OrthoPediatrics Corp. (KIDS) Q4 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Quarter Four and Full Year of 2019 OrthoPediatrics Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Ms. Tram Bui from Ruth Group. Thank you. Please go ahead.

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 most recent annual report on Form 10-K, which will be filed with the Securities and Exchange Commission shortly. During the call today, management will 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 conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, March 5, 2020. 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 2019 earnings conference call. We are very pleased with our fourth quarter results that drove a strong finish to 2019, which was our second full year as a public company. Systematic execution of our integrated growth initiatives generated another record performance, and continued to distance the company as the clear leader in pediatric orthopedics. This morning, I'll review these growth initiatives, which include expansion of our product offering, acquisitions, set investments, conversion of international stocking distributors to sales agencies, domestic sales force development, clinical education, and culture. Fred will then provide a financial review, after which we'll open the call to questions. We continued to build significant momentum in 2019 as evidenced by our industry-leading sales performance of 26% annual revenue growth to $72.6 million, which represents our 11th consecutive year exceeding 20% growth. More importantly, this performance results from helping 29,400 children in 2019. During the fourth quarter, we reported strength across our entire business, with Trauma and Deformity growing 34%, Scoliosis growing 21% and Sports Medicine/Other growing 18%, resulting in 30% total revenue growth in the quarter. This robust increase was in part driven by deploying $18.2 million of sets during the year and launching seven new surgical systems that will have a significantly greater impact on revenue growth in 2020 and beyond. 2019 also proved to be a pivotal year for OrthoPediatrics with the acquisition of Orthex and our entry into external fixation, which expands our addressable market by $200 million. Our strong sales performance in 2019 was not produced at the expense of gross margin, which increased to 75% or adjusted EBITDA which improved by $2.4 million for the full-year 2019, despite the significant and unplanned increases in quality and regulatory, which have strengthened our competitive position. The company continues to pursue the primary goal of top line growth, while also steadily improving the bottom line as a secondary objective. As we look ahead to 2020, with the strengthened the balance sheet from the successful capital raise in December, we believe that OrthoPediatrics can leverage the impact of the strongest pediatric orthopedic product portfolio on the market, supported by a sales force of 167 domestic consultants at the end of the fourth quarter, up 27% from the same period in 2018. The domestic sales organization continues to grow at a pace that supports our sales projections. Based on our performance in 2019, we are confident we will continue to execute on our growth initiatives to support our full-year 2020 revenue guidance of 22% to 24%. We also believe that investing $19 million to $21 million in consigned sets in 2020 will be sufficient because we are deploying increasingly capital efficient systems, while also beginning to realize revenue growth from the full rollout of recent product launches. Let me now highlight the progress on the execution of these integrated growth initiatives, starting with new products. Throughout 2019, we maintained an aggressive cadence of new product introductions, with seven surgical systems, bringing our total product offering to 33 systems. As we further expand the broadest line of pediatric orthopedic products on the market, we're pleased with the recent domestic launch of QuickPack bone void filler in December 2019. The US introduction of this synthetic bone graft substitute in a dual mixing syringe was the result of a new partnership with Graftys, a medical technology company committed to developing and manufacturing synthetic bone biomaterials. This product and its efficient delivery system works to fill remote bone cavities and defects commonly seen in oncology and trauma surgeries. QuickPack closes a significant gap in our product line, and when used in conjunction with other OP surgical systems, increases revenue per case. In addition to QuickPack, in November, we initiated the domestic launch of PediFoot, the first pediatric-specific system to treat deformities of the feet. This system incorporates the star lock, variable angle locking screw technology, we licensed from CoorsTek earlier in the year. The system offers the smallest plates and screws in our product line and provides greater effectiveness in addressing cavus foot, flat foot, club foot and hallux valgus foot deformities. More specifically, this sophisticated system is designed to focus on lateral column lengthening, calcaneal slide osteotomies, opening and closing wedge osteotomies and arthrodesis procedures, with innovative instrumentation that flexibly follows the anatomic movement of the bones during the correction process. Based on positive initial feedback, we look forward to an expanded rollout of this product in 2020. In September, we launched two cannulated screw systems in the US that improve efficiency and reduce time in the operating room. Similar to PediFoot, we are very pleased with the initial adoption and will ramp up production to meet increasing demand. In February 2019, we initiated the global launch of a major scoliosis line extension, BandLoc DUO that also continues to receive excellent feedback and growing utilization. We advanced our longer-term early onset scoliosis and non-fusion projects, which are a growing rod for scoliosis and a spinal tethering system. We're also pleased with the substantial progress we have made on a novel pediatric device we licensed from an adult spine company that had chosen not to support its further development. This is a different technology from the current scoliosis growing rod on the market, and we're confident that we can develop a second generation version and enhance its use. We also submitted the RESPONSE neuromuscular system to the FDA and completed development of our slipped capital femoral epiphysis system. We anticipate both products will launch in the United States in the first half of 2020. This year, we also plan to launch an Osteogenesis Imperfecta system domestically that will address the many issues associated with the primary product currently on the market for use in this surgery. We also plan to launch several additional implants acquired in the Vilex acquisition that expand our PediFoot system. Turning to Vilex, this was our first major acquisition which we made in June 2019. The purpose of this transaction was to acquire Orthex, a novel external fixation technology with revolutionary point and click software that expands our reach from 60% to 80% of the trauma and deformity correction market and opens up a new $200 million market opportunity. This transaction closed the biggest gap in our Trauma and Deformity product offering and expanded our surgeon base to deformity correction specialists who treat children outside of pediatric hospitals. We're extremely pleased with our initial integration of this product line and with multiple new account approvals, which validate our conviction that this innovative external fixation technology will thrive in the hands of our focused pediatric sales force. When we announced this acquisition, we reiterated our intention to remain solely dedicated to pediatrics by selling the adult assets of Vilex by year-end. We fulfilled this commitment with the sale of Vilex to Squadron Capital for $25 million in December. Squadron submitted the highest bid after an independent process was run by a committee of our non-executive board members. Proceeds were used to pay down the debt facility