Establishment Labs Holdings Inc. (ESTA) Q3 2019 Earnings Report, Transcript and Summary

Greetings, and welcome to the Establishment Labs' Third Quarter 2019 Earnings Conference Call. [Operator Instructions]. Please note, this conference is being recorded.I will now turn the conference over to your host, Jeremy Feffer, Investor Relations. Sir, you may begin.

Thank you, Jerry. And thank you for -- everyone, for participating on today's call. Joining me from the company are Juan Jose Chacon Quiros, Chief Executive Officer; and Renee Gaeta, Chief Financial Officer. Before we begin, I would like to caution listeners that comments made by management during this call will include forward-looking statements within the meaning of federal securities laws. These include statements on Establishment Labs' financial outlook and the company's plans and timing for product development and sales.These forward-looking statements involve material risks and uncertainties and the company's actual results may differ materially. For a discussion on risk factors, I encourage you to review the company's quarterly report on Form 10-Q that will be filed later today with the SEC. The content of this conference call contains time-sensitive information accurate only as of the date of this live broadcast, November 12, 2019. Except as required by law, Establishment Labs undertakes no obligation to revise or otherwise update any statement to reflect events or circumstances after the date of this call.With that said, it's my pleasure to turn the call over to the company's Chief Executive Officer, Juan Jose Chacon Quiros. Juan Jose?

