Welcome to the Fourth Quarter and Full-Year 2020 OrthoPediatrics Corp. Earnings Conference Call. My name is April and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions]. Please note that this conference is being recorded. I will now turn the call over to Christine Petraglia. Thank you. You may begin.

Thank you, operator, and thanks everyone for participating in today's call. Joining me from the company are Mark Throdahl, Chief Executive Officer; Fred Hite, Chief Operating Officer and Chief Financial Officer; and David Bailey, President. Before we begin, I would 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, including among others, the risks related to COVID-19, the impact such pandemic may have on the demand for the company's products and the company's ability to respond to the related challenges, I encourage you to review the company's most recent quarterly report on Form 10-K, which will be filed with the Securities and Exchange Commission soon. 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 the 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 the 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, today, March 11, 2021. 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 thank you for joining us today on our fourth quarter and full-year 2020 earnings conference call. We stand at the one year anniversary of the COVID-19 pandemic, which is the greatest public health crisis in a century. 2020 reminded us how fortunate we are to partner with surgeons and healthcare providers who so deeply impact the lives of patients and their families, particularly during the past year. 2020 also brought out the best in our company and our associates, who rose to meet unprecedented challenges, found new ways of working, demonstrated resilience, and most importantly, continued the disciplined and consistent execution of our growth strategies. Their efforts position us well as we emerge from the pandemic stronger than when we entered it. On March 16, 2020, we closed our office and began working remotely. My colleagues and I immediately resolved to stabilize our employee base by announcing that there would be no job cuts or salary reductions. We stabilized our sales organization by making available low interest loans to our 36 domestic sales agencies and reassured suppliers that we would not reduce orders for new consignment inventory. We continue to stand by pediatric surgical societies throughout the world that depend on our leading financial support. And we were the only industry sponsor that did not reduce or eliminate its financial contributions to these organizations in 2020. I'm proud that OrthoPediatrics has managed through the pandemic in a manner befitting a company that has been recognized as one of the best places to work in Indiana, recently, for the fifth year. As a result of the resilience of our people, we delivered full year sales of $71.1 million, down 2% from 2019, primarily due to fewer elective deformity surgeries and international stocking distributors who were affected by…

Thank you, Mark. Total revenue for the fourth quarter of 2020 was $18.9 million, a 0.1% decrease compared to $19.0 million in the same period last year. US revenue for the fourth quarter of 2020 was $17.9 million, a 26% increase, compared to $14.2 million for the same period last year, representing 94.3% of total revenue. International revenue for the fourth quarter of 2020 was $1.1 million, a 78% decrease compared to $4.8 million for the same period last year, representing 5.7% of total revenue. In December 2020, we recorded a $2.7 million revenue reduction due to the repurchase of inventory from a large stocking distributor in Germany, Austria and Switzerland as we converted the DACH region to a sales agency model. The $2.7 million reduction impacted fourth quarter total revenue growth by a negative 14%. Total revenue in 2020 was $71.1 million, a 2% decrease compared to $72.6 million for 2019. US revenue in 2020 was $63.0 million, a 14% increase compared to $55.1 million for 2019, representing 89% of total revenue. International revenue in 2020 was $8.1 million, a 54% decrease compared to $17.5 million for 2019, representing 11% of total revenue. The aforementioned $2.7 million reduction of revenue impacted total year 2020 revenue growth by negative 4%. We're strongly encouraged that we could build on the momentum we carried from the third quarter to deliver accelerated domestic growth in the fourth quarter of 2020. Outside of the US, as Mark has mentioned many times, with fewer standalone pediatric hospitals, ex-US procedure trends are taking longer to normalize and recovery in the international market continues to lag the recovery seen thus far in the US, which again resulted in little to no set sales during the fourth quarter of 2020 to our stocking distributors. That being said, international…

Thank you, Fred. While we have not yet emerged from the COVID pandemic, we have recently seen a significant uplift in sales to international stocking distributors. This turnaround, coupled with strong international sales agency growth, should correct the performance issue we had in 2020. With continued domestic growth and strong synergies from Orthex, ApiFix and Telos, we believe that the company will indeed emerge even stronger from the pandemic than when we entered it. As always, this is due to the dedication of our associates around the world who have risen so admirably to the challenges of the past year. OrthoPediatrics' designation as one of the best places to work in Indiana, recently named that honor for the fifth year, reinforces our conviction that our performance in 2020 and our outlook for 2021 are due to our culture, which is this company's most valuable asset. With that, let's turn the call over to your questions, please.

