UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from
____________ to ____________.
Commission File Number: 0-19961
ORTHOFIX INTERNATIONAL N.V.
(Exact name of registrant as specified in its charter)
Netherlands Antilles N/A
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7 Abraham de Veerstraat
Curacao
Netherlands Antilles N/A
- ------------------------------- -------------------
(Address of principal (Zip Code)
executive offices)
599-9-4658525
----------------------------------------------------
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.10 par value
(Title of Class)
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 [ X ] 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 an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [ X ] No [ ]
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, 2004, as
reported by the Nasdaq National Market, was approximately $394.7 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 10, 2005, 15,796,473 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 2005 Annual General Meeting of Shareholders
are incorporated by reference in Part III of this Form 10-K.
Orthofix International N.V.
Table of Contents
Page
PART I.........................................................................5
Item 1. Business............................................................5
Item 2. Properties.........................................................28
Item 3. Legal Proceedings..................................................29
Item 4. Submission of Matters to a Vote of Security Holders................30
PART II.......................................................................30
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters................................................30
Item 6. Selected Financial Data............................................32
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations..........................................33
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.........45
Item 8. Financial Statements and Supplementary Data........................45
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure................................45
Item 9A. Controls and Procedures...........................................45
PART III......................................................................47
Item 10. Directors and Executive Officers of the Registrant................47
Item 11. Executive Compensation............................................50
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholders...............................50
Item 13. Certain Relationships and Related Transactions....................50
Item 14. Principal Accountant Fees and Services............................50
PART IV......................................................................51
Item 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K....................................................51
3
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 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," "predicts,"
"potential" or "continue" or other comparable terminology. These forward-looking
statements are not guarantees of future performance and involve risks,
uncertainties, estimates and assumptions that are difficult to predict.
Therefore, actual outcomes and results may differ materially from those
expressed in these forward-looking statements. You should not place undue
reliance on any of these forward-looking statements. Further, any
forward-looking statement speaks only as of the date on which it is made, and we
undertake no obligation to update any such statement to reflect new information,
the occurrence of future events or circumstances or otherwise.
Factors that could cause actual results to differ materially from those
indicated by the forward-looking statements or that could contribute to such
differences include, but are not limited to, unanticipated expenditures,
changing relationships with customers, suppliers and strategic partners,
unfavorable results in litigation matters, risks relating to the protection of
intellectual property, changes to the reimbursement policies of third parties,
changes to governmental regulation of medical devices, the impact of competitive
products, changes to the competitive environment, the acceptance of new products
in the market, conditions of the orthopedic industry and the economy, currency
or interest rate fluctuations and the other risks described under Item 1 -
"Business - Risk Factors" in this Form 10-K.
4
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. For purposes of this Form 10-K, the subsidiaries of a person
include all entities that such person controls.
OVERVIEW
We are a diversified orthopedic products company offering a broad line
of minimally invasive surgical, as well as non-surgical, products for the spine,
reconstruction and trauma market sectors. Our products are designed to address
the lifelong bone-and-joint health needs of patients of all ages, helping them
achieve a more active and mobile lifestyle. We design, develop, manufacture,
market and distribute medical equipment used principally by musculoskeletal
medical specialists for orthopedic applications. Our main products are external
and internal fixation devices used in fracture treatment, limb lengthening and
bone reconstruction, non-invasive stimulation products used to enhance the
success rate of spinal fusions and to treat non-union fractures, 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 the bone cement used to fix artificial
implants and airway management products used in anesthesia applications.
We have administrative and training facilities in the United States,
the United Kingdom and Italy and manufacturing facilities in the United States,
the United Kingdom, Italy, Mexico and the Seychelles. We directly distribute our
products in the United States, the United Kingdom, Ireland, Italy, Germany,
Switzerland, Austria, France, Belgium, Mexico, Brazil, and Puerto Rico. In
several of these and other markets, we also distribute our products through
independent distributors.
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, Curacao, 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 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.
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 in 2003 and 2004
On December 28, 2004, we announced that we had received from the U.S.
Food and Drug Administration (FDA) approval 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 high-risk
patients. The FDA approval of Cervical-Stim is based upon a PMA (pre-market
approval) 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.
In April 2004, we purchased the intellectual property of the Gotfried
Percutaneous Compression Plating (PC.C.P) System for approximately $4.0 million.
As a result of this new agreement, the previous agreement which included a
license and worldwide marketing rights for this product was terminated.
5
On February 16, 2004, the Company acquired 100% of the common stock of
a Puerto Rican distribution company, Implantes Y Sistemas Medicos, Inc.
("ISMI"), for approximately $1.4 million. ISMI distributes Orthofix and other
third party products.
On December 30, 2003, we completed the acquisition of privately held
Breg, Inc. ("Breg"), a designer, manufacturer and distributor of post-operative
reconstruction and rehabilitative products to hospitals and orthopedic offices.
The purchase price for the acquisition was $150.0 million plus closing
adjustments and transaction costs totaling approximately $6.3 million. Financing
costs were approximately $3.6 million. The acquisition and related costs were
financed with $110.0 million of senior secured bank debt, cash on hand and the
issuance of 731,715 shares of Orthofix common stock.
Breg, based in Vista, California, designs, manufactures and distributes
orthopedic products for post-operative reconstruction and rehabilitative patient
use, including bracing products, cold therapy products and pain therapy
products. Breg generated $68.3 million in net revenues in 2004.
Concurrently with the closing of the Breg acquisition, Colgate Medical
Limited (Colgate), a wholly owned subsidiary of Orthofix, entered into a senior
secured bank facility which provides for (1) a five-year amortizing term loan
facility of $110 million, and (2) a five-year revolving credit facility of $15
million. As of March 11, 2005, we had no amounts outstanding under the revolving
credit facility and $76.8 million outstanding under the term loan. Loans under
the senior secured bank facility bear interest at a rate per annum equal to
LIBOR or prime rate, plus a margin that is adjusted quarterly based on Colgate's
leverage ratio.
Business Strategy
Our business strategy is to offer innovative, cost-effective orthopedic
products to the spine, reconstruction and trauma market sectors that are
minimally invasive and that reduce patient suffering and healthcare costs. We
intend to continue to expand applications for our products by utilizing
synergies among our core technologies, including those acquired from the Breg
acquisition. We expect 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 that are available to them. We
will continue to enhance physician relationships through extensive education
efforts and strengthen contracting and reimbursement relationships through our
dedicated sales and administrative staff.
Products
Our revenues are generally derived from two primary sources: sales of
orthopedic and non-orthopedic products. Sales of orthopedic products are in
three market sectors, Spine (28%), Reconstruction (42%) and Trauma (22%), which
together accounted for 92% of our total net sales in 2004. Sales of
non-orthopedic products, including airway management products for use during
anesthesia, woman's care and other products, accounted for 8% of our total net
sales in 2004.
6
The following table identifies our principal products by trade name and
describes their primary applications:
Product Primary Application
------- -------------------
Orthopedic Products
-------------------
Spine
Spinal-Stim PEMF non-invasive lumbar spinal bone
growth stimulation
Cervical-Stim PEMF non-invasive cervical spine bone
growth stimulation
Orthotrac Pneumatic vest used to reduce pressure
on the spine
EZ Brace Rigid external brace for spine
stabilization
Reconstruction
ExFix External fixation, including the
Sheffield Ring, OASIS and
limb-lengthening systems
A-V Impulse System Enhancement of venous circulation,
principally used after orthopedic
procedures to prevent deep vein
thrombosis
Cemex Bone cement
ISKD Internal limb-lengthening device
OSCAR Ultrasonic bone cement removal
Breg Bracing Bracing products which provide support
and protection of limbs and extremities
Polar Care Cold therapy products to reduce swelling
and accelerate the rehabilitation
process
Pain Care Pain therapy products that provide
continuous post-surgery infusion of
local anesthetic into surgical site
Trauma
ExFix External and internal fixation,
including DAF, ProCallus, Xcaliber and
nailing systems
Physio-Stim PEMF long bone non-invasive bone growth
stimulation
PC.C.P Percutaneous compression plating system
for hip fracture
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 over all of the above products with
the exception of the Laryngeal Mask, Cemex, and ISKD. 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 worldwide.
We have numerous trademarked products and services including
but not limited to the following: Orthofix(R), ProCallus(R),
Orthotrac(TM), XCaliber(TM), PC.C.P(TM), OASIS(TM), EZBrace(TM),
Spinal-Stim(R), Cervical-Stim(R), Physio-Stim(R), Breg(R), Polar
Care(R), and Pain Care(R).
7
Net Sales
The following tables display the net sales by business segment, net of
intercompany eliminations, and by each of our market sectors for the three most
recent fiscal years ended December 31, 2004. We provide net sales by market
sector for informational purposes only. We maintain our books and records by
business segment.
Business Segment:
----------------
Year ended December 31,
(In US$ thousands)
2004 2003 2002
-------------------------- ----------------------------- ----------------------------
Percent of Percent of Percent of
Total Net Total Net Total Net
Net Sales Sales Net Sales Sales Net Sales Sales
----------- ------------- -------------- ------------- -------------- -------------
Americas Orthofix $125,972 44% $116,848 57% $102,850 58%
Americas Breg 68,294 24% -- -- --
International Orthofix 92,372 32% 86,859 43% 74,745 42%
----------- ------------- -------------- ------------- -------------- -------------
Total $286,638 100% $203,707 100% $177,595 100%
=========== ============= ============== ============= ============== =============
Market Sector:
-------------
Year ended December 31,
(In US$ thousands)
2004 2003 2002
-------------------------- ----------------------------- ----------------------------
Percent of Percent of Percent of
Total Net Total Net Total Net
Net Sales Sales Net Sales Sales Net Sales Sales
----------- ------------- -------------- ------------- -------------- -------------
Orthopedic
Spine $81,375 28% $ 79,552 39% $ 69,613 39%
Reconstruction (1) 120,935 42% 51,183 25% 43,838 25%
Trauma 62,892 22% 53,706 26% 46,551 26%
----------- ------------- -------------- ------------- -------------- -------------
Total Orthopedic 265,202 92% 184,441 90% 160,002 90%
Non-Orthopedic 21,436 8% 19,266 10% 17,593 10%
----------- ------------- -------------- ------------- -------------- -------------
Total $286,638 100% $203,707 100% $177,595 100%
=========== ============= ============== ============= ============== =============
(1) Reconstruction includes Breg, Inc. acquired December 30, 2003.
Additional financial information regarding our geographic markets can
be found in Part II, Item 8, "Financial Statements and Supplementary Data".
Orthopedic Products
Orthopedic product sales represented 92% of our total net sales in
2004.
Our orthopedic product sales cover three market sectors: Spine,
Reconstruction and Trauma.
8
Spine
Spine product sales represented 28% of our total net sales in 2004.
We believe that neck and back pain is a common health problem for many
patients throughout the world, which 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 changes who wish to have a better quality of life in their
senior years 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 surgery, such as spine fusion.
Orthofix spine products are positioned to address the needs of spine
patients at any point within the non-invasive care cycle, offering
non-operative, pre-operative and post-operative treatments. Our products
currently address the cervical and lumbar fixation and fusion segment which is
the largest sub-segment of the spine market. According to Healthpoint Capital
Research, this sub-segment is estimated to be approximately $1.8 billion in the
United States and is expected to grow at 8%. Further, the overall spine market,
according to Knowledge Enterprises 2003, a market research firm, is currently
estimated at $2.9 billion, with a compounded annual growth rate expected to be
between 19% and 21% through the year 2010.
Spinal-Stim
The Spinal-Stim Bone Growth Stimulator (Spinal-Stim) is designed to
enhance the success rate of spinal fusions by stimulating the body's own natural
healing mechanism. This portable device is intended to be used as part of a
post-surgery home treatment program prescribed by a physician.
Spinal-Stim was the first non-invasive spinal fusion stimulator system
commercially available in the United States. Spinal-Stim is designed for
treatment of the lower thoracic and lumbar regions of the spine. Some spine
fusion patients are at greater risk than most patients of not fusing following a
spine fusion procedure due to risk factors such as smoking, obesity or because
their surgery involves fusion of multiple levels of vertebra in one procedure.
For these patients, bone growth stimulation using Spinal-Stim Lite, the second
generation of the Spinal-Stim product line, has been shown to increase the
probability of fusion, without the need for additional surgery. More than
135,000 patients have been treated using Spinal-Stim since the product was
introduced in 1990. The device uses proprietary technology 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
spinal fusion surgery. The recommended minimum daily treatment time for
Spinal-Stim is two hours. The attending medical staff can instruct the patient
regarding operation of the product and the appropriate duration of daily
treatments. The overall length of treatment is determined by the prescribing
physician, but is typically between three and nine months in duration.
Our stimulation products use a pulsating electric current to enhance
the growth of bone tissue following surgery and are placed externally over the
site to be healed. These products generate low level signals that induce low
pulsating current flow into the living tissues and cells exposed to the energy
field of the products. This pulsating current flow is believed to change enzyme
activities, induce mineralization, enhance vascular penetration and result in a
process resembling normal bone growth at the spinal fusion site. Our different
stimulation products each use unique PEMF signals or differing physical
configurations tailored to specific applications. These differing signals and
configurations are proprietary to Orthofix. In addition to the direct sales of
this product by our sales force, the Spinal-Stim Lite is also distributed in the
United States by Medtronic Sofamor Danek Group under a manufacturer's
representative agreement.
We operate limited guarantee programs for Spinal-Stim to heighten
awareness of the healing enhancement properties of PEMF technology. These
programs provide, in general, for reimbursement of the full price of the device
if radiographic evidence indicates that healing is not occurring at the fusion
site when the device is used in accordance with the prescribed treatment
protocol. Over the multi-year history of this program, we have received few
claims for reimbursement for which we carry a nominal financial reserve.
9
Cervical-Stim
On December 28, 2004, we announced that we had 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 high-risk
patients.
The FDA approval of Cervical-Stim is based upon a PMA (pre-market
approval) 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.
Without a bone growth stimulator, the failure rate of cervical and
lumbar fusions in high risk patients can be significant. Application of PEMF
signals activates the body's natural repair mechanism when it is absent or not
fully functional in certain patients, and consequently enhances bone growth for
successful fusion outcomes. Orthofix is sponsoring independent research at the
Cleveland Clinic, where scientists are conducting "mechanism of action" studies
to identify the influence of PEMF on bone cell proliferation. Results, which
have been submitted to peer review in advance of publication, show that
application of Orthofix's PEMF signal activates specific bone cell membrane
receptors and sets off internal signaling within the bone cell-causing
proliferation. We believe the results of these studies will be
published in 2005.
Orthotrac
The Orthotrac pneumatic vest is the first clinically validated,
non-operative treatment device that delivers external, self-administered spinal
"unloading", or upper body weight transfer, resulting in reduced pressure on the
lumbar spine. The Orthotrac pneumatic vest uses patented, pneumatic lifts that
decompress lumbar discs and associated soft tissue structures, and can
significantly improve the quality of life for patients with lower back pain.
Since patients remain mobile and ambulatory during their use of the Orthotrac
pneumatic vest, they may participate more actively in daily activities, physical
therapy and return-to-work programs or prescribed exercise routines.
The Orthotrac pneumatic vest is designed for a patient who is not
responding to conservative care, who is not presently an appropriate surgical
candidate or who has a consistent history of worsening back pain symptoms.
EZ Brace
We manufacture the EZ Brace spine brace for patients, either
post-operative or non-operative, who require rigid external support for spine
stabilization. The product is designed to be a comfortable, easy on off,
external bracing system. EZ Brace is available for mid-and low-back
applications.
Reconstruction
Reconstruction products represented 42% of our total net sales in 2004.
We offer a comprehensive solution package to the highly specialized
limb reconstruction market for correction of deformed limbs, such as length
discrepancies or angular deformities. We believe that our products enable a much
simpler product application and superior performance over existing alternatives
for the correction of lower limb deformities. In addition, we introduced in 2002
an internal lengthening system called the ISKD which is used when patient's
limbs are unequal in length. The ISKD is implanted using a minimally invasive
technique and lengthens internally. In late 2004, we introduced a reconstruction
plate called Eight-Plate Guided Growth System to correct varus and valus
deformity in children.
Our non-invasive vascular therapy products, primarily used on patients
following orthopedic joint replacement procedures, are designed to reduce
dangerous deep vein thrombosis and post-surgery pain and swelling by improving
venous blood return and improving arterial blood flow. For patients who cannot
walk or are
10
immobilized, these products simulate the effect that would occur naturally
during normal walking or hand flexion with a mechanical method and without the
side effects and complications of pharmacologics.
As a result of our acquisition of Breg, we now have a more well-rounded
and complete product line offering within the reconstruction market. A leading
manufacturer of orthopedic bracing, cold therapy products and pain care
products, Breg possesses strong brand recognition and a high quality reputation.
Functional bracing, load shifting and post-surgery bracing are used for the
protection of surgical repair and promotion of faster healing. Additionally, we
believe that cold therapy and pain therapy products are emerging as a standard
of care with physicians and hospitals.
According to Knowledge Enterprises 2003, the market size for
reconstruction products is currently estimated to be $6.8 billion with a
compounded annual growth rate between 10% and 12% through 2010.
ExFix
In addition to the treatment of bone fractures, we manufacture and
distribute external fixators that are used to treat congenital bone deformities,
such as limb length discrepancies, or deformities that result from previous
trauma. To serve the highly specialized limb reconstruction market, we developed
the Sheffield fixator. A Sheffield fixator is radiolucent and uses fewer
components than other products for limb reconstruction. In addition, a 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 a Sheffield fixator over competing products include the rapid
assembly, ease of use and the numerous possibilities for customization for each
individual patient.
The Osteoarthritis Surgical Intervention System, or the OASIS, is
designed for younger patients suffering from the degeneration of the cartilage
and bone of the knee. The OASIS is a minimally invasive system that allows
gradual post-operative adjustment of the affected limb and also helps unload the
damaged cartilage.
A-V Impulse System
We manufacture and distribute the A-V Impulse System line of foot and
hand pumps, a non-invasive method of reducing post-operative pain and swelling
and deep vein thrombosis, or the formation or presence of a blood clot. 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. We believe that a majority of the net sales of the A-V
Impulse System are for orthopedic applications, most notably to prevent deep
vein thrombosis following large joint surgeries such as hip or knee replacements
with the remaining net sales of the A-V Impulse System addressing various venous
or circulatory problems of patients. The A-V Impulse System is distributed in
the United States by Kendall Healthcare Products. 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.
Cemex
Cemex, a product of Tecres S.p.A., is a bone cement used by surgeons to
repair hip and knee prostheses once they have been inserted. We have the
exclusive distribution rights for Cemex in Italy.
ISKD (Intramedullary Skeletal Kinetic Distractor)
The Intramedullary Skeletal Kinetic Distractor, or ISKD, system is a
patented, internal limb-lengthening device that uses a magnetic sensor to
monitor limb-lengthening progress on a daily basis. The ISKD system is an
expandable tubular structure that is completely implanted inside the bone to be
lengthened. Only the patient and
11
surgeon need know the bone is being lengthened. Once implanted, the ISKD system
lengthens the patient's bone gradually, and, after lengthening is completed, the
system stabilizes the lengthened bone. This product received 510(k) clearance
from the FDA in 2001 and is being introduced in the United States and Europe on
a controlled basis. We have the exclusive worldwide distribution rights for this
product.
