OrthoPediatrics Corp. (NASDAQ:KIDS) Q3 2023 Earnings Call Transcript

OrthoPediatrics Corp. (NASDAQ:KIDS) Q3 2023 Earnings Call Transcript November 7, 2023

Operator: Good morning, and welcome to the OrthoPediatrics Corporation Third Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Trip Taylor, from the Gilmartin Group for a few introductory comments.

Trip Taylor: Thank you for joining today’s call. With me from the company are David Bailey, President and Chief Executive Officer; and Fred Hite, Chief Operating and Financial Officer. Before we begin today, let me remind you that the company’s remarks include forward-looking statements within the meaning of federal securities laws, including the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to numerous risks and uncertainties and the company’s actual results may differ materially. For a discussion of risk factors, I encourage you to review the company’s most recent quarterly report on Form 10-Q, which will be filed with the SEC today. During the call today, management will also discuss certain non-GAAP financial measures, which are supplemental measures of performance.

The company believes these measures provide useful information for investors in evaluating its operations period-over-period. For each non-GAAP financial measure referenced on this call, the company has included a reconciliation of the non-GAAP financial measure to the most directly comparable GAAP financial measures in its earnings release. Please note that the non-GAAP financial measures have limitations of analytical tools and should not be considered in isolation or as substitute towards the pediatrics financial results prepared in accordance with GAAP. In addition, the content of this conference call contains time-sensitive information that is accurate only as of the date of this live broadcast today, November 7, 2023. Except as required by law the company undertakes no obligation to revise or update any statements to reflect events or circumstances taking place after the date of this call.

With that, I would like to turn the call over to David Bailey, President and Chief Executive Officer.

David Bailey: Thanks, Trip. Good morning, everyone, and thank you for joining us on our third quarter 2023 conference call. As we start all earnings calls, I’d like to begin by highlighting that we helped nearly 22,000 children in the third quarter of 2023, a new record for OrthoPediatrics. And since inception, we have helped over 692,000 kids, helping more children remains the best measure of our success. Before I continue, I’d like to acknowledge our 14 OP colleagues in Israel, who regardless of situation continue to tirelessly support one another and this company through unimaginable time. In the third quarter of 2023, we generated record quarterly revenue of $40 million, representing growth of 14% compared to the third quarter of 2022 and produced a record adjusted EBITDA of $3.6 million.

We are proud of the progress we’re making, balancing strong revenue growth with improving profitability and continued progress towards achieving cash flow breakeven sooner. Our business continues to grow by taking market share in an environment where Children’s Hospitals inpatient surgery volumes remain suppressed. As expected, we continue to see incremental staffing and efficiency improvements, yet these factors remain a headwind. During the quarter, we benefited from the diverse nature of our business as the trauma and deformity and international businesses were very strong, offset by lower growth in scoliosis due to an extremely tough comparable quarter, a decline in international scoliosis revenue due to abnormal ordering patterns from a few large South American distributors and continued procedural headwinds in a few key U.S. accounts that are easing in Q4.

With that said our October Scolio performance indicates an extremely positive growth trajectory in Q4 and continued strong performances in T&D and international. Therefore, we are reiterating our revenue guidance for full year 2023 of $148 million to $151 million, representing growth of 21% to 23%. We are raising our full year EBITDA guidance to $4 million to $5 million from $3 million to $4 million. And we now estimate set deployment of $23 million as we continue to focus on profitability and cash usage. From this rock solid foundation and continued advancement of our strategy, we expect a similar annual company growth profile in 2024, while we further improve EBITDA and reduce the need for increased set deployment. With a plethora of growth drivers in place, continuing legacy product growth, several new organic product launches, Pega sales expansion, normalization of international markets, positive long-term ApiFix data publication, a newly formed and rapidly expanding specialty bracing business, OPSB, and an early start in digital health care, we believe this company is well positioned for continued success.

