Conformis, Inc.
Q3 2018 Earnings Call Transcript

Published: 1 Nov 2018

[Operator:]

Good afternoon. My name is Heather. I will be your conference operator today. At this time, I would like to welcome everyone to the ConforMIS Third Quarter 2018 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 the management will make statements during this call that include forward-looking statements within the meaning of 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 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, product 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 alert 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, October 31, 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' third quarter 2018 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. From a commercial perspective as noted last quarter, we continue to face headwinds in our OUS business, primarily reimbursement related challenges in Germany. Our U.S. growth performance of 5%, a general improvement over previous quarters were outlined with our expectations. Fortunately, we had a very good performance in many other aspects of our business. In the third quarter, we were able to successfully settle our patent disputes with Smith & Nephew resulting in a large one time royalty revenue, increase of $10.5. Our Conformis hip system continues to progress in limited launch. We now over ten surgeons have performed implantations with our hip. The surgeons are very pleased with the product and provided valuable feedback for our use and moving forward towards a full commercial launch anticipated next year. In addition over the last few months, we have had additional positive peer-reviewed clinical results published on our implants, which contribute to the growing value of evidence for the benefits of our technology. In a study of iView implant which allows surgeons to preserve both the ACL and the PCL, while treating arthritic compartments of the knee, result should high survivorship out to five years and a satisfaction rate above 90% with patients who received this Cruciate Retaining knee. In addition, we continue to see positive results for iTotal CR. In a recently published peer-reviewed study data from 360 patients at nine different centers demonstrated low post-operative manipulation rates, high knee, society knee and functional scores and high level of patient satisfaction at one year. Importantly, an average of just under two years, survivorship was at 99.2% adding another data point to our existing data from the U.K. National Joint Registry which is those similar lower using rates to this co-work. Finally, once again, we were able to demonstrate good operational results in both our gross margin and expense management. Let me now turn the call over to Paul for more detailed financial review. Paul.

[Paul Weiner:]

Thank you, Mark, and thank you all for joining us. We've reported third quarter revenue of $29 million, representing an increase of 57% or $10.6 million year-over-year on a reported basis. Excluding the positive impact of changes in foreign currency exchange rates of $10,000, revenue increased 57% on a consequence currency basis. Revenue in the third quarter of 2018 and 2017 includes royalty revenue of $10.7 million and $249,000 respectively related to the patent license agreements. Royalty revenue in the third quarter of 2018 includes of Smith & Nephew royalty settlement of $10.5 million. Third quarter product revenue was $18.3 million, represent an increase of $157,000 or 1% year-over-year on a reported and constant currency basis. Sales of iTotal PS includes $804,000 to $6.1 million or 15% year-over-year on a reported and constant currency basis. Sales of the iTotal CR, iDuo and iUni declined $867,000 to $12 million or 7% year-over-year on a reported and constant currency basis. iTotal PS represented approximately 33% of total product revenue in the third quarter a 2018 compared to approximately 29% for the same quarter last year. With the limited launch beginning in the third quarter, Conformis hip system sales were $219,000. U.S. product revenue increased $753,000 to $16.3 million or 5% year-over-year. U.S. product revenue was driven by sales of our iTotal PS, which increased 17% year-over-year, offset by a 3% year-over-year decrease in sales of the base business product lines. Third quarter U.S. product revenue represented 89% of total product revenue compared to 85% for the same quarter last year. Rest of World product revenue was $2.1 million, a decline of $596,000 or 22% year-over-year on a reported basis and 22% on a constant currency basis. Rest of World product revenue was affected primarily by sales of the base business product line, including reimbursement challenges in Germany. Turning to a review of our results across the rest of the P&L. Third quarter gross margin was 68% of revenue compared to 40% of revenue last year, a 2,800 basis point increase. The increase in gross margin year-over-year includes the $10.5 million royalty settlement. Without the royalty settlement, the gross margin would be been 50%. Excluding the royalty settlement, the 1,000 basis point gross margin improvement was driven by cost reductions as a result of vertical integration, manufacturing efficiencies and material cost decreases. Gross margin improvement has been a point of emphasis and we continue to see the positive impact from the hard work that has gone into the cost reduction programs. Total operating expenses increased $6 million to $26.2 million or 30% year-over-year. The increase in expenses was driven primarily by an increase in general and administrative expense, due to a non-cash write-off of $1.9 million unused manufacturing equipment and an non-cash right-off of $6.7 million related to an impairment of goodwill due to the company's market capitalization cash flow position. This is partially offset by $2.8 million of reductions in in patent litigation expense, business insurance expense, personnel costs and other administrative expenses. Net loss was $7.4 million or $0.12 compared to net loss of $12.5 million or $0.29 per share for the same period last year. Net loss for basic share calculations assume weighted average basic shares outstanding of $60.2 million for the third quarter of 2018 compared to $43.5 million for the same period last year. Net loss in the third quarter included foreign exchange expense of $272,000 compared to foreign currency exchange income of $1.1 million in the same period last year. As of September 30, 2018, we had cash and cash equivalents and investments totaling $36.9 compared to $45.2 million as of December 31, 2017 and $46.6 million as of June 30, 2018. The $10.5 million related to the royalty settlement is not included in cash at the end of the third quarter 2018 as it was received in October. Turning to discussion of the update to our 2018 financial guidance, which we introduced in this afternoon's press release. For the full year 2018, the company expects total revenue in the range of $88.6 to $89.1 million. Excluding the $10.5 million royalty settlement, the company expects revenue total revenue in the range of $78.1 million to $78.6 million. This is updated from previous guidance in a range of $79.6 to $83.6 million. The company's 2018 guidance assumes the following. Product revenue in the range of $77.5 million to $78 million compared to previous guidance in the range of $79 million to $83 million. Royalty revenue of approximately $11.1 million including the $10.5 million royalty settlement. This is updated from previous guidance of approximately $600,000 related to ongoing patent license royalty payments. Excluding the $10.5 million royalty settlement, we believed we will finish the year ahead of our total gross margin guidance to 44% to 46% and well ahead of our 2017 gross margin of 37%. With our hip system remaining and limited launch through the first half of 2019 and a transition to full commercial launch targeted sometime in the second half of 2019, we will be revealing our guidance policy. In the meantime, directionally we are thinking that year-over-year total product revenue growth in 2019 will be in the 5% range. With that let me turn the call back over to Mark.