[Operator Instructions]. Your first question comes from Kaila Krum with Truist Securities.

First, can you guys just provide a little bit more detail on this $2.7 million revenue reduction? Just what prompted the change from the preliminary number? What have you learned, I guess, from the time of the January pre-announcement and today that resulted in that change?

The agreement that we had with the stocking distributor in Germany, Austria and Switzerland was signed on December 31 of 2020. And the new agency agreement was then signed the first week of January in 2021. And we completed our normal sales reporting process in early January. And we issued the pre-announcement on January 11 before the investor conferences at that time. As we then really got into it and examined the transaction, we recognized its complexity. And working with our auditors, we determined that the correct accounting treatment in light of the new revenue recognition guidelines, ASC 606, required us to book this as a revenue reduction in December of 2020. This situation is a bit unique, in that this is a very, very large, I guess, stocking distributor for us, unlike some of our other smaller, independent family-owned businesses. And so, the current agreement that we had, the termination agreement and the new agency agreement were different, I would say, than other agreements we have in place. That all culminated throughout the auditing processes as we were closing our financials. And obviously, it shows up as it does in the results that you're seeing today.

That makes a ton of sense. You guys mentioned this international stocking picking up in the first quarter. Is there a way to quantify that potential benefit?

I'm not sure we want to put an exact number on it. But I would say that it gives us high confidence in our $93 million to $98 million for the year, and as well as making statement that we expect to report continued increase in growth for the overall business here in the first quarter of 2021.

Just one on ApiFix. It sounds like the early rollout is going really well and that you're expecting to complete the registry numbers this year. Can you just help us frame sort of the supply capacity? Because I think that myself and a lot of us on the line get pretty excited about ApiFix. Just how comfortable are you sort of that you have the right capacity this year and next. Thank you.

Those are good problems to have. Listen, the demand for this, we have been anticipating for some time. And so, we had been building inventory of this product in anticipation of this launch. And we anticipated a significant increase in demand for the product as more and more of these 20 surgery hospitals come online. So, I am pleased to report that we will not have a lack of inventory for this product. Again, as Mark said, the investment required for these sets are very, very small. So, it makes a ton of sense to have plenty of sets available, as well as plenty of inventory on our shelves to make sure we can meet the ever increasing demand across the world for this product.

Your next question is from Ryan Zimmerman with BTIG.

2020 was, obviously, a unique year and your cadence of sales got a little [indiscernible] through the year, just given what we'd normally think of with KIDS and its typical seasonality kind of in the second and third quarter. Curious if Mark or Dave or Fred, if you want to give any color in terms of expectations around seasonal cadence for the year? How you're thinking about this? I appreciate, obviously, the impact in the first quarter. But could we get back to maybe a more normalized scoli season, for example, mid-year, just some thoughts there, I think, would be helpful.

I think, at this stage, we can't say for sure. But it does appear, particularly in the last several weeks, that we're moving back to a more normal environment. And hopefully that continues. We don't know exactly how this will affect, obviously, our busy summer season. But there's no question that there are patients that are still backlogged through the back part of the fourth quarter and early part of the first quarter. And while we may be seeing an increased volume of those patients come online now, I guess, Ryan, we would expect to see that continue throughout the balance of the summer. We believe there's still a reasonable backlog of pediatric patients from even last summer that didn't get done. Again, this is speculation at this point. Obviously, we've had a difficult time with the impact of COVID to really understand the seasonal impact on our business. But I do think it's fair to say that we will get back to a more normalized environment where we hope to see us get back to a more normalized environment and have the cadence of our revenue and the volumes return back to normal throughout the summer season.

