Good afternoon. My name is Kenzie, and I will be your conference operator today. At this time, I would like to welcome, everyone to the Apollo Endosurgery First Quarter 2019 Results Conference Call. [Operator Instructions]. Thank you. John Gillings, you may begin your conference..

Thanks, Kenzie. And thanks, everyone, for participating in today's call. Joining me on the call are Todd Newton, Chief Executive Officer; and Stefanie Cavanaugh, Chief Financial Officer.

Before we begin, I would 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.

These forward-looking statements involve material risks and uncertainties and Apollo's actual results may differ materially. For a discussion of risk factors, I encourage you to review the company's quarterly report on Form 10-Q filed today May 2, 2019, with the Securities and Exchange Commission.

The content of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, May 2, 2019. 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 terms ESS for OverStitch and the term IGB for Orbera and vice versa. In this call, we will also refer to the term continuing product revenue, which excludes the revenue associated with our Surgical products, which we divested on December 17, 2018.

Continuing product revenue will differ from our GAAP revenue as we will still report historical and transitional Surgical product sales as part of our GAAP revenues. Now I would like to turn the call over to Todd..

Thank you, John. And good afternoon, everyone. And thank you for joining today's call to discuss our first quarter 2019 results. We are pleased with our product sales growth this quarter, especially for ESS.

The constant currency information that we reported in our press release removes the effects of foreign exchange rate changes and provides a better understanding of our real local currency sales performance in the first quarter versus our GAAP reported revenue, which includes currency effects.

Constant currency sales performance, also aligns better to what management expects from our commercial organization worldwide, that being year-over-year growth in the local currency in which our respected teams operate.

In the first quarter of 2019, our Endo-bariatric product sales, which represent our continuing product sales increased 9% in constant currency. Worldwide ESS or OverStitch sales increased 17% in constant currency, and we are very pleased with this result.

Of these continuing product sales in the quarter, about 60% were from markets outside the United States where our periodic sales reporting has exposure to changing foreign currency rates.

In our 2018 year-end call, we said we expected our endo product sales in 2019 to grow around 15%, with a lower growth rate in the first half and higher in the second half. The U.S. dollar continued to strengthen during the first quarter versus the euro, which is our largest sales currency after the U.S. dollar.

We will not attempt to forecast currency rates, however, if rates were to remain at current levels, we would expect the impact of currency on our revenue growth rates to decline as the year progresses. And at this time, we see no reason to change our 2019 guidance.

I will turn the call over to Stefanie now to cover our financial results in greater detail. Stefanie..

Thank you, Todd. And good afternoon, everyone. ESS sales increased 13% to $6.5 million in the first quarter of 2019 versus $5.8 million in the first quarter of 2018. On a constant currency basis, total ESS sales increased 17%. Sales in the United States increased 20% and outside the U.S., ESS sales increased 7% on an as-reported basis.

And in constant currency terms OUS ESS sales increased 14%. ESS growth resulted from expanded procedure use within existing accounts and the addition of new users. Sales from OverStitch Sx contributed, but were not particularly meaningful to sales growth in the quarter.

Intragastric Balloon or IGB sales were $4.3 million in the first quarter versus $4.5 million in the first quarter of last year. Sales in OUS markets were roughly 2/3 of our total IGB revenue in the first quarter. And roughly flat on an as-reported basis while up 5% on a constant currency basis when compared to the first quarter of 2018.

Constant currency OUS growth was due to increased sales in Europe, where we have available the Orbera365 product, partially offset by declines in the other OUS markets, especially Brazil, where we do not yet have Orbera365.

In the United States, IGB sales were down approximately $150,000 versus the first quarter of last year, more or less back to prior year level. Due to financial related issues, one of our largest customers in the first quarter of last year was unable to receive product shipments in the first quarter of this year.

This single customer alone resulted in a decline this quarter of more than $200,000. Since the end of the first quarter, it appears that their issues have been resolved, and we expect shipments will resume.

