Good day, ladies and gentlemen, and welcome to the LivaNova PLC second quarter 2018 earnings conference call. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Matthew Dodds, LivaNova's Senior Vice President of Corporate Development.
Thank you, Matthew, and welcome to our conference call and webcast discussing LivaNova's financial results for the second quarter of 2018. Joining me on today's call are Damien McDonald, our Chief Executive Officer, Thad Huston, our Chief Financial Officer, and Melissa Farina, our new Vice President of Investor Relations. Just yesterday, Melissa was promoted to her new role, having previously served as the CFO of our North America region. Before I begin, I would like to remind you that the discussions during this call will include forward-looking statements. Factors that can cause actual results to differ materially are discussed in the company's most recent filings with the SEC. 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 an exhibit to LivaNova's current report on Form 8-K filed today with the SEC.
We have 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 website under News and Events, Presentations at www.livanova.com. With that, I will now turn the call over to Damien.
Thanks, Matt. Well, welcome to our second quarter 2018 conference call. The results from this quarter reflect the initial success of our growth strategy, which is centered on our cardiac surgery and neuromodulation portfolios. We saw acceleration in our underlying sales growth and grew earnings while making significant commercial and R&D investments. I'm going to provide some highlights and then discuss our sales results by business, and after my comments, Thad will provide you with additional color on the financials, and I'll wrap up with closing comments before moving to Q&A. Starting with the quarterly highlights and recent events. At the end of May, the U.S. Centers for Medicare and Medicaid Services published a tracking sheet to reconsider its national coverage determination, or NCD, for our VNS Therapy system for treatment-resistant depression.
The tracking sheet was in response to a letter that we submitted to CMS requesting a formal reconsideration of the NCD. We requested this review after a significant body of new evidence emerged about TRD and the role of VNS Therapy in its treatment. We are encouraged that CMS has taken this step, and we were pleased with the comments received during the initial 30-day public comment period, which closed at the end of June. The process to release a proposed decision memorandum can take up to 6 months. Once that occurs, CMS will have another 30-day public comment period. By the end of February 2019, the agency will render a final decision. Depression affects more than 300 million people worldwide and is the leading cause of disability in the U.S.
TRD is a smaller subset comprised of patients who have tried four or more treatments for their depression and failed. This is an area of high unmet need and one where LivaNova can make a difference. We are hopeful that a result will help ensure adequate patient access to this important therapy. On June 11th, we announced that Japan's Ministry of Health, Labour and Welfare approved Perceval Sutureless aortic heart valve. The Perceval Sutureless valve is supported by more than 10 years of clinical evidence. To date, more than 25,000 patients worldwide have been treated with Perceval. We are currently working to obtain reimbursement in Japan. This is a large opportunity that allows us to provide patients and clinicians with a new option for aortic heart valve replacement. A couple of days later, on June 13th, we announced that Bill Kozy was elected to our board of directors.
His career spans more than 40 years in the global medical technology industry and most recently as Executive Vice President and Chief Operating Officer at Becton, Dickinson. He brings extensive board and healthcare experience to LivaNova, and he offers a broad knowledge of global strategy, manufacturing, M&A, and product development. We welcome Bill to the LivaNova board and look forward to his contribution. In the coming weeks, we expect to announce the conclusion of the PRELUDE feasibility study of our transcatheter mitral valve replacement, or TMVR, system. The PRELUDE first-in-human study evaluated Caisson's TMVR system to treat moderate to severe mitral regurgitation using a transseptal approach. Following the encouraging patient outcomes from the PRELUDE study, we will focus on enrolling patients in the INTERLUDE CE Mark trial and finalizing the protocol with the FDA for the U.S. pivotal trial ENSEMBLE.
The INTERLUDE trial will be conducted in North America and European centers, with enrollment completion expected by 2020. Before I turn to our sales results, I want to provide an update on our June 6th announcement regarding a pause in the THN3 ImThera OSA clinical trial. While we are generally pleased with the progress of this clinical trial, we have stopped enrollment at 138 patients and will continue to treat patients as originally planned. However, we believe that improvements can be made to the titration process and the level of product variation that existed throughout the data collection period. Given these factors, we intend to approach the FDA with a protocol for a confirmatory trial. Turning now to our net sales results for the quarter. These will be stated on a constant currency basis unless indicated otherwise.