[Mark Augusti:]

Thank you, Paul. Early in my tenure, I announced that we will have four imperatives at ConforMIS, namely commercial execution, gross margin improvement, innovation and investment in our people. As you can see in the third quarter, we had positive performances in many of these areas from financial metrics such as gross margin expense management and other areas such as clinical evidence publication and patent litigation resolution. However, as mentioned earlier, our commercial performance in Q3 did not meet our expectations. The anticipated U.S. headwinds, we expected better performance in the U.S. As a result, we have lower slightly our full year guidance. I mentioned in previous commentary that while we have seen some quarterly improvement in U.S. revenue future, quarterly growth performance may not result in straight line year-over-year improvement. However, given the commercial investments we've made in sales, I believe we should be seeing better growth than we are realizing. As such I mean a change in our sales leadership. As of last week, U.S. sales is reporting directly to me while we search for a new SVP of Sales. This change will allow me to work even closer with the sales leadership team to ensure that we have good alignment with marking to help support each and every representative in the field and thereby drive revenue growth. To be fair, we have made good progress in certain U.S. commercial activities, including our national account contracting, direct to consumer activities and our market access programs. That said, our commercial performance on a regional basis has varied with some geographic regions delivering double digit percentage growth but also with a few delivering offsetting declining growth. I believe we should have better consistency in performance among our geographies which is led to my decision to make a change in sales leadership. Turning to gross margin improvement. We've previously detailed much of our gross margin activity. Our performance in this area in Q3 was excellent given that we had to turn on new operating processes in order to support our limited hip launch. In addition, I believe our expense control performance in Q3 demonstrates our ability to manage expenses going forward at a material lower rate as we mentioned last quarter. As for innovation, our next generation iTotal G3 knee replacement as well as our [indiscernible] \program continue to make progress. Our early results from limited hip launch, while identifying a number of areas need of improvement and give us confidence at this point that we should be able to achieve full commercial launch in the latter half of 2019. That's all the comments I have for now. I look forward to answering any questions you may have about our Q3 results and then even announcements we have made today. Thank you. And with that I'll turn it back over the operator. Thank you. [Operator Instructions] And your first question comes from Bruce Nudell with SunTrust. Your line is open.