Thank you, Jeremy, and good morning, everyone. During the third quarter of this year, revenue was $22.9 million, an increase of 40% over the same period of 2018. This is another record quarter, made possible by the continued global adoption of Motiva Implants, and marks our fifth consecutive quarter of record performance.With patient safety and improved outcomes as the main drivers for capturing market share, our company's focused on breast aesthetics and reconstruction has allowed us to consistently drive strong revenue growth and capture new accounts. At a time of concern for women about the breast safety of their implants are innovative and differentiated products offer important support and alternative for the plastic surgery community and their patients. Our commitment to women's health is paramount as we transform the industry, and this will continue to be our main guiding principle.Establishment Labs continues to add to its science and patient data regarding Motiva Implants superior safety profile. We are also proud to see an increasing number of surgeons providing independent verification, both in conferences and publications of the merits of our technology platform and their work also contributes to our growth.With our continued momentum in Q3, we are comfortable, once again, raising our full year 2019 revenue guidance to a range of $86 million to $87 million, up from the prior range of $84 million to $86 million. We are very pleased with our sales growth's trajectory. And this guidance reflects our conviction that we will achieve a minimum of 40% year-over-year growth from the full year 2018 to full year 2019.Turning now to the specific drivers of our Q3 performance, our increased market share was driven by balanced growth across all regions of the world. Alongside double-digit growth in our direct markets, Australia and Vietnam were particularly strong and underscore the breadth of our success in different markets. The launch of our direct sales force across Europe and Brazil positively impacted our performance.Direct market revenue for the third quarter accounted for 41% of total revenue and 45% for the 9 months ending September 30. As expected, this represents an anticipated decline relative to last quarter, driven by the fact that Q3 is seasonally softer in our direct markets. Our expectation is that our direct market revenue as a percentage of total revenue will continue to grow over the long term. Particularly as we expand our direct sales teams into other territories.During the third quarter, Brazil was once again our strongest market, generating 16.3% of our total year-to-date revenue. Additionally, we entered 2 new distributor markets earlier this year, Taiwan and Thailand. These markets are performing ahead of plan and are ramping faster than anticipated. As a reminder, Thailand is one of the largest breast aesthetic markets in Asia.Motiva Implants are now commercially available in 80 countries. Geographic expansion is a key part of a long-term strategy, and we will continue to grow our product portfolio into the global standard in breast aesthetics and reconstruction. Our regulatory work continues to make progress with geographic expansion and current product offerings. In a path towards the approval of several new products, we have the most comprehensive portfolio of advanced smooth implants worldwide.In continuing the expansion of our product portfolio, we announced last month the 510(k) submission for SmoothSilk anatomical tissue expander. We also filed for CE Mark registration of our tissue expander at the end of the fourth quarter of 2018. These submissions are important milestones for our global regulatory pipeline and demonstrate our commitment to the breast reconstruction market.While Motiva Implants are already being used by plastic surgeons in breast reconstruction, much of the total addressable market is driven by the inclusion of a tissue expander as a part of a product portfolio. The advanced sign of our tissue expander should fuel adoption in the breast reconstruction market for all of our products.Our tissue expander is a real difference for the industry. As this product not only includes our Smoothsilk surface but will be the only tissue expander with an integrated board with no magnets, enabling the use of the expander safely alongside MRI scanning and creating a reduced shield to radiation therapy. This innovation that makes a substantial difference to oncologists, plastic surgeons and patients and will have a real impact on women's health as they undergo breast reconstruction. Our R&D team incorporated our existing RFID technology into this new product, reinforcing the strength of our intellectual property. We continue to work hard on our minimally invasive breast augmentation initiative, Motiva Mía.We're scheduling the first clinical cases to take place in Japan before the end of the year, with a carefully planned sub-launch in 2020.Similar to the introduction of minimally invasive surgeries in other medical specialties, we believe that bringing a minimally invasive breast augmentation to market may grow the worldwide total addressable market for breast aesthetics. In Q3, regulatory agencies around the world continue to take action on textured and polyurethane implants. Notably, in September, the FDA identify a major competitor's textured breast implants and tissue expanders as a Class 1 recall due to the elevated risk of breast implant associated anaplastic large cell lymphoma, a rare type of non-Hodgkin's lymphoma.For the global plastic surgeon community, we believe this is the start of a transition to smooth implants, which will take some time to complete. Textured and smooth implants have different surgical techniques. And responsibly transitioning from one to the other, does involve medical education. As global regulatory agencies take action, we would expect some doctors to move quickly into using smooth implants, but for many more their initial reaction is to continue using other available textured implants in the market.As we provide considerable medical education around the world, we believe this transition to smooth implants and more specifically, our advanced smooth implants will accelerate. While we did not see -- while we do see some moderate pickup in our sales from their regulatory events of this year, we believe that most of the transition has yet to come. And you will see this continue to be a factor in our growth. In October, the FDA released its draft guidance as a result of the advisory panel the FDA convened last March. We are in full support of their guidelines as they should serve to help doctors and patients understand the differentiation of our implants relative to the current offerings in the market. We do not expect these FDA actions to have any negative impact on our ongoing U.S. clinical trial. Against this challenging regulatory environment and negative media coverage, our product portfolio remains available in all markets.With the unique safety profile of Motiva Implants, we remain confident about our long-term growth prospects and continue to monitor our product vigilantly through a product post-market surveillance metrics. We believe our implants can be a substantive part of the solution to the concerns raised by the global regulatory agencies, and we have taken this as another opportunity to provide our industry, both surgeons and patients with further scientific details and medical education about our surface technology. These regulatory concerns unquestionably demonstrate the need for innovation in our industry through research and development and we strive to take the lead in these efforts.With that in mind, we continue to strengthen the intellectual property around Motiva Implants. In September, we announced that we received a notice of allowance for a key U.S. patent application covering our unique implant surface technology. We continue to develop and file patent applications around the world in an effort to protect our innovation.We are progressing with the FDA clinical trial for Motiva implants. During our last call, we announced that we completed all surgeries in the aesthetic cohorts of the trial. With the U.S. market, constituting roughly half of the world market on a dollar basis, entering into this new market for Establishment Labs is an important opportunity.As a reminder, to date, we have completed all surgeries in the primary augmentation cohort, completed all surgeries in the revision augmentation cohort, and we continue to make progress with enrollment and surgeries in the reconstruction cohorts. We are very pleased to have achieved over 90% enrollment in the revision reconstruction cohort and over 50% enrollment in the second stage reconstruction cohort.We continue to make progress enrolling the single-stage reconstruction cohort and recently received approval from the FDA on a practical amendment, getting us one step closer to an important CMS approval required for some centers focused on single-stage reconstruction.In light of the fact that we were able to complete the primary augmentation and revision augmentation cohorts, we have implemented a bifurcation strategy in which we intend to pursue submission for the aesthetic indications ahead of our submission for the reconstruction indications. This keeps the time line of a PMA package submission to the FDA on track.To raise awareness and education regarding the aesthetic and safety advantages of Motiva Implants, we sponsored the Fifth Annual World Symposium on ergonomic implants in Lago Di Garda, Italy. This annual event brings together hundreds of industry experts and surgeons from around the world to discuss the evolution of surgical techniques and breast implant technology.With a record 500 attendees, including top scientists from some of the world's premier institutions, this event speaks to the rapidly growing interest in Motiva. For me, some of the best moments of this year conference were scientists from the Langer Lab at MIT, giving an update on the research regarding breast implant surface biocompatibility and the differentiation of our SmoothSilk implant surface.Surgeons from different countries in Europe providing their K-Series with Motiva Implants in breast reconstruction, including 1 center from Switzerland, delivering safety information with surgeries of up to 5 years that demonstrate a significant reduction in the percentage and severity of capsular contracture and an improvement in the quality of life of patients.Plastic surgeons from around the world, giving lectures on the advanced use of Motiva Implants in breast augmentation with minimal scars, surgical 3D planning using the algorithms of our Divina technology and hybrid use of Motiva Implants with our fat grafting suite. Educational industry gatherings like these are an important forum for us to better understand surgeons' experiences with Motiva Implants, and we are already looking ahead to the next year event. We are conducting many medical education events across the world, with more than 50 taking place this quarter alone.With that, I'd like to turn the call over to Renee to discuss the financials in detail. Renee?

