Apollo Endosurgery, Inc.
Q3 2017 Earnings Call Transcript

Published: 28 Oct 2017

[Operator:]

Good day and welcome to the Apollo Endosurgery Third Quarter 2017 Financial Results Conference Call. Today's conference is being recorded. At this time, I'd 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 products, 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, October 26, 2017. The content of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, October 26, 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. The third quarter was a significant quarter for Apollo in many respects. We successfully completed an equity offering that raised $33.6 million, we obtained CE Mark for Orbera 365 which expands the market leading Orbera product family. And we work through a challenging event in the U.S. market for enterogastric balloons created by an FDA communication in early August. Further, the third quarter also marked an important inflection point for our business as the momentum of our Endo-bariatric products overtook the maturation and decline of our surgical product sales and we achieved year-over-year revenue growth of close to 5% worldwide. Endo-bariatric sales increased 21% driven by excellent OverStitch demand in both, the United States and our international direct markets. And although surgical sales continued to decline, the rate of decline continued to improve with surgical sales down 12% for the quarter. Endo-bariatric products sales in the third quarter were more than 56% of our total revenues. Outside the United States, we had a very strong quarter and more than 52% of our total revenues came from markets outside the United States and now these sales close to 73% came from the markets where we are direct. Endo-bariatric product sales outside the United States increased by 35% this quarter, primarily because of growing interest in the Endoscopic Sleeve Gastroplasty or ESG procedure. A great example of this is Australia where we are direct, and where OverStitch also enjoys a good level of reimbursement. In Australia, the number of OverStitch cases doubled in the third quarter compared to the second quarter. Similarly in Brazil, where we are also direct, and the market is a cash pay market for bariatrics; we obtained OverStitch regulatory approval in the latter part of the second quarter. Here in the third quarter, our first full quarter of OverStitch sales in Brazil, there were already more than 180 ESG cases performed. We were generally pleased with Orbera sales international with sales increasing most of our direct markets outside of the United States during the third quarter. These markets are very advanced and established for enterogastric balloons, and we were pleased at the end of September to announce the CE Marking of Orbera365 which increases the end-well time for Orbera from 6 months to 12 months, doubling the amount of time patients can dedicate to behavior modification and the achievement of their weight loss goals. Orbera365 is/or will soon be commercially available in most European countries starting now here in the fourth quarter. We are excited to introduce Orbera365 to the European markets and are optimistic that it will add value to our enterogastric balloons market share and sales. We will have more to tell you about how this project is doing at the end of the year. Turning to the U.S., our business experienced a great deal of volatility in the third quarter, particularly with regards to our endo-bariatric products. The one consistent was OverStitch sales in the United States which were very strong this quarter. The demand for OverStitch user training was very robust in the third quarter and this quarter we trained more than 90 physicians and more than 60 allied health supporting staff on OverStitch at Apollo sponsored training opportunities. Most of these conducted using our mobile learning center. In addition, we supported through grant requests, 7 physician society or third-party led suturing training labs in the United States as well as 3 outside of the United States this quarter. We have requests to supporting additional 12 third-party led suturing training labs in the fourth quarter. The fact that societies and third-parties are pushing to advance their training offerings centered on OverStitch in our opinion is very affirming of its value propositions and interest among physicians. This week we announced a registry funding agreement as well with the American Gastroenterology Association Center for GI Innovation and Technology to establish a clinical registry to track and evaluate patient outcomes after trans-oral endoscopic suturing procedures with OverStitch. This is an important part of our reimbursement support effort for OverStitch here in the United States. With the contract now signed, the next step is to finalize the detailed protocol and obtain the required IRB approvals with the AGA staff which will then be followed by site selection. While the protocols are still being finalized, we anticipate the registry will include three main arms. First, approximately 135 patients undergoing all the [ph] reductions after a failed bariatric surgery with a 12 month follow-up period. Second, approximately 110 patients