Edwards Lifesciences Corp (EW) — Q4 2017 Earnings Call Transcript

Welcome, and thank you for joining us today. Just after the close of regular trading, we released our fourth quarter 2017 financial results. During today's call, we'll discuss the results included in the press release and the accompanying financial schedules and then we will use the 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'd 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 are not limited to, financial guidance and current expectations for new product approvals, benefits and introductions, clinical and regulatory timelines, competitive matters, expectations for therapy adoption, and foreign currency fluctuations. 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 safety information about products may be found in our press release, our 2016 annual report on Form 10-K, and our other SEC filings, all of which are available on our website at edwards.com. Also, a quick reminder that when we use the terms underlying and adjusted, 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 on our website. And now I'll turn the call over to Mike Mussallem.

Thank you, David. We're pleased to report robust fourth quarter results including double-digit organic revenue growth in each region driven by increased adoption of our therapies. We ended the quarter strong with total adjusted sales of $909 million representing 16% underlying growth as we did not experience as much of a slowdown as we typically see in the last weeks of the year. Our growth rates strengthened in the fourth quarter contributing to full year 2017 results of 16% underlying growth and over $3.4 billion of sales. Each of our product lines performed very well as demand for our innovative portfolio exceeded our expectations. Profitability was also strong in 2017 with adjusted EPS growing over 30% even as we continued to invest aggressively in our technology pipeline and infrastructure. And we continue to bring meaningful therapies to large unmet patient needs and further strengthen our leadership positions. Turning to transcatheter heart valve therapy adjusted global sales were $540 million up 22% on an underlying basis over the prior year including the adjustment for the consumption of stocking inventory in Germany. Double-digit TAVR sales growth across all regions was driven by continued strong therapy adoption and our average selling price remained stable overall. In the U.S., transcatheter heart valve sales for the quarter were $327 million representing 22% growth versus the prior year. We believe overall U.S. procedure growth was roughly in line with our growth. These strong results were driven by robust therapy adoption across the more than 575 TAVR centers with particularly strong growth in lower volume hospitals. And our best-in-class SAPIEN 3 valve continued to provide excellent outcomes including faster patient recovery, enhanced quality of life, and exceptional value to this healthcare system. We continue to be encouraged by the strong international adoption of TAVR particularly when overall therapy penetration is still relatively low. Outside the U.S., our fourth quarter underlying sales growth rate was 22% with all regions contributing. Double-digit procedure growth in Europe continued this quarter and our growth was also aided by a recovery from the interruption in fresh sales last year. Growth in countries with lower TAVR adoption rates continued to outpace countries where therapy is more established. And we continue to see strong TAVR therapy adoption in Japan driven by SAPIEN 3 and new centers continue to become qualified. As our fastest growing region this quarter, we believe the aortic stenosis still remains a large undertreated disease in Japan. Turning to our near-term product pipeline, we continue to expect a CE Mark for our SAPIEN 3 Ultra system this quarter. This system features advancements designed to help TAVR heart teams simplify procedures and reduce the risk of complications. The Ultra system also adds to TAVR outer polyamide on the valve which is designed to further improve its outstanding performance and we continue to expect the U.S. introduction of this system in late 2018. Additionally, we expect to receive CE Mark for our CENTERA system this month which we will introduce as a premium self-expanding system. We remain enthused by this feature-rich platform and encouraged by its excellent early clinical results and we plan to initiate a U.S. pivotal trial in 2018. As noted in our December Investor Conference, we've completed enrollment in the main study of our PARTNER 3 trial for low-risk patients with severe aortic stenosis. We anticipate data from this trial will be presented at ACC 2019 and to receive FDA approval later that year. We are also enrolling our groundbreaking early TAVR trial, the first of its kind to study severe aortic stenosis patients without diagnosed symptoms. In summary based on our momentum we now expect our 2018 THVT underlying sales growth to be at the higher end of our 11% to 15% range that we shared at our investor conference in December.

