OrthoPediatrics Corp. (KIDS) Q4 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2017 OrthoPediatrics Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Ms. Tram Bui. Ma'am, you may begin.

Thanks, operator, and thanks, everyone, for participating in today's call. Joining me from the company are Mr. Mark Throdahl, Chief Executive Officer, and Mr. Fred Hite, Chief Financial Officer. Before we begin I'd like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of federal securities laws, including the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve material risks and uncertainties, and the company's actual results may differ materially. For a discussion of risk factors, I encourage you to review the Company's Registration Statement on Form S-1/A filed with the Securities and Exchange Commission on October 10, 2017, and its most recent Quarterly Report on Form 10-Q. Through the call today management will also discuss certain non-GAAP financial measures which are used as supplemental measures of performance. The company believes these measures provide useful information for investors in evaluating its operation period over period. For each non-GAAP financial measure referenced on this call the company has included a reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures in its earnings release. Please note that non-GAAP financial measures have limitations as analytical tools and should not be considered in isolation or as a substitute for OrthoPediatrics' financial results prepared in accordance with GAAP. In addition, the content of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, March 8, 2018. Except as required by law, the company undertakes no obligation to revise or update any statement to reflect events or circumstances that take place after the date of this call. With that said, I'd like to turn the call over to Mark.

