OrthoPediatrics Corp. (KIDS) Q3 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q3 2018 OrthoPediatrics Corp Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call may be recorded. I would now like to introduce your host for today's conference, Ms. Tram Bui with The Ruth Group, you may begin.

Thanks, operator, and thanks everyone, for participating in today's call. Joining me from the company are Mark Throdahl, Chief Executive Officer, and 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 Form 10-K filed with the Securities and Exchange Commission on March 15, 2018, and its most recent quarterly report on Form 10-Q, which was filed last night. During 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 operations 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 live conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, November 1, 2018. Except as required by law, the company undertakes no obligation to revise or update any statements 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 thanks for joining us today on our third quarter 2018 earnings conference call. I'll begin with an overview of our third quarter performance, including the factors that are contributing to our ongoing success and future drivers of our growth. I'll then turn the call over to Fred, who will provide a detailed financial review before opening the call for any questions. In the third quarter we again demonstrated strengths across all segments of our business. This drove another consecutive quarter of record revenues of $15.8 million, representing 28% year-over-year growth. Third quarter domestic sales were up 30%, international sales up 21%, worldwide trauma and deformity up 21% and scoliosis up 52%. We were particularly pleased by the acceleration of our domestic growth rate which was led by our U.S. scoliosis business and reflected the initial benefits from the $10.6 million deployed consigned sets in the first nine months of this year. We also continue to benefit from growth in the United Kingdom, Ireland, Australia, and New Zealand, four markets that we have converted to a sales agency model and we added Canada to this group in the third quarter. We also continued to demonstrate our ability to deliver a consistent cadence of innovative products, including the full launch of our Pediatric Nailing Platform, FEMUR, expanded indications for the FIREFLY Pedicle Screw Navigation Guides and the recent 510(k) clearance for our Small Stature Response Scoliosis Systems. These new products and indications position us for future growth at industry leading levels. Overall, our outperformance reflects steady execution of our growth strategy and supports the increased revenue growth guidance to a range of 25.0% to 25.5%, as well as investment in consigned sets to $12 million for the full-year 2018. During the quarter we deployed $2.3 million in additional consigned sets and increased our target to $12 million for the full-year as we continue to address the broad pent up demand for our pediatric specific surgical solutions. While we saw the initial benefits of these new sets, we anticipate recognizing their full impact in upcoming quarters as our dedicated sales force drives surgeon adoption and utilization. This dedicated sales team combined with our 36 international stocking distributors and 5 international sales agencies is integral to OrthoPediatrics gaining more and more distance from unfocused market competitors. Therefore we are constantly evaluating the effectiveness of our sales reps as we continue to strive for the very best to represent our company. While we on boarded two full-time equivalent sales reps during the quarter, we took action on three underperforming reps and involuntarily lost a fourth rep due to noncompete issues. That being said, we expect to hit our year end goal of 92 reps as we look to supplement staffing and territories where we believe we are underrepresented. Furthermore, in addition to commencing agency sales in Canada, we expect to convert another international market during the next several months. We're impressed by the dedication of our sales team and its continuous study of the surgical procedures used by pediatric orthopedic surgeons around the world to treat the unique pathologies of children. The team continues to rise to the challenge of driving utilization of the broadest pediatric orthopedic surgical portfolio in the industry, products such as the recently launched Pediatric Nailing Platform, FEMUR. We are always delighted to receive positive feedback from surgeons who comment that they now can perform procedures they otherwise would have avoided because our company is providing the surgical solutions they never had before. Of course such feedback supports our confidence in the growth potential of our product line. These surgical solutions are the result of 12 years of deepening understanding of the unique needs of pediatric surgeons and their patients. For example, our Response 4.5/5.0 System is specifically designed for adolescent idiopathic scoliosis, rather than being based on an adult lumbar screw. It can accommodate three rod sizes intraoperatively and it boasts sophisticated ergonomic instrumentation that can help speed surgery. We estimate that smaller stature children represent 20% to 30% of scoliosis surgeries and we're excited by our expanded ability to treat this subset of patients. While we're ready to launch this new system, we have recently learned that additional testing is required to comply with new European CE Mark requirements. This is also the case with BandLoc Duo, our sub-laminar polyester banding system which is also ready for launch. We anticipate launching both systems at the end of the fourth quarter or early next year. Development has also been completed on our osteogenesis imperfecta nail and PediFoot [ph] systems. However, both are also subject to the same testing requirements and are expected to launch early in 2019. In July we announced expanded indications for FIREFLY Pedicle Screw Navigation Guides which we exclusively distributed in the U.S. and which have experienced strong surgeon adoption. These new indications include S2-Alar screw trajectory sacroiliac fixation in scoliosis. The precise nature of patient specific guidance is ideal for this challenging trajectory which crosses the sacroiliac joint. Just as a reminder, FIREFLY provides 3-D printed, patient specific navigation solutions that does not require on intraoperative radiation and thus can considerably reduce surgery time. Our partnership with Mighty Oak Medical is indicative of the new technologies that are increasingly being brought to us by companies that recognized OrthoPediatrics as their only gateway to the pediatric orthopedic market. Our partnership on active growing implants reached an important development milestone in the third quarter and we are encouraged by our progress. The spinal tethering program also proceeds on schedule. In addition to product development we continue to support clinical education and surgical societies in a manner that reflects our role as the leading pediatric orthopedic company. We sponsored the Third Annual Pediatric Orthopedic Surgical Techniques Course in Memphis, a cadaver based, multiple day course taught by a Blue Ribbon Panel OrthoPediatrics, orthopedic surgeons. It was again fully subscribed by the fellows and young surgeons for which it is designed. We helped sponsor the inaugural [ph] of New York University Hip Dysplasia course. OrthoPediatrics also supported the Annual Meetings of the American Academy for Cerebral Palsy and Developmental Medicine and the Scoliosis Research Society, both of which we attended in October. Closer to home, we announced $1 million expansion of our Indiana Headquarters, which will include dedicated training and education facilities as well as much-needed office and warehouse space. Lastly, we are excited by the growth of our social and media platform, DocMatter. At the end of the third quarter, nearly 900 surgeons had signed up which is double the number in January. This platform allows surgeons to post cases and questions to their colleagues around the world 24x7. It replicates the informal discussions that can take place during surgical society meetings. We are the only company in the orthopedic industry to have such a platform. Before turning the call over to Fred, let me note that we do not have any updates on the K2M litigation which is on hold pending resolution of the inter partes reviews is or IPRs by the United States Patent and Trademark Office. However, in the third quarter we filed three additional IPRs and the trial date for our two previous IPRs by the Patent Trial and Appeal Board remains scheduled for February 20, 2019. I'll now turn the call over to Fred for a review of our financial results. Fred?

