Orthofix Medical Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; unaudited. Orthofix is a global musculoskeletal medical-device company with BioStim, Spine Fixation, Biologics, and Extremity Fixation reporting segments. On July 31, 2018, it completed its change of jurisdiction from Curaçao to Delaware and changed its name from Orthofix International N.V. to Orthofix Medical Inc.
Financial results and liquidity
- Q2 revenue: $111.5 million, up 2.4% reported and 1.3% at constant currency year over year. Six-month revenue was $220.3 million, up 4.1% reported and 2.3% at constant currency.
- Q2 profitability: Gross profit was $88.7 million; gross margin rose to 79.5% from 78.7%. Operating income was $7.0 million, down from $8.0 million, and operating margin declined to 6.3% from 7.3%. Continuing-operations net income was $0.9 million versus $4.7 million; net income was $0.9 million versus $3.9 million. Diluted EPS was $0.05 versus $0.21.
- Six-month profitability: Operating income was $14.9 million versus $13.9 million. Continuing-operations net income was $6.2 million versus $2.4 million; net income was $6.2 million versus $1.2 million. Diluted EPS was $0.32 versus $0.07.
- Margins and expenses: Non-GAAP net margin, defined as gross profit less sales and marketing expense, increased 5.4% to $37.2 million in Q2 and 6.8% to $71.5 million for six months. Q2 G&A rose 9.1% to $22.3 million and R&D rose 14.6% to $7.9 million.
- Cash flow: Six-month operating cash flow was $13.0 million, versus use of $4.6 million in 2017; free cash flow was $6.4 million versus use of $13.2 million. Investing cash outflow was $51.5 million, largely reflecting the Spinal Kinetics acquisition. Cash and cash equivalents were $45.7 million at June 30, down from $81.2 million at year-end.
- Balance sheet and debt: Total assets were $441.8 million and total liabilities $121.9 million. Current assets were $237.4 million and current liabilities $63.9 million. The company reported no borrowings under its $125 million revolving facility or its Italian line of credit and was in compliance with financial covenants.
Changes versus comparable periods
- By segment, Q2 sales rose 11.8% in Spine Fixation, 2.2% in BioStim, and 0.2% in Extremity Fixation; Biologics declined 6.3%. Six-month sales rose in all but Biologics, which fell 5.4%.
- Spine Fixation growth included $2.3 million of Spinal Kinetics sales after the April 30 acquisition. Biologics revenue was pressured by a contractual reduction in MTF marketing fees and pricing pressure. Extremity Fixation’s Q2 constant-currency sales declined 4.0%; management cited international orders that shipped in Q3.
- Reported comparisons are affected by the January 1 adoption of ASC 606. Prior periods were not restated. Compared with historical Topic 605 accounting, ASC 606 reduced Q2 2018 revenue by $1.9 million and continuing-operations income by $0.9 million, but increased six-month revenue by $5.5 million and continuing-operations income by $3.0 million. Adoption increased opening retained earnings by $4.8 million.
- Q2 other expense included a $3.3 million noncash foreign-currency remeasurement loss and a $1.1 million increase in the fair value of acquisition-related contingent consideration. G&A also reflected higher share-based compensation and strategic, acquisition-integration, and domestication costs.
Outlook, risks, contingencies, and unusual items
- The filing provides no quantified revenue or earnings guidance. Management highlighted Q2 sales growth and improved non-GAAP net margin; forward-looking statements remain subject to risks and uncertainties.
- Orthofix acquired Spinal Kinetics for $50.6 million cash at closing, with potential milestone payments up to $60 million. The June 30 fair value of contingent consideration was $26.6 million. Milestones include FDA approval of the M6-C disc and revenue targets for M6-C and M6-L products; final purchase-price allocation remained preliminary.
- The company accrued €2.8 million ($3.3 million) for Italy’s medical-device payback measure. Management said the law’s implementation remained unclear and the final liability could differ.
- A July 2018 court order froze approximately $2.5 million in cash in a pending legal action; Orthofix contests the basis for the order. Separately, it paid $1.7 million under an indemnification obligation related to a Breg cold-therapy claim, recorded in discontinued operations.
- The eNeura debt security was valued at $18.0 million, versus a $9.0 million amortized cost basis, using significant unobservable inputs. Its fair value is therefore subject to estimation uncertainty.
- Management reported disclosure controls were effective as of June 30, 2018. Spinal Kinetics was excluded from the company’s 2018 annual internal-control effectiveness assessment, as permitted for an acquisition year. No material changes to the risk factors in the 2017 Form 10-K were reported.
Important facts for investors to verify
- Underlying growth and earnings trends after separating ASC 606 timing effects, currency movements, and Spinal Kinetics’ contribution.
- Progress toward FDA approval and revenue milestones for Spinal Kinetics, and the eventual cash payments and completed purchase-price allocation.
- Collectability of receivables and the effect of ASC 606 on stocking-distributor revenue; days sales outstanding increased to 61 from 51 a year earlier.
- Resolution and potential financial impact of the Italian payback measure, the frozen cash order, and remaining Breg-related indemnification exposure.
- Valuation assumptions for the eNeura security and contingent consideration, as well as cash and liquidity after the acquisition.