[Bruce Nudell:]

Hi Paul. You know clearly the unexpected headwinds of the U.S. are going to be problematic for investors and you know just given the toughness of the market and as offset by you know some very unique technology, have you explored the idea of like a co-marketing agreement with the majors to kind of provide a proof of concept or is that just an outlandish idea?

[Mark Augusti:]

Hello, Bruce, this is Mark. I'll take that question. I've been asked similar questions that before and I respond as I have. You know from the moment I got here, I remain open to those types of discussions. And you know I would explore them. There's no doubt that you know well I feel we've done well given our limited product portfolio to take 2% of the overall primary sharing and if you back out not having a press fit, it's actually a larger share than that. There's no doubt that the big players the incumbents have really great market power from training centers to the big luminaries and great distribution sales forces. So that's a long answer to say yes and it's the same answer, I've given for a while that I'm open to those types of opportunities. But you know as of today we have nothing further to announce on that.

[Bruce Nudell:]

And just give some more color on the disparity between kind of high performing regions and you know low performing regions, what's the difference, I mean what elements are missing in the regions that are not successful and what's the formula in the regions that are successful?

[Mark Augusti:]

Well, it's multi-factorial, but you know there's a few things out just kind of contribute to. The other day distribution really matters and then distribution experience that can execute on the playbook around targeting surgeons and really being able to grow the business. That being said, I mean some of the regions there's sometimes it's just unlock, I mean we have - we get buffeted by things that affect us in a more bigger way when we lose surgeons to the various regions health reasons and retirements and stuff like that, I feel like that hurts us more than frankly any type of competitive losses. But it is a disparity Bruce, I mean we have a number of regions that actually do quite well. But then we have a couple areas where from a geographic standpoint whether it be insurance, contracting changes, pricing, access to the reference sites that are regional reference side, it's been a challenge to get out of and starting to get there. So those are ones we have to get more aggressive on frankly.

[Bruce Nudell:]

And I guess this is a follow-up. Are those underperforming regions just structurally kind of impossible or would greater adherence to a proven playbook make those - could make those region successful as well?

[Mark Augusti:]

No, I don't think they are structurally impossible, they may be structurally more challenging, but not impossible. At the end of the day our clinical evidence shows the technology's good, we do get part, I mean the biggest impediment to you know it's a challenging market is getting really good distribution that doesn't have non-competes issues and what not. And frankly conformist Bruce is you know has been a little bit handicapped by being a one product company to really go get that next level of distributor and that's why as I've mentioned on previous calls, we're excited about our hip product, because once we get that the full market launch, now we have the ability I think the more aggressively be able to find that next level of distributor. And that's frankly speaking probably some of the stuff that will help us get into some of the areas that are tractable. And it's a limited set I can tell you because we roughly sell going forward we sell it like ten regions. And I can actually tell you it's only two or three that are the ones that we need kind of a renewed focus on. The rest of them are all positive net contributors some of them being actually very, very good net contributors. So I know this is operational and every company has this but when you're dealing at the revenue levels that we're at these really do exacerbate themselves.

[Bruce Nudell:]

Thanks so much.

[Operator:]

Thank you. Your next question comes from Larry Biegelsen with Wells Fargo. Your line is open.

[Larry Biegelsen:]

Hey, guys. Thanks for taking the question. I'm sorry jumping between calls I apologize if this was asked. But Paul, any color commentary on 2019, I think the streets modeling about 12% I mean at this point, it seems a little aggressive, it's that fair?

[Paul Weiner:]

Yeah, so yeah, since you miss that commentary, basically I gave direction on main part of this call. They were thinking year-over-year total product revenue growth for next year somewhere in the range of about 5%. So yes you're right on in line with our thinking.

[Larry Biegelsen:]

But okay. And then on the hip market, I did hear your comments earlier about 10 surgeons used it. Could you talk about kind of what you've learned and how confident you are in a second half of 2019 launch and if you feel like you need to make any changes to the hip before you launch and then I'll drop it off with you guys offline?

