Apollo Endosurgery, Inc.
Q3 2018 Earnings Call Transcript

Published: 10 Nov 2018

[Operator:]

Good afternoon, my name is Shelsa, I will be your conference operator today. At this time I would like to welcome everyone to the Apollo Endosurgery’s Third Quarter 2018 Conference Call. [Operator Instructions] John Gillings, you may begin your conference.

[John Gillings:]

Thanks, operator, and thanks, everyone, for participating in today’s call. Joining me on the call 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 Company’s Quarterly Report on Form 10-Q filed today, November 8, 2018, with the Securities and Exchange Commission. The content of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, November 8, 2018. 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 call, we will interchangeably use the terms ESS for OverStitch and the terms IGB for Orbera and vice versa. With that said, I’d like to turn the call over to Todd.

[Todd Newton:]

Thank you, John. Good afternoon, everyone, and thank you for joining today’s call. The third quarter was a really solid quarter for ESS sales and it continued to be our top selling product line and increased to 37% of our total revenue. We also continued to see great progress with Orbera365 in Europe. We established a European registry that will record European procedure and outcomes data following the use of OverStitch during core GI procedures so that we can provide real-world data on safety and effectiveness to European physicians, patients, and payers. We also recently completed enrollment for the ORBERA Post Approval Study here in the United States and we completed two important gross margin improvement projects that will produce product cost savings starting in 2019. There were headwinds this quarter as well. The year-over-year decline in our worldwide Surgical sales remained high this quarter, by itself resulting in a $2.4 million reduction in revenue this quarter. The IGB market at large here in the United States was weak this quarter not just for us, as the market leader, but for all IGB offerings in the market. For Orbera in particular, our efforts were directed toward rebuilding momentum following the media and consumer impact of the June 4 FDA letter to healthcare providers that announced a series of Orbera product labeling changes. In addition, the softness we experienced in the second quarter in Brazil, our largest six-month balloon market outside the U.S., continued during the third quarter. As I said in my very first comment, the third quarter was a very solid quarter for ESS sales. We had very strong growth in our two largest OverStitch markets, the United States and Europe. This underlying ESS sales performance in the U.S. and Europe though was masked because of circumstances from the third quarter of last year in two other markets, namely Brazil and Australia, which contributed to the third quarter of 2017 being our highest OUS ESS revenue quarter of all of 2017 outside the United States and these circumstances set-up a difficult comparative period for the third quarter of this year. So, we are going to take some time on our call today to explain this in more depth. I’ll turn the call over to Stefanie, and she can provide more details on our third quarter financial results. Stef? Stefanie Cavanaugh Thank you, Todd, and good afternoon everyone. ESS sales increased to $5.2 million in the third quarter versus $4.9 million in the third quarter of last year, an increase of 6%. Sales in the United States increased 24%. Outside the U.S., ESS sales declined 6% to $2.7 million. European sales growth continued to be consistent with past OUS reported sales growth for ESS, in excess of 30%. But in other OUS markets, especially Brazil and Australia, we had high sales in the third quarter of last year that due to circumstances that were non-recurring masked the strength of our overall ESS revenue performance. As we stated in last year’s Q3 reporting, we launched OverStitch in Brazil in the third quarter of 2017 and had very significant pent-up demand prior to the launch which led to a high volume of initial orders last year. Looking past the obvious comparative issue, our ESS Q3 sales in Brazil this year are the highest since that initial launch period a year ago and we are really satisfied with the OverStitch progress being made in Brazil. Also as we stated during last year’s Q3 earnings call, ESS sales in Australia in the third quarter of 2017 benefited from local reimbursement of ESG patients as providers began to use an existing gastroplasty reimbursement code for ESG procedures. This proved to be temporary as in late Q4 of last year, the Australian department of Health warned providers against the use of this code for any procedures intended to treat obesity until the procedure had been evaluated by Australia’s Medical Services Advisory Committee, or MSAC, specific for the treatment of obesity. While the government’s notice referenced another manufacturer’s product, other treatments such as ESG were also affected. Since the end of 2017, the ESG procedure in Australia has been on a cash pay basis similar to other markets and sales in Australia have come down. Both of these two market circumstances this quarter created a particularly challenging hurdle in terms of year-over-year sales comparison that is not indicative of the underlying trend for our ESS sales. More fundamentally, for the nine-month period ended September 30, our OUS ESS sales have increased 47% compared to the same nine-month period in 2017. Intragastric balloon, or IGB sales were $4.1 million in the third quarter versus $4.4 million in the third quarter of last year. In the United States, IGB sales declined less than $100,000 which calculated to a 7% decline in the third quarter of this year versus the third quarter of last year, but is essentially flat. Outside the United States, IGB sales decreased 8%. Product sales were strong in our European direct markets where we have Orbera365 available and increased 20% compared to the third quarter of 2017. However, IGB sales were weak from our 6-month balloon markets. Brazil remains challenging and our IGB sales there declined 300,000 dollars in the third quarter versus the prior-year period, on a combination of lower sales volumes and negative currency effects. In distributor markets, IGB sales were also slightly down versus the third quarter of last year, mostly due to distributor order timing. Worldwide Surgical sales were $4.6 million this quarter, compared to $7 million in Q3 2017, or a decline of 34%. In the U.S., Surgical sales declined 37%, and 29% outside the U.S. Taking everything into account, total revenues for the third quarter of 2018 decreased 15% compared to the third quarter of 2017, to $14.1 million. Gross margin for the third quarter 2018 was 54.7% compared to 63.7% in the prior year period as our sales mix continued to shift from declining Surgical products with higher gross margin to growing Endo-bariatric products, and especially to our ESS product line, which has a lower gross margin. Total operating expenses increased 7% to $15.8 million for the third quarter 2018, compared to $14.8 million in the third quarter 2017. Most of our operating expense increase was attributable to higher research and development expenses due to higher clinical trial activities associated with our Endo-bariatric products, new product development costs, and costs incurred in connection with our various gross margin improvement projects. Our net loss for the third quarter 2018 was $9.8 million, compared to $4.9 million for the third quarter 2017, on the lower Surgical product sales, reduced gross margin also due to lower Surgical sales and higher clinical expenses as I just described. Finally, we finished the quarter with total cash and cash equivalents of $29.5 million dollars. Cash used for operations in Q3 totaled $2.7 million, which is back in line with our historical norms. As forecasted in last quarter’s update, inventory spend has decreased from the first half of 2018. Before turning it back to Todd, we think it’s important to provide our thoughts for Q4, especially revenue. We expect continued growth in ESS revenue except for the Australia market where we expect to be approximately $300,000 below Q4 of last year for the same reimbursement situation I earlier discussed. We remain cautious about the IGB market in the U.S. in the short-term. And we expect similar volatile OUS Orbera revenue with good European sales performance combined with softer sales in other markets. One last assumption for revenue, we expect Lap-Band revenue to continue to decline. Taking this all into consideration, we estimate total revenue will likely land somewhere in the range of $15.8 million to $16.5 million. For gross margin, we anticipate Q4 gross margin as a percentage of sales to be approximately equal to Q3. I will now turn it back to Todd.

