Conformis, Inc. (NASDAQ:CFMS) Q3 2022 Results Conference Call November 2, 2022 4:30 PM ET
Company Participants
Mark Augusti – President and CEO
Bob Howe – CFO and Treasurer
Conference Call Participants
Eric Anderson – Cowen
Caitlin Cronin – Canaccord Genuity
Operator
Good morning and welcome to the Third Quarter 2022 Earnings Conference Call for Conformis, Inc. My name is Shannon, and I will be your conference operator today. All lines have been placed on listen-only mode 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 meaning of federal securities laws, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements 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 Conformis public filings with the U.S. Securities and Exchange Commission.
You should not place undue reliance on these forward-looking statements. Conformis 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 2, 2022.
I will now turn the call over to Mark Augusti, President and Chief Executive Officer of Conformis.
Mark Augusti
Thank you, operator. With me today is our CFO, Bob Howe. We appreciate you taking the time to hear our business update. I will start by reiterating that we remain confident in our long-term growth strategy.
We are gaining traction with Imprint and Platinum Services, which I’ll elaborate on in a moment. However, translating our growing surgery and patient interest in the top line revenue is taking longer than we initially expected.
Based on that, we are taking proactive measures with our cost structure to improve our overall cash management. This will result in delivering expense control efforts that do not impact our long-term opportunity but do help us in the short term as we execute on our strategy. Bob will share more details on this shortly.
We had a good quarter of awareness [indiscernible] in our Platinum Services program for personalized knees. On top of this, we had several positives in the third quarter. One, we initiated the full commercial launch of our Imprint knee; two, we formally transitioned to our new Platinum Services model on September 1; three, we received 510(k) clearance of the Actera Hip System and are positioned to launch the limited market release shortly; and four, our international sales grew 5% in constant currency primarily through our continued progress in Australia.
As we execute on our strategic pivot, our near-term performance is driven by two initiatives. Our Imprint knee system continues to receive great reviews from surgeons that use it. Imprint combined several of the best features of our fully personalized solution with aspects of traditional off-the-shelf system. So it is truly in the category by itself.
Adoption continues to ramp, and we now have Imprint on contract with approximately 90% of our current customers. We continue to focus on skill training and [now] focus to the ASC to increase our overall penetration there.
Interest with our new Platinum Services program continues to gain traction as evidenced by the fact that we added to the number of facilities on the contract. We increased the number of health care facilities enrolled to 49 at the end of the third quarter, up from 21 through the end of second quarter. We formally transitioned new business model on September 1. So going forward, our fully personalized knees are only available through the Platinum Services program.
We’ve been pleased with the interest we are receiving from surgeons new to Conformis or those who have not ordered from us longer than a year. For example, Platinum Services orders were up 4x since September over what they were in the five months leading up to the transition.
In terms of our entire product portfolio, we have not seen much change in the overall macro environment. We are still experiencing higher-than-normal cases that are being rescheduled or canceled due to labor and supply chain challenges. This continues to lead to tight product deliveries and, at times, the need to reschedule surgical cases. In addition, we continue to focus on penetrating the ASC segment as reflected by the growth in revenue for this site of care over Q3 2021.
Moving on to an update on our pipeline. We held our own in the quarter. For Actera, we continue to build inventory to support our limited market release and expect the first procedure to be done shortly. We’re excited about the product design and feel it will position us well to address the growing physician interest in interior hip procedures.
The other major project is our porous coated knee. On a positive note, we have submitted our regulatory package to the FDA. However, supply chain challenges remain a headwind. We are exploring options to expedite the time line. But for now, we continue to expect the limited market release in early Q2 of next year.
Lastly, as you saw on October 26, our shareholders approved additional ratios on a reverse stock split to help us regain compliance with NASDAQ listing requirements. The Company’s Board of Directors has determined to proceed with implementing the reverse stock split using the 1-for-25 ratio. The Company is working with its transfer agent, NASDAQ and other applicable parties to implement the reverse stock split with an expected completion date in November of 2022. We will continue to provide updates via press release and a Form 8-K as this matter is finalized.
I will now turn the call over to Bob for some more details about our financial performance for the quarter and our outlook.
