LivaNova PLC

NASDAQ:LIVN

Earnings Call Transcript 2018-Q1

[Operator]

Good day, ladies and gentlemen, and welcome to the LivaNova PLC First Quarter 2018 Earnings Conference Call. [Operator Instructions]

As a reminder, this conference call is being recorded. I would now like to introduce your host for today’s conference, Ms. Karen King, LivaNova’s Vice President of Investor Relations & Corporate Communications.

[Karen King, VP, IR and Corporate Communications]

Thank you, and welcome to our conference call and webcast discussing LivaNova’s financial results for the first quarter 2018. Joining me on today’s calls are Damien McDonald, our Chief Executive Officer; and Thad Huston, our Chief Financial Officer.

This morning’s press release, slide presentation and conference call include forward-looking statements. Forward-looking statements may be identified by the use of forward-looking terminology including, but not limited to, may, believe, will, expect, anticipate, estimate, plan, intend and forecast or other similar words. Statements are based on information presently available to us and assumptions that we believe to be reasonable.

Investors are cautioned that all such statements involve risks and uncertainties. Our actual results, performance or achievements may differ materially from those expressed or implied by these forward-looking statements which are not guarantees of future performances and involved known and unknown risks and uncertainties, and other factors that are in some cases beyond the company’s control. For detailed discussion of the factors that may cause our actual results to differ, please refer to our most recent filings with the SEC and other regulatory filings.

Included in the press release today are selected non-GAAP operating results. In this press release management has disclosed financial measurements that present financial information, not necessarily in accordance with Generally Accepted Accounting Principles or GAAP. Company management uses these measurements as aids in monitoring the company’s ongoing financial performance from quarter-to-quarter and year-to-year on a regular basis and for benchmarking against other medical technology companies.

Non-GAAP financial measures used by the company may be calculated differently from and therefore may not be comparable to, similarly titled measures used by other companies. These non-GAAP financial measures should be considered along with, but not as alternatives to the operating performance measures as prescribed per GAAP. Please review the financial tables provided in the press release that reconcile such non-GAAP measures to directly comparable financial measures presented in accordance with GAAP.

To enhance the call, we have posted a presentation to our website that summarizes the points of today’s call. This presentation is complementary to other call materials and should be used as an enhanced communication tool. You can find the presentation in the Investor Relations section of our website under News & Events, Presentations at www.livanova.com. In just a few moments, Damien will be discussing net sales results for the quarter.

In our press release, we provide a table that shows both reported net sales growth and constant currency growth, so you can see the impact of foreign currency fluctuations. For discussion purposes, our comments on net sales growth during opening remarks will be expressed in constant currency.

And with that, I will now turn the call over to Damien.

[Damien McDonald, Chief Executive Officer]

Thanks, Karen, and good morning and good afternoon, everyone. Welcome to our first quarter 2018 conference call. We started the year with another strong quarter showing topline growth, improved gross margins and solid earnings. Since the beginning of the year we announced the commencement of four new clinical studies, received approval for two products, completed a strategic acquisition and divested our CRM business.

I’m going to walk you through those items and additional highlights and then discuss our sales results by business. After my comments, Thad will provide you with additional color on the financials and I’ll wrap up with closing comments before moving on to Q&A.

First, we started the year by initiating numerous clinical studies. On January 4, we announced the launch and enrollment of the first patient in our Global RESTORELIFE study which evaluates the use of our VNS therapy system in patients who have treatment resistant depression and who failed to achieve an adequate response to standard psychiatric management.

Our plan is to enroll a minimum of 500 patients who will be implanted at up to 80 sites outside of the U.S. We are currently enrolling patients in Germany and will expand to other European countries during the year.

On January 11, we announced that we had started enrollment in BELIEVE. This study focuses on the overall incidence of reduced leaflet motion identified by CT imaging in patients receiving a LivaNova aortic heart valve. We are planning to enroll approximately 230 patients at 15 sites in the U.S. and Canada.

Then on March 22, we announced that we had started enrollment in PERFECT, a Perceval valve clinical study in China. This study is being conducted to demonstrate the safety and effectiveness of Perceval in the Chinese population. We plan to enroll approximately 160 patients at eight investigational sites.

And finally on March 28, we announced the launch and enrollment of the first patient in a clinical study to examine the use of our VNS Therapy System using Microburst technology. This feasibility study will determine the initial safety and effectiveness of delivering VNS Therapy using high frequency bursts of stimulation in patients who have drug-resistant epilepsy. The study consists of two cohorts enrolling up to 40 patients at approximately 15 sites in the U.S.

