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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from____________ to ____________.
Commission File Number: 0-19961
ORTHOFIX INTERNATIONAL N.V.
(Exact name of registrant as specified in its charter)
Netherlands Antilles N/A
- --------------------------------- ----------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
7 Abraham de Veerstraat
Curacao
Netherlands Antilles N/A
- --------------------------------- ----------------------------------------
(Address of principal (Zip Code)
executive offices)
599-9-4658525
--------------------------
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.10 par value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for at least the past 90 days.
Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [ X ] No [ ]
The aggregate market value of registrant's common stock held by non-affiliates,
based upon the closing price of the common stock on the last business day of the
registrant's most recently completed second fiscal quarter, June 28, 2002, as
reported by the Nasdaq National Market, was approximately $230.5 million. Shares
of common stock held by executive officers and directors and persons who own 5%
or more of the outstanding common stock have been excluded since such persons
may be deemed affiliates. This determination of affiliate status is not a
determination for any other purpose.
As of March 25, 2003, 14,068,972 shares of common stock were issued and
outstanding.
Table of Contents
Page
----
PART I........................................................................3
Item 1. Business....................................................3
Item 2. Properties.................................................22
Item 3. Legal Proceedings..........................................23
Item 4. Submission of Matters to a Vote of Security Holders........24
PART II......................................................................25
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters..............................25
Item 6. Selected Financial Data....................................27
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations............28
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk........................................36
Item 8. Financial Statements and Supplementary Data................36
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure......................36
PART III.....................................................................37
Item 10. Directors and Executive Officers of the Registrant.........37
Item 11. Executive Compensation.....................................39
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholders......................39
Item 13. Certain Relationships and Related Transactions.............39
Item 14. Controls and Procedures....................................39
PART IV......................................................................40
Item 15. Exhibits, Financial Statement Schedules and
Reports on Form 8-K......................................40
Forward-Looking Statements
This Form 10-K contains forward-looking statements within the meaning
of Section 21E of the Securities Exchange Act of 1934, relating to our business
and financial outlook, which are based on our current expectations, estimates,
forecasts and projections. In some cases, you can identify forward-looking
statements by terminology such as "may," "will," "should," "expects," "plans,"
"anticipates," "believes," "estimates," "predicts," "potential" or "continue" or
other comparable terminology. These forward-looking statements are not
guarantees of future performance and involve risks, uncertainties, estimates and
assumptions that are difficult to predict. Therefore, actual outcomes and
results may differ materially from those expressed in these forward-looking
statements. You should not place undue reliance on any of these forward-looking
statements. Further, any forward-looking statement speaks only as of the date on
which it is made, and we undertake no obligation to update any such statement to
reflect new information, the occurrence of future events or circumstances or
otherwise.
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for forward-looking statements to encourage companies to provide
prospective information about their companies without fear of litigation. We
would like to take advantage of the "safe harbor" provisions of the Private
Securities Litigation Reform Act in connection with the forward-looking
statements included in this document.
A number of important factors could cause actual results to differ
materially from those indicated by the forward-looking statements, including,
but not limited to, the risks described under Item 1 - "Business - Risk Factors"
in this Form 10-K.
2
PART I
Item 1. Business
In this Form 10-K, the terms "we," "us," "our," "Orthofix" and "our
company" refer to the combined operations of all of Orthofix International N.V.
and its respective consolidated subsidiaries and affiliates, unless the context
requires otherwise. For purposes of this Form 10-K, the subsidiaries of a person
include all entities that such person controls.
OVERVIEW
We 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,
and non-invasive stimulation products used to enhance the success rate of spinal
fusions and to treat non-union fractures. Our products also include devices for
removal of the bone cement used to fix artificial implants, the ultrasonic
treatment of musculoskeletal pain, bracing products and a bone substitute
compound. We also produce a device for enhancing venous circulation.
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 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 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 2002 and Early 2003
On March 4, 2003, we announced that we would complete 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
$20,450,000. IOL distributes Orthofix products, Laryngeal Mask 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) for 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 trusts, which own 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 February 5, 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 $1,500,000 provides Orthofix
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.
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.CP) 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 million for the worldwide rights to market
this product for four years. In addition, we will pay a royalty of up to $5
million based on future sales. We have the right to acquire all patents
pertaining to this
3
System for $5 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.
On October 15, 2002, we announced that the United States Patent and
Trademark Office had issued re-examination certificates validating four U.S.
vascular patents that we own. We filed a motion asking the U.S. District Court
in San Antonio, Texas to proceed expeditiously with our long-pending patent
infringement suit against Kinetic Concepts Inc. and KCI New Technologies Inc. In
February 2003, we received from the court a Scheduling Order that will govern
this matter through September 30, 2003. See Item 3 - "Legal Proceedings."
On February 15, 2002, we announced the selection of Ernst & Young LLP
as our new independent auditors to audit our financial statements for the year
ending December 31, 2002. Ernst & Young replaced PricewaterhouseCoopers, or PwC,
upon PwC's completion of its audit of our financial statements for the year
ended December 31, 2001. See Item 9 - "Changes in and Disagreements with
Accountants on Accounting and Financial Disclosure."
