Edwards Lifesciences Corp (EW) — Q1 2016 Earnings Call Transcript

Welcome and thank you for joining us today. Just after the close of regular trading, we released our first quarter 2016 financial results. During today's call, we'll discuss the results included in the press release and accompanying financial schedules and then use remaining time for Q&A. Our presenters on today's call are Mike Mussallem, Chairman and CEO, and Scott Ullem, CFO. Before we begin, I would like to remind you that, during today's call, we will be making forward-looking statements that are based on estimates, assumptions, and projections. These statements include, but aren't limited to, financial guidance and current expectations for clinical, regulatory, and commercial matters, as well as therapy trends and foreign currency movements. These statements speak only as of the date on which they are made and we do not undertake any obligation to update them after today. Additionally, the statements involve risks and uncertainties that could cause actual results to differ materially. Information concerning factors that could cause these differences and important product safety information may be found in our press release, our 2015 Annual Report on Form 10-K, and our other SEC filings, all of which are available on our website at edwards.com. Also, as a quick reminder, that when we use the terms underlying, adjusted, and excluding special items, we are referring to non-GAAP financial measures. Otherwise, we are referring to our GAAP results. Additional information about our use of non-GAAP measures is included in today's press release and our website.

Thank you, David. Forgive the sketchiness of my voice. I'm just getting over a cold, but if my voice gives out, I'll ask for Scott to help me out. So let’s jump into it. We are very pleased to report a strong start to 2016 with first quarter sales of $697 million, representing an underlying growth rate of 20%. Significant Transcatheter Heart Valves sales once again drove the majority of this quarter's growth, with solid performance in our core businesses, in particular Critical Care. We are also pleased to report strong bottom-line results while aggressively investing in new therapies that can have meaningful future impact. And most importantly, even more patients are benefiting from our life-saving therapies than ever before. In Transcatheter Heart Valves, global underlying sales were $366 million, up 38% over the prior year. Growth was led by continued strong therapy adoption in the U.S.; globally, average selling prices remain stable. In the U.S., underlying THV sales for the quarter were $215 million and grew 64% versus the prior year. Our performance was driven primarily by procedure growth which continued to exceed our expectations. We saw this growth across both large and small TAVR sites and it was fueled by the recent U.S. launch of SAPIEN 3. We estimate modest share gain also contributed to our results. Following the end of the quarter, at the American College of Cardiology meeting, data from intermediate risk cohorts of two clinical studies were presented. The large randomized PARTNER II trial, which compared to SAPIEN XT Valve to surgery, met its primary endpoint for two years and demonstrated non-inferiority when compared to surgery. The second trial showed that SAPIEN 3 TAVR demonstrated clinical superiority to surgery at one year on a composite endpoint, and also on individual assessments of all-cause mortality and stroke. We are very proud of these robust data and believe they provide powerful evidence in favor of expanding the SAPIEN 3 technology to a broader population of patients with aortic stenosis. We remain on track to submit the final intermediate risk data sets to the FDA in the next couple of weeks. Based on the strength of these data, it’s possible for the approval to come earlier than expected, although it's difficult to predict regulatory timelines. We are now modeling an approval and launch at the beginning of the fourth quarter. As a reminder, intermediate risk patients continue to be treated with our continued access protocol of the PARTNER II trial, which has been tracking at about $10 million in sales per quarter. This would end as commercial sales begin. Enrollment in our PARTNER III trial began recently. This randomized trial will study SAPIEN 3 in more than 1200 low-risk patients, and enrollment is expected to continue in 2017. We are pleased to receive a Pulmonic indication for SAPIEN XT this quarter. This will allow for the treatment of adult and pediatric patients in the U.S. who suffer from either a narrowed pulmonary valve or regurgitation caused by congenital heart disease. Outside the U.S., underlying THV sales grew 13% driven by ongoing therapy adoption in Europe and Japan. Also, our SAPIEN 3 valve was approved in the first quarter in Japan, and we are currently in the process of training sites on this best-in-class valve in preparation for rollout beginning next month. In Europe, we estimate the procedures continue to grow more than 20% in the first quarter