Orthofix Medical Inc. - Quarter Report: 2017 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark one)

For the quarterly period ended September 30, 2017

OR

For the transition period from                      to                     .

Commission File Number: 0-19961

ORTHOFIX INTERNATIONAL N.V.

(Exact name of registrant as specified in its charter)

599-9-4658525

(Registrant’s telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ☒  Yes    ☐  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   ☒  Yes    ☐  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.     ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ☐  Yes    ☒  No

As of October 27, 2017, 18,231,334 shares of common stock were issued and outstanding.

 Table of Contents

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Forward-Looking Statements

This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (“the Exchange Act”), and Section 27A of the Securities Act of 1933, as amended, relating to our business and financial outlook, which are based on our current beliefs, assumptions, expectations, estimates, forecasts and projections. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “intends,” “predicts,” “potential,” or “continue” or other comparable terminology. These forward-looking statements are not guarantees of our future performance and involve risks, uncertainties, estimates and assumptions that are difficult to predict , including the risks described Part I, Item 1A under the heading Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2016 (the “2016 Form 10-K”). Therefore, our actual outcomes and results may differ materially from those expressed in these forward-looking statements. You should not place undue reliance on any of these forward-looking statements. Further, any forward-looking statement speaks only as of the date hereof, unless it is specifically otherwise stated to be made as of a different date. We undertake no obligation to further update any such statement, or the risk factors described in the 2016 Form 10-K, to reflect new information, the occurrence of future events or circumstances or otherwise.

Trademarks

Solely for convenience, our trademarks and trade names in this report are referred to without the ® and ™ symbols, but such references should not be construed as any indicator that we will not assert, to the fullest extent under applicable law, our rights thereto.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ORTHOFIX INTERNATIONAL N.V.

Condensed Consolidated Balance Sheets

The accompanying notes form an integral part of these condensed consolidated financial statements

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ORTHOFIX INTERNATIONAL N.V.

Condensed Consolidated Statements of Operations and Comprehensive Income

The accompanying notes form an integral part of these condensed consolidated financial statements

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ORTHOFIX INTERNATIONAL N.V.

Condensed Consolidated Statements of Cash Flows

The accompanying notes form an integral part of these condensed consolidated financial statements

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ORTHOFIX INTERNATIONAL N.V.

Notes to the Unaudited Condensed Consolidated Financial Statements

Business and basis of presentation

Orthofix International N.V. (the “Company”) is a diversified, global medical device company focused on improving patients’ lives by providing superior reconstructive and regenerative orthopedic and spine solutions to physicians. The Company has four strategic business units (“SBUs”) that are also its reporting segments: BioStim, Biologics, Extremity Fixation, and Spine Fixation.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Pursuant to these rules and regulations, certain information and note disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair statement have been included. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s Form 10-K for the year ended December 31, 2016. Operating results for the three and nine months ended September 30, 2017 are not necessarily indicative of the results that may be expected for other interim periods or the year ending December 31, 2017.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. On an ongoing basis, the Company evaluates its estimates including those related to revenue recognition, contractual allowances, doubtful accounts, inventories, goodwill and intangible asset impairment, fair value measurements, litigation and contingent liabilities, income taxes, and share-based compensation. Actual results could differ from these estimates.

1. Recently issued accounting pronouncements

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2. Inventories

Inventories were as follows:

3. Other current liabilities

In December 2016, the Company approved and initiated a planned restructuring, which primarily affects the Extremity Fixation SBU (the “Extremity Fixation restructuring plan”), to streamline costs, improve operational performance, and wind down a non-core business. The Extremity Fixation restructuring plan consists primarily of severance charges and the write-down of certain assets. The Company expects to incur total pre-tax expense of approximately $3.1 million in connection with this restructuring activity and has incurred cumulative costs to date of $2.4 million. The Company had an accrual of $1.5 million as of December 31, 2016 in other current liabilities related to the planned restructuring. In the nine months ended September 30, 2017, the Company incurred costs of

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approximately $0.5 million and made additional payments of $1.6 million, resulting in an ending accrual of $0.4 million as of September 30, 2017.

In September 2017, the Company approved and executed an additional restructuring plan, which primarily affects the entity’s corporate shared services in the U.S. (the “U.S. restructuring plan”), to streamline costs and to improve operational performance. The U.S. restructuring plan consists primarily of severance charges. The Company estimates total pre-tax expense of approximately $1.8 million in connection with this restructuring activity, all of which was incurred during the third quarter of 2017, and recorded within operating expenses. No payments were made as of September 30, 2017; therefore, $1.8 million is accrued within other current liabilities at September 30, 2017.

4. Long-term debt

As of September 30, 2017, the Company has not made any borrowings under the five year $125 million secured revolving credit facility it entered into in August 2015 with JPMorgan Chase Bank, N.A., as Administrative Agent, and certain lenders. The Company has also not made any borrowings on its €5.8 million ($6.9 million) available line of credit in Italy at September 30, 2017.  The Company is in compliance with all required financial covenants as of September 30, 2017.

