Ladies and gentlemen, thank you for standing by and welcome to the OrthoPediatrics Corporation Third Quarter 2019 Earnings Conference Call. At this time, all participants' lines are in a listen-only mode. After the speakers' presentation there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Ms. Tram Bui with the Ruth Group. Thank you, please go ahead ma'am.

Thanks, operator, and thanks, everyone, for participating in today's call. Joining me from the company are Mark Throdahl, Chief Executive Officer; and Fred Hite, Chief Financial Officer. Before we begin, I'd like to caution listeners that comments made by management during this conference call will 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 involve material 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 annual report on Form 10-K, which was filed with the Securities and Exchange Commission on March 7, 2019. During the call today, management will also discuss certain non-GAAP financial measures, which are used as 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 measures to the most directly comparable GAAP financial measures in its earnings release. Please note that non-GAAP financial measures have limitations as analytical tools and should not be considered in isolation or as a substitute for OrthoPediatrics' 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 the live broadcast, November 8, 2019. Except as required by law, the company undertakes no obligation to revise or update any statement to reflect events or circumstances that take place after the date of this call. With that said, I'd like to turn the call over to Mark.

Good morning, everyone, and thank you for joining us today on our third quarter 2019 earnings conference call. I'm pleased to review with you our strategic progress and our accelerated growth. I'll start with an overview of our performance for the quarter and then review our key growth initiatives which include certain investments, new products, acquisitions and the integration of Orthex, international growth, culture and clinical education. I'll then turn the call over to Fred for a detailed financial review and update to our full year 2019 guidance. We will then open the call up to questions. The third quarter was another period of systematic execution that produced the largest revenue quarter in the company's history, $20.7 million in sales and more than 31% growth year-over-year. We drove growth across all product lines with Trauma and Deformity growing 31%, Scoliosis 29% and Sports Medicine and Other 90%. Domestic growth was 35% and International growth was 16%. We're pleased with the impact of recent new product introductions together with the increased utilization our recent set deployments. In addition to our strong Trauma and Deformity performance, we're pleased by the impact of new product sales supporting our Scoliosis business with continued adoption of our small stature scoliosis system and BandLoc DUO introduced in December 2018 and February 2019 respectively. We also saw three of the five high-volume scoliosis surgeons who were out of practice in the second quarter returning to limited practice in the third quarter. While these surgeons will not immediately return to the same level of volume overnight, we're pleased to see their impact on third quarter revenues and we anticipate that they will ramp up surgical volume at their new institutions. Contributing to our overall performance was our first full quarter with Orthex which was approved in multiple new…

Thanks Fred. To summarize, we are excited that we can report a quarterly revenue growth rate exceeding 30%. We are pleased that this acceleration in growth was produced by consistent performance across all three of our product lines. We are proud of our ability to execute systematically across multiple growth initiatives. We are convinced that this success continues to be driven by our exclusive focus on pediatric orthopedics. We're delighted by our initial success with Orthex and its likely contribution to future growth. We are confident that the divestiture of Vilex's adult assets will be completed by year-end. We are gratified that our investments in clinical education are enhancing our brand equity in the minds of experienced and newly trained surgeons alike. We are proud of our positive contribution to society by making a difference in the lives of children around the globe. So on behalf of my colleagues, I'd like to thank all our associates for their passion, their commitment, and their hard work that made the third quarter such a success. And with that, I'd now like to open the call up for questions. Operator?

[Operator Instructions] Our first question comes from Matthew O'Brien with Piper Jaffray. Your line is now open.

Thanks, good morning. Thanks for taking my questions. Just for starters, on the Q4 guidance, I understand roughly 25% of your sales are generated in Q4, but this would be the biggest sequential step down from an absolute revenue perspective that we've seen. What's your implied at the midpoints about down 2.6 and the most we've seen is 1.2 over the last couple of years. So can you just help us understand where that big step down comes from? Is it just a level of conservatism or is there something else that we should be mindful of?