Importantly, we remain in an extremely strong financial position and are confident that the current balance sheet enables us to execute our long-term strategy without additional equity capital. I would also like to directly address the recent noise resulting from hypothesized market implications from GLP-1s that has impacted the sector’s valuations in recent months. OrthoPediatrics patients are children, and the conditions we treat are almost entirely acute injuries or congenital conditions. We have not experienced any impact on our current business nor do we expect any impact to our future market opportunity. Our business is not exposed to downstream GLP impacts. Moving to our revenue segments. In the third quarter of 2023, we generated total trauma and deformity revenue of $28.8 million, representing growth of 21% compared to the prior year period.

Revenue growth in the quarter was led by strong performances from Pega products, trauma and OP SB. The quarter saw record Pega product performance with fantastic growth in the U.S., and international growth just beginning. Trauma Growth was strong globally, again, highlighted by PNP Femur and cannulated screws and continued share taking across the entire portfolio. Sales of Pega remained better than we ever expected, and we anticipate this to persist for a few more months as we deeply penetrate our U.S. accounts with the full [indiscernible] product portfolio and complete the transition to our international sales agencies and stocking distribution network as well as continued relaunch of many of their products, which had limited sets deployed.

For the first time, international Pega revenue grew significantly in the third quarter as we have nearly completed all of the distribution transition. We expect this growth to follow the U.S. trajectory and become a major revenue driver internationally in 2024. Beyond the revenue performance, we are excited to have received FDA approval and beta launched the PNP Tibia system, which is a first of its kind pediatric rigid Tibia Nailing system modeled after our market leading and largest trauma product, the PND femur. Initial surgeries have gone extremely well and several more are scheduled. We expect a full market launch of PMP Tibia to start in Q2 of 2024 and continue for many quarters. Throughout 2023, we have seen an increasing number of customers using more of our products as a result of the continued execution of our key account conversion strategy.

We have additional new high-technology products on the way, and our robust pipeline was strengthened by the Pega acquisition. The T&D business is well positioned to continue to deliver sustainable growth. Further, we believe certain players are placing even less focus on pediatric trauma on limb deformity, if not entirely exiting the space in the coming years. This places us in the driver seat to claim the dominant share position across the next 5 years. Within the T&D business, our OrthoPediatrics non-surgical specialty bracing business, or OP SB, continues to perform extremely well. As we mentioned on our Q2 call, we are successfully executing a build aggressively strategy in OP SB and anticipate it to grow very rapidly in the coming several years.

We see many of the same characteristics in the OP SB opportunity that we witnessed when we started OP 17 years ago. There are countless unmet needs and opportunities to innovate, a concentrated customer base who we already service, an opportunity to further support clinical education and no focused competition. Beyond all of that, it fits with our goal of surrounding our customers with all the products they need to treat children with orthopedic conditions, and it builds further brand loyalty across our entire surgical and non-surgical portfolio. Since the acquisition of MDO in April of 2022, we have been bombarded with new product ideas and partnership opportunities and opportunities for expansion, which we continue to prioritize as part of our strategy.

For example, in early Q3, we completed the asset acquisition of RHINO Orthopedics and the cruiser brace, a product developed and popularized by the legendary pediatric orthopedic surgeons, Dr. Dennis Wenger and Scott Mubarak at Rady Children’s Hospital in San Diego. The Cruiser is the first of many new products designed to treat hip disorders in infants and children. Earlier this month, we executed an exclusive distribution agreement with ARA Medical and expect to launch their new product called the Levity in the next few weeks. The Levity device supports patients with cerebral palsy, allowing a one-of-a-kind hands-free experience that reinforces muscles for optimal walking rehabilitation. Internally, organic product development, both within the MDO team in Iowa and with the OrthoPediatrics team in Warsaw has been very productive.

