Good day, ladies and gentlemen, and welcome to the Obalon Therapeutics Fourth Quarter and Year-End 2019 Financial Results Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the conference over to Bill Plovanic, President and Chief Executive Officer for Obalon. Mr. Plovanic, you may begin, sir. .

Thank you, operator. Good morning and welcome to Obalon Therapeutics Fourth Quarter and Year-End 2019 Financial Results Conference Call.

With me on today's call are Bob Macdonald, Chief Retail Officer, who is responsible for driving future site expansion for the Obalon Center for Weight Loss retail treatment center model, a function that's similar to a role he played with Sono Bello, the largest aesthetic surgery chain in the United States.

Also on today's call is Nooshin Hussainy, our Chief Financial Officer. This morning, the company issued a press release detailing our financial results for the 3 months and year ended December 31, 2019.

This release can be accessed through the Investor Relations section of the Obalon website at www.obalon.com, and you can also access the webcast of this call from there..

Before we get started, I'd like to remind everyone that any statements made on today's conference call that express a belief, expectation, projection, forecast, anticipation or intent regarding future events and the company's future performance may be considered forward-looking statements as defined by the Private Securities Litigation Reform Act..

Forward-looking statements in this release include Obalon's expectations regarding the near and long-term growth potential of its business, including our company-managed retail treatment centers.

These forward-looking statements are based on information available to Obalon management as of today and involve risks and uncertainties, which include, but are not limited to, the risk factors disclosed in the periodic and current reports filed by the company with the SEC from time to time, including the Form 10-K for the year ended December 31, 2019.

Such forward-looking statements are not guarantees of future performance. Actual results may differ materially from those projected in the forward-looking statements, and listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof..

Obalon specifically disclaims any intent or obligation to update these forward-looking statements, except as required by law. The archived webcast will be available for 1 year on the company's website, www.obalon.com..

For the benefit of those who may be listening to the archived webcast, this call was held and recorded on February 27, 2020. And since then, Obalon may have made announcements related to the topics discussed. So please reference the company's most recent press releases and SEC filings..

I will now provide an update on our business and review highlights from the recently reported quarter. We will then have Nooshin Hussainy, CFO of Obalon, provide an overview of our financials for the quarter and for the full year of 2019.

I'll then provide some color on our current goals for the new retail treatment center model, in order to help investors better understand the potential opportunity..

Overall, I am pleased with the fourth quarter 2019 operational results and accomplishments. It was the first full quarter of operation for our first company-managed retail treatment center, the Obalon Center for Weight Loss.

Initial results from the San Diego site provides support for our belief that we may be able to releverage the 2-plus years of commercial experience with our physician customers and create a service business model in a dedicated facility, focused on weight loss program with the Obalon Balloon System.

On our last call, we stated that we believe that the foundation could be laid for a standardized, repeatable retail treatment center model and last week, we announced the opening of our second location in Orange County, California..

We have also entered into a lease for another site in California, which we expect to have operational within the next quarter. And we look forward to opening additional sites this year and will provide more information on our goals for 2020..

Although our primary commercial focus is on establishing the Obalon Center for Weight Loss retail treatment center strategy, we have continued to provide balloon systems to a few key high-volume private practices and have signed a new 1-year distribution agreement with a distributor in Qatar that has experienced with the Obalon Balloon System.

We intend to support U.S. physicians and our distributor in Qatar with a centralized model that does not require field-based sales personnel. We believe this may provide the flexibility to reenter these channels in the future, if we believe it to be complementary to our Obalon-branded store strategy..

At this time, I'd like to describe in more detail the Obalon Center for Weight Loss.

These treatment facilities are Obalon-managed and branded retail treatment centers where a patient is able to receive a comprehensive weight loss treatment experience, including 6 months of treatment with the Obalon Balloon System and 12 months of nutritional counseling in a high-end med spa-like setting.

The first 2 Obalon centers are located in California in suburbs of San Diego and Orange County, respectively. If -- which have easy access to and from major roads and thorough fares. The centers are located in higher-end medical buildings with other practices such as plastic surgery, cosmetic dentistry and orthodontics.

They have the look and feel of a high-end medical spa. .

The centers are staffed to provide everything required for a patient's weight loss journey from initial interest through balloon treatment to nutritional counseling and endoscopic removal, with all medical care provided by a separate professional corporation owned by a physician.

Staffing at the center includes physicians who are experienced in weight loss, supported by a medical assistant to manage the medical aspects of treating a patient with the Obalon Balloon System; a registered dietitian to provide nutritional counseling to drive the lifestyle changes that can help, create and sustain meaningful weight loss for patients; a professional office manager to oversee daily operations; and a professional experienced salesperson with an aesthetic medical background that seeks to convert initial patient interest into a treatment decision, including qualifying the patient financially..

