Obalon Therapeutics, Inc.
Q2 2018 Earnings Call Transcript

Published: 4 Aug 2018

[Operator:]

Good day, ladies and gentlemen. And welcome to the Obalon Therapeutics Second Quarter 2018 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the conference over to Bill Plovanic, Chief Financial Officer for Obalon. You may begin.

[Bill Plovanic:]

Thank you. Good morning. And welcome to Obalon Therapeutics second quarter 2018 financial results conference call. With me on today’s call is Andy Rasdal, Chief Executive Officer of Obalon. This morning, the company issued a press release detailing financial results for the three months ended June 30, 2018. This release can be accessed through the Investor Relations section of the Obalon website at obalon.com, and you can also access the webcast of this call from there. Before we get started, I’d like to remind everyone that any statements made on today’s conference call that expresses a belief, expectation, projection, forecast, anticipation or intent regarding future events and the company’s future performance may be considered forward-looking statements as defined by the Private Securities Litigation Reform Act. Forward-looking statements in this release include Obalon’s financial guidance for the full year 2018, its expectations regarding the near and long-term growth potential of its business and product pipeline. These forward-looking statements are based on information available to Obalon management as of today and involve risks and uncertainties, which include, but are not limited to, the risk factors disclosed in the periodic and current reports by the company filed with the SEC from time-to-time, including the Form 10-Q for the quarter ended June 30, 2018. Such forward-looking statements are not guarantees of future performance. Actual results may differ materially from those projected in the forward-looking statements. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Obalon specifically disclaims any intent or obligation to update these forward-looking statements, except as required by law. The archived webcast will be available for one year on the company’s website, obalon.com. For the benefit of those who may be listening to the archived webcast, this call was held and recorded on August 2, 2018. Since then, Obalon may have made announcements related to the topics discussed, so please reference the company’s most recent press releases and SEC filings. And with that, I will turn the call over to Obalon’s CEO, Andy Rasdal.

[Andy Rasdal:]