Bob Howe
Thank you, Mark, and good afternoon, everyone. Product revenue was in line with our expectations at $13.6 million, which is down 3% on a reported basis and 2% on a constant currency basis, versus the third quarter of last year. Within product revenue, our worldwide knee business was down 1% on a constant currency basis, and our hip business was down 19%. As Mark mentioned, our international knee business was up 5% on a constant currency basis due to strong growth in Australia.
Product gross margin for the third quarter was 34.6%, a slight sequential decline of 50 basis points as compared to the second quarter. While we continue to face headwinds from increased material and labor costs and we work through some initial transition inefficiencies related to our new business model, we are focused on making the necessary changes to improve our operations.
For the fourth quarter, we expect product gross margin to sequentially improve to the upper 30s. As we head into 2023, this metric should continue to improve as Imprint and Platinum Services becomes a larger portion of our product mix and we make efficiency improvements in our business model transformation.
I will now move to OpEx, where we continue to manage our cost. Our total operating expenses for the third quarter were $16.8 million, which was $1.4 million lower than the second quarter and down 3% versus the third quarter of last year. As Mark mentioned, we recently implemented a cost reduction plan related to our OpEx structure. This plan is anticipated to stay in place until we regain top line momentum. We are currently targeting to reduce annual variable and employee-related expenses by $10 million to $12 million, the majority of which will impact 2023.
Several initiatives have already been put in place, with others to be implemented this quarter and into early 2023. These expense reductions will not impact our porous knee and Actera hip new product development, nor will we significantly reduce our investments in sales and marketing programs focused on driving greater Imprint and Platinum Services adoption. We believe these cash saving actions will have limited to no impact on our long-term opportunity, but they will help us maximize our cash near term.
For the full year of 2022, we now expect our OpEx to be between $73 million to $75 million, which is lower than the guidance range we provided back in August, where we indicated we would be at the low end of our previous range of $75 million to $81 million.
Moving to our balance sheet. We have cash and cash equivalents of $59.6 million at the end of the third quarter. Our level of cash use will continue to fluctuate quarter-to-quarter near term. And as highlighted last quarter, we expect to increase inventory over the next few quarters to support our product launch cadence, which includes the full commercial launch of Imprint and the limited market release of our Actera hip and porous coated knee. We expect additional inventory investment to be between $2 million to $4 million over the next few quarters.
In terms of outlook, we expect our fourth quarter product revenue to be between $13 million to $14 million. This puts us at the low end of the $57 million to $61 million range for the year we established back in August. We believe our revenue performance has been impacted by transitioning our existing customers to our new [product] offering and by continuing supply chain and operational challenges.
At this point, we expect one to two quarters of top line pressure as we complete the transition to our new business model. While this is disappointing, we believe the impact will be relatively short term. And then after we work through these challenges, we’ll return to growth.
With that, Mark and I are happy to take your questions.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from Eric Anderson from Cowen.
Eric Anderson
Wanted to just start with the Platinum Services program. It sounds like feedback from customers adopting the service model has been positive, but it’s not quite translating into revenue growth. Just curious to hear what the Company is trying to do to bridge that gap. Is this just a surgeon education sort of thing? Is there anything you can do with the sales force to try and accelerate uptake for that program?
Mark Augusti
Yes. That’s a great question. So there’s a couple of things we’re doing. One is we’re taking the feedback from some customers. They agree to the program, but then it takes them a little longer to implement a change in their billing and collection since this is outside their normal sort of course of business. So the actual implementation from them is taking longer than we expected from some of the earlier sites that were able to implement it quicker. So we’re putting some things in place and working with consultants to try to package some stuff up to help that implementation go quicker, Eric. So that’s one of the things we’re doing.
The other thing is we’ve gotten into work some additional promotional materials as well as direct-to-consumer advertising and whatnot, which we plan to launch first quarter of next year. So that should help support that effort.
We’re pleased, though, with the amount of contract that got done. I mean this was a big lift as we move from 21 at the end of Q3 to 49. So we added 28 new contracts. And importantly, some of those contracts involve multiple facilities. So we’re pleased with that. But you’re right, it’s taking longer to translate into actual growth as they now try to operationalize the Platinum Services program on their end.
Eric Anderson
Okay. And then just on the international opportunity. It seems like you’re seeing some nice growth, especially in Australia here. Are there any other international markets that we could see the Conformis portfolio enter in the near to medium term?