No, you're right, Matt. The fourth quarter is always our softest quarter, it's our lowest quarter. When you look across the four quarters, the summer months are always strong with June and July. We do have an uptick in December, when there is a small break for the kids, but we do have a lower sales in the fourth quarter compared to the third quarter. There is nothing I would say going on. We continue to be conservative as we always have been in our forecasting and I think that just continues with the year throughout the rest of 2019.

Okay, fair enough. And then I would love to, it's a follow-up question, just hear a little bit more about Orthex. I know it's early days, but you know a lot of interest in that product line. So as we go into some of the accounts, you already have relationships, can you just talk about what that conversation has been like, and then how much interest level you're seeing so far, as we think about that product rolling into 2020? Thank you.

Well, Matt, as we said, we are very, very pleased that the relationships we have with a number of leading surgeons, who are also big frame users is making it reasonably straightforward to gaining evaluation. And then we've been very pleased that these evaluations have been going well. We would have expected frankly there to be a somewhat slower process of gaining evaluations given the stickiness of supply relationships with the several major suppliers historically of external fixation systems. And I think it just validates this expectation we have, that with the nature of a pediatric focus selling organization, we would have any easier task of gaining these evaluations. So I think that's what we see so far. There have been some very gratifying conversions already. And this is a sort of thing where you don't need many conversions to goose the sales growth rate of this thing, and at least in the first quarter we owned it, I think we saw a significant acceleration of sales in July and August - the second, no, it's, sorry, August and September. In August and September, the second two months of the quarter, we saw this very gratifying increase in sales. So we'll see what the fourth quarter brings, but so far, this thing has easily patience.

Great to hear. Thank you.

Thank you. Our next question comes from Ryan Zimmerman with BTIG. Your line is now open.

Good morning, and congrats on the quarter. I want to ask, your gross margins were very impressive this quarter, and I don't think you called out international stocking distributor conversions. So maybe help us understand what drove the gross margin performance this quarter and what we should be thinking about for the cadence of international stocking distributor conversions into FY20? And then I have a follow-up. Thank you.

Great. Thanks, Ryan. So the gross margin is really driven by the mix of our revenue, as you saw 81% little higher domestic percentage of our total revenue. Again summer selling season is helping drive that. We also had the addition of the Orthex product, which is primarily sold on the domestic front with some international included, but they have very similar gross margins to other products in that 80% to 85% range. And so, as the domestic growth outpaced the international growth here in the third quarter, that helped drive our gross margins. If you look at the trend of our gross margin percentages across the quarters this year, it's very similar to last year. It's obviously just a little better given the strong growth on the domestic side of the business.

And with regard to the international stocking conversions, we continue to work on a major one in Western Europe, that we would hope would be done by year-end. It is astonishing how complex these are in terms of various legal and regulatory requirements, but nonetheless, that is progressing well. We will then shift our attention to an even more significant conversion that will require perhaps several years to fully be played out, but this will be quite transformative with regard to our European business.

That's very helpful guys. And then on the set deployment, you're on pace to do $15 million to $17 million, as you said, just directionally, I'm not looking for guidance for FY20, but maybe just comment on where you see set deployment going in next year, consistent with what you're doing this year expect to accelerate. Just any color there, I think would be directionally helpful. Thank you.

Yes, we're very pleased with the set deployment that we've done this year and what we'll finish out strong this year. I think couple of things drive that, number one is demand for the legacy system. So fulfilling the demand we have on legacy systems and then also the pace that we deliver new product introductions, and the pace at which we roll out those new sets. So we're in the final stages, I think of our strategic planning that will roll into the budgeting process which will determine what is that demand and the appetite for deploying sets next year. But it's really measuring the demand and how much of that we're going to fulfill along with how aggressive we get on new product development. So I would say that we're not going to provide a number, but it's going to continue at a very healthy pace to support the growth of the business.

Understood, thanks for taking the questions guys. Congrats again.

Thanks, Ryan.

Thank you. Our next question comes from Rick Wise with Stifel. Your line is now open.

Hi. Good morning, Mark. Good morning, Fred. Let me start with a question on the extra day that "you lost" in the second quarter, that was a little bit of a headwind, you had indicated it would come back in the second half. Fred, how do we think about that impact in the quarter you just reported and/or the fourth quarter?

