Edwards Lifesciences Management Discusses Q3 2013 Results - Earnings Call Transcript

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Edwards Lifesciences (NYSE:EW)

Q3 2013 Earnings Call

October 28, 2013 10:00 am ET

Executives

David Erickson

Michael A. Mussallem - Chairman and Chief Executive Officer

Thomas M. Abate - Chief Financial Officer, Principal Accounting Officer and Corporate Vice President

Analysts

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

Amit Bhalla - Citigroup Inc, Research Division

Jason R. Mills - Canaccord Genuity, Research Division

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

David H. Roman - Goldman Sachs Group Inc., Research Division

Misha Dinerman

Bruce M. Nudell - Crédit Suisse AG, Research Division

Danielle Antalffy - Leerink Swann LLC, Research Division

David R. Lewis - Morgan Stanley, Research Division

Kristen M. Stewart - Deutsche Bank AG, Research Division

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

Robert A. Hopkins - BofA Merrill Lynch, Research Division

Matthew Taylor - Barclays Capital, Research Division

Suraj Kalia - Northland Capital Markets, Research Division

Frederick A. Wise - Stifel, Nicolaus & Co., Inc., Research Division

Operator

Greetings, and welcome to the Edwards Lifesciences Corporation Third Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, David Erickson, Vice President, Investor Relations. Thank you. Mr. Erickson, you may begin.

David Erickson

Welcome, and thank you for joining us today. Earlier this morning, we issued a press release with our third quarter 2013 financial results. On today's call, we will discuss those results and follow our prepared remarks -- and following our prepared remarks, we'll open up for questions. Our presenters today are Mike Mussallem, Chairman and CEO; and Tom Abate, CFO.

Before I turn the call over to Mike, I'd like to remind you that during today's call, we will be making forward-looking statements that are based on estimates, assumptions and projections. These statements include, but aren't limited to, our expectations regarding sales and sales growth, gross profit margin, earnings per share, SG&A, R&D, taxes, free cash flow, diluted shares outstanding, interest expense and foreign currency impacts. These statements also include our current expectations for the timing, status and expected outcomes of our clinical milestones and trials, regulatory approvals, regulatory compliance and reimbursement, as well as expectations regarding market growth and opportunities, the U.S. and Japan launches of SAPIEN products and associated economics, new product introductions, impacts of competition and the timing and impact of patent litigation. These statements speak only as of the date on which they are made, and we do not undertake any obligation to update them after today. Although we believe them to be reasonable, these statements involve risks and uncertainties that could cause actual results or experiences to differ materially from the forward-looking statements.

Information concerning factors that could cause these differences may be found in our press release, our annual report on Form 10-K for the year ended December 31, 2012, and our other SEC filings, which are available on our website at edwards.com.

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

Now I'll turn the call over to Mike Mussallem. Mike?

Michael A. Mussallem

Thank you, David. This quarter, we're pleased to report strong sales growth driven by transcatheter and surgical heart valves, as well as solid bottom line results. A number of important transcatheter valve developments were among this quarter's highlights, including the approval to begin the U.S. clinical study of our most advanced valve, SAPIEN 3, expanded approval to include alternate delivery approaches for SAPIEN in the U.S., a favorable patent infringement ruling in Germany and the receipt of reimbursement in Japan. This approval means Edwards is the first to offer this novel technology to patients in Japan, which brings our lifesaving therapy to over 60 countries.

Now turning to the quarterly results. Reported sales grew 11% to $496 million. Sales growth, excluding the impact of foreign exchange, was 13%, driven by transcatheter and surgical heart valves, with a strong contribution from Europe. In transcatheter heart valves, third quarter sales grew 39% to $172 million, driven by the ongoing U.S. SAPIEN launch and strong growth in Europe. In the U.S., THV sales for the quarter grew 56% to $86 million, which included $12 million of clinical sales, but was reduced by $2 million of net stocking.

As we previously projected, activities slowed sequentially due to seasonality, and the impact of consignment conversions exceeded stocking sales.

Clinical sales were driven by enrollment in our PARTNER IIa trial and the ongoing nested registries. We estimate commercial procedures grew 80% over last year. As a reminder, in third quarter last year, net stocking had a favorable $8 million impact to sales. At the end of September, 265 sites in the U.S. offered SAPIEN to their patients.

Overall, we continue to believe that TAVR economics and hospital capacity are not yet optimized at most sites, and there remains significant opportunity for improvement. Our U.S. team is strengthening its capability to educate sites on TAVR economics and share best demonstrated practices from some of the leading U.S. programs. Importantly, nearly 15,000 patients in the U.S. have been treated with our transcatheter heart valves over the past 2 years and clinicians continue to maintain very high procedural success rates.

In September, the FDA approved revised labeling for our SAPIEN valve to include alternate access points in addition to the transfemoral and transapical approaches. This change enables U.S. reimbursement for patients regardless of which implantation approach a physician uses.

Outside the U.S., THV sales grew 25% over last year or 20% excluding the impact of foreign exchange. Growth was driven primarily by transfemoral units. We estimate the favorable patent infringement ruling in Germany had negligible impact on sales in the quarter, as affected customers continue to work down inventory of the competitor's product. While more recent competitors had a small impact on this quarter's results, we expect it to be greater in the fourth quarter due to new product approvals.

Now updating our clinical and product development milestones. We're actively working with FDA and continue to expect a mid-2014 U.S. approval for SAPIEN XT with a NovaFlex delivery system and anticipate a rapid introduction will follow. We're proud to announce that we've completed enrollment in Cohort A, the surgical arm of the PARTNER II trial. This is the first randomized study -- first randomized trial to study transcatheter heart valves in moderate risk patients, which has the potential to significantly expand patient access to transcatheter valve technology.