Mark Augusti
I don’t think there’s anything in the near term that is significant as the Australian opportunity. There’s some things we’re doing to look at improving growth performance in some of our bigger existing markets. But as you know, we’re also challenged with some of [their recurrence] and things like that. So that’s really sort of distracted the ability to focus on those areas.
I think longer term, we’re looking at some of the Asian markets, as you might expect, Japan and China. But as you know, the regulatory pathway is convoluted there, especially for a custom product. So I wouldn’t factor that in anything in the near term.
Operator
Our next question comes from Caitlin Cronin from Canaccord Genuity.
Caitlin Cronin
This is Caitlin on for Kyle Rose. So just to jump off on Platinum as well. How much time do you guys really need to tell how Platinum Services is taking hold? And any metrics from Platinum that you can disclose such as conversion rate, mix, percent, et cetera?
Mark Augusti
Yes. The only metric I would say — I’ll answer reversely. When a facility offers the program, it’s clearly, clearly successful. And the numbers are bearing out that anywhere from 20% to 30% of the patients upgrade. So the opportunity is real. The challenge is like anything else. It’s a smaller market share player, getting that message and reach out. We have a challenge with our distribution and field sales force about going after that. I think we’ve got to continue to educate and make them feel confident or help them feel confident. But when it’s offered, it’s clearly successful. We’ve seen that every time a new facility launches the program.
As I said earlier, with Eric’s question, it was — it’s been a surprise to us or in the sense that for some of the bigger places that are interested, which we’re pleased because we’ve executed these contracts with some pretty big places. But their ability to quickly operationalize it, because they have to get IT and revenue cycle management, they have to think through their policies, it’s just taking them longer. And so they’re actually asking us for help to do some things in the short term.
So we’re doing a quick adjustment to that and respond to those things. And hopefully, that’ll kick in, but it is taking longer from that standpoint. But I’m very pleased with the number of facilities that increased and that we continue to have interesting discussions, and we have a lot of people that are in the queue. So I expect the — I fully expect the number of facilities that are offering Platinum Services to grow. And as long as we do that, it should translate into top line growth. It just got more of a lag from when they execute the agreement to when they operationalize it than we would have anticipated.
Caitlin Cronin
Got you. And then just two more questions. With the impact of the business model transition, are you losing customers? And also with the changes to the reduction of spending, what’s the updated timing of all the products that you currently have under development?
Mark Augusti
Well, thanks, Caitlin. So I think it’s a really insightful question, the first one, which I think is — you asked in a really good way. There’s no doubt that there — so first off, as we said in the prepared remarks, the good news is we have about 90% of our existing business contracted with Imprint. So the Imprint — access to Imprint by existing customers is pretty significant.
There’s no doubt there is some impact on some customers that didn’t want their world changed. They want to continue to do what they were doing. And as a result, for whatever reason, they may have decided, well, if I can’t do a fully custom product, then I’ll do something else. It’s hard to estimate exactly what that is. We’ve gone through it detail by detail. We think that probably it’s like sort of 5% to 10% range, but a lot of it is short-term stuff that could — that we think will come back after we get some exposure in Imprint and where we’re at. So there’s clearly some disruption, and we’re seeing that in the top line.
Now I would just like to remind everybody that we also still suffer from a non-optimized portfolio. We don’t have a robotic solution. We don’t have interoperative guidance. We don’t have cementless. So those are all things we don’t have, but we’re working on, as we know, porous coated and things like that. So we’ll come back. But we do have a very unique program in Platinum Service that we have to continue to market.
We’re also very pleased with our Imprint clinical performance. I mean everybody who has used it now, and it’s — and we’ve had more surgeons use it for the first time, in the last quarter, clinical performance is good.
I would say the other thing — it’s implicit in your question — has caused us potentially to see a pullback from a small number of surgeons some of the operational challenges we’ve had, which we mentioned in the prepared remarks. And as you’ve seen from the other companies reporting, while that’s a top line growth, which is great, the reality is there’s a lot of pressure throughout the supply chain.
And for a company like Conformis that has aggressive just-in-time delivery model, that has continued to be a headwind for us. And that’s a challenge. And so it’s — our field has had to deal with rescheduling of cases and moving things around. And I think that’s a headwind to top line growth. Okay?
Operator
Our next question comes from Steven Lichtman from Oppenheimer & Company.
