Fisher & Paykel Healthcare Corporation Limited (FSPKF) CEO Lewis Gradon on Q2 2021 Results - Earnings Call Transcript
Fisher & Paykel Healthcare Corporation Limited (OTCPK:FSPKF) Q2 2021 Earnings Conference Call November 24, 2020 4:00 PM ET
Company Participants
Marcus Driller - Vice President, Corporate
Lewis Gradon - Managing Director and Chief Executive Officer
Lyndal York - Chief Financial Officer
Paul Shearer - Senior Vice President of Sales & Marketing
Conference Call Participants
Andrew Goodsall - MST Marquee
Marcus Curley - UBS
Lyanne Harrison - Bank of America
David Low - JP Morgan
John Deakin-Bell - Citi
Chris Cooper - Goldman Sachs
Tom Deacon - Macquarie
Chelsea Leadbetter - Forsyth Barr
Stephen Ridgewell - Craigs Investment Partners
Operator
Good day everyone. Welcome to Fisher & Paykel Healthcare's Results Conference Call. My name is [Kellyanne] and I'll be your operator for today's conference. At this time, everyone except the guest speakers will be in a listen-only mode. Later, we will conduct a question-and-answer session. We ask for your assistance in keeping the call to a maximum of one hour today. [Operator Instructions] Please note that today’s call is being recorded.
At this time, I like to turn things over to Marcus Driller, Vice President of Corporate. Please go ahead.
Marcus Driller
Thank you, [Kellyanne]. Good morning everyone, and welcome to the Fisher & Paykel Healthcare first half 2021 results conference call. On the call today are Lewis Gradon, our Managing Director and Chief Executive Officer; Lyndal York, Chief Financial Officer; Paul Shearer, Senior VP of Sales and Marketing; and Andrew Somervell, our VP of Products and Technology.
Lewis and Lyndal will first provide an overview of the results and then we’ll open the call to questions for the team. We’ll be discussing our results for the six months ended 30 September, 2020. And we have earlier today provided our interim reporting including financial statements and commentary on our results to the NZX and ASX. These documents can be accessed on our website at fphcare.com/investor.
With that, I'd now like to turn the call over to Lewis.
Lewis Gradon
Okay, thank you, Marcus, and welcome, everyone. Today I'm going to be referring to the investor presentation pack that was released to the NZX and ASX this morning. I’m going to start on Page 3, but before getting into details of our financial results, I really want to start by thanking some people who are very important to us.
First, I'd like to express my thanks and our admiration to the thousands of healthcare providers around the world who have responded to the COVID-19 pandemic with such care and such courage. Second, I want to thank everyone across our entire business, but especially our families and partners, for the contribution you have made this year, supporting the single minded focus of our people, either working from home, or the long hours at the manufacturing and distribution sites, and all of us for extended periods of time, and all of us at a time when you may have had other major concerns as well.
Our families and partners have made a big contribution to Fisher & Paykel Healthcare’s results this year and we really want to acknowledge that. And thirdly, I want to thank our suppliers all around the world. They've all gone above and beyond to provide the raw materials, the components, and the services we need to add to the global call through our products. So thank you.
So now, turning to Page 3, I'd like to acknowledge some of the highlights for the half year. Our biggest achievement by far was ramping up production on a number of our hospital hardware and consumable products to meet that customer demand. We accelerated production in the new Daniell Building, and we commenced planning for our third manufacturing facility in Mexico all in the half. We also developed a wealth of new online resources to support healthcare providers who are treating patients with COVID-19.
So turn now to our results on Page 5. For the first six months of the 2021 financial year, Fisher & Paykel Healthcare delivered extremely strong financial performance. Overall, operating revenue for the first half of 2021 was $910.2 million. And this was a 59% increase compared to the first half of the 2020 financial year. And it's 61% in constant currency. Net profit after tax was $225.5 million. That's up 86% on the first half of last year or 87% in constant currency terms.
Growth continued to be driven by hospital hardware, and they did increased 383% in constant currency. In short, the world needed our Airvo our Optiflow and our humidification systems and we have delivered. Our consistent practice has been to pay a dividend to shareholders. Given the positive result, our board of directors has approved a fully imputed dividend of $0.16 per share. That's an increase of 33% on the first half of the previous financial year.
Now, achieving these results has required an extraordinary effort from our entire team. And to acknowledge the way our global team has gone above and beyond for what has doubled the discretionary profit sharing [times] our people will receive for the first half of the financial year. This total bonus is equal to approximately 3.1% of annual base pay for each person. And it's a total profit share of about $12 million.
So, now looking more closely at our product groups, starting with hospital Page 6. So, these are products and systems used for invasive and non-invasive ventilation in nasal hydrotherapy and during surgery. This includes the Airvo devices and the therapies like Optiflow that are being used to treat COVID patients.