provided by Squadron, which Fred will describe in more detail. The novel Orthex technology, combined with the new systems we have launched since the IPO in 2017, are gaining considerable attention from both existing and new hospital accounts. This broad and differentiated line of products has, for the first time, enabled us to initiate discussions with major pediatric centers about OrthoPediatrics becoming their primary source of all trauma and deformity products and indicates our progress building brand recognition as the pediatric orthopedic provider of choice. From a broader perspective, however, our external fixation market penetration remains in its early stages. The sales training process and account conversions are proceeding as well as we had expected. This is a complex technology and training takes time. However, more and more reps have been formally qualified to sell the product and we have added a second Orthex specialist in the US and a third in Brazil. We look forward to continued rapid growth as we expand our addressable market and fund additional deployment of sets. Which brings me to another growth initiative – set deployments. During the year, we demonstrated our strong commitment to increasing children's access to our superior surgical solutions by consigning $18.2 million of sets, an increase of 52% compared to $12 million for the full-year 2018. This included $4.5 million deployed in the fourth quarter. We are pleased with our ability to meet increasing demand and make set investments beyond our target of $15 million to $17 million for the full-year 2019. We continue to monitor the return on each and every set deployed to drive optimal utilization. And we anticipate set deployments in 2020 will be between $19 million and $21 million. As previous previously mentioned, a majority of this investment will be focused on recently launched new products, such as our two cannulated screw systems, PediFoot, the pediatric nailing platform FEMUR system launched in 2018, as well as other capital efficient systems such as Orthex and QuickPack. To support increased set deployments and the growth of our product lines to 7,300 stock keeping units, we doubled the size of our warehouse in late 2018 and are planning to double its size again in 2020. We consolidated a significant portion of our implant supply in the hands of our highest quality and most responsive supplier. OP's business represents the vast majority of the volume of this contract manufacturer, which is located 45 minutes from our Warsaw headquarters. We also established a rapid prototype cell, thus significantly reducing lead times on prototypes used in new product development. Turning to our international and domestic sales organizations, we implemented our sales agency model in Belgium and the Netherlands during 2019 and in Italy earlier this week. We continue to be pleased with the growth in countries where we have converted stocking distributors to sales agencies, which enables us to sell directly to end customers at full hospital prices and gross margin. Furthermore, in 2019, we added one international stocking distributor as we expanded to 43 countries serviced outside the US, bringing us to a total of 39 stocking distributors and eight sales agencies at this time. During the year, we created a new European legal entity headquartered in the Netherlands. We transferred a trusted senior executive to serve as our first European managing director, established banking relationships, introduced accounting systems and implemented pan-European logistics capabilities. Also related to our international operations, we addressed a major regulatory affairs challenge posed by new requirements of the Medical Device Single Audit Program, or MDSAP, and by the new European Union Medical Device Requirements, or EU MDR. This challenge required a significant increase in full-time professionals as well as unbudgeted consulting fees. While the personnel cost is now part of our G&A expense base, consulting expenses should somewhat moderate in 2020. We are confident that this investment in quality and regulatory capabilities will support our aggressive international growth at a time when many companies are dropping hundreds of their products once sold in the European Union. In addition to muscle building our international infrastructure, we increased the size of the domestic selling organization from 131 to 167 sales personnel, an increase of 27%. We continue to work with our distributor partners in the US on strategies for scaling their organizations appropriately to keep pace with the company's growing product line. At the end of 2019, we had 38 domestic sales partners. We are actively managing these partnerships to ensure that every territory achieves a balanced sales performance among our businesses. We established a new domestic sales management structure, increasing our regional sales executives from four to six. Three of the six specialists are now focused exclusively on Trauma and Deformity, while three are focused exclusively on Scoliosis. Clinical education remains fundamental to our business and we allocate approximately 3% of our revenues to training the next generation of surgeons entering the dynamic field of pediatric orthopedics. This investment represents more than simply influencing potential users and advocates of our products. It helps us stay on the cutting edge of clinical developments, advances the field of pediatric orthopedics, and enables children around the world to have better access to appropriate surgical care. The company remains the Double Diamond sponsor of the International Pediatric Orthopedic Symposium, the only diamond sponsor of the European Pediatric Orthopedic Society, a platinum level sponsor of the American Academy of Cerebral Palsy and Developmental Medicine, a gold level sponsor of the International Meeting on Advanced Spine Techniques, and a gold level sponsor of the Scoliosis Research Society. In 2019, we significantly increased our sponsorship of the prestigious Baltimore Limb Deformity Course. We conducted the fourth annual International Children's Spine Symposium, the third Annual Pediatric Orthopedic Surgical Techniques course and the Akron and PediOrtho WEST resident review courses. We also provided scholarships to some 80 residents and fellows to attend important surgical meetings and we funded multiple full-year academic fellowships for promising young surgeons at leading pediatric centers. This past June, we hired a VP of Sales Training and Clinical Education. This new role will focus on developing innovative clinical and sales training programs, some utilizing novel technologies. Our DocMatter surgeon community now has approximately 1,200 followers, representing nearly half of the pediatric orthopedic surgeons in the world. Surgeons utilizing this platform can post cases and pose questions 24/7. During the year, we initiated a number of programs to enhance the OP customer experience. These programs include frequent surgeon visits to Warsaw to meet with our technical staff to review our product development initiatives. We also conducted our first surgeon satisfaction survey on products, clinical education programs, sales support and responsiveness, which produced an average grade of 3.67 out of 4.0 and triggered several continuous improvement initiatives. Finally, our company's culture remains at the foundation of our past success and our future prospects. Culture is our most valuable asset, particularly at a time when many orthopedic companies have suffered through repeated restructurings in the wake of M&A activity. Few companies emphasize culture as we do, and this is evident in being recognized as one of the best places to work in Indiana for the fourth year. In a selection process which entails pulling employees at thousands of companies by the Indiana Chamber of Commerce, less than 100 companies are designated for this honor. We'd like to recognize our employees and partners that helped us achieve success in 2019 in multiple dimensions of performance. With that, let me now turn the call over to Fred to review our financial results. Fred?