Thanks Mike. I am pleased to report that our strong finish to the year enabled us to exceed our sales, earnings, and free cash flow targets for 2017. For the full year sales increased 16% on an underlying basis to $3.4 billion, adjusted earnings per share increased 31% to $3.80 and we generated $695 million of adjusted free cash flow. Turning to the fourth quarter, our strong sales performance in transcatheter valves drove significant top and bottom line growth versus the prior year. Underlying sales grew 16% and adjusted earnings per share grew 25% to $0.94. GAAP earnings per share was $0.17 driven by several one-time adjustments including a non-cash charge of $211 million or $0.98 per share related primarily to the enactment of the new U.S. tax law partially offset by a gain from litigation Mike mentioned. A full reconciliation between our GAAP and adjusted earnings per share is included with today's release and I'll provide further details on the impact of tax reform a bit later. I'll now cover the details of our results and then discuss guidance for 2018. For the fourth quarter, our gross profit margin was 73.5% compared to 72.2% in the same period last year. This improvement primarily reflects a benefit of a more profitable product mix led by growing sales of TAVR partially offset by expenses associated with the planned closure of our manufacturing plant in Switzerland which was announced last year. We continue to expect our 2018 gross profit margin excluding special items to be between 74% and 76%. Our rate should be lifted by an improved product mix but tempered by capacity investments. Selling, general, and administrative expenses in the fourth quarter were $267 million or 30% of sales compared to $234 million in the prior year. This increase was driven by personnel-related and performance-based compensation expenses and a strengthening of the euro against the dollar. We continue to expect SG&A excluding special items to be between 28% and 29% of sales for the full year 2018 which includes the continued suspension of the medical device excise tax until 2020. Research and development investments in the quarter grew 28% to $147 million or 16.5% of sales. This increase was primarily the result of continued investments in our transcatheter structural heart programs including spending on clinical trials. For the full year 2018, we continued to expect R&D as a percentage of sales to be between 16% and 17%. Turning to taxes, our high reported tax rate for the fourth quarter was driven by a $211 million expense related primarily to the implementation of U.S. tax law changes. The expense is comprised of $289 million of tax on unremitted foreign earnings which is payable over the next eight years. This amount is offset by $65 million related to adjustments of tax accounts arising from a lower U.S. corporate tax rate and a $13 million discrete benefit from a tax audit settlement. Excluding the impact of tax reform and other special items, our tax rate would have been 21.3%. This rate includes an approximate 200 basis point benefit from the new accounting for employee stock-based compensation consistent with our guidance. Starting in 2018, the benefit of our lower U.S. tax rate will be partially offset by a higher foreign minimum tax and other items. We expect the net impact from tax reform to lower our effective tax rate in 2018 by approximately 300 basis points. We now expect our 2018 tax rate excluding special items to be between 15% and 18% which includes an estimated 2% to 3% point benefit from employee stock-based compensation accounting rules implemented in 2017. Foreign exchange rates increased fourth quarter sales by approximately 2% compared to the prior year. Compared to our October guidance FX rates positively impacted earnings per share by less than a penny. Adjusted free cash flow for the quarter was $174 million. We define this as cash flow from operating activities of $364 million, less capital spending of $77 million, and excluding the receipt of the $113 million litigation payment mentioned earlier. For the full year 2017, adjusted free cash flow was $695 million. Turning to our balance sheet, at the end of the quarter we had cash, cash equivalents, and short-term investments of $1.3 billion, the majority of which is held outside the United States. Total debt was approximately $1 billion. In November 2017 we entered into an accelerated share purchase agreement for $150 million. In total we repurchased 2.3 million shares during the quarter for $251 million. As a result of these repurchases, average shares outstanding during the quarter declined to $215 million. We continue to expect average diluted shares outstanding for 2018 to be between $213 million and $215 million. And I'll finish up with our 2018 guidance. Given our strong fourth quarter momentum combined with the strengthening of the euro at current exchange rates we now expect to be at the higher end of all of our 2018 full year sales guidance ranges communicated at investor conference in New York in December. Those ranges are $2.1 billion to $2.4 billion for transcatheter heart valve therapy, for surgical heart valve therapy, $810 million to $850 million and for critical care $610 million to $650 million, for total Edwards $3.5 billion to $3.9 billion. The full year 2018 adjusted earnings per share we expect to be between $4.43 and $4.63, up from $4.10 to $4.30 driven by a lower projected tax rate and higher projected operating performance. This includes the investment of a significant portion of the tax savings to accelerate growth initiatives consistent with our strategy. Lastly, we now expect full year 2018 free cash flow to be at the higher end of the $700 million to $775 million range that we shared at our investor conference in December. For the first quarter of 2018, we project total sales to be between $900 million and $950 million and adjusted earnings per share of $1.04 to $1.14 and with that, I will hand it back to Mike.