Second, we received regulatory approval for two products, one in cardiac surgery and one in neuromodulation. On February 1, we announced that we had received CE Mark for our PureFlex line of adult arterial cannulae. We are eager to offer this advanced line of cannulae to cardiac surgery clinicians and patients to deliver the best care possible.

While the cannulae business is still a small portion of our cardiopulmonary portfolio, it is an important and growing business for LivaNova. On April 17, we announced we received CE Mark for our SenTiva VNS Therapy System. This follows the approval in the U.S. by the FDA in October 2017. This recent announcement combined with the FDA approval advances VNS Therapy treatment for patients and drug-resistant epilepsy across the globe.

Third, we announced the completion of our strategic acquisition and the divestiture. On April 4, we announced that we had completed the acquisition of TandemLife, a privately held company focused on advanced temporary cardiopulmonary support solutions for $200 million, with an additional $50 million to be paid based on regulatory milestones.

The acquisition of TandemLife allows us to complement our portfolio with a complete set of solutions for Extracorporeal Life Support and Percutaneous Mechanical Circulatory Support. Thad will provide an update shortly regarding our 2018 guidance, which now reflects the addition of TandemLife.

And earlier this week, on April 30, we announced that we successfully completed the divestiture of our Cardiac Rhythm Management business to MicroPort for $190 million in cash. The cash we received from the deal will be used in the second quarter to pay down the six-month bridge loan that we obtained for our TandemLife acquisition.

With the completion of the CRM sale to MicroPort, we will now focus on the next stage of our growth strategy for Cardiac Surgery and Neuromodulation portfolios, where we have strength and market leadership.

Before I turn to our sales results I want to provide a brief update on a couple of other items. Starting with Transcatheter Mitral Valve Replacement or TMVR, we discussed on our last earnings call in late February, we had temporarily paused enrollment in our PRELUDE feasibility study to make a submission to the FDA on various design enhancements to the Caisson system and the development of two large valve sizes.

We’re very pleased to report that we received FDA approval in late March and we’ve begun the process of enrolling patients again, and are back on track to complete the PRELUDE study in the third quarter.

Next, we are making progress in our ability to address potential aerosolization issues with the 3T Heater-Cooler devices. The FDA agreed to allow us to move forward with the deep cleaning service in the U.S. This service is being performed at no charge and we are offering a loaner device to hospitals while the unit is being serviced. We continue to work closely with the FDA to secure our clearance to implement a full device remediation plan which includes design modifications to devices in the field.

And finally, on April 30, we distributed a proxy for our 2018 Annual General Meeting of shareholders or AGM. We posted it on the Investor Relations section of our website.

This meeting will be held on June 12 in Houston, Texas as well as virtually.

The proxy discloses that Stefano Gianotti resigned from the Board on March 23, 2018. I’d like to take a moment to thank Stefano for his support and guidance through this important transitional period for LivaNova.

William Kozy, Director Nominee is up for election at the upcoming AGM. Mr. Kozy has spent more than 40 years in the healthcare industry, most recently as Executive Vice President and Chief Operating Officer at Becton, Dickinson and Company.

So, now turning to net sales results for the quarter. Total net sales were up 5.3%, but Neuromodulation and Cardiac Surgery showed growth in the quarter compared to the first quarter of 2017.

Starting with Cardiac Surgery, Cardiac Surgery sales were $156 million up 4.9% from the first quarter of 2017. Strong growth in cardiopulmonary offset a decline in heart valves.

Cardiopulmonary sales were $125 million in the quarter, an increase of 9.1% versus the first quarter of 2017. Growth in heart-lung machines was the major contributor to the favorable performance in every region.

Our focus on funnel management and execution is building momentum resulting in strong global sales. The majority of our heart-lung machine sales in the quarter were the result of upgrading customers from our legacy S3 device to our current S5 device with the remaining contribution coming from competitive catches and replacement of existing S5 devices. As we’ve said before that funnel visibility gives us conversion opportunities for the next couple of years.

Turning to heart valve, sales for heart valves were $31 million in the quarter, a decrease of 9.5% versus the first quarter of 2017. As we discussed during our last earnings call, the majority of the decline in the quarter was due to a known change in a contract manufacturing agreement.

The loss of this agreement impacted rest of valve sales by approximately $2.6 million. If we isolate Perceval, sales for the sutureless valve were up in every region, showing consistent double-digit growth. Sales of Perceval are now greater than the combined sales of both mechanical and traditional tissue valves.

We continue to make significant progress with Perceval and are on track to exit the year with a run rate equivalent to $80 million in annual sales. Now, let’s turn to Neuromodulation. Sales were $94 million, up 6.2% versus the first quarter of 2017. We saw a strong demand and implant rates for SenTiva.