In August, we received FDA approval to expand our PARTNER II clinical trial to include a 500-patient cohort to study 1-year outcomes of our SAPIEN 3 system in high-risk and inoperable patients. Recently, we started enrollment and are excited to bring our most advanced valve delivered through a 14-French eSheath and designed to reduce paravalvular leak to patients in the U.S.

In Europe, we remain on track to receive a CE Mark to launch our SAPIEN 3 valve by year end. We completed an initial clinical experience with our CENTERA valve and expect to begin another clinical series with an enhanced delivery system in the next several months.

During the quarter, we received reimbursement for SAPIEN XT in Japan, which became effective October 1. We've completed our first commercial cases. And since sites are required to undergo a rigorous certification process, we anticipate sales will ramp slowly. We believe transcatheter valve technology will be particularly attractive to Japanese patients, and the introduction of our SAPIEN XT valve in that market should contribute meaningfully to sales beginning next year.

And finally, we received approval in the quarter for SAPIEN in Australia and SAPIEN XT in Canada.

Treating mitral disease with transcatheter technology continues to be one of our primary development efforts, and we still believe a first in human experience with a transcatheter mitral valve is likely in 2013. We expect to provide an update at our December Investor Conference. We are continuing to invest broadly in structural heart disease solutions and have dedicated teams working on multiple therapies.

In our patent litigation with Medtronic, we had 2 significant recent developments: First, in Germany, the court found that Medtronic infringes our Spenser patent. The validity of this patent is still being contested. We posted the necessary bond, putting into effect the court's injunction and recall. Contrary to our interpretation of the court's decision, Medtronic has not instructed hospitals to return product. We've requested further enforcement action by the court, and we anticipate more clarity in the next few weeks.

Second, in our U.S. case involving the Andersen patent, the U.S. Supreme Court has denied Medtronic's request for further review of the case. Edwards' request for a permanent injunction and additional damages are pending before the Delaware trial court, and no timing for these decisions has been established.

In summary, we continue to expect global transcatheter heart valve underlying sales growth of 25% to 30% and are tightening our 2013 sales guidance range to $700 million to $730 million. Included in our assumptions are U.S. sales at the low end of our previous guidance range of $350 million to $400 million and stronger o U.S. performance. In the fourth quarter, we expect minimal impact from the German injunction and the Japan launch.

Now turning to Surgical Heart Valve Therapy group. Reported sales increased 3% over last year to $192 million. Excluding the impact of foreign exchange, sales grew 6% compared to the prior year, driven by unit growth. This quarter's growth was led primarily by strong performance in the U.S. and Europe and tempered somewhat by a competitor's launch in Japan. INTUITY contributed approximately 2% to total sales growth.

Globally, our pricing remains steady. ASPs were stable in the U.S. and higher in Europe, due to INTUITY, but offset by geographic mix. In the U.S., sales grew 6.7%. We estimate that we regained share in the quarter and that the market grew in low single digits. We also believe we are beginning to benefit from our recently published long-term durability data.

In Europe, we're making good progress on our key INTUITY milestones. We continue to expect a CE Mark in the near future for INTUITY Elite, our next-generation platform, which has been well received by clinicians for its lower profile. In the U.S., enrollment in our TRANSFORM Trial remains on track, and we now have upgraded all sites to INTUITY Elite. Also in the U.S., we continue to enroll patients in our COMMENCE IDE trial, studying the GLX tissue on our aortic and mitral Magna Ease platforms.

Based on current trends, we are raising the bottom end of our sales growth range in Surgical Heart Valve therapy and now project 3% to 5% underlying growth in 2013.

Turning to the Critical Care product group, total sales of $132 million for the quarter declined 5% over last year. The primary driver of the decline was a foreign exchange impact in Japan. Excluding the impact of foreign exchange, sales increased 1%, as double-digit growth of FloTrac was nearly offset by the continued reduction of distributor inventories in China and the ongoing exit of our Access product line. The incorporation of our noninvasive monitoring technology into our EV1000 platform is continuing, and the integrated product remains on track to be introduced in 2014. This quarter, noninvasive products once again contribute modestly to sales.

We remain enthusiastic about the significant opportunity represented by our GlucoClear system and are encouraged by the progress on our 2013 goals. We completed enrollment in our ICU accuracy study in Europe and expect it to demonstrate compelling results in the hospital setting. We expect to receive further insight on the pathway toward U.S. approval in the fourth quarter.

Based on our year-to-date results, we now expect full year 2013 underlying sales growth for Critical Care product group to be at the bottom of our previously stated 2% to 4% range.

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

Thomas M. Abate

Thanks, Mike. Turning to the financials. This quarter, our strong sales performance in valves allowed us to achieve diluted EPS of $0.68, representing growth of 17% over the prior year. At the same time, we increased our R&D investments by 14%. During the quarter, we repurchased 3.1 million shares for $250 million and now project fully diluted shares outstanding to be between $111 million and $112 million at year end.

Just after the end of the quarter, we issued $600 million of 5-year notes at 2 7/8% and fully paid down the $532 million balance on our revolving credit facility.

For the quarter, our gross profit margin was 73.8% compared to 75.1% in the same period last year. The reduction was driven by higher manufacturing costs as we prepare for the SAPIEN XT launch in the U.S. and SAPIEN 3 launch in Europe, as well as the reduced benefit from foreign exchange of 40 basis points. These items were partially offset by a more profitable product mix of 180 basis points. Excluding special items for the fourth quarter of 2013, we expect our gross profit margin to remain at approximately 74%.