Thanks, Bill. Good morning, everyone. Thanks for joining us today. This morning we announced the promotion Kelly Huang to President of Obalon. Since joining Obalon almost one year ago as Chief Operating Officer, Kelly has overseen commercial operations, including sales, marketing, manufacturing and quality assurance. Over the past year, Kelly has proven to be a strong and capable leader and we are now asking Kelly to take an expanded role in the daily operations of Obalon. As a result, Kelly, will also assume direct responsibility for the research and development, and the regulatory and clinical functions. Kelly’s expanded role will allow me to focus more on strategic initiatives that we believe will build long-term value. Bill Plovanic, our CFO, will continue to report directly to me. I will now shift to our financial results. On this call, I will discuss highlights of our commercial progress, our revised go-to-market strategy, our product and clinical performance, and our new product pipeline. Following that, Bill, will then review our second quarter financial results, some of the specific underlying business issues and our thoughts about future financings. We will then briefly answer questions. We were pleased to see Q2 ‘18 revenue improved over 100% as to Q1 2018, led by a strong rebound in U.S. revenues, which increased more than 200% versus the first quarter of 2018. Perhaps, most importantly, reorders from existing accounts drove that sequential increase, rising over 220% from Q1 ‘18 and accounting for 64% of U.S. revenues in Q2 ‘18. The number of new accounts sold in Q2 ‘18 increased and was up about 53% over the prior quarter. We have learned more about the characteristics that create a productive account, meaning an account which makes an initial purchase, begins treating patients in a short timeframe and increases the number of patients treated each period, which ultimately results in reorders and a more sustainable revenue stream. As a result, we have made our new account targeting process more selective to incorporate these learnings. The primary obstacles to acquiring a new account, as well as getting that account up and treating quickly, are the clinical logistics, especially the time and cost associated with acquiring x-ray imaging necessary to administer the Obalon balloon today. One of our key learnings is that nearly all of our most productive accounts have made an investment to provide ready access to x-ray imaging on site. In Q2, we developed new value-added partnership programs to reduce the burden of clinical logistics for a potential new account, including programs to help acquire x-ray imaging until our Navigation is available in the U.S. We have continued to work on the approval and potential commercialization of the Obalon Navigation System, which is intended to eliminate the need for x-ray imaging during balloon placement. We believe Navigation has the potential to address the largest initial barrier for a new account to purchase and then quickly begin treating patients by eliminating the need to acquire x-ray imaging. We believe Navigation has the potential to both increase adoption in our existing target channels, bariatric surgeons, gastroenterologists and aesthetics, and could also expand potentially the use of Obalon into new channels with other specialties such as OB/Gyn and bariatricians. We have made strong progress towards FDA approval for Navigation. We successfully completed a clinical trial to collect the additional information requested by the FDA. We placed over a 390 total first, second and third balloons using our Navigation System instead of x-ray imaging with 100% success. We also used the new Touch Inflation Dispenser exclusively with our Navigation System, during the trial also with 100% success. We have filed our PMA-S for a combined Navigation and Touch system with the successful clinical trial data. We believe the submission for Navigation and Touch positions the FDA to make a decision in Q1 of ‘19, although we cannot accurately predict the FDA timings or ultimate decision. Last quarter, we announced the expanded longer term relationship with Sono Bello. We have continued to see the benefits and learned greatly from our accounts with a more retail medicine approach and have begun to leverage that learning into creating a more efficient patient funnel, meaning converting a higher percentage of initial interest into consultations and a higher percentage of consultations into treatment. Sono Bello has further expanded the number of accounts treating and the retail medicine capabilities continue to be impressive, especially in converting interest all the way through to treatment. We will continue to explore other opportunities in the retail medicine channel and leverage learnings from the approach to patient acquisition and conversion. We have recently added roles to our field organization exclusively focused on retail medicine and large medical networks to capitalize on these opportunities. We are also very cognitive of our position in capital markets, especially our current valuation. We will continue to explore financing and operational opportunities that will allow us to extend our financial runway as we develop this important new therapy and market. We have also taken actions to manage our cash flow in a manner intended to extend our runway through Q4 of ‘19 with use of our current cash and new additional debt facility. Although, we may still increase spend opportunistically to accelerate adoption and market development or opportunity to raise additional capital. We completed our field force study with ZS Associates and as part of our updated strategy, have organized our field structure into a structure we believe provides a more efficient means to service our customers. We will not be expanding our field force with a number of territories at this time, but rather increase our focus on going deep at least until we have Navigation, which may allow us to potentially more efficiently and rapidly expand productive new accounts, as well as make new accounts productive much faster. By going deep, we are increasing our focus on our highest performing and most productive accounts, by providing programs that incent them to co-invest with us to a greater extent and to increase the efficiency of the patient funnel, meaning increasing the rates of conversion from initial patient interest to consultation and from consultation to treatment. We intend to leverage these new learnings and capabilities to accelerate adoption if and when we launch Navigation. Finally, product performance continues to be strong based on our registry data and low adverse event profile. As we continue to observe, FDA approval does not always mean products will perform the same in commercial issues as they may have in controlled clinical trial, especially in the field of obesity. We believe we have a novel clearly differentiated technology that is performing as intended and believe the clinical and scientific community are beginning to take note. Earlier this year, we submitted the weight loss and safety data from approximately 500 patients in our commercial registry, which we believe to be the largest single data set of consecutive patients for an intragastric balloon to ASMBS for consideration of presentation of publication at their annual Scientific Session in November. We are very pleased that this data has been accepted for oral presentation and we hope to present this even larger data set from our registry at ASMBS in November. I would now like to hand the call over to Bill Plovanic, Obalon’s CFO.

