SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
☐ 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
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification Number)
2850 Frontier Drive
Warsaw, IN 46582
(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|
The NASDAQ Stock Market LLC
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
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 November 6, 2019, the registrant had 14,967,128 outstanding shares of common stock, $0.00025 par value per share.
For the Quarterly Period Ended September 30, 2019
TABLE OF CONTENTS
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 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 7, 2019 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.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
|September 30, 2019||December 31, 2018|
|Cash||$||19,669 || ||$||60,691 || |
Accounts receivable - trade, less allowance for doubtful accounts of $365 and $134, respectively
|14,182 || ||8,999 || |
|Inventories, net||34,533 || ||25,708 || |
|Notes receivable||545 || ||502 || |
|Prepaid expenses and other current assets||1,623 || ||1,256 || |
|Current assets held for sale, net||38,168 || ||— || |
|Total current assets||108,720 || ||97,156 || |
|Property and equipment, net||21,532 || ||12,768 || |
|Amortizable intangible assets, net||10,200 || ||1,921 || |
|Goodwill||10,732 || ||— || |
|Other intangible assets||2,240 || ||260 || |
|Total other assets||23,172 || ||2,181 || |
|Total assets||$||153,424 || ||$||112,105 || |
|LIABILITIES AND STOCKHOLDERS' EQUITY|
|Accounts payable - trade||$||7,746 || ||$||3,971 || |
|Accrued compensation and benefits||3,858 || ||3,552 || |
|Current portion of long-term debt with affiliate||123 || ||118 || |
|Short-term debt with affiliate||30,000 || ||— || |
|Current liabilities held for sale||3,085 || ||— || |
|Other current liabilities||1,372 || ||1,576 || |
|Total current liabilities||46,184 || ||9,217 || |
|Long-term debt with affiliate, net of current portion||21,090 || ||21,156 || |
|Other long-term liabilities||45 || ||— || |
|Total long-term liabilities||21,135 || ||21,156 || |
|Total liabilities||67,319 || ||30,373 || |
Common stock, $0.00025 par value; 50,000,000 shares authorized; 14,967,128 shares and 14,538,202 shares issued and outstanding as of September 30, 2019 (unaudited) and December 31, 2018, respectively
|4 || ||4 || |
|Additional paid-in capital||210,479 || ||197,442 || |
|Accumulated deficit||(123,393)|| ||(115,091)|| |
|Accumulated other comprehensive loss||(985)|| ||(623)|| |
|Total stockholders' equity||86,105 || ||81,732 || |
|Total liabilities and stockholders' equity||$||153,424 || ||$||112,105 || |
See notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Share and Per Share Data)
|Three Months Ended September 30,||Nine Months Ended September 30,|
|Net revenue||$||20,744 || ||$||15,820 || ||$||53,600 || ||$||42,991 || |
|Cost of revenue||4,849 || ||3,843 || ||13,431 || ||10,825 || |
|Gross profit||15,895 || ||11,977 || ||40,169 || ||32,166 || |
|Sales and marketing||8,771 || ||7,150 || ||22,924 || ||20,005 || |
|General and administrative||7,267 || ||4,877 || ||19,448 || ||16,393 || |
|Research and development||1,396 || ||1,122 || ||3,843 || ||3,455 || |
|Total operating expenses||17,434 || ||13,149 || ||46,215 || ||39,853 || |
|Operating loss||(1,539)|| ||(1,172)|| ||(6,046)|| ||(7,687)|| |
|Interest expense, net||1,297 || ||608 || ||2,232 || ||1,722 || |
|Other expense||41 || ||85 || ||78 || ||148 || |
|Total other expenses||1,338 || ||693 || ||2,310 || ||1,870 || |
|Net loss from continuing operations||$||(2,877)|| ||$||(1,865)|| ||$||(8,356)|| ||$||(9,557)|| |
|Net gain from discontinued operations||$||213 || ||$||— || ||$||54 || ||$||— || |
|Net loss||$||(2,664)|| ||$||(1,865)|| ||$||(8,302)|| ||$||(9,557)|| |
|Net loss attributable to common stockholders||$||(2,664)|| ||$||(1,865)|| ||$||(8,302)|| ||$||(9,557)|| |
|Weighted average common stock - basic and diluted||14,639,020 || ||12,624,858 || ||14,487,015 || ||12,417,972 || |
|Net loss per share attributable to common stockholders - basic and diluted||$||(0.18)|| ||$||(0.15)|| ||$||(0.57)|| ||$||(0.77)|| |
See notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
|Three Months Ended September 30,||Nine Months Ended September 30,|
|Net loss||$||(2,664)|| ||$||(1,865)|| ||$||(8,302)|| ||$||(9,557)|| |
|Other comprehensive income (loss):|
| Foreign currency translation adjustment||(530)|| ||(101)|| ||(362)|| ||(478)|| |
