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OFIX Orthofix Medical

Filed: 5 Nov 20, 8:16am

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

(Mark one)

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

 

For the quarterly period ended September 30, 2020

OR

 

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

 

For the transition period from                     to                     .

Commission File Number: 0-19961

 

ORTHOFIX MEDICAL INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

98-1340767

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

 

 

3451 Plano Parkway,

Lewisville, Texas

 

75056

(Address of principal executive offices)

 

(Zip Code)

(214) 937-2000

(Registrant’s telephone number, including area code)

 

Not applicable

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

 

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

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

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

 

Large Accelerated filer

Accelerated filer

 

 

 

 

Non-Accelerated filer

Smaller Reporting Company

 

 

 

 

 

 

Emerging Growth Company

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

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

As of November 2, 2020, 19,333,698 shares of common stock were issued and outstanding.

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Trading Symbol(s)

 

Name of each exchange on which registered

Common stock, $0.10 par value per share

 

OFIX

 

Nasdaq Global Select Market

 

 

 

 


 

 Table of Contents

 

 

 

 

 

 

Page

PART I

 

FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Financial Statements

 

4

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets as of September 30, 2020, and December 31, 2019

 

4

 

 

 

 

 

 

 

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three and nine months ended September 30, 2020 and 2019

 

5

 

 

 

 

 

 

 

Condensed Consolidated Statements of Changes in Shareholders’ Equity for the three and nine months ended September 30, 2020 and 2019

 

6

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2020 and 2019

 

7

 

 

 

 

 

 

 

Notes to the Unaudited Condensed Consolidated Financial Statements

 

8

 

 

 

 

 

Item 2.

 

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

 

21

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

31

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

31

 

 

 

 

 

PART II

 

OTHER INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

32

 

 

 

 

 

Item 1A.

 

Risk Factors

 

32

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

33

 

 

 

 

 

Item 3.

 

Defaults Upon Senior Securities

 

33

 

 

 

 

 

Item 4.

 

Mine Safety Disclosures

 

33

 

 

 

 

 

Item 5.

 

Other Information

 

34

 

 

 

 

 

Item 6.

 

Exhibits

 

34

 

 

 

 

 

SIGNATURES

 

35

2


 

Forward-Looking Statements

This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (“the Exchange Act”), and Section 27A of the Securities Act of 1933, as amended, relating to our business and financial outlook, which are based on our current beliefs, assumptions, expectations, estimates, forecasts and projections. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “intends,” “predicts,” “potential,” or “continue” or other comparable terminology. These forward-looking statements are not guarantees of our future performance and involve risks, uncertainties, estimates, and assumptions that are difficult to predict, including the risks described in Part II Item 1A under the heading Risk Factors of this filing; Part I, Item 1A under the heading Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K); and other Securities and Exchange Commission (“SEC”) filings. In addition to the risks described there, factors that could cause or contribute to such differences may include, but are not limited to, risks relating to the effects of the COVID-19 pandemic on our business, including (i) surgeries that use our products being delayed or cancelled as a result of hospitals and surgery centers being closed or limited to life threatening and/or essential procedures, (ii) portions of our global workforce being unable to work fully and/or effectively due to illness, quarantines, government actions (including "shelter in place" orders or advisories), facility closures, or other reasons related to the pandemic, (iii) disruptions to our supply chain, (iv) customers and payors being unable to satisfy contractual obligations to us, including the ability to make timely payment for purchases, (v) general economic weakness in markets in which we operate affecting customer spending, and (vii) other unpredictable aspects of the pandemic. To the extent that the COVID-19 pandemic continues to adversely affect our business and financial results, it may also have the effect of heightening many of the other risks described in Part I, Item 1A under the heading Risk Factors in our 2019 Form 10-K, such as our ability to generate sufficient cash flows to run our business and our ability to protect our information technology networks and infrastructure from unauthorized access, misuse, malware, phishing, and other events that could have a security impact as a result of our remote working environment or otherwise. As a result of these various risks, our actual outcomes and results may differ materially from those expressed in these forward-looking statements.

 

This list of risks, uncertainties, and other factors is not complete. We discuss some of these matters more fully, as well as certain risk factors that could affect our business, financial condition, results of operations, and prospects, in reports we file from time-to-time with the Securities and Exchange Commission (“SEC”), which are available to read at www.sec.gov. Any or all forward-looking statements that we make may turn out to be wrong (due to inaccurate assumptions that we make or otherwise), and our actual outcomes and results may differ materially from those expressed in these forward-looking statements. You should not place undue reliance on any of these forward-looking statements. Further, any forward-looking statement speaks only as of the date hereof, unless it is specifically otherwise stated to be made as of a different date. We undertake no obligation to update, and expressly disclaim any duty to update, our forward-looking statements, whether as a result of circumstances or events that arise after the date hereof, new information, or otherwise.

 

Trademarks

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

 

3


 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ORTHOFIX MEDICAL INC.

Condensed Consolidated Balance Sheets

 

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

 

September 30,

2020

 

 

December 31,

2019

 

 

 

(Unaudited)

 

 

 

 

 

Assets

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

79,810

 

 

$

69,719

 

Restricted cash

 

 

490

 

 

 

684

 

Accounts receivable, net of allowances of $5,524 and $3,987, respectively

 

 

73,053

 

 

 

86,805

 

Inventories

 

 

82,859

 

 

 

82,397

 

Prepaid expenses and other current assets

 

 

18,457

 

 

 

20,948

 

Total current assets

 

 

254,669

 

 

 

260,553

 

Property, plant, and equipment, net

 

 

63,689

 

 

 

62,727

 

Intangible assets, net

 

 

62,309

 

 

 

54,139

 

Goodwill

 

 

83,503

 

 

 

71,177

 

Deferred income taxes

 

 

38,047

 

 

 

35,117

 

Other long-term assets

 

 

14,915

 

 

 

11,907

 

Total assets

 

$

517,132

 

 

$

495,620

 

Liabilities and shareholders’ equity

 

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

 

Accounts payable

 

$

16,943

 

 

$

19,886

 

Current portion of finance lease liability

 

 

498

 

 

 

323

 

Other current liabilities

 

 

75,938

 

 

 

64,674

 

Total current liabilities

 

 

93,379

 

 

 

84,883

 

Long-term portion of finance lease liability

 

 

22,463

 

 

 

20,648

 

Long-term debt

 

 

 

 

 

 

Other long-term liabilities

 

 

46,394

 

 

 

62,458

 

Total liabilities

 

 

162,236

 

 

 

167,989

 

Contingencies (Note 9)

 

 

 

 

 

 

 

 

Shareholders’ equity

 

 

 

 

 

 

 

 

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

   19,267,420 and 19,022,619 issued and outstanding as of September 30,

   2020 and December 31, 2019, respectively

 

 

1,927

 

 

 

1,902

 

Additional paid-in capital

 

 

285,203

 

 

 

271,019

 

Retained earnings

 

 

68,757

 

 

 

57,749

 

Accumulated other comprehensive loss

 

 

(991

)

 

 

(3,039

)

Total shareholders’ equity

 

 

354,896

 

 

 

327,631

 

Total liabilities and shareholders’ equity

 

$

517,132

 

 

$

495,620

 

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

4


 

ORTHOFIX MEDICAL INC.

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)

 

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

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

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Net sales

 

 

110,985

 

 

$

113,499

 

 

$

288,943

 

 

$

338,461

 

Cost of sales

 

 

26,243

 

 

 

24,896

 

 

 

72,818

 

 

 

74,416

 

Gross profit

 

 

84,742

 

 

 

88,603

 

 

 

216,125

 

 

 

264,045

 

Sales and marketing

 

 

52,926

 

 

 

54,805

 

 

 

150,718

 

 

 

165,363

 

General and administrative

 

 

16,541

 

 

 

21,090

 

 

 

49,453

 

 

 

63,497

 

Research and development

 

 

9,962

 

 

 

7,982

 

 

 

28,691

 

 

 

26,191

 

Acquisition-related amortization and remeasurement (Note 13)

 

 

1,138

 

 

 

23,608

 

 

 

(2,766

)

 

 

31,873

 

Operating income (loss)

 

 

4,175

 

 

 

(18,882

)

 

 

(9,971

)

 

 

(22,879

)

Interest income (expense), net

 

 

(731

)

 

 

186

 

 

 

(2,055

)

 

 

386

 

Other income (expense), net

 

 

1,817

 

 

 

(8,146

)

 

 

6,088

 

 

 

(8,786

)

Income (loss) before income taxes

 

 

5,261

 

 

 

(26,842

)

 

 

(5,938

)

 

 

(31,279

)

Income tax benefit (expense)

 

 

(607

)

 

 

(13,656

)

 

 

17,833

 

 

 

(8,869

)

Net income (loss)

 

$

4,654

 

 

$

(40,498

)

 

$

11,895

 

 

$

(40,148

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss) per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.24

 

 

$

(2.14

)

 

$

0.62

 

 

$

(2.13

)

Diluted

 

 

0.24

 

 

 

(2.14

)

 

 

0.61

 

 

 

(2.13

)

Weighted average number of common shares:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

19,335,718

 

 

 

18,957,876

 

 

 

19,217,057

 

 

 

18,847,728

 

Diluted

 

 

19,398,567

 

 

 

18,957,876

 

 

 

19,319,302

 

 

 

18,847,728

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss), before tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized loss on debt security

 

 

 

 

 

 

 

 

 

 

 

(2,593

)

Reclassification adjustment for amortization of historical unrealized gains on debt security

 

 

 

 

 

(345

)

 

 

 

 

 

(1,034

)

Reclassification adjustment for other-than-temporary impairment on debt security

 

 

 

 

 

(5,193

)

 

 

 

 

 

(5,193

)

Currency translation adjustment

 

 

2,275

 

 

 

(1,893

)

 

 

2,048

 

 

 

(2,195

)

Other comprehensive income (loss) before tax

 

 

2,275

 

 

 

(7,431

)

 

 

2,048

 

 

 

(11,015

)

Income tax related to other comprehensive income (loss)

 

 

 

 

 

1,388

 

 

 

 

 

 

2,200

 

Other comprehensive income (loss), net of tax

 

 

2,275

 

 

 

(6,043

)

 

 

2,048

 

 

 

(8,815

)

Comprehensive income (loss)

 

$

6,929

 

 

$

(46,541

)

 

$

13,943

 

 

$

(48,963

)

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

5


 

ORTHOFIX MEDICAL INC.

Condensed Consolidated Statements of Changes in Shareholders’ Equity

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

 

Number of

Common

Shares

Outstanding

 

 

Common

Shares

 

 

Additional

Paid-in

Capital

 

 

Retained

Earnings

 

 

Accumulated

Other

Comprehensive

Loss

 

 

Total

Shareholders’

Equity

 

At December 31, 2019

 

 

19,022,619

 

 

$

1,902

 

 

$

271,019

 

 

$

57,749

 

 

$

(3,039

)

 

$

327,631

 

Cumulative effect adjustment from adoption of ASU 2016-13

 

 

 

 

 

 

 

 

 

 

 

(887

)

 

 

 

 

 

(887

)

Net income

 

 

 

 

 

 

 

 

 

 

 

25,665

 

 

 

 

 

 

25,665

 

Other comprehensive loss, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,711

)

 

 

(1,711

)

Share-based compensation

 

 

 

 

 

 

 

 

3,859

 

 

 

 

 

 

 

 

 

3,859

 

Common shares issued, net

 

 

33,559

 

 

 

4

 

 

 

808

 

 

 

 

 

 

 

 

 

812

 

At March 31, 2020

 

 

19,056,178

 

 

$

1,906

 

 

$

275,686

 

 

$

82,527

 

 

$

(4,750

)

 

$

355,369

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

(18,424

)

 

 

 

 

 

(18,424

)

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,484

 

 

 

1,484

 

Share-based compensation

 

 

 

 

 

 

 

 

4,699

 

 

 

 

 

 

 

 

 

4,699

 

Common shares issued, net

 

 

152,885

 

 

 

15

 

 

 

1,902

 

 

 

 

 

 

 

 

 

1,917

 

At June 30, 2020

 

 

19,209,063

 

 

$

1,921

 

 

$

282,287

 

 

$

64,103

 

 

$

(3,266

)

 

$

345,045

 

Net income

 

 

 

 

 

 

 

 

 

 

 

4,654

 

 

 

 

 

 

4,654

 

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2,275

 

 

 

2,275

 

Share-based compensation

 

 

 

 

 

 

 

 

3,841

 

 

 

 

 

 

 

 

 

3,841

 

Common shares issued, net

 

 

58,357

 

 

 

6

 

 

 

(925

)

 

 

 

 

 

 

 

 

(919

)

At September 30, 2020

 

 

19,267,420

 

 

$

1,927

 

 

$

285,203

 

 

$

68,757

 

 

$

(991

)

 

$

354,896

 

 

 

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

 

Number of

Common

Shares

Outstanding

 

 

Common

Shares

 

 

Additional

Paid-in

Capital

 

