Orthofix International N.V.
ORTHOFIX INTERNATIONAL N V (Form: 10-Q, Received: 10/30/2017 16:13:54)

 

 

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

(Mark one)

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

For the quarterly period ended September 30, 2017

OR

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

For the transition period from                      to                      .

Commission File Number: 0-19961

 

ORTHOFIX INTERNATIONAL N.V.

(Exact name of registrant as specified in its charter)

 

 

Curaçao

 

98-1340767

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

 

 

7 Abraham de Veerstraat

Curaçao

 

Not applicable

(Address of principal executive offices)

 

(Zip Code)

599-9-4658525

(Registrant’s telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.        Yes       No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      Yes       No

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

 

Large Accelerated filer

Accelerated filer

 

 

 

 

Non-Accelerated filer

  (Do not check if a smaller reporting company)

Smaller Reporting Company

 

 

 

 

 

 

Emerging Growth Company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    

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

As of October 27, 2017, 18,231,334 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 September 30, 2017, and December 31, 2016

 

4

 

 

 

 

 

 

 

Condensed Consolidated Statements of Operations and Comprehensive Income for the three and nine months ended  September 30, 2017, and 2016

 

5

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2017 and 2016

 

6

 

 

 

 

 

 

 

Notes to the Unaudited Condensed Consolidated Financial Statements

 

7

 

 

 

 

 

Item 2.

 

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

 

14

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

21

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

21

 

 

 

 

 

PART II

 

OTHER INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

23

 

 

 

 

 

Item 1A.

 

Risk Factors

 

23

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

23

 

 

 

 

 

Item 3.

 

Defaults Upon Senior Securities

 

23

 

 

 

 

 

Item 4.

 

Mine Safety Disclosures

 

23

 

 

 

 

 

Item 5.

 

Other Information

 

23

 

 

 

 

 

Item 6.

 

Exhibits

 

24

 

 

 

 

 

SIGNATURES

 

25

2


 

Forward-Looking Statements

This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (“the Exchange Act”), and Section 27A of the Securities Act of 1933, as amended, relating to our business and financial outlook, which are based on our current beliefs, assumptions, expectations, estimates, forecasts and projections. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “intends,” “predicts,” “potential,” or “continue” or other comparable terminology. These forward-looking statements are not guarantees of our future performance and involve risks, uncertainties, estimates and assumptions that are difficult to predict , including the risks described Part I, Item 1A under the heading Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2016 (the “2016 Form 10-K”). Therefore, our actual outcomes and results may differ materially from those expressed in these forward-looking statements. You should not place undue reliance on any of these forward-looking statements. Further, any forward-looking statement speaks only as of the date hereof, unless it is specifically otherwise stated to be made as of a different date. We undertake no obligation to further update any such statement, or the risk factors described in the 2016 Form 10-K, to reflect new information, the occurrence of future events or circumstances or otherwise.

 

 

Trademarks

Solely for convenience, our trademarks and trade names in this report are referred to without the ® and ™ symbols, but such references should not be construed as any indicator that we will not assert, to the fullest extent under applicable law, our rights thereto.

 

3


 

PART I. F INANCIAL INFORMATION

Item 1. Financial Statements

ORTHOFIX INTERNATIONAL N.V.

Condensed Consolidated Balance Sheets

 

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

 

September 30,

2017

 

 

December 31,

2016

 

 

 

(Unaudited)

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

53,925

 

 

$

39,572

 

Restricted cash

 

 

 

 

 

14,369

 

Accounts receivable, net of allowances of $8,925 and $8,396, respectively

 

 

61,187

 

 

 

57,848

 

Inventories

 

 

80,124

 

 

 

63,346

 

Prepaid expenses and other current assets

 

 

18,172

 

 

 

19,238

 

Total current assets

 

 

213,408

 

 

 

194,373

 

Property, plant and equipment, net

 

 

46,678

 

 

 

48,916

 

Patents and other intangible assets, net

 

