Apollo Endosurgery Inc (APEN) 2020 Q3 法說會逐字稿

Good day, everyone, and welcome to today's Apollo Endosurgery Third quarter 2020 results. (Operator Instructions)

It is now my pleasure to turn today's program over to Matt Kreps. Please go ahead.

Thank you, Gretchen, and thanks, everyone, for participating in today's call to discuss Apollo's Third Quarter 2020 Financial and Operating Results. 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. In addition, there is uncertainty about the spread of COVID-19 virus, and the also impact it may have on our operations, demand for our products, global supply chains and economic activity in general. 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 annual report on Form 10-K for the year ending December 31, 2019, as well as our most recent Form 10-Q filed today with the Securities and Exchange Commission.

The content of this conference call contains time-sensitive information and is accurate only as of the date of this live broadcast, November 5, 2020. Except as required by law, Apollo undertakes no obligation to revise or update any statements to reflect events or circumstances after the date of this call.

During the call, we will interchangeably use the term ESS for OverStitch and term IGB for Orbera and vice versa.

And now I'd like to turn the call over to Todd.

Thank you, Matt, and good afternoon, everyone, and thank you for joining today's call to discuss our third quarter 2020 results. As we disclosed in late September, third quarter revenue exceeded the expectations we had at the beginning of the quarter. The easing of COVID-19 public health restrictions at the end of the second quarter helped create a rapid recovery in our elective procedure volumes in June and July. And this elected procedure recovery trend continued through the third quarter in our direct markets. Looking at the third quarter more closely, our U.S. endoscopy product sales were very good. OverStitch increased 28% and Orbera increased 70%. Together, U.S. sales increased 37% versus the third quarter of 2019. Outside the United States, it was a tale of 2 markets. Very good direct markets where sales rebounded along with improved elective procedure volume, but slower distributor market recovery. In addition, we still had some LAP-BAND sales back in the third quarter of last year, which affected comparability. Overall, our worldwide endoscopy product sales increased 21% in the third quarter compared to the third quarter of 2019.

With the recovery of procedure volumes in the third quarter, we brought our employee furlough program that began in April to an end in late September. And 35 of the 57 initially furloughed positions were eliminated in order to produce a leaner operating structure. Of course, as business developments -- business develops in future periods, we may need to expand our staffing levels, but we have no plans to do so at this time. In addition, we implemented a short-term salary reduction program in April that affected all employees as part of the overall effort to offset the negative impact of COVID-19 on our cash flows.

In August, we began to restore employee compensation. And as of November 1, compensation is now back to pre-pandemic levels. Finally, it was really important to us from the very beginning of the pandemic to keep moving forward on our most important future growth investments. And I will give an update on these areas momentarily.

But first, I'll turn the call over to Stefanie to cover the third quarter financial results in greater detail.

Thank you, Todd, and good afternoon, everyone. As addressed in our press release and 10-Q filing from earlier today, the dominant theme in the third quarter has been the rapid recovery from the COVID-19 disruption to elective procedure volumes in our direct markets. As a result of this resurgence, total revenues increased to $12.8 million, a gain of 14% in the third quarter of 2020 from the third quarter of 2019. Total endoscopy revenue increased 21% to $12.5 million, with U.S. endoscopy sales increasing 37%, while OUS endoscopy sales increased 7%. As Todd mentioned, we had divergent results in our 2 OUS sales channels. In our direct markets, these being the traditional major markets of Western Europe and Australia, our product sales increased 46% from the third quarter 2019, demonstrating the return of elective procedure volumes.

This OUS direct market sales growth was offset, however, to a large degree by lower distributor purchases this quarter. Third quarter ESS product revenue increased 15% from 2019, primarily due to a 28% increase in U.S. ESS revenue while OUS ESS revenue was essentially unchanged from the third quarter of 2019. ESS product revenue in our OUS direct markets increased 35% from the third quarter of 2019, which was offset by lower distributor purchases.

