TELA Bio, Inc. Q2 FY2024 Earnings Call

Good afternoon, everyone, and welcome to the TELA Bio Second Quarter 2024 Earnings Conference Call. A question-and-answer session will follow the prepared remarks. Please note that this conference call is being recorded. I will now hand the call over to Louisa Smith from Gilmartin Group.

Thank you, Marvin, and good afternoon, everyone. Earlier today, TELA Bio released financial results for the second quarter of 2024. A copy of the press release is available on the company's website. Joining me on today's call are Tony Koblish, President and Chief Executive Officer; and Roberto Cuca, Chief Operating Officer and Chief Financial Officer. Before we begin, I'd like to remind you that during this conference call, the company may make projections and forward-looking statements regarding future events. We encourage you to review the company's past and future filings with the SEC including, without limitation, the company's annual report on Form 10-K and quarterly reports on Form 10-Q, which identify the specific factors that may cause actual results or events to differ materially from those described in these forward-looking statements. These factors may include, without limitation, statements regarding product development and pipeline opportunities, product potential, the impact of various macroeconomic conditions identified in our filings, changes in surgical procedure volumes, the regulatory environment, sales and marketing strategies, capital resources or operating performance. With that, I'd now like to turn the call over to Tony.

Thanks, Louisa, and good afternoon, everyone. Thank you for joining TELA Bio's second quarter 2024 earnings call. During the call, I'll provide updates on our business and strategic initiatives, after which Roberto will elaborate further on Q2 results before we open the call up for questions. During the quarter, TELA faced some transient challenges that we were able to manage through and still grow revenue 11% to $16.1 million. Demand for our products remained strong in the second quarter, and we do not expect these adverse issues to persist into the second half of 2024. The biggest challenge in the quarter was a ransomware attack at our most recently added and consequently fastest-growing GPO customer that consists of approximately 150 separate hospitals. The customer detected the attack in the second week of May and resolved it two weeks later, but it appears that the return to normal operations may have taken a couple of additional weeks. As a result, this customer has substantially reduced surgeries for about a month of the quarter, affecting usage of both our hernia and PRS products. We estimate that this negatively affected our revenues by $1.25 million to $1.75 million during the quarter. Separately, one of our largest single hospital customers in our most successful territory also experienced a similar but independent cybersecurity event during the quarter, which we believe reduced surgical volumes and adversely affected our sales by at least $250,000. Finally, like some other market participants, we saw some lightness in procedure volumes in the second quarter, which was exacerbated in our case by the departure via retirement or, in one case, a death of several surgeons who are reliable users of our PRS product. We believe that these challenges were confined to the second quarter, and sales in July bolstered this conclusion. We have a number of initiatives ongoing that I'll describe shortly. Based on current Q3 revenue trends and the implementation of those initiatives within our sales organization, we continue to expect to deliver sales of $74.5 million to $76.4 million for the year, reflecting growth of $27.5 million or 27.5% over 2023 at the bottom end of the range. Essentially, we expect the second-quarter headwinds to affect the timing but not overall delivery of revenues in 2024. As it relates to our product portfolio, we continue to receive positive feedback from surgeons who have utilized the two products we launched in March and April, LIQUIFIX, the only FDA-approved liquid adhesive for internal use in hernia surgery, and OviTex IHR, a trocar compatible next-generation soft tissue repair platform designed for inguinal, specifically for use in laparoscopic and robotic-assisted procedures. IHR is available in three configurations and complements our existing product portfolio and allows for further penetration into the inguinal market, which has historically been dominated by permanent synthetic meshes. Across the market, we're seeing a deliberate shift away from permanent synthetic mesh, and