After releasing the MDO move bar earlier in the second quarter, we recently announced the launch of the Ponseti Plus clubfoot brace and anticipate the launch upon [indiscernible] in the coming weeks. Further, the much anticipated DF2 femur fracture was recently launched through a limited release, and our supplier is currently scaling production capabilities for a full global release in early 2024. Beyond these product launches and partnerships, there will be several more supporting our thesis that we can build a more capital-efficient $100 million business in this space in the coming years. As we have said previously, OP SB, along with other key products such as ApiFix and Orthex, produced very strong returns on capital by requiring low or no consigned inventory obligation while generating high revenue.

As we grow OP SB, we will see a diminishing need for capital deployment while we bolster our growth prospects. Moving to the scoliosis business. In the third quarter of 2023, we generated revenue of $10.3 million, representing global growth of 3% compared to the prior year period, driven by a continuation of our strategy of promoting the combined strength of ApiFix, response and 7D placements. Growth in the quarter was lower than normal due to difficult international and domestic comps of 33% and 38%, respectively. Irregular ordering patterns from a few large international stocking distributors in South America and continued procedural volume headwinds in a few key U.S. accounts. U.S. scoliosis revenue grew 9%, driven by strong response and ApiFix demand and the onboarding of several new first-time users of both products.

Surgery schedules strengthened late in the third quarter and has continued into the fourth quarter. Despite difficult third quarter domestic comps for ApiFix, usage grew both in new users and increased amongst several previous users, but was offset by an ongoing major slowdown from 3 of our largest sites as all surgeon€™s transition to new practice locations and only started performing a few cases in Q3. Based on scheduling visibility, we expect this to largely reverse in the fourth quarter and throughout 2024. For the recent positive publications related to the longer-term performance of the ApiFix device are driving more and more surgeons to seek access to ApiFix, and we are seeing an increased rate of IRB approval requests from new potential users.

Additionally, we expect to see published 2-year data from the U.S. registry in the coming quarter. Moving on to international. In the third quarter of 2023, we generated international revenue of $10.6 million compared to $8.4 million in the prior year period, delivering 26% growth, led by extremely strong performance with our legacy T&D products, offset by slow scoliosis sales to stocking distributors in South America. We are pleased to see a continuation of the rebound in our international business in the third quarter and expect it to continue into the fourth quarter and 2024. International Agency market sales were particularly strong, both in trauma and deformity and scoliosis signaling a normalizing surgical environment. Progress on our German direct sales model continues to track favorably.

Additionally, sales of Pega products materially contributed to international revenue growth in the third quarter as we completed most of the final stocking distributor and agency transition. We believe third quarter growth is just the start for Pega products internationally and expect to see similar results to that of the U.S. and believe this will be a major tailwind to international growth in the fourth quarter and in 2024. That brings us the surgeon training and education. In the third quarter, the company had strong attendance at several premier surgeon training events. Overall, throughout the quarter, we conducted 70 training sessions and educational programs reaching over 1,200 health care professionals. In August, we were a lead order of the Baltimore Limb Deformity Conference, which featured 5days interactive hands-on labs on complex limb construction using the Orthex external fixation system.

Then in September, OrthoPediatrics continued its gold level sponsorship of the Scoliosis Research Society Meeting, which took place in Seattle. There, we highlighted the ApiFix technology. In October, we announced our strategic partnership with Children’s National Hospital under the Alliance for Pediatric device innovation to advance the development and commercialization of medical devices designed for children. OP will serve as the Alliance of Strategic Adviser and role model for device innovators whose primary focus is children. This coalition of thought leaders will advance all aspects of pediatric medicine for years to come and provide OrthoPediatrics with exposure to exciting opportunities and technologies beyond trauma, limb deformity and scoliosis.

With that, I’d like to turn the call over to Fred to provide more details on our financial results. Fred?

