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, 2006
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 o
|
|
Accelerated
filer x
|
|
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 6, 2006, 16,392,959 shares of common stock were issued and
outstanding.
|
3
|
Item
1.
|
|
|
3
|
Item
2.
|
|
|
22
|
Item
3.
|
|
|
34
|
Item
4.
|
|
|
35
|
|
36
|
Item
1.
|
|
|
36
|
Item
1A.
|
|
|
36
|
Item
6.
|
|
|
40
|
|
43
|
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, unanticipated expenditures, changing relationships
with
customers, suppliers and strategic partners, unfavorable results in litigation
matters, risks relating to the protection of intellectual property, changes
to
the reimbursement policies of third parties, changes to 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 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, 2005 and Part II, Item 1A - “Risk Factors” in this Form
10-Q.
Item
1. Condensed
Financial Statements
CONDENSED
CONSOLIDATED BALANCE SHEETS
(U.S.
Dollars, in thousands except share data and per share
date)
|
|
September
30,
|
|
December
31,
|
|
|
|
2006
|
|
2005
|
|
Assets
|
|
(Unaudited)
|
|
(Note
2)
|
|
Current
assets:
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
37,114
|
|
$
|
63,786
|
|
Restricted
cash
|
|
|
19,524
|
|
|
13,762
|
|
Trade
accounts receivable, net
|
|
|
102,248
|
|
|
80,745
|
|
Inventories,
net
|
|
|
63,925
|
|
|
32,853
|
|
Deferred
income taxes
|
|
|
5,405
|
|
|
4,511
|
|
Prepaid
expenses and other current assets
|
|
|
18,880
|
|
|
11,618
|
|
Total
current assets
|
|
|
247,096
|
|
|
207,275
|
|
Securities
and other investments
|
|
|
4,082
|
|
|
4,082
|
|
Property,
plant and equipment, net
|
|
|
22,917
|
|
|
18,987
|
|
Patents
and other intangible assets, net
|
|
|
261,943
|
|
|
65,585
|
|
Goodwill
|
|
|
329,577
|
|
|
174,738
|
|
Deferred
taxes and other long-term assets
|
|
|
16,287
|
|
|
3,194
|
|
Total
assets
|
|
$
|
881,902
|
|
$
|
473,861
|
|
Liabilities
and shareholders’ equity
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
Bank
borrowings
|
|
$
|
3,109
|
|
$
|
79
|
|
Current
portion of long-term debt
|
|
|
3,301
|
|
|
15,187
|
|
Trade
accounts payable
|
|
|
19,699
|
|
|
11,602
|
|
Other
current liabilities
|
|
|
40,510
|
|
|
51,208
|
|
Total
current liabilities
|
|
|
66,619
|
|
|
78,076
|
|
Long-term
debt
|
|
|
326,868
|
|
|
21
|
|
Deferred
income taxes
|
|
|
109,608
|
|
|
25,652
|
|
Other
long-term liabilities
|
|
|
1,370
|
|
|
1,227
|
|
Total
liabilities
|
|
|
504,465
|
|
|
104,976
|
|
|
|
|
|
|
|
|
|
Contingencies
(Note 16)
|
|
|
|
|
|
|
|
Shareholders’
equity:
|
|
|
|
|
|
|
|
Common
shares (16,385,625 and 16,009,249 shares issued at September 30,
2006 and
December 31, 2005, respectively)
|
|
|
1,639
|
|
|
1,602
|
|
Additional
paid-in capital
|
|
|
122,867
|
|
|
106,746
|
|
Retained
earnings
|
|
|
241,031
|
|
|
255,475
|
|
Accumulated
other comprehensive income
|
|
|
11,900
|
|
|
5,062
|
|
Total
shareholders’ equity
|
|
|
377,437
|
|
|
368,885
|
|
|
|
|
|
|
|
|
|
Total
liabilities and shareholders’ equity
|
|
$
|
881,902
|
|
$
|
473,861
|
|
The
accompanying notes form an integral part of these condensed consolidated
financial statements.
CONDENSED
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
FOR
THE
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
(Unaudited,
U.S. Dollars, in thousands except share and per share
data)
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$
|
83,368
|
|
$
|
75,812
|
|
$
|
249,219
|
|
$
|
233,040
|
|
Cost
of sales
|
|
|
21,007
|
|
|
20,193
|
|
|
63,665
|
|
|
61,864
|
|
Gross
profit
|
|
|
62,361
|
|
|
55,619
|
|
|
185,554
|
|
|
171,176
|
|
Operating
expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
and marketing
|
|
|
36,277
|
|
|
29,148
|
|
|
98,985
|
|
|
85,373
|
|
General
and administrative
|
|
|
11,747
|
|
|
8,431
|
|
|
36,337
|
|
|
25,706
|
|
Research
and development
|
|
|
42,865
|
|
|
2,595
|
|
|
48,550
|
|
|
8,677
|
|
Amortization
of intangible assets
|
|
|
1,929
|
|
|
1,635
|
|
|
5,408
|
|
|
4,923
|
|
|
|
|
92,818
|
|
|
41,809
|
|
|
189,280
|
|
|
124,679
|
|
Operating
income (loss)
|
|
|
(30,457
|
)
|
|
13,810
|
|
|
(3,726
|
)
|
|
46,497
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income (expense), net
|
|
|
(482
|
)
|
|
(1,160
|
)
|
|
164
|
|
|
(3,721
|
)
|
Other
income (expense), net
|
|
|
(508
|
)
|
|
73
|
|
|
(753
|
)
|
|
1,508
|
|
KCI
settlement, net of related costs
|
|
|
0
|
|
|
40,860
|
|
|
1,093
|
|
|
40,355
|
|
Income
(loss) before income tax
|
|
|
(31,447
|
)
|
|
53,583
|
|
|
(3,222
|
)
|
|
84,639
|
|
Income
tax expense
|
|
|
(3,970
|
)
|
|
(7,563
|
)
|
|
(11,221
|
)
|
|
(18,434
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(35,417
|
)
|
$
|
46,020
|
|
$
|
(14,443
|
)
|
$
|
66,205
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss) per common share - basic
|
|
$
|
(2.19
|
)
|
$
|
2.88
|
|
$
|
(0.90
|
)
|
$
|
4.17
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss) per common share - diluted
|
|
$
|
(2.17
|
)
|
$
|
2.81
|
|
$
|
(0.89
|
)
|
$
|
4.07
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of common shares - basic
|
|
|
16,193,086
|
|
|
15,986,599
|
|
|
16,084,388
|
|
|
15,881,902
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of common shares - diluted
|
|
|
16,322,827
|
|
|
16,384,106
|
|
|
16,229,221
|
|
|
16,279,724
|
|
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, 2006 AND 2005
(Unaudited,
U.S. Dollars, in thousands)
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
Net
income (loss)
|
|
$
|
(14,443
|
)
|
$
|
66,205
|
|
Adjustments
to reconcile net income (loss) to net cash (used in) provided by
operating
activities:
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
10,937
|
|
|
10,254
|
|
Amortization
of debt costs
|
|
|
316
|
|
|
722
|
|
Deferred
royalty income
|
|
|
--
|
|
|
(2,443
|
)
|
Acquired
in process research and development
|
|
|
40,000
|
|
|
--
|
|
Provision
for doubtful accounts
|
|
|
4,330
|
|
|
3,279
|
|
Tax
benefit on non-qualified stock options
|
|
|
--
|
|
|
1,307
|
|
Deferred
taxes
|
|
|
(8,808
|
)
|
|
(1,580
|
)
|
Share
based compensation
|
|
|
4,980
|
|
|
441
|
|
Other
|
|
|
1,398
|
|
|
1,945
|
|
Change
in operating assets and liabilities:
|
|
|
|
|
|
|
|
Restricted
cash
|
|
|
(5,762
|
)
|
|
2,985
|
|
Accounts
receivable
|
|
|
(7,397
|
)
|
|
(11,653
|
)
|
Inventories
|
|
|
(7,621
|
)
|
|
(4,221
|
)
|
Prepaid
expenses and other
|
|
|
(4,994
|
)
|
|
(3,211
|
)
|
Accounts
payable
|
|
|
7,551
|
|
|
270
|
|
Current
liabilities
|
|
|
(29,882
|
)
|
|
30,488
|
|
Net
cash (used in) provided by operating activities
|
|
|
(9,395
|
)
|
|
94,788
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
Investments
in affiliates and subsidiaries
|
|
|
(336,808
|
)
|
|
--
|
|
Capital
expenditures
|
|
|
(6,769
|
)
|
|
(8,928
|
)
|
Net
cash used in investing activities
|
|
|
(343,577
|
)
|
|
(8,928
|
)
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
Net
proceeds from issuance of common stock
|
|
|
11,172
|
|
|
6,367
|
|
Tax
benefit on non-qualified stock options
|
|
|
2,048
|
|
|
--
|
|
Repayment
of loans and borrowings
|
|
|
(15,039
|
)
|
|
(24,199
|
)
|
Payment
of debt issuance costs
|
|
|
(5,708
|
)
|
|
--
|
|
Proceeds
from loans and borrowings
|
|
|
333,048
|
|
|
139
|
|
Net
cash provided by (used in) financing activities
|
|
|
325,521
|
|
|
(17,693
|
)
|
Effect
of exchange rate changes on cash
|
|
|
779
|
|
|
(637
|
)
|
Net
(decrease) increase in cash and cash equivalents
|
|
|
(26,672
|
)
|
|
67,530
|
|
Cash
and cash equivalents at the beginning of the year
|
|
|
63,786
|
|
|
25,944
|
|
Cash
and cash equivalents at the end of the period
|
|
$
|
37,114
|
|
$
|
93,474
|
|
The
accompanying notes form an integral part of these condensed consolidated
financial statements.
NOTES
TO
THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Orthofix
International N.V. (the “Company”) is a multinational corporation principally
involved in the design, development, manufacture, marketing and distribution
of
medical equipment, 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, 2006 are not necessarily indicative
of
the results that may be expected for the year ending December 31, 2006. The
balance sheet at December 31, 2005 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 our Annual Report
on Form
10-K for the year ended December 31, 2005.
NOTE
3:
|
RECENTLY
ISSUED ACCOUNTING STANDARDS
|
In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value
Measurements. This Statement defines fair value as used in numerous accounting
pronouncements, 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 Statement is to be effective
for the
Company’s financial statements issued in 2008; however, earlier application is
encouraged. The Company is currently evaluating the timing of adoption and
the
impact that adoption might have on its financial position or results of
operations.
In
September 2006, the Securities and Exchange Commission (“SEC”) issued Staff
Accounting Bulletin No. 108 (“SAB 108”). Due to diversity in practice among
registrants, SAB 108 expresses SEC staff views regarding the process by which
misstatements in financial statements are evaluated for purposes of determining
whether financial statement restatement is necessary. SAB 108 is effective
for
fiscal years ending after November 15, 2006, and early application is
encouraged. The Company does not believe SAB 108 will have a material impact
on
its financial position or results from operations.
In
July 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes—an interpretation of FASB Statement
No. 109 (“FIN
48”), which clarifies the accounting for uncertainty in income tax positions.
This Interpretation requires that the Company recognize in the consolidated
financial statements the impact of a tax position that is more likely than
not
to be sustained upon examination based on the technical merits of the position.
The provisions of FIN 48 will be effective as of the beginning of the Company’s
2007 fiscal year, with the cumulative effect of the change in accounting
principle recorded as an adjustment to opening retained earnings. The Company
is
currently evaluating the impact of adopting FIN 48 on the consolidated financial
statements.
In
June
2006, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 06-3, How
Taxes Collected from Customers and Remitted to Governmental Authorities Should
Be Presented in the Income Statement (That Is, Gross Versus Net Presentation).
This standard allows companies to present in their statements of income any
taxes assessed by a governmental authority that are directly imposed on
revenue-producing transactions between a seller and a customer, such as sales,
use, value-added, and some excise taxes, on either a gross (included in revenue
and costs) or a net (excluded from revenue) basis. This standard is effective
for interim and fiscal years beginning after December 15, 2006. The Company
is
currently evaluating the potential impact of this issue on the financial
statements, but does not believe the impact of the adoption of this standard
will be material.
In
February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid
Instruments, which is an amendment to SFAS No. 133 and SFAS No. 140. SFAS
No.
155 allows financial instruments which have embedded derivatives to be accounted
for as a whole (eliminating the need to bifurcate the derivative from its
host)
if the holder elects to account for the instrument as a whole instrument
on a
fair value basis. This statement is effective for all financial instruments
acquired or issued after the beginning of an entity’s first fiscal year that
begins after September 15, 2006. The Company does not believe the adoption
of
this statement will have a material impact on the financial
statements.
In
May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections, which is a replacement of APB Opinion No. 20, Accounting
Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial
Statements. Among other changes, SFAS No. 154 requires that a
voluntary change in accounting principle be applied retrospectively such
that
all prior period financial statements are presented in accordance with the
new
accounting principle, unless impracticable to do so. SFAS No. 154 also
provides that (1) a change in method of depreciating or amortizing a
long-lived nonfinancial asset be accounted for as a change in estimate
(prospectively) that was effected by a change in accounting principle, and
(2) correction of errors in previously issued financial statements should
be termed a “restatement”. SFAS No. 154 is effective for accounting
changes and correction of errors made in fiscal years beginning after
December 15, 2005. The adoption of SFAS No. 154 did not have a material
impact on the financial statements.
