Orthofix International N.V.
ORTHOFIX INTERNATIONAL N V (Form: 10-Q, Received: 11/10/2008 16:46:50)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q

(Mark one)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2008

OR

o
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)

 
Netherlands Antilles
 
N/A
 
 
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
         
 
7 Abraham de Veerstraat Curaçao
Netherlands Antilles
 
N/A
 
 
(Address of principal executive offices)
 
(Zip Code)
 
         
 
   
 599-9-4658525
 
 
 
 (Registrant’s telephone number, including area code)
 
 
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 x    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):  Large Accelerated filer  x    Accelerated filer  o     Non-Accelerated filer o

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

As of  November 7, 2008, 17,101,718 shares of common stock were issued and outstanding.
 


 
 

 

Table of Contents



Forward-Looking Statements

This Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, which relate to our business and financial outlook and 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.  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 on which it is made, and we undertake no obligation to update any such statement to reflect new information, the occurrence of future events or circumstances or otherwise.

Factors that could cause actual results to differ materially from those indicated by the forward-looking statements or that could contribute to such differences include, but are not limited to, risks relating to the expected sales of products, including recently launched products, unanticipated expenditures, changing relationships with customers, suppliers, strategic partners and lenders, unfavorable results in litigation matters, risks relating to the protection of intellectual property, changes to the reimbursement policies of third parties, changes to and interpretation of governmental regulation of medical devices, the impact of competitive products, changes to the competitive environment, the acceptance of new products in the market, conditions of the orthopedic industry and the economy, currency or interest rate fluctuations, corporate development and marketing development activities, including acquisitions and divestitures, unexpected costs or operating unit performance related to recent acquisitions, unexpected difficulties meeting covenants under our senior secured bank credit facility and the other risks described under Item 1A – “Business – Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007 and Part II, Item 1A – “Risk Factors” in this Form 10-Q.


PART I   

Item 1.       
Condensed Consolidated Financial Statements
 
CONDENSED CONSOLIDATED BALANCE SHEETS

(U.S. Dollars, in thousands except share data)
 
September 30,
   
December 31,
 
   
2008
   
2007
 
Assets
 
(Unaudited)
   
(Note 2)
 
Current assets:
           
Cash and cash equivalents
  $ 10,286     $ 25,064  
Restricted cash
    16,761       16,453  
Trade accounts receivable, net
    115,679       108,900  
Inventories, net
    97,368       93,952  
Deferred income taxes
    11,373       11,373  
Prepaid expenses and other current assets
    30,059       25,035  
Total current assets
    281,526       280,777  
Investments, at cost
    2,095       4,427  
Property, plant and equipment, net
    33,154       33,444  
Patents and other intangible assets, net
    55,354       230,305  
Goodwill
    187,353       319,938  
Deferred taxes and other long-term assets
    19,305       16,773  
Total assets
  $ 578,787     $ 885,664  
Liabilities and shareholders’ equity
               
Current liabilities:
               
Bank borrowings
  $ 6,197     $ 8,704  
Current portion of long-term debt
    3,337       3,343  
Trade accounts payable
    26,561       24,715  
Other current liabilities
    33,361       36,544  
Total current liabilities
    69,456       73,306  
Long-term debt
    288,370       294,588  
Deferred income taxes
    5,475       75,908  
Other long-term liabilities
    5,630       7,922  
Total liabilities
    368,931       451,724  
                 
Contingencies (Note 18)
               
Shareholders’ equity:
               
Common shares (17,101,718 and 17,038,304 shares issued at September 30, 2008 and December 31, 2007, respectively)
    1,710       1,704  
Additional paid-in capital
    166,954       157,349  
Retained earnings
    30,364       258,201  
Accumulated other comprehensive income
    10,828       16,686  
Total shareholders’ equity
    209,856       433,940  
                 
Total liabilities and shareholders’ equity
  $ 578,787     $ 885,664  
 
The accompanying notes form an integral part of these condensed consolidated financial statements.


CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007

(Unaudited, U.S. Dollars, in thousands except share and per share data)
 
Three Months Ended
   
Nine Months Ended
 
   
2008
   
2007
   
2008
   
2007
 
                         
Net sales
  $ 129,301     $ 121,120     $ 387,372     $ 361,488  
Cost of sales
    47,998       30,742       117,284       94,546  
Gross profit
    81,303       90,378       270,088       266,942  
Operating expenses
                               
Sales and marketing
    50,210       47,055       153,652       138,949  
General and administrative
    19,293       16,908       60,252       49,619  
Research and development
    6,447       5,953       19,400       18,313  
Amortization of intangible assets
    5,347       4,671       15,220       13,710  
Impairment of goodwill and certain intangible assets
    289,523       -       289,523       -  
Gain on sale of Pain Care® operations
    -       -       (1,570 )     -  
      370,820       74,587       536,477       220,591  
Operating income (loss)
    (289,517 )     15,791       (266,389 )     46,351  
                                 
Other income (expense), net
                               
Interest expense, net
    (4,249 )     (5,666 )     (13,708 )     (17,200 )
Loss on refinancing of senior secured term loan
    (5,735 )     -       (5,735 )     -  
Other, net
    (3,822 )     519       (2,737 )     234  
      (13,806 )     (5,147 )     (22,180 )     (16,966 )
Income (loss) before income taxes
    (303,323 )     10,644       (288,569 )     29,385  
Income tax (expense) benefit
    66,072       (2,616 )     60,732       (7,902 )
                                 
Net (loss) income
  $ (237,251 )   $ 8,028     $ (227,837 )   $ 21,483  
                                 
Net income (loss) per common share - basic
  $ (13.87 )   $ 0.48     $ (13.33 )   $ 1.30  
                                 
Net income (loss) per common share - diluted
  $ (13.87 )   $ 0.48     $ (13.33 )   $ 1.27  
                                 
Weighted average number of common shares -basic
    17,101,718       16,639,019       17,093,133       16,546,385  
                                 
Weighted average number of common shares - diluted
    17,101,718       16,889,303       17,093,133       16,925,084  
 
The accompanying notes form an integral part of these condensed consolidated financial statements.