 

Retained

Earnings

 

 

Accumulated

Other

Comprehensive

Income (Loss)

 

 

Total

Shareholders’

Equity

 

At December 31, 2018

 

 

18,579,688

 

 

$

1,858

 

 

$

243,165

 

 

$

87,078

 

 

$

3,296

 

 

$

335,397

 

Cumulative effect adjustment from adoption of ASU 2016-02

 

 

 

 

 

 

 

 

 

 

 

71

 

 

 

 

 

 

71

 

Cumulative effect adjustment from adoption of ASU 2018-02

 

 

 

 

 

 

 

 

 

 

 

(938

)

 

 

938

 

 

 

 

Net income

 

 

 

 

 

 

 

 

 

 

 

897

 

 

 

 

 

 

897

 

Other comprehensive loss, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2,401

)

 

 

(2,401

)

Share-based compensation

 

 

 

 

 

 

 

 

5,685

 

 

 

 

 

 

 

 

 

5,685

 

Common shares issued, net

 

 

211,081

 

 

 

21

 

 

 

4,012

 

 

 

 

 

 

 

 

 

4,033

 

At March 31, 2019

 

 

18,790,769

 

 

$

1,879

 

 

$

252,862

 

 

$

87,108

 

 

$

1,833

 

 

$

343,682

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

(547

)

 

 

 

 

 

(547

)

Other comprehensive loss, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(371

)

 

 

(371

)

Share-based compensation

 

 

 

 

 

 

 

 

5,849

 

 

 

 

 

 

 

 

 

5,849

 

Common shares issued, net

 

 

40,812

 

 

 

4

 

 

 

(823

)

 

 

 

 

 

 

 

 

(819

)

At June 30, 2019

 

 

18,831,581

 

 

$

1,883

 

 

$

257,888

 

 

$

86,561

 

 

$

1,462

 

 

$

347,794

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

(40,498

)

 

 

 

 

 

(40,498

)

Other comprehensive loss, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(6,043

)

 

 

(6,043

)

Share-based compensation

 

 

 

 

 

 

 

 

5,844

 

 

 

 

 

 

 

 

 

5,844

 

Common shares issued, net

 

 

43,603

 

 

 

5

 

 

 

(668

)

 

 

 

 

 

 

 

 

(663

)

At September 30, 2019

 

 

18,875,184

 

 

$

1,888

 

 

$

263,064

 

 

$

46,063

 

 

$

(4,581

)

 

$

306,434

 

 

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

6


 

ORTHOFIX MEDICAL INC.

Condensed Consolidated Statements of Cash Flows

 

 

Nine Months Ended

September 30,

 

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

 

2020

 

 

2019

 

Cash flows from operating activities

 

 

 

 

 

 

 

 

Net income (loss)

 

$

11,895

 

 

$

(40,148

)

Adjustments to reconcile net income (loss) to net cash from operating activities

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

22,299

 

 

 

18,180

 

Amortization of operating lease assets, debt costs, and other assets

 

 

2,811

 

 

 

2,724

 

Provision for expected credit losses

 

 

945

 

 

 

861

 

Deferred income taxes

 

 

(2,471

)

 

 

(3,309

)

Share-based compensation

 

 

12,399

 

 

 

17,378

 

Interest and loss on valuation of investment securities

 

 

219

 

 

 

5,000

 

Change in fair value of contingent consideration

 

 

(7,600

)

 

 

28,140

 

Other

 

 

(1,798

)

 

 

1,307

 

Changes in operating assets and liabilities, net of effects of acquisitions

 

 

 

 

 

 

 

 

Accounts receivable

 

 

11,551

 

 

 

(3,298

)

Inventories

 

 

246

 

 

 

(4,995

)

Prepaid expenses and other current assets

 

 

2,453

 

 

 

1,637

 

Accounts payable

 

 

(3,106

)

 

 

447

 

Other current liabilities

 

 

5,742

 

 

 

347

 

Contract liability (Note 11)

 

 

13,851

 

 

 

 

Payment of contingent consideration

 

 

 

 

 

(1,340

)

Other long-term assets and liabilities

 

 

(17,455

)

 

 

(2,841

)

Net cash from operating activities

 

 

51,981

 

 

 

20,090

 

Cash flows from investing activities

 

 

 

 

 

 

 

 

Acquisition of a business

 

 

(18,000

)

 

 

 

Capital expenditures for property, plant, and equipment

 

 

(11,625

)

 

 

(13,737

)

Capital expenditures for intangible assets

 

 

(1,079

)

 

 

(1,144

)

Purchase of investment securities

 

 

(5,000

)

 

 

 

Asset acquisitions and other investments

 

 

(7,240

)

 

 

(6,400

)

Net cash from investing activities

 

 

(42,944

)

 

 

(21,281

)

Cash flows from financing activities

 

 

 

 

 

 

 

 

Proceeds from revolving credit facility

 

 

100,000

 

 

 

 

Repayment of revolving credit facility

 

 

(100,000

)

 

 

 

Proceeds from issuance of common shares

 

 

3,839

 

 

 

6,821

 

Payments related to withholdings for share-based compensation

 

 

(2,029

)

 

 

(4,271

)

Payment of contingent consideration

 

 

 

 

 

(13,660

)

Payments related to finance lease obligation

 

 

(204

)

 

 

(276

)

Other financing activities

 

 

(1,023

)

 

 

(1,224

)

Net cash from financing activities

 

 

583

 

 

 

(12,610

)

Effect of exchange rate changes on cash

 

 

277

 

 

 

(885

)

Net change in cash, cash equivalents, and restricted cash

 

 

9,897

 

 

 

(14,686

)

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

 

 

70,403

 

 

 

72,189

 

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

 

$

80,300

 

 

$

57,503

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

79,810

 

 

$

56,849

 

Restricted cash

 

 

490

 

 

 

654

 

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

 

$

80,300

 

 

$

57,503

 

 

 

 

 

 

 

 

 

 

Noncash investing activities - Purchase of intangible assets

 

$

1,575

 

 

$

 

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

7


 

ORTHOFIX MEDICAL INC.

Notes to the Unaudited Condensed Consolidated Financial Statements

1. Business, basis of presentation, COVID-19 update, and CARES Act

Description of the Business

Orthofix Medical Inc., together with its subsidiaries (the “Company” or “Orthofix”), is a global medical device company focused on musculoskeletal products and therapies. The Company’s mission is to deliver innovative, quality-driven solutions while partnering with health care professionals on improving patients’ lives. Headquartered in Lewisville, Texas, Orthofix’s spine and orthopedic extremities products are distributed in more than 70 countries via the Company's sales representatives and distributors.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Pursuant to these rules and regulations, certain information and note disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair statement have been included. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s Form 10-K for the year ended December 31, 2019. Operating results for three and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for other interim periods or the year ending December 31, 2020.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. On an ongoing basis, the Company evaluates its estimates, including those related to revenue recognition; contractual allowances; allowance for expected credit losses; inventories; valuation of intangible assets; goodwill; fair value measurements, including contingent consideration; litigation and contingent liabilities; tax matters; and share-based compensation. Actual results could differ from these estimates.

COVID-19 Update

The global Coronavirus Disease 2019 ("COVID-19") pandemic has significantly affected the Company’s patients, communities, employees and business operations. The pandemic has led to the cancellation or deferral of elective surgeries and procedures within certain hospitals, ambulatory surgery centers, and other medical facilities; restrictions on travel; the implementation of physical distancing measures; and the temporary or permanent closure of certain businesses. In addition, broad economic factors resulting from the pandemic, including increased unemployment rates and reduced consumer spending, are affecting the Company’s patients and partnersThese circumstances have negatively affected the Company’s net sales, particularly during the period from March 2020 through May 2020, when elective surgery restrictions were most pronounced, though these effects remain ongoing in certain geographical areas. However, the Company remains focused on protecting the health and wellbeing of its employees, partners, patients, and the communities in which it operates while assuring the continuity of its business operations.

The Company's condensed consolidated financial statements reflect estimates and assumptions made by management that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and reported amounts of revenue and expenses during the reporting periods presented. At this time, the future trajectory of the COVID-19 pandemic remains uncertain, both in the U.S. and in other markets. Progress continues to be made on therapeutic treatments and vaccine candidates, though the efficacy and timing of various treatments and vaccines is uncertain.

Given these various uncertainties, it is unclear the extent to which lingering slowdowns in elective procedures will affect the Company’s business during the remainder of 2020 and beyond. The expected effects of COVID-19 on the Company’s business will depend on various factors including (i) the magnitude and length of increased case waves during the fall and winter, (ii) the comfort level of patients in returning to clinics and hospitals, (iii) the extent to which localized elective surgery shutdowns occur, (iv) the unemployment rate’s effect on potential patients lacking medical insurance coverage, and (v) general hospital capacity constraints occurring because of the need to treat COVID-19 patients.

In addition, while the Company has not seen such effects to date, risk remains that COVID-19 could have material negative effects on contractual counterparties, leading to supply chain disruptions or counterparty payment defaults and bankruptcies (including bankruptcies to hospital systems that significantly rely on revenue from elective surgeries).

These matters are also described in Part II, Item 1A of this Form 10-Q under the heading Risk Factors.

8


 

Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”)

On March 27, 2020, the President of the United States signed the CARES Act into federal law, which is aimed at providing emergency assistance and health care for individuals, families, and businesses affected by the COVID-19 pandemic and generally supporting the U.S. economy. The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer side social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations, and technical corrections to tax depreciation methods for qualified improvement property. The CARES Act had no impact to the Company’s income tax benefit reported within the condensed consolidated statements of operations for the nine months ended September 30, 2020.

The CARES Act has provided financial relief to the Company through other various programs, which are each described in further detail below.

In April 2020, the Company received $13.9 million in funds from the Centers for Medicare & Medicaid Services (“CMS”) Accelerated and Advance Payment Program. For discussion of the Company’s accounting for these funds, see Note 11.

The Company also automatically received, as a durable medical equipment provider, without request, $4.7 million in funds from the U.S. Department of Health and Human Services in April 2020 as part of the Provider Relief Fund. Upon review of the qualifying criteria required to retain the funding, which primarily relate to lost revenues or the incurrence of expenses attributable to COVID-19, it was determined that the Company met the criteria to retain the funds received. During the quarter ended June 30, 2020, the Company recognized other income of $4.7 million related to this in-substance grant.

In addition, as part of the CARES Act, the Company is permitted to defer all employer social security payroll tax payments for the remainder of the 2020 calendar year, such that 50% of the taxes is deferred until December 31, 2021, with the remaining 50% deferred until December 31, 2022. As of September 30, 2020, the Company has deferred $2.2 million associated with this program, all of which is classified within other long-term liabilities.

 

 

2. Recently adopted accounting standards and recently issued accounting pronouncements

 

Adoption of Accounting Standards Update (“ASU”) 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and Subsequent Amendments

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-13 (which was then further clarified in subsequent ASUs), which requires that credit losses for certain types of financial instruments, including trade accounts receivable, be estimated based on expected credit losses among other changes. Effective January 1, 2020, the Company adopted ASU 2016-13 using a modified retrospective approach. Therefore, results for reporting periods after January 1, 2020 are presented under Topic 326, while prior period amounts are not adjusted and continue to be reported in accordance with the historical accounting guidance. See Note 11 for additional discussion of the Company’s adoption of Topic 326 and its resulting accounting policies.

Adoption of ASU 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment

In January 2017, the FASB issued ASU 2017-04, which eliminates Step 2 of the previous goodwill impairment test, which required a hypothetical purchase price allocation to measure goodwill impairment. Under ASU 2017-04, a goodwill impairment loss will now be measured as the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the recorded amount of goodwill. The Company adopted this ASU effective January 1, 2020 on a prospective basis. Adoption of this ASU did not impact the Company’s condensed consolidated balance sheet, statements of operations, or cash flows, but is expected to impact the measurement of any future goodwill impairment.

Adoption of ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement

In August 2018, the FASB issued ASU 2018-13, which eliminates certain disclosures, such as the amount and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, and adds new disclosure requirements for Level 3 measurements. The Company adopted this ASU effective January 1, 2020, with certain provisions of the ASU applied retrospectively and other provisions provided prospectively. Adoption of this ASU did not impact the Company’s condensed consolidated balance sheet, statements of operations, or cash flows; however, adoption of the ASU did result in modified disclosures in Note 8.

9


 

Adoption of ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract

In August 2018, the FASB issued ASU 2018-15, which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The accounting for the service element of a hosting arrangement that is a service contract was not affected by the amendments in this update. The Company adopted this ASU effective January 1, 2020 on a prospective basis. Adoption of this ASU did not have a material impact to the Company’s condensed consolidated balance sheet, statements of operations, or cash flows, but is expected to impact future cloud computing arrangements.

