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, 2005
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 Identification No.)
incorporation or organization)
7 Abraham de Veerstraat
Curacao
Netherlands Antilles N/A
- ------------------------------------------------------- --------------------------------------------------
(Address of principal executive offices) (Zip Code)
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 Nasdaq National Market
(Title of Class) (Name of Exchange on Which Registered)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.
Yes [ ] No [ X ]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.
Yes [ ] No [ X ]
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 a large accelerated filer, an
accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the
Act).
Large Accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
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, 2005, as
reported by the Nasdaq National Market, was approximately $428.5 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 9, 2006, 16,021,250 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 2006 Annual General Meeting of Shareholders
are incorporated by reference in Part III of this Form 10-K.
Table of Contents
Page
PART I.........................................................................................................4
Item 1. Business.........................................................................................4
Item 1A. Risk Factors....................................................................................21
Item 1B. Unresolved Staff Comments.......................................................................26
Item 2. Properties......................................................................................27
Item 3. Legal Proceedings...............................................................................28
Item 4. Submission of Matters to a Vote of Security Holders.............................................28
PART II.......................................................................................................29
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters and Issuer
Purchases of Equity Securities................................................................29
Item 6. Selected Financial Data.........................................................................31
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...........32
Item 7A. Quantitative and Qualitative Disclosures About Market Risk......................................43
Item 8. Financial Statements and Supplementary Data.....................................................44
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............44
Item 9A. Controls and Procedures.........................................................................44
Part III......................................................................................................45
Item 10. Directors and Executive Officers of the Registrant..............................................45
Item 11. Executive Compensation..........................................................................48
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters...................................................................48
Item 13. Certain Relationships and Related Transactions..................................................48
Item 14. Principal Accountant Fees and Services..........................................................48
Part IV.......................................................................................................49
Item 15. Exhibits, Financial Statement Schedules.........................................................49
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Forward-Looking Statements
This Form 10-K contains forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended, relating to our
business and financial outlook, which are based on our current beliefs,
assumptions, expectations, estimates, forecasts and projections. In some cases,
you can identify forward-looking statements by terminology such as "may,"
"will," "should," "expects," "plans," "anticipates," "believes," "estimates,"
"projects," "intends," "predicts," "potential" or "continue" or other comparable
terminology. These forward-looking statements are not guarantees of our future
performance and involve risks, uncertainties, estimates and assumptions that are
difficult to predict. Therefore, our actual outcomes and results may differ
materially from those expressed in these forward-looking statements. You should
not place undue reliance on any of these forward-looking statements. Further,
any forward-looking statement speaks only as of the date on which it is made,
and we undertake no obligation to update any such statement, or the risk factors
described in Item IA under the heading "Risk Factors," to reflect new
information, the occurrence of future events or circumstances or otherwise.
Factors that could cause actual results to differ materially from those
indicated by the forward-looking statements or that could contribute to such
differences include, but are not limited to, unanticipated expenditures,
changing relationships with customers, suppliers and strategic partners,
unfavorable results in litigation matters, risks relating to the protection of
intellectual property, changes to the reimbursement policies of third parties,
changes to governmental regulation of medical devices, the impact of competitive
products, changes to the competitive environment, the acceptance of new products
in the market, conditions of the orthopedic industry and the economy, currency
or interest rate fluctuations and the other risks described under Item 1A -
"Business - Risk Factors" in this Form 10-K.
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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
non-invasive stimulation products used to enhance the success rate of spinal
fusions and to treat non-union fractures, external and internal fixation devices
used in fracture treatment, limb lengthening and bone reconstruction, and
bracing products used for ligament injury prevention, pain management and
protection of surgical repair to promote faster healing. Our products also
include a device for enhancing venous circulation, cold therapy, other pain
management products, bone cement and devices for removal of 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, annual proxy statement on Schedule
14A and amendments to those reports, are available free of charge on our website
as soon as reasonably practicable after they are filed with, or furnished to,
the Securities and Exchange Commission. Information on our website or connected
to our website is not incorporated by reference into this Form 10-K. Our
Internet website is located at http://www.orthofix.com. Our SEC filings are also
available on the SEC Internet website as part of the EDGAR database
(http://www.sec.gov).
Important Events
On September 30, 2005, we announced that we had reached an agreement to
settle the patent litigation between our subsidiary Novamedix and Kinetic
Concepts, Inc. ("KCI") related to our A-V Impulse System(R). Under the terms of
the settlement, KCI agreed to pay Novamedix $75 million, and we received an
assignment of certain KCI foot pump patent rights. KCI retains rights in the
patents and will maintain its Plexi Pulse foot pump product line going forward.
The settlement resolves and settles all claims between the parties. We have
contractual obligations to distribute a portion of the settlement proceeds to
certain parties including former owners of Novamedix.
On September 6, 2005, we announced that Alan W. Milinazzo had joined the
Company in a newly established position of Chief Operating Officer. Mr.
Milinazzo joined the Company from Medtronic Inc. where he was Vice President of
Medtronic's Vascular business, as well as Vice President and General Manager of
Medtronic's Coronary and Peripheral business. On February 16, 2006, we announced
that Mr. Milinazzo had been
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promoted to Group President and Chief Executive Officer, effective April 1,
2006. He will succeed Charles W. Federico, who will remain a Director of the
Company.
On April 11, 2005, we announced an agreement with Stryker Corp. to conclude
the 1998 Assignment Agreement for the manufacture and marketing of "BoneSource"
Bone Void Filler. Stryker retained all rights assigned to it under the original
agreement with no further obligation to make royalty payments to Orthofix for
use of product patents or trademarks. Orthofix retained all payments previously
made by Stryker, including an initial prepaid royalty payment of $2.4 million,
which was recorded as a one-time item to "Other Income" in March 2005.
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.
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. We intend to expand our product offerings
through business or product acquisition and assignment or licensing agreements,
as well as through our own product development efforts. We will leverage our
sales and distribution network by selling our products in all markets that are
available to them. We intend to 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 (33%), Reconstruction (40%) and Trauma (20%), which
together accounted for 93% of our total net sales in 2005. Sales of
non-orthopedic products, including airway management products for use during
anesthesia, woman's care and other products, accounted for 7% of our total net
sales in 2005.
5
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 spine bone growth stimulator
Cervical-Stim PEMF non-invasive cervical spine bone growth stimulator
Orthotrac Pneumatic vest used to reduce pressure on the spine
EZ Brace Rigid external brace for spine stabilization
Reconstruction
Fixation 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
eight-Plate Guided Growth System Treatment to cure the bowed legs or knock knees of children
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, pain and accelerate the
rehabilitation process
Pain Care Pain therapy products that provide continuous post-surgery
infusion of local anesthetic into surgical site
Trauma
Fixation External and internal fixation, including DAF, ProCallus,
XCaliber and nailing systems
Physio-Stim PEMF long bone non-invasive bone growth stimulator
PC.C.P Percutaneous compression plating system for hip fractures
Contours VPS Internal plating system for wrist fractures
Non-Orthopedic Products
- -----------------------
Laryngeal Mask Maintenance of airway during anesthesia
Other Several non-orthopedic products for which various Orthofix
subsidiaries hold distribution rights
We have proprietary rights in all of the above products with the exception
of the Laryngeal Mask, Cemex, ISKD, eight-Plate, and Contours VPS. We have the
exclusive distribution rights for the Laryngeal Mask and Cemex in Italy, for the
Laryngeal Mask in the United Kingdom and Ireland and for the ISKD, eight-Plate
and Contours VPS worldwide.
We have 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), Pain Care(R) and
Fusion(TM) XT.
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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, 2005. 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)
2005 2004 2003
-------------------------- ---------------------------- ----------------------------
Percent of Percent of Percent of
Total Net Total Net Total Net
Net Sales Sales Net Sales Sales Net Sales Sales
--------- ---------- --------- ---------- --------- ----------
Americas Orthofix $144,174 46% $125,972 44% $116,848 57%
Americas Breg 72,022 23% 68,294 24% - -
International Orthofix 97,108 31% 92,372 32% 86,859 43%
--------- ---------- --------- ---------- --------- ----------
Total $313,304 100% $286,638 100% $203,707 100%
========= ========== ========= ========== ========= ==========
Market Sector:
-------------
Year ended December 31,
(In US$ thousands)
2005 2004 2003
-------------------------- ---------------------------- ----------------------------
Percent of Percent of Percent of
Total Net Total Net Total Net
Net Sales Sales Net Sales Sales Net Sales Sales
--------- ---------- --------- ---------- --------- ----------
Orthopedic
Spine $101,622 33% $81,372 28% $ 79,552 39%
Reconstruction 125,416 40% 120,944 42% 51,183 25%
Trauma 63,538 20% 62,887 22% 53,706 26%
-------- ---- --------- ---- -------- ----
Total Orthopedic 290,576 93% 265,203 92% 184,441 90%
Non-Orthopedic 22,728 7% 21,435 8% 19,266 10%
-------- ---- --------- ---- -------- ----
Total $313,304 100% $286,638 100% $203,707 100%
======== ==== ========= ==== ======== ====
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 93% of our total net sales in 2005.
Our orthopedic product sales cover three market sectors: Spine,
Reconstruction and Trauma.
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Spine
Spine product sales represented 33% of our total net sales in 2005.
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 fusion segment which is the largest
sub-segment of the spine market.
Bone Growth Stimulators used in spinal applications are designed to enhance
the success rate of spinal fusions by stimulating the body's own natural healing
mechanism. These portable devices are intended to be used as part of a
post-surgery home treatment program prescribed by a physician.
Spinal-Stim
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 has been shown to
increase the probability of fusion, without the need for additional surgery.
According to internal sales data, more than 154,000 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.
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 refund 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 refund and
we carry a nominal financial reserve.
8
Cervical-Stim
On December 28, 2004, we received approval from the U.S. Food and Drug
Administration (FDA) to market our Cervical-Stim bone growth stimulator.
Cervical-Stim is the first and only FDA-approved bone growth stimulator for use
as an adjunct to cervical (upper) spine fusion in 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 pulsed
electromagnetic field ("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 has
sponsored independent research at the Cleveland Clinic, where scientists
conducted molecular and cellular mechanism studies to identify the influence of
Orthofix's PEMF signals on bone cells. Four of the six studies have been
published; one in each of the years 2003, 2004, 2005, and 2006. One of the two
remaining studies has been accepted for publication in a peer-reviewed journal,
the publication date is to be determined and the final manuscript is currently
under journal review. Among other insights, the studies, illustrate the positive
effects of PEMF on bone loss, callus formation, and collagen. Furthermore,
characterization and visualization of the Orthofix PEMF waveform is paving the
way for signal optimization for a variety of applications and indications.
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 40% of our total net sales in 2005.
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 offer 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 valgus deformity in
children.
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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 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 have a more well-rounded and
complete product line offering within the reconstruction market. As 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 has become a standard of care with physicians and
hospitals and pain therapy products are experiencing rapid acceptance as a
standard of care as well.
Fixation
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.
eight-Plate Guided Growth System
The eight-Plate Guided Growth System is a minimally invasive, secured
pediatric implant, designed to gently correct angular deformities such as bowed
legs and knock knees through guided growth. Guided growth is a technique that
harnesses the growth process at the joint without the need for invasive
osteotomy.
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.
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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 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. 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 have 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 evaluation 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 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 agents
and independent distributors that currently covers 36 states. A version of OSCAR
has a built-in endoscopic function for visual examination of the femoral canal.
Breg
On December 30, 2003, we acquired 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 55% of Breg's net revenues were attributable to the sale of
bracing products in 2005, 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
2005 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 8% of Breg's 2005 net revenues came from the sale of pain
therapy products used for patient control over post-operative pain management
after common sports medicine procedures such as arthroscopy of the knee and
shoulder. Approximately 7% of Breg's 2005 net revenues came from the sale of
other rehabilitative products. Breg sells its products through a network of
domestic and international independent distributors and related international
subsidiaries.
Breg Bracing
We design, manufacture and market a broad range of rigid knee bracing
products, including ligament braces, post-operative braces and osteoarthritic
braces. The rigid knee brace products are either customized braces or standard
adjustable off-the-shelf braces. Breg braces are endorsed by the Professional
Football Athletic Trainers Society.
Ligament braces provide durable support for moderate to severe knee
ligament instabilities and help stabilize the joint so that patients may
successfully complete rehabilitation and resume their daily activities. The
product line includes premium custom braces and off-the-shelf braces designed
for use in all activities. All ligament braces are also available with a
patellofemoral option to address tracking and subsequent pain of the
patellofemeral joint. We market the ligament product line under the Fusion and
X2K brand names.
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Post-operative braces limit a patient's range of motion after knee surgery
and protect the repaired ligaments and/or joints from stress and strain. These
braces promote a faster and healthier healing process. The products within this
line provide both immobilization and/or a protected range of motion. The Breg
post-op family of braces, featuring the Quick-Set hinge, offers complete range
of motion control for both flexion and extension, along with a simple-to-use
drop lock mechanism to lock the patient in full extension. The release lock
mechanism allows for easy conversion to full range of motion. The straps,
integrated through hinge bars, offer greater support and stability. This hinge
bar can be "broken down" for use during later stages of rehabilitation. The Breg
T-Scope is a premium brace in the post-operative bracing market and has every
feature available offered in our post-operative knee braces, including
telescoping bars, easy application, full range of motion and a drop lock
feature.
Osteoarthritic braces are used to treat patients suffering from
osteoarthritis of the knee. Osteoarthritis ("OA") is a form of damage to, or
degeneration of, the articular surface of a joint. This line of custom and
off-the-shelf braces is designed to shift the load going through the knee,
providing additional stability and reducing pain. In some cases, this type of
brace may serve as a cost-efficient alternative to total knee replacement.
Breg's CounterForce Plus, our newest bracing technology for patients suffering
from OA, is based on a functional knee brace design that controls both
anterior/posterior and varus/valgus instabilities.
Polar Care
We manufacture, market and sell a leading cold therapy product line, Polar
Care. Breg created the market for cold therapy products in 1991 when it
introduced the Polar Care 500, a cold therapy device used to reduce swelling,
minimize the need for post-operative pain medications and generally accelerate
the rehabilitation process. Today, we believe that cold therapy is a standard of
care with physicians despite limited historical reimbursement by insurance
companies over the years. Based on the increasing acceptance of cold therapy,
reimbursement by insurance companies is improving.
The Polar Care product uses a circulation system to provide constant fluid
flow rates to ensure safe and effective treatment. The product consists of a
cooler filled with ice and cold water connected to a pad, which is applied to
the affected area of the body; the device provides continuous cold therapy for
the relief of pain. Breg's cold therapy line consists of the Polar Care 500,
Polar Care 500 LITE, Polar Care 300, Polar Cub and cold gel packs.
Pain Care
We manufacture, market and sell a 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 strong position in this fast growing
market. In early 2006, we introduced the ePain Care, an electronic, reusable
infusion pump, which delivers a bolus of local anesthetic in a programmable
treatment protocol.
Other
Additionally, Breg offers a line of continuous passive motion (CPM) and
home therapy products to accommodate post-surgical ambulation and recovery from
shoulder, knee and ankle injuries.
Trauma
Trauma products represented 20% of our total net sales in 2005.
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.
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We believe our trauma products will assist in improving hospitals'
efficiency as the trauma market grows.
Fixation
For a fracture to heal properly, without misalignment or rotation, the bone
must be set and fixed in the correct position. The bone must be kept stable, but
not absolutely rigid, in order to alleviate pain, maintain the correct alignment
and initiate 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.
Our 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 may be removed when healing is completed. Our principal
internal fixation devices include:
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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 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; and
o the Centronail is a new state of the art nailing system for
stabilizing fractures in the femur, tibia and humerus. It has all the
attributes of the Orthofix Nailing System but has additional
advantages: it is made of titanium; has improved mechanical distal
targeting and instrumentation and a design which requires
significantly reduced inventory.
