Entellus Medical's (ENTL) CEO Bob White on Q3 2017 Results - Earnings Call Transcript

Entellus Medical, Inc. (NASDAQ:ENTL) Q3 2017 Earnings Conference Call November 1, 2017 4:30 PM ET

Executives

Carrie Mendivil - IR, The Gilmartin Group

Bob White - President and CEO

Brent Moen - CFO

Analysts

Kaila Krum - William Blair

Operator

Welcome to Entellus Medical's 2017 Third Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will hold a Q&A session. [Operator Instructions] As a reminder, this conference call is being recorded today, November 1, 2017.

I'd now like to turn the conference over to Carrie Mendivil, Investor Relations. Please go ahead.

Carrie Mendivil

Thank you. Thank you. This is Carrie Mendivil with The Gilmartin Group. Thanks for participating in today's call. Joining me from Entellus Medical is President and Chief Executive Officer, Bob White; and Chief Financial Officer, Brent Moen.

Earlier today, Entellus released financial results for the quarter ended September 30, 2017. If you've not received this news release or if you'd like to be added to the company's distribution list, please send an email to [e-mail].

Before we begin, I'd like to remind you that management will make statements during this call that are forward-looking statements within the meaning of federal securities laws. These statements involve material risks and uncertainties that could cause actual results or events to materially differ from those anticipated. Additional information regarding these risks and uncertainties appears in the section entitled "Forward-Looking Statements" in the press release Entellus issued today. For a complete list and description, please see the Risk Factors section on the company's most recently filed Annual Report on Form 10-K and the third quarter report on Form 10-Q, which the company intends to file with the Securities and Exchange Commission.

Entellus' earnings release and discussions today includes three non-GAAP financial measures; adjusted EBITDA, adjusted gross margin, and adjusted operating expenses. Please refer to the GAAP reconciliations which appear in tables of today's press release and are otherwise available on our Web site. Please note that non-GAAP financial measures have limitations and that they do not reflect all of the amounts associated with Entellus' financial results as determined in accordance with GAAP. Non-GAAP financial measures should only be used to evaluate Entellus' financial results in conjunction with the corresponding GAAP measures.

Entellus disclaims any intention or obligation to update or revise any financial projections or forward-looking statements, whether because of new information, future events or otherwise. This conference call contains time-sensitive information and is accurate only as of the live broadcast, November 1, 2017.

I will now turn the call over to Bob White. Bob?

Bob White

Thanks, Carrie, and good afternoon everyone and thank you for joining us. We achieved several key milestones in the third quarter, and enter the final months of the year with strong momentum. Our results demonstrate traction of our broadening product platform, offering less invasive treatment options to ENTs with Entellus solutions extending beyond chronic sinusitis to also include Eustachian tube dysfunction, and nasal airway obstruction.

Each year, in the U.S., over 40 million people experience common symptoms from chronic sinusitis, Eustachian tube dysfunction and/or nasal airway obstruction, which results in over 12 million patient visits to physicians. The current standard of care to treat these patients is invasive, complex, and costly, which leaves the market vastly underserved. Our focus is to provide better patient outcomes by offering less invasive solutions, and help transition these medical procedures to more cost effective sites of care. During the third quarter we once again made progress on this front.

Third quarter revenues totaled $23.3 million, representing growth of 30% over the prior year quarter. We did incur some revenue impact due to the hurricanes in Houston and the Southeast states. Brent will provide more details on that in the financial section. I would like to take a moment to acknowledge the courage and resilience of all those who have been directly impacted by these storms, as well as the fires on Northern California. This includes a number of our employees and customers who were directly affected.

