Conformis, Inc.
Q4 2017 Earnings Call Transcript

Published: 8 Feb 2018

[Operator:]

Good afternoon. My name is Kevin and I'll be your conference operator today. At this time, I would like to welcome everyone to the ConforMIS Fourth Quarter and Year Ended 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 this call that include forward-looking statements within the meaning of the federal securities law, 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 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 the 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 of the live broadcast today, February 7, 2018. I will now turn the call over to Mark Augusti, the Company's President and Chief Executive Officer. Mark?

[Mark Augusti:]

Thank you, operator, and welcome everyone to ConforMIS' fourth quarter and year-end 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 fourth quarter financial and operating performance, our financial outlook and guidance for 2018, which we originally introduced in our press release of January 8. Additionally, I thought it might be worthwhile to reflect back on my first year at ConforMIS. Following the prepared remarks, Paul and I look forward to answering your questions. We are pleased with the fourth quarter results as we beat our revenue and gross margin guidance. The U.S. sales organization and management changes are now in place and our patient engagement campaigns continue to bear fruit. Our vertical integration, including the Broad Peak asset acquisition last August, and operational initiatives are driving gross margin improvement. We have continued to report positive clinical results, such as the paper by Dr. Gary Levengood, which was published in the peer-reviewed Journal of Knee Surgery during the fourth quarter and which I will discuss in more detail later. I would like to take a moment to briefly reflect on my first full year since joining ConforMIS as CEO. To me, the most important thing to note is that just as I relayed a year ago, we believe our technology is highly differentiated and offers clear advantages as compared to the products from the rest of the industry. I hear this regularly from physicians and patients alike. The clinical data we have compiled continues to confirm this. What is also true is what I relayed early on, we have to do a better job from a commercial standpoint in telling our story and connecting with physicians and patients. This is why commercial execution remains a critical imperative for us. We have made changes in people talent across the fields of sales management, marketing, national accounts, and market access teams towards this goal. We operate in a very competitive industry that is highly concentrated among a few significant players. We have to be that much better. Second, as I mentioned a year ago, I believe we have an opportunity to demonstrate significant patient satisfaction and health economic benefit improvements over off-the-shelf knee replacement surgery. The June publication of Arthroplasty Today of the study by Dr. Steven Culler that favorably compared adverse event rates and cost of care for customized implants against certain off-the-shelf implants is an example of this. Today I continue to believe that this is an important opportunity for us. We believe that the current industry trends towards value-based episode of care, analysis and contracting favor us and we will be aggressively exploring ways to exploit this. Third, let me comment on our imperative around gross margin. A year ago I talked about how this would be a point of emphasis for us and that my early assessment was that there were opportunities to achieve significantly higher gross margins. We have made significant strides down that path in 2017 putting us on track to focus on further gross margin improvement. We have made personnel changes and investments to bring about a cultural focus on leaning out our processes. We have an aspirational plan to achieve greater than 60% gross margin and have identified specific projects and plans that we believe can help us achieve that goal. As well, we will continue to evaluate and seek additional opportunity to be on specific cost reduction projects that have already been identified. Lastly, I'm often asked what has surprised me over the last year. I would say that I've had two surprises, one negative and one positive. The negative one is quite easy. The Germany partial knee reimbursement change negatively impacted our international business. Coming in as the new CEO, this was a disappointing and a challenging headwind to deal with over the first year. However, while this will continue to impact our business in Germany, we expect that our financial year-over-year comps will stabilize with respect to this issue after Q1 of 2018. The positive surprise was our strong patient engagement. Coming to ConforMIS a year ago, I had heard that patients like the technology, but I had no idea just how engaged they actually are and can be. The fact that we had patient ambassador volunteers that give themselves and their time freely to tell our story is amazing to me. Just as amazing, we have had a patient travel all the way from Australia to the U.S. to have her knee done with our system. She said she's so happy that she's coming back to get the other knee done later this year. As I have mentioned previously, through our direct-to-consumer market initiative, we are exploring how we can leverage this high engagement and turn it into a larger patient activation campaign for ConforMIS. This is truly a differentiated opportunity for us. In summary, I kicked off 2017 saying that it would be a year of transition and investment for ConforMIS, and it has been that. We believe our changes in investments during the past year will have a positive impact for us both commercially and operationally throughout 2018. With that, let me turn the call over to Paul for a detailed review of our 2017 financial results and our 2018 guidance. Paul?