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007

(Unaudited, U.S. Dollars, in thousands)
 
2008
   
2007
 
             
Cash flows from operating activities:
           
Net income (loss)
  $ (227,837 )   $ 21,483  
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
Depreciation and amortization
    22,707       21,334  
Amortization of debt costs
    868       523  
Provision for doubtful accounts
    4,585       3,532  
Deferred taxes
    (76,861 )     (3,919 )
Share-based compensation
    7,855       8,006  
Change in inventory obsolescence estimate
    10,913       -  
Loss on refinancing of senior secured term loan
    3,660       -  
Impairment of goodwill and certain intangible assets
    289,523       -  
Impairment of investments held at cost
    1,500       -  
Amortization of step up of fair value in inventory
    365       2,718  
Gain on sale of Pain Care® operations
    (1,570 )     -  
Other
    3,062       (1,328 )
Change in operating assets and liabilities:
               
Restricted cash
    (352 )     (4,270 )
Accounts receivable
    (13,805 )     (14,829 )
Inventories
    (16,703 )     (19,086 )
Prepaid expenses and other current assets
    (5,250 )     (5,976 )
Accounts payable
    2,500       (2,707 )
Other current liabilities
    (2,739 )     8,277  
Net cash provided by operating activities
    2,421       13,758  
                 
Cash flows from investing activities:
               
Payments made in connection with acquisitions and investments in subsidiaries, net of cash acquired
    (501 )     (2,117 )
Capital expenditures
    (15,831 )     (23,752 )
Proceeds from sale of investment held at cost
    766       -  
Proceeds from sale of Pain Care® operations
    5,980       -  
Net cash used in investing activities
    (9,586 )     (25,869 )
                 
Cash flows from financing activities:
               
Net proceeds from issuance of common shares
    1,734       6,799  
Repayments of long-term debt, net
    (6,223 )     (6,505 )
Proceeds from (repayments of) bank borrowings, net
    (2,377 )     7,870  
Payment of refinancing fees
    (283 )     -  
Tax benefit on non-qualified stock options
    22       1,164  
Net cash (used in) provided by financing activities
    (7,127 )     9,328  
Effect of exchange rate changes on cash
    (486 )     464  
Net decrease in cash and cash equivalents
    (14,778 )     (2,319 )
Cash and cash equivalents at the beginning of the year
    25,064       25,881  
Cash and cash equivalents at the end of the period
  $ 10,286     $ 23,562  
 
The accompanying notes form an integral part of these condensed consolidated financial statements.


NOTES TO THE CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 1:  
BUSINESS

Orthofix International N.V. (the “Company”) is a multinational corporation principally involved in the design, development, manufacture, marketing and distribution of medical devices, principally for the orthopedic products market.

 
NOTE 2:  
BASIS OF PRESENTATION

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States 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 accounting principles generally accepted in the United States, have been condensed or omitted.  In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included.  Operating results for the three and nine months ended September 30, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008.  The balance sheet at December 31, 2007 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.  For further information, refer to the Consolidated Financial Statements and Notes thereto of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

 
NOTE 3:
RECENTLY ISSUED ACCOUNTING STANDARDS

In December 2007, the FASB ratified Emerging Issues Task Force (EITF) Issue No. 07-1, “Accounting for Collaborative Arrangements” (EITF 07-1). EITF 07-1 provides guidance related to the classification of the payments between participants, the appropriate income statement presentation, as well as disclosures related to certain collaborative arrangements. EITF 07-1 is effective for fiscal years beginning after December 15, 2008 and will be adopted by the Company in the first quarter of 2009. Unless other authoritative guidance prevails, the Company will apply the guidance included in EITF 07-1 to collaborative arrangements entered into in 2008.

In May 2008, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 162, “The Hierarchy of Generally Accepted Accounting Principles.”  The Statement identified the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements that are presented in conformity with generally accepted accounting principles in the United States.  The Statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.”  We do not anticipate the adoption of SFAS No. 162 to have a material impact on the Company’s results of operations or financial position.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.”  The Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosure related to the use of fair value measures in financial statements.  The provisions of SFAS No. 157 were to be effective for fiscal years beginning after November 15, 2007.  On February 6, 2008, the FASB agreed to defer the effective date of SFAS No. 157 for one year for certain nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).  Effective January 1, 2008, the Company adopted SFAS No. 157 except as it applies to those nonfinancial assets and nonfinancial liabilities.  The adoption of SFAS No. 157 did not have a material impact on the Company’s results of operations or financial position.

Effective January 1, 2008, the Company adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – including an amendment of FASB Statement No. 115.”  SFAS No. 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement of certain financial assets and liabilities under an instrument-by-instrument election.  Subsequent measurements for the financial assets and liabilities an entity elects to fair value will be recognized in the results of operations.  SFAS No. 159 also establishes additional disclosure requirements.  The Company did not elect the fair value option under SFAS No. 159 for any of its financial assets or liabilities upon adoption.  The adoption of SFAS No. 159 did not have a material impact on the Company’s results of operations or financial position.

 
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133.”  SFAS No. 161 requires entities to provide greater transparency through additional disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities” and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, results of operations, and cash flows.  SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company is currently evaluating the potential impact of adopting SFAS No. 161 on the Company’s disclosures of its derivative instruments and hedging activities.

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations (revised 2007).”  SFAS No. 141(R) amends SFAS No. 141, “Business Combinations,” and provides revised guidance for recognizing and measuring identifiable assets and goodwill acquired, liabilities assumed, and any noncontrolling interest in the acquiree.  It also provides disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination.  SFAS No. 141(R) is effective for fiscal years beginning after December 15, 2008 and is to be applied prospectively.  The Company is currently evaluating the potential impact of adopting SFAS No. 141(R) on its consolidated financial position and results of operations.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB 51,” which establishes accounting and reporting standards pertaining to ownership interest in subsidiaries held by parties other than the parent, the amount of net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of any retained noncontrolling equity investment when a subsidiary is deconsolidated.  SFAS No. 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners.  SFAS No. 160 is effective for fiscal years beginning on or after December 15, 2008.  The Company is currently evaluating the potential impact of adopting SFAS No. 160 on its consolidated financial position and results of operations.


NOTE 4:  
SHARE-BASED COMPENSATION

The Company accounts for its share-based compensation plans in accordance with SFAS No. 123(R), “Share-Based Payment”, using the modified prospective transition method.  Under SFAS No. 123(R), all share-based compensation costs are measured at the grant date, based on the estimated fair value of the award, and are recognized as expense in the statement of operations over the requisite service period.  Commencing in June 2007, the Company offered restricted shares in addition to stock options as a form of share-based compensation.


The following table shows the detail of share-based compensation by line item in the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2008 and 2007:

(In US$ thousands)
 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2008
   
2007
   
2008
   
2007
 
                         
Cost of sales
  $ -     $ 113     $ 116     $ 293  
                                 
Sales and marketing (1)
    579       800       1,353       1,993  
                                 
General and administrative
    2,433       1,846       5,793       4,978  
                                 
Research and development
    186       126       593       742  
                                 
Total
  $ 3,198     $ 2,885     $ 7,855     $ 8,006  


(1)           There are no performance requirements and there was no consideration received for share-based compensation awarded to sales and marketing employees.
 

NOTE 5:   
RECLASSIFICATIONS

Certain prior year amounts have been reclassified to conform to the 2008 presentation.  The reclassifications have no effect on previously reported net income or shareholders’ equity.


NOTE 6:  
INVENTORIES

Inventories are valued at the lower of cost or estimated net realizable value, after provision for excess or obsolete items. Cost is determined on a weighted-average basis, which approximates the FIFO method.  The valuation of work-in-process, finished goods, field inventory and consignment inventory includes the cost of materials, labor and production.  Field inventory represents immediately saleable finished goods inventory that is in the possession of the Company’s direct sales representatives.

