ORTHOPEDIATRICS CORP - Quarter Report: 2022 June (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2022
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number: 001-38242
OrthoPediatrics Corp.
(Exact name of registrant as specified in its charter)
Delaware | 26-1761833 | ||||
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | ||||
2850 Frontier Drive Warsaw, IN 46582 | (574) 268-6379 | ||||
(Address of principal executive offices, including zip code) | (Registrant’s telephone number, including area code) | ||||
| Title of Each Class | Trading Symbol(s) | Name of each exchange on which registered | ||||||||||||
| Common Stock, $0.00025 par value per share | KIDS | Nasdaq Global Market | ||||||||||||
________________________________________________________________________________________
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ☐ | Accelerated filer | ☐ | ||||||||
Non-accelerated filer | ☒ | Smaller reporting company | ☒ | ||||||||
Emerging growth company | ☒ | ||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of August 2, 2022, the registrant had 20,278,189 outstanding shares of common stock, $0.00025 par value per share.
OrthoPediatrics Corp.
Form 10-Q
For the Quarterly Period Ended June 30, 2022
TABLE OF CONTENTS
| Page No. | ||||||||
| PART I. FINANCIAL INFORMATION | ||||||||
| Item 1 | ||||||||
| Item 2 | ||||||||
| Item 3 | ||||||||
| Item 4 | ||||||||
| PART II. OTHER INFORMATION | ||||||||
| Item 1 | ||||||||
| Item 1A | ||||||||
| Item 2 | ||||||||
| Item 3 | ||||||||
| Item 4 | ||||||||
| Item 5 | ||||||||
| Item 6 | ||||||||
NOTE REGARDING FORWARD-LOOKING STATEMENTS
All statements, other than statements of historical facts, contained in this quarterly report, including statements regarding our business, operations and financial performance and condition, as well as our plans, objectives and expectations for our business, operations and financial performance and condition, are forward-looking statements. You can often identify forward-looking statements by words such as "anticipate," "believe," "continue," "could," "estimate," "expect," "intend," "may," "might," "target," "ongoing," "plan," "potential," "predict," "project," "should," "will" or "would," or the negative of these terms or other terms. Forward-looking statements involve known and unknown risks, uncertainties and other factors, such as the impact of the COVID-19 pandemic, that may cause our results, activity levels, performance or achievements to be materially different from the information expressed or implied by the forward-looking statements. Forward-looking statements may include, among other things, statements relating to:
•our ability to achieve or sustain profitability in the future;
•our ability to raise additional capital to fund our existing commercial operations, develop and commercialize new products and expand our operations;
•our ability to commercialize our products in development and to develop and commercialize additional products through our research and development efforts, and if we fail to do so we may be unable to compete effectively;
•our ability to generate sufficient revenue from the commercialization of our products to achieve and sustain profitability;
•our ability to comply with extensive government regulation and oversight both in the United States and abroad;
•our ability to maintain and expand our network of third-party independent sales agencies and distributors to market and distribute our products; and
•our ability to protect our intellectual property rights or if we are accused of infringing on the intellectual property rights of others;
We cannot assure you that forward-looking statements will prove to be accurate, and you are encouraged not to place undue reliance on forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations expressed or implied by the forward-looking statements. You are urged to carefully review and consider the various disclosures made by us in this quarterly report, in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (the "SEC") on March 3, 2022 and in other reports filed with the SEC that discuss the risks and factors that may affect our business. Other than as required by law, we undertake no obligation to update or revise any forward-looking statements to reflect new information, events or circumstances occurring after the date of this quarterly report.
3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ORTHOPEDIATRICS CORP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In Thousands, Except Share Data)
| June 30, 2022 | December 31, 2021 | ||||||||||
| ASSETS | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | 37,198 | $ | 7,641 | |||||||
| Restricted cash | 1,357 | 1,365 | |||||||||
| Short term investments | 13,963 | 45,902 | |||||||||
Accounts receivable - trade, less allowance for doubtful accounts of $412 and $347, respectively | 25,434 | 17,942 | |||||||||
| Inventories, net | 67,484 | 57,569 | |||||||||
| Prepaid expenses and other current assets | 2,712 | 3,229 | |||||||||
| Total current assets | 148,148 | 133,648 | |||||||||
| Property and equipment, net | 36,601 | 28,515 | |||||||||
| Other assets: | |||||||||||
| Amortizable intangible assets, net | 58,777 | 55,494 | |||||||||
| Goodwill | 71,707 | 72,349 | |||||||||
| Other intangible assets | 15,708 | 14,268 | |||||||||
| Total other assets | 146,192 | 142,111 | |||||||||
| Total assets | $ | 330,941 | $ | 304,274 | |||||||
| LIABILITIES AND STOCKHOLDERS' EQUITY | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable - trade | $ | 14,591 | $ | 9,325 | |||||||
| Accrued compensation and benefits | 6,087 | 5,351 | |||||||||
| Current portion of long-term debt with affiliate | 141 | 137 | |||||||||
| Current portion of acquisition installment payable | 7,445 | 12,862 | |||||||||
| Other current liabilities | 2,949 | 2,040 | |||||||||
| Total current liabilities | 31,213 | 29,715 | |||||||||
| Long-term liabilities: | |||||||||||
| Long-term debt with affiliate, net of current portion | 31,836 | 907 | |||||||||
| Acquisition installment payable, net of current portion | 7,626 | 14,309 | |||||||||
| Contingent consideration | 26,470 | 28,910 | |||||||||
| Deferred income taxes | 6,280 | 4,771 | |||||||||
| Other long-term liabilities | 300 | 293 | |||||||||
| Total long-term liabilities | 72,512 | 49,190 | |||||||||
| Total liabilities | 103,725 | 78,905 | |||||||||
| Stockholders' equity: | |||||||||||
Common stock, $0.00025 par value; 50,000,000 shares authorized; 20,238,870 shares and 19,677,214 shares issued as of June 30, 2022 (unaudited) and December 31, 2021, respectively | 5 | 5 | |||||||||
| Additional paid-in capital | 418,354 | 394,899 | |||||||||
| Accumulated deficit | (187,459) | (178,026) | |||||||||
| Accumulated other comprehensive income | (3,684) | 8,491 | |||||||||
| Total stockholders' equity | 227,216 | 225,369 | |||||||||
| Total liabilities and stockholders' equity | $ | 330,941 | $ | 304,274 | |||||||
See notes to condensed consolidated financial statements.
4
ORTHOPEDIATRICS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In Thousands, Except Share and Per Share Data)
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Net revenue | $ | 32,928 | $ | 26,695 | $ | 56,345 | $ | 48,157 | |||||||||||||||
| Cost of revenue | 7,947 | 6,252 | 12,798 | 11,389 | |||||||||||||||||||
| Gross profit | 24,981 | 20,443 | 43,547 | 36,768 | |||||||||||||||||||
| Operating expenses: | |||||||||||||||||||||||
| Sales and marketing | 12,431 | 10,876 | 22,189 | 19,825 | |||||||||||||||||||
| General and administrative | 14,546 | 11,088 | 27,713 | 23,129 | |||||||||||||||||||
| Research and development | 1,747 | 1,325 | 3,774 | 2,633 | |||||||||||||||||||
| Total operating expenses | 28,724 | 23,289 | 53,676 | 45,587 | |||||||||||||||||||
| Operating loss | (3,743) | (2,846) | (10,129) | (8,819) | |||||||||||||||||||
| Other expenses (income): | |||||||||||||||||||||||
| Interest expense, net | 1,212 | 581 | 1,777 | 1,309 | |||||||||||||||||||
| Fair value adjustment of contingent consideration | (5,010) | 990 | (2,440) | 5,140 | |||||||||||||||||||
| Other expense (income) | 827 | (375) | 723 | (535) | |||||||||||||||||||
| Total other expenses (income) | (2,971) | 1,196 | 60 | 5,914 | |||||||||||||||||||
| Loss before income taxes | $ | (772) | $ | (4,042) | $ | (10,189) | $ | (14,733) | |||||||||||||||
| Provision for income taxes (benefit) | (439) | (286) | (756) | (598) | |||||||||||||||||||
| Net loss | $ | (333) | $ | (3,756) | $ | (9,433) | $ | (14,135) | |||||||||||||||
| Weighted average common stock - basic and diluted | 19,792,286 | 19,275,779 | 19,693,216 | 19,263,506 | |||||||||||||||||||
| Net loss per share - basic and diluted | $ | (0.02) | $ | (0.19) | $ | (0.48) | $ | (0.73) | |||||||||||||||
See notes to condensed consolidated financial statements.
5
ORTHOPEDIATRICS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)
(In Thousands)
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Net loss | $ | (333) | $ | (3,756) | $ | (9,433) | $ | (14,135) | |||||||||||||||
| Other comprehensive loss: | |||||||||||||||||||||||
| Foreign currency translation adjustment | (9,299) | 1,867 | (11,497) | (1,631) | |||||||||||||||||||
| Unrealized loss on short-term investments | (125) | (70) | (678) | (194) | |||||||||||||||||||
| Other comprehensive loss, net of tax | (9,424) | 1,797 | (12,175) | (1,825) | |||||||||||||||||||
| Comprehensive loss | $ | (9,757) | $ | (1,959) | $ | (21,608) | $ | (15,960) | |||||||||||||||
See notes to condensed consolidated financial statements.
6
ORTHOPEDIATRICS CORP.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(Unaudited)
(In Thousands, Except Share Data)
| Three and Six Months Ended June 30, 2022 | |||||||||||||||||||||||||||||||||||
| Accumulated | |||||||||||||||||||||||||||||||||||
| Additional | Other | Total | |||||||||||||||||||||||||||||||||
| Common Stock | Paid-in | Accumulated | Comprehensive | Stockholders' | |||||||||||||||||||||||||||||||
| Shares | Value | Capital | Deficit | Income (Loss) | Equity | ||||||||||||||||||||||||||||||
| Balance at January 1, 2022 | 19,677,214 | $ | 5 | $ | 394,899 | $ | (178,026) | $ | 8,491 | $ | 225,369 | ||||||||||||||||||||||||
| Net loss | — | — | — | (9,100) | — | (9,100) | |||||||||||||||||||||||||||||
| Other comprehensive loss | — | — | — | — | (2,751) | (2,751) | |||||||||||||||||||||||||||||
| Restricted stock | 144,084 | — | 1,526 | — | — | 1,526 | |||||||||||||||||||||||||||||
| Balance at March 31, 2022 | 19,821,298 | $ | 5 | $ | 396,425 | $ | (187,126) | $ | 5,740 | $ | 215,044 | ||||||||||||||||||||||||
| Net loss | — | — | — | (333) | — | (333) | |||||||||||||||||||||||||||||
| Other comprehensive loss | — | — | — | — | (9,424) | (9,424) | |||||||||||||||||||||||||||||
| Stock option exercise | 1,340 | — | 42 | — | — | 42 | |||||||||||||||||||||||||||||
| Restricted stock | 57,180 | — | 1,770 | — | — | 1,770 | |||||||||||||||||||||||||||||
| Consideration for MD Ortho acquisition | 173,241 | — | 9,707 | — | — | 9,707 | |||||||||||||||||||||||||||||
| Stock portion of ApiFix anniversary installment payment | 185,811 | — | 10,410 | — | — | 10,410 | |||||||||||||||||||||||||||||
| Balance at June 30, 2022 | 20,238,870 | $ | 5 | $ | 418,354 | $ | (187,459) | $ | (3,684) | $ | 227,216 | ||||||||||||||||||||||||
7
ORTHOPEDIATRICS CORP.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(Unaudited)
(In Thousands, Except Share Data)
| Three and Six Months Ended June 30, 2021 | |||||||||||||||||||||||||||||||||||
| Accumulated | |||||||||||||||||||||||||||||||||||
| Additional | Other | Total | |||||||||||||||||||||||||||||||||
| Common Stock | Paid-in | Accumulated | Comprehensive | Stockholders' | |||||||||||||||||||||||||||||||
| Shares | Value | Capital | Deficit | Income (Loss) | Equity | ||||||||||||||||||||||||||||||
| Balance at January 1, 2021 | 19,560,291 | $ | 5 | $ | 388,622 | $ | (161,766) | $ | 7,907 | $ | 234,768 | ||||||||||||||||||||||||
| Net loss | — | — | — | (10,379) | — | (10,379) | |||||||||||||||||||||||||||||
| Other comprehensive loss | — | — | — | — | (3,622) | (3,622) | |||||||||||||||||||||||||||||
| Stock option exercise | 2,010 | — | 62 | — | — | 62 | |||||||||||||||||||||||||||||
| Restricted stock | 97,111 | — | 1,316 | — | — | 1,316 | |||||||||||||||||||||||||||||
| Balance at March 31, 2021 | 19,659,412 | $ | 5 | $ | 390,000 | $ | (172,145) | $ | 4,285 | $ | 222,145 | ||||||||||||||||||||||||
| Net loss | — | — | — | (3,756) | — | (3,756) | |||||||||||||||||||||||||||||
| Other comprehensive income | — | — | — | — | 1,797 | 1,797 | |||||||||||||||||||||||||||||
| Restricted stock | 10,632 | — | 1,415 | — | — | 1,415 | |||||||||||||||||||||||||||||
| Balance at June 30, 2021 | 19,670,044 | $ | 5 | $ | 391,415 | $ | (175,901) | $ | 6,082 | $ | 221,601 | ||||||||||||||||||||||||
See notes to condensed consolidated financial statements.
