LivaNova PLC (LIVN) Q3 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the LivaNova PLC third quarter 2018 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Matthew Dodds, LivaNova's Senior Vice President of Corporate Development.

Thank you, Leandra, and welcome to our conference call and webcast discussing LivaNova's financial results for the third quarter of 2018. Joining me on today's call are Damien McDonald, our Chief Executive Officer; Thad Huston, our Chief Financial Officer; and Melissa Farina, our Vice President of Investors Relations. Before we begin, I would like to remind you that the discussions during this call will include forward-looking statements. Factors that could cause actual results to differ materially are discussed in the company's most recent filings with the SEC and we do not undertake to update any forward-looking statement. Also, the discussions will include certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures can be found in today's press release that is available on our website. We have also posted a presentation to our website that summarizes the points of today's call. This presentation is complementary to the other call materials and should be used as an enhanced communication tool. You can find the presentation and press release in the Investor Relations section of our website, under News and Events, Presentations at www.investor.livanova.com. With that, I will now turn the call over to Damien.

Thanks, Matt. Well, welcome to our third quarter 2018 conference call. The results from this quarter reflect the success of our growth strategy. During the quarter, we saw strong sales growth and expanded gross margins. As we’ll explain in more detail later, an acceleration in our R&D investments impacted the year-over-year earnings comparison this quarter. However, we remain confident that we will achieve our full-year EPS guidance. I'm going to provide some 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 we move on to Q&A. Starting with quarterly highlights and recent events. On September 18, we announced the first successful implant in the ANTHEM-HFrEF pivotal trial. ANTHEM-HFrEF is an international, randomized, multicenter trial to evaluate the VITARIA System for the treatment of advanced heart failure. We have made faster-than-anticipated progress since the start of the trial with over 30 sites activated. On October 18, we received CE Mark approval for MEMO 4D, a semirigid mitral annuloplasty ring. The next generation of the MEMO device family now offers a broader range of ring sizes, expanding the patient population. The product simplifies and standardizes degenerative complex mitral valve repair, uses a minimally invasive surgical approach and offers improved leaflet mobility. And lastly, we remain encouraged that the US Centers for Medicare and Medicaid Services is reconsidering its national coverage determination for our VNS Therapy System for treatment-resistant depression. The release of a proposed decision memorandum is expected in the fourth quarter. Depression affects more than 300 million people worldwide and is the leading cause of disability in the US. TRD is a small subset comprised of patients who have experienced four or more treatment failures. This is an area of high unmet need and one where LivaNova can make a difference. Turning now to our net sales results for the quarter, which will be stated on a constant currency basis unless indicated otherwise. Total net sales were up 10.3%. Both Neuromodulation and Cardiovascular showed strong growth in the quarter compared to the quarter of 2017. Cardiovascular sales were $167 million, up 7.1% from the third quarter of 2017 due to growth in cardiopulmonary, Perceval within heart valves and the inclusion of advanced circulatory support. Cardiopulmonary sales were $128 million in the quarter, an increase of 5.9% versus third quarter of 2017. Heart-lung machine sales grew in the mid-single digits, including double-digit growth in the US and Europe as we continue to replace our legacy S3 machines with our current S5 machines. Our oxygenator sales grew in the high-single digits as we are now turning our attention to driving share gains in this business. Our autotransfusion business also performed well, growing in double digits. And these last two categories had sales growth in all regions. Turning to heart valves, sales of heart valves were $33 million in the quarter, a decline of 5.8% versus the third quarter of 2017. We were disappointed that Perceval only grew in the high-single digits, with continued strong growth in rest of world, offset by softness in the United States and Europe. While we are seeing exceptional performance in some sales territories, overall performance has been mixed as we implement additional training and professional education programs. We have also recently made changes to our US leadership. In the quarter, we also took a $3.4 million non-recurring reserve charge. This was the result of our decision to go direct in a key Asia-Pacific market in 2019. Excluding the impact of this charge, heart valve sales increased in the mid-single digits. Advanced circulatory support reflects our recently acquired TandemLife business. Sales in the third quarter was $6 million, representing over 20% growth versus third quarter of 2017. We are slightly behind our hiring plan and it’s taking a bit longer than expected to ramp our new sales hires, so we now expect this business to grow in the 20% to 30% range in 2018. And we continue to expect TandemLife to grow sales in excess of 20% over the long-term as we previously discussed. Now, let’s turn to Neuromodulation. Sales were $105 million, up 15.8% versus the third quarter of 2017. In the US, sales increased 14% driven by double-digit growth in our initial implants and high-single digit growth in our end-of-service implants. US adoption of SenTiva continues to increase and represented 55% of our generator sales for the third quarter. We saw 20% sales growth in Europe based on our continued adoption of SenTiva, which was launched in April, and our rest of world region delivered nearly 30% growth driven by early success of a business model change in Japan and strong growth in Latin America. I’ll now turn the call over to Thad for an overview of our financial results. Thad?

