Orthofix Medical Inc.

Ladies and gentlemen, thank you for standing by, and welcome to the OrthoFix Third Quarter 2020 Earnings Conference Call. I will now turn the conference call over to Alexa.

Thank you, Operator, and good morning, everyone. Welcome to the OrthoFix Third Quarter 2020 Earnings Call. Joining me on the call today are our President and Chief Executive Officer, John Cervosic, and Chief Financial Officer, Doug Rice. I will start with the Safe Harbor Statement and then pass it over to John. During this call, we will be making forward-looking statements that involve risks and uncertainties. All statements, other than those of historical facts, are forward-looking statements, including any earnings guidance we provide and any statement about our plans, beliefs, strategies, expectations, goals, or objectives. Investors are cautioned not to place undue reliance on such forward-looking statements, as there is no assurance that the matters contained in such statements will occur. The forward-looking statements we make on today's call are based on our beliefs and expectations as of today, November 5, 2020. We do not undertake any obligation to revise or update such forward-looking statements. Some factors that could cause actual results to be materially different from the forward-looking statements made by us on the call include the risk factors disclosed under the heading Risk Factors in our Form 10-K for the year ended December 31, 2019, and our Form 10-Q expected to be filed later today, as well as additional SEC filings we make in the future. If you need copies of these documents, please contact my office at OrthoFix in Louisville, Texas. In addition, on today's call, we will refer to various non-GAAP financial measures. We believe that in order to properly understand our short-term and long-term financial trends, investors may wish to review these matters as a supplement to the financial measures determined in accordance with U.S. GAAP. Please refer to today's press release announcing our third quarter 2020 results for reconciliations of these non-GAAP financial measures to our U.S. GAAP financial results. At this point, I will turn the call over to John.

Thank you, Alexa. Welcome everyone and thank you for joining our third quarter 2020 results conference call. On today's call, I'll provide an update on the third quarter performance. I will then review the progress we have made within each of our strategic initiatives before handing the call over to Doug, who will provide a financial update. I will close with our perspective on the business going forward before opening the line for questions. Shifting to the third quarter performance, total revenue for the quarter was down 2% on a reported basis and 3% on a constant currency basis compared to the prior year quarterly performance. largely driven by a decline in elective procedure volumes during the third quarter. Despite the year-over-year decline, we were very encouraged by our performance during the quarter, which reflects continued strong execution and leadership as we navigate uncertainty of COVID-19 and begin to carry out our strategic plan with the new team. Month-to-month performance was generally flat throughout the quarter, which we view as a positive indicator that we are returning to some level of normalcy On a sequential basis, revenue increased 52% over Q2, and we saw a positive trend across the businesses with procedure volumes rebounding and restrictions continue to be lifted across geographies we operate in. Now let's turn to the performance within each of our business units. Starting with bone growth therapies, sales were down 4% versus prior year, which is in line with the trends we observed in elected procedure volumes. Bone growth therapies continue to be impacted by COVID-19 driven by year-over-year declines in procedure volumes. On a sequential basis, VTT was up 66% over the second quarter. The sequential growth of this business demonstrates our ability to work with our physician customers to identify patients in need of our technology and provide flexible solutions to fit these patients to include remote and virtual fitting when necessary. Moving to global spinal implants, we are proud to report that cells were up 11% in constant currency versus the prior year. This was driven by an increase in our U.S. cells, growing at 19% over prior year. As a reminder, this category is made up of our spinal fixation and motion preservation products, which are typically used in elective procedures. U.S. motion preservation cells were 5.2 million in the quarter, up 400% over the prior year. and also a 44% sequentially over the second quarter. We continue to see strong adoption trends for the M6C artificial disc. Our sales training team was able to virtually train approximately 150 surgeons on the M6C technology during the third quarter of 2020. And these surgeons have defined a surgeon performing their first M6 procedure in the third quarter of 2020 generated 1.1 million in revenue for the quarter. Since our 2019 launch of the M6C artificial cervical disc in the U.S., we have trained over 650 surgeons. In biologics, sales were down 7% versus prior year, primarily as a result of the reduction in elective procedure volumes during the quarter. Generally, our biologics business is in line with the market procedure volumes, but it's coming off a double-digit growth in the third quarter of 2019 and continued ASP pressure. Sequentially, biologics is up 37% over the second quarter. Moving to our extremities business, sales were down 9% on a reported basis versus a prior year and 12% on a constant currency basis, primarily as a result of negative impact of COVID on procedure volumes and distributor stocking patterns in certain geographies such as the UK and Brazil. We have seen a recent sales rebound in certain European countries, such as Italy and France, but the uptick in COVID cases in many regions may put pressure on elective procedures and volumes. Sequentially, extremities is up 54% over second quarter. While certain procedures in the extremities business