Apollo Endosurgery, Inc. (NASDAQ:APEN) Q4 2020 Earnings Conference Call February 25, 2021 4:30 PM ET
Matt Kreps - IR
Todd Newton - CEO
Stefanie Cavanaugh - CFO
Conference Call Participants
Matt Hewitt - Craig-Hallum Capital Group
Good afternoon, ladies and gentlemen, and welcome to the Apollo Endosurgery Fourth Quarter 2020 Results Conference Call. [Operator Instructions]
It is now my pleasure to turn the floor over to your host, Matt Kreps. Sir, the floor is yours.
Thank you, John, and thanks, everyone, for participating in today's call to discuss Apollo's fourth quarter 2020 financial and operating results. Joining me on the call are Todd Newton, Chief Executive Officer; and Stefanie Cavanaugh, Chief Financial Officer.
Before we begin, I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of federal securities laws, including Apollo's financial outlook and Apollo's plans and timing for product development and sales. In addition, there is uncertainty around the spread of the COVID-19 virus and the ultimate impact it may have on our operations, the demand for our products, global supply chains and economic activity in general. These forward-looking statements involve material risks and uncertainties and could cause actual results may differ materially. For a discussion of risk factors, I encourage you to review the company's annual report on Form 10-K for the year ending December 31, 2020, filed today with the Securities and Exchange Commission. The content of this conference call contains time-sensitive information that is accurate only as of the day of this live broadcast, February 25, 2021. Except as required by law, Apollo undertakes no obligation to revise or update any statement to reflect events or circumstances after the date of this call.
During this call, we will interchangeably use the term ESS for OverStitch and term IGB for Orbera and vice versa. And now with that completed, I'd like to turn the call over to Todd.
Thank you, Matt. Good afternoon, everyone. Thank you for joining today's call to discuss our fourth quarter 2020 results. Our expectation coming into the fourth quarter was for COVID disruption to persist, but to be less severe than certainly we experienced in the first half of 2020, and that overall procedure volumes using our products would return to levels similar to the fourth quarter of last year. This expectation was more or less what occurred in our business during the fourth quarter, with the U.S. market being up 15% versus Q4 of 2019, which made up for the more noticeable COVID procedure weakness, which lingered in our international markets, particularly in our European direct markets during November and December. Taken together, our worldwide endoscopy product sales increased 4% in the fourth quarter year-over-year. I am really pleased with our ability to reduce and maintain control over our cash burn in the fourth quarter.
Expense reduction programs that were born from necessity due to the coronavirus, along with gradual gross margin progress, resulted in a 53% reduction in our net operating loss in Q4 compared to the same period in 2019 and a 58% improvement in our cash used in operations. The improvement in these 2 important financial metrics should be not just sustainable but can improve from here as our markets stabilize, health care utilization gets back on track and product revenues grow. I'm also pleased to tell you we have completed the X-Tack limited launch. I will give you more detail shortly, but I will tell you now, it went great. And with that, I'll turn the call over to Stefanie to cover the fourth quarter financial results in greater detail. Stef?
Thank you, Todd, and good afternoon, everyone. As Todd mentioned, the fourth quarter of 2020 overall was a stabilizing period for our revenues, even amid regional COVID disruption fluctuations. On the top line, total revenues increased to $12.9 million, a gain of 7% in the fourth quarter of 2020 from the fourth quarter of 2019. Total endoscopy revenue increased 4% to $12.2 million, with U.S. endoscopy sales increasing 15%, while OUS endoscopy sales decreased 6%. Similar to the third quarter, these results reflect continuing U.S. rebound from COVID-19 and differing trend lines in our 2 OUS sales channels. In our OUS direct markets, endoscopy product sales declined 10% due to ongoing COVID case volatility in the fourth quarter.
Product sales to distributors began to rebound somewhat and were back to the fourth quarter of 2019 levels. By product, fourth quarter ESS sales increased 2% from 2019, with U.S. ESS sales increasing 10%, to offset the weaker OUS ESS sales, which were impacted by the lingering COVID-19 disruption that I just noted. Fourth quarter IGB product revenue increased 7% from 2019 and U.S. Orbera sales increased 33%, and OUS IGB revenue remained largely stable and consistent compared with the fourth quarter of 2019.
Gross margin for the fourth quarter was 56% compared with 49% for the fourth quarter of 2019, increasing from the benefits of our gross margin improvement projects as well as the increase in direct market IGB sales this quarter. Increased inventory production also improved the fourth quarter gross margin results through higher overhead absorption. During the fourth quarter, we restarted select gross margin improvement projects that were put on hold during the pandemic.