Moving to the quarter, as many of you recall, on July 13, we closed the acquisition of Spirox, meaningfully enhancing our market opportunity and the growth potential of our business. As a reminder, nasal valve compromise is among the largest single contributors to nasal obstruction symptoms, and LATERA is the only available technology that offers a less invasive, simple, and effective method for treating this problem. Nasal airway obstruction impacts as many as 19 million people in the U.S., and nearly 1 million of those people undergo some type of surgical procedure each year. Our near-term estimate of the market opportunity of those patients who may benefit from the less invasive lateral wall intervention used in the LATERA implant is over $700 million.

LATERA was commercially introduced in mid-2016, and now just over a year later, more than 7,500 patients have been successfully treated with over 15,000 LATERA absorbable nasal implants. Our confidence in our business and product platform reaffirm that the recent American Academy of Otolaryngology annual meeting in Chicago, which was an overwhelming success. We trained over 300 physicians in cadaveric training labs and other training sessions, and experienced significant interest in our Eustachian tube dysfunction and nasal airway obstruction products. The clinician response to these products further validates our confidence that we have more effective treatment options to address these challenging patient populations.

One of the key advantages of our XprESS ENT Dilation System for Eustachian tube dysfunction is that the physicians do need a second device if the patient also requires balloon sinus dilation. This is a significant cost savings to the provider and healthcare system. When combined with our clinical data, our cost-effective approach to Eustachian tube dilation positions our products well in this emerging market segment. This is important while reimbursement coverage is being pursued. As a reminder, on July 1, CMS established a unique C-code and payment for endoscopic balloon dilation to treat Eustachian tube dysfunction. This new code facilitates payment for the outpatient treatment of Eustachian tube dysfunction using balloon dilation in hospitals and ambulatory surgery centers.

Since closing the Spirox acquisition in July, integration efforts are well underway with highly engaged team members from both Entellus and Spirox working towards a common vision. We are bringing customer service and distribution capabilities together, leveraging synergies, and back office capabilities across the entire organization.

We also just announced Mike Rosenthal will become our new Chief Operating Officer. Mike has been the General Manger of Spirox since we closed the acquisition. Mike has over 20 years of R&D, operations, and regulatory experience, including leadership positions at CardioGenesis, FoxHollow, and Sawtooth.

On the sales and marketing front, we ended the third quarter with 104 full quota carrying reps. Our full quote carrying sold an annualized run rate of approximately $813,000 for the third quarter. We continue to expect our pipeline of new products and the more tenured sales force to continue to drive increasing levels of productivity. As our full quota carrying reps become more productive we are on track to hit our goal of an annualized run rate of between $800,000 and $900,000 for 2017.

As we continue to refine our commercialization strategy we maintain Spirox's dedicated sales team, while combining it with Entellus sales team under common leadership to ensure focus on the core product lines, including XprESS and LATERA. In addition, we have been adding LATERA to certain Entellus sales reps' bags as we aim to broaden U.S. coverage and ensure we are able to respond to customer interest in a timely manner. During Q3, we also cross-trained the entire sales organization on all products, and introduced programs to drive collaboration and capitalize on the near-term potential of our combined customer base, which now exceeds 2,200 accounts. As we look ahead to Q4 and beyond, we will be increasing the number of reps selling LATERA, but we are not ready to provide specific numbers at this time.

Over overall U.S. sales organization included 177 people at quarter end, compared to 161 people at the end of the second quarter. Overall, we believe we have reached a reasonable number of sales personnel to achieve our near-term goals, and expect this total figure to remain relatively stable in the near term.

On the clinical front, we are pleased to announce new data from our first in-human study of a LATERA absorbable nasal implant presented recently at the 2017 annual conference of the European Academy of Facial Plastic Surgery, and the 2017 annual meeting of the American Academy of Facial Plastic and Reconstructive Surgery. The 18 and 24 month data demonstrate that patients who receive LATERA had significant improvement in nasal obstruction symptoms with no negative cosmetic changes.

