Good day, ladies and gentlemen. Welcome to the LivaNova PLC first quarter 2019 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Matthew Dodds, LivaNova's Senior Vice President of Corporate Development. Please go ahead.
Thank you, Lisa. Welcome to our conference call and webcast discussing LivaNova's financial results for the first quarter of 2019. Joining me on today's call are Damien McDonald, our Chief Executive Officer, Thad Huston, our Chief Financial Officer, and Melissa Farina, our Vice President of Investor Relations. Before we begin, I would like to remind you that the discussions during this call will include forward-looking statements. Factors that could cause actual results to differ materially are discussed in the company's most recent filings and documents furnished to the SEC, including today's press release that is available on our website. We do not undertake to update any forward-looking statement. Also, the discussions will include certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures can be found in today's press release that is available on our website.
We have also posted a presentation to our website that summarizes the points of today's call. This presentation is complementary to the other call materials and should be used as an enhanced communication tool. You can find the presentation and press release in the investor relations section of our website under news and events, presentations at investor.livanova.com. With that, I will now turn the call over to Damien.
Thanks, Matt. Welcome to our first quarter 2019 conference call. Today, we will discuss our first quarter results, outline our plans to address the sales shortfall in Neuromodulation and Perceval in the U.S., and update guidance. To be clear, we are disappointed in our first quarter results. While we have made significant progress in transforming LivaNova portfolio over the last two years, we have more work to do. As Thad and I will explain in more detail during this call, we are implementing several actions to address the root causes of the sales shortfall and leaning in harder on our cost structure to countermeasure the near-term impact. I'm going to start off by discussing our sales results by business and provide color on actions already underway. After my comments, Thad will provide you with additional detail on the financials and our revised 2019 guidance.
I will wrap up with closing comments before moving on to Q&A. On April 5th, we announced preliminary first quarter 2019 revenue results. The U.S. Neuromodulation business experienced an unexpected weakness due to a combination of factors, including competitive dynamics and sales force turnover. In addition, softness in Perceval sales negatively impacted the Cardiovascular business during the quarter. All of the weakness we saw occurred in the U.S. as both Europe and rest of world grew above plan. Turning now to our net sales results for the first quarter, which will all be stated on a constant currency basis. Total net sales were up 4.2% compared to the first quarter of 2018. Cardiovascular showed strong operational growth in the quarter, while Neuromodulation was below expectations. Cardiovascular sales were $155 million, up 5.1% from the first quarter of 2018 due to growth in cardiopulmonary and the inclusion of ACS.
Cardiopulmonary sales were $122 million in the quarter, an increase of 2.6% versus the first quarter of 2018. Heart-lung machines grew double digits, driven by strength in both S3 conversions and competitive placements. Our oxygenator sales declined due to the termination of a Canadian distribution agreement but grew overall. In the first quarter of 2018, sales from the Canadian distribution agreement were $7.8 million and were located in the rest of world category of cardiopulmonary. Excluding this impact, oxygenator sales posted another solid quarter. Turning to heart valves, sales for heart valves were $26 million in the quarter, a decline of 11.2% versus the first quarter of 2018. Perceval declined in low single digits overall, driven by declines in the U.S. We continue to believe the U.S. issues are related to execution, not the impact of transcatheter valves. ACS reflects our TandemLife business that we acquired in April of 2018.
We were very pleased to see sales in the first quarter in excess of $8 million, representing greater than 40% growth versus the first quarter of 2018. We believe last year's sales force expansion is now gaining traction with strong growth across all product lines, especially ProtekDuo. Now let's turn to Neuromodulation. Sales were $95 million, up 2.3% versus the first quarter of 2018. In the U.S., sales decreased 1.4%, driven by competitive pressures and field turnover. Our subsequent analysis of the shortfall leads us to believe the following. First, we have no evidence that we lost market share to other implantable therapies. Second, we saw a deviation from historical trends in the timing between new patient identification and implant. We believe this was related to the initial enthusiasm by patients for EPIDIOLEX, as initial prescriptions written have meaningfully outpaced prescriptions filled.
Third, we have recently seen a step-up in competitive hiring, and while our turnover was only slightly higher than normal trends, it had a sizable impact on two U.S. sales regions in the first quarter. Fourth, competitive dynamics and turnover led to a reduction in customer purchasing patterns at the end of the quarter. We now believe we have a better understanding of the situation surrounding our U.S. Neuromodulation business and have formed and implemented dedicated teams to oversee programs designed to address the current market dynamics, including sales force retention and compensation plans, customer and territory optimization, competitive positioning, and replicating best practices. While we are confident these are short-term challenges, we are resetting our expectations for 2019, which Thad will run through during the financial update. Turning to SenTiva, U.S. adoption continues to increase and represented 67% of our generator sales in the first quarter.
