Half Year 2019 Cochlear Ltd Earnings Call
Feb 18, 2019 PM UTC
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COH.AX - Cochlear Ltd
Half Year 2019 Cochlear Ltd Earnings Call
Feb 18, 2019 / 11:00PM GMT
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Corporate Participants
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* Dig Howitt
Cochlear Ltd. - President
* Brent Cubis
Cochlear Ltd. - CFO
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Conference Call Participants
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* David Low
JPMorgan - Analyst
* Andrew Goodsall
MST Marquee - Analyst
* Sean Laaman
Morgan Stanley - Analyst
* Steve Wheen
Evans and Partners - Analyst
* Chris Cooper
Goldman Sachs - Analyst
* David Stanton
CLSA Limited - Analyst
* Saul Hadassin
UBS - Analyst
* John Deakin-Bell
Citigroup - Analyst
* Craig Wong-Pan
Deutsche Bank - Analyst
* Lyanne Harrison
BofA Merrill Lynch - Analyst
* Gretel Janu
Credit Suisse - Analyst
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Presentation
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Dig Howitt, Cochlear Ltd. - President [1]
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Okay, let's get underway. Thank you for those who are in the room for coming along and welcome to everyone on the phone. For those on the phone, I am Dig Howitt, CEO, and let's get underway.
So, to start with, I just want to run through some of the highlights of the results, then I will get into a bit of the detail of what is going on in some of our markets. Then Brent will talk through the P&L and the balance sheet and then I will come back and finish it with reiterating our strategy and guidance.
So the results highlights, obviously services revenue up 26% is very strong. Our implant unit growth of 5%, which I will talk more about both developed markets and emerging markets as we get into this.
Very importantly, our strategy holds and the opportunity that we see for long-run growth, particularly in the adults and seniors in developed market, all holds and we continue to invest heavily in that segment as well as in building our product portfolio over the long run. I will talk about those things as we go through. And from a financial perspective good growth in the net profit and very strong cash flow generation continue.
So let's look at cochlear implant sales first. So 58% of our revenue. As you can see, there units up 5% overall. They were flat in the developed markets and up more than 15% in emerging markets. So let me talk first about developed markets.
So over the last few years, we have seen growth in our developed markets CI sales and revenue on the back of market growth and market share gains, and those share gains coming in large part to the strength of our product portfolio with Kanso 532 and then Nucleus 7. And we have also seen the market grow.
Now in the last half one of our competitors launched an implant that has 3 Tesla MRI compatibility with the magnet in place. Now our implants have 3 Tesla MRI compatibility but the magnet needs to be removed, which was a minor surgical procedure so there is a difference there. And now two of our competitors have that 3 Tesla MRI compatibility. That has affected our market share in the US and Germany, which are the largest two markets for cochlear implants.
In terms of the market growth, market growth -- we continue to see good underlying growth in many markets. However, some markets in Western Europe have been affected in this last half by caps, an indication in caps in funding. And we have talked about those caps over time being in place in many Western European companies and the work that we do in market access, it's important to remove those caps over time.
And examples of that are Japan. So Japan expanded indications about 18 months ago. Japan was our strongest growing market, developed market for CI systems in the last half and that builds on the half before that. So we see that when indications in funding expand, access to implants expands and the implants grow.
Right now in the UK, the health authorities in UK are looking at the indications for the UK. And we are optimistic that in the next few months we will review on a change expansion of the indications in the UK. So it really shows the importance of market access and our investment in market access, which leads to the next point on our cochlear implants.
We continue to invest in long-run growth. We continue to see that there is a significant opportunity for adults and seniors in developed markets, and so we are investing to do that. The three things that we need to do are market access, so invest in expanding indications and funding so the work in Japan and in the UK and other markets over time takes time to do. So the results that we see in Japan and the UK are many years of work and, as we have been saying, we have been expanding our market access capability over the last few years to address constraints in more countries.
The second thing we need to do is build awareness. The best example of that is in the US where we have been running our direct-to-consumer campaigns for several years now. And the implants that we get through that direct-to-consumer channel make up a significant proportion of our sales.
The third thing we need to do is build a channel from hearing aids to cochlear implants, because the majority of our future customers in the adults and seniors segment are sitting in the hearing aid channel -- hundreds of thousands of people a year with a severe to profound hearing loss continuing to get hearing aids, not moving to cochlear implants.
So we are investing to try to build a path from hearing aids to cochlear implants. In the US again, where we are most advanced, we are seeing growth in referrals from hearing aid providers, albeit off a small base. But we are seeing that growth which is pleasing and gives us confidence in the strategies that we have for future growth.
Underlying that too is that the senior segment has been the fastest growing segment. So the over 65s continues to be the fastest-growing segment in developed markets as it has been for the last few years.
Let me move to emerging markets now, so more than 15% growth in emerging markets. And as we talked about over time, emerging market cochlear implant sales can move up and down depending on tender timing, depending on local economies, but we do see very good potential over the very long run to achieve growth.
We have been investing in emerging markets over the last several years to expand our presence. We have seen that come through in terms of increased sales. And are certainly pleased by the increased sales particularly because two countries, Argentina and Turkey, which are significant markets for us for CI sales, both have some pretty significant economic problems, have significant currency devaluation in the half.
And obviously as an importer of medical products into a country that's currency devalued significantly, our sales in those two countries declined quite a bit through the half, but overall we still grew strongly. So pleasing to see that growth in emerging markets.
Now let's move on to services which is certainly a highlight of the result, up 21% in constant currency. The upgrade revenue part of that up 26% in constant currency and that is on the back of strong demand for Nucleus 7, which we launched back in October 2017, and now has an Android app to control as well as the iPhone app and the streaming with iPhone. So we are seeing very positive -- continuing very positive response to Nucleus 7 and that was particularly true in Australia and in Western Europe in the last half.
One of the nuances of funding in some parts of Western Europe is that hospitals often have a set budget for their cochlear implant program which includes both new implants and upgrades. So if the upgrades rise there is therefore less money available for new implants. So that is one of the nuances of -- there is a trade-off in some areas between services growth and implant growth and I think we have seen a little bit of that in the last half.
Again, we have a very clear strategy over the long run for services, which is to invest in better engagement, better customer information so that we can connect with people, we can give them the best hearing experience they can get, which both improves their outcome and builds our brand. The cochlear family is the main vehicle we have for driving that engagement.
We have now over 120,000 members, up 20% since June 2018 and that is exceeding our internal targets for growth. So very pleased with the work that we are doing there to build the connection to enable us to sustain services revenue growth over the long term, because that base is obviously significantly bigger than it was going back over the last three, four, five years.
Acoustics, acoustics is a bit more of a mixed view. 13% of sales, up 1% in constant currency. We see continuing good demand for the Baha 5 system. We see some good growth -- I've talked before about the opportunity to expand the number of countries in which we sell acoustic implants. We have continued that over the last six months and seen some good growth off a low base as we expand the countries.