Third quarter IGB product revenue increased 31% from 2019, primarily due to an increase of 70% in the U.S. While OUS IGB revenue increased 15% from the third quarter of last year. IGB product revenue in our OUS direct markets increased 58% from the third quarter of 2019. In the U.S., the ESS sales growth in Q3 was due to increased activity at accounts that are either new since Q3 of 2019 or accounts that were not among our top 50 U.S. OverStitch accounts last year. This speaks to the effectiveness of our medical education programs, which Todd will address further in a moment.

Of our historically largest U.S. OverStitch accounts, many of these are larger hospitals in the Northeast, which was a region that was slower to restart elective procedures in the third quarter. For the U.S. IGB sales growth in Q3. Again, the majority of the growth came from new accounts or relatively smaller pre-existing customers. IGB sales to our top accounts from the third quarter of 2019 as a group were mostly flat.

In our direct markets outside the U.S., for OverStitch, the majority of our third quarter sales increase came from new accounts. OUS direct market IGB sales growth was from both procedure volume increases at pre-existing accounts as well as market share gains from new account wins or win backs. Gross margin for the third quarter was 55% compared with 48% for the third quarter of 2019. The increase in gross margin percentage is primarily the result of 3 factors. First, the effectiveness of previously completed gross margin improvement projects that reduce the per unit cost of our products. Second, the increase in direct market sales mix this quarter. And then finally, the increase in IGB product sales this quarter.

Total operating expenses were $8.6 million down, more than $3.7 million compared to the third quarter of 2019. This 30% reduction is due to cost savings initiatives the management team implemented in response to the COVID-19 pandemic. Some of the cost savings were temporary, such as the salary reductions introduced in April, which are being restored, but other cost savings are due to structural changes we've implemented. As Todd mentioned in his introductory remarks, at the end of the quarter, we eliminated 35 positions, which we estimate will reduce our operating expense by approximately $5 million per year compared to pre-COVID spending levels. We also eliminated another roughly $5 million of additional annual operating expenses associated with activities that no longer align to our current priorities. As a result of all the financial elements I just described, our operating loss in the third quarter of 2020 decreased to $1.6 million from $6.9 million in the third quarter of 2019.

Cash at the end of the third quarter was $38.2 million, and we were in compliance with our credit agreement. We expect that our liquidity will be sufficient to get us through 2021 and pass COVID disruptions through the completion of the MERIT trial and the X-Tack launch.

I will now turn it back to Todd.

Thanks, Stef. We were very pleased with the rebound of the procedures that use our products and the affirmation of the value proposition that our technologies deliver to our customers today. Our products allow complex treatments to be performed less invasively and typically without the same level of hospital admissions as alternative interventional therapies. And I believe both physicians and patients have especially appreciated this outpatient value proposition during the pandemic. To build on what Stef just presented, the ESG procedure for the treatment of obesity was an important driver of our third quarter OverStitch sales increase. The ESG procedure has tremendous future growth opportunity for us, especially once the procedure is reimbursed. In 2019, there were over 200,000 bariatric surgeries in the United States, and closer to 400,000, if we include our direct markets outside the United States. Just posing this in 2019, we estimated approximately 7,500 ESG procedures will perform worldwide, primarily in cash-pay environments. With coverage, ESG should gain significant market share and could also grow the overall 400,000 procedure per year market, which today serves only a very small portion of the patient population eligible for bariatric surgery.

An annual 10,000 case increase in ESG procedures means an incremental $16 million of revenue to Apollo based on our pricing today. And this brings me to the MERIT study. The cornerstone data that we need to support ESG payer engagement. In October, the final MERIT patient reached their 12-month follow-up visit, which means that the investigators can now determine the study's primary outcomes. It is our expectation that we will see MERIT study data published in Q2 of 2021. Only the MERIT study sponsors have access to the study's data, but we have high confidence the study will achieve its primary outcome objectives. And this confidence is based on more than 80 studies and articles published in peer-reviewed literature describing and analyzing the ESG procedure since 2015. This data comes from various positions at sites around the world and has been remarkably consistent in reporting efficacy and safety results.

The latest ESG paper of note was a Brazilian consensus published in the third quarter in the journal obesity surgery, which combined the results of more than 1,800 ESG cases performed by 47 individual endoscopists. This paper reported an average total body weight loss of 18% at 12 months and less than a 1% adverse event rate.