[Bill Plovanic:]

Thanks, Andy. Today I’d like to share details on our financial results for the second quarter ended June 30, 2018. As a reminder, we began U.S. commercialization in January of 2017 and in the third quarter of 2017, we began shipping our current generation six-month product to our Middle East distributor. Second quarter revenue was reported at $2.7 million, compared with $2.0 million in the second quarter of 2017. U.S. revenues of $1.5 million were down, compared with $1.9 million in the second quarter 2017, but increased significantly from about $500,000 in the first quarter of 2018. The number of U.S. starter kit sales were down from Q2 2017, but up solidly from the first quarter of this year. In the second quarter of 2018, we sold to 26 new accounts as compared to 46 in the second quarter of 2017 and only 17 in the first quarter of 2018. On a revenue basis year over year, starter kit sales decreased slightly more starting in the Q1 ‘18, our promotions included an option with a smaller upfront commitment from the physician, reducing the amount of revenue per new account. Alternatively, reorders from existing accounts were up significantly, both year-over-year and quarter-over-quarter, and comprised about 64% of second quarter U.S. revenues. And for the third consecutive quarter exceeded sales from starter kits, which were about 36% of U.S. revenues. International sales were $1.2 million in the second quarter 2018, as compared to about $40,000 last year second quarter and about $800,000 in the first quarter of 2018. As a reminder, we began shipping our current generation six-month duration product to our Middle East distributor in the third quarter of 2017. We continue to believe our greatest opportunity for creating value is meaningfully executing in the U.S. and we plan to continue to make the U.S. our highest priority for 2018 and beyond. Cost of revenue was $1.7 million in the second quarter of 2018, as compared to $1 million in the second quarter of 2017 and $800,000 in the first quarter of 2018. Gross profit for the second quarter of 2018 was $1 million, as compared to $1 million in the second quarter of ‘17 and $600,000 in the first quarter of 2018. Gross margins were down year over year to 37% from 50% in the second quarter 2017 and down 43% -- from 43% in the first quarter of 2018. The higher mix of international sales sold at a lower transfer price negatively impacted gross margin compared with the same quarter a year ago. Sequentially, gross margins were negatively impacted by higher scrap and the impact of certain components of our value-added marketing programs. We continue work in reducing scrap and improving manufacturing yields. I’d also note that overhead continues to be the largest component of cost of goods sold, and therefore, higher volumes should provide improved efficiencies. R&D expense for the second quarter totaled $3.4 million, which was up from $2.8 million of R&D expense in the second quarter of 2017 and $2.6 million in the first quarter of 2018. The second quarter 2018 included costs associated with gathering a significant amount of clinical data for support of our PMA-S filing for the Navigation System with the Touch Dispenser. We have continued to make investments to support development of our new product pipeline primarily intended to make the Obalon balloon system easier to use, more convenient and more economically attractive to help expand our overall market opportunity. SG&A expense for the second quarter totaled $7.3 million. That’s up from $5.9 million in the second quarter of 2017, but down significantly from $10 million in the first quarter 2018. On a year-over-year basis, SG&A increased due to higher public company expenses and sales expenses due to a larger field force. On a sequential basis, the majority of the difference was $1.3 million of one-time expenses in the first quarter that did not reoccur in the second quarter and lower overall marketing sales expenses. Operating loss for the second quarter was $9.6 million, up from $7.6 million in the second quarter of 2017, but down from $12.1 million in the first quarter 2018 and net loss for the second quarter of 2018 was $9.8 million or $0.57 per weighted diluted average share of common share outstanding, as compared to $7.7 million or $0.46 in the second quarter 2017 and $12.1 million or $0.71 in the first quarter of this year. We ended June 30, 2018, with $25.2 million in cash, cash equivalents and short-term investments. We reduced our cash usage in the second quarter ‘18 by $2.7 million to $8.3 million, as compared to $10.9 million in the first quarter 2018. In July 2018, we amended our loan agreement with Pacific Western Bank, extending the interest-only period on the current $10 million outstanding and added the ability to draw down an additional $10 million. We continue to explore financing and operational opportunities that will allow us to extend our financial runway as we develop this important new therapy and market. That said, combining our cash, access to capital with the amended loan facility and the manner in which we are now managing our spend we believe we have extended our runway through the fourth quarter of 2019. Although, we may still spend opportunistically to accelerate adoption and market development or raise additional capital. In terms of guidance and metrics, we are updating our global revenue guidance for 2018 to a range of $9.0 million to $10.5 million. That’s down from a range of $14 million to $18 million. For the U.S., we are targeting revenue in a range of $5.5 million to $6.5 million, down from $12 to $16 million, and for international, we are targeting revenue of $3.5 million to $4.0 million from a previous range of $2 million to $4 million. The updated U.S. revenue range includes the following assumptions, one, no expansion of the U.S. sales force, two, the impact from fewer new accounts through the first six months of 2018, which also impacts overall follow-on business associated with those accounts or reorder business, three, although, revenues accelerated in the second quarter of 2018 versus the first quarter of 2018, they were not high enough to offset the lower Q1 ‘18 revenues, four, the impact from offering a starter kit configuration with a smaller upfront commitment from the physician reduces the amount of revenue per new account, and then, five, as you think about Q3 2018 revenues, it is important to note that the revisions to our sales structure occurred at the end of the second quarter of 2018, and as a result of the sales force change, we do believe Q3 new account generation could be adversely impacted, but we are cautiously optimistic. At this time, I’d like to provide certain underlying business metrics for the second quarter of 2018 that we use to look at the business. As a reminder, in the second quarter of 2018, the registry incentive for new accounts went away. We do not believe the data is as accurate as prior quarters. As a result, we are unable to accurately provide the number of treating accounts or patients treated. We are able to provide the number of new accounts and revenue mix. The percent of U.S. revenues to total revenues in the second quarter 2018 was 57%. That compared to 98% in the second quarter of 2017 and 37% in the first quarter of this year. The number of starter kit sales in the second quarter was 26. That compared to 46 in the second quarter of 2017 and 17 in the first quarter of this year. And the percent of total U.S. revenues for reorder kits was 64% in the second quarter of 2018 and that compared to 32% in the year ago quarter and 60% in the first quarter of this year. Finally, in closing, we are aware that the investment community would like further clarity and more insight into potentially predicting and measuring our performance as we pioneer this new therapy and market. As a result, we intend to schedule a special call later this quarter where we can summarize our learnings from the first 18 months of commercialization, including the successes and failures. On that call, we would also intend to provide greater clarity on our strategies based on those learnings, our objectives, and how we intend to measure our progress against those strategies and objectives. As a reminder, we will be presenting at the Canaccord Global Growth Conference in Boston on Thursday, August 9th. With that, my comments are complete. Operator, will you please now open the line for questions?

