ofix-10q_20180331.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

(Mark one)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2018

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     .

Commission File Number: 0-19961

 

ORTHOFIX INTERNATIONAL N.V.

(Exact name of registrant as specified in its charter)

 

 

Curaçao

 

98-1340767

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

 

 

7 Abraham de Veerstraat

Curaçao

 

Not applicable

(Address of principal executive offices)

 

(Zip Code)

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.

 

Large Accelerated filer

Accelerated filer

 

 

 

 

Non-Accelerated filer

  (Do not check if a smaller reporting company)

Smaller Reporting Company

 

 

 

 

 

 

Emerging Growth Company

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 April 23, 2018, 18,757,700 shares of common stock were issued and outstanding.

 


 

 

 Table of Contents

 

 

 

 

 

 

Page

PART I

 

FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Financial Statements

 

4

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets as of March 31, 2018, and December 31, 2017

 

4

 

 

 

 

 

 

 

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three months ended  March 31, 2018, and 2017

 

5

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2018 and 2017

 

6

 

 

 

 

 

 

 

Notes to the Unaudited Condensed Consolidated Financial Statements

 

7

 

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

18

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

25

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

25

 

 

 

 

 

PART II

 

OTHER INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

26

 

 

 

 

 

Item 1A.

 

Risk Factors

 

26

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

26

 

 

 

 

 

Item 3.

 

Defaults Upon Senior Securities

 

26

 

 

 

 

 

Item 4.

 

Mine Safety Disclosures

 

26

 

 

 

 

 

Item 5.

 

Other Information

 

26

 

 

 

 

 

Item 6.

 

Exhibits

 

27

 

 

 

 

 

SIGNATURES

 

28

2


 

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, 2017 (the “2017 Form 10-K”) and other SEC filings. 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 2017 Form 10-K and other SEC filings, 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.

 

3


 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ORTHOFIX INTERNATIONAL N.V.

Condensed Consolidated Balance Sheets

 

(U.S. Dollars, in thousands, except share data)

 

March 31,

2018

 

 

December 31,

2017

 

 

 

(Unaudited)

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

77,056

 

 

$

81,157

 

Accounts receivable, net of allowances of $8,934 and $8,405, respectively

 

 

77,182

 

 

 

63,437

 

Inventories

 

 

77,686

 

 

 

81,330

 

Prepaid expenses and other current assets

 

 

31,219

 

 

 

25,877

 

Total current assets

 

 

263,143

 

 

 

251,801

 

Property, plant and equipment, net

 

 

43,973

 

 

 

45,139

 

Patents and other intangible assets, net

 

 

13,150

 

 

 

10,461

 

Goodwill

 

 

53,565

 

 

 

53,565

 

Deferred income taxes

 

 

28,359

 

 

 

23,315

 

Other long-term assets

 

 

6,814

 

 

 

21,073

 

Total assets

 

$

409,004

 

 

$

405,354

 

Liabilities and shareholders’ equity

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

Accounts payable

 

$

14,012

 

 

$

18,111

 

Other current liabilities

 

 

51,171

 

 

 

61,295

 

Total current liabilities

 

 

65,183

 

 

 

79,406

 

Other long-term liabilities

 

 

30,647

 

 

 

29,340

 

Total liabilities

 

 

95,830

 

 

 

108,746

 

Contingencies (Note 5)

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

 

 

 

Common shares $0.10 par value; 50,000,000 shares authorized;

   18,405,344 and 18,278,833 issued and outstanding as of March 31,

   2018 and December 31, 2017, respectively

 

 

1,841

 

 

 

1,828

 

Additional paid-in capital

 

 

228,356

 

 

 

220,591

 

Retained earnings

 

 

78,493

 

 

 

70,402

 

Accumulated other comprehensive income

 

 

4,484

 

 

 

3,787

 

Total shareholders’ equity

 

 

313,174

 

 

 

296,608

 

Total liabilities and shareholders’ equity

 

$

409,004

 

 

$

405,354

 

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

4


 

ORTHOFIX INTERNATIONAL N.V.