[Paul Weiner:]

That you, Mark, and thank you all for joining us. We reported fourth quarter revenue of $20.8 million, representing a decline of 4% or $900,000 year-over-year on a reported basis. Excluding the positive impact of changes in foreign currency exchange rates of $169,000, the Company's revenue declined 5% on a constant currency basis. Revenue in the fourth quarter of 2017 and 2016 included royalty revenue of $252,000 and $238,000 respectively related to patent license agreements. Fourth quarter product revenue was $20.5 million, representing a decline of 4% or a $936,000 year-over-year on a reported basis and 5% on a constant currency basis. Sales of the Company's iTotal PS increased $1.1 million to $5.7 million or 23% year-over-year on a reported and constant currency basis. Sales of the iTotal CR, iDuo and iUni products declined $2 million to $14.8 million or 12% year-over-year on a reported basis and 13% on a constant currency basis. iTotal PS represented approximately 28% of total product revenue in the fourth quarter of 2017 compared to approximately 22% for the same quarter last year. U.S. product revenue remained consistent at $17.7 million year-over-year. U.S. product revenue was driven by strong sales of our iTotal PS product which increased 22% year-over-year, offset by an 8% year-over-year decline in sales of the Company's base business product lines. Fourth-quarter U.S. product revenue represented 86% of total product revenue compared to 83% for the same quarter of 2016. Rest of World product revenue was $2.8 million, a decline of $900,000 or 24% year-over-year on a reported basis and 29% on a constant currency basis, which was affected by sales of the base business product lines including the Germany partial knee reimbursement rate change and weakness in our iTotal CR sales. Fourth-quarter Rest of World product revenue represented 14% of total product revenue compared to 17% in the same quarter of 2016. Turning to a review of our results across the rest of the P&L, fourth quarter gross margin was 42% of revenue, compared to 37% of revenue last year, a 500 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, so we are now seeing the positive impact from the hard work that has gone into the COGS reduction programs. As of the end of 2017, we in-sourced all of our iTotal CR and PS metal tibial trays and polyethylene inserts. Earlier in 2017 we began manufacturing of our polyethylene inserts for iTotal CR and have ramped up to producing internally a 100% of these poly inserts. In December, we completed the vertical integration of iTotal PS poly inserts, which should have a positive impact on gross margin beginning in the second quarter. We continue to make significant progress with the development of new processes for the 3D printing of our patient-specific instruments, resulting in print cycle time reductions and lower powder utilization. We expect that this will reduce our capital outlays for 3D printers in 2018. Our multiyear plan to offshore some of our CAD design work as well as our continued improvements in design, software and CAD automation, should continue to provide additional gross margin expansion. In short, we have experienced substantial progress in our COGS reduction programs, which we believe will yield continued gross margin improvement as we move forward. Fourth-quarter operating expenses decreased $1.6 million to $20.4 million or 7% year-over-year. The decrease in operating expenses was driven primarily by lower general administrative costs, due primarily to reduction in patent litigation expense, strategic consultant expense, severance, business insurance expense, and other administrative expenses, and lower sales and marketing costs due to a decrease in personnel costs. Net loss was $11.9 million, or $0.27 per share, compared to $15.7 million or $0.37 per share for the same period last year. We reported 12-month revenue of $78.1 million, representing a decline of 2% or $1.8 million year-over-year on a reported and constant currency basis. 2017 gross margin was 36.9% of revenue compared to 33.4% of revenue last year, a 350 basis point increase. Net loss was $53.6 million or $1.24 per share, compared to $57.6 million or $1.39 per share for the same period last year. As of December 31, 2017, we had cash and cash equivalents and investments totaling $45.2 million compared to $65.5 million last year, or for 2016. Regarding our recent financing activity, on January 29 we closed our follow-on public offering in which the Company received $23 million in gross proceeds from the sale of 15.3 million shares of common stock. Net proceeds were $21.6 million before legal and accounting expenses. This included an offering of 13.3 million shares of stock plus the exercise by our underwriters of the full overallotment or Greenshoe of 2 million shares. Turning to a discussion of our 2018 financial guidance, which we introduced in our press release on January 8, for the full-year 2018 the Company expects total revenue in the range of $79.6 million to $83.6 million, representing year-over-year growth of 2% to 7% on a reported basis and 1% to 6% on a constant currency basis. The Company's 2018 revenue guidance assumes the following; product revenue in a range of $79 million to $83 million, representing year-over-year growth of 2% to 8% on a reported basis and 2% to 7% on a constant currency basis; royalty revenue of $600,000 related to ongoing patent license royalty revenue. A product revenue constant currency growth of 2% to 7% assumes growth in the United States in the mid-single-digit percentage to low-teens percentage and a decline in the Rest of the World in the low 20s percentage to the high-teens percentage on a constant currency basis. For the full-year 2018, the Company expects total gross margin in a range of 44% to 46% as compared to 37% in 2017. For modeling purposes, for the full-year 2018 we expect depreciation and amortization expense of approximately $4 million, stock compensation expense of approximately $4 million, and fully diluted weighted average shares outstanding for EPS purposes of approximately 59 million shares. We expect our first quarter total revenue in the range of $19.1 million to $19.8 million, representing year-over-year decline of 6% to 3% on a reported and constant currency basis, and product revenue in a range of $19 million to $19.7 million representing year-over-year decline of 7% to 3% on a reported and constant currency basis. The first quarter will be the last quarter that revenue will be negatively impacted on a year-over-year basis due to the change in the customized partial knee replacement reimbursement in Germany. We expect gross margin to be comparable to the fourth quarter of 2017 of 42%, or 900 basis points above the same period last year. With that, I'll turn the call back to Mark.

