LivaNova PLC (LIVN) 2018 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the LivaNova PLC Fourth Quarter and Full Year 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, 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 fourth quarter and full year 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 Investor 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 and documents furnished to the SEC, including today's press release that is available on our website. 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 investor.livanova.com.

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

Thanks, Matt. Welcome to our fourth quarter and full year 2018 conference call. This was a transformative year for LivaNova and our portfolio. In addition to closing the sale of our CRM business, we also completed the acquisitions ImThera and TandemLife. The results from this quarter and the full year reflect the success of our growth strategy as we achieved strong set of growth, expanded gross margins, increased R&D to fuel our pipeline and further integrated our recent acquisitions.

I'm going to provide some highlights and then discuss our sales result by business. And after my comments, Thad will provide you with additional color on the financials, updates on our Form 10-K filings and our 2019 guidance. Then I'll wrap up with closing comments before moving on to Q&A.

So starting with the recent events and quarterly highlights. On February 15, CMS finalized its National Coverage Determination for the use of VNS Therapy for the Treatment-Resistant Depression or TRD. We're pleased to see that CMS meaningfully expanded the potential beneficiaries to include patients with bipolar disorder. In addition, CMS expanded its research questions to include response to treatment as a primary outcome measure. This provides a much better guide of benefit to this very ill patient population, a preference shared by both us and clinicians. We're now working with CMS to finalize details of the study, and our current projection is to begin enrollment in the third quarter of 2019.

We expect the study size to be approximately 500 patients and enrollment to take 18 months. This is a monumental step forward for patients with this severely debilitating disease and to have a potential treatment alternative. We'd like to thank CMS for their careful consideration of the input from all stakeholders in reaching this important decision.

Perceval has received 2 positive outcomes on the clinical and regulatory front since the beginning of the year. First, we announced on February 21, that Japan's Ministry of Health, Labor and Welfare granted favorable national reimbursement for Perceval to treat aortic valve disease. By adding Perceval to Japan's health insurance system, physicians and patients have greater access to this versatile biological heart valve. Second, we announced on February 25, that we added new safety and technical information to the Perceval instructions for use in the U.S. to support Valve-in-Valve procedures.

Next, we continue to make good progress in the ANTHEM-HFrEF pivotal trial. As you may recall, the study is evaluating our VITARIA system that delivers Autonomic Regulation Therapy via VNS. Sites are activated in Europe and North America, patients are being enrolled and randomized to therapy and control arms. The total number of randomized subjects is based on an adaptive design, which was highly encouraged by the FDA.

In addition, 3 posters will be presented at the upcoming American College of Cardiology meeting in New Orleans on March 16. These posters provide additional insights regarding our therapeutic approach and will include longer-term follow-up data from the original ANTHEM pilot study and should provide additional insight on the durability of this new promising therapy that addresses a large unmet need in health care.

Turning to obstructive sleep apnea. We remain in discussions with the FDA on the design of a confirmatory study for our THN system for the treatment of obstructive sleep apnea and expect to start this trial in 2019. And regarding transcatheter mitral valve replacement or TMVR, we recently stopped the INTERLUDE trial after experiencing seriously adverse events in 2 patients. Our analysis of root cause is determined that the anchor system will require a design modification, and our current expectation is to restart trial enrollment in the first half of 2020.

Turning now to our net sales results for the fourth quarter, which we all stated on a constant currency basis. Total net sales were up a robust 9.2%. Both Neuromodulation and Cardiovascular showed strong growth in the quarter compared to the fourth quarter of 2017. Cardiovascular sales were $183 million, up 6.1% from the fourth quarter of 2017 due to growth in cardiopulmonary and the inclusion of advanced circulatory support.

Cardiopulmonary sales were $147 million in the quarter, an increase of 6.8% versus the fourth quarter of 2017. Heart-lung machine sales grew in the low double digits, driven by strength in both S3 conversions and competitive placements. And our oxygenator sales also grew in the low double digits, driven by strength in our international markets.

In the U.S., we recorded several competitive conversions in the back half of the year that should set this business up for solid 2019. Our autotransfusion business declined modestly in the quarter as trends in this business can be a bit lumpy and while we're seeing mid-single-digit growth for the full year.

Turning to heart valves. Sales of heart valves were $29 million in the quarter, a decline of 17.1% versus the fourth quarter of 2017. Excluding the impact of Japan and the OEM contract termination, sales declined 4.1%. Perceval declined in the mid-single digits overall, and high single-digits growth in the U.S. and Europe was offset by unfavorable international sales.