Contours VPS
The Contours VPS is an internal fixation plating system for wrist
fractures. It was designed from extensive cadaveric research. The Contours VPS
offers high and low contoured options that allow the plate to fix within the
variable surface geometry of the distal radius and its fixed angle screws to
obtain optimal bone purchase without danger of protrusion.
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 the Physio-Stim, a bone growth stimulation device which has
proved to be successful in treating many fracture non-unions. Our patient data
shows that eight out of ten patients with fracture non-unions that use
Physio-Stim are healed by our product without additional invasive surgical
treatment. The systems offer portability, rechargeable battery operation,
integrated component design, patient monitoring capabilities and the ability to
cover a large treatment area without factory calibration for specific patient
application. According to internal sales data, more than 115,000 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 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 proprietary to Orthofix.
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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 refund of 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 refund, for which we
carry a nominal financial reserve.
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.
There is growing concern about the mortality and complications associated
with hip fractures and their cost to society. 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 7% of our total net sales in 2005.
Laryngeal Mask
The Laryngeal Mask, a product of Venner Capital S.A. (formally known as LMA
International S.A.), is an anesthesia medical device used for establishing and
maintaining the patient's airway during an operation. We have exclusive
distribution rights for the Laryngeal Mask in the United Kingdom, Ireland and
Italy.
Other
We hold distribution rights for several other non-orthopedic products
including Mentor breast implants in Brazil and women's care products in the
United Kingdom.
Product Development
Our research and development departments are responsible for new product
development. We work regularly with certain institutions referred to below as
well as with physicians and other consultants on the long-term scientific
planning and evolution of our research and development efforts. Our primary
research and development facilities are located in Verona, Italy; McKinney,
Texas; Vista, California; and Andover, United Kingdom.
We maintain interactive relationships 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,
Rutgers University, and the University of Verona in Italy. Several of the
products that we market have been developed through these collaborations. In
addition, we regularly receive suggestions for new products from the scientific
and medical community, some of which result in Orthofix entering into assignment
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.
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In 2005, 2004 and 2003, we spent $11.3 million, $11.5 million and $8.1
million, respectively, on research and development. In 2005, we introduced the
Cervical-Stim for spine as well as several new products for the trauma and
reconstruction markets and several next generation products as extensions to
existing products.
In January 2000, we agreed to provide approximately $2.0 million to the
Orthopedic Research and Education Foundation to fund a four-year study to
explore the molecular and cellular mechanisms underlying bone-healing in
response to Orthofix's PEMF technology. These studies were conducted at the
Lerner Research Institute of the Cleveland Clinic. The results from these
studies include two published papers indicating positive effects on bone growth
and callus formation due to PEMF, one published paper indicating wave-form
dependent responses of collagen in the extracellular matrix to PEMF, and one
published paper regarding visualization of the current PEMF signal. Two
additional papers, one of which has been accepted for publication and the other
currently under journal review, explore the positive response of a particular
signaling molecule to PEMF and the absorption of PEMF energy by target tissues.
The signaling molecule identified by the studies is one that has already been
shown to be important for cell growth and proliferation.
In January 2003, we invested $1.5 million to purchase an equity interest in
Innovative Spinal Technologies a start-up company focused on commercializing
spinal products.
Patents, Trade Secrets, Assignments and Licenses
We rely on a combination of patents, trade secrets, assignment and license
agreements as well as non-disclosure agreements to protect our proprietary
intellectual property. We own numerous U.S. and foreign patents and have
numerous pending patent applications and license rights 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 patents or the economic life of the product. These license and
assignment 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 our submission of the required pre-market approval
applications.
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The medical devices that we develop, manufacture and market are subject to
rigorous regulation by the FDA and numerous other federal, state and foreign
governmental authorities. The process of obtaining FDA and other regulatory
approvals to develop and market a medical device, particularly from the FDA, can
be costly and time-consuming, and there can be no assurance that such approvals
will be granted on a timely basis, if at all. While we believe that we have
obtained all necessary clearances for the manufacture and sale of our products
and that they are generally in compliance with applicable FDA and other material
regulatory requirements, there can be no assurance that we will be able to
continue such compliance. If the FDA came to believe that we were not in
compliance with applicable law or regulations, it could institute proceedings to
detain or seize our products, issue a recall, impose operating restrictions,
enjoin future violations and assess civil and criminal penalties against us, our
officers or our employees and could recommend criminal prosecution to the
Department of Justice. In addition, the regulatory process may delay the
marketing of new products for lengthy periods and impose substantial additional
costs if the FDA lengthens review times for new devices. The FDA also has the
ability to reclassify medical devices from one category of regulatory
classification to another and there can be no assurance that one or more of our
products will not be reclassified.
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. 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 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 have healthcare compliance officers
for each of our major business units and we maintain a Healthcare Compliance
Committee as recommended by applicable U.S. government guidelines which meets
regularly to address healthcare regulatory policy. 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, together with opportunities in
emerging markets such as China and Latin America, as well as our focus on
innovative, minimally invasive products will continue to have a positive effect
on the demand for our products.
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Primary Markets
In 2005, Americas Orthofix including its principal market, the United
States, accounted for 46% of total net sales; Americas Breg accounted for 23% of
total net sales; and International Orthofix accounted for 31% of total net
sales. Other than Kendall Healthcare Products and sales directed to customers
through a marketing services agreement with Medtronic Sofamor Danek Group, no
single customer accounted for greater than 2% of total net sales.
We have a marketing services agreement for our spinal stimulation products
with Medtronic Sofamor Danek Group. As an agent for Orthofix, Medtronic Sofamor
Danek provides marketing introductions to potential customers in exchange for a
service fee. This agreement is set to expire in 2007, and if not renewed, could
have a negative impact on net sales of spinal stimulation products. Our 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 2005. 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, which have publicly funded healthcare systems as well as 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 a sales and marketing force of
approximately 470 direct sales and marketing representatives. Our products are
also sold through distributors. Worldwide we have approximately 239 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, 2005.
Direct
Sales & Marketing Headcount Distributors
--------------------------------------------- -----------------------------------------------
United States International Total United States International Total
------------- ------------- ----- ------------- ------------- -----
Orthofix 273 146 419 44 91 135
Breg 48 3 51 55 49 104
------------- ------------- ----- ------------- ------------- -----
Total 321 149 470 99 140 239
============= ============= ===== ============= ============= =====
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 an independent commissioned
distributor network addressing the Reconstruction market sector.
Outside the United States, we employ both direct sales representatives and
distributors within our international sales subsidiaries. We also utilize
independent distributors in Europe, the Far East, the Middle East and Central
and South America where we do not have subsidiaries. In order to provide support
to our independent distributor network, we have a group of sales and marketing
specialists who regularly visit independent distributors to provide training and
product support.
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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 product development relationships with the leading
orthopedic, trauma and other surgeons. These relationships facilitate the
introduction of design improvements and create innovative products that meet the
needs of surgeons and patients, thereby expanding the market for our products.
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 2005 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 have implemented a web-based sales
training program, which provides continued training to our sales
representatives.
Competition
Our bone growth stimulation products compete principally with similar
products marketed by EBI Medical Systems, a subsidiary of Biomet, Inc, dj
Orthopedics, Inc., and Exogen, Inc., a subsidiary of Smith & Nephew plc. For
external and internal fixation devices, our principal competitors include
Synthes AG, Zimmer, Inc., Stryker Corp., Smith & Nephew plc and EBI Medical
Systems. OSCAR competes principally with products produced by Biomet, Inc. and
Norian Corporation. The principal non-pharmacological products competing with
our A-V Impulse System are manufactured by Huntleigh Technology PLC and Kinetic
Concepts Inc. We recently settled an action against Kinetic Concepts Inc. for
alleged 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 operating flexibility in meeting
demand while focusing our resources on product development and marketing yet
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.
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Our products are currently manufactured and assembled in the United States,
Italy, the United Kingdom, Mexico and the Seychelles. We believe that our plants
comply in all material respects with the requirements of the FDA and all
relevant regulatory authorities outside the United States. For a description of
the laws to which we are subject, see Item 1 - "Business - Government
Regulation." We actively monitor each of our subcontractors in order to maintain
manufacturing and quality standards and product specification conformity.
Our business is generally not seasonal in nature. However, sales associated
with products for elective procedures appear to be influenced by the somewhat
lower level of such procedures performed in the late summer. Certain of the Breg
bracing products experience greater demand in the fall and winter corresponding
with high school and college football schedules and winter sports. In addition,
we do not consider the backlog of firm orders to be material.
Capital Expenditures
We had tangible and intangible capital expenditures in the amount of $12.2
million, $12.2 million and $5.2 million in 2005, 2004 and 2003, 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 $2.9 million in Americas Breg,
and approximately $4.0 million in International Orthofix in 2006 for a total of
approximately $11.0 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, 2005, we had 1,092 employees worldwide. 356 were employed
at Americas Breg, 504 were employed at Americas Orthofix and 232 were employed
at International Orthofix. Our relations with our Italian employees, who
numbered 81 at December 31, 2005, are governed by the provisions of a National
Collective Labor Agreement setting forth mandatory minimum standards for labor
relations in the metal mechanic workers industry. We are not a party to any
other collective bargaining agreement. We believe that we have good relations
with our employees. Of our 1,092 employees, 470 were employed in sales and
marketing functions, 190 in general and administrative, 406 in production and 26
in research and development.
20
Item 1A. Risk Factors
- ----------------------
In addition to the other information contained in the Form 10-K and the
exhibits hereto, you should carefully consider the risks described below. These
risks are not the only ones that we may face. Additional risks not presently
known to us or that we currently consider immaterial may also impair our
business operations. This Form 10-K also contains forward-looking statements
that involve risks and uncertainties. Our actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including the risks faced by us described below or elsewhere in
this Form 10-K.
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 our products arising from
research, we may not be able to maintain the confidentiality of information
relating to these products. In addition, when a patent relating to any of our
products lapses, we may experience greater competition arising from new market
entrants.
Third parties may claim that we infringe on their proprietary rights and may
prevent us from manufacturing and selling certain of our products.
There has been substantial litigation in the orthopedic medical devices
industry with respect to the manufacture, use and sale of new products. These
lawsuits relate to the validity and infringement of patents or proprietary
rights of third parties. We may be required to defend against allegations
relating to the infringement of patent or proprietary rights of third parties.
Any such litigation could, among other things:
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
21
may be substantial and could include the long-term payment of royalties.
Furthermore, the required assignments or licenses may not be made available to
us on acceptable terms. Accordingly, an adverse determination in a judicial or
administrative proceeding or a failure to obtain necessary assignments or
licenses could prevent us from manufacturing and selling some products or
increase our costs to market these products.
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. These products
may be reimbursed 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
provided to a patient or used in a procedure does not meet medical necessity
criteria; was not used in accordance with cost-effective treatment methods as
determined by such third-party payor; was investigational; was used for an
unapproved indication or if the policy holder's benefits are limited. Also,
third-party payors are increasingly challenging the prices charged for medical
products and services. Limits put on reimbursement could make it more difficult
for people to buy our products and reduce, or possibly eliminate, the demand for
our products. In addition, 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. Third-party payors, whether
private or governmental entities, also regularly institute coverage or
reimbursement review proceedings designed to determine whether a particular
product, treatment modality, device or therapy will be subject to reimbursement
and, if so, at what level of payment.
Orthofix Inc., a subsidiary of the Company, is currently involved in two
such proceedings. The first is before the Medicare Coverage Advisory Committee
("MCAC") which advises the Centers for Medicare and Medicaid Services ("CMS") on
whether specific medical items and services are reasonable and necessary under
applicable law. The MCAC is currently gathering factual information regarding
the use of bone growth stimulators such as those manufactured by the Company and
certain biological products (known generally as "orthobiologics") for the repair
of non-union bone fractures. The second proceeding is being conducted by the
General Accounting Office to determine whether an increase above the current
level of reimbursement will be given to the Company's bone growth stimulation
products in calendar year 2007, and, if so, at what level. The outcomes of these
proceedings and whether they could limit or reduce coverage or reimbursement for
the Company's products is currently unknown. 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 revenue by payor type is:
o Independent Distributors 27%
o Third Party Insurance 24%
o International Public Healthcare Systems 19%
o Direct (hospital) 19%
o U.S. Government - Medicare, Medicaid, TriCare 9%
o Self pay 2%
22
We may be subject to extensive government regulation that increases our costs
and could limit our ability to market or sell our products.
The medical devices we manufacture and market are subject to rigorous
regulation by the Food and Drug Administration, or FDA, and numerous other
federal, state and foreign governmental authorities. These authorities regulate
the development, approval, classification, testing, manufacture, labeling,
marketing and sale of medical devices. For a description of these regulations,
see Item 1 - "Business - Government Regulation."
The approval by governmental authorities, including the FDA in the United
States, is generally required before any medical devices may be marketed in the
United States or other countries. We cannot predict whether in the future, the
U.S. or foreign governments may impose regulations that have a material adverse
effect on our business, financial condition or results of operations. The
process of obtaining FDA and other regulatory approvals to develop and market a
medical device can be costly and time-consuming, and is subject to the risk that
such approvals will not be granted on a timely basis if at all. The regulatory
process may delay or prohibit the marketing of new products and impose
substantial additional costs if the FDA lengthens review times for new devices.
The FDA has the ability to change the regulatory classification of an approved
device from a higher to a lower regulatory classification which could materially
adversely impact our ability to market or sell our devices. Our subsidiary,
Orthofix Inc., is currently involved in a proceeding before the FDA addressing
whether the FDA classification of bone growth stimulation products should be
reclassified from FDA Class III to FDA Class II. We are actively participating
in this proceeding, and maintain that the current FDA Class III classification
is correct. We do not know when or whether the FDA will reach a determination on
this classification issue or whether any such determination would adversely
impact our ability to market or sell these products.
Our profitability depends, in part, upon the ability of the Company, our
sales representatives, and our distributors to obtain and maintain all necessary
certificates, permits, approvals and clearances from U.S. and foreign regulatory
authorities and to operate in compliance with applicable regulations. If the FDA
or other U.S. or foreign regulatory authority determines that we were not in
compliance with applicable law or regulations, it could institute proceedings to
detain or seize our products, issue a recall, impose operating restrictions,
enjoin future violations and assess civil and criminal penalties against us, our
officers or our employees and could recommend criminal prosecution to the
Department of Justice. Any such consequences could have a material adverse
effect on our business, financial condition or results of operations.
We may be subject to product liability claims that may not be covered by
insurance and could require us to pay substantial sums.
We are subject to an inherent risk of, and adverse publicity associated
with, product liability and other liability claims, whether or not such claims
are valid. We maintain product liability insurance coverage in amounts and scope
that we believe is reasonable and adequate. There can be no assurance, however,
that product liability or other claims will not exceed our insurance coverage
limits or that such insurance will continue to be available on reasonable
commercially acceptable terms, or at all. A successful product liability claim
that exceeds our insurance coverage limits could require us to pay substantial
sums and could have a material adverse effect on us.
New developments by others could make our products or technologies
non-competitive or obsolete.
The orthopedic medical device industry in which we compete is undergoing,
and is expected to continue to undergo, rapid and significant technological
change. We expect competition to intensify as technological advances are made.
New technologies and products developed by other companies are regularly
introduced into the market, which may render our products or technologies
non-competitive or obsolete.
The approval and introduction of Bone Morphogenic Proteins (BMPs) by
Medtronic Sofamor Danek Group have shown market acceptance as a substitute for
autograft bone in spinal fusion surgeries. Our Spinal-Stim product is FDA
approved for both failed fusions and healing enhancement as an adjunct to spinal
fusion surgery, most typically for multilevel or high-risk patients. While BMPs
are considered or classified as a bone growth material,
23
they have yet to be clinically proven to be effective or approved for use in the
high-risk patients such as those who use our Spinal-Stim and our new
Cervical-Stim products. Off-label use or the FDA approval of BMPs for risk
indications could have an adverse effect on sales of our bone-growth stimulation
products in high-risk patients. Additionally, in 2004, Artificial Disks were
introduced into the market as an alternative to spinal fusions. The use of
artificial disks on high risk patients could have an adverse effect on sales of
our products in such 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."
