Orthofix(OFIX) - 2018 Q4 - Annual Report

Part I Business Orthofix is a global medical device company specializing in musculoskeletal products and therapies across four reporting segments - Orthofix is a global medical device company focused on musculoskeletal products and therapies, with products distributed in over seventy countries[15] - In July 2018, the company changed its jurisdiction of organization from Curaçao to Delaware and changed its name to Orthofix Medical Inc[17] 2018 Net Sales by Business Segment | Business Segment | 2018 Net Sales % | | :--- | :--- | | Bone Growth Therapies | 43% | | Spinal Implants | 20% | | Biologics | 13% | | Orthofix Extremities | 24% | Business Segments The company's operations are divided into Bone Growth Therapies, Spinal Implants, Biologics, and Orthofix Extremities segments - The Bone Growth Therapies segment's strategy is to expand patient access to its noninvasive devices, leveraging its STIM onTrack mobile app to monitor patient adherence[24][25] - The Spinal Implants segment was strengthened by the April 2018 acquisition of Spinal Kinetics, which added the M6-C and M6-L artificial discs to its portfolio; the M6-C disc received FDA approval in February 2019[40] - The Biologics segment exclusively markets Trinity Evolution and Trinity ELITE tissue forms through a partnership with MTF Biologics, which processes and supplies the tissues[42][49] - The Orthofix Extremities segment focuses on pediatrics and deformity correction worldwide, leveraging its TL-HEX system and JuniOrtho pediatric brand[53][64] Product Development, IP, and Compliance The company invested $33.2 million in R&D in 2018 and protects its technology through patents, trade secrets, and licenses Research and Development Expense (2016-2018) | Year | R&D Expense (in millions) | | :--- | :--- | | 2018 | $33.2 | | 2017 | $29.7 | | 2016 | $28.8 | - The company relies on a combination of patents, trade secrets, assignment and license agreements, and non-disclosure agreements to protect its proprietary intellectual property[70] Government Regulation and Sales The company's products and sales practices are subject to extensive regulation by the FDA and other global authorities - Bone Growth Therapies products and the M6-C artificial cervical disc are classified as class III by the FDA, requiring the most stringent Premarket Approval (PMA) process[75] - The Biologics segment's allograft products (Trinity Evolution, Trinity ELITE) are regulated under the FDA's Human Cell, Tissues and Cellular and Tissue-Based Products (HCT/P) framework, not as medical devices[78] - Sales and marketing practices are subject to U.S. laws including the federal Anti-Kickback Statute, the Stark Law, the Civil False Claims Act, and HIPAA[85] Competition, Manufacturing, and Employees Orthofix competes with major medical device firms, relies on subcontracting, and employed 954 people worldwide as of year-end 2018 - Key competitors include Zimmer Biomet, DJO Global, Medtronic, DePuy Synthes (a division of Johnson & Johnson), and Stryker Corp[99] - The company subcontracts a substantial portion of component part manufacturing and relies on MTF as the sole supplier for its Trinity Evolution and Trinity ELITE HCT/Ps[101][102] - As of December 31, 2018, the company had 954 employees worldwide, with 686 in the U.S. and 268 in other locations[104] Risk Factors The company faces significant risks from its legal environment, industry competition, third-party reliance, and financial exposures - The company has previously settled violations of the Foreign Corrupt Practices Act (FCPA) related to its Brazilian and Mexican subsidiaries and retained an independent compliance consultant which concluded its review in March 2018[109] - The business is subject to extensive government regulation by the FDA and other authorities, and a potential FDA down-classification of Class III bone growth stimulators could increase competition[119] - The company is dependent on third-party manufacturers, including a sole-supplier relationship with MTF for its Trinity Evolution and Trinity ELITE allografts[139] - A $15 million loan to eNeura, Inc matures on March 4, 2019, and the company does not expect to collect the full principal and interest on the maturity date[157][159] Properties Orthofix's principal facilities include a leased corporate headquarters in Texas and an owned manufacturing