Inventories were as follows:

   
September 30,
   
December 31,
 
(In US$ thousands)
 
2008
   
2007
 
             
Raw materials
  $ 9,302     $ 10,804  
Work-in-process
    6,998       6,100  
Finished goods
    57,840       42,384  
Field inventory (as described above)
    12,368       13,997  
Consignment inventory
    33,563       30,560  
      120,071       103,845  
Less reserve for obsolescence
    (22,703 )     (9,893 )
    $ 97,368     $ 93,952  


In the quarter ended September 30, 2008, due to reduced projections in revenue, distributor terminations, new products, and the replacement of one product with a successor product, the Company changed its estimates regarding the inventory allowance at Blackstone, primarily based on estimated net realizable value using assumptions about future demand and market conditions.  The change in estimate resulted in an increase in the reserve for obsolescence of approximately $10.9 million ($7.0 million net of tax or $0.41 per basic and diluted share).



NOTE 7: 
GOODWILL

The changes in the net carrying value of goodwill by reportable segment for the period ended September 30, 2008 are as follows:

(In US$ thousands)
 
Domestic
   
Blackstone
   
Breg
   
International
   
Total
 
At December 31, 2007
  $ 31,793     $ 136,240     $ 101,322     $ 50,583     $ 319,938  
                                         
Disposals (1)
    -       -       (2,027 )     -       (2,027 )
                                         
Purchase price adjustment (2)
    -       -       -       (248 )     (248 )
                                         
Impairment (3)
    -       (126,873 )     -       -       (126,873 )
                                         
Foreign currency
    -       -       -       (3,437 )     (3,437 )
                                         
At September 30, 2008
  $ 31,793     $ 9,367     $ 99,295     $ 46,898     $ 187,353  



(1) 
Sale of operations relating to the Pain Care® business at Breg during the first quarter of 2008.

(2) 
Principally relates to the acquisition of the remaining 38.74% of the minority interest in the Company’s Mexican subsidiary and the remaining 10.5% of the minority interest in the Company’s Brazilian subsidiary during the first and third quarters of 2008, respectively.

(3) 
In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” the Company performed an impairment analysis of indefinite-lived intangibles.  As part of the Company's debt refinancing completed in September 2008, five year projections were prepared for Blackstone.  Due to the recent trend of decreasing revenues at Blackstone, the Company evaluated the goodwill at Blackstone.  The fair value of the Blackstone reporting unit was estimated using a combination of the income approach, which estimates the fair value of the reporting units based on the expected present value of future cash flows and the market approach, which estimates the fair value of the reporting units based on comparable market prices.  The impairment analysis resulted in a goodwill impairment charge of $126.9 million because the carrying value exceeded the implied fair value of goodwill .


NOTE 8: 
PATENTS AND OTHER INTANGIBLE ASSETS
 
(In US$ thousands)
 
September 30, 2008
 
December 31, 2007
 
Cost          
Patents and other
  $ 33,233     $ 107,235  
Trademarks – definite lived (subject to amortization)
    682       714  
Trademarks – indefinite lived (not subject to amortization)
    23,876       80,844  
Distribution networks
    44,586       98,586  
      102,377       287,379  
Accumulated amortization
               
Patents and other
    (20,826 )     (28,254 )
Trademarks – definite lived (subject to amortization)
    (657 )     (559 )
Distribution networks
    (25,540 )     (28,261 )
    $ 55,354     $ 230,305  



Amortization expense for intangible assets is estimated to be approximately $2.4 million for the remainder of 2008 and $8.5 million, $7.8 million, $7.2 million, $6.8 million and $5.9 million for the periods ending December 31, 2009, 2010, 2011, 2012, and 2013 respectively.

During the third quarter of 2008, the Company determined that a test for impairment of goodwill in accordance with SFAS No. 142 “Goodwill and Other Intangible Assets,” was necessary due to Blackstone projections prepared in connection with the Company’s debt refinancing completed in September 2008, being materially different than projections used in Blackstone’s original purchase accounting.  The Company evaluated the indefinite-lived intangible assets which included the Blackstone Trademark acquired during the acquisition of Blackstone.  The impairment analysis resulted in the carrying value of the Trademark exceeding the fair value for which there is a $57.0 million impairment charge included in Impairment of Goodwill and Certain Intangible Assets.

Also, during the third quarter of 2008, the Company determined that a Triggering Event as defined by SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” occurred with respect to the definite-lived intangibles at Blackstone.  Due to the Triggering Event, the Company compared the expected cash flows to be generated by the definite-lived intangibles on an undiscounted basis to the carrying value of the intangible asset.  The Company determined the carrying value exceeded the undiscounted cash flow and impaired the distribution network and technologies at Blackstone to their fair value which resulted in an impairment charge of $105.7 million which is included in Impairment of Goodwill and Certain Intangible Assets.
 
 
NOTE 9: 
BANK BORROWINGS

(In US$ thousands)
 
September 30,
2008
   
December 31,
 2007
 
Borrowings under line of credit
  $ 6,197     $ 8,704  


The weighted average interest rates on borrowings under lines of credit as of September 30, 2008 and December 31, 2007 were 6.97% and 4.79%, respectively.

Borrowings under lines of credit consist of borrowings in Euros.  The Company had unused available lines of credit of 2.9 million Euros ($4.1 million) and 1.3 million Euros ($2.0 million) at September 30, 2008 and December 31, 2007, respectively, in its Italian line of credit, which gives the Company the option to borrow amounts in Italy at rates which are determined at the time of borrowing.  This line of credit is unsecured.


NOTE 10: 
LONG-TERM DEBT

(In US$ thousands)
 
September 30,
 2008
   
December 31,
2007
 
             
Long-term obligations
  $ 291,525     $ 297,700  
Other loans
    182       231  
      291,707       297,931  
Less current portion
    (3,337 )     (3,343 )
    $ 288,370     $ 294,588  


On September 22, 2006 the Company’s wholly-owned U.S. holding company subsidiary, Orthofix Holdings, Inc. (“Orthofix Holdings”), entered into a senior secured credit facility with a syndicate of financial institutions to finance the acquisition of Blackstone.  Certain terms of the senior secured credit facility were amended September 29, 2008.  The senior secured credit facility provides for (1) a seven-year amortizing term loan facility of $330.0 million, the proceeds of which, together with cash balances were used for payment of the purchase price of Blackstone; and (2) a six-year revolving credit facility of $45.0 million.  As of September 30, 2008, the Company had no amounts outstanding under the revolving credit facility and $291.5 million outstanding under the term loan facility.  Obligations under the senior secured credit facility have a floating interest rate of the London Inter-Bank Offered Rate (“LIBOR”) plus a margin or prime rate plus a margin.  Currently, the term loan is a LIBOR loan, and the margin is 4.50%, which is adjusted quarterly based upon the leverage ratio of the Company and its subsidiaries.  In June 2008, the Company entered into an interest rate swap agreement to manage its interest rate exposure on LIBOR borrowings; see Note 16, Derivative Instruments, for further detail.  The effective interest rates as of September 30, 2008 and December 31, 2007 on the senior secured credit facility were 8.2% and 6.6%, respectively.


