LivaNova PLC (LIVN) Earnings Call Transcript & Summary

Well thank you all for joining today. My name is Neha Begwani, and I'm part of our medtech investment banking coverage team. And there's an important disclosure that you can find on our website as well. And if you have any questions, please reach out to a Morgan Stanley representative. I'm very pleased to have the LivaNova team here today CEO, Vlad; CFO, Alex and VP of IR, Briana, and it's going to be a good discussion.

But maybe to start us off, for those who are newer to the story, can you frame LivaNova today and where you all are headed?

Yes. So Neha, first of all, thank you for the opportunity to join you and thank you all for your interest in the company. Look, I would say three things about LivaNova that are important to know. One is that we have strong and durable growth in our core businesses and we have a diversified portfolio. So on one side, it's neuromodulation treatment of epilepsy. On the other side, it's cardiopulmonary business, and those businesses have -- take leadership role in their spaces and continue to go very strong. At the same time, we believe that moving forward, we need to expand into the markets with significant unmet need from a patient point of view, markets of high growth and markets where we have the right to win. And we believe neuromodulation creates that opportunity for us. So the next step for us is expansion into obstructive sleep apnea. And we have submitted PMA approval to the FDA. And then beyond that is getting to the next wave of potential neuromodulation indication, then we have an optionality with difficult-to-treat depression business that is currently under reimbursement review with CMS. So strong foundation in terms of core businesses and some significant opportunities for expanding markets in which we compete as a consequence is accelerating our growth profile.

Okay. And maybe we'll start with the core business, cardiopulmonary. So this business has been growing sustainably double digits for 10 straight quarters and most recently was a 13% grower. So you guys raised guidance 300 basis points for 12% to 13% full year growth, what do you think are the drivers behind the sustained growth profile?

Yes. Thank you for that question. It's -- so first of all, the growth of procedures in open heart surgery has been elevated versus the historic rates. We estimate it to be in the area of 4% to 5% now. At the same time, within our own business, we have a number of growth drivers that have been performing well. So first of all, we are continuing to gain market share in oxygenators and over the last 2 years, went from 30% to approximately 40% share, and we see that trend continue. We launched a new piece of equipment in heart-lung machines in 2023. And now we're in the upgrade cycle of our heart-lung machine, and that cycle will continue to deliver double-digit or high single-digit growth for the next 2.5 years. And then finally, LivaNova is very strong pricing capabilities. And last year, for example, 300 bps of our growth was contributed due to price increases and pricing continues to be a strong growth driver for us.

Great. And Essenz, which I think is the technology you're referencing. Can you talk to us about the progression of the rollout and the penetration across different geographies?

Yes. So think about it with the worldwide market for heart-lung machines, we have about 8,000 units placed around the world, and that represents approximately 70% market share. The previous generation of heart-lung machine called S5 was launched approximately 18 years ago. So we are well overdue in terms of upgrade. We estimate that since the beginning of our -- since the launch in 2023, it should take us about 8 years to upgrade all the machines around the world. And so year 1, 20% of our installed base in that year came from Essenz, the new machine. Last year, 40% came from Essenz. This year, we estimate that 60% of our old placements came from Essenz and then 80% next year and then 100% in 2027. So that has been an upgrade cycle. And obviously, the new machine has significantly broader functionality and has digital platforms, has software upgrade opportunities. And ultimately, the goal is to shift from a smart machine that kind of is guided by perfusionists into a smart machine that actually guides the perfusionists and so kind of building that AI capability, learning capability, that is an important vision for the future innovation.

Right. And you recently launched Essenz in China. How do you view the opportunity there? How are you navigating the geopolitical dynamics and the tender process? And how do you think about being able to protect that price premium that you guys garner in other regions?

Yes. So China is a very important market for us because there's huge patient population, significant unmet need in cardiovascular disease. So we focus on health versus geopolitics. And we received -- 6 months ago, we received approval from CFDA on Essenz. That was 6 months before expected date, which by itself is a very positive indicator for us in terms of demand for this innovation in China. We then spend our time preparing for a launch and 2 weeks ago was the launch event in China. Obviously, there's a lot of excitement in the medical community about the launch, and we're doing our best to make sure that it's an impactful launch, and we yet have to see how we execute it.

Okay. And so maybe if we turn to oxygenators, a lot of recent success in taking share. How are you thinking about manufacturing capacity? And are there any expansion initiatives underway?

