Conformis, Inc.
Q3 2017 Earnings Call Transcript

Published: 2 Nov 2017

[Operator:]

Good afternoon. My name is Suzanne. I will be your conference operator today. At this time, I would like to welcome everyone to the ConforMIS Third Quarter 2017 Earnings 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. Before we begin, I would like to remind you that management will make statements during the call that include forward-looking statements within the meaning of the federal securities laws, which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements contained in this call that are not statements of historical facts should be considered to be forward-looking statements. All forward-looking statements, including without limitation, statements about ConforMIS' strategy, future operations, future financial position and results, gross margin, product margin, operating trends, financial guidance, market growth, total revenue and revenue mix by product and geography, the anticipated timing of the limited launch of our hip product offering, the potential impact and advantages of using customized implants, business initiatives and transitions in our commercial operations, are based upon current estimates and various assumptions. These statements involve material risks and uncertainties that could cause actual results or events to materially differ from those anticipated or implied by these forward-looking statements, including those discussed in the Risk Factors section of ConforMIS’ public filings with the Securities and Exchange Commission. Accordingly, you should not place undue reliance on these forward-looking statements. While ConforMIS may elect to update these forward-looking statements at some point in the future, ConforMIS disclaims any obligation, except as required by law, to update or revise any financial projections and forward-looking statements whether because of new information, future events or otherwise. This conference call contains time-sensitive information and is accurate only as the live broadcast today, November 01, 2017. I will now turn the call over to Mark Augusti, the Company's President and Chief Executive Officer. Mark, please go ahead?

[Mark Augusti:]

Thank you, Suzanne, and welcome everyone to ConforMIS' third quarter 2017 earnings conference call. With me on the call today is our CFO, Paul Weiner. During the call, Paul and I will share our prepared remarks on a variety of topics including our third quarter financial and operating performance. Following the prepared remarks, Paul and I look forward to answering your questions. We are pleased with our Q3 results. The changes we have made to our U.S. sales organization are beginning to take root and have a positive impact. Our gross margin and operational improvement initiatives are starting to appear in our results and the actions we took during the third quarter to reduce operating expenses has all such focused on our core business initiatives. Additionally, in the third quarter, we closed the asset purchase deal of broad peak manufacturing to integrate the bulk of our policy operations in house. We announced the publications of more positive clinical data from a comparative study using ConforMIS’s technology and we made good progress in our direct-to-consumer campaign. I will touch on each of these later on the call. With that, let me turn the call over to Paul for a detailed review of our financial results. Paul?

[Paul Weiner:]

Thank you, Mark and thank you all for joining us. We reported third quarter revenue of $18.4 million representing growth of minus 1.2% or $280,000 year-over-year on a reported basis. Excluding the positive impact of changes in foreign currency exchange rates of $76,000 the company’s revenue declined 1.6% on a constant currency basis. Revenue in the third quarter of 2017 and 2016 included royalty revenue of $249,000 and $243,000 respectively, related to related to patent license agreements. Third quarter product revenue was $18.2 million or representing growth of minus 1.2% or $224,000 year-over-year on a reported basis and 1.6 % on a constant currency basis. Sales of the company’s iTotal PS increased $1.2 million to $5.2 million, a 29% year-over-year on a reported and constant currency basis. Sales of the iTotal CR, iDuo and iUni products, declined $1.4 million to $13 million or 9.7% year-over-year on a reported basis and 10.2% on a constant currency basis. These base product lines represented approximately 71% of total product revenue in the third quarter of 2017, compared to approximately 78% of total product revenue for the same quarter last year. U.S. product revenue increased $573,000 to $15.5 million or 3.8% year-over-year. The increase in U.S. product revenue was driven by strong sales of our iTotal PS product, which increased 30% year-over-year, offset partially by 5% year-over-year decline in sales of the company's base business product lines. Third quarter U.S. product revenue represented 85% of total product revenue, compared to 81% of total product revenue for the same quarter of 2016. Rest of world product revenue was $2.7 million a decline of $797,000 or 23.1% year-over-year on a reported basis and 25% on a constant currency basis, which was affected by sales of the base business product lines, including the Germany's partial knee reimbursement rate change and weakness in our iTotal CR sales. Third quarter Rest of World product revenue represented 15% of total product revenue, compared to 19% of total product revenue in the same quarter of 2016. Turning to a review of our results across the rest of the P&L, third quarter gross margin was 40% of revenue, compared to 32% of revenue last year, an 800 basis point increase. The increase in gross margin year-over-year was driven primarily by cost reductions as a result of vertical integration and manufacturing efficiencies. Gross margin improvement has been a point of emphasis and we are now starting to see the positive impact from the hard work that has gone into the cost reduction program that we are executing. As of the end of 2016, we in sourced all of our iTotal CR and PS Metal. Earlier this year, we began manufacturing all of our polyethylene inserts for iTotal CR and are now pleased to report that we are producing internally a 100% of these poly inserts. Our plans to complete the vertical integration of iTotal PS polys in the beginning of next year remain on track. We continue to make significant progress with the development of new processes for the 3D printing of our patient-specific iJigs resulting in print cycle time reductions and lower powder utilization. We believe this will reduce our capital outlays for 3D nylon printers for the remainder of 2017 and even more so next year. Our multi-year plan to offshore some of our CAD design work as well as our continued improvements in design software and CAD automation should provide additional growth margin expansion. In short, we are experiencing substantial progress in our cost reduction programs which we believe will yield continued growth margin improvement. Third quarter operating expenses increased $1.3 million to $20.2 million, or 7% year-over-year. The increase in operating expenses was driven primarily by higher general and administrative costs, due to a charge related to an impairment of a fixed asset and severance payments partially offset by lower sales and marketing costs due to a decrease in personnel cost. Net loss was $12.5 million, or $0.29 per share, compared to $12.8 million, or $0.31 per share, for the same period last year. With that, I’ll turn the call back to Mark for more color.