We saw another strong growth quarter of double-digit sales in Europe based on continued adoption of SenTiva, which was launched last April. E.U. adoption is now 55% of generator sales, with strong uptake in the U.K., Nordics, Germany, and Spain. Our rest of world region delivered another great quarter, driven by strong performance in the Middle East, China, Brazil, and Russia. Finally, our neuromodulation pipeline continues to make good progress in both our treatment-resistant depression, or TRD, and heart failure programs. In TRD, we are making solid progress on site recruitment, have engaged a high-profile CRO, and still expect our first implant in the third quarter. While we continue to build our TRD team and attract talent with the addition of two senior leaders, including the head of our TRD program globally and a commercial VP.
In heart failure, our ANTHEM-HFrEF U.S. pivotal trial continues to enroll faster than our expectations at over 60 active sites. We recently presented encouraging long-term 30 and 42-month data during the American College of Cardiology annual meeting in March. We are confident in our growth prospects and will continue to focus on execution, strong portfolio management, and developing the talent and culture at LivaNova. I'll now turn the call over to Thad for an overview of our financial results. Thad?
Thank you, Damien. I'm going to discuss the first quarter financials in greater detail and provide our revised 2019 guidance. As Damien mentioned, sales growth in the first quarter was 4.2% versus the first quarter of 2018, led by growth in HLMs and oxygenators, offset by lower growth in neuromodulation. Adjusted gross margin as a percent of net sales in the quarter was 69.3%, up 240 basis points from the first quarter of 2018. The margin improvement was driven primarily by mix and price. Adjusted R&D expense in the first quarter was $37 million, compared to $29 million in the first quarter of 2018. R&D as a percentage of net sales was 14.7% versus 11.6% in the first quarter of 2018.
As we previously discussed, R&D is increasing behind the development of our next-generation HLM, SenTiva, and TandemLife products, along with the clinical trials and strategic investments we're making in TRD, TMVR, sleep apnea, and heart failure. Adjusted SG&A expense for the first quarter was $105 million, compared to $97 million in the first quarter of 2018. SG&A as a percentage of net sales was 41.6%, up 290 basis points versus the first quarter of 2018. The increase is largely due to U.S. investments in a DTC campaign for epilepsy, the full impact of including and expanding ACS commercial capabilities, strengthening our commercial organization in international markets, and lower-than-expected overall sales results. Adjusted operating income from continuing operations was $33 million, compared to $42 million in the first quarter of last year, which reflects the impact of lower neuromodulation sales while increasing investments in our key growth drivers in R&D.
Adjusted operating margin from continuing operations declined 370 basis points to 12.9%. Our adjusted effective tax rate in the quarter was 15.5%, an improvement versus 15.7% in the first quarter of 2018 as a result of ongoing tax efforts. Finally, adjusted diluted EPS from continuing operations in the quarter was $0.54 compared to $0.68 a year ago. Moving to cash flow. Our cash flow from operations for the quarter ended March 31st, 2019, was $2 million. Cash flow from operations excluding payments for one-time integration and restructuring costs was $30 million. Capital spending for the quarter was $6 million, which was flat versus the first quarter of 2018. Our cash balance at March 31st, 2019, was $51 million, up from $47 million at December 31st, 2018. Our net debt at quarter end was $124 million, no change versus year-end 2018. Turning to 2019 guidance.
Given the previously mentioned challenges, we are revising our financial guidance for 2019. In neuromodulation, we are now expecting the disruption we saw in the U.S. in the first quarter to persist in the current quarter and then gradually improve in the back half of the year. We believe the impact will primarily occur in new patient implants and consequently impact customer buying patterns. Overall, we expect U.S. neuromodulation to decline to a range of $315 million-$325 million, with the second quarter expected to fall into a range of $70 million-$80 million. In terms of overall guidance, we are forecasting 2019 sales growth of between 1% and 3% on a constant currency basis. If current exchange rates remain unchanged, the company's full year revenue guidance would be negatively impacted by 1%.
Note that this guidance includes one quarter of sales from TandemLife prior to the deal closing in April 2018, or $8 million. The impact of exiting a low margin OEM distribution agreement in Canada that represented $32 million in sales in 2018. In order to address the current market dynamics that are impacting our U.S. neuromodulation business while positioning our company for long-term growth, we have already begun to advance plans designed to improve profitability in order to offset some of the expected impact. Specifically, we are undertaking plans to optimize expenses across the board, reallocating resources to focus on the highest value opportunities within our new product pipeline, redeploying resources, investment, and talent towards our U.S. epilepsy business to return this business back to growth. Turning back to the rest of the P&L.
Adjusted gross margin in 2019 is now projected to be in the 68.5%-69.5% range. In 2019, we expect adjusted R&D to be in the range of 13.5%-14% of sales and adjusted SG&A to be in the range of 38%-39% of sales, with TRD having added an additional 50 basis points to each range. As a result of these factors, we are projecting 2019 adjusted operating margin from continuing operations to be in the 16%-17% range. Our adjusted effective tax rate for 2019 is expected to be in a range of 16%-17%.