Each of the domestic subsidiaries of the Company (which includes Orthofix Inc., Breg Inc., and Blackstone) and Colgate Medical Limited and Victory Medical Limited (wholly-owned financing subsidiaries of the Company) have guaranteed the obligations of Orthofix Holdings under the senior secured credit facility.  The obligations of the subsidiaries under their guarantees are secured by the pledges of their respective assets.

In conjunction with obtaining the senior secured credit facility, the Company incurred debt issuance costs of $6.4 million which it has been amortizing over the life of the facility.  A portion of the capitalized debt issuance costs included in other long-term assets related to the senior secured credit facility were expensed as a result of the amendment on September 29, 2008, and are included in the loss on refinancing of senior secured term loan.  In connection with the amendment to the credit facility, the Company paid additional fees of $2.4 million in the quarter ended September 30, 2008, of which $2.1 million are included in the loss on refinancing of senior secured term loan..  As of September 30, 2008, $0.8 million of debt issuance costs which relate to the Company’s revolving credit facility are included in other long-term assets compared to debt issuance costs related to the senior secured term loan and the revolving credit facility which were $5.2 million at December 31, 2007.

Certain subsidiaries of the Company have restrictions on their ability to pay dividends or make intercompany loan advances pursuant to the Company’s senior secured credit facility.  The net assets of Orthofix Holdings and its subsidiaries are restricted for distributions to the parent company.  Domestic subsidiaries of the Company as parties to the credit agreement have access to these net assets for operational purposes.  The amount of restricted net assets of Orthofix Holdings and its subsidiaries as of September 30, 2008 is $6.4 million compared to $300.7 million at December 31, 2007.

In addition, the Company’s senior secured credit facility contains certain financial covenants, including a fixed charge coverage ratio and a leverage ratio applicable to Orthofix and its subsidiaries on a consolidated basis.  A breach of any of these covenants could result in an event of default under the credit agreement, which could permit acceleration of the debt payments under the facility unless such breach is waived by the lenders, who are a party to the agreement, or the agreement is amended.   Management believes the Company was in compliance with these financial covenants as measured at September 30, 2008.

NOTE 11: 
COMMON SHARES

For the nine months ended September 30, 2008, the Company issued 63,414 shares of common stock upon the exercise of outstanding stock options, vesting of restricted stock, and shares issued pursuant to its employee stock purchase plan for net proceeds of $1.7 million.

NOTE 12: 
COMPREHENSIVE INCOME (LOSS)

Accumulated other comprehensive income (loss) is comprised of foreign currency translation adjustments and the effective portion of the gain (loss) for derivatives designated and accounted for as cash flow hedges.  The components of and changes in other comprehensive income (loss) are as follows:


(In US$ thousands)
 
Foreign Currency Translation Adjustments
   
Fair Value of Derivatives
   
Accumulated Other Comprehensive Income/(Loss)
 
Balance at December 31, 2007
  $ 15,156     $ 1,530     $ 16,686  
Unrealized loss on derivative instruments, net of tax of $(71)
    -       (76 )     (76 )
Foreign currency translation adjustment
    (5,782 )     -       (5,782 )
Balance at September 30, 2008
  $ 9,374     $ 1,454     $ 10,828  


(In US$ thousands)
 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2008
   
2007
   
2008
   
2007
 
Net (loss) income
  $ (237,251 )   $ 8,028     $ (227,837 )   $ 21,483  
                                 
Other comprehensive income:
                               
Unrealized loss on derivative instrument, net of tax
    (1,997 )     (367 )     (76 )     (575 )
Foreign currency translation adjustment
    (5,953 )     1,227       (5,782 )     2,699  
Total comprehensive income (loss)
  $ (245,201 )   $ 8,888     $ (233,695 )   $ 23,607  


NOTE 13: 
BUSINESS SEGMENT INFORMATION

The Company’s segment information is prepared on the same basis that the Company’s management reviews the financial information for operational decision making purposes. The Company is comprised of the following segments:

Domestic
Domestic (“Domestic”) consists of operations in the United States of Orthofix Inc., which designs, manufactures and distributes stimulation and orthopedic products.  Domestic uses both direct and distributor sales representatives to sell Spine and Orthopedic products to hospitals, doctors and other healthcare providers in the United States market.

Blackstone
Blackstone (“Blackstone”) consists of Blackstone Medical, Inc., based in Springfield, Massachusetts and its two subsidiaries, Blackstone GmbH and Goldstone GmbH. Blackstone specializes in the design, development and marketing of spinal implant and related human cellular and tissue based products (“HCT/P products”, often referred to as Biologic products). Blackstone distributes its products through a network of domestic and international distributors, sales representatives and affiliates.

Breg
Breg (“Breg”) consists of Breg, Inc. Breg, based in Vista, California, designs, manufactures, and distributes orthopedic products for post-operative reconstruction and rehabilitative patient use and sells its products through a network of domestic and international distributors, sales representatives and affiliates.

International
International (“International”) consists of international operations located in Europe, Mexico, Brazil and Puerto Rico, as well as independent distributors located outside the United States.  International uses both direct and distributor sales representatives to sell Spine, Orthopedics, Sports Medicine, Vascular and Other products to hospitals, doctors, and other healthcare providers.

 
Group Activities
Group Activities are comprised of the Parent’s and Orthofix Holdings’ operating expenses and identifiable assets.

The following tables below present information by reportable segment for the three and nine month periods ended September 30:

For the three month period ended September 30:

   
External Sales
   
Intersegment Sales
 
(In US$ thousands)
 
2008
   
2007
   
2008
   
2007
 
Domestic
  $ 47,065     $ 41,971     $ 1,552     $ 858  
Blackstone
    25,338       29,448       349       1,012  
Breg
    22,377       21,206       1,392       1,337  
International
    34,521       28,495       6,240       5,958  
Total
  $ 129,301     $ 121,120     $ 9,533     $ 9,165  


For the nine month period ended September 30:

   
External Sales
   
Intersegment Sales
 
(In US$ thousands)
 
2008
   
2007
   
2008
   
2007
 
Domestic
  $ 138,397     $ 122,718     $ 4,856     $ 3,137  
Blackstone
    81,093       85,859       2,938       2,449  
Breg
    66,341       61,522       4,048       2,561  
International
    101,541       91,389       19,673       22,108  
Total
  $ 387,372     $ 361,488     $ 31,515     $ 30,255  


The following table presents operating income (loss) by segment for the three and nine month periods ended September 30:
 

Operating Income (Loss)
 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
(In US$ thousands)
 
2008
   
2007
   
2008
   
2007
 
                                 
Domestic
  $ 17,155     $ 14,050     $ 47,235     $ 42,124  
                                 
Blackstone (1)
    (309,201 )     (816 )     (319,993 )     (2,164 )
                                 
Breg
    2,206       2,686       9,273       6,013  
                                 
International
    4,741       4,230       14,451       14,824  
                                 
Group Activities
    (4,309 )     (3,735 )     (16,525 )     (11,644 )
                                 