[Mark Augusti:]

Thanks, Paul. As I've mentioned on prior calls, we are focused on four strategic priorities here at ConforMIS, commercial execution, gross margin improvement, innovation and talent management. On commercial execution, as anticipated Rest of World revenue declined to match the step forward on U.S. commercial performance. U.S. product revenue of $15.5 million constituting 3.8% growth over the prior year, this was a good result for us during this year of U.S. commercial transition. We continue our focus on sales execution, direct-to-consumer marketing programs and expanding our clinical and health economic results. As noted during our call last quarter, we have a new Senior Vice-President of U.S. sales, under his leadership we are focused on additional distribution and proved account targeting sales force assessment in training to increase the effectiveness of our sale force. I had confident that we’re making rate changes and believe they will improve our sales execution. For our marketing team, consumer awareness is a key area of focus. Our Patient Ambassador Program has been helping to increase patient awareness and educate patients on the benefits of our technology, while our Track My Implant program is allowing us to communicate directly with patients prior to their surgery, both of which helps patients make informed decisions with respect to their care. Also, we have initiated an investment in a direct-to-consumer pilot program to drive patient interest in our products. These are key components of our commercial strategy. Adding to our library of study results, we reported in Q3 the publication of a study evaluating knee strength and mechanics that compared healthy control patients to those of either modern Off-the-Shelf total knee replacement or a customized bi-compartmental knee replacement. In this study published in International Orthopedics in September of 2017, the authors concluded that “Customized bi-compartmental knee replacement patients exhibit better strength and mechanics while performing activities of daily living” Statistically significant results were seen in a number of key areas. For example, the Off-the-Shelf CKR Group walks significantly slower when compared to both our customized bi-compartmental knee replacement as well as the healthy controls. ConforMIS did provide financial support for the study. Though the customized bi-compartmental knee replacement is only a small segment of this market, this publication contributes in a positive manner to the overall growing body of evidence supporting patient’s specific implants versus the less tailored off-the-shelf knees. I'm also pleased to report that we completed enrollment ever iTotal PS retrospective study, which looks at two-year follow-up reported outcomes of 100 conformist patients. We expect to submit the results of this study for publication over the coming months. As Paul already detailed our gross margin improvement -- excuse me, improved by 800 basis points over the prior year, which is the result of our recent in sourcing and cost reduction initiatives. In addition to these gains we continue to build our internal infrastructure as an eye toward increasing operational capability and efficiency. For example, in August we acquired substantially all of the assets associated with the polishing of our femoral components from Broad Peak Manufacturing which had provided polishing services to ConforMIS femoral and component manufacturing since 2014. This acquisition represents an important step in enhancing the manufacturing of our customize knee implant by integrating broad peaks proven and innovative manufacturing operation directly into our operations. We expect that this will further reduce costs, improve gross margin and add additional manufacturing expertise which we intend to leverage as part of our larger plan to continue to improve our manufacturing operations and gross margin. Further, we were able to hold the line on our expenses in third quarter, backing out one time expense for charge related to an impairment of the fixed asset and severance payments were roughly flat versus prior year. Commenting briefly on innovation, we continue to work on the next generation of iUni and iTotal knees, and in addition of course our iTotal program has a major for us and it’s currently on track. I’ve been please by the surgeon engagement, interaction with the company around the development and commercialization of these new product programs. We have a great team here at ConforMIS as I’ve said in the past. We consider ourselves agent of change in the field of orthopedics and are committed to producing the best total knee system available. We’re passionate in our belief that everyone should have access to our technology and everyone should have the ability to make a chose that leads to better outcomes and satisfactions. Thank you very much. With that, I’ll turn it back to Suzanne and we’d be happy to take calls.

