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TRNX > SEC Filings for TRNX > Form 10-Q on 9-Nov-2012All Recent SEC Filings

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Form 10-Q for TORNIER N.V.


9-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of our financial condition and results of operations together with the unaudited consolidated financial statements and the notes thereto included elsewhere in this report, and other financial information included in this report. The following discussion may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties, including those discussed under "Special Note Regarding Forward-Looking Statements" and elsewhere in this report. These risks could cause our actual results to differ materially from any future performance suggested below.

Overview

We are a global medical device company focused on surgeons that treat musculoskeletal injuries and disorders of the shoulder, elbow, wrist, hand, ankle and foot. We refer to these surgeons as extremity specialists. We sell to this extremity specialist customer base a broad line of joint replacement, trauma, sports medicine and biologic products to treat extremity joints. Our motto of "specialists serving specialists" encompasses this focus. In certain international markets, we also offer joint replacement products for the hip and knee. We currently sell over 110 product lines in over 35 countries, including products acquired as a result of our acquisition of OrthoHelix subsequent to September 30, 2012.

We believe we are differentiated by our full portfolio of upper and lower extremity products, our extremity-focused sales organization and our strategic focus on extremities. We further believe that we are well positioned to benefit from the opportunities in the extremity products marketplace as we are among the global leaders in the shoulder and ankle joint replacement markets. We also have expanded our technology base and product offering to include: new joint replacement products based on new designs and materials; improved trauma products based on innovative designs; proprietary biologic materials for soft tissue repair; and the innovative lower extremity products of OrthoHelix, our recent acquisition. In the United States, which is the largest orthopaedic market, we believe that our single, "specialists serving specialists" distribution channel is strategically aligned with what we believe is an ongoing trend in orthopaedics for surgeons to specialize in certain parts of the anatomy or certain types of procedures.

Our principal products are organized in four major categories: upper extremity joints and trauma, lower extremity joints and trauma, sports medicine and biologics, and large joints and other. Our upper extremity joints and trauma products include joint replacement, bone fixation devices for the shoulder, hand, wrist and elbow. Our lower extremity joints and trauma products include joint replacement, bone fixation devices for the foot and ankle and the products from our acquisition of OrthoHelix. Our sports medicine and biologics product category includes products used across several anatomic sites to repair or regenerate soft tissue. Our large joints and other products include hip and knee joint replacement implants and ancillary products.

In the United States, we sell products from our upper extremity joints and trauma, lower extremity joints and trauma, and sports medicine and biologics product categories; we do not actively market large joints in the United States. While we market our products to extremity specialists, our revenue is generated from sales to healthcare institutions and distributors. We sell through a focused sales channel consisting of a network of mostly independent commission-based sales agencies, with some direct sales organizations in certain territories. Internationally, in select markets, we sell our full product portfolio, including upper extremity joints and trauma, lower extremity joints and trauma, sports medicine and biologics and large joints. We utilize several distribution approaches depending on the individual market requirements, including direct sales organizations in the largest European markets and Australia, and independent distributors for most other international markets. In the second quarter of 2012, we opened a direct sales office in Japan and received additional product registrations in China. For the nine months ended September 30, 2012, we generated revenue of $198.5 million, 56% of which was in the United States and 44% of which was international.

We have significantly grown our business during the past several years and have built an extremities focused business that offers a broad range of products to a focused group of specialty surgeons. We believe this strategy has been the primary factor in enabling our revenue growth during such time. During the past several years, we also have increased our operating expenses significantly. We have strategically invested with particular emphasis on product development, acquisition of strategic products and technologies, manufacturing capacity, sales commissions and infrastructure to support both current and anticipated growth.