Total net sales were up 10.2% and 8.7% on an underlying basis. That is, excluding the impact of foreign currency, the TandemLife acquisition, and the termination of a contract manufacturing agreement we previously mentioned. Both neuromodulation and cardiac surgery showed strong growth in the quarter compared to the second quarter of 2017. Cardiac surgery sales were $176 million, up 8.3% from the second quarter of 2017 due to growth in cardiopulmonary, Perceval, within the heart valve, and the inclusion of TandemLife or advanced circulatory support. Cardiopulmonary sales were $137 million in the quarter, an increase of 7.2% versus the second quarter of 2017. Double-digit growth in heart-lung machine sales in both the U.S. and rest of world was a major contributor as we continue to replace our legacy S3 device with our current S5 device. Turning to heart valves.
Sales for heart valves were $34 million in the quarter, a decline of 5.1% versus the second quarter of 2017. Perceval grew in excess of 20% in all three regions and offset declines from the mechanical and traditional tissue valves. Excluding the terminated contract manufacturing impact, heart valve sales grew 1%. Advanced circulatory support captures our recently acquired TandemLife business, and sales in the second quarter were $6 million, representing roughly 20% growth versus the company's second quarter 2017 sales. We expect this business to grow 30% for the full year as our expanding sales force builds momentum going into the second half of the year. Now let's turn to neuromodulation. Sales were a record $111 million, up 13.2% versus the second quarter of 2017.
In the U.S., we saw continued momentum in our initial implants and an improvement in the end-of-service implants versus the first quarter of this year. U.S. adoption of SenTiva continues to increase, represented 51% of our generator sales in the second quarter. We saw 18% growth in neuromodulation sales in Europe based on the approval and launch of SenTiva during the quarter. Our rest of world region delivered over 50% growth in neuromodulation, driven by the early success of our business model change in Japan and favorable reimbursement decisions in five additional countries. 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 second quarter financials in greater detail and speak further about guidance. As Damien mentioned, sales growth in the second quarter accelerated to 10.2% versus second quarter of 2017 due to strong sales in all of our growth drivers in each region. Adjusted gross margin as a percent of net sales in the quarter was 68.3%, up 70 basis points from the second quarter of 2017. The margin improvement was primarily driven by price and mix, partially offset by a 30 basis point foreign currency headwind. Adjusted R&D expense in the second quarter was $33 million, compared to $23 million in the second quarter of 2017. R&D as a percentage of net sales was 11.3% versus 8.9% in the second quarter of 2017.
This 240 basis point increase equates to approximately $0.15 in EPS and represents an increase of 43% over the prior year. As we previously discussed, R&D is increasing behind our development of next-generation products, including HLM, SenTiva, and TandemLife, and clinical trials and investments in TRD, TMVR, sleep apnea, and heart failure. Adjusted SG&A expense for the second quarter was $104 million, compared to $86 million in the second quarter of 2017. SG&A as a percentage of net sales was 36.2%, up 260 basis points versus the second quarter of 2017. The increase is due to a number of factors, including foreign currency exchange headwinds of 70 basis points, investments in our key growth drivers, including DTC for epilepsy, TandemLife, and strengthening our go-to-market capabilities in emerging markets, as well as building organizational capabilities to support our future growth, including investments in our IT infrastructure.
Adjusted operating income from continuing operations was $60 million, compared to $64 million in the second quarter of last year, which reflects an improvement in gross margin offset by the expected investments in our key growth drivers, clinical activities, and a negative impact from foreign currency. Adjusted operating margins from continuing operations was 20.8%, down from 25.1% in the second quarter last year, but up from 16.6% in the first quarter of 2018. Our adjusted effective tax rate in the quarter was 17.4%, an improvement from 24% in the second quarter of 2017, as a result of ongoing tax efforts and recent changes in the U.S. and U.K. tax laws. Adjusted dilutive EPS from continuing operations in the quarter was $0.96, an increase of 3.2% compared to the second quarter of 2017. Moving to cash flow.
Our cash flow from operations for the six months ended June 30th was $49 million. Cash flow from operations, excluding payments for one-time integration and restructuring costs, was $89 million. Capital spending for the six months of 2018 was $13 million, down from $15 million for the same period of 2017. Reflecting the impact of the $78 million payment for ImThera, the $205 million payment for TandemLife, and the net proceeds of $187 million from the divestiture of the CRM division, our cash balance at June 30th, 2018 was $47 million, down from $65 million at March 31st, 2018. Our net debt at June 30th was $113 million, down from $121 million as of March 31st. Turning to 2018 guidance.
