UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
DC 20549
FORM
10-K
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x
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ANNUAL
REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For
the
fiscal year ended December 31, 2006
or
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o
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
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For
the
transition period from ____________ to ____________.
Commission
File Number: 0-19961
ORTHOFIX
INTERNATIONAL N.V.
(Exact
name of registrant as specified in its charter)
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Netherlands
Antilles
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N/A
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(State
or other jurisdiction of incorporation
or organization)
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(I.R.S.
Employer Identification No.)
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7
Abraham de Veerstraat
Curaçao
Netherlands
Antilles
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N/A
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(Address
of principal executive offices)
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(Zip
Code)
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599-9-4658525
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(Registrant’s
telephone number, including area code)
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Securities
registered pursuant to Section 12(b) of the Act:
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None
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Securities
registered pursuant to Section 12(g) of the Act:
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Common
Stock, $0.10 par value
(Title
of Class)
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Nasdaq
Global Select Market
(Name
of Exchange on Which
Registered)
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Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act.
Yes T No £
Indicate
by check mark if the registrant is not required to file reports pursuant
to
Section 13 or Section 15(d) of the Act. Yes £
No T
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
at least the past 90 days.
Yes T No £
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment
to this
Form 10-K. £
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of
“accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act. (Check one):
Large
Accelerated filer £ Accelerated
filer T Non-accelerated
filer £
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes £ No
T
The
aggregate market value of registrant’s common stock held by non-affiliates,
based upon the closing price of the common stock on the last business day
of the
registrant’s most recently completed second fiscal quarter, June 30, 2006, as
reported by the Nasdaq National Market, was approximately $611.2
million. Shares of common stock held by executive officers and
directors and persons who own 5% or more of the outstanding common stock
have
been excluded since such persons may be deemed affiliates. This
determination of affiliate status is not a determination for any other
purpose.
As
of
March 13 , 2007, 16,472,443 shares of common stock were issued and
outstanding.
DOCUMENTS
INCORPORATED BY REFERENCE
Certain
sections of the registrant's Proxy Statement to be filed with the Commission
in
connection with the 2007 Annual General Meeting of Shareholders are incorporated
by reference in Part III of this Form 10-K.
1
Table
of Contents
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Page
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4
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Item
1.
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4
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Item
1A.
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23
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Item
1B.
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32
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Item
2.
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33
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Item
3.
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34
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Item
4.
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34
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35
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Item
5.
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35
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Item
6.
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38
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Item
7.
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39
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Item
7A.
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51
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Item
8
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52
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Item
9.
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52
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Item
9A.
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52
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Item
9B
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52
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53
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Item
10.
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53
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Item
11.
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57
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Item
12.
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57
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Item
13.
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57
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Item
14.
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57
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58
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Item
15.
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58
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Forward-Looking
Statements
This
Form
10-K contains forward-looking statements within the meaning of Section 21E
of
the Securities Exchange Act of 1934, as amended, relating to our business and
financial outlook, which are based on our current beliefs, assumptions,
expectations, estimates, forecasts and projections. In some cases,
you can identify forward-looking statements by terminology such as “may,”
“will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,”
“projects,” “intends,” “predicts,” “potential” or “continue” or other comparable
terminology. These forward-looking statements are not guarantees of
our future performance and involve risks, uncertainties, estimates and
assumptions that are difficult to predict. Therefore, our actual
outcomes and results may differ materially from those expressed in these
forward-looking statements. You should not place undue reliance on
any of these forward-looking statements. Further, any forward-looking
statement speaks only as of the date on which it is made, and we undertake
no
obligation to update any such statement, or the risk factors described in Item
IA under the heading “Risk Factors,” to reflect new information, the occurrence
of future events or circumstances or otherwise.
Factors
that could cause actual results to differ materially from those indicated by
the
forward-looking statements or that could contribute to such differences include,
but are not limited to, unanticipated expenditures, changing relationships
with
customers, suppliers and strategic partners, unfavorable results in litigation
matters, risks relating to the protection of intellectual property, changes
to
the reimbursement policies of third parties, changes to governmental regulation
of medical devices, the impact of competitive products, changes to the
competitive environment, the acceptance of new products in the market,
conditions of the orthopedic industry and the economy, currency or interest
rate
fluctuations and the other risks described under Item 1A – “Business – Risk
Factors” in this Form 10-K.
PART
I
Item
1. Business
In
this Form 10-K, the terms “we”, “us”, “our”, “Orthofix” and “our Company” refer
to the combined operations of all of Orthofix International N.V. and its
respective consolidated subsidiaries and affiliates, unless the context requires
otherwise.
OVERVIEW
We
are a
diversified orthopedic products company offering a broad line of surgical and
non-surgical products principally in the Spine, Orthopedics, Sports Medicine
and
Vascular market sectors. Our products are designed to address the
lifelong bone-and-joint health needs of patients of all ages, helping them
achieve a more active and mobile lifestyle. We design, develop,
manufacture, market and distribute medical equipment used principally by
musculoskeletal medical specialists for orthopedic applications. Our
main products are invasive and minimally invasive spinal implant products and
related biologics; non-invasive stimulation products used to enhance the success
rate of spinal fusions and to treat non-union fractures; external and internal
fixation devices used in fracture treatment, limb lengthening and bone
reconstruction; and bracing products used for ligament injury prevention, pain
management and protection of surgical repair to promote faster
healing. Our products also include a device for enhancing venous
circulation, cold therapy, other pain management products, bone cement and
devices for removal of bone cement used to fix artificial implants and airway
management products used in anesthesia applications.
We
have
administrative and training facilities in the United States and Italy and
manufacturing facilities in the United States, the United Kingdom, Italy and
Mexico. We directly distribute our products in the United States, the
United Kingdom, Italy, Germany, Switzerland, Austria, France, Belgium, Mexico,
Brazil and Puerto Rico. In several of these and other markets, we
also distribute our products through independent distributors.
Orthofix
International N.V. is a limited liability company, organized under the laws
of
the Netherlands Antilles on October 19, 1987. Our principal
executive offices are located at 7 Abraham de Veerstraat, Curaçao, Netherlands
Antilles, telephone number: 599-9-465-8525. Our filings
with the Securities and Exchange Commission, including our annual report on
Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, annual proxy
statement on Schedule 14A and amendments to those reports, are available free
of
charge on our website as soon as reasonably practicable after they are filed
with, or furnished to, the Securities and Exchange
Commission. Information on our website or connected to our website is
not incorporated by reference into this Form 10-K. Our Internet
website is located at http://www.orthofix.com. Our SEC filings
are also available on the SEC Internet website as part of the EDGAR database
(http://www.sec.gov).
Important
Events
On
December 11, 2006, we announced that Chief Executive Officer Alan W. Milinazzo
had been appointed to the Company's Board of Directors, to fill the vacancy
on
the Board of Directors left by the retirement of Mr. Robert Gaines-Cooper,
one
of Orthofix's founders and the Chairman of the Board from 1989 to
2004. Mr. Milinazzo does not currently serve on any committees of the
Board of Directors. Mr. Gaines-Cooper, retired as director of
Orthofix International N.V. on December 5, 2006.
On
September 22, 2006, we completed the acquisition of privately held Blackstone
Medical, Inc. (“Blackstone”), a company specializing in the design, development
and marketing of spinal implant and related biologics products. The
purchase price for the acquisition was $333.0 million, subject to certain
closing adjustments, plus transaction costs totaling approximately $9.2 million
as of December 31, 2006. Financing costs were approximately $6.0
million. The acquisition and related costs were financed with $330.0
million of senior secured bank debt and cash on hand. The Company’s
results, for the year ended December 31, 2006, include the results of Blackstone
from the date of acquisition along with the impact of purchase accounting and
interest expense associated with the acquisition.
On
February 16, 2006, we announced that Alan W. Milinazzo, 47, the Company's then
Chief Operating Officer, had been promoted to Group President and Chief
Executive Officer effective April 1, 2006. Mr. Milinazzo succeeded
Charles W. Federico, who remains a Director of Orthofix. Mr.
Milinazzo joined the Company on September 6, 2005, in a newly established
position of Chief Operating Officer, from Medtronic Inc. where he was Vice
President of Medtronic’s Vascular business, as well as Vice President and
General Manager of Medtronic’s Coronary and Peripheral business.
On
September 30, 2005, we announced that we had reached an agreement to settle
the
patent litigation between our subsidiary Novamedix Distribution, Ltd. and
Kinetic Concepts, Inc. (“KCI”) related to our A-V Impulse
System®. Under the terms of the settlement, KCI agreed to pay
Novamedix $75 million, and we received a limited assignment of certain KCI
foot
pump patent rights. KCI retains rights in the patents and will
maintain its Plexi Pulse foot pump product line going forward. The
settlement resolves and settles all claims between the parties. In
the first quarter of 2006, we distributed approximately $22.9 million of the
settlement proceeds to certain parties including former owners of Novamedix,
pursuant to contracts requiring those disbursements.
Business
Strategy
Our
business strategy is to offer innovative, cost-effective orthopedic products
to
the Spine, Orthopedic, Sports Medicine and Vascular market sectors that reduce
both patient suffering and healthcare costs. We intend to continue to
expand applications for our products by utilizing synergies among our core
technologies. We intend to expand our product offerings through
business or product acquisition and assignment or licensing agreements, as
well
as through our own product development efforts. We will leverage our
sales and distribution network by selling our products in all markets in which
we can generate adequate financial returns. We intend to continue to
enhance physician relationships through extensive education efforts as well
as
strengthen contracting and reimbursement relationships through our dedicated
sales and administrative staff.
Business
Segments and Market Sectors
Our
business is divided into four reportable segments: Orthofix Domestic
(“Domestic”), Blackstone, Breg, and Orthofix International
(“International”). Domestic consists of operations of our subsidiary
Orthofix Inc. that uses both direct and distributor sales representatives to
sell Spine and Orthopedic products to hospitals, doctors, and other healthcare
providers in the United States market. We have designated Blackstone,
our newly acquired subsidiary, as a business segment. Blackstone
specializes in the design, development and marketing of spinal implant and
related biologic products. Blackstone uses distributor sales
representatives to sell Spine products domestically and
internationally. Breg designs, manufactures, and distributes
orthopedic products for post-operative reconstruction and rehabilitative patient
use and sells those Sports Medicine products through a network of domestic
and
international distributors, sales representatives, and
affiliates. International consists of locations in Europe, Mexico,
Brazil, and Puerto Rico, as well as independent distributors outside the United
States. International uses both direct and distributor sales
representatives to sell Spine, Orthopedic, Sports Medicine, Vascular, and Other
products.
Business
Segment (a):
|
Year
ended December 31,
(In
US$ thousands)
|
||||||||||||||||||||||||
|
2006
|
2005
|
2004
|
||||||||||||||||||||||
|
Net
Sales
|
Percent
of
Total
Net Sales
|
Net
Sales
|
Percent
of Total Net Sales
|
Net
Sales
|
Percent
of Total Net Sales
|
|||||||||||||||||||
|
Domestic
|
$
|
152,560
|
|
42
|
%
|
$
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135,084
|
|
43
|
%
|
$
|
118,074
|
|
41
|
%
|
|||||||||
|
Blackstone
|
28,134
|
8
|
%
|
-
|
-
|
-
|
-
|
|||||||||||||||||
|
Breg
|
76,219
|
21
|
%
|
72,022
|
23
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%
|
68,294
|
24
|
%
|
|||||||||||||||
|
International
|
108,446
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29
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%
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106,198
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34
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%
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100,270
|
35
|
%
|
|||||||||||||||
|
Total
|
$
|
365,359
|
100
|
%
|
$
|
313,304
|
100
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%
|
$
|
286,638
|
100
|
%
|
||||||||||||
|
(a)
|
Prior
to 2006 our operations in Mexico and Brazil were included within
the
Orthofix Domestic segment. Conversely,
in 2006 such operations are included within Orthofix
International. The prior year presentation has been
restated to conform with the current
presentation.
|
Additional
financial information regarding our business segments can be found in Part
II,
Item 8, “Financial Statements and Supplementary Data”, as well as in Item 7,
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations”.
We
maintain our books and records by business segment; however, we use market
sectors to describe our business. The Company’s segment information
is prepared on the same basis that the Company’s management reviews the
financial information for operational decision making
purposes. Market sectors, which categorize our revenues by types of
products, describe the net sales of our Company more clearly than our business
segments.
Our
market sectors, which were reformatted in 2006 to more clearly associate our
products with markets, are Spine, Orthopedics, Sports Medicine, Vascular, and
Other.
Market
Sector:
|
Year
ended December 31,
(In
US$ thousands)
|
||||||||||||||||||||||||
|
2006
|
2005
|
2004
|
||||||||||||||||||||||
|
Net
Sales
|
Percent
of
Total
Net Sales
|
Net
Sales
|
Percent
of Total Net Sales
|
Net
Sales
|
Percent
of Total Net Sales
|
|||||||||||||||||||
|
Spine
|
$
|
145,113
|
|
40
|
%
|
$
|
101,622
|
|
33
|
%
|
$
|
81,373
|
|
28
|
%
|
|||||||||
|
Orthopedics
|
95,799
|
26
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%
|
92,097
|
29
|
%
|
90,112
|
31
|
%
|
|||||||||||||||
|
Sports
Medicine
|
79,053
|
22
|
%
|
72,970
|
23
|
%
|
68,488
|
24
|
%
|
|||||||||||||||
|
Vascular
|
21,168
|
6
|
%
|
23,887
|
8
|
%
|
25,226
|
9
|
%
|
|||||||||||||||
|
Other
|
24,226
|
6
|
%
|
22,728
|
7
|
%
|
21,439
|
8
|
%
|
|||||||||||||||
|
Total
|
$
|
365,359
|
100
|
%
|
$
|
313,304
|
100
|
%
|
$
|
286,638
|
100
|
%
|
||||||||||||
Additional
financial information regarding our market sectors can be found in Part II,
Item
8, “Financial Statements and Supplementary Data”, as well as in
Item 7, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations”.
Products
Our
revenues are generally derived from the sales of products in four market
sectors, Spine (40%), Orthopedics (26%), Sports Medicine (22%) and Vascular
(6%), which together accounted for (94%) of our total net sales in
2006. Sales of Other products, including airway management products
for use during anesthesia, woman’s care and other products, accounted for (6%)
of our total net sales in 2006.
The
following table identifies our principal products by trade name and describes
their primary applications:
|
Product
|
Primary
Application
|
|
|
|
|
|
|
Spine Products
|
|
|
|
|
|
|
|
Spinal-Stim®
|
PEMF
non-invasive lumbar spine bone growth stimulator
|
|
|
Cervical-Stim®
|
PEMF
non-invasive cervical spine bone growth stimulator
|
|
|
|
|
|
|
3
Degree/Reliant
|
Plating
systems implanted during anterior cervical spine fusion
procedures
|
|
|
Hallmark
|
A
cervical plating system implanted during anterior cervical spine
fusion
procedures
|
|
|
ICON
Modular Spinal Fixation System
|
A
system of rods, crossbars and modular pedicle screws designed
to be
implanted during a minimally invasive posterior lumbar spine
fusion
procedure
|
|
|
Ascent
POCT System
|
A
system of pedicle screws and rods implanted during a posterior
spinal
fusion procedure involving the stabilization of several degenerated
or
deformed cervical vertebrae
|
|
|
Construx
VBR System
|
A
modular device implanted during the replacement of degenerated
or deformed
spinal vertebrae to provide additional anterior support
|
|
|
Construx
Mini VBR System
|
Smaller,
unibody versions of the Construx VBR System, implanted during
the
replacement of degenerated or deformed spinal vertebrae
|
|
|
Unity
Lumbosacral Fixation System
|
A
plating system implanted during anterior lumbar spine fusion
procedures
|
|
|
Ngage
Surgical Mesh
|
A
modular metallic interbody implant placed between two vertebrae
to restore
disc space and increase stability that has been lost due to degeneration
or deformity
|
|
|
Newbridge
Laminoplasty Fixation System
|
A
device implanted during a posterior surgical procedure to expand the
cervical vertebrae and relieve pressure on the spinal
canal
|
|
|
Trinity
Bone Matrix
|
An
adult stem-cell based bone growth matrix used during surgery
to enhance
the success of a spinal fusion procedure
|
|
|
Alloquent
Allografts
|
Interbody
devices made of cortical bone that is used to restore the space
that has
been lost between two or more vertebrae due to a degenerated
disc
|
|
Product
|
|
Primary
Application
|
|
Orthopedic
Products
|
|
|
|
|
|
|
|
Fixation
|
|
External
fixation and internal fixation, including the Sheffield Ring,
limb-lengthening systems, DAF, ProCallus, XCaliber™, Contour
VPS, VeroNail and Centronail
|
|
Physio-Stim®
|
|
PEMF
long bone non-invasive bone
growth stimulator
|
|
PC.C.P®
|
|
Percutaneous
compression plating
system for hip fractures
|
|
eight-Plate
Guided Growth System®
|
|
Treatment
to treat the bowed legs or knock knees of children
|
|
Cemex
|
|
Bone
cement
|
|
ISKD®
|
|
Internal
limb-lengthening
device
|
|
OSCAR
|
|
Ultrasonic
bone cement
removal
|
|
|
|
|
|
Sports
Medicine
|
|
|
|
Breg
Bracing
|
|
Bracing
products which provide
support and protection of limbs and extremities during healing
and
rehabilitation
|
|
Polar
Care®
|
|
Cold
therapy products to reduce
swelling, pain and accelerate the rehabilitation
process
|
|
Pain
Care®
|
|
Pain
therapy products that
provide continuous post-surgical infusion of local anesthetic
into surgical site
|
|
|
|
|
|
Vascular
|
|
|
|
A-V
Impulse System
|
|
Enhancement
of venous circulation, used principally after orthopedic procedures
to
prevent deep vein thrombosis
|
|
|
|
|
|
Non-Orthopedic
Products
|
|
|
|
Laryngeal
Mask
|
|
Maintenance
of airway during
anesthesia
|
|
Other
|
|
Several
non-orthopedic products for which various Orthofix subsidiaries
hold
distribution rights
|
We
have
proprietary rights in all of the above products with the exception of the
Laryngeal Mask, Cemex, ISKD, eight-Plate, Contours VPS and Trinity Bone
Matrix. We have the exclusive distribution rights for the Laryngeal
Mask and Cemex in Italy, for the Laryngeal Mask in the United Kingdom and
Ireland and for the ISKD, eight-Plate and Contours VPS worldwide. We
have U.S. distribution rights for Trinity Bone Matrix for use in spinal
applications.
We
have
numerous trademarked products and services including but not limited to the
following: Orthofix®, ProCallus®,
XCaliber™,
PC.C.P®, OASIS™, Spinal-Stim®,
Cervical-Stim®, Physio-Stim®,
Blackstone®, Alloquent®,
Ascent®, Construx®,
Hallmark®, ICON®,
Newbridge®, Ngage®,
Trinity™ Matrix,
Unity®,
Breg®, Polar
Care®, Pain
Care® and
Fusion™ XT.
Spine
Spine
product sales represented 40% of our total net sales in 2006.
Neck
and
back pain is a common health problem for many people throughout the world,
and
often requires surgical or non-surgical intervention for
improvement. Neck and back problems are usually of a degenerative
nature and are more prevalent among the older population. As the
population ages, we believe physicians will see an increasing number of patients
with degenerative spine issues, who wish to have a better quality of life than
that experienced by previous generations. Treatment options for spine
disorders are expected to expand to fill the existing gap between conservative
pain management and invasive surgical options, such as spine
fusion.
Orthofix’s
Spine products are positioned to address the needs of spine patients at many
points along the continuum of care, offering non-operative, pre-operative,
operative and post-operative products. Our products currently
address the cervical fusion segment as well as the lumbar fusion segment which
is the largest sub-segment of the spine market.
The
wide
array of spine implants offered by Blackstone are used during surgical
procedures intended to treat a variety of spine conditions. Most of
these surgeries are fusion procedures in the cervical and lumbar spine that
utilize Blackstone’s metal plates, rods and screws, their interbody devices or
vertebral body replacements, and their biologic bone growth
product.
Additionally,
bone growth stimulators used in spinal applications are designed to enhance
the
success rate of certain spinal fusions by stimulating the body’s own natural
healing mechanism post-surgically. These non-invasive portable
devices are intended to be used as part of a home treatment program prescribed
by a physician.
Spinal
Implants
The
human
spine is made up of 33 interlocking vertebrae that protect the spinal cord
and
provide structural support for the body. The top seven vertebrae make
up the cervical spine, which bears the weight of the skull and provides the
highest range of motion. The next 17 vertebrae encompass the thoracic
and lumbar, or thoracolumbar , sections of the spine. The thoracic
area helps protect the internal organs in the body’s abdomen by attaching to the
rib cage, and is the least mobile segment of the spine. The lumbar
area carries the greatest portion of the body’s weight, allowing some rotation
and handling the majority of the bending. The vast majority of
medical procedures involving the spine are performed in the cervical and lumbar
segments.
Spinal
bending and rotation are accomplished through the vertebral discs located
between each vertebrae. Each disc is made up of a tough fibrous
exterior, called the annulus, which surrounds a soft core called the nucleus.
Excess pressure, deformities, injury or disease can lead to a variety of
conditions affecting the vertebrae and discs that ultimately require medical
intervention in order to relive patient pain and restore stability in the
spine.
Spinal
fusion is the permanent union of two or more vertebrae to immobilize and
stabilize the affected portion of the spine. Most fusion surgeries
involve the placement of a bone graft between the affected vertebrae, which
is
typically held in place by metal implants that also provide stability to the
spine until the desired growth of new bone can complete the fusion
process. These implants consist of some combination of rods, screws
and plates that are designed to remain in the patient even after the fusion
has
occurred.
Most
fusion procedures performed on the lumbar area of the spine are done
posterially, or from the back, while the majority of cervical fusions are
performed from the anterior, or front, of the body. However, the
growing use of mesh cages and other interbody devices has resulted in the
increasing use of an anterior, or frontal, approach to many lumbar
surgeries. Interbody devices are small hollow implants typically made
of either bone, metal or a thermoplastic compound called
Polyetheretherketones that are placed between the affected vertebrae
to restore the space lost by the degenerated disc. The hollow spaces
within these interbody devices are typically packed with some form of biologic
material designed to accelerate the formation of new bone around the graft
which
ultimately results in the desired fusion.
Orthofix’s
wholly-owned subsidiary, Blackstone, provides a wide array of implants designed
for use primarily in cervical and lumbar fusion surgeries. These
implants are made of metal, bone, or PEEK. Additionally, Blackstone’s
product portfolio includes a unique adult stem cell-based biologic bone grafting
product, called Trinity™ Matrix.
The
majority of implants offered by Blackstone are made of titanium
metal. This includes the 3 Degree, Reliant and Hallmark cervical
plates. Additionally, the Spinal Fixation System (SFS) and the Ascent
POCT System are sets of rods, crossbars and screws which are implanted during
posterior fusion procedures. The more recently introduced ICON
Modular Spinal Fixation System is designed to be used in minimally-invasive
posterior lumbar fusion procedures. The Company also offers specialty
plates that are used in less common procedures, and as such are not manufactured
by many device makers. This would include the Newbridge Laminoplasty
Fixation System used to expand the cervical vertebrae and relieve pressure
on
the spinal canal, as well as the Unity plate which is used in anterior lumbar
fusion procedures.
Blackstone
also offers a variety of devices made of PEEK, which is a thermoplastic material
with mechanical properties that make it ideal for use in certain medical
devices. The products Blackstone offers that are made of this
material include vertebral body replacements and interbody
devices. As the name would suggest, vertebral body replacements
are used to replace a patient’s degenerated or deformed vertebrae. On
the other hand, interbody devices replace a damaged disc, restoring the space
that had been lost between two vertebrae. Blackstone also offers
interbody devices, or cages, made of titanium metal.
Blackstone is also a distributor of biologic products, including interbody
devices made of human cadaveric bone that has been harvested from donors and
carved by a machine into a desired shape, and a unique adult stem cell-based
product used to enhance a patient’s ability to quickly grow new bone around a
spinal fusion site. This product contains live adult stem cells
harvested from human donors. It is intended to be a safer, simpler
alternative to an autograft, which is commonly performed in connection with
a
spine fusion procedure. An autograft involves a separate surgical
incision in the patient’s hip area in order to harvest the patient’s own bone to
be used during the fusion procedure. An autograft procedure adds risk
of an additional surgical procedure and related patient discomfort in
conjunction with the spinal fusion.
Spinal
Bone Growth Stimulators
Separate
from Blackstone, Orthofix offers two spinal bone growth stimulation devices.
Our
stimulation products use a pulsing electromagnetic field (“PEMF”) technology to
enhance the growth of bone tissue following surgery and are placed externally
over the site to be healed. Clinical data shows our PEMF signal
enhances the body’s enzyme activities, induces mineralization, encourages new
vascular penetration and results in a process that generates new bone growth
at
the spinal fusion site. Orthofix has sponsored independent research at the
Cleveland Clinic, where scientists conducted animal and cellular studies to
identify the influence of Orthofix’s PEMF signals on bone cells. Four
of the six studies have been published; one in each of the years 2003, 2004,
2005, and 2006. One of the two remaining studies has been accepted
for publication in a peer-reviewed journal; the publication date is to be
determined and the final manuscript is currently under journal
review. Among other insights, the studies illustrate the positive
effects of PEMF on bone loss, callus formation, and
collagen. Furthermore, characterization and visualization of the
Orthofix PEMF waveform is paving the way for signal optimization for a variety
of applications and indications.
Spinal-Stim
was the first non-invasive spinal fusion stimulator system commercially
available in the United States. Spinal-Stim is designed for the
treatment of the lower thoracic and lumbar regions of the spine. Some
spine fusion patients are at greater risk than most patients of not generating
new bone around the damaged vertebrae after the operation. These
patients typically have one or more risk factors such as smoking, obesity or
diabetes, or their surgery involves the revision of a previously attempted
fusion procedure that failed, or the fusion of multiple levels of vertebra
in
one procedure. For these patients, post-surgical bone growth
stimulation using Spinal-Stim has been shown to increase the probability of
fusion, without the need for additional surgery. According to
internal sales data, more than 190,000 patients have been treated using
Spinal-Stim since the product was introduced in 1990. The device uses
proprietary technology and a wavelength to generate a pulsed electromagnetic
field (PEMF) signal. Our FDA approval to market Spinal-Stim
commercially is for both failed fusions and healing enhancement as an adjunct
to
initial spinal fusion surgery.
On
December 28, 2004, we received approval from the U.S. Food and Drug
Administration (FDA) to market our Cervical-Stim® bone growth
stimulator. Cervical-Stim® is the first and only
FDA-approved bone growth stimulator for use as an adjunct to cervical (upper)
spine fusion in certain high-risk patients.
The
FDA
approval of Cervical-Stim® is based upon a pre-market approval
(“PMA”) application that included the results of a prospective, randomized,
multi-center clinical investigation of Cervical-Stim. The clinical
trial randomized a total of 323 “high-risk” patients who had undergone cervical
fusion surgery for degenerative conditions. The trial defined “high
risk” as patients who had at least two risk factors. Results showed
that 84% of patients who wore the device healed and 69% of patients who did
not
wear the device healed. These results are clinically
significant.
Orthopedics
Orthopedics
products represented 26% of our total net sales in 2006.
The
medical devices offered in Orthofix’s Orthopedic market sector are used for two
primary purposes. These are bone fracture management and bone
deformity correction.
Fixation
For
a
fracture to heal properly, without misalignment or rotation, the bone must
be
set and fixed in the correct position. The bone must be kept stable,
but not absolutely rigid, in order to alleviate pain, maintain the correct
alignment and initiate new bone formation for proper
healing. Fractures initially should not bear any weight but, at the
appropriate time in the healing cycle, benefit from gradually increasing
micromovement, weight-bearing and function, which further stimulate the new
bone
formation. In most fracture cases, physicians use casting, the simplest
available non-surgical procedure. We believe, however, that
approximately 15-20% of all fractures require surgical
intervention.
Our
fracture management products consist of fixation devices designed to stabilize
a
broken bone until it can heal, as well as non-invasive post-surgical bone growth
stimulation devices designed to accelerate the body’s formation of new
bone. Our fixation products come in two main types: external devices
and internal devices. We initially focused on the production of
external fixation devices for management of fractures that require surgery.
External fixation devices are used to stabilize fractures from outside the
skin
with minimal invasion into the body. Our fixation devices use screws
that are inserted into the bone on either side of the fracture site, to which
the fixator body is attached externally. The bone segments are
aligned by manipulating the external device using patented ball joints and,
when
aligned, are locked in place for stabilization. Unlike other
treatments for fractures, external fixation allows micromovement at the fracture
site, which is beneficial to the formation of new bone. We believe
that it is among the most minimally invasive and least complex surgical options
for fracture management.
Internal
fixation devices come in various sizes, depending on the bone which requires
treatment and consist of either long rods commonly referred to as nails, or
as
plates that are attached with the use of screws. A nail is inserted
into the hollow core of a fractured long bone, such as the humerus, tibia and
fibula, found in human arms and legs. Alternatively, a plate is
attached by screws to an area such as a broken wrist or hip. External
devices are designed in large part to be used for the same types of conditions
that can be treated by internal fixation devices. The difference is
that the external fixator is a set of rods, rings and screws attached at the
fracture site from outside the arm or leg, and is held in place by the screws
that extend from the device through the patient’s skin into the fractured
bone. The choice of whether to use an internal or external fixation
device is driven in large part by physician preference. Many
patients, however, favor internal fixation devices for aesthetic
reasons.
An
example of one of our external fixation devices is the XCaliber™ fixator,
which is
made from a lightweight radiolucent material and provided in three
configurations to cover long bone fractures, fractures near joints and ankle
fractures. The radiolucency of XCaliber™ fixators allows X-rays
to pass through the device and provides the surgeon with significantly improved
X-ray visualization of the fracture and alignment. In addition, these
three configurations cover a broad range of fractures with very little
inventory. The XCaliber™ fixators are provided pre-assembled in
sterile kits to decrease time in the operating room.
Our
proprietary XCaliber™ bone screws are designed to be compatible with our
external fixators and reduce inventory for our customers. Some of
these screws are covered with hydroxyapatite, a mineral component of bone that
reduces superficial inflammation of soft tissue. Other screws in this
proprietary line do not include the hydroxyapatite coating but offer different
advantages such as patented thread designs for better adherence in hard or
soft
bone. We believe we have a full line of bone screws to meet the
demands of the market.
Another
example of an external fixation device designed for the treatment of fractures
is our Sheffield fixator. The Sheffield fixator is radiolucent and
uses fewer components than other products used for limb
reconstruction. In addition, the Sheffield fixator is more stable and
stronger than most competing products – two critical concerns for a long-term
limb reconstruction treatment. We believe other advantages of the
Sheffield fixator over competing products include the rapid assembly, ease
of
use and the numerous possibilities for customization for each individual
patient.
Examples
of our internal fixation devices include:
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The
Centronail is a new state of the art nailing system for stabilizing
fractures in the femur, tibia and humerus. It has all the attributes
of
the Orthofix Nailing System but has additional advantages: it is
made of
titanium; has improved mechanical distal targeting and instrumentation
and
a design which requires significantly reduced
inventory;
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The
VeroNail marks Orthofix’s entry into the intramedullary hip nailing
market. For use in hip fractures, it provides a
minimally-invasive screw and nail design intended to reduce surgical
trauma and allow patients to begin walking again as soon as possible
after
the operation. It uses a dual screw configuration that provides
more stability than previous single screw designs;
and
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The
Gotfried Percutaneous Compression Plating or PC.C.P® System is
another minimally invasive method of stabilization and fixation for
hip-fracture surgery developed by Y. Gotfried, M.D. Traditional
hip-fracture surgery can require a 5-inch-long incision down the
thigh,
but the PC.C.P® System involves two smaller incisions, each
less than one inch long. The PC.C.P® System then
allows a surgeon to work around most muscles and tendons rather than
cutting through them. Major benefits of this new approach to
hip-fracture surgery include (1) a significant reduction of complications
due to a less traumatic operative procedure; (2) reduced blood loss
and
less pain (important benefits for the typically fragile and usually
elderly patient population, who often have other medical problems);
and
(3) faster recovery, with patients often being able to bear weight
a few
days after the operation, and improved post-operative
results.
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Bone
Growth Stimulation
Our Physio-Stim® bone growth stimulator products use a pulsed
electromagnetic field (PEMF) technology similar to that described previously
in
the discussion of our spine stimulators. The primary difference is
that the Physio-Stim® physical configuration is designed for use on
bones found in areas other than the spine.
A bone’s regenerative power results in most fractures healing naturally within a
few months. In certain situations, however, fractures do not heal or
heal slowly, resulting in “non-unions.” Traditionally, orthopedists
have treated such fracture conditions surgically, often by means of a bone
graft
with fracture fixation devices, such as bone plates, screws or intramedullary
rods. These are examples of “invasive” treatments. Our
patented bone growth stimulators use a low level of PEMF signals to activate
the
body’s natural healing process and have proven successful in treating fracture
non-unions. The stimulation products that we currently market are
external and apply bone growth stimulation without implantation or other
surgical procedures.
Our patient data shows that eight out of ten patients with fracture non-unions
that use Physio-Stim® are healed by our product without additional
invasive surgical treatment. The systems offer portability,
rechargeable battery operation, integrated component design, patient monitoring
capabilities and the ability to cover a large treatment area without factory
calibration for specific patient application. According to internal
sales data, more than 123,000 patients have been treated using
Physio-Stim® for long bone non-unions since the product was
introduced.
Deformity
Corrections
In
addition to the treatment of bone fractures, we also design, manufacture and
distribute devices that are used to treat congenital bone conditions, such
as
limb length discrepancies, angular deformities (e.g., bowed legs in children),
or degenerative diseases, as well as conditions resulting from a previous
trauma. Examples of products offered in these areas include the
eight-Plate Guided Growth System® and the Intramedullary Skeletal
Kinetic Distractor, or ISKD®. The ISKD® system
is a patented, internal limb-lengthening device that uses a magnetic sensor
to
monitor limb-lengthening progress on a daily basis. ISKD®
is an expandable tubular device that is completely implanted inside the bone
to
be lengthened. Only the patient and surgeon need know the bone is
being lengthened. Once implanted, ISKD® lengthens the
patient’s bone gradually, and, after lengthening is completed, the system
stabilizes the lengthened bone. ISKD® is the only
FDA-approved intramedullary bone lengthener on the market, and we have the
exclusive worldwide distribution rights for this product.
Sports
Medicine
Sports
Medicine product sales represented 22% of our total net sales in
2006.
We
believe Breg is a market leader in the sale of orthopedic post-operative
reconstruction and rehabilitative products to hospitals and orthopedic
offices. Breg’s products are grouped primarily into three product
categories: Breg Bracing, Polar Care and Pain
Care. Approximately 58% of Breg’s net revenues were
attributable to the sale of bracing products in 2006, including: (1) functional
braces for prevention of ligament injuries, (2) load-shifting braces for
osteoarthritic pain management, (3) post-operative braces for protecting
surgical repair and (4) foot and ankle supports that provide an alternative
to
casting. Approximately 29% of Breg’s 2006 net revenues came from the
sale of cold therapy products used to minimize the pain and swelling following
knee, shoulder, elbow and back injuries or surgery. Approximately 7%
of Breg’s 2006 net revenues came from the sale of pain therapy products used for
patient control over post-operative pain management after common Sports Medicine
procedures such as arthroscopy of the knee and
shoulder. Approximately 6% of Breg’s 2006 net revenues came from the
sale of other rehabilitative products. Breg sells its products
through a network of domestic and international independent distributors and
related international subsidiaries.