|Other comprehensive income (loss)||(530)|| ||(101)|| ||(362)|| ||(478)|| |
|Comprehensive loss||$||(3,194)|| ||$||(1,966)|| ||$||(8,664)|| ||$||(10,035)|| |
See notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(In Thousands, Except Share Data)
|Three and Nine Months Ended September 30, 2019|
|Balance at January 1, 2019||14,538,202 || ||$||4 || ||$||197,442 || ||$||(115,091)|| ||$||(623)|| ||$||81,732 || |
|Net loss||— || ||— || ||— || ||(3,020)|| ||— || ||(3,020)|| |
|Other comprehensive income||— || ||— || ||— || ||— || ||301 || ||301 || |
|Stock option exercise||18,427 || ||— || ||565 || ||— || ||— || ||565 || |
|Restricted stock||125,769 || ||— || ||471 || ||— || ||— || ||471 || |
|Balance at March 31, 2019||14,682,398 || ||4 || ||198,478 || ||(118,111)|| ||(322)|| ||80,049 || |
|Net Loss||— || ||— || ||— || ||(2,618)|| ||— || ||(2,618)|| |
|Other comprehensive loss||— || ||— || ||— || ||— || ||(133)|| ||(133)|| |
|Acquisition consideration||245,352 || ||— || ||10,000 || ||— || ||— || ||10,000 || |
|Stock option exercise||2,983 || ||— || ||92 || ||— || ||— || ||92 || |
|Restricted stock||8,729 || ||— || ||692 || ||— || ||— || ||692 || |
|Balance at June 30, 2019||14,939,462 || ||$||4 || ||$||209,262 || ||$||(120,729)|| ||$||(455)|| ||$||88,082 || |
|Net Loss||— || ||— || ||— || ||(2,664)|| ||— || ||(2,664)|| |
|Other comprehensive loss||— || ||— || ||— || ||— || ||(530)|| ||(530)|| |
|Stock option exercise||17,511 || ||— || ||484 || ||— || ||484 || |
|Restricted stock||10,155 || ||— || ||733 || ||— || ||— || ||733 || |
|Balance at September 30, 2019||14,967,128 || ||$||4 || ||$||210,479 || ||$||(123,393)|| ||$||(985)|| ||$||86,105 || |
|Three and Nine Months Ended September 30, 2018|
|Balance at January 1, 2018||12,621,781 || ||$||2 || ||$||150,424 || ||$||(103,066)|| ||$||135 || ||$||47,495 || |
|Net loss||— || ||— || ||— || ||(5,000)|| ||— || ||(5,000)|| |
|Other comprehensive income||— || ||— || ||— || ||— || ||82 || ||82 || |
|Restricted stock||149,015 || ||— || ||2,177 || ||— || ||— || ||2,177 || |
|Balance at March 31, 2018||12,770,796 || ||2 || ||152,601 || ||(108,066)|| ||217 || ||44,754 || |
|Net Loss||— || ||— || ||— || ||(2,692)|| ||— || ||(2,692)|| |
|Other comprehensive loss||— || ||— || ||— || ||— || ||(459)|| ||(459)|| |
|Restricted stock||18,243 || ||— || ||454 || ||— || ||— || ||454 || |
|Balance at June 30, 2018||12,789,039 || ||2 || ||153,055 || ||(110,758)|| ||(242)|| ||42,057 || |
|Net Loss||— || ||— || ||— || ||(1,865)|| ||— || ||(1,865)|| |
|Other comprehensive loss||— || ||— || ||— || ||— || ||(101)|| ||(101)|| |
|Stock option exercise||11,533 || ||— || ||326 || ||— || ||— || ||326 || |
|Restricted stock||6,948 || ||— || ||268 || ||— || ||— || ||268 || |
|Balance at September 30, 2018||12,807,520 || ||$||2 || ||$||153,649 || ||$||(112,623)|| ||$||(343)|| ||$||40,685 || |
See notes to condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
|Nine Months Ended|
|Net loss||$||(8,302)|| ||$||(9,557)|| |
|Adjustments to reconcile net loss to net cash used in operating activities:|
|Depreciation and amortization||3,258 || ||2,177 || |
|Stock-based compensation||1,896 || ||2,899 || |
|Changes in certain current assets and liabilities:|
|Accounts receivable - trade||(5,126)|| ||(4,077)|| |
|Inventories||(6,491)|| ||(5,274)|| |
|Prepaid expenses and other current assets||(360)|| ||(214)|| |
|Accounts payable - trade||3,680 || ||408 || |
|Accrued expenses and other liabilities||11 || ||798 || |
|Other||1 || ||(15)|| |
|Net cash used in operating activities - continuing operations||(11,433)|| ||(12,855)|| |
|Net cash provided by operating activities - discontinued operations||590 || ||— || |
|Net cash used in operating activities||(10,843)|| ||(12,855)|| |
|Acquisition of Vilex and Orthex, net of cash acquired||(49,687)|| ||— || |
|Purchases of licenses||(170)|| ||(195)|| |
|Purchases of property and equipment||(10,536)|| ||(5,311)|| |
|Net cash used in investing activities||(60,393)|| ||(5,506)|| |
|Payments on mortgage notes||(88)|| ||(84)|| |
|Proceeds from issuance of debt with affiliate||30,000 || ||— || |
|Proceeds from exercise of stock options||1,141 || ||326 || |
|Net cash provided by financing activities||31,053 || ||242 || |
|NET DECREASE IN CASH||(40,183)|| ||(18,119)|| |
|Cash, beginning of year||60,691 || ||42,582 || |
|Cash, end of period||20,508 || ||24,463 || |
|Less cash of discontinued operations, end of period||839 || ||— || |
|Cash of continuing operations, end of period||$||19,669 || ||$||24,463 || |
