Orthofix Medical Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; the filing also provides unaudited fourth-quarter results. Orthofix is a global musculoskeletal medical-device company with four reporting segments: Bone Growth Therapies, Spinal Implants, Biologics, and Orthofix Extremities. The company completed its change of domicile from Curaçao to Delaware on July 31, 2018.
Financial performance and position
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Net sales | $453.0 million | $433.8 million |
| Gross profit / gross margin | $356.4 million / 78.7% | $340.8 million / 78.6% |
| Operating income / margin | $30.1 million / 6.6% | $40.8 million / 9.4% |
| Net income from continuing operations | $13.8 million | $7.3 million |
| Net income per diluted share | $0.72 | $0.39 |
| Net cash from operating activities | $49.9 million | $39.0 million |
| Free cash flow | $34.7 million | $22.0 million |
Sales increased 4.4% reported and 3.9% at constant currency. Management’s non-GAAP net margin, defined as gross profit less sales and marketing expense, was $150.9 million, up 5.9%; it is not equivalent to GAAP operating profit.
FY 2018 segment sales were Bone Growth Therapies $195.3 million (+5.0%), Spinal Implants $91.7 million (+11.8%), Biologics $59.7 million (-4.8%), and Orthofix Extremities $106.4 million (+3.1%).
Unaudited Q4: Sales were $121.1 million versus $116.9 million in Q4 2017; operating income was $12.4 million versus $17.9 million; net income was $8.9 million versus $1.6 million. The filing does not provide Q4 cash-flow figures.
At year-end, cash and cash equivalents were $69.6 million and restricted cash was $2.6 million, compared with $81.2 million of cash and cash equivalents in 2017. Total assets were $466.6 million and shareholders’ equity was $335.4 million. There was no borrowing outstanding on the $125 million secured revolving credit facility; long-term debt was reported as zero. The Italian line of credit was also undrawn.
Material changes versus prior period
- Operating income fell $10.7 million despite higher sales and a slightly improved gross margin. General and administrative expense rose 17.5% to $84.5 million, including acquisition and domestication costs, higher share-based compensation, and legal-related costs; the company also recorded $3.1 million of expense from increased fair value of Spinal Kinetics contingent consideration.
- Net income from continuing operations rose 89.4%, helped in part by income tax expense declining to $9.1 million from $29.1 million. The 2017 tax expense included an $8.3 million charge related to U.S. tax reform; the 2018 effective tax rate was 39.7% versus 80.0%.
- Operating cash flow increased $10.9 million, primarily reflecting improved working-capital movements, including inventory. Investing cash outflow rose to $61.0 million, mainly due to the Spinal Kinetics acquisition.
- Biologics sales declined following a contractual reduction in MTF marketing fees, despite 3.3% growth in Trinity tissue volume. Spinal Implants growth included M6 disc sales following the acquisition, while legacy international sales faced distribution disruption.
- Adoption of the new revenue standard increased reported FY 2018 sales by $7.7 million and continuing-operations net income by $4.8 million compared with the company’s historical accounting method. Prior-year figures were not restated; the accounting change also increased opening retained earnings by $4.8 million.
Outlook, commentary, risks and unusual items
- No quantified company-wide revenue or earnings guidance is provided in the supplied filing text. Management described continued product launches, sales-force and market development, and investment in research and development as priorities. The company spent $33.2 million on R&D in 2018.
- Orthofix acquired Spinal Kinetics on April 30, 2018 for approximately $51.1 million cash at closing, plus potential milestone payments of up to $60 million. FDA approval of the M6-C artificial cervical disc followed on February 6, 2019, triggering a $15 million payment, paid February 14, 2019. The company planned a controlled, limited U.S. launch in 2019. Up to $45 million of additional revenue-based milestones may be payable.
- The company reported it did not expect to collect the complete principal and interest on its $15 million eNeura note, which matured March 4, 2019, and was negotiating a possible extension or modification. The note’s year-end fair value was $17.8 million; collection and valuation remain uncertain.
- Approximately $2.6 million of cash remained restricted following a Brazilian court order connected with an investigation into tender irregularities involving more than 30 companies. The company contested the order and stated it did not expect a material loss based on information then available.
- Other exposures include reimbursement and pricing pressure, device regulation and product liability, reliance on distributors and third-party tissue supplier MTF, foreign exchange, and potential changes to the Italian medical-device payback measure. The company accrued $3.7 million for that Italian measure, while noting the ultimate liability could differ.
- The company disclosed prior SEC/FCPA matters and a 2017 settlement, including $14.4 million of U.S. Government resolution charges recorded in 2016. The independent compliance consultant’s engagement concluded in March 2018. Management reported effective disclosure controls and internal control over financial reporting; the acquired Spinal Kinetics business was excluded from the 2018 internal-control assessment.
- CEO Bradley Mason entered a transition and retirement arrangement on February 25, 2019; he was to remain in role until a successor began and then provide transition consulting.
Important facts for investors to verify
- Track sales and profitability by segment, particularly whether Biologics fee reductions and Spinal Implants international distribution issues persist.
- Verify the commercial uptake and economics of the M6-C launch, including remaining revenue-based milestone obligations of up to $45 million.
- Follow collection, extension, conversion, or impairment outcomes for the eNeura note and the release of Brazil-restricted cash.
- Assess cash conversion and working-capital quality, including the rise in days sales outstanding to 63 days from 53 days; the filing attributes much of this increase to the revenue-standard adoption.
- Review the full audited financial statements and notes for legal contingencies, tax uncertainties, and acquisition accounting. Ernst & Young issued an unqualified opinion on the financial statements and internal control, with Spinal Kinetics excluded from the internal-control audit.