On January 10, 2002, we established a joint venture, OrthoRx Inc.
OrthoRx Inc. provides to patients orthopedic durable medical equipment products
built around physician protocols that specify the treatment and product required
for each patient. OrthoRx Inc. is vendor-neutral, which means that the product
requested by the physician is the exact product given to the patient. OrthoRx
Inc. arranges supply agreements for the products specified by the referring
physicians. See "Joint Venture - OrthoRx."
In 2002, we purchased the remaining 15% interest in Orthosonics Limited
that we did not own. Orthosonics became our wholly-owned subsidiary after the
purchase. See Item 7 - "Management's Discussion and Analysis of Financial
Conditions and Results of Operations - Liquidity and Capital Resources," and
Note 2 to the Consolidated Financial Statements.
Business Strategy
Our business strategy is to offer innovative, cost-effective orthopedic
products that are minimally invasive and that reduce patient suffering and
healthcare costs. We intend to continue to expand applications for our products
by utilizing synergies among our core technologies. We expect to expand our
product offerings through 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 direct operations in the United States, 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,
including orthopedic devices (31%), stimulation products (45%) and vascular
products (12%), accounted for 88% of our total net sales in 2002. Sales of
non-orthopedic products, including some vascular products and the Laryngeal Mask
product, accounted for 12% of our total net sales in 2002.
4
The following table identifies our products by trade names within
product groups and describes their primary applications:
Product Primary Application
Orthopedic Devices
Orthofix external and internal fixation,
including DAF, ProCallus,
XCaliber and nailing systems
Osteogenics BoneSource bone substitute material
OSCAR ultrasonic bone cement removal
Orthotrac pneumatic vest used to reduce
pressure on the spine
EZ Brace rigid external brace for spine
stabilization
STORM and VacoSplint advanced bracing fitted for
fracture and tendon repair
ISKD internal limb-lengthening device
PC.CP percutaneous compression plating
system for hip fracture
Cemex bone cement
SEM Prosthetic Devices prostheses
Stimulation Products
Spinal-Stim PEMF non-invasive spinal fusion
bone growth stimulation
Physio-Stim PEMF non-invasive bone growth
stimulation
Vascular Therapy Products
A-V Impulse System enhancement of venous
circulation
Non-Orthopedic Products
Laryngeal Mask maintenance of airway during
anesthesia
Other several non-orthopedic products
for which various Orthofix
subsidiaries hold distribution
rights
We have proprietary rights over all of the above products with the
exception of the Laryngeal Mask, Cemex, SEM prosthetic devices,
STORM/VacoSplint, ISKD and PC.CP. We have the exclusive distribution rights for
the Laryngeal Mask, Cemex and SEM prosthetic devices in Italy, for the Laryngeal
Mask in the United Kingdom and Ireland, for the STORM/VacoSplint bracing in the
United States and for the ISKD and PC.CP 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), and Physio-Stim(R).
5
Product Sales
The following tables display the net sales by geographic destination
and by geographic origination, net of intercompany eliminations, for each of our
geographic markets and by each of our product groups for the three most recent
fiscal years ended December 31, 2002. We provide net sales by geographic
destination and by product group for information purposes only. We maintain our
books and records by geographic origination.
Geographic Destination:
Year ended December 31,
(In US$ thousands)
2002 2001 2000
--------------------------- --------------------------- ---------------------------
Percent of Percent of Percent of
Net Sales Total Net Sales Net Sales Total Net Sales Net Sales Total Net Sales
---------- ---------------- ---------- ---------------- ---------- ----------------
Americas $122,911 69% $113,034 70% $ 87,374 66%
International 54,684 31% 49,326 30% 44,408 34%
---------- ---------------- ---------- ---------------- ---------- ----------------
Total $177,595 100% $162,360 100% $131,782 100%
---------- ---------------- ---------- ---------------- ---------- ----------------
---------- ---------------- ---------- ---------------- ---------- ----------------
Geographic Origination:
Year ended December 31,
(In US$ thousands)
2002 2001 2000
------------------------------ ---------------------------- -----------------------------------
Percent of Percent of Percent of
Net Sales Total Net Net Sales Total Net Net Sales Total Net
Sales Sales Sales
-------------- -------------- ------------- ------------- --------------- ------------------
Americas $102,850 58% $ 93,995 58% $ 72,025 55%
International 74,745 42% 68,365 42% 59,757 45%
-------------- -------------- ------------- ------------- --------------- ------------------
Total $177,595 100% $162,360 100% $131,782 100%
-------------- -------------- ------------- ------------- --------------- ------------------
-------------- -------------- ------------- ------------- --------------- ------------------
Product Groups:
Year ended December 31,
(In US$ thousands)
2002 2001 2000
------------------------------ ---------------------------- ------------------------------
Percent of Percent of Percent of
Total Net Total Net Total Net
Net Sales Sales Net Sales Sales Net Sales Sales
-------------- -------------- ------------- ------------- --------------- -------------
Orthopedic
Devices $ 54,838 31% $ 49,188 30% $ 41,814 32%
Stimulation 79,828 45% 71,715 44% 57,079 43%
Vascular(1) 21,879 12% 21,052 13% 16,868 13%
-------------- -------------- ------------- ------------- --------------- -------------
Total Orthopedic 156,545 88% 141,955 87% 115,761 88%
Non-Orthopedic
Vascular(1) 3,861 2% 3,715 2% 2,977 2%
Other 17,189 10% 16,690 11% 13,044 10%
-------------- -------------- ------------- ------------- --------------- -------------
Total Non-Orthopedic 21,050 12% 20,405 13% 16,021 12%
-------------- -------------- ------------- ------------- --------------- -------------
Total $177,595 100% $162,360 100% $131,782 100%
-------------- -------------- ------------- ------------- --------------- ----------------
-------------- -------------- ------------- ------------- --------------- ----------------
- -----------------------
(1) Approximately 85% of the revenue from vascular products is classified
as from Orthopedic applications while 15% is classified as from
Non-Orthopedic applications.