Unidentified Analyst
This is [Amir] on for Steve. I just had a quick question around supply chain headwinds. Is there any commentary around what you’re seeing on the ground as it relates to your previously indicated, like, supply chain headwinds?
Mark Augusti
So what we’re seeing on the ground, is that what you said, [Amir]?
Unidentified Analyst
Yes, Mark. Correct. Yes.
Mark Augusti
Yes. Bob is very close to it, too, but I give my impression that from my perspective is there’s two things going on. One is we’re building out a new business model, which requires build-to-stock capabilities, right, running a warehouse, as well as the just-in-time capabilities. But even in our build-to-stock on Imprint, we’ve got our patient-specific instrumentation, and we deliver that to a specific patient in about a three-week to four-week time frame. And so there’s transition involved in our manufacturing facility.
At the same time, two things have really challenged us. One is suppliers, as I’ve said in the past, not meeting their delivery commitments because everything from packaging to femoral components to metals, I mean it’s been — raw materials. It’s been, frankly, a never-ending game of Whac-A-Mole. As soon as you think you’ve got one problem solved, another one rears its head. And then you combine that with the labor market that we have a lot of transition and a lot of turnover. And so the level of institutional knowledge continues to change, and that would be a struggle for any organization.
I think smaller organizations get hurt worse than that because we don’t have large purchasing departments or large manufacturing engineering departments. So when you have departments that consist of just one person or three people, and you lose a person, you can lose the bandwidth through that department anywhere from 1/3 to 100%. So other people have to pick up the slack, and that affects us in other areas.
So the labor challenges that are macroeconomic issues particularly hit small companies, and in particular, have hit us pretty hard. Those are my observations around sort of three things, but I don’t know if you want to add.
Bob Howe
Yes. The only thing I would add — I think Mark hit the big one from here — are we sporadically deal with some unpredictable shipping, right? So we’re shipping, as Mark mentioned, just in time. So when the shipment doesn’t show up and we thought it was going to show up, it causes [indiscernible] the standard off-the-shelf product. So that’s ebbed and flowed, but that certainly has added to some of the complexities.
Unidentified Analyst
Great. And just another question on my side. Is there anything you can provide on working through the backlog of these prior rescheduled cases? And then just a quick follow-up to that. Do you see elevated levels of rescheduled cases being a potential tailwind in ’23?
Bob Howe
Yes. I mean, look at the backlog, I don’t think there is necessarily a big backlog. As you know, we have scans, and that’s how we do our projections, and those are scheduled, and that’s how we plan and forecast. There are times when we have cases that get back on the schedule, and those — and that factors into it. But I don’t think, from our standpoint, backlog is a big driver. As far as you’re seeing the elevated levels of canceled cases in ’23 being a headwind, did I hear you right?
Unidentified Analyst
Correct. Yes. Yes.
Bob Howe
Look, that’s been something, again, that has ebbed and flowed. It hasn’t been consistent. Recent quarters, it’s elevated. I think part of that is due to some of the dynamics with staffing [indiscernible]. Part of that is some of the challenges with us having to reschedule and move because of the stuff we just talked about.
I don’t think — I don’t expect it’s going to be worse, but it’s tricky to predict. This has been — honestly, the last several quarters have been challenging for us. So I don’t expect at this point that it should get worse than what we’re seeing.
Unidentified Analyst
Great. Great. Just one last question on my side. On the — is there any updates on the Vizient contract that you guys mentioned in the prior call? Has it been helping you guys increase or attract more customers for the Platinum Services program recently?
Mark Augusti
Yes. I don’t have a specific number to provide, but it definitely has helped. And it’s definitely helped in a couple of situations. But as I said, when we announced that, it’s more of a “license to hunt.” And so again, it takes our sales force time to go and qualify and find those. But it’s been real helpful, and not only in the Vizient customers, but it’s also been helpful with some of the other corporate partners that we’re talking to about, Platinum Services, and I feel really good about that moving forward. So that part has been good. Okay?
Operator
[Operator Instructions] Okay. At this time, I would like to now turn it back to Mark for any closing remarks.
Mark Augusti
Thank you. Appreciate, operator. Thank you for everybody who attended the call today. Appreciate you listening in, and thanks to the questions that we had. Appreciate it. We look forward to providing a further update at the start of the new year on fourth quarter. Thank you.
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