EndoChoice Holdings' (GI) CEO Mark Gilreath on Q2 2016 Results - Earnings Call Transcript

| About: EndoChoice Holdings (GI)

EndoChoice Holdings, Inc. (NYSE:GI)

Q2 2016 Earnings Conference Call

August 03, 2016 09:00 AM ET

Executive

Zack Kubow - The Ruth Group

Mark Gilreath - Founder and CEO

David Gill - President and CFO

Analyst

Robbie Marcus - JP Morgan

Rick Wise - Stifel Nicolaus

Scott Schaper - William Blair

Travis Steed - Bank of America Merrill Lynch

Operator

Good afternoon, and welcome to the EndoChoice Second Quarter 2016 Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note that this event is being recorded.

I’d now like to turn the conference over to Zack Kubow. Please go ahead.

Zack Kubow

Thanks, operator, and good afternoon, everyone. Welcome to the EndoChoice second quarter 2016 financial results conference call. Joining me on the call today are Mark Gilreath, Founder and Chief Executive Officer; and David Gill, President and Chief Financial Officer.

This afternoon EndoChoice issued a press release announcing its second quarter 2016 financial results. A copy of this press release and a document containing supplemental and financial information are available on the Investor Relation section of the EndoChoice website at investor.endochoice.com.

Today’s conference call, including the Q&A session, will include forward-looking statements reflecting management’s current forecast of certain aspects of the company’s future business, including its guidance for 2016. Forward-looking statements are denoted by such words as will, would, believe, should, expect, outlook, estimate, plan, goal, anticipate, project, potential, forecast, and similar expressions that look towards future events or performance.

Forward-looking statements are based on current information that is by its nature, dynamic and subject to rapid and even abrupt changes. Our forward-looking statements are subject to risks and uncertainties, which may cause actual results to differ materially from those projected or implied in our statements. These risks and uncertainties are discussed in the company’s filings with the Securities and Exchange Commission.

In addition during today’s call, management will discuss non-GAAP measures for the company, which the company believes can be useful in evaluating its performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP, and reconciliations to comparable GAAP measures are available on the company’s earnings release.

With that said, I’d now like to turn the call over to Mark.

Mark Gilreath

Thank you, Zack, and good afternoon everyone. On today’s call I’ll provide you with an update on our performance and the factors contributing to our second quarter results, and then we’ll touch on our future growth drivers. I’ll then turn the call over to David Gill, our President and CFO, who will provide a more detailed second quarter financial review and our updated guidance for 2016. There’s some positives and negatives in the second quarter, each of which impacted our financial performance.

First let me start with a brief overview of our single use products in pathology businesses, which we combine and refer to as our base business, followed by a more detailed overview of imagining, the impact, the launch of the Gen 3 had in the quarter, and our outlook on the business going forward.

In Q2, we continued to see steady growth in our SUP and Pathology businesses. These businesses continued to perform very well, they benefited from our growing Fuse installed base, our continued progress in cross-selling the broad platform, and from an increasingly tenured sales force.

In the aggregate, our Q2 2016 base business revenues grew 7% sequentially from Q1 and 10% over the prior year. In addition, the gross margin from our base business improved to 52.4% from 47.3%, a full 5% increase from Q1.

Pathology revenues in the quarter were up 29% year-over-year, driven by a 33% increase in specimens processed, and are up 7% sequentially from the first quarter. SUP revenues for the quarter were up 8% sequentially from the first quarter, despite an (inaudible) competitive environment. Our SUP growth was driven by our platform approach, as every one of our new Fuse customers in the second quarter also purchased our SUP products.

Now with our recent launch of our RescueNet, we achieved sales of more than 150 new customer accounts in just two months, and this product enjoys a much higher gross margin profile than on our SUP average.

Turning to our sales force, we’ve made significant progress in our hiring goals, and as of July 31, we have completed the hiring of all 20 account managers or AMs, which are focused on driving the base business. We also stand at 50 territory mangers or TMs. Our TMs are focused on driving Fuse placements and are working diligently to expand the sales pipeline and are gaining tenure with every quarter.

