Orthofix International N.V.
ORTHOFIX INTERNATIONAL N V (Form: 10-Q, Received: 08/01/2016 16:19:20)

 

 

 

 

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 June 30, 2016

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

 

Not applicable

(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.     x   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).     x   Yes     ¨   No

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

 

Large Accelerated filer

¨

Accelerated filer

x

 

 

 

 

Non-Accelerated filer

¨   (Do not check if a smaller reporting company)

Smaller Reporting Company

¨

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

As of July 29, 2016, 18,124,817 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 June 30, 2016, and December 31, 2015

 

4

 

 

 

 

 

 

 

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three and six months ended  June 30, 2016, and 2015

 

5

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and 2015

 

6

 

 

 

 

 

 

 

Notes to the Unaudited Condensed Consolidated Financial Statements

 

7

 

 

 

 

 

Item 2.

 

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

 

16

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

24

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

24

 

 

 

 

 

PART II

 

OTHER INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

25

 

 

 

 

 

Item 1A.

 

Risk Factors

 

25

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

25

 

 

 

 

 

Item 3.

 

Defaults Upon Senior Securities

 

25

 

 

 

 

 

Item 4.

 

Mine Safety Disclosures

 

25

 

 

 

 

 

Item 5.

 

Other Information

 

25

 

 

 

 

 

Item 6.

 

Exhibits

 

26

 

 

 

 

 

SIGNATURES

 

27

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, 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. 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 Part I, Item 1A under the heading  Risk Factors  in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015, to reflect new information, the occurrence of future events or circumstances or otherwise.

 

Factors that could cause or contribute to such differences may include, but are not limited to, risks relating to: the expected sales of our products, including recently launched products; the continuation of our ongoing share repurchase program; our ongoing settlement discussions with the Division of Enforcement of the Securities Exchange Commission (the “SEC”) related to investigation that arose out of our prior accounting review and restatements of financial statements and our review of allegations of improper payments involving our Brazil-based subsidiary (which review is described in Part I, Item 3, “Legal Proceedings”); the geographic concentration of certain accounts receivable in countries or territories that are facing severe fiscal challenges; unanticipated expenditures; changing relationships with customers, suppliers, strategic partners and lenders; changes to and the interpretation of governmental regulations; the resolution of pending litigation matters (including our indemnification obligations with respect to certain product liability claims against our former sports medicine global business unit (as further described in Part I, Item 3, “Legal Proceedings”); our ongoing compliance obligations under a corporate integrity agreement with the Office of Inspector General of the Department of Health and Human Services (and related terms of probation); risks relating to the protection of intellectual property; changes to the reimbursement policies of third parties; the impact of competitive products; changes to the competitive environment; the acceptance of new products in the market; conditions of the orthopedic and spine industries; credit markets and the global economy; corporate development and market development activities, including acquisitions or divestitures; unexpected costs or operating unit performance related to recent acquisitions; and other risks described in Part I, Item 1A under the heading  Risk Factors  in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015, as well as in other current and periodic reports that we file with the SEC in the future.

 

3


 

PA RT I. F INANCIAL INFORMATION

Item 1. Financial Statements

ORTHOFIX INTERNATIONAL N.V.

Condensed Consolidated Balance Sheets

 

 

 

June 30,

 

 

December 31,

 

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

 

2016

 

 

2015

 

 

 

 

 

 

 

 

 

 

 

 

(unaudited)

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

40,482

 

 

$

63,663

 

Trade accounts receivable, less allowance for doubtful accounts of $9,560 and

   $8,923 at June 30, 2016 and December 31, 2015, respectively

 

 

56,438

 

 

 

59,839

 

Inventories

 

 

61,334

 

 

 

57,563

 

Prepaid expenses and other current assets

 

 

19,734

 

 

 

31,187

 

Total current assets

 

 

177,988

 

 

 

212,252

 

Property, plant and equipment, net

 

 

52,499

 

 

 

52,306

 

Patents and other intangible assets, net

 

 

7,822

 

 

 

5,302

 

Goodwill

 

 

53,565

 

 

 

53,565

 

Deferred income taxes

 

 

56,443

 

 

 

57,306

 

Other long-term assets

 

 

16,421

 

 

 

19,491

 

Total assets

 

$

364,738

 

 

$

400,222

 

Liabilities and shareholders’ equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Trade accounts payable

 

$

13,676

 

 

$

16,391

 