Advanced circulatory support reflects our recently acquired TandemLife business. We were very pleased to see sales in the fourth quarter in excess of $7 million representing greater than 20% growth versus fourth quarter of 2017. The business saw strength across the board especially in the ProtekDuo category.

For now let's turn to Neuromodulation. Sales were $114 million, up 14.5% versus a strong performance in the fourth quarter of 2017. In the U.S., sales increased 10%, driven by similar growth in initial implants and our end-of-service implants despite challenging comparisons for both. U.S. adoption of SenTiva continues to increase and represented 63% of our generated sales in the fourth quarter.

We saw a 20% sales growth in Europe based on the continued adoption of SenTiva, which was launched last April. EU adoption of SenTiva is now more than 50% of generated sales, with strong uptake in the U.K., Nordic and Italy. Our rest of world region delivered greater than 75% growth, driven by strong performance in China, Japan and 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 fourth quarter financials in greater detail, provide our initial 2019 guidance and walk through some accounting items that occurred this quarter.

As Damien mentioned, sales growth in the fourth quarter was 9.2% versus the fourth quarter of 2017, led by double-digit growth in neuromodulation, HLMs and oxygenators. Adjusted gross margin as a percent of net sales in the quarter was 69%, up 470 basis points from the fourth quarter of 2017. The margin improvement was primarily driven by pricing mix. And for the fourth quarter of 2018 -- sorry, for the full year of 2018, the gross margin was 68.1%, up 240 basis points versus our 2017 Investor Day goal of 100 basis points per year.

Adjusted R&D expense in the fourth quarter was $36 million compared to $31 million in the fourth quarter of 2017. R&D as a percentage of net sales was 12.2% versus 11.1% in the fourth quarter of 2017.

As we previously discussed, R&D is increasing behind the development of next-generation products including HLM, SenTiva and TandemLife, along with clinical trials and strategic investments in TRD, TMVR, sleep apnea and heart failure.

For the full year 2018, R&D expense was $136 million, up 42.8% versus the prior year and representing 12.3% of net sales.

Adjusted SG&A expense for the fourth quarter was $101 million compared to $92 million in the fourth quarter of 2017 and flat sequentially. SG&A as a percentage of net sales was 33.9%, up 80 basis points versus the fourth quarter of 2017. This increase is largely due to U.S. investments in a DTC campaign for epilepsy, advanced circulatory support commercial capabilities and strengthening our commercial organization in international markets.

Adjusted operating income from continuing operations was $68 million compared to $56 million in the fourth quarter of last year, which reflects an improvement in gross margin partially offset by investments in our key growth drivers in R&D.

Adjusted operating margin from continuing operations improved 280 basis points to 22.8%. Our adjusted effective tax rate in the quarter was 16%, an improvement from 20.3% in the fourth quarter of 2017 as a result of our ongoing tax efforts and the recent changes in U.S. and U.K. tax laws.

Finally, adjusted diluted EPS from continuing operations in the quarter was $1.12, an increase of 27.3% compared to the fourth quarter of 2017.

For the full year 2018, adjusted diluted EPS was $3.55, an increase of 7.3% compared to the prior year period.

Now moving to cash flow. Our cash flow from operations for the year ended December 31, 2018, was $120.5 million. Cash flow from operations, excluding payments for onetime integration and restructuring costs, was $217 million, up 39% versus prior year. Capital spending for the full year was $38 million compared to $34 million for the full year 2017.

Our cash balance at December 31, 2018, was $47 million, down from $94 million at December 31, 2017.

Our net debt at year-end was $124 million, up from $50 million at the end of the year 2017, impacted by M&A and share repurchases.

As Damien mentioned and as noted in our press release, there are few other important accounting items to discuss. In the fourth quarter 2018, we established a $294 million pretax provision related to litigation involving the company's 3T Heater-Cooler because we now have enough information about the claims to estimate a reserve. We believe the reserve, which does not reflect any insurance recovery, is sufficient to address these outstanding global legal claims. We received $350 million in aggregate financing commitments from Bank of America Merrill Lynch, Barclays, BNP Paribas and Intesa Sanpaolo for a debt facility to increase our debt capacity and provide additional liquidity for estimated future cash payments related to this provision.

I'd like to now address some accounting items that were identified this quarter. In 2018, there was significant complexity carving out the CRM business and expanding our SAP platform globally.