6
Additional financial information regarding our geographic markets can
be found in Note 12 to the Consolidated Financial Statements.
Orthopedic Devices
Orthopedic Devices revenues represented 31% of our total net sales in
2002.
The Orthofix
For a fracture to heal properly, without misalignment or rotation, the
bone must be set and fixed in the correct position. The bone must be kept
stable, but not absolutely rigid, in order to alleviate pain, maintain the
correct alignment and initiate the callus formation for proper healing.
Fractures initially should not bear any weight, but, at the appropriate time in
the healing cycle, benefit from gradually increasing micromovement,
weight-bearing and function, which further stimulate the callus.
In most fracture cases, physicians use casting, the simplest available
non-surgical procedure. We believe, however, that approximately 15-20% of all
fractures require surgical intervention. We initially focused on the production
of external fixation devices for management of fractures that require surgery.
External fixation devices are used to stabilize fractures from outside the skin
with minimal invasion into the body. Our fixation devices use crews 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, 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. 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 radiolucent 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.
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;
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;
and
o the Osteoarthritis Surgical Intervention System, or the OASIS, 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.
In addition to the treatment of bone fractures, Orthofix external
fixators 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.
7
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 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.
Osteogenics BoneSource
General. 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. The license covers know-how, two United States patents, applications for
additional patents in the United States and various foreign countries and future
technology developments, whether or not patented, that are hydroxyapatite
cement-related. The license is subject to the rights of the United States
government under law to use the subject matter of the licensed patents for
governmental purposes and to certain rights of ADAHF.
Products. BoneSource received 510(k) clearance from the FDA for repair
of certain cranial defects in July 1997. It has also obtained a CE mark for
certain cranial symptoms and for use as a bone void filler in certain non-weight
bearing orthopedic symptoms. A CE mark is required in order for a product to be
sold or distributed in the European Union. 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 under which
Stryker has the right to develop, manufacture, market, and pursue regulatory
approvals for BoneSource. From the date of the agreements through 2002, we have
supplied BoneSource to Stryker. Beginning in 2003, Stryker will manufacture
BoneSource and pay Orthofix a royalty on sales of the 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.
8
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.
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 employs patented, pneumatic lifts
that decompress lumbar discs and associated soft tissue structures, and can
significantly improve the quality of life for lower back pain sufferers. Since
patients remain mobile and ambulatory during their use of the Orthotrac
pneumatic vest, they are free to participate more actively in daily functional
activities, physical therapy and return-to-work programs or prescribed exercise
routines.
The Orthotrac pneumatic vest is designed for the 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.
STORM and VacoSplint
In 2002, we introduced the STORM and the VacoSplint, two new products
for foot and ankle fractures, to the United States market. The VacoSplint is a
post-injury or post-operative non-weight-bearing splinting device for lower leg
and foot injuries. The STORM (Stabilization Orthosis allowing Range of Motion)
is a cast replacement and functional brace for foot and ankle fractures. Like
traditional devices, the STORM immobilizes the joint. These two products are
enhancements to the Vacoped product we introduced in 2001. Both the STORM and
the VacoSplint are manufactured by OPED GmbH in Germany, a subsidiary of OPED,
AG. We have exclusive distribution rights for these products in the United
States. Orthofix International NV holds a 10% equity interest in privately held
OPED, AG, which it acquired in 2000 for $2.5 million.
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.
PC.CP (Gotfried Percutaneous Compression Plating System)
The Gotfried Percutaneous Compression Plating, or PC.CP, 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.CP System, Orthofix
has 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%
9
of patients regain their pre-operative mobility. In contrast, the PC.CP 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.CP System.
Traditional hip-fracture surgery can require a 5-inch-long incision
down the thigh, but the new PC.CP System involves two smaller incisions, each
less than one inch long. The PC.CP 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.
Other
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.
In addition, the SEM prosthetic devices, produced by SEM S.A., offer
prostheses for the hip, knee and shoulder. We have the exclusive distribution
rights for SEM prosthetic devices in Italy.
Stimulation Products
Stimulation Products revenues represented 45% of our total net sales in
2002.
General
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.
We currently market two stimulation products, Spinal-Stim and
Physio-Stim. Spinal-Stim is designed to enhance the success rate of spinal
fusions and Physio-Stim is designed to treat non-union fractures. These devices
are portable and are intended to be used as part of home treatment programs
prescribed by physicians. The attending medical staff can instruct the patient
regarding operation of the products 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.