Thanks Mark. Total revenue for the third quarter 2018 was $15.8 million, up 28% when compared to total revenue of $12.4 million for the same period prior year. U.S. revenue for the third quarter 2018 increased 30% to $12.4 million compared to $9.6 million for the same period prior year, representing 79% of our total revenue. International revenue increased 21% to $3.4 million compared to $2.8 million for the same period prior year representing 21% of our total revenue. Our third quarter revenue breakdown by product category was as follows; trauma and deformity revenue for the third quarter 2018 increased 21% to $10.6 million compared to $8.7 million for the same period last year, scoliosis revenue increased 52% to $5.0 million compared to $3.3 million for the third quarter 2017, with FIREFLY Pedicle Screw Navigation Guides having a meaningful impact as Mark previously discussed. Lastly sports medicine/other revenue for the third quarter 2018 decreased 33% to $231,000 compared to $346,000 for the same period last year. Moving down the income statement, gross profit for the third quarter 2018 was $12.0 million, a 26% increase compared to $9.5 million for the same period last year. Gross profit margin for the third quarter 2018 was 76% compared to 77% for the same period last year attributable to lower international gross margins. Sales and marketing expenses in the third quarter 2018 increased 27% to $7.2 million when compared to $5.6 million in the same period last year. G&A expenses in the third quarter of 2018 were $4.9 million, an increase of 40% compared to $3.5 million in the third quarter 2017. Third quarter 2018 G&A expense increase included $473,000 of unusually higher nonrecurring professional fees as well as $340,000 in public company costs, both of which are being excluded from our adjusted EBITDA calculation. Excluding these items, our underlying G&A expense grew by approximately 17% versus the prior year. Research and development expenses were stable at $1.1 million in the third quarter 2018. Total operating expenses for the third quarter 2018 were $13.1 million a 28% increase compared to $10.2 million for the same period last year. Operating loss for the third quarter was $1.2 million from $0.8 for the same period last year, mainly attributable to the increased operating expenses just discussed. Adjusted EBITDA for the third quarter of 2018 was $1.0 million as compared to $0.3 million for the third quarter of 2017 driven primarily by the significant increase in revenue. Net interest expense for the third quarter of 2018 was $608,000, a 20% decrease compared to $761,000 for the same period last year. The decrease in interest expense was related to the interest income on our positive cash balance resulting from the IPO in the fourth quarter of 2017. Net loss attributable to common stockholders for the period was $1.9 million compared to a loss of $3.0 million for the third quarter of 2017. Net loss per share attributable to common stockholders for the third quarter of 2018 was $.15 per basic and diluted share compared to $1.70 per basic and diluted share for the same period last year. Turning to our balance sheet, as of September 30, 2018 our cash balance was $24.5 million compared to $26.5 million as of June 30, 2018. Net purchases of property and equipment during the third quarter of 2018 were flat at $1.1 million. This investment reflects the $2.3 million deployed in consigned sets which includes procedure, specific implants, instruments and cases and trays. This compares to $2.2 million during the third quarter of 2017; however, most of which were international set sales due to the conversion of agency models from a stocking distributor in select markets. In the quarter of 2018, our independent sales agencies in the United States employed 86 fulltime equivalent sales representatives specifically most focused on pediatric orthopedics. As of September 30, 2018 total net debt was $25.4 million including $3.9 million outstanding under the revolving credit facility. One last note, we will be filing a shelf registration statement later today at Standard Corporate Governance Best Practice given it is the first available date we could file the following; our IPO last October and will be available for three years. That concludes our financial update and let me now turn the call back over to Mark for closing remarks.