Adoption of ASU 2020-04, Reference Rate Reform (Topic 848)

In March 2020, the FASB issued ASU 2020-04, which provides temporary optional guidance to ease the potential financial reporting burden of the expected market transition away from LIBOR. The new guidance provides optional expedients and exceptions for applying U.S. GAAP to contract modifications, hedge accounting, and other transactions affected by reference rate reform if certain criteria are met through December 31, 2022. The Company adopted this ASU effective March 12, 2020, the effective date of the ASU, on a prospective basis. Adoption of this ASU did not have a material impact to the Company’s condensed consolidated balance sheet, statements of operations, or cash flows, but is expected to impact the future borrowing rate used for the Company’s secured revolving credit facility.

Recently issued accounting pronouncements

 

Topic

 

Description of Guidance

 

Effective Date

 

Status of Company's Evaluation

Simplifying the accounting for income taxes (ASU 2019-12)

 

Reduces the complexity of accounting for income taxes by eliminating certain exceptions to the general principles in ASC 740, Income Taxes. Additionally, the ASU simplifies U.S. GAAP by amending the requirements related to the accounting for "hybrid" tax regimes and also adding the requirement to evaluate when a step up in the tax basis of goodwill should be considered part of the business combination and when it should be considered a separate transaction. Certain of the provisions are to be applied retrospectively with other provisions applied prospectively.

 

January 1, 2021

 

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

 

 

3. Acquisitions

FITBONE Asset Purchase Agreement

On February 3, 2020, the Company, through a wholly owned subsidiary, entered into an Asset Purchase Agreement (the “Purchase Agreement”) with Wittenstein SE (“Wittenstein”), a privately-held German-based company, to acquire assets associated with the FITBONE intramedullary lengthening system for limb lengthening of the femur and tibia bones. Under the terms of the Purchase Agreement, as consideration for the acquired assets, the Company paid $18.0 million in cash consideration and entered into a Contract Manufacturing and Supply Agreement (“CMSA”) with Wittenstein. The Company has accounted for this acquisition as a business combination. The acquisition was completed on March 26, 2020.

The following table summarizes the preliminary estimated fair values of assets acquired and liabilities assumed at the acquisition date. A final determination of the allocation of the purchase price to assets acquired and liabilities assumed has not been made and is subject to completion of the Company’s valuation of the assets acquired and liabilities assumed, which may take up to one year.

10


 

(U.S. Dollars, in thousands)

 

Preliminary Acquisition Date Fair Value

 

 

Balance Sheet Classification

 

Assigned Useful Life

Assets acquired

 

 

 

 

 

 

 

 

Inventories

 

$

528

 

 

Inventories

 

 

Developed technology

 

 

4,500

 

 

Intangible assets, net

 

8 years

Customer relationships

 

 

800

 

 

Intangible assets, net

 

15 years

Trade name

 

 

600

 

 

Intangible assets, net

 

15 years

In-process research and development ("IPR&D")

 

 

300

 

 

Intangible assets, net

 

Indefinite

Total identifiable assets acquired

 

 

6,728

 

 

 

 

 

Goodwill

 

 

11,272

 

 

 

 

 

Total fair value of consideration transferred

 

$

18,000

 

 

 

 

 

The Company recorded goodwill of $11.3 million in connection with the acquisition, of which $11.1 million was assigned to the Global Extremities reporting segment and $0.2 million was assigned to the Global Spine reporting segment. Specifically, goodwill includes synergies associated with the purchase of the acquired assets and is expected to be deductible for tax purposes.

The IPR&D intangible asset is considered an indefinite-lived asset until the completion or abandonment of the associated research and development efforts. Accordingly, during the development period after the acquisition, this asset is not amortized but, instead, is subject to impairment review and testing provisions. Upon completion of the IPR&D project, the Company will determine the useful life of the asset and begin amortization.

The Company also entered into a CMSA with Wittenstein for an initial term of up to two years to manufacture the FITBONE product line. The Company is accounting for the CMSA as a finance lease. See Note 5 for further discussion of the recognized finance lease.

The Company did 0t recognize significant acquisition-related costs during the three months ended September 30, 2020 and 2019 and recorded $0.4 million and $0.3 million of acquisition related costs during the nine months ended September 30, 2020 and 2019, respectively. These costs are included in the condensed consolidated statements of operations within general and administrative expenses. Additionally, the Company recognized $0.8 million and $1.0 million in revenues related to the FITBONE product line during the three and nine months ended September 30, 2020.

Distributor Acquisition

In July 2020, the Company, through a wholly owned subsidiary, entered into an agreement to acquire certain assets of a medical device distributor. The Company agreed to pay consideration of up to $7.6 million in accordance with the parties’ agreement. The following table summarizes the fair values of assets acquired and of consideration paid:

(U.S. Dollars, in thousands)

 

Fair Value

 

 

Balance Sheet Classification

 

Assigned Useful Life

Fair Value of Consideration Transferred

 

 

 

 

 

 

 

 

Cash paid or payable

 

$

7,200

 

 

 

 

 

Contingent consideration

 

 

375

 

 

 

 

 

Total fair value of consideration transferred

 

$

7,575

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair value of assets acquired

 

 

 

 

 

 

 

 

Customer relationships

 

$

7,340

 

 

Intangible assets, net

 

5 years

Assembled workforce

 

 

235

 

 

Intangible assets, net

 

5 years

Total fair value of assets acquired

 

$

7,575

 

 

 

 

 

 

 

11


 

4. Inventories

Inventories were as follows:

(U.S. Dollars, in thousands)

 

September 30,

2020

 

 

December 31,

2019

 

Raw materials

 

$

7,779

 

 

$

9,587

 

Work-in-process

 

 

12,050

 

 

 

14,027

 

Finished products

 

 

26,384

 

 

 

20,712

 

Field/consignment

 

 

36,646

 

 

 

38,071

 

Inventories

 

$

82,859

 

 

$

82,397

 

 

5. Leases

A summary of the Company’s lease portfolio as of September 30, 2020 and December 31, 2019 is presented in the table below:

(U.S. Dollars, in thousands)

 

Classification

 

September 30,

2020

 

December 31, 2019

 

Right-of-use assets ("ROU assets")

 

 

 

 

 

 

 

 

 

Operating leases

 

Other long-term assets

 

$

4,972

 

$

5,798

 

Finance leases

 

Property, plant and equipment, net

 

 

21,001

 

 

20,207

 

Total ROU assets

 

 

 

 

25,973

 

 

26,005

 

 

 

 

 

 

 

 

 

 

 

Lease Liabilities

 

 

 

 

 

 

 

 

 

Current

 

 

 

 

 

 

 

 

 

Operating leases

 

Other current liabilities

 

 

1,999

 

 

1,875

 

Finance leases

 

Current portion of finance lease liability

 

 

498

 

 

323

 

Long-term

 

 

 

 

 

 

 

 

 

Operating leases

 

Other long-term liabilities

 

 

3,166

 

 

4,084

 

Finance leases

 

Long-term portion of finance lease liability

 

 

22,463

 

 

20,648

 

Total lease liabilities

 

 

 

$

28,126

 

$

26,930

 

 

Supplemental cash flow information related to leases was as follows:

(U.S. Dollars, in thousands)

 

Nine Months Ended

September 30, 2020

 

 

Nine Months Ended

September 30, 2019

 

Cash paid for amounts included in the measurement of lease liabilities

 

 

 

 

 

 

 

 

Operating cash flows from operating leases

 

$

3,170

 

 

$

3,037

 

Operating cash flows from finance leases

 

 

458

 

 

 

687

 

Financing cash flows from finance leases

 

 

204

 

 

 

276

 

ROU assets obtained in exchange for lease obligations

 

 

 

 

 

 

 

 

Operating leases

 

 

619

 

 

 

598

 

Finance leases

 

 

1,949

 

 

 

21,179

 

 

Wittenstein Contract Manufacturing and Supply Agreement

In March 2020, the Company entered into a CMSA with Wittenstein for an initial term of two years to manufacture the FITBONE product line. As consideration, the Company will pay $2.0 million to Wittenstein at the conclusion of the CMSA if certain conditions are met in relation to the prompt delivery of manufactured products. The Company is accounting for the CMSA as a finance lease as the Company has the right to direct the use of and to obtain substantially all of the economic benefits of the dedicated equipment used to manufacture the products and has the option to obtain title and possession of the equipment at the conclusion of the CMSA.  As a result, the Company recognized both a finance lease liability and a related ROU asset of $1.9 million as of the commencement date of the CMSA.

 

12


 

6.  Other current liabilities

In December 2019, the Company approved and initiated a targeted restructuring plan in the U.S. to streamline costs and to better align talent with the Company’s strategic initiatives. The plan consists primarily of the realignment of certain personnel, representing a limited number of positions, which require severance payments. As of December 31, 2019, the Company recorded a liability of $3.2 million in connection with this activity, all of which was recognized in 2019 within general and administrative expenses. During the three and nine months ended September 30, 2020, the Company recorded additional accruals of $1.1 million and $2.5 million, respectively, associated with these activities. Payments were made during the three and nine months ended September 30, 2020 totaling $1.1 million and $2.1 million, respectively. As of September 30, 2020, the Company had a liability of $3.7 million associated with the restructuring plan.

 

7. Long-term debt

As a precautionary measure to increase the Company’s cash position and preserve financial flexibility during the uncertainty resulting from the COVID-19 pandemic, the Company completed a borrowing of $100.0 million under its five year $300 million secured revolving credit facility on April 16, 2020. The Company made payments of $100.0 million in the third quarter of 2020 to fully pay down the outstanding balance. As of September 30, 2020, the Company had no borrowings outstanding under the secured revolving credit facility and was in compliance with all required financial covenants.

In addition, the Company had 0 borrowings on its €5.5 million ($6.4 million) available lines of credit in Italy as of September 30, 2020.

 

8. Fair value measurements and investments

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

 

 

 

September 30,

2020

 

 

December 31,

2019

 

(U.S. Dollars, in thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bone Biologics equity securities

 

$

 

 

$

 

 

$

 

 

$

 

 

$

219

 

Total

 

$

 

 

$

 

 

$

 

 

$

 

 

$

219

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Spinal Kinetics contingent consideration

 

$

 

 

$

 

 

$

(35,100

)

 

$

(35,100

)

 

$

(42,700

)

Other contingent consideration

 

$

 

 

$

 

 

$

(375

)

 

$

(375

)

 

$

 

Deferred compensation plan

 

 

 

 

 

(1,366

)

 

 

 

 

 

(1,366

)

 

 

(1,255

)

Total

 

$

 

 

$

(1,366

)

 

$

(35,475

)

 

$

(36,841

)

 

$

(43,955

)

 

Contingent Consideration

The Company recognized a contingent consideration obligation in connection with the acquisition of Spinal Kinetics in 2018. The Spinal Kinetics contingent consideration consists of potential future milestone payments of up to $60.0 million in cash. The milestone payments included (i) $15.0 million upon U.S. Food and Drug Administration (“FDA”) approval of the M6-C artificial cervical disc (the “FDA Milestone”) and (ii) revenue-based milestone payments of up to $45.0 million in connection with future sales of the acquired artificial discs. Milestones must be achieved within five years of April 30, 2018 to trigger applicable payments. In February 2019, the FDA Milestone was achieved and paid.

The estimated fair value of the remaining Spinal Kinetics contingent consideration was $35.1 million as of September 30, 2020. The estimated fair value reflects assumptions made by management as of September 30, 2020, including the impact of COVID-19 on significant unobservable assumptions, such as the expected timing and volume of elective procedures and the impact of these procedures on future revenues. However, the impact of COVID-19 on the Company’s business remains uncertain and difficult to predict. As information surrounding the pandemic is continuing to evolve, the actual amount ultimately paid could be higher or lower than the fair value of the remaining contingent consideration. At September 30, 2020, the Company has classified $14.7 million of the liability attributable to the revenue-based milestone within other current liabilities, as the Company currently expects to pay one of the revenue-based milestones in the next twelve months, and the remaining $20.4 million within other long-term liabilities. Any changes in fair value are recorded as an operating expense within acquisition-related amortization and remeasurement.

13


 

The following table provides a reconciliation of the beginning and ending balances for the Spinal Kinetics contingent consideration measured at estimated fair value using significant unobservable inputs (Level 3):

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

Spinal Kinetics contingent consideration estimated fair value at January 1

 

$

42,700

 

 

$

28,560

 

Increase (decrease) in fair value recognized in acquisition-related amortization and remeasurement

 

 

(7,600

)

 

 

28,140

 

Payment made

 

 

 

 

 

(15,000

)

Spinal Kinetics contingent consideration estimated fair value at September 30

 

$

35,100

 

 

$

41,700

 

The $7.6 million decrease in fair value in 2020 is primarily attributable to a change in management’s forecast of future net sales of artificial discs because of uncertainty in the market and the economy attributable to COVID-19.

The Company estimated the fair value of the remaining potential future revenue-based milestone payments using a Monte Carlo simulation and a discounted cash flow model. This fair value measurement is based on significant inputs that are unobservable in the market and thus represents a Level 3 measurement. The key assumptions in applying the valuation model include the Company’s forecasted future revenues for Spinal Kinetics products, the expected timing of payment, applicable discount rates applied, and assumptions for potential volatility of the Company’s forecasted revenue. Significant changes in these assumptions could result in a significantly higher or lower fair value.