[Todd Newton:]

Thank you, Stefanie. To add some additional color on our third quarter results, we like beat and raise quarters just like everyone else does, but that isn’t this quarter. We spent quite a bit of time already making sure our ESS sales outside the United States are understood. Sometimes the raw numbers of a three-month period do not tell by themselves the full story of what is really going on. We continue to have a lot of physician demand for OverStitch training around the world. Outside the United States, we trained 34 new physicians on OverStitch during the quarter and another 150 in the U.S. through our mobile learning center, which has made 96 stops in 59 cities so far this year. Similar to past quarters, we also provided educational grants to 15 different third-party sponsored physician training events worldwide. With respect to adoption of the endoscopic sleeve gastroplasty, or ESG, procedure we estimate over 120 physicians are currently performing ESG outside the U.S. And in the U.S., we estimate the number to be around 90 as of the end of September which is on pace with our goal to have 100 U.S. physicians routinely performing ESG by the end of the year. As indicated by our increased operating expense this year, we are deep into a number of data generation initiatives, especially for our ESS product. In the United States, the MERIT trial for ESG remains in active enrollment across its various participating sites. The last update we received reported that roughly 120 of the 200 patients have been enrolled. For the AGA registry, which is focused on Core GI ESS uses and bariatric revisions, we have our first site now enrolling patients, with other sites still getting through the paperwork phase. The registry sites that are expected to be through their IRB process soon are active OverStitch customers and we think the registry cases will populate fairly quickly once paperwork is done. In Europe, the bariatric registry that began in May of this year with the intent to capture data on ESG and bariatric surgery revisions – such as outlet reductions - has over 170 patients enrolled. Our purpose for all of these studies is to support future reimbursement efforts, especially for the bariatric uses of OverStitch. Outside the United States, Core GI procedural use of OverStitch is much less developed than in the United States, representing no more than 10% of our OUS ESS sales compared to probably around 60% of all OverStitch cases in the U.S. market, and thus we have a significant opportunity to expand OverStitch use outside the United States for Core GI uses. To accomplish this, we need to improve payor awareness of the clinical and cost benefits that suturing offers. And to this objective, we announced in September the establishment of a European GI registry in cooperation with the Humanitas Clinic in Milan, Italy, and one of Europe’s leading gastroenterology hospitals, with the goal to capture data on the various Core GI applications that benefit from the use of OverStitch. This registry is now up and running and due to expressed interest the principal investigator is planning to expand the number of participating centers from the initial six centers to 15. As to where we are in our OverStitch Sx development activity, we expect initial market introduction of Sx units to begin in the very near-term with the broader market launch to occur in early 2019. So stay tuned. One last note on ESS, in early October, we announced a distribution agreement with Slater Endoscopy to sell and distribute their Ensizor flexible endoscopic scissors. This rounds out and fits very nicely with our ESS product line offering. As the leader in endoscopic suturing, it is natural that we would offer suture cutting capability to our customers. The Ensizor scissor is a single use device and indicated for the cutting of suture and soft tissue. While we don’t anticipate that they will be used in every OverStitch case, there are many circumstances that arise in clinical practice when suture needs to be cut and therefore these scissors will be a valuable tool for suture management in the hands of our customers. We continue to be bullish on the Orbera. For Orbera in the U.S., the FDA’s letter in August of 2017 took about four months to recover from and it appears it will take about that same time to work past the effect of the FDA’s June letter too. Because Orbera is a cash pay procedure here in the U.S., our business today is very consumer-driven and can be heavily influenced by media impressions, either positive or negative. Since the June FDA letter, which generated negative media impressions, we and our largest Orbera customers have continued to be engaged in consumer education and marketing throughout the quarter. One continuing development during the third quarter was the growing importance of the plastic surgery practice as a site of service for Orbera, which we attribute to the operational acumen that these types of practices have for cash pay procedures. Over half of our new user accounts so far in 2018 are connected with plastic practices and our experience has been that once these sites commit to the offering, they are quicker to do procedures. Plastic surgery practices were 32% and 29% of our U.S. Orbera sales for the quarter and nine-months of 2018, respectively, and growing. For the same periods of last year, plastic surgery practices were 18% and 13% of U.S. Orbera sales. We have made very good progress towards concluding our Orbera post approval study obligation in the United States. On October 1, we announced the