|Cash paid for interest||$||2,232 || ||$||1,722 || |
|Transfer of instruments from property and equipment to inventory||$||593 || ||$||1,061 || |
|Acquisition consideration of common shares||$||10,000 || ||$||— || |
See notes to condensed consolidated financial statements.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(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 and devices 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, RESPONSE Spine, BandLoc, Pediguard, Pediatric Nailing Platform | Femur and Orthex, 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.
In 2017, we expanded operations and established legal entities in the United Kingdom, Australia and New Zealand permitting us to sell under an agency model direct to local hospitals in these countries. In September 2018, we further expanded operations in Canada selling direct to local hospitals, and in January 2019 we expanded to Belgium and the Netherlands. Additionally, in March 2019 we established a holding company and an operating company in the Netherlands that are expected to enhance our operations in Europe.
On June 4, 2019, we purchased all the issued and outstanding shares of stock of Vilex in Tennessee, Inc. ("Vilex") and all the issued and outstanding units of membership interests in Orthex, LLC ("Orthex") 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 Orthex Hexapod technology which is used to treat pediatrics congenital deformities and limb length discrepancies. Because the current products of Vilex also include adult offerings that are not core to the Company's pediatrics business, the Company has begun taking steps to divest the non-core Vilex assets. The Company anticipates completing the divestiture by the end of 2019.
Our largest investor is Squadron Capital LLC (“Squadron”), a family office firm headquartered near Hartford, Connecticut.
NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
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., and OP Netherlands B.V., Vilex in Tennessee, Inc., and Orthex, LLC (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 September 30, 2019 and December 31, 2018, the condensed consolidated statements of operations for the three and nine months ended September 30, 2019 and 2018, the condensed consolidated statements of comprehensive loss for the three and nine
months ended September 30, 2019 and 2018, the condensed consolidated statements of stockholders’ equity for the three and nine months ended September 30, 2019 and 2018 and the condensed consolidated statements of cash flows for the nine months ended September 30, 2019 and 2018 are unaudited and should be read in conjunction with the annual consolidated financial statements as of and for the year ended December 31, 2018 and related notes thereto contained in our Annual Report on Form 10-K filed with the Securities and Exchange Commission ("SEC") on March 7, 2019. 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, 2018 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 nine months ended September 30, 2019 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 $123,393 and $115,091 as of September 30, 2019 and December 31, 2018, respectively. In conjunction with the acquisition of Vilex and Orthex, the Company entered into a new $30,000 short-term loan facility with Squadron in addition to the existing $20,000 term loan facility and $15,000 revolving credit facility previously established. The new term loan is due upon the earliest of: (i) the date on which any 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; (ii) the date on which the Company sells its equity interest in, or all or substantially all of the assets of, Vilex; and (iii) May 31, 2020. The maturity date for the remaining Squadron debt is January 31, 2023. Management continues to monitor cash flows and liquidity on a regular basis. We believe that our cash balance at September 30, 2019, expected cash flows from operations for the next twelve months subsequent to the issuance of the condensed consolidated financial statements, and the likelihood that the Vilex assets held for sale will be sold prior to the maturity of the new term loan are sufficient to enable us to maintain current and essential planned operations for more than the next twelve months. If the Vilex assets are not sold prior to the maturity of the new term loan, we will work to extend the maturity date or obtain external funding in order to repay the loan.