Adoption of SenTiva exceeded 35% and continues to increase. We believe SR is a superior technology and their long term goal is to move the U.S. market almost entirely to AspireSR or SenTiva.

In addition to strong adoption with SenTiva, we’re attracting physicians there haven’t been recent implanters of VNS Therapy. Since the label expansion and the launch of SenTIva, we have seen average patient age decline. This is extremely important for multiple reasons. We know that the earlier we start a patient on VNS Therapy, the better the clinical outcome.

In addition, we know that if a patient has implanted a second VNS Therapy device, the chance of them using our third device is 90%. We were pleased to announce that we received CE Mark for SenTiva, an implanted our first patient at King’s College Hospital in London. We will take a phased approach to our launch in Europe, initially focusing on a handful of countries that have favorable reimbursement climates, and physicians who are interested in new technology.

Now I’d turn the call over to Thad, for an overview of our financial results. Thad?

[Thad Huston, Chief Financial Officer]

Thank you, Damien. I’m going to discuss the first quarter financials in greater detail and speak further about guidance. As Damian mentioned, sales growth in the first quarter was solid at 5.3% versus first quarter of 2017 due to strong sales at all of our growth drivers.

Adjusted gross margin as a percent of net sales in the quarter was 66.9% up 170 basis points from the first quarter of 2017. The margin improvement was primarily driven by product mix, pricing discipline, and our continued focus on cost efficiencies.

Adjusted R&D expense in the first quarter was $29 million compared to $20 million in the first quarter of 2017. R&D as a percentage of net trade, trade sales was 11.6% versus 8.9% in the first quarter of 2017.

As we previously discussed, we expected R&D to ramp-up due to the development of next-generation products, clinical trials and investments in TMVR sleep apnea, and heart failure.

Adjusted SG&A for the first quarter was $97 million compared to $82 million in the first quarter of 2017. SG&A as a percentage of net sales with 38.7%, up 260 basis points versus the first quarter of 2017 primarily due to an increase in sales and marketing related you know - to related expenses to our growth drivers in foreign currency.

Adjusted operating income from continuing operations was $42 million, compared $46 million in the first quarter of last year, which reflects an improvement in gross margin offset by expected investments in our key growth drivers in clinical activities. Adjusted operating margin from continuing operations was 16.6% compared to 20.2% in the first quarter last year.

Our adjusted effective tax rate in the quarter was 15.7% an improvement from 23.5% in the first quarter of 2017 as a result of our ongoing tax efforts and the recent changes in the U.S. and UK tax laws. Finally adjusted diluted EPS from continuing operations in the quarter was $0.68, an increase of 1.5% compared to the first quarter of 2017.

Now, moving to cash flow. Our cash flow from operations for the three months ended March 31 was $20 million. Cash flow from operations excluding payments for one time integration and restructuring costs was $36 million. Capital spending for the first three months of 2018 was $6 million, down from $8 million for the same period of 2017.

Our cash balance at March 31, 2018 was $65 million, down from $94 million at December 31, 2017. Our net debt at March 31 was $121 million up from the $50 million as of year-end 2017, which included $78 million related to the ImThera acquisition.

Now turning to 2018 guidance. On February 28, during our last earnings call we provided financial guidance for the full year. As a result of closing the TandemLife acquisition and changes in the tax laws, we are increasing both our sales and adjusted earnings guidance and decreasing our adjusted effective tax rate projections.

We now expect sales to grow in 2018 between 6% and 8% on a constant currency basis, an increase of 200 basis points due to the sales contribution from TandemLife. Regarding foreign currency if we use the current exchange rates, they remain unchanged.

The company’s full year revenue guidance benefits by approximately 2%. Our adjusted effective tax rate for 2018 is now expected to be in the range of 18% to 20% a decrease of 200 basis points, primarily reflecting recent changes in the U.S. and U.K. tax laws.

We are now projecting adjusted diluted earnings per share from continuing operations to be in the range of $3.50 to $3.70 which includes a $0.10 contribution from the TandemLife acquisition and the changes in the tax rate.

The earnings projection includes an impact from foreign currency of negative $0.10 to $0.15. We are reaffirming all other guidance ranges we’ve provided during our last earnings call on February 28.

With that, I’ll turn the call back to Damien for some final comments.

[Damien McDonald, Chief Executive Officer]

Thanks Thad. As I mentioned in my initial comments, we started out the year with another good quarter, showing top line growth and solid earnings. We continue to make good progress in many areas of our business as evidenced by the numerous activities since the beginning of the year, four clinical studies, two product approvals, the completion of the TandemLife acquisition and the CRM divestiture.

