Item 1. Business - -----------------
In this Form 10-K, the terms "we", "us", "our", "Orthofix" and "our company" refer to the combined operations of all of Orthofix International N.V. and its respective consolidated subsidiaries and affiliates, unless the context requires otherwise. For purposes of this Form 10-K, the subsidiaries of a person include all entities that such person controls.
Overview
We are a diversified orthopedic products company offering a broad line of minimally invasive surgical, as well as non-surgical, products for the spine, reconstruction and trauma market sectors. Our products are designed to address the lifelong bone-and-joint health needs of patients of all ages, helping them achieve a more active and mobile lifestyle. We design, develop, manufacture, market and distribute medical equipment used principally by musculoskeletal medical specialists for orthopedic applications. Our main products are external and internal fixation devices used in fracture treatment, limb lengthening and bone reconstruction, non-invasive stimulation products used to enhance the success rate of spinal fusions and to treat non-union fractures, and bracing products used for ligament injury prevention, pain management and protection of surgical repair to promote faster healing. Our products also include a device for enhancing venous circulation, cold therapy, other pain management products, bone cement and devices for removal of the bone cement used to fix artificial implants, 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 and Brazil. In several of these and other markets, we also distribute our products through independent distributors.
Orthofix International N.V. is a limited liability company, organized under the laws of the Netherlands Antilles on October 19, 1987. Our principal executive offices are located at 7 Abraham de Veerstraat, Curacao, Netherlands Antilles, telephone number: 599-9-465-8525. Our filings with the Securities and Exchange Commission, including our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports, are available free of charge on our website as soon as reasonably practicable after they are filed with, or furnished to, the Securities and Exchange Commission. Our internet website is located at http://www.orthofix.com.
Important Events in 2003 and 2004
On February 16, 2004, the Company acquired 100% of the common stock of a Puerto Rican distribution company, Implantes Y Sistemas Medicos, Inc. (ISMI), for approximately $1.4 million in cash. ISMI distributes Orthofix and other third party products.
On December 30, 2003, we completed the acquisition of privately held Breg, Inc. (Breg), a designer, manufacturer and distributor of post-operative reconstruction and rehabilitative products to hospitals and orthopedic offices. The purchase price for the acquisition was $150.0 million plus closing adjustments and transaction costs totaling approximately $6.3 million. Financing costs were approximately $3.8 million. The acquisition and related costs were financed with $110.0 million of senior secured bank debt, cash on hand and the issuance of 731,715 shares of Orthofix common stock.
Breg, based in Vista, California, designs, manufactures and distributes orthopedic products for post-operative reconstruction and rehabilitative patient use, including bracing products, cold therapy products and pain therapy products. Breg generated $61.9 million in net revenues in 2003, approximately 53% of which were attributable to the sale of bracing products, including: (1) functional braces for prevention of ligament injuries, (2) load-shifting braces for osteoarthritic pain management, (3) post-operative braces for protecting surgical repair and
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(4) foot and ankle supports that provide an alternative to casting. Approximately 30% of Breg's 2003 net revenues came from the sale of cold therapy products used to minimize the pain and swelling following knee, shoulder, elbow and back injuries or surgery. Approximately 9% of Breg's 2003 net revenues came from the sale of pain therapy products used for patient control over post-operative pain management after common sports medicine procedures such as arthroscopy of the knee and shoulder. Breg sells its products through a network of domestic and international independent distributors.
Concurrently with the closing of the Breg acquisition, Colgate Medical Limited (Colgate), a wholly owned subsidiary of Orthofix, entered into a new senior secured bank facility with a syndicate of financial institutions arranged by Wachovia Securities. The new 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 March 12, 2004, we had no amounts outstanding under the revolving credit facility. Loans under the new senior secured bank facility bear interest at a rate per annum equal to LIBOR or prime rate, plus a margin that is adjusted quarterly based on Colgate's leverage ratio. As of March 12, 2004, the interest rate on the term loan was set at LIBOR plus 2.75%, or 3.91% per annum.
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 pledge of their respective assets. Certain of Orthofix'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 certain negative covenants applicable to Colgate and its subsidiaries, including restrictions on indebtedness, liens, dividends and mergers or sales of assets. The credit agreement also contains certain financial covenants, including a fixed charge coverage ratio, an interest coverage ratio and a leverage ratio applicable to Colgate, and a leverage ratio applicable to Orthofix. See Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources."
On September 2, 2003, we announced that we had submitted to the FDA, as part of our Pre-Market Approval (PMA) application, the final results of a clinical trial for the Cervical-Stim(R) bone growth stimulator. The prospective, randomized, multi-center clinical investigation, led by Kevin Foley, M.D., of the University of Tennessee, enrolled a total of 323 patients and concluded in January 2003. The objective of this clinical study was to demonstrate safety and efficacy of the Cervical-Stim(R) device in high-risk subjects who had undergone cervical fusion for degenerative conditions. We believe that the results of the study show that there is a "statistically significant positive effect" in the patients who receive cervical stimulation via our pulsed electromagnetic field (PEMF)-based bone growth stimulator, Cervical-Stim(R).
On August 18, 2003, we announced the settlement of a two-year-long federal investigation by the Office of Inspector General of our billings to federal and state healthcare programs for the off-label use of our FDA-approved pulsed electronic magnetic field device. Without admitting any wrongdoing, we agreed to pay approximately $1.7 million to Tri Care (formerly CHAMPUS) to settle allegations involving payments to us for bone growth stimulators prescribed by physicians for patients undergoing surgery on the cervical spine. We recorded the settlement charge with an after-tax effect of approximately $1.1 million or $.07 per share, in the third quarter of 2003. The Department of Justice also closed a related concurrent investigation of our billings to other federal healthcare programs, including Medicare and Medicaid, without taking further action.
On June 30, 2003, we announced that Ferrer, Freeman and Company, a Greenwich, Connecticut based venture capital firm, had purchased 100% of HealthSouth's shares in the OrthoRx joint venture. As a result, Ferrer, Freeman and Company is now our partner in the OrthoRx joint venture, which was established in 2001 to serve the fragmented and underserved orthopedic DME (Durable Medical Equipment) market.
Effective April 2, 2003, our two Italian subsidiaries, DMO S.r.l. and Orthofix S.r.l, merged into one entity, with Orthofix S.r.l being the surviving entity.
In January 2003, we announced that we had purchased an equity interest in Innovative Spinal Technologies (IST), a start-up company focused on commercializing spinal products. The investment of $1.5 million provides Orthofix with the ability to participate in spine product research and development efforts with IST.
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This collaboration has already assisted us to create the next generation of dynamic bracing: Dynamic Adjustable Spine Stabilization (DASS), which will address the need for controlled bracing of post-surgical rehabilitation patients.
Effective on January 14, 2003, we completed a Share Purchase Agreement to acquire the remaining 48% minority interest in our United Kingdom distribution company, Intavent Orthofix Limited (IOL). We purchased the 48% interest from Intavent Limited (Intavent) for a cash purchase price of $20.6 million, including transaction costs. IOL distributes Orthofix products, airway management products and other orthopedic products. Concurrent with the completion of the Share Purchase Agreement, we completed a Distribution Agreement with Intavent and a Guarantee Agreement with LMA International S.A. (LMA) to assure the supply of Laryngeal Mask products in the United Kingdom, Ireland and Channel Islands for an initial period of seven years. Mr. Robert Gaines-Cooper, Chairman of Orthofix, is a settlor of a trust, which owns a 30% interest in Intavent and a 40% interest in LMA. IOL has been, and will continue to be, a consolidated subsidiary of Orthofix.
On January 7, 2003, we announced that we had entered into an exclusive distribution agreement with Efratgo Limited to market the Gotfried Percutaneous Compression Plating (PC.C.P) System, a minimally invasive method of fracture stabilization and fixation for hip-fracture surgery developed by Y. Gotfried, M.D. Under this agreement, we paid $1.0 million for the worldwide rights to market this product for four years. In addition, we will pay a royalty of up to $5.0 million based on future sales. We have the right to acquire all patents pertaining to this system for $5.0 million. The royalty fee paid by us during the four-year licensing period will be applied against the purchase price of the patents. The 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.
Business Strategy
Our business strategy is to offer innovative, cost-effective orthopedic products to the spine, reconstruction and trauma market sectors that are minimally invasive and that reduce patient suffering and healthcare costs. We intend to continue to expand applications for our products by utilizing synergies among our core technologies, including those acquired from the Breg acquisition. We expect to expand our product offerings through business or product acquisition and licensing agreements, as well as through our own product development efforts. We will leverage our sales and distribution network by selling our products in all markets that are available to them. We will continue to enhance physician relationships through extensive education efforts and strengthen contracting and reimbursement relationships through our dedicated sales and administration staff.
Products
We have two reportable geographic markets (1) the Americas, which includes our Orthofix Inc. and Breg operations in the United States, as well as Mexico and Brazil, and (2) International, which includes our direct and distributor operations in the rest of the world. Our revenues are generally derived from two primary sources: sales of orthopedic and non-orthopedic products. Sales of orthopedic products are made into three market sectors, Spine (39%), Reconstruction (25%) and Trauma (26%), which together accounted for 90% of our total net sales in 2003. Sales of non-orthopedic products, including airway management, woman's care and other products, accounted for 10% of our total net sales in 2003.
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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 spinal bone growth stimulation
Orthotrac Pneumatic vest used to reduce pressure on the spine
EZ Brace Rigid external brace for spine stabilization
Reconstruction
ExFix External fixation, including the Sheffield Ring, OASIS and limb-lengthening systems
A-V Impulse System Enhancement of venous circulation, principally used after orthopedic procedures
Cemex Bone cement
ISKD Internal limb-lengthening device
OSCAR Ultrasonic bone cement removal
BoneSource Bone substitute material
Breg Bracing (1) Bracing products which provide support and protection of limbs and extremities
Polar Care (1) Cold therapy products to reduce swelling and accelerate the rehabilitation process
Pain Care (1) Pain therapy products that provide continuous infusion of local anesthetic into surgical site post-surgery
Trauma
ExFix External and internal fixation, including DAF, ProCallus, Xcaliber and nailing systems
Physio-Stim PEMF non-invasive bone growth stimulation
PC.C.P Percutaneous compression plating system for hip fracture
Non-Orthopedic Products -----------------------
Laryngeal Mask Maintenance of airway during anesthesia
Other Several non-orthopedic products for which various Orthofix subsidiaries hold distribution rights
(1) Acquired through the acquisition of Breg on December 30, 2003.
We have proprietary rights over all of the above products with the exception of the Laryngeal Mask, Cemex, ISKD and PC.C.P. 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 and PC.C.P systems worldwide.
We have trademarked the following products and services: Orthofix(R), ProCallus(R), Orthotrac(TM), XCaliber(TM), OASIS(TM), EZBrace(TM), Spinal-Stim(R), Physio-Stim(R), Breg(R), Polar Care(R), and Pain Care(R).
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Net Sales
The following tables display the net sales by geographic destination and net sales by geographic origination, net of intercompany eliminations, for each of our geographic markets and by each of our Market Sectors for the three most recent fiscal years ended December 31, 2003. We provide net sales by geographic destination and by market sector for information purposes only. We maintain our books and records by geographic origination.
Geographic Destination:
Geographic Origination:
Market Sector:
Prior to completion of the Breg acquisition on December 30, 2003, we provided for information purposes our net sales by Product Groups. We believe that it is more meaningful to investors to classify net sales from our products based on the Market Sector that those products are sold into. We have therefore classified 2003 net sales by Market Sector and restated corresponding net sales from earlier periods by Market Sector. The "Product" table on page 7 identifies the Market Sector into which each of our products has been classified.
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Additional financial information regarding our geographic markets can be found in Note 12 to the Consolidated Financial Statements.
Orthopedic Products
Orthopedic product sales represented 90% of our total net sales in 2003.
Our orthopedic product sales cover three Market Sectors: Spine, Reconstruction and Trauma.
Spine
Spine product sales represented 39% of our total net sales in 2003.
We believe that back pain is a common health problem for many patients throughout the world, which often requires surgical or non-surgical intervention for improvement. 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 dramatically to fill the existing gap between conservative pain management and invasive surgery, such as spine fusion.
Our spine products are positioned to address the needs of spine patients at any point within the care cycle, offering non-operative, pre-operative and post-operative treatments. According to Frost & Sullivan, a market research firm, the market size for spine products is currently estimated at $2.4 billion, with a compounded annual growth rate expected to exceed 23% through the year 2010.
Spinal-Stim
The Spinal-Stim Bone Growth Stimulator (Spinal-Stim) is designed to enhance the success rate of spinal fusions by stimulating the body's own natural healing mechanism. This portable device is intended to be used as part of a post-surgery home treatment program prescribed by a physician.
Spinal-Stim was the first non-invasive spinal fusion stimulator system commercially available in the United States. Spinal-Stim is designed for treatment of the lower thoracic and lumbar regions of the spine. Some spine fusion patients are at greater risk than most patients with non-healing fractures due to risk factors such as smoking, obesity or multiple levels of spine fusion. For these patients, bone growth stimulation using Spinal-Stim Lite, the second generation of the Spinal-Stim product line, has been shown to increase the probability of fusion, without the need for additional surgery. More than 120,000 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 from a 9-volt battery. 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 we would expect it to be 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 a low level of PEMF 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. In addition to the direct sales of this product by our sales force, the Spinal-Stim Lite is also distributed in the United States by Medtronic Sofamor Danek Group.
We operate limited guarantee programs for Spinal-Stim to heighten awareness of the healing enhancement properties of PEMF technology. These programs provide, in general, for reimbursement of the full price of the device if radiographic evidence indicates that healing is not occurring at the fusion site when the device is used in
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accordance with the prescribed treatment protocol. Over the multi-year history of these programs, we have received few claims for reimbursement for which we carry a nominal financial reserve.
We have submitted to the FDA, as part of our PMA application, the final results of a clinical trial for a new product, the Cervical-Stim(R) bone growth stimulator. The objective of this clinical study was to demonstrate the safety and efficacy of the Cervical-Stim(R) device in high-risk patients who had undergone cervical spine fusion for degenerative conditions. Without a bone growth stimulator, the failure rate of cervical fusions can be significant. Pulsed electromagnetic field stimulation enhances bone healing in the cervical spine. Application of PEMF stimulation is believed to activate the body's natural repair mechanism, which is absent or not fully functional in certain patients, and enhances bony fusion for successful outcomes.
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 and 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 25% of our total net sales in 2003.