The following table provides a range of key assumptions used within the valuation as of September 30, 2020.

 

(U.S. Dollars, in thousands)

 

Fair Value as of

September 30, 2020

 

 

Valuation Technique

 

Unobservable inputs

 

Range

Spinal Kinetics contingent consideration

 

$

35,100

 

 

Discounted cash flow

 

Revenue discount rate

 

7.41% - 7.49%

 

 

 

 

 

 

 

 

Payment discount rate

 

4.33% - 4.40%

 

 

 

 

 

 

 

 

Projected year of payment

 

2021 - 2022

 

Other contingent consideration is attributable to an agreement closed in the third quarter of 2020 to acquire certain assets of a medical device distributor as a portion of the consideration is based upon meeting certain revenue-based targets.

 

eNeura Debt Security and Warrant

Until October of 2019, the Company held a debt security and a related warrant to purchase common stock of eNeura, Inc. (“eNeura”), a privately held medical technology company that is developing devices for the treatment of migraines. On October 25, 2019, the Company and eNeura settled the debt security for a $4.0 million cash payment and agreed to transfer the warrant to eNeura as part of such settlement. As such, at September 30, 2019, the Company determined the Restructured Debt Security and Warrant were impaired and adjusted the carrying value of the Restructured Debt Security to $4.0 million, its settlement value, by recording a net other-than-temporary impairment of $6.5 million in other expense, net, which includes a reclassification of the related unrealized gains included in accumulated other comprehensive income of $5.2 million. 

The following table provides a reconciliation of the beginning and ending balances for the eNeura debt security and warrant measured and reflected in the condensed consolidated balance sheets at fair value using significant unobservable inputs (Level 3) prior to the settlement discussed above:

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

eNeura debt security and Warrant at January 1

 

$

 

 

$

17,820

 

Gains or losses recorded for the period

 

 

 

 

 

 

 

 

Recognized in other comprehensive income (loss)

 

 

 

 

 

(2,593

)

Change in classification of debt security to held to maturity

 

 

 

 

 

(15,227

)

Issuance of Warrant as consideration for prior extension of debt maturity date

 

 

 

 

 

491

 

Impairment of warrant

 

 

 

 

 

(491

)

eNeura debt security and Warrant at September 30

 

$

 

 

$

 

 

14


 

 

9. Contingencies

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

Italian Medical Device Payback (“IMDP”)

In 2015, the Italian Parliament introduced rules for entities that supply goods and services to the Italian National Healthcare System. This healthcare law is expected to impact the business and financial reporting of companies operating in the medical technology sector that sell medical devices in Italy. A key provision of the law is a ‘payback’ measure, requiring medical device companies in Italy to make payments to the Italian government if medical device expenditures exceed regional maximum ceilings. Companies are required to make payments equal to a percentage of expenditures exceeding maximum regional caps. There is considerable uncertainty about how the law will operate and what the exact timeline is for finalization. The Company’s current assessment of the IMDP involves significant judgment regarding the expected scope and actual implementation terms of the measure as the latter have not been clarified to date by Italian authorities. The Company accounts for the estimated cost of the IMDP as sales and marketing expense and recorded expense of $0.4 million and $0.3 million for the three months ended September 30, 2020 and 2019, respectively, and $1.1 million and $1.0 million for the nine months ended September 30, 2020 and 2019, respectively. As of September 30, 2020, the Company has accrued $6.3 million related to the IMDP, which it has classified within other long-term liabilities; however, the actual liability could be higher or lower than the amount accrued once the law has been clarified by the Italian authorities.

Brazil

In September 2019, in relation to an ongoing legal dispute with a former Brazilian distributor, approximately $0.5 million (based upon foreign exchange rates as of September 30, 2020) of the Company’s cash in Brazil was frozen upon request to satisfy a judgment. Although the Company is appealing the judgment, this cash has been reclassified to restricted cash. As of September 30, 2020, the Company has an accrual of $1.3 million related to this matter.

 

10. Accumulated other comprehensive loss

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

 

(U.S. Dollars, in thousands)

 

Currency

Translation

Adjustments

 

 

 

Accumulated Other

Comprehensive Loss

 

Balance at December 31, 2019

 

$

(3,039

)

 

 

$

(3,039

)

Other comprehensive income

 

 

2,048

 

 

 

 

2,048

 

Income taxes

 

 

 

 

 

 

 

Balance at September 30, 2020

 

$

(991

)

 

 

$

(991

)

 

11. Revenue recognition and accounts receivable

Revenue Recognition

The Company has two reporting segments, which consist of Global Spine and Global Extremities. Within the Global Spine reporting segment there are three product categories: Bone Growth Therapies, Spinal Implants and Biologics.

The tables below presents net sales by major product category by reporting segment:

 

 

Three Months Ended September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

Change

 

Bone Growth Therapies

 

$

47,066

 

 

$

48,836

 

 

 

-3.6

%

Spinal Implants

 

 

25,505

 

 

 

22,947

 

 

 

11.1

%

Biologics

 

 

15,245

 

 

 

16,308

 

 

 

-6.5

%

Global Spine

 

 

87,816

 

 

 

88,091

 

 

 

-0.3

%

Global Extremities

 

 

23,169

 

 

 

25,408

 

 

 

-8.8

%

Net sales

 

$

110,985

 

 

$

113,499

 

 

 

-2.2

%

 

15


 

 

 

Nine Months Ended September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

Change

 

Bone Growth Therapies

 

$

120,888

 

 

$

146,228

 

 

 

-17.3

%

Spinal Implants

 

 

67,025

 

 

 

69,076

 

 

 

-3.0

%

Biologics

 

 

40,319

 

 

 

48,784

 

 

 

-17.4

%

Global Spine

 

 

228,232

 

 

 

264,088

 

 

 

-13.6

%

Global Extremities

 

 

60,711

 

 

 

74,373

 

 

 

-18.4

%

Net sales

 

$

288,943

 

 

$

338,461

 

 

 

-14.6

%

 

Product Sales and Marketing Service Fees

The table below presents product sales and marketing service fees, which are both components of net sales:

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Product sales

 

$

96,305

 

 

$

97,833

 

 

$

250,161

 

 

$

291,632

 

Marketing service fees

 

 

14,680

 

 

 

15,666

 

 

 

38,782

 

 

 

46,829

 

Net sales

 

$

110,985

 

 

$

113,499

 

 

$

288,943

 

 

$

338,461

 

 

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

Adoption of ASU 2016-13

As discussed in Note 2, the Company adopted ASU No. 2016-13 - Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and subsequent amendments, using a modified retrospective approach. Adoption of the new standard resulted in an increase to the Company’s allowance for expected credit losses of $1.1 million, an increase in deferred income tax assets of $0.2 million, and a decrease in retained earnings of $0.9 million as of January 1, 2020. The net impact of adoption to the Company’s balance sheet as of January 1, 2020 is presented in the table below. The standard did not have a material impact to the Company’s condensed consolidated statements of operations or cash flows. 

 

(U.S. Dollars, in thousands)

 

December 31, 2019

 

 

Impact

of Adoption

of ASC 326

 

 

January 1, 2020

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

 

 

 

 

 

Cash, cash equivalents, and restricted cash

 

$

70,403

 

 

$

 

 

$

70,403

 

Accounts receivable, net

 

 

86,805

 

 

 

(1,120

)

 

 

85,685

 

Inventories

 

 

82,397

 

 

 

 

 

 

82,397

 

Prepaid expenses and other current assets

 

 

20,948

 

 

 

 

 

 

20,948

 

Total current assets

 

 

260,553

 

 

 

(1,120

)

 

 

259,433

 

Deferred income taxes

 

 

35,117

 

 

 

233

 

 

 

35,350

 

Other long-term assets

 

 

199,950

 

 

 

 

 

 

199,950

 

Total assets

 

$

495,620

 

 

$

(887

)

 

$

494,733

 

Liabilities and shareholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

Total liabilities

 

$

167,989

 

 

$

 

 

$

167,989

 

Shareholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

Common shares

 

$

1,902

 

 

$

 

 

$

1,902

 

Additional paid-in capital

 

 

271,019

 

 

 

 

 

 

271,019

 

Retained earnings

 

 

57,749

 

 

 

(887

)

 

 

56,862

 

Accumulated other comprehensive loss

 

 

(3,039

)

 

 

 

 

 

(3,039

)

Total shareholders’ equity

 

 

327,631

 

 

 

(887

)

 

 

326,744

 

Total liabilities and shareholders’ equity

 

$

495,620

 

 

$

(887

)

 

$

494,733

 

 

16


 

Accounts receivable and related allowances

Subsequent to the adoption of ASU 2016-13, the Company’s allowance for expected credit losses represents the portion of the receivable’s amortized cost basis that an entity does not expect to collect over the receivable’s contractual life, considering past events, current conditions, and reasonable and supportable forecasts of future economic conditions.

The process for estimating the ultimate collection of accounts receivable involves significant assumptions and judgments. The determination of the contractual life of accounts receivable, the aging of outstanding receivables, as well as the historical collections, write-offs, and payor reimbursement experience over the estimated contractual lives of such receivables, are integral parts of the estimation process related to reserves for expected credit losses and the establishment of contractual allowances. Accounts receivable are analyzed on a quarterly basis to assess the adequacy of both reserves for expected credit losses and contractual allowances. Revisions in allowances for expected credit loss estimates are recorded as an adjustment to bad debt expense within sales and marketing expenses. Revisions to contractual allowances are recorded as an adjustment to net sales. These estimates are periodically tested against actual collection experience. In addition, the Company analyzes its receivables by geography and by customer type, where appropriate, in developing estimates for expected credit losses.

The following table provides a detail of changes in the Company’s allowance for expected credit losses for the three and nine months ended September 30, 2020:

(U.S. Dollars, in thousands)

 

Three Months Ended September 30, 2020

 

 

Nine Months Ended September 30, 2020

 

Allowance for expected credit losses beginning balance

 

$

6,364

 

 

$

3,987

 

Impact of adoption of ASU 2016-13

 

 

 

 

 

1,120

 

Current period provision (recovery) for expected credit losses

 

 

(619

)

 

 

945

 

Writeoffs charged against the allowance and other

 

 

(309

)

 

 

(647

)

Effect of changes in foreign exchange rates

 

 

88

 

 

 

119

 

Allowance for expected credit losses ending balance

 

$

5,524

 

 

$

5,524

 

 

Contract Liabilities

The Company’s contract liabilities largely relate to a prepayment of $13.9 million received in April 2020 from the CMS as part of the Accelerated and Advance Payment Program of the CARES Act intended to increase cash flow to providers of services and suppliers impacted by the COVID-19 pandemic.

On October 1, 2020, the President of the United States signed the “Continuing Appropriations Act, 2021 and Other Extensions Act,” which relaxed a number of the Medicare Accelerated and Advance Payment Programs recoupment terms for providers and suppliers that received funds from the program. Under these new terms, recoupment will be delayed until one year after payment was issued. After that first year, Medicare will automatically recoup 25% of Medicare payments otherwise owed to the provider or supplier for 11 months. At the end of the 11-month period, recoupment will increase to 50% for another 6 months. Thus, during these time periods, rather than receiving the full amount of payment for newly submitted claims, the Company’s outstanding accelerated / advance payment balance will be reduced by the recoupment amount until the full balance has been repaid.

As of September 30, 2020, the Company has classified $6.9 million of this contract liability within other current liabilities and $6.9 million within other long-term liabilities based upon the Company’s estimates of when such funds will be recouped. The Company did not recognize any net sales during the three and nine months ended September 30, 2020, respectively, attributable to the satisfaction of performance obligations related to the CMS prepayment.

Other Contract Assets

The Company’s contract assets, excluding trade accounts receivable (“Other Contract Assets”), largely consist of payments made to certain distributors to obtain contracts, gain access to customers in certain territories, and to provide the benefit of the exclusive distribution of Orthofix products. Other Contract Assets are included in other long-term assets or other current assets, dependent upon the original term of the related agreement, and totaled $2.3 million and $3.7 million as of September 30, 2020, and December 31, 2019, respectively.

17


 

 

12. Business segment information

The Company has 2 reporting segments: Global Spine and Global Extremities. The primary metric used in managing the Company is earnings before interest, tax, depreciation, and amortization (“EBITDA”). Corporate activities are comprised of the operating expenses and activities of the Company not necessarily identifiable within the two reporting segments, such as human resources, finance, legal, and information technology functions. The table below presents EBITDA by reporting segment: 

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Global Spine

 

$

19,960

 

 

$

(6,033

)

 

$

38,670

 

 

$

21,065

 

Global Extremities

 

 

1,258

 

 

 

1,229

 

 

 

(3,995

)

 

 

3,806

 

Corporate

 

 

(6,196

)

 

 

(15,949

)

 

 

(16,259

)

 

 

(38,356

)

Total EBITDA

 

$

15,022

 

 

$

(20,753

)

 

$

18,416

 

 

$

(13,485

)

Depreciation and amortization

 

 

(9,030

)

 

 

(6,275

)

 

 

(22,299

)

 

 

(18,180

)

Interest income (expense), net

 

 

(731

)

 

 

186

 

 

 

(2,055

)

 

 

386

 

Income (loss) before income taxes

 

$

5,261

 

 

$

(26,842

)

 

$

(5,938

)

 

$

(31,279

)

 

Geographical information

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

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Global Spine

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S.