Eliminations
    (109 )     (624 )     (830 )     (2,802 )
                                 
Total
  $ (289,517 )   $ 15,791     $ (266,389 )   $ 46,351  


(1)  Includes impairment charges of $289.5 million during the three and nine months ended September 30, 2008 for goodwill and certain intangible assets

The following tables present sales by market sector for the three and nine month periods ended September 30, 2008 and 2007:

   
Sales by Market Sector
for the three month period ended September 30, 2008
 
 (In US$ thousands)
 
Orthofix
Domestic
   
Blackstone
   
Breg
   
Orthofix
International
   
Total
 
                               
Spine
  $ 35,340     $ 25,338     $ -     $ 640     $ 61,318  
Orthopedics
    11,725       -       -       22,099       33,824  
Sports Medicine
    -       -       22,377       1,323       23,700  
Vascular
    -       -       -       4,274       4,274  
Other
    -       -       -       6,185       6,185  
                                         
Total
  $ 47,065     $ 25,338     $ 22,377     $ 34,521     $ 129,301  


   
Sales by Market Sector
for the three month period ended September 30, 2007
 
 (In US$ thousands)
 
Orthofix
Domestic
   
Blackstone
   
Breg
   
Orthofix
International
   
Total
 
                               
Spine
  $ 31,693     $ 29,448     $ -     $ 168     $ 61,309  
Orthopedics
    10,278               -       16,026       26,304  
Sports Medicine
    -       -       21,206       869       22,075  
Vascular
    -       -       -       4,718       4,718  
Other
    -       -       -       6,714       6,714  
                                         
Total
  $ 41,971     $ 29,448     $ 21,206     $ 28,495     $ 121,120  


   
Sales by Market Sector
for the nine month period ended September 30, 2008
 
 (In US$ thousands)
 
Orthofix
Domestic
   
Blackstone
   
 
 
Breg
   
Orthofix
International
   
Total
 
                               
Spine
  $ 104,143     $ 81,093     $ -     $ 1,252     $ 186,488  
Orthopedics
    34,254       -       -       62,665       96,919  
Sports Medicine
    -       -       66,341       3,871       70,212  
Vascular
    -       -       -       13,391       13,391  
Other
    -       -       -       20,362       20,362  
                                         
Total
  $ 138,397     $ 81,093     $ 66,341     $ 101,541     $ 387,372  



   
Sales by Market Sector
for the nine month period ended September 30, 2007
 
 (In US$ thousands)
 
Orthofix
Domestic
   
Blackstone
   
 
 
Breg
   
Orthofix
International
   
Total
 
                               
Spine
  $ 92,650     $ 85,859     $ -     $ 421     $ 178,930  
Orthopedics
    30,068       -       -       51,865       81,933  
Sports Medicine
    -       -       61,522       3,033       64,555  
Vascular
    -       -       -       15,217       15,217  
Other
    -       -       -       20,853       20,853  
                                         
Total
  $ 122,718     $ 85,859     $ 61,522     $ 91,389     $ 361,488  


The following table presents identifiable assets by segment, excluding intercompany balances and investments in consolidated subsidiaries.

Identifiable Assets
           
             
(In US$ thousands)
 
September
30, 2008
   
December
31, 2007
 
             
Domestic
  $ 112,807     $ 118,178  
                 
Blackstone (1)
    122,828       404,788  
                 
Breg
    174,911       180,157  
                 
International
    173,839       177,586  
                 
Group activities
    10,198       20,063  
                 
Eliminations
    (15,796 )     (15,108 )
                 
Total
  $ 578,787     $ 885,664  


(1) Includes impairment charges related to goodwill and certain intangibles of $289.5 million recorded as of September 30, 2008


NOTE 14: 
INCOME TAXES

The difference between the reported benefit for income taxes and the tax benefit computed by applying the statutory rates applicable to each subsidiary of the Company is principally related to an impairment charge to goodwill for which the Company receives no tax benefit. Further, the effective tax rate has been positively affected by the Company’s European restructuring in 2006 and a similar transaction in 2002, whereby certain intangible assets were sold between subsidiaries in order to optimize the Company’s supply chain.  Such assets were sold at estimates of fair value based upon valuations which remain subject to review by the local taxing authorities.  Further, the effective tax rate has been affected by the generation of un-utilizable net operating losses in various jurisdictions, and the Section 199 deduction related to income attributable to production activities occurring in the United States.


As of  September 30, 2008, the Company’s gross unrecognized tax benefit was $1.7 million plus $0.5      million accrued for interest and penalties.  The entire $1.7 million of unrecognized tax benefit would affect the Company’s effective tax rate if recognized.  It is anticipated that the Company will release approximately $1.0 million in tax reserves within the next twelve months for uncertain tax positions due to the expiration of certain statutes of limitations.

The Company recognizes accrued interest and penalties related to unrecognized tax benefits within its global operations in income tax expense.   To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision.   As of September 30, 2008, the Company had approximately $0.5 million of accrued interest and penalties related to uncertain tax positions.
 
The Company is subject to tax examinations in all major taxing jurisdictions in which it operates.  The Company files a consolidated income tax return in the U.S. federal jurisdiction and numerous consolidated and separate income tax returns in many state and foreign jurisdictions. The following table summarizes these open tax years by major jurisdiction:

   
Open Tax Year
 
   
Examination in
   
Examination not yet
 
Jurisdiction
 
Progress
   
Initiated
 
             
United States
   
2004-2006
   
2007
 
               
Various States
   
1996-2005
     
1996-2007
 
                 
Brazil
   
N/A
     
2004-2007
 
                 
Cyprus
   
N/A
     
2005-2007
 
                 
France
   
N/A
     
2002-2007
 
                 
Germany
   
2003-2005
     
2006-2007
 
                 
Italy
   
N/A
     
2003-2007
 
                 
Mexico
   
N/A
     
2000-2007
 
                 
Netherlands
   
N/A
     
2004-2007
 
                 
Puerto Rico
   
N/A
     
N/A
 
                 
Seychelles
   
N/A
     
N/A
 
                 
Switzerland
   
N/A
     
2004-2007
 
                 
United Kingdom
   
N/A
     
2005-2007
 




NOTE 15: 
EARNINGS PER SHARE

For the three and nine months ended September 30, 2008 and 2007, there were no adjustments to net income for purposes of calculating basic and diluted net income (loss) per common share.  The following table is a reconciliation of the weighted average shares used in the basic and diluted net income (loss) per common share computations.

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2008
   
2007
   
2008
   
2007
 
                         
Weighted average common shares - basic
    17,101,718       16,639,019       17,093,133       16,546,385  
                                 
Effect of dilutive securities
    -       250,284       -       378,699  
                                 
Weighted average common shares – diluted
    17,101,718       16,889,303       17,093,133       16,925,084  


No adjustment has been made in the three and nine months ended September 30, 2008 for any common stock equivalents because their effects would be anti-dilutive.  For the three and nine month periods ended September 30, 2008, potentially dilutive shares totaled 4,638 and 37,496, respectively.