The next 2 of these projects will address our Sx material costs, and we expect both projects to be completed in the first half of this year. The Sx products represented over 1/3 of our ESS sales outside the U.S. as of the end of 2020 and is the product of choice for most of our newer distributor markets. At current Sx volumes, these 2 projects will reduce material costs by approximately $200,000 per year. Total operating expenses were $10.4 million, down more than $2.3 million compared to the fourth quarter of 2019. The 18% reduction in operating costs is due to the permanent cost savings initially implemented in response to the COVID-19 pandemic. As we referenced last quarter, we eliminated approximately $10 million of annual costs compared to pre-COVID spending levels as a result of restructuring efforts and realignment of our business priorities.
Pulling all of this together, our operating loss in the fourth quarter of 2020 decreased to $3.2 million from $6.9 million in the fourth quarter of 2019. Cash at the end of the fourth quarter was $37.2 million compared with $38.2 million at the end of the third quarter. We received our second $2 million installment payment from the sale of the surgical product line in December as required. Excluding this payment, our cash used in the fourth quarter was approximately $3 million. As we announced in December, we further enhanced our 2021 liquidity by $12 million through extension of the interest-only period and maturity date of our term loan by 12 months to March 2022 and September 2024, respectively. In addition, the amendment will automatically extend the interest-only period and maturity date by an additional 6 months if we meet specific revenue milestones during 2021.
Our cash position, along with this amendment, provides a solid foundation as we focus on reaching positive operating cash flow over the next 4 or 5 quarters. With that, I'll turn it back to Todd.
Thanks, Stef. I want to update you on 2 important topics this afternoon: the X-Tack U.S. limited launch and the reimbursement effort underway to bring coding and coverage to our products. We completed the limited launch earlier this week, and the results were tremendous. During the limited launch, we completed 24 cases, consisting of 13 lower GI cases and 11 cases in the upper GI tract. These cases were performed by 10 doctors across 9 different accounts.
The limited launch suggested a physician learning curve after only 1 device. Several of the limited launch cases have been done without our presence after that first use. It is proving to be a see one, do one, teach one kind of product.
Our very first X-Tack case was to close a large dissection at the hepatic flexure of the colon of close to 6 centimeters in size and irregularly shaped. The dissection itself to remove the large flat polyp of this size was a significant and time-consuming procedure. Closing a dissection site of this size would likely have been an OverStitch case, except that the hepatic flexure, it would have been a big access challenge with OverStitch on a gastroscope. The physician used 4 X-Tack devices to close this particular defect site.
Perhaps, we would have liked a little bit more of a conservative case right out of the gate as our procedure number one, but the challenging cases represent the big unmet need and the reason why we designed X-Tack to begin with. And the device worked great in this highly challenging clinical environment. Each case in the limited launch is its own story and represents a life-changing procedure for the patient. For those 24 limited launch cases completed, the closure sites range from a relatively standard 18-millimeter size all the way to 80 millimeters, which is getting to be a really large site.
During the limited launch, X-Tack has been used to close a large ESD site, all the way across the colon at the ileocecal valve close to the end of the ascending colon where the small intestine turns into the large intestine, a location where OverStitch could not reach. And the X-Tack was also used to successfully close large and irregularly shaped sites where through the scope clips, even in multiple numbers, could not span and would have been ineffective. Closure have been completed using 1 X-Tack device in the more straightforward cases, all the way up to 4 X-Tack devices in the larger and complex cases, such as the one at the ileocecal valve. The average number of X-Tack devices per case in the limited launch was 2. After each case, we asked the physician to rate the functionality and ease of use of the device across a number of performance attributes on a scale of 1 being poor and 5 being excellent, and the device has shown consistently high ratings across all performance measures, with an overall average rating of 4.7. With confirmation of X-Tack's stellar clinical performance and the closeout of our limited launch protocol, we have a very high degree of confidence as we direct our attention to scaling up our manufacturing capacity for the product.
The most important capacity enhancing step in front of our manufacturing team is to convert from prototype molds to production molds, and this conversion is on track. Also, the closeout of our limited launch with such high marks gives our sales team confidence as they pursue our highest-priority target accounts and get in front of customer new product evaluation committees. In summary, as we end the limited launch, we are exactly where we hope to be. And if anything, our expectations have been exceeded. We have confirmed device function across a broad diversity of cases and array of closure needs throughout the GI track. User ratings have been excellent. Feedback is that X-Tack is easy to learn and easy to use. We are moving into the next launch stage right on schedule with an acceleration of our X-Tack commercial programs.