completion of enrollment in this study and we expect the study should close about a year from now, when follow-up is completed. This post approval study is characterized currently by the FDA as progress adequate. Outside the United States, Orbera365 continues to be well received by our customers and has had a pronounced effect on both unit volumes and price in the markets where it is available. We are focused now on the regulatory effort to obtain clearance for Orbera365 in both Brazil and Australia. We hope that Orbera365 can revitalize our Brazilian IGB sales in the same way that our European market has benefited since 365’s introduction there in Q4 of last year. Additionally, we recognize the need to expand the presence of Orbera365 in distributor markets. Currently, of our top 20 distributor markets, only about a third currently have the regulatory clearance for 365. We hope to be able to update you soon on these active efforts to expand Orbera365’s regulatory clearance outside of Europe. So we have a lot to be excited about with OverStitch and Orbera. Probably the one thing that I’m personally excited about right now is the notable uptick of interest within the hepatology community to use endobariatric therapies, and Orbera in particular, to treat patients with fatty liver disease such as NASH following the very compelling Mayo Clinic data that was presented during Digestive Disease Week and that we highlighted in our press release on June 5. Fatty liver disease represents a large, underserved, market. To put some numbers to the size of the problem, non-alcoholic fatty liver disease affects up to 70% of the obese population, which is currently estimated to be 650 million worldwide. Further, 30% to 40% of those will progress to NASH and 10% to 30% of those with NASH will progress to Cirrhosis. And another 2% to 6% percent of NAFLD patients are expected to develop liver cancer. Today, there are a lot of companies and drug candidates – and investor dollars, all focused on this disease area because of the unmet need and the size of the market opportunity, but most drug candidates are still a long way from being commercial. Given this lack of available pharmaceutical options, the guidelines of most hepatology societies today focus on weight loss. The relationship between weight loss and liver improvement has been long established clinically, with 7% to 10% total body weight loss usually leading to a notable level of improvement in liver function. A meta-analysis published in Hepatology in 2010 showed that while weight loss is effective to treat liver disease, it is difficult to achieve and more than 50% of patients fail to meet the established weight loss targets necessary to improve their disease. And this is not surprising as we consistently see in bariatric studies that highly engaged diet and exercise control arms report total body weight loss only in the 3% to 4% range. As I mentioned, the evidence of the efficacy of Orbera to treat liver disease is consistently positive. Of course, Orbera’s clinical data consistently shows a greater than 10% total body weight loss. Additionally, among the more than 230 peer-reviewed publications describing the clinical effectiveness of Orbera are many that capture data concerning functional liver improvement following Orbera treatment. Frutos for example in 2007 established that Orbera was an effective means of reducing liver volume or inflammation; Ricci in 2008 showed improvement in hepatic damage following Orbera; Forlano in 2010 showed normalization trends in liver function following Orbera. Lee in 2012 reported a randomized sham controlled study that Orbera treated patients showed a significantly lower NAFLD activity score versus the control group; and a meta-analysis published in Digestive Disease in 2016 looked at data from 11 studies and close to 550 patients and reported significant improvements in a number of key fatty liver indicators such as liver enzymes, hepatic steatosis and histology following Orbera treatment. Importantly, these are not generic intragastric balloon studies, these are all Orbera studies. Our first target market where we are pursuing this liver disease opportunity is Europe where we have more advantageous product labeling and a better established reimbursement pathway for IGBs for medical use. Our initial observation is that among the hepatology community, the awareness of nonsurgical interventional weight loss is surprisingly low and our initial efforts are centered on societal and clinician communications. Lastly, we recently concluded two gross margin improvement projects. One was the transfer of the cinch manufacturing from a contract manufacturer to our manufacturing facility. And the second was a number of cost reductions associated with certain components of the Orbera delivery system, both are now completed. Once older inventory is sold off, we expect these two projects, together, will improve our annual cost of goods sold by roughly $2 million at current unit sales volumes. To put this another way, our gross margin in Q3 had it included the effect of these two gross margin projects would have been 58% versus the roughly 55% that we just reported. What’s next on the margin improvement front? We have five other OverStitch projects that we aim to complete at various times during 2019 and 2020, some of which relate to VSX product that we estimate will contribute approximately $3.5 million annually to gross profit at current sales volumes upon their successful completion. And with that, we will now open the lines up for questions. Operator?

