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Executives

John McDermott - Chairman of the Board, President, Chief Executive Officer

Analysts

Endologix Inc. (ELX) Morgan Stanley Global Healthcare Conference September 10, 2012 11:45 AM ET

Unidentified Analyst

Great, let's go ahead and get started here. I look managed care with medical devices. So it’s a pleasure to have with us here the session before we get into the lunch break here, Endologix's CEO, John McDermott. Just quickly for medical device recent disclosures, go to the Morgan Stanley website and you can see all of my recent disclosures. It’s a great read.

So, for many of you know this, that Endologix is not a covered company for Morgan Stanley. So the real question is, why are they here and the route is, we see Endologix is attacking a very large and growing end-market in AAA stenting and John will sort of walk us through that.

I also would say this, since John has joined the company, several years ago, you have seen significant improvement in both their international distribution, their product reps have expanded the business in terms of the pipeline with their acquisition of Nellix. So this business in the last three to four years has been completely transformed and John obviously has a lot to with that.

So we see here is an emerging medical device company in an important growing end market and frankly with a significant amount of operational change. So what we are going to do is let John and he will give us a minute preamble and then we are going to jump into the Q&A. John.

John McDermott

Okay, thank you. So, Endologix, for those of you who aren’t familiar with the company is a medical device business. We make a device to treat abdominal aortic aneurisms. That is a leading cause of death in the United States, particularly for men. The historical way to fix these aneurisms is with an open surgery. There is a new way to fix aneurisms and that is with a percutaneous or through the catheter type of approach, so this less invasive.

We were one of the later entrants into this market, have grown very rapidly over the last few years, have a differentiated technology which is capturing share but more interestingly over the last couple of years have invested a considerable amount of our efforts and resource into a new portfolio of devices as that are getting ready to be introduced over the next few years in Europe first and then in the United States.

So we have been growing nicely. We grew in the first half about 30%. We have given five year guidance to grow at 20% or better over the next several years. We have just been expanding into Europe and have very promising future. So it's an exciting company with a lot of growth potential.

Question-and-Answer Session

Unidentified Analyst

Great job, thanks. So you were one of the reasons why I think Endologix is particularly interesting. Obviously there is a pullback in the stocks past the quarter. In fact, they would have bought you anyway but it is a clear opportunity for investors. Maybe in the sense of star care, there are some people who believe that it was related to Nellix but, frankly, probably it was more related to earnings expectations and guidance there. So maybe walk us through what happened on the quarter specifically.

John McDermott

Yes, I think there was a pullback in the stock. For those of you, again, who aren’t familiar with it, one of the featured new technologies in the portfolio was a device called Nellix. The current devices today, we treat an aneurism by putting in a tube to isolate the blood flow from the aneurism sack and that has worked pretty well with pretty good results but the problem is you still get, what we call and endo leak. You get leaks around these tubes that require annual CT scans and life time of surveillance for these patients.

We have developed a new technology which effectively seals that aneurism sack and there isn’t anything like it. It's been developed for many, many years. We actually bought the company that have been developing it about a year and half ago and integrated some of our technologies.

We made a decision just prior to the last call to hold that device back a little bit, make a few final design enhancements before we start our USIDE and our European trial and the effect of that was, instead of getting a CE mark and launching that in Europe around now, it was a limited market release, we will do that in about the middle of next year. I think that was the biggest reason for the change in the stock.

Unidentified Analyst

Okay, and obviously, we have got a pretty big room here. So if there are questions, please raise them high enough and we will get to them. John, I want to mention another (inaudible) debate that has been out there for several months. Actually in upwards of a year, and just your larger competitor, there really are two competitors in the market. One today, and the one potential in the future.

So, talking about Medtronic and Endurant and Endurant II, with that now in the market place, can we talk as to how the competitive environment in your mind has changed in the last 12 and 24 months, specifically with Endurant and if you think about, and obviously it is much further in the future but with TriVascular, maybe several years in the future, how does the competitive environment for you transform last year and the next two years?