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)

 

 

 

Three Months Ended

March 31,

 

(Unaudited, U.S. Dollars, in thousands, except share and per share data)

 

2018

 

 

2017

 

Net sales

 

$

108,709

 

 

$

102,738

 

Cost of sales

 

 

24,147

 

 

 

22,581

 

Gross profit

 

 

84,562

 

 

 

80,157

 

Sales and marketing

 

 

50,268

 

 

 

48,532

 

General and administrative

 

 

19,484

 

 

 

18,282

 

Research and development

 

 

6,937

 

 

 

7,424

 

Operating income

 

 

7,873

 

 

 

5,919

 

Interest income (expense), net

 

 

(183

)

 

 

45

 

Other income (expense), net

 

 

2,912

 

 

 

(4,348

)

Income before income taxes

 

 

10,602

 

 

 

1,616

 

Income tax expense

 

 

(5,373

)

 

 

(3,924

)

Net income (loss) from continuing operations

 

 

5,229

 

 

 

(2,308

)

Discontinued operations (Note 5)

 

 

 

 

 

 

 

 

Loss from discontinued operations

 

 

(3

)

 

 

(527

)

Income tax benefit

 

 

 

 

 

181

 

Net loss from discontinued operations

 

 

(3

)

 

 

(346

)

Net income (loss)

 

$

5,226

 

 

$

(2,654

)

Net income (loss) per common share—basic

 

 

 

 

 

 

 

 

Net income (loss) from continuing operations

 

$

0.28

 

 

$

(0.13

)

Net loss from discontinued operations

 

 

 

 

 

(0.02

)

Net income (loss) per common share—basic

 

$

0.28

 

 

$

(0.15

)

Net income (loss) per common share—diluted

 

 

 

 

 

 

 

 

Net income (loss) from continuing operations

 

$

0.27

 

 

$

(0.13

)

Net loss from discontinued operations

 

 

 

 

 

(0.02

)

Net income (loss) per common share—diluted

 

$

0.27

 

 

$

(0.15

)

Weighted average number of common shares:

 

 

 

 

 

 

 

 

Basic

 

 

18,404,856

 

 

 

17,979,675

 

Diluted

 

 

18,874,591

 

 

 

17,979,675

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, before tax

 

 

 

 

 

 

 

 

Unrealized gain (loss) on debt securities

 

 

 

 

 

(3,220

)

Reclassification adjustment for loss on debt securities in net income

 

 

 

 

 

5,585

 

Currency translation adjustment

 

 

697

 

 

 

234

 

Other comprehensive income before tax

 

 

697

 

 

 

2,599

 

Income tax related to items of other comprehensive loss

 

 

 

 

 

(900

)

Other comprehensive income, net of tax

 

 

697

 

 

 

1,699

 

Comprehensive income (loss)

 

$

5,923

 

 

$

(955

)

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

5


 

ORTHOFIX INTERNATIONAL N.V.

Condensed Consolidated Statements of Cash Flows

 

 

 

Three Months Ended

March 31,

 

(Unaudited, U.S. Dollars, in thousands)

 

2018

 

 

2017

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

Net income (loss)

 

$

5,226

 

 

$

(2,654

)

Adjustments to reconcile net income to net cash from operating activities

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

4,369

 

 

 

5,075

 

Amortization of debt costs and other assets

 

 

375

 

 

 

360

 

Provision for doubtful accounts

 

 

(35

)

 

 

532

 

Deferred income taxes

 

 

277

 

 

 

5,074

 

Share-based compensation

 

 

3,916

 

 

 

2,816

 

Other-than-temporary impairment on debt securities

 

 

 

 

 

5,585

 

Gain on valuation of equity securities

 

 

(1,629

)

 

 

 

Other

 

 

208

 

 

 

242

 

Changes in operating assets and liabilities

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(4,925

)

 

 

(2,074

)

Inventories

 

 

1,664

 

 

 

(2,750

)

Prepaid expenses and other current assets

 

 

2,166

 

 

 

(203

)

Accounts payable

 

 

(4,459

)

 

 

1,014

 

Other current liabilities

 

 

(11,310

)

 

 

(23,253

)

Other long-term assets and liabilities

 

 

597

 

 

 

(663

)

Net cash from operating activities

 

 

(3,560

)

 

 

(10,899

)

Cash flows from investing activities

 

 

 

 

 

 

 

 

Capital expenditures for property, plant and equipment

 

 

(2,831

)

 

 

(3,721

)

Capital expenditures for intangible assets

 

 

(607

)

 

 

(184

)

Purchase of intangible assets and other investments

 

 

(1,217

)

 

 

 

Other investing activities

 

 

 

 

 

474

 

Net cash from investing activities

 

 

(4,655

)

 

 

