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Edited Transcript of CFMS earnings conference call or presentation 30-Oct-19 8:30pm GMT

Q3 2019 Conformis Inc Earnings Call

Bedford Nov 6, 2019 (Thomson StreetEvents) -- Edited Transcript of ConforMIS Inc earnings conference call or presentation Wednesday, October 30, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Mark A. Augusti

Conformis, Inc. - CEO, President & Director

* Paul S. Weiner

Conformis, Inc. - Consultant

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Conference Call Participants

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* Bryan C. Bergin

Cowen and Company, LLC, Research Division - Director

* Samuel Brodovsky

BTIG, LLC - Equity Research Associate

* Steven Michael Lichtman

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

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Presentation

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Operator [1]

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Good afternoon. My name is Jimmy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Conformis Third Quarter 2019 Earnings Conference Call. (Operator Instructions)

Before we begin, I would like to remind you that Conformis' 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 position and results, gross margin, product margin, operating trends, financial guidance, market growth, total revenue and revenue mix by product and geography, the anticipated timing of the limited launch of our hip product offering, the potential impact and advantages of using customized implants, business initiatives and transitions in our commercial operations are based upon current estimates and various assumptions. These statements involve material risks and uncertainties that could cause actual results or events to materially differ from those anticipated or implied by these forward-looking statements, including those discussed in the Risk Factors section of Conformis' public filings with the U.S. 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, October 30, 2019.

I will now turn the call over to Mark Augusti, Conformis' President and Chief Executive Officer. Mark?

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Mark A. Augusti, Conformis, Inc. - CEO, President & Director [2]

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Thank you, Jimmy, and welcome, everyone, to Conformis' Third Quarter 2019 Earnings Conference Call. With me on the call today is Paul Weiner, our previous CFO and now consultant; as well as Fred Driscoll, our Interim CFO.

During the call, we will share prepared remarks on a variety of topics, including our third quarter financial and operating performance. Following the prepared remarks, we look forward to answering your questions.

From a commercial and operating perspective, we had a challenging quarter as we anticipated. Our U.S. business was impacted by Aetna coverage denials among our surgeon user base. Our international commercial performance continued its slow improvement as our overseas investments start to deliver results. Importantly, our expense reduction plans from Q4 2018 continue to produce results as we had our third straight quarter with a significant reduction in expenses versus prior year quarter.

Before Paul goes into further details on the financials, I wanted to highlight a few of the significant events we had in Q3 that I will be commenting on later in the call.

For our Conformis Hip System, we submitted our full commercial launch dossier to the FDA for clearance in this quarter. We successfully launched our Identity total knee into a limited clinical release, we executed a significant strategic development and distribution relationship with Stryker Corporation. We, as I mentioned, hired Fred Driscoll, a seasoned former public company CFO, as our Interim CFO, and engaged with Paul as a consultant to help us through the transition. Both Fred and Paul will help ensure stability while we search for a permanent CFO. And we hired a new Senior Vice President of Sales for our U.S. selling organization.

Let me turn the call over to Paul now for a more detailed financial review.

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Paul S. Weiner, Conformis, Inc. - Consultant [3]

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Thank you, Mark, and thank you all for joining us. We reported third quarter revenue of $17.3 million, representing a decrease of 40% or $11.7 million year-over-year on a reported basis. Excluding the negative impact of changes in foreign currency exchange rates of $64,000, revenue decreased 40% on a constant currency basis.

Revenue in the third quarter of 2019 and in 2018 includes royalty revenue of $191,000 and $10.7 million, respectively, related to patent license agreements. This includes the royalty settlement of $10.5 million in the third quarter of 2018 from Smith & Nephew.

Third quarter product revenue was $17.1 million, representing a decrease of $1.2 million or 7% year-over-year on a reported basis and 6% on a constant currency basis. Sales of iTotal PS increased $286,000 to $6.4 million or 5% year-over-year on a reported and constant currency basis. Sales of iTotal CR, iDuo and iUni declined $1.7 million to $10.3 million or 14% year-over-year on a reported and constant currency basis.

iTotal PS represented approximately 38% of total product revenue in the third quarter of 2019 compared to approximately 33% for the same quarter last year. With the limited launch beginning in the third quarter of 2018, sales of the Conformis Hip System increased $171,000 to $390,000 or 78% year-over-year, which were all in the United States.

U.S. product revenue decreased $1.1 million to $15.1 million or 7% year-over-year. U.S. product revenue was driven by sales of our iTotal PS, which increased 5% year-over-year, offset by a 14% year-over-year decrease in sales of the base business product lines. Third quarter U.S. product revenue represented 88% of total product revenue compared to 89% for the same quarter last year.

