Good afternoon. My name is Julianne, and I will be your conference operator today. At this time, I would like to welcome everyone to the Apollo Endosurgery Second Quarter 2019 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

[Operator Instructions] Thank you. John Gillings, Investor Relations, you may begin your conference..

Thanks, operator 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 for the three-month period ending June 30, 2019, which we expect to file later this week 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 July 23, 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 terms IGB for Orbera and vice versa. In this call, we will also refer to the term continuing product revenue, which excludes the revenues associated with our Surgical products, which we divested on December 17, 2018.

Continuing product revenue will differ from our GAAP revenues, as we will still report historical and transitional Surgical product sales as part of our GAAP revenues. Now, I'd 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 second quarter 2019 results.

This quarter is only our second quarterly report since the sale of our surgical product line in December of last year, which was done to focus the company on the opportunities for our therapeutic endoscopy products, while also monetizing a nonstrategic asset. The second quarter was a great quarter for OverStitch, or ESS, on many levels.

OverStitch sales increased in constant currency by 43%.

Digestive Disease Week, which is the most significant GI conference of the year, was an incredible event for Apollo, with more than 40% clinical presentations that described the results for the use of our endo products, including over 30 papers related to procedures that relied on the use of our OverStitch endoscopic suturing system and other presentations providing clinical updates regarding Orbera experiences.

Further, DDW represented a significant training event for physicians from various geographies around the world, who have heard about OverStitch and wanted to learn more.

DDW itself offered four training events that included endoscopic suturing and, of course, since OverStitch is the only full-thickness endoscopic suturing system available, these sessions featured the OverStitch device.

In addition, we had our mobile learning center on site to allow physicians to spend individual lab time to be introduced to our endo products or further develop their experience with our devices.

As could be seen at DDW, there is tremendous physician interest to develop and adopt endoluminal approaches to treat a broad range of gastrointestinal disease and defects. Our previous product sales guidance for our endo products for 2019 was to grow around 15%. At this time, we are maintaining this stated guidance.

I'll turn the call over to Stefanie now to cover our financial results in greater detail. And then, I'll come back with an operational update afterwards.

Stef?.

Thank you, Todd, and good afternoon, everyone. ESS sales increased 40% to $7.7 million in the second quarter of 2019, versus $5.5 million in the second quarter of 2018. On a constant currency basis, total ESS sales increased 43%. Sales in the United States increased 42% and outside the U.S. ESS sales increased 38% on an as-reported basis.

In constant currency terms, OUS ESS sales increased 44%. ESS growth resulted from expanded procedure use by existing customers and the addition of new users. Sales from OverStitch Sx contributed, but the dual-channel device was the primary contributor to second quarter growth.

Intragastric Balloon, or IGB, sales were $4.5 million in the second quarter versus $5.3 million in the second quarter of last year. Sales in OUS markets were roughly two-third of our total IGB revenue in the second quarter and declined 15% on an as-reported basis and 12% on a constant currency basis compared to the second quarter of 2018.

We continue to see stable sales in OUS markets where Orbera365 is available being offset by lower sales in markets selling our six months balloon and thus we remain active with efforts to gain clearance for Orbera365 in these markets.

On a constant currency basis, IGB sales in our direct markets were essentially flat in Q2 compared to the prior year, while distributor sales were down, primarily due to lower orders from our Middle East distributor this quarter, which we believe is a timing effect.

In the United States, IGB sales were down approximately $200,000 versus the second quarter of last year due to weakness in the cash pay market for intragastric balloon treatment in the U.S.

In total, our second quarter 2019 continuing product revenue defined as our Endo-bariatric product sales following the divestment of our surgical products in the fourth quarter of 2019 increased 13% as reported to $12.2 million or 16% on a constant currency basis compared to the second quarter of 2018.

Total GAAP revenues in the second quarter of 2019 were $14.3 million, which included $1.3 million of surgical product sales and $0.6 million of surgical transition charges compared to $15.8 million in the second quarter 2018, which included $4.7 million of surgical product sales for a decrease of 10% or $1.5 million.

Gross margins for the second quarter 2019 was 50.3% compared to 58.2% in the prior-year period. The decline in gross margin was due largely to the shift of revenue to ESS sales, which carries a lower margin than our other products, partially offset by the positive impact of the two gross margin improvement projects we completed last fall.

Gross margin for our Endo-bariatric products was 50% for the second quarters of both 2019 and 2018.

In addition to the impact of increasing mix to greater ESS sales, the reduction in gross margin from the first quarter to the second quarter of 2019 was due to completing the transition of surgical product sales to ReShape in certain OUS markets during the quarter, and a greater proportion of OUS surgical product sales are at a distributor sales price that previously would have been sold at end-user price.