Thank you, Damien. I’m going to discuss the third quarter financials in greater detail and speak further about guidance. As Damien mentioned, sales growth in the third quarter was 10.3% versus the third quarter of 2017 due to strong sales in all growth drivers in each region. Adjusted gross margin as a percent of net sales in the quarter was 68.2%, up 250 basis points from the third quarter of 2017. The margin improvement was primarily driven by price and mix. Adjusted R&D expense in the third quarter was $38 million compared to $21 million in the third quarter of 2017. R&D as a percentage of net sales was 13.9% versus 8.4% in the third quarter of 2017. This investment represents an increase of 79% over the prior year, which equates to approximately $0.29 in earnings per share. As we previously discussed, R&D increasing behind the development of next-generation products, including HLM, SenTiva and TandemLife, and clinical trials and strategic investments in TRD, TMVR, sleep apnea and heart failure. Compared to the second quarter, the sequential increase in R&D is largely due to the initiation of our ANTHEM HFrEF pivotal trial. This increase in the quarter was above our expectations due to the phasing of site activations. Adjusted SG&A expense for the third quarter was $101 million compared to $90 million in the third quarter of 2017 and down $3 million sequentially. SG&A as a percentage of net sales was 37.1%, up 110 basis points versus the third quarter of 2017. The increase is due to a number of factors, including key growth driver investments in the US, including DTC for epilepsy and advanced circulatory support commercial capabilities, strengthening our commercial organization in the international markets, building our organizational capabilities to support growth including investments in our IT infrastructure, and a foreign-exchange headwind of 30 basis points. Adjusted operating income from continuing operations was $47 million compared to $54 million in the third quarter of last year, which reflects an improvement in gross margin offset by investment in our key growth drivers and R&D. Adjusted operating margin from continuing operations was 17.3%, down from 21.3% in the third quarter of last year. Our adjusted effective tax rate in the quarter was 12.6%, an improvement from 23.5% in the third quarter of 2017 as a result of our ongoing tax efforts and recent changes in the US and UK tax laws. Finally, adjusted diluted EPS from continuing operations in the quarter was $0.78, a decline of 6% compared to the third quarter of 2017 based on 49.7 million adjusted diluted weighted average shares outstanding. Moving to cash flow, our cash flow from operations for the nine months ended September 30 was $100 million. Cash flow from operations, excluding payments for one-time integration and restructuring cost was $156 million. Capital spending for the nine months of 2018 was $25 million compared to $24 million for the same period of 2017. Our cash balance at September 30, 2018 was $80 million, up from $47 million at June 30, 2018. Our net debt at September 30 was $72 million, down from $113 million as of June 30. Now, turning to 2018 guidance. We are updating our 2018 guidance which includes constant currency sales growth of 7% to 9%, up from 6% to 8%. We have increased and narrowed our gross margin guidance to 67.5% to 68.5% from 66% to 68% and narrowed our range for R&D expense as a percent of sales to 12% to 13% from 11% to 13%. We now forecast our SG&A expense as a percent of sales to be in the range of 35.5% to 36.5%, up from 34% to 36%. And we now expect our tax rate to be in a range of 16% to 18%, down from 18% to 20%. We are not changing our operating margin guidance from 19% to 21%, our adjusted diluted earnings per share from continuing operations guidance of $3.50 to $3.70 and our cash flow from operations guidance of $180 million to $200 million. Assuming current rates, foreign currency is expected to contribute approximately 100 basis points to sales growth and negatively impact earnings by approximately $0.10 to $0.15 per share. While we will not be providing 2019 guidance until we report fourth quarter 2018 results, we are, however, exiting a low-margin OEM distribution agreement in Canada at the end of the year that is expected to represent approximately $32 million in sales and $0.13 to $0.15 in earnings per share in 2018. With that, I’ll turn the call back to Damien for some final comments.