Good morning, everyone, and thank you for joining us today on our Fourth Quarter and Full Year 2017 Financial Results Conference Call. I'll begin with an overview of our fourth quarter and full year financial and operational highlights, followed by Fred, who will provide a detailed financial review. I will then return for closing remarks before opening the call for questions. First, I'd like to thank our team at OrthoPediatrics for their dedication in making 2017 a transformational year. We increased sales growth and profitability, completed a public offering, and changed the lives of approximately 20,000 children. Concerning fourth quarter results, we're pleased to report another consecutive quarter of strong revenue growth, which contributed to another year of 20% plus sales growth. Total revenue for the fourth quarter increased 24 percent, to $11.7 million, compared to Q4 2016, and increased 22%, to $45.6 million for the full year, compared to full year 2016. All three of our product lines contributed to both the fourth quarter and the full year performance: trauma and deformity; spine, which we are now going to refer to as scoliosis; and ACL reconstructive/other, which we are now referring to as sports medicine and other. However, we were particularly pleased with the growth of our U.S. scoliosis segment, which considerably outpaced our overall growth in both the fourth quarter and the full year and significantly outstripped the growth of the industry. Furthermore, we're also proud of the improvement in profitability that we achieved in the fourth quarter and full year 2017. Gross margin for the fourth quarter was 76%, up from 68% for the same period last year and 76% for the full year 2017, compared to 71% for 2016. This increase was in part driven by transitioning stocking distributors in select geographies to a sales agency model which we have in the United States and consider one of our company's core strengths. We're reporting our first full quarter results as a public company, so let me provide a more detailed overview of three strategic strengths that position the company for continued growth. First, technology development. OrthoPediatrics has developed 24 surgical systems, five of which were recently launched, with more than 3,000 individual products. This is the most extensive surgical offering in the orthopedic industry. In 2017 our products were used in surgeries on an estimated 20,000 children in the United States and 37 countries around the world. On our third quarter 2017 conference call, we discussed three product launches, including PediFrag pediatric clavicle plates; FIREFLY pedicle screw navigation guides; and the MPFL, or Medial Patellofemoral Ligament Reconstruction System. Since then, we introduced an additional two products, for a total of five recent product launches over the past year. In December we launched the first ever pediatric-specific Wrist Fusion Plate System, featuring stainless steel plates in two implant lengths to accommodate patients both with and without a proximal row carpectomy. The plates are designed to minimize plate prominence and reduce soft-tissue irritation. This was a significant clinical achievement, and surgeon feedback has been very favorable. When pediatric wrist deformities are severe enough to make daily tasks difficult or painful, surgical intervention can greatly improve the quality of life. We worked in collaboration with the Sydney Children's Hospital Network in Australia, with support from an accelerating commercialization grant from the Australian government, and we are delighted that this new technology comes from our association with talented surgeons on the other side of the globe. In early January we introduced the Titanium PediPlate system, expanding our comprehensive physeal tethering offering, which harnesses the power of the growth plate to correct leg deformities through a simple, minimally invasive and reversible surgery. This system includes our O-Plates and I-Plates as well as solid and cannulated low-profile screws, and it expands physicians' treatment options, especially for patients who have a nickel allergy. As we look forward, we are encouraged by a robust new product pipeline and anticipate five additional systems to be launched in 2018. The targeted launches include a small stature RESPONSE scoliosis system and a small stature BandLoc polyester sub-laminar banding system, both of which will broaden our offering to treat pediatric spinal deformities. We also plan to introduce an Osteogenesis Imperfecta nail system that greatly improves treatment options for this difficult pediatric condition. In addition, we plan to introduce a new generation PediNail Rigid Intramedullary Nail System and a pediatric foot system. We've also initiated active growing implants and spinal tethering development programs. We are developing active growing implants for the treatment of early-onset scoliosis and limb length discrepancies and spinal tethering to enable surgeons to intervene in scoliosis patients as young as 10 without fusing their spines. The second strength is our sales organization. In order to sell our extensive product portfolio to our relatively concentrated market, we have built and trained the only dedicated sales and distribution system in pediatric orthopedics. As a reminder, pediatric orthopedists differ significantly from adult orthopedic surgeons because they are generalists who can use all of our products. This means that every case is an opportunity for cross-selling. During 2017 we grew our sales team to over 75 dedicated reps. We will continue to scale our domestic selling organization with additional sales personnel who are focused on our products, in most cases exclusively. Our strong U.S. scoliosis growth rate confirms the effectiveness of our specialized pediatric selling organization, and we've already begun replicating our U.S. sales agency structure in certain international distributors, which, as I mentioned earlier, contributed to our significant gross margin expansion. In the second and third quarter of 2017 we converted stocking distributors in the United Kingdom, Ireland, Australia, and New Zealand to sales agencies that are paid a commission, which delivered significant sales growth in those geographies and expanded total company gross margins. We intend to continue converting certain international stocking distributors in the future. The third strength is clinical education. We believe that training young surgeons is another critical factor as OrthoPediatrics continues building its brand equity as the company dedicated to advancing the field of pediatric orthopedics. We have developed extensive clinical education programs that touched roughly 2,000 medical professionals in 2017. We also sponsored two continuing medical education courses for experienced surgeons, the International Pediatric Spine Symposium and the Pediatric Orthopedic Surgical Techniques course. We sponsored the Akron Resident Review Program and established a web-based pediatric surgeon community with over 425 followers around the world. We plan to increase our commitment to clinical education in 2018, including industry-sponsored events such as the May 2018 meeting of the Pediatric Orthopedic Society of North America, of which we have been a leading sponsor since our inception. These strengths -- technology, sales organization, clinical education -- coupled with the proceeds from our recent IPO, make us confident that we can accelerate our growth. We plan to increase our annual investment in consigned sets from an average of $3.5 million historically to $10 million in 2018, thus eliminating a significant constraint to the company's growth. In addition to our current products, we believe our sales team will be quick to integrate new surgical systems with ease, given our focus on only one thing: pediatric orthopedics. One final comment. While we are still working to resolve our patent dispute with K2M related to an instrument in our RESPONSE scoliosis system, our confidence grows that our case is particularly strong. As stated previously, we welcome constructive discussions on a negotiated settlement, but we have demonstrated that we will vigorously defend ourselves in this matter. So let me now turn the call over to Fred for a review of our financial results.