In
December 2004, the FASB issued SFAS No. 123 (R), Share-Based Payment, a revision
of FASB Statement No. 123, Accounting for Stock-Based Compensation. SFAS
No. 123
(R) also supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees
and amends SFAS No. 95, Statement of Cash Flows. The revision required companies
to recognize compensation costs in the income statement based on the fair
value
of the equity or liability instruments issued and to report the benefits
of tax
deductions in excess of recognized compensation cost as a financing cash
flow
rather than as an operating cash flow as reported in the accompanying
consolidated statements of cash flows. SFAS No. 123 (R) covers a wide range
of
share-based compensation arrangements including share options, restricted
share
plans, performance-based awards, share appreciation rights, and employee
share
purchase plans. The Company adopted SFAS No. 123 (R) effective January 1,
2006
using the “modified prospective” method. Under the modified prospective method,
compensation cost is recognized in the income statement beginning with the
effective date, based on the requirements of SFAS No. 123 (R) for all
share-based payments granted after that date, and based on the requirements
of
SFAS 123 for all unvested awards granted prior to the effective date of SFAS
No.123 (R). The adoption of SFAS No.123 (R)’s fair value method had a
significant impact on the Company’s results of operations. See Note 4
“Stock-Based Compensation”.
NOTE
4:
|
STOCK-BASED
COMPENSATION
|
Prior
to
January 1, 2006, the Company accounted for stock based compensation plans
under
the recognition and measurement provisions of APB Opinion No. 25, Accounting
for
Stock Issued to Employee, and related Interpretations, as permitted by SFAS
No.
123, Accounting for Stock-Based Compensation. Stock-based employee compensation
expense was recognized relating to options granted at exercise prices lower
than
the fair market value of the underlying stock on the date of the grant.
Effective
January 1, 2006, the Company adopted the fair value recognition provisions
of
SFAS No. 123(R), Share-Based Payment, using the modified prospective transition
method. Under this transition method, compensation cost recognized in the
first
quarter of 2006 includes: (a) compensation cost for all share-based payments
granted prior to, but not yet vested as of January 1, 2006, based on the
grant
date fair value estimated in accordance with the original provisions of SFAS
No.
123, and (b) compensation cost for all share-based payments granted subsequent
to January 1, 2006, based on the grant-date fair value estimated in accordance
with the provisions of SFAS No. 123(R). The fair value of stock options is
determined using the Black-Scholes valuation model, which is consistent with
our
valuation techniques previously utilized for options in footnote disclosures
required under SFAS No. 123. Such value is recognized as expense over the
service period net of estimated forfeitures. Results for prior periods have
not
been restated. During the nine months ended September 30, 2006, options were
valued at risk-free interest rates between 4.35% and 5.07%, expected volatility
of 33.4%, expected term of 4.3 years and a dividend rate of zero.
As
a
result of adopting SFAS No. 123(R) on January 1, 2006 the Company’s income
before income taxes and net income for the three months ended September 30,
2006, are $1.3 million and $0.9 million lower, respectively, than if it had
continued to account for share-based compensation under APB 25. For the nine
month period ended September 30, 2006, the Company’s income before income taxes
and net income are $4.9 million and $3.5 million lower, respectively, than
if it
had continued to account for share-based compensation under APB 25. Basic
and
diluted earnings per share for the three months ended September 30, 2006
would
have been $0.07 and $0.08 higher, respectively, if the Company had not adopted
SFAS No. 123(R). Basic and diluted earnings per share for the nine months
ended
September 30, 2006 would have each been $0.22 higher if the Company had not
adopted SFAS No. 123(R). As of September 30, 2006, the compensation expense
relating to options already granted and expected to be recognized is $14.2
million. This expense is expected to be recognized over a weighted average
period of 1.59 years.
The
following table shows the detail of stock-based compensation by line item
in the
Condensed Consolidated Statements of Income for the three and nine months
ended
September 30, 2006:
(In
thousands)
|
|
Three
Months Ended
September
30,
2006
|
|
Nine
Months Ended
September
30,
2006
|
|
|
|
|
|
|
|
Cost
of sales
|
|
$
|
83
|
|
$
|
151
|
|
|
|
|
|
|
|
|
|
Sales
and marketing
|
|
|
472
|
|
|
882
|
|
|
|
|
|
|
|
|
|
General
and administrative (1)
|
|
|
691
|
|
|
3,639
|
|
|
|
|
|
|
|
|
|
Research
and development
|
|
|
64
|
|
|
247
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,310
|
|
$
|
4,919
|
|
|
(1)
|
Amount
includes $656 of stock-based compensation from the accelerated
vesting of
options associated with the transition of senior management in
the first
quarter of 2006.
|
Prior
to
the adoption of SFAS No. 123(R), the Company presented all tax benefits of
deductions resulting from the exercise of stock options as operating cash
flows
in the Statement of Cash Flows. SFAS No. 123(R) requires the cash flows
resulting from the tax benefits resulting from the tax deductions in excess
of
the compensation cost recognized for those options (excess tax benefits)
to be
classified as financing cash flows. The $2.0 million excess tax benefit
classified as a financing cash inflow, in the nine months ended September
30,
2006, would have been classified as an operating cash inflow had the Company
not
adopted SFAS No. 123(R).
The
following table illustrates the effect on net income and earnings per share
if
the fair value based method had been applied to all stock-based awards granted
for all periods presented.
|
|
Three
Months Ended
September
30,
|
|
Nine
Months Ended
September
30,
|
|
(In
thousands, except per share data)
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
|
|
|
|
|
|
|
|
As
reported
|
|
$
|
(35,417
|
)
|
$
|
46,020
|
|
$
|
(14,443
|
)
|
$
|
66,205
|
|
Add:
Stock-based employee compensation expense included in reported
net income,
net of related tax effects
|
|
|
938
|
|
|
87
|
|
|
3,469
|
|
|
261
|
|
Less:
Total stock-based employee compensation expense determined under
fair
value method for all awards, net of tax
|
|
|
(938
|
)
|
|
(906
|
)
|
|
(3,469
|
)
|
|
(2,189
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pro
forma
|
|
$
|
(35,417
|
)
|
$
|
45,201
|
|
$
|
(14,443
|
)
|
$
|
64,277
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income per common share - basic
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
reported
|
|
$
|
(2.19
|
)
|
$
|
2.88
|
|
$
|
(0.90
|
)
|
$
|
4.17
|
|
Pro
forma
|
|
$
|
(2.19
|
)
|
$
|
2.83
|
|
$
|
(0.90
|
)
|
$
|
4.05
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income per common share - diluted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
reported
|
|
$
|
(2.17
|
)
|
$
|
2.81
|
|
$
|
(0.89
|
)
|
$
|
4.07
|
|
Pro
forma
|
|
$
|
(2.17
|
)
|
$
|
2.76
|
|
$
|
(0.89
|
)
|
$
|
3.95
|
|
NOTE
5:
|
RECLASSIFICATIONS
|
Certain
prior year amounts have been reclassified to conform to the 2006 presentation.
The reclassifications have no effect on previously reported net income or
shareholders’ equity.
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
thousands)
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
Raw
materials
|
|
$
|
7,867
|
|
$
|
7,242
|
|
Work-in-process
|
|
|
5,798
|
|
|
3,344
|
|
Finished
goods
|
|
|
36,137
|
|
|
11,538
|
|
Field
inventory (as described above)
|
|
|
6,492
|
|
|
7,404
|
|
Consignment
inventory
|
|
|
12,676
|
|
|
6,659
|
|
Less
reserve for obsolescence
|
|
|
(5,045
|
)
|
|
(3,334
|
)
|
|
|
$
|
63,925
|
|
$
|
32,853
|
|
On
September 22, 2006, the Company purchased 100% of the stock of Blackstone
Medical, Inc. (“Blackstone”) for a purchase price of $333.0 million plus
acquisition costs and is subject to certain closing adjustments. The acquisition
and related costs were financed with $330.0 million of senior secured bank
debt
and cash on hand. Blackstone, based in Springfield, Massachusetts, specializes
in the design, development and marketing of spinal implant and related biologic
products. Blackstone’s product lines include spinal fixating devices including
hooks, rods, screws, plates, various spacers and cages and related biologics
products. Blackstone generated $62.1 million in net revenues for the period
January 1, 2006 to September 22, 2006.
The
Company considered this acquisition as a way to fortify and further advance
its
business strategy to expand its spinal sector. The acquisition broadened
the
Company’s product lines, reduced reliance on the success of any single product
and enlarged channel opportunities for products from both
companies.
Factors
that contributed to the valuation of Blackstone included the recognition
that
Blackstone had established itself as what the Company believes to be one
of the largest private spine companies with a broad portfolio of spinal
product offerings. Further, Blackstone has a strong brand name and product
identity in the spinal industry. Blackstone has a history of sales and earnings
growth that compares favorably to the fast growing spinal market that its
product lines serve. Orthofix valued Blackstone after reviewing a range of
valuation methodologies provided by its financial advisors for the transaction,
including comparable publicly-traded companies, comparable precedent
transactions, discounted cash flow analysis and comparison to Orthofix’s trading
multiples. The resulting purchase price of Blackstone exceeded the value
of the
net assets acquired.
The
acquisition has been accounted for using the purchase method in accordance
with
SFAS No. 141, Business Combinations. The purchase price has been preliminarily
allocated to the assets acquired and liabilities assumed based on their
estimated fair market value at the date of acquisition.
A
preliminary allocation of the purchase price reflects the
following:
(In
thousands)
|
|
|
|
Working
capital, other than cash
|
|
$
|
25,041
|
|
Fixed
assets acquired
|
|
|
2,953
|
|
Identifiable
intangible assets (definite lived)
|
|
|
124,503
|
|
Identifiable
intangible assets (indefinite lived)
|
|
|
77,000
|
|
Deferred
tax liability
|
|
|
(83,935
|
)
|
In-process
research and development
|
|
|
40,000
|
|
Goodwill
|
|
|
150,865
|
|
Preliminary
purchase price, including acquisition costs
|
|
$
|
336,427
|
|
The
purchase price has been allocated to assets acquired, purchased in-process
research and development, and liabilities assumed based on their estimated
fair
value at the acquisition date. The amount of the purchase price allocated
to
purchased in-process research and development was written off at the date
of
acquisition and resulted in a charge of $40.0 million. This charge is included
in the research and development expense line item on the Condensed Consolidated
Statements of Income (Loss) and included the Dynamic Stabilization and Cervical
Disk which together accounted for 93% of the fair value. The fair value of
the
in-process research and development was estimated using the
discounted earnings method. The amount written off as purchased in-process
research and development is not deductible for income tax purposes in the
United States. The purchase price for the acquisition is subject to potential
upward or downward adjustments based on the difference between the estimated
and
final working capital of Blackstone, as defined in the agreement and plan
of
merger. In addition, other items that may affect the final purchase price
allocation include finalization of acquisition costs, revisions to tangible
and
intangible assets based on final appraisals and other information that provides
a better estimate of the fair value of the assets acquired and the liabilities
assumed.
There
are
no residual values for any of the intangible assets subject to amortization
acquired during the Blackstone acquisition. Definite lived intangible assets
acquired in the Blackstone acquisition consist of:
(Dollar
amounts in thousands)
|
|
|
|
|
|
|
|
Fair
value at Acquisition
|
|
Remaining
Useful Life
|
|
Top
six distributor relationships
|
|
$
|
28,000
|
|
|
12
Years
|
|
All
other distributor relationships
|
|
|
25,000
|
|
|
16
Years
|
|
Technology
|
|
|
71,000
|
|
|
13
Years
|
|
Total
definite lived intangible assets
|
|
$
|
124,000
|
|
|
|
|
The
Company has determined that trademarks acquired during the Blackstone
acquisition, valued at $77.0 million, are indefinite lived intangible assets.
The Company considered the criteria prescribed by paragraphs 11 (a), (c),
(e)
and (f) of SFAS 142 in determining that registered trademarks acquired during
the Blackstone acquisition have an indefinite life. The Company is not aware
of
any legal, regulatory, or contractual provisions that limit the useful lives
of
these registered trademarks. The Company does not believe the effects of
obsolescence, demand, competition, or other economic factors will cause the
useful lives of these registered trademarks to be limited. The Company concluded
that no legal, regulatory, contractual, competitive, economic, or other factors
limit the useful life of the registered trademarks to the Company, and therefore
the useful lives of the registered trademarks are considered to be
indefinite.
The
summary pro forma condensed unaudited results of operations and earnings
per
share for the three and nine month periods ended September 30, 2006 and 2005,
assuming consummation of the Blackstone acquisition as of January 1, 2005
and
Janurary 1, 2006, are as follows:
|
|
Three
Months Ended
September
30, 2006
|
|
Three
Months Ended
September
30, 2005
|
|
(In
thousands except per share data)
|
|
As
Reported
|
|
Pro
Forma
|
|
As
Reported
|
|
Pro
Forma
|
|
Net
sales
|
|
$
|
83,368
|
|
$
|
104,684
|
|
$
|
75,812
|
|
$
|
90,244
|
|
Net
income (loss)
|
|
$
|
(35,417
|
)
|
$
|
(1,363
|
) |
$
|
46,020
|
|
$
|
39,895
|
|
Per
share data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(2.19
|
)
|
$
|
(0.08
|
) |
$
|
2.88
|
|
$
|
2.50
|
|
Diluted
|
|
$
|
(2.17
|
)
|
$
|
(0.08
|
) |
$
|
2.81
|
|
$
|
2.43
|
|
|
|
Nine
Months Ended
September
30, 2006
|
|
Nine
Months Ended
September
30, 2005
|
|
(In
thousands except per share data)
|
|
As
Reported
|
|
Pro
Forma
|
|
As
Reported
|
|
Pro
Forma
|
|
Net
sales
|
|
$
|
249,219
|
|
$
|
311,360
|
|
$
|
233,040
|
|
$
|
276,577
|
|
Net
income (loss)
|
|
$
|
(14,443
|
)
|
$
|
9,425
|
|
$
|
66,205
|
|
$
|
48,307
|
|
Per
share data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.90
|
)
|
$
|
0.59
|
|
$
|
4.17
|
|
$
|
3.04
|
|
Diluted
|
|
$
|
(0.89
|
)
|
$
|
0.58
|
|
$
|
4.07
|
|
$
|
2.97
|
|
In-process
research and development charge of $40.0 million recorded during the three
and
nine months ended September, 30, 2006 has been excluded from the pro forma
financial information.
