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spk01: And welcome to the third quarter 2021 earnings conference call for Conformance, Inc. My name is Phyllis, and I will be your conference operator today. All lines have been placed on mute to prevent any background noise. After management's remarks, there will be a question and answer session. Before we begin, I would like to remind you that this call will include forward-looking statements within the meaning of federal securities law, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements made during this call that are not statements of historical facts should be considered forward-looking. 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 conformance public filings with the U.S. Securities and Exchange Commission. You should not place undue reliance on these forward-looking statements. Conformance disclaims any obligation except as required by law. to update or revise any financial projections or forward-looking statements, whether because of new information, future events, or otherwise. This conference call will include time-sensitive information and is accurate only as of the live broadcast today, November 3, 2021. I will now turn the call over to Mark Augusty, President and Chief Executive Officer of Conformis.
spk06: Thank you, Phyllis, and welcome, everyone, to our third quarter earnings call. With me today is our CFO, Bob Howe. We appreciate you joining us for an update on Conformis. We're pleased with the progress we made against our stated growth strategy in the third quarter. We had several wins on important initiatives that I'd like to discuss. Regarding the identity imprinting system, we're off to a nice start with our limited market release. The first procedures were completed by several surgeons and all met our high expectations. Our imprint knee was designed to integrate the benefits of our personalized knee solution with the convenience and flexibility of an off-the-shelf system. This allows us to deliver knees faster and at a lower cost while maintaining the unique surgery-in-a-box delivery model that surgeons prefer. While we expect our imprint knee to be used at hospital settings, We believe that the unique value proposition Imprint offers will be particularly attractive to ambulatory surgery centers. Notwithstanding disruptions caused by COVID-19 and the Delta variant, we've been pleased with the ASC interest we have received in our Imprint knee since FDA clearance in May. We are also pleased to complete the first procedures under the limited market release specific to our striker partnerships. Our patient-specific instrumentation is being used in conjunction with Stryker's popular triathlon knee. For those following us for a while, you know this partnership is a great testament to our extensive know-how related to patient-specific instrumentation and a capital-like delivery model. We're working with Stryker on a regular basis to plan and execute on the supply levels needed for a full commercial release. With the imprint knee and Stryker PSI projects, both in limited market release, Our R&D team has turned their focus to delivering the next two critical projects for our company. The first is our cementless knee. Last quarter, we mentioned that we were evaluating the application of cementless technology to our imprint knee system, given initial feedback from surgeons. Following our evaluation, we've decided to apply cementless technology first to our imprint system and then to our fully personalized solution, Identity. We currently expect a limited market release for cementless in the fourth quarter of 2022. The second key project is the expansion of our hip portfolio. We plan to offer additional stems to address specific segments of the hip arthroplasty market that are projected to grow at higher rates over the next several years. Our second stem, which we expect to add by mid-2022, will be a shorter style model conducive to the popular direct interior approach. We have made nice progress on our HIP business to date. This quarter notwithstanding, we have had a nice ramp of growth in HIP revenue since we launched HIP in the third quarter of 2018, and we expect this to resume in the coming quarters. Our progress on the products and limited market release and R&D projects was particularly pleasing given we were once again faced with COVID-19 headwinds due to the Delta variant. As we entered August, we expected to see a modest sequential bump in our third quarter revenue as business continued to recover. This is important since historically we have seen a seasonal dip in the third quarter. We believed at the time that we had adequately incorporated the impact that the Delta variant would have into our planning. However, in mid-August, we began to see a higher than usual drop-off of scheduled cases. That continued for the rest of the quarter as hospitals were once again managing levels of elected procedures. We do have some visibility into the status of cases that did not take place as originally scheduled. The vast majority of those cases have either been rescheduled or in a to-be-determined status, which for us is just a temporary hold without a specific rescheduled surgery date. Typically, cases are rescheduled within four to six weeks. Recently, that range has been wider as we are seeing up to 20 weeks between the original date and rescheduled date. We believe the delays and wider range for rescheduling are related to COVID-19 and staffing shortages in medical facilities. We further believe as schedules for both surgeons and patients normalize, our TBD cases are likely to become scheduled procedures. Our current thinking is that hospitals and ASCs will attain normalized elective procedure environment both in the U.S. and internationally at some point in 2022. Clearly, this assumes recovery from the Delta variant, that no other significant variants present themselves, and that staffing levels at hospitals get back to normal levels. We cannot say exactly when this will happen, which makes planning and forecasting challenging. That said, we tentatively plan to provide our preliminary thoughts on 2022 in early January. Let me now turn the call over to Bob for a more detailed financial review of the quarter.