Thanks Scott. Our strong 2017 reinforces our confidence in our focused innovation strategy and our longer-term outlook and we look forward to an exciting 2018 as we continue to aggressively invest in our future. We expect to achieve a number of important milestones supporting progress in the development of transformative therapies across all of our product lines. Our differentiated strategy continues to benefit patients and serve us well as we plan for future growth and value creation and we're focused on staying at the forefront by creating strong evidence for promising new therapies for patients we serve in the many years to come. And with that, I'll turn it back over to David.

Thank you Mike. We are ready to take questions now. In order to allow broad participation we ask that you please limit the number of questions. If you have additional questions, please reenter the queue and we'll answer as many as we can during the remainder of the call. Operator please go ahead.

Great, thanks very much for taking the questions and congratulations on such a strong finish to the year. The first question I wanted to ask about was really the TAVR performance in the quarter because obviously it was stronger than I think most everybody was looking for and so maybe I will focus the question on the U.S. performance. Can you just talk about what went on in the quarter in terms of both your performance in the market and really in your minds what drove the outperformance in the quarter, how broad based was it, how sustainable is it, thank you?

Yeah, thanks Bob. The key driver was therapy adoption. Therapy adoption in the U.S. continues through rapid. We estimated it was somewhat consistent with our own growth so therefore it got over 20%. What was a little different, the other thing that I had mentioned in our comments here is the procedures sort of grew broadly across the network but particularly strength in lower volume centers. And so we take that to mean places where there may be just a lower adoption rate around the U.S. It seemed to grow faster and then we also didn't see the typical seasonal falloff that we see as well. And so that combination of effects was very meaningful and we were very pleased to see it.

The other thing I wanted to ask about was the pipeline because you had some really strong positive updates in your prepared remarks so I was wondering if you could just talk a little bit about the upcoming CENTERA launch in Europe, how broad it will be, and how you plan on positioning the valve, and then also if you wouldn’t mind talking about Ultra and giving us a sense for the features of that because I think that may be a product that people don't have as good enough appreciation for it?

Yes, so, let me start with CENTERA. As you mentioned that we expect to receive that CE Mark this month and we're really looking forward to launching that. We're going to introduce it as a premium self-expanding system. We're very enthused about it. It is feature rich and the early results are terrific with it. The label is still not clear and it's going to be probably a little different by country but we're pleased to be able to launch out and then we expect to bring that to the U.S. later on this year and then begin a trial, an IDE trial later at that time. Ultra, again we're expecting a CE Mark this quarter and it has a lot of advanced features and particularly we think it's going to help simplify these procedures and reduce the risk of complications and this is not to be underestimated as well. We are so pleased with the performance of SAPIEN 3 already we think Ultra has a chance to even take it to the next level.

Thanks very much.

Good afternoon. Thanks for taking the question. Scott, at the Analyst Meeting you expected sales growth to ramp through 2018. Is that still the case and could you remind us why that's the case? Thank you.

So originally we did expect sales growth to ramp during the quarters in 2018, now just given the momentum we had coming out of year-end we think that that's probably going to be more consistent growth between quarters during the year.

Okay, that's helpful. And then on the tax rate Scott, the 15% to 18% relatively wide range, could you talk a little bit about what would get you to the high end and low end on that? Thanks for taking the questions guys and congrats on the quarter.

Sure, thanks as you know there are still guidance coming out from Treasury and the IRS and the ICPA is asking questions and so there are some uncertainties. We also have the excess tax benefit that could cause fluctuations within the 15% to 18% range but as you know typically I will guide people to the middle of that range for modeling purposes.

Thanks for taking the questions guys.

