Orthofix International N.V. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. The filing identifies the registrant as Orthofix International N.V., a global medical-device company with BioStim, Biologics, Extremity Fixation, and Spine Fixation reporting segments. Unless noted otherwise, amounts below are U.S. dollars.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $105.2 million | $98.5 million | $316.9 million | $301.3 million |
| Gross profit / margin | $81.5 million / 77.5% | $78.6 million / 79.8% | $247.5 million / 78.1% | $236.7 million / 78.6% |
| Operating income | $9.0 million | $9.3 million | $23.0 million | $13.7 million |
| Net income | $3.5 million | $9.9 million | $4.7 million | $6.3 million |
| Diluted EPS | $0.19 | $0.54 | $0.25 | $0.34 |
- Q3 sales grew 6.9% reported and 6.0% at constant currency; nine-month sales grew 5.2%. All four segments grew in Q3. Spine Fixation led with 19.3% Q3 growth; nine-month growth was 12.6%. Extremity Fixation nine-month sales declined 2.2%.
- Sales and marketing expense rose 13.8% in Q3 and 10.5% year to date, outpacing sales growth. The company’s non-GAAP net margin—gross profit less sales and marketing—fell 7.8% in Q3 to $34.0 million and 3.1% year to date to $101.0 million. Its percentage of sales declined to 32.3% from 37.5% in Q3 and to 31.9% from 34.6% year to date.
- Operating income improved year to date principally because the comparable 2016 period included $14.4 million of U.S. Government-resolution charges, absent in 2017. Q3 operating income was slightly lower year over year.
- Net income was affected by higher income-tax expense and a $5.6 million pretax impairment of the eNeura debt security recorded in Q1 2017. The security’s reported fair value was $9.0 million versus an amortized cost basis of $18.4 million.
Cash flow, liquidity, and debt
- Cash and cash equivalents were $53.9 million at September 30, 2017, versus $39.6 million at year-end 2016; restricted cash declined from $14.4 million to zero. Current assets were $213.4 million and current liabilities $74.1 million, an approximately 2.9x current ratio.
- Nine-month operating cash flow was $23.5 million, down from $38.4 million; capital expenditures were $13.3 million, producing reported free cash flow of $10.2 million versus $24.1 million. Management cited working-capital changes, particularly increased inventory and receivables. Inventory was $80.1 million versus $63.3 million at year-end; days sales in receivables were 53 versus 49 a year earlier.
- No borrowings were outstanding under the $125 million secured revolving facility or the approximately $6.9 million Italian credit line. The company reported compliance with required financial covenants. Total liabilities were $101.0 million; the filing reports no material changes to debt instruments.
Material changes, outlook, and risks
- Q3 sales growth reflected increased sales across all segments, including U.S. Spine Fixation growth attributed to new distributor partners and product uptake. Management cited hurricane impacts in Florida and southern Texas as a partial offset to BioStim growth. Extremity Fixation results also reflected restructuring and conversion to stocking distributors in Brazil and Puerto Rico.
- Sales and marketing costs increased with commissions, geographic mix, and rates from new distributors. Gross margin was pressured by product mix, inventory-related charges, distributor conversions, and $0.6 million of nonrecurring U.S. restructuring expense.
- A U.S. corporate shared-services restructuring approved in September carried estimated pretax costs of $1.8 million, all recorded in Q3 and accrued at quarter-end. The earlier Extremity Fixation plan had incurred $2.4 million cumulatively against expected total costs of about $3.1 million.
- The company reported no new financial guidance in the provided filing text. It warned that interim results are not necessarily indicative of full-year results. Effective tax rates were elevated and subject to jurisdictional earnings mix, unrecognized tax benefits, and losses in jurisdictions where no tax benefit was recognized. The IRS was examining 2012 and 2013 federal returns; the potential impact was not reasonably determinable.
- A post-sale Breg cold-therapy product-liability claim remained pending; the company had accrued $1.8 million, but the ultimate liability could be higher or lower. In October 2017, HHS-OIG confirmed the company had satisfied and completed its five-year Corporate Integrity Agreement. The SEC settlements relating to previously self-reported matters were approved in January 2017 and resolved those matters.
- Revenue-recognition guidance effective January 1, 2018 was expected to materially change timing for certain stocking-distributor sales, with significant increases in receivables and decreases in inventory and a retained-earnings adjustment expected at adoption. The company also expected lease accounting guidance to materially increase balance-sheet lease obligations.
- Management reported effective disclosure controls as of September 30, 2017 and no material changes in internal control during the quarter. The filing reported no material changes to previously disclosed risk factors.
Important facts for investors to verify
- How adoption of the new revenue standard changes reported revenue, receivables, inventory, and opening retained earnings, particularly for stocking-distributor sales.
- Whether sales growth can translate into improved gross margin and non-GAAP net margin given higher selling costs and segment mix.
- Whether elevated inventory and receivables convert to cash; operating cash flow and free cash flow fell substantially year over year.
- The resolution and ultimate cost of the pending Breg claim, and the outcome of the IRS examinations and related tax uncertainties.
- The filing presents inconsistent year-to-date effective tax-rate figures: the financial statements and tax note indicate 70.8%, while the MD&A table shows 78.8%. The clear value should be confirmed against the filed financial statements.