Conformis, Inc.

Good morning and welcome to the first quarter 2022 earnings conference call for conformance. My name is Michelle and I'll be your conference operators 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. I would like to remind you that this call will include forward-looking statements within the meanings of the federal securities law, which are made pursuant to the safe harbor revisions of the Private Securities Litigation Reform Act of 1995. Any statements made during this call that are not statements of historical facts could 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 followings 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, May 4, 2022. I will now turn the call over to Mark Agusti, President and Chief Executive Officer of Conformance.

Thank you and welcome everyone to our first quarter earnings call. With me today is our CFO, Bob Howe. We had a quarter of steady progress with our identity imprinting e-system, our new platinum services program, and the products in our development pipeline. These will be the cornerstones of our product and service offerings going forward and we believe will be the catalyst for our growth. We achieved several imprint milestones during the quarter. We successfully completed our 250th imprint procedure, and now have over 500 orders in the queue. The clinical feedback remains compelling, and we continue to see a positive response from the ASC market, which is the primary target for this product. Importantly, Imprint is already on contract at nearly 70% of our existing accounts, an average price that is roughly the same as our total identity. This positions us well to drive gross margins as orders and procedures ramp. We remain on pace to transition to the full market release in June. at which time we anticipate that we will have Implant on contract with well over 90% of our customers. To support the full launch, we have a series of training and medical education events planned to drive further awareness and expand surgeon access. The market has reacted very favorably to this new Implant knee offering, and we expect this to continue as we target the ASC setting. Our new Platinum Services program is also progressing well. This program allows facilities to offer a fully personalized knee system as a deluxe upgrade option for their patients. Since its launch on January 6th, interest has been strong from ASCs and hospitals. We're educating all stakeholders about the numerous benefits of the program and the potential to generate additional facility revenue. We developed imprint and launched our Platinum Services program to address the ASC opportunity, while simultaneously providing a premium choice to patients as they consult with surgeons regarding their knee replacement options. We believe that a leading indicator of our success is our ability to gauge the appeal to a broad spectrum of facilities. We are committed to providing additional metrics to help you monitor our progress of our new program through 2022. To date, we've enrolled 18 healthcare facilities in the Platinum Services Program, and the pipeline remains robust, including many competitive accounts. We expect the growth of contracted Platinum Services facilities to be lumpy since contracting with new customers is a very variable experience depending on the size of the customer and the number of stakeholders in the decision-making progress. That being said, our team is energized with the new business opportunities that Platinum Services is creating with current and competitive accounts, and we expect to grow the number of enrolled healthcare facilities we do business with over the coming quarters. Another favorable achievement to report in the past quarter is the way we are extending our brand presence through a strategic partnership with Synchrony Financial, a leading consumer finance company. Synchrony has added our Platinum Services program to their successful care credit offering, which is accepted at more than 250,000 provider and healthcare-focused retail locations and has more than 11 million cardholder accounts. We believe this will provide healthcare facilities and patients an easy to use and readily available financing option to offer patients for out-of-pocket costs related to the personalization service upgrade. We've already noted that the platinum upgrade is eligible for any health savings and flexible spending accounts. And now with CareCredit, we're making sure patients have increased access and choice in their healthcare journey. Turning to the macro environment. Elective procedures are still below pre-pandemic levels, and staffing shortages continue to persist across the healthcare system. On the positive side, Omicron seems to have run its course after peaking in January. As we look to the future, we do not expect an immediate snapback in procedure levels, but we also do not anticipate any further major COVID-related shutdowns. What we do expect is a methodical procedure ramp as clinic visits pick up and hospitals and agencies normalize operations and staffing levels. COVID-related issues, combined with our business model transition, have put our product growth margins under pressure over the past few quarters, with a plain impact in Q1. The main driver for this is we are operating our manufacturing plant at suboptimal levels due to the challenges caused by higher-than-normal turnover and absenteeism. Constantly changing staffing and shift rotations have negatively impacted our manufacturing efficiency and has triggered higher levels of scrap and longer manufacturing times. Recently, we've made strides at improving staffing levels, and I'm pleased to report that we're currently at about 90% of our target levels. It's important for me to point out that we believe these challenges peaked in Q1, and our gross margin will show sequential improvement throughout the year. We forecast that we'll be back at our gross margin levels of low 40s by year end. I'm confident in our ability to do this, especially given that this is a significant area of focus for the newest member of our executive team, Mike Fillion, who started with us on April 1st as our COO. This is a new position for us, but one we plan to add for a while. I'm extremely excited we were able to attract someone as talented and seasoned as Mike to our company. He has 30 years of experience in manufacturing and operations and is well-versed in applying lean principles to make plants run more efficiently. Now I'd like to give you an update on important products in development. Our pipeline projects remain on track as follows. Our Acterra primary hip stem continues to be on schedule for mid-22 limited market release. The Acterra stem will be a shorter proximal filling type design conducive to the popular direct anterior approach. We believe having a broader hip portfolio will help us to continue to grow our hip franchise. We also remain on track for a fourth quarter limited market release of our porous coated knee offering. The sun cemented option will be first available with our imprint knee system And then we evaluate expanding the technology to a fully personalized platform. Let me now turn the call over to Bob for more detailed financial review of the quarter.

