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Edited Transcript of LIVN.L earnings conference call or presentation 1-Mar-17 2:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 LivaNova PLC Earnings Call

London Mar 1, 2017 (Thomson StreetEvents) -- Edited Transcript of LivaNova PLC earnings conference call or presentation Wednesday, March 1, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Karen King

LivaNova PLC - VP of IR and Communications

* Damien McDonald

LivaNova PLC - CEO

* Vivid Sehgal

LivaNova PLC - CFO

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Conference Call Participants

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* Jason Mills

Canaccord Genuity - Analyst

* Scott Bardo

Berenberg Bank - Analyst

* Brooks West

Piper Jaffray & Co. - Analyst

* Michele Baldelli

Exane BNP Paribas - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the LivaNova PLC fourth-quarter and full-year 2016 earnings conference call.

(Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Ms. Karen King. Ma'am, you may begin.

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Karen King, LivaNova PLC - VP of IR and Communications [2]

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Thank you, and welcome to our conference call and webcast discussing LivaNova's financial results for the fourth-quarter and full-year 2016. My name is Karen King, and I'm the Vice President of Investor Relations and Communications for LivaNova. I'm very happy to introduce to you today Damien McDonald, our new CEO, who will be joining us on today's call, along with Vivid Sehgal, our Chief Financial Officer, who many of you know.

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

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

Included in the press release today are selected non-GAAP operating results. In this press release, Management has disclosed financial measurements that present financial information not necessarily in accordance with generally accepted accounting principles, or GAAP. Company Management uses these measurements as aides in monitoring the Company's ongoing financial performance from quarter to quarter and year to year on a regular basis, and for benchmarking against other medical technology companies. Non-GAAP financial measures used by the Company may be calculated differently from and, therefore, may not be comparable to, similarly titled measures used by other companies. These non-GAAP financial measures should be considered along with, but not as alternatives to, the operating performance measures as prescribed per GAAP.

To enhance the call, we have posted a presentation to our website that summarizes the points of today's call. This presentation is complementary to the call materials, and should be used as an enhanced communication tool. You can find the presentation in the investor relations section of our website under news & events, presentations, at www.LivaNova.com. And with that, I will now turn the call over to Damien.

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Damien McDonald, LivaNova PLC - CEO [3]

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Thanks, Karen, and good morning from Houston, and welcome to our fourth-quarter and year-end 2016 conference call. I'm extremely pleased to be at LivaNova and to be hosting my first conference call. I've been encouraged by what I have seen during my 100-day onboarding, and even more excited to be heading this Company today than when I accepted the role.

I've spent significant time on the road meeting hundreds of people, visiting with customers at hospitals and medical centers, working closely with our senior management team, and meeting with employees. I've been to most of our manufacturing facilities, have done a deep dive with every franchise and sales region, and have been trained on all our products. I was most impressed by the passion that I've seen across the Organization and the dedication to making a difference in a patient's life.

2016 was our first year as a public company, and with that came opportunities but also challenges. While we weren't able to grow our top line as fast as we would've liked, we made significant improvements throughout the rest of the income statement, cash flow, and balance sheet, and hit the top end of our adjusted EPS guidance. Our goal, first and foremost, was to ensure that we had a solid foundation in place from which to drive long-term growth, and we believe we accomplished that objective.

So, let's talk about that foundation. We ended the year with adjusted gross margin in the mid-60%s, 150 basis points higher than in 2015. We met our commitment of $19 million in merger synergies. We were able to keep adjusted SG&A relatively flat versus 2015, showing our ability to manage expenses while continuing to invest. We restructured less profitable businesses.

We reduced adjusted R&D as we eliminated duplication, and accelerated our efforts to re-prioritize investments in our growth drivers. We reduced our adjusted effective tax rate from the mid-30%s in 2015 to the mid-20%s through various tax planning initiatives. We improved in-channel inventory levels and enhanced distributor relationships. We maintained net debt at relatively low levels while undertaking restructuring activities, funding our equity investments, and delivering on our share buyback program. And lastly, we ended the year with $3.05 in adjusted earnings per share, which was at the high end of our guidance range.

I really see tremendous opportunity to increase shareholder value at LivaNova by maintaining our strong leadership positions, focusing on key drivers like Perceval, executing on patient-centric innovation like in neuromodulation, and disciplined investment in both organic and inorganic growth. I look forward to sharing with you our thoughts and ideas on how we will advance LivaNova to the next level at our upcoming investor day in the third quarter of 2017.

Before we move to our sales discussion, I wanted to touch on two recent announcements. Our decision to de-list from the London Stock Exchange and the 3T Heater-Cooler Remediation Plan. Last week, on February 23, we issued a press release where we announced our intent to de-list from the London Stock Exchange over the next six weeks. We made the decision to apply for the voluntary cancellation primarily because of the low volume of shares being traded on the LSE, and the fact that the majority of our shareholders were trading on NASDAQ. I want to assure you that this is not a reflection of our commitment to our European investors. The majority of my management team and I work and live in the UK and in other parts of Europe, and we're committed to all our investors.

Additionally, this morning we issued an 8-K and RNS disclosing information regarding the 3T Heater-Cooler device. We disclosed that we have now developed a 3T device remediation plan and, as a result, we recognized a liability in the fourth quarter which includes three key elements. First, we implemented a loaner program, offering new 3T loaners. We prioritized and allocated these machines to customers with confirmed bacterial contamination, and machines manufactured prior to September 2014. This program started in the fourth quarter of 2016 in the US, and is being rolled out to customers on a global basis.