Yesterday, we went live with the X-Tack product website and began a campaign to harvest our medical education training records to introduce this new technology to physicians who have come through our medical education programs in the past. Right now, outstanding quotes in front of customers pending their new product committee approval aggregate to a high 6-figure dollar amount. Everything learned so far suggests that X-Tack has a real opportunity to significantly disrupt the GI closure market. Shifting to reimbursement. There are activities underway for all products. First, for OverStitch, this is where most of our management team's efforts are directed with specific focus on the ESG procedure and bariatric revisions. We are closing in on the time when we expect the MERIT investigators to publish their study results, which we then plan to use as the cornerstone data piece for our ESG reimbursement strategy. All indications remain that we will see the MERIT study data accepted for publication sometime before the middle point of 2021.
We do not have access to this independent study's data, but we have high confidence that the study will achieve its primary outcome objectives based on more than 80 studies and articles published in peer-reviewed literature describing and analyzing the ESG procedure since 2015. This worldwide data has been remarkably consistent in reporting favorable efficacy and safety results. As MERIT data nears release, we have turned to other groundwork that is part of the ESG reimbursement plan. In the fourth quarter, we submitted applications to begin the process for both ICD-10 coding and HCPCS coding for all OverStitch applications, including the ESG procedure and for bariatric revisions. The reviews of these code applications are in process, and the earliest date for a decision on either code application is probably October. The CPT coding effort will become better known following the publication of MERIT data, but it would be our goal for ESG coding to be considered by the CPT panel hopefully before the end of the year. The MERIT data will also be of interest to the payer communities in the U.S. and several other key countries, and we intend to engage these communities in coverage and payment discussions with the primary endpoint results once they're published. The prize for expanding the market access for the ESG procedure is very meaningful.
There were an estimated 350,000 bariatric procedures performed in our direct markets during 2019, while only 7,500 ESGs were performed, largely without coverage. Each 1% increase in ESG's market share that comes with coverage is an incremental $5.6 million of revenue at today's average selling prices. And of course, a 10% market share is therefore equivalent to $56 million of revenue. In addition to reimbursement, we have plans to expand the OverStitch labeling to include both the ESG procedure and bariatric revisions. The MERIT data, again, is very critical, along with other prospectively collected ESG and revision data for this label expansion effort. Label expansion adds value because it will allow us to improve our medical education content that we provide to physicians today and also improve patient awareness.
Second, there appears to be some progress with respect to U.S. codings that could be beneficial to both Orbera and X-Tack. First, for Orbera. In the fourth quarter, ICD-10 codes for the endoscopic insertion and removal of devices were approved by CMS, which are applicable to Orbera. These became effective in October. And in the fourth quarter, we saw that an application for a CPT code for intragastric balloons was on the agenda for the CPT editorial panel meeting, which occurred earlier this month.
Separately, we submitted for a HCPCS code for Orbera during the fourth quarter. And we continue to be in various society and regulator discussions for the consideration of Orbera as a treatment for pre-cirrhotic NASH patients with fibrosis ever since the publication of the Mayo Clinic study on this in early 2020. This data, along with previously published data outside the United States, in our opinion, shows that Orbera has a reasonable likelihood of both technical success and clinical success in providing a more effective NASH treatment than today's standard of care. If these discussions are successful, all these codings developments could be very meaningful for our U.S. Orbera product line.
But the consideration of an IGB code wasn't the only CPT panel agenda item of interest to us. Also on this same agenda was consideration for a CPT code for endoscopic submucosal dissection or what is referred to as ESD. ESD is an endoluminal procedure for the en bloc resection of larger flat gastrointestinal tumors, especially colorectal tumors. The approval of this CPT code, along with the coverage and payments down the road, would expand the already attractive addressable market for X-Tack. The AMA's website indicates that the CPT panel results will be released by March 8.
Lastly, our team also filed ICD-10 and HCPCS applications for X-Tack back in December upon its 510(k) clearance.
For the past few years, we have made medical education the cornerstone of our OverStitch strategy. There were 2 important elements to this. First, because endoluminal suturing was so novel, it was very important to capture physician mind share through peer-reviewed publications that describe the clinical value that endoluminal suturing can deliver. And second, we needed world-class training capability to teach physicians the mechanics of using OverStitch, which can be technically challenging to get through a learning curve and get started with.
Since we implemented this strategy in 2015, OverStitch revenue CAGR has been 38% up until the 2020 coronavirus disruption. In 2020, the literature side of the strategy, though, continued to deliver results, as 73 publications and medical journals mentioned OverStitch and 35 publications mentioned our intragastric balloons. 18 of these intragastric balloon publications referenced the potential as part of the treatment for NASH.