8
ORTHOPEDIATRICS CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In Thousands)
| Six Months Ended June 30, | |||||||||||
| 2022 | 2021 | ||||||||||
| OPERATING ACTIVITIES | |||||||||||
| Net loss | $ | (9,433) | $ | (14,135) | |||||||
| Adjustments to reconcile net loss to net cash used in operating activities: | |||||||||||
| Depreciation and amortization | 6,292 | 5,147 | |||||||||
| Stock-based compensation | 3,296 | 2,731 | |||||||||
| Fair value adjustment of contingent consideration | (2,440) | 5,140 | |||||||||
| Acquisition installment payable | 1,545 | 1,212 | |||||||||
| Deferred income taxes | (756) | (602) | |||||||||
| Changes in certain current assets and liabilities: | |||||||||||
| Accounts receivable - trade | (6,614) | (1,781) | |||||||||
| Inventories | (10,905) | (3,297) | |||||||||
| Prepaid expenses and other current assets | 557 | 106 | |||||||||
| Accounts payable - trade | 5,298 | 191 | |||||||||
| Accrued legal settlements | — | (6,342) | |||||||||
| Accrued expenses and other liabilities | 1,133 | 1,080 | |||||||||
| Other | (340) | (341) | |||||||||
| Net cash used in operating activities | (12,367) | (10,891) | |||||||||
| INVESTING ACTIVITIES | |||||||||||
| Acquisition of MD Ortho, net of cash acquired | (8,360) | — | |||||||||
| Sale of short-term marketable securities | 31,600 | — | |||||||||
| Purchases of licenses | — | (2,858) | |||||||||
| Purchases of property and equipment | (9,465) | (4,474) | |||||||||
| Net cash provided by (used in) investing activities | 13,775 | (7,332) | |||||||||
| FINANCING ACTIVITIES | |||||||||||
| Proceeds from issuance of debt with affiliate | 31,000 | — | |||||||||
| Installment payment for ApiFix | (3,234) | — | |||||||||
| Proceeds from exercise of stock options | 42 | 62 | |||||||||
| Payments on mortgage notes | (67) | (64) | |||||||||
| Net cash (used in) provided by financing activities | 27,741 | (2) | |||||||||
| Effect of exchange rate changes on cash | 400 | 29 | |||||||||
| NET (DECREASE) INCREASE IN CASH | 29,549 | (18,196) | |||||||||
| Cash and restricted cash, beginning of year | $ | 9,006 | $ | 30,132 | |||||||
| Cash and restricted cash, end of period | $ | 38,555 | $ | 11,936 | |||||||
| SUPPLEMENTAL DISCLOSURES | |||||||||||
| Cash paid for interest | $ | 60 | $ | 29 | |||||||
| Transfer of instruments from property and equipment to inventory | $ | (130) | $ | 330 | |||||||
| Issuance of common shares to acquire MD Ortho | $ | 9,707 | $ | — | |||||||
| Issuance of common shares for ApiFix installment | $ | 10,410 | $ | — | |||||||
See notes to condensed consolidated financial statements.
9
ORTHOPEDIATRICS CORP.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars In Thousands, Except Share and Per Share data)
NOTE 1 – BUSINESS
OrthoPediatrics Corp., a Delaware corporation, is a medical device company committed to designing, developing and marketing anatomically appropriate implants, instruments and braces for children with orthopedic conditions, giving pediatric orthopedic surgeons and caregivers the ability to treat children with technologies specifically designed to meet their needs. We sell our specialized products, including PediLoc®, PediPlates®, Cannulated Screws, PediFlexTM nail, PediNailTM, PediLoc® Tibia, ACL Reconstruction System, Locking Cannulated Blade, Locking Proximal Femur, Spica Tables, RESPONSETM Spine, BandLocTM, Pediatric Nailing Platform | Femur, Orthex, QuickPackTM and ApiFix® Mid-C System, to various hospitals and medical facilities throughout the United States and various international markets. We currently use a contract manufacturing model for the manufacturing of implants and related surgical instrumentation.
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. Since inception we have impacted the lives of over 560,000 children. We design, develop and commercialize innovative orthopedic implants and instruments to meet the specialized needs of pediatric surgeons 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 $3,300,000 opportunity globally, including over $1,500,000 in the United States.
Our largest investor is Squadron, a private investment firm based in Granby, Connecticut.
A novel strain of the coronavirus disease was first identified in Wuhan, China in December 2019, and the related outbreak was subsequently declared a pandemic by the World Health Organization and a national emergency by the President of the United States. As a result of the pandemic, we have experienced significant business disruption. For example, in order to meet the demand for COVID-19-related hospitalizations, various governments, governmental agencies and hospital administrators required certain hospitals to postpone some elective procedures. In addition, elective procedures are also being 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 deferrals of such surgeries and procedures have had, and may continue to have, a significant negative impact on our business and results of operations. Despite the impact COVID-19 has had on our business, we continued to invest in research and development, invest in our people, and take steps to position ourselves for long-term success. We continue to train and educate our sales team and our surgeons on our products. We have continued to focus on developing innovative solutions, acquired multiple enabling technologies, invested in both new and existing partnerships and continued to deploy additional consigned instrument and implant sets in furtherance of our strategy. The extent to which COVID-19 may continue to negatively impact the Company's consolidated financial position, results of operations or cash flows is uncertain and will be closely monitored.
NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
10
The accompanying condensed consolidated financial statements include the accounts of OrthoPediatrics Corp. and its wholly-owned subsidiaries, OrthoPediatrics US Distribution Corp., OrthoPediatrics EU Limited, OrthoPediatrics AUS PTY LTD, OrthoPediatrics NZ Limited, OP EU B.V., OP Netherlands B.V., Orthex, LLC, Telos Partners, LLC, ApiFix, Ltd., OrthoPediatrics Iowa Holdco, Inc., MD Orthopaedics, Inc., and MD International, Inc. (collectively, the “Company,” “we,” “our” or “us”). All intercompany balances and transactions have been eliminated.
Unaudited Interim Condensed Consolidated Financial Statements
We have prepared the accompanying condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The accompanying condensed consolidated balance sheets as of June 30, 2022 and December 31, 2021, the condensed consolidated statements of operations for the three and six months ended June 30, 2022 and 2021, the condensed consolidated statements of comprehensive loss for the three and six months ended June 30, 2022 and 2021, the condensed consolidated statements of stockholders’ equity for the three and six months ended June 30, 2022 and 2021 and the condensed consolidated statements of cash flows for the six months ended June 30, 2022 and 2021 are unaudited and should be read in conjunction with the annual consolidated financial statements as of and for the year ended December 31, 2021 and related notes thereto contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC") on March 3, 2022. The financial data and other financial information disclosed in the notes to the accompanying condensed consolidated financial statements are also unaudited. As such, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to applicable rules and regulations thereunder.
The unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements as of and for the year ended December 31, 2021 and, in management’s opinion, include all adjustments, consisting of only normal recurring adjustments, necessary for the fair presentation of the financial statements for the interim periods. The results of operations for the three and six months ended June 30, 2022 are not necessarily indicative of the results to be expected for the full fiscal year or for any other period.
The accompanying condensed consolidated financial statements have been prepared assuming our Company will continue as a going concern. We have experienced recurring losses from operations since our inception and had an accumulated deficit of $187,459 and $178,026 as of June 30, 2022 and December 31, 2021, respectively. Management continues to monitor cash flows and liquidity on a regular basis. We believe that our cash balance, including short term investments, at June 30, 2022 and expected cash flows from operations for the next twelve months subsequent to the issuance of the accompanying condensed consolidated financial statements, are sufficient to enable us to maintain current and essential planned operations for more than the next twelve months.
Use of Estimates
Preparation of our condensed consolidated financial statements requires the use of estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, as of the date of the condensed consolidated financial statements. By their nature, these judgments are subject to an inherent degree of uncertainty. We use historical experience and other assumptions as the basis for our judgments and estimates. Because future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Any changes in these estimates will be reflected in our consolidated financial statements.
Foreign Currency Transactions
11
We currently bill our international stocking distributors in U.S. dollars, resulting in minimal foreign exchange transaction expense.
Beginning in early 2017 and continuing through 2021, we expanded operations and established legal entities outside the United States, permitting us to sell under an agency model direct to local hospitals internationally. The countries we serve under the agency model include the United Kingdom, Ireland, Australia, New Zealand, Canada, Belgium, the Netherlands, Poland, Italy, Israel, Germany, Switzerland, and Austria. Additionally, in March 2019, we established an operating company in the Netherlands in order to enhance our operations in Europe. The financial statements of our foreign subsidiaries are accounted for in local functional currencies and have been translated into U.S. dollars using end-of-period exchange rates for assets and liabilities and average exchange rates during each reporting period for results of operations. Foreign currency translation adjustments have been recorded as a separate component of the consolidated statements of comprehensive loss.
Revenue from Contracts with Customers
In accordance with ASC 606, "Revenue from Contracts with Customers," revenue is recognized when our performance obligations under the terms of a contract with our customer are satisfied. This typically occurs when we transfer control of our products to the customers, generally upon implantation or when title passes upon shipment. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these goods or services, and excludes any sales incentives or taxes collected from a customer which are subsequently remitted to government authorities.
Revenue Recognition – United States
Revenue in the United States is generated primarily from the sale of our implants and, to a much lesser extent, from the sale of our instruments. Sales in the United States are primarily to hospital accounts through independent sales agencies. We recognize revenue when our performance obligations under the terms of a contract with our customer are satisfied. The products are generally consigned to our independent sales agencies, and revenue is recognized when the products are used by or shipped to the hospital for surgeries on a case by case basis. On rare occasions, hospitals purchase product for their own inventory, and revenue is recognized when the products are shipped and the title and risk of loss passes to the customer. Pricing for each customer is dictated by a unique pricing agreement.
Revenue Recognition – International
Outside of the United States, we sell our products directly to hospitals through independent sales agencies or to independent stocking distributors. Generally, the distributors are allowed to return products, and some are thinly capitalized. Based on a history of reliable collections, we have concluded that a contract exists and revenue should be recognized when we transfer control of our products to the customer, generally when title passes upon shipment. Additionally, based on our history of immaterial returns from international customers, we have historically estimated no reserve for returns.
