Orthofix(OFIX) - 2023 Q4 - Annual Report

PART I Item 1. Business Orthofix, a global spine and orthopedics company, operates through two segments and completed a significant merger in 2023 - Orthofix completed an all-stock merger with SeaSpine Holdings Corporation on January 5, 2023[21] Net Sales by Reporting Segment (2021-2023) | Reporting Segment | 2023 Net Sales (%) | 2022 Net Sales (%) | 2021 Net Sales (%) | | :--- | :--- | :--- | :--- | | Global Spine | 85% | Not specified | Not specified | | Global Orthopedics | 15% | Not specified | Not specified | - Products are distributed in over 60 countries via direct sales, agents, and distributors[18][110] - As of December 31, 2023, Orthofix had 1,634 employees worldwide, with 1,271 in the U.S.[131] Research and Development Expenses (2021-2023) | Year | R&D Expense (in millions) | | :--- | :--- | | 2023 | $80.2 | | 2022 | $49.1 | | 2021 | $49.6 | Global Spine Segment The Global Spine segment, accounting for 85% of 2023 net sales, offers implantable devices, biologics, and enabling technologies - The Global Spine segment includes Bone Growth Therapies and Spinal Implants, Biologics, and Enabling Technologies[27] - Key Bone Growth Therapies products include CervicalStim, the only FDA-approved stimulator for cervical spine fusion, and SpinalStim[32][37][39] - The Spinal Implants portfolio features the M6-C artificial cervical disc, FDA-approved in February 2019[45] - Enabling Technologies include the 7D FLASH Navigation System for fast, radiation-free surgical navigation[30][51] - The Biologics portfolio offers cellular allografts like Trinity Elite and the shelf-stable Virtuos Lyograft[56][59][60] Global Orthopedics Segment The Global Orthopedics segment, representing 15% of 2023 net sales, provides solutions for limb deformity and complex reconstruction - This segment offers products for limb deformity correction, complex limb reconstruction, trauma, and foot and ankle procedures[64] - Key external fixation products include the TrueLok and TL-HEX systems[68][72] - The Fitbone Intramedullary Limb-Lengthening System is a key internal fixation product with an FDA-cleared pediatric indication[68][74] - The segment's strategy focuses on expanding leadership in complex deformity and limb reconstruction using the OrthoNext digital planning platform[68] Government Regulation The company's operations are subject to extensive global regulation, including FDA oversight, EU MDR, and healthcare fraud and abuse laws - Products are extensively regulated by the FDA and internationally, with Bone Growth Therapies and the M6-C artificial cervical disc classified as Class III devices[86][87] - The company is transitioning to the European Union's stricter Medical Device Regulation (MDR), incurring additional compliance costs[88] - Biologics derived from human tissue are regulated under the FDA's HCT/P framework and Good Tissues Practices[92] - Sales and marketing are subject to U.S. healthcare fraud and abuse laws, including the Anti-Kickback Statute and Physician Payments Sunshine Act[103][107] Item 1A. Risk Factors The company faces significant risks from merger integration, evolving regulations, intense competition, supply chain reliance, and internal control weaknesses - The company may not successfully integrate the Orthofix and SeaSpine businesses or realize anticipated merger benefits[141][143] - A material weakness in internal control over financial reporting was identified regarding management review controls for business combinations and goodwill[150][151] - An FDA panel recommended reclassifying bone growth stimulator devices from Class III to Class II, potentially increasing competition and negatively impacting sales[141][174][175] - The company relies on a limited number of third-party manufacturers and suppliers, posing risks of delays and increased costs[142][236] - International operations expose the business to risks from political and economic conditions, regulatory differences, tariffs, and foreign currency fluctuations[142][250] Item 1C. Cybersecurity Orthofix maintains a cybersecurity program based on the NIST Framework, overseen