Another underlying driver of OverStitch sales growth this quarter was medical education. As Stef indicated, new accounts were important contributors to our sales growth in the third quarter and the seeds planted by our medical education program in the past visibly bore fruit for us this quarter. For a long time now, we have defined medical education as an essential core competency that we need to have within Apollo. But unfortunately, this was one of the activities we had to suspend due to COVID. We mothballed our mobile learning center and had to furlough some of our valued medical education staff. Fortunately, very fortunately, we were able to bring back our medical education talent and restarted elements of our medical education program as of October 1, including the mobile learning center. Much of our didactic training can be done virtually. But for our products, especially OverStitch, there is simply no substitute for hands on training for a new user.

Orbera also had a great quarter. Orbera sales from international markets are nearly 1/4 of our total business, and our international commercial team achieved market share gains in a number of our direct markets. In the U.S., Orbera also produced tremendous results. The most notable driver being an increase in utilization at many bariatric surgeon-led accounts across the country. We attribute some of this increase to patients and bariatric surgeons selecting perhaps temporarily, to shift out of other inpatient surgical options due to various COVID concerns. Stef also mentioned operating expense reductions, some of which were temporary COVID responses and others are more permanent in nature. One such area of go-forward reduced spend is our direct-to-consumer advertising efforts for Orbera. Our focus instead is to position Orbera as a therapy to address medical needs. And for the past few quarters, we have highlighted the precirrhotic NASH patient as an excellent example where Orbera appears to deliver positive benefits. We remain focused on cost-effective evidence generation to support Orbera's medical value proposition and hope to have more updates in the months ahead.

Turning to distributor markets. Our largest distributor countries in Asia, South America and the Middle East were slow to recover from COVID disruptions in the third quarter. We are seeing indicators of improvement early in the fourth quarter in these distributor markets, but we still expect purchasing from our distributor markets will remain below 2019 fourth quarter levels. But during the third quarter, we obtained OverStitch clearance in 2 new distributor countries: Thailand and Taiwan, both of which will be Sx markets. In addition, 2 leading medical centers in Japan have received IRB approval to begin ESG procedures, and we expect the first cases in Japan to occur this quarter. Japan is one of the major therapeutic endoscopy markets in the world. And there have been many inquiries from Japanese endoscopists about how to gain access to OverStitch. Currently, we are actively pursuing regulatory clearance for OverStitch with the PMDA.

Let me take a few moments to touch on a couple of other items before we open the lines up for questions. We continue to be on track with the 510(k) for the X-Tack Endoscopic HeliX Tacking System. Since our 510(k) submission in late June, we have received a round of comments from FDA, most of which centered on technical product testing. We have completed this work needed to respond fully to these comments in our best estimate of when we might see the 510(k) clearance remains by the end of 2020. X-Tack will bring the benefits of endoluminal suturing to the lower GI track. One of the clearest immediate addressable markets for X-Tack is the large complex polyps. Removal of these polyps creates for the endoscopist a large irregular closure challenge to avoid delayed bleeding or even delayed perforation in the colon, a challenge which is suboptimally met by today's standard of care. X-Tack is ideal for this application. Based on a review of clinical literature, there is at least 1 million large or complex polyps encountered each year that are being removed endoscopically. Once cleared, X-Tack will be a very good fit for our sales organization and our current OverStitch customer base. Because of X-Tack's design, endoscopists should find its learning curve materially shorter when compared with OverStitch. Also importantly, the range of use for X-Tack includes a number of commonly described gastrointestinal procedures with existing coding and coverage. For both these reasons, easier adoption in an existing procedure definition, we expect the X-Tack sales ramp will be steeper than OverStitch's. Internally, we are readying our manufacturing facility and supply chain to support the imminent -- limited launch after clearance as well as the broader U.S. launch in the first half of 2021. In our third quarter results, we realized benefits from previously completed gross margin improvement projects, as Stef indicated. Unfortunately, we had to put the next wave of gross margin improvement projects temporarily on hold at the outbreak of COVID. We have now reinitiated these projects. In total, we are targeting a mid-60s gross margin by 2023.