We are projecting adjusted dilutive earnings per share from continuing operations to be in a range of $3-$3.10, which includes a negligible impact from foreign currency, the previously disclosed negative impact of $0.12-$0.14 to account for the OEM transition in Canada, as well as $0.15-$0.20 impact from TRD. We assume our share count to be approximately 49 million. While we don't normally provide quarterly guidance, we are providing a second quarter EPS forecast range of $0.60-$0.70. Our adjusted cash flow from operations for 2019, excluding integration, restructuring, product remediation, and litigation payments, is expected to be in the range of $150 million-$170 million. The integration, restructuring, and product remediation payments are expected to be in the range of $55 million-$65 million.
Capital spending is projected to range between $35 million and $40 million, and depreciation and amortization expense is expected to be in the range of $28 million-$30 million. While we are lowering our guidance for 2019, we remain focused on investing in our highest growth opportunities to deliver long-term growth. With that, I'll turn the call back to Damien for some final comments.
Thanks, Thad. As a management team, we are looking to build long-term shareholder value. I'm proud of the foundation we have built so far. We have transformed LivaNova's portfolio with the sale of our CRM business, coupled with investments in our internal R&D portfolio and our recent acquisitions. At the same time, we have been able to expand gross margins, increase R&D to fuel our pipeline, and strengthen our talent and capabilities. While our U.S. neuromodulation and Perceval sales fell short of our expectations, many of our other business lines are performing well, and we have a sense of urgency to course-correct these challenges and further streamline our cost structure. Although the results of our efforts will not be visible overnight, I am confident that our focus and attention will return us to our declared aspirations.
We look forward to updating you on our continued progress and delivering on our commitments to drive shareholder value. With that, Lisa, we are ready for questions.
Thank you. At this time, I would like to remind everyone that in order to ask a question, press star, then the number 1 on your telephone keypad. Our first question comes from the line of Raj Denhoy from Jefferies. Your line is open.
Hi, Raj.
Yep. Good morning. I wanted to maybe just start on the VNS line. Obviously, probably a lot of questions there. I guess, as you've described the recovery from this EPIDIOLEX issue you've seen so far, how do we get confidence that this isn't going to cut deeper for longer, in a sense? There is something, it seems different about this drug in terms of people's willingness to try it or their desire to try it. Again, just trying to frame why you think we'll see recovery. I know you've guided very conservatively here for the second and third quarter, but why you think we'll see recovery by the fourth quarter and then into 2020?
Well, I think there's a range of things that we've dug into since we've pre-announced our sales rise. First is digging into what do we think drove the shortfall. In our Pareto think that around 30% of this was related to EPIDIOLEX, 40% related to our commercial issues and the balance really related to the change in the customer buying patterns. We're expecting this disruption that we saw in the first quarter to read into the second quarter, then in the second half, start to bounce back, Q3 being a little stronger and then Q4 returning to growth. We've broken down the Pareto. I think the other thing is too, we've begun to understand more, from customers around EPIDIOLEX, and think that the trial and evaluation period is like a six to nine-month period.
I think that also informed us on how we think we're going.
Okay. That's helpful. I guess, to that point, 40% of it was Salesforce turnover, kind of execution on the commercial side. Maybe you could offer something in terms of how you've replaced those folks or how quickly you think it'll be before you can refill the positions that were lost.
Yeah. Look, we had a slight acceleration in turnover in the first quarter, and the impact was really meaningful in two regions. In a lot of instances, we've replaced people in the field, many of those with internal candidates. We were able to retain a number of people who were entertaining alternative offers. I think that's also been key. I think the other aspect of this too is getting into the commercial execution and making sure that we're focused on Salesforce compensation, the territory optimization, the communication and positioning messages. Those have all been key steps that we've taken in the last few weeks to start stabilizing this.
Okay. Maybe just for my last question, I could just kind of ask a broader one. I think one of the other things that perhaps drove the sharp reaction in the stock on the pre-announcement was kind of the company's communication strategy. You had, I think, been on the road, meeting with investors just shortly before all of this happened, and there wasn't any indication that something was going to happen. Obviously, you couldn't have said much because you were deep into the quarter. Maybe just, there's a couple questions there just about communication and also visibility, I guess, in terms of the business and why the miss wasn't known until very late in the quarter. At least, things weren't tracking as you expected until very late.
Look, Raj, it's a very fair point, clearly, we typically see the quarter sales cadence is definitely skewed towards the end of the month for our Neuromod business. We didn't see that pickup in the last week. When we were out talking, of course, we were describing where we were at that point in time. We did see that deviation in the trends that occurred really towards the back end of the quarter, and that created a challenge for us. That's why as soon as we had clarity on the sales results, we started our efforts to publicly communicate, and that's why we did the pre-announcement.
How much of VNS revenue then does fall in the last week or so, two weeks of the quarter, typically?
It's Matt. We won't give you the last couple of weeks, for the last month, it's about 50% for the quarter, generally in every quarter.
That's fair. I'll leave it there. Thank you.
Thank you, Raj.
All right. Thanks, Raj. Cheers.
Our next question comes from the line of Rick Wise from Stifel. Your line is open.
Good morning.
Morning, Rick.