We’re improving our gross margins through price discipline, product mix and efficiencies, while also investing in our future, expanding our pipeline, innovating in next generation products and funding clinical trials for our growth drivers and strategic portfolio initiatives which include TMVR, treatment resistant depression, obstructive sleep apnea and heart failure. This is an exciting year for both our Cardiac Surgery and Neuromodulation business.

In Cardiac Surgery, high single-digit growth in our heart-lung machines is breaking records and vastly surpassing low single-digit market growth. Perceval continues to show strong double-digit growth quarter-after-quarter and is becoming a much more significant portion of our valve portfolio. We are integrating TandemLife into our Cardiac Surgery business and focusing initially on growing ExtraCorporeal Life Support and Right Heart Support in the U.S. to increase patient care options and access.

In Neuromodulation, we are seeing strong demand for our SenTiva and VNS Therapy System in the U.S. and we are excited to receive CE Mark approval and to now offer SenTiva VNS Therapy System to patients around the world. We look forward to updating you on our continued progress and delivering on our commitments to drive shareholder value.

And with that Sharon, we’re ready for questions.

[Operator]

[Operator Instructions] Your first question comes from Raj Denhoy with Jefferies. Please go ahead. Your line is open.

[Raj Denhoy, Jefferies]

Wonder if I could maybe start on two areas kind of two numbers that stood out on the quarter. First on VNS, the U.S. growth in particular at 5.9% was a step down from last quarter and I think given where you are in the launch of SenTiva maybe a little surprising that it wasn’t a bit stronger, so maybe you could give us a little more detail around that?

And then the second question is around SG&A, a big step up in SG&A quite a bit beyond where you’re guiding for the full year. So I’m curious about whether there’s - you described you’re just kind of investing in the business but is there any sort of one timers in that or should we look at this just kind of a new level of spending as the year progresses?

[Damien McDonald, Chief Executive Officer]

Let me go in order there Raj. So on Neuromod look, we’re really pleased with how Neuromod’s going, especially with the progress of SenTiva. I mean, we’re in early stages of the launch both in the U.S. and now globally. And 35% adoption of SenTiva out of the gate, I think is really strong. And I think importantly this new account acquisition is an important driver for us in the future.

We just received the CE Mark and we’re really looking forward to rolling that out in the EU. And I think the big market for us about the future too is we’re encouraged by this reduction in the patient age. We know that earlier intervention improves the clinical outcome and I’m convinced that the SenTiva launch plus the label expansion is really driving the change in behavior there. So I was really encouraged by what we’re saying here.

On SG&A, look candidly this is all about pricing and we just reaffirmed guidance for SG&A in our guidance range with respect to the increase in the quarter of 50%...

[Thad Huston, Chief Financial Officer]

50% was related to currency related items, as well as we’ve mentioned that we are investing in DTC and Neuromod as well as our international expansion. We are very comfortable with our full year guidance as far we reaffirmed.

[Raj Denhoy, Jefferies]

Maybe just one follow up, if I could on, under Neuromodulation. You mentioned 35% in SenTiva, if I’m not mistaken that does have a price premium on it and I think you do take a price premium early in the year as well. So, how does price factor into this, the growth you’re seeing in the United States?

[Damien McDonald, Chief Executive Officer]

On SenTiva, we’re still seeing a roughly 5% upgrade for the SenTiva device versus the others. And again that’s why I think this conversion for us is so important and we’re looking to continue to drive that. So more to come I think with this device as more accounts get the news about the advantages and as I said I think coupled with the changes in the indications, we were really encouraged by what we’re seeing.

[Operator]

Next question comes from Scott Bardo with Berenberg. Please go ahead. Your line is open.

[Scott Bardo, Berenberg]

So, first question, just following on from Neuromodulation. I appreciate that gross is in a straight line here, but you mentioned 35% of your initial system orders being SenTiva. My recollection is that somewhat lower than what you saw with AspireSR which I think was 40%, 45% of new products shipped when it launched.

So is the slightly weak growth we see in the quarter here a reflection of less than desirable launch trajectory for this product or put it another way, should we expect to see accelerated growth throughout the remainder of the year for Neuromodulation purchasing. Can you give us some additional color there?

Also on heart valves, obviously we’ve seen some - several years of relatively negative growth here. Some encouraging signs the last few quarters but now back into a negative. I appreciate you had quite a large one-off contract manufacturing revenue. So, is all of that contract manufacturing revenue now gone and should we expect better performance from heart valves going forward? Perhaps if you could give us a feeling for where you are towards your $80 million possible target for year-end please? Lastly - I won’t come back for a follow-up.