Yes, we did in fact pick up that extra day here in the third quarter. So that drove a small portion of the 31% growth that we saw. So we are back even and the fourth quarter will have the same number of days that we had last year, so it will be an even comparable.

And can you quantify that impact this quarter? I mean, it's obviously modest, I mean, it seems like a few hundred thousand dollars maybe of revenue.

That's right. It's pretty modest.

Okay. Second, and again back to international briefly, I guess two part question. One, international growth seemed a lot slower this quarter than when I look at the more typical mid 20s-ish kind of growth we've seen, maybe help us understand what's happening this quarter and what that might mean or not mean going forward? And maybe, Mark, you could highlight, I mean, clearly you're, I feel like you're a little more focused on growth opportunities internationally, whether it's conversion, whether it's stepping up on the leadership front, investing in infrastructure. Maybe help us think about what you're trying to achieve and when we see that impact of some of these investments and changes in 2020 or no, it's going to take longer. Is this just about sustaining that mid 20s kind of growth or could it accelerate? Again any color would be welcome.

Well, with regard to the international growth, I think we have to admit that international sales are inherently lumpy. They are very much a function of - for example, set sales that we don't totally control and in certain quarters we get a lot of them and others, we don't. We were very satisfied by the replenishment volume growth that occurred in the third quarter and in many ways that is the truest indication of strategic strengths in markets, because that's indicative of surgeries. We also saw some structural things that happened in the quarter completely unrelated to primary demand, such as a very large stocking order that didn't quite make the quarterly cut-off and we'll enjoy that in the fourth quarter. And to be frank, we didn't need international growth in the quarter to achieve this sort of performance. With regard to what we're trying to achieve internationally, particularly in Europe, I think we feel that we are all in - that we are now, in the right countries. So country expansion is not the issue. It is a drive for penetration of market share growth in these areas. And so the conversion of stocking distributors to sales agencies is one element in that. Secondly is the investment in people in Europe. The individual that will be moved to Europe to takeover our business, ran our Trauma and Deformity business worldwide for a period of time. And in fact had actually been President of a distributor in Europe before we hired him. So he is a very experienced guy, and we will now be building out around him, focused infrastructure on clinical training and education, on regulatory affairs, and sales managers who will focus on specific country markets. And then I think a third element of this is the huge investment we've been making in quality and regulatory, a lot of which is directed at compliance to the EU MDR, and this other initiative of unifying regulatory standards in seven of the major markets, including the United States. And we're doing that in the background of other companies who are actually coming to us, wanting us to buy their pediatric lines, because they're going to abandon them. So I would think that over time, we would see a further acceleration of our international growth, particularly in Europe. As we do more than, to be blunt, skimming the market, which is what we have done historically.

Got you. And just one last one from me, if I could. Mark, you highlighted that you're reviewing other interesting acquisitions, which is always exciting to hear and makes tremendous sense, at least to me, as you continue to flush out - build out your very special portfolio. But I'd be curious to hear your thoughts on a couple of points related to that. How do we think about size, type? I mean it's just a complementary and adjacent to everything you have? And thinking about your balance sheet, in round numbers $20 million in cash, $50 million debt, are you in a sense restricted? Do you feel like restrained from doing anything until you sell Vilex? And can we assume that if, let's just say, Vilex cuts debt in half plus-minus, I don't know what you're expecting, then you feel you have sufficient financial flexibility to go out and do what you want to do? A lot of questions in there, but curious to hear your thoughts.

Yes, as usual, let me try to answer the conceptual on this, and leave the hard one to Fred, with regard to adequacy of capital. We are right now evaluating both, some small acquisitions that in no way would tap our capacity financially as well as some very significant acquisitions. These are all directly in our wheelhouse with the exception of one, that is of a longer-term nature that might move the company into an adjacency of non-surgical products that are used by our customers directly. But at any rate, I think the key point is, these will be most definitely complementary acquisitions. Some of those for example that we're looking at are in this whole field of early onset scoliosis or non-fusion technologies that are reversible, that we see the market moving to, so that people at a younger and younger age can be treated before their spine deformities progress with surgeries that are not a permanent fusion of the back. And we see that as the future of pediatric scoliosis treatment. And so there are some very interesting things out there to look at, that will further increase the innovation that our company can bring to the market. Now I'll leave it to Fred to answer how the hell we're going to pay for all this.