Can you just give us a little more color, Damien, on the U.S. Perceval weakness? You sort of spelled out a little more detail on the neuro side and what you're doing and the sales. I am not as clear about what is happening there. Clearly Perceval is doing great OUS. Just talk about the leadership changes that you have made and help us think through there, the cadence or the drivers of improvement as the year unfolds, and maybe what you have assumed around that.
Right. Yeah, we put in a new leadership structure around Q4 last year. The diagnosis, I think, is reasonably clear with them. They have dug in much more, especially this last three months. I think, for us, this really relates to a few things. I will say, and we said in the script, it is commercial execution on our part. We do not believe any of this had to do with a meaningful change in the perception of low risk. Our plan is around better commercial execution, better procedure training, both of our internal people as well as the accounts that we are supporting. The valve-in-valve indication, I think is a meaningful change in our communication plan, as well as the 10-year data. We will be implementing more discipline around the, what we call daily management for the sales force execution.
There are what many would just refer to as Sales 101 that were really not in place. Rick and the team are really starting to execute on that now.
Yeah. Again, just as you reflect on, does this take a full year to make all these things happen, Damien? Or do you think we can sequentially imagine improvement now that you're focused on it in each quarter? Or no, it's back-half loaded? Again, if you could frame that'd be helpful.
Yeah. I think you stabilize it in Q2, then you start building in the second half. By the time you start getting traction in the accounts. There's two parts of this. There's the account acquisition, finding new accounts and then account penetration. Both of those things, coupled with the internal efforts, I think will take a few quarters to read through.
Damien, going back to neuro, just can you help us understand what you've talked about, the breakdown of the headwinds in neuro short-term. I wonder what you've assumed in terms of on the EPIDIOLEX side. What have you assumed about trialing or maybe de novo neural implants going to drugs out of the gate as you trial? What change in assumptions and what are you assuming now going forward?
Well, I think the big thing for us is, we really looked at this, our key opinion leader and neurosurgeon neuroscience input said, "Look, this looks a lot like another drug." It's a 12-week trial. It's an acute therapy. It's relatively expensive, limited indications. This looks like drugs that we've seen in the past 4-6 months. What I think we were really caught off guard by was the enthusiasm for things that are anything cannabis. You probably know as much as anyone that there's a lot of noise and enthusiasm for that. What we've really begun to understand is maybe this is more like a 6-9 month program. By the time people try it, see what the effects are. Again, our pipeline of the start of our funnel, the patient identification, was really robust.
What we saw was a slowdown in the movement of people from patient ID through to implant. That's where probably our systems or process or methodology for analyzing it was slightly off. Just that timing and what it would do to the conversion from ID through implant.
Yeah. I guess that, clearly we also, Rick, wanted to provide more clarity around the U.S. kind of phasing. As we were surprised in Q1, we also have described a range of $70 million-$80 million in Q2 for U.S. Neuromod. Then clearly as we go into the back half of the year, we still have an impact forecasted, that's again why we provided a full-year range as well.
Right. Just one last from me. I'm sure I would be astonished to think that you weren't trying to be incredibly conservative as you reset the bar here. Can you help us think through your guidance here? Are you thinking, hoping this is conservative and working hard to make it better? Or no, this is realistic? Would you hope it could be better than this? Maybe, Damien, at a high level, help us think through what might make it better. You have a lot of new products in the pipeline in the basic business, SenTiva 2.0, HLM, Tandem. Where would the you do a little better side of things come from? Thanks so much.
Yeah. Sure. This is where an old mentor of several of us would say hope is not a strategy. Our key activity here is focusing the U.S. sales force on execution, giving them the resources to be more effective. That's why we came back to the product messaging, the field training, and our account acquisition and penetration. Moving patients through from identification to implant is really key here. I think we've been prudent in the guidance. This is our best estimate of how the year looks. Our intention is to work our plan now.
Thank you very much.
Our next question comes from the line of Matthew O'Brien from Piper Jaffray. Your line is open.
Morning. Thanks for taking the question. As we think about the business from here, given the shortfall in Q1 and the adjusted guidance here, I think what most people are trying to get a sense for are a couple of things, and I'll break up the question. The first piece would be, as we base here for the core business and then hopefully improve in the second half of the year with all the spending that's going on, how do we think about the business as we exit this year and then we get into 2020? Because obviously this is a soft year and an investment year. How do we think about the business unfolding late this year and into 2020 in terms of top-line growth plus potential leverage to the bottom line?
Yeah. Thanks for the question. It's clear that we wanted to better understand the impact on the Neuromod business, that's again, why we provided revised guidance. We're not in a position to provide 2020 guidance at this point. Clearly, we'll provide updates as we go throughout the year and as we get closer, give more of a line of sight on, frankly, the biggest driver, which is how our growth is projecting, particularly in U.S. Neuromod. We need a few quarters, obviously, to understand the impact of both EPIDIOLEX and also the field dynamics that we've described.