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 alternatives to correct lower limb deformities. In addition, we introduced in 2002 an internal lengthening system called the ISKD(TM) which is used when patient's limbs are unequal in length. The ISKD(TM) is implanted using a minimally invasive technique and lengthens internally.
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 recent acquisition of Breg, we now have a more well-rounded and complete product line offering within the reconstruction market. A leading manufacturer of orthopedic bracing and cold therapy products, Breg possesses strong brand recognition and a high quality reputation. Functional bracing, load shifting and post-surgery bracing are used for the protection of surgical repair and promotion of faster healing. Additionally, we believe that cold therapy and pain therapy products are emerging as a standard of care with physicians and hospitals.
According to Frost & Sullivan, the market size for reconstruction products is currently estimated to be $6.2 billion with a compounded annual growth rate of 9% through 2005.
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ExFix
In addition to the treatment of bone fractures, we manufacture and distribute external fixators that are used to treat congenital bone deformities, such as limb length discrepancies, or deformities that result from previous trauma. To serve the highly specialized limb reconstruction market, we developed the Sheffield fixator. A Sheffield fixator is radiolucent and uses fewer components than other products for limb reconstruction. In addition, a Sheffield fixator is more stable and stronger than most competing products - two critical concerns for a long-term limb reconstruction treatment. We believe other advantages of a Sheffield fixator over competing products include the rapid assembly, ease of use and the numerous possibilities for customization for each individual patient.
The Osteoarthritis Surgical Intervention System, or the OASIS, is designed for younger patients suffering from the degeneration of the cartilage and bone of the knee. The OASIS is a minimally invasive system that allows gradual post-operative adjustment of the affected limb and also helps unload the damaged cartilage.
A-V Impulse System
We manufacture and distribute the A-V Impulse System line of foot and hand pumps, a non-invasive method of reducing post-operative pain and swelling and deep vein thrombosis, or the formation or presence of a blood clot. The A-V Impulse System consists of an electronic controller attached to a special inflatable slipper or glove, or to an inflatable bladder within a cast, which promotes the return of blood to the veins and the inflow of blood to arteries in the patient's arms and legs. The device operates by intermittently impulsing veins in the foot or hand, as would occur naturally during normal walking or hand clenching. Conventionally, in order to reduce the incidence of deep vein thrombosis, heparin or related pharmacological products have been administered during and after operations. The A-V Impulse System has been demonstrated to give prophylactic benefits that are comparable to the forms of pharmacological treatment but without their adverse side effects, the most serious of which typically is bleeding. We believe that approximately 85% 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. We believe the remaining net sales of the A-V Impulse System are to address various venous or circulatory problems of patients. The A-V Impulse System is distributed in the United States by Kendall Healthcare Products. Outside the United States, the A-V Impulse System is sold directly by our distribution subsidiaries in the United Kingdom, Italy and Germany and through selected distributors in the rest of the world.
Cemex
Cemex, a product of Tecres S.p.A., is a bone cement used by surgeons to repair hip and knee prostheses once they have been inserted. We have the exclusive distribution rights for Cemex in Italy.
ISKD (Intramedullary Skeletal Kinetic Distractor)
The Intramedullary Skeletal Kinetic Distractor, or ISKD, system is a patented, internal limb-lengthening device that uses a magnetic sensor to monitor limb-lengthening progress on a daily basis. The ISKD system is an expandable tubular structure that is completely implanted inside the bone to be lengthened. Only the patient and surgeon need know the bone is being lengthened. Once implanted, the ISKD system lengthens the patient's bone gradually, and, after lengthening is completed, the system stabilizes the lengthened bone. This product received 510(k) clearance from the FDA in 2001 and is being introduced in the United States and Europe on a controlled basis. We have the exclusive worldwide distribution rights for this product.
OSCAR (Orthosonics System for Cement Arthroscopy Revision)
We have developed the Orthosonics System for Cement Arthroscopy Revision, or OSCAR, an ultrasonic device designed to soften and remove the bone cement used to fix artificial implants within the patient's bone. We believe that it offers a significant improvement, both in terms of cost and patient outcomes, over existing bone cement removal techniques. Existing techniques involve the use of hand chisels and manual or pneumatic hammers and drills, which generally increase the risk of femoral shaft fracture with greatly increased patient trauma and significant cost implications. OSCAR has been demonstrated to greatly reduce femoral fractures and substantially reduce cement removal times to approximately 15 to 20 minutes.
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The product was launched in the United Kingdom in 1994, and selectively elsewhere in 1995. OSCAR is now well established in the United Kingdom, and we believe it is gaining support in certain other European countries. We are expanding distribution of OSCAR in the United States through a network of independent distributors that currently covers 25 states. A new version of OSCAR was launched in 2001, which has a built-in endoscopic function for visual examination of the femoral canal.
BoneSource
We hold an exclusive license from the American Dental Association Health Foundation, or ADAHF, for technology for BoneSource, a patented hydroxyapatite cement. The licensed technology combines calcium-phosphate salts with water to produce a bone substitute that converts to hydroxyapatite, a mineral component of bone, and promotes new bone growth by resorption, a process by which hydroxyapatite is converted back into living bone.
BoneSource received 510(k) clearance from the FDA for repair of certain cranial defects in July 1997. It has also obtained a CE mark, required for a product to be sold or distributed in the European Union, for certain cranial symptoms and for use as a bone void filler in certain non-weight bearing orthopedic symptoms. We have licensed exclusive worldwide marketing rights for BoneSource to Stryker Corporation, which currently sells the product both in the United States and Europe.
On April 22, 1998, we entered into agreements with Stryker Corporation under which Stryker has the right to develop, manufacture, market and pursue regulatory approvals for BoneSource for additional orthopedic applications. From the date of the agreements through February 17, 2003, we supplied BoneSource to Stryker. Stryker currently manufactures BoneSource and pays Orthofix a royalty on sales of the product.
Breg
On December 30, 2003, we completed the acquisition of Breg, which we believe is a market leader in the sale of orthopedic post-operative reconstruction and rehabilitative products to hospitals and orthopedic offices. We have categorized all of Breg's products as Reconstructive products. Breg's products are grouped into three product categories: Breg Bracing, Polar Care and Pain Care.
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 to help patients regain range of motion capability so that patients may successfully complete rehabilitation and resume their daily activities. The product line includes premium-customized braces generally designed for strenuous athletic activity and off-the-shelf braces designed for use in less rigorous activity. These dual-function custom-fabricated braces address both ligamentous instability and/or unicompartmental osteoarthritis as well as patellofemoral pain with or without instability or maltracking of the patella. We market the ligament product line under the X2 K name.
Post-operative braces limit a patient's range of motion after knee surgery and protect the repaired ligaments and/or joints from stress and strain. These braces promote a faster and healthier healing process. The products within this line provide both immobilization and/or a protected range of motion. The Breg post-op family of braces, featuring the Quick-Set hinge, offers complete range of motion control for both flexion and extension, along with a 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.
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Osteoarthritic braces are used to treat patients suffering from osteoarthritis. Osteoarthritis (OA) is a form of damage to, or degeneration of, the articular surface of a joint. This line of customized 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 recently introduced the CounterForce Plus, our newest bracing technology for patients suffering from OA. These braces address not only the pain associated with unicompartmental osteoarthritis but also the stability needs of the patient. The braces are based on a functional knee brace design that controls both anterior/posterior and varus/valgus instabilities.
Polar Care
We manufacture, market and sell the leading cold therapy product line, Polar Care. Breg created the market for cold therapy products in 1991 when it introduced the Polar Care 500, a cold therapy device used to reduce swelling, minimize the need for post-operative pain medications and generally accelerate the rehabilitation process. Today, we believe that cold therapy is emerging as a standard of care with physicians despite limited reimbursement.
The Polar Care product uses a circulation system to provide constant fluid flow rates, thereby minimizing temperature fluctuations which can reduce device effectiveness and create the potential for tissue or nerve damage. The products consist of a cooler filled with ice and cold water that continuously provides cold therapy for the relief of pain. Breg's cold therapy line consists of the Polar Care 500, Polar Care 300, Polar Cub and cold gel packs.
Pain Care
We manufacture, market and sell a leading line of pain therapy products, Pain Care. This product line includes the Pain Care 3200 and 4200 lines of disposable, pain management infusion pumps. These pain management and relief systems provide a continuous infusion of local anesthetic dispensed directly into the surgical site following a surgical procedure. The Pain Care family provides controlled infusions of a local anesthetic to alleviate and moderate severe pain experienced following surgery. We believe we maintain a leading position in this fast growing market
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 26% of our total net sales in 2003.
Our trauma products are designed to be minimally invasive and are based on a philosophy of treatment that focuses not only on the broken bone but also considers the long-term preservation of function and quality of life for the patient. Our method for fracture reduction protects and preserves proper anatomy and limb alignment, allowing patients to function naturally and bear weight at the fracture site very early in the healing cycle, which we believe are important considerations for a positive outcome.
We believe our trauma products will assist in improving hospitals' efficiency as the trauma market grows. Knowledge Enterprises 2003, an independent market research firm, estimates that the size of the trauma market will be $1.6 billion by 2005 and that the market is currently growing 7-8% per year.
ExFix
For a fracture to heal properly, without misalignment or rotation, the bone must be set and fixed in the correct position. The bone must be kept stable, but not absolutely rigid, in order to alleviate pain, maintain the correct alignment and initiate the callus formation for proper healing. Fractures initially should not bear any weight, but, at the appropriate time in the healing cycle, benefit from gradually increasing micromovement, weight-bearing and function, which further stimulate the callus.
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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 70 countries.
In 2001, we introduced XCaliber fixators, a new generation alternative to our previous external fixators. The XCaliber fixators are made from a lightweight radiolucent material and are provided in three configurations to cover long bone fractures, fractures near joints and ankle fractures. The radiolucency of XCaliber fixators allows X-rays to pass through the device and provides the surgeon with significantly improved X-ray visualization of the fracture and alignment. In addition, these three configurations cover a broad range of fractures with very little inventory. The XCaliber fixators are provided pre-assembled in sterile kit packaging to decrease time in the operating room.
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 that 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 pins, nails and screws designed to temporarily stabilize traumatic bone injuries. These devices are used to set and stabilize fractures and are removed when healing is completed. Our three principal internal fixation devices include:
o the Orthofix Nailing System, a nailing system for fractures of the tibia and femur that requires a surgical insertion of a metal rod into the medullary canal, the central canal of the bone, to maintain 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, an implant for fixing small fracture fragments, usually used for the treatment of fractures near the joints; and
o our proprietary XCaliber bone screws, which 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
Orthofix International N.V.
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.
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 fragments 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 spinal fusion or fracture site.
In some patients, such as patients who smoke, the fracture healing process is impaired or absent and the fracture fragments may not mend properly, resulting in a non-union. We manufacture our second generation of the Physio-Stim product line, the Physio-Stim Lite, a bone growth stimulation device which has proved to be successful in treating many fracture non-unions. Our patient data shows that 8 out of 10 patients with fracture non-unions that use Physio-Stim Lite are healed by our product without additional invasive surgical treatment. The systems offer portability, long-term battery operation, integrated component design, patient monitoring capabilities and the ability to cover a large treatment area without factory calibration for specific patient application. More than 88,000 patients have been treated using Physio-Stim since the product was introduced in 1986. Physio-Stim uses a proprietary technology to generate a PEMF signal from a 9-volt battery, thus eliminating the need for rechargeable battery packs and chargers. The result is a self-contained, very light and ergonomic device with a three hour per day wear time that we believe makes the unit significantly easier and more comfortable to use than competing products. The comprehensive Physio-Stim Lite product line treats all the small and long bones, with a current redesign for the treatment of the pelvis. Physio-Stim also features a compliance monitoring system that provides hard copy printouts of patient files.
We operate limited guarantee programs for Physio-Stim to heighten awareness of the healing enhancement properties of PEMF technology. This program provides, in general, for reimbursement for the full price of the device if radiographic evidence indicates that healing is not occurring at the fracture site when the device is used in accordance with the prescribed treatment protocol. Over the multi-year history of this program, we have received few claims for reimbursement, for which we carry a nominal financial reserve.
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. Under our exclusive distribution agreement with Efratgo Limited to market the PC.C.P System, we have the right to license the product worldwide, and the option to purchase the technology.
There is growing concern about the mortality and complications associated with hip fractures and their cost to society. Recently published papers detailing clinical results using currently available systems indicate that only 40% of patients regain their pre-operative mobility. In contrast, the PC.C.P System has been shown to increase this percentage to 83% in a clinical study of 118 patients ranging in age from 58-98 years whose hip-fracture surgery utilized the PC.C.P System.
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Traditional hip-fracture surgery can require a 5-inch-long incision down the thigh, but the new 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 10% of our total net sales in 2003.
Laryngeal Mask
The Laryngeal Mask, a product of The Laryngeal Mask Company, is an anesthesia medical device used for establishing and maintaining the patient's airway during an operation. We have exclusive distribution rights for the Laryngeal Mask in the United Kingdom, Ireland and Italy.
Other
We hold distribution rights for several other non-orthopedic products including Mentor breast implants in Brazil and women's care products in the United Kingdom.
Joint Venture
OrthoRx
In 2000, we commenced operation of OrthoRx, a full service durable medical equipment distribution and billing business. OrthoRx provides to patients orthopedic durable medical equipment products built around physician protocols that specify the treatment and product required for each patient. The business is vendor-neutral, which means that the product requested by the physician is the exact product given to the patient. OrthoRx arranges supply agreements for the products specified by the referring physicians.
On January 10, 2002, we established a joint venture, OrthoRx, Inc. (OrthoRx). The OrthoRx joint venture is headquartered in Plano, Texas, where the business processes insurance authorizations, maintains inventory levels, and processes product billing and collections, which is intended to allow individual OrthoRx service centers to focus on patient interaction and physician follow-up. The prototype for the joint venture has been operating in St. Louis, Missouri since November 2000. Initial plans identified 40 potential markets for OrthoRx service centers. Prior to the formation of the joint venture, the operations of OrthoRx were included in our financial statements. Sales from the OrthoRx business were approximately $2.0 million in 2001, $3.1 million in 2002 and $6.8 million in 2003. We initially invested $3.0 million for a 45% share of the joint venture through a combination of $2.0 million in cash and $1.0 million in contributed assets. In November 2002 and in 2003, we invested an additional $1.0 million and $1.5 million, respectively, in cash, raising our total investment in the joint venture to $5.5 million and our ownership stake to 47%. Our current partner in the joint venture is Ferrer, Freedman, & Co., a Greenwich, Connecticut based venture capital firm, which purchased 100% of HealthSouth's shares in the OrthoRx joint venture in June 2003.