our inguinal product is poised to capture market share as part of that underlying trend. Very few players in the space are as well positioned as TELA to be an alternative to the plastics predominantly used in inguinal repairs. In the second quarter, OviTex units grew 29% year-over-year, with a greater share of growth among the smaller units that are employed for inguinal hernia repairs, including in robotic and laparoscopic procedures. We expect to see continued adoption of OviTex IHR as we educate surgeons on the benefits of this product and create greater product awareness in the market, particularly around its ease of use within robotic cases. Outside the U.S., we are experiencing significant momentum in Europe, where OviTex was launched in 2019. As a reminder, OviTex PRS has not yet received CE certification. The hernia portfolio is now sold in seven countries: Great Britain, Austria, Germany, the Netherlands, Switzerland, Spain, and Italy. In June, we secured a long-term agreement with the group purchasing organization, Sana GmbH of Ismaning, Germany. Sana is the largest GPO in Germany, and this contract provides OviTex access to Sana's 350 corporate partners in the country. We achieved $2.4 million in sales in Europe in Q2 versus $1.5 million in 2023, with year-to-date unit growth of 87%. In the second quarter, EU revenues were 15% of our total revenue with the same gross margin as in the U.S. given the structure of our agreement with our manufacturer. As a more recently launched product market, we expect continued strong growth from our EU colleagues. We look forward to updating you soon on a collaboration with the National Health Service in England regarding OviTex, so stay tuned for that. We have continued to make significant strides with our education efforts. In Q2, we educated over 300 surgeons globally through TELA Bio labs and various peer-to-peer training programs with a strong focus on using OviTex in minimally invasive and robotic procedures. These programs include comprehensive VIP visits to our Malvern headquarters, cadaver labs in both the U.S. and EU and various other educational sessions. One standout event was the abdominal wall reconstruction symposium in Las Vegas in May which saw our largest attendance to date with 68 healthcare professionals engaging with our products. Additionally, we participated in several national and regional conferences with exposure to thousands of surgeons and attended two exclusive meetings with Intuitive Surgical. Intuitive Connect hosted more than 1,000 general surgeons who use the da Vinci REBAR and women in da Vinci surgery, a smaller but equally impactful opportunity for TELA. Given OviTex's unique compatibility for robotic hernia repair, we are excited to deepen this relationship and look forward to attending Intuitive 360 in September. We are also gaining momentum on the podium of key industry meetings globally and in medical journals. TELA is now up to 43 published or presented works on OviTex. We see these events and publications as a key driver behind surgeon education and adoption within the context of the transition away from permanent synthetic mesh. As we continue to gather evidence about the clinical efficacy and low recurrence rates associated with OviTex, the market feedback remains positive, even among surgeons who tend to be slower or more conservative adopters. We are driving awareness and expanding market share with the breadth of our portfolio and are committed to offering premier products for hernia repair and plastic reconstructive surgery, both of which are serving preference-driven markets. On the commercial side, we have a maturing sales organization now led by Greg Firestone. In May, we appointed Greg as Chief Commercial Officer to drive our next phase of growth by refocusing the U.S. sales force on balanced, data-driven selling. Greg has been pivotal to the TELA story since 2017, supporting our commercial strategy and securing contracts with key GPOs and IDNs. He has experience navigating GPO and IDN contracting and will be instrumental as we secure further access to new organizations. Greg is already enhancing sales rep training, increasing operational efficiency, and refining productivity metrics across the organization. He and we are committed to having one of the best-trained sales forces in the marketplace. I am pleased with the progress we made in the second quarter. We have a mature sales team, and we are driving operational leverage. We have our eye on profitability in the near future, and our guidance points to our expectation of another year of very strong growth for TELA.