In
February 2006, the Company purchased 52% of International Medical Supplies
Distribution GmbH (“IMES”), a German distributor of Breg products, for
approximately $1.1 million in cash. The preliminary purchase price allocation
included approximately $1.1 million of goodwill. The operations of the acquired
distributor are included in the Company’s statement of operations from the date
of acquisition. Management will complete the purchase price allocation in
2006.
The
change in the net carrying value of goodwill for the period ended September
30,
2006 is as follows:
(In
thousands)
|
|
Americas
Orthofix
|
|
Americas
Breg
|
|
Americas
Blackstone
|
|
International
Orthofix
|
|
Total
|
|
At
December 31, 2005
|
|
$
|
32,916
|
|
$
|
101,322
|
|
$
|
-
|
|
$
|
40,500
|
|
$
|
174,738
|
|
Acquisition
|
|
|
-
|
|
|
-
|
|
|
150,865
|
|
|
1,108
|
|
|
151,973
|
|
Foreign
Currency
|
|
|
(41
|
)
|
|
-
|
|
|
-
|
|
|
2,907
|
|
|
2,866
|
|
At
September 30, 2006
|
|
$
|
32,875
|
|
$
|
101,322
|
|
$
|
150,865
|
|
$
|
44,515
|
|
$
|
329,577
|
|
(In
thousands)
|
|
September
30, 2006
|
|
December
31, 2005
|
|
|
|
|
|
|
|
Long-term
obligations
|
|
$
|
330,000
|
|
$
|
14,750
|
|
Other
loans
|
|
|
169
|
|
|
458
|
|
|
|
|
330,169
|
|
|
15,208
|
|
Less
current portion
|
|
|
(3,301
|
)
|
|
(15,187
|
)
|
|
|
$
|
326,868
|
|
$
|
21
|
|
On
September 22, 2006 our wholly-owned US 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. 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, 2006 and as of November 6, 2006 we had no amounts outstanding under the
revolving credit facility and $330.0 million outstanding under the term loan
facility. Obligations under the senior secured credit facility have a floating
interest rate of LIBOR or prime rate plus a margin, currently LIBOR plus
1.75%,
which is adjusted quarterly based upon the leverage ratio of the Company
and its
subsidiaries. The effective interest rate as of September 30, 2006 on the
senior
secured debt is 7.12%.
The
Company, certain foreign subsidiaries of the Company, including Victory
Medical Limited (Orthofix Holdings’s immediate parent) and Colgate Medical
Limited (Victory Medical Limited's immediate parent), and each of Orthofix
Holdings’s direct and indirect subsidiaries, including Orthofix Inc., Breg and
Blackstone, have guaranteed the obligations of Orthofix Holdings under the
senior secured credit facility. The obligations of Orthofix Holdings under
the
senior secured bank facility and the guarantors under their guarantees are
secured by the pledge of their respective assets located in the United States.
The senior secured bank facility restricts the Company's, Colgate Medical
Limited's and Victory Medical Limited's access to the funds borrowed
under the credit facility. Orthofix Holdings and its subsidiaries that are
the
guarantors may have access to the funds borrowed under the credit facility
for operational purposes.
For
the
nine months ended September 30, 2006, the Company issued 376,376 shares of
common stock upon the exercise of outstanding stock options and shares issued
pursuant to the Company’s employee stock purchase plan for proceeds of $11.2
million.
NOTE
11:
|
COMPREHENSIVE
INCOME (LOSS)
|
Accumulated
other comprehensive income is comprised of foreign currency translation
adjustments and the effective portion of the gain (loss) for derivatives
designated and accounted for as a cash flow hedge. The components of and
changes
in other comprehensive income are as follows:
(In
thousands)
|
|
Accumulated
Other Comprehensive Income
|
|
Balance
at December 31, 2005
|
|
$
|
5,062
|
|
Foreign
currency translation adjustment
|
|
|
6,838
|
|
Balance
at September 30, 2006
|
|
$
|
11,900
|
|
(In
thousands)
|
|
Three
Months Ended
September
30,
|
|
Nine
Months Ended
September
30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Net
income (loss)
|
|
$
|
(35,417
|
)
|
$
|
46,020
|
|
$
|
(14,443
|
)
|
$
|
66,205
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
comprehensive income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized
gain on derivative instrument
|
|
|
--
|
|
|
70
|
|
|
--
|
|
|
155
|
|
Foreign
currency translation adjustment
|
|
|
397
|
|
|
(499
|
)
|
|
6,838
|
|
|
(8,505
|
)
|
Total
comprehensive income (loss)
|
|
$
|
(35,020
|
)
|
$
|
45,591
|
|
$
|
(7,605
|
)
|
$
|
57,855
|
|
NOTE
12:
|
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.
Americas
Orthofix
Americas
Orthofix operation (“Americas”) consists of operations in the United States
excluding Breg and Blackstone (each as defined below), Mexico, Brazil, and
Puerto Rico. Americas, as defined, uses both direct and distributor sales
representatives to sell to hospitals, doctors, and other healthcare providers
in
the Americas market.
Americas
Breg
Americas
Breg operation (“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.
Americas
Blackstone
Americas
Blackstone operation (“Blackstone”) consists of Blackstone Medical, Inc. and its
two subsidiaries, Blackstone GmbH and Goldstone GmbH. Blackstone, based in
Springfield, Massachusetts, specializes in the design, development and marketing
of spinal implant and related biologic products. Blackstone’s operating income
(loss) includes amortization of acquired intangible assets and inventory
which
has been stepped-up in value for the Blackstone acquisition. The operating
results for the five business days in the third quarter are not material.
International
Orthofix
International
Orthofix operation (“International”) consists of operations which are located in
the rest of the world as well as independent distributors. International,
as
defined, uses both direct and distributor sales representatives to sell Orthofix
and Breg products to hospitals, doctors, and other healthcare
providers.
Group
Activities
Group
Activities are comprised of the Parent’s operating expenses and identifiable
assets.
The
following table presents external and intersegment sales by segment for the
three month period ended September 30:
|
|
External
Sales
|
|
Intersegment
Sales
|
|
(In
thousands)
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Americas
Orthofix
|
|
$
|
41,525
|
|
$
|
35,957
|
|
$
|
818
|
|
$
|
300
|
|
Americas
Breg
|
|
|
18,667
|
|
|
17,983
|
|
|
406
|
|
|
102
|
|
International
Orthofix
|
|
|
23,176
|
|
|
21,875
|
|
|
10,072
|
|
|
13,289
|
|
Total
|
|
$
|
83,368
|
|
$
|
75,815
|
|
$
|
11,296
|
|
$
|
13,691
|
|
The
following table presents external and intersegment sales by segment for the
nine
month period ended September 30:
|
|
External
Sales
|
|
Intersegment
Sales
|
|
(In
thousands)
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Americas
Orthofix
|
|
$
|
122,285
|
|
$
|
105,596
|
|
$
|
2,476
|
|
$
|
1,304
|
|
Americas
Breg
|
|
|
55,901
|
|
|
53,368
|
|
|
1,027
|
|
|
365
|
|
International
Orthofix
|
|
|
71,033
|
|
|
74,076
|
|
|
44,218
|
|
|
42,192
|
|
Total
|
|
$
|
249,219
|
|
$
|
233,040
|
|
$
|
47,721
|
|
$
|
43,861
|
|
The
following table presents operating income by segment for the three and nine
month periods ended September 30:
Operating
Income (Expense)
|
|
Three
Months Ended
September
30,
|
|
Nine
Months Ended
September
30,
|
|
(In
thousands)
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Americas
Orthofix
|
|
$
|
6,877
|
|
$
|
8,475
|
|
$
|
25,235
|
|
$
|
25,195
|
|
Americas
Breg
|
|
|
1,392
|
|
|
1,534
|
|
|
4,926
|
|
|
6,881
|
|
Americas
Blackstone
|
|
|
(40,271
|
)
|
|
-
|
|
|
(40,271
|
)
|
|
-
|
|
International
Orthofix
|
|
|
4,444
|
|
|
5,314
|
|
|
15,189
|
|
|
19,237
|
|
Group
Activities
|
|
|
(2,594
|
)
|
|
(1,298
|
)
|
|
(7,123
|
)
|
|
(4,056
|
)
|
Eliminations
|
|
|
(305
|
)
|
|
(215
|
)
|
|
(1,682
|
)
|
|
(760
|
)
|
Total
|
|
$
|
(30,457
|
)
|
$
|
13,810
|
|
$
|
(3,726
|
)
|
$
|
46,497
|
|
The
following table presents identifiable assets by segment, excluding intercompany
balances and investments in consolidated subsidiaries.
Identifiable
Assets
|
|
|
|
|
|
(In
thousands)
|
|
September
30, 2006
|
|
December
31, 2005
|
|
|
|
|
|
|
|
Americas
Orthofix
|
|
$
|
90,138
|
|
$
|
112,057
|
|
|
|
|
|
|
|
|
|
Americas
Breg
|
|
|
182,756
|
|
|
185,921
|
|
|
|
|
|
|
|
|
|
Americas
Blackstone
|
|
|
435,968
|
|
|
-
|
|
|
|
|
|
|
|
|
|
International
Orthofix
|
|
|
138,043
|
|
|
178,682
|
|
|
|
|
|
|
|
|
|
Group
activities
|
|
|
49,747
|
|
|
9,958
|
|
|
|
|
|
|
|
|
|
Eliminations
|
|
|
(14,750
|
)
|
|
(12,757
|
)
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
881,902
|
|
$
|
473,861
|
|
|
|
Sales
by Market Sector
for
the three month period ended September 30, 2006
|
|
(In
thousands)
|
|
Americas
Orthofix
|
|
Americas
Breg
|
|
International
Orthofix
|
|
Total
|
|
Orthopedic
|
|
|
|
|
|
|
|
|
|
Spine
|
|
$
|
29,263
|
|
$
|
-
|
|
$
|
19
|
|
$
|
29,282
|
|
Reconstruction
|
|
|
2,761
|
|
|
18,667
|
|
|
10,737
|
|
|
32,165
|
|
Trauma
|
|
|
8,531
|
|
|
-
|
|
|
7,270
|
|
|
15,801
|
|
Total
Orthopedic
|
|
|
40,555
|
|
|
18,667
|
|
|
18,026
|
|
|
77,248
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Orthopedic
|
|
|
970
|
|
|
-
|
|
|
5,150
|
|
|
6,120
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
41,525
|
|
$
|
18,667
|
|
$
|
23,176
|
|
$
|
83,368
|
|
|
|
Sales
by Market Sector
for
the three month period ended September 30, 2005
|
|
|
|
|
|
|
|
|
|
|
|
(In
thousands)
|
|
Americas
Orthofix
|
|
Americas
Breg
|
|
International
Orthofix
|
|
Total
|
|
Orthopedic
|
|
|
|
|
|
|
|
|
|
Spine
|
|
$
|
25,422
|
|
$
|
-
|
|
$
|
26
|
|
$
|
25,448
|
|
Reconstruction
|
|
|
1,955
|
|
|
17,983
|
|
|
10,062
|
|
|
30,000
|
|
Trauma
|
|
|
8,092
|
|
|
-
|
|
|
6,900
|
|
|
14,992
|
|
Total
Orthopedic
|
|
|
35,469
|
|
|
17,983
|
|
|
16,988
|
|
|
70,440
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Orthopedic
|
|
|
485
|
|
|
-
|
|
|
4,887
|
|
|
5,372
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
35,954
|
|
$
|
17,983
|
|
$
|
21,875
|
|
$
|
75,812
|
|
|
|
Sales
by Market Sector
for
the nine month period ended September 30, 2006
|
|
|
|
|
|
|
|
|
|
|
|
(In
thousands)
|
|
Americas
Orthofix
|
|
Americas
Breg
|
|
International
Orthofix
|
|
Total
|
|
Orthopedic
|
|
|
|
|
|
|
|
|
|
Spine
|
|
$
|
86,722
|
|
$
|
-
|
|
$
|
59
|
|
$
|
86,781
|
|
Reconstruction
|
|
|
8,235
|
|
|
55,901
|
|
|
32,782
|
|
|
96,918
|
|
Trauma
|
|
|
24,908
|
|
|
-
|
|
|
22,613
|
|
|
47,521
|
|
Total
Orthopedic
|
|
|
119,865
|
|
|
55,901
|
|
|
55,454
|
|
|
231,220
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Orthopedic
|
|
|
2,420
|
|
|
-
|
|
|
15,579
|
|
|
17,999
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
122,285
|
|
$
|
55,901
|
|
$
|
71,033
|
|
$
|
249,219
|
|
|
|
Sales
by Market Sector
for
the nine month period ended September 30, 2005
|
|
|
|
|
|
|
|
|
|
|
|
(In
thousands)
|
|
Americas
Orthofix
|
|
Americas
Breg
|
|
International
Orthofix
|
|
Total
|
|
Orthopedic
|
|
|
|
|
|
|
|
|
|
Spine
|
|
$
|
73,752
|
|
$
|
-
|
|
$
|
95
|
|
$
|
73,847
|
|
Reconstruction
|
|
|
6,270
|
|
|
53,368
|
|
|
34,737
|
|
|
94,375
|
|
Trauma
|
|
|
24,345
|
|
|
-
|
|
|
23,230
|
|
|
47,575
|
|
Total
Orthopedic
|
|
|
104,367
|
|
|
53,368
|
|
|
58,062
|
|
|
215,797
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Orthopedic
|
|
|
1,229
|
|
|
-
|
|
|
16,014
|
|
|
17,243
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
105,596
|
|
$
|
53,368
|
|
$
|
74,076
|
|
$
|
233,040
|
|
The
difference between the reported provision for income taxes and a provision
computed by applying the statutory rates applicable to each subsidiary of
the
Company is attributable to the
non-deductible $40.0 million purchased in-process research and development
charge associated with the Blackstone acquisition, as described in Note 7,
along
with a
non-recurring discrete
tax
benefit resulting from the Company’s election to adopt a new tax provision in
Italy. The election allowed the Company
to
increase, for tax purposes only, the value of our trademarks in Italy by
approximately $15.0
million. The Company incurred a tax liability of $2.7 million from
applying a 19% tax rate to the revaluation of the trademark value. The
Company expects
to receive
a future
tax benefit of $5.6 million associated with amortization of that step-up
in
value which is based on the current Italian tax rates of approximately
37%. The net of the $5.6 million deferred tax asset and the $2.7 million
tax liability resulted in a $2.9 million non-recurring discrete
tax
benefit. Further the effective tax rate has been affected by
non-deductible foreign losses, the generation of unutilizable net operating
losses in various jurisdictions, tax planning associated with the acquisition
of
Breg and the Section 199 deduction related to income attributable to production
activities occurring in the United States.
