愛德華生命科學 (EW) 2014 Q2 法說會逐字稿

Greetings, and welcome to the Edwards Lifescience Corporation second-quarter 2014 earnings conference.

(Operator Instructions)

As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, David Erickson, Vice President, Investor Relations. Thank you, Mr. Erickson. You may begin.

Welcome, and thank you for joining us today. Just after the close of regular trading, we released our second-quarter 2014 financial results. During today's call, we will discuss the results included in the press release and accompanying financial schedules, and then use the remaining time for Q&A. Our presenters on today's call are Mike Mussallem, Chairman and CEO, and Scott Ullem, CFO.

Before we begin, I'd like to remind you that during today's call we will be making forward-looking statements that are based on estimates, assumptions and projections. These statements include, but are not limited to, our expectations regarding sales, gross profit margin, earnings per share, SG&A, R&D, interest expense, taxes, free cash flow, and foreign currency impacts. These statements also include our current expectations for the timing, status of expected outcomes of our clinical trials, regulatory compliance, submissions and approvals, as well as expectations regarding industry growth expectations, new products, and launch expectations and reimbursement. These statements speak only as of the date on which they are made, and we do not undertake any obligation to update them after today.

Although we believe them to be reasonable, these statements involve risks and uncertainties that could cause actual results or experiences to differ materially from the forward-looking statements. Information concerning factors that could cause these differences may be found in our press release, our annual report on Form 10-K for the year ended December 31, 2013, and our other SEC filings, which are available on our website at Edwards.com.

Also, a quick reminder that when we use the terms underlying, excluding the impact of foreign exchange, excluding special items, and adjusted for special items, we are referring to non-GAAP financial measures. Otherwise, we are referring to our GAAP results. Information about the use of non-GAAP measures is included in today's press release and on our website.

And with that, I'll turn the call over to Mike Mussallem. Mike?

Thank you, David. While our litigation settlement provided a large boost this quarter, we are particularly pleased that our sales were better than expected across all product lines, which drove strong bottom-line results. The ongoing launch of SAPIEN 3 in Europe helped drive share gains in the quarter. And the launch of SAPIEN XT in the US, which just got underway in June, will enable treatment of an even broader group of patients, while helping to reinforce our leadership position in that growing region.

Strong contributions from our surgical valve and critical-care product lines also helped drive the results. Even as TAVR competition intensifies, with the increasing adoption of this therapy around the globe, we believe that we are poised for continued strong sales growth in the second half of 2014.

Now turning to quarterly specifics, total underlying sales grew 11% to $577 million. These results exclude the impacts of foreign exchange, the THV sales return reserve, and include the THV royalty payment, which Scott will detail later.

In transcatheter valves, underlying global sales grew 19%, driven once again by strong O-US sales, which accounted for approximately 60% of our total THV sales. US THV sales were more favorable than our earlier expectations. And on a global basis, pricing was stable.

Outside the US, THV sales grew 35% on an underlying basis, once again driven by strong growth in Europe and the SAPIEN XT launch in Japan. In Europe, adoption of transcatheter valve therapy continues to be quite strong. And, additionally, we believe we gained share with SAPIEN 3. Representing more than half of our European THV sales, SAPIEN 3 is being well received by clinicians who appreciate its best-in-class low profile and paravalvular leak solution.

We have been aggressively launching SAPIEN 3 at the highest-volume hospitals, and expect to complete the launch by year end. Although the impact of competitors in Europe was limited again this quarter, we are beginning to see a modest pickup in their growth.

In Japan, THV sales in the quarter were $10 million, and our commercial rollout there is proceeding on track. We continue to expect $40 million to $50 million of SAPIEN XT sales in the region this year.

In the US, underlying THV sales were $92 million for the quarter, including a benefit of $4.7 million from royalties, and adds back the $6-million sales return reserve. The $92-million underlying sales reflects increased clinical sales, and an approximate $5-million negative impact from net stocking.

Procedures with Edwards's transcatheter valves in the US increased sequentially, as well as compared to a year ago. We remain on track with our previously stated goal to add 45 to 65 new sites during 2014.

In mid-June, we were very pleased to receive FDA approval of our next-generation SAPIEN XT system for high-risk and inoperable indications, including transfemoral and alternate access systems in the 23-, 26-, and 29-millimeter sizes. Although it had limited impact this quarter, clinician demand has been quite strong for this lower-profile system, particularly for the larger 29-millimeter size, which has allowed for the treatment of patients with a large native annulus. We are implementing a rapid upgrade of hospitals from SAPIEN to SAPIEN XT, and it is well underway.

On the reimbursement front, we're pleased that CMS proposed two new DRGs for all endovascular valve replacement procedures, including TAVR. CMS recognized that TAVR patients tend to be significantly different from typical surgical valve patients, and that the level of hospital resources required for these patients is usually higher. Overall, our preliminary modeling indicates average payment increases of 10% to 15% for most hospitals. This change is expected to take effect October 1.

Although we have always believed that the TAVR opportunity in the US to be large, it appears that there is an increase in the growth that is being fueled by new lower-profile systems, additional valve sizes, increased clinician experience, and the growing body of compelling clinical evidence.