We have commenced a facilities consolidation initiative pursuant to which we intend to consolidate a number of our facilities in France, Ireland and the United States. The facilities consolidation initiative is driven by our strategy to drive operational productivity and to realize operating costs savings beginning in 2013. Under the initiative, we consolidated our Dunmanway, Ireland manufacturing facility into our Macroom, Ireland manufacturing facility during the second quarter of 2012. We also leased a new facility located in Bloomington, Minnesota to use as our U.S. business headquarters and for the consolidation of our Minneapolis-based marketing, training, regulatory, clinical, supply chain and corporate functions with our Stafford, Texas-based distribution operations, which are expected to be finalized during the fourth quarter of 2012. During the third quarter of 2012, we consolidated our St. Ismier, France manufacturing facility into our existing Montbonnot, France manufacturing facility. We anticipate that, in connection with implementing the facilities consolidation initiative, we will record pre-tax charges of approximately $6 to $7 million,


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comprised of one-time employee termination costs; facility closure, moving and related expenses; fixed asset write-offs net of anticipated proceeds from the sale of facilities in Stafford, Texas and Dunmanway, Ireland; and other miscellaneous related charges. We expect to record substantially all of the charges during 2012. During the nine months ended September 30, 2012, we recorded $5.3 million of expense related to the facilities consolidation initiative.

Recent Developments

On October 4, 2012, we acquired OrthoHelix Surgical Designs, Inc. In the transaction, we paid consideration consisting of $100 million cash and 1,941,270 of our ordinary shares (which was determined to be equal to $35 million divided by the average closing sale price per ordinary share during the five trading days immediately prior to and after the date of our initial public announcement of the merger agreement). In addition, we agreed to make additional earn-out payments in cash of up to an aggregate of $20 million based upon our sales of lower extremity joints and trauma products during fiscal years 2013 and 2014. A portion of the transaction consideration consisting of $11 million cash was deposited with an escrow agent to fund payment obligations with respect to a post-closing working capital adjustment and post-closing indemnification obligations of OrthoHelix's former equity holders. In addition, a portion of the earn-out payments are subject to certain rights of set-off for post-closing indemnification obligations of OrthoHelix's equity holders.

In addition, and as part of the OrthoHelix transaction, on October 4, 2012, we and our U.S. operating subsidiary, Tornier, Inc. (which we refer to as Tornier USA), entered into a credit agreement with Bank of America, N.A., as Administrative Agent, SG Americas Securities, LLC, as Syndication Agent, BMO Capital Markets and JPMorgan Chase Bank, N.A., as Co-Documentation Agents, Merrill Lynch, Pierce, Fenner & Smith Incorporated and SG Americas Securities, LLC, as Joint Lead Arrangers and Joint Bookrunners, and the other lenders party thereto. The credit agreement provides for an aggregate credit commitment to Tornier USA, as borrower, of $145 million, consisting of: (1) a senior secured term loan facility to Tornier USA denominated in dollars in an aggregate principal amount of up to $75 million; (2) a senior secured term loan facility to Tornier USA denominated in euros in an aggregate principal amount of up to the U.S. dollar equivalent of $40 million; and (3) a senior secured revolving credit facility to Tornier USA denominated at the election of Tornier USA, in U.S. dollars, euros, pounds, sterling and yen in an aggregate principal amount of up to the U.S. dollar equivalent of $30 million. Funds available under the revolving credit facility may be used for general corporate purposes. The borrowings under the credit facility were used at the closing of the acquisition of OrthoHelix described above to pay the consideration for such acquisition, and such fees, costs and expenses incurred in connection with the acquisition and the credit agreement and to repay prior existing indebtedness of us and our subsidiaries. The credit agreement contains customary covenants, including financial covenants which require us to maintain minimum interest coverage, annual capital expenditure limits and maximum total net leverage ratios, and customary events of default. The obligations under the credit agreement are guaranteed by us, Tornier USA and certain other of our subsidiaries, and subject to certain exceptions, are secured by a first priority security interest in substantially all of our assets and the assets of certain of our existing and future subsidiaries of Tornier.