 

9,915

 

 

 

7,461

 

Goodwill

 

 

53,565

 

 

 

53,565

 

Deferred income taxes

 

 

47,052

 

 

 

47,325

 

Other long-term assets

 

 

15,683

 

 

 

20,463

 

Total assets

 

$

386,301

 

 

$

372,103

 

Liabilities and shareholders’ equity

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

Accounts payable

 

$

13,352

 

 

$

14,353

 

Other current liabilities

 

 

60,718

 

 

 

69,088

 

Total current liabilities

 

 

74,070

 

 

 

83,441

 

Other long-term liabilities

 

 

26,920

 

 

 

25,185

 

Total liabilities

 

 

100,990

 

 

 

108,626

 

Contingencies (Note 6)

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

 

 

 

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

   18,212,916 and 17,828,155 issued and outstanding as of September 30,

   2017 and December 31, 2016, respectively

 

 

1,821

 

 

 

1,783

 

Additional paid-in capital

 

 

215,778

 

 

 

204,095

 

Retained earnings

 

 

68,834

 

 

 

64,179

 

Accumulated other comprehensive loss

 

 

(1,122

)

 

 

(6,580

)

Total shareholders’ equity

 

 

285,311

 

 

 

263,477

 

Total liabilities and shareholders’ equity

 

$

386,301

 

 

$

372,103

 

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

 

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

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

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Net sales

 

$

105,247

 

 

$

98,497

 

 

$

316,927

 

 

$

301,251

 

Cost of sales

 

 

23,717

 

 

 

19,880

 

 

 

69,475

 

 

 

64,533

 

Gross profit

 

 

81,530

 

 

 

78,617

 

 

 

247,452

 

 

 

236,718

 

Sales and marketing

 

 

47,493

 

 

 

41,717

 

 

 

146,496

 

 

 

132,582

 

General and administrative

 

 

18,068

 

 

 

19,272

 

 

 

56,759

 

 

 

54,822

 

Research and development

 

 

6,935

 

 

 

6,858

 

 

 

21,246

 

 

 

21,294

 

Charges related to U.S. Government resolutions

 

 

 

 

 

1,499

 

 

 

 

 

 

14,369

 

Operating income

 

 

9,034

 

 

 

9,271

 

 

 

22,951

 

 

 

13,651

 

Interest income (expense), net

 

 

(15

)

 

 

471

 

 

 

106

 

 

 

320

 

Other income (expense), net

 

 

479

 

 

 

(634

)

 

 

(3,284

)

 

 

1,346

 

Income before income taxes

 

 

9,498

 

 

 

9,108

 

 

 

19,773

 

 

 

15,317

 

Income tax benefit (expense)

 

 

(6,150

)

 

 

1,276

 

 

 

(13,998

)

 

 

(6,703

)

Net income from continuing operations

 

 

3,348

 

 

 

10,384

 

 

 

5,775

 

 

 

8,614

 

Discontinued operations (Note 6)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from discontinued operations

 

 

65

 

 

 

(1,018

)

 

 

(1,762

)

 

 

(3,580

)

Income tax benefit

 

 

43

 

 

 

530

 

 

 

642

 

 

 

1,258

 

Net income (loss) from discontinued operations

 

 

108

 

 

 

(488

)

 

 

(1,120

)

 

 

(2,322

)

Net income

 

$

3,456

 

 

$

9,896

 

 

$

4,655

 

 

$

6,292

 

Net income (loss) per common share—basic

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income from continuing operations

 

$

0.18

 

 

$

0.57

 

 

$

0.32

 

 

$

0.47

 

Net income (loss) from discontinued operations

 

 

0.01

 

 

 

(0.02

)

 

 

(0.06

)

 

 

(0.13

)

Net income per common share—basic

 

$

0.19

 

 

$

0.55

 

 

$

0.26

 

 

$

0.34

 

Net income (loss) per common share—diluted

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income from continuing operations

 

