Orthofix International N.V. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; unaudited, U.S. GAAP. The filing registrant is Orthofix International N.V. (the request identifies Orthofix Medical Inc.). Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions where applicable.
Business context and results
Orthofix develops and sells medical devices and related products for spine and orthopedic markets. Its continuing operations report two business units: Spine and Orthopedics. The former Sports Medicine business, including Breg, is presented as discontinued operations following its 2012 sale.
- Net sales were $100.3 million, down 14% reported and 13% at constant currency from $116.0 million. Product sales declined to $88.4 million; marketing service fees rose to $11.9 million.
- Spine sales fell 12% to $66.3 million; Orthopedics sales fell 17% reported (16% constant currency) to $33.9 million.
- Gross profit was $77.6 million versus $94.1 million; gross margin declined to 77% from 81%.
- Operating income was $4.0 million versus $22.4 million. Continuing-operations net income was $4.9 million versus $12.2 million. Consolidated net income was $2.1 million, or $0.11 per diluted share, versus $12.0 million, or $0.63 per diluted share.
Cash flow, liquidity and debt
- Operating cash flow was $15.5 million, down from $49.1 million. Capital expenditures were $6.5 million, implying operating cash flow less capital expenditures of about $9.0 million.
- Cash and cash equivalents were $33.7 million; restricted cash was $29.4 million. Combined cash was $63.1 million, but restricted cash was subject to credit-agreement limitations.
- Long-term debt was $20.0 million, all under the revolving credit facility; the term loan was repaid in 2012. The revolving balance bore interest at LIBOR plus 2.50%, with an effective rate of 2.7%, and was due August 2015. The company reported covenant compliance and no defaults.
- An Italian line of credit had approximately $7.4 million available and no borrowings at quarter-end. Management said available cash, expected operating cash flows and credit capacity were sufficient for anticipated needs over the next 12 months.
Material changes and management commentary
- Sales weakness reflected an 18% decline in Spine regenerative stimulation, distribution disruption effects and higher wholesale mix in the prior-year comparison, pricing pressure and international weakness in Spine, and competitive, regulatory-delay and macroeconomic challenges in Orthopedics. Management also cited a 24% decline in Physio-Stim sales, including the loss of reimbursement in France.
- Margin pressure reflected unfavorable product and geographic mix, lower stimulation sales, Spine implant pricing challenges and depreciation from recent product launches.
- Sales and marketing expense declined slightly in dollars but increased to 49% of sales from 43%. General and administrative expense rose 29% to $18.8 million, including $3.6 million of management succession charges and the new medical-device excise tax. R&D expense decreased to $5.4 million from $7.1 million.
- Operating income included the impact of the sharp revenue decline and higher corporate costs. Other income included a $4.4 million cash gain from an insurance-company demutualization; foreign-exchange transaction gains were $0.6 million. Interest expense declined to $0.6 million from $2.2 million, principally due to lower debt.
- Q1 discontinued operations included a $4.0 million expense related to indemnification obligations from the Breg sale; the total net loss from discontinued operations was $2.8 million. In 2012, discontinued operations included Breg results through its sale, including $27.1 million of sales in the comparable quarter.
Outlook, risks and contingencies
- The filing provides no specific revenue or earnings guidance. Management’s liquidity statement covers anticipated working capital, capital expenditures and R&D needs over the next 12 months.
- On May 8, 2013, the board authorized share repurchases of up to $50 million, expected to begin around May 10. The company may fund purchases with cash, operating cash flow or additional borrowings; timing and amount are discretionary.
- Breg-related matters include product-liability claims involving former infusion pumps and cold-therapy products, a DOJ investigation and a qui tam complaint. The company had accrued $4.2 million for indemnification related to a 2012 cold-therapy verdict; actual liability could be higher or lower. It reported an arbitration award requiring an insurer to reimburse defense expenses, settlements and judgments under certain policies, estimating about $13 million of reimbursement for past losses and up to $15 million of potential future coverage. The ultimate outcomes and recoveries remain uncertain.
- The company stated it could not reasonably estimate possible losses for certain other indemnification obligations and legal matters. It also cited reimbursement changes, competition, product acceptance, regulation, foreign-exchange and interest-rate exposure, and ongoing government-compliance obligations among its risks.
- Controls and procedures were concluded to be effective at quarter-end; the company reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether sales declines in Spine stimulation and Orthopedics stabilize, and whether new products offset pricing and reimbursement pressure.
- Whether the lower gross margin and operating profitability persist, separating recurring operations from the $4.4 million demutualization gain and $3.6 million succession charges.
- Whether operating cash flow remains adequate, given its decline from the prior year and the $29.4 million of restricted cash.
- The resolution, amount and timing of Breg-related claims, indemnification payments and expected insurance reimbursements.
- Whether the proposed $50 million repurchase proceeds, and its effects on liquidity, borrowing and covenant capacity.