Second, where approved by local regulatory authorities, we are now offering a deep disinfection service, free of charge, to customers who have confirmed bacterial contamination on machines manufactured prior to September 2014. We are also offering the service to other customers who request assistance with the cleaning of their machines. This service has been available for some time in many countries around the world, and will be expanded to additional geography as approvals are received.

And third, we have developed a design solution to address the issue of potential aerosolization. Subject to final verification and validation of these design changes, we will begin implementing this solution in the second quarter in Europe, and progressively expand the implementation to other countries as we receive regulatory approval.

In the US, we continue to work closely with the FDA on the remediation plan. With the loaner program and deep disinfection process in place, and the design solution nearing implementation, we are now able to provide an estimated cost of approximately $38 million, which includes costs already incurred in 2016. We made assumptions on the timing of the implementation due to various global regulatory timelines.

The device remediation plan assumes that the estimated costs, which are all in cash, will primarily be incurred over the next two years, approximately 70% in 2017 and 30% in 2018. The plan assumes that all 3T Heater-Cooler devices currently in use will receive the design solution during that time frame. As a leader in the industry, we are committed to our customers and patients who rely on our devices. Our remediation plan ensures continued clinical access to this important device that enables lifesaving cardiac surgery.

I'm now going to move to a discussion of our sales performance, and then Vivid will discuss details of our financials and our 2017 full-year guidance. I'll then wrap up with closing comments, and we will move to questions.

Turning now to our net sales results for the quarter, as a reminder, in our press release we provide a table that shows both reported net sales growth and constant-currency growth, so you can see the impact of foreign currency fluctuations. For discussion purposes, we are going to focus our comments on net sales results with constant-currency growth. Net sales were down 1.6% compared to the fourth quarter of 2015, primarily due to declines in our cardiopulmonary business. For the full year, net sales were up 1% versus full-year 2015, primarily due to strong sales in neuromodulation.

Let's look at each franchise. Cardiac surgery decreased 3.2% for the quarter. Sales for the cardiopulmonary products are at $125 million during the quarter, down 3.4% compared to fourth quarter of 2015, primarily relating to our 3T Heater-Cooler device and our heart-lung machine in Europe.

A majority of the decline was due to our 3T Heater-Cooler device. As I mentioned previously, we started our loaner program in the fourth quarter, offering loaners free of charge to customers in the US, and we are rolling out the program on a global basis. As a result, we have ceased selling almost all devices, and are allocating manufactured products to the loaner program.

Also, as we anticipated last quarter, we experienced softness in Europe in capital equipment sales. We have heard from customers that they are delaying new purchases and holding on to their machines longer in anticipation of the next round of innovation. In the US, we're not seeing the same type of behavior, and in fact, excluding heater-cooler devices, sales in heart-lung machines were comparable to 2015.

For the full year, cardiopulmonary was relatively flat to full-year 2015. This was primarily due to declines mentioned, offset by strong performance in share gains over the year in INSPIRE, our newest oxygenator.

Sales for heart valves were $34 million in the quarter, a decrease of 2.2%. For the full year, heart valves declined 1.6%.

Our tissue valve business increased 8% as a result of strong performance in Perceval, our new sutureless valve, particularly in the US. However, this was offset by declines from mechanical heart valves.

Turning to CRM, sales were $61 million during the quarter, an increase of 1.3% compared to the fourth quarter of 2015. In high voltage, we continue to see good interest in PLATINIUM in both the US and Europe. Sales were hampered in the fourth quarter of 2016 in Europe due to a delay in approval of our IS4 standard for our CRT-D devices, coupled with a challenging year-over-year comparison. If you recall, PLATINIUM was launched in the fourth quarter of 2015, and had a particularly strong initial adoption. Our IS4 standard has since been approved in Europe.

In low voltage, pacemakers grew in the fourth quarter in low double-digit range, driven by growth in KORA 250 in Japan. For the full year, sales in CRM were down 4.7%, primarily due to challenging year-over-year comparisons as a result of the transition from KORA 100 to KORA 250, and the delay in IS4 standard approval in Europe.

Now let's turn to neuromodulation. Sales were $91 million, down slightly versus fourth quarter of 2015. Growth in the US was offset by declines in Europe and the rest of the world.

While AspireSR continued to perform well, we had several unusual items in the US that contributed to lower sales growth than the rest of the year. First, as previously discussed, there was an anticipated decline in selling days in 2016 versus 2015; second, our sales cycle changed from a fiscal to a calendar year; and third, the fourth quarter of 2015 was impacted by an initial launch and conversion of AspireSR. In aggregate, we believe these items negatively impacted the fourth quarter, and our underlying growth would have been more in the mid-single-digit range, a range we feel is more indicative of future growth. Innovation then becomes the accelerator to improve growth beyond that range.

In Europe and the rest of the world, sales were down primarily as a result of in-channel inventory management. As I mentioned in my opening remarks, we are making progress in working with our distributors to optimize inventory levels and improve sales predictability. For the full year, sales in neuromodulation were up 8.8%, primarily due to strong adoption and growth of AspireSR. Average new patient growth over the course of 2016 was approximately 7%, which reflects the strong interest and demand for the device. I will now turn the call over to Vivid for an overview of our financial results. Vivid?

