ORTHOPEDIATRICS CORP 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the condensed consolidated financial statements and related notes thereto contained elsewhere in this quarterly report, as well as the information under "Note Regarding Forward-Looking Statements." The description of our business included in this quarterly report is summary in nature and only includes material developments that have occurred since the latest full description. The full description of the history and general development of our business is included in "Item 1. Description of Business" section of the Company's Annual Report on Form 10-K filed with the SEC on March 8, 2024, which section is incorporated herein by reference. Overview We are the only global medical device company focused exclusively on providing a comprehensive trauma and deformity correction, scoliosis and sports medicine product offering to the pediatric orthopedic market in order to improve the lives of children with orthopedic conditions. We design, develop and commercialize innovative orthopedic implants, instruments and specialized braces to meet the needs of pediatric surgeons or orthotists and their patients, who we believe have been largely neglected by the orthopedic industry. We currently serve three of the largest categories in this market. We estimate that the portion of this market that we currently serve represents a $3.9 billion opportunity globally, including over $1.7 billion in the United States. We sell implants, instruments and specialized braces to our customers for use by pediatric orthopedic surgeons, orthotists or physical therapists to treat orthopedic conditions in children. We provide our implants in sets that consist of a range of implant sizes and include the instruments necessary to perform the surgical procedure. In the United States and a few selected international markets, our customers typically expect us to have full sets of implants and instruments on site at each hospital but do not purchase the implants until they are used in surgery. Accordingly, we must make an up-front 24 investment in inventory of consigned implants and instruments before we can generate revenue from a particular hospital and we maintain substantial levels of inventory at any given time. In the international markets where we sell to stocking distributors or in the case of our braces, we transfer control of our products to the distributor or customer when title passes upon shipment. We currently market 71 surgical and specialized bracing systems that serve three of the largest categories within the pediatric orthopedic market: (i) trauma and deformity correction, (ii) scoliosis and (iii) sports medicine/other. We rely on a broad network of third parties to manufacture the components of our products, which we then inspect and package. We believe our innovative products promote improved surgical accuracy, increase consistency of outcomes and enhance surgeon confidence in achieving high standards of care. In the future, we expect to expand our product offering within these categories, as well as to address additional categories of the pediatric orthopedic market. The majority of our revenue has been generated in the United States, where we sell our products through a network of multiple direct sales representatives as well as 38 independent sales agencies employing more than 210 sales representatives specifically focused on pediatrics. These independent sales agents are trained by us, distribute our products and are compensated through sales-based commissions and performance bonuses. We do not sell our products through or participate in physician-owned distributorships, or PODs. We market and sell our products internationally in over 70 countries, through independent stocking distributors and sales agencies. Our independent distributors manage the billing relationship with each hospital in their respective territories and are responsible for servicing the product needs of their surgeon customers. In 2017, we began to supplement our international stocking distributors with sales agencies using direct sales programs in the United Kingdom, Ireland, Australia and New Zealand where we sell directly to the hospitals. We began selling direct to Canada in September 2018, Belgium and the Netherlands in January 2019, Italy in March 2020 and Germany, Switzerland and Austria in January 2021. In order to further enhance our operations in Europe, we established operating companies in the Netherlands and Germany in March 2019 and April 2022, respectively. In January 2023, we established a direct sales organization in Germany, the Company's first direct selling organization serving an international market. In our international markets, excluding Germany, we work through sales agencies that are paid a commission, similar to our U.S. sales model. These arrangements have generated an increase in revenue and gross margin. We believe there are significant opportunities for us to strengthen our position in U.S. and international markets by increasing investments in consigned implant and instrument sets, strengthening our global sales and distribution infrastructure and expanding our product offering. Environmental, Social and Governance ("ESG") Activities OrthoPediatrics was founded on the cause of impacting the lives of children with orthopedic conditions. Since inception we have impacted