We depend on our senior management team.
Our success depends upon the skill, experience and performance of members
of our senior management team, who have been critical to the management of our
operations and the implementation of our business strategy. We do not have key
man insurance on our senior management team, and the loss of one or more key
executive officers could have a material adverse effect on our operations and
development.
Termination of our existing relationships with our independent sales
representatives or distributors could have an adverse effect on our business.
We sell our products in many countries through independent distributors.
Generally, our independent sales representatives and our distributors have the
exclusive right to sell our products in their respective territories and are
generally prohibited from selling any products that compete with ours. The terms
of these agreements vary in length from one to ten years. Under the terms of our
distribution agreements, each party has the right to terminate in the event of a
material breach by the other party and we generally have the right to terminate
if the distributor does not meet agreed sales targets or fails to make payments
on time. Any termination of our existing relationships with independent sales
representatives or distributors could have an adverse effect on our business
unless and until commercially acceptable alternative distribution arrangements
are put in place.
We are party to numerous contractual relationships.
We are party to numerous contracts in the normal course of our business. We
have contractual relationships with suppliers, distributors and agents, as well
as service providers. In the aggregate, these contractual relationships are
necessary for us to operate our business. From time to time, we amend, terminate
or negotiate our contracts. We are also periodically subject to, or make claims
of breach of contract, or threaten legal action relating to our contracts. These
actions may result in litigation. At any one time, we have a number of
negotiations under way for new or amended commercial agreements. We devote
substantial time, effort and expense to the administration and negotiation of
contracts involved in our business. However, these contracts may not continue in
24
effect past their current term or we may not be able to negotiate satisfactory
contracts in the future with current or new business partners.
We face risks related to foreign currency exchange rates.
Because some of our revenue, operating expenses, assets and liabilities are
denominated in foreign currencies, we are subject to foreign exchange risks that
could adversely affect our operations and reported results. To the extent that
we incur expenses or earn revenue in currencies other than the U.S. dollar, any
change in the values of those foreign currencies relative to the U.S. dollar
could cause our profits to decrease or our products to be less competitive
against those of our competitors. To the extent that our current assets
denominated in foreign currency are greater or less than our current liabilities
denominated in foreign currencies, we have potential foreign exchange exposure.
We have substantial activities outside of the United States that are subject to
the impact of foreign exchange rates. The fluctuations of foreign exchange rates
during 2005 have had a positive impact of $1.2 million on net sales outside of
the United States. Although we seek to manage our foreign currency exposure by
matching non-dollar revenues and expenses, exchange rate fluctuations could have
a material adverse effect on our results of operations in the future. To
minimize such exposures, we enter into currency hedges from time to time. At
December 31, 2005, we had outstanding a foreign currency hedge for 5.0 million
Euros to balance our current liabilities denominated in Euros with our current
assets denominated in Euros.
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, 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 could adversely affect our
profitability.
We are subject to differing customs and import/export rules in several
jurisdictions in which we operate.
We import and export our products to and from a number of different
countries around the world. These product movements involve subsidiaries and
third-parties operating in jurisdictions with different customs and
import/export rules and regulations. Customs authorities in such jurisdictions
may challenge our treatment of customs and import/export rules relating to
product shipments under aspects of their respective customs laws and treaties.
If we are unsuccessful in defending our treatment of customs and import/export
classifications, we may be subject to additional customs duties, fines or
penalties that could adversely affect our profitability.
Provisions of Netherlands Antilles law may have adverse consequences to our
shareholders.
Our corporate affairs are governed by our Articles of Association and the
corporate law of the Netherlands Antilles as laid down in Book 2 of the Civil
Code (CCNA). Although some of the provisions of the CCNA resemble some of the
provisions of the corporation laws of a number of states in the United States,
principles of law relating to such matters as the validity of corporate
procedures, the fiduciary duties of management and the rights of our
shareholders may differ from those that would apply if Orthofix were
incorporated in a jurisdiction within the United States. For example, there is
no statutory right of appraisal under Netherlands Antilles corporate law nor is
there a right for shareholders of a Netherlands Antilles corporation to sue a
corporation derivatively. In addition, we have been advised by Netherlands
Antilles counsel that it is unlikely that (1) the courts of the Netherlands
Antilles would enforce judgments entered by U.S. courts predicated upon the
civil liability provisions of the U.S. federal securities laws and (2) actions
can be brought in the Netherlands Antilles in relation to liabilities predicated
upon the U.S. federal securities laws.
25
Our business is subject to economic, political, regulatory and other risks
associated with international sales and operations.
Since we sell our products in many different countries, our business is
subject to risks associated with conducting business internationally. Net sales
outside the United States represented 30% of our total net sales in 2005. 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.
We may incur costs and undertake new debt and contingent liabilities in a search
for acquisitions.
We continue to search for viable acquisition candidates that would expand
our market sector or global presence. We also seek additional products
appropriate for current distribution channels. The search for or acquisition of
another company or product line by us could result in our incurrence of costs
from such efforts as well as the undertaking of new debt and contingent
liabilities from such searches or acquisitions. Such costs may be incurred at
any time and may vary in size depending on the scope of the acquisition or
product transactions and may have a material impact on our results of
operations.
Item 1B. Unresolved Staff Comments
- -----------------------------------
None.
26
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
International Distribution Center for Orthofix products Verona, Italy 18,000 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 9,001 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 4,415 Leased
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 5,705 Leased
Administrative, manufacturing, warehousing, distribution Vista, California 104,832 Leased
and 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
27
Item 3. Legal Proceedings
- --------------------------
Our subsidiary, Novamedix, filed an action on February 21, 1992 against
Kinetic Concepts Inc. ("KCI") alleging infringement of the patents relating to
Novamedix's A-V Impulse System foot pump product, breach of contract, unfair
competition and seeking damages. KCI filed counterclaims alleging inequitable
conduct by Novamedix before the United States Patent and Trademark Office, fraud
and unfair competition. KCI withdrew several of its counterclaims, but continued
to assert affirmative defenses contending that the patents were invalid,
unenforceable, and not infringed. 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 denied certain motions filed by KCI that would have disposed of the case
without a trial. On September 30, 2005 KCI, Novamedix and the Company announced
a settlement had been reached under which KCI agreed to pay Novamedix $75.0
million and give Novamedix an option to receive a limited assignment or license
to certain KCI foot pump patent rights, which the Company chose to receive a
limited assignment. We have contractual obligations to distribute a portion of
the settlement proceeds to certain former owners of Novamedix and the original
patents.
We are from time to time involved in legal proceedings in the normal course
of business which may include, but are not limited to, product liability
actions.
Although we cannot predict the outcome of any proceedings or claims made
against us, management does not expect that the ultimate outcome of any such
proceedings or claims will have a material adverse effect on our financial
position, results of operations or cash flows.
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 2005.
28
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
- ------------------------------------------------------------------------------
and Issuer Purchases of Equity Securities
-----------------------------------------
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, 2005. As of March 9, 2006 we had
approximately 270 holders of record of our common stock. The closing price of
our common stock on March 9, 2005 was $42.24.
High Low
---- ----
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
2005
----
First Quarter $42.44 $36.24
Second Quarter 48.61 37.57
Third Quarter 46.98 40.59
Fourth Quarter 45.09 35.30
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 2005
that were not registered under the Securities Act.
In 2005, we issued 2,972 shares of our common stock to warrant holders upon
the exercise of 2,972 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.
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.
29
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.
30
Item 6. Selected Financial Data
- --------------------------------
The following selected consolidated financial data for the years ended
December 31, 2005, 2004, 2003, 2002 and 2001 have been derived from our audited
consolidated financial statements. The financial data as of December 31, 2005
and 2004 and for the years ended December 31, 2005, 2004, and 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,
--------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(In US$ thousands, except margin and per share data)
Consolidated operating results
Net sales......................................... $313,304 $286,638 $203,707 $177,595 $162,360
Gross profit...................................... 229,516 207,461 152,617 132,776 119,408
Gross profit margin............................... 73% 72% 75% 75% 74%
Total operating income............................ 59,706 56,568 44,568 42,939 30,499
Net income(1)..................................... 73,402 34,149 24,730 25,913 20,964
Net income per share of common stock (basic)...... 4.61 2.22 1.76 1.96 1.60
Net income per share of common stock (diluted).... 4.51 2.14 1.68 1.76 1.42
Consolidated financial position As of December 31,
(at year-end) ---------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(In US$ thousands, except share data)
Total assets ..................................... $473,861 $440,969 $413,179 $220,774 $188,914
Total debt........................................ 15,287 77,382 110,207 7,420 5,560
Shareholders' equity.............................. 368,885 297,172 240,776 168,084 138,102
Weighted average number of shares of
common stock outstanding (basic)............... 15,913,475 15,396,540 14,061,447 13,196,524 13,086,467
Weighted average number of shares of
common stock outstanding (diluted)............. 16,288,975 15,974,945 14,681,883 14,685,236 14,737,567
_______________
(1) Net income for 2005 includes $37.4 million of income after tax related
to the KCI settlement.
31
Item 7. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations
-------------
The following discussion and analysis addresses the results of our
operations which are based upon the consolidated financial statements included
herein, which have been prepared in accordance with accounting principles
generally accepted in the United States. This discussion should be read in
conjunction with "Forward-Looking Statements" and our consolidated financial
statements and notes thereto appearing elsewhere in this Form 10-K. This
discussion and analysis also addresses our liquidity and financial condition and
other matters.
General
We are a diversified orthopedic products company offering a broad line of
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
non-invasive stimulation products used to enhance the success rate of spinal
fusions and to treat non-union fractures, external and internal fixation devices
used in fracture treatment, limb lengthening and bone reconstruction, and
bracing products used for ligament injury prevention, pain management and
protection of surgical repairs 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 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 both interest rate and foreign currency
fluctuation exposures. 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, excluding the operations 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 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.
32
Critical Accounting Policies and Estimates
Our discussion of operating results is based upon the consolidated
financial statements and accompanying notes to the consolidated financial
statements prepared in conformity with accounting principles generally accepted
in the United States. The preparation of these statements necessarily requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amount of revenues and
expenses during the reporting period. These estimates and assumptions form the
basis for the carrying values of assets and liabilities. On an ongoing basis, we
evaluate these estimates, including those related to allowance for doubtful
accounts, sales allowances and adjustments, inventories, investments, intangible
assets and goodwill, income taxes, litigation and contingencies. We base our
estimates on historical experience and various other assumptions and believe our
estimates for the carrying values of assets and liabilities are reasonable.
Actual results may differ from these estimates. We have reviewed our critical
accounting policies with the Audit Committee of the Board of Directors.
Revenue Recognition
For bone growth stimulation and certain bracing products that are
prescribed by a physician, we recognize revenue when the product is placed on
and accepted by the patient. For 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 related to the carrying value
of goodwill or indefinite lived intangible assets as of December 31, 2005.
33
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 or our present insurance coverage.
Tax Matters
We and each of our subsidiaries are taxed at the rates applicable within
each of their respective jurisdictions. The composite income tax rate, tax
provisions, deferred tax assets and deferred tax liabilities will vary according
to the jurisdiction in which profits arise. Further, certain of our subsidiaries
sell products directly to our other subsidiaries or provide administrative,
marketing and support services to our other subsidiaries. These intercompany
sales and support services involve subsidiaries operating in jurisdictions with
differing tax rates. The tax authorities in such jurisdictions may challenge our
treatments under residency criteria, transfer pricing provisions, or other
aspects of their respective tax laws, which could affect our composite tax rate
and provisions.
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,
-------------------------------------------------------
2005 2004 2003
---- ---- ----
(%) (%) (%)
---- ---- ----
Net sales...................................... 100 100 100
Cost of sales.................................. 27 28 25
Gross profit................................... 73 72 75
Operating expenses
Sales and marketing ......................... 37 36 38
General and administrative................... 11 11 11
Research and development..................... 4 4 4
Amortization of intangible assets............ 2 2 -
Total operating income......................... 19 19 22
Net income (1)................................. 23 12 12
__________
(1) Net income for 2005 includes $37.4 million of net income after tax related
to the KCI settlement.
34
Segment and Market Sector Revenue
The following tables display net sales by business segment and net sales by
market sector. We provide net sales by market sector for information purposes
only. We keep our books and records and account for net sales, costs of sales
and expenses by business segment.
Business Segment:
Year ended December 31,
(In US$ thousands)
2005 2004 2003
-------------------------- ---------------------------- ----------------------------
Percent of Percent of Percent of
Total Net Total Net Total Net
Net Sales Sales Net Sales Sales Net Sales Sales
--------- ---------- --------- ---------- --------- ----------
Americas Orthofix $144,174 46% $125,972 44% $116,848 57%
Americas Breg 72,022 23% 68,294 24% - -
International Orthofix 97,108 31% 92,372 32% 86,859 43%
--------- ---------- --------- ---------- --------- ----------
Total $313,304 100% $286,638 100% $203,707 100%
========= ========== ========= ========== ========= ==========
Our revenues are generally derived from two primary sources: sales of
orthopedic and non-orthopedic products. Orthopedic products are sold into three
market sectors, Spine, Reconstruction and Trauma. Sales of non-orthopedic
products include the Laryngeal Mask product, woman's care and other products.
Market Sector:
Year ended December 31,
(In US$ thousands)
2005 2004 2003
-------------------------- ---------------------------- ----------------------------
Percent of Percent of Percent of
Total Net Total Net Total Net
Net Sales Sales Net Sales Sales Net Sales Sales
--------- ---------- --------- ---------- --------- ----------
Orthopedic
Spine $101,622 33% $81,372 28% $79,552 39%
Reconstruction 125,416 40% 120,944 42% 51,183 25%
Trauma 63,538 20% 62,887 22% 53,706 26%
--------- ---------- --------- ---------- --------- ----------
Total Orthopedic 290,576 93% 265,203 92% 184,441 90%
Non-Orthopedic 22,728 7% 21,435 8% 19,266 10%
--------- ---------- --------- ---------- --------- ----------
Total $313,304 100% $286,638 100% $203,707 100%
========= ========== ========= ========== ========= ==========
2005 Compared to 2004
Sales by Business Segment:
Net sales increased 9% to $313.3 million in 2005 compared to $286.6 million
in 2004. The impact of foreign currency increased sales by $1.2 million in 2005
when compared to 2004.
Net sales in Americas Orthofix (the "Americas") increased 14% to $144.2
million in 2005 compared to $126.0 million in 2004. The Americas net sales
represented 46% and 44% of our total net sales in 2005 and 2004, respectively.
The increase in sales was primarily the result of a 25% increase in sales in the
Spine market sector
35
attributable to sales of Cervical-Stim which was approved by the FDA in December
2004, and growth in the sales of Spinal-Stim, used for lumbar applications. The
Americas Reconstruction market sector increased 11% in 2005 compared to 2004.
