ConforMIS' (CFMS) CEO Philipp Lang on Q2 2016 Results - Earnings Call Transcript

| About: ConforMIS (CFMS)

ConforMIS, Inc. (NASDAQ:CFMS)

Q2 2016 Earnings Conference Call

August 08, 2016 4:30 PM ET

Executives

Philipp Lang – President and Chief Executive Officer

Paul Weiner – Chief Financial Officer

Analysts

Andrew Hanover – JPMorgan

Kristen Stewart – Deutsche Bank

Larry Biegelsen – Wells Fargo

Kyle Rose – Canaccord Genuity

Steven Lichtman – Oppenheimer

Operator

Good afternoon. My name is Latoya and I will be the operator today. At this time, I would like to welcome everyone to the ConforMIS Second Quarter 2016 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 forward-looking statements during this call 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 fact 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, market growth, total revenue and revenue mix by product and geographies, gross margins, operating trends, the potential impact and advantages of using customized implants, the results of the broad commercial launch of iTotal PS, the progress and results of clinical studies, the company’s targeted regional commercial strategy, price - and results of the company’s product and the impact of the company’s voluntary recall, are based upon current estimates and various assumptions. These statements involve material risk and uncertainties that could cause actual results or events to materially differ from those anticipated or implied by the forward-looking statements, including those discussed in the Risk Factors section of the 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 the 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, August 08, 2016.

I will now turn the call over to Philipp Lang, the company’s President and Chief Executive Officer. Philipp?

Philipp Lang

Thank you, Latoya and thank you all for attending this call today. Joining me on the call this good afternoon is Paul Weiner, our Chief Financial Officer. There have been many developments at ConforMIS since our last earnings call, on which we will update you now. Let me start out by defining a short agenda for today’s call. I will provide you with a brief overview of our Q2 financial results; Paul will give a detailed financial review of the second quarter along with an outlook on the remainder of the year and an update on our 2016 revenue guidance.

I will then update you on our overall commercial progress, our progress at iTotal PS which we find very exciting, the progress made with our C-suite selling approach and pricing strategy, our progress with hospitals that will participate in the Medicare Comprehensive Care for Joint Replacement bundling program or CJR, about which we’re equally excited, a snapshot of upcoming clinical and economic data releases as well as operational progress that will help us in the second half of 2016 and going forward. We will then open the call for questions.

We posted product revenue of $19.1 million in the second quarter of 2016, representing growth of 21% year-over-year on a reported and constant currency basis, and exceeding the high-end of our guidance expectations which we provided on our first quarter earnings report. This positive result led us to increase the low-end of our 2016 revenue guidance. Notably, U.S. product revenue increased 27% year-over-year. We are also extremely pleased with the progress made with iTotal PS during the first full quarter of full commercial launch in Q2 of 2016. While early in the full commercial launch of iTotal PS, we reported more than 450% growth year-over-year in Q2. We are very encouraged by the strong results in just the first quarter following our full commercialization of this exciting implant.

With this brief introduction, let me turn the call over to Paul for a detailed financial review.

Paul Weiner

Thank you, Philipp. Total revenue for the second quarter of 2016 increased $100,000 million to $19.3 million, or 1% year-over-year on a reported basis, and no change on a constant currency basis. Total revenue in the second quarter of 2016 includes royalty revenue of $200,000 as compared to $3.5 million in the second quarter of 2015. The second quarter of 2015 included back-owed royalty related to lump-sum payments received upon the signing of non-exclusive worldwide license agreements in connection with the settlement of patent litigation. Second quarter product revenue increased $3.3 million to $19.1 million, or 21% year-over-year on a reported and constant currency basis. U.S. product revenue increased $3.2 million to $15 million, or 27% year-over-year; Rest of the World product revenue increased $200,000 to $4.1 million, or 4% year-over-year on a reported basis and 3% on a constant currency basis.

As detailed in our press release this afternoon, second quarter product revenue from sales of our base products the iTotal CR, iDuo and iUni increased $600,000 to $15.7 million, or 4% year-over-year on a reported and constant currency basis. Second quarter product revenue from sales of iTotal PS which we launched on a limited basis in February 2015 and initiated a full commercial launch in March of this year increased $2.8 million to $3.4 million or 456% year-over-year on a reported and constant currency basis. Second quarter U.S. product revenue represented 79% of total product revenue compared to 75% of total product revenue in the same quarter of 2015. Second quarter Rest of the World product revenue represented 21% of product revenue compared to 25% of total product revenue in the same quarter of 2015.