5. Fair value measurements

The fair value of the Company’s financial assets and liabilities measured on a recurring basis were as follows:

The Company holds a debt security of eNeura, Inc., a privately held medical technology company that is developing devices for the treatment of migraines. The debt security is further described in Note 6 to the financial statements contained within our Form 10-K for the year ended December 31, 2016. The fair value of the debt security, which is recorded within other long-term assets, is based upon significant unobservable inputs, including the use of a discounted cash flow model, requiring the Company to develop its own assumptions; therefore, the Company has categorized this asset as a Level 3 financial asset. As of September 30, 2017, the Company reassessed its estimate of fair value based on current financial information and other assumptions, resulting in a fair value of $9.0 million, which is consistent with the Company’s estimated fair value from the first and second quarters of 2017. This compares to an amortized cost basis in the debt security of $18.4 million.

The Company evaluated the decline in fair value of the debt security, which was recorded during the first quarter of 2017, to determine if the impairment was other-than-temporary. Based on this evaluation, the Company recorded an other-than-temporary impairment charge of $5.6 million before income taxes, which is recorded in other expense. In addition to the decrease in fair value, the other-than-temporary impairment included a reclassification of the amount that was previously considered temporary and included in accumulated other comprehensive loss.

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The following table provides a reconciliation of the beginning and ending balances for debt securities measured at fair value using significant unobservable inputs (Level 3):

6. Contingencies

In addition to the matters described below, in the normal course of its business, the Company is involved in various lawsuits from time to time and may be subject to certain other contingencies. The Company believes losses with respect to these additional matters are individually and collectively immaterial as to a possible loss and range of loss.

Discontinued Operations – Matters Related to Breg and Possible Indemnification Obligations

On May 24, 2012, the Company sold Breg to an affiliate of Water Street Healthcare Partners II, L.P. (“Water Street”). Under the terms of the agreement, the Company indemnified Water Street and Breg with respect to certain specified matters.

At the time of its divestiture by the Company, Breg was engaged in the manufacturing and sales of motorized cold therapy units used to reduce pain and swelling. Several domestic product liability cases were filed, mostly in California state court. In September 2014, the Company entered into a master settlement agreement resolving then pending pre-close cold therapy claims. Currently pending is a post-close cold therapy claim in California state court. As of September 30, 2017, the Company has an accrual of $1.8 million recorded within other current liabilities; however, the actual liability could be higher or lower than the amount accrued.

Charges incurred as a result of this indemnification are reflected as discontinued operations in the condensed consolidated statements of operations.

Expiration of Corporate Integrity Agreement with HHS-OIG

In May 2012, the Company entered into a five-year corporate integrity agreement (the “CIA”) with the Office of Inspector General of the Department of Health and Human Services (“HHS-OIG”), in connection with a U.S. government settlement. In October 2017, the Company received a letter from HHS-OIG confirming that the Company has satisfied its CIA requirements and that the CIA has expired.

7. Accumulated other comprehensive loss

The components of and changes in accumulated other comprehensive loss were as follows:

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8. Revenue recognition

The table below presents net sales, which includes product sales and marketing service fees, for both the three and nine months ended September 30, 2017 and 2016.

Product sales primarily consist of stimulation devices and fixation products. Marketing service fees are received from the Musculoskeletal Transplant Foundation (“MTF”) based on total sales of biologics tissues.

9. Business segment information

The table below present net sales, which includes product sales and marketing service fees, by reporting segment:

The primary metric used in managing the Company is non-GAAP net margin, which is an internal metric that the Company defines as gross profit less sales and marketing expense. The table below presents non-GAAP net margin by reporting segment:

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10. Share-based compensation

The following tables present the detail of share-based compensation by line item in the condensed consolidated statements of operations as well as by award type:

The decreases in share-based compensation expense of $4.5 million and $3.0 million, respectively, for the three and nine months ended September 30, 2017, as compared to the prior period were primarily attributable to certain performance-based awards that were first determined to be probable to vest during the third quarter of 2016, resulting in additional expense of $5.1 million during the third quarter of 2016.

During the three months ended September 30, 2017 and 2016, the Company issued 93,486 and 181,235 shares, respectively, of common stock related to stock purchase plan issuances, stock option exercises and the vesting of restricted stock awards. During the nine months ended September 30, 2017 and 2016, the Company issued 384,761 and 710,026 shares, respectively, of common stock related to stock purchase plan issuances, stock option exercises and the vesting of restricted stock awards.

11. Income taxes

Income tax provisions for interim periods are based on an estimated annual income tax rate, adjusted for discrete tax items.  As a result, the Company’s interim effective tax rates may vary significantly from the statutory tax rate and the annual effective tax rate.