(3,431

)

Cash flows from financing activities

 

 

 

 

 

 

 

 

Proceeds from issuance of common shares

 

 

4,378

 

 

 

3,876

 

Payments related to withholdings for share-based compensation

 

 

(516

)

 

 

(2,079

)

Payment of debt issuance costs

 

 

(165

)

 

 

 

Net cash from financing activities

 

 

3,697

 

 

 

1,797

 

Effect of exchange rate changes on cash

 

 

417

 

 

 

244

 

Net change in cash,  cash equivalents, and restricted cash

 

 

(4,101

)

 

 

(12,289

)

Cash,  cash equivalents, and restricted cash at the beginning of the period

 

 

81,157

 

 

 

53,941

 

Cash, cash equivalents, and restricted cash at the end of the period

 

$

77,056

 

 

$

41,652

 

 

 

 

 

 

 

 

 

 

Noncash activities:

 

 

 

 

 

 

 

 

Purchase of intangible assets

 

 

1,181

 

 

 

 

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

 

 

6


 

ORTHOFIX INTERNATIONAL N.V.

Notes to the Unaudited Condensed Consolidated Financial Statements

Business and basis of presentation

Orthofix International N.V., together with its subsidiaries (the “Company”) is a global medical device company focused on musculoskeletal healing products and value-added services. Headquartered in Lewisville, Texas, the Company has four strategic business units (“SBUs”) that are also its reporting segments: BioStim, Extremity Fixation, Spine Fixation, and Biologics.

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, 2017. Operating results for the three months ended March 31, 2018 are not necessarily indicative of the results that may be expected for other interim periods or the year ending December 31, 2018.

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 adopted accounting standards and recently issued accounting pronouncements

 

Adoption of accounting standards update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606)

In May 2014, the FASB issued ASU 2014-09. Topic 606 supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, and requires entities to recognize revenue when control of the promised goods or services is transferred to customers at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company adopted ASC 606 as of January 1, 2018 using the modified retrospective transition method. Results for prior period amounts are not adjusted and continue to be reported in accordance with the Company’s historic accounting under the previous revenue recognition standard, Topic 605. See Note 7 for further details.

Adoption of ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10), and ASU 2018-03, Technical Corrections and Improvements to Financial Instruments – Overall (Subtopic 825-10)

In January 2016, the FASB issued ASU 2016-01, which was then further clarified in ASU 2018-03, in February 2018. This guidance requires entities to generally measure equity investments at fair value and recognize any changes in fair value in net income. However, for certain equity investments that do not have readily determinable fair values, the new guidance allows entities to choose to measure these investments using a new measurement alternative, which values the investments at cost, less any impairments, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. The Company prospectively adopted both ASU 2016-01 and ASU 2018-03 on January 1, 2018 and elected to use the new measurement alternative for the Company’s equity investments in Bone Biologics, Inc. (“Bone Biologics”), which have historically been held at cost. This resulted in an increase in the previously recorded value of the Company’s equity investments in Bone Biologics, which are recorded within other long term assets, of $1.6 million, or $0.09 per share before taxes, which was included in other income. See Note 4 for further details.

Adoption of ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory

In October 2016, the FASB issued ASU 2016-16, which reduces diversity in practice of accounting for intra-entity transfers of assets, particularly for intra-entity transfers of intellectual property. The new standard states an entity should recognize the income tax consequences of an intra-entity transfer when the transfer occurs, as opposed to historical U.S. GAAP guidance which prohibited the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset had been sold to an outside party. During the third and fourth quarters of 2017, the Company executed two intra-entity asset transfers that resulted in prepaid income taxes of $8.6 million. The Company adopted this new standard using a modified retrospective approach as of January 1, 2018, which

7


 

resulted in a reduction of prepaid income taxes and an increase in deferred tax assets with these changes offset by an adjustment to the Company's opening retained earnings of approximately $1.9 million. Adoption of this guidance did not have a material impact to the Company’s consolidated statements of operations and comprehensive income (loss) or to its consolidated statements of cash flows.

Adoption of ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash

In November 2016, the FASB issued ASU 2016-18, which reduces diversity in classification and presentation of restricted cash, including transfers between cash and restricted cash, on the statement of cash flows. The Company adopted this standard as of January 1, 2018 using a retrospective transition approach. Adoption of this ASU resulted in a decrease in net cash from operating activities of $14.4 million for the three months ended March 31, 2017.

