Orthopediatrics Corp Q3 FY2020 Earnings Call

Welcome to the Quarter Three 2020 OrthoPediatrics Corporation Earnings Conference Call. My name is Holly, and I’ll be your conference operator today. After the speakers’ remarks, we will have a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Jan Medina. Jan, you may begin.

Thank you, Holly, and thank you everyone for joining today’s call. With me from the Company are Mark Throdahl, Chief Executive Officer; Fred Hite, Chief Operating Officer and Chief Financial Officer; and David Bailey, 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 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 quarterly report on Form 10-Q, 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 this 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 non-GAAP financial measures have limitations as analytical tools and should not be considered in isolation or as a substitute for OrthoPediatrics’ financial results prepared in accordance with GAAP. In addition, the content of this conference call contains time-sensitive information that is accurate only as of the date of the live broadcast, November 05, 2020. 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 third quarter 2020 earnings conference call. I want to start by acknowledging all our OrthoPediatrics associates for their remarkable efforts that have resulted in strong outcomes during the recent quarter, including record revenue and enhanced EBITDA. The pandemic continues to present challenges, especially in some international markets, but our associates have excelled during these unprecedented times. While the operating environment remains unpredictable, the positive momentum observed since May gained speed during the recent quarter and has persisted into October. We achieved accelerating growth in the United States, improved our gross margin, and delivered enhanced EBITDA along with positive adjusted EBITDA. This morning, I will provide an overview of our results by geography and product line, including our thoughts on recovery rates for procedures in the U.S. and internationally. I will also discuss our recent acquisitions, followed by additional progress and factors that are driving our business. Then I’ll hand over to Fred for a comprehensive financial review and guidance for the fourth quarter, after which we will open the call to your questions. The recovery in the U.S., which started in the second quarter, continued to pick up speed in the third quarter, achieving a domestic growth of 17% year-over-year, with Trauma and Deformity and Scoliosis growing in line with total domestic sales, and Scoliosis increasing its total user base by 33% year-to-date compared to the third quarter of 2019. This represents a significant improvement compared to the 12% decline witnessed during the prior quarter. Moreover, U.S. sales continued to grow monthly throughout the third quarter, with consistent increases in domestic sales every month since April's sharp decline. October domestic sales remained strong, confirming a clear upward trajectory despite some fluctuations. However, we are concerned about the recent rise in COVID-19 cases nationwide and cannot predict if there will be another deferral of elective surgeries in this country. Looking at the final quarter of 2020, we believe we are well-positioned for continued strong domestic growth, slightly better than Q3's performance. The recovery overseas is still lagging behind that in the U.S. Most pediatric surgeries abroad take place in general hospitals, many of which also handle COVID cases. There is a notable frequency of last-minute cancellations, likely due to parental concerns about hospital visits. Additionally, given the low number of procedures, our stocking distributors made little to no purchases in Q3, and we expect this trend to continue in Q4. While international sales fell 34% year-over-year, EMEA and APAC were relatively bright spots. Sales in EMEA grew by 5% during Q3, partly due to growth from agency sales, while APAC saw a 7% increase, driven by strong performance from agencies in Australia. Overall, agency sales rose 26%, representing half of our third-quarter international sales compared to the historical average of 25%. This surge contributed positively to gross profit performance in Q3. Despite the ongoing rise in COVID cases globally, we have observed only localized effects on elective surgeries thus far. In addition to trailing behind the U.S. recovery, trends internationally vary significantly by region, particularly in Latin America, which was the only disappointing area for the company in Q3. Despite these challenges, we