We are pleased that we now have a full complement of AMs in the field, as they’ve continued to show the benefits of a dedicated sales force focused on penetrating our single use products and pathology services more [for] our customers.

Moving from the base business to Fuse, we reached another major milestone in Q2, with the launch of our Gen 3 Fuse system ahead of schedule. Since our original Fuse launch just a couple of years ago, Fuse Gen 3 now delivers a higher quality image, a curved 4K monitor, integration with the EMR platforms, and now a new controlled body with advanced ergonomics, increased (inaudible) and improved durability.

In addition, we are pleased to announce that Lumos, our novel advanced Matrix Imaging system, was cleared just yesterday by the FDA. Lumos enables physicians to see [sole] differentiation in tissue with enhanced clarity. We believe this is an important breakthrough for GI imaging and detection.

The new Generation 3 system with Lumos, solidifies Fuse as the most advanced imaging platform available to the GI specialists, and early indications have shown that customers are thrilled with these improvements.

While we are excited about the long term potential of our Gen 3 Fuse system, the transition to Gen 3 has presented some short term challenges, which negatively impacted our system sales in the second quarter of 2016.

The underperformance in system placements in the second quarter can primarily be attributed two things; weakness in a few European markets, where we market through distributors, and the timing of our Gen 3 Fuse system launch.

Let me take a minute to provide you with more color on the impact of the Gen 3 launch and also why we remain optimistic about our long term opportunities. One of our main corporate goals for 2016 was the launch of Gen 3 system mid-year. The R&D for this system progressed nicely in the first quarter. We saw an opportunity to launch Gen 3 product early at the DDW meeting in May.

We made this decision at the DDW, as the most important GI medical meeting of the year, with tens of thousands of GI physicians participating and is well attended and presents the best opportunity to show the new system to as many physicians as possible.

However the decisions to debut the Gen 3 system at DDW had two consequences. We found that the announcement of Gen 3 caused more customers than expected to pause their purchase decisions, awaiting an opportunity to redemo with the Gen 3 system.

With the introduction of the DDW in late May or two-thirds of the way through the quarter, we don’t have enough time to deliver sufficient quantity of demo unit to our sales team, thereby causing a delay with several of our best prospects. Despite this headwind, our domestic Fuse sales in the second quarter actually came in very close to our expectations, and those of the analysts that follow our company.

As we move forward, upgrading our field demo equipment to Gen 3 is one of the highest priorities. We expect this upgrade process to be completed late in the third quarter, which will have some impact on the ability to close quarters in the second half of 2016. We have therefore lowered our expectations for Fuse system placements in the second half of this year, and David will provide additional color on guidance shortly.

While we are disappointed by the short term impact of our Fuse placements from the Gen 3 launch, we believe the positive long term impact of the Gen 3 Fuse system far outweigh these near term disruptions. We received some of the highest praises from physicians for Gen 3 during its introduction in DDW and during its short time in the field.

The positive reaction to the Fuse system, along with a recent approval of Lumos only increases our confidence that we have the right leading technology that’s poised to take market share from larger competitors.

Fuse continues to see strong win rates against key competitors in the GI space, and during the second quarter, the majority of our system placements were head-to-head wins against Olympus. In fact, one of these wins resulted in a trade-in on Olympus 190 systems, their most current model which had over 30 months left on the active lease. In addition, three current Fuse customers placed repeat orders and bought additional systems during the first half of this year.

Wins like these are a testament to the power of the Fuse technology, and are a glimpse of what we expect in the long run, despite our near term lumpiness. Further supporting our conviction in Fuse is an expanded installed base, which now covers 71% of our domestic sales territories, as compared to about 50% at the beginning of this year. Placing systems in a sales territory has historically been a very important lever (inaudible) adoption, and we expect this will help us gain momentum in system placements going forward.

One of the reasons our excitement remains, is the unprecedented clinical data from Fuse. One of the recent studies presented at the DDW was from Mount Sinai and Carnegie Hill Endoscopy in New York, comparing the last nine months of traditional (inaudible) viewing scopes to their first nine months with Generation 2 Fuse video system.