Third quarter SG&A expenses were 36.4% of sales or $180 million, an increase of 8% over the prior year. This increase was driven primarily by U.S. and Japan transcatheter valve launch-related expenses and U.S. Medical Device Tax, partially offset by lower incentive compensation and FX. As a percentage of sales, SG&A should decrease in the fourth quarter, and we continue to expect SG&A to be between 36% and 37% of sales for the full year.

We continue to aggressively invest in R&D, and spending in the quarter grew 14% to $84 million or 17% of sales. This increase was primarily the result of additional investments in multiple heart valve clinical studies. For the full year, we continue to expect R&D to be approximately 16% of sales.

Net interest expense for the quarter was $1 million. In the fourth quarter, we expect net interest expense will increase to approximately $4 million to $5 million as a result of the $600 million debt issuance earlier this month. We estimate our recent share repurchases will largely offset the EPS impact of the higher interest expense and, therefore, have a neutral effect on our fourth quarter EPS.

Our reported tax rate for the quarter was 23%, down from 25.9% in the prior year, due primarily to the absence of the federal R&D tax credit last year and favorable reserve adjustments this year. We continue to expect our full year tax rate, excluding special items, to be at the low end of our 23% to 24% range.

FX rates negatively impacted third quarter sales by $9 million compared to the prior year, driven by the weakening of the yen. Compared to our recent guidance, FX rates negatively impacted EPS by $0.01. At current FX rates, we now expect a $45 million negative impact to full year 2013 sales.

Free cash flow generated during the quarter was $110 million. We define this as cash flow from operating activities of $147 million, less capital spending of $37 million. For 2013, excluding special items, we continue to expect free cash flow to be between $270 million and $310 million.

Turning to our balance sheet. At the end of the quarter, we had cash, cash equivalents and short-term investments of $758 million. Total debt increased to $532 million as a result of our share repurchases during the quarter. Our DSO at the end of the quarter was 58 days and our inventory turns were 1.7, both consistent with the prior quarter.

Turning to our sales and earnings guidance. At current exchange rates, for the Surgical Heart Valve Therapy product group, we are raising the bottom end of our range now expect -- and now expect sales of $780 million to $810 million. In transcatheter heart valves, we have tightened the range to $700 million to $730 million, which reflects U.S. sales at the low end of our $350 million to $400 million range and stronger o U.S. performance. In the Critical Care product group, we now expect sales at the low end of our previous $530 million to $570 million range.

In summary, we are reiterating our full year guidance, with sales of $2 billion to $2.1 billion and earnings per diluted share excluding special items of $3 to $3.10. For the quarter -- for the fourth quarter of 2013, we project total sales of $520 million to $550 million; and diluted EPS, excluding special items, to be between $0.81 and $0.85.

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

Michael A. Mussallem

Thanks, Tom. We continue to project double-digit underlying sales growth in 2013 and believe that our many clinical and commercial accomplishments this year have strengthened our leadership. This positions us well for continued success, and we remain committed to developing innovative technologies in structural heart disease and critical care that provide clinicians with transformational therapies to treat their patients.

Before we open it up with the questions, I'd like to remind you about our 2013 Investor Conference on Monday, December 9, in New York, where we'll provide an update on our new technologies, as well as our outlook for 2014.

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

David Erickson

Thank you, Mike. If you haven't yet RSVP-ed for our December Investor Conference, you can do so on our website. And as a reminder to those of you who are here in San Francisco for the TCT conference this week, Edwards is hosting an informal breakfast meeting on Thursday morning at the Intercontinental Hotel. Please RSVP for the breakfast by contacting a member of our Investor Relations team.

[Operator Instructions] Operator, we're ready for questions, please.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Larry Biegelsen with Wells Fargo.

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

Mike, maybe if we could spend a minute on the Q4 guidance and how you're thinking about that. If I'm doing the math correctly, I think this quarter, TAVI sales were up 39%. The midpoint of the guidance for Q4 implies about 19%, 20%. The U.S. in particular implies a pretty significant deceleration in growth from what you reported this quarter. So maybe you can talk a little bit about that. And I know there was a lot of stocking in Q4 2012. So maybe if you can talk about just the commercial growth that's implied in kind of the -- in the U.S. guidance.

Michael A. Mussallem

Yes, thanks, Larry. Yes, the -- we actually -- we expect a good quarter in the fourth quarter, and I think there's enough guidance out there, with 3 quarters under our belt and you now have our full year expectation. You have a pretty good feel of what we think is going to happen. But yes, if you're just looking at growth rates on a reported basis, you have to take into account what you mentioned, which is the fact that we had a positive net stocking in the fourth quarter of last year that was pretty substantial. Remember, that was the quarter when the Cohort A was approved and transapical came into being. And so that was a boost for the quarter as much in stocking. As you see this quarter, actually, we had negative net stocking and we wouldn't be surprised if it would stay -- it certainly is not going to be the positive driver that it was in the fourth quarter of last year.

Lawrence Biegelsen - Wells Fargo Securities, LLC, Research Division

And then just one on mitral, obviously, encouraging commentary from you earlier that you still think the first-in-man is likely this year, only 2 months left in the year. Is there any additional color that you can give us, Mike, on what gives you the confidence that you'll be able to do a first-in-man in 2013? And I'll drop.

Michael A. Mussallem

Yes. Thanks, Larry. Yes, as you can imagine, it's quite a process for us to move forward with a first-in-man experience. And I think the good news that you should take away from our continued statement that it's likely this year is that we continue to make progress and to achieve milestones along that way. And we really don't have much more to share. Just wanted to let you know that we're going to provide an update at the Investor Conference in December. And so I'd say, really stay tuned for that.

Operator

Our next question comes from the line of Amit Bhalla with Citi.