$

0.18

 

 

$

0.56

 

 

$

0.31

 

 

$

0.46

 

Net income (loss) from discontinued operations

 

 

0.01

 

 

 

(0.02

)

 

 

(0.06

)

 

 

(0.12

)

Net income per common share—diluted

 

$

0.19

 

 

$

0.54

 

 

$

0.25

 

 

$

0.34

 

Weighted average number of common shares:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

18,180,845

 

 

 

18,091,650

 

 

 

18,071,093

 

 

 

18,238,533

 

Diluted

 

 

18,572,791

 

 

 

18,382,118

 

 

 

18,394,542

 

 

 

18,569,861

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income, before tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on derivative instrument

 

 

 

 

 

(3

)

 

 

 

 

 

124

 

Unrealized gain (loss) on debt securities

 

 

 

 

 

4,703

 

 

 

(3,220

)

 

 

843

 

Reclassification adjustment for loss on debt securities in net income

 

 

 

 

 

 

 

 

5,585

 

 

 

 

Currency translation adjustment

 

 

1,111

 

 

 

820

 

 

 

3,993

 

 

 

1,471

 

Other comprehensive income before tax

 

 

1,111

 

 

 

5,520

 

 

 

6,358

 

 

 

2,438

 

Income tax related to items of other comprehensive loss

 

 

 

 

 

(1,694

)

 

 

(900

)

 

 

(354

)

Other comprehensive income, net of tax

 

 

1,111

 

 

 

3,826

 

 

 

5,458

 

 

 

2,084

 

Comprehensive income

 

$

4,567

 

 

$

13,722

 

 

$

10,113

 

 

$

8,376

 

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

5


 

ORTHOFIX INTERNATIONAL N.V.

Condensed Consolidated Statements of Cash Flows

 

 

 

Nine Months Ended

September 30,

 

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

 

2017

 

 

2016

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

Net income

 

$

4,655

 

 

$

6,292

 

Adjustments to reconcile net income to net cash from operating activities

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

15,421

 

 

 

15,483

 

Amortization of debt costs and other assets

 

 

1,072

 

 

 

1,259

 

Provision for doubtful accounts

 

 

1,555

 

 

 

1,059

 

Deferred income taxes

 

 

153

 

 

 

1,246

 

Share-based compensation

 

 

9,124

 

 

 

12,154

 

Other-than-temporary impairment on debt securities

 

 

5,585

 

 

 

 

Other

 

 

823

 

 

 

663

 

Changes in operating assets and liabilities

 

 

 

 

 

 

 

 

Restricted cash

 

 

14,369

 

 

 

 

Accounts receivable

 

 

(4,302

)

 

 

5,887

 

Inventories

 

 

(14,714

)

 

 

(6,638

)

Prepaid expenses and other current assets

 

 

1,377

 

 

 

(568

)

Accounts payable

 

 

(2,233

)

 

 

(2,291

)

Other current liabilities

 

 

(11,639

)

 

 

5,502

 

Other long-term assets and liabilities

 

 

2,248

 

 

 

(1,652

)

Net cash from operating activities

 

 

23,494

 

 

 

38,396

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

Capital expenditures for property, plant and equipment

 

 

(11,441

)

 

 

(12,934

)

Capital expenditures for intangible assets

 

 

(1,849

)

 

 

(1,327

)

Other investing activities

 

 

474

 

 

 

(3,613

)

Net cash from investing activities

 

 

(12,816

)

 

 

(17,874

)

Cash flows from financing activities

 

 

 

 

 

 

 

 

Proceeds from issuance of common shares

 

 

6,277

 

 

 

19,688

 

Payments related to withholdings for share-based compensation

 

 

(3,679

)

 

 

(2,354

)

Repurchase and retirement of common shares

 

 

 

 

 

(54,996

)

Net cash from financing activities

 

 

2,598

 

 

 

(37,662

)

Effect of exchange rate changes on cash

 

 

1,077

 

 

 

301

 

Net change in cash and cash equivalents

 

 

14,353

 

 

 

(16,839

)

Cash and cash equivalents at the beginning of the period

 

 

39,572

 

 

 

63,663

 

Cash and cash equivalents at the end of the period

 

$

53,925

 

 

$

46,824

 

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

 

 

6


 

ORTHOFIX INTERNATIONAL N.V.