As a result, we identified 2 deficiencies in the design of 2 internal controls and we expect to report 2 material weaknesses. First, we identified a deficiency related to the design controls intended to restrict access to our primary financial system resulting in potential inappropriate access at both the information technology and end-user levels. Second, we identified a deficiency related to the review of price and quantity in the billing processes. This billing process issue is linked to the deficiency related to access of our primary financial system.

We expect to file a Form 12b-25 with the Securities and Exchange Commission providing for a 15-calendar day extension for our Form 10-K, and we also expect to file the Form 10-K prior to the expiration of the extension.

No material misstatements have been identified, and we believe that our consolidated financial statements are accurate in all material respects. We have initiated remediation efforts and we are performing a comprehensive review of the financial reporting application, which the deficiencies were identified in order to provide our IT -- improve our IT controls. In addition, we're enhancing the design controls over the billing process to prevent the possibility of price and quantity errors. Our objective is to complete remediation in 2019.

Now turning to 2019 guidance. First, I'll discuss the TRD opportunity and then provide detail on overall 2019 guidance. As you heard in Damien's comments, we have refined our expectations on the reimbursement pathway for obtaining CMS coverage for TRD patients. Given the timing of our clinical study start and the infrastructure build for replacements and private payer engagement, we expect revenue from TRD to be in the range of $5 million to $10 million in the second half of 2019. While CMS has agreed to pay for the VNS Therapy Systems used in our clinical study and for replacement implants, we will incur additional R&D costs for study management such as the CRO, electronic data capture, psychiatric core lab an additional clinical headcount. Our sales and marketing spend is geared towards device replacement and initial engagement of private payers and will include field-based therapeutic consultants, market access specialists, patient assistant programs and professional education.

Overall, we expect our TRD initiative to be approximately $0.15 to $0.20 dilutive to earnings per share in 2019. In 2020, our current expectation is that we will generate sales of $20 million to $30 million, and the impact on earnings per share will be less dilutive compared to 2019.

Given our success in creating a $400 million epilepsy franchise, we believe this initial investment in TRD is modest given the market opportunity.

In terms of overall guidance, we're forecasting 2019 sales growth of between 5% and 7% on a constant currency basis. If current exchange rates remain unchanged, the company full year revenue guidance will be negatively impacted by 1%. Also note that this guidance includes 1 quarter of sales from TandemLife prior to the deal closing in April 2018 and the impact of exiting a low-margin OEM distribution agreement in Canada that represented $32 million in sales in 2018. Adjusted gross margin in 2019 is projected to be in the 69% to 70% range.

In 2019, we expect adjusted R&D to be in the range of 12.5% to 13.5% of sales and adjusted SG&A to be in the range of 37% to 39% of sales with TRD having added an additional 50 basis points to each range.

As a result of these factors, we're projecting 2019 adjusted operating margin from continuing operations to be in the 18% to 20% range. And our adjusted effective tax rate for 2019 to be in a range of 17% to 19%.

We're projecting adjusted diluted earnings per share from continuing operations to be in the range of $3.55 to $3.75, which includes a negligible impact from foreign currency, the previous disclosed negative impact of $0.12 to $0.14 to account for the OEM transition in Canada and the aforementioned $0.15 to $0.20 impact from TRD. We assume our share count to be approximately $49.5 million.

While we don't provide quarterly guidance, our sales base is lower in the first and third quarters while our expenses are generally more evenly spread out. In particular, the first quarter is historically our softest earnings quarter.

Our adjusted cash flow from operations for 2019, excluding integration restructuring, product remediation and litigation payments, is projected to be in the range of $180 million to $200 million. The integration, restructuring, product remediation payments are expected to be in the range of $55 million to $65 million. Capital spending is projected to be between $38 million and $42 million and depreciation and amortization expense is expected to be in the range of $28 million to $30 million.

From a financial perspective, we are delivering on our financial commitments by accelerating growth, investing and building global capabilities and a strong product portfolio while improving working capital and addressing our 3T liability. This positions us well for a great future and an exciting 2019.

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

Thanks, Thad. I'm very encouraged by our progress on a number of fronts in 2018. We delivered sales growth above the upper end of our guidance while improving gross margin through pricing discipline, product mix and cost efficiencies. We're also making significant investments in our future, expanding our pipeline, innovating next-generation products and funding studies for our growth drivers and strategic portfolio initiatives, which include TRD, heart failure, obstructive sleep apnea and TMVR.

In Cardiovascular, we continue to drive upgrade of S5 heart-lung machines and improve growth in oxygenators and other products in the cardiopulmonary portfolio.