Amit Bhalla - Citigroup Inc, Research Division

Mike, just on fourth quarter and Germany. Can you talk just a little bit about the impact there? You said you're not expecting much from Germany and you expect Medtronic to remove its products. How does that balance against the compassionate use that's still allowed and why is there not just greater contribution into the fourth quarter guidance from Germany?

Michael A. Mussallem

Yes, it's a good point. So just to keep in mind what's going on there, recall that in anticipation of the injunction that Medtronic provided some excess sales, it appears, to their accounts, and I think they acknowledged that. And so there's some inventory that still remains and we believe that, that was being worked off to some extent in the third quarter. There's a difference of opinion on the court's interpretation. We feel that the court expected customers to return product, Medtronic has not ask their customers to do that. And so we've gone back to court to provide clarity in that regard. And further, as you know, we proactively provided for compassionate cases and have a specific set of valves that we thought were appropriate that wouldn't be appropriately treated with an Edwards system. I think Medtronic may have a different interpretation or broader interpretation of that. We're also asking the court for clarity on that point.

Amit Bhalla - Citigroup Inc, Research Division

And, Mike, just a second question just on U.S. demand. Yesterday at the conference, under the discussion of the TVT Registry in which the speaker said the U.S. market is plateauing at about 250 sites and 800 U.S. procedures per month. Do you have a comment on the U.S. market saturating or plateauing?

Michael A. Mussallem

No, we don't believe that the U.S. market is plateauing. I think the TVT Registry has a substantial look back there. I'm not sure that you're able to really draw conclusions from the collection of that data. And our experience is that there's still a growing market in the U.S., and I think that the results this quarter that we believe that procedures versus third quarter a year ago grew approximately 80% is a pretty good indication that this is not a flat market.

Operator

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

Jason R. Mills - Canaccord Genuity, Research Division

With so much scrutiny on just one aspect of one division of your business, U.S. TAVI, wondering if you could comment about the U.S. business commercial and also including clinical. If -- correct me if I'm wrong, but you -- last year, I think you had somewhere in the mid-single digits from a clinical perspective in terms of contribution to U.S. TAVI. And this year, it was significantly bigger than that. In our research, some of your bigger clinical centers, in some cases, prefer to enroll patients than to implant with the a -- in commercial setting, given the different innovations, the different products that they have access to. So how would you have us look at your U.S. business? I know you gave commercial sales growth, but should we include clinical in that, given the phenomenon of clinical centers, perhaps in some cases, preferring to enroll than to implant in commercial?

Michael A. Mussallem

Yes. Thanks, Jason. Yes, as you pointed out, there were significant clinical sales this quarter, larger than they've been in the past, particularly because there was pretty stout enrollment of the PARTNER II trial with SAPIEN XT. And if you just step back, I think a reasonable way to think about this is those cases that are being done clinically could very well have been done commercially. And I like to look at the total number of procedures that are happening and think that clinical volume should be sort of added to the commercial volume when you consider what is the demand that's in the marketplace. So I think that's a correct observation. We expect the clinical demand to stay pretty robust here in the future. And you have to remember that there's also competitive clinical demand as well. So I think that's worth taking into account when you think about just how big the market is or how fast it's growing.

Jason R. Mills - Canaccord Genuity, Research Division

That's helpful. And my follow-up would stay with U.S. TAVI. I know you're not ready at this point to give your 2014 expectations. But perhaps you could give us a sense for how you're building that up and what variables you see as the biggest drivers to growth in your U.S. business next year in terms of how you're building up the number of synergy think [ph] will contribute to that number. And then utilization rates just juxtaposed to your experience in Europe in your 3 there versus what you may expect here in terms of utilization, how that might trend next year.

Michael A. Mussallem

Sure. Well, I think one of the things that we indicated is over time, the impact of stocking and consignment will diminish. And so we think that'll be a less pronounced effect in 2014 than it is in 2013. You're right, we're not going to give specific guidance about 2014. But the high procedural success rate gives us confidence that we've got a very robust and growing procedure base, and that will continue. And one of the biggest headwinds, I think, to growth so far has been some of the economic concerns, and those just continue to improve over time. We still have a young procedure. And that is, we believe, getting considerably better on a consistent basis. And so we think that's really what will provide the underlying lift for continued growth next year. And as you point out, in Europe, here we are -- this is the sixth year after introduction, and Europe just had a growth quarter of about 20%. So pretty remarkable. I know it's maybe the comparison last year was at the depth of some problems in Europe. But nonetheless, it's pretty encouraging to see how that's going.

Operator

Our next question comes from the line of Mike Weinstein with JPMorgan.

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

Just 2 quick clarifications first. So one, I wasn't sure what the fourth quarter full year U.S. TAVI guidance is now if that had changed. And second, Mike, will we not hear anything on mitral side until the Analyst Meeting? If you could clarify that.

Michael A. Mussallem

Yes. So yes, on the mitral question, I don't think you should anticipate that you're going to hear things from us until the investor conference. We don't have any plans to report anything at this point. And then, in particular, you're asking about what the guidance is for the remainder of the year?

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

Yes, in the U.S -- I know you had the $350 million to $400 million range. But did you change that today?

Michael A. Mussallem

We -- what we said is that you should...

Thomas M. Abate

At the low end.

Michael A. Mussallem

Expect it to be at the low end of that range. Correct. We kept the overall global range the same because of the stronger o U.S. performance.

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

Got you. And then just one question. I don't know if you caught Datreek's [ph] comments yesterday on the TVT Registry. I felt like he let a little something slip out of the bag ahead of the publication. But he said that 25% of the implants to date, and this is in the first 50 to 700 cases, had STS scores below 5. Is that possible? That just didn't seem right to me, but I was hoping you would know the data better than we would.

