OrthoPediatrics Corp. — Q3 2019 Form 10-Q
Business context and period. The unaudited report covers the quarter and nine months ended September 30, 2019. OrthoPediatrics designs and markets orthopedic implants and instruments for children. Continuing-operations results reflect its pediatric business; non-core adult Vilex assets are classified as held for sale and reported as discontinued operations.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $20.7m | $15.8m | $53.6m | $43.0m |
| Gross profit / margin | $15.9m / 77% | $12.0m / 76% | $40.2m / 75% | $32.2m / 75% |
| Operating loss | $(1.5)m | $(1.2)m | $(6.0)m | $(7.7)m |
| Net loss from continuing operations | $(2.9)m | $(1.9)m | $(8.4)m | $(9.6)m |
| Net loss, including discontinued operations | $(2.7)m | $(1.9)m | $(8.3)m | $(9.6)m |
| Loss per share, basic and diluted | $(0.18) | $(0.15) | $(0.57) | $(0.77) |
Q3 revenue rose 31%; nine-month revenue rose 25%. Management attributed growth mainly to higher unit volumes, particularly trauma and deformity and scoliosis products, rather than price changes. U.S. revenue was $16.8m for Q3 and $40.9m year to date; international revenue was $4.0m and $12.7m, respectively. Q3 and year-to-date sales growth was led by trauma and deformity, followed by scoliosis.
Operating expenses increased year over year: Q3 sales and marketing rose 23%, general and administrative 49%, and R&D 24%. Management cited sales commissions, growth-support and quality/regulatory resources, higher depreciation and amortization, and product development. Q3 net loss widened despite revenue growth, in part as interest expense increased to $1.3m from $0.6m; nine-month net loss improved versus 2018.
Cash, liquidity and debt
- Cash from continuing operations was $19.7m at September 30, 2019, down from $60.7m at December 31, 2018. Total cash including discontinued operations was $20.5m.
- Continuing-operations cash used in operating activities was $11.4m for the first nine months, versus $12.9m in 2018. Working-capital use was $8.3m, including a $6.5m inventory increase.
- Investing activities used $60.4m, primarily for the Vilex and Orthex acquisition ($49.7m net of acquired cash) and instrument-set purchases ($10.5m). Financing provided $31.1m, including $30.0m of new borrowing. Cash decreased by $40.2m.
- Total debt was $51.2m, including a $30.0m short-term Squadron term loan, approximately $19.9m under the Squadron term note, and a $1.3m affiliate mortgage. The new loan bears interest at the greater of three-month LIBOR plus 8.61% or 10%.
- The $30.0m loan is due upon specified change-of-control events, sale of Vilex equity or substantially all its assets, or May 31, 2020, whichever occurs first. The revolving facility cannot be drawn until that loan and accrued interest are repaid. Existing Squadron term debt generally matures January 31, 2023.
Material changes, outlook and risks
- On June 4, 2019, the company acquired Vilex and Orthex for preliminary total consideration of $60.3m, including $50.0m cash and 245,352 shares valued at $10.0m; $3.0m was placed in escrow. The preliminary purchase-price allocation included $31.3m goodwill and $18.3m identifiable intangible assets and may be revised.
- The company is pursuing a sale of Vilex’s non-core adult assets, expected by management to be completed by year-end 2019. At September 30, assets held for sale were $38.2m and related liabilities were $3.1m. Discontinued operations contributed Q3 revenue of $1.3m and a $0.2m gain; nine-month revenue was $1.7m and gain was $0.1m.
- Management expects near-term losses as it expands products, markets, and consigned implant and instrument sets. It stated that cash, expected operating receipts, and the anticipated Vilex sale should support operations for more than 12 months. If the sale does not occur before the new loan matures, the company expects to seek an extension or external funding. No specific revenue or earnings guidance is provided.
- Key risks include ongoing operating losses and cash use, substantial inventory investment, the short-dated acquisition loan and its high interest rate, and execution of the Vilex divestiture. The K2M patent-infringement case resumed after a stay was lifted in October 2019; the company disputes the claims but says an adverse outcome could materially affect its finances and cash flows. The filing reports no material change to previously disclosed risk factors.
- Other notable items: the company recorded no income-tax benefit because deferred tax assets were fully offset by a valuation allowance. Management reported effective disclosure controls and no material change in internal control over financial reporting. The purchase-price allocation remains preliminary.
Investor verification points
- Track progress, proceeds, timing, and final terms of the Vilex asset sale, and whether it triggers repayment of the $30.0m loan.
- Verify available liquidity and funding plans if the sale or loan extension is delayed; assess the effect of the loan’s minimum 10% interest rate and restrictions on revolver borrowing.
- Monitor operating cash burn, inventory growth, collections, and progress toward profitability as sales expand.
- Review final acquisition accounting and any resulting changes to goodwill, intangibles, or assets and liabilities held for sale.
- Follow developments and potential financial exposure in the K2M patent litigation.