It takes time to open a new country and to build the surgical presence and the audiological referral for acoustic implants. But we do have a very strong belief in the future of the potential for future growth for our acoustics portfolio.
Now just looking through regionally, I will move through this reasonably quickly because I think I've covered sort of these CI and the servicing depth. But we saw growth across all three regions, US obviously the lowest at 3% and that is coming off some pretty -- very strong growth over the last few years. And as I said, that is where the market share impact has been most pronounced for us.
In EMEA again good growth largely driven by services through Western Europe and I talked about the funding constraints that we see. But we also saw competitor activity in some Western European countries which had some impact on share particularly in Germany.
And then Asia-Pacific growing consistently, Japan very strong for implants and Australia very strong for upgrades in the last half.
So now move on to technology. Our technology competitiveness is a critical part of our strategy, so we continue to spend 12% of our revenue into R&D and there we are obviously focused on a short-term portfolio of product launches and building our long-term technology base so that in the five- to 10-year horizon we have a very strong underlying portfolio.
You can see some of our products that we have launched over the last few years here which have built our competitive portfolio. We have great confidence in our near-term pipeline and the products that we will launch of the next 18 months from here.
And in the half two announcements that we made about the long-term portfolio, our strengthened collaboration with GN ReSound, which over the longer run will help us have a strong bimodal solution and be able to get hearing aids and cochlear implants working together to improve the customer experience.
And as we have previously announced the TIKI clinical trial started in that last half and we've done the first few implants there and wait to see how they perform over time. The important part of our -- leg of our strategy is to make sure we continue to invest in our technology pipeline and our product portfolio.
And then I want to move on to the AMF patent dispute. So we made an announcement through the half of that judgment in November of the USD268 million in damages awarded against us. So there's a few pieces of information in this that are very important.
One is that we have moved to treating this issue as a contingent liability rather than having a provision on the balance sheet. The reason for that is twofold. One is that, based on independent legal advice, the Board believes that it is quite probable that we will win on appeal. And secondly, the range of outcomes -- financial outcomes are very broad and to be able to pick one number out of that doesn't make sense. So we thought it better that we disclose all of the relevant information on this as a contingent liability.
As you can see there, since the November judgment AMF and Advanced Bionics have applied for USD123 million in pre-interest judgment. Now we have opposed that interest both on legal grounds and we have opposed the calculation of the interest. The judge has reserved his decision and, again, any decision there is contingent on the outcome of the appeal.
I talked about the legal advice and so that provision that we did have to recover potential damages we have reversed and we have created a new provision to cover our ongoing costs of running this case over the next few years.
Importantly, as we have said many times, this is about expired patents. So any decision does not affect our products in the market or our ability to sell our current portfolio. And as you can see and Brent will talk to, we have a very strong balance sheet with conservative (inaudible), so if there is an award against us we will be able to fund that and continue to that to operate the business which is obviously a very important aspect of this case.
So still lots of uncertainty over where this will play out. What we want to do is provide all of the relevant information that we can on -- as this case develops. So now I will hand over to Brent to talk through the financial results.
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Brent Cubis, Cochlear Ltd. - CFO [2]
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Okay, thanks, Dig. All right, we will go to the P&L. Dig has already spoken about an amazing upgrade cycle and everything, so I won't really touch on these. But I think the real thing I want you to walk away with today is how strong the balance sheet is as well and the amazing cash flow.
In terms of the P&L, you can see here our margin improved by about 2 points or so. That is worth about $11 million if we were at 72% this year and we have plowed all that into the areas that Dig spoke about before, the long-term investments. Out of that long-term investments you would probably say half or so of that is in long -- out of the increase there is in longer-term stuff. So, or the DTC, market access, university partnerships, everything that is growing the market in the long term.
It's important to note too you can see there the impact of the FX. We are using -- $0.72 is the year-to-date amount and we have assumed that for the rest of the year. The point here when you go down with the -- up here in terms of -- you can see the difference here with the admin, how much of that is weighted in sales and marketing, how much of that is weighted in the states and in Europe is about 4 percentage points difference there.
A lot of that is if -- the revenue up top there is about $34 million more in reported compared to constant currency less the expenses overseas of about $15 million or so. Amazingly we end up at 16% in constant currency for net profit and for reported. So all that ups and downs ends up at the same amount.
If we took out the tax impact of last year, remember the Trump tax changes, would be about 11%. So that 11% is in line with what Dig has always said we are trying to grow the net profit margin in line with our revenue growth. So I think overall it's a fantastic result in terms of the first half. And when we look to the cash flow, you can see how good that is as well and we will get to that next.
I love this page because it just is an amazing cash flow business. You can see here the change in working capital; we will go into the debtors in a sec. But the net interest paid, despite spending triple the amount in CapEx and investments compared to last year, we still managed to save about $1 million in interest.
Part of that is also because of our loan mix that we have and you can see that in the notes; we have actually changed one of our loans to a SEK loan and the interest rates in Sweden are really low so that helps as well. The income taxes paid there appears as if it's a bit lower. Last year we had a bit of a catch up in December for the June 2017 tax return. But since we have gone to monthly tax payments it's actually come down. It was a bit of a lumpy one last year.
Overall the CapEx we spoke about, it's mainly China. The acquisition of the Nyxoah is in other net investments at the bottom there. So overall the cash flows, incredible result there and that's able to support the increase in dividend which we will touch on later.
Trade receivables or debtors, we've really pushed hard on that, you can see the improvement there. In constant currency terms that would probably be about a 10% improvement. That is in reported. Inventories is a little bit high; we are building up a little bit of stock there for Brexit as we are coming up to that in June. So that might stay a little bit higher at the end of the year, but overall our capital employed is in really good shape.
In terms of net debt, I mentioned that before, we have worked really hard. Cash is a little bit higher than I would have liked to have been at the end of the year. We were holding on some cash for the China manufacturing plant for first deposit for the construction up there.
You can see at the bottom that our weighted debt in Aussie terms has dropped from 98 to 69 because we did that SEK loan and that is in the notes of the accounts. Overall -- and the weighted average debt is still three years, which is I think a very good maturity level. Dig spoke about how safe our balance sheet and how -- the low gearing we have. So we have plenty of capacity there if we ever need it.
In terms of our dividends, again, that's up 11% over last year and we are keeping the payout ratio at 70%. So it is a very strong balance sheet. I don't think I have ever seen such a strong balance sheet with low gearing and [I think] we are in a nice position there. So over to Dig.
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Dig Howitt, Cochlear Ltd. - President [3]
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Thanks, Brent. So let me just finish up with just reiterating our strategy very quickly because I know you are all familiar with it and it is unchanged. And then going back to our outlook and guidance. So three priorities as we talked about for a while now.