The other element of our medical education strategy, which is positioned product training, did get disrupted by COVID. Physician society meetings went virtual, and travel and group gatherings were restricted. But nonetheless, at the beginning of the fourth quarter, we restarted the mobile lab in the United States and conducted hands-on training for 75 physicians in 14 different U.S. cities. We expect this effort will refill both our new account and expanding user pipelines for OverStitch in 2021 as well as support the launch of X-Tack. Before I open the call to questions, I want to say that we will not be providing 2021 guidance today. I think it's best for Apollo's next CEO to speak to that without me setting expectations for him, and I hope you will all understand that. I will say, however, that we are off to a good start in the first quarter and tracking to produce at least 10% sales growth over the first quarter of 2020, even before considering any X-Tack contribution.
We have still been experiencing through the first 2 months of the first quarter some intermittent pockets of COVID weakness, which suggests that March results could surprise in either direction, but we are doing well so far in the first quarter. And demand from our international markets, particularly from distributor markets, is improving. And of course, the U.S. is continuing to progress very well. As I've said before, as long as elective procedures are allowed and health care delivery is normal, our business will do well. So after questions and answers, I'm going to have a couple of closing comments.
But on that note, we'll now open the lines for questions. John, please proceed with questions.
[Operator Instructions] We have a question coming from Matt Hewitt from Craig-Hallum Capital Group.
And I guess before I get to those, I just want to say, Todd, it's been a pleasure working with you. And best of luck in, obviously, all of your endeavors going forward. I look forward to checking your progress, see where you land next, but congratulations on all the progress that you've made here at Apollo.
Thank you, Matt.
First question in there, you hit some really key topics. But the first one, on X-Tack, congratulations on the soft launch. How quickly can we start to think about, from a commercial standpoint -- I think you mentioned that you've already got 6-figure orders outstanding, how quickly will that translate into the income statement? And where can that go maybe over the course of the year?
Yes. Matt, unfortunately, I did mention that I don't feel like I should give 2021 guidance, and that would include ramp rates and the like. I just feel like that's better for the next CEO to come. But I can tell you that I feel like we have a really good level of activity going on right now. As I indicated, the -- those quotes that are in front of accounts where we're going through the new product committee process, sometimes called the VAC process, that is going well. And the limited launch results certainly give us a great deal of confidence as we pursue those opportunities.
Okay. And maybe a different way of asking the question without getting necessary guidance, but how -- help us think about a 6-figure order. How quickly will an account work through something of that size? I mean, is that over a couple of months? Is that a couple of quarters? Just help us size that up.
Yes. So our view, if you base it off the limited launch results, we are going -- we're using about 2 X-Tack devices per case. And those cases generally are at that 2 -- let's say, 2-centimeter size that we have indicated is really the ideal target for X-Tack or higher. . And so I think it will just depend a little bit upon each individual account and how often they are encountering those, but I can feel confident in saying that our view is that the frequency at which doctors are going to have those cases will be at a greater rate than OverStitch use within a relatively short period of time. Relatively short period being over the next, say, few years, couple of years.
Okay. That's helpful. And then as far as OverStitch is concerned, I think everyone is excited and waiting on the MERIT data. But walk through -- so the data comes out, is it your hope and expectation that Apollo would have some, albeit maybe minor, but have some reimbursement in place even by the end of the year? Or is that more of a '22-type event before the reimbursement starts to layer on?
Yes. And just to remind you, Matt, I think you certainly you know this from our earlier conversations, we have, in some places, reimbursement today for ESG. And it's just not broad coverage. It's more individual accounts working with specific, let's call it, insurance providers, private payers, where they are getting reimbursed for OverStitch, the ones being used for ESG. And certainly, that's the case today for bariatric revisions. Bariatric revisions are nearly always paid for. It's an exceedingly rare situation today when we don't have a bariatric revision using OverStitch that is being just normally paid for. So what we're really looking at is trying to expand that and using the MERIT data to expand that and to really broaden this to being more of a national coverage and part of national coverage policies. That's probably still though going to involve coding and coverage and timing around all those things such that it's unlikely to affect us in 2021. Hopefully, there could even be some benefits in 2022. But the way that most of these coding processes lay out their calendars, it's probably more of a 2023 event in our future.
Okay. Understood. All right. And then shifting to Orbera. Obviously, the CPT code news was positive when we saw that it was on the calendar. We're still waiting for that news. But maybe -- that business has -- is starting to recover even without reimbursement, per se. And as we start to think about areas where reimbursement is possible or likely, I think some of the areas you talked about as having interest are NASH -- as a treatment for NASH, for surgical procedures where maybe high BMI patient, getting them down to a fighting weight beforehand. I know that there's trials ongoing for that and for orthopedic procedures. But how do you -- help us understand, from a size perspective, like how big of a market or -- what kind of an opportunity does that represent for Orbera?