TandemLife is off to a great start and should benefit in 2019 from both our commercial expansion and approval of our next-generation pump.

In Neuromodulation, we continue to see the increased amount of SenTiva VNS Therapy System in the U.S. and Europe and should see the benefits of our DTC campaign begin to kick in.

We look forward to updating you on our continued progress and delivering on our commitments to drive shareholder value.

And with that, Leandra, we're ready for questions.

(Operator Instructions) And your first question comes from the line of Rick Wise with Stifel.

Maybe just to start this off, if you would, with a little more color on the TRD decision trial. And you indicated that you're hoping to get underway in the third quarter. Can you give us any better sense of how many centers the U.S. OUS mix, if any? And just your thoughts, just even at the roughest level, about timing in terms of enrollment and just some of the big metrics that you'd want us to focus on over the next 12 to 24 months.

Yes, sure. Thanks, Rick. No doubt we're really thrilled about this news for TRD. It's been a legacy campaign for a lot of people, and the team is excited about this opportunity not only us but for patients. And if you look at the way we think this is panning out, 500 patients, 40-plus centers. We all -- all of them are going to be in the U.S. And if you think about the timeline, we've got discussions with CMS just to finalize the protocol of for the study that's 1 to 3 months. Then we start going through the IRB process with the various clinics and negotiate the trial agreements of the study. And then, we begin enrolling. So all of that leads us to kicking off in Q3. And we've talked before about delivering all the business system and the discipline. The team have done a phenomenal job of building out the whole way we're going to track this, the accounts we've identified, the discussions we've had already. So we really like what this is opening up for us.

Okay. And 2 other questions and I'll move on. Maybe just give us a little more color on the DTC campaign on the epilepsy side. You said you hope to see the benefits kick in. Again, how comprehensive is this? Why are you doing it now? What do you hope to see from one of those benefits you're talking about? And my -- just the last question, if you could talk a little bit more about the mitral valve redesign issues and how confident you are you can get after this and get this program back on track.

Yes. Thanks, Rick. So the DTC, the whole point of this for us is about creating demand for therapy and epilepsy. We think clearly, one of the issues is awareness of VNS as an opportunity in the whole treatment paradigm for epilepsy, and we think DTC is a way to do it. We started off with direct-to-physician, to start talking about this and create awareness. Then we started the DTC in the second half of the year. We're seeing, definitely, an increase in physician and patient engagement. The web metrics we're tracking definitely ramps up significantly. And we've also been doing some testing. We know that it's very responsive to the campaign. You can see the metrics ramp up and down when we turn it on and off. It's really quite fascinating. And we've seen some bright spots on lead generation and conversion to therapy. So for us, this is about creating awareness, a lot to do with the carers, the families of patients. And because of the way we've approached it, we've decided to turn it from a pilot into a significant campaign for the 2019. On mitral, this is one of the things about being in early-stage development is that you run into bumps. And we definitely did with this one and that's why we've leaned into it. We take our responsibility to the patients and the physicians who participate in our trials very seriously. And we saw 2 adverse events in patients in Q4, and as a result, decided to stop the trial while we understood where the issues were. We think that it's a design modification issue around the anchor system, not the valve itself, but the anchor. And that's why we press pause. And what we're going to do is reboot that design. And the team is confident about getting back into the trial in 2020. They've worked out a whole program to go through this and prototype and get back through the IRB process so we can start enrolling in 2020.

Your next question comes from the line of Raj Denhoy with Jeffrey.

I wonder if maybe I could ask a few more on the depression progress here. And congratulations on the progress over the last few months. And I'm curious about a couple of things. So the interim look at the data that CMS has provided in their ruling, can you maybe offer a bit more about how you think that will play out? Will it be just a look at the response endpoints? How many patients do you think are going to be required before you can take that look? Really do you have any thoughts around how quickly we can get to that very important point?

Raj. This is Melissa. The longitudinal study is approximately 200 patients and the -- it'll be looking at all endpoints of the study. So primary and secondary endpoints of the study will be evaluated at that time.

Okay. So both response and remission will need to be showing some sort of efficacy on both those endpoints at that point?

Yes. I think the movement to a longitudinal study doesn't -- isn't predicated on the secondary endpoints.

Okay. Understood. And then the other question is around the control group and whether it's going to be an active sham or in a sense, will the patients in the control arm receive even low-level stimulation or will the device be entirely off?