 

$

83,477

 

 

$

82,816

 

 

$

215,819

 

 

$

246,943

 

International

 

 

4,339

 

 

 

5,275

 

 

 

12,413

 

 

$

17,145

 

Total Global Spine

 

 

87,816

 

 

 

88,091

 

 

 

228,232

 

 

 

264,088

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Global Extremities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S.

 

 

6,356

 

 

 

6,636

 

 

 

16,439

 

 

 

20,078

 

International

 

 

16,813

 

 

 

18,772

 

 

 

44,272

 

 

 

54,295

 

Total Global Extremities

 

 

23,169

 

 

 

25,408

 

 

 

60,711

 

 

 

74,373

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

U.S.

 

 

89,833

 

 

 

89,452

 

 

 

232,258

 

 

 

267,021

 

International

 

 

21,152

 

 

 

24,047

 

 

 

56,685

 

 

 

71,440

 

Net sales

 

$

110,985

 

 

$

113,499

 

 

$

288,943

 

 

$

338,461

 

 

13. Acquisition-related amortization and remeasurement

Acquisition-related amortization and remeasurement consists of amortization related to intangible assets acquired through business combinations or asset acquisitions and the remeasurement of any related contingent consideration arrangement. Components of acquisition-related amortization and remeasurement are as follows:

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Changes in fair value of contingent consideration

 

$

(700

)

 

$

22,270

 

 

$

(7,600

)

 

$

28,140

 

Amortization of acquired intangibles

 

 

1,838

 

 

 

1,338

 

 

 

4,834

 

 

 

3,733

 

Total

 

$

1,138

 

 

$

23,608

 

 

$

(2,766

)

 

$

31,873

 

 

18


 

14. Share-based compensation

Components of share-based compensation expense are as follows:

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Cost of sales

 

$

149

 

 

$

169

 

 

$

535

 

 

$

536

 

Sales and marketing

 

 

668

 

 

 

583

 

 

 

2,897

 

 

 

1,885

 

General and administrative

 

 

2,770

 

 

 

4,760

 

 

 

7,939

 

 

 

13,888

 

Research and development

 

 

254

 

 

 

332

 

 

 

1,028

 

 

 

1,069

 

Total

 

$

3,841

 

 

$

5,844

 

 

$

12,399

 

 

$

17,378

 

 

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Stock options

 

$

786

 

 

$

599

 

 

$

1,840

 

 

$

3,637

 

Time-based restricted stock awards and units

 

 

1,632

 

 

 

3,805

 

 

 

6,804

 

 

 

8,462

 

Market-based restricted stock units

 

 

1,049

 

 

 

1,092

 

 

 

2,529

 

 

 

4,015

 

Stock purchase plan

 

 

374

 

 

 

348

 

 

 

1,226

 

 

 

1,264

 

Total

 

$

3,841

 

 

$

5,844

 

 

$

12,399

 

 

$

17,378

 

During the three months ended September 30, 2020 and 2019, the Company issued 58,357 and 43,603 shares, respectively, of common stock related to stock purchase plan issuances, stock option exercises, and the vesting of restricted stock awards and units. During the nine months ended September 30, 2020 and 2019, the Company issued 244,801 and 295,496 shares, respectively, of common stock related to stock purchase plan issuances, stock option exercises, and the vesting of restricted stock awards and units.

 

15. Income taxes

Income tax provisions for interim periods are based on an estimated annual income tax rate, adjusted for discrete tax items.  As a result, the Company’s interim effective tax rates may vary significantly from the statutory tax rate and the annual effective tax rate.

For the three months ended September 30, 2020 and 2019, the effective tax rate was 11.5% and (50.9)%, respectively. For the nine months ended September 30, 2020 and 2019, the effective tax rate was 300.3% and (28.4)%, respectively. The primary factors affecting the Company’s effective tax rate for the three and nine months ended September 30, 2020, were statute expirations related to unrecognized tax benefits, financial deductions not recognized for tax purposes, limits on executive compensation, and reversal of tax benefits related to certain performance stock units forfeited in the current year. The financial deductions not recognized for tax purposes are primarily related to the remeasurement of contingent consideration.

The CARES Act, among other things, includes income tax provisions relating to net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations, and technical corrections to tax depreciation methods for qualified improvement property. As of September 30, 2020, the Company does 0t expect a significant impact to its income tax expense (benefit) for fiscal year 2020 as a result of the CARES Act.

During the three and nine months ended September 30, 2020, the Company recognized a net benefit of less than $0.1 million and $17.8 million, respectively, related to uncertain tax benefits. The net benefit resulted from expired statute of limitations related to certain unrecognized tax benefits. The Company believes it is reasonably possible that, in the next 12 months, the amount of unrecognized tax benefits related to the resolution of federal, state and foreign matters could be reduced by $0.1 million to $0.6 million as audits close and statutes expire.

 

 

19


 

16. Earnings per share (“EPS”)

The Company uses the two-class method of computing basic EPS due to the existence of non-vested restricted stock awards with nonforfeitable rights to dividends or dividend equivalents (referred to as participating securities). For the three and nine months ended September 30, 2020, no significant adjustments were made to net income for purposes of calculating basic and diluted EPS.

The following is a reconciliation of the weighted average shares used in diluted EPS computations.

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

 

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Weighted average common shares-basic

 

 

19,335,718

 

 

 

18,957,876

 

 

 

19,217,057

 

 

 

18,847,728

 

Effect of dilutive securities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unexercised stock options and stock purchase plan

 

 

10,607

 

 

 

 

 

 

41,701

 

 

 

 

Unvested restricted stock awards and units

 

 

52,242

 

 

 

 

 

 

60,544

 

 

 

 

Weighted average common shares-diluted

 

 

19,398,567

 

 

 

18,957,876

 

 

 

19,319,302

 

 

 

18,847,728

 

 

There were 1,771,113 and 1,814,544 weighted average outstanding stock options and restricted stock awards and units not included in the diluted EPS computation for the three months ended September 30, 2020 and 2019, respectively, and 1,527,735 and 1,880,423 weighted average outstanding stock options and restricted stock awards and units not included in the diluted EPS computation for the nine months ended September 30, 2020 and 2019, respectively, because inclusion of these awards was anti-dilutive or, for performance-based and market-based restricted stock awards and units, all necessary conditions had not been satisfied by the end of the respective period.

 

17. Subsequent Events

Neo Medical SA

On October 1, 2020, the Company and Neo Medical SA, a privately held Swiss-based company developing a new generation of products for spinal surgery (“Neo Medical”), entered into a partnership that includes a co-development agreement covering the parties’ joint development of single use instruments for cervical spine procedures, and a distribution agreement under which Orthofix will exclusively distribute Neo Medical’s thoracolumbar procedure solutions to certain U.S. customer accounts.

Separately, the Company also purchased shares of Neo Medical’s preferred stock for consideration of $5.0 million and entered into a Convertible Loan Agreement pursuant to which Orthofix loaned Neo Medical CHF 4.6 million (the “Convertible Loan”). The loan bears interest at 8.0%, with interest due semi-annually. At each interest payment date, the borrower may elect to capitalize any interest due to the then outstanding principal balance of the loan. The Convertible Loan matures on October 1, 2024, provided that if a change in control of Neo Medical occurs prior to the maturity date, the Convertible Loan shall become immediately due upon such event.

The Convertible Loan may be convertible by either party into shares of Neo Medical’s preferred stock. The price per share at which the loan converts is dependent upon i) the party electing conversion and ii) Neo Medical’s price per share in its most recent fundraising activities at the time of conversion, as specified within the agreement.

In relation to the purchased equity shares, the Company was required to pay the requisite funds into a blocked capital increase account administered by a third party on September 30, 2020, prior to the closing of the transaction. This amount is classified within other long-term assets as of September 30, 2020.

20


 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of Orthofix Medical Inc.’s (sometimes referred to as “we,” “us” or “our”) financial condition and results of our operations should be read in conjunction with the “Forward-Looking Statements” and our condensed consolidated financial statements and related notes thereto appearing elsewhere in this Form 10-Q.

Executive Summary

We are a global medical device company focused on musculoskeletal products and therapies. Our mission is deliver innovative, quality-driven solutions as we partner with health care professionals on improving patients’ lives. Headquartered in Lewisville, Texas, our spine and orthopedic extremities products are distributed in more than 70 countries via our sales representatives and distributors.

Notable financial metrics and achievements in the third quarter of 2020 include the following:

 

Net sales of $111.0 million, an increase of 52% sequentially and within 2% of our 2019 performance

 

US Spinal Implants third quarter net sales increased 19% over the prior year

 

Motion Preservation sales in the U.S. of $5.2 million, an increase of 44% sequentially and over 400% over prior year

 

Entered into a $10.0 million investment and co-development agreement with Neo Medical SA

 

COVID-19 Update and Outlook

The global COVID-19 pandemic has significantly affected our patients, communities, employees and business operations. The pandemic has led to the cancellation or deferral of elective surgeries and procedures with certain hospitals, ambulatory surgery centers, and other medical facilities; restrictions on travel; the implementation of physical distancing measures; and the temporary or permanent closure of businesses. In addition, broad economic factors resulting from the pandemic, including increased unemployment rates and reduced consumer spending, are affecting our patients and partnersThese circumstances have negatively affected the sales of our products, particularly during the period from March 2020 through May 2020 when elective surgery restrictions were most pronounced, though these effects remain ongoing in certain geographical areas. However, we remain focused on protecting the health and wellbeing of our employees, partners, patients, and the communities in which we operate while assuring the continuity of our business operations.

At this time, the future trajectory of the COVID-19 pandemic remains uncertain, both in the U.S. and in other markets. Progress continues to be made on therapeutic treatments and vaccine candidates, though the efficacy and timing of various treatments and vaccines is uncertain.

Given these various uncertainties, it is unclear the extent to which lingering slowdowns in elective procedures will affect our business during the remainder of 2020 and beyond. We expect that the effects of COVID-19 on our business will depend on various factors including (i) the magnitude and length of increased case waves during the fall and winter, (ii) the comfort level of patients in returning to clinics and hospitals, (iii) the extent to which localized elective surgery shutdowns occur, (iv) the unemployment rate’s effect on potential patients lacking medical insurance coverage, and (v) general hospital capacity constraints occurring because of the need to treat COVID-19 patients.

In addition, while we have not seen such effects to date, risk remains that COVID-19 could have material negative effects on contractual counterparties, leading to supply chain disruptions or counterparty payment defaults and bankruptcies (including bankruptcies to hospital systems that significantly rely on revenue from elective surgeries).

21


 

Results of Operations

The following table provides certain items in our condensed consolidated statements of operations and comprehensive income (loss) as a percent of net sales:

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

 

 

2020

(%)

 

 

2019

(%)

 

 

2020

(%)

 

 

2019

(%)

 

Net sales

 

 

100.0

 

 

 

100.0

 

 

 

100.0

 

 

 

100.0

 

Cost of sales

 

 

23.6

 

 

 

21.9

 

 

 

25.2

 

 

 

22.0

 

Gross profit

 

 

76.4

 

 

 

78.1

 

 

 

74.8

 

 

 

78.0

 

Sales and marketing

 

 

47.7

 

 

 

48.3

 

 

 

52.2

 

 

 

48.9

 

General and administrative

 

 

14.9

 

 

 

18.6

 

 

 

17.1

 

 

 

18.8

 

Research and development

 

 

9.0

 

 

 

7.0

 

 

 

9.9

 

 

 

7.7

 

Acquisition-related amortization and remeasurement

 

 

1.0

 

 

 

20.8

 

 

 

(0.9

)

 

 

9.4

 

Operating income (loss)

 

 

3.8

 

 

 

(16.6

)

 

 

(3.5

)

 

 

(6.8

)

Net income (loss)

 

 

4.2

 

 

 

(35.7

)

 

 

4.1

 

 

 

(11.9

)

Net Sales by Product Category and Reporting Segment

The following tables provide net sales by major product category by reporting segment:

 

 

Three Months Ended

September 30,

 

 

Percentage Change

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

Reported

 

 

Constant Currency

 

Bone Growth Therapies

 

$

47,066

 

 

$

48,836

 

 

 

-3.6

%

 

 

-3.6

%

Spinal Implants

 

 

25,505

 

 

 

22,947

 

 

 

11.1

%

 

 

10.7

%

Biologics

 

 

15,245

 

 

 

16,308

 

 

 

-6.5

%

 

 

-6.5

%

Global Spine

 

 

87,816

 

 

 

88,091

 

 

 

-0.3

%

 

 

-0.4

%

Global Extremities

 

 

23,169

 

 

 

25,408

 

 

 

-8.8

%

 

 

-11.5

%

Net sales

 

$

110,985

 

 

$

113,499

 

 

 

-2.2

%

 

 

-2.9

%

 

 

 

Nine Months Ended

September 30,

 

 

Percentage Change

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

Reported

 

 

Constant Currency

 

Bone Growth Therapies

 

$

120,888

 

 

$

146,228

 

 

 

-17.3

%

 

 

-17.3

%

Spinal Implants

 

 

67,025

 

 

 

69,076

 

 

 

-3.0

%

 

 

-2.9

%

Biologics

 

 

40,319

 

 

 

48,784

 

 

 

-17.4

%

 

 

-17.4

%

Global Spine

 

 

228,232

 

 

 

264,088

 

 

 

-13.6

%

 

 

-13.6

%

Global Extremities

 

 

60,711

 

 

 

74,373

 

 

 

-18.4

%

 

 

-18.2

%

Net sales

 

$

288,943

 

 

$

338,461

 

 

 

-14.6

%

 

 

-14.6

%

Global Spine

Global Spine offers the following products categories:

 

-

Bone Growth Therapies, which manufactures, distributes, sells, and provides support services for market leading devices that enhance bone fusion. Bone Growth Therapies uses distributors and sales representatives to sell its devices and provide associated services to hospitals, healthcare providers, and patients.

