Conformis Inc (CFMS) 2017 Q3 法說會逐字稿

Good afternoon. My name is Suzanne. I will be your conference operator today. At this time, I would like to welcome everyone to the ConforMIS Third Quarter 2017 Earnings Conference Call. (Operator Instructions)

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 laws, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements contained in this call that are not statements of historical facts should be considered to be forward-looking statements. All forward-looking statements, including, without limitation, statements about ConforMIS' strategy, future operations, future financial positions and results, gross margin, product margin, operating trends, financial guidance, market growth, total revenue and revenue mix by product and geography, the anticipated timing of the limited launch of our hip product offering, the potential impact and advantages of using customized implants, business initiatives and transitions in our commercial operations are based upon current estimates and various assumptions.

These statements involve material risks and uncertainties that could cause actual results or events to materially differ from those anticipated or implied by these forward-looking statements, including those discussed in the Risk Factors section of ConforMIS' public filings with the Securities and Exchange Commission. Accordingly, you should not place undue reliance on these forward-looking statements. While ConforMIS may elect to update these forward-looking statements at some point in the future, ConforMIS disclaims any obligation, except as required by law, to update or revise any financial projections and forward-looking statements, whether because of new information, future events or otherwise. This conference call contains time-sensitive information and is accurate only as of the live broadcast day, November 1, 2017.

I will now turn the call over to Mark Augusti, the company's President and Chief Executive Officer. Mark, please go ahead.

Thank you, Suzanne, and welcome, everyone, to ConforMIS' Third Quarter 2017 Earnings Conference Call. With me on the call today is our CFO, Paul Weiner. During the call, Paul and I will share our prepared remarks on a variety of topics, including our third quarter financial and operating performance. Following the prepared remarks, Paul and I look forward to answering your questions.

We are pleased with our Q3 results. The changes we have made to our U.S. sales organization are beginning to take root and have a positive impact. Our gross margin and operational improvement initiatives are starting to appear in our results, and the actions we took during the third quarter to reduce operating expenses helped us focus on our core business initiatives.

Additionally, in the third quarter, we closed the asset purchase deal with Broad Peak Manufacturing to integrate the bulk of our polishing operations in-house. We announced the publications of more positive clinical data from a comparative study using ConforMIS' technology, and we made good progress on our direct-to-consumer campaign. I will touch on each of these later on the call.

With that, let me turn the call over to Paul for a detailed review of our financial results. Paul?

Thank you, Mark, and thank you all for joining us. We reported third quarter revenue of $18.4 million, representing growth of minus 1.2% or $218,000 year-over-year on a reported basis. Excluding the positive impact of changes in foreign currency exchange rates of $76,000, the company's revenue declined 1.6% on a constant currency basis. Revenue in the third quarter of 2017 and 2016 included royalty revenue of $249,000 and $243,000, respectively, related to patent license agreements.

Third quarter product revenue was $18.2 million, representing growth of minus 1.2% or $224,000 year-over-year on a reported basis and 1.6% on a constant currency basis. Sales in the company's iTotal PS increased $1.2 million to $5.2 million or $0.29 year-over-year on a reported and constant currency basis. Sales of the iTotal CR, iDuo and iUni products declined $1.4 million to $13 million or 9.7% year-over-year on a reported basis and 10.2% on a constant currency basis. These base product lines represented approximately 71% of total product revenue in the third quarter of 2017 compared to approximately 78% of total product revenue for the same quarter last year.

U.S. product revenue increased $573,000 to $15.5 million or 3.8% year-over-year. The increase in U.S. product revenue was driven by strong sales of our iTotal PS product, which increased 30% year-over-year, offset partially by a 5% year-over-year decline in sales of the company's base product -- business product lines. Third quarter U.S. product revenue represented 85% of total product revenue compared to 81% of total product revenue for the same quarter of 2016.

Rest of World product revenue was $2.7 million, a decline of $797,000 or 23.1% year-over-year on a reported basis and 25% on a constant currency basis, which was affected by sales of the base business product lines, including the Germany partial knee reimbursement rate change and weakness in our iTotal CR sales. Third quarter Rest of World product revenue represented 15% of total product revenue compared to 19% of total product revenue in the same quarter of 2016.

Turning to a review of our results across the rest of the P&L. Third quarter gross margin was 40% of revenue compared to 32% of revenue last year, an 800 basis point increase. The increase in gross margin year-over-year was driven primarily by cost reductions as a result of vertical integration and manufacturing efficiencies. Gross margin improvement has been a point of emphasis, and we are now starting to see the positive impact from the hard work that has gone into the cost-reduction programs that we are executing. As of the end of 2016, we in-sourced all of our iTotal CR and PS metal tibial trays. Earlier this year, we began manufacturing all of our polyethylene inserts for iTotal CR and are now pleased to report that we are producing internally 100% of these poly inserts. Our plans to complete the vertical integration of iTotal PS polys the beginning of next year remain on track.

