ORTHOPEDIATRICS CORP. This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the condensed consolidated financial statements and related notes thereto contained elsewhere in this quarterly report, as well as the information under "Note Regarding Forward-Looking Statements."
Overview
We are the only medical device company focused exclusively on providing a comprehensive product offering to the pediatric orthopedic market in order to improve the lives of children with orthopedic conditions. We design, develop and commercialize innovative orthopedic implants and instruments to meet the specialized needs of pediatric surgeons and their patients,who we believe have been largely neglected by the orthopedic industry. We currently serve three of the largest categories in this market. We estimate that the portion of this market that we currently serve represents a$3.2 billion opportunity globally, including over$1.4 billion inthe United States . We sell implants and instruments to our customers for use by pediatric orthopedic surgeons to treat orthopedic conditions in children. We provide our implants in sets that consist of a range of implant sizes and include the instruments necessary to perform the surgical procedure. Inthe United States , our customers typically expect us to have full sets of implants and instruments on site at each hospital but do not purchase the implants until they are used in surgery. Accordingly, we must make an up-front investment in inventory of consigned implants and instruments before we can generate revenue from a particular hospital and we maintain substantial levels of inventory and instruments at any given time. 31 -------------------------------------------------------------------------------- We currently market 35 surgical systems that serve three of the largest categories within the pediatric orthopedic market: (i) trauma and deformity, (ii) scoliosis and (iii) sports medicine/other. We rely on a broad network of third parties to manufacture the components of our products, which we then inspect and package. We believe our innovative products promote improved surgical accuracy, increase consistency of outcomes and enhance surgeon confidence in achieving high standards of care. In the future, we expect to expand our product offering within these categories, as well as to address additional categories of the pediatric orthopedic market. The majority of our revenue has been generated inthe United States , where we sell our products through a network of 37 independent sales agencies employing more than 164 sales representatives specifically focused on pediatrics. These independent sales agents are trained by us, distribute our products and are compensated through sales-based commissions and performance bonuses. We do not sell our products through or participate in physician-owned distributorships, or PODs. We market and sell our products internationally in 43 countries, primarily through independent stocking distributors. Our independent distributors manage the billing relationship with each hospital in their respective territories and are responsible for servicing the product needs of their surgeon customers. InApril 2017 , we began to supplement our use of independent distributors with direct sales programs in theUnited Kingdom ,Ireland ,Australia and New Zealand and further expanded toCanada inSeptember 2018 andBelgium andthe Netherlands inJanuary 2019 , and inItaly onMarch 1, 2020 . In these markets, we work through sales agencies that are paid a commission, similar to ourU.S. sales model. We expect these arrangements to generate an increase in revenue and gross margin. OnJune 4, 2019 , we purchased all of the issued and outstanding shares of stock of Vilex inTennessee, Inc. ("Vilex") and all of the issued and outstanding units of membership interests inOrthex, LLC ("Orthex") for$60.2 million in total consideration, net of working capital adjustments. Vilex and Orthex (the "Vilex Companies") are primarily manufacturers of foot and ankle surgical implants, including cannulated screws, fusion devices, surgical staples and bone plates, as well as Orthex Hexapod technology which is used to treat pediatrics congenital deformities and limb length discrepancies. OnDecember 31, 2019 , we divested substantially all of the assets relating to Vilex's adult product offerings to a wholly-owned subsidiary ofSquadron Capital LLC ("Squadron") in exchange for a$25.0 million reduction in a term note owed to Squadron in connection with the initial acquisition. As part of the sale, we also executed an exclusive license arrangement with Squadron providing for perpetual access to certain intellectual property.
