ResMed Eyes Continued Growth Despite Medicare Cuts

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It's fitting that ResMed specializes in equipment to treat sleep disorders, because the company has had to convince investors not to lose sleep over the potential impact of Medicare cuts to its gear.

ResMed ( RMD ) is a major supplier of durable medical equipment (DME) to treat obstructive sleep apnea.

Sleep apnea occurs when the airway is at least partly blocked for several seconds during sleep.

The company's airflow generator equipment is based on continuous positive air pressure (CPAP) therapy. The gear is designed to deliver pressurized air through a nasal mask. This prevents the collapse of the upper airway during sleep.

Starting in July, the Centers for Medicare & Medicaid Services will institute a second round of reimbursement cuts for CPAP devices as well as masks and accessories used in the treatment of sleep apnea.

The cuts are the result of a process in which distributors of CPAP equipment and masks put in competitive bids for Medicare's business. The first round of competitive bidding involved about 10% of the U.S. population. The second round added about 56% more Americans.

The Round 2 bidding results will lead to a 47% reimbursement reduction for CPAP equipment and masks. This means distributors will receive 47% less from Medicare than they did before.

The CMS estimates that competitive bidding will save the Medicare Part B Trust Fund $25.7 billion and Medicare beneficiaries $17.1 billion between 2013 and 2022.

One result of the cuts is that sleep apnea equipment makers like ResMed and Philips Respironics, a subsidiary ofPhilips ( PHG ), might face pressure to lower their own prices to Medicare distributors.

Negative Reaction

Wall Street's initial reaction was negative. When the Round 2 cuts were announced on Jan. 31, ResMed's stock price fell 6.5% to 43.80. One concern was that the cuts were larger than expected, analysts say.

"Clearly the quantum of the reimbursement adjustment to the CPAP segment was a surprise, with initial expectations of a cut of about 30% to 35%," JPMorgan analyst Steven Wheen noted in a report following the CMS announcement.

There was also concern about the possibility that payers and insurers, which account for about 80% of U.S. CPAP volumes, might use the cuts as leverage to negotiate lower reimbursement rates with distributors.

Despite those concerns, most analysts downplay the impact on DME manufacturers in general and ResMed in particular.

"Remember that Medicare is only about 20% to 25% of ResMed's U.S. business," said David Clair, analyst at Piper Jaffray. "I expect there to be some pushback in the DME channel, and probably some pricing pressure. I think it will be manageable, though."

JPMorgan's Wheen points out that ResMed has plenty of other growth areas it can fall back on.

"We expect the pricing impact will be more than offset by the increasing global awareness of obstructive sleep apnea, the volume and margin effect stimulated by Home Sleep Testing in the U.S., the pipeline of new product releases -- particularly masks -- and the ongoing buyback (of ResMed shares)," Wheen noted.

He also says ResMed's status as a leading supplier of CPAP equipment should give it an edge over smaller, lesser known firms.

"The ability of a distributor to be profitable has just gotten harder, leaving very little latitude for them to experiment with unknown manufacturers," Wheen said.

Renewed confidence in ResMed is reflected in its recently rising stock price, which currently trades near 44.

"When everyone did a back-of-envelope analysis, they got more comfortable with the Medicare reductions, which is why the stock price has been doing well," Clair said. "And (ResMed) has been putting up solid results."

Financially, ResMed has strung together five straight quarters of double-digit earnings growth. It logged profit of 54 cents a share during its fiscal second quarter, which ended in December. That was up 23% from the prior year and 3 cents above Wall Street estimates.

Q2 revenue climbed 13% to $376.5 million, topping views for $363.8 million. Revenue in the Americas grew 16% to $211.8 million, while revenue elsewhere climbed 10%. Gross margin widened to 61.8% from 59.7% a year earlier.

During a conference call with analysts, Don Darkin, president of ResMed's SDB Strategic Business Unit, offered a bullish assessment of the company's pipeline of new products.

"(ResMed has) a number of offerings in all segments coming through this calendar year," Darkin said.

That includes new masks scheduled to be launched toward the end of 2013.

ResMed is slated to report fiscal Q3 results April 25. Analysts surveyed by Thomson Reuters expect earnings of 57 cents a share vs. 46 cents the previous year.

Meanwhile, ResMed has taken recent steps to protect its intellectual property. On March 28, it filed parallel lawsuits in the International Trade Commission ( ITC ) and in U.S. federal court to stop the infringement of patents.

The company filed the actions against Taiwanese manufacturer Apex Medical and its U.S. distributor, Medical Depot, doing business as Drive Medical Design and Manufacturing.

Patent Suits

ResMed alleges that multiple ResMed patents are infringed by Apex products. ResMed is asking the ITC to stop the importation and sales of these products in the U.S. It is asking the U.S. federal court to stop the infringement and award damages against the defendants.

In a statement, David Pendarvis, ResMed's global general counsel and chief administrative officer, said the company has spent more than two decades generating "significant advances in innovative products" for sleep-disordered breathing therapy.

"We invest over $100 million in research and development each year to fuel these advances," Pendarvis said. "Other companies should not be allowed to infringe ResMed's intellectual property by using our technology."

In another recent development, Michael Farrell March 1 succeeded his father, Peter Farrell, as ResMed's chief executive. Michael Farrell previously served as the president of the company's Americas business unit.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: ITC , PHG , RMD

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