Scott Youngstrom - Chief Financial Officer Dan Gladney - President, CEO and Chairman of the Board.

Jeffrey Cohen - Ladenburg Thalmann Suraj Kalia - Northalnd Securities.

Good morning, ladies and gentlemen. And welcome to the EnteroMedics First Quarter 2017 Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time [Operator Instructions]. As a reminder, this conference call is being recorded.

I will now turn the call over to Scott Youngstrom, Chief Financial Officer. You may begin..

Good morning. And thank you for joining us on today’s call. I am joined this morning by Dan Gladney, our President, CEO and Chairman of the Board, who will provide an overview of the Company’s recent commercialization success and business highlights. I will then review our financial results for the first quarter.

After that, Dan will provide you with additional business highlights. Following our remarks, we will be available for questions during the Q&A session.

As a reminder, this conference call as well as EnteroMedics SEC filings and Web site at enteromedics.com, contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Our actual results could differ materially from those discussed due to the known and unknown risks, uncertainties and other factors.

These risks and uncertainties are described more fully in the Company’s filings with the SEC, particularly those factors identified as risk factors in the Company’s 10-K filed March 8, 2017 and the Company’s 10-Q filed yesterday, May 15, 2017. Today’s discussion includes certain non-GAAP financial measures.

Please refer to the reconciliations available on our Web site at www.enteromedics.com. I will now turn the call over to Dan..

Thanks, Scott. We’ve had a very eventful start to the year here at EnteroMedics, and I’m excited to share with you some of the key progress that we’ve made. After successfully rebuilding our capital structure and strengthening our balance sheet, we’re now in a position to continue the commercialization of vBloc Therapy.

During the first quarter of 2017, we accomplished significant achievements essential to our business strategy; most noticeably, we secured a key strategic partnership to clinically demonstrate the use of vBloc System for the treatment of obese patients with Type 2 diabetes and related co-morbidities as detailed in our recently filed 8-K.

Additionally, we continued to develop and maintain our global intellectual property portfolio, which has broad coverage in two key quarter areas; one, our technology, the vBloc System and blocking signals and the vagus nerve; and two, our various methods of treating clinical indications with the technology that I’ll discuss later.

Towards the middle of the first quarter, the Company resumed vBloc marketing efforts, which have already proven to be effective at attracting and converting cash paid patients for vBloc Therapy. We’re also targeting veterans who may be eligible to receive vBloc Therapy at little to no cost thanks to our partnership with Academy Medical.

In concert, we remained steadfast with positioning the vBloc System to receive favorable insurance coverage decisions. We have hired additional personnel in the reimbursement and marketing departments to further bolster our efforts in these areas.

Our new Director of Reimbursement brings over 25 years of field experience, and our Marketing Director comes to us from a direct-to-consumer weight loss program where she has a solid proven track record. Year-over-year, sales have progressed nicely.

And while first quarter sales were not where we would like to see them, given the 100% cut in all radio advertising expenses in quarter four last year and not back to full strength until early February, we do expect to pick back up in quarter two going into the second half 2017.

With a stable balance sheet, we can continue educating prospective patients, driving awareness of vBloc Therapy as a novel, safe non-anatomy altering and lifelong treatment for obesity and related co-morbidities. In the last six months, the landscape in our industry has developed rapidly.

With growing attention from large corporations and technology players on the battle against obesity and diabetes, we believe we are well positioned for success.

As the year progresses, we look forward to sharing more with you regarding how we intend to use the foundation built here in EnteroMedics to execute a broader strategy for the battle against obesity, diabetes and other metabolic diseases.

I will now turn the call back over to Scott to briefly walk you through the financial results for the quarter of 2017. After that, I’ll provide you with some updates on our progress with commercial and clinical patient data and strategic partnerships, which are key components for securing positive payer coverage decisions.

Scott?.

Thanks, Dan. As we previously stated, in the fourth quarter 2016, it was really critical for us to reset the Company’s financial situation and establish a shareholder-friendly path for 2017 and beyond. As we have reported previously, we are very pleased that this has been accomplished.

Reporting now on revenues; for the three months ended March 31, 2017, we reported sales of $40,000 with gross profit totaling $11,000 and the net loss of $7.4 million or $1.27 per share. As Dan mentioned earlier, advertising expenses were cut during fourth quarter of 2016 and that remained for the first half of first quarter.

Selling, general and administrative expenses for the quarter were $5.9 million and research and development expenses were $1.1 million.

After accounting for the non-cash items of stock-based compensation and depreciation and amortization, our true cash spend, which is a non-GAAP financial measure in the first quarter of 2017 totaled $4.8 million as compared to $6.4 million for the same period in the first quarter of 2016.