Turning to our pipeline, enrollment in our US SAPIEN 3 trial of 1,000 intermediate-risk patients is on track to be completed in the next several months. As a reminder, enrollment in the high-risk and inoperable patient arm is complete, and we are focused on bringing this life-saving technology to patients.

Based on the enthusiasm clinicians have for SAPIEN 3, and our expectations it'll quickly become the leading transcatheter valve in Europe, we've elected to slow the introduction of our CENTERA valve platform. This will allow us to incorporate some enhancements that we believe will make CENTERA a best-in-class self-expanding device. In the meantime, we continue to gain experience with CENTERA, and the commercial launch in Europe is now expected to occur in 2016.

In addition, we are pleased to announce that Dr. Martyn Thomas will be joining us later this year in a newly created position of Vice President of Medical Affairs for Transcatheter Heart Valves. He is currently the Clinical Director of Cardiovascular Services at St. Thomas Hospital in London, and a global leader in transcatheter heart valve research.

In summary, we are very pleased with the global THV sales performance, and are increasing 2014 sales guidance. Excluding royalty payments, we now estimate underlying sales growth in this product line to be at the high end of our previous 0% to 14% range. We continue to believe global transcatheter aortic valve replacements will grow 15% to 20% annually over the longer term.

Turning to surgical heart valve therapy group, sales were $214 million, up 4% on an underlying basis, driven by growth across all regions, and partially offset by a small ASP decline due primarily to regional mix. Our premium valves drove stronger growth in both aortic and mitral units. Sales of cardiac surgery system products, or CSS, which are part of this product group, were flat compared to last year.

In the US, surgical valve sales grew this quarter, led by unit growth of our premium valves. We believe that surgical valve procedure trends continued again this quarter, with an increase in overall procedures in the low-single digits.

We're on track to complete patient enrollment in our TRANSFORM trial for INTUITY Elite by the end of the year, as well as our COMMENCE trial studying GLX, our advanced tissue platform. We are introducing US hospitals to our undertreated patient access initiative, and have seen a number of hospitals begin implementing the program.

The introduction of INTUITY Elite lifted results in Europe this quarter, and clinician interest is building in this minimally invasive platform. During the quarter, three-year data from the European CE Mark TRITON trial for our INTUITY valve platform was presented, which demonstrated that these patients had a significant improvement in hemodynamics and heart function. Based on the continued strength of our surgical valve business, but lowered by the performance in our CSS products, we now expect underlying sales growth for the total product group to be at the low end of our previous 4% to 7% range in 2014.

Turning to the critical care product group, total sales for the quarter grew 9% on an underlying basis to $141 million. We saw strong performance across the board. And we experienced double-digit ESR product sales growth across most regions.

As a reminder, ESR, or enhanced surgical recovery, facilitates shorter hospital stays, resulting from better monitoring and fluid management. These minimally invasive and non-invasive monitoring products include FloTrac and ClearSight.

During the quarter, we were pleased to initiate the US launch of the ClearSight system, our non-invasive monitoring technology. We believe ClearSight, which is integrated into our EV1000 system, is the most advanced non-invasive monitor of its kind. Given our strong first-half results and the continuing adoption of ESR products, we now expect underlying sales growth in critical care to be at the high end of our previous 3% to 6% range.

Now turning to our transcatheter mitral valve program, as previously reported, data about the first-in-human experience with our FORTIS valve were presented at EuroPCR in May. This early experience has demonstrated that the FORTIS valve can be successfully implanted, and functions as intended. Compassionate patients are continuing to be treated in this early experience, with cases now having been performed at four different hospitals.

We expect clinicians to report on their progress at future medical meetings. We and the clinicians involved in the FORTIS program remain enthusiastic about the opportunity to develop a transformational therapy to address the needs of the many patients who are not candidates for surgical mitral valve intervention.

Earlier this year, we received a follow-up inspection to our 2013 warning letter in Draper, Utah, which resulted in multiple 483 observations. This facility produces a variety of products, including CSS devices and our THV delivery systems. To address compliance issues, we are making significant investments in our CSS operations, which include increased validation expenses, additional technical talent, and expert consultants.

Separately, we have dedicated resources focused on complying with the agreed-upon action plan for the SAPIEN XT delivery system that verifies compliance. Our efforts will result in increased expenses, but are not expected to impact availability of key products.

During the quarter, we were very pleased to reach an agreement with Medtronic to settle all outstanding patent litigation between the two companies. Under this agreement, all pending cases and appeals in courts and patent offices worldwide have been dismissed. We also agreed not to litigate patent disputes with each other in the field of transcatheter valves for eight years. We're pleased that we were able to reach an agreement that preserves physician choice, while also recognizing Edwards's leadership in the pioneering of transcatheter heart valves. Under the terms of a patent cross license agreement, Medtronic made a $750-million payment to Edwards this quarter, and will make quarterly royalty payments through April 2022.

And now I'll turn the call over to Scott.

Thanks, Mike. I am pleased to report that we achieved non-GAAP diluted earnings per share of $0.88, driven by stronger-than-expected sales in the quarter. Total adjusted sales in the quarter were $577 million, an 11.6% growth over last year. This includes royalties of $4.7 million, and excludes the global net impact of the THV sales return reserve of $2 million. More detail regarding the sales return reserve is available in our supplemental schedule posted on www.edwards.com.