On Page 7, our reported revenue for hospital products was $681 million, up 93% or 94% in constant currency. And that's over the first half of the 2020 financial year of course. Sales and hardware and consumables continue to track surges in COVID-19 globally, and it says the virus moved across Europe, North America, South America, and South Asia. Revenue growth and new applications consumables was strong at 43% over the first half of the previous year in constant currency terms.
So, now if we move on to the homecare product group starting on Page 8, so this includes products used in the treatment of obstructive sleep apnea or OSA, and chronic obstructive pulmonary disease or COPD, as well as other chronic respiratory conditions.
Heading to Page 9, in our Homecare product group, operating revenue grew 5% to $226.2 million, with 6% growth in constant currency. The first half was challenging for our sales team and obstructive sleep apnea. Many sleep clinics around the world were closed or operating at reduced capacity. And that resulted in a reduction in new patient diagnoses.
Having said that, customers have responded positively to our Evora and Vitera mask for OSA, our new masks, and we're confident that these great products and that they've yet to reach their full potential.
So now, I'll turn over to our CFO, Lyndal York to give you some more details about the financials. Lyndal?
Lyndal York
Thanks, Lewis, and good morning everyone. On Page 10, gross margin decreased by 534 basis points to 61.7% for the half, down 420 basis points in constant currency. As Lewis discussed, there has been a sustained high level of demand for our respiratory products. Because of the challenges with global supply chains, we have been and continue to use air freight to bring in raw materials and deliver product to customers quickly.
The cost of air freight and expediting the supply of raw materials has been significant. With the cost per cubic meter of air freight averaging four times to five times higher than normal. However, we have opted not to increase prices to our customers. And this has impacted our gross margin. Excluding the additional freight costs, gross margin was in-line with the same period last year in constant currency.
The amounts and cost of air freight has reduced from the early months of the pandemic, but is still at elevated levels. We have assumed that the freight costs will continue at these current levels for the remainder of the year.
Moving on to Page 11, total operating expenses grew 17%. As this was significantly lower than the revenue growth, the operating margin increased 489 basis points to 34%. There was a negligible net impact on our operating expenses from COVID-19. Higher costs, such as personal protective equipment, well being, cleaning, and security will largely offset by reduced travel and sales event costs.
R&D expenses grew 20% to $64.6 million, reflecting continued growth and timing of R&D projects. R&D expenses were 7% of revenue for the half. We have a strong new product pipeline, including new humidification systems, flow generators, masks, consumables, and information solutions all under development.
SG&A increased 15% to $118.1 million for the half or a 16% increase in constant currency. We anticipate that our constant currency operating expense growth for the second half will be slightly lower than the growth rate in the first half.
Moving to Page 12, operating cash flow was $218.1 million. Our working capital increased, primarily reflecting the growth in the business and rebuilding our inventory including the sea freight pipeline, which were lower than usual at the end of March.
Capital expenditure, which includes purchases of intangible assets was $94.5 million for the half, compared with 86.6 million last year. Our fourth New Zealand building, the Daniell Building, was completed this half and we have been accelerating our investment in manufacturing capacity to ensure we have an increasing supply of our products. We're still expecting to spend approximately $195 million in CapEx for the full-year.
Our free cash flow, which is operating cash flow less capital expenditure and lease payments was $118 million for the half. From this free cash flow and our short-term deposits, we paid $89 million in dividends during the half. The balance sheet remains strong. Debtor days are within the normal range at 44 days and in-line with the prior year.
Inventory has increased with business growth and a rebuild from lower levels in March. Net property plant and equipment increased by $42 million from the 31 of March, mainly as the result of the acceleration of manufacturing capacity.
Net cash at the 30 of September 2020 totaled $78.1 million, up from 42.2 million at the end of March, predominantly as a result of higher sales driven by the COVID-19 demand. We had cash balances and short-term investments, mainly in New Zealand dollars, over $158.3 million at the end of September.
Interest bearing [risk] was $80.2 million with 26% of that being non-current. The $30 million facility that matured on the first of November, and was classified as current has now been replaced with [230 million New Zealand dollar] multi currency facilities maturing in September 2025. Most of the debt is held in U.S. dollars as a balance sheet hedge.
Turning to Page 13, our gearing ratio at the 30 of September 2020 was minus 7.1%, which is below our target gearing range of minus 5% to plus 5%. Based on our guide assumptions that Lewis will go through shortly, we are projecting to be around the bottom of our target gearing range at the end of FY 2021.
As Lewis mentioned previously, we will be paying an increased interim dividend of $0.16 per share payable on the 16 of December. This represents a 33% increase on the interim dividend declared last year and enables us to make the accelerated investments in manufacturing capacity that we're currently doing and expect to continue over the next year. The dividend will be fully imputed and a supplementary dividend of [$0.282] per share will be paid to non-resident shareholders.