This represents a decline of $1.6 million, which reflects our commitment to keeping our eye on our spending. But that said, our savings in the direct-to-consumer advertising affected our top-line.

As we continue with the full quarter of direct-to-consumer advertising and our additional headcount, our quarterly spend will increase over that of the first quarter of 2017. On March 31, 2017, the Company’s cash position totaled $18.7 million, an increase of $15.3 million from year-end.

This increase was due primarily to our January 2017 underwritten public offering of units of common stock, convertible, preferred stock and warrants to purchase common stock, which raised net proceeds of approximately $17.5 million and to a lesser extent, the exercise of common stock warrants, which resulted in proceeds to the Company of an additional $3.1 million.

Looking forward, we plan to continue to tightly manage our cash on hand as we intend to execute our commercialization strategies we’ve shared thus far. We believe that we are well positioned for a strong 2017. Back to you, Dan..

Thank you, Scott. As Scott mentioned, we’re actively monitoring our cash burn, ensuring the dollar spent are put to good work in achieving key milestones for our commercialization strategy. Our long-term goal of obtaining broad acceptance and coverage for vBloc Therapy remains a top priority.

Now, in addition to previously mentioned partners and integrated delivery network, such as MedSTAR Health, Roper St. Francis, and Winthrop University Hospital, we are very excited about our new relationship with Kaiser Permanente that is centered on studying the treatment of Type 2 diabetes, obesity and other co-morbidities with the vBloc System.

If you review the data we previously reported from our clinical trials, you can see that with vBloc, we are making a meaningful impact on patients’ metabolic health, specifically vBloc Therapy patients with Type 2 diabetes; have recorded either reducing or altogether stopping their diabetes medications, would suggest the potential to represent a significant savings to insurers, patients at our health care system.

Based on three-year outcomes data from the DM2 trial of vBloc Therapy in obese patients with Type 2 diabetes, published in February of this year, the average percent excess weight loss shown to be 21% with reductions in hemoglobin of 0.06 percentage points.

In the study, 39% of the participants reported either reducing or stopping completely their diabetes medications, and 71% of the study participants were at or below the American Diabetes Association target for HbA1c of 7% for people with diabetes.

The Company has been working for years to demonstrate the related health economics with vBloc Therapy as a Body Mass Index or BMI management and co-morbidity reduction therapy.

Now, we are able to share with you that we have formalized our commitment into the space by entering into this vBloc Type 2 diabetes trial with Southern California Permanente Medical Group, a division of Kaiser Permanente.

The 60-patient vBloc trial is designed to validate vBloc Therapy for the treatment and possible prevention strategies of patients with Type 2 diabetes and moderate to morbid obesity. In published data from 2013, lifetime direct medical costs of Type 2 diabetes was estimated to range from around 54,000 to 130,000.

The abstract concludes; over the lifetime, Type 2 diabetes imposes a substantial economic burden on healthcare systems; effective interventions that prevents or delay Type 2 diabetes and diabetic complications might result in substantial long-term savings and health care costs.

So if you look at what we’re doing with Kaiser and the data we’ve reiterated today regarding our DM2 study, yes, we are very excited about the role vBloc will play in helping pre-diabetic and diabetic patients with obesity, and we look forward to updating you on patient progress in the future.

In regard to peer-reviewed published data, a vital enabler for payer coverage decisions, we recently submitted data from our vBloc Institutes to the American Society of Metabolic and Bariatric Surgery for this year’s annual fall symposium.

Unlike a rigorous FDA controlled trial, this data represents what we would call real-world efficacy of vBloc, which is demanded by payers and insurers. We are encouraged by the results we have submitted and we’ll continue to prepare additional data for publication to support favorable coverage decisions.

Now regarding our vBloc Institutes, we have seen growing advocacy for vBloc Therapy with our individual centers and surgeons promoting vBloc in their community and educating new perspective patients on the benefits of our differentiated solution.

Despite our delay initiating our advertising and marketing this year, we’ve received about 25% more leads during the first quarter of 2017 that came in late in the quarter once we started advertising, as compared to the same period during 2016 with our online and radio campaigns. We look forward to seeing this trend to continue.

We’ve grown from 13 vBloc Institutes at the end of last year to 16 now at the end of quarter one. I want to make sure our investors understand the value of vBloc Achieve and these institutes. vBloc’s Institutes are premier preferred sites, which have at least one trained vBloc surgeon and also participate in the vBloc Achieve program.

If you were to look at the list of physicians on our Web site at vbloc.com, you will find our institute partner physicians as well as those who are not participating in the vBloc Institute.