Breg
Bracing
We
design, manufacture and market a broad range of rigid knee bracing products,
including ligament braces, post-operative braces and osteoarthritic
braces. The rigid knee brace products are either customized braces or
standard adjustable off-the-shelf braces. Breg braces are endorsed by
the Professional Football Athletic Trainers Society.
Ligament
braces provide durable support for moderate to severe knee ligament
instabilities and help stabilize the joint so that patients may successfully
complete rehabilitation and resume their daily activities. The
product line includes premium custom braces and off-the-shelf braces designed
for use in all activities. All ligament braces are also available
with a patellofemoral option to address tracking and subsequent pain of the
patellofemeral joint. We market the ligament product line under the
Fusion™ and X2K™ brand
names.
Post-operative
braces limit a patient’s range of motion after knee surgery and protect the
repaired ligaments and/or joints from stress and strain. These braces
promote a faster and healthier healing process. The products within
this line provide both immobilization and/or a protected range of
motion. The Breg post-op family of braces, featuring the Quick-Set
hinge, offers complete range of motion control for both flexion and extension,
along with a simple-to-use drop lock mechanism to lock the patient in full
extension. The release lock mechanism allows for easy conversion to
full range of motion. The straps, integrated through hinge bars,
offer greater support and stability. This hinge bar can be “broken
down” for use during later stages of rehabilitation. The Breg
T-Scope® is a premium brace in the post-operative bracing market and
has every feature available offered in our post-operative knee braces, including
telescoping bars, easy application, full range of motion and a drop lock
feature.
Osteoarthritic
braces are used to treat patients suffering from osteoarthritis of the
knee. Osteoarthritis (“OA”) is a form of damage to, or degeneration
of, the articular surface of a joint. This line of custom and
off-the-shelf braces is designed to shift the load going through the knee,
providing additional stability and reducing pain. In some cases, this
type of brace may serve as a cost-efficient alternative to total knee
replacement. Breg’s CounterForce Plus, our newest bracing technology
for patients suffering from OA, is based on a functional knee brace design
that
controls both anterior/posterior and varus/valgus
instabilities.
Cold
Therapy
We
manufacture, market and sell a leading cold therapy product line, Polar
Care®. Breg created the market for cold therapy products
in 1991 when it introduced the Polar Care® 500, a cold therapy device
used to reduce swelling, minimize the need for post-operative pain medications
and generally accelerate the rehabilitation process. Today, we
believe that cold therapy is a standard of care with physicians despite limited
historical reimbursement by insurance companies over the years. Based
on the increasing acceptance of cold therapy, reimbursement by insurance
companies is improving.
The
Polar
Care® product uses a circulation system to provide constant fluid
flow rates to ensure safe and effective treatment. The product
consists of a cooler filled with ice and cold water connected to a pad, which
is
applied to the affected area of the body; the device provides continuous cold
therapy for the relief of pain. Breg’s cold therapy line consists of
the Polar Care® 500, Polar Care® 500 LITE, Polar
Care® 300, Polar Cub and cold gel packs.
Infusion
Pumps
We
manufacture, market and sell a line of pain therapy products called Pain
Care®. This product line includes the Pain
Care® 3200 and 4200 lines of disposable, pain management infusion
pumps. These pain management systems provide a continuous infusion of
local anesthetic dispensed directly into the surgical site following a surgical
procedure. The Pain Care® family provides infusions,
controlled by the patient, of a local anesthetic to alleviate and moderate
severe pain experienced following surgery. We also sell the ePain
Care, an electronic, reusable infusion pump, which delivers a bolus of local
anesthetic in a programmable treatment protocol.
Other
Additionally,
Breg offers a line of
continuous passive motion (CPM) and home therapy products to accommodate
post-surgical ambulation and recovery from shoulder, knee and ankle
injuries.
Vascular
Vascular
product sales respresented 6% of our total net sales in 2006. Our
non-invasive post-surgical vascular therapy product, called the A-V Impulse
System, is primarily used on patients following orthopedic joint replacement
procedures. It is designed to reduce dangerous deep vein thrombosis, or blood
clots and post-surgery pain and swelling by improving venous blood return and
improving arterial blood flow. For patients who cannot walk or are
immobilized, this product simulates the effect that would occur naturally during
normal walking or hand flexion with a mechanical method and without the side
effects and complications of medication.
The
A-V
Impulse System consists of an electronic controller attached to a special
inflatable slipper or glove, or to an inflatable bladder within a cast, which
promotes the return of blood to the veins and the inflow of blood to arteries
in
the patient’s arms and legs. The device operates by intermittently
impulsing veins in the foot or hand, as would occur naturally during normal
walking or hand clenching. Conventionally, in order to reduce the
incidence of deep vein thrombosis, heparin or related pharmacological products
have been administered during and after operations. The A-V Impulse
System has been demonstrated to give prophylactic benefits that are comparable
to the forms of pharmacological treatment but without their adverse side
effects, the most serious of which typically is bleeding. The A-V
Impulse System is distributed in the United States by Kendall Healthcare
(“Kendall”), a division of Tyco Healthcare Group
LP. Outside the United States, the A-V Impulse System is
sold directly by our distribution subsidiaries in the United Kingdom, Italy
and
Germany and through selected distributors in the rest of the world.
Other
Products
Other
product sales represented 6% of our total net sales in 2006.
Laryngeal
Mask
The
Laryngeal Mask, a product of Venner Capital S.A. (formally known as LMA
International S.A.), is an anesthesia medical device used for establishing
and
maintaining the patient’s airway during an operation. We have
exclusive distribution rights for the Laryngeal Mask in the United Kingdom,
Ireland and Italy.
Other
We
hold
distribution rights for several other non-orthopedic products including Mentor
breast implants in Brazil and women’s care products in the United
Kingdom.
Product
Development
Our
research and development departments are responsible for new product
development. We work regularly with certain institutions referred to
below as well as with physicians and other consultants on the long-term
scientific planning and evolution of our research and development
efforts. Our primary research and development facilities are located
in Wayne, New Jersey; Springfield, Massachusetts; Verona, Italy; McKinney,
Texas; Vista, California; and Andover, United Kingdom.
We
maintain interactive relationships with prestigious spine and orthopedic centers
in the United States, Europe, Japan and South and Central America, including
research and development centers such as the Cleveland Clinic Foundation,
Rutgers University, and the University of Verona in Italy. Several of
the products that we market have been developed through these
collaborations. In addition, we regularly receive suggestions for new
products from the scientific and medical community, some of which result in
Orthofix entering into assignment or license agreements with physicians and
third-parties. We also receive a substantial number of requests for
the production of customized items, some of which have resulted in new
products. We believe that our policy of accommodating such requests
enhances our reputation in the medical community.
To
support its new product development efforts, Blackstone identifies noted spine
surgeons each year to participate in its Executive Medical Advisory Board
(“eMAB”). These physicians, who typically have at least 10 years of
experience in spine surgery, assist Blackstone in setting the overall direction
of its research and development efforts based on emerging trends and
technologies in the field. The eMAB also assists with the
identification and allocation of resources necessary to carry out specific
research and development initiatives. The eMAB meets formally once a
year and also provides additional ongoing support to management through
discussions throughout the year. In addition to the eMAB , Blackstone
maintains a Medical Advisory Board of approximately 50 surgeons from across
the
country who are involved in various aspects of product development including
early product evaluation and the development of product operating
guides.
In
2006
we spent $15.0 million on research and development and recorded a $40.0 million
charge for In Process Research and Development as part of the purchase
accounting for the Blackstone transition. In 2005 and 2004, we spent
$11.8 million and $11.5 million, respectively, on research and
development.
Patents,
Trade Secrets, Assignments and Licenses
We
rely
on a combination of patents, trade secrets, assignment and license agreements
as
well as non-disclosure agreements to protect our proprietary intellectual
property. We own numerous U.S. and foreign patents and have numerous
pending patent applications and license rights under patents held by third
parties. Our primary products are patented in major markets in which
they are sold. There can be no assurance that pending patent
applications will result in issued patents, that patents issued or assigned
to
or licensed by us will not be challenged or circumvented by competitors or
that
such patents will be found to be valid or sufficiently broad to protect our
technology or to provide us with any competitive advantage or
protections. Third parties might also obtain patents that would
require assignments to or licensing by us for the conduct of our
business. We rely on confidentiality agreements with key employees,
consultants and other parties to protect, in part, trade secrets and other
proprietary technology.
We
obtain
assignments or licenses of varying durations for certain of our products from
third parties. We typically acquire rights under such assignments or
licenses in exchange for lump-sum payments or arrangements under which we pay
to
the licensor a percentage of sales. However, while assignments or
licenses to us generally are irrevocable, there is no assurance that these
arrangements will continue to be made available to us on terms that are
acceptable to us, or at all. The terms of our license and assignment
agreements vary in length from a specified number of years to the
life of product patents or the economic life of the product. These
agreements generally provide for royalty payments and termination rights in
the
event of a material breach.
Government
Regulation
Sales
of
medical devices, including our products, are subject to regulatory requirements
in the U.S. and abroad which regulate the development, approval, testing,
manufacture, labeling, marketing and sale of medical products and which vary
widely from country to country. The amount of time required to obtain
approvals or clearances from regulatory authorities also differs from country
to
country.
Our
products are subject to the regulatory powers of the U.S. Food and Drug
Administration (“FDA”) pursuant to the Medical Device Amendments Act of 1976 to
the Federal Food, Drug, and Cosmetics Act, as amended, and regulations issued
or
proposed hereunder. With certain exceptions, our products fall into
FDA classifications that require a less rigorous standard of review by the
FDA
pursuant to Section 510(k) of the 1976 Amendments than devices that require
pre-market approval applications. However, our bone growth
stimulation products are classified as Class III by the FDA, and have been
approved for commercial distribution in the United States following our
submission of the required pre-market approval applications. We also
have under development, an artificial cervical disc product which is currently
classified as FDA Class III. As such, this product is required to
complete a rigorous pre-market approval process including a human clinical
trial. We also have under development other products designed to
treat degenerative spinal disc disease but which allow greater post-surgical
mobility than standard surgical approaches involving spinal fusion
techniques. Certain of these products may be classified as FDA Class
III products and may require pre-market approval process including a human
clinical trial. In addition, our subsidiary, Blackstone Medical, is a
distributor of a product for bone repair and reconstruction under the brand
name
Trinity™ Matrix which is an allogeneic bone matrix containing viable adult
mesenchymal stem cells. We believe that Trinity™ Matrix is properly
classified by the FDA under its Human Cell, Tissues and Cellular and
Tissue-Based Products, or HCT/P, regulatory paradigm and not as
a medical device or as a biologic or as a drug. Rather, we believe it
is regulated under Section 361 of the Public Health Service Act and C.F.R.
Part
1271. Blackstone also distributes certain surgical implant products
known as “allograft” products which are derived from human tissues and which are
used for bone reconstruction or repair and are surgically implanted into the
human body. We believe that these products are properly classified by
the FDA as minimally-manipulated tissue and are covered by FDA’s “Good Tissues
Practices” regulations, which cover all stages of allograft
processing. There can be no assurance that our suppliers of the
Trinity™ Matrix and allograft products will continue to meet applicable
regulatory requirements or that those requirements will not be changed in ways
that could adversely affect our business. Further, there can be no
assurance that these products will continue to be made available to us or that
applicable regulatory standards will be met or remain
unchanged. Moreover, products derived from human tissue or bone are
from time to time subject to recall for certain administrative or safety reasons
and we may be affected by one or more such recalls. For a description
of these risks, see Item 1A “Risk Factors.”
The
medical devices that we develop, manufacture and market are subject to rigorous
regulation by the FDA and numerous other federal, state and foreign governmental
authorities. The process of obtaining FDA and other regulatory approvals to
develop and market a medical device, particularly from the FDA, can be costly
and time-consuming, and there can be no assurance that such approvals will
be
granted on a timely basis, if at all. While we believe that we have obtained
all
necessary clearances for the manufacture and sale of our products and that
they
are generally in compliance with applicable FDA and other material regulatory
requirements, there can be no assurance that we will be able to continue such
compliance. If the FDA came to believe that we were not in compliance with
applicable law or regulations, it could institute proceedings to detain or
seize
our products, issue a recall, impose operating restrictions, enjoin future
violations and assess civil and criminal penalties against us, our officers
or
our employees and could recommend criminal prosecution to the
Department of Justice. In addition, the regulatory process
may delay the marketing of new products for lengthy periods and impose
substantial additional costs if the FDA lengthens review times for new
devices. The FDA also has the ability to reclassify medical devices
from one category of regulatory classification to another and there can be
no
assurance that one or more of our products will not be
reclassified. Reclassification can, among other things, adversely
affect the level of reimbursement that can be obtained for that
product.
Moreover,
governmental authorities outside the U.S have become increasingly stringent
in
their regulation of medical devices, and our products may become subject to
more
rigorous regulation by non-U.S. governmental authorities in the
future. U.S. or non-U.S. government regulations may be imposed in the
future that may have a material adverse effect on our business and
operations. The European Commission, or EC, has harmonized national
regulations for the control of medical devices through European Medical Device
Directives with which manufacturers must comply. Under these new
regulations, manufacturing plants must have received CE certification from
a
“notified body” in order to be able to sell products within the member states of
the European Union. Certification allows manufacturers to stamp the
products of certified plants with a “CE” mark. Products covered by
the EC regulations that do not bear the CE mark cannot be sold or distributed
within the European Union. We have received certification for all
currently existing manufacturing facilities and products.
Our
sales
and marketing practices are also subject to a number of U.S. laws regulating
healthcare fraud and abuse such as the federal Anti-Kickback Statute and the
federal Physician Self-Referral Law (known as the “Stark Law”), the Civil False
Claims Act and the Health Insurance Portability and Accountability Act of 1996
as well as numerous state laws regulating healthcare and
insurance. These laws are enforced by the Office of Inspector General
within the United States Department of Health and Human Services, the United
States Department of Justice, and other
federal, state and local agencies. Among other things, these laws and
others generally: (1) prohibit the provision of any thing of value in
exchange for the referral of patient for, or the purchase, order, or
recommendation of, any item or service reimbursed by a healthcare program,
(including Medicare and Medicaid), (2) require that claims for payment submitted
to the government healthcare programs be truthful, (3) prohibit the transmission
of protected healthcare information to persons not authorized to receive that
information, (4) require the provision of certain information to the government,
and (5) require the maintenance of certain government licenses and
permits.
In
addition, U.S. federal and state laws protect the confidentiality of certain
health information, in particular individually identifiable information such
as
medical records, and restrict the use and disclosure of that protected
information. At the federal level, the U.S. Department of Health and
Human Services promulgated health information privacy and security rules under
the Health Insurance Portability and Accountability Act of 1996, or
HIPAA. These rules protect health information by regulating its use
and disclosure, including for research and other purposes. Failure of
a HIPAA “covered entity” to comply with HIPAA regarding such “protected health
information” could constitute a violation of federal law, subject to civil and
criminal penalties. Covered entities include healthcare providers
(including those that sell devices or equipment) that submit electronic
claims. Consequently, health information that we access, collect,
analyze, and otherwise use and/or disclose may include protected health
information that is subject to HIPAA. As noted above,
many state laws also pertain to the confidentiality of health
information. Such laws are not necessarily preempted by HIPAA, in
particular those state laws that afford greater privacy protection to the
individual than HIPAA. These state laws typically have their own
penalty provisions, which could be applied in the event of an unlawful action
affecting health information.
Sales,
Marketing and Distribution
General
Trends
We
believe that demographic trends, principally in the form of a better informed,
more active and aging population in the major healthcare markets of the United
States, Western Europe and Japan, together with opportunities in emerging
markets such as the Asia-Pacific Region (including China) and Latin America,
as
well as our focus on innovative products, will continue to have a positive
effect on the demand for our products.
Primary
Markets
In
2006,
Domestic accounted for 42% of total net sales; Blackstone accounted for 8%
of
total net sales; Breg accounted for 21% of total net sales; and International
accounted for 29% of total net sales. No single non-governmental
customer accounted for greater than 5% of total net sales. Sales to
customers were broadly distributed.
Our
products sold in the United States are either prescribed by medical
professionals for the care of their patients or selected by physicians, sold
to
hospitals, clinics, surgery centers, independent distributors or other
healthcare providers, all of whom may be primarily reimbursed for the healthcare
products provided to patients by third-party payors, such as government
programs, including Medicare and Medicaid, private insurance plans and managed
care programs. Our products are also sold in many other countries,
such as the United Kingdom, France and Italy, which have publicly funded
healthcare systems as well as private insurance plans. (See Item 1A
Risk Factors, page 24 for table of revenue by payor type.)
Sales,
Marketing and Distributor Network
We
have
established a broad distribution network comprised of direct sales
representatives and distributors. This established distribution
network provides us with a strong platform to introduce new products and expand
sales of existing products. We distribute our products through a
sales and marketing force of approximately 508 direct sales and marketing
representatives. Our products are also sold through
distributors. Worldwide we have approximately 280 independent
distributors who represent our products in approximately 65
countries. The table below highlights the makeup of our sales,
marketing and distribution network at December 31, 2006.
|
Direct
Sales
& Marketing Headcount
|
Distributors
|
|||||||||||||||||||||||
|
United
States
|
International
|
Total
|
United
States
|
International
|
Total
|
|||||||||||||||||||
|
Domestic
|
280
|
-
|
280
|
32
|
-
|
32
|
||||||||||||||||||
|
Blackstone
|
40
|
4
|
44
|
38
|
25
|
63
|
||||||||||||||||||
|
Breg
|
26
|
3
|
29
|
48
|
61
|
109
|
||||||||||||||||||
|
International
|
6
|
149
|
155
|
-
|
76
|
76
|
||||||||||||||||||
|
Total
|
352
|
156
|
508
|
118
|
162
|
280
|
||||||||||||||||||
In
our
largest market, the United States, our sales, marketing and distributor network
is separated between several distinct sales forces addressing different market
sectors. The Spine market sector is addressed primarily by a direct
sales force for spinal bone growth stimulation products and Blackstone biologics
products and a distributor network for Blackstone spinal implant
products. The Orthopedic market sector is addressed by a hybrid
distribution network of predominately direct sales supplemented by
distributors. The Sports Medicine market sector is
primarily a distributor network for Breg products.
Outside
the United States, we employ both direct sales representatives and distributors
within our international sales subsidiaries. We also utilize
independent distributors in Europe, the Far East, the Middle East and Central
and South America in countries where we do not have subsidiaries. In
order to provide support to our independent distributor network, we have a
group
of sales and marketing specialists who regularly visit independent distributors
to provide training and product support.
Marketing
and Product Education
We
seek
to market our products principally to medical professionals and group purchasing
organizations (“GPO”) or hospital organizations who buy on a large
scale. The focus on marketing to physicians is designed to complement
our product development and marketing strategy, which seeks to encourage and
maintain product development relationships with the leading orthopedic, trauma
and other surgeons. These relationships facilitate the introduction
of design improvements and create innovative products that meet the needs of
surgeons and patients, thereby expanding the market for our
products. The focus on selling to GPO’s and large national accounts
reflects a recent trend toward large scale procurement efforts in the healthcare
industry.
We
support our sales force and distributors through specialized training workshops
in which surgeons and sales specialists participate. We also produce
marketing materials, including materials outlining surgical procedures, for
our
sales force and distributors in a variety of languages in printed, video and
multimedia formats. To provide additional advanced training for
surgeons, we organize monthly multilingual teaching seminars at our facility
in
Verona, Italy. The Verona product education seminars, which in 2006
were attended by over 850 surgeons and over 450 distributor representatives
and
sales specialists from around the world, include a variety of lectures from
specialists as well as demonstrations and hands-on workshops. Each
year many of our sales representatives and distributors independently conduct
basic courses locally for surgeons in the application of certain of our
products. We also provide sales training at our training centers in
McKinney, Texas and at our Breg training center in Vista,
California. Additionally, we have implemented a web-based sales
training program, which provides continued training to our sales
representatives.
Blackstone
maintains a Los Angeles Spine Center to educate spine surgeons on its
products. Blackstone currently holds training sessions at the center
every other month with groups of 9 to 10 physicians who come from around the
world to view surgery, work on cadavers and participate in a spinal
conference. Spine surgeons have also come to the center on an individual basis
to see various new products used in surgery. They have also brought X-rays
to review difficult cases and discuss various trends in the marketplace.
Blackstone also has relationships with a number of hospitals and noted spine
surgeons around the country that periodically participate in physician training
events, and it has plans to expand the Los Angeles Spine Center in
2007. Additional planned future programs include a surgical fellows
internship and additional one day seminars.
Competition
Our
bone
growth stimulation products compete principally with similar products marketed
by Biomet Spine a business unit of Biomet, Inc, DJO Incorporated, and Exogen,
Inc., a subsidiary of Smith & Nephew plc. Our Blackstone spinal
implant and biologic products compete with products marketed by Medtronic Inc.,
De Puy, a division of Johnson and Johnson, Synthes AG, Stryker Corp, Zimmer,
Inc., Biomet Spine and various smaller public and private
companies. For external and internal fixation devices, our principal
competitors include Synthes AG, Zimmer, Inc., Stryker Corp., Smith & Nephew
plc and Biomet Orthopedics. OSCAR competes principally with products
produced by Biomet, Inc. and Norian Corporation. The principal
non-pharmacological products competing with our A-V Impulse System are
manufactured by Huntleigh Technology PLC and Kinetic Concepts Inc.
The
principal competitors for the Breg bracing and cold therapy products include
DJO
Inccorporated, Biomet, Ossur Lf. and various smaller private
companies. For pain therapy products, the principal competitors are
I-Flow Corporation, Stryker Corp. and DJO Incorporated.
We
believe that our competitive position is strong with respect to product features
such as innovation, ease of use, versatility, cost and patient
acceptability. We attempt to avoid competing based solely on
price. Overall cost and medical effectiveness, innovation,
reliability, after-sales service and training are the most prevalent methods
of
competition in the markets for our products, and we believe that we compete
effectively.
Manufacturing
and Sources of Supply
We
generally design, develop, assemble, test and package our stimulation and
orthopedic products, and subcontract the manufacture of a substantial portion
of
the component parts. We design and develop our Blackstone spinal
implant and Allograft biologic products but subcontract their manufacture and
packaging. Through subcontracting, we attempt to maintain operating
flexibility in meeting demand while focusing our resources on product
development, education and marketing as well as quality assurance
standards. We generally source for distribution other biologics
products including Trinity™ Matrix, our adult stem-cell based bone growth matrix
product. In addition to designing, developing, assembling, testing,
and packaging its products, Breg also manufactures a substantial portion of
the
component parts used in its products.
Although
certain of our key raw materials are obtained from a single source, we believe
that alternate sources for these materials are available. Adequate
raw material inventory supply is maintained to avoid product flow
interruptions. We have not experienced difficulty in obtaining the
materials necessary to meet our production schedule. Trinity™ Matrix
Multipotential Cellular Bone Matrix is a single source product obtained under
an
exclusive distribution agreement through December 2008. Under this
agreement, as long as we purchase 80% of the product manufactured by the
supplier, we maintain our position as the only spine manufacturer with exclusive
distribution rights to the product. The supply of Trinity™ Matrix as
well as the Alloquent implants are made from human tissue where availability
is
subject to supply of human donors.
Our
products are currently manufactured and assembled in the United States, Italy,
the United Kingdom, and Mexico. We believe that our plants comply in
all material respects with the requirements of the FDA and all relevant
regulatory authorities outside the United States. For a description
of the laws to which we are subject, see Item 1 – “Business – Government
Regulation.” We actively monitor each of our subcontractors in order
to maintain manufacturing and quality standards and product specification
conformity.
Our
business is generally not seasonal in nature. However, sales
associated with products for elective procedures appear to be influenced by
the
somewhat lower level of such procedures performed in the late
summer. Certain of the Breg bracing products experience greater
demand in the fall and winter corresponding with high school and college
football schedules and winter sports. In addition, we do not consider
the backlog of firm orders to be material.
Capital
Expenditures
We
had
tangible and intangible capital expenditures in the amount of $12.6 million,
$12.2 million and $12.2 million in 2006, 2005 and 2004, respectively,
principally for computer software and hardware, patents, licenses, plant and
equipment, tooling and molds and product instrument sets. We
currently plan to invest approximately $17 million in capital expenditures
during 2007 to support the planned expansion of our business. We
expect these capital expenditures to be financed principally with cash generated
from operations.
Employees
At
December 31, 2006, we had 1,324 employees worldwide. 428 were employed at
Domestic, 150 were employed at Blackstone, 422 were employed at Breg and 324
were employed at International. Our relations with our Italian
employees, who numbered 98 at December 31, 2006, are governed by the provisions
of a National Collective Labor Agreement setting forth mandatory minimum
standards for labor relations in the metal mechanic workers
industry. We are not a party to any other collective bargaining
agreement. We believe that we have good relations with our
employees. Of our 1,324 employees, 508 were employed in sales and
marketing functions, 263 in general and administrative, 457 in production and
96
in research and development.
Item
1A. Risk Factors
In
addition to the other information contained in the Form 10-K and the exhibits
hereto, you should carefully consider the risks described
below. These risks are not the only ones that we may
face. Additional risks not presently known to us or that we currently
consider immaterial may also impair our business operations. This
Form 10-K also contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including the risks faced by us described below or elsewhere in this Form
10-K.
Our
acquisition of Blackstone Medical could present challenges for
us.
On
September 22, 2006, we completed the acquisition of Blackstone
Medical. We are in the process of integrating the operations of
Blackstone Medical into our business. We may not be able to
successfully integrate Blackstone Medical’s operations into our business and
achieve the anticipated benefits of the acquisition. The integration
of Blackstone Medical’s operations into our business involves numerous risks,
including:
|
|
·
|
difficulties
in incorporating Blackstone Medical’s product lines, sales personnel and
marketing operations into our
business;
|
|
|
·
|
the
diversion of our resources and our management’s attention from other
business concerns;
|
|
|
·
|
the
loss of any key distributors;
|
|
|
·
|
the
loss of any key employees; and
|
|
|
·
|
the
assumption of unknown liabilities.
|
In
addition, Blackstone Medical’s business is subject to many of the same risks and
uncertainties that apply to our other business operations, such as risks
relating to the protection of Blackstone Medical’s intellectual property and
proprietary rights, including patents that it owns or licenses. If
Blackstone Medical’s intellectual property and proprietary rights are
challenged, or if third parties claim that Blackstone Medical infringes on
their
proprietary rights, our business could be adversely affected.
Failure
to overcome these risks or any other problems encountered in connection with
the
acquisition of Blackstone Medical could adversely affect our business, prospects
and financial condition. In addition, if Blackstone Medical’s
operations and financial results do not meet our expectations, we may not
realize synergies, operating efficiencies, market position, or revenue growth
we
anticipate from the acquisition.
We
depend on our ability to protect our intellectual property and proprietary
rights, but we may not be able to maintain the confidentiality, or assure the
protection, of these assets.
Our
success depends, in large part, on our ability to protect our current and future
technologies and products and to defend our intellectual property
rights. If we fail to protect our intellectual property adequately,
competitors may manufacture and market products similar to, or that compete
directly with, ours. Numerous patents covering our technologies have
been issued to us, and we have filed, and expect to continue to file, patent
applications seeking to protect newly developed technologies and products in
various countries, including the United States. Some patent
applications in the United States are maintained in secrecy until the patent
is
issued. Because the publication of discoveries tends to follow their
actual discovery by several months, we may not be the first to invent, or file
patent applications on, any of our discoveries. Patents may not be
issued with respect to any of our patent applications and existing or future
patents issued to, or licensed by, us and may not provide adequate protection
or
competitive advantages for our products. Patents that are issued may
be challenged, invalidated or circumvented by our
competitors. Furthermore, our patent rights may not prevent our
competitors from developing, using or commercializing products that are similar
or functionally equivalent to our products.
We
also
rely on trade secrets, unpatented proprietary expertise and continuing
technological innovation that we protect, in part, by entering into
confidentiality agreements with assignors, licensees, suppliers, employees
and
consultants. These agreements may be breached and there may not be
adequate remedies in the event of a breach. Disputes may arise
concerning the ownership of intellectual property or the applicability or
enforceability of confidentiality agreements. Moreover, our trade
secrets and proprietary technology may otherwise become known or be
independently developed by our competitors. If patents are not issued
with respect to our products arising from research, we may not be able to
maintain the confidentiality of information relating to these
products. In addition, if a patent relating to any of our products
lapses or is invalidated, we may experience greater competition arising from
new
market entrants.
Third
parties may claim that we infringe on their proprietary rights and may prevent
us from manufacturing and selling certain of our products.
There
has
been substantial litigation in the medical devices industry with respect to
the
manufacture, use and sale of new products. These lawsuits relate to
the validity and infringement of patents or proprietary rights of third
parties. We may be required to defend against allegations relating to
the infringement of patent or proprietary rights of third
parties. Any such litigation could, among other things:
|
|
·
|
require
us to incur substantial expense, even if we are successful in the
litigation;
|
|
|
·
|
require
us to divert significant time and effort of our technical and management
personnel;
|
|
|
·
|
result
in the loss of our rights to develop or make certain products;
and
|
|
|
·
|
require
us to pay substantial monetary damages or royalties in order to license
proprietary rights from third parties or to satisfy judgments or
to settle
actual or threatened litigation.
|
Although
patent and intellectual property disputes within the orthopedic medical devices
industry have often been settled through assignments, licensing or similar
arrangements, costs associated with these arrangements may be substantial and
could include the long-term payment of royalties. Furthermore, the
required assignments or licenses may not be made available to us on acceptable
terms. Accordingly, an adverse determination in a judicial or
administrative proceeding or a failure to obtain necessary assignments or
licenses could prevent us from manufacturing and selling some products or
increase our costs to market these products.
For
example, our subsidiary, Blackstone, maintains a license agreement with Cross
Medical, Inc./Biomet Spine (“Cross/Biomet”) covering certain pedicle screw
products currently sold by Blackstone. Prior to the
completion of its acquisition by us, Blackstone requested that Cross/Biomet
consent to the assignment of the license agreement to the extent Blackstone’s
acquisition by the Company constituted an assignment thereunder. At
this time, Cross/Biomet and the Company are in discussions about the terms
of
such consent and the scope of products marketed by Blackstone that fall within
the ambit of the license. The Company believes that no consent is
necessary for Blackstone to maintain its rights under the license agreement
and
that to the extent such consent is necessary, Cross/Biomet is required to
provide it under the terms of the agreement. The Company also
believes that it has properly interpreted the scope of the
license. However, there can be no assurance that Cross/Biomet will
not challenge Blackstone’s rights under the license agreement if current
negotiations are not successful.
Reimbursement
policies of third parties, cost containment measures and healthcare reform
could
adversely affect the demand for our products and limit our ability to sell
our
products.
Our
products are sold either directly by us or independent sales representatives
to
customers or to our independent distributors and purchased by hospitals, doctors
and other healthcare providers. These products may be reimbursed by third-party
payors, such as government programs, including Medicare, Medicaid and Tricare,
or private insurance plans and healthcare networks. Third-party
payors may deny reimbursement if they determine that a device provided to a
patient or used in a procedure does not meet applicable payment criteria or
if
the policy holder’s healthcare insurance benefits are limited. Also,
third-party payors are increasingly challenging the prices charged for medical
products and services. Limits put on reimbursement could make it more
difficult for people to buy our products and reduce, or possibly eliminate,
the
demand for our products. In addition, should governmental authorities
enact additional legislation or adopt regulations that affect third-party
coverage and reimbursement, demand for our products may be reduced with a
consequent material adverse effect on our sales and
profitability. Third-party payors, whether private or governmental
entities, also may revise coverage or reimbursement polices that
address whether a particular product, treatment modality, device or therapy
will
be subject to reimbursement and, if so, at what level of payment.
The
Centers for Medicare and Medicaid Services (“CMS”), in its ongoing
implementation of the Medicare program recently obtained information from an
advisory panel known as the Medicare Evidence Development and Coverage Advisory
Committee (“MedCAC”) that could affect our business. Specifically, in
one meeting, MedCAC addressed the use of bone growth stimulators such as those
manufactured by the Company and certain biological products (known generally
as
“orthobiologics”) for the repair of non-union bone fractures, while in another
meeting it addressed evidence relating to indications for spinal fusion,
clinical outcomes relating to different spinal fusion procedures and the
generalizability of this information to the Medicare population. In
addition, CMS has obtained a related technical assessment of the medical study
literature to determine how the literature addresses spinal fusion surgery
in
the Medicare population. The impact that this information will have
on Medicare coverage policy for the Company’s products is currently unknown, but
we cannot provide assurances that the resulting actions would not restrict
Medicare coverage for our products. As required by law, the Centers
for Medicare and Medicaid Services (“CMS”) is expected to implement a
competitive bidding program for durable medical equipment paid for by the
Medicare program. The competitive bidding program is likely to begin
with a limited set of products in limited areas in 2007, be expanded to more
areas and more products in 2009, and implemented in full some time
thereafter. While some of our products are designated by the Food and
Drug Administration as Class III medical devices and thus are not included
within the competitive bidding program, some of our products may be encompassed
within the program at varying times. There can be no assurance that
the implementation of the competitive bidding program will not have an adverse
impact on the sales of some of our products.
Third-party
payors, whether private or governmental entities, also may revise coverage
or
reimbursement policies that address whether a particular product, treatment
modality, device or therapy will be subject to reimbursement and, if so, at
what
level of payment. CMS, in its ongoing implementation of the Medicare
program recently obtained information from an advisory panel known as the
Medicare Evidence Development and Coverage Advisory Committee (“MedCAC”) that
could affect our business. Specifically, in one meeting, MedCAC
addressed the use of bone growth stimulators such as those manufactured by
the
Company and certain biological products (known generally as “orthobiologics”)
for the repair of non-union bone fractures, while in another meeting it
addressed evidence relating to indications for spinal fusion, clinical outcomes
relating to different spinal fusion procedures and the generalizability of
this
information to the Medicare population. In addition, CMS has obtained
a related technical assessment of the medical study literature to determine
how
the literature addresses spinal fusion surgery in the Medicare
population. The impact that this information will have on Medicare
coverage policy for the Company’s products is currently unknown, but we cannot
provide assurances that the resulting actions would not restrict Medicare
coverage for our products. It is also possible that the government’s
focus on coverage of off-label uses the FDA-approved devices could lead to
changes in coverage policies regarding off-label uses by TriCare, Medicare
and/or Medicaid. There can be no assurance that we or our
distributors will not experience significant reimbursement problems in the
future related to these or other proceedings. Our products are sold
in many countries, such as the United Kingdom, France, and Italy, with publicly
funded healthcare systems. The ability of hospitals supported by such
systems to purchase our products is dependent, in part, upon public budgetary
constraints. Any increase in such constraints may have a material
adverse effect on our sales and collection of accounts receivable from such
sales.
We
estimate that revenue by payor type is:
|
·
|
Independent
Distributors
|
27%
|
|
|
||
|
·
|
Third
Party Insurance
|
22%
|
|
|
||
|
·
|
International
Public Healthcare Systems
|
16%
|
|
|
||
|
·
|
Direct
(hospital)
|
23%
|
|
·
|
U.S.
Government – Medicare, Medicaid, TriCare
|
10%
|
|
|
||
|
·
|
Self
pay
|
2%
|
We
may be subject to extensive government regulation that increases our costs
and
could limit our ability to market or sell our products.