Thanks, Thad. I’m really encouraged by our progress on a number of fronts so far this year. We have delivered sales growth at the upper end of our guidance, while improving gross margin through pricing discipline, product mix and cost efficiencies. We are also making significant investments in our future, expanding our pipeline, innovating next-generation products and funding clinical trials for our growth drivers and strategic portfolio initiatives, which include treatment-resistant depression, mitral valve replacement (TMVR), obstructive sleep apnea and heart failure. In Cardiovascular, we continue to drive upgrades of S5 heart-lung machines and improve growth in oxygenators and other products in the cardiopulmonary portfolio. Perceval was below our expectations, but we are investing in the business to drive growth back above double-digits in the fourth quarter and beyond. TandemLife is off to a good start and we expect the business to accelerate in the fourth quarter, behind our commercial expansion. In Neuromodulation, we are seeing increasing demand for the SenTiva VNS Therapy System in the US and Europe and we look forward to updating you on our continued progress in delivering on our commitments to drive shareholder value. And with that, Leandra, let’s open it up for questions.

[Operator Instructions]. And your first question comes from the line of Raj Denhoy with Jefferies. Your line is open.

Hi, good morning.

Hey, good morning, Raj. How are you?

Good, good. Maybe I could start with the spending in the quarter. It was, I think, quite a bit higher than maybe a lot of us were expecting. You sort of explained that you were investing in R&D and things. So, maybe you could give us a little bit more about the trajectory of spending in the business, your ability to show leverage and really how we should think about the operating margin going forward.

Yeah. Thanks, Raj, for the question. We are very confident that we’re going to deliver the SG&A expense for the full year within our new guidance range. And as you saw, we moved it up slightly given some of the investments that we've made. But one of the reasons for that, clearly, is that we have basically really been focused on procurement and expense management. We absolutely expected spending to remain relatively flat quarter-over-quarter in the fourth quarter, which is actually our highest sales quarter of the year. So, as a percentage, you see that those numbers come down. In addition, FX added about 50 basis points year-to-year on our SG&A expense through the first three quarters. And so, we expect that will have a minimal impact in Q4.

Okay. So, I guess, it was really R&D – it was sort of across the board, but the R&D spending was up almost – a little above $5 million quarter-over-quarter.

Yes.

I respect that it’s part of the ANTHEM spending, but is this a new level of R&D spending we should expect going forward? Was there some upfront costs that started to come down?

It was clearly driven by ANTHEM. So, you saw in the quarter-on-quarter, this spike up, we expect the R&D expenses overall to remain relatively flat in Q4 as well. We are looking at Caisson, VITARIA, ImThera and TandemLife as well. There’s a lot of investments that we’ve been making, as we’ve highlighted, in R&D to drive the overall…

But the quarter-on-quarter is going to remain essentially flat. And this really – the spike really related to the phasing of the site activation. I’ve been really on the team, me and funnel management, right? How do you enroll patients quickly? You need sites activating. So, I've really been on the team about getting the sites activated and the funnel and – and they've done an incredible job. We had 30 sites roll in in the quarter, which was slightly faster than our phasing.

Okay, fair enough. And then, maybe just two others on VNS. So, very strong results. And I think you mentioned, internationally, you’re seeing good traction in some new geographies. Again, really kind of the sustainability of this growth, the very strong 16% growth, do you think you saw some perhaps stocking or upfront sales or do you really think this is kind of a new level of growth out of the business we can expect?

We’ve been really diligent since we came into this gig to make sure that what we are doing is sustainable. That’s been a big mantra of us. Don’t do stupid in the quarter. So, there’s a couple of things. Firstly, we always said we think this should be a high single-digit growth. I’d be at the upper end of our range there for that. Don’t forget there’s a bit of a soft comp on Q3 with some weather from last year. That was the hurricane issue in the US last year. As much as that was an impact on the US, what we saw in Europe was nearly 20% growth and international nearly 30% growth. So, I think we really do see this as a high single-digit grower.

Okay. And my last question is really we’re now, I guess, less than a month away, about a month away from the November 30th decision from CMS. Is there anything you could maybe offer in terms of expectations or how you really would have us think about that decision and possible outcomes? How are you guys kind of thinking about what could come out of that at this point?

Look, the simple answer to this, Raj, is we’re just not going to comment on where we are with CMS. I’m hoping that, in the quarter, sticking to their timeline, that we have an idea about the decision memorandum. But we’re just not in a position to comment one way or the other. I will tell you, we are preparing internally, as you would expect us to, but we’re not making any significant investment. As we previously talked about, we’re going to wait until we see what signal, if any, we get from CMS and then we’ll come out with some ideas about how we’re going to invest.

Fair enough. But I had to ask. So, thank you.

Appreciate it.

Your next question comes from the line of Rick Wise with Stifel.

Good morning, gentlemen. Let me start with guidance, if we could. Obviously, you’ve raised your guidance range. If I’m doing the math correctly, that suggests that fourth quarter top line growth might have a range of something like 2% to 10%. Help us understand, if you would, some of the drivers that could result in a lower or higher end performance. I assume you’re targeting something in the middle. And just, if you would, help us reflect on and think about the seemingly tougher comp. If I’m thinking about correctly, you launched SenTiva in the fourth quarter a year ago. Heart-lung upgrade cycle began then. Again, just help us think about the puts and takes and how we should frame our thoughts about the quarter ahead.