On
OnApril 1, 2020 , we purchased all of the issued and outstanding shares of stock ofApifix Ltd. ("Apifix") for (a)$2.0 million in cash, and (b) 934,783 shares of the Company's common stock,$0.00025 par value per share, representing approximately$35.2 million (based on a closing share price of$37.63 onApril 1, 2020 ). ApiFix, a corporation organized under the laws ofIsrael , has developed and manufactures a minimally invasive deformity correction system for patients with Adolescent Idiopathic Scoliosis (AIS) (the "ApiFix System"). The purchase price is subject to a post-closing working capital adjustment. In addition, the Company has also agreed to pay as part of the purchase price the following anniversary payments: (i)$13.0 million on the second anniversary of the closing date, provided that such payment will be paid earlier if 150 clinical procedures using the ApiFix System are completed inthe United States before such anniversary date; (ii)$8.0 million on the third anniversary of the closing date; and (iii)$9.0 million on the fourth anniversary of the closing date. In addition, to the extent that the product of the Company's revenues from the ApiFix System for the twelve months endedJune 30, 2024 multiplied by 2.25 exceeds the anniversary payments actually made for the third and fourth years (subject to certain limitations), the Company has agreed to pay the selling shareholders a system sales payment in the amount of such 32 -------------------------------------------------------------------------------- excess. The anniversary payments and the system sales payment may each be made in cash or cash and common stock, subject to certain limitations; provided that the Company may make the determination with respect to anniversary payments and a representative of the former ApiFix shareholders may make the determination with respect to the system sales payment, if any. OnJune 10, 2020 , we purchased certain intellectual property assets fromBand-Lok, LLC , aNorth Carolina limited liability company ("Band-Lok"), related to its Tether Clamp and Implantation System ("Tether Clamp System") for approximately$3,400 in total consideration. We use the Tether Clamp System in connection with our Bandloc 5.5/6.0 System. We were previously the sole licensee of the purchased assets under a license agreement with Band-Lok. We believe there are significant opportunities for us to strengthen our position inU.S. and international markets by increasing investments in consigned implant and instrument sets, strengthening our global sales and distribution infrastructure and expanding our product offering.
Impact of COVID-19 on our Business
A novel strain of the coronavirus disease ("COVID-19") was first identified in
Wuhan, China in December 2019 , and the related outbreak was subsequently
declared a pandemic by the World Health Organization and a national emergency by
the President of the United States .
Health and Safety
From the earliest signs of the outbreak, we have taken proactive, aggressive action to protect the health and safety of our employees, customers, partners and suppliers. We enacted rigorous safety measures in all applicable locations, including implementing social distancing protocols, requiring working from home for those employees that do not need to be physically present on the warehouse floor, suspending travel, extensively and frequently disinfecting our workspaces and providing masks to those employeeswho must be physically present. We expect to continue to implement these measures until we determine that the COVID-19 pandemic is adequately contained for purposes of our business, and we may take further actions as government authorities require or recommend or as we determine to be in the best interests of our employees, customers, partners and suppliers. Supply We have not yet experienced any significant impacts or interruptions to our supply chain as a result of the COVID-19 pandemic. To mitigate the risk of any potential supply interruptions from the COVID-19 pandemic, we chose to increase certain inventory levels during the quarter. We may decide to take similar actions going forward. Additionally, restrictions or disruptions of transportation, such as reduced availability of air transport, port closures and increased border controls or closures, have started to result in higher costs and delays. Demand The outbreak has significantly increased economic and demand uncertainty. We anticipate that the current outbreak or continued spread of COVID-19, and the actions taken by governmental authorities and other third parties to contain the virus, will cause a global economic slowdown, and it is possible that it could cause a global recession. In the event of a recession, demand for our products would decline and our business would be adversely effected. We have experienced a reduction in revenue as a result of global delays in elective surgeries.
Liquidity
Although there is uncertainty related to the anticipated impact of the recent COVID-19 outbreak on our future results, we believe our business model, our current cash reserves and the recent steps we have
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taken to strengthen our balance sheet, including our June 2020 and December 2019
equity offerings, leave us well-positioned to manage our business through this
crisis as it continues to unfold. We believe our existing balances of cash and
our currently anticipated operating cash flows will be sufficient to meet our
cash needs arising in the ordinary course of business for the next twelve
months.
We continue to monitor the rapidly evolving situation and guidance from
international and domestic authorities, including federal, state and local
public health authorities and may take additional actions based on their
recommendations. In these circumstances, there may be developments outside our
control requiring us to adjust our operating plan. As such, given the dynamic
nature of this situation, we cannot reasonably estimate the impacts of COVID-19
on our financial condition, results of operations or cash flows in the future.