Use of Estimates
Preparation of the 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 the condensed consolidated financial statements.
Foreign Currency Transactions
We currently bill our international distributors in United States ("U.S.") dollars, resulting in minimal foreign exchange transaction expense.
Beginning in the second quarter of 2017, we began selling direct within the United Kingdom, Ireland, Australia and New Zealand and billing using the local currency for each country. In September 2018, we
began selling direct in Canada and in January 2019 in Belgium and the Netherlands. The financial statements of our foreign subsidiaries are accounted for 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 condensed consolidated statements of comprehensive loss.
Revenue from Contracts with Customers
In accordance with ASC 606, "Revenue From Contracts With Customers (ASC 606)", revenue is recognized when a customer obtains control of promised goods or services. 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. This typically occurs when we transfer control of our products to the customer, generally upon implantation or when title passes upon shipment. 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 the hospital obtains control of the product, typically either upon shipment or delivery of the product dependent on the terms of the contract. Pricing for each customer is dictated by a unique pricing agreement, which does not generally include rebates or discounts.
Revenue Recognition – International
Outside of the United States, we primarily sell our products through independent stocking distributors. Generally, the distributors are allowed to return products, and some are thinly capitalized. Based on our history of collections and returns from international customers, we previously concluded that collectibility was not reasonably assured at the time of delivery for certain customers who had not evidenced a consistent pattern of timely payment. Accordingly, in the past we did not recognize international revenue and associated cost of revenue at the time title transfers for these customers for whom collectibility had not been deemed probable based on the customer’s history and ability to pay, but rather when cash had been received. Until such payment, cost of revenue was recorded as inventories held by international distributors, net of adjustment for estimated unreturnable inventory, on our condensed consolidated balance sheets.
Following a review of our collection history, we deemed collectibility was probable for all international stocking distributors effective January 1, 2019. 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 upon implantation or when title passes upon shipment.
In early 2017, we expanded operations and established legal entities in the United Kingdom, Australia and New Zealand permitting us to sell under an agency model direct to local hospitals in these countries. Additionally, in September 2018 we began selling in Canada and in January 2019 to Belgium and the Netherlands utilizing the agency model. 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 the hospital obtains control of the product, typically either upon shipment or delivery of the product dependent on the terms of the contract. Pricing for each
customer is dictated by a unique pricing agreement, which does not generally include rebates or discounts.
Cash and Cash Equivalents
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 sheet for cash are valued at cost, which approximates fair value.
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.
Inventories are stated at the lower of cost or net realizable value, with cost determined using the first-in-first-out method. Inventories, which consist of implants and instruments held in our warehouse or with third-party independent sales agencies or distributors, are considered finished goods and are purchased from third parties.
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 Zealand, Canada, Belgium and the Netherlands 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
3 to 5 years
|Office and other equipment|
5 to 7 years
Amortizable Intangible Assets, net
Amortizable intangible assets include fees necessary to secure various patents and licenses, and the value of internally developed software, customer relationships and non-competition agreements related to the acquisition of Orthex. Vilex has amortizable intangible assets including patents, customer relationships and non-competition agreements which are included in current assets held for sale, net on the condensed consolidated balance sheet as of September 30, 2019. 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 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 annually or whenever events or changes in circumstances 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 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 the reporting unit exceeds its respective fair value.
We have indefinite lived tradename assets that are reviewed for impairment by performing a quantitative analysis, which occurs annually in the fourth quarter or whenever events or changes in circumstances 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 assets. No impairment charges were recorded in any of the periods presented.
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 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.