I'll take this one. Let me start off by saying our team has done a great job of managing the supply chain under a difficult situation where market demand exceeds the supply in the overall marketplace. So we've been gaining share by way of just being able to supply our customers. And that has contributed to our ability to continue to grow. It also has enabled us to take price in the oxygenator segment. We -- last year, we focused primarily on process improvements to drive about a 10% capacity increase. It translated into a 10% output increase as well. We're doing much of the same. Again, this year, we're going to multiple shifts, 24/7 shifts. So we're able to continue to expand our own capacity. Our biggest governor on growth today is our third-party suppliers scaling with us and their ability to supply critical components, so we're working with them. Our operations team has done a really good job of working with them. And we feel like we have a path to continue to expand their own capacity, we just have to get our suppliers to scale with us.

Well it looks like the recent growth drivers provide great visibility for growth for the next couple of years. How are you thinking about that -- the durability of that growth beyond that 2-year period?

In cardiopulmonary or...?

Yes. Cardiopulmonary.

Yes. So the way I would think about this is on the heart and lung machine front, the next 2, 2.5 years are about upgrade. Then once all the units during the year and when we phase out the old units, the S5 then the growth is going to come from software upgrades and from service and from additional equipment that is used during the procedure. On the oxygenator front, growth over the next 2 years, we expect to continue market share gains obviously. And over the next 2 years, this will be driven by improvements in our manufacturing practices, what Alex referred to. Beyond that, we plan to launch a new oxygenator. That is from a clinical performance point of view, at least what we see in the preclinical testing performs better than anything on the market today. So we believe that is going to be a truly differentiated innovation, and that will be an additional growth driver for us moving forward. So I feel confident about the short-term and long-term durability of our cardiopulmonary business.

Right. And maybe we'll move to your other core business, which is on the epilepsy side. You grew mid-single digits in Q2 with a lot of positive recent news flow, including strong real-world evidence with CORE-VNS, how is CORE changing behavior in the market? And what do you think that will do for the growth trajectory of the business?

Great question. I'll take that one. So CORE-VNS is our largest global prospective VNS therapy study to date. The impressive outcomes demonstrate early durable and an impressive seizure freedom rates and seizure reduction rate in a wide variety of seizures and in children and adults. So we're confident that this will improve the foundation of our epilepsy business and early feedback from the field suggests that KOLs are saying, based on the strength of this -- and the quality of the data that this will change the way that they counsel patients and consider VNS therapy earlier in their treatment algorithm. So we're excited about this data.

That's great. Very impressive data. And switching to reimbursement, our reimbursement procedures are moving from Level 4 to Level 5 APC and the primary ruling from CMS for 2026. If finalized, how could that influence the growth trajectory of this business? And how do you think about reimbursement dynamics for this business more broadly?

Yes. I'll take that one. So we are really encouraged to see CMS included in their proposal in July replacement standards into a Level 5 versus Level 4. That incorporates a 48% increase in reimbursement for Medicare therapy patients. As a reminder, about 70% of U.S. implants are replacement. 40% of DRE patients are Medicare and 30% are Medicaid. So we believe that this would create a more sustainable financial profile for a provider to establish and maintain a monotherapy practice. We have strengthened our capabilities in market access and health economics with key talent, and we're really pleased to see this coming to life. Also, this is the second straight year that the independent top advisory panel recommended that new patient implants be included in a Level 6 or establish a Level 6 code. So we're also excited about that.

Great. I mean, those are a couple of really strong levers to help drive the business and the growth trajectory. But what do you think are some other levers that could exist to accelerate adoption in this very under-penetrated drug-resistant epilepsy market.

Yes, great question. So our strategy here is multifaceted. Of course, it's market access, which we just described. It's clinical evidence as demonstrated in the CORE-VNS data. Beyond that, it's commercial excellence and innovation. So in innovation, we'll touch a bit more on this on Investor Day, but at a very high level. Here, we're focused on connectivity and enabling remote programming, which would create value for patients and providers. Beyond that, collecting data and analytics and combining that with treatment detection and even seizure prevention would be -- is where this is going at some point.

Right. And Vlad, you touched on OSA and you commented this will be an important long-term driver for the business. You had very competitive data come out with the OSPREY clinical trial, but it will be third to market. How do you expect yourself to be positioned within the market? And how does the strength of that data help you in that positioning?