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Vivid Sehgal, LivaNova PLC - CFO [4]

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Thank you, Damien. Adjusted gross margin as a percentage of net sales in the quarter was 64.4%, up 250 basis points from the fourth quarter of 2015, due to a positive mix impact from sales of higher-margin products, a favorable country mix, and hitting our synergy targets. For the full year, gross margin was 64.6%, up 150 basis points from full-year 2015, driven by favorable mix, on-target synergy delivery, and the suspension of the US medical device tax.

Adjusted R&D expense in the fourth quarter was $28 million. R&D as a percentage of net sales was 9%, compared to 11% for the fourth-quarter 2015 as a result of our focus on restructuring and synergy delivery, which has allowed us to reallocate investments to current and future growth drivers. For the full year, R&D as a percentage of net sales was 10%, in line with our 2016 guidance.

Adjusted SG&A expense for the fourth quarter was $115 million. In Q4, we booked material bad debt reserves in light of credit risk associated with certain partners. SG&A as a percentage of net sales was 37%, up 20 basis points from the fourth quarter of 2015.

Adjusted operating income was $57 million compared to $45 million in the fourth quarter of last year, an improvement of 28% (corrected by company after the call), which demonstrates our commitment to leveraging the income statement. Operating margin was 18%, a major improvement compared to 14% in the fourth quarter of last year.

Our adjusted effective tax rate in the quarter was 21%, an improvement from 25.5% in the third quarter, as a result of ongoing tax efforts. For the full year, our effective tax rate was 25%, in line with our projected range, and representing a more normalized view going forward.

Finally, adjusted diluted EPS for the fourth quarter of 2016 was $0.85. For the full year, diluted EPS was $3.05, at the top end of our guidance range.

Turning now to cash flow, our adjusted cash flow from operations for the 12 month ended December 31 was $90 million. Cash flow from operations excluding integration and restructuring was $143 million. Capital spending for the full-year 2016 was $37 million, down slightly from 2015 of $40 million.

Our cash balance at December 31, 2016, was $40 million, down from $64 million at September 30, and down from $113 million at December 31, 2015, reflecting planned debt reduction, costs associated with restructuring and integration activities, funding our equity investments, and our 2016 $50 million share repurchase program. Our net debt as at December 31, 2016, was $75 million, relatively flat versus December 31, 2015.

Before I move to guidance, I want to briefly discuss our merger-related synergies. We stated that our goal this year was $19 million. We were able to meet our annual commitment in 2016, and are well positioned to achieve our long-term targets.

Moving to 2017 guidance, we expect net sales to grow in 2017 between 1% and 3% on a constant-currency basis. While the impact of foreign currency exchange is subject to change, if current exchange rates remain similar for the remainder of the year, the Company's full-year revenue guidance is affected in the range of negative 1% to 0%. Adjusted gross margin in 2017 is projected to be in the mid-60% range. In 2017, we expected adjusted R&D to be in the range of 9% to 11% of sales, and adjusted SG&A to be in the range of 35% to 36%.

As a result of these factors, we are projecting 2017 adjusted operating income in the high teens. Our adjusted effective tax rate for 2017 is expected to be in the range of 24% to 25%. We are projecting adjusted diluted earnings per share to be in the range of $3.25 to $3.45, with our share count to be approximately 49 million.

In terms of EPS calendarization, we expect earnings in the second half of the year to be more than 20% greater than that of the first half of the year, primarily due to momentum in emerging markets over the course of the year and the launch of SenTiva in the second half of 2017. In addition, as a reminder, the first quarter is historically our softest earnings quarter.

Our adjusted cash flow from operations for 2017, excluding integration restructuring and 3T remediation payments, is projected to be in the range of $190 million to $210 million. The integration restructuring and 3T remediation payments are expected to be in the range of $55 million to $60 million. Capital spending is projected to range between $40 million and $50 million, and depreciation and amortization is expected to be in the mid-$30 million range.

The key assumptions in our 2017 guidance are: In neuromodulation, we are planning to launch our next-generation VNS therapy device in the second half of the year. This new innovative device, which we will call SenTiva, combines the small size of our [demi] pulse with the advanced technology of our AspireSR. We believe this will be a significant addition to our existing neuromodulation portfolio. In cardiac surgery, we assume the Perceval will continue to drive strong growth, both in the US and Europe, and that tissue valve growth will offset continued softness in mechanical valves. In CRM, we anticipate that KORA 250 will continue to gain share in Japan, and that we will see the benefit of the launch of our IS4 standard in Europe.

With our 3T Heater-Cooler devices, we assume that we are successful in implementing our design solutions starting in the second quarter in Europe, and progressively expand implementation to other countries as we receive regulatory approval. We also assume that sales in Europe and the rest of the world will be impacted, as manufacturing capacity is switched to loaner machines. As a result, we expect continued sales deterioration in all markets, resulting in global sales for 3T Heater-Cooler devices in 2017 to be well under 1% of total sales. With that, I'll turn the call back to Damien for some final comments.

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Damien McDonald, LivaNova PLC - CEO [5]

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Thanks, Vivid. In summary, 2016 has been more challenging and had more moving pieces than we originally expected. However, it was a year of firsts for LivaNova. It was our first year as a public company, our first year to bring together a dedicated and talented workforce of over 4,500 employees, our first year to build and create the solid foundation that will drive our long-term growth, and our first year of significant accomplishments and progress.

We made great strides in new product launches, executed on our synergies, implemented restructuring efforts to improve profitability, remained disciplined with our expenses, reprioritized our investments to focus on our highest growth drivers, eliminated duplication in our R&D portfolio, and optimized levels of inventory in our channel, all while enhancing our distributor relationships in many of our emerging markets. In addition, we have a solid remediation plan in place for the 3T Heater-Cooler devices.

