OrthoPediatrics Corp. — FY2017 Form 10-K
Reporting period: Year ended December 31, 2017. The company designs and sells orthopedic implants and instruments specifically for children. It reported one operating segment and operates through U.S. sales agencies and international distributors, with new agency-based direct sales operations launched in the U.K., Australia and New Zealand during 2017.
Financial performance
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Revenue | $45.6 million | $37.3 million | +22% |
| Gross profit / gross margin | $34.5 million / 76% | $26.4 million / 71% | Margin expanded about 5 percentage points |
| Operating loss | $6.5 million | $6.1 million | Loss widened $0.3 million |
| Net loss | $8.9 million | $6.6 million | Loss widened $2.4 million |
| Adjusted EBITDA (non-GAAP) | $(0.1) million | $(1.0) million | Improved |
| Operating cash flow | $(7.2) million | $(1.1) million | Cash use increased |
Revenue growth was primarily volume-driven, with little contribution from price changes. Trauma and deformity generated $32.8 million (72% of revenue), scoliosis $11.6 million (25%), and sports medicine/other $1.2 million (3%). U.S. revenue was $34.9 million (77%); international revenue was $10.7 million (23%), unchanged as a share of total revenue from 2016.
Sales and marketing expense rose 23% to $20.5 million; general and administrative expense increased 46% to $17.0 million; and research and development expense rose 54% to $3.4 million. The company attributed the higher G&A in part to growth investments, public-company costs and $2.0 million of noncash accelerated restricted-stock expense related to the IPO. FY2016 included $2.0 million of costs for an abandoned IPO.
Liquidity, cash flow and debt
- Cash and cash equivalents were $42.6 million at year-end, compared with $1.6 million a year earlier. Current assets were $69.6 million and current liabilities $9.5 million.
- Operating cash use was $7.2 million; investing cash use was $6.5 million, primarily reflecting $5.2 million of instrument-set purchases. Financing provided $54.7 million, including IPO proceeds and borrowing.
- The October 2017 IPO sold 4.6 million shares at $13 per share for $59.8 million gross proceeds. The filing reports approximately $46.9 million net proceeds after underwriting costs, offering costs and a Series B dividend payment. Preferred shares converted to common stock at the IPO.
- Total debt was $25.5 million at year-end, including $20.0 million of term debt, $3.9 million drawn on a $15.0 million revolving facility, and a $1.5 million mortgage. The Squadron Capital loan bears interest at three-month LIBOR plus 8.61% (10% at inception), is interest-only, and matures January 2023. It is secured by substantially all company assets and has restrictive covenants.
- Management said cash, expected operating receipts and available borrowing capacity were expected to fund anticipated needs for at least 12 months. The company had an accumulated deficit of $103.1 million and had incurred losses since inception.
Changes, outlook and notable items
- Gross margin improved from 71% to 76%, which management attributed primarily to increased sales and greater cost controls. International operations generally have lower gross margins than U.S. sales.
- Management plans to expand consigned instrument sets, product development, clinical education and sales infrastructure. It aims to increase R&D spending to 10% of sales and aspires to launch at least one new surgical system and multiple product extensions annually. These are strategic targets, not quantified earnings guidance.
- Product-development milestones included planned 2018 launches for two small-stature spine systems, subject to testing and FDA clearance; timing for active growing implants remained uncertain. Spine tethering development faced uncertain regulatory requirements.
- Revenue is typically higher in summer and holiday periods because of school-break scheduling for pediatric procedures. FY2017 quarterly net loss was $4.8 million in Q4 versus $1.3–$1.5 million in each of the first three quarters; Q4 included significant IPO-related stock compensation. Net loss attributable to common stockholders and per-share figures also reflect preferred-stock conversion and preference/dividend accounting.
- The company is named in a K2M patent-infringement suit concerning instruments used in part of its RESPONSE spine systems. It denied infringement, asserted counterclaims, and filed inter partes review petitions; an adverse outcome could materially affect the business.
- Squadron Capital is both the controlling investor/lender and an affiliate of suppliers. The company purchased components from Squadron-affiliated suppliers and disclosed no long-term supply contracts. It also disclosed no traditional financial covenants under the loan, but significant negative covenants apply.
- Key risks include continuing losses and cash use, reliance on consigned inventory and third-party manufacturers and sales partners, product and regulatory risks, reimbursement uncertainty, competition, international expansion and currency exposure, and potential product-liability and intellectual-property claims. Management said a material weakness identified in 2015 had been remediated; disclosure controls were assessed as effective. The company was not required to provide an auditor attestation on internal control for this report.
Important facts for investors to verify
- Whether revenue growth and gross-margin gains persist, particularly as direct agency-based international sales expand.
- Cash burn, working-capital needs and returns on the growing investment in consigned inventory and instrument sets.
- Debt terms, availability under the revolving facility, interest-rate exposure and compliance with restrictive covenants.
- Progress, regulatory clearance and commercial timing for the product pipeline and stated R&D and launch ambitions.
- Developments in the K2M litigation and any related product, legal or financial exposure.
- Effects of preferred-stock conversion, IPO-related compensation and other unusual items when comparing reported losses and per-share results.