Apollo Endosurgery, Inc.
Q2 2017 Earnings Call Transcript

Published: 6 Aug 2017

[Operator:]

Good day and welcome to the Apollo Endosurgery Second Quarter 2017 Financial Results Conference Call. Today's conference is being recorded. At this time I would like to turn the conference over to Zack Kubow. Please go ahead, sir.

[Zack Kubow:]

Thanks, Operator and thanks everyone for participating in today's call. Joining me from the Company are Todd Newton, Chief Executive Officer, and Stefanie Cavanaugh, Chief Financial Officer. Before we begin, I would like to caution listeners that comments made by Management during this conference call will include forward-looking statements within the meaning of federal securities laws, including Apollo's financial outlook and Apollo's plans and timing for product development and sales. These forward-looking statements involve material risks and uncertainties, and Apollo's actual results may differ materially. For a discussion of risk factors, I encourage you to review the Form 10-Q filed today, August 1, 2017. The content of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, August 1, 2017, except as required by law, Apollo undertakes no obligation to revise or update any statement to reflect events or circumstances after the date of this call. During this conference call, we will be discussing certain non-GAAP financial measures, including adjusted total revenues. While we believe this information to be helpful in understanding Apollo's financial performance, it is not meant to be considered in isolation or as a substitute for the comparable GAAP metric. These measures should only be read in conjunction with Apollo's condensed consolidated financial statements prepared in accordance with GAAP. A reconciliation of the non-GAAP financial measures to the GAAP measures can be found in today's press release which was posted on our website and furnished today to the SEC on Form 8-K. With that said, I'd now like to turn the call over to Todd.

[Todd Newton:]

Thank you, Zack and good afternoon everyone. On today's call I will provide an operational overview of the second quarter followed by Stefanie's review of our second quarter financial results. The second quarter provided positive signs that we are approaching an inflection point where our Endobariatric product sales growth will overtake the maturation of our Surgical product sales. Endo-bariatric product sales were $9.5 million or 55% of our total sales this quarter, which was an increase of 13% over the second quarter of last year before or any adjustments for starter kits sold as part of our US Orbera product launch. When adjusted for US Orbera starter kit sales, our worldwide Endo-bariatric product sales increased by close to 26% and total revenues increased by just under 4% here in the second quarter. This was a solid result for Apollo and we are pleased with the momentum we are building. Looking first at OverStitch, physician education is an important part of our effort to drive continued adoption and higher use of the product. Last year, we directed the majority of our medical education resources, especially in the first half of last year, to Orbera physician training. This year, a larger proportion of our resources have been directed to OverStitch physician education. So far in the first half of 2017 we have trained more than 350 physicians on endoscopic suturing using OverStitch through a combination of formal faculty-led OverStitch programs, and hands-on training conducted in our Mobile Learning Center, and through the end of the second quarter, our Mobile Learning Center has made stops in 34 cities across the United States bringing OverStitch training to physicians who would not have otherwise had access to this without a significant amount of travel and disruption from their practice. Clinically, the second quarter was very active with a number of new publications about our products cited in peer reviewed medical journals. This included 10 new articles which discussed the growing interest within the medical community for endoscopic obesity treatment, and each of these articles supported the use of Apollo's core Endo-bariatric products. Three of these articles we consider to be particularly important to OverStitch. In June, Surgical Endoscopy published a paper describing the use of OverStitch to treat gastric bypass patients who had experienced weight regain. This study consisted of 130 patients from three different centers which compared results using a meta-analysis of 330 other patients. All patient groups in the study achieved clinically relevant weight loss, and 75% of patients had achieved complete cessation of their weight regain or stabilization of their weight at 12 months following the procedure. The results of the study demonstrated that endoscopic suturing intervention to arrest and reverse weight regain for previous gastric bypass patients to be safe, reproducible and effective. In April, Obesity Surgery published the results of a multi-center study for the Endoscopic Sleeve Gastroplasty procedure otherwise known as ESG, which is a primary endoscopic obesity intervention that is enabled by OverStitch. This article studied 248 patients including the first patients with 24-month follow-up at three separate institutions. Across these three independent centers, the overall total body weight loss was approximately 19% at 24 months with a very low rate of complication. The data points in this study support the durability and reproducibility of the ESG procedure. Also in April, Clinical Gastroenterology and Hepatology published data from Dr. Reem Sharaiha at the Weill Cornell Medical Center on her initial 91 patients who had an ESG procedure, which showed close to 21% total body weight loss for those patients who had reached 24 months, and also showed significant statistical reductions in obesity-related comorbidities such as diabetes, triglycerides and hypertension. This was also an important quarter for geographic expansion of OverStitch. One of our previously stated goals is to have our whole product portfolio available for sale in each of our direct markets. In Q2 we received approval for OverStitch in Brazil, our largest market in Latin America and where we are direct. We began selling the product in Brazil at the end of Q2. For Orbera, our US commercialization program this year has shifted from a focus on installing new users, which was essential to our early product launch following Orbera's FDA approval in mid 2015, to patient education and other activities to drive patient awareness with the goal to support procedure adoption and therefore product utilization at existing accounts. We are still training new users at roughly a pace of 25 to 35 new users per quarter, and we expect to stay on this pace for the rest of 2017. As of the end of the second quarter, we have trained 875 physicians on the product, up from approximately 850 as of the end of Q1. We are also generally pleased that utilization continues to steadily build. In Q2, our customers self-reported close to 1,300 Orbera patient placements, up from just under 1,200 placements in Q1 of this year. As of the end of the second quarter, 38% of accounts have now placed one or more Orbera reorders. Before turning the call over to Stefanie, I'll add a couple of comments about our Surgical sales in the quarter. In the second quarter, our Surgical sales decreased 16% from the second quarter of 2016. This consisted of an 18% decrease in the US coupled with an 11% decline outside the US The largest component of our Surgical business is in the United States, which was $4.8 million in Q2 or close to two thirds of our worldwide Surgical sales. Through the first half of the year, approximately half of our Surgical product sales were to a dedicated group of physicians who demonstrate a continued commitment to effective band therapy and in whose hands patients get excellent results. Another 20% of our sales relate to Surgical accessories. The remaining 30% of our US Surgical sales come from periodic users of Lap-Band and their ordering patterns are far more uncertain compared to the other two sources of US Surgical revenue I mentioned. I am providing this color because although our Surgical decline rate thus far in 2017 is much improved versus 2016, there is still work to be done as stabilizing Surgical sales remains a priority for us. I'll now turn the call over to Stefanie for a review of our Q2 financial results.