So the final decision memo did leave that up to the clinician to whether the device will be on or off or at a sub-therapeutic simulation.

And you've not yet decided which that will be or is that still being negotiated?

Yes, the device will likely be off during the trial.

Okay. Fair enough.

(inaudible) the final protocol.

Okay, great. And then I just wanted to ask a question on -- you mentioned the ImThera the sleep apnea trial that you're finalizing design with the FDA and you expect to start this year. Any updates on that timeline and what that trial will look like?

Yes, one of the things that we said when we talked about the THN3 trial is the issues around the stability and the protocol for titration weren't very clear. And we've done a bunch of work over the last 3 or 4 months. We took the last cohort of patients who were coming into that THN3 trial, titrated them with a different algorithm and saw a very definite change in the response. So using that -- we've had discussions with the FDA about doing a confirmatory trial and going back and doing a small cohort of patients starting in 2019. We're going to meet with them in March and look at wrapping up the study design.

When you say a small cohort, so I guess, I'm really just curious about when you think that trial could provide the evidence to support the approval of that technology.

Yes. I think we've got to just get through the discussions with the FDA. But we're pushing hard to start the trial in 2019.

Okay. That's fair. Maybe just one last question, just on cash position and thoughts around M&A. So you've outlined some of the costs you anticipate around the Heater-Cooler issue. You've taken on some additional capacity for debt around that. Maybe if you could offer a bit more about what you think your capacity is for further M&A over the near term and your thoughts around whether you're likely to do further M&A to build out the portfolio over the near term.

Yes. Thanks, Raj. I mean, first of all, we're very strong financially and we have been improving our working capital. We've accelerated the growth and we're generating roughly $200 million in cash flow from operations every year. So of course, having this liability behind us, I think, is a prudent thing to do. As you know, M&A is always going to be part of our growth strategy and we still have capacity to do acquisitions. We'll always look at alternative financing if we find the right thing. But clearly, we have to address the current liability. And that's why we were able to secure these commitments from the banks to address the 3T.

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

Three questions, please. So firstly, I wonder if you could give us a little bit more understanding of the provision that you've made for 3T. What sort of inputs have led to that calculation with respect to potential claim numbers and so forth? And what gives you confidence that this will be adequate and not need to be extended at some point in the future? And second question is an operational one, please. I appreciate there's a lot going on from an innovation standpoint in LivaNova, but it was my feeling that management had a degree of comfort in somewhat stable operating margins in '19 and absorbing some of these impacts. I know that within your guidance framework, you're calling for an 18% to 20% margin, so highlighting prospects of 150 basis points decline at the low end. So can you talk a little bit -- I mean, is there more cost than you expected in developing the pipeline here? Or what are some of the moving parts from your operational cost perspective that we need to consider now that perhaps we shouldn't have considered before? And last question, on Perceval, please. Obviously, heart valves has been the perennial disappointment for LivaNova for the last 5 years or so and a pretty shocking number in the fourth quarter. So within your guidance, you've highlighted expectations for double-digit growth from Perceval. Can you please just add a little bit of flavor around that? What underpins that confidence? What visibility do you have?

Scott, let's talk about -- I'll talk about the 3T provision. Thad, why don't you jump in on the guidance and the SG&A and then I'll come back on Perceval? So look, for 3T, we think it's important to draw a line under this issue. And if you look at the total number of cases and the provision amount, we think this is a reasonable and appropriate number for us. I think the thing for us is we looked at this business decision at the time that this was taken, the inconvenience and expense of continuing litigation, of really distractions from operations and also our mission of improving patient care, we really think that it's the right time to take this provision. And again, the fact that the banks, the 4 banks we're able to provide the financial commitments was an important market for that. So this is about drawing a line under this legacy issue. Can you talk about the guidance?

Yes. Absolutely. Thanks, Scott. Yes, we're super pleased with the growth of the business and the momentum that we see. And clearly, as we highlighted back in Investor Day that we had a very clear plan to invest in R&D in 2018 and 2019 to help build out the pipeline but then use gross margin to support a lot of this investment. If you look at the base business, excluding TRD, we are growing our business both top and bottom line in a similar margin profile. We are making incremental investments in TRD, which is basically 100 basis points on the operating margin. We think that, that investment is prudent given the size of the opportunity.

