OrthoPediatrics Corp.

Welcome to the fourth quarter and full year 2020 Orthopediatrics Corp Earnings Conference Call. My name is April, and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please note that this conference is being recorded. I will now turn the call over to Christine Petraglia. Thank you. You may begin.

Thank you, Operator, and thanks, everyone, for participating in today's call. Joining me from the company are Mark Dordal, Chief Executive Officer, Fred Haidt, Chief Operating Officer and Chief Financial Officer, and David Daly, President. Before we begin, I would like to caution listeners that comments made by management during this conference call will include forward-looking statements within the meaning of federal securities laws. including the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve material risks and uncertainties, and the company's actual results may differ materially. For a discussion of risk factors, including, among others, the risks related to COVID-19, the impact such a pandemic may have on the demand for the company's products and the company's ability to respond to the related challenges, I encourage you to review the company's most recent annual report on Form 10-K, which will be filed with the Securities and Exchange Commission soon. During the call today, management will also discuss certain non-GAAP financial measures which are used as supplemental measures of performance. The company believes these measures provide useful information for investors in evaluating its operations period over period. For each non-GAAP financial measure referenced on the call, the company has included a reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures in its earnings release. Please note that the non-GAAP financial measures have limitations and analytical tools should not be considered in isolation or as a substitute for orthopediatrics financial results prepared in accordance with GAAP. In addition, In addition, the content of this conference call contains time-sensitive information that is accurately only as of the date of this live broadcast, today, March 11th, 2021, except as required by law. The company undertakes no obligation to revise or update any statements to reflect events or circumstances that take place after the date of this call. With that said, I'd like to turn the call over to Mark.