Great. Thanks, Mark. Total revenue in the fourth quarter of 2019 was $19.0 million, up 30% when compared to $14.6 million for the same period in 2018. US revenue in the fourth quarter of 2019 increased 30% to $14.2 million when compared to $10.9 million in the same period last year, representing 75% of total revenue. International revenue in the fourth quarter of 2019 was $4.8 million, a 32% increase, compared to $3.6 million in the same period last year, representing 25% of total revenue. Total revenue in 2019 was a record setting $72.6 million, a 26% increase compared to $57.6 million for 2018. US revenue in 2019 was $55.1 million, a 27% increase, compared to $43.5 million for 2018, representing 76% of our total revenue. International revenue in 2019 was $17.5 million, a 24% increase compared to $14.1 million for 2018, representing 24% of total revenue. Our fourth quarter and full-year 2019 revenue breakdown by category was as follows. Trauma and Deformity revenue in the fourth quarter 2019 was $13.6 million, a 34% increase compared to $10.2 million in the same period last year and $49.4 million in 2019, a 24% increase compared to $39.7 million in 2018, driven particularly by the addition of the Orthex hexapod deformity correction system, new product introductions, and our increase in deployed sets. Scoliosis revenue in the fourth quarter of 2019 was $4.9 million, a 21% increase compared to $4.1 million in the same period last year, and $21.5 million in 2019, 29% increase compared to $16.7 million in 2018, driven by continued product acceptance, customer adoption, combined with our increase in deployed sets. Lastly, Sports Medicine/Other revenue in the fourth quarter of 2019 was $430,000, representing an 18% increase compared to $365,000 in the same period last year. Sports Medicine/Other revenue in 2019 was $1.7 million, a 41% increase compared to $1.2 million in the same period 2018, driven by continued product acceptance and an increase in deployed sets. Nearly all of our revenue continued to be driven by increased unit volume. Moving down the income statement, gross profit for the fourth quarter 2019 was $14.5 million, a 37% increase compared to $10.5 million in the same period last year. Gross margin in the fourth quarter of 2019 was 76% compared to 72% in the fourth quarter of 2018. The increasing gross margin was attributable to increased domestic sales at strong margin, as well as an increase in international agency sales. Gross profit in 2019 was $54.6 million, an increase of 28% compared to $42.7 million in 2018. Gross margin in 2019 was 75% compared to 74% in 2018. Sales and marketing expenses in the fourth quarter 2019 increased 28% to $8.4 million when compared to $6.6 million in the same period last year. And full-year 2019 sales and marketing expenses increased 18% to $31.3 million when compared to $26.6 million in 2018. This increase was driven by an increase in unit volumes sold and associated commissions in the US, the additional commissions being paid in the international markets that we have transitioned to the agency model and ongoing marketing expenses. General and administrative expenses in the fourth quarter 2019 were $7.2 million, an increase of 59% compared to $4.5 million in the fourth quarter of 2018. This increase was driven by higher depreciation and amortization expense, higher quality and regulatory expenses, and the addition of the Orthex expenses not there in 2018. Full-year 2018 (sic) [2019] G&A expenses were $26.7 million, an increase of 27% compared to $20.9 million in the prior year. The increase was primarily due to the addition of personnel, resources, consultants, and external testing to support the increased quality and regulatory requirements placed on the industry, as well as an increase in depreciation and amortization, resulting from the aggressive increase in deployed sets in 2018 and 2019, as well as our recent acquisition. Research and development expenses increased 49% to $1.9 million in the fourth quarter of 2019 when compared to $1.3 million in the same period last year, and increased 21% to $5.7 million compared to $4.7 million in 2018. The increase was due to support of product validation and launches, in addition to the development of our future product pipeline. Total operating expenses in the fourth quarter 2019 were $17.5 million, an increase of 41% when compared to $12.4 million in the fourth quarter of 2018. Total operating expenses in 2019 were $63.7 million, an increase of 22% when compared to $52.2 million in 2018. Operating loss