And lastly on Perceval. I think you used perennially. It's -- look, our Q4 again was disappointing. But overall, I think one of the bright spots for us is that overall in 2018, Perceval was double-digit growth. So I like the fact that it's a double-digit growth product. I still think there's plenty of work for us to do. The high single digits that we had in U.S. and Europe in Q4 were outweighed by international ordering patterns. And I'd rather us build a sustainable business than just hit a double-digit number for the sake of it. So I can identify where the issues are and we're working on that. But as you say, it's been a disappointment. And let me just say that the team are well aware that there's plenty of work to be done, and we're expecting a significant effort in this portfolio.

Understood. And just one quick follow-up. So the mitral program, obviously, this is a complex program, has been delayed several times since the inception, I think, of Caisson. So I wonder, could you give us some flavor of when an impairment test for your Caisson acquisition would come into effect? Obviously, it's been delayed further now. I just wonder, what hard endpoints do you decide to write off the asset altogether or not? And if you could just give some flavor there, please.

Yes, I mean, every year we have to do impairment testing on all the different things we have in the pipeline. The value of Caisson and the market opportunity is still significant. It is unfortunately costing more and taking longer. So we have to continually look at the net present value of that. If you recall though, also, we spent, I would say, a relatively modest amount for Caisson given that we had owned roughly half of the business previously. So to trigger an impairment hasn't been an issue per se, given the fact that we didn't actually spend that much for the asset.

And I think, importantly, the fact that the team have identified the root cause, they've developed a remediation plan, and we know what the timeline looks like. We believe that the program is healthy. We just need to rectify the issues we've identified.

Your next question comes from the line of Matthew O'Brien with Piper Jaffray.

Just to finish off the 3T commentary, when you say this is a reasonable estimate, is there any chance this could snowball into being much, much higher of a liability? And then when do you figure out whether or not the insurance providers are going to cover some of this liability?

Yes. So we don't believe so. We think this is a reasonable estimate. And we are in negotiations with the insurance companies that cover us. But we've taken our provisions for the whole amount that we believe is reasonable.

Got it. And then as far as TRD goes I'm having a little bit of a hard time reconciling the commentary on the revenue you expect this year and next year. If memory serves, and please correct me if I'm wrong, I think you do about 100 replacement cases per year, and then I know you said about 500 patients in total. So either I'm getting that 100 number wrong in terms of the replacement folks per year or the ASP is much higher than I was expecting. So which of the 2 of it -- which of the 2 of those would it be?

So it's in that number is the replacement plus some incremental replacements due to the -- change in the file decision memo for the funding of replacements. Additionally, clinical trial units are also in there.

Okay. So sorry, Melissa. Just to put a little bit of finer point on that. If you do, call it, $7.5 million this year in the back half, that's 300 patients at an ASP of $25,000 a piece? And I think you do about 100 replacements. That'll be 200 enrolled this year is what you would be expecting then?

And then you have to consider the additional replacements due to the change in the final decision memo.

That's a combination of end-of-service plus the clinical.

Sure. I think the end-of-service -- my end-of-service number -- yes.

Is higher. [Roughly].

Right. So we -- and obviously, we're doing everything to accelerate, build the capabilities to ensure we get the clinical up and running. But we're also trying to provide a range around that.

Okay, okay. Maybe we can follow-up offline because that's 1,000 patients roughly the next year to $25,000 ASP.

Yes. That's roughly what we're thinking, yes.

Got it. Okay. And lastly just real quick, on the guidance for the core business, 4% to 6%. You're coming off of a pretty good cardiopulmonary number. Neuromod was a monster in '18. Where does that 4% to 6% growth come from when you net out the 100 basis point contribution from TRD this year?

Well, 5% to 7%. That's the...

When you net out the 100 basis points?

Yes, got it. So we have great momentum. And I guess, to me, we could have probably characterized it differently, but it's very similar to the growth momentum that we have this year. As you may recall, we talked about this OEM Canadian distribution agreement that we're exiting. So that you have to pack off $32 million there of the top line. So that's roughly 300 basis points. In addition, you have 1% due to FX. So I would say, as we go into 2019, it's a very similar kind of growth trajectory that we're seeing today.

And the bits we're leaning into, specifically, driving international and you see the results in international continuing to improve. DTC driving epilepsy in the U.S. and Europe. And ACS, we're, again, building heavily into TandemLife and we expect the productivity of that commercial group to really ramp and in the second half launching the next-generation product for ACS. So those things excluding TRD is really what we're leaning into it.

Yes. And then the $5 million to $10 million for TRD is about 30 basis points of the growth.

Your next question comes from the line of Matt Taylor with UBS.