Michael A. Mussallem

Yes, I don't know about that, Mike, we understand that they are struggling to enroll that trial. And I think that probably as a result, that there's a...

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

No, I'm not talking about SURTAVI. Mike, I'm not talking about SURTAVI. I'm talking about the TVT Registry.

Michael A. Mussallem

Oh, the Registry, oh the TVT. Are you talking about the U.S. or European data?

Michael N. Weinstein - JP Morgan Chase & Co, Research Division

No, no. U.S. TVT Registry.

Michael A. Mussallem

Yes, that doesn't sound likely to us. We're not sure that STS captures all the factors. Sometimes what confounds that is the frailty or porcelain aorta. So maybe that's confounding the statistics. But broadly, we think people are pretty disciplined about the way that they utilize the valves.

Operator

Our next question comes from the line of David Roman with Goldman Sachs.

David H. Roman - Goldman Sachs Group Inc., Research Division

I wanted to come back to the surgical valve business, which you kind of glossed over a little bit in your prepared remarks though you did see somewhat of a turn in that business. So I'm hoping you could walk us through in a little bit more detail what's happening with that franchise. To what extent, if any, are centers seeing a pull-through effect from having TAVI programs in the U.S.? And then how shall we think about the surgical valve business going forward from a cannibalization standpoint?

Michael A. Mussallem

Yes. Thanks very much. The -- we're -- we still believe that there will be a halo, although we just haven't seen substantial impact on our results so far. The growth this quarter was unit growth. And so we believe that the market was probably growing in low single digits, and that we also had share increase, I think, as we're regaining share in the U.S. is part of that. We saw growth both in THV accounts and non-THV accounts this quarter. So both sort of lifted. So we're pretty optimistic about our surgical heart valve franchise in terms of where it is right now. Does that answer your question?

David H. Roman - Goldman Sachs Group Inc., Research Division

Yes. Now -- and then I guess your -- the corollary question to that would be if you're not seeing much of a halo effect or pull-through effect, why wouldn't this business see increased pressure over time as the sort of PARTNER A group starts to pick up as a percentage of total units?

Michael A. Mussallem

Yes, it's a good question. And we'll get deeper into that at the Investor Conference. But big picture is yes, there will be some pressure and some cannibalization, of course. But we think that the awareness of aortic stenosis is going to increase. It's a largely untreated population, and that there are likely to be more people that flow into the system. And so we'll get a boost from that. And so we're not sure that it's just purely a subtractive effect.

David H. Roman - Goldman Sachs Group Inc., Research Division

Okay, all right, got it. And maybe just for Tom on the P&L, just a clarification around the moving parts in the gross margin line, could you maybe first give us some perspective, what was sort of the underlying or sort of real gross margin this quarter? And then how long do we see this headwind from inventory build?

Thomas M. Abate

Yes, that's a good question. I think we're going to see the inventory effects throughout the launch. It's going to continue into 2014. When exactly? I don't have a date. But there's a number of things that are involved with the training and inventory and so forth. So I think that's likely to continue into the future. I'd say this -- the benefit -- we're still seeing some benefit in this quarter from FX, if you just isolate the current quarter. But that's pretty much gone by next quarter. So we had a strong first half. Remember, we were getting help, 150 to 100 basis points. We also had a real strong benefit last year, second half. So -- but that's tapering down. Now, of course, as you wrap around rates, whenever you have a big movement, that's pretty normal until the next movement. So predicting FX, we'll take another shot at it in December but it's always a variable.

Operator

Our next question comes from the line of Brooks West with Piper Jaffray.

Misha Dinerman

This is actually Misha Dinerman for Brooks. I was just wondering, Mike, if you could give us an update on TA training and how the rollout there is going, how many of the sites have been now set up with training? And...

Michael A. Mussallem

Yes, thanks. I think at this point, great, great majority. I don't know the exact number. But my estimate would be 95% or more of sites in the U.S. are trained on transapical approach.

Operator

Our next question comes from the line of Bruce Nudell with Crédit Suisse.

Bruce M. Nudell - Crédit Suisse AG, Research Division

Mike, one of the consternations about the stock is the view that the U.S. market, given the constraints of the NCD, can't really grow that fast until there's indication expansion. And that given the emergence of competitors and just trialing efforts that are going on in clinicals, that it's going to be difficult for Edwards to grow the U.S. TAVI business reliably in '14 and '15. And just kind of schematically, how do you respond to that? And is there anything we should be thinking about that we're maybe missing?

Michael A. Mussallem

Yes. We continue to be optimistic about the U.S. market. I think the improving economics will be gradual, but I think they will be deliberate, and we'll see that. And we think as economics improve, that it will stimulate hospitals to increase their capacity and to further develop their referral networks. So that's just the -- it would be an underlying boost. Remember, we expect a SAPIEN XT approval next year, which we think is also very helpful and that [ph] comes along with additional sizes. So we think that also helps increase the number of patients that you might touch in the United States compared to just the SAPIEN technology that's there today.

Bruce M. Nudell - Crédit Suisse AG, Research Division

And Mike, my follow-up is about the kind of hospital profitability situation. And just to put a clarifying point on it, if a patient is mapped to the correct MS-DRG and you can reduce length of stay with kind of discharge to home, that in your mind really will allow the hospital to kind of pocket more of the profit and there won't be some recoupment on the part of CMS?

Michael A. Mussallem

Yes, I think that's right. Overall, we believe that profitability is not only improving, we think that most hospitals today are profitable on a per procedure basis. And as they improve their economics, for example, improve their length of stay and have proper discharge planning, yes, the benefit comes to the hospitals.