[Stefanie Cavanaugh:]

Thank you, Todd. Good afternoon everyone. I'm pleased to provide an update on our Q2 operating results which were in line with our preliminary estimates that we disclosed on July 12th. Our total revenue for the second quarter of 2017 was $17.1 million, $9.5 million in Endo-bariatric sales and $7.4 million in Surgical product sales. This compares to total revenue of $17.3 million for the second quarter of 2016 or a decrease of 1% year-over-year. As previously discussed, as part of our US Orbera launch strategy, we sold starter kits to interested accounts that were shipped following completion of a physician's Orbera training program. The second quarter of 2016 was a very active period for US physician training for Orbera, resulting in starter kit sales of $1.1 million, while in the second quarter of 2017 starter kit sales were $300,000. As Todd mentioned, when we adjust for this anticipated reduction in Orbera starter kit sales, total revenue increased in the second quarter by 4% from the second quarter of last year. Worldwide, our total Endo-bariatric sales were $9.5 million in the second quarter, representing an increase of 13% on an unadjusted basis compared to the second quarter of last year, and an increase of just under 26% after factoring out the initial starter kit sales associated with the US Orbera launch. In the US, Endo-bariatric sales in the second quarter 2017 excluding the US Orbera starter kit sales were $3.8 million and $7 million for the first half of 2017, an increase of close to 31% for both the quarter and six months versus the same periods in the prior year. The increase in US Endo-bariatric sales was due to increased Orbera reorder volumes and OverStitch sales. Outside of the US, Endo-bariatric sales increased more than 22% in Q2 2017 to $5.4 million, bringing our first half OUS Endo-bariatric sales increase to 15% for total sales of $9.3 million for the first half of 2017, mainly due to increasing OverStitch sales. Surgical sales in the second quarter 2017 were $7.4 million, a decrease of 16% compared to the same period in the prior year. In the United States, our Surgical sales decline rate was 18% in the second quarter due to declining gastric banding procedures. Outside the United States, Surgical sales decreased 11% compared to the second quarter of last year. Gross margin in the second quarter of 2017 was 61% compared to 47% for second quarter 2016. Cost of sales included inventory impairment charges of $3.2 million in the second quarter of last year, but only $100,000 for the second quarter of this year. So, excluding the impact of the inventory impairment charges, gross margin was 62% for second quarter 2017 compared to 66% for second quarter 2016. The decline in gross margin after removing inventory impairment charge was the result of a shift in our product sales mix to our higher growth Endo-bariatric products that realize a lower gross margin compared to our Surgical products. On the expense side, total operating expenses were $16 million for the second quarter of 2017 compared to $14.4 million for the second quarter 2016. The increase is primarily due to higher costs associated with being a public company. Research and development expenses also increased due to higher costs associated with new product development efforts. Interest expense was $1.1 million for the second quarter 2017 compared to $2.5 million for the second quarter of 2016. Of the $1.4 million decrease, about $1.2 million is from the elimination of non-cash interest on convertible notes that converted to equity when Apollo merged with LPath in December 2016, and the remaining reduction in interest expense is due to principal reductions on our senior secured credit facility. In summary, our net loss for the second quarter of 2017 was $6.9 million compared to $9.5 million for the second quarter 2016. We ended the second quarter 2017 with cash, cash equivalents and restricted cash of $6.2 million versus $9.2 million at the end of our first quarter, reflecting a cash burn rate of approximately $1 million per month. This is consistent with our recent experience over the past several quarters after normalizing for one-time expenses. Approximately half of our annual cash use funds from our operations, including our investment in a large and global sales and distribution organization as well as ongoing product development efforts. Interest payments and recurring capital expenditure requirements make up the other half of our annual cash use. On July 20, 2017, we completed a public offering of 6,542,453 shares at a price of $5.50 per share. This includes 853,363 shares sold to the underwriters for the exercise of the overallotment option to purchase additional shares. The public offering generated net proceeds of approximately $33.6 million after deducting underwriting fees and estimated expenses. That concludes my comments and I'll now give it back to Todd.