[Damien McDonald, Chief Executive Officer]

Let me get those two and I’ll come back with some follow-up. The launch trajectory of AspireSR was candidly a real breakthrough with the change in the technology there, the seizure response technology was really a step change and that I think is what I really rapid uptake.

Now there’s some real advantages to SenTiva with the order titration and now also with the pad and the Bluetooth communication with the one, and the whole new software reboot. I think those things are important but I think the launch trajectory for AspireSR because that was such a change from the previous generations really is what drove that.

I don’t view this conversion rate as anything but positive and we’re continuing as I said to have really great discussions with a number of accounts that either had stopped being VNS accounts or had just never implied VNS in the first place. And I think that’s what’s really encouraging us.

So, I think you should be very positive about VNS therapy and what we’re doing. And especially as we start into the back half of the year getting into more of the DTC view of the world, I think that’s going to help us change behavior.

Heart valves, look I think you’ve got to take out this OEM relationship and it’s going to be a full year issue. And I think we tried to signal that in the last quarter. So, the results for us were really positive. I mean the principal results in the quarter were fantastic. And really strong double digit growth and the fact that it’s now significantly more than the other two previous legacy parts of the portfolio I think is a really important sign.

And we’re really encouraged and you know we expect to be on an $80 million run rate by the fourth quarter. So I think that’s reading through really well. I’m going to give little off piece anecdote. There was a country where this week in one account we had five Perceval implanted in one day and which is really phenomenal acceptance of the technology in this one account.

So we’re really pleased to see what’s going through there. Now, for the follow-up.

[Scott Bardo, Berenberg]

So we’ll just a follow-up on those reports. An $80 million run rate by Q4 is not an $80 million for the full year so probably slightly below what you’re expecting initially if I understood that correctly.

And just lastly on the Neuromod, I think your Capital Market Day you expressed quite a lot of confidence that you can sustain high-single-digit, double-digit growth rates in this business. Is that still with the expectation? Is that still what you see for this division going forward? Thanks.

[Damien McDonald, Chief Executive Officer]

Yes, we do. Like I said, I think we’re really encouraged about what we’re seeing in Neuromod and I think the expansion now internationally with SenTiva is going to be really important. The EU approval, literally just came through and I know that Mark and the team are excited about being able to show what they can do there. And we’ve got lots more work to do in the U.S. So I’m really encouraged by Neuromod and happy to be on the track that we talked about at Investor Day.

[Scott Bardo, Berenberg]

And just lastly then, with the - so progress of the pipeline which is exciting good to hear some progress on the monitor trial prelude. Is it your expectation, I know there’s a large conference coming up in September here, that this date it will be showcased there, also if you could give some feeling for how your chats with CMS are going forward for treatment resistant depression? Thanks.

[Damien McDonald, Chief Executive Officer]

We try to have prelude present at all the major interventional cardiology meetings. It’s not up to us, it’s up to the organizers and the committee that steer the presentations. But we’re working hard to be visible at all of those and we hope that we’ll be able to get live at that, we’ll let you know, we’ll post these things as we get accepted at the various conferences.

CMS again as we’ve said before it’s not a statutory requirement to have timelines. What I will say is, I think we continue to be encouraged by the discussions that we’re having with them on treatment resistant depression. And I think there’s a lot of change in the tone as I’ve said before because we’re really taking a data based approach to it. So I think also, you’ll see our commitment and belief that this is the right technology by opening up the restore life trial.

We wouldn’t have made that commitment unless we really do believe that makes a meaningful difference in patients with CRD and we’re trying to signal to pay regulators and payers around the world that we have a strong belief in this technology.

[Operator]

[Operator Instructions] Your next question comes from Matthew O’Brien with Piper Jaffray. Please go ahead. Your line is open.

[Matthew O’Brien, Piper Jaffray]

Thanks for taking the questions. Just to the clarification point either Damien or Thad, the contract manufacturing impact $2.6 million did that cost you about 110 basis points on the top line, so you would have been more like 6.4% top line growth including - I know you expected it, but was it that the amount that you’d expected to come out?

[Thad Huston, Chief Financial Officer]

It’s our growth excluding the OEM impact was roughly 6.7%.

[Matthew O’Brien, Piper Jaffray]

And then the same kind of clarification question on FX. I think you mentioned this, but did it cost you about 13% - sorry, $0.13 in SG&A in the quarter and how much of that headwind is going to linger throughout the rest of the year on the SG&A side specifically?

[Thad Huston, Chief Financial Officer]

The impact of SG&A was about 120 basis points. So the growth rate would have actually been closer to 37% excluding FX.