In terms of the P&L, what we've indicated too is we're going to be making changes in our cost structure to be more prudent there. Again, I think we were pretty transparent about that. Having said that, what we've ring-fenced is a lot of the growth program and the R&D. Leading into later this year with the Delta program for ACS, just to come back on the previous question from Rick as well, that we've got that in the pipeline. We've got really, I think, a lot of opportunity to talk about with Perceval, with the valve-in-valve. I think that opens up a lot of opportunity for us. Then, heading into next year, with the next generation heart-lung machine, as well as SenTiva 2.0.
We've really ring-fenced key near-term opportunities and you know a very big focus for us is bringing depression to commercialization. That is progressing well. We're still anticipating our start of our program in Q3. The idea for us is let's make sure we stabilize the base and get the core growing again. Let's make the right cost decisions in the middle of the P&L. Let's make sure we ring-fence the near term and key growth drivers. That's our playbook.
Makes sense. Would you get aggressive with the balance sheet to offset the lack of leverage maybe later this year or even into next year in terms of buying back stock?
I think we always look at the balance sheet and obviously, our capital allocation plans. Clearly where we are today, we have to also look at addressing this 3T liability, that's one of our priorities. We will look at everything.
Okay. The other question for me is, again, all the investment this year, you're sticking with your pipeline and really trying to be aggressive there. I know we're only three months after you gave us an update last quarter, but given all that investment, what have you seen in the last three months that gives you more confidence, either in the existing pipeline, be it heart failure or TRD, mitral, whatever it may be, or even on the circulatory support OUS. Anything along those lines you can point people towards as we transition through this investment year here in 2019 and look into 2020 and beyond?
Yeah. Look, I think a few things. In terms of we've talked about the LivaNova business system and we've really very much isolated these issues to U.S. and particularly Neuromodulation for epilepsy and Perceval. The growth in the other regions, Europe and international, has been really strong. I think that's a positive for us. We recently reviewed the next generation heart-lung machine program and a deep dive with that team. Very happy with the progress they're making. The Delta program, which is the project name for the next generation ACS device, which is the pump and monitor, is progressing well. We're really encouraged by the VITARIA heart failure recruitment. That's really, again, as we mentioned, ahead of expectations there now and coming around on 100 patients randomized. And 300 patients is the point of the functional endpoints that we'd be submitting as a PMA. That's progressing well.
The TRD program, while we're finishing off negotiations with CMS, we have begun in parallel recruiting sites. We can't go through IRB without a finalized protocol, but we're doing everything up to that point. I'm really impressed with the focus and the business discipline that that clinical team has implemented there. I think there are a number of things that we're really pleased with the progress. Lastly, just to wrap around on Caisson, that we've really identified that the single issue here is about the anchor design. The team have really made tremendous progress on coming around to finalize two potential designs. They're going to try to nail that down in the next month or two. They'll go into the cycle of testing on that, and we expect to be back in recruiting for the trial in the first half of 2020.
I think that's a bit of a list of things that we think are continuing to operate well.
Got it. Thank you.
Thanks, Matt. Cheers.
Our next question comes from the line of Scott Bardo from Berenberg. Your line is open.
Thanks for taking my questions. On VNS, I think the narrative has always been that the penetration opportunity is quite significant, even in the U.S. market, where I think you've called out around 5% of the addressable new patients for drug-resistant epilepsy getting VNS Therapy, which makes it somewhat surprising that EPIDIOLEX causes such a material and surprising impact to your business given the narrow indication of that product. What I want to understand is your guidance now for the second quarter for U.S. Neuromod, if I understand correctly, is highlighting a negative 10%-20% fall in your U.S. neuromodulation business, and particularly in keeping with the mindset that you have some regular business, if you like, or you have a replacement business here would imply that new patient adds grind to a halt.
I wonder if you could sort of square the circle for me with respect to the penetration opportunity and why all of a sudden no new patients are going on VNS Therapy in the U.S. Just help me understand really what forms this, particularly with the mindset that half of your sales are coming in the last few weeks in this business. That's question one. I have two follow-ups. Thanks.
Okay. Look, a few things. You're right. The end of service numbers for us were still very robust. The slowdown for us is in the new patient identification or new patient implants. For us, you're right, the penetration is relatively low. There's still a lot of drug-resistant epileptics coming into the funnel every year. You've got to move those patients through a process with a combination of neurologist, neurosurgeon, or another implanter like an ENT. In the big centers, it's a panel of people. Again, we were surprised, and what messed our models up is just the enthusiasm for everything cannabis. We can see a meaningful difference between the number of prescriptions written and the number of prescriptions filled for EPIDIOLEX. We believe that the patients are in that pool, delaying their decision about an implant.
Now we get back to competitive positioning, which is, we've got a series of messages that I think we have to be more aggressive about in terms of the benefits of drug plus VNS, whatever drug, EPIDIOLEX or whatever. As I said, I mentioned that as one of our countermeasures to start this working again. Yeah, it is new patient implants. It's in a very focused number of centers, and we've got work to do.