Looking now at foreign currency on Page 14, profit after tax for the half declined by $4.9 million, compared to the prior period, primarily due to the New Zealand dollar bank stronger than at the 31 of March 2020. This includes the results of our hedging program, which contributed a loss of $1 million after tax for the first half of this year.
Our policy remains unchanged, and when there are opportunities to extend our hedging position, we're able to do so up to five years forward and in some circumstances up to 10. At current rates and the assumptions used in our guide, for the second half this year, we would have an after tax gain from hedging of approximately $10 million. These rates and assumptions would result in a decline of our H2 net profit after tax, compared to the second half of last year by approximately $13 million, due to net currency impacts.
Now, I’ll pass back over to Lewis who will outline our full-year guide assumptions. Lewis?
Lewis Gradon
Okay. So, I’ll move now to Page 16. We've had a strong first half to the year and we've continued to expand our installed base of hardware and hospitals. And since the last trading update we gave in August, we've maintained the same level of hardware and consumables revenue in our hospital group for the half year. And in our homecare product group, OSA mask revenue also continued at similar levels to the first four months of the financial year.
Now, we cannot predict the course of COVID-19, the effectiveness of preventive measures, the adoption of preventive measures, the progress of the vaccine, outcomes of vaccines, the impact of any of those on future hospital rates, or basements that countries, you know, may choose to make and treatment measures. So consequently, we really have no basis on which to provide traditional guidance for the full 2021 financial year.
So what we're doing is providing a guide to the full-year results based on the following assumptions, which I’ll list. So first, we assume that hospital hardware sales return to normal levels from January 2021. Second, we assume that the use of our hospital hardware returns down to approximately normal rates for the second half of the financial year. And third, we assume that OSA diagnosis rates are reduced for the second half of the financial year. And that's due to limited access to patients.
Finally, we assume that freight costs remain elevated, resulting in a reduction in gross margin of approximately 200 basis points in constant currency terms for the full financial year. So now, based on these assumptions and reflecting the sustained stronger hospital hardware sales to date, [on debt basis], full-year, operating revenue would be approximately $1.72 billion and net profit after tax would be in the range of approximately $400 million to $415 million.
And this guide is based on exchange rates of NZD:USD 0.69 and NZD:EUR 0.58. Just to be clear, our assumptions used in providing this guide, they're not a prediction or a forecast of the course of COVID-19 around the world or its impact on us. And they don't impact our production planning. We are continuing to grow the manufacturing capacity of those hospital respiratory products for the rest of the 2021 financial year. And that's because we think the world's counting on us and we think it's the right thing to do.
Now while the efforts to contain COVID-19 remain uncertain, we believe the exposure of clinicians around the world who have [had our hardware] bodes well for treating respiratory patients in hospitals over the long-term.
Now with that, I think we can now open for questions.
Marcus Driller
Thanks. Thanks, Lewis. And operator [Kellyanne], if I could ask you to please open the lines up for questions. And before we move to the Q&A, can I ask everybody to limit your questions to two. This is just with the view to giving everybody an opportunity to ask their questions. And of course, if you do have further questions, you're welcome to join the queue again, one at a time.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions]
Marcus Driller
Thanks, [Kellyanne]. I think we have our first question and it's from Andrew Goodsall at MST Marquee. Please go ahead, Andrew.
Andrew Goodsall
Thanks very much for taking my question. Congratulations on a great response to the COVID, and a great result. I was just going to quickly ask just if you could – any comment around third quarter trading to date just with the northern hemisphere second wave and lockdown.
Lewis Gradon
Yes, I can. But before I do that, Andrew, I want to point out one really, really big thing and maybe could relate to all the questions we're about to get. And that is, when we look back on that first half, we have massive variability from month-to-month in both our hardware and our consumable revenue. If we look at a region over the six months, we have really big variability from month-to-month. It teams to track COVID hospitalizations.
If we just take a snapshot of one month from time and we look at the world, again, we have really big variability. And I think that if we took the last three months and we tried to forecast the next three months of that, we'd be changing our forecast on a monthly basis. So, I don't think there's a lot of value in doing that or going – Andrew, there's just such massive variability. Having said all that, and you know, with that caveat, it's looking pretty strong.
Andrew Goodsall
Any anything else you want to add to that or [just strong]?
Lewis Gradon
Well, again, it's impossible to draw, you know, a trend of what looks like a pretty random. It doesn't look to us like anything's going away.
Andrew Goodsall
Okay. And then the second question, just curious around your [indiscernible] comments on OSA, and the comment on diagnostics in the second half, I was just going to say, if you could expand on that, because I guess I'm reading it as, as you're seeing it slowing of new patients in the second northern hemisphere lockdown, because of lack of access to diagnostics.