As to what to expect for the fourth quarter, it really comes down to external influences. If elective procedures are able to proceed and health care delivery is normal, our business will continue to do well. Clearly, there are concerns, and we share these concerns about a second wave of COVID-19. While many of our accounts have learned how to manage patient flows in a pandemic, a severe second wave could trigger actions to temporary close or reduce procedure capacity. Health care professionals are not -- are also not immune to COVID-19, and there have been instances of procedure cancellation at specific accounts when members of hospital staff have tested positive. In addition, the third quarter benefited at least partially from a procedure backlog. In a limited survey we conducted with our U.S. customers, about 30% of the responders indicated that at least to some degree, their third quarter volume benefited from a backlog.

The overall economy, unemployment and insurance coverage are additional key variables that could impact the fourth quarter. And as I mentioned earlier, distributor purchases are likely to continue to be lower than pre-COVID. On the other hand, the majority of physicians responding to our survey indicated that their endoluminal suturing volume is likely to continue to be strong in the fourth quarter. Consequently, fourth quarter sales are challenging to forecast. As we look at liquidity management and expense decisions, we are planning for fourth quarter revenue to be approximately the same as the fourth quarter of last year when our product sales were around $12 million. This is an appropriate estimation at this time given the many variables and risks in play.

We expect our gross margin for the full year of 2020 to approximate our 9-month actual gross margin percentage, but that could vary based on fourth quarter product or sales channel mix. And as we've already indicated, operating expenses in the fourth quarter should approximately $10 million with the reinstatement of employee compensation.

And with that, we will now open the lines for questions. Operator?

(Operator Instructions)

We'll take our first question from Matt Hewitt.

Yes. This is [Lucas] on for Matt Hewitt here at Craig-Hallum. Congrats on the great quarter. I guess, starting us off, given the disruptions last spring, there was clearly some backlog that had to be worked through during the summer months, do you feel like all of that has flowed through now? And how are physicians doing in terms of refilling the case pipeline?

Yes. [Lucas], it's good to talk to you. First of all, it's a great question, but it's one that is very challenging, I think, right now for us to answer. I can tell you, repeating again, that we did a survey of our customers, those who responded indicated -- about 30% of them indicated that backlog was a factor in the third quarter. But at the same time, when asked to respond to that same question for the fourth quarter, it was nowhere close to as prevalent as 30% indicating that a backlog would still be a factor in Q4. Now that doesn't necessarily mean that it won't be. But at the same time, that's the information we received as a result of surveying our customers.

Okay. Yes, that's definitely helpful. And then I guess turning to ESG. We actually believe some of your ESG procedures are being reimbursed even without the MERIT study being complete. Could you give us a sense like how common that is? And maybe what types of situations you're seeing it?

Yes, we are seeing reimbursement. It's more at an account level. So I would not call it coverage per se. But for example, I have been in touch with several of our customers who indicate that they are now commonly receiving reimbursement for ESG. And I think that has a lot to do with their practice, their particular hospital, these that I'm hearing this front -- from tend to be university hospital settings, so they have a tremendous reputation, and they have a tremendous amount of credibility with the payer communities. And I don't doubt that, that helps tremendously because of their reputation. But no doubt about it. There are ESG accounts across the United States today who are successful having their patients insurance pay for the procedure.

Well, it's definitely encouraging to see hospitals of that stature getting reimbursement for it. And then, I guess, that kind of transition as to my last question. About a year ago, you announced that Kaiser was running a pilot study with Orbera. Where does it sit right now?

That is still ongoing as for my last update, but I don't have any results at this point.

We'll take our next question from Adam Maeder.

Todd and Stef, congrats on the great quarter. I have a handful, if that's okay. And maybe just kicking it off with some questions on Q3. I just wanted to confirm that I heard correctly in the prepared remarks. It sounded like the progression of the recovery or the run rate of the business improved in a linear fashion throughout Q3 and that September was run rating nicely ahead of July. Did I hear that correctly?

Yes. Yes. Each month was progressively improving over the previous month. We had a good quarter.