Turning to review of our results across the rest of the P&L. Second quarter gross margin was 31% of total revenue, compared to 41% of total revenue in the same quarter of 2015. The decrease in gross margin compared to the prior year was caused by gross margin related royalty revenue of $200,000 in the second quarter of 2016 as compared to $3.5 million in the second quarter of 2015. Gross margin excluding royalty revenue was 30% of the product revenue in the second quarter of 2016 compared to 28% of product revenue in the second quarter of 2015. As indicated in our press release this afternoon, we have reclassified cost related to unused products as a result of cancelled cases into our cost of revenue line which was previously included in our selling and marketing expense line.

Historically, we have treated these costs as sales and marketing expense and accounted for them accordingly each quarter. Following the recent analysis, we have reclassified these expenses into cost of revenue. Importantly, these reclassifications did not have any impact on loss from operations, net loss or cash flow. We have provided a detailed reconciliation of these reclassifications between cost of revenue and selling and marketing expense. The reconciliation includes figures for the quarterly period from 2014 to the second quarter of 2016 to aid in modeling these P&L line items under the new change in presentation and is available in the supplemental presentation on our Investor Relations page. Historically, the cost of our unused product is a result of cancelled orders has averaged approximately 4% of product revenue with modest volatility in this item on a quarter-to-quarter basis over time.

Returning to the discussion of our Q2 gross margin performance; the cost of unused product as a result of cancelled orders were $1.2 million and $1.6 million for the three and six months ended June 30, 2016 respectively compared to $700,000 and $1.2 million for the three and six months ended June 30, 2015 respectively. Excluding the impact of the reclassification of unused product cost in the second quarters of 2016 and 2015, the company’s product gross margins increased 420 basis points. Second quarter operating expenses increased $1.4 million to $20.1 million or 8% year-over-year. Sales and marketing expense accounted for substantially all of that increase, the majority of which came from increases in commissions as a result of the increase in product revenue and other sales support related expenses.

Net loss was $14.1 million or $0.34 per share, compared to $10.9 million or $2.51 per share for the same period last year. The increase in net loss as compared to the prior year was primarily caused by net income related to royalty revenue. The change in net loss per share as compared to last year was impacted by an increase in our weighted average shares outstanding, specifically the fully diluted weighted average shares outstanding for EPS purposes increased to 41.3 million shares in the second quarter of 2016, from 12.3 million shares in the second quarter of 2015. The increase in shares relates to issuance of shares in our initial public offering, and the conversion of outstanding shares to preferred stock into shares of common stock upon the closing of the IPO.

Turning to a discussion of the update to our 2016 financial guidance which we introduced this afternoon in the press release. For the full year 2016, the company now expects total revenue in the range of $77 million to $81 million from previous guidance in the range of $76 million to $81 million. The company’s 2016 revenue guidance assumes the following; product revenue in the range of $76 million to $80 million compared to previous guidance in the range of $75 million to $80 million. Royalty revenue guidance of approximately $800,000 related to ongoing patent license royalty payment has not changed.

Our revenue guidance assumes the following; we increased the low-end of the range by $1 million to reflect the Q2 revenue results which exceeded our second quarter guidance range; continued adoption of iTotal PS over the balance of the year; measured improvements of our base business in the second half of 2016. There were two factors why we beat the midpoint of our Q2 guidance and the beat the higher end of the guidance range. We converted more orders into surgeries in Q2 and therefore revenue than we have been averaging in the past few quarters. Our ASPs[ph] in the second quarter were also higher than we have been averaging in the past few quarters. You can account on these two positive factors continue into the third quarter and that is why even though we do not expect a decline in orders, it is possible to see a decline in revenue sequentially from Q2 to Q3.

With that, I’ll turn the call back to Philipp.

