OrthoPediatrics Corp. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Financial statements are unaudited; dollar amounts below are in millions unless stated otherwise.
Business context
OrthoPediatrics designs and markets orthopedic implants and instruments for children. It sells through U.S. and international sales agencies and distributors and invests in consigned instrument and implant sets. On June 4, 2019, it acquired Vilex and Orthex, manufacturers of foot and ankle products, including technology for pediatric deformities. The company plans to divest Vilex assets it considers non-core to its pediatric business.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $18.2 | $15.1 | $32.9 | $27.2 |
| Gross profit | $13.6 | $11.3 | $24.3 | $20.2 |
| Gross margin | 75% | 75% | 74% | 74% |
| Operating loss | $(1.8) | $(2.1) | $(4.5) | $(6.5) |
| Net loss | $(2.6) | $(2.7) | $(5.6) | $(7.7) |
| Loss per share, basic and diluted | $(0.18) | $(0.21) | $(0.39) | $(0.62) |
Revenue rose 21% in both comparison periods, primarily from higher unit volume. Trauma and deformity and scoliosis were the largest growth categories; management attributed category growth mainly to product volume rather than pricing. Gross margins were unchanged. Operating expenses increased, including sales commissions and costs to support growth; Q2 general and administrative expense also included $0.6 million of acquisition costs. Continuing-operations net loss improved year over year.
Cash flow, debt and liquidity
- Cash and cash equivalents at June 30 were $21.9 million for continuing operations; total cash including discontinued operations was $22.2 million. Cash was $60.7 million at December 31, 2018.
- Six-month cash used in continuing operating activities was $10.8 million, versus $11.7 million a year earlier. Working capital used $8.2 million, including a $5.3 million inventory increase.
- Investing activities used $58.6 million for continuing operations, including $49.9 million net cash paid for the acquisition and $8.5 million for property and equipment, primarily instrument sets. Financing activities provided $30.6 million, mainly from new borrowing.
- Total debt was $51.2 million at June 30, including $30.0 million of short-term affiliate debt and approximately $19.9 million under the existing Squadron term note, plus the mortgage. The new $30 million loan bears interest at the greater of three-month LIBOR plus 8.61% or 10% and is due on the earliest of specified change-of-control events, sale of Vilex equity or substantially all its assets, or May 31, 2020. The existing term facilities mature January 31, 2023. Revolver borrowings are barred until the new loan and accrued interest are repaid.
- Management said available cash and expected operating receipts should fund planned operations for more than twelve months. It also stated that if Vilex assets are not sold before the new loan matures, the company would seek an extension or external funding. The new borrowing is secured by substantially all company assets; Squadron is the company’s largest investor.
Outlook, risks and unusual items
- The company expects near-term losses as it expands its product portfolio, sales infrastructure and consigned sets. No quantified revenue, earnings or cash-flow guidance is provided in the filing.
- Management anticipates completing the divestiture of non-core Vilex assets by the end of 2019. The acquisition purchase-price allocation is preliminary and may change during the measurement period.
- Liquidity depends in part on continued sales growth and resolution of the short-dated affiliate loan; failure to sell Vilex assets before maturity could require refinancing or new capital. The company has a history of operating losses and reported a $120.7 million accumulated deficit.
- In the K2M patent litigation, the Patent Trial and Appeal Board ruled against OrthoPediatrics in its challenge to one patent; a rehearing request was denied in July 2019. District court proceedings remained stayed. The company warned an adverse outcome could materially affect its business and financial condition.
- Revenue is typically higher during summer and holiday periods, reflecting pediatric surgery scheduling. The company identified no material changes to its previously disclosed risk factors.
Important facts for investors to verify
- Progress, timing and net proceeds from the planned sale of non-core Vilex assets, and whether the sale could trigger repayment of the $30 million loan.
- Available liquidity and financing options if the Vilex sale is delayed or proceeds are insufficient to repay the loan.
- Final acquisition accounting and any material purchase-price allocation or working-capital adjustments.
- Developments in the K2M litigation and potential effects on the RESPONSE spine product line.
- Whether growth can continue while maintaining gross margins and narrowing operating losses, given ongoing investment and working-capital needs.