Good morning, everyone. and thank you for joining us today on our fourth quarter and full year 2020 earnings conference call. We stand at the one-year anniversary of the COVID-19 pandemic, which is the greatest public health crisis in a century. 2020 reminded us how fortunate we are to partner with surgeons and healthcare providers who so deeply impact the lives of patients and their families, particularly during the past year. 2020 also brought out the best in our company and our associates, who rose to meet unprecedented challenges, found new ways of working, demonstrated resilience, and most importantly, continued the disciplined and consistent execution of our world strategies. Their efforts position us well as we emerge from the pandemic, stronger than when we entered it. On March 16th, 2020, we closed our office and began working remotely, my colleagues and I immediately resolved to stabilize our employee base by announcing that there would be no job cuts or salary reductions. We stabilized our sales organization by making available low-interest loans to our 36 domestic sales agencies and reassured suppliers that we would not reduce orders for new consignment inventory. We continued to stand by pediatric surgical societies throughout the world that depend on our leading financial support, and we were the only industry sponsor that did not reduce or eliminate its financial contributions to these organizations in 2020. I'm proud that Orthopediatrics has managed through the pandemic in a manner befitting a company that has been recognized as one of the best places to work in Indiana recently for the fifth year. As a result of the resilience of our people, we delivered full-year sales of $71.1 million, down 2% from 2019, primarily due to fewer elected deformity surgeries and international stocking distributors who were affected by the economic collapse of their markets. However, fourth quarter and annual sales were also impacted. by a $2.7 million revenue reduction booked in December 2020 due to the repurchase of inventory from a stocking distributor in Germany, Austria, and Switzerland that we converted to a sales agency in December. This $2.7 million reduction decreased fourth quarter revenue growth by 14% and total year revenue growth by 4%. It's important to separate the impact of this accounting treatment from the fundamentals of the business, which continued to improve in the fourth quarter. In fact, during the fourth quarter, our domestic business grew 26% to $17.9 million. Total domestic sales grew 14% to $63 million. While we saw a slowdown in December, which continued into the first six weeks of 2021, We are encouraged by an acceleration in domestic sales over the past several weeks, and we look forward to reporting continued growth in the first quarter of 2021. International sales in 2020 were $8.1 million, representing a 54% decrease year-over-year impacted by the reluctance of our 42 stocking distributors to purchase inventory due to the decline of elective surgeries in their markets. International sales were also negatively impacted by the aforementioned repurchase of $2.7 million of inventory from Germanic countries as they converted to the sales agency model in December. However, it is important to note that international sales agency revenues grew 51% in the fourth quarter, nearly double the impressive 26% growth in the third quarter of 2020. And this growth was before the conversion of Germany, Austria, and Switzerland, which we anticipate will further stimulate agency growth in 2021 and beyond. We are encouraged by the momentum of international sales agency growth throughout the second half of the year and are pleased to have expanded the sales agency model in December 2020 to 14 agencies in 13 countries. Even though we're not yet out of the woods on COVID, our domestic and international recoveries give us confidence in our guidance for 2021, which is full-year sales growth in the range of 31 percent to 38 percent, reaching $93 million to $98 million. This morning, Fred will provide a detailed review of these results and discuss our financials and procedure recovery rates by geography and business unit. I would now like to focus on four factors that give us confidence in the outlook for 2021 and our plan to execute a seamless management transition this year. I'll then turn the call over to Fred, after which we will open the call up to your questions. There are at least four reasons we are optimistic about the 2021 sales outlook. They include continued domestic sales momentum, the turnaround in international stocking distributor purchases, international sales agency growth, and synergies from our three acquisitions. Point number one, domestic revenue continues to demonstrate significant momentum. In the fourth quarter of 2020, U.S. sales were $17.9 million, a 26.1% increase compared to $14.2 million for the same period in 2019, and an acceleration, from the 17% growth in the third quarter of 2020. This represented a turnaround from the second quarter of 2020 when domestic sales declined 12%. While we faced domestic headwinds late in the fourth quarter of 2020 and during the first six weeks of 2021 when we saw a temporary decline in elective surgical volumes, domestic sales have improved dramatically since that time. We believe that recent progress on vaccines and vaccination rates, coupled with the greater capability of hospitals to treat COVID patients, should allow us to weather any future spikes in COVID cases over the next six months when a majority of American adults are being vaccinated. Domestically, we were encouraged in the fourth quarter of 2020 by the performance of our trauma products, such as PNP-Femur, which exceeded 1,000 cases since its introduction in 2018. Our sports medicine and other category delivered $1.0 million of revenue and benefited from the addition of Telos sales. Scoliosis revenue was $6.6 million, a 35.7% increase compared to $4.9 million in the fourth quarter of 2019. Throughout the year, we built solid momentum in our Response 5560 system and Firefly pedicle screw navigation guides as we added 23 new response users. Point number two. While international revenue in the fourth quarter of 2020 was $1.1 million, a 77.7% decrease compared to $4.8 million for the same period last year, Sales reflected the aforementioned $2.7 million reduction of revenue, as well as the impact of weak sales to international stocking distributors. Many of these distributors are small, private companies focused on specialty orthopedic products, and they've been reluctant to commit to additional inventory given the economic dislocations in their home markets. Beginning in January 2021, however, international stocking distributors have begun purchasing increased quantities of product. This may be due both to the depletion of their inventories, as well as what we believe to be an enormous backlog of surgical