[Paul Weiner:]

Yeah, no so as comment and I'll put a little more color on that. We feel really good about where we are I've had a number of people that have a longer history with conformance to myself but I have suggested we are kind of much farther along place than say we were when we did our first parcel and our first total knee. Having said that, I will tell you hip presents different challenges and the bar is really high as far as it should be because we've done frankly such a good job on a knee that the expectations for making sure this surgical technique is just really dialed in is important to us. And I'm kind of trying to approach this with a religious fervor that would make Steve Jobs so to speak proud. I really wanted to be right. And so, what I would tell you Larry is we're got a few - more than a few things that need to be fixed but they're tiny things that are not going to require invention, they're just going require work that has to get done. There's a couple things where we have some really good ideas for even further improvement and we have to balance our ability that to get that in and get that approved from a regulatory standpoint and make some decision about approve the launch. So I'm pretty confident, we're going to hit second half of the year again nothing certain in this slide, but I'm pretty confident around that. The thing that I have to balance is what that final package looks like and the trade off in time and also our ability to ramp that up. So there's some little few moving pieces there. But I can tell you we're bringing the most comprehensive set of guidance jigs to the market, we're dialed in the femur, I feel really good about what we're doing. We have some work to do to make it a little easier to use, but when it's used, it works. There's no doubt that we're giving surgeons more information than we have in the past. So I'm really - I'm actually really pleased about the opportunity we have with us on this.

[Larry Biegelsen:]

Thanks for taking the questions.

[Operator:]

Thank you. Your next question comes from Robert Marcus with JP Morgan. Your line is open.

[Allen Gong:]

Hi, this is actually Alan on for Robby. So I guess I just had my first question it was just about [Technical Difficulty]

[Mark Augusti:]

Are we back? Who's that?

[Allen Gong:]

Yeah, this is Alan on for Robby. Can you hear me?

[Mark Augusti:]

Yeah, Alan, thank you. This is Mark. Maybe we lost you or something went down on our end, I don't know if that happened on year-end. So could you repeat the question?

[Allen Gong:]

Yeah just on the new like what you're looking for in your new SVP of Sales, what kind of qualification that you're going to be looking for and what kind of impact would you really want this and you hired to have and like first six to twelve months of hire and beyond that?

[Mark Augusti:]

Yeah, look these are challenging jobs. I think first and foremost [Technical Difficulty] in our capacity and can bring kind of a level of energy and passion that I think is commensurate with the opportunity we have ahead of us. So there's a lot to us and it's a great question. I'm not going to be in a rush to do this. I will tell you that this news is less than two weeks old and we've already had some inbound calls, so I think it shows there's still interest. But I want to make sure obviously that we get this right from that standpoint, so that's why I said I'm taking the opportunity. I love the two AVPs that we have. I like the region line up that we rolled out and now we've got a kind of work with a different level of energy especially going forward in what [Technical Difficulty] So it sounds like we're getting some feedback operator. If you hear, the call keeps dropping in and out, I'm not sure. So we'll try to shoulder on as we can, but I want to apologize to those of you on the call, we're having the same technical difficulty. Operator?

[Operator:]

Yeah, I'm here. I apologize.

[Mark Augusti:]

Okay. Who's next?

[Operator:]

Your next question comes from Josh Jennings with Cowen. Your line is open.

[Josh Jennings:]

Hi, Mark and Paul. Thanks for taking the questions. I was hoping to start off on the U.S. business and just maybe get an update on just with this departure sales leadership, just the bulling on of more sales reps in the quarter, I think you had 20% net ads in 2Q, if there's any update you can provide there?

[Mark Augusti:]

Yeah, so first off, look I know and rightly, so should be a lot of focus on this. I mean in about itself you know the 5% given where the market necessarily horrible is a little under where we would have liked to have been and certainly I think from that space is, my bigger concern is just around some of these problem areas and the energy going forward in the drag. So I think, I hope there's an acknowledgment that we're trying to get ahead of this from that standpoint. To just directly answer your question, we did indicate that we have 20% additional growth and we were a little shy of that. At the end of Q3, I want to say we're kind of in the 15% to 17% range but we start that as a target and team still keeps working to find quality representation.

[Josh Jennings:]

So you would thinking about, I mean there is always attrition in addition but was there net attrition in Q3 and was that - did that impacted the results in the quarter in the U.S.?

[Mark Augusti:]

I'll let Paul answer that.

[Paul Weiner:]

There's a little bit of a attrition you are talking a couple of percent from where we were looking to grow but no I would say that it wouldn't have any track impact on it related to the ads and if it's does take a while for them to get really productive. So I want to check any changes in the sales force of having a fact on our top line in the third quarter.