[Matthew O’Brien, Piper Jaffray]

So, the two questions that you have the earnings guide going up by about a dime. There’s a bunch of moving parts here and I was hoping you could just kind of tease out. The gross margin improvement was very good to see in the quarter. How much of the earnings guide increases gross margin the extra spend on SG&A plus FX in there and then the tax rate coming down, just the components would be helpful.

[Thad Huston, Chief Financial Officer]

I mean, we have very clearly highlighted that we’re improving the sales growth because of TandemLife that the fact is that we’re pleased that basically all other items are coming in within our ranges on gross margin. We were really pleased to see nearly 67% in the quarter. There were some even currency headwinds that we were even delivering against and still getting that resolved. So we feel good about the guidance we gave on gross margin.

SG&A was higher but, again, if you back out the currency impact, it was a little bit outside the range. But we know that our spending is relatively frontend loaded because of some of the things we’re doing with DTC International expansion, whereas we’re assuming growth will come in higher in the back corridors.

So, I feel really good about the overall guidance, the tax rate. We felt that given where we landed on tax for the quarter at 15.7%, we thought that we should bring down the guidance by 200 basis points.

[Matthew O’Brien, Piper Jaffray]

Okay.

[Damien McDonald, Chief Executive Officer]

Does it answer your question?

[Matthew O’Brien, Piper Jaffray]

Yes, that’s helpful. Last one from me on the Tandem integration. Just any updates on how things are going so far in terms of retaining people and starting to move that technology through your broader distribution network?

[Damien McDonald, Chief Executive Officer]

We’re really encouraged by what’s going on. We have one of our key guys there leading the integration. So, Alex has moved to Pittsburgh to work with the team to bring them on board. And Travis, who is Chief Operating Officer, has stayed on as the GM of that business. And we’re working through to integrate that into our Cardiac business.

We’ve had a number of meetings with what you’d expect around the Executive leadership there but also between their sales force and our sales force is one of the early kick-off meetings in week one was with the two sales forces learning about territory planning and we’ll do lead generation. And I think we’re really off to a good start. I think that people see a lot of opportunity by collaborating.

And so we’re really excited about this and we’re continuing to focus not only on the growth in the U.S. but also their pipeline development and getting their next-gen product out. So all around I’m really happy with how this is going.

[Operator]

Next question comes from Jason Mills with Canaccord Genuity. Please go ahead. Your line is open.

[Jason Mills, Canaccord Genuity]

So I just wanted to follow up on a few questions asked earlier Damien. Starting with case on congratulations on getting that back into the clinic, it’s terrific. Perhaps you could give us a bit of a medium term view on what comes next after PRELUDE both from a European and U.S. perspective. As you look at clinical trial strategies in both geographies?

[Damien McDonald, Chief Executive Officer]

Look I love the team we’re able to execute on what they promised here and get back into recruiting. Literally the day after we received the approval we were back in all of the IRBs with submissions. So I think the team really did a great job getting live there and we’re recruiting again, so PRELUDE 20 patients we’re expecting sometime in Q3 to be done with that.

We started only INTERLUDE trial. We know we’re going to really start focusing our efforts now on cranking the INTERLUDE and pushing that for CE. And then after that is the Ensemble trial which is the U.S. FDA pivotal. We believe that the number of patients there is around about 400, and so look I think all around the team they’re continuing to execute well, I think the single biggest thing now is , now that is to finish all of these IRB approvals and get, get more patients done.

[Jason Mills, Canaccord Genuity]

Let me follow-up on that, with respect to the CE mark in U.S. trials, and specifically early trial. Are the parameters exclusion and inclusion criteria et cetera set in stone at this point or are there, is there a potential for continued negotiation with respect to number of patients an inclusion exclusion end points et cetera. Just wondering if that’s locked, as a trial design or if there is potential movement in that?

[Damien McDonald, Chief Executive Officer]

Yes, INTERLUDE is done, because we’re already recruiting for that, the Ensemble is not, that still, that still a discussion.

[Jason Mills, Canaccord Genuity]

Sorry, I got the names wrong Ensemble is what I meant. Thanks.

[Damien McDonald, Chief Executive Officer]

These are all the code names for all of these things. Yes, so Ensemble is not locked but INTERLUDE is.

[Jason Mills, Canaccord Genuity]

So, when will we, you expect to have some details on, on Ensemble for us?

[Damien McDonald, Chief Executive Officer]

I think once we get the PRELUDE done and we’re through the feasibility that will really open up the discussions about the what next with the FDA.