procedures in many European countries and Brazil. Point number three, international sales agency revenues accelerated from 26% in the third quarter of 2020 to 51% in the fourth quarter. That is why we're pleased by the successful conversion of the largest European market, Germany, Austria, and Switzerland, to a sales agency. Past conversions in other markets have produced an approximate doubling of revenues and gross margin because we bill hospitals at retail prices rather than selling to stocking distributors at wholesale prices. Over time, we have also increased the organic growth rate in converted markets by consigning instrument sales more aggressively. The turnaround in stocking distributor demand, the significant backlog in several countries, coupled with continued growth by international sales agencies, give us confidence that our international business is rebounding. It is in this context that we can cite receiving UK regulatory clearance for PMP-FEMER and initiating the clinical use of our Apifex system in the UK where initial feedback from surgeons has been overwhelmingly positive. Additionally, the first OrthEx surgical cases for pediatric orthopedic deformities in Europe were performed at the Paleo-European Institute MediCover Hospital in January and February 2021. We look forward to launching OrthEx across additional locations in Europe, the Middle East, and Africa during the first half of this year. In addition to Europe, we received 14 regulatory approvals in Canada in 2020, including Orthex, PNP Femur, PDFoot, Response 4550 and 5560, and Bandlock. We also expanded our product offering in Australia to include PNP Femur, Response 4550, and Orthex. Point number four. Our recent acquisitions have delivered strong synergies in 2020, and we're confident they will do so to an even greater degree in 2021. Orthex, which we acquired in 2019, continued to deliver strong growth with 38 surgeon conversions in 2020, and we recently received CE mark approval for Orthex in Europe. International sales agencies have performed their first cases, and inventory has been built for what we anticipate will be the largest international launch in our company's history. Orthex increases our reach from 65% to 85% of the trauma and deformity addressable market, and it has fulfilled the promise of positioning our company for total account conversions, both domestically and internationally. In April 2020, we acquired Apithex, which is one of two recently approved non-fusion technologies and represents a revolutionary approach to how scoliosis is treated. We then received FDA approval to expand the label to 35 to 60 degrees for progressive curves from 40 to 60 degrees previously, which allows Apifix to compete head-to-head with spinal tethering, the only other non-fusion technology approved for use in skeletally immature patients. Apifix enables surgeons to provide permanent curve correction while retaining spine flexibility and is a less invasive surgical procedure compared to spinal fusion. At the end of January 2021, Apifix had received full IRB approvals at 11 of the 20 IRB hospitals and has conducted 27 extremely successful surgeries. Surgeons continue to be impressed by its results, and we anticipate that in 2021, Apifix will complete the 200 cases to fill the registry, whereupon we will expand the launch in the United States. Apifix produces very high revenue contribution per dollar of said inventory and improves our return on capital. Telos has also produced robust sales growth. Our rationale for this acquisition was to gain access to state-of-the-art expertise on the complex and sweeping changes in the worldwide regulatory environment. We had not expected that TELUS's expertise would be in significant commercial demand and are delighted that TELUS continues to win significant contracts at medical device companies, some of which are in the orthopedic space. To summarize, domestic momentum, the international turnaround, and acquisition synergies are all potentiated by other investments we continue to make in 2020 despite the pandemic. We deployed $5 million in consigned sets during the fourth quarter, bringing the total investment in 2020 to $18 million, the same level of investment we made in 2019. We also completed a 20,000 square foot expansion of our distribution facility in our Warsaw headquarters, which represented the second expansion in the past two years. We believe that our investments in international markets, consigned sets, and facilities will allow us to advance our commitment to being the end-to-end provider of pediatric orthopedic surgical products around the globe. Turning to management succession, you will recall that in April 2020, the board elected Dave Bailey president and Fred Height, Chief Operating Officer and Chief Financial Officer. These appointments took effect on June 3rd, 2020 at our annual shareholder meeting and represented an orderly succession process that began three years ago when I informed the board of my intention to step aside as CEO upon reaching my 70th birthday in 2021. At the upcoming annual meeting, it is expected that Dave Bailey will become CEO and I will become executive chairman of the board. I plan to remain involved in industrial relations, strategy development, and field travel as an executive officer of the company. Dave's expected appointment as president and CEO will meet both our board's intention to execute a seamless leadership succession and my personal desire to make way for a new generation of management while continuing to contribute to the company's goal of helping children throughout the world. Dave has been with Orthopediatrics over 14 years, and during his time with OP, he has cultivated an extensive knowledge of our technologies, customers, and sales organization. Fred has been our CFO for six years, and has deep experience in operations and corporate development from his years at Symmetry Medical and General Electric. I've had the pleasure of working closely with Dave and Fred over many years, and I have seen firsthand their acumen, professionalism, and character. Our goal has been to conduct an orderly, one might say even an inevitable, management succession, and I'm confident that Dave and Fred are a powerful team that will lead the company to the next stage of its development. Before turning the call over to Fred to review the financials, I want to take a moment to thank our shareholders for standing by us in late 2020 and early 2021. We will continue operating with integrity and transparency, guided by our company's cause of transforming the lives of children with orthopedic conditions. As of last week, Orthopediatrics products have been used in an estimated 200,000 surgeries throughout the world, and we're just getting started. With that, I'd now like to turn the call over to Fred to review our financial results and provide an outlook for the first quarter. Fred?