facility in Italy Principal Facilities | Location | Approx. Square Feet | Ownership | | :--- | :--- | :--- | | Lewisville, TX | 140,000 | Leased | | Sunnyvale, CA | 25,000 | Leased | | Verona, Italy | 38,000 | Owned | | Verona, Italy | 18,000 | Leased | | Verona, Italy | 9,000 | Leased | Legal Proceedings Material pending legal proceedings are detailed in Note 13 of the Notes to the Consolidated Financial Statements - A description of material pending legal proceedings is provided in Note 13 of the Notes to the Consolidated Financial Statements[169] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock trades on Nasdaq under the symbol "OFIX," and the company does not intend to pay dividends - The company's common stock is traded on the Nasdaq Global Select Market under the symbol "OFIX"[173] - The company has not paid dividends in the past and has no present intention to pay dividends in the foreseeable future[175] 2018 Quarterly Stock Price Range | Quarter | High | Low | | :--- | :--- | :--- | | First | $61.00 | $51.01 | | Second | $61.86 | $51.38 | | Third | $61.98 | $50.41 | | Fourth | $63.57 | $48.00 | Selected Financial Data This section presents a five-year summary of key financial data, showing net sales of $453.0 million for 2018 Selected Financial Data (2016-2018) | (U.S. Dollars, in thousands) | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Net sales | $453,042 | $433,823 | $409,788 | | Gross profit | $356,414 | $340,786 | $321,935 | | Operating income | $30,094 | $40,811 | $21,067 | | Net income (loss) | $13,811 | $6,223 | $3,056 | | Diluted EPS | $0.72 | $0.34 | $0.17 | | Total assets (at year-end) | $466,641 | $405,354 | $372,103 | | Shareholders' equity (at year-end) | $335,397 | $296,608 | $263,477 | Management's Discussion and Analysis of Financial Condition and Results of Operations Net sales grew 4.4% in 2018, though operating income decreased due to acquisition costs and higher G&A expenses Results of Operations Net sales growth in 2018 was driven by the Bone Growth Therapies and Spinal Implants segments, while the effective tax rate decreased significantly Net Sales by Reporting Segment (2017 vs. 2018) | (U.S. Dollars, in thousands) | 2018 | 2017 | % Change (Reported) | | :--- | :--- | :--- | :--- | | Bone Growth Therapies | $195,252 | $185,900 | 5.0% | | Spinal Implants | $91,658 | $81,957 | 11.8% | | Biologics | $59,684 | $62,724 | -4.8% | | Orthofix Extremities | $106,448 | $103,242 | 3.1% | | Total Net Sales | $453,042 | $433,823 | 4.4% | - General and administrative expenses increased by $12.6 million (17.5%) in 2018, primarily due to $6.3 million in costs associated with the Spinal Kinetics acquisition and domestication, and a $5.5 million increase in share-based compensation[199][200] - The effective tax rate decreased from 80.0% in 2017 to 39.7% in 2018, as the 2017 rate was significantly impacted by a one-time charge of $8.3 million related to the U.S. Tax Cuts and Jobs Act[212][213] Liquidity and Capital Resources Cash from operations increased, but overall cash decreased due to the Spinal Kinetics acquisition, while a $125 million credit facility remains undrawn Summary of Cash Flows (2018 vs. 2017) | (U.S. Dollars, in thousands) | 2018 | 2017 | | :--- | :--- | :--- | | Net cash from operating activities | $49,918 | $38,972 | | Net cash from investing activities | $(60,998) | $(16,474) | | Net cash from financing activities | $2,993 | $3,538 | | Net change in cash | $(8,968) | $27,216 | - The acquisition of Spinal Kinetics involved a closing payment of $45.0 million in cash, with potential future milestone payments up to $60.0 million; the FDA approval of the M6-C disc in February 2019 triggered a $15.0 million payment[229][230] - The company has a $125 million secured revolving credit facility that was undrawn as of December 31, 2018[226] Critical Accounting Estimates Management identifies critical accounting estimates in revenue recognition, intangible asset valuation, and fair value measurements - For stocking distributors, revenue is recognized upon shipment, and the transaction price is estimated based on historical collection experience, a change resulting from the adoption of Topic 606 in 2018[245] - The valuation of intangible assets and goodwill from the Spinal Kinetics acquisition required significant judgment, including forecasting future operating results and estimating probabilities of