Yes. No, thank you for this question. So just to recap why this is an important opportunity for us. I mean, outside of -- I think it's important to have more competitors in this very important space for us is an opportunity to get into a faster growth market and accelerate our growth and ultimately expand our margin creation opportunity. So we are very pleased with the outcomes of OSPREY study. And we've learned a lot during the study. I mean, one is our patient population in this study was significantly more complex than in the previous studies in terms of BMI, ODI, AHI. We showed the big differentiator as well the fact that the CCC patients, so complete concentric collapse patients were not excluded. And we estimate in our study based on the algorithm that we've applied we believe that about 40% of the patients in the study have complete concentric collapse. And the fact that we can include patients with complete concentric collapse also changes patient flow. Like now patients will not be required to go into DISE procedure and can go straight from prescription into the interventional procedure. And that's, I think, a major improvement in the patient flow. We also think from the technology point of view, we have a differentiated technology. Our device has 6 electrodes, and it gives us opportunity to additionally improve potentially the clinical outcome through more options on how titration is done. Our devices implanted more proximally. So at the trunk of the nerve versus the branches, and that gives us access to impact not only tongue, but also throat muscles and so broader spectrum of muscles. So all of that together -- and the other point is the procedure time has improved as well. And so all of that together gives us the right, I believe, to have a differentiated commercial model and focused on more on the clinical outcomes and science, and we are confident in our ability to launch it.

Yes. And what gives you confidence in your ability to treat more severe patients. If you just unpack that a little bit, you mentioned patients with CCC in particular, how do you think about really addressing that patient population.

So it's not scientifically correct to compare different trials. So I will try to stay away from that. But if you -- we can look at patient population. And in some of the previous trials, CCC patients were excluded from the trial. In our case, the designers of the product believe that because we're treating the trunk of the nerve that we will be able to impact CCC patients. And in the trial, we did not see significant difference -- statistically significant difference between the patients with and without CCC. And so that -- if you think about it, depending on the literature, I think the medical community kind of agrees that in the entire patient population, 20% to 25% of patients -- sorry, 25% to 30% of patients have CCC. And so that gives us -- today, these patients basically have to look at other options versus neuromodulation. So I think that gives us a very interesting and significant opportunity to expand the patient population.

Okay. And strategically, you've previously mentioned that you would entertain a partnership if it was the right fit. What's your latest thinking there? And is this something that you plan to provide additional details on during your upcoming Investor Day on November 12? Or is there something that you can give us as a preview?

Yes. I think during the Investor Day, we will frame our plan, including the long-term financial plan on OSA. We are confident, like I said, that to commercialize this ourselves. While doing it ourselves will require creating a sales force in the category in which we're not competing today, there are some key underlying capabilities that we can leverage across the organization, health economics, reimbursement, manufacturing, R&D, clinical and so forth and so on. And so that gives us kind of an opportunity to plug in a new business and then focus on building commercial organization in the area of sleep.

Okay. And then you -- sorry.

Yes. And we are open to partnerships and the lens at which we're looking at is value creation for the business and for the shareholders.

That makes sense. And you have one more growth driver as well. So as we switch to DTD, you initiated a CMS reconsideration process for VNS treatment in treatment-resistant depression. What do think the key milestones are there?

Yes. So we're excited about the totality of the clinical evidence generated through the RECOVER trial. So that was despite the fact that we failed the primary endpoints, the data shows the totality of evidence, it makes it a compelling therapy for an underserved patient population today. They have no other treatment options at that point in time. And so we feel like the data is compelling enough and we're cautiously optimistic about the opportunity. We've initiated the process, as you said, with CMS. So it's preliminary discussions around the coverage statement. So we expect that we'll get some sort of an indication in the near future, and then we'll submit our draft for a final sort of approval and expect that process will go into a backlog essentially what CMS has at this point in time. Once it is in the -- once they sort of elevated from the backlog and raise the file, it's about a 6-month process that will then sort of -- after the 6 months, there's a 30-day common period. And then beyond that, it's 60 days for a reconsideration and sort of the final resolution on that.

Got it. Okay.

