Establishment Labs Holdings Inc. (ESTA) Earnings Call Transcript & Summary

Well, thank you for joining us this afternoon. We have right now with us, Establishment Labs, including the CEO, President and Founder, Juan Jose. I'm going to kill your last name. Say your last name for me.

Chacon-Quiros.

Chacon-Quiros. Thank you. Beautiful name. And Raj Denhoy. And I'm still Joanne Wuensch.

And I have a whole list of questions here, but admittedly, all of these were written before you reported last night. So I'm going to skip over most of them and go straight to can you give us a summary of the quarter and your guidance and how the guidance came together, but mostly the quarter, start there.

Sure. I can start there. Certainly, I think in the context of the latter half of last year, I think we need to talk about the first quarter, we experienced a slowdown in our markets in the second half of last year. And we saw both our direct markets, and we sell roughly 40% of our revenue through direct markets and 60% through distributors. So we saw some softness in our direct markets as patients were delaying procedures. That got magnified significantly as distributors seeing that same sort of dynamic, chose to stop ordering from us for a period of time, right? So there was that kind of disconnect between what they were selling out and what they were purchasing from us. And so that dynamic really hit us in the back half of last year. The fourth quarter, I think, was a reflection of that continuing. As again, that dynamic of distributors essentially selling out inventory continued. As we're entering here into 2024 and with the guidance that we've given, we are seeing our markets starting to stabilize. And we are seeing improved demand. So both in direct markets, surgery schedules that surgeons are starting to improve. And then with distributors, we're starting to see the orders start to come back. And even in commentary from distributors, they're starting to sell out more. And over time, those orders will start to improve. And so the guidance that we've given for this year is really a reflection of that, right? So again, the markets are stabilizing. We're not saying it's all the way back. But things are improving, and we expect to see a continued improvement over the course of the year.

So when you put together your 2024 guidance, that was your base case? Improving, stable to improving?

Yes, stabilizing and improving as the year unfolds.

And you're starting to launch in China. How did that factor into the guidance?

Yes. So on top of that kind of dynamic in the base business that we have now, we have a couple of new things that are coming this year. So China, you mentioned, we have now launched into China, second largest market in the world. We've also launched our tissue expander, Flora, in the United States. And so those will contribute as well on top of that.

So it includes China and it includes Flora. Let's spend a little bit more time on China. I think your language last evening was that you pulled $10 million out of the guide at the end of 2023, and that's a good place to start to think about for 2024. Am I paraphrasing correctly?

Yes. I think you need to understand the market dynamics to go to that number. And when you think about Tier 1 cities in China and Tier 2 cities in China, where we will be having this product at different locations, change of clinics, new clinic centers on the aesthetic side, then this is what it takes to be able to start the business in Tier 1 and Tier 2 cities. So that should happen throughout Q1, Q2 and maybe into Q3. And after that, what you will see is a pattern of reordering. Now the guidance was constructed with that number in mind and being very cautious with the reordering patterns. Because at this point, it's too early on to know exactly what those reorders will be later in the year.

Walk me through -- it's a distributor model that you're selling in China with. Is there a stocking that happens that you can count on? Or is it sort of a pull method as it's being needed?

To all distributors that we have around the world, we sell ex-works. So we recognized the revenue the moment it leaves our manufacturing facilities. So these are -- like, these orders will be the tuck-in orders for those Tier 1 and Tier 2 cities. And then as they need to reorder based on demand that they have in market, we will see new orders coming in later in the year. But the construction of the guidance includes that base case of the stock.

That's the roughly $10 million? That's your base case? Okay. And that moves of that is stocking. And then you have to see the distributor afterwards. What are your Tier 1 and Tier 2 cities or regions?

So it's basically -- when you think about China, you have the main cities like Shanghai, Beijing, Guangzhou, where you see a lot of movement in aesthetics. But then you have new cities, as they call them, like you go to Shenzhen, Tianjin and places like that, where there's a lot of economic activity, people that have basically improved their financial wealth. And they're very open to aesthetics. So that's the main focus for this year with our distribution partner. Our distribution partner is exclusive. It's basically the same group that we have as distributors in Hong Kong and also in South Korea. And they've been extremely successful with our brand. Motiva is a market leader in Asia. And when you look at reference markets for China, we are already market leaders in Singapore. As I said before, in Hong Kong, in Taiwan, and those are markets that represent well what would happen in China.