Lewis Gradon
Yeah, I think that's a fair comment. And we're trying to take account of the impact of COVID on sleep labs being open, whether they can pervert to home diagnosis where the patients want to be engaged in treating sleep apnea, where the patients have the money to contribute to that, to try to take account of a whole lot of things. We've kind of landed on, it's almost possible impossible to try and predict those impacts. So, we've taken an arbitrary number to put in our guide. And that arbitrary number, we just assumed that we would have 80% of last year's new patient stats. Now second half would be 80% of that this year. Just want to emphasize, we've used that – it's relatively arbitrary number. Fair comment to say from what we're seeing. We know it's reduced. But to what extent and to how long in the future, we just picked the number.
Andrew Goodsall
That's fantastic. Thank you very much.
Lewis Gradon
Okay, thanks, Andrew.
Marcus Driller
So our next question comes from Marcus Curley at UBS. Go ahead, Marcus.
Marcus Curley
Good morning. I just wondered if you could talk to, you know what you think the benefit from COVID has been across invasive ventilation versus new apps or high flow? Yeah, I suppose it looks like the growth and consumables and invasive ventilation was stronger. Obviously, the average consumable price there is lower. So, would suggest quite a large skew in terms of COVID patients towards your traditional business. This is your new app business.
Lewis Gradon
That’s a complex question, Marcus. So, remember that given you new apps growth rate. And in new apps, you've got also got non-invasive ventilation that's running a bit under the average rate, and you've also got surgical, which has pretty much disappeared during this, you know, during the last six months. So, you've got some drags on the new apps, right? That would be the first comment. Second comment to your question would be that, you know, we’re fairly confident that all these intensive care ventilators that have gone out, not all, but a large proportion of these ventilators have gone out, we've managed to supply them with humidifiers and humidification products.
And then I guess the third caveat is, typically in a normal year, we talk about utilization, we're talking about our revenue in a normal year, that kind of makes sense. But what we don't actually have visibility to utilization. So, what we have visibility to is our sales. So, there's another variable there that we can't put a number to, and that is how much of this is being utilized. And how much of this is customers, hospitals, supply chains, rebuilding the inventory.
Marcus Curley
Could you talk a little bit to what you think your installed base has increased by across invasive installation and [high flow]?
Lewis Gradon
Now that's not a place that we're comfortable going, you can see certainly the numbers for the half. You know, so you can draw a conclusion that it's increased substantially.
Marcus Curley
Okay. And secondly, just on the flu season, is that an influence on why you're suggesting for the second half, or assuming I should say that utilization in the hospital space falls back?
Lewis Gradon
So, we're not really thinking about the flu season this year. We think it's just being completely and utterly swamped by the other flu’s, the COVID-19. So it really hasn't played into any of the assumptions. Again, it's kind of an arbitrary number that we've chosen to say, well, we'll assume normal utilization for the second half, but I spoke about all the variability in the first half. And on a month-to-month basis, it's all over the place, but if you take the average over the first half, it doesn't look too unusual. So that's kind of the only thought that's gone into that assumption for the second half of averaging about normal utilization.
Marcus Driller
Thanks very much Marcus. Yeah, appreciate it. Next question comes from Lyanne Harrison at Bank of America.
Lyanne Harrison
Good morning, all. Thank you for taking my question. I know you've mentioned you can't speak exactly to the October and November trends, but can you give us some indication? And if we look at the hospital revenue, if we look at hardware, are us still seeing demand on hardware come through from all the geographic regions such as U.S., Europe, APAC, and other or other specific regions that you can call out that is still demanding hardware?
Lewis Gradon
I think the answer to your question Lyanne is yes. And it's all regions. With the caveat that we're talking about two months, what's been a very variable, well, you're up to eight months now, very, very variable eight months, but it's last two, I'd say across all regions and hardware demand continues.
Lyanne Harrison
Okay. And would that hardware demand be stronger or less strong than what you experienced through the first wave, particularly through the United States?
Lewis Gradon
Okay, not caveat, that with the very, very variable, taking two months out or something, you know, to try and put a color on it, you know, we can go, we can have a month that's utilization looks like maybe double normal [to months] where it looks like half. You know, so you're talking big variation, which is, I think it's very, very dangerous to focus in on two and a bit, months, one and a half months, one and a half months, really dangerous. And, again, with that caveat, the last couple of months, look, you can pick a couple of months that look like that out of the first half, put for any region actually.
Lyanne Harrison
So just to clarify that, if I looked at, you know, the first, you know, say one and a half months of third quarter, compared to, you know, April and May or April in the first half of May, would that demand to be – the [indiscernible] demand be stronger or less strong than that period? I guess what I'm trying to understand [Multiple Speakers]
Lewis Gradon
What I'm telling you is I could find two months in the first half look like these two months. So, I think we are just on such dangerous ground trying to draw any extrapolation, the other two months, I'd really want to caution you on that it’s dangerous.