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.
Spinal-Stim
Spinal-Stim was the first non-invasive spinal fusion stimulator system
commercially available in the United States. Spinal-Stim is designed for
treatment of the lower thoracic and lumbar regions of the spine. Some spine
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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 106,000 patients have been treated using Spinal-Stim since the product
was introduced in 1990. We received FDA clearance and introduced a new model of
Spinal-Stim in 1997. The device uses proprietary technology to generate a PEMF
signal from a 9-volt battery, thus eliminating the need for rechargeable battery
packs and chargers. 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. We have completed the enrollment in our investigational study to obtain
pre-marketing FDA approval for a cervical spine indication using the PEMF
signal. The study started in the first quarter of 1999 and is expected to
conclude in the second half of 2003. 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.
Physio-Stim
In some fracture 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. Orthofix manufactures its 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 system offers portability, long-term battery operation,
integrated component design, patient monitoring capabilities and ability to
cover a large treatment area without factory calibration for specific patient
application. More than 74,000 patients have been tested 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. In addition to the direct sales of this product by
our sales force, the Physio-Stim Lite is also distributed in the United States
by BREG, Inc. and Royce Medical Company.
Vascular Therapy Products
Vascular Therapy Products revenues represented 14% of our total net
sales in 2002, consisting of 12% from orthopedic applications and 2% from
non-orthopedic applications. That is, within the Vascular Therapy Products
group, approximately 85% of the net sales is classified as from orthopedic
applications while 15% is classified as from non-orthopedic applications.
A-V Impulse System
We manufacture and distribute the A-V Impulse System family 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. 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.
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Other Products
Other Products, excluding non-orthopedic vascular products, represented
10% of our total net sales in 2002.
The 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 Sulzer heart valves in Mexico, 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 activity 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. During 2001,
Orthofix had underway a market evaluation of the business model. On January 10,
2002, we established a joint venture, OrthoRx Inc. The OrthoRx joint venture is
headquartered in Plano, Texas, where the business processes insurance
authorizations, maintains inventory levels, and processes product billing and
collections, which is intended to allow individual OrthoRx service centers to
focus on patient interaction and physician follow-up. The prototype for the
joint venture has been operating in St. Louis, Missouri since January 2000.
Initial plans identified 40 potential markets for these centers. Prior to the
formation of the joint venture, the operations of OrthoRx were included in our
financial statements. In 2001, sales from the OrthoRx business were
approximately $2.0 million. In 2002, the OrthoRx joint venture recorded sales of
$3.1 million. 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, we invested an additional $1.0 million of
cash which raised our ownership stake to 46%.
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.
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 and Andover,
United Kingdom.
In 2002, 2001 and 2000, we spent $7.5 million, $7.0 million and $6.9
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
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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.
On February 5, 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. 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 2002 and received a royalty based on Stryker's
revenues from BoneSource sales. Beginning in 2003, Stryker will manufacture
BoneSource and continue 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.
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
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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 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 and Marketing
General
We believe demographic trends, principally in the form of an aging
population in the major healthcare markets of the United States, Western Europe
and Japan, together with our focus on innovative, minimally invasive products,
will continue to have a positive effect on the demand for our products.
In 2002, the Americas and its principal market, the United States,
accounted for 69% of our total net sales. We distribute all of our stimulation
products and most of our orthopedic products in the United States through a
sales force of approximately 180 representatives made up of direct sales people
and independent distributors. Independent distributors receive a commission per
sale that is substantially similar to the commissions paid to our direct sales
people. In addition, we have non-exclusive distribution agreements for the
Spinal-Stim Lite with Medtronic Sofamor Danek Group and for the Physio-Stim Lite
with BREG, Inc. and 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 10% of
our total net sales in 2002 while sales through Medtronic Sofamor Danek Group
accounted for approximately 7% of total net sales. Sales to all other customers
were broadly distributed.
In 2002, International accounted for 31% of our total net sales with
12% derived from the United Kingdom and 7% derived from Italy. No single
international customer accounted for greater than 2% of our total net sales.
Outside the United States, we have approximately 60 direct sales
representatives who are employed by 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 addition, we have a
sales service group, consisting of seven sales and marketing specialists who
support and regularly visit our independent distributors.
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Up through 1999, we primarily sold orthopedic devices outside the
United States and primarily sold stimulation products in the United States.
However, since 2000 we have been expanding our offerings of orthopedic devices
in the United States and we have begun to market our stimulation products in
Europe. To facilitate distribution of stimulation products in the European
Union, we obtained a CE mark for our stimulation products in December 1998. For
a description of CE marks, please see Item 1 - "Business - Government
Regulation."
In general, we seek to market our products principally to medical
professionals who are the decision makers in their patients' treatment. This
focus is designed to complement our product development and marketing strategy,
which seeks to encourage and maintain interactive relationships with leading
orthopedic, trauma and other surgeons. These relationships have enabled us to
introduce design improvements and create innovative products that meet the needs
of surgeons and patients, thereby expanding the market for our products.