John McDermott

Yes, so last year, Medtronic, go back into 2011, was when they introduced Endurant I, we saw a flattening of our sales during that period of time and then started to grow in the second half. For those of you aren’t familiar, our device is very different. We actually sit our device on the patient's bifurcation. We are not taking through much detail.

The devices are different enough that although we had some of our customers try the Medtronic device, for the most part, we got them back and it has continued on our growth trajectory. Endurant II, which was launched by Medtronic in June of this year were just some small enhancements to that product line.

I wouldn’t put that in significant improvement category but they do have a large sales force and so we do expect some more competitive pressure from them in the second half.

As far as other competitors, you mentioned TriVascular. We do think that they will get an approval by the end of this year. It is a slightly differentiated product off of the same of the other devices that are fixed proximally but I still don’t think it addresses the biggest unmet needs in EVAR which are difficult aortic necks and sealing endo leaks.

So I don’t personally expect that to be a major share capturing device. I think the most interesting new products that are coming to market are Ventana and Nellix.

Unidentified Analyst

So just let's go back to TriVascular for a second here. Is it that you don’t think that their value added opportunity is big enough to make an impact in the market or is it more when they launch, they are probably not going to have the breadth of sizing and distribution to compete.

John McDermott

I think it's more the former. I don’t think, if you spend time with this customer set. These procedures are done primarily by vascular surgeons. If you spend a lot of time with them and ask them what are the big problems that they face, it's not profile, which is the primary attribute of that device.

The primary problems are endo leaks, as I mentioned, in treating more challenging anatomies and this device, it doesn’t solve those problems. So, again, I give them a lot of credit and I want to be very respectful for the work that they have done. I think they have made a lot of progress and they have been at it a long time. I just don’t believe that it offers enough of a difference over the currently available devices to move market share.

So, for us, I don’t think see them as a big threat relative to our portfolio.

Unidentified Analyst

At a relative basis, Endurant I and Endurant II or TriVascular, which of those three has the biggest or you think it has the biggest on your business, competitively.

John McDermott

Well, I would put Endurant as a more meaningful product for two reasons. As Medtronic, they have got a large well established sales organization. You have heard of them, yes. So I would put them ahead. I think, again, the TriVascular device is primarily focused on profile but it comes with some procedural steps. It's not that easy to use and I think that that matters in this business too.

Unidentified Analyst

Okay, and you mentioned in your prepared remarks your Ventana. So now with the CE mark for Ventana done, what steps have you taken heading into launch. Maybe help share with us some of the early feedback.

John McDermott

On Ventana?

Unidentified Analyst

Yes.

John McDermott

So, just to clarify, we don’t have CE mark yet for Ventana. We expect to get that by the end of this year. But in terms of steps that we are taking to get ready for that is, we have already identified the targeted institutions that we will roll it out too, on a limited basis and then gradually build the number of centers that get access to it.

We just announced last week a CE mark for Nellix. That is on the current generation of the device that we are making a few changes to. So the final version of the Nellix, the final commercial device, we expect to get approval in the first half of nest year.

Unidentified Analyst

Okay, so let's just go back, so you are at CE mark filing for Ventana.

John McDermott

That’s correct.

Unidentified Analyst

And just help us understand, the peak market potential for that device and how it compares to your existing portfolio?

John McDermott

So, Ventana is a device to treat more complex aortic anatomy, specifically those patients that have an aneurism up and around the renal arteries. It's about 20% of the diagnosed aneurisms today. They are really untreatable. This device enables the treatment of those people.

The importance of that is if somebody gets diagnosed with one of those more complex anatomies today, and they are not a surgical candidate, they don’t get their aneurism treated. So it is a meaningful unmet need in the space and we have completed a European clinical trial, submitted that data and have our CE mark pending for that device.

Unidentified Analyst

Okay, questions in the audience? So maybe talk just a little about PEVAR, maybe explain to the audience what PEVAR was. Obviously what you impact that data can have on the marketplace.