Our guidance for 2019 has been that our consolidated gross margin will be in the low to mid-50% range and at this time, we are maintaining this stated guidance. Margin improvement continues to be a focus for us as we have several projects underway. We will continue to update you on our progress.

Total operating expenses were $14.4 million for the second quarter 2019 compared to $16.7 million in the second quarter 2018.

This decrease was mainly due to lower amortization of intangibles related to the sale of surgical business last December of $1.3 million along with reduced sales and marketing expense of $700,000, primarily due to lower advertising spend related to U.S. IGB sales.

Our net loss for the second quarter of 2019 was $8.8 million compared to $9.5 million for the second quarter of 2018 and we ended the second quarter with $23.9 million of cash, restricted cash and cash equivalents. I will now turn it back to Todd..

first, the aesthetic weight loss market, which is the market we have today, especially here in the United States; and second, a medical market, which is very attractive, but needs some market development effort.

Sometimes our medical use market development efforts are hard to see, especially from the outside and we often talk about our efforts and objectives, but it is difficult sometimes to see the tangible evidence of progress. During the second quarter, there were some very tangible developments that we wanted to share on this call.

In June, we announced a U.S. labeling update on ORBERA that clarifies the contraindication that was previously very loosely referenced as hepatic insufficiency or cirrhosis. The new updated labeling is much more specific and clarifies that the contraindication does not apply to the pre-cirrhotic NASH patient with fibrosis.

Still it is important for you to know that ORBERA is not that indicated for the treatment of NASH either.

However, ORBERA is of course indicated for weight loss and weight loss is identified by the American Association for the Study of Liver Disease or the AASLD in their patient treatment guidelines as one of the most effective treatments to stop and potentially reverse the progression of fatty liver disease.

Second, we were notified that an application for a level one CPT code for intragastric balloons was submitted under the joint sponsorship of the American Gastroenterology Association or AGA; American Society for Gastrointestinal Endoscopy or ASGE; American College of Gastroenterology or ACG; the American Society of Metabolic and Bariatric Surgery; and the Society of American Gastrointestinal and Endoscopic Surgeons or SAGES.

This joint filing for a level one CPT code reflects a remarkable consensus between the GI and surgeon communities in support of IGB therapy and the strength of our clinical data. It is our hope that the IGB application will be on the agenda for the CPT editorial panel that is scheduled to meet in late September.

We understand that the agenda for this meeting should be posted on the American Medical Association's website by the end of this week.

Third, CMS or the Centers for Medicare and Medicaid Services has had a national non-coverage decision related to intragastric balloon therapy that dates all the way back to the 1980s and the Garren-Edwards Gastric Bubble which was later pulled from the U.S. market.

We recently met with CMS and have a mutually agreed on a plan for reevaluating this long-standing national non-coverage decision. Lastly, two separate the investigator-initiated studies began enrolling in the second quarter here in the United States for the use of ORBERA for medical purposes.

Within Kaiser at the Downey location a pilot study underway to compare patients treated with ORBERA to patients in their medically-managed weight loss program.

The specific idea being to understand whether ORBERA would be a better pre-op treatment for obese patients who need to lose weight to better prepare them for success from another general surgery that they are in need of.

At the VA in San Diego, they were also studying the pre-op impact of ORBERA on patients who are in need of a total knee replacement, but have too high of a BMI to otherwise be considered high-success candidates for a knee replacement. Each of these developments are very important building blocks, or examples of our medical market efforts for ORBERA.

To recap, it was a very good commercial quarter for endo products and in particular for OverStitch and highly productive for our market development efforts and other activity streams to build out critical clinical data and drive greater market access for our products. And with that, we'll now open the line for questions. Operator, please proceed..

[Operator Instructions] Your first question comes from Matt Hewitt from Craig-Hallum Capital. Your line is open..

Thank you for taking the questions and for the update.

The first one a very strong quarter for OverStitch, and I'm curious how much of that can you attribute to just the growth that you've been seeing versus how much of that could you attribute to maybe the strong training experience that you had at DDW, or do you see DDW as kind of a springboard for Q3 in the second half of the year?.

All right, Matt. Good to talk to you. So I think most of our growth this quarter really relates to people, who have been using OverStitch and had been introduced to OverStitch for some time.

As I was mentioning in my prepared remarks, we have found and we found this over now several quarters that the medical education execution just requires that we continue to bring users along at their pace. But once they do reach that point, where they feel comfortable and confident in the product.

They'd see all the different uses that they can – that have for the product within their practice. So, I do think we would attribute really very much of the OverStitch growth here in Q2 to training events at DDW itself.