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. We do not
consider backlog of firm orders to be material to an understanding of our
business.
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 together
with us 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,
with publicly funded healthcare systems. The ability of hospitals supported by
such systems to purchase our products is dependent, in part, upon public
budgeting constraints. Because of third-party reimbursement in the United States
and the publicly funded nature of healthcare systems in other countries,
accounts receivable balances and related collection periods as measured by days
sales in receivables outstanding (DSO) for companies that provide healthcare
products are generally longer than those of industrial or commercial companies.
We believe that collection periods for our receivables are comparable with those
of other international healthcare product companies.
We provide demo units and field inventory to our direct sales
representatives and independent distributors for use in their marketing and for
filling customer orders. We also consign inventory to hospitals and
international distributors in several countries. As of December 31, 2002, we had
approximately $5.3 million in field inventory, and approximately $5.9 million in
consigned inventory out of a total inventory of $23.5 million. We also had $2.3
million in demo units that at December 31, 2002 were fully amortized and
classified as other long-term assets.
We are aware of the cost constraints currently affecting healthcare
markets and attempt to provide products which not only improve patient outcomes
but which also meet the demanding cost requirements of hospitals, physicians'
practices and third party payors.
Orthopedic Devices
We seek to expand awareness of the advantages of our products primarily
by providing training and support to orthopedic and trauma surgeons.
We support our sales force and distributors through specialized basic
training workshops in which surgeons and sales specialists participate. We
produce marketing materials, including materials outlining surgical procedures,
for our sales force and distributors in a variety of languages in printed, video
and multimedia formats. To provide additional advanced training for surgeons, we
organize monthly multilingual teaching seminars at our facility in Verona,
Italy. The Verona seminars, which in 2002 were attended by over 650 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.
Additionally, each year many of our sales representatives and distributors
independently conduct basic courses for surgeons in the application of our
products.
15
Stimulation Products
We believe that the success of these products is dependent not only on
the fostering of good relations with the physicians who employ them but also on
being sensitive to the needs and requirements of the hospitals and third party
payors to whom the products are also marketed. Private insurance companies,
workers' compensation carriers, Medicare, self-insured plans, health maintenance
organizations, or HMOs, and various other state, federal and private healthcare
payors are the principal sources of payment for our stimulation products,
although patients usually are responsible for co-payment and deductible amounts.
In addition to providing training to our sales force, we undertake a
number of marketing-related initiatives directed at increasing the focus of our
sales force on third-party payors. As a result of these initiatives, we have
been able to enter into a number of contracts with HMOs and other third-party
payors that establish pricing and reimbursement criteria for use of our
stimulation products. We market to third party payors primarily through our
National Accounts Department. This Department consists of seven account
specialists and one government liaison who solicit third party contracts, assist
in keeping us abreast of changes in the United States healthcare marketplace and
enhance and expand our relationships with third party payors.
We operate limited guarantee programs for Physio-Stim and Spinal-Stim
to heighten awareness of the healing enhancement properties of PEMF technology.
These programs provide, in general, for reimbursement for the full price of the
device if radiographic evidence indicates that healing is not occurring at the
fracture or fusion site when the device is used in accordance with the
prescribed treatment protocol.
Competition
For orthopedic 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, OrthoLogic Corp., 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."
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.
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 and the Seychelles. We believe that our plants
comply in all material respects with the requirements of the FDA and all
relevant regulatory authorities outside the United States. For a description of
the 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.
16
Capital Expenditures
We had capital expenditures in the amount of $5.6 million in 2000, $6.8
million in 2001 and $7.1 million in 2002, principally for computer software and
hardware, patents and plant and equipment, including the leasehold improvements
for a new leased facility in McKinney, Texas in 2001. We currently plan to
invest approximately $3.6 million in the Americas and approximately $3.5 million
in International in 2003, to support the planned expansion of our business. We
expect these capital expenditures to be financed principally with cash generated
from operations.
Employees and Organizational Structure
At December 31, 2002, we had approximately 667 employees worldwide, of
which approximately 436 were employed within the Americas unit and approximately
231 were employed within the International unit. Our relations with our Italian
employees, who numbered 61, 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 667 employees, 381 were employed in
sales and marketing functions, 123 in general and administrative, 105 in
production and 58 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.
17
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 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."
18
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.
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. As
physicians complete their participation in BMP clinical studies, we expect them
to return in 2003 to their historic patterns of prescribing stimulation
products. 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.
19
The industry in which we operate is highly competitive.
The medical devices industry is fragmented and highly competitive. We
compete with a large number of companies, many of which have significantly
greater financial, manufacturing, marketing, distribution and technical
resources than we do. Many of our competitors may be able to develop products
and processes competitive with, or superior to, our own. Furthermore, we may not
be able to successfully develop or introduce new products that are less costly
or offer better performance than those of our competitors, or offer purchasers
of our products payment and other commercial terms as favorable as those offered
by our competitors. For more information regarding our competitors, see Item 1 -
"Business - Competition."
We depend on our senior management team.
Our success depends upon the skill, experience and performance of
members of our senior management team, who have been critical to the management
of our operations and the implementation of our business strategy. We do not
have key man insurance on our senior management team, and the loss of one or
more key executive officers could have a material adverse effect on our
operations and development.