 

-

Spinal Implants, which designs, develops and markets a broad portfolio of motion preservation and fixation implant products used in surgical procedures of the spine. Spinal Implants distributes its products globally through a network of distributors and sales representatives to sell spine products to hospitals and healthcare providers.

 

-

Biologics, which provides a portfolio of regenerative products and tissue forms that allow physicians to successfully treat a variety of spinal and orthopedic conditions. Biologics markets its tissues to hospitals and healthcare providers, primarily in the U.S., through a network of employed and independent sales representatives.

22


 

Three months ended September 30, 2020 compared to 2019

Net sales decreased $0.3 million or 0.3%

 

Bone Growth Therapies net sales decreased $1.8 million or 3.6%, primarily driven by the disruption caused by COVID-19, which has led to lower order volumes and a longer revenue cycle for these products

 

Spinal Implants net sales increased $2.6 million or 11.1%, as Motion Preservation net sales increased $4.2 million in the U.S. compared to prior year as a result of increases in case volumes and active surgeons, partially offset by a decrease in Spine Fixation net sales, driven by a reduction in elective procedures in both the U.S. and internationally due to COVID-19

 

Biologics net sales decreased $1.1 million or 6.5%, primarily driven by lower procedure volumes as a result of the disruption caused by COVID-19

Nine months ended September 30, 2020 compared to 2019

Net sales decreased $35.9 million or 13.6%

 

Bone Growth Therapies net sales decreased $25.3 million or 17.3%, primarily driven by the disruption caused by COVID-19, which has led to lower order volumes and a longer revenue cycle for these products, particularly due to many patients only being able to be fitted for devices in a virtual or telehealth environment

 

Spinal Implants net sales decreased $2.1 million or 3.0%, primarily driven by the reduction in elective procedures in both the U.S. and internationally due to COVID-19; however, Motion Preservation net sales increased $10.5 million in the U.S. when compared to prior year as a result of increases in case volumes and active surgeons

 

Biologics net sales decreased $8.5 million or 17.4%, primarily driven by lower procedure volumes as a result of the disruption caused by COVID-19

Global Extremities

Global Extremities offers products and solutions that allow physicians to successfully treat a variety of orthopedic conditions unrelated to the spine. Global Extremities distributes its products globally through a network of distributors and sales representatives to sell orthopedic products to hospitals and health providers.

Three months ended September 30, 2020 compared to 2019

Net sales decreased $2.2 million or 8.8%

 

Decrease of $2.9 million, primarily a result of the impact of COVID-19 on procedure volumes

 

Partially offset by an increase of $0.7 million due to the changes in foreign currency exchange rates, which had a positive impact on net sales in the third quarter of 2020

Nine months ended September 30, 2020 compared to 2019

Net sales decreased $13.7 million or 18.4%

 

Decrease of $13.5 million, primarily a result of the impact of COVID-19 on procedure volumes

 

Decrease of $0.1 million due to the changes in foreign currency exchange rates, which had a negative impact on net sales for the year-to-date period in 2020

Gross Profit

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

% Change

 

 

2020

 

 

2019

 

 

% Change

 

Net sales

 

$

110,985

 

 

$

113,499

 

 

 

(2.2

%)

 

$

288,943

 

 

$

338,461

 

 

 

(14.6

%)

Cost of sales

 

 

26,243

 

 

 

24,896

 

 

 

5.4

%

 

 

72,818

 

 

 

74,416

 

 

 

(2.1

%)

Gross profit

 

$

84,742

 

 

$

88,603

 

 

 

(4.4

%)

 

$

216,125

 

 

$

264,045

 

 

 

(18.1

%)

Gross margin

 

 

76.4

%

 

 

78.1

%

 

 

(1.7

%)

 

 

74.8

%

 

 

78.0

%

 

 

-3.2

%

Three months ended September 30, 2020 compared to 2019

Gross profit decreased $3.9 million

 

Decrease in gross profit and gross margin primarily related to the recognition of non-cash inventory charges on products due to lower procedure volumes, largely as a result of COVID-19

23


 

Nine months ended September 30, 2020 compared to 2019

Gross profit decreased $47.9 million

 

Decrease primarily due to the decline in net sales and lower fixed cost absorption, primarily attributable to COVID-19 and its negative effect on elective procedure volumes

 

Decrease also partially due to the recognition of non-cash inventory charges on products due to lower procedure volumes, largely as a result of COVID-19

Sales and Marketing Expense

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

% Change

 

 

2020

 

 

2019

 

 

% Change

 

Sales and marketing

 

$

52,926

 

 

$

54,805

 

 

 

(3.4

%)

 

$

150,718

 

 

$

165,363

 

 

 

(8.9

%)

As a percentage of net sales

 

 

47.7

%

 

 

48.3

%

 

 

(0.6

%)

 

 

52.2

%

 

 

48.9

%

 

 

3.3

%

Three months ended September 30, 2020 compared to 2019

Sales and marketing expense decreased $1.9 million

 

Decrease is primarily a result of a shift in the timing of national sales conferences and the leveraging of virtual training and events as a result of the COVID-19 pandemic

Nine months ended September 30, 2020 compared to 2019

Sales and marketing expense decreased $14.6 million

 

Decrease largely attributable to reduced commissions as a result of the decline in net sales, partially offset by commission support provided to our direct sales representatives during the second quarter of 2020

 

Decrease also related to a shift in the timing of national sales conferences and the leveraging of virtual training and events as a result of the COVID-19 pandemic

General and Administrative Expense

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

% Change

 

 

2020

 

 

2019

 

 

% Change

 

General and administrative

 

$

16,541

 

 

$

21,090

 

 

 

(21.6

%)

 

$

49,453

 

 

$

63,497

 

 

 

(22.1

%)

As a percentage of net sales

 

 

14.9

%

 

 

18.6

%

 

 

(3.7

%)

 

 

17.1

%

 

 

18.8

%

 

 

(1.7

%)

Three months ended September 30, 2020 compared to 2019

General and administrative expense decreased $4.5 million

 

Decrease of $2.0 million attributable to lower succession and transition charges, including acceleration of certain share-based compensation expense, relating to the retirement, transition, or termination of certain executive officers and from targeted restructuring activities

 

Decrease of $1.5 million in expenses associated with lower strategic investments, largely due to diligence and integration costs associated with strategic initiatives

 

Decrease of $1.0 million attributable to lower legal judgments and settlements

Nine months ended September 30, 2020 compared to 2019

General and administrative expense decreased $14.0 million

 

Decrease of $6.3 million in expenses associated with lower strategic investments, largely due to diligence and integration costs associated with strategic initiatives

 

Decrease of $4.3 million attributable to lower succession and transition charges, including acceleration of certain share-based compensation expense, relating to the retirement, transition, or termination of certain executive officers and from targeted restructuring activities

 

Decrease of $1.1 million in lower share-based compensation expense, excluding the impact of succession and transition charges

 

Decrease of $1.0 million attributable to lower legal judgments and settlements

24


 

 

Research and Development Expense

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

% Change

 

 

2020

 

 

2019

 

 

% Change

 

Research and development

 

$

9,962

 

 

$

7,982

 

 

 

24.8

%

 

$

28,691

 

 

$

26,191

 

 

 

9.5

%

As a percentage of net sales

 

 

9.0

%

 

 

7.0

%

 

 

2.0

%

 

 

9.9

%

 

 

7.7

%

 

 

2.2

%

Three months ended September 30, 2020 compared to 2019

Research and development expense increased $2.0 million

 

Increase primarily the result of our efforts to build out our internal team to support the acceleration of our new product innovation initiative and to comply with recent medical device reporting regulations

 

Increase partially due to product development costs related to future planned organic product launches

Nine months ended September 30, 2020 compared to 2019

Research and development expense increased $2.5 million

 

Increase primarily the result of our efforts to build out our internal team to support the acceleration of our new product innovation initiative

 

Increase of $1.2 million related to costs to comply with recent medical device reporting regulations

Acquisition-related Amortization and Remeasurement

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

% Change

 

 

2020

 

 

2019

 

 

% Change

 

Acquisition-related amortization and remeasurement

 

$

1,138

 

 

$

23,608

 

 

 

(95.2

%)

 

$

(2,766

)

 

$

31,873

 

 

 

(108.7

%)

As a percentage of net sales

 

 

1.0

%

 

 

20.8

%

 

 

(19.8

%)

 

 

(0.9

%)

 

 

9.4

%

 

 

(10.3

%)

Acquisition-related amortization and remeasurement consists of amortization related to intangible assets acquired through business combinations or asset acquisitions and the remeasurement of any related contingent consideration arrangement.

Three months ended September 30, 2020 compared to 2019

Acquisition-related amortization and remeasurement decreased $22.5 million

 

Decrease of $23.0 million related to the remeasurement of potential future revenue-based milestone payments associated with the Spinal Kinetics acquisition that become due upon achievement of certain revenue targets, primarily attributable to the effects and uncertainty of COVID-19 as it relates to the estimated likelihood and timing of potential milestone payments

 

Partially offset by an increase of $0.5 million related to the amortization of intangible assets acquired through business combinations or asset acquisitions

Nine months ended September 30, 2020 compared to 2019

Acquisition-related amortization and remeasurement decreased $34.6 million

 

Decrease of $35.7 million primarily related to the remeasurement of potential future revenue-based milestone payments associated with the Spinal Kinetics acquisition that become due upon achievement of certain revenue targets, primarily attributable to the effects and uncertainty of COVID-19 as it relates to the estimated likelihood and timing of potential milestone payments

 

Partially offset by an increase of $1.1 million related to the amortization of intangible assets acquired through business combinations or asset acquisitions

Non-operating Income and Expense

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

% Change

 

 

2020

 

 

2019

 

 

% Change

 

Interest income (expense), net

 

$

(731

)

 

$

186

 

 

 

(493.0

%)

 

$

(2,055

)

 

$

386

 

 

 

(632.4

%)

Other income (expense), net

 

 

1,817

 

 

 

(8,146

)

 

 

(122.3

%)

 

 

6,088

 

 

 

(8,786

)

 

 

(169.3

%)

25


 

Three months ended September 30, 2020 compared to 2019

Interest income (expense), net, decreased $0.9 million

 

Decrease of $0.5 million attributable interest income recognized on our investment in eNeura in 2019

 

Decrease of $0.2 million associated with interest expense incurred on our outstanding indebtedness under our secured revolving credit facility

Other income (expense), net, increased $10.0 million

 

Increase of $6.5 million associated with an other-than-temporary impairment on the eNeura debt security during the third quarter of 2019

 

Increase of $3.5 million associated with changes in foreign currency exchange rates, as we recorded a non-cash remeasurement gain of $1.9 million in the third quarter of 2020 compared to a loss of $1.6 million in the third quarter of 2019

Nine months ended September 30, 2020 compared to 2019

Interest income (expense), net, decreased $2.4 million

 

Decrease of $1.5 million attributable interest income recognized on our investment in eNeura in 2019

 

Decrease of $0.8 million associated with interest expense incurred on our outstanding indebtedness under our secured revolving credit facility

Other income (expense), net, increased $14.9 million

 

Increase of $6.5 million associated with an other-than-temporary impairment on the eNeura debt security during the third quarter of 2019

 

Increase of $4.7 million attributable to funds received from the U.S. Department of Health and Human Services as part of the Provider Relief Fund included within the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”)

 

Increase of $4.0 million associated with changes in foreign currency exchange rates, as we recorded a non-cash remeasurement gain of $1.8 million in 2020 compared to a loss of $2.2 million in 2019