Our 2018 guidance remains unchanged from the guidance provided on May 2nd, which includes constant currency sales growth of 6%-8% and adjusted dilutive earnings per share from continuing operations in the range of $3.50-$3.70. Assuming current rates, foreign currency is expected to contribute 100 to 200 basis points to sales growth and negatively impact earnings by approximately $0.10 per share. I'll turn the call back to Damien for some final comments.
Thanks, Thad. As we round the turn into the back half of the year, I'm very pleased with our results to date. We have delivered sales growth towards the upper end of our guidance and solid earnings growth. We are improving our gross margin through price discipline, product mix, and cost efficiencies, while also making significant investments in our future. Expanding our pipeline, innovating next-generation products, and funding clinical trials for our growth drivers and strategic portfolio initiatives, which include treatment-resistant depression, TMVR, obstructive sleep apnea, and heart failure. In cardiac surgery, double-digit growth in our heart-lung machines is well above market rates, and we are starting to see positive momentum in oxygenators. Perceval continues to grow north of 20% and now represents over 50% of our surgical heart valve replacement sales.
TandemLife is off to a good start post-closing, we expect the business to accelerate in the back half of the year behind our planned commercial expansion. In neuromodulation, we're seeing strong demand for our SenTiva VNS system in the U.S. and now Europe. We look forward to updating you on our continued progress and delivering on our commitments to drive shareholder value. With that, Matthew, we're ready for questions.
Ladies and gentlemen, in order to ask a question, please press star and the number one on your telephone keypad. Your first question comes from Rick Wise of Stifel. Your line is open.
Good morning, everybody, thanks for the excellent quarter. Maybe just starting off with guidance. Obviously, a nice step up on multiple fronts in the second quarter versus the first. If I just step back and think about the first half ex FX, you grew top line 7.9%. Maintaining your 6%-8% guidance for the year would imply a 4%-8% guidance second half growth range, if I'm doing the math right. At the upper end, second half basically doing what you did in the first half overall. Maybe just help us think through some of the variables that would drive the lower or the upper end of that range. I assume there's no particular reason we should assume you'd decelerate in the second half. I think you'd feel, frankly, more confident about the upper end of that range.
Just talk us through some of those factors. Thank you.
Thanks, Rick, great question. Clearly, we're very pleased with the first half performance. As you know, the comparisons vary kind of quarter by quarter. We definitely feel very comfortable with this range, given where we are and how we're progressing. I think one of the things to consider is that we do have somewhat of a difficult comp into Q4 due to the strong results for SenTiva and in particular HLMs. Again, we're very pleased with the momentum that we have, and again, excited about where we are in this range.
Turning to Neuromod. Obviously, second quarter, much better than the first. Maybe talk us through some of the factors that drove that. You mentioned a couple of points, do we think about second quarter Neuromod growth as representing more sustainable growth? Is this how it should grow? Maybe talk us through where you are in the SenTiva rollout.
Yeah, look, I think that Neuromod really proved itself, not just in the U.S. Those results in Europe and international were really fabulous. Again, the go-to-market strategy is starting to read through in all the regions. The first half performance, I think was great. In the U.S., I think the things that really drove it here are new patient implants. We saw a continued growth there. Improved end of service versus Q1, which we spoke about. The mix to SenTiva, I think, is continuing well. More than 51% of the units were in SenTiva. As I mentioned, the EU rest of world growth really kicked. Overall, I think that the numbers we've been talking about, it's high single digits for the portfolio. I think we're continuing to see that.
Just one last one from me on treatment-resistant depression. As you highlighted, we'll wait for the CMS decision, but maybe talk us through a couple of points, particularly on the commercialization front. What kind of investments have you made, are you making, will you make? What needs to be done? When will you do it in terms of expanding, if you're going to expand the sales force? Really the bottom line, how quickly, if assuming and hoping for a favorable ruling, how quickly can you capitalize on that commercially? Do we expect you to have, again, assuming reasonable timelines, a favorable impact in 2019? No, it's more like 2020? Thank you very much again.