In total, our first quarter of 2019 continuing product revenues, which we define as our Endo-bariatric product sales after the sale of our Surgical products in the fourth quarter of 2018, those continued product revenues increased 5% as reported, to $10.8 million or 9% on a constant currency basis compared to the first quarter of 2018.

Total GAAP revenues in the first quarter were $13.2 million, which included $1.7 million of Surgical product sales, compared to $15.7 million in the first quarter 2018, which included $5.2 million of Surgical product sales for a decrease of 16% or $2.5 million.

Gross margin for the first quarter 2019 was 54.8% compared to 58.4% in the prior year period.

The decline in gross margin was due largely to the sale of the Surgical products and the ongoing shift of revenue toward ESS sales, which carries a lower margin than our other products, partially offset by the positive impact of the 2 gross margin projects we completed last fall related to the Cinch component of OverStitch and the Orbera delivery system.

The impact of the two completed projects, maybe difficult to clearly pick out as we are also continuing to transfer portions of the OUS Surgical products over the course of the year. But on our continuing revenue base exiting 2018 at $41 million, the targeted $2 million of cost savings is roughly a 5% gross margin improvement.

We had a nice sequential increase from Q4 2018 margin of 46.6% to the 54.8% this quarter and the impact of these projects played a role.

Margin improvement continues to be an ongoing effort as we are currently working on several projects that when completed over the next few quarters, will result an additional margin improvement for our continuing products of roughly $3.5 million, calculated using our 2018 volumes.

Total operating expenses were $9.8 million for the first quarter 2019 compared to $16.8 million in the first quarter 2018.

The largest contributor to this decrease in operating expense was a settlement gain related to the resolution of a dispute with Allergan regarding inventory purchases and transition services provided through 2018 [indiscernible] after our December 2013 acquisition of their obesity products business.

Excluding this onetime gain, total operating expenses were $15.4 million, a decrease of 8% or roughly $1.4 million over the first quarter of 2018. This remaining decrease was mainly due to lower amortization of intangible related to the sale of the Surgical business last December.

Our net loss for the first quarter of 2019 was $2.8 million compared to $8.1 million for the first quarter 2018. Excluding the settlement gain, our net loss is $8.4 million, an increase of roughly $300,000. Now, I will turn it back to Todd..

Core GI use and bariatrics. There are phenomenal core GI cases being reported to us, including cases involving full-thickness resection and treating several complications that would have required surgical intervention in the past but can be addressed endoscopically because of the ability to suture.

Core GI will continue to be an area were suturing is gaining momentum. But I want to discuss today our market development for our OverStitch and bariatrics, as it represents the largest potential procedure market for OverStitch, especially the ESG procedure.

We have a solid user base for ESG, a large and growing body of published research that consistently shows a compelling safety and efficacy profile for the ESG procedure.

In the first quarter, the journal Gastrointestinal Endoscopy or GIE, published Professor Alqahtani's report on his first 1,000 consecutive ESG procedures, which you can read about in our press release from February 19. Since then, two other ESG experiences came out.

First, GIE also published a case-match study from Johns Hopkins that compared ESG with laparoscopic sleeve gastrectomy.

The highlight of this study was the attention it drew to the proportion of patients that had new onset of GERD following the laparoscopic sleeve procedure, which was 14.5% versus their ESG group, which was less than 2% in a much notable lower rate of adverse events.

Second, last month Professor Silvana Perretta from IRCAD in Strasbourg, France, presented an abstract at SAGES that compared matched patient quality of life after ESG and after laparoscopic sleeve gastrectomy. They reported similar results as the Johns Hopkins GIE paper.

While absolute weight loss was higher in IRCAD's laparoscopic sleeve patients, their ESG patients showed similar resolution or improvements to comorbidities, and their quality of life scores showed clear advantage for ESG.

In the IRCAD study, for example, 30% of laparoscopic sleeve patients showed worsening GERD symptoms compared to 0% in the ESG patient group. The ESG procedure is no longer in a proof-of-concept stage, and we expect more clinical experiences will be published.