For the quarter, our gross profit margin was 73.7% compared to 76.1% in the same period last year. This reduction was driven principally by a negative impact from foreign exchange, as well as the smaller impact of the write-off of SAPIEN valves in the US in connection with our SAPIEN XT launch. For full-year 2014, we continue to expect our gross profit margin, excluding special items, to be approximately 73%.

Second-quarter selling, general and administrative expenses were $216 million, or 37.5% of sales, compared to $187 million in the prior year. The largest components of the increase were transcatheter valve launch-related expenses and a larger accrual for incentive compensation. We continue to expect SG&A, excluding special items, to be between 37% and 38% of sales for the full year.

We continue to aggressively invest in research and development, and spending in the second quarter was $89 million, or 15.5% of sales, compared to $80.5 million in the prior-year period. Heart valve clinical studies continue to be one of the largest drivers of our increased spending. We also increased our investments in our transcatheter mitral valve programs. We continue to expect our R&D investments to remain at approximately 16% of sales for the full year.

During the second quarter, we recorded four adjustments to our GAAP earnings-per-share results, which provided a $4.21 net benefit, but which are excluded from our non-GAAP earnings per share. First, the $750-million upfront payment from Medtronic has been included in our statement of operations. And it's listed as intellectual property litigation income, which we exclude in our non-GAAP results. Second, the $50-million contribution to the Edwards Lifesciences Foundation.

Third, we are excluding from non-GAAP earnings a $6.2-million benefit resulting from the release of tax reserves based upon our current expectations of the outcome of routine tax examinations. Fourth and finally, consistent with prior quarters, we excluded the impact of the THV sales return reserve in our non-GAAP results, which reduced our pre-tax earnings by $6.1 million. A complete reconciliation of our GAAP to non-GAAP diluted EPS was included in our press release.

Net interest expense for the quarter increased from the prior year to $3.1 million, primarily as a result of our $600-million issuance of five-year notes last October. For the full-year 2014, we now expect net interest expense to be at the low end of our $12 million to $15 million range.

Our reported tax rate for the quarter was 32.7%, which was higher than normal, as a result of the Medtronic payment. Excluding this and other special items, our adjusted tax rate was 22.9%. We expect our rate to be approximately 22% next quarter, excluding special items, and then drop to approximately 16% in the fourth quarter, assuming renewal of the federal research and development tax credit.

Foreign exchange rates increased second-quarter sales by $5 million compared to the prior year. Compared to our recent guidance, FX rates had less than a $0.01 impact on earnings per share. Looking forward, at current rates we continue to expect a $10-million negative impact to full-year sales compared to last year.

Free cash flow generated during the quarter was $762 million, which included proceeds from the recent litigation settlement. We define free cash flow as cash flow from operating activities of $778 million, less capital spending of $16 million. Excluding the impacts of the payment from Medtronic, and our $50-million contribution to the Edwards Lifesciences Foundation, free cash flow was $73 million. For 2014, excluding special items, we continue to expect free cash flow to be between $325 million and $425 million.

In July, our Board of Directors authorized a new share repurchase program to acquire up to an additional $750 million of outstanding common shares. This supplements the approximately $200 million remaining on our current share repurchase program.

Turning to our sales and earnings guidance, given our strong first-half performance in transcatheter valves, and including full-year estimated royalty payments of $25 million, we now expect sales in this product group to be between $830 million and $900 million, and total Company sales at the high end of our $2.05 billion to $2.25 billion range. For the surgical heart valve therapy group, we continue to expect sales of $810 million to $850 million. And in the critical care product group, we continue to expect sales of $535 million to $575 million.

We are increasing our full-year guidance for diluted earnings per share, excluding special items, to $3.24 to $3.34, from the previous guidance of a range around $3.10. For modeling purposes, we continue to expect full-year diluted shares outstanding to be approximately 108 million. For the third quarter of 2014, we project total sales to be between $530 million and $570 million, and diluted earnings per share, excluding special items, to be between $0.66 and $0.72.

And with that, I'll hand it back to Mike.

Thank you, Scott. As we reflect on our first-half results, we are very pleased with the performance we've achieved across all our product lines, and believe our future remains bright. Our transcatheter valve franchise is poised to drive market growth through indication expansion and next-generation technologies. Our surgical heart valve product line remains strong, and we are investing in innovative products to strengthen our leadership position. And our critical care product line should continue to benefit from sales of our best-in-class monitoring technologies, including the launch of the non-invasive ClearSight system. Overall, we are confident in our outlook for continued strong organic sales growth, reflecting our focused innovation strategy and our commitment to helping patients.

And with that, I'll turn it back over to David.

Thank you, Mike. Before we open it up for questions, I would like to encourage you to mark your calendars for Monday, December 8, when we will be hosting our 2014 investor conference in New York. This event will include updates on our new technologies, as well as our outlook for 2015. More information will be available in the next couple of months.

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

(Operator Instructions)

Jason Mills, Canaccord Genuity.

Thank you. Congratulations on a great quarter.