Notes to the Unaudited Condensed Consolidated Financial Statements

Business and basis of presentation

Orthofix International N.V. (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 has four strategic business units (“SBUs”) that are also its reporting segments: BioStim, Biologics, Extremity Fixation, and Spine Fixation.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Pursuant to these rules and regulations, certain information and note disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair statement have been included. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s Form 10-K for the year ended December 31, 2016. Operating results for the three and nine months ended September 30, 2017 are not necessarily indicative of the results that may be expected for other interim periods or the year ending December 31, 2017.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. On an ongoing basis, the Company evaluates its estimates including those related to revenue recognition, contractual allowances, doubtful accounts, inventories, goodwill and intangible asset impairment, fair value measurements, litigation and contingent liabilities, income taxes, and share-based compensation. Actual results could differ from these estimates.

 

 

1. Recently issued accounting pronouncements

 

Topic

 

Description of Guidance

 

Effective Date

 

Status of Company's Evaluation

Revenue Recognition

(ASU 2014-09,

as amended)

 

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. Applied either retrospectively or as a cumulative effect adjustment as of the adoption date.

 

January 1, 2018

 

The Company is continuing to evaluate the impact this ASU will have on its consolidated financial statements and disclosures. The Company completed an initial impact assessment and believes adopting this ASU will materially impact the timing of revenue recognition, primarily for Extremity Fixation and Spine Fixation product sales to stocking distributors, which are currently accounted for using the sell-through method. Specifically, the Company believes the revenue associated with these sales will be recorded at the time of the sale instead of deferring recognition until cash is received. Further, as a result of adopting ASU 2014-09, the Company expects to record a significant increase in accounts receivable and a decrease within inventories, with these changes offset by an adjustment to the Company's retained earnings balance on January 1, 2018, as a result of the changes in judgments. Adopting this guidance will also result in material changes to the Company's disclosures for revenue recognition and contracts with customers. The Company expects to adopt this new guidance using the modified retrospective transition method.

7


 

Topic

 

Description of Guidance

 

Effective Date

 

Status of Company's Evaluation

Financial Instruments

(ASU 2016-01)

 

Requires entities to measure equity investments, except in limited circumstances, at fair value and recognize any changes in fair value in net income. Applied prospectively.

 

January 1, 2018

 

The Company is currently evaluating the impact this ASU may have on its consolidated financial statements, but based upon its initial assessment, the Company does not believe the adoption of this ASU will materially impact its consolidated financial statements.

Leases

(ASU 2016-02)

 

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

 

January 1, 2019

 

The Company is currently evaluating the impact this ASU may have on its consolidated financial statements; however, the Company expects this guidance will materially impact the Company's consolidated balance sheet, resulting in current operating lease obligations being reflected on the consolidated balance sheet.

Income Taxes

(ASU 2016-16)

 

Reduces complexity by requiring current and deferred income taxes for intra-entity asset transfers, other than inventory, to be recognized when the transfer occurs. Applied using a modified retrospective approach.

 

January 1, 2018

 

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

Statement of Cash Flows

(ASU 2016-18)

 

Reduces diversity in classification and presentation of restricted cash, including transfers between cash and restricted cash, on the statement of cash flows. Applied retrospectively.

 

January 1, 2018

 

The Company is expected to adopt this ASU as of January 1, 2018, and believes that it will materially impact its consolidated statements of cash flows. Adoption of this ASU is expected to result in an increase in net cash from operating activities of $14.4 million for the year ended December 31, 2016 and would have resulted in a decrease in net cash from operating activities of $14.4 million for the nine months ended September 30, 2017 if this ASU had been early adopted.