These institutes not only performed device implants, but also engage with patient in vBloc Achieve, where we are providing one-on-one coaching for the vBloc Therapy patient with a registered dietitian. This after care relationship builds a valuable data-driven connection between the Company and the vBloc patients.

Patient data, such as weight, is gathered in near real term and used by the medical care team to optimize the individualized vBloc Therapy, supporting that patient’s success.

With veterans and the Veterans Administration, we’re working with VA facilities now in Dallas, Texas, Richmond, Boston and Huntington, West Virginia, as well as 10 VA choice facilities.

As you may recall, the VA choice facilities are our VA institutes that have -- vBloc Institutes that have also registered with the VA to provide services for veterans to qualify for the Choice Program and can obtain care outside of a VA facility.

Finally, on the international front, we are still working to expand into Canada as previously stated and we’ll update investors when we have more material information to share. Regarding research and development, as efficiently as possible, we have continued the development of our next generation implantable neuroregulator.

Our target is a device that is further optimized in terms of size, functionality and manufacturing cost. We hope to submit to the FDA during the second half of 2018. In regard to our intellectual property, we continue to develop and maintain a broad set of claims, which are protected now in the United States and many other countries worldwide.

Our patents are an important asset in protecting our current technology, as well as future generations of the vBloc System.

Beyond the specific application of vagal blocking for the treatment of obesity and its related co-morbidities, the Company now holds intellectual property for systems and methods related to neuroblocking, neuromodulation and also neurostimulation technology for a variety of medical indications.

This patent protection includes, and is not limited to, bulimia; pancreatitis, gastroparesis, blood pressure and heart rate regulation and glucose regulation. In summary, we are actively commercializing the vBloc System in studying vBloc Therapy for potential application in multiple related indications.

We have built considerable set of assets to support this effort and we remain committed to the fight against obesity, diabetes and other related co-morbidities. With that, I’d like to open up the call to questions..

[Operator Instructions] And our first question comes from Jeffrey Cohen of Ladenburg Thalmann. Your line is now open..

So a few questions have come to mind, so I’m assuming as far as units for Q1 that was 3 or 4; is that a good guesstimate?.

Jeff, we had four implants in the first quarter. We sold a total of eight, but there were two that were at no charge. We were part of our promotions and then two that were just sold that a hospital keeps on inventory; so actually eight went out the door, but four implants..

And the last two for hospital inventory to be implanted?.

Yes….

Could you talk a little bit about the Kaiser arrangement as it relates to this protocol in this trial? What kind of timeline do you expect as far as them -- is your protocol that it's just now is approved? And what will the timeline look like throughout the next few months as far as enrolling?.

Two things I’d like to answer, if I could. Before we go to that, I just wanted to point out -- this is Dan. I just wanted to point out that the units for the first quarter that were sold and shipped were low.

But the realities are what I shared with our investment community here at our last quarter conference call that our first quarter was going to be slow, because we stopped all spend. So when you don’t advertise in this market, you lose your patient funnel.

And it takes about two to three months to build up the patient funnel, so we stopped all advertising in quarter four. So we had a pretty decent quarter four because that was the advertisement took place at quarter three. When we stopped all advertising in quarter four and didn’t start up again until early, beyond mid-February, we lost quarter one.

So really what was sold in quarter one was a rollover from the excess from quarter four. So we would expect quarter two, three and four to settle quite nicely as we are seeing an increase in leads there. Now to answer your question about Kaiser, we’re very excited about Kaiser.

And I would let our investment community now know that we’ve been working at Kaiser for well over a year. And the reason for this is because we recognize that one of the most expensive expenses that a insurer has is providing Type 2 diabetic drugs to these patients over a long haul. So that’s a huge expense.

As we talk to peers, we hear that all the time. And what payers are saying is look, if you guys could show us a device that can reduce that expense, that’s very important to us. So our DM2 study, which we published the three years results in February, was an Australian study. It doesn’t get a lot of press here in the United States.

So we were working and we wanted to find a major institution, such as Kaiser who has what about how many million lives? I think somewhere in the neighborhood of 10 million lives in their healthcare system that we could partner with to do a study, where comparative of Type 2 diabetic drugs were half those patients will be on those drugs for three years, and the other half will not be on the drugs but instead will get an implant.

And we’ll compare over that three-year period, HbA1c levels to determine if at the end of that three years that we are competitive with drugs. Now, we have the rights to get that information on a regular basis.

So we would hope that at six months, a year, a year and half, we’ll be able to get that information and get it out to the public before that three-year period is up and fully reported by Kaiser. So where we are right now, the Kaiser expects their IRB approval in July and their patient enrollment will start in the fall. And yes, the protocol is done..