spk03: Thank you, Mark, and good afternoon, everyone. We had a fairly straightforward quarter from a financial perspective, so I'll jump straight to revenues. We reported total revenue of $14.3 million in the third quarter, which was down 12%. Product revenue was $14.1 million in the third quarter, which was down 12% year-over-year on both a reported and constant currency basis. As Mark mentioned earlier, our product revenue was significantly impacted by Delta variant headwinds in the second half of the quarter. Sales of our new products were $13.4 million, representing a decrease of 11% versus 2020 on a reported basis. Sales of our conformist hip system were approximately $700,000, a decrease of 16% versus the third quarter of 2020. Our hip business still has a small base of surgeons, and during the third quarter, several of our largest surgeons were notably impacted by the surge in the COVID-19 Delta variant. U.S. product revenue was $12.4 million, representing a decrease of 12% in the third quarter of 2020. Rest of world product revenue was $1.7 million, a decrease of 6% on a reported basis and down 10% on a constant currency basis. Our royalty revenue for the third quarter was $123,000. As a quick reminder, we had a number of one-time items in the second quarter which resulted in an all-time quarterly high for royalty revenue of $41 million. This included the final milestone for the development of patient-specific instrumentation for Stryker, revenue related to the protection of our IP, and a small new licensing deal. Our product gross margin was 42% of revenue in the third quarter, which was flat from the second quarter, and down 540 basis points from the third quarter of 2020. This was driven primarily by lower volume, increased material, labor, and other manufacturing costs, higher canceled case inventory expense, and a reduction in selling price. Like many other manufacturers, we are experiencing a challenging labor market. This has resulted in higher than normal employee turnover, increased labor costs, and temporary manufacturing inefficiencies as we recruit and train new employees. In the near term, we expect our gross margin rates to be in the low 40s, but growing over time to anticipated higher overall production volumes and increased revenue contribution from our higher margin products. Total operating expenses for the third quarter was $17.4 million, which reflects the most investments we are making in sales and marketing and R&D. It also reflects planned higher G&A related to the investment in professional fees we are making to protect our IP. We have been extremely successful in winning or settling these cases as evidenced by the over $51 million we have generated in royalty and license revenue over the past two years. We expect operating expenses for 2021 to end the year relatively consistent to our previous assumptions communicated last quarter. We anticipate sales and marketing expenses to be between $25 and $26 million for fiscal year 2021, R&D to be between $14.5 and $15.5 million, and G&A to be between $28.5 and $29.5 million. Both sales and marketing and R&D are modestly lower than the projections provided last quarter. Moving to our bottom line performance, we generated a net loss of $13.0 million in the quarter, or 7 cents per share. This included foreign currency exchange loss of $1.0 million compared to foreign currency exchange income of $1.5 million in the same period last year. Our balance sheet remained strong as we had cash and cash equivalents of $97.1 million at the end of the third quarter. In October, we received $15.5 million related to the licensed settlement agreements we resolved and recorded revenue for during the second quarter. These payments further strengthen our balance sheet and provide the capital needed to execute our growth strategy. Lastly, I would like to provide some thoughts on our outlook. Based on our performance through October and our forecast for November and December, we expect our total product revenue to be between $15 to $17 million. This wider than usual range is due to the unpredictable recovery from the Delta variant negative impacts from staffing shortages in medical facilities, and the uncertainty of rescheduling cases over the coming months. To the extent we see a more normal conversion rate of our existing Q4 scheduled surgeries into revenue, and we experience the typical seasonal bump we see as patients book procedures before the end of the insurance plan year, we expect to be closer to the high end of the range. If we do not see any meaningful improvement in elective procedures, we experience a higher postponement rate of existing scheduled surgeries, and staffing shortages continue or get worse, we expect to be closer to the low end of our revenue range. Either way, we expect to grow sequentially from the third quarter. I will point out that this outlook does not reflect any potential impact due to manufacturing inefficiencies, which may become associated with the difficult labor market and the shipping disruptions that many companies have experienced over recent months. The good news is that the feedback we are hearing from our surgeons on resuming procedure levels in earnest is trending positive. So we are optimistic that we're on a path to return to growth as the environment normalizes. With that, I'll turn the call back over to Mark.