Other current liabilities

 

 

63,523

 

 

 

65,597

 

Total current liabilities

 

 

77,199

 

 

 

81,988

 

Other long-term liabilities

 

 

29,308

 

 

 

27,923

 

Total liabilities

 

 

106,507

 

 

 

109,911

 

Contingencies (Note 11)

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

 

 

 

Common shares $0.10 par value; 50,000,000 shares authorized; 18,108,540 and

   18,659,696 issued and outstanding as of June 30, 2016 and December 31,

   2015, respectively

 

 

1,811

 

 

 

1,866

 

Additional paid-in capital

 

 

205,337

 

 

 

232,126

 

Retained earnings

 

 

59,057

 

 

 

62,551

 

Accumulated other comprehensive loss

 

 

(7,974

)

 

 

(6,232

)

Total shareholders’ equity

 

 

258,231

 

 

 

290,311

 

Total liabilities and shareholders’ equity

 

$

364,738

 

 

$

400,222

 

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

 

 

Six Months Ended

 

 

 

June 30,

 

 

June 30,

 

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

 

2016

 

 

2015

 

 

2016

 

 

2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product sales

 

$

90,868

 

 

$

86,868

 

 

$

176,493

 

 

$

163,700

 

Marketing service fees

 

 

13,207

 

 

 

14,086

 

 

 

26,261

 

 

 

27,016

 

Net sales

 

 

104,075

 

 

 

100,954

 

 

 

202,754

 

 

 

190,716

 

Cost of sales

 

 

22,515

 

 

 

21,910

 

 

 

44,651

 

 

 

41,249

 

Gross profit

 

 

81,560

 

 

 

79,044

 

 

 

158,103

 

 

 

149,467

 

Operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing

 

 

46,037

 

 

 

42,946

 

 

 

90,853

 

 

 

87,231

 

General and administrative

 

 

17,954

 

 

 

22,506

 

 

 

34,672

 

 

 

44,075

 

Research and development

 

 

6,792

 

 

 

6,451

 

 

 

14,428

 

 

 

12,296

 

Restatements and related costs

 

 

545

 

 

 

2,213

 

 

 

790

 

 

 

8,129

 

Charges related to U.S. Government resolutions (Note 11)

 

 

12,870

 

 

 

 

 

 

12,870

 

 

 

 

 

 

 

84,198

 

 

 

74,116

 

 

 

153,613

 

 

 

151,731

 

Operating (loss) income

 

 

(2,638

)

 

 

4,928

 

 

 

4,490

 

 

 

(2,264

)

Other income and expense

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest (expense) income, net

 

 

(113

)

 

 

74

 

 

 

(151

)

 

 

(198

)

Other income, net

 

 

147

 

 

 

853

 

 

 

1,980

 

 

 

1,544

 

 

 

 

34

 

 

 

927

 

 

 

1,829

 

 

 

1,346

 

(Loss) income before income taxes

 

 

(2,604

)

 

 

5,855

 

 

 

6,319

 

 

 

(918

)

Income tax expense

 

 

(3,685

)

 

 

(1,778

)

 

 

(7,979

)

 

 

(2,742

)

Net (loss) income from continuing operations

 

 

(6,289

)

 

 

4,077

 

 

 

(1,660

)

 

 

(3,660

)

Discontinued operations (Note 11)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss from discontinued operations

 

 

(1,572

)

 

 

(730

)

 

 

(2,562

)

 

 

(1,511

)

Income tax benefit

 

 

474

 

 

 

225

 

 

 

728

 

 

 

364

 

Net loss from discontinued operations

 

 

(1,098

)

 

 

(505

)

 

 

(1,834

)

 

 

(1,147

)

Net (loss) income

 

$

(7,387

)

 

$

3,572

 

 

$

(3,494

)

 

$

(4,807

)

Net income (loss) per common share—basic:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income from continuing operations

 

$

(0.35

)

 

$

0.22

 

 

$

(0.09

)

 

$

(0.20

)

Net loss from discontinued operations

 

 

(0.06

)

 

 

(0.03

)

 

 

(0.10

)

 

 

(0.06

)

Net (loss) income per common share—basic

 

$

(0.41

)

 

$

0.19

 

 

$

(0.19

)

 

$

(0.26

)

Net income (loss) per common share—diluted:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income from continuing operations

 

$

(0.35

)

 

$

0.21

 

 

$

(0.09

)

 