[Operator:]

Thank you very much. [Operator Instructions] And our first question comes from the line of Larry Biegelsen of Wells Fargo. Please go ahead. Your line is open.

[Adam Maeder:]

Hi, guys, it’s actually Adam Maeder on for Larry. Thanks for talking the questions. I guess first ones on the strategic side. At our healthcare conference back in September, you seem to be interested in finding the strategic partner to help you better penetrate the market. Can you talk about where you are in those discussions? Would you expect to announce something in 2018 and exactly what you’re looking for in the partner? And then I had one quick follow-up?

[Mark Augusti:]

Adam, actually I think that’s a little bit of miss characterization. I had been ask the question by Larry, would be willing to talk our strategic partner and the answer of course is yes, As I answered there, we’re open to various ideas, but that’s not currently a strategic priority for us. As I outline in my four priorities before. So nothing obviously that I’m going to comment on at this point, there’s certainly nothing to suggest in the progress.

[Adam Maeder:]

Okay. Understood. Thanks for clarifying. And then just a quick follow-up upon whether -- I didn’t anything in the prepared remarks, so, I guess could you jut comment on the impact you saw in Q3? Thanks for taking my questions.

[Mark Augusti:]

Impact related to what sorry..?

[Mark Augusti:]

So whether.

[Mark Augusti:]

From the hurricanes, yes. So, from our analysis we calculate that there is about two, the $250,000 impact related to the hurricanes in Q3 and from our analysis we come up with about the same amount for Q4 that we would expect of our $250, 000 impact.

[Adam Maeder:]

That’s helpful. Thanks.

[Mark Augusti:]

Thank, Adam.

[Operator:]

Thank you. And the next question comes from the line of Mr. Bruce Nudell of SunTrust Robinson. Your line is open.

[Mark Augusti:]

Bruce, are you there? Yes, go ahead.

[Bruce Nudell:]

Can you hear me, okay.

[Mark Augusti:]

Yes, Bruce. Go ahead. This is Mark.

[Unidentified Analyst:]

This is [Indiscernible] for Bruce. About the phone issues, I guess, the first question you saw a nice performance improvement in the U.S. in the quarter. I just wondered if you give us little more color on what attributed to that and especially specifically you mentioned on the last call some issues with [Indiscernible] west being denied or putting a dent in demand that you’re seeing there or with the sales force that specifically contributed to improving growth in the third quarter?

[Mark Augusti:]

Sure. Just to clarify. Was that math that I hear?

[Mark Augusti:]

Hi. Okay, great. Welcome. Yes. So this is Mark. So first thanks for the question and on scan, some of CT scan, we did experience comparable headwind in Q3 to what we experienced in Q2 and we’re able to achieve the result in spite of that. And I think that to continued efforts around that to working with payers and as I've indicated previously its going to continue to be a headwind through at least the rest of the year but we bake that in and we continue to attack it. I think the other results were a factor around the slow but steady improvements we’re making in our U.S. commercialization strategy under the leadership of our new SVP of Sales, Dan Krupp. We’ve started making some of those changes. We had brought into new management. As indicated before we still have to look to add feet on the street and are aggressively looking to do that. But we’re doing that with very thoughtful and programmatic methodology to that. So, I've indicated before that the transition is kind of a four to six quarter thing. So it's tough on orthopedics and we’re about halfway through it. So, this is a positive step forward, baby step but a positive step forward.

[Unidentified Analyst:]

Got it. Just overall I think there’s also a little better than we thought in the third quarter you maintain guidance which looks like it implies a step down and growth in the fourth quarter. Anything there that we should be thinking about that maybe get a little bit verse to work hard at?