spk06: Thank you, Bob. I'd just like to make a couple of closing comments. First, we've been saying all year that 2021 is a transitional and recovery year, and that 2022 is where our growth strategy will really begin to see traction. I still see that as the case. Our company has worked extremely hard to get all the pieces in place to win in 2022. How fast the full recovery will take is still a question, but we believe that our preparations to succeed are well on track. It's an exciting time for Conformis, and we're all aligned behind our new strategy. In the meantime, Like our customers and patients, we are looking forward to a normalized operating environment. To this end, and on behalf of our entire company, we want to acknowledge the efforts and sacrifices of every healthcare professional who's helping us navigate through the continued effects of COVID-19. Their work is inspiring. With that, Bob and I are happy to take your questions. Thank you.
spk02: Thank you. As a reminder, to ask a question, you'll need to press star 1 on your telephone. To withdraw your question, please press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from Josh Jennings with Cowan. Your line is now open.
spk04: Hi, this is Eric on for Josh. Thanks for taking the question. I'd like to focus just on your guidance for 4Q and what you're baking in in terms of COVID disruption. It looks like we may be finally returning to normal as vaccination rates continue to continue to improve. Just thinking about the 15 to 17 million dollar range. Does the top end of this range still suggest some level of COVID disruption? Or if we were at that $17 million figure, is that virtually no COVID impact later this year? Any detail there would be helpful. Thank you.
spk06: Eric, this is Mark. Thank you. I'll comment and then Bob can provide his color. I think obviously the top end of the range would be, say, a more muted impact and really a manageable impact. sort of situation with staffing shortages from our customers, as well as there's assumption of our customers being able to reschedule some of the deferred cases at a higher rate into the year. So that's what would get us to that higher end of the range. Am I missing anything else, Bob?
spk03: No, I think that's accurate. It's a combination of procedures, and as you know, we have visibility to schedule cases, so it's really converting those at our more normal rate would get us closer to that top end of the range.
spk04: That's helpful. Thank you. And then international expansion remains an untapped opportunity for you guys here. You're making some great progress with China, I think, possibly seeing the first conformance procedures later this year. Are there any other markets that you would highlight that we could see conformance possibly entering, probably not later this year, but maybe in 2022? And then maybe just if we could get an update on the progress in China, that would be great as well. Thank you for the questions.
spk06: We don't have a specific update on China, Eric. We're really trying to keep expectations somewhat muted because it's early and we're figuring that out. And, frankly, you know, a lot of this is made more difficult by the pandemic and different requirements in each market. But I can tell you Australia is a target for us. We just received some approvals around our – our knee variation was going to help with reimbursement. So we would expect to see, you know, some better performance out of there. You know, it remains a challenge for us internationally because of the reimbursement headwinds that we've suffered all along in Germany and, frankly, the medical necessity approval hoops that they've required us to go through. I'll tell you the one area that I think we're seeing a, some slight improvements. It's not a new market, but I'll comment on it. And I hope it doesn't, you know, again, have more pandemic challenges, but we're starting to slowly see some improvements in the UK. They have an incredible, incredible back order on their lists, as you know, and our model is helpful for that. And we've seen some stability in those customers as those medical facilities have been able to, you know, try to ramp up to demand. So, Going forward, I'm a little more bullish on those markets, UK and Australia, and I'll just leave it at that. But you're right. We need to do better there. It's just been really challenging.
spk04: Great. Thanks again.
spk02: Thank you. As a reminder, that's star one to ask your question. Our next question comes from the line of Stephen Lichtman with Oppenheimer & Co. Please, you may begin.
spk05: Hi, guys. This is Amir in for Steve. My first question was, can you guys talk about any initial feedback you've gotten from the limited launch of Identity Imprint? And I guess in particular, how it fits in the ACS setting? Thank you.