Thank you, Mark.

Total revenue for the fourth quarter of 2020. Mark, can you mute your line, please? Total revenue for the fourth quarter of 2020 was $18.9 million, a 0.1% decrease compared to $19.0 million for the same period last year. U.S. revenue for the fourth quarter of 2020 was $17.9 million, a 26% increase compared to $14.2 million for the same period last year. representing 94.3% of total revenue. International revenue for the fourth quarter of 2020 was $1.1 million, a 78% decrease compared to $4.8 million for the same period last year, representing 5.7% of total revenue. In December 2020, we recorded a $2.7 million revenue reduction due to the repurchase of inventory from a large stocking distributor in Germany, Austria, and Switzerland as we converted the DACA region to a sales agency model. The $2.7 million reduction impacted fourth quarter total revenue growth by a negative 14%. Total revenue in 2020 was $71.1 million, a 2% decrease compared to $72.6 million for 2019. U.S. revenue in 2020 was $63.0 million, a 14% increase compared to $55.1 million for 2019, representing 89% of total revenue. International revenue in 2020 was $8.1 million, a 54% decrease compared to $17.5 million for 2019, representing 11% of total revenue. The aforementioned $2.7 million reduction of revenue impacted total year 2020 revenue growth by a negative 4%. We are strongly encouraged that we could build on the momentum we carried from the third quarter to deliver accelerated domestic growth in the fourth quarter of 2020. Outside of the U.S., as Mark has mentioned many times, with fewer standalone pediatric hospitals, ex-U.S. procedure trends are taking longer to normalize, and recovery in the international market continues to lag the recovery seen thus far in the U.S., which again resulted in little to no set sales during the fourth quarter of 2020 to our stocking distributors. That being said, international performance was strongest in EMEA and Asia Pacific, particularly with our sales agencies. Our fourth quarter and full year revenue byproduct category was as follows. Trauma and deformity revenue in the fourth quarter of 2020 was $11.3 million, a 17% decrease compared to $13.6 million in the same period last year, and $47.7 million for the full year of 2020, a 3% decrease compared to $49.4 million in 2019, driven particularly by stronger trauma growth and encouraging signs of recovery in elective deformity corrective surgeries specifically our PNP femur and cannulated screw systems. The aforementioned $2.7 million reduction of revenue impacted the trauma and deformity fourth quarter growth rate by a negative 20% and impacted the full year 2020 revenue growth by a negative 5%. Scoliosis revenue in the fourth quarter of 2020 was $6.6 million, a 36% increase compared to $4.9 million in the same period last year, and $20.7 million in 2020, a 3% decrease compared to $21.5 million in 2019. The decrease was driven by lower sales of our Response 5560 system and Firefly Pedicle Screw Navigation Guides, resulting from fewer elective procedures. Lastly, sports medicine other revenue in the fourth quarter of 2020 was $1.0 million, representing a 135% increase when compared to $430,000 in the same period last year. Sports medicine other revenue in 2020 was $2.7 million, a 57% increase compared to $1.7 million in the same period in 2019, due primarily to the acquisition of Pellis. Moving down the income statement, gross profit for the fourth quarter of 2020 was $15.1 million, a 5% increase compared to $14.5 million for the same period last year. Gross profit margin for the fourth quarter of 2020 was 79.9% compared to 76.2% for the same period last year. Gross profit was negatively impacted. by $1.1 million for both the fourth quarter and full year 2020 due to the aforementioned $2.7 million reduction of revenue. Gross profit in 2020 was $55.0 million, an increase of 1% compared to $54.6 million in 2019. Gross margin for the full year 2020 was 77.4% compared to 75.3% for 2019. The increase in gross margin was due primarily to the increased domestic revenue and the addition of sales agents in our international markets, driving favorable myths. Sales and marketing expenses in the fourth quarter of 2020 increased 13% to $9.4 million, compared to $8.4 million in the same period last year. And full-year sales and marketing expenses increased 2% to $31.9 million last when compared to $31.3 million in 2019. The increase was due primarily to increased sales commission expenses driven by both domestic sales growth as well as the converted sales agents in our international markets. General and administrative expenses in the fourth quarter of 2020 were $10.0 million, an increase of 39% compared to $7.2 million in the fourth quarter of 2019. Full year 2020 G&A expenses were $38.3 million, an increase of 44% when compared to $26.7 million in the prior year. The increase in G&A expense was due primarily to increased stock compensation expense driven by a third year of restricted stock grants in a three-year cliff vesting cycle and one-time stock grants related to executive management transitions. the addition of personnel and resources to support the growth of our business, increased legal expenses related to our ongoing litigation and acquisitions, increased depreciation from additional consigned sets, increased amortization from our recent acquisitions, and the increased G&A expenses associated with the acquisition of Epifix and Telos. In the fourth quarter of 2020, we accrued $6.3 million related to multiple legal settlements as those amounts became estimatable and probable. The amounts in the future may differ from our accrued amounts. Research and development expense was $2.1 million in the fourth quarter of 2020, an increase of 8% from $1.9 million in the fourth quarter of 2018. For the full year 2020, research and development expense decreased 8% to $5.3 million compared to $5.7 million in 2019. The decrease in full year research and development expense was driven by a reduction, reduced investment in research and development projects as a result of the sales decline related to COVID-19 pandemic. Total operating expenses for the fourth quarter of 2020 were $27.9 million, a 59% increase compared to $17.9 million for the same period last year. The primary increases during the fourth quarter were due to the accrued legal settlements of $6.3 million, as well as other G&A expense previously mentioned. Full-year operating expenses were $81.8 million for 2020, a 28% increase compared to $63.7 million for 2019. The increase in operating expense for full-year 2020 was primarily driven by a 44% increase in G&A previously mentioned, including the accrued legal settlement. Operating losses for 2020 was negative $26.8 million compared to negative $9.1 million for 2019. Adjusted EBITDA for the fourth quarter of 2020 was negative $2.6 million compared to negative $919,000 for the fourth quarter of 2019. Adjusted EBITDA for the full year of 2020 was negative $5.9 million from a negative $1.1 million for the full year of 2019. The changes were permanently driven by the impact of COVID on our demand. Interest expense in the fourth quarter was $0.6 million compared to $1.3 million in the same period last year and with $3.4 million for 2020 compared to $3.5 million for 2019. Fair value adjustment of contingent considerations was $1.7 million in the fourth quarter and $3.5 million for the full year 2020 as compared to zero in 2019. These amounts represent the time value of money associated with our year four system sales payment on the AppyFix acquisition and will continue in varying amounts until the second quarter of 2024. Net loss from the continuing operations to the fourth quarter of 2020 was $14.0 million compared to a net loss of $4.3 million in the same period last year. Net loss per share in the fourth quarter of 2020 was negative 0.73 per basic and diluted share compared to a negative 0.36 per basic and diluted share in the same period last year. And net loss from continued operations in 2020 was $32.9 million compared to $12.7 million in 2019. Net loss per share in the full year of 2020 was negative 1.8%. two per basic and diluted share compared to a negative 0.94 per basic and diluted share in 2019 turning to our balance sheet as of december 31st 2020 our cash restricted cash and short-term investments were 85.3 million dollars compared to 89.7 million dollars as of september 30th of 2020. Currently, we have no outstanding obligation on our $25 million revolving credit facility, which expires in January of 2024. The change in net purchase of PP&E during the fourth quarter of 2020 was $4.1 million as compared to $1.3 million for the same period last year, and was $10.5 million in 2020 compared to $11.8 million in 2019. This investment reflects the deployment of consigned sets, which includes product-specific instruments and cases and trays, including the implants. $5.1 million of consigned sets were deployed during the fourth quarter of 2020, compared to $4.5 million during the fourth quarter of 2019. For the full year 2020, we deployed $18.2 million of consigned sets, compared to $18.2 million in the full year 2019. I would now like to turn to our outlook for 2021. As we head into the first quarter and full year of 2021, we remain diligent and pay close attention to the evolving landscape of surgical procedures. Domestically, elective surgeries were being deferred in Southern California and at several of the hospitals in the Northeast. However, unlike the widespread deferrals during the second quarter of 2020, children's hospitals are less affected by the surge in adult COVID cases. Hospitals appear to be treating adult patients more effectively in this environment. With that being said, during the end of the fourth quarter of 2020, as well as the start of the first quarter of 2021, we did continue to hear of selected cases that were canceled as pediatric patients tested positive for COVID prior to surgery. Recently, we have seen a significant increase in demand and expect that to continue for some time to come as reported COVID cases decline and a larger percentage of the population becomes vaccinated. Internationally, there's a wide divergence on the COVID impact. Germany, Australia, New Zealand appear to have controlled the pandemic very well, and there's little to no impact on elective surgeries. However, there are partial deferrals of elective surgeries in several countries in the EU, and the UK remains significantly impacted. For the full year 2021, we expect to see very significant growth over the prior year, with sales reaching $93 to $98 million and representing a 31 to 38% growth. We believe the following developments will significantly contribute to reaching our expected sales goals in 2021. Apifex will have the 200th case registry completed by late 2021. Orthex will benefit from 38 new domestic users and conversions will continue to accelerate. Our launch of the Orthex and sterile package products in Europe during the second quarter of 2021. Major pediatric center conversions to 80% or more. Benefits from the countless hours of virtual training which we have completed in 2020. $18 million of consigned sets deployed in 2019 and 2020 will impact domestic and and international sales agency markets. International stocking distributors are starting to place larger replenishment orders, and for the first time since March of 2020, they are starting to place set orders to meet the increased demand in their market. Germany, Austria, and Switzerland conversions are already showing favorable impacts in the first quarter of 2021 and will continue for the full year of 2021 and beyond. As the pandemic environment continues to evolve, we believe our business model focused on strong execution, cost containment, and a robust balance sheet position us optimally to execute and adapt to these new challenges. Let me now turn the call back over to Mark for some final comments.