are not elective, especially trauma procedures, a larger portion is compromised through deformity correction procedures, which are elective and can be postponed. Due to this mix of procedures, we believe the segment generally follows the elected procedure trends. I would now like to provide a brief overview of the progress we have made within each of our four strategic focus areas, starting with our first initiative, structure and leadership. As previously announced, we completed the integration of the biologic and spinal implant product categories under a single-cells management team during the second quarter. Having now filled all key senior leadership roles in our global spine business, we are well positioned and seeing early positive results from the new structure. In September, we announced the appointment of Paul Gonzalez as president of Global Extremities. Paul brings a wealth of global experience and proven leadership to the organization. Most recently, Paul served as corporate vice president and chief commercial officer at Integra Life Sciences. We are very excited to have him on board. He's a great addition to the team, and we believe his leadership can accelerate the growth of our global extremities business. While we still have a few hires to make within the organization, we have effectively completed our structured leadership initiative. With that effort behind us, we are now shifting our focus to execution and driving the business forward. Moving on to our second initiative, operational execution, where we are also making meaningful progress. As we continue to manage through challenges associated with COVID, we've been able to consistently deliver for our customers, which is a testament to our team. We are currently 100% operational at each of our manufacturing facilities in California, Texas, and Italy. And for the second straight quarter during this global pandemic, we had no manufacturing or supply disruptions. We continue to closely monitor procedure volumes to allow us to supply near-term demand while at the same time ensuring we'll meet all future demands. While we have learned to manufacture and supply in the global COVID environment, we are now focusing our operational efforts on strengthening and enhancing our supply chain with the goal of working capital optimization while reducing our demand to stock timing for existing products and our pipeline of new product innovations going forward. The third quarter, as well as the first part of the fourth quarter, has been significant for us in terms of new products and launches, which brings me to our third initiative, product innovation and differentiation. As we mentioned in August, our new product innovation strategy has been ramping up and has gained traction. A great example of the progress we have made in Spine is the presence we had at this year's virtual NAS conference, where we were able to launch our new campaign, OrthoFix on the Move. We received positive feedback on this campaign and how we have positioned the new OrthoFix. In October, we announced an additional FDA clearance for the Firebird SI fusion system, specifically to the nanotechnology feature. The Firebird SI fusion system is designed to compress and stabilize the sigarily act or SI joint during fusion. The technology consists of a 3D printed core surface that is designed to allow bone tree growth to aid in the fusion process. While we have high expectations for the Firebird SI fusion system, we are still only in a limited launch release, but are excited for the markets to open up for the analysis of new technologies, which has been a challenge in some institutions. We also launched our new Ogenesis bone graft delivery system. This complete graft delivery system is designed to deliver allograft, autograft, or synthetic bone graft to orthopedic surgical sites. This product was developed to further drive Trinity product line in MIS procedures. The company also introduced Eloquent Structural Allograft Q-Pak, a hydrated, ready-to-use cervical and lumbar spacer system, which is available for immediate use. While both Ogenesis Graph Delivery and Eloquence Structural Allograft QPAC are small revenue opportunities, they demonstrate our commitment to building the biologic portfolio in conjunction with our value MTF biologic partnership. Beyond the new product launches, we had a strong podium presence with multiple clinical and scientific abstracts during NAS. We presented a variety of abstracts focusing on the M6C artificial cervical disc, the Trinity Elite Allograft with viable cells, the Firebird SI fusion system, and various peak titanium composite or PTC spacer systems. Throughout the course of the meeting, we were very pleased with participation in our virtual experience, and through this forum, we were able to highlight our new products and share our scientific data while gathering excitement from our surgeon customers and distributor partners. While we were just getting started under the new spine leadership team, we were very encouraged based on the outcome of our efforts at this meeting. In late September, we announced an investment and partnership with Neo Medical SA, a privately held Swiss-based spine company, to develop and market innovative, outcome-driven procedural solutions. Specifically, the partnership focused on the co-development of a cervical platform that including single-use, sterile-packed procedure solutions designed to increase operative efficiency, reduce procedure times, reduce infection rates, and improve patient outcomes through novel device designs and techniques. Beyond those advantages, the associated instruments are ideal for forward-looking surgical settings, including ASCs. We believe this collaboration will further position us as a leader in a cervical spine care market and expand our applicability within the growing ambulatory surgery center segment. Moving on to extremities. We continue to make good early progress with FitBone, our lengthening now. But we remain on track with our integration plan. We are focused on training, bringing new distributor partners, and