the lives of over 1,000,000 children, when including those served by our acquired companies. We believe we should continue to expand our social efforts while minimizing our impact to the environment and ensuring corporate governance. In 2021, we created an internal ESG team, which reports directly to our Board’s Governance Committee, to identify ESG topics for disclosure by assessing both the impact on our business and the importance to our stakeholders. We encourage you to review our ESG page and summary report which can be found under the "About" section of our corporate website for more detailed information regarding our ESG efforts and current initiatives. On our website, among other information, are the following highlights: • OrthoPediatrics cares about our environmental impact while working in a highly regulated industry and we are certified according to ISO 13485. Our team in Warsaw, Indiana recently implemented 25 an enhanced recycling program and our team in the United Kingdom created a carbon reduction plan. • The Company and its associates regularly participate in philanthropic causes important to our local communities. We also partner with charitable organizations that provide pediatric orthopedic care around the world. In 2020, we were named as "Corporate Partner of the Year" by World Pediatrics - with whom we work to provide access to medical care for children in developing countries. • We are committed to fostering an environment that is respectful, compassionate, and inclusive of everyone in our community which is communicated in our diversity and inclusion policy. For eight years we have been recognized by the Indiana Chamber of Commerce - Best Companies to Work in Indiana. • Th e Company and its Board of Directors understand the value of diversity. In 2022 and again in 2023, the Company added diverse Directors to our Board and will continue its Board diversity initiative in the future. We believe effectively managing our priorities, as well as increasing our transparency related to ESG programs, will help create long-term value for our stakeholders. We expect to increase our disclosures and communicate our ESG efforts in future SEC filings. Nothing on our website shall be deemed part of or incorporated by reference into this Quarterly Report on Form 10-Q. Trends and Uncertainties From time to time we acquire, make investments in or license other technologies, products and business that may enhance our capabilities, complement our current products or expand the breadth of our markets or customer base. As a result of these transactions, we may record certain intangible assets, including goodwill and trademarks, which are subject to annual impairment testing. Fair value is based on our current assessment of the expected future cash flows based on recent results and other specific market factors. During 2023 and 2022, we determined that a triggering event had occurred indicating it was more likely than not the fair value of the ApiFix trademark was less than the associated carrying value. Subsequently, the Company completed a quantitative analysis and concluded that the fair value was in fact less than the carrying value and a partial impairment losses of $1.0 million and $3.6 million were recorded in 2023 and 2022, respectively. We believe that the expected future cash flows in the most recent calculations represent management’s best estimate; however, if actual results differ materially from these estimates, we could record an additional impairment charge which could be material to our consolidated financial statements and have an adverse impact on our results of operations. In 2022 and 2023, there was a significant and unprecedented increase in cases of respiratory syncytial virus, or RSV, and other respiratory illnesses. RSV is a common respiratory virus that follows a seasonal pattern. The typical season shows an increase in mid-September, peaks in late December and drops around mid-April. In 2023 the United States experienced a significant increase in RSV activity outside of the typical peak season as well as a heightened impact during the winter months. The volume of elective procedures utilizing our products were negatively impacted as a significant percent of hospital capacity was absorbed to cover the increase in RSV-related hospitalizations. This had a negative impact on our sales volume in 2022 and 2023 and may continue to do so into the future. We are unable to accurately determine exactly how this will impact us in the future. As a result of the COVID-19 pandemic, we experienced significant business disruption throughout the last several years. Elective procedures were delayed in some cases as hospitals continue to struggle with adequate staffing levels. As a majority of our products are utilized in elective surgeries or procedures, the 26 deferrals of such surgeries and procedures have had, and may continue to have, a significant negative impact on our business and results of operations. Throughout the pandemic, we took a variety of steps to address the impact. We continue to monitor the impact of the pandemic on our employees and customers and the markets in which we operate and will take further actions that are considered prudent to address the pandemic. We cannot accurately predict with certainty the full extent to which the pandemic will impact demand for our products in the