Beginning in early 2017 and continuing through 2021, we expanded operations and established legal entities outside the United States, permitting us to sell under an agency model direct to local hospitals internationally. The products are generally consigned to our independent sales agencies, and revenue is recognized when the products are used by or shipped to the hospital for surgeries on a case by case basis. On rare occasions, hospitals purchase products for their own inventory, and revenue is recognized when title passes upon shipment. Pricing for each customer is dictated by a unique pricing agreement.
Cash, Cash Equivalents and Short Term Investments
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We maintain cash in bank deposit accounts which, at times, may exceed federally insured limits. To date, we have not experienced any loss in such accounts. We consider all highly liquid investments with original maturity of three months or less at inception to be cash equivalents. The carrying amounts reported in the balance sheets for cash are valued at cost, which approximates fair value.
The Company invests in available-for-sale short term investments. The Company has the ability, if necessary, to liquidate without penalty any of its short term investments to meet its liquidity needs in the next twelve months. As such, those investments with contractual maturities greater than one year from the date of purchase are classified as short-term on the accompanying Consolidated Balance Sheets. The company includes unrealized gains or losses in stockholders' equity. If the adjustment to fair value reflects a decline in the value of the investment, the Company considers available information to determine whether the decline is "other than temporary" and, if so, reflects the change on the Consolidated Statements of Operations.
Restricted Cash
In conjunction with the sale of Vilex, $1,250 was placed into a separate escrow account. This cash is reported as restricted cash on the June 30, 2022 and December 31, 2021 condensed consolidated balance sheets. These funds were to remain restricted until August 31, 2021, at which time, they were to be released to the Company subject to no claims related to the purchase being asserted; however, due to the pending IMED Surgical litigation, the cash remains reported as restricted until the conclusion of the legal matter (see “Legal Proceedings” under Note 13 – Commitments and Contingencies for additional information). The Company also maintains restricted cash of 100 Euro at its Netherlands entity for potential Italian tenders.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable are uncollateralized customer obligations due under normal trade terms, generally requiring payment within 30 days from the invoice date. Account balances with invoices over 30 days past due are considered delinquent. No interest is charged on past due accounts. Payments of accounts receivable are applied to the specific invoices identified on the customer's remittance advice or, if unspecified, to the customer's account as an unapplied credit.
The carrying amount of accounts receivable is reduced by an allowance that reflects management's best estimate of the amounts that will not be collected, determined principally on the basis of historical experience, management's assessment of the collectability of specific customer accounts and the aging of the accounts receivable. All accounts or portions thereof deemed to be uncollectible or to require an excessive collection cost are written off to the allowance for doubtful accounts.
Fair Value of Financial Instruments
The accounting standards related to fair value measurements define fair value and provide a consistent framework for measuring fair value under the authoritative literature. Valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect market assumptions. This guidance only applies when other standards require or permit the fair value measurement of assets and liabilities. The guidance does not expand the use of fair value measurements. A fair value hierarchy was established, which prioritizes the inputs used in measuring fair value into three broad levels.
Level 1 – Quoted prices in active markets for identical assets or liabilities;
Level 2 – Observable market-based inputs or unobservable inputs that are corroborated by market data; and
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Level 3 – Significant unobservable inputs that are not corroborated by market data. Generally, these fair value measures are model-based valuation techniques such as discounted cash flows, and are based on the best information available, including our own data.
The Company's financial instruments include cash and cash equivalents, short-term investments, accounts receivable, accounts payable, acquisition installment payables, contingent consideration and long-term debt. The carrying amounts of accounts receivable, accounts payable, acquisition installment payables and long-term debt approximate the fair value due to the short-term nature or market rates of these instruments. The company bases the fair value of short-term investments on quoted market prices for identical or comparable assets except for investments classified as asset backed securities which we identify as Level 2. These securities are predominately priced by third parties, either a pricing vendor or dealer. When a quoted price in an active market for an identical security is not available these third parties will utilize an alternative market approach, such as a recent trade or matrix pricing, or an income approach, such as a discounted cash flow pricing model that calculates values from observable inputs such as quoted interest rates, yield curves and other observable market information. Contingent consideration represents the system sales payment the Company is obligated to make. The fair value of the contingent consideration payment is considered a level 3 fair value measurement and was determined with the assistance of an independent valuation specialist at the original issuance date and as of the balance sheet date. See Note 5 for further discussion of financial instruments that carried a fair value on a recurring and nonrecurring basis.
Inventories, net
Inventories are stated at the lower of cost or net realizable value, with cost determined using the first-in-first-out method. Inventories purchased from third parties, which consist of implants and instruments held in our warehouse or with third-party independent sales agencies or distributors, are considered finished goods.
We evaluate the carrying value of our inventories in relation to the estimated forecast of product demand, which takes into consideration the life cycle of the product. A significant decrease in demand could result in an increase in the amount of excess inventory on hand, which could lead to additional charges for excess and obsolete inventory.
The need to maintain substantial levels of inventory impacts our estimates for excess and obsolete inventory. Each of our implant systems are designed to include implantable products that come in different sizes and shapes to accommodate the surgeon’s needs. Typically, a small number of the set components are used in each surgical procedure. Certain components within each set may become obsolete before other components based on the usage patterns. We adjust inventory values, as needed, to reflect these usage patterns and life cycle.
In addition, we continue to introduce new products, which may require us to take additional charges for excess and obsolete inventory in the future.
Property and Equipment, net
Property and equipment are carried at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful life of the assets. When assets are retired or otherwise disposed of, costs and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized in operations for the period. Maintenance and repairs that prolong or extend the useful life are capitalized, whereas standard maintenance, replacements, and repair costs are expensed as incurred.
Instruments are hand-held devices, specifically designed for use with our implants and are used by surgeons during surgery. Instruments deployed within the United States, United Kingdom, Australia, New
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Zealand, Canada, Belgium, the Netherlands, Italy, Germany, Switzerland and Austria are carried at cost less accumulated depreciation and are recorded in property and equipment, net on the condensed consolidated balance sheets.
Sample inventory consists of our implants and instruments, and is maintained to market and promote our products. Sample inventory is carried at cost less accumulated depreciation.
Depreciable lives are generally as follows:
| Building and building improvements | 25 to 30 years | ||||
| Furniture and fixtures | 5 to 7 years | ||||
| Computer equipment | 3 to 5 years | ||||
| Business software | 3 years | ||||
| Office and other equipment | 5 to 7 years | ||||
| Instruments | 5 years | ||||
| Sample inventory | 2 years | ||||
Amortizable Intangible Assets, net
Amortizable intangible assets include fees necessary to secure various patents and licenses (including those acquired in the Band-Lok and MD Ortho transactions), the value of internally developed software (including by Orthex), and the value of acquired customer relationships and non-competition agreements (including in the Orthex, Telos, ApiFix and MD Ortho transactions, as applicable). Amortization is calculated on a straight-line basis over the estimated useful life of the asset. Amortization for patents and licenses commences at the time of patent approval, and for licenses upon market launch, respectively. Amortization for assets acquired commences upon acquisition. Intangible assets are amortized over a 3 to 20 year period.
Amortizable intangible assets are assessed for impairment upon triggering events that indicate that the carrying value of an asset may not be recoverable. Recoverability is measured by a comparison of the carrying amount to future net undiscounted cash flows expected to be generated by the associated asset. If such assets are determined to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount exceeds the fair market value of the intangible assets. No impairment charges were recorded in any of the periods presented.
Goodwill and Other Intangible Assets
Our goodwill represents the excess of the cost over the fair value of net assets acquired. The determination of the value of goodwill and intangible assets arising from acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of net tangible and intangible assets acquired. Goodwill is not amortized and is assessed for impairment using fair value measurement techniques on an annual basis or more frequently if facts and circumstances warrant such a review. The goodwill is considered to be impaired if we determine that the carrying value of our one reporting unit exceeds its respective fair value. No impairment charges were recorded in any of the periods presented.
The Company tests goodwill for impairment by either performing a qualitative evaluation or a quantitative test. The quantitative assessment for goodwill requires us to estimate the fair value of our one reporting unit using either an income or market approach or a combination thereof.
We have indefinite lived trademark assets that are reviewed for impairment by performing a quantitative analysis, which occurs annually in the fourth quarter, utilizing balances as of October 1, or whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable.
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Recoverability is measured by a comparison of the carrying amount to future net discounted cash flows expected to be generated by the associated asset. If such assets are determined to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount exceeds the fair market value of the assets. No impairment charges were recorded in any of the periods presented.
Acquisition Payable and Contingent Consideration
Upon the completion of an acquisition, the Company may record an acquisition installment payable, contingent consideration or both. Acquisition installment payables, which are fixed future payments, are recorded at their net present value, and contingent consideration is recorded at fair value as determined by management with the assistance of an independent valuation specialist at the original issuance date and is marked to fair value on a recurring basis. Accretion of interest expense attributable to the acquisition installment payable is recorded as a component of interest expense, net. Changes in the fair value of the contingent consideration are included in fair value adjustments of contingent consideration on the condensed consolidated statement of operations. The amount of expense related to acquisition installment payables recorded in interest expense, net for the three and six months ended June 30, 2022 were $1,092 and $1,545, respectively, and $569 and $1,212, respectively, for the same periods last year. The fair value adjustments of contingent consideration for the three and six months ended June 30, 2022 were income adjustments of $5,010 and $2,440, respectively, and expense adjustments of $990 and $5,140, respectively, for the same periods last year.
Cost of Revenue
Cost of revenue consists primarily of products purchased from third-party suppliers, excess and obsolete inventory adjustments, inbound freight, and royalties. Our implants and instruments are manufactured to our specifications by third-party suppliers who meet our manufacturer qualifications standards. Our third-party manufacturers are required to meet the standards of the Food and Drug Administration (the “FDA”), and the International Organization for Standardization, as well as other country-specific quality standards. The majority of our implants and instruments are produced in the United States.
Sales and Marketing Expenses
Sales and marketing expenses primarily consist of commissions to our domestic and select international independent sales agencies and consignment distributors, as well as compensation, commissions, benefits and other related costs for personnel we employ. Commissions and bonuses are generally based on a percentage of sales. Our international independent stocking distributors purchase instrument sets and replenishment stock for resale, and we do not pay commissions or any other sales related costs for international sales to distributors.
Advertising Costs
Advertising costs consist primarily of print advertising, trade shows, and other related expenses. Advertising costs are expensed as incurred and are recorded as a component of sales and marketing expense.
Research and Development Costs
Research and development costs are expensed as incurred. Our research and development expenses primarily consist of costs associated with engineering, product development, consulting services, outside prototyping services, outside research activities, materials, development and protection of our intellectual property portfolio, as well as other costs associated with development of our products. Research and development costs also include related personnel and consultants’ compensation expense.
Stock-Based Compensation
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Immediately prior to our IPO, we adopted our 2017 Incentive Award Plan (the "2017 Plan"). The 2017 Plan provides for grants of options and restricted stock to officers, employees, consultants or directors of our Company. The 2017 Plan has authorized 1,832,460 shares for award.
Options holders, upon vesting, may purchase common stock at the exercise price, which is the estimated fair value of our common stock on the date of grant. Option grants generally vest immediately or over three years. No stock options were granted in any of the periods presented.
Restricted stock may not be transferred prior to the expiration of the restricted period, which is typically three years. The restricted stock that had been granted under the 2007 Plan had restriction periods that generally lasted until the earlier of six years from the date of grant, or an IPO or change in control, as defined in the 2007 Plan. All restricted stock granted prior to May 2014 vested upon our IPO and the remaining grants under the 2007 Plan vested six months after the IPO. We recognize the reversal of stock compensation expense when a restricted stock forfeiture occurs as opposed to estimating future forfeitures.
We record the fair value of restricted stock at the grant date. Stock-based compensation is recognized ratably over the requisite service period, which is generally the restriction period for restricted stock.