undergoing procedures for the fixed station of [indiscernible] to prevent their migration with upto a 6 month follow-up period for those patients. And then a third arm will collect data on a variety of other OverStitch procedures that a side may perform such as [indiscernible] etcetera. We anticipate this third arm will also collect procedure and safety data of the ESG procedure to the extent as is performed at a participating site. We expect that the registry data will support informed decision making among physicians, purchasers and payers related to the approval, coverage and adoption of flexible endoscopic suturing procedures that use OverStitch. In addition to the AGA registry, we are also working to finalize a contract for an investigator led multicenter randomized control trial specific to the ESG procedure. As we've stated in the past, we anticipate this trial will include a two-year follow-up period with a goal of generating level one clinical data to support the establishment of reimbursement coverage for the ESG procedure. We expect to have more to report on this soon. To wrap up on OverStitch in June, we filed a 510(k) for what we call OverStitch Sx, which is a single channel endoscope compatible version of OverStitch that enhances visualization and provides greater maneuverability. The 510(k) review process is still ongoing and our expectation is that the Sx 510(k) will be cleared in early 2018. We also expect to achieve CE Marking of the Sx around that same time. The current version of OverStitch is only compatible on a small number of dual channel endoscopes and our goal with the Sx is to remove this hardware compatibility limitation that requires a customer to make a capital investment to acquire a dual channel endoscope and enable our endoscopic suturing technology to be used with a majority of scopes in the market, and scopes that the hospital or surgery center already owns in most cases. In regard to Orbera, we had a challenging quarter in the United States. As most of you know, in early August the FDA issued a letter to healthcare providers regarding potential risks of liquid filled enterogastric balloons and we hosted the conference call the next day to add key facts that the FDA had omitted and add important context that was missing from their letter. But as we feared, the FDA's letter and its aftermath fuelled a wave of negative and inaccurate media reporting which has clearly set back the development of the enterogastric balloon market generally and Orbera's momentum in the United States this quarter. We can see the effect of the FDA letter in our reported Orbera implant volumes this quarter which was 1,020, still up 5% over the reported implant volumes in the third quarter of last year. However, in the month of July which was of course immediately prior to the FDA letter, reported implant volumes were trending 27% higher than in the same month of last year which was an implant growth rate very consistent with our first and second quarter experience of this year. In August, this trend came to an abrupt stop, and in September, our Orbera reported implant number was the lowest for any month during 2017. Similarly, we experienced lower demand for product training among targeted new Orbera users following the letter. We have moved quickly though to communicate with our customers and to provide resources regarding the safety of Orbera. As of the end of Q3, we have trained 887 physicians on the product here in the United States and we have received one or more Orbera reorders from 47% of the accounts connected to these physicians since their initial starter kit purchases. The FDA letter also created some other operational distractions for us; following the FDA letter, a consumer filed a voluntary of then report through the FDA's MedWatch program alleging a patient death in the month of August following an Orbera placement. Upon investigation however, we were able to determine that this was an inaccurate report and that the patient never received an Orbera or was ever treated using any Apollo device. So this quarter was the setback quarter in the United States for Orbera. Our goal is to get Orbera moving again, and how long this will take, we hope we can answer after the fourth quarter. We continue to believe the impact will be transient [ph] and we are absolutely confident in Orbera's safety and efficacy that has been demonstrated over a clinical history of more than 277,000 balloons distributed worldwide. Lastly, for our surgical sales; our reported surgical product sales outside the United States were relatively stable. In these markets gastric banding procedures continue to decline, however, we have been able to gain market share in certain key banding markets that has allowed us to offset most of the decline in banding procedures. For the United States surgical sales decreased 17% in the third quarter with roughly half of our surgical product sales attributive to a group of about 80 physicians who are very active in gastric banding. And 20% of our sales were surgical accessories, the remaining 30% of sales were from periodic but infrequent users of lab band. And now I'll turn the call over to our Chief Financial Officer, Stefanie.