Yeah, I would add, I do think it's prudent for us to think about the bolus of patients that are essentially affected by this new drug launch and to look at the first half of the year and to assume that there's going to be a reduction in new patient implants, at least temporarily. Then as we look at the rest of the year, that it would gradually improve through the back half of the year. Picturing a dip and then an improvement over time. That's how we've been thinking about it and understanding it. You also have then an impact on this kind of customer buying patterns until they understand there was an impact on the NPI, there's an impact on the amount that's being purchased.
Understood. You're entirely confident that there has been no stuffing of the channel or excess inventory in your hospitals, and this is just in part a normalization of stock. You're very confident that there's no excess stock in the market. This is really end market demand trends you're seeing here.
Yeah. If you're implanting as an account a few less patients, I think it's natural that the buyers look at their par levels and say, "Look, what do we need to buy this month?" Again, that's what caught us in the quarter, in that last month. We just didn't see the customer buying patterns as normal.
Historically, when you talk about ICDs and pacemakers, spinal cord stim, when the market slowed, you've seen impact to how much a customer will hold based on the unit demand.
Understood. Second question, please. Clearly, not great to be cutting guidance only a few months after setting it. You've decided to stick with meaningful investments into your pipeline. I think given the obvious impact that this is having on near-term performance, could you please give us some sense as for the main four projects, sleep apnea, mitral TRD, heart failure, how much you're investing actually across the P&L? Maybe give us some sense of time frame when you expect these assets to materialize. That would help, if you like, balance some of the investments with some of the opportunities.
Right. As you point out, we are in this guidance, continue to maintain our investment in our innovative R&D pipeline. We think that we have some really exciting opportunities, clearly with TRD, with heart failure, with sleep apnea, with Caisson. Clearly, they kind of all come in this different time horizons, and clearly heart failure and actually TRD are more near term and then sleep apnea and then Caisson is are further out. We spend roughly half of R&D on our innovative pipeline. I think that is one of the things that makes us very unique versus a lot of other companies in the space. When you look at the number of cents or the amount of cents that we're spending, we're spending roughly $0.70 on our innovative pipeline. That is the choice that we're making, and it is roughly similar.
I mean, $0.10-$0.15 per item that we have in our pipeline on an annual basis that we spend. I could provide more detail, but clearly we believe that these things are prudent investments. Investments that are going to ultimately drive the long-term success. We'll also look at all these pipeline opportunities and balance those choices.
A portion of the other half is spent on the organic pipeline, the Polaris Program for next generation heart-lung machine, the ACS Delta product, and SenTiva 2.0. Again, the strategic priorities or strategic projects that we've talked about, the big four, as well as these internal programs that we kicked off roughly 18 months ago.
Yeah. The excitement that we have around TandemLife, obviously a next generation HLM and next generation SenTiva will really carry us into 2020 and beyond.
That's helpful color. Sorry, just lastly on this then. I'm also assuming that there's been some additional SG&A investments related to this decline. A 40% SG&A ratio is quite astonishing. Could you give us a sense of how much of your SG&A ratio relates to these pipeline assets as well?
Yeah. Clearly, SG&A has been moving up and part of the reason it's moved up is that we have made strategic investments in really neuromodulation, particularly the direct-to-consumer promotion campaign, as well as rest of world global expansion, as well as now we're bringing on TandemLife ACS into our portfolio, and we doubled the sales force last year. We have stepped up the investments on our priority areas. Clearly, as that approaches 40%, that becomes a high water mark, I would say, and one where we have to offset and make some other choices within our expense portfolio. We are optimizing expenses. We're reallocating resources, in many cases, from cardiac surgery to neuromodulation. We are redeploying investments to support epilepsy, and it's roughly $0.15 of our guidance is coming from these expense cuts.
We're ring-fencing the R&D programs in a geographic expansion we think is important, we're cutting in other areas to help mitigate at least some of this downside.
Got it. I'll jump back in the queue. Thanks, guys.
Thanks, Scott. Cheers.
Our next question comes from the line of Matthew Taylor from UBS. Your line is open.
Hi. Thanks for taking the question. Good morning.
Good morning.
A follow-up question on the dynamics with EPIDIOLEX that you called out. There's been some prior cases of drug launches in the past that you can compare this to. Could you walk us through any color comparisons or qualitative comparisons from those launches, and how do they inform your view of what's happening here with EPIDIOLEX?
Sure. Hey, Matt, it's Melissa. The last most comparable launch would be launch of Vimpat, which was in June of 2009. During that timeframe, we saw approximately a two-quarter impact to new patients. While that drug was significantly different than EPIDIOLEX, has lots of very generalized indication. We do, as we mentioned previously, expect the impact of EPIDIOLEX to be slightly longer due to just the timeframe it takes to receive the prescriptions and the scheduling. Although the impact is quite similar on a percentage basis.
Okay. Then with regards to the commercial disruption that you called out in Neuromod, could you talk a little bit more about what the plans are to make sure that that gets better? If you're losing some reps, is this a change in the market, or was just a one-off event that happened together? Could you give us any color on where you might be losing folks to?