First question for me is on the transcatheter mitral program. Perhaps you could give us a broader perspective on how you're thinking about bringing products to market there, both from an internal perspective and your considerations now with the incremental cash from Medtronic. You have, I see, obviously a share repurchase program authorized. But perhaps tell us about the acquisition of digital program, additional shots on goals. Just generally speaking how you're thinking about building that franchise over the next couple of years.

Sure. Thanks, Jason.

We're still early on in terms of the development of transcatheter mitral valves. We're optimistic about our FORTIS program but it's still difficult to fully judge the value. The path to commercialization of mitral transcatheter valves is likely to be a long and rigorous one, similar to the experience we had in SAPIEN valves.

Our intention is to be the leader in this field. We remain open to considering acquisitions to supplement our existing portfolio. But as it goes along with the comments that we've made previously, we're not really changing acquisition strategy based on the Medtronic settlement.

Okay. Just another one on the transcatheter side, this time on the aortic in the US. The SAPIEN 3 high-risk valve primary endpoint included a 30-day endpoint. I was just curious what the discussions have been, or what the possibility would be, that you would be able to bring that to market perhaps sooner than what may have otherwise been expected if we were to wait for a full one-year, if that's possible.

Yes. Thanks, Jason. We are very excited about SAPIEN 3. We think it's a best-in-class valve. Obviously we're going to work to make that valve available to US patients as soon as we can. We just don't have anything specific to share at this point.

Okay. With that in mind, just let me throw in one other one. In the US, now that you have Medtronic on the market, one of the things that we've been discovering in our research is the length of stay is trending down. And it seems to be, perhaps, an advantage that we've heard with respect to the SAPIEN valves, given the permanent pacemaker issues with the CoreValve. I'm wondering if there's any data to come, or if there's any anecdotal discussions that you've had that you'd like to perhaps pass along to us with respect to length of stay and the competitive landscape here in the US.

Yes, thanks Jason. We're going to have to let others ask some questions.

Overall, we have been observing length of stay fall. This is something that we've been really working on, been focusing on for more than a year at this point. It's too early, probably, for us to detail any comparison between ourselves and CoreValve. We're really familiar with our own experience. And the clinicians that we're associated with are sharing optimism that they are able to drive better performance than we've seen certainly historically.

Thank you.

David Roman, Goldman Sachs.

Thank you and good afternoon everybody. I wanted just to follow-up a little bit on Jason's question there about the impact of CoreValve being on the market. I think, Mike, if I heard you correctly in your prepared remarks, you listed out a few factors that you thought were helping market growth in the US, including new technology size, as an indication. Could you maybe help us understand how the competitive landscape has played out over the first six months, and whether in fact you are seeing an uptick in demand associated with smaller products and a second player being on the market?

Yes. It's a good question, Dave. You've got a few things wrapped up in there.

It's difficult to peg exactly what is lifting the US market, but it feels like that the number of procedures in the US is lifted. We feel that clearly the impact of a low-profile system and larger sizes clearly has impact. But we also believe that the continued strong data that's being demonstrated broadly in the field of transcatheter valves is also helpful.

Did I get at your question or there was more in there, David? Do you want to restate?

No, that is what I was trying to get at, is whether, I think coming into this year you were concerned about the share loss impact, and it sounds like there might be a market growth impact to consider, as well.

That's right.

My follow-up, just for Scott, on the gross margin line, maintaining the 73% gross margin target, can I just clarify that that's a GAAP number? Because year to date you're obviously trending way above that. And the impact of the Medtronic royalty, based on what you disclosed in the 8-K, sounds like that would add just about 100 basis points to gross margin for the year. So, is there anything else going on in that line that we need to consider?

The other big thing that's going on in that line is just the effect of FX flowing through versus the rates in the second quarter of last year. So, FX is the big driver of that shift in the gross margin.

Okay. But you're not raising gross margin even with the royalty? Is that implicitly lowering the underlying margin, or is that not the right way to look at it?

Sorry, David. Say that one more time.

Why would you not raise the gross margin target, given the now inclusion of the royalty from Medtronic, which I'm assuming has obviously 100% margin on it? Are you lowering the underlying margin target here?

It does benefit the gross margin rate to the tune of about 30 basis points. But, again, the big factor that's influencing our rate this year versus last year is the FX move.

I got it. Thank you.

Bruce Nudell, Credit Suisse.

Good afternoon. Thank you.

Mike, just to be clear, royalties and destocking basically cancel each other, and reserves don't count, to get your $92 million. And if that's the case, it sounds like, based on what we know about Medtronic, the market could be $135 million, $145 million. So, that means the market in the US could have grown 35%, 40%. Is that conceivable, in your mind?

I think, just from what you said, Bruce, sounds like your math about our sales is correct. I think you got that right. There's a lot of moving pieces and Scott can help detail that if you want to get into it. In terms of estimating what the US growth rate is, I don't know. It's a little difficult. There so many moving parts right now.

We also believe that once XT is approved, some of these patients that have large annulus, that might have been on the sideline, came into the system. So, exactly pegging a growth rate is tough. But it does appear that we do have lift versus what we were expecting, and we are very encouraged by that.

And, Mike, my follow-up is regarding Europe. Could you just give us some sense of how you think that market in aggregate is doing north, south Europe, Northern versus Southern Europe, overall reimbursement, constraints, et cetera?