This list of accomplishments is a promising start. However, as we close out 2016 and begin 2017, we know we have a lot of work to do, and we are in no way satisfied. The Management team is committed to building this Business, investing behind our growth drivers, funding our equity investments, and leveraging our strong balance sheet. We are encouraged by our first year, and are focused and committed to our goal of delivering sustainable growth and delivering long-term shareholder value. And with that, Charlotte, we are open for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Jason Mills from Canaccord Genuity.

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Jason Mills, Canaccord Genuity - Analyst [2]

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Great. Thanks for taking the question. Can you hear me okay, Damien?

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Damien McDonald, LivaNova PLC - CEO [3]

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Yes, Jason. Cheers. Got you.

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Jason Mills, Canaccord Genuity - Analyst [4]

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Cheers to you as well. I wanted to start with your pipeline. You mentioned it briefly but didn't go into great detail with respect to your R&D pipeline. I know it's been an area that investors have focused on with me and you've had a full pipeline for quite some time, but you also talked about last quarter prioritizing that pipeline and perhaps focusing on a few areas. Could you give us a bit of color there and anything that might come out of that pipeline, besides SenTiva of course, which I have a question on later, but anything else in the next couple of years?

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Damien McDonald, LivaNova PLC - CEO [5]

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I think two things. Yes, you picked on the thing that I think is most important this year for us which is SenTiva and other aspects of the neuromodulation that are coming to bear, the MRI portfolio, pediatric indication. Those things for me are really the pipeline starting to pay off.

A deeper dive on that is really I think the best place for that is going to be our investor day when we get to Q3. We're really bringing a lot of things together right now. I'm deep diving with the entire group on making sure we've got the right priorities across the whole portfolio. So I think the best place for us to really deep dive will be Q3.

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Jason Mills, Canaccord Genuity - Analyst [6]

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Okay. That's helpful. And just with respect to your guidance. Obviously, you go back to the time of the merger the expectations on the top line were a little bit higher than what the run rate has been. So perhaps it's impacting your expectations on the bottom line to some extent because your leverage, your synergies have come through at least on an adjusted basis in 2016. Nonetheless, your growth expectations on the bottom line are a little lower than obviously what they were originally.

So maybe talk us through the thought process there and sort of what you see as sort of your longer-term growth rate. One other thing just on that question is the tax rate. I think there was contemplation that perhaps tax planning may help you to reduce your tax rate a little bit more than you're guiding to on an adjusted basis this year. Perhaps that's part of it and you can speak to that.

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Damien McDonald, LivaNova PLC - CEO [7]

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I got the first part. Let's come back on the second part, but I think related to tax rate.

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Vivid Sehgal, LivaNova PLC - CFO [8]

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Yes. Sorry, the phone went -- Yes, let's talk about the sales first.

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Damien McDonald, LivaNova PLC - CEO [9]

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Jason, I think that's a pretty fair question, and over the last couple of months as I've been evaluating the Company and the portfolio and work with the management team, I've given pretty significant time to looking at our growth. And what Vivid and I really landed on was, it was prudent to develop a near-term plan that was something we could commit to and deliver.

We come from cultures, Vivid from Allergan, me from Danaher, a meet and beat culture, and as we laid out what the year looked like, we really believed coming in with the numbers that we've outlined today put something out there that we can commit to as a leadership team and I think that was important.

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Vivid Sehgal, LivaNova PLC - CFO [10]

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And I also think, Jason, I think your comments around the bottom line, with Damien, we've sat down as a management team and considered, as you said, credibility about making sure that we aim to hit our quarters, but I think what's really important is an acceleration of top-line growth. And I think what we've had to do importantly is to balance some competing priorities.

It's about obviously creating some bottom-line EPS improvement, but you will see that we are going to invest further in our key growth drivers right now, and we are also putting back a focus, as Damien said, in terms of R&D. So I think what we try to create here is a credible plan for 2017 that allows investment, that allows bottom-line growth, consolidates our balance sheet position, but ultimately, like I said, allows R&D growth which we will talk about during the investor day.

And we lost you a little bit. Did you ask a question about tax, Jason? Sorry, we missed that one.

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Jason Mills, Canaccord Genuity - Analyst [11]

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Yes, I apologize, I'm traveling. I'm on a cell phone. That may have contributed to it. The tax rate question was, again going back to your original commentary about some of the bolsters with respect to reducing your tax rate. You obviously have done that quite a bit this year, but I think there was an expectation that, that would continue, and the guidance this year doesn't reflect a significant leverage on the tax line, so that was that part of the question.

And then I'll just slip one more in and then get back in queue to let others in. On the top line, specifically in heart valves, maybe talk a little bit about Perceval juxtaposed to aortic valve surgical market that doesn't seem to be growing a significant amount, but maybe you can give us a bit of color as to what you're seeing on the tissue valve side relative to what's going on in TAVR and what your expectations are there for overall market growth? Clearly you expect to gain share. Maybe you can give us some color about line extensions on the Perceval valve, et cetera. Thanks for questions.

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Vivid Sehgal, LivaNova PLC - CFO [12]

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Okay. Just in terms of your question on tax. We've been extremely pleased with all the work that the team has done in relation to our tax rate. As you rightly mentioned, we've had some good leverage this year bringing tax rate down from approximately mid-30s range in 2015 to a mid-20s range, and that's driven a lot of shareholder value and given us a definite boost in terms of our future plans.