Operator

Our next question comes from the line of Danielle Antalffy with Leerink Swann.

Danielle Antalffy - Leerink Swann LLC, Research Division

Mike, I was hoping I could follow up on the mitral program. Sorry to harp on this, but can you give us any color on sort of what are the milestones that still need to be hit before we can go first-in-man? And then secondly, to follow up on that, how quickly can this go from first-in-man into a pivotal CE Mark trial.

Michael A. Mussallem

Yes. We really haven't gone to the point where we lay out the specific milestones. I think as we mentioned, we go through quite a process. Our -- all of our in vitro tests, as well as the early preclinical tests that we would do, both on acute animals and chronic animals, it's quite a process. And I don't know that it's appropriate to get into that in a deliberate way. I -- we think there's a lot to learn in a first-in-man. There are no great models for really doing this in the mitral position. And so I think getting in front of ourselves would be inappropriate. We're going to try and bring this more to life when we're with you at the Investor Conference. And so we'll try and get much deeper. But I think at this point, we'll hesitate to make any projections beyond that we think it's likely that we're going to get in the first-in-man, and we look forward to that experience.

Danielle Antalffy - Leerink Swann LLC, Research Division

Okay, great. And I was hoping you could comment on your Q4 guidance and for o U.S. THV sales and how you're factoring in. Just this -- earlier this morning, a competitor got a next-gen valve, a CE Mark approval. So how are you thinking about the competitive ramping up in Q4, particularly since you don't expect a benefit from Medtronic and Germany quite yet?

Michael A. Mussallem

Yes, thanks. We've been really pleased with both the -- what the market's been doing in Europe and also our performance compared to competitors. And that's gone very well. And we felt like we leave the third quarter with a lot of momentum. I think what was just approved this morning is no surprise to us. This is fully what we expected, and that's fully anticipated in our guidance.

Operator

Our next question comes from the line of David Lewis with Morgan Stanley.

David R. Lewis - Morgan Stanley, Research Division

Just a couple of quick questions here. Mike, just on XT, maybe a couple of questions. First, the timing you're giving for mid-next year seems a little longer than maybe some more optimistic expectations, considering that it's not a novel valve. Maybe just give us a sense of could that estimate actually prove conservative and what your thoughts are there. And then secondarily, I'd love to know kind of how you think about XT in the U.S. in terms of being able -- as a key growth driver next year, can it really drive increased growth? Or do you see XT as a valve that likely cannibalizes a lot of TA procedures? So those 2 points, both the FDA process and how you see XT play on next year as a growth catalyst.

Michael A. Mussallem

Thanks, David. I think we need to bring you with us to the next FDA meeting, so you can explain to them that XT is not a novel valve and that they should rapidly move to approve this. We try to make similar arguments but they're pretty convinced that it is a unique and novel valve. And we're pretty pleased. We think that profile change is going to be substantial. I'm not sure everybody really thinks about the difference of moving from a 24-French system to an 18-French eSheath. That's a big change that customers are going to go through, and I think it's going to have a big impact on patients. In addition, I also mentioned that we have -- we'll have a range of sizes that are significant, and that will make a difference as well. There are patients that are being excluded today because we can't serve them with a 23 and 26 millimeter size.

David R. Lewis - Morgan Stanley, Research Division

Okay. And then, Tom, just maybe a quick follow-up on gross margins. Obviously, this year, there's a significant series of launches in multiple markets, which are pressuring GMs. Next year, you start to anniversary some of those launches, but we kind of gear up for the U.S. push of XT. I mean, is XT in the U.S. is going to have the same type of inventory pressure that we're seeing here in '13, or can we sort of expect the broader mix of your business with the multiple countries driving per valve to maybe take those GMs higher? So I'm just trying to get a sense of whether the pressures we're seeing in the back half of '13, are we going to see them again in '14 because of XT? Or the net benefit should be GMs heading higher?

Thomas M. Abate

Yes, it's difficult to predict. We need to get the actual approval dates behind us and see how these launches are actually going to work, how aggressively, we'll look at inventory in both cases. But our goal is to get everything that we can outside the U.S. to XT, including the U.S. So it will give us some efficiencies. Obviously, S3 will be the leader. But next year, it's probably mainly Europe that we're looking at. So being able to drop SAPIEN should help. I don't know how quickly we would see that benefit, probably a little bit of time before we get that work through the system because we do still have some -- we'd still have SAPIEN in some indications in the U.S.

Michael A. Mussallem

Yes, maybe I'll just to add to Tom's answer that although we do pick up efficiency when we'd leave SAPIEN and go to XT, we will be producing a more expensive SAPIEN 3 valve as we move forward, so...

Operator

Our next question comes from the line of Kristen Stewart with Deutsche Bank.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Just as a follow-up to that last one, just in terms of the SAPIEN XT label. Have you changed your view on -- or expectation that it will be not only approved for the inoperable patient population but also for high risk? So I'm just confused as to how you would then be able to transition everything over to SAPIEN XT without that label also specifying high risk.

Michael A. Mussallem

Yes. No, we haven't changed our view. Of course, we would love to have the label be not only inoperable but high risk. But at this point, we don't have any reason to be able to really provide any guidance on that, Kristen. It -- the trial provide -- you're familiar with where -- what the trial tested.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Right. And so I guess, if it doesn't change, then, I guess, we could continue to see some of this inventory pressure in gross margins because you'll have to have both product lines continue in the U.S. until presumably PARTNER IIa results and approval.