Yes. Thanks, Bruce.

We actually find it remarkable. The results in Europe were better than we expected. Of course we were optimistic about SAPIEN 3, but there really appears to be some strong growth in the number of procedures. We think it's probably growing in the mid teens.

And that's not exclusive to a single country. That's broadly across the continent. And when we try and get into what's behind it, I think one of our beliefs is just the growing body of impressive clinical evidence is helping lift the use of transcatheter heart valves.

Thanks so much, Mike.

Rick Wise, Stifel Nicolaus.

Good afternoon.

Mike, you talked about, in Europe, for the first time it sounded like you're saying competing products launching, you're starting to see the impact. Maybe if you could just expand on where you're seeing it, how you're seeing it. Is it a certain geographic area, a certain type of product or segment? Maybe just give us a little more color.

And maybe as part of that, can you discuss in the United States the impact of what seems to be an acceleration in competing US pivotal competing clinical trials getting underway? And should that be something we should be concerned about longer term, as well?

Okay. Let me try and take the two pieces.

First, on Europe THV competition, recall going into the year, we indicated that we were going to have some headwinds, and that we were going to see the introduction of two large competitors, Boston Scientific and St. Jude. Although, we've seen them on the scene, we haven't seen substantial impact so far this year.

We think that might be because their introductions have been somewhat delayed in terms of having full product line. We expect to see the more complete product line from those companies later on in the year. So, I don't know, does that answer that question?

Sure.

And then on the US side, so far clinical trials in 2014 have probably been somewhat similar to what they were in 2013. Remember, 2013 we thought it probably accounted for close to 15% of all the procedures done. We are starting to see more clinical trials. It's tough for us to define that, Rick, but we do think it is going to lift in the future, those competitive clinical trials.

Which should be an accelerant, you're saying, for you.

No. I would say, depending on the growth of overall procedures, if some of them go to competitive clinical trials, we would probably feel that. But there's so many moving parts, Rick, it's difficult to quantify that now.

Just a quick follow-up on CENTERA, the delay -- and it makes sense that you'd want to keep focusing on new capabilities. But does this at all suggest you're less interested or less optimistic about the Sulfex expanding segment? And maybe if you can, give us any color on what you're thinking about there, and just the new capabilities. Thanks so much.

Okay. Yes, thanks.

No, as a matter of fact, we are very optimistic about CENTERA. As a matter fact, we think we have a shot here to introduce a best-in-class self-expanding THV. There's a number of opportunities, though, for enhancement that we identified during the initial clinical experience. And, so, as we've seen so much enthusiasm for SAPIEN 3, we just have elected to slow down CENTERA so that we can incorporate those enhancements. But, no, we have not lost enthusiasm.

Thanks.

Larry Biegelsen, Wells Fargo Advisors.

Good afternoon. Thanks for taking the question and congratulations on the good quarter. Let me start with the guidance and then I had a follow-up.

You raised the guidance by $0.14 to $0.24. Can you parse that out for us? The royalty, when you put out the 8-K, with Medtronic, you expect the royalty to initially be $25 million to $28 million, or, by our math, about $0.16. But yet you're increasing your sales guidance to the high end. So, can you just help us understand the component of the guidance raise?

I think it's a good question and thanks, Larry. The points that you mentioned, of course we had a beat in the second quarter and, yes, we got a lift from Medtronic. So, those things clearly help us.

But I think as Scott detailed when he talked about our expenses, we are going to have a little higher incentive comp or performance that is performance-based in the second half of the year. And, also, we have some new expenses related to our CSS products in Draper, Utah. So, those provide somewhat of a drag, Larry, and that's where it nets out to the lift that we have in there.

So, just to confirm, the royalty, you are still expecting $25 million to $28 million this year. And then for my follow-up on SAPIEN 3, with the intermediate-risk trial coming to an end soon, how should we think about the likelihood of a cap? And how should we think about clinical implants for you in the second half of 2014 and 2015? Because if you don't get a cap, your clinical sales, which were approximately $25 million the first half of this year, go away.

Thanks.

Hey, Larry, it's Scott.

On the guidance for royalties, we booked $4.7 million in the second quarter, as you know. We expect that for the full year we'll be around $25 million, give or take. There is a nominal royalty on top of the US royalty for outside US sales. And that will contribute to the total that we end up booking. But $25 million range is the right assumption for now.

Thank you.

And, Larry, related to clinical sales, as we mentioned, clinical sales were up this quarter. That was driven by the SAPIEN 3. We don't have clarity on whether there's going to be a continued access program or not. If you were asking us to estimate at this point, this might be the high water mark for our clinical sales, but it's difficult for us to say right now.

Thanks.

Brooks West, Piper Jaffray.

Thanks for taking the question. Mike, I wanted to ask a question on hospital profitability and how we might think about the impact of the proposed reimbursement. You've spent a lot of time helping hospitals with their profitability, I'm specifically thinking about the US on THV procedures. Can you give us an idea of how many US hospitals are profitable all-in on the procedure, and how you think this proposed reimbursement increase might impact that?

Yes. Thanks, Brooks. That's a really tough question.