Thanks, Mark. Total revenue for the fourth quarter 2017 was $11.7 million, up 24% when compared to $9.4 million for the same period in 2016. U.S. revenue in the fourth quarter 2017 increased 21%, to $8.8 million, when compared to $7.3 million in the same period last year, representing 75% of our total revenue. International revenue in the fourth quarter 2017 was $2.9 million, a 33% increase compared to $2.1 million in the same period last year, representing 25% of our total revenue. Total revenue in 2017 was $45.6 million, a 22% increase compared to $37.3 million for 2016. U.S. revenue in 2017 was $34.9 million, a 21% increase compared to $28.8 million for 2016, representing 77% of our total revenue. International revenue in 2017 was $10.7 million, a 27% increase compared to $8.5 million for 2016, representing 23% of our total revenue. Our fourth quarter and full year 2017 revenue breakdown by product category was as follows. Trauma and deformity revenue in the fourth quarter 2017 was $8.5 million, a 27% increase compared to $6.7 million in the same period last year and $32.8 million in 2017, a 22% increase compared to $26.8 million in 2016. This was driven by double-digit growth across the majority of our product line. Scoliosis revenue in the fourth quarter 2017 was $2.9 million, a 22% increase compared to $2.4 million in the same period last year and $11.6 million in 2017, a 24% increase compared to $9.3 million in 2016. This was driven by strong product acceptance and customer adoption, supplemented with growing sales competency in the U.S., partially offset by a slight reduction in international scoliosis sales due to the timing of cash collections. Lastly, sports medicine and other revenue in the fourth quarter of 2017 was $286,000, representing an 18% decrease when compared to $348,000 in the same period last year, primarily due to lower set sales to our international distributors. Sports medicine/other revenue in 2017 was $1.2 million, an increase of 12% compared to $1.1 million in 2016. Nearly all of our revenue growth was driven by increased unit volumes. Moving down the income statement, gross profit for the fourth quarter 2017 was $8.8 million, a 38% increase compared to $6.4 million in the same period last year. Gross margin in the fourth quarter of 2017 was 76%, compared to 68% in the fourth quarter of 2016. Gross profit in 2017 was $34.5 million, an increase of 31% compared to $26.4 million in 2016. Gross margin in 2017 was 76%, compared to 71% in 2016. As previously discussed, we have multiple factors driving the improvement in our gross margin, but the primary benefit comes from transitioning four countries from stocking distributors to an agency model. Sales and marketing expense in the fourth quarter 2017 increased 27%, to $5.4 million, when compared to $4.3 million in the same period last year, and full year sales and marketing expense increased 23%, to $20.5 million, when compared to $16.7 million in 2016. This was driven by an increase in unit volumes sold and associated commissions in the U.S., the addition of commissions being paid in the four international markets that we have transitioned to an agency model, and ongoing marketing expenses. General and administrative expenses in the fourth quarter 2017 were $6.7 million, an increase of 140% when compared to $2.8 million in the fourth quarter 2016. Fourth quarter 2017 included $2.1 million for accelerated noncash stock compensation as a result of our October 2017 IPO and $500,000 for new public company expenses. Total year 2017 G&A expenses were $17 million, an increase of 46% when compared to $11.6 million in the prior period. The full year results were also impacted by the unusual items reported in the fourth quarter. Excluding the previously mentioned unusual items, the fourth quarter and total year G&A expense increased as a result of additional personnel and resources to support the growth of our business as well