Prior to our Initial Public Offering ("IPO") in October 2017, we maintained an Amended and Restated 2007 Equity Incentive Plan (the “2007 Plan”) that provided for grants of options and restricted stock to employees, directors and associated third-party representatives of the Company as determined by the Board of Directors. The 2007 Plan had authorized 1,585,000 shares for award.
Immediately prior to our IPO, we adopted our 2017 Incentive Award Plan (the "2017 Plan") which replaced the 2007 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 1,789,647 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 estimate the fair value of stock options and restricted stock at the grant date. Stock-based compensation is recognized ratably over the requisite service period, which is generally the vesting period for stock options and the restriction period for restricted stock.
Calculating the fair value of stock-based awards requires that we make highly subjective assumptions. We use the Black-Scholes option pricing model to value our stock options. Use of the valuation methodology requires that we make assumptions as to the volatility of our common stock, the expected term of our stock options and the risk free rate of return for a period that approximates the expected term of our stock options. Because we were a privately-held company with a limited operating history, we utilized the historical stock price volatility from a representative group of comparable industry competitors to estimate expected stock price volatility.
Prior to our IPO, for restricted stock awards we applied a discount for lack of marketability to the fair value of common stock to estimate the impact of valuing a minority interest in our Company as a closely held, non-public company with no liquid market for its shares. Following the IPO, we value restricted stock awards using the market value on the grant date.
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.
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.
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.
“Emerging Growth Company” and "Smaller Reporting Company" Reporting Requirements
We qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act (the “JOBS Act”). 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. 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 and our disclosure obligations regarding executive compensation may be reduced. We may take advantage of these provisions until the last day of our fiscal year following the fifth anniversary of our initial public offering, or December 31, 2022. However, if certain events occur prior to the end of such five-year period, including if we become a "large accelerated filer," our annual gross revenue exceeds $1.07 billion or we issue more than $1.0 billion of non-convertible debt in any three-year period, we will cease to be an emerging growth company prior to the end of such five-year period.
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 are subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.
We are also a "smaller reporting company," as such term is defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended. As a result, many of the same exemptions from reporting requirements available to us as an emerging growth company are also available to us as a smaller reporting company, including not being required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act and reduced disclosure obligations regarding executive compensation. To the extent that we continue to qualify as a smaller reporting company, after we cease to qualify as an emerging growth company, those exemptions may continue to be available to us.
Recent Accounting Pronouncements
In February 2016, the FASB issued ASU 2016-02 “Leases,” which increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The Company adopted this standard on January 1, 2019.
The new standard requires lessees to recognize both the right-of-use assets and lease liabilities in the balance sheet for most leases, whereas under previous GAAP only finance lease liabilities (previously referred to as capital leases) were recognized in the balance sheet. In addition, the definition of a lease has been revised which may result in changes to the classification of an arrangement as a lease. Under the new standard, an arrangement that conveys the right to control the use of an identified asset by obtaining substantially all of its economic benefits and directing how it is used is a lease, whereas the previous definition focuses on the ability to control the use of the asset or to obtain its output. Quantitative and qualitative disclosures related to the amount, timing and judgments of an entity's accounting for leases and the related cash flows are expanded. Disclosure requirements apply to both lessees and lessors, whereas, previous disclosures related only to lessees. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee have not significantly changed from previous GAAP. Lessor accounting is also largely unchanged.
The new standard provides a number of transition practical expedients, which the Company has elected, including:
•a "package of three" expedients that must be taken together and allow entities to (1) not reassess whether existing contracts contain leases, (2) carryforward the existing lease classification, and (3) not reassess initial direct costs associated with existing leases, and
•an implementation expedient which allows the requirements of the standard in the period of adoption with no restatement of prior periods.
The Company has assessed the lease standard and executed a detailed implementation plan, which included the following key activities:
•Developed a complete lease inventory and abstracted the required data attributes as applicable in a manner that supports the Company's lease portfolio.
•Evaluated the transition practical expedients available under the standard.
•Identified, assessed and documented technical accounting issues, policy considerations and financial reporting implications.
•Identified and implemented changes to processes and controls to ensure all impacts of the new standard are effectively addressed.
The adoption of the new standard did not result in a material right of use asset or lease obligation for operating leases recorded in the Company's condensed consolidated balance sheets on January 1, 2019, primarily due to the lack of existing lease contracts, or other contracts that meet the standard for consideration as a lease under the definitions discussed above. The Company has limited operating leases for office equipment maintained at its headquarters, and has not historically leased any real estate or office space.