adding new surgeon users and building out the inventory to position ourselves for a larger commercial impact in 2021. In our first six months and through COVID, we already exceeded our 2020 revenue targets despite the delays in deformity procedures. In the third quarter, we launched the Juni Ortho plating system globally. This innovative internal fixation system is designed to address the demands of treating an advanced deformity of the lower extremities, specifically for pediatric patients. We started a limited launch in the product in the third quarter, and the initial feedback was positive and focused on the advantages of the dedicated pre-operative OrthoNext software planning system created for JuniOrtho. Since our initial launch announcement for the JuniOrthoPlaty system, I'm happy to announce we recently received FDA clearance for the OrthoNet software platform. surgeons have been pleased with the accuracy of the planning software and how it allows for a precise sequencing of surgical steps and creates hospital efficiency. With the addition of FitBone, junior orthoplating system, along with TLX, A-Plate, limb reconstruction system, and our preoperative planning platforms, we believe we have now established the industry-leading most complex deformity care offering to address all pediatric extremity deformities. Moving now to our fourth and final strategic initiative, commercial channel development. We continue to focus on adding and developing long-term strategic partnerships in the U.S. and moving away from transient transactional relationships. With our now complete Spine and Extremities commercial leadership teams, we continue to execute our plan over the near and long term. I am pleased with the progress in partnerships with distributors that are now carrying multiple spine product lines and the extremity distributors that are adding our biologics and bone growth therapies product lines to their bags. This has positioned us well to capture synergies among our product lines in the U.S. Outside the U.S., we are scoping our spine business and making investments that we look forward to sharing with you in future quarters. Before handing the call over to Doug, I would like to comment on our recent activities around the FDA's proposed reclassification of bone growth stimulation devices. On September 8, the Medical Device Advisory Committee Orthopedic Rehabilitation Device Panel recommended requiring robust and complete clinical data for the proposed reclassification of bone growth stimulators from Class III to Class II with special controls to ensure patient safety and therapy efficacy. We support the panel's decision requiring robust critical evidence for the effectiveness of these devices, as we believe there should be a high hurdle to prove that these products are beneficial to the patient. We continue to believe that if the proposed ruling is finalized as recommended by the panel, which could not likely issue any earlier than late 2021, there will be little impact on our business and we continue to maintain our market share position. From a new product development perspective, we will embrace the change and consider pursuing additional bone growth stimulation indications. In addition to our solid performance, we have made significant strides towards achieving each of our strategic focus areas. As an organization, we look very different than we did at the beginning of 2020. We've assembled a group of highly talented people to build on the existing talent base. We have restructured the organization to optimize our commercial and product development teams. And we have initiated the strategies and processes that we believe will make us successful going forward. Overall, I'm extremely happy with our progress during the quarter. With this solid foundation in place, we are well positioned to execute. With that, I would now like to hand the call over to Doug for further commentary on our financial performance. Thanks, John, and good morning, everyone. I'll provide additional details into our net sales and earnings results and then discuss some of our other financial measures. Many of the financial measures covered in today's call are on a non-GAAP basis. Please refer to today's earnings release for further information regarding our non-GAAP reconciliations and disclosures. As John noted, total net sales for the quarter were $111 million, down 2% on a reported basis and 3% on a constant currency basis when compared to the third quarter of 2019. Sales in the U.S., despite a decrease in the elective surgery market, were up slightly during the third quarter. International sales were not as strong in the quarter, down 15% to prior year at constant currency. Gross margin in the third quarter of 2020 was 76% compared to 78% in the prior year period. The primary driver of this decrease was the increased non-cash inventory reserves on certain products due to lower procedure volumes, mainly resulting from the COVID impact. As mentioned last quarter and as demonstrated in the third quarter of 2020, we expect gross margins to trend back to historical levels as volumes rebound and revenue increases. Sales and marketing expenses in the third quarter of 2020 were 48% of net sales, which was flat to the third quarter of 2019. This was in line with our expectations as we saw our sales rebound sequentially over the second quarter. We expect total sales and marketing expenses to normalize to prior year levels as revenue increases. GAAP G&A expenses in the third quarter of 2020 were 15% of net sales, down from 19% in the prior year period. This decrease as a percentage of net sales was due to lower succession and transition-related expenses in the third quarter as a result of the departures of two executives last year. Additional expense reductions were driven by lower spend on strategic initiatives, as we now are more targeted in our business development approach. Many of our short-term expense savings actions continued into the third quarter of 2020, including travel restrictions and hiring and project delays. GAAP R&D expenses for the third