Orthofix International N.V. — Q3 2015 Form 10-Q
Reporting period: Three and nine months ended September 30, 2015. The filing identifies the registrant as Orthofix International N.V.; the company metadata refers to Orthofix Medical Inc. Amounts below are in U.S. dollars, millions, unless otherwise stated.
Financial performance
| Metric | Q3 2015 | Q3 2014 | First 9 months 2015 | First 9 months 2014 |
|---|---|---|---|---|
| Net sales | $101.2 | $101.0 | $291.9 | $302.0 |
| Gross profit / margin | $77.3 / 76.4% | $75.7 / 75.0% | $226.8 / 77.7% | $224.5 / 74.4% |
| Operating income / margin | $4.1 / 4.2% | $6.5 / 6.5% | $1.9 / 0.6% | $13.2 / 4.5% |
| Net income (loss) | $(1.4) | $0.5 | $(6.2) | $(2.7) |
| Operating cash flow | Not separately presented | Not separately presented | $26.2 | $36.0 |
- Q3 diluted loss per share was $0.07, versus earnings per share of $0.02 a year earlier; nine-month diluted loss per share was $0.33, versus $0.15.
- Q3 sales were nearly flat as reported but increased 4.1% at constant currency. Nine-month sales fell 3.4% as reported but rose 0.6% at constant currency.
- Cash and cash equivalents were $63.7 at September 30, compared with $36.8 at year-end 2014. The year-end balance also included $34.4 of restricted cash, which was released during 2015. Total assets were $402.4; current liabilities were $78.6; total liabilities were $105.2.
- Operating cash flow declined $9.7 year over year for the first nine months. Investing used $31.6, including the eNeura investment and higher capital spending; financing provided $34.7, largely reflecting release of restricted cash.
- The company had no borrowings under its new credit facility at quarter-end. It entered a five-year, secured $125.0 million revolving facility; it was in compliance with its financial covenants. The Italian credit line was also undrawn.
Material changes and operating drivers
- BioStim sales rose 8.6% in Q3 and 4.4% year to date; Biologics rose 5.7% and 7.8%, respectively. Management attributed growth chiefly to sales-channel expansion.
- Extremity Fixation sales declined 10.6% in Q3 and 12.1% year to date as reported, primarily due to currency translation; constant-currency growth was 3.4% and 2.1%. Brazil remained weak.
- Spine Fixation sales fell 4.5% in Q3 and 13.1% year to date, primarily due to disruption following restructuring and investment in the domestic sales channel.
- Gross margin improved, supported by product mix, foreign exchange and lower costs; nine-month 2014 cost of sales also included $1.9 of inventory shrinkage charges.
- Operating expenses increased $3.9 in Q3 and $13.5 year to date. Sales and marketing rose with sales-force expansion, commissions and higher bad-debt provisions; G&A rose year to date with finance staffing, professional fees, Bluecore infrastructure and a legal judgment. Restatement-related costs declined year over year.
Outlook, risks and unusual items
- No quantified full-year revenue or earnings guidance is provided. Management said it expected to complete its 2015 sales-channel optimization by year-end, then move to more moderate sales-force expansion. Seven significant products had launched during the first nine months; additional spine products were targeted for 2016.
- Project Bluecore, a multi-year systems and controls initiative, remained on schedule and within budget; U.S. ERP implementation was expected in Q2 2016, with rollout elsewhere continuing into 2017. The company spent $16.9 on the initiative in the first nine months, of which $12.2 was capitalized.
- Puerto Rico fiscal and economic difficulties led to a $2.0 increase in Q3 bad-debt expense and a valuation allowance on net deferred tax assets. The company expected near-term Puerto Rico government-customer revenue to decline after changing recognition to when cash is received, effective October 1, 2015.
- Continuing-operations tax expense was $3.1 in Q3 and $5.8 year to date; reported effective tax rates were 134.6% and 427.0%, respectively. Management cited discrete items, jurisdictional earnings mix, Puerto Rico and losses in jurisdictions where no tax benefit was recognized.
- The company invested $15.0 in an 8% eNeura convertible note and paid a $0.3 option fee for an exclusive acquisition option through September 2016. The note and accrued interest were carried at $15.7 using Level 3 fair-value inputs; interest would be forgiven if the option were exercised.
- A securities class action settlement was agreed in principle in October 2015, subject to final documentation and court approval. The company accrued the settlement and a matching insurance receivable and expected insurers to cover the payment; finalization and approval were not assured.
- The DOJ extended the deferred prosecution agreement through July 17, 2016, stating that compliance efforts had been insufficient. The company could not estimate potential losses relating to the Brazil subsidiary review or the agreement. The SEC investigation into prior accounting matters also remained unresolved, with no reasonably estimable loss range.
- Other exposures include Breg-related product-liability indemnities; the company reported a $5.7 accrual for specified cold-therapy liabilities and could not estimate possible losses for certain cases. It also had $15.5 of unrecognized tax benefits and ongoing IRS and Massachusetts tax examinations.
- Management concluded disclosure controls were ineffective at September 30, 2015 because material weaknesses in internal control over financial reporting continued, including areas involving revenue recognition, receivables, inventory, foreign-subsidiary oversight and manual journal entries. Remediation was ongoing.
- The board had authorized up to $75.0 of share repurchases through September 2017; no shares were repurchased in Q3. The authorization does not obligate the company to buy shares.
Most important facts for investors to verify
- Whether the company completes remediation of material weaknesses and restores effective disclosure controls.
- Progress and final outcome of the DOJ/DPA and Brazil review, the SEC investigation and the class-action settlement, including insurer coverage and court approval.
- Collectability of receivables, particularly in Puerto Rico and Brazil, and the effect of cash-basis revenue recognition for Puerto Rico government customers.
- Whether sales-channel investment reverses weakness in Spine Fixation and supports sustained constant-currency growth without further margin pressure.
- Liquidity and covenant headroom under the new secured facility, alongside planned capital spending, Bluecore costs and any share repurchases.
- Valuation and strategic outcome of the eNeura note and acquisition option, which depend on significant unobservable inputs.