NOTE
14:
|
EARNINGS
PER SHARE
|
For
the
three and nine month periods ended September 30, 2006 and 2005, there were
no
adjustments to net income (the numerators) for purposes of calculating basic
and
diluted net income per common share. The following table sets forth a
reconciliation of the share numbers (the denominators) in computing earnings
per
share in accordance with SFAS No. 128, Earnings Per Share:
|
|
Three
Months Ended
September
30,
|
|
Nine
Months Ended
September
30,
|
|
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares - basic
|
|
|
16,193,086
|
|
|
15,986,599
|
|
|
16,084,388
|
|
|
15,881,902
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
of SFAS No. 123 (R)
|
|
|
(158,654
|
)
|
|
--
|
|
|
(151,745
|
)
|
|
--
|
|
Stock
options outstanding
|
|
|
288,395
|
|
|
397,507
|
|
|
296,578
|
|
|
397,822
|
|
Weighted
average common shares - diluted
|
|
|
16,322,827
|
|
|
16,384,106
|
|
|
16,229,221
|
|
|
16,279,724
|
|
The
Company did not include 680,300 options in the treasury method for calculating
the diluted shares calculation for both the three and nine month periods
ended
September 30, 2006, because their inclusion would have been antidilutive
or
because their exercise price exceeded the average market price of our common
stock during the period. For the three and nine month periods ended September
30, 2005, the Company did not include 266,000 and 617,000 options in the
treasury method for calculating the diluted shares outstanding because their
inclusion would have been antidilutive or because their exercise price exceeded
the average market price for our common stock during the period.
NOTE
15:
|
DERIVATIVE
INSTRUMENT
|
The
Company utilizes foreign currency forward contracts to manage its foreign
currency exposure related to a portion of the Company’s accounts receivable that
are denominated in Euros. The strategy of the foreign currency contracts
is to
neutralize the foreign currency impact on earnings when converting 5.0 million
Euros of accounts receivable into U.S. dollars. The conversion of the underlying
exposure and the forward contracts offset and had no net impact on earnings
in
the three and nine month periods ended September 30, 2006. The Company made
no
cash payments in the third quarter to settle forward contracts. For the nine
month period ended September 30, 2006, the Company paid cash of $385,000
to
settle forward contracts. On September 29, 2006, the Company entered into
a new
forward currency contract to sell 5.0 million Euro at an all-in rate of 1.2733
which was outstanding at September 30, 2006 and will terminate or settle
on
December 29, 2006. All foreign currency forward contracts entered into in
the
three or nine months ended September 30, 2006, have been accounted for as
fair
value hedges in accordance with SFAS No. 133 and the related gains (losses)
were
recorded in other income and the related tax amounts in taxation.
Litigation
The
Company, in the normal course of its business, is involved in various lawsuits
from time to time and may be subject to certain other
contingencies.
In
management’s opinion, except as discussed below, the Company is not currently
involved in any legal proceeding, individually or in the aggregate, that
could
have a material effect on the financial position, liquidity or operating
results
of the Company.
The
Company’s subsidiary, Blackstone Medical, is a defendant in 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. The plaintiffs allege that
(i)
they are the exclusive licensees of United States Patent Nos. 6,926,718 B1,
6,936,050 B2 ( the “Patents”), and (ii) Blackstone Medical’s making, selling,
offering for sale, and using within the United States its Anterior Cervical
Plate and 3º Anterior Cervical Plate products is infringing and has infringed
the Patents, and that such infringement has been willful. The Complaint requests
both damages and an injunction against further alleged infringement of the
Patents. The Complaint does not specifically state an amount of damages.
On
October 18, 2006, Blackstone Medical filed its Answer and Counterclaims,
denying
infringement and asserting that the Patents are invalid.
Risks
and Uncertainties
As
of
September 30, 2006, the Company has a Euro denominated intercompany receivable
of 48.3 million in an entity with U.S. Dollar functional currency for which
there was no offsetting Euro payable. Accordingly, the Company is exposed
to
potential movements in currency rates between the Euro and the U.S. Dollar.
The
Company is currently evaluating the options to limit the currency exposure
on
this Euro denominated receivable.
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 year ended December 31, 2005.
Item
2. Management’s Discussion and Analysis of Financial Condition
and Results of Operations
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, 2006 compared to our results of operations for the three and nine months
ended September 30, 2005. 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 year ended December 31, 2005.
General
We
are a
diversified orthopedic products company offering a broad line of surgical,
as
well as non-surgical, products for the Spine, Reconstruction and Trauma 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 non-invasive 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. With the acquisition of Blackstone Medical on September 22,
2006, our main products will now also include spinal implant and biologics
products for spinal applications. Our products also include a device for
enhancing venous circulation, cold therapy, other pain management products,
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, the United Kingdom
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, Ireland, 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 our wholly-owned and majority-owned subsidiaries and entities
over
which we have control. All intercompany accounts and transactions are eliminated
in consolidation. The equity method of accounting is used when we have
significant influence over significant operating decisions but do not hold
control. Under the equity method, original investments are recorded at cost
and
adjusted by our share of undistributed earnings or losses of these companies.
All material intercompany transactions and profits are eliminated in
consolidation.
Our
reporting currency is the United States dollar. All balance sheet accounts,
except shareholders’ equity, are translated at the 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 (loss) component of
shareholders’ equity.
Our
financial condition, results of operations and cash flows are not significantly
impacted by seasonal 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. 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. We also use derivative
instruments from time to time to hedge foreign currency fluctuation exposures.
See Item 3 - “Quantitative and Qualitative Disclosures About Market Risk.”
On
September 22, 2006, we completed the acquisition of privately held Blackstone
Medical, Inc. (“Blackstone”), a company specializing in the design, development
and marketing of spinal implant and related biologics products. The purchase
price for the acquisition was $333.0 million, subject to certain closing
adjustments, plus transaction costs totaling approximately $4.2 million as
of
September 30, 2006. Financing costs were approximately $6.0 million. The
acquisition and related costs were financed with $330.0 million of senior
secured bank debt and cash on hand. The Company’s reported third quarter results
include the impact of purchase accounting and interest expense associated
with
the acquisition. Blackstone’s other operating results for the remaining five
business days in the third quarter were not material and will be included
in the
Company’s fourth quarter results.
Effective
with the acquisition of Blackstone, we manage our operations as four business
segments: Americas Orthofix, Americas Breg, Americas Blackstone and
International Orthofix. Americas Orthofix consists of operations in the United
States excluding the operations of Breg and Blackstone, as well as operations
in
Mexico, Brazil and Puerto Rico. Americas Breg consists of Breg’s domestic and
independent international distributor operations. Americas Blackstone consists
of the recently acquired Blackstone. International Orthofix 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 Parent’s
operating expenses and identifiable assets.
Segment
and Market Sector Revenues
Our
revenues are generally derived from two primary sources: sales of orthopedic
and
non-orthopedic products. Orthopedic products are sold into three market sectors,
Spine, Reconstruction, and Trauma, which together accounted for 93% of our
total
net sales in the three and nine months ended September 30, 2006 and 2005.
Sales
of non-orthopedic products, including the Laryngeal Mask product, woman’s care
and other products, accounted for 7% of our total net sales in the three
and
nine months ended September 30, 2006 and 2005.
The
following tables display the net sales by business segment and net sales
by
market sectors for the three and nine months ended September 30, 2006 and
2005.
We provide net sales by market sector for information purposes only. We keep
our
books and records and account for net sales, cost of sales and expenses by
business segment.
Business
Segment:
|
|
Three
Months Ended September 30,
|
|
(In
thousands)
|
|
2006
|
|
2005
|
|
|
|
Net
Sales
|
|
Percent
of
Total
Net
Sales
|
|
Net
Sales
|
|
Percent
of
Total
Net
Sales
|
|
|
|
|
|
|
|
|
|
|
|
Americas
Orthofix
|
|
$
|
41,525
|
|
|
50
|
%
|
$
|
35,954
|
|
|
47
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Americas
Breg
|
|
|
18,667
|
|
|
22
|
%
|
|
17,983
|
|
|
24
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
International
Orthofix
|
|
|
23,176
|
|
|
28
|
%
|
|
21,875
|
|
|
29
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
83,368
|
|
|
100
|
%
|
$
|
75,812
|
|
|
100
|
%
|
|
|
Nine
Months Ended September 30,
|
|
(In
thousands)
|
|
2006
|
|
2005
|
|
|
|
Net
Sales
|
|
Percent
of
Total
Net
Sales
|
|
Net
Sales
|
|
Percent
of
Total
Net
Sales
|
|
|
|
|
|
|
|
|
|
|
|
Americas
Orthofix
|
|
$
|
122,285
|
|
|
49
|
%
|
$
|
105,596
|
|
|
45
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Americas
Breg
|
|
|
55,901
|
|
|
22
|
%
|
|
53,368
|
|
|
23
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
International
Orthofix
|
|
|
71,033
|
|
|
29
|
%
|
|
74,076
|
|
|
32
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
249,219
|
|
|
100
|
%
|
$
|
233,040
|
|
|
100
|
%
|
Market
Sector:
|
|
Three
Months Ended September 30,
|
|
(In
thousands)
|
|
2006
|
|
2005
|
|
|
|
Net
Sales
|
|
Percent
of
Total
Net
Sales
|
|
Net
Sales
|
|
Percent
of
Total
Net
Sales
|
|
Orthopedic
|
|
|
|
|
|
|
|
|
|
Spine
|
|
$
|
29,282
|
|
|
35
|
%
|
$
|
25,448
|
|
|
34
|
%
|
Reconstruction
|
|
|
32,165
|
|
|
39
|
%
|
|
30,000
|
|
|
40
|
%
|
Trauma
|
|
|
15,801
|
|
|
19
|
%
|
|
14,992
|
|
|
19
|
%
|
Total
Orthopedic
|
|
|
77,248
|
|
|
93
|
%
|
|
70,440
|
|
|
93
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Orthopedic
|
|
|
6,120
|
|
|
7
|
%
|
|
5,372
|
|
|
7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
83,368
|
|
|
100
|
%
|
$
|
75,812
|
|
|
100
|
%
|
|
|
Nine
Months Ended September 30,
|
|
(In
thousands)
|
|
2006
|
|
2005
|
|
|
|
Net
Sales
|
|
Percent
of
Total
Net
Sales
|
|
Net
Sales
|
|
Percent
of
Total
Net
Sales
|
|
Orthopedic
|
|
|
|
|
|
|
|
|
|
Spine
|
|
$
|
86,781
|
|
|
35
|
%
|
$
|
73,847
|
|
|
32
|
%
|
Reconstruction
|
|
|
96,918
|
|
|
39
|
%
|
|
94,375
|
|
|
41
|
%
|
Trauma
|
|
|
47,521
|
|
|
19
|
%
|
|
47,575
|
|
|
20
|
%
|
Total
Orthopedic
|
|
|
231,220
|
|
|
93
|
%
|
|
215,797
|
|
|
93
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Orthopedic
|
|
|
17,999
|
|
|
7
|
%
|
|
17,243
|
|
|
7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
249,219
|
|
|
100
|
%
|
$
|
233,040
|
|
|
100
|
%
|
The
following table presents certain items from our statements of income as a
percentage of net sales for the periods indicated:
|
|
Three
Months Ended
September
30,
|
|
Nine
Months Ended
September
30,
|
|
|
|
2006
(%)
|
|
2005
(%)
|
|
2006
(%)
|
|
2005
(%)
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
|
100
|
|
|
100
|
|
|
100
|
|
|
100
|
|
Cost
of sales
|
|
|
25
|
|
|
27
|
|
|
26
|
|
|
27
|
|
Gross
profit
|
|
|
75
|
|
|
73
|
|
|
74
|
|
|
73
|
|
Operating
expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales
and marketing
|
|
|
44
|
|
|
39
|
|
|
40
|
|
|
36
|
|
General
and administrative
|
|
|
15
|
|
|
11
|
|
|
15
|
|
|
11
|
|
Research
and development
|
|
|
51
|
* |
|
3
|
|
|
20
|
* |
|
4
|
|
Amortization
of intangible assets
|
|
|
2
|
|
|
2
|
|
|
2
|
|
|
2
|
|
Total
operating income
|
|
|
(37
|
)
|
|
18
|
|
|
(2
|
)
|
|
20
|
|
Net
income
|
|
|
(43
|
)
|
|
61
|
|
|
(6
|
) |
|
28
|
|
*
-
Includes $40.0 million related to the write-off of acquired in-process research
and development of Blackstone.