Fred Hite: Thanks, Dave. Our third quarter 2023 worldwide revenue of $40.0 million is a new record for us and increased 14.4% compared to the third quarter of 2022. We Growth in the quarter was driven primarily by record Pega performance, strong global trauma growth as well as continued share gains across our legacy portfolio and growth of our non-surgical specialty bracing business. U.S. revenue was $29.4 million, a 10.6% increase from the third quarter of 2022. Growth in the quarter was primarily driven by our Trauma and Deformity product line, including our non-surgical specialty bracing business. We generated total international revenue of $10.6 million, representing growth of 26.2% compared to the third quarter of 2022.

Growth in the quarter was driven by strong performance with our T&D products, offset by slower scoliosis sales due to the timing of orders from stocking distributors in South America. In the third quarter of 2023, Trauma and Deformity global revenue of $28.8 million increased 20.6% compared to the prior year period. Growth in the quarter was driven primarily by the share gains across our entire portfolio with strong contributions from Pega, Trauma and OP SB. In the third quarter of 2023 scoliosis revenue of $10.3 million increased 3.3% compared to the prior year period. Growth was primarily driven by the continuation of our strategy of the combined strength of ApiFix, response and 70 placements in the U.S., offset by international weakness driven by timing of set sales to our South American stocking distributors.

Finally, Sports Medicine/Other revenue in the third quarter of 2023 was $0.9 million, which decreased 20% compared to the prior year period. Turning to set deployment, $3.9 million of sets were consigned in the third quarter of 2023 compared to $6.4 million in the third quarter of 2022. Year-to-date, we have deployed $16.1 million compared to $13.8 million in the same period last year. The increase was driven by significant new product development deployments, significant Pega deployment as well as multiple consigned 70 units. Touching briefly on a few key metrics. For the third quarter of 2023, gross profit margin was 77.4% compared to 74.1% from the third quarter of 2022. The improvement was primarily driven by timing of favorable purchase price variances as well as fewer scoliosis set sales to South America.

Total operating expenses increased $2.6 million or 8% to $35.5 million in the third quarter of 2023. The increase was primarily driven by the addition of incremental personnel related to expenses required to support the ongoing growth of the company as well as increased sales and marketing expenses, driven by the increase in revenue. Sales and marketing expenses increased $1.7 million or 14.0% to $13.6 million in the third quarter of 2023. The increase was driven primarily by increased sales commission expenses. General and administrative expenses increased $3.4 million or 22% to $18.5 million in the third quarter of 2023. The increase was driven primarily by an increase in non-cash G&A expenses, including depreciation, amortization and stock-based compensation as well as additional personnel related to support the growth of the business.

In the third quarter of 2023, we recorded a $1.0 million charge to operations related to intangible impairment as compared to $3.6 million charge in the third quarter of 2022. These charges were primarily driven by the decrease in forecasted revenue that was lower compared to the same period in the prior year. Research and development expenses increased $0.2 million or 8% to $2.4 million in the third quarter of 2023, driven by payments to third-party providers. Total other income was $0.8 million for the third quarter of 2023 compared to $1.7 million of expense for the same period last year. In the third quarter of 2022, we realized a $23.0 million fair value adjustment benefit, which was driven by the decrease in forecasted revenue that was lower in comparison to the same period last year.

We did not realize an adjustment for the fair value in the third quarter of 2023. We reported adjusted EBITDA income of $3.6 million in the third quarter of 2023, which is a new record for us and compares to $1.9 million for the third quarter of 2022. This increase was driven by incremental revenue combined with improved gross margin and cost controls across the organization. We ended the third quarter with $84 million in cash, short-term investments and restricted cash. We continue to make a strong cash position as well as the $50 million available to us on our line of credit. Overall, we are well capitalized to continue to execute on our strategy. Given the current economic environment, our strong balance sheet, positive adjusted EBITDA and line of sight to cash flow breakeven places us in a position of tremendous strength.

Turning to guidance. We are reiterating our expectations for full year 2023 revenue to be in the range of $148 million to $151 million, representing year-over-year growth of 21% to 23%. Additionally, we now expect to generate between $4 million and $5 million of adjusted EBITDA in 2023, up from our previous guidance of $3 million to $4 million. Lastly, we now expect around $23 million of new set deployment in 2023, representing a year-over-year annual growth of 24% and represents our continued focus on driving the business to cash flow breakeven sooner rather than later. I’ll now turn the call back over to Dave for closing remarks.