[Mark Augusti:]

Thank you, Paul. I have given fairly substantial comments earlier in the call. The important thing to focus on is what we need to do in 2018 to be successful. I think there are three operational objectives. These are, meeting our top line revenue guidance, continuing to improve our gross margin, and successful limited launch of our ConforMIS Hip System later this year. It is worth mentioning that our four strategic priorities here at ConforMIS, which I outlined earlier last year, won't change in 2018. They remain, commercial execution, gross margin improvement, innovation, and talent management. I've already commented on the investments and changes that I believe will allow us to improve our commercial execution and achieve our guidance, namely we will continue our focus on sales execution, direct-to-consumer marketing programs, and expanding our clinical and health economic results. Further to that last point, Q4 saw the publication of Accuracy of Coronal Plane Mechanical Alignment in a Customized, Individually Made Total Knee Replacement with Patient-Specific Instrumentation in the December edition of The Journal of Knee Surgery. This article by Dr. Gary Levengood, which studied 63 patients, showed no post-operative outliers that were greater than plus or minus 3 degrees of neutral, the industry-standard. This study adds to our clinical results, demonstrating that the iTotal knee replacement system is very accurate. Paul has already detailed much of our gross margin activity and I have commented that we have longer-term aspirational goals of greater than 60% gross margin. We have given guidance of 44% to 46% for 2018 and this will be a critical year in our journey towards that aspiration. Regarding innovation, our ConforMIS Hip System remains on track for limited launch in the second half of this year. We continue to work on the next-generation of our iUni partial knee replacement system and anticipate the limited launch in the first half of 2019. Furthermore, in the second half of 2019, we anticipate the limited launch of our next-generation iTotal knee replacement system. We are particularly excited about new features that will be available in this system, such as new cutting guide technology, new poly insert options, and optional longer stems on the tibial component. I've been pleased by the surgeon engagement and interaction with the Company around the development and commercialization of all these new product programs. Finally, regarding our recent financing, the cash gives us additional runway to execute on our commercial strategy and continue our gross margin expansion as well as to explore other opportunities. We have a great team here at ConforMIS, we consider ourselves agents of change in the field of orthopaedics, and are committed to producing the best total knee system available. We are passionate in our belief that everyone should have access to our technology. We look forward to a successful 2018. Thank you.

[Operator:]

[Operator Instructions] Our first question comes from Mike Weinstein with JP Morgan.

[Michael Weinstein:]

To start, so you gave your first quarter guidance, should I assume that after you get through that last tough comp in Europe, that revenue growth does turn positive in your modeling on the second quarter?

[Mark Augusti:]

That is correct, Michael, yes.

[Michael Weinstein:]

Okay. And can you just circle back, I think I missed just your commentary on your product cadence between the next-generation knee and the hip, I just want to make sure we heard exactly what you guys were expecting?

[Mark Augusti:]

This is Mark. We're on track for the limited launch of our ConforMIS Hip System in the second half of this year, so 2018. And then in the first half of 2019 we'll have our next generation, what we call our G3, of our iUni. And then later on in 2019 we'll have the limited launch of the next-generation of our iTotal with some of those feature attributes that I outlined.

[Michael Weinstein:]

Got you, okay. And Mark, could you spend a few minutes just on distribution right now and the personnel in place and [indiscernible] spend some time talking about the shift in your distribution from more of a 50-50 direct distributor model to one that's now more heavily weighted towards the distributors, could you just talk about what you have in place right now and the plans to grow it in 2018?

[Mark Augusti:]

Yes, absolutely. So, you're right, there's been a shift, and I think we've said before, we were somewhere between 75% and 80% of our revenue is in distributors and the remainder is in direct agents. And as far as one other thing that I think we struggled and we talked about in 2017 was just we were able to work out underperforming reps in territories and getting new management in, but we didn't really add as many people as we would have liked in 2017 because we were making those management changes. So, we're very pleased with Dan and the leadership team he's put in place. As I've said before, the market access and national account executives he has brought in are really high quality talent. We're seeing really good things from them. The key now is to attract good talent at the street-level in terms of distribution and in some cases still direct agents, and we have a claim to grow our feet on the street by approximately 20% to 25% throughout 2018. So that is a key point of emphasis for us going forward.

[Michael Weinstein:]

Okay. And just as we think about the timing of bringing those people on, how would you think about it first half versus second half?

