Orthofix Medical Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Orthofix is a global musculoskeletal medical-device company with four reporting segments: Bone Growth Therapies, Spinal Implants, Biologics, and Orthofix Extremities. Unless stated otherwise, financial amounts below are in U.S. dollars, millions.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $111.7 | $105.2 | $332.0 | $316.9 |
| Gross profit / margin | $87.7 / 78.5% | $81.5 / 77.5% | $261.0 / 78.6% | $247.5 / 78.1% |
| Operating income / margin | $3.9 / 3.5% | $9.0 / 8.6% | $17.7 / 5.3% | $23.0 / 7.2% |
| Net income (loss) | $(1.2) | $3.5 | $4.9 | $4.7 |
| Continuing operations diluted EPS | $(0.07) | $0.18 | $0.26 | $0.31 |
- Q3 sales rose 6.1% reported and 6.6% at constant currency; nine-month sales rose 4.7% reported and 3.7% at constant currency.
- Management’s non-GAAP net margin, defined as gross profit less sales and marketing expense, was $37.8 million, or 33.8% of sales, in Q3 versus $34.0 million, or 32.3%. Nine-month non-GAAP net margin was $109.3 million versus $101.0 million.
- Q3 operating income declined despite higher sales and gross margin, reflecting higher general and administrative and research and development expenses and $1.6 million of contingent-consideration remeasurement expense. Q3 other expense included a $4.4 million Bone Biologics investment impairment and foreign-exchange losses.
- Segment sales in Q3: Bone Growth Therapies $48.1 million (+8.2%); Spinal Implants $22.1 million (+9.7%); Biologics $14.6 million (-3.8%); Orthofix Extremities $26.9 million (+5.8%). Biologics was affected by a contractual reduction in MTF marketing fees.
Cash flow, balance sheet, and debt
- Nine-month operating cash flow was $28.8 million, versus $9.1 million in 2017. Capital expenditures were $10.7 million, producing reported free cash flow of $18.1 million versus $(4.2) million. Working-capital changes, including improved inventory management, contributed to the operating cash flow increase.
- Investing cash outflow was $55.9 million, principally reflecting $43.7 million paid net of acquired cash for Spinal Kinetics. Cash, cash equivalents, and restricted cash ended at $56.2 million, down from $81.2 million at year-end 2017; this included $2.5 million of restricted cash.
- At September 30, current assets were $245.0 million and current liabilities were $76.8 million. Total assets were $450.2 million and total liabilities were $126.8 million.
- No borrowings were outstanding under the amended JPMorgan credit agreement or the available €5.8 million Italian credit line. The company reported compliance with financial covenants. The filing reports no material off-balance-sheet arrangements.
Material changes, outlook, and risks
- Spinal Kinetics acquisition: Completed April 30, 2018. Consideration had an acquisition-date fair value of $76.1 million, including $50.6 million cash and $25.5 million estimated contingent consideration. Potential milestone payments are up to $60 million: up to $15 million upon FDA approval of the M6-C cervical disc and up to $45 million tied to future M6-C and M6-L sales. Contingent consideration was valued at $28.2 million at September 30, 2018. Spinal Kinetics contributed $2.9 million of Q3 sales and $2.1 million of loss since acquisition in Q3.
- The company completed its change of jurisdiction from Curaçao to Delaware on July 31, 2018. It adopted Topic 606 revenue accounting using the modified retrospective method; 2017 comparative figures were not restated. Topic 606 increased reported 2018 sales by $2.2 million in Q3 and $7.7 million for the first nine months, so reported growth comparisons are affected by the accounting change.
- Management expected FDA approval of M6-C around mid-2019 and expected completion of the related in-process research and development project around mid-2019. The filing provides no formal company-wide earnings or revenue guidance.
- Other risks and contingencies include the Italian medical-device payback accrual of €3.0 million ($3.5 million), which could change as implementation is clarified, and a Brazilian investigation into tender irregularities. Approximately $2.5 million of Brazilian cash was frozen and reclassified as restricted cash; Orthofix contests the basis for the order and said it did not expect a material loss based on information then available. The company also disclosed continuing indemnification obligations related to former subsidiary Breg.
- Management cited spine business leadership disruption and realignment, distributor-order timing, currency movements, and uncertainty in estimates and contingent consideration as factors affecting results. The company stated that disclosure controls were effective and reported no material changes to risk factors from its 2017 Form 10-K.
Key facts for investors to verify
- Underlying sales growth and comparability after the Topic 606 transition, including the effect of stocking-distributor revenue recognition.
- Spinal Kinetics integration, FDA approval progress for M6-C, and the assumptions and potential cash payments behind contingent consideration of up to $60 million.
- Drivers of weaker GAAP operating income and the possibility of further investment impairments, foreign-exchange losses, or contingent-consideration remeasurement.
- Resolution and financial impact of the Brazilian investigation and Italian payback measure, as well as the status of the Breg-related indemnification matters.
- Cash generation and liquidity after the acquisition, including the use and availability of restricted cash and undrawn credit facilities.