Thank you, Juan Jose. As Juan Jose stated earlier, our momentum from the second quarter carried into Q3, and we are pleased to again report record revenue. You can find additional details on our third quarter financials in our earnings press release and our Form 10-Q, which we plan to file later today. Our total revenue for the third quarter was $22.9 million, which represents a 40% increase over the $16.3 million we reported in Q3 of 2018.As Juan Jose mentioned, revenue growth for this quarter was driven by double-digit growth in our direct markets. Alongside strong performance in our distributor markets. We anticipate full year 2019 revenues to be in a range of $86 million to $87 million up from our previous guidance of $84 million to $86 million. The lower end of our revised guidance represents revenue growth of more than 40% year-over-year.Our revised full year guidance reflects a planned manufacturing and distribution delivery shutdown in the fourth quarter as we complete a critical milestone in our planned ERP system implementation. This allows for a higher process controls on product and supply chain alongside efficiencies to support our expected growth. This year, the shutdown happened in addition to our required annual maintenance that we perform every year in Q4.I would like to mention that a major milestone for any medtech company is achieving a $100 million revenue run rate. And based on our performance to date, we expect to achieve and exceed that milestone in 2020.Gross profit for the third quarter was $14.2 million or 62.3% of revenue, which compares favorably to 60% of revenues last quarter and is similar to the third quarter 2018.The sequential increase in gross margin percentage was driven primarily by increased volume. Our gross profit percentage was negatively impacted by 2.1% during the quarter due to amortization related to the fair value of inventory recorded from our asset acquisitions from distributors in recent quarters. As we sell-through the remaining inventory required, the impact of this amortization dissipates.Total operating expenses for the third quarter of 2019 were $23 million, an increase of 42.2 -- 42.4% as compared to $16.2 million in the third quarter of 2018. This increase was driven by continued investment across the company for our current and future growth. In particular, we continue to implement our business excellence model, and we are building efficiencies in our systems to ensure that our organization can scale with the growth ahead. For example, we are undertaking a comprehensive system upgrade to our ERP system with SAP, a multiyear investment across our global operations. It is key to our scalability and will bring us closer to our customers, providing them with exceptional service using advanced digital tools.SG&A expense increased $6.3 million or 48.1% to $19.2 million. The increase in SG&A was primarily due to $3.2 million of personnel and related costs as a result of hiring additional sales, marketing and administrative employees, $1.2 million in increased legal and consulting costs, a $700,000 increase in sales commissions and a $700,000 increase in marketing expenses.Our sales force has grown to 93 employees and contractors from 64 in the year ago period, driven by the new direct market additions from Q4 2018.While our direct markets have added to our SG&A expense, the normal course of their operations, they have contributed to our revenue and they are accretive to our gross margin. Another example of an investment in 2019 is the many educational events we are organizing with plastic surgeons around the world to educate them on the important surgical technique nuances of our advanced smooth implants.We will continue to make these investments to improve those patient outcomes and satisfaction as well as creating loyal relationships with the plastic surgery community.Our research and development expenses increased 19% to $3.8 million. The increase in R&D expenses is primarily due to the related cost of our FDA clinical trial in the United States. Research and development continues to be a cornerstone of our future growth and product portfolio.With an eye on both the short and long term, we evaluate the use of our capital with a high level of scrutiny, and we are constantly making adjustments where necessary to capitalize on growth. Our level of investment today is a deliberate strategy by management, and we are confident that these steps will both reduce cash burn and increase growth in 2020 and beyond. The investments we make today, such as the U.S. clinical trial, should allow us to become a global market leader with a product portfolio and a brand that is highly differentiated and creates long-term competitive advantage.As we continue these investments, we should begin to see cash burn come down in 2020 from its current highs as our business achieves scale. Net loss for the third quarter of 2019 was $12.8 million as compared to net income of $1.3 million for the same period in 2018. As a reminder, the third quarter net income of 2018 was effected by noncash gain on the fair value of debt-related derivative of $11.4 million.Our cash position remains strong. We held a cash balance of $42.6 million at the end of September 30, 2019. During the quarter, we used $10.9 million to found our operations. We know that this is slightly higher than our average quarterly run rate for 2019, in part due to seasonal items such as insurance renewals that occur in July.I will now turn the call back over to Juan Jose for some concluding remarks. Juan Jose?