Termination of our existing relationships with our independent distributors
could have an adverse effect on our business.
We sell our products in certain 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 term of our distribution agreements varies 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 or
sales outside of the United States was to increase net sales $1.5 million for
2002 primarily as the result of a stronger Euro and U.K. Sterling 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.
20
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 (Articles 33-115 of the Commercial
Code of the Netherlands Antilles, or CLNA). Although some of the provisions of
the CLNA 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 commercial law nor
is there a right for shareholders of a Netherlands Antilles corporation to sue a
corporation derivatively. In addition, we have been advised by Netherlands
Antilles counsel that it is unlikely that (1) the courts of the Netherlands
Antilles would enforce judgments entered by U.S. courts predicated upon the
civil liability provisions of the U.S. federal securities laws and (2) actions
can be brought in the Netherlands Antilles in relation to liabilities predicated
upon the U.S. federal securities laws.
Our business is subject to economic, political and other risks associated with
international sales and operations.
Since we sell our products in many different countries, our business is
subject to risks associated with doing business internationally. Net sales
outside the United States represented 34% of our total net sales in 2002. 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.
21
Item 2. Properties
The Company's principal facilities are:
Facility Location Square Feet Ownership
- -------- -------- ----------- ---------
Manufacturing, warehousing, distribution and research McKinney, TX 70,000 Leased
and development facility for Stimulation and Bracing
Products and administrative facility for Orthofix Inc.
Research and development, component manufacturing, Verona, Italy 38,000 Owned
quality control and training facility for fixation
products and sales management and administrative
facility for Italy
Research and development, training and technology Winston-Salem, NC 7,600 Leased
facility
Administrative offices for Orthofix International, Huntersville, NC 7,300 Leased
N.V. and Orthofix Inc.
Administrative offices for Orthofix International, Henley, England 1,480 50% Owned
N.V.
Administrative offices for Orthofix Ltd. Guildford, England 8,000 Leased
Sales management for OSCAR product and administrative South Devon, England 2,500 Leased
offices for Orthosonics
Administrative offices for A-V Impulse product Andover, England 9,000 Leased
Sales management, distribution and administrative Maidenhead, England 9,000 Leased
facility for United Kingdom
Sales management, distribution and administrative Mexico City, Mexico 3,444 Leased
facility for Mexico
Sales management, distribution and administrative Sao Paulo, Brazil 1,300 Owned
facility for Brazil
Sales management, distribution and administrative Gentilly, France 3,854 Leased
facility for France
Sales management, distribution and administrative Valley, Germany 3,000 Leased
facility for Germany
Sales management, distribution and administrative Steinhausen, Switzerland 1,180 Leased
facility for Switzerland
Assembly and packaging facility for fixation products Victoria, Mahe, Seychelles 5,597 Leased
22
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.
EBI Litigation
On January 21, 2000, defendants Biomet, Inc. and Electro-Biology, Inc.
paid $64.2 million to satisfy a judgment in favor of Orthofix S.r.l., Inter
Medical Supplies Limited, and Orthofix Inc. for breaching three contracts,
tortiously interfering with an existing contract and prospective contracts,
infringing registered trademarks, defaming those companies and their employees,
and unfairly competing with them in the marketing of Orthofix's external bone
fixator. The $64.2 million payment satisfied the outstanding judgment and
completed the EBI litigation. Net of contingent legal and other costs, Orthofix
received $38.0 million before tax and $29.9 million after tax from the
litigation.
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, 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 EBI litigation (described in the preceding
paragraph), 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.
We are vigorously defending against the two consolidated actions. Thus
far, one of the two actions has been resolved in favor of the Company and a
briefing schedule on pre-answer motions has been set in the other action.
Specifically, in the arbitration review action, the New York federal court on
July 12, 2002 denied the motion to vacate the consent award. In the action
transferred from Colorado to New York, plaintiffs served an amended complaint
and a motion for leave to do so on February 13, 2003. The Company responded on
March 14, 2003. The Company anticipates that the motion will be submitted to the
New York court in the late spring or early summer of 2003 and that the court
will decide the motion in the succeeding months. We have previously set aside
approximately $5.0 million plus accrued interest for settlement of this matter.
KCI Litigation
Novamedix Limited, a wholly owned U.K. subsidiary of Orthofix
International, which markets the A-V Impulse System, filed an action on February
21, 1992 against Kinetic Concepts Inc., or KCI, alleging infringement of United
States Patent Nos. Re 32,939; Re 32,940; 4,696,289; and 4,721,101 (the
"Patents"), breach of contract,
23
and unfair competition. Novamedix Limited v. Kinetic Concepts Inc., United
States District Court for the Western District of Texas, San Antonio Division,
Civil Action No. SA-92-CA-0177. In April, 2000, Novamedix Distribution Limited,
a wholly owned Cyprus subsidiary of Orthofix, was added as a party plaintiff. In
this action, Novamedix Limited and Novamedix Distribution Limited (collectively,
"Novamedix") seeks a permanent injunction enjoining further infringement of the
Patents by KCI. Novamedix also seeks damages relating to past infringement,
breach of contract, and unfair competition. KCI has filed counterclaims alleging
that Novamedix engages in inequitable conduct before the United States Patent
and Trademark Office, fraud as to KCI, and 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.