Of course, the ultimate decision to treat any patient with the Obalon Balloon System is made by a physician of the professional medical corporation. After the first full quarter of operation for the Obalon-branded retail center, I'm encouraged with the initial results.

We have been able to successfully leverage the capabilities we developed during our initial 2-plus years of commercialization to stimulate consumer interest in Obalon.

The majority of our marketing efforts are through direct response digital advertising, mostly Facebook and Google, utilizing our own in-house organization, as we have been doing since the Obalon Balloon System was first commercialized in the U.S. in January 2017. We have also executed on print, traditional radio and digital radio advertising..

Our in-house call center that was established in late 2018 is converting patient interest from our marketing efforts into book consultations with our store-based sales consultant.

The benefits of the Obalon-branded center model become more tangible as the patient moves through the full patient journey, with a standardized patient experience from initial interest to treatment.

Specifically, our in-house call center will book a consultation for the prospective patient with a professional, experienced sales person at one of our Obalon-branded retail centers, who then discusses the nonmedical aspects of the treatment and financially qualifies the patient.

Once the patient is medically and financially approved, a physician from the professional medical corporation medically screens and qualifies the patient who is unable to begin the treatment program. One of the major benefits of the new branded retail treatment center model is speed to treatment.

Specifically, the patients have been able to book a consult, purchase and complete their initial examination, all in the same day, with first balloon placement the next day..

We have established a set of strict metrics to measure our performance, and we continually review these metrics to determine the effectiveness of our marketing and patient conversion funnel. From creating initial patient interest, converting that interest to a consultation and ultimately, to a patient choosing to receive treatment.

As a result, we believe we are able to accurately and quickly measure the performance of our marketing efforts, which in turn allows us to adjust our demand generation efforts based on the learnings to invest in the most efficient marketing mix..

This is not something we could previously do when we were selling the balloon through more traditional physician practice channels..

As part of the comprehensive treatment program currently being offered at this center, nutritional counseling is available for up to 12 months through both in person and virtual sessions with a registered dietitian in all -- who's at the center and also through an Obalon-branded phone-based application, and the phone app also includes unlimited access to on-demand video content, including meal plans, recipes and fitness classes..

While no patient has yet completed the full 6 months of therapy at the Obalon Center for Weight Loss, we are pleased with the initial clinical results for patients that are currently in treatment.

Safety and efficacy are trending in line with what was reported in our commercial registry data, and we have not had a single device-related event -- adverse event at the Obalon Center for Weight Loss..

As a reminder, we estimate that there are approximately 69 million adults in the U.S. that qualify for the Obalon Balloon System's FDA-approved indication, which is a BMI, body mass index, in the range of between 30 to 40 -- are those that can benefit by losing approximately 30 to 100 pounds.

We believe the Obalon-branded retail treatment center model will improve access to care for people with obesity for our candidates for treatment with the Obalon Balloon System..

Overall, I'm pleased with the initial results of the first full quarter of operations at the first center and that we now have our second site operational..

With the opening of the second center, we continue to gain confidence that we are developing a portable, replicable retail treatment center model that can be expanded into new markets. We have analyzed and identified our next potential markets for expansion and believe that we are positioned to move quickly.

We are encouraged by the initial results and trends of the first center, and are in the initial stages of commercialization of that second center, and we look forward to open additional sites this year..

I'd now like to have Nooshin Hussainy, our Chief Financial Officer, provide a brief financial recap for the quarter ended December 31 and year. .

Thanks, Bill. Today, I would like to share details on our financial results for the fourth quarter and year ended December 31, 2019. I will compare fourth quarter 2019 to third quarter 2019. As I believe sequential growth is what the majority of investors are most interested and given the pivot in our business model in the second quarter of 2019.

I will then provide a comparison of full year 2019 versus 2018 financial results. Lastly, I will discuss our recently announced equity line with Lincoln Park Capital. .

Fourth quarter revenue was reported at $786,000 compared with $333,000 in the third quarter of 2019. Revenues in the fourth quarter of 2019 included the first full quarter of operations from the retail treatment center model, U.S.

physician customer revenues and sales to our international distributors as compared to sales on ETU as physician customers in the third quarter of 2019..

In the fourth quarter, we recognized approximately $140,000 in revenue from the new retail treatment center model, but collected cash of almost $350,000, which is reflected in cash from operations.