[Mark Augusti:]

I'm pushing to kind of have it be done on a quarterly basis and it would probably be kind of pro rata. You can't predict these things but the team is aggressively out with those targets looking now. So, I wouldn't think in terms – I see the question you're asking but I don't see all being frontloaded. I think we're going to see some over the quarters as we go.

[Paul Weiner:]

As Mark said, it should be over the quarters but we are trying our frontloading as much as possible in getting them in here as soon as possible, and maybe we've hit the 20% mark on the third quarter, and that's basically our goals.

[Michael Weinstein:]

Got you, understood. Thanks for taking the questions.

[Operator:]

Our next question comes from Kristen Stewart with Deutsche Bank.

[Kristen M. Stewart:]

I was just wondering, how should we think about cash flow usage during the course of the year? I know you guys really turned back these cash throughout 2017 and saw that decline with the improved profitability, but how should we just think about cash flow use during 2018? Thanks.

[Paul Weiner:]

So in the fourth quarter we had about $9.3 million in cash usage, which is like the lowest amount we've had in maybe ever. And in 2018 we are making some investments in various areas, including the launch of the hip. So we would expect that in the first quarter there would be a bit more spending, a little bit higher than maybe the rest of the year, and then the rest of the year should be around somewhere in the range of around 10 million-plus per quarter.

[Kristen M. Stewart:]

Okay, perfect. And then is there anything that we should be focused on for AAOS or this should be a relatively quiet meeting for you guys?

[Mark Augusti:]

This is Mark. It's good question. I think it will be medium so to speak. We plan on certainly interacting with the analysts and we will talk a little bit more about our Hip System and maybe give a little more color and detail for that. So you should see us talk about that. We will also be talking obviously about some of the Generation 3 products as part of what we anticipate in 2019. So, it's not a huge blast in the sense that there is something going to come out that we haven't talked about before, but I particularly think that Hip will be interesting because we'll be able to get a little more granular on how that product concept is going to roll out.

[Operator:]

Our next question comes from Kyle Rose with Canaccord Genuity.

[Unidentified Analyst:]

This is actually [indiscernible] on for Kyle. First if I could just ask in the fourth quarter did you guys experienced any more of the headwinds from CT scan reimbursements, and I guess looking forward, do you think that's something that are you guys contemplating an impact from that in 2018 or is that kind of behind us now?

[Mark Augusti:]

This is Mark. No, it was about the same as far as we could tell. Again, this is not as accurate and specific as you'd like, but as best we could tell, it was about the same. And it will continue, if you recall, it should continue certainly through the Q1 because as we talked about middle of last year, it kind of got operationalized towards the end of Q1, beginning of Q2. So I would expect to kind of anniversary out of it in Q1 [indiscernible]. But it certainly hasn't gotten worse by any means. It's about the same, and again, as I indicated in the past, it actually made some headway in a couple of states with a couple of commercial suppliers. So, I feel pretty good, and again, I have no news to suggest anything would change going forward in this year as we stand now.

[Unidentified Analyst:]

Great, thank you very much. And one other question if I could sneak one in here is just in terms of, just to dovetail off of the sales force comments that you were making earlier, are you kind of guiding for 2018 or you planning for 2018 growth to come more from maybe increased utilization from your current accounts or is it increased feet on the street is going to kind of expand territories and drive growth that way? And just one part off of that as well is how long you'll expect it to take for these new reps to become fully productive?

[Mark Augusti:]

The answer to the first part of your question is, yes, it is both of those. We anticipate that we will seek to do better with our existing ConforMIS users and hopefully grow as a percentage share of their surgical value. And then certainly we want to have people. And then to your question part of how long does it take to get people up and running, it's a great question, it's a complex question. If it's somebody who comes over very experienced, takes him some time to get up and running quicker. If it's somebody that we're training, depending on the circumstance it can take longer. One of the things we have done under Dan's leadership is put a particular emphasis on how we onboard sales reps and sales rep training and the modules thereabout. So we have kind of upped our game there with the aim of hopefully making them more effective and productive sooner rather than later.

[Operator:]

Our next question comes from Larry Biegelsen with Wells Fargo.

[Larry Biegelsen:]

I wanted to start with the guidance, the U.S. guidance of mid-single digits to low teens for 2018. In the quarter Q4 was flattish. For the year it was up slightly. What are you assuming for the U.S. that drives that improvement in 2018?

[Paul Weiner:]

There's a couple of things. One, as Mark had mentioned and we've been talking about, we have a couple of headwinds through the first quarter. So, those will anniversary out after the first quarter, so that will help us as far as year-over-year costs. And the other area is, certainly we are looking to, our iTotal PS has been doing well certainly in the United States. We plan on continue to drive that. We plan to stabilize our iTotal CR and base product line as far as the sales are concerned. And we've made all the changes or most of the changes as far as sales management in 2017. So, 2017 during that transition period, it was a difficult year as far as onboarding new surgeons and adding feet on the street as the same time we were changing sales management. So now that that is done, the Company and the sales team are concentrating on, as Mark said, adding feet on the street and onboarding surgeons and penetrate deeper into those accounts. So, I think that our hope is that as 2018 progresses, we should start to see that come to the top line and certainly into 2019 it is our plan.