as higher external professional fees. Research and development expenses increased 51%, to $900,000, in the fourth quarter of 2017, when compared to $600,000 in the same period last year, and increased 54% to $3.4 million, compared to $2.2 million in 2016. The increase was due to the addition of experienced engineer personnel, significant product launches, as well as incremental project to accelerate our product development and future pipeline. Total operating expenses in the fourth quarter 2017 were $13 million, an increase of 35% compared to $9.7 million in the fourth quarter of 2016, and total operating expenses in 2017 were $40.9 million, an increase of 26% compared to $32.5 million in 2016. Operating loss in the fourth quarter 2017 was $4.2 million, as compared to a loss of $3.3 million in the fourth quarter of 2016, and full year 2017 was a loss of $6.5 million, up from a loss of $6.1 million in 2016. Adjusted EBITDA for the fourth quarter of 2017 was negative $612,000, compared to negative $473,000 for the fourth quarter of 2016, and adjusted EBITDA for the full year of 2017 increased approximately $937,000, or 94%, to a negative $58,000 compared to negative $995,000 for the full year of 2016. Interest expense in the fourth quarter 2017 was $600,000, a 51% increase to $400,000 in the same period last year, and was $2.5 million for 2017, a 69% increase compared to $1.5 million for 2016. The increase in interest expense was due to the use of incremental debt to support the growth of the company and the transition of the four international countries to agency model. Net loss in the fourth quarter 2017 was $4.8 million, compared to a net loss of $3.6 million in the same period last year. Net loss per share attributable to common stockholders in the fourth quarter of 2017 was $4.35 per basic and diluted share, or $3.03 per basic and diluted share in the same period last year. Net loss in 2017 was $8.9 million, compared to $6.6 million in 2016. Net loss per share attributable to common stockholders in 2017 was $6.12 per basic and diluted share, compared to a loss of $7.14 per basic and diluted share in 2016. Turning to our balance sheet, as of December 31, 2017, our cash balance was $42.6 million, compared to $1.6 million as of December 31, 2016. As a reminder, in October we raised $46.9 million in net proceeds from our IPO after deducting underwriting expenses, commissions, offering expenses and payment of Series B dividends. Net purchases of property and equipment during the fourth quarter 2017 were $1.3 million, a 27% decrease compared to $1.7 million during the same period last year, and were $5.2 million in 2017, a 20% increase compared to $4.3 million in 2016. The primary driver of an increase in purchase of property and equipment was the deployment of consigned sets, which include product-specific instruments as well as cases and trays. As Mark noted before, the consignment of additional sets in the future should drive future growth for the company. As of December 31, 2017, total net debt was $25.5 million, up from $17.5 million as of December 31, 2016. The increase was primarily driven by the conversion of our four international countries to our agency model and additional consigned sets. During the fourth quarter we signed an amendment to our current debt agreement with Squadron Capital, our largest shareholder, to modify and extend the terms of our term notes and revolving credit facility. We were able to consolidate a majority of the term note amounts into a $20 million term loan and reestablish a $15 million revolver. We have used $3.9 million of the revolver credit facility. In terms of guidance, we anticipate 22% annual sales growth for total year 2018. We plan to increase our annual investment in consigned sets from an average of $3.5 million historically to approximately $10 million for the full year of 2018. Let me now turn the call back over to Mark for closing remarks.