Emerging Growth Company and Smaller Reporting Company Status
The condensed consolidated financial statements are prepared in conformity with accounting principles generally accepted inthe United States of America ("GAAP") and reflect the financial position, results of operations, and cash flows ofOrthoPediatrics Corp (the "Company," "we," "our" or "us"). We qualify as an "emerging growth company" as defined in the Jumpstart Our Business Startups Act (the "JOBS Act"). For as long as a company is deemed to be an emerging growth company, it may take advantage of specified reduced reporting and other regulatory requirements that are generally unavailable to other public companies. We also qualify as a "smaller reporting company," as such term is defined in Rule 12b-2 under the Exchange Act. To the extent that we continue to qualify as a smaller reporting company, after we cease to qualify as an emerging growth company, certain of the exemptions available to us as an emerging growth company may continue to be available to us as a smaller reporting company. The JOBS Act also provides that an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards and, therefore, we are subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.
Summary of Statements of Operations for the Three and Six Months Ended
The following table sets forth our results of operations for the three and six
months ended
Six Months Ended
Three Months Ended June 30, June 30,
Increase Increase
2020 2019 (Decrease) % 2020 2019 (Decrease) %
Net revenue $ 13,593 $ 18,200 $ (4,607) (25) % $ 29,949 $ 32,856 $ (2,907) (9) %
Cost of revenue 3,532 4,581 (1,049) (23) % 7,675 8,582 (907) (11) %
Sales and marketing expenses 5,620 7,606 (1,986) (26) % 13,184 14,153 (969) (7) % General and administrative expenses 10,577 6,569 4,008
61 % 18,458 12,181 6,277 52 % Research and development expenses 881 1,234 (353) (29) %
2,146 2,447 (301) (12) %
Other expenses 2,430 669 1761 263 % 2,878 972 1,906 196 %
Net loss from continuing operations $ (9,447) $ (2,459) $ 6,988 284 % $ (14,392) $ (5,479) $ 8,913 163 %
Net loss from discontinued
operations $ - $ (159) $ 159 - % $ - $ (159) $ 159 - %
Net loss $ (9,447) $ (2,618) $ 6,829 261 % $ (14,392) $ (5,638) $ 8,754 155 %
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Net Revenue
The following tables set forth our net revenue by geography and product category
for the three and six months ended
Six Months Ended June
Three Months Ended June 30, 30,
Product sales by geographic location: 2020 2019 2020 2019
U.S. $ 12,146 $ 13,848 $ 25,530 $ 24,115
International 1,447 4,352 4,419 8,741
Total $ 13,593 $ 18,200 $ 29,949 $ 32,856
Six Months Ended June
Three Months Ended June 30, 30,
Product sales by category: 2020 2019 2020 2019
Trauma and deformity $ 9,220 $ 11,887 $ 21,430 $ 21,904
Scoliosis 3,836 5,866 7,547 10,124
Sports medicine/other 537 447 972 828
Total $ 13,593 $ 18,200 $ 29,949 $ 32,856
Net revenue decreased $4.6 million , or 25%, from $18.2 million for the three
months ended June 30, 2019 to $13.6 million for the three months ended June 30,
2020 and decreased $2.9 million , or 9%, from $32.9 million for the six months
ended June 30, 2019 to $29.9 million for the six months ended June 30, 2020 . The
decrease was due to the global suspension of elective surgeries related to the
COVID-19 pandemic. International revenue decreased at a higher rate than U.S
revenue, and international markets continue to be impacted by COVID-19, as there
are fewer stand-alone pediatric hospitals internationally and elective
procedures have been slower to return.