remain committed to the region and are continuing our rigorous training programs and support for surgical societies. Concerning revenue contributions by business, Trauma & Deformity sales grew by 8% for the third quarter, with domestic sales propelled by strong trauma performance and positive recovery indicators in elective deformity correction surgeries. PNP, Cannulated Screws, and Orthex all made substantial contributions to domestic sales growth as well. Worldwide Scoliosis sales increased by 1%, with domestic growth aligning with overall U.S. sales growth, supported by RESPONSE and FIREFLY, along with a 33% rise in total users year-to-date compared to the previous year. Sports Medicine & Other saw a growth of 56%, reflecting contributions from Telos Partners. Regarding acquisitions, although they represent a small portion of our sales, we are pleased with Telos's revenue impact after securing several multi-year consulting contracts with new medical technology clients. We acquired Telos in March to incorporate advanced expertise in regulatory trends and clinical trial management, expertise that is in high demand during the COVID-19 pandemic. While we operate Telos at an arm's length to ensure client confidentiality, we have benefitted from their knowledge, which allows OrthoPediatrics to gather clinical data on our surgical systems and anticipate future regulations effectively. Orthex continues to experience strong growth, attracting numerous new users and sales agencies during their initial cases; now, 50% of our U.S. sales team is actively involved in complex external fixation surgery. Orthex recently gained approval in Australia, where we are now booking cases. We expect to launch Orthex in Europe with the CE Mark in Q1 2021 and are already hiring a European Orthex Sales Director in anticipation of the strong demand we are witnessing. Clearly, the acquisition of Orthex, our first, is generating synergy with our extensive line of internally developed surgical systems launched since our IPO, thus bolstering our reputation as the preferred supplier for pediatric hospitals. Acquired in April, ApiFix is another strategic technology acquisition that can expand our Scoliosis franchise, which has seen annual growth rates between 20% and 40% in recent years. ApiFix is among the recently approved non-fusion technologies and represents a groundbreaking approach to Scoliosis treatment. Earlier this year, we also received FDA approval to widen the treatment label from 35 degrees to 60 degrees for progressive curves previously set at 40 to 60 degrees. This upgrade allows the ApiFix system to compete directly with spinal tethering, the only other non-fusion technology permitted for use in skeletally immature patients. However, ApiFix offers a significantly simpler surgical procedure than spinal tethering, which entails a challenging learning curve. From a return on capital standpoint, we expect to see high revenue contributions per dollar of inventory. Although ApiFix sales have not yet made a substantial impact, we anticipate that this will change next year. In its brief time with OrthoPediatrics, ApiFix has reached important milestones. The system is currently undergoing various phases of IRB approval at 20 U.S. sites. Out of these, seven are fully approved to conduct surgeries, having received both IRB and registry clearances. We expect the remaining sites to receive full approval by the end of the year or early 2021. Four sites have already completed nine successful surgeries, with three recently approved sites scheduling cases very soon. Surgeons are responding positively to the outcomes achievable with ApiFix, as the correction is comparable to fusion, but with a simpler surgical process and shorter procedure times. Surgeries are completed in just a few hours or less, and the hospital stays for patients are brief, ranging from 24 to 48 hours, along with rapid post-operative recovery. We expect IRB sites to continue their internal approval processes, with surgeries starting at most of the 20 hospitals by the end of the year or in early 2021. We have reached an agreement with the FDA to include the first 200 patients in the U.S. in a registry, which we expect to complete by mid-to-late 2021. Now, shifting to factors enhancing our competitive advantage, the pandemic has, so far, provided an excellent opportunity to strengthen our industry-leading position in pediatric orthopedics. The Company is committed to supporting our patients and surgeons, maintaining financial support for important surgical societies, in stark contrast to other industry sponsors. In Q3, we upheld our Gold Level