Thanks, Fred. Let me summarize in five points. One, our strong fourth quarter and full year results keep OrthoPediatrics on a steady growth trajectory of at least 22%. Two, we continue to expand and enhance an already extensive portfolio of innovative surgical technologies, while also driving market penetration. We are deepening our understanding across the range of unique pediatric pathologies our surgeons treat and the very different surgical procedures they employ and our commitment to clinical education. Three, let us not underestimate the power of culture driving our success. We have a company -- we are building a company that is both performance-oriented and focused on engaging on our people. Four, our dedicated sales organization has developed strong relationships with our surgeon base and is able to cross-sell all our products during every surgery they attend. Five, we are committed to increasing the number of children we can help this year with our technologies by tripling the number of consigned sets using proceeds from our IPO. It is for these five reasons that we enter 2018 well positioned for substantial growth, and the outlook for our business has never been brighter. Operator, we'd now like to open the call for questions.

[Operator Instructions] Our first question comes from Kaila Krum, with William Blair.

So, I guess to start on that $10 million in instrument sets you guys are expecting to deploy this year, first, can you talk a little bit -- I guess can you tell us, I guess, how much of an investment perhaps you've made perhaps year to date, and then how you're thinking about contribution per set in your 2018 guidance?

Good morning. Yes, so as we've talked in the past, right after the IPO completed in October we came back and in the fourth quarter ordered approximately $5 million of those sets. That $5 million has been trickling in late into the fourth quarter and throughout the first quarter, and we plan on completing that $5 million of sets here at the end of March and starting to deploy that both in the U.S. as well as into the international markets. So that's the first big wave of the sets that are going to be consigned. We also have placed a significant order in the first quarter, which we expect to be delivered here in the second quarter, and then we'll be deployed at the end of the second quarter. And then in the third and fourth quarter of this year there'll be fewer amounts, smaller amounts, to total about that $10 million we talked about. As we talk about the contribution that those will make, first of all, it takes anywhere from 6 to 9, maybe 12 months for those systems to be fully utilized. Historically, we have driven a return of about $1.64 of annualized revenue for every dollar that we deploy. But we also know that we were overutilizing the sets that we have today, and I'm using in my model about $1.00 of incremental revenue for every dollar that is deployed. On the trauma and deformity side we think that's similar to the industry average. It's a little conservative, but right now that's what we're using in our model. As those sets gradually become more and more utilized they'll reach that dollar, maybe a little higher than that in the future, but for right now that's what we're using to model the contribution from those sets.

Great. That's helpful. And then I guess, I mean, you guys have talked about a lot of new and exciting product launches. So I guess how are you thinking about new product contribution, again, as it relates to that 22% growth guidance? Thank you.

Yes, so historically when I look at the growth of the business and look at the drivers it's very textbook. It's really a third from new customers, a third from additional sales with our current customers, and a third from our new product introductions. It's very -- it was a little surprising when I saw how evenly it was distributed. So that's kind of how we see the overall growth model going forward is coming from those three drivers. And, as we've talked in the past, all three of those drivers require incremental consigned sets. And so we think that the incremental consigned sets that we're going to be deploying will help all three of those areas to continue to grow the overall growth rate of the business.

Got it.

Our next question comes from Matthew O'Brien, with Piper Jaffray.

Just to start off with on the distributor side of things, we'd love to hear a bit more about how the conversions went in terms of getting your agency reps up and going there. Did you see any big churn in terms of customers or anything else like that? And then, along those lines, as you're going to do more of these have you disclosed how many more countries you're going to convert, and is that the potential, or is there a potential for some headwind from those conversions on the revenue side?

Matt, thanks for the question. The bottom line is that we were delighted by how these conversions went in the U.K. and Ireland and Australia and New Zealand. They, frankly, exceeded our expectations. And I think one of the reasons that the conversion worked so well is that there was no change in the selling organization. They were the same reps who were calling on the same surgeons. What changed was the fact that we were able to make decisions about the pace and the location of the deployment of instrument sets. And I think that's the key requirement as we would look at other stocking distributors and the conversion of those, that there not be any disruption to the relationships that sales reps, that their sales reps today have, with customers. We have not disclosed the number or the location of the stocking distributors in future. There is another one that we're working on now. But we want to take this at a judicious pace to see to it that the same success we enjoyed last year with these conversions is achieved this year.

That's helpful. And then along the lines of what Kaila was asking on the instrument side, and I may have missed this, but you've got a bunch more sets that are out there already. You're going to have even more. Can you just talk a little bit about exactly where some of those sets are going between existing and new accounts, and then the opportunity that you now have, given some of these additional resources, to open new accounts and drive even more business as we exit this year and into '19?

Absolutely. So, just to be clear, we really haven't deployed any yet. So we're getting ready to deploy the incremental sets here at the end of March, so those will start being deployed and will be completed by the end of March, and so we'll start to see some incremental revenue from that April going forward. We're really spreading it across all areas. So it's pretty evenly spread across our T&D business and our scoliosis business. It's also evenly spread across our historical product lines that we've been selling for many, many years, as well as recent product launches that we launched last year. And then as we go into future rollouts, particularly in the second and third quarter of 2018, there will be significant dollars there for the new products that we'll be launching this year.

Helpful.

Our next question comes from Rick Wise, with Stifel.

Let me start off with the sales. Mark, you commented, I think, that you'll continue to scale the sales force from the 75 currently. How do we think about maybe the ultimate right size, and how many folks are you thinking about adding this year, and maybe any incremental color about where you're going to deploy these people? Is it new regions? Is it adding to existing teams? Just any more details on that side would be helpful.