That will also be measuring EWL and TWL as well?.

Yes, it will. And I would also point out that Kaiser Permanente is a premier institution, it’s recognized across the country, including the FDA, as a Center of Excellence and leadership in establishing the standard of care. So to partner with them is -- this is a pretty big deal for the Company..

And Jeff, from our information, they have more than 10 million lives in their healthcare system. So we have a great big pool to choose from, if you will..

And so what you’re saying before, Dan, I wanted to get back to that as far as the patient funnel as you define it. So the marketing ramped back up late in the first quarter and you were talking about a general funnel of three to six months.

So we should see levels normalized to, let’s say, where they were in the second half of ’16? Is that what you expect over the coming three to six months?.

Yes, we would expect it's going to be better than that. Yes, absolutely. The great thing here that we’ve seen from just the advertising that started in mid-February is that our leads generated for the quarter actually ended up being about 25% more than what we did in 2016 when we started advertising in January of that year.

So that’s a very positive sign..

And one more if I may.

Any commentary on the general macro environment as it may relate to obesity and diabetes or competition or information out there over the last number of months that changes anything for you?.

Yes, what I would mention there is that we’re excited about the landscape. And we continue to see heavy venture investment in s obesity and diabetes space. So new funds are coming together and putting dollars to work, fighting the battle against obesity.

As an example, Novo Nordisk and University of Oxford announced €135 million collaboration that’s focused on Type 2 diabetes research. They did that in January. Samsung Ventures invested in Noom and educated patient behavioral modification approach, which sounds similar to what we’re doing with our vBloc Achieve program.

Another drug company, and there are many raise venture funds, around Pfizer venture and some other big names. And as you know, we don’t believe the solution is a simple, is that as simple as swallowing a pill for a short-term solution, whether it turns out to be a balloon or whatever. We think the solution is a lifelong solution.

So Weight Watchers recently reported that in their update it was well received by investors while much different from EnteroMedics we use Weight Watchers as a bellwether in regard to how many people are watching the space and doing something about their weight.

And lastly, most noticeably, we continue to see media notes that large technology players are moving into the field of obesity and diabetes control; Apple computer is getting into the space; last summer, we learned Google and GlaxoSmithKline formed $715 million venture, called Galvani Bioelectronics.

We know technology is the future, the battle against obesity and diabetes, and our Company has been here working, studying and now commercializing the space for 10 years. So I think we're ahead of the game and we’re very excited about it..

And our next question comes from Suraj Kalia of Northalnd Securities. Your line is now open..

So Dan, I just wondered, I have a bunch of questions on this Kaiser partnership. So Dan my understanding is that payers are generally, I mean generally, more available to provide great expense for devices that address co-morbidities rather than obesity.

Second, my question is, are you guys going to use this Kaiser study for difficult good enough for getting an actual reimbursement, or is this just designed purely for covering Kaiser lives?.

Certainly, we would expect both. So we start by doing the study with Kaiser which, Suraj, as you know you just said, I mean these payers are telling us; look, we need more commercial data, number one; and number two, if you can work with us and show us improvements in the area of Type 2 diabetes, we’re interested.

So we sent out, published in February the DM2 study, which gives them getting a lot of press here in the United States, because that was done in Australia, and I’ve done a small number of patients. Although, we did notice it raised the eyebrows of some payers that we’re talking soon too.

So we feel we’re going down the right path here by partnering with a major, well-recognized name nationally, such as Kaiser. And yes, they do have 10 million lives and I think if the study goes well, it’s certainly going to open the door for us to hopefully get those covered lives as well.

But the real objective here is to show that over this period of time of the study that our implant is competitive with Type 2 diabetic drugs. And if it is, that’s a very strong selling point that we can make with payers..

Dan, in terms of A1c for this Kaiser study, how’s the data be stratified in terms of baseline.

I guess what I’m trying to understand is can we expect to see this persistent A1c reduction stratified by baseline A1c buckets?.

I’m not sure exactly what you mean by stratify. But I could tell you, —if I’m going to answer your question, that there -- these are going to be patients that are both pre-diabetic and diabetic. And the goal is to keep the pre-diabetic from moving into the diabetic arena with our implant and to get the diabetic patient reduced.

And the DM2 study shows that we were competitive with drugs. So in fact, after first year of our implant, we were showing the neighborhood of a full 1.0 reduction to HbA1c. And if you look at the top-selling drugs, the Type 2 diabetic drugs, they’re there or slightly below that.

So after three years, I think we were at 0.6, which is still very competitive drug. So what we’re trying to do is expand upon that study by having a very highly credible study done here in the United States have the attention of payers..