The
medical devices we manufacture and market are subject to rigorous regulation
by
the Food and Drug Administration, or FDA, and numerous other federal, state
and
foreign governmental authorities. These authorities regulate the
development, approval, classification, testing, manufacture, labeling, marketing
and sale of medical devices. Likewise, our use and disclosure of
certain categories of health information may be subject to federal and state
laws, implemented and enforced by governmental authorities, that protect health
information privacy and security. For a description of these
regulations, see Item 1 – “Business – Government Regulation.”
The
approval by governmental authorities, including the FDA in the United States,
is
generally required before any medical devices may be marketed in the United
States or other countries. We cannot predict whether in the future,
the U.S. or foreign governments may impose regulations that have a material
adverse effect on our business, financial condition or results of
operations. The process of obtaining FDA and other regulatory
approvals to develop and market a medical device can be costly and
time-consuming, and is subject to the risk that such approvals will not be
granted on a timely basis if at all. The regulatory process may delay
or prohibit the marketing of new products and impose substantial additional
costs if the FDA lengthens review times for new devices. The
FDA has the ability to change the regulatory classification of a cleared or
approved device from a higher to a lower regulatory classification which could
materially adversely impact our ability to market or sell our
devices. Our subsidiary, Orthofix Inc., is currently involved
in a proceeding before the FDA addressing whether the FDA classification of
Physio-Stim and Spinal-Stim bone growth stimulation products should be
reclassified from FDA Class III to FDA Class II. We are
actively participating in this proceeding, and maintain that the current FDA
Class III classification is correct. A meeting was held on June 2,
2006 before the FDA’s Orthopedic and Rehabilitation Devices Panel (the “Panel”)
for the purpose of gathering information to allow the Panel to make a
recommendation to the FDA regarding reclassification. At that
meeting, the Panel determined that the present FDA Class III classification
for
the products at issue is proper. On January 17, 2007, the FDA issued
a federal register notice announcing that it was prepared to adopt the position
of the Panel that the bone growth stimulator products at issue should remain
in
FDA Class III and opened the record for public comment. We do not
know when the FDA will reach a determination on this classification issue or
whether any such determination would adversely impact our ability to market
or
sell these products.
Our
profitability depends, in part, upon the ability of the Company, our sales
representatives, and our distributors to obtain and maintain all necessary
certificates, permits, approvals and clearances from U.S. and foreign regulatory
authorities and to operate in compliance with applicable
regulations. If the FDA or other U.S. or foreign regulatory authority
determines that we were not in compliance with applicable law or regulations,
it
could institute proceedings to detain or seize our products, issue a recall,
impose operating restrictions, enjoin future violations and assess civil and
criminal penalties against us, our officers or our employees and could recommend
criminal prosecution to the Department of Justice. Any such consequences could
have a material adverse effect on our business, financial condition or results
of operations.
We
may be subject to federal and state health care fraud and abuse laws, and could
face substantial penalties if we are unable to fully comply with such
laws.
Health
care fraud and abuse regulation
by federal and state governments impact our business. Health care
fraud and abuse laws potentially applicable to our operations
include:
|
|
·
|
the
Federal Health Care Programs Anti-Kickback Law, which constrains
our
marketing practices, educational programs, pricing and discounting
policies, and relationships with health care practitioners and providers,
by prohibiting, among other things, soliciting, receiving, offering
or
paying remuneration, in exchange for or to induce the purchase or
recommendation of an item or service reimbursable under a federal
health
care program (such as the Medicare or Medicaid
programs);
|
|
|
·
|
federal
false claims laws which prohibit, among other things, knowingly
presenting, or causing to be presented, claims for payment from Medicare,
Medicaid, or other federal government payers that are false or fraudulent;
and
|
|
|
·
|
state
laws analogous to each of the above federal laws, such as anti-kickback
and false claims laws that may apply to items or services reimbursed
by
non-governmental third party payers, including commercial
insurers.
|
Due
to the breadth of some of these
laws, there can be no assurance that we will not be found to be in violation
of
any of such laws, and as a result we may be subject to penalties, including
civil and criminal penalties, damages, fines and the curtailment or
restructuring of our operations. Any penalties could adversely affect
our ability to operate our business and our financial results. Any
action against us for violation of these laws, even if we successfully defend
against them, could cause us to incur significant legal expenses and divert
our
management’s attention from the operation of our business.
Our
allograft and mesenchymal stem cell products could expose us to certain risks
which could disrupt our business.
Our
Blackstone Medical subsidiary
distributes a product under the brand name Trinity™ Matrix which is an
allogeneic bone matrix containing viable adult mesenchymal stem
cells. We believe that Trinity™ Matrix is properly classified under
the FDA’s Human Cell, Tissues and Cellular and Tissue-Based Products, or HCT/P,
regulatory paradigm and not as a medical device or as a biologic or
drug. There can be no assurance that the FDA would agree that this
category of regulatory classification applies to Trinity™ Matrix and the
reclassification of this product could have adverse consequences for us or
for
the supplier of this product and make it more difficult or expensive for us
to
conduct this business by requiring premarket clearance or approval and
compliance with additional postmarket regulatory requirements. Our
ability to continue to sell the Trinity™ Matrix product also depends on our
supplier continuing to have access to donated human tissue for their supply
of
mesenchymal stem cells, as well as, the maintenance of high standards by the
supplier in its stem cell collection methodology. Moreover, the
success of our Trinity™ Matrix product will depend on these products achieving
broad market acceptance which can depend on the product achieving broad clinical
acceptance, the level of third-party reimbursement and the introduction of
competing technologies.
Blackstone
Medical also distributes
allograft products which are also derived from human tissue harvested from
cadavers and which are used for bone reconstruction or repair and which are
surgically implanted into the human body. We believe that these
allograft products are properly classified as HCT/Ps and not as a medical device
or a biologic or drug. There can be no assurance that the FDA would
agree that this regulatory classification applies to these products and any
regulatory reclassification could have adverse consequences for us or for the
suppliers of these products and make it more difficult or expensive for us
to
conduct this business by requiring premarket clearance or approval and
compliance with additional postmarket regulatory
requirements. Moreover, the supply of these products to us could be
interrupted by the failure of our suppliers to maintain high standards in
performing required donor screening and infectious disease testing of donated
human tissue used in producing allograft implants. Our allograft
implant business could also be adversely affected by shortages in the supply
of
donated human tissue or negative publicity concerning methods of recovery of
tissue and product liability actions arising out of the distribution of
allograft implant products.
We
may be subject to product liability claims that may not be covered by insurance
and could require us to pay substantial sums.
We
are
subject to an inherent risk of, and adverse publicity associated with, product
liability and other liability claims, whether or not such claims are
valid. We maintain product liability insurance coverage in amounts
and scope that we believe is reasonable and adequate. There can be no
assurance, however, that product liability or other claims will not exceed
our
insurance coverage limits or that such insurance will continue to be available
on reasonable commercially acceptable terms, or at all. A successful
product liability claim that exceeds our insurance coverage limits could require
us to pay substantial sums and could have a material adverse effect on
us.
Fluctuations
in insurance expense could adversely affect our
profitability.
We
hold a number of insurance policies,
including product liability insurance, director’s and officers’ liability
insurance, property insurance and workers’ compensation insurance. If
the costs of maintaining adequate insurance coverage should increase
significantly in the future, our operating results could be materially adversely
impacted.
Our
quarterly operating results may fluctuate.
Our
operating results have fluctuated
significantly in the past on a quarterly basis. Our operating results
may fluctuate significantly from quarter to quarter in the future and we may
experience losses in the future depending on a number of factors, including
the
extent to which our products continue to gain or maintain market acceptance,
the
rate and size of expenditures incurred as we expand our domestic and establish
our international sales and distribution networks, the timing and
level of reimbursement for our products by third-party payors, and other
factors, many of which are outside our control.
New
developments by others could make our products or technologies non-competitive
or obsolete.
The
orthopedic medical device industry in which we compete is undergoing, and is
expected to continue to undergo, rapid and significant technological
change. We expect competition to intensify as technological advances
are made. New technologies and products developed by other companies
are regularly introduced into the market, which may render our products or
technologies non-competitive or obsolete.
The
approval and introduction of Bone Morphogenic Proteins (BMPs) by Medtronic
Sofamor Danek Group have shown market acceptance as a substitute for autograft
bone in spinal fusion surgeries. Our Spinal-Stim product is FDA
approved for both failed fusions and healing enhancement as an adjunct to spinal
fusion surgery, most typically for multilevel or high-risk
patients. While BMPs are considered or classified as a bone growth
material, they have yet to be clinically proven to be effective or approved
for
use in the high-risk patients such as those who use our Spinal-Stim and our
new
Cervical-Stim products. Off-label use or the FDA approval of BMPs for
risk indications could have an adverse effect on sales of our bone-growth
stimulation products in high-risk patients. Additionally, in 2004,
Artificial Spinal Discs were introduced into the market as an alternative to
spinal fusions. The use of artificial discs on certain patients could
have an adverse effect on sales of our products in such patients. In
addition, the increased usage of internal fixation plates and nails could have
an adverse effect on sales of our external fixation products for the repair
of
certain fractures.
Our
ability to market products successfully depends, in part, upon the acceptance
of
the products not only by consumers, but also by independent third
parties.
Our
ability to market orthopedic products successfully depends, in part, on the
acceptance of the products by independent third parties (including hospitals,
doctors, other healthcare providers and third-party payors) as well as
patients. Unanticipated side effects or unfavorable publicity
concerning any of our products could have an adverse effect on our ability
to
maintain hospital approvals or achieve acceptance by prescribing physicians,
managed care providers and other retailers, customers and patients.
The
industry in which we operate is highly competitive.
The
medical devices industry is fragmented and highly competitive. We
compete with a large number of companies, many of which have significantly
greater financial, manufacturing, marketing, distribution and technical
resources than we do. Many of our competitors may be able to develop
products and processes competitive with, or superior to, our
own. Furthermore, we may not be able to successfully develop or
introduce new products that are less costly or offer better performance than
those of our competitors, or offer purchasers of our products payment and other
commercial terms as favorable as those offered by our
competitors. For more information regarding our competitors, see
Item 1 – “Business – Competition.”
We
depend on our senior management team.
Our
success depends upon the skill, experience and performance of members of our
senior management team, who have been critical to the management of our
operations and the implementation of our business strategy. We do not
have key man insurance on our senior management team, and the loss of one or
more key executive officers could have a material adverse effect on our
operations and development.
Termination
of our existing relationships with our independent sales representatives or
distributors could have an adverse effect on our business.
We
sell
our products in many countries through independent
distributors. Generally, our independent sales representatives and
our distributors have the exclusive right to sell our products in their
respective territories and are generally prohibited from selling any products
that compete with ours. The terms of these agreements vary in length
from one to ten years. Under the terms of our distribution
agreements, each party has the right to terminate in the event of a material
breach by the other party and we generally have the right to terminate if the
distributor does not meet agreed sales targets or fails to make payments on
time. Any termination of our existing relationships with independent
sales representatives or distributors could have an adverse effect on our
business unless and until commercially acceptable alternative distribution
arrangements are put in place.
We
are party to numerous contractual relationships.
We
are party to numerous contracts in
the normal course of our business. We have contractual
relationships with suppliers, distributors and agents, as well as service
providers. In the aggregate, these contractual relationships are
necessary for us to operate our business. From time to time, we
amend, terminate or negotiate our contracts. We are also periodically
subject to, or make claims of breach of contract, or threaten legal action
relating to our contracts. These actions may result in litigation. At
any one time, we have a number of negotiations under way for new or amended
commercial agreements. We devote substantial time, effort and expense
to the administration and negotiation of contracts involved in our
business. However, these contracts may not continue in effect past
their current term or we may not be able to negotiate satisfactory contracts
in
the future with current or new business partners.
We
face risks related to foreign currency exchange rates.
Because
some of our revenue, operating expenses, assets and liabilities are denominated
in foreign currencies, we are subject to foreign exchange risks that could
adversely affect our operations and reported results. To the extent
that we incur expenses or earn revenue in currencies other than the U.S. dollar,
any change in the values of those foreign currencies relative to the U.S. dollar
could cause our profits to decrease or our products to be less competitive
against those of our competitors. To the extent that our current
assets denominated in foreign currency are greater or less than our current
liabilities denominated in foreign currencies, we have potential foreign
exchange exposure. We have substantial activities outside of the
United States that are subject to the impact of foreign exchange
rates. The fluctuations of foreign exchange rates during 2006 have
had a positive impact of $0.6 million on net sales outside of the United
States. Although we seek to manage our foreign currency exposure by
matching non-dollar revenues and expenses, exchange rate fluctuations could
have
a material adverse effect on our results of operations in the
future. To minimize such exposures, we enter into currency hedges
from time to time. At December 31, 2006, we had outstanding a
currency swap to hedge a 42.6 million Euro foreign currency
exposure.
We
are subject to differing tax rates in several jurisdictions in which we
operate.
We
have
subsidiaries in several countries. Certain of our subsidiaries sell
products directly to other Orthofix subsidiaries or provide marketing and
support services to other Orthofix subsidiaries. These intercompany
sales and support services involve subsidiaries operating in jurisdictions
with
differing tax rates. Further, in 2006 we restructured and
consolidated our International operations in part through a series of
intercompany transactions. Tax authorities in these jurisdictions may
challenge our treatment of such intercompany transactions. If we are
unsuccessful in defending our treatment of intercompany transactions. We may be
subject to additional tax liability or penalty, which could adversely affect
our
profitability.
We
are subject to differing customs and import/export rules in several
jurisdictions in which we operate.
We
import
and export our products to and from a number of different countries around
the
world. These product movements involve subsidiaries and third-parties
operating in jurisdictions with different customs and import/export rules and
regulations. Customs authorities in such jurisdictions may challenge
our treatment of customs and import/export rules relating to product shipments
under aspects of their respective customs laws and treaties. If we
are unsuccessful in defending our treatment of customs and import/export
classifications, we may be subject to additional customs duties, fines or
penalties that could adversely affect our profitability.
Provisions
of Netherlands Antilles law may have adverse consequences to our
shareholders.
Our
corporate affairs are governed by our Articles of Association and the corporate
law of the Netherlands Antilles as laid down in Book 2 of the Civil Code
(CCNA). Although some of the provisions of the CCNA resemble some of
the provisions of the corporation laws of a number of states in the United
States, principles of law relating to such matters as the validity of corporate
procedures, the fiduciary duties of management and the rights of our
shareholders may differ from those that would apply if Orthofix were
incorporated in a jurisdiction within the United States. For example,
there is no statutory right of appraisal under Netherlands Antilles corporate
law nor is there a right for shareholders of a Netherlands Antilles corporation
to sue a corporation derivatively. In addition, we have been advised
by Netherlands Antilles counsel that it is unlikely that (1) the courts of
the Netherlands Antilles would enforce judgments entered by U.S. courts
predicated upon the civil liability provisions of the U.S. federal securities
laws and (2) actions can be brought in the Netherlands Antilles in relation
to liabilities predicated upon the U.S. federal securities laws.
Our
business is subject to economic, political, regulatory and other risks
associated with international sales and operations.
Since
we
sell our products in many different countries, our business is subject to risks
associated with conducting business internationally. Net sales
outside the United States represented 29% of our total net sales in
2006. We anticipate that net sales from international operations will
continue to represent a substantial portion of our total net
sales. In addition, a number of our manufacturing facilities and
suppliers are located outside the United States. Accordingly, our
future results could be harmed by a variety of factors, including:
|
|
·
|
changes
in foreign currency exchange rates;
|
|
|
·
|
changes
in a specific country’s or region’s political or economic
conditions;
|
|
|
·
|
trade
protection measures and import or export licensing requirements
or other
restrictive actions by foreign
governments;
|
|
|
·
|
consequences
from changes in tax or customs
laws;
|
|
|
·
|
difficulty
in staffing and managing widespread
operations;
|
|
|
·
|
differing
labor regulations;
|
|
|
·
|
differing
protection of intellectual
property;
|
|
|
·
|
unexpected
changes in regulatory requirements;
and
|
|
|
·
|
application
of the U.S. Foreign Corrupt Practices Act (“FCPA”) and other anti-bribery
or anti-corruption laws to our
operations.
|
We
may incur costs and undertake new debt and contingent liabilities in a search
for acquisitions.
We
continue to search for viable acquisition candidates that would expand our
market sector or global presence. We also seek additional products
appropriate for current distribution channels. The search for
an acquisition of another company or product line by us could result
in our incurrence of costs from such efforts as well as the undertaking of
new
debt and contingent liabilities from such searches or
acquisitions. Such costs may be incurred at any time and may
vary in size depending on the scope of the acquisition or product transactions
and may have a material impact on our results of operations.
Our
subsidiary Orthofix Holdings, Inc.'s senior secured bank credit facility
contains significant financial and operating restrictions and requires mandatory
prepayments that may have an adverse effect on our operations and limit our
ability to grow our business.
When
we
acquired Blackstone on September 22, 2006, one of our wholly-owned subsidiaries,
Orthofix Holdings, Inc. (Orthofix Holdings), entered into a senior secured
bank
credit facility with a syndicate of financial institutions to finance the
transaction. Orthofix and certain of Orthofix Holdings’ direct and indirect
subsidiaries, including Orthofix Inc., Breg, and Blackstone have guaranteed
the
obligations of Orthofix Holdings under the senior secured bank facility. The
senior secured bank facility provides for (1) a seven-year amortizing term
loan
facility of $330.0 million for which $315.2 million was outstanding at December
31, 2006, and (2) a six-year revolving credit facility of $45.0
million upon which we had not drawn as of December 31, 2006.
Further,
in addition to scheduled debt payments, the credit agreement requires us to
make
mandatory prepayments with (a) the excess cash flow (as defined in the credit
agreement) of Orthofix and its subsidiaries, in an amount equal to 50% of the
excess annual cash flow beginning with the year ending December 31, 2007,
provided, however, if the leverage ratio (as defined in the credit agreement)
is
less than or equal to 1.75 to 1.00, as of the end of any fiscal year, there
will
be no mandatory excess cash flow prepayments, with respect to such fiscal year
(b) 100% of the net cash proceeds of any debt issuances by Orthofix or any
of
its subsidiaries or 50% of the net cash proceeds of equity issuances by any
such
party, excluding the exercise of stock options, provided, however, if the
leverage ratio is less than or equal to 1.75 to 1.00 at the end of the preceding
fiscal year, Orthofix Holdings shall not be required to prepay the loans with
the proceeds of any such debt or equity issuance, (c) the net cash proceeds
of
asset dispositions over a minimum threshold, or (d) unless reinvested, insurance
proceeds or condemnation awards. These mandatory prepayments could limit our
ability to reinvest in our business.
The
credit agreement contains negative covenants applicable to Orthofix and its
subsidiaries, including restrictions on indebtedness, liens, dividends and
mergers and sales of assets. The credit agreement also contains certain
financial covenants, including a fixed charge coverage ratio and a leverage
ratio applicable to Orthofix and its subsidiaries on a consolidated basis.
A
breach of any of these covenants could result in an event of default under
the
credit agreement, which could permit acceleration of the debt payments under
the
facility. See Part II, Item 7 - “Management's Discussion and Analysis of
Financial Condition and Results of Operations” - “Liquidity and Capital
Resources” of this Form 10-K.
In
order to compete, we must attract, retain and motivate key employees, and our
failure to do so could have an adverse effect on our results of
operations.
In
order
to compete, we must attract, retain and motivate executives and other key
employees, including those in managerial, technical, sales, marketing and
support positions. Hiring and retaining qualified executives, engineers,
technical staff and sales representatives are critical to our business, and
competition for experienced employees in the medical device industry can be
intense. To attract, retain and motivate qualified employees, we utilize stock-based
incentive
awards such as employee stock options. If the value of such stock awards does
not appreciate as measured by the performance of the price of our common stock
and ceases to be viewed as a valuable benefit, our ability to attract, retain
and motivate our employees could be adversely impacted, which could negatively
affect our results of operations and/or require us to increase the amount we
expend on cash and other forms of compensation.
Our
results of operations could vary as a result of the methods, estimates and
judgments we use in applying our accounting policies.
The
methods, estimates and judgments we use in applying our accounting policies
have
a significant impact on our results of operations (see “Critical Accounting
Estimates” in Part II, Item 7 of this Form 10-K). Such methods,
estimates and judgments are, by their nature, subject to substantial risks,
uncertainties and assumptions, and factors may arise over time that leads us
to
change our methods, estimates and judgments. Changes in those methods, estimates
and judgments could significantly affect our results of operations. In
particular, beginning in the first quarter of 2006, the calculation of
share-based compensation expense under SFAS No. 123(R) required us to
use valuation methodologies (which were not developed for use in valuing
employee stock options) and a number of assumptions, estimates and conclusions
regarding matters such as expected forfeitures, expected volatility of our
share
price, the expected dividend rate with respect to our common stock and the
exercise behavior of our employees. Furthermore, there are no means, under
applicable accounting principles, to compare and adjust our expense if and
when
we learn of additional information that may affect the estimates that we
previously made, with the exception of changes in expected forfeitures of
share-based awards. Factors may arise over time that leads us to change our
estimates and assumptions with respect to future share-based compensation
arrangements, resulting in variability in our share-based compensation expense
over time. Changes in forecasted share-based compensation expense could impact
our gross margin percentage; research and development expenses; sales and
marketing expenses; general and administrative expenses; and our tax
rate.
Item
1B. Unresolved
Staff
Comments
None.
Item
2. Properties
Our
principal facilities are:
|
Facility
|
|
Location
|
|
Square
Feet
|
|
Ownership
|
|
Manufacturing,
warehousing, distribution and research and development facility
for
Stimulation and Orthopedic Products and administrative facility
for
Orthofix Inc.
|
|
McKinney,
TX
|
|
70,000
|
|
Leased
|
|
Sales
management, distribution, research and development and administrative
offices for Blackstone.
|
|
Springfield,
MA
|
|
19,000
|
|
Leased
|
|
Sales
management, research and development and administrative offices
for
Blackstone.
|
|
Wayne,
NJ
|
|
16,548
|
|
Leased
|
|
Sales
management and distribution for Blackstone.
|
|
Laichingen,
Germany
|
|
2,422
|
|
Leased
|
|
Research
and development, component manufacturing, quality control and training
facility for fixation products and sales management, distribution
and
administrative facility for Italy
|
|
Verona,
Italy
|
|
38,000
|
|
Owned
|
|
International
Distribution Center for Orthofix products
|
|
Verona,
Italy
|
|
18,000
|
|
Leased
|
|
Administrative
offices for Orthofix International N.V. and Orthofix Inc.
|
|
Huntersville,
NC
|
|
10,084
|
|
Leased
|
|
Sales
management, distribution and administrative offices
|
|
South
Devon, England
|
|
2,500
|
|
Leased
|
|
Sales
management, distribution and administrative offices for A-V Impulse
and
fixation products
|
|
Andover,
England
|
|
9,001
|
|
Leased
|
|
Sales
management, distribution and administrative facility for United
Kingdom
|
|
Maidenhead,
England
|
|
9,000
|
|
Leased
|
|
Sales
management, distribution and administrative facility for
Mexico
|
|
Mexico
City, Mexico
|
|
3,444
|
|
Leased
|
|
Sales
management, distribution and administrative facility for
Brazil
|
|
São
Paulo, Brazil
|
|
4,415
|
|
Leased
|
|
Sales
management, distribution and administrative facility for
France
|
|
Gentilly,
France
|
|
3,854
|
|
Leased
|
|
Sales
management, distribution and administrative facility for
Germany
|
|
Valley,
Germany
|
|
3,000
|
|
Leased
|
|
Sales
management, distribution and administrative facility for
Switzerland
|
|
Steinhausen,
Switzerland
|
|
1,180
|
|
Leased
|
|
Administrative,
manufacturing, warehousing, distribution and research and development
facility for Breg
|
|
Vista,
California
|
|
104,832
|
|
Leased
|
|
Manufacturing
facility for Breg products
|
|
Mexicali,
Mexico
|
|
63,000
|
|
Leased
|
|
Sales
management, distribution and administrative facility for Puerto
Rico
|
|
Guaynabo,
Puerto Rico
|
|
4,400
|
|
Leased
|
Item
3. Legal Proceedings
The
Company’s subsidiary, Blackstone Medical, is a defendant in a patent
infringement lawsuit captioned Medtronic Sofamor Danek USA Inc., Warsaw
Orthopedic, Inc., Medtronic Puerto Rico Operations Co., and Medtronic Sofamor
Danek Deggendorf, GmbH v. Blackstone Medical, Inc., Civil Action No.
06-30165-MAP, filed on September 22, 2006 in the United States District Court
for the District of Massachusetts. The plaintiffs allege that (i)
they are the exclusive licensees of United States Patent Nos. 6,926,718 B1,
6,936,050 B2, 6,936,051 B2, 6,398,783 B1 and 7,066,961 B2 (the “Patents”), and
(ii) Blackstone Medical’s making, selling, offering for sale, and using within
the United States its Blackstone Anterior Cervical Plate, 3º Anterior Cervical
Plate Hallmark Anterior Cervical Plate and Construx Mini PEEK VBR System
products is infringing and has infringed the Patents, and that such infringement
has been willful. The Complaint does not specifically state an amount
of damages. Blackstone Medical has denied infringement and asserts
that the Patents are invalid.
We
are
from time to time involved in legal proceedings in the normal course of business
which may include, but are not limited to, product liability
actions.
Although
we cannot predict the outcome of any proceedings or claims made against us,
management does not currently expect that the ultimate outcome of any such
proceedings or claims will have a material adverse effect on our financial
position, results of operations or cash flows. However, there can be
no assurance that the ultimate resolution of any claim will not have a material
adverse impact on our financial position, results of operations, or cash
flows.
Item
4. Submission of Matters to a Vote of Security
Holders
There
were no matters submitted to a vote of security holders during the fourth
quarter of 2006.
PART
II
Item
5.Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities
Market
for Our Common Stock
Our
common stock is traded on the Nasdaq Global Select Market under the symbol
“OFIX.” The following table shows the quarterly range of high and low
sales prices for our common stock as reported by Nasdaq for each of the two
most
recent fiscal years ended December 31, 2006. As of March 13,
2007 we had approximately 254 holders of record of our common
stock. The closing price of our common stock on March 13, 2007 was
$49.48.
|
High
|
Low
|
|||||||
|
2005
|
||||||||
|
First
Quarter
|
$
|
42.44
|
$
|
36.24
|
||||
|
Second
Quarter
|
48.61
|
37.57
|
||||||
|
Third
Quarter
|
46.98
|
40.59
|
||||||
|
Fourth
Quarter
|
45.09
|
35.30
|
||||||
|
2006
|
||||||||
|
First
Quarter
|
$
|
48.48
|
$
|
38.76
|
||||
|
Second
Quarter
|
42.00
|
35.00
|
||||||
|
Third
Quarter
|
46.40
|
38.01
|
||||||
|
Fourth
Quarter
|
50.48
|
42.08
|
||||||
Dividend
Policy
We
have
not paid dividends to holders of our common stock in the past. We
currently intend to retain all of our consolidated earnings to finance credit
agreement obligations resulting from the recently completed Blackstone
acquisition and to finance the continued growth of our business. We
have no present intention to pay dividends in the foreseeable
future.
In
the
event that we decide to pay a dividend to holders of our common stock in the
future with dividends received from our subsidiaries, we may, based on
prevailing rates of taxation, be required to pay additional withholding and
income tax on such amounts received from our subsidiaries.
Recent
Sales of Unregistered Securities
There
were no securities sold by us during 2006 that were not registered under the
Securities Act.
Exchange
Controls
Although
there are Netherlands Antilles laws that may impose foreign exchange controls
on
us and that may affect the payment of dividends, interest or other payments
to
nonresident holders of our securities, including the shares of common stock,
we
have been granted an exemption from such foreign exchange control regulations
by
the Central Bank of the Netherlands Antilles. Other jurisdictions in
which we conduct operations may have various currency or exchange
controls. In addition, we are subject to the risk of changes in
political conditions or economic policies that could result in new or additional
currency or exchange controls or other restrictions being imposed on our
operations. As to our securities, Netherlands Antilles law and our
Articles of Association impose no limitations on the rights of persons who
are
not residents in or citizens of the Netherlands Antilles to hold or vote such
securities.
Taxation
Under
the
laws of the Netherlands Antilles as currently in effect, a holder of shares
of
common stock who is not a resident of, and during the taxable year has not
engaged in trade or business through a permanent establishment in, the
Netherlands Antilles will not be subject to Netherlands Antilles income tax
on
dividends paid with respect to the shares of common stock or on gains realized
during that year on sale or disposal of such shares; the Netherlands Antilles
do
not impose a withholding tax on dividends paid by us. There are no
gift or inheritance taxes levied by the Netherlands Antilles when, at the time
of such gift or at the time of death, the relevant holder of common shares
was
not domiciled in the Netherlands Antilles. No reciprocal tax treaty
presently exists between the Netherlands Antilles and the United
States.
Performance
Graph
The
following performance graph in this Item 5 of this Annual Report on Form 10-K
is
not deemed to be “soliciting material” or to be "filed" with the SEC or subject
to Regulation 14A or 14C under the Securities Exchange Act of 1934 or to the
liabilities of Section 18 of the Securities Exchange Act of 1934, and will
not
be deemed to be incorporated by reference into any filing under the Securities
Act of 1933 or the Securities Exchange Act of 1934, except to the extent we
specifically incorporate it by reference into such a filing.
The
graph below compares the five-year
total return to shareholders for Orthofix common stock with comparable return
of
two indexes: the NASDAQ Stock Market and NASDAQ stocks for surgical, medical,
and dental instruments and supplies.
The
graph
assumes that you invested $100 in Orthofix Common Stock and in each of the
indexes on December 31, 2001. Points on the graph represent the
performance as of the last business day of each of the years
indicated.
Item
6. Selected
Financial
Data
The
following selected consolidated financial data for the years ended
December 31, 2006, 2005, 2004, 2003 and 2002 have been derived from our
audited consolidated financial statements. The financial data as of
December 31, 2006 and 2005 and for the years ended December 31, 2006, 2005,
and 2004 should be read in conjunction with, and are qualified in their entirety
by, reference to, Item 7 – “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” and our consolidated financial
statements and notes thereto included elsewhere in this Form
10-K. Our consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
(US GAAP).
|
Year
ended December
31,
|
|||||||||||||||||||||
|
2006
|
2005
|
2004
|
2003
|
2002
|
|||||||||||||||||
|
(In
US$ thousands, except margin
and per share data)
|
|||||||||||||||||||||
|
Consolidated
operating results
|
|||||||||||||||||||||
|
Net
sales
|
$
|
365,359
|
$
|
313,304
|
$
|
286,638
|
$
|
203,707
|
$
|
177,595
|
|||||||||||
|
Gross
profit
|
271,734
|
229,516
|
207,461
|
152,617
|
132,776
|
||||||||||||||||
|
Gross
profit margin
|
74
|
%
|
73
|
%
|
72
|
%
|
75
|
%
|
75
|
%
|
|||||||||||
|
Total
operating income
|
8,853
|
59,706
|
56,568
|
44,568
|
42,939
|
||||||||||||||||
|
Net
income (loss) (1) (2)
(3)
|
(7,042
|
)
|
73,402
|
34,149
|
24,730
|
25,913
|
|||||||||||||||
|
Net
income (loss) per share of common stock (basic)
|
(0.44
|
)
|
4.61
|
2.22
|
1.76
|
1.96
|
|||||||||||||||
|
Net
income (loss) per share of common stock (diluted)
|
(0.44
|
)
|
4.51
|
2.14
|
1.68
|
1.76
|
|||||||||||||||
|
(1)
|
Net
loss for 2006 includes $40.0 million after tax earnings charge related
to
In-Process Research and Development costs related to the Blackstone
acquisition.
|
|
(2)
|
Net
income for 2005 includes $37.4 million of income after tax related
to the
KCI settlement.
|
|
(3)
|
The
Company has not paid any dividends in any of the years
presented.
|
|
Consolidated
financial position
|
As
of December
31,
|
|||||||||||||||||||
|
(at
year-end)
|
2006
|
2005
|
2004
|
2003
|
2002
|
|||||||||||||||
|
(In
US$ thousands, except share
data)
|
||||||||||||||||||||
|
Total
assets
|
$
|
862,285
|
$
|
473,861
|
$
|
440,969
|
$
|
413,179
|
$
|
220,774
|
||||||||||
|
Total
debt
|
315,467
|
15,287
|
77,382
|
110,207
|
7,420
|
|||||||||||||||
|
Shareholders’
equity
|
392,635
|
368,885
|
297,172
|
240,776
|
168,084
|
|||||||||||||||
|
Weighted
average number of shares of common
stock outstanding (basic)
|
16,165,540
|
15,913,475
|
15,396,540
|
14,061,447
|
13,196,524
|
|||||||||||||||
|
Weighted
average number of shares of common
stock outstanding (diluted)
|
16,165,540
|
16,288,975
|
15,974,945
|
14,681,883
|
14,685,236
|
|||||||||||||||
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The
following discussion and analysis addresses the results of our operations which
are based upon the consolidated financial statements included herein, which
have
been prepared in accordance with accounting principles generally accepted in
the
United States. This discussion should be read in conjunction with
“Forward-Looking Statements” and our consolidated financial statements and notes
thereto appearing elsewhere in this Form 10-K. This
discussion and analysis also addresses our liquidity and financial condition
and
other matters.
General
We
are a
diversified orthopedic products company offering a broad line of surgical and
non-surgical products for the Spine, Orthopedics, Sports Medicine and Vascular
market sectors. Our products are designed to address the lifelong
bone-and-joint health needs of patients of all ages, helping them achieve a
more
active and mobile lifestyle. We design, develop, manufacture, market
and distribute medical equipment used principally by musculoskeletal medical
specialists for orthopedic applications. Our main products are
invasive and minimally invasive spinal implant products and related biologics;
non-invasive bone growth stimulation products used to enhance the success rate
of spinal fusions and to treat non-union fractures; external and internal
fixation devices used in fracture treatment, limb lengthening and bone
reconstruction; and bracing products used for ligament injury prevention, pain
management and protection of surgical repair to promote faster
healing. Our products also include a device for enhancing venous
circulation, cold therapy, other pain management products, bone cement and
devices for removal of bone cement used to fix artificial implants and airway
management products used in anesthesia applications.
We
have
administrative and training facilities in the United States and Italy and
manufacturing facilities in the United States, the United Kingdom, Italy and
Mexico. We directly distribute our products in the United States, the
United Kingdom, Italy, Germany, Switzerland, Austria, France, Belgium, Mexico,
Brazil, and Puerto Rico. In several of these and other markets, we
also distribute our products through independent distributors.
Our
consolidated financial statements include the financial results of the Company
and its wholly-owned and majority-owned subsidiaries and entities over which
we
have control. All intercompany accounts and transactions are
eliminated in consolidation.
Our
reporting currency is the United States Dollar. All balance sheet
accounts, except shareholders’ equity, are translated at year-end exchange
rates, and revenue and expense items are translated at weighted average rates
of
exchange prevailing during the year. Gains and losses resulting from
foreign currency transactions are included in other income
(expense). Gains and losses resulting from the translation of foreign
currency financial statements are recorded in the accumulated other
comprehensive income (loss) component of shareholders’ equity.
Our
financial condition, results of operations and cash flows are not significantly
impacted by seasonality trends. In addition, we do not believe our
operations will be significantly affected by inflation. However, in
the ordinary course of business, we are exposed to the impact of changes in
interest rates and foreign currency fluctuations. Our objective is to
limit the impact of such movements on earnings and cash flows. In
order to achieve this objective, we seek to balance non-dollar income and
expenditures. During the year, we have used derivative instruments to
hedge foreign currency fluctuation exposures. See Item 7A –
“Quantitative and Qualitative Disclosures About Market Risk.”