For the three and nine month periods ended September 30, 2007, the Company did not include 172,218 and 145,218 options, respectively, in the diluted shares outstanding calculation because their inclusion would have been anti-dilutive or because their exercise price exceeded the average market price of the Company’s common stock during the period.


NOTE 16: 
DERIVATIVE INSTRUMENTS

In June 2008, the Company entered into a three year fully amortizable interest rate swap agreement (the “Swap”) with a notional amount of $150.0 million and an expiration date of June 30, 2011.  The amount outstanding under the Swap as of September 30, 2008 was $150.0 million.  Under the Swap the Company will pay a fixed rate of 3.73% and receive interest at floating rates based on the three month LIBOR rate at each quarterly re-pricing date until the expiration of the Swap.  As of September 30, 2008 the interest rate on the debt related to the Swap was 8.2% (3.73% plus a margin of 4.50%). Our overall effective interest rate, including the impact of the Swap, as of September 30, 2008 on the senior secured debt was 8.2%.  The instrument is designated as a cash flow hedge.  The Company recognized an unrealized loss on the change in fair value of this swap arrangement of $1.0 million and $0.3 million, net of tax, for the three and nine months ended September 30, 2008, respectively.

In 2006, the Company entered into a cross-currency swap agreement to manage its foreign currency exposure related to a portion of the Company’s intercompany receivable of a U.S. dollar functional currency subsidiary that is denominated in Euro.  The derivative instrument, a ten-year fully amortizable agreement with a notional amount of $63.0 million is scheduled to expire on December 30, 2016.  The instrument is designated as a cash flow hedge.  The amount outstanding under the agreement as of September 30, 2008 is $59.8 million.  Under the agreement, the Company pays Euro and receives U.S. dollars based on scheduled cash flows in the agreement.  The Company recognized an unrealized loss on the change in fair value of this swap arrangement of $1.0 million, net of tax, within other comprehensive income in the three months ended September 30, 2008.  The Company recognized an unrealized gain on the change in fair value of this swap arrangement of $0.2 million, net of tax, within other comprehensive income in the nine months ended September 30, 2008.


NOTE 17:
 FAIR VALUE MEASUREMENTS


As described in Note 3, “Recently Issued Accounting Standards,” the Company adopted SFAS No. 157 effective January 1, 2008.  SFAS No. 157 defines fair value as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  SFAS No. 157 also describes three levels of inputs that may be used to measure fair value:

Level 1 – quoted prices in active markets for identical assets and liabilities

Level 2 – observable inputs other than quoted prices in active markets for identical assets and liabilities

Level 3 – unobservable inputs in which there is little or no market data available, which require the reporting entity to develop its own assumptions

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

   
Balance
 September 30,
2008
   
Level 1
   
Level 2
   
Level 3
 
Cash Equivalents
  $ 26     $ 26     $ -     $ -  
                                 
Derivative Financial Instruments (1)
                               
                                 
 Cash Flow Hedges
  $ (2,176 )   $ -     $ (2,176 )   $ -  


(1)   See Note 16, “Derivative Instruments”.
 

NOTE 18: 
CONTINGENCIES

Litigation
 
Effective October 29, 2007, the Company’s subsidiary, Blackstone, entered into a settlement agreement with respect to a patent infringement lawsuit captioned Medtronic Sofamor Danek USA Inc., Warsaw Orthopedic, Inc., Medtronic Puerto Rico Operations Co., and Medtronic Sofamor Danek Deggendorf, GmbH v. Blackstone Medical, Inc., Civil Action No. 06-30165-MAP, filed on September 22, 2006 in the United States District Court for the District of Massachusetts. In that lawsuit, the plaintiffs had alleged that (i) they were the exclusive licensees of United States Patent Nos. 6,926,718 B1, 6,936,050 B2, 6,936,051 B2, 6,398,783 B1 and 7,066,961 B2 (the “Patents”), and (ii) Blackstone's making, selling, offering for sale, and using within the United States of its Blackstone Anterior Cervical Plate, 3º Anterior Cervical Plate, Hallmark Anterior Cervical Plate and Construx Mini PEEK VBR System products infringed the Patents, and that such infringement was willful.  The Complaint requested both damages and an injunction against further alleged infringement of the Patents. Blackstone denied infringement and asserted that the Patents were invalid.  On July 20, 2007, the Company submitted a claim for indemnification from the escrow fund established in connection with the agreement and plan of merger between the Company, New Era Medical Corp. and Blackstone, dated as of August 4, 2006 (the “Merger Agreement”), for any losses to the Company or Blackstone resulting from this matter.  The Company was subsequently notified by legal counsel for the former shareholders that the representative of the former shareholders of Blackstone has objected to the indemnification claim and intends to contest it in accordance with the terms of the Merger Agreement The settlement agreement is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

On or about July 23, 2007, Blackstone received a subpoena issued by the Department of Health and Human Services, Office of Inspector General, under the authority of the federal healthcare anti-kickback and false claims statutes.  The subpoena seeks documents for the period January 1, 2000 through July 31, 2006, which is prior to Blackstone’s acquisition by the Company.  The Company believes that the subpoena concerns the compensation of certain physician consultants and related matters.  On September 17, 2007, the Company submitted a claim for indemnification from the escrow fund established in connection with the Merger Agreement for any losses to the Company or Blackstone resulting from this matter.  The Company was subsequently notified by legal counsel for the former shareholders that the representative of the former shareholders of Blackstone has objected to the indemnification claim and intends to contest it in accordance with the terms of the Merger Agreement.


On or about January 7, 2008, the Company received a federal grand jury subpoena from the United States Attorney’s Office for the District of Massachusetts.  The subpoena seeks documents for the period January 1, 2000 through July 15, 2007 from the Company, including its subsidiaries.  The Company believes that the subpoena concerns the compensation of physician consultants and related matters, and further believes that it is associated with the Department of Health and Human Services, Office of Inspector General’s investigation of such matters.  On September 18, 2008, the Company submitted a claim for indemnification from the escrow fund established in connection with the Merger Agreement for any losses to the Company or Blackstone resulting from this matter.

In connection with the matters described above involving the Department of Health and Human Services, Office of the Inspector General, and United States Attorney’s Office for the District of Massachusetts, the Company’s legal counsel has been informed by representatives of the Department of Justice (“DOJ”) that a qui tam lawsuit against Blackstone and another affiliate of the Company is pending in the U.S. District Court for the District of Massachusetts.  The Company believes that the complaint alleges causes of action under the False Claims Act for alleged inappropriate payments and other items of value conferred on physician consultants.  The Company further understands that the seal in this qui tam lawsuit has been partially lifted for the purpose of allowing DOJ to disclose to the Company the existence of the qui tam lawsuit and discuss the allegations in the complaint, but that the qui tam lawsuit otherwise remains under seal as required by law.  The Company intends to defend vigorously against this lawsuit.  On September 18, 2008, we submitted a claim for indemnification from the escrow fund established in connection with the Merger Agreement for any losses to the Company or Blackstone resulting from this matter.