Lyanne Harrison
No problems. Why don't I move on and let's talk about consumables revenue, would you say that there is possibly increased – likely to be increased consumables growth given that you've got a high install base now, and then also a second wave of coronavirus, particularly through the United States?
Lewis Gradon
Well, yeah, we do think that's likely. And if you look at the guide, we gave to the second half that is kind of built in there. We're assuming that the hardware base is utilized. So that gives a consumables growth. And then the only additional comment to make to that was once we get to our second half, we're lapping February and March. February and March, we had already begun to see the pandemic response in our consumables revenue.
Lyanne Harrison
Okay, thank you very much.
Lewis Gradon
Thanks, Lyanne.
Marcus Driller
Thanks, Lyanne. Our next question comes from David Low at JP Morgan.
David Low
Thanks very much. Lewis, could we start with just talking a little bit about how much pull forward sales you think you've received as a result of the recent period? So, where did the airflow Airvo nasal high flow sales end up versus where you perhaps would have predicted they would have been a year ago? I'm just trying to get a sense as to how much additional equipments been sold into the market on the hardware side?
Lewis Gradon
Well, the best sense we can give you is that 383% hardware growth of what's happened. In terms of trying to, you know, estimate what's been pulled forward, you know, I wish we could, but at the moment we have, I’d just say, we couldn't – we can interpret what's been pulled forward at all. We don’t think this is pulled forward. So far, looking at our data, we see, it looks like what we've placed is being utilized.
David Low
Okay, yeah, I guess what I was trying to get a sense is, how far ahead of plan are you like terms of rolling out of the nasal high flow? And then of course, the real question, I think, for the business is, you know, where to after the pandemic? You know, are we – have we just stepped forward a number of years and growth continues from there, or have we seen a whole lot of hardware sales into the market, which will now take a little bit of time for the underlying normalized demand to catch up, any thoughts on that?
Lewis Gradon
Yeah, you're right. That is the question. In terms of Optiflow and Airvo, we had such low global penetration prior to the pandemic. We don't think we're anywhere near saturating that market whatsoever. We think the challenge and what our job is, what our opportunity is, is to ensure it continues to be used post pandemic for, as a default therapy for respiratory support. That's what we'll be working on. And that's what we'll be aiming for. So, if we achieve that, then you know, you're right, we will have just managed to roll progress forward several years, depending on how long these rights go on for.
David Low
So, we saw a low in the COVID cases, particularly in the U.S., I wonder if there's any anecdotes that came through from that period as we as we passed the [indiscernible], there was a lot of different hardware, different type of hardware in some of these hospitals. And I'm thinking in some regions, obviously, more had earlier peaks than others. And what happened to utilization in those periods that followed, perhaps that's possible to say, but just any thoughts or anecdotes on that front?
Lewis Gradon
I think during the low that was mostly about trying to replenish inventory. So, it's a bit hard to say, from any data, what was actually going on there. People were trying to build inventory. And that might have impacted their treatment decisions also. And also bearing in mind that our sales people haven't had great access to hospitals, it's been really essential exits only during this whole period. I'm going to let Paul to add some color.
Paul Shearer
It's been lumpy for a whole variety of reasons. And David, and then and of course, you know, COVID has kind of, you know, [started] in New York and spread on other states and things. So that is an impact too. It's too much variability there to draw any real conclusions.
Lewis Gradon
And no real anecdotal that I [indiscernible].
Paul Shearer
Alright. I think there's only one other thing I would say. What has been very helpful is that we've got a whole lot of new customers, and they are gaining exposure and interest in Airvo and Optiflow. And I think that bodes pretty well for the future.
David Low
Yeah, now, look, I gather, it's an impossible question, but it's also the crucial question. If I could squeeze in one more, just the Homecare business, there's a comment there about myAirvo sales being strong. Can we just talk to how much demand you saw for treatment of patients at home, presumably COVID patients at home with myAirvo?
Lewis Gradon
So, we don't know what the myAirvo product is being used for in the home. I know, we can't give you any data around it. I think three or four months ago, you know myAirvo has been growing strongly for a while. It was sitting on a similar trajectory three or four months ago and I’m sure probably it's picked up. It's been accelerating over the last three or four months.
David Low
Yeah.
Lewis Gradon
[Indiscernible] hard to say.
Marcus Driller
Thanks, David. Next question comes from John Deakin-Bell at Citi. Go ahead, John.
John Deakin-Bell
Thanks very much. I was just trying to get a little more, I just asked that question a little differently around the geographic demand. So, you know, we've got your general geographic growth North America from a 44%, Europe 70. So, quite a big difference, but we don't have any color between the businesses and also between the hardware and the consumables in the hospital side, can you just try and give us a bit more color on where the demand geographically has come from?
