Orthofix International N.V. (Orthofix Medical Inc.) — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. The company is a global medical-device business organized into BioStim, Biologics, Extremity Fixation and Spine Fixation. Financial amounts below are in U.S. dollars; millions unless noted.
Financial performance
- Revenue: Q3 net sales were $98.5 million, down 2.6% year over year (down 2.3% at constant currency). Nine-month sales were $301.3 million, up 3.2% (up 3.9% at constant currency).
- Segment trends: Q3 BioStim sales rose 3.4%; Biologics fell 2.1%, Extremity Fixation fell 1.5%, and Spine Fixation fell 16.6%. For nine months, BioStim grew 7.3% and Extremity Fixation 5.2%; Biologics declined 2.7% and Spine Fixation 3.5%.
- Profit and margins: Q3 gross profit was $78.6 million, with a 79.8% gross margin versus 76.4% a year earlier. Operating income was $9.3 million versus $4.1 million; net income was $9.9 million versus a $1.4 million loss. Nine-month gross profit was $236.7 million (78.6% margin), operating income $13.7 million, and net income $6.3 million versus a $6.2 million loss.
- Cash flow: Nine-month operating cash flow was $38.4 million versus $26.5 million. Investing used $17.9 million; financing used $37.7 million, principally reflecting $55.0 million of share repurchases. Cash declined $16.8 million from year-end to $46.8 million.
- Liquidity and debt: At September 30, cash was $46.8 million, current assets $185.2 million and current liabilities $83.3 million. The company reported no borrowings under its $125 million secured revolving facility and was compliant with its financial covenants. It also had no borrowings on its Italian line of credit.
- Other metrics: Nine-month R&D expense rose 13.2% to $21.3 million. Share-based compensation expense was $8.1 million in Q3 and $12.2 million for nine months. Discontinued operations produced a $0.5 million Q3 loss and a $2.3 million nine-month loss.
Changes versus prior comparable periods
- Q3 sales softened, led by a steep decline in Spine Fixation; nine-month sales increased, led by BioStim and Extremity Fixation.
- Gross margin improved in both the quarter and nine-month period, which management attributed primarily to lower fixed costs and a richer BioStim sales mix.
- Operating income improved despite $1.5 million of Q3 government-resolution charges; nine-month results included $14.4 million of such charges, versus none in 2015.
- Q3 net income included a $2.9 million benefit from a revised estimate of the tax deductibility of certain compensation expenses. Tax rates were also affected by settlement charges with substantially no tax benefit.
Outlook, commentary and material matters
- Management targeted modest operating-margin improvement over the next four quarters, citing continuing efficiency work and anticipated sales growth. It provided no quantified revenue or earnings guidance in the supplied filing text.
- Planned and recent launches included BioStim bone-growth products expected in early 2017, a Biologics delivery system planned for Q1 2017, and Spine Fixation products planned for late 2016 and mid-2017. Management also described ongoing clinical research into PEMF applications.
- The company accrued $14.4 million for anticipated SEC resolutions concerning prior accounting restatements and allegations involving its Brazil subsidiary. Discussions and agreement-in-principle terms remained subject to final documentation and SEC approval. The DOJ deferred prosecution agreement expired in July 2016, and the related case was dismissed without prejudice in August.
- Product-liability and indemnification matters tied to former subsidiary Breg remain. The company had accrued $5.7 million for certain cold-therapy liabilities; the possible loss on some outstanding claims could not be reasonably estimated. The company reported $0.8 million of Breg-related settlements and judgments in the first nine months.
- The company’s $15 million eNeura convertible note was valued at $14.47 million at September 30 using Level 3 inputs. Its estimate rose during Q3 after impairments earlier in 2016; valuation depends on significant unobservable assumptions.
- The company repurchased 1.3 million shares for $55.0 million during the first nine months. It completed the remaining $8.4 million of the authorization after quarter-end, by October 28.
- Management said disclosure controls were effective as of September 30 and reported no material change in internal control over financial reporting during the quarter. The filing also notes risks from foreign currency, customer and geographic concentration of receivables, competition, reimbursement policies, litigation, and regulatory compliance.
Key facts for investors to verify
- Whether the SEC matters reach final, approved settlements and whether any additional payments or consequences arise.
- Whether Spine Fixation sales stabilize and planned product launches deliver the expected commercial contribution.
- How the eNeura note’s valuation and recoverability develop, given its Level 3 assumptions and prior impairments.
- The eventual cost and timing of Breg-related litigation, including claims for which the company could not estimate a loss range.
- The sustainability of operating cash flow and margin gains after substantial share repurchases and elevated share-based compensation.
- The impact of the compensation-tax estimate and other discrete tax items on future reported earnings.