David Bailey: Thanks, Fred. As we look back so far on 2023, we are proud of all that we’ve achieved and are excited about the growing opportunities in front of us next year. We expect positive trends in the business to continue, including robust top line revenue growth and continued profitability growth as we move towards cash flow breakeven even sooner than anticipated. Much of our predicted strength in the upcoming period lies with our recent product portfolio expansion, ApiFix, Orthex and the specialty bracing business that are all producing higher return on invested capital and require less set deployment to drive profitable revenue growth. All of our long-term plans, including profitability growth are supported by our robust balance sheet, strong cash position and access to debt.

The future is bright for OrthoPediatrics and we have never been more excited about what lies ahead. In closing, I’d like to thank our surgeon partners, my OP associates and all of the innovators in pediatric healthcare for standing together to help KIDS. Operator, let’s open the call for Q&A.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question is from Matthew O’Brien, with Piper Sandler. Please proceed.

Matthew O’Brien: Good morning. Thanks for taking the questions. Dave, maybe just first of all, clarification. Just similar growth profile on the top line of 24%, that’s assuming 20%? And then the real question there is, is this commentary about people like exiting the space. Can you just give a little bit more color on that? Is it some of the bigger folks that you’re hearing specifically that are potentially exiting the space? And how big of an opportunity could that be?

David Bailey: Yes. Thanks, Matt. Yes, I think our comments on growth or growth trajectory similar to what we saw in 2023 as we think about 2024. Obviously, we’re not providing guidance at the moment. But yes, you’re right in that kind of range. What we have seen historically, particularly since the advent of EU MDR is more and more companies that have either come to us to potentially acquire some of their smaller pediatric devices because they want to take those to the MDR. And so I guess from my perspective, when you hear companies talking about different asset classes or different product lines that they are not heavily focused on. We obviously know that there is very few people, if any, other than us focused in pediatric trauma limb deformity in particular.

And so I guess our forward thinking is that there will be less competitors coming out with devices, particularly in our trauma space and maybe to a certain – to a lesser degree in our limb deformity space. And I think that just hastens our position in terms of taking a dominant market share position going forward. Does that make sense?

Matthew O’Brien: Makes total sense. Appreciate that. And then a question for Fred. The profitability number in the quarter was fantastic. I know it’s a seasonally strong quarter for you guys. But the gross margin number specifically was really, really strong. Can you talk about that? And then how we think about the EBITDA progression going forward because you’re up about $4 million this year versus last year. I don’t think we’re going to get that kind of level of improvement next year. But just maybe talk a little bit about that in the free cash flow breakeven sooner. There is a little bit more color you can provide there specifically. Thanks.

Fred Hite: Yes. Absolutely, thanks, Matt. Very pleased, obviously, with the gross margin in the quarter. Typically, the higher volume does deliver higher gross margin for us, which we saw here in the third quarter, highest revenue the company has ever delivered, which is our third quarter is always our strongest quarter within the year. And it was nice to see that show up in the gross margin line as well as the adjusted EBITDA line. So very pleased with the profitability. We still think for the year, it’s in the 76% range, gross margin, and that’s probably what we will anticipate next year as well, 75% to 76% higher in the third quarter when the volume is the highest. The adjusted EBITDA, very strong in the quarter and enabled us to increase the full year guidance on adjusted EBITDA up to that $4 million to $5 million this year compared to positive $0.2 million last year.

And I would guess we would anticipate seeing some similar type of improvement next year. Again, number one goal is growing the top line. Secondary goal is to improve year-over-year adjusted EBITDA, not maximize it, but to show a nice improvement. And the third is to get to that cash flow breakeven sooner. So that adjusted EBITDA growing, less cash on sets gets us to that cash flow breakeven as we said sooner than we would have anticipated even 12 or 18 months ago.