Thank you, Fred. While we have not yet emerged from the COVID pandemic, we have recently seen a significant uplift in sales to international stocking distributors. This turnaround, coupled with strong international sales agency growth, should correct the performance issue we had in 2020. With continued domestic growth and strong synergies from Orthex, Apithex, and Telos, we believe that the company will indeed emerge even stronger from the pandemic than when we entered it. As always, this is due to the dedication of our associates around the world who have risen so admirably to the challenges of the past year. Orthopediatrics designation as one of the best places to work in Indiana recently named that honor for the fifth year reinforces our conviction that our performance in 2020 and our outlook for 2021 are due to our culture, which is this company's most valuable asset.

With that, let's turn the call over to your questions, please.

As a reminder, if you would like to ask a question, please press star then the number one on your telephone keypad. Again, that is star then the number one. Your first question comes from Kayla Crum with Truist Securities.

Hi, guys. Thanks for taking our questions. So first, can you guys just provide a little bit more detail on this $2.7 million revenue reduction? Just what prompted the change from the preliminary number? You know, what did we learn, I guess, from the time of the January preannouncement and today that resulted in that change?

Yeah, absolutely. Thank you for the question, Kayla. The agreement that we had with the stocking distributor in Germany, Austria, and Switzerland was signed on December 31st of 2020. And the new agency agreement was then signed the first week of January in 2021. And, you know, we completed our normal sales reporting process in early January. and we issued the pre-announcement on January 11th before the investor conferences at that time. As we then really got into it and examined the transaction, we recognized its complexity, and working with our auditors, we determined that the correct accounting treatment in light of the new revenue recognition guidelines ASC 606 required us to book this as a revenue reduction in December of 2020. This situation is a bit unique in that this is a very, very large, I guess, stocking distributor for us, unlike some of our other smaller independent family-owned businesses. And so the current agreement that we had the termination agreement and the new agency agreement were different, I would say, than other agreements we have in place. That all culminated throughout the auditing process as we were closing our financials and obviously shows up as it does in the results that you're seeing today.

Got it. No, that makes a ton of sense. Thank you for clarifying that. And then you guys mentioned this international stocking picking up in the first quarter. Is there a way to quantify that potential benefit?

I'm not sure we want to put an exact number on it, but I would say that it gives us high confidence in our $93 to $98 million for the year, as well as making the statement that we expect to report continued increase in growth for the overall business here in the first quarter of 2021.

Great. Understood. Thank you, guys. And then I guess just one on Appifix. You know, I mean, it sounds like the early rollout is going really well and that you're expecting to complete the registry numbers this year. You know, can you just help us frame sort of the supply capacity? Because I think that myself and a lot of us on the line get pretty excited about Appifix. And just, you know, how comfortable are you sort of that you have the right capacity this year and next? Thank you.

Yeah, another great question, Kayla, and those are good problems to have. You know, listen, the demand for this we have been anticipating for some time, and so we have been building inventory of this product in anticipation of this launch and of the anticipated significant increase in demand for the product in as more and more of these 20 surgery hospitals come online. So I am pleased to report that we will not have a lack of inventory for this product. Again, as Mark said, the investment required for these sets are very, very small, so it makes a ton of sense to have plenty of sets available as well as plenty of inventory on our shelves to make sure we can meet the ever-increasing demand across the world for this product.

Very helpful. Thanks. Your next question is from Ryan Zimmerman with BTIG.

Great. Thanks for taking the questions. Good morning, everyone. So, you know, 2020 was obviously a unique year, and, you know, your cadence of sales got a little turned on its head through the year, just given what we normally think of with kids and its typical seasonality kind of in the second and third quarter. Curious if Mark or Dave or Fred, if you want to give any color in terms of expectations around seasonal cadence for the year, how you're thinking about this. I appreciate, obviously, the impact in the first quarter, but could we get back to maybe a more normalized scoley season, for example, you know, mid-year? Just some thoughts there I think would be helpful.

Yeah, that's a really good question. I think at this stage we can't say for sure, but it does appear, particularly in the last several weeks, that we're moving back to a more normal environment, and hopefully that continues. We don't know exactly how this will affect, obviously, our busy summer season, but there's no question that there are patients that are still backlogged through the back part of the fourth quarter and early part of the first quarter, And while we may be seeing an increased volume of those patients come online now, I guess, Ryan, we would expect to see that continue throughout the balance of the summer. We believe there's still a reasonable backlog of pediatric patients from even last summer that didn't get done. Again, this is speculation at this point. Obviously, we've had a difficult time with the impact of COVID to really understand the seasonal impact on our business. But I do think it's fair to say that we will get back to a more normalized environment. What we hope to see is get back to a more normalized environment and have the cadence of our revenue and the volumes return back to normal throughout the summer season.

Okay. And maybe one, Fred, for you. Historically, you've given us your exhortations for deployment of capital in 21. You talked about the capital you did deploy in 19 and 20. Can you talk a little bit about your expectations for deployed capital, particularly in sets for 21?