Product Development, Patents and Licenses
We maintain a continuous interactive relationship with the main orthopedic centers in the United States, Europe, Japan and South and Central America, including research and development centers such as Wake Forest University in the United States 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. 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.
Orthofix International N.V.
Our research and development departments are responsible for new product development and regularly consult with a group of internal and designated external experts. The expert group advises these departments on the long-term scientific planning of research and development and also evaluates our research programs. Our primary research and development facilities are located in Verona, Italy; McKinney, Texas; Winston-Salem, North Carolina; Vista, California; and Andover, United Kingdom.
In 2003, 2002 and 2001, we spent $8.1 million, $7.5 million and $7.0 million, respectively, on research and development.
In January 2002, we agreed to provide approximately $2.0 million to Orthopedic Research and Education Foundation to fund a four-year study to define the molecular and cellular mechanism underlying bone-healing in response to pulsed electromagnetic field (PEMF) technology. This study is being conducted at the Lerner Research Institute of the Cleveland Clinic Foundation and is entitled "Optimizing Bone-Healing Using PEMF," which also seeks to identify specific signal characteristics that are causally related to a bone-healing response to PEMF technology in order to optimize the PEMF signal.
In January 2003, we announced that we had purchased an equity interest in IST, a start-up company focused on commercializing spinal products. The investment of $1.5 million provides us with the ability to participate in spine product research and development efforts with IST. This collaboration has already assisted us to create the next generation of dynamic bracing: Dynamic Adjustable Spine Stabilization (DASS), which will address the need of controlled bracing for post-surgical rehabilitation patients.
Patents, Trade Secrets and Licenses
We rely on a combination of patents, trade secrets, license agreements and non-disclosure agreements to protect our proprietary intellectual property. We own numerous U.S. and foreign patents and have numerous pending patent applications and license rights regarding patents held by third parties. Our primary products are patented in all major markets in which they are sold. There can be no assurance that pending patent applications will result in issued patents, that patents issued 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 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 license certain orthopedic products from third parties. We have acquired rights under such licenses in exchange for lump-sum payments or arrangements under which we pay to the licensor a percentage of sales. However, 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 agreements generally provide for royalty payments and termination rights in the event of a material breach.
We also license certain of our products to others. Pursuant to our license agreement with Stryker for BoneSource, we manufactured and sold BoneSource to Stryker through February 17, 2003 and received a royalty based on Stryker's revenues from BoneSource sales. In 2003, Stryker began manufacturing of BoneSource and continues to pay us a royalty based on sales of the product.
Government Regulation
Sales of medical devices, including our orthopedic products, are subject to U.S. and foreign 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.
Orthofix International N.V.
Our products are subject to the regulatory powers of the FDA pursuant to the Medical Device Amendments of 1976 to the Federal Food, Drug and Cosmetics Act, or the 1976 Amendments, 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 stimulation products are classified as Class III by the FDA, and have been approved for commercial distribution in the United States following the submission of the required pre-market approval applications.
The medical devices that we develop, manufacture and market are subject to rigorous regulation by the FDA and numerous other federal, state and foreign governmental authorities. The process of obtaining regulatory approvals to market a medical device, particularly from the FDA, can be costly and time-consuming, and there can be no assurance that such approvals will be granted on a timely basis, if at all. While we believe that we have obtained all necessary clearances for the manufacture and sale of our products and that they are generally in compliance with applicable FDA and other material regulatory requirements, there can be no assurance that we will be able to continue such compliance. If the FDA came to believe that we were not in compliance with applicable law or regulations, it could institute proceedings to detain or seize our products, issue a recall, impose operating restrictions, enjoin future violations and assess civil and criminal penalties against us, our officers or our employees and could recommend criminal prosecution to the Department of Justice. In addition, the regulatory process may delay the marketing of new products for lengthy periods and impose substantial additional costs if the FDA lengthens review times for new devices.
Moreover, foreign governmental authorities have become increasingly stringent in their regulation of medical devices, and our products may become subject to more rigorous regulation by foreign governmental authorities in the future. We cannot predict whether U.S. or foreign 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.
We devote significant time, effort and expense to addressing government and regulatory requirements applicable to our business. We believe our operations are in material compliance with applicable law. 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 foreign regulatory authorities and to operate in compliance with applicable regulations.
Sales, Marketing And Distribution
General Trends
We believe that demographic trends, principally in the form of a better informed, more active and aging population in the major healthcare markets of the United States, Western Europe and Japan, and our focus on innovative, minimally invasive products will continue to have a positive effect on the demand for our products.
Primary Markets
In 2003, the Americas, including its principal market, the United States, accounted for 57% of total net sales by geographic origination. After the acquisition of Breg, we now have approximately 330 direct and distributor sales representatives dedicated to the domestic market and 150 direct and distributor sales representatives focused on foreign markets.
Orthofix International N.V.
In 2003, International accounted for 43% of total net sales by geographic origination with 19% derived from the United Kingdom and 8% derived from Italy. Other than Kendall Healthcare Products, no single international customer accounted for greater than 2% of total net sales.
We have non-exclusive distribution agreements for the Spinal-Stim Lite with Medtronic Sofamor Danek Group and for the Physio-Stim Lite with Royce Medical Company. The A-V Impulse System is distributed in the United States under an exclusive, long-term distribution agreement with Kendall Healthcare Products. Kendall Healthcare Products accounted for approximately 10% of our total net sales in 2003, while sales through Medtronic Sofamor Danek accounted for approximately 9% of total net sales. Sales to all other customers were broadly distributed.
Our products sold in the United States are either prescribed by medical professionals for the care of their patients or sold to hospitals, 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 and Italy, to publicly funded healthcare systems.
Sales Force and Distribution Network
We have established a broad distribution network within the United States and across 86 countries via 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 product lines through approximately 230 direct sales representatives, including 170 field sales representatives in the United States. These sales representatives undergo extensive training and develop the necessary technical expertise to sell our products to orthopedic physicians and surgeons, orthopedic shops, hospitals, surgery centers and others.
By acquiring Breg, we added approximately 46 domestic relationships, most with independent distributors. These relationships sell primarily to surgery centers and office environments, which represent new distribution channels for Orthofix. These clients are served by approximately 160 sales representatives.
Outside the United States, we employ approximately 60 direct sales representatives throughout our international sales subsidiaries. We also utilize 50 independent distributors in over 70 countries in Europe, the Far East, the Middle East and Central and South America. In order to provide support to our independent distributor network, we have a sales service group consisting of seven sales and marketing specialists who regularly visit the independent distributors.
As a result of the Breg transaction, we added Breg's existing 50 international distributor relationships to our own. These Breg relationships are served by approximately 90 international sales representatives.
Marketing
Until 2000, we primarily sold orthopedic devices outside the United States and focused our stimulation products sales efforts in the United States. However, since 2000, we have expanded our offerings of orthopedic devices in the United States and have since begun to market the Spinal-Stim and Physio-Stim lines in Europe and Mexico. To facilitate distribution of stimulation products in the European Union, we obtained a CE mark for our stimulation products in December 1998.
In general, we seek to market our products principally to medical professionals who are the decision makers in their patient's treatment. This focus is designed to complement our product development and marketing strategy, which seeks to encourage and maintain interactive relationships with the leading orthopedic, trauma and other surgeons. These relationships facilitate the introduction of design improvements and create innovative products that meet the needs of surgeons and patients, thereby expanding the market for our products.
We support our sales force and distributors through specialized training workshops in which surgeons and sales specialists participate. We also produce marketing materials, including materials outlining surgical
Orthofix International N.V.
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 2003 were attended by over 880 surgeons from around the world, include a variety of lectures from specialists as well as demonstrations and hands-on workshops. We also provide sales training at our training centers in Winston-Salem, North Carolina and McKinney, Texas and at our recently acquired Breg training center in Vista, California. Additionally, each year many of our sales representatives and distributors independently conduct basic courses for surgeons in the application of certain of our products.
Competition
For external and internal fixation devices, our principal competitors include Synthes AG, Zimmer, Inc., Stryker Corp., Smith & Nephew plc and EBI Medical Systems, a subsidiary of Biomet, Inc. OSCAR and BoneSource compete principally with products produced by Biomet, Inc. and Norian Corporation, respectively. Our stimulation products compete principally with similar products marketed by EBI Medical Systems, dj Orthopedics, Inc., and Exogen, Inc., a subsidiary of Smith & Nephew plc. The principal non-pharmacological products competing with our A-V Impulse System are manufactured by Huntleigh Technology PLC and Kinetic Concepts Inc. We have filed an action against Kinetic Concepts Inc. for patent infringement. For a description of the litigation, see Item 3 - "Legal Proceedings."
The principal competitors for the newly acquired 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 and the avoidance of a second operative procedure for the removal of treatment devices.
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 and still maintaining quality assurance standards. In addition to designing, developing, assembling, testing and packaging its products, Breg, our recently acquired subsidiary, also manufactures a substantial portion of the component parts used in its products.
Although certain of our key raw materials are obtained from a single source, we believe that alternate sources for these materials are available. Adequate raw material inventory supply is maintained to avoid product flow interruptions. We have not experienced difficulty in obtaining the materials necessary to meet our production schedule.
Our products are currently manufactured and assembled in the United States, Italy, the United Kingdom, Mexico and the Seychelles. We are in the process of transitioning a majority of Breg's manufacturing activities from its Vista, California facility to the Mexicali, Mexico plant. We expect this transition to be completed by the end of 2004. 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 regulations 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. In addition, we do not consider backlog of firm orders to be material.
Orthofix International N.V.
Capital Expenditures
We had capital expenditures in the amount of $5.2 million, $7.1 million and $6.8 million in 2003, 2002 and 2001, respectively, principally for computer software and hardware, patents and machinery and equipment, including the leasehold improvements for a leased facility in McKinney, Texas in 2001. We currently plan to invest approximately $5.4 million in the Americas, including approximately $1.9 million in Breg, and approximately $3.7 million in International in 2004 for a total of approximately $9.1 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, 2003, we had approximately 988 employees worldwide, including employees gained through the acquisition of Breg, of which approximately 752 were employed within the Americas unit and approximately 236 were employed within the International unit. Our relations with our Italian employees, who numbered 61 at December 31, 2003, are governed by the provisions of a National Collective Labor Agreement setting forth mandatory minimum standards for labor relations in the metal mechanic workers industry. We are not a party to any other collective bargaining agreement. We believe that we have good relations with our employees. Of our approximately 988 employees, 426 were employed in sales and marketing functions, 175 in general and administrative, 315 in production and 72 in research and development.
RISK FACTORS
You should carefully consider the risks described below. These risks are not the only ones that our company may face. Additional risks not presently known to us or that we currently consider immaterial may also impair our business operations. This Form 10-K also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including the risks faced by us described below or elsewhere in this Form 10-K.
We depend on our ability to protect our intellectual property and proprietary rights, but we may not be able to maintain the confidentiality, or assure the protection, of these assets.
Our success depends, in large part, on our ability to protect our current and future technologies and products and to defend our intellectual property rights. If we fail to protect our intellectual property adequately, competitors may manufacture and market products similar to, or that compete directly with, ours. Numerous patents covering our technologies have been issued to us, and we have filed, and expect to continue to file, patent applications seeking to protect newly developed technologies and products in various countries, including the United States. Some patent applications in the United States are maintained in secrecy until the patent is issued. Because the publication of discoveries tends to follow their actual discovery by several months, we may not be the first to invent, or file patent applications on, any of our discoveries. Patents may not be issued with respect to any of our patent applications and existing or future patents issued to, or licensed by, us 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 licensees, suppliers, employees and consultants. These agreements may be breached and there may not be adequate remedies in the event of a breach. Disputes may arise concerning the ownership of intellectual property or the applicability or enforceability of confidentiality agreements. Moreover, our trade secrets and proprietary technology may otherwise become known or be independently developed by our competitors. If patents are not issued with respect to products arising from research, we may not be able to maintain the confidentiality of information relating to these products.
Third parties may claim that we infringe on their proprietary rights and may prevent us from manufacturing and selling certain of our products.
There has been substantial litigation in the 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 charges relating to the alleged infringement of patent or proprietary rights of third parties. Any such litigation could:
o require us to incur substantial expense, even if the costs of our defense are covered by insurance or we are successful in the litigation;
o require us to divert significant time and effort of our technical and management personnel;
o result in the loss of our rights to develop or make certain products; and
o require us to pay substantial monetary damages or royalties in order to license proprietary rights from third parties or to satisfy judgments or to settle actual or threatened litigation.
Although patent and intellectual property disputes within the medical devices industry have often been settled through licensing or similar arrangements, costs associated with these arrangements may be substantial and could include the long-term payment of royalties. Furthermore, the required licenses may not be made available to us on acceptable terms. Accordingly, an adverse determination in a judicial or administrative proceeding or a failure
Orthofix International N.V.
to obtain necessary 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 to our customers or to our independent distributors and purchased by hospitals, doctors and other healthcare providers, who together with us may be reimbursed for the healthcare services provided to their patients by third-party payors, such as government programs, including Medicare and Medicaid, private insurance plans and managed care programs. Third-party payors may deny reimbursement if they determine that a device used in a procedure was not used in accordance with cost-effective treatment methods as determined by such third-party payor, was investigational or was used for an unapproved indication or for other reasons. Also, third-party payors are increasingly challenging the prices charged for medical products and services. Limits put on reimbursement could make it more difficult for people to buy our products and reduce, or possibly eliminate, the demand for our products. In addition, in the event that governmental authorities enact additional legislation or adopt regulations that affect third-party coverage and reimbursement, demand for our products may be reduced with a consequent material adverse effect on our sales and profitability. It is also possible that the government's focus on coverage of off-label uses for FDA-approved devices could lead to changes in coverage policies regarding off-label uses by TriCare, Medicare and/or Medicaid. There can be no assurance that we or our distributors will not experience significant reimbursement problems in the future.
Our products are sold in many countries, such as the United Kingdom and Italy, with publicly funded healthcare systems. The ability of hospitals supported by such systems to purchase our products is dependent, in part, upon public budgetary constraints. Any increase in such constraints may have a material adverse effect on our sales and collection of accounts receivable from such sales.
We are subject to extensive government regulation that increases our costs and could prevent us from marketing or selling our products.