[Operator:]

Certainly. [Operator Instructions] Our first question comes from the line of Kyle Rose with Canaccord Genuity. Your line is now open.

[Kyle Rose:]

Great. Thank you for taking the question. So I just wondered if we could go back a little bit to the work that you have done with ZS Associates as far as the sales force structure and alignment. Just maybe tell us a little bit more about the background there and what was really the driving force as far as moving away from expanding the sales force from account openings and more to utilization and I guess just what specifically over the last, call it, the last six months may have driven that decision relative to how you thought about structure in the sales force last year?

[Andy Rasdal:]

Good morning, Kyle. Thanks.

[Bill Plovanic:]

Good morning, Kyle.

[Andy Rasdal:]

I think there is a combination of factors that drove that decision. As always, when you are pioneering a new market, especially with a novel approach that combines attacking three channels, bariatric surgeons, GIs and aesthetics, it’s critical to periodically review the performance and get sort of best-in-class thinking, which is certainly believe ZS Associates helped take what we can feel qualitatively and quantitatively in-house and use as good models to develop the structure for a sales force that most efficiently economically best services the customer base that we have. So I think we took their learnings, our learnings and focused first on being sure that we could still drive new account acquisitions. But new account acquisitions in a manner, which would allow us to have accounts become productive more quickly and to continue to build a business, which would generate reoccurring reorder revenue. I think we are also cognizant, as we said specifically, of our capital position and I also want to focus on making sure that we create a runway, which would allow us to continue to learn and develop the capabilities to make sure as new accounts come on, they are highly productive and then to leverage those learnings and then accelerate with navigation approval.