On
September 22, 2006, we completed the acquisition of Blackstone Medical, Inc.
(“Blackstone”), a privately held company specializing in the design, development
and marketing of spinal implant and related biologics products. The purchase
price for the acquisition was $333.0 million, subject to certain closing
adjustments, plus transaction costs totaling approximately $9.2 million as
of
December 31, 2006. The acquisition and related costs were financed with $330.0
million of senior secured bank debt and cash on hand. Financing costs
were approximately $6.0 million.
Effective with the acquisition of Blackstone, we manage our operations as four
business segments: Domestic, Blackstone, Breg, and
International. Domestic consists of operations of our subsidiary
Orthofix Inc. Blackstone consists of Blackstone’s domestic and
international operations. Breg consists of Breg’s domestic operations
and international distributors. International consists of
operations which are located in the rest of the world (excluding Blackstone’s
international operations) as well as independent export distribution
operations. Group Activities are comprised of the operating expenses
and identifiable assets of Orthofix International N.V. and its US holding
company, Orthofix Holdings, Inc.
Critical
Accounting Policies and Estimates
Our
discussion of operating results is based upon the consolidated financial
statements and accompanying notes to the consolidated financial statements
prepared in conformity with accounting principles generally accepted in the
United States. The preparation of these statements necessarily
requires management 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. These estimates
and assumptions form the basis for the carrying values of assets and
liabilities. On an ongoing basis, we evaluate these estimates,
including those related to allowance for doubtful accounts, sales allowances
and
adjustments, inventories, investments, intangible assets and goodwill, income
taxes, litigation and contingencies. We base our estimates on
historical experience and various other assumptions and believe our estimates
for the carrying values of assets and liabilities are
reasonable. Actual results may differ from these
estimates. We have reviewed our critical accounting policies with the
Audit Committee of the Board of Directors.
Revenue
Recognition
For
bone
growth stimulation and certain bracing products that are prescribed by a
physician, we recognize revenue when the product is placed on and accepted
by
the patient. For domestic spinal implant and biologic products, we
recognize revenue when the product has been utilized and we have received a
confirming purchase order from the hospital. For sales to commercial
customers, including hospitals and distributors, revenues are recognized at
the
time of shipment unless contractual agreements specify that title passes only
on
delivery. We derive a significant amount of our revenues in the
United States from third-party payors, including commercial insurance carriers,
health maintenance organizations, preferred provider organizations and
governmental payors such as Medicare. Amounts paid by these
third-party payors are generally based on fixed or allowable reimbursement
rates. These revenues are recorded at the expected or pre-authorized
reimbursement rates, net of any contractual allowances or
adjustments. Some billings are subject to review by such third-party
payors and may be subject to adjustment.
Allowance
for Doubtful Accounts and Contractual Allowances
The
process for estimating the ultimate collection of accounts receivable involves
significant assumptions and judgments. Historical collection and
payor reimbursement experience is an integral part of the estimation process
related to reserves for doubtful accounts and the establishment of contractual
allowances. Accounts receivable are analyzed on a quarterly basis to
assess the adequacy of both reserves for doubtful accounts and contractual
allowances. Revisions in allowances for doubtful accounts 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. In the judgment of management,
adequate allowances have been provided for doubtful accounts and contractual
allowances. Our estimates are periodically tested against actual
collection experience.
Inventory
Allowances
We
write
down our inventory for inventory excess and obsolescence by an amount equal
to
the difference between the cost of the inventory and the estimated net
realizable value based upon assumptions about future demand and market
conditions. Inventory is analyzed to assess the adequacy of inventory
excess and obsolescence provisions. Reserves in excess and
obsolescence provisions are recorded as adjustments to cost of goods
sold. If conditions or assumptions used in determining the market
value change, additional inventory write-down in the future may be
necessary.
Goodwill
and Other Intangible Assets
The
provisions of SFAS No. 142, “Goodwill and Other Intangible Assets,” require that
goodwill and indefinite lived intangible assets be tested at least annually
for
impairment. As a result, we evaluate the recoverability and measure
the potential impairment of our goodwill under SFAS 142. The annual
impairment test requires an estimation of the fair value of the reporting unit,
which involves judgment. We performed the impairment test of goodwill
as required by SFAS No. 142 and noted no impairment related to the carrying
value of goodwill or indefinite lived intangible assets as of December 31,
2006.
Litigation
and Contingent Liabilities
From
time
to time, we are parties to or targets of lawsuits, investigations and
proceedings, including product liability, personal injury, patent and
intellectual property, health and safety, employment and healthcare
regulatory matters, which are handled and defended in the ordinary course of
business. These lawsuits, investigations or proceedings could involve
substantial amounts of claims and could also have an adverse impact on our
reputation and client base. Although we maintain various liability
insurance programs for liabilities that could result from such lawsuits,
investigations or proceedings, we are self-insured for a significant portion
of
such liabilities. We accrue for such claims when it is probable that
a liability has been incurred and the amount can be reasonably
estimated. The process of analyzing, assessing and establishing
reserve estimates for these types of claims involves
judgment. Changes in the facts and circumstances associated with a
claim could have a material impact on our results of operations and cash flows
in the period that reserve estimates are revised. We believe that
present insurance coverage and reserves are sufficient to cover currently
estimated exposures, but we cannot give any assurance that we will not incur
liabilities in excess of recorded reserves or our present insurance
coverage.
Tax
Matters
We
and
each of our subsidiaries are taxed at the rates applicable within each of their
respective jurisdictions. The composite income tax rate, tax
provisions, deferred tax assets and deferred tax liabilities will vary according
to the jurisdiction in which profits arise. Further, certain of our
subsidiaries sell products directly to our other subsidiaries or provide
administrative, marketing and support services to our other
subsidiaries. These intercompany sales and support services involve
subsidiaries operating in jurisdictions with differing tax rates. The
tax authorities in such jurisdictions may challenge our treatments under
residency criteria, transfer pricing provisions, or other aspects of their
respective tax laws, which could affect our composite tax rate and
provisions.
Share-based
compensation
Prior
to
the adoption of SFAS No. 123(R) on January 1, 2006, we accounted for
our employee stock option plans and employee stock purchase plan using the
recognition and measurement principles of Accounting Principles Board (APB)
Opinion No. 25, Accounting for Stock Issued to Employees and its related
interpretations, and had adopted the disclosure only provisions of SFAS
No. 123, Accounting for Stock-Based Compensation and its related
interpretation.
As
of
January 1, 2006, we began recording compensation expense associated with
stock options and other equity-based compensation in accordance with SFAS
No. 123(R), using the modified prospective transition method and therefore
we have not restated results for prior periods. Under the modified prospective
transition method, stock-based compensation expense for 2006 includes: (a)
compensation cost for all stock-based awards granted on or after January 1,
2006 as determined based on the grant date fair value estimated in accordance
with the provisions of SFAS No. 123(R) and (b) stock-based
compensation awards granted prior to, but not yet vested as of January 1,
2006, based on the grant date fair value estimated in accordance with the
original provisions of SFAS No. 123(R). We recognize these compensation
costs ratably over the vesting period, which is generally three years. As a
result of the adoption of SFAS No. 123(R), our net income for the year
ended December 31, 2006 has been reduced by stock-based compensation
expense, net of taxes, of approximately $5.2 million.
The
fair
value of each equity award is estimated on the date of grant using the
Black-Scholes valuation model for option pricing. The model relies upon
management assumptions for expected volatility rates based on the historical
volatility (using daily pricing) of our common stock. In accordance with SFAS
No. 123(R), we reduce the calculated Black-Scholes value by applying a
forfeiture rate, based upon historical pre-vesting option cancellations. The
expected term of options granted is estimated based on a number of factors,
including the vesting term of the award, historical employee exercise behavior
for both options that are currently outstanding and options that have been
exercised or are expired, the expected volatility of our common stock and an
employee’s average length of service. The risk-free interest rate is determined
based upon a constant U.S. Treasury security rate with a contractual life that
approximates the expected term of the option award.
Selected
Financial Data
The
following table presents certain items in our statements of operations as a
percentage of net sales for the periods indicated:
|
Year
ended December 31,
|
||||||||||||
|
2006
(%)
|
2005
(%)
|
2004
(%)
|
||||||||||
|
Net
sales
|
100
|
100
|
100
|
|||||||||
|
Cost
of sales
|
26
|
27
|
28
|
|||||||||
|
Gross
profit
|
74
|
73
|
72
|
|||||||||
|
Operating
expenses
|
|
|
|
|||||||||
|
Sales
and marketing
|
40
|
37
|
36
|
|||||||||
|
General
and administrative
|
15
|
11
|
11
|
|||||||||
|
Research
and development (1)
|
15
|
4
|
4
|
|||||||||
|
Amortization
of intangible assets
|
2
|
2
|
2
|
|||||||||
|
Total
operating income
|
2
|
19
|
19
|
|||||||||
|
Net
income (loss) (1)
(2)
|
(2)
|
23
|
12
|
|||||||||
__________
|
(1)
|
Research
and development and net loss for 2006 includes $40.0 million of In
Process
Research and Development costs
related to the Blackstone
acquisition.
|
|
(2)
|
Net
income for 2005 includes $37.4 million of net income after tax related
to
the KCI settlement.
|
Segment
and Market Sector Revenue
The
following tables display net sales by business segment and net sales by market
sector. We provide net sales by market sector for information
purposes only. We keep our books and records and account for net
sales, costs of sales and expenses by business segment. In 2006,
concurrent with the acquisition of Blackstone, we have redefined our business
segments and market sectors. All prior period information has been
restated to conform to the new segments and market sectors.
Business
Segment:
|
Year
ended December 31,
(In
US$ thousands)
|
||||||||||||||||||||||||
|
2006
|
2005
|
2004
|
||||||||||||||||||||||
|
Net
Sales
|
Percent
of
Total
Net Sales
|
Net
Sales
|
Percent
of
Total
Net Sales
|
Net
Sales
|
Percent
of Total Net Sales
|
|||||||||||||||||||
|
Domestic
|
$
|
152,560
|
|
42
|
%
|
$
|
135,084
|
|
43
|
%
|
$
|
118,074
|
|
41
|
%
|
|||||||||
|
Blackstone
|
28,134
|
8
|
%
|
-
|
-
|
-
|
-
|
|||||||||||||||||
|
Breg
|
76,219
|
21
|
%
|
72,022
|
23
|
%
|
68,294
|
24
|
%
|
|||||||||||||||
|
International
|
108,446
|
29
|
%
|
106,198
|
34
|
%
|
100,270
|
35
|
%
|
|||||||||||||||
|
Total
|
$
|
365,359
|
100
|
%
|
$
|
313,304
|
100
|
%
|
$
|
286,638
|
100
|
%
|
||||||||||||
Our
revenues are derived from sales of products into the market sectors of Spine,
Orthopedics, Sports Medicine, Vascular and Other.
Market
Sector:
|
Year
ended December 31,
(In
US$ thousands)
|
||||||||||||||||||||||||
|
2006
|
2005
|
2004
|
||||||||||||||||||||||
|
Net
Sales
|
Percent
of
Total
Net Sales
|
Net
Sales
|
Percent
of
Total
Net Sales
|
Net
Sales
|
Percent
of Total Net Sales
|
|||||||||||||||||||
|
Spine
|
$
|
145,113
|
|
40
|
%
|
$
|
101,622
|
|
33
|
%
|
$
|
81,373
|
|
28
|
%
|
|||||||||
|
Orthopedics
|
95,799
|
26
|
%
|
92,097
|
29
|
%
|
90,112
|
31
|
%
|
|||||||||||||||
|
Sports
Medicine
|
79,053
|
22
|
%
|
72,970
|
23
|
%
|
68,488
|
24
|
%
|
|||||||||||||||
|
Vascular
|
21,168
|
6
|
%
|
23,887
|
8
|
%
|
25,226
|
9
|
%
|
|||||||||||||||
|
Other
|
24,226
|
6
|
%
|
22,728
|
7
|
%
|
21,439
|
8
|
%
|
|||||||||||||||
|
Total
|
$
|
365,359
|
100
|
%
|
$
|
313,304
|
100
|
%
|
$
|
286,638
|
100
|
%
|
||||||||||||
2006
Compared to 2005
Net
sales increased 17% to $365.4
million in 2006, which included $28.1 million of net sales attributable to
Blackstone, compared to $313.3 million in 2005. The impact of foreign
currency increased sales by $0.6 million in 2006 when compared to
2005.
Sales
by Business Segment:
Net
sales
in Domestic increased 13% to $152.6 million in 2006 compared to $135.1 million
in 2005. Domestic represented 42% and 43% of our total net sales in
2006 and 2005, respectively. The increase in sales was primarily the
result of a 15% increase in sales in the Spine market sector which was
attributable to increased demand for both our Cervical-Stim® and
Spinal-Stim® products. The Orthopedics market sector also
experienced a 7% increase in 2006 compared to 2005. This increase is
primarily due to growth in sales of newer internal fixation products such as
the
eight-plate and ISKD®. External fixation devices are
sharing the market for treatment of difficult fractures with internal fixation
alternatives such as plating and nailing. Recognizing this trend, we
are continuing to expand our offering of internal fixation products, such as
the
Contours VPS® for distal radius fractures, the PC.C.P® for
hip fractures, and the recently introduced Veronail also for hip fractures
and
on limited release the CentroNail.
Orthofix
Domestic Sales by Market Sector:
|
(In
US$ thousands)
|
2006
|
2005
|
Growth
|
|||||||||
|
Spine
|
$
|
116,701
|
$
|
101,470
|
15%
|
|
||||||
|
Orthopedics
|
35,813
|
33,569
|
7%
|
|
||||||||
|
Other
|
46
|
45
|
22%
|
|
||||||||
|
|
||||||||||||
|
Total
|
$
|
152,560
|
$
|
135,084
|
13%
|
|
||||||
Net
sales
in Blackstone were $28.1 million in 2006, which represents 8% of total sales
in
2006. Blackstone was acquired on September 22, 2006 and therefore
only sales after that date are included on our sales. There are no
sales for Blackstone for the comparable period of the prior year. All
of Blackstone’s sales are recorded in our Spine market sector. On a
pro forma basis Blackstone sales increased 51% when compared to 2005 and would
have represented 21% of pro forma total net sales in 2006.
Net
sales
in Breg increased 6% to $76.2 million in 2006 compared to $72.0 million in
2005. This increase in sales was primarily attributable to the sale
of Breg bracing products, which increased 11% in 2006 and to Breg Polar
Care® products, which increased 5% in 2006. Our new Fusion
XT™ knee
brace was the primary contributor to the increase. This increase was
partially offset by a 12% decrease in sales for pain therapy products resulting
from delayed introduction of new pain therapy
products. All of Breg’s sales are recorded in our Sports Medicine
market sector. Breg net sales represented 21% and 23% of our total
net sales in 2006 and 2005, respectively.
Net
sales
in International increased 2% to $108.4 million in 2006 from $106.2 million
in
2005. International net sales represented 29% and 34% of our total
net sales in 2006 and 2005, respectively. The International Sports
Medicine market sector increased $1.9 million compared to 2005 due to increased
distribution of Breg products and the acquisition during the year of our German
distributor for Breg products. The Orthpedics market sector increased
2% due to increased sales of internal fixation devices, including the
ISKD® and increased sales of the
Physio-Stim®. These increases were partially offset by
decreases in sales of external fixation devices and OSCAR. The
Vascular market sector decreased compared to the prior year due to pricing
and
competitive pressures while sales of other product sales increased compared
to
the prior year. The impact of foreign currency increased
International sales by 1.0% or $0.6 million when compared to 2005.
Orthofix
International Sales by Market Sector:
|
(In
US$ thousands)
|
2006
|
2005
|
Growth
|
|||||||||
|
Spine
|
$ |
278
|
$ |
152
|
83%
|
|||||||
|
Orthopedics
|
59,986
|
58,528
|
2%
|
|||||||||
|
Sports
Medicine
|
2,834
|
948
|
199%
|
|||||||||
|
Vascular
|
21,168
|
23,887
|
(11)%
|
|||||||||
|
Other
|
24,180
|
22,683
|
7%
|
|||||||||
|
|
||||||||||||
|
International
|
$ |
108,446
|
$ |
106,198
|
2%
|
|||||||
Sales
by Market Sector:
Sales
of
our Spine products grew 43% to $145.1 million in 2006 from $101.6 million in
2005. As discussed above, the increase is primarily due to increased
sales of Spinal-Stim® and Cervical-Stim® products
attributable to increased demand in the United States together with the addition
of Blackstone Spine sales from September 22, 2006.
Sales
of
our Orthopedics products increased 4% to $95.8 million in 2006 compared to
$92.1
million in 2005. The increase in this market sector is primarily
attributable to increased sales of internal fixation devices which have been
added to our product offering and increased sales of
Physio-Stim®. This market sector was negatively impacted
by sales of external fixation devices, which decreased 1% compared to the prior
year.
Sales
of
our Sports Medicine products increased 8% or $6.1 million from $73.0 million
to
$79.1 million. As discussed above, the increase in sales is primarily
due to sales of our Breg Bracing Products, particularly the Fusion XT™ knee brace
as
well as by increased sales of Breg products in the International
Market.
Sales
of
our Vascular products decreased 11% to $21.2 million in 2006, compared to $23.9
million in 2005 due to increased world-wide competition.
Sales
of
Other products grew 7% to $24.2 million in 2006 compared to $22.7 million in
2005 due to increased sales of women’s care and other distributed products in
the UK and Brazil with essentially flat sales of airway management
products.
Gross
Profit — Gross profit increased 18.4% to $271.7 million in 2006
from $229.5 million in 2005, primarily due to the increase of 16.6% in net
sales
including the addition of Blackstone sales. Gross profit as a
percentage of net sales in 2006 was 74.4% compared to 73.3% in 2005 reflecting
in part the impact of the inclusion of Blackstone with higher gross
margins. The improvement in gross margin was also attributable to a
favorable product mix, resulting from the sales of higher margin stimulation
products as well as ongoing operational improvement
initiatives. Gross margins were impacted negatively by the inclusion
of a charge to cost of sales of approximately $1.0 million from September 22,
2006 for the amortization of the step-up in value of acquired Blackstone
inventory. Additional step-up amortization totaling approximately
$2.7 million will be incurred over the first three quarters of
2007.
Sales
and Marketing Expenses — Sales and marketing expenses, which
include commissions, royalties and bad debt provision, generally increase and
decrease in relation to sales. Sales and marketing expenses increased
$30.3 million to $145.7 million in 2006 from $115.4 million in 2005, an increase
of 26.3% on a sales increase of 16.6%. The higher sales and marketing
expense relates to the inclusion of Blackstone sales and marketing expense
for
which there is no 2005 comparable cost (approximately $13.0 million), higher
commissions and other variable costs including bad debt provisions and sales
tax
(approximately $7.0 million), distribution termination costs following the
Blackstone acquisition (approximately $4.5 million), stock compensation costs
related to the adoption of SFAS 123(R) (approximately $1.4 million) and other
costs intended to build our distribution capabilities. Sales and
marketing expenses as a percentage of net sales increased to 39.9% in 2006
from
36.8% in 2005.
General
and Administrative Expenses — General and administrative expenses
increased $17.3 million to $53.3 million in 2006 from $36.1 million in
2005. The increase is primarily attributable to the inclusion of
Blackstone general and administrative expense of $2.1 million for which there
is
no 2005 comparable cost , share-based compensation of $4.6 million related
to
the adoption of SFAS 123(R) for which there is no comparable cost in 2005,
management transition and divisional restructuring costs (approximately $2.6
million) and additional corporate development, legal and professional costs
($2.6 million). General and administrative expense as a percent of net sales
was
14.6% in 2006 and 11.5% in 2005.
Research
and Development Expenses — Research and development expenses
increased $43.2 million to $55.0 million in 2006 from $11.8 million in
2005. The increase in research and development expense includes a
charge of $40.0 million related to the write-off of in–process research and
development resulting from the Blackstone acquisition. Of the
remaining increase, approximately $2.8 million is related to Blackstone, for
which there was no comparable cost in 2005. Share-based compensation
costs related to the adoption of SFAS 123(R) were $0.4 million, for which there
was also no comparable cost in the prior year. Research and
Development expense as a percent of sales was 15.1% in 2006 and 3.8% in
2005.
Amortization
of Intangible Assets — Amortization of intangible assets was $8.9
million in 2006 compared to $6.6 million in 2005. The increase in
amortization expense was due to the amortization associated with definite-lived
intangible assets acquired in the Blackstone acquisition. The
acquisition of Blackstone will increase amortization of intangibles by
approximately $11.1 million in 2007.
Interest
Income — Interest income earned on cash balances held during the
period was $2.2 million in 2006 compared to $0.9 million in 2005.
Interest
Expense — Interest expense was $8.4 million in 2006 compared to
$6.4 million in 2005. We incurred interest expense on borrowings
under our senior secured term loan which financed the Blackstone acquisition
of
$6.9 million. Additional interest expense of $1.5 million was
incurred on the senior secured term loan associated with the Breg acquisition
which was repaid in the first quarter of 2006 and under a line of credit in
Italy.
Other
Income (Expense), Net — Other income (expense), net was income of
$2.5 million in 2006 compared to income of $1.2 million in
2005. Other income in 2006 was primarily attributable to a $2.1
million foreign currency gain related to an uncovered intercompany loan of
42.6
million Euro created as part of a European restructuring. In December
we arranged a currency swap to hedge the intercompany exposure and minimize
future foreign currency exchange risk related to the intercompany
position.
KCI
Settlement, Net of Related Costs — In the first quarter of 2006, we
entered into final agreements with certain former owners of Novamedix, which
established the portion of the proceeds we were required to disburse in
connection with the KCI settlement. Accordingly, we recorded a gain
of $1.1 million, which was the difference between what we had reserved to
disburse at December 31, 2005 and the amount of the final settlement
obligations.
Income
Tax Expense — In 2006 and 2005, the effective tax rate was 210.5%
and 23.2%, respectively. The effective tax rate for 2006 reflects the
non-deductibility, for tax purposes, of the $40.0 million purchased in-process
research and development charge associated with the Blackstone
acquisition. Excluding the charge for in-process research and
development, our effective tax rate would have been 28.8%. Our 2006
tax rate also benefited from a one-time tax benefit of $2.8 million resulting
from our election to adopt a new tax provision in Italy. Without
these discrete items, our worldwide effective tax rate was 35% in
2006. The effective tax rate in 2005 was affected by the gain
recorded from the KCI settlement which was recorded at Novamedix Distribution
Limited, a wholly-owned Cypriot subsidiary, which is in a favorable tax
jurisdiction. Without this discrete item, our worldwide effective tax
rate was 35% in 2005.
Net
Income (Loss) — Net loss for 2006 was $7.0 million compared to
net income of $73.4 million in 2005 and reflects the items noted
above. Net loss was $0.44 per basic share and $0.44 per diluted share
in 2006, compared to net income of $4.61 per basic share and $4.51 per diluted
share in 2005. The weighted average number of basic common shares
outstanding was 16,165,540 and 15,913,475 during 2006 and 2005,
respectively. The weighted average number of diluted common shares
outstanding was 16,165,540 and 16,288,975 during 2006 and 2005,
respectively.
2005
Compared to 2004
Net
sales
increased 9% to $313.3 million in 2005 compared to $286.6 million in
2004. The impact of foreign currency increased sales by $1.2 million
in 2005 when compared to 2004.
Sales
by Business Segment:
Net
sales in Domestic increased
14% to $135.1 million in 2005 compared to $118.1 million in 2004. The
Domestic net sales represented 43% and 41% of our total net sales in 2005 and
2004, respectively. The increase in sales was primarily the result of
a 25% increase in sales in the Spine market sector attributable to sales of
Cervical-Stim, which was approved by the FDA in December 2004, and growth in
the
sales of Spinal-Stim, used for lumbar applications. The
Domestic Orthopedics market sector decreased 9% in 2005 compared to
2004. This decrease is attributable to a decline in external fixation
sales as well as decline in Physio-Stim long bone stimulation sales resulting
from increased competition and the cannibalization of some stimulation sales,
previously recorded in the Orthopedic market sector, by the recent introduction
of the Cervical-Stim. The decrease in external fixation was partially
offset by sales of recently introduced internal fixation products like the
eight-plate and ISKD limb lengthening system. In the Domestic
Orthopedic market sector, external fixation devices are sharing the market
for
treatment of difficult fractures with alternatives such as plating, nailing
and
biologics. Recognizing this trend, we have introduced the VPS Contour
plate for distal radius fractures, the Osteomax bone void filler product line,
and anticipate the introduction of other internal fixation and biologic products
to our Domestic Orthopedic product line. The following table
illustrates sales by market sector in Domestic:
|
(In
thousands)
|
2005
|
2004
|
Growth
|
|||||||||
|
Spine
|
$ |
101,470
|
$ |
81,182
|
25%
|
|||||||
|
Orthopedics
|
33,569
|
36,874
|
(9)%
|
|||||||||
|
Other
|
45
|
18
|
150%
|
|||||||||
|
|
||||||||||||
|
Domestic
|
$ |
135,084
|
$ |
118,074
|
14%
|
|||||||
Net
sales
in Breg increased 5% to $72.0 million in 2005 compared to $68.3 million in
2004. This increase in sales was primarily attributable to the sale
of Breg bracing products, which increased 10% in 2005. Our new Fusion
XT™ knee
brace, which experienced positive market response upon its limited introduction,
contributed to this increase. This increase was partially offset by
an 8% decrease in sales for pain therapy products resulting in part from delays
in the introduction of new pain therapy products. All of Breg’s sales
are recorded in our Sports Medicine market sector. Breg net sales
represented 23% and 24% of our total net sales in 2005 and 2004,
respectively.
Net
sales
in International increased 6% to $106.2 million in 2005 from $100.3 million
in
2004. International net sales represented 34% and 35% of our total
net sales in 2005 and 2004, respectively. Our Orthopedic market
sector continues to contribute to the growth in International, led primarily
by
the sales of external fixation products, the Physio-Stim® and the
PC.C.P® hip fracture system. The Vascular market sector
continues to be impacted by a decrease in sales of the A-V Impulse product
when
compared to the same period of the prior year. This decrease is
primarily attributable to the competitive landscape for this product and
decreased prices to our principal U.S. distributor. The impact of
foreign currency increased International sales by $0.6 million for 2005 when
compared to 2004. The following table illustrates sales by market
sector in International:
|
(In
thousands)
|
2005
|
2004
|
Growth
|
|||||||||
|
Spine
|
$ |
152
|
$ |
191
|
(20)%
|
|||||||
|
Orthopedics
|
58,528
|
53,238
|
10%
|
|||||||||
|
Sports
Medicine
|
948
|
194
|
389%
|
|||||||||
|
Vascular
|
23,887
|
25,226
|
(5)%
|
|||||||||
|
Other
|
22,683
|
21,421
|
6%
|
|||||||||
|
|
||||||||||||
|
International
|
$ |
106,198
|
$ |
100,270
|
6%
|
|||||||
Sales
by Market Sector:
Net
sales
of our Spine products grew 25% to $101.6 million in 2005 from $81.4 million
in
2004. This increase is primarily due to sales of
Cervical-Stim®, which was approved by the FDA in December 2004 and
began selling in January 2005, and growth of our Spinal-Stim®, used
for lumbar applications.
Sales
of
our Orthopedic products increased 2% to $92.1 million in 2005 compared to $90.1
million in 2004. The increase is attributable to sales of fixation
products which overall increased 6%. Growth in this market sector was
negatively impacted by a decrease of 10% in sales of stimulation products used
for long bone applications. The growth in this product has been
impacted by increased competition and the effect of cannibalization of some
stimulation sales previously recorded in this market sector by
Cervical-Stim®.
Sales
of
our Vascular A-V Impulse product decreased 5% to $23.9 million in 2005 compared
to $25.2 million in 2004 for the reasons discussed above.
Sales
of
our Other products grew 6% to $22.7 million in 2005 compared to $21.4 million
in
2004. The increase was primarily due to an increase in sales of
women’s care and other products. This increase was slightly offset by
a decrease in sales of airway management products due to increased competition
as a result of this product coming off patent.
Gross
Profit — Gross profit increased 11% to $229.5 million in 2005
from $207.5 million in 2004, primarily due to the increase of 9% in net
sales. Gross profit as a percentage of net sales in 2005 was 73.3%
compared to 72.4% in 2004. The improvement in gross profit margin in
2005 as compared to 2004 is due to operational process improvements which
increased margins on our stimulation products, and a more favorable product
mix
resulting from higher sales of higher margin stimulation products.
Sales
and Marketing Expenses — Sales and marketing expenses, which
include commissions, royalties and bad debt provisions, generally increase
and
decrease in relation to sales. Sales and marketing expenses increased
$12.9 million to $115.4 million in 2005 from $102.5 million in 2004, an increase
of 13% on a sales increase of 9%. Sales and marketing expenses as a
percentage of net sales increased to 36.8% in 2005 from 35.7% in
2004. The higher sales and marketing expense relates to higher
commissions and other variable costs on higher sales, additional personnel,
principally in Domestic, and higher related benefits costs, all of which were
deemed to be more operational in nature. In addition, we
discretionarily spent approximately $3.1 million for market development efforts
in our Latin Americas subsidiaries and marketing programs.
General
and Administrative Expenses — General and administrative expenses
increased $5.4 million to $36.1 million in 2005 from $30.6 million in
2004. This increase is a result of corporate development, higher
costs associated with Section 404 of the Sarbanes-Oxley Act of 2002, legal
activity, employee benefit costs in the United States, consulting and training
costs associated with implementing an Oracle system at Breg, and sponsorships
at
Breg. We also had an increase in the area of business development,
when compared to the same period of the prior year. We added a new
Chief Operating Officer during the current year to lead these activities and
have incurred costs of outside consultants to help us define market potential
and target and assess new opportunities. General and
administrative expense as a percent of net sales was 12% in 2005 and 11% in
2004.
Research
and Development Expenses — Research and development expenses
increased $0.3 million to $11.8 million in 2005 from $11.5 million in 2004,
an
increase of 3%, and remained constant as a percentage of net sales at
4%.
Amortization
of Intangible Assets — Amortization of intangible assets was $6.6
million in 2005 compared to $6.3 million in 2004.
Interest
Income — Interest income earned on cash balances held during the
period was $0.9 million in 2005 compared to $0.3 million in 2004.
Interest
Expense — Interest expense was $6.4 million in 2005 compared to
$6.3 million in 2004 primarily due to an increase of approximately $2.0 million
in the amortization of debt placement costs resulting from the prepayment of
debt on the senior secured term loan and an increase in interest rates in
2005. These additional costs were offset by lower interest
expense incurred on lower outstanding debt balances following debt prepayments
as well as the termination of an interest rate swap agreement that reduced
interest expense by $0.4 million.
Loss
in Joint Venture, Net — In 2005, we did not record a loss in
joint venture and in 2004 we recorded a net loss of $0.3
million. During 2004, we sold part of our ownership in the OrthoRx
joint venture. This sale resulted in a gain of approximately $0.8
million. The gain was offset by our portion of the joint venture’s
operating losses in 2004 of approximately $1.1 million. As of
December 31, 2005 our ownership percentage in the joint venture was 6.4% and
our
investment in the joint venture had been reduced to zero through the equity
method of accounting.
Other
Income (Expense), Net — Other income (expense), net was income of
$1.2 million in 2005 compared to income of $1.3 million in
2004. Other income in 2005 was attributable to $2.4 million of
deferred royalty income resulting from the conclusion of the BoneSource
agreement with Stryker which was partially offset by $0.9 million of foreign
currency losses. In 2004, other income was generated from the sale of
our interest in a U.K. facility that resulted in a gain of approximately $0.6
million and foreign exchange gains of $0.9 million, primarily as a result of
uncovered trade receivables denominated in Euros in subsidiaries whose
functional currency is the U.S. Dollar. These gains were slightly
offset with a loss in joint venture of $0.3 million.
KCI
Settlement, Net of Related Costs — In September 2005, we reached an
agreement to settle our case against Kinetics Concepts Inc.
(“KCI”). The gain, net of related costs, for 2005 was $40.1 million,
compared to costs of $1.6 million in 2004. The net gain recorded in
2005 was subject to adjustment based on potential differences between the amount
accrued and final contractual obligations.
Income
Tax Expense — In 2005 and 2004, the effective tax rate was 23.2%
and 32.2%, respectively. The effective tax rate in 2005 was primarily
affected by the KCI settlement gain recorded at Novamedix Distribution Limited,
a wholly-owned Cypriot subsidiary, which is in a favorable tax jurisdiction.
Excluding the nonrecurring KCI settlement, our effective tax rate was
approximately 35% for 2005. The increase in our effective tax rate
excluding the KCI litigation settlement is primarily attributable to a change
in
tax law in the United Kingdom and earning more taxable income in higher tax
jurisdictions such as the United States.
Net
Income — Net income for 2005 was $73.4 million compared to $34.1
million in 2004, an increase of 115%. Net income was $4.61 per basic
share and $4.51 per diluted share in 2005, compared to $2.22 per basic share
and
$2.14 per diluted share in 2004, an increase in diluted earnings per share
of
111%. Net income for 2005 included a gain of $37.4 million or $2.35
per basic share and $2.30 per diluted share from the settlement of the KCI
litigation. The weighted average number of basic common shares
outstanding was 15,913,475 and 15,396,540 during 2005 and 2004,
respectively. The weighted average number of diluted common shares
outstanding was 16,288,975 and 15,974,945 during 2005 and 2004,
respectively.
Liquidity
and Capital Resources
Cash
and
cash equivalents at December 31, 2006 were $33.2 million, of which $7.2 million
is subject to certain restrictions under the senior secured credit agreement
described below. This compares to cash and cash equivalents of $77.5
million at December 31, 2005, of which $13.8 million was subject to certain
restrictions under a previous senior secured credit agreement, which was fully
repaid and cancelled as of March 31, 2006.
Net
cash
provided by operating activities was $8.2 million in 2006 compared to $106.7
million, including $67.5 million from the KCI settlement, in 2005, a decrease
of
$101.6 million. Net cash provided by operating activities is
comprised of net income (loss), non-cash items (including share based
compensation and non-cash purchase accounting items from the Blackstone
acquisition, notably in-process research and development) and changes in working
capital including changes in restricted cash. Net income (loss)
decreased approximately $80.4 million, to a net loss of $7.0 million in 2006
from net income of $73.4 million in 2005. The reduction of net income
includes $40.0 million of in-process research and development from the
Blackstone transaction and the non-recurrence of $37.4 million in after tax
income from the KCI settlement in 2005. Non-cash items of $56.7
million in 2006 increased $36.1 million compared to 2005 principally due to
in-process research and development costs of $40.0 million and $7.9 million
in
share based compensation costs offset by non-cash usage from deferred taxes
related to the Blackstone transaction of $12.3 million. Working
capital accounts consumed $41.5 million of cash in 2006, including a reduction
of other current liabilities related principally to previously accrued
contractual payments made in 2006 to former Novamedix shareholders following
the
KCI settlement. Excluding the effect of KCI settlement payments,
working capital consumed $15.3 million of cash in 2006 compared to $12.7 million
in 2005. The principal uses of working capital were for increases in
accounts receivable and inventory to support sales growth and certain
operational initiatives. Inventory growth and resultant lower
inventory turns reflect inventory investment to open an international
distribution center, the purchase of safety stock of A-V Impulse Impads to
support the transfer of production from the UK to Mexico and inventories
associated with new internal fixation products.