Trauma and deformity sales declined $2.7 million , or 22%, and $0.5 million , or
2%, during the three and six months ended June 30, 2020 , respectively, primarily
driven by lower sales of our deformity correction product portfolio,
specifically our PNP Femur and two new cannulated screw systems. Scoliosis sales
declined $2.0 million , or 35%, and $2.6 million , or 25%, during the three and
six months ended June 30, 2020 , respectively, primarily driven by lower sales of
our RESPONSE 5.5/6.0 system and FIREFLY® Pedicle Screw Navigation Guides. These
sales declines were offset by sports medicine / other growth of $0.1 million , or
20%, and $0.1 million , or 17%, during the three and six months ended June 30,
2020 , respectively. Nearly all the change in each category was due to a decrease
in the unit volume sold and not a result of price changes.
Cost of Revenue and Gross Margin
Cost of revenue decreased$1.0 million , or 23%, from$4.6 million for the three months endedJune 30, 2019 to$3.5 million for the three months endedJune 30, 2020 . Cost of revenue decreased$0.9 million , or 11%, from$8.6 million for the six months endedJune 30, 2019 to$7.7 million for the six months endedJune 30, 2020 . The decrease was due primarily to decreased sales volume in both theU.S. and international markets resulting from the suspension of elective surgeries related to the COVID-19 pandemic. Gross margin was 75% for the three months endedJune 30, 2019 , 74% for the three months endedJune 30, 2020 and 74% for the six months endedJune 30, 2019 andJune 30, 2020 , respectively.
Sales and Marketing Expenses
Sales and marketing expenses decreased$2.0 million , or 26%, to$5.6 million for the three months endedJune 30, 2020 from$7.6 million for the three months endedJune 30, 2019 . Sales and marketing expenses decreased$1.0 million , or 7%, to$13.2 million for the six months endedJune 30, 2020 from$14.2 million for the six months endedJune 30, 2019 . The decrease for the three and six month periods 35 --------------------------------------------------------------------------------
ended
General and Administrative Expenses
General and administrative expenses increased$4.0 million , or 61%, from$6.6 million for the three months endedJune 30, 2019 to$10.6 million for the three months endedJune 30, 2020 . General and administrative expenses increased$6.3 million , or 52%, from$12.2 million for the six months endedJune 30, 2019 to$18.5 million for the six months endedJune 30, 2020 . The increase for the three and six month periods endedJune 30, 2020 were due primarily to increased stock compensation of$2.3 million related to a one-time stock grant of$1.3 million to our Chief Executive Officer and the increase of our stock price on new stock grants, increased legal expenses of$0.8 million related to our ongoing litigation and acquisitions, and increased general and administrative expenses associated with the acquisitions of ApiFix and Telos. Depreciation and amortization expenses increased$0.9 million , or 80%, from$1.1 million for the three months endedJune 30, 2019 to$1.9 million for the three months endedJune 30, 2020 . Depreciation and amortization expenses increased$1.4 million , or 74%, from$1.9 million for the six months endedJune 30, 2019 to$3.3 million for the six months endedJune 30, 2020 . The increase for the three and six month periods endedJune 30, 2020 were primarily due to increased investments in consigned surgical instrument sets and amortization of intangible assets acquired through the Vilex, Telos and ApiFix acquisitions and the purchase of the Band-Lok intellectual property.
Research and Development Expenses
Research and development expenses decreased$0.4 million , or 29%, from$1.2 million for the three months endedJune 30, 2019 to$0.9 million for the three months endedJune 30, 2020 . Research and development expenses decreased$0.3 million , or 12%, from$2.4 million for the six months endedJune 30, 2019 to$2.1 million for the six months endedJune 30 , 2020.The decrease for the three and six month periods endedJune 30, 2020 were driven by a reduced investment in research and development project expenses as a result of the sales decline related to the COVID-19 pandemic and the reversal of the Bandloc minimum royalty.
Other Expenses
Other expenses were$2.4 million and$0.7 million for the three months endedJune 30, 2020 and 2019, respectively. Other expenses were$2.9 million and$1.0 million for the six months endedJune 30, 2020 and 2019, respectively. The increase in other expenses is due to fair value adjustment of$1.8 million related to the ApiFix contingent consideration payment.