The medical devices we manufacture and market are subject to rigorous regulation by the Food and Drug Administration, or FDA, and numerous other federal, state and foreign governmental authorities. These authorities regulate the development, approval, testing, manufacture, labeling, marketing and sale of medical devices. For a description of these regulations, see Item 1 - "Business - - Government Regulation."
For example, approval by governmental authorities, including the FDA in the United States, is generally required before any medical devices may be marketed in the United States or other countries. The process of obtaining FDA and other regulatory approvals to develop and market a medical device can be costly and time-consuming, and is subject to the risk that such approvals will not be granted on a timely basis or at all. The regulatory process may delay or prohibit the marketing of new products and impose substantial additional costs if the FDA lengthens review times for new devices. Moreover, we cannot predict whether U.S. or foreign government regulations that may have a material adverse effect on us may be imposed in the future.
Our profitability depends, in part, upon our and our distributors' ability to obtain and maintain all necessary certificates, permits, approvals and clearances from U.S. and foreign regulatory authorities and to operate in compliance with applicable regulations. There can be no assurance that we have obtained, will obtain or will remain in compliance with, applicable FDA and other U.S. and foreign material regulatory requirements. If the FDA or other U.S. or foreign regulatory authority determines that we were not in compliance with applicable law or regulations, it could institute proceedings to detain or seize our products, issue a recall, impose operating restrictions, enjoin future violations and assess civil and criminal penalties against us, our officers or our employees and could recommend criminal prosecution. Any such consequences could have a material adverse effect on our business, financial condition or results of operations.
Orthofix International N.V.
We are subject to product liability claims that may not be covered by insurance and could require us to pay substantial sums.
We are subject to an inherent risk of, and adverse publicity associated with, product liability and other liability claims, whether or not such claims are valid. We maintain product liability insurance coverage in amounts and scope that we believe is adequate. There can be no assurance, however, that product liability or other claims will not exceed our insurance coverage limits or that such insurance will continue to be available on commercially acceptable terms, or at all. A successful product liability claim that exceeds our insurance coverage limits could require us to pay substantial sums and could have a material adverse effect on us.
New developments by others could make our products or technologies non-competitive or obsolete.
The orthopedic 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.
Recent approval and introduction of Bone Morphogenic Proteins (BMPs) by Medtronic Sofamor Danek Group have begun to show some market acceptance as a substitute for autograft bone in spinal fusion surgeries. Our Spinal-Stim product is FDA-approved for both failed fusions and healing enhancement as an adjunct to spinal fusion surgery, most typically for multilevel or high-risk patients. In 2002, Medtronic Sofamor Danek Group conducted clinical studies with BMPs. Participation of physicians in the clinical studies had an adverse impact on our stimulation product sales growth in the second half of 2002. Although product sales growth returned to historic product growth rates in 2003, as physicians participate in further clinical studies with BMPs, it could have a further adverse impact on stimulation product sales. Although BMPs are considered or classified as a bone growth material, they have yet to be clinically proven to be effective in high-risk patients.
Our 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.
Orthofix International N.V.
Termination of our existing relationships with our independent distributors could have an adverse effect on our business.
We sell our products in many countries through independent distributors. Each distributor has the exclusive right to sell our products in its territory and is generally prohibited from selling any products that compete with ours. The terms of our distribution agreements vary in length from one to ten years. Under the terms of our distribution agreements, each party has the right to terminate in the event of a material breach and we generally have the right to terminate if the distributor does not meet agreed sales targets or fails to make payment on time. Any termination of our existing relationships with independent distributors could have an adverse effect on our business unless and until alternative distribution arrangements are put in place.
We face risks related to foreign currency exchange rates.
Because some of our revenue, operating expenses, assets and liabilities are denominated in foreign currencies, we are subject to foreign exchange risks that could adversely affect our operations and reported results. To the extent that we incur expenses or earn revenue in currencies other than the U.S. dollar, any change in the values of those foreign currencies relative to the U.S. dollar could cause our profits to decrease or our products to be less competitive against those of our competitors. To the extent that our foreign currency and receivables denominated in foreign currency are greater or less than our liabilities denominated in foreign currency, we have foreign exchange exposure. We have substantial activities outside of the United States that are subject to the impact of foreign exchange rates. The impact of foreign exchange rates on sales outside of the United States was to increase net sales by $7.6 million in International for 2003, primarily as the result of a stronger Euro and U.K. Sterling against the U.S. dollar, and to decrease net sales by $0.5 million in the Americas for 2003, primarily as a result of a weaker Mexican Peso against the U.S. dollar. Although we seek to manage our foreign currency exposure by matching non-dollar revenues and expenses, exchange rate fluctuations could have a material adverse effect on our results of operations in the future.
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 would 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 Incorporation and the corporate law of the Netherlands Antilles (CCNA) (Articles 100-144). Although some of the provisions of the CCNA resemble some of the provisions of the corporation laws of a number of states in the United States, principles of law relating to such matters as the validity of corporate procedures, the fiduciary duties of management and the rights of our shareholders may differ from those that would apply if Orthofix were incorporated in a jurisdiction within the United States. For example, there is no statutory right of appraisal under Netherlands Antilles corporate law nor is there a right for shareholders of a Netherlands Antilles corporation to sue a corporation derivatively. In addition, we have been advised by Netherlands Antilles counsel that it is unlikely that (1) the courts of the Netherlands Antilles would enforce judgments entered by U.S. courts predicated upon the civil liability provisions of the U.S. federal securities laws and (2) actions can be brought in the Netherlands Antilles in relation to liabilities predicated upon the U.S. federal securities laws.
Orthofix International N.V.
Our business is subject to economic, political and other risks associated with international sales and operations.
Since we sell our products in many different countries, our business is subject to risks associated with doing business internationally. Net sales outside the United States represented 35% of our total net sales in 2003. 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 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.
Our subsidiary Colgate Medical Limited's senior secured bank credit facility contains significant financial and operating restrictions and mandatory prepayments that may have an adverse effect on our operations and limit our ability to grow our business.
When we acquired Breg on December 30, 2003, one of our wholly owned subsidiaries, Colgate Medical Limited, entered into a new senior secured bank credit facility with a syndicate of financial institutions to finance the transaction. Orthofix and each of Colgate's direct and indirect subsidiaries, including Orthofix Inc. and Breg, have guaranteed the obligations of Colgate under the senior secured bank facility. The senior secured bank facility provides for (1) a five-year amortizing term loan facility of $110.0 million and (2) a five-year revolving credit facility of $15.0 million, upon which we had not drawn as of March 12, 2004.
Further, in addition to scheduled debt repayments, our new senior secured bank facility requires us to make mandatory prepayments with (a) the excess cash flow (as defined in the credit agreement) of Colgate and its subsidiaries in an amount initially equal to 75% of the excess annual cash flow of Colgate and its subsidiaries, reducing to 50% upon the attainment of a leverage ratio of less than or equal to 1.50 to 1.00 or less, (b) the net cash proceeds of any debt issuance by Colgate and its subsidiaries or any equity issuance by us or Colgate or any of its subsidiaries, (c) the net cash proceeds of asset dispositions over a minimum threshold or (d) unless reinvested, insurance proceeds or condemnation awards. These mandatory prepayments could limit our ability to grow our business.
The credit agreement contains customary negative covenants applicable to Colgate and its subsidiaries, including restrictions on indebtedness, liens, dividends and mergers and sales of assets. The credit agreement also contains certain financial covenants, including a fixed charge coverage ratio, an interest coverage ratio and a leverage ratio applicable to Colgate and its subsidiaries on a consolidated basis, and a leverage ratio applicable to Orthofix and its subsidiaries on a consolidated basis. A breach of any of these covenants could result in an event of default under the credit agreement, which could permit acceleration of the debt payments under the facility. See Item 7 - "Liquidity and Capital Resources."
Orthofix International N.V.
We may not be able to successfully integrate Breg's operations into our business and may not achieve the anticipated benefits of the acquisition.
We are in the process of integrating into our company the operations of Breg. The integration of Breg's operations into our business involves numerous risks, including:
o difficulties in incorporating Breg's product lines, sales personnel and marketing operations into our business;
o the diversion of our resources and our management's attention from other business concerns;
o the loss of key distributors; and
o the loss of key employees.
Our failure to integrate and manage Breg's business successfully could adversely affect our business and financial performance. In addition, if Breg's operations and financial results do not meet our expectations, we may not realize the synergies, operating efficiencies, market position, or revenue growth we anticipate from the acquisition.
Item 2.
Item 2. Properties - -------------------
The Company's principal facilities are:
Orthofix International N.V.
Over the last twelve months, Breg has shifted several labor-intensive manufacturing operations from its Vista, California plant to its Mexicali, Mexico facility. We expect that the transition of Breg's manufacturing operations to Mexico will be completed by the end of 2004. Approximately 21,888 square feet of manufacturing space that is no longer being utilized at the Vista, California plant has been listed for sublease.
In 2004, we expect to consolidate our U.K. facilities in Henley, Guildford, and Maidenhead into a single facility. We believe this will bring greater efficiency and future cost savings to our U.K. and International operations.
Item 3.
Item 3. Legal Proceedings - --------------------------
Except as described below, there are no material pending legal proceedings to which the Company is a party or of which any of its property is subject.
Earnout and Bonus Litigation
On December 4, 1998, the special committee, or the Review Committee, established to determine the amount of any contingent contract rights under the Merger Agreement, dated May 8, 1995, between Orthofix International and American Medical Electronics (AME) in settlement of all claims of the holders of record of AME common stock and the options and warrants to acquire such stock as of August 21, 1995, unanimously determined that Orthofix International would pay to the AME record holders an earnout of $500,000 plus interest and 12% of the net recovery received from the resolution in 2000 of a litigation against Biomet, Inc. and Electro Biology, Inc., up to a maximum of $5,500,000, plus interest. The Review Committee has not calculated the amount of the capped figure, but Orthofix International believes it is between $5,000,000 and $5,500,000. An arbitrator acting under the auspices of the American Arbitration Association, or AAA, subsequently entered a consent award based on the Review Committee's determination.
On January 29, 1999, two couples who owned shares of AME common stock commenced a civil action in Colorado federal court against Orthofix Inc. and the members of the Review Committee seeking, among other relief, the maximum earnout and bonus under the Merger Agreement of $18 million plus interest. The plaintiffs also seek to represent all AME record holders. Clarence Frere, Louise Frere, Joseph Mooibroek and Marla B. Mooibroek, individually and on behalf of all others similarly situated v. Orthofix Inc., Arthur Schwalm, Robert Gaines-Cooper, James Gero, and John and Jane Does One (1) Through Four (4), No. 99-S-445 (D. Colo.). In a related action, commenced on June 2, 1999, the same plaintiffs filed a motion in the United States District Court for the Southern District of New York seeking to intervene in the AAA arbitration and vacate the consent award. Clarence Frere, Louise Frere, Joseph Mooibroek, and Marla B. Mooibroek, individually and on behalf of all others similarly situated v. Orthofix Inc., Arthur Schwalm, Robert Gaines-Cooper, James Gero, and John and Jane Does One (1) Through Four (4), No. 99 Civ. 4049 (S.D.N.Y.). The two actions have been consolidated in the New York federal court and Orthofix International has been added as a party.
The New York federal court resolved the two consolidated actions in favor of the Company and its subsidiary. On July 12, 2002, the New York federal court denied the plaintiffs' motion to vacate the consent award. On May 21, 2003, the court denied plaintiffs' motion for leave to file a second amended complaint and dismissed the Earnout and Bonus action in its entirety with prejudice. Plaintiffs filed an appeal to the United States Court of Appeals for the Second Circuit. The appeal is fully briefed and was submitted in March 2004.
We are vigorously defending the trial court's decision in favor of the Company and its subsidiary. We expect the appeal to be heard and decided in the first half of 2004. We have previously reserved approximately $5.2 million plus accrued interest for the settlement of this matter.
Orthofix International N.V.
KCI Litigation
Novamedix, a subsidiary of the Company, filed an action in federal court in the Western District of Texas on February 21, 1992 against Kinetic Concepts Inc (KCI) alleging infringement of the patents relating to Novamedix's A-V Impulse System product, breach of contract, and unfair competition. In this action, Novamedix is seeking a permanent injunction enjoining further infringement by KCI. Novamedix also seeks damages relating to past infringement, breach of contract, and unfair competition. KCI has filed counterclaims alleging that Novamedix engaged in inequitable conduct before the United States Patent and Trademark Office and fraud as to KCI and that Novamedix engaged in common law and statutory unfair competition against KCI. KCI seeks a declaratory judgment that the patents are invalid, unenforceable, and not infringed. KCI also seeks monetary damages, injunctive relief, costs, attorney's fees, and other unspecified relief. During 2002, the United States Patent and Trademark Office issued re-examination certificates validating four U.S. vascular patents owned by us. The U.S. District Court in San Antonio, Texas has restored the litigation to active status, and has provided a Scheduling Order that will govern this matter. KCI has sought to add a charge of infringement against Novamedix under a recently issued KCI patent but that request was denied on a procedural basis. KCI retains the right to seek enforcement of its patent in a separate proceeding. A portion of any amounts received will be payable to former owners of Novamedix under the original purchase agreement. In 2003, discovery was largely completed and several motions are now pending before the Court on liability and damage issues.
Item 4.
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 2003.
Orthofix International N.V.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters - ------------------------------------------------------------------------------
Market for Our Common Stock
Our common stock is traded on the Nasdaq National Market under the symbol "OFIX." The following table shows the quarterly range of high and low sales prices for our common stock as reported by Nasdaq for each of the two most recent fiscal years ended December 31, 2003. As of March 5, 2004 we had approximately 240 holders of record of our common stock.
High Low 2002 ------ ------ First Quarter $41.49 $32.80 Second Quarter 41.67 33.00 Third Quarter 35.97 24.68 Fourth Quarter 29.37 23.50
First Quarter 30.64 23.69 Second Quarter 34.42 25.68 Third Quarter 37.54 31.81 Fourth Quarter 51.05 36.10
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 2003 that were not registered under the Securities Act.
On May 28, 2003, we issued 132 shares of our common stock to one of our warrant holders upon the exercise of 132 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.
In connection with our acquisition of Breg on December 30, 2003, we issued an aggregate of 731,715 shares of our common stock to certain former shareholders of Breg at a price of $38.00 per share.
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.
Orthofix International N.V.
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 Incorporation impose no limitations on the right of nonresident or foreign owners 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.
Orthofix International N.V.
Item 6.