support for the Scoliosis Research Society, our Platinum Level support for the American Academy for Cerebral Palsy and Developmental Medicine, and our Diamond Level sponsorship of the 30th Annual Baltimore Limb Deformity Course. We expanded our domestic sales organization by 5% compared to Q3 of 2019, now totaling 166 sales representatives. Despite the uncertain environment, we take pride in our domestic sales agencies making personnel investments that will drive future growth, a clear indication of their confidence in OrthoPediatrics and the market we serve. As the U.S. market normalizes, we anticipate hiring more new sales associates in Q4. While our international operations remain significantly affected by the pandemic, making it difficult to predict consistent international growth, there are several tailwinds that could substantially impact growth in 2021. These include a substantial number of new regulatory approvals in foreign jurisdictions, the launch of Orthex with the CE Mark in Europe, introducing individually packaged sterile configurations of many OrthoPediatrics products now in demand by numerous European hospitals, and the upcoming transition of several stocking distributors to sales agencies. Discussions about distributor conversion are already in advanced stages in three EMEA markets, with completion expected by the end of 2020 or the first quarter of 2021. As a reminder, our sales agencies, both domestically and internationally, do not take ownership of the product; they receive a commission on sales generated, while OrthoPediatrics determines the pace of inventory consignment, which remains on our books. Transitioning a stocking distributor to a sales agency enables us to interact with customers directly at full hospital prices, thereby doubling our revenues and gross margins, while also accelerating organic growth in the market. Regarding our inventory investment and operations, we have mostly maintained our instrument implant set deployments with $13.1 million in investments during the first nine months of 2020, compared to $13.7 million during the same period last year. We have made significant strides in consolidating our contract manufacturing suppliers. Several years ago, we initiated a strategy to keep 80% of our implant volume with a single supplier in Northern Indiana, who is similarly dependent on OrthoPediatrics. This strategy was largely executed in 2020, allowing us to lower costs, enhance quality control, and boost responsiveness. We are currently building a 20,000 square foot warehouse in Warsaw, nearly tripling the size of the warehouse expansion completed just 18 months ago. We expect the facility to be operational by Q1 of 2021. In the long term, the current warehouse will be transformed into office space for our new personnel. We also believe we will beta launch a new mobile app this year, which is well in development. This app will provide surgeons and sales consultants access to all of OP’s training videos, surgical technique guides, and other pertinent information about the Company’s 35 surgical systems, both before and during surgeries. We see ourselves as the market leader in Pediatric Orthopedics. Recently, a few companies have announced initiatives in our market, and we welcome the broader commitment from the industry to the welfare of children. However, being the market leader demands more than just targeting one or two profitable pediatric products. It’s more than just grouping several outdated products under a new marketing label. It involves more than unconventional attempts to stitch together a company that is merely seeking a quick exit for a strategic or financial buyer. True market leadership requires a long-term, comprehensive commitment to innovative product development, selective acquisition of complementary technologies, investment in non-commercial clinical education, and substantial financial support for pediatric orthopedic surgical societies. It necessitates a sustainable, built-to-last strategy of consistent execution that aligns growth with profitability. We believe that OrthoPediatrics has successfully maintained market leadership and resilience even amidst the pandemic, both during the shutdown earlier this year and the subsequent improved operating conditions. Throughout this process, nearly all our 2020 corporate goals have remained on track. As we approach the final quarter of the year and look toward 2021, we are confident that our market leadership and resilience will continue to benefit our customers and shareholders. Now, let me turn the call over to Fred for a review of our financial results and a forecast for Q4.