Foreign Currency Exchange Rates

A substantial portion of our business is located outside the United States and as a result we generate revenue and incur expenses denominated in currencies other than the U.S. dollar. The majority of our operations denominated in currencies other than the U.S. dollar are denominated in Euros. In both the nine months ended September 30, 2012 and October 2, 2011, approximately 44% of our revenue was denominated in foreign currencies. As a result, our revenue can be significantly impacted by fluctuations in foreign currency exchange rates. We expect that foreign currencies will continue to represent a similarly significant percentage of our revenue in the future. Selling, marketing and administrative costs related to these sales are largely denominated in the same foreign currencies, thereby limiting our foreign currency transaction risk exposure. In addition, we also have significant levels of other selling, general and administrative expenses and research and development expenses denominated in foreign currencies. Historically, our non-U.S. Dollar revenue and expenses have been generally balanced, however, as our business continues to grow, fluctuations in these balances could affect operating results. At that time, we may pursue a derivative program to hedge this risk.

A substantial portion of the products we sell in the United States are manufactured in countries where costs are incurred in Euros. Fluctuations in the Euro to U.S. dollar exchange rate will have an impact on the cost of the products we manufacture in those countries, but we would not likely be able to change our U.S. dollar selling prices of those same products in the United States in response to those cost fluctuations. As a result, fluctuations in the Euro to U.S. dollar exchange rates could have a significant impact on our gross profit in future periods in which that inventory is sold. Fluctuations in the value of foreign currencies relative to the U.S. dollar impact our operating results. Impacts associated with fluctuations in foreign currency exchange rates are discussed in more detail under "Item 3 -Quantitative and Qualitative Disclosures about Market Risk." In countries with functional currencies other than the U.S. dollar, assets and liabilities are translated into U.S. dollars using end-of-period exchange rates; and revenues, expenses and cash flows are translated using average rates of exchange. Constant currency growth rates used in the following discussion of results of operations eliminate the impact of period-over-period foreign currency fluctuations.


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We evaluate our results of operations on both an as reported and a constant currency basis. The constant currency presentation is a non-GAAP financial measure, which excludes the impact of fluctuations in foreign currency exchange rates. We believe providing constant currency information provides valuable supplemental information regarding our results of operations, consistent with how we evaluate our performance. We calculate constant currency percentages by converting our current-period local currency financial results using the prior-period foreign currency exchange rates and comparing these adjusted amounts to our prior-period reported results. This calculation may differ from similarly-titled measures used by others; and, accordingly, the constant currency presentation is not meant to be a substitution for recorded amounts presented in conformity with GAAP nor should such amounts be considered in isolation.


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Results of Operations

The three and nine months ended September 30, 2012 and October 2, 2011 each
consisted of 13 and 39 weeks, respectively. The following table sets forth, for
the periods indicated, our results of operations as a percentage of revenue:



                                                     Three months ended                                    Nine months ended
                                          September 30,               October 2,               September 30,                October 2,
                                               2012                      2011                       2012                       2011
                                                       (in thousands)                                       (in thousands)
Statements of Operations Data:
Revenue                                $  58,015        100 %     $ 57,556        100 %     $ 198,487        100 %     $ 192,149        100 %
Cost of goods sold                        15,730         27 %       16,650         29 %        54,944         28 %        54,708         28 %

Gross profit                              42,285         73 %       40,906         71 %       143,543         72 %       137,441         72 %
Selling, general and administrative       38,524         66 %       37,937         66 %       124,157         62 %       119,895         62 %
Research and development                   5,260          9 %        4,309          7 %        16,329          8 %        14,608          8 %
Amortization of intangible assets          2,730          5 %        2,741          5 %         8,013          4 %         8,448          4 %
Special charges                            6,503         11 %           56          0 %         9,413          5 %           188          0 %

Operating loss                           (10,732 )      (18 )%      (4,137 )       (7 )%      (14,369 )       (7 )%       (5,698 )       (3 )%
Interest income                               70          0 %          145          0 %           304          0 %           415          0 %
Interest expense                            (481 )       (1 )%        (524 )       (1 )%       (1,430 )       (1 )%       (3,761 )       (2 )%
Foreign currency transaction loss           (326 )       (1 )%        (228 )       (0 )%         (195 )       (0 )%          (81 )       (0 )%
Loss on extinguishment of debt                -           *             -           *              -           *         (29,475 )      (15 )%
Other non-operating income (expense)          56          0 %          993          2 %            54          0 %         1,009          1 %

