Business context and reporting period
Orthofix International N.V. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2011. The company designs, manufactures and distributes orthopedic medical products across Spine, Orthopedics and Sports Medicine. It began reporting these three global business units, plus Corporate, in 2011. The filing identifies the registrant as Orthofix International N.V.
Financial performance and position
Amounts below are U.S. dollars; financial statement figures are rounded to millions.
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $143.6m | $142.8m | $282.7m | $281.7m |
| Gross profit | $108.9m | $108.8m | $214.7m | $214.9m |
| Gross margin | 75.8% | 76.1% | 75.9% | 76.3% |
| Operating income (loss) | $18.6m | $21.2m | $(7.5)m | $53.2m |
| Net income (loss) | $10.0m | $10.2m | $(25.8)m | $27.7m |
| Diluted EPS | $0.54 | $0.57 | $(1.43) | $1.56 |
| Operating cash flow | Not provided for quarter | $23.4m | $19.5m |
- Q2 sales were nearly flat as reported; foreign exchange added $3.0m, while constant-currency sales declined 2%. Strategic product sales rose 2% as reported, but Spine products fell 3%, largely due to a 12% decline in stimulation products. Orthopedics rose 7% as reported (flat at constant currency), and Sports Medicine rose 9%.
- For the first half, reported sales were essentially flat and constant-currency sales declined 1%. Strategic products grew 3% as reported; Spine declined 1%, Orthopedics grew 6%, and Sports Medicine grew 7%.
- Q2 operating income and net income declined year over year; general and administrative expense rose $3.6m, including $3.2m in senior management succession costs and $2.0m of additional Sports Medicine product-liability insurance expense. The six-month operating and net losses principally reflect $46.0m of charges related to U.S. Government inquiries: $43.0m for a probable bone-growth-stimulation settlement and $3.0m for the Promeca FCPA matter. No tax benefit was recorded on these charges.
- Six-month operating cash flow was positive despite the net loss, supported in part by noncash items and the accrued government-inquiry charges. Working capital used $16.0m of cash. Receivables days were 88 versus 82 a year earlier; inventory turns were 1.4 versus 1.6. Management attributed inventory investment to preparations for product launches.
- At June 30, cash and cash equivalents were $27.5m and restricted cash was $25.3m, or $52.7m combined. Total current assets were $346.1m and current liabilities $133.2m. Inventory was $98.0m, up from $84.6m at year-end.
- Term-loan and revolver borrowings totaled $213.7m; bank borrowings were $2.4m. The company had $82.6m available on its $200m revolving facility and $8.2m available on Italian lines of credit. The credit facilities had a 3.5% effective rate and mature in 2015. Covenant ratios were 2.44 leverage (maximum 3.25) and 3.80 fixed-charge coverage (minimum 1.25); management said it was compliant.
Outlook, risks and unusual items
- No quantified full-year revenue or earnings guidance is provided in the filing. Management identified successful new-product launches, stronger distribution coverage, improved operating leverage and potential resolution of government investigations as priorities for 2011. It said available cash, expected operating cash flow and borrowing capacity should fund near-term settlement, working-capital and capital-expenditure needs, while cautioning that future covenant compliance is not assured.
- The anticipated bone-growth-stimulation resolution remained subject to definitive agreements with government authorities. The company accrued approximately $43m, including related costs, and said additional material loss beyond that amount was remote, but did not guarantee a settlement.
- The Promeca FCPA investigation and settlement discussions were ongoing. The $3m accrual may be insufficient; any additional loss was not reasonably estimable. Management said the government’s acceptance of settlement terms was uncertain.
- Other material legal exposures include legacy Blackstone physician-compensation investigations and qui tam matters, for which possible loss ranges could not be estimated. The First Circuit revived a Blackstone qui tam case in June 2011. The company reported a $15.3m escrow receivable tied to Blackstone matters, with reimbursement claims generally contested; the escrow fund held $52m. Separate product-liability claims involving former pain-pump products and current cold-therapy products also had no estimable loss range.
- Other notable items: the company acquired Omni Motion for $5.3m in February; recognized $3.2m of CEO succession costs in Q2; and continued to face bone-growth-stimulation reimbursement and industry-investigation pressures. Management cited unfavorable product/geographic mix and U.S. pricing pressure as factors in lower gross margins.
- Market risks include floating-rate debt and foreign exchange exposure. A 1 percentage-point interest-rate change was estimated to affect annual interest expense by about $2.1m. Disclosure controls were reported effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Final terms, timing and total cash cost of the anticipated $43m bone-growth-stimulation settlement, and whether related claims or costs exceed the accrual.
- Outcome and potential additional liability from the Promeca FCPA investigation; the filing says additional loss cannot currently be estimated.
- Collection prospects for the $15.3m Blackstone escrow receivable and the status of the related contested indemnification claims and litigation.
- Whether stimulation-product sales stabilize amid reimbursement challenges, and whether growth in Orthopedics and Sports Medicine offsets ongoing weakness in Spine.
- Inventory and receivables trends, cash available for settlement payments given restricted cash, and continued compliance with credit-facility covenants.