OrthoPediatrics Corp. (KIDS) Earnings Call Transcript & Summary

Good afternoon, everyone. A quick disclaimer before we get started. Please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. To our member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley's sales representative. Good afternoon, everyone. My name is Jonathan Guskind, Executive Director at Morgan Stanley's Investment Banking Group. I would like to thank you all for joining us here for the continuing coverage of day 2 of the Morgan Stanley Healthcare Conference 2020. It's my pleasure to have with us here OrthoPediatrics and the company's Chief Executive Officer, Mark Throdahl; President, Dave Bailey; Chief Financial Officer, Fred Hite. To start things off this afternoon, Mark is going to give us a bit of a preamble and provide a high-level overview on the platform and then we are going to jump into Q&A. With that, the floor is yours, Mark.

Great, Jonathan. Thanks so much. It's a pleasure for us to be with you today. OrthoPediatrics is the only diversified medical device company that's focused exclusively on pediatric orthopedic surgery. This is a market with limited focused competition that we can calculate is worth about $1.4 billion here in the United States. And that we can estimate maybe worth something like $3.2 billion on a global basis. So perhaps the most unique aspect of this market is its high concentration. Here in the United States, some 270 hospitals conduct 62% of the surgeries. There are only about 1,400 pediatric orthopedic surgeons in North America. And so this is an ideal opportunity for a young company to address. It's also an interesting characteristic that our customers are generalists who can use all of our surgical systems, unlike in the adult orthopedic world where there are specialists who may only do hips and knees or may only do lumbar fixation surgery. In terms of sources of our competitive advantage, we now have 35 pediatric-specific surgical systems, which is, of course, the broadest pediatric-specific product offering that's available. By the way, those 35 systems have something north of 7,500 individual products in them. We have deep relationships with pediatric orthopedic surgeons, whom we have called on in a very intensive way now for more than 12 years. We have a deep commitment to clinical education that is noncommercial in nature and we spent some 3% of revenues on clinical training programs. And finally, our sales personnel attend every surgery and are viewed as a consultative resource to our surgeons. The company has grown consistently at 20% or more since inception. And in fact, last year revenues were $72.6 million and increased 26%. In fact, sales in the first 2 months of this year, January and February, were in excess of 30% before the impact of COVID-19. And yet we have seen after a precipitous decline in elective surgeries in April, a consistent improvement in our domestic sales, month by month, May through this month, where they are beginning to return to normal growth rates. We would hope the U.S. market would be back to normal by year-end, more or less. The international markets remain very choppy. And so that's at least a quarter behind the U.S. Finally, in the last year or so, we have made 2 substantive acquisitions of novel technologies; Orthex, which is a leading technology and external fixation frames; and ApiFix, which is 1 of 2 non-fusion scoliosis technologies. And these 2 acquisitions give the company proprietary technologies that can expand our position in the marketplace and our relevance to our customers. So Jonathan, that might be a bit of an overview of the company.

No, that's perfect. Thank you, Mark. Dave, I'd like to start with you in terms of my first question here. It's been announced that you'll be assuming the CEO title next year as part of a planned leadership transition. Can you speak to what you see as your strategic priorities for the business going forward? And what really excites you about the overall platform?