Okay. What is the competitive landscape looking like in the markets that you're -- these distributors already winning in, such as Singapore and Hong Kong and Korea? And are they the same competitors in China?

So basically, it's very similar in terms of the competitive landscape. In many of these markets, when we have gone into over the last few years, what we have seen is Johnson & Johnson with [ dormant ] brands being the market leader and us, over time, taking over that leadership. Not only in the countries that I mentioned before, but also in Thailand, Japan and Vietnam. So overall, it's been an exercise in basically attacking with our technologies, those markets and making sure that consumers, potential patients get an understanding of the benefits of the Motiva technology.

And how long does it usually take you to get to the leadership position in the market?

It varies. But I think we have a very good blueprint in which we go 10%, 20%, 30% and eventually 40% of the market in all the markets that I just mentioned. We are north of 40% and some of them north of 50% and more. So we've taken a substantial leadership position in those markets.

Is it based on distributor just doing a very good job, the product price, some combination?

I think it's a partnership that we've been able to craft in the blueprint that we are using that is very effective and that we've been able to roll out in each one of these markets. And on top of that, the way we price in which we are using a good, better, best pricing strategy. And we're not charging more for safety, all price points have the same level of safety, but then consumers can upgrade based under demand, basically.

What do you think -- how do I word this? I don't want to say peak sales, but your revenue run rate in China can be after you go through this initial launch and stocking phase?

So I think it's too early to see that. But I think that what I just described as the market share-taking exercise, it's potentially one that we can replicate in China because there's a very good awareness already of the Motiva brand in China. And in the past, we've spoken about, for instance, in South Korea, pre-pandemic, 25% of women getting Motiva came from China, and they came not to pay less. Actually, they were paying more. So all of that awareness is built into the market share that we intend to take in that market.

Okay. Anything else we should talk about as it relates to that region?

So I think what's really interesting about the Asia Pacific region for us is that these are very specific markets with different dynamics, some are more print-sensitive than others. China is probably the highest ASP by far in the region. But in all of these different markets, we've been able to go to market leaders, and it really shows you what the technology can do over time.

Okay. If I take your guidance and I don't include anything from the U.S., and I assume $10 million for China, that leaves me with a base other OUS growing roughly mid-single digits year-over-year. If I've done my math right, what led you to sort of think about that as being the right number?

I think the way we look at it is not so much driven by just a percentage, right? I think given the slowdown we've seen in the markets, the distributor dynamic, I think the guidance this year, there was quite a bit of kind of bottoms-up building of it, right, actually looking market by market in terms of where we saw potential for growth, where we saw the distributor dynamic working itself out. And so we think it's more of a really just sort of a very well-grounded view on how this year will progress for us. I think that base business, again, is recovering, and we'll see it continue, over the course of the year. And then some of these new things we've just been talking about will add on top of that. That's how you're going to unfold for us.

And for your base business, there is a difference between your direct and your distributor model. And remind us what percentage of OUS sales are direct versus distributor?

Yes. So prior to the slowdown, we were roughly 60% distributor, 40% were direct. In the most recent quarter as a banking was 51% were through distributors, right? So it's down from where it has been. So we sell in 85 countries globally, as you know. We're direct in most of the countries of Europe as well as Brazil and Argentina, but the rest of the world, we sell through distributors.

And what is the growth rate difference between the distributors and the direct?

Again, it varies by region, right? So we have some very good distributors who have done quite well as Juan Jose was describing about the share taking in some of the Asia Pacific markets. Those are all distributor markets for us. Some of our partners there have done a tremendous job in taking market share and really growing our business there. In direct markets, we've also done pretty nicely in some of the European markets in which we've gone into. We think it's probably better to think about it more kind of on a regional basis. Asia has been probably where the growth has been coming from most recently. That's probably thinking about it kind of mid- to high-single-digit growth coming out of that market. And again, this is all kind of pre the recent slowdown. Europe is -- Europe and Latin America are probably up low single digits. The U.S. has historically been kind of growing low single digits, kind of flattish. You kind of roll out it up and you have a global market that's kind of growing in the mid-single digits, 3% to 5% globally.

Okay. But you historically have been growing faster than 3% to 5%?

Yes. And again, that's as Juan Jose was describing about the technology and the share taking, we've built on top of that.