Absolutely. I think as Mark mentioned, we continue to look at a lot of opportunities. Many of them range in size from very small nice tuck-ins to larger opportunities. And obviously the smaller stuff we can execute ourselves on our own. As we look at larger things, the first step, as you mentioned, would be to get rid of some of the debt that we have on our books through selling the adult, the product lines of Vilex. But beyond that, we have a great strategic partner on our Board and supportive of the company, Squadron, who helps us if we need to move in a quick fashion to support the business through short-term debt. I think longer term, if there is anything upsize, it would obviously require a funding through the equity side of the balance sheet, and I think that could happen either before or after an acquisition to make sure we have funds available to pay for acquisitions, to pay for the operations of the business going forward, and to fund any potential future acquisitions that we would be looking at as well. So I think it's a combination of all three things. Reducing the debt we have on our books now, helping, getting help from Squadron, and then eventually over time some equity capital raise as well to shore up the balance sheet.

And just to amplify on what Fred said and answer your question about Vilex. The timing is such that the Vilex acquisition will have taken place before we make any further purchases.

Okay, that's great, thanks, and thanks for another great quarter.

Thanks very much.

Thanks Rick.

Thank you. Our next question comes from David Turkaly with JMP Securities. Your line is now open.

Great, thanks. Good morning. So EBITDA positive in the quarter, and I think we're looking for breakeven on the P&L sometime next year. I was wondering if maybe you could comment on that as a goal in 2020 or 2021.

Yes, I mean, it's a balancing act as we've talked about, Dave. It's a balancing act between controlling the expanding and driving growth opportunities that we see ahead of us. And so I think we'll continue to try to balance that equation, best we can, but bringing in the Orthex acquisition is additional cost. Obviously it was a nice addition to the P&L, actually helping some of the profitability. But those type of opportunities as they are in front of us, we'll continue to take advantage of that. The quality and regulatory, I think is a new world that we're in. It's not something that is temporary or that's just a quick project that we're working on. This is the new world that we live in and it's a new world, all of our competitors live in as well. And I think those costs are going to continue on, but we see that as a strategic advantage by supporting the qualification of CE Mark on all of these products and when many other people are abandoning these marketplaces, we see it as true competitive advantage, which will continue to help drive our growth. And so, I think we are again balancing the opportunities we see to support the business and to drive the growth and advancements of this space with trying to get to profitability. We could be profitable very quickly as you can imagine, if that's what we want to do, but we're going to continue to support the overall growth of the business that we see tremendous opportunities and as we see fit.

Got it. And then, I don't know if you want to talk about the contribution specifically from Vilex. But I think there was also Orthex and then maybe four or something to that in order of magnitude, foot and ankle type products that came as well, that I believe you said you might start with PediFoot. I just wondered if you could comment on either side of that or if that had any contribution and how that is going along with I think kind of [indiscernible] quite early, but any thoughts there?

Well, certainly Orthex is the biggie. These additional products that came along with it are minor. They are line extensions. They can be sold with some of our other products. And they are interesting in terms of flushing out a product line more fully, but from a financial standpoint would be very, very marginal. Orthex was the reason we did this deal and that is what we are looking at growing robustly.

Yes, I would just additionally comment that those other product lines that we look to add to the PediFoot, 510(k) is a process that is going to take time. It's going to require 510(k) adjustments, and we have not even started on that process to be honest with you. So what's included right now is just continuing selling the Orthex and the Ex-Fix product lines. In the future in 2020, we will be then taking a few of those other foot and ankle products, let's say a staple and rebranding that under the OrthoPediatrics name and bringing that to the marketplace under our product lines, but that is not something that contributed here in the third quarter. That will be something that will help us in the future.