Thanks Mark. Total revenue for the third quarter of 2020 was a record-setting $22.2 million and a 7% increase compared to $20.7 million for the same period last year. U.S. revenue for the third quarter of 2020 was $19.6 million, a 17% increase compared to $16.8 million for the same period last year, representing 88% of total revenue. International revenue for the third quarter of 2020 was $2.6 million, a 34% decrease compared to $4.0 million for the same period last year, representing 12% of total revenue. With domestic sales growth accelerating during the third quarter, we are very encouraged that we could build on the momentum we carry from earlier in the summer. Outside of the U.S., as Mark mentioned, with fewer stand-alone pediatric hospitals, the ex-U.S. procedure trends are taking longer to normalize and recovery in the international market continues to lag the recovery we’ve seen in the U.S., which also has resulted in little to no set sales to our stocking distributors outside of the U.S. That being said, international performance was strongest in EMEA and Asia Pacific, particularly with the sales of our sales agencies. The recovery overseas is also more variable, with Latin America a lagging performer for OP during the third quarter. Our third quarter revenue breakdown by product category was as follows: Trauma & Deformity revenue was $15.0 million, an 8% increase compared to $13.8 million in the same period last year. Strong growth in trauma continued to drive domestic sales, with encouraging signs of recovery seen in elective deformity surgeries. Scoliosis revenue in the third quarter of 2020 was $6.6 million, a 1.3% increase compared to $6.5 million in the same period last year, and as Mark mentioned, our domestic Scoliosis business showed improvement during the latest quarter. Lastly, Sports Medicine/Other revenue in the third quarter of 2020 was $0.7 million, representing a 56% increase over the $0.4 million in the same period last year. Telos continues to perform very strongly. As mentioned earlier, the U.S. growth rate of Trauma & Deformity and Scoliosis grew in line with our overall domestic growth of 17%. Moving down the income statement, gross profit for the third quarter of 2020 was $17.6 million, an 11% increase compared to $15.9 million for the same period last year. Gross profit margin for the third quarter of 2020 was 79.4%, compared to 76.6% for the same period last year. The strength in gross margin was driven by a large percentage of domestic and OUS agency sales with little to no set sales to our OUS stocking distributors as a result of COVID. Sales and marketing expenses in the third quarter of 2020 increased 5% to $9.2 million, compared to $8.8 million in the same period last year. This was driven by an increase in unit volumes sold and associated commissions in the U.S. and international markets with sales agencies. General and administrative expenses in the third quarter of 2020 were $9.8 million, an increase of 35% over $7.3 million in the third quarter of 2019. The increase in expense was primarily driven by the increased non-cash stock compensation, depreciation and amortization expenses, as well as the addition of ApiFix and Telos G&A. Research and development expense of $1.1 million in the third quarter of 2020 was a decrease of 23% from $1.4 million in the third quarter of 2019. Total operating expenses in the third quarter of 2020 were $20.1 million, compared to $17.4 million for the same period last year. Operating loss in the third quarter of 2020 was $2.5 million compared to a loss of $1.5 million in the third quarter of 2019. Adjusted EBITDA for the third quarter of 2020 was a record-setting $1.1 million, compared to $0.7 million for the third quarter of 2019. This performance was achieved in the middle of a global pandemic, with single-digit overall sales growth, and was the result of effective cost containment across all aspects of our business combined with continued strategic investments in the business, which will drive future growth. Interest expense in the third quarter was $1.0 million, compared to $1.3 million in the same period last year. The $1 million expense in the current quarter includes $0.8 million for the accretion of the ApiFix acquisition installment payments. Effectively, this is the difference between the net present value of the liability and the total anticipated value expected to be paid in the future. Separately, from interest expense, we also had a non-cash charge and other expense for the fair value adjustments of contingent considerations of $900,000 associated with the ApiFix year four payment, which is based on sales performance. Net loss from continued operations for the third quarter of 2020 was $4.5 million, compared to a net loss of $2.9 million in the same period last year. Net loss per share in the third quarter of 2020 was $0.24 per basic and diluted share, compared to $0.18 per basic and diluted share in the same period last year. Turning to our balance sheet, as of September 30 2020, our cash and restricted cash was $89.7 million, compared to $114.4 million as of June 30, 2020. Related to our debt on July 15 2020, we repaid our $20 million principal amount outstanding under our term loan agreement together with all unpaid interest and other related amounts payable. And currently, we have no outstanding long-term debt. We also expanded our $15 million revolving credit facility up to $25 million, and extended the expiration date from January of 2023 to January of 2024 at a 10% interest rate, with the full $25 million currently available to us. The change in property and equipment during the third quarter of 2020 was $1.3 million, which compares to $2.0 million during the same period last year, reflecting a decrease in construction and process, which includes partial sets waiting to be deployed. Including implants, $4.0 million of consigned sets were deployed during the quarter, compared to $1.7 million during the third quarter of 2019. Year-to-date, we have now deployed $13.1 million of sets, compared to $13.7 million in 2019. We now turn to our outlook. Regarding our performance during the last quarter of 2020, the Company expects overall sales growth in the fourth quarter to be similar to the third quarter of 2020. Fourth quarter sales growth in the U.S. is expected to accelerate slightly, while the international sales decline in the fourth quarter should be similar to that of the third quarter. As we discussed, the recovery overseas is lagging the domestic market, and performance by geography is uneven, particularly in Latin America. As we continue into the remainder of the fall and eye the winter months, there is also the continued dynamic of the pandemic to consider both in the U.S. and abroad. As we continue to advance our strategic review and planning sessions, we see a number of tailwinds benefiting growth in 2021. These include robust ApiFix growth that will start to have a significant impact on our revenue. We expect Orthex conversions will continue to accelerate, both here and in Europe. Individually packaged sterile products will be launched in Europe. We will convert at least three EMEA stocking distributors to sales agencies with a doubling of revenue and gross margins in those countries. And the Company expects to continue to gain share OUS as well as within the major pediatric centers in the U.S. Consequently, while the pandemic environment will continue to evolve and potentially in unexpected ways, our proven business model, consistent and strong execution, continued focus on cost containment, and our strong balance sheet all combine to provide us confidence in the future.