in the fourth quarter of 2019 was $3.0 million compared to a loss of $1.9 million in the fourth quarter of 2018. And the full-year 2019 was a loss of $9.1 million compared to a loss of $9.6 million in 2018. Adjusted EBITDA for the fourth quarter of 2019 was a negative $0.9 million compared to a negative $0.9 million for the fourth quarter of 2018. Adjusted EBITDA for the full year of 2019 was a negative $1.1 million, an improvement from a negative $3.5 million for the full year of 2018. The change was primarily driven by the increase in revenue and associated gross margin. Interest expense in the fourth quarter of 2019 was $1.3 million compared to $0.5 million for the same period last year and was $3.5 million for 2019 compared to $2.3 million for 2018. The increase in interest expense was due to interest associated with the financing to support our Orthex acquisition, which we fully paid off at the end of the year, and I will discuss in more detail. Net loss from continuing operations for the fourth quarter 2019 was $4.3 million compared to a net loss of $2.5 million in the same period last year. Total net loss including discontinued operations for the fourth quarter of 2019 was $5.4 million or $0.36 per basic and diluted share attributable to common stockholders compared to a loss of $2.5 million or $0.19 per basic and diluted share for the same period last year. Net loss from continuing operations in 2019 was $12.7 million compared to $12.0 million in 2018. Total net loss including discontinued operations in 2019 was $13.7 million or $0.94 per share attributable to common stockholders compared to a loss of $12.0 million or $0.96 per basic and diluted share in 2018. Turning to our balance sheet. As of December 31, 2019, our cash balance was $72.0 million compared to $19.7 million as of September 30, 2019. As a reminder, in December, we raised approximately $60 million in net proceeds from our secondary public offering after deducting, underwriting discounts, commissions and offering expenses. Also, as Mark previously mentioned, we completed the sale of substantially all of the assets related to the adult product offering of Vilex at the end of 2019. As consideration for the Vilex adult business and the Orthex adult license, the amount we owed under our term note B payable to Squadron Capital was reduced by $25 billion. We repaid in full the remaining $5 million of our principal outstanding under the term note, plus all accrued interest, with funds received from our revolving credit facility. As of December 31, 2019, total net debt was $26.2 million, which does include the $5.0 million outstanding under the revolving credit facility. I also wanted to highlight a new line on the balance sheet called deferred revenue. This consists of the unearned portion of the exclusive license arrangement to allow the new owner of Vilex the ability to sell products using the Orthex technology to non-pediatric accounts. This deferred revenue will be recognized on a proportional basis across the term of the agreement, effectively recognizing royalty revenue and income over time. The remaining $12.5 million of the total $25 million purchase price went against the Vilex assets sold. The change in net purchases of property and equipment during the fourth quarter of 2019 was $1.3 million as compared to a negative $58,000 for the same period last year and was $11.8 million in 2019 compared to $5.3 million in 2018. This investment reflects the deployment of consigned sets, which includes product-specific instruments and cases and trays. Including the implants, $4.5 million of consigned sets were deployed during the fourth quarter of 2019 compared to $1.3 million during the fourth quarter of 2018. As Mark mentioned, this is a substantial increase over our historical annual deployment prior to our IPO and one of the key growth drivers. In terms of guidance, we anticipate 22% to 24% annual revenue growth for 2020. Additionally, we plan to increase our annual investment in consigned sets to a range between $19 million to $21 million in 2020. While we don't provide EPS guidance, I do think it's worth mentioning an estimated $2 million increase in depreciation/amortization we expect to see in 2020 as a result of our aggressive set launches and acquisition-related intangibles. I'd also like to mention the third year of our three-year cliff vesting restricted stock, which will increase non-cash restricted stock compensation by approximately $2 million in 2020. Now, let me turn the call back to Mark for closing remarks.