Okay. Okay. Great. Thanks for clarifying that, Stef. And then maybe if I was to ask, as we look thus far into Q4, just any comments around recent volume trends for October and thus far in November. Obviously, we're all aware of the climbing case counts here in the states and in Europe from COVID-19 standpoint. So just any details you can share as to what you seen play out in recent weeks? And then also maybe just talk to patient willingness that -- to come in for procedures in this current environment? And then I had a follow-up or 2.

Yes. Adam, there's -- first of all, just to avoid a lot of details about Q4 so far. I will say, though, that we have not seen, at least in the United States, a disruption so far in Q4. Now outside the United States, we obviously are seeing some, let's call it, lack of stability in certain countries. We know, for example, of regional decisions that are being made in Germany and France and Italy as well as in Madrid again. So I think we feel good about what we have seen so far, but we would say, clearly, there are signs of instability. And to what degree does that affect the delivery of health care is yet to be seen.

Okay. And the next question is on '21. And I know it's early here, but as we start to look ahead to next year, just would appreciate some additional color if you can provide it, just as to how we should be thinking about '21 from a top line perspective. It feels like you're carrying some good momentum here into Q4 and next year. So maybe just talk about the puts and takes. And the Street's modeling, I think, $48 million for '21. I'm just curious if you had any reaction to that number?

No. I don't want to comment upon that number, Adam. And I don't really want to give any thoughts around 2021. We will certainly do that, though, as we get to the end of the year, and we give our update for the whole year of 2020, we'll give you at that time, our view about 2021. We have a lot of good things, though, that we can expect in 2021. I do think that the adoption of OverStitch will continue to be very good. I think our medical education program getting going again will be a very positive thing for us. And I also think that the X-Tack product which may or may not be in that number. I just haven't studied that number. But the X-Tack product is going to be, in our view, a very successful product in the U.S. market. So I think we're feeling bullish about 2021, but I really can't comment upon a given number that you might be looking at right now.

Totally understand, Todd. Maybe just 2 more, if I can squeeze it in. I think I heard just on the MERIT study, data publication, likely in Q2 of '21, if positive, and it sounds like you certainly have optimism that it will be a positive outcome based on the legacy data from other studies. My question is, how quickly does that translate into potentially broader reimbursement coverage. How do we think about reimbursement time lines? And what will your strategy be from a payer standpoint?

Yes. And Adam, first, I think we're going to see MERIT study results being published, the primary outcome data being published, whether it's good or bad. I think they're going to publish the data. Largely, I think, of course, it is an IDE study. So that influences the timing of when the information may be available for consumption outside -- in the outside world. The reimbursement activity has been something that continues -- that has been ongoing now for a while. We are going to pursue 2 different call it, channels of reimbursement, one being private payers and one being the national payers, CMS and both those activities look a little bit different. So we have a plan. It will certainly, though, not be immediate, as with anything involving coverage it takes a while, and it will be at a different pace depending upon who the payer is.

Okay. Understood. And if I can sneak in just one last one. Just on the balance sheet, I think I heard in the prepared remarks, it feels like you feel comfortable that you have sufficient runway to get you through '21. And then I also heard the commentary about maybe operating with a leaner operating structure going forward. But I guess I just want to better understand. You have good momentum as procedures continue to return. How aggressive will you be with spend in reimbursement in subsequent quarters? Does it make sense to try and pursue some sort of supplemental financing to position the company for strength going forward? Just any thoughts there would be much appreciated.

So we -- as you have appropriately described, have the vision runway to get us through 2021, and we feel good about that. Our cash position and our ability to to meet our requirements through the year that is with our leaner operating structure, which we talked about how much that saves us. And we have no comment about any future financing beyond that.

And it appears we have no further questions at this time. I will now turn the program back over to our speakers for any additional or closing remarks.

Okay. Well, thank you, operator. And thank you, everyone, for joining us today on the call. Should you have any questions or would like to arrange a follow-up call with us, please contact Matt Kreps of Darrow Associates. We will also plan to participate in several virtual investor conferences later this month and welcome a chance to meet with you as far as one of those events. Please also contact Matt if you would like to request a meeting. Thank you, and have a good evening.

This does conclude today's program. Thank you for your participation. You may disconnect at any time.