Excellent. United States, you put the fourth PMA module in February of '23. So we're lapping the year. What has been the interaction with the FDA been like over the last 12 months?

It has been collaborative. Our team has participated in the previous breast implant PMAs. And they describe it as a very different approach from what they had seen in the past. So I think we are making the best of that collaborative effort, and we've been making a lot of progress. I think right now, we're just in the midst of getting our manufacturing inspection date. Once we get that, we could run through any questions that they may have regarding our manufacturing. And then the labeling discussions will be done in parallel. So we're really in the last phase of our PMA and considering that we were told by the FDA that there would be no panel, it really derisks this last phase of the process.

What do you think is holding up setting the date for your manufacturing facility inspection?

We don't think there's anything really holding it up. We think it's just normal paperwork taking place because with the visibility that we have is what is taking us to say that we expect this to happen imminently.

Happens imminently, how long do you think it takes to get approval?

So look, in the past, we have said super clearly, we're not going to speculate on dates precisely because sometimes you get cut up in paperwork. Sometimes things are going faster. So it's really difficult to do that. But what we are trying to do is be as transparent as possible with our progress so that people can see where this is taking place.

Okay. It's going to be sold in the United States with the direct sales force. Are those people hired?

So the way to think about our commercial effort is to understand that we have been setting up for the last 1.5 years for commercial operations. Our medical affairs structure exists already in the United States. We can do all of this support for medical education and whatever is needed to support the plastic surgery community once we launch. In addition to that, for the launch of the tissue expander, we finalize everything that we need to be able to invoice and ship. So all of those things already exist. What we will be adding over the course of the year are more sales reps. And of course, once we get the approval from Motiva Implants, we will need a significant amount more sales reps. But we don't need to hire them all at once. Depending on the target number of accounts, we will need a target number of sales reps.

There's this thought process that getting Flora approved in the U.S. -- Flora? No, Tissue Expander.

It's Flora.

Thank you. Long day already. Flora approved in the United States was a leading indicator for Motiva. Is that the right way to think about it?

Well, it is a very important milestone for us because there's a lot of finality in terms of the technology between the tissue expander and the breast implant. For instance, one of the biggest differentiators of our technology is the surface. And both of those devices share the same surface technology. So while it took us longer to get the tissue expander cleared because of the discussions around how to describe this patented proprietary surface, it has now sold it for the breast implant. So in that sense, it is a very positive thing for us from that perspective. But also, it allows us to start conversations with the plastic surgery community, tell them about Establishment Labs and start talking about our innovation and technology.

It also it sounds like you had to create an infrastructure to start selling it that creates the base for when Motiva comes around.

Absolutely. And that's why we are always being very clear in terms of all the work that has been done to create the commercial operations necessary to market the tissue expander and eventually the breast implants.

Okay. Are you building supply ahead of a U.S. launch?

So last year, we finalized the new manufacturing unit.

Which is gorgeous, by the way.

Which is quite an accomplishment as well. It is several times larger than our second-biggest facility. So with that, we have the manufacturing capacity to take on any demand from the United States. We've been doing some efficiency measures because now that, that facility is coming online, it gives us the opportunity to decommission the first facility and be more efficient with the manufacturing shifts and everything. But we are well prepared for this. And the manufacturing unit that they will be inspecting when the FDA come, comes is our second facility.

Okay. Raj, for you. Gross margins. How do -- how does the U.S. approval and the China approval -- and they get a complex question, impact your margin leverage?

It's not as complex as you think. Both those markets will be higher ASPs than their respective comparator, right? So you think about China is a distributor market for us. It has -- will have the highest ASPs and the highest gross margin of any of our distributor markets. It actually has some of the highest ASPs in the world. And then the U.S. is the highest price market in the world, and it will be a direct market for us. And so when you think about the underlying cost of making a product for us, it is not different for either of those markets and the markets in which we currently serve. And so as those ASPs increase significantly, it's going to have a pretty nice effect on our gross margin.

And how long does it take? I mean, is this a conversation of, well, Joanne, we're ramping supply? We're just getting there? Or is this something like...

It's pretty immediate. The standard cost and the way we do it, it's -- once we start selling there, the cost of those implants will be sort of our standard cost, right? And you're just banking that against a much higher realized price. And so of course, the mix will take time to build from those markets relative to the overall business, but it will start to contribute.