Retaining market leadership, which both comes from making sure we have market-leading technology and a world-class customer experience. So both technology and service are critical to retaining our market leadership. By doing that we are able to fund market growth and there are three aspects to market growth: building awareness, which I've talked about; building access, which we see in Japan and when we do that it works and we know that there are constraints across a range of countries that we need to move to be able to continue to grow.
And then the clinical evidence and that evidence and awareness all part of education in the hearing aid channel to build a referral path for hearing aids through to cochlear implants for this adult senior segment, which is the core part of our near-term growth. And then we want to deliver consistent revenue and earnings growth over time. And as Brent said and I've said and we continue to say, we want to match our profit growth with our revenue growth and reinvest in the business as much as we possibly can.
When we look by segment, again, revenue growth drives cochlear implants. It is our awareness and sales force expansion, the adults and seniors are the target there. Our product portfolio is very important and continuing to invest in emerging markets over time.
Services, the recipient base grows obviously year on year. As we help more customers here that growing base helps expand our upgrade pool. And by providing new and better technology, like we have done with Nucleus 7, it makes it attractive for people to upgrade and keeps that revenue growing.
And the acoustics I have talked about, strong product portfolio, strong product pipeline as well, and the opportunity to expand geographies because our sales there are limited to a few geographies than we have for cochlear implants. And matching that will help acoustics drive over time. But opening up new countries does take time to build that capability.
So we expect the revenue to grow across each of these segments over time. To do that we will invest, we keep saying that, we will continue -- we generate a lot of cash, we will continue to invest as much of that back in our technology and our future growth. We do get operational improvement.
We do get efficiency savings and we are putting those back in. And where we get money, whether it is from tax savings or currency, we will continue to invest to hold that net profit margin and continue to have a strong balance sheet and still targeting a 70% payout ratio for our dividends.
And then finally, the outlook. So we are holding our guidance -- or consistent with our guidance of $265 million to $275 million, up 8% to 12% on the previous year. Given our first half on the outlook we expect more of our revenue growth to come through from services and less of it to come from cochlear implant growth.
We again expect some emerging market growth to continue albeit, as we always say, there is variability. We have a good pipeline of tenders but there is variability in when those tenders will be awarded. We continue to see good private pay growth across emerging markets.
And we will continue to invest in both retaining market leadership and driving long-term growth. We are really very much focused on the next five years on how do we drive growth over that time and really build the channel from hearing aids to cochlear implants and make cochlear implants in adults and seniors the standard of care. And you can see the exchange rates there. And with that we will close the presentation and open up for questions.
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Questions and Answers
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David Low, JPMorgan - Analyst [1]
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David Low from JPMorgan. Perhaps if we could just start with your assessment of what happened with market growth in the period. I know it varies between markets, but given it would seem Cochlear's unit sales came in a little bit soft on the back of this competition issue, what do you think happened with market growth?
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Dig Howitt, Cochlear Ltd. - President [2]
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Yes, so back at growth it's hard to look at a macro level; we have got to look by country and then by segment. So right across the developed world, as we've talked about before, there is limited opportunity to grow in children because birthrates are largely flat and penetration is relatively high.
Now there are four countries, the US, France, Japan and Korea where the penetration in children is 50% to 60%. So there is still potential to grow in children in those countries but across the rest of the developed world not as much.
Then in adults and seniors, as I said, we continue to see very strong growth in seniors right across the developed world. And the extent to which that growth impacts the overall growth rate in a country obviously depends on the proportion of surgeries that are in adults and seniors.
So in the US where 70% of surgeries are in adults and seniors, a high growth rate in adults and seniors translates to a high overall market growth rate. And we continue to see that growth in the market in the US. Whereas in much of Western Europe where the proportion of adults and seniors is 50% and 50% is children with limited opportunity to grow, then even if there is growth in the adults and seniors, the growth of the overall country is half.
And then we obviously then have impacts of -- in some countries of tight indications and the funding caps that we talked about.
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David Low, JPMorgan - Analyst [3]
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So you won't suggest a growth rate? I mean I know the US the data is better. Would it be fair to say the market growth was ahead of Cochlear's growth?
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Dig Howitt, Cochlear Ltd. - President [4]
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In the last half, yes. Definitely.
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David Low, JPMorgan - Analyst [5]
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The other question I have is probably an obvious one as well. You have talked about new product launches. You have talked about MRI and effectively having a competitive disadvantage. What sort of time frames are we talking before Cochlear can match up on that?
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Dig Howitt, Cochlear Ltd. - President [6]
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I was expecting that question, but I am not going to answer it. We don't give time frames on product launches or product features --
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David Low, JPMorgan - Analyst [7]
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I'll ask it a slightly different way then.
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Dig Howitt, Cochlear Ltd. - President [8]
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-- because our competitors would love to know that information.
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David Low, JPMorgan - Analyst [9]
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How challenging is it to put together a device that can meet the same MRI compatibility?
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Dig Howitt, Cochlear Ltd. - President [10]
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Any change in an implant or any development of an implant does take time. There is an enormous amount of work that goes into make sure an implant is safe and the regulatory hurdles. So it does take time to make any changes, but that doesn't really tell you anything about what we are going to have into the future or when we will have it.
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David Low, JPMorgan - Analyst [11]
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I did see that you'd made a comment in the presentation about product launches planned in the next 18 months. Is that a ridiculous time frame to think about having compatibility available?
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Dig Howitt, Cochlear Ltd. - President [12]
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I'm not going to go into what features we may or may not have it new products and when. As I said, that is information our competitors would love to have.
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Andrew Goodsall, MST Marquee - Analyst [13]
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Thank you, it's Andrew Goodsall from MST Marquee. But actually just I guess continuing on that MRI theme, obviously that's a fairly new launch for Advanced Bionics, but at this stage they still don't have a made for iPhone compatibility. So just trying to understand -- I know you have called out that FY19 unit sales are going to be soft, by just trying to understand sort of where we are in that profile of sort of competition. Is it still fairly early stage? Are they getting a bit of share against you? And I guess what is the feedback from your sales force?
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Dig Howitt, Cochlear Ltd. - President [14]
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There is lots of feedback from different perspectives. Certainly the made for iPhone is still very popular. And we continue to have obviously the majority of people choosing to go with Cochlear when they get an implant. That said, I think the MRI issue has been very well marketed and that is having an effect on some people's decision. But it really comes down to the individual level as much as it is a macro issue of what are the things that people consider when they make a decision.
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Andrew Goodsall, MST Marquee - Analyst [15]
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I mean if they get a made for I think -- they are close to having something around made for iPhones as they get that. Do you think that sort of just brings a bit more up to speed with where you are?
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Dig Howitt, Cochlear Ltd. - President [16]
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I don't know -- we don't know when they will have or what they have in their plan around made for iPhone or other phones. I think we have said in the past that the lead that we have on iPhone compatibility is one that our competitors particularly with a hearing aid background will be able to do something about over time. And that is why we continue to put 12% of a revenue into R&D as we have got a competitive technology field we have got to keep moving.