Got it. I guess one last one quickly, if I could. I think Zimmer got approval of a tether product and I would just like to get your thoughts on sort of them as a competitor and how maybe your system that you're developing kind of compares with that, are they pretty similar? I would imagine they aren't, but any thoughts there? Thank you.

They are based on the same principle, we would like to see ours as different. I think that one needs to recognize that Zimmer has been selling the only product that has been used in tethering off label for a number of years. It's a product called Dynesys, and it was developed for the adult lumbar fixation market. I think Zimmer found itself in a very difficult regulatory quandary, because FDA had, we are told, alerted it that it would not tolerate this product to continue to be sold in these quantities without there being some kind of regulatory approval. And that is why we think Zimmer sought the Humanitarian Device Exemption. We do not see this as some harbinger of a new competitor in the pediatric orthopedic space, quite the contrary. So, we actually view this though as very encouraging, because it is the first time FDA has approved a device for spinal tethering. There will be others, not only for spinal tethering, but for non-fusion scoliosis treatment and that is of enormous interest to us. And I think we've said also Dave that our goal is to develop a portfolio of these products that are not fusion related and that can be used with younger patients and that are reversible. And so in that general sense, we're very encouraged by the FDA's approval of Dynesys.

Thank you for that.

Thank you. Our next question comes from Margaret Kaczor with William Blair. Your line is now open.

Hi, good morning. This is Anna on for Margaret. I first wanted to focus on Trauma and Deformity, again and if you could just walk us through some of the primary drivers of growth this quarter, whether it was the contribution of Orthex or just continuing strong demand of legacy products, new products? Should we expect those same drivers to continue in the next several quarters? And then on top of that the PediFoot launch in the coming months. And then, just curious if you plan on launching Orthex internationally too in the near future?

Well, you know the story on Trauma and Deformity is a very boring one Anna, because when we look at the growth rate of every product family in the Trauma and Deformity area, they were positive and with one exception, I think they were all in the 20% range. It is extraordinary, how these products - all these product families in Trauma and Deformity grew more or less consistently and contributed to this performance. With regard to the PediFoot launch, we have been awaiting the few instruments that require us to finish out the sets, to build out the sets, those are all here and that product should be launched literally within a week or so. So we're very optimistic about the impact that PediFoot would have to this integrated portfolio of solutions for deformity and trauma correction. And there has been considerable interest internationally in Orthex, and so we would anticipate that, again it's a function of getting enough sets, but we will be aggressively putting that in the hands of distributors that will be representing it, and there has been considerable enthusiasm already from our international distributors in terms of taking that product on and promoting it.

Yes, as Mark mentioned, there is tremendous demand for that product, which we're excited to see. We're selling it today in Brazil and Colombia, a few limited countries, but I think the big opportunity for that will be the continued expansion in those areas, but as well getting the CE Mark for that product. That product today has never had the CE Mark on it, and so we are, have focused resources, working to obtain the CE Mark. We don't think that's a quick process given all the other activities going on in that space. But eventually when we do get the CE Mark on that product, we anticipate high demand for that product across all CE marked countries. And we're very excited about moving forward with that. We did also just in the month of September, early October, received approval in Australia for the product for the first time. And so we've not yet sold it into Australia, but we'll be doing that here starting in the fourth quarter and beyond, so another very nice opportunity for us going forward.

Okay. That's really helpful, thank you. And then my second one quickly is on the Scoliosis side. So on the Scoliosis revenues in the quarter again, and you said that you saw three of the five surgeons, high volume surgeons return to practice. Going forward, are these surgeons now included in guidance, and even are you assuming that the other to come back? And then, if I recall correctly, last quarter you saw a number of conversion, surgeon conversions, is this something you're also continuing to see?

As to the guidance, I'm certain that Fred has taken into account, the three people who have returned to practice. They've all moved, it takes time for each of the three to increase their volume, but we're seeing that occurring. I think the other two are both on military deployment, and I'm not sure when they're coming back, but they were significant users and they will. I think though the headline here with Scoliosis is that all of these conversions that continue to take place simply increase the gene pool and so we are not as dependent on five high volume surgeons as we might have been, and with each passing quarter the number of people using our scoliosis product grows, the scale of the business grows and that dependency on individual surgeons decreases. So that's my conclusion with regard to this. It's great to see the three returning to practice, but I'm not sure this is even a factor that you specifically comprehend Fred in the guidance that you put together, but you might want to comment on that.