[Mark Augusti:]

That's exactly what I was going to say, more of issue of just some other changes in dynamics from that standpoint.

[Josh Jennings:]

Understood. And just want to ask about the 2019 kind of targets that you're setting. Can you help us just break that down a little bit just in terms of U.S. versus international growth and just any outlook to some terms of how much a hip can add to the revenue growth as well?

[Paul Weiner:]

Yeah, well we might be able to give you a little flavor for U.S. I guess and I don't want to get too deep into it Josh and I appreciate it, I mean this is the earliest we've ever signal. But one of the challenges we have obviously is trying to help you guys model off the hip and how we think about hip. And you know, this quarter it was only about 200,000, the next quarter it's going to be a little bigger in we don't want to get into arguments about materiality and stuff. And but it is - it is little bit of challenge for us for management standpoint because we don't know exactly when we're going to turn the full commercial launch on. I don't want to be in a position where I feel like I have to do something ahead of time, I really want to get this right and it's going to introduce a lot of variability in there. And then like I said part of the challenge the reason I mean it changes the go forward in the U.S. knee growth around some of these like the previous questions comment about these retractable or structurally challenging geographies we have and how we can change some of that so.

[Mark Augusti:]

Yeah, so again directionally since we not given guidance for 2019, I want to be clear about that but as far as directionally our thinking around the 5%, one, you have to does include hip but really that revenue relates to the limited logic because even if we hit our target in the second half of 2019 related to the full commercial launch, it still takes a while for on-board surgeons and penetrate their accounts such that it is anything meaningful on the top line. So again if we're successful in hitting our second half target and depending on when we hit it in the second half, we wouldn't expect the top line really to be positively affected by the full commercial launch until the beginning of first half of 2020. As far as directionally on U.S. versus O-U.S., if we're talking about 5% overall, we're talking a little bit above that 5% in the U.S. and we're probably talking continued negative grow O-U.S. is Germany had the biggest part of our O-U.S. business while we continue to add on other countries and resolve the reimbursement issue in Germany.

[Josh Jennings:]

Great. And that's helpful. And then it just lastly, I know you guys have ramped up to decree direct patient outreach, social media programs et cetera. Any update in terms of the progress there or how you're tracking it and whether or not you're you feel like you're having some incremental success as we're moving through this year? Thanks for take the questions.

[Mark Augusti:]

Yeah no Josh, that's right. So we're getting a much better putting the analytics behind that. I think just being very candid the - in the test marketing that we've done, one, there's been really, actually good feedback that suggests that we're moving the needle, another one, it's kind of still questionable for us. And when I look personally at the difference of those market I feel like the one success mark we have more of a concentration of conformist surgeons that really liked the technology and on our locator and really espouse the patient marketing from that standpoint, the digital marketing. The other is the little more sparse. So I think it's harder, work for us to get the patients to that. So there's a learning there that we're kind of processing to put into our 2019 plans, around that spend. But we continue to do that and that's part of our efforts.

[Josh Jennings:]

Great. Thank you.

[Operator:]

Thank you. Your next question comes from Kyle Rose of Canaccord. Your line is open.

[Kyle Rose:]

Great. Thank you very much. Do you hear me, all right?

[Mark Augusti:]

Yeah, Kyle, it's Mark. We hear you good.

[Kyle Rose:]

So I just want to kind of build on –some of Josh's questions about the commercial business in the reps you were talking about hiring this year. I mean just help us understand, is it taking longer than you expected for them to become productive. I guess I'm just trying to really understand the dynamics of what's slowing down the U.S. business or seemingly slowing the momentum that we were seeing in some of the previous quarters?

[Mark Augusti:]

Yeah, that's harder thing to tease out. I think there is some of that. But like I said I think there's really just kind of a miss in the couple geographies around the funnel and execute the right surgeons and making sure that on boarding process goes well. So it's if you got to - I don't think - I don't believe that it's about the ads which I believe as being asked about before. There is a question of getting them kind of up and productive and that does take a while. But I feel like we've got some programs in there and we're not going to win every one, but we've done well we just continue to struggle in a couple of areas where through some surgeon departures and some distribution challenges that - that's kind of a hard hardest thing is to rebuild of that.