[Bill Plovanic:]

Yeah. Kyle, I’d like to add. We are not reducing our focus on new accounts. We are just making our new account targeting process more selective to incorporate our learnings. So when we do bring a new account on it’s more efficient. So it’s bringing those accounts on that are going to be more active and efficient and getting them driving faster, and then taking our current accounts and increasing the utilization that we have with those accounts.

[Kyle Rose:]

Okay. And then I don’t want to put words in your mouth. But I guess is the right way to think about this is you are confident that Navigation will be an inflection point as far as your ability to open better accounts longer term and it’s -- the way to think about it now is, I don’t know if consolidating is the right word, but taking the next six months to focus on building a foundation so that when you do have that, you have got a better playbook to go on the offensive in 2019? Is that the way we should think about how you have structured guidance and kind of the next six months from a commercial standpoint?

[Andy Rasdal:]

I guess you put very good words into our mouths. Thanks. I would just like to expand on that in terms of Navigation. This was a pretty large experience across a pretty large number of accounts and physicians, actually more accounts and physicians than we even had in our pivotal trial and pretty vast experience to see both Navigation and Touch in use, in an actual clinical setting in use. We will tell you, the physician feedback was very encouraging. We had a couple of physicians who after they did the first two cases with Navigation, turned to our people and said, what does the aftermarket look like for x-ray systems and when we concluded the trial in a very timely manner, again, with full enrollment, beginning not to take it away from him. So I think the feedback we got on what we sort of believed and saw with our initial early feasibility experience was really more than confirmed in a broader range. So again, I think, one, the largest barrier as I said two initial adoption and to getting up and treating is the acquisition of imaging and the costs and logistics associated with that. So I think we have the potential to accelerate the number of new accounts that can then also become productive quickly. And then, look, as we have said, it really allows even existing accounts who may have had x-ray to more conveniently treat a patient and place a balloon anytime, anyplace. And so, yeah, I think, now having a much deeper and broader experience with Navigation just further confirms what we thought about the system.

[Kyle Rose:]

Great. Thank you for taking the questions.

[Bill Plovanic:]

Thanks, Kyle.

[Operator:]

Thank you. Our next question comes from the line of Rick Wise with Stifel. Your line is now open.

[Rick Wise:]

Hello. Good morning, Andy. Good morning, Bill.

[Andy Rasdal:]

Good morning.

[Rick Wise:]

Following sort of a similar line of thought, just reflecting on existing accounts, obviously, up 64% very excellent. First, was there anything unusual driving that in terms of promotions or anything onetime in nature and I will just go ahead and ask the rest of related question, Andy. What percent of current accounts have x-ray and maybe talk just a little bit more about going deep in these accounts. Is that finding additional docs in the same practice or, no, it’s more about promotion and logistics, just maybe reflect on those, some of those factors?

[Bill Plovanic:]

So, Rick, let me take the first question in terms of anything onetime driving the reorder kit business. Actually the programs we put together for the second quarter are very value-add and partnership based where we are working with our customers that want to work with us to help drive the business forward. Nothing significant one-time, if you looked at our reorder kit business, it continues to be very organic and naturally flows throughout the quarter. In terms of the x-ray, what we have stated and we have seen is that our top accounts have x-ray. In terms of the percentage, I don’t have that number with me and I will let, Andy, go with the -- answering the going deep question.