[Stefanie Cavanaugh:]

Thank you, Todd and good afternoon everyone. I'm pleased to review our Q3 financial results and report that they were in line with expectations. Our total revenue for the third quarter of 2017 increased 5% to $16.5 million, when compared to total revenue of $15.8 million for the third quarter of 2016. The increase was primarily driven by an increase in Endo-bariatric revenue of 21% to $9.3 million offset by a decrease in surgical revenue of 12% to $7 million. As Todd mentioned, this marks an important inflection where the growth of our endo-bariatrics revenue exceeded the decline of our surgical sales. In the U.S., endo-bariatric sales in third quarter 2017 excluding the U.S. Orbera starter kit sales were $3.2 million, an increase of 14% versus the same period last year, mainly driven by higher OverStitch sales. As Todd mentioned earlier, U.S. endo-bariatric sales were hindered by the disruptive effect of the FDA letter resulting in lower U.S. consumer demand for Orbera and lower demand for product training among our targeted new users during the quarter. Outside of the U.S., endo-bariatric sales increased more than 35% in Q3 2017 to $6 million. Again, primarily due to increased OverStitch demand in our direct market. Surgical sales in the third quarter of 2017 decreased $900,000 to $7 million, representing a decrease of 12% compared to the same period in the prior year. In the United States, our surgical sales decline were 17% in the third quarter due to the continuing decline of gastric banding procedures. Our of the U.S., surgical sales decreased 2% compared to the third quarter of last year. Gross margin in the third quarter of 2017 was 63.7% compared to 66.7% for the third quarter of 2016. The decline in gross margin was as a result of the ongoing shift in our products sales mix from our higher margin surgical products to our higher growth endo-bariatric product that realized a lower gross margin compared to our surgical product. On the expense side, total operating expenses were $14.8 million for the third quarter 2017 compared to $14.3 million for the third quarter 2016. The included an increase in sales and marketing expense of $1.1 million which was due to higher incentive compensation and increase in Orbera marketing campaigns and expanded OverStitch training program and was partially offset by a reduction in general and administrative expense of $1 million due to transaction cost incurred during the third quarter of last year that were related to the LPath merger. Research and development expenses also increased primarily due to higher costs associated with new product development efforts including Orbera365 and OverStitch as Todd was talking about previously. Interest expense was $1.1 million for the third quarter 2017 compared to $1.5 million for the third quarter in last year. A decrease of $0.5 million primarily resulting from reduced cash interest on our senior secured credit facility due to principal reduction. In summary, our net loss for the third quarter of 2017 was $4.9 million compared to $5.9 million in the third quarter of last year. We ended the third quarter 2017 with cash, cash equivalents and restricted cash of $35.5 million versus $6.2 million at the end of our second quarter. And as a reminder, in July we completed the public equity offering of approximately 6.5 million shares at a price of $5.50 per share that generated net proceeds of approximately $33.6 million after underwriting fees and transaction cost; that means that we used approximately $4.5 million in the third quarter which is up about $1.5 million from our experience in the first two quarters of 2017 due to the payment of a non-recurring or the non-recurring expenses that were recorded in the first quarter 2017 associated with initial public company activities and filing. Excluding this payment, our use of cash continued to trend around $1 million per month in the third quarter. And just as a reminder, approximately half of our annual cash used, funds of our operations including the new product development efforts while the other half supports interest payments and recurring capital expenditure requirements. And that concludes our financial update. Now I'll turn it back to Todd.

[Todd Newton:]

Thank you, Stefanie. Just to recap before we move onto questions. We had a terrific quarter in our direct markets outside of the United States. In the United States we also had a great quarter for OverStitch sales but it was a setback quarter of Orbera. One last topic; and as we've discussed before, a major goal of ours is to improve gross margins for our endo-bariatric products. As our sales mix shifts from surgical to endo-bariatric products, we expect our gross margin to decline. And we've identified a number of programs to offset this decline and improve gross margins. Our goal is the same as previously stated which is a consolidated gross margin of 70%. The first project in this program was completed back in early June with the transfer of the Helix part of the OverStitch system from a contract manufacturer to our manufacturing facility. We expect this item will improve annual gross profit by at least $0.25 million per year starting next year. Additionally, this quarter our manufacturing facility successfully completed the expansion of our ISO certificate to include anchor needle production. We believe this is a key first step to eventually reduce our cost suture which is another part of our gross margin improvement plan. The cost improvement programs are expected to take 8 to 10 quarters to implement from here. And with that, we'll now open the line for questions. Operator?

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Matt Hewitt with Craig-Hallum Capital Group.

[Matt Hewitt:]

Good afternoon, and congratulations on the progress. First one for Stefanie, and I'm wondering if you could breakout what the OverStitch contribution was this quarter and maybe versus the year ago period so that we can calculate a growth rate there?

[Stefanie Cavanaugh:]

Well, we don't usually breakout OverStitch from Orbera, we stay focused on the endo-bariatric products as a combined number. But as we indicated, in the U.S. our endo-bariatric growth is primarily driven by OverStitch revenue and you will see in the table the growth rate for endo-bariatric in the U.S. And then over U.S., OverStitch and Orbera both contributed nicely to that growth rate that you'd see in the table in the press release.

[Matt Hewitt:]

Okay. And then Todd, I know that you mentioned regarding Lap-Band, obviously we've seen the rate of decline to continue to slow and not to put you on the spot but as we look how maybe of the next year or two. Do you envision -- do you anticipate that maybe finally bottoming, and is there in the opportunity for that to maybe grow at some point even if it's low single digits? Is there the potential for that to grow again at some point in the future?

[Todd Newton:]

Well Matt, thanks for that question. First of all, I absolutely believe that Lap-Band is going to be something that stabilizes, it's not necessarily something I can predict when but I do expect the decline rate of Lap-Band will stabilize at some point, we think that the physicians who used that product, they get -- and they are loyal to that product, they get very good results, I don't see them changing from their experience; and I think that's key. As far as whether or not it will be a growth product, let's get the stabilization first.

[Matt Hewitt:]

Fair enough. I guess shifting gears a little bit, the -- with Orbera365 what is the initial reaction then? Are you seeing maybe an uptick in demand because you now have that one year versus the six months?