Litigation and Contingencies
Accruals for litigation and contingencies are reflected in the condensed consolidated financial statements based on management’s assessment, including advice of legal counsel, of the expected outcome of litigation or other dispute resolution proceedings and/or the expected resolution of contingencies. Liabilities for estimated losses are accrued if the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated. Significant judgment is required in both the determination of probability of loss and the determination as to whether the amount is reasonably estimable. Accruals are based only on information available at the time of the assessment due to the uncertain nature of such matters. As additional information becomes available, management reassesses potential liabilities related to pending claims and litigation and may revise its previous estimates, which could materially affect the Company’s results of operations in a given period.
Comprehensive Income (Loss)
Comprehensive income (loss) is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources. Comprehensive income (loss) includes foreign currency translation adjustments and unrealized gain (loss) on our short term investments.
Income Taxes
We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the condensed consolidated financial statements. Under this method, we determine deferred tax assets and liabilities on the basis of the differences between the financial statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
We recognize deferred tax assets to the extent that we believe that these assets are more likely than not to be realized. In making such a determination, we consider all available positive and negative evidence. If we determine that we would be able to realize our deferred tax assets in the future in excess of their net recorded amount, we would make an adjustment to the valuation allowance.
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We record uncertain tax positions on the bases of a two-step process in which (i) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the positions and (ii) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50% likely to be realized upon ultimate settlement with the related tax authority.
Leases
At the inception of a contractual arrangement, the Company determines whether the contract contains a lease by assessing whether there is an identified asset and whether the contract conveys the right to control the use of the identified asset in exchange for consideration over a period of time. If both criteria are met, the Company calculates the associated lease liability and corresponding right-of-use asset upon lease commencement using a discount rate based on a borrowing rate commensurate with the term of the lease.
The Company records lease liabilities within current liabilities or long-term liabilities based upon the length of time associated with the lease payments. The Company records its operating lease right-of-use assets as long-term assets.
“Emerging Growth Company” and "Smaller Reporting Company" Reporting Requirements
We qualify as an “emerging growth company” as defined in the JOBS Act. "Emerging growth companies" may take advantage of specified reduced reporting and other regulatory requirements that are generally unavailable to other public companies. Among other things, we are not required to provide an auditor attestation report on the assessment of the internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act of 2002. Our status as an emerging growth company will remain until December 31, 2022. As such, our external auditors for the fiscal year ending December 31, 2022 will be required to provide an attestation over the operating effectiveness of our internal controls under Section 404(b) of the Sarbanes-Oxley Act.
Section 107 of the JOBS Act also provides that an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards and, therefore, we have been and will continue to be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.
We also qualify as a "smaller reporting company," as such term is defined in Rule 12b-2 under the Exchange Act. To the extent that we continue to qualify as a smaller reporting company, after we cease to qualify as an emerging growth company, certain of the exemptions available to us as an emerging growth company may continue to be available to us as a smaller reporting company.
Recent Accounting Pronouncements
In October 2021, the FASB issued ASU No. 2021-08 "Business Combinations (Topic 805)-Accounting for Contract Assets and Contract Liabilities from Contracts with Customers". The amendments in this Update address diversity and inconsistency related to the recognition and measurement of contract assets and contract liabilities acquired in a business combination. The amendments in this Update require that an acquirer recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606, Revenue from Contracts with Customers. The amendments in this Update require that an entity (acquirer) recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606. For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal
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years. The amendments in this Update should be applied prospectively to business combinations occurring on or after the effective date of the amendments. Early adoption of the amendments is permitted, including adoption in an interim period. An entity that early adopts in an interim period should apply the amendments (1) retrospectively to all business combinations for which the acquisition date occurs on or after the beginning of the fiscal year that includes the interim period of early application and (2) prospectively to all business combinations that occur on or after the date of initial application. The Company is currently evaluating the impact of adopting ASU 2021-08 on its consolidated financial statements.
In May 2021, the FASB issued ASU No. 2021-04 "Earnings Per Share (Topic 260), Debt-Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock Compensation (Topic 718), and Derivatives and Hedging-Contracts in Entity's Own Equity (Subtopic 815-40): Issuer's Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options (a consensus of the FASB Emerging Issues Task Force)". This ASU is intended to clarify and reduce diversity in an issuer's accounting for modifications or exchanges of freestanding equity-classified written call options (for example, warrants) that remain equity classified after modification or exchange. The guidance clarifies whether an issuer should account for a modification or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange as (1) an adjustment to equity and, if so, the related earnings per share effects, if any, or (2) an expense and, if so, the manner and pattern of recognition. The amendments in this ASU affect all entities that issue freestanding written call options that are classified in equity. The amendments do not apply to modifications or exchanges of financial instruments that are within the scope of another Topic and do not affect a holder’s accounting for freestanding call options. The amendments in this ASU are effective for all entities for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. An entity should apply the amendments prospectively to modifications or exchanges occurring on or after the effective date of the amendments. Early adoption is permitted for all entities, including adoption in an interim period. The Company adopted this guidance effective January 1, 2022. The adoption of this guidance did not have a significant impact on the Company's consolidated financial statements and related disclosures.
In June 2016, the FASB issued ASU No. 2016-13 "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments". The ASU is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The ASU requires the measurement of all expected credit losses for financials assets including trade receivables held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Based on ASU 2019-10 and our status as a smaller reporting company, the Company will adopt ASU 2016-13 effective January 1, 2023. The adoption of this guidance is not expected to have a significant impact on the Company's consolidated financial statements and related disclosures.
NOTE 3 – BUSINESS COMBINATION
MD Orthopaedics
On April 1, 2022, OrthoPediatrics Iowa Holdco, Inc., a newly-formed, wholly-owned subsidiary of the Company, merged with and into MD Orthopaedics, Inc., an Iowa corporation (“MD Ortho”). MD Ortho has developed and manufactures a portfolio of orthopedic clubfoot products. The acquisition expands our total addressable market, serving as a specialty bracing platform company within our Trauma and Deformity business.
Under the terms of the related merger agreement, the Company paid to the indirect, sole shareholder of MD Ortho consideration of (a) $8,781 in cash, after adjusting for closing net working capital, and (b) 173,241 shares of unregistered common stock, $0.00025 par value per share, of the Company, representing approximately $9,707 (based on the April 1, 2022 closing share price of $56.03). The
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Company incurred approximately $381 of acquisition-related costs, that are included in general and administrative expenses on the consolidated statement of operations for the six months ended June 30, 2022.
The following table summarizes the total consideration paid for MD Ortho and the preliminary allocation of purchase price to the estimated fair value of the assets acquired and liabilities assumed at the acquisition date:
| Fair value of estimated total acquisition consideration | $ | 18,487 | ||||||
| Assets | ||||||||
| Cash and cash equivalents | 420 | |||||||
| Accounts receivable-trade | 1,062 | |||||||
| Inventories | 1,126 | |||||||
| Prepaid expenses and other current assets | 100 | |||||||
| Property and equipment | 2,444 | |||||||
| Amortizable Intangible assets | 9,120 | |||||||
| Other intangible assets | 2,410 | |||||||
| Total assets | 16,682 | |||||||
| Liabilities | ||||||||
| Accounts payable and accrued liabilities | 45 | |||||||
| Other current liabilities | 586 | |||||||
| Deferred Tax Liability | 2,721 | |||||||
| Total liabilities | 3,352 | |||||||
| Less: total net assets | 13,330 | |||||||
| Goodwill | $ | 5,157 | ||||||
The fair value of identifiable intangible assets were based on preliminary valuations using a combination of the income and cost approach, inputs which would be considered Level 3 under the fair value hierarchy. The estimated fair value and useful life of identifiable intangible assets are as follows:
| Amount | Remaining Economic Useful Life | |||||||||||||
| Trademarks / Names | $ | 2,410 | Indefinite | |||||||||||
| Patents | 2,660 | 10 years | ||||||||||||
| Customer Relationships | 6,460 | 15 years | ||||||||||||
| $ | 11,530 | |||||||||||||
The fair value estimates and purchase price allocation included above are preliminary while the Company finalizes fair value estimates of the acquired intangible assets and related tax considerations.
The following table represents the pro forma net revenue and net loss assuming the acquisition occurred on January 1, 2021.
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| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Net revenue | $ | 32,928 | $ | 29,471 | $ | 58,814 | $ | 53,308 | |||||||||||||||
| Net loss | $ | (333) | $ | (3,336) | $ | (9,024) | $ | (12,897) | |||||||||||||||
NOTE 4 - GOODWILL AND INTANGIBLE ASSETS
Goodwill
Changes in the carrying amount of goodwill for the six months ended June 30, 2022 were as follows:
| Total | ||||||||
| Goodwill at January 1, 2022 | $ | 72,349 | ||||||
| MD Ortho Acquisition | 5,157 | |||||||
| Foreign currency translation impact | (5,799) | |||||||
Goodwill at June 30, 2022 | $ | 71,707 | ||||||
Intangible Assets
As of June 30, 2022, the balances of amortizable intangible assets were as follows:
| Weighted-Average Amortization Period | Gross Intangible Assets | Accumulated Amortization | Net Intangible Assets | |||||||||||||||||||||||
| Patents | 13.0 years | $ | 43,584 | $ | (6,652) | $ | 36,932 | |||||||||||||||||||
| License Agreements | 5.0 years | 10,674 | (3,211) | 7,463 | ||||||||||||||||||||||
| Customer Relationships & Other | 12.9 years | $ | 10,388 | $ | (1,154) | $ | 9,234 | |||||||||||||||||||
| Intellectual Property | 10.2 years | $ | 5,861 | $ | (713) | $ | 5,148 | |||||||||||||||||||
| Total amortizable assets | $ | 70,507 | $ | (11,730) | $ | 58,777 | ||||||||||||||||||||
As of December 31, 2021, the balances of amortizable intangible assets were as follows:
| Weighted-Average Amortization Period | Gross Intangible Assets | Accumulated Amortization | Net Intangible Assets | |||||||||||||||||||||||
| Patents | 13.7 years | $ | 44,493 | $ | (5,664) | $ | 38,829 | |||||||||||||||||||
| Intellectual Property | 10.1 years | 9,847 | (1,408) | 8,439 | ||||||||||||||||||||||
| License Agreements | 5.5 years | 10,674 | (2,448) | 8,226 | ||||||||||||||||||||||
| Total amortizable assets | $ | 65,014 | $ | (9,520) | $ | 55,494 | ||||||||||||||||||||
Licenses are tied to product launches and do not begin amortizing until the product is launched to the market.
Trademarks are non-amortizing intangible assets which were $15,708 and $14,268 as of June 30, 2022 and December 31, 2021, respectively. Trademarks are recorded in Other Intangible assets on the condensed consolidated balance sheets. The change in balance during the six months ended June 30, 2022 was the result of foreign currency translation of the ApiFix trademark and the acquisition of Trademarks associated with MD Ortho.
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NOTE 5 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company measures certain financial assets and liabilities at fair value. The accounting standards related to fair value measurements define fair value and provide a consistent framework for measuring fair value under the authoritative literature. A fair value hierarchy was established, which prioritizes the inputs used in measuring fair value into three broad levels.
Level 1 – Quoted prices in active markets for identical assets or liabilities;
Level 2 – Observable market-based inputs or unobservable inputs that are corroborated by market data; and
Level 3 – Significant unobservable inputs that are not corroborated by market data. Generally, these fair value measures are model-based valuation techniques such as discounted cash flows, and are based on the best information available, including our own data.
The following table summarizes the assets and liabilities measured at fair value on a recurring basis as of June 30, 2022 and December 31, 2021.