Office of Inspector General Investigation
On April 17, 2001, we received an administrative request for records
from the Office of the Inspector General of the United States Department of
Health and Human Services. On June 20, 2001, we received a similar
administrative request for records from the Office of the Inspector General of
the United States Department of Defense.
We have cooperated with government representatives throughout the
inquiry. We continue to believe the primary focus of the United States
government's inquiry concerns the appropriateness of claims we submitted to
federal health programs for the off-label use of our FDA-approved pulsed
electronic magnetic field device, and billing and coding for its off-label use.
Our outside counsel have presented to government representatives
several letters describing our coding and billing practices for the off-label
use of our pulsed electronic magnetic field device, and have discussed our
understanding of Medicare, Medicaid and CHAMPUS/TriCare rules with respect to
the off-label use of FDA-approved devices. We do not believe that resolution of
this matter will have a material adverse effect on our financial condition or
cash flows. The resolution, which we expect to occur in 2003, could have a
material adverse effect on our results of operations in the period in which it
occurs.
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 2002.
24
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
- ------------------------------------------------------------------------------
Market for Our Common Stock
Our common stock is traded on the Nasdaq National Market under the
symbol "OFIX." The following table shows the quarterly range of high and low
sales prices for our common stock as reported by Nasdaq for each of the two most
recent fiscal years ended December 31, 2002. As of March 25, 2003 we had
approximately 230 holders of record of our common stock.
High Low
---- ---
2001
----
First Quarter $23.06 $19.13
Second Quarter 27.07 22.13
Third Quarter 30.45 20.50
Fourth Quarter 37.90 26.87
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
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 the
continued growth of our business and 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 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
2002 that were not registered under the Securities Act.
In 2002, we issued 1,449 shares of our common stock upon the exercise
of warrants as described below. These warrants were initially issued by Kinesis
Medical, Inc. and originally entitled the holder of warrants to purchase one
share of Kinesis common stock at an exercise price per share ranging from $1.00
to $2.00. On August 15, 2000, in conjunction with our asset purchase agreement
with Kinesis, each outstanding Kinesis warrant was converted into 0.05261
Orthofix warrants to purchase shares of our common stock at a price per share
ranging from $19.125 to $38.25, subject to adjustment as determined by the
warrant agreement. The shares of our common stock were issued as follows:
o On January 30, 2002 we issued 395 shares of our common stock to
one of our warrant holders upon the exercise of 395 of our
warrants.
o On April 10, 2002 we issued 659 shares of our common stock to one
of our warrant holders upon the exercise of 659 of our warrants.
25
o On July 15, 2002 we issued 395 shares of our common stock to one
of our warrant holders upon the exercise of 395 of our warrants.
These 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 transaction did not
involve a public offering.
Exchange Controls
Although there are Netherlands Antilles laws that may impose foreign
exchange controls on us and that may affect the payment of dividends, interest
or other payments to nonresident holders of our securities, including the shares
of common stock, we have been granted an exemption from such foreign exchange
control regulations by the Central Bank of the Netherlands Antilles. Other
jurisdictions in which we conduct operations may have various currency or
exchange controls. In addition, we are subject to the risk of changes in
political conditions or economic policies that could result in new or additional
currency or exchange controls or other restrictions being imposed on our
operations. As to our securities, Netherlands Antilles law and our Articles of
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.
26
Item 6. Selected Financial Data
- --------------------------------
The following selected consolidated financial data for the years ended
December 31, 2002, 2001, 2000, 1999 and 1998 have been derived from our audited
consolidated financial statements. The financial data for the years ended
December 31, 2002, 2001 and 2000 and at December 31, 2002, 2001 and 2000 should
be read in conjunction with, and are qualified in their entirety by reference
to, Item 7 - "Management's Discussion and Analysis of Financial Condition and
Results of Operation" and our consolidated financial statements and notes
thereto included elsewhere in this Form 10-K. Our consolidated financial
statements have been prepared in accordance with United States generally
accepted accounting principles, or U.S. GAAP.
Year ended December 31,
---------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(In US$ thousands, except margin and per share data)
Consolidated operating results
Net sales......................................... $177,595 $162,360 $131,782 $121,284 $104,065
Gross profit...................................... 132,776 119,408 95,993 87,733 74,572
Gross profit margin............................... 75% 74% 73% 72% 72%
Total operating income(1)......................... 42,939 30,499 22,725 23,216 11,917
Net income(2)..................................... 25,913 20,964 44,816 12,912 14,276
Net income per share of common stock (basic)...... 1.96 1.60 3.40 0.99 1.10
Net income per share of common stock (diluted).... 1.76 1.42 3.20 0.97 1.07
Consolidated financial position As of December 31,
(at year-end)
----------------------------------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(In US$ thousands, except share data)
Total assets ..................................... 220,774 188,914 190,434 136,722 122,400
Total debt........................................ 7,420 5,560 10,818 14,248 9,585
Shareholders' equity.............................. 168,084 138,102 132,988 89,570 78,736
Weighted average number of shares of
common stock outstanding (basic)............... 13,196,524 13,086,467 13,182,789 13,029,834 12,966,830
Weighted average number of shares of
common stock outstanding (diluted)............. 14,685,236 14,737,567 13,986,098 13,364,127 13,291,988
- ---------------
(1) Total operating income for 1998 is after provision for impairment of
long-held assets of $3.3 million.