When you go from hospital to hospital you get very different accounting systems. And we're not sure that they're fully transparent with us about their actual profitability. So, it's tough for us to say.

I think we've estimated in the past that, on average, hospitals used to break even on transcatheter heart valves. We think that's been gradually improving over time as they gain experience and they shorten their length of stay. We're optimistic that this change to the new DRGs is going to be helpful.

We did some modeling on this and there's a lot of things that it depends on. It depends on a hospital's case mix, on their practice patterns, on their regional payment. But we think, on average, that we modeled that payment could increase 10% to 15% for most hospitals.

Okay. Thanks for that.

And then on Japan, it came in a little bit below what we were thinking. You're running at about $17 million for the first six months. Did you see some -- other companies have seen some weakness in Japan in Q2? Was there anything specific there? And then how should we think about the drivers of the acceleration there to make the $40 million to $50 million in guidance.

Thanks.

No, we didn't see anything noteworthy. We're right on track with our plan. I think we did $7 million in the first quarter, $10 million in the second. It's clearly a ramp and it's building. And we continue to expect to be in the $40 million to $50 million range this year.

Great. Thanks, Mike.

Danielle Antalffy, Leerink Partners.

Hi. Good afternoon. Thanks so much for taking the question.

Mike, I was hoping you could give a little bit more color on the SAPIEN 3 rollout in Europe, specifically in the centers in which you've launched. How much of the growth that you're seeing is market share gains versus more aggressive implanting of intermediate-risk patients? And how much incremental runway do see there, particularly on the intermediate-risk patient side of things? Any color there?

It's very difficult to say overall with any level of precision, Danielle. Overall we would say no. It's not like a bunch of intermediate-risk patients are coming into the system. As a matter of fact, if you look at our surgical heart valve business it's continued to grow. That would be a good indicator if that were shifting.

But, rather, we see a general lift in the overall number of procedures. And that's almost the biggest impact. We did note that we have some share gain, but we think that's the smaller component of the two compared to procedure growth.

Okay. And then just as a follow-up, because I'm viewing, obviously, the intermediate-risk patient population is for the next leg of growth for this market, while there's still some runway on the high-risk side. Longer term, of course; you need that patient population. So, what's the first key data point we should expect to see there? You've got several. You and Medtronic, both, several registries in Europe and the US trial. What should we expect to see first? And when, if you can put a timeline to it?

Broadly, Danielle, you're on a key point. If the data demonstrates that we can effectively treat intermediate-risk patients, that would clearly be a big lift to the field. And we're optimistic that that will be the case.

Because all that data is presented in a clinical setting and clinical meetings, we really don't have complete control of that, and we're not sure when it's going to happen. We are currently, in our trial, pointed at a two-year end point. So, you know what the implications of that are. We continue to have discussions, you can imagine, on changing or looking at other options for that, but we have really nothing to speak about at this point.

Okay. Thanks so much.

Raj Denjoy, Jefferies.

Hi, good afternoon.

I wonder if I could ask a bit about the competitive dynamic in the US. As the quarter progressed with Medtronic, obviously, the litigation getting settled, and then with XT getting on the market. I'm just curious how things ebbed and flowed over the quarter? Whether you saw accounts maybe moving away to get trained with Medtronic and then perhaps coming back once XT got approved. I'm just trying to get a sense of how that dynamic is shaking out, and how you expect it's going to play out for the next quarter or two.

It's a good question Raj. If you go all the way back to our investor conference in terms of what we assumed, we thought that they were going to get their high-risk approval in Q3, and they actually got that in June. So, that's what their direction. We probably thought our XT approval would come sooner although still within our guidance.

So, during that period, where we had SAPIEN available at the same time they had CoreValve, they had the ability to treat some larger annulus patients. And, so, we did see accounts trained, we did some larger annulus patients go that way. And then, obviously, that changed once SAPIEN was available, particularly the 29-millimeter valve. And we know that some of these patients were being queued up for that. And, again, I'm sorry, I want to relate it to the approval of XT.

There's been a lot of back and forth in the quarter. I'm not sure that you could know exactly where it is. We feel like we exited strong. And we probably didn't seem the Medtronic be as aggressive as we thought they were going to be during this early launch period.

Okay. Fair enough. And maybe just my second question, we're starting to hear a bit about SAPIEN 4 from some clinicians who might be in the know. And I'm curious if there's anything you can offer about that or any details you can provide on if there's a SAPIEN 4 and when we might hear about it. And anything around it would be helpful.

You're making me smile, Raj.

Obviously, that wouldn't be something that we would talk about. We value keeping confidential our next-generation development. As you might imagine, we do work on next-generation products. We are working on products beyond the SAPIEN 3 and beyond CENTERA. You could be sure of that. But we don't have anything to announce at this point.

Fair enough. Thank you.

David Lewis, Morgan Stanley.

Good afternoon.

Mike, you made a lot of new comments about the European markets, specifically around S3. There was one comment you made that was interesting to us: one-third conversion last quarter, I think you mentioned one-half conversion second quarter. Obviously, those are pretty remarkable results. But it slowed a little bit in the second quarter.