Maybe one, Fred, for you. Historically, you've given us your expectations for deployment of capital in 2021. You talked about the capital you did deploy in 2019 and 2020. Can you talk a little bit about your expectations for deployed capital, particularly in sets for 2021?

I guess rather than putting a number on it, I would just say that we're going to continue to deploy sets for sure. We're going to continue to invest in the business just like we did throughout 2020 despite the lower volume. I think we're also going to start to see the benefit of the ApiFix lower capital required to drive those growth numbers. So, we can deploy very little amount of capital and drive significant multi million dollars of growth with ApiFix which will slightly reduce the necessary capital to continue to deploy more and more. So, we're going to continue to deploy sets and meet the demand of our products, but it may be at a slightly lower pace, as we kind of let the demand catch up with what we've done here in the last two years.

If I could squeeze one more in. You ended with 171 reps. Hey, help us understand kind of how you think about that sales agent group increase in 2021, particularly as we think about productivity per rep and the implied guidance and the necessary requirements, step ups, if you will, in productivity for 2021. Thanks for taking the question.

As you know, this isn't a metric that we – we track it, but it's primarily for the benefit of the market. We don't necessarily track productivity of reps because it has such a difference between the geography on a rep by rep basis and the volumes within a specific hospital. That said, I think what you can probably expect to see is a more normalized environment in terms of our sales agents in the United States adding reps to meet demand. As you know, 90%, 95% of our surgeries are covered. So, those are sales rep in the room. And as sales grow by 31% to 38%, it's just simply going to require more people to be able to cover those cases. And so, I think that you probably will see sales rep growth. It may not near that 31% to 38% range, but it certainly will be better than you saw in 2020.

Your next question is from Rick Wise with Stifel.

Let me start off, come back to some of your quarterly thinking and the cadence, of course, at a higher level. Just starting with the first quarter. I sort of say to myself, where it's March 11, you're seeing some clear trends, I appreciate that things could change, but can you help us think through how the first quarter could shape up? Are we likely to see it off the now-reduced fourth quarter number because of the stocking accounting? Should we assume it's sequentially better than the fourth quarter, given the trends you've seen? Just help us think through the first quarter and how you all are thinking about the flow of quarters to get to your guidance as the year unfolds? Stronger second half versus first, I assume. Just any quarter would be great.

I think we see continued increase in the growth rate. So, we saw 7% in the third quarter. If you back out to $2.7 million, which has a negative 14% on the fourth quarter, the first quarter could be something like 21% growth. So, continued increase revenue growth of the business as the recovery continues to impact us. And I think, obviously, the second quarter is going to be tremendously high growth because of last year, but we would see the revenue continue to then kind of increase and follow a similar pattern of ex-COVID historical. So, many of the schools today are back in full swing. So, there are some patients that are not getting surgery until the summer months because, right now, they're in school. And so, we would expect to be very strong June and July. And then, if things continue as expected, the fourth quarter, probably a lower revenue dollar than the third quarter.

Fred, just to make sure I'm understanding, so first quarter dollars ahead of fourth quarter, second ahead of first, third quarter as always, as you say, the strongest and sort of returning to, hopefully, more normal, seasonally slower fourth quarter. So, that would be the one sequentially lower quarter as we sort of frame the year? Am I hearing you correctly?

Yes, that is absolutely correct. Better said, thank you.

I was hoping also to get a little more color on gross margins. And you sort of alluded to it. Gross margins were much better than we looked for this quarter. Again, I assume that's the US versus – greater US mix versus O-US. How do we think about gross margin this year? Because I say to myself, volumes returning, yes, O-US rebounding, but now you've got direct in three of your largest markets, Germany, Austria, Switzerland. Help us think through the GM setup for 2021 as well.