Thanks, Rick. And, clearly, as you said, the comps in Q4 are certainly more challenging, given the SenTiva launch, even the performance of HLM in Q4 last year. But I think when you think about looking at the quarterly phasing of both profitability and sales, the fourth quarter is normally expected to be our highest sales quarter. And we are again forecasting that this year. So, there is more leverage in the P&L and profit than what you see in the first three quarters. And as I mentioned, we are really ramping on cost management and procurement initiatives throughout the year that really are starting to show a more meaningful benefit in Q4, and that’s one of the reasons why we are modeling or expecting relatively sequential flat absolute spending in Q4. And when you look at Q4 last year, we had an initial ramp in our R&D investment. So, the leverage is also there. So, there’s a number of factors we feel good about, staying within our range as we guided previously on EPS and we are really pleased that we are seeing the great top line momentum.

And on the top line, I think if you look at heart-lung machines, yeah, it’s a tough comp, but we’re still forecasting growth and expect the team to execute well there. And on oxys, we’re starting to gather a bit of momentum from our focus on share gain. And we really believe, with SenTiva, we've still got a lot of runway on the Neuromod, both US and outside the US. So, those three things continue to be drivers and we’re pretty confident about Q4.

Okay. One clinical question and then one sort of portfolio question. Maybe you could touch on just your mitral – the ENSEMBLE trial thoughts post-TCT. Any more updated thinking about the setup for your program or the progress you’re making or what’s next post-COAPT? And I’ll just do my last question, obviously, you’re exiting the Canadian distributorship, you said. Should we expect more portfolio pruning here? Are there other opportunities left as we look ahead? Thanks a lot.

Okay. Two big and disparate questions. So, look, on COAPT, mitral clip, ENSEMBLE, clearly, it was a great set of results out of the COAPT trial. We are in the process of trying to figure out what does that mean for ENSEMBLE. One strategy here might be the randomized against mitral clip, which, obviously, has benefits about how we enroll, the speed of enrollment, number of patients we’d have to enroll again. Candidly, it’s still pretty early to tell. We haven’t even really started the deep conversations with the FDA on the pivotal trial design. But from our point of view, we think that this really points to – mitral valve repair and replacement is a really valid area to be in. We think mitral valve replacement is a really key opportunity because we are looking to eliminate mitral regurgitation, not just decrease it. But I think, all round, it was an exciting opportunity for the whole space. On portfolio changes, do you want to…

Look, I think we are very, very focused on driving our innovative portfolio. Clearly, having an OEM distribution agreement that was low-margin, we wanted to get out of that. I think we’re being very proactive in exiting some of these arrangements. It will have a sales and earnings impact, but we think that being focused is really where we want to be. There aren’t other big items that we are looking to exit in 2019, but we are going direct in most of our international markets over time. So, this is another example of just really that focus on our innovation portfolio.

And eliminating those legacy agreements that were low-margin OEM.

Thanks again.

Yeah. Thanks, Rick. Cheers.

Your next question comes from the line of Scott Bardo with Berenberg. Your line is open.

Yeah. Thanks very much for taking my questions. So, the first question is a 2018 guidance question. If I understood correctly, you're maintaining your expectation on adjusted operating margin of 19% to 21%, and yet you're lowering your effective tax rate assumptions to 16% to 18%, but still maintaining EPS guidance of $3.50 to $3.70. So, I'm sort of slightly confused there why that would be the case. Is this a bit of wiggle room or is it the message that you now expect to come at the low end of this operating margin range? Can you just further explain that for us please?

Yeah. I think it’s really, I’d say, being conservative within the ranges here. Of course, the tax trends are really positive and we’re pleased to see that the rates are coming down. We wanted to send a clear message that we are holding our EPS guidance. And, of course, we’re looking at and we’re managing the phasing of expenses to bring that in line.

At the same time as driving higher growth. That’s part of the thread here is, we adjusted SG&A up slightly. But, again, the R&D spend is all valid focus on the critical few things we’ve talked about in the start of the investor day a few months back. So, the intention here is invest for the future, but also be disciplined about how we are investing to drive growth. And that’s why we took the sales growth up.

And gross margin, which we are super pleased that we are ahead of our plans even on gross margin. So, I think there’s a lot of really positive signs in the quarter. Obviously, the EPS is lower, but that’s because of the R&D investment largely.