Matthew O’Brien: Got it. Thank you so much.

Operator: Thank you. [Operator Instructions] And it comes from the line of Rick Wise, with Stifel. Please proceed.

Rick Wise: Hi, good morning to you both. Maybe just to start, you could talk a little bit more, Dave, about the pediatric costal environment. I mean I heard several things about volume trends for specific products. If I heard you correctly, you start to improve or improve as you’re exiting the quarter as you’re heading into the fourth quarter. But have you seen steady month-to-month improvement? Are you seeing staffing recovery? How far away from normal are you? When do we get back to normal usual across the board? A lot in there, but I just wanted to – if you could expand on all that.

David Bailey: You bet. Thanks, Rick. Yes. I mean, certainly, this is still a headwind, and we’re feeling it. As you know, our patients are an inpatient, they are not going to outpatient surgery centers, where I think the environment is better. So this remains a headwind for us. I think we are seeing, as we’ve said in the past, we’re seeing hospitals higher. Obviously, staffs coming together, efficiencies improving. I think we probably haven’t come off our position in thinking that maybe this is a mid-next year type of thing we when we get back to normal. And I would just say that it’s incremental, Rick. I mean, we’re seeing kind of month-to-month, quarter-to-quarter, the lightning of this. We’d like to see some hospitals that we’re running more rooms get back to running all their rooms.

I’m not sure that we’re seeing that. And so that depresses some of the volume that we see in our more complex procedures like scoliosis. But it is improving. It’s hard to give you a specific percentage, but I think we’re on a track to certainly within the next 12 months or so getting back to a pretty normal environment.

Rick Wise: Got it. And I was hoping you could – you touched on the scoliosis pressures and some of the factors that restrain performance there. But maybe you can help us – maybe you could sort of tie a bow on it, so to speak, and help us understand why you are so optimistic and so confident that that along with the basically excellent performance elsewhere that scoli is going to be better in the fourth quarter and you feel equally I assume constructive about next year. Is it the new products? Is it those three large sites getting back up? What are the biggest factors in your current confidence in improvement there? Thank you.

David Bailey: Yes. So one of the things I think gives me a lot of confidence on the scoli side in the United States, 9% growth, a little lower than we would have thought. But when we look at total new users, we actually added substantial volumes and new users on the Fusion side as well as the ApiFix side, which is kind of odd, obviously, to see our new user base go in a way that it was really positive. But just in general, to see volume slow or be a little bit lower than we thought. When we isolate where that volume comes from, again, this is still a relatively small business at $10 million plus in a quarter. And so we remain impacted by three to five accounts that we haven’t lost any share, but volumes are off. And obviously, you feel that pretty substantially in a quarter in the United States where we – the comparable was a 38% growth number previous year.

So we don’t have a lot of those comparables out there that are at that rate. And so we feel pretty good about where we’re going. I also think – well, we have a line of sight, obviously, into Q4. And while December is a big month for us, obviously, it’s the third largest month we have in kind of the second scoli season, we have gotten off to a really, really nice start. And so scoli has been choppy. We’ve said that for a while, but it’s really nice to see here that we got a strong line of sight into Q4 and with the new users. And some of those surgeons that we said have moved accounts started to pick up, and that’s why in the script, we talk about scheduling improving in the back part of Q3. And we expect that to start to become a bit of a tailwind for us as those surgeons have now gotten into their new locations and have started scheduling cases.

Fred Hite: Yes. I would add that in addition to that, Rick, on the OUS side, actually, the spine was negative growth, and that was driven because we had 35% growth internationally in the third quarter of last year, driven by set sales to South America that did not repeat here in the third quarter of this year. And again, we have line of sight into what that looks like for the fourth quarter, which has much improved over the third quarter revenue. So feeling confident in both the fourth quarter and next year on that side of the business as well.