June 30, 2022 | |||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||
| Financial Assets | |||||||||||||||||||||||
| Short term investments | |||||||||||||||||||||||
| Corporate Bonds | $ | 7,056 | $ | — | $ | — | $ | 7,056 | |||||||||||||||
| Treasury Bonds | $ | 3,923 | $ | — | $ | — | $ | 3,923 | |||||||||||||||
| Asset Backed Securities | $ | — | $ | 2,545 | $ | — | $ | 2,545 | |||||||||||||||
| Other | $ | 439 | $ | — | $ | — | $ | 439 | |||||||||||||||
| Financial Liabilities | |||||||||||||||||||||||
| Contingent Consideration | $ | — | $ | — | $ | 26,470 | $ | 26,470 | |||||||||||||||
December 31, 2021 | |||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||
| Financial Assets | |||||||||||||||||||||||
| Short term investments | |||||||||||||||||||||||
| Corporate Bonds | $ | 22,476 | $ | — | $ | — | $ | 22,476 | |||||||||||||||
| Treasury Bonds | $ | 14,317 | $ | — | $ | — | $ | 14,317 | |||||||||||||||
| Asset Backed Securities | $ | — | $ | 8,272 | $ | — | $ | 8,272 | |||||||||||||||
| Other | $ | 837 | $ | — | $ | — | $ | 837 | |||||||||||||||
| Financial Liabilities | |||||||||||||||||||||||
| Contingent Consideration | $ | — | $ | — | $ | 28,910 | $ | 28,910 | |||||||||||||||
The Company's level 1 assets consist of cash equivalents which are generally comprised of short-term, liquid investments with original maturity of three months or less at inception and other short term investments which are comprised of exchange traded mutual funds and marketable securities with a maturity date greater than 3 months.
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The fair value of the contingent consideration payment is considered a Level 3 fair value measurement and was determined with the assistance of an independent valuation specialist at the original issuance date using an option pricing model and a Monte Carlo simulation based on forecasted annual revenue, expected volatility and discount rates. The fair value of contingent consideration liabilities assumed in business combinations is recorded as part of the purchase price consideration of the acquisition and is determined using a discounted cash flow model or probability simulation model. The significant inputs of such models are not always observable in the market, such as certain financial metric growth rates, volatility rates, projections associated with the applicable milestone, the interest rate, and the related probabilities and payment structure in the contingent consideration arrangement. The adjustments in the fair value of the contingent consideration payments included an income adjustment of $5,010 and an expense adjustment of $990 for the three month periods ended June 30, 2022 and June 30, 2021, respectively, and an income adjustment of $2,440 and an expense adjustment of $5,140 for the six month periods ended June 30, 2022 and June 30, 2021, respectively, in other expenses on the condensed consolidated statements of operations.
The following table summarizes the change in fair value of Level 3 instruments in 2022:
| Total | ||||||||
Balance at January 1, 2022 | $ | 28,910 | ||||||
| Change in fair value of contingent consideration | (2,440) | |||||||
Balance at June 30, 2022 | $ | 26,470 | ||||||
The recurring Level 3 fair value measurements of contingent consideration liabilities associated with commercial sales milestones include the following significant unobservable inputs as of June 30, 2022 and December 31, 2021:
| June 30, 2022 | December 31, 2021 | ||||||||||
| Valuation techniques | Discounted cash flow, Monte Carlo | ||||||||||
Present value discount rate(1) | 19.3 | % | 18.4 | % | |||||||
| Volatility factor | 42.7 | % | 50.3 | % | |||||||
| Expected years | 1.9 years | 2.4 years | |||||||||
(1) The present value discount rate includes estimated risk premium.
The estimated fair value reflects assumptions made by management as of June 30, 2022; however, the actual amount ultimately paid could be higher or lower than the fair value of the remaining contingent consideration.
NOTE 6 - DEBT AND CREDIT ARRANGEMENTS
Long-term debt consisted of the following:
| June 30, 2022 | December 31, 2021 | ||||||||||
| Revolving credit facility with Squadron | 31,000 | — | |||||||||
| Mortgage payable to affiliate | $ | 977 | $ | 1,044 | |||||||
| Total debt | 31,977 | 1,044 | |||||||||
| Less: current maturities | 141 | 137 | |||||||||
| Long-term debt with affiliate, net of current maturities | $ | 31,836 | $ | 907 | |||||||
On June 13, 2022, the Company entered into a Fourth Amendment (the “Fourth Amendment”) to its Fourth Amended and Restated Loan and Security Agreement with Squadron Capital LLC, or Squadron (as so amended, the “Loan Agreement”). The Fourth Amendment increased the amount available under
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the revolving credit facility from $25,000 to $50,000 in anticipation of using the facility to fund the cash portion of the Company’s July 1, 2022 acquisition of Pega Medical Inc. See Note 14 – Subsequent Events for information relating to the acquisition.
The Loan Agreement provides a $25,000 revolving credit facility, with interest only payments, at an annual interest rate equal to the greater of (a) six month SOFR plus 8.69% and (b) 10.0%. Prior to December 31, 2021, the interest rate on the facility had been equal to the greater of (a) three month LIBOR plus 8.61% and (b) 10.0%. The Company pays Squadron an unused commitment fee in an amount equal to the per annum rate of 0.50% (computed on the basis of a year of 360 days and the actual number of days elapsed) times the daily unused portion of the revolving credit commitment. The unused commitment fee is payable quarterly in arrears.
Borrowings under the revolving credit facility are made under a First Amended and Restated Revolving Note, dated August 4, 2020 (the “Amended Revolving Note”), payable, jointly and severally, by the Company and each of its subsidiaries party thereto. The Amended Revolving Note will mature at the earlier of: (i) the date on which any person or persons acquire (x) capital stock of the Company possessing the voting power to elect a majority of the Company’s Board of Directors (whether by merger, consolidation, reorganization, combination, sale or transfer), or (y) all or substantially all of the Company’s assets, determined on a consolidated basis; and (ii) January 1, 2024.
Borrowings under the Loan Agreement are secured by substantially all of the Company's assets and are unconditionally guaranteed by each of its subsidiaries with the exception of Vilex. There are no traditional financial covenants associated with the Loan Agreement. However, there are negative covenants that prohibit us from, among other things, transferring any of our material assets, merging with or acquiring another entity, entering into a transaction that would result in a change of control, incurring additional indebtedness, creating any lien on our property, making investments in third parties and redeeming stock or paying dividends, in each case subject to certain exceptions.
In connection with the purchase of our office and warehouse space in Warsaw, Indiana in August 2013, we entered into a mortgage note payable to Tawani Enterprises Inc., an affiliate of Squadron. Pursuant to the terms of the mortgage note, we pay Tawani Enterprises Inc. monthly principal and interest installments of $16 with interest compounded at 5% until maturity in 2028, at which time a final payment of remaining principal and interest is due. The mortgage is secured by the related real estate and building. At June 30, 2022 the mortgage balance was $977 of which current principal of $141 was included in the current portion of long-term debt. As of December 31, 2021, the mortgage balance was $1,044 of which current principal due of $137 was included in the current portion of long-term debt.
The aggregate interest expense relating to the notes payable to Squadron and the mortgage note payable to Tawani was $47 and $14 for the three months ended June 30, 2022 and 2021, respectively, and $60 and $29 for the six months ended June 30, 2022 and 2021, respectively. The unused commitment fee paid to Squadron was $36 and $32 for the three months ended June 30, 2022 and 2021, respectively, and $67 and $63 for the six months ended June 30, 2022 and 2021, respectively.
NOTE 7 - INCOME TAXES
The Company utilizes an estimated annual effective tax rate to determine its provision or benefit for income taxes for interim periods. The income tax provision or benefit is computed by multiplying the estimated annual effective tax rate by the year-to-date pre-tax book income (loss).
For the six months ended June 30, 2022, the income tax benefit was $756 compared to $598 for the six months ended June 30, 2021. Our effective income tax rate was 7.4% and 4.0% for the six months ended June 30, 2022 and 2021, respectively.
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The deferred tax assets were fully offset by a valuation allowance at June 30, 2022 and December 31, 2021, with the exception of certain deferred tax liabilities recognized in a foreign jurisdiction as a result of fair value adjustments recorded upon the acquisition of ApiFix. The company has recorded a tax benefit during the period ended June 30, 2022 for losses generated in the foreign jurisdiction. As of December 31, 2021, we had available federal, state and foreign tax loss carryforwards of $114,008, $73,997 and $22,671, respectively. We had available federal tax credits of $176. Net operating losses generated prior to December 31, 2017 will begin to expire in 2028. Federal net operating losses generated after January 1, 2018 will have an indefinite carryforward period. An ownership change under Section 382 of the Internal Revenue Code was deemed to occur on May 30, 2014. Given the limitation calculation, we anticipate approximately $23,920 in losses generated prior to the ownership change date will be subject to potential limitation. The estimated annual limitation is $1,062. A second ownership change under Section 382 was deemed to occur on December 11, 2018. The estimated annual limitation is $9,736, which is increased by $22,430 annually over the first five years as a result of an unrealized built in gain. NOLs sustained prior to May 30, 2014 will still be constrained by the lower limitation.
Management assesses the available positive and negative evidence to estimate whether sufficient future taxable income will be generated to permit use of the existing deferred tax assets. A significant piece of objective negative evidence evaluated was the cumulative loss incurred over the three-year period ended June 30, 2022. Such objective evidence limits the ability to consider other subjective evidence, such as our projections for future growth.
NOTE 8 - STOCKHOLDERS’ EQUITY
Stock Options
The fair value for options granted at the time of issuance were estimated at the date of grant using a Black-Scholes options pricing model. Significant assumptions included in the option value model include the fair value of our common stock at the grant date, weighted average volatility, risk-free interest rate, dividend yield and the forfeiture rate. There were no stock options granted in any of the periods presented.
Our stock option activity and related information are summarized as follows:
| Weighted-Average | Contractual Terms | |||||||||||||||||||
| Options | Exercise Price | (in Years) | ||||||||||||||||||
| Outstanding at January 1, 2022 | 6,638 | $ | 30.97 | 1.3 | ||||||||||||||||
| Exercised | (1,340) | 30.97 | ||||||||||||||||||
Outstanding at June 30, 2022 | 5,298 | $ | 30.97 | 0.9 | ||||||||||||||||
Options generally include a time-based vesting schedule permitting the options to vest ratably over three years. At June 30, 2022 and December 31, 2021, all options were fully vested.
There was no stock-based compensation expense on stock options for the three and six months ended June 30, 2022 and 2021, respectively.
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Restricted Stock
Our restricted stock activity and related information are summarized as follows:
| Weighted-Average | ||||||||||||||
| Remaining | ||||||||||||||
| Restricted | Contractual Terms | |||||||||||||
| Stock | (in Years) | |||||||||||||
| Outstanding at January 1, 2022 | 368,446 | 1.1 | ||||||||||||
| Granted | 209,584 | |||||||||||||
| Forfeited | (8,320) | |||||||||||||
| Vested | (136,617) | |||||||||||||
Outstanding at June 30, 2022 | 433,093 | 1.9 | ||||||||||||
Restricted stock exercisable at June 30, 2022 | — | |||||||||||||
At June 30, 2022, there was $13,753 of unrecognized compensation expense remaining related to our service-based restricted stock awards. The unrecognized compensation cost was expected to be recognized over a weighted-average period of 1.9 years or earlier upon an elimination of the restriction period as a result of a change in control event.
Stock-based compensation expense on restricted stock amounted to $1,770 and $1,415 for the three months ended June 30, 2022 and 2021, respectively, and $3,296 and $2,731 for the six months ended June 30, 2022 and 2021, respectively. The increase in the stock compensation for the three and six months ended June 30, 2022 is primarily due to increase in plan participants from acquired businesses and newly hired employees to support the continued expansion of our business.
NOTE 9 – NET LOSS PER SHARE
The following is a reconciliation of basic and diluted net loss per share:
| Three Months Ended | Six Months Ended | ||||||||||||||||||||||
| June 30, | June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Net loss | $ | (333) | $ | (3,756) | $ | (9,433) | $ | (14,135) | |||||||||||||||
| Weighted average number of shares - basic and diluted | 19,792,286 | 19,275,779 | 19,693,216 | 19,263,506 | |||||||||||||||||||
| Net loss per share - basic and diluted | $ | (0.02) | $ | (0.19) | $ | (0.48) | $ | (0.73) | |||||||||||||||
Our basic and diluted net loss per share is computed using the two-class method. The two-class method is an earnings allocation that determines net income per share for each class of common stock and participating securities according to their participation rights in dividends and undistributed earnings or losses. Non-vested restricted stock that includes non-forfeitable rights to dividends are considered participating securities.