[Mark Augusti:]

Larry, that's a really good question, if I can just add another comment, the other thing is just continued improvement in our consumer messaging in our direct-to-consumer. You have heard us talk about a pilot program last year. We identified a number of patients. Some had what I would call limited success in converting them to ConforMIS surgeons and really making sure they ,kind of got the whole story. We are rolling out next month an upgrade in our Web-site and the platform technology it's based off of as well as making some investments in that area. So, our goal will be to be able to be more effective and really connecting up patients with surgeons that can give these patients, who are interested in ConforMIS, a ConforMIS technology. As you can imagine, given our market share we're at, there's a lot against these patients as far as trying to get to the right surgeon to get them the technology they want. So, I think we'll do better in 2018 than we did in 2017.

[Larry Biegelsen:]

That's helpful. Just one follow-up on that and one other question, so for stabilizing the base business, should we assume, Paul, that the base business is flat on a year-over-year basis in 2018? I'll just pause there. That's my follow-up. I just had one other after that. So what's the assumption for the base business in that 2018 guidance?

[Paul Weiner:]

In the United States, after the first quarter we would [indiscernible] year-over-year headwinds in the cost, we would expect it to be relatively flat and the base as well really coming from the PS. Internationally we would anticipate still some continued weakness in the base business with growth lift, some limited growth on the PS.

[Larry Biegelsen:]

That's helpful. And then just lastly, Paul, on the raise I think you said net $21 million. Can you talk about why that was the right number? I think you said that gets you through 2019. And just some additional thinking on your capital needs would be appreciated. Thanks for taking the questions guys.

[Paul Weiner:]

It was really a balance between obviously the dilutive transaction as far as the raise was concerned and it was about between getting additional runway and dilution. So, we wanted additional runway, we had enough cash to get through 2018. This additional cash will allow us more time to be able to execute on that top line as well as show continued improvement in the gross margin. So, yes, we would anticipate at some point in time needing to have additional cash, whether it's dilutive or non-dilutive way to raise capital, but we just wanted additional time, if you will, to be able to execute on that top line gross margin before we again do a non-dilutive transaction to raise capital or dilutive transaction. Hopefully what we would again hope would be higher valuations.

[Larry Biegelsen:]

Got it. Thanks for taking the questions guys.

[Operator:]

Our next question comes from Bruce Nudell with SunTrust Robinson Humphrey.

[Bruce Nudell:]

Just to clarify the mid-single-digit to low teens growth in the U.S. next year, is that inclusive of hips, and if it is, to what extent would you expect knee growth to be in the U.S.?

[Paul Weiner:]

So that is inclusive of hip, but the hip is not material to our guidance. So, I would take a look at those numbers as being really the market. Again, our guidance does not include a lot of hip that you would have to be concerned about in your numbers.

[Bruce Nudell:]

Okay. And then just thinking about the sales force adds and that it's principally distributors, traditionally in this industry when people buy another company, there are always dis-synergies because the surgeons go with the distributors. In the sense that you are adding mainly distributors, will they have captive surgeons that will adopt this or is this going to be a piece of their knee businesses that wherein it won't be full conversion but rather partial conversion or people just don't have books of business right now?

[Mark Augusti:]

This is Mark. I appreciate the question. It's a little all over the board. I mean the key, obviously there is a deep connection and relationship that runs through distribution and orthopaedics which anybody who follows the industry appreciates that as they get into the industry dynamics. And it's all different. I mean when we – you look for a bunch of different things in a distributor. Certainly your preference to have somebody that really knows total knee and total hip arthroplasty and understands the technique and the procedure and can usually translate the value proposition of ConforMIS from traditional off-the-shelf systems, and you hope that with that individual there comes some reputational benefits and knowledge and connections in the geography that they are going to cover, and that helps get you the right accessory exposure and opportunity to explain your value proposition. So that's what you look for in an ideal surgeon. I don't know that I would call it captive business but I would call it relationships have the ability to really represent you in a good way, and one of the very frustrating things for the smaller share players like us is due to the non-competes and the other stuff it's very hard to find distributors that meet, kind of check all those boxes. So, a lot of times you find yourselves working with very good distributors, but maybe they don't have quite the experience specifically in knees or hips, they are coming from another part of the business and you train them up and you do that or maybe they move geographies. So they do bring hip and knee experience but they don't have as much of relationships in the new geography. So all those situations exist, and what it presses us to do is to try to support those new agents as best as possible depending on what they need.