As a reminder, net revenue from the treatment center model is recognized in line with the delivery of services, while for cash payment, for -- the treatment package is collected upfront, prior to the delivery of services.

The majority of net revenue is recognized over the course of balloon placements during the first 3 months of treatment, with the balance expected to be recognized in future quarters. As a result, there's a lag between cash collection and recognized revenue..

U.S. physician revenue was approximately $340,000 and sales to our international distributors contributed $300,000 to fourth quarter revenue, bringing total revenue in Q4 to $786,000. This compared to approximately $330,000 of sales only to U.S. physician customers in third quarter 2019..

Cost of revenue was $626,000 in Q4 as compared to $626,000 in Q3. Gross profit for the fourth quarter of 2019 was $238,000, which was an improvement from a gross deficit of $79,000 in the third quarter of 2019..

Increased volume and absorption of overheads contributed to the sequential improvement in gross profit. Research and development expense for the fourth quarter of 2019 totaled approximately $1,500,000 compared to $1,200,000 in the third quarter of 2019. .

Increased enrollment and the post-approval study tied to our original FDA approval through the sequential increase. Furthermore, we continue to make investments to support improvements of our recently approved Obalon Navigation System and Obalon Touch Dispenser as well as continued development of our new product pipeline..

Sales and the general administration expense for the fourth quarter totaled $3,643,000, up from $2,489,000 in the third quarter of 2019..

And increase in D&O liability insurance rates, marketing expenses for the San Diego Obalon Center of Weight Loss, legal and other onetime expenses contributed to the sequential increase..

The operating loss for the quarter was approximately $5 million, which was up to $3,663,000 in the Q3 2019.

Net loss for the fourth quarter of 2019 was approximately $4,900,000 or $0.64 per share based on 7,700,000 weighted diluted average common shares outstanding, as compared to a net loss of approximately $3,700,000 or $0.61 per share based on 6,100,000 weighted diluted average common shares outstanding in the third quarter of 2019..

Full year 2019 revenue was reported at approximately $3,300,000 as compared to $9,100,000 for the full year of 2018. U.S. revenue of $2,400,000 decreased from $4,700,000. International revenue of $1 million in 2019 compared to $4,400,000 of international revenue in 2018..

Gross profit for the full year of 2019 was $331,000, resulting in a gross margin of 10% as compared to approximately $3,700,000 for the first quarter of 2018 and a gross margin of 40%. Research and development expense totaled to approximately $6,900,000 for the full year of 2019 as compared to $10,700,000 for the full year of 2018..

Selling, general and administrative expenses decreased to approximately $16,700,000 for the full year of 2019 as compared to $29,900,000 for the full year of 2018. Operating loss for the full year of 2019 was approximately $23,200,000 compared to an operating loss of $37 million for the full year of 2018..

Net loss was reported at $23,700,000 for the full year of 2019 compared to a net loss of $37,400,000 for the full year of 2018. The net loss per share was $5.03 for the full year of 2019 as compared to the net loss per share of $19.64 for the full year of 2018..

Lastly, I would like to touch on our recent financing agreement with Lincoln Park Capital, which could enable us to access up to $15 million over the next 36 months. The intention for this agreement is to help fund expansion of our retail treatment center model.

We have filed an S-1 as part of this agreement, and is expected to go effective next month. It is important to note that the equity line with Lincoln Park would provide us the ability to sell shares of our common stock at purchase price that are based on prevailing market rates.

It does not include warrants, derivatives, financials or business covenants, and provides us the flexibility to risk capital opportunistically and cost effectively. Most importantly, Obalon is not obligated to sell shares to Lincoln Park, but has the ability to, at our discretion, subject to various conditions..

As a reminder, we ended Q4 2019 with $14,100,000 cash and cash equivalents and short-term investments and no debt. And with that, my comments are complete, and I will turn the call back to Bill. .

I would now like to share our goals with you to provide a better understanding of how we measure the business internally. As for expansion plans for the number of Obalon-branded retail treatment centers, our current goal is to have between 5 and 8 sites operational by the end of this year.

We currently have 2 sites operational and have a signed lease for an additional site, which we are targeting to have operational within the next 4 months..

In terms of patient flow per core per center, our goal is an average of 15 to 30 new patients per month, after initial ramp-up period of a few months. The 15 to 30 average new patients sold per month at steady state is equivalent to the performance that was experienced at our top accounts, top sites, best month.

For patient pricing, our current goal is to achieve average net revenue recognized per patient in a range of $5,000 to $6,000 over the term of the patient treatment, which is currently 12 months. .