It has the interest of many physicians and societies right now and there continues to be new interest and growing commitment from a variety of academic centers worldwide. In the first quarter, for example, we learned of two new IRB approvals for ESG study protocols that will soon start in both Oslo and Rome.

On the reimbursement front, there are 2 ESG coverage efforts outside the United States that we have high expectations for, prior to the end of the year.

In Australia, we filed an ESG application with the Medical Services Advisory Committee or MSAC for patients with Class I or Class II obesity and comorbidities who have failed their first-line treatments for weight loss. The MSAC is a body that advises the Australian government on coverage adoption of new medical technologies and procedures.

The MSAC process includes 4 stages, we are currently through the first two stages, we anticipate clearing the next stage in October with the potential for a final MSAC decision before the end of 2019. There were approximately 24,000 bariatric procedures performed in Australia last year.

In Germany, a procedure or OPS code was first granted in late 2017 for endoscopic plication using endoscopy but without the assignment of funds. In 2018, we were successful in obtaining an initial funding level for this OPS code. In Q1 of this year, we made a further application for additional funding with input from key users in Germany.

We expect to have feedback on this latest funding application in Q4 this year. In the United States, we are on a traditional pathway for ESG with our most important reimbursement activity centered on the MERIT study, a multicenter randomized controlled trial for ESG being co-led by the Mayo Clinic and University of Texas, in Houston.

In Rome, it slowed at the end of 2018 and early 2019 and currently stands with about 170 of the 200 patients having been screened and randomized. Lastly more than 240 patient cases have been reported to date in the European bariatric registry. This registry is intended to capture both ESG and bariatric surgical revision patient data.

We expect the first abstract of data from this bariatric registry to be presented at DDW, later this month. Turning now to our Intragastric Balloon activity. We think our first quarter efforts have positioned this product for a return to growth as this year progresses. Here in the United States market, our sales and marketing team has returned our U.S.

IGB sales to the approximate same level as in Q1 of last year. And it's also a healthier business compared to this time last year in many respects. For one, the efficiency of our patient education or promotional spend has improved, as our U.S. promotional spend per U.S. dollar sold decreased by 20%.

As you would expect, the market disruptions of the past couple of years resulted in some customer turnover but our U.S. sales are less dependent now on any single customer or set of customers. In Q1 of last year, the top 10 customer locations were over 1/3 of our total U.S. Orbera sales, this year the top 10 represent only a quarter of Orbera sales.

Our sales organization has done a really good job remaining focused through the disruption and today, we have a wider customer base, less customer concentration and a greater proportion of our customers have solid cash pay operations. It's nice to have a sales force.

In Q1, our sales team was also actively engaged in efforts to transition former ReShape Intragastric Balloon accounts to Orbera. As part of our Surgical product divestiture in late 2018, we acquired the ReShape Balloon product and probably discontinued its sale as of the end of 2018.

So in Q1, we offered a product exchange program for legacy ReShape accounts, In addition to an inventory exchange, this program offered these accounts the ability to complete a smooth transition to Orbera, including training on the Orbera procedure for their physicians and their staff and access to consumer marketing and education content.

A total of 44 former ReShape Intragastric Balloon customers elected to participate in this special program. The program did not result in significant product sales in Q1 though these accounts may represent promising Orbera accounts going forward. Also relevant to our U.S.

Intragastric Balloon business, we have made excellent progress towards the completion of our FDA-required Orbera post approval study. This past week the last enrolled-patients balloon was explanted, which concluded the study's Patient Treatment Stage. The only effort remaining is the post-balloon 6-month follow-up period.

We are therefore on target for this study to wrap up by the end of this calendar year. Outside of the United States, Orbera365 sales were satisfactory in the markets where it was available.

Of our top 20 distributor markets, only about 1/3 currently have a regulatory clearance for Orbera365, and this represents a significant opportunity for us in the future. In April, we also participated in the International Liver Congress for the first time.

Our main goal at the Congress was to expand awareness in the hepatic community about Endo-bariatric therapies. The Congress include the first ever meet-the-expert session focused on the benefits of endoscopic weight loss therapy as an effective treatment option for patients with fatty liver disease.

