Conformis, Inc.

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.

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.

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.