Adoption of ASU 2017-01, Business Combinations (Topic 805)

In January 2017, the FASB issued ASU 2017-01, which clarifies the definition of a business. This amendment states that when substantially all of the fair value of gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets, that the set of assets acquired is not a business, which will likely result in more acquisitions being accounted for as asset acquisitions rather than business combinations. Based upon this guidance, which the Company adopted as of January 1, 2018, the Company accounted for an acquisition during the first quarter of 2018 for approximately $1.9 million as an asset acquisition rather than a business combination, as the set of assets acquired did not meet the definition of a business.

Recently issued accounting pronouncements

 

Topic

 

Description of Guidance

 

Effective Date

 

Status of Company's Evaluation

Leases

(ASU 2016-02)

 

Requires a lessee to recognize lease assets and lease liabilities for leases classified as operating leases. Applied using a modified retrospective approach.

 

January 1, 2019

 

The Company has established a cross-functional implementation team to analyze the impact of the standard on the Company's population of leases and to evaluate the Company's current accounting policies relating to leases. The Company is currently evaluating the impact this ASU may have on its consolidated financial statements; however, the Company expects this guidance will materially impact the Company's consolidated balance sheet, resulting in current operating lease obligations being reflected on the consolidated balance sheet.

Goodwill

(ASU 2017-04)

 

Eliminates Step 2 of the current goodwill impairment test, which requires a hypothetical purchase price allocation to measure goodwill impairment. A goodwill impairment loss will instead be measured at the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the recorded amount of goodwill. Applied on a prospective basis, with early adoption permitted.

 

January 1, 2020

 

The Company is currently evaluating the impact this ASU may have on its consolidated financial statements. However, the Company does not expect this ASU to have a significant impact on its financial statements or disclosures.

Comprehensive income

(ASU 2018-02)

 

Allows entities to reclassify from accumulated other comprehensive income to retained earnings stranded tax effects resulting from the Tax Cuts and Jobs Act (the "Tax Act"). Applied either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Act is recognized.

 

January 1, 2019

 

The Company is currently evaluating the impact this ASU may have on its consolidated financial statements.

 

 

8


 

2. Inventories

Inventories were as follows:

 

(U.S. Dollars, in thousands)

 

March 31,

2018

 

 

December 31,

2017

 

Raw materials

 

$

5,889

 

 

$

6,067

 

Work-in-process

 

 

13,666

 

 

 

12,487

 

Finished products

 

 

58,131

 

 

 

60,441

 

Deferred cost of sales

 

 

 

 

 

2,335

 

Inventories

 

$

77,686

 

 

$

81,330

 

 

Prior to the adoption of ASU 2014-09, or for all periods presented prior to January 1, 2018, deferred cost of sales resulted from transactions where the Company had shipped product or performed services for which all revenue recognition criteria had not yet been met. Once all revenue recognition criteria had been met, the revenue and associated cost of sales were recognized. Subsequent to the adoption of ASU 2014-09, the Company no longer has transactions which result in the recognition of deferred cost of sales. See Note 7 for further discussion of the Company’s adoption of ASU 2014-09.

 

 

3. Long-term debt

As of March 31, 2018, 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 ($7.1 million) available line of credit in Italy as of March 31, 2018.  The Company is in compliance with all required financial covenants as of March 31, 2018.

 

 

4. Fair value measurements

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

 

 

 

March 31,

2018

 

 

December 31,

2017

 

(U.S. Dollars, in thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Collective trust funds

 

$

 

 

$

100

 

 

$

 

 

$

100

 

 

$

100

 

Treasury securities

 

 

563

 

 

 

 

 

 

 

 

 

563

 

 

 

556

 

Equity warrants

 

 

 

 

 

519

 

 

 

 

 

 

519

 

 

 

311

 

Equity securities

 

 

 

 

 

4,379

 

 

 

 

 

 

4,379

 

 

 

2,457

 

Debt security

 

 

 

 

 

 

 

 

16,050

 

 

 

16,050

 

 

 

16,050

 

Total

 

$

563

 

 

$

4,998

 

 

$

16,050

 

 

$

21,611

 

 

$

19,474

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred compensation plan

 

$

 

 

$

(1,398

)

 

$

 

 

$

(1,398

)

 

$

(1,379

)

Total

 

$

 

 

$

(1,398

)

 

$

 

 

$

(1,398

)

 

$

(1,379

)