OSCAR (Orthosonics System for Cement Arthroscopy Revision)
We have developed the Orthosonics System for Cement Arthroscopy
Revision, or OSCAR, an ultrasonic device designed to soften and remove the bone
cement used to fix artificial implants within the patient's bone. We believe
that it offers a significant improvement, both in terms of cost and patient
outcomes, over existing bone cement removal techniques. Existing techniques
involve the use of hand chisels and manual or pneumatic hammers and drills,
which generally increase the risk of femoral shaft fracture with greatly
increased patient trauma and significant cost implications. OSCAR has been
demonstrated to greatly reduce femoral fractures and substantially reduce cement
removal times to approximately 15 to 20 minutes. We have under development a new
ultrasonic product for the larger uncemented hip revision market.
The product was launched in the United Kingdom in 1994, and selectively
elsewhere in 1995. OSCAR is now well established in the United Kingdom, and we
believe it is gaining support in certain other European countries. We are
expanding distribution of OSCAR in the United States through a network of
independent distributors that currently covers 44 states. A new version of OSCAR
was launched in 2001, which has a built-in endoscopic function for visual
examination of the femoral canal.
Breg
On December 30, 2003, we completed the acquisition of Breg Inc., which
we believe is a market leader in the sale of orthopedic post-operative
reconstruction and rehabilitative products to hospitals and orthopedic offices.
We include all of Breg's products in our Reconstruction market sector. Breg's
products are grouped primarily into three product categories: Breg Bracing,
Polar Care and Pain Care. Approximately 53% of Breg's net revenues were
attributable to the sale of bracing products, 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 30% of Breg's 2004 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 9% of Breg's 2004 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. Breg sells its products through a network
of domestic and international independent distributors and related international
subsidiaries. Approximately 8% of Breg's 2004 net revenues came from the sale of
other rehabilitative products.
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 generally designed for strenuous
athletic activity and off-the-shelf braces designed for use in less vigorous
activity. 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 X2K name.
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
12
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.
Polar Care
We manufacture, market and sell the 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 emerging as a
standard of care with physicians despite limited reimbursement historically 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 300, Polar Cub and cold gel packs.
Pain Care
We manufacture, market and sell a leading line of pain therapy
products, 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 believe we
maintain a leading position in this fast growing market.
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.
Trauma
Trauma products represented 22% of our total net sales in 2004.
Our trauma products are designed to be minimally invasive and are based
on a philosophy of treatment that focuses not only on the broken bone but also
considers the long-term preservation of function and quality of life for the
patient. Our method for fracture reduction protects and preserves proper anatomy
and limb alignment, allowing patients to function naturally and bear weight at
the fracture site very early in the healing cycle, which we believe are
important considerations for a positive outcome.
We believe our trauma products will assist in improving hospitals'
efficiency as the trauma market grows. Knowledge Enterprises 2003, an
independent market research firm, estimates that the size of the trauma market
will be $2.0 billion in 2005 and that the market is currently growing between 8%
and 10% per year.
13
ExFix
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 the callus 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 callus.
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. 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. We market our
external fixation devices in over 60 countries.
In 2001, we introduced XCaliber fixators, a new generation alternative
to our previous external fixators. The XCaliber fixators are made from a
lightweight radiolucent material and are 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 kit packaging 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 and soft bone. We believe
we have a full line of bone screws to meet the demands of the market.
In situations that require rapid yet solid stabilization of complex
fractures, we have introduced the Pre-Fix(TM) temporary fixator, which offers a
simpler application technique than is sometimes required in trauma treatments.
We have designed several other additions to our external fixation
product line to address specific types of fractures. These products include:
o fixation devices for pelvic fractures that permit quicker
application in the emergency room;
o an elbow fixator that permits early mobilization of the elbow joint
while fixing the fracture itself; and
o a radiolucent wrist fixator developed to facilitate easy
application, especially for use in the emergency room. This fixator
is provided in sterile-kit packages with all of the instruments for
surgical use.
Internal fixation devices include nails, screws, and plates designed to
temporarily stabilize traumatic bone injuries. These devices are used to set and
stabilize fractures and are removed when healing is completed. Our principal
internal fixation devices include:
o the Orthofix Nailing System, a nailing system for fractures of the
tibia and femur that requires a surgical insertion of a metal rod
into the medullary canal, the central canal of the bone, to maintain
14
bone stability. The locking screws in the Orthofix Nailing System
can be inserted mechanically and without the use of an image
intensifier, resulting in a simpler operative technique. The locking
screws also help reduce implant failure rates by providing
significantly higher fatigue resistance than similar competing
products. The tibial and femoral nails are available in all of our
markets except the United States;
o the Magic Pins Fragment Fixation System is an implant for fixing
small fracture fragments, usually used for the treatment of
fractures near the joints.
In 2005, we plan to introduce a new line of plates, the Contours VPS,
an internal fixation plating system that allows for anatomically correct
alignment in wrist fractures.
Physio-Stim
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. In the 1950s, scientists discovered
that, when human bone is broken, it generates an electrical field. This
low-level electrical field activates the body's internal repair mechanism, which
in turn stimulates bone healing. In some patients, this healing process is
impaired or absent and the fracture may not mend properly, resulting in a
non-union. Orthofix's patented bone growth stimulators use a low level of pulsed
electromagnetic field, or PEMF, signals to activate the body's natural healing
processes and have proven successful in treating fracture non-unions. The
stimulation products that we currently market apply bone growth stimulation
without implantation or other surgical procedures.
The technology used in our stimulation products uses a pulsating
electric current to enhance the growth of bone tissue following surgery or bone
fracture. Our stimulation products are placed externally over the site to be
healed. These products generate a low level of PEMF signals that induce low
pulsating current flow into living tissue and cells exposed to the energy field
of the products. This pulsating current flow is believed to change enzyme
activities, induce mineralization, enhance vascular penetration and result in a
process resembling normal bone growth at the fracture site.
We manufacture our second generation of the Physio-Stim product line,
the Physio-Stim Lite, a bone growth stimulation device which has proved to be
successful in treating many fracture non-unions. Our patient data shows that 8
out of 10 patients with fracture non-unions that use Physio-Stim Lite are healed
by our product without additional invasive surgical treatment. The systems offer
portability, long-term battery operation, integrated component design, patient
monitoring capabilities and the ability to cover a large treatment area without
factory calibration for specific patient application. More than 50,000 patients
have been treated using Physio-Stim for long bone non-unions since the product
was introduced in 1986. Physio-Stim uses a proprietary technology to generate a
PEMF signal. The result is a self-contained, very light and ergonomic device
with a three hour per day wear time that we believe makes the unit significantly
easier and more comfortable to use than competing products. The comprehensive
Physio-Stim Lite product line treats all the small and long bones, with a
current redesign for the treatment of the pelvis. Physio-Stim also features a
compliance monitoring system that provides hard copy printouts of patient
compliance. Physio-Stim uses a PEMF signal that is distinct from the Spinal-Stim
product but is also patented and proprietary to Orthofix.
We operate limited guarantee programs for Physio-Stim to heighten
awareness of the healing enhancement properties of PEMF technology. This program
provides, in general, for reimbursement for the full price of the device if
radiographic evidence indicates that healing is not occurring at the fracture
site when the device is used in accordance with the prescribed treatment
protocol. Over the multi-year history of this program, we have received few
claims for reimbursement, for which we carry a nominal financial reserve.
15
PC.C.P (Gotfried Percutaneous Compression Plating System)
The Gotfried Percutaneous Compression Plating, or PC.C.P System is a
minimally invasive method of fracture stabilization and fixation for
hip-fracture surgery developed by Y. Gotfried, M.D.
In 2002, we entered into an exclusive distribution agreement with
Efratgo Limited to market the PC.C.P System which contained an option to
purchase the technology. In 2004, we purchased the intellectual property of the
PC.C.P System for approximately $4.0 million.
There is growing concern about the mortality and complications
associated with hip fractures and their cost to society. Recently published
papers detailing clinical results using currently available systems indicate
that only 40% of patients regain their pre-operative mobility. In contrast, the
PC.C.P System has been shown to increase this percentage to 83% in a clinical
study of 118 patients ranging in age from 58-98 years whose hip-fracture surgery
utilized the PC.C.P System.
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.
Non-Orthopedic Products
Non-orthopedic product sales represented 8% of our total net sales in
2004.
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.
Joint Venture
OrthoRx
In 2000, we commenced OrthoRx, a full service durable medical equipment
distribution and billing business. OrthoRx provides to patients orthopedic
durable medical equipment products built around physician protocols that specify
the treatment and product required for each patient. The business is
vendor-neutral, which means that the product requested by the physician is the
exact product given to the patient. OrthoRx arranges supply agreements for the
products specified by the referring physicians.
On January 10, 2002, we established a joint venture, OrthoRx Inc. The
OrthoRx joint venture is headquartered in Plano, Texas, where the business
processes insurance authorizations, maintains inventory levels, and processes
product billing and collections, which is intended to allow individual OrthoRx
service centers to focus on patient interaction and physician follow-up. In 2002
and 2003, we invested a total of $5.5 million in the joint venture for an
ownership stake of approximately 47%. In 2004, we elected not to make a further
investment in the joint venture and sold 2.0 million of our 5.5 million shares
to our partner in the joint venture, Ferrer, Freedman, & Co. for $1.3 million.
As of December 31, 2004 our ownership stake in the joint venture was
approximately 22%.
16
Our investment in the joint venture has been reduced to zero
as a result of recording our share of the losses in the joint venture.
Product Development
We maintain a continuous interactive relationship with the main
orthopedic centers in the United States, Europe, Japan and South and Central
America, including research and development centers such as the Cleveland Clinic
Foundation 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 and 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.
Our research and development departments are responsible for new
product development and regularly consult with a group of internal and
designated external experts. The expert group advises these departments on the
long-term scientific planning of research and development and also evaluates our
research programs. Our primary research and development facilities are located
in Verona, Italy; McKinney, Texas; Vista, California; and Andover, United
Kingdom.
In 2004, 2003 and 2002, we spent $11.5 million, $8.1 million and $7.5
million, respectively, on research and development. In 2005, we expect to
introduce several new products for the trauma and reconstruction markets as well
as several next generation products as extensions to existing products.
In January 2002, we agreed to provide approximately $2.0 million to the
Orthopedic Research and Education Foundation to fund a four-year study to define
the molecular and cellular mechanism underlying bone-healing in response to
pulsed electromagnetic field (PEMF) technology. This study is being conducted at
the Lerner Research Institute of the Cleveland Clinic Foundation and is entitled
"Optimizing Bone-Healing Using PEMF," which also seeks to identify specific
signal characteristics that are causally related to a bone-healing response to
PEMF technology in order to optimize the PEMF signal. We expect initial results
from these studies to be published in 2005.
In January 2003, we announced that we had purchased an equity interest
in Innovative Spinal Technologies ("IST"), a start-up company focused on
commercializing spinal products. The investment of $1.5 million provides us with
the ability to participate in spine product research and development efforts
with IST.
Patents, Trade Secrets, Assignments and Licenses
We rely on a combination of patents, trade secrets, as well as
assignment and license agreements and 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 regarding patents
held by third parties. Our primary products are patented in all 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 assignment 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 that we seek to protect.
We obtain assignments or licenses of varying durations for certain
orthopedic products from third parties. We have acquired 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
to us generally are irrevocable, there is no assurance that these licenses will
continue to be made available to us on terms that are acceptable to us or at
all. The terms of our license agreements vary in length from three years to the
life of product
17
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 orthopedic products, are
subject to U.S. and non-U.S. regulatory requirements that regulate the
development, approval, testing, manufacture, labeling, marketing and sale of
medical products, 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 FDA pursuant
to the Medical Device Amendments Act of 1976 to the Federal Food, Drug and
Cosmetics Act, the Safe Medical Devices Act of 1990, and regulations issued or
proposed hereunder. With the exception of our stimulation products, our products
fall into FDA classifications that require less review by the FDA pursuant to
Section 510(k) of the 1976 Amendments than devices that require pre-market
approval applications. 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 the submission of the required pre-market approval
applications.
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 regulatory approvals to
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.
Moreover, non-U.S. governmental authorities 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. We cannot predict whether 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 Anti-Kickback Statute and
the Physician's Self-Referral Law (known as the "Stark Law"), the Civil False
Claims Act and the Health Insurance Portability and Accountability Act as well
as numerous state laws regulating healthcare and insurance. These laws are
enforced by the Office of Inspector General and the United States Department of
Justice along with other federal, state and local agencies. These laws
generally: (1) prohibit the provision of any thing of value in exchange for a
patient referral from a healthcare program, (2) require that claims for payment
submitted to the Government 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.
We devote significant time, effort and expense to addressing government
and regulatory requirements applicable to our business. We believe our
operations are in compliance with applicable law. We maintain a
18
Healthcare Compliance Committee as recommended by applicable U.S. government
guidelines which meets regularly to address healthcare regulatory policy and
potential employee discipline. Our employees receive healthcare regulatory
compliance training on an ongoing basis. Our profitability depends in part upon
our ability and our distributors' ability to obtain and maintain all necessary
certificates, permits, approvals and clearances from U.S. and non-U.S.
regulatory authorities and to operate in compliance with applicable regulations.
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, and our focus on innovative,
minimally invasive products will continue to have a positive effect on the
demand for our products.
Primary Markets
In 2004, Americas Orthofix including its principal market, the United
States, accounted for 44% of total net sales; Americas Breg accounted for 24% of
total net sales, and International Orthofix accounted for 32% of total net
sales. Other than Kendall Healthcare Products and sales directed to customers
through a Manufacturers' Representative agreement with Medtronic Sofamor Danek
Group, no single customer accounted for greater than 2% of total net sales.
We have a Manufacturer's Representative agreement for the Spinal-Stim
Lite with Medtronic Sofamor Danek Group. As an agent for Orthofix, Medtronic
Sofamor Danek represents our products to their customers on a commission basis.
The A-V Impulse System is distributed in the United States under an exclusive,
long-term distribution agreement with Kendall Healthcare Products. Kendall
Healthcare Products accounted for approximately 5% of our total net sales in
2004, while sales through Medtronic Sofamor Danek's Manufacturer's
Representative agreement accounted for approximately 7% of total net sales.
Sales to all other customers were broadly distributed.
Our products sold in the United States are either prescribed by medical
professionals for the care of their patients or 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, to publicly funded healthcare systems and private insurance plans.
Sales, Marketing and Distributor Network
We have established a broad distribution network comprised of direct
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 sales and marketing force of
approximately 444 direct sales and marketing representatives. Our products are
also sold through distributors. Worldwide we have approximately 188 independent
distributors who represent our products in approximately 60 countries. The table
below highlights the makeup of our sales, marketing, and distribution network at
December 31, 2004.
Direct
Sales & Marketing Headcount Distributors
--------------------------------------------- -----------------------------------------------
United
States International Total United States International Total
---------- ------------- ------------- --------------- ------------- --------------
Orthofix 263 138 401 33 65 98
Breg 42 1 43 52 38 90
---------- ------------- ------------- --------------- ------------- --------------
Total 305 139 444 85 103 188
========== ============= ============= =============== ============= ==============
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In our largest market, the United States, our sales, marketing and
distributor network is separated between a dedicated spine sales force
addressing the spine market sector, an orthopedic sales force addressing the
reconstruction and trauma market sectors and the Breg sales, marketing and
distributor network which is predominately a distributor network addressing the
reconstruction market sector.
Outside the United States, we employ direct sales representatives
throughout our international sales subsidiaries. We also utilize independent
distributors in Europe, the Far East, the Middle East and Central and South
America. In order to provide support to our independent distributor network, we
have a group of sales and marketing specialists who regularly visit the
independent distributors.
Marketing
We seek to market our products principally to medical professionals who
are the decision makers in their patient's treatment. This focus is designed to
complement our product development and marketing strategy, which seeks to
encourage and maintain interactive 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.
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 seminars, which in 2004 were attended by over 750 surgeons
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 are implementing a web-based sales
training portal to provide continued training to our sales representatives.
Competition
For external and internal fixation devices, our principal competitors
include Synthes AG, Zimmer, Inc., Stryker Corp., Smith & Nephew plc and EBI
Medical Systems, a subsidiary of Biomet, Inc. OSCAR and BoneSource compete
principally with products produced by Biomet, Inc. and Norian Corporation,
respectively. Our stimulation products compete principally with similar products
marketed by EBI Medical Systems, dj Orthopedics, Inc., and Exogen, Inc., a
subsidiary of Smith & Nephew plc. The principal non-pharmacological products
competing with our A-V Impulse System are manufactured by Huntleigh Technology
PLC and Kinetic Concepts Inc. We have filed an action against Kinetic Concepts
Inc. for patent infringement. For a description of the litigation, see Item 3 -
"Legal Proceedings."
The principal competitors for the Breg bracing and cold therapy
products include dj Orthopedics, Inc., Aircast Inc., EBI Medical Systems and
various smaller private companies. For pain therapy products, the principal
competitors are I-Flow Corporation, Stryker Corp. and dj Orthopedics, Inc.
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 in these areas,
particularly with respect to cost savings resulting from the reduction of
operating time resulting from the non-invasive or minimally invasive nature of
many of our products.
Manufacturing and Sources of Supply
We generally design, develop, assemble, test and package all our
products, and subcontract the manufacture of a substantial portion of the
component parts. Through subcontracting, we attempt to maintain
20
operating flexibility in meeting demand while focusing our resources on product
development and marketing while still maintaining quality assurance standards.
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.
Our products are currently manufactured and assembled in the United
States, Italy, the United Kingdom, Mexico and the Seychelles. In 2004, we
completed the process of transitioning a majority of Breg's manufacturing
activities from its Vista, California facility to its Mexicali, Mexico plant. 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 capital expenditures in the amount of $12.2 million, $5.2
million and $7.1 million in 2004, 2003 and 2002, respectively, principally for
computer software and hardware, patents, licenses, plant and equipment, tooling
and molds. We currently plan to invest approximately $4.1 million in the
Americas Orthofix, approximately $4.9 million in Americas Breg, and
approximately $3.2 million in International Orthofix in 2005 for a total of
approximately $12.2 million 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, 2004, we had approximately 997 employees
worldwide. Approximately 294 were employed at Americas Breg, 471 were employed
at Americas Orthofix and approximately 232 were employed within International
Orthofix. Our relations with our Italian employees, who numbered 75 at December
31, 2004, 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 approximately 997 employees, 444 were employed in sales and marketing
functions, 172 in general and administrative, 356 in production and 25 in
research and development.
21
RISK FACTORS
You should carefully consider the risks described below. These risks
are not the only ones that our company 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.
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 seek to 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 products arising from
research, we may not be able to maintain the confidentiality of information
relating to these products.
Third parties may claim that we infringe on their proprietary rights and may
prevent us from manufacturing and selling certain of our products.
There has been substantial litigation in the orthopedic medical devices
industry with respect to the manufacture, use and sale of new products. These
lawsuits relate to the validity and infringement of patents or proprietary
rights of third parties. We may be required to defend against allegations
relating to the infringement of patent or proprietary rights of third parties.
Any such litigation could:
o require us to incur substantial expense, even if the costs of our
defense are covered by insurance or we are successful in the
litigation;
o require us to divert significant time and effort of our technical
and management personnel;
o result in the loss of our rights to develop or make certain
products; and
o 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
22
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.
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 our independent sales
representatives to our customers or to our independent distributors and
purchased by hospitals, doctors and other healthcare providers, who together
with us may be reimbursed for the healthcare services provided to their patients
by third-party payors, such as government programs, including Medicare and
Medicaid, private insurance plans and managed care programs. Third-party payors
may deny reimbursement if they determine that a device used in a procedure was
not used in accordance with cost-effective treatment methods as determined by
such third-party payor, was investigational or was used for an unapproved
indication or for other reasons. 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, in the
event that 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. It is also possible that the government's focus on coverage
of off-label uses for 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. 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.