Thanks Fred. October marked our first full year as a public company and we're proud of our progress over the last four quarters, outperforming expectations and building the foundation for future sustained growth. The IPO has enabled us to accelerate the strategy we established years ago. Our goal is category leadership in pediatric orthopedics. This strategy rests on four pillars. First, surround pediatric orthopedic surgeons with systems specifically designed for the unique needs of children. Second, offer outstanding clinical education for surgeons at all levels, residents, fellows, young attendings and experts. Third, grow and develop the only selling organization focused exclusively on pediatric orthopedics. Fourth, expand to all the important markets of the world. Our third quarter reflects systematic progress on these four fronts. We deployed more sets, developed more innovative new products, sponsored more clinical education programs, deepened our sales reach and competency and converted an important international market to the agency model. Our performance in the quarter gives us the confidence to increase revenue guidance for the year. More important than whether quarterly growth maybe 25% or 27% or 28%, the third quarter demonstrates that OrthoPediatrics continues to build competitive advantage as the category leader in pediatric orthopedics. And with that, we'll take any questions.

Thank you. [Operator Instructions] And our first question comes from Rick Wise with Stifel. You may proceed Sir.

All right, good morning gentlemen and sincere congratulations on the truly impressive quarter, exciting to see. Let me start if I could with some followup some additional follow-ups and comments on sets. Just in general, where are we in the new set deployment process in the third inning, sixth inning if you will of catching up Mark with pent-up demand you've bumped up the consignment set investment again now $12 million? And maybe help us reflect on is there a right normalized annual number that we should think about in years ahead?

Well, let me start and then perhaps Fred could provide additional quantification. He is closer to these decisions of deployment and specific than I am. My impression Rick is that there still is pent up demand. I think we could go higher than the $12 million where we decide to supply all of the requests of the sales force. Certainly we could go to $13 million this year and next year it would probably be at a comparable order of magnitude. We do not though just deploy sets at the unvetted request of a sales rep. We have a process internally here of doing that. And so, I don't think that we have the egregious problem that we had in past years where there were many, many surgeons who were frustrated that they couldn’t get their hands on our stuff. The other point is that there a number of new products that will require considerable set deployment and so as we look at next year where there will be additional releases of new products, I think that that will consume a fair degree of that $13 million plus bottom. Fred though, what are your thoughts on this?