[Todd Newton:]

Thank you, Stefanie. As Stefanie just highlighted, in July we raised equity capital to support the ongoing execution of our business plans. We are an execution story and we believe that this additional capital will fund ongoing programs and operations as we continue to drive market adoption of our Endo-bariatric products. We expect the funds to also allow us to advance in key reimbursement-focused initiatives to support longer term Endo-bariatric adoption including a Level 1 study of the ESG procedure, which we believe holds tremendous promise for OverStitch. These funds will also finance some of our margin improvement initiatives underway at Apollo. We are very attentive to improving our gross margin. In the short term, as our product sales shift from Surgical to Endo-bariatric, our gross margin as a percentage of sales will have pressure, so we are diligently working on cost improvement plans for our Endo-bariatric products. Over the past couple of weeks, we just recently completed the transfer of the Helix product from its previous contract manufacturer into our Apollo manufacturing facility, which we anticipate will improve gross profit by $250,000 per year within the OverStitch product family. This is one of many discrete projects that will contribute to gross margin improvement over the course of the next several quarters. Just to summarize before going to questions, we had a very productive quarter led by increased utilization and market penetration of our Endo-bariatric products, while our more mature Surgical business continued to be in the decline phase of its product lifecycle, albeit at a moderating decline rate. In Q3 and Q4 ahead of us, the year-over-year US Orbera starter kit comparative becomes easier. In Q3 and Q4 of last year, US Orbera starter kit sales were $500,000 and $650,000, respectively, far closer to what we expect US Orbera starter kit sales to be in the back half of 2017. We like the positive trends we are seeing with Orbera and OverStitch, and our team continues to focus on greater utilization within our user base. We believe we excel in medical education and we are leveraging our medical education capabilities to expand the number of physicians who use our Endo-bariatric products. With that, we'll now open the lines up for questions. Jonny, please proceed. Operator Thank you so much. [Operator Instructions] We'll take our first question from Matt Hewitt with Craig-Hallum Capital Group.

[Matt Hewitt:]

Good afternoon. Congratulations on the progress you saw in the quarter.

[Todd Newton:]

Thank you, Matt.

[Stefanie Cavanaugh:]

Thanks, Matt.

[Matt Hewitt:]

First question, and thank you for some of the metrics you're providing regarding the ESG procedure and the training there. I was wondering if we could dig in a little bit more on that. One of the things that I think you've highlighted as an opportunity is to take that product, not only to the bariatric surgeons but also to the gastroenterologists. I'm wondering if you could provide a little bit of color on the adoption that you're seeing between those two groups.

[Todd Newton:]

Yes, I would be happy to do that, Matt. So, these numbers are not real precise but I think they are very directionally correct. Of those doctors that we know today as being active users of OverStitch for the ESG procedure, say in the United States it's roughly 50% gastroenterologists and 50% surgeons. Outside the United States, the proportion of gastroenterologists would be higher, probably closer to 65/35.

[Matt Hewitt:]

Okay, great. I would assume that given some of the challenges they've been facing, the GI practices that is, from reimbursement changes and whatnot, are you finding a very receptive audience there and how do you think that can help drive adoption, particularly within that group?

