Orthofix International N.V. — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2013. The filing was signed March 24, 2014, following substantial filing delays. Amounts below are U.S. dollars; financial statements are unaudited. Comparative 2012 figures are restated.
Business context and reporting period
Orthofix is a global medical-device company focused on spine and orthopedic repair and regenerative products. It reports two business units: Spine and Orthopedics. The filing reports the former Sports Medicine business, including Breg, as discontinued operations following its 2012 sale.
Financial results and liquidity
| Metric | Q2 2013 | Q2 2012, restated | Six months 2013 | Six months 2012, restated |
|---|---|---|---|---|
| Net sales | $98.3 million | $113.4 million | $201.7 million | $222.4 million |
| Gross profit / margin | $78.0 million / 79.4% | $85.9 million / 75.7% | $155.8 million / 77.3% | $173.4 million / 78.0% |
| Operating income | $8.8 million | $14.3 million | $16.9 million | $32.2 million |
| Continuing-operations net income | $4.1 million | $9.9 million | $11.7 million | $18.5 million |
| Consolidated net income (loss) | $(2.3) million | $7.3 million | $2.2 million | $16.7 million |
| Operating cash flow | Not stated quarterly | Not stated quarterly | $34.2 million | $57.8 million |
- Q2 diluted loss per share was $0.12; first-half diluted earnings per share were $0.11. Discontinued operations produced after-tax losses of $6.4 million in Q2 and $9.6 million for the first half, mainly reflecting Breg-related indemnification matters.
- At June 30, cash and cash equivalents were $27.4 million and restricted cash was $20.6 million. Total current assets were $296.4 million; current liabilities were $71.6 million.
- Long-term debt was $20.0 million, outstanding under the secured revolving credit facility; the term loan had been repaid. The revolving facility’s effective rate was 2.7%, with the balance due August 30, 2015. The company also had an unused Italian credit line of approximately $7.5 million.
- First-half investing cash outflow was $13.5 million, including $13.5 million of capital expenditures. Financing cash outflow was $23.9 million, including $26.9 million of share repurchases. Cash and cash equivalents declined $3.7 million during the period.
Material changes versus the prior comparable period
- Net sales declined 13% in Q2 (12% at constant currency) and 9% for the first half (10% at constant currency). Management attributed the overall weakness primarily to lower Spine regenerative-stimulation sales and, in Orthopedics, the prospective change to sell-through distributor revenue recognition beginning April 1, 2013.
- Q2 Spine sales fell 12%; Spine regenerative stimulation sales fell 18%. First-half Spine sales fell 8%, while repair implants and regenerative biologics increased 1%.
- Orthopedics sales declined 17% in Q2 and 12% in the first half. The filing says the new sell-through method caused most of the Q2 decline.
- Operating income and continuing-operations income fell in both periods. Q2 gross margin improved to 79.4% from 75.7%, while first-half gross margin decreased to 77.3% from 78.0%. Management cited the lower sales contribution from higher-margin regenerative-stimulation products as a factor in first-half margin pressure.
- First-half operating cash flow decreased to $34.2 million from $57.8 million. Cash from working-capital accounts was $12.3 million, versus $31.3 million a year earlier; the 2012 comparison included Breg-sale-related and escrow movements.
Restatement, outlook, risks and unusual items
- An Audit Committee review led to restatement of previously issued financial statements for 2010–2012 and Q1 2013, and correction of earlier-period errors. For the first half of 2012, the restatement reduced sales by $13.2 million and continuing-operations net income by $7.7 million. For Q2 2012, it reduced sales by $6.1 million and continuing-operations net income by $4.1 million.
- The principal issues included distributor sales recorded before revenue-recognition criteria were met, including undocumented concessions, extended payment terms and return or exchange rights; inventory-reserve errors; and royalty classification. The company adopted sell-through accounting for specified distributor groups and prospectively for remaining Orthopedics distributor arrangements from April 1, 2013.
- Management identified material weaknesses in distributor revenue controls, inventory-reserve controls and oversight of certain foreign subsidiaries. It concluded disclosure controls and internal control over financial reporting were ineffective as of June 30, 2013. Remediation efforts included training, revised sales certification and review procedures, new finance/control roles, and additional internal-audit and external support; the company stated remediation was not complete.
- The company reported legal and compliance exposure involving the accounting review and related proceedings, potential SEC enforcement action, allegations concerning improper payments at its Brazil subsidiary, Nasdaq listing-rule noncompliance, and ongoing obligations under a corporate integrity agreement, probation terms and a deferred prosecution agreement. The filing said there had been no material developments in the legal matters described in the 2012 Form 10-K/A.
- Breg-related indemnification expenses were approximately $8.8 million in Q2 and $12.8 million for the first half before the statement’s net-of-tax presentation. The filing also identifies indemnification obligations related to product-liability and government-investigation matters involving the former business.
- The company was delinquent in filing reports and therefore not in compliance with Nasdaq listing rules. Nasdaq had stayed delisting pending a hearing scheduled for March 27, 2014; the company said it believed it would remedy the noncompliance, but acknowledged delisting remained possible. Lenders granted waivers regarding delivery of Q2 and Q3 2013 financial statements and related covenant certificates. A separate June 2013 waiver addressed the minimum fixed-charge-coverage-ratio requirement for the twelve months ended June 30, 2013.
- Management stated that cash, projected operating cash flow and available credit were expected to cover the next twelve months’ needs, including repurchases and investment. This is not quantified earnings guidance. A $50 million repurchase authorization was announced in May 2013; $26.9 million had been spent by June 30, with a further $12.6 million repurchased afterward, according to the filing.
- Other notable items included $4.4 million received from an insurance-company demutualization, contributing to first-half other income, and foreign-exchange effects. The filing warns that currency, interest-rate, reimbursement, competition, product acceptance and industry conditions could affect results.
Important facts for investors to verify
- Review the contemporaneous 2012 Form 10-K/A and Q1 2013 Form 10-Q/A for the full restatement, prior-period impacts and any additional corrected errors.
- Track whether distributor revenue recognition, inventory reserves and foreign-subsidiary oversight weaknesses were fully remediated and independently tested.
- Confirm the status and outcome of Nasdaq listing compliance and any related hearings, and the timing and terms of lender waivers or covenant requirements.
- Assess the scale, duration and potential cash impact of Breg indemnification obligations and other legal, regulatory and compliance matters.
- Monitor sales trends—especially regenerative stimulation—and the effects of sell-through accounting on reported revenue, receivables, inventory and cash conversion.
- Reconcile unrestricted cash, restricted cash, debt availability and share repurchases when assessing liquidity; restricted cash is not freely available to all parts of the company.