Orthofix International N.V. — FY 2013 Form 10-K
Reporting period: Fiscal year ended December 31, 2013; filed March 31, 2014. This is an annual filing, not a standalone Q4 report. Financial statements are presented in U.S. GAAP and include restated comparative periods.
Business context and financial performance
Orthofix is a global medical-device company focused on spine and orthopedic products. Its four reporting segments are BioStim, Biologics, Extremity Fixation and Spine Fixation. Amounts below are in U.S. dollars.
| Metric | FY 2013 | FY 2012, restated |
|---|---|---|
| Net sales | $400.5 million | $447.6 million |
| Gross profit / margin | $298.2 million / 74.5% | $349.3 million / 78.0% |
| Operating income (loss) | ($5.1 million) | $76.6 million |
| Continuing-operations income (loss) | ($14.9 million) | $45.1 million |
| Net income (loss) | ($25.5 million); EPS ($1.37) | $42.8 million; diluted EPS $2.21 |
| Operating cash flow | $66.9 million | $10.2 million |
| Capital expenditures | $29.7 million | $28.8 million |
| Year-end total debt | $20.0 million | $20.0 million |
FY 2013 quarterly results included Q4 sales of $106.1 million, gross profit of $73.6 million, operating loss of $6.4 million and net loss of $7.9 million (basic and diluted EPS each ($0.43)).
At year-end, cash and cash equivalents totaled $54.2 million, including $23.8 million restricted under the credit agreement; unrestricted cash was $30.5 million. The $200 million revolving facility had $20 million drawn and approximately $180 million available. The facility matures August 2015; its effective interest rate was 2.7%. Cash flow from operations was strong relative to net income, which included substantial noncash impairment and other items. The filing reports no material off-balance-sheet arrangements.
Changes versus prior periods
- Sales declined 10.5% year over year. BioStim sales fell 18.7% to $147.9 million; Extremity Fixation declined 7.7% to $103.4 million; Spine Fixation declined 4.4% to $95.5 million. Biologics was essentially flat at $53.8 million.
- Management attributed BioStim weakness to distribution turnover, changes in certain payor policies and more complex insurance-billing requirements. Spine Fixation faced lower average selling prices, partly offset by international growth. Extremity Fixation was affected by Brazil sales deterioration and a prospective distributor revenue-recognition change.
- Gross margin fell 3.5 percentage points, primarily because of lower high-margin BioStim sales and higher inventory-reserve and salary costs. General and administrative expense increased 21.9% to $65.1 million, including investment in finance, accounting, information systems and controls.
- Operating cash flow rose from $10.2 million to $66.9 million, while net loss replaced prior-year net income. Investing cash flow was an outflow of $29.7 million; 2012 had benefited from Breg sale proceeds. Financing cash outflow fell to $38.4 million, compared with $137.6 million in 2012, which included substantial debt repayment. Orthofix repurchased $39.5 million of shares in 2013.
- The Audit Committee review led to restatements: 2012 sales were reduced by $14.7 million and continuing-operations income by $8.9 million; 2011 sales were reduced by $28.2 million and continuing-operations income by $14.5 million. The restatement involved distributor revenue, inventory reserves and royalties, with corrections also made for earlier periods.
Outlook, risks, contingencies and unusual items
- No earnings or revenue guidance is provided. Management planned approximately $24.3 million of 2014 capital expenditures, principally to support business expansion, expected to be funded mainly from operating cash flow.
- FY 2013 included $12.9 million of costs related to the accounting review and restatement and a $19.2 million goodwill impairment for the Extremity Fixation and Spine Fixation reporting units. Discontinued operations included a $10.6 million net loss, primarily related to legal settlements and costs tied to former subsidiary Breg.
- Management reported material weaknesses in revenue-recognition controls for distributor sales, inventory-reserve controls, oversight of certain foreign subsidiaries and manual journal-entry controls. Management concluded disclosure controls and internal control over financial reporting were ineffective at December 31, 2013; the auditor also issued an adverse opinion on internal control. Remediation was underway but incomplete.
- The filing was delayed following the independent accounting review and restatement. SEC Enforcement Staff requests and a securities class action were pending; the company could not reasonably estimate potential losses. A review of allegations of improper payments involving the Brazil subsidiary was ongoing and had been self-reported to the DOJ and SEC, with potential loss not estimable.
- The company remained subject to a five-year HHS-OIG Corporate Integrity Agreement and a DOJ deferred prosecution agreement related to prior matters. Breaches could result in penalties, prosecution or exclusion from federal healthcare programs. Nasdaq delisting proceedings were pending at the filing date, although the company believed it had remedied its filing delinquency.
- Other significant uncertainties include Breg-related indemnification and product-liability claims, reimbursement and pricing pressure, regulatory requirements, allograft supply and classification risks, competition, foreign-exchange exposure, and compliance with credit-facility covenants. A $4.2 million accrual was recorded for one Breg indemnification matter; other possible losses were not estimable.
Most important facts for investors to verify
- Whether the distributor revenue and inventory-control remediation was completed and tested effectively, and whether any further restatement or reporting delay occurred.
- Subsequent developments, financial exposure and resolution of the SEC review, securities class action and Brazil-related anti-bribery investigation.
- Whether Nasdaq listing compliance was maintained and the credit-facility waiver and covenants remained satisfied.
- Whether BioStim sales stabilized and margin pressure, distributor accounting effects and reimbursement changes persisted.
- The ultimate cost and insurance recovery for Breg indemnification and product-liability matters, and the accessibility of cash reported as restricted.