Orthofix Medical Inc. — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019. Orthofix is a global musculoskeletal medical-device company with Global Spine and Global Extremities reporting segments. Amounts below are in U.S. dollars; financial statement figures are in millions unless otherwise stated.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $115.9 | $111.5 | $225.0 | $220.3 |
| Gross profit / margin | $90.0 / 77.7% | $88.7 / 79.5% | $175.4 / 78.0% | $173.3 / 78.7% |
| Operating income (loss) | $0.5 | $5.9 | $(4.0) | $13.8 |
| Net income (loss) | $(0.5) | $0.9 | $0.4 | $6.2 |
| EBITDA | $6.4 | $6.8 | $7.3 | $22.0 |
| Operating cash flow | Not separately presented for Q2 | $8.3 | $13.0 | |
| Free cash flow | Not separately presented for Q2 | $(2.0) | $6.4 |
Q2 sales increased 3.9% reported and 5.0% at constant currency; first-half sales rose 2.1% reported and 3.5% at constant currency. Q2 Global Spine sales grew 3.8%, led by Biologics (+14.2%); Global Extremities grew 4.0%. For the first half, Global Spine grew 4.8%, while Global Extremities declined 6.4% reported (down 1.4% at constant currency).
At June 30, cash and cash equivalents were $52.1, down from $69.6 at year-end 2018; total current assets were $232.8 and current liabilities $68.0. Total liabilities were $141.0. There were no borrowings under the $125 million revolving facility or the available Italian credit lines, and the company reported compliance with financial covenants. Lease liabilities totaled $27.6, including $21.1 classified as finance leases. Six-month capital expenditures were $10.3.
Material changes and unusual items
- Gross margin contracted 1.8 percentage points in Q2 and 0.7 points for the first half. Management attributed much of the pressure to higher-than-normal costs from building Spinal Implants inventory for new sales partners.
- Sales and marketing expense rose 10.4% in Q2 and 8.6% year to date, reflecting added headcount, training, marketing for the M6-C disc launch, and higher Biologics variable compensation. R&D expense rose 13.8% in Q2 and 22.8% year to date.
- Acquisition-related amortization and remeasurement was $8.3 for the first half, versus $1.5 a year earlier, including a $5.9 increase in the fair value of Spinal Kinetics contingent consideration. The M6-C FDA approval triggered a $15.0 milestone, paid in February; remaining revenue-based milestone liability was $19.4 at June 30, with actual payments potentially higher or lower.
- The first-half income tax benefit was $4.8 despite a $4.4 pretax loss, including a $1.8 benefit from settlement of the 2015 IRS examination. Q2 recorded tax expense of $1.2 on pretax income of $0.7.
- Cash declined by $20.0 in the first half, principally reflecting the $15.0 milestone payment and $6.4 Options Medical asset acquisition. First-half free cash flow was negative $2.0, compared with positive $6.4 in 2018.
- Adoption of lease accounting added approximately $20.2 of lease assets and $20.5 of lease liabilities at January 1, 2019. The corporate headquarters lease was reclassified as a finance lease during Q1.
Outlook, commentary, and risks
The filing provides no quantified full-year revenue or earnings guidance. Management said it expects disruption in legacy Spinal Implants sales to lessen as new distributors gain traction. It highlighted Biologics growth and reported, citing SmartTRAK, that Orthofix believed it had the leading U.S. cellular allograft market share. The M6-C disc received FDA approval in February 2019; launch-related selling and research costs increased.
- Orthofix accrued $4.3 for the Italian Medical Device Payback measure; the rules and implementation remain uncertain, and the ultimate liability may differ.
- In Brazil, approximately $2.5 of frozen cash was released in April 2019. The filing describes the wider investigation into tender irregularities but does not report a final resolution of the investigation.
- The eNeura debt was restructured, extending maturity to no later than March 2022 under specified events. Recoverability depends on estimated future collections; lower collections could cause impairment.
- Management identified estimates involving contingent consideration, litigation, tax matters, receivables, inventory, and asset valuations as areas where actual results may differ. The company reported effective disclosure controls and no material change in internal controls; it reported no material changes to previously disclosed risk factors.
Key facts for investors to verify
- Whether distributor transitions and the M6-C launch translate into sustained Spinal Implants growth, and whether inventory-related margin pressure eases.
- Whether Biologics growth continues and Global Extremities stabilizes, particularly after its first-half decline.
- Future cash generation and spending, including the remaining Spinal Kinetics revenue milestones and capital expenditures.
- Final scope and cost of Italy’s payback measure, the status of the Brazil inquiry, and collection assumptions for the eNeura debt.
- The sustainability of reported earnings given acquisition remeasurement charges, executive-transition compensation, and the significant first-half tax benefit.