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Executives

Zack Kubow – The Ruth Group, IR

John McDermott – President and CEO

Bob Krist – CFO

Analysts

Duane Nash – Wedbush Securities

Steven Lichtman – Oppenheimer

Chris Cooley – Stephens Incorporated

John Putnam – Capstone Investments

Endologix, Inc. (ELGX) Q3 2011 Earnings Conference Call October 27, 2011 5:00 PM ET

Operator

Greetings and welcome to the Endologix Incorporated Third Quarter 2011 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Zack Kubow of The Ruth Group Investor Relations. Thank you, Mr. Kubow. You may begin.

Zack Kubow

Thanks operator and thanks everyone for participating in today’s call. Joining me from the company are John McDermott, President and Chief Executive Officer; and Bob Krist, Chief Financial Officer. This call is also being broadcast live over the Internet at www.endologix.com and a replay of the call will be available on the company’s website for 30 days.

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 the Federal Securities laws. These forward-looking statements involve material risks and uncertainties. For a discussion of risk factors, I encourage you to review the Endologix’ Annual Report on Form 10-K and subsequent reports as filed with the Securities and Exchange Commission.

Furthermore, the content of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, October 27, 2011. Endologix undertakes no obligation to revise or update any statements to reflect events or circumstances after the date of this call.

With that said, I would like to turn it over to John McDermott.

John McDermott

Thanks, Zack and welcome everyone to today’s call. We achieved several important milestones during the third quarter as we continued to gain market share. Global revenue was up 25% to a record $22.3 million led by 33% year-over-year and 22% sequential growth in the U.S.

Our strong results were driven by the launch of AFX in the second half of August. Many of our customers and several new Endologix users were eagerly awaiting the opportunity to try our new AFX Endovascular AAA System and the feedback has been positive. In particular, physicians like the low-profile delivery system and our new STRATA graft material. We fully transitioned our U.S. sales customer base to AFX during the quarter and continued to be only company that offers an endovascular graft with the clinical advantages of anatomical fixation. Based upon the strong quarter and year-to-date results, we are increasing our full year revenue guidance to $82 million to $84 million which represents 22% to 25% annual growth.

Turning now to our U.S. sales force, we ended the quarter with a total of 71 reps and clinical specialists. This is our first year adding clinical specialists and the early results are very encouraging, so we plan to keep gradually adding more over time. In addition to supporting reps to get double booked with cases, several of the clinical specialists will provide support for our upcoming Ventana and Nellix clinical trials. We planned to finish 2011 with at least 72 reps and clinical specialists and we expect to increase that to up around 80 by the end of 2012.

Outside the U.S., we completed the transition of our European distribution agreement with LeMaitre Vascular and began working directly with European customers on September 1. We are actively recruiting, training, and building the team to support our current customers and prepare for the European launches of AFX, Nellix, and Ventana in 2012.

Turning to our new product pipeline, we continue to make good progress on all programs. First, we are still on track to complete enrollment in the PEVAR clinical trial by the end of this year. Second, we have 20 of the 30 patients enrolled in the Ventana international clinical trial. Third, we have a conditional IDE approval for Ventana. And last, we are still on track to submit our EU regulatory submission for Nellix by the end of this year.

Combined with the AFX, these new products will give Endologix a lineup of innovative market expanding devices that will enhance our ability to gain market share and be the leader in endovascular aneurysm repair. In Europe, we expect to launch AFX in the first quarter of 2012 and then pending CE Mark approval, we will start with a very limited market introduction of Nellix in mid 2012. We have planned to move very deliberately and limit the number of centers in order to focus on good outcomes and refining all aspects of the procedure. We’ll probably stay in a limited market release phase through the balance of 2012 and then look at opening it up in 2013.

For Ventana, we hope to gain CE approval in the fall and begin a limited rollout in selected centers again focusing on clinical outcomes and building one good customer at a time. In U.S., we expect to keep growing with a full year of AFX sales in 2012 and hope to receive the percutaneous indication by the end of next year, which would position Endologix is the only is our company that can promote and trained the percutaneous technique.