Management estimates that its revenue by payor type are:
o Independent Distributors 27%
o Third Party Insurance 26%
o International Public Healthcare Systems 18%
o Direct (hospital) 18%
o U.S. Government - Medicare, Medicaid, TriCare 9%
o Self pay 2%
We may be subject to extensive government regulation that increases our costs
and could prevent us from marketing or selling 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. 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. 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 or 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 also has the ability
to change the regulatory classification of an approved device from a higher to a
lower regulatory classification which could materially adversely impact our
ability to market or sell our device. Moreover, we cannot predict whether U.S.
or foreign government regulations that may have a material adverse effect on us
may be imposed in the future.
23
Our profitability depends, in part, upon the ability of the Company,
our sales representatives, and our distributors' ability 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. There can be no assurance that we have obtained, will obtain or
will remain in compliance with, applicable FDA and other U.S. and foreign
material regulatory requirements. 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. Any such consequences could have a
material adverse effect on our business, financial condition or results of
operations.
We are 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 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 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.
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 recent 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 could have an
adverse affect on sales of our bone-growth stimulation products in high-risk
patients. Additionally, in 2004, Artificial Disks were introduced into the
market as an alternative to spinal fusions. The proliferation of market
acceptance could have an adverse effect on sales of our products in high-risk
patients.
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."
24
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 and we generally have the right to
terminate if the distributor does not meet agreed sales targets or fails to make
payment 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 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. The Company has contractual relationships with suppliers, distributors
and agents as well as service providers. In the aggregate, these contractual
relationships are necessary for the Company to operate its business. From time
to time, the Company amends, terminates or negotiates is contracts. The Company
is also periodically subject to, or makes, claims of breach or threats of legal
action arising out of one or more of its contracts which, from time to time, may
result in litigation. At any one time, the Company has 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, there can be no assurance that these contracts will
continue in effect past their current term or that we will 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 foreign currency and
receivables denominated in foreign currency are greater or less than our
liabilities denominated in foreign currency, we have foreign exchange exposure.
We have substantial activities outside of the United States that are subject to
the impact of foreign exchange rates. The impact of foreign exchange rates on
sales outside of the United States was to increase net sales by $6.7 million in
International for 2004, primarily as the result of a stronger Euro and U.K.
Pound against the U.S. dollar, and to decrease net sales by $0.2 million in the
Americas for 2004, primarily as a result of a weaker Mexican Peso against the
U.S. dollar. 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. From time
to time, the Company may examine whether a currency hedge program is appropriate
for the Company's needs and may enter into a currency hedge.
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. Tax authorities in such jurisdictions may challenge our treatment of
such intercompany transactions under the residency criteria,
25
transfer pricing provisions or any other aspects of their respective tax laws.
If we are unsuccessful in defending our treatment of intercompany transactions,
we may be subject to additional tax liability or penalty, which would 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 (CCNA) (Articles 100-144).
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 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 doing business internationally. Net sales
outside the United States represented 35% of our total net sales in 2004. 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:
o changes in foreign currency exchange rates;
o changes in a specific country's or region's political or economic
conditions;
o trade protection measures and import or export licensing
requirements or other restrictive actions by foreign governments;
o consequences from changes in tax or customs laws;
o difficulty in staffing and managing widespread operations;
o differing labor regulations;
o differing protection of intellectual property; and
o unexpected changes in regulatory requirements.
26
Our subsidiary Colgate Medical Limited's senior secured bank credit facility
contains significant financial and operating restrictions and mandatory
prepayments that may have an adverse effect on our operations and limit our
ability to grow our business.
When we acquired Breg on December 30, 2003, one of our wholly owned
subsidiaries, Colgate Medical Limited ("Colgate"), entered into a senior secured
bank credit facility with a syndicate of financial institutions to finance the
transaction. Orthofix and each of Colgate's direct and indirect subsidiaries,
including Orthofix Inc. and Breg, have guaranteed the obligations of Colgate
under the senior secured bank facility. The senior secured bank facility
provides for (1) a five-year amortizing term loan facility of $110.0 million and
(2) a five-year revolving credit facility of $15.0 million, upon which we had
not drawn as of March 11, 2005.
Further, in addition to scheduled debt repayments, our senior secured
bank facility requires us to make mandatory prepayments with (a) the excess cash
flow (as defined in the credit agreement) of Colgate and its subsidiaries in an
amount initially equal to 75% of the excess annual cash flow of Colgate and its
subsidiaries, reducing to 50% upon the attainment of a leverage ratio of less
than or equal to 1.50 to 1.00, (b) the net cash proceeds of any debt issuance by
Colgate and its subsidiaries or any equity issuances, excluding the exercise of
stock options, by any of the credit parties as defined (in the credit agreement)
or (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 Colgate
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, an interest
coverage ratio and a leverage ratio applicable to Colgate and its subsidiaries
on a consolidated basis, 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 Item 7 - "Liquidity
and Capital Resources."
We may not be able to successfully integrate Breg's operations into our business
and may not achieve the anticipated benefits of the acquisition.
We are continuing the process of integrating Breg's operations into our
company. The integration of Breg's operations into our business involves
numerous risks, including:
o difficulties in incorporating Breg's product lines, sales
personnel and marketing operations into our business;
o the diversion of our resources and our management's attention from
other business concerns;
o the loss of key distributors; and
o the loss of key employees.
Our failure to integrate and manage Breg's business successfully could
adversely affect our business and financial performance. In addition, if Breg's
operations and financial results do not meet our expectations, we may not
realize the synergies, operating efficiencies, market position, or revenue
growth we anticipate from the acquisition.
27
Item 2. Properties
- -------------------
Our principal facilities are:
Facility Location Square Feet Ownership
- -------- -------- ----------- ---------
Manufacturing, warehousing, distribution and research and McKinney, TX 70,000 Leased
development facility for Stimulation and Bracing Products
and administrative facility for Orthofix Inc.
Research and development, component manufacturing, quality Verona, Italy 38,000 Owned
control and training facility for fixation products and
sales management, distribution and administrative facility
for Italy
Warehousing facility for fixation products Verona, Italy 6,460 Leased
Administrative offices for Orthofix International N.V. and Huntersville, NC 10,084 Leased
Orthofix Inc.
Sales management, distribution and administrative offices South Devon, England 2,500 Leased
Sales management, distribution and administrative offices Andover, England 9,000 Leased
for A-V Impulse and fixation products
Sales management, distribution and administrative facility Maidenhead, England 9,000 Leased
for United Kingdom
Sales management, distribution and administrative facility Mexico City, Mexico 3,444 Leased
for Mexico
Sales management, distribution and administrative facility Sao Paulo, Brazil 1,300 Owned
for Brazil
Sales management, distribution and administrative facility Gentilly, France 3,854 Leased
for France
Sales management, distribution and administrative facility Valley, Germany 3,000 Leased
for Germany
Sales management, distribution and administrative facility Steinhausen, Switzerland 1,180 Leased
for Switzerland
Assembly and packaging facility for fixation products Victoria, Mahe, Seychelles 5,597 Leased
Administrative, manufacturing, warehousing, distribution and Vista, California 104,832 Leased
research and development facility for Breg
Manufacturing facility for Breg products Mexicali, Mexico 63,000 Leased
Sales management, distribution and administrative facility Guaynabo, Puerto Rico 4,400 Leased
for Puerto Rico
28
Item 3. Legal Proceedings
- --------------------------
Except as described below, there are no material pending legal
proceedings to which the Company is a party or of which any of its property is
subject.
KCI Litigation
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 product, breach of contract, and
seeks damages relating to past infringement, breach of contract, and unfair
competition. KCI has filed counterclaims alleging that Novamedix engaged in
inequitable conduct before the United States Patent and Trademark Office and
fraud as to KCI and that Novamedix engaged in common law and statutory unfair
competition against KCI. KCI withdrew several of its counterclaims, but
continues to assert affirmative defenses contending that the patents are
invalid, unenforceable, and not infringed. KCI also seeks monetary damages,
injunctive relief, costs, attorney's fees, and other unspecified relief. During
2002, the United States Patent and Trademark Office issued re-examination
certificates validating four U.S. vascular patents owned by us. The U.S.
District Court in San Antonio, Texas restored the litigation to active status. A
portion of any amounts received by us will be payable to former owners of
Novamedix under the original purchase agreement. This matter is currently in the
pre-trial motions phase.
Triage Litigation
On September 29, 2004, Triage Medical Inc. ("Triage") filed an action
against Orthofix International N.V. in State Court in California. The Company
subsequently removed the case to the federal United States District Court for
the Central District of California. Triage alleges that the Company agreed to
negotiate an acquisition of Triage and to make an unconditional $2.0 million
escrow payment to Triage. Triage contends the Company terminated the acquisition
process and failed to make the escrow payments and, as a result, Triage has been
damaged. We have answered the complaint denying any liability and pleading
certain defenses. We believe this case is without merit and intend to vigorously
defend it.
29
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 2004.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
- ------------------------------------------------------------------------------
Market for Our Common Stock
Our common stock is traded on the Nasdaq National 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, 2004. As of March 10, 2005 we had
approximately 224 holders of record of our common stock.
High Low
------ -------
2003
----
First Quarter $30.64 $23.69
Second Quarter 34.42 25.68
Third Quarter 37.54 31.81
Fourth Quarter 51.05 36.10
2004
----
First Quarter $55.40 $43.50
Second Quarter 51.48 40.96
Third Quarter 42.00 29.00
Fourth Quarter 40.37 32.00
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 Breg 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
Except as described below, there were no securities sold by us during
2004 that were not registered under the Securities Act.
On February 2, 2004, we issued 1,291 shares of our common stock to one
of our warrant holders upon the exercise of 1,291 of our warrants. These
warrants were initially issued by Kinesis Medical, Inc. and originally entitled
the holder of warrants to purchase one share of Kinesis common stock at an
exercise price per share ranging from $1.00 to $2.00. On August 15, 2000, in
conjunction with our asset purchase agreement with Kinesis, each outstanding
Kinesis warrant was converted into 0.05261 Orthofix warrants to purchase shares
of our common stock at a price per share ranging from $19.125 to $38.25, subject
to adjustment as determined by the warrant agreement.
30
The above transactions were exempt from the registration requirements
of the Securities Act pursuant to Section 4(2) and the rules and regulations
promulgated under the Securities Act on the basis that the transactions did not
involve a public offering.
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.
31
Item 6. Selected Financial Data
- --------------------------------
The following selected consolidated financial data for the years ended
December 31, 2004, 2003, 2002, 2001 and 2000 have been derived from our audited
consolidated financial statements. The financial data as of December 31, 2004
and 2003 and for the years ended December 31, 2004, 2003 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,
--------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(In US$ thousands, except margin and per share data)
Consolidated operating results
Net sales......................................... $286,638 $203,707 $177,595 $162,360 $131,782
Gross profit...................................... 207,461 152,617 132,776 119,408 95,993
Gross profit margin............................... 72% 75% 75% 74% 73%
Total operating income............................ 55,000 40,584 42,939 30,499 22,725
Net income(1)..................................... 34,149 24,730 25,913 20,964 44,816
Net income per share of common stock (basic)...... 2.22 1.76 1.96 1.60 3.40
Net income per share of common stock (diluted).... 2.14 1.68 1.76 1.42 3.20
Consolidated financial position As of December 31,
(at year-end)
--------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(In US$ thousands, except share data)
Total assets ..................................... $431,100 $413,179 $220,774 $188,914 $190,434
Total debt........................................ 77,382 110,207 7,420 5,560 10,818
Shareholders' equity.............................. 297,172 240,776 168,084 138,102 132,988
Weighted average number of shares of
common stock outstanding (basic)............... 15,396,540 14,061,447 13,196,524 13,086,467 13,182,789
Weighted average number of shares of
common stock outstanding (diluted)............. 15,974,945 14,681,883 14,685,236 14,737,567 13,986,098
---------------
(1) Net income for 2000 includes $29.9 million of income after tax related
to the EBI litigation.
32
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 the Company's 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 minimally invasive surgical, as well as non-surgical, products for the spine,
reconstruction and trauma market sectors. Our products are designed to address
the lifelong bone-and-joint health needs of patients of all ages, helping them
achieve a more active and mobile lifestyle. We design, develop, manufacture,
market and distribute medical equipment used principally by musculoskeletal
medical specialists for orthopedic applications. Our main products are external
and internal fixation devices used in fracture treatment, limb lengthening and
bone reconstruction, non-invasive stimulation products used to enhance the
success rate of spinal fusions and to treat non-union fractures, 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 the bone cement used to fix artificial
implants, a bone substitute compound and airway management products.
We have administrative and training facilities in the United States,
the United Kingdom and Italy and manufacturing facilities in the United States,
the United Kingdom, Italy, Mexico and the Seychelles. We directly distribute our
products in the United States, the United Kingdom, Ireland, Italy, Germany,
Switzerland, Austria, France, Belgium, Mexico, Brazil and Puerto Rico. In
several of these and other markets, we also distribute our products through
independent distributors.
Our 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. The equity method of accounting is used when we
have significant influence over significant operating decisions but do not hold
control. Under the equity method, original investments are recorded at cost and
adjusted by our share of undistributed earnings or losses of these companies.
All material intercompany transactions and profits associated with the equity
investees 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 the
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 interest rate fluctuation exposure. We do
not ordinarily use derivative instruments to hedge foreign exchange exposure.
See Item 7A - "Quantitative and Qualitative Disclosures About Market Risk."
We manage our operations as three business segments: Americas Orthofix,
Americas Breg, and International Orthofix. Americas Orthofix consists of the
operations in the United States, existing prior to the acquisition of Breg, as
well as operations in Mexico, Brazil, and Puerto Rico. Americas Breg consists of
Breg's domestic and independent international distributor operations.
International Orthofix consists of operations, existing prior to the acquisition
of Breg, which are located in the rest of the world as well as independent
export distribution operations. Group Activities are comprised of the Parent's
operating expenses and identifiable assets.
33
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 bracing products, prescribed by a
physician, we recognize revenue when the product is placed on and accepted by
the patient. For sales to commercial customers, including hospitals and
distributors, revenues are recognized at the time of shipment unless contractual
agreements specify FOB destination. 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 market 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
We adopted the provisions of SFAS No. 142, "Goodwill and Other
Intangible Assets," effective January 1, 2002. The ongoing impact was that
goodwill and indefinite lived intangible assets are no longer amortized, but
instead 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 issues with the
carrying value of goodwill or indefinite lived intangible assets as of December
31, 2004.
34
Litigation and Contingent Liabilities
From time to time, we and our operations 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.
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.
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,
--------------------------------------------------------------
2004 2003 2002
---- ---- ----
(%) (%) (%)
Net sales........................... 100 100 100
Cost of sales....................... 28 25 25
Gross profit........................ 72 75 75
Operating expenses
Sales and marketing .............. 36 38 36
General and administrative........ 11 10 10
Research and development.......... 4 4 4
Amortization of intangible assets. 2 -- --
Litigation and settlement costs.. -- 3 --
Total operating income.............. 19 20 24
Net income.......................... 12 12 15
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.
35
Business Segment:
Year ended December 31,
(In US$ thousands)
2004 2003 2002
-------------------------- ----------------------------- ----------------------------
Percent of Percent of Percent of
Total Net Total Net Total Net
Net Sales Sales Net Sales Sales Net Sales Sales
----------- ------------- -------------- ------------- -------------- -------------
Americas Orthofix $125,972 44% $116,848 57% $102,850 58%
Americas Breg 68,294 24% -- -- -- --
International Orthofix 92,372 32% 86,859 43% 74,745 42%
----------- ------------- -------------- ------------- -------------- -------------
Total $286,638 100% $203,707 100% $177,595 100 %
=========== ============= ============== ============= ============== =============
Our revenues are generally derived from two primary sources: sales of
orthopedic and non-orthopedic products. Orthopedic products are sold into three
market sectors, Spine, Reconstruction and Trauma. Sales of non-orthopedic
products include the Laryngeal Mask product, woman's care and other products.
Market Sector:
Year ended December 31,
(In US$ thousands)
2004 2003 2002
-------------------------- ----------------------------- ----------------------------
Percent of Percent of Percent of
Total Net Total Net Total Net
Net Sales Sales Net Sales Sales Net Sales Sales
----------- ------------- -------------- ------------- -------------- -------------
Orthopedic
Spine $81,375 28% $ 79,552 39% $ 69,613 39%
Reconstruction 120,935 42% 51,183 25% 43,838 25%
Trauma 62,892 22% 53,706 26% 46,551 26%
----------- ------------- -------------- ------------- -------------- -------------
Total Orthopedic 265,202 92% 184,441 90% 160,002 90%
Non-Orthopedic 21,436 8% 19,266 10% 17,593 10%
----------- ------------- -------------- ------------- -------------- -------------
Total $286,638 100% $203,707 100% $177,595 100%
=========== ============= ============== ============= ============== =============
36
2004 Compared to 2003
Sales by Business Segment:
Net sales increased 41% to $286.6 million in 2004, which included $68.3
million of net sales attributable to Americas Breg, compared to $203.7 million
in 2003. The impact of foreign currency increased sales by $6.5 million in 2004
when compared to 2003.
Net sales in Americas Orthofix (the "Americas") increased 8% to $126.0
million in 2004 compared to $116.8 million in 2003. The Americas net sales
represented 44% and 57% of our total net sales in 2004 and 2003, respectively.
The Americas experienced growth in all market sectors, led by a 23% increase in
trauma products. The following table illustrates sales by market sector in the
Americas:
2004 2003
(In thousands) Net Sales Net Sales Growth
--------- --------- ------
Orthopedic
Spine $ 81,190 $ 79,453 2%
Reconstruction 7,318 6,775 8%
Trauma 36,058 29,242 23%
--------- ---------
Total Orthopedic 124,566 115,470 8%
Non-Orthopedic 1,406 1,378 2%
--------- ---------
Americas Orthofix $125,972 $116,848 8%
========= =========
Net sales in Americas Breg ("Breg") were $68.3 million in 2004 which
represented 24% of total net sales in 2004. Breg was acquired on December 30,
2003; therefore there are no sales for Breg for the comparable period of the
prior year. All of Breg's sales are recorded in our Reconstruction Market
Sector. On a pro forma basis Breg sales increased 10% when compared to 2003 and
would have represented 25% of our total net sales in 2003.
Net sales in International Orthofix ("International") increased 6% to
$92.4 million in 2004 from $86.9 million in 2003. International net sales
represented 32% and 43% of our total net sales in 2004 and 2003, respectively.