Yeah, I guess rather than putting a number on it, I would just say that we're going to continue to deploy sets for sure. We're going to continue to invest in the business just like we did throughout 2020, despite the lower volume. I think we're also going to start to see the benefit of the AppyFix program lower capital required to drive those growth numbers. So we can deploy very little amount of capital and drive significant multi-million dollars of growth with AppyFix, which will reduce, slightly reduce the necessary capital to continue to deploy more and more. So we're going to continue to deploy sets and meet the demand of our products. but it may be at a slightly lower pace as we kind of let the demand catch up with what we've done here in the last two years.

Okay, fair enough. And then if I could squeeze one more in, just you ended with 171 reps and, you know, hey, help us understand kind of how you think about that sales agent group increasing in 21, you know, particularly as we think about productivity per rep and, you know, the implied guidance and the necessary requirements, step ups, if you will, in productivity. for 21. Thanks for taking the question.

Good question, Ryan. So, you know, as you know, this isn't a metric that we track it, but it's primarily for the benefit of the market. We don't necessarily track productivity or reps because it has such a difference between the geography on a rep-by-rep basis and the volumes within a specific hospital. That said, I think what you could probably expect to see is a more normalized environment in terms of our sales agents in the United States adding reps to meet demand. As you know, 90%, 95% of our surgeries are covered, so there's a sales rep in the room. And, you know, as sales grow by 31%, it's just simply going to require more people to be able to cover those cases. And so I think that you probably will see sales rep growth. It may not mirror that 31 to 38% range, but it certainly will be better than you saw in 2020. Yeah.

Okay. Appreciate the call. Thank you for taking the questions.

Your next question is from Rick Wise with Stifel.

Good morning, everybody. Let me start off, come back to some of your quarterly thinking and the cadence of quarters at a higher level. Just starting with the first quarter, I sort of say to myself, it's March 11th. You're seeing some clear trends. I appreciate that things could change, but can you help us think through how the first quarter could shape up? Are we likely to see it off the – now reduced fourth quarter number because of the stocking accounting. Should we assume it's sequentially better than the fourth quarter, given the trends you've seen? Just help us think through the first quarter and how you all are thinking about the flow of quarters to get to your guidance as the year unfolds. Stronger second half versus first, I assume, you know, just any color would be great.

Yeah, Rick, I think we see continued increase in the growth rate. So we saw 7% in the third quarter. You know, if you back out to 2.7, which had a negative 14% on the fourth quarter, you know, the first quarter could be something like 21% growth. So, you know, continued increased revenue growth of the business as the recovery continues to impact us. And I think, obviously, the second quarter is going to be tremendously high growth because of last year. But we would see the revenue continue to then kind of increase and follow a similar pattern of, you know, ex-COVID historical growth. So, you know, many of the schools today are back in full swing. So there are some patients that are not getting surgery until the summer months because right now they're in school. And so we would expect to see very strong June and July. And then if things continue as expected, the fourth quarter probably a lower revenue dollar than the third quarter.

So, Seth, just to make sure I'm understanding, so first quarter dollar is ahead of fourth quarter, second ahead of first, third quarter, as always, as you say, the strongest, and sort of returning to hopefully more normal, seasonally slower fourth quarter. So that would be the one sequentially lower quarter as we sort of frame the year. Am I hearing you correctly? Yes, that is absolutely correct.

That is better said. Thank you.

All right. Good. And I was hoping also to get a little more color on gross margins. and you sort of alluded to it, gross margins were much better than we looked for this quarter. Again, I assume that's the U.S. versus greater U.S. mix versus OUS. How do we think about gross margins this year? Because I say to myself, volumes are turning. Yes, OUS rebounding, but now you've got direct in three of your largest markets, Germany, Austria, Switzerland. I mean, how Help us think through the GM setup for 21 as well.

Sure. I think it's important to understand the negative 2.7 impact on the fourth quarter gross margin rate at 79.9. The products we returned had been, you know, they're used sets that we had sold to that stocking distributor over the last 5, 7, 10 years, and they came back to us at a discount. And so... It came back to the books at a 40% gross margin. So it's a negative. So it's a return of sales of 40%, which did inflate the fourth quarter gross margin rate because of that transaction. And so if you were to back that out, I think it's going to be something more like a normalized 75%, 76%. which is kind of where we see the overall business on a full-year basis going forward, 76-ish, and then having the positive impact of the agencies. But if we start selling sets to our stocking distributors at our cost, that's a negative impact. So it's kind of offsetting one another for 2021. Great.

I'm so glad I asked, actually. Two other questions from me. Can you talk a little bit about your thinking about your strong balance sheets and how you might deploy it in 2021? Should I be thinking that given everything that's going on and integrating your acquisitions of 2020, et cetera, that you're probably not going to be as active on the M&A front or technology tuck-in front as you've been in the recent past? Is that not the right way to think about it?

I would say that, you know, we continue to look for good technologies that we can deploy and help this industry. And so if there's an opportunity out there, we would look to take advantage of it. The strong balance sheet helps us make those decisions. And if necessary, we could go get some debt, which we don't have any debt really to set – on the balance sheet today to help finance something like that. We'll continue smaller tuck-ins, but we continue to look for anything that could help this industry, regardless of size. With that being said, I don't anticipate us making any announcements anytime soon, but we continue to look.

Gotcha. And just last, for some reason I'm obsessed with the total account conversion aspect of the story. Can you Is it possible to tell us how many accounts at this point or give us any color around what percentage of your U.S. business today is, you know, what you would define as total account conversion? And is there a pipeline? How do we think about your activities around that and the impact of that kind of mindset on your 21 outlook or business, you know? Thank you.

