certainly seen significant drops in things like travel and conferences. They're coming back. They came -- they started to come back more heavily in '22. We're still not back at full sort of pre-COVID levels. And I think -- particularly things like travel, I'm not sure we'll get back to 100% of pre-COVID level because I think everyone's realized there's a number of things that are just more efficient to do online. That said, we're getting in front of customers for the sales staff, particularly still a very high priority. So I think there's a degree of moderation there and it has forced us to think differently about -- certainly, where we put stock in the supply chain and how much stock we hold.

I guess, the other thing is a lot of the stock and componentry, we have material buffers there. And so I think, on average, for a year. But if you think about '23, at least the first 3 quarters of the year, we're making stuff with items we procured more than a year ago. So again, probably a bit more insulation there as well.

Great. And a follow-up, please. So last couple of presentations, I think units have been a little bit softer than what we thought but the -- certainly offset by processor and processor upgrade and service revenue. And feedback has been that the clinics not having the patient throughput or new patient throughput, sorry and access to theaters has really been focusing on drilling into the installed base, if you like, to extract revenue that way. So I’m wondering, as things more open up and particularly as you talk to the launch of the N8, is the N8 going to be soaking up more audiologist time so we might still consider somewhat of a suppression to unit growth? Or is that not the right way to think about it?

No, I think, as I said earlier, we -- should we expect to see unit growth lift through this year? That's a good point. Nucleus 8 upgrades can take clinic capacity away. One of the things that we've done more of through COVID is to be able to do more upgrades with less or no intervention from the clinic in a number of countries. That comes from having [indiscernible] in the cloud and Cochlear Link. So there's some things we've been working on over time to reduce the load on clinics to avoid some of these bottlenecks.

Great. And squeeze last one in, please. So typically, you’ve talked with launches in the past with upgrades, something like 50% of the installed base by year three, it would be kind of rough target. I’m wondering if some of these more patient tactile systems you have at the moment like or cycle Remote Check you’re talking to remote assist that you could expect a greater penetration rates for the installed base? Or is it kind of reaching to the same absolute numbers, if you like but over a bigger base if that question makes sense?

Yes. I think probably a little bit too early to tell. I think things like Remote Check, it's still very early days. So going forward, on a much longer horizon, yes, it should give us greater connectivity with patients and more frequent interaction as well and that will all help because I think one of the biggest barriers, if not the biggest barrier is often just awareness around upgrading. But in the next one or 2 years, it's -- we're still very much aiming for that 50% round number.

The next question comes from Lyanne Harrison from Bank of America.

If I could come back to Services, can you talk a little bit? Obviously, we've had a huge backlog of upgrade because of COVID and then now that the clinics have reopened, we're having strong growth through the Services upgrade? Has that backlog been worked through? Or do you think that there's still some way to go? And then, the second part to my question is coming back to Sean’s question about proportion of your installed base that have upgraded. Given the recent strength in upgrades, what sort of implications you might have there for the Nucleus 8 over the next 12 months following launch?

So, I'll start on that one. I think the biggest driver of upgrades in any year is the number of people who reached their 5-year point where they're eligible for another upgrade. And given our growth, that number grows each year. So that's the biggest driver. To the extent that there's a backlog from COVID, it's a much smaller impact on the numbers. Hopefully, I think that answers the first bit. On the second bit on Nucleus 8, I think talked a bit about this one of the earlier questions that we people -- again, when people become eligible for their upgrades sort of from many dictates when they get it. With Nucleus 8 coming, probably we would, that's why we've got the profit weighted to the second half, we'd expect some people to hold off on Nucleus 7 over the next few months and wait for Nucleus 8 to some degree that will [indiscernible].

Okay. And if I could squeeze one more question in on Acoustics. Obviously, very good growth there with the new launches. You mentioned the United States and obviously, the challenges in the U.K. But can you shed some color on what you’re seeing in Germany?

Yes. So it's, we're pleased with how the roll-out of Osia is going in Germany. We think -- and Germany has never been a very big Baha market. We certainly got a big opportunity. And I think what we're seeing is when we go -- and we bring Osia to market, that doesn't have a lot of Baha. It takes some while to build up the patient pipelines, to build the surgical -- surgeons understanding of who's the candidate and to build awareness of the product. So pleased with how we're going but -- and see that it's a long run -- this is a long run race opportunity. Osia is effectively a new category. And while it treats some of the sort of similar patient group with Baha, the intervention, the effectiveness of it is very much a new category and it takes time to build a new category.

The next question comes from Chris Cooper from Goldman Sachs.

Dig, I appreciate the backlogs in most of your geographies here. Can I just ask how you're seeing surgery volumes at this stage of the pandemic? Has there been a sequential change in recent months? And tying it back to the backlog at current rates of surgery volumes, what is your best guess about how long it's going to take to pay down those backlogs?

