Orthofix International N.V. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are with Q1 2016 unless noted. The filing identifies the registrant as Orthofix International N.V.
Business and operating results
Orthofix is a global medical-device company with four reporting segments: BioStim, Biologics, Extremity Fixation, and Spine Fixation. Management reported improving sales in three segments, but lower operating income and a net loss, including a significant impairment charge.
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Net sales | $102.7 million | $98.7 million |
| Gross profit / gross margin | $80.2 million / 78.0% | $76.5 million / 77.6% |
| Operating income / margin | $5.9 million / 5.8% | $7.1 million / 7.2% |
| Continuing-operations net income (loss) | $(2.3) million | $4.6 million |
| Net income (loss), including discontinued operations | $(2.7) million | $3.8 million |
| Diluted EPS | $(0.15) | $0.20 |
| Cash from operating activities | $3.5 million | $4.6 million |
| Capital expenditures | $3.9 million | $6.4 million |
| Free cash flow (company-defined, non-GAAP) | $(0.4) million | $(1.8) million |
Sales rose 4.1% as reported and 4.6% at constant currency. Segment sales were BioStim $44.5 million (+8.5%), Biologics $15.0 million (+6.3%), Extremity Fixation $23.9 million (−3.1%; −1.0% constant currency), and Spine Fixation $19.3 million (+2.3%). Net margin, defined by the company as gross profit less sales and marketing expense, was $31.6 million, essentially flat year over year; its share of sales fell to 30.8% from 32.1%.
Financial position and liquidity
At March 31, 2017, cash and cash equivalents were $41.7 million, versus $39.6 million at year-end; restricted cash was zero, down from $14.4 million. Current assets were $186.8 million and current liabilities $62.9 million. Total assets were $354.7 million and total liabilities $87.6 million. The filing reports no borrowings under the $125 million secured revolving credit facility or the Italian line of credit; the company said it was in compliance with financial covenants. No material off-balance-sheet arrangements were reported.
Key changes and management commentary
- Operating income declined despite higher sales: sales and marketing expense increased 8.3% to $48.5 million, faster than revenue, while general and administrative expense rose 7.5% to $18.3 million. Research and development expense decreased 2.8% to $7.4 million.
- Other expense included a $5.6 million pre-tax other-than-temporary impairment of the eNeura debt security, whose fair value was reduced to $9.0 million. This was a major factor in the swing to a continuing-operations loss.
- Income tax expense was $3.9 million, producing a 242.8% effective tax rate on continuing operations, versus 48.4% in Q1 2016. Management cited the impairment-related reduction in pre-tax income, jurisdictional earnings mix, and losses in jurisdictions where no tax benefit was recognized.
- Operating cash flow declined by $1.2 million year over year. Working-capital movements included a $23.3 million reduction in other current liabilities; the cash-flow statement also reflects a $14.4 million release of restricted cash.
- BioStim growth was attributed to a wider prescribing-physician base, supportive NASS coverage recommendations, and next-generation product launches. Biologics benefited from distributor additions, partly offset by lower Trinity average selling prices amid competition. Spine Fixation U.S. sales rose 12%, while Extremity Fixation was affected by currency, a U.K. non-core business divestiture, and lower distributor cash collections.
Outlook, risks, and contingencies
The filing provides no quantified earnings or revenue guidance. Management said Q1 results are not necessarily indicative of the full year and cautioned that forward-looking statements are subject to risks and uncertainties. The company expects adoption of the new revenue-recognition standard in 2018 to materially affect timing, particularly for implant sales to stocking distributors currently recognized using the sell-through method; it expects to use the modified retrospective method.
- The SEC approved settlements in January 2017 resolving investigations into prior accounting matters and Brazil-related improper-payment reviews. Payments had been accrued and funded in escrow in 2016; the Brazil settlement requires an independent compliance consultant for one year.
- For indemnification matters related to the 2012 Breg sale, one local infusion-pump product-liability case remains outstanding and the possible loss cannot be reasonably estimated. The company accrued $2.4 million for cold-therapy claims; actual liability could be higher or lower.
- A restructuring initiated in December 2016, primarily affecting Extremity Fixation and including a non-core business wind-down, had an expected total pre-tax cost of approximately $2.8 million. Cumulative costs were $1.7 million; the March 31 accrual was $1.0 million.
- The IRS was examining the company’s 2012 and 2013 federal returns; the company could not determine whether the examinations would have a material impact or when they would be resolved.
- Management reported effective disclosure controls as of March 31, 2017, and no material change in internal control over financial reporting during the quarter. It reported no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether sales growth translates into improved operating profitability, particularly given rising sales and marketing costs and declining net margin percentage.
- The valuation, recovery prospects, and potential further impairment of the eNeura debt security, and the resulting effects on earnings and taxes.
- Cash-flow quality and working-capital trends, including distributor collections, inventory turns, and changes in current liabilities.
- Potential exposure from Breg indemnification claims, the SEC settlement compliance-monitor requirement, and IRS examinations.
- The eventual financial-statement effects and transition impact of the new revenue-recognition standard.