Thanks, Renee. We continue to be very pleased with our performance, and we'll continue to work on maintaining this momentum by taking advantage of current and emerging market opportunities. In the middle of a complicated regulatory environment, we work to lead the industry through a commitment to women's health, innovation and by setting new safety standards in the breast aesthetics and reconstruction market.Our goal is to take a commanding position in our industry by bringing unmatched innovation and technologies that result in superior long-term safety and improved aesthetic outcomes.With that, I will hand the call over to the operator for the Q&A.

[Operator Instructions]. The first question is from Raj Denhoy from Jefferies.

Maybe I could start a bit on the comments you made around training, right? So having been to some of your sessions and meetings and things, the necessity of training is, I think, something that maybe is coming to light. So I'm curious about the pace of training and the pace of demand for training. Are you seeing any acceleration in physicians that want to learn about Motiva Implants and learn about the techniques for the implants?

Thank you, Raj, for this question. Yes, I think the -- one of the most important things to understand these days is the process in which we acquire new accounts. And by that, I mean that most people would have a first impulse, do you think that whatever Allergan loses because of the recall, we are going to get a substantial amount of it. And that can be a logical thing to think. But actually, in reality, most of these surgeons in the international market that have used highly textured devices for decades and were never trained in the use of smooth devices, their natural impulse is to move to the next texture device that they can get their hands into. Some of them do initially see the really -- the reality of it, which is that old texture devices have those same potential complications. So our job is to train them into the science behind Motiva Implants, into the new surgical techniques.So to your question, I think that we are seeing a lot more interest that's why we are conducting so many events every quarter. I mean last quarter, it was more than 50. This quarter, we're going to do at least 50, although we have the Christmas shutdown early. And what we do see is that more surgeons are also being put in this situation by their patients because their patients are coming in and saying don't put textured implants on me. I want smooth implants. And if they don't know how to use them appropriately then they contact us because we are doing currently most of the work that the scientific societies should have done. We are doing most of the trainings to plastic surgeons on the use of advanced smooth implants. So we do work hard to get more and more surgeons involved in our medical education, but this is a process that is not immediate. It takes time, but we are very happy to see that it yields long-term relationships with these accounts. And we hope to see the surgeons with us for years to come, with excellent aesthetic and safety results.