Yes, absolutely. I mean as you recall Rick, we historically when we were growing the business 20% we deploy about $3.5 million. In the first quarter we launched $5.5 million and most of that was all legacy systems. We followed that up with $2.8 million in the quarter, again most of it legacy systems and then $2.3 million here in the third quarter which majority of that was this PNP new product that we launched in the third quarter that's getting tremendous response. So 10, 6, year to date increasing the full year up to $12 million, that could have probably gone higher if some of the other launches happened here in the fourth quarter those are going to roll into the first quarter and new products will be launched in the first quarter of next year. Next year we probably see something in between that $10 million and $12 million based on the rollup of the business teams right now looking at customer demand as well as the new product launches. And I would think it's going to be in that range for the next couple of years based on our cadence of new product launches and continued demand from the customer as we continue to expand the sales force.

Yes, that makes sense. If we turn to scoliosis, obviously scoliosis growth accelerated across 18 up 52% this quarter even without the just approved and my understanding very important small stature response system. So how we think about growth now looking ahead do we sustain the really truly impressive growth we've seen or does it accelerate? And maybe talk a little bit about how you're approaching commercialization there with the just approved system?

Yes absolutely. I think the first thing to keep in mind is this FIREFLY technology that we have mentioned. So we licensed that technology in July of 2017 and then launched that product into the field and we started to see some benefit of that starting in the fourth quarter of last year. So this coming fourth quarter of 2018 is the first time we're really going to anniversary where we will have comparable year-over-year in the first, second, and third quarter of this year all of that growth was truly incremental and was definitely driving some of that aggressive growth in the third quarter of 52% was tremendous. As we launched the small stature system, obviously it is not going to have any impact in the four quarter revenue, but it will start to have an impact out into next year. And as Mark mentioned, we think about 20% of the overall procedures are used for that small stature system and we will be looking for our current surgeons which is an expanding base to quickly adopt that surgery and that procedure. And then it will also really enable us to address one of the big criticism that surgeons have had for not using our other system which is we don't offer all sizes, which is a pretty understandable objection. So we're very excited about what that can do for us overall into next year and we are very, very pleased with the strong domestic growth that we saw here in the third quarter increasing to 30% as compared to 25% in the second quarter and a lot of that was driven by the initial uptake of these sets as the trauma and deformity business domestically grew very nicely for us.

Yes that's great, but just last from me, your competitor was recently acquired by a much larger ortho company, no names here, any thoughts on how would you have us think about the implications of this industry consolidation? Could there be a short term benefit for you of some kind as we've often seen in ortho industry consolidation deals where reps are freed up or there is some general disruption or and long term any sense of potential competitive dynamics or changes good or bad after the competitor is integrated? Thanks.

Yes, that's a very good question Rick and I think we have to say we do view it as n opportunity. Those of us who come from managing spine businesses and acquisitions recognize there is a huge potential dislocation, sales reps and distributors and there is a window opportunity for competitors to take advantage of that situation. I think that beyond that we see relatively little change in terms of competitive dynamics of the business. We do not see any significant activity from the one or two other companies that are much smaller than we are that purport to be focused on pediatric orthopedics. We see nothing with regard to the very large orthopedic companies that have diversified into many adult areas showing any degree of interest or emphasis in pediatrics.

Thanks again.

Thank you, Rick.

And our next question comes from Matthew O'Brien with Piper Jaffray. You may proceed.

Good morning, Mark, good morning Fred. This is Will on for Matt. Thanks for taking the questions. I was hoping to break apart the spine growth in the quarter, 52% very strong, how much of this is driven by deeper penetration versus new clinicians, and how sustainable do you see that growth from that perspective? I understand you mentioned FIREFLY was a key contributor, but just maybe a little bit more detail, maybe if new sets had an impact as well?

Yes, I think it is all of the above is the short answer. It is definitely deeper penetration within the surgeons that were using the system before. It is definitely new surgeons that are coming on which FIREFLY again is a key driver of that. And then the other point to keep in mind is it also includes global growth, so it has international growth where we would be launching sets and growing the sets and penetration in our international markets as well. So the good news is it's not any just one of those things. There are multiple drivers of the growth which continue.

I might just amplify that, there truly is a synergy here between all of the products that are in the spine business, both the 5.5/6.0 Response, FIREFLY, the polyester banding system we call BandLoc and from that standpoint we're delighted by the strength, the diversified strength of that revenue growth. And so that's extremely encouraging to us. We are however entering our fourth quarter where there is a dramatic decrease in procedure volumes of scoliosis and so this is always a difficult period to project in terms of what is going on. Finally, we also see that there is a diversified expansion of the business in terms of new accounts and then greater use of the system by surgeons who might have used it initially.