[Todd Newton:]

Matt, we certainly are seeing a lot of enthusiasm among the gastroenterology community. As we just think back here in the second quarter, one of the major gastroenterology events every year is Digestive Disease Week, or DDW, which is a major physician conference for the GIs. The amount of excitement and enthusiasm around the treatment of obesity was very encouraging for us to see, and in particular the interest in the ESG procedure was very obvious during the DDW event. So, we are indeed seeing a lot of interest among the GI community for being able to offer a meaningful solution to obesity patients.

[Matt Hewitt:]

Okay. Regarding, I know that you had planned to perform a clinical study for ESG; the endpoint not being approval but rather to help on the reimbursement front. Maybe could you walk through the timeline maybe when you would anticipate starting enrolment and how that study should play out over the coming years?

[Todd Newton:]

Yes. At least I can give you some of the broad strokes of it. We are currently working on finalizing a protocol for that study. We believe that that study's principal investigator has been identified. I don't want to disclose that quite yet, but we're also working with both the bariatric surgeon community and the gastroenterology community to ensure that the respective societies are supportive of this study and the way it's being designed. If everything goes according to my plan and my desire, we hope to have the first enrolment, potentially even still before the end of this year. It will most likely be a two-year follow-up study. It's important to be able to demonstrate that ESG is durable for a period of at least two years and that will be the target that we have, as well as we'll capture other data associated with comorbid condition improvements and things of that nature. So, it will probably be an undertaking that will take some time while the study is going through the fullness of follow-up required for each of the enrolled patients. In the interim we would absolutely expect that there will be some interim publications of data from the centers involved in this study, and ultimately, we're still figuring out exactly the cost but we're thinking that the cost is most likely going to be somewhere in the range of $3 million to $4 million based upon what we're planning to do as of today.

[Stefanie Cavanaugh:]

To be clear, I would just add that the primary purpose of the study is to have enough evidence to approach the payer reimbursement community and support reimbursement of that procedure.

[Matt Hewitt:]

That's great. Is it possible, especially since you will have - you've already got some data on hand and since you'll be able to provide some interim data for this, do you think that you'll actually have to wait until it's fully complete, or will there be the potential or the opportunity maybe even mid-study for this study to maybe pick up some of the smaller Blues? Are there any opportunities between now and then to pick up reimbursement?

[Todd Newton:]

I'll answer that, Matt, with a solid maybe. We'll have to just let that play out a little bit.

[Matt Hewitt:]

Fair enough. Maybe two more for me and then I'll hop back in the queue. You mentioned you've already completed one of your manufacturing moves. How should we be thinking about not only the timing of some of these additional steps that you're going to take, but how those should be reflected in gross margin? Do we anticipate lift yet this year, or are you thinking that maybe it's going to take over a year as you've still got some declines in the Surgical segment and then you're starting to get the lift maybe next year or longer than that?

[Todd Newton:]

Most likely, Matt, you're going to see the improvement next year. We have an aggressive plan to see these margin improvement programs completed, but at the same time we have inventory realities that obviously we need to run through before lower cost inventory is hitting the market. So I'm anticipating that it will really be next year, and of course a big function on our overall gross margin will be the degree to which we see stabilization of the Surgical revenue. That's still probably the most important thing that we can do ultimately to help gross margins in the short term.

[Matt Hewitt:]

Got it. One last one from me. Maybe if you could just remind us timing of the Orbera 365 overseas, and then more importantly, at least as I think about this, OverStitch Sx, what are your thoughts there as far as the potential launch of that product?

[Todd Newton:]

So, just to answer that question, Matt, the Orbera 365, our anticipated timing is still to have CE Mark for the European market by the end of this calendar year, and that is unchanged. As it relates to OverStitch Sx for others on the phone who may not know what that is, that's a single channel compatible OverStitch device which we think is a very important area to follow given that the majority of scopes in the market are single-channel scopes versus dual-channel scopes, which today is the only kind of scope that OverStitch is compatible with is a dual-channel scope. For that product line extension, we have filed the 510(k). We're in that process, and so we, just looking ahead, think that that's probably an early 2018 product for the market.

[Matt Hewitt:]

Great. Thank you very much for taking the questions.

[Stefanie Cavanaugh:]

Thanks, Matt.

[Operator:]

[Operator Instructions] We'll take our next question from Chris Lewis with ROTH Capital Partners.

[Chris Lewis:]

Hey guys, thanks for taking the questions.

[Todd Newton:]

Hey Chris, how are you?

[Chris Lewis:]

I'm doing well. In terms of OverStitch, can you just talk about what applications it's primarily being used on today, and as we think about that product and the potential to expand into ESG, can you help us kind of understand how you size up the market potential for ESG over time?