No, that's helpful. And maybe as a follow-up to that, you mentioned the regulatory issues with textured implants. And while it's not, obviously, in your numbers, but have you seen any impact in the market? Are you seeing any slowdown or any -- having in-patient demand for breast implant procedures?

We have not been able to quantify to date any slowdown. What we have seen is increased concern by patients worldwide. If you check the chatter on social media and the different messages that many patient advocates are giving, of course, there is concern. And there's reason for concern. I think they are right to be concerned. So it's one of the things that we look for every quarter. But to date, we have not been able to quantify any significant slowdown in the market.

That's helpful as well. And maybe just one last one. You mentioned the regulatory filing for the tissue expander in the United States. Have you -- what are your plans, I guess, is the question for that product? Will you launch it in the United States prior to getting the Motiva Implants approved?

Yes. This, of course, is a great opportunity for Establishment Labs to be in the U.S. market ahead of the launch of Motiva Implants. But this is a decision that we cannot take lightly. We are going to have to do significant investments to launch products in the U.S. market and bringing breast reconstruction, tissue expanders ahead of time could be one of the options that we are looking at. I would say the timing would be closer for a proper response from me when we get the final decision from the FDA and the timing of that. But we certainly do see it as a very important opportunity for the company.

That's helpful. And congratulations on a good quarter.

Thank you.

The next question is from Chris Cooley, Stephens Inc. Mr. Cooley, is your microphone open?

I'm sorry. Can you hear me now?

We can hear you.

Okay. Congratulations. Maybe just two for me then I'll get back in queue. Following on what Raj touched on just there at the outset. Could you talk to a little bit about how you educate the end market, the consumer not only about the benefits of the Motiva Implant, but also just more generally about their selection choice. Now there's been positive feedback we received from some of our recent European survey work that we had done not only practitioners but also patients appreciated the information that the company was putting forth. And so talk about -- little bit about how you strike that balance about the clinical information, and at the same time, drive to a skilled and well-trained surge? Then I have a quick follow-up.

Yes. Thank you, Chris. For us, patient education is paramount. We have to balance the health care compliance rules because we cannot be in direct contact with patients. But at the same time, we can put communications that are meaningful regarding the safety and effectiveness of Motiva Implants in the international market. So it is for us one of the key drivers is that patients are beginning to understand that there are substantial differences between Motiva Implants and the legacy products. So one example of that is that we have, by far, the largest presence on social media of all brands in the international market. And that is part of the work that we are doing to educate the patient population about it.At the time of this complex regulatory environment. We are putting out what we call a good news campaign. So in different social media and digital channels. We are putting out the positive messages about all the work that we have done to innovate this industry about the qualities of our low-inflammatory surface technology. What we can do in terms of reducing capsular contracture rates, the understanding of women trying to get breast implants and their commitment to it, and that to be balanced with the potential complications and how Motiva can help them reduce those complications.At the same time, that you have all these patients asking surgeons about Motiva, then you have all these surgeons asking themselves, why are -- why am I not using Motiva. And that's part of the work that we have to do in terms of bringing quality medical education to surgeons so that they can serve this population of patients who do see in Motiva a solution to their commitment to having a breast augmentation without the complications that they see in newspapers and beyond.

That's very helpful. And then maybe just as my follow-on for Renee. If you can maybe just give us a little bit more color around your expectations for reducing the burn in 2020. Is that a function of further gross margin leverage as you continue to scale getting some leverage to middle the P&L on the recent sales and marketing hires. Just help us think about what is going to be driving that reduction in cash burn. And to the extent that you can, or unless you don't have 2020 guidance yet. But just maybe order of magnitude, how we should be thinking about that reduction over the course of the year?