John McDermott

PEVAR stands for percutaneous endovascular aneurysm repair and the way our device works is it’s a sheath based system which means you insert, basically, catheters in to the femoral artery and then you can work through those catheters or those sheaths. That’s a bit unique.

The other devices, you have to take them in, you do part of the procedure, you take them out and you go back in with a different (inaudible). Because of the unique characteristics of our device doctors can actually do this procedure with a technique called percutaneous or just over a guide wire. All the other devices currently require bilateral surgical groin incisions to insert their devices.

But nobody has an indication for a fully percutaneous EVAR repair. We did a clinical trial together with Abbot who has some closure devices and completed that trial recently and have submitted to the FDA to broaden our indication to be the only company with an EVAR device that can treat these patients fully percutaneous.

We expect to get approval for that by the end of this year. the significance of that, its not a new device, it’s a broadened indication, we will be the only company that can actively promote, teach and train physicians how to do this new technique on our device and we think that represents a growth opportunity for us in the U.S.

Unidentified Analyst

So couple of things of PEVAR that are, I don’t want you get push in, some actually in full disclosure concern me a little bit. So you take a procedure that’s well established, been actually as great clinical (inaudible), start thinking about percutaneous, so how concerned are you?

On the one hand, the negative here, how concerned would you be in terms of taking a procedure, you are getting great (inaudible), you go in percutaneous, you start getting acceleration of adverse events. That would be the potential downside.

I guess, the potential upside, at least in my estimation would be as you think about TriVascular, and what they are going to try to say to the market place in a year or so, this seems to potentially mute some of the claims that I thought they were going to make. So help us understand that bull case and bear case of PEVAR.

John McDermott

Well, if what you said was true is that the introduction of PEVAR resulted in more adverse events then I would agree that’s a problem. That won't be the case. We have done the first randomized multi centered trial. We will release those data around the end of this year or first part of next year. We don’t expect that to the case.

We expect, in fact, the clinical results to be comparable except there will be shorter procedure times, less blood less and quicker patient ambulation. So I think that we will be able to demonstrate there is clinical benefit to PEVAR and that’s already been proven in a lot of the literature that’s out there today.

As it relates to TriVascular, although they will have a lower profile device, they won't have the indication and I still believe that having the indication is what will give us competitive advantage.

Unidentified Analyst

Okay, so (inaudible) are moving out 24 to 36 months. What percent of your procedures you think will migrate to percutaneous?

John McDermott

Yes, we did a survey at the society of vascular surgery meeting in June and of the people that participated in that survey, the feedback was 30% to 40% of them were already doing percutaneous and when asked those that were not doing it, what was the limiting factor, they cited training and that validates our assumption because that technique is off label there is nowhere for them to go to get trained.

They have to learn through somebody else that knows or they have adopted the technique. So we know training is a barrier and then for those that are already doing it, when asked if they would be interested in additional training, they said, absolutely yes. So our expectation is, in three to four years, post PEVAR approval, that well over half of the market should be doing this percutaneously.

One of the reasons they don’t do percutaneous in academic institutions is to give the fellows a chance to operate and cut down into the patient's groins. But that’s not necessarily, that’s really more for training the fellows than it is what the patients want.

Once patients find out that they can get their aneurism repaired and sent home with band aids in their groins instead of bilateral surgical incisions, I think, you will feel that patients start asking for that approach so they get lap choly. Lots and lots of examples of where open surgical repair have migrated to fully percutaneous procedures.

Unidentified Analyst

Who do you think is the closest? Where do you think Medtronic is in terms of pursuing a percutaneous indication?

John McDermott

There isn’t anybody that’s started a study to get a specific indication.

Unidentified Analyst

As you think about your training and distribution, is there anything maybe investors are missing about what this indication will let you do in the markets or see an increase or decrease in selling cost because of the indication?