That was a really comprehensive question, Rick. There's a whole bunch of things there. I think the take we had on the 30-day comments was really positive. There's a lot of pent-up demand, we believe, and we're continuing to hope that CMS can find a way to make this available to more broad set of patients. We're really going to wait for the CMS results. That's the single largest gating item for us in the U.S. Having said that, at the same time, I think we've talked about this a little bit before, we're really working on understanding the patient pathway, how you move from a psychiatrist to an implanting surgeon, which is a neurosurgeon or ENT, and then back to the psychiatrist. The German team with the European leadership is really taking the lead on that.
We'll, in the U.S., wait until we see where we get to with CMS. In the meantime, we're learning from the German team about how to move patients through this pipeline.
Again.
I think that more or less covers it. It's clearly a long conversation, but we're not waiting around. We're trying to learn and understand the ramp, and then we'll come back with CMS.
Appreciate the color.
Thanks, Rick. Cheers.
Our next question comes from the line of Raj Denhoy with Jefferies. Your line is open.
Hi. Good morning.
Hey, Raj. How are you?
Hey. Doing okay, thanks. What if I could maybe just ask a couple of follow-ups to Rick's question. On the VNS results in the quarter, particularly in the U.S., the rebound from the first quarter. How much of that could you maybe say was catch-up from the first quarter in the sense that maybe some of the procedures got delayed and then recognized here in the second quarter?
Yeah, I wouldn't say a lot of it's catch-up. I would point a lot to sales force execution. There was an uptick for sure in the end of service. We wouldn't really characterize it as catch-up. I think last quarter we talked about some contract movement. Really saw minimal benefit from that in the quarter. It's a full-year contract. Really, it's just about continued focus of the U.S. team, and again, I'm really pleased that their efforts read through.
Okay, that's fair. Maybe I could ask about the initial TandemLife contribution of the $six-ish million in the quarter was probably a little better than we were expecting. What's been the initial receptivity there? Does that represent a pace we can expect going forward? How has that rollout been now that you own that product? Maybe just a little more detail would be helpful.
Hi, Raj. Look, I think this is really a great example of good portfolio management and a business that the more that we learn about it, we get even more excited about the opportunity. I think we're off to a really good start. The team's highly engaged. The leadership team went out and spent some time, and Damien and others are going back out again to Pittsburgh. The team is highly engaged about the opportunity. We feel really confident about the 30% sales growth target for the full year as we continue to expand and ramp up the resources to support that business.
That sort of segues to my other question. The spending in the quarter, again, I think you've sort of conditioned us to expect the spending is going to be higher over the short term, as you invest in the business and things. On an absolute dollar basis, SG&A did tick up pretty significantly, $104 million here in the quarter. R&D was up as well. How do we think about those numbers on sort of an absolute spending level? Could you see the $104 million in SG&A, for instance, still going higher? Are there additional areas that you're planning on investing in over the near term?
We're clearly investing to grow, I think the growth results are coming through. We're very pleased with the top-line performance, we're also very confident that we will deliver the SG&A expense for the full year within our guidance range. There is kind of a bit of a phasing of sales and a phasing of expenses. The way I would think about it is overall SG&A should remain relatively flat at this level on an absolute dollar basis. In the back half, the sales start to rise. In addition, we had in the front half of the year, FX that basically added about 100 basis points of headwind to SG&A. When you look at the back half, we're not expecting that. Again, I believe, we'll be within the ranges.
That's helpful, very nice quarter. Thank you.
Thank you, Raj.
Thanks, Raj. Cheers.
Our next question comes from the line of Matthew O'Brien with Piper Jaffray. Your line is open.
Morning. Thanks for taking the questions. Just to put a little bit finer point on the neuromodulation commentary. I think, Damien, you've talked about a lot of new physicians that you've been able to capture since the SenTiva launch. Can you talk about where we are in that process as far as some of those new clinicians go, their utilization and how that's trending and how we should think about that, and this is specific to the U.S., throughout the course of the year. Layered on top of that question, the OUS business, I know it's smaller as a percentage of the total neuromod business, but the numbers there are eye-popping, especially rest of world. Can you just provide a little bit more detail on some areas of strength, rest of world and growth opportunities, in those regions?
A great thread there, Matt, and a few things. The implanting physicians, I think there's two things happening here. We've seen a number of new physicians come on. That's important. What we've seen is that they've come on quickly, which is unusual. Normally our conversion time has been longer. I think the SenTiva upgrade has really given new implanting physicians more reason, as we'll talk about inside, let's remove the barriers. Making it smaller, it's got the responsive technology, the MRI, and then the age indication, I think has removed a number of barriers for new physicians. The speed with which they've come on has been really important to us. I think the other thing is there's been a number of returning physicians, and these are people that had not implanted for greater than 12 months.