Thanks, Fred. To summarize, our performance in 2019 was driven by systematic execution of multiple growth initiatives, many of which we initiated years ago. All three of our businesses reported strong growth. And we believe that our diversified revenue base holds the promise of consistent future performance and supports 2020 revenue guidance of 22% to 24%. We appreciate the support of both legacy and new shareholders that helped us close the recent $60 million capital raise that gives the company the financial flexibility to support our ongoing growth, including $19 million to $21 million of investment in consigned sets in 2020 and further development and acquisition of new products and technologies. But most importantly, we are pleased that our exclusive focus on pediatric orthopedics has allowed us to change the lives of over 165,000 children since our inception. This volume of surgeries is highly unusual for a company of our size and is a testament to the strength of our product offering and our deep relationships with pediatric orthopedic surgeons. We look forward to continuing advancing the field of pediatric orthopedics, while we also drive increasing shareholder value. And with that, we'll open the call up to questions. David Bailey, our Executive Vice President, has joined us this morning. And I'm sure between the three of us, we'll do our best to answer them.

Thank you. [Operator Instructions]. Our first question is from Rick Wise of Stifel. Go ahead, please.

Good morning to you both. Thank you for the fantastic question. Let me start off, and I apologize for – after the outstanding results and the brilliant outlook for the year ahead, starting on the COVID-19 situation, just if you could help us think through the potential – any concerns that the coronavirus issues might have on supply chain, on manufacturing, on procedures? Remind us about China or Asia-Pac exposure. And separately, with your direct push into Italy, how are you thinking about the situation there? Again, sorry to start there, but just it would be good to hear your high-level thoughts on all that.

Absolutely, Rick. Let me take a stab at this. So, I guess, first of all, we do not sell any products in China. So, that's the first statement. I would say that less than $1 million of our revenue today or maybe 1% of the $73 million comes from Italy and Japan. Obviously, we just completed the Italy transaction. We would do that with or without this going on. And we're very excited about that transaction. I think the majority of this million dollars is really coming from deformity correction surgeries, and can be delayed. The remaining is very small and would be trauma related volume, which is obviously not deferrable. If we look around the supply chain, we have one very, very small supplier that we do get products from China. They were on a two-week shutdown. That has been completed as of last week, and they are now shipping products again. It's probably less than 1% of our SKUs comes from China. So, we think that will have a minimal to zero impact on us. The one thing we are keeping an eye on is currency fluctuations. The Brazil currency has changed by about 30% in the last eight weeks. And while it might not all be related to this, they are pointing to this as one possibility. And so, we're keeping an eye on that. And then, we may see – I would say we haven't yet, but we may see some delays in surgeries maybe in Italy and other places in Europe, but it's a very, very small portion of our overall revenue. So, I think it's early days as of right now. It's obviously developing day by day. We don't feel it's impacted the business at all as of today, but we'll see what happens in the next several months.

Thanks for the thorough answer. Turning to the 2020 outlook and the growth guidance, again, very impressive 22% to 24%. But just help us, maybe at a high level first, reflect on the fact that the revenue base keeps getting larger, and yet you're sort of stepping up your 2020 revenue growth outlook to 22% to 24%, step up in growth versus the past few years. So, Mark or Fred, talk about the factors in your guidance. Clearly, new products, more people, I heard you clearly, but what gives you that extra confidence that the business can sort of step up that growth? And given your wonderful consistent track record of outperformance, what factors/elements do you think give you confidence at the high end or potentially could be better than as we contemplate 2020?

Well, Rick, I guess my take on that is that we have – any businesses faces theoretical concerns going forward. But when we look at the tremendous success of Orthex so far, the fact that it is outstripping the growth rate of the company as a whole, when we look at seven new surgical systems introduced last year, many of which were late in the year and have really not even begun to contribute. And finally, when we look at the growth in infrastructure, both sales infrastructure as well as capabilities internally, in quality and regulatory that are here at a time when many companies are dropping products internationally, I think we think that those strings would trump any potential headwinds that company might face.

Yeah, I would just add, particularly on the Orthex side – sorry, Rick, let me just add a couple of comments on the Orthex side. Absolutely agree. And it's going to be particularly important in the first two quarters because it is all incremental revenue. And then, obviously, in the second two quarters, we'll anniversary having the product last year. So, that's a factor. And I also think, the significant investment in sets that we've done, not just 2019, but the significant increase we've done in 2018 and 2019, those combined, I think, enable us to feel like we've made the investments in sets, in people, growing the domestic sales force and our international agencies gives us confidence in that 22% to 24%.

Thanks. And just one last quick one from me. It's not the first time I've heard you, Mark, call out the attention you're getting because of Orthex specifically and what the impact on your total product line from – your language was from new and existing accounts to be a primary source of all pediatric products. I don't know if it's the right question. Please reframe if it isn't. But how many accounts of all your accounts are you? In fact, the primary source of all pediatric products. And how do we think about that march forward? Is this something we should be asking about and tracking and paying attention to? Obviously, that's a meaningful statement. Thank you.