The study included 25 physicians and over 4,000 patients treated in ambulatory surgery center environments, and found that the Adenoma Detection Rate or ADR with traditional colonoscopes was 23.5%, while Fuse delivered a 28.9% ADR, an increase of 23%. In addition, more polyps were detected in the right colon, which are particularly dangerous, and more polyps were detected per patient using the Fuse system. This study was designed to look at the impact that Fuse has in the real world, day-today practice in a busy Endoscopy Center among skilled endoscopist.

We also know from a previous Kaiser study, which was published in New England Journal of Medicine, for every one percentage point increase in ADR, we should expect a 3% decrease in Interval cancer and a 5% decrease in mortality from Interval cancer.

If you want to extrapolate this New England Journal data to the Carnegie Center data, a center which treats approximately 15,000 patients per year, the risk of Interval cancer decreased by 16% and the Interval mortality decreased by 27%. With this compelling clinical data and the launch of Gen 3 we’re positioned well for the future.

In summary, the base business has delivered excellent sales growth in gross margin improvements and this engine has plenty of room to grow, with more new products launching later this year. For Fuse, we achieved an important milestone launching Gen 3 at DDW ahead of schedule. The transition to Gen 3 has presented some short term challenges, with Gen 2 product ops lessons and delayed Gen 3 demos, but despite these hiccups, our domestic sales were very close to expectations.

Gen 3 is gaining excellent feedback from customers, and the sales team is thrilled to get Gen 3 with Lumos into the demo pool. As a result, we remain optimistic in the long term opportunity and expect to see growing success and improving gross margins in the second half of 2016.

I will now turn the call over to David for a detailed second quarter 2016 financial review, as well as an update on 2016 guidance. David.

David Gill

Thank you Mark, and good afternoon everyone. I will begin with a review of our second quarter 2016 financial results. Total revenue in the second quarter was 19.3 million, up 3.3% year-over-year and 4.3% sequentially. Imaging revenue for the second quarter was down 9.7% year-over-year as we shipped a total 25 Fuse systems during the quarter, compared to 27 shipments in the same period a year ago.

We ended the quarter with a cumulative installed base of 174 Fuse systems, up 14% from the first quarter of 2016. We continue to build a strong pipeline of sales opportunities, and we are currently tracking more than 250 leads for over 400 possible system placements, over the next four quarters.

As Mark discussed, we expect to realize the benefits of our growing sales pipeline, once we have completed the transition to Gen 3 Fuse system in our [demo tool] and probably demoing this new system.

Fuse [domesticated] speed declined slightly by 2% from the first quarter to an unfavorable mix of the average number of scopes per system ordered. We expect our Fuse ASPs to hold steady over the next few quarters, as we complete the rollout of the Gen 3 system. Single use products revenue growth in the second quarter was 2.5% year-over-year and pathology services revenue growth was 28.7% year-over-year.

Both businesses continue to benefit from the expansion of our Fuse installed base, and in the second quarter every one of our new Fuse customers also purchased our single use products.

Pathology services continued to be strong with a 33% increase in specimen’s processed from the prior year as the number of referring physicians continues to grow.

We reported a gross margin of 33.4% in the second quarter, compared to 35% a year ago. Second quarter gross margin was negatively impacted by the fewer number of Fuse system sold, thereby providing less absorption of this fixed manufacturing cost, as well as a $506,000 obsolescence charge relating to various Gen 2 parts, which will no longer be used in the Gen 3 system.

Excluding this obsolescence charge, gross margins would have been in line with our expectations. It is worth noting that our gross margin percentage is a full 9% higher in the second quarter from the 24.5% realized in the first quarter. As a result of our decision to lower revenue estimates for the second half of 2016, we performed an interim impairment analysis of our intangible assets that were acquired during the 2013 acquisitions of both pure medical and RMS endoscopy.

Based upon our impairment assessments and the lowered expected future cash flows associated with these assets, during the second quarter we recorded a non-cash impairment charge of $12.6 million, which fully impairs the developed technology, customer relationships, and other intangible assets arising from those acquisitions.