Great, thanks for that. And then the 20% to 30% of procedures, that are small stature with those being new customers to OrthoPediatrics or those existing customers?

Well, if customer means surgeon it would be the same. If it means patients, it definitely is new.

Yes, I get it, just to add to that. So the surgeons are using the system today only can use the 5.5/6.0 they're using somebody else's system for the 4.5/5.0 application. So we anticipate early adoption of those surgeons that will now be able to use all of our systems. In addition to that, we have had some pushback from a few surgeons in the past that they don't want use our 5.5/6.0 because they can't convert everything to our systems. So this will eliminate that objection and we're hopeful that over time that will enable us to convert new surgeons that are not using any of our systems today.

So there could be pull-through for the T&D franchise?

Yes, there is a definite synergy between the trauma deformity and the scoliosis businesses because we do and of course many more trauma deformity cases than we do scoliosis cases. Our sales reps are in the OR constantly with surgeons who are remember generalists, they do both of these kinds of procedures and so the brand equity that we build and trauma deformity helps us with spine and vice versa.

Great, and then just one quick followup. So if we assume a dollar in sales for a dollar of sets deployed, you know that is going to assume upside net year of about $12 million, is that still the right way to think about it? And then I would assume that there is still plenty of opportunity for upside, but just any color there would be helpful?

Yes, that's right. We do anticipate that after a 9 to 12-month period of deployed sets, they become fully utilized and we are targeting that dollar of revenue to dollar of investment. So the $5.5 million deployed in the first quarter would start to become fully utilized in the first quarter of 2019 in the second and third quarter of 2019. The $2.3 million we just launched in the third quarter is not going to be running at that one dollar of revenue to dollar deployment in the first quarter. It won't be probably fully utilized over the third or fourth quarter of next year.

Great, thanks for taking the questions.

Thanks Will.

And our next question comes from the line of Ryan Zimmerman with BTIG. You may proceed.

Good morning.

Hey, Ryan.

Hello, Ryan.

Good morning. So first off, congrats on a very strong quarter. That was a tremendous scoliosis number. Just to begin, we've done some channels checks recently on the use of the PNP product and in fact it does appear to be getting a tremendous response. And so, just so we could dig in there a little bit more and talk about kind of where we are at in the rollout of this product and how much more you have capacity for in the market with sets and your distributor risk?

Well, I think it's early days with regard to the rollout as well as acceptance and so we have been delighted by the robust response to the system. Frankly, we had anticipated that because the surgeons who had seen it in a limited release said this was the finest nailing – rigid nailing system they had ever seen for adults or pediatric application. So I think we would see there to be very significant potential for increased growth. Typically in a trauma and deformity business, the rigid nail is the most important product. It is the foundational product. And so we would anticipate this to have a lot of legs of growth left.

Okay, understood. The just turning - this is more for Fred I guess, gross margins continue to be strong, continue to trend up, directionally is there any commentary you have on where you feel gross margins could be going into 2019? Thank you for taking the questions guys.

Thanks, Ryan. Yes, so as Mark mentioned, one of the big drivers of the gross margin is our OUS agency shifting to agencies away from the stocking distributors. So we obviously have the UK, Ireland, Australia, and New Zealand, which we've had now for over year. We did in the third quarter convert Canada and it previously was a stocking distributor on a limited basis. We now have two agencies up there that are selling our products and hopefully we'll be adding a third here in the fourth quarter. We have plans to do more of that potentially in the fourth quarter or early first quarter of next year. And as we continue those conversions that definitely impacts and has a favorable impact on our margin. So right now I think it's 76% to 77% is probably the normal rate for the business and that can increase a little bit as we add additional agencies to that overall model.

Understood, thank you.

And that concludes our Q&A portion of today's call. I would now like to turn the call back over to Mark Throdahl, CEO for closing remarks.

Well, once again we'd like to thank all of you for joining us and we'd like to thank those of you who are shareholders for your ongoing support. We're very proud of the third quarter and also by our efforts to put into place the ingredients for continued robust growth of the business. So thank you all again.

Ladies and gentlemen, thank you for attending today's conference. This concludes today's program and you may all disconnect. Everyone have a great day.