Rest of World product revenue was $2 million, a decrease of $93,000 or 5% year-over-year on a reported basis and 1% on a constant currency basis. Rest of World product revenue continued to be affected by reimbursement challenges in Germany.

Turning to a review of our results across the rest of the P&L. Third quarter gross margin was 44% of revenue compared to 68% of revenue for the same quarter last year, a 2,400 basis point decrease. The decrease in gross margin was driven primarily by the $10.5 million royalty settlement, which contributed 1,800 basis points of the decrease and 600 basis points due to lower volumes; an increase in unused product believed to be due, in part, to Aetna insurance coverage denials, resulting in possible delay and subsequent cancellations; and a higher scrap rate, related to design changes of the hip made during the limited launch.

Total operating expenses decreased $11.8 million to $14.5 million or 45% year-over-year. Of this decrease in expenses, $3.2 million was driven primarily by reductions in personnel costs, marketing programs and patent litigation expense as part of a plan announced at the end of 2018 to reduce cash burn in 2019.

Personnel costs in sales and marketing were reduced as a result of the reduction in the number of sales managers, open positions, the conversion of direct reps to independent agents and the reduction of certain marketing programs. Personnel costs in research and development were reduced mainly due to the completion of certain software and product development projects in 2018 and the timing of product development projects in 2019.

The remaining $8.6 million reduction in expense was due to the noncash write-off of $1.9 million of unused manufacturing equipment and a noncash write-off of $6.7 million related to impairment of goodwill, both incurred in the third quarter of 2018.

Net loss was $8.7 million or $0.13 per share compared to net loss of $7.4 million or $0.12 per share for the same period last year. Net loss per share calculations assume weighted average shares outstanding of 64.8 million shares for the third quarter of 2019 compared to 60.2 million shares for the same period last year. Net loss in the third quarter included foreign currency exchange expense of $1.3 million compared to foreign currency exchange expense of $272,000 in the same period last year.

We had cash and cash equivalents and investments totaling $29.4 million as of September 30, 2019, compared to $23.6 million as of December 31, 2018. The cash balance as of September 30, 2019, includes the $14 million we received from the Stryker transaction.

With that, let me turn the call back over to Mark to add additional color.

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Mark A. Augusti, Conformis, Inc. - CEO, President & Director [4]

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Thank you, Paul. Turning towards further comments on meaningful items in the quarter. Aetna has not yet updated their policy. However, we still expect a revised policy to be issued prior to year-end.

As disclosed previously, Fred Driscoll has joined Conformis as our interim CFO. We are very pleased to have Fred on the team to help us through the CFO transition. Over a distinguished career, Fred has 20-plus years of public company chief financial officer experience and roles with small cap public health care companies. Fred's contributions will allow us to take the time we need to recruit best-in-class talent for a full-time CFO position. We have already initiated a search with a leading retained search firm and are actively interviewing candidates.

I'm also pleased to announce that we have hired a new Senior Vice President of Sales for our U.S. sales organization. Eric Rickenbach joins us with over 20 years of experience in orthopedic sales and marketing and is well versed in positioning total joint solutions to surgeons and hospital systems. In his recent role as the General Manager at Stryker, Eric was responsible for a successful branch turnaround, overseeing joint reconstruction, trauma and extremities, he's able to take a poor-performing brand and develop into one of the highest performing. His team was able to achieve significant growth over multiple years.

As we announced on October 1, 2019, we have entered into an innovative and strategic partnership with Stryker. The transaction provides for us to develop, manufacture and sell to Stryker, patient-specific 3D-printed instruments for their Triathlon Knee System. This transaction provides Conformis a meaningful amount of nondilutive financing and the potential for incremental revenue beyond our current product sales over the upcoming years. We also believe this demonstrates the strength of our intellectual property portfolio as well as our technical expertise and clinical performance of our patient-specific cutting guide capabilities.

There were 2 significant milestones to report regarding our new product pipeline. First, we successfully launched our iTotal Identity total knee system. This system represents a significant upgrade to our existing system as it provides new and improved instrumentation, extended tibia stem options for our surgeon customers as well as more poly insert flexibility. It also introduces our new titanium tibia baseplate, which will be the foundation of our Press Fit cementless total knee offering.

Second, regarding our hip system, we have submitted a comprehensive package to the FDA that includes improvements to the system based on feedback from our limited market release. We still anticipate full market release prior to year-end, likely late December. We remain excited about fully launching into the approximate $4 billion U.S. total hip market.