I think it's important to understand the negative $2.7 million impact on the fourth quarter gross margin rate at 79.9%. The products we returned, they're used sets that we had sold to that stocking distributor over the last 5, 7, 10 years. And they came back to us at a discount. And so, it came back to the books at a 40% gross margin. So, it's a negative. So. it's a return of sales of 40%, which did inflate the fourth quarter gross margin rate because of that transaction. And so, if you were to back that out, I think it's going to be something more like a normalized 75%, 76%, which is kind of where we see the overall business on a full-year basis going forward. 76-ish, and then having the positive impact of the agencies. But if we start selling sets to our stocking distributors at our cost, that's a negative impact. So, it's kind of offsetting one another for 2021.

Two other questions from me. Can you talk a little bit about your thinking about your strong balance sheet and how you might deploy it in 2021? Should I be thinking that, given everything that's going on, and integrating your acquisitions of 2020, et cetera, that you're probably not going to be as active on the M&A front or technology tuck-in front as you've been in the recent past? Or is that not the right way to think about it?

I would say that we continue to look for good technologies that we can deploy and help this industry. And so, if there's an opportunity out there, we would look to take advantage of it, the strong balance sheet helps us make those decisions. And if necessary, we could go get some debt, which we don't have any debt really to sit on the balance sheet today, to help finance something like that. We'll continue smaller tuck-ins. But we continue to look for anything that could help this industry regardless of size. With that being said, I don't anticipate us making any announcements anytime soon. But we continue to look.

And just last. For some reason, I'm obsessed with the total account conversion aspect of the story. Is it possible to tell us how many accounts at this point or any color around what percentage of your US business today – what you would define as total account conversion? And is there a pipeline? How do we think about your activities around that and the impact of that kind of mindset on your 2021 outlook or business? Thank you.

We have a pipeline. That pipeline consists of – in fact, I just looked at it before this call. We have a pipeline of well over 100 accounts that we are monitoring very specifically and looking for opportunities, obviously, to improve share, but also to contract with to move our business to that, let's say, 80% plus, particularly in the trauma and limb deformity area. We normally place about 10 of those accounts as very, very high order kind of possibilities, and hope to close a couple of those accounts every quarter and have a very specific number of accounts that we want to move into that 80% category every year. And so, we observe, as an executive leadership group, about 10 of those accounts on a quarter-over-quarter basis and measure against that, and we like the pace of conversion of a few of these accounts kind of every quarter. And at this stage, we have a very long runway. As you know, we are present in every major children's hospital in the United States and most in kind of the developed world. And I would say at this stage, very few of those are at the 80% range of our trauma and limb deformity products. That said, as you talk about inventory and the inventory we deployed last year, we deployed $18.2 million worth of inventory last year on a sales number that was expected to be a lot larger, obviously, but got affected by the pandemic. And we are starting to see the deployment of that inventory that we put out last year going right into hospitals. And a few of accounts, even over the last few months, we're seeing – we're not deploying a few sets into an account. But we may be deploying 25 sets into a specific account. And whether those were contracted to be 80% contracts or not, we know when we get shelf space, when we have a rep that's there, present every day, that those are the types of accounts that tend to grow from 30% to 50% to ultimately 80% share. And we like the funnel that we have and we like our position right now.

Your next question is from Mike Matson with Needham.

Fred, I guess first, has the audit been completed? And when do you expect to file your 10-K?

Yeah, absolutely. We have completed everything. Have a clean opinion from Deloitte and the 10-K we filed yesterday. So, that should be out there.

For the distributor that you acquired, to put the $2.7 million of revenue adjustment into contact, can you quantify their annual sales?

They're probably doing about $2 million a year of annualized sales today, with definite opportunity to grow. I would say that that was probably 2020's revenue, throughout COVID, but it's around $2 million.

Has the experience with COVID and the fact that a lot of the stocking distributors O-US were really kind of going through these destocking phase, has that caused you to accelerate your conversion effort? Or is it just continuing at kind of the normal pace?