Chris, first on backlog. So the backlogs are not uniform. It's -- some is at a country level, like the U.K., for example. Others are at a clinic level which is in the U.S. So we know number of U.S. clinics with backlogs. We also know a number of U.S. clinics that have no backlog and able to see people straightaway. So the backlog isn't uniform and does vary, as I said, country level and at a clinic level. Sorry, I've just jumped out -- dropped the second half of your question on backlogs.

I was asking sort of a mark-to-market assessment on where you’re seeing surgery volumes right now relative to the CapEx and through most of fiscal ‘22?

So what we saw through the second half of '22 was an increase in the surgery volumes through the developed world. So that gives us some confidence that some of these restrictions are moving and hospitals are opening, capacity is increasing again. And yes, as that increased through the second half, that was positive and we expect to see that continuing through '23. Hence the outlook for growth in CI units and the weighting into the second half as capacity opens up through the year.

Okay. And perhaps a philosophical question around your net margin. So for this year, ‘23, if I back solve the guidance, you’re implicitly guiding to 9% sales growth at the very top end. On this call, Dig, you spoke about sort of mid- to longer-term ambition of exceeding 10%. And you also described the revenue outlook for this year is strong. So my question, I guess, is to what extent is -- are those comments conservatism, I guess, for this year in your guidance? Or to what extent are they just a sort of rigid strategy to not allow net margin to exceed that 18% level even if revenue and leverage would suggest it is possible?

So first of all, to finish with the -- start with the last part. So now we hold -- we're very clear that we're holding to a net margin of 18%. And it's not about getting leverage. We aren't getting leverage in the business, about investing for growth. And as we get leverage, we're going to keep reinvesting as we should given the low penetration and the significant opportunity that we have in front of us. In terms of your interpretation of the guidance, I'm not quite sure how it worked that out. So we're saying pre-cloud, looking at the 18% net margin, we're expecting -- we're guiding to 8% to 13% increase in profit with a constant profit margin from '22 into '23. So that guides you on the revenue range.

The math was very crudely, if I just take the top end of your underlying net profit guidance of $305 million and then just sort of crudely back out the 17% net margin guidance, including the cloud costs for this year, that gets me to sort of an implicit top line of about 9% growth.

Better off to go off pre-cloud, 8% to 13% growth in net profit.

Yes. And remember and the cloud is going to be high next year. So it was about 1% off this year. It will be slightly high than that next year but that’s why we’re staying focused on that pre-cloud number.

The next question comes from David Stanton from Jefferies.

In terms of the integration costs, just to follow up on a previous question, should we think of those as being sort of front loaded into the second half of FY ’23 of those 30 to 60 you talked about?

That’s as good as -- yes, look as good assumption as any at the moment. It depends on the timing of closing as to what extent that in ‘23 versus going to ‘24?

Yes. And I think certainly within first 12 months of when we take it on.

Understood. And my other questions have sort of been asked but if you could sort of talk to R&D as a percentage of sales in F ‘23, should we see more like the 12% number compared to the 13% number we saw in ‘22?

Okay. And then two others for me. D&A in ‘23 compared to -- in absolute terms compared to ‘23, I guess, we should be still seeing a step-up in depreciation at least into ‘23, compared to ‘22.

Pretty consistent '22 into '23. I think it was a $3 million difference, haven't got the number in front of me. I think it was something like that. So it might move by material amount.

Understood. And final question, tax rate for ‘23. Any color on that, please?

So broadly, about 26. So we were, 3 years ago, we were running at about 28, the R&D tax and said it knocks off about 2 points. So 26 is good as any.

The next question comes from David Bailey from Macquarie.

Just following on from one of Chris’ questions, maybe 8% to 13% NPAT guidance ex cloud. Are you holding that margin 8% to 13% revenue growth given you’ve announced the launch of the N8 or you announced the launch that it won’t be rolled out. I mean the right way to think about top line as being more weighted to CI, less Services and probably a bit more Acoustics. Is that how you’re sort of thinking about revenue growth for ‘23?

Look, I think broadly, I mean, there's a timing issue of when N8 goes out but I think we're still -- I think at a broad level, that's a good way to think about it and the extent of Services, it will just be a little bit around time.

And there's really 2 dynamics -- 2 big dynamics that we can see in '23. One is not related to N8. It's kind of more return of capacity and that's a slow gradual return in the U.S. and the continuation of the long-term return in places like Western Europe. And then there's the N8 dynamic overload on that.

Got it. And then just in relation to the OTC change for hearing aid in the U.S., just any initial thoughts you have -- might have around that. Just sort of wondering if it’s in the near term anyway or might just for some people not to see an audiologist which gives you a temporary slowdown in new patients? Or do you think it’s not really an issue overall?