Thanks, Tony. Revenue for the second quarter of 2024 grew 11% year-over-year to $16.1 million, with revenue from OviTex growing 11% and OviTex PRS growing 9% in the period. The double-digit growth was primarily driven by an increase in unit sales of products due to the addition of new customers, increased penetration within existing customer accounts, and growing international sales under our expanded commercial organization. This is partially offset by a decrease in average selling prices caused by a shift in product mix as our strategy to more broadly penetrate the inguinal and minimally invasive hernia repair markets showed success. As Tony mentioned, there was one larger and a couple of smaller adverse dynamics affecting the quarter, but we do not expect to meaningfully affect revenue in the second half of 2024. Growth for the first half of 2024 was up 24% over the first half of 2023, reflecting more general commercial performance before the customer-focused adoptions in the second quarter. Gross margin was 69% for the second quarter compared to 70% in the prior year period. The decrease was primarily due to higher charges for excess and obsolete inventory as a percentage of revenue as a result of inventory purchases during the quarter. Sales and marketing expense was $16.7 million in the second quarter of 2024 compared to $14.6 million in the same period in 2023. This increase was mainly due to higher compensation costs as a result of our expanded commercial organization, increased travel expenses, and a marketing distribution fee, which offset lower marketing expense. General and administrative expense was $3.6 million compared to $3.5 million in the same period of 2023. R&D expense was $2.3 million in the second quarter compared to $2.5 million in the prior year. The decrease is primarily due to lower study and development costs, which offset higher compensation and benefits. Loss from operations was $11.6 million in the second quarter of 2024 compared to $10.4 million in the prior year period. Net loss was $12.6 million in the second quarter of 2024 compared to $10.8 million in the same period in 2023. We ended the first quarter with $26.5 million in cash and cash equivalents. Turning to the outlook for 2024. We continue to project revenue for the full year to be in the range of $74.5 million to $76.5 million, representing growth of 27% to 31% from the prior year. Additionally, we continue to expect operating loss and net loss to be less in 2024 than in 2023, even excluding the contribution from the divestiture of NIVIS. Operating expenses will remain steady or slightly lower sequentially over the course of the year so that both operating loss and net loss decline from quarter to quarter over the course of 2024, again, even excluding the contribution from the divestiture of NIVIS. Relatedly, cash consumption should be meaningfully lower in the second half of the year. Added to this, in the third quarter, we will begin to receive revenue share payments related to the divestiture of NIVIS. Over the course of the next eight quarters, these payments will sum to at least $3 million and could be as much as $7 million. With this combination of growing revenue, improving operating leverage and incremental NIVIS payments, we continue to expect that our cash and cash equivalents will be sufficient to fund us to profitability.

Thanks, Roberto. I'm pleased by the company's progress and resilience in the second quarter. I'm excited by the enormous opportunity in front of us. I believe that TELA Bio has never been better positioned for success for several reasons. First, I've been very impressed by Greg's leadership of our seasoned commercial team so far, and I'm confident that he will do an excellent job in driving adoption of our portfolio of products. Second, we possess broad GPO coverage and have products that position us well for the ongoing shift to robotic hernia repair. Finally, and most importantly, our products offer patients and surgeons unparalleled clinical outcomes at a competitive price. We are confident that this combination of essential factors for success can drive solid growth for TELA for years to come. So, with that, I'll now ask Marvin to open the line for your questions. Please go ahead.

Our first question comes from Frank Takkinen of Lake Street Capital. Your line is now open.

I was hoping to start with a follow-up on some of the cyber-attack commentary. Can you just help us understand a little bit better of what's really occurring at the account level when these cyber-attacks occurred? And really what I'm trying to understand is when this occurred, are these procedures in backlog? Were the physicians able to use a different mesh? Were they using no mesh? And kind of how does that lead into the confidence behind the guide and backlog and those types of things to think about the second half of the year?

Yes, Frank, I'll begin. From what we understand, there was a situation where patient records were essentially compromised. This led to a scenario where many tasks that are usually performed through the electronic medical record system had to be done manually. This includes writing prescriptions and dictating notes, affecting every part of surgical procedures. Consequently, hospitals were forced to reconsider which procedures to prioritize. We’ve learned that some patients were transferred to other facilities, which isn't advantageous for us since we haven’t fully implemented those facilities yet. To our knowledge, the attacks, including secondary ones outside the group purchasing organization system, were mainly related to the patient medical records, effectively paralyzing hospital operations on a daily basis.