Item 6. Selected Financial Data - --------------------------------
The following selected consolidated financial data for the years ended December 31, 2003, 2002, 2001, 2000 and 1999 have been derived from our audited consolidated financial statements. The financial data as of December 31, 2003 and 2002 and for the years ended December 31, 2003, 2002 and 2001 should be read in conjunction with Item 7
Item 7. Management's Discussion and Analysis of Financial Condition and Results - -------------------------------------------------------------------------------- of Operations -------------
The following discussion and analysis addresses the results of our operations which are based upon the consolidated financial statements included herein, which have been prepared in accordance with accounting principles generally accepted in the United States. This discussion should be read in conjunction with "Forward-Looking Statements" and the Company's consolidated financial statements and notes thereto appearing elsewhere in this Form 10-K. This discussion and analysis also addresses our liquidity and financial condition and other matters.
General
We are a diversified orthopedic products company offering a broad line of minimally invasive surgical, as well as non-surgical, products for the Spine, Reconstruction and Trauma Market Sectors. Our products are designed to address the lifelong bone-and-joint health needs of patients of all ages, helping them achieve a more active and mobile lifestyle. We design, develop, manufacture, market and distribute medical equipment used principally by musculoskeletal medical specialists for orthopedic applications. Our main products are external and internal fixation devices used in fracture treatment, limb lengthening and bone reconstruction, non-invasive stimulation products used to enhance the success rate of spinal fusions and to treat non-union fractures, and bracing products used for ligament injury prevention, pain management and protection of surgical repair to promote faster healing. Our products also include a device for enhancing venous circulation, cold therapy, other pain management products, bone cement and devices for removal of the bone cement used to fix artificial implants, a bone substitute compound and airway management products.
We have administrative and training facilities in the United States, the United Kingdom and Italy and manufacturing facilities in the United States, the United Kingdom, Italy, Mexico and the Seychelles. We directly distribute our products in the United States, the United Kingdom, Ireland, Italy, Germany, Switzerland, Austria, France, Belgium, Mexico and Brazil. In several of these and other markets, we also distribute our products through independent distributors.
Our consolidated financial statements include the financial results of the Company and its wholly owned and majority owned subsidiaries and entities over which we have control. All intercompany accounts and transactions are eliminated in consolidation. The equity method of accounting is used when we have significant influence over significant operating decisions but do not hold control. Under the equity method, original investments are recorded at cost and adjusted by our share of undistributed earnings or losses of these companies. All material intercompany transactions and profits associated with the equity investees are eliminated in consolidation.
Our reporting currency is the United States dollar. All balance sheet accounts, except shareholders' equity, are translated at year-end exchange rates, and revenue and expense items are translated at weighted average rates of exchange prevailing during the year. Gains and losses resulting from foreign currency transactions are included in other income (expense). Gains and losses resulting from the translation of foreign currency financial statements are recorded in the accumulated other comprehensive income (loss) component of the shareholders' equity.
Our financial condition, results of operations and cash flows are not significantly impacted by seasonality trends. In addition, we do not believe our operations will be significantly affected by inflation. However, in the ordinary course of business, we are exposed to the impact of changes in interest rates and foreign currency fluctuations. Our objective is to limit the impact of such movements on earnings and cash flows. In order to achieve this objective, we seek to balance non-dollar income and expenditures. We do not ordinarily use derivative instruments to hedge foreign exchange exposure. See Item 7A
Item 7A. Quantitative and Qualitative Disclosures About Market Risk - --------------------------------------------------------------------
In the ordinary course of business, we are exposed to foreign currency fluctuations and to the impact of changes in interest rates. These fluctuations can vary sales, cost of goods, and costs of operations, the cost of financing and yields on cash and short-term investments. Our foreign currency exposure results from fluctuating currency exchange rates, primarily the U.S. dollar against the Euro, U.K. 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 U.K. 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 local 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. Historically, we have not used financial derivatives to hedge against fluctuations in currency exchange rates. Based on our overall exposure for foreign currency at December 31, 2003, a hypothetical 10% change in foreign currency rates would impact the company's balance sheet approximately $3.5 million, net sales approximately $7.1 million and net income and cash flows approximately $0.8 million over a one-year period.
Our cash and cash equivalent balances and interest sensitive debt at December 31, 2003 were $33.6 million and $110.2 million. Based on such balances, a 1% movement in interest rates would have a $0.3 million and $1.1 million effect on interest receivable and interest payable per year, respectively.
Item 8.
Item 8. Financial Statements and Supplementary Data - ----------------------------------------------------
See "Index to Consolidated Financial Statements" on page of this Form 10-K.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and - ------------------------------------------------------------------------ Financial Disclosure --------------------
None.
Item 9A.
Item 9A. Controls and Procedures - ---------------------------------
As of December 31, 2003, 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 2003 that have materially affected, or are reasonably likely to materially affect, our company's internal control over financial reporting.
Orthofix International N.V.
Part III
Certain information required by Item 10
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 - ---- --- -------- Robert Gaines-Cooper 66 Chairman of the Board of Directors Edgar Wallner 67 Deputy Chairman and Director Charles W. Federico 55 Chief Executive Officer, President and Director Thomas Hein 56 Chief Financial Officer Peter Clarke 62 Executive Vice President and Director Gary D. Henley 55 Senior Vice President and President, Americas Division Galvin Mould 58 Vice President and President, International Division Bradley R. Mason 49 Vice President and President, Breg, Inc. Peter J. Hewett 68 Director Jerry C. Benjamin (2) 63 Director James F. Gero (1) 59 Director Frederik K. J. Hartsuiker (2) 63 Director John W. Littlechild (1) 52 Director Alberto C d'Abreu de Paulo (2) 65 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.
Robert Gaines-Cooper. Mr. Gaines-Cooper became Chairman of Orthofix International N.V. in 1989 and has been a Director of Orthofix International since our formation in 1987. He is Managing Director of Chelle Medical Ltd-Seychelles. Mr. Gaines-Cooper is also Chairman of LMA International S.A., Jersey, Channel Islands.
Edgar Wallner. Mr. Wallner became a Director and President and Chief Executive Officer of Orthofix International N.V. in October 1987. Mr. Wallner resigned as President and Chief Executive Officer on January 1, 2001, succeeding Mr. Hewett as Deputy Chairman on that date. From 1978 until 1987, Mr. Wallner was Vice President of European Operations for EBI, now a subsidiary of Biomet. From 1973 until 1978, he was Vice President of Marketing for Hydron Europe Inc., a soft contact lens manufacturer. Prior to 1973, Mr. Wallner spent 15 years with The Boots Company Ltd., a multinational pharmaceutical company.
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 succeeded Mr. Wallner as President and Chief Executive Officer of Orthofix International. 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.
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 V.P. 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.
Peter Clarke. Mr. Clarke became a Director and Executive Vice President and Secretary of Orthofix International N.V. in March 1992 and was the Chief Financial Officer of Orthofix International N.V. from January 1988 to June 30, 2002, at which time he was succeeded by Mr. Hein in that position. From 1985 to 1987, he was Financial Controller of EBI Medical Systems Ltd., a United Kingdom subsidiary of EBI.
Gary D. Henley. Mr. Henley joined Orthofix International N.V. in January 1997 as Senior Vice President. On January 1, 2002, Mr. Henley succeeded Mr. Federico as President of Orthofix Inc. Prior to joining Orthofix, Mr. Henley was President of Smith and Nephew Video Division from 1987 until 1996. Mr. Henley was founder and President of Electronic Systems Inc. from 1975 to 1984 and CeCorp Inc. from 1984 until 1987.
Galvin Mould. Mr. Mould became Vice President and President of the International Division of Orthofix International N.V. on January 1, 2004. He is also a Director of Intavent Ltd., Novamedix, Orthosonics Ltd., Orthofix AG and Oped AG, which are subsidiaries or investments of Orthofix International N.V. He joined Orthofix in 1995 as Managing Director of Intavent Orthofix Ltd. Prior to joining Orthofix, Mr. Mould served in several Director of Sales and Marketing Positions in the healthcare market.
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 six other principal shareholders. Mr. Mason has over 20 years 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.
Peter J. Hewett. Mr. Hewett was the Deputy Group Chairman of Orthofix International N.V. between March 1998 and December 2000. He is Chairman of the Board of Orthofix Inc. He has been a non-executive Director of Orthofix International N.V. since March 1992. 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.
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.
James F. Gero. Mr. Gero became a non-executive Director of Orthofix International N.V. in February 1998. Mr. Gero became a Director of AME in 1990 and served subsequently as a Director of Orthofix Inc. He is the Chairman and Chief Executive Officer of each of Sierra Technologies Inc. and Sierra Networks Inc. and a Director of each of LBP, Inc., Intrusion, Inc. and Drew Industries Inc., and Chairman of Thayer Aerospace.
Frederik K. J. Hartsuiker. Mr. Hartsuiker became a non-executive Director of Orthofix International N.V. in March 1992 and has been a Director of Orthofix International B.V. since 1987. Mr. Hartsuiker is a Director of New Amsterdam Cititrust B.V. in The Netherlands.
John W. Littlechild. Mr. Littlechild became a non-executive Director of Orthofix International N.V. in 1987. He has served as a General Partner of each of HealthCare Ventures' funds, a U.S. venture capital fund, since 1991. From 1985 to 1991, he was a Senior Vice President of Advent International Corporation. Mr. Littlechild is a Director of NitroMed, Inc. and Dyax, Inc. as well as other privately held HealthCare portfolio companies.
Orthofix International N.V.
Alberto C d'Abreu de Paulo. Mr. d'Abreu de Paulo became a non-executive Director of Orthofix International N.V. in March 1992 and has been associated with Orthofix since its formation in 1987 as the President and Managing Director of First Independent Trust (Curacao) N.V., a director of Orthofix until February 28, 1992. Mr. d'Abreu de Paulo is a tax attorney in private practice and a member of the Audit Court of the Netherlands Antilles.
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, Hartsuiker and d'Abreu de Paulo currently serve as members of the Audit Committee. Under the current SEC rules and the rules of the Nasdaq, all of the members are independent. Our Board of Directors has determined that Mr. Benjamin is an "audit committee financial expert" in accordance with current SEC rules. Mr. Benjamin is also independent, as that term is used in Item 7(d)(3)(iv) of Schedule 14A under the Securities Exchange Act of 1934, as amended.
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 filed as Exhibit 14.1 to this Form 10-K.
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 by reference in this Item 10 by reference.
Orthofix International N.V.
Item 11.
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.
Item 12. Security Ownership of Certain Beneficial Owners and Management and - ---------------------------------------------------------------------------- Related Stockholders --------------------
We will provide information that is responsive to this Item 12 regarding ownership of our securities by certain beneficial owners and our directors and executive officers, as well as information with respect to our equity compensation plans, in our definitive proxy statement or in an amendment to this annual report not later than 120 days after the end of the fiscal year covered by this annual report, in either case under the captions "Security Ownership of Certain Beneficial Owners and Management and Related Stockholders" and "Equity Compensation Plan Information," and possibly elsewhere therein. That information is incorporated in this Item 12 by reference.
Item 13.
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.
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.
Orthofix International N.V.
Part IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K - -------------------------------------------------------------------------
(a) Documents filed as part of report on Form 10-K
The following documents are filed as part of this report on Form 10-K:
1. Financial Statements
See "Index to Consolidated Financial Statements" on page of this Form 10-K.
2. Financial Statement Schedules
See "Index to Consolidated Financial Statements" on page 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 for the fiscal year ended December 31, 2000 and incorporated herein by reference).
3.2 Articles of Incorporation of the Company (filed as an exhibit to the Company's annual report on Form 20-F for the fiscal year ended December 31, 2000 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). (1)
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). (1)
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). (1)
10.4 Orthofix International N.V. Executive 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). (1)
10.5* Form of Performance Accelerated Stock Option Inducement Agreement. (1)
10.6 Employment Agreement, dated as of July 1, 2001, between Orthofix International N.V. and Charles W. Federico (filed as an exhibit to the Company's annual report on Form 10-K for the fiscal year ended December 31, 2002 and incorporated herein by reference). (1)
10.7 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). (1)
10.8 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). (1)
Orthofix International N.V.
10.9 Employment Agreement, dated as of July 1, 1999, between Orthofix International N.V. and Robert Gaines-Cooper (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). (1)
10.10 Employment Agreement, dated as of July 1, 1999, between Orthofix International N.V. and Edgar Wallner (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). (1)
10.11* Employment Agreement, dated as of November 20, 2003, between Orthofix International N.V. and Bradley R. Mason. (1)
10.12 Full Recourse Promissory Note between Orthofix International N.V. and Charles W. Federico dated January 10, 2002 (filed as an exhibit to the Company's annual report on Form 10-K for the fiscal year ended December 31, 2002 and incorporated herein by reference).
10.13 Full Recourse Promissory Note between Orthofix International N.V. and Gary D. Henley dated January 10, 2002 (filed as an exhibit to the Company's annual report on Form 10-K for the fiscal year ended December 31, 2002 and incorporated herein by reference).
10.14 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 on Form 10-Q for the quarter ended June 30, 2003 and incorporated herein by reference).
10.15 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).
10.16 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).
10.17 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).
14.1* Code of Ethics of the Company.
21.1* Subsidiaries of the Company.
23.1* Consent of Ernst & Young, independent auditors.
23.2* Consent of PricewaterhouseCoopers, independent accountants.
31.1* Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2* Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32.1* Section 1350 Certification of Chief Executive Officer.
32.2* Section 1350 Certification of Chief Financial Officer. - ---------- * Filed herewith.
(1) Management Contract or Compensatory Plan or Arrangement.
Orthofix International N.V.
(b) Reports on Form 8-K
The following reports on Form 8-K were filed during the fourth quarter of 2003:
On November 26, 2003, we filed a current report on Form 8-K (Date of Report: November 25, 2003) reporting under Item 5 that we had entered into an acquisition agreement with Breg, Inc. and a representative of Breg's shareholders for the acquisition of Breg, and that we had entered into a voting and subscription agreement with certain significant shareholders of Breg.
Orthofix International N.V.