Operating expenses in the second quarter came in at 33.1 million; however if you exclude the impairment charge, operating expenses were 20.5 million or down $900,000 or 4% compared to 21.4 million in the second quarter of 2015. The decrease in OpEx was driven by lower G&A and R&D expenses, partially offset by higher sales and marketing expenses tied to the increases in our domestic sales force.

As Mark mentioned, we’re now at full complement of sales representatives in the field, so sales and marketing expenses should increase slightly over the remaining two quarters of the year. Net loss for the second quarter was 24.7 million or a negative $0.99 per share.

Excluding the impairment charge, second quarter 2016 net loss was $15.1 million or a negative $0.60 per share, compared to a loss of 19.5 million during the second quarter 2015 or a loss of $1.01 per share. Both our net loss and the cash burn declined or improved sequentially during the second quarter from the first quarter 2016 levels.

On a non-GAAP basis, the company reported second quarter adjusted EBITDA of negative 10.5 million or 54.7% of revenue, compared to the negative 9.6 million or 51.5% of revenue for the second quarter of 2015. Adjusted EBITDA also improved sequentially over the first quarter of 2016 by $1.4 million. Reconciliation of our GAAP net loss to adjusted EBITDA is included in our press release.

Turning now to the balance sheet; we ended the quarter with cash, cash equivalents, and marketable securities of 56.9 million, which is just slightly below our internal expectation. Collections remained strong, and I'm pleased to note a $2 million reduction in inventory levels from the beginning of the year. We expect our cash burn to decrease during the second half of 2016 tied to a continued reduction in inventory levels, as well as higher sales and resulting gross margins.

Based on our operating plan and subject to execution, we believe that we have sufficient cash to get into 2018, and we also have a $15 million credit facility that is fully available. However, as a matter of good housekeeping, we will be filing a Shelf Registration Statement after this call, which will be good for three years and will allow us the flexibility to raise money if and when it is needed.

Turning to guidance, we are lowering our 2016 full year guidance to match our Fuse system expectations for the second half for the year. As Mark discussed, as we roll out the new Gen 3, it will take two to three months to fully upgrade all of our field demo equipment. We expect this to elongate our sales cycle and most likely dampen in the near term, a positive impact we expect from introducing Gen 3 into the marketplace.

In terms of revenue, we are now expecting full 2016 revenue to come in between $80 million to $82 million, we are seeing imaging revenue growing up by approximately 10% to 12% in 2016, pathology revenue to grow by 23% to 24%, and single use product revenues to grow by 7% to 8%, driven by the team of dedicated account managers, as well as the additional product launches.

We expect gross margins to continue to improve sequentially in both Q3 and Q4, as we transition till the Gen 3 system is completed and to average 32% to 33% for the full year. We should exit 2016 with a corporate gross profit in the high 30s.

We now expect a net loss in the range of 65 million to 66.5 million, excluding the $12.6 million non-GAAP impairment charge, which translates to a loss of $2.59 to $2.65 per share. This assumes 25.1 million weighted average shares outstanding for the year.

For adjusted EBITDA, I see a range of negative 38 million to 39.5 million for the year, and we expect to have free cash flow of negative 43 million to 45 million during 2016, and doing current estimated CapEx of $7 million for the year. Thank you.

And I’ll now turn the call back over to Mark.

Mark Gilreath

Thank you, David. In summary, we believe the long term fundamentals and competitive dynamics of our business remain strong. We have a robust based business that is steadily growing and expanding margins. We are working quickly to get Generation 3 demos with Lumos fully into the marketplace and introduce to the GI community to what we believe is the most advanced technology with the most robust clinical data set in colonoscopy.

And while we are disappointed that some prospects chose to pause their purchasing decisions to the (inaudible) Gen 3; we take it as a very positive sign that the technology has had this type of effect on our customers. We further are encouraged by the early feedback on Gen 3 and we are convinced that Fuse Gen 3 with Lumos will be our most important and impactful product ever.

I will now open the call up to questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Robbie Marcus of JP Morgan. Please go ahead.