There's a group of people who've come back to VNS, as a result of SenTiva. I think those two things have been really important. Again, it's still pretty early days, I think what we're encouraged by is some other metrics that we've been tracking, like the average age of a patient, which is continuing to come down quarter-on-quarter. I'm really pleased with how the U.S. team have leaned into that. We still have an enormous upside here. Not getting into the physician numbers, let's talk about the patient opportunity. There's, in round figures, 5,000 new patient implants a year, out of a patient pool of about 100,000 new DRE patients every year. We just see a tremendous upside for us as we continue to do our go-to-market activities. Internationally, I would say there's a number of things there.
Firstly, as a combined entity now, I think we've put much more emphasis on international growth, and I mean Europe and the rest of world. The teams there have been significantly upgraded. The drive and the focus has been changed. We've changed the business model in a number of markets, in Japan, in Latin America, and Australia. Japan particularly is early days, going to this hybrid model where we have direct feet on the street now, I think is critical. This is a complex sell. You need to be hand in hand with the physicians, it's hard to do that in the alternative structure. Putting feet on the street, I think, has really started to make a difference.
I'm thrilled for the teams there because we've asked a lot of them, to see these results pull through in Europe and international is really tremendous.
Yeah. In addition, having CE mark for SenTiva in Europe.
Yeah
I think is a really key driver for our growth in Europe. As Damien said, we're really investing in globalizing our neuromod portfolio. It's an exciting time. One of the reasons our SG&A is higher is that we're investing to go direct in many markets.
Yeah. That was one of the highlights of our investor day last year, is we said, we really want to focus on international growth of the neuromod. 85% of the revenue came from the U.S., that's where we saw a real opportunity to drive growth.
Got it. Then, to follow up on Rick's question on TRD, we're all trying to get a little bit better sense of the potential outcomes, from this reexamination by CMS. How do we think about the potential variance in terms of coverage that the agency could put on VNS for depression? Then, back when you had the clearance plus coverage, is basically drug and VNS, now you have another layer in there of some less invasive approaches like TMS therapy. Just within the treatment paradigm, where does VNS fit, assuming that there is some coverage that's provided sometime next year?
Yeah. Look, I think coming back to the options. One is they could reaffirm the non-coverage decision, which still remains a possibility. There's the other end of the pendulum, which is they completely open up and reverse the non-coverage so that there is a National Coverage Decision. There's variations of that. It could be a National Coverage Decision or just a regional coverage, so allowing the 12 regional MACs to get into a MAC-by-MAC coverage. There's sort of a middle ground, which is a coverage with evidence. In that, there's variations on that. Could it be a clinical trial or a registry? I think we've signaled to CMS we're really interested in working with them to make sure we answer all the questions. We've had tremendous interaction with them up till now.
I think we continue to believe that we've got a great therapy that I think can meet some of these incredible unmet patient needs. Think about it like those are more or less the four outcomes. I'd love to handicap it for you, except that there's no real precedent for this, and so handicapping is not particularly useful. We're hopeful that we can come to a positive decision. In terms of the other approaches, there's a couple of ways to think of this. One is that this market is just absolutely huge. There's clearly a pent-up demand, and you could see that in the last time when we had coverage, the sort of ramp that occurred. I look at these other things like TMSs slightly earlier for treating treatment-resistant depression.
They have merit, and we've seen results of some of these approaches, and I think they've definitely got merit in the treatment pathway. Nevertheless, this treatment-resistant depression is quite refractory. We believe that the market is an enormous opportunity for us. Again, that's why we're trying to learn from the German market about where this occurs and how to make the patient flow work. I was with a group of level 2 and level 3 clinic psychiatrists in the U.K. a couple of weeks back. What really intrigued me is the discussion wasn't about, "Does this work? Yes, no." I was really encouraged by the focus of the discussion, which is, how do we make this accessible to patients? What do we have to do to convince payers to get at this?
I'm really encouraged by this pent-up demand for something that is just desperately debilitating for patients.
Okay, last one from me. I really appreciate all the detail so far. It's been very helpful. Just specifically on TRD, are you starting to put some more resource in place? I see a little bit of a spike in SG&A, like Raj mentioned. Are you starting to put some more resource in place, be it reimbursement folks or sales force specifically to TRD at this point? Are you going to wait until you get clarity before doing that?