As Nooshin noted in her comments, revenue from the treatment center model are recognized in line with delivery of services, while full payment for the treatment package is collected prior to delivery of services, creating a lag between new patient sales and recognized revenue..

The fourth quarter 2019 was an important quarter for Obalon. It was the first full quarter of operation for our first company-managed retail treatment center, and initial results from that San Diego site continue to support our belief that we may be able to leverage our 2-plus years of commercial experience in the U.S.

and create a service business model in a dedicated facility focused solely on a weight loss treatment program with the Obalon Balloon System..

With the opening of the second location in Orange County, California this month, we believe the foundation has been laid for a standardized, repeatable retail treatment center model.

We look forward to opening additional sites and improve access to care for an estimated 69 million adults with obesity in the United States that are candidates for treatment with the Obalon Balloon System..

With that, our prepared comments are complete.

Operator, will you please now open the line for questions?.

[Operator Instructions] And your first question comes from the line of Kyle Rose with Canaccord. .

So I wanted to see if we can just get a little more information regarding the treatment centers. Particularly just the overall experience thus far.

How are you seeing the patient conversion rates now that you control the whole, I guess, patient experience from the marketing to the actual delivery? Have you seen the improvements in the conversion rates that you were expecting? And then any insights just as far as what you've learned at the first center that are maybe going to change or improve potential productivity at centers 2, 3 and then eventually 5 to 8?.

Yes. Thank you for the question. In terms of the marketing, as we mentioned, we're taking the capabilities we had and leveraging those, including our marketing abilities in advertising and our call center to create that lead generation.

And then we generate those leads that are the booked -- our call center transfers or converts into booked appointments at the call -- at the treatment center. So we're -- and then once they show up to the treatment centers, we -- then our salesperson has the opportunity to convert that person into a sole patient and somebody to go through treatment.

So we are measuring and analyzing all the layers of that lead generation funnel, and have the ability and the granularity to go back all the way to the initial advertising that's utilized to drive that lead.

So as we look at that from lead generation to reaching out to them, to booking the consults, to people that show up and then convert into a sale, we've been very pleased with that. We measure all that, analyze it and are looking to pull levers at which to improve different areas of that funnel.

We have been very pleased in our meeting or exceeding our goals in several of those metrics and looking to optimize that at all-time -- throughout the process.

In terms of the patient experience, and the learnings, we -- obviously, we got the first center up and going at the end of September, and then we took those learnings to apply it to the second center, and very encouraged by the initial results of the second test center in terms of not just from the marketing standpoint of turning that on and driving the leads and the conversion at that second center, but also from an operational standpoint.

And I think from our standpoint, started out with a model, and we continue to execute on that model and are very, very encouraged and pleased with what those results are, I would say, very minor changes to what we're doing. Nothing significant that we have come across at this point. .

Okay. That's very helpful. And then this is the first quarter that you reengaged revenues from the international markets. Can you just maybe talk -- your goals are pretty clear in the United States.

Help us understand how we should think about that OUS line on a go-forward basis? Was there -- was that an initial stocking order? And then we should expect it to pull back? Or is that kind of a consistent a steady-as-she-goes number that we should contemplate moving forward?.

I think as you think of our international distributor, as I said, our primary focus is the Obalon Center for Weight Loss in the U.S. We do continue to provide the balloon systems to a few key physicians, high-volume in the U.S. and also our international distributor now in Qatar.

This was a distributor that was very familiar with the Obalon Balloon System, and had been distributing it in that country and had a demand for us to continue to supply the new generation of product. I think as we think of that business, we've signed a 1-year agreement, it's a pretty straightforward agreement.

I mean the revenue should be very similar on a quarter, but it may be a little less as each -- we go each quarter from the current one, but it won't be significantly different. .

Your next question comes from Ryan Zimmerman with BTIG. .

Great. So I want to just ask. I think I heard this correctly, but I apologize, Nooshin, you said of the total revenue, I think there was about $340,000 in physician revenue in kind of those high-volume accounts and $300,000 from your international distributor.

So if we back that out and plus the revenue of that, that is still yet to be recognized, kind of where -- can you just help us understand where that puts the center at? And more so, the bigger question is, from a productivity standpoint, that I think would imply similar to some of the metrics you gave out, Bill, but how do you feel about the capacity of the centers today? And what you saw this quarter? And what it can ultimately translate to over time as you scale?.

Okay. So do you mind to repeat the last part of the question for me because I didn't hear you clearly? I'm sorry about that. .

Sure. So my question was just specifically the components of revenue.