Michael A. Mussallem

I think that your broad assumption is correct. If that were to persist, then we would have to keep SAPIEN going as well as XT, as well as SAPIEN 3. That would sort of hurt our efficiencies, and we'd feel that in the margin.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Okay. And then I was wondering if you could just expand a little bit more on just the Japanese market. I know you had mentioned that you expect the ramp to be a little bit slower. Can you maybe just help us get a little bit more perspective just on the number of centers you're looking at there; what, in particular, is causing the slower ramp, what centers need to be credentialed for or anything in that regard?

Michael A. Mussallem

Sure. So the -- we've already begun training centers. But there -- in addition to what Edwards typically does, there's an additional criteria that was established by the Ministry of Health and Welfare in Japan and medical societies for there actually to be a certification that would be done by local physician societies. And that is an additional gating item and would need to be done along the way. So what we're concerned is it will make the launch actually even more deliberate. So it will be -- provide a slower ramp than if we had -- if we didn't have that requirement in there. Now having said that, we think this is going to be a very popular procedure in Japan, and ultimately, it's going to grow very nicely. But I think this additional requirement is going to mean that it's going to go slower. So even though we've trained some centers, for example, I'll doubt that we'll have an additional 10 centers trained in the fourth quarter.

Kristen M. Stewart - Deutsche Bank AG, Research Division

Okay. And I missed in the beginning, but how many centers are in the U.S. right now?

Michael A. Mussallem

265 at the end of the third quarter.

Kristen M. Stewart - Deutsche Bank AG, Research Division

And do you still feel good about the targets that you had set? It seems like it's tracking a little bit lighter.

Michael A. Mussallem

I'm sorry, Kristen, what was that?

Kristen M. Stewart - Deutsche Bank AG, Research Division

Do you feel still positive about the number of centers that you expect to add? That number seems to be tracking a little bit lower?

Michael A. Mussallem

Yes. Given where we are right now, it's probably less likely that we reach 300 by the end of the year. But we think, typically, the third quarter is slow. So it's not surprising that it's a little less this quarter than we have experienced in the past. I think we need to let some others ask questions now, Kristen.

Operator

Our next question comes from the line of Glenn Novarro with RBC Capital Markets.

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

Just a follow-up on Germany and a follow-up on Japan. In Germany, I believe Medtronic's CoreValve was doing somewhere about $15 million to $20 million per quarter. And I guess, what I'm hearing is you're saying in 4Q, they have enough product in the channel that you're not going to be able to really benefit. But how should we think about the benefit in 2014? Can you capture at least 50% to 75% of CoreValve? And then I have a follow-up on Japan.

Michael A. Mussallem

Yes, it's a really good question, Glenn. When we said there was minimal impact this quarter, actually our local team actually thinks there might have been even slightly negative impact, as they're still working off quite a bit of this competitive inventory. Before we can make a call on how things might go in the future, I think we're going to need these decisions from the courts. Because the courts will tell us a couple of things: One is whether there is going to be a recall of the products that are still on the shelf; and two, just how rigorous this definition of compassionate is. We think it's quite rigorous. And again, we've tried to be generous with the idea that we're really going to do the very best for patients and their physicians, but that's not clear. So we would expect over the next several weeks to have some decisions there that help clarify that, but it's not perfectly clear right now, Glenn.

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

And I would assume we'll get the update at the Analyst Day, correct?

Michael A. Mussallem

Certainly.

Glenn J. Novarro - RBC Capital Markets, LLC, Research Division

All right. And then in just Japan, can you remind me, I believe in the past you've said no stock in Japan, just consignment. Is that correct?

Michael A. Mussallem

That is correct. We're going to go directly to consignment model in Japan.

Operator

Our next question comes from the line of Bob Hopkins with Bank of America Merrill Lynch.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

So just a couple of quick follow-ups. First of all, on the U.S. side, can you give us a sense as to what you expect in terms of Q4 revenue from the -- from clinical trials for U.S. TAVI? And then to follow-up on the question on number of centers in the U.S., I was wondering if you could comment on are you still comfortable longer term that you can have, really, 400 centers up and running, ultimately. Or is that number now lower? Because that certainly was what some of the commentary was yesterday in a few of the sessions.

Michael A. Mussallem

Yes. So -- the -- so let me -- I'm trying to...

Thomas M. Abate

Q4 clinical...

Michael A. Mussallem

Oh, yes. So Q4 clinicals, we hesitate to make predictions about what clinical cases will be in the quarter. We think that there will continue to be some pretty good clinical volume, with SAPIEN 3 beginning in the PARTNER II trial. We think that will be pretty popular. So that could drive some pretty rapid uptake, but it's difficult for us to predict exactly where that comes out. In terms of the number of sites, yes, you're right. Given that we're at 265, it does call into question on whether we'd get to 400 by the end of next year. We're going through that analysis now. We'll try and give maybe a sharper picture of that when we get to the Investor Conference. But your observation is a good one.

Robert A. Hopkins - BofA Merrill Lynch, Research Division

So -- and then just as a follow-up, on the clinical trial revenue, I know you don't want to give an exact number for Q4, but should we assume it's roughly the same as what that is right now? And then my last follow-up is simply, do you have any update for us in terms of your expectations for a decision from the European Patent Office on validity?

Michael A. Mussallem

Yes, thanks, Bob. Well, I admire your persistence on trying to get a clinical number out of us in the fourth quarter, but I think we're going to hesitate to offer that up. I think I pretty much offered the best insight that I can. In terms of the Spenser patent, we would expect the European Patent Office to make a decision in the first half of '14 on the validity.

Operator

Our next question comes from the line of Matt Taylor with Barclays.

Matthew Taylor - Barclays Capital, Research Division

So just wanted to ask a question about SAPIEN 3. You've got -- your launch expected here early next year and you're also due some additional clinical work in the U.S. So first question is you mentioned the clinical trial, I guess, drain on commercial volumes in the U.S. And I'm curious as to how you see that evolving sequentially. Meaning, you got a lot of clinical stuff going on, but you mentioned before there's more competitive clinical trials going on at the same time. So do you think that you'll actually see more clinical sales for Edwards or less because of that dynamic?