And the question I have is, what do you think is the barrier of why that number wasn't two-thirds in this particular quarter? Is it training? Is it just that you're focused on specific regions? We would've thought that that number could have actually been a little higher here in the second quarter even though it's a pretty good number.

I think what we said in our results are about 50% of the sales this quarter were from SAPIEN 3. So I'm not sure that it speaks -- and to some extent the sales are probably a little bit of a lagging indicator of exactly what's going on.

The conversion across Europe is happening at pretty much our planned pace, which is pretty aggressive. We first went into our largest hospitals, for the most part, and those have been the people we've gone to first. But we're just working our way through this in a very uniform fashion. We are pleased with what's going on. You think about it, we've got a 35% underlying growth rate O-US, and so that's even better than we expected.

Okay. And, Mike, just a related question in the US market around XT., Is there any reason to believe, across valve sizes or in the XT conversion, we would expect the XT conversion in the US to be much more rapid to the S3 conversion in Europe. Is that a safe assumption? And can you share with us how you would expect that mix to progress here in the US?

Yes. There is a rapid conversion that's going on from SAPIEN to SAPIEN XT. It's been greatly anticipated and that's been moving very quickly. We expect the vast majority of hospitals to be converted by the end of Q3.

Okay. Thank you very much.

Bob Hopkins, Bank of America.

Hi. Thank you very much and good afternoon. Would love to start out, Mike, if you could just give us a little bit of insight as to what kind of incremental clinical data you expect might come out of the upcoming TCT meeting here in just a short period of time. Are we going to see some two-year data on XT? And just if you could highlight the conference for us and what we should expect, that would be great.

Yes, thanks, Bob.

We expect there are going to be a number of key presentations at TCT related to the PARTNER trial. We just don't know right now which ones have been accepted. Remember, that PARTNER data is in a publication office that's jointly managed with clinicians. And exactly how that's going to roll out is not clear to us yet. But we expect there to be news.

Okay. I guess we'll just wait on that. And then the other thing I wanted to ask on, I know this question was asked earlier about SAPIEN 3 and the prospects for a time frame in the United States is a little faster than people expect. Could you just give us a sense as to what data exists on SAPIEN 3 that you might be able to show FDA that could shorten that process relative to the current expectations? Does any incremental data exists on that front?

As we mentioned, we already enrolled our 500-patient high-risk trial. And that was done in 2013. And we are rapidly enrolling the 1,000-patient intermediate risk. That'll be, we felt like, enrolled here over the next several months.

In addition to that, there's European data. And the European data is not only the data that was used for CE Mark but there is a European registry that's collecting data for SAPIEN 3. So there's a fair amount of data out there already, quite a lot of patients. And, so, the ability to be able to use that to assess performance will be what's a key determinant in our ability to make any more aggressive arguments.

Great. Thank you very much.

Kristen Stewart, Deutsche Bank.

Hi. Thanks for taking the question.

I just wanted to go back to the US sales number, Mike, that you had mentioned. I think it was $92 million. I wasn't exactly sure how that broke down. It sounded like it included royalties, added back reserves, but then I'm not sure where stocking, clinical fell out there.

Yes. Scott why don't you --.

Sure, Kristin.

There are a lot of different elements to this. Maybe the easiest way to approach it is to say the re-order sales for commercial, combined with clinical, was $92 million. Three other elements that influence the GAAP results were the net stocking charge, royalty, and the sales return reserve. And that's how you get to that $86 million that's on the far left-hand side of the schedule on the website.

Okay. And so, the $86 million would be your non-GAAP US transcatheter valve number?

No. The $86 million is the GAAP US transcatheter valve sales number for the second quarter.

Okay. So to that, then, we add back, to get to non-GAAP, your $6 million in sales return? Or is it the $2 million?

Yes. If you add $6 million and the sales return reserve, you get to $92 million, which is inclusive of all the other three elements.

Okay. And then just in terms of going back to SAPIEN 3 and the intermediate risk, is it your expectation that that will have a one-year follow-up period at this point? It seems to be suggested by the clinicaltrials.gov site.

Yes, that's our understanding.

Okay, perfect.

Then the last question that I had is just to go back a little bit to the lack of better leverage I would have expected given the increased amounts with the royalty and the higher sales results. Can you maybe help us quantify what the incremental cost related to the for 483 observations? It sounds to me like you would be expecting to get a warning letter? Is that fair to say?

No, it's not to fair to say that we are expecting to get a warning letter. I think what we stated is that we had a significant number of 483 observations, and that we have two things that we're doing. One is applying additional resources to our CSS operations, and the other a focused effort on the action plan around the XT delivery systems.

So, those two things are driving some costs. We are not going to detail those out, but those are significant and they are having an impact on the earnings growth here in the near term.

What exactly is XT delivery system? Changes? I assume that's what's in the market today.

There's no changes. These are simply compliance issues.

Okay. Thank you.

Mike Weinstein, JPMorgan.

Thanks for taking the questions and congratulations on the quarter.

Let me just clarify from the back and forth in there. When you sell in the US, in the quarter, a SAPIEN XT, are you recording stocking revenue for XT into existing accounts?

No, We are not.

Okay. So the net stocking numbers that we're getting, it's still the positive is the stocking on a new account, and the negative is an account that did have inventory and is moving to consignment. And I understanding it correct?