John McDermott

I don’t think people are missing anything necessarily. I think it’s a great incremental selling opportunity for us but I don’t believe it represents the same order of magnitude as Nellix and Ventana. My sense for it is that the investment community has got them appropriately ranked in terms of impact and valuation creation.

What PEVAR does for us is it sets us further aside from the competitive landscape in the U.S. and gives us continued growth opportunity in the U.S. while we wait for our portfolio of new products to come to the U.S. In the meantime we can launch those new devices outside the U.S., get good growth there.

Unidentified Analyst

Sure, in the nature of the AAA space, when you find out, either through abdominal ultrasound that you have an aneurism, you are not going to wait to treat that aneurism in a lot of cases, you are transitioning, to fancy more of an MIS or minimally invasive percutaneous procedure. Is there any sense that that transition, that 30%-40% would be percutaneous moving to 50% or more percent in the next two to three years? Any sense that can actually could change the trajectory of the end market growth rate for EVAR?

John McDermott

I don’t think so. I don’t think percutaneous changes it. I just think patients get treated better. But the core market in the U.S. is expected to continue to grow on a procedure basis at 6% to 8%. So relative to a lot of other medical basis, it’s a pretty good growth.

If you include the impact of what Nellix can do by treating a broader range of patients, a broader range of anatomy and then you add to that this Ventana technology, which will treat that 20% that don’t have an EVAR solution today, you have got market growth of well over 10%.

So it's an attractive market and for a company our size, it's roughly $100 million in revenue. We have got a long runway of growth.

Unidentified Analyst

Okay, are there questions? Sorry, I got excited. In terms of Nellix, obviously, you talked about it several times during the presentation, the first 20 minutes. So obviously and probably the most significant growth driver or the most significant growth driver of the company in the next several years, maybe just start describing the what Nellix is, relative to a traditional EVAR implementation.

How does Nellix really differ and then maybe just start by discussing from that second quarter in terms of that extension. Your confidence in the data that’s going to be required for that submission and your confidence in that time line.

John McDermott

Okay, so I touched on this just briefly but again, if you think about the open surgical repair, these are polyester woven grafts that are the open repair sewn into the patient's aorta to exclude or eliminate this aneurism. Current generation EVAR devices are effectively that same substrate with stents either embedded in or sewn to the devices put into a catheter and that’s kind of what current generation EVAR devices are.

So it's like putting a surgical graft on the inside of an artery and shunting the blood to keep it off of the aneurism wall. The problem with that is the aorta has a lot of side branches. So if you ever saw an open surgical repair, they ligate all the side branches on each side of the aorta.

You can’t do that when you fix it with traditional EVAR device. These side branches continue to profuse the aneurism and in some cases even through you have successfully implanted an EVAR device, the aneurism still grows. So you have to communicate to the patient, I am sorry, we have repaired your aneurism but there is still pulsatile blood flow because of these side branches.

Nellix was designed to seal that aneurism sack with a biostable polymer so that there can be no continued blood flow into the aneurism. There isn’t anything like that. You are familiar with neuroaneurism treatments with coils and ballic materials. This Nellix is kind of like that type of a therapy for the abdominal aorta, is the way to think about it.

For that reason, and based on early clinical results, there is a lot of interest in solving that problem. If, in fact, it works as well as it has so far in the early clinical results, there is the possibility we won't have to keep patients on life time surveillance and so they won't have to come back for an annual CT scan. Right now, they have to come back and have their device monitored to make sure there hasn’t been a late leak.

Nellix affords the potential of that. What was the second part of your question?

Unidentified Analyst

You covered the questions. The first piece, I think it is very important for anyone to hear it but the first thing would be the incremental changes that you are going to make and what are those changes and why are they so important, which is that (inaudible)?

John McDermott

Yes, so we had one reported case of a thrombosis in one out of our 60 patients and when we looked at that, even though one out of 60 is still less then 2% which is still within the reported rates of thrombosis in the literature, we just felt, its only 60 patients and that’s a small number, lets take one more spin through the device and make sure that if there is anything else we can improve and we found a couple of things that we think opportunistically we should take this time to fix.