What does the in-center revenue look like when you net out the high-volume physician accounts? And as we think about that from a capacity standpoint, where can that go? Are you feeling -- just based on the metrics you provided, that -- it seems like that would be in line with kind of where you expect it to go, but do you have capacity for, say, much more patients over time in a given center?.

Yes, Ryan, I'll answer the second part of the question to see if -- and then hand it over to Nooshin for the first part. But in the second part of the question, it's really -- you're asking a capacity question.

And just the way to think about capacity is at this current time, we believe there's -- peak capacity is beyond our current monthly new patient goals that we provided.

Remember, it's approximately 15 minutes for delivery of a balloon and our staffing model is variable with our -- with medical delivery, so we're able to titrate or optimize the staffing and the medical to meet demand.

But we're currently not maximizing that -- the office hours, and we do have office hours -- are currently only 5 days a week, 8 hours a day basically. So we could be able to adjust that to support additional demand if needed.

I think in terms of the revenue, you're asking, Nooshin had mentioned or stated the 100 -- about $140,000 was recognized, and we -- there is a lag between the revenue collected upfront and the net recognized revenue over time, because it's delivery services, and the cash flow from operations from that, recognized revenue, was approximately $350,000.

So the net revenue would be collected over time as the delivery of services. .

Okay. That's very helpful. And then the pricing -- when I think back to when you're selling, just say the balloons, direct to a physician, and what the end consumer pricing is, it was a little higher, and now you're doing patient pricing in that $5,000 to $6,000 range.

What impact have you seen, if any, from that, as you think about kind of the right way to price it?.

Yes. In terms of patient pricing, I mean, we've seen our physician customers hit on average price between $6,000 and $8,000 or $6,000 to $9,000 with an average of about $8,000 across the U.S. Our more high-volume physician customers tended to price towards -- below the midpoint and towards the bottom end of that range.

So when they were -- we said, our goals are to meet or exceed the volumes of what our high-volume customers were doing on a monthly basis at their best months, best sites. And so we're looking to drive that volume level. So that's what our goal is. .

And your next question comes from Ben Haynor with Alliance Global Partners. .

It looks -- sorry, I saw in a couple of calls here. But it looks to me like you've shared a couple of different marketing strategies in terms of offering rebates for a certain amount of weight loss and such to patients to attract people so far.

Is there anything that you've learned or anything that you can share on that? And do you feel like you have something that's kind of locked in now that it would be hard to do better than that then? Or anything you can share on that front?.

Yes. Thanks, Ben. We -- remember, when we -- our physician customers, we had -- there were different promotional programs, and our physician customers would utilize that we were providing outlines for as they were driving patient flow into their physician practices. We've leveraged several -- those learnings into the programs we're doing now.

There have been different incentive programs available since September. The overall intent of these programs is to drive that patient interest in conversion, and we're looking at different points in the lead to treatment conversion funnel and looking to optimize.

So we continue to take those learnings from the different programs that are run and leverage those learnings into the next program. .

Okay.

And then just looking at where the 2 centers that you've opened now are located, is that kind of what we should just expect in the future in terms of as you branch out kind of in terms of population centers? Or is that -- is there anything you can share on that front?.

Yes. Thank you for the question. So our growth strategy is predicated on the fact that approximately 1/3 of the U.S. population is between a 30 and 40 BMI. So there's a huge market out there.

Obviously, being located in San Diego, we thought it made sense to open our first center here locally and then, as Bill had mentioned, we have a second center now open in Orange County. So as we spread out, we want to balance the need not to travel too far, along with addressing those large markets where most of the people are.

So we're very optimistic that there is a big -- a huge opportunity out there, and we'll proceed accordingly. .

So it's kind of like the In-N-Out Burger model, not yet too far from [indiscernible].

You could phrase it that way, yes. .

And I think, Ben, as you look at it, there's a lot of examples out there. You can look -- take a top down approach, a bottoms-up approach. But we look at the different geographies, the population income and then several other different layers that we filter through it. We analyze that data. We've looked at similar players in this space as well.

You can look at where our clear choice is of bodily hair restoration at Sono Bello, and just gives you an idea. But looking at it at this point, we're still -- believe that the NFL City strategy is really the way to go.

Given the prevalence of obesity in our -- at the target market that we're indicated for, it's really looking at those larger city populations that you can move into. .

And I think the other thing, Ben, is leveraging the physician corporation we have in place in all the assets we have put together for the first site makes a lot of sense as well. .

[Operator Instructions] We have no questions in queue.

Do you have any closing remarks?.

I'd just like to thank everybody for joining the call today, and we look forward to our next call. Thank you very much. Have a good day. .

This does conclude today's conference call. You may now disconnect..