Yes. And so, Frank, what I'd add is if you do some research, you'll see some accounts where the affected hospital system was redirecting ambulances to alternative hospitals. So, it's not to have them arrive at their emergency departments. So, for at least two weeks, they were doing very, very few procedures, if any. When they were able to lift the ransomware attack and regain access to their systems, they began getting up to speed somewhat slowly. It sounds like it took another couple of weeks before they were back to where they were before. And so, the procedures that we are involved in were either delayed or redirected to other locations. As in the COVID-19 experience, we expect that probably the PRS type procedures were sent to other hospitals and are difficult to reschedule, but that the hernia surgeries were simply delayed. We don't think there's going to be a big backlog. It's about a month's worth of surgery, and hernia repairs in particular are rescheduled one approach other than to the biggest eventual hernia repairs that require watchful waiting. So, you can't delay those for a month. Our expectation though is that as the hospital system gets up to speed, as to the hospitals in COVID-19, we want to prioritize more remunerative surgeries before the less remunerated ones, which means that premium may take a little bit longer to get up to speed at those hospitals. All that said, we do have indications, particularly from the performance in July that this is something that's been isolated to the second quarter and that things are pretty close to back to normal. And added to that, the initiatives that Greg has kicked off and the morale that we see in our sales force as a result of all that work, we feel very strongly about being able to perform in the second half and recoup the lost procedures that we experienced in the second quarter.

I'm just going to add a little bit more, Frank, to that color. I mean, keep in mind, or if you recall, this GPO is super important to us, right? It's not the biggest, that's for sure. But the structure of the contract is the most favorable to us, right? Dual-source contract, us and another player, and that other player was not the market leader, right? So, the contract had not annualized yet over the year, and so it's also our fastest growing. So, it's acutely painful for us.

Okay. That's helpful information. I have two questions I'd like to ask at once. How should we consider the revenue distribution in Q3 compared to Q4 in order to meet the projected range of $74.5 million to $76.5 million? Also, how should we assess the blended OviTex average selling price now that IHR is included?

I will start with the first question. We anticipate that a larger portion of the revenue will come in the fourth quarter. This is primarily driven by the initiatives that Greg is launching, which will take some time to ramp up. Consequently, we expect to see a greater impact in the fourth quarter compared to the third, while still seeing some results in both quarters. Regarding average selling price, we expect it to start decreasing as we achieve more volume in the IHR sector. Generally, we have always anticipated that our average selling prices would be lower in the long run since we entered the market with the larger end of the hernia repair spectrum, particularly large ventral repairs with substantial components. We have consistently expected to expand into other market segments by starting with smaller components. Therefore, we do not see this as a negative outcome; rather, it reflects our aim to capture a greater market share across various types of repairs.

And it might be a little choppy, Frank, as we sort out the mix between the large complex cases with large pieces and the slope of the ramp rate of the IHR; both products should grow, but it may be out of sync every now and then. But I think definitely, what Roberto said is correct. We want the volume at some point.

Thank you for taking my question. Cash burn was still pretty high this quarter. Was this mostly just due to not getting the leverage lost in revenue growth or anything else to really call out here?

Sure. That's exactly it. If you consider that revenue could have been higher, we learned about the disruption partway through May, towards the end of the month, even though it started earlier. There wasn't much opportunity to adjust expenses within the second quarter. We did make some minor changes in the timing of expenses to try to offset this and give ourselves more flexibility while we analyzed what was happening during the quarter. Had we had additional revenue on top of the operating expenses you saw in the second quarter, that would have all contributed to the bottom line. We expect to get back on track with that, as we mentioned in our guidance. One thing we believe investors might not be aware of for the third quarter is that we'll start receiving the revenue share payment, which will have a gross margin of 100%, depending on how quickly it ramps. It could be more or less front-loaded over the next eight months and quarters, and that will obviously contribute to our cash position.