compared to last year. We saw a strong growth across most countries and total procedures are becoming more dispersed throughout the region, with other countries growing faster than Germany. Edwards grew at a slower rate, and we estimate our market share decrease as competitors continue to broaden their product offerings. While difficult to estimate, we believe that more recent competitive entrants collectively realized a significant year-over-year growth rate but account for approximately 15% or so of total procedures. As we previously mentioned, we plan to use our U.S. intermediate risk data to expand our CE Mark indication. These data will be submitted to European regulators in the next few weeks, with the expectation for approval of an expanded label in late 2016 or early 2017. Because some European countries have already been aggressive adopters of TAVR technology, we expect the strong data reported at ACC to have a limited impact on European treatment rates until guidelines are updated and, where applicable, reimbursement is modified to cover the broader label. Our SAPIEN 3 Ultra System is still on track for CE Mark in the fourth quarter of this year. This new system, featuring an on-balloon delivery system and next-generation sheath technology, is expected to enhance ease-of-use, further reduce possible complications, and shorten procedure time. In summary, we continue to believe that TAVR provides an important and compelling therapy option for a large number of untreated elderly patients. Based primarily on the continuing strong therapy adoption of TAVR, we are increasing our 2016 sales guidance by $100 million, to $1.4 billion to $1.6 billion. We now expect our underlying sales growth to exceed 25%. Turning to the Surgical Heart Valve Therapy product group, sales for the first quarter were $196 million, up slightly over last year on an underlying basis. Globally, sales were lifted by an increase in surgical heart valve units, which we believe was primarily driven by greater aortic disease awareness that prompted a larger number of surgical procedures. Our growth was offset by the ongoing exit of non-strategic cannula products. Sales of our premium products contributed to solid heart valve performance across the U.S., Europe, and Japan. Worldwide surgical aortic units grew approximately 7%, and global average selling prices saw a slight decline. In Japan, we recently launched our tricuspid surgical valve repair product and have seen strong interest in this therapy. We’ve been in discussion with the FDA regarding approval of our rapid deployment INTUITY Elite Valve and believe we remain on track for a mid-2016 launch in the U.S. Additionally, in response to our application for a new technology add-on payment for INTUITY Elite, CMS has expressed concern that the technology may not meet certain eligibility criteria, and our team is preparing a formal response. In summary, we are pleased with the strength of our premium surgical heart valve products. We continue to invest in this area and believe that surgery will continue to have a vital role for patients, even as TAVR expands. We are reiterating our 2016 underlying sales growth expectation for the total product group of 3% to 6% as we expect stronger second-half growth from INTUITY Elite launch in the U.S. and a diminishing impact from the exit of non-strategic cannula products. In the Critical Care product group, sales for the quarter were $134 million and grew 9% on an underlying basis. Overall growth for the quarter was strong in our core products and our enhanced surgical recovery program, which once again saw double-digit underlying sales growth across most regions. Our sales this quarter benefited from the announced discontinuation of our legacy monitor that lifted replacement monitor sales. Our recent investments in U.S. sales resources also stimulated stronger adoption of our market-leading products. Overall, we are pleased with the continued adoption of enhanced surgical recovery and the strengthening of our core products and we continue to expect Critical Care underlying sales growth of 2% to 4% in 2016. Turning to our investments in structural heart initiatives, we continue to make progress on our FORMA system for reducing tricuspid regurgitation and on our CardiAQ Edwards transcatheter mitral valve platform, or TMVR, which we expect to be the first of multiple generations. In our early generation CardiAQ Edwards platform, we are already in the process of implementing several enhancements and we expect clinical updates to be presented later this year. Learnings from our experience in the U.S. early feasibility study now underway have informed our first CE Mark trial called the Relief trial, which is still on track to begin in the middle of this year. We remain committed to developing this therapy and, although commercialization timelines are still unclear, we continue to believe that innovative structural heart therapies will ultimately benefit patients with mitral valve disease, who aren’t well served today. And with that, let me turn the call over to Scott.