 

Equity Warrants and Securities

The Company holds investments in common stock and warrants to purchase shares of common stock of Bone Biologics, Inc. (“Bone Biologics”). Both of these instruments are recorded within other long-term assets. Prior to 2018, these instruments were accounted for at cost as the fair value of these instruments was not readily determinable. Effective January 1, 2018, the Company is required to measure these equity investments at fair value and recognize any changes in fair value in net income as a result of adopting ASU 2016-01. However, for certain equity investments that do not have readily determinable fair values, the new guidance allows entities to choose to measure these investments using a new measurement alternative, which values the investments at cost, less any impairments, plus or minus changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer. The Company has elected to use the new measurement alternative for these equity investments in Bone Biologics, which resulted in an increase in the previously recorded value of the equity investments of $1.6 million, or $0.09 per

9


 

share before taxes, which was included in other income. In addition, the Company made an additional investment in Bone Biologics during the first quarter of 2018, in which it purchased an additional 250,000 shares of common stock for $0.5 million.

 

Debt Security

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 matures on March 4, 2019. The fair value of the debt security, which is recorded within other current 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 March 31, 2018, the Company reassessed its estimate of fair value based on current financial information and other assumptions, resulting in a fair value of $16.1 million, which is consistent with the Company’s estimated fair value of the debt security as of December 31, 2017. This compares to an amortized cost basis in the debt security of $9.0 million.

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):

 

(U.S. Dollars, in thousands)

 

2018

 

 

2017

 

Balance at January 1

 

$

16,050

 

 

$

12,220

 

Accrued interest income

 

 

 

 

 

 

Gains or losses recorded for the period

 

 

 

 

 

 

 

 

Recognized in net income

 

 

 

 

 

(5,585

)

Recognized in other comprehensive income

 

 

 

 

 

2,365

 

Balance at March 31

 

$

16,050

 

 

$

9,000

 

 

 

5. 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 any losses related to these 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 March 31, 2018, the Company has an accrual of $1.7 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 and comprehensive income (loss).

Italian Medical Device Payback (“IMDP”)

In 2015, the Italian Parliament introduced rules for entities that supply goods and services to the Italian National Healthcare System. The healthcare law is expected to impact the business and financial reporting of companies operating in the medical technology sector that sell medical devices in Italy. A key provision of the law is a ‘payback’ measure, requiring companies selling medical devices in Italy to make payments to the Italian government if medical device expenditures exceed regional maximum ceilings. Companies are required to make payments equal to a percentage of expenditures exceeding maximum regional caps. There is considerable uncertainty about how the law will operate and what the exact timeline is for finalization. The Company’s current assessment of the IMDP involves significant judgment regarding the expected scope and actual implementation terms of the measure as the latter have not been clarified to date by Italian authorities. The Company accounts for the estimated cost of the IMDP as sales and marketing expense and as of March 31, 2018, the Company has accrued €2.6 million ($3.2 million) relating to the IMDP; however, the actual liability could be higher or lower than the amount accrued once the law has been clarified by the Italian authorities.

 

10


 

6. Accumulated other comprehensive loss

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

 

(U.S. Dollars, in thousands)

 

Currency

Translation

Adjustments

 

 

Debt Security

 

 

Accumulated Other

Comprehensive Loss

 

Balance at December 31, 2017

 

$

(563

)

 

$

4,350

 

 

$

3,787

 

Other comprehensive income

 

 

697

 

 

 

 

 

 

697

 

Income taxes

 

 

 

 

 

 

 

 

 

Balance at March 31, 2018

 

$

134

 

 

$

4,350

 

 

$

4,484

 

 

 

7. Revenue recognition and accounts receivable

Adoption of ASU 2014-09, “Revenue from Contracts with Customers”

Effective January 1, 2018, the Company adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606) using the modified retrospective transition method, which was applied to all contracts. Results for the quarter ended March 31, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with the Company’s historic accounting under the previous revenue recognition standard, Topic 605.

The Company recorded a net increase to opening retained earnings of $4.8 million as of January 1, 2018 due to the cumulative impact of adopting Topic 606 as presented in the table below.