With that, before I close, I'd just like to say a couple of comments. As mentioned, Paul is moving on. I want to personally thank him for the services he's brought to Conformis over the last 5-plus years. He joined us as a private company, helped take the company public and has been a very good member of the executive team here and a good partner for myself personally. So I want to thank Paul and wish him the best of luck in his new endeavors and his personal pursuits.

With that, at this time, I'm happy to take any questions, operator.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Ryan Zimmerman with BTIG.

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Samuel Brodovsky, BTIG, LLC - Equity Research Associate [2]

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It is actually Sam on for Ryan. Just to start out, could you -- just can you characterize the discussions you're having with Aetna? And what gives you confidence that you can see a resolution in the policy before year-end?

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Mark A. Augusti, Conformis, Inc. - CEO, President & Director [3]

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Yes. So as we mentioned last time, they normally update, and we had view from our advisers that they had planned and communicated an update in September. We have had a subsequent update from our advisers, Ryan, in direct discussion with -- excuse me, I'm sorry, Sam, with Aetna that the revision was delayed, and they are now expecting to target prior year-end, hopefully, end of November, early December. I just do want to emphasize again that we don't know what the policy update will be. So we can't obviously make any predictions about that. But we do expect to have an update based on discussions with Aetna, again, through our advisers by year-end. Okay?

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Samuel Brodovsky, BTIG, LLC - Equity Research Associate [4]

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That's helpful. So then on those -- on the denials that you're getting now, how is that impacting your day-to-day sales with physicians? Are you seeing that restricting overall usage at all?

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Mark A. Augusti, Conformis, Inc. - CEO, President & Director [5]

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Yes. Again, it's hard to justify since we don't have clear line of sight directly into that. But based on anecdotal discussions and based on estimates from that, that we've given before on Aetna's market share, it is impacting surgeon usage because they've had to adopt their prescribing patterns, knowing that Aetna is not going to cover our technology. Many of them have indicated they're looking forward to getting this resolved, so they can go back to their normal usage patterns. But that has been an issue. And I think, as Paul talked about in some of the discussion on the financials, we probably saw some onetime hits with canceled surgeries and stuff like that, that we normally wouldn't see from that standpoint. So, yes.

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Paul S. Weiner, Conformis, Inc. - Consultant [6]

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From a numbers standpoint, just a follow-up on what Mark was saying, we believe that Aetna has about 5% of the overall market, and it could be impacting our business anywhere between 5% to as much as even 10%, depending on what the surgeons are -- what is affecting surgeons even more so from a -- within their business. And we'll see that, hopefully, reverse its -- reverse course if Aetna comes out with a positive reversal of their current policy.

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Operator [7]

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And the next question comes from Steven Lichtman with Oppenheimer.

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Steven Michael Lichtman, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [8]

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Just following up on the Stryker agreement. You talked about some of the specific benefits. But I'm wondering how else do you think that this agreement could help Conformis in the marketplace?

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Mark A. Augusti, Conformis, Inc. - CEO, President & Director [9]

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Hold on just -- sorry, I was making sure that we can be broadcast here. So Steve -- so the question, I think I heard you, I just want to rephrase it. How is this potentially going to help Conformis in the marketplace?

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Steven Michael Lichtman, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [10]

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Correct.

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Mark A. Augusti, Conformis, Inc. - CEO, President & Director [11]

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Okay. Well, I mean, look, as I said on the outset, first off, this is a deal for total knees with Stryker. We're very pleased to partner with a large multinational like Stryker, but we hope this -- we can -- we'll look at other areas. And I think, as I said, it validates our IP and it validates our capabilities to get this done and get this done well. The other thing is, is it's based on our jig technology, our knee in a box. And I think it does demonstrates our business model, Steve. Especially as -- at total knee arthroplasty, we're seeing this outpatient increase -- this outpatient trend, and this is what this is really designed to do, is provide a knee in a box.

So as I said and indicated, this provides additional revenue opportunity through the deal, the nature of transaction as we disclosed, 5 to potentially up to 10 years of supply of patient-specific instrumentation. So it's a very good revenue opportunity for us as well.

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Steven Michael Lichtman, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [12]

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Okay. Great. And then you talked about some pipeline progress during the quarter. So can you just lay out for us sort of specifically, as we think about going into '20, the time lines, as you think about the full launch of Hip, Identity and then on cementless? What's sort of the cadence as we should be thinking about it next year?