Net
cash
used in investing activities was $354.9 million in 2006, compared to $12.2
million during 2005. On September 22, 2006 we purchased Blackstone
for $333.0 million plus various transaction costs. In the first
quarter of 2006 we also paid $1.1 million to purchase 52% of our Breg
distributor in Germany. Further, we invested $12.6 million in capital
expenditures in 2006 compared to $12.2 million in 2005. In 2007 we
anticipate the use of cash for capital expenditures will be approximately $17.0
million.
Net
cash
used in financing activities was $307.8 million in 2006 compared to $55.6
million in 2005. In 2006 we received proceeds of $11.5 million from
the issuance of 436,610 shares of our common stock upon the exercise of stock
options and shares purchased pursuant to our employee stock purchase
plan. In March 2006, we repaid the remaining $14.8 million of
outstanding principal from a $110 million senior term loan used to finance
the
Breg acquisition in December 2003. On September 22, 2006, we entered
into a new $330 million senior secured term loan, which along with cash balances
were used to finance the acquisition of Blackstone and pay debt issuance costs
of $6.0 million and other costs associated with the transaction. In
December 2006, we repaid approximately $14.8 million against the principal
on
this senior secured term loan. During the year we also received a tax
benefit of $2.2 million on the exercise of non-qualified stock
options.
On
September 22, 2006, our wholly-owned
US holding company subsidiary, Orthofix Holdings Inc. (“Orthofix Holdings”),
entered into a senior secured credit facility with a syndicate of financial
institutions to finance the acquisition of Blackstone. The senior
secured credit facility provides for (1) a seven-year amortizing term loan
of
$330.0 million, the proceeds of which together with cash balances were used
for
payment of the purchase price of Blackstone; and (2) a six-year revolving credit
facility of $45.0 million. As of December 31, 2006 and as of March
14, 2007, we had no amounts outstanding under the revolving credit facility
and
$315.2 million outstanding under the term loan facility. Obligations
under the senior secured term loan have a floating interest rate of LIBOR plus
a
margin or prime plus a margin. Based on LIBOR plus a margin
of 1.75%. The interest rate as of December 31, 2006 on our
senior secured term loan is 7.12%. The Company, certain foreign
subsidiaries of the Company, including Colgate Medical Ltd. (Orthofix Holding’s
immediate parent) and certain of Orthofix Holding’s direct and indirect
subsidiaries, including Orthofix Inc., Breg and Blackstone, have guaranteed
the
obligations of Orthofix Holdings under the senior secured credit
facility. The obligations of Orthofix Holdings under the senior
secured bank facility and the guarantors under their guarantees are secured
by
the pledge of their respective assets located in the United States.
At
December 31, 2006, we had outstanding borrowings of $0.1 million and unused
available lines of credit of approximately $6.2 million Euros ($8.1 million)
under a line of credit established in Italy to finance the working capital
of
our Italian operations. The terms of the line of credit give us the
option to borrow amounts in Italy at rates determined at the time of
borrowing.
We
continue to search for viable acquisition candidates that would expand our
global presence as well as additional products appropriate for current
distribution channels. An acquisition of another company or product
line by us could result in our incurrence of additional debt and contingent
liabilities.
We
believe that current cash balances together with projected cash flows from
operating activities, the unused revolving credit facility and available Italian
line of credit, the exercise of stock options, and our remaining available
debt
capacity are sufficient to cover anticipated working capital and capital
expenditure needs including research and development costs over the near
term.
Contractual
Obligations
The
following chart sets forth our contractual obligations as of December 31,
2006:
|
Contractual
Obligations
|
Payments
Due By Period
|
|||||||||||||||||||
|
(In
thousands)
|
Total
|
Less
Than 1 Year
|
1
to 3 Years
|
4
to 5 Years
|
Over
5 Years
|
|||||||||||||||
|
Senior
secured term loan
|
$
|
315,175
|
$
|
3,300
|
$
|
6,600
|
$
|
6,600
|
$
|
298,675
|
||||||||||
|
Other
borrowings
|
200
|
39
|
92
|
69
|
-
|
|||||||||||||||
|
Operating
Leases
|
15,204
|
4,388
|
6,248
|
4,070
|
498
|
|||||||||||||||
|
Total
|
$
|
330,579
|
$
|
7,727
|
$
|
12,940
|
$
|
10,739
|
$
|
299,173
|
||||||||||
On
September 22, 2006, a new credit agreement was entered into by Orthofix
Holdings, Inc., Orthofix International N.V. and certain of their domestic and
foreign direct and indirect subsidiaries concurrent with the closing of the
Blackstone acquisition. This credit agreement includes a seven year,
$330.0 million term loan on which $315.2 million was outstanding at December
31,
2006.
In
addition to scheduled contractual obligations of the debt as set forth above,
our credit agreement requires us to make mandatory prepayments with (a) the
excess cash flow (as defined in the credit agreement) of Orthofix International
N.V. and its subsidiaries, in an amount equal to 50% of the excess annual cash
flow beginning with the year ending December 31, 2007, provided, however, if
the
leverage ratio (as defined in the credit agreement) is less than or equal to
1.75 to 1.00, as of the end of any fiscal year, there will be no mandatory
excess cash flow prepayments, with respect to such fiscal year (b) 100% of
the
net cash proceeds of any debt issuances by Orthofix International N.V. or any
of
its subsidiaries or 50% of the net cash proceeds of equity issuances by any
such
party, excluding the exercise of stock options, provided, however, if the
leverage ratio is less than or equal to 1.75 to 1.00 at the end of the preceding
fiscal year, Orthofix Holdings shall not be required to prepay the loans with
the proceeds of any such debt or equity issuance, (c) the net cash proceeds
of
asset dispositions over a minimum threshold, or (d) unless reinvested, insurance
proceeds or condemnation awards.
Off-balance
Sheet Arrangements
As
of December 31, 2006 we did not have
any material 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, liquidity,
capital expenditures or capital resources.
Item
7A. Quantitative and Qualitative Disclosures
About Market Risk
We
are exposed to certain market risks
as part of our ongoing business operations. Primary exposures include
changes in interest rates and foreign currency fluctuations. These exposures
can
vary sales, cost of goods, and costs of operations, the cost of financing and
yields on cash and short-term investments. We use derivative
financial instruments, where appropriate, to manage these
risks. However, our risk management policy does not allow us to
hedge positions we do not hold nor do we enter into derivative or other
financial investments for trading or speculative purposes. As of
December 31, 2006, we had a currency swap transaction in place to minimize
future foreign currency exchange risk related to a 42.6 million Euro
intercompany note foreign currency exposure. See Item 7 –
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations – 2006 Compared to 2005 – “Other Income (Expense), net”.
We
are exposed to interest rate risk in
connection with our senior secured term loan and borrowings under our revolving
credit facility, which bear interest at floating rates based on London
Inter-Bank Offered Rate (LIBOR) or the prime rate plus an applicable borrowing
margin. Therefore, interest rate changes generally do not affect the fair
market
value of the debt, but do impact future earnings and cash flows, assuming
other
factors are held constant.
As
of
December 31, 2006, we had $315.2 million of variable rate term debt
represented by borrowings under our senior secured term loan at a floating
interest rate of LIBOR or prime rate plus a margin, currently LIBOR plus
1.75%. The effective interest rate as of December 31, 2006 on the
senior secured term loan is 7.12%. Based on the balance outstanding
under the credit facility as of December 31, 2006 an immediate change of one
percentage point in the applicable interest rate on the variable rate debt
would
cause an increase or decrease in interest expense of approximately $3.2 million
on an annual basis.
Our
foreign currency exposure
results from fluctuating currency exchange rates, primarily the U.S. Dollar
against the Euro, Great Britain Pound, Mexican Peso and Brazilian
Real. We face cost of goods currency exposure when we produce
products in foreign currencies such as the Euro or Great Britain Pound and
sell
those products in U.S. Dollars. We face transactional currency
exposures when foreign subsidiaries (or the Company itself) enter into
transactions, denominated in currencies other than their functional
currency. For the period from August 1, 2006 to December 15, 2006, we
had an uncovered intercompany receivable denominated in Euro of approximately
46.2 million due to a European restructuring. On December 15, 2006 we
entered into a currency swap transaction with a bank to offset this
exposure. During the period from August 1, 2006 to December 15, 2006
we recorded a foreign currency gain of $2.1 million which resulted from the
strengthening of the Euro against the U.S. Dollar during that
period.
We
also
face currency exposure from translating the results of our global operations
into the U.S. dollar at exchange rates that have fluctuated from the beginning
of the period. The U.S. dollar equivalent of international sales
denominated in foreign currencies was favorably impacted in 2006 and 2005 by
foreign currency exchange rate fluctuations with the weakening of the U.S.
dollar against the local foreign currency in 2006 and 2005. The U.S.
dollar equivalent of the related costs denominated in these foreign currencies
was unfavorably impacted in 2006 and 2005. As we continue to
distribute and manufacture our products in selected foreign countries, we expect
that future sales and costs associated with our activities in these markets
will
continue to be denominated in the applicable foreign currencies, which could
cause currency fluctuations to materially impact our operating
results.
See
“Index
to Consolidated Financial Statements” on page F-1 of this Form
10-K.
Item
9. Changes
in
and Disagreements with Accountants on Accounting and Financial
Disclosure
None.
Item
9A. Controls and
Procedures
As
of
December 31, 2006, we performed an evaluation under the supervision and with
the
participation of our Company’s management, including the Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation
of
our Company’s disclosure controls and procedures. Based on the
evaluation, our management, including the Chief Executive Officer and Chief
Financial Officer, concluded that our Company’s disclosure controls and
procedures were effective as of the end of the period covered by this
report.
On
September 22, 2006 the Company acquired Blackstone Medical, Inc. and, as a
result, is integrating the processes, systems and controls relating to the
acquired subsidiary into the Company’s existing system of internal control over
financial reporting. Except for the processes, systems, and controls
relating to the integration of Blackstone Medical, Inc. there have not been
any
changes in the Company’s internal control over financial reporting during the
year ended December 31, 2006 that have materially affected or are reasonably
likely to materially affect, its internal control over financial
reporting.
Our
Management’s assessment regarding the Company’s internal control over financial
reporting can be found immediately prior to the financial statements in a
section entitled “Management’s Report on Internal Control over Financial
Reporting” in this annual report on Form 10-K.
PART
III
Certain
information required by Item 10 of Form 10-K and information required by Items
11, 12, 13 and 14 of Form 10-K is omitted from this annual report and will
be
filed in a definitive proxy statement or by an amendment to this annual report
not later than 120 days after the end of the fiscal year covered by this annual
report.
Item
10. Directors, Executive Officers and
Corporate Governance
The
following table sets forth certain information about the persons who serve
as
our directors and executive officers.
|
Name
|
Age
|
Position
|
|
James
F. Gero
|
62
|
Chairman
of the Board of Directors
|
|
Alan
W. Milinazzo
|
47
|
Chief
Executive Officer, President and Director
|
|
Thomas
Hein
|
59
|
ChieChief
Financial Officer
|
|
Matthew
Lyons
|
43
|
PresPresident,
Blackstone Medical, Inc.
|
|
Bradley
R. Mason
|
53
|
VicePresident
and President, Breg, Inc.
|
|
Raymond
C. Kolls
|
44
|
Senior
Vice President, General Counsel and Corporate Secretary
|
|
Michael
M. Finegan
|
43
|
Vice
President Business Development
|
|
Oliver
Burckhardt
|
34
|
President,
Orthofix International
|
|
Peter
J. Hewett
|
71
|
Deputy
Chairman of the Board of Directors
|
|
Charles
W. Federico
|
59
|
Director
|
|
Jerry
C. Benjamin (2)
(3)
|
66
|
Director
|
|
Walter
von Wartburg (1)
|
67
|
Director
|
|
Thomas
J. Kester (1)
(2)
|
60
|
Director
|
|
Kenneth
R. Weisshaar (2)
(3)
|
56
|
Director
|
|
Guy
Jordan (1)
(3)
|
58
|
Director
|
|
Stefan
Widensohler (1)
(3)
|
47
|
Director
|
______________
(1) Member
of the Compensation Committee
(2) Member
of the Audit Committee
(3) Member
of Nominating and Governance Committee
All
directors hold office until the next annual general meeting of our shareholders
and until their successors have been elected and qualified. Our
officers serve at the discretion of the Board of Directors. There are
no family relationships among any of our directors or executive
officers. The following is a summary of the background of each
director and executive officer.
James
F. Gero. Mr. Gero became Chairman of Orthofix
International N.V. on January 1, 2005 and has been a Director of Orthofix
International N.V. since 1998. Mr. Gero became a Director of AME Inc. in
1990. He is a Director of Intrusion, Inc., and Drew Industries Inc.
and is a private investor.
Alan
W. Milinazzo. Mr. Milinazzo joined Orthofix International in
2005 as Chief Operating Officer and succeeded to the position of CEO effective
as of April 1, 2006. From 2002 to 2005, Mr. Milinazzo was Vice
President of Medtronic Inc.’s Vascular business, as well as, Vice President and
General Manager of Medtronic’s Coronary and Peripheral
businesses. Prior to his time with Medtronic, Mr. Milinazzo spent 12
years as an executive with Boston Scientific Corporation in numerous roles,
including Vice President of Marketing for SCEMED Europe. Mr.
Milinazzo brings more than two and a half decades of experience in the
management and marketing of medical device businesses, including positions
with
Aspect Medical Systems and American Hospital Supply. He earned a
bachelor’s degree, cum laude, at Boston College in 1980.
Thomas
Hein, CPA. Mr. Hein became the Chief Financial Officer of
Orthofix International N.V. on July 1, 2002. For the prior three
years, Mr. Hein had been the Chief Financial Officer of Orthofix Inc., our
wholly- owned U.S. subsidiary. From 1996 to 1999, Mr. Hein was the
Chief Financial Officer for Prime Vision Health Inc., a diversified healthcare
services company. From 1988 to 1996, Mr. Hein was Vice President of
Finance and Chief Financial Officer of MDT Corporation, a sterilization and
hospital capital equipment company. Previously, he held financial
management positions with Metheus Corporation, Memorex Corporation and Kaiser
Aetna.
Matthew
Lyons. Mr. Lyons became President, Blackstone Medical,
Inc. in October 2006 upon the acquisition of Blackstone Medical,
Inc. He is also President and Chief Executive Officer of Blackstone
which he co-founded in 1996. Mr. Lyons has over twenty years of
experience in the medical device industry starting in product development in
1986 for Osteonics Corp, Division of Stryker, and product Development Manager
for Exactech Inc., and Vice President of Brimfield Precision, Inc. as a
co-owner. Mr. Lyons is named on numerous Patents in orthopedics and
is a graduate of Syracuse University where he earned his Bachelor of Science
degree in Mechanical Engineering.
Bradley
R. Mason. Mr. Mason became a Vice President of Orthofix
International N.V. in December 2003 upon the acquisition of Breg,
Inc. He is also the President of Breg, Inc., which he founded in 1989
with five other principal shareholders. Mr. Mason has over 25 years
of experience in the medical device industry, some of which were spent with
dj
Orthopedics (formally DonJoy) where he was a founder and held the position
of
Executive Vice President. Mr. Mason is the named inventor on 35
issued patents in the orthopedic product arena with several other patents
pending.
Raymond
C. Kolls, J.D. Mr. Kolls became Vice President, General
Counsel and Corporate Secretary of Orthofix International N.V. on July 1, 2004.
Mr. Kolls was named Senior Vice President, General Counsel and Corporate
Secretary effective October 1, 2006. From 2001 to 2004, Mr. Kolls was
Associate General Counsel for CSX Corporation. Mr. Kolls began his
legal career as an attorney in private practice with the law firm of Morgan,
Lewis & Bockius.
Michael
M. Finegan. Mr. Finegan joined Orthofix International in
June 2006 as Vice President of Business Development. Prior to joining
Orthofix, Mr. Finegan spent sixteen years as an executive with Boston Scientific
in a number of different operating and strategic roles, most recently as Vice
President of Corporate Sales. Earlier in his career, Mr. Finegan held
sales and marketing roles with Marion Laboratories and spent three years in
banking with First Union Corporation (Wachovia). Mr. Finegan earned a
BA in Economics from Wake Forest University.
Oliver
Burckhardt. Mr. Burckhardt joined Orthofix in 2006 as
President, Orthofix International. From 1998 to 2006, Mr. Burckhardt
was with Aesculap where he was Vice President of Marketing and Sales for the
Spine Division in the U.S. Additionally, he has served in a senior
global marketing position with Aesculap and assumed several different sales
positions with Johnson & Johnson’s Ethicon and Mitek Divisions in
Europe.
Peter
J. Hewett. Mr. Hewett was appointed Deputy Chairman of the
Board of Directors in 2005 and has been a non-executive Director of Orthofix
International N.V. since March 1992. He was the Deputy Group Chairman
of Orthofix International N.V. between March 1998 and December
2000. Previously, Mr. Hewett served as the Managing Director of
Caradon Plc, Chairman of the Engineering Division, Chairman and President of
Caradon Inc., Caradon Plc’s U.S. subsidiary and a member of the Board of
Directors of Caradon Plc of England. In addition, he was responsible
for Caradon Plc’s worldwide human resources function, and the development of its
acquisition opportunities.
Charles
W. Federico. Mr. Federico has been a Director of Orthofix
International N.V. from October 1996, President and Chief Executive Officer
of
Orthofix International N.V. from January 1, 2001 until April 1, 2006 and
President of Orthofix Inc. from October 1996 to January 1,
2001. From 1985 to 1996 Mr. Federico was the President of Smith
& Nephew Endoscopy (formerly Dyonics, Inc.). From 1981 to 1985,
Mr. Federico served as Vice President of Dyonics, initially as Director of
Marketing and subsequently as General Manager. Previously he held
management and marketing positions with General Foods Corporation, Puritan
Bennett Corporation and LSE Corporation
Jerry
C. Benjamin. Mr. Benjamin became a non-executive
Director of Orthofix International N.V. in March 1992. He has been a
General Partner of Advent Venture Partners, a venture capital management firm
in
London, since 1985. Mr. Benjamin is a director of Micromet, Inc.
Phoqus, Ltd. and a number of private health care companies.
Dr.
Walter von Wartburg. Dr. von Wartburg, became a
non-executive Director of Orthofix International N.V. in June
2004. He is an attorney and has practiced privately in his own law
firm in Basel, Switzerland since 1999, specializing in life sciences
law. He has also been a Professor of administrative law and public
health policy at the Saint Gall Graduate School of Economics in Switzerland
for
25 years. Previously, he held top management positions with Ciba
Pharmaceuticals and Novartis at their headquarters in Basel,
Switzerland.
Thomas
J. Kester, CPA. Mr. Kester became a non-executive Director
of Orthofix International N.V. in August 2004. Mr. Kester retired
after 28 years, 18 as an audit partner, from KPMG LLP in 2002. While
at KPMG, he served as the lead audit engagement partner for both public and
private companies and also served four years on KPMG’s National Continuous
Improvement Committee. Mr. Kester earned a Bachelor of Science degree
in mechanical engineering from Cornell University and an MBA degree from Harvard
University.
Kenneth
R. Weisshaar. Mr. Weisshaar became a non-executive Director
of Orthofix International N.V. in December 2004. From 2000 to 2002,
Mr. Weisshaar served as Chief Operating Officer and strategy advisor for
Sensatex, Inc. Prior to that, Mr. Weisshaar spent 12 years as a
corporate officer at Becton Dickson, a medical device company, where at
different times he was responsible for global businesses in medical devices
and
diagnostic products and served as Chief Financial Officer and Vice President,
Strategic Planning. Mr. Weisshaar earned a Bachelor of Science degree
from MIT and an MBA from Harvard University. He currently also serves
on the board of Digene Corporation.
Guy
J. Jordan, Ph.D. Dr. Jordan became a non-executive Director
of Orthofix International N.V. in December 2004. Most recently, from
1996 to 2002, Dr. Jordan served as a Group President at CR Bard, Inc., a medical
device company, where he had strategic and operating responsibilities for Bard’s
global oncology business and functional responsibility for all of Bard’s
research and development. Dr. Jordan earned a Ph.D. in organic
chemistry from Georgetown University as well as an MBA from Fairleigh Dickinson
University. He also currently serves on the boards of Specialized
Health Products International, Inc., Xillix Technologies Corporation and
EndoGastric Solutions, Inc.
Stefan
Widensohler. Mr. Widensohler became a non-executive Director of
Orthofix International N.V. in February 2005. Mr. Widensohler has
been the President and Chief Executive Officer of KRAUTH medical group, a
European medical supply distributor based in Germany, since
1992. Previously, he was General Manager of MEDICALIS, now a GE
Company. Mr. Widensohler holds a degree in economics from the Private
Academy of Bad Harzburg, Germany. He is Deputy Chairman of the Board
of BV-Med, the German Health Industry Manufacturer’s Association and is an
Active Member of the German Economic Council. He currently also
serves on the board of St. Jude Medical, Inc.
Audit
Committee
We
have a separately designated
standing Audit Committee established in accordance with Section 3(a)(58)(A)
of
the Securities Exchange Act of 1934, as amended. Messrs. Benjamin,
Kester and Weisshaar currently serve as members of the Audit
Committee. All of the members of our Audit Committee are
“independent” as defined by the current SEC and NASDAQ rules. Our
Board of Directors has determined that Messrs. Benjamin, Kester and Weisshaar
are “audit committee financial experts” in accordance with current SEC
rules.
Code
of Ethics
We
have adopted a code of ethics
applicable to our directors, officers and employees worldwide, including our
Chief Executive Officer and Chief Financial Officer. A copy of our
code of ethics is available on our website at
www.orthofix.com.
Section
16(a) Beneficial Ownership Reporting Compliance
We
will provide the information
regarding Section 16(a) beneficial ownership reporting compliance in our
definitive proxy statement or in an amendment to this annual report not later
than 120 days after the end of the fiscal year covered by this annual report,
in
either case under the caption “Section 16(a) Beneficial Ownership Reporting
Compliance,” and possibly elsewhere therein. That information is
incorporated in this Item 10 by reference.
Item
11. Executive
Compensation
We
will
provide information that is responsive to this Item 11 regarding executive
compensation in our definitive proxy statement or in an amendment to this annual
report not later than 120 days after the end of the fiscal year covered by
this
annual report, in either case under the caption “Executive Compensation,” and
possibly elsewhere therein. That information is incorporated in this
Item 11 by reference.
Item
12. Security Ownership of Certain
Beneficial Owners and Management and Related Stockholder
Matters
We
will
provide information that is responsive to this Item 12 regarding ownership
of
our securities by certain beneficial owners and our directors and executive
officers, as well as information with respect to our equity compensation plans,
in our definitive proxy statement or in an amendment to this annual report
not
later than 120 days after the end of the fiscal year covered by this annual
report, in either case under the captions “Security Ownership of Certain
Beneficial Owners and Management and Related Stockholders” and “Equity
Compensation Plan Information,” and possibly elsewhere therein. That
information is incorporated in this Item 12 by reference.
Item
13. Certain Relationships and Related
Transactions, and Director Independence
We
will
provide information that is responsive to this Item 13 regarding transactions
with related parties and director independence in our definitive proxy statement
or in an amendment to this annual report not later than 120 days after the
end
of the fiscal year covered by this annual report, in either case under the
caption “Certain Relationships and Related Transactions,” and possibly elsewhere
therein. That information is incorporated in this Item 13 by
reference.
Item
14. Principal Accountant Fees and
Services
We
will
provide information that is responsive to this Item 14 regarding principal
accountant fees and services in our definitive proxy statement or in an
amendment to this annual report not later than 120 days after the end of the
fiscal year covered by this annual report, in either case under the caption
“Principal Accountant Fees and Services,” and possibly elsewhere
therein. That information is incorporated in this Item 14 by
reference.
PART
IV
Item
15. Exhibits
and Financial Statement
Schedules
|
(a)
|
Documents
filed as part of report on Form
10-K
|
The
following documents are filed as
part of this report on Form 10-K:
|
|
1.
|
Financial
Statements
|
See
“Index
to Consolidated Financial
Statements” on page F-1 of this Form 10-K.
|
|
2.
|
Financial
Statement Schedules
|
See
“Index
to Consolidated Financial
Statements” on page F-1 of this Form 10-K.
|
|
3.
|
Exhibits
|
|
Exhibit
Number
|
Description
|
|
|
3.1
|
Certificate
of Incorporation of the Company (filed as an exhibit to the Company’s
annual report on Form 20-F dated June 29, 2001 and incorporated
herein by
reference).
|
|
|
Articles
of Association of the Company as Amended.
|
||
|
10.1
|
Orthofix
Inc. Employee Stock Purchase Plan (filed as an exhibit to the Company’s
annual report on Form 10-K for the fiscal year ended December 31,
2002 and
incorporated herein by reference).
|
|
|
10.2
|
Orthofix
International N.V. Staff Share Option Plan (filed as an exhibit
to the
Company’s annual report on Form 10-K for the fiscal year ended December
31, 2002 and incorporated herein by reference).
|
|
|
10.3
|
Form
of Performance Accelerated Stock Option under the Staff Share Option
Plan
(filed as an exhibit to the Company’s annual report on Form 10-K for the
fiscal year ended December 31, 2002 and incorporated herein by
reference).
|
|
|
10.4
|
Form
of Performance Accelerated Stock Option Inducement Agreement (filed
as an
exhibit to the Company’s annual report on Form 10-K for the fiscal year
ended December 31, 2003 and incorporated here in by
reference).
|
|
|
10.5
|
Orthofix
International N.V. 2004 Long Term Incentive Plan, as amended (filed
as an
exhibit to the Company’s quarterly report on Form 10-Q for the quarter
ended September 30, 2004 and incorporated herein by
reference).
|
|
|
10.6
|
Form
of Nonqualified Stock Option Agreement Under the Orthofix International
N.V. 2004 Long Term Incentive Plan (filed as an exhibit to the
Company’s
current report on Form 8-K filed April 17, 2006 and incorporated
herein by
reference).
|
|
|
10.7
|
Form
of Nonqualified Stock Option Agreement for Non-Employee Directors
under
the Orthofix International N.V. 2004 Long Term Incentive Plan (filed
as an
exhibit to the Company’s annual report on Form 10-K for the fiscal year
ended December 31, 2004 and incorporated herein by
reference).
|
|
Orthofix
Deferred Compensation Plan.
|
||
|
10.9
|
Employment
Agreement, dated as of April 15, 2005, between the Company and Charles
W.
Federico (filed as an exhibit to the Company’s current report on Form 8-K
filed April 18, 2005 and incorporated herein by
reference).
|
|
|
10.10
|
Employment
Agreement, dated as of July 13, 2006, between the Company and Thomas
Hein
(filed as an exhibit to the Company’s annual report on Form 8-K filed July
18, 2006 and incorporated herein by reference).
|
|
|
10.11
|
Employment
Agreement, dated as of November 20, 2003, between Orthofix International
N.V. and Bradley R. Mason (filed as an exhibit to the Company’s annual
report on Form 10-K for the fiscal year ended December 31, 2003and
incorporated herein by reference).
|
|
|
10.12
|
Full
Recourse Promissory Note between Orthofix International N.V.
and Charles W. Federico dated January 10, 2002 (filed as an
exhibit to the Company’s annual report on Form 10-K for the fiscal year
ended December 31, 2002 and incorporated herein by
reference).
|
|
|
10.13
|
Full
Recourse Promissory Note between Orthofix International N.V. and
Gary D.
Henley dated January 10, 2002 (filed as an exhibit to the Company’s annual
report on Form 10-K for the fiscal year ended December 31, 2002 and
incorporated herein by reference).
|
|
|
10.14
|
Acquisition
Agreement dated as of November 20, 2003, among Orthofix International
N.V., Trevor Acquisition, Inc., Breg, Inc. and Bradley R. Mason,
as shareholders' representative (filed as an exhibit to the Company’s
current report on Form 8-K filed January 8, 2004 and incorporated
herein
by reference).
|
|
| 10.15 | Voting and Subscription Agreement dated as of November 20, 2003, among Orthofix International N.V. and the significant shareholders of Breg. Inc. identified on the signature pages thereto (filed as an exhibit to the Company's Current report on Form 8-K filed January 8, 2004 and incorporated herein by reference). | |
|
10.16
|
Employee
Agreement, as amended, dated December 29, 2005 between Orthofix
International N.V. and Charles W. Federico (filed as an exhibit to
the
Company’s current report on Form 8-K filed December 30, 2005 and
incorporated herein by reference).
|
|
|
10.17
|
Form
of Indemnity Agreement (filed as an exhibit to the Company’s annual
report on Form 10-K filed December 31, 2005 and incorporated herein
by
reference).
|
|
|
10.18
|
Settlement
Agreement dated February 23, 2006, between Intavent Orthofix Limited,
a
wholly-owned subsidiary of Orthofix International N.V. and Galvin
Mould (filed as an exhibit to the Company’s annual report on Form 8-K
filed on April 17, 2006 and incorporated herein by
reference).
|
|
|
10.19
|
Employment
Agreement, dated July 13, 2006, between Orthofix Inc. and Alan
W. Milinazzo (filed as an exhibit to the Company’s current report
on Form 8-K filed July 18, 2006 and incorporated herein by
reference).
|
|
|
10.20
|
Employment
Agreement, dated July 13, 2006, between Orthofix Inc. and Raymond
C. Kolls
(filed as an exhibit to the Company’s current report on Form 8-K filed
July 18, 2006 and incorporated herein by reference).
|
|
|
10.21
|
Employment
Agreement, dated July 13, 2006, between Orthofix Inc. and Michael
M.
Finegan (filed as an exhibit to the Company’s current report on Form 8-K
filed July 18, 2006 and incorporated herein by
reference).
|
|
|
10.22
|
Credit
Agreement, dated as of September 22, 2006, among Orthofix Holdings,
Inc.
Orthofix International N.V., certain domestic subsidiaries of Orthofix
International N.V., Colgate Medical Limited, Victory Medical Limited,
Swiftsure Medical Limited, Orthofix UK Ltd, the several banks and
other
financial institutions as may from time to time become parties thereunder,
and Wachovia Bank, National Association (filed as an exhibit to the
company current report on Form 8-K filed September 27, 2006 and
incorporated herein by reference).
|
|
|
10.23
|
Agreement
and Plan of Merger, dated as of August 4, 2006, among Orthofix
International N.V., Orthofix Holdings, Inc., New Era Medical Limited,
Blackstone Medical, Inc. and William G. Lyons, III, as Equityholder's
Representative (filed as an exhibit to the Company's current report
on
Form 8-K filed August 7, 2006 and incorporated herein by
reference).
|
|
10.24*
|
Employment
Agreement, dated as of September 22, 2006, between Blackstone Medical,
Inc. and Matthew V. Lyons.
|
|
|
List
of Subsidiaries.
|
||
|
Consent
of Ernst & Young LLP.
|
||
|
Rule
13a-14(a)/15d-14(a) Certification of Chief Executive
Officer.
|
||
|
Rule
13a-14(a)/15d-14(a) Certification of Chief Financial
Officer.
|
||
|
Section
1350 Certification of Chief Executive Officer.
|
||
|
Section
1350 Certification of Chief Financial
Officer.
|
|
*
|
Filed
herewith.
|
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 INTERNATIONAL N.V. | |||
|
Dated:
March 16, 2007
|
By:
|
/s/ Alan W. Milinazzo | |
| Name: Alan W. Milinazzo | |||
| Title: Chief Executive Officer and President | |||
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.
|
Name
|
Title
|
Date
|
||
|
/s/
ALAN W. MILINAZZO
|
Chief
Executive Officer,
|
March
16, 2007
|
||
|
Alan
W. Milinazzo
|
President
and Director
|
|||
|
/s/
THOMAS HEIN
|
Chief
Financial Officer
|
March
16, 2007
|
||
|
Thomas
Hein
|
(Principal
Accounting Officer)
|
|||
|
/s/
JAMES F. GERO
|
Chairman
of the Board of Directors
|
March
16, 2007
|
||
|
James
F. Gero
|
||||
|
/s/
PETER J. HEWETT
|
Deputy
Chairman of the Board of Directors
|
March
16, 2007
|
||
|
Peter
J. Hewett
|
||||
|
/s/
CHARLES W. FEDERICO
|
Director
|
March
16, 2007
|
||
|
Charles
w. Federico
|
||||
|
/s/
JERRY C. BENJAMIN
|
Director
|
March
16, 2007
|
||
|
Jerry
C. Benjamin
|
||||
|
/s/
WALTER VON WARTBURG
|
Director
|
March
16, 2007
|
||
|
Walter
von Wartburg
|
||||
|
/s/
THOMAS J. KESTER
|
Director
|
March
16, 2007
|
||
|
Thomas
J. Kester
|
||||
|
/s/
KENNETH R. WEISSHAAR
|
Director
|
March
16, 2007
|
||
|
Kenneth
R. Weisshaar
|
||||
|
/s/
GUY JORDAN
|
Director
|
March
16, 2007
|
||
|
Guy
Jordan
|
||||
|
/s/
STEFAN WIDENSOHLER
|
Director
|
March
16, 2007
|
||
|
Stefan
Widensohler
|
Index
to
Consolidated Financial Statements
|
|
Page
|
| Index to Consolidated Financial Statements |
F-1
|
|
F-2
|
|
|
F-3
|
|
|
F-4
|
|
|
F-5
|
|
|
F-6
|
|
|
F-7
|
|
|
F-8
|
|
|
F-9
|
|
|
F-10
|
|
|
S-1
|
|
|
S-5
|
All
other
schedules for which provision is made in the applicable accounting regulation
of
the Securities and Exchange Commission are not required under the related
instructions or are inapplicable and therefore have been omitted.
Statement
of Management’s Responsibility for Financial
Statements
To
the
Shareholders of Orthofix International N.V.:
Management
is responsible for the preparation of the consolidated financial statements
and
related information that are presented in this report. The
consolidated financial statements, which include amounts based on management’s
estimates and judgments, have been prepared in conformity with accounting
principles generally accepted in the United States. Other financial
information in the report to shareholders is consistent with that in the
consolidated financial statements.
The
Company maintains accounting and internal control systems to provide reasonable
assurance at reasonable cost that assets are safeguarded against loss from
unauthorized use or disposition, and that the financial records are reliable
for
preparing financial statements and maintaining accountability for
assets. These systems are augmented by written policies, an
organizational structure providing division of responsibilities and careful
selection and training of qualified personnel.
The
Company engaged Ernst & Young LLP independent registered public accountants
to audit and render an opinion on the consolidated financial statements in
accordance with auditing standards of the Public Company Accounting Oversight
Board (United States). These standards include an assessment of the
systems of internal controls and test of transactions to the extent considered
necessary by them to support their opinion.
The
Board
of Directors, through its Audit Committee consisting solely of outside directors
of the Company, meets periodically with management and our independent
registered public accountants to ensure that each is meeting its
responsibilities and to discuss matters concerning internal controls and
financial reporting. Ernst & Young LLP have full and free access
to the Audit Committee.
James
F. Gero
Chairman
of the Board of Directors
Alan
W. Milinazzo
President,
Chief Executive Officer and Director
Thomas
Hein
Chief
Financial Officer
Management’s
Report on Internal Control over Financial
Reporting
Our
management is also responsible for establishing and maintaining adequate
internal control over financial reporting, as defined in Rules 13a-15(f)
and 15d-15(f) under the Securities Exchange Act of 1934, as amended. Because
of
inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may
become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
Our
management, including our principal executive officer and principal financial
officer, conducted an assessment of the effectiveness of our internal control
over financial reporting as of December 31, 2006. In conducting its
assessment, our management used the criteria issued by the Committee of
Sponsoring Organizations of the Treadway Commission in Internal Control —
Integrated Framework. We completed the acquisition of Blackstone
Medical, Inc. (“Blackstone”) on September 22, 2006 as more fully described in
Note 2 to the consolidated financial statements. As part of our
ongoing integration activities, we are in the process of incorporating the
operations of Blackstone into our controls and procedures and we expect to
complete the process by no later than September 22, 2007. Management
has excluded from its evaluation of effectiveness of its internal control
over
financial reporting, as of December 31, 2006, certain elements of the internal
control over financial reporting of Blackstone. We plan to include
these businesses into our assessment of the effectiveness of our internal
controls within one year of the acquisition.