(U.S. Dollars, in thousands)

 

December 31, 2017

 

 

Impact

of Adoption

of ASC 606

 

 

January 1,

2018

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

81,157

 

 

$

 

 

$

81,157

 

Accounts receivable, net

 

 

63,437

 

 

 

8,648

 

 

 

72,085

 

Inventories

 

 

81,330

 

 

 

(2,338

)

 

 

78,992

 

Prepaid expenses and other current assets

 

 

25,877

 

 

 

 

 

 

25,877

 

Total current assets

 

 

251,801

 

 

 

6,310

 

 

 

258,111

 

Deferred income taxes

 

 

23,315

 

 

 

(1,549

)

 

 

21,766

 

Other long-term assets

 

 

130,238

 

 

 

 

 

 

130,238

 

Total assets

 

$

405,354

 

 

$

4,761

 

 

$

410,115

 

Liabilities and shareholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities

 

 

108,746

 

 

 

 

 

 

108,746

 

Shareholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

Common shares

 

 

1,828

 

 

 

 

 

 

1,828

 

Additional paid-in capital

 

 

220,591

 

 

 

 

 

 

220,591

 

Retained earnings

 

 

70,402

 

 

 

4,761

 

 

 

75,163

 

Accumulated other comprehensive income

 

 

3,787

 

 

 

 

 

 

3,787

 

Total shareholders’ equity

 

 

296,608

 

 

 

4,761

 

 

 

301,369

 

Total liabilities and shareholders’ equity

 

$

405,354

 

 

$

4,761

 

 

$

410,115

 

The impact primarily related to an increase in trade accounts receivable, net, from the Company’s stocking distributors, for which revenue was historically recognized when cash payment was received, and the recognition of previously deferred cost of sales for certain stocking distributor transactions, which were historically included within inventory. Adoption of Topic 606 had no impact to cash from or used in operating, investing, or financing activities on the consolidated statement of cash flows.

11


 

The table below presents the impact to the Company’s consolidated statement of operations for the three months ended March 31, 2018 as a result of the adoption of Topic 606.

 

 

Three Months Ended March 31, 2018

 

(U.S. Dollars, in thousands)

 

Based on historical accounting under Topic 605

 

 

Impact of

adoption

 

 

As reported under Topic 606

 

Net sales

 

$

101,362

 

 

$

7,347

 

 

$

108,709

 

Cost of sales

 

 

22,116

 

 

 

2,031

 

 

 

24,147

 

Gross profit

 

 

79,246

 

 

 

5,316

 

 

 

84,562

 

Sales and marketing

 

 

50,361

 

 

 

(93

)

 

 

50,268

 

Other operating expenses

 

 

26,421

 

 

 

 

 

 

26,421

 

Operating income

 

$

2,464

 

 

$

5,409

 

 

$

7,873

 

Income tax expense

 

 

(3,918

)

 

 

(1,455

)

 

 

(5,373

)

Net income from continuing operations

 

$

1,275

 

 

$

3,954

 

 

$

5,229

 

Net income from continuing operations per common share—basic

 

$

0.07

 

 

$

0.21

 

 

$

0.28

 

Net income from continuing operations per common share—diluted

 

$

0.07

 

 

$

0.20

 

 

$

0.27

 

 

Revenue Recognition Under Topic 606

The Company accounts for a contract when there is approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance, and collectability of consideration is probable. The Company’s contracts may contain one or more performance obligations. If a contract contains more than one performance obligation, the Company allocates the total transaction price to each of the performance obligations based upon the observable standalone selling price of the promised goods or services underlying each performance obligation. The Company recognizes revenue when control of the promised goods or services is transferred to the customer, which typically occurs at a point in time upon shipment, delivery, or utilization, in an amount that reflects the consideration which the Company expects to be entitled in exchange for the promised goods or services. The amount the Company expects to be entitled to in exchange for the goods or services reflects any fixed amount stated per the contract and estimates for any variable consideration, such as discounts, to the extent that is it probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved.

BioStim

BioStim revenue is largely attributable to the U.S. and is comprised of third-party payor transactions and wholesale revenue.

The largest portion of BioStim revenue is derived from third-party payors. This includes commercial insurance carriers, health maintenance organizations, preferred provider organizations and governmental payors such as Medicare, in connection with the sale of the Company’s stimulation products. The customer obtains control and revenue is recognized when the stimulation product is fitted to and accepted by the patient and all applicable documents that are required by the third-party payor have been obtained. Amounts paid by these third-party payors are generally based on fixed or allowable reimbursement rates. These revenues are recorded at the expected or preauthorized reimbursement rates, net of any contractual allowances or adjustments. Certain billings are subject to review by the third-party payors and may be subject to adjustment. Adoption of Topic 606 had an immaterial impact to the BioStim SBU.