Yeah, there remain very few accounts where we are in that position of being the primary source. I can only think of one or two at the moment. What is encouraging to me, however, is that several of the largest pediatric centers in the United States are now engaged in discussions with us about this and we're seeing a very significant increase in revenues from them. And this rolling ball will collect more and more mass as our image, our brand equity continues to grow. I think we would hesitate – Fred would blanch if we said that we would start sort of revealing where we are account by account because, of course, that gets us into telling you more about penguins than you need to know.

Never enough. But thanks.

Thanks, Rick. Wonderful questions as always.

Thank you. The next question is from Matt O'Brien of Piper Jaffray. Your question, please.

Hi, guys. Good morning. This is Drew on for Matt. Thank you for taking the question. I guess just to start out, I kind of wanted to talk about the progression of the spine business. Obviously, it's grown pretty significantly over the last couple of years. I guess what type of new surgeons are you attracting? Are these dabblers or high volume users? And then, has that changed from early days in the company's history?

Why don't we ask Dave to answer that question?

Drew, that's a great question. It's Dave Bailey. I think we're seeing an expansion of our user base across both of those customers. The dabblers, those customers who do, let's say, less than 15 scoliosis procedures a year, as well as starting to be taken much more seriously by a number of the major scoliosis centers in the United States. And I think what we believe is driving that, obviously, it's just a perpetual increasing of our credibility with those customers as our spine business and our scoli business grows, but also our commitment to some of these very novel, unique technologies and the development of those technologies for true unmet needs in scoliosis, such as the growing spine and early onset scoliosis. So, I think those factors are improving our image and our credibility with customers across the spectrum of usage.

Got it, thank you. And then, on your set deployment guidance for the year, you're guiding to $20 million bucks at the midpoint. This is a target you put out every year and beat and I expect you're being pretty conservative with the outlook there once again. So, I guess the question is, are you starting to feel that you're getting to the point where sets in the field is not constraining the growth of the business in any way? Or are you still a long way from that point yet? Thank you.

I think we're still a long way from that point. There is still tremendous demand for sets. But what we are trying to emphasize in this message is that we're now beginning to back the deployment of more capital efficient sets. The Orthex sets are much more capital efficient than most of our legacy sets with the possible exception of Pedi plates, which remains a tremendous money earner, and QuickPack will be even more capital efficient than Orthex. And so, we can stretch the $20 million investment grosso modo and get enormous traction from it as a result. Fred might be able to provide, though, a more precise answer to that question.

Yeah, that's exactly right, Mark. In 2019, we increased our set deployment by 50% over 2018. In 2020, we're projecting an 11% increase at that midpoint. And I think to Mark's point, yes, there is tremendous demand out there for sets and we're trying to be more measured, I think, in 2020 on those efficient sets and we feel like we'll get more revenue dollars for it. Orthex is a tremendous example, in that we get $20,000 to $30,000 for a surgery and the set costs about $40,000. Our Scoliosis business, we get about $20,000 per surgery and our set costs $200,000. So, Orthex, we're very, very pleased with that not only product technology, but also the capital efficiency of that system.

Very helpful. Thank you.

Thank you, Drew.

All right. Our next question is from Ryan Zimmerman of BTIG. Go ahead please.

Thank you. Thanks for taking the questions. Congrats on all your progress, guys. Want to start with guidance, follow-up on some of Rick's questions earlier, some of his great questions earlier. Just on the cadence of guidance for the year, we have a couple dynamics going on between, certainly, the inorganic contribution of Orthex, you have some of the seasonality that you typically see and seasonality with pediatric patients in the summer. And so, maybe you can just comment kind of on the cadence of growth for the year and how you see that kind of playing out.

Absolutely. Yeah, that's the point I was trying to make earlier is the growth we feel in the first two quarters is probably going to be slightly higher than the growth we see in the third quarter and the fourth quarter. With that being said, we think that the pattern that we have seen in the last five years in our business as far as the third quarter still being the largest quarter, followed by the second quarter and then the fourth and then the first, is the same pattern we'll see in 2020.

Okay, that's helpful. And then, on Orthex for a minute here, you commented certainly on the ability to train your sales force, but maybe if you could indulge me a little bit in terms of Orthex, where are we at in terms of its contribution? And I know maybe not maybe disclosing specifically, but do you feel like you're seeing growth from the sales force on Orthex and [indiscernible] or are we are still on a position where it's the legacy Orthex and we haven't seen the impact of training the sales force yet and that's to be seen over the balance of 2020 once you do kind of really get it out there in the field.

Actually, we are seeing the impact of new accounts with Orthex, new users. And so, while the legacy business is there, it is not supporting the growth, but this has been very steady actually. So, this is a new user, new sales rep selling the product kind of story.

I'd also add that this product is really brand new. When we bought it, it was maybe three years on the market. It maybe had a handful of users because, again, they were adult foot and ankle business and they didn't have a channel to market. And so, we're really in the very early stages of this thing and it's very exciting for us not only in 2020, but for the next five years as we continue to increase the training the sales force.

Ryan, this is Dave. One last thing I would say is what, I think, I'm really pleased with seeing is that this technology and the enhancement of our overall technology platform is also driving interest from sales reps and new reps without history with selling external fixation devices. So, we're hoping using this technology also to expand our selling organization. And while we're growing very competent with the device through our own organic sales training initiatives, we're also getting much, much more healthy, at least in terms of our understanding of these very complex procedures because of additions to our selling organization that have had historical experience with very complex, three dimensional external fixation devices.