[Bruce Nudell:]

I guess, Mark, just one follow-up, like what will you be looking for in 2018 in terms of commercial execution unless you know you're turning the corner and that the clinical outcome story is beginning to resonate where you could begin to gain serious momentum?

[Mark Augusti:]

That's a great question. There's a number of things I'm going to be looking at, but probably the critical ones are, are we meeting our goals to add distribution because we have to do that, that's number one. Number two is, what do the 'same-store sales' look like, do we feel like we're penetrating with surgeons and getting meaningfully increases in their business? Those are really kind of the two big things from that standpoint. And then obviously we'll be laser-focused on new surgeon prospects and how we onboard them in a good way, and we did a little bit of that last year but we're still not at the level that we would like. And then there's a lot of other things that come around to support it, but I do want to mention again this consumer piece, I think if we can do a better job on really helping surgeons, I will tell you that we continue to see really good engagement and marketing ability with helping surgeons build their practices, we continue to just get so many positive stories and stories that are much more persuasive frankly than traditional knee surgery. It's just hard breaking through, but the patients really are seeking this out and we have to continue to do a better job of or a good job of, like I said, helping to convert that interest over to action with a ConforMIS surgeon.

[Operator:]

Our next question comes from Steven Lichtman with Oppenheimer.

[Steven Lichtman:]

Mark, just building on that last point relative to DTC, can you talk a little bit more about what the programs will look like in 2018? I know your Patient Ambassadors has been a big focus to date. What type of DTC are you looking at ahead?

[Mark Augusti:]

So, there's a couple of pieces, Steven. First off, we've had a limited pilot and that was a very modest spend in the new wave of advertising through social media platforms, through engagement around that and getting your message in front of interested and targeted users. Going forward with our new platform we're going to be able to better target those users to serve up to their more tailored messaging information. And frankly, we plan to increase our spend a bit, so that we'll actually increase the number of leads that we get. But beyond that point to your question, Steven, is what are the things we can do to make it easy for that patient to get connected with or get engaged with a ConforMIS surgeon, and we hope to pilot some things around that in 2018 which I'm not prepared to give the specifics on but I'm pretty excited about some of the ideas that we're coming up with, and now it's a question if we can execute with our marketing team and our advisors and consultants that help us kind of put some of these programs in place.

[Steven Lichtman:]

Okay, great. And then, are there additional papers that you expect to get published in 2018, and if not specifically this year, are there key data that you could point us to specifically that are being collected this year that you're building for publication in the future?

[Mark Augusti:]

It's a great question. So, it's a balance doing clinical studies and good clinical work, it has expenses. And so I really thought through 2017 to kind of cone that down to the vital ones and we still have a fair amount. I would argue that for the size of company we are, we really have made a strong commitment to continued support of demonstrating not just clinical evidence, but importantly health economic evidence. There are a number of things. I guess the thing I would point to the most, I can't obviously guarantee publication, I would actually say that it's been, we've had really good research by our clinicians and really good papers put forth and it's a crowded field, and it's remained very frustrating because there's more stuff that I believe should be published that hasn't made it through that peer-reviewed process yet. Having said that, we have some health economic work that we're putting the finishing touches on our manuscript and I would hope to see that certainly in the first half of next year, which will corroborate and confirm my expectation on seeing the manuscript some of the work that was published previously by Dr. Culler in a 248 patient study that came out in June in Arthroplasty Today. So, that to me will be a big deal because that will help us continue to support the value proposition for those institutions that are interested in episode care cost analysis, value based initiatives, and they are participating in those. So, that's a key kind of first half thing. We are going to continue to enroll patients in our comparative study and other studies around that. So, as I said, I can't predict when those things will get published, but we certainly have a number of manuscripts that we expect to submit in the first quarter and actually even in the second quarter, and hope that they'll get published in a timely manner.

[Steven Lichtman:]

Okay, great. And the economic study, was that first half 2018?

[Mark Augusti:]

Yes. Again, I can't guarantee it will get published but it will definitely – again, in Q1 it will get submitted and it will be more in a healthcare finance type publication than a traditional orthopaedic clinical outcomes journal.

[Steven Lichtman:]

Got it. Thanks Mark.

[Operator:]

Our next question comes from Ryan Zimmerman with BTIG.

[Ryan Zimmerman:]

Thanks for squeezing me in. So I just want to talk, follow-up on the sales strategy a little bit here, and has your sales strategy changed? I know you've certainly changed your leadership, but in terms of the C-suite selling and revert of that back to more MD focused selling, if you could just comment kind of on where that headed? You had I think a target of sales force going after the C-suite before. Maybe kind of where that is today?