Wholesale revenue is related to the sale of the Company’s bone growth stimulators directly to physicians and other healthcare providers. Wholesale revenues are typically recognized upon shipment and receipt of a confirming purchase order, which is when the customer obtains control of the promised goods.

Extremity Fixation and Spine Fixation

Extremity Fixation and Spine Fixation products are distributed world-wide, with U.S. sales largely comprised of commercial revenue and international sales derived from commercial sales and through stocking distributor arrangements.

Commercial revenue is related to the sale of the Company’s internal and external fixation products, generally representing hospital customers. The customer obtains control and revenues are recognized when these products have been utilized and a confirming purchase order has been received from the hospital.

12


 

Certain revenue within the Extremity Fixation and Spine Fixation SBUs are derived from stocking distributors, who purchase the Company’s products and then re-sell them directly to customers, such as hospitals. For revenue from stocking distributor arrangements, subsequent to the adoption of Topic 606 effective January 1, 2018, the Company recognizes revenue upon shipment and receipt of a confirming purchase order, which is when the distributor obtains control of the promised goods. The transaction price with stocking distributors is estimated based upon the Company’s historical collection experience with the stocking distributor. To derive this estimate, the Company analyzes twelve months of historical invoices by stocking distributor and the subsequent collections on those invoices, for a period of up to 24 months subsequent to the invoice date. This percentage, which is specific to each stocking distributor, is then used to calculate the transaction price. Cost of sales is also recorded upon transfer of control of the product to the customer.

Prior to the adoption of Topic 606, or for all periods presented prior to January 1, 2018, the Company recognized revenue from stocking distributor arrangements once the product was delivered to the end customer (the “sell-through method”). Because the Company did not have reliable information about when its distributors sold the product through to end customers, the Company used cash collection from distributors as a basis for revenue recognition under the sell-through method. Although in many cases the Company was legally entitled to the accounts receivable at the time of shipment, the Company did not recognize accounts receivables or any corresponding deferred revenues at the time of shipment associated with stocking distributor transactions for which revenue was recognized on the sell-through method. The Company also considered whether to match the related cost of sales with revenue or to recognize cost of sales upon shipment. In making this assessment, the Company considered the financial viability of its stocking distributors based on their creditworthiness to determine if collectability of amounts sufficient to realize the costs of the products shipped was reasonably assured at the time of shipment to these stocking distributors. In instances where the stocking distributor was determined to be financially viable, the Company deferred the costs of sales until the revenue was recognized.

Biologics

Biologics revenue is largely attributable to the U.S. and is primarily related to a collaborative arrangement with MTF Biologics (“MTF”), which extends through July 28, 2027, through which the Company markets tissue for bone repair and reconstruction under the brand names Trinity Evolution and Trinity ELITE. Under the terms of the agreement, MTF sources the tissue, processes it to create the bone growth matrix, packages and delivers it to the customer in accordance with orders received from the Company. The Company has exclusive global marketing rights for the Trinity Evolution and Trinity ELITE tissues as well as non-exclusive marketing rights for other products, and receives marketing fees from MTF based on total sales. MTF is considered the primary obligor in these arrangements and therefore the Company recognizes these marketing service fees on a net basis within net sales upon shipment of the product to the customer. Adoption of Topic 606 had an immaterial impact to the Biologics SBU.

Product Sales and Marketing Service Fees

The table below presents net sales, which includes product sales and marketing service fees, for the three months ended March 31, 2018 and 2017.

 

 

Three Months Ended

March 31,

 

(U.S. Dollars, in thousands)

 

2018

 

 

2017

 

Product sales

 

$

94,889

 

 

$

88,401

 

Marketing service fees

 

 

13,820

 

 

 

14,337

 

Net sales

 

$

108,709

 

 

$

102,738

 

 

Product sales primarily consist of the sale of bone growth stimulation devices and internal and external fixation products. Marketing service fees are received from MTF based on total sales of biologics tissues and relates solely to the Biologics SBU. Revenues exclude any value added or other local taxes, intercompany sales and trade discounts. Shipping and handling costs for products shipped to customers are included in cost of sales.