(2) Net income for 2000 includes $29.9 million of nonrecurring income after tax
related to the EBI litigation. For a description of the EBI litigation, see
Item 3 - "Legal Proceedings."
27
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
---------------------------------------------------------------
The following should be read in conjunction with "Forward-Looking
Statements" and our combined consolidated financial statements and notes thereto
appearing elsewhere in this Form 10-K.
The following table presents certain items in our statements of
operations as a percentage of net sales for the periods indicated:
Year ended December 31,
--------------------------------------------------------------
2002 2001 2000
---- ---- ----
(%) (%) (%)
Net sales........................... 100 100 100
Cost of sales....................... 25 26 27
Gross profit........................ 75 74 73
Operating expenses
Sales and marketing .............. 36 37 36
General and administrative........ 10 11 12
Research and development.......... 4 4 5
Amortization of intangible assets. -- 3 3
Total operating income.............. 24 19 17
Net income(1)....................... 15 13 34
- ---------------------------
(1) Includes $29.9 million of nonrecurring income after tax related to the EBI
litigation in 2000 which represented 23% of net sales in 2000. For a
description of the EBI litigation, please see Item 3 - "Legal Proceedings."
General
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,
and non-invasive stimulation products used to enhance the success rate of spinal
fusions and to treat non-union fractures. Our products also include devices for
removal of the bone cement used to fix artificial implants, the ultrasonic
treatment of musculoskeletal pain, bracing products and a bone substitute
compound. We also produce a device for enhancing venous circulation.
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 and Seychelles. We directly distribute our products in
the United States, the United Kingdom, Ireland, Italy, Germany, Switzerland,
Austria, France, Belgium, Mexico and Brazil. In these and other markets, we also
distribute our products through independent distributors.
Our revenues are generally derived from two primary sources: sales of
orthopedic and non-orthopedic products. Sales of orthopedic products, including
orthopedic devices (31%), stimulation products (45%) and vascular products
(12%), accounted for 88% of our total net sales in 2002. Sales of non-orthopedic
products, including some vascular products and the Laryngeal Mask product,
accounted for 12% of our total net sales in 2002.
We keep our books and records and account for net sales, costs and
expenses in accordance with the geographic origination of our products. The
following table displays net sales by origination, net of intercompany
eliminations, for the three most recent fiscal years ended December 31.
28
Geographic Origination:
Year ended December 31,
(In US$ thousands)
2002 2001 2000
------------------------------ ------------------------------ ---------------------------------
Percent of Percent of Percent of
Net Sales Total Net Sales Net Sales Total Net Sales Net Sales Total Net Sales
---------- ------------------ ----------- ----------------- -------------- -----------------
Americas $102,850 58% $ 93,995 58% $ 72,025 55%
International 74,745 42% $ 68,365 42% $ 59,757 45%
---------- ------------------ ----------- ----------------- -------------- -----------------
Total $177,595 100% $ 162,360 100% $ 131,782 100%
---------- ------------------ ----------- ----------------- -------------- -----------------
---------- ------------------ ----------- ----------------- -------------- -----------------
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 or fluctuations in
interest rates, although current lower interest rates did negatively affect
interest income earned on our cash and cash equivalents balances in 2002. See
Item 7A - "Quantitative and Qualitative Disclosures About Market Risk."
Our 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. All intercompany accounts and transactions
are eliminated in consolidation. The equity method of accounting is used when
the Company has significant influence over significant operating decisions but
does not hold 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 or disposed of during the year are included in
the consolidated statements of operations from the date of their acquisition or
up to the date of their disposal.
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 component of the
shareholders' equity.
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.
Critical Accounting Policies
Our discussion of operating results is based upon the consolidated
financial statements and accompanying notes to the consolidated financial
statements prepared in conformity with accounting principles generally accepted
in the United States. The preparation of these statements necessarily requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amount of revenues and
expenses during the reported period. These estimates and assumptions form the
basis for the carrying values of assets and liabilities. On an ongoing basis, we
evaluate these estimates, including those related to allowance for doubtful
accounts, sales allowances and adjustments, inventories, investments, intangible
assets and goodwill, income taxes, litigation and contingencies. We base our
estimates on historical experience and various other assumptions and believe our
estimates for the carrying values of assets and liabilities are reasonable.
Actual results may differ from these estimates. We have reviewed our critical
accounting policies with the Audit Committee of the Board of Directors.
Revenue Recognition
For bone growth stimulation and bracing products, we recognize revenue
when the product is placed on and accepted by the patient. For sales to
commercial customers, including hospitals and distributors, revenues are
recognized at the time of shipment. We derive a significant amount of our
revenues in the United States from third-
29
party payors, including commercial insurance carriers, health maintenance
organizations, preferred provider organizations and governmental pay