Understood. And appreciate there’s a lot of places that your spending and a lot of moving parts at the moment. But as you see it, you highlighted a midterm expectation for some of your cost ratios. We’re now starting to trend up a little bit on R&D. Do you think that those cost ratios that you've outlined at the CMD over the medium term still hold or are they subject to some revision now given all of these projects that are developing through the company?

I think we are not giving 2019 guidance today, but I would assume something that’s in this ballpark, right? We are not expecting another tick-up in SG&A or R&D from where we are today. We’re always looking at driving efficiencies and improving our cost management. So, we clearly want to drive growth both top and bottom, but 2018 and 2019 are clearly investment years for our business as we bring forward this pipeline, which we outlined on our investor day.

Okay. I just want to understand a little bit about heart valve performance, which again was pretty poor this quarter. So, first of all, just wanted to understand what this non-recurring return revenue actually means for heart valve, so if you could explain a little bit about that and why that's a one-off. And also, with respect to Perceval, it seems somewhat surprising that growth is only high-single digits given the opening of the Japanese market and the continued transition toward these solutions in the US. So, is there evidence of price pressure here? Is there evidence of competitive pressure or pressures outside of your own control and operational issues? Thanks.

You do the charge and I will come back…

The charge was a non-recurring accounting adjustment and was related to a distribution agreement for heart valves where we decided to go direct in a market in Asia, and it's an agreement that expires in May of 2019. So, we took that charge. It, obviously, had an EPS impact of about $0.04 in the quarter, but also impacted the overall growth rate.

Yeah. So, that’s a one-off charge. We have, obviously, a lot of debate – it’s a May 2019 exit, but you need to take the charge when you’ve made the position. So, that’s a one-off. Just a couple of things on Perceval. First of all, we’re not live in Japan yet. We’ve got approval, but not reimbursement. We are still working through that. So, candidly, first of all, it was disappointing. And we have these pockets of really exceptional performance. There’s a group of people who are just doing phenomenally well on executing at, what I would call, best practice. But the implementation has been mixed. We’ve invested more in sales training recently. Their cross-ed programs are ramping and we’ve made changes to the US leadership. So, I really am convinced we have something here. It’s unique. It has patient benefits. We are still at less than 5% market share in a really active market of aortic surgery replacement. So, I’m convinced about the long-term runway of this. Q3 was a bump in execution and we are on it. And I’m sure the people in that team understand that.

Thank you. Maybe just very quick last follow-up. And again, just coming on to this distribution agreement, if you like, in Canada, this OEM business. I just wanted to understand a little bit the rationale better. If I got your comments correctly, this relates to about a 2.5% impact to next year’s revenues, but about a just over 3% impact to next year’s bottom line. So, it seems that this is a relatively above-group profitability or certainly an economically viable agreement that you have in place. So, why would you exit from that?

Yeah. It’s really – if you look at the gross margin on that business, it’s at a much lower level. It’s certainly an OEM business, first of all, and it kind of takes away some of our focus. There are some kind of trap costs, of course, when you stop one of those agreements, but we see longer-term that we really want to focus our resources and energy around our innovative portfolio and not other companies’ businesses that are lower margin.

Okay. Thanks very much, guys.

Thanks, Scott.

Your next question comes from the line of Matthew O’Brien with Piper Jaffray. Your line is open. Matthew O’Brien: Good morning. Thanks so much for taking the questions. Just for starters, as I look at 2018, you've had a lot of really good performance – heart-lung machines, oxygenators, Neuromod this quarter was really good. So, a lot of things are moving in your direction. But as we head into next year, we’ve talked about the Canada thing. I think we’ll probably exit that out. Excluding TRD, is next year likely going to be a top line growth number that’s lower than what we saw this year? Within the context, are you talking about kind of mid to high-single digits over that 2017 to 2022 projection period?

Look, we clearly want to continue to build on our high single-digit momentum that we have and we feel really, really good about the quarter, where we’re going in Q4 and going into 2019 to maintain that. Clearly, as you highlighted, Neuromod is really doing well and we want to continue to invest behind that. We’re also investing quite a bit in international expansion and going direct in a lot of markets to really drive our Neuromod business as well as HLM globally. As Damien mentions, we’ve had some disappointments with Perceval, but we’re working through that. And we’ve been investing in new things like TandemLife, which is going to be a growth driver for us going into 2019. We are expecting a new pump in – a new device there next year. So, there’s a lot to be excited about. I wouldn’t go modelling double-digit growth next year. But, clearly, we want to continue the sustainable rhythm of high single-digits.