This growth continues to be driven by fixation products used in reconstruction
applications, including the recently introduced growth plate (the eight-Plate)
and the ISKD limb lengthening system. These increases in the Americas Spine and
Reconstruction market sectors were partially offset by a 9% decrease in the
Americas Trauma market sector in 2005 as compared to the prior year. This
decrease is attributable to a decline in external fixation sales used in Trauma
applications as well as decline in Physio-Stim long bone stimulation sales
resulting from increased competition and the cannibalization of some stimulation
sales, previously recorded in the Trauma market sector, by the recent
introduction of the Cervical-Stim. In the Americas Trauma market sector,
external fixation devices are sharing the market for treatment of difficult
fractures with alternatives such as plating, nailing and biologics. Recognizing
this trend, we have introduced the VPS Contour plate for distal radius
fractures, the Osteomax bone void filler product line, and anticipate the
introduction of other internal fixation and biologic products to our Americas
Trauma product line. The following table illustrates sales by market sector in
the Americas:
(In thousands) 2005 2004
Net Sales Net Sales Growth
--------- --------- ---------
Orthopedic
Spine $101,497 $81,190 25%
Reconstruction 8,147 7,318 11%
Trauma 32,846 36,058 (9)%
-------- -------
Total Orthopedic 142,490 124,566 14%
Non-Orthopedic 1,684 1,406 20%
-------- -------
Americas Orthofix $144,174 $125,972 14%
======== =======
Net sales in Americas Breg ("Breg") increased 5% to $72.0 million in 2005
compared to $68.3 million in 2004. This increase in sales was primarily
attributable to the sale of Breg bracing products, which increased 10% in 2005.
Our new Fusion XT knee brace, which experienced positive market response upon
its limited introduction, contributed to this increase. This increase was
partially offset by an 8% decrease in sales for pain therapy products resulting
in part from delays in the introduction of new pain therapy products. All of
Breg's sales are recorded in our Reconstruction market sector. Breg net sales
represented 23% and 24% of our total net sales in 2005 and 2004, respectively.
Net sales in International Orthofix ("International") increased 5% to $97.1
million in 2005 from $92.4 million in 2004. International net sales represented
31% and 32% of our total net sales in 2005 and 2004, respectively. Our Trauma
market sector continues to contribute to the growth in International, led
primarily by the sales of external fixation products, the Physio-Stim and the
PC.C.P hip fracture system. The International Reconstruction market sector
continues to be impacted by a decrease in sales of the A-V Impulse product when
compared to the same period of the prior year. This decrease is primarily
attributable to the competitive landscape for this product and decreased prices
to our principal US distributor. The impact of foreign currency increased
International sales by $0.6 million for 2005 when compared to 2004. The
following table illustrates sales by market sector in International:
(In thousands) 2005 2004
Net Sales Net Sales Growth
--------- -------- --------
Orthopedic
Spine $125 $182 (31)%
Reconstruction 45,247 45,543 (1)%
Trauma 30,692 26,618 15%
-------- -------
Total Orthopedic 76,064 72,343 5%
Non-Orthopedic 21,044 20,029 5%
-------- -------
International Orthofix $97,108 $92,372 5%
======== =======
36
Sales by Market Sector:
Net sales of our spine products grew 25% to $101.6 million in 2005 from
$81.4 million in 2004. This increase is primarily due to sales of Cervical-Stim,
which was approved by the FDA in December 2004 and began selling in January
2005, and growth of our Spinal-Stim, used for lumbar applications.
Sales of our reconstruction products increased 4% to $125.4 million in 2005
compared to $120.9 million in 2004. The increase is attributable to sales of the
Breg products which increased 7% worldwide, sales of our OSCAR product which
increased 12%, and sales of the ISKD limb lengthening device which increased
36%. These increases were partially offset by a 5% decrease in the sale of our
A-V Impulse product as discussed above.
Sales of our trauma products increased 1% to $63.5 million in 2005,
compared to $62.9 million in 2004. This market sector was positively impacted
from a 7% growth in sales of external fixation products and a 31% growth in
sales of PC.C.P. Growth in this market sector was negatively impacted by a
decrease of 11% in sales of stimulation products used for long bone
applications. The growth in this product has been impacted by increased
competition and the effect of cannibalization of some stimulation sales
previously recorded in this market sector by Cervical-Stim.
Sales of our non-orthopedic products grew 6% to $22.7 million in 2005
compared to $21.4 million in 2004. The increase was primarily due to an increase
in sales of woman's care and other products. This increase was slightly offset
by a decrease in sales of airway management products due to increased
competition as a result of this product coming off patent.
Gross Profit -- Gross profit increased 11% to $229.5 million in 2005 from
$207.5 million in 2004, primarily due to the increase of 9% in net sales. Gross
profit as a percentage of net sales in 2005 was 73.3% compared to 72.4% in 2004.
The improvement in gross profit margin in 2005 as compared to 2004 is due to
operational process improvements which increased margins on our stimulation
products, and a more favorable product mix resulting from higher sales of higher
margin stimulation products.
Sales and Marketing Expenses -- Sales and marketing expenses, which include
commissions, royalties and bad debt provisions, generally increase and decrease
in relation to sales. Sales and marketing expenses increased $13.2 million to
$115.7 million in 2005 from $102.5 million in 2004, an increase of 13% on a
sales increase of 9%. Sales and marketing expenses as a percentage of net sales
increased to 36.9% in 2005 from 35.7% in 2004. The higher sales and marketing
expense relates to higher commissions and other variable costs on higher sales,
additional personnel, principally in the Americas, and higher related benefits
costs, all of which were deemed to be more operational in nature. In addition,
we discretionarily spent approximately $3.1 million for market development
efforts in our Latin Americas subsidiaries and marketing programs, some of which
costs will continue in 2006.
General and Administrative Expenses -- General and administrative expenses
increased $5.6 million to $36.2 million in 2005 from $30.6 million in 2004. This
increase is a result of corporate development, higher costs associated with
Section 404 of the Sarbanes-Oxley Act of 2002, legal activity, employee benefit
costs in the United States, consulting and training costs associated with
implementing an Oracle system at Breg, and sponsorships at Breg. We also had an
increase in the area of business development, when compared to the same period
of the prior year. We added a new Chief Operating Officer during the current
year to lead these activities and have incurred costs of outside consultants to
help us define market potential and target and assess new opportunities. General
and administrative expense as a percent of net sales was 11% in 2005 and 2004.
In February 2006, we announced the succession of our CEO and President along
with a restructuring of our International operations. We expect to incur costs
of approximately $1.0 million in the first quarter of 2006 associated with these
items.
Research and Development Expenses -- Research and development expenses
decreased $0.2 million to $11.3 million in 2005 from $11.5 million in 2004, a
decrease of 1%, and remained constant as a percentage of net sales at 4%.
Amortization of Intangible Assets -- Amortization of intangible assets was
$6.6 million in 2005 compared to $6.3 million in 2004.
37
Interest Income -- Interest income earned on cash balances held during the
period was $0.9 million in 2005 compared to $0.3 million in 2004.
Interest Expense -- Interest expense was $6.4 million in 2005 compared to
$6.3 million in 2004 primarily due to an increase of approximately $2.0 million
in the amortization of debt placement costs resulting from the prepayment of
debt on the senior secured term loan and an increase in interest rates in 2005.
These additional costs were offset by lower interest expense incurred on lower
outstanding debt balances following debt prepayments as well as the termination
of an interest rate swap agreement that reduced interest expense by $0.4
million.
Loss in Joint Venture, Net -- In 2005, we did not record a loss in joint
venture and in 2004 we recorded a net loss of $0.3 million. During 2004, we sold
part of our ownership in the OrthoRx joint venture. This sale resulted in a gain
of approximately $0.8 million. The gain was offset by our portion of the joint
venture's operating losses in 2004 of approximately $1.1 million. As of December
31, 2005 our ownership percentage in the joint venture was 6.4% and our
investment in the joint venture had been reduced to zero through the equity
method of accounting.
Other Income (Expense), Net -- Other income (expense), net was income of
$1.2 million in 2005 compared to income of $1.7 million in 2004. Other income in
2005 was attributable to $2.4 million of deferred royalty income resulting from
the conclusion of the BoneSource agreement with Stryker which was partially
offset by $0.9 million of foreign currency losses. In 2004, other income was
generated from the sale of our interest in a U.K. facility that resulted in a
gain of approximately $0.6 million and foreign exchange gains of $0.9 million,
primarily as a result of uncovered trade receivables denominated in Euros in
subsidiaries whose functional currency is the US Dollar.
KCI Settlement, Net of Related Costs -- In September 2005, we reached an
agreement to settle our case against Kinetics Concepts Inc. ("KCI"). The gain,
net of related costs, for 2005 was $40.1 million, compared to costs of $1.6
million in 2004. The net gain recorded in 2005 was subject to adjustment based
on potential differences between the amount accrued and final contractual
obligations. In the first quarter of 2006, we entered into final agreements with
certain former owners of Novamedix, which established the amount we will be
required to disburse in connection with the KCI litigation settlement. As a
result of these negotiations, we expect to disburse approximately $24.9 million
instead of the $26.2 million accrued at December 31, 2005. The difference of
approximately $1.3 million will be recorded as income in the first quarter of
2006.
Income Tax Expense -- In 2005 and 2004, the effective tax rate was 23.2%
and 32.2%, respectively. The effective tax rate in 2005 was primarily affected
by the KCI settlement gain recorded at Novamedix Distribution Limited, a
wholly-owned Cypriot subsidiary, which is in a favorable tax jurisdiction.
Excluding the nonrecurring KCI settlement, our effective tax rate was
approximately 35% for 2005. The increase in our effective tax rate excluding the
KCI litigation settlement is primarily attributable to a change in tax law in
the United Kingdom and earning more taxable income in higher tax jurisdictions
such as the United States.
Net Income -- Net income for 2005 was $73.4 million compared to
$34.1 million in 2004, an increase of 115%. Net income was $4.61 per basic share
and $4.51 per diluted share in 2005, compared to $2.22 per basic share and $2.14
per diluted share in 2004, an increase in diluted earnings per share of 111%.
Net income for 2005 included a gain of $37.4 million or $2.35 per basic share
and $2.30 per diluted share from the settlement of the KCI litigation. The
weighted average number of basic common shares outstanding was 15,913,475 and
15,396,540 during 2005 and 2004, respectively. The weighted average number of
diluted common shares outstanding was 16,288,975 and 15,974,945 during 2005 and
2004, respectively.
38
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:
(In thousands) 2004 2003
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:
(In thousands) 2004 2003
Net Sales Net Sales Growth
--------- --------- --------
Orthopedic
Spine $182 $99 84%
Reconstruction 45,543 44,408 3%
Trauma 26,618 24,464 9%
-------- -------
Total Orthopedic 72,343 68,971 5%
Non-Orthopedic 20,029 17,888 12%
-------- -------
International Orthofix $92,372 $86,859 6%
======== =======
39
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.
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 $8.4 million to $30.6 million from $22.2 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. 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.
40
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.
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.
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 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.
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.
KCI Settlement Cost, Net of Related Costs -- Litigation costs for our case
against Kinetic Concepts, Inc. ("KCI") was $1.6 million in 2004 compared to $4.0
million in 2003. See Item 3 - "Legal Proceedings" for a description of the legal
proceedings.
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) 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.
41
Liquidity and Capital Resources
Cash and cash equivalents at December 31, 2005 were $77.5 million, of which
$13.8 million is subject to certain restrictions under the senior secured credit
agreement described below and of which $26.2 is provided for in an accrual and
expected to be paid to Novamedix parties in 2006 as a part of the KCI
settlement. This compares to cash and cash equivalents of $40.2 million at
December 31, 2004, of which $14.3 million was subject to certain restrictions
under the senior secured credit agreement.
Net cash provided by operating activities was $106.7 million in 2005,
including $67.5 million from the KCI settlement, compared to $27.5 million in
2004, an increase of $79.2 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 $39.3 million,
including $37.4 million from the KCI settlement, to $73.4 million in 2005 from
$34.1 million in 2004. Non-cash items increased $2.2 million in 2005 compared to
2004, primarily due to the amortization of debt placement costs of $2.0 million,
to loss on disposal of fixed assets of $0.9 million compared to a gain on the
sale of fixed asset of $0.7 million in 2004, an increase in depreciation and
amortization expense of $0.5 million and an increase in the provision for
doubtful accounts of $0.5 million. These increases in non-cash items were
partially offset by deferred royalties received from the Stryker settlement of
$2.4 million. Working capital accounts generated $12.7 million of cash,
including $26.2 million related to the accrual for amounts due to the former
Novamedix shareholders as part of the KCI litigation settlement, in 2005
compared to the use of $25.0 million in cash during 2004, of which $14.3 million
resulted from the reclassification of cash as restricted cash. Excluding the KCI
litigation settlement, working capital accounts consumed $13.5 million in 2005
primarily due to the increases in accounts receivable to support additional
sales. Overall performance indicators of our two primary working capital
accounts, accounts receivable and inventory, reflect days sales in receivables
of 93 days at December 31, 2005 compared to 94 at December 31, 2004 and
inventory turnover of 2.7 times at December 31, 2005 compared to 2.5 times at
December 31, 2004.
Net cash used in investing activities was $12.2 million during 2005,
compared to $11.4 million during 2004. Net cash used in investing activities in
2005 was comprised of capital expenditures for tangible assets of approximately
$10.5 million and intangible assets of approximately $1.7 million. In 2006, we
anticipate the use of cash for tangible and intangible capital expenditures will
be approximately $11.0.
Net cash used in financing activities was $55.6 million in 2005 compared to
cash used in financing activities of $22.1 million in 2004. In 2005, we received
proceeds of $6.5 million from the issuance of 297,306 shares of our common stock
upon the exercise of stock options, warrants and shares purchased pursuant to
our employee stock purchase plan. In 2005, we repaid approximately $62.0 million
against the principal of our senior secured term loan, and paid $0.3 million
against other outstanding debt. By March 31, 2006, we anticipate repaying the
remaining outstanding balance on our senior secured term loan of $14.8 million
and canceling the revolver under this facility.
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, 2005 and as of March 13,
2006, we had no amounts outstanding under the revolving credit facility and
$14.8 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. Due to
accelerated prepayment of the term loan, we terminated the swap agreement on
December 22, 2005 and recorded a gain on cash received of $0.4 million as a
reduction to interest expense. Our effective interest rate as of December 31,
2005 on our senior secured debt was 6.38%. 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.
42
At December 31, 2005, we had outstanding borrowings of $0.1 million and
unused available lines of credit of approximately 6.8 million Euros ($8.0
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.
Contractual Obligations
The following chart sets forth our contractual obligations as of December
31, 2005:
Contractual Obligations Payments Due By Period
- ----------------------------------------------------------------------------------------------------------------
(In thousands) Less Than 1 to 3 4 to 5 Over 5
Total 1 Year Years Years Years
----- --------- ------ ------ ------
Senior secured term loan $14,750 $14,750 $ - $ - $ -
Other borrowings 458 437 21 - -
Operating Leases 12,940 3,096 5,003 3,728 1,113
------- ------- ------ ------ ------
Total $28,148 $18,283 $5,024 $3,728 $1,113
======= ======= ====== ====== ======
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 equal to 50% of the excess annual
cash flow of Colgate and its subsidiaries, provided we maintain 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 2005, we voluntarily prepaid $52.3
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, 2005.
Off-balance Sheet Arrangements
As of December 31, 2005 we did not have any material off-balance sheet
arrangements that have or are reasonably likely to have a current or future
effect on our financial condition, changes in financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures or capital
resources.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
- --------------------------------------------------------------------
We are exposed to certain market risks as part of our ongoing business
operations. Primary exposures include changes in interest rates and foreign
currency fluctuations. These exposures can vary sales, cost of goods, and costs
of operations, the cost of financing and yields on cash and short-term
investments. We use derivative financial instruments, where appropriate, to
manage these risks. However, our risk management policy does not allow us to
hedge positions we do not hold nor do we enter into derivative or other
financial investments for trading or speculative purposes. As of December 31,
2005, we had a currency hedge transaction in place to balance our
43
Euro-denominated current liabilities with our Euro-denominated current assets.
See Item 7 - "Management's Discussion and Analysis of Financial Condition and
Results of Operations - 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, 2005, we had $14.8 million of variable rate debt
represented by borrowings under our senior secured term loans at an interest
rate of 6.38%. Based on the balance outstanding under the credit facility as of
December 31, 2005 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 $0.1 million on an annual basis.