[Kyle Rose:]

Okay. And then Paul, when you put together guidance or not guidance, your directional thoughts on what 2019 looks like. Can you just kind of help us understand I mean I think the comment that as far as the U.S. and O-U.S. thoughts there but it just, when I think about hip potentially growing off of these levels even if it is small, it seems to imply a bit of your continued slowdown in the U.S. business in 2019, I guess it might interpret appropriately because at the same time you've got your hires and this year it's become more productive you've got some of the previous marketing and national accounts initiatives that should become increasingly productive, and then you'll be a potentially bring on your new leadership to hopefully turn around some of the commercial issues. I guess just what's included in that 5% and how much of that is still conservatism verses this is our first shot?

[Paul Weiner:]

Yeah, so I mean you're talking about primarily U.S. keep in mind, the O-U.S. business, we are looking for are one thing as far as reimbursement issue, we know that they are the partial issue which we thought we would anniversary out of this year which we did. But then bigger issue came in with this group called MBK, we talked about this last quarter, pushing back on this higher investment that do get when they put in our customized implant. So that affected even a larger part of our business this year and is expected to continue into next year. .We are working on ways to resolve that issue but we certainly can't count on resolving it at this point time. So we do expect those headwinds to continue into next year. As far as the U.S. is concerned, we do have higher growth rates in these numbers in the United States then we've had in 2018. So we are looking for step-up in 2019 over 2018, it's just too early at this point in time to say to be able to activate that productivity of the new reps and from the new surgeon onboarding programs to determine when that growth rate will get to that next level. And like as I said regarding the hip, as far as the revenue we expect from the hip whether we do the full commercial launch or not in the second half of the year, the revenue will be coming for the limited launch and the commercial launch won't be a positively impacting our revenue, we wouldn't envision until the first half of 2020.

[Kyle Rose:]

Okay. Thank you for taking the questions.

[Operator:]

Thank you. Your next question comes from Steven Lichtman with Oppenheimer. Your line is open.

[Steven Lichtman:]

Thank you. Hi, guys. I'm just want to follow-up on Germany and what's your line of side in terms of stabilization there, when does this issue anniversary and what other types of initiatives you working on to help improve the situation, I know what the last quarter you talked about bringing on a some new personnel in Germany, internationally to help that?

[Mark Augusti:]

Yeah. So well that's different, that's the person, that's actually been helping grow slightly businesses outside of Germany. In Germany, there's really two specific things and this is just a challenge. This is - first is on the parcel which we've already anniversary out, it was a big issue, it was significant issue, it cost us $3 million to $3.5 million in revenue headwind for the better part of 2017, going into 2018. The issue is the strategy that we put in place when this happened to work through certain surgeons in Germany and to work with reimbursed by we're going to know in Q4, if that was successful because the issue there new guidelines going forward. So we will have more information when we do our Q4 announcement but where we are today, it's just an uncertainty we don't know. And if something doesn't change, then we clearly won't be partial business coming back from the table. On the MDK issue which is the total business, what we've done is working with various customers we've put in place a proactive strategy where we can give them templates of their patients, need to justify a conformist personalized me versus an off-the-shelf me. And then use that proactively to hopefully defend against these reimbursement denials which are what's affecting our business. It's too early in that process to know how successful we are, so it's hard for us to gauge where that is and that is the challenge but hopefully through Q4, as we get more experience with understanding where that stands, we'll see the willingness of customers that have historically been supportive of conformists to continue to work with us.

[Paul Weiner:]

And Steve, just to follow-up on quarterly question you asked about, when do we anniversary out. So as Mark said, we anniversary it out as we talked about before regarding the partial implant after first quarter. With the total implant collaborator isn't necessarily an anniversary date, because there is impacting negatively on our revenues and until we resolve this issue, it could potentially continue to negatively impact our revenues that much more as the pushback continues regarded from this MBK reinvestment group. So there's no specific anniversary day for the totals, we our working on different strategies to alleviate these issues and hopefully turn this around, but it's still too early to tell when that might happen.

[Steven Lichtman:]

Got it. Thanks. And then Paul on gross margin you have the benefits that were seeing here year-over-year and can you remind us what are the primary initiatives that have driven that and what are sort of the next wave of things that you're working on to continue to expand gross margin looking ahead?