Let me now turn the call over to Fred for some final comments. Thanks, Fred. In conclusion, the past nine months have been a strong reminder of how fortunate we are to serve the surgeons and healthcare providers we are proud to call our customers. We have unbounded admiration for their sacrifices as they put their lives on the line to improve the lives of children. I'd also like to thank our associates throughout the world for their personal leadership that has allowed us to treat more than 188,000 children since 2008. I'm confident that our consistent execution will continue strengthening OrthoPediatrics' leading market position in pediatric orthopedics, and I'm confident that we will emerge from the COVID pandemic even stronger than when we entered it. With that, let's turn the call over to your questions, please.

Thank you. Our first question will come from Ryan Zimmerman at BTIG.

Thank you. Good morning, everyone.

Hey, Ryan, how are you doing?

Good. Thank you. I just want to follow-up on a couple of dynamics that you've talked about. One, I think at our recent investor meetings, you talked about the dynamic in the fall, where the Scoliosis season was extended into the fall a little bit, typically done in summer. And so, I'm wondering, Mark, if you can give some commentary and thoughts around how that is playing out and what that says, maybe, about the durability or the seasonality you expect going forward here? And what it could suggest for the fourth quarter around scoliosis? And then I have a follow-up.

Certainly, Ryan. Dave Bailey has actually been talking to a number of our scoliosis surgeons personally on this issue. Dave?

Hey, Ryan, how are you? I think what we are seeing is a bit of a tail on the summer scoliosis season. We started to see that tail continue to pick up through the balance of the end of summer and early into the fall. While it's too early to determine what the long-term ramifications are of COVID in terms of the seasonality of our business. I think what we can say is that we're very pleased with the rate of surgeon adoption of our products in the scoliosis space. And we are starting to see a bit of a ramp into the back few months of the year here that would probably signal that we're picking up some of those cases that weren't done during the normal scoliosis season in the summer.

That's helpful. Regarding the initiative to offer individually packed sterile products, has there been a competitive change that prompted your interest in developing that product portfolio? I'm curious because we've observed this trend in other markets and with some competitors. Are you now pursuing it more aggressively, especially in the European market, and what are the driving factors behind that?

I think Dave and I can both comment on that. Very quickly, my observation has been this is something we've been working on for three years and has been an enormous undertaking in terms of finding the appropriate people who have been sterilized and configuring products and gaining regulatory approval to make that happen. This has been something that has been in demand in Europe for some time.