Yes, that's a great question. Thanks, Jonathan. So I think that I have to answer that in a way that's not very exactly, unfortunately. But the fact is the company has executed the strategy that Mark talked about, really since 2011, and that is being extremely focused with our sales teams on very high-volume institutions that are primarily these 300 children's hospitals where more than 60% of the pediatric surgery occurs. We're in a constant process of deploying assets to those 300 children's hospitals and growing our sales force to support those 300 children's hospitals. From an R&D standpoint, we continue to develop new products to address these -- the several different indications, the pediatric orthopedic surgeon treat. And for example, in our trauma and limb deformity space through the acquisition of Orthex, we have about 85% of all the pediatric -- all the products that a pediatric orthopedic surgeon might use on a given day. And in the scoliosis side, we have the great majority of anything, a pediatric orthopedic surgeon could use at this point. So we'll continue to expand the addressable procedures, but also continue to invest in very new novel technologies, like Orthex and ApiFix. And then we're going to continue to expand our clinical education programs in partnerships with the leading pediatric surgical society. And I think if we continue to do those 4 things, really well. And frankly, those are the 4 things that we've done since 2011 that have driven an increasing growth rate beyond 20% since that point in time. I see the opportunity to continue to accelerate that growth rate and to continue to see the company grow well into the future. So no big drastic change in strategy. I've had the opportunity as an executive of the company to be here for the entire 14 years since we started the business. And have had a great fortune of having Mark Throdahl as my mentor for the last 10. And I think Mark has taught me and Fred well to continue to invest in the things that are going really well. And so that's what we'll do in the future.

Thank you, Dave. I want to go back to a bit that Mark talked about in the preamble and spend some time on the continued recovery in the business as it relates to the COVID-19 pandemic. You guys have previously stated on your Q2 earnings that you started off the year with very strong growth in January and February and I think you noted it was around 30%. And then as many other players in the space saw -- you had a steep drop in March and April as elective surgeries around the world were postponed. And then as you mentioned just a bit ago, there was a significant turnaround in May and June. Can we talk a little bit more about how that recovery has continued through today? And what you're seeing in maybe some of your various business lines and also internationally?

Fred, would you want to take that?

Yes, absolutely. So yes, we continued very strong growth in January and February for the business, similar to what we had in the third and fourth quarter of last year, which was 31% growth. Obviously, March and then April, dramatic reductions across the business, both domestically and on the international side of the business. Very pleased to see May, June, July, really, since then, the domestic business starting to recover. And in fact, most recently, having growth over the previous year. It was a bit spotty at first. Northeast was very slow to come back, but that is now coming back very strong. And we have a couple of other spots that do slow down. Texas and Florida as they shut down some elective surgeries, but overall, we're very pleased with the domestic side of the business and the continued growth increase month-on-month in that business. OUS is a little different. I would say it's much slower to recover for a couple of reasons: number one, in the U.S., there are stand-alone children's hospitals. And I think the majority of the COVID patients are going to the main hospitals, not to the pediatric hospitals. And so patients, I think, feel a lot more comfortable going back to the stand-alone entities that don't have COVID in them. Outside of the U.S., there's really no stand-alone children's hospitals. It's all combined. And so we've heard definitely stories of patients being concerned about going into those hospitals despite the need for the surgery. So that's the first thing. The second thing is outside of the U.S., we sell-through the stocking distributors, about 75% of our sales outside of the U.S. are through stocking distributors. These are small mom-and-pop firms that are not really well capitalized. And so as you can imagine, during COVID, they are being very conservative, trying to get their feedback under them again before they start buying more sets and worrying about growing their business. We sell them sets at our cost so that they can grow their business in the different countries and the set sales have been really nonexistent since the start of COVID. That will come back, but it's going to be much delayed as compared to the domestic market. And so for those 2 reasons, the OUS market is not growing at this time and we don't anticipate it growing really anytime soon. Maybe as we start into next year, the beginning of next year, we would see some growth in that business. But domestically, we're very encouraged by the recovery, and we see that continuing to gain strength as we move throughout the process.

Great. Have you all reacted to the pandemic through utilizing new technology in light of telemedicine or virtual meetings? Could you delve into that a bit more and explain if you've had any interactions there?