Philipp Lang

Thank you, Paul for that detailed financial update. We are excited about the progress made in Q2 2016 and we were pleased that Q2 revenue beat the high end of our guidance. The second quarter showed progressive recoveries with sequential improvement in our base business of partial knee and iTotal CR. Clearly, we are not back yet to the growth rate in our base business that we have see in 2015 prior to the disruption caused by the recall. However, the recovery in the existing - accounts is underway. We anticipate that Q3 will be affected by the summer month due to many of our surgeons taking time off. Nonetheless, we are confident that we will see a continuation of that recovery trend in Q4 in particular given some of the other developments that we will be discussing shortly on this call.

We’re extremely pleased with the market acceptance of iTotal PS in its first complete quarter following broad commercial launch. This innovative new product approximately triples the addressable market for ConforMIS. We’re equally excited about several important business catalysts that will help ConforMIS in the second half of 2016 and going forward. Our C-suite sales team has made tremendous in-roads with the economic value proposition offered by our ConforMIS technology by leveraging our compelling single package delivery model for partial and total knee replacement and by demonstrating the potential economic benefits of our technology to the hospital.

As our clinical data is demonstrating, the economic benefits are real and include among other shorter surgical time for the surgeons potential savings and OR setup and TAT on time for the OR staff which together offer the potential for additional surgeries in a day. Potential additional economic benefits for the hospital include shorter length of stay and reduction in adverse event rates. This was corroborated in a previously presented direct compared economic study for which we have provided financial support which show that patients in the iTotal CR study arm 5.5 times more likely to be discharged to home rather than rehab or other secured care facility than patients in the off-the-shelf implant arm.

Patients in the iTotal CR study arm of 4.4 times are more likely not to experience an adverse event during the initial hospitalization and they were 2.5 times more likely not to experience an adverse event up to 90 days post-discharge than patients in the off-the-shelf arm. Our C-suite sales team used this data in negotiating new contracts and contract renewals through 2015 and the first half of 2016. Since we instituted our new pricing strategy at the beginning of 2015, our average contracted price from new contracts and importantly contract renewal have consistently been above our historical average contracted prices. While we will take time to build volume in these accounts, this progress corroborates our success leveraging the economic valuable position of ConforMIS technology. This progressive increase in average contracted price is a remarkable achievement in an industry that has experienced progressive downward pressure on implant prices in the low single digits. And proud to see continued favorable pricing trends for ConforMIS in contrast with the pricing headwinds reported by industry peers.

Now what about the Medicare Comprehensive Care for Joint Replacement bundling program or CJR? The Comprehensive Care for Joint Replacement model was launched by CMS in the second half of 2015 and became effective on April 1, 2016. It is an exciting new development which we believe will help ConforMIS expand its commercial footprint due to the economic value proposition of our technology. CJR applied bundled payment and quality measurement for an episode of care associated with knee and hip replacement to encourage hospitals, physicians and post-acute care providers to work together to improve the quality and coordination of care from the initial hospitalization through recovery. Economic savings resulting from better outcome are the key objectives of this program.

In the CJR model, hospitals are held accountable for costs related to adverse event rates during the 90-day episode of care as well as costs related to post-acute care for example in rehabilitation centers or skilled nursing facilities. These objectives are directly aligned with the value proposition of our implant system. ConforMIS is well positioned to address these goals of production and cost related to adverse event rates and post-acute care as seen in the economic studies directly comparing economic outcomes in our total CR patients versus off-the-shelf patients.

The economic value proposition of ConforMIS technology for hospitals is corroborated by the fact that ConforMIS has established signed vendor agreements in 45% of the hospitals across the United States that participate in the CJR program. This is a notable achievement for a company our size which provides further testament to the economic value proposition of our technology. In many of these hospitals, we were able to establish agreements prior to accessing their broad faculty of orthopedic surgeons which will be the focus of our sales force in the coming quarters and years as we leverage the opportunity created by the Medicare CJR program. In short, this is a wonderful growth opportunity.

We expect that this progress will be further supported with introduction of more clinical and economic data directly comparing our customized implant systems with leading off-the-shelf implants. For example, at the 2016 3rd Annual Pan Pacific Orthopedic Congress which will be held from August 10 to August 13 in new independent investigator initiative study will be presented which was not funded from ConforMIS. The study compares clinical outcomes including length of stay and discharge destination such as to home or rehabilitation facilities for comparable cohorts of patients who received an iTotal CR and patients who received the leading brand of the shelf implant. The full data will be released after the 3rd Annual Pan Pacific Orthopedic Congress in August 15, 2016.