I think the guidance right now is a very, very sensible approach from us. I think the one thing in the current environment that we're facing, I think putting out tax numbers that are not achievable, and I have said on numerous occasions that we are trying to create a sustainable tax rate, I think is the right thing for us to do.

So this is a fluid situation at the moment and we know that this -- the world of tax is changing on a dramatic basis. So we feel very confident where we stand right now, and we will keep everyone updated, but I think our guidance today reflects where we think our tax rate will be.

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Damien McDonald, LivaNova PLC - CEO [13]

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Let's come back on the Perceval thing. It's a pretty long discussion but let me try and do it a little bit of justice while we're on the phone briefly with you. So, first of all, yes, TAVI is growing, but there's a huge unmet need in aortic valve replacement with traditional valves. And that market is still 65%-ish of all of the replacements done in the US, and we really believe we've got a tremendous growth trajectory there with Perceval.

We only recently launched it. We talked about launching it in phases and we're through our sort of Phase 1. I talked a little bit about reprioritizing our focus. I really have pushed the team to make sure we increase our investment in Perceval both in the US and Europe. We have a very solid program, and I also believe we have the best product. We have the only truly sutureless valve that has great application.

And honestly, I think this also opens up the chance for more minimally invasive surgery using an aortic valve replacement. I think there is tremendous growth in the US and Europe, and added to that, we are planning to launch in the back end of the year in Japan, so we really see tremendous opportunity from our cardiac portfolio in this respect.

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Jason Mills, Canaccord Genuity - Analyst [14]

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Thank you for taking the questions.

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Damien McDonald, LivaNova PLC - CEO [15]

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You're welcome, Jason. Travel safely.

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Operator [16]

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Scott Bardo from Berenberg.

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Scott Bardo, Berenberg Bank - Analyst [17]

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Thanks very much for taking my questions. The first question please, 100 days in, Damien, I wonder if you could share some thoughts on how you see the organizational setup of the business across the major divisions? Were there huge gaping holes leading to obvious underperformance with respect to selling and marketing practices, or were you pleasantly surprised? If you could share some thoughts there, please. Second question -- Sorry. Go ahead and I'll ask a follow up.

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Damien McDonald, LivaNova PLC - CEO [18]

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Sure. Scott, great question. Thanks for calling in today, too. A couple of things, and I think I mentioned this to you before, I was really pleasantly surprised as I looked across the organization, where we have really tremendous pockets of what good looks like. If it's in growth, I can see in the neuromodulation team or in the Perceval team an ability to drive high double-digit growth. What that tells me is we know we can do it.

I looked at R&D, particularly the neuromodulation team, their ability to execute on R&D is really phenomenal, so we know we can do it. And in ops, as I looked at the organization and toured the plants, I see the embers of really great lean manufacturing, so we know we can do it. The challenge for us is just templating and replicating this.

The background that I came from is very much about that and being very focused on prioritizing our resources and then executing. I see pockets of good, and we just need to be really good at replicating that across the organization.

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Scott Bardo, Berenberg Bank - Analyst [19]

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Thank you. And given the capital side of your business caught everyone by surprise, including I think LivaNova management, it would be useful I think just to give us a sense of how big is the capital side of LivaNova's business? And if you can give us some sense of how much heart lung machines declined in absolute dollars? And same for heater-coolers just so we can get a better sense for our modeling going forward, that would be very helpful, please.

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Vivid Sehgal, LivaNova PLC - CFO [20]

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Scott, it's Vivid here. In terms of our -- let me sort of try and give you a bridge to that question. I think what's important to understand is that if you take our cardiac surgery business, which is obviously our largest part of our business, which is in excess of 50% of our sales, that is sort of broken down into two parts. We have the cardiac surgery business, which is about three-quarters of the business, and the heart valve which is about a quarter, 25%, of the business.

Within that section in the cardiopulmonary, we have about two-thirds of the business is what we call the disposable business, largely driven by the oxygenator and the INSPIRE range that we have, that has been traditionally growing at 3% to 5% and we see that as a continuation of that momentum going out into 2017, which is the largest part of our cardiac surgery business.

And then we have the capital equipment side which represents about a third of the cardiopulmonary business. That has obviously had two areas of pressure in 2016, driven by the 3T Heater-Cooler. If you look at our heater-cooler sales compared to 2015, we are significantly down, but we also had some pressure in relation to our heart-lung machines in Europe.

So I think what you're going to see from us is the capital equipment represents about a third of our cardiopulmonary business, and two-thirds of it will continue to grow at a reasonable 3% to 5%. And we will see some continued declines and struggles within the capital side, largely driven by continued pressure on the 3T Heater-Cooler.

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Scott Bardo, Berenberg Bank - Analyst [21]

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Thanks for reminding us of the structure there, but you did not actually get to the discussion about how much that capital business has contracted. I think that is the sensitive issue here, so I wonder if you can give us a sense of how much that contracted in FY16? And also if you would follow on from that discussion as to what is embedded actually within your 1% to 3% growth forecast actually?

I think we are only 12 months or 18 months progressed from capital markets day, where you're looking to grow neuromodulation some 8% to 10%. If that still holds with your new product launch, it wouldn't imply too much for the rest of the legacy Sorin business, which perhaps would be a surprise given where you are with Perceval, INSPIRE, and your CRM products. I'd just like a bit more understanding of how you go about budgeting for the top line, please?