No, I think it is continuing as normal pace. Clearly, we see the benefit – we saw the benefit when we started down this road many years ago of, I would say, eliminating some of the lumpiness of the revenue and not having our partners rely or not have cash available to invest in the business. And so, I think it absolutely encouraged us to continue moving forward. But I don't know that we're going to really change any direction because of it.

I would add. This is a big one. This is one that we've had on the docket for a long time. It was extremely complex, as Fred talked about earlier, and I don't see anything in the near term of that scale. But certainly, we expect this one to have a very substantial impact on revenue this year and into the future. And then, I think we will resume this pace of maybe one, maybe two of these a year. But we definitely haven't accelerated these. Even the small ones are complex. So, it's a matter of bandwidth as well.

Finally, just on the legal settlement, the accrual there, can you provide any additional detail around what that involves? Thanks.

I think most everybody knows, we've got several outstanding items with K2M, there's the Dr. Barry matter, there's IMED in Florida, typical cases related to IP. And some things have, I guess, progressed here recently, such that those have become potential settlements, have become estimated and probable. And so, we for the first time put those on the books because we can now see the end is in insight on many of those. And so, while those amounts are not final, they're estimates, we think we're a lot closer than we were just six months ago to wrapping some of these things up and get them behind us.

Your next question is from Dave Turkaly with JMP Securities.

Fred, just so I understand this, and I think this puts it to bed, hopefully. You recognize $2.7 million in sales, let's say, over the last, I don't know, maybe 5, 10 years, I think you even mentioned. And this new ASC 606 you mentioned, I'm not familiar with that, but is that something new? Are you familiar with it? And I imagine that is the pronouncement that says, Hey, take it all if you buy that stocking distributor, reverse or contra revenue, the cumulative sales in one period. Is that fair? And have you seen that before?

I have seen it before. As you said, we've sold the sets, which is what we bought, are sets, so that we can consign the inventory into the hospitals and continue to serve the marketplace. We sold those sets to them over many, many years. They're not used sets, but they're absolutely required to be able to service the marketplace. And yes, AASC 606 is related to revenue recognition and returns. And so, it is – I have seen it before – and it is absolutely correct, where you would book a lower revenue number for this, in this case, $2.7 million as we brought that back on to our books.

Looking at the guidance, return to solid growth in 2021. I was wondering if you might want to give us any color in terms of whether its operating or net loss, like do we think you guys experienced some incremental leverage as the revenue growth comes back, the loss shrinks or grows or just any color there in terms of what your kind of high level thoughts are for 2021 maybe on the bottom line?

Obviously, adjusted EBITDA was negatively impacted by COVID, by this legal settlement, by other things. But aside from those, we have continued statement that we want to grow the business aggressively on the top line, and at the same time, from an operating point, improve the bottom line of the business. We have definitely learned how to do some things differently related to travel and communicating effectively, obviously, with Zoom and other methods. And we'll be deploying those and continue to deploy those in 2021 to save some money. So, as that revenue returns very aggressively, 31% to 38%, will be controlling our spending and improving the bottom line of the business for sure.

I'm going to sneak one last one if I could. I think you said you had 14 O-US sales agencies and 42 stocking distributors. As you look at the 42 potentially for conversion, are there others in there that you think would, I don't know, meet the materiality level of this ASC 606? Or are most of them smaller? I guess, just any thoughts there? Because I don't recall seeing it in the past, so I figure maybe you have an idea of the size of some of those entities. And if there's certain ones you're considering converting. Thank you.

What I would say is that, there's nobody else out there anywhere close to this size. This was by far our largest, most sophisticated stocking distributor. But really, it wasn't just the size. It was the contracts, the legal contracts that were in place as well. And so, we'll evaluate each one of them independently as we move forward and make the right decision. But they're all going to be in a much smaller nature for sure.

The next question is from Matthew O'Brien with Piper Sandler.

Mark, I know you're going to stay involved in the business. I just wanted to recognize your outstanding stewardship with the company since joining.

Thank you, Matt. I appreciate that very much.