Based
on
this assessment, our management concluded that the Company’s internal control
over financial reporting was effective at the reasonable assurance level
as of
December 31, 2006. Reasonable assurance includes the understanding that there
is
a remote likelihood that material misstatements will not be prevented or
detected on a timely basis.
Our independent registered public accounting firm has issued an attestation
report on management’s assessment of our internal control over financial
reporting, which appears on the following page of this Annual Report on
Form 10-K.
James
F. Gero
Chairman
of the Board of Directors
Alan
W. Milinazzo
President,
Chief Executive Officer and Director
Thomas
Hein
Chief
Financial Officer
Report
of Independent Registered Public Accounting
Firm
The
Board
of Directors and Shareholders of Orthofix International N.V.
We
have
audited the accompanying consolidated balance sheets of Orthofix International
N.V. as of December 31, 2006 and 2005, and the related consolidated statements
of operations, changes in shareholders’ equity, and cash flows for each of the
three years in the period ended December 31, 2006. Our audits also
included the financial statement schedules listed in the index at Item
15(a). These financial statements and schedules are the
responsibility of the Company’s management. Our responsibility is to
express an opinion on these financial statements and the schedules based on
our
audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In
our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Orthofix International N.V. at
December 31, 2006 and 2005, and the consolidated results of its operations
and
its cash flows for each of the three years in the period ended December 31,
2006
in conformity with U.S. generally accepted accounting
principles. Also, in our opinion, the related financial statement
schedules, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
As
discussed in Note 1, the Company adopted Financial Accounting Standards Board
Statement No. 123(R), Share-Based Payments, as of January 1, 2006 using the
modified prospective application method.
We
also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of Orthofix International
N.V.’s internal control over financial reporting as of December 31, 2006, based
on criteria established in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated March 14, 2007 expressed an unqualified opinion thereon.
/s/
Ernst
& Young LLP
Charlotte,
North Carolina
March
14,
2007
Report
of Independent Registered Public Accounting Firm on
Management’s Assessment and the Effectiveness of Internal Control Over Financial
Reporting
The
Board of Directors and Shareholders of Orthofix International
N.V.
We
have
audited management’s assessment, included in the accompanying Management’s
Report on Internal Control Over Financial Reporting, that Orthofix International
N.V. maintained effective internal control over financial reporting as of
December 31, 2006, based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (the COSO criteria). Orthofix International N.V.’s management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management’s
assessment and an opinion on the effectiveness of the Company’s internal control
over financial reporting based on our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control
over
financial reporting, evaluating management’s assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing
such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain
to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors
of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may
not
prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
As
indicated in the accompanying Management’s Report on Internal Control Over
Financial Reporting, management’s assessment of and conclusion on the
effectiveness of internal control over financial reporting did not include
the
internal controls of Blackstone Medical, Inc., which is included in the 2006
consolidated financial statements of Orthofix International N.V. and constituted
46% of total assets as of December 31, 2006 and 8% of revenues for the year
then
ended. Our audit of internal control over financial reporting of
Orthofix International N.V. also did not include an evaluation of the internal
control over financial reporting of Blackstone Medical, Inc.
In
our
opinion, management’s assessment that Orthofix International N.V. maintained
effective internal control over financial reporting as of December 31, 2006,
is
fairly stated, in all material respects, based on the COSO
criteria. Also, in our opinion, Orthofix International N.V.
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2006, based on the COSO
criteria.
We
also have audited, in accordance
with the standards of the Public Company Accounting Oversight Board (United
States), the consolidated balance sheets as of December 31, 2006 and 2005,
and
the related consolidated statements of operations, changes in shareholders’
equity, and cash flows for each of the three years in the period ended December
31, 2006 of Orthofix International N.V. and our report dated March 14, 2007
expressed an unqualified opinion thereon.
/s/
Ernst
& Young LLP
Charlotte,
North Carolina
March
14,
2007
Consolidated
Balance Sheets as of December 31, 2006 and
2005
|
(U.S.
Dollars, in thousands except share and per share data)
|
2006
|
2005
|
||||||
|
Assets
|
||||||||
|
Current
assets:
|
||||||||
|
Cash
and cash equivalents
|
$ |
25,881
|
$ |
63,786
|
||||
|
Restricted
cash
|
7,300
|
13,762
|
||||||
|
Trade
accounts receivable, less allowance for doubtful accounts of $6,265and
$4,155 at December 31, 2006 and 2005, respectively
|
104,662
|
80,745
|
||||||
|
Inventories
|
70,395
|
32,853
|
||||||
|
Deferred
income
|
6,971
|
4,511
|
||||||
|
Prepaid
expenses
|
5,641
|
4,165
|
||||||
|
Other
current assets
|
13,118
|
7,453
|
||||||
|
Total
current assets
|
233,968
|
207,275
|
||||||
|
Securities
and other investments
|
4,082
|
4,082
|
||||||
|
Property,
plant and equipment, net
|
25,311
|
18,987
|
||||||
|
Patents
and other intangible assets, net
|
261,159
|
65,585
|
||||||
|
Goodwill,
net
|
313,070
|
174,738
|
||||||
|
Other
long-term assets
|
24,695
|
3,194
|
||||||
|
Total
assets
|
$ |
862,285
|
$ |
473,861
|
||||
|
Liabilities
and shareholders’ equity
|
||||||||
|
Current
liabilities:
|
||||||||
|
Bank
borrowings
|
$ |
78
|
$ |
79
|
||||
|
Current
portion of long-term debt
|
3,334
|
15,187
|
||||||
|
Trade
accounts payable
|
23,577
|
9,891
|
||||||
|
Accounts
payable to related parties
|
2,474
|
1,711
|
||||||
|
Other
current liabilities
|
31,577
|
51,208
|
||||||
|
Total
current liabilities
|
61,040
|
78,076
|
||||||
|
Long-term
debt
|
312,055
|
21
|
||||||
|
Deferred
income taxes
|
95,019
|
25,652
|
||||||
|
Other
long-term liabilities
|
1,536
|
1,227
|
||||||
|
Total
liabilities
|
469,650
|
104,976
|
||||||
|
Commitments
and contingencies (Notes 12 and 16)
|
||||||||
|
Shareholders’
equity
|
||||||||
|
Common
shares $0.10 par value
|
||||||||
|
Authorized:
50,000,000
(2005:50,000,000)
|
||||||||
|
Issued:
16,445,859 (2005:16,009,249)
|
1,645
|
1,602
|
||||||
|
Outstanding:
16,445,859
(2005:16,009,249)
|
||||||||
|
Additional
paid-in capital
|
128,297
|
106,746
|
||||||
|
129,942
|
108,348
|
|||||||
|
Retained
earnings
|
248,433
|
255,475
|
||||||
|
Accumulated
other comprehensive income
|
14,260
|
5,062
|
||||||
|
Total
shareholders’ equity
|
392,635
|
368,885
|
||||||
|
Total
liabilities and shareholders’ equity
|
$ |
862,285
|
$ |
473,861
|
||||
The
accompanying notes form an integral part of these consolidated financial
statements.
Consolidated
Statements of Operations for the years ended
December 31, 2006, 2005 and 2004
|
(U.S.
Dollars, in thousands, except share and per share data)
|
2006
|
2005
|
2004
|
|||||||||
|
Net
sales
|
$
|
365,359
|
$
|
313,304
|
$
|
286,638
|
||||||
|
Cost
of sales
|
93,625
|
83,788
|
79,177
|
|||||||||
|
Gross
profit
|
271,734
|
229,516
|
207,461
|
|||||||||
|
Operating
expenses
|
||||||||||||
|
Sales
and marketing
|
145,707
|
115,422
|
102,453
|
|||||||||
|
General
and administrative
|
53,309
|
36,050
|
30,621
|
|||||||||
|
Research
and development, including $40 million of purchased in-process research
and development
|
54,992
|
11,766
|
11,471
|
|||||||||
|
Amortization
of intangible
assets
|
8,873
|
6,572
|
6,348
|
|||||||||
|
262,881
|
169,810
|
150,893
|
||||||||||
|
Total
operating
income
|
8,853
|
59,706
|
56,568
|
|||||||||
|
Other
income (expense)
|
||||||||||||
|
Interest
income
|
2,236
|
905
|
341
|
|||||||||
|
Interest
expense
|
(8,361
|
)
|
(6,373
|
)
|
(6,307
|
)
|
||||||
|
Other,
net
|
2,524
|
1,188
|
1,325
|
|||||||||
|
KCI
settlement, net of litigation costs
|
1,093
|
40,089
|
(1,568
|
)
|
||||||||
|
Other
income (expense), net
|
(2,508
|
)
|
35,809
|
(6,209
|
)
|
|||||||
|
Income
before minority interests and income taxes
|
6,345
|
95,515
|
50,359
|
|||||||||
|
Minority
interests
|
(26
|
)
|
-
|
-
|
||||||||
|
Income
before income taxes
|
6,319
|
95,515
|
50,359
|
|||||||||
|
Income
tax expense
|
(13,361
|
)
|
(22,113
|
)
|
(16,210
|
)
|
||||||
|
Net
income (loss)
|
$
|
(7,042
|
)
|
$
|
73,402
|
$
|
34,149
|
|||||
|
Net
income (loss) per common share - basic
|
$
|
(0.44
|
)
|
$
|
4.61
|
$
|
2.22
|
|||||
|
Net
income (loss) per common share - diluted
|
$
|
(0.44
|
)
|
$
|
4.51
|
$
|
2.14
|
|||||
|
Weighted
average number of common shares - basic
|
16,165,540
|
15,913,475
|
15,396,540
|
|||||||||
|
Weighted
average number of common shares - diluted
|
16,165,540
|
16,288,975
|
15,974,945
|
|||||||||
The
accompanying notes form an integral part of these consolidated financial
statements.
Consolidated
Statements of Changes in Shareholders’ Equity for
the years ended December 31, 2006, 2005 and 2004
|
(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
|
Total
Shareholders’ Equity
|
||||||||||||||||||
|
At
December 31, 2003
|
14,980,010
|
$
|
1,498
|
$
|
81,960
|
$
|
147,924
|
$
|
9,394
|
$
|
240,776
|
|||||||||||||
|
Net
income
|
–
|
–
|
–
|
34,149
|
–
|
34,149
|
||||||||||||||||||
|
Other
comprehensive income:
|
||||||||||||||||||||||||
|
Unrealized
gain on derivative instrument (net of taxes of $40)
|
–
|
–
|
–
|
–
|
92
|
92
|
||||||||||||||||||
|
Translation
adjustment
|
–
|
–
|
–
|
–
|
5,653
|
5,653
|
||||||||||||||||||
|
Total
comprehensive income
|
39,894
|
|||||||||||||||||||||||
|
Tax
benefit on exercise of stock options
|
–
|
–
|
3,667
|
–
|
–
|
3,667
|
||||||||||||||||||
|
Common
shares issued
|
731,933
|
74
|
12,761
|
–
|
–
|
12,835
|
||||||||||||||||||
|
At
December 31, 2004
|
15,711,943
|
1,572
|
98,388
|
182,073
|
15,139
|
297,172
|
||||||||||||||||||
|
Net
income
|
–
|
–
|
–
|
73,402
|
–
|
73,402
|
||||||||||||||||||
|
Other
comprehensive income:
|
||||||||||||||||||||||||
|
Reclassification
adjustment for gain on termination of derivative instrument (net
of taxes
of $40)
|
–
|
–
|
–
|
–
|
(92
|
)
|
(92
|
)
|
||||||||||||||||
|
Translation
adjustment
|
–
|
–
|
–
|
–
|
(9,985
|
)
|
(9,985
|
)
|
||||||||||||||||
|
Total
comprehensive income
|
63,325
|
|||||||||||||||||||||||
|
Tax
benefit on exercise of stock options
|
–
|
–
|
1,329
|
–
|
–
|
1,329
|
||||||||||||||||||
|
Common
shares issued
|
297,306
|
30
|
7,029
|
–
|
–
|
7,059
|
||||||||||||||||||
|
At
December 31, 2005
|
16,009,249
|
1,602
|
106,746
|
255,475
|
5,062
|
368,885
|
||||||||||||||||||
|
Net
loss
|
–
|
–
|
–
|
(7,042
|
)
|
–
|
(7,042
|
)
|
||||||||||||||||
|
Other
comprehensive income:
|
||||||||||||||||||||||||
|
Unrealized
loss on derivative instrument (net of taxes
of $30)
|
–
|
–
|
–
|
–
|
(55
|
)
|
(55
|
)
|
||||||||||||||||
|
Translation
adjustment
|
–
|
–
|
–
|
–
|
9,253
|
9,253
|
||||||||||||||||||
|
Total
comprehensive income
|
2,156
|
|||||||||||||||||||||||
|
Tax
benefit on exercise of stock options
|
–
|
–
|
2,175
|
–
|
–
|
2,175
|
||||||||||||||||||
|
Share-based
compensation expense
|
–
|
–
|
7,912
|
–
|
–
|
7,912
|
||||||||||||||||||
|
Common
shares issued
|
436,610
|
43
|
11,464
|
–
|
–
|
11,507
|
||||||||||||||||||
|
At
December 31, 2006
|
16,445,859
|
$
|
1,645
|
$
|
128,297
|
$
|
248,433
|
$
|
14,260
|
$
|
392,635
|
|||||||||||||
The
accompanying notes form an integral part of these consolidated financial
statements.
Consolidated
Statements of Cash Flows for the years ended December
31, 2006, 2005 and 2004
|
(U.S.
Dollars, in thousands)
|
2006
|
2005
|
2004
|
|||||||||
|
Cash
flows from operating activities:
|
||||||||||||
|
Net
income (loss)
|
$
|
(7,042
|
)
|
$
|
73,402
|
$
|
34,149
|
|||||
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||||||
|
Depreciation
and amortization
|
16,457
|
14,867
|
14,396
|
|||||||||
|
Amortization
of debt costs
|
501
|
2,666
|
684
|
|||||||||
|
Minority
interests
|
26
|
-
|
-
|
|||||||||
|
Deferred
royalty income
|
-
|
(2,443
|
)
|
-
|
||||||||
|
Provision
for doubtful accounts
|
5,475
|
4,753
|
4,266
|
|||||||||
|
Share
based compensation
|
7,912
|
-
|
-
|
|||||||||
|
Loss
(Gain) on sale or disposal of fixed assets
|
518
|
896
|
(692
|
)
|
||||||||
|
Deferred
taxes
|
(12,363
|
)
|
(1,533
|
)
|
(3,874
|
)
|
||||||
|
In
process research & development
|
40,000
|
-
|
-
|
|||||||||
|
Tax
benefit on non-qualified stock options
|
-
|
1,329
|
3,667
|
|||||||||
|
Other
|
(1,858
|
)
|
(7
|
)
|
(107
|
)
|
||||||
|
Changes
in operating assets and liabilities:
|
||||||||||||
|
Restricted
cash
|
6,582
|
540
|
(14,302
|
)
|
||||||||
|
Accounts
receivable
|
(10,308
|
)
|
(13,293
|
)
|
(6,658
|
)
|
||||||
|
Inventories
|
(12,867
|
)
|
(1,498
|
)
|
(882
|
)
|
||||||
|
Other
current assets
|
(4,521
|
) |
(2,119
|
)
|
1,427
|
|||||||
|
Trade
accounts payable
|
6,448
|
2,834
|
(2,931
|
)
|
||||||||
|
Other
current liabilities
|
(26,789
|
)
|
26,279
|
(1,658
|
)
|
|||||||
|
Net
cash provided by operating activities
|
8,171
|
106,673
|
27,485
|
|||||||||
|
Cash
flows from investing activities:
|
||||||||||||
|
Payments
made in connection with acquisitions and investments, net
of cash acquired
|
(342,290
|
)
|
-
|
(2,556
|
)
|
|||||||
|
Capital
expenditures for tangible and intangible assets
|
(12,613
|
)
|
(12,248
|
)
|
(12,243
|
)
|
||||||
|
Proceeds
from sale of assets and marketable securities
|
-
|
-
|
1,635
|
|||||||||
|
Proceeds
from sale of joint venture
|
-
|
-
|
1,300
|
|||||||||
|
Proceeds
from settlement of distributor agreement
|
-
|
-
|
440
|
|||||||||
|
Net
cash used in investing activities
|
(354,903
|
)
|
(12,248
|
)
|
(11,424
|
)
|
||||||
|
Cash
flows from financing activities:
|
||||||||||||
|
Net
proceeds from issue of common shares
|
11,507
|
6,471
|
12,247
|
|||||||||
|
Payment
of debt issuance costs
|
(5,884
|
)
|
-
|
(821
|
)
|
|||||||
|
Tax
benefit on non-qualified stock options
|
2,175
|
-
|
-
|
|||||||||
|
Proceeds
from loans and borrowings
|
330,000
|
193
|
-
|
|||||||||
|
Repayment
of loans and borrowings
|
(29,974
|
)
|
(62,278
|
)
|
(33,534
|
)
|
||||||
|
Net
cash provided (used in) by financing activities
|
307,824
|
(55,614
|
)
|
(22,108
|
)
|
|||||||
|
Effect
of exchange rates changes on cash
|
1,003
|
(969
|
)
|
635
|
||||||||
|
Net
increase (decrease) in cash and cash equivalents
|
(37,905
|
)
|
37,842
|
(5,412
|
)
|
|||||||
|
Cash
and cash equivalents at the beginning of the year
|
63,786
|
25,944
|
31,356
|
|||||||||
|
Cash
and cash equivalents at the end of the year
|
$
|
25,881
|
$
|
63,786
|
$
|
25,944
|
||||||
|
Supplemental
disclosure of cash flow information
|
||||||||||||
|
Cash
paid during the year for:
|
||||||||||||
|
Interest
|
$
|
7,386
|
$
|
3,753
|
$
|
5,237
|
||||||
|
Income
taxes
|
$
|
31,773
|
$
|
26,290
|
$
|
12,854
|
||||||
The
accompanying notes form an
integral part of these consolidated financial
statements.
Notes to the consolidated
financial
statements
Description
of business
Orthofix
International N.V. (the “Company”) is a multinational corporation principally
involved in the design, development, manufacture, marketing and distribution
of
medical equipment, principally for the Orthopedic products market.
1
Summary of significant accounting policies
|
(a)
|
Basis
of consolidation
|
The
consolidated financial statements include the financial statements of the
Company and its wholly-owned and majority-owned subsidiaries and entities over
which the Company has control.
The
results of acquired businesses are included in the consolidated statements
of
operations from the date of their acquisition. All intercompany
accounts, transactions and profits are eliminated in consolidation. The equity
method of accounting is used when the Company has significant influence over
operating decisions but cannot exercise control. Under the equity
method, original investments are recorded at cost and adjusted by the Company’s
share of undistributed earnings or losses of these companies. The Company’s
investments in which it does not have significant influence or control are
accounted for under the cost method of accounting.
|
(b)
|
Foreign currency translation
|
Foreign
currency translation is performed in accordance with SFAS No. 52, “Foreign
Currency Translation.” All balance sheet accounts, except
shareholders’ equity, are translated at year end exchange rates and revenue and
expense items are translated at weighted average rates of exchange prevailing
during the year. Gains and losses resulting from the translation of
foreign currency are recorded in the accumulated other comprehensive income
component of shareholders’ equity. Transactional foreign currency
gains and losses, including intercompany transactions that are not long-term
investing in nature, are included in other income (expense) and were $2.8
million, ($1.0) million and $0.9 million for the years December 31, 2006, 2005
and 2004, respectively.
|
(c)
|
Inventories
|
Inventories
are valued at the lower of cost or estimated net realizable value, after
provision for excess or obsolete items. Cost is determined on a
weighted-average basis, which approximates the FIFO method. The
valuation of work-in-process, finished goods, field inventory and consignment
inventory includes the cost of materials, labor and production. Field
inventory represents immediately saleable finished goods inventory that is
in
the possession of the Company’s direct sales representatives.
|
(d)
|
Reporting
currency
|
The
reporting currency is the United States Dollar.
|
(e)
|
Market
risk
|
In
the
ordinary course of business, the Company is exposed to the impact of changes
in
interest rates and foreign currency fluctuations. The Company’s
objective is to limit the impact of such movements on earnings and cash
flows. In order to achieve this objective the Company seeks to
balance its non-dollar income and expenditures. During 2006, the
Company made use of an interest rate swap agreement and foreign currency forward
contracts to manage these exposures of fluctuations in interest
rates. See Note 11 for additional information.
Notes
to the consolidated financial statements (cont.)
|
(f)
|
Long-lived
assets
|
Property,
plant and equipment is stated at cost less accumulated depreciation and any
impairment charges as computed in accordance with the Company’s
policy. Depreciation is computed on a straight-line basis over the
useful lives of the assets, except for land, which is not
depreciated. Depreciation of leasehold improvements is computed over
the shorter of the lease term or the useful life of the asset. The
useful lives are as follows:
|
Years
|
|
|
Buildings
|
25
to 33
|
|
Plant
and equipment
|
2
to 10
|
|
Furniture
and fixtures
|
4
to 8
|
Expenditures
for maintenance and repairs and minor renewals and improvements, which do not
extend the life of the respective asset, are expensed. All other
expenditures for renewals and improvements are capitalized. The
assets and related accumulated depreciation are adjusted for property
retirements and disposals, with the resulting gain or loss included in
operations. Fully depreciated assets remain in the accounts until
retired from service.
Patents
and other intangible assets are recorded at cost, or when acquired as a part
of
a business combination, at estimated fair value. These assets
primarily include patents and other technology agreements, trademarks, licenses,
customer relationships and distribution networks and they are generally
amortized using the straight-line method over estimated useful lives of 5 to
25
years for all acquisitions completed prior to June 30, 2001. For
acquisitions completed subsequent to June 30, 2001, identifiable intangible
assets are generally amortized over their useful lives using a method of
amortization that reflects the pattern in which the economic benefit of the
intangible assets are consumed. Intangible assets deemed to have
indefinite lives and goodwill are not subject to amortization in accordance
with
Statement of Financial Accounting Standards (SFAS) No. 142.
The
Company reviews long-lived and indefinite lived intangible assets at least
annually or when events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. For long-lived amortizable
intangible assets, the Company recognizes an impairment loss when the sum of
undiscounted expected future cash flows over the assets remaining estimated
useful lives are less than the carrying value of such assets. For
long-lived intangible assets not subject to amortization, the Company recognizes
an impairment loss when the sum of discounted expect future cash flows are
less
than the carrying value of such assets. The measurement for such
impairment loss is then based on the fair value of the related asset or group
of
assets.
|
(g)
|
Revenue
recognition
|
Revenue
is generally recognized as income in the period in which title passes and the
products are delivered. For bone growth stimulation and certain
bracing products prescribed by a physician, the Company recognizes revenue
when
the product is placed on and accepted by the patient. For domestic
spinal implant and biologic products, revenues are recognized when the product
has been utilized and a confirming purchase order has been received from the
hospital. For sales to commercial customers, including hospitals and
distributors, revenues are recognized at the time of shipment unless contractual
agreements specify that title passes on delivery. The Company derives
a significant amount of revenues in the United States from third-party payors,
including commercial insurance carriers, health maintenance organizations,
preferred provider organizations and governmental payors such as
Medicare. Amounts paid by these third-party payors are generally
based on fixed or allowable reimbursement rates. These revenues are
recorded at the expected or pre-authorized reimbursement rates, net of any
contractual allowances or adjustments. Some billings are subject to
review by such third-party payors and may be subject to
adjustment. For royalties, revenues are recognized when the royalty
is earned. Revenues for inventory delivered on consignment are
recognized as the product is used by the consignee. Revenues exclude
any value added or other local taxes, intercompany sales and trade
discounts. Shipping and handling costs are included in cost of
sales.
Notes
to the consolidated financial statements (cont.)
|
(h)
|
Research
and development costs
|
Expenditures
for research and development are expensed as incurred. In accordance
with EITF 96-7 “Accounting for Deferred Taxes on In-Process Research and
Development Activities Acquired in a Purchase Business Combination”, the Company
writes off acquired in-process research and development to research and
development expense on the day of acquisition.
|
(i)
|
Income
taxes
|
Income
taxes have been provided using the liability method in accordance with SFAS
No.
109, “Accounting for Income Taxes.” Deferred income taxes arise
because of differences in the treatment of income and expense items for
financial reporting and income tax purposes. Deferred tax assets and
liabilities resulting from such differences are recorded based on the enacted
tax rates that will be in effect when the differences are expected to
reverse. The Company has operations in various tax
jurisdictions.
|
(j)
|
Net
income per common share
|
Net
income per common share is computed in accordance with SFAS No. 128, “Earnings
per Share.” Net income per common share – basic is computed
using the weighted average number of common shares outstanding during each
of
the respective years. Net income per common share – diluted is
computed using the weighted average number of common and common equivalent
shares outstanding during each of the respective years. Common
equivalent shares represent the diluted effect of the assumed exercise of
outstanding share options (see Note 19 to the Consolidated Financial
Statements) and the only differences between basic and diluted shares result
solely from the assumed exercise of certain outstanding share options and
warrants.
|
(k)
|
Cash
and cash equivalents
|
The
Company considers all highly liquid investments with an original maturity of
three months or less at the date of purchase to be cash
equivalents.
|
(l)
|
Restricted
cash
|
Restricted
cash consists of cash held at certain subsidiaries, the distribution or transfer
of which to Orthofix International N.V. (the “Parent”) is
restricted. The senior secured bank facility, described further in
Note 10, restricts only the Parent’s access to the cash held by Colgate Medical
Limited and its subsidiaries. All other subsidiaries of the Orthofix
Group have access to this cash for operational purposes.
|
(m)
|
Sale
of accounts receivable
|
The
Company follows the provisions of SFAS No. 140, “Accounting for Transfers
and Servicing of Financial Assets and Extinguishment of
Liabilities”. Trade accounts receivables sold without recourse are
removed from the balance sheet at the time of sale. The Company
generally does not require collateral on trade receivables.
|
(n)
|
Use
of estimates in preparation of financial
statements
|
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States 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 contractual allowances, doubtful accounts,
inventories, taxes and potential goodwill and intangibles
impairment. Actual results could differ from these
estimates.
|
(o)
|
Reclassifications
|
Certain
prior year amounts have been reclassified to conform to the 2006
presentation. The reclassifications have no effect on previously
reported net income or shareholders’ equity.
Notes
to the consolidated financial statements (cont.)
|
(p)
|
Stock
based compensation
|
Prior
to
January 1, 2006, the Company accounted for stock based compensation plans under
the recognition and measurement provisions of APB Opinion No. 25, Accounting
for
Stock Issued to Employees, and related Interpretations, as permitted by SFAS
No.
123, Accounting for Stock-Based Compensation. Stock-based employee compensation
expense was recognized relating to options granted at exercise prices lower
than
the fair market value of the underlying stock on the date of the
grant.
Effective
January 1, 2006, the Company adopted the fair value recognition provisions
of
SFAS No. 123(R), Share-Based Payment, using the modified prospective transition
method. Under this transition method, compensation cost recognized in 2006
includes: (a) compensation cost for all share-based payments granted prior
to,
but not yet vested as of January 1, 2006, based on the grant date fair value
estimated in accordance with the original provisions of SFAS No. 123, and (b)
compensation cost for all share-based payments granted subsequent to January
1,
2006, based on the grant-date fair value estimated in accordance with the
provisions of SFAS No. 123(R). The fair value of stock options is determined
using the Black-Scholes valuation model, which is consistent with our valuation
techniques previously utilized for options in footnote disclosures required
under SFAS No. 123. Such value is recognized as expense over the service period
net of estimated forfeitures. Results for prior periods have not been
restated. The expected term of options granted is estimated based on
a number of factors, including the vesting term of the award, historical
employee exercise behavior for both options that are currently outstanding
and
options that have been exercised or are expired, the expected volatility of
our
common stock and an employee’s average length of service. The risk-free interest
rate is determined based upon a constant U.S. Treasury security rate with a
contractual life that approximates the expected term of the option
award. For the year ended December 31, 2006, options were valued at
risk-free interest rates between 4.35% and 5.07%, expected volatility of 33.4%,
expected term of 4.3 years and a dividend rate of zero. The Company
has chosen to use the “short-cut method” to determine the pool of windfall tax
benefits as of the adoption of SFAS No. 123(R).
As
a
result of adopting SFAS No. 123(R) on January 1, 2006 the Company's income
before income taxes and net income for the year ended December 31, 2006, are
$7.3 million and $5.2 million lower, respectively, than if it had continued
to
account for share-based compensation under APB 25. Basic and diluted
earnings per share for the year ended December 31, 2006 would have been $0.32
and $0.32 higher, respectively, if the Company had not adopted SFAS No.
123(R). As of December 31, 2006, the compensation expense relating to
options already granted and expected to be recognized is $14.2 million. This
expense is expected to be recognized over a weighted average period of 1.47
years.
Notes
to the consolidated financial statements (cont.)
The
following table shows the detail of stock-based compensation by line item in
the
Consolidated Statements of Operations for the year ended, December 31, 2006
(in
thousands):
|
(In
thousands)
|
Year
Ended
December
31,
2006
|
|||
|
Cost
of sales
|
$
|
238
|
||
|
Sales
and marketing (2)
|
1,411
|
|||
|
General
and administrative
|
5,243
|
(1)
|
||
|
Research
and development
|
432
|
|||
|
Total
|
$
|
7,324
|
||
|
|
(1)
|
Amount
includes $656 of stock-based compensation from the accelerated
vesting of
options associated with the transition of senior management in
the first
quarter of 2006.
|
|
(2)
|
There
are no performance requirements and there was no consideration
received
for stock-based compensation awarded to sales and marketing
employees.
|
Prior
to
the adoption of SFAS No. 123(R), the Company presented all tax benefits of
deductions resulting from the exercise of stock options as operating cash flows
in the Statement of Cash Flows. SFAS No. 123(R) requires the cash flows
resulting from the tax benefits resulting from the tax deductions in excess
of
the compensation cost recognized for those options (excess tax benefits) to
be
classified as financing cash flows. The $2.2 million excess tax benefit
classified as a financing cash inflow, for the year ended December 31, 2006,
would have been classified as an operating cash inflow had the Company not
adopted SFAS No. 123(R).
Notes
to the consolidated financial statements (cont.)
The following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to all stock-based awards granted for all periods presented.
|
Year
ended December 31,
|
||||||||||||
|
(In
thousands except per share data)
|
2006
|
2005
|
2004
|
|||||||||
|
Net
income
|
||||||||||||
|
As
reported
|
$
|
(7,042
|
)
|
$
|
73,402
|
$
|
34,149
|
|||||
|
Add: Stock-based
employee compensation expense included in reported net income, net
related
tax effects
|
5,191
|
347
|
346
|
|||||||||
|
Less: Total
stock-based employee compensation expense determined under fair value
method for all awards, net of tax
|
(5,191
|
)
|
(3,348
|
)
|
(1,944
|
)
|
||||||
|
Pro
forma
|
$
|
(7,042
|
)
|
$
|
70,401
|
$
|
32,551
|
|||||
|
Net
income per common share – basic
|
||||||||||||
|
As
reported
|
$
|
(0.44
|
)
|
$
|
4.61
|
$
|
2.22
|
|||||
|
Pro
forma
|
$
|
(0.44
|
)
|
$
|
4.42
|
$
|
2.11
|
|||||
|
Net
income per common share – diluted
|
||||||||||||
|
As
reported
|
$
|
(0.44
|
)
|
$
|
4.51
|
$
|
2.14
|
|||||
|
Pro
forma
|
$
|
(0.44
|
)
|
$
|
4.32
|
$
|
2.04
|
|||||
|
(q)
|
Recently
issued Accounting
Standards
|
In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This
Statement defines fair value as used in numerous accounting pronouncements,
establishes a framework for measuring fair value in generally accepted
accounting principles and expands disclosure related to the use of fair value
measures in financial statements. The Statement is to be effective for the
Company's financial statements issued in 2008; however, earlier application
is
encouraged. The Company is currently evaluating the timing of adoption and
the
impact that adoption might have on its financial position or results of
operations.
In
July 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes--an interpretation of FASB Statement
No. 109 (“FIN 48”), which clarifies the accounting for
uncertainty in income tax positions. This Interpretation requires that the
Company recognize in the consolidated financial statements the impact of a
tax
position that is more likely than not to be sustained upon examination based
on
the technical merits of the position. The provisions of FIN 48 will be effective
as of the beginning of the Company's 2007 fiscal year, with the cumulative
effect of the change in accounting principle recorded as an adjustment to
opening retained earnings. The Company
is
currently evaluating the impact of adopting FIN 48 on the consolidated financial
statements.
In
June
2006, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 06-3, How
Taxes Collected from Customers and Remitted to Governmental Authorities Should
Be Presented in the Income Statement (That Is, Gross Versus Net Presentation).
This standard allows companies to present in their statements of operations
any
taxes assessed by a governmental authority that are directly imposed on
revenue-producing transactions between a seller and a customer, such as sales,
use, value-added, and some excise taxes, on either a gross (included in revenue
and costs) or a net (excluded from revenue) basis. This standard is effective
for interim and fiscal years beginning after December 15, 2006. The Company
is
currently evaluating the potential impact of this issue on the financial
statements, but does not believe the impact of the adoption of this standard
will be material.
Notes
to the consolidated financial statements (cont.)
In
February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid
Instruments, which is an amendment to SFAS No. 133 and SFAS No.
140. SFAS No. 155 allows financial instruments which have embedded
derivatives to be accounted for as a whole (eliminating the need to bifurcate
the derivative from its host) if the holder elects to account for the instrument
as a whole instrument on a fair value basis. This statement is
effective for all financial instruments acquired or issued after the beginning
of an entity’s first fiscal year that begins after September 15,
2006. The Company does not believe the adoption of this statement
will have a material impact on the financial statements.
|
(r)
|
Fair
value of financial
instruments
|
The
carrying amounts reflected in the consolidated balance sheet for cash and cash
equivalents, restricted cash, accounts receivable, short-term bank debt and
accounts payable approximate fair value due to the short-term maturities of
these instruments. The Company’s long term secured debt carries a
floating rate of interest and approximates fair value.
|
(s)
|
Advertising
costs
|
The
Company expenses all advertising costs as incurred. Advertising
expense for the years ended December 31, 2006, 2005 and 2004 was $1.0 million,
$0.5 million and $0.5 million, respectively.
|
(t)
|
Derivative
instruments
|
The
Company manages its exposure to fluctuations in interest rates and foreign
exchange within the consolidated financial statements according to its hedging
policy. Under the policy, the Company may engage in non-leveraged transactions
involving various financial derivative instruments to manage exposed
positions. The policy requires the Company to formally document the
relationship between the hedging instrument and hedged item, as well as its
risk-management objective and strategy for undertaking the hedge
transaction. For instruments designated as a cash flow hedge, the
Company formally assesses (both at the hedge’s inception and on an ongoing
basis) whether the derivative that is used in the hedging transaction has been
effective in offsetting changes in the cash flows of the hedged item and whether
such derivative may be expected to remain effective in future
periods. If it is determined that a derivative is not (or has ceased
to be) effective as a hedge, the Company will discontinue the related hedge
accounting prospectively. Such a determination would be made when (1)
the derivative is no longer effective in offsetting changes in the cash flows
of
the hedged item; (2) the derivative expires or is sold, terminated, or
exercised; or (3) management determines that designating the derivative as
a
hedging instrument is no longer appropriate. Ineffective portions of
changes in the fair value of cash flow hedges are recognized in
earnings. For instruments designated as a fair value hedge, the
Company ensures an exposed position is being hedged and the changes in fair
value of such instruments are recognized in earnings.