First thing I wanted to ask was, it's just a follow-up on the TRD discussion. I was hoping you could -- I know you're in discussions, but I was hoping you could give us some flavor for what the trial structure could look like in terms of the primary and secondary endpoints to the extent that you can reveal any of that.

Well, your primary...

Yes, I guess -- I'm Bryan Olin. Our focus is obviously on response as our primary endpoint. We will look at remission as well. We've said it will be double-blinded, randomized, controlled, approximately 500 patients. A lot of it is laid out. And it's very consistent with what we've talked about in in the past. This is why we feel pretty comfortable that by the end of March, we should have clarity with them on getting the trial, I guess, with its final approval.

And I think the important thing there too is the addition of the bipolar patients. That's 25% of the patient population back in the pool, which we think is a really important inclusion that CMS came to.

And then on sleep apnea, could you talk about what that trial looks like and what the timeline could be if you started here in '19?

Yes. Not yet. Just give us a couple of days until we've met with the FDA in March, and then we'll come out and talk about it more clearly by either with a separate press release or we'll talk about it in April. But just give us a couple of days with the FDA on that one. But we're really encouraged by what he saw in the titration improvements that we made over the last few months.

Okay. And last one, I just wanted to clarify on TMVR. I guess, can you disclose what the adverse events were? And more specifics on why you think the anchoring system is the right fix?

Yes, so the 2 adverse events were [death]. And we've got a significant piece of work that the team have done over the last 2 months looking at all of the root causes. They've gone back and looked through the cases. They've talk to the physicians not just the physicians but the entire team at the hospital. So it's been a pretty exhaustive review of those 2 cases. And looking at all the imaging, we're confident that it's to do with the anchoring system. As I said, not the valve. The valve has really proven out to be very versatile. So that's why we're focusing our efforts on the anchoring system.

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

I guess I just wanted to start with your Neuromodulation. You're continuing to see really strong growth outside the U.S., so -- particularly in the emerging markets. So just curious what's driving the growth? Is it the investments in the channel or is it the SenTiva product?

Yes. So in Europe, it's SenTiva. And now the SenTiva generator is more than 50% of the sales of the devices for epilepsy, which is just tremendous. And I put this down to sales leadership and execution, particularly in the U.K. and Nordics and Italy. In international, I will say a lot has to do with the team's focus on execution but also changes in our channel. We went direct in Japan. We went direct in Australia. They don't have SenTiva yet in the international group. So we're working towards that and excited about the possibility of that. But it's really, I would say, sales force 101, the team being very focused on account acquisition and account penetration.

And one of the reasons that we've talked about our SG&A this year being both in 2018 and 2018 a bit higher is that we've been investing ahead of the curve in basically going direct in key international markets with the real focus on building out teams to sell Neuromod, and we're seeing amazing growth as a result. So this past quarter, it was 76% in the rest of world region, nearly 20% in Europe and 10% in the United States. So we're seeing great signs with that investment in both the U.S. and in international.

Okay. And then just curious if you could give us your thoughts on the potential threat of DBS in epilepsy? I think Medtronic just announced a U.S. commercial launch about a week ago of that product?

Yes. Look, I would say a few things. Firstly, anything that raises the awareness of drug-resistant epilepsy is a good thing. And again, that's why we're leaning into the direct-to-consumer campaign. We think this is a large unmet need. I think you've heard me say, there's roughly 100,000 new patients identified with DRE every year. 5,000 of them roughly get VNS Therapy. 5,000 of them get some other form of therapy. It leaves roughly 90,000 patients a year that are not getting a therapy other than drugs, and that's the large unmet population. And so I really think that what we have established with VNS with more than 100,000 patients implanted now, more than any other nondrug therapy. And so we think that we've got a great opportunity with VNS. We're continuing to improve the product. And DBS coming into the party and talking about drug-resistant epilepsy, we think we're good with that.

Okay. And then finally, just curious if you had factored any additional R&D expense for -- around the European MDR changes that are happening. Are you expecting to have to go back and recertify products over there? For example, I know some -- there's been other companies that have specifically called that out as driving higher spending, at least in the shorter term?

Yes. Yes, we have included that in our projections for 2019.

It's part of outlay in our R&D line. But we've largely absorbed that as basically a cost of doing business. And we've leaned into that. We've got a great team working on it.