Robbie Marcus

A couple of questions here, we had the first quarter call basically two months into the quarter in first quarter. So what happened from then until the end of the quarter that sales guidance had to come down roughly $10 million, because it seems a lot of the problems in terms of the Fuse roll-out were self-inflicted?

So, maybe talk about, how you are thinking about the different drawdown in self-guidance and then also maybe spend a few minutes on what was the thought process in moving up ahead to DDW instead of waiting for maybe later in the year, when you would have had appropriate inventory in the field?

David Gill

Hi Robbie, this is David Gill, good afternoon. I’m not sure I agree with your premise that we were two-thirds of the way through the quarter when we had our first quarter conference call. I think we had it in late April. But given that as it may, I have told people that our business is lumpy not only during the year from quarter-to-quarter, but also intra quarter.

It’s very normal for us to book 10% to 20% of the business in the first month of the quarter, 10% to 20% of the business in the second month of the quarter, and 60% to 80% of the business in the third month of the quarter, of which half can happen in the last week or two weeks of the quarter.

So, I would never read too much into the progress after one month of the quarter, because the business tends to be extremely backend weighted. With regard to the decision to launch at the DDW, Mark would you like to cover that?

Mark Gilreath

Yes. I think that we were pretty clear about our expectations that the R&D team would be able to deliver Generation 3 mid-year. We said summer time and when they exceeded our expectations, we could take advantage of DDW, and this is the meeting that happens once per year and almost 20,000 attendees, and it’s something that we thought we should seize that opportunity. But you can’t go to the show unless you can actually ship to customers that quarter, and we felt like we could do that, and we did do that and so what we shipped in June was Generation 3 systems.

And it was a bit of a surprise that some physicians said, well wait a second we need to try that, and so, there were a few that we were not able to support, because we couldn’t get the demo systems out in time. And I think we’ll have that complete towards the end of this quarter, and we’ll able to run forward on all cylinders, but we have had this short-term bump.

Robbie Marcus

So would you say the - maybe you could breakdown the change in the revenue guidance. Was it a 100% due to the delay in the demo units or is there also some degree of maybe a lower expectation for placements for the year outside of this temporary disruption?

Mark Gilreath

Yes. First of all the change in revenue guidance is 100% attributable to Fuse. It’s not related to single use products in Pathology. And as we talked about, we expect this transition to take through the end of the third quarter. We have roughly 50 people in the sales force. It’s a lot of demo equipment that has to be manufactured and placed and put in circulation, and we do expect that during the third quarter that some of those potential orders may have to be pushed to the fourth quarter because of timing delays to get demos done.

We don’t think this is due to any kind of hesitance to adoption or because the feedback on the Gen 3 system has all been very, very positive. Unfortunately on a logistics basis, we weren’t fully prepared on the day of launch to fully output our sales force. And we do expect the fourth quarter to be stronger than the third quarter.

Robbie Marcus

Okay. And then maybe if I could just touch, without giving formal guidance for next year, how are you thinking or how do you want the street to be thinking about the sales trajectory with - you’ll have used Gen 3 fully stocked and ready to go by the end of the year. How do you want us to be thinking about the trajectory into next year? Thanks.

Mark Gilreath

Yes, so we will give guidance in Q1 maybe as early as the JP Morgan conference, but we will see either late this year, most likely in the first quarter. We really don’t want to start providing that or tit-bits to that today, because we are going to complete our full budgeting cycle.

I think the key point is that we do expect a near-term hiccup, but by the end of the year, we expect it to be firing on all cylinders, and we do have a nice book of business that’s building and we hope to execute very strongly in the fourth quarter. So based on that at the end the year, we’ll be able to give much clear guidance for 2017.

Operator

And our next question comes from Rick Wise of Stifel. Please go ahead.

Rick Wise

Let me continue on, because I think it’s an important thing to understand this Mark, that Gen 2 to Gen 3 transition and maybe you can just give us a little more detail to understand that. And I still have multipart question related to the transition.