Thanks, Mike. This quarter, our underlying sales were $696 million and grew 20% on an underlying basis, which exceeded our expectations for two reasons. First, strong THV sales drove performance to the top end of our guidance range, and second, strengthening foreign currencies since last quarter's guidance contributed over $10 million. Reported sales, including the effects of foreign-exchange and the sales return reserve grew 18% to $697 million. We have made strategic decisions about how to utilize savings from the two-year suspension of the medical device excise tax. The suspension provided us the flexibility to reinvest in research and development, for example, by accelerating investments in structural heart initiatives. We also made a special $5 million contribution to the Edwards Lifesciences Foundation, in support of the Every Heartbeat Matters initiative. This initiative is focused on addressing the global burden of heart valve disease in underserved people. The $5 million contribution is reflected in the Other expense line of our income statement. Adjusted earnings per share in the quarter grew 25% versus prior-year to $0.71, primarily driven by our THV sales performance and reflects solid leverage. This growth was partially offset by the unfavorable impact of foreign-exchange, increased research and development investments, and our charitable contribution. I'll now cover the details behind our results, including guidance for the remainder of the year. For the quarter, our gross profit margin was 74.1%, compared to 77% in the same period last year. This decrease, which we expected, was driven primarily by the foreign-exchange impact from inventory sold internationally and higher spending in our global manufacturing operations, partially offset by a more profitable product mix. To accommodate our increased sales demand going forward, we are investing in manufacturing capacity, which will negatively impact our gross profit margin for the remainder of 2016. Combined with a lower than expected benefit from FX contracts, we now expect our full-year gross profit rate, excluding special items, to be between 73% and 74%. First quarter selling, general and administrative expenses increased 5% over the prior year to $213 million or 30.5% of sales. This increase was driven primarily by sales and marketing expenses related to transcatheter valves and personnel-related expenses. This was partially offset by the suspension of the medical device excise tax, as well as the favorable FX impact on our expenses outside the U.S. We continue to expect SG&A, excluding special items, to be between 30% and 32% of sales for the full-year. Research and development investments in the quarter increased 19% over the prior-year to $102 million or 14.7% of sales. This increase was primarily the result of continued investments in our transcatheter mitral and aortic valve programs and a lower than normal spend in the prior-year quarter. The suspension of the medical device excise tax provided additional flexibility to accelerate investments in structural heart initiatives this quarter. We continue to expect our research and development investments, excluding special items, to be approximately 16% of sales for the full-year. During the first quarter, we recorded $12.2 million in intellectual property-related expenses, which have been excluded from adjusted earnings per share. The expenses include the resolution of an IT matter and expenses related to ongoing litigation against Neovasc in the United States, and with Boston Scientific, where we now have multiple litigation matters in the U.S. and Europe. Our reported tax rate for the quarter was 22%, down from 24.1% in the prior year period. This decrease was driven largely by our manufacturing sourcing strategy. We now expect our full-year tax rate, excluding special items, to be between 22% and 23%. Foreign-exchange rates decreased first quarter sales by $9 million compared to the prior year. At current rates, which have been volatile, we now estimate minimal impact to full-year 2016 sales, compared to the prior year. This is $55 million less than the impact we estimated last quarter. Compared to our February guidance, foreign-exchange rates had less than a $0.01 impact on earnings per share in the first quarter. Free cash flow generated during the quarter was $79 million. We define this as cash flow from operating activities of $107 million less capital spending of $28 million. Turning to the balance sheet. At the end of the quarter, we had cash, cash equivalents, and short-term investments of approximately $950 million. Total debt was approximately $600 million. In February 2016, we entered into accelerated share repurchase agreements for $325 million. Upon entering into the agreements, we received and retired an initial delivery of 3.2 million shares. As a result, average shares outstanding during the quarter declined to $218 million. We continue to expect average diluted shares outstanding for 2016 of $216 million to $220 million. Turning to our 2016 guidance. We now expect full-year sales to be between $2.7 billion and $3 billion, an increase from last quarter's guidance of more than $100 million at the midpoint of the range. This increase reflects an anticipated $55 million of improvements from foreign-exchange, as well as higher expectations for THV, as a result of strong momentum in the first quarter, the strength of the PARTNER II presented at ACC, and a planned earlier U.S. indication expansion for SAPIEN 3. We now expect THV sales of $1.4 billion to $1.6 billion. Our sales guidance for surgical heart valves in Critical Care remain unchanged. We continue to expect sales for surgical heart valves within the range of $780 million to $820 million and for Critical Care within the range of $510 million to $550 million. With today's increase in sales guidance, we now expect our adjusted earnings per share to be between $2.67 and $2.77. We expect the earnings per share drop-through of today's sales guidance increase to be lower than last quarter's due to a lower benefit from foreign-exchange contracts, increased performance-based compensation, and increased expenses associated with the expansion of manufacturing capacity. For the second quarter of 2016 at current foreign-exchange we project sales to be between $700 million and $740 million and adjusted earnings per share to be between $0.67 and $0.73. Finally, for full-year 2016, given our expected improved operating performance, we now expect free cash flow excluding special items to be between $500 million and $600 million. So, with that, I'll hand it back to Mike.

Thanks, Scott. In conclusion, our strong start to 2016 positions us well for another successful year. We’re enthusiastic about the continued expansion of transcatheter-based therapies for the many structural heart patients still in need, and we are confident in our outlook for strong sales growth and we remain passionate about developing impactful therapies to help more patients around the world. And with that, I'll turn it back over to David.