We continue to make significant progress with the development of new processes for the 3D printing of our patient-specific iJigs, resulting in print cycle time reductions and lower powder utilization. We believe this will reduce our capital outlays for 3D nylon printers for the remainder of 2017 and even more so next year.

Our multiyear plan to offshore some of our CAD design work as well as our continued improvements in design software and CAD automation should provide additional gross margin expansion. In short, we are experiencing substantial progress in our cost-reduction programs, which we believe will yield continued gross margin improvement.

Third quarter operating expenses increased $1.3 million to $20.2 million or 7% year-over-year. The increase in operating expenses was driven primarily by higher general and administrative costs due to a charge related to an impairment of a fixed asset and severance payments, partially offset by lower sales and marketing costs due to a decrease in personnel costs. Net loss was $12.5 million or $0.29 per share compared to $12.8 million or $0.31 per share for the same period last year.

With that, I'll turn the call back to Mark for more color.

Thanks, Paul. As I mentioned on prior calls, we're focused on 4 strategic priorities here at ConforMIS: commercial execution, gross margin improvement, innovation and talent management.

On commercial execution, as anticipated, Rest of World revenue declined to mask the step-forward on U.S. commercial performance. U.S. product revenue of $15.5 million, constituting 3.8% growth over the prior year, this was a good result for us during this year of U.S. commercial transition. We continue our focus on sales execution, direct-to-consumer marketing programs and expanding our clinical and health economic results. As noted during our call last quarter, we have a new Senior Vice President of U.S. Sales. Under his leadership, we are focused on additional distribution, improved account targeting, sales force assessment and training to increase the effectiveness of our sales force. I have confidence that we're making the right changes and believe that we'll improve our sales execution.

For our marketing team, consumer awareness is a key area of focus. Our Patient Ambassador Program has been helping to increase patient awareness and educate patients on the benefits of our technology, while our Track My Implant program is allowing us to communicate directly with patients prior to the surgery, both of which helps patients make informed decisions with respect to their care. Also, we have initiated an investment in a direct-to-consumer pilot program to drive patient interest in our products. These are key components of our commercial strategy.

Adding to our library of study results, we reported in Q3 the publication of a study evaluating knee strength and mechanics that compared healthy control patients to those with either a modern off-the-shelf total knee replacement or our customized bicompartmental knee replacement. In this study published in International Orthopaedics in September of 2017, the authors concluded that "customized bicompartmental knee replacement patients exhibit better strength and mechanics while performing activities of daily living." Statistically significant results were seen in a number of key areas. For example, the off-the-shelf TKR group walked significantly slower when compared to both our customized bicompartmental knee replacement as well as the healthy controls. ConforMIS did provide financial support for this study. Though the customized bicompartmental knee replacement is only a small segment of this market, this publication contributes in a positive manner to the overall growing body of evidence supporting patient-specific implants versus the less-tailored off-the-shelf knees.

I am also pleased to report that we completed enrollment of our iTotal PS retrospective study, which looks at 2-year follow-up reported outcomes of 100 ConforMIS patients. We expect to submit the results of this study for publication over the coming months.

As Paul already detailed, our gross margin improvement and -- excuse me, improved by 800 basis points over the prior year, which is a result of our recent in-sourcing and cost-reduction initiatives. In addition to these gains, we continue to build our internal infrastructure with an eye toward increasing operational capability and efficiency. For example, in August, we acquired substantially all of the assets associated with the polishing of our femoral components from Broad Peak Manufacturing, which had provided polishing services to ConforMIS femoral component manufacturing since 2014. This acquisition represents an important step in enhancing the manufacturing of our customized knee implants by integrating Broad Peak's proven and innovative manufacturing operation directly into our operations. We expect that this will further reduce costs, improve gross margin and add additional manufacturing expertise, which we intend to leverage as part of our larger plan to continually improve our manufacturing operations and gross margin. Further, we were able to hold the line on our expenses in the third quarter. Backing out onetime expense for a charge related to an impairment of a fixed asset and severance payments, we were roughly flat versus prior year.

Commenting briefly on innovation. We continue to work on the next generation of iUni and iTotal knees. And in addition, of course, our iTotal hip program is a major focus for us and is currently on track. I've been pleased by the surge in engagement and interaction with the company around the development and commercialization of these new product programs.

We have a great team here at ConforMIS, as I've said in the past. We consider ourselves agents of change in the field of orthopedics and are committed to producing the best total knee system available. We have passion in our belief that everyone should have access to our technology, and everyone should have the ability to make a choice that leads to better outcomes and satisfactions.

Thank you very much. With that, I'll turn it back over to Suzanne, and we'll be happy to take calls.

(Operator Instructions) And our first question comes from the line of Larry Biegelsen of Wells Fargo.