The primary factors that led to this increase were currency, increased sales of
external fixation products, strong start-up sales of the PC.C.P hip fracture
fixation system and growth of non-orthopedic airway management products; these
were partially offset by a decrease in sales of the A-V Impulse system,
primarily the Impad component. The decrease in A-V Impulse system sales was due
to a combination of lower contract pricing, a more competitive environment and
inventory balancing in the second quarter by our primary customer in the United
States. The impact of foreign currency increased International sales by $6.7
million for 2004, primarily as a result of a stronger Euro and U.K. Pound
against the U.S. Dollar. On a constant currency basis, International net sales
would have been down 1%. The following table illustrates sales by market sector
in International:
2004 2003
(In thousands) Net Sales Net Sales Growth
--------- --------- ------
Orthopedic
Spine $185 $99 87%
Reconstruction 45,534 44,408 3%
Trauma 26,623 24,464 9%
--------- ---------
Total Orthopedic 72,342 68,971 5%
Non-Orthopedic 20,030 17,888 12%
--------- ---------
International Orthofix $92,372 $86,859 6%
========= =========
37
Sales by Market Sector:
Net sales of our spine products grew 2% to $81.4 million in 2004 from
$79.6 million in 2003. Sales of stimulation products for spine applications, the
main component of our Spine Market Sector, increased 4% when compared to the
same period of the prior year. This Market Sector was negatively impacted by
reimbursement issues relating to our Orthotrac and EZ Brace products. A change
in the reimbursement for the EZ Brace product has had a negative impact on the
period-over-period sales for this product. On December 28, 2004, we announced
FDA approval for the Cervical-Stim, the first and only `on-label' bone growth
stimulator for use as an adjunct to cervical (upper) spine fusions in `high
risk' patients. We expect this approval will positively impact the growth of
this Market Sector in future periods. We also acknowledge that reimbursement
issues, emerging new technologies, including BMP's, and increased competitive
activity for spinal stimulators could negatively impact growth in this Market
Sector.
Net sales of our reconstruction products increased 136% to $120.9
million in 2004 from $51.2 million in 2003. This increase is primarily
attributable to the sales of Breg products, classified as reconstruction
products, which totaled $68.3 million in 2004. Sales of our external fixation
products used in reconstruction applications increased 32%, which also
contributed to the year-over-year growth in this Market Sector. This Market
Sector was negatively impacted in 2004 by lower sales of the A-V Impulse system,
discussed above, which decreased 14% when compared to 2003.
Net sales of our trauma products increased 17% to $62.9 million in 2004
from $53.7 million in 2003. This Market Sector benefited from an 11% growth in
sales of external fixation products used for trauma applications, a 21% growth
in sales of stimulation products used for long bone applications, and strong
start-up sales of the PC.C.P hip fracture fixation system.
Net sales of our non-orthopedic products grew 11% to $21.4 million in
2004 from $19.3 million in 2003. This Market Sector continues to be driven by
the airway management products, including a new single-use version of the
Laryngeal Mask which we distribute in the United Kingdom, Ireland and Italy.
Gross Profit -- Gross profit increased 36% to $207.5 million in 2004
from $152.6 million in 2003, primarily due to the increase of 41% in net sales,
including the addition of Breg sales. Gross profit as a percentage of net sales
in 2004 was 72.4% compared to 74.9% in 2003, reflecting the impact of the
inclusion of Breg with lower gross margins (64%) relative to pre-Breg gross
profit margins, purchase accounting and foreign currency. Although currency
contributed $6.5 million to sales growth, the year-over-year appreciation of the
Euro and the U.K. Pound against the U.S. dollar has been detrimental to our
gross profit and gross profit margin in those situations where we produce
products whose costs are denominated in Euros and Pounds and are sold in U.S.
dollars.
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 $25.7
million to $102.5 million in 2004 from $76.8 million in 2003, an increase of 33%
on a sales increase of 41%. The incremental increase is primarily the result of
the addition of Breg marketing and sales costs, for which there are no
comparable costs in 2003 and the impact of currency. Sales and marketing
expenses as a percentage of net sales decreased to 35.7% in 2004 from 37.7% in
2003. The decrease as a percent of net sales is primarily associated with our
new Breg segment, which carries a lower sales and marketing expense as a percent
of net sales than the Company has experienced in prior years.
General and Administrative Expenses -- General and administrative
expenses increased $10.1 million to $30.6 million from $20.5 million in 2003.
This increase is primarily attributable to the additional general and
administrative expenses of Breg for which there are no comparable costs in the
same period of the prior year, purchase accounting adjustments from the
acquisition of Breg for the depreciation of step-up in the value of fixed assets
acquired, and the acquisition of a Puerto Rico distributor, for which there are
no comparable costs in 2003. We also incurred incremental internal and external
costs associated with the successful compliance with Section 404 of the
Sarbanes-Oxley Act of 2002 and additional legal costs associated principally
with the addition of new distribution.
38
Research and Development Expenses -- Research and development expenses
increased $3.4 million to $11.5 million in 2004 from $8.1 million in 2003, an
increase of 42%, and remained constant as a percentage of net sales at 4%.
Approximately $2.9 million of this increase is attributable to expense related
to Breg, for which there are no comparable expenses in 2003.
Amortization of Intangible Assets -- Amortization of intangible assets
was $6.3 million in 2004 compared to $1.0 million in 2003. The increase in
amortization expense of approximately $5.1 million was due to the amortization
of the intangible recorded for the distribution network acquired in the Breg
acquisition.
Litigation and Settlement Costs -- Litigation and settlement costs for
our case against Kinetic Concepts, Inc. ("KCI") was $1.6 million in 2004
compared to $4.0 million in 2003. Further, in 2003, we incurred $1.7 million of
settlement costs to conclude the investigation by the Office of Inspector
General into the appropriateness of claims made to federal health care programs
for the off-label use of our FDA approved pulsed electronic magnetic field
device, and billing and coding for its off-label use. We expect to incur KCI
litigation costs in 2005 at approximately the same level as 2004. See Item 3 -
"Legal Proceedings" for a description of the legal proceedings.
Interest Income (Expense), Net -- Interest income (expense), net was an
expense of $6.0 million in 2004 compared to an expense of $0.2 million in 2003.
We incurred interest expense on borrowings under our senior secured term loan of
$5.5 million which included the amortization of debt costs and current year
expenses associated with maintaining the term loan. We also incurred $0.5
million of expense relating to withholding taxes paid by us on a portion of the
interest expense associated with the term loan. Additional interest expense of
$0.3 million was incurred on borrowings under a line of credit in Italy. We also
generated $0.3 million of interest income on cash deposits.
Other Income (Expense), Net -- Other income (expense), net was income
of $1.7 million in 2004 compared to an expense of $0.7 million in 2003. In 2004,
other income was generated by the sale of a facility that resulted in a gain of
approximately $0.6 million. The sale of this facility was part of a
consolidation plan in the United Kingdom. We also experienced 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 partially offset by other various transactional foreign
currency losses associated with the Euro and the U.K. Pound.
Loss in Joint Venture, Net -- Loss in joint venture, net was a net loss
of $0.3 million in 2004 compared to a net loss of $1.8 million in 2003. During
2004, we sold part of our ownership in the OrthoRx joint venture to our partner
Ferrer Freedman & Company; 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, 2004 our
ownership percentage in the joint venture was 21.7% and our investment in the
joint venture had been reduced to zero.
Income Tax Expense -- In 2004 and 2003, the effective tax rate was
32.2% and 37.1%, respectively. The effective tax rate in 2004 was reduced by the
following: (i) the non-taxable gain recorded on the sale of OrthoRx shares; (ii)
lower spending on the KCI case (which occurs in a low tax jurisdiction); and
(iii) inherent tax benefits resulting from the financing structure of our senior
secured term loan obtained in conjunction with the Breg acquisition.
Net Income -- Net income for 2004 was $34.1 million compared to $24.7
million in 2003, an increase of 38%. Net income was $2.22 per basic share and
$2.14 per diluted share in 2004, compared to $1.76 per basic share and $1.68 per
diluted share for 2003, an increase in diluted earnings per share of 27%. The
weighted average number of basic common shares outstanding was 15,396,540 and
14,061,447 during 2004 and 2003, respectively. The weighted average number of
diluted common shares outstanding was 15,974,945 and 14,681,833 during 2004 and
2003, respectively.
39
2003 Compared to 2002
Sales- Net sales increased 15% to $203.7 million in 2003 from $177.6
million in 2002.
Net sales by business segment in the Americas (primarily in the United
States) increased 14% to $116.8 million in 2003 compared to $102.9 million in
2002. The Americas net sales represented 57% and 58% of our total net sales in
2003 and 2002, respectively. The increase in net sales for 2003 was due to
strong growth in the United States (14%) and Brazil (11%) of net sales in all
orthopedic product market sectors. This increase was slightly offset by a
decrease in net sales of non-Orthofix products in Mexico where we are
discontinuing the distribution of certain non-Orthofix products.
Net sales in International increased 16% to $86.9 million in 2003 from
$74.7 million in 2002. International net sales represented 43% and 42% of our
total net sales in 2003 and 2002, respectively. The incremental impact of
foreign exchange rates on International sales was to increase International net
sales by $7.6 million or approximately 10% for 2003, primarily as a result of a
stronger Euro and U.K. Pound against the U.S. Dollar. Net of foreign currency
impact, International sales were up in all International subsidiaries except
Orthosonics, our bone cement removal business, with the largest increases in
France (24%) and in our A-V Impulse business (14%).
All of our market sectors experienced strong net sales growth in 2003.
Sales of Spine products grew 14% to $79.6 million in 2003 from $69.6 million in
2002, with the sale of Spinal-Stim bone growth stimulation products growing
approximately 17% in 2003 over 2002. Increased sales of spinal stimulation
resulted principally from an increase in the volume of stimulators sold and from
the renewal of our distribution agreement with Medtronic Sofamor Danek. We
estimate that the renewed distribution agreement had the effect of increasing
sales by $5.9 million in 2003. Approval and introduction of BMPs by Medtronic
Sofamor Danek have begun to show some 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. In
2002, Medtronic Sofamor Danek Group conducted clinical studies with BMPs.
Participation of physicians in the clinical studies had an adverse impact on our
stimulation product sales growth in the second half of 2002. Although product
sales growth returned to historic product growth rates in 2003, as physicians
participate in further clinical studies with BMPs, it could have a further
adverse impact on stimulation product sales. Although BMPs are considered or
classified as a bone growth material, they have yet to be clinically proven to
be effective in high-risk patients. Our sales of Reconstruction products grew
17% to $51.2 million in 2003 from $43.8 million in 2002, primarily due to sales
of our A-V Impulse system, which grew 14% in 2003, as well as from sales of
ExFix products for Reconstruction such as the Sheffield ring system and several
International distribution products all experienced strong double digit rates of
growth. Sales of Trauma products grew 15% to $53.7 million in 2003 from $46.6
million in 2002. Sales of our Physio-Stim bone growth stimulator for long bone
non-unions grew approximately 21% in 2003 over 2002 while ExFix products for
Trauma grew approximately 13%. Sales of Non-Orthopedic products, principally the
Laryngeal Mask which we distribute in the United Kingdom, Ireland and Italy,
grew by 9% to $19.2 million in 2003 from $17.6 million in 2002.
Gross Profit -- Our gross profit increased 15% to $152.6 million in
2003 from $132.8 million in 2002, primarily due to the increase in net sales of
15%. Gross profit as a percentage of net sales increased slightly to 74.9% in
2003 from 74.8% in 2002. The increase in gross profit as a percentage of net
sales was the result of a higher growth rate in higher margin bone growth
stimulation product sales, including the renewal of our distribution agreement
with Medtronic Sofamor Danek, the favorable impact of additional direct
distribution and continuing improvement in manufacturing efficiencies in our
United States operations. These positive impacts were partially offset by a
negative foreign currency impact. Although foreign currency contributed $7.6
million to our International sales growth, the year-over-year appreciation of
the Euro and the U.K. Pound against the U.S. Dollar increased production costs
of external fixation and vascular products, which was detrimental to our gross
profit and gross profit margin in those situations where we sell these products
in U.S. dollars.
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 $12.4
million to $76.8 million in 2003 from $64.4 million in 2002, an increase of 19%
on a sales increase of 15%. Sales and marketing expenses as a percentage of net
sales increased to 37.7% in 2003 from 36.3% in 2002. The 1.4% increase in 2003
reflects the negative impact of foreign currency on International operating
expenses, higher
40
commissions on stimulation sales under the terms of our renewed
distribution agreement with Medtronic Sofamor Danek and additional costs to
support the hiring of additional sales people and the launch of new products.
The PC.C.P product was launched in the International market in the second
quarter and on a limited basis in the United States in the third quarter. In
connection with the launch of the PC.C.P product, we conducted a large training
seminar for surgeons in Verona, Italy and a training seminar for U.S. surgeons
in Chicago. Further, we conducted training meetings for the sales force in
Europe and the United States.
General and Administrative Expenses -- General and administrative
expenses increased $3.3 million to $20.5 million from $17.2 million in 2002.
General and administrative expenses increased as a percentage of net sales to
10.0% in 2003 from 9.7% in 2002. The 0.3% increase in 2003 also reflects the
negative impact of foreign currency on International operating expenses. In
addition, we incurred additional expenses associated with becoming a U.S. SEC
registrant and with building administrative support in our direct sales
organizations in Europe and Mexico.
Research and Development Expenses -- Research and development expenses
increased $0.6 million to $8.1 million in 2003 from $7.5 million in 2002, an
increase of 8%, and decreased slightly as a percentage of net sales to 4.0% in
2003 from 4.2% in 2002. Research and development decreased as a percent of net
sales in 2003 as a result of a decrease in clinical study spending in our
International unit.
Amortization of Intangible Assets -- Amortization of intangible assets
was $1.0 million in 2003 compared to $0.7 million in 2002. Amortization of
intangible assets consists principally of the amortization of patents and
trademarks.
Litigation and Settlement Costs -- Based on an assessment of the merits
of our case against Kinetic Concepts, Inc. ("KCI"), we incurred $4.0 million in
litigation costs in 2003 compared to no expense in 2002. We also incurred $1.7
million of settlement cost to conclude the investigation by the Office of
Inspector General into the appropriateness of claims made to federal health care
programs for the off-label use of our FDA approved pulsed electronic magnetic
field device, and billing and coding for its off-label use. See Item 3 - "Legal
Proceedings" for a description of the legal proceedings. We expect to incur
additional KCI litigation costs in 2004, but at a lower rate than they were
incurred in 2003.
Interest Income (Expense), Net -- Interest income (expense), net was an
expense of $0.2 million in 2003 compared to income of $0.2 million in 2002.
Other Income (Expense), Net -- Other income (expense), net was income
of $0.7 million in 2003 compared to an expense of $0.6 million in 2002. The
increase in income was a result of a gain on foreign exchange transactions in
2003 of $0.4 million, compared with a loss in 2002 of $0.6 million, resulting in
net improvement of $1.0 million. We also realized an additional $0.4 million
gain on the sale of available-for-sale marketable securities.
Loss in Joint Venture, Net -- Loss in joint venture, net was a net loss
of $1.8 million in 2003 compared to a net loss of $2.1 million in 2002. These
losses represented our share of losses in the OrthoRx joint venture, an
improvement of $0.3 million from 2002.
Income Tax Expense -- In 2003 and 2002, the effective tax rate was 37%
and 32%, respectively. The effective tax rate in 2003 was negatively impacted by
3.1% as a result of the KCI litigation expenses, a majority of which was not
deductible for income tax purposes. Our effective tax rate was also affected by
the fact that a larger proportion of pre-tax earnings was earned in the United
States, a relatively higher tax jurisdiction.
Net Income -- Net income for 2003 was $24.7 million, or $1.76 per basic
share and $1.68 per diluted share, compared to $25.9 million, or $1.96 per basic
share and $1.76 per diluted share, for 2002, a decrease in net income of 5%. The
weighted average number of basic common shares outstanding was 14,061,447 and
13,196,524 during 2003 and 2002, respectively. The weighted average number of
diluted common shares outstanding was 14,681,833 and 14,685,236 during 2003 and
2002, respectively.
41
Liquidity and Capital Resources
Cash and cash equivalents at December 31, 2004 were $40.2 million, of
which $14.3 million is subject to certain restrictions under the senior secured
credit agreement described below. This compares to $31.4 million at December 31,
2003, an increase of $8.8 million.
Net cash provided by operating activities was $27.5 million in 2004
compared to $31.5 million in 2003, a decrease of $4.0 million. Net cash provided
by operating activities is comprised of net income, non-cash items and changes
in working capital including changes in restricted cash. Net income increased
approximately $9.4 million to $34.1 million in 2004 from $24.7 million in 2003.
Non-cash items increased $1.5 million in 2004 compared to 2003, primarily as a
result of the increased depreciation and amortization expense of $5.5 million
associated with the application of purchase accounting to the assets acquired in
the Breg acquisition partially offset by a decrease in losses or equity
investments and an increase in deferred tax benefits. Working capital accounts
consumed $25.0 million of cash in 2004 compared to the use of $10.0 million in
cash during 2003. The principal use of cash for working capital in 2004 was the
designation of $14.3 million of cash as restricted cash. The restricted cash is
held at Colgate Medical Limited and its subsidiaries and is restricted in
conjunction with the Company's senior secured credit facility. The cash is only
restricted from being dividend, advanced or loaned to the parent company. All
other subsidiaries of the Orthofix Group have access to this cash for
operational purposes. The other uses of cash for working capital in 2004 were
accounts receivable of $6.7 million and the final payout pursuant to the
Agreement and Plan of Merger among the Company and American Medical Electronics,
Inc. The aggregate amount of the payout was $5.6 million which had previously
been fully reserved. Increases in accounts receivable stem principally from the
increase in year-over-year sales and an increase in Italian receivables. As
expected, we factored approximately $5.4 million in Italian receivables in the
fourth quarter of 2004 and our Italian accounts receivable are consistent with
published DSO statistics for Italian healthcare suppliers. Overall performance
indicators of our two primary working capital accounts, accounts receivable and
inventory, reflect days sales in receivables of 94 days at December 31, 2004
compared to 123 days (94 days on a pro forma basis including Breg) at December
31, 2003 and inventory turnover of 2.5 times at December 31, 2004 compared to
1.7 times (2.5 times on a pro forma basis including Breg) at December 31, 2003.
Net cash used in investing activities was $11.4 million during 2004,
compared to $155.5 million during 2003. During 2004, we paid $1.1 million as
part of the consideration for the purchase of a Puerto Rican distributor.
Capital expenditures in 2004 were approximately $7.5 million for tangible assets
and $4.7 million for intangible assets, including a payment of $4.0 million to
purchase the technology of the PC.C.P hip fracture fixation system. In 2004, we
also purchased the remaining 30% minority interest in our Switzerland
subsidiary, Orthofix AG, for approximately $0.5 million. Further, in 2004 we
paid $1.0 million for transaction fees associated with the acquisition of Breg.
During 2004 we received $1.3 million from the sale of shares in the OrthoRx
joint venture, $1.6 million from the sale of a facility in the UK, and $0.4
million from a contract settlement in Mexico. During 2003, we purchased the
remaining 48% minority interest in our UK distribution company for $20.6
million, invested $1.5 million to take an equity interest in Innovative Spinal
Technologies (IST), invested an additional $1.5 million in the OrthoRx joint
venture and on December 30, 2003 completed the acquisition of Breg for $150.0
million plus closing adjustments and transaction costs totaling approximately
$6.3 million. In addition we invested $5.2 million in capital expenditures.
In 2005, we anticipate the use of cash for tangible and intangible
capital expenditures will be approximately $12.2 million compared to $12.2
million in 2004.
Net cash used in financing activities was $22.1 million in 2004
compared to cash provided by financing activities of $106.6 million in 2003. In
2004, we received proceeds of $12.2 million from the issuance of 731,933 shares
of our common stock upon the exercise of stock options, warrants and shares
purchased pursuant to our employee stock purchase plan. In 2004, we repaid
approximately $33.3 million against the principal of the senior secured term
loan obtained to help finance the Breg acquisition, paid $0.2 million against
other outstanding debt. Further in 2004, we paid $0.5 million for costs
associated with obtaining the senior secured term loan and paid $0.3 million for
costs associated with an amendment to the senior secured term loan, which will
be amortized over the remaining term of the credit facility. The majority of the
financing activity in 2003 resulted from the completion of a senior secured term
loan for $110.0 million obtained in conjunction with the Breg acquisition.