Yes. Ryan, at this stage this is primarily a European issue for us. As Mark mentioned, we have been working on this for several years, engaging various accounts, and there are countries currently seeking our products. One requirement for our products is that they must be individually sterile packed. While I'm not sure if the surgeons are specifically asking for this, I believe regulations will require it in the future. We wanted to proactively address this demand in Europe, which is why we've made the necessary investments. We are pleased to be nearing the completion of our capacity to sterilize these products and deliver them to our customers in Europe. There is no demand in the United States for individually sterile-packaged products, except in certain systems where we could benefit from having just the implants sterile for some of our larger kits. Over the coming years, you may see a diversification in our portfolio, where some instrument sets might be non-sterile while some implants might be sterile, which is common in the industry. However, we see limited to no demand for such products within domestic children's hospitals.

Got it. Okay. And then just one more for Fred; I don't want to leave him out. The gross margins were clearly impacted by the reduced set purchases internationally, and it seems that trend will continue at least into the fourth quarter. Following that, Fred, should we expect gross margins to return to more normalized levels, closer to the mid-seventies as we move into 2021, given that you anticipate stocking distributors purchasing sets at potentially lower margins? Thanks for taking the questions, guys.

Yes, Ryan, thanks for including me. The third quarter is always our highest gross margin when you look back in history, because the revenue is always the highest in the third quarter. And then traditionally, the fourth quarter revenue is always a little softer. And so the margins will come down a little bit in the fourth quarter. With that being said, we do anticipate that in 2021, we will get the benefit of the more sales coming from our agencies outside of the U.S. So while 2020 has been a little unusual with the limited set sales, we do think that we can continue kind of the 76%-ish, plus or minus, gross margin next year, which is similar to what we're going to see this year as we do increase agency sales and at the same time start to sell sets at the zero margin that we've done historically.

Understood. Thank you.

Thank you, Ryan.

And our next question will come from the line of Dave Turkaly, JMP Securities.

Good morning, everyone. Congratulations on the domestic recovery. I wanted to hear your thoughts quickly. You mentioned some concerns regarding COVID hotspots. Are you experiencing anything recently that makes you more apprehensive domestically? What are your expectations for Q4 regarding the possibility of elective procedures being postponed or hospitals shutting down again?

So far we're not seeing that occurring. And I think that we're simply guarded as to what the future might bring. I think we would agree with others who observed that hospital stays generally are now shorter, treatment is more robust for COVID patients, and we continue to, of course, see the majority of our business occurring in pediatric hospitals that would be unaffected. Internationally, it is a different story. In the U.K., there has begun yesterday a lockdown, a circuit breaker for the situation and that will impact the surgeries in non-pediatric centers. Italy, France, Spain are not quite as bad, but that is occurring there as well. So, internationally, we're much more guarded with regard to the impact of deferral of elective surgeries.

Got it. And you mentioned the three conversions that are likely to happen. I was just wondering if you could comment on how many others are there that you could look to do, let's say, over the next couple of years?

Yes, Dave. It's Dave Bailey. I think that there are others. I think these three are probably the big ones for us at the moment, and so, we've really focused our attention on ensuring that we can get these accomplished, have been in the works all year. And as you can imagine, this isn't a simple process and it isn't aided frankly by COVID environment or traveling outside of the United States has been very difficult. So the great majority of our focus has been on getting these three done. And I think we'll be very pleased to have that accomplished here by year-end or end of the first quarter. And I think those three markets will have a substantially larger impact than any of the other markets at least in the short term that we may choose to take toward the agency model. That said, there are others, those would primarily be other substantial markets in Western Europe, and we are in early discussions with a few others. We may see the opportunity to do this with one or two Middle Eastern markets, but at this time, our heavy focus is really on these three markets in Europe that I think will substantially benefit us in 2021.