Fatty liver disease is an ideal target area for Orbera for a couple of reasons. First, lifestyle modifications targeting 7% to 10% weight loss is the current recommended treatment for histological improvement of fatty liver disease. And second, Orbera consistently facilitates patient weight loss in excess of 10%.

We will have more on this to report to you in future updates as our plans in this area develop. To recap, we have exciting opportunities we are pursuing. For OverStitch, we are launching Sx to bring suturing to places where it has not been accessible before.

We are pursuing clinical data and reimbursement for the ESG procedure and think there could be news on some of our reimbursement efforts outside the United States later this year. And of course, we continue to support exciting core GI use of OverStitch. For Orbera, we are in the midst of a solid recovery effort in the U.S. market.

We are pursuing new Orbera365 market clearances outside of the United States, and we are actively developing plans for the treatment of patients with NASH and other weight-related comorbidities. And we are on target to bring our FDA-mandated post approval obligation for Orbera to a successful close later this year.

Furthermore, as Stef already updated you, also on our ongoing margin-improvement initiatives. The last matter I would like to discuss is what is next on the product development front for us. We continue to invest in new product development. We have been on a journey to make suturing with a flexible endoscope more broadly available.

First was OverStitch, which successfully conquered the longstanding clinician desire to suture with a flexible endoscope but has limited scope compatibility.

This year, we are introducing OverStitch Sx, which expands the capability to suture to include over 20 single-channel endoscopes across 4 different manufacturer platforms, including the leading endoscopes available in the market today. Our next new product objective is to make flexible endoscopic suturing compatible with the colonoscope.

Suturing with a flexible endoscope is highly disruptive to traditional management of colorectal disease. The lower GI tract represents a sizable and addressable market opportunity, with the potential to increase a number of colorectal procedures that can be safely completed entirely endoluminally.

This is what is next for us, and we have some very interesting working concepts already, and we look forward to updating you as we proceed through our product development stages. Finally, we are quickly approaching DDW or Digestive Disease Week, which is the most significant conference of the year for us.

And we look forward to seeing you -- some of you there. Demand for suturing courses and training opportunities will be high. There are 4 suture courses being posted by DDW, in addition to the opportunities we will provide during DDW in our Mobile Learning Center. And with that, we will now open the lines up for questions. Operator..

[Operator Instructions]. Our first question comes from the line of Matt Hewitt with Craig-Hallum..

A couple of questions.

First, regarding OverStitch and Sx in particular, are there any metrics that you can provide and maybe the number of doctors that you have trained to date or number of facilities, or [indiscernible] that you have gotten through? Any color along those lines?.

No. We don't have any metrics for you today other than what we said, which was we feel very good about the pipeline of activity where we are currently engaged in the value-analysis committee answers..

Okay. And shifting gears quick to Orbera. Obviously, there has been some disruption. I hear recently one of your competitors, and I realize it's pretty early, but I'm wondering if you have seen any benefit from them going indirect and obviously, you having the direct sales force.

Anything along those lines?.

Yes. We feel very optimistic about where we are heading into Q2 with Orbera. We feel like we have put in place a lot of good things here in the last couple of quarters to position us well. And as it relates specifically to any competitor situation, I don't really have any comments for you in that regard.

And I wouldn't probably be able to attribute anything that we are seeing within our business to a competitive situation anyway. We just feel like we are making good progress, and we are happy with that..

Okay. And maybe one last one and then I will hop back into queue. And this is more of a big-picture question. It seems like almost every single day, there is a headline, an article, some new data that is pointing to the benefits of treating obesity.

Whether it be due to the number of cancers that are being attributed to obesity or some of the other issues that come from having a high BMI, yet, it appears that we are not quite seeing the wheels turn on the reimbursement front maybe as fast as you would expect or would hope.

And I'm just curious your take on, what do you think is going to be the trigger? What is going to finally wake the health care community up that this is something that needs to be addressed to reduce health care costs. I mean that seems to be a big as we enter the election cycle, that is a big issue - is reducing health care costs.