by the Audit and Finance Committee, with no material impact reported in 2023 - The cybersecurity program and incident response procedures are based on the NIST Cybersecurity Framework and tested annually[309] - The Audit and Finance Committee oversees cybersecurity risks, receiving quarterly reports from the Chief Information Officer[315] - Third-party firms are engaged for security technology, audits, penetration testing, and preparedness drills[310] - As of December 31, 2023, cybersecurity risks have not materially affected the company's business or financial condition[312] Item 2. Properties Orthofix operates key leased and owned facilities globally, including its Lewisville, TX headquarters and Verona, Italy manufacturing site Key Company Properties | Location | Approx. Square Feet | Ownership | Primary Use | | :--- | :--- | :--- | :--- | | Lewisville, TX | 140,000 | Leased | Corporate HQ, Manufacturing, R&D | | Carlsbad, CA | 82,000 | Leased | Spine & Biologics, R&D, Admin | | Irvine, CA | 70,000 | Leased | Biologics Manufacturing & Distribution | | Verona, Italy | 38,000 | Owned | Orthopedics R&D, Manufacturing, Admin | Item 3. Legal Proceedings Material pending legal proceedings are detailed in Note 13 of the Consolidated Financial Statements - Details on material pending legal proceedings are in Note 13 of the Consolidated Financial Statements[322] PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Orthofix common stock trades on Nasdaq under 'OFIX'; the company has no current dividend policy and retains earnings for growth - The company's common stock trades on the Nasdaq Global Select Market under the symbol "OFIX"[326] - Orthofix has not paid dividends and intends to retain earnings for business growth[328] Common Stock Price Range (2022-2023) | Year | Quarter | High ($) | Low ($) | | :--- | :--- | :--- | :--- | | 2022 | Q1 | 36.13 | 28.66 | | 2022 | Q2 | 35.34 | 23.17 | | 2022 | Q3 | 26.35 | 18.97 | | 2022 | Q4 | 21.12 | 13.76 | | 2023 | Q1 | 23.19 | 15.09 | | 2023 | Q2 | 20.65 | 16.27 | | 2023 | Q3 | 21.60 | 12.25 | | 2023 | Q4 | 14.39 | 9.57 | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations In 2023, net sales grew 62.1% to $746.6 million due to the SeaSpine merger, but gross margin declined, leading to significant operating and net losses Key Financial Results 2023 vs 2022 | Metric | 2023 | 2022 | Change (%) | | :--- | :--- | :--- | :--- | | Net Sales | $746.6M | $460.7M | +62.1% | | Gross Profit | $486.3M | $337.2M | +44.2% | | Gross Margin | 65.1% | 73.2% | -8.1 pts | | Operating Loss | ($139.1M) | ($13.3M) | N/A | | Net Loss | ($151.4M) | ($19.7M) | N/A | - Net sales growth was primarily driven by the SeaSpine merger, with U.S. Spinal Implants, Biologics, and Enabling Technologies growing 7.6% pro forma[339][342] - Gross margin significantly declined due to $36.0 million in inventory fair value step-up amortization and $6.0 million in rationalization charges[347] - General and administrative expenses increased 80.9% to $144.7 million, including $22.7 million in merger costs and $10.0 million for an independent investigation[345][349][350] Cash Flow Summary (2023 vs 2022) | Cash Flow Activity | 2023 (in millions) | 2022 (in millions) | | :--- | :--- | :--- | | Net cash from operating activities | $(45.8) | $(11.5) | | Net cash from investing activities | $(33.1) | $(24.5) | | Net cash from financing activities | $65.3 | $(0.1) | - In November 2023, the company secured a new $150 million financing agreement, including a $100 million term loan[290][366] Item 7A. Quantitative and Qualitative Disclosures About Market Risk The company faces market risks from interest rate fluctuations on floating-rate debt and foreign currency exposure, primarily impacting net sales and operating income - The company faces interest rate risk from outstanding debt bearing floating rates based on SOFR[431] - Foreign currency exposure primarily involves the U.S. Dollar against the Euro, Brazilian Real, Australian Dollar, Swiss Franc, British Pound, and Canadian Dollar[433] - A 10% strengthening of the U.S. Dollar would decrease net sales by $9.4 million