In conjunction with the Company's acquisition of Vilex and Orthex on June 4, 2019, the Company acquired two leased facilities in Tennessee and Florida. The Company analyzed each lease agreement and recorded a right-of-use asset and liability of $77 for Orthex and $246 for Vilex, respectively, on its condensed consolidated balance sheet as of the acquisition date. As of September 30, 2019, the Company's right-of-use asset and liabilities were $70 and $69, respectively, associated with Orthex. The Vilex operating leases were recorded in current assets held for sale, net and current liabilities held for sale as of September 30, 2019.
NOTE 3 – BUSINESS COMBINATION
On June 4, 2019, the Company purchased all the issued and outstanding shares of stock of Vilex and units of membership interests in Orthex for $50,000 in cash, adjusted for working capital, and 245,352 shares of common stock, $0.00025 par value per share, of the Company. The shares of common stock were valued at $40.76 per share, the volume weighted average trading price during the thirty day trading period ending on May 30, 2019. In addition, $3,000 was placed in an escrow account for a period of up to twenty months to cover certain indemnification obligations and to secure certain closing adjustments. The Company incurred $737 of acquisition-related costs, $148 of which were incurred in the quarter ended September 30, 2019, that are included in general and administrative expenses on the condensed consolidated statements of operations. The purchase price allocation set forth herein is preliminary and may be revised as we finalize the fair value determination for certain assets acquired, and determine any further working capital adjustments. Any revisions or changes identified during the measurement period, which could be up to 12 months from the closing date of the acquisition, may be material and could affect what is included in assets and liabilities held for sale.
The following table summarizes the total consideration paid for Vilex and Orthex and the preliminary allocation of purchase price to the estimated fair value of the assets acquired and liabilities assumed at the acquisition date (in thousands):
|Preliminary fair value of estimated total acquisition consideration||$||60,276 || |
|Cash||348 || |
|Accounts receivable-trade||2,088 || |
|Inventories||3,905 || |
|Prepaid expenses and other current assets||12 || |
|Property and equipment||7,541 || |
|Intangible assets||18,260 || |
|Operating lease right-of-use asset||323 || |
|Total assets||32,477 || |
|Accounts payable and accrued liabilities||564 || |
|Operating lease liabilities||323 || |
| Deferred tax liability||2,575 || |
|Other long-term liabilities||68 || |
|Total liabilities||3,530 || |
|Less: total net assets||28,947 || |
|Goodwill||$||31,329 || |
Measurement period adjustments during the third quarter of fiscal year 2019 included an increase of $239 to accounts receivable - trade and $2,575 to deferred tax liability as a result of information identified as of the date of acquisition. These measurement period adjustments to the purchase price allocation in the third quarter of fiscal year 2019 increased goodwill by $2,336.
The fair value of identifiable intangible assets were based on valuations using a combination of the income and cost approach. The estimated fair value and useful life of identifiable intangible assets are as follows:
|Amount||Remaining Economic Useful Life|
|Trademarks / Names||$||4,160 || ||Indefinite|
|Patents||8,380 || ||15 years|
|Internally Developed Software||960 || ||10 years|
|Customer Relationships||4,690 || ||12 years|
|Non-competition Agreements||70 || ||5 years|
|$||18,260 || |
NOTE 4 - DISCONTINUED OPERATIONS
On June 4, 2019, the Company acquired Vilex, a manufacturer of foot and ankle surgical implants. Since the Vilex products include adult offerings that are not core to the Company's pediatric business, the Company received Board approval to take the steps necessary to divest the non-core Vilex assets. As a result, certain assets and liabilities of Vilex are classified as held for sale on the condensed consolidated balance sheet as of September 30, 2019.