No, I don't think it has any short-term impact on implants sales. I think, overall for people with hearing loss, this is very good. Anything that increases access for people which this is aimed to do by creating access, lowering costs, getting more people to take care of their hearing and getting used to taking care of their hearing and hearing well, all of that, I think, is very helpful in the long run as people lose their hearing and continue to lose their hearing that this hopefully expect to get good outcomes and that will reach many of them, will reach a point where a good outcome means getting an implant.

The next question comes from David Nayagam from E&P.

Yes. So Cochlear has traditionally played close to its core business of hearing restoration, noting the additional investments into your innovation fund for projects like Epi-Minder and Precisis, do you envisage future diversification of your implant business into areas like electrical stimulation, diagnostics monitoring, [indiscernible] protection, electroceuticals, regenerative technologies, et cetera, outside of that core auditory demand?

Yes, good questions. Firstly, we're very focused on hearing. We've got a huge opportunity to grow our business in hearing and that's where nearly all our focus goes. We have started this investment a few years ago. What we're looking at there is we have very, very powerful technology from implantable electrical stimulation. There may be some opportunity to use that in other fields. What we're doing with the innovation fund is just exploring that opportunity at this stage and not more than that.

Great. My other question on the OTC hearing aids has already been asked. So I’ll leave it there.

[Operator Instructions] The next question comes from Craig Wong-Pan from RBC.

Just a question on the new Nucleus 7 S and 7 SE that’s being launched in emerging markets. I just want to know what the main difference was to the Nucleus 7 and what sort of models were previously being sold in those emerging markets?

Okay, Craig, I'll give you a high-level answer to that one, won't go to specifics. So there are versions of Nucleus 7 just with slightly different and obviously lesser feature set but still very good hearing performance. What we've done historically in emerging markets is sell older generations of processors. So again, people get good hearing outcomes. With the benefit of moving to a more -- a newer platform is that it's easier to keep that platform in the market. We see the life cycles of electronic components shortening. It gets harder for us to maintain some of the older products. And therefore, over time, it's more cost effective to maintain the newer platforms across the emerging market portfolio.

Okay. And does that mean if you’re selling one of your newer implants -- sorry, sound processors, then that could be an opportunity to gain further share in those emerging markets?

I think it's just -- it's about just making sure we retain our competitiveness. We have a very good share in emerging markets. It's not as high as our share in developed markets and that's largely because a lot of business in emerging markets is price based and therefore, easier for others to compete with us. Harder when it's on features. So what we're doing is just making sure that we've got a flexible and effective feature set that we can -- maintaining our margins at -- when the prices are lower.

Okay. And then just my last question. The gross margin drag in FY ‘24 from the Chinese manufacturing facility. Just wondering why there’s not a drag coming through in FY ‘23.

So the drag shows up when you start selling the stock and so we're still going through the sort of qualification, certification phase in '23.

The next question is a follow-up from David Low from JPMorgan.

Just a quick one. The FX impact on FY ‘23, I mean the Aussie dollar is a little bit lower and obviously, U.S. dollar strength. Just wondering how that’s impacting. And then just a quick update on your thoughts or your plans for that large cash balance and whether you’ve given more consideration to returning some of it, please?

Yes. Look, that would -- as Dig said, we're assuming sort of USD 0.70 going in and EUR 0.68. That's probably as good as any given where the spot rates are at right now. And the guidance is certainly given with those as a caveat to it. So we'll pay close attention to those through the year. Obviously, Aussie dollar appreciating hurts us. Aussie dollar depreciating helps us. And the second one, just remind me, cash -- cash balance.

Remain very, very comfortable sitting on that balance. Obviously, Oticon, if it gets the nod from the regulators will take a small bite out of that. But yes, still very comfortable holding that for now.

And just a follow-up on the FX, the U.S. dollar and euro have moved in opposite direction there. So the net impact is basically neutral.

The next question comes from Jackson Lee from Insignia Financial.

Yes. Sorry about that. So just trying to understand the sort of demographic split in your sales. Look, correct me if I’m wrong but my understanding is that in your sort of domestic -- I’m sorry, developed markets, you have a sort of 50-50 split between children and seniors and in the emerging, you have sort of mostly children, is sort of one doing better than the other? Can you sort of split the sort of maybe growth -- growth rate between the demographic segments?

So Jackson, first up, yes, in emerging markets, it's mostly children versus old [ph] children, small numbers of adults coming through. And in developed markets, it depends. So some markets are 50-50 typically through Western Europe but across Germany, U.S., Australia, it’s 25% children, 75% adults and seniors. And we don’t explicitly split out the growth rates of the two, across emerging and developed. What we do say is that emerging is more variable because there are more factors that influence what goes on in emerging markets.

Thank you. At this time, we're showing no further questions. I'll hand the conference back to Mr. Howitt.

Okay. So it’s -- we’ll finish up there. Thanks all for joining and thank you for questions and look forward to talking again in 6 months’ time.

Thank you. That does conclude our conference for today. Thanks for participating. You may now disconnect.