Yes, Rick, that's a very good question. The way I think about this is that in 2017 the sales force grew proportionally with our sales, and we expect that to occur again this year. I think the key point to remember is that the decision of adding more sales reps is not ours alone. We have a significant input in that decision, but the decision is ultimately made by our 33 domestic sales agencies. And so for that reason I think the structure of the selling organization is particularly scaleable in terms of where demand is growing in particular regions of the country. And for that reason we're very confident that this model is a lot better at keeping pace with our robust growth than if we were to say, well, we can only afford to hire X sales reps this year and we were to budget for it ourselves. That said, however, we are focusing a great deal of energy in California, which in particular is an enormous market, and our sales agency there has been very receptive to adding new personnel. Likewise, our business in the mid-Atlantic states is growing extremely robustly, and we have been adding sales representatives there through our sales agency.

That's great. Mark, for you, as well, maybe talk just a little about we're down -- a number of us are down in New Orleans at AAOS. I know this is not the most sort of important meeting of the year for you, but anything -- I know you all were down here, anything new competitively that we should be sensitive to, or just in general competitively?

Well, you know, Rick, we see nothing, really, in terms of competitive activity that is at all a change from the environment we have been operating in. We continue to see focused competition in the scoliosis area, as you might imagine, from companies like Medtronic and DePuy Synthes, but we see very little in the trauma and deformity area. So I would have to say that there is nothing we are seeing that would represent a significant change in the competitive environment in which we play.

Okay. And just last for Fred, two quick ones. Fred, cash ended a little over $42 million. Just help us think about the 2018 cash burn rate and where you would hope to end up the year. And last, obviously you're not giving quarterly guidance or anything, but just should we think about the flow of the quarters this year in the context of the growth rate you gave us as roughly similar to 2017? Is that the right way to think about it?

Thanks, Rick. Yes, so on the cash side, as shown in the adjusted EBITDA, in 2016 it was negative $1 million. In 2017 it's effectively breakeven. And so we're really proud of the fact that we've kind of turned that corner, and obviously with incremental revenue growth you would expect that that number would become positive in 2018. And so really the cash usage really comes down to deploying sets. And so obviously roughly this $10 million we'll be using to deploy sets in 2018 is the single biggest user of the cash driver in 2018.

Got you. And the quarterly flow?

Yes, I think it's probably similar to 2017. The growth, you would think, would accelerate maybe a little bit as these additional sets are deployed here starting in the second quarter and throughout the year. So I would guess that that's pretty similar to 2017.

Our next question comes from Ryan Zimmerman, with BTIG.

So a lot of questions I'm going to ask, but I just want to ask you certainly had gross margins stronger, I think, than we expected this quarter, and you communicated on what drove that, but just your thoughts around gross margins headed into '18 with new product introductions. Should we expect any incremental pressure on gross margins just to start in FY '18? Thank you.

Thanks, Ryan. The simple answer is no. We do not anticipate negative forces that will cause gross margins to decline due to competitive or market reasons. Likewise, the gross margins of all of our products are remarkably similar in percentage terms, and so we would anticipate that the margins of the new systems that we will launch will be comparable to those that we now have. That said, we are always trying to scratch out incremental price increases and to see some gross margin uplift in the product lines, but that certainly is not going to be anything discontinuous.

Understood. And then just to follow up, you certainly talked about the seasonality of the business, Fred, and just on the sports medicine business, I recognize it's a small portion of the business today, but it is variable quarter to quarter. Does that, in your view, start to smooth out, per se, over time as that grows? Will we continue to see some variability in that segment? Thank you.

Absolutely. Yes, I mean, obviously it's a smaller portion of the business and it'll probably smooth out as we go forward. Typically it's a little stronger in the fourth quarter actually, but, as you saw in this fourth quarter compared to last year, one of the drivers is the set sales in the international stocking distributor markets. The business is just so small if we sell a few sets that drives quite a bit of sales there. But overall it would smooth out as we go forward.

Understood.

At this time I'm showing no further questions. I'd like to turn the call back over to Mark for closing remarks.

I've already said my piece. Perfect. So I'd like to thank everyone for joining us on this call, and obviously Fred and myself are always available if there are any particular questions the shareholders might have. So thank you for your support and your participation this morning.

Ladies and gentlemen, thank you for your participation. You may now disconnect. Everyone have a great day.