And can I just -- I want to build a little bit on what Alex said and focus on the clinical learnings that we had. So RECOVER was the largest randomized clinical study with the medical device in -- to treat depression. And we're still finding new learnings and that came out of the trial. Now we have 24 months [indiscernible] it was randomized and some patients were in the control group, some patients were in treatment group and at the end of year 1, every patient was turned on basically. But now we have 24 months data. And there are 3 things I want to point out. The first one is there was a 43% suicidality reduction in the group. And that reduction started to show first signs after 3 months of treatment. So that is, in my mind, a very important clinical outcome from the medical community. The second one is that the MADRS score continued to improve in 24 months versus 12 months. So it's basically we can conclude at this point that the longer patients are on this therapy, the better they do. And then the third one is the compliance of the durability of the treatment in patients 24 months versus 12 months was above 80% and that is significantly higher than any other international treatment of difficult-to-treat depression patients. And if -- when we talk to our key opinion leaders in the space of interventional psychiatry, this is one metric that they're most excited about. So that -- Alex talked a little bit about the process, but I would say from the clinical point of view, these learnings give us more and more confidence that of a potential outcome of this request.

And as you think about the data points that give you confidence around getting national coverage, how should investors think about DTD as a bigger part of the broader LivaNova story, which as we talked about, has many different growth facets.

Yes. I think for us, obviously, as we said, we -- the super power in our capability is neuromodulation, right? And that's why we're building on our current capability in epilepsy, we -- and we -- the goal is to maintain our leadership there, getting into OSA, and we have a clinically differentiated product and the ability to launch the product in a very competitive manner. And then obviously, we have optionality with depression. Now it's a little bit of a switch on and off, right? Because without CMS reimbursement, we don't see that this business is long-term viable. But given the -- some of the data points I gave you on the clinical learnings and then the process that we're going through with CMS, again, there are reasons to believe that this technology could be reimbursed and then could become a very important part of our portfolio. But like I said, it's an optionality for us right now.

That makes sense. And I think we did a nice job of unpacking all of your different top line growth opportunities, which as I said, there are many of them. But you've also been focused on margin expansion. And how do you think about the margin trajectory? Is there still additional room for margin expansion in the business? And how will that be a focus going forward for you all?

Yes, absolutely. We stand by our statement that we want to grow our top line faster than the markets in which we compete in and absolutely drive our bottom line at a faster pace than our top line. So in our core business, there's still opportunities to do that, which gives us other opportunities to invest behind these exciting new assets that we talked about here.

And maybe Alex, I'll just stick with you. So the stock has performed nicely recently, really been on a nice trajectory. At the same time, you really stepped up your gain when it comes to fashion. Do you think those 2 items are correlated with each other?

No, no. I knew where this question was coming from.

That was all Vlad, that was not me.

I model my fashion after Vlad.

So maybe just to refocus us, you meaningly improved your free cash flow generation profile and raised your guidance last quarter to $140 million to $160 million. How do you prioritize use of cash? And what are your capital allocation priorities going forward?

Great question. So our top priority is to continue to support our core, right, as evidenced by our investments in our capacity increases. We're supporting our investments in IT and systems infrastructure, innovation for both cardiopulmonary and epilepsy. This is all to sustain the growth that we have in the great core, right? Number two is we're going to invest behind the OSA business, right? It's an exciting growth opportunity for the company. And so it presents a terrific return on investment for the company and for shareholders. We obviously left the optionality on DTD, so that could become an investment opportunity. And then lastly, we're looking at external or M&A opportunities in large underserved markets where we have the ability to win.

Okay. Great. And Vlad, how would you say those capital allocation priorities support the long-term strategy of the company and vision where you see LivaNova going over the next...

Yes. Look, we are very excited to share the vision with the community, with investors, with the overall broader business community at the Investor Day. But I think that -- may be the one thing that I would leave you with is we will compete in 2 very important spaces. So cardiovascular market, you have a huge patient population. It's number one disease burden on our society. At the same time, the medtech market in cardiovascular disease is very large and significant. At the same time, with neurological disorders, you have significant patient population. One of the large -- fastest-growing, actually, disease states. But the market itself is not as large as cardiovascular market. And I think the gap between the patient population or the potential of this market and where it is today is innovation. It is under research territory. And we believe we're very well positioned to continue to expand our neuromodulation capability. And that kind of that gap, if you like, between where we need to be and where we are today, create significant growth opportunities for us. So when we think about getting stronger in epilepsy, getting into the obstructive sleep apnea, an opportunity to get bigger in the depression space, I think ultimately, that is in service of addressing those patients' needs where there is no kind of -- where there's no better alternatives today.

Okay. Great. Look, thank you so much for taking the time to walk us through the story. And I think I'll speak for everyone that we're excited to see what November 12 brings and additional detail you can provide on that day.

Thank you for great questions.

Thank you.