[Paul Weiner:]

Yeah, without getting to the specific details on our part-by-part basis, the vertical integration is a big thing, we've been doing that for a while; we are still in that mode as far as some of the final components vertically integrating that into our manufacturing this year. For instance, the poly search for PS were done, we're working on the partial inserts and a few other items that were vertically integrated into our process which will help drive the cost out and even decrease the time that it takes to deliver implant we might be able to deliver implants even faster than we have in the past. So those are some of the main areas on the vertical integration and then the other area is just really lean manufacturing through our plan, we have dedicated resources working slowly on leaning out the facility and that also driving the cost down so those of the couple of the main initiatives.

[Steven Lichtman:]

Got it. Thanks, guys.

[Paul Weiner:]

Thanks.

[Operator:]

Thank you. Your next question comes from Ryan Zimmerman with BTIG. Your line is open.

[Ryan Zimmerman:]

Alright, happy Halloween. So just to begin. Paul - excuse me, not Paul, Mark just hearing your commentary around taking your time to find a new head of sales, you're going to dedicate a lot of time I suspect to at this role. And what is it you feel that you can do differently from what we've seen multiple previous Head at sales and given your other responsibilities I mean can you dedicate the time necessary to work with the distributors and the sales force at two inch level as they say?

[Mark Augusti:]

That's a great question, Ryan. And it if you'd ask me that, when I first started here, I would have said absolutely not because of the level of detail to be involved in some of the operational things. But because we're actually got the gross margin progressing, I've got such a good team I think in place on the inside operational as well as of course the great contributions of our CFO. I feel like I can actually try to turn even more attention and I'm going to have to by that. And look I'm not trying to suggest that I personally and going to be answer to the issues, but I do feel good about them so the AVPs I have in place, have a good relation firmly know the business. I don't think it takes a lot to summarize that you know I would have liked the outcome of the first person that I got to choose to for the Chair, I don't know about all the people before I form the company lot around that. But I go back to one of the questions earlier, there is an energy level, amount of travel needs to be evolved some other things. And I'm hoping that it won't take a lot of time but I'm also really - I just I want to be - I want to get the right person that's a fit for the company and where we're at and really can support. The company is getting more complicated with the launch of hip that we don't spend a lot of time around this, but in our knee we don't need any physician approval. On the hip just like other companies with their PSI work, there needs to be a feedback with the physicians and approval. As Paul said so that process a little difference and we need to be thoughtful about how we train reps and physicians around that. We've got to build out the hip capability if you will, the talk now you've got, a lot of things that go with this. And so there's just a lot of coordination and alignment with marketing and energy around kind of what the expectation setting for the field. And I feel I can bring some of that by nature of the office if you well. And I feel comfortable that will be able to answer the question about leadership sooner rather than later. But I just I guess I just want to make the comment that I don't feel reactionary. I guess my point is thought disappointed, I really like all the other positive stuff that's going on with the company. I really like what the hip up to have. I like what certain geographies are doing and what all the other stuff. So I don't want to be overly reactionary, I want to really dig deep and get the right fit for the role.

[Ryan Zimmerman:]

Okay. I appreciate the color there. And then you did manage your expenses better this quarter than I think we're staying in last few quarters. And so help me understand or help investor understand kind of what you are pulling back on in your expense management and what that may pull back on going forward, just given the expense management you do need to do on the P&L?

[Paul Weiner:]

Yeah, so as we talked about last quarter, we came together with a plan to really start reducing our operating spending starting 2019. We weren't necessarily focused on 2018 as who are working on completing some projects before the end of this year, so we didn't think we would be successful in starting to decrease those expenses this year. We did obviously which we at Q3, we were successful actually starting to pull back into those expenses already. So that relate to litigation expense and reducing that. So we are seeing that positive impact related to the settlement of the Smith & Nephew royalty litigation. We are already starting to see that in the third quarter and we continue to see that in the fourth quarter as well as continuing to look future quarters. As I said in the call, we were able to negotiate some lower rates and expected such as insurance in other areas that are already starting to take. So we're starting to see a positive impact, but really we're looking for step-up from that starting 2019 as far as even further expense reductions to materially decrease our cash burn.

[Ryan Zimmerman:]

Okay, thank you guys for the questions.

[Operator:]

Thank you. And this concludes our question-and-answer session as well as today's conference. We thank you so much for your participation and you may now disconnect. Everyone have a wonderful day.