success for IPR&D projects[249][250][251] - Fair value measurements for the eNeura debt security and the Spinal Kinetics contingent consideration are classified as Level 3, as they are based on significant unobservable inputs and internal assumptions[254][255][258] Quantitative and Qualitative Disclosures About Market Risk The company's primary market risks are interest rate changes and foreign currency fluctuations, particularly against the Euro, Real, and Pound - The company's primary market risk exposures are changes in interest rates and foreign currency fluctuations, particularly the U.S. Dollar against the Euro, Brazilian Real, or British Pound[281][284] - For the year ended December 31, 2018, the company recorded a foreign currency loss of $3.3 million[284] - A sensitivity analysis indicates that a 10% change in the value of the U.S. Dollar relative to foreign currencies would result in an $8.6 million change in net sales and a $0.4 million change in operating income[285] Financial Statements and Supplementary Data This section contains the company's audited consolidated financial statements and related notes for the fiscal year ended December 31, 2018 Consolidated Balance Sheets Total assets grew to $466.6 million in 2018, driven by goodwill and intangible assets from the Spinal Kinetics acquisition Consolidated Balance Sheet Highlights (as of Dec 31) | (U.S. Dollars, in thousands) | 2018 | 2017 | | :--- | :--- | :--- | | Total Current Assets | $244,639 | $251,801 | | Goodwill | $72,401 | $53,565 | | Total Assets | $466,641 | $405,354 | | Total Current Liabilities | $85,908 | $79,406 | | Total Liabilities | $131,244 | $108,746 | | Total Shareholders' Equity | $335,397 | $296,608 | Consolidated Statements of Income and Comprehensive Income The company reported net income of $13.8 million and diluted EPS of $0.72 for the year ended December 31, 2018 Consolidated Income Statement Highlights (Year Ended Dec 31) | (U.S. Dollars, in thousands) | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | Net Sales | $453,042 | $433,823 | $409,788 | | Gross Profit | $356,414 | $340,786 | $321,935 | | Operating Income | $30,094 | $40,811 | $21,067 | | Net Income from Continuing Operations | $13,811 | $7,291 | $3,497 | | Net Income | $13,811 | $6,223 | $3,056 | | Diluted EPS | $0.72 | $0.34 | $0.17 | Consolidated Statements of Cash Flows Net cash from operations was $49.9 million, while investing activities used $61.0 million, primarily for an acquisition Consolidated Cash Flow Highlights (Year Ended Dec 31, 2018) | (U.S. Dollars, in thousands) | 2018 | | :--- | :--- | | Net cash from operating activities | $49,918 | | Net cash from investing activities | $(60,998) | | Net cash from financing activities | $2,993 | | Effect of exchange rate changes | $(881) | | Net change in cash | $(8,968) | | Cash at end of year | $72,189 | Controls and Procedures Management concluded that disclosure controls and internal controls over financial reporting were effective as of December 31, 2018 - Management concluded that as of December 31, 2018, the company's disclosure controls and procedures were effective[288] - Management concluded that the company's internal control over financial reporting was effective as of December 31, 2018; the assessment excluded Spinal Kinetics, which was acquired during the year[291] - The independent registered public accounting firm, Ernst & Young LLP, issued an unqualified audit report on the effectiveness of the company's internal control over financial reporting as of December 31, 2018[292][296] Part III Information required by Part III is omitted from this Form 10-K and will be filed in the company's definitive proxy statement Directors, Executive Compensation, and Corporate Governance Information for Items 10 through 14 is incorporated by reference from the company's definitive proxy statement to be filed later - Information required by Items 10, 11, 12, 13 and 14 of Form 10-K is omitted from this Annual Report and will be filed in a definitive proxy statement or by an amendment to this Annual Report not later than 120 days after the end of the fiscal year[307] Part IV Exhibits, Financial Statement Schedules This section lists the financial statements and exhibits filed as part of the Form 10-K report - This section contains the index to consolidated financial statements and a list of all exhibits filed with the Form 10-K[314]