That's very helpful. Thank you for that color. And then, just squeeze one last one in and I'll hop back in queue. International is a bright spot this quarter. Are there any one-time larger orders and stock in there to call out or is that all just kind of steady as she goes orders? Thank you.

Great question. We're very pleased with the mix of sales between our agencies and our replenishment stock. I would say we were less dependent on those stocky sales in the fourth quarter than we have traditionally. And I think it's reflected in the gross margin that we see in the overall business. It is a focus point for us to get to a steady growth of more replenishments and agencies and have much less of a dependency on set sales. And we took a big step forward in that regard in the fourth quarter.

Thank you very much.

Thanks, Ryan.

All right. Our next question is from Michael Matson of Needham. Go ahead please.

Yeah. Hi, Mark and Fred. It's David on for Mike. Thanks for taking the questions. So, the first one just on the sales force. You've grown the sales force pretty significantly. So, how are you thinking about managing that round of hiring? And then also, revenue growth is kind of tracking sort of in line with the rate of sales force expansion. So, any initiatives you have in place to kind of drive productivity and get newer reps up that curve a little quicker?

Well, you're quite right in observing that the sales force growth mirrored that of revenues and that has been the case the last couple of years and it has occurred more or less spontaneously. We're not setting targets for particular people. It's simply the way this thing is evolving naturally. I think that we remain in the mode of not worrying about driving sales force efficiency and leveraging that investment in some way, in large part because it's not our investment to leverage. It's not on our P&L. We simply pay a commission for sales as they are occurring. I think that the key thing that's occurred is that we had increased the number of our own field sales managers who are our employees from four to six and then have attempted to specialize. Three of them only focus on Trauma and Deformity and three only focused on spine and this is having a very significant impact on the pressure being applied to our sales partners in the United States in terms of turning in a balanced sales performance among all of our businesses, rather than just focusing on Scoliosis or just focusing on Trauma and Deformity. And that is actually working even better than I would have thought.

Great. That's helpful. And then, on the gross margin, that saw some pretty strong improvement this year and it sounds like a lot of it was geographic mix. Going into 2020, you have some new product launches and then converting some international distributors to sales agencies. How should we think of the improvement in 2020? Thanks.

Absolutely, David. So, yes, we've very pleased with what we saw, particularly in the fourth quarter and our 75% overall for the year. I would say that we're going to be probably in that range in 2020. Italy will help us slightly. It's not a tremendous size today. We'll be looking to grow that in the future, but that immediate transition will not change it dramatically. So, we'll be looking to keep it in that 75% range, growing over time, but very slightly.

Great. Thanks so much, guys.

Thanks, David.

Our next question is from David Turkaly of JMP Securities. Go ahead please.

Yeah, good morning. This is actually Dan on for Dave. Thanks for taking the questions. Just first off, going back to consigned sets, deployment in 4Q came in strongly than we had expected. So, just curious if you could touch on what led to that during the quarter, whether it's more opportunistic or just as a means of meeting demand for your new product launches? And then, just looking out to 2020, how should we think about investment cadence for sets? Should it be no more similar to 2019 as far as getting the sets on the field prior to the busier summer months? Thanks.

Yeah. Great question, Danny. Good to have you on the call. The fourth quarter, we are very pleased with. The majority of that was new product related launches. And to your point, the cadence is going to be similar to 2019 where we want to get as much of the stuff out in the first quarter and the second quarter to get ahead of that summer selling season, get those assets in the field before then. And then, typically, the third and fourth quarter is kind of reserved for a few other sets, but whatever our new product introductions are throughout that time period as well.

Great. And then, just as a follow-up, I know you talked about all the recent changes to the balance sheet, but just wanted to ask heading into 2020, how do you view your capacity for acquisitions. Obviously, have some adequate room for tuck-ins to the portfolio, but any idea how large of an acquisition, your balance sheet could shoulder at this point and any areas that you feel there's still gaps in your offering that you'd want to sell? Thanks.

Yeah, great question. So, we do have cash on the balance sheet, which is great. We're very pleased with our endeavor in December to put some more cash on the balance sheet to support the operations, more set sales. As you can imagine, we use some of that $72 million to eliminate the $5 million line of credit usage early this year to save some interest, but we still have plenty of cash available. As we look at acquisitions and we look at product offerings in general, there are still some gaps in the portfolio. We're working on filling some of those internally and there's definitely some assets out there that would help us fill those gaps faster as well. As far as size, we have some cash. If it was dramatic – I don't know what it would be, but if there was dramatic, we could go back to the market again in the future. We, obviously, have enough cash as we sit here today for the next several years and an acquisition would be the only thing that may require us to come back to the market. So, we feel really good about where we're at, particularly some of the volatility in the marketplace right now. We have plenty of cash on the books and we continue to look for assets, as you said, to build those product gaps.