Good afternoon. I wanted to talk about a couple of the big debates during the Analyst Day if I could and Mike maybe one for you and one for you Scott. So Mike I know you talked about the quarter already but as I think about the guide the real focus for investors in Analyst Day was your expectations for market growth seemed more Draconian than I think people were expecting. I think you are obviously taking Q3 guidance to the high end of the range, so relative to your view at Analyst Day are you clearly feeling better about the market this year so, my real question is that high end of the THVT range do you feel better about the market in 2018 or better about your relative share?

So, I think if there is anything changed it's really our view of how fast adoption will be for the market the way you say it. That's the change. Naturally as this gets large we naturally assumed it would slow down more and we saw some pretty robust growth in the fourth quarter. We're very pleased by that. We don’t think there is going to be much of a story in terms of our market share in 2018. In 2018 we think that's going to be our relatively flat story so, I don’t know if that gets at your question.

Thanks, it is perfect Mike. And I think Scott the second question I think margins broadly, I think people left feeling there is more room to go on the margins. The key tree is moving higher, GMs are not so could you talk about some of those capacity investments and where they're going and sales are going higher yet relative margins are not so there is some reinvestment as you mentioned which I think most investors would support. But where are some of those dollars going that are keeping these margins relatively stable in light of the fact that the revenue is growing faster early on the year? Thanks so much.

Sure, and we are expecting more leverage than we did at the investor conference largely because now we've got better top line growth expectations now. In terms of investments a lot of our investments are going into facilities and expanding our capacity both in the U.S. and outside of the U.S. And so we have got pressure on gross margin, headwinds on the gross margin from that perspective. But THV is our highest margin business and we are expecting higher growth now that helps our overall margin performance and leverage to the P&L.

Thanks for taking the questions. So I just wanted to clarify the guidance update in a couple of different ways. So, you have moved your revenue guidance to the higher end of the range but the overall reported range is not as the dollars moved. So can you share with us on an underlying basis how your guidance's change is underlying in the remaining constant currency and then just on the FX question, so FX getting more favorable into initial guidance, how much is that adding to your 2018 EPS outlook relative to what you are assuming at the time of initial guidance? Thanks.

Sure, so as we are moving our sales expectations higher in the ranges that we provided earlier about half of that is driven by FX and half of that is driven by operating performance mostly from THV. And so we are expecting sales results in the higher end of the dollar ranges for all three businesses and at the higher end of the underlying growth rate range for THV but still right in the middle of the underlying growth rate ranges for HVT and critical care because more of their businesses are outside of the U.S.

Okay, just to clarify, you are looking at 18% underlying, which is in constant currency, and for the other two, you are still in the middle of the underlying range?

So, higher end of that 11% to 15% range for THV and right in the middle of 2% to 4% range for HVT and 6% to 8% range for critical care.

And Scott the EPS swing from FX?

Yes, FX has a number of different contributing factors and if you just isolated FX then it would be reflected by that increase in the non-FX related earnings growth in THV. So in other words, about half of the sales increase is FX, the other half is actual underlying performance. And that underlying performance would largely drop through to the bottom line. But there are a lot of other contributing factors as a result of the tax legislation and the incremental investments that we're planning to make with some of the proceeds from those tax benefits.

Yeah, I understand that the tax should be about $0.20 or there about and you reinvesting some of that but I was asking typically to FX, you don’t know what that EPS contribution is relative to the initial guide?

Yeah, FX specifically is about $0.03.

Thank you for your response. Regarding international performance, the European results you mentioned benefited from a comparison with France last year. Even without that factor, we estimate at least high teens growth. Are you observing any trends in Europe, particularly concerning intermediate risk and attrition? Are they shifting towards younger, less sick patients considered lower risk? Thank you for addressing my question.

No, I think generally not. You have to remember that Europe is this combination of many countries, some of the countries that just didn’t have reimbursement in place in the early days are starting to have it in place. So, that may help but just broadly if those places that were less penetrated so the smaller countries if you will they are probably making the bigger contribution to growth in Europe.

Thank you for joining us on today's call. Reconciliations between GAAP and non-GAAP numbers mentioned during this call which include underlying sales and growth rates 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 and to access this please dial 877-660-6853 or 201-612-7415 and use conference number 13674893. Let me repeat those numbers dial 877-660-6853 or 201-612-7415 and the conference number is 13674893. In addition an audio replay will be available on the Investor Relations section of our website. Thank you very much.