spk06: Yeah, I can. And thanks for that, Amir. And that's, you know, certainly one of the highlights for us. We're pretty excited about the initial feedback that we've gotten. We're also, you know, still it's in limited release. We're pretty excited about the percentage of new users or new cases, if you will, that we've booked in the new users that have taken on. So, in general, they found the technique, you know, similar to iTotal with the same principles, if you will, of an off-the-shelf, especially as it relates to positioning of the tibia and whatnot. They really like the surgery-in-a-box model. and, you know, all the things they've always liked about our iView and our jigs. The jigs, you know, as you would expect, are working and are accurate, just like they, you know, are in our fully custom model. But probably the biggest thing that is maybe not appreciated is our ability to really predict the sizing. I mean, the whole secret sauce in here, which there will be more about when we go on full market release, is how we used our data. to design the sizing of the implants, you know, three-dimensional design and sizing, and then converted that into our sizing software, which is all FDA cleared, and allows us to really accurately provide the surgeon the exact femoral and tibia component that is best, and then the alignment to execute that. And, you know, one of the things we were exploring in our early market release was, you know, would there be – conditions or scenarios where we would need the surgeon to, you know, to approve, you know, trade-offs, if you will, that they necessarily have to make in the off-the-shelf world because there's different, you know, there's just, you know, fit more poorly, if you will, or fit poorly compared to ours. And the point I'm trying to make is that's going exceedingly well. Like, as we've gone through these first cases, our sizing is really accurate, and there's actually very little, you know, question about the right femoral and tibia combination with our lineup. And, you know, it's early days, but we've planned well over, you know, 50 of these in the first, you know, 60 days or so, and we're really excited about how the product's fitting and how our software is working. get through the end of the year and make sure, you know, all signals will go. But right now we're pretty excited about the early returns.
spk05: That's great. That's great. And just one more follow-up from me. I guess you guys sort of spoke about it in the prepared remarks, but I guess what are your latest thoughts, I guess, if you could just comment a bit more in terms of the timing for, you know, when these previously deferred procedures could be an incremental tailwind for you guys? Any color on that would be great.
spk06: Sure. Well, I think as you see in the prepared remarks, it's one of the reasons why our range is a little larger here. It's just really hard, Amir. You know, there's no predictable cadence with COVID and disruption of operations. And I'm not trying to, you know, whatever. You know, I don't know what the right word is. I'm just trying to be as transparent and provide you guys as much color as I can. If I knew, I'd tell you. But, you know, the models we had and the amount of typical reschedule or drop-off that, you know, occurs normally has gone out the window. And a lot of that is due to just the capacity of the medical facilities to, you know, to staff up and to reschedule and really work through the schedule. And it's really hard. So in the past, you know, I guess the only way I can look at this in the past, the ability to reschedule uh was easier it was just there was more capacity so the surgeons could do that but they sort of filled that limited capacity they have there's uncertainty and so we're not seeing them get reset scheduled as quicker into the queue and that's the real challenge for us so it's really hard for us to predict you know you know are some of these cases going to come into q4 are they going to end up in q you know q1 of 22 so you know as we realize that we'll provide more color on it but um that's one of the reasons why this range is a little wider than normal, as well as just our concern about staffing and impacts in general in Q4. Bob, is there anything else I'm missing there? But I think that's sort of the gist of it, right?
spk03: No, I think you nailed it, Mark. That's the gist. It's the predictability of the traditional model we had in the past has been thrown for a loop with COVID. But, you know, as we spin out of this, we should see those start to schedule. It's just challenges. They've been unpredictable, and they've been taking a lot longer to get them back on the books because of everything that's been going on.
spk05: Thank you. Thank you, guys. Thank you, Amir.
spk02: Thank you. And at this time, I'm showing no further questions in the queue. I'd like to hear the call back over to Mr. Mark Agusti. Any closing comments?
spk06: No, thank you, Operator. I hope you can tell we are pleased with the progress we're making in our strategy. We really look forward to closing out the year in a good note and heading into 22 with some tailwind, hopefully tailwind in the form of normalized or stabilized operations on behalf of our customers. But most importantly, with getting into full market release on the critical projects we've launched, we're obviously really excited about what we've done in a very short amount of time with our imprint product and really like the value propositions. So we'll be providing more color on that as time moves on. Obviously, please reach out if anyone has any questions. We thank you for joining us today. And everyone, please have a great evening. Thank you.
spk02: This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone have a wonderful day.
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