[Mark Augusti:]

Ryan, just a clarification on that, I think from a C-suite selling and contracting standpoint, as I said early in Q1 or in Q1, we brought in some people that lead that organization, and they have done in my mind a very good job in bringing about some processes and a structure and approach to that. And we actually from that standpoint do a pretty good job in getting access and in responding to pricing proposals and contracts as well as getting the C-suite to the right larger organizations. Now, we now have with the Culler article some other stuff, some more interesting data to support that, and that's helped. And that's where, if you recall, I talked about the market access investment that we've made and it's been helping us to generate the data to support those initiatives as well as this article I just referred to, that's coming out of the work that was done in 2017. So, that continues and that's not a change, that's always been there, and I feel like we're in some respects right ahead of the curve there on the performance metrics. The feet on the street selling is the one that's harder, and for all the issues we've talked about with getting good distribution and what not, and the real change there, as you said, was bringing in Dan in the middle of the year of 2017 to really kind of do a more lasered and professional focus on the selling organization and making the management changes that we needed to make. And fortunately, we need some time to have that play out. We have to demonstrate that we are making those market improvements on a quarter by quarter basis throughout 2018. And I will tell you, we just had a national sales meeting, the teams excited and pumped, and all of us who are part of the ConforMIS family, whether they are direct W-2 employees of some of our very good distribution agents and partners, kind of get it and continue to remain committed to doing this. And we're also very, we're very, very excited as well about the fact that we're going to get the hip out and some additional product innovation, because that's an important part of growth and we didn't talk as much about it in 2017 but you did hear me talk about innovation as one of the imperatives and by nature it takes a little longer, but that's going to be an important part of our growth story going forward. I mean, you guys have to remember, we're as far as I know, and you guys follow the industry just as deeply as I do, we're kind of the largest one product orthopaedic company out there, just me. So, the hip is going to be a nice shot in the arm for us, even though it will be a limited launch and we'll be as material as Paul said in this year but it's such an important growth opportunity for us in 2019 and beyond.

[Ryan Zimmerman:]

Sure. And this is a follow-up to that point, if you can answer it, my next question, but how long do you anticipate the limited launch of the hip? Should we think of that as a six-month data process in beta or should we think of that [indiscernible] maybe into 2019?

[Mark Augusti:]

No, I think it's 12 months and hopefully [indiscernible], it could be as long as 2018, and you'll get from me transparency and we'll talk through that. Hopefully you guys will modulate in your models and stuff. The real key will be how many iterations I have to do, and I should say, we as a team have to do on the patient-specific guides, because part of what we're committed to here is doing the right thing by our surgeons and our patients. We're very excited about what we have but we also recognize the industry has gotten a black eye in the past sometimes by rushing products to market and not having the nest outcomes, let's just say. So, we are innovating with some exciting opportunities here, Ryan, and we think we are on mark, but my experience and my close to 30 year now med device history is that something is going to probably need to be changed in my guides to fine-tune where we're at, that's why you do a limited launch, and the real question is, will it be a minor change and one change or will there be a major change and maybe two tweaks. So, 12 to 18, I'm hoping we can keep it around 12, but you'll hear more from us in the second half of 2018 as we launch. Right now my big thing is to make sure we get into these beta sites and we're able to do those first patients and really get the feedback to figure out where we're at.

[Operator:]

Our next question comes from Josh Jennings with Cowen.

[Joshua Jennings:]

I was hoping to just follow up on the iHip platform and if you could help us just think through in terms of the limited launch, the low-hanging fruit seems to be your current customer base that have adopted ConforMIS iTotal knees, but can you just talk about how you're framing up the opportunity post limited launch and also the value proposition of a customer hip?

[Mark Augusti:]

Let me try to take this in reverse. So, from a value proposition, and again, we'll share more of this at [indiscernible] and certainly can answer more detailed questions, but just kind of high level, we certainly see this very consistent with the ConforMIS brand, and where we're at, we're going to do the preoperative CT scan, we're going to provide a very detailed pre-surgical plan for the physician, we are going to be able to provide a custom stem as well as a custom cup with screw holes around the fixation on the [indiscernible] side, and it is going to be hip in a box. We are going to have a hip in with the implants and patient-specific instruments that you need to do that procedure, in one box and one small instrument tray. So, we're pretty excited about that. The key here, Josh, I think is actually on the patient-specific instrumentation. We are going to have in my estimation the most comprehensive and well thought out set of patient-specific guides that will help the physician really innovate and do that procedure with a lot more confidence and a lot more accuracy than they would historically, beginning with off-the-shelf instruments and off-the-shelf guides. So, we're pretty excited about that, that's a big part of the value proposition. And what I can tell you is we've had really good surgeon interest. So, initially we'll be in our few SAB sites and then what we call our MAB, Medical Advisory Boards, which are those beta sites that are non-designing [indiscernible] and we have had good interest from people that want surgeons specifically that want to get onboard. And I will tell you we are executing clinical agreements, we're executing contracts with their facilities to get in to them and be part of that as we speak, and I've been very pleased with all the efforts around that. So we've got a full core press from the team about operationally to deliver on this. With IT, as you can imagine, giving our ordering systems change in up-running as well as our clinical team, we've already got our clinical study, critical protocol established so we can collect data early on to validate our accuracy, what we're doing, and we've had really great engagements from physicians, the people that are working with us, they are real excited. So, more to come and it's up to us to execute and hit the mark now.