In addition, an update on our STEP Study will be provided. The study is directly comparing functional outcomes measured by blinded operators in patients who received a ConforMIS iTotal CR implant, the patients who received leading off-the-shelf brand implants. The study now has more than 740 patients completed which exceeds the 500 that we had originally planned. We believe these studies some supported by ConforMIS and some independent investigator initiative will help us maintain and expand our progress with our pricing strategy in average contracted price. We also expect that these studies will be the key drivers for recruiting knee surgeons and for increasing account penetration.

Let’s take a moment to discuss our operational progress. While our iJig manufacturing process has been 100% vertically integrated for some time, through 2015 most of our implant component manufacturing was outsourced. This is expected for a company our size. However, it means that ConforMIS does high material cost with our vendors limiting our gross margin expansion. We have made significant progress with the implementation of our vertical integration strategy in the first half of 2016. We are confident that our in-sourcing of metal tibial for iTotal CR and iTotal PS will be fully deployed by the end of 2016. Moreover, our in-sourcing plans for polyethylene inserts of iTotal CR scheduled to take effect in early 2017. We expect that the two combined will yield a significant growth margin improvement in 2017.

We have also made significant progress with the development of new processes of the 3D printing of our patient’s specific iJigs using 3D add-on[ph] printers. These programs are focused on 3D print cycle time reduction and powder utilization optimization which we believe will translate into additional gross margin improvement as well as enhanced utilization of our existing fleet of 3D printers in 2017. We believe this will reduce our capital outlays for 3D printers in 2017 and onward. If made additional progress with our software programs and CAD automation which we believe will yield further gross margin expansion in 2016 and 2017. In this context, we received three U.S. FDA 510(k) clearances for new software versions providing more automation for the design of iTotal CR and iTotal PS in 2016 so far.

We are also preparing for off-shoring some of our CAD work in 2017 and 2018 which will provide additional growth margin expansion to do reductions in labor cost. Last but not least, volume had increased over – the third driver of growth margin expansion strategy in addition to reductions in material cost and labor cost. We believe volume and increased over-absorption will continue to contribute to growth margin expansion over the next several years. In short, we are seeing steady progress in operational programs which we believe will yield progressive improvements in gross margin in the second half of 2016 and through 2017.

Let me summarize this as follows; first, year-over-year product revenue beat our guidance in the second quarter of 2016. This positive result is among the reasons why we’re increasing the lower end of our guidance for 2016. Second, Q2 of 2016 was the first quarter of full commercial launch of iTotal PS. iTotal PS revenues exceeded our expectations. Third, since we instituted our new product pricing strategy at the beginning of 2015, our average contracted price for new contracts and contract renewals have consistently been above our historical average contracted prices. Fourth, leveraging the economic value proposition of ConforMIS technology, ConforMIS has an established vendor agreement now in 45% of the hospitals across the United States to participate in the new Medicare Comprehensive Care for Joint Replacement model, CJR. Fifth, we believe this progress will be further supported by data from two studies that will be presented in mid-August of 2016 3rd Annual Pan Pacific Orthopedic Congress. This data will include a new independent investigator initiative, clinical and economic study and an update on the steps comparing blinded functional outcomes in more than 740 patients completed. Last, our operational improvements are progressing favorably and we believe these will result in progressive gross margin expansion for the remainder of 2016 and in 2017. I’m personally thrilled about this progress.

Operator, let us please go ahead and open the line for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. The first question is from Michael Weinstein of JPMorgan. Your line is open.

Andrew Hanover

Thanks for taking our question. This is actually Andrew Hanover in for Mike. I wanted to start just by focusing on the surgeon front for a second and one, did you see surgeons coming back and placing orders again in a more incremental way? And two, just wanted to confirm whether or not you’re gaining surgeons, lost surgeons in the quarter?

Philipp Lang

All of the above. So when you think what’s happening in our business specifically the base business, not all of our customers are back to their pre-recall level. However, we continue to make progress and we believe we will see a progressive recovery in our base business in Q4 and particular given all the new clinical and economic data that will be forthcoming and this should help us with the existing customers as well as new customer acquisition.

