Conformis, Inc. (CFMS) Q4 2022 Earnings Call Transcript

Conformis, Inc. (NASDAQ:CFMS) Q4 2022 Results Conference Call March 1, 2023 4:30 PM ET

Company Participants

Mark Augusti - President and Chief Executive Officer

Bob Howe - CFO and Treasurer

Conference Call Participants

Steven Lichtman - Oppenheimer

Eric Anderson - Cowen

Operator

Good afternoon, and welcome to the Fourth Quarter and Full Year 2022 Earnings Conference Call for Conformis, Inc. My name is Josh, 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 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 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, March 1, 2023.

I will now turn the call over to Mark Augusti, President and Chief Executive Officer of Conformis.

Mark Augusti

Thank you. With me today is our CFO, Bob Howe. I'll start with an update on our marketing efforts. We continue to explore new and effective ways to generate awareness about our products and services and have recently launched a new TV advertising campaign. Our goal with this advertisement investment is to educate and inspire surgery-ready patients to explore the benefits of a fully personalized Conformis need.

We are piloting a TV ad in two target markets with the objective to test time of day, program choice frequency and format length before adding additional metro markets. The early feedback has been good, and I invite you to see the full commercial, which can be found on the homepage of our website. We believe the ad does a nice job of conveying the benefits of a fully personalized need to our target audience and reinforcing that patients have a choice of which implement to use when undergoing total knee arthroplasty.

The launch of this campaign signifies another step in the transformation of the Company where our new Platinum Services program is now the only way U.S. customers can gain access to our exclusive fully personalized knee system. Since we initiated the limited launch of the Platinum Services program in January of last year, we have been working tirelessly to educate all stakeholders about the numerous benefits of the program and the potential to generate additional facility revenue.

We now have over 150 facilities of access to our Platinum Services program, which is over twice as many as the 70 facilities at the end of Q3. More importantly, our Platinum Services orders continue to grow. In Q4, we had approximately 380 new PSP orders, which was up 3x over the 110 orders in Q3. The commercial team is focused on contracting with new health care facilities with the goal of continuing to grow our PSP orders.

While we were encouraged by the progress we are making with our Platinum Services program, we are still looking for ways to drive order value. Since we moved to our new model on September 1, we know some of our existing surgeons are not ordering at the same level as they were before the change. We understand that this new model is different from what they had grown accustomed to from Conformis, so working with these surgeons as well as new surgeon prospects to stress the benefits of our new program in order to drive our business.

A compounding factor that has added pressure to our sales during our business model transition is that we have been dealing with supply chain challenges and manufacturing issues. Although the availability of raw materials, product components and packaging supplies have somewhat stabilized, we are still experiencing longer lead times on certain items and expect to continue through most of 2023.

While our delivery times are improving and the plan is running smooth than it was at this time last year, we still expect that the next quarter or two will be challenged as our plan continues to transition from just-in-time model to a hybrid approach, where we balance the operational requirements of a made-to-order model with the needs to be made-to-stock model.

We have added resources that are making select investments in technology to improve our operational efficiency. And as we do, we believe we will see a corresponding ramp in orders from our surgeon base.

Before I turn the call over to Bob, I would like to briefly cover a few other important updates. On our financial results for Q4 and the full year, we implemented a cost reduction plan to improve our cash position and extend our operating runway. The early results are in line with our expectation, and I see no reason this should not continue.

From a product revenue perspective, it was another year of holding our own. Given all the work we did to transform the business in 2022, we are now focused on executing our growth plan for 2023. Next, in Q4, we initiated the limited market release of our new hip stem called Actera. Recall, Actera is a shorter stem with the triple taper design that supports the growing interest in the direct inferior surgical approach. Initial clinical feedback has been positive, and we expect this to continue as we support the launch by building inventory and adding incremental instrument sets.

On R&D, our most important project remains our porous coated knee. Porous are what many refer to as cementless as one of the faster-growing segments within Orthopedics and is commanding more interest from surgeons. We've submitted our 510(k) application and are working with the FDA to gain approval. We are now targeting a limited market release in late 2023.

And finally, a quick update on the Aetna litigation. In late January, we received a favorable ruling on our appeal, and we intend to continue to vigorously pursue our claims against Aetna. We believe that patients in consultation with their physicians should have a choice and access in their health care decisions.

In short, we continue to be motivated by helping our patients live better lives through better clinical outcomes for their knees and hips. We still have much to do and look at 2023 as the year of normalized operations and improved growth performance.