 

 

2. Inventories

Inventories were as follows:

 

(U.S. Dollars, in thousands)

 

September 30,

2017

 

 

December 31,

2016

 

Raw materials

 

$

5,269

 

 

$

7,978

 

Work-in-process

 

 

12,322

 

 

 

9,505

 

Finished products

 

 

58,964

 

 

 

42,434

 

Deferred cost of sales

 

 

3,569

 

 

 

3,429

 

 

 

$

80,124

 

 

$

63,346

 

 

 

3. Other current liabilities

In December 2016, the Company approved and initiated a planned restructuring, which primarily affects the Extremity Fixation SBU (the “Extremity Fixation restructuring plan”), to streamline costs, improve operational performance, and wind down a non-core business. The Extremity Fixation restructuring plan consists primarily of severance charges and the write-down of certain assets. The Company expects to incur total pre-tax expense of approximately $3.1 million in connection with this restructuring activity and has incurred cumulative costs to date of $2.4 million. The Company had an accrual of $1.5 million as of December 31, 2016 in other current liabilities related to the planned restructuring. In the nine months ended September 30, 2017, the Company incurred costs of

8


 

approximately $0.5 million and made additional payments of $1.6 million, resulting in an ending accrual of $0.4 million as of September 30, 2017.

In September 2017, the Company approved and executed an additional restructuring plan, which primarily affects the entity’s corporate shared services in the U.S. (the “U.S. restructuring plan”), to streamline costs and to improve operational performance. The U.S. restructuring plan consists primarily of severance charges. The Company estimates total pre-tax expense of approximately $1.8 million in connection with this restructuring activity, all of which was incurred during the third quarter of 2017, and recorded within operating expenses. No payments were made as of September 30, 2017; therefore, $1.8 million is accrued within other current liabilities at September 30, 2017.

 

 

4. Long-term debt

As of September 30, 2017, the Company has not made any borrowings under the five year $125 million secured revolving credit facility it entered into in August 2015 with JPMorgan Chase Bank, N.A., as Administrative Agent, and certain lenders. The Company has also not made any borrowings on its €5.8 million ($6.9 million) available line of credit in Italy at September 30, 2017.  The Company is in compliance with all required financial covenants as of September 30, 2017.

 

 

5. Fair value measurements

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

 

 

 

September 30,

2017

 

 

December 31,

2016

 

(U.S. Dollars, in thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Collective trust funds

 

$

 

 

$

1,565

 

 

$

 

 

$

1,565

 

 

$

1,584

 

Treasury securities

 

 

522

 

 

 

 

 

 

 

 

 

522

 

 

 

467

 

Certificates of deposit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

468

 

Debt security

 

 

 

 

 

 

 

 

9,000

 

 

 

9,000

 

 

 

12,220

 

Total

 

$

522

 

 

$

1,565

 

 

$

9,000

 

 

$

11,087

 

 

$

14,739

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deferred compensation plan

 

$

 

 

$

(1,307

)

 

$

 

 

$

(1,307

)

 

$

(1,452

)

Total

 

$

 

 

$

(1,307

)

 

$

 

 

$

(1,307

)

 

$

(1,452

)

 

The Company holds a debt security of eNeura, Inc., a privately held medical technology company that is developing devices for the treatment of migraines. The debt security is further described in Note 6 to the financial statements contained within our Form 10-K for the year ended December 31, 2016. The fair value of the debt security, which is recorded within other long-term assets, is based upon significant unobservable inputs, including the use of a discounted cash flow model, requiring the  Company  to develop its own assumptions; therefore, the Company has categorized this asset as a Level 3 financial asset. As of September 30, 2017, the Company reassessed its estimate of fair value based on current financial information and other assumptions, resulting in a fair value of $9.0 million, which is consistent with the Company’s estimated fair value from the first and second quarters of 2017. This compares to an amortized cost basis in the debt security of $18.4 million.