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Vivid Sehgal, LivaNova PLC - CFO [22]

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Okay. Maybe I just touch upon the heater-cooler side, Scott, and we can obviously follow up after the call as well. Right now, look, the numbers that I'm providing at the moment is the numbers that we have given as public disclosures in the past, so let me try and give you a bit more color. So that said, the heater-cooler, which represents the capital side of our business right now, we've seen a significant decline in cardiopulmonary.

For example, in the US, and we did talk about up to 1% of sales being the number in 2016, but as a whole sales of heater-coolers were down almost 70% in the US on a year-on-year basis. On a worldwide basis, sales were almost half of what they were in 2015, so we have been impacted by this, and as we've just said as well, we expect to see only minimal sales that will occur in 2017. So the capital equipment business has seen declines in 2016 and relatively significant ones, and we continue to see pressure in 2017. Let me had over to Damien on the sales.

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Damien McDonald, LivaNova PLC - CEO [23]

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I think so broadly, as I mentioned that we've had a few more challenges in the year than I think we anticipated, and that's why Vivid and I really decided to give the guidance that we did and provide targets both internally and externally that we believe we can meet and beat. That is an important thing for us. As we looked at the entire portfolio, we really tried to prioritize our options and investments and where we're going to focus the organization.

Back to cardiac surgery where Vivid was, we really do believe that we've got continued growth in the consumables, which is two-thirds of that business, and it's a tremendous opportunity for us. We have market share gains, we have tremendous relationships with our heart-lung machines, and knowledge of accounts. So our heart-lung machine share is much higher than our oxygenator share, and we believe that, that is an important part of driving growth in the consumables part of it.

Vivid talked about capital. I think in heart valves we saw growth, actually tremendous growth in Perceval, north of 50% across the geographies last year, and we continue to believe we have got tremendous upside in Perceval as we expand our footprint there. And there's a lot of opportunity, as I mentioned in an earlier question, to continue our penetration of the aortic valve replacement.

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Vivid Sehgal, LivaNova PLC - CFO [24]

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I think what's important to understand is that our guidance I think reflects the reality of our 2016 performance, and I think that's what we need to do right now. I think it's important to understand that while sales were absolutely not where we would want them to be, we did hit every other line in the operating leverage side, and our net debt was in the position that we expect it to be. So we exited the year in a good shape in terms of the bottom line and in good shape in terms of the balance sheet.

I think one thing we're not going to try and do this year, or we're going to have to reflect on, is to make sure, again, is that we put out numbers that we feel we can hit and numbers that doesn't mean that we have to end up doing what we did last year, and that is certainly not something we are planning for this year out.

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Scott Bardo, Berenberg Bank - Analyst [25]

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Fully understand. Obviously you appreciate what I'm trying to determine is what is the degree of conservatism and have the underlying drivers of the business materially changed in the last 12 months? So, Damien, have you -- and I appreciate you're going to give us some sort of mid-term guidance in the Q3.

But do you feel at this point any necessity to walk away from a view that Perceval could be [$80 million, $100 million] product, that neuromodulation has high single-digit growth, that the CRM business generally speaking should have some modest growth? I just wonder if you could help us get some feeling actually as to whether the underlying drivers of the business have any real change since last update? And that's the last question.

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Damien McDonald, LivaNova PLC - CEO [26]

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Yes. So, look, I will come back to where Vivid was. Clearly, 2016 was different than what everyone anticipated. So in as much value coming off the direction previously, look at the reality of 2016. Having said that, we really do believe that we've got tremendous opportunity in cardiac with [oxys], so there is a consumable play there that has a great recurring revenue stream. In CRM, we've got the KORA 250 expansion continued PLATINIUM and IS4, so I think they are important drivers for CRM.

In neuromodulation, we are continuing to believe that new patient acquisition is around about that 7% range. We've still got the end of service and price driver that we previously outlined. And as we talked about, we have SenTiva, MRI, pediatric, and I've also asked the team to really explore additional resources in Europe for depression. And we see tremendous opportunity for depression treatment in Germany in particular, which in and of itself is interesting, but is also a pilot for us about expanding the TRD indication more broadly as we work through the regulatory opportunity.

So that's a longer answer than you probably wanted but it really gets to the point that we believe there's a lot of growth drivers that will give us the opportunity to hit our guidance.

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Scott Bardo, Berenberg Bank - Analyst [27]

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Very good. Perhaps a cheeky last one if I may. Obviously you've been investing a lot into new venture programs, and this has certainly been [admitted] to in the past as being a potential accelerator into higher growth for the organization. Can you give us an update actually as to where we are with mitral and whether you envision this being any sort of contributor to your mid-term growth? Thank you.

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Damien McDonald, LivaNova PLC - CEO [28]

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I'm really excited about a number of our investments there, equity investments is the word I was looking for. Mitral is an exciting space. There's a lot of hype, which is always interesting, but I think there's a lot of reality to the unmet need of patients in this space, and we are excited about our equity investments in Caisson and HighLife.

If you look at obstructive sleep apnea, I personally really love that market, I think it's a huge unmet need. If you've ever seen a CPAP patient and what they have to go through, we think there's tremendous patient unmet need there, and we're excited about our equity investment in ImThera.

Heart failure continues to be something that we have to monitor. Clearly the trials that occurred last year had a reset in terms of the entire market, but again, there's a huge unmet need in heart failure therapy, and we're very happy with what the team is working on in that respect. So I remain really bullish about our equity investments and more to come.

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Vivid Sehgal, LivaNova PLC - CFO [29]

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And I think again from a balance sheet and a cash perspective, Scott, it's important to understand all of our internal workings, and going forward, we are committed to fully funding, as Damien said, our equity investments, and that's reflected in our financial numbers for 2017.