Thank you, Mark, and good morning, everyone. I'll start with a walkthrough of our financial highlights and then close with a few thoughts on our outlook. Product revenue is our most important financial metric, and we had a nice start to the year. We generated $14.9 million of product revenue, which was 8.6% growth over our first quarter last year. This was better than our expectations, primarily due to fewer Q1 scheduled surgeries pushing out to future quarters. The growth over prior year was due to a modest increase in elective surgeries and growth in our ASC channel. Within product revenue, sales of our conformance hip system were approximately 800,000, up 18% compared to last year's first quarter. Our hip growth rates are expected to accelerate later in the second half of the year as we expand our product portfolio with the limited market lease of our Atera Hip Stem and trialing by surgeons resumes in earnest. I would now like to spend time on our product gross margin. As good as we felt about our product revenue results, we had a similar level of disappointment in our product gross margin for the first quarter, which was 34.1%. Although we indicated on our last call that this metric would be under pressure and should be in the high 30s during the quarter, Our plant continued to operate inefficiently. We experienced higher manufacturing scrap, and we continue to face macro headwinds, including inflationary pressure, higher input costs, supply chain constraints, and labor shortages. Additionally, our cancel case inventory expense was higher than forecasted, as this remained elevated during the quarter. Unscheduled surgeries can still occur, and we continue to work with healthcare facilities to establish procedure dates for these cases. We are focused on improving these issues impacting our product close margin, although we expect the macro headings will remain an overhang. As Mark mentioned, we are now running about 90% of capacity from a workforce perspective, so we have bridged the gap on personnel. Now we are working hard to get our workforce operating as a cohesive unit. By doing so, we will improve labor efficiencies, lower scrap, improve delivery performance, and accelerate our inventory bills to support our input full commercial launch. I'm excited Mike Fillion has joined the performance team and I'm looking forward to working with him to get these metrics back in line over the next few quarters. For now, our forecasts show product gross margin sequentially improving in Q2 to the mid to upper 30s and low 40s in the second half of the year. So this is a short-term issue that we believe will correct quickly. Longer term, we believe that as we ramp imprint in the Platinum Service Program, we had a meaningful opportunity to further expand our gross margins. I will now move to OPEX. Our total operating expenses for the first quarter were $20.5 million. This was about $5.2 million higher than the same period last year and related to a few items. We had $1.6 million of higher costs in sales and marketing, which was partly due to the timing of the AAOS trade show, which occurred in the third quarter last year. Additionally, we had higher commission and employee-related expenses as we continue to invest in our commercial team to support our growth strategy. R&D expense increased by $900,000, primarily related to employee and project-related costs required to support our product pipeline. And lastly, we had $2.7 million of higher G&A expense driven by professional fees related to IP litigation and higher delivery expense, as we again relied heavily on expedited shipping methods because of our manufacturing capacity challenges. Our OpEx expectations for the year remain unchanged, despite Q1 being a little higher than expected. Accordingly, we continue to expect operating expenses to be between $75 and $81 million for the year. However, the timing in the buckets may change slightly as we manage to this number. Moving to our balance sheet, it remains strong with cash and cash equivalents of $82.7 million at the end of the first quarter. As highlighted last quarter, we are building our inventory balance on imprint needs. We expect this build to continue, and we also add the initial inventory production for the Acterra HIP over the coming quarters to support our product launch cadence. Net cash flow in the first quarter was $17.8 million used, which was higher than in recent quarters. The increase was driven by lower margins, higher operating expenses, timing of one-time annual payments, and changes in working capital. We anticipate quarterly net cash use to improve throughout the year as revenue growth rates improve and product margins improve as well. I will close with our outlook for the second quarter. We expect our second quarter product revenue to be between 14.5 to 15.5 million. We confirm our full year product revenue expectations of 60 to 70 million. A couple of things to note on this range. First, sequentially from Q1 2022, It is important to keep in mind that in five of the past six years, our second quarter product revenue has been lower than the first quarter due to general seasonality trends. Second, I want to remind you that last year's second quarter had significant rescheduled activity from Q1 delayed surgeries during a period of heightened procedure recovery. While our entire business was impacted by this in Q2 last year, our hip business had an even more pronounced level of rescheduled case activity that resulted in a relatively high Q2 making for a difficult comp from a year-over-year perspective. So taking all of this into consideration, like we did last quarter, we've taken a conservative approach to our outlook. Our Q2 guidance does not assume significant improvement in either elective procedures or staffing shortages in medical facilities. We do not expect noticeable recovery in elective procedures until the second half of 2022. With that, Mark and I are happy to take your questions.