Thank you, Mike. In order to allow broad participation in the Q&A, we ask that you please limit the number of questions. If you have additional questions, please reenter the queue and we will answer as many as we can during the remainder of the hour. Operator, we are ready for questions please.

Good evening, Mike and congrats on another terrific quarter. For question one, you are going to submit the final intermediate risk data soon to the FDA. Are you now thinking potential approval at the start of the fourth quarter? Can you talk just a little more about your dialogue with the FDA, and if approval does come earlier, as I think everybody would hope, how quickly could you be ready to fully rollout the intermediate risk program?

Thanks, Rick. Appreciate it. Yes, it's tough to predict the FDA. What we've said is for modeling purposes to assume an October 1st launch—that's what's in our guidance estimates. And you can take it from there; of course, we’re in regular dialogue with the FDA about it. One thing to be aware of is that this is a product that's already approved and in the hands of hospitals. Given that that's the case, this is only an indication expansion. We will be training our team and our sites on how to handle that to ensure that they indicate the proper patients for this, but other than that we expect to be ready for launch. With big production increase, of course, that's a bit of a strain on our manufacturing operations, but we expect to be able to handle all that. Thanks.

And just one follow-up for Scott if I could, Scott maybe talk a little more about the inventory drag because of the OUS inventory. When does it run off, and when will manufacturing investments realize a gross margin expansion benefit?

Sure. So it's actually not its inventories outside of the U.S. that have been replaced by higher value inventories with the strengthening of the U.S. dollar. So, for example, in 2015 we had protection as foreign currencies weakened, and so our gross profit margin rate was higher than it would have otherwise been. Now that we've depleted those inventories and they’re being replaced by U.S. dollar denominated inventories, we’re now seeing that come through in our lower gross margin. To give you some detail, our gross margin was about 290 basis points lower, 380 basis points of that was related to this inventory phenomenon. There was another 70 basis points reduction from operations including some manufacturing capacity expansion. The mix improvement helped gross margin by about 200 basis points.

Good afternoon. Maybe two questions, one for Mike and then one for Scott. Mike, just thinking about revenue guidance for the remainder of the year, have you seen any appreciable change in the market sort of post ACC? And if you think about the guidance, which obviously was raised again, it still implies some deceleration into the back half of the year. Is there anything we should be thinking about other than the difficult timeline of the FDA approval?

Thanks, David. I’m not sure that we could say we really saw anything change post ACC. I mean think about for a quarter we just reported—it's the 64% growth, and we said the bulk of that is due to a growing market. So the U.S. market is growing fast and it’s tough to pinpoint whether it's changed very much. When we say that there is a pick-up—when we added $100 million to transcatheter heart valves, there are several things in there; some of that includes the earlier FDA approval. We do expect that the momentum coming out of Q1 and just the positive data out of ACC also contributed to that, so that’s all rolled into our guidance and that's helpful.

Yes, we’re trying carefully to manage growth in SG&A expenses as you know. The longer we can maintain that difference between the growth rate in sales and the growth rate in SG&A, the better. That said, we do have some headwinds coming out in 2016 relating to SG&A and so we're trying to manage through those. But generally we think we're on the right trajectory.

Can you hear me now?

We can hear you.

Perfect, sorry I thought you could hear me the first time. Mike, sorry to hear you are not sounding so good. But hope you feel better. So, Mike, the question people care about most is kind of what's going to change post PARTNER II. And, in addition to the feedback that you've gotten from the clinical community, just number one obviously to the overall results and your thoughts about the treatment of intermediate risk patients. And two, the willingness to change treatment patterns or practice patterns prior to the actual FDA label change?

Thanks for that. And thanks, I actually feel better than I sound. Post ACC, there are a lot of people feeling very good about it. We’ve got an incredible amount of very positive feedback from clinicians; much of what they appreciate most is the solid large piece of high-quality data that they can rely on for decision making. I keep hearing that over and over again. I don't know what it changes on day-to-day practice. I think there’s an NCD in place, people try to stay disciplined. But as we know there's not a bright line between high-risk patients and intermediate-risk patients. We wonder if in these borderline cases, if heart teams will decide to say, hey, that person is close enough to the high-risk category and deem it that way. I would expect some of that to happen, but as I point out, the market is already growing at a healthy pace and we’ve taken guidance up more, so it tells you about our confidence in the future.

Sure. In terms of sales TAVR increase is $100 million. In terms of total sales increase, it's about $55 million of FX due to the weakening of the U.S. dollar since February. So, in terms of earnings, the benefit of that THV sales growth has fallen through to the bottom line, but it's offset by several different factors, some in cost of sales and some in SG&A. But principally the improvement to the bottom line, Mike, is due to the THV sales increase.