Yeah. I think it was a confluence of events. You had the EPIDIOLEX timing at the same time as some competitors acting and hiring. Some of them did go to GW Pharmaceuticals, and I think they made fairly compelling offers to them financially. Having said that, I think we were able to retain a number of people, and I think our value proposition or patient proposition is something that goes beyond just compensation. I think being able to explain that was a key part of it. Having said that, we are re-looking at the sales force compensation and have implemented changes already for this quarter and beyond. We're looking at territory optimization, which is a key step that we're taking. We're looking at our competitive positioning and the story we're telling, and how we tell that story.
I think all of those things are going to help us readjust the sales force and commercial disruption. As I said, we've been on top of where Melissa was with how do we deal with the timing of EPIDIOLEX.
Great. Thanks a lot for the color.
Cheers, Matt.
Our next question comes from the line of Mike Matson from Needham & Company. Your line is open.
Morning. Thanks for taking my questions. I guess just want to start with the OpEx guidance. On a dollar basis, Thad, maybe you can comment on SG&A and R&D spending on a dollar basis. Is that expected to be up or down versus your prior plans?
SG&A is clearly going to be down in roughly $0.15 of EPS to kind of mitigate what is roughly about $0.75 of EPS impact due to the sales shortfall that we're calling out here. We're covering a portion of that. We are, as I mentioned earlier, ring-fencing the R&D programs within our guidance at this point. We will take a deeper look at R&D and see what we can do to further optimize the spend there.
Okay. Given the issues in the Neuromodulation business, are you planning any changes to the DTC efforts there? Are you going to increase it, decrease it, maintain it in the shorter term?
I think for the most part, we're kind of continuing with our plans, but what we are looking at, better understanding the pull-through. We've increased the number of patients into the funnel, and so we're pleased with the results, but it's still early. We're kind of closely monitoring that and phasing some investment and slowing down some other things till we have a deeper understanding of the results.
As we mentioned, re-looking at our competitive positioning, how we're telling the story.
Right
versus the drugs and drugs plus VNS and why it plays a critical part of the thought process, not as an afterthought.
Sure. Just with the gross margin guidance, I guess I'm a little surprised it was only down 50 basis points from previously, just given the high margins on the Neuromodulation products. Are you offsetting some of the impact somehow, or?
Yeah. The good news is that we have seen and continue to see really great momentum.
In ACS.
Yeah, on ACS, also just generally on the mix of our business. We are also seeing SenTiva as a percentage of total Neuromod implants also improve as a percentage overall. We think that SenTiva could reach 70%-75% of total generator sales. The price is holding up. Overall regional mix is strong. Although we took Neuromod sales down, we still feel confident about that range that we provided.
Okay, great. Thanks a lot.
Thanks, Mike. Cheers.
Our next question comes from the line of Jason Mills from Canaccord Genuity. Your line is open.
Hi, Damien, Thad, and Matt. Thanks for taking my questions.
Hi, Jason.
Damien, I wanted to go back to the questions about neuromodulation and some of the drivers of the impact there, and specifically the sales force. Look, I have a hard enough time climbing into my own mind, but I'm going to ask you to help us understand the calculus that may be going through some of the minds of these reps that are leaving. The dynamic, as I look at it, as you're portraying it from an opportunistic standpoint, is that you have still a big opportunity in DRE and a pending opportunity that isn't too far out in TRD. The question is just why are these reps leaving? Is it truly, in your mind, a near-term comp issue?
As a related follow-up to that question, that doesn't seem like something or a driver that would be a surprising sort of end of quarter situation, or was it? Could you give us some help there on the calculus of reps leaving? It seems like it implies that they think it could be longer term.
Well, I'll come around on that second part first. What surprises is, a few reps did leave in the quarter, and they were particularly high-profile reps. A significant amount of revenue dried up with their exit in the quarter. Where you change the patient dynamic as well as the ordering, purchasing from their specific accounts. In the quarter, that was a definitive issue for us, and the bigger issue is for us, the whole competitive landscape has really amped up. We've found a lot more competitive hiring, not just in epilepsy, but in implantables. We saw an uptick in turnover, and again, in a few key regions. Those are the things for us that really ticked up. Now, what do we need to do about it? We need to really dive into compensation and territory optimization.
Do we need to make some changes to the way territories are aligned and supported? We've already made changes in the compensation at all three levels of the area director, the regional manager, and the salespeople. I think that's the key thing. We also look at what resources we're giving them and how they can be more effective. Are those the things that were causing them to think about alternatives where I could go to a job that had better resources or better support. We believe on the first compensation changes, we've made great progress. We've got work to do on the support and the messaging, and that's one of the other key sets of programs that we're leaning into.
Okay, thanks for that. As a follow-up to that, could you just talk about in general, the neuromodulation sort of marketplace. As you think through some of these dynamics that are impacting the business, in addition to some of the things you're talking about putting in place, could you talk about just the cadence as you roll through the year? If you've got a 6 to 9-month trialing period, as you pointed out with the drug, and you also have more difficult comps for the U.S. Neuromodulation business in the second half of the year, is it reasonable for us to expect that organic growth in the second half of the year will actually tick up?