I will now turn the call over to Bob to provide more details about our financial performance for the quarter and year as well as share thoughts on our outlook.

Bob Howe

Thank you, Mark. And good afternoon, everyone. Product revenue for the quarter was $14.2 million, which was down 7% on a reported basis and 6% on a constant currency basis versus the fourth quarter of last year. Fourth quarter U.S. product revenue of $12.4 million was down 9%. Rest of World product revenue of $1.8 million was up 4% on a reported basis and up 19% on a constant currency basis, primarily due to continued growth in Australia.

While we are pleased with the surgeon feedback from our recent limited launch of the Actera Hip, our overall hit business was down 15% in the fourth quarter. Actera launched in the fourth quarter and only had a small impact on our hip revenue. It is now rolling out to more surgeons, and we are making progress on building the appropriate level of inventory. We expect our hip business to increase sequentially and to return to growth possibly soon in the first quarter. For the year, product revenue was $57.8 million, which was down 1% on a reported basis and flat on a constant currency basis.

Royalty and licensing revenue in the fourth quarter was $3.3 million. The increase above our typical quarterly run rate is reflective of the successful settlement and license agreement we closed in the quarter. Total revenue for the fourth quarter was $17.4 million, an increase of 13% on a reported basis and 14% on a constant currency basis. Product gross margin was 37.6% in the fourth quarter, a decrease of 40 basis points compared to the fourth quarter of last year, but a sequential improvement relative to the third quarter.

As you look at our total gross margin, which was 41.1% in the quarter, please keep in mind that our Q4 cost of goods includes legal costs associated with the settlement and license agreement I referred to earlier. These costs are removed from the product cost of goods when calculating our product gross margin. While we continue to face gross margin headwinds due to increased labor material costs, operational inefficiencies and lower unit volume as we transition to our new business model, we believe Imprint and Platinum Services will both have a positive impact on our gross margins as they ramp.

Total operating expenses for the fourth quarter were $14 million, a decline of $5.4 million or a 28% reduction from the fourth quarter of last year. While a portion of this reduction in the quarter was a result of the cost reduction plan Mark referred to, we also had several nonrecurring noncash adjustments that I would like to call out. We had a reduction in our stock compensation expense related to our equity plan performance shares. An adjustment to our crude expense estimate for third-party legal costs and a reclassification of legal costs associated with our settlement and license agreement that I referred to earlier to cost of goods. These adjustments were in total a little over $2 million and should not recur in future quarters.

Moving to our balance sheet. We have cash and cash equivalents of $48.7 million at the end of the fourth quarter. We continue to prudently manage our cash and make select investments that align with our strategic priorities. Our new advertising campaign that Mark mentioned earlier and the inventory builds to support our new products are recent examples of these investments.

In terms of outlook, as previously announced, we expect our first quarter product revenue to be between $12 million to $13 million. We believe the first quarter will see the most pronounced impact of our business model disruption and should be the low point of the year. We expect to improve sequentially from the first quarter as we expand the Actera launch, grow our Platinum Services business and drive imprint order volumes with our customers.

For first quarter product gross margin, we anticipate to be in the mid-30s due to the expected lower volume. Following Q1, we expect to see sequential quarterly improvements as we progress through the year. For the full year of 2023, we expect our OpEx to be between $59 million to $61 million, which includes our cost reduction plan initiatives.

Finally, I want to thank the entire Conformis team for all their hard work and navigating through our business model transition. While there is still work to be done to improve our operations and strengthen our commercial execution, the interest from health care facilities in our Platinum Services program and our product offerings is encouraging.

With that, Mark and I are happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Steven Lichtman with Oppenheimer.

Steven Lichtman

So I guess first one to start on Platinum Services. Wondering if you could give us sort of a couple of metrics? I appreciate the number of customers that you've updated us on, what sort of the pipeline looks like there? Anything you could talk about in terms of number of potential customers looking to sign up?

And then secondly, as you look at those that were signed up in the third quarter, any sort of metric you could provide in terms of how that's expanded at those institutions sort of quarter-to-quarter increase?

Mark Augusti

Steve, it's Mark. Yes, actually, that's a good question. And we're looking at -- so taking your questions in reverse order, I think of that -- I think you're asking sort of like same-store sales like of the people that are starting off with PSP or are they sticking to it. And we're certainly looking at that. But I think it's a little too early for us to give that number, because there's a lot of noise in the data as we transition, but it's something we're looking at and we'll consider given like a Q1 number, okay?