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Scott Bardo, Berenberg Bank - Analyst [30]

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Thanks very much, guys.

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Damien McDonald, LivaNova PLC - CEO [31]

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Great to have you on, Scott. Cheers. Thanks.

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Operator [32]

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Brooks West from Piper Jaffray.

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Brooks West, Piper Jaffray & Co. - Analyst [33]

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Thanks. Can you hear me?

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Damien McDonald, LivaNova PLC - CEO [34]

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Yes, Brooks. Good to have you.

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Brooks West, Piper Jaffray & Co. - Analyst [35]

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Thanks, Damien. Good to speak to you again. I wanted to follow up on the VNS business if I could. The weakness in Q4 I think explainable, but just want to understand if there's any other competition, headwinds, be it from other devices or some of the new pharmaceutical agents? Any more detail there would be helpful.

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Damien McDonald, LivaNova PLC - CEO [36]

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Yes. Look, I think VNS is really interesting. There is a huge patient pool that is identified and is an opportunity for VNS therapy, and moving patients through that adoption pathway just takes time. We believe we have developed a real competency in that, in helping patients understand the pathway and working with the clinics to move patients through, and that's why we continue to believe our patient adoption rate is north of 7%.

Having said that, every new drug that comes along causes people to step back and reevaluate a drug. We've talked before that, that could cause a delay in four to six months in the decision of putting someone on to VNS. We continue to believe that there is a large patient pool identified, and our opportunity, frankly, is to crack the code on how to move patients through that faster.

But we remain very confident about VNS, and as I said, I think -- you see the R&D investments paying off, not only with SenTiva but the full body MRI we are anticipating; pediatric application, an approval which we are anticipating. And back to one of the earlier questions about what does the reorganization do, we think having a group of people focused on a geography, as we do now in the new organizational structure, gives us more focus on Europe, and going after neuromodulation in Europe, both in epilepsy and TRD, we think is a real opportunity.

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Brooks West, Piper Jaffray & Co. - Analyst [37]

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Thanks. Continuing on that thought. Cyberonics had traditionally been able to take kind of 10% price on new product introductions. Is it your sense that you're going to be able to get some price above and beyond the typical annual price increases on SenTiva? And then can you give us some sense of timing on the MRI and pediatric label indications? And I have one follow up. Thanks.

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Vivid Sehgal, LivaNova PLC - CFO [38]

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Brooks, let me touch on the pricing first of all. As you are aware, AspireSR was effectively a real paradigm shift in the whole area of drug-resistant epilepsy. We certainly believe that innovation does create opportunity for pricing, and obviously that is something with SenTiva that we are seeing is certainly available to us.

So, I don't think we can talk about the same level of pricing increases that we saw with AspireSR, which we talked in sort of the 8% to 10% range, but absolutely we do see opportunities of a slightly slower level in relation to pricing when SenTiva comes out. Again, innovation demands a premium and that's what we're going to see right now.

So, I think what you're going to see from us is the normal cadence of pricing. We're going to look for reasonable annual pricing improvements, plus an innovation premium for SenTiva, which we have baked into the 2017 guidance.

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Damien McDonald, LivaNova PLC - CEO [39]

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On timelines there, the other thing you asked. MRI, we're hoping for mid-year, and peds towards the end of the year. But we are actually very excited about that because in the US, for example, 40% of patients are children, and we know that earlier intervention has a better outcome with VNS, and so we are particularly excited about that.

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Brooks West, Piper Jaffray & Co. - Analyst [40]

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Okay. And then I guess just last for me. Vivid, you said $40 million in cash. Are you confident that you have the right amount of cash to fund the venture opportunities and also run the business? Obviously you're generating cash, but is there anything you can say about your comfort with the level of cash you are carrying on the balance sheet right now?

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Vivid Sehgal, LivaNova PLC - CFO [41]

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I think, Brooks, cash is obviously a big focus for us. I look more let's say at net debt because I want to ensure that as a company we have got our level of debt right, and we will be proactive at looking at both our cash balances and our net debt balances at the same time. I think what's important for us is that we have delivered a net debt and cash balance, which was in line with our expectations despite some of the obvious softness that we had in our numbers, and I think we've managed our position on the balance sheet extremely well for 2016.

In terms of going forward into 2017, yes, I think right now, again we've -- I'm pleased with the level of cash and debt strength that we have. I believe right now that we have enough in our tank to be able to both keep our capital allocation strategies and options fully open, as we discussed previously, and that will include, like I said, organic internal growth, it could include further share buyback programs, it can include equity investment and M&A.

So, I think we are in good shape. And as I said before, I think we have the capacity right now to go out, if we require, into the markets, and basically I did talk about leverage potential, and in my opinion nothing has changed on that.

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Damien McDonald, LivaNova PLC - CEO [42]

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Brooks, this is one of the things that Vivid and his team have really put us in a great position throughout this first year. Bringing a lot of discipline to the whole P&L and balance sheet has been I think one of the strengths of our first year, and I think that sets us up really well for doing all sorts of organic investment, but frankly, great inorganic opportunities that are out there.

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Brooks West, Piper Jaffray & Co. - Analyst [43]

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That's helpful. Thanks, guys.

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Operator [44]

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Michele Baldelli from Exane.