We continue to be very enthusiastic about a product pipeline and encouraged by the feedback we are receiving from physicians. Next month, we will highlight the pipeline at the Annual (inaudible) conference in New York including presentation on AFX, PEVAR, Nellix, and Ventana. We also expect to have new articles published over the next year and just recently had an AFX initial case experience published in endovascular today.

Before turning the call over to Bob, I want to provide a brief update on our company’s patent litigation activities. We recently signed across license agreement with Bard Peripheral Vascular that ends the patent dispute. Well, we always tell we had a strong case of non-infringement we view this agreement as a positive and net of reduced our legal fees and ultimately any uncertainty. The terms of the cross license with Bard are confidential.

Regarding the Cook litigation in August, the judge issued a Markman Ruling which we still provides a favorable claim construction and we are preparing for the trial that will likely take place in the fall of 2012.

Now, turn the call over to Bob for his financial review. Bob?

Bob Krist

Thank you, John. Good afternoon to all. Today, I’ll provide a brief overview of our financial results and key metrics with the third quarter 2011. As John mentioned, total revenue in the third quarter increased by 25% year-over-year to $22.3 million, domestic revenue in the third quarter increased by 33% year-over-year to $20.3 million and was up by 22% sequentially from the second quarter. Domestic growth was driven by the mid quarter launch of AFX and the addition of five new sales territories on average relatively to the prior year.

The international business was down on a year-over-year and sequential basis as a result of the early termination with LeMaitre. We recorded no sales to LeMaitre in July and August and on September 1 we transitioned to direct sales and begin recording initial revenue from our direct European customers. Gross margin in the quarter were 78.3% essentially unchanged from the 78.6% in the third quarter of last year.

Operating expenses for the quarter were $22.6 million compared to $14.6 million in the same period last year. Of this increase, $3 million is related to the Nellix acquisition, which includes both the ongoing technology development work and the establishment of a direct sales organization in Europe and additional $1.3 million was the one-time payment for the LeMaitre early termination agreement and litigation expenses in the quarter totaled $1 million, net of these items, operating expenses increased by less than the 25% rate of increase in sales for the quarter.

Research, development, and clinical expenses grew to $4.8 million from $3.3 million in the third quarter 2010. This increase was in line with our expectations and was driven primarily by our pipeline development programs and clinical trials in support of the regulatory pathways for Nellix and Ventana.

Marketing and sales expense grew from $8.6 million in the third quarter to $12.3 million in the third quarter of 2010 due to growth in the base business principally the addition of new sales territories and variable commissions on the 33% increase in U.S. revenue plus expenses related to developing our direct sales organization in Europe. G&A expense grew from $2.7 million in the third quarter 2010 to $4.2 million in the current quarter. This increase includes the incremental litigation expense and cost to establish our legal entity structures in Europe.

So for the third quarter of 2011, our GAAP net loss was $6.6 million or $0.12 per share compared to a net loss of $466,000 or $0.01 per share for the third quarter of 2010. On an adjusted non-GAAP basis and excluding the $1.4 million fair value adjustment related to the contingent purchase price liability for the Nellix acquisition, we’ve reported an adjusted net loss in the third quarter 2011 of $5.2 million or $0.09 per share.

The contingent payment is non-cash payable in shares of Endologix’s common stock when we achieved the specified milestones with the Nellix Technology. The $1.4 million increase in the contingent consideration in the third quarter was substantially related to the increase in Endologix stock price from June 30th to September 30th. Day sales outstanding including both U.S. and international accounts was just under 160 days at the end of the third quarter 2011 compared to 54 days at the close of 2010 and 59 days at the end of the second quarter 2011. The increase in the second and third quarters compared to year end 2010 was the result of the strong sequential sales increases achieved in those quarters.

Inventory turnover was 1.3 terms at September 30th versus two terms at year end 2010. Again this was due to the planned inventory buildup for the AFX launch and with the AF launch concluded in the U.S. inventory turnover will improve in the fourth quarter. During the third quarter, we use $7 million in cash including a $5.5 million increase in working capital primarily for building inventory and preparation for the launch. We ended the third quarter with $23.9 million in cash and we remained on track with our expectations for cash use in 2011. We have no outstanding bank debt and we have $10 million availability on our line of credit giving sample resources to execute on our growth initiatives.