It seems like somewhat of a precarious place to be modeling growth to tick up against a difficult comp, given that you'll still be sort of overlaying some of the trialing periods that you pointed out. Thanks for taking the question.
Yeah, that's okay. Well, a few things. You come in on guidance day.
Yeah.
Look, first of all, the number of reps we're talking about isn't the entire sales force. We've got a bunch of really talented people who are very committed to the patient messages that we have. We've got a sales force that has still lots of opportunity, I think that the people that have stayed see that. We're going to continue to work with them again. Compensation's one part of it, but tools and messaging, I think, is really key. We've been very prudent with, I think, the guidance saying that where we think Q2 is in that $70 million-$80 million range, and what we're saying about the full year with the $315 million-$325 million. I think we're also trying to let people understand that it's largely going to continue in Q2. Again, we've given the Q2 number.
Right
This is unusual for us. We also wanted to be clear about why we think it's going to look different in the back half of the year.
Right. I think to me, and again, we recognize we surprised the market in Q1 with the results. Providing the range of $70 million-$80 million provides a baseline for what we think the impact will be of this EPIDIOLEX effect. Then, as you look at the back half of the year, showing an improvement versus Q2, but still a decline versus probably prior NBI, is kind of how we're thinking about it from a forecast perspective, and that's how we get to this $315-$325 overall annual U.S. Neuromod sales.
Okay.
Thank you, guys. I'll get back in queue.
Thanks, Jason. Appreciate it.
Our final question today comes from the line of Scott Bardo from Berenberg. Your line is open.
Yeah. Thanks very much for taking the follow-up. Just a discussion on the heart valve business. Clearly, this has not been performing, not just the last few quarters, but in honesty, the last 10 years or so. I guess the question I have is, what makes you convinced that LivaNova is the right owner for Perceval and the structural valves franchise? As a follow-on, can you operate in mitral valve if you don't have structural valve within your portfolio? Thank you.
Hey, Scott, great questions. First of all, let's do the second part first. The answer is yes. It's a different call point, different disease state. In some instances, there are panels where you've got the entire cardiac group. We largely believe that that call point is a different one between the surgical and the transcatheter. I would point you back on the heart valve business to the last two years. We've largely transformed the portfolio. We've been able to make changes across the board. We've exited some businesses, doubled down in others. That transformation, I think, has progressed well. We've built this robust pipeline, which is, I think, really going to read through, mostly starting later this year into next year. We've largely really focused on key issues, and we intend to fix them. One of those being the Perceval business.
I think we've been very clear that the traditional surgical valves are probably going to head towards zero, and relitigating that part of the portfolio wasn't ever our intention. Stabilizing mechanical while getting Perceval growing was a key opportunity for us. I do see a number of our salespeople on the commercial teams being able to execute at what I consider benchmark performance. We're seeing strong growth in parts of the world, in international and Europe. We've got reps in the U.S. who are performing brilliantly. Focusing on them, giving them the resources and the things that I talked about, the procedure training, better indications to talk about, better data, the 10-year data. Now we've got reinvestment in Japan, commercializing in Japan.
Valve in valve.
The valve in valve, right? The history of our last two years is transform the portfolio, build the pipeline, focus, and fix. That's our intention with this part of the portfolio, too. You'll know that we'll make the tough decisions when we need to.
Understood. Last one, please. I've always argued that in your Neuromodulation business, growth is also pretty aligned to product cycles. Clearly here we are in a year where growth is pretty subdued, we haven't got a major new introduction of a product. With that in mind, can you lift the curtain a little bit on SenTiva 2.0? Is that evolution or a revolution, or how should we be thinking about that into next year to give us some comfort that the sort of growth impacts are transient? Thank you.
I think two things. I'm a believer, too, that SenTiva was a significant opportunity. An 18-month or 24-month cycle isn't anywhere near long enough to fully exploit the benefits of that. I still think we've got plenty of runway with SenTiva. Having said that, 2.0 is, I think, going to be really an impressive change. It's got the Bluetooth capability that the team are developing and the ability for the product to communicate into the cloud. When you talk to patients, the big issue is empowerment. We think that being able to give them more access to information is going to empower them. I think from the clinical side, being able to access the data and do more with the data, and not necessarily have the patient coming into the clinic is also going to be powerful.
We believe there's a lot of upside in that. This is why we believe our investment in digital innovation is really key here. It's a major opportunity for us.
Got it. Thanks very much, Damien.
Brilliant. Thank you, Scott.
We have no further questions in queue. I'll turn the call back to the presenters for closing remarks.
Well, thank you everyone. We know that the queue was not the sort of numbers that you wanted us to print, nor was it the numbers we wanted to print. We've been focused on transforming the company over this last two years. We've built a robust pipeline, and we intend to focus and fix the issues that we've spoken about. Thanks for your questions, and we look forward to the conversations with you on behalf of the whole team here. Thanks.
Thank you.
This concludes today's conference call. You may now disconnect.