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Michele Baldelli, Exane BNP Paribas - Analyst [45]

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Hello, everybody. I have two questions, two relate to the products. The MRI compatibility will be adopted on the new epilepsy device? The second question relates to these product [steel]. International option was a way to get also the synergies from the merger, but it seems that the sales in Europe of the epilepsy devices are still weak. Can you elaborate on what your strategy about this, please?

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Damien McDonald, LivaNova PLC - CEO [46]

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Hi, Michele, how are you? Great question. So, on MRI, yes, it's a full-body MRI compatibility, and that is, as I said, more mid-year. On the international expansion, I'll come back to our dissatisfaction with year one and things that we hoped would have gone better but didn't.

I continue to believe that Europe is a great opportunity for VNS. We perhaps didn't execute the way that we had hoped, and I think doubling down there is a really important opportunity for us, both on epilepsy, but as I mentioned in terms of treatment-resistance depression, and in particular in Germany, where the market conditions are very favorable for that.

Additionally, we made some changes in our market structure, where in Canada and Australia we went direct, and I think that will also give us some opportunities in terms of OUS growth. So you called it, it's not like we had anticipated, but I'm not in any way backing off the global expansion. I think that's one of our great opportunities.

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Michele Baldelli, Exane BNP Paribas - Analyst [47]

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Okay, so let's say the strategy is for launch of new products or enforcing sales force or just to get a better feeling of what is the strategy on these?

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Damien McDonald, LivaNova PLC - CEO [48]

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The answer is yes, and I'm not being glib. I really do believe. The first thing is you're seeing our R&D investments pay off. New products, new indications and that's a very key part of our growth, but related to that, sales force execution.

Again, those of you that I've spoken to know that I'm a big proponent of discipline and a very disciplined approach to process and driving behaviors, and I think one of the key opportunities for us is in sales force effectiveness. And I'm really excited about the way the team has approached those ideas, and our investments in this area are going to pay off over the short and the medium term.

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Vivid Sehgal, LivaNova PLC - CFO [49]

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Michele, I would just add if you look at our income statement for 2016 versus 2015, we have made some really important choices in terms of investment that hopefully will drive growth in 2017. If you look at our total operating expenses, for example, we have improved our operating expenses, we reduced operating expenses in excess of $20 million from 2016 versus 2015.

But in that sort of in terms of the ability to bring those expenses down, we have certainly not backed off in terms of selected investments. And I think as Damien said in terms of driving future growth, we have put more into R&D, we have put more and started to put more in terms of sales force execution. So I think we've done a decent job at balancing operating leverage while continuing to actually put investments into future growth drivers.

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Damien McDonald, LivaNova PLC - CEO [50]

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And these are not plans. These are actions that have already been put in place in some instances. In Europe, we've already moved resources from one portfolio and in very specific geographies into the neuromodulation space.

We've already increased our funding in Europe for the TRD indication and have moved resources specifically into that and hired new external resources. I don't want you to just think we're talking about this in the oxygen tent of the London boardroom. We've made the decisions with the executives and already acting on that, Michele.

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Michele Baldelli, Exane BNP Paribas - Analyst [51]

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Okay. Thank you very much. And lastly a few quick questions on 2017, like what is the R&D expansion sales that you foresee stable compared to 2016? And then an update on the synergy targets for 2017 and the losses on the equity investments that you expect this year.

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Damien McDonald, LivaNova PLC - CEO [52]

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Sorry, Michele, your phone line went a little strange. The question, I believe, was on R&D about whether we were increasing R&D spend in 2017, was that the first part of your question?

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Michele Baldelli, Exane BNP Paribas - Analyst [53]

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Yes, compared to the sales, as a percentage of sales.

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Damien McDonald, LivaNova PLC - CEO [54]

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At the moment that's exactly right. I think we have given a range and the bottom end of our range for 2017 is more in line with our 2016 number. I think what that's really going to try and show is that in 2016, if you think about it from an R&D perspective, we continue to focus on selective R&D areas.

We actually increase spend, for example, in neuromodulation, while we also took the opportunity to restructure part of our business as well, largely in the CRM side. We also had a number of launches that came out during 2016 as well. We've never taken our eye off the R&D pipeline, but right now, we will let's say go back to normalized R&D spending and start spending more in line with what we expect to be in the future as well.

And the other thing is we talked about it earlier, we have incredible equity investments, and I think you have got to look at that as also part of our pipeline. We took some I think really great strategic bets, and we expect some of those to pay off, and that's an important part of our R&D strategy.

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Vivid Sehgal, LivaNova PLC - CFO [55]

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Yes, and just in terms of the equity investments, these equity investments that we have are going through some pretty important stages. We did talk in the past around, for example, our mitral assets and the investments we have about going through clinical phases right now.

And so our 2017 guidance, for example on the minority interest line, does reflect our commitment in relation to support the funding of an important transition phase across the portfolio on equity investments, and we are certainly making sure that we're finding those appropriately.

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Michele Baldelli, Exane BNP Paribas - Analyst [56]

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Okay. So let's say should be higher than last year excluding the impairment done on the (inaudible).

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Damien McDonald, LivaNova PLC - CEO [57]

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I think if you look at it overall, we're going to invest as we see fit. I think we're going through an important part, so certainly everything you're seeing in our numbers right now will show us fully in, in terms of our investment profile.

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Karen King, LivaNova PLC - VP of IR and Communications [58]

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We're going to wrap up the call. We're past the top of the hour, but we thank everybody today for being on the call and we hope you have a wonderful day.

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Damien McDonald, LivaNova PLC - CEO [59]

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Thanks very much, everyone.

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Operator [60]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone, have a great day.