$

(0.20

)

Net loss from discontinued operations

 

 

(0.06

)

 

 

(0.02

)

 

 

(0.10

)

 

 

(0.06

)

Net (loss) income per common share—diluted

 

$

(0.41

)

 

$

0.19

 

 

$

(0.19

)

 

$

(0.26

)

Weighted average number of common shares:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

18,147,681

 

 

 

18,769,415

 

 

 

18,312,781

 

 

 

18,750,804

 

Diluted

 

 

18,147,681

 

 

 

18,989,579

 

 

 

18,312,781

 

 

 

18,750,804

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on derivative instruments, net of tax

 

 

50

 

 

 

271

 

 

 

76

 

 

 

936

 

Unrealized loss on debt securities, net of tax

 

 

(1,942

)

 

 

 

 

 

(2,469

)

 

 

 

Foreign currency translation adjustment

 

 

(570

)

 

 

1,559

 

 

 

651

 

 

 

(3,301

)

Comprehensive (loss) income

 

$

(9,849

)

 

$

5,402

 

 

$

(5,236

)

 

$

(7,172

)

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

5


 

ORTHOFIX INTERNATIONAL N.V.

Condensed Consolidated Statements of Cash Flows

 

 

 

Six Months Ended

 

 

 

June 30,

 

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

 

2016

 

 

2015

 

 

 

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

21,268

 

 

$

8,954

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Capital expenditures for property, plant and equipment

 

 

(9,600

)

 

 

(13,493

)

Capital expenditures for intangible assets

 

 

(756

)

 

 

(83

)

Purchases of assets and investments

 

 

(3,613

)

 

 

 

Purchase of debt securities

 

 

 

 

 

(15,250

)

Net proceeds from sale of assets

 

 

 

 

 

4,800

 

Net cash used in investing activities

 

 

(13,969

)

 

 

(24,026

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Net proceeds from issuance of common shares

 

 

13,035

 

 

 

1,646

 

Changes in restricted cash

 

 

 

 

34,424

 

Repurchase and retirement of common shares

 

 

(43,885

)

 

 

Excess income tax benefit on employee stock-based awards

 

 

105

 

 

 

54

 

Net cash (used in) provided by financing activities

 

 

(30,745

)

 

 

36,124

 

Effect of exchange rate changes on cash

 

 

265

 

 

 

(1,921

)

Net (decrease) increase in cash and cash equivalents

 

 

(23,181

)

 

 

19,131

 

Cash and cash equivalents at the beginning of the period

 

 

63,663

 

 

 

36,815

 

Cash and cash equivalents at the end of the period

 

$

40,482

 

 

$

55,946

 

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

1. Nature of operations, basis of presentation and recently issued accounting pronouncements

Nature of operations

Orthofix International N.V. (together with its subsidiaries, the “Company”) is a diversified, global medical device company focused on improving patients’ lives by providing superior reconstructive and regenerative orthopedic and spine solutions to physicians. The Company is comprised of four reportable segments: BioStim, Biologics, Extremity Fixation and Spine Fixation supported by corporate activities.

Basis of presentation

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 Annual Report on Form 10-K for the year ended December 31, 2015 (the “2015 Form 10-K”). Operating results for the three and six months ended June 30, 2016, are not necessarily indicative of the results that may be expected for other interim periods or the year ending December 31, 2016. The balance sheet at December 31, 2015, has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

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, potential goodwill and intangible asset impairment, fair value measurements, litigation and contingent liabilities, income taxes, and shared-based compensation. Actual results could differ from these estimates. As permitted under U.S. GAAP, interim accounting for certain expenses, including income taxes, are based on full year forecasts.

Recently issued accounting pronouncements

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers . ASU 2014-09 supersedes the revenue recognition requirements in Revenue Recognition (Topic 605), and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. The standard was originally effective for public entities for annual and interim periods beginning after December 15, 2016. On July 9, 2015, the FASB agreed to defer the effective date by one year to December 15, 2017 for annual reporting periods beginning after that date. The FASB also agreed to permit early adoption of the standard, but not before the original effective date. The standard is to be applied either retrospectively or as a cumulative effect adjustment as of the adoption date. The Company is currently evaluating the effect that adopting this new accounting guidance will have on the consolidated results of operations, cash flows, and financial position and developing processes and procedures to implement this guidance.