We’re getting better at our sales force execution too. A lot of the practices, as one of my team call it, methodologies – new methodologies for a lot of the organization. And those muscles take a little time to build, but we’re continuing to see progress on a lot of fronts there. So, I’m confident about the growth trajectory and how we are doing and the team. As I said, settling into the new methodology is continuing to do well. Matthew O’Brien: That’s super helpful. As far as Tandem goes, I think you were saying before you were going to grow about 30% in that business or year-over-year grow 30%. Now, you are talking 20% to 30%. Can you just flesh out a little bit more on what’s going on with the sales force and getting them up the productivity curve? And then, any other commentary on international markets and when you’re going to push into those territories?

Great question. Look, we love TandemLife. Every time, I visit those guys in Pittsburgh, I get more excited about what we can do with this. I think the integration has gone really well. We had plans for ramping commercial hires. That's gone a little slower. Getting the right people in the right geographies is important. And I'd rather pick the right person than rush numbers. So, that was one thing. And, candidly, it's a pretty complex sell. And ramping their capabilities is just taking a little longer. So, really, that's the two things there that, I think, is holding us back just a little bit. So, we've come a little bit off the 30% to the 20% to 30%. Our long-term goal was greater than 20%, and we still see that. But like I said, just a little lighter in the full year. In terms of international, we're really waiting for the new Delta program – it’s a new pump and a new controller – before we go international. The existing product isn't CE Marked and there's a whole – sometime over a longer conversation, I can talk to you about RoHS agreements and EU certification, but this is really waiting for the new Delta program to come along, which will be mid next year. Matthew O’Brien: Got it. And then, last one for me. On the R&D spend, obviously, the heart failure patient population in the US and around the world is enormous. A lot of your competitors that have tried in the space have had, I’d say, mixed results at best. So, what is it that you’re seeing recently that gives you more confidence in that opportunity to make these investments, now that I know it’s on the center side of things at this point? What is it that mechanistically you’re seeing from a clinical perspective that's giving you more confidence?

I think one of the things – after the two studies of 18 months ago, sort of the very big public trial failures came out, our team ripped apart the results. And, in their opinion, there were two big issues. One was trial design and the patient selection. And the other part was the dosing. And so, our team really believe that they understood how to make a difference with those two parameters inside a trial design. We went to the FDA with our thoughts on this. And the FDA said, hey, funny you should say that, that’s what we think. And that’s why they granted us the expedited access pathway on this with an adaptive trial design. So, we’re being very careful about the patient selection, and I think that’s an important part of this, but the team, I think, are highly confident in understanding the disease state. And especially, I think importantly around how VNS affects this whole treatment pathway. So, again, I'm respectful of the fact that others have not been successful, but I really like the early read on the 12-month data from the ANTHEM trial and the pilot, and that’s what gave us confidence to go into this adaptive trial design. Matthew O’Brien: Very helpful. Thank you.

Your next question comes from the line of Mike Matson with Needham & Company. Your line is open.

Good morning. Thanks for taking my questions. I guess I just want to follow-up with another heart failure question. So, can you just talk a little bit more about the trial design and sort of the anticipated timing, how much follow-up is required and when you could potentially be on the market in the US or even O-US with this product?

If you want to come back with the team sometime and dive in with them, I'm really happy for you to dive in with Bruce and the team in Minneapolis. It's a 2025-ish plan. If you think about our horizons, we have four horizons – TRD first, the mitral valve next. The long-range one for us was always the heart failure. So, we've got a few years here with work to go. But the specifics of the patient selection and all of the inclusion/exclusion criteria, that's a great conversation with Bruce and the team.

Okay, understand. And then, just with regard to the – it’s good to see the improved growth in oxygenators. So, can you maybe talk about what you’re doing there to kind of capture more share in that portion of the market?

Look, the reason that we focus on the second is, with heart-lung machines, you miss a capital sale – we were at it 7 to 10 years. So, the first tool we had to introduce with funnel management was around the heart-lung machine conversions. Now, we’ve sort of got the momentum on that. We’re turning to the oxygenators. It’s a very similar process. And, look, we have 70% market share in the heart-lung machines. The idea is to take all of those heart-lung machines sites and look at what oxygenator they are using and then, very specifically, go and target the accounts where we have a footprint and a relationship and look at conversion. It’s working in Europe. It’s working in the US. We are expanding this internationally. And we've done some other things internationally with really rationalizing the portfolio and what we’re offering. I actually love what the team is doing there in terms of their marketing thought process. So, this is really an application of funnel management that we’ve spoken about before, Mike, and how we execute in the field. Some people, sales 101; but it’s a new methodology for our organization.

Okay, thanks. And then, just with regard to neuromodulation in the international markets, it’s good to see the growth picking up there as well. So, how much of that is being driven – is that primarily epilepsy or are you getting success with treatment-resistant depression as well?