Our foreign currency exposure results from fluctuating currency exchange
rates, primarily the U.S. Dollar against the Euro, Great Britain Pound, Mexican
Peso and Brazilian Real. We face cost of goods currency exposure when we produce
products in foreign currencies such as the Euro or Great Britain Pound and sell
those products in U.S. Dollars. We face transactional currency exposures when
foreign subsidiaries (or the Company itself) enter into transactions, generally
on an intercompany basis, denominated in currencies other than their functional
currency. 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 2005 and 2004
by foreign currency exchange rate fluctuations with the weakening of the U.S.
dollar against the local foreign currency in 2005 and 2004. The U.S. dollar
equivalent of the related costs denominated in these foreign currencies was
unfavorably impacted in 2005 and 2004. 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.
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, 2005, 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 2005 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.
44
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 61 Chairman of the Board of Directors
Charles W. Federico 57 Chief Executive Officer, President and Director
Alan W. Milinazzo 46 Chief Operating Officer
Thomas Hein 58 Chief Financial Officer
Gary D. Henley 57 Senior Vice President and President, Americas Division
Bradley R. Mason 52 Vice President and President, Breg, Inc.
Raymond C. Kolls 43 Vice President, General Counsel and Corporate Secretary
Peter J. Hewett 70 Deputy Chairman of the Board of Directors
Robert Gaines-Cooper 68 Director
Jerry C. Benjamin (2) 65 Director
Walter von Wartburg (1) 66 Director
Thomas J. Kester (1) (2) 59 Director
Kenneth R. Weisshaar (2) 55 Director
Guy Jordan (1) 57 Director
Stefan Widensohler (1) 46 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. He is a Director of
Intrusion, Inc., and Drew Industries Inc. and is a private investor.
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. Effective April 1, 2006, Mr. Federico will resign as President and
Chief Executive Officer of Orthofix International N.V. but will remain a
Director of the Company.
Alan W. Milinazzo. Mr. Milinazzo joined Orthofix International NV on
September 6, 2005 as Chief Operating Officer. Prior to joining Orthofix, Mr.
Milinazzo was Vice President of Medtronic Inc.'s Vascular business, as well as,
Vice President and General Manager of Medtronic's Coronary and Peripheral
businesses. Prior to his time with Medtronic, Mr. Milinazzo spent 12 years as an
executive with Boston Scientific Corporation in numerous roles, including Vice
President of Marketing for SCIMED Europe. Mr. Milinazzo brings more than 24
45
total years of experience in the management and marketing of medical device
businesses, including positions with Aspect Medical Systems and American
Hospital Supply. He earned a bachelor's degree, cum laude, at Boston College in
1980. Effective April 1, 2006, Mr. Milinazzo will succeed Mr. Federico and
become President and Chief Executive Officer of Orthofix International N.V.
Thomas Hein, CPA. Mr. Hein became the Chief Financial Officer of Orthofix
International N.V. on July 1, 2002. For the prior three years, Mr. Hein had been
the Chief Financial Officer of Orthofix Inc., our wholly-owned U.S. subsidiary.
From 1996 to 1999, Mr. Hein was the Chief Financial Officer for Prime Vision
Health Inc., a diversified healthcare services company. From 1988 to 1996, Mr.
Hein was Vice President of Finance and Chief Financial Officer of MDT
Corporation, a sterilization and hospital capital equipment company. Previously,
he held financial management positions with Metheus Corporation, Memorex
Corporation and Kaiser Aetna.
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.
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, J.D. 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 & Bockius.
Peter J. Hewett. Mr. Hewett was appointed Deputy Chairman of the Board of
Directors in 2005 and has been a non-executive Director of Orthofix
International N.V. since March 1992. He was the Deputy Group Chairman of
Orthofix International N.V. between March 1998 and December 2000. Previously,
Mr. Hewett served as the Managing Director of Caradon Plc, Chairman of the
Engineering Division, Chairman and President of Caradon Inc., Caradon Plc's U.S.
subsidiary and a member of the Board of Directors of Caradon Plc of England. In
addition, he was responsible for Caradon Plc's worldwide human resources
function, and the development of its acquisition opportunities.
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 N.V., a Netherlands Antilles Corporation listed on the
Singapore Stock Exchange.
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.
Dr. Walter von Wartburg. Dr. von Wartburg, became a non-executive Director
of Orthofix International N.V. in June 2004. He is an attorney and has practiced
privately in his own law firm in Basel, Switzerland since 1999, specializing in
life sciences law. He has also been a Professor of administrative law and public
health policy at the Saint Gall Graduate School of Economics in Switzerland for
25 years. Previously, he held top management positions with Ciba Pharmaceuticals
and Novartis at their headquarters in Basel, Switzerland. In addition, Mr. von
Wartburg currently serves as a director on the board of Nymox Pharmaceutical
Corporation.
46
Thomas J. Kester, CPA. Mr. Kester became a non-executive Director of
Orthofix International N.V. in August 2004. Mr. Kester retired after 28 years,
18 as an audit partner, from KPMG LLP in 2002. While at KPMG, he served as the
lead audit engagement partner for both public and private companies and also
served four years on KPMG's National Continuous Improvement Committee. Mr.
Kester earned a Bachelor of Science degree in mechanical engineering from
Cornell University and an MBA degree from Harvard University.
Kenneth R. Weisshaar. Mr. Weisshaar became a non-executive Director of
Orthofix International N.V. in December 2004. 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
businesses in medical devices and diagnostic products and served as Chief
Financial Officer and Vice President, Strategic Planning. Mr. Weisshaar earned a
Bachelor of Science degree from MIT and an MBA from Harvard University. He
currently also serves on the board of Digene Corporation.
Guy J. Jordan, Ph.D. Dr. Jordan became a non-executive Director of Orthofix
International N.V. in December 2004. Most recently, Dr. Jordan served as a Group
President at CR Bard, Inc., a medical device company, where he had strategic and
operating responsibilities for Bard's global oncology business and functional
responsibility for all of Bard's research and development. Dr. Jordan earned a
Ph.D. in organic chemistry from Georgetown University as well as an MBA from
Fairleigh Dickinson University. He also currently serves on the boards of
Specialized Health Products International, Inc., Xillix Technologies Corporation
and 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.
47
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 Stockholder Matters
---------------------------
We will provide information that is responsive to this Item 12 regarding
ownership of our securities by certain beneficial owners and our directors and
executive officers, as well as information with respect to our equity
compensation plans, in our definitive proxy statement or in an amendment to this
annual report not later than 120 days after the end of the fiscal year covered
by this annual report, in either case under the captions "Security Ownership of
Certain Beneficial Owners and Management and Related Stockholders" and "Equity
Compensation Plan Information," and possibly elsewhere therein. That information
is incorporated in this Item 12 by reference.
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------
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.
48
PART IV
Item 15. Exhibits, Financial Statement Schedules
- -------------------------------------------------
(a) Documents filed as part of report on Form 10-K
The following documents are filed as part of this report on Form
10-K:
1. Financial Statements
See "Index to Consolidated Financial Statements" on page F-1 of
this Form 10-K.
2. Financial Statement Schedules
See "Index to Consolidated Financial Statements" on page F-1 of
this Form 10-K.
3. Exhibits
Exhibit
Number Description
------ -----------
3.1 Certificate of Incorporation of the Company (filed as an exhibit to the Company's annual
report on Form 20-F dated June 29, 2001 and incorporated herein by reference).
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 June 30, 2005 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 April 15, 2005, between Orthofix International N.V.
and Charles W. Federico (filed as an exhibit to the Company's current report on Form 8-
49
Exhibit
Number Description
K filed April 18, 2005 and incorporated herein by reference).
10.9 Employment Agreement, dated as of March 1, 2003, between the Company and Thomas Hein
(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 Change of Control Agreement, dated as of September 1, 2005, between Orthofix Inc. and
Alan W. Milinazzo (filed as an exhibit to the Company's current report on Form 8-K filed
September 8, 2005 and incorporated herein by reference).
10.14 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).
10.15 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).
10.16 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).
10.17 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).
10.18 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).
10.19 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).
10.20 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
50
Exhibit
Number Description
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).
10.21 Employment Agreement, as amended, dated December 29, 2005 between Orthofix International
N.V. and Charles W. Federico (filed as an exhibit to the Company's current report on
Form 8-K filed December 30, 2005 and incorporated herein by reference).
10.22* Form of Indemnity Agreement.
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 registered public accounting firm.
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.
51
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 14, 2006 By: /s/ Charles W. Federico
--------------------------------
Name: Charles W. Federico
Title: Chief Executive Officer
and President
52
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 14, 2006
Charles W. Federico President and Director
/s/ Thomas Hein
------------------------------------------------ Chief Financial Officer March 14, 2006
Thomas Hein (Principal Accounting Officer)
/s/ James F. Gero
------------------------------------------------ Chairman of the Board of Directors March 14, 2006
James F. Gero
/s/ Peter J. Hewett
------------------------------------------------ Deputy Chairman of the Board of March 14, 2006
Peter J. Hewett Directors
/s/ Robert Gaines-Cooper
------------------------------------------------ Director March 14, 2006
Robert Gaines-Cooper
/s/ Jerry C. Benjamin
------------------------------------------------ Director March 14, 2006
Jerry C. Benjamin
/s/ Walter von Wartburg
------------------------------------------------ Director March 14, 2006
Walter von Wartburg
/s/ Thomas J. Kester
------------------------------------------------ Director March 14, 2006
Thomas J. Kester
/s/ Kenneth R. Weisshaar
------------------------------------------------ Director March 14, 2006
Kenneth R. Weisshaar
/s/ Guy Jordan
------------------------------------------------ Director March 14, 2006
Guy Jordan
/s/ Stefan Widensohler
------------------------------------------------ Director March 14, 2006
Stefan Widensohler
53
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, 2005 and 2004....................................................F-6
Consolidated Statements of Income for the years ended December 31, 2005, 2004 and 2003..........................F-7
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 2005, 2004 and 2003...........................................................................F-8
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003......................F-9
Notes to the Consolidated Financial Statements.................................................................F-10
Schedule 2 -- Valuation and Qualifying Accounts.................................................................S-1
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 to audit and
render an opinion on the consolidated financial statements in accordance with
auditing standards of the Public Company Accounting Oversight Board (United
States). These standards include an assessment of the systems of internal
controls and test of transactions to the extent considered necessary by them to
support their opinion.
The Board of Directors, through its Audit Committee consisting solely of
outside directors of the Company, meets periodically with management and our
independent 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, 2005. 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, 2005. Reasonable assurance includes the
understanding that there is a remote likelihood that material misstatements will
not be prevented or detected on a timely basis.
Our independent registered public accounting firm has issued an attestation
report on management's assessment of our internal control over financial
reporting, which appears on the following page of this Annual Report on Form
10-K.
James F. Gero
Chairman of the Board of Directors
Charles W. Federico
President, Chief Executive Officer and Director
Thomas Hein
Chief Financial Officer
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, 2005 and 2004, and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows for each of the three years in the period ended December 31, 2005. Our
audits also included the financial statement schedule listed in the index at
Item 15(a). These financial statements and the schedule are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements and the schedule 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, 2005 and 2004, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31, 2005
in conformity with U.S. generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
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, 2005, 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 13, 2006 expressed an unqualified opinion
thereon.
/s/ Ernst & Young LLP
Charlotte, North Carolina
March 13, 2006
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, 2005, 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, 2005, 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, 2005, 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, 2005 and 2004, and the related consolidated statements of
income, changes in shareholders' equity, and cash flows for each of the three
years in the period ended December 31, 2005 of Orthofix International N.V. and
our report dated March 13, 2006 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Charlotte, North Carolina
March 13, 2006
F-5
Consolidated Balance Sheets as of December 31, 2005 and 2004
(U.S. Dollars, in thousands except share and per share data) 2005 2004
----------------- ----------------
Assets
Current assets:
Cash and cash equivalents............................................... $63,786 $25,944
Restricted cash......................................................... 13,762 14,302
Trade accounts receivable, less allowance for doubtful accounts of $4,155
and $4,195 at December 31, 2005 and 2004, respectively............ 80,745 75,321
Inventories............................................................. 32,853 32,895
Deferred income taxes................................................... 4,511 4,200
Prepaid expenses........................................................ 4,165 2,490
Other current assets.................................................... 7,453 7,510
----------------- ----------------
Total current assets..................................................... 207,275 162,662
Securities and other investments......................................... 4,082 4,082
Property, plant and equipment, net....................................... 18,987 18,326
Patents and other intangible assets, net................................. 65,585 70,627
Goodwill, net............................................................ 174,738 178,889
Other long-term assets .................................................. 3,194 6,383
----------------- ----------------
Total assets............................................................. $473,861 $440,969
================= ================
Liabilities and shareholders' equity
Current liabilities:
Bank borrowings........................................................ $79 $76
Current portion of long-term debt...................................... 15,187 10,057
Trade accounts payable................................................. 9,891 8,121
Accounts payable to related parties.................................... 1,711 1,386
Other current liabilities.............................................. 51,208 25,745
----------------- ----------------
Total current liabilities.............................................. 78,076 45,385
Long-term debt........................................................... 21 67,249
Deferred income taxes.................................................... 25,652 27,424
Deferred income.......................................................... - 2,443
Other long-term liabilities.............................................. 1,227 1,296
------------------ -----------------
Total liabilities...................................................... 104,976 143,797
Commitments and contingencies (Notes 12 and 17)
Shareholders' equity
Common shares $0.10 par value
Authorized: 50,000,000 (2004: 50,000,000)....
Issued: 16,009,249 (2004: 15,711,943) 1,602 1,572
Outstanding: 16,009,249 (2004: 15,711,943)....
Additional paid-in capital ............................................ 106,746 98,388
------------------ -----------------
108,348 99,960
Retained earnings...................................................... 255,475 182,073
Accumulated other comprehensive income................................. 5,062 15,139
----------------- ----------------
Total shareholders' equity............................................... 368,885 297,172
----------------- ----------------
Total liabilities and shareholders' equity............................... $473,861 $440,969
================= ================
The accompanying notes form an integral part of these consolidated financial
statements.