For the three months ended September 30, 2017 and 2016, the effective tax rate on continuing operations was 64.8% and (14.0%), respectively. For the nine months ended September 30, 2017 and 2016, the effective tax rate on continuing operations was 70.8% and 43.8%.The primary factors affecting the Company’s effective tax rate for the three and nine months ended September 30, 2017, were the method for estimating income taxes at interim periods, the mix of earnings among tax jurisdictions, increases in unrecognized tax benefits, and current period losses in certain jurisdictions for which the Company does not currently receive a tax benefit.

The Internal Revenue Service is currently conducting examinations of the Company’s federal income tax returns for 2012 and 2013. The Company cannot reasonably determine if these examinations will have a material impact on its financial statements and cannot predict the timing regarding resolution of these tax examinations.

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12. Earnings per share (“EPS”)

For the three and nine months ended September 30, 2017 and 2016, no adjustments were made to net income (loss) for purposes of calculating basic and diluted EPS. The following is a reconciliation of the weighted average shares used in diluted EPS computations.

There were 503,757 and 571,601 outstanding options, restricted stock, and performance-based or market-based equity awards not included in the diluted earnings per share computation for the three months ended September 30, 2017 and 2016, respectively, and 534,288 and 468,296 outstanding options, restricted stock, and performance-based or market-based equity awards not included in the diluted earnings per share computation for the nine months ended September 30, 2017 and 2016, respectively, because inclusion of these awards was anti-dilutive or, for performance-based and market-based awards, all necessary conditions had not been satisfied by the end of the respective period.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of Orthofix International N.V.’s (sometimes referred to as “we,” “us” or “our”) financial condition and results of our operations should be read in conjunction with the “Forward-Looking Statements” and our condensed consolidated financial statements and related notes thereto appearing elsewhere in this Form 10-Q.

Executive Summary

We are a diversified, global medical device company focused on improving patients’ lives by providing superior reconstructive and regenerative orthopedic and spine solutions to physicians worldwide. Headquartered in Lewisville, Texas, we have four strategic business units (“SBUs”) that are also our reporting segments: BioStim, Biologics, Extremity Fixation and Spine Fixation. Our products are widely distributed by our sales representatives and distributors.

Notable highlights and achievements in the third quarter of 2017 include the following:

Results of Operations

The following table provides certain items in our condensed consolidated statements of operations as a percent of net sales:

Net Sales by Strategic Business Unit

The following tables provide net sales by SBU:

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BioStim

BioStim manufactures, distributes, and provides support services of market leading devices that enhance bone fusion. BioStim uses distributors and sales representatives to sell its devices to hospitals, doctors, other healthcare providers, and patients.

Three months ended September 30, 2017 compared to 2016

Net sales increased $1.5 million, or 3.4%

Nine months ended September 30, 2017 compared to 2016

Net sales increased $7.4 million, or 5.7%

Biologics

Biologics provides a portfolio of regenerative products and tissue forms that allow physicians to successfully treat a variety of spinal and orthopedic conditions. Biologics markets its tissues primarily in the U.S. through a network of distributors and independent sales representatives to supply to hospitals, doctors, and other healthcare providers.

Three months ended September 30, 2017 compared to 2016

Net sales increased $0.9 million or 6.2%

Nine months ended September 30, 2017 compared to 2016

Net sales increased $3.2 million or 7.5%

Extremity Fixation

Extremity Fixation offers products and solutions that allow physicians to successfully treat a variety of orthopedic conditions unrelated to the spine. Extremity Fixation distributes its products globally through a network of distributors and sales representatives to sell orthopedic products to hospitals, doctors, and other health providers.

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Three months ended September 30, 2017 compared to 2016

Net sales increased $1.1 million or 4.7%

Nine months ended September 30, 2017 compared to 2016

Net sales decreased $1.7 million or 2.2%

Spine Fixation

Spine Fixation specializes in the design, development and marketing of a portfolio of implant products used in surgical procedures of the spine. Spine Fixation distributes its products globally through a network of distributors and sales representatives to sell spine products to hospitals, doctors and other healthcare providers.

Three months ended September 30, 2017 compared to 2016

Net sales increased $3.3 million or 19.3%

Nine months ended September 30, 2017 compared to 2016

Net sales increased $6.8 million or 12.6%

Gross Profit and Non-GAAP Net Margin

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Three months ended September 30, 2017 compared to 2016

Gross profit, sales and marketing expense, and non-GAAP net margin, an internal metric that we define as gross profit less sales and marketing expense, changed as follows:

Nine months ended September 30, 2017 compared to 2016

Gross profit, sales and marketing expense, and non-GAAP net margin, an internal metric that we define as gross profit less sales and marketing expense, changed as follows:

The following table provides non-GAAP net margin by SBU. The reasons for the changes in non-GAAP net margin by SBU are generally consistent with the information provided above for gross profit and sales and marketing expense.