We've made some investments, clearly, also in registries globally around TRD to both support more data, but also preparing scenarios at this point. We haven't really fully ramped up until we have more clarity around CMS's decision.
Specifically about sales force. We haven't started hiring a sales force in the U.S.
Right.
Got it. Very helpful. Thanks so much.
Cheers, Matt. Thank you.
Our next question comes from the line of Mike Matson with Needham & Company. Your line is open.
Good morning. Thanks for taking my questions. Just wanted to start with the ImThera trial issue that you mentioned. Wondering if you could provide a little more detail around that and what it means for the timing of potential approval for that in the U.S.
Yeah. Look, thanks. Again, I'm glad you raised that. We bought the asset when they were getting into a fundraising period. In our diligence, we knew there were things that we were going to learn as we went. As we've learned about what's going on with the product, we really felt that what we needed to do was make improvements to the product, we needed to make improvements to the titration process, and we needed to make improvements to the trial design. We stopped enrollment really to allow us to do that. We think these are best implemented probably in a new cohort of patients under one common set of conditions. What that does will really optimize the way we look at the patient benefits and the approval and the reimbursement process.
I think this is a really prudent way of looking at this asset. You know we like fixing things. We've really taken a pretty deep look at this. In terms of timeline, our original PMA submission was late 2019, early 2020. I think what you do is add at least 12 months to that timeline.
Okay. That's helpful. Then just also want to ask about another pipeline product, the Caisson. I think you mentioned finalizing the U.S. pivotal trial and completing the CE mark enrollment by 2020. With that, I guess, can you clarify what sort of time you would expect or when you expect the U.S. trial to actually start and when you would expect to get CE mark, potentially? I assume that-
Yeah.
-that's coming.
Look, I think the team have done a great job. The pause that we had on Caisson really set us up well for this back half of the PRELUDE trial. Having the additional sizes has really helped with enrollment, which is why we were able to bring it in a little earlier on completion. Now, the focus on INTERLUDE in the U.S. and European sites, we're really assuming completion of this in 2020. Then, depending on where we are in the year, 2020 or 2021 for CE mark. We're really excited about not only what happened in PRELUDE, but what the team learned. I think that the way they've built out their training and procedure development here has really been impressive. We were up in Minneapolis a few weeks back. I really like how these guys are progressing on therapy development.
Okay, thanks. Just one question on Perceval. It was approved in Japan, is that material enough that you could see an acceleration in Perceval growth given the launch there? Thanks.
Yeah. Look, first thing is, Perceval growing north of 20%. In the past, we've been a little more oblique in the transparency there. Hopefully everyone likes the fact that we're a little more declarative of what solid double-digit means. We do see Japan as a growth accelerant. First, we have to get through reimbursement. We're going to work with the Japanese reimbursement authority to get that locked down, and then at the same time put some more feet on the street to make sure that we can get after this. It's a great growth opportunity.
I would expect Perceval to accelerate.
Great. Thanks.
Once again, if you'd like to ask a question, press star, then the number one on your telephone keypad. Our next question comes from the line of Scott Bardo with Berenberg. Your line is open.
Yeah. Thanks very much for taking my questions. First question, please, just relates to the gross margin. I appreciate you've had some gross margin progress this quarter, but I think you had 170 basis points gross margin progress in the first quarter, and 70 basis points in the second quarter, despite pretty strong mix effects from Neuromod, which grew very robust in the second quarter, and heart-lung machines. I wonder, is there any particular negative effects? I think currency was even worse in the first quarter. Was there any other business-related negative effects limiting your gross margin progression in the second quarter? That's first question, please. Second question just relates to the cardiopulmonary business. Can you give us a status update on the progress of the oxygenator business, which I think is a more sustainable growth driver than the heart-lung machine upgrade cycle?
Where are we with that, and where are plans to accelerate that? I'll give another question and have another follow-up, please.
All right.
With respect to the ImThera delay, can you confirm then that the payout or the earn-out payments of this $225 million that you initially outlined may now be less than initially expected, such that you won't end up paying this full sum? Thank you.