I guess if we can just deconstruct the scoli performance in Q4, it was obviously eye catching how strong it was. And maybe talk a little bit about the elongated scoli season this time around, but can you deconstruct what we saw in Q4 as far as maybe some of that backlog of cases, ApiFix kicking in, and more importantly – I guess not more importantly, but other underlying dynamics that are durable going forward in terms of new account capture, going deeper in existing accounts, things like that, because the scoli market is obviously enormous and a huge opportunity for you over the next couple of years.

To deconstruct fourth quarter, I think we saw about what a number of the other spine companies saw was this almost a whiplash effect. And we're seeing a bit of that now here again in the first quarter, where we had a backlog of surgeries throughout the early fall. Then we saw October, November, really, really strong scoliosis demand, saw elective demand across the board in those periods. We had a really solid December, but it was a slowing rate of demand for scoli. And then that kind of continued here into the early part of the first quarter. So, I think what we've seen from a demand standpoint is pretty consistent with what I have been reading, at least from some of the other companies on the scoliosis side or on the spine side in elective. I think what we're really pleased about is the numbers that – we have 23 new users that we captured in 2020. And again, there's only 300 children's hospitals and only a certain number of pediatric orthopedic surgeons that regularly do scoliosis. So, that 23 new users was a very substantial and concrete representation of share gain for us. And we have kind of a goal of that order of magnitude again for this year, and feel like we're off to a really, really good start. So, I think that's what's durable. There's no question we're getting a larger percentage of the take of some of our accounts already. So, some of the accounts that we had before these 23 new users, I think we're getting deeper penetration. But adding new users that are consistently calling for the RESPONSE scoli system, I think, is a very concrete – the thing we're resting on for growth next year. Obviously, we're extremely excited about ApiFix. And we continue to see accelerated interest in being a part of the IRB sites, although, as you know, we have our 20 and will remain there until we fill this 200 patient registry. What I will say, though, is that we can very clearly – we're very clearly deriving revenue and newer customers from our acquisition of ApiFix and people being connected to this non-fusion technology. Not every patient, as you well know, is a candidate for non-fusion surgery. And so, a number of patients are being driven to these clinics that have access to this site. And ultimately, in some of those sites, there are places where we didn't have previous fusion business. And we're definitely seeing an increase in fusion business with our RESPONSE system at locations where that have access to the ApiFix technology. So, like the synergies there. And as that continues to expand and become a bigger part of our business in 2021, 2022, we would expect to see that synergies only get better.

Following up on one of Rick's questions on just the kind of core domestic business, you've got those 10 accounts, I think you said that you target, how sizable are those 10? I'm assuming you're in some of the really big children's centers around the US already. Are there some areas where you just haven't historically been able to penetrate or are you able to get into some bigger places you hadn't been in the past? Are you going deeper? I guess the question just to sum it all up is, can you keep growing the domestic business around 20% in the future and more normalized times?

There's no question that we are on the early start – we are still in the early innings of kind of this growth curve. We are present in every major children's hospital here in the United States. But as we've said in the past, this is a surgeon by surgeon, product by product conversion. And with 35 implant systems and a lot of these accounts that have a lot of surgeons, Matt, we may have one or two surgeons out of 10, let's say, that use all of our products. But that obviously only accounts for 20 or so percentage of the volume in that account. And so, we're measuring those accounts there as yet on an individual basis by their TAM. And I would say that most of those accounts that we're measuring are accounts that are worth in excess – certainly in excess of a million dollars and some accounts in excessive of a few million dollars, particularly for T&D. And again, we're just in the early phases of moving more and more accounts into that kind of 50% to 80% share range. But again, we like the pace with which this is happening and feel like we can maintain that pace for a really long time in the future.

And there are no further questions at this time.

All right, very good. Well, let me thank you everyone for joining today's call. We certainly expect 2021 to prove to be a pivotal year, although a more normal year for the company. And we'd like to thank all of you for your continued interest and support of our mission to help children throughout the world. So, have a good day.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.