42
When we acquired Breg on December 30, 2003, one of our wholly owned
subsidiaries, Colgate Medical Limited ("Colgate"), entered into a senior secured
bank credit facility with a syndicate of financial institutions to finance the
transaction. The senior secured bank facility provides for (1) a five-year
amortizing term loan facility of $110.0 million, the proceeds of which were used
for partial payment of the purchase price of Breg; and (2) a five-year revolving
credit facility of $15.0 million. As of December 31, 2004 and as of March 11,
2005, we had no amounts outstanding under the revolving credit facility and
$76.8 million outstanding under the term loan facility. Obligations under the
senior secured bank facility have a floating interest rate of LIBOR or prime
rate plus a margin, currently LIBOR plus 2.00%, which is adjusted quarterly
based on Colgate's leverage ratio. In May 2004 we entered into a three year
fully amortizable interest rate swap agreement (the "Swap") with a notional
amount of $50.0 million and an expiration date of June 27, 2007. The amount
outstanding under the Swap as of December 31, 2004 was $41.6 million. Under the
Swap we will pay a fixed rate of 3.16% and receive interest at floating rates
based on the three month LIBOR rate at each quarterly re-pricing date until the
expiration of the Swap. As of December 31, 2004 the interest rate on the debt
related to the Swap was 5.16% (3.16% plus a margin of 2.00%). Our effective
interest rate, including the impact of the Swap, as of December 31, 2004 on our
senior secured debt was 4.88%. Orthofix and each of Colgate's direct and
indirect subsidiaries, including Orthofix Inc. and Breg, have guaranteed the
obligations of Colgate under the senior secured bank facility. The obligations
of Colgate under the senior secured bank facility and Colgate's subsidiaries
under their guarantees are secured by the pledges of their respective assets.
Certain of our other subsidiaries have also guaranteed the obligations of
Colgate under the senior secured bank facility on a limited recourse basis.
During 2004, Colgate entered into an amendment of the term loan
facility. The amendment reduced the interest rate applicable to borrowings under
the term loan facility by reducing the initial interest rate of LIBOR plus 2.75%
to LIBOR plus 2.25%. During the third quarter of 2004 we made an additional
voluntary prepayment of $10.4 million on the borrowings under the term loan
facility. The amendment along with this prepayment further reduced the interest
rate to LIBOR plus 2.0% upon delivering our third quarter compliance report to
the lender's administrative agent that evidenced our attainment of a leverage
ratio threshold that reduced the interest rate.
The credit agreement relating to the senior secured bank facility
contains customary negative covenants applicable to Colgate and its
subsidiaries, including restrictions on indebtedness, liens, dividends, mergers
and the sale of assets. The credit agreement also contains certain financial
covenants, including a fixed charge coverage ratio, an interest coverage ratio
and a leverage ratio applicable to Colgate and its subsidiaries on a
consolidated basis, and a leverage ratio applicable to Orthofix and its
subsidiaries on a consolidated basis. We have assessed our compliance with the
financial covenants as of December 31, 2004, as required by the credit
agreement, and note that we are in compliance with all financial covenants.
At December 31, 2004, we had outstanding borrowings of $0.1 million and
unused available lines of credit of approximately $11.4 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 operating
capital needs and research and development costs over the near term.
43
Contractual Obligations
The following chart sets forth our contractual obligations as of
December 31, 2004:
Contractual Obligations Payments Due By Period
- ----------------------------------------------------------------------------------------------------------------
(Dollars in thousands) Total Less Than 1 to 3 4 to 5 Over 5
1 Year Years Years Years
------- ---------- -------- ------- -------
Senior secured term loan $76,750 $ 9,700 $67,050 $ - $ -
Other borrowings 556 357 199 - -
Operating Leases 15,320 3,509 5,250 3,652 2,909
------- ---------- -------- ------- -------
Total $92,626 $13,566 $72,499 $3,652 $2,909
In addition to scheduled contractual obligations of the debt as set
forth above, our senior secured bank facility requires us to make mandatory
prepayments with (a) the excess cash flow (as defined in the credit agreement)
of Colgate and its subsidiaries in an amount initially equal to 75% of the
excess annual cash flow of Colgate and its subsidiaries, reducing to 50% upon
the attainment of a leverage ratio of less than or equal to 1.50 to 1.00, (b)
the net cash proceeds of any debt or equity issuances, excluding the exercise of
stock options, by any of the Credit Parties (as defined in the credit
agreement), (c) the net cash proceeds of asset dispositions over a minimum
threshold, or (d) unless reinvested, insurance proceeds or condemnation awards.
During 2004, we voluntarily prepaid $23.0 million which was applied to the
excess annual cash flow obligation. After applying the voluntary prepayments, we
have no additional obligation under the excess cash flow provision as of and for
the period ended December 31, 2004.
Off-balance Sheet Arrangements
As of December 31, 2004 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.
44
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,
2004, we had an interest rate hedge transaction in place that swapped variable
rate debt for a fixed rate. See Item 7 - "Management's Discussion and Analysis
of Financial Condition and Results of Operation - Liquidity and Capital
Resources".
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, 2004, we had $76.8 million of variable rate debt
represented by borrowings under our senior secured term loans at an interest
rate of 4.55% of which $41.7 million was swapped for fixed rate debt at an
interest rate of 5.16%. Based on the balance outstanding under the credit
facility as of December 31, 2004 and the swap agreement, 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 $0.4
million on an annual basis. The fair value of the interest rate swap agreement
was $0.1 million at December 31, 2004.
Our foreign currency exposure results from fluctuating currency
exchange rates, primarily the U.S. Dollar against the Euro, Great Britain Pound,
Mexican Peso and Brazilian Real. We face cost of goods currency exposure when we
produce products in foreign currencies such as the Euro or Great Britain Pound
and sell those products in U.S. Dollars. We face transactional currency
exposures when foreign subsidiaries (or the Company itself) enter into
transactions, generally on an intercompany basis, denominated in currencies
other than their functional currency. 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 2004 and 2003 by foreign currency exchange rate
fluctuations with the weakening of the U.S. dollar against the local foreign
currency in 2004 and 2003. The U.S. dollar equivalent of the related costs
denominated in these foreign currencies was unfavorably impacted in 2004 and
2003. 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. Historically, we have not used financial derivatives to
hedge against fluctuations in currency exchange rates.
Item 8. Financial Statements and Supplementary Data
- ----------------------------------------------------
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, 2004, 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. There were no changes in our company's internal control over financial
reporting that occurred during the fourth quarter of 2004
45
that have materially affected, or are reasonably likely to materially affect,
our company's 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.
46
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 and Executive Officers of the Registrant
- ------------------------------------------------------------
The following table sets forth certain information about the persons
who serve as our directors and executive officers.
Name Age Position
- ---- --- --------
James F. Gero 60 Chairman of the Board of Directors
Charles W. Federico 56 Chief Executive Officer, President and Director
Thomas Hein 57 Chief Financial Officer
Gary D. Henley 56 Senior Vice President and President, Americas Division
Galvin Mould 59 Vice President and President, International Division
Bradley R. Mason 51 Vice President and President, Breg, Inc.
Raymond C. Kolls 42 Vice President, General Counsel and Corporate Secretary
Robert Gaines-Cooper 67 Director
Jerry C. Benjamin (2) 64 Director
Peter J. Hewett 69 Director
Walter von Wartburg (1) 65 Director
Thomas J. Kester (1) (2) 58 Director
Kenneth R. Weisshaar (2) 54 Director
Guy Jordan (1) 56 Director
Stefan Widensohler (1) 45 Director
- --------------
(1) Member of the Compensation Committee
(2) Member of the Audit 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 and served from 1995 to
1998 as a Director of Orthofix Inc. He is the Chairman and Chief Executive
Officer of Sierra Technologies Inc., and a Director of each of Intrusion, Inc.,
Drew Industries Inc., and Greenleaf Inc., and Chairman of Thayer Aerospace.
Charles W. Federico. Mr. Federico became a Director of Orthofix
International N.V. in October 1996 and was the President of Orthofix Inc. from
October 1996 to January 1, 2002. On January 1, 2001, Mr. Federico was appointed
President and Chief Executive Officer of Orthofix International N.V. 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, Air Products Corporation, Puritan Bennett Corporation and LSE
Corporation.
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
47
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.
Gary D. Henley. Mr. Henley joined Orthofix International N.V. in
January 1997 as Senior Vice President. On January 1, 2002, Mr. Henley succeeded
Mr. Federico as President of Orthofix Inc. Prior to joining Orthofix, Mr. Henley
was President of Smith and Nephew Video Division from 1987 until 1996. Mr.
Henley was founder and President of Electronic Systems Inc. from 1975 to 1984
and CeCorp Inc. from 1984 until 1987.
Galvin Mould. Mr. Mould became Vice President and President of the
International Division of Orthofix International N.V. on January 1, 2004. He
joined Orthofix in 1995 as Managing Director of Intavent Orthofix Ltd. Prior to
joining Orthofix, Mr. Mould served in several Director of Sales and Marketing
Positions in the healthcare market, lastly with Zimmer.
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 20 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. Mr. Kolls became Vice President, General Counsel and
Corporate Secretary of Orthofix International N.V. on July 1, 2004. Prior to
joining Orthofix, Mr. Kolls was Associate General Counsel for CSX Corporation.
Mr. Kolls began his legal career as an attorney in private practice with Morgan,
Lewis & Brockius.
Robert Gaines-Cooper. Mr. Gaines-Cooper is one of the founders of
Orthofix and stepped down as Chairman of Orthofix International N.V. on January
1, 2005. He became Chairman of Orthofix International N.V. in 1989 and has been
a Director of Orthofix International since our formation in 1987. He is Managing
Director of Chelle Medical Ltd, Seychelles. Mr. Gaines-Cooper is also Chairman
of LMA International S.A., Jersey, Channel Islands.
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. In the past, Mr. Benjamin was a Director for a number of private health
care companies.
Peter J. Hewett. Mr. Hewett has been a nonexecutive Director of
Orthofix International N.V. since March 1992. He is Chairman of the Board of
Orthofix Inc. 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.
Walter von Wartburg. Mr. von Wartburg, became a 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. In addition, Mr. von
Wartburg currently serves as a director on the board of Nymox Pharmaceutical
Corporation.
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.
48
Kenneth R. Weisshaar. Mr. Weisshaar became a non-executive Director of
Orthofix International N.V. in December 2004. Most recently, Mr. Weisshaar has
served as Chief Operating Officer and strategy advisor for Sensatex, Inc. Also,
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 business
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 boards of Digene Corporation.
Guy Jordan, Ph D. Dr. Jordan became a non-executive Director of
Orthofix International N.V. in December 2004. Most recently, 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. XillixTechnologies Corporation,
and EsophyX, Inc..
Stefan Widensohler. Mr. Widensohler became a non-executive Director of
Orthofix International N.V. in February 2005. Mr. Widensohler is the President
and Chief Executive Officer of KRAUTH medical group, a European medical supply
distributor based in Germany. 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.
49
Item 11. Executive Compensation
- --------------------------------
We will provide information that is responsive to this Item 11
regarding compensation paid to our executive officers 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 Stockholders
- --------------------
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
- --------------------------------------------------------
We will provide information that is responsive to this Item 13
regarding transactions with related parties 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.
50
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
- -------------------------------------------------------------------------
(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).
3.2 Articles of Association of the Company as Amended (filed as
an exhibit to the Company's quarterly report on Form 10-Q for
the quarter ended September 30, 2004 and incorporated herein
by reference).
10.1 Orthofix Inc. Employee Stock Purchase Plan (filed as an
exhibit to the Company's annual report on Form 10-K for the
fiscal year ended December 31, 2002 and incorporated herein
by reference).
10.2 Orthofix International N.V. Staff Share Option Plan (filed as
an exhibit to the Company's annual report on Form 10-K for
the fiscal year ended December 31, 2002 and incorporated
herein by reference).
10.3 Form of Performance Accelerated Stock Option under the Staff
Share Option Plan (filed as an exhibit to the Company's
annual report on Form 10-K for the fiscal year ended
December 31, 2002 and incorporated herein by reference).
10.4 Form of Performance Accelerated Stock Option Inducement
Agreement (filed as an exhibit to the Company's annual report
on Form 10-K for the fiscal year ended December 31, 2003 and
incorporated here in by reference).
10.5 Orthofix International N.V. 2004 Long Term Incentive Plan, as
amended (filed as an exhibit to the Company's quarterly
report on Form 10-Q for the quarter ended September 30, 2004
and incorporated herein by reference).
10.6 * Form of Nonqualified Stock Option Agreement Under the
Orthofix International N.V. 2004 Long Term Incentive Plan.
10.7 * Form of Nonqualified Stock Option Agreement for Non-Employee
Directors under the Orthofix International N.V. 2004 Long
Term Incentive Plan.
10.8 Employment Agreement, dated as of July 1, 2001, between
Orthofix International N.V. and Charles W. Federico (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).
10.9 Employment Agreement, dated as of March 1, 2003, between the
Company and Thomas Hein
51
(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).
10.10 Employment Agreement, dated as of March 1, 2003, between the
Company and Gary D. Henley (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).
10.11 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, 2003 and incorporated herein
by reference).
10.12 Change of Control Agreement, dated as of February 18, 2005,
between Orthofix Inc. and Raymond C. Kolls (filed as an
exhibit to the Company's current report on Form 8-K filed
February 22, 2005 and incorporated herein by reference).
10.13 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).
10.14 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).
10.15 Share Purchase Agreement, dated as of March 20, 2003, between
Orthofix International N.V. and Intavent Limited (filed as an
exhibit to the Company's quarterly report of Form 10-Q for
the quarter ended June 30, 2003 and incorporated herein by
reference).
10.16 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).
10.17 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).
10.18 Credit Agreement dated as of December 30, 2003, among Colgate
Medical Limited, as borrower, and Orthofix International N.V
and certain subsidiaries of the borrower, as guarantors,
certain limited guarantors party thereto, the lenders parties
thereto, Wachovia Bank, National Association, as
administrative agent, and Wachovia Capital Markets, LLC, as
sole lead arranger and book manager (filed as an exhibit to
the Company's current report on Form 8-K filed January 8,
2004 and incorporated herein by reference).
10.19 The First Amendment dated as of September 30, 2004 of the
Credit Agreement dated as of December 30, 2003, among Colgate
Medical Limited, as borrower, and Orthofix International N.V
and certain subsidiaries of the borrower, as guarantors,
certain limited guarantors party thereto, the lenders parties
thereto, Wachovia Bank, National Association, as
administrative agent, and Wachovia Capital Markets, LLC, as
sole lead arranger and book manager (filed as an exhibit to
the Company's current report on Form 8-K filed October 6,
2004 and incorporated herein by reference).
14.1 Code of Ethics of the Company (filed as an exhibit to the
Company's annual report on Form 10-K for the fiscal year
ended December 31, 2003 and incorporated herein by
reference).
21.1* Subsidiaries of the Company.
23.1* Consent of Ernst & Young, independent auditors.
52
31.1* Rule 13a-14(a)/15d-14(a) Certification of Chief Executive
Officer.
31.2* Rule 13a-14(a)/15d-14(a) Certification of Chief Financial
Officer.
32.1* Section 1350 Certification of Chief Executive Officer.
32.2* Section 1350 Certification of Chief Financial Officer.
* Filed herewith.
(1) Management Contract or Compensatory Plan or Arrangement.
53
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 15, 2005 By: /s/ Charles W. Federico
--------------------------------
Name: Charles W. Federico
Title: Chief Executive Officer
and President
54
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/ CHARLES W. FEDERICO
------------------------------------------------ Chief Executive Officer, March 15, 2005
Charles W. Federico President and Director
/S/ THOMAS HEIN Chief Financial Officer March 15, 2005
------------------------------------------------ (Principal Accounting Officer)
Thomas Hein
/S/ JAMES F. GERO Chairman of the Board of Directors March 15, 2005
------------------------------------------------
James F. Gero
/S/ ROBERT GAINES-COOPER Director March 15, 2005
------------------------------------------------
Robert Gaines-Cooper
/S/ JERRY C. BENJAMIN Director March 15, 2005
------------------------------------------------
Jerry C. Benjamim
/S/ PETER J. HEWETT Director March 15, 2005
------------------------------------------------
Peter J. Hewett
/S/ WALTER VON WARTBURG Director March 15, 2005
------------------------------------------------
Walter von Wartbug
/S/ THOMAS J. KESTER Director March 15, 2005
------------------------------------------------
Thomas J. Kester
/s/ KENNETH R. WEISSHAAR Director March 15, 2005
------------------------------------------------
Kenneth R. Weisshaar
/s/ GUY JORDAN Director March 15, 2005
------------------------------------------------
Guy Jordan
/s/ STEFAN WIDENSOHLER Director March 15, 2005
------------------------------------------------
Stefan Widensohler
55
Index to Consolidated Financial Statements
Page
Index to Consolidated Financial Statements......................................................................F-1
Statement of Management's Responsibility for Financial Statements...............................................F-2
Management's Report on Internal Control over Financial Reporting................................................F-3
Report of Independent Registered Public Accounting Firm.........................................................F-4
Report of Independent Registered Public Accounting Firm On Management's Assessment and the Effectiveness of
Internal Control Over Financial Reporting..................................................................F-5
Consolidated Balance Sheets as of December 31, 2004 and 2003....................................................F-6
Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002......................F-7
Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2004, 2003
and 2002...................................................................................................F-8
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002......................F-9
Notes to the Consolidated Financial Statements.................................................................F-10
Schedule 1 - Condensed Financial Information of Registrant Orthofix International N.V...........................S-1
Schedule 2 -- Valuation and Qualifying Accounts.................................................................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.
F-1
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 accountants in 2004,
2003 and 2002, 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) generally accepted in the 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 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
Charles W. Federico
President, Chief Executive Officer and Director
Thomas Hein
Chief Financial Officer
F-2
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, 2004. 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.
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, 2004. 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.
F-3
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, 2004 and 2003, 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, 2004. 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 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, 2004 and 2003, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31, 2004
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, present fairly
in all material respects the information set forth therein.
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, 2004, 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, 2005 expressed an unqualified opinion
thereon.
/s/ Ernst & Young LLP
Charlotte, North Carolina
March 14, 2005
F-4
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, 2004, 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.
In our opinion, management's assessment that Orthofix International N.V.
maintained effective internal control over financial reporting as of December
31, 2004, 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, 2004, 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, 2004 and 2003, 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, 2004 of Orthofix International N.V.
and our report dated March 14, 2005 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Charlotte, North Carolina
March 14, 2005
F-5
Consolidated Balance Sheets as of December 31, 2004 and 2003
(U.S. Dollars, in thousands except share and per share data) 2004 2003
----------------- ----------------
Assets
Current assets:
Cash and cash equivalents............................................... $25,944 $31,356
Restricted cash......................................................... 14,302 -
Trade accounts receivable, less allowance for doubtful accounts of $4,195
and $4,314 at December 31, 2004 and 2003, respectively.................. 75,321 70,690
Inventories............................................................. 32,895 30,713
Deferred income taxes................................................... 4,130 3,978
Prepaid expenses........................................................ 2,490 2,865
Other current assets.................................................... 7,510 8,266
----------------- ----------------
Total current assets..................................................... 162,592 147,868
Securities and other investments......................................... 4,082 5,775
Property, plant and equipment, net....................................... 18,326 19,169
Patents and other intangible assets, net................................. 70,627 65,726
Goodwill, net............................................................ 169,329 168,397
Other long-term assets .................................................. 6,144 6,244
----------------- ----------------
Total assets............................................................. $431,100 $413,179
----------------- ----------------
Liabilities and shareholders' equity
Current liabilities:
Bank borrowings........................................................ $76 $72
Current portion of long-term debt...................................... 10,057 11,063
Trade accounts payable................................................. 8,121 9,640
Accounts payable to related parties.................................... 1,386 1,929
Other current liabilities.............................................. 25,745 30,236
----------------- ----------------
Total current liabilities.............................................. 45,385 52,940
----------------- ----------------
Long-term debt........................................................... 67,249 99,072
Deferred income taxes.................................................... 17,555 16,642
Deferred income.......................................................... 2,443 2,500
Other long-term liabilities.............................................. 1,296 1,249
------------------ -----------------
Total liabilities...................................................... 133,928 172,403
Commitments and contingencies (Notes 12 and 17)
Shareholders' equity
Common shares $0.10 par value
Authorized: 30,000,000 (2003: 30,000,000)....