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Andrew Goodsall, MST Marquee - Analyst [17]
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Just one on unit sales up 5, constant currency revenue zero. Obviously sort of implied price decline there. But I guess just trying to understand the extent to which that is really just a reflection of the [sole] US sort of higher price point or (multiple speakers)?
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Dig Howitt, Cochlear Ltd. - President [18]
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Yes, it's very much a mix issue with that price in emerging markets, which is obviously a lower average price point part because of distributor sales, part because of the tender business. I would say it is a mix issue.
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Andrew Goodsall, MST Marquee - Analyst [19]
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So just largely that mix with the US previously pulling it up? No particular change in price that you've seen?
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Dig Howitt, Cochlear Ltd. - President [20]
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No, look, and we've talked for certainly the last little while about pricing pressure through Western Europe. Every medical device company faces pricing pressure in Western Europe because of health budget constraints. We haven't seen -- we see a little bit of that happening, so -- but in the last half it wasn't a particular issue for us.
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Operator [21]
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Sean Laaman, Morgan Stanley.
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Sean Laaman, Morgan Stanley - Analyst [22]
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Good morning, Dig; good morning, Brent. I know you don't guide to unit growth on halves, spent just given the timing of the AB launch, do you expect things to get softer before they get better looking into the second half?
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Dig Howitt, Cochlear Ltd. - President [23]
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So the question, do we expect the units to get softer before it gets better? I couldn't hear the question.
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Sean Laaman, Morgan Stanley - Analyst [24]
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Because I understand that AB probably didn't launch until September-ish, so maybe September quarter numbers were better than December quarter and then we've got a -- for want of a better term, annualization going to the second half.
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Dig Howitt, Cochlear Ltd. - President [25]
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Yes, okay, I see what you are saying. Yes, look, we -- obviously as we put our forecast together based on what we see happening in the market, we take account of when products came to market and what the impact of that will be. The best we can judge and then roll our forecast together. So I am not sure I can give you much more of an answer than that but obviously they will have this product in the market for the full six months of this half and it was about four months in the last half.
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Sean Laaman, Morgan Stanley - Analyst [26]
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Sure, thanks, Dig. And just on the Cochlear provider network, can you could give us a sort of runway of where you are in that program, a percentage rollout perhaps across centers across the US if that is the way to look at it --?
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Dig Howitt, Cochlear Ltd. - President [27]
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Yes, so we continue to expand the number of Cochlear provider network clinics in the US, so this is the hearing aids that refer, that link with a surgeon, link with a clinic and refer people with severe to profound hearing loss on to a surgeon. So the number of clinics that we have is in the hundreds now and we continue to expand that.
What we see is it does take time for the flow of candidates from that clinic to start. But as I said and as we've said over time, we are seeing an increase in the referrals from the Cochlear provider network and from the work we are doing with Sycle. Now albeit off a low base, but it gives us confidence that we are on the right track.
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Sean Laaman, Morgan Stanley - Analyst [28]
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Sure. And can you make any comment on market share within those networks or not?
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Dig Howitt, Cochlear Ltd. - President [29]
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Not explicitly, but so typically if we educate the Cochlear provider network on cochlear implants and the candidacy that they -- we then would hope that they are more likely to refer someone through having provided them with information on Cochlear and that is typically what we see happening.
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Sean Laaman, Morgan Stanley - Analyst [30]
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Sure, thanks, Dig. And just finally on just the upgrades, a very strong number there. Are you able to give us a sense of where you feel you are in terms of market penetration and the uptake and whether that is improved upon compared to last upgrade cycle?
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Dig Howitt, Cochlear Ltd. - President [31]
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Yes, so still relatively early days in terms of that cycle, so we launched in October 2017, so a bit over 15 months into a four- or five-year cycle. We are tracking about where we were with Nucleus 6, remembering that we did have Kanso in the middle there as well. So certainly quite happy with where we are and obviously working with a much larger base than we were going back to when we launched Nucleus 6.
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Sean Laaman, Morgan Stanley - Analyst [32]
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Okay, that's all I have. Thank you, Dig. Appreciate it.
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Operator [33]
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Steve Wheen, Evans and Partners.
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Steve Wheen, Evans and Partners - Analyst [34]
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Hi, good morning, Dig. I just wanted to talk about the growth in seniors. Are you able to just put some numbers around what sort of growth you are actually seeing in that segment, particularly in the US where you have spent the most amount of time with -- or say the most amount of investment with regards to the patient support network?
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Dig Howitt, Cochlear Ltd. - President [35]
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Yes, so the growth in the over 65s, so certainly that is the fastest-growing segment and it is typically double digit growth that we see and even higher in some countries. And some countries are coming off a low base. The US now is -- quite a significant proportion of the surgeries are over 65s, but we are seeing double-digit growth in that segment across many of the countries in which we operate.
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Steve Wheen, Evans and Partners - Analyst [36]
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Okay and would that be your experience in the period with just that particular segment or that is just the market growth rate?
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Dig Howitt, Cochlear Ltd. - President [37]
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Look, I think that the two are pretty similar. Over a six-month period is pretty difficult to sort of distinguish at that segment level given there is a lag in when surgeries are registered as to what is our -- is our growth different from the market growth.
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Steve Wheen, Evans and Partners - Analyst [38]
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I also just wanted to touch on the MRI aspect of the cochlear implant. And considering how much you spend on R&D, was there a decision or reason why you perhaps didn't go down that path with regards to the MRI capability? I mean I know you have that -- with the earlier round of MRIs the 1.5 grade MRI. But was there -- just trying to understand the decision process not to sort of pursue that given the elderly is where your focus is.
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Dig Howitt, Cochlear Ltd. - President [39]
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Yes, so I think some of the more complicated decisions we make are how do we spend the R&D budget. We have got a whole range of opportunities and our primary focus there is on hearing outcomes and the ability to -- for people to improve their hearing. And on lowering the overall cost of care so that there is more capacity for more people to get care.
So I'm not going to go into the sort of explicit decisions we've made, yes or no, on various features over time. Those decisions are complicated, but certainly our priority is around hearing outcomes and making sure that care is convenient and low-cost. It is natural in a competitive market that our competitors will look for things that we don't have.
And they continually do that, as they should, and try to find a feature that we don't have and push and market that feature well. And we have got very strong competitors, so I expect from time to time there will be features that we don't have that our competitors do have. And that is the nature of a competitive technology business.
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Steve Wheen, Evans and Partners - Analyst [40]
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And just some questions for Brent on the provision. Could you explain the contingent consideration release that went through the P&L? A little bit unsure as to what that is.
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Brent Cubis, Cochlear Ltd. - CFO [41]
------------------------------
Nothing has really gone through the P&L. We have just changed it to contingent liability, as Dig mentioned. Before we used to have that 21 -- we had about $21 million or so in the provision at June. And you can't have your provision and then also have the contingent liability.