Obviously, you had a tough transition from Gen 1 to Gen 2 in 2015. Now in 2016, it turns out to be tougher than expected, but one element of the transition this year is having enough demo sales units that sounds like that’s going to be addressed in short order. The rest is obviously scheduling the demos and the like.

But help us understand why you seemed optimistic, and I think it’s a fair assessment that you could make that transaction smoothly maybe around the time of DDW. And again, I hate to ask this, but what changed and I’m not trying to sound blame, but more to understand what was more complicated.

Back to Robbie’s question, is the 10 million excess caution, as you wait to see now how the second half unfolds. So, can you take us through I mean it is a lot to ask, but what’s different, what did you learn, why were you sort of hopeful you could get it done this time and is that that the demo units took longer to produce. I’m just not understanding, because obviously the setup is great, this is a great product, just help us understand how we can have confidence in what’s next, if you will?

Mark Gilreath

Rick, some of the question was breaking up. I will take a stab at that, if I didn’t understand it correctly then of course you can rephrase it and go again. So, when we were at DDW, we presented the Fuse Generation 3 system. I thought we were really bullish on being able to shift that in June to the customers that ordered and we were successful in that. And in fact in the US, we were very, very close to our expectations on fuse shipments.

We did find a softer market in the European marketplace, and getting Gen 3 is not just your sales reps in the United States, but getting into your distribution force around the world. And so, having the equipment available is one piece, having distributors make sure they place that orders to get it in their hands is another piece to that puzzle.

So, there is a bit of live time, and we took advantage of the DDW cycle which we are very pleased that we were able to hit that timeline, because our customer base, our eventual buying customers, many more of them got to see it and since it’s the longer selling cycle it’s just important to get that stake in the ground.

So we are now rolling out Gen 3 system and what’s really unusual is in our space typically in the last few decades were just three Japanese camera companies. Customers didn’t wait for a demo, and they were asked for a re-demo. They never said please come back and show us again. The fact that they are doing that, I think is a very positive sign that we are going to have long-term success, and any time that we have been asked to do a re-demo, our likelihood of sales are much, much higher. So I think that these still play to a long term advantage, and it was absolutely a short term bump.

David Gill

The only thing I would add Rick just to understand the financial consequences. So if we outfit (inaudible) systems it’s an outlay of in total about $5 million. So we want to be very careful before we pull the trigger on that large capital equipment outlay, that the fall R&D cycle has been completed.

We went through a full V&V process, validated the product, we also did a long three month clinical evaluation, and we waited the results of that which were all very favorable, before we pulled the trigger on a pretty significant capital equipment expenditure.

Mark Gilreath

Rick, I will just mention one other point, which I think is relevant to your question. Since the IPO we have not done a good job of forecasting capital sales. We know that capital business is lumpy, with small data points, it makes it more of a challenge to predict. But as we’ve gone back and reviewed our customers who did buy, and done the analysis on the process, we’ve discovered that we really are disrupting the sales cycle.

Their normal sales cycle is demo three companies that have been around for decades, make a decision to move on, and typically they buy Olympus. When Fuse enters into the picture, we are invited to demos, we don’t have a trouble getting demos.

And what happens is that half the partners say that they want Fuse, maybe a chunk of them say they don’t really want to change. But what it leads to is the group having to come back together and say wow, we need to bring Fuse back in again, because they start taking us very seriously. It elongates the sales cycle, and so our estimated times to close are looking more like six to nine months, not three to four months, and so that’s been a factor as well.

Rick Wise

Yes, so that makes sense. Just a couple of follow-ups, just in thinking about the guidance David, and I am not trying to pile on here or anything, but you did in round, numbers 38 million in the first half of this year at the midpoint of you guidance 81 million, if my rough math is right suggest just you grow second half over first half 15%.

Should I be concerned that you are still not - I want to believe that you are being conservative and that there could be upside probably more in the fourth quarter than the third, but should I be concerned that you are still not setting the bar low enough. I mean ‘17 could be a big year, as you get all the demos, the experienced sales force, the broader product line - SUP line. I mean get all that, but is the bar low enough for the second half?