I just think it's a little early given the noise that we had in Q4. So one of the reasons why we're giving sort of the facility numbers, because that shows sort of how many people are signing up, and it's sort of a recognition of a longer-term sales cycle, which I've alluded to, right, in the Platinum Services program. So we'll continue to do that.

As far as -- I think the first part of your question was sort of a little bit how the year is starting off. Is that sort of...?

Steven Lichtman

Yes. I mean any sort of sneak peek with the sort of the pipeline of new business or new potential customers as you've now fully transitioned on plan.

Mark Augusti

Yes, I can tell you that we definitely continue to work down a large pipeline, and we're looking to build more interest. And we will see more -- and we've seen more at the start of the year, facilities and contracting. So that should be positive. And we continue to see a pretty nice healthy split as far as standard ordering versus PSP ordering on the numbers coming in. Now again, there's a couple of our larger surgeons, it took a little longer for them to get kind of PSP in place at their facilities, and we're seeing some of that come online.

So I think that's going to provide a little bit of a tailwind for us, Steve. But yes, I'm feeling pretty good about the split. I mean, the -- and I feel good about the guidance that we've given, which is why we gave it. But there's no doubt that we're working through that disruption, and I think we have upside going into the rest of the year as we get through sort of this dislocation in Q1.

Steven Lichtman

Okay. That's helpful. And then can you update us on your latest thoughts about the ASC opportunity for you guys, particularly with Imprint and where you see that potential this year and next?

Mark Augusti

Well, I think the ASC is still a very good potential for sure. And I think it's really a little bit of a moving dynamic, right? Because there's a lot activity going on in the ASCs from the private equity investment that's going there through the physician movement transitions, there's a lot of interest. And we're going to continue to be part of that. We think we have the best and most unique offering. Having said that, it's so unique. Every surgeon is in a different situation clinically professionally about their practice. So -- and as they think about what ASC they're with or what their facility is doing, they've got to incorporate this into the thinking.

So we're -- look, we're -- our goal is to hit it on multiple fronts. We're going to continue to create awareness among surgeons and train our sales force about how to talk not only the clinical benefits of custom knee, but also the new business model and the financial aspects that we think are particularly intriguing to the AC. We're going to talk about the ASC owner operators to make sure they understand the opportunity. And then as we've alluded to in the call here, we're going to hit the patients up and make sure they're aware of their options.

And so it's a multifaceted effort that we're going after. But we clearly, clearly believe we've got a very good sort of clinical and business story proposition, if you will, for the ASC. We just have to get the reach. I mean, the biggest challenge we have continues to be distribution and reach as a smaller market share player in this space.

Steven Lichtman

Got it. Just lastly, Bob, can you give us a range or best estimate for your exit sort of 4Q gross margin? Yes, I'll stop there.

Bob Howe

Yes. I mean, obviously, I can give you directional Steve. Obviously, a lot of it depends on the ramp and the recovery, as we talked about. That's why we were just going to talk about looking at our goal is to get this. The goal is to certainly get it in the 40s and hopefully in the upper 40s as we exit. That's dependent on, like I said, the volume that will drive it as well that we feel good about, the portfolio of products, higher pace higher price due to Platinum Services and lower cost on Imprint. So the portfolio is going to help. We got to get the volume back, right, to help with the margin.

Mark Augusti

Yes. So we just exited -- just to make sure I understand your question, Steve, because you said Q4, but I think you were saying, okay, given what we just reported that we exited Q4 at 37.6%, right? And next year -- Yes, I didn't hear him. So you're saying like next year. So look, I think we've said before, we'll have improvements throughout the quarter, throughout the year.

We might take a slight -- very slight small kind of little step back, depending on revenue and some other factors in Q1, don't forget we've got different expenses, right? So certainly, we're not suggest or guide that they'll have an improvement from -- in Q1 over Q4 in slide back. But then after that, it's going to be fine going forward.

Bob Howe

Yes. And that's what we said in the prepared remarks in Q1, given the volume is going to be, we believe, the low point and we're going to sequentially improve there. So our goal certainly is to get it back in the 40s and then certainly beyond that, hopefully, continue to grow beyond that as well.