We have spent quite a lot in legals in the last few years on the case anyway and we also outlined before with the ASX announcement that we have a bond in place and there is some interest cost. So the future cost associated with the AMF case will be around that [19 million] that we have in the balance sheet now.
------------------------------
Steve Wheen, Evans and Partners - Analyst [42]
------------------------------
Yes, sorry, that wasn't exactly what -- I mean that was useful, but I also was asking about the Sycle.
------------------------------
Brent Cubis, Cochlear Ltd. - CFO [43]
------------------------------
Oh, the Sycle -- sorry, are you talking --?
------------------------------
Steve Wheen, Evans and Partners - Analyst [44]
------------------------------
Yes, yes.
------------------------------
Brent Cubis, Cochlear Ltd. - CFO [45]
------------------------------
Oh, you're talking Sycle; sorry, I thought you were talking AMF.
------------------------------
Steve Wheen, Evans and Partners - Analyst [46]
------------------------------
Yes, I just was talking about what were some of the line items in the other income (multiple speakers).
------------------------------
Brent Cubis, Cochlear Ltd. - CFO [47]
------------------------------
Yes, so there is about -- there is a release of the Sycle and there is also an offset of Earlens. You might recall in June we wrote off some Earlens cost which is one of those investments we made a few years ago. The two, it's about $3 million favorable also the net impact of those two.
On the summary P&L we have netted them off, but in the notes to the accounts you can see them broken out. It is on -- in the notes you can see the release for Sycle and you can see the Earlens expense above it.
------------------------------
Steve Wheen, Evans and Partners - Analyst [48]
------------------------------
Okay. And sorry, just to be clear on Sycle -- so is it you are not expecting, based on the performance of Sycle, to actually pay the consideration that was originally agreed?
------------------------------
Brent Cubis, Cochlear Ltd. - CFO [49]
------------------------------
We are paying -- we are paying a little bit for referrals and so forth, but there were two -- there was a component for -- the earn-out was based on meeting certain hurdles which was a bit below the historical growth rates that they had for the three years prior to buying the business and they have just fallen a little bit below that. They were pretty aggressive targets because we were keen for the previous owners to pursue those.
Part of the reason it went a little bit below is because the pro software that they are rolling out has just been a bit slower than we thought. But we are very happy with how the referral progress is going and that is another component of the earn-out. So rather than doing it all in June we are just releasing it almost matching, if you like, a little bit each six months. There is a little bit left there for F20. It was for three years also when we bought the business.
------------------------------
Steve Wheen, Evans and Partners - Analyst [50]
------------------------------
Okay right, that's clear. Last one for me just on the gross margin, the 300 basis points improvement, just talk to what sort of manufacturing efficiencies and how that has come about.
------------------------------
Brent Cubis, Cochlear Ltd. - CFO [51]
------------------------------
Probably, I would say half is -- it's a mix, as Dig mentioned before, with the upgrades the N7 has obviously got a little bit of a better margin. So that is part of it, but a lot of that improvement is the work that's happened which we spoke to in June with the global repair center and things like this and just improvements in manufacturing here. So there is a little bit of mix and it's also just doing things better.
------------------------------
Steve Wheen, Evans and Partners - Analyst [52]
------------------------------
Right. Thank you.
------------------------------
Operator [53]
------------------------------
Chris Cooper, Goldman Sachs.
------------------------------
Chris Cooper, Goldman Sachs - Analyst [54]
------------------------------
Hi, good morning, thank you for taking my questions. I have got three I think. So, the first one, obviously the competitor activity, the impact from that that we've seen in the period is significantly larger than we've seen for some time. Now I appreciate you are not necessarily in a position to comment on when you might be able to catch up.
But I guess my question might be historically we do see some cyclicality around innovation on the product side. Is there anything structural on this occasion which suggests that we may not see a rebound in your kind of market share position if you were to come up with a competitive similar product over the next sort of six months say?
------------------------------
Dig Howitt, Cochlear Ltd. - President [55]
------------------------------
Yes, that's a difficult question to answer. You are certainly right that over time product launches have led to shifts in market share. I think the interesting thing looking back over the last three years is we have launched products and our competitors are launching products -- I think the shifts there have still been towards us on the strength of the launches. And then in the last half we've seen a launch from a competitor which has taken meant that we have lost share.
I would expect in the future that new product launches will continue to move share to some degree. It is very hard to predict in advance how much any launch or any feature would move the share, so I don't really see that changing looking forward.
------------------------------
Chris Cooper, Goldman Sachs - Analyst [56]
------------------------------
I guess my concern would be -- I mean if you were to come to the market tomorrow with a 3 Tesla product, you would then have to go one step beyond I guess where AB and [Model] are in terms of recapturing some of the momentum you may have lost over the last six months.
------------------------------
Dig Howitt, Cochlear Ltd. - President [57]
------------------------------
I think, look, I mean sort of getting into speculating about what may or may not happen, so there is not too much I want to say there -- apart from this is one feature of many features in the portfolio. And as I said earlier, how individuals make their decision varies significantly across different people as to which features are interesting and which are not. But I don't want to get into speculating about levels of (multiple speakers).
------------------------------
Chris Cooper, Goldman Sachs - Analyst [58]
------------------------------
Sure. Just on the (multiple speakers), that was clearly a strong number. Could you just talk to the main drivers of that a bit more? I mean in your prepared remarks you mentioned the growing recipient base, but to my mind that's kind of been a feature for quite some time. And there has always been a lot of headroom in this line I would of thought. Can you help us just understand a bit more about what specifically has driven this uptake in the period and perhaps how sustainable those levels of growth might be?
------------------------------
Dig Howitt, Cochlear Ltd. - President [59]
------------------------------
So one thing to remember on the growth -- well first of all, the biggest driver is the expanding base. So certainly our base has expanded significantly since Nucleus 6. We have seen strong services growth over the last four years and more consistent growth than we have seen in previous launches.
So with previous launches we used to see with a smaller base sort of quite a spike and then it would run off the longer the market -- the product was in the market those growth rates would slow. We have seen that be a bit smoother more recently with part the launch of Kanso sort of coming mid-cycle, part our ability -- the larger base and our ability to connect with people being better. I expect that there will still be some sort of cyclicality around the cycle of an upgrade but less than we have seen in the past.
And the other thing to remember too is that -- sorry, just the other part of that to remember is that we did launch Nucleus 7 in the corresponding half and it was still strong growth. If you go back to the first half of 2018 we still had strong services growth which included the launch of Nucleus 7 partway through that half. But we also are cycling a full six months of Nucleus 7 in this half versus a little bit less in the previous one.
------------------------------
Chris Cooper, Goldman Sachs - Analyst [60]
------------------------------
Good and just a quick follow-up. Can you disaggregate the impact of Cochlear Family on this as well? Because my understanding was Cochlear Family was a larger initiative in the US than it was in Europe, but it does appear as though the services growth is much stronger in Europe than it is in the US. Is that correct?