You understand it perfectly. That's it.

Okay, good.

And then, Scott, I thought you'd said that from the Q3 call you said you might be in a better position to talk about use of the proceeds from the Medtronic windfall here. It sounds like you aren't at that point yet. How do you want us to think about the balance sheet today?

You've got this great cash position, you're generating good cash flow. But it seems like it's being under-utilized. And I know that's not something you're comfortable with, so could you just talk here about that?

Sure. It's something we've been spending a lot of time thinking about and talking about with our Board, and listening to what investors are thinking and hearing out there. At this point, we think the right thing to do is to preserve the cash and liquid shorter-duration investments, and have it available for share repurchase and potentially, down the road, any funding any kind of acquisitions.

But while we like buying back our stock, we've demonstrated that we bought back stock to the tune of $800 million in 2013 and the first quarter of 2014. We also want to be careful about how much we buy back all at once. We believe in dollar cost averaging.

But you should expect that over time we're going to be active in the share repurchase market. I don't think we like the negative arbitrage of having all that cash sitting on our balance sheet. But we're also going to be very deliberate and disciplined in how we spend it.

And, Mike, you've been pretty clear on acquisitions, that you want to stay in structural heart. But the challenge there is there hasn't been a lot of progress outside of what you've done internally. Is that still the thought process, that structural heart is where you want to stay? And if there are no assets in structural heart what do you consider?

Thanks, Mike. We're going to need to let others ask questions after this.

But to your broad point, yes. Our focus is structural heart, but also critical care technologies. So we are focused on our core. Our intention is not some kind of a broad diversification strategy. And even though you maybe haven't seen us do anything that's really sizable or public, we have been active out there, looking for the new bright ideas that we might use that can be meaningful in the area of structural heart and critical care technologies in the future.

Thank you.

Glenn Novarro, RBC Capital Markets.

Hi. Good afternoon. Just had two follow-ups. One on price, Mike.

I think you said in the quarter, pricing really didn't have much of an impact, particularly on transcatheter valves. And I was just wondering, in Europe, is SAPIEN 3 being priced at a premium and you're discounting, for example, SAPIEN XT? And I'm wondering if it's the same dynamic maybe happening in the US. So, any additional color.

Yes, thanks, Glenn. Yes.

In an effort to make sure that we were an aggressive competitor, we've made the conversion from SAPIEN XT to SAPIEN 3 essentially at the same prices. We had a few places where, so, for example, in the UK, where the pound had moved, where we made some adjustments. But overall pricing is pretty much constant, with the one thing being some discounts for large-volume customers.

Much of the same is true in the US where we are moving customers, or helping them move from SAPIEN to SAPIEN XT at same prices. And, so, continuing to use the $30,000 for modeling purposes is still a good surrogate.

Okay. And then just quickly on a follow-up on mitral. You've done a few implants now. And I'm assuming that there is going to be some tweaks to the design. So I'm wondering if you can walk us through the timelines as to when we can see some design changes, when you can initiate maybe a small pilot study again, and when we can get into, perhaps, a European transcatheter mitral pivotal trial? Thanks.

Yes, thanks, Glenn. The bottom line is it's premature to be able to anticipate a pathway to commercialization. We're still in the midst of our first-in-human experience, still learning a lot. And we want to let ourselves complete that experience and gain all that knowledge and insight before we decide on any clinical trial or regulatory pathways.

Okay. Maybe we'll get an update in December at the analyst meeting?

I hope we have clarity by then, Glenn. That's for sure. We will let you know if we do.

Okay. Thank you.

Ben Andrew, William Blair.

Great.

You've talked in the past about the different valve margins, as things scale. How is the ramp going with SAPIEN 3 and the margin structure this year? Your guidance was consistent. But is there an opportunity with that in 2015 to see margin moving higher as volumes decrease on that?

As you can imagine, it's an area of focus for us. We do get improvement that comes along with volume. But you also have to anticipate that we anticipated some of that volume improvement. So, that's in front of us.

I hesitate to give, really, guidance on margin for 2015 at this point, Ben. And we'll provide a lot more clarity on that when we get to our investor conference in December.

Okay. And then you talked about the clinicians wanting to show the mitral data. Is it possible we'll see something at TCT?

Yes, it is possible. I think you all know the clinician community pretty well. If they have something that they are able to report on, and they get accepted by TCT, it would be presented. But I just don't know how to be able to advise you on that.

Okay. Thank you.

Okay. Thanks very much for your continued interest in Edwards. Scott and David and I welcome any additional questions by telephone. And with that, back to you, David.

Thank you for joining us on today's call.

Reconciliations between GAAP and non-GAAP numbers mentioned during this call, which include underlying growth rates, sales results excluding currency impacts, and amounts adjusted for special items are included in today's press release, and can also be found in the investor relations section of our website at edwards.com.

If you missed any portion of today's call, a telephonic replay will be available for 72 hours. To access this, please dial 877-660-6853 or 201-612-7415 and use conference number 13585946. I'll repeat all those numbers for you. 877-660-6853 or 201-612-7415 and the conference number is 13585946. Additionally, an audio replay will be archived on the investor relations section of our website.

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