Liquidity and Capital Resources
We have incurred operating losses since inception which resulted in negative cash flows for continuing operations from operating activities of$14.7 million and$10.8 million for the six months endedJune 30, 2020 and 2019, respectively. As ofJune 30, 2020 , we had an accumulated deficit of$143.2 million . We anticipate that our losses will continue in the near term as we continue to expand our product portfolio and invest in additional consigned implant and instrument sets to support our expansion into existing and new markets. Since inception, we have funded our operations primarily with proceeds from the sales of our common and preferred stock, convertible securities and debt, as well as through sales of our products. AtJune 30, 2020 , we had cash and restricted cash of$114.4 million . 36
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Cash Flows
The following table sets forth our cash flows from operating, investing and financing activities for the periods indicated:
Six
Months Ended
2020 2019
Net cash used in operating activities - continuing operations
$ (10,785)
Net cash provided by operating activities - discontinued operations
- 371
Net cash used in investing activities - continuing operations (9,349)
(58,610)
Net cash used in investing activities - discontinued operations
- (47)
Net cash provided by financing activities 66,427 30,598
Effect of exchange rate changes on cash 17 -
Net increase (decrease) in cash $ 42,388 $ (38,473) Cash Used in Operating Activities
Net cash used in operating activities from continuing operations was$14.7 million and$10.8 million for the six months endedJune 30, 2020 and 2019, respectively. The primary use of this cash was to fund our operations related to the development and commercialization of our products in each of these years. Net cash used for working capital was$8.8 million and$8.2 million for the six months endedJune 30, 2020 and 2019, respectively. During the six months endedJune 30, 2020 , the primary driver of working capital cash usage was the increase in inventory of$9.6 million related to future sales growth and our acquisitions and new agencies.
Cash Used in Investing Activities
Net cash used in investing activities from continuing operations was$9.3 million and$58.6 million for the six months endedJune 30, 2020 and 2019, respectively. Net cash used in investing activities consisted primarily of the acquisition of Telos of$1.7 million , net of cash received, the acquisition of ApiFix for$1.7 million , net of cash received, the acquisition of the Band-Lok intellectual propoerty of$0.8 million , the acquisition of Vilex and Orthex of$49.9 million , net of cash received, and the purchases of instrument sets, which were consigned inthe United States ,United Kingdom ,Australia ,New Zealand ,Belgium andthe Netherlands of$5.2 million and$8.5 million for the six months endedJune 30, 2020 and 2019, respectively.
Cash Provided By Financing Activities
Net cash provided by financing activities was$66.4 million and$30.6 million for the six months endedJune 30, 2020 and 2019, respectively. Net cash provided by financing activities for the six months endedJune 30, 2020 consisted primarily of the proceeds from the issuance of common stock of$70.2 million , net of issuance costs and$1.3 million from the exercise of stock options, offset by the payment of$5.0 million of the revolving credit facility with Squadron. Indebtedness Loan Agreement OnDecember 31, 2017 , we entered into a Fourth Amended and Restated Loan and Security Agreement, or the Loan Agreement, withSquadron Capital LLC , or Squadron, the Company's largest investor. Under the terms of the Loan Agreement, Squadron provided us a term loan in the principal amount of$20.0 million , represented by a Term Note A, and a revolving loan in an aggregate principal amount to not 37 -------------------------------------------------------------------------------- exceed$15.0 million , represented by a Revolving Note. Interest on the Term Note A and Revolving Note accrued at the greater of (a) three month LIBOR plus 8.61% and (b) 10.0%. In order to finance a portion of the cash consideration for the acquisition of the Vilex Companies, the Company entered into a First Amendment, or the First Amendment, to the Loan Agreement (as so amended, the "First Amended Loan Agreement"), with Squadron. The First Amended Loan Agreement provided for a new$30.0 million term loan facility, represented by a Term Note B, in addition to the existing$20.0 million Term Note A and$15.0 million revolving credit facility. Similar to the other facilities under the First Amended Loan Agreement, the Term Note B was subject to interest only payments at an interest rate equal to the greater of (a) three month LIBOR plus 8.61%, and (b) 10.00%. The Term Note B, which would have matured no later thanMay 31, 2020 , was paid in full onDecember 31, 2019 using$25.0 million received in exchange for the divestiture of the adult product offerings of Vilex and the related Orthex license agreement, and$5.0 million from the available Squadron revolving credit facility. OnJanuary 4, 2020 , the Company repaid$5.0 million on the revolving credit facility with Squadron.