It's actually Adam Maeder on for Larry. I guess first, one on the strategic side. At our healthcare conference back in September, you seemed to be interested in finding a strategic partner to help you better penetrate the market. Can you talk about where you are in those discussions? Would you expect to announce in 2018 exactly what you're looking for in a partner? And I had one quick follow-up.

Adam, actually, I think that's a little bit of a mischaracterization. I had been asked the question by Larry, would we be willing to talk to a strategic partner, and the answer, of course, is yes. As I answered there, we're open to various ideas. But that's not currently a strategic priority for us, as I outlined in my 4 priorities before. So there's nothing, obviously, that I'm going to comment on at this point. There's certainly nothing to suggest in the progress, okay?

Okay, understood. And then just a quick follow-up on weather -- I didn't hear anything in the prepared remarks, so I guess could you just comment on the impact you saw on Q3?

Impact related to what, sorry?

To weather?

Oh, from the hurricanes?

Yes.

Yes. So from our analysis, we calculate that there's about a $200,000 to $250,000 impact related to the hurricanes in Q3. And from our analysis, we come up with about the same amount for Q4 that we would expect, about a $200,000 to $250,000 impact.

And your next question comes from the line of Mr. Bruce Nudell of SunTrust Robinson.

This is Matt on for Bruce. I guess just the first question. You showed nice performance improvement in the U.S. in the quarter. I just wondered if you could give us a little more color on what attributed to that, especially -- specifically, you mentioned on the last call some issues with scans perhaps being denied or putting a dent in demand. Anything there, or with the sales force that specifically contributed to improving growth in the third quarter?

Sure. Just to clarify, was that Matt did I hear?

Yes.

All right. Okay, great. Welcome. Yes, so this is Mark. So first, thanks for the question. And on the scans, some of the CT scans, we did experience a comparable headwind in Q3 to what we experienced in Q2 and were able to achieve the result in spite of that. And I think that goes to continued efforts around that to working with payers. And as I've indicated previously, it's going to continue to be a headwind through, at least, the rest of the year, but we've baked that in, and we continue to attack it. I think the other results were a factor around the slow but steady improvements we're making in our U.S. commercialization strategy under the leadership of our new SVP of Sales, Dan Krupp. We've already started making some of those changes. We have brought in some new management. As indicated before, we still have to look to add feet on the street and are aggressively looking to do that. But we're doing that with a very thoughtful and programmatic methodology to that. So I've indicated before that the transition is kind of a 4- to 6-quarter thing. It's always tough in orthopedics, and we're about halfway through it. So this is a positive step forward, a baby step, but a positive step forward.

Got it. Just overall, I think results were a little better than we thought in the third quarter. You maintained guidance, which looks like it implies a step-down in growth in the fourth quarter. Is anything there that we should be thinking about that maybe gets a little bit worse or harder?

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

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

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

Yes. No, as you've mentioned, Brandon, and welcome, we don't give those numbers. We are making headway but not where we want to be on the actual feet on the street. It's just not enough yet. We've got to do more, but like I said, we want to make sure we get quality adds. I will say that we do have, I believe, net adds from a management standpoint, and we made the management changes that we wanted to make, and that's been very positive. So if you recall, not only the additions around national accounts, around direct-to-consumer, around the AVPs, but we've also done a nice job with our regional sales managers, or what we're calling regional sales directors. I feel good we've put the management infrastructure to have quality control over the process, but we're still not where we want to be as far as total feet on the street.

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

Yes. That's a great question. And again, it's small, but we have had the headwinds in our German business, as we talked about. But the distributorship in the U.K. is going exceedingly well. We've got more feet on the street from that acquisition. And on unit volume, they're up, so obviously, with the conversion to distributor from direct, there's some different accounting things there. But from just the actual unit volume in surgeries, we saw nice growth. We're actually excited in the fourth quarter. We're preparing for a user group meeting. We've got a nice 1.5 day session and then really looking forward to that. So I'm very pleased with what our distributors have done there, and we have a couple other international markets around the docket that we're looking to enter into in 2018. So I'm excited. It's small steps internationally, but we're moving in the right direction, except for this, obviously, this headwind on the reimbursement, which we've obviously talked about in the past. So thanks for the question because we're very pleased with the U.K. performance. Anything else?

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

So I just want to -- a lot of questions have been asked already, but I just want to talk about the cadence of gross margin gains that you picked up this quarter and then kind of your thoughts going out into '18. Paul, do you still look at yourselves as kind of exiting this year in the mid- to high 30% range for the year? And then how should we think about you gross margin cadence into FY '18?

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

Great. I appreciate the color on that. And then, Mark, if you could just remind us -- you said that the iTotal Hip was on track. But just kind of remind us around the timing and kind of where you're thinking in terms of commercialization for the iTotal Hip at this stage. That'd be great.

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

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