[Todd Newton:]

Yes, anecdotally the feedback has been very positive. I believe most doctors are of the view that if you can have an enterogastric balloon that can provide a weight loss boost to a patient for a full year, especially one that is non-surgical like Orbera but that adds a lot of value, especially compared to the six month product, it just takes a while for patients to have their metabolism reset so that they can maintain that weight loss and there is many doctors who are very excited about this because they think it will in fact help their patients with that weight loss journey that they are on.

[Matt Hewitt:]

Fair enough. One last one for me and then I'll hop back in the queue; regarding Orbera domestically here in the U.S. post the FDA letter, obviously disappointing but I'm wondering as you look at it, it sounds like you had a little bit of a pullback even on the physician training side, is that a function of education? Is that a function -- and there with the patients obviously, is there an education component there as well to help them understand what happened? Why it happened? And more importantly, why the risk isn't as great as maybe perceived? Any color there would be helpful. Thank you.

[Todd Newton:]

What I guess I would say is, when it comes to physician training, the physician is one voice that is making the determination of whether or not to put in the starter kit and move forward with Orbera. So we did see a number of bad committee discussions renew as a result of the letter which is what we would normally expect with the letter such as what the FDA issued. But we're going to get Orbera going again, we're going to get it back on-track.

[Matt Hewitt:]

Okay, great. Thank you.

[Operator:]

[Operator Instructions] We next move to [indiscernible].

[Unidentified Analyst:]

Good afternoon, everyone. Todd, just to take it fine to piggyback on the Orbera question, first of all, was Orbera365 -- can you remind us what the TWO -- EWO [ph] profile looks like? And forgive me if my memory fails me.

[Todd Newton:]

Well, we don't have any clinical data to point to related to Orbera as a 12 month balloon. What we do have is we have the expectation that we'll have some clinical work being done now that it's been approved for human use. One thing that we know for sure though is that Orbera is safe for 12 month use and that was the critical news event if you will for us to obtain the CE Mark.

[Unidentified Analyst:]

Got it. But I presume at some point, presumably next year, you all would have some -- either registry data or some additional information on the weight loss profile?

[Todd Newton:]

I think that's exactly right.

[Unidentified Analyst:]

I'm just hopping in between calls so maybe you guys have already talked about this, do your letter -- the FDA letter in August and earlier in February, has that essentially affected the entire ICD market, the enterogastric loan market or is there a share shift; I thought I heard you say about 1,020 Orbera's in the U.S. in the quarter and I'm curious if you can give us some relative texture, that mean non-fluid filled ICDs have gained or it is a class that for its total balloon-wide effect happening because of the latter?

[Todd Newton:]

That's a great question. I don't have really the answer for you that is definitive. I think we will wait and see what other companies say during this earning season, we'll get a better read for all that. Our view though is that -- that I'd give you today is that the enterogastric balloon market has been impacted and I don't believe that is necessarily going to be a share kind of issue but we'll -- we will see. What we do know from monitoring the media, we call it our DTC type of metrics; since the FDA letter came out we've seen a decline in just the number of people looking for information about enterogastric balloons, so that would tell me that it's not necessarily share driven, it's probably more of a market disruption as we've said in our comments.

[Unidentified Analyst:]

Got it. And finally Todd, this might be a naïve question but let's say I come in and the physician has to make a decision between -- originally let's say we are the [indiscernible] is great candidate for Orbera; now he is freaked out about the deer-dark [ph] letter because it means that this -- he can refer me to someone else or the physician himself can use an OverStitch. I guess what I'm trying to see is, do the patients stand the Apollo umbrella or is there some leakage occurring temporary or permanent, which is showing up or not showing up into other categories, the non-balloon category?

[Todd Newton:]

Suraj, this may not really answer your question but I believe that it is fair to say that if a patient comes in to talk to a doctor about Orbera, the doctor is going to reinforce to that patient just the very strong safety profile of Orbera. The one factor that was missing from the FDA letter that we thought was so critical was the mortality rate to take about a numerator without a denominator as I've said before; I find that to be surprising. And the mortality rate associated with Orbera is 0.0001%. And I think when you're having a conversation with a doctor and a patient, that is compelling. I think our challenge right now is that of course, patients more and more today find their news on the internet about their different options and when the media/press is negative as it has been, that obviously -- if you will prevent or stops patients from even going in and having that doctor conversation; and I think that's the issue they were working through.

[Unidentified Analyst:]

Got it. Thank you for taking the questions.

[Stefanie Cavanaugh:]

Thank you.

[Operator:]

And now with no further questions in the queue, I'd like to turn the conference back over to management for closing remarks.

[Todd Newton:]

Well, thank you operator. And in closing, we want to thank you for your interest in Apollo Endosurgery this afternoon. Should you have any follow-up questions that you have, please contact The Ruth Group team as listed on our press release today. Thank you very much.

[Operator:]

Thank you, ladies and gentlemen. That does conclude today's conference. We thank you for your participation. You may now disconnect.