I think we would view this as being a reflection of things that have been work in medical education in particular that we been executing on now for the last many quarters..

That's great. And then – so the doctors and the physicians that you are training and were training at DDW and since then with the Mobile Learning Center.

Maybe walk through what is the process? Do they go back talk to their hospital the purchasing groups within the hospital need to reach out to you? What is that process? How quickly does that move? And how can that be a driver over the remainder of this year and going forward?.

Yeah. So, basically, I would – I guess characterize or walk you through it this way. Typically, we would want to see that a physician has had some level of conversation with their hospital prior to the medical education that they receive for OverStitch.

DDW is somewhat unique, because it's a big GI congress and they're going to have their own programs that will include suturing. So that's a little bit unique in that regard.

But in a typical Apollo-sponsored training course, we would for example want there to have already been some level of engagement at the hospital level so that we know that that particular trainee is a near-term viable user for OverStitch. So that would – that makes DDW a little bit unusual in that regard.

And then, it's just a matter of taking them through the steps and getting them comfortable with how to attach it to the scope and of course use the device in a variety of different ways..

Okay. Maybe a couple of questions about ORBERA and then I'll hop back in the queue. Regarding the 365 approval you mentioned that you do anticipate possibly some more approvals by the end of the year.

Are these – maybe if you could describe some of the markets where you see that as a possibility are those decent-sized markets? And how quickly once you have that 365 approved there do you anticipate that product ramping? And then, I guess, the last question on ORBERA, you just provided some details on the Kaiser and VA studies.

Maybe a little bit more color as far as number of patients and when we might expect to see some data out of those two studies? Thank you..

Yes. And just on the first one first Matt. ORBERA365. We don't really have any specific country that we want to talk about so much today. But in general, we have a goal in markets, which do not have ORBERA365, but do have Orbera to expand the access for the 365 products. So it's just an ongoing goal that we're working on all the time.

And each market has a different pace, at which those things proceed..

Kaiser and VA and when can I get some report..

I'm not sure that the -- I would not characterize these as big studies. I think they are more rightfully characterized as pilot studies that both institutions are interested to evaluate how Orbera works within their patient population. But I don't think they are big studies.

Certainly based upon the grant request that the two institutions have sent to us, no indication that they are big studies. And I don't have any information as to what they're publishing strategy per se might be or whether they will just use the information purely internally..

Your next question comes from JP McKim from Piper Jaffray. Your line is open..

Hi, good afternoon. Congratulations on the good quarter. I was -- the OverStitch growth was great. I wanted to touch on that. To think I was most surprised by how much was just the legacy OverStitch and the Sx being normally 10% of that growth, so maybe or 10% of that business.

So can you just touch on that? Like are the sales reps still focusing on accounts that have the dual-channel scopes, or I don't know maybe just talk about that because that really jumped out to me..

Yeah, there's definitely a focus on the Sx from the standpoint of introducing it in new accounts.

With that said, we've been now continuing to see really good OverStitch sales results over the course of the last several quarters and this quarter was a continuation of that, which is all about the user continuing to see the product is adding value to their practice and finding more and more applications for its use.

And I think that has been what we've always seen with OverStitch. As the doctor gets comfortable with it they run into situations in their clinical practice where suturing makes sense and so we just see that evolve. And that's really also a reflection of what we saw in the abstracts from DDW.

There was just very broad range of procedures that were being addressed in those abstracts and it's just very satisfying for us. Of course, OverStitch is a general use tool and we would like to see it being used generally and that's exactly what we saw this quarter as well.

But the emphasis at the sales level is always going to be continue to support old customers but also, of course, try to drive new introduction at those locations where they have not made the investment in the dual-channel endoscope. And of course that's the whole purpose of Sx..

Is it fair to say, I mean the bulk of the growth in OverStitch came from existing customers and to your point they're learning where they can use the suture technology on more and more procedures as they get comfortable with it?.

Yeah. I think that's exactly right JP..

Okay. And then just on Sx. It's definitely still from your comment still a measured rollout and you're learning a ton as you do so.

When do you feel like you'll have the confidence you need to do a more just aggressive broader push on that product, given all the learning that you have thus far and you're getting the training perfected?.

Yeah, I think it really is a function of confidence and building confidence and for different people and sometimes this isn't really at all tied to the individual from a skill perspective, just what kind of time that they have to dedicate to learning about new product variants.

So we just continue to try to be persistent with our training and persistent with assisting the physician to get -- to gaining confidence and getting comfortable.

Sometimes that involves making available for the doctors some kind of proctoring, so he can learn from another physician who is actually very experienced with the device and that's a scheduling issue. Sometimes it's something that our sales rep can just bring along themselves. So it just varies case-by-case.