------------------------------
Dig Howitt, Cochlear Ltd. - President [61]
------------------------------
Yes, certainly in the half services growth was stronger in Europe than in the US. Our Cochlear Family is a global initiative; we continue to expand the number of countries in which we offer Cochlear Family. And Cochlear Family is more a longer-term play for us to stay engaged and connected with our customers than a direct driver of upgrades at the moment.
So people who are joining Cochlear Family are new customers who therefore are not eligible for an upgrade for perhaps another five years, or people who hear about the Cochlear Family and then want to join. And they may be eligible for upgrade but equally could be someone who comes for an upgrade and then learns about Cochlear Family.
So I would say at this stage Cochlear Family is not a big driver of the upgrades but it is a big driver of us having better connection with our recipients, which is important in four and five years' time as we get into future upgrade cycles.
------------------------------
Chris Cooper, Goldman Sachs - Analyst [62]
------------------------------
Understood. Thanks for the help.
------------------------------
Operator [63]
------------------------------
David Stanton, CLSA.
------------------------------
David Stanton, CLSA Limited - Analyst [64]
------------------------------
Good morning and thank you very much for taking my questions. Look, I am interested in understanding a little bit more about the EU and the health budget constraints that you are seeing. Is that continuing into the second half and sort of more -- I'd like your opinion as to whether it is a macro call as well.
------------------------------
Dig Howitt, Cochlear Ltd. - President [65]
------------------------------
It's too early to call if that's continuing into the second half. Look, we have always seen in Western Europe -- we have a portfolio of countries in Western Europe. And when we look into the detail going back over time you always see some countries going down and some going up and some going flat, which is a combination of funding caps and indications and local conditions. This time we have seen more of them flat than growth that we've seen.
I think we have sort of foreshadowed for a while that there are indications of funding constraints in Western Europe. They have been there for quite a while and if you look back over time our revenue has grown -- actually grown consistently in Western Europe. So we know that the markets do grow but it can not necessarily always be linear.
We can see in some countries waiting lists building. Those waiting lists of people then start to put pressure on the government to expand funding, raise the issue of in some places competition between the services budget and the implant budget. That means that if services grow well there might be less money for implants.
It is complicated. It's country by country. We have always had a portfolio effect and this time we have seen more flat than normal where we'd see some expansion. But too early to call in this half if that's a timing issue or more of a structural issue and is it related to sort of macroeconomic conditions in Europe.
And it does highlight the importance of the work that we do, as I said, in market access. So we are hopeful of an indication expansion in the UK coming soon which would come with some market growth and some funding.
------------------------------
David Stanton, CLSA Limited - Analyst [66]
------------------------------
Thank you. Understood. I wonder if I could press you a little bit more on granularity on the number of China tender implants you did in this half and in first half 2018.
------------------------------
Dig Howitt, Cochlear Ltd. - President [67]
------------------------------
Insignificant for both. It's a rounding error in our growth numbers.
------------------------------
David Stanton, CLSA Limited - Analyst [68]
------------------------------
Okay. And I wouldn't want Brent to feel left out. Can you give us some indication, Brent, for effective tax rate for 2019 and potentially for 2020 as well if you are able to give that, thank you?
------------------------------
Brent Cubis, Cochlear Ltd. - CFO [69]
------------------------------
Assume the 26% going forward.
------------------------------
David Stanton, CLSA Limited - Analyst [70]
------------------------------
For 2019 and 2020?
------------------------------
Brent Cubis, Cochlear Ltd. - CFO [71]
------------------------------
Yes. We missed out -- the Senate last week unfortunately kicked the R&D thing down the road. We went down to Melbourne to present on that inquiry and they decided with the election all that stuff is all too hard. We are hoping to get a little bit more from that but if we did then that would save us another $1.5 million or so. But at the moment it will be around 26%.
------------------------------
David Stanton, CLSA Limited - Analyst [72]
------------------------------
Thank you. Understood. Thank you.
------------------------------
Operator [73]
------------------------------
Saul Hadassin, UBS.
------------------------------
Saul Hadassin, UBS - Analyst [74]
------------------------------
Good morning and thanks for taking my question. I will just start with guidance. So you have reiterated the guide there, but I noticed currency has come down a bit, 75 to 76 (inaudible). So just thinking about that and looking at your likely second half performance across -- particularly across the revenue line, I'm just wondering, either Dig or Brent, I mean do you think -- it looks like it's a very tough sales number for the second half you are coming up against.
I am wondering what you are assuming in terms of both unit sales growth in the second half but also on the upgrade side as well there was a big step up last year in the second half in services. And so do you think you can grow either both of those revenue lines or is this more of a cost phasing issue for second half so in fact revenues are likely to be weaker but your costs will come down in line with those?
------------------------------
Dig Howitt, Cochlear Ltd. - President [75]
------------------------------
Yes, look, we are not going to go into specifics of breaking down our forecast revenue into the second half. We did guide -- I did just guide that our services growth would be a bigger part, and our developed market implant growth a lesser part. But we are still maintaining guidance. We still are aiming to hold the net profit margin to grow in line with our revenue. Certainly you are right to recognize that we had a strong second half last year and obviously we factor that into our forecasting and our price.
------------------------------
Saul Hadassin, UBS - Analyst [76]
------------------------------
Okay, I will ask a different question. Just on the upgrade cycle, you mentioned it's tracking sort of [circa] in line with the Nucleus 6 processor rollout. So can you tell us, Dig, roughly where you are in terms of the penetration of the installed base?
And historically Cochlear said that there was certainly room to drive that penetration rate up from what used to be about 50%. So where are you at now and do you think you can get that installed base penetrated at a higher rate than 50% for this cycle?
------------------------------
Dig Howitt, Cochlear Ltd. - President [77]
------------------------------
Yes, so you are right, we say the penetration in developed markets goes to sort of 40% to 50% over the five years. Our penetration at the moment is in line with -- about in line with where Nucleus 6 was at the same time. That penetration does vary by country and that's dependent on how funding works, our ability to contact our customers varies by country. The role of clinics in providing upgrades varies by country.
With all of that we do believe that there continues to be an opportunity to expand the penetration over time in some of the countries that are I suppose below the average and we are working hard to do that. We are on track with where we expect to be at this point in the cycle.
------------------------------
Saul Hadassin, UBS - Analyst [78]
------------------------------
Okay, and if I could ask one last question again sort of on the lines of quick guidance, but on cost, Brent, so looking at SG&A and R&D growth in the half in constant currency, is that a reasonable run rate to assume for the full-year growth for the cost line?
------------------------------
Brent Cubis, Cochlear Ltd. - CFO [79]
------------------------------
As Dig mentioned, basically the guidance number that we have will be a mix of all that. So you can see the difference there with the local currency -- with the reported and the constant currency in the sales line. So that gives you a good feeling for the overseas proportion. But overall the guidance we are happy with and it would just be a mix of the balance between the revenue and the cost.