In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory . This ASU requires that an entity should measure inventory, unless accounted for under the last-in, first-out (“LIFO”) or retail inventory methods, at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The guidance will be effective prospectively for interim and annual periods beginning after December 15, 2016, with early adoption permitted. The Company is currently evaluating the new guidance and does not expect it will have a material impact on its consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities . This ASU requires entities to measure equity investments, except those accounted for under the equity method of accounting or those that result in consolidation of the investee, at fair value and recognize any changes in fair value in net income unless the investments qualify for the new practicability exception. The guidance will be effective prospectively for annual periods beginning after December 15, 2017, including interim periods within those fiscal years with early adoption permitted. The Company is currently evaluating the new guidance and does not expect it will have a material impact on its consolidated financial statements.

7


 

In February 2016, the FASB issued ASU 2016-02, L eases (Topic 842) . This ASU requires that a lessee recognize lease assets and lease liabilities for those leases classified as operating leases. The guidance is effective for interim and annual periods beginning after December 15, 2018, and will be applied at the beginning of the earliest period presented using a modified retrospective approach. The Company is currently evaluating the impact this ASU may have on its consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting . This ASU simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, accounting for forfeitures, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The guidance is effective for interim and annual periods beginning after December 15, 2016, with early adoption permitted. The guidance will be applied prospectively, retrospectively, or by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted, dependent upon the specific amendment that is adopted within the ASU. The Company is currently evaluating the effect that adopting this new guidance will have on the consolidated results of operations, cash flows, and financial position and developing processes and procedures to implement this guidance.

 

 

2. Inventories

The Company’s inventories are valued at the lower of cost or estimated net realizable value, after provision for excess or obsolete items, which is reviewed and updated on a periodic basis by management determined on a first-in, first-out basis. Work-in-process and finished products include the cost of materials, labor and other production costs. Finished products include field inventory which represents immediately saleable finished products that are in the possession of the Company’s independent sales representatives, and consignment inventory which represents immediately saleable finished products located at third party customers, such as distributors and hospitals. Deferred cost of sales result from transactions where the Company has shipped product or performed services for which all revenue recognition criteria have not been met. Once the revenue recognition criteria have been met, both the revenues and associated cost of sales are recognized.

Inventories were as follows:

(U.S. Dollars, in thousands)

 

June 30,

2016

 

 

December 31,

2015

 

 

 

 

 

 

 

 

 

 

Raw materials

 

$

7,070

 

 

$

4,976

 

Work-in-process

 

 

9,442

 

 

 

5,087

 

Finished products

 

 

40,484

 

 

 

42,947

 

Deferred cost of sales

 

 

4,338

 

 

 

4,553

 

Total inventory

 

$

61,334

 

 

$

57,563

 

 

 

 

3. Long-term debt

On August 31, 2015, the Company, through certain of its subsidiaries entered into a Credit Agreement (the “Credit Agreement”) with JPMorgan Chase Bank, N.A. (“JPMorgan”), as Administrative Agent, and certain lenders party thereto. The Credit Agreement provides for a five year $125 million secured revolving credit facility (the “Facility”).  As of June 30, 2016, the Company has not made any borrowings under the Credit Agreement.

The Credit Agreement contains financial covenants requiring the Company to maintain, as of the last day of any fiscal quarter, a total leverage ratio of not more than 3.0 to 1.0 and an interest coverage ratio of at least 3.0 to 1.0 based upon the Company’s consolidated adjusted earnings.  The Company is in compliance with all required financial covenants as of June 30, 2016. The Credit Agreement also includes events of default customary for facilities of this type, and upon the occurrence of such events of default, subject to customary cure rights, all outstanding loans under the Facility may be accelerated and/or the lenders’ commitments terminated.

The Company had no borrowings and an unused available line of credit of €5.8 million ($6.4 million and $6.3 million) at June 30, 2016 and December 31, 2015, respectively, on its Italian line of credit. This unsecured line of credit provides the Company the option to borrow amounts in Italy at rates which are determined at the time of borrowing.

 

 

8


 

4. Derivative instruments

In the ordinary course of business, the Company is exposed to the impact of changes in interest rates and foreign currency fluctuations. During 2016 and 2015, the Company made use of a foreign cross-currency swap agreement to manage cash flow exposure generated from foreign currency fluctuations.

The tables below disclose the types of derivative instruments the Company owns, the classifications and fair values of these instruments within the balance sheet, and the amount of gain (loss) recognized in other comprehensive income (loss). Any gains or losses reported in accumulated other comprehensive income are reclassified into earnings upon maturity.