[Operator:]

[Operator Instructions] Your line first question comes from Matt Hewitt with Craig-Hallum Capital. Your line is open.

[Matt Hewitt:]

Good afternoon, thanks for providing the update and for taking our questions.

[Todd Newton:]

Happy to do it, Matt.

[Matt Hewitt:]

First off, Lap Band, and I realize this is a declining portion of your business, but the rate of decline has slowed pretty dramatically over the past couple of quarters. Do you feel like we are maybe getting close to a bottom, or is this just going to continue to erode, maybe just at this slower pace.

[Todd Newton:]

That’s a great question and I wish I had a great answer for that, Matt. The fact is I think we – this is going to sound a little silly, but I think we’re obviously closer to the bottom today than we have been before. With that said, as Stefanie mentioned in her comments about Q4, we have no reason to believe that decline rate is not going to continue and we think the best estimate would be to continue to use current decline rates when people forecast future performance for Lap Band.

[Matt Hewitt:]

Understood. Okay. Shifting to a more exciting topic, ESS, specifically OverStitch, and obviously some nice progress around training doctors, I’m just curious, as you look at the 120 O-U.S. and 90 or so here in the U.S., as you look at that group, are you seeing utilization within some of the key doctors, physicians – are you seeing their utilization increase in addition to – so basically, you’re growing the base and you’re seeing better utilization rates within that base?

[Todd Newton:]

Yes, Matt. That’s exactly what we are seeing. We’re seeing both an increase in number of accounts and we’re also seeing that dollars per account, are both contributing to our OverStitch growth.

[Matt Hewitt:]

All right. And then, I guess, last one. As far as Australia and Brazil, obviously disappointing, but have those markets kind of turned the corner now and stabilized, getting back to growth? I know it’s up against a tough comp, I’m just trying to figure out if we’ve turned the corner and it’ll start to grow from here or if it’s going to take another quarter or two before we start to see that growth return? Thank You.

[Todd Newton:]

Thanks, Matt. On that, I would not want to characterize our view of Brazil and Australia at the moment is disappointing. I would say that in Brazil, obviously, quarter three of last year being the launch quarter, we had a lot of demand and it was natural we would sell a lot of initial kits and things to meet that demand, so what we continue to see in Q3 of this year, for example, Q3 of this year for OverStitch sales in Brazil was our largest quarter so far this year. So we continue to see that progressing really well. And I think for Australia, what I would say is think about this as being the important factor here. What we have in Australia is symbolic of what we should be able to expect when the ESG procedure has reimbursement dollars behind it. When that market, albeit a small market, with not very many users – when it believed that it had reimbursement, we saw tremendous results in Australia. And I think that’s something we should look at in the future, and a reason why we feel it is so important to be investing in the data to support reimbursement efforts around that procedure.