Great. Thanks so much, guys.

. :

Hey, guys. Thanks so much for taking our questions and congrats again on the progress in the fourth quarter. So, two quick ones from us. On set deployment, you guys gave some color as to what segments of the business you'll be investing in and you're growing set investments. But it is at a lower rate than prior year. So, can you just remind us about the capital efficiencies behind set investments with Orthex just relative to other areas of your business? Any additional color there would be helpful.

Sure. We're deploying sets in all of our systems – legacy systems, new products that were launched in 2019 and new products that will be launched in 2020. But we are trying to be more disciplined and focused on those sets that are more efficient. And Orthex is just a great example. We love the technology of the product, but the asset utilization is tremendous. As I mentioned, I think before the – a case maybe builds out at $20,000 or $30,000 for Orthex and a set maybe costs $30,000 to $40,000 for Orthex compared to our scoliosis system, a $20,000 surgery with a $200,000 set deployment. So, we just get a lot more leverage, a lot more utilization on the Orthex side of the business than some of our other systems. And even within our Trauma and Deformity product lines, we have some that are much better than others. With that being said, at the IPO, we said we're targeting a dollar of revenue for every dollar that was deployed and we feel very good about that metric. We still are very confident in that metric. It's a 12 to 18-month time period delay before all of the sets are up to speed and running, but we still feel good about that metric and think it's the right metrics going forward.

I think we're also trying to signal, Kayla, that we are very concerned as a company about capital efficiency. And in fact, the investment decisions we make, any future acquisitions, much like the Orthex thing will have to have capital efficiency box ticked. And so, I think that will keep us from needing to be on a treadmill to oblivion to increase capital deployments at the same pace as revenue growth indefinitely.

That's really helpful. Thank you, guys. That's great color. And then, just on EBITDA – and thanks, Fred, for your comments there on the quarter. I'm sorry if I missed this, but can you just give us the sense for any items that you view as sort of more one time in nature? And how we should think about go-forward spending? Should we still be modeling EBITDA profitability in the coming quarters? Just want to understand sort of the puts and takes there? Thank you.

Absolutely. So, you can see in the adjusted EBITDA section on the last page of the press release some of those adjustments. But, really, the other things that are not called out in here in the fourth quarter are really heavy quality and regulatory spending along with validation. The new requirements from the MDSAP, the new requirements from the EU MDR were tremendous. A lot of new requirements. And so, we worked very hard to make sure that we're up to speed in complying on those. We made tremendous progress in 2019. We've got some more work to do in 2020. And as Mark said, the additional staff that we brought on, there will be some additional consulting fees, some additional validation fees, but a lot of those expenses were very heavy in the fourth quarter. And as you saw, we had $900,000 of loss – adjusted EBITDA loss in the fourth quarter compared to a negative $1.1 million for the full year. So, very heavy in the fourth quarter. We feel like we did get some of those out of the way, some will continue, but we made a tremendous amount of progress. As we look at the business and growing 22% to 24%, we're still definitely confident in our statement that sales and marketing is probably going to continue in the same range. R&D is probably going to continue in the same range and we're going to try to leverage the G&A side of the business. It is more and more challenging because, as I mentioned earlier, we have a $2 million increase in depreciation and amortization in 2020 compared to 2019 and we have a $2 million increase in non-stock – restricted stock expense in 2020 as we reach our third year of cliff vesting in our restricted stock. But with that being said, we're still committed to leveraging that segment of the business and having those expenses grow at a slower pace than the revenue.

Great. Thank you, guys.

Our next question is from Jon Braatz of Kansas City Capital. Your question please.

Good morning, Mark, Fred.

Hi, Jon.

Mark, in your commentary, you mentioned that you're pursuing maybe some exclusive arrangements with some – to be the exclusive provider of orthopedic equipment to hospitals. What does that really mean? What are the opportunities if you were to obtain some exclusive arrangement?

At a large account of it would be in the millions of dollars, several million dollars of incremental revenue.

Is this something that would be unusual for a hospital to do and it would be out of the ordinary?

No. In fact, many of these accounts, years ago, by default had to use Synthes as their primary supplier because these were adult instrument systems that were the only ones available, surgeons were used to MacGyvering bring their way through procedures with those systems, very few were ever developed for pediatric use specifically. And so, there are still a number of legacy contracts out there with companies like DePuy Synthes which we have been chipping away at quite systematically over the years and now are reaching a tipping point because we have this product line that is fully comparable except it's all developed for pediatric patients.

How quickly do you think something like that could – an arrangement could be achieved?

Everything in the hospital world goes slowly. So, it will be a gradual thing. But it's encouraging that we're beginning to see that now. There are two or three accounts that immediately pop into mind and we're seeing significant increases in revenue there at the expense of the very company I just mentioned.

Okay. All right, Mark. Thank you very much.

Hey, thank you, Jon.

That ends our Q&A session. I would now like to turn the call back to our presenters.

Well, I'd like to thank you all for your interest in the company and for joining us on today's update and we look forward to keeping you posted on our continued progress. Thanks again.

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