Issued: 15,711,943 (2003: 14,980,010)..... 1,572 1,498
Outstanding: 15,711,943 (2003: 14,980,010)....
Additional paid-in capital 98,388 81,960
------------------ -----------------
99,960 83,458
Retained earnings...................................................... 182,073 147,924
Accumulated other comprehensive income................................. 15,139 9,394
----------------- ----------------
Total shareholders' equity............................................... 297,172 240,776
----------------- ----------------
Total liabilities and shareholders' equity............................... $431,100 $413,179
================= ================
The accompanying notes form an integral part of these consolidated financial
statements.
F-6
Consolidated Statements of Operations for the years ended December 31, 2004,
2003 and 2002
(U.S. Dollars, in thousands, except share and per share data) 2004 2003 2002
----------- ------------ ------------
Net sales...................................................... $286,638 $203,707 $177,595
Cost of sales.................................................. 79,177 51,090 44,819
----------- ------------ ------------
Gross profit.............................................. 207,461 152,617 132,776
----------- ------------ ------------
Operating expenses
Sales and marketing........................................ 102,453 76,756 64,433
General and administrative................................. 30,621 20,465 17,192
Research and development................................... 11,471 8,128 7,509
Amortization of intangible assets.......................... 6,348 995 703
Litigation and settlement costs............................ 1,568 5,689 --
----------- ------------ ------------
152,461 112,033 89,837
----------- ------------ ------------
Total operating income .................................... 55,000 40,584 42,939
----------- ------------ ------------
Other income (expense)
Interest income............................................ 341 654 813
Interest expense .......................................... (6,307) (815) (610)
Loss in joint venture...................................... (328) (1,785) (2,056)
Other, net................................................. 1,653 677 (556)
----------- ------------ ------------
Other income (expense), net.................................... (4,641) (1,269) (2,409)
----------- ------------ ------------
Income before income taxes and minority interests............ 50,359 39,315 40,530
Income tax expense............................................. (16,210) (14,585) (12,875)
----------- ------------ ------------
Income before minority interests............................. 34,149 24,730 27,655
----------- ------------ ------------
Minority interests............................................. -- -- (1,742)
----------- ------------ ------------
Net income .................................................. $34,149 $24,730 $25,913
----------- ------------ ------------
Net income per common share - basic............................ $2.22 $1.76 $1.96
----------- ------------ ------------
Net income per common share - diluted.......................... $2.14 $1.68 $1.76
----------- ------------ ------------
Weighted average number of common shares - basic............... 15,396,540 14,061,447 13,196,524
----------- ------------ ------------
Weighted average number of common shares - diluted............. 15,974,945 14,681,883 14,685,236
----------- ------------ ------------
The accompanying notes form an integral part of these consolidated financial
statements.
F-7
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 2004, 2003 and 2002
Number of Accumulated
(U.S. Dollars, in Common Additional l Treasury Other Total
thousands, except share Shares Common Paid-in Shares Retained Comprehensive Shareholders'
data) Outstanding Shares Capital (at cost) Earnings Income Equity
----------- ------ ---------- --------- --------- ------------- -------------
At December 31, 2001..... 12,802,276 $1,384 $68,466 $(22,297) $97,281 $(6,732) $138,102
Net income............... - - - 25,913 - 25,913
Other comprehensive income
Translation adjustment... - - - - - 4,635 4,635
------------
Total comprehensive income 30,548
Common shares issued..... 1,510,902 151 21,169 - - - 21,320
Shares retired from treasury - (151) (38,751) 38,902 - - -
Shares purchased for
treasury................. (677,000) - - (21,886) - - (21,886)
----------- ------ ---------- --------- --------- ------------- -------------
At December 31, 2002..... 13,636,178 1,384 50,884 (5,281) 123,194 (2,097) 168,084
Net income............... - - - - 24,730 - 24,730
Other comprehensive income
Unrealized gain on
marketable securities
(net of taxes of $112) - - - - - 185 185
Reclassification adjustment
for gains on the sale of
marketable securities.... - - - - - (341) (341)
Translation adjustment... 11,647 11,647
------------
Total comprehensive income 36,221
Common shares issued..... 769,117 73 12,988 - - - 13,061
Common shares issued in
connection with Breg
acquisition.............. 731,715 73 27,732 - - - 27,805
Shares retired from treasury (32) (9,644) 9,676 - - -
Shares purchased for
treasury.................. (157,000) - - (4,395) - - (4,395)
----------- ------ ---------- --------- --------- ------------- -------------
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
Common shares issued..... 731,933 74 16,428 - - - 16,502
----------- ------ ---------- --------- --------- ------------- -------------
At December 31, 2004..... 15,711,943 $1,572 $98,388 - $182,073 $15,139 $297,172
----------- ------ ---------- --------- --------- ------------- -------------
The accompanying notes form an integral part of these consolidated financial
statements.
F-8
Consolidated Statements of Cash Flows for the years ended December 31, 2004,
2003 and 2002
(U.S. Dollars, in thousands) 2004 2003 2002
-------- ------- ---------
Cash flows from operating activities:
Net income .......................................................... $34,149 $24,730 $25,913
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization.................................... 14,396 6,949 5,829
Amortization of debt costs....................................... 684 - -
Provision for doubtful accounts.................................. 4,266 5,192 4,980
(Gain) Loss on sale or disposal of fixed assets.................. (692) - 39
Gain on sale of equity investments............................... (834) - -
Loss on equity investments....................................... 1,162 3,504 2,156
Deferred taxes................................................... (3,874) 131 1,092
Minority interest in net income of consolidated subsidiaries..... - - 1,742
Tax benefit on non-qualified stock options....................... 3,667 1,358 863
Other............................................................ (435) (311) -
Changes in operating assets and liabilities, net of effects of
acquisitions:
Restricted cash.................................................. (14,302) - -
Accounts receivable.............................................. (6,658) (9,287) (11,567)
Inventories...................................................... (882) (435) (3,790)
Other current assets............................................. 1,427 734 2,839
Trade accounts payable........................................... (2,931) (1,024) 939
Other current liabilities........................................ (1,658) (7) (1,198)
-------- ------- ---------
Net cash provided by operating activities............................ 27,485 31,534 29,837
-------- ------- ---------
Cash flows from investing activities:
Payments made in connection with acquisitions and investments,
net of cash acquired........................................ (2,556) (150,572) (8,514)
Capital expenditures............................................. (12,243) (5,238) (7,130)
Proceeds from sale of assets and marketable securities........... 1,635 354 218
Proceeds from sale of joint venture.............................. 1,300 - -
Proceeds from settlement of distributor agreement................ 440
Other............................................................ -- - (1,330)
-------- ------- ---------
Net cash used in investing activities................................ (11,424) (155,456) (16,756)
-------- ------- ---------
Cash flows from financing activities:
Net proceeds from issue of common shares......................... 12,247 11,705 20,457
Repurchase of treasury shares.................................... -- (4,395) (21,886)
Payment of debt issuance costs................................... (821) (2,783) -
Proceeds from loans and borrowings............................... -- 110,092 3,144
Repayment of loans and borrowings................................ (33,534) (7,995) (2,028)
-------- ------- ---------
Net cash provided by (used in) financing activities.................. (22,108) 106,624 (313)
-------- ------- ---------
Effect of exchange rates changes on cash............................. 635 1,789 2,305
-------- ------- ---------
Net increase (decrease) in cash and cash equivalents................. (5,412) (15,509) 15,073
Cash and cash equivalents at the beginning of the year............... 31,356 46,865 31,792
-------- ------- ---------
Cash and cash equivalents at the end of the year..................... $25,944 $31,356 $46,865
-------- ------- ---------
Supplemental disclosure of cash flow information
Cash paid during the year for:
Interest........................................................... $5,237 $770 $683
Income taxes....................................................... $12,854 $14,546 $9,219
Non-cash investing activities
Issuance of common stock to acquire Breg, Inc........................ - $27,805 -
The accompanying notes form an integral part of these consolidated financial
statements.
F-9
Orthofix International N.V.
Notes to the consolidated financial statements
Description of business
Orthofix International N.V. and its subsidiaries (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 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. Percents of ownership at December 31, 2004
were as follows (100% owned unless otherwise noted):
Orthofix Inc. (U.S.A.)
Breg, Inc. (U.S.A.)
Orthofix Holdings Inc. (U.S.A)
Orthofix US LLC (U.S.A.)
Orthofix S.r.l. (Italy)
Novamedix Services Limited (U.K.)
Orthosonics Limited (U.K.)
Intavent Orthofix Limited (U.K.)
Colgate Medical Limited (U.K.)
Orthofix Limited (U.K.)
Orthofix UK Limited (U.K.)
Novamedix Distribution Limited (Cyprus)
Inter Medical Supplies Limited (Cyprus)
Inter Medical Supplies Limited (Seychelles)
Orthofix AG (Switzerland)
Orthofix GmbH (Germany)
Orthofix International B.V. (Holland)
Orthofix II B.V. (Holland)
Orthofix S.A. (France)
Implantes Y Sistemas Medicos, Inc. (Puerto Rico)
Orthofix do Brasil (Brazil) 89.5% owned
Promeca S.A. de C.V. (Mexico) 61.25% owned
All intercompany accounts and transactions 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.
All material intercompany transactions and profits associated with the equity
investees are eliminated in consolidation.
The results of subsidiaries acquired during the year are included in
the consolidated statements of operations from the date of their acquisition.
(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 of $0.9 million, $0.4 million, and $(0.6)
million for the years December 31, 2004, 2003, and 2002, respectively,
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
component of shareholders' equity.
F-10
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
(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.
(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. The Company does not ordinarily use
derivative instruments to hedge foreign exchange exposure. During 2004, the
Company made use of an interest rate swap agreement to manage its exposure to
fluctuations in interest rates. See Note 11 for additional information.
(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. 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.
Goodwill represents the excess of the purchase price over the fair
value of the net assets of acquired businesses and was amortized by the
straight-line method, in most cases over 15 to 20, years for all acquisitions
completed prior to June 30, 2001. Effective July 1, 2001, the Company adopted
the provisions of Statement of Financial Accounting Standards (SFAS) No. 142,
"Goodwill and Other Intangible Assets," applicable to business combinations
completed after June 30, 2001. Effective January 1, 2002, additional provisions
of SFAS No. 142 relating to business combinations completed prior to June 30,
2001 became effective and were adopted. Under the provisions of SFAS No. 142,
intangible assets deemed to have indefinite lives and goodwill are not subject
to amortization beginning January 1, 2002.
F-11
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
The Company reviews long-lived assets other than goodwill and
indefinite lived intangible assets whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. In
general, 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. The measurement for such impairment
loss is then based on the fair value of the related asset or group of assets.
(g) Revenue recognition
Revenues are recognized as income in the period in which title passes
and the products are delivered. For royalties, revenues are recognized when the
royalty is earned. Revenues for inventory delivered on consignment are
recognized as the product is accepted or used by the consignee. Revenues exclude
any value added or other local taxes, intercompany sales and trade discounts.
Revenues are reduced for estimated returns under the Company's limited guarantee
programs. Shipping and handling costs are included in cost of sales.
(h) Research and development costs
Expenditures for research and development are expensed as incurred.
(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) Concentration of credit risk
The Company performs on-going credit evaluations of its customers and
generally does not require collateral. When the Company becomes aware of a
customer's inability to meet its obligations, such as in the case of bankruptcy
filing or deterioration in the customer's financial condition, the Company
records a specific reserve to reduce the related receivable to the amount the
Company reasonably believes is collectible. The Company also records reserves
for bad debt 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 experience. The Company
maintains reserves for potential credit losses and such losses have been within
management's expectations.
The Company invests its excess cash in deposits with major banks. The
Company has not experienced any losses on its deposits.
(k) 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.
(l) 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.
F-12
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
(m) 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.
(n) 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 receivable sold without recourse are removed from the balance
sheet at the time of sale.
(o) Securities and other investments
Marketable equity securities are classified as available-for-sale. Such
securities are carried at fair value, with the unrealized gains and losses, net
of income taxes, reported as a component of shareholders' equity. Any gains or
losses from the sale of these securities are recognized using the specific
identification method.
(p) 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. Actual results could differ from these
estimates.
(q) Reclassifications
Certain prior year amounts have been reclassified to conform to the
2004 presentation. The reclassifications have no effect on previously reported
net income or shareholders' equity.
(r) Acquisition of treasury stock
The Company's practice has from time to time been to buy in its own
shares in order to enhance shareholder value. Treasury stock is held at cost
until it is retired.
(s) Stock based compensation
The Company accounts for stock based awards to employees under the
intrinsic value method in accordance with APB 25 and related interpretation.
Accordingly, the Company has adopted the disclosure only alternative of SFAS No.
148 "Accounting for Stock Based Compensation Transition and Disclosure, an
amendment of FASB statement No. 123" (SFAS No. 148). Under APB 25, no
compensation cost has been recognized for stock options issued at fair market
value under these plans. The Company does recognize compensation expense for
awards granted at less than fair market value.
F-13
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
Pro forma information regarding the Company's net income and net income
per common share for the years ended December 31, 2004, 2003 and 2002 as
required by SFAS No. 148 has been determined as if the Company had accounted for
its employee stock option plans under the fair value method of the statement.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period.
Year ended December 31,
---------------------------------------
(In thousands except per share data) 2004 2003 2002
--------- ---------- ----------
Net income
As reported $34,149 $24,730 $25,913
Add: Stock-based employee compensation expense included in reported 346 - -
net income, net related tax effect of $241
Less: Total stock-based employee compensation expense determined
under fair value method for all awards net of tax (1,741) (2,454) (2,492)
--------- ---------- ----------
Pro forma $32,754 $22,276 $23,421
Net income per common share - basic
As reported $2.22 $1.76 $1.96
Pro forma $2.13 $1.58 $1.77
Net income per common share - diluted
As reported $2.14 $1.68 $1.76
Pro forma $2.05 $1.52 $1.59
The fair value of the options under each plan is estimated on the date
of grant using the Black-Scholes option pricing model with the following
weighted average assumptions used for grants in 2004, 2003 and 2002,
respectively: dividend yield of 0%, 0% and 0%; expected volatility of 35%, 35%
and 35%; risk-free interest rates of 3.5%, 3.5% and 3.5% and expected lives of
4.50, 4.50 and 4.50 years.
(t) Recently issued Accounting Standards
In December 2004, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 123 (R),
"Share-Based Payment", a revision of FASB Statement No. 123, "Accounting for
Stock-Based Compensation". SFAS No. 123 (R) also supersedes APB Opinion No. 25,
"Accounting for Stock Issued to Employees". The revision will require companies
to recognize compensation costs based on the fair value of the equity or
liability instruments issued and to report the benefits of tax deductions in
excess of recognized compensation cost as a financing cash flow rather than as
an operating cash flow as reported in the accompanying consolidated statements
of cash flows. Statement 123 (R) covers a wide range of share-based compensation
arrangements including share options, restricted share plans, performance-based
awards, share appreciation rights, and employee share purchase plans. The
Company currently expects to adopt SFAS 123 (R) effective July 1, 2005 using the
"modified prospective" method. Under the modified prospective method,
compensation cost is recognized in the financial statements beginning with the
effective date, based on the requirements of SFAS 123 (R) for all share-based
payments granted after that date, and based on the requirements of SFAS 123 for
all unvested awards granted prior to the effective date of SFAS 123 (R). The
Company is currently evaluating the different valuation methods available to
determine the fair market value of the Company's stock options and therefore is
unable to estimate the impact of this new standard.
F-14
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
(u) 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.
(v) Advertising costs
The Company expenses all advertising costs as incurred.
(w) Derivative instruments
The Company manages its exposure to fluctuations in interest rates
within the consolidated financial statements according to a 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. In addition, 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 (1) when 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.
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. The Company's interest rate swap has been identified as
a cash flow hedge. 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.
F-15
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
(x) Other Comprehensive Income
Accumulated other comprehensive income (loss) is comprised of foreign
currency translation adjustments, the effective portion of the gain (loss) for
derivatives designated and accounted for as a cash flow hedge and unrealized
gains and losses on available for sale securities. The components of and changes
in other comprehensive income (loss) are as follows:
Unrealized Accumulated
Foreign Currency gains on Other
Translation Fair Value of marketable Comprehensive
Adjustments Derivatives securities Income/(Loss)
---------------- --------------- ------------- --------------
Balance at December 31, 2001 $(6,888) $ - $156 $(6,732)
Foreign currency translation adjustment 4,635 - - 4,635
---------------- --------------- ------------- --------------
Balance at December 31, 2002 (2,253) - 156 (2,097)
Net unrealized gains on marketable - - 185 185
securities, net of tax of $112
Reclassification adjustment for gains on the - - (341) (341)
sale of marketable securities included in net
income
Foreign currency translation adjustment 11,647 - - 11,647
---------------- --------------- ------------- --------------
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
---------------- --------------- ------------- --------------
2 Acquisitions
The following acquisitions were recorded using the purchase method of
accounting: On December 30, 2003, the Company purchased 100% of the stock of
Breg, Inc. (Breg) for a purchase price of $150 million plus closing adjustments
and acquisition costs. The acquisition and related costs were financed with $110
million of senior secured bank debt, cash on hand and the issuance of 731,715
shares of Orthofix common stock.
The acquisition has been accounted for using the purchase method in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 141
"Business Combinations". The allocation of the purchase price has been performed
based on assignment of fair values to assets acquired and liabilities assumed.
Fair values are based, in part, on appraisals performed by an independent
appraisal firm.
In accordance with SFAS No. 141, the Company has used the year to
finalize the purchase price allocation for the acquisition. The purchase price
was subject to potential upward or downward adjustments based on the difference
between the estimated and final working capital of Breg as defined in the
Acquisition Agreement. A portion of the purchase price, $12.0 million, has been
placed into escrow to fund indemnities as defined in the Acquisition Agreement.
Distributions under the Escrow Agreement are scheduled for March 1, 2005 and
December 30, 2005.
F-16
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
Allocation of the final purchase price reflects the following:
(In thousands)
Working capital, other than cash $10,712
Fixed assets acquired 5,570
Identifiable intangible assets (definite lived) 41,501
Identifiable intangible assets (indefinite lived) 23,900
Deferred tax liability (17,612)
Other 1,526
Goodwill 91,762
---------------
Total purchase price $157,359
---------------
On March 20, 2003, the Company completed the acquisition of the
remaining 48% minority interest in Intavent Orthofix Limited (IOL) for $20.6
million, including acquisition costs, with an effective date of January 14,
2003. The Company utilized an independent firm to complete a valuation of IOL.
The Company used cash on hand to complete this purchase from Intavent Limited
(Intavent). Mr. Gaines-Cooper, a Director of Orthofix, is a settlor of a trust
which owns a 30% interest in Intavent. IOL has been a fully consolidated
subsidiary and is now a wholly-owned subsidiary of the Company. The Company
recorded this additional equity purchase using the purchase method of accounting
and the impact has been included in the results of operations from the date of
acquisition. A final allocation of the purchase price reflects the settlement of
a minority interest obligation of approximately $9.9 million, identifiable
intangible assets of approximately $1.2 million and $9.5 million of additional
goodwill.