And that's why we emphasize that the roll-out will continue to be deliberate because that's just our reality. It will be deliberate because of the nature of the physician community that we're targeting..

Got it. Thank you. .

[Operator Instructions] Your next question comes from Suraj Kalia from Northland Securities. Your line is open..

Good afternoon, everyone.

Can you hear me all right?.

Yes, we can hear you just fine, Suraj..

Great. So Todd, a bunch of questions. Maybe you can help clarify this. If today, obviously OverStitch growth looked very good in the quarter. If I were to draw a pie chart today for OverStitch, what would the usage look like in terms of different categories? And primarily, I'm talking about the U.S..

If in the U.S., I think what you would see is you'd see primarily a 50-50 to 60-40 usage split between core GI use, which would be the larger proportion and bariatric use. And the bariatric use would be both for gastroplasty or ESG and it would be for bariatric revisions and endoscopic bariatric revisions.

And so within that bariatric category it would be mostly split 50-50. So hopefully that's instructive. Somewhere between 50% to 60% what we call core GI uses and somewhere between 40% and 50% which would be the broad category of bariatric use..

Got it. And was price a component of growth? I presume it would be a minuscule portion.

But nonetheless how does OverStitch stand on pricing? And at the same time Todd can you give us some color on account utilization metrics in the U.S.? How should we think about it? The last I remember at least we had in our models like close to 300 -- a little over 300 accounts. But I confess it seems stale right now that number.

Any color to help us better model OverStitch especially the U.S. would be greatly appreciated..

Yes. Just taking your first question on pricing, Suraj. This year, we did not have a price increase per se for OverStitch. We are rolling out the Sx at a price premium compared to the dual-channel version.

But I think our economic rationale for doing that is that new accounts who want to adopt OverStitch are not required with Sx to purchase the piece of capital equipment i.e. the dual-channel scope, and therefore there's a justification for a slight pricing premium on Sx.

But, this year was not a price increase year across the board from our stated pricing tables. And as it relates to utilization metrics, we're about the same as where we have been in terms of those metrics. We have roughly 300 accounts that we would consider to be our most active accounts.

They are probably growing in two ways both in terms of their utilization but also in terms of their user base, because if we take a given hospital or we take a given clinic, it's typically not just a single physician within that clinic that is in the clinical practice.

And what our experience has been is that even though OverStitch may come into a clinic or come into a hospital because of a particular physician's interests, it soon begins to become a part of the practice more generally and there's more users within that hospital setting that begin to be OverStitch users.

So, the account metric is probably roughly about the same, a little bit maybe different from when we last talked about it, but let's say roughly these 300 accounts. But definitely we think that within those accounts we're seeing more physicians and of course more utilization..

Two quick questions Todd, then I'll jump back in queue. First, I'd love to get your high-level thoughts on the IGB space, and especially one of your competitors going down a brick-and-mortar route. I'd love to get that. Also, if there was any pull-through from the ReShape client base.

And more specifically on OverStitch, I know Stefanie mentioned about some internal programs for improving manufacturing efficiencies. The math seems to suggest OverStitch gross margins are give or -- on a standalone basis give or take 45%, 46%.

Where can that eventually land up? Just kind of walk us through in how we can get some OpEx leverage in the model. Thank you for taking my questions..

Yeah, you bet. So I'm going to let Stef here in a second address the gross margin and OpEx question. But as it relates to competitors, I'll just be very quick and just say, I appreciate the invite to speak about competitor strategies, but I'm going to elect not to do so today. So with that, I'm going to transfer to you Stef..

Okay. Very good. So for OverStitch gross margin, as we have shared, we completed a couple of projects in late 2018 that are helping improve our margin, actually for both the balloon and for OverStitch each -- one project each.

We have several projects that we're working on now that are in various stages of completion and will complete over the next several quarters that are primarily focused on OverStitch, that will continue to get at improving the margin for that project or that product in particular.

And I think, we have shared that once completed, we expect the annual benefit from all of these projects to improve our cost by $3.5 million on an annual basis using 2018 sales level, volumes, if that helps you get at that.

And then on operating expense leverage, we think that we're in a pretty good position where we are with the size of our own operation and with our operating expenses to support our growth for the foreseeable future..

Thank you..

[Operator Instructions] We have no further questions. I'll turn the call back over to Todd Newton, CEO for closing remarks..

Well, thank you, operator. And in closing, we just want to thank you for your interest in Apollo Endosurgery today. Should you have any questions or need for a follow-up, please contact John Gillings, our Investor Relations Manager who is listed on our press release today. Thank you again..

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