Thanks, guys for taking the question. I apologize for the background noise. I am traveling. Scott, sticking with the operating leverage question, back of the envelope, it looks like you are spending away perhaps as much as 100 to 120 basis points of operating margin this year that you could have captured vis-à-vis the TAVI upside in these investments that you’ve talked about. As you think about moving forward, do you start to capture some of that leverage that you're sort of taking away from the business this year, or does it take longer than that?

Well, I think we're already capturing it, which is why you're seeing a significant drop-through from sales growth into our earnings per share. Obviously, we want to make that wider and really leverage our scale around these investments that we're making in both gross margin and SG&A. I won't say that those investments are going to stop and all of a sudden we are going to have a materially different P&L. But I will say that we are continuing to get leverage out of these investments and really trying to control growth in expenses as we grow revenue.

Yes, thanks, Jason. Yes, I think what we said before is that we expect around 400 sites; we expect that to increase maybe 10% or 40 sites during 2016. I think we are on a path to do that, so I don't know the precise number for Q1. But I think it's pretty consistent with that sort of a ramp. In terms of PCR, I don't know that you're going to see anything like you saw at ACC, where you are going to see those kind of large trials. I'm sure there are going to be a lot of transcatheter heart valve papers and news. But I’m not expecting anything major that really is going to cause any shift in behavior, at least not in my mind.

Hi, good afternoon. I wonder if I could maybe ask a bit about mitral. You gave a little bit of an update in terms of still beginning the trial this year. But also that you're looking to make some changes to the CardiAQ Valve, and I'm just curious if your thoughts have changed really on the timing or how long it will take to get a viable valve to market?

Thanks, Raj. I consider it a major victory if we could stay on path to begin a CE Mark trial by midyear and I was pleased to report that we're actually doing that. There's an awful lot that goes on behind the scenes. We're implementing several enhancements to that CardiAQ platform. But we still have a lot to learn, so we're going to be jumping into this trial and we're enthusiastic about getting into the trial, but we have to admit we're on a steep learning curve and we're putting a priority on gaining clinical experience because it provides so much more guidance for running the program. So, a lot of uncertainty still around timelines at this point. In terms of how we're behaving, we're really not changing our pricing practices. Our pricing has been very stable. We do have some very small downward drift, but that's purely based on volume discounts and it's been consistent with what we've been doing. We continue to have a substantial price premium versus competitors; our estimate is in the 10% to 20% range.

Good afternoon. Thanks for taking the call. Scott, a question for you and then a follow-up to Mike. Could you give us how you think about R&D in the context of ramping up on mitral and tricuspid programs?

Yes, it's a little bit of both. We are very deliberate in how we stage and sequence investments in these new growth platforms and opportunities. Similar to the development of the SAPIEN platform, we invested significantly in developing clinical evidence, while also investing in actual new product design. We are intended to do the same when you look at things like our transcatheter mitral valve program, and even on the tricuspid side.

Yes, and part of what encourages us to make the investment is the number of green lights we've seen along the way. When you see an significant opportunity, that encourages us to make that spending. If we didn't see that, we wouldn't feel obligated to make that kind of investment. Yes, as you point out, it’s a very competitive marketplace. There are at least five or six competitors, and we have the strongest share leadership. We’re very proud of that and we expect that to endure over time. As pointed out, part of the way we'll do that is with our new product introductions. So SAPIEN 3 has been fantastic, but we’re certainly not going to stop there; behind that is Ultra and then more yet, including CENTERA. Our intention is to continue improving this therapy.

Hey, good afternoon guys. Thanks for taking the question. Mike, I was wondering if you could talk a little bit about reimbursement for intermediate risk and how you think about timing for that.

So the way that the NCD is written with a label change, automatically comes reimbursement. If that continues as is, we would expect accounts to continue doing what they've done in the past. Now in Europe and other regions, guidelines may need to change first. Reimbursement is managed on a country by country basis, so each will go through that process and it will take some time.

Thank you for joining us on today's call. Reconciliations between GAAP and non-GAAP numbers mentioned during this call, which include underlying growth rates, sales results excluding currency impacts and amounts adjusted for special items are included in today's press release and can also be found in the Investor Relations section of our website at edwards.com. If you missed any portion of today's call, a telephonic replay will be available for 72 hours. To access this, please dial 877-660-6853 or area 201-612-7415 and use conference number 13633520. Additionally, an audio replay will be available on the Investor Relations section of our website.