Lewis Gradon
Yeah, well, first of all, those numbers you're looking at are confounded by a couple of things. They are confounded by currency, foreign exchange rates. And also, you've got kind of different proportions of [RSI] in those different markets also. So, I wouldn't go to that as my guide or and also they – more strictly defined as the geographical region where the sale was made, which may not be where the product ends up. So, I don't know if I'd rely on those numbers.
What I can tell you is that over this last half, about somewhere around half of the hardware placements during the half were outside North America and Europe. And we saw stronger consumable growth of a smaller base in consumables, outside North America and outside Europe. And I would say, in that region, outside North America and Europe, it's pretty well distributed across kind of all different sub regions. They all look pretty similar growth rates of magnitudes.
John Deakin-Bell
Okay, and in that – in those numbers, [indiscernible] is a very big Airvo line, which is that sort of North America, Europe, and AIPAC, I just wasn't sure where that was.
Lewis Gradon
Me neither.
Lyndal York
Yeah. John, it is Lyndal here. So that is basically everything that's not Europe, North America, or Asia Pacific, so, you’re Africa, Middle East Latin America, primarily there.
John Deakin-Bell
Okay, because that grew 300% or something. So, effectively you've sold stuff everywhere in the world is what you what you say?
Lyndal York
Correct.
John Deakin-Bell
Okay, thanks very much.
Lewis Gradon
If you take any under sub region, you know, if you take Latin America, if you take Middle East, if you take Eastern Europe that they will look pretty similar over, you know, six month period.
John Deakin-Bell
Okay, thanks Lewis.
Marcus Driller
Thanks, John. Our next question comes from Chris Cooper at Goldman Sachs.
Chris Cooper
Hi, thank you for taking my questions. So, my two are really on utilization, but I think you've been, you know, as clear as you can be, I guess that you expect to see some relative stability there. So look, perhaps I can just ask an even longer-term question. I mean, the longer-term ambition to sort of displace conventional oxygen therapy, you've got it on Slide 27. How much has that changed over the years? Let's just take a five year view, instead of like a one or two year view here. I mean, what percentage of conventional oxygen therapy, you know, has been displaced already today, sort of pre-COVID or during COVID, and where do you think that number is in five years time? And I guess the question is, has that steepened that penetration trajectory through COVID or do you think it's more or less the same as it was? I just be interested to hear your thoughts on the, you know, slightly longer-term view here, but perhaps I can also ask a slightly more granular one just on gross margins. Airfreight is obviously still having an effect. I wonder whether you're seeing any sort of selling advantages, actually, in terms of, you know, efficiency or speed to market. I know, you're now sort of, you know, having spent a few years above your gross margin target. You're now a bit below it. Should we think there's any sort of stickiness to some of these costs that you've incurred through the pandemic? And you know, it's actually helping to deliver some of this top line strength that we're seeing or you know, rather, you know, as we get back to more normal conditions do we gross margin come back up to where it was?
Lewis Gradon
Okay, we’ll [Technical Difficulty] the gross margin one for now, and we'll go to the first question. So, longer-term, so over the last six months, I don't know if we can put any data or number even anecdotally on have we displaced conventional oxygen therapy, you can see it in some of the clinical data certainly for COVID patients where the protocol is to start patients on nasal high flow or Optiflow. So you can see it from the clinical data whether it's a protocol. I don't know if we can help you with what percentage.
I think the fundamental here is that we've placed a lot of hardware. So, in terms our normal selling process, we need to talk about the clinical advantages and clinical benefits of Optiflow, we need to talk about the economic advantages. And then we need to have our customer purchase some hardware, and then we need to go in and install it. And then we need to go in and train every single user in the institution on how to use it. So, by placing all this hardware, we certainly over and I call it half the hurdles, the job’s half done. And maybe it's all done, depending on the experiences and thinking about COVID versus respiratory patients, maybe it's not, but that's what we'll be working on.
So today, the way we are thinking of it is that it depends how long things go on at this rate, of course, where we finish, but we are thinking that, you know, we've at least moved things forward maybe two or three years. And if we've got some work to do to displace conventional auction therapy, we're doing network with a lower hurdle. So, I think that's the best answer I can give you. The first question, of course I forgotten the second question. So Lyndal, she can remember.
Lyndal York
It's something that gross margin. So, I'll talk you through gross margin, Chris. We have seen significant impact from freight in the first half. And if you stripped out the excess freight costs, which is the percentage that we've sent air freight, which got up to 60%, earlier in the half, and averaged around 25% for the half, it's currently down slightly below 20%, but we're sending air freight at the moment. And that's what we have assumed in our guides that the second half. So, in terms of stickiness there. Then also the cost per cube of that air freight, it got up to about eight times what it would normally cost us, which is in a normal world, four to five times more expensive than sea. So, it’s quite – air freight is more expensive than sea freight, and we were saying it's exorbitantly expensive in the early months of the pandemic.