The summary pro forma condensed unaudited results of operations and
earnings per share for the years ended December 31, 2003 and 2002, assuming
consummation of the acquisitions during 2003 as of January 1, 2003 and 2002,
respectively, are as follows:
Year Ended December 31, 2003 Year Ended December 31, 2002
---------------------------------------- --------------------------------------
As Reported Pro Forma As Reported Pro Forma
------------------ ------------------ --------------- ------------------
(In thousands,
except per share data)
Net sales $203,707 $265,219 $177,595 $231,822
Net income 24,730 26,129 25,913 28,589
Per share data:
Basic $1.76 $1.77 $1.96 $2.05
Diluted $1.68 $1.70 $1.76 $1.85
In 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.
The Company had an option to purchase the remaining 30% of the shares
of Orthofix AG. The Company exercised this option in 2004 and paid approximately
$0.5 million for the remaining shares, which was recorded as additional
goodwill. This resulted in Orthofix AG being a wholly owned subsidiary.
F-17
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
3 Inventories
December 31,
------------------------
(In thousands) 2004 2003
--------- ---------
Raw materials $6,456 $6,153
Work-in-process 2,445 2,453
Finished goods 14,823 13,437
Field inventory 5,346 5,202
Consignment inventory 7,835 7,124
Less reserve for obsolescence (4,010) (3,656)
--------- ---------
$32,895 $30,713
========= =========
4 Securities and other investments
During 2003, Ferrer Freeman & Co., a private equity firm that invests
exclusively in health care and health care-related companies, purchased 100% of
HealthSouth's interest in OrthoRx, which resulted in it becoming the Company's
new partner in the joint venture. On May 6, 2003 and June 16, 2003, the Company
invested an additional $350,000 and $1,150,000, respectively, in the OrthoRx
joint venture. Ferrer Freeman & Co. matched the Company's investment. The
Company is accounting for this investment using the equity method and has
reduced its investment to zero and $1.6 million as of December 31, 2004 and
2003, respectively, to reflect its portion of the joint venture's net losses for
the years then ended.
In March 2004, the Company sold a portion of its investment in OrthoRx
to its partner in the joint venture, Ferrer Freeman & Co. The sale, combined
with not electing to participate in the next round of financing, reduced the
Company's ownership in OrthoRx to approximately 21%. The Company recorded a gain
on the sale of the investment of approximately $0.8 million, which is reported
as other income.
In 2003, the Company purchased an equity interest in Innovative Spinal
Technologies (IST), a start-up company focused on commercializing spinal
products, for $1.5 million. The investment is accounted for under the cost
method.
In 2003, the Company sold $250,000 of marketable equity securities for
$354,000 in cash.
The Company has total investments held at cost of $4.1 million, $4.1
million, and $2.6 million as of December 31, 2004, 2003, and 2002, respectively.
The Company has assessed these cost investments noting no impairment in carrying
value.
F-18
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
5 Property, plant and equipment
December 31,
------------------------
(In thousands) 2004 2003
--------- ----------
Cost
Buildings $3,733 $4,728
Plant and equipment 40,409 31,445
Furniture and fixtures 7,258 9,064
--------- ----------
51,400 45,237
Accumulated depreciation (33,074) (26,068)
--------- ----------
$18,326 $19,169
========= ==========
Depreciation expense for the years ended December 31, 2004, 2003 and
2002 was $7.8 million, $5.7 million and $5.1 million, respectively.
6 Patents and other intangible assets
December 31,
------------------------
(In thousands) 2004 2003
--------- ----------
Cost
Patents $25,411 $19,709
Trademarks 24,612 24,589
Distribution networks 42,343 36,243
--------- ----------
92,366 80,541
Accumulated amortization
Patents (15,989) (14,366)
Trademarks (332) (271)
Distribution networks (5,418) (178)
--------- ----------
$70,627 $65,726
========= ==========
During 2004, the Company acquired the patented technology of the PC.C.P
System for approximately $4.0 million, which has a weighted average useful life
of 10 years.
Amortization expense for intangible assets is estimated to be
approximately $6.4 million, $6.5 million, $6.7 million, $6.3 million and $6.1
million for the periods ending December 31, 2005, 2006, 2007, 2008 and 2009,
respectively. The Company has $23.9 million of intangibles with indefinite lives
as of December 31, 2004 and 2003.
F-19
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
7 Goodwill
Under SFAS No. 142, intangible assets deemed to have indefinite lives
and goodwill are 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 tests of goodwill and indefinite lived intangible assets and has
determined that no impairment exists. Also, in accordance with SFAS No. 142, the
Company discontinued the amortization of goodwill effective January 1, 2002. 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)
Americas Americas International
Orthofix Breg Orthofix Total
---------- ----------- --------------- -----------
At December 31, 2002 $32,472 $ - $26,309 $58,781
Acquisitions - 94,512 9,494 104,006
Adjustments (71) - 19 (52)
Foreign Currency - - 5,662 5,662
---------- ----------- --------------- -----------
At December 31, 2003 32,401 94,512 41,484 168,397
Acquisitions 532 - 475 1,007
Adjustments - (2,750) - (2,750)
Foreign Currency 19 - 2,656 2,675
---------- ----------- --------------- -----------
At December 31, 2004 $32,952 $91,762 $44,615 $169,329
========== =========== =============== ===========
8 Bank borrowings
December 31,
------------------
(In thousands) 2004 2003
-------- --------
Borrowings under line of credit $76 $72
Weighted average interest rates on borrowings under lines of credit as
of December 31, 2004 and 2003 were 3.40% and 4.00%, respectively.
Borrowings under lines of credit consist of borrowings in Euros. The
Company had unused available lines of credit of $11.4 million and $10.6 million
at December 31, 2004 and 2003, 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. The
Company also has available an unused senior credit facility of $15.0 million.
F-20
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
9 Other current liabilities
December 31,
---------------------
(In thousands) 2004 2003
--------- ----------
Accrued expenses $10,280 $9,963
Salaries and related taxes payable 7,721 11,259
Income taxes payable 4,525 2,038
Other payables 3,219 1,794
Provision for AME bonus and earnout (Note 17) -- 5,182
--------- ----------
$25,745 $30,236
========= ==========
10 Long-term debt
December 31,
---------------------
(In thousands) 2004 2003
--------- ----------
Long-term obligations $76,750 $110,000
Other loans 556 135
--------- ----------
77,306 110,135
Less current portion (10,057) (11,063)
--------- ----------
$67,249 $99,072
========= ==========
Concurrently with the closing of the Breg acquisition, Colgate Medical
Limited ("Colgate", or the "Borrower"), a wholly owned subsidiary of the
Company, entered into a senior secured bank facility. The senior secured bank
facility provides for (1) a five-year amortizing term loan of $110 million, the
proceeds of which were used for partial payment of the purchase price of Breg,
and (2) a five-year revolving credit facility of $15 million, which was not
drawn on as of December 31, 2004. This obligation has a floating interest rate
of LIBOR or prime rate plus a margin. The current interest rate is LIBOR plus
2.00%, which is adjusted quarterly based on the Borrower's leverage ratio.
During 2004, Colgate entered into an amendment of its senior secured term loan
facility. The amendment and accelerated prepayments of principal during 2004
reduced the interest rate applicable to borrowings under the term loan facility
by reducing the initial interest rate of LIBOR plus 2.75% to LIBOR plus 2.00%.
At December 31, 2004 and 2003, long-term obligations include a senior secured
term note for $76.8 million and $110.0 million, respectively.
In conjunction with obtaining the senior secured bank facility and the
amendment thereto, the Company incurred debt issuance costs of $3.3 million and
$0.3 million, respectively. As of December 31, 2004, $2.9 million of unamortized
debt issuance costs was recorded in other assets.
In May 2004, the Company entered into a three year fully amortizable
interest rate swap agreement (the "Swap"). Under the Swap, the Company pays a
fixed rate of 3.16% and receives interest at floating rates based on the three
month LIBOR rate at each quarterly re-pricing date until the expiration of the
Swap. As of December 31, 2004 the interest rate on the debt related to the Swap
was 5.16% (3.16% plus a margin of 2.00%). The effective interest rate, including
the impact of the Swap, as of December 31, 2004 on the senior secured debt was
4.88%.
F-21
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
Orthofix and each of Colgate's direct and indirect subsidiaries,
including Orthofix Inc. and Breg, have guaranteed the obligations of Colgate
under the senior secured bank facility. The obligations of Colgate under the
senior secured bank facility and Colgate's subsidiaries under their guarantees
are secured by the pledges of their respective assets. Certain of the Company's
other subsidiaries have also guaranteed the obligations of Colgate under the
senior secured bank facility on a limited recourse basis.
The credit agreement relating to the senior secured bank facility
contains customary negative covenants applicable to Colgate and its
subsidiaries, including restrictions on indebtedness, liens, dividends, mergers
and the sale of assets. The credit agreement also contains certain financial
covenants, including a fixed charge coverage ratio, an interest coverage ratio
and a leverage ratio applicable to Colgate and its subsidiaries on a
consolidated basis, and a leverage ratio applicable to Orthofix and its
subsidiaries on a consolidated basis. The Company is in compliance with the
financial covenants as of December 31, 2004.
Weighted average interest rates on current maturities of long-term
obligations as of December 31, 2004 and 2003 were 4.43% and 3.92%, respectively.
The aggregate maturities of long-term debt after December 31, 2004 are
as follows: 2005 - $10.1 million, 2006 - $10.1 million, 2007 - $10.0 million,
and 2008 - $47.1 million.
11 Derivative Instruments
During the second quarter of 2004, the Company entered into the Swap to
manage its interest rate exposure related to a portion of the Company's $110
million credit facility entered into on December 30, 2003. The Swap, a three
year fully amortizable agreement with a notional amount of $50.0 million,
expires on June 27, 2007. The amount outstanding under the Swap as of December
31, 2004 was $41.6 million. Under the Swap, the Company is paying a fixed rate
of 3.16% and receiving interest at floating rates based on the three month LIBOR
rate at each quarterly re-pricing date until the expiration of the Swap.
The Swap is designated as a cash flow hedge and, at December 31, 2004,
is determined to be effective. At December 31, 2004, the fair value of the
derivative was approximately $132,000 and has been included in other current
assets. The net unrealized gain of approximately $92,000, net of tax of $40,000,
has been included in other comprehensive income for the year ended December 30,
2004. The fair value of the Swap is the estimated amount the Company would pay
or receive to terminate the agreement at the reporting date.
F-22
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
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, 2004, 2003 and 2002 was approximately $3.5 million, $2.6 million
and $2.3 million, respectively. Future minimum lease payments under operating
leases as of December 31, 2004 are as follows:
(In thousands)
2005 $3,509
2006 3,005
2007 2,245
2008 1,830
2009 1,822
Thereafter 2,909
--------------
Total $15,320
==============
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.
Prior to the acquisition of Breg, the Company's segments were
identified by geographic areas. In 2004, management identified Breg as a
reportable segment because Breg's customer type differed from the previous type
of Orthofix customer.
Americas Orthofix
Americas Orthofix operation ("Americas") consists of operations in the
United States existing prior to the acquisition of Breg, as well as, Mexico,
Brazil, and Puerto Rico. Americas Orthofix uses both direct and distributor
sales representatives to sell to hospitals, doctors, and other healthcare
providers in the Americas market.
International Orthofix
International Orthofix operation ("International") consists of
operations, existing prior to the acquisition of Breg, which are located in the
rest of the world as well as independent distributors. International Orthofix
uses both direct and distributor sales representatives to sell to hospitals,
doctors, and other healthcare providers.
Americas Breg
Americas Breg operation ("Breg") consists of Breg, Inc., which was
acquired December 30, 2003. 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 and affiliates.
Group Activities
Group Activities are comprised of the Parent's operating expenses and
identifiable assets.
F-23
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
The tables below present information by reportable segment:
External Sales Intersegment Sales
-------------------------------------------- -------------------------------------------
(In thousands) 2004 2003 2002 2004 2003 2002
------------- ------------- -------------- ------------- ------------- -------------
Americas Orthofix $125,972 $116,848 $102,850 $1,357 $1,072 $774
Americas Breg 68,294 -- -- 422 -- --
International Orthofix 92,372 86,859 74,745 54,464 50,800 41,856
------------- ------------- -------------- ------------- ------------- -------------
Total $286,638 $203,707 $177,595 $56,243 $51,872 $42,630
============= ============= ============== ============= ============= =============
Operating Income (Expense)
(In thousands) 2004 2003 2002
------------- ----------- -----------
Americas Orthofix $28,840 $25,770 $25,130
Americas Breg 11,498 -- --
International Orthofix 18,808 17,564 26,143
Group Activities (4,599) (4,021) (3,788)
Eliminations 453 1,271 (4,546)
------------- ----------- -----------
Total $55,000 $40,584 $42,939
============= =========== ===========
The following table presents identifiable assets by segment, excluding
intercompany balances and investments in consolidated subsidiaries. The 2003 and
2002 balances have been reclassified to conform to the current period
presentation.
Identifiable Assets
(In thousands) 2004 2003 2002
------------- ----------- -----------
Americas Orthofix $108,119 $103,493 $95,844
Americas Breg 177,365 181,298 -
International Orthofix 148,517 137,011 134,497
Group activities 9,688 5,036 4,870
Eliminations (12,589) (13,659) (14,437)
-------------- ----------- -----------
Total $431,100 $413,179 $220,774
============= =========== ===========
F-24
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
Depreciation and
amortization Income tax expense Other income (expense)
--------------------------- ---------------------------- ---------------------------
(In thousands) 2004 2003 2002 2004 2003 2002 2004 2003 2002
------- -------- -------- ------- --------- -------- ------- -------- --------
Americas Orthofix $3,360 $3,664 $2,902 $12,284 $9,867 $9,061 $267 $324 $(934)
Americas Breg 7,328 - - 2,242 - - 22 - -
International Orthofix 3,708 3,285 2,927 1,525 4,706 3,757 (4,938) 1,515 1,695
Group activities - - - 159 12 57 8 (3,108) (3,170)
------- -------- -------- ------- --------- -------- ------- -------- --------
Total $14,396 $6,949 $5,829 $16,210 $14,585 $12,875 $(4,641) $(1,269) $(2,409)
Capital expenditures for each segment are as follows:
(In thousands) 2004 2003 2002
------------- ----------- -----------
Americas Orthofix $3,245 $2,903 $3,631
Americas Breg 2,820 - -
International Orthofix 6,178 2,327 3,492
Group activities - 8 7
------------- ----------- -----------
$12,243 $5,238 $7,130
============= =========== ===========
Geographical information
Analysis of net sales by geographic destination:
(In thousands) 2004 2003 2002
------------- ----------- -----------
U.S. $198,392 $132,858 $117,991
Other 9,546 4,995 4,920
------------- ----------- -----------
Americas 207,938 137,853 122,911
U.K. 28,858 25,162 22,099
Italy 20,761 16,447 12,601
Other 29,081 24,245 19,984
------------- ----------- -----------
International 78,700 65,854 54,684
------------- ----------- -----------
$286,638 $203,707 $177,595
============= =========== ===========
There are no sales in the Netherlands Antilles.
F-25
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
Analysis of long-lived assets by geographic area:
(In thousands) 2004 2003
----------- -----------
U.S. $199,808 $200,626
Italy 12,957 12,122
U.K. 24,521 24,866
Cyprus 10,533 10,619
Others 14,545 10,834
----------- -----------
$262,364 $259,067
=========== ===========
Sales by Market Sector for the year ended December 31, 2004
------------------------------------------------------------
Americas Americas International
(In thousands) Orthofix Breg Orthofix Total
-------------- ----------- --------------- ---------------
Orthopedic
Spine $81,190 $ - $ 185 $81,375
Reconstruction 7,318 68,083 45,534 120,935
Trauma 36,058 211 26,623 62,892
-------------- ----------- --------------- ---------------
Total Orthopedic 124,566 68,294 72,342 265,202
Non-Orthopedic 1,406 - 20,030 21,436
-------------- ----------- --------------- ---------------
Total $125,972 $68,294 $92,372 $286,638
============== =========== =============== ===============
Sales by Market Sector for the year ended December 31, 2003
------------------------------------------------------------
Americas Americas International
(In thousands) Orthofix Breg Orthofix Total
-------------- ----------- --------------- ---------------
Orthopedic
Spine $79,453 $ - $99 $79,552
Reconstruction 6,775 - 44,408 51,183
Trauma 29,242 - 24,464 53,706
-------------- ----------- --------------- ---------------
Total Orthopedic 115,470 - 68,971 184,441
Non-Orthopedic 1,378 - 17,888 19,266
-------------- ----------- --------------- ---------------
Total $116,848 $ - $86,859 $203,707
============== =========== =============== ===============
F-26
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
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) 2004 2003 2002
------------- ----------- -----------
Italy - Current $2,727 $1,948 $2,097
- Deferred (241) (371) (51)
Cyprus - Current 251 224 516
- Deferred -- 16 28
U.K. - Current 985 2,670 1,518
- Deferred (34) 37 17
U.S. - Current 15,928 9,471 7,651
- Deferred (3,711) 333 1,319
Netherlands Antilles
- Current 25 12 5
- Deferred 134 -- --
Other - Current 168 (212) (4)
- Deferred (22) 457 (221)
------------- ----------- -----------
Total tax expense $16,210 $14,585 $12,875
============= =========== ===========
Income from continuing operations before provision for income taxes
consisted of:
Year ended December 31,
-------------------------------------------
(In thousands) 2004 2003 2002
------------- ----------- -----------
U.S. $32,254 $26,624 $24,781
Non U.S. 18,105 12,691 15,749
------------- ------------ -----------
$50,359 $39,315 $40,530
============= =========== ===========
F-27
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
The tax effects of the significant temporary differences, which
comprise the deferred tax liabilities and assets, are as follows:
(In thousands) 2004 2003
----------- ------------
Deferred tax liabilities
Goodwill $(662) $(845)
Patents and other intangible assets (14,598) (13,605)
Property, Plant and Equipment (491) (170)
Other (1,804) (2,022)
----------- ------------
(17,555) (16,642)
Deferred tax assets
Other current $182 $193
Inventories and related reserves 1,526 1,461
Allowance for doubtful accounts 2,422 2,324
Net operating loss carry forwards 3,760 609
Deferred royalties 916 939
Other long term 873 -
----------- ------------
9,679 5,526
Valuation Allowance (3,325) (529)
----------- ------------
6,354 4,997
----------- ------------
Net deferred tax asset (liability) $(11,201) $(11,645)
=========== ============
During 2004, the Company generated net taxable losses in locations
where it was more likely than not that those losses will not be utilized;
accordingly, a valuation allowance was established.
During 2004, as a result of a non-recurring transaction, the Company
recognized $0.5 million of tax benefit from the utilization of net operating
loss carry forwards for which a valuation allowance had been previously
established in 2003. The Company has net operating loss carry forwards of $13.3
million which expire at various dates from 2008 - 2012.