The
Company follows Statement of Financial Accounting Standards (“SFAS”)
No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as
amended and interpreted, which requires that all derivatives be recorded as
either assets or liabilities on the balance sheet at their respective fair
values. For a cash flow hedge, the effective portion of the
derivative’s change in fair value (i.e. gains or losses) is initially reported
as a component of other comprehensive income, net of related taxes, and
subsequently reclassified into net earnings when the hedged exposure affects
net
earnings.
The
Company’s foreign currency hedges are forward contracts used to manage its
foreign currency exposure related to a portion of the Company’s accounts
receivable that are denominated in Euros. These forward
contracts have been accounted for as a fair value hedge in accordance with
SFAS
No. 133. In addition, the Company utilizes a cross currency swap to
manage its foreign currency exposure related to a portion of the Company’s
intercompany receivable of a U.S. dollar functional currency subsidiary that
is
denominated in Euro. The cross currency swap has been accounted for as a cash
flow hedge in accordance with SFAS No. 133.
Notes
to the consolidated financial statements (cont.)
See
Note
11 “Derivative instruments” for a description of the types of derivative
instruments the Company utilizes.
|
(u)
|
Other
comprehensive income
|
Accumulated
other comprehensive income (loss) is comprised of foreign currency translation
adjustments, and the effective portion of the gain (loss) for derivatives
designated and accounted for as a cash flow hedge. The components of
and changes in other comprehensive income (loss) are as follows:
|
(In
thousands)
|
Foreign
Currency Translation Adjustments
|
Fair
Value of Derivatives
|
Accumulated
Other Comprehensive Income/(Loss)
|
|||||||||
|
Balance
at December 31, 2003
|
$
|
9,394
|
$
|
-
|
$
|
9,394
|
||||||
|
Unrealized
gain on derivative instrument, net of tax of $40
|
-
|
92
|
92
|
|||||||||
|
Foreign
currency translation adjustment
|
5,653
|
-
|
5,653
|
|||||||||
|
Balance
at December 31, 2004
|
15,047
|
92
|
15,139
|
|||||||||
|
Reclassification
adjustment for gain on derivative instrument, net of tax of
$40
|
-
|
(92
|
)
|
(92
|
)
|
|||||||
|
Foreign
currency translation adjustment
|
(9,985
|
)
|
-
|
(9,985
|
)
|
|||||||
|
Balance
at December 31, 2005
|
5,062
|
-
|
5,062
|
|||||||||
|
Unrealized
gain (loss) on derivative instrument, net of tax of $30
|
-
|
(55
|
)
|
(55
|
)
|
|||||||
|
Foreign
currency translation adjustment
|
9,253
|
-
|
9,253
|
|||||||||
|
Balance
at December 31, 2006
|
$
|
14,315
|
$
|
(55
|
)
|
$
|
14,260
|
|||||
|
2
|
Acquisitions
|
The
following acquisitions were recorded using the purchase method of
accounting:
Blackstone
Acquisition
On
September 22, 2006, the Company purchased 100% of the stock of Blackstone
Medical, Inc. (“Blackstone”) for a purchase price of $333.0 million plus
acquisition costs and is subject to certain closing adjustments. The acquisition
and related costs were financed with approximately $330.0 million of senior
secured bank debt, as described in Note 10, and cash on
hand. Blackstone, a privately held company based in Springfield,
Massachusetts, specializes in the design, development and marketing of spinal
implant and related biologic products. Blackstone's product lines
include spinal fixating devices including hooks, rods, screws, plates, various
spacers and cages and related biologics products
The
Company considered this acquisition as a way to fortify and further advance
its
business strategy to expand its spinal sector. The acquisition broadened the
Company's product lines, reduced reliance on the success of any single product
and enlarged channel opportunities for products from Blackstone’s and Orthofix’s
existing operations.
Notes
to the consolidated financial statements (cont.)
Factors
that contributed to the valuation of Blackstone included the recognition that
Blackstone had established itself as what the Company believes to be one
of the largest private spine companies with a broad portfolio of spinal
product offerings. Further, Blackstone has a strong brand name and product
identity in the spinal industry. Blackstone has a history of sales and earnings
growth that compares favorably to the fast growing spinal market that its
product lines serve. Orthofix valued Blackstone after reviewing a range of
valuation methodologies provided by its financial advisors for the transaction,
including comparable publicly-traded companies, comparable precedent
transactions, discounted cash flow analysis and comparison to Orthofix's trading
multiples.
The
acquisition has been accounted for using the purchase method in accordance
with
SFAS No. 141, Business Combinations. The purchase price has been preliminarily
allocated to the assets acquired and liabilities assumed based on their
estimated fair market value at the date of acquisition.
A
preliminary allocation of the
purchase price reflects the following:
|
Current
assets, other than cash
|
$
|
40,101
|
||
|
Fixed
assets acquired
|
2,872
|
|||
|
Intangible
assets not subject to amortization – registered trademarks
|
77,000
|
|||
|
Intangible
assets subject to amortization (12-16 year weighted average useful
life):
|
||||
|
Distribution
Networks (12 – 16 year weighted average useful
life)
|
55,000
|
|||
|
Patents
(13 year weighted average useful life)
|
70,000
|
|||
|
$
|
244,973
|
|||
|
Goodwill
(indefinite lived intangible asset)
|
132,784
|
|||
|
In-process
research and development
|
40,000
|
|||
|
Deferred
tax asset
|
14,985
|
|||
|
Total
assets acquired
|
$
|
432,742
|
||
|
Current
liabilities
|
$
|
(13,037
|
)
|
|
|
Deferred
tax liability
|
(78,442
|
)
|
||
|
Total
liabilities assumed
|
(91,479
|
)
|
||
|
Net
assets acquired
|
$
|
341,263
|
The
results of Blackstone’s operations have been included in the Company’s
consolidated results of operations from the date of acquisition.
The
preliminary purchase price has been allocated to assets acquired, purchased
in-process research and development, and liabilities assumed based on their
estimated fair value at the acquisition date. The amount of the purchase price
allocated to purchased in-process research and development was written off
at
the date of acquisition and resulted in a charge of $40.0 million. This charge
is included in the research and development expense line item on the
Consolidated Statements of Operations and was principally comprised of the
value
of the Dynamic Stabilization and Cervical Disk which together accounted for
93%
of the fair value. The fair value of the in-process research and development
was
estimated using the discounted earnings method. The amount written off as
purchased in-process research and development is not deductible for income
tax purposes in the United States. In addition, other items that may
affect the final purchase price allocation include finalization of acquisition
costs, revisions to tangible and intangible assets based on final assessments
and other information that provides a better estimate of the fair value of
the
assets acquired and the liabilities assumed.
Notes
to the consolidated financial statements (cont.)
There are no residual values for any of the intangible assets subject to
amortization acquired during the Blackstone acquisition. Definite lived
intangible assets acquired in the Blackstone acquisition consist
of:
|
(In
thousands)
|
Fair
value at Acquisition
|
Remaining
Useful Life
|
|||
|
Distribution
network
|
$
|
55,000
|
12
to 16 Years
|
||
|
Patents
|
70,000
|
13
Years
|
|||
|
Total
definite lived intangible assets
|
$
|
125,000
|
|||
The
Company has determined that trademarks acquired during the Blackstone
acquisition, valued at $77.0 million, are indefinite lived intangible assets.
The Company considered the criteria prescribed by paragraphs 11 (a), (c), (e)
and (f) of SFAS 142 in determining that registered trademarks acquired during
the Blackstone acquisition have an indefinite life. The Company is not aware
of
any legal, regulatory, or contractual provisions that limit the useful lives
of
these registered trademarks. The Company does not believe the effects of
obsolescence, demand, competition, or other economic factors will cause the
useful lives of these registered trademarks to be limited. The Company concluded
that no legal, regulatory, contractual, competitive, economic, or other factors
limit the useful life of the registered trademarks to the Company, and therefore
the
useful lives of the registered trademarks are considered to be
indefinite.
The
summary unaudited pro forma condensed results of operations and earnings per
share, for the years ended, December 31, 2006 and 2005, assuming consummation
of
the Blackstone acquisition as of January 1, 2005, are as follows:
|
(In
thousands)
|
Year
Ended
December
31, 2006
|
Year
Ended
December
31, 2005
|
||||||||||||||
|
As
Reported
|
Pro
Forma*
|
As
Reported
|
Pro
Forma*
|
|||||||||||||
|
Net
sales
|
$
|
365,359
|
$
|
427,489
|
$
|
313,304
|
$
|
373,005
|
||||||||
|
Net
income (loss)
|
(7,042
|
)
|
16,494
|
73,402
|
52,255
|
|||||||||||
|
Per
share data:
|
||||||||||||||||
|
Basic
|
$
|
(0.44
|
)
|
$
|
1.02
|
$
|
4.61
|
$
|
3.28
|
|||||||
|
Diluted
|
$
|
(0.44
|
)
|
$
|
1.02
|
$
|
4.51
|
$
|
3.21
|
|||||||
* In-process
research and development charge of $40.0 million recorded during the year ended
December 31, 2006 has been excluded from the pro forma financial
information.
International
Medical Supplies Distribution GmbH Acquisition
Notes
to the consolidated financial statements (cont.)
In
February 2006, the Company purchased 52% of International Medical Supplies
Distribution GmbH (“IMES”), a German distributor of Breg products, for $1.5
million plus closing adjustments and acquisition costs. The
operations of the acquired distributor are included in the Company's statement
of operations from the date of acquisition. The results of operations
would not be materially different if the acquisition had been consolidated
as of
January 1, 2006. The final purchase price included
approximately $0.1 million of working capital and $1.0 million of
goodwill.
Puerto
Rico Distributor Acquisition
In
the
first quarter 2004, the Company purchased a distributor in Puerto Rico for
$1.4
million, which consisted of $1.1 million in cash and $0.3 million of assumed
liabilities. The final purchase price included approximately $0.9
million of working capital and $0.5 million of goodwill. The
operations of the acquired distributor are included in the accompanying
consolidated statement of operations from the date of acquisition.
|
3
|
Inventories
|
|
December
31,
|
||||||||
|
(In
thousands)
|
2006
|
2005
|
||||||
|
Raw
materials
|
$
|
8,384
|
$
|
7,242
|
||||
|
Work-in-process
|
6,665
|
3,344
|
||||||
|
Finished
goods
|
34,901
|
11,538
|
||||||
|
Field
inventory
|
7,485
|
7,404
|
||||||
|
Consignment
inventory
|
20,173
|
6,659
|
||||||
|
77,608
|
36,187
|
|||||||
|
Less
reserve for obsolescence
|
(7,213
|
)
|
(3,334
|
)
|
||||
|
$
|
70,395
|
$
|
32,853
|
|||||
See
Note
1 “Summary of significant accounting policies” part (c) “Inventories” for a
description of field inventory.
|
4
|
Securities
and other investments
|
The
Company had total investments held
at cost of $4.1 million as of December 31, 2006 and 2005 comprised of an
investment of $1.5 million in Innovative Spinal Technologies (IST), a start-up
company focused on commercializing spinal products, and $2.6 million in OPED
AG,
a German-based bracing company. The Company’s ownership percentage in
IST is 2.87%. The Company has assessed these cost investments noting
no impairment in carrying value. The Company also has an investment
in OrthoRx. The investment was reduced to zero in 2004. As
of December 31, 2006, the Company’s ownership percentage in OrthoRx has been
reduced to 5.5%.
Notes
to the consolidated financial statements (cont.)
|
5
|
Property,
plant and equipment
|
|
December
31,
|
||||||||
|
(In
thousands)
|
2006
|
2005
|
||||||
|
Cost
|
||||||||
|
Buildings
|
$
|
2,852
|
$
|
2,131
|
||||
|
Plant
and equipment
|
59,316
|
47,498
|
||||||
|
Furniture
and fixtures
|
8,791
|
6,896
|
||||||
|
70,959
|
56,525
|
|||||||
|
Accumulated
depreciation
|
(45,648
|
)
|
(37,538
|
)
|
||||
|
$
|
25,311
|
$
|
18,987
|
|||||
Depreciation
expense for the years ended December 31, 2006, 2005 and 2004 was $7.6 million,
$8.3 million and $7.8 million, respectively.
|
6
|
Patents
and other intangible
assets
|
|
December
31,
|
||||||||
|
(In
thousands)
|
2006
|
2005
|
||||||
|
Cost
|
||||||||
|
Patents
and other
|
$
|
99,731
|
$
|
26,501
|
||||
|
Trademarks
– definite lived (subject to amortization)
|
860
|
836
|
||||||
|
Trademarks
– indefinite lived (not subject to amortization)
|
100,900
|
23,900
|
||||||
|
Distribution
networks
|
98,586
|
42,343
|
||||||
|
300,077
|
93,580
|
|||||||
|
Accumulated
amortization
|
||||||||
|
Patents
and other
|
(20,727
|
)
|
(17,172
|
)
|
||||
|
Trademarks
– definite lived (subject to amortization)
|
(460
|
)
|
(387
|
)
|
||||
|
Distribution
networks
|
(17,731
|
)
|
(10,436
|
)
|
||||
|
$
|
261,159
|
$
|
65,585
|
|||||
Amortization
expense for intangible
assets is estimated to be approximately $19.1 million, $20.7 million, $19.9
million, $19.6 million and $17.9 million for the periods ending
December 31, 2007, 2008, 2009, 2010 and 2011,
respectively.
The
Company has performed the impairment test of indefinite-lived assets in
accordance with FAS 142 and has determined that no impairment
exists.
Notes
to the consolidated financial statements (cont.)
|
7
|
Goodwill
|
Under
SFAS No. 142, intangible goodwill is subject to annual impairment testing
using the guidance and criteria described in the standard. This
testing requires the comparison of carrying values to fair values, and when
appropriate, the carrying value of impaired assets is reduced to fair
value. The Company has performed the impairment test of goodwill and
has determined that no impairment exists. For a discussion of
acquisitions since January 1, 2004 and the associated goodwill, see Note 2
to
the Consolidated Financial Statements.
The
following table presents the changes in the net carrying value of goodwill
by
reportable segment:
|
(In
thousands)
|
Domestic
|
Blackstone
|
Breg
|
International
|
Total
|
|||||||||||||||
|
At
December 31, 2004
|
$
|
31,793
|
$
|
-
|
$
|
101,322
|
$
|
45,774
|
$
|
178,889
|
||||||||||
|
Foreign
Currency
|
-
|
-
|
-
|
(4,151
|
)
|
(4,151
|
)
|
|||||||||||||
|
At
December 31, 2005
|
31,793
|
-
|
101,322
|
41,623
|
174,738
|
|||||||||||||||
|
Acquisitions
|
-
|
132,784
|
-
|
1,086
|
133,870,
|
|||||||||||||||
|
Foreign
Currency
|
-
|
-
|
-
|
4,462
|
4,462
|
|||||||||||||||
|
At
December 31, 2006
|
$
|
31,793
|
$
|
132,784
|
$
|
101,322
|
$
|
47,171
|
$
|
313,070
|
||||||||||
|
8
|
Bank
borrowings
|
|
December
31,
|
||||||||
|
(In
thousands)
|
2006
|
2005
|
||||||
|
Borrowings
under line of credit
|
$
|
78
|
$
|
79
|
||||
The
weighted average interest rate on borrowings under lines of credit as of
December 31, 2006 and 2005 was 3.00% for both years.
Borrowings
under lines of credit consist of borrowings in Euros. The Company had
unused available lines of credit of 6.2 million Euros ($8.1 million) and 6.8
million Euros ($8.0 million) at December 31, 2006 and 2005, respectively, in
its
Italian line of credit, which gives the Company the option to borrow amounts
in
Italy at rates which are determined at the time of borrowing. This
line of credit is unsecured.
Notes
to the consolidated financial statements (cont.)
|
9
|
Other
current liabilities
|
|
December
31,
|
||||||||
|
(In
thousands)
|
2006
|
2005
|
||||||
|
Accrued
expenses
|
$
|
4,289
|
$
|
7,206
|
||||
|
Salaries
and related taxes payable
|
15,201
|
11,032
|
||||||
|
Income
taxes payable
|
3,988
|
2,044
|
||||||
|
Other
payables
|
8,099
|
4,724
|
||||||
|
KCI
settlement proceeds due to third parties
|
-
|
26,202
|
||||||
|
$
|
31,577
|
$
|
51,208
|
|||||
|
10
|
Long-term
debt
|
|
December
31,
|
||||||||
|
(In
thousands)
|
2006
|
2005
|
||||||
|
Long-term
obligations
|
$
|
315,175
|
$
|
14,750
|
||||
|
Other
loans
|
214
|
458
|
||||||
|
315,389
|
15,208
|
|||||||
|
Less
current portion
|
(3,334
|
)
|
(15,187
|
)
|
||||
|
$
|
312,055
|
$
|
21
|
|||||
On
September 22, 2006 our wholly-owned US holding company subsidiary, Orthofix
Holdings, Inc. (“Orthofix Holdings”), entered into a senior secured credit
facility with a syndicate of financial institutions to finance the acquisition
of Blackstone. The senior secured credit facility provides for (1) a
seven-year amortizing term loan facility of $330.0 million, the proceeds of
which, together with cash balances were used for payment of the purchase price
of Blackstone; and (2) a six-year revolving credit facility of $45.0
million. As of December 31, 2006 we had no amounts outstanding under
the revolving credit facility and $315.2 million outstanding under the term
loan
facility. Obligations under the senior secured credit facility have a
floating interest rate of LIBOR plus a margin or prime rate plus a
margin. Currently, the term loan is a LIBOR loan, and the margin is
1.75%, which margin is adjusted quarterly based upon the leverage ratio of
the
Company and its subsidiaries. The effective interest rate as of
December 31, 2006 on the senior secured debt is 7.12%.
Each
of
the domestic subsidiaries of Orthofix (which includes Orthofix Inc., Breg Inc.,
and Blackstone Medical Inc.), Colgate Medical Limited and Victory Medical have
guaranteed the obligations of Orthofix Holdings Inc. under the senior secured
bank facility. The obligations of the subsidiaries under their
gurantees are secured by the pledges of their respective assets.
In
conjunction with obtaining the senior secured bank facility and the amendment
thereto, the Company incurred debt issuance costs of $6.0 million. As
of December 31, 2006, $5.8 million of capitalized debt costs is included in
other long-term assets.
Notes
to the consolidated financial statements (cont.)
Certain
subsidiaries of the Company have effective restrictions on their ability to
pay
dividends or make intercompany loan advances pursuant to the Company’s senior
secured credit facility. The net assets of Orthofix Holdings Inc. and
its subsidiaries are restricted for distributions to the parent
company. All other subsidiaries of the Orthofix Group have access to
these net assets for operational purposes. The amount of restricted
net assets of Orthofix Holdings Inc. and its subsidiaries as of December 31,
2006 is $247.2 million.
Weighted
average interest rates on current maturities of long-term obligations as of
December 31, 2006 and 2005 were 7.12% and 6.12%, respectively.
The
aggregate maturities of long-term debt after December 31, 2006 are as
follows: 2007 - $3.3 million, 2008 - $3.3 million, 2009 - $3.4
million, 2010 - $3.4, 2011 - $3.3 million, thereafter - $298.7
million.
|
11
|
Derivative
instruments
|
In
2006,
the Company entered into a cross-currency swap agreement to manage its foreign
currency exposure related to a portion of the Company’s intercompany receivable
of a U.S. dollar functional currency subsidiary that is denominated in
Euro. The derivative instrument, a ten-year fully amortizable
agreement with a notional amount of $63.0 million, is scheduled to expire on
December 30, 2016. The instrument is designated as a cash flow
hedge. The amount outstanding under the agreement as of December 31,
2006 is $63.0 million. Under the agreement, the Company pays Euro and
receives U.S. dollars based on scheduled cash flows in the
agreement. During 2006, the Company recognized the unrealized loss on
the change in fair value of this swap arrangement of $0.1 million within
other comprehensive income.
In
2005
and 2006 the Company utilized foreign currency forward contracts to manage
its
foreign currency exposure related to a portion of the Company’s accounts
receivable that are denominated in Euros. The strategy of the foreign
currency contracts is to neutralize the foreign currency impact on earnings
when
converting 5.0 million Euros of accounts receivable into U.S.
dollars. The conversion of the underlying exposure and the forward
contracts offset and had no net impact on earnings in 2006. The
Company paid cash of $0.6 million to settle forward contracts for the year
and
received cash of $0.3 million from the settlement of the foreign currency
exposures in 2005. All foreign currency forward contracts entered
into in the year ended December 31, 2006 , have been accounted for as fair
value
hedges in accordance with SFAS No. 133 and the related gains (losses) were
recorded in other income and the related tax amounts in taxation.
In
2004,
the Company utilized an interest rate swap to manage its interest rate exposure
related to a portion of the Company senior secured term loan. The
derivative instrument, a three-year fully amortizable agreement with a notional
amount of $50.0 million, was scheduled to expire on June 27,
2007. The instrument was designated as a cash flow
hedge. The Company terminated the agreement on December 22, 2005 when
a portion became ineffective. This termination resulted in a one-time
gain of $0.4 million in 2005 recorded as a reduction of interest
expense.
|
12
|
Commitments
|
Leases
The
Company has entered into operating leases for facilities and
equipment. Rent expense under the Company’s operating leases for the
years ended December 31, 2006, 2005 and 2004 was approximately
$4.2 million, $3.7 million and $3.5 million,
respectively. Future minimum lease payments under operating
leases as of December 31, 2006 are as follows:
Notes
to the consolidated financial statements (cont.)
|
(In
thousands)
|
||||
|
2007
|
$
|
4,388
|
||
|
2008
|
3,393
|
|||
|
2009
|
2,855
|
|||
|
2010
|
2,290
|
|||
|
2011
|
1,780
|
|||
|
Thereafter
|
498
|
|||
|
Total
|
$
|
15,204
|
||
|
13
|
Business
segment information
|
The
Company’s segment information is prepared on the same basis that the Company’s
management reviews the financial information for operational decision making
purposes. Concurrent with the acquisition of Blackstone, the Company redefined
its business segments and market sectors. All prior period
information presented has been restated to conform to the new segments and
market sectors. The Company is comprised of the following
segments:
Orthofix
Domestic
Orthofix
Domestic (“Domestic”) consists of operations in the United States of Orthofix
Inc. which distributes stimulation and orthopedic products. Domestic
uses both direct and distributor sales representatives to sell Spine and
Orthopedic products to hospitals, doctors and other healthcare providers in
the
United States market.
Blackstone
Blackstone
(“Blackstone”) consists of Blackstone Medical, Inc., based in Springfield,
Massachusetts, and its two subsidiaries, Blackstone GmbH and Goldstone GmbH.
Blackstone specializes in the design, development and marketing of spinal
implant and related biologic products. Blackstone's operating loss includes
amortization of acquired intangible assets and inventory which has been
stepped-up in value for the Blackstone acquisition.
Breg
Breg
(“Breg”) consists of Breg, Inc. Breg, based in Vista, California, designs,
manufactures, and distributes orthopedic products for post-operative
reconstruction and rehabilitative patient use and sells its products through
a
network of domestic and international distributors, sales representatives and
affiliates.
Orthofix
International
Orthofix
International (“International”) consists of international operations located in
Europe, Mexico, Brazil and Puerto Rico, as well as independent distributors
located outside the United States. International, uses both direct
and distributor sales representatives to sell Spine, Orthopedics, Sports
Medicine, Vascular and Other products to hospitals, doctors, and other
healthcare providers.
Group
Activities
Group
Activities are comprised of the Parent and Orthofix Holdings, Inc., the U.S.
holding company’s, operating expenses and identifiable assets.
Notes
to the consolidated financial statements (cont.)
The
tables below present information by reportable segment:
|
External
Sales
|
Intersegment
Sales
|
|||||||||||||||||||||||
|
(In
thousands)
|
2006
|
2005
|
2004
|
2006
|
2005
|
2004
|
||||||||||||||||||
|
Domestic
|
$
|
152,560
|
$
|
135,084
|
$
|
118,074
|
$
|
3,511
|
$
|
1,931
|
$
|
1,357
|
||||||||||||
|
Blackstone
|
28,134
|
-
|
-
|
699
|
-
|
-
|
||||||||||||||||||
|
Breg
|
76,219
|
72,022
|
68,294
|
1,651
|
489
|
422
|
||||||||||||||||||
|
International
|
108,446
|
106,198
|
100,270
|
50,521
|
55,271
|
54,464
|
||||||||||||||||||
|
Total
|
$
|
365,359
|
$
|
313,304
|
$
|
286,638
|
$
|
56,382
|
$
|
57,691
|
$
|
56,243
|
||||||||||||
|
Operating
Income (Expense)
|
||||||||||||
|
(In
thousands)
|
2006
|
2005
|
2004
|
|||||||||
|
Domestic
|
$
|
36,560
|
$
|
34,513
|
$
|
28,841
|
||||||
|
Blackstone
|
(39,268
|
)*
|
-
|
-
|
||||||||
|
Breg
|
6,218
|
8,082
|
11,498
|
|||||||||
|
International
|
17,581
|
23,932
|
20,555
|
|||||||||
|
Group
Activities
|
(11,262
|
)
|
(6,343
|
)
|
(4,779
|
)
|
||||||
|
Eliminations
|
(976
|
)
|
(478
|
)
|
453
|
|||||||
|
Total
|
$
|
8,853
|
$
|
59,706
|
$
|
56,568
|
||||||
|
*
|
Includes
$40.0 million of in-process research and development related to the
acquisition of Blackstone.
|
The
following table presents identifiable assets by segment, excluding intercompany
balances and investments in consolidated subsidiaries.
|
Identifiable
Assets
|
||||||||
|
(In
thousands)
|
2006
|
2005
|
||||||
|
Domestic
|
$
|
100,633
|
$
|
99,033
|
||||
|
Blackstone
|
397,420
|
-
|
||||||
|
Breg
|
182,273
|
185,921
|
||||||
|
International
|
171,000
|
188,538
|
||||||
|
Group
activities
|
24,612
|
13,126
|
||||||
|
Eliminations
|
(13,653
|
)
|
(12,757
|
)
|
||||
|
Total
|
$
|
862,285
|
$
|
473,861
|
||||
Notes
to the consolidated financial statements (cont.)
|
Depreciation
and amortization
|
Income
tax expense
|
Other
income (expense)
|
||||||||||||||||||||||||||||||||||
|
(In
thousands)
|
2006
|
2005
|
2004
|
2006
|
2005
|
2004
|
2006
|
2005
|
2004
|
|||||||||||||||||||||||||||
|
Domestic
|
$
|
2,934
|
$
|
3,021
|
$
|
3,360
|
$
|
14,444
|
$
|
13,680
|
$
|
12,155
|
$
|
300
|
$
|
2,522
|
$
|
267
|
||||||||||||||||||
|
Blackstone
|
2,011
|
-
|
-
|
(1,710
|
)
|
-
|
-
|
199
|
-
|
-
|
||||||||||||||||||||||||||
|
Breg
|
8,154
|
7,786
|
7,328
|
125
|
961
|
2,242
|
(24
|
)
|
56
|
22
|
||||||||||||||||||||||||||
|
International
|
3,347
|
4,060
|
3,708
|
(1,042
|
)
|
4,791
|
2,052
|
1,190
|
32,999
|
(6,506
|
)
|
|||||||||||||||||||||||||
|
Group
activities
|
11
|
-
|
-
|
1,544
|
2,681
|
(239
|
)
|
(4,173
|
)
|
232
|
8
|
|||||||||||||||||||||||||
|
Total
|
$
|
16,457
|
$
|
14,867
|
$
|
14,396
|
$
|
13,361
|
$
|
22,113
|
$
|
16,210
|
$
|
(2,508
|
)
|
$
|
35,809
|
$
|
(6,209
|
)
|
||||||||||||||||
Capital
expenditures of tangible and intangible assets for each segment are as
follows:
|
(In
thousands)
|
2006
|
2005
|
2004
|
|||||||||
|
Domestic
|
$
|
2,240
|
$
|
3,243
|
$
|
2,831
|
||||||
|
Blackstone
|
1,473
|
-
|
-
|
|||||||||
|
Breg
|
3,496
|
5,040
|
2,820
|
|||||||||
|
International
|
5,360
|
3,965
|
6,592
|
|||||||||
|
Group
|
44
|
-
|
-
|
|||||||||
|
Total
|
$
|
12,613
|
$
|
12,248
|
$
|
12,243
|
||||||
Geographical
information
Analysis
of net sales by geographic destination:
|
(In
thousands)
|
2006
|
2005
|
2004
|
|||||||||
|
U.S.
|
$
|
263,442
|
$
|
218,096
|
$
|
198,392
|
||||||
|
Domestic
|
263,442
|
218,096
|
198,392
|
|||||||||
|
U.K.
|
|
|
26,708
|
|
|
|
28,949
|
|
|
|
28,858
|
|
|
Italy
|
|
|
23,436
|
|
|
|
22,004
|
|
|
|
20,761
|
|
|
Other
|
|
|
51,773
|
|
|
|
44,255
|
|
|
|
38,627
|
|
|
International
|
|
|
101,917
|
|
|
|
95,208
|
|
|
|
88,246
|
|
|
Total
|
|
$
|
365,359
|
|
|
$
|
313,304
|
|
|
$
|
286,638
|
|
There
are
no sales in the Netherlands Antilles.
Notes
to the consolidated financial statements (cont.)
Analysis
of long-lived assets by geographic area:
|
(In
thousands)
|
2006
|
2005
|
||||||
|
U.S.
|
$
|
537,480
|
$
|
206,287
|
||||
|
Italy
|
20,250
|
11,443
|
||||||
|
U.K.
|
30,461
|
22,379
|
||||||
|
Cyprus
|
5,277
|
13,426
|
||||||
|
Others
|
10,154
|
9,857
|
||||||
|
Total
|
$
|
603,622
|
$
|
263,392
|
||||
|
Sales
by Market Sector for the year ended December 31,
2006
|
||||||||||||||||||||
|
(In
thousands)
|
Domestic
|
Blackstone
|
Breg
|
International
|
Total
|
|||||||||||||||
|
Spine
|
$
|
116,701
|
$
|
28,134
|
$
|
-
|
$
|
278
|
$
|
145,113
|
||||||||||
|
Orthopedics
|
35,813
|
-
|
-
|
59,986
|
95,799
|
|||||||||||||||
|
Sports
Medicine
|
-
|
-
|
76,219
|
2,834
|
79,053
|
|||||||||||||||
|
Vascular
|
-
|
-
|
-
|
21,168
|
21,168
|
|||||||||||||||
|
Other
|
46
|
-
|
-
|
24,180
|
24,226
|
|||||||||||||||
|
Total
|
$
|
152,560
|
$
|
28,134
|
$
|
76,219
|
$
|
108,446
|
$
|
365,359
|
||||||||||
|
Sales
by Market Sector for the year ended December 31,
2005
|
||||||||||||||||||||
|
(In
thousands)
|
Domestic
|
Blackstone
|
Breg
|
International
|
Total
|
|||||||||||||||
|
Spine
|
$
|
101,470
|
$
|
-
|
$
|
-
|
$
|
152
|
$
|
101,622
|
||||||||||
|
Orthopedics
|
33,569
|
-
|
-
|
58,528
|
92,097
|
|||||||||||||||
|
Sports
Medicine
|
-
|
-
|
72,022
|
948
|
72,970
|
|||||||||||||||
|
Vascular
|
-
|
-
|
-
|
23,887
|
23,887
|
|||||||||||||||
|
Other
|
45
|
-
|
-
|
22,683
|
22,728
|
|||||||||||||||
|
Total
|
$
|
135,084
|
$
|
-
|
$
|
72,022
|
$
|
106,198
|
$
|
313,304
|
||||||||||
Notes
to the consolidated financial statements (cont.)
|
Sales
by Market Sector for the year ended December 31,
2004
|
||||||||||||||||||||
|
(In
thousands)
|
Domestic
|
Blackstone
|
Breg
|
International
|
Total
|
|||||||||||||||
|
Spine
|
$
|
81,182
|
$
|
-
|
$
|
-
|
$
|
191
|
$
|
81,373
|
||||||||||
|
Orthopedics
|
36,874
|
-
|
-
|
53,238
|
90,112
|
|||||||||||||||
|
Sports
Medicine
|
-
|
-
|
68,294
|
194
|
68,488
|
|||||||||||||||
|
Vascular
|
-
|
-
|
-
|
25,226
|
25,226
|
|||||||||||||||
|
Other
|
18
|
-
|
-
|
21,421
|
21,439
|
|||||||||||||||
|
Total
|
$
|
118,074
|
$
|
-
|
$
|
68,294
|
$
|
100,270
|
$
|
286,638
|
||||||||||
|
14
|
Income
taxes
|
The
Company and each of its subsidiaries are taxed at the rates applicable within
each respective company’s jurisdiction. The composite income tax rate
will vary according to the jurisdictions in which profits arise. The
components of the provision for income tax expense (benefit) are as
follows:
|
Year
ended December 31,
|
||||||||||||
|
(In
thousands)
|
2006
|
2005
|
2004
|
|||||||||
|
Italy
- Current
|
$
|
5,030
|
$
|
3,011
|
$
|
2,727
|
||||||
|
- Deferred
|
(6,167
|
)
|
(310
|
)
|
(241
|
)
|
||||||
|
Cyprus -
Current
|
1,148
|
2,924
|
251
|
|||||||||
|
-
Deferred
|
5
|
17
|
-
|
|||||||||
|
U.K. -
Current
|
481
|
2,015
|
985
|
|||||||||
|
-
Deferred
|
-
|
-
|
(34
|
)
|
||||||||
|
U.S.