[Todd Newton:]

Yes. We think the market opportunity for OverStitch is really broad and just a - it has tremendous potential. OverStitch is the world's first and only suturing device that enables full thickness suturing from a flexible endoscope and that makes it by itself very unique and enables physicians to do things in a endoluminal way that previously they've not been able to do. So, as just a platform we feel like it has tremendous opportunity. As we look at how OverStitch has traditionally been used in its early stages here of commercialization, it's been used in a very broad fashion. Last year - this is all our own internal data, but last year it was used probably for advanced gastroenterology procedures close to 40% of the time and what I'm talking about there are procedures such as endoscopic submucosal defection, endoscopic mucosal resection, things that are really not related to obesity at all but things that are just go-to procedures for the gastroenterologists, the advanced gastroenterologists as well, solving real medical problems. Of course it has a great application for bariatric revisions. I mentioned the one clinical paper that was published here in June that re-emphasized that. That was probably about 35% of its use last year was for bariatric revision procedures, and then for ESG, ESG we feel like it just has a true disruptive potential within the bariatric marketplace. And while it's not a perfect analogue, I would say that laparoscopic sleeve hysterectomies, last year in the United States there were about 115,000 of those procedures performed and based upon our typical OverStitch ASP we see that alone being a proxy for OverStitch as a $300 million market and beyond the US it's probably an equivalent sized market out in the international markets. So, we're very bullish on OverStitch, obviously, as my comments reflect, and we think it just has a lot of different directions to go for its growth in the future.

[Chris Lewis:]

Okay, thanks. That's very helpful. Then in terms of new product development efforts, you have the Orbera 365 and OverStitch Sx, but for each of those kind of product line extensions, can you help us understand how that kind of expands the applicable markets for each of those over time?

[Todd Newton:]

Sure. For Orbera 365 - and again, we're looking at Orbera 365 first and foremost for the European market, that's why we're focused on CE Mark approval. We think that Orbera 365 can help with improving what is probably our most mature market for Orbera. It allows us to really introduce the next generation of balloon that lengthens the period of time in which patients can receive the boost in their weight loss journey that a balloon is intended to provide, and we think that elongation of that therapy period is going to add value. That's our hypothesis and we feel absolutely confident that Orbera 365 is going to be impactful to the European market. With that said, we are going to wait and see just how impactful before we look at bringing a 12 month balloon into the US market. That's, I think for us the reality of a little bit more expensive and complicated US regulatory pathway; we obviously want to know that it makes commercial sense. Then for the OverStitch Sx, that product we think really opens up the user base for OverStitch. There's many hospitals and accounts where we know that they don't have the required dual-channel scope, and we know that by being able to provide a single-channel alternative that we're going to be able to provide access to endoscopic suturing in those accounts that are very interested in it. That, to us, is really the appeal for the Sx. It's going to do some other things we believe that will be enhancements. It enhances visualization. Single-channel scopes typically have greater maneuverability, and all those things we think will add value, but primarily our goal is to be able to take OverStitch into accounts that just because of the capital purchase decisions that they have made around their scopes simply don't have the right flavor of scope to be able to use OverStitch today.

[Chris Lewis:]

Great. Then on the surgical Lap-Band business, in terms of the trends you're seeing with respect to the customer base there, can you talk about just the level of visibility you have into that business now given the mix continues to weight more heavily towards kind of the dedicated Lap-Band users, and maybe how that compares to 12 months ago?

[Todd Newton:]

Obviously we have greater visibility. We have a much better sense as the product has gone through this more maturing phase of its product lifecycle. We have a much better sense of who are those users that are - it's our word probably more than anybody else's word, but a loyal Lap-Band customer, someone who just simply gets good results. They get great results from the therapy and those are the people that we want to continue to support. When we look at our strategy for stabilization of that revenue source, these are the people that our ability to stabilize will be very dependent upon. So our focus is on how to serve that group in a better way, add value to that group in a better way.

[Chris Lewis:]

Okay, great. Thanks for the time.

[Stefanie Cavanaugh:]

Thanks, Chris.

[Operator:]

It appears we have no further questions in the queue at this time. I'd like to turn the conference back over to Todd Newton for any closing remarks.

[Todd Newton:]

Jonny, thank you. In closing, we just want to thank you for your interest in Apollo Endosurgery today and invite you, should you have any questions for follow-up, to please contact The Ruth Group team that is listed on our press release today, and thank you for being here this afternoon.

[Operator:]

Ladies and gentlemen that does conclude today's conference. We'd like to thank you all for your participation. You may now disconnect.