[Paul Weiner:]

Not particularly other than headwinds that we have throughout the year including the Germany partials for instance as far as the reimbursement rating, CT Scan that Mark just talk about, so the some of the same headwinds that we've had all. We will continue into Q4 as well as we would anticipate the beginning part of next year. But we – as far as guidance that we had given out in the last quarter's call for the year of 2017, we still on hold to that guidance in the mid to high end of that range.

[Unidentified Analyst:]

Okay. Thanks for taking questions.

[Paul Weiner:]

Great.

[Operator:]

And your next question comes from the line of Kyle Rose of Canaccord Genuity. Your line is open.

[Unidentified Analyst:]

This is Brandon [ph] in for Kyle. My first question just on sales rep hiring. I think you previously had mentioned coming into Q3 you're hoping to start making some bigger pushes on that. So, I know you don't give numbers but are you guys kind of net adding reps at this point? Are you moving here then so maybe just an update on attrition and when you think some of these new reps might start to get more productive?

[Mark Augusti:]

Okay. As you mentioned Brandon and welcome, we don’t give those numbers. We are making headway, but not where we want to be on the actual feet on the street. It's not enough yet, we got to do more, But like I said, we want to make sure we get quality add. I will say that we do have I believe net ads from a management standpoint. We’ve made the management changes that we want to make and that's been very positive. So if you recall, not only the additions around national accounts, around direct-to-consumer, around the AVPs but we’ve also I've done a nice job with our regional sales managers or what we call regional sales directors. So, I feel good we put the management infrastructure to have quality control over the product process, but we’re still – we’re still not where we want to be as far as total feed on the street.

[Unidentified Analyst:]

Great. Thanks. That’s helpful. And if you I could sneak one more in. You had mentioned the last quarter I believe it was that you expanded your presence in U.K. Can you just talk to about how that ramp is kind of going with your new distributors over there? I know that you guys outperformed at least relative to our expectations and in lot of the buckets in rest of world those one of them, so, any kind of commentary around there and how the distributors are doing? Thanks

[Mark Augusti:]

Yes. That’s a great question and again its small that we have had the headwinds in our German business we talked about, but distributive share in the U.K. its going extremely well. We’ve got more the feed on the street from that acquisition. And on the heating home, they’re up so obviously with the conversion to distributor from directors, some different accounting things there, but from just actually unit volume surgery as we saw nice growth. We’re actually said it in the fourth quarter, we are preparing for a user group meeting. We’ve got a nice day and half session and really looking forward to that. So I’m very please with what our distributors done there and we have couple of other in the national markets, but on the docket that we’re looking to enter into 2018, so I’m excited – its small step internationally but we’re in the right direction except for this obviously this headwind on the reimbursement which we’ve obviously talk about in the past. So thanks for the question, because we’re very please with the UK performance. Anything else. Okay.

[Operator:]

Your next question comes from the line of Ryan Zimmerman of BTIG. Your line is open.

[Ryan Zimmerman:]

Thanks for the questions. So, just one, lot of questions had been answered. But just want to talk about the cadence of gross margin gain that you picked up this quarter. And then, kind of your thoughts going into 2018. Paul, you still looking yourselves as kind of exiting this year in the mid to high 30% range for the year, and then how should we think about your gross margin cadence into FY 2018? Thank you.

[Mark Augusti:]

So, like you’ve said, we plan on being in the mid product of the 30% range for the full year which means continuing at around 40% gross margin range for fourth quarter. Next beginning part of next year, we plan on having 100% as I said, 100% of not just the iTotal CR poly and search being done in house but also the iTotal PS poly in certain house. And that would be the next step up in our growth margin improvement, and that’s in addition to the other items that we’re working on as far as efficiencies within our factory and the use of the machine. So we would anticipate as we are now starting to see the substantial improvements in our gross margins in the second half of this year, we should continue those improvements well into 2018.

[Ryan Zimmerman:]

Great. Appreciate the color on that. and then Mark, if you can just remind us, you said that the iTotal hip was on track, but just kind of remind us around the timing and kind of way you’re thinking in terms of commercialization for the iTotal hip at this stage, that would be great? Thank you. And thanks for taking the questions.

[Mark Augusti:]

Yes, absolutely. So we are looking at the limited launch of the iTotal Hip in kind of Q3 time frame next year. So we’ll provide more color on that as we get closer but it remains on track for us in a major area focused.

[Ryan Zimmerman:]

Thank you very much guys.

[Mark Augusti:]

Okay.

[Operator:]

And there are no further questions in the queue at this time. So, Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. And have a wonderful day. You may all disconnect.