Yes. We -- in our Investor Relations slide deck, which is on our website, and I don't have these numbers right in front of me right now. But on that -- in that deck, we have a number of demographic data points that talk about those top 3, if you will, priority areas that we have been pursuing. It talks about the population, for example, that is in our BMI range of 30 to 40, who also are going to be those NASH patients. And so I'd just refer you there. But the size of these markets are significant. I think you'll see that the number for NASH, for example, where the fibrosis levels are 2 or 3 and their BMI is over 30, but lower than 40, so it makes it consistent with Orbera label. That's roughly a 10 million U.S. population. If you go down to the -- to those that would be eligible for using Orbera, again, BMI 30 to 40 and the number of just total joint replacements done per year, that's another 300,000 procedures that are done for those patients that are within that range of BMI and so on and so on. So these are significant markets that can make a difference for our Orbera business here in the United States.
Okay. Maybe one last one for me, and I'll hop back in the queue. Another nice improvement in gross margin in the quarter. You've taken some steps. You mentioned that you're in the process of starting the next phase of gross margin improvement projects. But as we think about fiscal '21 and not so much of guidance, but that should continue, the gross margin should continue to trend higher along with your revenues as sales continue to grow? Is that accurate?
Yes. It is. And our biggest contributor to gross margin improvement this year will be X-Tack. It has a high variable gross margin, and so that will be contributing to our gross margin improvement this year as will the 2 projects I talked about in my prepared remarks.
I'd now like to turn the floor back to Todd Newton for some additional remarks.
Well, thank you, operator, and thank you, everyone, for joining us today. This will be my last call as CEO of Apollo. Earlier this month, we announced the appointment of Chas McKhann as CEO effective on March 1. And this is a good time for transition as great things are on the horizon. Today, we sit with a high-growth product portfolio, and each of our products are directed at high-value, large addressable markets. As I reflect back about OverStitch, this was a product originally designed for NOTES, or Natural Orifice Transluminal Endoscopic Surgery, which is a leading-edge and maybe you'd even say it's a bleeding-edge surgical concept. But no one is doing or looking to do oral appendectomies. 6 years ago, when we would engage physicians about OverStitch, their reactions would be, "Well, gee, that's a cool technology. When will I ever use it?" Since that time, we have answered that question. Today, OverStitch is emerging as the standard of care for bariatric provisions and for esophageal stent fixation in addition to various other core GI applications that call for full-thickness tissue approximation.
Physicians see the enormous value potential of ESG for the obese as a primary obesity procedure. And in the months ahead, I expect us to hear more from physicians developing an OverStitch endoscopic antireflux procedure, which is today being called RAP, as a possible alternative to surgical fundoplication. We have taken down other OverStitch adoption barriers by building world-class medical education capabilities.
We developed the Sx for those at locations or in markets who do not have access to a dual-channel scope. And now we are expanding the incredible versatility of suturing into the large lower GI market with X-Tack. Orbera, too, is under revival with a medical-use strategy that leverages its unique patient value proposition. Thank you to Matt Hewitt for that question of what those things look like today. And along the way, we have made some tough decisions to shed lower-performing products and programs to reach the point we are at today, a company with a clear identity.
The future looks good, and we have specific plans for further improving the structural self-sufficiency of the business with very specific, well-conceived and executable gross margin improvement projects. We have dramatically reduced our cash burn, and we have probably the best ever balance sheet as a company. The business is certainly not on cruise control, and I would never say that it is, but we have a solid plan and the human and financial resources to execute it. So it's time to close the repositioning chapter and begin to write a great commercial execution chapter. I'll be supporting my transition and have every confidence in Chas, along with our executive team, to lead Apollo Endosurgery forward. Chas has an impressive track record, with a resume that includes successful commercial roles at Boston Scientific, Johnson & Johnson, Torax Medical and Intersect ENT.
And lastly, to all the men and women of Apollo Endosurgery past and present over the past 6.5 years, thank you. We've come a long way, baby. Apollo Endosurgery has truly changed interventional gastrointestinal endoscopy as well as the treatment options for the many affected by the various metabolic diseases caused by obesity. And the company is poised to burn its mark even deeper. So should you have any questions or would like to arrange a call with us, please contact Matt Kreps at Darrow Associates. The company also plans to participate in several virtual investor conferences coming up ahead in the month of March. Please also contact Matt if you'd like to request a meeting as part of one of those events. Thank you, and have a good evening.
Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.