Yeah, Rick, great question. So we have a pipeline. That pipeline consists of, in fact, I just looked at it before this call. We have a pipeline of well over 100 accounts that we are monitoring very specifically and looking for opportunities, obviously, to improve share, but also to contract with to move our business to that, let's say, 80% plus, particularly in the trauma and limb deformity area. We normally place about 10 of those accounts as very, very high order kind of possibilities and hope to close a couple of those accounts every quarter and have a very specific number of accounts that we want to move into that 80% category every year. And so we observe as an executive leadership group about 10 of those accounts on a quarter-over-quarter basis and measure against that. And we like the pace of conversion of a few of these accounts kind of every quarter and And at this stage, Rick, we have a very long runway. You know, as you know, we are present in every major children's hospital in the United States and most in kind of the developed world. And I would say at this stage very few of those are at the 80% range of our trauma and limb deformity products. That said, as you talk about inventory and the inventory we deployed last year, You know, we deployed $18.2 million worth of inventory last year on a sales number that was expected to be a lot larger, obviously, but got affected by the pandemic. And we are starting to see the deployment of that inventory that we put out last year going right into hospitals. And a few of the accounts emailed over the last We're seeing where we're not deploying a few sets into an account, but we may be deploying 25 sets into a specific account. And whether those are contracted to be 80% contracts or not, we know when we get shelf space, when we have a rep that's there present every day, that those are the types of accounts that tend to grow from 30% to 50% to ultimately 80% share. And we like the funnel that we have, and we like our position right now.

Thank you so much.

Your next question is from Mike Mattson with Natum.

Yeah, thanks for taking my questions. Fred, I guess first, has the audit been completed, and when do you expect to file your 10-K?

Yeah, absolutely. We have completed everything, have a clean opinion from Deloitte, and the 10-K will be filed yet today, so that should be out there.

Okay, great. And then for the distributor that you acquired, to put the $2.7 million of revenue, sorry, of the revenue adjustment into context, can you quantify their annual sales?

They're probably doing about $2 million a year of annualized sales. sales today with definite opportunity to grow that, you know, I would say that that was probably 2020s revenue, you know, throughout COVID, but it's around $2 million.

Okay. All right. And then has the experience with COVID and the fact that a lot of these, the stocking distributors, OUS, were really kind of going through these stocking phase, has that caused you to accelerate your conversion effort, or is it just continuing at kind of the normal pace?

No, I think it just is continuing at its normal pace. I mean, clearly we see the benefit, we saw the benefit when we started down this road many years ago of, you know, having, I would say, eliminating some of the lumpiness of the revenue and not having our partners, you know, rely or not have cash available to invest in the business. And so I think it absolutely encouraged us to continue moving forward, but I don't know that we're going to really change any direction because of it.

I would add that, you know, this is a big one. This is one that we've had on the docket for a long time. It was extremely complex, as Fred talked about earlier, and I don't see anything in the near term of that scale changing. But certainly we expect this one to have a very substantial impact on revenue this year and into the future. And then I think we will resume this pace of maybe one, maybe two of these a year. But we definitely haven't accelerated these. And, again, even the small ones are complex. So it's a matter of bandwidth as well.

Okay, got it. And then finally, just on the legal settlement, the accrual there, can you provide any additional detail around what that involves? Thanks.

Yeah, I think as most everybody knows, we've got several outstanding items with K2M. There's the Dr. Berry matter. There's the IOMED program. IOMED in Florida, typical cases related to IP. And some things have, I guess, progressed here recently such that those have become potential settlements have become estimatable and probable. And so we, for the first time, put those on the books. because we can now see the end is in sight on many of those. And so while those amounts are not final, they're estimates, we think we're a lot closer than we were just six months ago to wrapping some of these things up and getting them behind us.

Okay, got it. Thank you.

Thanks, Mike. Thank you.

Hello?

Hi, Dave.

Sorry about that. Can you hear me? Yeah, yeah, we can hear you. Okay. I didn't hear my name called, but thanks for getting me in. So, Fred, just so I understand this, and I think this puts it to bed, hopefully, you recognize $2.7 million in sales, let's say, over the last, I don't know, maybe five, ten years, I think you even mentioned. Yes. This new ASC 606 you mentioned, I'm not familiar with that, but is that something new? Are you familiar with it? And I imagine that is the pronouncement that says, hey, take it all, you know, if you buy that stocking distributor, reverse or contra revenue, the cumulative sales in one period. Is that fair? And have you seen that before? Sure.

Yeah, I have seen it before. As you said, we've sold the sets, which is what we bought, our sets, so that we can consign the inventory into the hospitals and continue to serve the marketplace. We've sold those sets to them over many, many years. They're now used sets, but they're absolutely required to be able to service the marketplace. And, yes, ASC 606 is related to revenue recognition and returns. And so it is, I have seen it before, and it is absolutely correct, where you would book a lower revenue number for this, in this case, $2.7 million, as we brought that back onto our books.

Got it. And then, you know, looking at the guidance, you know, return to solid growth, In 2021, I was wondering if you might want to give us any color in terms of whether it's operating or net loss. Do we think you guys experience some incremental leverage as the revenue growth comes back, the loss shrinks, or grows, or just any color there in terms of what your kind of high-level thoughts are for 2021, maybe on the bottom line? Yeah, absolutely.

So, obviously, adjusted EBITDA was negatively impacted by COVID, by this legal settlement, by other things. But aside from those, we have continued the statement that we want to grow the business aggressively on the top line and, at the same time, from an operating point, improve the bottom line of the business. We have definitely learned how to do some things differently related to travel and transportation. communicating effectively, obviously, with Zoom and other methods. And we'll be deploying those and continue to deploy those in 2021 to save some money. So as that revenue returns very aggressively, 31% to 38%, we'll be controlling our spending and improving the bottom line of the business for sure.