Thank you.

Thanks, Dave.

Thank you. Our next question is going to come from the line of Mike Matson with Needham & Company.

Good morning. Thanks for taking my questions. I guess I wanted to start with the international business, the decline that you saw there. Obviously, there is some procedural impact, but I was wondering if you could quantify or have a feel for the difference in the kind of destocking/set sales impact versus the actual procedure decline that happened there or maybe just don't have visibility of that?

We are very pleased with the growth we experienced in our agency sales, which were up 26%. This is encouraging for us. The significant reduction year-over-year primarily resulted from the decline in set sales that we typically see, as our small independent stocking distributors have been affected by COVID and are working to stabilize their cash flow before reinvesting in their business. While we believe overall demand is lower in the U.S. due to various hotspots where activity has slowed, the year-over-year reduction is mostly attributable to the drop in set sales. Additionally, currency fluctuations in Brazil have impacted our business, with the real currently around 5.7 compared to approximately 3.5 a year ago, creating a notable increase in the cost of U.S. products sold in Brazil.

Thank you, that's helpful. Regarding the shift to this supplier, which accounts for 80% of your manufacturing, has this positively impacted your gross margin or do you anticipate it will, and can you provide an estimate of the expected impact?

I think it'd be my perspective that we are not doing this to improve gross margin as much as we're doing this to improve responsiveness and the control over quality, because this is a supplier just 40 minutes from our facility here in Warsaw, Indiana. Fred, do you have any sense as to whether there is a material gross margin impact here?

Yes. I completely agree. The main focus here is speed and getting product, particularly around our launches. But with that being said, our overall dramatic increase in volume to where we were three years ago has earned us volume discounts, particularly with this one supplier, which has helped our gross margin a little bit, but more importantly, it's reduced the amount of capital needed to deploy new sets into the marketplace. So, for example, that $13 million that we deployed this year may be cost us $14 million three years ago, if you look at the cost we're paying today to what we paid historically.

Okay. That makes sense. And then just in terms of the M&A pipeline, I didn't hear as much commentary on that. I know you've got a few deals. So maybe you're going to digest those, but what's the outlook there? And did the pandemic help or hurt the M&A prospects, companies out there that are willing to sell and pricing, things like that? Thanks.

Yes, Mike. I agree with your assessment that we need to integrate some of the technologies we've acquired over the past few years. We saw significant growth in the Orthex business, and we're still actively launching and training our sales team. As for ApiFix, we're just at the beginning stages. Although the acquisition process itself wasn't complex, launching the product in the U.S. and globally requires a lot of effort. Therefore, you shouldn't expect any major developments in the short term. There may be some minor additions, especially in external fixation. We are confident in our position with the Orthex Hexapod and see potential for some small enhancements that could improve our market standing. We're also open to partnerships, particularly in digitizing the operating room and developing navigation and planning solutions. Our strategy in pediatrics is quite different from that of the adult market, and we're continually discussing how to align with that. However, there are no significant changes anticipated in the near term.

Okay. Thank you.

Thanks, Mike.

Thank you. Our next question will come from the line of Matt O'Brien with Piper Sandler.

Thanks. Good morning. Thanks for taking the questions. And I'll start with Fred to make sure he doesn't feel left out at all.

Excellent.

Thank you. Of course, Fred, so you made a lot of comments about your confidence in 2021 with the set deployments and new products and ApiFix and conversions of distributors to direct. As I look at the Street numbers for next year, essentially, we're assuming that you get all the revenue you lost this year back next year and then you also grow again around that 20% level for next year. So, just not wanting to get too much into the guidance for next year right now, but just from a set perspective and from a personnel perspective, can you deliver that type of performance next year where you're getting close to $100 million in sales?