Three
Months Ended September 30, 2006 Compared to Three Months Ended September
30,
2005
Net
sales
increased 10% to $83.4 million for the third quarter of 2006 compared to
$75.8
million for the third quarter of 2005. The impact of foreign currency increased
sales by $0.9 million during the third quarter of 2006 as compared to the
third
quarter of 2005.
Sales
by Business Segment:
Net
sales
in Americas Orthofix (the “Americas”), primarily in the United States, increased
to $41.5 million in the third quarter of 2006 compared to $36.0 million in
the
third quarter of 2005, an increase of 15%. The Americas represented 50% of
total
net sales during the third quarter of 2006 and 47% of total net sales for
the
third quarter of 2005. While the Americas experienced sales growth in all
market
sectors, the increase was primarily the result of a 15% increase in sales
in the
Spine market sector attributable to increased demand for our Spinal-Stim® and
Cervical-Stim® products. The Reconstruction and Trauma market sectors were
positively affected by increased sales of internal and external fixation
products and sales of Physio-Stim®. Non-Orthopedic products increased to $1.0
million during the third quarter of 2006 compared to $0.5 million in the
third
quarter of 2005 due primarily to increased sales of other distributed
products.
Americas
Orthofix Sales by Market Sector:
|
|
Net
Sales for the
Three
Months Ended September 30,
|
|
|
|
(In
US$ thousands)
|
|
2006
|
|
2005
|
|
Growth
|
|
Orthopedic
|
|
|
|
|
|
|
|
Spine
|
|
$
|
29,263
|
|
$
|
25,422
|
|
15%
|
|
Reconstruction
|
|
|
2,761
|
|
|
1,955
|
|
41%
|
|
Trauma
|
|
|
8,531
|
|
|
8,092
|
|
5%
|
|
Total
Orthopedic
|
|
|
40,555
|
|
|
35,469
|
|
14%
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Orthopedic
|
|
|
970
|
|
|
485
|
|
100%
|
|
Americas
Orthofix
|
|
$
|
41,525
|
|
$
|
35,954
|
|
15%
|
|
Net
sales
in Americas Breg (“Breg”) increased $0.7 million to $18.7 million for the third
quarter of 2006 compared to $18.0 million for the third quarter of 2005,
an
increase of 4%. The increase in sales was primarily due to the sale of Breg
bracing products which increased 7% from the third quarter of 2005. Our new
Fusion XT™ knee brace, which experienced positive market response upon its
introduction, contributed to this increase. This increase was partially offset
by a 13% decrease in sales for pain therapy products resulting in part from
delayed introduction of new pain therapy products. All of Breg’s sales are
recorded in our Reconstruction market sector.
Net
sales
in International Orthofix (“International”) increased 6% to $23.2 million in the
third quarter of 2006 compared to $21.9 million in the third quarter of 2005.
International net sales represented 28% and 29% of our total net sales in
the
third quarter of 2006 and the third quarter of 2005, respectively. International
sales in the third quarter of 2006 were positively impacted by a 9% increase
in
external fixation products which was partially offset by a 13% decrease in
sales
of the A-V Impulse product. International sales growth in the third quarter
was
aided by restructuring efforts which included creating business zones and
opening a new international distribution center. Sales of Non-Orthopedic
products, principally the Laryngeal Mask sold in the United Kingdom and Italy,
increased 5% when compared to the same period of the prior year.
International
Orthofix Sales by Market Sector:
|
|
Net
Sales for the
Three
Months Ended September 30,
|
|
|
|
(In
US$ thousands)
|
|
2006
|
|
2005
|
|
Growth
|
|
Orthopedic
|
|
|
|
|
|
|
|
Spine
|
|
$
|
19
|
|
$
|
26
|
|
(27)%
|
|
Reconstruction
|
|
|
10,737
|
|
|
10,062
|
|
7%
|
|
Trauma
|
|
|
7,270
|
|
|
6,900
|
|
5%
|
|
Total
Orthopedic
|
|
|
18,026
|
|
|
16,988
|
|
6%
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Orthopedic
|
|
|
5,150
|
|
|
4,887
|
|
5%
|
|
International
Orthofix
|
|
$
|
23,176
|
|
$
|
21,875
|
|
6%
|
|
Sales
by Market Sector:
Net
sales
of spine products increased 15% to $29.3 million in the third quarter of
2006
compared to $25.4 million in the third quarter of 2005. As discussed above,
the
increase is primarily due to sales of our Spinal-Stim and Cervical-Stim products
attributable to increased demand in the United States. The Cervical-Stim
continues to be the only FDA-approved device for the enhancement of fusion
in
the cervical spine.
Sales
of
our reconstruction products increased 7% to $32.2 million in the third quarter
of 2006 compared to $30.0 million in the third quarter of 2005. The increase
of
$2.2 million in this market sector was attributable to sales of the Breg
products which increased 7%, sales of internal fixation, including ISKD™ and
eight-Plate™, which increased 19% and sales of external fixation products used
in reconstruction applications which increased 42%. The majority of these
increases were offset by sales of A-V Impulse which decreased 13% as discussed
above.
Sales
of
our trauma products increased 5% to $15.8 million in the third quarter of
2006,
compared to $15.0 million in the third quarter of 2005. This market sector
was
positively impacted from a 56% increase in sales of internal fixation products
and a 12% increase in sales of Physio-Stim® products due to increased demand.
Sales
of
our non-orthopedic products grew 14% to $6.1 million in the third quarter
of
2006 compared to $5.4 million in the third quarter of 2005. The increase
was
primarily due to an increase in sales of woman’s care and other distributed
products and an increase in sales of airway management products.
Gross
Profit
- Our
gross profit increased 12.1% to $62.4 million in the third quarter of 2006,
from
$55.6 million in the third quarter of 2005. The increase was primarily due
to
the increase of 10% in net sales and the increase in sales of higher margin
spine stimulation products. Gross profit as a percent of net sales in the
third
quarter 2006 was 74.8% compared to 73.4% in the third quarter of 2005, which
was
a result of a favorable product mix resulting from higher sales of higher
margin
stimulation products.
Sales
and Marketing Expenses
- Sales
and marketing expenses, which include commissions, royalties and bad debt
provision, generally increase and decrease in relation to sales. Sales and
marketing expense increased $7.1 million to $36.3 million in the third quarter
of 2006, which includes a charge of $4.7 million related to the termination
of a
marketing services agreement with Medtronic Sofamor Danek (“Danek”), compared to
$29.2 million in the third quarter of 2005. The increase in sales and marketing
expense was also due to higher commissions on higher sales, increased bad
debt
expense, an increase in market development expense and share-based compensation
cost related to the adoption of SFAS No. 123 (R) of $0.5 million for which
there
was no comparable cost in the prior year.
General
and Administrative Expense
-
General and administrative expense increased $3.3 million in the third quarter
of 2006 to $11.7 million compared to $8.4 million in the third quarter of
2005.
This increase is primarily attributable to additional share-based compensation
costs related to the adoption of SFAS No. 123 (R) of $0.7 million for which
there was no comparable cost in the prior year, additional corporate development
costs of $0.7 million, additional legal costs of $0.6 million, and additional
market development costs of $0.2 million.
Research
and Development Expense
-
Research and development expense increased $40.3 million in the third quarter
of
2006 to $42.9 million compared to $2.6 million in the third quarter of 2005.
Research and development expense in the third quarter of 2006 included a
charge
of $40.0 million related to the write-off of in-process research and development
resulting from the Blackstone acquisition. Share-based compensation costs
related to the adoption of SFAS No. 123 (R) was $0.1 million in the third
quarter of 2006 for which there was no comparable cost in the prior
year.
Amortization
of Intangible Assets
-
Amortization of intangible assets increased $0.3 million in the third quarter
of
2006 to $1.9 million compared to $1.6 million in the third quarter of 2005.
Amortization expense included $0.2 million related to amortization of
intangibles related to the Blackstone acquisition.
Interest
Income (Expense), net - Interest
expense, net was $0.5 million in the third quarter of 2006 compared to $1.2
million of interest expense in the third quarter of 2005. Interest expense
for
the third quarter of 2006 included interest expense of $0.7 million related
to
the senior secured term loan used to finance the Blackstone acquisition.
Interest expense in the third quarter of 2005 included the interest related
to
the term loan associated with the Breg acquisition.
Other
Income (Expense), net - Other
expense, net was $0.5 million in the third quarter of 2006 compared to other
income of $0.1 million in the third quarter of 2005. The other expense in
the
third quarter 2006 was due to foreign exchange losses resulting from the
strengthening during the quarter of the U.S. Dollar as contrasted to the
opposite effect in the third quarter of 2005.
KCI
Settlement, Net of Related Costs
- The
gain, net of related costs, on the settlement of the KCI litigation in the
third
quarter of 2005 was $40.9 million for which there was no comparable gain
in the
third quarter of 2006.
Income
Tax Expense -
Our
estimated worldwide effective tax rate was 12.6% and 14.1% during the third
quarter of 2006 and 2005, respectively. The effective tax rate for the
third quarter of 2006 reflects the non-deductibility, for tax purposes, of
the
$40.0 million purchased in-process research and development charge associated
with the Blackstone acquisition. Excluding the charge for in-process
research and development, our effective tax rate was 46%. During the third
quarter of 2006, we incurred tax expense of $0.3 million related to our European
restructuring and tax adjustments in foreign jurisdictions of $0.4
million. The effective tax rate for the third quarter of 2006 was also
affected by a higher percentage of income being earned in the United States,
a
higher tax jurisdiction. The effective tax rate for the third quarter of
2005
was affected by the gain recorded from the KCI settlement which was recorded
at
Novamedix Distribution Limited, a wholly-owned Cypriot subsidiary, which
is in a
favorable tax jurisdiction.
Net
Income (Loss)
-
Net loss
for the third quarter of 2006 was $35.4 million, or $2.19 per basic share
and
$2.17 per diluted share, compared to net income of $46.0 million, or $2.88
per
basic share and $2.81 per diluted share, for the third quarter of 2005. The
weighted average number of basic common shares outstanding was 16,193,086
and
15,986,599 during the third quarter of 2006 and 2005, respectively. The weighted
average number of diluted common shares outstanding was 16,322,827 and
16,384,106 during the third quarter of 2006 and 2005, respectively.
Nine
Months Ended September 30, 2006 Compared to Nine Months Ended September 30,
2005
Sales
by Business Segment:
Net
sales
increased 7% to $249.2 million for the first nine months of 2006 compared
to
$233.0 million for the first nine months of 2005. The impact of foreign currency
decreased sales by $0.9 million during the first nine months of 2006 as compared
to the first nine months of 2005.
Net
sales
in the Americas, primarily in the United States, increased $16.7 million
to
$122.3 million in the first nine months of 2006 compared to $105.6 million
in
the first nine months of 2005, an increase of 16%. The Americas represented
49%
of total net sales during the first nine months of 2006 and 45% of total
net
sales for the first nine months of 2005. The increase in sales was primarily
the
result of an 18% increase in sales in the Spine market sector which was
attributable to increased demand for our Spinal-Stim® and Cervical-Stim®
products. The Reconstruction market sector also experienced a 31% increase
in
sales which was attributable to growth in sales of newer internal reconstruction
products such as the eight-Plate™ and ISKD. In the Americas Trauma market
sector, external fixation devices are sharing the market for treatment of
difficult fractures with alternatives such as plating and nailing. Recognizing
this trend, we have introduced the Contours VPS for distal radius fractures,
the
PC.C.P. for hip fractures, and on a limited release the CentroNail™. Growth from
these products together with growth from the Physio-Stim for long-bone
non-unions enabled us to offset a negative 1% growth for external fixation
and
show an overall 2% growth in Trauma for the first nine months of 2006 compared
to 2005. Sales of non-orthopedic products increased $1.2 million due primarily
to an increase in sales of other distributed products.
Americas
Orthofix Sales by Market Sector:
|
|
Net
Sales for the
Nine
Months Ended September 30,
|
|
|
|
(In
US$ thousands)
|
|
2006
|
|
2005
|
|
Growth
|
|
Orthopedic
|
|
|
|
|
|
|
|
Spine
|
|
$
|
86,722
|
|
$
|
73,752
|
|
18%
|
|
Reconstruction
|
|
|
8,235
|
|
|
6,270
|
|
31%
|
|
Trauma
|
|
|
24,908
|
|
|
24,345
|
|
2%
|
|
Total
Orthopedic
|
|
|
119,865
|
|
|
104,367
|
|
15%
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Orthopedic
|
|
|
2,420
|
|
|
1,229
|
|
97%
|
|
Americas
Orthofix
|
|
$
|
122,285
|
|
$
|
105,596
|
|
16%
|
|
Net
sales
in Breg increased 5% to $55.9 million for the first nine months of 2006 compared
to $53.4 million for the first nine months of 2005. The increase in sales
was
primarily due to the sale of Breg bracing products which increased 10% from
the
first nine months of 2005. Our new Fusion™ XT knee brace was the primary
contributor to the increase. This increase was partially offset by a 11%
decrease in sales for pain therapy products resulting from delayed introduction
of new pain therapy products. All of Breg’s sales are recorded in our
Reconstruction market sector. Breg net sales represented 22% and 23% of our
total net sales in the nine months of 2006 and 2005, respectively.