and operating income by $0.6 million[434] Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The company reported no disagreements with its accountants regarding accounting and financial disclosure - No changes or disagreements were reported[436] Item 9A. Controls and Procedures Management concluded that disclosure controls were ineffective as of December 31, 2023, due to a material weakness in business combination and goodwill review controls - Management concluded that disclosure controls and procedures were not effective as of December 31, 2023[437] - A material weakness was identified in management review controls for business combinations and goodwill recoverability assessment[440][450] - The remediation plan includes hiring additional accounting personnel, providing training, and enhancing financial reporting controls[444] - Management's internal control assessment excluded the SeaSpine business, representing 52% of total assets and 35% of revenues for the year[442][451] PART III Items 10-14 Information for Items 10-14, including executive and governance details, is incorporated by reference from the company's definitive proxy statement - Information for Items 10-14 is incorporated by reference from the company's definitive proxy statement[463] PART IV Item 15. Exhibits, Financial Statement Schedules This section lists all documents filed as part of the Form 10-K, including consolidated financial statements and a comprehensive list of exhibits - This section includes the Index to Consolidated Financial Statements and a list of all exhibits filed with the Form 10-K[470] Financial Statements Consolidated Financial Statements The 2023 consolidated financial statements reflect the SeaSpine merger's impact, with total assets nearly doubling to $925.3 million and a net loss of $151.4 million Consolidated Balance Sheet Highlights (as of Dec 31) | (in thousands) | 2023 | 2022 | | :--- | :--- | :--- | | Assets | | | | Cash and cash equivalents | $33,107 | $50,700 | | Inventories | $222,166 | $100,150 | | Goodwill | $194,934 | $71,317 | | Total Assets | $925,315 | $458,629 | | Liabilities & Equity | | | | Total current liabilities | $165,223 | $83,624 | | Long-term debt | $93,107 | $0 | | Total Liabilities | $326,585 | $121,769 | | Total Shareholders' Equity | $598,730 | $336,860 | Consolidated Statement of Operations Highlights (Year Ended Dec 31) | (in thousands, except per share data) | 2023 | 2022 | 2021 | | :--- | :--- | :--- | :--- | | Net sales | $746,641 | $460,713 | $464,479 | | Gross profit | $486,273 | $337,169 | $349,565 | | Operating loss | $(139,110) | $(13,268) | $(8,315) | | Net loss | $(151,395) | $(19,749) | $(38,379) | | Net loss per share (Basic & Diluted) | $(4.12) | $(0.98) | $(1.95) | Consolidated Statement of Cash Flows Highlights (Year Ended Dec 31) | (in thousands) | 2023 | 2022 | | :--- | :--- | :--- | | Net cash from operating activities | $(45,753) | $(11,538) | | Net cash from investing activities | $(33,131) | $(24,534) | | Net cash from financing activities | $65,322 | $(78) | | Net change in cash | $(12,943) | $(37,147) | Notes to the Consolidated Financial Statements The notes detail accounting policies, the SeaSpine merger's $376.7 million consideration, segment performance, legal contingencies, new financing, and a $200.2 million valuation allowance against deferred tax assets - The SeaSpine merger was accounted for as a business combination with $376.7 million consideration, resulting in $123.6 million goodwill allocated to Global Spine (Note 4)[533][534][535] - In September 2023, the CEO, CFO, and Chief Legal Officer were terminated for cause, leading to arbitration claims in January 2024 (Note 13)[600][601] - The company accrued $7.6 million related to the Italian Medical Device Payback (IMDP) law (Note 13)[603][605] - As of December 31, 2023, a $200.2 million valuation allowance was held against deferred tax assets, primarily from net operating loss carryforwards (Note 20)[676][678] - The company has $331.7 million in federal net operating loss carryforwards, subject to IRC Section 382 limitations and expiring from 2026 (Note 20)[679]