Yes. I think the message was just relaying how strong we feel about the confidence in our business and our business model. Obviously, we have to react and our results will be based on COVID, both domestically and outside of the U.S. and we can't predict that; nobody can. But regardless of COVID, we're very confident in our ability to continue to grow the business. We have many, many really positive growth drivers that we're going to be coming online here next year. And we're going to do very well to continue to take share both domestically and outside of the U.S. You're right, I don't want to get into predicting next year's revenue at this time, but I think the message is just clear that we're very, very confident, we're very pleased with the progress we've made this year in moving the business forward in strengthening the business model, and that's going to continue to benefit us in the long term and we'll really start to see some of that kick in next year in 2021.

Got it. Okay. Fred, regarding the instrument set side, what are your thoughts on set deployments looking ahead? In Q3, you've shown growth, but year-to-date you're about flat. Should we expect an increase in set deployment in Q4 and into next year compared to 2020? Also, can you discuss the productivity of those sets? I have one more follow-up for either Mark or Dave. Thanks.

Absolutely. Yes. So it's $13.1 million compared to $13.7 million, which is consistent with last year at this time. We expect to continue rolling out more sets in the fourth quarter as we invest in these products. Much of our focus is on new products that have been developed or launched over the last couple of years, and we are encouraged by getting more of those sets into the market. Some of these efforts are also aimed at our agency countries outside of the U.S., which we are investing in and growing. We anticipate that this growth will continue at a similar pace into next year. What’s particularly promising is our developments with ApiFix and Orthex; both systems are very capital efficient. As these systems increase their share of our sales, we believe the need for capital investment will decrease, which is a positive outlook for us starting next year and beyond. The returns we are observing are impacted by the trailing 12-month sales analysis, and the softness in second-quarter sales skews the overall return. However, we are very pleased with the returns from all sets, especially the new products being adopted. Mark mentioned systems like PNP, Cannulated Screw, and PediFoots, which are experiencing strong adoption and driving demand for additional sets. We will continue to deploy these sets this year and into next year.

That's really encouraging. For either Mark or Dave, could you discuss the 20 IRB sites related to ApiFix? Are they all existing customers, or do any of them represent new customers for OrthoPediatrics due to ApiFix? If they are all existing customers, have any traditionally been smaller clients that might transform into significantly larger customers for OrthoPediatrics because of ApiFix? Thank you.

It's a mix, Matt. There are some existing customers, there are a number of new customers. Most interesting to me is there are a number of new surgeons who have never used OrthoPediatrics' response system. And so we would expect over time that there would be a pull-through of our conventional scoliosis fusion technology as these surgeons get to know us as a supplier and they see the outstanding service that our sales representatives might provide them. Do you have any other comments, Dave, more specifically?

Yes, Matt. We are very optimistic about the chance to engage several response cases from these accounts in the coming years. I would estimate that more than half of these accounts are not currently utilizing the response system. Additionally, there are a significant number of well-known key opinion leaders among these accounts. Although they may be using our trauma and limb deformity products, they have not engaged actively with the response system in the past. In some of these cases, we have faced challenges in getting our product or the response product approved due to their existing contracts with suppliers like Medtronic or DePuy. However, we are in a favorable position now because the ApiFix device necessitates the use of two response screws. Therefore, for the ApiFix device to be used at an IRB site, that site must also approve the response system for contractual use. This scenario provides our sales team with excellent opportunities to approach large key accounts that we have previously been unable to access due to contracting issues. This was one of the key short-term motivations behind acquiring ApiFix, in addition to its potential impact on children's lives through a non-fusion technique.

That's very helpful. Thank you so much.

Thanks, Matt.

Thank you. And at this time, we have no further questions.

Okay. Very good. Well, let me just close by thanking all of you for joining us today. We appreciate your interest in OrthoPediatrics and of course your support for the cause of helping kids throughout the world. So we hope everyone has a safe and healthy holiday season. And we're looking very much forward to updating you on our future progress. So, everyone, please have a good day.

Thank you, ladies and gentlemen. This does conclude today's conference. You may now disconnect.