Yes. Sure, Chris. Thanks for the question. I think it's a combination of both of those things. Of course, going to be seeing top line revenue growth and improvement on the gross margins, especially as our direct markets continue to perform as they have in the current year and we expect them to do in 2020 and beyond. But of course, it's going to also come from optimization of the P&L as well on the operating expense side. So we are making critical investments this year that will help us with leverage for next year. And you're right, I'm not going to provide explicit guidance right now for cash burn for 2020. But I will tell you that the improvements that we're making today leverage on top of the growth that we expect for next year will allow for the cash burn to come down.

Understood. Congrats on a great quarter.

Thank you.

[Operator Instructions]. We have a question from Josh Jennings, Cowen and Company.

Congratulations as well on another record quarter. I just wanted to start off I want to say just on the ergonomic symposium and the material science that's been evolving in some of the presentations that occurred there, but particularly on MIT Labs the biocompatibility data. I know it's very early, since that was presented. But how's the response been from some surgeon customers has -- as it resonated? And how do you plan on using that data to market Motiva and the potential safety benefits from the biocompatibility that has now been put on the table?

Thank you, Josh. Yes, and this is a very important set of new information that was given at the ergonomic symposium. And it highlights the work and the collaboration with Professor Langer at MIT and his team. And their work has proven that we have a low-inflammatory surface technology. And this can have a fundamental effect on the complication rates. So at a time where everyone else is trying to explain their surface technology, we have now real scientific proof of how the surface technology and its architecture elicit a positive interaction with cells. And this is something that is a first in our industry, and it describes the difference with Motiva Implants. So I think that it is a complex subject. And at this point, what we are doing is definitely working through the materials so that we can explain the significance of it to the plastic surgery community, but most of this is going to happen in podium. Having different of our experts explaining the importance of the MIT data. And as we go forward, definitely, what would be more important is the final publication of that information in a peer-reviewed journal.

Great. And I wanted to follow-up just on Mía. The minimally invasive approach in the Japan, first in women and then the soft launch in 2020. I guess, specifically, can you just help frame the opportunity in Japan? And maybe talk a little bit more about what your share position is in Japan today? And whether or not minimally invasive approach can expand there and also globally?

Thank you. We have been present in the Japanese market since 2012. And we now control over 60% of the market in breast aesthetics in Japan. So while this is significant, 70% of the total market for breast augmentation is not done with breast implants, but it is done by the injection of hydrogels like hyaluronic acid. That procedure is banned in most countries, including the United States and the European Union, but it is done in Japan because Japanese women do not want big scars. They want a minimally invasive type of augmentation. So we have -- of the total 10,000 approximate women that are being implanted every year with implants -- breast implant -- silicone breast implants you have 30%. So you have 7,000 women who are the lion share of the market, who are being implanted with hyaluronic acid or other hydrogels.So I would say, our first objective is to slowly train Japanese surgeons on how to use this novel minimally invasive silicone breast implant augmentation. And this is going to take time. This is absolutely new to this industry. So we are going to be patient, and we are going to go slow because we want to get it right. And at the same time, there's the other part of it, which is we have to talk to a completely new group of customers about why this minimally invasive procedure is safer than the current use of hyaluronic acid or other hydrogels in breast augmentation. But further than that, is to learn from it so that when we go and market in other countries in Asia, like Korea or China, or that we move this to Europe or the United States, that we understand what is the best way to talk to women who are not looking for a breast augmentation, they are looking to have a differentiated breast size and shape that is not a keen to that. It is normally considered a 2 size up breast augmentation. So we do see a lot of potential in this. We think that this has the potential to grow the market, not only in Japan but also worldwide. So because of it you will see us going very slow in 2020 before we accelerate in 2021 and beyond in other geographies.

We have reached the end of the question-and-answer session. I will now turn the call back over to Juan Jose for closing remarks.

Thank you, everyone, for joining us on today's earnings call. We look forward to providing our next quarterly update in March. We wish you a very good day.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation, and have a good day.