F-6
Consolidated Statements of Income for the years ended December 31, 2005, 2004
and 2003
(U.S. Dollars, in thousands, except share and per share data) 2005 2004 2003
-------- -------- --------
Net sales...................................................... $313,304 $286,638 $203,707
Cost of sales.................................................. 83,788 79,177 51,090
-------- -------- --------
Gross profit.............................................. 229,516 207,461 152,617
Operating expenses
Sales and marketing........................................ 115,744 102,453 76,756
General and administrative................................. 36,177 30,621 22,170
Research and development................................... 11,317 11,471 8,128
Amortization of intangible assets.......................... 6,572 6,348 995
-------- -------- --------
169,810 150,893 108,049
-------- -------- --------
Total operating income .................................... 59,706 56,568 44,568
Other income (expense)
Interest income............................................ 905 341 654
Interest expense .......................................... (6,373) (6,307) (815)
Loss in joint venture...................................... - (328) (1,785)
Other, net................................................. 1,188 1,653 677
KCI settlement, net of litigation costs.................... 40,089 (1,568) (3,984)
-------- -------- --------
Other income (expense), net.................................... 35,809 (6,209) (5,253)
Income before income taxes................................... 95,515 50,359 39,315
Income tax expense............................................. (22,113) (16,210) (14,585)
-------- -------- --------
Net income .................................................. $73,402 $34,149 $24,730
======== ======== ========
Net income per common share - basic............................ $4.61 $2.22 $1.76
-------- -------- --------
Net income per common share - diluted.......................... $4.51 $2.14 $1.68
-------- -------- --------
Weighted average number of common shares - basic............... 15,913,475 15,396,540 14,061,447
---------- ---------- ----------
Weighted average number of common shares - diluted............. 16,288,975 15,974,945 14,681,883
---------- ---------- ----------
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, 2005, 2004 and 2003
Number of Accumulated
Common Additional Treasury Other Total
(U.S. Dollars, in thousands, Shares Common Paid-in Shares Retained Comprehensive Shareholders'
except share data) Outstanding Shares Capital (at cost) Earnings Income Equity
----------- ------ ---------- ---------- -------- ------------- -------------
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
---------- ----- -------- ------ ------- -------- ---------
Net income...................... - - - - 73,402 - 73,402
Other comprehensive income:
Reclassification adjustment
for gain on termination of
derivative instrument (net
of taxes of $40).............. - - - - - (92) (92)
Translation adjustment.......... - - - - - (9,985) (9,985)
---------
Total comprehensive income...... 63,325
Common shares issued............ 297,306 30 8,358 - - - 8,388
---------- ----- -------- ------ ------- ------- ---------
At December 31, 2005............ 16,009,249 $1,602 $106,746 $ - $255,475 $5,062 $368,885
========== ====== ======== ====== ======== ======= =========
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, 2005,
2004 and 2003
2005 2004 2003
(U.S. Dollars, in thousands) ------- -------- --------
Cash flows from operating activities:
Net income .......................................................... $73,402 $34,149 $24,730
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization.................................... 14,867 14,396 6,949
Amortization of debt costs....................................... 2,666 684 -
Deferred royalty income.......................................... (2,443) - -
Provision for doubtful accounts.................................. 4,753 4,266 5,192
(Gain) Loss on sale or disposal of fixed assets.................. 896 (692) -
Gain on sale of equity investments............................... - (834) -
Loss on equity investments....................................... - 1,162 3,504
Deferred taxes................................................... (1,533) (3,874) 131
Tax benefit on non-qualified stock options....................... 1,329 3,667 1,358
Other............................................................ (7) (435) (311)
Changes in operating assets and liabilities, net of effects of
acquisitions:
Restricted cash.................................................. 540 (14,302) -
Accounts receivable.............................................. (13,293) (6,658) (9,287)
Inventories...................................................... (1,498) (882) (435)
Other current assets............................................. (2,119) 1,427 734
Trade accounts payable........................................... 2,834 (2,931) (1,024)
Other current liabilities........................................ 26,279 (1,658) (7)
------- -------- --------
Net cash provided by operating activities............................ 106,673 27,485 31,534
------- -------- --------
Cash flows from investing activities:
Payments made in connection with acquisitions and investments,
net of cash acquired........................................ - (2,556) (150,572)
Capital expenditures for tangible and intangible assets.......... (12,248) (12,243) (5,238)
Proceeds from sale of assets and marketable securities........... - 1,635 354
Proceeds from sale of joint venture.............................. - 1,300 -
Proceeds from settlement of distributor agreement................ - 440 -
------- -------- --------
Net cash used in investing activities................................ (12,248) (11,424) (155,456)
------- -------- --------
Cash flows from financing activities:
Net proceeds from issue of common shares......................... 6,471 12,247 11,705
Repurchase of treasury shares.................................... - - (4,395)
Payment of debt issuance costs................................... - (821) (2,783)
Proceeds from loans and borrowings............................... 193 - 110,092
Repayment of loans and borrowings................................ (62,278) (33,534) (7,995)
------- -------- --------
Net cash (used in) provided by financing activities.................. (55,614) (22,108) 106,624
------- -------- --------
Effect of exchange rates changes on cash............................. (969) 635 1,789
------- -------- --------
Net increase (decrease) in cash and cash equivalents................. 37,842 (5,412) (15,509)
------- -------- --------
Cash and cash equivalents at the beginning of the year............... 25,944 31,356 46,865
------- -------- --------
Cash and cash equivalents at the end of the year..................... $63,786 $25,944 $31,356
======= ======== ========
Supplemental disclosure of cash flow information
Cash paid during the year for:
Interest........................................................... $3,753 $5,237 $770
Income taxes....................................................... $26,290 $12,854 $14,546
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
Notes to the consolidated financial statements
Description of business
Orthofix International N.V. (the "Company") is a multinational corporation
principally involved in the design, development, manufacture, marketing and
distribution of medical equipment, principally for the orthopedic products
market.
1 Summary of significant accounting policies
(a) Basis of consolidation
The consolidated financial statements include the financial statements of
the Company and its wholly-owned and majority-owned subsidiaries and entities
over which the Company has control. Percentages of ownership at December 31,
2005 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.)
Swiftsure Medical Limited (U.K.)
Victory Medical 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
The results of acquired businesses are included in the consolidated
statements of income from the date of their acquisition. All intercompany
accounts, transactions and profits are eliminated in consolidation. The equity
method of accounting is used when the Company has significant influence over
operating decisions but cannot exercise control. Under the equity method,
original investments are recorded at cost and adjusted by the Company's share of
undistributed earnings or losses of these companies. The Company's investments
in which it does not have significant influence or control are accounted for
under the cost method of accounting.
(b) Foreign currency translation
Foreign currency translation is performed in accordance with SFAS No. 52,
"Foreign Currency Translation." All balance sheet accounts, except shareholders'
equity, are translated at year end exchange rates and revenue and expense items
are translated at weighted average rates of exchange prevailing during the year.
F-10
Notes to the consolidated financial statements (cont.)
Transactional foreign currency gains and losses are included in other
income (expense) and were ($1.0) million, $0.9 million and $0.4 million for the
years December 31, 2005, 2004 and 2003, respectively. Gains and losses resulting
from the translation of foreign currency are recorded in the accumulated other
comprehensive income component of shareholders' equity.
(c) Inventories
Inventories are valued at the lower of cost or estimated net realizable
value, after provision for excess or obsolete items. Cost is determined on a
weighted-average basis, which approximates the FIFO method. The valuation of
work-in-process, finished goods, field inventory and consignment inventory
includes the cost of materials, labor and production. Field inventory represents
immediately saleable finished goods inventory that is in the possession of the
Company's direct sales representatives.
(d) Reporting currency
The reporting currency is the United States Dollar.
(e) Market risk
In the ordinary course of business, the Company is exposed to the impact of
changes in interest rates and foreign currency fluctuations. The Company's
objective is to limit the impact of such movements on earnings and cash flows.
In order to achieve this objective the Company seeks to balance its non-dollar
income and expenditures. During 2005, the Company made use of an interest rate
swap agreement and foreign currency forward contracts to manage these exposures
of fluctuations in interest rates. See Note 11 for additional information.
(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.
Intangible assets deemed to have indefinite lives and goodwill are not subject
to amortization in accordance with Statement of Financial Accounting Standards
(SFAS) No. 142.
The Company reviews long-lived and indefinite lived intangible assets at
least annually or when events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. For long-lived amortizable
intangible assets, the Company recognizes an impairment loss when the sum of
undiscounted expected
F-11
Notes to the consolidated financial statements (cont.)
future cash flows over the assets remaining estimated useful lives are less than
the carrying value of such assets. For long-lived intangible assets, not subject
to amortization, the Company recognizes an impairment loss when the sum of
discounted expect future cash flows are less than the carrying value of such
assets. The measurement for such impairment loss is then based on the fair value
of the related asset or group of assets.
(g) Revenue recognition
Revenues are recognized as income in the period in which title passes and
the products are delivered. For bone growth stimulation and certain bracing
products prescribed by a physician, the Company recognizes revenue when the
product is placed on and accepted by the patient. For sales to commercial
customers, including hospitals and distributors, revenues are recognized at the
time of shipment unless contractual agreements specify FOB destination. The
Company derives a significant amount of revenues in the United States from
third-party payors, including commercial insurance carriers, health maintenance
organizations, preferred provider organizations and governmental payors such as
Medicare. Amounts paid by these third-party payors are generally based on fixed
or allowable reimbursement rates. These revenues are recorded at the expected or
pre-authorized reimbursement rates, net of any contractual allowances or
adjustments. Some billings are subject to review by such third-party payors and
may be subject to adjustment. For royalties, revenues are recognized when the
royalty is earned. Revenues for inventory delivered on consignment are
recognized as the product is used by the consignee. Revenues exclude any value
added or other local taxes, intercompany sales and trade discounts. 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) Net income per common share
Net income per common share is computed in accordance with SFAS No. 128,
"Earnings per Share." Net income per common share - basic is computed using the
weighted average number of common shares outstanding during each of the
respective years. Net income per common share - diluted is computed using the
weighted average number of common and common equivalent shares outstanding
during each of the respective years. Common equivalent shares represent the
diluted effect of the assumed exercise of outstanding share options (see Note 19
to the Consolidated Financial Statements) and the only differences between basic
and diluted shares result solely from the assumed exercise of certain
outstanding share options and warrants.
(k) Cash and cash equivalents
The Company considers all highly liquid investments with an original
maturity of three months or less at the date of purchase to be cash equivalents.
(l) Restricted cash
Restricted cash consists of cash held at certain subsidiaries, the
distribution or transfer of which to Orthofix International N.V. (the "Parent")
is restricted. The senior secured bank facility, described further in Note 10,
restricts only the Parent's access to the cash held by Colgate Medical Limited
and its subsidiaries. All other subsidiaries of the Orthofix Group have access
to this cash for operational purposes.
F-12
Notes to the consolidated financial statements (cont.)
(m) Sale of accounts receivable
The Company follows the provisions of SFAS No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities".
Trade accounts receivables sold without recourse are removed from the balance
sheet at the time of sale.
(n) Use of estimates in preparation of financial statements
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from these
estimates.
(o) Reclassifications
Certain prior year amounts have been reclassified to conform to the 2005
presentation. The reclassifications have no effect on previously reported net
income or shareholders' equity.
(p) 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.
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" and amends SFAS No. 95, "Statement of Cash
Flows". The revision will require companies to recognize compensation costs in
the income statement based on the fair value of the equity or liability
instruments issued and to report the benefits of tax deductions in excess of
recognized compensation cost as a financing cash flow rather than as an
operating cash flow as reported in the accompanying consolidated statements of
cash flows. 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 plans to adopt SFAS 123 (R) effective January 1, 2006 using the
"modified prospective" method. Under the modified prospective method,
compensation cost is recognized in the income statement beginning with the
effective date, based on the requirements of SFAS 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 estimates that the adoption of SFAS NO. 123 (R) will reduce its
operating income for 2006 by approximately $5.0 million. The adoption of
Statement 123 (R)'s fair value method will have a significant impact on the
Company's results of operations, although it will have no impact on the overall
financial position. This estimate assumes that the number of employee stock
options granted in 2006 will be similar to the number granted in 2005 and is
subject to change based on the actual number of stock options granted in 2006,
the dates on which the grants are made and the share price on the date of grant.
Statement 123 (R) also requires the benefits of tax deduction in excess over
recognized compensation costs to be reported as financing cash flow, rather than
as an operating cash flow as required under current literature. This requirement
will reduce net operating cash flows and increase net financing cash flows in
periods after adoption. While we cannot estimate what those amounts will be in
the future (because they depend on, among other things, when employees exercise
stock options), the amount of operating cash flows recognized in the twelve
months ended December 31, 2005, 2004, and 2003, for such excess tax deductions
were $1.3 million, $3.7 million, and $1.4 million, respectively. Pro forma
information regarding the Company's net income and net income per common share
for the years ended December 31, 2005, 2004 and 2003 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.
F-13
Notes to the consolidated financial statements (cont.)
Year ended December 31,
---------------------------------------
(In thousands except per share data) 2005 2004 2003
-------- -------- --------
Net income
As reported $73,402 $34,149 $24,730
Add: Stock-based employee compensation expense included in 347 346 -
reported 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 (3,348) (1,944) (2,597)
-------- -------- --------
Pro forma $70,401 $32,551 $22,133
Net income per common share - basic
As reported $4.61 $2.22 $1.76
Pro forma $4.42 $2.11 $1.57
Net income per common share - diluted
As reported $4.51 $2.14 $1.68
Pro forma $4.32 $2.04 $1.51
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 stock option grants in 2005, 2004 and 2003 for each
of the three years, 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.
(q) Recently issued Accounting Standards
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain
Hybrid Instruments, which is an amendment to SFAS No. 133 and SFAS No. 140. SFAS
No. 155 allows financial instruments which have embedded derivatives to be
accounted for as a whole (eliminating the need to bifurcate the derivative from
its host) if the holder elects to account for the instrument as a whole
instrument on a fair value basis. This statement is effective for all financial
instruments acquired or issued after the beginning of an entity's first fiscal
year that begins after September 15, 2006. The Company does not believe the
adoption of this statement will have a material impact on the financial
statements.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error
Corrections, which is a replacement of APB Opinion No. 20, Accounting Changes,
and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements.
Among other changes, SFAS No. 154 requires that a voluntary change in accounting
principle be applied retrospectively such that all prior period financial
statements are presented in accordance with the new accounting principle, unless
impracticable to do so. SFAS No. 154 also provides that (1) a change in method
of depreciating or amortizing a long-lived nonfinancial asset be accounted for
as a change in estimate (prospectively) that was effected by a change in
accounting principle, and (2) correction of errors in previously issued
financial statements should be termed a "restatement". SFAS No. 154 is effective
for accounting changes and correction of errors made in fiscal years beginning
after December 15, 2005. The Company does not believe the adoption of this
statement will have a material impact on the financial statements.
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an
amendment of ARB No. 43, which is the result of its efforts to converge U.S.
accounting standards for inventories with International Accounting Standards.
SFAS No. 151 requires idle facility expenses, freight, handling costs, and
wasted material (spoilage)
F-14
Notes to the consolidated financial statements (cont.)
costs to be recognized as current-period charges. It also requires that the
allocation of fixed production overheads to the costs of conversion be based on
the normal capacity of the production facilities. SFAS No. 151 will be effective
for inventory costs incurred during fiscal years beginning after June 15, 2005.
The Company does not expect the adoption of SFAS No. 151 to have a material
impact on its consolidated financial statements.
(r) Fair value of financial instruments
The carrying amounts reflected in the consolidated balance sheet for cash
and cash equivalents, restricted cash, accounts receivable, short-term bank debt
and accounts payable approximate fair value due to the short-term maturities of
these instruments. The Company's long term secured debt carries a floating rate
of interest and approximates fair value.
(s) Advertising costs
The Company expenses all advertising costs as incurred. Advertising expense
for the years ended December 31, 2005, 2004 and 2003 was $0.5 million in each
year.
(t) Derivative instruments
The Company manages its exposure to fluctuations in interest rates and
foreign exchange within the consolidated financial statements according to its
hedging policy. Under the policy, the Company may engage in non-leveraged
transactions involving various financial derivative instruments to manage
exposed positions. The policy requires the Company to formally document the
relationship between the hedging instrument and hedged item, as well as its
risk-management objective and strategy for undertaking the hedge transaction.
For instruments designated as a cash flow hedge, the Company formally assesses
(both at the hedge's inception and on an ongoing basis) whether the derivative
that is used in the hedging transaction has been effective in offsetting changes
in the cash flows of the hedged item and whether such derivative may be expected
to remain effective in future periods. If it is determined that a derivative is
not (or has ceased to be) effective as a hedge, the Company will discontinue the
related hedge accounting prospectively. Such a determination would be made when
(1) the derivative is no longer effective in offsetting changes in the cash
flows of the hedged item; (2) the derivative expires or is sold, terminated, or
exercised; or (3) management determines that designating the derivative as a
hedging instrument is no longer appropriate. Ineffective portions of changes in
the fair value of cash flow hedges are recognized in earnings. For instruments
designated as a fair value hedge, the Company ensures an exposed position is
being hedged and the changes in fair value of such instruments are recognized in
earnings.
The Company follows Statement of Financial Accounting Standards ("SFAS")
No. 133, "Accounting for Derivative Instruments and Hedging Activities," as
amended and interpreted, which requires that all derivatives be recorded as
either assets or liabilities on the balance sheet at their respective fair
values. 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.
The Company's foreign currency hedges are forward contracts used to manage
its foreign currency exposure related to a portion of the Company's accounts
receivable that are denominated in Euros. These forward contracts have been
accounted for as a fair value hedge in accordance with SFAS No. 133.