Now that has come down slightly, and we're currently tracking around two times the normal cost of air freight. That's what we've used in our assumptions for the guide for the second half. So, on those assumptions, and if that fright level of air and cost per cubic [there] hold steady, we’re expecting or we would project in our second half gross margin in constant currency to be about the same as it was in the second half of last year. So, we will still have some elevated fright costs compared to last year, but don't forget last year, we did start to see some of that elevated freight costs in March, but we are then going to see some of that volume benefit and that efficiency benefit come through to offset it. So that for the total half, second half, we would be assuming to be similar to last year, second half, which is around about that target 65% constant currency.
Lewis Gradon
And then long-term when we are carrying some additional operating costs related to COVID we don't see anything here that we think is long-term sticky.
Lyndal York
No.
Lewis Gradon
You know, PPA and sterilizing and cleaning.
Lyndal York
Correct. Yeah.
Chris Cooper
Got it. Thanks. And just a quick follow up, just on price. I mean, I noticed, I mean, last two times, you've given us updates. You've commented that you haven't increased prices. Prior to the pandemic, I believe there were modest price increases going through, you've obviously caused them, should we be thinking that price increases begin to come back at some point as we get to more normal conditions or are you happy with the current level?
Lewis Gradon
I’ll pass that question over to Paul.
Paul Shearer
Yeah, I think that – I think we can just assume, Chris, you know, when things go back to normal, our business will go back to normal, you know, the way we've conducted our business in the past will be, you know, pretty consistent with how we'd like to conduct our business in the future.
Chris Cooper
Yeah. Understood. Thank you.
Marcus Driller
Thanks, Chris. Next question comes from Tom Deacon at Macquarie. Go ahead, Tom.
Tom Deacon
Good morning, guys. And good result here. Good morning. Just one on CapEx for me, how are you guys feeling about manufacturing capacity at the moment with the continued COVID demand, and you kind of mentioned that we should expect [185 million] or so in this financial year, any indication of what we could expect in this like 2022 at the moment, given what you're seeing out there? Thank you.
Lewis Gradon
I'll give you the thinking and then I'll hand over Lyndal to get the numbers straight. Thinking that we keep building manufacturing capacity for these products until things have clearly stabilized that's the sum total of the thought. The manufacturing expansion plans currently go out to about mid next year. And obviously, it's something we are continually reassessing. Lyndal do you want to talk to the CapEx for 2022?
Lyndal York
Yeah, look, we haven't had a good look through into FY 2022 at this stage. However, there will be some carryover CapEx from what we have started this year, particularly our third building in Mexico will finish and continue spending and complete there. Likewise, as Lewis said, we'll be continuing to accelerate that manufacturing capacity into sort of the middle of next year. So there'll be some carry on of that. So that will probably have it a bit more elevated than it would normally be. It really will depend on how we're seeing COVID as well as our sales play out and making sure that we always are aiming to keep plenty of manufacturing capacity ahead of the demand and the need.
Lewis Gradon
I suppose the other comment, we're not thinking of this as abnormal or extraordinary, or one off CapEx in anyway, we’re just thinking of it as being pulled forward. We would have built this equipment and built these buildings sooner or later anyhow.
Lyndal York
Correct.
Tom Deacon
It's very helpful, guys. Thank you very much and that's it from me. Cheers.
Lewis Gradon
Thank you.
Marcus Driller
Our next question comes from Chelsea Leadbetter at Forsyth Barr.
Chelsea Leadbetter
Thanks, Marcus and morning team. Maybe if I come back to the questions that have been around hardware in the hospital, and just trying to see if I can get some context in terms of, I mean, clearly, it's been a big year in terms of the uplift, but in terms of the mix between Airvo versus your sort of [950, 850]?
Lewis Gradon
Sure. Airvo is of a smaller base and rate. So, it’s the higher end of the growth rate. Humidifiers, larger base, larger underlying rate, so it's at the lower growth rate in, low side. Does that help you?
Chelsea Leadbetter
Alright, understood. No visibility on sort of, I guess, net 50/50 split 60/40, you know, that type of kind of split between the actual demand.
Lewis Gradon
Chelsea you’re right again.
Chelsea Leadbetter
Okay. All right.
Lewis Gradon
That's good.
Chelsea Leadbetter
And then in terms of the actual guide assumption sets, so when you say return back to normal levels and appreciate this is just a, you know, a statement that you're basing your assumptions on, but what do you mean by normal? Are you referring to, sort of pre-COVID levels of revenue for hardware or are you assuming? Is it the way I should be thinking about it?