The following summarized financial information has been segregated from continuing operations and reported as discontinued operations for the three and nine months ended September 30, 2019:
|Three Months Ended||Nine Months Ended|
|September 30, 2019||September 30, 2019|
|Revenue||$||1,285 || ||$||1,699 || |
|Operating expenses||707 || ||1,213 || |
|Other expenses||365 || ||432 || |
|Operating gain||213 || ||54 || |
|Gain from discontinued operations||$||213 || ||$||54 || |
The assets and liabilities held for sale on the condensed consolidated balance sheet as of September 30, 2019 are as follows:
|September 30, 2019|
|Cash||$||840 || |
|Accounts receivable||893 || |
|Inventories||2,054 || |
|Prepaid expenses and other current assets||18 || |
|Property and equipment||5,939 || |
|Amortizable intangible assets||5,350 || |
|Goodwill||20,597 || |
|Operating lease right-of-use asset||227 || |
|Other intangible assets||2,250 || |
|Current assets held for sale, net||38,168 || |
|Accounts payable||106 || |
|Accrued compensation and benefits||172 || |
|Operating lease liabilities||219 || |
| Deferred tax liability||2,575 || |
|Other current liabilities||13 || |
|Liabilities held for sale||$||3,085 || |
NOTE 5 - DEBT AND CREDIT ARRANGEMENTS
Long-term debt consisted of the following:
|September 30, 2019||December 31, 2018|
|Note payable to Squadron||$||19,883 || ||$||19,856 || |
|Short-term debt with Squadron||30,000 || ||— || |
|Mortgage payable to affiliate||1,330 || ||1,418 || |
|Total debt||51,213 || ||21,274 || |
|Less: current maturities||30,123 || ||118 || |
|Long-term debt with affiliate, net of current maturities||$||21,090 || ||$||21,156 || |
In April 2017, we entered into the Third Amended and Restated Loan and Security Agreement with Squadron providing us with (i) a term loan in the amount of $18,400, bearing interest at a per annum rate of 10%, and (ii) a term loan in the amount of $16,000, bearing interest at a per annum rate of 11%. Each of the term loans was to have matured on March 31, 2019. In addition, the agreement provided for a $1,000 extension fee payable in annual installments. The extension fee was recorded in full upon closing as a deferred financing cost within long-term debt with affiliate, net of current portion, and was to be recognized ratably over the term of the agreement as deferred financing charges within interest expense on the consolidated statements of operations assuming an IPO did not happen.
Effective December 31, 2017, we entered into a Fourth Amended and Restated Loan and Security Agreement, or the Loan Agreement, with Squadron. Pursuant to the Loan Agreement, a majority of the term loan amounts under the previous agreement with Squadron were consolidated into a $20,000 term note, or the Term Note A, and a $15,000 revolving credit facility was established. Also, $667 of the extension fee was canceled as of the completion of our IPO in October 2017. Both facilities include interest only payments and have interest rates equal to the greater of (a) three month LIBOR plus 8.61% and (b) 10%. The Loan Agreement also extended the maturity date to January 31, 2023.
In order to finance a portion of the cash consideration for the acquisition of Vilex and Orthex, the Company entered into a first Amendment, or the Amendment, to the Loan Agreement (as so amended, the "Amended Loan Agreement"), with Squadron. The Amended Loan Agreement provides for a new $30,000 term loan facility, represented by a Term Note B, in addition to the existing $20,000 Term Note A and $15,000 revolving credit facility. Similar to the other facilities under the Amended Loan Agreement, the Term Note B is subject to interest only payments at an interest rate equal to the greater of (a) three month LIBOR plus 8.61%, and (b) 10.00%. The maturity date for the Term Note B is the earliest of: (i) the date on which any 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; (ii) the date on which the Company sells its equity interest in, or all or substantially all of the assets of, Vilex; and (iii) May 31, 2020. Until such time that the Term Note B and all accrued interest thereon has been paid in full, no borrowings under the revolving loan facility are permitted.
As provided in the Amendment, Orthex has become a "Borrower" under the Amended Loan Agreement and, as such, granted to Squadron a security interest in all of its personal property as collateral for all borrowings under the Amended Loan Agreement. In connection with the Amendment, the Company granted a security interest in (a) the units of membership interest in Orthex held by the Company, and (b) the shares of stock of Vilex held by the Company, as collateral for borrowings under the Amended Loan Agreement. Borrowings under the Amended 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.
The fair value of our notes payable to Squadron were estimated based on prices for the same or similar issues and the current interest rates offered for the debt of the same remaining maturities, which are considered level 2 inputs in accordance with ASC Topic 820, “Fair Value Measurements and Disclosures.” At September 30, 2019, the fair value approximated the carrying value.
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 December 31, 2018, the mortgage balance was $1,418 of which current principal due of $118 was included in current portion of long-term debt. At September 30, 2019, the mortgage balance was $1,330 of which current principal due of $123 was included in current portion of long-term debt.
Interest expense relating to notes payable to Squadron and Tawani was $1,297 and $