Because we have incurred a net loss for all periods presented, diluted net loss per common share is the same as basic net loss per common share. The following contingently issuable and convertible equity shares were excluded from the calculation of diluted net loss per share because their effect would have
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been anti-dilutive for all periods presented:
| Six Months Ended June 30, | |||||||||||
| 2022 | 2021 | ||||||||||
| Restricted stock | 433,093 | 381,657 | |||||||||
| Stock options | 5,298 | 10,792 | |||||||||
| Total shares | 438,391 | 392,449 | |||||||||
NOTE 10 – BUSINESS SEGMENT
Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. We have one operating and reporting segment, OrthoPediatrics Corp., which designs, develops and markets anatomically appropriate implants and devices for children with orthopedic problems. Our chief operating decision-maker, our Chief Executive Officer, reviews financial information presented on a consolidated basis for purposes of making operating decisions and assessing financial performance, accompanied by disaggregated revenue information by product category. We determined that disaggregating revenue into these categories achieves the disclosure objective of illustrating the differences in the nature, timing and uncertainty of our revenue streams. We do not assess the performance of our individual product categories on measures of profit or loss, or other asset-based metrics. Therefore, the information below is presented only for revenue by category and geography.
Product sales attributed to a country or region includes product sales to hospitals, physicians and distributors and is based on the final destination where the products are sold. No customers accounted for more than 10% of total product sales for the three and six months ended June 30, 2022 or 2021. No customer accounted for more than 10% of consolidated accounts receivable as of June 30, 2022 and December 31, 2021.
Product sales by source were as follows:
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| Product sales by geographic location: | 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||
| U.S. | $ | 24,960 | $ | 21,737 | $ | 43,148 | $ | 38,576 | |||||||||||||||
| International | 7,968 | 4,958 | 13,197 | 9,581 | |||||||||||||||||||
| Total | $ | 32,928 | $ | 26,695 | $ | 56,345 | $ | 48,157 | |||||||||||||||
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| Product sales by category: | 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||
| Trauma and deformity | $ | 22,568 | $ | 17,933 | $ | 39,084 | $ | 32,485 | |||||||||||||||
| Scoliosis | 9,421 | 7,657 | 15,404 | 13,608 | |||||||||||||||||||
| Sports medicine/other | 939 | 1,105 | 1,857 | 2,064 | |||||||||||||||||||
| Total | $ | 32,928 | $ | 26,695 | $ | 56,345 | $ | 48,157 | |||||||||||||||
No individual country with sales originating outside of the United States accounted for more than 10% of consolidated revenue for the three and six months ended June 30, 2022 and 2021.
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NOTE 11 - RELATED PARTY TRANSACTIONS
In addition to the debt and credit agreements and mortgage with Squadron and its affiliate (see Note 6), we currently use Structure Medical, LLC (“Structure Medical”) as one of our suppliers. Structure Medical is affiliated with Squadron and a supplier with which we maintain certain long-term agreements. We made aggregate payments to Structure Medical for inventory purchases of $234 and $197 for the three months ended June 30, 2022 and 2021, respectively, and $550 and $269 for the six months ended June 30, 2022 and 2021, respectively.
On December 31, 2019, the Company divested Vilex for $25,000 to an affiliate of Squadron. In conjunction with the divestiture, the Company also entered into an exclusive perpetual license agreement to permit the purchasers of Vilex the ability to access intellectual property and sell products using the external fixation technology of Orthex, LLC to non-pediatric accounts. We had sales and payments related to inventory purchases to Squadron's affiliate, now known as Vilex, LLC, of $52 and $6, respectively, for the three months ended June 30, 2022, and sales and payments of $60 and $32, respectively, for the six months ended June 30, 2022. We had sales and payments related to inventory purchases to Vilex, LLC of $68 and $336, respectively, for the three months ended June 30, 2021, and sales and payments of $155 and $525, respectively, for the six months ended June 30, 2021.
NOTE 12 - EMPLOYEE BENEFIT PLAN
We have a defined-contribution plan, OrthoPediatrics 401(k) Retirement Plan (the “401(k) Plan”), which includes a cash or deferral (Section 401(k)) arrangement. The 401(k) Plan covers those employees who meet certain eligibility requirements and elect to participate. Employee contributions are limited to the annual amounts permitted under the Internal Revenue Code. The 401(k) Plan allows us to make a discretionary matching contribution. Discretionary matching contributions are determined annually by management. We have elected to match our employees' 401(k) contributions up to 4% of employees' salary.
NOTE 13 – COMMITMENTS AND CONTINGENCIES
Leases
As of June 30, 2022, the Company has recorded a lease liability of $300 and corresponding right-of-use-asset of $302 on its .
Legal Proceedings
From time to time, we are involved in various legal proceedings arising in the ordinary course of our business.
IMED Surgical - Software Ownership Dispute
On October 16, 2020, the Company, its wholly-owned subsidiary, Orthex, LLC (“Orthex”), the Company’s largest investor, Squadron Capital, LLC (“Squadron”), and certain other defendants, were named in a lawsuit filed by IMED Surgical, LLC, a New Jersey company (the “Plaintiff”), in Broward County, Florida Circuit Court. In the lawsuit, the Plaintiff claims, among other things, that it is the rightful owner of certain patented point-and-click planning software being used by the Company, Orthex and Squadron (specifically, U.S. Patent No. 10,258,377 (titled “Point and click alignment method for orthopedic surgeons, and surgical and clinical accessories and devices,” issued on April 16, 2019) (hereinafter, the “’377 Patent”).
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In June 2019, the Company purchased all the issued and outstanding units of membership interests in Orthex, and all the issued and outstanding shares of stock of Vilex in Tennessee, Inc. for $60,000 in total consideration. Vilex and Orthex are primarily manufacturers of foot and ankle surgical implants, including cannulated screws, fusion devices, surgical staples and bone plates, as well as the Orthex Hexapod technology, a system of rings, struts, implants, hardware accessories, and the Point & Click Software used to treat congenital deformities and limb length discrepancies. On December 31, 2019, the Company divested substantially all of the assets relating to Vilex's adult product offerings to a wholly-owned subsidiary of Squadron, in exchange for a $25,000 reduction in a term note owed to Squadron in connection with the initial acquisition. As part of the sale, the Company also executed an exclusive license arrangement with Squadron providing for perpetual access to certain intellectual property, including the ‘377 Patent. According to the lawsuit, the other defendants, who are unrelated to the Company, assigned the ‘377 Patent to Orthex in violation of certain agreements with the Plaintiff.
The Plaintiff, among other things, requests that the defendants be ordered to convey and assign to Plaintiff all of their rights, title and interests in and to the ’377 Patent and seeks certain compensatory, consequential and unjust enrichment damages from Orthex and the unrelated defendants.
On May 13, 2021, the Court ordered the lawsuit stayed pending arbitration. To the extent the Plaintiff desires to further pursue the matter, it must first do so through a separate arbitration proceeding. In mid-November 2021, the Plaintiff initiated an arbitration proceeding. In connection with the stay order, the Court also ordered the Company, Orthex and Squadron to give notice to the Plaintiff before any attempt to dispose, assign, sell or otherwise encumber the ‘377 Patent. The Company, Orthex and Squadron filed an appeal of this component of the order, but the appellate court affirmed the lower court’s decision. The Company, Orthex and Squadron have not sought to further pursue an appeal of the subject order.
Although we believe the IMED lawsuit is without merit and will vigorously defend the claims asserted against us, arbitration and litigation can involve complex factual and legal questions, and an adverse resolution of such proceedings could have a material adverse effect on our business, operating results and financial condition.
Wishbone Medical, Inc. – Patent Infringement Litigation
On October 30, 2020, OrthoPediatrics, along with its wholly-owned subsidiary, Orthex, LLC, filed a lawsuit in federal district court (N.D. Indiana, South Bend Division, Case No. 3:20-cv-00929) against Wishbone Medical, Inc. and Nick A. Deeter (collectively “Wishbone”), claiming infringement of ’377 Patent, unfair competition, false advertising, breach of contract, defamation per se, tortious interference with contractual relationships, and tortious interference with prospective contractual relationships. In early January 2021, OrthoPediatrics amended its lawsuit by adding a declaratory judgment claim of infringement of the ‘377 Patent against Wishbone.
Thereafter, in January 2021, Wishbone filed a motion to dismiss all OrthoPediatrics’ causes of action. In late August 2021, the Court denied Wishbone's motion to dismiss with respect to OrthoPediatrics’ infringement and breach of contract claims and dismissed OrthoPediatrics' remaining causes of action. In late September 2021, Wishbone filed its answer and counterclaims, in part, seeking declaratory judgment of non-infringement and invalidity of the ‘377 Patent, and alleging OrthoPediatrics patent infringement claim(s) against Wishbone was made in bad faith. In mid-October 2021, OrthoPediatrics filed its answer to Wishbone’s counterclaims, denying all of them. Although we believe Wishbone’s counterclaims are without merit and will vigorously defend the claims asserted against us, litigation can involve complex factual and legal questions, and an adverse resolution of this proceeding could have an adverse effect on our business, operating results and financial condition.
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We are not presently a party to any other legal proceedings the outcome of which, if determined adversely to us, would individually or in the aggregate materially affect our financial position or results of operations or cash flows.
Purchase Obligations and Performance Requirements
As a result of entering into a license agreement for the exclusive distribution of the 7D Surgical FLASHTM Navigation platform, the Company has agreed to a minimum purchase commitment for the first twelve months of that agreement. As of June 30, 2022, the remaining purchase commitment under the agreement was $1,140.
On July 20, 2021, we entered into an amended license agreement, resulting in a five-year extension of our exclusive distribution rights of the FIREFLY Technology. As a component of the agreement the Company is required to meet minimum performance metrics, measured by the number of spine procedures in the fiscal year which used the FIREFLY products against the annual requirement in the agreement. This includes any scheduled surgeries whereby the Company has committed to payment of the product. The number of required surgeries varies each year of the agreement. The Company analyzes its projected achievement of these performance metrics and accrues for any estimated shortfall. During the three and six months ended June 30, 2022, the Company recorded an expense of $240 and $341, respectively. No expense was recorded for either the three or six months ended June 30, 2021.
Royalties
As of June 30, 2022, we are contracted to pay royalties to individuals and entities that provide research and development services, which range from 0.5% to 20% of sales.
We have products in development that have milestone payments and royalty commitments. In any development project, there are significant variables that will affect the amount and timing of these payments and as of June 30, 2022, we have not been able to determine the amount and timing of payments. We do not anticipate these future payments will have a material impact on our financial results.
NOTE 14 – SUBSEQUENT EVENTS
Pega Medical Acquisition
On July 1, 2022, the Company, along with its newly-formed, indirect wholly-owned subsidiary OrthoPediatrics Canada ULC, purchased all of the issued and outstanding share capital of Pega Medical Inc., a corporation incorporated under the Canada Business Corporations Act (“Pega Medical”). Pega Medical has developed and sells a portfolio of trauma and deformity correction devices for children, including the Fassier-Duval Telescopic Intramedullary System, a well-recognized, innovative implant designed to treat bony deformities in children with osteogenesis imperfecta without disrupting their normal growth. Pega's product portfolio increases our total systems and increases the percentage of total trauma and deformity cases we can treat.