[Joshua Jennings:]

Thanks for that. And just a follow-up just on the pipeline, the iTotal G3 limited launch I think you referred to in the second half of 2019, you gave some detail, I hope you don't mind, if you could just kind of reiterate some of the features in the design evolution, and should we be assuming that you guys can get the order to implant timing down less under six weeks by then or is that you need full vertical integration in the manufacturing process to get there? And then I assume you listen to the physician feedback on the current channel, I guess what's been incorporated in iTotal Gen-3 that you can share? Thanks a lot.

[Mark Augusti:]

Sure. So, I just want to comment on our iUni, and that's a smaller market, but one of the key things in iUni is a couple, so a couple of key things that are needed is our current iUni we don't use a faceted kind of approach on the implant. So you have to kind of scrape cartilage and that's something that has I think prevented it from gaining broader adoption. So, we're going, what we found when we did the iTotal, Josh, is we referenced off the osteophyte and as we can see from our alignment papers, that's highly accurate for us. So, part of what the iUni G3 is going to bring to the table is faceted cuts and we'll reference off the osteophyte. So, people are excited about that. That's the iUni. On the iTotal, we actually have already made some software changes and introduced those going forward. But the big things that I talked about was what you're seeing with our iTotal G3 is actually we're merging our tibial plateau platform so that we don't have two separate tibial components and we can work out similar designs. With that we'll allow new insert options for our CR product, so they can go to a single poly if people want to choose that, as well as we've got some interesting stuff which I don't want to let the cat out of the bag yet, but we're making kind of our next-gen guides, so we were innovating with some new guides for iTotal, which I think are surgeon feedbacks have been really positive about. And also it'll provide cost savings for us as well as clinical advantages, because like anything else, as we've gone through the experience of doing what is now well over 60,000, probably close to 70,000 patients, we're learning more about the process and what we're doing. And then the other thing that we're particularly excited about, which most players in the industry have different tibial stem length options. For surgeons, especially if they have kind of a high BMI patient or they've got some concerns around fixation on the tibial side, so we're going to be able to offer that with our G3 Total launch in late, second half 2019, as I talked about.

[Paul Weiner:]

And Josh, as far as your other question regarding order time, so our order time to surgery, as you said, was six weeks and we actually moved that up to five weeks due to the vertical integration we have done, now that we are manufacturing more in-house. We have already moved from six weeks to five weeks, the time from ward to surgery, and we believe it's possible as we complete the vertical integration towards the latter part of this year or the beginning part of next year, it's plausible to even get down to four weeks. But keep in mind that the average timeframe from order to surgery is eight weeks. So we welded in the period of time that most of the surgeons are booking their OR, [indiscernible] better, but we'll continue to drive that time down as we vertically integrate the manufacturing process.

[Operator:]

Our next question comes from Larry Biegelsen with Wells Fargo.

[Larry Biegelsen:]

Mark, you guys have made really good progress on the gross margin in 2017. I'm just curious how these new products, particularly the hip, might impact the gross margins. I'm just asking because obviously when a company comes out with a new product, sometimes the margins are initially lower. So, is that the case, are you going to be able to kind of continue to make good progress on the gross margins despite coming out with these new products? Thanks for taking the question.

[Mark Augusti:]

Thanks, Larry, and thanks for acknowledging the success we've had in gross margin. I mean, we've got more to go clearly. And yes, all the guidance we've given you both certainly for this year incorporates that hip, but even the aspirational guidance which you heard me mention in the prepared remarks of getting to 60% incorporates the hip in there. So we don't expect the hip in 2019 to be dilutive. It should certainly – we've got it in there where we think, so we have to execute, as well as we have thought through kind of the G3 products both for the Uni and the Total, and like I said, some of the changes we are making are consistent with those gross margin opportunities and also delivering clinical benefit. So, all that's factored in, and again, barring any major dislocation or miss in execution, I feel confident in the aspirational opportunity. And I would say, part of what we are hoping is through continued expense management and hopefully continued overachievement in how we have the gross margin. We'll do better on that cash piece and what not, but we've been I think prudent in the guidance we've given you, but we'll continue to update you on that journey every quarter.

[Operator:]

There are no further questions at this time. I'd like to turn the call back over to our host.

[Mark Augusti:]

Okay. Thanks, operator, that's it, and thanks again for all the questions we had. With that, we'll end the conference call.

[Operator:]

Ladies and gentlemen, that concludes today's presentation. You may now disconnect and have a wonderful day.