[Jason Mills, Canaccord Genuity]

And, and just, just a few additional thoughts, and I’ll get back in queue. With respect to U.S., U.S. Neuromodulation sort of following up on couple of questions earlier. You mentioned 35% conversion at and a 5% premium, 5% growth rate in the quarter. So, am I right as to, to estimate that about two out of the 5% of the growth for the U.S. business was priced, and then with respect to the unit growth, I’m wondering if you could tease out replacement growth, and new implant growth for us?

[Damien McDonald, Chief Executive Officer]

Why don’t we - would take that as a follow-up with you and we’ll pass that out a little bit.

[Jason Mills, Canaccord Genuity]

And then lastly HLM is really cranking. And you’ve been telling us that that’s going to happen, so congratulations on that. I’m just wondering sort of if you used the baseball analogy, within a year end with respect to the new product cycle and the momentum we have there?

[Damien McDonald, Chief Executive Officer]

Having lived in America for 15 years now, I actually understand that. Look I’d say we’re probably in like the fifth inning on this, Seth is giving me a thumbs up because he understands more about baseball.

So, I’d say we’re at about the fifth. I think we’ve got really great visibility for another couple of years on the conversions and that’s also why we’re focusing so much on the next-gen HLM and getting Polaris developed in and out.

And so, I think we’ll continue to see growth now but a lot of this is subject to phasing, it’s the capital equipment, there is tenders, there is contracting. But we’re continuing to see a really strong demand for this.

And I will say I give a lot of credit to the sales teams around the world, who’ve really leaned into this idea of funnel management. It was a new methodology, but it’s really reading through. And next, is to stop using that net competency and skillset and start applying it to oxygenators.

[Thad Huston, Chief Financial Officer]

I think it’s a really fantastic example of really, driving accountability, driving the focus on the funnel, and delivering the results that we’ve brought to the team. And you know I think, we’re seeing at HLM that’s going to continue I think, with Percival we’re seeing great momentum. So again really driving great account penetration and sales.

[Jason Mills, Canaccord Genuity]

Well, you might have the best baseball team in the world down there. So, yes baseball is important to you guys down there in Houston these days so. Anyway, I’ll get back in the queue. Thanks.

[Operator]

[Operator Instructions] Your next question comes from Mike Matson with Needham. Please go ahead. Your line is open.

[Mike Matson, Needham]

I guess I just wanted start with the recent news that Medtronics, deep brain stimulator got an FDA approval for epilepsy. So how big of a competitive threat is that to your VNS technology? Thanks.

[Damien McDonald, Chief Executive Officer]

Great question, Mike. Here’s the thing from my point of view. First of all, I think anything that raises the awareness of treatment-resistant epilepsy is a good thing. We’ve been battling this area and trying to get people to understand that more drugs isn’t necessarily the answer. And having Medtronic validate that this is a relevant market is tremendous in my opinion.

Having said that, we believe VNS is a much more elegant and significantly less invasive option. I think that’s something that’s very important to us. The comparisons between trials are always have. We believe VNS is more efficacious with the gold standard here is response rate. VNS is 65% at five years.

Honestly, it’s hard to compare with the DBS pathway here is because they didn’t publish that result. So that’s something that I hope that they get visible with. So look, DBS is very invasive bilateral surgery it’s got a short battery life, it’s not responsive. The side effects are pretty well-known here including infection.

So we like the fact that we have a more elegant solution and we like the fact that people are going to be talking about this.

[Mike Matson, Needham]

And then just with regard to the drag in the heart valve business from this contract manufacturing headwind, so how long is that going to last. I mean the $2.6 million that we saw this quarter you know should we expect that to continue at that kind of range over the next few quarters?

[Thad Huston, Chief Financial Officer]

Yes, it would be a very similar amount by quarter and it’s just for this year. We have highlighted the impact on first half growth of heart valves being negatively impacted but as Perceval continues to grow and we think back half will be back to a growth position despite this impact.

[Mike Matson, Needham]

And then just - just with regard to TandemLife, now that you’ve closed the deal, how do you or how are you going to integrate their sales team with your existing, I guess cardiopulmonary sales team or teams. I mean is it going to be a single team selling all the products or are you going to have a separate team for the TandemLife products?

[Damien McDonald, Chief Executive Officer]

One of the important things in our pre-acquisition discussions, you know what we’re going to do is have their specialists sales force tuck into our regional sales structure. So you are a TandemLife rep with a sales manager that comes from LivaNova and you have partners in that sales team who are from the cardiac group.

So it’s a regional structure and we think that this really builds the bonds and in terms of approaching account as a key account and it’s a much more customer intimate model than keeping a separate sales force and we intend to add the TandemLife - add to the TandemLife pool, as we get to know this more and figure out where the real opportunities are.