Yes. We certainly have seen and have learned new ways that we can work with surgeons, particularly in product development, where we don't need to be with them face-to-face, but we can have virtual meetings. We have not seen this as much with regard to attending cases. Although the ApiFix people have developed a very elegant system, allowing remote monitoring of surgery, so that someone in Israel or in Warsaw, Indiana can supervise an ApiFix case and give pointers to the surgeon. But in many institutions, that runs or follow HIPAA regulations and various other security measures. I think though, the headline for OrthoPediatrics is that we had not done the things that conventional wisdom would say we should do when in the -- after April, we suffered a 58% decline in our sales. We have not furloughed employees. We have not cut anyone salary. We put into place a distributed relief fund, so that our distributors would be able to take low interest loans from us, which did not need to be repaid until the end of next year. That was superseded, of course, by the PPP, but we got there within days of this decline in the business beginning to occur. We made a major acquisition of ApiFix rather than shelving acquisition activities. And we have continued to execute on all of our corporate objectives that we stated for this year. Bottom line in all that is I think we have learned that we can continue to operate more efficiently in utilizing various technologies. And certainly, going forward, we will have a huge cut in our travel budgets, which I think we realize we just don't need to spend any more. And one day, we'll all be working together again. But until that time, we've proven we can work very well in a virtual kind of setting in terms of continuing to progress the company. Our objective has been to emerge from this COVID-19 situation stronger than when we went into it. And I think we're well along the way to realizing that objective.

Great. Maybe switching lanes a bit. A big part of the story for you guys over the last few years has been new product introductions and developments. I think it'd be great to hear and have you provide an update on your pipeline, highlight any programs you expect to have an impact on your growth in the coming quarters?

Dave, why don't you address that one?

Sure. Thank you. So certainly, as we've highlighted, the Orthex acquisition and the product launch there has been really substantial for the company. This was a technology that moved our product portfolio, as mentioned, from about 60% of all the products available to pediatric orthopedic surgeons and P&D to about 85%. And that, combined with the recent launch of our PNP FEMUR, which is the next generation of our PD Nail system, with also the launch of the Cannulated Screw systems as well as PediFoot have really given us, I think, a lot of momentum coming out of COVID. A number of those products we had announced previous as launches were really beta launches. So we had just a few sets going to KOL surgeons who were part of those design teams to ensure that we had all of the design development features built into the system. And now as we start to emerge from COVID, we are launching those product systems in earnest. So I think the Orthex and particularly PNP have really performed in ways that are, well beyond what we thought they would perform and really exceeding expectations even through COVID. So I think we have a lot to be excited for as we come back with the full product portfolio, but specifically some of the new things. Certainly, as Mark mentioned, the ApiFix acquisition is something for us to be extremely excited about. We have seen, frankly, far more demand than we had expected when we made the acquisition. As you may know, we've assigned 20 IRB sites that will be the first 20 hospitals that will do the first 200 procedures here in the United States. And those procedures will be placed into a public registry so that we can account for the clinical efficacy of this particular product. We expect to do the first 200 of these procedures by third quarter of next year. And as soon as that occurs, then we will open the ApiFix product up to a multitude of accounts. And right now, we have an extremely high level of inbound interest from pediatric orthopedic surgeons and major institutions that are wanting to sign up and get trained on that product. So we're holding back the tide a bit on that right now. I don't want to say, though, that I don't want to insinuate that we're down playing the growth that we've seen in our historical scoliosis business, which in the past, our fusion business that has grown somewhere in the range of 25% to 40% year-over-year for the last several years. In fact, what we're seeing with the ApiFix acquisition is an increased adoption in response as well by some of those new customers. The first 20 sites or so that we've signed up for ApiFix, many of those sites weren't regular users of our RESPONSE fusion system. And we're already starting to see a lot of pull-through of new RESPONSE customers who have been exposed to our scoliosis product -- that scoliosis product through their exposure of ApiFix. And I think in both of these businesses, we have an extremely long runway of growth. And that doesn't mention even the internal organic product development that we have going. And our intention is to continue to launch 3 to 5 new implant systems organically for the foreseeable future. So a lot of runway for growth and a lot of new products that we've developed in the last few years or acquired in the last few years that will fuel that growth.

Great. And could you touch on what your M&A strategy will look like going forward? Are there certain areas or size deals that you're going to be targeting?