- Current
|
12,231
|
15,299
|
15,928
|
|||||||||
|
-
Deferred
|
(1,601
|
)
|
(1,564
|
)
|
(3,711
|
)
|
||||||
|
Netherlands
Antilles/Netherlands
|
||||||||||||
|
-
Current
|
6,772
|
506
|
25
|
|||||||||
|
- Deferred
|
(4,852
|
)
|
892
|
134
|
||||||||
|
Other -
Current
|
314
|
(4
|
)
|
168
|
||||||||
|
-
Deferred
|
-
|
(673
|
)
|
(22
|
)
|
|||||||
|
Total
tax
expense
|
$
|
13,361
|
$
|
22,113
|
$
|
16,210
|
||||||
Income
before minority interests and provision for income taxes consisted
of:
|
Year
ended December 31,
|
||||||||||||
|
(In
thousands)
|
2006
|
2005
|
2004
|
|||||||||
|
U.S.
|
$
|
(11,264
|
)
|
$
|
36,511
|
$
|
32,254
|
|||||
|
Non-U.S.
|
17,609
|
59,004
|
18,105
|
|||||||||
|
$
|
6,345
|
$
|
95,515
|
$
|
50,359
|
|||||||
The
tax
effects of the significant temporary differences, which comprise the deferred
tax liabilities and assets, are as follows:
|
(In
thousands)
|
2006
|
2005
|
||||||
|
Deferred
tax liabilities
|
||||||||
|
Goodwill
|
$
|
79
|
$
|
(5
|
)
|
|||
|
Patents,
trademarks and other intangible assets
|
(97,446
|
)
|
(22,306
|
)
|
||||
|
Property,
plant and equipment
|
(783
|
)
|
(925
|
)
|
||||
|
Other
|
3,131
|
(2,416
|
)
|
|||||
|
$
|
(95,019
|
)
|
$
|
(25,652
|
)
|
|||
|
Deferred
tax assets
|
||||||||
|
Other
current
|
$
|
202
|
$
|
111
|
||||
|
Inventories
and related reserves
|
1,968
|
1,781
|
||||||
|
Accrued
compensation
|
1,555
|
-
|
||||||
|
Allowance
for doubtful accounts
|
3,247
|
2,619
|
||||||
|
Net
operating loss carryforwards
|
19,380
|
6,344
|
||||||
|
Other
long-term
|
8,091
|
1,993
|
||||||
|
34,443
|
12,848
|
|||||||
|
Valuation
allowance
|
(9,428
|
)
|
(6,324
|
)
|
||||
|
25,015
|
6,524
|
|||||||
|
Net
deferred tax liability
|
$
|
(70,004
|
)
|
$
|
(19,128
|
)
|
||
The
valuation allowance as of December 31, 2006 and 2005 was $9.4 million and $6.3
million, respectively. The net increase in the valuation allowance
was $3.1 million for the period ended December 31, 2006. The
valuation allowance is attributable to net operating loss carryforwards in
certain foreign jurisdictions, the benefit for which is dependent upon the
generation of future taxable income in that location. In assessing
the realizability of deferred tax assets, management considers whether it is
more likely than not that some portion or all of the deferred tax assets will
not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities, projected future
taxable income and tax planning strategies in making this
assessment. Based upon the level of historical taxable income and
projections for future taxable income over the periods which the deferred tax
assets are deductible, management believes it is more likely than not the
Company will realize the benefits of these deductible differences, net of the
existing valuation allowances at December 31, 2006.
Notes
to the consolidated financial statements (cont.)
As
part
of the acquisition of Blackstone, the Company acquired a net operating loss
carryforward of $31.1 million which was subject to annual section 382
limitations of approximately $11.6 million per year. During 2006, the Company
utilized $5.9 million of these net operating loss carryforwards. The
Company has not established a valuation allowance for this net operating loss
carryforward because management believes the net operating loss carryforwards
will be utilized against future taxable income. The Company
also has tax net operating loss carryforwards in other taxing jurisdictions
of
approximately $29.0 million expiring in various amounts in tax years beginning
in 2009. The Company has provided a valuation allowance against these
net operating loss carryforwards since it does not believe that this deferred
tax asset can be realized prior to expiration.
In
connection with the Company’s European Restructuring in 2006 and a similar
transaction in 2002, certain intangible assets were sold between subsidiaries
in
order to optimize the Company’s supply chain. Such assets were sold
at estimates of fair value based upon valuations provided by an independent
third party. There can be no assurance that local tax authorities
will not challenge such valuations. A successful challenge by the tax
authorities could have a materially adverse effect on the Company's tax profile
(including the ability to recognize the intended tax benefits from the
transaction) or significantly increase the Company’s future tax
payments. The Company has not accrued any financial statement
reserves in connection with these valuation matters.
The
rate
reconciliation presented below is based on the U.S. federal income tax rate,
rather than the parent company’s country of domicile tax
rate. Management believes, given the large proportion of taxable
income earned in the United States, such disclosure is more
meaningful.
|
(In
thousands, except percentages)
|
2006
|
2005
|
2004
|
|||||||||||||||||||||
|
Amount
|
Percent
|
Amount
|
Percent
|
Amount
|
Percent
|
|||||||||||||||||||
|
Statutory
U.S. federal income tax rate
|
$
|
2,221
|
35
|
%
|
$
|
33,431
|
35.0
|
%
|
$
|
17,626
|
35.0
|
%
|
||||||||||||
|
Net
effect of foreign tax
|
(3,089
|
)
|
-48.7
|
%
|
(3,513
|
)
|
-3.7
|
%
|
(3,068
|
)
|
-6.1
|
%
|
||||||||||||
|
Net
effect of KCI settlement
|
(113
|
)
|
-1.8
|
%
|
(11,366
|
)
|
-11.9
|
%
|
-
|
-
|
||||||||||||||
|
Change
in valuation allowance
|
2,875
|
45.3
|
%
|
238
|
0.2
|
%
|
(391
|
)
|
-0.8
|
%
|
||||||||||||||
|
Tax
holiday benefit – Seychelles
|
(566
|
)
|
-8.9
|
%
|
(986
|
)
|
-1.0
|
%
|
(918
|
)
|
-1.8
|
%
|
||||||||||||
|
US-UK
Tax Treaty
|
(1,543
|
)
|
-24.3
|
%
|
(664
|
)
|
-0.7
|
%
|
(1,880
|
)
|
-3.7
|
%
|
||||||||||||
|
State
taxes net of federal benefit
|
1,394
|
22
|
%
|
1,314
|
1.4
|
%
|
1,132
|
2.2
|
%
|
|||||||||||||||
|
Net
effect of non-deductible
foreign
losses
|
42
|
0.7
|
%
|
3,119
|
3.3
|
%
|
2,950
|
5.9
|
%
|
|||||||||||||||
|
Blackstone
purchased R&D
|
14,000
|
220.6
|
%
|
-
|
-
|
-
|
-
|
|||||||||||||||||
|
Italy
brand revaluation *
|
(2,778
|
)
|
-43.8
|
%
|
-
|
-
|
-
|
-
|
||||||||||||||||
|
European
restructuring
|
(1,235
|
)
|
-19.5
|
%
|
-
|
-
|
-
|
-
|
||||||||||||||||
|
Tax
ruling Netherlands Antilles
|
577
|
9.1
|
%
|
289
|
0.1
|
%
|
-
|
-
|
||||||||||||||||
|
Withholding
tax
|
765
|
12.1
|
%
|
622
|
1.9
|
%-
|
-
|
-
|
||||||||||||||||
|
Cyprus
interest rate ruling
|
460
|
7.2
|
%
|
-
|
-
|
-
|
-
|
|||||||||||||||||
|
Domestic
production deduction
|
(331
|
)
|
-5.2
|
%
|
(456
|
)
|
-1.4
|
%-
|
-
|
-
|
||||||||||||||
|
Other
|
682
|
10.7
|
%
|
85
|
-
|
759
|
1.5
|
%
|
||||||||||||||||
|
Income
tax expense/effective rate
|
$
|
13,361
|
210.5
|
%
|
$
|
22,113
|
23.2
|
%
|
$
|
16,210
|
32.2
|
%
|
||||||||||||
|
*
|
The
difference between the reported provision for income taxes and
a provision
computed by applying the statutory rates applicable to each subsidiary
of
the Company is attributable to the Company's election to adopt
a new tax
provision in Italy. The election allowed the Company to increase,
for tax
purposes only, the value of our trademarks in Italy by approximately
$15.0
million. The Company incurred a tax liability of $2.7 million from
applying a 19% tax rate to the revaluation of the trademark value.
The
Company expects to receive a future tax benefit of $5.6 million
associated
with amortization of that step-up in value which is based on the
current
Italian tax rates of approximately 37%. The net of the $5.6 million
deferred tax asset and the $2.7 million tax liability resulted
in a $2.9
million non-recurring discrete tax
benefit.
|
The
Company has not recorded additional income taxes applicable to undistributed
earnings of foreign subsidiaries (residing outside the Netherlands Antilles)
that are considered to be indefinitely reinvested and the taxes attributable
to
such amounts not deemed to be indefinitely reinvested are not
material. In the event that undistributed earnings which have been
deemed to be indefinitely reinvested no longer meet the criteria to remain
as
such, these undistributed earnings will also be considered when calculating
any
potential future tax liabilities relating to undistributed foreign
earnings. Total undistributed earnings, which amounted to
approximately $191.1 million, $232.1 million and $201.9 million at December
31,
2006, 2005 and 2004, respectively, may become taxable upon their remittance
as
dividends or upon the sale or liquidation of these foreign
subsidiaries. It is not practicable to determine the amounts of net
additional income tax that may be payable if such earnings were
repatriated.
Notes
to the consolidated financial statements (cont.)
|
15
|
Related
parties
|
The
following related party balances and transactions as of and for the three years
ended December 31, 2006, between the Company and other companies in which
directors and/or executive officers have an interest are reflected in the
consolidated financial statements. The Company buys components
related to the A-V Impulse System, purchases quality control and logistic
services and buys the Laryngeal Mask from companies in which a former board
member has a beneficial minority interest.
|
Year
ended December 31,
|
||||||||||||
|
(In
thousands)
|
2006
|
2005
|
2004
|
|||||||||
|
Sales
|
$
|
404
|
$
|
573
|
$
|
987
|
||||||
|
Purchases
|
$
|
16,733
|
$
|
17,411
|
$
|
16,986
|
||||||
|
Accounts
payable
|
$
|
2,474
|
$
|
1,711
|
$
|
1,386
|
||||||
|
Accounts
receivable
|
$
|
86
|
$
|
126
|
$
|
198
|
||||||
|
Due
from officers (included in other long-term assets)
|
$
|
208
|
$
|
370
|
$
|
356
|
||||||
|
16
|
Contingencies
|
Litigation
The
Company, in the normal course of its business, is involved in various lawsuits
from time to time. In addition, the Company is subject to certain
other contingencies discussed below:
The
Company's subsidiary, Blackstone Medical, is a defendant in a patent
infringement lawsuit captioned Medtronic Sofamor Danek USA Inc., Warsaw
Orthopedic, Inc., Medtronic Puerto Rico Operations Co., and Medtronic Sofamor
Danek Deggendorf, GmbH v. Blackstone Medical, Inc., Civil Action
No. 06-30165-MAP, filed on September 22, 2006 in the United States District
Court for the District of Massachusetts. The plaintiffs allege that (i) they
are
the exclusive licensees of United States Patent Nos. 6,926,718 B1, 6,936,050
B2,
6,936,051 B2, 6,398,783 B1 and 7,066,961 B2 ( the “Patents”), and (ii)
Blackstone Medical's making, selling, offering for sale, and using within the
United States its Blackstone Anterior Cervical Plate, 3º Anterior Cervical
Plate, Hallmark Anterior Cervical Plate and Construx Mini PEEK VBR System
products is infringing and has infringed the Patents, and that such infringement
has been willful. The Complaint requests both damages and an injunction against
further alleged infringement of the Patents. The Complaint does not specifically
state an amount of damages. Blackstone Medical has denied infringement and
asserts that the Patents are invalid.
Novamedix,
a subsidiary of the Company, filed an action on February 21, 1992 against
Kinetic Concepts Inc. (“KCI”) alleging infringement of the patents relating to
Novamedix’s A-V Impulse System foot pump product, breach of contract, unfair
competition and was seeking damages. On September 30, 2005 KCI,
Novamedix and the Company announced a settlement had been reached under which
KCI agreed to pay Novamedix $75.0 million and to give Novamedix an option to
receive a limited assignment of certain KCI foot pump patent
rights. The Company had contractual obligations to distribute a
portion of the settlement proceeds to certain former owners of Novamedix and
the
original patents. The final settlement amounts to be paid to these
former owners and patent holders was not concluded at December 31, 2005.
The Company recorded a gain of $40.1 million and the related tax amount of
$2.7 million and accrued $26.2 million for contractual
obligations. Further, the Company agreed to indemnify KCI against certain
tax liabilities that might arise out of the settlement. Management
believes the risk that any such claims might arise under this indemnity to
be
remote.
In
management’s opinion, the Company is not currently involved in any other legal
proceeding, individually or in the aggregate, that will have a material effect
on the financial position, liquidity or operating results of the
Company.
Notes
to the consolidated financial statements (cont.)
Concentrations
of credit risk
Financial
instruments which potentially subject the Company to concentrations of credit
risk are primarily cash investments and accounts receivable. Cash
investments are primarily in money market funds deposited with major financial
center banks. Concentrations of credit risk with respect to accounts
receivable are limited due to the large number of individuals comprising the
Company’s customer base. The Company performs ongoing credit
evaluations of its customers and generally does not require
collateral. Certain of these customers rely on third party healthcare
payers, such as private insurance companies and governments, to make payments
to
the Company on their behalf. Accounts receivable in countries where
the government funds medical spending are primarily located in North Africa,
Middle East, South America, Asia and Europe. The Company has
considered special situations when establishing allowances for potentially
uncollectible accounts receivable in such countries as India, Egypt and
Turkey. The Company also records reserves for bad debts for all other
customers based on a variety of factors, including the length of time the
receivables are past due, the financial condition of the customer, macroeconomic
conditions and historical experiences. The Company maintains reserves
for potential credit losses and such losses have been within management’s
expectations.
The
Company sells via a direct sales force and distributors. There were
no customers that accounted for 10% or more of net sales in 2006, 2005 or
2004.
|
17
|
Pensions
and deferred compensation
|
Orthofix
Inc. sponsors a defined contribution benefit plan (the “401(k) Plan”) covering
substantially all full time employees. This 401(k) Plan allows for
participants to contribute up to 15% of their pre-tax compensation, subject
to
certain limitations, with the Company matching 100% of the first 2% of the
employee’s base compensation and 50% of the next 4% of the employee’s base
compensation if contributed to the 401(k) Plan. During the years
ended December 31, 2006, 2005 and 2004, expenses incurred relating to the 401(k)
Plan, including matching contributions, were approximately $945,000, $962,000
and $760,000, respectively. Breg also sponsors a 401(k)
plan. This 401(k) Plan allows for participants to contribute up to
100% of their compensation, subject to certain limitations, with the Company
matching 100% of the first $750 deferred. During the years ended
December 31, 2006, 2005 and 2004, expenses incurred relating to the Breg 401(k)
Plan, including matching contributions were $102,000, $101,000 and $111,000,
respectively. Blackstone also sponsors a 401(k) plan. This
401(k) plan allows for participants to contribute up to 75% of their
compensation, subject to certain limitations, with the Company matching 50%
of
the first 6% of the employee’s compensation deferred. During the
fourth quarter of 2006, expense incurred relating to the Blackstone 401(k)
Plan
including matching contributions were $38,000.
The
Company operates defined contribution pension plans for its
other International employees not described above meeting minimum service
requirements. The Company’s expenses for such pension contributions
during 2006, 2005 and 2004 were approximately $489,000, $450,000 and $468,000,
respectively.
Under
Italian Law, Orthofix S.r.l. accrues, on behalf of its employees, deferred
compensation, which is paid on termination of employment. Each year’s
provision for deferred compensation is based on a percentage of the employee’s
current annual remuneration plus an annual charge. Deferred
compensation is also accrued for the leaving indemnity payable to agents in
case
of dismissal which is regulated by a national contract and is equal to
approximately 3.5% of total commissions earned from the Company. The
Company’s expense for deferred compensation during 2006, 2005 and 2004 was
approximately $352,000, $316,000 and $292,000, respectively. Deferred
compensation payments of $274,000, $215,000 and $207,000 were made in 2006,
2005
and 2004, respectively. The balance as of December 31, 2006 of $1.4
million represents the amount which would be payable if all the employees and
agents had terminated employment at that date and is included in other long-term
liabilities.
Notes
to the consolidated financial statements (cont.)
|
18
|
Share
option plans
|
Option
and stock purchase plans
At
December 31, 2006, the Company had three stock-based compensation plans and
one
stock purchase plan which are described below.
2004
Long Term Incentive Plan
The
2004
Long Term Incentive Plan (the “2004 LTIP Plan”) is a long term incentive plan
that was adopted in April 2004. The 2004 LTIP Plan was approved by
shareholders on June 29, 2004 and 2.0 million shares were reserved for issuance
under this plan. Awards generally vest on years of service with all
awards fully vesting within five years of the grant date. Awards can
be in the form of an option, restricted share unit, performance share unit,
or
other award form determined by the Board of Directors. Awards granted
under the 2004 LTIP Plan expire no later than 10 years after the date of the
grant. At December 31, 2006, there were 1,530,186 awards outstanding
under the 2004 LTIP Plan of which 308,222 were exercisable.
Staff
Share Option Plan
The
Staff
Stock Option Plan (the “Staff Plan”) is a fixed stock option plan which was
adopted in April 1992. Under the Staff Plan, the Company granted
options to its employees at the estimated fair market value of such options
at
the date of grant. Options generally vest based on years of service
with all options to be fully vested within five years from date of
grant. Options granted under the Staff Plan expire ten years after
date of grant. There are no options left to be granted under the
Staff Plan. At December 31, 2006, there were 346,675 options
outstanding under the Staff Plan of which 331,675 are exercisable.
Performance
Accelerated Stock Option Agreement
On
June
29, 2000, the Company’s shareholders approved, the grant to certain executive
officers of the Company of performance accelerated stock options (“PASOs”),
which it administers as a sub-plan of the Staff Plan, to purchase up to
1,000,000 shares of the Company’s common stock, subject to the terms summarized
below. The option to purchase the Company’s common stock under the
PASOs was granted effective January 1, 2000 (the “Grant Date”) at an exercise
price equal to $17.875 per share, the price of the Company’s common stock on the
date shareholders approved the reservation of 1,000,000 shares for issuance
under the PASO plan.
The
PASOs
include both service-based and performance-based vesting
provisions. Under the service-based provisions, subject to the
continued employment of the executive, the PASOs became 100% non-forfeitable
and
exercisable on the fifth anniversary of the Grant Date. Vesting under
the PASOs would be accelerated, however, if certain stock price targets are
achieved. The performance-based vesting provisions provide for the
vesting of one-eighth of the PASO grant for each $5.00 increase in the price
of
the Company’s common stock above $15.00 per share. The total number
of shares eligible for the accelerated vesting on an annual basis was limited
to
20% of the number of shares subject to the PASO with a cumulative carryover
for
the unvested portion of shares eligible for accelerated vesting for each of
the
prior years. During the period ended December 31, 2006, 200,000 stock
options were exercised and none were forfeited. As of December 31,
2006, 187,500 options remain outstanding under the option
agreements. Under the initial agreement, all options expire on
January 1, 2009. Due to the resignation from the Board of Directors
of the only remaining option holder on December 5, 2006, under the terms of
this
option agreement, his outstanding options will expire on December 5,
2007.
Performance
Accelerated Stock Option Inducement Agreements
On
December 30, 2003, the Company granted inducement stock option awards to two
key
executives of Breg, Inc, in conjunction with the acquisition of Breg,
Inc. The exercise price was fixed at $38.00 per share on November 20,
2003, when the Company announced it had entered into an agreement to acquire
Breg, Inc. The inducement grants include both service-based and
performance-based vesting provisions. Under the service-based
provisions, subject to the continued employment of the executive, the inducement
grants become 100% non-forfeitable and exercisable on the fourth anniversary
of
the grant date. Vesting of a portion of the options under the
inducement agreement will be accelerated if certain stock price targets are
achieved. The performance-based vesting provisions generally provide
for the vesting of one-fifth of the inducement grants for each $5.00 increase
in
the price of the Company’s common stock above $40.00 per share. The
total number of shares eligible for the accelerated vesting on an annual basis
is limited to 25% of the number of shares subject to the inducement grants
with
a cumulative carryover for the unvested portion of shares eligible for
accelerated vesting for each of the prior years. Prior to the
expiration of the term of the options, only one-half of the vested options
can
be exercised in any one year. As of December 31, 2006, 200,000
options remain outstanding under the inducement grants, of which 30,000 were
exercisable.
Notes
to the consolidated financial statements (cont.)
Employee
Stock Purchase Plan
The
Employee Stock Purchase Plan provides for the issuance of shares of the
Company’s common stock. During each purchase period, eligible
employees may designate between 1% and 25% of their cash compensation to be
deducted from their cash compensation for the purchase of common stock under
the
plan. The purchase price of the shares under the plan is equal to 85%
to the fair market value on the first day of the plan year (July 1st to June
30th). The purchase price for the Company’s officers is equal to 100%
of the fair market value on the first day of each plan year. The
aggregate number of shares reserved for issuance under the Employee Stock
Purchase Plan in 2006 was 450,000 shares. As of December 31, 2006,
308,977 shares had been issued under the Employee Stock Purchase
Plan.
Summaries
of the status of the Company’s stock option and warrant plans as of December 31,
2006, 2005 and 2004 and changes during the years ended on those dates are
presented below:
|
2006
|
2005
|
2004
|
||||||||||||||||||||||
|
Shares
|
Weighted
Average Exercise Price
|
Shares
|
Weighted
Average Exercise Price
|
Shares
|
Weighted
Average Exercise Price
|
|||||||||||||||||||
|
Outstanding
at beginning of year
|
1,944,199
|
$
|
32.02
|
1,783,693
|
$
|
27.36
|
2,051,502
|
$
|
21.62
|
|||||||||||||||
|
Granted
|
816,950
|
$
|
39.70
|
508,500
|
$
|
43.15
|
434,000
|
$
|
37.18
|
|||||||||||||||
|
Exercised
|
(406,225
|
)
|
$
|
25.54
|
(246,374
|
)
|
$
|
19.45
|
(698,428
|
)
|
$
|
16.41
|
||||||||||||
|
Forfeited
|
(90,563
|
)
|
$
|
39.29
|
(101,620
|
)
|
$
|
34.55
|
(3,381
|
)
|
$
|
30.40
|
||||||||||||
|
Outstanding
at end of year
|
2,264,361
|
$
|
35.67
|
1,944,199
|
$
|
32.02
|
1,783,693
|
$
|
27.36
|
|||||||||||||||
|
Options
exercisable at end of year
|
857,397
|
777,225
|
834,593
|
|||||||||||||||||||||
|
Weighted
average fair value of options granted during the year at market
value
|
$
|
13.78
|
$
|
15.09
|
$
|
13.03
|
||||||||||||||||||
|
Weighted
average fair value of options granted during the year at less
than market value
|
-
|
-
|
-
|
|||||||||||||||||||||
Notes
to the consolidated financial statements (cont.)
|
Outstanding
and exercisable by price range as of December 31,
2006
|
|||||||||||||||||||||||
|
Options
Outstanding
|
Options
Exercisable
|
||||||||||||||||||||||
|
Range
of Exercise Prices
|
Number Outstanding
|
Weighted
Average Remaining Contractual Life
|
Weighted
Average Exercise Price
|
Number
Exercisable
|
Weighted
Average Exercise Price
|
||||||||||||||||||
| $ |
7.50
- $17.00
|
127,475
|
1.81
|
$ |
12.36
|
127,475
|
$ |
12.53
|
|||||||||||||||
| $ |
17.87
- $25.00
|
225,150
|
1.58
|
$ |
19.07
|
225,150
|
$ |
19.07
|
|||||||||||||||
| $ |
26.72
- $36.57
|
209,550
|
6.55
|
$ |
32.43
|
195,217
|
$ |
32.25
|
|||||||||||||||
| $ |
36.58
- $41.33
|
1,171,051
|
8.54
|
$ |
38.44
|
200,920
|
$ |
38.12
|
|||||||||||||||
| $ |
41.34
- $46.33
|
531,135
|
9.03
|
$ |
43.42
|
108,635
|
$ |
43.67
|
|||||||||||||||
|
2,264,361
|
7.40
|
$ |
35.67
|
857,397
|
$ |
28.68
|
|||||||||||||||||
The
weighted average remaining contractual life of exercisable options was 4.6
years
at December 31, 2006. The total intrinsic value of options exercised
was $1.9 million, $2.8 million and $9.3 million for the years ended December
31,
2006, 2005 and 2004, respectively. The aggregate intrinsic value of
options outstanding and options exercisable as of December 31, 2006 is
calculated as the difference between the exercise price of the underlying
options and the market price of the Company’s common stock for the shares that
had exercise prices that were lower than the $50.00 closing price of the
Company’s stock on December 31, 2006. The aggregate intrinsic value
of options outstanding was $26.5 million, $8.4 million and $9.9 million for
the
years ended December 31, 2006, 2005 and 2004, respectively. The
aggregate intrinsic value of options exercised was $11.9 million, $5.4 million
and $6.3 million for the years ended December 31, 2006, 2005 and 2004,
respectively.
|
19
|
Earnings
per share
|
For
each
of the three years in the period ended December 31, 2006, there were no
adjustments to net income for purposes of calculating basic and diluted net
income per common share. The following is a reconciliation of the
weighted average shares used in the basic and diluted net income per common
share computations.
|
Year
Ended December 31,
|
||||||||||||
|
2006
|
2005
|
2004
|
||||||||||
|
Weighted
average common shares-basic
|
16,165,540
|
15,913,475
|
15,396,540
|
|||||||||
|
Effect
of diluted securities:
|
||||||||||||
|
Stock
options
|
--
|
375,500
|
578,405
|
|||||||||
|
Weighted
average common share-diluted
|
16,165,540
|
16,288,975
|
15,974,945
|
|||||||||
The
Company did not include in the diluted shares outstanding calculation 763,564
options in 2006, 392,400 options in 2005 and 200,000 options in 2004 because
their inclusion would be anti-dilutive.
Notes
to the consolidated financial statements (cont.)
|
20
|
Quarterly
financial data (unaudited)
|
(U.S.
Dollars, In thousands, except per share data)
|
1st
Quarter
|
2nd
Quarter
|
3rd
Quarter
|
4th
Quarter
|
Year
|
||||||||||||||||
|
2006
|
||||||||||||||||||||
|
Net
sales
|
$
|
81,116
|
$
|
84,735
|
$
|
83,368
|
$
|
116,140
|
$
|
365,359
|
||||||||||
|
Gross
profit
|
59,657
|
63,536
|
62,361
|
86,180
|
271,734
|
|||||||||||||||
|
Net
income
|
8,246
|
12,728
|
(35,417
|
)
|
7,403
|
(7,042
|
)
|
|||||||||||||
|
Net
income per common share:
|
||||||||||||||||||||
|
Basic
|
0.51
|
0.79
|
(2.19
|
)
|
0.45
|
(0.44
|
)
|
|||||||||||||
|
Diluted
|
0.51
|
0.79
|
(2.19
|
)1
|
0.44
|
(0.44
|
)
|
|||||||||||||
|
2005
|
||||||||||||||||||||
|
Net
sales
|
$
|
77,688
|
$
|
79,540
|
$
|
75,812
|
$
|
80,264
|
$
|
313,304
|
||||||||||
|
Gross
profit
|
56,792
|
58,765
|
55,619
|
58,340
|
229,516
|
|||||||||||||||
|
Net
income
|
10,779
|
9,405
|
46,020
|
7,198
|
73,402
|
|||||||||||||||
|
Net
income per common share:
|
||||||||||||||||||||
|
Basic
|
0.68
|
0.59
|
2.88
|
0.45
|
4.61
|
|||||||||||||||
|
Diluted
|
0.67
|
0.58
|
2.81
|
0.44
|
4.51
|
|||||||||||||||
The
sum
of per share earnings by quarter may not equal earnings per share for the year
due to the change in average share calculations. This is in
accordance with prescribed reporting requirements.
|
|
(1) The
Company formerly reported $2.17 which has been adjusted to exclude
the
antidilutive effect of options.
|
F-37
Orthofix
International N.V.
Schedule
1 — Condensed Financial Information of Registrant Orthofix International
N.V.
Condensed
Balance Sheets
|
(U.S.
Dollars, in thousand)
|
December
31,
|
December
31,
|
||||||
|
|
2006
|
2005
|
||||||
|
Assets
|
||||||||
|
Current
assets:
|
||||||||
|
Cash
and cash equivalents
|
$
|
10,745
|
$
|
6,240
|
||||
|
|
||||||||
|
Prepaid
expenses and other current assets
|
718
|
548
|
||||||
|
Total
current assets
|
11,463
|
6,788
|
||||||
|
Other
long term assets
|
292
|
372
|
||||||
|
Investments
in and amounts due from subsidiaries and affiliates
|
384,711
|
363,855
|
||||||
|
Total
assets
|
$
|
396,466
|
$
|
371,015
|
||||
|
Liabilities
and shareholders’ equity
|
||||||||
|
Current
liabilities
|
$
|
1,911
|
$
|
975
|
||||
|
|
||||||||
|
Long-term
liabilities
|
1,920
|
1,155
|
||||||
|
Shareholders’
equity
|
||||||||
|
Common
stock
|
1,645
|
1,602
|
||||||
|
Additional
paid in capital
|
128,297
|
106,746
|
||||||
|
Accumulated
earnings
|
248,433
|
255,475
|
||||||
|
Accumulated
other comprehensive income
|
14,260
|
5,062
|
||||||
|
392,635
|
368,885
|
|||||||
|
Total
liabilities and shareholders’ equity
|
$
|
396,466
|
$
|
371,015
|
||||
See
accompanying notes to condensed financial
statements.
Orthofix International N.V.
Schedule
1 — Condensed Financial Information of Registrant Orthofix International
N.V.
Condensed
Statements of Operations
|
(U.S.
Dollars, in thousands)
|
December
31,
|
December
31,
|
December
31,
|
|||||||||
|
2006
|
2005
|
2004
|
||||||||||
|
(Expenses)
Income
|
||||||||||||
|
General
and administrative
|
$
|
(8,774
|
)
|
$
|
(5,115
|
)
|
$
|
(4,599
|
)
|
|||
|
Equity
in earnings of investments in subsidiaries and affiliates
|
692
|
79,603
|
38,571
|
|||||||||
|
Other,
net
|
2,800
|
204
|
336
|
|||||||||
|
Income
(loss) before income taxes
|
(5,282
|
)
|
74,692
|
34,308
|
||||||||
|
Income
tax expense
|
(1,760
|
)
|
(1,290
|
)
|
(159
|
)
|
||||||
|
Net
income (loss)
|
$
|
(7,042
|
)
|
$
|
73,402
|
$
|
34,149
|
|||||
See
accompanying notes to condensed financial statements.
Orthofix International N.V.
Schedule
1 — Condensed Financial Information of Registrant Orthofix International
N.V.
Condensed
Statement of Cash Flows
|
(U.S.
Dollars, in thousands)
|
December
31,
|
December
31,
|
December
31,
|
|||||||||
|
2006
|
2005
|
2004
|
||||||||||
|
Net
income (loss)
|
$ | (7,042 | ) | $ |
73,402
|
$ |
34,149
|
|||||
|
Equity
in earnings of investments in subsidiaries and affiliates
|
(692 | ) | (79,603 | ) | (38,571 | ) | ||||||
|
Cash
used in other operating activities
|
(1,066 | ) | (39,486 | ) | (6,234 | ) | ||||||
|
Net
cash used in operating activities
|
(8,800 | ) | (45,687 | ) | (10,656 | ) | ||||||
|
Cash
flows from investing activities:
|
||||||||||||
|
Investments
and advances made in subsidiaries and affiliates
|
-
|
-
|
(6,400 | ) | ||||||||
|
Distributions
and amounts received from subsidiaries
|
24,468
|
38,538
|
7,547
|
|||||||||
|
Cash
provided by other investing activities
|
-
|
-
|
1,300
|
|||||||||
|
Net
cash provided by investing activities
|
24,468
|
38,538
|
2,447
|
|||||||||
|
Cash
flows from financing activities:
|
||||||||||||
|
Net
proceeds from issuance of common stock
|
11,507
|
6,471
|
12,247
|
|||||||||
|
Dividends
to subsidiaries and affilliates
|
(24,845 | ) | - | - | ||||||||
|
Tax
benefit on exercise of stock options
|
2,175
|
-
|
-
|
|||||||||
|
Net
cash provided by financing activities
|
(11,163
|
) |
6,471
|
12,247
|
||||||||
|
Net
(decrease) increase in cash and cash equivalents
|
4,505
|
(678 | ) |
4,038
|
||||||||
|
Cash
and cash equivalents at the beginning of the year
|
6,240
|
6,918
|
2,880
|
|||||||||
|
Cash
and cash equivalents at the end of the year
|
$ |
10,745
|
$ |
6,240
|
$ |
6,918
|
||||||
See
accompanying notes to condensed financial statements.
Orthofix International N.V.
Schedule
1 — Condensed Financial Information of Registrant
Orthofix International N.V.
Notes
to Condensed Financial Statements
|
1
|
Background
and Basis of Presentation
|
These
condensed parent company financial statements have been prepared in accordance
with Rule 12-04, Schedule 1 of Regulation S-X, as the restricted net assets
of
Orthofix Holdings Inc. and it subsidiaries exceed 25% of the consolidated net
assets of Orthofix International N.V. and its subsidiaries (the
“Company”). This information should be read in conjunction with the
Company’s consolidated financial statements included elsewhere in this
filing.
|
2
|
Restricted
Net Assets of Subsidiaries
|
Certain
of the Company’s subsidiaries have restrictions, with an effective date of
September 22, 2006, on their ability to pay dividends or make intercompany
loans
and advances pursuant to their financing arrangements. The amount of
restricted net assets the Company’s subsidiaries held at December 31, 2006 is
approximately $247.2 million. Such restrictions are on net assets of
Orthofix Holdings Inc. and its subsidiaries.
|
3
|
Commitments,
Contingencies and Long Term
Obligations
|
For
a
discussion of the Company’s commitments, contingencies and long term obligations
under its senior secured credit facility see Note 10 Long Term Debt and Note
12
Commitments and Note 16 Contingencies of the Company’s consolidated financial
statements.
|
4
|
Dividends
From Subsidiaries
|
Cash
dividends paid to Orthofix International N.V. from its consolidated subsidiaries
accounted for by the equity method were $24.5 million, $38.5 million and
$7.5 million for the periods ended December 31, 2006, 2005 and 2004,
respectively.
Schedule
2 – Valuation and Qualifying Accounts
For
the
years ended December 31, 2006, 2005 and 2004:
|
(US
Dollars, in thousands)
|
Additions
|
|||||||||||||||||||||||
|
Provisions
from assets to which they apply:
|
Balance
at beginning of year
|
Charged
to cost and expenses
|
Charged
to other accounts
|
Deductions/
Other
|
Blackstone
Acquisition
|
Balance
at end of year
|
||||||||||||||||||
|
2006
|
||||||||||||||||||||||||
|
Allowance
for doubtful accounts receivable
|
4,155
|
5,475
|
41
|
(3,634
|
)
|
228
|
6,265
|
|||||||||||||||||
|
Inventory
provisions
|
3,334
|
3,042
|
242
|
(1,309
|
)
|
1,905
|
7,213
|
|||||||||||||||||
|
Deferred
tax valuation allowance
|
6,324
|
3,024
|
80
|
-
|
-
|
9,428
|
||||||||||||||||||
|
2005
|
||||||||||||||||||||||||
|
Allowance
for doubtful accounts receivable
|
4,195
|
5,124
|
40
|
(5,204
|
)
|
-
|
4,155
|
|||||||||||||||||
|
Inventory
provisions
|
4,010
|
1,234
|
-
|
(1,910
|
)
|
-
|
3,334
|
|||||||||||||||||
|
Deferred
tax valuation allowance
|
138
|
238
|
5,948
|
-
|
-
|
6,324
|
||||||||||||||||||
|
2004
|
||||||||||||||||||||||||
|
|
||||||||||||||||||||||||
|
Allowance
for doubtful accounts receivable
|
4,314
|
4,266
|
47
|
(4,432
|
)
|
-
|
4,195
|
|||||||||||||||||
|
Inventory
provisions
|
3,656
|
667
|
(48
|
)
|
(265
|
)
|
-
|
4,010
|
||||||||||||||||
|
Deferred
tax valuation allowance
|
529
|
138
|
-
|
(529
|
)
|
-
|
138
|
|||||||||||||||||
S-5