No, you're absolutely right. I know the one, I think he is on sabbatical is not coming back in the fourth quarter, and it's not a level of detail that we would get into in the specific forecasting. We feel good about the Scoliosis business in the fourth quarter regardless of those two surgeons. The three that have now started will be ramping up, which is going to help us, obviously. But the other two will benefit us later in 2020.

Fred has actually been very modest in not crowing about his prediction that the small stature system would have a dramatic impact. It has. And so that is I think another great headline here that the small stature system complementing our normal system has been very helpful in account conversions.

That's helpful. Thank you.

Thanks, Anna.

Thank you. Our next question comes from Mike Matson with Needham & Company. Your line is now open.

Thanks. So I apologize if you've gone through this, but I didn't hear it. So I just wanted to try to get an understanding of what the true kind of underlying growth was in the quarter. So I think you had an extra selling day and obviously had some contribution from the acquisition. So can you quantify those two things in terms of dollars or percent on the growth in the quarter?

Yes, as Rick was saying earlier, in the second quarter of 2019, we had one less selling day, and so that - we did call that out on our call, which had a small impact. I mean, we're talking a couple of hundred thousand dollars, and we did pick that back up in the third quarter, which helped us again a few hundred thousand dollars. It's rounding. And so that helped us a little bit, that keeps us even now year-to-date, and in the fourth quarter will be comparable year-over-year with the same number of days. The overall growth of the business, as you saw in all three segments was up dramatically. The Orthex to the extent that that had an impact on it all came in the T&D business, which grew nicely at 31%, but we're very pleased with the underlying growth in that business, that returned to the above 20% growth, which is where we saw that business growing previously except for the first quarter when we had unusual slowdown in the Deformity Correction business.

Okay. So I mean, I guess if we're estimating that the deal that 750,000 deal, I'm sorry, not deals, I mean is that a reasonable assumption?

Yes, we're not going to break out specifically what it is. The overall business, the growth is steady with or without Orthex. Orthex just gives us a little adder.

Okay. But I mean it sounds like you think that the underlying growth is as per even stripping out these one-offs in the quarter?

Absolutely.

It is accumulative, Mike.

All right, thanks.

All of these Trauma and deformity products particularly one that's significant is an external fixation device in making us more attractive for total hospital conversions, more relevant, more competitive in total hospital conversions. And not having an external fixation device was a big gap in the product line. And now that that's closed, we would expect to see that together with our current Trauma and Deformity line or our legacy line, there will be an uplift in sales, and hopefully it will help increase the growth rate of Trauma and Deformity. Who knows, maybe even into the range of the Scoliosis business, which has been so robust over the last years.

Yes, okay. So there's sort of a halo effect with that product line you acquired, the Ex-Fix.

That's an excellent description. That's an excellent description, a halo effect indeed.

All right. And then just one final question on the sales force expansion. So it seems like it's been kind of tracking with your revenue growth, which I guess makes sense. Is that kind of where you expect it to continue going in the next few years?

Yes, there is no question that we would view the selling organization is needing to grow more or less in pace with sales. But as, as I'm sure you'd be aware, every territory has its own dynamics. And the key here is we think a new selling organization - a sales management organization, where we've added the number of managing directors, who are our employees in the field, working with our distributors on strategically, how does each of them scale their business, so as to keep up, not only with a bigger company, but also more and more products. And so that is a story that will have 34 different chapters, each one for the 34 territories we have nationally. But in aggregate, the answer should be that the selling organization ought to grow with sales.

Okay, got it. Thank you.

Thanks, Mike.

Thank you, ladies and gentlemen. This concludes our question-and-answer session. I would now like to turn the call back over to Mark Throdahl for any closing remarks.

Well, I'd like just thank you all today for joining us and for your interest in our company, as we improve the lives of kids around the world, while also enhancing shareholder value. So have a good day everybody.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating, you may now disconnect.