Turning to guidance as John mentioned for the full year 2011, we are increasing guidance for revenue to be in the range of $82 to $84 million, a 22% to 25% increase over 2010, this compares to the previous guidance range of $78 million to $82 million. On the bottom-line, we are reiterating our full year 2011 guidance of a net loss of between $0.25 and $0.30 per share. This loss per share guidance includes the development of the acquired Nellix Technology and the building of a direct sales force in Europe.

The guidance also assumes ongoing base business investments in the U.S. sales force, other research and development and clinical initiatives and litigation expenses. However, not included in our guidance are the potential impacts of adverse litigation outcomes, acquisition related charges or other business development transactions. As examples, the one-time expense related to the LeMaitre early termination agreement which was $1.3 million or about $0.02 per share along with the fair value of the contingent consideration for the Nellix acquisition that was recorded in the second and third quarters are not included in our loss per share guidance.

So, with that I’ll turn the call back to John.

John McDermott

Thanks Bob. Overall, we’re pleased with our third quarter results and believe we have positioned the company for sustained near-term and long-term growth. Our product pipeline continues to advance in our sales organization is getting stronger every quarter. Looking forward to the rest of the year, we are focused on the following key objectives. One, continued penetration with AFX in the U.S., two, Hiring and training a talented team of sales and marketing professionals in Europe, three, complete enrollment in the Ventana international trial and get the final IDE approval, four, completing the enrollment in the PEVAR clinical trial, and fifth, submitting our Nellix CE regulatory (inaudible).

We look forward to keeping you posted on our progress and are planning to presented several investor conferences before our next quarterly call. In November, we are scheduled to present at the Lazard Healthcare Conference, the Steven’s Fall Conference, and the Piper Jaffray Healthcare Conference. In December, we’ll be at the Canaccord Genuity Cardiac Conference and the Oppenheimer Healthcare Conference and we’ll kickoff 2012 at the JPMorgan Healthcare Conference.

With that, we’ll open it up for questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Our first question comes from the line of Duane Nash with Wedbush Securities. You may proceed with your question.

Duane Nash – Wedbush Securities

Good afternoon and thanks for taking the questions. I understand that your cross license with Bard is confidential, but can you discuss what affect if any this might have on future gross margins or EPS or should we assume it’s relatively neutral?

John McDermott

Well, as you indicated Duane, we are limited in terms of what we can specifically say, but there will be no charge associated with any past sales. However, there will be a royalty on our future sales of our legacy products. And by that, I mean, all of the Powerlink lines of product prior to AFX, so into a track, for example, as long as that line is sold internationally will have a royalty obligation. And I would size that for you at approximately 1 point of margin impact at least over the next several quarters.

Duane Nash – Wedbush Securities

Thanks. And then one last one your quarterly revenues were significantly higher than Street estimates, how much of the surprise in U.S. growth do you attribute to market share again and how much do you think is overall market growth in the U.S.?

John McDermott

I don’t think the market is growing any faster than we had been talking about in the past. So, I think that we had a big Q3 really driven by AFX. There were a lot of physicians that were interested in trying the device. And so I really attribute our growth in the third quarter related to that. Having said that, I do think it will settle back down a bit as we go into Q4, so we did get a bolus of cases, but we still like our growth prospects moving forward.

Duane Nash – Wedbush Securities

So, one finial related question, so it sounds like there may have been some patient warehousing in anticipation?

John McDermott

I have never heard of patient warehousing. I will tell you that there were physicians that were looking forward to using the device. So, to the extent that they could hold off a week or two to schedule the case with the device being available, they did that. Yeah, we did see some of that.

Duane Nash – Wedbush Securities

Great. Well, thanks very much and congratulations.

John McDermott

You bet.

Operator

Our next question comes from the line of Steven Lichtman with Oppenheimer. You may proceed with your question.

Steven Lichtman – Oppenheimer

Thanks. Hi guys.

John McDermott

Hi, Steve.

Steven Lichtman – Oppenheimer

So, I guess just the first question in Europe, I am not sure, if you mentioned how many people you have on the ground now, I know you are still on track for sort of 12 plus by the end of the year?