future. We encourage the readers of this document to read our risk factors in their entirety contained in Item 1A “Risk Factors” in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (the "SEC") on March 8, 2024 and in other reports filed with the SEC that discuss the risks and factors that may affect our business. Summary of Statements of Operations for the Three Months Ended March 31, 2024 and 2023 The following table sets forth our results of operations for the three months ended March 31, 2024 and 2023: Three Months Ended March 31, 2024 2023 Increase (Decrease) % Net revenue $ 44,685 $ 31,588 $ 13,097 41 % Cost of revenue 12,511 8,027 4,484 56 % Sales and marketing expenses 14,169 12,549 1,620 13 % General and administrative expenses 24,730 17,157 7,573 44 % Research and development expenses 2,998 2,446 552 23 % Other expense (income), net 613 (1,211) 1,824 (151) % Provision for income taxes (benefit) (2,531) (574) (1,957) (341) % Net loss $ (7,805) $ (6,806) $ 999 15 % Net Revenue The following tables set forth our net revenue by geography and product category for the three months ended March 31, 2024 and 2023: Three Months Ended March 31, Product sales by geographic location: 2024 2023 U.S. $ 34,305 $ 23,800 International 10,380 7,788 Total $ 44,685 $ 31,588 Three Months Ended March 31, Product sales by category: 2024 2023 Trauma and deformity $ 33,302 $ 23,395 Scoliosis 10,203 7,072 Sports medicine/other 1,180 1,121 Total $ 44,685 $ 31,588 Net revenue increased $13.1 million, or 41%, from $31.6 million for the three months ended March 31, 2023 to $44.7 million for the three months ended March 31, 2024. The increase during the three months ended March 31, 2024 was primarily driven by the addition of Boston O&P sales, as well as strong performance across global Trauma and Deformity, International Scoliosis and OP Specialty Bracing. 27 Trauma and deformity sales increased $9.9 million, or 42%, from $23.4 million during the three months ended March 31, 2023, to $33.3 million for the three months ended March 31, 2024. The increase for the three months ended March 31, 2024 was primarily driven by strong growth across numerous product lines, specifically our Cannulated Screws, PNP Femur, PediPlate, external fixation and Pega systems, as well as the addition of Boston O&P . Scoliosis sales increased $3.1 million, or 44%, during the three months ended March 31, 2024. The increase for the three months ended March 31, 2024 was primarily driven by increased sales of our RESPONSE 5.5/6.0 and ApiFix systems and revenue generated from 7D Technology, as well as the addition of Boston O&P. Sports medicine / other increased $0.1 million, or 5%, during the three months ended March 31, 2024. The change in sports medicine / other was primarily driven by sales from our Telos operations. Nearly all the change in each category was due to an increase or decrease in the unit volume sold and not a result of price changes. Cost of Revenue and Gross Margin Cost of revenue increased $4.5 million, or 56%, from $8.0 million for the three months ended March 31, 2023 to $12.5 million for the three months ended March 31, 2024. The increase is due primarily to sales volume, including the added cost of revenue associated with the revenue generated by acquisitions and mix related to additional international sales. Gross margin was 72% and 75% for the three months ended March 31, 2024 and March 31, 2023, respectively. Sales and Marketing Expenses Sales and marketing expenses increased $1.6 million, or 13%, to $14.2 million for the three months ended March 31, 2024 from $12.5 million for the three months ended March 31, 2023. The changes in the three month periods ended March 31, 2024 was due primarily to increased sales commission expenses, as well as the addition of Boston O&P. General and Administrative Expenses General and administrative expenses increased $7.6 million, or 44%, from $17.2 million for the three months ended March 31, 2023 to $24.7 million for the three months ended March 31, 2024. The increases for the three month period ended March 31, 2024 was due primarily to the addition of Boston O&P. Stock compensation increased by $0.5 million with the increase in personnel and also as a result of restricted stock issued as part of the Boston O&P acquisition. Depreciation and amortization expenses increased $1.2 million, or 31%, from $3.8 million for the three months ended March 31, 2023 to $5.0 million for the three months ended March 31, 2024. The increase in depreciation for the three month period ended March 31, 2024 was primarily due to higher set deployments and increased amortization associated with acquisitions, as well as the addition of Boston O&P. Research and Development Expenses Research and development expenses increased $0.6 million, or 23%, from $2.4 million for the three months ended March 31, 2023 to $3.0 million for the three months ended March 31, 2024. The increase for the three month period ended March 31, 2024 was primarily due to incremental product development and the addition of personnel to support the future growth of the business, including $0.4 million of additional non-cash stock based compensation expense. Total Other (Income) Expenses Other expense was $0.6 million for the three months ended March 31, 2024 compared to other income of $1.2 million for the three months ended March 31, 2023, a change of $1.8 million