Andrew Hanover

And then in terms of the C-suite sales team, how large is that? And then, were the higher ASPs in the quarters is that because of contracts you had in place prior to quarter or those that you add in the quarter, may be some more clarity around that? And thanks for taking our question.

Philipp Lang

So I’ll take the first part of the question related to the C-suite sales team, I’ll let Paul answer on the ASP. The group is actually a very small group of four people which again is commensurate with the company our size. And you can imagine in this context, it’s all the more remarkable what they have achieved with the CJR program. As I said, 45% of hospitals are contracted now who are in the CJR, that’s quite remarkable and again, it’s all driven by our economic value proposition. And if you think through this now, we have a lot of contracts now available and pricing available in these hospitals but we’ve barely touched on the available surgeon population in these hospitals. So that’s the growth opportunity that we’ll be going after in the next 12 months.

Paul Weiner

Yeah and as far as second part of your question regarding the higher ASPs in the quarter, it’s not necessarily related to the higher contract pricing we’ve had as of late through starting in 2015. It is possible that some of it relates to that. But on a quarter-to-quarter basis, there is some variability in our average selling prices for the quarter depending on the mix of customers, hospitals that are ordering from us in that particular quarter. So we have seen different ASPs in a quarterly basis, this second quarter happened on a higher side. But I would say it’s probably more to order mix than it is from the recent higher contract pricing over the last 18 months.

Operator

Thank you. And the next question comes from Kristen Stewart of Deutsche Bank. Your line is open.

Kristen Stewart

Hi, thanks for taking the question. Just wondering Philipp, if you could comment on the CEO search and any progress that you guys are making there?

Philipp Lang

Sure. The CEO search quest is continuing. As we said on the Q1 earnings call, as the Board and I collectively move forward with the search for potential candidates, we’re searching for the best qualified person for the job. I plan to remain CEO until that candidate assumes the role. The intent is that we identify someone who is highly experienced, who will bring deep commercial expertise and a high growth environment to ConforMIS and who will help us strengthen the team and accelerate the growth – so the search is ongoing and we are interviewing candidates.

Kristen Stewart

And so, no sense of timeframe I guess, I assume, since you’re interviewing seems like you have a good set of candidates at this stage?

Philipp Lang

We had a good set of candidates, we are not in a rush because again we are looking for someone really highly qualified, it is a high growth business and we would clearly like it to be higher growth and that said, I think it’s really important that we find the right candidate.

Kristen Stewart

Okay, perfect. And then would you guys mind commenting on the I guess the run rate that you’re seeing in terms of orders coming in and just the timeline from getting the CT scan and then to being able to fill the orders. Where has that gone over the last quarter and just the level of visibility going into 3Q and just confirming that it really does look like seasonal trends with the quarter expectation being sequentially flat? Just to clarify, is that with the base business or just kind of overall? Flat to down I guess.

Philipp Lang

Let me answer that last part of the question first. In terms of, I mean what we see every year in the summer month, specifically July and August, surgeons are taking time off. They are not in their practice and to the extent that they are not operating, it affects all product lines. So base business, PS etcetera. And so generally during that period, we’re somewhat flattish and I think we’ll see that reflected in Q3 and that’s nothing new on that front. With regard to the first part of your question, the timeline from the order to the surgery, there is always some minor fluctuation but it hasn’t -- Paul do you want to weigh in?

Paul Weiner

Yeah I mean from the time that we’ve received an order to the time the surgery takes place, we recognize revenue is generally around two months, that does fluctuate somewhat. And as I said in my comments, in the second quarter, we’re able to convert a higher percentage of these leading orders if you will, in Q2. So timing wise, that could affect Q3. So there’s a couple of things to look at, one, it’s the summer month of Q3; two, higher conversion rate in Q2 which could affect Q3 and then the third part is like I said the higher average selling prices in Q2 that can’t necessarily count on in Q3, but it’s too early to tell where our ASPs are going to fall for Q3.

Philipp Lang

If you think for the sequence part of your question, Kristen, from Q1 to Q2 we saw nice progress as it pertains to sequential scan and order rates. Going into Q3 now clearly we’ll see the impact of the summer month with some flattishness and then clearly for us, looking at Q4, the focus is towards progressive recovery. If the recovery is modest as you’ve seen it so far, the results will point to the midpoint of our updated guidance.