The study was conducted at three sites in Germany, and included 30 adult patients with nasal valve collapse. Patients had severe or extreme symptoms as established by the validated nasal obstruction symptom evaluation instrument, and were treated with LATERA alone. A total of 56 LATERA implants were placed in these 30 subjects, and patients were assessed at one week, and one, three, six, 12, 18, and 24 months post procedure. Key findings of the study include continuing significant nose pore reduction at all time points out to 24 months, no adverse change in cosmetic appearance at 24 months post procedure, and a short learning curve for physicians adopting the technology.

We are very pleased to see continued evidence reinforcing LATERA as a safe and effective treatment option for patients with nasal valve collapse. We are continuing to make progress on two clinical studies to treat nasal valve collapse with the LATERA absorbable implant. As a reminder, these are both single-arm cohort studies designed to measure the proportion of patients who respond to treatment at six months post procedure in each of the OR and office settings. Both studies completed enrolling patients well ahead of plan, and we expect to have more comprehensive updates over the next couple of quarters.

During the quarter, we completed collection of follow-up data from patients in the Eustachian tube dysfunction trial. This was a prospective multi-center randomized trial of the XprESS balloon dilation device in patients with persistent Eustachian tube dysfunction. The primary efficacy endpoint was met with Eustachian tube balloon dilation demonstrating superiority over medical treatment. And the primary safety endpoint was met with a zero percent complication rate. Importantly, nearly three-fourths of balloon dilation procedures were completed in the office under local anesthesia. We look forward to publication of these results by early 2018.

Outside of the U.S., the market for balloon-based sinus surgery remains largely undeveloped. Business continued to progress nicely during the quarter. We are in over 15 countries, and continue to make inroads in market development and penetration.

And with that, I'd like to turn it over to Brent Moen, our CFO, for a more detailed review of our financial results and guidance. Brent?

Brent Moen

Thanks, Bob, and good afternoon everyone. Revenue for the third quarter increased 30% to $23.3 million from $17.9 million during the same period of the prior year. This includes $3.1 million of revenue from products acquired during the past 12 months consisting entirely of LATERA revenue from our July 13 acquisition of Spirox. We estimate that we experienced roughly $700,000 to $900,000 of disruption from hurricanes in Houston and the Southeast states during the third quarter.

Growth in revenue was solid across all product categories, as we continue to see strong adoption of our core XprESS family products as well as momentum in our capital products. Total sales to the office setting represented 47% of revenues in the quarter. Excluding contribution from LATERA as nasal airway obstruction procedures are largely performed in a hospital or ASC, our office OR split was consistent with prior quarters at roughly 56% of revenue. We will continue to drive our chronic sinusitis business towards the office setting, but as we expand our presence to treat Eustachian tube and nasal airway obstruction, we expect our mix to shift towards the OR and ASC setting. Long-term as we gain reimbursement for office-based procedures, we expect to shift in our overall business to resume towards the office driven by our technologies and advantages.

Revenue per procedure trend slightly upward in Q3 versus the prior year driven by increased sales of new single used products including XeroGel and Cyclone. We expect revenue per procedure to continue to rise as our recently introduced single-use products gain market traction.

Reported gross margin for the third quarter of 2017 came in at 71.9%. Associated with the Spirox acquisition we recorded a non-cash inventory fair value adjustment impacting our gross margin. Excluding the impact of the inventory fair value adjustments, our non-GAAP adjusted gross margin was 73.3% for the quarter and 73.7% for the year-to-date period, consistent with our guidance range. This compares to our prior year third quarter GAAP gross margin of 74%. Compared to a year-ago, adjusted gross margin was primarily impacted by changes in sales mix, including our capital product lines and continued international expansion.

Operating expenses for the third quarter of 2017 came in at $34 million, an increase of 53% compared to $22.2 million for the same period of the prior year. We have expanded our income statement presentation to disclose the impact of acquisition-related expenses, which includes $2.3 million of contingent consideration accretion and $1.5 million of transaction and integration expenses for the quarter. We have also specifically identified the non-cash amortization expense related to the acquired intangible assets which totaled $2.0 million for the quarter and $2.3 million year-to-date.