[Matt Hewitt:]

Understood. All right, thank you.

[Operator:]

Your next question comes from JP McKim with Piper Jaffray. Your line is open.

[JP McKim:]

Hi, thanks for taking the question. I wanted to start with ESS in the U.S. Specifically, it sounded like you had a lot of good momentum on the training front, but then again the revenue line item was kind of flat sequentially from June. Is that just a seasonality aspect we should think about or – all the leading indicators that you talked about for ESS in the U.S. seem to be going well? I was expecting more of this sort of revenue bump there over the last couple of quarters.

[Stefanie Cavanaugh:]

Thanks for the question, JP, and for being on the call. Essentially, we look at Q3 this year versus Q3 last year. The sequential comparison is not as meaningful, and our growth from Q3 of this year to Q3 of last year was 24%. We’re very pleased with that result.

[JP McKim:]

Got you. And I appreciate the Q4 guidance and I know you’re not going to give 2019 guidance, but I just wanted to gauge your level of confidence in just the ability just to grow the overall business in 2019, given the stuff going on internationally, plus the Surgical, which sounds like it will continue to decline?

[Stefanie Cavanaugh:]

So, we remain confident with our growth objectives for our endobariatric products, both OverStitch and Orbera. Q4 guidance aside, we’re very pleased with what we’ve achieved so far and look forward to the continued growth of Orbera365 O-U.S. and OverStitch outside of the U.S., as well as inside the U.S. We feel very good about our growth potential there.

[JP McKim:]

Ok, that’s helpful, and then just one last one on the MERIT like enrollment. It sounds like you’re over halfway there. I just wanted to gauge your – when do you expect to get full enrollment, when should we expect to see some sort of data from that where you can then take it to payors? Like is this middle of 2019 or sooner or can you put kind of a timeline for when we should expect that?

[Todd Newton:]

Yes, a little bit, JP. We expect that enrollment should be completing sometime, actually, in early 2019. That’s just a speculation on our part, but we feel like that’s a reasonable expectation. And then obviously, it’s a two-year study, which will have a crossover point after one year. So we’re not likely to see the study complete still for quite some time. With that said, I believe that we will have the opportunity to have many discussions with payors about the ESG procedure sooner than that, especially outside the United States. Stef mentioned the MSAC, in Australia. We have filed the paperwork with MSAC and we’re working on that. And we were just talking about of course the Australia results when it was perceived to be reimbursed. We think that’s a really good market for OverStitch. We think, in Europe, there may be opportunities for reimbursement decisions before we necessarily see it here in the U.S. So while we think the MERIT trial is really important, it’s not necessarily something that has to be done in all markets for us to see improvement coming from reimbursement dollars getting behind this procedure that physicians like, patients like and we’re pretty sure payors are going to like.

[JP McKim:]

Got it. Thank you.

[Operator:]

Your next question comes from Suraj Kalia with Northland Securities. Your line is open.

[Todd Newton:]

I think we understand it, is that you, Suraj?

[Suraj Kalia:]

Yes, it was me. Hey, Todd and hey, Stefanie, how are you?

[Stefanie Cavanaugh:]

How you doing?

[Suraj Kalia:]

Forgive me, I’ve been hoping in between calls. Specifically on Orbera, I guess I just have one question. The numbers were softer than what we were expecting, and maybe you’ve already shared color here, so please forgive me on that. Any guidance you can give us on the structural dynamics of the landscape, the Dear Doc letter – is it still impacting – how you see it, would be great. Appreciate it. Thank you for taking my questions.

[Todd Newton:]

No problem, and it has, no doubt, it has been a tough last few months for the U.S. intragastric balloon market. We think that to be the case across the board, not just for Orbera. What we continue to see, though, which gives us a lot of encouragement, we continue to see a number of our most important customers continuing to spend their marketing dollars. They definitely understand how important it is to continue to engage patients in a dialogue, and that, that’s the key to doing that. At the same time, we also understand that the whole pipeline around lead conversion got disrupted following that last letter so we’re very focused on rebuilding that momentum. We obviously are wanting to rebuild it as soon as possible and we’re expending a lot of efforts to try to make that happen.

[Suraj Kalia:]

Thanks you.

[Operator:]

There are no further questions at this time. I’ll now turn the call back over to Todd Newton.

[Todd Newton:]

Thank you, Operator. In closing, we want to thank you for your interest in Apollo Endosurgery today. Should you have any questions or follow-up, please contact John Gillings, our Investor Relations Manager, listed on our press release today. Thank you very much.

[Operator:]

This concludes today’s conference call. You may now disconnect.