 

(U.S. Dollars, in thousands)

As of June 30, 2016

 

Fair   value:  f avorable

(unfavorable)

 

 

Balance sheet classification

Cross-currency swap

 

$

2,374

 

 

Prepaid expenses and other current assets

Warrants

 

$

321

 

 

Other long-term assets

 

 

 

 

 

 

 

As of December 31, 2015

 

 

 

 

 

 

Cross-currency swap

 

$

2,485

 

 

Prepaid expenses and other current assets

Warrants

 

$

321

 

 

Other long-term assets

 

 

 

Three Months Ended

June 30,

 

 

Six Months Ended

June 30,

 

(U.S. Dollars, in thousands)

 

2016

 

 

2015

 

 

2016

 

 

2015

 

Cross-currency swap unrealized gain, net of taxes

 

$

50

 

 

$

267

 

 

$

76

 

 

$

936

 

Warrants unrealized loss, net of taxes

 

$

 

 

$

4

 

 

$

 

 

$

 

 

 

 

5. Fair value measurements

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

 

(U.S. Dollars, in thousands)

 

June 30,

2016

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Collective trust funds

 

$

1,599

 

 

$

 

 

$

1,599

 

 

$

 

Treasury securities

 

 

521

 

 

 

521

 

 

 

 

 

 

 

Certificates of deposit

 

 

443

 

 

 

443

 

 

 

 

 

 

 

Derivative instruments

 

 

2,374

 

 

 

 

 

 

2,374

 

 

 

 

Debt securities

 

 

9,438

 

 

 

 

 

 

 

 

 

9,438

 

Total

 

$

14,375

 

 

$

964

 

 

$

3,973

 

 

$

9,438

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred compensation plan

 

$

(1,488

)

 

$

 

 

$

(1,488

)

 

$

 

Total

 

$

(1,488

)

 

$

 

 

$

(1,488

)

 

$

 

 

(U.S. Dollars, in thousands)

 

December 31,

2015

 

 

Level 1

 

 

Level 2

 

 

Level 3

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Collective trust funds

 

$

1,622

 

 

$

 

 

$

1,622

 

 

$

 

Treasury securities

 

 

495

 

 

 

495

 

 

 

 

 

 

 

Certificates of deposit

 

 

337

 

 

 

337

 

 

 

 

 

 

 

Derivative instruments

 

 

2,485

 

 

 

 

 

 

2,485

 

 

 

 

Debt securities

 

 

12,658

 

 

 

 

 

 

 

 

 

12,658

 

Total

 

$

17,597

 

 

$

832

 

 

$

4,107

 

 

$

12,658

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred compensation plan

 

$

(1,503

)

 

$

 

 

$

(1,503

)

 

$

 

Total

 

$

(1,503

)

 

$

 

 

$

(1,503

)

 

$

 

9


 

 

Debt Securities

 

On March 4, 2015, the Company entered into an Option Agreement (the “Option Agreement”) with eNeura, Inc. (“eNeura”), a privately held medical technology company that is developing devices for the treatment of migraines. The Option Agreement provides the Company with an exclusive option to acquire eNeura (the “Option”) during the 18-month period following the grant of the Option. In consideration for the Option, (i) the Company paid a non-refundable $0.3 million fee to eNeura, and (ii) eNeura issued a Convertible Promissory Note (the “eNeura Note”) to the Company. The principal amount of the eNeura Note is $15.0 million and interest accrues at 8.0%. The eNeura Note will mature on the earlier of (i) March 4, 2019, or (ii) exercise of the Option. The interest is not due until the note matures and will be forgiven if the Company exercises the option. The investment is recorded in other long-term assets as an available for sale debt security and interest is recorded in interest income.

 

The fair value of the debt security is based upon significant unobservable inputs, including the use of a discounted cash flows model, requiring the  Company  to develop its own assumptions; therefore, the Company has categorized this asset as a Level 3 financial asset. During the first quarter of 2016, the Company revised the estimated fair value which resulted in an impairment of $0.8 million. During the second quarter of 2016, the Company further revised its estimate based on current financial information and other assumptions.  Revisions to current financial information had a significant negative impact on the valuation of the debt security resulting in an additional impairment of $3.0 million, which the Company recorded in accumulated other comprehensive loss as an unrealized loss on debt securities. The Company continues to classify the impairment as temporary in nature as the Company does not intend to sell the debt security nor does it believe that recoverability of the investment will not occur.