Excluding the aforementioned income statement lines, third quarter 2017 non-GAAP adjusted operating expense totaled $28.2 million, an increase of $6 million or 27% compared to the year-ago quarter. The change is primarily the result of increased employee-related expenses resulting from the addition of Spirox operations and further expansion of our sales and corporate staff.

During the quarter, we recognized a special income tax benefit related to the Spirox acquisition in the amount of $14.9 million. This acquisition-related non-cash income tax benefit for the quarter resulted from the reversal of a previously established deferred tax asset valuation allowance primarily because of the net deferred tax liability recorded relating to the Spirox acquisition.

The net loss for the quarter ended September 30, 2017 was $3.2 million or $0.13 per share, compared to a net loss of $9.5 million or $0.50 per share for the same period of the prior year. Our third quarter 2017 non-GAAP adjusted EBITDA came in at a negative $8.1 million, favorable to our previously issued guidance range of negative $9 million to negative $11 million.

Transitioning to our balance sheet, we finished the third quarter with $51.5 million in cash and cash equivalents. We have $48 million of total debt outstanding, including $40 million of term loans and $7.9 million of borrowings under our $10 million revolving line of credit.

Moving on to our outlook for full-year 2017, we expect full-year 2017 revenue to be in the range of $92 million to $94 million, representing growth of 22% to 25% over 2016 revenue. This compares to our previous annual revenue expectation for 2017 of $91.5 million to $94.5 million, and previous growth expectations of 22% to 26%. Exclusive of any non-cash inventory fair value adjustment, non-GAAP adjusted gross margin is expected to be in the range of 72% to 74% for the full year 2017. We expect margin contribution from LATERA to be in line with our corporate gross margins with opportunity for improvement in the longer term driven by manufacturing efficiencies.

Full-year 2017 non-GAAP adjusted EBITDA is expected to be in the range of negative $23 million to negative $25 million. This compares to our previous annual adjusted EBITDA range for the full year 2017 of negative $22 million to negative $26 million. We expect international revenue to grow faster than the U.S., with international sales growing to be in the mid single digits as a percentage of our total consolidated revenue for the year.

At this point, I'd like to turn the call back to Bob for closing comments.

Bob White

Thanks Brent. We are excited about our growth prospects with XprESS, LATERA, and our pipeline, and are confident in our ability to continue to deliver meaningful growth in the quarters and years to come. I want to again highlight our broad strategy as our solutions now extend beyond chronic sinusitis to also include Eustachian tube dysfunction and nasal airway obstruction. There is meaningful patient overlap among these three market segments being treated by our ENT customers, which are dramatically underpenetrated.

We are leveraging our technology advantages, market expertise, and commercial infrastructure to address these markets which we believe will drive sustainable revenue growth. We have a terrific team assembled here at Entellus. And as our operational and commercial capabilities continue to grow we are well positioned to continue our positive momentum.

With that, we will now open it up for questions. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our question comes from Matt O'Brien with Piper Jaffray. Your line is now open.

Unidentified Analyst

Hi guys. This is Kevin on for Matt today. Thank you so much for taking the questions. I wanted to start with the in-office revenue split. I heard 47%, but you also mentioned that was in line with historical at 56% ex LATERA. So I was wondering how you guys think about the office/OR split over time assuming the reimbursement comes in down the line?

Brent Moen

Hi, Kevin, it's Brent. I'll take that question. So you're exactly right. 47% as we reported actually takes into account the LATERA product within that number. If you back out the LATERA product, just to kind of provide a comparison base, the number is 56%, which is just right in line with where we expect it to be. Now over the course of at least the next one or two years, we expect that shift will actually start to happen more to the OR setting and the ASC setting as Eustachian tube and LATERA continue to grow market share in those areas. And then over the time when we get some reimbursement those will actually start to transition into the office, and we'll see that office number grow as soon as reimbursement comes in.