[Andy Rasdal:]

Yeah. Rick, actually three things in a row early in the morning here. I will just expand. In terms of driving reorder revenue, I think, the focus as we -- especially as we came into the second quarter with existing accounts was the get them to increase their investment both in terms of time commitment and financially to grow their business in conjunction with us and to expand the current business. In terms of x-ray, I would agree with Bill. It’s the largest obstacle. Obviously to place a balloon, every account has to have x-ray imaging. It’s the only way to place a balloon. But there are accounts which would say rent it on a daily basis or they have it a couple of floors down or down the hall and what we have seen is the folks who truly have x-ray imaging, it’s in their office, gives them the ability to treat more conveniently, more quickly and fosters a great focus and investment on the business. And that’s really where the starter kit program’s focus was to help them to both invest and have and acquire them to go. In terms of going deep, again, the focus there is we continue to see a very high level of patient interest measured by all the metrics we have given before and now we have seen this retail channel. It had some visibility, this retail medicine channel, visibility where the rates of taking interest, not necessarily creating just, but creating -- taking interests and converting it to consultations. And then especially when they get a consultation, converting that to therapy are much more efficient and we are now taking those learnings, and I think ,we want to try to leverage them to the non-retail medicine accounts, prove that we can do that, improve those capabilities and really set the stage to make the best use of Navigation if and when it’s approved.

[Rick Wise:]

Yeah. Thank you. And just last for me. Just maybe a little bit more color on the FDA process. Obviously the 100% success rate for both Navigation and Touch excellent, that’s encouraging. And I just want to make sure just from a logistics point of view, when you say you filed Navigation and Touch together, does that literally -- is it mean at the same time, but two separate tracks and approvals or no, you are saying that you are asking them to be approved as a system, I just want to make sure, maybe I didn’t fully take it in. And I just wondered, is that unusual, if that -- if it’s simultaneous, is that an unusual approach? Thanks so much.

[Andy Rasdal:]

Yeah. Look, the regulatory process is always difficult to predict accurately. I think, Amy VandenBerg, the clinical regulatory team both here and our prior companies has a strong record of determining the best and most efficient means to work something through the FDA, I think, as evidenced in our original PMA approval in only eight months, and at this time, it’s hard to put into an easy nutshell. But for sure, what we learned in the trial is that Navigation, working in conjunction with Touch, makes it easier, more reliable, more convenient, more economical for balloon placements to occur on many fronts and we believe that the most efficient path for us and the FDA was to make sure that Navigation and Touch could without doubt be paired and be used together and marketed together hence that approach.

[Bill Plovanic:]

So that -- so, Rick, the Navigation was filed with Touch.

[Rick Wise:]

Got you. Thank you for clarifying.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from the line of Suraj Kalia with Northland Securities. Your line is now open.

[Suraj Kalia:]

Good morning, folks. So, Andy, on the last call you had mentioned, if I remember correctly, you have given some stats and customer concentrations. Would you care to give some follow-up stats especially in Q2 and what did the customer concentration in the U.S. look like?

[Andy Rasdal:]

Yes, Suraj. Good morning and thanks for the question. No. At this point, we have not provided that level of detail. As you can imagine, I think, to-date, if you -- we have sold over 200 accounts, so we are still at a small number of accounts, so the variability is pretty wide. But we do see strong usage out of a significant number of our accounts at this point in time.

[Suraj Kalia:]

Fair enough. And final question, you mentioned retail medicine a few times. I am not sure I follow what retail medicine means, if you will kindly expand on that. Thank you for taking my questions.

[Andy Rasdal:]

Yeah. Sure. So retail medicine, Sono Bello would be an example at a retail medicine chain. These are people that are -- are companies that are very focused with large footprints, focused on more of a consumer approach and institutionalized approach rather than a specific or independent physician.

[Operator:]

Thank you. Our next question comes from the line of Alex Harding with Polyzen. Okay. All right. We have no further questions at this time. I would now like to turn the call back over to Bill Plovanic for any further remarks.

[Bill Plovanic:]

Great. Thank you for joining our conference call today. We sincerely appreciate your interest and have a good day.

[Operator:]

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program. You may all disconnect. Everyone have a great day.