------------------------------
Saul Hadassin, UBS - Analyst [80]
------------------------------
All right. Thank you.
------------------------------
Operator [81]
------------------------------
John Deakin-Bell, Citigroup.
------------------------------
John Deakin-Bell, Citigroup - Analyst [82]
------------------------------
Good morning. I just wanted to dig a little bit deeper into this developed market slowdown. I note that in the AGM in mid-October the Chairman said that you were expecting continued growth across developed markets. So did you see a slowdown going into the potential launch of the competitive product or was it kind of business as usual and then it really became obvious post the AGM that you were going to have flat developed market sales?
------------------------------
Dig Howitt, Cochlear Ltd. - President [83]
------------------------------
So, we do expect continued developed market growth and we expect that to happen over the medium and the long run. That is why we are investing in awareness and access and building this channel from hearing aids through to cochlear implants. There is enormous potential there with the demographics and all of the things that we have talked about over time. So I'm not quite sure what your question is around the timing of seeing --.
------------------------------
John Deakin-Bell, Citigroup - Analyst [84]
------------------------------
Well, specifically now for FY19 we expect continued growth across the developed markets. And I have to admit I see at the time he was talking about cochlear implants. So to come out just a few months later and not have any growth it's just a bit confusing. That is why I am trying to understand did he think that you were going to have cochlear implant growth in the developed markets when he made those comments in mid-October or was it subsequent to that that the kind of market conditions changed?
------------------------------
Dig Howitt, Cochlear Ltd. - President [85]
------------------------------
Okay, I see your question. I think as we talked about earlier. The launch of this competing product was in September. Our AGM was in October. We obviously see more the longer a product's in so I think it's probably fair to say we've seen more of the impact of that than we could see in October. And that is natural to be sort of five months after launch than one month after launch to have a better feel for what is the impact of that launch.
------------------------------
John Deakin-Bell, Citigroup - Analyst [86]
------------------------------
Okay. And just so I am clear, the impact being more on the pediatric or on the older population where the share loss has been?
------------------------------
Dig Howitt, Cochlear Ltd. - President [87]
------------------------------
Again, it varies based on individual decisions as to what is important to them, what other medical conditions they have can relate to how important MRI is or not. So there's not necessarily an impact across different -- to the extent there is an impact across different segments, it is more about individual decisions than it is about age.
------------------------------
John Deakin-Bell, Citigroup - Analyst [88]
------------------------------
Right. Okay. And just finally, I did note also that in your release today you told us that the District Court was asked to award USD123 million in interest against you, which I thought was not immaterial. Did you consider mentioning that at the time or has that just happened in the last few days that has caused you to release that information today?
------------------------------
Dig Howitt, Cochlear Ltd. - President [89]
------------------------------
Okay, so that has happened obviously after the November judgment and the November announcement. It is an application to the court. It is not a decision, not an award and so we are disclosing it now knowing that there is still significant uncertainty over all of this. But as I said, we wanted to disclose everything we knew in the contingent liability.
------------------------------
John Deakin-Bell, Citigroup - Analyst [90]
------------------------------
Okay. That's helpful. Thanks, Dig.
------------------------------
Operator [91]
------------------------------
Craig Wong-Pan, Deutsche Bank.
------------------------------
Craig Wong-Pan, Deutsche Bank - Analyst [92]
------------------------------
Good morning. Just wanted to ask about Advanced Bionics. You called out that they have impacted your US and German sales. Have they launched and are you competing with them in your other key markets?
------------------------------
Dig Howitt, Cochlear Ltd. - President [93]
------------------------------
Yes, they certainly have launched and obviously there has been an MRI compatible implant around in the market since -- many markets since 2014. I called out Germany and the US because that is where we've seen the biggest impact in terms of market share.
------------------------------
Craig Wong-Pan, Deutsche Bank - Analyst [94]
------------------------------
Okay. So would you expect that to impact your other markets in the short term or do you feel that is kind of filtered through at the moment?
------------------------------
Dig Howitt, Cochlear Ltd. - President [95]
------------------------------
Look, I think we will wait to see that. I called out those two because those two have had the biggest impact. Again decisions -- the importance of different features varies by individual, it varies by clinic. There are some country specific factors around this. So if you look at Germany for example, Germany does more MRIs per capita than virtually any other developed country. So MRI is used as a medical treatment much more in Germany than many other countries.
So there is a range of factors that lead to how important a feature is or isn't in a country. So we obviously are basing what we are seeing now on the impact that we are seeing across the world and called out two countries because the impact there has been most significant.
------------------------------
Craig Wong-Pan, Deutsche Bank - Analyst [96]
------------------------------
Okay. And then just on your guidance, the change in FX rate, are you able to help me quantify what the impact of that was at the NPAT line from using a lower FX rate?
------------------------------
Dig Howitt, Cochlear Ltd. - President [97]
------------------------------
So let me answer it -- let me give you a more generic one because I'm not quite sure of the specific question. But as we have said over time, we aim to hold the net margin in line with revenue. And if we get gains from tax or if we get gains from FX or anywhere or interest or efficiency we will aim to reinvest any gains that we get in market growth.
------------------------------
Craig Wong-Pan, Deutsche Bank - Analyst [98]
------------------------------
Okay. I was getting at like given you're using a lower FX rate now, did that provide like a sort of $3 million benefit or something similar to that versus what you were using a previous FX rate?
------------------------------
Brent Cubis, Cochlear Ltd. - CFO [99]
------------------------------
No, you can see that with the FX contracts as well. So I think we've got contracts going out the next 12 months, it's going to soften the $0.72 anyway because those contracts are a little bit higher, which you can see in the FX line. So overall we have allowed for that in our guidance using the FX of $0.72.
------------------------------
Craig Wong-Pan, Deutsche Bank - Analyst [100]
------------------------------
Okay. And then just the last question on your cash conversion, another strong performance. Just wondering if you believe that level of cash conversion can hold that going forward.
------------------------------
Brent Cubis, Cochlear Ltd. - CFO [101]
------------------------------
It's probably going to be one of the best ones I've seen for a while I'd say. It won't be that high going forward because you didn't have that one-off from the tax last year. And there are some non-cash kind of releases in there like Sycle and stuff like that.
------------------------------
Dig Howitt, Cochlear Ltd. - President [102]
------------------------------
But we would expect operating cash flow to stay above our net profit -- around or above our net profit.
------------------------------
Brent Cubis, Cochlear Ltd. - CFO [103]
------------------------------
It will always be very strong.
------------------------------
Craig Wong-Pan, Deutsche Bank - Analyst [104]
------------------------------
All right, thank you.
------------------------------
Operator [105]
------------------------------
Lyanne Harrison, Merrill Lynch.
------------------------------
Lyanne Harrison, BofA Merrill Lynch - Analyst [106]
------------------------------
Hi, I just want to -- if you could elaborate a little bit more on the adult market. I think previously you called out that about 70% of your implants in the US were adults. Can you give us an indication of what it is in say Germany, Australia and some of the other key markets?