The Company acquired Pega Medical for $32,047 in cash. Approximately $1,052 of the cash consideration was deposited into escrow and will be held for a period of up to eighteen (18) months to cover certain indemnification obligations of the selling shareholders of Pega Medical. Final purchase consideration is subject to certain working capital adjustments yet to be finalized. Additionally, 34,899 shares of unregistered common stock, $0.00025 par value per share, of the Company, representing approximately $1,497 (based on the July 1, 2022 closing share price of $42.90) were issued to the selling shareholders. The common stock issued to the selling shareholders is not considered part of the purchase consideration and is subject to a repurchase right by the Company in the event a selling shareholder leaves employment with Pega Medical for certain reasons during the three-year period following the closing. In the event the repurchase right is triggered, the Company will have the right to repurchase the shares of common stock issued to such selling shareholder at a price of $0.10 per share.
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Pursuant to the terms of the transaction, the Company also issued $499 in restricted stock units to employees of Pega Medical, which are subject to an approximate three-year vesting schedule.
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 3, 2022, 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 and instruments to meet the specialized needs of pediatric surgeons 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 $3.3 billion opportunity globally, including over $1.5 billion in the United States.
We sell implants, instruments and braces to our customers for use by pediatric orthopedic surgeons 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 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, we also sell to stocking distributors, where we transfer control of our products to the distributor when title passes upon shipment.
We currently market 39 surgical systems that serve three of the largest categories within the pediatric orthopedic market: (i) trauma and deformity, (ii) scoliosis and (iii) sports medicine/other. We primarily 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 40 independent sales agencies employing more than 205 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.
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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. Additionally, in March 2019, we established an operating company in the Netherlands in order to enhance our operations in Europe. In these markets, we work through sales agencies that are paid a commission, similar to our U.S. sales model. We expect these arrangements to generate 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. For example, on April 1, 2022, the Company acquired MD Orthopaedics, Inc., a developer and manufacturer of a portfolio of orthopedic clubfoot products. Also, on July 1, 2022, the Company, along with its newly-formed, indirect wholly-owned subsidiary OrthoPediatrics Canada ULC, purchased all of the issued and outstanding share capital of Pega Medical Inc., which has developed and sells a portfolio of trauma and deformity correction devices for children, including the Fassier-Duval Telescopic Intramedullary System, a well-recognized, innovative implant designed to treat bony deformities in children with osteogenesis imperfecta without disrupting their normal growth.
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 560,000 children, including MD Ortho. 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 and Nominating 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 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 recently implemented an enhanced recycling program.
•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 the World Pediatric Project - 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.
•The Board of Directors understands the value of diversity and will increase the diversity of the Board over the next 12 months. The Governance and Nominating Committee engaged a global recruiting firm to assist in adding two diverse Board candidates.
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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.
Impact of COVID-19 on our Business
As a result of the COVID-19 pandemic (“COVID-19” or the “pandemic”), we have experienced significant business disruption. For example, in order to meet the demand for COVID-19-related hospitalizations, various governments, governmental agencies and hospital administrators required certain hospitals to postpone some elective procedures. In addition, elective procedures are also being 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 deferrals of such surgeries and procedures have had, and may continue to have, a significant negative impact on our business and results of operations. 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 3, 2022 and in other reports filed with the SEC that discuss the risks and factors that may affect our business.
Despite the impact COVID-19 has had on our business, we continue to invest in research and development, invest in our people, and take steps to position ourselves for long-term success.
Health and Safety
From the earliest signs of the outbreak, we have taken proactive, aggressive action to protect the health and safety of our employees, customers, partners and suppliers. We enacted rigorous safety measures in all applicable locations, including implementing social distancing protocols, requiring working from home for those employees that do not need to be physically present on the warehouse floor, suspending travel, extensively and frequently disinfecting our workspaces and providing masks to those employees who must be physically present. We also installed enhanced HVAC systems across our Warsaw facility to reduce the spreading of germs. We will continue to utilize some or all of these measures until we determine that the COVID-19 pandemic is adequately contained for purposes of our business. We may also take further actions as government authorities require or recommend or as we determine to be in the best interests of our employees, customers, partners and suppliers.
Supply
We have not yet experienced any significant impacts or interruptions to our supply chain as a result of the COVID-19 pandemic. To mitigate the risk of any potential supply interruptions from the COVID-19 pandemic, we chose to increase certain inventory levels during the quarter. We may decide to take similar actions going forward. Additionally, restrictions or disruptions of transportation, such as reduced availability of air transport, port closures and increased border controls or closures, may result in higher costs and delays.
Demand
The outbreak has significantly increased economic and demand uncertainty. We anticipate that the current outbreak or continued spread of COVID-19, and the actions taken by governmental authorities and other third parties to contain the virus, may cause a global economic slowdown, and it is possible that it could cause a global recession. In the event of a recession, demand for our products would decline and our business would be adversely effected. We have experienced a reduction in revenue as a result of global delays in elective surgeries.
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Liquidity
Although there is uncertainty related to the anticipated impact of COVID-19 on our future results, we believe our business model, our current cash reserves and the recent steps we have taken to strengthen our balance sheet, including expanding our line of credit from $25 million to $50 million and our June 2020 and December 2019 equity offerings, leave us well-positioned to manage our business through this crisis as it continues to unfold. We believe our existing balances of cash, including our short-term investments, and our currently anticipated operating cash flows will be sufficient to meet our cash needs arising in the ordinary course of business for the next twelve months.
We continue to monitor the evolving situation and guidance from international and domestic authorities, including federal, state and local public health authorities and may take additional actions based on their recommendations. In these circumstances, there may be developments outside our control requiring us to adjust our operating plan. As such, given the dynamic nature of this situation, we cannot reasonably estimate the impacts of COVID-19 on our financial condition, results of operations or cash flows in the future.
Other 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. Impairment is based on our current assessment of the expected future cash flows based on recent results and other specific market factors. Although we have not recorded any impairment charges to date, the most recently prepared assessment indicates our passing rate has narrowed for certain intangible assets. We believe that the expected future cash flows represent management’s best estimate; however, if actual results differ materially from these estimates, we could record an impairment charge which could be material to our consolidated financial statements and have an adverse impact on our results of operations.
Emerging Growth Company and Smaller Reporting Company Status
We will qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act (the “JOBS Act”) until December 31, 2022. For as long as a company is deemed to be an emerging growth company, it may take advantage of specified reduced reporting and other regulatory requirements that are generally unavailable to other public companies. We also qualify as a "smaller reporting company," as such term is defined in Rule 12b-2 under the Exchange Act. To the extent that we continue to qualify as a smaller reporting company, after we cease to qualify as an emerging growth company, certain of the exemptions available to us as an emerging growth company may continue to be available to us as a smaller reporting company. The JOBS Act also provides that an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards and, therefore, we are subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.
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Summary of Statements of Operations for the Three and Six Months Ended June 30, 2022 and 2021
The following table sets forth our results of operations for the three and six months ended June 30, 2022 and 2021:
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||||||||
| 2022 | 2021 | Increase (Decrease) | % | 2022 | 2021 | Increase (Decrease) | % | ||||||||||||||||||||||
| Net revenue | $ | 32,928 | $ | 26,695 | $ | 6,233 | 23 | % | $ | 56,345 | $ | 48,157 | $ | 8,188 | 17 | % | |||||||||||||
| Cost of revenue | 7,947 | 6,252 | 1,695 | 27 | % | 12,798 | 11,389 | 1,409 | 12 | % | |||||||||||||||||||
| Sales and marketing expenses | 12,431 | 10,876 | 1,555 | 14 | % | 22,189 | 19,825 | 2,364 | 12 | % | |||||||||||||||||||
| General and administrative expenses | 14,546 | 11,088 | 3,458 | 31 | % | 27,713 | 23,129 | 4,584 | 20 | % | |||||||||||||||||||
| Research and development expenses | 1,747 | 1,325 | 422 | 32 | % | 3,774 | 2,633 | 1,141 | 43 | % | |||||||||||||||||||
| Total other expenses (income) | (2,971) | 1,196 | (4,167) | (348) | % | 60 | 5,914 | (5,854) | (99) | % | |||||||||||||||||||
| Provision for income taxes (benefit) | (439) | (286) | (153) | (53) | % | (756) | (598) | (158) | (26) | % | |||||||||||||||||||
| Net loss | $ | (333) | $ | (3,756) | $ | (3,423) | (91) | % | $ | (9,433) | $ | (14,135) | $ | (4,702) | (33) | % | |||||||||||||
Net Revenue
The following tables set forth our net revenue by geography and product category for the three and six months ended June 30, 2022 and 2021:
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| Product sales by geographic location: | 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||
| U.S. | $ | 24,960 | $ | 21,737 | $ | 43,148 | $ | 38,576 | |||||||||||||||
| International | 7,968 | 4,958 | 13,197 | 9,581 | |||||||||||||||||||
| Total | $ | 32,928 | $ | 26,695 | $ | 56,345 | $ | 48,157 | |||||||||||||||
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| Product sales by category: | 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||
| Trauma and deformity | $ | 22,568 | $ | 17,933 | $ | 39,084 | $ | 32,485 | |||||||||||||||
| Scoliosis | 9,421 | 7,657 | 15,404 | 13,608 | |||||||||||||||||||
| Sports medicine/other | 939 | 1,105 | 1,857 | 2,064 | |||||||||||||||||||
| Total | $ | 32,928 | $ | 26,695 | $ | 56,345 | $ | 48,157 | |||||||||||||||
Net revenue increased $6.2 million, or 23%, from $26.7 million for the three months ended June 30, 2021 to $32.9 million for the three months ended June 30, 2022 and increased $8.2 million, or 17%, from $48.2 million for the six months ended June 30, 2021. The increase during the three and six months ended June 30, 2022 was driven primarily by non-elective trauma sales. Additionally, in the second quarter we saw non-organic growth of approximately $2.6 million related to the acquisition of MD Ortho for the three and six month periods ended June 30, 2022.
Trauma and deformity sales, which include the non-organic growth from the MD Ortho acquisition, increased $4.6 million, or 26%, during the three months ended June 30, 2022, and increased $6.6 million,
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or 20%, during the six months ended June 30, 2022. In each case, the increase was primarily driven by strong trauma and deformity growth across numerous product lines, specifically our Cannulated Screws, PediFoot System, and PNP Femur System as well as the non-organic growth from MD Ortho. Scoliosis sales increased $1.8 million, or 23%, during the three months ended June 30, 2022, and increased $1.8 million, or 13%, during the six months ended June 30, 2022. In each case, the growth was primarily driven by increased sales of our RESPONSE 4.5/5.0, sales of the FireFly surgical guides, and Bandloc. Sports medicine / other decreased $0.2 million, or 15%, during the three months ended June 30, 2022, and decreased $0.2 million, or 10%, during the six months ended June 30, 2022. In each case, the decrease was driven by a decline in 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 $1.7 million, or 27%, from $6.3 million for the three months ended June 30, 2021 to $7.9 million for the three months ended June 30, 2022. Cost of revenue increased $1.4 million, or 12%, from $11.4 million for the six months ended June 30, 2021 to $12.8 million for the six months ended June 30, 2022. In both cases, the increase was due primarily to an increase in volumes sold. Gross margin was 77% for the three months ended June 30, 2021 and 76% for the three months ended June 30, 2022. Gross margin was 77% for the six months ended June 30, 2022 and 76% for the six months ended June 30, 2021.
Sales and Marketing Expenses
Sales and marketing expenses increased $1.6 million, or 14%, to $12.4 million for the three months ended June 30, 2022 from $10.9 million for the three months ended June 30, 2021. Sales and marketing expenses increased $2.4 million, or 12%, to $22.2 million for the six months ended June 30, 2022 from $19.8 million for the six months ended June 30, 2021. The changes in the three and six month periods ended June 30, 2022 were due primarily to increased sales commission expenses, driven by increased unit volumes sold.