Net
sales
in International decreased 4% to $71.0 million in the first nine months of
2006
compared to $74.1 million in first nine months of 2005. International net
sales
represented 29% and 32% of our total net sales in the first nine months of
2006
and 2005, respectively. The impact of foreign currency decreased International
sales by 1.8%, or $1.3 million, during the first nine months of 2006 as compared
to the first nine months of 2005. International sales in the first nine months
of 2006 were also negatively impacted by a 17% decrease in sales of the A-V
Impulse product. International sales were also negatively impacted in the
Reconstruction and Trauma market sectors by a continued shift towards internal
fixation from external fixation products. In recognizing this market preference,
we have added new internal fixation products to our product offering, which
have
increased 40% in the first nine months as compared to the first nine months
of
2005. Sales of Non-Orthopedic products, principally the Laryngeal Mask sold
in
the United Kingdom and Italy, were down 3% when compared to the same period
of
the prior year.
International
Orthofix Sales by Market Sector:
|
|
Net
Sales for the
Nine
Months Ended September 30,
|
|
|
|
(In
US$ thousands)
|
|
2006
|
|
2005
|
|
Growth
|
|
Orthopedic
|
|
|
|
|
|
|
|
Spine
|
|
$
|
59
|
|
$
|
95
|
|
(38)%
|
|
Reconstruction
|
|
|
32,782
|
|
|
34,737
|
|
(6)%
|
|
Trauma
|
|
|
22,613
|
|
|
23,230
|
|
(3)%
|
|
Total
Orthopedic
|
|
|
55,454
|
|
|
58,062
|
|
(4)%
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-Orthopedic
|
|
|
15,579
|
|
|
16,014
|
|
(3)%
|
|
International
Orthofix
|
|
$
|
71,033
|
|
$
|
74,076
|
|
(4)%
|
|
Sales
by Market Sector:
Net
sales
of spine products increased 18% to $86.8 million in the first nine months
of
2006 compared to $73.8 million in the first nine months of 2005. As discussed
above, the increase is primarily due to sales of our Spinal-Stim and
Cervical-Stim products attributable to increased demand in the United
States.
Sales
of
our reconstruction products increased 3% to $96.9 million in the first nine
months of 2006 compared to $94.3 million in the first nine months of 2005.
The
increase in this market sector was attributable to increased sales of the
Breg
products which increased 7% worldwide together with increased sales of internal
fixation products. The majority of this growth was offset by decreased sales
of
our A-V Impulse products as discussed above and decreased sales in other
reconstruction products due to the discontinuation of certain distributed
products in the International market.
Sales
of
our trauma products were nearly flat at $47.5 million in the first nine months
of 2006, compared to $47.6 million in the first nine months of 2005. This
market
sector was negatively impacted from a 7% decline in sales of external fixation
products which was due to fluctuations of foreign currency and decreased
demand
for external fixation products partially offset by increased demand for internal
fixation and Physio-Stim products.
Sales
of
our non-orthopedic products increased 4% to $18.0 million in the first nine
months of 2006, compared to the first nine months of 2005. Sales of woman’s care
and other distributed products increased; however, this increase was offset
by a
decrease in sales of airway management products.
Gross
Profit
- Our
gross profit increased 8% to $185.6 million in the first nine months of 2006,
from $171.2 million in the first nine months of 2005. The increase was primarily
due to the increase of 7% in net sales. Gross profit as a percent of net
sales
in the first nine months of 2006 was 74.5% compared to 73.5% in the first
nine
months of 2005. The higher gross profit margin was a result of a favorable
product mix, resulting from the sales of higher margin stimulation products
as
well as ongoing operational improvement initiatives. Share-based compensation
costs related to the adoption of SFAS No. 123(R) in the first nine months
of
2006 was $0.2 million for which there was no comparable cost in the prior
year.
Sales
and Marketing Expenses
- Sales
and marketing expenses, which include commissions, royalties and bad debt
provision, generally increase and decrease in relation to sales. Sales and
marketing expense increased $13.4 million to $99.0 million in the first nine
months of 2006 which includes a charge of $4.7 million related to the
termination of a marketing services agreement with Danek, compared to $85.4
million in the first nine months of 2005. Sales and marketing expense as
a
percent of net sales increased to 39.7% in the first nine months of 2006
from
36.7% in the first nine months of 2005. The increase in sales and marketing
expense is primarily due to higher commissions on higher sales, increased
bad
debt expense, an increase in ongoing market development expenses, and
share-based compensation costs related to the adoption of SFAS No. 123(R).
Share-based compensation costs related to the adoption of SFAS No. 123(R)
in the
first nine months of 2006 was $0.9 million for which there was no comparable
cost in the prior year.
General
and Administrative Expense
-
General and administrative expense increased $10.5 million in the first nine
months of 2006 to $36.3 million compared to $25.7million in the first nine
months of 2005. This increase is primarily attributable to management transition
costs of $1.7 million, which included $0.7 million of non-cash share-based
compensation, additional share-based compensation related to the adoption
of
SFAS No. 123(R) of $3.6 million for which there is no comparable cost in
the
prior year, additional corporate development costs of $1.0 million, additional
legal costs of $0.8 million, and market development activities of $0.4
million.
Research
and Development Expense
-
Research and development expense increased $39.9 million in the first nine
months of 2006 to $48.6 million compared to $8.7 million in the first nine
months of 2005. Research and development expense in the first nine months
of
2006 included a charge of $40.0 million related to the write-off of in-process
research and development resulting from the Blackstone acquisition. Share-based
compensation costs related to the adoption of SFAS No. 123(R) in the first
nine
months of 2006 was $0.2 million for which there was no comparable cost in
the
prior year.
Amortization
of Intangible Assets
-
Amortization of intangible assets was $5.4 million in the first nine months
of
2006 compared to $4.9 million for the first nine months of 2005. Amortization
expense included $0.2 million related to amortization of intangibles related
to
the Blackstone acquisition.
Interest
Income
(Expense), net - Interest
income, net was $0.2 million in the first nine months of 2006 compared to
an
expense of $3.7 million in the first nine months of 2005. The reduction in
interest expense in the first nine months of 2006 when compared to the same
period in 2005 is the result of the repayment of our senior secured term
loan
associated with the Breg acquisition.
Other
Income (Expense), net - Other
expense, net was $0.8 million in the first nine months of 2006 as a result
of
foreign currency losses compared to other income of $1.5 million in the first
nine months of 2005 which was primarily attributable to $2.4 million of deferred
royalty income resulting from the conclusion of the BoneSource agreement
with
Stryker which was partially offset by $0.9 million of foreign currency losses.
KCI
Settlement, Net of Related Costs -
In the
first nine months of 2006, we entered into final agreements with certain
former
owners of Novamedix, which established the portion of the proceeds we were
required to disburse in connection with the KCI settlement. Accordingly,
we
recorded a gain of $1.1 million which was the difference between what we
had
reserved to disburse at December 31, 2005 and the amount of the final settlement
obligations. This gain compares to $40.4 million of gain in the first nine
months of 2005 which relates to the settlement of the KCI
litigation.
Income
Tax Expense - Our
estimated worldwide effective tax rate was (348.3%) and 21.8% during the
first
nine months of 2006 and 2005, respectively.
The
effective tax rate for the first nine months of 2006 reflects the
non-deductibility, for tax purposes, of the $40.0 million purchased in-process
research and development charge associated with the Blackstone
acquisition. Excluding the charge for in-process research and development,
our effective tax rate is 31%. Our nine month 2006 effective tax
rate benefited from a one-time tax benefit of $2.9 million resulting from
our
election to adopt a new tax provision in Italy. The election allowed us to
increase, for tax purposes only, the value of our trademarks in Italy by
approximately $15.0 million. We
incurred a tax liability of $2.7 million from applying a 19% tax rate to
the
revaluation of the trademark value. We will receive a future tax benefit
of $5.6 million associated with amortization of that step-up in value which
is
based on the current Italian tax rates of approximately 37%. The
net of the $5.6 million deferred tax asset and the $2.7 million tax liability
resulted in a $2.9 million non-recurring discrete tax benefit. Without
this discrete item, our estimated worldwide effective tax rate for the nine
months ended September 30, 2006 was 38% as a result of a higher proportion
of
pre-tax income being earned in the United States, a higher tax jurisdiction,
in
2006 when compared to the same period of the prior year excluding the impact
of
the KCI settlement (as discussed below). The effective tax rate for
the first nine months of 2005 was affected by the gain recorded from the
KCI
settlement which was recorded at Novamedix Distribution Limited, a wholly-owned
Cypriot subsidiary, which is in a favorable tax jurisdiction. This lower
rate was slightly offset by a change in tax law in the United Kingdom and
earning more taxable income in higher tax jurisdictions such as the United
States.
Net
Income (Loss)
-
Net loss
for the first nine months of 2006 was $14.4 million, or $0.90 per basic share
and $0.89 per diluted share, compared to $66.2 million, or $4.17 per basic
share
and $4.07 per diluted share, for the first nine months of 2005. The weighted
average number of basic common shares outstanding was 16,084,388 and 15,881,902
during the first nine months of 2006 and 2005, respectively. The weighted
average number of diluted common shares outstanding was 16,229,221 and
16,279,724 during the first nine months of 2006 and 2005,
respectively.
Liquidity
and Capital Resources
Cash
and
cash equivalents at September 30, 2006 were $56.6 million of which $19.5
million
is subject to certain restrictions under the senior secured credit agreement
described below. This compares to $77.5 million at December 31, 2005 of which
$13.8 million was subject to certain restrictions under a previous senior
secured credit agreement, which was fully repaid and cancelled as of March
31,
2006.
Net
cash
used in operating activities was $9.4 million for the first nine months of
2006
compared to $94.8 million, including $67.5 million from the KCI settlement,
provided by operating activities in the first nine months of 2005. Net cash
(used in) provided by operating activities is comprised of net income (loss),
non-cash items (including share-based compensation and non-cash purchase
accounting items from the Blackstone acquisition, notably in-process research
and development) and changes in working capital. Net income decreased $80.6
million to a loss of $14.4 million in the first nine months of 2006 from
$66.2
million in the comparable 2005 period. The reduction in net income includes
$40.0 million of in-process research and development from the Blackstone
transaction and the non-recurring of $37.4 million in after tax income from
the
KCI settlement in 2005. Non-cash items increased $39.1 million in the first
nine
months of 2006 compared to the same period in 2005 principally as a result
of
the non-cash effect of share based compensation and the recording of Blackstone
in-process research and development. Working capital accounts consumed $48.0
million of cash in the first nine months of 2006, including a reduction in
other
current liabilities related principally to the KCI settlement. Excluding
the
effect of the KCI settlement, working capital consumed $8.9 million of cash
in
the first nine months of 2006 compared to $24.4 million in the same period
in
2005. The principal uses of cash for working capital were for increases in
accounts receivable and inventory to support additional sales and certain
operational initiatives. Overall performance indicators for our two primary
working capital accounts, accounts receivable and inventory, reflect days
sales
in receivables of 95 days at September 30, 2006 compared to 98 days at September
30, 2005 and inventory turns of 2.0 times at September 30, 2006 compared
to 2.3
times at September 30, 2005. The lower inventory turns and resultant higher
inventory reflect inventory investment to open an international distribution
center, the purchase of a safety stock of A-V Impulse Impads to support the
transfer of production from the UK to Mexico and inventories associated with
new
internal fixation product lines.
Net
cash
used in investing activities was $343.6 million during the first nine months
of
2006 compared to $8.9 million during the first nine months of 2005. On September
22, 2006 we purchased Blackstone for $333.0 million plus various transaction
costs. In addition, during the first nine months of 2006, we invested $6.8
million in capital expenditures and we paid $1.1 million to purchase 52%
of our
distributor of Breg products in Germany. During the fist nine months of 2005,
we
invested $8.9 million in capital expenditures.
Net
cash
provided from financing activities was $325.5 million in the first nine months
of 2006 compared to $17.7 million used by financing activities during the
first
nine months of 2005. In March 2006, we repaid the remaining $14.8 million
of
principal of the senior secured term loan, which was obtained to finance
the
Breg acquisition. On September 22, 2006, we borrowed $330.0 million in the
form
of a new senior secured credit agreement, which along with cash balances
were
used to finance the acquisition of Blackstone and pay debt issuance and other
costs. In addition, we received proceeds of $11.2 million from the issuance
of
376,376 shares of our common stock upon the exercise of stock options and
shares
issued pursuant to our employee stock purchase plan and $2.0 million of related
tax benefit. In the first nine months of 2005 we prepaid $24.0 million of
principal of the Breg senior secured term loan and we received proceeds of
$6.4
million from the issuance of 292,606 shares of our common stock upon the
exercise of stock options and shares issued pursuant to our employee stock
purchase plan.
On
September 22, 2006 our wholly-owned US 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. 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, 2006 and as of November 6, 2006 we had no amounts outstanding under the
revolving credit facility and $330.0 million outstanding under the term loan
facility. Obligations under the senior secured credit facility have a floating
interest rate of LIBOR or prime rate plus a margin, currently LIBOR plus
1.75%,
which is adjusted quarterly based upon the leverage ratio of the Company
and its
subsidiaries. Our effective interest rate as of September 30, 2006 on our
senior
secured debt is 7.12%. The Company, certain foreign subsidiaries of the Company,
including Colgate Medical Limited (Orthofix Holdings’s immediate parent)
and certain of Orthofix Holdings’s direct and indirect subsidiaries,
including Orthofix Inc., Breg and Blackstone, have guaranteed the obligations
of
Orthofix Holdings under the senior secured credit facility. The obligations
of
Orthofix Holdings under the senior secured bank facility and the guarantors
under their guarantees are secured by the pledge of their respective assets
located in the United States.