Great. And then just on gross margins, what are your expectations really going forward given the IHR launch more broadly?

So, IHR, the way we pay for the product that we manufacture from our manufacturers with a revenue share. So, we give them 27% of the revenue. That's true across our portfolio with very minor adjustments in certain cases. So even though those products are lower ASP, they should be fairly close to that standard 27% revenue share. We split the cost of shipping. So that takes about a percentage point or two off. And so, the long-term goal of gross margin is about 70%, plus or minus a little bit.

Awesome. And then just a quick one. What was the split this quarter between OviTex and PRS?

So, this quarter, PRS was 30% of the total revenue, right. A little bit down.

Just one clarification question. What was the split U.S. versus OUS? Did I hear you right? OUS was $2.4 million in the quarter, up about 60%?

Correct. Correct. Yes.

Okay. I understand. I apologize for pushing, but I'm reviewing the guidance for the year, and the lower end of the range suggests around $42 million for the remainder of the year, which translates to an average of $21 million per quarter. Clearly, Q3 is expected to be slower than Q4, making it difficult to achieve those numbers. What growth rate did you observe in July, and what can you share about that? Also, why is the lower end of the range appropriate? Considering the disruptions you've experienced and the fact that some cases have been redirected to other hospitals, it seems like we should potentially adjust below that level. So again, why is the bottom end of the range the right figure?

So, thanks for the question. So first, let me start with July. So, as you know, our quarters tend to be slightly backloaded. So, the first month of the quarter tends to be the lowest of the quarter, below 33% of the quarter. So, one of the things we look at on a quarterly basis is how that first month of the quarter looks compared to other first months or quarters. So, what I can tell you is that July was the highest first month of a quarter that we've had in our history. So that suggests that we are back on track for growth and that, in particular, because had the disruption that you've seen in the second quarter lasted into the third quarter, you wouldn't have seen that kind of performance in the first month of the quarter. The second thing that makes us comfortable about achieving the amount over the second half that we need to hit our guidance is the plans that we had in place even at the beginning of the year, which we felt strongly about. And then what Greg has been doing since he took over a little bit less than three months ago. So, he was one of that he was instrumental in structuring our response to our disruption in the third quarter of last year in which we revamped our education of our sales forces, in which we retargeted our compensation system and has extended that into this year and then took over in May at the end of May and has extended that and expanded it. And so, what we're seeing with our sales force and how they're responding to it and the morale they're exhibiting as a result gives us a lot of confidence about being able to make up the shortfall that we saw in the second quarter.

Yes, that said, I think, Matt, it's going to be weighted a little bit more towards the fourth quarter once all the programs and all the training and all the elements kick in.

Okay. How much flexibility did you really take into account? Does everything need to go perfectly for you to reach the low end? Or are there other factors that we should consider to get you all the way there?

Yes. So, as we've been describing over the course of this year, we view this tense range as a commitment to investors. So, we placed it in a place where we felt comfortable that we had all the levers to hit it. And what we did going through the years said if we learn over the course of the year to performance in any one of the quarters that there's additional upside, we would adjust that guidance number later rather than trying to express the full amount of what could be achieved early on before we had some data points. So, we feel very confident with that range, and we will be expending considerable efforts to make sure we hit not just the bottom at the end of the range but get pretty close to the top end of the range.

Our next question comes from the line of Michael Sarcone of Jefferies. Your line is now open.

Good afternoon, and thank you for taking my question. Could you provide us with a bit more detail? You mentioned bringing on Greg Firestone and also referred to refining some training processes and productivity metrics. Can you elaborate on what specific changes Greg is implementing and how those changes will drive additional productivity?