Trade Accounts Receivable and Allowances

Payment terms vary by the type and location of the Company’s customers and the products or services offered. The term between invoicing and when payment is due is not significant. Accounts receivable are analyzed on a quarterly basis to assess the adequacy of both reserves for doubtful accounts and contractual allowances. Revisions in allowances for doubtful accounts estimates are recorded as an adjustment to bad debt expense within sales and marketing expenses. Revisions to contractual allowances are recorded as an adjustment to net sales. The Company’s estimates are periodically tested against actual collection experience.

13


 

Other Contract Assets

The Company’s contract assets, excluding trade accounts receivable (“other contract assets”), largely consist of payments made to certain distributors to obtain contracts, gain access to customers in certain territories, and to provide the benefit of the exclusive distribution of Orthofix products. Other contract assets are included in other long-term assets and were $0.8 million and $1.0 million as of March 31, 2018, and December 31, 2017, respectively.

Other contract assets are amortized on a straight-line basis over the term of the related contract. There were no changes to such treatment as a result of adoption of Topic 606. No impairments were incurred for other contract assets in 2018 or 2017. Further, the Company has applied the practical expedient allowed within the guidance to expense sales commissions when incurred as the amortization period would be for one year or less.

 

 

8. Business segment information

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

 

 

 

Three Months Ended March 31,

 

(U.S. Dollars, in thousands)

 

2018

 

 

2017

 

 

Change

 

BioStim

 

$

46,163

 

 

$

44,539

 

 

 

3.6

%

Extremity Fixation

 

 

27,504

 

 

 

23,945

 

 

 

14.9

%

Spine Fixation

 

 

20,707

 

 

 

19,267

 

 

 

7.5

%

Biologics

 

 

14,335

 

 

 

14,987

 

 

 

-4.4

%

Net sales

 

$

108,709

 

 

$

102,738

 

 

 

5.8

%

 

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:

 

 

 

Three Months Ended

March 31,

 

(U.S. Dollars, in thousands)

 

2018

 

 

2017

 

BioStim

 

$

18,946

 

 

$

17,133

 

Extremity Fixation

 

 

8,158

 

 

 

6,412

 

Spine Fixation

 

 

1,261

 

 

 

2,007

 

Biologics

 

 

6,080

 

 

 

6,171

 

Corporate

 

 

(151

)

 

 

(98

)

Non-GAAP net margin

 

$

34,294

 

 

$

31,625

 

General and administrative

 

 

19,484

 

 

 

18,282

 

Research and development

 

 

6,937

 

 

 

7,424

 

Operating income

 

$

7,873

 

 

$

5,919

 

Interest income (expense), net

 

 

(183

)

 

 

45

 

Other income (expense), net

 

 

2,912

 

 

 

(4,348

)

Income before income taxes

 

$

10,602

 

 

$

1,616

 

14


 

 

Geographical information

The table below present net sales by geographic destination for each reporting unit and for the consolidated Company:

 

 

 

Three Months Ended

March 31,

 

(U.S. Dollars, in thousands)

 

2018

 

 

2017

 

BioStim

 

 

 

 

 

 

 

 

U.S.

 

$

46,137

 

 

$

44,539

 

International

 

 

26

 

 

 

 

Total BioStim

 

 

46,163

 

 

 

44,539

 

 

 

 

 

 

 

 

 

 

Extremity Fixation

 

 

 

 

 

 

 

 

U.S.

 

 

6,916

 

 

 

6,579

 

International

 

 

20,588

 

 

 

17,366

 

Total Extremity Fixation

 

 

27,504

 

 

 

23,945

 

 

 

 

 

 

 

 

 

 

Spine Fixation

 

 

 

 

 

 

 

 

U.S.

 

 

17,579

 

 

 

16,035

 

International

 

 

3,128

 

 

 

3,232

 

Total Spine Fixation

 

 

20,707

 

 

 

19,267

 

 

 

 

 

 

 

 

 

 

Biologics

 

 

 

 

 

 

 

 

U.S.

 

 

14,322

 

 

 

14,963

 

International

 

 

13

 

 

 

24

 

Total Biologics

 

 

14,335

 

 

 

14,987

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

 

 

 

 

 

 

U.S.

 

 

84,954

 

 

 

82,116

 

International

 

 

23,755

 

 

 

20,622

 

Net sales

 

$

108,709

 

 

$

102,738

 

 

 

 

9. 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:

 

 

 

Three Months Ended

March 31,

 

(U.S. Dollars, in thousands)

 

2018

 

 

2017

 

Cost of sales

 

$

125