John McDermott

Yeah. So, today we have eight. Another person just accepted this week that will start next month. So that will get us to 9. And I think given the candidates that we have in the pipeline, we think we’ll finish around 12 to 13. So, pretty close to our plan maybe slightly light, but we are being selective. For us, it’s important to get the right talent.

Steven Lichtman – Oppenheimer

Great. And then in the U.S. just again on AFX in terms of the impact to what extent is this unit market share versus price premium, it sounds like a little bit of both, but maybe you could scale those two impacts?

John McDermott

Yeah, I am trying to think of the best way to carve that up for you. We did get a little bit of price, but not I would say that, that increase is significantly volume as opposed to price.

Steven Lichtman – Oppenheimer

Okay. And are you starting to get any of the pull-through from those centers that are in the Ventana trial that you previously didn’t call on significantly?

John McDermott

Yeah, I would say, we have seen some of that. We started to see some of that as early as Q2 some more in Q3. The good news is I don’t think that stops, because we still have other sites that are kind of getting up to speed and they have minimum AFX case requirements to get trained on the infrarenal device to get into the trial. So, we will continue to see some benefit of that moving forward.

Steven Lichtman – Oppenheimer

Okay, great. And then just lastly at (Beat) in a few weeks, maybe you can highlight for us a couple of three things that we should be seeing more specifically data wise.

John McDermott

Yeah, there won’t be any meaningful new data presentations will be more along the lines of updates. So, there will be a PEVAR talk that we can’t actually report yet on the pivotal data. So that will be a refresh of roll-in patients. For Ventana, we’ll provide an update on the international trial and the patients that have been rolled there. Nellix, we also provide an update, we may have available the two-year follow-up on a certain subset of patients there so that would be interesting. But those are the primary data highlights.

Steven Lichtman – Oppenheimer

Okay, great. Thanks, John.

Operator

Our next question comes from the line of Chris Cooley with Stephens Incorporated. You may proceed with your question.

Chris Cooley – Stephens Incorporated

Thank you and good afternoon.

John McDermott

Hi, Chris.

Chris Cooley – Stephens Incorporated

Just to clarify, I think about the third quarter great growth here in the US. We think about normal sequential trends there. Was there anything in the 3Q maybe like couple of extreme service days with the AFX in accounts that normally having serviced in the past. It might make a 3Q to 4Q growth rate look little different this year. Should just thing to its steady state going forward and I have one quick follow-up after that? Thank you.

John McDermott

Well, as I said earlier we did get bullish cases in Q3. So, we started doing cases and the middle of August. In August, it’s historically a more of summer kind of month and we had a very high volume because there was the sales force had been well-trained and create a lot of interest in that device. So, I would say we got nice shot in the arm in Q3 and I would expect that to settle a bit as we go into Q4, but then continue rolling.

Chris Cooley – Stephens Incorporated

Okay, I understood. And I apologizes I switching couple of calls for this afternoon, you may have already touched on this. But just in terms of when we should expect to see just seem like being ready here in the United States in terms of trials and in terms of IDE on Ventana and also for Nellix. When we should expect to see those filings respectably the actual IDE and in the Nellix as well? Thanks.

John McDermott

Yep, so with Ventana we have a conditional IDE approval. We are still working with the agency on some additional testing and data that they would like before we get to final approval on that process is ongoing. So, I can’t tell you exactly when will be done with that, but that’s the status. Our hope is to get that approved obviously as soon as we can, but we still have a little work to do. As it relates to Nellix and the IDE for Nellix, our plan is to get that submitted sometime in the first quarter. I can’t be more precise than that. We still have some more testing and work to do, but that’s our target.

Chris Cooley – Stephens Incorporated

Superb, congratulations on a great job in the third quarter.

John McDermott

Thank you.

Operator

(Operator Instructions) Our next question comes from line of Sean Lavin with Lazard Capital Markets. You may proceed with your question.

Unidentified Analyst

Hi, this was Marie (inaudible) for Sean, how are you?

John McDermott

Hi, Marie.

Unidentified Analyst

Hi, congrats on the strong launch of AFX, I am wondering if you can breakdown the portion of the U.S. sales versus Powerlink and what portion works on AFX if you have that?