F-15
Notes to the consolidated financial statements (cont.)
(u) 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
(In thousands) Adjustments Derivatives Securities Income/(Loss)
---------------- ------------- ---------- -------------
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 - - (341) (341)
the 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
Reclassification adjustment for gain on
derivative instrument, net of tax of - (92) - (92)
$40
Foreign currency translation adjustment (9,985) - - (9,985)
-------- ------ ----- -------
Balance at December 31, 2005 $5,062 $ - $ - $5,062
======== ====== ===== =======
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 privately
held Breg, Inc. ("Breg") for a purchase price of $150.0 million plus closing
adjustments and acquisition costs. 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.
Pursuant to a voting and subscription agreement dated November 20, 2003 and
as amended and restated on December 22, 2003, among the Company and certain
shareholders of Breg, certain shareholders applied a portion of the proceeds
that they received from the acquisition to purchase 731,715 shares of Orthofix
common stock at a negotiated price of $38.00 per share, for an aggregate
purchase price of $27.8 million. The price took into consideration the fair
market value as determined by the Nasdaq stock market on the or about the date
the terms of the acquisition were agreed to and announced (November 20, 2003).
Breg, based in Vista, California, designs, manufactures and distributes
orthopedic products for post-operative reconstruction and rehabilitative patient
use. Breg's product lines include bracing products, cold therapy products and
pain therapy products. Breg generated $72.0 million and $68.3 million in net
revenues in 2005 and 2004, respectively.
F-16
Notes to the consolidated financial statements (cont.)
The Company considered this acquisition as a way to fortify and further
advance its business strategy to expand in three key sectors in orthopedics:
Spine, Reconstruction and Trauma. The acquisition broadened the Company's
product lines, reduced reliance on the success of any single product and
enlarged channel opportunities for products from both companies.
Factors that contributed to the valuation of Breg included the recognition
that Breg was among the top three participants in terms of market share in its
key markets of bracing, cold therapy and pain therapy. Further, Breg has a
strong brand name and product identity in the orthopedic industry. Breg had a
history of sales and earnings growth at rates faster than the markets that its
three product lines serve. Orthofix valued Breg after reviewing a range of
valuation methodologies provided by its financial advisors for the transaction,
including comparable publicly-traded companies, comparable precedent
transactions, discounted cash flow analysis and comparison to Orthofix's trading
multiples. The resulting purchase price of Breg exceeded the value of the net
assets acquired by a substantial amount.
The final purchase price reflects the following assets acquired and
liabilities assumed:
Current assets, other than cash $ 16,768
Fixed assets acquired 5,570
Intangible assets not subject to amortization - registered
trademarks 23,900
Intangible assets subject to amortization (10 year weighted
average useful life):
Distribution Network (10 year weighted average 41,100
useful life)
Patents (16 year weighted average useful life) 401
------------
41,501
Goodwill (indefinite lived intangible asset) 101,322
Other long-term assets 599
------------
Total assets acquired $ 189,660
------------
Current liabilities $ (4,996)
Deferred tax liability (27,172)
Other long-term liability (133)
------------
Total liabilities assumed (32,301)
------------
Net assets acquired (Final purchase price) $157,359
============
There are no residual values for any of the intangible assets subject to
amortization acquired during the Breg acquisition.
The results of Breg's operations have been included in the Company's
consolidated results of operations from the date of acquisition.
The Company made a correction in 2005 to the purchase accounting for the
Breg acquisition to increase goodwill and deferred tax liabilities by $9.6
million each to reflect the deferred tax liability associated with the
trademarks acquired. The correction has been reflected as of December 31, 2005
and 2004.
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.
F-17
Notes to the consolidated financial statements (cont.)
The summary pro forma condensed unaudited results of operations and
earnings per share for the year ended December 31, 2003, assuming consummation
of the acquisitions during 2003 as of January 1, 2003 was as follows:
Year Ended December 31, 2003
----------------------------------------
As Reported Pro Forma
------------------ ------------------
Net sales $203,707 $265,219
Net income 24,730 26,129
Per share data:
Basic $1.76 $1.77
Diluted $1.68 $1.70
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.
3 Inventories
December 31,
--------------------
(In thousands) 2005 2004
------- -------
Raw materials $7,242 $6,456
Work-in-process 3,344 2,445
Finished goods 11,538 14,823
Field inventory 7,404 5,346
Consignment inventory 6,659 7,835
------- -------
36,187 36,905
------- -------
Less reserve for obsolescence (3,334) (4,010)
------- -------
$32,853 $32,895
======== ========
See Note 1 "Summary of significant accounting policies" part (c)
"Inventories" for a description of field inventory.
4 Securities and other investments
The Company had total investments held at cost of $4.1 million as of
December 31, 2005 and 2004 comprised of an investment of $1.5 million in
Innovative Spinal Technologies (IST), a start-up company focused on
commercializing spinal products, and $2.6 million in OPED AG, a German-based
bracing company. The Company has assessed these cost investments noting no
impairment in carrying value. The Company also has an investment in OrthoRx. The
investment was reduced to zero in 2004. As of December 31, 2005, the Company's
ownership percentage in OrthoRx has been reduced to 6.4%.
F-18
Notes to the consolidated financial statements (cont.)
5 Property, plant and equipment
December 31,
--------------------
(In thousands) 2005 2004
------ -------
Cost
Buildings $3,535 $3,733
Plant and equipment 46,094 40,409
Furniture and fixtures 6,896 7,258
------ -------
56,525 51,400
Accumulated depreciation (37,538) (33,074)
------ -------
$18,987 $18,326
======= ========
Depreciation expense for the years ended December 31, 2005, 2004 and 2003
was $8.3 million, $7.8 million and $5.7 million, respectively.
6 Patents and other intangible assets
December 31,
-----------------
(In thousands) 2005 2004
---- ----
Cost
Patents and other $26,501 $25,411
Trademarks - definite lived (subject to amortization) 836 712
Trademarks - indefinite lived (not subject to amortization) 23,900 23,900
Distribution networks 42,343 42,343
------ ------
93,580 92,366
Accumulated amortization
Patents and other (17,172) (15,989)
Trademarks - definite lived (subject to amortization) (387) (332)
Trademarks - indefinite lived (not subject to amortization) - -
Distribution networks (10,436) (5,418)
------- -------
$65,585 $70,627
======= =======
Amortization expense for intangible assets is estimated to be approximately
$6.9 million, $6.9 million, $6.6 million, $5.9 million and $5.1 million for the
periods ending December 31, 2006, 2007, 2008, 2009 and 2010, respectively.
F-19
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. 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:
International
(In thousands) Americas Orthofix Americas Breg Orthofix Total
----------------- ------------- ------------- ---------
At December 31, 2003 $32,401 $94,512 $41,484 $168,397
Acquisitions 532 - 475 1,007
Adjustments - 6,810 - 6,810
Foreign Currency 19 - 2,656 2,675
----------- --------- --------- ---------
At December 31, 2004 32,952 101,322 44,615 178,889
----------- --------- --------- ---------
Foreign Currency (36) - (4,115) (4,151)
----------- --------- --------- ---------
At December 31, 2005 $32,916 $101,322 $40,500 $174,738
=========== ========= ========= =========
8 Bank borrowings
December 31,
------------------
(In thousands) 2005 2004
---- ----
Borrowings under line of credit $79 $76
==== ====
Weighted average interest rates on borrowings under lines of credit as of
December 31, 2005 and 2004 were 3.00% and 3.40%, respectively.
Borrowings under lines of credit consist of borrowings in Euros. The
Company had unused available lines of credit of 6.8 million Euros ($8.0 million)
and 8.4 million Euros ($11.4 million) at December 31, 2005 and 2004,
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.
F-20
Notes to the consolidated financial statements (cont.)
9 Other current liabilities
December 31,
--------------------
(In thousands) 2005 2004
-------- --------
Accrued expenses $7,206 $10,280
Salaries and related taxes payable 11,032 7,721
Income taxes payable 2,044 4,525
Other payables 4,724 3,219
KCI settlement proceeds due to third parties 26,202 -
--------- --------
$51,208 $25,745
========= ========
10 Long-term debt
December 31,
--------------------
(In thousands) 2005 2004
-------- --------
Long-term obligations $14,750 $76,750
Other loans 458 556
--------- --------
15,208 77,306
Less current portion (15,187) (10,057)
--------- --------
$21 $67,249
========= ========
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, 2005. 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. At
December 31, 2005 and 2004, long-term obligations included a senior secured term
note for $14.8 million and $76.8 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, 2005 and 2004, unamortized debt
issuance costs were $0.2 million and $2.9 million, respectively, and recorded in
other long-term assets.
In May 2004, the Company entered into a three-year fully amortizable
interest rate swap agreement. Under the agreement, the Company paid a fixed rate
of 3.16% and received interest at floating rates based on the three month LIBOR
rate at each quarterly re-pricing date until the termination of the agreement.
The Company's accelerated prepayment of its senior secured term loan caused a
portion of the swap agreement to be ineffective on December 22, 2005. Therefore,
the Company terminated the interest rate swap agreement.
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
F-21
Notes to the consolidated financial statements (cont.)
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, 2005.
The Company received a waiver from its lenders for technical covenant
violations associated with changes in its structure, done to maximize tax
benefits in the United Kingdom. In connection with this waiver, the Company is
required to take certain actions with respect to certain new subsidiaries of the
borrowing group, including having them joined as guarantors to the credit
agreement. The waiver requires the Company to satisfy these obligations by March
31, 2006, and management believes it is probable that it will satisfy such
obligations by repaying the outstanding amount under the term loan and canceling
its revolver under this facility. Accordingly, all of the Company's outstanding
obligations under this credit agreement is classified as current in the balance
sheet at December 31, 2005.
Weighted average interest rates on current maturities of long-term
obligations as of December 31, 2005 and 2004 were 6.12% and 4.43%, respectively.
The aggregate maturities of long-term debt after December 31, 2005 are as
follows: 2006 - $15.2 million.
11 Derivative instruments
During the second quarter of 2004, the Company entered into an interest
rate swap agreement 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 derivative instrument, a three-year fully amortizable agreement with a
notional amount of $50.0 million, was scheduled to expire on June 27, 2007. The
instrument was designated as a cash flow hedge. The Company terminated the
agreement on December 22, 2005 when a portion became ineffective. This
termination resulted in a one-time gain of $0.4 million in 2005 recorded as a
reduction of interest expense.
In 2005, the Company utilized foreign currency forward contracts to manage
its foreign currency exposure related to a portion of the Company's accounts
receivable that are denominated in Euros. The strategy of the foreign currency
contracts was to neutralize the foreign currency impact on earnings when
converting 5.0 million Euros of accounts receivable into U.S. dollars. The
conversion of the underlying exposure and the forward contracts offset and had
no net impact on earnings in 2005. All foreign currency forward contracts
entered into in 2005 have been accounted for as fair value hedges in accordance
with SFAS No. 133 and the related gains were recorded in other income and the
related tax amounts in taxation. The Company received cash of $0.3 million from
the settlement of forward contracts to hedge foreign currency exposures in 2005.
On December 30, 2005, the Company entered into a new forward currency contract
to sell 5.0 million Euro at an all-in rate of 1.1840 which is outstanding at
December 31, 2005.
F-22
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, 2005, 2004 and 2003 was approximately $3.7 million, $3.5 million and $2.6
million, respectively. Future minimum lease payments under operating leases as
of December 31, 2005 are as follows:
(In thousands)
2006 $3,096
2007 2,650
2008 2,353
2009 1,886
2010 1,842
Thereafter 1,113
-------------
Total $12,940
=============
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, as defined, 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, as defined, uses both
direct and distributor sales representatives to sell Orthofix and Breg products
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 to hospitals, doctors, and
other healthcare providers through a network of domestic and international
distributors, sales representatives and affiliates.
Group Activities
Group Activities are comprised of the Parent's operating expenses and
identifiable assets.
F-23
Notes to the consolidated financial statements (cont.)
The tables below present information by reportable segment:
External Sales Intersegment Sales
-------------------------------------- --------------------------------------
(In thousands) 2005 2004 2003 2005 2004 2003
-------- -------- -------- ------- ------- -------
Americas Orthofix $144,174 $125,972 $116,848 $1,931 $1,357 $1,072
Americas Breg 72,022 68,294 - 489 422 -
International Orthofix 97,108 92,372 86,859 55,271 54,464 50,800
-------- -------- -------- ------- ------- -------
Total $313,304 $286,638 $203,707 $57,691 $56,243 $51,872
======== ======== ======== ======= ======= =======
Operating Income (Expense)
(In thousands) 2005 2004 2003
------------------ ----------------- -----------------
Americas Orthofix $32,595 $28,840 $24,065
Americas Breg 8,082 11,498 -
International Orthofix 24,677 20,376 23,253
Group Activities (5,170) (4,599) (4,021)
Eliminations (478) 453 1,271
------------- ------------- ------------
Total $59,706 $56,568 $44,568
============= ============= ============
The following table presents identifiable assets by segment, excluding
intercompany balances and investments in consolidated subsidiaries.
Identifiable Assets
(In thousands) 2005 2004
-------------- --------------
Americas Orthofix $112,058 $108,119
Americas Breg 185,921 186,925
International Orthofix 178,682 148,826
Group activities 9,957 9,688
Eliminations (12,757) (12,589)
-------------- --------------
Total $473,861 $440,969
============== ==============
F-24
Notes to the consolidated financial statements (cont.)
Depreciation and
amortization Income tax expense Other income (expense)
--------------------------- ---------------------------- ----------------------------
(In thousands) 2005 2004 2003 2005 2004 2003 2005 2004 2003
---- ---- ---- ---- ---- ---- ---- ---- ----
Americas Orthofix $3,503 $3,360 $3,664 $14,456 $12,284 $9,867 $2,673 $267 $324
Americas Breg 7,786 7,328 - 961 2,242 - 56 22 -
International Orthofix 3,578 3,708 3,285 5,299 1,525 4,706 32,854 (6,506) (2,469)
Group activities - - - 1,397 159 12 226 8 (3,108)
------- ------- ------ ------- ------- ------- ------- -------- --------
Total $14,867 $14,396 $6,949 $22,113 $16,210 $14,585 $35,809 $(6,209) $(5,253)
======= ======= ====== ======= ======= ======= ======= =======- ========
Capital expenditures of tangible and intangible for each segment are as
follows:
(In thousands) 2005 2004 2003
------ ------- ------
Americas Orthofix $3,798 $3,245 $2,903
Americas Breg 5,040 2,820 -
International Orthofix 3,410 6,178 2,327
Group activities - - 8
------- ------- ------
Total $12,248 $12,243 $5,238
======= ======= ======
Geographical information
Analysis of net sales by geographic destination:
(In thousands) 2005 2004 2003
-------- -------- --------
U.S. $218,096 $198,392 $132,858
Other 9,471 9,546 4,995
-------- -------- --------
Americas 227,567 207,938 137,853
U.K. 28,949 28,858 25,162
Italy 22,004 20,761 16,447
Other 34,784 29,081 24,245
-------- -------- --------
International 85,737 78,700 65,854
-------- -------- --------
Total $313,304 $286,638 $203,707
======== ======== ========
There are no sales in the Netherlands Antilles.
F-25
Notes to the consolidated financial statements (cont.)