David Gill

We believe so Rick. We’ve had a short term stumble here and disruption of the rollout of the equipment. But the anecdotal feedback from the initial customers that are using is very, very positive, so that bodes well. We believe that the conservative, as Mark just said we haven’t done a very good job of predicting sales and revenues particularly on the Fuse shipments from the IPO. Hopefully we’ve have learned from that.

We believe that the guidance has been appropriately set for the second half. I wouldn’t expect a huge increase and huge shipments from Q2 to Q3, but we do expect a bump up in the fourth quarter as the Gen 3 transition is behind us, and we gain some momentum, and the sales force has full equipment at their disposal.

Rick Wise

And just a bit last from me. SUP, I mean there was number of bright spots pathology, but SUP and as you highlighted Mark, some of the new products are making a difference. Maybe you said in passing that there are a number of other products. Did I understand you correctly, coming. Maybe can you highlight those and what are we looking for there and what impact do you think that’s going to have on growth there.

Mark Gilreath

On the SUP business, Rick we’ve had really a good fortune with the new RescueNet launch. We think that’s approximately a $40 million market. Around the world it’s highly differentiated with much higher margins than our broader portfolio, and it has been a fantastic tool to break into places and introduce even more products.

We also had announced recently the FDA clearance for the Orca disposable valves, and we expect those to launch in the near term, and in the next couple of months. I think that will make a meaningful impact on our kit business, and will allow us to be really ahead of any of the competitors in that space. And of course, kits are a major driver to the SUP portfolio.

We have a few other products that will be coming out later in the second half of this year. One is a new biopsy forceps which as everyone knows a real foundational product to GI, and the most commonly used device in GI. We think we have something innovative coming out later this year there as well. So it’s a division that is benefiting from our organic R&D, and the team is doing an excellent job. I think we’re really well positioned to continue to expand margins and grow the top line.

Operator

And our next question comes from Margaret Kaczor of William Blair. Please go ahead.

Scott Schaper

Hey this is Scott Schaper on for Margaret. Thanks for taking the question. I wanted to go back to the Gen 3 launch. You mentioned that people are pausing to evaluate the Gen 3 in the US. Can you just maybe quantify how many accounts or how many physicians held off in the quarter that you were expecting would be Q2 placements, and kind of what those conversations are like?

Is it all people they want to do a full demo again, because it seems like, as people have pointed out there’d be a lot 50 system cut to guidance from Fuse. So any color on what’s causing the hold off or demand another demo before buying, just given that the upgrade just seems to be more ergonomic handle to the system and not a complete revamp?

Mark Gilreath

Hi, Scott, I am sorry the connection is a little bit challenging today. I’m not sure I got the question completely, but I will try to take a stab at it. I think you are asking about why a buyer would delay in the Fuse buying process. What we find is that typically, let’s say you got a GI tract system, might have 5, 10, 25 physicians. We might have a third with a very high level of interest in Fuse, a third that don’t care, and a third that don’t want to change.

Typically after our first demo, we have maybe two-thirds that want to buy Fuse, and I think frankly it catches the practice by surprise, and so they have to go huddle up in their Board meeting to decide, do they really want to break away from the vendor they have been using for a long term. And thankfully we’re able to win a very high percentage of these.

So we are pleased with where we are progressing in this area, but it does elongate the sales cycle. And when you introduce a new generation of a product in that same process, it could elongate it further.

Scott Schaper

So I guess my question was more - it seems like the Gen 3 is just a new handle, and your new handle just kind of gets it up to par with kind of the other competitors or what they are currently using. So is that enough to cause a physician to have a full new demo, and maybe you could maybe quantify how many people that you were expecting to close in the quarter that ended up pushing out wanting a new demo.

Mark Gilreath

Well there are two or three pieces to your question Gen 3 was more than a new handle. Those ergonomics were applied in several pieces of the Endoscope, and included a number of functional improvements, and really significant improvements to the reliability of the scope. So I think that with Lumos it really sets us up further, and we’ll experience that as we go further this quarter.