Thanks, Scott. Let me first take the gross margin. I could also probably comment a bit on the earn-out as well. First of all, on gross margin, we're extremely pleased with the progress. First of all, as you know, we have been very focused on pricing discipline, also improving the mix of our portfolio, both regionally and in overall sales, trying to drive more profitable sales. We're definitely trending towards the high end of the range, given the pricing discipline and the cost improvements that we've seen quarter-on-quarter. As you rightly point out, we had currency headwinds in Q1. We had currency headwinds in Q2 that in Q3, Q4 should be less of a factor for us going forward.
I think when you look at it quarter-by-quarter, though, we do typically see slightly lower gross margin in Q3 due to plant absorption issues in Europe. There's a lot of holidays going on and things like that. Also, we're starting to see our Rest of World business grow at a higher level than our overall growth. To me, the mix of kind of regional gross margin changes as Rest of World is a bit lower than the U.S.
Although improving.
Improving.
Yeah.
It's improved significantly over the last year. I think, again, we promised and communicate very clearly Investor Day that we would see 100 basis points of improvement per year. We're on track to do that this year, and we think that that will continue.
Do you want me to do oxygen?
Sure, you do oxygen.
Look, the CP and the oxy business is really tremendous what the team has done. Again, you consider where we were 18 months ago. The ramp here has been phenomenal, and I'm really pleased on what they've done and what we asked people to focus on first, which was heart-lung machines. We saw that as critical given that the selling cycle for that is quite long, 10-12 years. Shoring up our customer base on heart-lung machines was the first critical step. Related to that, getting something new into the pipeline, which we talked, again, about Investor Day, was one of the more pressing needs to ramp. We've come a really long way in 15 months on that pipeline product. The next thing we asked people to do was to focus on oxygenators. That effort is just really kicking off in Europe and the U.S.
What we're seeing early on is some recent account wins in the U.S. at some really big accounts, and we're continuing to focus on that. It's still early days. The trial period for that is a bit longer than I think people anticipated. Nevertheless, we've leaned into that and put in place essentially what we've talked about with heart-lung machines, which is the funnel management. We're now putting the same process in place for account conversion. We see a long runway with this, both in the U.S. and Europe. In international markets, it's a slightly different approach. It's very tender-driven. The international team have really leaned into that by putting investment into the tender management processes. Again, we're starting to see some portfolio simplification and better tender management read through. Early days on oxygenators.
As you say, it's got a long tail, and we're pleased with how people have leaned into it. We really did it that way because there's only so much you can throw at a sales organization in one go. I think we picked the right rhythm here, going after heart-lung first, then coming in oxygenator second, and I think you can expect to see that to ramp.
On ImThera, clearly the earn-outs are related to the sales levels. Of course, if sales change, then obviously the level earn-outs are tied to that.
Okay. Very good. Thank you.
Is that good [crosstalk] ?
Last question.
Yeah.
Thanks, Damien. Just last question, if I may. Just with respect to treatment-resistant depression, I appreciate you guys must be doing your scenario analysis, as are we all. Just to understand, I think at your investor day, you also outlined treatment-resistant depression as a potential opportunity. Can you confirm then that, in the event of a coverage with evidence recommendation from CMS, that you would expect some acceleration to your neuromodulation targets of 9%-10% or so? Are those targets, do they encapsulate a scenario where you get coverage with evidence for TRD?
Yeah. If we had coverage with evidence, that would accelerate beyond what we had highlighted investor day.
Very good. Thanks, guys.
Thank you.
Great. Thanks, Scott. Good to hear your voice.
We have a question from Jason Mills with Canaccord Genuity. Your line is open.
Thanks for squeezing me in, Damien and Thad. Can you hear me okay?
Yeah, we can. Great to hear you, Jason.
Thank you. Congrats on a great quarter. I wanted to go back to TRD, and I appreciate, Damien, that we're all sort of talking in hypotheticals here. Going back to a previous question with respect to how you see TRD fitting within the treatment continuum, and it's gratifying to hear that clinicians in Europe are talking about a when, not if. Just curious, as CMS does its work on this and ultimately comes to a conclusion, it seems like they're obviously working down a path toward trying to provide perhaps some reimbursement for this.
Within your models, and again, appreciating that we're talking in hypotheticals, do you need to see, or do you expect to see the same sort of reimbursement levels that were established initially, or are there ranges, obviously higher would be better, but are there ranges lower than previous that would fit comfortably within your pricing scheme and still provide the gross margin and growth infrastructure that you would require for this to be a good business for you? Can you speak at all about the range of potential outcomes there?