Unidentified Analyst

Okay. So thinking about maybe a little bit more penetration into the office after the reimbursement comes in, like higher 50s perhaps?

Brent Moen

That's correct.

Unidentified Analyst

Okay, great. And then secondly -- thanks again. I wanted to spend some time on the new opportunities, both pediatric and Eustachian, curious how those are progressing. I heard some commentary in the prepared remarks, but are you seeing an inflection point here, any kind of color on what needs to happen for that shift if the inflection point isn't here yet?

Bob White

Yes, Kevin, it's Bob. I'll take a shot at your questions here. So on pediatric, we see continued momentum there. We had shared, I think, a couple of conference calls ago that those accounts where we had pediatric procedures going on we're growing 30% faster, actually in excess of 30% faster than adult-only accounts. And that trend continues. The Eustachian tube is early; very promising as evidenced by the numbers we've shared regarding the training and level of interest at the Academy meeting.

The trick on that side is going to simply be getting reimbursement to settle in. So it's terrific that Medicare implemented a C-code on July 1. As you know well, that covers the Medicare population. Now our eyes are on commercial payers to see how the adoption of that goes. But from an enthusiasm standpoint, amongst doctors, it's quite high namely because there's no good surgical alternative today for those patients. We just need to see that get supported by good reimbursement. So we're very bullish on Eustachian tube going forward.

Unidentified Analyst

Perfect. Thanks so much.

Bob White

Thanks, Kevin.

Operator

Thank you. [Operator Instructions] You have a question from Kaila Krum with William Blair. Your line is now open.

Kaila Krum

Hi guys. Thanks for taking my questions. So first, I mean, congrats on the progress you've made with the integration of Spirox. Can we just start out by talking about the recent clinical work that you guys presented; how you're hearing those data resonate with the field? And then in terms of the sales force integration, I mean it seems like headcount has been fairly stable. Can you just give us a little bit more comfort into your visibility into the fourth quarter, and whether or not that that continues?

Bob White

Yes, Kaila. So, it has been stable, and we like the numbers the way they currently are. What we'll likely see is that the overall sales team size will remain roughly where it is. As you just heard, we hit 177 at the end of last quarter in terms of total count including all commercial headcount. We like that number going forward. So plus or minus a few, that's where we're going to be.

And so then I guess then switching back over to your question on the data. So it's early. We just shared the 18 and 24-month data on Monday. So it's early, but it's very, very promising. We are eager to se how data would look especially after the 18th month mark. As a reminder, the resorption [ph] of the absorbable implant occurs at roughly around 18 months. So to see that there is good durability going now to 24 months is encouraging, albeit it is a relatively small trial, but is certainly a direction that we wanted to see. So there was a lot of interest and enthusiasm last Friday at the Facial Plastics meeting that occurred. And so I think that's certainly an optimistic and bullish sign that this is going to be a product that's going to be worthwhile.

Kaila Krum

Great, that's helpful. And then I guess just a follow-up on ETD. Can you just talk about whether or not [technical difficulty] seen or you're starting to see some pull-through revenues on the chronic sinusitis side, as you are pulling docs in to the ETD training lab, I think that would be helpful.

Bob White

The answer is definitely yes. It's early, but the one thing that we do know is, so when you've got concomitant patients where you may not have reimbursement that's in place for Eustachian tube, if the concomitant was sinus procedures they can immediately treat those patients' Eustachian tubes and get reimbursed for the sinus side. So that traction is already occurring. That's only going to hopefully increase over time, so, so far so good.

Kaila Krum

Great. Thank you.

Bob White

Thanks.

Operator

Thank you. And I show no further questions at this time. I'd like to turn the call back over to Bob White for any closing remarks.

Bob White

Thank you for joining us tonight, and we'll look forward to talking to everybody soon.

Operator

Ladies and gentlemen, this does conclude your program for today, and you may all disconnect. Everyone have a great day.