It's much better to do that now than start our IDE and start our European clinical work. So we decided to take the time and make those changes. Our level of confidence in those changes is high. I can't tell you exactly what the changes are, for confidentiality and proprietary reasons.

We don’t necessarily want to educate the competition or anybody else that may want to follow us in aneurism sack sealing but I can tell you that we have a lot of confidence in what we are in the changes.

Unidentified Analyst

It's safe to say that the changes were limited, the iteration was limited to things that you think can reduce thrombosis?

John McDermott

Yes.

Unidentified Analyst

Okay, I think that’s clear enough. I means it's just me and a couple of hundreds friends, by the way, so don’t feel to speak.

John McDermott

No, we feel good about the changes. In fact most of them are done as a practical matter. The only thing, that the reason it takes so much time is, with all these types of implantable devices, there is a fairly rigorous process of testing and validation, verification work that we have to do to put into our submission.

The CE mark that we announced last week, really were the most significant changes that we have made to the device. The next dossier that we submit represents actually fairly minor changes.

Unidentified Analyst

Okay, so you classify your, (inaudible) that your confidence in mid-13 launch is high, extremely high?

John McDermott

Yes, I feel good about it. I don’t know high, extremely high. You are always feeling what the regulatory agencies but and as much as we got a CE last week for a device with significantly more changes. That certainly gives us a good bit of confidence that we should get this done in the timeframe that we set out to.

Unidentified Analyst

Okay, maybe switching over to the U.S. part of the process. So who would your expect the follow up to be on the U.S. trial and then are we still thinking 2016?

John McDermott

Yes, so the way this will work in the U.S. is we will file an IDE in the first part of next year. Depending on how long it takes for that IDE to get approved by the FDA, we will then start to enroll patients in a trial. It will probably take nine to twelve months to enroll. Most of the EVAR trials have involved about 150 patients. The follow up is one year. We will follow those patients for a year and then submit a PMA. That gets your right into this 2015, 2016 time frame.

Unidentified Analyst

Okay, and then assuming no changes based on what happened in the European experience, you would expect that not to delay the USIDE process in the first (inaudible)?

John McDermott

Well, no, and that was the other reason we decided to make the device changes before we submitted the IDE.

Unidentified Analyst

Got it.

John McDermott

That was part of the rationale for it. We are in a little bit of an unique situation because there isn’t anybody else that’s working on anything like this. So we don’t have a competitor breathing down our neck with a similar technology where we have got to be in a hurry.

Our view was, let's take our time, let's do this right. We think this is very disruptive and lets make the final improvements before we start the USIDE and we are also going to run a good sever pre-clinical trial post market.

Unidentified Analyst

Okay, and then you also maintained guidance despite this small setback. So I guess, what does that say to us? Is that, say, the underlying strength of your business is better than we expected or you simply had very conservative expectations to begin with for the initial approval?

John McDermott

We didn’t have big numbers put in for Nellix this year and the rest of the business is performing as we expected.

Unidentified Analyst

Questions for John. We have got about four and half minutes left. So, John, I was going to transition over to some macro stuff for a second. Large cap medical device companies are basically saying, we are going to offset the medical device tax in various ways. Some will buy back stocks, some will cut spending. Small cap companies are actually impacted even more but likely to take a different tactic in dealing with it.

You are a growth focused company. So help us understand to what extent does medical device tax impacted you in '13 and then what is your ideology in terms of dealing with it?

John McDermott

So we have done the math, which is remarkably complicated and it's about $1 million next year based on our latest estimates, $1 million to $1.2 million and I don’t see us being able to push that on price. The hospitals don’t have the capacity to absorb that. We just bake it into our operating plans and still plan to be cash flow positive despite the tax.

Really, as we are not going to buy back shares or do any other financial gymnastics to cover. We will just have to grow our way out of it.