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 12, 2004 By: /s/ Charles W. Federico --------------------------------------- Name: Charles W. Federico Title: Chief Executive Officer and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Name Title Date ---- ----- ---- /s/ CHARLES W. FEDERICO Chief Executive Officer, March 12, 2004 - ------------------------- President and Director Charles W. Federico
/s/ THOMAS HEIN Chief Financial Officer March 12, 2004 - ------------------------- (Principal Accounting Officer) Thomas Hein
/s/ ROBERT GAINES-COOPER Chairman of the Board of March 12, 2004 - ------------------------- Directors Robert Gaines-Cooper
/s/ EDGAR WALLNER Deputy Chairman and Director March 12, 2004 - ------------------------- Edgar Wallner
/s/ PETER CLARKE Executive Vice President and March 12, 2004 - ------------------------- Director Peter Clarke
/s/ JERRY C. BENJAMIN Director March 12, 2004 - ------------------------- Jerry C. Benjamim
/s/ ALBERTO C D'ABREU DE PAULO Director March 12, 2004 - ------------------------------ Alberto C d'Abreu de Paulo
/s/ JAMES F. GERO Director March 12, 2004 - ------------------------- James F. Gero
/s/ FREDERIK K. J. HARTSUIKER Director March 12, 2004 - ------------------------------ Frederik K. J. Hartsuiker
/s/ PETER J. HEWETT Director March 12, 2004 - ------------------------- Peter J. Hewett
/s/ JOHN W. LITTLECHILD Director March 12, 2004 - ------------------------- John W. Littlechild
Orthofix International N.V.
Index to Consolidated Financial Statements Page
Index to Consolidated Financial Statements..................................F-1 Statement of Management's Responsibility for Financial Statements...........F-2 Report of Independent Auditors..............................................F-3 Report of Independent Accountants...........................................F-4 Report of Independent Auditors..............................................F-5 Report of Independent Auditors..............................................F-6 Consolidated Balance Sheets as of December 31, 2003 and 2002................F-7 Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and 2001.......................................................F-8 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2003, 2002 and 2001......................................F-9 Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001......................................................F-10 Notes to the Consolidated Financial Statements.............................F-11 Schedule 2-- Valuation and Qualifying Accounts..............................S-1 Report of Independent Accountants on Financial Statement Schedule...........S-2
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.
Orthofix International N.V.
Statement of Management's Responsibility for Financial Statements
To the Shareholders of Orthofix International N.V.:
Management is responsible for the preparation of the consolidated financial statements and related information that are presented in this report. The consolidated financial statements, which include amounts based on management's estimates and judgments, have been prepared in conformity with accounting principles generally accepted in the United States. Other financial information in the report to shareholders is consistent with that in the consolidated financial statements.
The Company maintains accounting and internal control systems to provide reasonable assurance at reasonable cost that assets are safeguarded against loss from unauthorized use or disposition, and that the financial records are reliable for preparing financial statements and maintaining accountability for assets. These systems are augmented by written policies, an organizational structure providing division of responsibilities and careful selection and training of qualified personnel.
The Company engaged Ernst & Young LLP independent accountants in 2003 and 2002, and engaged PricewaterhouseCoopers (and for two subsidiaries, Ernst & Young) in 2001, to audit and render an opinion on the consolidated financial statements in accordance with auditing standards generally accepted in the United States. These standards include an assessment of the systems of internal controls and test of transactions to the extent considered necessary by them to support their opinion.
The Board of Directors, through its Audit Committee consisting solely of outside directors of the Company, meets periodically with management and our independent accountants to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and financial reporting. Ernst & Young LLP have and PricewaterhouseCoopers had full and free access to the Audit Committee.
Robert Gaines-Cooper Chairman of the Board of Directors
Charles W. Federico President, Chief Executive Officer and Director
Thomas Hein Chief Financial Officer
Orthofix International N.V.
Report of Independent Auditors
The Board of Directors and Shareholders Orthofix International N.V.
We have audited the accompanying consolidated balance sheets of Orthofix International N.V. as of December 31, 2003 and 2002, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the two years in the period ended December 31, 2003. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the 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 consolidated financial position of Orthofix International N.V. at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the two years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States. 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.
As described in Note 7 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, effective January 1, 2002.
/s/ ERNST & YOUNG LLP
Charlotte, North Carolina March 5, 2004
Orthofix International N.V.
Report of Independent Accountants
To the Board of Directors and Shareholders of Orthofix International N.V.:
In our opinion, based on our audit and the report of another auditor, the consolidated statement of operations, of changes in shareholders' equity and of cash flows for the year ended December 31, 2001 present fairly, in all material respects, the results of Orthofix International N.V. and its subsidiaries' (the "Company") operations and cash flows for the year ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audit. We did not audit the financial statements of Novamedix Distribution Limited or Inter Medical Supplies Limited, for the year ended December 31, 2001, both of which are wholly owned subsidiaries, which statements reflect total revenues of $21.2 million for the year ended December 31, 2001. Those statements were audited by another auditor whose report thereon has been furnished to us, and our opinion expressed herein, insofar as it relates to the amounts included for Novamedix Distribution Limited or Inter Medical Supplies Limited is based solely on the report of the other auditor. We conducted our audit of these statements in accordance with auditing standards generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit and the report of the other auditor provide a reasonable basis for the opinion expressed above.
/s/ PRICEWATERHOUSECOOPERS
London, England June 25, 2002
Report of Independent Auditors
To the Board of Directors and Management of Inter Medical Supplies Limited, a subsidiary of Orthofix International N.V.
We have audited the accompanying statements of operations, shareholder's equity and cash flows for the year ended December 31, 2001 of Inter Medical Supplies Limited, a subsidiary of Orthofix International N.V. (not presented separately herein). These financial statements are the responsibility of the Company's Directors. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the 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 the Directors, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Inter Medical Supplies Limited for the year ended December 31, 2001 in conformity with accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG
7 June 2002 Nicosia, Cyprus
Orthofix International N.V.
Report of Independent Auditors
To the Board of Directors and Management of Novamedix Distribution Limited, a subsidiary of Orthofix International N.V.
We have audited the accompanying statements of operations, shareholders' equity and cash flows of Novamedix Distribution Limited, a subsidiary of Orthofix International N.V. for the year ended December 31, 2001 (not presented separately herein). These financial statements are the responsibility of the Company's Directors. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the 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 the Directors, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Novamedix Distribution Limited for the year ended December 31, 2001, in conformity with accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG
7 June 2002 Nicosia, Cyprus
Orthofix International N.V.
Consolidated Balance Sheets as of December 31, 2003 and 2002
The accompanying notes form an integral part of these consolidated financial statements.
Orthofix International N.V.
The accompanying notes form an integral part of these consolidated financial statements.
Orthofix International N.V.
The accompanying notes form an integral part of these consolidated financial statements.
Orthofix International N.V.
The accompanying notes form an integral part of these consolidated financial statements.
Orthofix International N.V. Notes to the consolidated financial statements
Description of business
Orthofix International N.V. and its subsidiaries (the Company) is a multinational corporation principally involved in the design, development, manufacture, marketing and distribution of medical equipment, principally for the orthopedic products market.
1 Accounting policies
(a) Basis of consolidation
The consolidated financial statements include the financial statements of the Company and its wholly owned and majority-owned subsidiaries and entities over which the Company has control. Percents of ownership at December 31, 2003 were as follows (100% owned unless otherwise noted):
Orthofix Inc. (U.S.A.) Breg, Inc. (U.S.A.) Orthofix Holdings Inc. (U.S.A) Orthofix US LLC (U.S.A.) Orthofix S.r.l. (Italy) Novamedix Services Limited (U.K.) Orthosonics Limited (U.K.) Intavent Orthofix Limited (U.K.) Colgate Medical Limited (U.K.) Orthofix Limited (U.K.) Orthofix UK Limited (U.K.) Novamedix Distribution Limited (Cyprus) Inter Medical Supplies Limited (Cyprus) Inter Medical Supplies Limited (Seychelles) Orthofix AG (Switzerland) 70% owned Orthofix GmbH (Germany) 70% owned Orthofix International B.V. (Holland) Orthofix II B.V. (Holland) Orthofix S.A. (France) Orthofix do Brasil (Brazil) 89.5% owned Promeca S.A. de C.V. (Mexico) 61.25% owned
All intercompany accounts and transactions are eliminated in consolidation. The equity method of accounting is used when the Company has significant influence over operating decisions but cannot exercise control. Under the equity method, original investments are recorded at cost and adjusted by the Company's share of undistributed earnings or losses of these companies. All material intercompany transactions and profits associated with the equity investees are eliminated in consolidation.
The results of subsidiaries acquired during the year are included in the consolidated statements of operations from the date of their acquisition.
(b) Foreign currency translation
Foreign currency translation is performed in accordance with SFAS No. 52, "Foreign Currency Translation." All balance sheet accounts, except shareholders' equity, are translated at year end exchange rates and revenue and expense items are translated at weighted average rates of exchange prevailing during the year. Gains and losses resulting from foreign currency transactions are included in other income (expense). Gains and losses
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
resulting from the translation of foreign currency financial statements 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.
(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 expenditure. The Company does not ordinarily use derivative instruments to hedge foreign exchange exposure.
(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 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 is 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 life using a method of amortization that reflects the pattern in which the economic benefit of the intangible assets are consumed.
Goodwill represents the excess of the purchase price over the fair value of the net assets of acquired businesses and was amortized by the straight-line method, in most cases over 15 to 20 years for all acquisitions completed prior to June 30, 2001. Effective July 1, 2001, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets," applicable to business combinations completed after June 30, 2001. Effective January 1, 2002, additional provisions of SFAS No. 142, relating to business combinations completed prior to June 30, 2001 became effective and were adopted. Under the provisions of SFAS No. 142, intangible assets deemed to have indefinite lives and goodwill are not subject to amortization beginning January 1, 2002.
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
The Company reviews long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In general, the Company recognizes an impairment loss when the sum of undiscounted expected future cash flows over the assets' remaining estimated useful life is 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 or for royalties, when the royalty is earned. Revenues for inventory delivered on consignment are recognized as the product is accepted or used by the consignee. Revenues exclude any value added or other local taxes, intercompany sales and trade discounts. Revenues are reduced for estimated returns under the Company's limited guarantee programs. Shipping and handling costs are included in cost of sales.
(h) Research and development costs
Expenditures for research and development are expensed as incurred.
(i) Income taxes
Income taxes have been provided using the liability method in accordance with SFAS No. 109, "Accounting for Income Taxes." Deferred income taxes arise because of differences in the treatment of income and expense items for financial reporting and income tax purposes. Deferred tax assets and liabilities resulting from such differences are recorded based on the enacted tax rates that will be in effect when the differences are expected to reverse.
(j) Concentration of credit risk
The Company performs on-going credit evaluations of its customers and generally does not require collateral. When the Company becomes aware of a customer's inability to meet its obligations, such as in the case of bankruptcy filing or deterioration in the customer's financial condition, the Company records a specific reserve to reduce the related receivable to the amount the Company reasonably believes is collectible. The Company also records reserves for bad debt for all other customers based on a variety of factors including the length of time the receivables are past due, the financial condition of the customer, macroeconomic conditions and historical experience. The Company maintains reserves for potential credit losses and such losses have been within management's expectations.
The Company invests its excess cash in deposits with major banks. The Company has not experienced any losses on its deposits.
(k) Net income per common share
Net income per common share is computed in accordance with SFAS No. 128, "Earnings per Share." Net income per common share - basic is computed using the weighted average number of common shares outstanding during each of the respective years. Net income per common share - diluted is computed using the weighted average number of common and common equivalent shares outstanding during each of the respective years. Common equivalent shares represent the diluted effect of the assumed exercise of outstanding share options (see Note 18 to the Consolidated Financial Statements) and the only differences between basic and diluted shares result solely from the assumed exercise of certain outstanding share options and warrants.
(l) Cash and cash equivalents
The Company considers all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash equivalents.
Orthofix International N.V. 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 receivable sold without recourse are removed from the balance sheet at the time of sale.
(n) Securities and other investments
Marketable equity securities are classified as available-for-sale. Such securities are carried at fair value, with the unrealized gains and losses, net of income taxes, reported as a component of shareholders' equity. Any gains or losses from the sale of these securities are recognized using the specific identification method.
(o) 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.
(p) Reclassifications
Certain prior year amounts have been reclassified to conform to the 2003 presentation.
(q) Acquisition of treasury stock
It is the Company's practice, where appropriate, to buy in its own shares in order to enhance shareholder value. Treasury stock is held at cost until it is retired.
(r) 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" (FASB 148). Under APB 25, no compensation cost has been recognized for stock options issued under these plans.
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
Pro forma information regarding the Company's net income and net income per common share for the years ended December 31, 2003, 2002 and 2001 as required by SFAS 148 has been determined as if the Company had accounted for its employee stock option plans under the fair value method of the statement. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period.
Year ended December 31, ---------------------------------- (In thousands except per share data) 2003 2002 2001 --------- ---------- ----------- Net income As reported $24,730 $25,913 $20,964
Stock based employee compensation cost, net of related tax effects (2,454) (2,492) (2,749) --------- ---------- -----------
Pro forma $22,276 $23,421 $18,215
Net income per common share - basic
As reported $1.76 $1.96 $1.60
Pro forma $1.58 $1.77 $1.39
Net income per common share - diluted
As reported $1.68 $1.76 $1.42
Pro forma $1.52 $1.59 $1.24
The fair value of the options under each plan is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 2003, 2002 and 2001, respectively: dividend yield of 0%, 0% and 0%; expected volatility of 35%, 35% and 40%; risk-free interest rates of 3.5%, 3.5% and 3.5%; and expected lives of 4.50, 4.50 and 4.50 years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. Option valuation models require the input of highly subjective assumptions including the expected price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
(s) Recently issued Accounting Standards
In January 2003, FASB Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities," was issued. The interpretation provides guidance on consolidating variable interest entities and requires the consolidation of any variable interest entities (VIE) in which an enterprise absorbs a majority of the entity's expected losses, receives a majority of the entity's expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. In December 2003, the FASB completed deliberations of proposed modifications to FIN 46 (Revised Interpretations) resulting in multiple effective dates based on the nature as well as the creation date of the VIE. However, the Revised Interpretations must be applied no later than the Company's first quarter of 2004. Based upon the information known to date, the Company does not believe it has any significant VIEs.
(t) Fair Value of Financial Instruments
The carrying amounts reflected in the consolidated balance sheet for cash and cash equivalents, accounts receivable, short-term bank debt and accounts payable approximate fair value due to the short-term maturities of
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
these instruments. The Company's long-term secured debt carries a floating rate of interest and approximates fair value.
(u) Advertising Costs
The Company expenses all advertising costs as incurred.
(v) Other Comprehensive Income
Other comprehensive income includes foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities. As of December 31, 2003 and 2002, foreign currency translation was a gain of $9.4 million and a loss of $2.3 million, respectively. There were no unrealized gains or losses on available-for-sale marketable securities as of December 31, 2003 and a gain of $0.2 million as of December 31, 2002.