[Mike Matson, Needham]

And then my final question would just be with regard to ImThera, we’ve seen their competitor inspire medical file and that’s one now. So for more visibility into kind of what they’re doing their revenue et cetera, so have you - when you look at that S1, assuming that you’ve looked at that, I mean was there anything in there that surprised you about that business relative to what you had thought about that market opportunity so forth?

[Damien McDonald, Chief Executive Officer]

A few things that surprised me, but I won’t talk about them publicly. Here’s the thing, we continue to really believe that this is a great therapeutic area. We like the fact that this market is being validated in the public market. We just acquired ImThera, so we’re still getting to work through the supply chain in the clinical and the commercial capabilities, but we think this is a great therapeutic area.

[Operator]

Next question comes from Scott Bardo with Berenberg. Please go ahead. Your line is open.

[Scott Bardo, Berenberg]

Thanks very much for taking my follow up questions. And great to see the tax rate, underlying tax rate come down. Just wonder if you can comment on the sustainability of that? Is that something you expect over the forecast period, and because it appears to be cash relevant, I’m somewhat surprised that your cash flow guidance hasn’t changed at all. And so maybe you could just give us some feeling actually as to why that doesn’t trickle all the way down to your operating cash guidance?

Also just like to comment a little bit on oxygenator is it possible? I think again in the capital market there was a lot of discussion about expanding your market position, leveraging your install base. That seems to be doing quite well on the install base side, but what is the dynamic with oxygenator, does this have any sort of light at the end of the tunnel to accelerate growth in that important and more predictable side of the business. Thanks.

[Damien McDonald, Chief Executive Officer]

So I’ll take the tax and cash flow comments. Clearly we do think it is sustainable, we certainly - that’s one of the key reasons why we brought the guidance down on the tax rate. There are a number of factors why we didn’t take it exactly the 16% in terms of the kind of level of international profitability that fluctuates. There’s always some uncertainty in terms of the impact on tax reform, but we feel really good about the 18% to 20% guidance that we provided.

To your point on cash flow, clearly it’s early in the year we did discuss whether we adjust the cash flow guidance. The tax impact and some of the real benefits on the cash flow come next year as we pay out the 2018 tax. So that’s one of the reasons why we didn’t adjust at this point in time.

Cash flow is really important to me and clearly is something that we’re focusing on in working capital. So I’m hopeful that you know as we go through the year, we will provide updates on improvements in cash flow, but at this point in the year we chose not to adjust the ranges and guidance.

[Thad Huston, Chief Financial Officer]

And oxygenator, here is the thing. I am a big believer of understanding stretch versus strain with a organization and how much change you throw at them in one go. Candidly I think the cardiac team has really done well to get on board with the final management methodology for heart-lung machines. The counterparts in Perceval team have really done a great job getting into this Perceval account planning methodology and going after what you know I’ve talked to you about before, which is average daily unit.

So the discussion around oxygenators that we had is really what’s next and that’s starting to ramp, I mean, if I look at the account wins in the U.S. in the last - in the last three months, we’re really pleased with how that’s starting to ramp, and we’re tracking wins, losses.

And I’m pleased now that we’re starting to be able to lean into that. But for me it’s just a capacity for change and you know that’s the next thing that we’re going to really work on.

[Scott Bardo, Berenberg]

And maybe just one last one please. I saw that the CMS discontinuing the anti-AP sort of more processing environment for Perceval as of February 2019. Is that a headache for your plans for adoption in North America or perhaps you can share some thoughts there? Thanks.

[Damien McDonald, Chief Executive Officer]

Honestly from that point of view, it’s a little annoying that they’ve changed the timeline, but it really doesn’t change our commitment and belief that Perceval will continue to grow like it is. When we talk to customers not many we’re really taking advantage of NTAP. And so, in terms of our view, we don’t think it changes the trajectory, but it’s a shame to introduce something and then to have it be pulled the way like that. I think that inconsistency makes it hard for companies to plan.

And that’s been a long ranging discussion with some of the governments around the world about. If you want people to innovate and be consistent you have to be consistent. And so, that’s the message certainly I’ll be giving at the [after-mid] meeting in a few weeks time that this sort of thing isn’t what drives innovation. But from our point of view, we don’t see any change.

[Operator]

And at this time, I will the call over to the presenters.

[Damien McDonald, Chief Executive Officer]

Okay. Thank you very much. And we look forward to updating you on our next call and continuing progression on our plans.

[Karen King, VP, IR and Corporate Communications]

Thank you. We’re going to disconnect now. Thank you.

[Operator]

This concludes today’s conference call. You may now disconnect.