At
September 30, 2006, we had outstanding borrowings of 2.5 million Euro ($3.1
million) and unused available lines of credit of approximately 4.1 million
Euro
($5.1 million) under a line of credit established in Italy to finance the
working capital of our Italian operations. The terms of the line of credit
give
us the option to borrow amounts in Italy at rates determined at the time
of
borrowing.
We
will
continue to search for viable acquisition candidates that would expand our
global presence as well as add additional products appropriate for current
distribution channels. An acquisition of another company or product line
by us
could result in our incurrence of additional debt and contingent
liabilities.
We
believe that current cash balances together with projected cash flows from
operating activities, the available Italian line of credit, the exercise
of
stock options, and our debt capacity are sufficient to cover anticipated
working
capital and capital expenditure needs including research and development
costs
over the near term.
Contractual
Obligations
The
following chart sets forth changes to our contractual obligations that have
occurred since December 31, 2005:
Contractual
Obligations
|
|
Payments
Due By Period
|
|
(In
thousands)
|
|
Total
|
|
Less
Than 1 Year
|
|
1
to 3 Years
|
|
4
to 5 Years
|
|
Over
5 Years
|
|
Senior
secured term loan:
|
|
|
|
|
|
|
|
|
|
|
|
As
of December 31, 2005
|
|
$
|
14,750
|
|
$
|
14,750
|
|
$
|
-
|
|
$
|
-
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of September 30, 2006
|
|
$
|
330,000
|
|
$
|
3,300
|
|
$
|
6,600
|
|
$
|
6,600
|
|
$
|
313,500
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
borrowings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of December 31, 2005
|
|
$
|
458
|
|
$
|
437
|
|
$
|
21
|
|
$
|
-
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of September 30, 2006
|
|
$
|
3,278
|
|
$
|
3,240
|
|
$
|
38
|
|
$
|
-
|
|
$
|
-
|
|
The
senior secured term loan balance as of December 31, 2005 was fully repaid
prior
to June 30, 2006. On September 22, 2006, a new credit agreement was entered
into
by Orthofix Holdings, Inc. with Orthofix International N.V., certain domestic
and foreign direct and indirect subsidiaries concurrent with the closing
of the
Blackstone acquisition. This credit agreement includes a seven year, $330.0
million term loan.
In
addition to scheduled contractual obligations of the debt as set forth above,
our credit agreement requires us to make mandatory prepayments with (a) the
excess cash flow (as defined in the credit agreement) of Orthofix International
N.V. and its subsidiaries, in an amount equal to 50% of the excess annual
cash
flow beginning with the year ending December 31, 2007, provided, however,
if the
leverage ratio (as defined in the credit agreement) is less than or equal
to
1.75 to 1.00, there will be no mandatory excess cash flow prepayments, (b)
100%
of the net cash proceeds of any debt issuances by Orthofix International
N.V. or
any of its subsidiaries or 50% of the net cash proceeds of equity issuances
by
any such party, excluding the exercise of stock options, provided, however,
if
the leverage ratio is less than or equal to 1.75 to 1.00 at the end of the
preceding fiscal year, Orthofix Holdings shall not be required to prepay
the
loans with the proceeds of any such debt or equity issuances, (c) the net
cash
proceeds of asset dispositions over a minimum threshold, or (d) unless
reinvested, insurance proceeds or condemnation awards.
Item
3. Quantitative
and Qualitative Disclosures About Market Risk
We
are
exposed to certain market risks as part of our ongoing business
operations. Primary exposures include changes in interest rates and
foreign currency fluctuations. These exposures can vary sales, cost of goods,
and costs of operations, the cost of financing and yields on cash and short-term
investments. We use derivative financial instruments, where appropriate,
to manage these risks. However, our risk management policy does not
allow us to hedge positions we do not hold nor do we enter into derivative
or
other financial investments for trading or speculative purposes. As of
September 30, 2006, we had a currency hedge transaction in place to balance
our
Euro-denominated current liabilities with our Euro-denominated current
assets. See Item 2 - “Management’s Discussion and Analysis of Financial
Condition and Results of Operations”.
We
are
exposed to interest rate risk in connection with our senior secured term
loan
and borrowings under our revolving credit facility, which bear interest at
floating rates based on London Inter-Bank Offered Rate (LIBOR) or the prime
rate
plus an applicable borrowing margin. Therefore, interest rate changes generally
do not affect the fair market value of the debt, but do impact future earnings
and cash flows, assuming other factors are held constant.
As
of
September
30, 2006, Orthofix Holdings had $330.0 million of variable rate term debt
represented by borrowings under its senior secured term loan at a floating
interest rate of LIBOR or prime rate plus a margin, currently LIBOR plus
1.75%,
which is adjusted quarterly based upon the leverage ratio of the Company
and its
subsidiaries. The effective interest rate as of September 30, 2006 on the
senior
secured debt is 7.12%. Based on the balance outstanding under the credit
facility as of December 31, 2006 an immediate change of one percentage point
in
the applicable interest rate on the variable rate debt would cause an increase
or decrease in interest expense of approximately $3.3 million on an annual
basis.
Our
foreign currency exposure results from fluctuating currency exchange rates,
primarily the U.S. Dollar against the Euro, Great Britain Pound, Mexican
Peso
and Brazilian Real. We face cost of goods currency exposure when we
produce products in foreign currencies such as the Euro or Great Britain
Pound
and sell those products in U.S. Dollars. We face transactional currency
exposures when foreign subsidiaries (or the Company itself) enter into
transactions, generally on an intercompany basis, denominated in currencies
other than their functional currency. As of September 30, 2006, we had an
uncovered intercompany receivable denominated in Euro for approximately 48.2
million. We are currently evaluating our options to limit the foreign
currency exposure on this receivable.
Disclosure
Controls and Procedures
Under
the
supervision and with the participation of our management, including our Chief
Executive Officer and our Chief Financial Officer, we performed an evaluation
of
the effectiveness of our disclosure controls and procedures (as defined in
Exchange Act Rule 13a - 15(e) or 15d - 15(e)) as of the end of the quarter
covered by this report. Based on the foregoing, our Chief Executive
Officer and Chief Financial Officer concluded that our disclosure controls
and
procedures were effective.
Changes
in Internal Control over Financial Reporting
Other
than as set forth below with respect to our recent acquisition of Blackstone,
there has been no change to our internal control over financial reporting
during
our most recent fiscal quarter that has materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.
We
completed the acquisition of Blackstone in September 2006, as more fully
described in Note 7 to the unaudited condensed consolidated financial statements
included in Part 1, Item 1, herein. As part of our ongoing integration
activities, we are in the process of incorporating our controls and procedures
into Blackstone. Management has excluded from its assessment of the
effectiveness of the Company’s internal control over financial reporting as of
September 30, 2006 certain elements of the internal control over financial
reporting of Blackstone.
Item
1. Legal Proceedings
The
Company’s subsidiary, Blackstone Medical, is a defendant in 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. The plaintiffs allege that
(i)
they are the exclusive licensees of United States Patent Nos. 6,926,718 B1,
6,936,050 B2, and (ii) Blackstone Medical’s making, selling, offering for sale,
and using within the United States its Anterior Cervical Plate and 3º Anterior
Cervical Plate products is infringing and has infringed the Patents, and
that
such infringement has been willful. The Complaint requests both damages and
an
injunction against Blackstone Medical’s further alleged infringement of the
Patents. The Complaint does not specifically state an amount of damages.
On
October 18, 2006, Blackstone Medical filed its Answer and Counterclaims,
denying
infringement and asserting that the Patents are invalid.
Other
than as set forth below there have been no material changes to our risk factors
from the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual
Report on Form 10-K for the year ended December 31, 2005.
Third
parties may claim that we infringe on their proprietary rights and may prevent
us from manufacturing and selling certain of our products.
There
has
been substantial litigation in the orthopedic medical devices industry with
respect to the manufacture, use and sale of new products. These lawsuits
relate
to the validity and infringement of patents or proprietary rights of third
parties. We may be required to defend against allegations relating to the
infringement of patent or proprietary rights of third parties. Any such
litigation could, among other things:
|
·
|
require
us to incur substantial expense, even if the costs of our defense
are
covered by insurance or we are successful in the
litigation;
|
|
·
|
require
us to divert significant time and effort of our technical and management
personnel;
|
|
·
|
result
in the loss of our rights to develop or make certain products;
and
|
|
·
|
require
us to pay substantial monetary damages or royalties in order to
license
proprietary rights from third parties or to satisfy judgments or
to settle
actual or threatened litigation.
|
Although
patent and intellectual property disputes within the orthopedic medical devices
industry have often been settled through assignments, licensing or similar
arrangements, costs associated with these arrangements may be substantial
and
could include the long-term payment of royalties. Furthermore, the required
assignments or licenses may not be made available to us on acceptable terms.
Accordingly, an adverse determination in a judicial or administrative proceeding
or a failure to obtain necessary assignments or licenses could prevent us
from
manufacturing and selling some products or increase our costs to market these
products.
For
example, the Company’s subsidiary, Blackstone, maintains a license agreement
with Cross Medical, Inc./EBI (“Cross/EBI”) covering certain pedicle screw
products currently sold by Blackstone. Prior to the completion of its
acquisition by the Company, Blackstone requested that Cross/EBI consent to
the
assignment of the license agreement to the extent Blackstone’s acquisition by
the Company constituted an assignment thereunder. At this time, Cross/EBI
and
the Company are negotiating the terms of such consent. Although the Company
believes that no consent is necessary for Blackstone to maintain its rights
under the license agreement, and that to the extent such a consent is necessary,
Cross/EBI is required to provide it under the terms of the agreement, there
can
be no assurance that Cross/EBI will not challenge Blackstone’s rights under the
license agreement if current negotiations are not successful.
In
order to compete, we must attract, retain and motivate key employees, and
our
failure to do so could have an adverse effect on our results of operations.
In
order
to compete, we must attract, retain and motivate executives and other key
employees, including those in managerial, technical, sales, marketing and
support positions. Hiring and retaining qualified executives, engineers,
technical staff and sales representatives are critical to our business, and
competition for experienced employees in the medical device industry can
be
intense. To attract, retain and motivate qualified employees, we utilize
stock-based incentive awards such as employee stock options. If the value
of
such stock awards does not appreciate as measured by the performance of the
price of our common stock and ceases to be viewed as a valuable benefit,
our
ability to attract, retain and motivate our employees could be adversely
impacted, which could negatively affect our results of operations and/or
require
us to increase the amount we expend on cash and other forms of compensation.
In
addition, our adoption of Statement of Financial Accounting Standards (“SFAS”)
No. 123(R), “Share-Based Payment,” during our first quarter of 2006 will
result in significant additional compensation expense compared to prior
periods.
Our
results of operations could vary as a result of the methods, estimates and
judgments we use in applying our accounting policies.
The
methods, estimates and judgments we use in applying our accounting policies
have
a significant impact on our results of operations (see “Critical Accounting
Estimates” in Part II, Item 7 of our Annual Report filed on
Form 10-K). Such methods, estimates and judgments are, by their nature,
subject to substantial risks, uncertainties and assumptions, and factors
may
arise over time that leads us to change our methods, estimates and judgments.
Changes in those methods, estimates and judgments could significantly affect
our
results of operations. In particular, beginning in our first quarter of 2006,
the calculation of share-based compensation expense under
SFAS No. 123(R) will require us to use valuation methodologies (which
were not developed for use in valuing employee stock options) and a number
of
assumptions, estimates and conclusions regarding matters such as expected
forfeitures, expected volatility of our share price, the expected dividend
rate
with respect to our common stock and the exercise behavior of our employees.
Furthermore, there are no means, under applicable accounting principles,
to
compare and adjust our expense if and when we learn of additional information
that may affect the estimates that we previously made, with the exception
of
changes in expected forfeitures of share-based awards. Factors may arise
over
time that leads us to change our estimates and assumptions with respect to
future share-based compensation arrangements, resulting in variability in
our
share-based compensation expense over time. Changes in forecasted share-based
compensation expense could impact our gross margin percentage; research and
development expenses; sales and marketing expenses; general and administrative
expenses; and our tax rate.
Our
acquisition of Blackstone Medical could present challenges for
us.
On
September 22, 2006, we completed the acquisition of Blackstone Medical. We
are
in the process of integrating the operations of Blackstone Medical into our
business. We may not be able to successfully integrate Blackstone Medical’s
operations into our business and achieve the anticipated benefits of the
acquisition. The integration of Blackstone Medical’s operations into our
business involves numerous risks, including:
|
·
|
difficulties
in incorporating Blackstone Medical’s product lines, sales personnel and
marketing operations into our
business;
|
|
·
|
the
diversion of our resources and our management’s attention from other
business concerns;
|
|
·
|
the
loss of any key distributors;
|
|
·
|
the
loss of any key employees; and
|
|
·
|
the
assumption of unknown liabilities.
|
In
addition, Blackstone Medical’s business is subject to many of the same risks and
uncertainties that apply to our other business operations, such as risks
relating to the protection of Blackstone Medical’s intellectual property and
proprietary rights, including patents that it owns or licenses. If Blackstone
Medical’s intellectual property and proprietary rights are challenged, or if
third parties claim that Blackstone Medical infringes on their proprietary
rights, our business could be adversely affected.