Kristen Stewart

Okay. Perfect. I’ll jump back in the queue. Thanks guys.

Operator

Thank you. The next question is from Larry Biegelsen of Wells Fargo. Your line is now open.

Unidentified Analyst

Hi guys. It’s Craig on for Larry. I wanted to start with the base business and just to clarify in Q2, I want to make sure it’s a normalized number, there is no residual effects from anything from the recall, there is no eight weeks moving down to six weeks. Paul I know you called out some orders or some surgeries happened before – the timing of the surgery in the orders. But I just want to make sure that the base business in Q2 is a “normalized” number.

Paul Weiner

Yes it is as far as the orders coming in and us filling the orders, yes, I would say that minimal impact, positive impact if any related to the recall and rescheduled cases most of those were covered in Q4. There were some additional ones like you said in Q1, we also had the reduction lead time from eight weeks to six weeks which positively affected Q1. When you take those numbers out of Q1 which we did not have those positive effects in Q2, you’d see that the order rate going sequentially from Q1 to Q2 did pick up. And the only unusual item that I would say or different items that I talked about as far as the higher conversion rate of orders and the higher ASPs and the norm.

Unidentified Analyst

Okay, great. That’s helpful. And if I could stick with the base business, I appreciate the comments on moderate growth for the rest of the year and looking at the run rate in Q4 being pretty strong. If I look at 2017 consensus revenue, it looks like consensus is expecting 30% growth in 2017. So, I guess my question is going from moderate growth in the base business and obviously strong early adoption of the PS, is that 30% realistic goal and how should we think about the breakdown PS and the base business in 2017?

Paul Weiner

Well it’s too early for us to be talking about 2017, and certainly we haven’t given you revenue guidance for 2017. But looking forward, we would look at breaking it out like you had as far as the base business and the continued improvement in our base business. Again, too early to comment on where that’s going to be in 2017 and then where the growth area is certainly beyond that would be adoption of iTotal PS which was introduced in February of 2015 on a limited basis. The full commercial launch was in March of this year. We should start to really see the positive effect of that full commercial launch in the second half of this year and mostly towards the backend as we get into Q4. And then, we would look for that trend to continue into 2017 on surgeons that we are adding for the PS in 2016.

Unidentified Analyst

Okay. And if I could just squeeze in one more on gross margin, just given some of the comments there and even the reclassification, I mean is mid-60s I know that was – had been a goal gross margin target, I wanted to know if that’s still realistic target? And then just with some of the vertical integration and some of the other things that Philipp mentioned, what’s the cadence of the gross margin improvement over the next several years, how should we think about that? Thanks.

Paul Weiner

Yeah, so that’s certainly an area that we do have quite a bit good visibility over, where we have a lot of projects that we are working on, in the manufacturing facility as far as driving the efficiency there. And a lot of the implementation of that we expect to see in the second half of this year as well as certainly into 2017, and then we have some longer term projects like the expansion of CAD off-shore which is really 2017-2018 improvement. But these should be marketable improvements through those years, I know that we had, as you had said, talked about the mid-60s as far as our target over the next let’s say few years, three four years or so for gross margin. We still have a target for gross margins in mid-60s, we’d like to see in the mid-60s but our plan now certainly is to get into at least the low-60s if not higher than that over that period of time.

Unidentified Analyst

Okay, great. Thanks for taking the questions.

Operator

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

Kyle Rose

Great. Thank you very much for taking the questions. Can you hear me alright?

Philipp Lang

Yes.

Kyle Rose

I just had one question on the dynamics in the Q2 and wanted to talk about the PS for a little bit here. So in the Q2 you mentioned higher ASPs and your conversion rate, just any sense of how much that may have contributed to the Q2 growth? I mean ASPs up mid-single digits, they were up 10%, and then when you think about the conversion, if you did pull some cases forward into the Q2 from the Q3, I mean how material do you think that was and just any aspect from a normalized basis in the Q2 would be helpful there.