Unidentified Analyst

Great, so it doesn’t sound like you will change your growth plan, your five year, three year, two year plan?

John McDermott

No, it doesn’t. It's unfortunate for sure. We may hire a few less people than we would have without it. So that’s entirely possible but I don’t think it materially changes our course.

Unidentified Analyst

You think investors have your opportunity in Europe, which I mentioned in my preamble, it is significant thing that you addressed when you got to the company but when you think about the European opportunity, and the Japanese opportunity, you think those opportunities are appropriately understood by investors and how big can those markets be for you in the next few years.

John McDermott

Yes, I think they are well understood. To put it into context, through, the European EVAR markets, roughly $250 million and we finished out last year with less than $5 million and we are about to introduce the three most interesting products in EVAR for a long, long time. So I think there is a real opportunity and I believe it's pretty significant. I think that’s well understood by the investment community.

Turning to Japan, we are expecting approval for IntuiTrak which is an earlier version of our device. We are a generation behind in Japan but that’s an attractive market. That’s about $50 million market. We have a distribution partner there. I see good growth there.

And I think over the next several years, that could also be a grower for us where today we just have a small amount of sales. Company our size, we focus on the bigger markets. We have now built a good direct sales organization in the U.S. We are doing that in Europe.

We will expand into these other markets over time but we forecast and you will find numbers bigger than this over the next five years. The EVAR market is to be worth well over $2 billion. So for a company our size, we have got, as I said earlier, a long runway.

Unidentified Analyst

Okay, two related questions, just to wrap us out here because we have a minute and half left. One capital raise, have you raised the last dollar that you have to raise?

Then sort of a related question, the company right now is about growth. There is no question, top line growth. You have got Nellix. Obviously you talked about Ventana. So there is a significant visibility for the investor on the top line. Help us understand how you are thinking about the bottom line, in terms of realistic profitability targets and when those could be reached?

John McDermott

Yes, so we did decide to bring on some more cash here a couple of months. We were trying to avoid doing that but we were just getting the balances, we had enough to maybe thread the needle but we had some opportunities to take our polymer license exclusive. So now we have the exclusive license for aneurism treatment over a wide range of polymers and hydrogels.

So we though that was money that was well spent. We had an opportunity to accelerate a buyout of our dealer in Italy. So we decided to do that. Couple of those types of things just made sense to continue to build this business.

Doing those would have put us just too thin, we felt. So that’s why decided to take on the additional capital and give us plenty of resource to support the growth. I don’t think we are going to need anymore and related to that, our ambition is certainly not to raise more cash. We would like to independent financially next year and generate positive cash flow.

We have a high amount of non cash expense in our P&L. So I am not, candidly for next year, not as focused on EPS positive as I am cash flow positive. We can be EPS positive in the following year, is my current thinking about that.

Our expectation is to be cash flow positive next year, EPS positive in the following year and not have to get any external financing for that.

Unidentified Analyst

So in terms of profitability inflections, it sounds like next year, when you are still launching some of your biggest products, it is probably than I would say, "is your inflection year". So if I had to label an inflection year as '13, '14 and '15, is it much more likely that EBIT or EBITDA inflection is more of a '14, '15 timeframe?

John McDermott

I think '14, '15 and then after that the leverage is substantial because what happens when you start to introduce Ventana and Nellix in the United States, you are going to have a 100 person sales force that these products drop into. Right now, I am building a sales force in Europe. So I am investing while I am launching. You see what I mean, but when you have got an infrastructure that’s already paid for in the U.S. and those new technologies drop into that, I think there is significant growth and leverage that comes out of that.

I am not saying we wait till we get profitable and tell Ventana and Nellix at the U.S. but I am saying that’s when the margins really start to expand pretty dramatically.

Unidentified Analyst

Okay, unfortunately we are out of time, please join us for lunch. John, thanks so much for being with us today.

John McDermott

Thank you.

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