 

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)

 

 

 

 

Balance at December 31, 2015

 

$

12,658

 

Accrued interest income

 

 

640

 

Unrealized loss on debt securities

 

 

(3,860

)

Balance at June 30, 2016

 

$

9,438

 

 

 

6. Accumulated other comprehensive loss

Accumulated other comprehensive loss is comprised of foreign currency translation adjustments; the effective portion of the gain (loss) on the Company’s cross-currency swap, which is designated and accounted for as a cash flow hedge; the unrealized gain (loss) on warrants; and the unrealized loss on the Company’s debt securities. The components of and changes in accumulated other comprehensive loss were as follows:

(U.S. Dollars, in thousands)

 

Currency

Translation Adjustments

 

 

Change

in Fair

Value of

Derivatives

 

 

Change in

Fair Value

of Debt

Securities

 

 

Accumulated Other

Comprehensive Loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2015

 

$

(4,389

)

 

$

228

 

 

$

(2,071

)

 

$

(6,232

)

Unrealized gain on derivative instruments,

   net of tax of $51

 

 

 

 

 

76

 

 

 

 

 

 

76

 

Unrealized loss on debt securities, net of tax benefit of $1,391

 

 

 

 

 

 

 

 

(2,469

)

 

 

(2,469

)

Foreign currency translation adjustment (1)

 

 

651

 

 

 

 

 

 

 

 

 

651

 

Balance at June 30, 2016

 

$

(3,738

)

 

$

304

 

 

$

(4,540

)

 

$

(7,974

)

 ___________________________________________

(1)

As unremitted earnings generally remain indefinitely reinvested in the non U.S. dollar denominated foreign subsidiaries, no deferred taxes are recognized on the related foreign currency translation adjustment.

 

 

10


 

7. Earnings per share

For the three and six months ended June 30, 2016 and 2015, no adjustments were made to net income (loss) for purposes of calculating basic and diluted net income (loss) available to common shareholders. The following is a reconciliation of the weighted average shares used in the basic and diluted net loss per common share computations.

 

 

 

Three Months Ended

June 30,

 

 

Six Months Ended

June 30,

 

 

 

2016

 

 

2015

 

 

2016

 

 

2015

 

Weighted average common shares-basic

 

 

18,147,681

 

 

 

18,769,415

 

 

 

18,312,781

 

 

 

18,750,804

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unexercised stock options net of treasury share repurchase

 

 

 

 

 

220,164

 

 

 

 

 

 

 

Weighted average common shares-diluted

 

 

18,147,681

 

 

 

18,989,579

 

 

 

18,312,781

 

 

 

18,750,804

 

Options to purchase shares of common stock with exercise prices in excess of the average market price of common shares and performance-based restricted stock awards deemed not probable to vest are not included in the computation of diluted earnings per share. There were 792,149 outstanding awards and options not included in the diluted earnings per share computation for the three months ended June 30, 2015, because their inclusion was antidilutive.

Due to the Company having a net loss from continuing operations position for the three and six months ended June 30, 2016, there were 490,296 and 484,201 potentially dilutive shares excluded from the computation, respectively, as their effects would be antidilutive. Due to the Company having a net loss from continuing operations position for the six months ended June 30, 2015, there were 1,081,308 potentially dilutive shares excluded from the computation as their effects would be antidilutive.

 

 

8. Share-based compensation

All share-based compensation costs are measured at the grant date, based on the estimated fair value of the award, and recognized as expense in the condensed consolidated statements of operations over the requisite service period. The Company recognized $1.9 million and $3.9 million, respectively, of share-based compensation expense for the three and six months ended June 30, 2016 and $1.8 million and $3.6 million, respectively, for the three and six months ended June 30, 2015.

On June 30, 2014, the Company granted 99,600 performance-based restricted share awards to officers and certain employees. Vesting is based on achieving earnings targets in two consecutive rolling four quarter periods. As of June 30, 2016, no expense has been recognized for these contingent restricted share awards.

On June 30, 2015, the Company granted 68,750 performance-based restricted share awards to officers and on August 5, 2015, granted an additional 41,910 performance-based restricted share awards to other members of management.  Vesting is based on achieving earnings and return on invested capital targets as of and for the years ended December 31, 2016, 2017 or 2018.  As of June 30, 2016, no expense has been recognized for these contingent restricted share awards.