Philipp Lang

So to give you some direction here without going through all the numbers, when we had our May 12 call, we updated our guide for the year. We also gave guidance for the second quarter and second quarter at that point in time, we had visibility into the orders that we were receiving but not the ASP or the conversion rate into surgeries to recognize the revenue. So you could take a look at where we were thinking we’re going for Q2 and the difference between I would say our guidance in Q2 really ended up was not due to an increase in orders because we had that visibility, it’s more tied to the increase in ASPs and conversion rate for the second quarter.

Kyle Rose

Thank you very much. I appreciate that incremental color that’s helpful. Obviously you’re making very strong progress in the PS launch. Just wondered if you could give us a little more granularity or feedback there, just kind of talk about how that utilization, what the physician and doctors look like there? I mean are these surgeons that are trying one to two cases and then following the patients for two months and then you expect to see a hockey stick of utilization after you get six months or one year follow up on those patients or is this steady thorough utilization from the existing physician based there?

Philipp Lang

Kyle it’s a little early to answer that question because we’re really in the first quarter of full commercial launch. So I would hold comment on the question with the hockey stick etcetera, if I just look at the data that we have, Q2, we know that the product really exceeded all expectations. And I think there’s three reason for that; the first is the product, it’s a fantastic product but we’re getting consistently back from the surgeons if they are amazed how well this is performing after the – first few surgeries. And that gets us to surgeon on-boarding the second aspect, surgeon on-boarding and conversion and then subsequent to that we have no data today, penetration into those accounts except we have all of those data related to CR, where we see progressive penetration over the first half four quarters after we started a new account.

So what we are hearing back is that the surgical technique is very simple, it’s very – not like your traditional office with PS system. And when a surgeon experiences that during the first two cases, I think it’s very straightforward to convert these new surgeon customers and to convince them of the benefits of our technology. Now the third aspect is something that our sales force and our medical education team has done really, really well. We intentionally target high volume surgeons for iTotal PS. And I can say that the surgeons that have been added now iTotal PS surgeon base is tracking significantly higher in the reported [indiscernible] from the available databases for example, Medicare databases, attracting significantly higher than our CR surgeons. So those three things combined, that’s really what – product on-boarding, surgical technique and targeting of surgeons, those three things combined I think are the key determinants of why we have such a good Q2 results, but again it’s too early to comment what would happen in the subsequent quarter.

Kyle Rose

Okay, thank you very much. I appreciate that. And then lastly on the CJR and the hospital C-suite there, what are your expectations as far as engaging those physician customers at those accounts where you have the hospital contracts and what that type of conversion will take and look like over the course of the next 12 months? And then when you think about the CJR and securing the additional hospital accounts there, I mean do you think that that’s something that takes nine months to really play through and CJR need to fully come into effect where now people are being audited on a retrospective basis or will you continue to add those accounts as we move through the year? And thank you for taking the questions.

Philipp Lang

Well again, it’s too early for us to answer the question but it’s really the right question that you’re asking here. If I benchmark for a moment our historical sales approach Kyle, we looked the sales rep would work with the surgeon, showing them the benefits of the technology as of 2015 and then also more and more clinical data and start converting that surgeon. Then after those initial discussion took place, we would need to establish those subsequent, we would need to establish pricing with that hospital, that’s typically a three month or so process. By the time you have a pricing window agreement established, so you’re looking overall from a surgeon on-boarding perspective until they do their first case easily three or four months. What has happened here is the exact opposite, I was taken by surprise when I saw the progress that our C-suite sales team has made with about 45% of all hospitals in the CJR under contract, it blew me away.

So that said, most of the surgeons there are completely untapped for us, but the dynamic has changed now because the sales force can now go into those hospitals, the pricing is established, there is no further negotiation and the dynamic has also changed generally to see exactly how that’s going to play out but the dynamic has also changed because for the very first time we actually have the hospital administration behind us. They want us to go into those hospitals, they want us to offer this technology. And so our focus now in the coming quarters really with the sales force and we have an upcoming call in fact tomorrow with sales management, there will be lot more activity on that front to specifically go after these decision opportunities, the broad surgeon faculty in these CJR hospitals that is currently untapped. We can go out, it’s a free hunting license.

Kyle Rose

Great. Thank you very much for taking the questions.

Operator

Thank you. The next question is from Steven Lichtman of Oppenheimer & Company. Your line is open.