Mark Augusti

It should be -- I mean, Steve, just to give you some thoughts, I mean, I would expect the Q1 margin to improve over Q1 prior year, okay? Yes, yes. So the mid -- right because we said mid-30s, so that's a good number for you. And then up and there, we're certainly not going to take a material step back as opposed to prior year and kind of where we're at, okay?

Operator

Our next question comes from Josh Jennings with Cowen. You may proceed.

Eric Anderson

This is Eric on for Josh. Just wanted to ask about your rollout of Identity Imprints. What percentage of your sales of your total knee franchise, do you think Imprint accounts for now? I know it's still early on, but I was just curious if we could get closer to a revenue figure for Imprint in 4Q?

Mark Augusti

I think that we're -- We'll we're not -- so we haven't given that, Eric. So there's -- I understand what you're trying to do what's not in there yet. We're still just sort of talking hip and knees as franchises. We really need just to sort of wash through the numbers, and then we'll give some more guidance on that. We -- it is -- we're going to think about providing more guidance. I think it goes back to the earlier question, do we look at the split or what the split is on orders coming in for the upgrade and where we're at.

So we expect that we could be in a position to give more color on that, but we want to see sort of how things look over Q1. Remember, we just did the switch in September. We really only had Q4 so far. And the problem is, I just want to remind people, Q4 is a mixed sandwich here, because it's sales. And there was a lot of old orders under the old model that were in the queue, right, because we have a lead time. So -- so the sales really don't fully represent exactly what the ordering pattern is as we go forward. And so we want a chance to sort of see how that's working its way through.

And so we'll give some more color on that, I think, in May. So you could start to model. It's an important point. But the one part I can tell you that is working is the margins are going up, because we're getting -- and I can tell you it's meaningful. I mean more than half of our business is in orders coming in, right, is standard. So it's at an improved margin profile on those orders. And then the bit that's PSP, which is not insignificant is, as you might imagine, a very, very nice price uplift, right?

So the fundamental margin profile of the Company will be changing, and that's fundamentally what we're -- what this business model switch has been about, right? So yes. So we'll try to give you more color on exactly what that split in our knee franchise looks like in May.

Eric Anderson

Okay. Great. And then maybe on your OpEx expectations for 2023, you've talked about your cost savings initiatives during 4Q. Could you talk a little bit about how you plan on monitoring cash burn through '23? And also just talk about how you plan on doing so without disrupting any of your new product launches or growth opportunities going forward?

Bob Howe

Yes. I mean monitoring it. I mean that.

Very closely. The answer -- I do that every day, I can tell you that. So and as far as making sure we're not impacted by the [indiscernible] part of our [indiscernible] process like most companies, we had to prioritize, we're not going to do. And that's how we came up with the original target that we communicated. And I think the result of that is we have made reductions, but we have investments still there. Mark mentioned the good example is the ad campaign. We found the room, we cut other things to fund that, because we thought it was important. So we continue to do that, and we're going to have to continue to adapt. But I can tell you, we're certainly all over it and monitoring it.

Mark Augusti

Yes. Yes. And it's -- Did we have to make some painful choice, so sure, because there's areas of the business you'd love to invest more in, whether it's new product programs or just people around certain things. And so we can't do those maybe to the extent we'd like. Having said that, there's also some things that work your way, right? So I don't go into the details, but certain other areas of cost that you maybe thought you had to spend, you don't have to and that's really what happened in the case of advertising. We thought we might have to do an increase there. But while we're putting more money towards that, we still, overall, in the marketing and ad, the marketing budget overall was able to come down because of some savings as it related to things going on internationally and some other stuff.

So we'll just continue to monitor that and do what's appropriate and make sure that in this environment, it's to make sure we -- we don't overhire so we look at things like employment freezes and stuff like that, no job gets approved without new hire gets approved without Bob and myself personally looking at it, we scrutinize things. It's the same thing that other companies are doing in the environment we're in.

Operator

And this concludes the Q&A session. I'd now like to turn the call back over to Mark Augusti for any closing comments.

Mark Augusti

Thank you, operator, and thanks, everyone, for your time and interest in Conformis. I really appreciate taking the time out to hear our update. I would like everybody to know that we do have several investor conferences over the next few weeks, including the Cowen Healthcare Conference, which we're presenting at next week and also the Oppenheimer Healthcare Conference the following week. Look forward to seeing interested investors there and reconnecting with everybody.

With that, we'll conclude the call and wish everybody a happy and safe evening.

Operator

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.