OrthoPediatrics Corp. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; unaudited. OrthoPediatrics designs and sells orthopedic implants and instruments for children, using third-party manufacturers and sales agencies, distributors, and direct-sales operations in select international markets. Unless noted otherwise, financial amounts below are in millions of dollars.
Financial performance and liquidity
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Revenue | $14.656 | $12.094 |
| Gross profit / margin | $10.655 / 73% | $8.919 / 74% |
| Operating loss | $(2.717) | $(4.395) |
| Net loss | $(3.020) | $(5.000) |
| Net loss per share, basic and diluted | $(0.21) | $(0.41) |
| Cash used in operating activities | $(3.471) | $(5.033) |
| Cash used in investing activities | $(4.982) | $(2.930) |
| Cash at period-end | $52.774 | $34.591 |
Revenue grew 21%. U.S. sales were $10.267 million and international sales $4.389 million. By category, trauma and deformity revenue was $10.017 million, scoliosis $4.258 million, and sports medicine/other $0.381 million. Gross margin slipped to 73% from 74%, which management attributed mainly to a higher proportion of lower-margin international stocking-distributor sales.
Operating expenses were $13.372 million, versus $13.314 million. Sales and marketing rose 8% to $6.547 million; general and administrative expense fell 7% to $5.612 million, partly because Q1 2018 included approximately $1.8 million of accelerated stock compensation following the IPO; research and development was essentially unchanged at $1.213 million. Net interest expense was $0.303 million, down from $0.552 million.
Cash declined $7.917 million during the quarter. Capital spending was principally for consigned instrument sets. At March 31, current assets were $93.111 million and current liabilities $10.823 million. Total debt was $21.254 million, including approximately $19.865 million payable to affiliate Squadron and a $1.389 million mortgage payable to a Squadron affiliate. The Squadron term and revolving facilities bear interest at the greater of three-month LIBOR plus 8.61% or 10%, mature in January 2023, and are secured by substantially all company assets. The filing does not clearly state the undrawn amount available under the $15 million revolver.
Material changes and management commentary
- Growth was driven mainly by scoliosis sales, up 59%, and trauma and deformity sales, up 10%; management said nearly all category growth reflected unit volume rather than pricing.
- The company expanded direct-sales operations to Belgium and the Netherlands in January 2019 and established Netherlands entities in March.
- Effective January 1, 2019, management concluded collection was probable for all international stocking distributors and began recognizing revenue upon transfer of control, rather than waiting for cash for certain customers. Investors should consider this policy change when assessing revenue comparability.
- Management expects losses to continue in the near term as it expands its product portfolio, sales infrastructure, and consigned inventory. It believes cash, expected operating receipts, and revolving-facility availability will fund current and essential planned operations for more than twelve months. No specific revenue or earnings guidance is provided.
- Revenue is typically higher in summer and holiday periods, reflecting pediatric surgery schedules; scoliosis procedure timing can be variable.
Risks, contingencies, and unusual items
- The company has recurring operating losses and an accumulated deficit of $118.111 million. Deferred tax assets are fully offset by a valuation allowance, and no income tax benefit was recorded.
- A patent lawsuit brought by K2M concerns instruments used in part of the RESPONSE spine portfolio. The district court case is stayed pending patent review proceedings. The PTAB held a hearing on challenges to one patent but had not issued a decision; it declined to institute challenges to another patent. An adverse outcome could materially affect the business, results, or financial condition.
- Debt is owed to the company’s largest investor, Squadron; the company also uses an affiliated supplier, Structure Medical, without a long-term contract. It paid that supplier $0.763 million in the quarter.
- The company maintains substantial inventory, and lower demand or product obsolescence could require write-downs. Royalty commitments include minimum payments of $0.5 million annually through 2026; development-related milestone amounts and timing were not determinable.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much revenue growth reflects the revised international revenue-recognition conclusion versus underlying sales and volume growth.
- The available borrowing capacity under the Squadron revolving facility, and the impact of its minimum 10% interest rate and secured, affiliate-lender terms.
- Whether cash consumption and investment in consigned sets remain consistent with management’s stated liquidity horizon.
- Developments in the K2M litigation and patent-review proceedings, including any effect on the RESPONSE spine product line.
- Progress toward profitability, gross-margin trends, and the financial effects of international expansion and inventory commitments.