John McDermott

Well, Marie, I’d say, I actually don’t have the preciously here in front of me, but we commenced the launch in middle of August. It was fully launched toward the end of August, the beginning at September, and we certainly had higher rate of sales activity in the post launch period, then the month an half the quarter prior. So, my guess is that something order of magnitude 60%, 65% of the revenue in Q3, would have been related to AFX.

Unidentified Analyst

Okay, that’s very helpful. And have you been receiving premium pricing on AFX?

Bob Krist

However, John mentioned, we – with each iteration of the technology we do get as a modest pricing impact, but by far the relative growth was driven by unit volume.

Unidentified Analyst

Okay, understood. And then just finally, one could we see the earlier results from the fully enrolled Ventana trial, national charter.

John McDermott

Well, we may provide an update that could be some of an update at these meeting, Marie.

Unidentified Analyst

Yeah, okay.

John McDermott

So, putting together, it’s a function of how much follow updated that we have available from the various sides.

Unidentified Analyst

Okay, alright. And on the 30 patients, it still just remains to be seen when you have the 30 patient enrolled and when we could see the results from that?

John McDermott

Yeah. So, the plan is to complete the 30 patients by the end of this calendar year. We have got 20 of them in now. So, that’s why we feel confident we can get that done at this point in time. And then the data update will this be a function of the follow-up that is available when we are at these. So, I can’t tell you the exact number of patients that will have out to the various follow-up points, but we are planning to provide a data update at these.

Unidentified Analyst

Okay, alright. Understood. Congrats again. Thanks a lot.

John McDermott

Yeah, thank you.

Operator

Our next question comes from the line of John Putnam with Capstone Investments. You may proceed with your question.

John Putnam – Capstone Investments

Yeah, thanks very much. John, I was wondering you must be taking share here in the United States. Do you have any idea what your current market share is and from whom you are taking share?

John McDermott

Yeah, I don’t know our precise number. I am a little reluctant to just annualize Q3 given the impact of AFX, but clearly we are trending up. We start to annualize some of our current rates you are starting to get into the 12% to 13% range. I don’t have that sourced independently. That’s just based upon our estimate as the size of the market in our run rates, our case run rates.

In terms of where we are getting it, it’s again there isn’t a one company that’s primary share donor. We continue to sell against all three of the traditional devices with pretty good success. And as we have talked about before, there is a growing interest in the pipeline. So, in addition to the product standing nicely on its own we are getting some more receptivity with people want to get to know the company and getting acquainted with our new product pipeline. So, it’s a combination of variables that’s driving the growth.

John Putnam – Capstone Investments

Okay. And do you think AFX will have much of an impact in converting overseas markets, I guess, particularly Europe from open procedure to EVAR procedure?

John McDermott

I don’t expect AFX to expand the market in Europe. The indications for the device are consistent with the other devices. So, I don’t see a market expansion. And honestly one of the challenges we have with three launches next year in Europe is just to make sure that we balance everything amongst the sales force and the customer. So, it’s when you think about AFX and Europe next year, think of it more as a transition of our current intuit track based business as opposed to a big, big launch. The benefit obviously is that it is the platform for Ventana, so people are interesting in using Ventana. They will also need to be trained on AFX. And for some people they may not be ready to switch to Nellix. I don’t see that happening very often, but AFX will represent a very nice baseline product. SO, AFX, we target in the first part of the year. Nellix start a limited launch midyear. And then everything goes well, Ventana near the end of the year.

John Putnam – Capstone Investments

Okay. And what do you think the conversion in Europe is right now?

John McDermott

You mean the mix between open repair and EVAR?

John Putnam – Capstone Investments

Yes.

John McDermott

Yeah, I think it’s about 50:50.

John Putnam – Capstone Investments

Great. Thanks very much and congratulations on a great quarter.

John McDermott

You’re welcome. Thanks John.

Operator

It appears there are no more questions at this time. I would like to turn the floor back over to management for closing comments

John McDermott

Okay. Well, I just like to thank everyone for joining us on the call today and for your interest in Endologix. We look forward to seeing you at the upcoming conferences and keeping you updated on our progress.

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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