At
OnAugust 4, 2020 , the Company entered into a Second Amendment (the "Second Amendment") to its First Amended Loan Agreement with Squadron (as so further amended, the "Second Amended Loan Agreement"). Pursuant to the Second Amendment, the First Amended Loan Agreement's revolving credit commitment was increased from the previously established$15,000 to$25,000 . The Company has agreed to pay Squadron an unused commitment fee in an amount equal to the per annum rate of 0.50% (computed on the basis of a year of 360 days and the actual number of days elapsed) times the daily unused portion of the revolving credit commitment. The unused commitment fee is payable quarterly in arrears. Borrowings under the revolving credit facility will be made under a First Amended and Restated Revolving Note, datedAugust 4, 2020 (the "Amended Revolving Note"), payable, jointly and severally, by the Company and each of its subsidiaries party thereto. The Amended Revolving Note will mature at the earlier of: (i) the date on which any person or persons acquire (x) capital stock of the Company possessing the voting power to elect a majority of the Company's Board of Directors (whether by merger, consolidation, reorganization, combination, sale or transfer), or (y) all or substantially all of the Company's assets, determined on a consolidated basis; and (ii)January 1, 2024 . Prior to the Second Amendment, the revolving credit facility was to have matured onJanuary 31, 2023 . The Second Amended Loan Agreement continues to provide for interest only payments, which are payable monthly, with interest rates equal to the greater of (a) three month LIBOR plus 8.61%, and (b) 10.00% Borrowings under the Second Amended Loan Agreement are secured by substantially all of the Company's assets and are unconditionally guaranteed by each of its subsidiaries with the exception of Vilex. There are no traditional financial covenants associated with the Second Amended Loan Agreement. However, there are negative covenants that prohibit us from, among other things, transferring any of our material assets, merging with or acquiring another entity, entering into a transaction that would result in a change of control, incurring additional indebtedness, creating any lien on our property, making investments in third parties and redeeming stock or paying dividends, in each case subject to certain exceptions as further detailed in the Second Amended Loan Agreement. The Second Amended Loan Agreement includes events of default, the occurrence and continuation of any of which provides Squadron with the right to exercise remedies against us and the collateral securing the loans, including cash. These events of default include, among other things, the failure to pay amounts due under the credit facilities, insolvency, the occurrence of a material adverse event, which includes a material adverse change in our business, operations or properties (financial or otherwise) or a material impairment of the prospect of repayment of any portion of the obligations, the occurrence of any default under certain other indebtedness and a final judgment against us in an amount greater than$250 38 --------------------------------------------------------------------------------
thousand. The occurrence of a material adverse change could result in the acceleration of payment of the debt.
Mortgage Note
InAugust 2013 , pursuant to the purchase of our office and warehouse space, we entered into a mortgage note payable toTawani Enterprises Inc. , the owner of which is a member of Squadron's Managing Committee. Pursuant to the terms of the mortgage note, we payTawani Enterprises Inc. monthly principal and interest installments of$16 thousand , with interest compounded at 5% until maturity inAugust 2028 , at which time a final payment of remaining principal and interest will become due. The mortgage is secured by the related real estate and building. The mortgage balance was$1.2 million and$1.3 million atJune 30, 2020 andDecember 31, 2019 , respectively.
Pediatric Orthopedic Business Seasonality
Our revenue is typically higher in the summer months and holiday periods, driven by higher sales of our trauma and deformity and scoliosis products, which is influenced by the higher incidence of pediatric surgeries during these periods due to recovery time provided by breaks in the school year. Additionally, our scoliosis patients tend to have additional health challenges that make scheduling their procedures variable in nature.
Critical Accounting Policies and Significant Judgments and Estimates
This management's discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenue and expenses during the reporting periods. We monitor and analyze these items for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Changes in estimates are reflected in reported results for the period in which they become known. Actual results may differ materially from these estimates under different assumptions or conditions.
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