2 Acquisitions
On December 30, 2003, the Company purchased 100% of the stock of Breg, Inc. (Breg) for a purchase price of $150 million plus closing adjustments and acquisition costs. The acquisition and related costs were financed with $110 million of senior secured bank debt, cash on hand and the issuance of 731,715 shares of Orthofix common stock. Breg, based in Vista, California, designs, manufactures and distributes orthopedic products for post-operative reconstruction and rehabilitative patient use and sells its products through a network of domestic and international independent distributors.
The acquisition has been accounted for using the purchase method in accordance with Statement of Financial Accounting Standards No. 141 "Business Combinations". The purchase price has been preliminarily allocated to the assets acquired and liabilities assumed based on their estimated fair market value at the date of acquisition.
A preliminary allocation of the purchase price reflects the following:
Working capital, other than cash $11,169 Fixed assets acquired 5,569 Identifiable intangible assets (definite lived) 35,401 Identifiable intangible assets (indefinite lived) 23,900 Deferred tax liability (14,250) Goodwill 94,512 --------------- Preliminary purchase price $156,301 ===============
The purchase price for the acquisition is subject to potential upward or downward adjustments based on the difference between the estimated and final working capital of Breg as defined in the acquisition agreement. An escrow account of $12.0 million has been established to fund the working capital adjustment and other indemnities. Distributions under the escrow agreement are scheduled during 2005. In addition, other items that may affect the final purchase price allocation include revisions to intangible assets based on final appraisals and other information that provides a better estimate of the fair value of the assets acquired and the liabilities assumed.
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, Chairman 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.
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
The summary pro forma condensed unaudited results of operations and earnings per share for the years ended December 31, 2003 and 2002, assuming consummation of the acquisitions during 2003 as of January 1, 2003 and 2002, respectively, are as follows:
In December 2001, the Company purchased an additional 15% equity interest in Orthosonics Limited (OSN) for $190,000, thereby raising the Company's ownership in OSN from 70% to 85%. In December 2002, minority interest holders exercised put options to sell their remaining 15% equity interest in OSN to the Company for approximately $660,000, therefore resulting in a wholly-owned subsidiary. The results of operations for the years ending December 31, 2002 and 2001 have been included on a fully consolidated basis in the Statement of Operations of the Company with a minority interest adjustment until the date OSN was wholly-owned. The impact of the additional equity ownership on the results of operations had the acquisition occurred at the beginning of the periods are immaterial. As a result of these transactions, a minority interest obligation of approximately $203,000 was settled and approximately $647,000 of additional goodwill was recorded. In July, 2003, the Company paid $0.7 million for the earn-up provision, accrued for in 2002, associated with the acquisition of the remaining 15% equity interest.
In December, 2002, the Company acquired an additional 21.5% equity interest in Orthofix do Brasil for $70,000, thereby raising the Company's ownership of Orthofix do Brasil to 89.5% from 68%.
On April 20, 1999, the Company paid $1.9 million to the shareholders in Novamedix Distribution Limited (NDL) for an additional 10% equity interest, following exercise by such shareholders of their put option over such shares, thereby raising the Company's ownership of NDL from 80% to 90%. In December 1999, the Company acquired the remaining 10% equity interest in NDL for $2 million. In April 2002, the Company paid $5.2 million for the earn-up provision associated with the acquisition of NDL.
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
3 Inventories
December 31, -------------------------- (In thousands) 2003 2002 ------------- ------------ Raw materials $6,153 $2,177 Work-in-process 2,453 1,210 Finished goods 13,437 11,668 Field inventory 5,202 5,260 Consignment inventory 7,124 5,910 Less reserve for obsolescence (3,656) (2,754) ------------- ------------ $30,713 $23,471 ============= ============
4 Securities and other investments
In 2003, the Company sold $250,000 of marketable equity securities for $354,000 in cash that were included in the Consolidated Balance Sheet as Securities and other investments at December 31, 2002.
During 2003, Ferrer Freeman & Co., a private equity firm that invests exclusively in health care and health care-related companies, purchased 100% of HealthSouth's interest in OrthoRx, which resulted in it becoming the Company's new partner in the joint venture. On May 6, 2003 and June 16, 2003, the Company invested an additional $350,000 and $1,150,000, respectively, in the OrthoRx joint venture. Ferrer Freeman & Co. matched the Company's investment. The Company is accounting for this investment on the equity method and has reduced its investment to $1.6 million and $1.9 million as of December 31, 2003 and 2002 to reflect its portion of the joint venture's net losses for the years then ended.
In 2003, the Company purchased an equity interest in Innovative Spinal Technologies (IST), a start-up company focused on commercializing spinal products, for $1.5 million. The investment is accounted for under the cost method.
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
5 Property, plant and equipment
December 31, ------------------------- (In thousands) 2003 2002 ------------ ----------- Cost Buildings $4,728 $3,414 Plant and equipment 31,445 23,026 Furniture and fixtures 9,064 7,138 ------------ ----------- 45,237 33,578 Accumulated depreciation (26,068) (19,737) ------------ ----------- $19,169 $13,841 ============ ===========
Depreciation expense for the years ended December 31, 2003, 2002 and 2001 was $5.7 million, $5.1 million and $3.8 million, respectively.
6 Patents and other intangible assets
Amortization expense for intangible assets is estimated to be approximately $5.7 million, $5.8 million, $5.9 million, $5.5 million and $5.3 million for the periods ending December 31, 2004, 2005, 2006, 2007 and 2008, respectively. The Company has $23.9 million of trademarks with indefinite lives as of December 31, 2003. There were no indefinite lived intangible assets at December 31, 2002.
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
7 Goodwill
Under SFAS No. 142, intangible assets deemed to have indefinite lives and goodwill are subject to annual impairment testing using the guidance and criteria described in the standard. This testing requires the comparison of carrying values to fair values, and when appropriate, the carrying value of impaired assets is reduced to fair value. The Company has performed the impairment tests of goodwill and indefinite lived intangible assets and has determined that no impairment exists.
In accordance with SFAS No. 142, the Company discontinued the amortization of goodwill effective January 1, 2002. The nonamortization of goodwill has increased the Company's net income and earnings per share beginning in 2002. The following are unaudited pro forma results assuming goodwill had not been amortized prior to January 1, 2002:
The changes in the net carrying values of goodwill for the years ended December 31, 2003 and 2002 are as follows:
December 31, ------------------------- (In thousands) 2003 2002 ------------ ----------- Beginning balance $58,781 $56,707 Acquisitions 103,935 601 Earnouts 19 850 Foreign currency effects 5,662 623 ------------ ----------- $168,397 $58,781 ============ ===========
For a discussion of acquisitions since January 1, 2002 and the associated goodwill, see Note 2 to the Consolidated Financial Statements.
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
Total goodwill acquired and earnouts by segment in 2003 and 2002 was as follows:
(In thousands) 2003 2002 ------------ ----------- Americas $ - $ 70 Breg 94,512 - International 9,442 1,381 ------------ ----------- $103,954 $1,451 ============ ===========
8 Bank borrowings
December 31, ------------ ----------- (In thousands) 2003 2002 ------------ ----------- Borrowings under line of credit $72 $6,977 ============ ===========
The weighted average interest rate on the line of credit as of December 31, 2003 and 2002 was 4.00% and 4.06%, respectively.
Borrowings under lines of credit consist of borrowings in Euros. The Company had unused available lines of credit of $10.6 million and $13.8 million at December 31, 2003 and 2002, respectively. The terms of these lines of credit give the Company the option to borrow amounts in Italy at rates which are determined at the time of borrowing. The lines of credit are unsecured.
9 Other current liabilities
December 31, ------------ ----------- (In thousands) 2003 2002 ------------ ----------- Accrued expenses $12,001 $7,031 Salaries and related taxes payable 11,259 4,367 Other payables 1,794 3,533 Provision for AME bonus and earnout (Note 15) 5,182 5,182 ------------ ----------- $30,236 $20,113 ============ ===========
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
10 Long-term debt
December 31, ------------ ----------- (In thousands) 2003 2002 ------------ -----------
Long-term obligations $110,000 $336 Other loans 135 107 ------------ ----------- 110,135 443 Less current portion (11,063) (399) ------------ ----------- $99,072 $44 ============ ===========
Long-term obligations include a senior secured term note for $110.0 million. Concurrently with the closing of the Breg acquisition, Colgate Medical Limited (Colgate or the Borrower), a wholly owned subsidiary of the Company, entered into the senior secured bank facility. The senior secured bank facility provides for (1) a five-year amortizing term loan of $110.0 million, which has a scheduled maturity of December 30, 2008, 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, which was not drawn on as of December 31, 2003. This obligation has a floating interest rate of LIBOR or prime rate plus a margin that is adjusted quarterly based on the Borrower's leverage ratio. The interest rate as of December 31, 2003 was 3.91%. 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 bank facility and Colgate's subsidiaries under their guarantees are secured by the pledge 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.
In addition to the scheduled debt repayments, the senior secured bank facility requires mandatory prepayments with (a) the excess cash flow (as defined in the credit agreement) of Colgate and its subsidiaries in an amount initially equal to 75% of the excess annual cash flow of Colgate and its subsidiaries, reducing to 50% upon the attainment of a leverage ratio of less than or equal to 1.50 to 1.00, (b) the net cash proceeds of any debt issuance by Colgate and its subsidiaries or any equity issuance by the Company or Colgate or any of its subsidiaries, (c) the net cash proceeds of asset dispositions over a minimum threshold or (d) unless reinvested, insurance proceeds or condemnation awards.
The credit agreement contains customary negative covenants applicable to Colgate and its subsidiaries, including restrictions on indebtedness, liens, dividends and mergers and sales of assets. The credit agreement also contains certain financial covenants, including a fixed charge coverage ratio, an interest coverage ratio and a leverage ratio applicable to Colgate and its subsidiaries on a consolidated basis, and a leverage ratio applicable to the Company and its subsidiaries on a consolidated basis.
The weighted average interest rate on long-term obligations as of December 31, 2003 and 2002 was 3.92% and 7.93%, respectively.
The aggregate maturities of long-term debt after December 31, 2003 are as follows: 2004 - $11.1 million, 2005 - $11.1 million, 2006 - $11.0 million, 2007 - $11.0 million and 2008 - $66.0 million.
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
11 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, 2003, 2002 and 2001 were approximately $2.6 million, $2.3 million and $2.5 million, respectively. Future minimum lease payments under operating leases as of December 31, 2003 are as follows:
(In thousands)
2004 $3,134 2005 2,903 2006 1,714 2007 1,139 2008 962 Thereafter 1,458 -------------- Total $11,310 ==============
Other
In connection with the incorporation of Orthofix AG, the Company has been granted an option to purchase a further 15% of the shares of that company by the minority shareholders. The latter have been granted an option to request the Company to purchase the remaining 15% of the shares. Both options are exercisable between five and ten years after the incorporation of Orthofix AG, November 2000. The purchase consideration is based on a multiple of the net income of Orthofix AG in the twelve month period preceding the exercise date.
In December 2002, the Company acquired the rights to a minimally invasive method of fracture stabilization and fixation for the hip. The Company paid $1 million for the worldwide rights to market this product for four years. In addition, the Company will pay a royalty of up to $5 million based on future sales. The Company at its option has the right to acquire all of the patents pertaining to the devices for $5 million. The royalty fee paid by the Company during the four year licensing period will be applied against the purchase price of the patents. Royalties for the year ended December 31, 2003 were approximately $0.2 million and are included in cost of sales.
12 Business segment information
The Company designs, manufactures, markets and distributes medical equipment used principally by musculoskeletal medical specialists for orthopedic applications.
During the three years ended December 31, 2003, the Company's operations were managed as two geographic business units (the Americas and International) plus Group activities. The Americas geographic business unit includes the United States, Mexico and Brazil. International consists of the rest of the world plus export distribution operations. Effective December 30, 2003, the Company acquired Breg. Due to the timing of the acquisition, Breg had no impact on the Company's statement of operations for the year ended December 31, 2003; however, its identifiable and long-lived assets are presented in the segment information below as of December 31, 2003.
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
Net sales, operating income, and identifiable assets as of and for the three years ended December 31, 2003 for the Company and its subsidiaries are as follows:
Capital expenditures for each segment are as follows:
(In thousands) 2003 2002 2001 -------- --------- ---------
International $2,316 $3,492 $2,863
Americas 2,914 3,631 3,902
Group activities 8 7 4 -------- --------- --------- $5,238 $7,130 $6,769 ======== ========= ==========
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
Geographical information
Analysis of net sales by geographic destination:
(In thousands) 2003 2002 2001 ---------- ---------- ---------- U.S. $132,858 $117,991 $110,345
Other 4,995 4,920 2,689 ---------- ---------- ---------- Americas 137,853 122,911 113,034
U.K. 25,162 22,099 19,053
Italy 16,447 12,601 11,041
Other 24,245 19,984 19,232 ---------- ---------- ---------- International 65,854 54,684 49,326 ---------- ---------- ---------- $203,707 $177,595 $162,360 ========== ========== ==========
There are no sales in the Netherlands Antilles.
Analysis of long-lived assets by geographic area:
(In thousands) 2003 2002 ---------- ---------- U.S. $200,626 $39,936
Italy 12,122 10,529
U.K. 24,866 12,202
Cyprus 10,619 10,373
Others 10,834 8,549 ---------- ---------- $259,067 $81,589 ========== ==========
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
13 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) 2003 2002 2001 -------- -------- -------- Italy - Current $1,948 $2,097 $1,085
- Deferred (371) (51) (211)
Cyprus - Current 224 516 (133)
- Deferred 16 28 56
U.K. - Current 2,670 1,518 1,342
- Deferred 37 17 404
U.S. - Current 9,471 7,651 5,097
- Deferred 333 1,319 165
Netherlands Antilles
- Current 12 5 145
Other - Current (212) (4) (83)
- Deferred 457 (221) - -------- -------- -------- Total tax expense $14,585 $12,875 $7,867 ======== ======== ========
Income from continuing operations before provision for income taxes consisted of:
Year ended December 31, ---------------------------------- (In thousands) 2003 2002 2001 -------- -------- -------- U.S. $26,624 $24,781 $11,689
Non U.S. 12,691 15,749 18,978 -------- -------- -------- $39,315 $40,530 $30,667 -------- -------- --------
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
The tax effects of the significant temporary differences, which comprise the deferred tax liabilities and assets, are as follows:
(In thousands) 2003 2002 ---------- ---------- Deferred tax liabilities
Goodwill $(845) $(570)
Patents and other intangible assets (13,605) (375)
Property, Plant and Equipment (170) (95)
Other (2,022) (1,162) ---------- ---------- (16,642) (2,202)
Deferred tax assets
Accrued compensation $193 $128
Inventories and related reserves 1,461 1,146
Allowance for doubtful accounts 2,324 1,997
Net operating loss carryforwards 609 80
Deferred royalties 939 939
Other - (162) ---------- ---------- 5,526 4,128
Valuation Allowance (529) - ---------- ---------- 4,997 4,128 ---------- ---------- Net deferred tax asset (liability) $(11,645) $1,926 ========== ==========
During 2003, the Company generated net taxable losses in locations where it was more likely than not that those losses will not be utilized, and accordingly, a valuation allowance was established. Additionally, in connection with the Breg acquisition, the Company recorded a $14.3 million deferred tax liability related to the preliminary purchase price allocation.