Great. Thank you for that. I'm going to sneak one last one in if I could. I think you said you had 14 OUS sales agencies and 42 stocking distributors. Yes. As you look at the 42, the conversion, potentially for conversion, are there others in there that you think would, I don't know, meet the materiality level of this ASC 606, or are most of them smaller? I guess just any thoughts there, because I don't recall seeing it in the past, so I figure maybe you have an idea of the size of some of those entities, and if there's certain ones you're considering converting. Thank you.

Yeah, absolutely. What I would say is that there's nobody else out there anywhere close to this size. This was by far our largest, most sophisticated stocking distributor. But really, it wasn't just the size. It was the contracts, the legal contracts that were in place as well. And so we'll evaluate each one of them independently as we move forward and make the right decision. But they're all going to be in a much smaller nature for sure. Thank you. Thanks, David.

Your next question is from Matthew O'Brien with Piper Sandler.

Morning. Thanks for taking the call and questions. And, Mark, I know you're going to stay involved in the business. I just wanted to recognize your outstanding stewardship of the company since joining. Well, thank you, Matt, and I appreciate that very much. Okay, of course. I guess if we could just deconstruct the SCOLE performance in Q4, it was obviously eye-catching how strong it was. And Dave, you talked a little bit about the, you know, the elongated SCOLE season this time around. But can you deconstruct what we saw in Q4 as far as, you know, maybe some of that backlog of cases, APIFIX kicking in, and more importantly, or not, I guess not more importantly, but other underlying dynamics that are durable going forward in terms of new account capture, going deeper in existing accounts, things like that, because the scoring market is obviously enormous and that's a huge opportunity for you over the next couple of years.

Yeah, Matt, good question. So, yeah, to deconstruct fourth quarter, I think we saw about what a number of the other spine companies saw was this almost a whiplash effect. And we're seeing a bit of that now here again in the first quarter where, you know, we have a backlog of surgeries throughout the early fall. Then we saw, you know, October, November, really, really strong scoliosis demand. Saw elective demand across the board in those periods. We had a really solid December, but it was at a slowing rate of demand for scoli. And then that kind of continued here into the early part of the first quarter. So I think what we've seen from a demand standpoint is pretty consistent with what I have been reading, at least from some of the other companies on the scoliosis side or on the spine side in elective. I think what we're really pleased about is these numbers that, you know, we have 23 new users that we captured in 2020. And, again, there's only – about 300 children's hospitals and only a certain number of pediatric orthopedic surgeons that regularly do scoliosis. That 23 new users is a very substantial and concrete representation of share gain for us. We have a goal of that order of magnitude again for this year and feel like we're off to a really, really good start. I think that's what's durable. There's no question we're getting a larger percentage of the take of some of our accounts already. So some of the accounts that we had before these 23 new users, I think we're getting deeper penetration. But adding new users that are consistently calling for the response goalie system, I think, is a very concrete thing we're resting on for growth next year. Obviously, we're extremely excited about Apifix, and we continue to see accelerated interest in being a part of the IRB sites, although, as you know, we have our 20 and will remain there until we fill this 200 patient registry. What I will say, though, is that we're very clearly deriving revenue and new customers from our acquisition of Apifix and people being connected to this non-fusion technology. You know, not every patient, as you well know, is a candidate for non-fusion surgery. And so a number of patients are being driven to these clinics that have access to this site. And ultimately, in some of those sites, there are places where we didn't have previous fusion business. And we're definitely seeing an increase in fusion business with our response systems at locations that have access to the Appifex technology. So like the synergies there, and as that continues to expand and become a bigger part of our business in 2021, 2022, we would expect to see that synergies only get better.

Got it. That's great to hear. And then following up on one of Rick's questions on, you know, just the, you know, kind of core domestic business, you know, you've got those 10 accounts, I think you said that you target How sizable are those 10? I mean, I'm assuming you're in some of the really big children's centers around the U.S. already. Are there some areas where you just haven't historically been able to penetrate? Are you able to get into some bigger places you hadn't been in the past? Are you going deeper? I guess the question, just to sum it all up, is can you keep growing the domestic business around 20% in the future in more normalized times?

There is no question that we are still in the early innings of kind of this growth curve. You know, we are present in every major children's hospital here in the United States. But as we've said in the past, I mean, this is a surgeon-by-surgeon, product-by-product conversion. And with 35 implant systems and a lot of these accounts that have a lot of surgeons, you know, Matt, we may have one or two surgeons out of ten, let's say, that use all of our products. but that obviously only accounts for 20 or so percentage of the volume in that account. And so we were measuring those accounts on an individual basis by their TAM. And I would say that most of those accounts that we were measuring are accounts that are worth certainly in excess of a million dollars and some accounts in excess of a few million dollars, particularly for T&D. And, again, we're just in the early phases of moving more and more accounts into that kind of 50% to 80% share range. But, again, we like the pace with which this is happening and feel like we can maintain that pace for a really long time in the future.

Excellent. Thank you.

Thanks, Matt.

And there are no further questions at this time.

All right, very good.

Well, let me thank everyone for joining today's call. We certainly expect 2021 to prove to be a pivotal year, although a more normal year for the company. And we'd like to thank all of you for your continued interest and support of our mission to help children throughout the world. So have a good day.

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