The Company evaluated the decline in fair value of the debt security, which was recorded during the first quarter of 2017, to determine if the impairment was other-than-temporary. Based on this evaluation, the Company recorded an other-than-temporary impairment charge of $5.6 million before income taxes, which is recorded in other expense. In addition to the decrease in fair value, the other-than-temporary impairment included a reclassification of the amount that was previously considered temporary and included in accumulated other comprehensive loss.

9


 

The following table provides a reconciliation of the beginnin g and ending balances for debt securities measured at fair value using significant unobservable inputs (Level 3):

 

(U.S. Dollars, in thousands)

 

2017

 

 

2016

 

Balance at January 1

 

$

12,220

 

 

$

12,658

 

Accrued interest income

 

 

 

 

 

969

 

Gains or losses recorded for the period

 

 

 

 

 

 

 

 

Recognized in net income

 

 

(5,585

)

 

 

 

Recognized in other comprehensive income

 

 

2,365

 

 

 

843

 

Balance at September 30

 

$

9,000

 

 

$

14,470

 

 

 

6. Contingencies

In addition to the matters described below, in the normal course of its business, the Company is involved in various lawsuits from time to time and may be subject to certain other contingencies. The Company believes losses with respect to these additional matters are individually and collectively immaterial as to a possible loss and range of loss.

 

Discontinued Operations – Matters Related to Breg and Possible Indemnification Obligations

On May 24, 2012, the Company sold Breg to an affiliate of Water Street Healthcare Partners II, L.P. (“Water Street”). Under the terms of the agreement, the Company indemnified Water Street and Breg with respect to certain specified matters.

At the time of its divestiture by the Company, Breg was engaged in the manufacturing and sales of motorized cold therapy units used to reduce pain and swelling. Several domestic product liability cases were filed, mostly in California state court. In September 2014, the Company entered into a master settlement agreement resolving then pending pre-close cold therapy claims. Currently pending is a post-close cold therapy claim in California state court. As of September 30, 2017, the Company has an accrual of $1.8 million recorded within other current liabilities; however, the actual liability could be higher or lower than the amount accrued.

Charges incurred as a result of this indemnification are reflected as discontinued operations in the condensed consolidated statements of operations.

 

Expiration of Corporate Integrity Agreement with HHS-OIG

In May 2012, the Company entered into a five-year corporate integrity agreement (the “CIA”) wi th the Office of Inspector General of the Department of Health and Human Services (“HHS-OIG”), in connection with a U.S. government settlement. In October 2017, the Company received a letter from HHS-OIG confirming that the Company has satisfied its CIA requirements and that the CIA has expired.

 

7. Accumulated other comprehensive loss

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

 

(U.S. Dollars, in thousands)

 

Currency

Translation

Adjustments

 

 

Debt Security

 

 

Accumulated Other

Comprehensive Loss

 

Balance at December 31, 2016

 

$

(5,115

)

 

$

(1,465

)

 

$

(6,580

)

Other comprehensive income (loss)

 

 

3,993

 

 

 

(3,220

)

 

 

773

 

Income taxes

 

 

 

 

 

1,223

 

 

 

1,223

 

Reclassification adjustments to:

 

 

 

 

 

 

 

 

 

 

 

 

Other expense, net

 

 

 

 

 

5,585

 

 

 

5,585

 

Income taxes

 

 

 

 

 

(2,123

)

 

 

(2,123

)

Balance at September 30, 2017

 

$

(1,122

)

 

$

 

 

$

(1,122

)

 

 

10


 

8. Revenue recognition

 

The table below presents net sales, which includes product sales and marketing service fees, for both the three and nine months ended September 30, 2017 and 2016.