And 1 of the things that struck me is your language around hitting cash flow breakeven. And if I remember correctly, it's next year. How much of that comes from just the -- I don't want to say extreme -- significant cost management that you're currently doing? And how much of that comes from just simply putting more product at higher ASPs through the system? Or is there something else?

It's a combination of those things. I think from our perspective, when we look at the last 4 or 5 months, when we started to see the slowdown in the markets kind of coming out of the third quarter, we took some very significant actions to reduce our cost base. And so we talked about last night on the call, reducing our headcount by 28% globally, taking some number of programs off-line, really focusing on our inventory. We're doing a lot to try to get our expenses down, get our cash use down to really kind of match the demand that we're currently seeing. And so we have taken a lot of cost out of our infrastructure. And so those comments around getting to that profitability are based really around that, right? So as we see the stabilization in the markets, as we look at the reduced cost that we're now -- the reduced cost base that we now have as a company, it leads us to those -- to those targets to being EBITDA positive by the end of this year and then achieving cash flow breakeven early next year.

Do you have enough cash to get to cash flow breakeven early next year?

We do. We ended the quarter with $40 million of cash. We did in early January a $50 million private placement. So that leaves us with roughly $90 million pro forma. We've talked about this year, our cash use being less than $48 million. And so we feel we're in a really good position to get to those targets while still funding the growth that we expect to see this year.

Do you think about M&A?

Yes. I think we've always been really good at having a very healthy pipeline of technologies that we are creating ourselves. And when we think about our focus, our focus is very clear in transforming breast aesthetics, breast reconstruction, creating a new standard for breast reconstruction with Flora and other technologies that will go into that. And the new category of minimum base breast aesthetics. So that close to regional expansions into China, into the United States is a lot to work with. So we don't need to buy growth. We don't need to go into facial aesthetics or other things. I think we have what it takes for multiyear growth.

One of the things that you -- the language you use is a women's health company. And women's health has a lot that can go under that umbrella. Do you think of yourself as an aesthetics company, a women's health company? Like obviously, you've got a lot near term, but I'm thinking visionary.

If you think about what makes a difference for Establishment Labs in the market is that we are a women's health company. And that translates into technologies that have less -- much less adverse events. It also translates into creating new standards for breast reconstruction so that we can help women fully recover from breast cancer. And when you think about things that we are doing for the future, I mean, we've talked about Zen and eventually putting into Zen the temperature reader, getting approval for that. The -- we did an IRB-approved trial that we have fully enrolled in which we have the Zen with temperature reading and it's reading temperature every second at 0.1 Celsius. So that eventually translates in understanding early on if there's going to be a complication post-surgery. Eventually, you can correlate that to potential cancer risk. So all of these things is so that we go from just addressing aesthetics of reconstruction and going more into the journey of breast health.

Okay. One of the things that struck me when I came to visit your facility was that there are many of the steps that are fairly manual. Do you see those as an opportunity for automation, or this is working just fine?

So with silicone as a base material, automation in the past has meant lower quality of products and increased events of rupture and others. So you have to be very careful about what you automate, and we will always make sure that it does not come at the expense of patients. So we believe that the very healthy gross margins that we have, that will be improving with China, with the U.S. With Mia, we will only do things that improve the quality of the products and not put them into question.

Okay. How many years do you think you'll be okay in that facility before you need more space?

So we designed that facility so that we can meet up to 50% of the world's demand for breast implants. And I think that gives us coverage for several years. And eventually, that can be expanded. We already have blueprints for expansion, but all the way to 50% of world's demand, we are good to go.

But that also implies you think you have 50% market share of the world.

Well, it is one of our aspirations, and there are many markets in which we are north of 50%. So this is not something that we are dreaming of. It's something that we have achieved in many markets.

Okay. You just -- you filed the PMA application with 3 years of clinical data. You should be getting 4 years of data pretty quickly. When might we see that?

So we were the first company ever to give data preapproval. And we did that because we are very transparent with our clinical data. And we did that with 2-year data. We did that with 3-year data, and we will do so with 4-year data once the FDA has the data and we can find a proper scientific conference for it, we will do so.

So they'll get the 4-year data? Do you have the steps by which they get 5 years, 6 years, 7-year and out to how many years?

There's a periodic provision with the FDA so that they can get the data in due time.

Is there any reason the FDA would wait for 4-year data before approval or...