General and Administrative Expenses
General and administrative expenses increased $3.5 million, or 31%, from $11.1 million for the three months ended June 30, 2021 to $14.5 million for the three months ended June 30, 2022. General and administrative expenses increased $4.6 million, or 20%, to $27.7 million for the six months ended June 30, 2022 from the $23.1 million for the six months ended June 30, 2021.The increases for the three and six month periods ended June 30, 2022 were due primarily to the addition of personnel and resources to support the continued expansion of our business and an increase in legal expenses, driven by two recent acquisitions, and other professional service expenses. Additionally, the Company saw higher expenses of approximately $0.9 million due to the acquisition of MD Ortho, including standard operating expenses and amortization of intangible assets which began amortizing on the date of acquisition.
Depreciation and amortization expenses increased $0.6 million, or 24%, from $2.6 million for the three months ended June 30, 2021 to $3.2 million for the three months ended June 30, 2022. Depreciation and amortization expenses increased $1.0 million, or 19%, to $6.1 million for the six months ended June 30, 2022 from $5.1 million for the six months ended June 30, 2021.The increases for the three and six month periods ended June 30, 2022 were primarily due to increases in depreciation from higher set deployments and the amortization of intangible assets, including licenses which had not yet been put into the market in the first half of 2021, as well as the intangible assets included in the acquisition of MD Ortho.
Research and Development Expenses
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Research and development expenses increased $0.4 million, or 32%, from $1.3 million for the three months ended June 30, 2021 to $1.7 million for the three months ended June 30, 2022. Research and development expenses increased $1.1 million, or 43%, to $3.8 million for the six months ended June 30, 2022 from the $2.6 million for the six months ended June 30, 2021. The increases for the three and six month periods ended June 30, 2022 were primarily due to incremental product development and the addition of personnel to support the future growth of the business.
Total Other Expenses
Total other expenses reflect income of $3.0 million and expense of $1.2 million for the three months ended June 30, 2022 and 2021, respectively, a decrease of $4.2 million or 348%. Other expenses decreased $5.9 million, or 99%, to $60 thousand for the six months ended June 30, 2022 from the $5.9 million for the six months ended June 30, 2021. The decrease in total other expenses for each of the three and six months ended June 30, 2022 was primarily due to the fair value adjustments of contingent consideration, which was driven by the valuation inputs that were lower in comparison to the same period last year. This was offset by additional interest expense of approximately $0.7 million as the result of the finalization of the ApiFix installment paid in the second quarter and increased losses due to foreign currency conversions of approximately $1.1 million and $1.2 million for the three and six months ended June 30, 2022, respectively. The increased interest expense was driven by the variance in our closing stock price on the payment date compared to the 30 day average used to calculate the number of shares paid, which increase was non-cash in nature.
Liquidity and Capital Resources
We have incurred operating losses since inception which resulted in negative cash flows for continuing operations from operating activities of $12.4 million and $10.9 million for the six months ended June 30, 2022 and 2021, respectively. As of June 30, 2022, we had an accumulated deficit of $187.5 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 June 30, 2022, we had cash and cash equivalents, restricted cash and short term investments of $52.5 million. We also currently have $19 million available on our line of credit.
Cash Flows
The following table sets forth our cash flows from operating, investing and financing activities for the periods indicated:
| Six Months Ended June 30, | |||||||||||
| 2022 | 2021 | ||||||||||
| Net cash used in operating activities | $ | (12,367) | $ | (10,891) | |||||||
| Net cash provided by (used in) investing activities | 13,775 | (7,332) | |||||||||
| Net cash provided by (used in) financing activities | 27,741 | (2) | |||||||||
| Effect of exchange rate changes on cash | 400 | 29 | |||||||||
| Net increase (decrease) in cash | $ | 29,549 | $ | (18,196) | |||||||
Cash Used in Operating Activities
Net cash used in operating activities from continuing operations was $12.4 million and $10.9 million for the six months ended June 30, 2022 and 2021, 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 $10.9 million for the six months ended June 30, 2022 compared to
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a source of $10.4 million for the six months ended June 30, 2021. During the six months ended June 30, 2022, the primary driver of working capital cash usage was the increase in inventory of $10.9 million and trade receivables of $6.6 million, offset by trade payables of $5.3 million to support future sales growth. We also saw an increase in the sourcing of cash from other accrued expenses of $1.1 million.
Cash Provided by (Used in) Investing Activities
Net cash provided by investing activities for the six months ended June 30, 2022 was $13.8 million compared to a use of cash of $7.3 million for the six months ended June 30, 2021. Net cash provided by investing activities for the six months ended June 30, 2022 consisted primarily of the sale of short-term marketable securities to fund the acquisition of MD Ortho, which was offset by the purchases of instrument sets of $9.5 million and the cash consideration paid to acquire MD Ortho.
Cash Provided By (Used in) Financing Activities
Net cash provided by financing activities for the six months ended June 30, 2022 was $27.7 million. Net cash used in financing activites for the six months ended June 30, 2021 was not material to the results of our operations. Net cash provided by financing activities for the six months ended June 30, 2022 consisted primarily of the proceeds from the $31 million of debt incurred in connection with the acquisition of Pega Medical Inc., which was offset by the first anniversary installment payment to ApiFix.
Indebtedness
Loan Agreement
On June 13, 2022, the Company entered into a Fourth Amendment (the “Fourth Amendment”) to its Fourth Amended and Restated Loan and Security Agreement with Squadron Capital LLC, or Squadron (as so amended, the “Loan Agreement”). The Fourth Amendment increased the amount available under the revolving credit facility from $25 million to $50 million in anticipation of using the facility to fund the cash portion of the Company’s July 1, 2022 acquisition of Pega Medical Inc.
The Loan Agreement provides a revolving credit facility, with interest only payments, at an annual interest rate equal to the greater of (a) six month SOFR plus 8.69% and (b) 10.0%. Prior to December 31, 2021, the interest rate on the facility had been equal to the greater of (a) three month LIBOR plus 8.61% and (b) 10.0%. The Company pays Squadron an unused commitment fee in an amount equal to the per annum rate of 0.50% (computed on the basis of a year of 360 days and the actual number of days elapsed) times the daily unused portion of the revolving credit commitment. The unused commitment fee is payable quarterly in arrears.
Borrowings under the revolving credit facility are made under a First Amended and Restated Revolving Note, dated August 4, 2020 (the “Amended Revolving Note”), payable, jointly and severally, by the Company and each of its subsidiaries party thereto. The Amended Revolving Note will mature at the earlier of: (i) the date on which any person or persons acquire (x) capital stock of the Company possessing the voting power to elect a majority of the Company’s Board of Directors (whether by merger, consolidation, reorganization, combination, sale or transfer), or (y) all or substantially all of the Company’s assets, determined on a consolidated basis; and (ii) January 1, 2024.
Borrowings under the Loan Agreement are secured by substantially all of the Company's assets and are unconditionally guaranteed by each of its subsidiaries with the exception of Vilex. There are no traditional financial covenants associated with the Loan Agreement. However, there are negative covenants that prohibit us from, among other things, transferring any of our material assets, merging with or acquiring another entity, entering into a transaction that would result in a change of control, incurring additional indebtedness, creating any lien on our property, making investments in third parties
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and redeeming stock or paying dividends, in each case subject to certain exceptions as further detailed in the Loan Agreement.
The Loan Agreement includes events of default, the occurrence and continuation of any of which provides Squadron with the right to exercise remedies against us and the collateral securing the loans, including cash. These events of default include, among other things, the failure to pay amounts due under the credit facilities, insolvency, the occurrence of a material adverse event, which includes a material adverse change in our business, operations or properties (financial or otherwise) or a material impairment of the prospect of repayment of any portion of the obligations, the occurrence of any default under certain other indebtedness and a final judgment against us in an amount greater than $250 thousand. The occurrence of a material adverse change could result in the acceleration of payment of the debt.
As of June 30, 2022 the Company has $31 million outstanding on the line of credit and a remaining $19 million available. As of December 31, 2021 there was no outstanding debt on the line of credit.
Mortgage Note
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. The mortgage is secured by the related real estate and building. The mortgage balance was $1.0 million and $1.0 million at June 30, 2022 and December 31, 2021, respectively.
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
This management’s discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenue and expenses during the reporting periods. We monitor and analyze these items for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Changes in estimates are reflected in reported results for the period in which they become known. Actual results may differ materially from these estimates under different assumptions or conditions.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a "smaller reporting company," we are not required to provide the information required by this item.
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ITEM 4. CONTROLS AND PROCEDURES
a.Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) at the end of the period covered by this quarterly report.
Based on this evaluation, we concluded that, as of such date, our disclosure controls and procedures were effective to provide reasonable assurance that the information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
We recognize that any controls system, no matter how well designed and operated, can provide only reasonable assurance of achieving its objectives, and our management necessarily applies its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
b. Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the period covered by this quarterly report that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act).
In April 2022, we completed the acquisition of MD Ortho and are currently integrating MD Ortho into our operations. The internal control over financial reporting of the acquired company was excluded from the evaluation of the effectiveness of our internal controls. This exclusion is in accordance with the general guidance issued by the Staff of the SEC that an assessment of a recent business combination may be omitted from management's report on internal control over financial reporting during the first year following an acquisition while integrating the acquired company. MD Ortho constituted approximately 5.9% of our total assets as of June 30, 2022, including goodwill and intangible assets recorded as a part of our purchase price allocation, and approximately 4.6% of our net revenue for the six months ended June 30, 2022.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we are involved in various legal proceedings arising in the ordinary course of our business.
A discussion of certain of those legal proceedings is contained in Note 13 – Commitments and Contingencies (under the heading “Legal Proceedings”) of the notes to the condensed consolidated financial statements included in Item 1. Financial Statements of Part I of this quarterly report on Form 10-Q, which discussion is incorporated herein by reference.
We are not presently a party to any other legal proceedings the outcome of which, if determined adversely to us, would individually or in the aggregate materially affect our financial position, results of operations or cash flows.
ITEM 1A. RISK FACTORS
In addition to the other information set forth in this quarterly report, you should carefully consider the factors discussed in “Risk Factors” in our Annual Report on Form 10-K filed with the SEC on March 3, 2022. There have been no material changes to these Risk Factors since the filing of our Annual Report on Form 10-K.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
a. Sale of Unregistered Securities.
None.
b. Use of Proceeds.
None.
c. Issuer Purchases of Equity Securities.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
None.
ITEM 5. OTHER INFORMATION
a. Failure to file under Form 8-K.
None.
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b. Modifications to nomination process.
None.
ITEM 6. EXHIBITS
The following exhibits are included within this Report or incorporated herein by reference.
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Exhibit Number | Description | |||||||||||||
| + | ||||||||||||||
| + | ||||||||||||||
| ++ | ||||||||||||||
| ++ | ||||||||||||||
| 101.INS | + | Inline XBRL Instance Document (The instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.) | ||||||||||||
| 101.SCH | + | Inline XBRL Taxonomy Extension Schema Document | ||||||||||||
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| 101.CAL | + | Inline XBRL Taxonomy Extension Calculation Linkbase Document | ||||||||||||
| 101.DEF | + | Inline XBRL Taxonomy Extension Definition Linkbase Document | ||||||||||||
| 101.LAB | + | Inline XBRL Taxonomy Extension Label Linkbase Document | ||||||||||||
| 101.PRE | + | Inline XBRL Taxonomy Extension Presentation Linkbase Document | ||||||||||||
| 104 | Cover Page Interactive Data File (formatted as Inline XBRL and included in Exhibit 101) | |||||||||||||
w The schedules to the applicable agreement have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company agrees to furnish a copy of any schedule omitted from such agreement to the SEC upon request.
* Exhibits that describe or evidence management contracts or compensatory plans or arrangements required to be filed as Exhibits to this Report.
+ Filed herewith.
++ Furnished herewith.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| August 4, 2022 | By: | /s/ David R. Bailey | ||||||
| David R. Bailey President and Chief Executive Officer | ||||||||
| August 4, 2022 | By: | /s/ Fred L. Hite | ||||||
Fred L. Hite Chief Financial Officer and Chief Operating Officer | ||||||||
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