Failure
to overcome these risks or any other problems encountered in connection with
the
acquisition of Blackstone Medical could adversely affect our business, prospects
and financial condition. In addition, if Blackstone Medical’s operations and
financial results do not meet our expectations, we may not realize synergies,
operating efficiencies, market position, or revenue growth we anticipate
from
the acquisition.
We
may be subject to extensive government regulation that increases our costs
and
could limit our ability to market or sell our products.
The
medical devices we manufacture and market are subject to rigorous regulation
by
the Food and Drug Administration, or FDA, and numerous other federal, state
and
foreign governmental authorities. These authorities regulate the development,
approval, classification, testing, manufacture, labeling, marketing and sale
and
recall of medical devices. For a description of these regulations, see
Item 1 - “Business - Government Regulation” in our Annual Report on Form
10-K for the year ended December 31, 2005.
The
approval by governmental authorities, including the FDA in the United States,
is
generally required before any medical devices may be marketed in the United
States or other countries. We cannot predict whether in the future, the U.S.
or
foreign governments may impose regulations that have a material adverse effect
on our business, financial condition or results of operations. The process
of
obtaining FDA and other regulatory approvals to develop and market a medical
device can be costly and time-consuming, and is subject to the risk that
such
approvals will not be granted on a timely basis if at all. The regulatory
process may delay or prohibit the marketing of new products and impose
substantial additional costs if the FDA lengthens review times for new devices.
The
FDA
has the ability to change the regulatory classification of an approved device
from a higher to a lower regulatory classification which could materially
adversely impact our ability to market or sell our devices. Our subsidiary,
Orthofix, Inc. is currently involved in a proceeding before the FDA addressing
whether the FDA classification of our Physio-Stim and Spinal-Stim bone growth
stimulation products should be reclassified from FDA Class III to FDA Class
II.
We are actively participating in this proceeding and maintain that the current
FDA Class III classification is correct. A meeting was held on June 2, 2006
before the FDA’s Orthopedic and Rehabilitation Devices panel for the purpose of
gathering information to allow the panel to recommend to the FDA whether
reclassification is appropriate. At the conclusion of the meeting, the Panel
determined that the present FDA Class III classification for the products
at
issue is proper. We do not know when or whether the FDA will reach a
determination on this classification issue or whether any such determination
would adversely impact our ability to market or sell these
products.
We
face risks related to foreign currency exchange rates.
Because
some of our revenue, operating expenses, assets and liabilities are denominated
in foreign currencies, we are subject to foreign exchange risks that could
adversely affect our operations and reported results. To the extent that
we incur expenses or earn revenue in currencies other than the U.S. dollar,
any
change in the values of those foreign currencies relative to the U.S. dollar
could cause our profits to decrease or our products to be less competitive
against those of our competitors. To the extent that our current assets
denominated in foreign currency are greater or less than our current liabilities
denominated in foreign currencies, we have potential foreign exchange
exposure. As part of our European restructuring in third quarter 2006, as
of September 30, 2006, we had a Euro denominated receivable of 48.3 million
for
which there was no related Dollar denominated payable. We are exposed to
potential movements in currency rates between the Euro and the Dollar. We
are currently evaluating our options to limit the currency exposure on this
Euro
denominated receivable.
We
have
substantial activities outside of the United States that are subject to the
impact of foreign exchange rates. The fluctuations of foreign exchange
rates during 2006 have had a negative impact of $0.9 million on net sales
outside of the United States. Although we seek to manage our foreign
currency exposure by matching non-dollar revenues and expenses, exchange
rate
fluctuations could have a material adverse effect on our results of operations
in the future. To minimize such exposures, we enter into currency hedges
from time to time. At September 30, 2006, we had outstanding a foreign
currency hedge for 5.0 million Euros to balance our current liabilities
denominated in Euros with our current assets denominated in Euros.
Our
subsidiary Orthofix Holdings, Inc.’s senior secured bank credit facility
contains significant financial and operating restrictions and mandatory
prepayments that may have an adverse effect on our operations and limit our
ability to grow our business.
When
we
acquired Blackstone on September 22, 2006, one of our wholly-owned subsidiaries,
Orthofix Holdings, Inc. (Orthofix Holdings), entered into a senior secured
bank
credit facility with a syndicate of financial institutions to finance the
transaction. Orthofix and certain of Orthofix Holdings’s direct and indirect
subsidiaries, including Orthofix Inc., Breg, and Blackstone have guaranteed
the
obligations of Orthofix Holdings under the senior secured bank facility.
The
senior secured bank facility provides for (1) a seven-year amortizing term
loan
facility of $330.0 million and (2) a six-year revolving credit facility of
$45.0
million upon which we had not drawn as of November 6, 2006.
Further,
in addition to scheduled debt payments, the credit agreement requires us
to make
mandatory prepayments with (a) the excess cash flow (as defined in the credit
agreement) of Orthofix and its subsidiaries, in an amount equal to 50% of
the
excess annual cash flow beginning with the year ending December 31, 2007,
provided, however, if the leverage ratio (as defined in the credit agreement)
is
less than or equal to 1.75 to 1.00, there will be no mandatory excess cash
flow
prepayments, (b) 100% of the net cash proceeds of any debt issuances by Orthofix
or any of its subsidiaries or 50% of the net cash proceeds of equity issuances
by any such party, excluding the exercise of stock options, provided, however,
if the leverage ratio is less than or equal to 1.75 to 1.00 at the end of
the
preceding fiscal year, Orthofix Holdings shall not be required to prepay
the
loans with the proceeds of any such debt or equity issuance, (c) the net
cash
proceeds of asset dispositions over a minimum threshold, or (d) unless
reinvested, insurance proceeds or condemnation awards. These mandatory
prepayments could limit our ability to reinvest in our business.
The
credit agreement contains negative covenants applicable to Orthofix and its
subsidiaries, including restrictions on indebtedness, liens, dividends and
mergers and sales of assets. The credit agreement also 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. See Part I, Item 2 - “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” - “Liquidity and Capital
Resources” of this Form 10-Q.
Exhibit
Number
|
|
Description
|
|
|
|
3.1
|
|
Certificate
of Incorporation of the Company (filed as an exhibit to the Company’s
annual report on Form 20-F dated June 29, 2001 and incorporated
herein by
reference).
|
|
|
|
3.2
|
|
Articles
of Association of the Company as Amended (filed as an exhibit to
the
Company’s quarterly report on Form 10-Q for the quarter ended September
30, 2004 and incorporated herein by reference).
|
|
|
|
10.1
|
|
Orthofix
Inc. Employee Stock Purchase Plan (filed as an exhibit to the Company’s
annual report on Form 10-K for the fiscal year ended December 31,
2002 and
incorporated herein by reference).
|
|
|
|
10.2
|
|
Orthofix
International N.V. Staff Share Option Plan (filed as an exhibit
to the
Company’s annual report on Form 10-K for the fiscal year ended December
31, 2002 and incorporated herein by reference).
|
|
|
|
10.3
|
|
Form
of Performance Accelerated Stock Option under the Staff Share Option
Plan
(filed as an exhibit to the Company’s annual report on Form 10-K for the
fiscal year ended December 31, 2002 and incorporated herein by
reference).
|
|
|
|
10.4
|
|
Form
of Performance Accelerated Stock Option Inducement Agreement (filed
as an
exhibit to the Company’s annual report on Form 10-K for the fiscal year
ended December 31, 2003 and incorporated here in by
reference).
|
|
|
|
10.5
|
|
Orthofix
International N.V. 2004 Long Term Incentive Plan, as amended (filed
as an
exhibit to the Company’s quarterly report on Form 10-Q for the quarter
ended September 30, 2004 and incorporated herein by
reference).
|
|
|
|
10.6
|
|
Form
of Nonqualified Stock Option Agreement Under the Orthofix International
N.V. 2004 Long Term Incentive Plan (filed as an exhibit to the
Company’s
current report on Form 8-K filed April 17, 2006 and incorporated
herein by
reference)
|
|
|
|
10.7
|
|
Form
of Nonqualified Stock Option Agreement for Non-Employee Directors
under
the Orthofix International N.V. 2004 Long Term Incentive Plan (filed
as an
exhibit to the Company’s annual report on Form 10-K for the fiscal year
ended December 31, 2004 and incorporated herein by
reference).
|
|
|
|
10.8
|
|
Employment
Agreement, dated as of April 15, 2005, between Orthofix International
N.V.
and Charles W. Federico (filed as an exhibit to the Company’s current
report on Form 8-K filed April 18, 2005 and incorporated herein
by
reference).
|
|
|
|
10.9
|
|
Employment
Agreement, dated as of July 13, 2006, between the Company and Thomas
Hein
(filed as an exhibit to the Company’s current report on Form 8-K filed
July 18, 2006 and incorporated herein by reference).
|
|
|
|
10.10
|
|
Employment
Agreement, dated as of November 20, 2003, between Orthofix International
N.V. and Bradley R. Mason (filed as an exhibit to the Company’s annual
report on Form 10-K for the fiscal year ended December 31, 2003
and
incorporated herein by
reference).
|
10.11
|
|
Full
Recourse Promissory Note between Orthofix International N.V. and
Charles
W. Federico dated January 10, 2002 (filed as an exhibit to the
Company’s
annual report on Form 10-K for the fiscal year ended December 31,
2002 and
incorporated herein by reference).
|
|
|
|
10.12
|
|
Full
Recourse Promissory Note between Orthofix International N.V. and
Gary D.
Henley dated January 10, 2002 (filed as an exhibit to the Company’s annual
report on Form 10-K for the fiscal year ended December 31, 2002
and
incorporated herein by reference).
|
|
|
|
10.13
|
|
Acquisition
Agreement dated as of November 20, 2003, among Orthofix International
N.V., Trevor Acquisition, Inc., Breg, Inc. and Bradley R. Mason,
as
shareholders’ representative (filed as an exhibit to the Company’s current
report on Form 8-K filed January 8, 2004 and incorporated herein
by
reference).
|
|
|
|
10.14
|
|
Voting
and Subscription Agreement dated as of November 20, 2003, among
Orthofix
International N.V. and the significant shareholders of Breg, Inc.
identified on the signature pages thereto (filed as an exhibit
to the
Company’s current report on Form 8-K filed January 8, 2004 and
incorporated herein by reference).
|
|
|
|
10.15
|
|
Employee
Agreement, as amended, dated December 29, 2005 between Orthofix
International N.V. and Charles W. Federico (filed as an exhibit
to the
Company’s current report on Form 8-K filed December 30, 2005 and
incorporated herein by reference).
|
|
|
|
10.16
|
|
Form
of Indemnity Agreement (filed as an exhibit to the Company’s annual report
on Form 10-K for the fiscal year ended December 31, 2005 and incorporated
herein by reference).
|
|
|
|
10.17
|
|
Settlement
Agreement, dated February 23, 2006, between Intavent Orthofix Limited,
a
wholly-owned subsidiary of Orthofix International N.V. and Galvin
Mould
(filed as an exhibit to the Company’s current report on Form 8-K filed on
April 17, 2006 and incorporated herein by reference).
|
|
|
|
10.18
|
|
Employment
Agreement, dated July 13, 2006, between Orthofix Inc. and Alan
W.
Milinazzo (filed as an exhibit to the Company’s current report on Form 8-K
filed July 18, 2006 and incorporated herein by
reference).
|
|
|
|
10.19
|
|
Employment
Agreement, dated July 13, 2006, between Orthofix Inc. and Raymond
C. Kolls
(filed as an exhibit to the Company’s current report on Form 8-K filed
July 18, 2006 and incorporated herein by reference).
|
|
|
|
10.20
|
|
Employment
Agreement, dated July 13, 2006, between Orthofix Inc. and Michael
M.
Finegan (filed as an exhibit to the Company’s current report on Form 8-K
filed July 18, 2006 and incorporated herein by
reference).
|
|
|
|
10.21
|
|
Credit
Agreement, dated as of September 22, 2006, among Orthofix Holdings,
Inc.,
Orthofix International N.V., certain domestic subsidiaries of Orthofix
International N.V., Colgate Medical Limited, Victory Medical Limited,
Swiftsure Medical Limited, Orthofix UK Ltd, the several banks and
other
financial institutions as may from time to time become parties
thereunder,
and Wachovia Bank, National Association (filed as an exhibit to
the
Company's current report on Form 8-K filed September 27, 2006 and
incorporated herein by reference).
|
|
|
|
10.22
|
|
Agreement
and Plan of Merger, dated as of August 4, 2006, among Orthofix
International N.V., Orthofix Holdings, Inc., New Era Medical Corp.,
Blackstone Medical, Inc., the principal shareholders of Blackstone
Medical, Inc. and William G. Lyons, III, as the Equityholders’
Representative (filed as an exhibit to the Company's Amendment
No. 1 to
current report on Form 8-K filed August 7, 2006 and incorporated
herein by
reference).
|
|
|
Rule
13a-14(a)/15d-14(a) Certification of Chief Executive
Officer.
|
|
|
Rule
13a-14(a)/15d-14(a) Certification of Chief Financial
Officer.
|
|
|
Section
1350 Certification of Chief Executive Officer.
|
|
|
Section
1350 Certification of Chief Financial
Officer.
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant
has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
|
|
ORTHOFIX
INTERNATIONAL N.V.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Date:
November 9, 2006
|
|
By:
|
/s/
Alan W. Milinazzo
|
|
|
|
|
Name:
|
Alan
W. Milinazzo
|
|
|
|
|
Title:
|
Chief
Executive Officer and President
|
|
|
|
|
|
|
|
Date:
November 9, 2006
|
|
By:
|
/s/
Thomas Hein
|
|
|
|
|
Name:
|
Thomas
Hein
|
|
|
|
|
Title:
|
Chief
Financial Officer
|
|