quarter were 9% of net sales, up from 7% in the prior year period. This increase is primarily due to the continued build-out of our internal team to support accelerating our new product innovation initiative and complying with the new medical device regulations. As mentioned earlier in the year, we intend to ramp up our efforts to drive organic innovation and differentiation and build a robust product pipeline in both spine and extremities. This will cause our R&D spending as a percent of net sales to outpace revenue growth in the near term. Adjusted EBITDA in the third quarter decreased to $19.7 million, or 18% of revenue, down from $20.3 million, or 18% of revenue, in the third quarter of 2019. As the percent of revenue adjusted EBITDA on the third quarter of 2020 is in line with 2019 and primarily benefited from our cost savings measures, including reduced travel expenses in the COVID environment and the timing of NASS this year, which has offset our additional R&D investment in building out our new product innovation pipeline. Now turning to tax, our GAAP effective tax rate for the quarter was 12% of income before taxes as compared to GAAP income tax benefit of 51% of income taxes in the same period of 2019. For the third quarter of 2020, we reported GAAP earnings of 24 cents per diluted share as compared to a loss of $2.14 per share in the third quarter of 2019. After adjusting for certain items and when normalizing for tax using a non-GAAP long-term effective tax rate, adjusted earnings for the third quarter of 2020 was 31 cents compared to 41 cents in the third quarter of 2019. Day sales outstanding, or DSOs, were 61 days at the end of the third quarter 2020, down from 65 days at the end of the third quarter 2019. This decrease was primarily due to the large reduction to the accounts receivable balance, while the revenue was within 2% versus the prior year. We have continued to be successful in collecting from our customers amid the global pandemic. Our inventory turns of 1.2 times at the end of the third quarter 2020 were flat compared with the third quarter of 2019. Regarding cash, cash equivalents, and restricted cash, we continue to maintain a strong liquidity position with $80 million at the end of the third quarter 2020, compared to $58 million at the end of the previous year's third quarter. As mentioned on the last call, we received $13.9 million in Medicare advance payments as part of the CARES Act during the second quarter of 2020. We will commence repaying these advances in April of 2021 in accordance with government directives. Late in the quarter, we repaid the remaining $50 million outstanding on our line of credit. The company now has no borrowings outstanding under our $309 secure and revolving credit facility. As John mentioned earlier, we announced a new partnership with Neo Medical to develop and market single-use spinal instrument solutions focused on improving patient outcomes. In early October, OrcaFix invested $10 million in Neomedical to support the ongoing partnership to a combination of a convertible term loan and an equity investment. Net cash provided by operating activities was $22 million in the quarter of $10 million compared to $12 million in the prior year due to an increase in cash-based earnings coming primarily from the cost savings initiatives put in place at the beginning of COVID and extending into the back half of the year. Our more targeted approach to business development has decreased excess spend on strategic initiatives, and we have learned how to provide surgeon training and attend conferences virtually, which has also saved additional cash. Capital expenditures were $3.4 million in the quarter, compared to $4.5 million in the prior year period due to pushing out spend on certain IT projects to conserve cash due to COVID, as well as reduced spending on facilities from the prior year. Consistent with our increased operating cash flow, our free cash flow, which we define as cash flow from operations minus capital expenditures, of $18.5 million during the quarter was up $11 million from $7.2 million in the third quarter last year. I'll now turn the call back over to John. Thanks, Doug. Shifting to our outlook for the remainder of the year, we've seen a strong rebound in electric procedure volumes and the associated revenues in the third quarter, there's still great uncertainty about how the balance year will play out. In Q3, we saw trends move in the right direction with elective procedures being performed at volumes approaching those of 2019. But there still is a great deal of unknown regarding market procedure volumes within this COVID environment. OrthoPix will continue to execute and drive our commercial execution with innovation and differentiation to be ready for the rebound in procedure volumes. which a key factor to this is the patient's willingness to schedule a procedure and head to the hospital or ASC to have that procedure performed. We have seen some stability in U.S. volumes, but our OUS business continues to have more variability. We will continue to adapt, drive new business, and take advantage of opportunities when they have presented themselves within the fourth quarter and beyond. With that said, because of the scope and duration of the COVID-19 pandemic and the timing of the global recovery remaining uncertain, we will not provide forward-looking guidance at this time. It is important to note Q4 of last year included some large stocking orders that we would not expect to reoccur in the fourth quarter of 2020. Despite the challenging environment, we've made tremendous strides throughout the year to put ourselves in a great position to build success for many years to come. While the macro environment remains uncertain, OrthoFix will continue to be ready to help patients improve their lives and help surgeons meet their patients' needs. Thank you to everyone at OrthoFix and all the healthcare providers around the world working through this challenging environment to continue to provide patient care. With that, I would like to now open the line for questions.