Absolutely. So, Greg has been with us for seven years, as you know. He's really been one of our commercial guys along the way, but more focused on GPO contracting, etc. So, I feel like we made a lot of progress in getting the GPOs. And now we've got to transition towards synthesizing that attainment with implementation into the GPOs. So, one of the things that Greg is deeply focused on is talk track and messaging and training, right? So, there are subtle differences in talk track when you talk to supply chain, right, at a contract at a hospital at a GPO. There's competitive dynamics with competitors, certainly. There's pricing and strategic dynamics, but the messaging is different. And I think the messaging is going to be inordinately important at the supply chain level as we go through this transition away from polypropylene, right? So polypropylene mesh has been the subject of these litigations. It's going to settle at some point in the future, and we're seeing lots of activity at the GPO level in transitioning for those companies that have polypropylene towards other more natural repair products. So, having Greg in the middle of this allows us to be strong when we need to be strong with GPO contracting messaging, right? It's with supply chain. The other factor is Greg has been around for a long time. He's run sales organizations. He has gravitas and credibility about him, which is very, very good for a young organization like ourselves. So, he is commanding and is going to demand accountability. And that's going to drive efficiency, leverage, and part of that is training, right? So, one of the brilliant things that he's done since he started, he's moving very fast is rather than thinking in terms of broad brush with the whole sales force in terms of training and education, talk track and messaging, we did benchmark testing for everybody in the organization. Whether they're sales leadership or territory managers, everybody. And we got a strength and weakness profile for everybody individually. And it allows us to really customize and develop our people on an individual basis, which is going to strengthen their talk track around GPOs and continue to strengthen and talk track their way around the surgeons. The other thing that we've done that he's doing a great job is he's implementing our two surgeons that we have on staff. So, we've had Bruce Friedman, general surgeon on staff now for a year or two. He's been instrumental in helping us do training and peer-to-peer discussions on the hernia side. But Howard Lansden has joined us as well. One of the unfortunate losses in PRS business. He was a big customer of ours up until recently, but he's retired. He was the Chief of Plastic Surgery at the University of Rochester. Very sophisticated man, awesome presenter and teacher and educator, and he's being deployed as part of our PRS surgeon peer-to-peer educational programs and also supply chain as well. So, Greg has been looking after the sales force as a CCO for the last several months, and it was just evident to us that he had the right stuff for all of these elements to take us to the next level. Thank you for that question. It was good for me to explain that.

Sure. So, the goal is to keep OpEx flattish to declining over the course of this year. With revenue growing on top of that, obviously, that drops to the bottom line and reduces sequentially our cash consumption, although there is some seasonality to our cash usage. But we expect that even next year, we should be able to hold OpEx flat, potentially even declining next year such that with additional year-on-year revenue growth next year on top of that OpEx savings. And then combined with the contribution from the NIVIS revenue share that can range from $3 million to $7 million, that together should get us to profitability. So, cash flow breakeven.

Good afternoon. Tony, did you have a CCO that position in the past?

Yes, we did. Yes, he was more of a traditional VP of sales type of guy. Greg is a more senior executive who has more of a strategic full set of experiences.

And Chris Smith is still there?

No. VP of Sales has moved on. We focused the business around Greg and the senior leadership that's been in place now for the last couple of years. We have a group of area directors that report into Greg, that are our most talented, most senior folks, they've been with us for years. So, it's a very tenured organization.

And one last one, just as we think about this NIVIS revenue share, I'm just trying to think about even just the back half of the year. I know it's over 8 quarters, but I mean could that be $1 million a quarter? Is that a possibility? Or is that too much?

The structure is that for the first four quarters, we receive 50% of what the new owner sells for NIVIS in each quarter. In the following four quarters, we receive 25%. Depending on how quickly the new owner can ramp up, they might sell $2 million in the third or fourth quarters, and we would then receive half of that, which would amount to $1 million.

Yes, the CEO has been quite optimistic in the past on the product uptake, but it's just launching a month or so ago.

I'm showing no further questions at this time. Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.