OrthoPediatrics Corp. — Q3 2017 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and nine months ended September 30, 2017. OrthoPediatrics designs and markets orthopedic implants and instruments for children. It reported one operating segment. The company expanded direct-sales operations in the U.K., Australia and New Zealand during 2017, alongside its U.S. sales-agency and international distributor networks.
Financial performance
Amounts below are in millions of dollars unless stated otherwise.
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $12.4 | $10.1 | $33.9 | $27.9 |
| Gross profit | $9.5 | $7.2 | $25.6 | $20.0 |
| Gross margin | 77% | 71% | 75% | 72% |
| Operating loss | $(0.8) | $(0.5) | $(2.3) | $(2.9) |
| Net loss | $(1.5) | $(0.8) | $(4.1) | $(2.9) |
| Net loss attributable to common stockholders | $(3.0) | $(2.4) | $(8.5) | $(7.2) |
| Basic and diluted loss per common share | $(1.70) | $(1.38) | $(4.82) | $(4.14) |
- Revenue growth: Revenue rose 22% in both comparative periods. Trauma and deformity was the largest category, contributing $8.7 million in Q3 and $24.3 million year to date; spine contributed $3.3 million and $8.7 million, respectively. Management attributed nearly all growth to higher unit volumes, rather than pricing.
- Profitability and costs: Q3 gross margin increased six percentage points, attributed to increased sales, cost control and improved margins from new international entities. Operating expenses rose 33% in Q3 to $10.2 million, with higher sales and marketing, general and administrative, and R&D costs. For the nine months, operating loss narrowed, but net loss increased, in part because prior-year results included $0.9 million of income from termination of an R&D fee obligation.
- Cash flow: Nine-month operating cash use was $3.9 million, versus $2.4 million in 2016; investing cash use was $5.3 million, versus $3.0 million. Financing provided $9.8 million, mainly from affiliate debt proceeds of $10.1 million. Cash increased $0.6 million to $2.2 million at September 30.
- Balance sheet and debt: Total assets were $41.1 million, including $18.4 million of inventory, compared with $30.7 million and $14.0 million, respectively, at year-end 2016. Total liabilities were $37.9 million. Debt was approximately $27.6 million, including $7.5 million drawn on the revolving facility, compared with $17.5 million at December 31, 2016. The Squadron debt was secured by substantially all company assets; stated interest rates were 10% on Term Note A and 11% on Term Note B. Accumulated deficit was $82.2 million.
Material changes, outlook and risks
- Liquidity and financing: In April 2017, the company amended its Squadron loan agreement, adding up to $16 million of availability and extending stated maturity to May 31, 2019, with a conditional extension to May 31, 2020. After quarter-end, the company completed an IPO of 4.6 million shares at $13 per share; disclosed net proceeds were approximately $53.2 million. The filing says proceeds were intended for investment in consigned sets, R&D, sales and marketing, working capital and general purposes, and that approximately $5.9 million of accumulated Series B dividends would be paid. The preferred shares converted upon the IPO.
- Debt amendment proposed: A November 8, 2017 non-binding letter of intent contemplated a $20 million term loan, a $15 million revolver, an approximately 10% interest rate at the signing date, and an extension through January 31, 2023. These terms were proposed, not a completed amendment in this filing.
- Management outlook: Management expected losses to continue in the near term while expanding the product portfolio and investing in consigned sets. It stated that cash, expected operating receipts, loan availability and IPO proceeds were expected to fund anticipated requirements for at least 12 months. No specific revenue or earnings guidance was provided.
- Operating and accounting risks: The business requires substantial inventory investment before sales from consigned sets; inventory increased and was a major working-capital use. Management cautioned that demand changes could lead to excess or obsolete inventory. The company also identified risks around profitability, future capital needs, product development and commercialization, regulation, distribution networks and intellectual property. Adoption of the new revenue standard was pending; the company had not determined its effect.
- Legal contingency: K2M sued the company alleging patent infringement involving instruments in its RESPONSE spine system and later added another patent claim. OrthoPediatrics denied the claims, filed counterclaims and said it intended to seek inter partes review. Mediation did not resolve the dispute; the filing states an adverse outcome could materially affect the business and financial condition. No material litigation accrual or clear quantified exposure is provided.
- Other items: Preferred dividends accreted by $4.4 million during the first nine months, contributing to the substantially larger common-stockholder loss than consolidated net loss. Minimum annual royalty commitments were disclosed at $0.3–$0.5 million through 2021. The filing reports no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Confirm final IPO proceeds, use of proceeds, payment of the Series B dividends, and the resulting post-conversion share count and dilution.
- Check whether the non-binding Squadron debt proposal was finalized, including pricing, availability, covenants, maturity and repayment terms.
- Monitor cash burn, inventory growth and the company’s ability to turn consigned sets and sales growth into sustainable operating cash flow and profitability.
- Follow the K2M patent litigation, related potential costs, and any effect on RESPONSE products or sales.
- Assess whether the new revenue-recognition standard changes the timing or amount of revenue and related costs, particularly for international distribution arrangements.
- Note that the filing gives different IPO closing dates in its disclosures: October 12 in the subsequent-events note and October 16 in MD&A. Verify the correct date in related filings.