During the three months ended June 30, 2016 and 2015, there were 325,393 and 81,974 shares, respectively, of common stock issued related to stock purchase plan issuances, stock option exercises and the vesting of restricted stock awards. During the six months ended June 30, 2016 and 2015, there were 528,791 and 227,840 shares, respectively, of common stock issued related to stock purchase plan issuances, stock option exercises and the vesting of restricted stock awards.

 

 

9. Income taxes

For the second quarter, our effective tax rate on continuing operations was (141.5%), or $3.7 million, as compared to 30.4%, or $1.8 million, for the same period in the prior year. Excluding the impact of various discrete tax charges, the effective tax rate on continuing operations for the second quarter of 2016 and 2015 was (131.6%) and 29.6%, respectively. For the first six months of 2016, our effective tax rate on continuing operations was 126.3%, or $8.0 million, as compared to (298.7%), or $2.7 million, for the same period in the prior year. Excluding the impact of various discrete tax charges, the effective tax rate on continuing operations for the first six months of 2016 and 2015 was 119.6% and (256.6%), respectively.

The primary factor affecting the Company’s effective tax rate for the three and six months ended June 30, 2016, was charges related to US Government Resolutions, which is non-deductible for tax purposes, and the impact of which is fully recognized in the second quarter.  Other factors affecting the Company’s effective tax rate for the three and six months ended June 30, 2016, and June 30, 2015, were the Company’s mix of earnings among various tax jurisdictions, state taxes, and current period losses in certain jurisdictions for which the Company does not currently provide a tax benefit.

11


 

During the third quarter of 2015, the Internal Revenue Service commenced an examination of our federal income tax return for 2012. The Company cannot reasonably determine if this examination will have a material impact on our financial statements and c annot predict the timing regarding res olution of this tax examination.

 

 

10. Business segment information

The Company has four strategic business units (“SBUs”), which are comprised of BioStim, Biologics, Extremity Fixation, and Spine Fixation supported by corporate activities. The primary metric used in managing the Company is net margin, which is defined as gross profit less sales and marketing expense. The Company neither discretely allocates assets, other than goodwill, to its operating segments nor evaluates the operating segments using discrete asset information.  

The tables below present net sales for continuing operations by SBU reporting segment. Net sales include product sales and marketing service fees. Marketing service fees, which are recorded on a net basis, are comprised of fees earned for the marketing of Trinity Evolution ® , Trinity ELITE ® and Versashield™ in our Biologics segment.

 

 

 

Three Months Ended June 30,

 

(U.S. Dollars, in thousands)

 

2016

 

 

2015

 

 

Reported

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BioStim

 

$

44,758

 

 

$

40,703

 

 

 

10.0

%

Biologics

 

 

14,256

 

 

 

15,274

 

 

 

(6.7

)%

Extremity Fixation

 

 

26,817

 

 

 

25,594

 

 

 

4.8

%

Spine Fixation

 

 

18,244

 

 

 

19,383

 

 

 

(5.9

)%

Total net sales

 

$

104,075

 

 

$

100,954

 

 

 

3.1

%

 

 

 

Six Months Ended June 30,

 

(U.S. Dollars, in thousands)

 

2016

 

 

2015

 

 

Reported

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

BioStim

 

$

85,802

 

 

$

78,403

 

 

 

9.4

%

Biologics

 

 

28,350

 

 

 

29,235

 

 

 

(3.0

)%

Extremity Fixation

 

 

51,526

 

 

 

47,409

 

 

 

8.7

%

Spine Fixation

 

 

37,076

 

 

 

35,669

 

 

 

3.9

%

Total net sales

 

$

202,754

 

 

$

190,716

 

 

 

6.3

%

 

The table below presents net margin, which is defined as gross profit less sales and marketing expense, by SBU reporting segment for the three and six months ended June 30, 2016 and 2015:

 

 

Three Months Ended

June 30,

 

 

Six Months Ended

June 30,

 

(U.S. Dollars, in thousands)

 

2016

 

 

2015

 

 

2016

 

 

2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

$

81,560

 

 

$

79,044

 

 

$

158,103

 

 

$

149,467

 

Less: Sales and marketing

 

 

(46,037

)

 

 

(42,946

)

 

 

(90,853

)

 

 

(87,231

)

Total net margin

 

$

35,523

 

 

$

36,098

 

 

$

67,250