Apollo Endosurgery Inc (APEN) 2017 Q3 法說會逐字稿

Good day, and welcome to this 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.

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, 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 GAAP financial measures. 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.

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 and raised $33.6 million. We obtained CE Mark for Orbera365, which expands the market-leading Orbera product family. And we worked through a challenging event in the U.S. market for intragastric 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 continue to decline, the rate of decline continue to improve, with surgical sales down 12% for the quarter.

Endo-bariatric product 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 of 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 internationally, with sales increasing in most of our direct markets outside the United States during the third quarter. These markets are very advanced and established for intragastric balloons. And we were pleased, at the end of September, to announce the CE marking of Orbera365, which increases the indwell 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 intragastric balloon market share and sales. We will have more to tell you about how this product 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 the United States this quarter. We have requests to support an 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 similar to an 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 (sic) [American Gastroenterological 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 3 main arms: first, approximately 135 patients undergoing [ardent] reductions after a failed bariatric surgery, with a 12-month follow-up period; second, approximately 110 patients undergoing procedures for the fixation of esophageal stents to prevent their migration, with up to 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 site may perform, such as POEMs, ESDs, EMRs fistula repairs, et cetera. We anticipate this third arm will also collect procedure and safety data of the ESG procedure to the extent it 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 controlled trial specific to the ESG procedure. As we've stated in the past, we anticipate this trial will include a 2-year follow-up period, with a goal of generating level 1 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 the capital investment to acquire a dual-channel endoscope and enable our endoscopic suturing technology to be used with the 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 intragastric balloons. And we hosted a 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 fueled a wave of negative and inaccurate media reporting, which has clearly set back the development of the intragastric 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 have provided 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 40% 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 event 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 a 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, 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 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 attributed 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 LAP-BAND.

And now I'll turn the call over to our CFO, Stefanie.

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 point, 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 was 17% in the third quarter due to the continuing decline of gastric banding procedures. Outside 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 a result of the ongoing shift in our product sales mix from our higher-margin surgical products to our higher-growth Endo-bariatric products that realized a lower gross margin compared to our surgical products.

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. This included an increase in sales and marketing expense of $1.1 million, which was due to higher incentive compensation, an increase in Orbera marketing campaigns and expanded OverStitch training programs. And it was partially offset by a reduction in general and administrative expense of $1 million due to transaction costs 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 Sx that Todd was talking about previously.

Interest expense was $1 million for the third quarter 2017 compared to $1.5 million for the third quarter 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 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 underlying fees and transaction costs. 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 2 quarters of 2017 due to the payment of a nonrecurring -- or the nonrecurring expenses that were recorded in the first quarter 2017 associated with initial public company activities and filings. 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 use funds 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.

Thank you, Stefanie. Just to recap before we move on to questions. We had a terrific quarter in our direct markets outside the United States. In the United States, we also had a great quarter for OverStitch sales, but it was a setback quarter for 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 of 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 Instructions) First question comes from Matt Hewitt with Craig-Hallum Capital Group.

First one for Stefanie. I'm wondering if you could break out what the OverStitch contribution was this quarter and maybe versus the year-ago period so that we can calculate the growth rate there.

Well, we don't usually break out 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'll see in the tables the growth rate for Endo-bariatrics in the U.S. And then OUS, OverStitch and Orbera both contributed nicely to that growth rate that you see in the table in the press release.

Okay, fair enough. And then, Todd, I know that you mentioned -- regarding LAP-BAND, obviously, we've seen the rate of decline that continued to slow. And not to put you on the spot, but as we look out maybe over the next year or 2, do you envision -- do you anticipate that maybe finally bottoming? And is there 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?

Well, Matt, thanks for that question. First of all, yes, 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 that the decline rate of LAP-BAND will stabilize at some point. We think that the physicians who use that product, they get -- and 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. And as far as whether or not it will be a growth product, let's get to stabilization first.

Fair enough, fair enough. I guess shifting gears a little bit. With the Orbera365, what is the initial reaction then? Are you seeing maybe an uptick in demand because you now have that 1 year versus the 6-month balloon?

Yes. Anecdotally, the feedback has been very positive. I believe most doctors are of the view that if you can have an intragastric balloon that can provide a weight-loss boost to a patient for a full year, especially one that is nonsurgical like Orbera, that that adds a lot of value, especially compared to the 6-month product. It just takes a while for patients to have their metabolism reset so that they can maintain that weight loss. And there's 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're on.

Fair enough. One last one for me, and then I'll hop back into 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 then 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.

And Matt, on that, 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 that committee discussions renew as a result of the letter, which is what we would normally expect with a 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.

(Operator Instructions) We next move to Suraj Kalia with Northland Securities.

So just Todd, trying to piggyback on the Orbera question. First of all, Orbera365, can you remind us what the TWL/EWL profile looks like? Forgive me if my memory fails me here.

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.

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

I think that's exactly right, Suraj.

I'm just hopping in between calls, so maybe you guys have already talked about this. The Dear Doc letter -- the FDA letter in August and earlier in February, has that essentially affected the entire IGB market, the intragastric balloon market? Or is there a share shift? I thought I heard you say about 1,020 Orberas in the U.S. in the quarter, and I'm curious if you can give us some relative picture. Does that mean nonfluid-filled IGBs have gained? Or it is a class -- or it's a total balloon-wide effect happening because of the letter?

That's a great question, Suraj. I don't have, really, the answer for you that is definitive. I think we'll wait and see what other companies say during this earnings season. We'll get a better read for all that. Our view, though, is that -- that I give you today is that the intragastric balloon market has been impacted. And I don't believe that is necessarily going to be a share kind of issue, but we will see. What we do know from monitoring the media, the -- 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 intragastric 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.

Got it. And finally, Todd, it might be a naive question, but let's say I come in, and the physician has to make a decision between -- originally, let's say, pre-August, he would have thought, you know what, Suraj is a great candidate for Orbera. Now he's freaked out about the Dear Doc letter. Does it mean that does 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 in the Apollo umbrella? Or is there some leakage occurring, temporary or permanent, which is showing up or not showing up at the other categories, the nonballoon categories?

Yes. And 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 talk 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 0.00, wait for it, 01%. And I think when you're having a conversation with the 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 presses negative, and it has been, that obviously, if you will, prevents or stops patients from even going in and having that doctor conversation. And I think that's the issue that we're working through.

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

Great. 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.

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