or 151%. The change for the three months ended March 31, 2024 was primarily due to the fair value adjustment of contingent 28 consideration associated with our ApiFix acquisition, as well as an increase to net interest expense related to the new Term Loan with MidCap. Liquidity and Capital Resources We have incurred operating losses since inception which resulted in negative cash flows used in operating activities of $6.7 million and $6.5 million for the three months ended March 31, 2024 and 2023, respectively. As of March 31, 2024, we had an accumulated deficit of $205.5 million. We anticipate that our losses will continue in the near term as we continue to expand our product portfolio and invest in additional consigned implant and instrument sets to support our expansion into existing and new markets. Since inception, we have funded our operations primarily with proceeds from the sales of our common and preferred stock, convertible securities and debt, as well as through sales of our products. At March 31, 2024, we had cash and cash equivalents, restricted cash and short-term investments of $49.7 million. Cash Flows The following table sets forth our cash flows from operating, investing and financing activities for the periods indicated: Three Months Ended March 31, 2024 2023 Net cash used in operating activities $ (6,690) $ (6,461) Net cash (used in) provided by investing activities (3,679) 32,310 Net cash used in financing activities (573) (36) Effect of exchange rate changes on cash, cash equivalents and restricted cash 1,479 (138) Net (decrease) increase in cash, cash equivalents and restricted cash $ (9,463) $ 25,675 Cash Used in Operating Activities Net cash used in operating activities was $6.7 million and $6.5 million for the three months ended March 31, 2024 and 2023, respectively. The primary use of this cash was to fund our operations related to the development and commercialization of our products in each of these periods. Net cash used for working capital was $4.5 million for the three months ended March 31, 2024 compared to $4.8 million for the three months ended March 31, 2023. The increase in cash used in operating activities was primarily driven by additional inventory purchased to support sales growth as well as accounts receivable from the increased sales which was offset by cash provided by accounts payable associated with the acquired inventory. Cash (Used in) Provided by Investing Activities Net cash used in investing activities for the three months ended March 31, 2024 was $3.7 million compared to cash provided of $32.3 million for the three months ended March 31, 2023. Net cash used in investing activities for the three months ended March 31, 2024 consisted primarily of the sale of short-term marketable securities, when netted against the purchase of similar securities, offset by purchases of property, plant and equipment of $6.5 million, the majority of which is instrument sets. The change in cash related to investing activities is primarily driven by business combinations and the purchase of short term marketable securities which decreased from the prior year. Cash Used in Financing Activities Net cash used in financing activities for the three months e nded March 31, 2024 was $0.6 million consisting primarily of $0.5 million payments on acquisition note payable that was assumed with the 29 Boston O&P acquisition . Net cash used in financing activities for the three months ended March 31, 2023 was not material to the results of our operations. Indebtedness The Company is party to a $80 million Credit, Security and Guaranty Agreement with Midcap Funding IV Trust and Midcap Financial Trust and other parties named therein. As of March 31, 2024, there was $10 million outstanding indebtedness under the Credit Agreement. In August 2013, pursuant to the purchase of our office and warehouse space, we entered into a mortgage note payable to Tawani Enterprises Inc., the owner of which is a member of Squadron’s management committee. Pursuant to the terms of the mortgage note, we pay Tawani Enterprises Inc. monthly principal and interest installments of $15,543, with interest compounded at 5% until maturity in August 2028, at which time a final payment of remaining principal and interest will become due. See Note 6 - Debt and Credit Arrangements in Item 1 for further detail regarding our debt. Pediatric Orthopedic Business Seasonality Our revenue is typically higher in the summer months and holiday periods, driven by higher sales of our trauma and deformity and scoliosis products, which is influenced by the higher incidence of pediatric surgeries during these periods due to recovery time provided by breaks in the school year. Additionally, our scoliosis patients tend to have additional health challenges that make scheduling their procedures variable in nature. Critical Accounting Policies and Significant Judgments and Estimates There were no material changes to our critical accounting policies that are disclosed in our audited consolidated financial statements for the year ended December 31, 2023 filed with the SEC on March 8, 2024. Recent Accounting Pronouncements See Note 2 - Significant Accounting Policies in Item 1 Financial Statements of Part 1 of this Quarterly report on Form 10-Q for a description of recent accounting pronouncements applicable to our condensed consolidated financial statements.