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
Year ended December 31, ------------------------------- (In thousands) 2003 2002 2001 -------- ------- --------- Statutory tax (tax rate presented is for 2003 only):
Italy (40.25%) $1,788 $2,050 $2,905
Cyprus (4.25%) 248 441 495
Seychelles (40%) 806 2,460 776
U.K. (30%) 2,584 930 1,556
U.S. (38.5%) 9,318 9,588 4,500
Netherlands Antilles 25 - -
Other (357) (654) 75 -------- -------- --------- 14,412 14,815 10,307 -------- -------- --------- Tax benefit on DMO transaction - - (1,955)
Goodwill - - 672
Change in valuation allowance 529 - (389)
Tax holiday benefit - Seychelles (806) (2,460) (776)
Other differences 450 520 8 -------- -------- --------- Income tax expense $14,585 $12,875 $7,867 ======== ======== =========
A portion of the other differences relates to income tax charged during the year on inter-group stock profits arising from the sale of inventories from one subsidiary to another and which have not been sold to third parties at year end. For the twelve months ended December 31, 2003, 2002 and 2001, this amounted to $369,000, $894,000 and $556,000, respectively.
In 2001, the effective tax rate benefited from the deduction in Italy of an intra-group dividend subsequent to the purchase of the remaining 30% minority interest in DMO. The resulting basis differential is not taxable in the future and therefore no deferred tax has been established for the difference between the book and tax basis of the net assets in DMO.
The Company has not recorded additional income taxes applicable to undistributed earnings of foreign subsidiaries that are considered to be indefinitely reinvested. Such earnings, which amounted to approximately $156.0 million, $124.1 million and $94.4 at December 31, 2003, 2002 and 2001, 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.
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
14 Related Parties
The following related party balances and transactions as of and for the three years ended December 31, 2003, 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 two board members have a beneficial minority interest.
Year ended December 31, ----------------------------------- (In thousands) 2003 2002 2001 ---------- --------- -------- Sales $1,706 $1,275 $1,264
Purchases $15,916 $18,038 $12,126
Accounts payable $1,929 $2,075 $1,455
Accounts receivable $403 $239 $233
Due from officers (included in other assets) $342 $330 -
15 Contingencies
Litigation
The Company, in the normal course of its business, is involved in various lawsuits from time to time. In addition, the Company is subject to certain other contingencies discussed below:
On December 4, 1998, the special committee, or the Review Committee, established to determine the amount of any contingent contract rights under the Merger Agreement, dated May 8, 1995, between Orthofix International and American Medical Electronics, or AME, in settlement of all claims of the holders of record of AME common stock and the options and warrants to acquire such stock as of August 21, 1995, unanimously determined that Orthofix International would pay to the AME record holders an earnout of $500,000 plus interest and 12% of the net recovery received from the resolution in 2000 of a litigation against Biomet, Inc. and Electro Biology, Inc., up to a maximum of $5.0 million plus interest. The Review Committee has not calculated the amount of the capped figure, but Orthofix International believes it is between $5.0 million and $5.5 million. An arbitrator acting under the auspices of the American Arbitration Association, or AAA, subsequently entered a consent award based on the Review Committee's determination.
On January 29, 1999, two couples who owned shares of AME common stock commenced a civil action in Colorado federal court against Orthofix Inc. and the members of the Review Committee seeking, among other relief, the maximum earnout and bonus under the Merger Agreement of $18 million plus interest. The plaintiffs also seek to represent all AME record holders. Clarence Frere, Louise Frere, Joseph Mooibroek and Marla B. Mooibroek, individually and on behalf of all others similarly situated v. Orthofix Inc., Arthur Schwalm, Robert Gaines-Cooper, James Gero, and John and Jane Does One (1) Through Four (4), No. 99-S-445 (D. Colo.). In a related action, commenced on June 2, 1999, the same plaintiffs filed a motion in the United States District Court for the Southern District of New York seeking to intervene in the AAA arbitration and vacate the consent award. Clarence Frere, Louise Frere, Joseph Mooibroek, and Marla B. Mooibroek, individually and on behalf of all others similarly situated v. Orthofix Inc., Arthur Schwalm, Robert Gaines-Cooper, James Gero, and John and Jane Does One (1) Through Four (4), No. 99 Civ. 4049 (S.D.N.Y.). The two actions have been consolidated in the New York federal court and Orthofix International has been added as a party.
The New York federal court resolved the two consolidated actions in favor of the Company and its subsidiary. On July 12, 2002, the New York federal court denied the plaintiffs' motion to vacate the consent award. On May 21, 2003, the court denied plaintiffs' motion for leave to file a second amended complaint and dismissed
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
the Earnout and Bonus action in its entirety with prejudice. Plaintiffs filed an appeal to the United States Court of Appeals for the Second Circuit.
The Company is vigorously defending the trial court's decision in favor of the Company and its subsidiary. The Company expects the appeal to be heard and decided in the first half of 2004. The Company has previously reserved approximately $5.2 million plus accrued interest for the settlement of this matter.
Novamedix, a subsidiary of the Company, filed an action on February 21, 1992 against Kinetic Concepts Inc (KCI) alleging infringement of the patents relating to Novamedix's A-V Impulse System product, breach of contract, and unfair competition. In this action, Novamedix is seeking a permanent injunction enjoining further infringement by KCI. Novamedix also seeks damages relating to past infringement, breach of contract, and unfair competition. KCI has filed counterclaims alleging that Novamedix engaged in inequitable conduct before the United States Patent and Trademark Office and fraud as to KCI and that Novamedix engaged in common law and statutory unfair competition against KCI. KCI seeks a declaratory judgment that the patents are invalid, unenforceable, and not infringed. KCI also seeks monetary damages, injunctive relief, costs, attorney's fees, and other unspecified relief. During 2002, the United States Patent and Trademark Office issued re-examination certificates validating four U.S. vascular patents owned by us. The U.S. District Court in San Antonio, Texas has restored the litigation to active status, and has provided a Scheduling Order that will govern this matter. KCI has sought to add a charge of infringement against Novamedix under a recently issued KCI patent but that request was denied on a procedural basis. KCI retains the right to seek enforcement of its patent in a separate proceeding. A portion of any amounts received will be payable to former owners of Novamedix under the original purchase agreement. In 2003, discovery was largely completed and several motions are now pending before the Court on liability and damage issues.
The Company is not currently involved in any other legal proceeding, individually or in the aggregate, that will have a material effect on the financial position, liquidity or operating results of the Company.
Concentrations of credit risk
Financial instruments which potentially subject the Company to concentrations of credit risk are primarily cash investments and accounts receivable. Cash investments are primarily in money market funds deposited with major financial center banks. Concentrations of credit risk with respect to accounts receivable are limited due to the large number of individuals comprising the Company's customer base. Certain of these customers rely on third party healthcare payers, such as private insurance companies and governments, to make payments to the Company on their behalf. Accounts receivable in countries where the government funds medical spending are primarily located in North Africa, Middle East, South America, Asia and Europe. The Company has considered special situations when establishing allowances for potentially uncollectible accounts receivable in such countries as Argentina, Egypt, and Turkey. The Company maintains an allowance for losses based on the expected collectability of all accounts receivable.
The Company sells via a direct sales force and distributors. The Company's distributor of the A-V Impulse System in North America, Kendall Healthcare Inc., accounted for 10% of net sales in 2003 and 2002, respectively, and 11% of net sales in 2001.
16 Retirement plans and deferred compensation
Orthofix Inc. sponsors a defined contribution benefit plan (the 401(k) Plan) covering substantially all full time employees. The 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, 2003, 2002 and 2001, expenses incurred relating to the 401(k) Plan, including matching contributions, were approximately $708,000, $763,000 and $696,000, respectively.
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
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 2003, 2002 and 2001 were approximately $487,000, $415,000 and $335,000, 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 2003, 2002 and 2001 was approximately $227,000, $200,000 and $163,000, respectively. Deferred compensation payments of $233,000, $120,000 and $211,000 were made in 2003, 2002 and 2001, respectively. The year-end balance represents the amount which would be payable if all the employees and agents had terminated employment at that date.
17 Share option plans and warrants
Option Plans
At December 31, 2003, the Company had four stock-based compensation plans which are described below.
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 may grant options to its employees for up to 2,239,700 shares of common stock 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.
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, 2003, 50,000 stock options were exercised and 50,000 were forfeited in conjunction with a termination. As of December 31, 2003, 900,000 options remain outstanding under the option agreements of which 540,000 are exercisable. Further, January 1, 2004 is the fifth anniversary of the grant date. Subsequent to the year end date, all options under these option agreements are exercisable.
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
AME 1983 and 1990 Plans
Under the terms of the Merger Agreement in which the Company acquired AME, all options for AME common stock still outstanding under the 1983 Plan and the 1990 Plan (hereinafter collectively referred to as the AME Plan) were assumed at the effective time of the Merger by the Company and are exercisable for common shares in accordance with their terms and after adjustment to reflect the exchange ratio. After such adjustment immediately following the Merger, options granted under the AME Plan totaled 624,794, of which 3,422 remained outstanding at December 31, 2003 and expire throughout 2004.
Executive Share Option Plan
Under the Executive Share Option Plan (Executive Plan), approved by shareholders in March 1992, 1,945,000 shares have been reserved for issuance to certain executive officers. The grant price, determined by the Company's Board of Directors, cannot be less than the fair market value at the time of grant or $14.40, the equivalent of 120% of the price in the initial public offering price of $12.00. Fifty percent of options granted vest automatically on the tenth anniversary of the date of grant, or earlier on the satisfaction of a performance keyed to the market price of the common shares and a service condition. The remaining fifty percent vest in 20% increments on the first through fifth anniversaries of the date of grant. Options granted under the Executive Plan expire no later than June 2004.
Performance Accelerated Stock Option Inducement Agreements
On December 30, 2003, the Company granted inducement stock option awards to two key executives of Breg, Inc, in conjunction with the acquisition of Breg, Inc. The exercise price was fixed at $38.00 per share on November 20, 2003, when the Company announced it had entered into an agreement to acquire Breg, Inc. The inducement grants include both service-based and performance-based vesting provisions. Under the service-based provisions, subject to the continued employment of the executive, the inducement grants become 100% non-forfeitable and exercisable on the fourth anniversary of the grant date. Vesting of a portion of the options under the inducement agreement will be accelerated, if certain stock price targets are achieved. The performance-based vesting provisions generally provide for the vesting of one-fifth of the inducement grants for each $5.00 increase in the price of the Company's common stock above $40.00 per share. The total number of shares eligible for the accelerated vesting on an annual basis is limited to 25% of the number of shares subject to the inducement grants with a cumulative carryover for the unvested portion of shares eligible for accelerated vesting for each of the prior years. Prior to the expiration of the term of the options, only one-half of the vested options can be exercised in any one year. As of December 31, 2003, 200,000 options remain outstanding under the inducement grants, none of which were exercisable.
Warrants
Kinesis Warrants
At the time of the acquisition of Kinesis Medical Inc.'s assets, warrants to purchase 672,685 shares of Kinesis common stock (the Kinesis warrants) were outstanding. These were assumed by the Company pursuant to the Asset Purchase Agreement. After adjustment to take into account the agreed exchange ratio, 27,400 common stock warrants were outstanding. At December 31, 2003, warrants to purchase 25,819 shares of the Company's common stock remain outstanding, all of which are exercisable and expire on August 31, 2005. The exercise prices are fixed, and range from $19.125 to $38.25 per common share.
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
Summaries of the status of the Company's stock option and warrant plans as of December 31, 2003, 2002 and 2001 and changes during the years ended on those dates are presented below:
At December 31, 2003, the Company has reserved a total of $2.1 million shares of common stock for issuance to eligible participants under the option plans (2,025,683) and to warrant holders (25,819).
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
18 Earnings Per Share
For each of the three years in the period ended December 31, 2003, there were no adjustments to net income for purpose 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, ----------------------------------------- 2003 2002 2001 -------------- ------------- ------------ Weighted average common shares-basic 14,061,447 13,196,524 13,086,467 Effect of diluted securities: Stock options 620,436 1,488,712 1,651,100 -------------- ------------- ------------ Weighted average common share-diluted 14,681,883 14,685,236 14,737,567 ============== ============= ============
We did not include in the diluted shares outstanding calculation 206,000 options in 2003, 59,000 options in 2002 and 53,144 options in 2001 because their inclusion would be anti-dilutive or their exercise price exceeded the average market price of our common stock during the respective periods.
19 Subsequent events
On February 16, 2004, the Company acquired 100% of the common stock of a Puerto Rican distribution company, Implantes Y Sistemas Medicos, Inc. (ISMI), for approximately $1.4 million in cash. ISMI distributes Orthofix and other third party products.
Orthofix International N.V. Notes to the consolidated financial statements (cont.)
20 Quarterly financial data (unaudited)
(In thousands, except per share data)
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.
Orthofix International N.V.
Schedule 2 -- Valuations and Qualifying Accounts
For the years ended December 31, 2003, 2002 and 2001:
(US Dollars, in thousands)
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Orthofix International N.V.
Schedule 2 -- Valuations and Qualifying Accounts
To the Board of Directors of Orthofix International N.V.:
Our audit of the consolidated financial statements referred to in our report dated June 25, 2002, appearing in this Form 10-K also included an audit of the financial statement schedule listed in the index on page of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein for the year ended December 31, 2001, when read in conjunction with the related consolidated financial statements.
/s/ PRICEWATERHOUSECOOPERS
London, England June 25, 2002
S-2