Analysis of long-lived assets by geographic area:
(In thousands) 2005 2004
-------- --------
U.S. $206,287 $209,368
Italy 11,443 12,957
U.K. 22,379 24,521
Cyprus 13,426 10,533
Others 9,857 14,545
-------- --------
Total $263,392 $271,924
======== ========
Sales by Market Sector for the year ended December 31, 2005
-------------------------------------------------------------------------
Americas International
(In thousands) Americas Orthofix Breg Orthofix Total
----------------- --------- ------------- ---------
Orthopedic
Spine $101,497 $ - $125 $101,622
Reconstruction 8,147 72,022 45,247 125,416
Trauma 32,846 - 30,692 63,538
-------- ------- -------- ---------
Total Orthopedic 142,490 72,022 76,064 290,576
Non-Orthopedic 1,684 - 21,044 22,728
-------- ------- ---------- ---------
Total $144,174 $72,022 $97,108 $313,304
========= ======= ========== =========
Sales by Market Sector for the year ended December 31, 2004
-------------------------------------------------------------------------
Americas International
(In thousands) Americas Orthofix Breg Orthofix Total
----------------- -------- ------------- ---------
Orthopedic
Spine $81,190 $ - $ 182 $81,372
Reconstruction 7,318 68,083 45,543 120,944
Trauma 36,058 211 26,618 62,887
-------- ------- ------- --------
Total Orthopedic 124,566 68,294 72,343 265,203
Non-Orthopedic 1,406 - 20,029 21,435
-------- ------- ------- --------
Total $125,972 $68,294 $92,372 $286,638
======== ======= ======= ========
F-26
Notes to the consolidated financial statements (cont.)
Sales by Market Sector for the year ended December 31, 2003
-------------------------------------------------------------------------
Americas International
(In thousands) Americas 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
========= ========= ======== ========
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) 2005 2004 2003
---- ---- ----
Italy - Current $3,011 $2,727 $1,948
- Deferred (310) (241) (371)
Cyprus - Current 2,924 251 224
- Deferred 17 - 16
U.K. - Current 2,015 985 2,670
- Deferred - (34) 37
U.S. - Current 15,299 15,928 9,471
- Deferred (1,564) (3,711) 333
Netherlands Antilles
- Current 506 25 12
- Deferred 892 134 -
Other - Current (4) 168 (212)
- Deferred (673) (22) 457
-------- -------- --------
Total tax expense $22,113 $16,210 $14,585
======== ======== ========
F-27
Notes to the consolidated financial statements (cont.)
Income from continuing operations before provision for income taxes
consisted of:
Year ended December 31,
----------------------------------
(In thousands) 2005 2004 2003
---- ---- ----
U.S. $36,511 $32,254 $26,624
Non-U.S. 59,004 18,105 12,691
------- ------- -------
$95,515 $50,359 $39,315
======= ======= =======
The tax effects of the significant temporary differences, which comprise
the deferred tax liabilities and assets, are as follows:
(In thousands) 2005 2004
--------- --------
Deferred tax liabilities
Goodwill $(5) $(110)
Patents and other intangible assets (22,306) (24,239)
Property, Plant and Equipment (925) (477)
Other (2,416) (2,598)
-------- --------
(25,652) (27,424)
Deferred tax assets
Other current $111 $171
Inventories and related reserves 1,781 1,619
Allowance for doubtful accounts 2,619 2,410
Net operating loss carryforwards 396 573
Deferred royalties - 916
Other long-term 1,993 1,111
-------- --------
6,900 6,800
Valuation allowance (376) (138)
-------- --------
6,524 6,662
-------- --------
Net deferred tax liability $(19,128) $(20,762)
======== ========
The valuation allowance as of December 31, 2005 and 2004 was $0.4 million
and $0.1 million, respectively. The net increase in the valuation allowance was
$0.3 million for the period ended December 31, 2005. The valuation allowance is
attributable to net operating loss carryforwards in certain foreign
jurisdictions, the benefit for which is dependent upon the generation of future
taxable income in that location. In assessing the realizability of deferred tax
assets, management considers whether it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future
taxable income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax
liabilities, projected future taxable income and tax planning strategies in
making this assessment. Based upon the level of historical taxable income and
projections for future taxable income over the periods which the deferred tax
assets are deductible, management believes it is more likely than not the
Company will realize the benefits of these deductible differences, net of the
existing valuation allowances at December 31, 2005.
F-28
Notes to the consolidated financial statements (cont.)
The Company's tax net operating loss carryforwards in all taxing
jurisdictions is approximately $1.0 million expiring in various amounts in tax
years beginning in 2009.
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.
The rate reconciliation presented below is based on the U.S. federal income
tax rate, rather than the parent company's country of domicile tax rate.
Management believes, given the large proportion of taxable income earned in the
United States, such disclosure is more meaningful.
(In thousands, except percentages) 2005 2004 2003
--------------------- ---------------------- ------------------------
Amount Percent Amount Percent Amount Percent
---------- ---------- ---------- ----------- ----------- ------------
Statutory U.S. federal income tax rate $33,431 35.0% $17,626 35.0% $13,760 35.0%
Net effect of foreign tax (3,513) -3.7% (3,068) -6.1% 636 1.6%
Net effect of KCI settlement (11,366) -11.9% - - - -
Change in valuation allowance 238 0.2% (391) -0.8% 529 1.4%
Tax holiday benefit - Seychelles (986) -1.0% (918) -1.8% (806) -2.1%
US-UK Tax Treaty (664) -0.7% (1,880) -3.7% - -
State taxes net of federal benefit 1,314 1.4% 1,132 2.2% 534 1.4%
Net effect of non-deductible
foreign losses 3,119 3.3% 2,950 5.9% - -
Other 540 0.6% 759 1.5% (68) -0.2%
------- ----- ------- ----- ------- -----
Income tax expense/effective rate $22,113 23.2% $16,210 32.2% $14,585 37.1%
======= ===== ======= ===== ======= =====
The Company has not recorded additional income taxes applicable to
undistributed earnings of foreign subsidiaries (residing outside the Netherlands
Antilles) that are considered to be indefinitely reinvested and the taxes
attributable to such amounts not deemed to be indefinitely reinvested are not
material. In the event that undistributed earnings which have been deemed to be
indefinitely reinvested no longer meet the criteria to remain as such, these
undistributed earnings will also be considered when calculating any potential
future tax liabilities relating to undistributed foreign earnings. Total
undistributed earnings, which amounted to approximately $232.1 million, $201.9
million and $156.0 million at December 31, 2005, 2004 and 2003, 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, 2005 is limited to the
amount remaining to be paid under the senior secured term loan of $14.8 million.
F-29
Notes to the consolidated financial statements (cont.)
16 Related parties
The following related party balances and transactions as of and for the
three years ended December 31, 2005, 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) 2005 2004 2003
---- ---- ----
Sales $573 $987 $1,706
Purchases $17,411 $16,986 $15,916
Accounts payable $1,711 $1,386 $1,929
Accounts receivable $126 $198 $403
Due from officers (included in other long-term assets) $370 $356 $342
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.
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:
Novamedix, a subsidiary of the Company, filed an action on February 21,
1992 against Kinetic Concepts Inc. ("KCI") alleging infringement of the patents
relating to Novamedix's A-V Impulse System foot pump product, breach of
contract, unfair competition and was seeking damages. KCI filed counterclaims
alleging inequitable conduct by Novamedix before the United States Patent and
Trademark Office, fraud and unfair competition. KCI withdrew several of its
counterclaims, but continued to assert affirmative defenses contending that the
patents were invalid, unenforceable, and not infringed. 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 denied certain motions filed by KCI that would have disposed of
the case without a trial. On September 30, 2005 KCI, Novamedix and the Company
announced a settlement had been reached under which KCI agreed to pay Novamedix
$75.0 million and give Novamedix an option to receive an assignment of or a
license to certain KCI foot pump patent rights, which the Company chose to
receive a limited assignment. The Company has contractual obligations to
distribute a portion of the settlement proceeds to certain former owners of
Novamedix and the original patents. The final settlement amounts were not
concluded at December 31, 2005; however, we have recorded a gain of $40.1
million and the related tax amount of $2.7 million and accrued $26.2 million for
contractual obligations. See Note 22 "Subsequent events" for further discussion
of the final settlement amounts. Further, the Company agreed to indemnify KCI
against certain tax liabilities that might arise out of the settlement.
Management believes the risk that any such claims might arise under this
indemnity to be remote.
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. Triage contended 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 contended further
that the Company terminated the acquisition process and failed to make the
payment as a result of which Triage was damaged. The Company answered the
complaint denying any liability and pleading
F-30
Notes to the consolidated financial statements (cont.)
certain defenses. On July 12, 2005, Triage and the Company engaged in mediation
proceedings at which the parties agreed to resolve the action against the
Company and to dismiss the lawsuit with prejudice. The settlement amount of
$350,000 was paid in 2005.
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. The Company performs ongoing credit
evaluations of its customers and generally does not require collateral. Certain
of these customers rely on third party healthcare payers, such as private
insurance companies and governments, to make payments to the Company on their
behalf. Accounts receivable in countries where the government funds medical
spending are primarily located in North Africa, Middle East, South America, Asia
and Europe. The Company has considered special situations when establishing
allowances for potentially uncollectible accounts receivable in such countries
as India, Egypt and Turkey. The Company also records reserves for bad debts for
all other customers based on a variety of factors, including the length of time
the receivables are past due, the financial condition of the customer,
macroeconomic conditions and historical experiences. The Company maintains
reserves for potential credit losses and such losses have been within
management's expectations.
The Company sells via a direct sales force and distributors. 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 there were no customers that
accounted for 10% or more of net sales in 2005 or 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, 2005, 2004 and 2003, expenses incurred relating to the 401(k) Plan,
including matching contributions, were approximately $962,000, $760,000 and
$708,000, respectively. Breg also sponsors a 401(k) plan. This 401(k) Plan
allows for participants to contribute up to 100% of their compensation, subject
to certain limitations, with the Company matching 100% of the first $750
deferred. During the years ended December 31, 2005 and 2004, expenses incurred
relating to the Breg 401(k) Plan; including matching contributions were $101,000
and $111,000, respectively.
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 2005, 2004 and 2003
were approximately $685,000, $573,000 and $487,000, 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 2005, 2004 and 2003 was approximately $316,000, $292,000 and
$227,000, respectively. Deferred compensation payments of $215,000, $207,000 and
$233,000 were made in 2005, 2004 and 2003, respectively. The balance as of
December 31, 2005 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
Notes to the consolidated financial statements (cont.)
19 Share option plans
Option and stock purchase plans
At December 31, 2005, the Company had three stock-based compensation plans
and one stock purchase plan which are described below.
2004 Long Term Incentive Plan
The 2004 Long Term Incentive Plan (the "2004 LTIP Plan") is a long term
incentive plan that was adopted in April 2004. The 2004 LTIP Plan was approved
by shareholders on June 29, 2004 and 2.0 million shares were reserved for
issuance under this plan. Awards generally vest on years of service with all
awards fully vesting within five years of the grant date. Awards can be in the
form of an option, restricted share unit, performance share unit, or other award
form determined by the Board of Directors. Awards granted under the 2004 LTIP
Plan expire no later than 10 years after the date of the grant. At December 31,
2005, there were 881,369 awards outstanding under the 2004 LTIP Plan of which
118,595 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, 2005, there were
475,330 options outstanding under the Staff Plan of which 251,130 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, 2005, 125,510 stock options were exercised and none
were forfeited. As of December 31, 2005, 387,500 options remain outstanding
under the option agreements, all of which are exercisable and expire on January
1, 2009.
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
F-32
Notes to the consolidated financial statements (cont.)
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, 2005, 200,000 options remain outstanding under the inducement
grants, of which 20,000 were exercisable.
Employee Stock Purchase Plan
The Employee Stock Purchase Plan provides for the issuance of shares of the
Company's common stock. During each purchase period, eligible employees may
designate between 1% and 25% of their cash compensation to be deducted from
their cash compensation for the purchase of common stock under the plan. The
purchase price of the shares under the plan is equal to 85% to the fair market
value on the first day of the plan year (July 1st to June 30th). The purchase
price for the Company's officers is equal to 100% of the fair market value on
the first day of each plan year. The aggregate number of shares reserved for
issuance under the Employee Stock Purchase Plan in 2005 was 450,000 shares. As
of December 31, 2005, 278,582 shares had been issued under the Employee Stock
Purchase Plan.
Summaries of the status of the Company's stock option and warrant plans as
of December 31, 2005, 2004 and 2003 and changes during the years ended on those
dates are presented below:
2005 2004 2003
----------------------- ---------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- -------- --------- --------- --------- ---------
Outstanding at beginning of year 1,783,693 $27.36 2,051,502 $21.62 2,424,781 $17.08
Granted 508,500 $43.15 434,000 $37.18 449,500 $34.46
Exercised (246,374) $19.45 (698,428) $16.41 (747,554) $14.77
Forfeited (101,620) $34.55 (3,381) $30.40 (75,225) $19.86
---------- ---------- -----------
Outstanding at end of year 1,944,199 $32.02 1,783,693 $27.36 2,051,502 $21.62
========== ========== ===========
Options exercisable at end of year 777,225 834,593 1,042,727
Weighted average fair value of
options granted during the year at
market value $15.09 $13.03 $10.86
Weighted average fair value of
options granted during the year at
less than market value - - $22.32
F-33
Notes to the consolidated financial statements (cont.)
At December 31, 2005, the Company has reserved a total of approximately 1.9
million shares of common stock for issuance to eligible participants under the
option plans (1,944,199 shares).
Outstanding and exercisable by price range as of December 31, 2005
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 - $17.00 139,830 2.88 $12.53 139,830 $12.53
$17.87 - $25.00 431,050 3.25 $18.60 431,050 $18.60
$26.72 - $36.57 364,950 7.64 $32.17 97,086 $31.97
$36.58 - $41.33 615,969 8.64 $38.38 109,259 $37.80
$41.34 - $46.33 392,400 9.52 $43.57 - -
----------- -----------
1,944,199 7.02 $32.02 777,225 $21.88
=========== ===========
20 Earnings per share
For each of the three years in the period ended December 31, 2005, 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,
-------------------------------------------------
2005 2004 2003
---------- ---------- ----------
Weighted average common shares-basic 15,913,475 15,396,540 14,061,447
Effect of diluted securities:
Stock options 375,500 578,405 620,436
---------- ---------- ----------
Weighted average common share-diluted 16,288,975 15,974,945 14,681,883
========== ========== ==========
The Company did not include in the diluted shares outstanding calculation
592,400 options in 2005, 200,000 options in 2004 and 206,000 options in 2003
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-34
21 Subsequent events (unaudited)
In February 2006, the Company announced the succession of its CEO and
President along with a restructuring of its International operations. The
Company expects to incur costs of approximately $1.0 million in the first
quarter of 2006 associated with these items.
In the first quarter of 2006, the Company entered into final agreements with
certain former owners of Novamedix, which established the amount the Company
will be required to disburse in connection with the KCI litigation settlement.
As a result of these negotiations, the Company expects to disburse approximately
$24.9 million instead of the $26.2 million accrued at December 31, 2005. The
difference of approximately $1.3 million will be recorded as income in the first
quarter of 2006.
Notes to the consolidated financial statements (cont.)
22 Quarterly financial data (unaudited)
(U.S. Dollars, In thousands, except per share data)
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter Year
----------- ----------- ----------- ---------- ----
2005
Net sales $77,688 $79,540 $75,812 $80,264 $313,304
Gross profit 56,792 58,765 55,619 58,340 229,516
Net income 10,779 9,405 46,020 7,198 73,402
Net income per common
share:
Basic .68 .59 2.88 .45 4.61
Diluted .67 .58 2.81 .44 4.51
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
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-35
Schedule 2 - Valuation and Qualifying Accounts
For the years ended December 31, 2005, 2004 and 2003:
(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
------------ --------------- -------------- ---------------- --------------
2005
Allowance for doubtful
accounts receivable 4,195 5,124 40 (5,204) 4,155
Inventory provisions 4,010 1,234 - (1,910) 3,334
Deferred tax valuation
allowance 138 238 - - 376
2004
Allowance for doubtful
accounts receivable 4,314 4,266 47 (4,432) 4,195
Inventory provisions 3,656 667 (48) (265) 4,010
Deferred tax valuation
allowance 529 138 - (529) 138
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
S-1