But as far as those that were delayed, there were a couple of deals that were delayed and demos that we couldn’t get there to complete the sales cycle. So keep in mind, just to reiterate again that we were very, very close to our expectations in the US market place, and we had further delays in the distributor sales organization, which really is what impacted the quarter.

Scott Schaper

Okay, that’s helpful. And then maybe David this one is for you, I want to push it, but on the cash position. You are little over 55 million in cash and investments, but looking inside your guidance on cash or your thoughts on cash have changed much. I was just wondering at what point would you consider managing your expenses, given the push-out in the revenue. Is there a level of cash you won’t go under, can you still get the breakeven next year on a cash basis or is that dependent on drawing on the credit facility to get you through next year?

David Gill

Yes, so first of all, we do expect our cash burn to go down in both Q3 and Q4. We continually look for areas to improve our operating efficiency and to reduce expenses. We certainly will continue that process, and we do expect sales rebound certainly in the second half of the year. So we got to be careful not to trim too much.

We will give guidance on 2017, we have a clear statement in our 10-Q that we have the cash to get into 2018, we also have a credit line available as well. But as you saw, we did file a registration statement for shelf, so we will evaluate our cash needs from time to time and possibility or need to raise money. So really I don’t have anything further to say, we’ll provide an updated cash flow analysis when we give guidance for 2017.

Scott Schaper

Okay, and then just one more on the retrieval, now it seems like the last time you talked there was about 65 accounts, now you have up to 150, so that’s good growth there. What’s your expectation for how many of those 2,500 or so accounts are going to buy this. Just trying to get a sense for how much runway with that product is less? Thanks.

Mark Gilreath

Scott, that’s a product that it will be needed and on the shelf and should be in every one of our customers in the hospital arena for sure. More of those are used in the hospital environment in an ASC. And as you’ll recall, probably 65% to 70% of our kit customers were also hospitals. So it’s a nice bid to drive that piece of the portfolio. We would expect the momentum to continue on that product, there’s no reason to expect a slowdown anytime soon.

David Gill

We estimated that’s $40 million to $50 million market in the United States, and we believe - globally, and that we have the best product in the market.

Operator

And our next question comes from Travis Steed of Bank of America Merrill Lynch. Please go ahead.

Travis Steed

Can you comment a little bit on what all is involved in upgrading the self-demo?

Mark Gilreath

Hey, Travis we can’t hear you buddy.

Travis Steed

Is this better?

Mark Gilreath

Yes sorry, down here at Atlanta, it’s the land of thunderstorms in late afternoon and our connection out is fine, but coming in we’re having trouble hearing the speakers.

Travis Steed

Alright, great, I will try again. So can you comment a little bit on what all is involved in upgrading the field demos, just any more color to get us comfortable with the time lines you laid out, and is there a strategy to make sure the best reps get the demos first?

Mark Gilreath

Yes, so the demo process is really quite clear, it is typically a week long, sometimes practices will ask us to go for and additional week, if they have a lot of partners that didn’t get a chance to use the equipment. And whether if it’s the limited pool, the sales leadership team determines where that pool goes for the best opportunities. We are very conscious of managing that on a day-to-day basis.

I think to reflect on David’s comment earlier, and how we see Q3 will probably look a little like Q2 related to Fuse, and then Q4 we expect to see an increase, that is based on a quantitative analysis; it’s not based on a gut feel. We have the fortune to look at the pipeline with a lot more clarity now with a year or so behind us, and getting these transitions done.

So we’re seeing the pipeline continue to build and having a more clear picture of time to close and demo efficiency.

Travis Steed

Is there anything to read into the fact that average monthly orders in the single use business were down a little bit both year-over-year and sequentially, or is this just the usual volatility, and is there any way to comment on same-store sales growth?

Mark Gilreath

Yes, the good news is there was a strong growth in the number of customers in the denominator, which brings down the equation. We had a very good month in the second quarter for new single use product customers, and that surely drives that. It’s based on the timing of when they come online, how much they order in the months, but we had good growth in the denominator.

Operator

And this concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

Mark Gilreath

Thank you for your time this afternoon, and we’ll give you an update next quarter. Thanks.

Operator

And ladies and gentlemen the conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.

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