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Mark A. Augusti, Conformis, Inc. - CEO, President & Director [13]

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Yes. So I think it hasn't changed from what we said before, Steve. We really feel pretty good about that. So again, we should get in here a very short order, the full market release of Conformis Hip. So that's going to be the big driver for us. Certainly, early 2020 it's getting into that. And then we'll see our limited release of Press Fit, first half, middle of the year 2020, probably targeting the femur only. But we're making actually good progress on tibia and patella.

And then Identity, the initial feedback from surgeons has really been excellent. So right now, as we said before, second half of 2020, we'd be looking for the Identity release. So knock on wood, if that goes well, we'll have the opportunity for a little bit of an uptick there at the end of 2020.

So when I think about 2020, we've kind of got 3 catalysts going on. The Hip is clearly the biggest one. Then we'll follow on in the second half with the full release of Identity. But we'll also be -- given that we're a knee company first and just now entering hip, I think our Identity limited launch, we're going to see some faster uptake on that than what we -- than how we kind of titrated the hip.

So there's a catalyst there. And then you've got -- as I said, you've got the Press Fit cementless limited launch in the middle of the year. So we've got 3 significant new product things that we'll be launching in 2020.

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Steven Michael Lichtman, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [14]

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Great. And then just lastly for Paul, and best of luck, Paul. On gross margin, did you break out specifically how much sort of the charges hit gross margin? I know you mentioned it was a combination of that and volumes. And what's your expectations overall for gross margin sort of looking forward here in the near term?

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Paul S. Weiner, Conformis, Inc. - Consultant [15]

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Yes. So the charge related to the scrap piece, which is certainly related to limit of launch of the Hip before going into the full launch, was about $200,000 worth of COGS. The rest is combination, again, potentially related to Aetna and other things, so the canceled cases and lower volumes, a combination of that. So it's hard to put a specific number around each of those things. So that's where that is. And then as far as where we expect to be for the year, we do expect to recover from the 44% that we ended up in Q3 to more, I would say, high 40s to close to 50% level in the fourth quarter based on our current expectations.

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Operator [16]

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And our next question comes from Josh Jennings with Cowen.

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Bryan C. Bergin, Cowen and Company, LLC, Research Division - Director [17]

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This is Bryan here for Josh. I have 2 on the Stryker deal. So first, can you discuss the price you'll receive from Stryker for the PSI that you'll supply? And I guess the follow-on there is, will that price change after year 1 or after the exclusive period? Or is it only the unit volume that's likely to vary, if anything?

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Mark A. Augusti, Conformis, Inc. - CEO, President & Director [18]

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Yes. At this point, we're -- I appreciate the questions. Obviously, as I said, we're very excited about the deal. At this point, as it's a little early and we're not ready to disclose the price, the unit price. I do expect volume to go up and there's expectations around that. Obviously, we're not ready to talk about that yet, either. We're still kind of in the early stages of development and all that stuff.

But look, I think if you think about, which I know people who follow the market do, look at the -- make some assumptions about the growth of the ASC side of care and what could happen and think through the unit volume that could go through there. And I think the desirability of a knee in a box that both we provide today as well as Stryker will be providing with their Triathlon. I think it's going to be a very exciting product offering.

So -- especially when Medicare, as anticipated, though they may not, but it's anticipated they're going to release it to the outpatient schedule. And when that happens, I think demand will increase for a product proposition such as this. So we're certainly anticipating that over the time of this deal, we'll see production units increase.

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Bryan C. Bergin, Cowen and Company, LLC, Research Division - Director [19]

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Okay. Understood. And maybe on the timing side, do you have a time estimate for when you can likely fulfill the requirements relating to the, I guess, final prototype/design freeze that will yield the first milestone?

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Mark A. Augusti, Conformis, Inc. - CEO, President & Director [20]

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So again, we're kind of working through all that. And we kind of aren't ready to disclose anything now on that. But we do provide for timing to work, and we're working closely with Stryker, on kind of anticipated launch dates and whatnot. But I think it's a little early to commit to anything specifically on that. But in conjunction with our partner, we will give more information on that certainly as the progress and the program progresses.

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Paul S. Weiner, Conformis, Inc. - Consultant [21]

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Yes. And Bryan, just as a follow-up, we will be filing or do plan on filing the agreements with our 10-Q. We will anticipate filing, hopefully, on Friday or early next week, but hopefully Friday. And again, in there will be the agreements. Now part of those agreements will be redacted, and then -- but obviously, the unredacted portions, you'll be able to get more details.

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Operator [22]

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And I am showing no further questions in the queue at this time. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.