No. Because the guidance document for breast implants of the FDA specifically says 3-year data. And that's what they asked for, and that's what we gave them. I think the willingness to show 4-year data is more out of transparency with the plastic surgery community.

More commercialization.

As well.

Okay. If -- when you launch in the United States, my impression is you'll be launching at a premium price. Is that the right impression?

So I have to be careful for competitive reasons, what I say around that. But I think we've been very successful with matrix pricing, making sure that we are pricing at different points for different types of consumers. And one thing we've done really well is communicate to patients the benefits of our technologies and that they understand that we're not charging more for safety, all the products have the same level of safety, but that they can access more aesthetic benefits and sometimes will come at a premium.

Okay. Well said. The economics to the physician, is he or she agnostic to that because the quality and clinical data of Motiva?

So every time we go into a market that has been commoditized and you do have to do some work to get plastic surgeons of that mindset, that they understand that actually patients want to pay more, but they have to see the value for what they are paying more for. So it does take some work at the beginning. But very quickly, they see this as such a positive because not only do they see less adverse events, but also, you're seeing happier patients. And word-of-mouth really is what drives aesthetics. So in -- I would say, in summary, this matrix pricing in which you're not pricing out certain consumers and then consumers can choose to upgrade is a very powerful tool for that.

Okay. Do women know about different breast implants have -- when they walk into the doctor's office, have they done their homework? Do they ask for a certain product?

So women are asking more and more about their options way ahead of visiting a plastic surgeon. I think some of the concerns around breast implant safety have led them to that. And we believe that educated patients will ultimately look at Motiva as their preferred choice, not only because of the safety outcomes, but there are options in terms of aesthetics. And in many markets, in which at first some plastic surgeons were not willing to try our products, they eventually get convinced by the patients that were asking for them.

Okay. A competitor in the breast implant market has recently gone away. Should we look at that as, well, they couldn't make it, why can you? Or should we look at it as cool, more for us?

Well, it's definitely always better to have less competitors. But I think what that competitor tried to do is to prove that innovation had a space in the market. And at first, the first generation that they brought to market, texture anatomical implants, was actually an innovation for the U.S. market. Eventually, as those products began not getting used because of concerns around ALCL, then basically what they were left with is round smooth implants just like the other 2. So in a market like that and a year like last, I think it exacerbated those dynamics. But I think, overall, for us, every time we go into a market, we are faced with many competitors of different types. We used to fight against Allergan in many markets, and they left all those markets. So we're sure it's not going to be an easy task in the United States, but at the same time, there are many positives for us. In this market, all plastic surgeons know how to use smooth devices. You can communicate more with potential consumers, and those 2 things tend to be very good for us.

So with the stock trading the way that it is, I don't think there's much that investors missed from last night's earnings call. But if -- even meeting with people all morning, you're talking to people all night, what may have been missed or what do you think you want to be like, I want to make sure everyone understands this.

So I think there are things that are important that people see that all of the efficiency and productivity measures that we have taken over the last few months did not take away from our ability to grow. We didn't touch one commercial head in all of the reduction in force that we did. We really cleared out many initiatives that were good to have, nice to have, but not necessary so that we can refocus our resources into growth. And that's what we will be doing this year. And that gives us a possibility not only to launch into the U.S. with Motiva Implants, but also to grow Mia. Mia is the most exciting thing that has happened in breast aesthetics in the last 6 years, because when you see the patient experience with Mia and the type of aesthetic results, it really brings out that new consumer. So we gave some data yesterday, 38% in this first phase, our new consumers. That is an amazing thing because in an industry that has had very little growth, all of a sudden, proving a 38% increase of new consumers really tells you where this could go.

Excellent. When we're together a year from now when we're talking, what do you think we'll be talking about?

I think we will be talking about how the market in the U.S. is being transformed by technology by providing more options. And also remember, we are getting approval for our first 2 product families that we launched in the international market more than a decade ago. And then we have Ergonomix2 with the platform in which we have the JOY program and the Mia programs. So those things will be coming after. So I think there's a lot of exciting new things. We have GEM, which is a minimally invasive procedure for contour aesthetics that is also in the midst of a clinical trial. And that eventually, we hope will come to market. So many exciting things to talk about next year as well.

Excellent. Well, Juan Jose and Raj, thank you so much for coming today. It's great catching up with you so recently after a great quarter.

Great. Thank you.

Thank you.