------------------------------
Dig Howitt, Cochlear Ltd. - President [107]
------------------------------
Yes, yes, we certainly talked about some markets and are happy to give those figures again. So the US is about 70/30, Australia is also about 70/30 -- 70% adults, 30% children. Germany is -- most of Western Europe is around 50/50, in Germany it's a little bit more adults. There are about 70% adults and 30% children in Germany as well.
------------------------------
Lyanne Harrison, BofA Merrill Lynch - Analyst [108]
------------------------------
And has that been the case --
------------------------------
Dig Howitt, Cochlear Ltd. - President [109]
------------------------------
Most of the rest of the countries are 50/50.
------------------------------
Lyanne Harrison, BofA Merrill Lynch - Analyst [110]
------------------------------
-- for this half?
------------------------------
Dig Howitt, Cochlear Ltd. - President [111]
------------------------------
Look, best we can see -- yes, remember there is a delay on registration of surgery. So we have pretty good visibility by segment that will improve as the months go on. But yes, we are still seeing pretty much -- look, over half that split doesn't change as much. As I said, the adult seniors are growing faster than children. So in all of those countries the percentage of adults as a proportion of total will grow over time, over six months you don't see a huge change in that.
------------------------------
Lyanne Harrison, BofA Merrill Lynch - Analyst [112]
------------------------------
And then -- thank you for that. And moving on to emerging markets, I guess you called out Argentina and Turkey. But can you talk to some of the other countries where you are seeing growth and what the mix is between private pay and tenders in those markets?
------------------------------
Dig Howitt, Cochlear Ltd. - President [113]
------------------------------
So, we certainly -- look, we are seeing growth across a broad spectrum of emerging markets over the last half which is pleasing. And that growth comes through both in tenders and in private pay, both are significant opportunities. So we continue to see expansion of tenders, so we see governments are seeing the benefits of cochlear implants and funding more -- typically funding more over time.
And equally as we said before, the private pay markets typically grow on the back of tender markets, that that gets more surgeons into doing cochlear implants. The results become more obvious and then parents who are wealthy enough and have a child born with severe to profound hearing loss then look for solutions and that expands the private pay in line.
------------------------------
Lyanne Harrison, BofA Merrill Lynch - Analyst [114]
------------------------------
And have you seen any particular trends in the Chinese market with the private pay and the change in exchange rates and the like?
------------------------------
Dig Howitt, Cochlear Ltd. - President [115]
------------------------------
So, the change in exchange rate with China hasn't had any significant impact on our sales there, not like Argentina. Argentina had a 50% devaluation. That does have an impact. Private pay continues to grow in China. It continues to be a market with a lot of potential over the long term and we continue to see growth in private pay surgeries.
------------------------------
Lyanne Harrison, BofA Merrill Lynch - Analyst [116]
------------------------------
And then just one last question following up with Steve's comments on gross margin. You called out the reason for that was manufacturing efficiencies, improvements in your repair center and warranties. You mentioned that also at the last annual results. How many more halves do you think that that can be improved on?
------------------------------
Brent Cubis, Cochlear Ltd. - CFO [117]
------------------------------
I think we are probably -- 75% margin is probably going to be the best we will see for a while. We have done a very good job but that there is only so much we can do. Remember down the track we will have China and things like that as well, so that will have an impact in the short term and maybe make it a little bit higher. Because you are gearing up the manufacturing plant over there. But that is a few years away.
------------------------------
Lyanne Harrison, BofA Merrill Lynch - Analyst [118]
------------------------------
Okay. Thank you very much.
------------------------------
Operator [119]
------------------------------
Gretel Janu, Credit Suisse.
------------------------------
Gretel Janu, Credit Suisse - Analyst [120]
------------------------------
Thanks, good morning. Just firstly on cochlear implants, until you potentially launch new product what are you trying to do to try and maintain your market share position? Are you responding with price?
------------------------------
Dig Howitt, Cochlear Ltd. - President [121]
------------------------------
Okay. No. Look, there is a whole range of features that lead to the sale of a cochlear implant in developed countries. Our focus is on hearing outcomes and the reliability of our products that we continue to sell those benefits hard.
------------------------------
Gretel Janu, Credit Suisse - Analyst [122]
------------------------------
Okay. So it's just more on your marketing as opposed to anything else?
------------------------------
Dig Howitt, Cochlear Ltd. - President [123]
------------------------------
Yes, marketing and our sales ability.
------------------------------
Gretel Janu, Credit Suisse - Analyst [124]
------------------------------
Okay, good. And I just wanted to clarify the Sycle-related strategic considerations. So, on my estimate there is roughly $23 million left. Should we assume like an extra $5 million per -- of releases per half until all that is complete?
------------------------------
Brent Cubis, Cochlear Ltd. - CFO [125]
------------------------------
It really just depends on how Sycle -- the growth of the business. We are hoping that we'll actually -- that we'll exceed their targets and we won't have to release it, we'll sit in the revenue line. So, and your $23 million is probably a little bit high, but there will be -- it will be released if they don't meet it.
------------------------------
Gretel Janu, Credit Suisse - Analyst [126]
------------------------------
Okay, thanks.
------------------------------
Operator [127]
------------------------------
There are no further questions on the phone.
------------------------------
Dig Howitt, Cochlear Ltd. - President [128]
------------------------------
Okay. I think if there is no more questions, thank you all -- sorry, one more question here locally.
------------------------------
Unidentified Analyst [129]
------------------------------
(Inaudible) from Taylor Collison. Could you just talk about the timeframe for the China factory, when you expect it to actually be complete? And secondly, sorry, on the US litigation, how long does your provision last for? What is your expected timeframe in terms of the appeal hearing?
------------------------------
Dig Howitt, Cochlear Ltd. - President [130]
------------------------------
Okay. So yes, on the China factory, so we have started construction. We expect the factory to be complete in 2020 and then a regulatory approval cycle that could be one year, it could be longer after that. So into production 2021, 2022, just depending on regulatory.
And then similarly for the AMF case, so we are in the hands of the appeal court but we expect that that appeal and decision process will run over perhaps the next 18 months or so, 18 months to two years. And that obviously depends on the outcome of the appeal as to whether there is then a retrial in the District Court, which would carry on into the future.
------------------------------
Unidentified Analyst [131]
------------------------------
(Inaudible - microphone inaccessible).
------------------------------
Brent Cubis, Cochlear Ltd. - CFO [132]
------------------------------
We have calculated that based on the cost to date for the AMF over the last three to five years or so. So that would really take you out for a worst-case scenario. So you have the appeal and depending what happens there.
------------------------------
Dig Howitt, Cochlear Ltd. - President [133]
------------------------------
Okay. If there are no more questions, thank you all for joining the call or coming out to see us that Cochlear. And we will close it off.
------------------------------
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