That’s nearly all epilepsy. They’re seeing some small signs in Germany where we are experimenting with the TRD. What we’re doing in Germany is really just trying to understand the treatment pathway and how you handoff between a psychiatrist and an implanter and back and who’s going to do the dosing. So, our big focus really is epilepsy. And again, both in Europe and in the international group, we’re seeing great execution. And some things that the international team did, changing the go-to-market strategy in Japan, the early read there is very positive. And then, Latin America again – one of our theses, I think, we talked about with you is that the Neuromod team were very US centric, and rightly so. And being able to capitalize on our broader geographic footprint and take the Neuromod epilepsy portfolio international was a real opportunity for us. And I’m thrilled that it’s reading through. And again, 20% in Europe, 30% internationally is just really great.

All right. Thanks a lot.

Your next question comes from the line of Jason Mills with Canaccord Genuity. Your line is open.

Hi, Damien, Thad and Matt. Thanks for taking the question. Damien, I want to start with mitral. Obviously, it’s a longer-term project. But what can you tell us with respect to progress you’d made in feasibility around the world in the last three months after you've relaunched that and just what you’re seeing out there in the field on the replacement side? I also observed early in this call on the scripted comments that you mentioned repair again. Can you let us know what, if anything, you have in development on the mitral repair side, transcatheter mitral repair side and what you might be looking at, if anything, to bring inhouse from an external perspective.

Just on the mitral repair, we are focused on the surgical aspect of this with minimally-invasive technology with the MEMO family. We don’t have a transcatheter mitral repair. But, again, I think the results from COAPT were tremendous and I think helped the whole space lift, and I think that was a really important aspect of what came out. I will say, since the pause, and when we made some changes to the procedure and also came out with the additional sizes, it’s been very positive. We’ve added the new sizes. That’s done a couple of things. It’s increased our screening rate. And also, we’ve understood more about the patient intelligence and who fits. So, I think importantly the screening rate is up. We’ve added new sites into the program, which, again, is an important part of how we’re going to get the enrollment. And even talking to the team in Minneapolis as recently as yesterday afternoon, the investigator confidence remains really positive. So, I’m really encouraged by the Caisson program. Look, it’s still early. We are just out of feasibility. We are in the early CE part of the trial and quite a few steps to go before we have a fully locked-down program with the ENSEMBLE and the FDA. But it’s progressing well and I really believe we’ve got the right team and the right product.

Got it. Would you be willing to give us any sort of numbers in terms of enrollment ramp? It’s great to hear that screening ramp that should translate to enrollment over time. I wonder if it’s too early for that or if you’re actually seeing enrollment increase? And then, maybe a question about the US market and design of trial. You mentioned a little earlier this call with the COAPT results that sort of adds a bit of calculus to how you set things up here in the United States. Maybe reflect on that a bit more and then I had one more follow-up.

Look, we’ve been releasing the enrollment numbers at each thing – TCT, London heart valve. I just want to make sure we're consistent on the exact number. But let us come back to you on that, so I'm not saying something that's different to what we said previously. So, we'll come back to you straight after the call. COAPT, look, I think one of the things for us is now that mitral repair has shown such a benefit, you get into a discussion about do you randomize against surgery or do you randomize against transcatheter repair. And so, I think that's part of our new calculus now the results from COAPT were so positive. Again, we're still early. We haven't had the full discussion with the FDA on ENSEMBLE, but we believe that randomizing against COAPT is a reasonable option, and that probably has an impact around patient numbers and also the enrollment rate.

Okay. That's helpful. Damien, thank you. And just, Thad, on the P&L, well, I guess going back to your commentary about the Canadian OEM and your plan to go direct over time and to sort of eliminate these low-margin OEM businesses, can you give us a sense for how many more of these there may be to come and/or sort of what percentage of the global market you seek to target direct that you're currently using distributors and how that gates over time in terms of adding that? Just wanting to get a sense for how many sort of more of these interjections to the guidance or to the numbers we might see over the next couple of years. And then, just separately, on the SG&A line, the R&D spend actually, on a go-forward basis, we already had ticking up. What we didn't have ticking up was SG&A, and perhaps that's our fault for mismodeling. But in terms of – I know you haven't given guidance for next year, Damien, but in terms of your spending levels on SG&A as a percentage of total revenue sort of excluding this OEM from Canada, should it stay at the same levels, generally speaking, next year as we are in this year? Just wanting to get a sense for whether or not we can expect more spending or about the same levels as a percentage of revenue. Thanks for taking the questions.