Yeah. Look, I'd love to. Again, this comes back to the handicapping CMS. Honestly, I think it's too early for us to speculate, and we really probably have to wait on CMS. Having said that, we know how to make this device. We have a really competent team in Houston. Scaling this in our existing infrastructure is going to be relatively simple. We think within the infrastructure we have that we could ramp up to meet any demand. We're not going to be adding additional manufacturing costs to really ramp here. In terms of the top-line pricing, it's really too early to get into that with any specificity.
Okay. Fair enough. Let me ask it a different way. Based on your analysis of the public comments, does it seem to you that, as you look over the period of the era of non-coverage, juxtaposed to the data that we saw originally and that you've seen in more recent studying you've done in Europe and the trials you've talked about, it would seem that, from a clinical evidence standpoint, there is a place for VNS Therapy for TRD. Do you get the sense that payers around the world, and specifically CMS in this country, are apprehensive about the level of reimbursement or the exposure that they could have to what you rightly characterize as a very, very large market? Do you get the sense that that's what they're, for lack of a better way to put it, scared about?
That's why I asked the question as to what would fit well within your model and still represent a really good opportunity for you?
Yeah. Okay. Without getting into the number, I think our health economics discussions have really shown the benefit of VNS Therapy in TRD. Look, again, the pivotal discussion here is really centered around the ARISTOTLE study, which is a really large trial. 800-patient cohort is a pretty significant trial size for a medical device. four plus drugs, five years of failed therapy. The cohort was really quite extraordinary. The response rate was a very significant shift from 41%-68%, the remission rate from 26%-43%.
When you package all that up and go back and talk about the total cost to the health system, when you consider how debilitating TRD is, how it completely incapacitates people, we believe that the discussions have really centered on how is it possible to make this available because for some health systems, it might seem like a scary number, but only if you look at it in isolation. You've got to look at it in terms of the total healthcare costs.
Yeah. The societal cost is very high of treatment-resistant depression.
Yes. The fact that we have such really solid data, not just in response, but remission.
Right
I think that's what really has crafted a lot of the reaction from psychiatrists and the payers so far. Again, you go step by step with this, but we really believe we can help people understand how this is a really positive effect for the healthcare systems.
Mm-hmm. Okay. That's helpful commentary. Lastly, Thad, maybe for you. Talk about portfolio management. You've done quite a lot, and obviously the model is bearing out the productivity that you and your team and Damien have put forward with respect to portfolio management and CRM divestiture. The question is, are there other things that we should expect to see you do over the course of the next, call it two to three years, that would materially change the look of your business? I suppose that's a question about what you could acquire or what your capacity is as much as it is about the potential that you see other opportunities for businesses that would fit better elsewhere. Thanks for taking the questions.
No, thanks. We truly have transformed this company in, let's say, a year and a half, from a low single-digit growth company to the results that we've announced today. It really is about great portfolio management. It's about focus. Divesting CRM, taking those proceeds, acquiring three other businesses in a little over a year, has really put us on a totally different trajectory for growth. We're investing behind those. TandemLife is a great example of near-term accretive deals that we want to do. We're looking for things that have revenue, that ideally are slightly profitable and where we can expand globally and invest around them. I'm super excited about TandemLife and where we can take that given the market size and the potential. We're going to look to do other deals and certainly bringing Matt on board and his insights.
We're looking at a number of different areas that are, I would say, complementary or tuck into our existing portfolio, either the technologies that we know or the call point that we could leverage upon and really scale up. I can't say by quarter, but clearly you should see more coming from us.
The capacity is there.
Yeah, we have the room.
We have almost no debt.
Exactly. We're very focused on improving our cash position. Even the fact that this past quarter, we were able to essentially divest and get proceeds from the CRM business, but at the same time acquire another business that's a high-growth asset, just shows you that we have more room to do more things, and we're going to continue to focus in that area.
Thank you, gentlemen.
Thank you.
All right. Thanks, Jason. Cheers.
There are no further questions. I'll turn the call back over to you.
Okay, Matthew. Well, look, thanks everyone for being with us this evening, this afternoon, this morning, and we appreciate the attention. Thanks everyone for the great questions. Again, as always, you are really well prepared, and we will look forward to the next call with you. Thanks very much for joining us today. Cheers.
This concludes today's conference call. You may now disconnect.