Orthofixed and Transformed?

Orthofix International N.V. has finally lifted the financial veil that fell over the company when its new CEO, Brad Mason, informed his board in 2013 that financial reports dating back to 2011 couldn’t be relied upon.

On March 31, 2015, the company filed their long awaited restated financial statements for fiscal years 2011, 2012 and 2013 and the fiscal quarter ended March 31, 2014. The company also filed 10-Qs for the quarters that ended on June 30, 2014 and September 30, 2014.

Orthofix has endured more perils than Pauline.

Dissident pirate shareholders tried to take over the board after the company acquired Blackstone Medical in 2006. Then, by association, they were dragged into a 2006 Blackstone kickback scandal in Arkansas. That was followed by rogue sales employees in the Northeast who paid providers to use the company’s bone-stim devices, resulting in a major fine and corporate integrity agreement with the U.S. Department of Justice.

CEO Musical Chairs

This all happened while there was a game of musical chairs in the CEO’s office following Charles Federico’s retirement in 2006after a long tenure. In 2013, the board of directors asked Brad Mason to become the third CEO since Federico after bidding farewell to Bob Vaters. Alan Milinazzo, who succeeded Federico, was on the job five years. Vaters less than two years.

Mason knew the company well after having spent seven years at Orthofix managing first BREG, then Spine and finally all of Orthofix Americas. Then he retired, but the challenge to renew the company brought him back.

Mason Reorganizes

Mason moved quickly to reorganize the company into different operating units and brought in a new set of financial experts.

One person who worked with Mason wrote this assessment: “Brad has always had an uncanny ability to place right team members in the right place, support them and then let them do their jobs. He hires people whose jobs will grow into their abilities rather than people whose jobs will outgrow them.”

But the perils weren’t over.

Accounting Weaknesses Discovered

Mason’s new team determined that the company’s previous financial controls didn’t meet generally accepted accounting principles and investors could not rely on financial numbers reported all the way back to 2011. After one attempt at restating numbers, a second restatement had to be initiated.

The restated financials are still a couple of quarters short, but Mason told us during an April 3 interview that the company hopes to be current with financial reports to the Securities and Exchange Commission (SEC) by the end of April.

Mason said that the restatement had nothing to do with the issues of the past that led to their corporate integrity agreement and was instead solely related to technical accounting errors and weaknesses in their accounting controls.

Mason told us that about four months after becoming CEO, the company was closing the second quarter and found some things that “didn’t look quite right.” This led to Mason to ask the board’s audit committee to do an independent investigation. They did and the company started the first restatement in 2013.

The company finished that first restatement at end of the first quarter of 2014. But as they were closing the books for the second quarter of 2014 they saw some technical errors, which were significant enough to trigger the second restatement.

Mason said he believes the root causes of the second restatement issues were weaknesses in the company’s internal control over financial reporting systems, which the company has been working to remediate. He said that if you look at the organization today, it has a new CFO and a substantially new finance support staff, including an outside consulting group that does internal audits. “The team that was there a few years ago has been replaced with a highly experienced and talented team that has fresh eyes on everything.”

Mason: “We’re a Much Different Company”

“Our shareholders rely on the numbers we report. We have to get them right. Orthofix is a much different company today than it was when I came in as the CEO two years ago, ” he added.

For example, over the last 18 months, two-thirds of the board members are new, including Chairman Ron Matricaria, and the Chairman of the Audit Committee, Jim Hinrichs, who most recently was the CFO at CareFusion Corporation. Additionally, said Mason, well over half of the senior management positions have been replaced…“not for wrongdoing, but to drive the execution of the company’s long-term strategy.” Eleven out of 13 of Mason’s senior team members are new in their roles at Orthofix.

Cultural Value

According to Mason, there is a culture at Orthofix today that “will not tolerate even the slightest breach of integrity. Integrity is the number one cultural value and is spoken about every day.” In regard to the corporate integrity agreement with the government, Orthofix is in its third year of the five-year agreement and “everything is going very well.”

Mason is hopeful the company will publish its 2014 full-year numbers sometime in April and at that time be able to discuss openly all topics and results in addition to a look into what the company sees ahead for itself.

Rebuilding Infrastructure and R&D

“What we have said in the past, ” continued Mason, “is that the current key strategies for the company are optimizing its sales channels worldwide, rebuilding its infrastructure and investing more in research and development.”

For example, in the past 18 months each of the company’s business units have been increasing their geographic sales coverage as well as improving sales and field education and training. The company has also developed a company-wide infrastructure process improvement initiative named “Bluecore, ” which has numerous work streams focused around implementing a new ERP [enterprise resource planning] system as well as process and control improvements in finance, order to cash and supply chain.

Betting on PEMF

Mason believes there has been too little investment over the years by the company in expanding some of its core product technologies, particularly in its PEMF (pulsed electromagnetic field therapy) technology, which is used in the company’s bone growth stimulator products. The company is now doing some heavy investing there, as demonstrated by two recently approved IDE’s (investigational device exemption) and a third one expected soon. The company also just announced acquiring an option to purchase eNeura, a company that uses PEMF to treat migraine headache.

While this might not intuitively be in Orthofix’s “wheel house, ” Mason says the company has core competencies in the design and manufacturing of PEMF devices as well as third party reimbursement expertise that could be a significant driver of this business.

By the Numbers

How has the company been performing? Financials have now been published through the third quarter of 2014. Orthofix has always been a good cash flow company, said Mason. “Cash flow is a great indicator of the health of a company and the numbers show that Orthofix is financially in good health and the restatements have not adversely affected our performance to any significant degree.”

The company also has a very strong balance sheet, no debt and lots of cash in the bank while continuing to create new cash every quarter. Additionally, its gross margins are improving and sales and marketing expenses decreasing. G&A (general and administrative) costs are high and Mason expects that to continue as they make the investments necessary to strengthen their infrastructure, processes and controls. Once that is complete, he expects those costs to drop.

Business Performance

The company now has four business units, up from the two that existed when Mason became CEO. He says each has their challenges and opportunities, but all are executing on their strategies and three of the four have very good momentum.

Mason said he split the business units to give both management and the shareholders better visibility into each unit. “When I arrived, it was very difficult to see what was really happening at the business unit level because of the way it was segmented. Some businesses with high margins were concealing the performance of businesses with lower margins. I want each business to stand on its own and be visible. If we have a business that isn’t performing well, I don’t want that to be hidden, I want to fix it, ” said Mason.

An example of this is the Spine Fixation business. The sales have dropped significantly in the last two years as the company intentionally restructured it for long-term profitability and success. According to Mason, he believes he was late in making the necessary changes, but says it is now structured for success going forward on both the top and bottom lines and given time, believes it will be a very good business for Orthofix.

On the other hand, Mason believes the other three business units, BioStim, Biologics and Extremity Fixation, are doing very well and executing the strategies that were developed in 2013.

Successful Transformation?

The story of Orthofix’s transformation is now becoming clearer. Mason says he expects that the actions the company has taken over the last two years will continue to transform the company in the years to come and believes that all of its stakeholders will benefit from these efforts.

Have the Perils of Orthofix ended? Probably not, after all, they are in the spine business. But has Mason pulled the company off the tracks from the rush of the oncoming locomotive? By all appearances the answer is a solid “YES” and we’ll see in the next set of financial reports as well as from a successful completion of the integrity agreement how far he and his team have come these past two years.