Income Taxes

 

 

Three Months Ended September 30,

 

 

Nine Months Ended September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

% Change

 

 

2020

 

 

2019

 

 

% Change

 

Income tax expense (benefit)

 

$

607

 

 

$

13,656

 

 

 

(95.6

%)

 

$

(17,833

)

 

$

8,869

 

 

 

(301.1

%)

Effective tax rate

 

 

11.5

%

 

 

(50.9

%)

 

 

62.4

%

 

 

300.3

%

 

 

(28.4

%)

 

 

328.7

%

Three months ended September 30, 2020 compared to 2019

The increase in the effective tax rate compared to the prior year period rate was primarily a result of the following factors:

 

Changes in financial benefits not recognized for tax purposes, primarily related to acquisition-related remeasurement

 

Tax detriment related to the settlement of certain stock awards

 

Increase in pre-tax earnings

The primary factors affecting our effective tax rate for the third quarter of 2020 are as follows:

 

Changes in financial deductions not recognized for tax purposes, primarily related to acquisition-related remeasurement

 

Tax detriment related to the settlement of certain stock awards

Nine months ended September 30, 2020 compared to 2019

The increase in the effective tax compared to the prior year period rate was primarily a result of the following factors:

 

Changes in financial benefits not recognized for tax purposes, primarily related to acquisition-related remeasurement

 

Reversal of tax benefits related to certain performance stock units that were forfeited

 

Partially offset by, benefits related to statute expirations for previously unrecognized tax benefits

 

Further offset by decreases in non-deductible executive compensation

 

26


 

The primary factors affecting our effective tax rate for the nine months ended September 30, 2020 are as follows:

 

Statute expirations related to previously unrecognized tax benefits

 

Financial benefits not recognized for tax purposes, primarily related to acquisition-related remeasurement

 

Reversal of tax benefits related to certain performance stock units that were forfeited

 

Non-deductible executive compensation

Segment Review

Our business is managed through two reporting segments:  Global Spine and Global Extremities. The primary metric used in managing the business by segment is EBITDA (which is described further in Note 12 to the Notes to the Unaudited Condensed Consolidated Financial Statements contained herein). The following table presents EBITDA by segment and reconciles consolidated EBITDA to income (loss) before income taxes:

Liquidity and Capital Resources

 

 

Three Months Ended

September 30,

 

 

Nine Months Ended

September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

2020

 

 

2019

 

Global Spine

 

$

19,960

 

 

$

(6,033

)

 

$

38,670

 

 

$

21,065

 

Global Extremities

 

 

1,258

 

 

 

1,229

 

 

 

(3,995

)

 

 

3,806

 

Corporate

 

 

(6,196

)

 

 

(15,949

)

 

 

(16,259

)

 

 

(38,356

)

Total EBITDA

 

$

15,022

 

 

$

(20,753

)

 

$

18,416

 

 

$

(13,485

)

Depreciation and amortization

 

 

(9,030

)

 

 

(6,275

)

 

 

(22,299

)

 

 

(18,180

)

Interest income (expense), net

 

 

(731

)

 

 

186

 

 

 

(2,055

)

 

 

386

 

Income (loss) before income taxes

 

$

5,261

 

 

$

(26,842

)

 

$

(5,938

)

 

$

(31,279

)

Cash, cash equivalents, and restricted cash at September 30, 2020, totaled $80.3 million compared to $70.4 million at December 31, 2019.

 

 

Nine Months Ended September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

Change

 

Net cash from operating activities

 

$

51,981

 

 

$

20,090

 

 

$

31,891

 

Net cash from investing activities

 

 

(42,944

)

 

 

(21,281

)

 

 

(21,663

)

Net cash from financing activities

 

 

583

 

 

 

(12,610

)

 

 

13,193

 

Effect of exchange rate changes on cash

 

 

277

 

 

 

(885

)

 

 

1,162

 

Net change in cash, cash equivalents and restricted cash

 

$

9,897

 

 

$

(14,686

)

 

$

24,583

 


The following table presents free cash flow, a non-GAAP financial measure, which is calculated by subtracting capital expenditures from net cash from operating activities:

 

 

Nine Months Ended September 30,

 

(U.S. Dollars, in thousands)

 

2020

 

 

2019

 

 

Change

 

Net cash from operating activities

 

$

51,981

 

 

$

20,090

 

 

$

31,891

 

Capital expenditures

 

 

(12,704

)

 

 

(14,881

)

 

 

2,177

 

Free cash flow

 

$

39,277

 

 

$

5,209

 

 

$

34,068

 

Operating Activities

Cash flows from operating activities increased $31.9 million

 

Increase in net income of $52.0 million

 

Net decrease of $43.5 million in non-cash gains and losses, largely related to changes in fair value of contingent consideration, share-based compensation expense, and losses on valuation of investment securities

 

Net increase of $23.3 million relating to changes in working capital accounts, primarily attributable to changes in accounts receivable, a $13.9 million prepayment received under the Medicare & Medicaid Services (“CMS”) Accelerated and Advance Payment Program, inventories, and other current and long-term assets and liabilities, which included the expiration of statute of limitations related to certain unrecognized tax benefits in the first quarter of 2020

27


 

Two of our primary working capital accounts are accounts receivable and inventory. Days sales in receivables were 61 days at September 30, 2020 compared to 65 days at September 30, 2019, with much of this decrease attributable to a decrease in net sales as a result of COVID-19, coupled with continued collections on accounts receivable. Inventory turns remained consistent at 1.2 times as of September 30, 2020 and 2019.

Investing Activities

Cash flows from investing activities decreased $21.7 million

 

Decrease of $18.0 million associated with cash paid in March 2020 to acquire assets associated with the FITBONE intramedullary lengthening system for limb lengthening of the femur and tibia bones

 

Decrease of $5.0 million associated with our purchase of preferred stock of Neo Medical SA in 2020

 

Partially offset by a decrease in capital expenditures of $2.2 million

Financing Activities

Cash flows from financing activities increased $13.2 million

 

Increase of $13.7 million associated with the payment of the Spinal Kinetics FDA Milestone during the first quarter of 2019, which represented the acquisition-date fair value attributable to the FDA Milestone liability originally recognized

 

Decrease in net proceeds of $0.7 million from the issuance of common shares

Credit Facilities

In the third quarter, we repaid $100.0 million of outstanding principal under our five year $300 million secured revolving credit facility, which was originally borrowed in the second quarter. Therefore, as of September 30, 2020, we had no borrowings outstanding under the secured revolving credit facility. In addition, we had no borrowings outstanding under on our €5.5 million ($6.4 million) available lines of credit in Italy. We were in compliance with all required financial covenants as of September 30, 2020.

Other

For information regarding Contingencies, see Note 9 to the Notes to the Unaudited Condensed Consolidated Financial Statements contained herein.

Impact of COVID-19 and the CARES Act on Liquidity and Capital Resources

In April 2020, as precautionary measures to increase our cash position and preserve financial flexibility in response to the uncertainty from the COVID-19 pandemic, we (i) completed a borrowing of $100.0 million under our secured revolving credit facility (which was subsequently repaid in full in the third quarter of 2020), (ii) instituted temporary salary reductions for U.S. employees and the Board of Directors, which were in effect for two months during the second quarter of 2020, (iii) suspended the 401(k) match program through the remainder of fiscal year 2020, and (iv) initiated organizational travel restrictions and a temporary reduction in new hiring.

On March 27, 2020, the CARES Act was signed into U.S. federal law, which provided emergency assistance and health care for individuals, families, and businesses affected by the COVID-19 pandemic.

In April 2020, we received $13.9 million in funds from the CMS Accelerated and Advance Payment Program to increase cash flow to providers of services and suppliers impacted by the COVID-19 pandemic. On October 1, 2020, the President of the United States signed the “Continuing Appropriations Act, 2021 and Other Extensions Act,” which relaxed previously existing recoupment terms for providers and suppliers that received funds from the program. Under these new terms, recoupment will be delayed until one year after payment was issued. After that first year, Medicare will automatically recoup 25% of Medicare payments otherwise owed to the provider or supplier for 11 months. At the end of the 11-month period, recoupment will increase to 50% for another 6 months. Thus, during these time periods, rather than receiving the full amount of payment for newly submitted claims, our outstanding accelerated / advance payment balance will be reduced by the recoupment amount until the full balance has been repaid.

In addition, in April 2020, we automatically received, without request, $4.7 million in funds from the U.S. Department of Health and Human Services as part of the Provider Relief Fund. Upon review of the qualifying criteria required to retain the funding, which primarily relate to lost revenues or the incurrence of expenses attributable to COVID-19, it was determined that we met the criteria to retain the funds received.

Further, as part of the CARES Act, we are permitted to defer all employer social security payroll tax payments for the remainder of the 2020 calendar year, such that 50% of the taxes is deferred until December 31, 2021, with the remaining 50% deferred until

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December 31, 2022. As of September 30, 2020, we have deferred $2.2 million associated with this program.

Given the various uncertainties attributable to the COVID-19 pandemic that remain, both in the U.S. and in other markets, our liquidity may be impacted in the future by the potential of continued decreases in elective surgical procedures, delays in payments from customers, facility closures, or other reasons related to the COVID-19 pandemic. As of the date of issuance of these condensed consolidated financial statements, the extent to which COVID-19 is likely to materially impact our liquidity in the future remains uncertain.

Spinal Kinetics Contingent Consideration

Under the terms of the acquisition agreement under which we acquired Spinal Kinetics, we agreed to make contingent milestone payments of up to $60.0 million in cash to Spinal Kinetics’ former shareholders. One milestone payment, which was for $15.0 million, became due upon FDA approval of Spinal Kinetics’ M6-C artificial cervical disc (the “FDA Milestone”). The FDA Milestone was achieved and paid in 2019.

The remaining milestone payments are comprised of revenue-based milestone payments of up to $45.0 million in connection with future sales of the acquired artificial discs. The fair value of the contingent consideration arrangement as of September 30, 2020 was $35.1 million; however, the actual amount ultimately paid could be higher or lower than the fair value of the contingent consideration (though not greater than $45.0 million). As of September 30, 2020, we classified $14.7 million of the liability attributable to the revenue-based milestone within other current liabilities, as we expect to pay one of the revenue-based milestones in the next twelve months, and the remaining $20.4 million within other long-term liabilities. For additional discussion of this matter, see Note 8 of the Notes to the Unaudited Condensed Consolidated Financial Statements.

FITBONE Asset Acquisition

On February 3, 2020, we entered into an Asset Purchase Agreement (the “Purchase Agreement”) with Wittenstein SE (“Wittenstein”), a privately-held German-based company, to acquire assets associated with the FITBONE intramedullary lengthening system for limb lengthening of the femur and tibia bones. Under the terms of the Purchase Agreement, as consideration for the acquired assets, we paid $18.0 million in cash consideration and entered into a Contract Manufacturing and Supply Agreement (“CMSA”) with Wittenstein. The acquisition was completed on March 26, 2020 and was treated as a business combination.

The CMSA with Wittenstein has an initial term of up to two years to manufacture the FITBONE product line. As consideration for the CMSA, we will pay $2.0 million to Wittenstein at the conclusion of the CMSA if certain conditions are met in relation to the prompt delivery of manufactured products.

Other Acquisitions

In July 2020, we entered into an agreement to acquire certain assets of a medical device distributor. We have agreed to pay consideration of up to $7.6 million in accordance with the parties’ agreement. As of September 30, 2020, we have paid $6.1 million per this agreement.

Neo Medical Investment and Convertible Loan

On October 1, 2020, we entered into a partnership with Neo Medical SA, a privately held Swiss-based Medtech company (“Neo Medical”), that includes a co-development agreement covering the parties’ joint development of single use instruments for cervical spine procedures, and a distribution agreement under which Orthofix will exclusively distribute Neo Medical’s thoracolumbar procedure solutions to certain U.S. customer accounts.

Separately, we also purchased shares of Neo Medical’s preferred stock for consideration of $5.0 million and entered into a Convertible Loan Agreement, whereby we loaned CHF 4.6 million to Neo Medical (the “Convertible Loan”). The loan bears interest at 8.0%, with interest due semi-annually. The Convertible Loan matures in October 2024, provided that if a change in control of Neo Medical occurs prior to maturity, the Convertible Loan shall become immediately due upon such event.

The Convertible Loan may be convertible by either party into shares of Neo Medical’s preferred stock. The price per share at which the loan converts is dependent upon i) the party electing conversion and ii) Neo Medical’s price per share in its most recent fundraising activities at the time of conversion, as specified within the agreement.

In relation to the purchased equity shares, the Company was required to pay the requisite funds into a blocked capital increase account administered by a third party on September 30, 2020, prior to the closing of the transaction. This amount is classified within other long-term assets as of September 30, 2020.

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Brazil

In September 2019, in relation to an ongoing legal dispute with a former Brazilian distributor, approximately $0.5 million (based upon foreign exchange rates as of September 30, 2020) of our cash in Brazil was frozen upon request to satisfy a judgment. Although we are appealing the judgment, this cash has been reclassified to restricted cash.