Well here is, in my opinion, a slam-dunk opportunity, yet, it doesn't seem that the gears are moving quite as fast.

What are your thoughts and what do you think it's going to take?.

Yes, that is a great question, Matt, and one that I probably will not have a really perfect answer for this afternoon. It's obviously an area where health economic data is critical. We know on the clinician side, we know on the patient's side.

For example, there has a great deal of interest on ESG but payers still need to see data that they need to see and they need to see it in a fashion that helps them understand that there is a cost benefit to offering a procedure like the ESG. And I think that is common for any type of area within medicine today.

There needs to be a cost benefit because it is with the rising cost of health care, it oftentimes appears to be a zero-sum game as to how many dollars do payers have to, let's call it, cover different procedures with. So you do need to be able to demonstrate that by addressing any disease that it actually is cost beneficial to do so..

Your next question comes from the line of JP McKim with Piper Jaffray..

This is Drew on for JP. And congrats on the nice quarter. I want to say on Sx here, too, and thanks for providing that early feedback. It sounds like the U.S. is starting really nice. They are obviously, pretty early in your launch here. Kind of as we try to get a feel for the rollout.

We are just curious though, what mix are you seeing between Sx and Gen 1 today. And kind of how do you see that trending throughout the year? And then sort of to piggyback on that as well.

Does that have a margin impact for the company given where Q1 took out?.

Yes. Good question. So first of all on the mix here in Q1. Keep in mind, I think it's important to remember that the Sx launch began in February. So in relation to the quarter that we are talking about, even though it's now, 1st - 2nd May, I should say, that is still relatively short period of time that Sx was in the market as it relates to Q1.

With respect to Q1, most of our OverStitch sales or ESS sales were still the dual-channel version of OverStitch by far. So we did have sales of Sx in the first quarter, but I would not say that Sx was a big contributor to our growth rates in Q1, that was still the traditional OverStitch product.

And when it comes to the, If you will, the rollout later this year, we expect that to, obviously, change. And as we get through value-analysis committees, we have every expectation that we will begin to see orders for product and then with our training, which we feel very good about, our training skills, medical education skills.

We are going to turn a lot of those accounts into very proficient users of OverStitch, and so we are excited about that. But it's going to be one of those rollouts that simply is an execution story where we do in fact have to execute. And now on the margin side, I think I will turn that over to Stef to talk about..

Well, I think the question was, is there a margin impact between dual-channel and single-channel OverStitch? And the answer to that is, it's basically the same. There has a slight difference but the bigger issue to our margin is that OverStitch as a whole, both dual-channel and single-channel is lower margin than our other products.

And therefore, we have our gross margin improvement projects that we are working on to improve that process or that profile, regardless of whether it's single-channel or dual-channel..

Okay, that is very helpful. And I just want to follow-up one more. I guess, you just mentioned right there in your opening remarks about your progress with your value-analysis committees.

I'm like, how long is that process kind of taking from start to finish? And sort of what are they pushing back on the most?.

Yes. And just to take the second part, I'm not aware of really a lot of push back that I'm hearing about. The value-analysis committee efforts depend a lot upon the specific hospital, depend a lot on the specific ASC.

Yes, it depends a lot upon just when they can get those people together and also depends a little bit about the sponsoring department and how that sponsoring department - how hard that sponsoring department, I should say, wants to push. So the factors are probably just site specific and hard to really give you a feel for.

In some cases, it goes really fast and in other cases, they can just simply drag on for a variety of reasons, including just peer scheduling reasons..

[Operator Instructions]. There are no further questions at this time. I turn the call back to our presenters..

Well, thank you, Kenzie. In closing, we just want to thank you for your interest in Apollo Endosurgery today. And if you do have any questions for follow-up, please feel free to contact John Gillings, our Investor Relations Manager. Tap the numbers that were listed on our press release earlier today. Thank you very much..

This concludes today's conference call. You may now disconnect..