On or about September 27, 2007, Blackstone received a federal grand jury subpoena issued by the United States’ Attorney’s Office for the District of Nevada (“USAO-Nevada”). The subpoena seeks documents for the period from January 1999 to the date of issuance of the subpoena. The Company believes that the subpoena concerns payments or gifts made by Blackstone to certain physicians. On September 18, 2008, the Company submitted a claim for indemnification from the escrow fund established in connection with the Merger Agreement for any losses to the Company or Blackstone resulting from this matter.

On February 29, 2008, Blackstone received a Civil Investigative Demand (“CID”) from the Massachusetts Attorney General’s Office, Public Protection and Advocacy Bureau, Healthcare Division.  The Company believes that the CID seeks documents concerning Blackstone’s financial relationships with certain physicians and related matters for the period from March 2004 through the date of issuance of the CID.  On September 18, 2008, the Company submitted a claim for indemnification from the escrow fund established in connection with the Merger Agreement for any losses to the Company or Blackstone resulting from this matter.

The Ohio Attorney General’s Office, Health Care Fraud Section has issued a criminal subpoena, dated August 8, 2008, to Orthofix, Inc (the “Ohio AG Subpoena”).  The Ohio AG Subpoena seeks documents for the period from January 1, 2000 through the date of issuance of the subpoena.  The Company believes that the Ohio AG Subpoena arises from a government investigation that concerns the compensation of physician consultants and related matters.    On September 18, 2008, the Company submitted a claim for indemnification from the escrow fund established in connection with the Merger Agreement for any losses to the Company or Blackstone resulting from this matter.  

Blackstone is cooperating with the government’s request in each of the subpoenas set forth above and is in the process of responding to the subpoenas.  The Company is unable to predict what actions, if any, might be taken by the governmental authorities that have issued these subpoenas or what impact, if any, the outcome of these matters might have on the Company’s consolidated financial positions, results of operations or cash flows.

By order entered on January 4, 2007, the United States District Court for the Eastern District of Arkansas unsealed a qui tam complaint captioned Thomas v. Chan, et al., 4:06-cv-00465-JLH, filed against Dr. Patrick Chan, Blackstone and other defendants including another device manufacturer.  A qui tam action is a civil lawsuit brought by an individual for an alleged violation of a federal statute, in which the U.S. Department of Justice has the right to intervene and take over the prosecution of the lawsuit at its option.  The complaint alleges causes of action under the False Claims Act for alleged inappropriate payments and other items of value conferred on Dr. Chan.  On December 29, 2006, the U.S. Department of Justice filed a notice of non-intervention in the case.  Plaintiff subsequently amended the complaint to add the Company as a defendant.  On January 3, 2008, Dr. Chan pled guilty to one count of knowingly soliciting and receiving kickbacks from a medical device distributor in a criminal matter in which neither the Company nor any of its business units or employees were defendants. In January 2008, Dr. Chan entered into a settlement agreement with the plaintiff and certain governmental entities in the civil qui tam action, and on February 21, 2008, a joint stipulation of dismissal of claims against Dr. Chan in the action was filed with the court, which removed him as a defendant in the action. On July 11, 2008, the court granted a motion to dismiss the Company as a defendant in the action. Blackstone remains a defendant. The Company believes that Blackstone has meritorious defenses to the claims alleged and it intends to defend vigorously against this lawsuit.  On September 17, 2007, the Company submitted a claim for indemnification from the escrow fund established in connection with the Merger Agreement for any losses to the Company or Blackstone resulting from this matter.  The Company was subsequently notified by legal counsel for the former shareholders that the representative of the former shareholders of Blackstone has objected to the indemnification claim and intends to contest it in accordance with the terms of the Merger Agreement.


Between January 2007 and May 2007, Blackstone and Orthofix Inc. were named defendants, along with other medical device manufacturers, in three civil lawsuits alleging that Dr. Chan had performed unnecessary surgeries in three different instances.  In January 2008, the Company learned that Orthofix Inc. was named a defendant, along with other medical device manufacturers, in a fourth civil lawsuit alleging that Dr. Chan had performed unnecessary surgeries.  All four civil lawsuits have been served and were filed in the Circuit Court of White County, Arkansas. The Company has reached a settlement in one of these four civil lawsuits, and the court has entered an order of dismissal.  The settlement agreement is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.   The Company believes that the Company and its subsidiaries have meritorious defenses to the claims alleged in the remaining three lawsuits and the Company and its subsidiaries intend to defend vigorously against these lawsuits if they are not settled. On September 17, 2007, the Company submitted a claim for indemnification from the escrow fund established in connection with the Merger Agreement for any losses to the Company or Blackstone resulting from one of these four civil lawsuits.  The Company was subsequently notified by legal counsel for the former shareholders that the representative of the former shareholders of Blackstone has objected to the indemnification claim and intends to contest it in accordance with the terms of the Merger Agreement.

Of the total Blackstone purchase price, approximately $50.0 million was placed into an escrow account.  As described in the Agreement and Plan of Merger, the Company can make claims for reimbursement from the escrow account for certain defined items relating to the acquisition for which the Company is indemnified.  As described in Note 18, the Company has certain contingencies arising from the acquisition that management expects will be reimbursable from the escrow account should the Company have to make a payment to a third party.  The Company records the claims against the escrow in an escrow receivable account which is included in other current assets on the consolidated balance sheets.  Because the Company believes that the settlement process of escrow claims is complex and all claims may not be reimbursed, management has recorded a partial reserve against the escrow receivable.

The Company is unable to predict the outcome of each of the escrow claims described above in the preceding paragraphs or to estimate the amount, if any, that may ultimately be returned to the Company from the escrow fund and there can be no assurance that the contingencies will not exceed the amount of the escrow account.

In addition to the foregoing claims, the Company has submitted claims for indemnification from the escrow fund established in connection with the Merger Agreement for losses that have or may result from certain claims against Blackstone alleging that plaintiffs and/or claimants were entitled to payments for Blackstone stock options not reflected in Blackstone's corporate ledger at the time of Blackstone's acquisition by the Company, or that their shares or stock options were improperly diluted by Blackstone.  To date, the representative of the former shareholders of Blackstone has not objected to approximately $1.5   million in such claims from the escrow fund, with certain claims remaining pending.

The Company cannot predict the outcome of any of the proceedings or claims made against the Company or its subsidiaries described above in the preceding paragraphs and there can be no assurance that the ultimate resolution of any claim will not have a material adverse impact on its consolidated financial position, results of operations, or cash flows.


In addition to the foregoing, in the normal course of our business, the Company is involved in various lawsuits from time to time and may be subject to certain other contingencies.

United Kingdom Payroll Taxes
 
In 2007, Intavent Orthofix Limited, the Company’s UK distribution subsidiary, received an inquiry from H.M. Revenue and Customs (HMRC) relating to the tax treatment of gains made by UK employees on the exercise of stock options.  The Company is in the process of formulating a response to HMRC.  Based on preliminary calculations, a provision of $0.5 million has been provided, of which the Company has paid $0.2 million.  The Company cannot predict the ultimate outcome of its discussions with HMRC.