Steven Lichtman

Thank you. Hi guys. As you’re going after new surgeons here with PS, just wondering your thoughts on adding to the sales force over the next 12 to 24 months as you also look to continue to reaccelerate the base business?

Philipp Lang

Okay, as you know we are not updating on expansion of sales force on a quarterly basis, we’ve done that historically on an annual basis. I can tell you that they are very opportunistic in terms of – available out there as well as distributors and personally I’m very bullish on the opportunity down the road in terms of expansion because more and more of those non-compete in the recent mergers and acquisitions I think are coming up. I think there will be more and more talent release. The key for us will be here to acquire the right talent. So this will be an ongoing effort for us in the coming quarters.

Paul Weiner

Okay, just to follow up on that. As we’ve talked about this before, we do have this hybrid model where it’s both direct and in the [indiscernible] and we’re focused on the best reps in that area regardless of whether they are direct or independent agents, we are looking for adding reps that are beyond non-compete, that have been in this industry and have the contacts. So we’re not focused on one or the other, we’re looking at the best reps within the different territories and we’ll bring them onboard as quickly as we can.

Steven Lichtman

Okay, great. And then just on data, obviously sounds like we’ll get a good update next week, just wondering when we – any updates on the double blind randomized trial as well I know Philipp you talked about that being certainly a longer tail but just any updates there.

Philipp Lang

So we couldn’t see this ongoing – the focus really for us has been the Step Study where we’ve been very successful, again we had originally planned for about 500 patients now that’s over 740. So that’s a fantastic result, you’ll hear about the results from that study next week and I think you’ll all hear continued update during the course of the year and certainly next year on the double blind trial. The double blind is also very exciting because not only are we collecting these blinded functional outcomes for example that we have in the Step Study but in addition to that, we were going to get more economic data from that trial. And I think that that will also be very helpful down the road as those data become available.

Steven Lichtman

Great. Thanks guys.

Operator

Thank you. The next question comes from Kristen Stewart of Deutsche Bank. Your line is open.

Kristen Stewart

Hi, thanks for taking the follow up. I was just wondering Philipp for the 45% of contracts that you now have with CJR, are those all incremental contracts or are those ones that you had before and a total of 45%?

Philipp Lang

Combination of both, Kristen, so some as you can imagine, when the program was announced we had contracts in some of those hospitals, and then just really good steady progress by our C-suite sales team adding more and more institutions.

Kristen Stewart

Great. And then, just going back to the speed from the order to the actual surgery, with the changes that you’re making with the 3D printing and CAD offshore, will it help to speed up the timeframe from that six or eight weeks whatever it is I guess currently now before you can book those out?

Philipp Lang

It’s currently six weeks, it was previously eight weeks as we came out of the recall and we have no plans currently to lower the six weeks, we feel that’s really, because most of the orders are on average again some fluctuation from quarter-to-quarter but ultimately 60 days out. And we feel that would be – of our surgeons and six weeks is also beneficial, you have seen how we are focused also on gross margin expansion and we hope that we can show more and more results on that front also compared to prior year 450 basis points. That said, clearly six weeks are great for us from a perspective of having steady order flow and a good utilization of our existing resources, so it’s also important from a gross margin perspective.

Kristen Stewart

Okay. And then in accounts where you are now launching iTotal PS, have you started to see some, I know it’s hard with the effect of the recall and everything, I guess in early stage are you starting to see some added adoption from iTotal PS accounts where you’ve been strong or CR or is it allowing you to enter additional hospitals?

Philipp Lang

We’re seeing both. We are seeing increase in penetration in fact in existing surgeon account with our CR users that again approximately 20% of all knee replacement is for the CR surgeon who does primarily CR, 20% of his or her surgeries are PS for example, if the ligament is damaged, the arthritis is too advanced. And so in the existing CR account, we are seeing progressive conversion that’s very positive and then the other thing clearly the focus for the sales force is focusing on new PS surgeons, the pure play PS surgeons that’s where we’re seeing all of this progress, we are succeeding and actually on-boarding higher volume surgeons and we currently have in our CR surgeon base. So it’s a twofold effort.

Kristen Stewart

Okay. Thanks very much guys.

Operator

Thank you. Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation and you may now disconnect. Good day.

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