For additional discussion regarding these matters, see Note 9 of the Notes to the Unaudited Condensed Consolidated Financial Statements.

Off-balance Sheet Arrangements

As of September 30, 2020, we did not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, cash flows, liquidity, capital expenditures or capital resources that are material to investors.

Contractual Obligations

There have been no material changes in any of our material contractual obligations as disclosed in our Form 10-K for the year ended December 31, 2019.

Critical Accounting Estimates

Our discussion of operating results is based upon the condensed consolidated financial statements and accompanying notes. The preparation of these statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Our critical accounting estimates are detailed in Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2019. There have been no significant changes to our critical accounting estimates except for the following:

Allowance for Expected Credit Losses and Contractual Allowances

Subsequent to the adoption of ASU 2016-13, our allowance for expected credit losses represents the portion of the receivable’s amortized cost basis that we do not expect to collect over the receivable’s contractual life, considering past events, current conditions, and reasonable and supportable forecasts of future economic conditions.

The process for estimating the ultimate collection of accounts receivable involves significant assumptions and judgments. The determination of the contractual life of accounts receivable, the aging of outstanding receivables, as well as the historical collections, write-offs, and payor reimbursement experience over the estimated contractual lives of such receivables, are integral parts of the estimation process related to reserves for expected credit losses and the establishment of contractual allowances. Accounts receivable are analyzed on a quarterly basis to assess the adequacy of both reserves for expected credit losses and contractual allowances. Revisions in allowances for expected credit loss estimates are recorded as an adjustment to bad debt expense within sales and marketing expenses. Revisions to contractual allowances are recorded as an adjustment to net sales. These estimates are periodically tested against actual collection experience. In addition, we analyze our receivables by geography and by customer type, where appropriate, in developing estimates for expected credit losses.

Recently Issued Accounting Pronouncements

See Note 2 of the Notes to the Unaudited Condensed Consolidated Financial Statements for detailed information regarding the status of recently issued accounting pronouncements.

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Non-GAAP Financial Measures

We believe that providing non-GAAP financial measures that exclude certain items provides investors with greater transparency to the information used by senior management in its financial and operational decision-making. We believe it is important to provide investors with the same non-GAAP metrics used to supplement information regarding the performance and underlying trends of our business operations in order to facilitate comparisons to historical operating results and internally evaluate the effectiveness of our operating strategies. Disclosure of these non-GAAP financial measures also facilitates comparisons of our underlying operating performance with other companies in the industry that also supplement their GAAP results with non-GAAP financial measures.

The non-GAAP financial measures used in this filing may have limitations as analytical tools, and should not be considered in isolation or as a replacement for GAAP financial measures. Some of the limitations associated with the use of these non-GAAP financial measures are that they exclude items that reflect an economic cost that can have a material effect on cash flows.

Constant Currency

Constant currency is calculated by using foreign currency rates from the comparable, prior-year period, to present net sales at comparable rates. Constant currency can be presented for numerous GAAP measures, but is most commonly used by management to analyze net sales without the impact of changes in foreign currency rates.

EBITDA

EBITDA is a non-GAAP metric defined as earnings before interest income (expense), income taxes, depreciation, and amortization. EBITDA is the primary metric used by our Chief Operating Decision Maker in managing the business.

Free Cash Flow

Free cash flow is calculated by subtracting capital expenditures from net cash from operating activities. Management uses free cash flow as an important indicator of how much cash is generated or used by our normal business operations, including capital expenditures. Management uses free cash flow as a measure of progress on its capital efficiency and cash flow initiatives.

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes to our market risks as disclosed in our Form 10-K for the year ended December 31, 2019.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) designed to provide reasonable assurance that the information required to be disclosed in reports filed or submitted under the Exchange Act are recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. These include controls and procedures designed to ensure that this information is accumulated and communicated to management, including our President and Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Management, with the participation of the President and Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2020. Based on this evaluation, our President and Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of September 30, 2020.

Changes in Internal Control over Financial Reporting

 

There was no change in our internal control over financial reporting, known to the President and Chief Executive Officer or the Chief Financial Officer that occurred for the quarterly period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

For information regarding legal proceedings, see Note 9 to the Notes to the Unaudited Condensed Consolidated Financial Statements contained herein, which is incorporated by reference into this Part II, Item 1.

Item 1A. Risk Factors

The following risk factors supplement and should be read in conjunction with those contained in the risk factors disclosed in the “Risk Factors” section of our Form 10-K for the year ended December 31, 2019 and our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2020, and June 30, 2020.

The novel coronavirus pandemic has materially affected our business in 2020 and is likely to cause further unpredictable effects during the remainder of 2020 and beyond

The novel coronavirus discovered in late 2019, and the disease it causes known as COVID-19, has caused significant affects to our business in 2020, and is likely to cause significant effects during the remainder of 2020 and into 2021. For Orthofix, the most significant effect to date on our business has been a significant reduction in elective surgery procedure volumes, which represent the majority of procedures in which our products are used. This reduction in procedure volumes began suddenly in March 2020 when shelter in place and social distancing instructions were instituted in the U.S. and many of our other sales markets, and caused a pronounced reduction in revenue during April 2020 and May 2020, when a significant number of hospitals were either closed for elective procedures or otherwise operating at significantly reduced volumes. Generally, this reduction in procedure volumes dissipated during June 2020 and July 2020, as many regions were able to reopen for elective procedures, with an existing patient backlog. At the present time, volumes have rebounded significantly, though there residual reductions in demand continue.

The future trajectory of the COVID-19 pandemic remains uncertain, both in the U.S. and in other markets. Within the U.S., case counts appear to be increasing throughout much of the country as cold weather increases. Similarly, a recent surge of cases has occurred in Europe, and several countries have begun reinstituting lockdown measures. However, less cases appear to be progressing to severe disease than earlier in the year, and progress continues to be made on therapeutic treatments and vaccine candidates, though the efficacy and timing of various treatments and vaccines remains uncertain.

Given these various uncertainties, it is unclear the extent to which lingering slowdowns in elective procedures will continue to affect our business during the remainder of 2020 and beyond. We expect that the effects of COVID-19 on our business will depend on various factors including (i) the magnitude and length of increased case waves during the fall and winter, (ii) the comfort level of patients in returning to clinics and hospitals, (iii) the extent to which localized elective surgery shutdowns occur, (iv) the unemployment rate’s effect on potential patients lacking medical insurance coverage, and (v) general hospital capacity constraints occurring because of the need to treat COVID-19 patients.

During the second and third quarters of 2020, we focused on making our facilities safe given updated COVID-19 public health guidelines, and we believe that our employee workforce has done excellent work in adapting to the new environment. In particular, we have been able to continue our manufacturing activities to keep pace with customer orders. However, given the potential for further shelter in place orders in our largest manufacturing and operational centers (particularly, Lewisville, Texas and Verona, Italy), there remains a risk that a significant localized surge in the virus could cause disruption to our manufacturing, distribution, administrative and other business operations (including downtime at our manufacturing facilities and the interruption of the production of our products).

In addition, while we have not seen such effects to date, risk remains that COVID-19 could have material negative effects on contractual counterparties, leading to supply chain disruptions or counterparty payment defaults and bankruptcies (including bankruptcies to hospital systems that significantly rely on revenue from elective surgeries).

To the extent the COVID-19 pandemic adversely affects our business and financial results, it may also have the effect of heightening many of the other risks described in Part I, Item 1A under the heading Risk Factors in our 2019 Form 10-K, such as our need to generate sufficient cash flows to service indebtedness and our ability to protect our information technology networks and infrastructure from unauthorized access, misuse, malware, phishing and other events that could have a security impact as a result of our remote working environment or otherwise.

All of these factors, collectively, could materially adversely affect our business, financial condition and results of operations.

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An FDA panel recently recommended that bone growth stimulator devices be reclassified by the FDA from Class III to Class II devices, which could increase future competition for us in this product category and negatively affect our future sales of such products.

We have the market-leading bone growth stimulation platform with the only cervical spinal indication granted by the U.S. Food and Drug Administration (the "FDA"), and the only mobile device app accessory designed to help patients adhere to their prescriptions and improve their clinical outcomes, STIM onTrack™ 2.1. We also are investing in investigational device exemption (“IDE”) studies to expand indications for use in areas such as rotator cuff tears. Our bone growth therapy products currently are designated as Class III devices. Class III devices are subject to the FDA’s most rigorous pathway to approval for medical devices in the U.S. The FDA may change classification of a device only if the proposed new class has sufficient regulatory controls to provide reasonable assurances of safety and effectiveness.

In September 2020, the FDA’s Orthopaedic and Rehabilitation Devices Panel recommended that bone growth stimulator devices be reclassified from Class III to Class II devices with “special controls” to ensure patient safety and therapy efficacy. These proposed special controls include the condition that such devices be subject to rigorous clinical studies and post market surveillance for any new products. This would be in addition to other special controls and the Class II general requirement that any new products show “substantial equivalence” to already-cleared or approved devices.

We believe that the panel’s recommendation correctly recognizes the importance of premarket approval (PMA)-like clinical data for these devices, so that manufacturers continue to be required to submit robust clinical data under the approval or clearance process to ensure the safety and efficacy of these devices for patients. We, along with other bone growth stimulation manufacturers, submitted comments in response to the FDA’s proposed rulemaking to underscore the panel’s recommendation of the need for robust clinical data prior to approval or clearance of bone growth stimulator products, together with post market surveillance requirements.

In the long-term, the recommended reclassification could enhance the ability of competitors to enter the market if they are able to create technologies with comparable efficacy to our devices, which could result in our products facing additional competition, thereby negatively affecting our future sales of these products.

We have provided $10 million in investments and loans to a privately-held company in Switzerland and may not be able to recoup our investment.

In October 2020, we entered into agreements with Neo Medical SA, a privately-held Swiss-based medical technology company developing a new generation of products for spinal surgery (“Neo Medical”). Our collaboration with Neo Medical focuses on co-developing with them a cervical platform and deploying single-use, sterile-packed procedure solutions designed to increase operating room efficiencies, reduce procedural times and costs, improve patient outcomes through novel device designs and techniques, and reduce infection rates. These instruments are designed surgical settings including acute care hospitals, outpatient hospitals and also ambulatory surgery centers. Under our agreements with Neo Medical, we will also exclusively distribute Neo Medical’s thoracolumbar procedure solutions to certain U.S. accounts.

In connection with these arrangements, we purchased $5 million of Neo Medical’s preferred stock, and loaned $5 million to Neo Medical pursuant to a convertible loan agreement. The loan, which is denominated in Swiss Francs and accrues interest at an annual rate of 8%, is convertible by either party into additional shares of Neo Medical’s preferred stock. If not otherwise converted to preferred stock in the interim, the loan and all accrued interest become due and payable in October 2024.

Neo Medical is using the proceeds of our preferred stock purchase and loan to fund its ongoing operations. However, no assurance can be made that Neo Medical’s business ultimately will be successful. As such, we could ultimately be unable to recoup any value for the preferred stock that we purchased, and unable to recoup the amount of our loan.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

We have not made any repurchases of our common stock during the third quarter of 2020.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

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Item 5. Other Information

There are no matters to be reported under this heading.

Item 6. Exhibits

 

  10.1

 

Consulting Agreement, dated July 4, 2020, between Michael Finegan and Orthofix Medical Inc. (filed as an exhibit to the Company’s Quarterly Report on Form 10-Q filed on August 6, 2020 and incorporated herein by reference).

 

 

 

  10.2*

 

Change in Control and Severance Agreement, dated September 11, 2020, between Paul Gonsalves and Orthofix Medical Inc.

 

 

 

  31.1*

 

Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.

 

 

 

  31.2*

 

Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.

 

 

 

  32.1*

 

Section 1350 Certifications of each of the Chief Executive Officer and Chief Financial Officer.

 

 

 

  101.INS*

 

Inline XBRL Instance Document (the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document).

 

 

 

  101.SCH*

 

Inline XBRL Taxonomy Extension Schema Document.

 

 

 

  101.CAL*

 

Inline XBRL Taxonomy Extension Calculation Linkbase Document.

 

 

 

  101.DEF*

 

Inline XBRL Taxonomy Extension Definition Linkbase Document.

 

 

 

  101.LAB*

 

Inline XBRL Taxonomy Extension Label Linkbase Document.

 

 

 

  101.PRE*

 

Inline XBRL Taxonomy Extension Presentation Linkbase Document.

 

 

 

  104*

 

Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101).

*

Filed herewith.

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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 MEDICAL INC.

 

 

Date: November 5, 2020

By:

 

/s/ JON SERBOUSEK

 

Name:

 

Jon Serbousek

 

Title:

 

President and Chief Executive Officer, Director

 

 

 

 

Date: November 5, 2020

By:

 

/s/ DOUG RICE

 

Name:

 

Doug Rice

 

Title:

 

Chief Financial Officer

 

 

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