Lewis Gradon
Yeah, absolutely right. We're thinking pre-COVID. You know, so take first part of FY 2020 or FY 2019 or something like that in pro rata, that's what we're thinking?
Chelsea Leadbetter
Now, that's clear and just a second question. I appreciate we've all tried to ask the same types of questions today around understanding, you know, what's going on, geographically, etcetera, but, I mean, can we come to, I guess, one market, be it China, that maybe is in a slightly different position and could you kind of give us some context in terms of what's actually happening there with respect to demand, you know, 10 rates for your consumables, all of those type of things that may help add some color to the discussion.
Lewis Gradon
Yeah, it is interesting. So, of course, we saw that – we saw the big jump up in demand in China. Just like everywhere else and we saw it in hardware we saw it in consumables. Then we saw, when they kind of go on top of it, we saw a low, I would say over the last six months or so china for us has now returned to normal, bearing in mind that China for us normal is actually pretty high growth anyway. So, it looks like China's returned to normal high growth rather than COVID high growth. And for our Chinese market, we are seeing a higher proportion of consumables, which looks like higher utilization. So, seeing a higher proportion of consumables than we would have seen 12 months ago.
Chelsea Leadbetter
Okay. I appreciate it. Thank you.
Lewis Gradon
Thanks, Chelsea.
Marcus Driller
Next question comes from Stephen Ridgewell at Craigs Investment Partners.
Stephen Ridgewell
Good morning. I just wanted to try and clarify some earlier comments, you know, in response to the questions about trading the last one and a half months. Lewis noting your comments about not extrapolating and caveats, I guess to be clear, our growth rate is tracking a similar or stronger or weaker relative to the 383% growth that we saw in hospital devices in the first half. And similarly, for hospital consumables, can you give us directionally, you know, how that’s tracking for the last two months?
Lewis Gradon
I kind of repeat the caveats Stephen, this is a very dangerous business extrapolating, you know, monthly stuff where months can go all over the place, very dangerous business. Having said that, let's do it, shall we? Is kind of where we're going. I think fair to say, if you look at – if you look at the six month, well, if you look at the period right up till now, that overall sort of trend is probably increasing hardware. Although we'll have a month where it goes the other way, for sure, but we don't see any lit up. I would say with just the best interpretation I can give you. If we average the whole, what is it, eight and a half months? Seven and a half months. I would say probably more up and down with the trend.
Stephen Ridgewell
Into consumables in the hospital phase.
Lewis Gradon
Similar comment. [Indiscernible].
Stephen Ridgewell
Yeah. Okay. Because I guess reading from your early comments it sounded like the [peaks you saw] on April and July you're probably seeing that again at the moment?
Lewis Gradon
Yeah, something like it.
Stephen Ridgewell
Okay, and then just, also just to finish up the comments on production capacity, I think they can join unless you're guided to 100% growth and production capacity for high flow and breathing circuits by about this time of the year. I guess could you just clarify, if you kind of hit that target for 100% production growth and then can you give us any insight as to how much more runway you've got to increase production, you know, over the second half or plans to further increase production by the by the end of the period?
Lewis Gradon
Yeah, that is a real tough one. [Indiscernible] kept increasing production capacity until things stabilize. We've hit all our targets, we've hit or exceeded all our targets, actually, that we were aiming for. Maybe it can be a better turn on what we're trying to do. We're trying to rebuild inventory. Inventory is a nightmare at the moment and that we normally talk about it in weeks of revenue. Problem right now is weeks of what revenue. So, our inventory target is three months of peak demand for hardware.
Three months of whatever we've seen as the peak would like to be carrying that as stock. And for consumables, we'd like to hit to a similar [rate], three months, 14 odd weeks of stock related to peak demand for the [indiscernible]. And what I can tell you is, we're nowhere near that kind of inventory holdings at present. And so, we think we're going to keep building up the capacity until mid-next year to do [indiscernible]. This is the thinking.
Stephen Ridgewell
Okay. No, that's helpful. Yeah, that's helpful. Thanks very much.
Marcus Driller
Thanks, Stephen. We've got no more questions in the queue. So, I think in the interests of keeping this call to an hour, we’ll pass back to you Lewis to wrap up.
Lewis Gradon
Thanks, Marcus. Hey, look, I just want to say, a heartfelt thanks does go out to our customers and to those healthcare providers for all of their efforts this year, and to our suppliers, shareholders and clinical partners, who are doing an outstanding job of supporting us during this extraordinary year. And at a time in history that really does defy expectations. We're still doing what we do best. And that's improving care and outcomes for patients. So, thank you all. Thanks for the high quality questions. Much appreciated. Thank you.
Operator
That will conclude today's conference. Again, thank you all for joining us.