What I was really trying to get at or at least understand. So let’s say you have start who has the MI at about 32 and then as you want to see, as I say, 7.2. As you might not see a change in A1c that much, but might see a change in EWL or TWLs. Conversely, you could have a patient who is at BMI of 28 but they put out an A1c of 9 or 10.

And you could see, just starting to see if it's anchors this to get reimbursement from co-morbidity perspective.

How do you reconcile this and what’s the game plan, if 60 patient could be sufficient? Maybe just as a longer discussion for offline, I was just kind of trying to think through how this looks like?.

Well, I can tell you that the BMI target here is going to be BMI of 35 and 45, and not below 35. And as you know, you get into ranges of 35 to 45 and there’s a high probability of HbA1c, increased level of HbA1c where the patients dealing with either a pre-diabetic situation or diabetic situation.

So we do believe and that patient range of 35 to 45, we are going to have an impact on HbA1c. And that’s what they’re going to measure..

Dan, are we at a stage where you can give us some color on the dollar spent per patient drawn into the funnel. Or I mean, if you have an idea [indiscernible] number of implants.

But -- or do you think it’s too soon to start quantifying some of these metrics in terms of -- I’m just trying to understand what’s the incremental spend needed, do you see what effort to draw the incremental patient into the funnel?.

Yes. Well, I could tell you right now it’s expensive because we’re spending, as the advertising ramped-up, we’re spending in the neighborhood of about $300,000 a month in advertising both radio, online and social media. And we're doing it, and I think it’s about 13 markets. So the realities are yeah we’re generating a lot of leads.

But this isn’t like, let’s say, a balloon where you can get it done for $5,000 or $7,000, right, this is an expensive implant neurometabolic implant, so neuroregulator. Well, you’re looking at a cash price to a patient of significantly more than that, 3 to 4 times that.

So your hit rate on finding that kind of wealthy obese patients that can do this is going to be lower, right. So the objective, what we look at is, we don’t necessary to look at trying to build a big line of revenue.

What we’re looking for is we’re looking for getting commercial patients implanted, whether we got to begin heavily discounting that or in some cases giving it away, because the payers are telling us, we have to have more commercial real world data in order to strengthen our position with them, the payers, in an effort to get insurance coverage.

So yes we had 239 patients in our FDA trial, but that was under a very controlled environment. And in a commercial setting, it's easy to lose those patients and they’re off doing their own thing. And the payers want to know, is the implant itself carrying the day.

And the good news here is that -- and by the way we are looking closely at how much we’re spending and that’s kind of all over the board. And we get spikes and values in that but I can give you, I think, a little clear data on that next quarter once we get a lot more patients going here.

But I will say that most recently, we’ve submitted our commercial patients and we expect, as I mentioned here in the call, we expect to have [technical difficulty] soon. So I can tell you that the results from those patients were very positive.

The results showed that those patients lost at least as much weight as we saw in a very rigorous clinical trial. And that’s what the patients want to see..

One last question Dan and I apologize for the background noise. Just with the half the discussions started about vBloc versus Intragastric Balloons, I mean well all know about Intragastric Balloons, almost three quarters of them have some sort of side effect that’s nausea, vomiting, pain, what not.

And also the temporary effect was just a more lasting effect with vBloc. At least in your centers or in the key clinicians that you guys talk to, has the discussion started? Or do you think it’s still too early to start growing the relative benefits and making a marketing argument based on that? Thank you for taking my questions..

Well, at the end of the day, what we’re seeing right now is your balloons are being pretty successful out there. I mean the realities are they’re very inexpensive, patients lose weight. Yes they get very, very sick the first week to 10 days they have this balloon.

But the FDA requires that balloons got to be out of the body, taken out or dissolved within six months. So, we view that as a short-term solution to this problem because if you go back and look at the clinicals on those patients who got the balloons, in most cases those patients regain their weight within a year.

So what we’re doing is we’re positioning with payers, not so much cosmetic industry, but rather payers that ours is a long-term solution to obesity. So the patients are going to lose about as much weight that you have with balloons. The difference is they’re going to keep the weight off and that’s the real benefit.

We now have, we published last two-year data, we’re about to publish three-year data that shows that these patients keep the weight off. So that’s the advantage of our technology versus these others..

Thank you. And I’m showing no further questions, at this time. I’d like to turn the conference back over to Dan Gladney for any closing remarks..

Well, thank you all very much for joining our call today. And feel free to reach out to us today or anytime with additional questions. And we look forward to updating you on our progress on our next call. Thanks again, folks..

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program, and you may all disconnect. Everyone, have a great day..