In the normal course of business the Company may have differences
between tax provision amounts initially recorded for financial reporting
purposes and its final tax settlements. These differences are subject to
applicable regulations. Management does not believe that any such final tax
settlements would have a material adverse effect on the Company's results of
operations and financial position.
F-28
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
2004 2003 2002
--------------------- ---------------------- ------------------------
Amount Percent Amount Percent Amount Percent
---------- ---------- --- ---------- ----------- -- ----------- ------------
Statutory U.S. federal income tax rate $17,626 35.0% $13,760 35.0% $14,186 35.0%
Net effect of foreign tax (3,068) -6.1% 636 1.6% (121) -0.3%
Change in valuation allowance 2,796 5.6% 529 1.4% - -
Tax holiday benefit - Seychelles (918) -1.8% (806) -2.1% (1,922) -4.9%
US-UK Tax Treaty (1,880) -3.7% - - - -
State taxes net of federal benefit 1,132 2.2% 534 1.4% 570 1.5%
Other 522 1.0% (68) -0.2% 162 0.4%
---------- ---------- ---------- ----------- ----------- ------------
Income tax expense/effective rate $16,210 32.2% $14,585 37.1% $12,875 31.7%
========== ========== ========== =========== =========== ============
The Company has not recorded additional income taxes applicable to
undistributed earnings of foreign subsidiaries that are considered to be
indefinitely reinvested. Such earnings, which amounted to approximately $201.9
million, $156.0 million and $124.1 at December 31, 2004, 2003 and 2002,
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.
15 Restricted Net Assets of Subsidiaries
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 Colgate Medical
Limited 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 Colgate
Medical Limited and its subsidiaries as of December 31, 2004 is approximately
$120.0 million.
16 Related Parties
The following related party balances and transactions as of and for the
three years ended December 31, 2004, 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 board member has a beneficial minority
interest.
Year ended December 31,
-----------------------------
(In thousands) 2004 2003 2002
-------- --------- ---------
Sales $987 $1,706 $1,275
Purchases $16,986 $15,916 $18,038
Accounts payable $1,386 $1,929 $2,075
Accounts receivable $198 $403 $239
Due from officers (included in other assets) $356 $342 $330
In 2004, the Company sold its one-half interest in a property as part
of its plan to consolidate its United Kingdom facilities. The sale resulted in a
gain of approximately $0.6 million, which is reported as other income. This
facility was purchased by a company owned by Mr. Robert Gaines-Cooper, a
Director. The fair value of this facility was determined by two independent
appraisal firms and the amount paid approximates fair value.
F-29
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
In 2003, the Company purchased the remaining 48% interest in Intavent
Orthofix Limited from Intavent Limited. Mr. Gaines-Cooper, a Director of
Orthofix, is a settlor of a trust which owns a 30% interest in Intavent Limited.
17 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:
On December 4, 1998, a Review Committee, established to determine the
amount of any contingent contract rights under the Merger Agreement, dated May
8, 1995, between Orthofix International and American Medical Electronics,
unanimously determined that Orthofix International would pay to the AME record
holders an earnout of $500,000 plus interest and 12% of the net recovery
received from the resolution in 2000 of a litigation against Biomet, Inc. and
Electro Biology, Inc., up to a maximum of $5.5 million, plus interest. Two
lawsuits were subsequently initiated disputing the determination of the Review
Committee and seeking monetary damages and interest. The lawsuits were entitled
Clarence Frere, Louise Frere, Joseph Mooibroek, and Marla B. Mooibroek,
individually and on behalf of all others similarly situated v. Orthofix Inc.,
Arthur Schwalm, Robert Gaines-Cooper, James Gero, and John and Jane Does One (1)
Through Four (4), No. 99-S-445 (D. Colo.); Clarence Frere, Louise Frere, Joseph
Mooibroek, and Marla B. Mooibroek, individually and on behalf of all others
similarly situated v. Orthofix Inc., Arthur Schwalm, Robert Gaines-Cooper, James
Gero, and John and Jane Does One (1) Through Four (4), No. 99 Civ. 4049
(S.D.N.Y.).
The federal district court hearing the cases resolved them in favor of
the Company on May 21, 2003. The plaintiff's subsequent appeal was denied and
the time within which the plaintiffs could have requested further review in the
United States Supreme Court expired on June 10, 2004.
On August 31, 2004 the Company concluded the above mentioned actions by
a final payout pursuant to the Merger Agreement between the Company and AME. The
aggregate amount of the payout was $5.6 million, which is the sum of $5.2
million in principal plus $0.4 million in interest from June 30, 2000, to the
payout date of August 31, 2004.
The final payout was fully reserved and had no impact on the Company's
financial results from operations for the year ended December 31, 2004.
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 product, breach of contract, and
seeks damages relating to past infringement, breach of contract, and unfair
competition. KCI has filed counterclaims alleging that Novamedix engaged in
inequitable conduct before the United States Patent and Trademark Office and
fraud as to KCI and that Novamedix engaged in common law and statutory unfair
competition against KCI. KCI withdrew several of its counterclaims, but
continues to assert affirmative defenses contending that the patents are
invalid, unenforceable, and not infringed. KCI also seeks monetary damages,
injunctive relief, costs, attorney's fees, and other unspecified relief. During
2002, the United States Patent and Trademark Office issued re-examination
certificates validating four U.S. vascular patents owned by the Company. The
U.S. District Court in San Antonio, Texas restored the litigation to active
status. A portion of any amounts received by the Company will be payable to
former owners of Novamedix under the original purchase agreement. This matter is
currently in the pre-trial motions phase.
On September 29, 2004, Triage Medical Inc. ("Triage") filed an action
against Orthofix International N.V. That action, which the Company removed to
federal court, is entitled Triage Medical Inc. vs. Orthofix International N.V.,
Case No: SACV04-1377 JVS and is pending in the United States District Court for
the Central District of California. Triage contends that the Company agreed to
negotiate an acquisition of Triage, and as a part of the acquisition process, to
make an unconditional $2.0 million escrow payment to Triage. Triage contends the
F-30
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
Company terminated the acquisition process and failed to make the payment as a
result of which, Triage has been damaged. The Company has answered the complaint
denying any liability and pleading certain defenses. The Company believes this
case is without merit and intends to vigorously defend this action.
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.
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. 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
maintains an allowance for losses based on the expected collectability of all
accounts receivable.
The Company sells via a direct sales force and distributors. The
Company's distributor of the A-V Impulse System in North America, Kendall
Healthcare Inc., accounted for 10% of net sales in 2003 and 2002 and there were
no customers that accounted for more than 10% of net sales in 2004.
18 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, 2004, 2003 and 2002, expenses incurred relating to the 401(k) Plan,
including matching contributions, were approximately $760,000, $708,000 and
$763,000, respectively. Breg also sponsors a 401(k) plan. This 401(k) Plan
allows for participants to contribute up to 100% of their pre-tax compensation,
subject to certain limitations, with the Company matching 100% of the first $750
deferred. During the year ended December 31, 2004, expenses incurred relating to
the Breg 401(k) Plan, including matching contributions were $111,000.
The Company operates defined contribution pension plans for all other
employees not described above meeting minimum service requirements. The
Company's expenses for such pension contributions during 2004, 2003 and 2002
were approximately $573,000, $487,000 and $415,000, 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 2004, 2003 and 2002 was approximately $292,000, $227,000 and
$200,000, respectively. Deferred compensation payments of $207,000, $233,000 and
$120,000 were made in 2004, 2003 and 2002, respectively. The balance as of
December 31, 2004 of $1.2 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.
F-31
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
19 Share option plans and warrants
Option Plans
At December 31, 2004, the Company had four stock-based compensation
plans 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, of 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. There were
419,000 awards outstanding under the 2004 LTIP Plan as of December 31, 2004 of
which none 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, 2004, there were
627,155 options outstanding under the Staff Plan of which 277,055 are
exercisable.
Performance Accelerated Stock Option Agreement
In December 1999, the Company's Board of Directors adopted a resolution
approving, and 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, 1999 (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 become 100% non-forfeitable and
exercisable on the fifth anniversary of the Grant Date. Vesting under the PASOs
will 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 is 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, 2004, 386,990 stock options were exercised and none
were forfeited. As of December 31, 2004, 513,010 options remain outstanding
under the option agreements, all of which are exercisable and expire on January
1, 2009.
AME 1983 and 1990 Plans
Under the terms of the Merger Agreement in which the Company acquired
AME, all options for AME common stock still outstanding under the 1983 Plan and
the 1990 Plan (hereinafter collectively referred to as the "AME Plan") were
assumed at the effective time of the Merger by the Company and are exercisable
for common shares in accordance with their terms and after adjustment to reflect
the exchange ratio. After such adjustment immediately following the Merger,
options granted under the AME Plan totaled 624,794, all of which expired
throughout 2004.
F-32
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
Executive Share Option Plan
Under the Executive Share Option Plan ("Executive Plan"), approved by
shareholders in March 1992, 1,945,000 shares have been reserved for issuance to
certain executive officers. The grant price, determined by the Company's Board
of Directors, cannot be less than the fair market value at the time of grant or
$14.40, the equivalent of 120% of the price in the initial public offering price
of $12.00. Fifty percent of options granted vest automatically on the tenth
anniversary of the date of grant, or earlier on the satisfaction of a
performance keyed to the market price of the common shares and a service
condition. The remaining fifty percent vest in 20% increments on the first
through fifth anniversaries of the date of grant. Options granted under the
Executive Plan expired no later than June 2004.
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, 2004, 200,000 options remain outstanding under the inducement grants, of
which 20,000 were exercisable.
Warrants
Kinesis Warrants
At the time of the acquisition of Kinesis Medical Inc.'s assets,
warrants to purchase 672,685 shares of Kinesis common stock (the "Kinesis
warrants") were outstanding. These were assumed by the Company pursuant to the
Asset Purchase Agreement. After adjustment to take into account the agreed
exchange ratio, 27,400 common stock warrants were outstanding. At December 31,
2004, warrants to purchase 24,528 shares of the Company's common stock remain
outstanding, all of which are exercisable and expire on August 31, 2005. The
exercise prices are fixed, and range from $19.125 to $38.25 per common share.
F-33
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
Summaries of the status of the Company's stock option and warrant plans
as of December 31, 2004, 2003 and 2002 and changes during the years ended on
those dates are presented below:
2004 2003 2002
---------------------- -------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Fixed Options & Warrants Shares Price Shares Price Shares Price
----------- ---------- ----------- --------- ----------- ----------
Outstanding at beginning of year 2,051,502 $21.62 2,424,781 $17.08 3,820,290 $15.46
Granted 434,000 $37.18 449,500 $34.46 108,650 $30.94
Exercised (698,428) $16.41 (747,554) $14.77 (1,502,137) $13.94
Forfeited (3,381) $30.40 (75,225) $19.86 (2,022) $17.86
---------- ---------- ---------- -------- ----------- ----------
Outstanding at end of year 1,783,693 $27.36 2,051,502 $21.62 2,424,781 $17.08
========== ========== ========== ======== =========== ==========
Options exercisable at end of year 834,593 1,042,727 1,412,552
Weighted average fair value of
options granted during the year at
market value $13.03 $10.86 $10.71
Weighted average fair value of
options granted during the year at
less than market value - $22.32 -
At December 31, 2004, the Company has reserved a total of approximately
$1.8 million shares of common stock for issuance to eligible participants under
the option plans (1,759,165 shares) and to warrant holders (24,528 shares).
Outstanding and exercisable by price range as of December 31, 2004
Options and Warrants Outstanding Options and Warrants Exercisable
-------------------------------------------- ----------------------------------
Weighted
Average Weighted
Remaining Average
Number Contractual Exercise Number Weighted Average
Range of Exercise Prices Outstanding Life Price Exercisable Exercise Price
------------- ----------- ---------- ------------ ------------------
$7.50 - $25.00 788,567 4.190 $17.241 788,567 $17.241
$26.72 - $32.18 285,600 8.360 $30.998 7,500 $28.400
$33.00 - $36.57 145,000 8.880 $34.246 - -
$37.76 - $37.76 331,000 9.920 $37.760 - -
$38.00 - $38.40 233,526 8.366 $38.046 38,526 $38.250
------------- ----------- ---------- ------------ ------------------
1,783,693 6.849 $27.358 834,593 $17.822
------------- ----------- ---------- ------------ ------------------
F-34
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
20 Earnings Per Share
For each of the three years in the period ended December 31, 2004,
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,
--------------------------------
2004 2003 2002
---------- ---------- ----------
SWeighted average common shares-basic 15,396,540 14,061,447 13,196,524
Effect of diluted securities:
Stock options 578,405 620,436 1,488,712
---------- ---------- ----------
Weighted average common share-diluted 15,974,945 14,681,883 14,685,236
========== ========== ==========
The Company did not include in the diluted shares outstanding
calculation 200,000 options in 2004, 206,000 options in 2003 and 59,000 options
in 2002 because their inclusion would be anti-dilutive or their exercise price
exceeded the average market price of our common stock during the respective
periods.
F-35
Orthofix International N.V.
Notes to the consolidated financial statements (cont.)
21 Quarterly financial data (unaudited)
(U.S. Dollars, in thousands, except per share data)
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Year
------------- ------------- ------------- ------------- ----------
2004
Net sales $70,739 $70,794 $71,488 $73,617 $286,638
Gross profit 51,193 51,097 51,906 53,265 207,461
Net income 8,344 7,875 8,417 9,513 34,149
Net income per common share:
Basic .55 .52 .54 .61 2.22
Diluted .53 .50 .53 .59 2.14
2003
Net sales $48,181 $51,565 $51,253 $52,708 $203,707
Gross profit 35,596 38,556 38,771 39,694 152,617
Net income 5,953 6,495 5,442 6,840 24,730
Net income per common share:
Basic .43 .46 .38 .48 1.76
Diluted .41 .44 .37 .46 1.68
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.
F-36
Orthofix International N.V.
Schedule 1 -- Condensed Financial Information of Registrant Orthofix
International N.V.
Condensed Balance Sheets
(U.S. Dollars, in thousands) December 31, December 31,
2004 2003
----------------- -----------------
Assets
Current assets:
Cash and cash equivalents............................................... $ 6,918 $ 2,880
Prepaid expenses and other current assets............................... 305 294
----------------- -----------------
Total current assets..................................................... 7,223 3,174
----------------- -----------------
Other long term assets................................................... 760 353
Investments in and amounts due from subsidiaries and affiliates.......... 290,178 243,573
----------------- -----------------
Total assets............................................................. $ 298,161 $ 247,100
================= =================
Liabilities and shareholders' equity
Current liabilities.................................................... $ 456 $ 6,324
Long term liabilities.................................................. 533 --
----------------- -----------------
Total liabilities..................................................... 989 6,324
Shareholders' equity
Common stock.......................................................... 1,572 1,498
Additional paid in capital............................................ 98,388 81,960
Accumulated earnings.................................................. 182,073 147,924
Accumulated other comprehensive income................................ 15,139 9,394
----------------- -----------------
297,172 240,776
================= =================
Total liabilities and shareholders' equity............................... $ 298,161 $ 247,100
================= =================
See accompanying notes to condensed financial statements.
S-1
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,
2004 2003 2002
---------------- ----------------- -----------------
(Expenses) Income
General and administrative................................. $ (4,599) $ (4,021) $ (3,788)
Equity in earnings of investments in subsidiaries and
affiliates................................................ 38,571 28,610 29,421
Other, net................................................ 336 153 285
---------------- ----------------- -----------------
Income before income taxes................................ 34,308 24,742 25,918
Income tax expense..................................... (159) (12) (5)
---------------- ----------------- -----------------
Net income................................................ $ 34,149 $ 24,730 $ 25,913
================ ================= =================
See accompanying notes to condensed financial statements.
S-2
Orthofix International N.V.
Schedule 1 -- Condensed Financial Information of Registrant Orthofix
International N.V.
Condensed Statements of Cash Flows
(U.S. Dollars, in thousands) December 31, December 31, December 31,
2004 2003 2002
---------------- ----------------- -----------------
Net cash used in operating activities...................... $(10,656) $(4,117) $(3,331)
Cash flows from investing activities:
Investments in and advances to subsidiaries and affiliates (6,400) (27,074) (7,945)
Distributions and amounts received from subsidiaries....... 7,547 23,000 15,390
Proceeds from sale of investments ......................... 1,300 -- --
---------------- ----------------- -----------------
Net cash provided by (used in) investing activities........ 2,447 (4,074) 7,445
---------------- ----------------- -----------------
Cash flows from financing activities:
Net proceeds from issuance of common stock............. 12,247 11,705 20,457
Repurchase of treasury shares.......................... (4,395) (21,886)
---------------- ----------------- -----------------
Net cash provided by (used in) financing activities........ 12,247 7,310 (1,429)
---------------- ----------------- -----------------
Net increase (decrease) in cash and cash equivalents....... 4,038 (881) 2,685
Cash and cash equivalents at the beginning of the year..... 2,880 3,761 1,076
---------------- ----------------- -----------------
Cash and cash equivalents at the end of the year........... $ 6,918 $ 2,880 $ 3,761
================ ================= =================
See accompanying notes to condensed financial statements.
S-3
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 Colgate Medical Limited and it subsidiaries exceed 25% of the
consolidated net assets of Orthofix International N.V. and its subsidiaries (the
"Company"). In the parent-company-only financial statements, the Company's
investment in subsidiaries is stated as cost plus equity in undistributed
earnings of subsidiaries since the date of acquisition. The Company's share of
net income of its unconsolidated subsidiaries is included in consolidated income
using the equity method. The parent-company-only financial statements should be
read in conjunction with the Company's consolidated financial statements.
2 Restricted Net Assets of Subsidiaries
Certain of the Company's subsidiaries have restrictions, with an
effective date of January 29, 2004, on their ability to pay dividends or make
intercompany loans and advances pursuant to their financing arrangements. The
amount of restricted net assets of the Company's subsidiaries at December 31,
2004 is approximately $120.0 million. Such restrictions are on net assets of
Colgate Medical Limited and its subsidiaries.
3 Guarantee
Colgate Medical Limited, a subsidiary of the Company, has $76.8 million
of long-term debt outstanding. Under the terms of the debt agreement, the
Company has guaranteed the payment of all principal and interest. In the event
of a default, under the debt agreement, the Company will be directly liable to
the debt holders. See Note 10 Long Term Debt of the Company's consolidated
financial statements included elsewhere in this document.
4 Commitments and Contingencies
For a discussion of the Company's commitments and contingencies see
Note 12 Commitments and Note 17 Contingencies of the Company's consolidated
financial statements included elsewhere in this document.
5 Dividends From Subsidiaries
Cash dividends paid to Orthofix International N.V. from its
consolidated subsidiaries accounted for by the equity method were $7.5 million,
$23.0 million and $0.0 million for the periods ended December 31, 2004, 2003 and
2002, respectively.
S-4
Orthofix International N.V.
Schedule 2 -- Valuation and Qualifying Accounts
For the years ended December 31, 2004, 2003 and 2002:
(US Dollars, in thousands)
Additions
---------------------------------
Balance at
Provisions from assets beginning of Charged to cost Charged to Balance at end
to which they apply: year and expenses other accounts Deductions/ Other of year
-------------- --------------- -------------- ----------------- --------------
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 3,325 - (529) 3,325
2003
Allowance for doubtful
accounts receivable 3,156 5,192 76 (4,110) 4,314
Inventory provisions 2,754 1,365 58 (521) 3,656
Deferred tax valuation
allowance - 529 - - 529
2002
Allowance for doubtful
accounts receivable 2,936 4,980 57 (4,817) 3,156
Inventory provisions 2,135 1,463 (126) (718) 2,754
S-5