Orthofix International N.V. (Orthofix Medical Inc.) — Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. The filing was signed and filed March 30, 2015, after delays related to accounting reviews and restatements. Although the request metadata says 2014 Q1, this filing reports the third quarter and nine-month period.
Business context and financial results
Orthofix operates in BioStim, Biologics, Extremity Fixation and Spine Fixation, with products and services for spine and orthopedic conditions. Financial amounts below are U.S. dollars; reported figures are in millions unless stated otherwise. 2013 comparisons are restated.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $101.0 | $91.8 | $301.9 | $291.7 |
| Gross profit | $75.7 | $66.7 | $224.5 | $218.9 |
| Gross margin | 75.0% | 72.7% | 74.4% | 75.0% |
| Operating income (loss) | $6.5 | $(14.1) | $13.2 | $(1.1) |
| Net income (loss) | $0.5 | $(18.8) | $(2.7) | $(18.4) |
| Diluted earnings (loss) per share | $0.02 | $(1.04) | $(0.15) | $(0.97) |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $36.0 | $51.9 |
Q3 revenue grew 10% reported (9% constant currency); nine-month revenue grew 4% reported (3% constant currency). Q3 operating income and net income improved substantially from the prior-year quarter, which included a $19.2 million goodwill impairment. Nine-month results also improved, but remained loss-making after tax and discontinued operations.
- Segment revenue, Q3: BioStim $38.3 million, up 25%; Biologics $13.9 million, up 5%; Extremity Fixation $27.6 million, up 12% reported (9% constant currency); Spine Fixation $21.2 million, down 9%.
- Segment revenue, nine months: BioStim $114.9 million, up 9%; Biologics $40.7 million, up 2%; Extremity Fixation $82.0 million, up 11% reported (9% constant currency); Spine Fixation $64.3 million, down 11%.
- Cash and liquidity at September 30: Cash and cash equivalents were $29.8 million and restricted cash was $34.6 million. Total cash including restricted cash was $64.5 million. The filing says restricted cash is subject to credit-agreement limitations.
- Debt: The $20.0 million revolving balance outstanding at year-end 2013 was repaid in September 2014. No balance was outstanding under the credit facilities at September 30; the Italian line also had no borrowings. The filing describes a $200 million revolving facility at the reporting date, but says capacity was reduced to $100 million on January 15, 2015.
- Balance sheet: Total assets were $411.0 million, total liabilities $106.0 million and shareholders’ equity $305.0 million. Current assets were $270.3 million and current liabilities $81.4 million.
Material changes and management commentary
- BioStim growth was largely attributed to the timing effect of transitioning in Q3 2013 to recognizing certain third-party payor revenue only after the full billable package accumulated; management also cited sales-organization improvements.
- Biologics benefited from channel expansion and adoption of Trinity ELITE. Extremity Fixation growth reflected product launches and international sales, partly offset by disruption in Brazil. Spine Fixation declined following sales-force reorganization intended to improve profitability.
- Nine-month gross margin fell to 74.4% from 75.0%, which management attributed primarily to product and channel mix, rebuilding the Brazil sales organization and excess-and-obsolete inventory reserves.
- General and administrative expense rose to $18.8 million in Q3 and $53.6 million year to date. Management cited investment in internal audit, process improvements and remediation of control weaknesses; year-to-date expense also included unusually high medical insurance payouts. The filing identifies approximately $1.5 million of 2014 spending on the multi-year “Bluecore” systems and process effort through Q3.
- Accounting review and restatement costs were $2.3 million in Q3 and $13.0 million year to date, versus $2.7 million year to date in 2013. Management expected further restatement-related fees during 2014.
- Operating cash flow was lower year over year, at $36.0 million versus $51.9 million. Investing cash outflow was $12.9 million, compared with $25.2 million; financing cash outflow was $20.5 million, including $20.0 million of debt repayment.
Restatement, risks and outlook
- Further Restatement: Additional errors involved co-pay and self-pay revenue recognition, bad-debt reserve timing, accounts-receivable reserves, intercompany inventory profit eliminations, inventory existence and inventory reserves. Previously filed financial statements for 2011–2013 and Q1 2014 were determined not to be reliable; this filing presents restated 2013 comparisons. Some corrections changed revenue and expenses without changing net income, while inventory and reserve adjustments affected reported earnings and assets.
- Controls: Management concluded disclosure controls were ineffective as of September 30, 2014 and identified material weaknesses involving revenue recognition, receivable and inventory reserves, inventory counts, oversight of foreign subsidiaries and manual journal entries. Remediation was underway but incomplete.
- Credit-agreement exposure: Lenders granted waivers and extensions for delayed financial statements and covenant certificates. The filing says the company was in compliance with covenants at September 30, 2014, but failure to satisfy waiver or credit-agreement requirements could result in default and materially harm financial position.
- Other risks and contingencies: The filing discusses possible SEC enforcement action, securities litigation, a review of alleged improper payments involving the Brazil subsidiary, Nasdaq listing-rule non-compliance and related proceedings, product-liability indemnities, and compliance obligations under government agreements. A settlement resolved most pending cold-therapy product claims, with one claim remaining; the company recorded approximately $1.3 million of settlement payments as expense in Q2 2014.
- Outlook: No specific revenue or earnings guidance is provided. Management stated that cash balances, projected operating cash flows, credit availability and debt capacity were expected to cover anticipated working capital, capital expenditure and R&D needs over the next twelve months. This assessment should be considered alongside restricted cash, covenant requirements and the reporting delays.
- Subsequent events: In January 2015, the company sold the Tempus Cervical Plate product line for $4.8 million cash, transferring net assets of $2.1 million. In March 2015, it granted eNeura an 18-month exclusive acquisition option, paid a $250,000 fee and received a $15 million convertible note bearing 8% interest; exercising the option would require $65 million of consideration, subject to adjustments and possible milestone payments.
Most important facts for investors to verify
- Review the amended 2013 Form 10-K and 2014 Q1 and Q2 filings to understand the full restatement, including effects on earnings, assets, reserves and cash flows.
- Check whether the identified material weaknesses have been remediated and whether subsequent filings report effective internal controls and reliable financial reporting.
- Confirm current revolver capacity, covenant compliance, waiver status, and how much cash is unrestricted and accessible to the parent company.
- Assess whether BioStim’s reported growth reflects sustained demand or primarily the prior-year revenue-recognition timing change, and monitor continuing weakness in Spine Fixation and Brazil.
- Track continuing restatement, legal, regulatory, listing and product-liability costs, as well as the potential funding and obligations associated with the eNeura option.