Michael A. Mussallem

Yes. Well, I guess, I'd say that we're really excited about SAPIEN 3. We think it's a terrific valve. We think clinicians are super excited about it. And the opportunity for them to implant in the U.S., especially in these leading centers that are in the PARTNER II trial, is going to be exciting to them, and we expect them to move along at a pretty rapid pace. I don't know how fast that's going to go. Naturally, they need to go back through their IRBs, which they do for any of these changes. I don't expect that to be onerous, but it's still a requirement. So it's tough to make the call exactly how fast that is. But we'd expect it to enroll pretty fast, and that would drive the clinical sales number up. Having said that, whether it's clinical sales or commercial sales, we're relatively indifferent. This is -- as long as we're making progress here in terms of moving the best system forward and that the therapy is continuing to grow and be popular and help patients, we're very pleased with that.

Matthew Taylor - Barclays Capital, Research Division

Great. And then just a follow-up on the centers. There's been some speculation about the total number, ultimately. Can you comment on the centers that you've trained so far? Have you retained all those centers, is your batting average pretty high there? And have any centers dropped off because of one reason or another?

Michael A. Mussallem

Yes. I don't know any exact numbers in terms of exactly what's going on. We don't tend to have centers that so-call drop off that I'm aware of at any serious numbers. I'm sure there are exceptions here and there. But for the most part, I think people try and meet their minimum requirements to stay within the NCD.

Operator

Our next question comes from the line of Suraj Kalia with Northland Securities.

Suraj Kalia - Northland Capital Markets, Research Division

So Mike, if I may piggyback on the question about Germany and inventory for CoreValve? I think sort of this why do you expect it that you're going to follow the same pattern in some the other countries, whether it's Italy, U.K., so on and so forth? Can you give us some perspective of if you will try to preempt any of the inventory issues with CoreValve, assuming in some of the other countries you'll go for litigation with the Spenser patents? And would the German court set a precedent in some of the other countries, also the interpretation?

Michael A. Mussallem

Yes. I think the other countries do pay attention to what the German courts do. But I hesitate to do any projection. We just don't comment on future litigation, Suraj. And so we really have nothing to share at this point.

Suraj Kalia - Northland Capital Markets, Research Division

Fair enough. One more question, Mike, and forgive me if this is a too forward-looking question. Obviously, a lot of the centers in the U.S. complain about profitability about TAVI. I think a lot of the centers that we talked to have consistently started giving feedback that the perioperative and immediate post op outcomes have improved substantially, but that the cost effectiveness is just killing them. Do you think given all the competitive clinical trials coming on board, do you -- what does your internal analysis suggest in the price elasticity of demand on the commercial side for your products? Do you think it's a viable strategy at this time in terms of causing a step-change in the demand curve?

Michael A. Mussallem

Yes. Just broadly, we think -- although everybody's not there at this point, we think more than half of the centers are profitable just on a per procedure basis today, and that, that is improving. And we've seen that results in the early data that we've had a chance to look back, the MEDPAR data. And we are feeling that in our own experiences. In terms of our pricing and the role in that, we think our pricing is fair and we think it does a good job of reflecting the value of the procedures. Even if you go back to The PARTNER Trial and Cohort B and remember that cost effectiveness versus other cardiovascular procedures, it was pretty comparable. And when you consider that it's a young procedure and that there's a large opportunity for improvement, we think we're pretty well positioned for that to continue to get better over time, especially as we're able to bring better systems that are going to be easier for patients and their physicians.

Operator

Our final question comes from the line of Rick Wise with Stifel.

Frederick A. Wise - Stifel, Nicolaus & Co., Inc., Research Division

Mike, 2 things. First, briefly, I hate to ask or even think about Mike's departure but -- Tom's departure, but any update on timing of the CFO search?

Michael A. Mussallem

Yes. The CFO search is going really well, Rick. We're going to be sorry to say goodbye to Tom as well. He's been a fantastic partner. He's continued to be highly engaged, and so we expect a very smooth transition. I think that we'll have something announced certainly before year end, hopefully even sooner than that. So just stay tuned, but that's all going well.

Frederick A. Wise - Stifel, Nicolaus & Co., Inc., Research Division

Good. CENTERA, a couple of questions to finish for me. You said you're starting a second trial. Maybe a couple of things around CENTERA, Mike, and you could just take it at whatever order you want. What does this all imply for a new trial, a second trial applied for EU approval? Do you think you can still come to market in 2014? You talked about a new delivery system. I think you said it went by sort of quickly. And maybe any larger reflections as the repositionable era grows closer?

Michael A. Mussallem

Sure, Rick. So yes, we're really excited about the CENTERA valve. We think it has the potential to be by far the best-in-class, self-expanding system. We decided to make a pretty significant change to the delivery system, and so we're going to start the trial with a new delivery system here in the next several months. And that will pick up the clinical cases. I -- we don't have any timing to project. Maybe we'll have some things that we can talk about at the Investor Conference, but we're pleased with the direction that this is going in, and we're really looking forward to starting this next series of patients.

Okay. Well, thanks for your continued interest in Edwards. Tom and David and I will welcome any additional questions by telephone. And with that, back to you, David.

David Erickson

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

If you missed any portion of today's call, a telephonic replay will be available for 72 hours. To access this, please dial (877) 660-6853 or (201) 612-7415 and use passcode 421584. Additionally, an audio replay will be archived on the Investor Relations section of our website. Thank you very much.

Operator

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.

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