Concentrations of credit risk
 
There have been no material changes from the information provided in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2007.



Item 2.

The following discussion and analysis addresses our liquidity, financial condition, and the results of our operations for the three and nine months ended September 30, 2008 compared to our results of operations for the three and nine months ended September 30, 2007.  These discussions should be read in conjunction with our historical consolidated financial statements and related notes thereto and the other financial information included in this Form 10-Q and in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

General

We are a diversified orthopedic products company offering a broad line of surgical and non-surgical products for the Spine, Orthopedics, Sports Medicine and Vascular market sectors.  Our products are designed to address the lifelong bone-and-joint health needs of patients of all ages, helping them achieve a more active and mobile lifestyle.  We design, develop, manufacture, market and distribute medical equipment used principally by musculoskeletal medical specialists for orthopedic applications.  Our main products are invasive and minimally invasive spinal implant products and related human cellular and tissue based products (“HCT/P products”), non-invasive bone growth stimulation products used to enhance the success rate of spinal fusions and to treat non-union fractures, external and internal fixation devices used in fracture treatment, limb lengthening and bone reconstruction; and bracing products used for ligament injury prevention, pain management and protection of surgical repair to promote faster healing.  Our products also include a device for enhancing venous circulation, cold therapy, bone cement and devices for removal of bone cement used to fix artificial implants and airway management products used in anesthesia applications.

We have administrative and training facilities in the United States and Italy and manufacturing facilities in the United States, the United Kingdom, Italy and Mexico.  We directly distribute our products in the United States, the United Kingdom, Italy, Germany, Switzerland, Austria, France, Belgium, Mexico, Brazil, and Puerto Rico.  In several of these and other markets, we also distribute our products through independent distributors.

Our condensed consolidated financial statements include the financial results of the Company and its wholly-owned and majority-owned subsidiaries and entities over which we have control.  All intercompany accounts and transactions are eliminated in consolidation.

Our reporting currency is the United States Dollar.  All balance sheet accounts, except shareholders’ equity, are translated at period-end exchange rates, and revenue and expense items are translated at weighted average rates of exchange prevailing during the period.  Gains and losses resulting from foreign currency transactions are included in other income (expense).  Gains and losses resulting from the translation of foreign currency financial statements are recorded in the accumulated other comprehensive income component of shareholders’ equity.

Our financial condition, results of operations and cash flows are not significantly impacted by seasonality trends.  However, sales associated with products for elective procedures appear to be influenced by the somewhat lower level of such procedures performed in the late summer.  Certain of the Breg® bracing products experience greater demand in the fall and winter corresponding with high school and college football schedules and winter sports.  In addition, we do not believe our operations will be significantly affected by inflation.  However, in the ordinary course of business, we are exposed to the impact of changes in interest rates and foreign currency fluctuations.  Our objective is to limit the impact of such movements on earnings and cash flows.  In order to achieve this objective, we seek to balance non-dollar income and expenditures.  During the first nine months of 2008, we have used derivative instruments to hedge certain foreign currency fluctuation exposures as well as interest rate exposure on LIBOR-based borrowings.  See Item 3 – “Quantitative and Qualitative Disclosures About Market Risk.”

We manage our operations as four business segments: Domestic, Blackstone, Breg, and International.  Domestic consists of operations of our subsidiary Orthofix Inc.  Blackstone consists of Blackstone’s domestic and international operations.  Breg consists of Breg Inc.’s domestic operations and international distributors.   International consists of operations which are located in the rest of the world as well as independent export distribution operations.  Group Activities are comprised of the operating expenses and identifiable assets of Orthofix International N.V. and its U.S. holding company subsidiary, Orthofix Holdings, Inc.
 

Segment and Market Sector Revenues

The following tables display net sales by business segment and net sales by market sector.  We keep our books and records and account for net sales, costs of sales and expenses by business segment.  We provide net sales by market sector for information purposes only.

Business Segment:
 
   
Three Months Ended September 30,
 
(In US$ thousands)
 
2008
   
2007
       
   
Net Sales
   
Percent of Total Net Sales
   
Net Sales
   
Percent of Total Net Sales
   
Growth
 
Domestic
  $ 47,065       36 %   $ 41,971       35 %     12 %
                                         
Blackstone
    25,338       20 %     29,448       24 %     (14 )%
                                         
Breg
    22,377       17 %     21,206       17 %     6 %
                                         
International
    34,521       27 %     28,495       24 %     21 %
                                         
Total
  $ 129,301       100 %   $ 121,120       100 %     7 %
 

   
Nine Months Ended September 30,
 
(In US$ thousands)
 
2008
   
2007
       
   
Net Sales
   
Percent of Total Net Sales
   
Net Sales
   
Percent of Total Net Sales
   
Growth
 
Domestic
  $ 138,397       36 %   $ 122,718       34 %     13 %
                                         
Blackstone
    81,093       21 %     85,859       24 %     (6 )%
                                         
Breg
    66,341       17 %     61,522       17 %     8 %
                                         
International
    101,541       26 %     91,389       25 %     11 %
                                         
Total
  $ 387,372       100 %   $ 361,488       100 %     7 %

Market Sector:

   
Three Months Ended September 30,
 
(In US$ housands)
 
2008
   
2007
       
   
Net Sales
   
Percent of Total Net Sales
   
Net Sales
   
Percent of Total Net Sales
   
Growth
 
                               
Spine
  $ 61,318       48 %   $ 61,309       51 %     - %
                                         
Orthopedics
    33,824       26 %     26,304       22 %     29 %
                                         
Sports Medicine
    23,700       18 %     22,075       18 %     7 %
                                         
Vascular
    4,274       3 %     4,718       4 %     (9 )%
                                         
Other
    6,185       5 %     6,714       5 %     (8 )%
                                         
Total
  $ 129,301       100 %   $ 121,120       100 %     7 %

 
   
Nine Months Ended September 30,
 
(In US$ thousands)
 
2008
   
2007
       
   
Net Sales
   
Percent of
   
Net Sales Total Net Sales
   
Percent of Total Net Sales
   
Growth
 
Spine
  $ 186,488       48 %   $ 178,930       49 %     4 %
                                         
Orthopedics
    96,919       25 %     81,933       23 %     18 %
                                         
Sports Medicine
    70,212       18 %     64,555       18 %     9 %
                                         
Vascular
    13,391       4 %     15,217       4 %     (12 )%
                                         
Other
    20,362       5 %     20,853       6 %     (2 )%
                                         
Total
  $ 387,372       100 %   $ 361,488       100 %     7 %


The following table presents certain items from our Condensed Consolidated Statements of Operations as a percent of total net sales for the periods indicated:

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2008
(%)
   
2007
(%)
   
2008
(%)
   
2007
(%)
 
                         
Net sales
    100       100       100       100  
Cost of sales                                           
    37       25       30       26  
Gross profit (1)                                           
    63       75       70       74