 

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

(U.S. Dollars, in thousands)

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Product sales

 

$

90,645

 

 

$

84,997

 

 

$

272,954

 

 

$

261,490

 

Marketing service fees

 

 

14,602

 

 

 

13,500

 

 

 

43,973

 

 

 

39,761

 

Net sales

 

$

105,247

 

 

$

98,497

 

 

$

316,927

 

 

$

301,251

 

 

Product sales primarily consist of stimulation devices and fixation products. Marketing service fees are received from the Musculoskeletal Transplant Foundation (“MTF”) based on total sales of biologics tissues.

 

 

9. Business segment information

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

 

 

 

Three Months Ended September 30,

 

(U.S. Dollars, in thousands)

 

2017

 

 

2016

 

 

Change

 

BioStim

 

$

44,427

 

 

$

42,956

 

 

 

3.4

%

Biologics

 

 

15,218

 

 

 

14,335

 

 

 

6.2

%

Extremity Fixation

 

 

25,447

 

 

 

24,314

 

 

 

4.7

%

Spine Fixation

 

 

20,155

 

 

 

16,892

 

 

 

19.3

%

Net sales

 

$

105,247

 

 

$

98,497

 

 

 

6.9

%

 

 

 

Nine Months Ended September 30,

 

(U.S. Dollars, in thousands)

 

2017

 

 

2016

 

 

Change

 

BioStim

 

$

136,140

 

 

$

128,758

 

 

 

5.7

%

Biologics

 

 

45,866

 

 

 

42,685

 

 

 

7.5

%

Extremity Fixation

 

 

74,139

 

 

 

75,840

 

 

 

-2.2

%

Spine Fixation

 

 

60,782

 

 

 

53,968

 

 

 

12.6

%

Net sales

 

$

316,927

 

 

$

301,251

 

 

 

5.2

%

The primary metric used in managing the Company is non-GAAP net margin, which is an internal metric that the Company defines as gross profit less sales and marketing expense. The table below presents non-GAAP net margin by reporting segment:

 

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

(U.S. Dollars, in thousands)

 

2017

 

 

2016

 

 

2017

 

 

2016

 

BioStim

 

$

18,285

 

 

$

19,996

 

 

$

54,887

 

 

$

54,980

 

Biologics

 

 

6,010

 

 

 

6,821

 

 

 

18,651

 

 

 

19,642

 

Extremity Fixation

 

 

7,723

 

 

 

8,834

 

 

 

20,901

 

 

 

24,170

 

Spine Fixation

 

 

2,122

 

 

 

1,388

 

 

 

6,825

 

 

 

5,925

 

Corporate

 

 

(103

)

 

 

(139

)

 

 

(308

)

 

 

(581

)

Non-GAAP net margin

 

$

34,037

 

 

$

36,900

 

 

$

100,956

 

 

$

104,136

 

General and administrative

 

 

18,068

 

 

 

19,272

 

 

 

56,759

 

 

 

54,822

 

Research and development

 

 

6,935

 

 

 

6,858

 

 

 

21,246

 

 

 

21,294

 

Charges related to U.S. Government resolutions

 

 

 

 

 

1,499

 

 

 

 

 

 

14,369

 

Operating income

 

$

9,034

 

 

$

9,271

 

 

$

22,951

 

 

$

13,651

 

Interest income (expense), net

 

 

(15

)

 

 

471

 

 

 

106

 

 

 

320

 

Other income (expense), net

 

 

479

 

 

 

(634

)

 

 

(3,284

)

 

 

1,346

 

Income before income taxes

 

$

9,498

 

 

$

9,108

 

 

$

19,773

 

 

$

15,317

 

11


 

 

 

10. Share-based compensation

The following tables present the detail of share-based compensation by line item in the condensed consolidated statements of operations as well as by award type:

 

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

(U.S. Dollars, in thousands)

 

2017

 

 

2016

 

 

2017

 

 

2016

 

Cost of sales

 

$

151

 

 

$

175

 

 

$

437

 

 

$

401

 

Sales and marketing

 

 

394

 

 

 

331

 

 

 

1,073

 

 

 

887

 

General and administrative

 

 

2,828