I'll do OEM first and you come back on the SG&A. So, OEM, we're done. We had a couple of big OEM sales distribution, a commercial arrangement, we had an OEM manufacturing agreement. We believe that exiting those legacy arrangements that were relatively low-margin and not promoting or investing in our innovative technology were not the strategy that we wanted to play forward. So, we're done with the big-ticket items here, and I think that's an important shift for the company to understand that we make and develop and innovate technologies, and it's an important message for not only our customers, but also our organization. So, we're done on the big ones. There are some little puts and takes in various markets as we change distribution arrangements, but those hybrid arrangements are not very big deals and we’ve sort of factored them into our SG&A spend. I'll pivot over to you…

So, exactly as we outlined in our investor day that we wanted to continue to focus on accelerating growth and improving gross margin, we feel really good that we're doing those things. As you point out, I think the SG&A is a little higher than probably what we had originally guided at the beginning of the year, but we think that we have really great growth momentum and opportunities to invest. So, you're right, we're not guiding yet for 2019, but I think to assume kind of a similar range is probably fair. The R&D, we clearly had highlighted that that was going to be an investment year as all these programs are coming online now. And this quarter, we had kind of an uptick in R&D because of the heart failure program coming online. But we don't see it stepping up beyond that level. So, in terms of absolute dollars, SG&A and R&D, we’re kind of staying relatively flat in terms of the level of spending that we're going to be seeing going into Q4 and into 2019.

Yeah. The step-up in SG&A happened Q1 to Q2.

Correct. So, Q1 to Q2, we started stepping up SG&A mainly because of DTC investments in Neuromod and the international expansion. Both of those things have started to show very positive signs. And so, our growth rate is picking up. And, of course, we're going to continue to monitor and manage investments, but if we continue to see great results, we'll continue to invest. That's the way I've been thinking about it.

Makes complete sense. Thank you.

And, your next question comes from the line of Scott Bardo with Berenberg. Your line is open.

Thanks very much for a quick follow-up. So, first of all, can you just remind us where we are with ImThera? Have you managed to get that back on track? Maybe just a status update there. Thad, you just mentioned the DTC investments into Neuromod. Can you share a little bit more thoughts as to what you're actually doing there and whether some of the signals are proving successful? And just a housekeeping question. I appreciate that some of your operating cost ratios have gone up this year. You mentioned R&D and also SG&A, but you've also had quite a lot of currency headwind this year. As we look to the euro/dollar next year – I think 1.13 at spot – can you share some thoughts about next year from a currency perspective? Is that going to be a benefit to your bottom line and some of your absolute operating costs? Thanks.

I'll address the last two. Clearly, you're absolutely right: We won't have that currency headwind that we had in the first three quarters of this year. So, looking ahead, it should be relatively flat, assuming currency rates stay the same. On the DTC, we basically are really pleased with the progress. In July, we started our direct-to-physician campaign and have recently moved to patients and caregivers. And so, we are seeing an increase in physician engagement with about half of those physicians being non-DNS users and also a small number of patients that have already come through from our DTC efforts. So, we will, obviously, continue to monitor that, but we want to successfully continue that investment into 2019.

And ImThera – look, first of all, let me headline this by saying we really love obstructive sleep apnea, we love the ImThera opportunity. What we've done is we've concluded the THN3 trial, which was the pivotal trial. In the last group of patients that hadn't yet come in for the final follow-up, we introduced a new titration protocol. One of our theses was that the titration protocol needed to be improved. We took one of our best titration people out of the Neuromod team and whacked him on to this problem, and they've done a really great job standardizing both the protocol, but also how it gets executed. We're evaluating a new protocol. And our anticipated meeting with the FDA is sometime in Q1 to go back and speak to them about the what next. But if you look at what we believed about this, it's a big market, large unmet need. We like our solution, which is a simpler procedure. There's a quicker recovery time. We think we know a lot about small implantable bioelectronics and what we're learning with SenTiva, and, certainly, our second-gen SenTiva is going to really play into this platform. And so, we know we've got work to do. There's aspects of this that we want to make sure we've got a stable product design, a titration algorithm that's understood, and a trial design that executes on that. And so, we go back to FDA in Q1, and we can see what we can do there.

Very good. Thanks, Damian.

Cheers, Scott.

And your next question comes from the line of Rick Wise with Stifel. Your line is open.

Or not. Rick, are you there? Leandra, I think we lost him.

And there are no further questions at this time. I will now turn the call back over to Damian McDonald for closing remarks.

Well, thank you all for the questions. And on behalf of the entire team, I'd like to thank you again for your support and your interest in LivaNova and we look forward to the next quarterly call with you all. Cheers. Thank you.

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