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

So Olin, take 2 questions already asked and smash them together and sort of ask the question about M&A and specifically in mitral. Regardless of the delay in Caisson, I think, I've asked you in the past about your strategy in mitral broadly speaking in the past. And clearly, what we see with the mitral valve is a need to have an armamentarium approach. At least that's how other companies are taking it. That's when we talk to physicians, it's not a one-size-fits-all kind of like the aortic valve is. And so I'm just curious. I'm glad you're asked about your M&A capacity or ability. You also have talked extensively about what's going on with Caisson. So maybe talk about over the next couple of years what you would have us think about with respect to your mitral portfolio and potential for augmenting it via acquisition, specifically that business.

Yes. So I would say our team largely agrees there's going to be a lot of different ways to go after the mitral opportunity. It's not just replacement. It's not even just repair. So the comments about toolbox and looking other areas and other therapies, we are looking at those. That is definitely something that is on our list of areas we're focused on for now. But again, we always thought that replacement has the largest long-term opportunity and that's why we started there.

Yes. And that's why we take an M&A, I'd say, portfolio approach. I mean, clearly, you're going to have -- and it's natural in a more complicated space such as mitral replacement that you're going to have delays, you're going to have obviously things that happen. But I think what we have built up in relatively short period of time with everything from TRD to ImThera, to even our heart failure program is a really unique portfolio of assets. We're going to continue to look at other things and evaluate them and see if it's the right fit for us as LivaNova.

I think we're just talking about it. It's a structural heart approach.

It's a broad structural heart approach, right.

Sure, right.

Makes sense. And just as a follow up on that, specifically. Do this latest issue, Damien, reduce your compensating way in the transseptal approach? Will you look at other delivery avenues? Or are you committed to transseptal on this specific avenue?

Yes, we're very committed to transseptal. We still believe that's the right approach. Again, the issue for us is not about the approach. It was about the anchoring. And so we're very committed. And I think the clinician field still views transseptal as very much the way to go, too.

Got it. And I'll just ask my 2 follow-ups in Tandem, no pun intended, and get back in queue. On the -- Thad, I took note of your commentary about the internal controls. And so the -- you said they were -- the 2 issues were linked, which almost made it sound like you had folks that you didn't want access to your internal systems that had access that perhaps made some changes. I didn't want to read too much into it, but it certainly sounded like there was something going on there and I wanted to get your sense -- confidence in the potential you stem that and that risk is completely off the table at this point. And then secondly, I'll throw it in there and then get back in queue. Just on your guidance. Companies -- but obviously, I'm sure you guys, went through guidance with a fine-tooth comb and you're hoping to show upside to your guidance. I'm wondering if you could give us where you think you have the best opportunity to exceed your guidance, whether it'd be maybe a little bit of more leverage than you're guiding to on the gross margin line or specific revenue area. And where you were especially cautious and wanted to make sure that you didn't see any downside? Any areas on both the ends would be helpful.

Yes. No, so on the accounting item side and clearly we -- as I mentioned in my comments, we had a lot of complexity in both the CRM divestiture and implementation of our SAP programming in 2018. Clearly, and I want to be extremely clear, we have not identified any misstatements in our financials. It's more of a control design matter related to access. And so it's more -- because there is more access, there is the potential, the potential, but we have not identified an issue. So we're working with our auditors on this. And clearly, we are very focused on addressing and remediating in 2019. On the financials and the guidance, I mean, look, I am super excited about the momentum that we have in the business. Clearly, we're doing great things in driving Neuromodulation globally. I think also, we're really excited about the potential with TandemLife and I think we can do better there. But we're also within the P&L showing fantastic results in gross margin. We're well above the 100 basis points that we've described in Investor Day, and we're reinvesting that to then grow the business even further. So again, I feel we could drop more to the bottom line while we're in this period of accelerated growth, really maximizing the opportunities that we have, particularly internationally in Neuromod and TandemLife.

Yes, I think you're right. And look, I'm really proud of what the team achieved in 2018, driving growth, the gross margin improvement. I mean, basically, the things we talked about with you at Investor Day nearly 2 years ago now, it's starting to [reap] through. the constant focus on execution is really what's important for us, Jason. And I think we've had a fairly transparent relationship with you guys. Clearly, Perceval for us is something that's disappointing and that's what we're watching very closely. But I think international and Neuromodulation, those are the big drivers for us.

We have no further questions at this time. I will now turn the call back to CEO, Damien McDonald, for closing remarks.

Well, all of you, thanks for your thoughtful questions. And on behalf of the entire team, we appreciate your support and your interest in LivaNova, and thank you. And we'll talk to you in a quarter, if not sooner. Cheers. Thank you.

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