Loss before income taxes                 (11,413 )      (19 )%      (3,751 )       (7 )%      (15,636 )       (8 )%      (37,591 )      (20 )%
Income tax (expense) benefit                (268 )       (0 )%       2,114          4 %        (1,305 )       (1 )%        9,116          5 %

Consolidated net loss                  $ (11,681 )      (20 )%      (1,637 )       (3 )%      (16,941 )       (8 )%      (28,475 )      (15 )%

* Not meaningful

The following tables set forth, for the periods indicated, our revenue by product category and geography expressed as dollar amounts and the changes in revenue between the specified periods expressed as percentages:

                                                    Three months ended                                                        Nine months ended
                                              September 30,        October 2,        Percent          Percent          September 30,        October 2,        Percent          Percent
Revenue by Product Category                       2012                2011            change           change              2012                2011            change           change
                                                     ($ in thousands)                  (as           (constant                ($ in thousands)                  (as           (constant
                                                                                    reported)        currency)                                               reported)        currency)
Upper extremity joints and trauma            $        39,429      $     37,690               5 %              8 %     $       129,434      $    120,640               7 %             10 %
Lower extremity joints and trauma                      5,815             5,943              (2 )              0                19,333            19,023               2                3
Sports medicine and biologics                          3,487             3,329               5                8                11,363            10,769               6                8

Total extremities                                     48,731            46,962               4                7               160,130           150,432               6                9
Large joints and other                                 9,284            10,594             (12 )             (1 )              38,357            41,717              (8 )              0

Total                                        $        58,015      $     57,556               1 %              5 %     $       198,487      $    192,149               3 %              7 %

                              Three months ended                                                   Nine months ended
                        September 30,       October 2,       Percent         Percent         September 30,       October 2,       Percent         Percent
Revenue by Geography        2012               2011           change          change             2012               2011           change          change
                               ($ in thousands)                (as          (constant               ($ in thousands)                (as          (constant
                                                            reported)       currency)                                            reported)       currency)
United States          $        34,377     $     32,781              5 %             5 %    $       110,647     $    104,197              6 %             6 %
International                   23,638           24,775             (5 )             6               87,840           87,952             (0 )             8

Total                  $        58,015     $     57,556              1 %             5 %    $       198,487     $    192,149              3 %             7 %


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Comparison of three months ended September 30, 2012 to three months ended October 2, 2011

Revenue. Revenue increased by 1% to $58.0 million for the third quarter of 2012 from $57.6 million for the third quarter of 2011, as a result of increased sales in our upper extremity joints and trauma category, partially offset by a decrease in sales of large joints and other. Our revenue was negatively impacted by foreign currency exchange rate fluctuations of approximately $2.7 million, principally due to the performance of the U.S. dollar against the Euro. Excluding the impact of foreign currency exchange rate fluctuations, revenue increased by 5% for the third quarter of 2012 from the third quarter of 2011. The most significant increase occurred in our upper extremity joints and trauma category. The growth experienced was due primarily to increased demand and product expansion, partially offset by pricing pressures experienced in certain geographics. Our overall revenue growth of $0.5 million consisted of 5% growth in the United States, partially offset by a revenue decrease of 5% in our international geographies.

Revenue by product category. Revenue in upper extremity joints and trauma increased by 5% to $39.4 million for the third quarter of 2012 from $37.7 million for the third quarter of 2011, primarily as a result of the continued increase in sales of our Aequalis reversed and Aequalis Ascend shoulder products, and to a lesser degree, our Simpliciti shoulder products. We believe that increased sales of our Aequalis reversed shoulder products resulted from continued market growth in shoulder replacement procedures and continued market movement towards reversed shoulder replacement procedures. We also saw an increase in sales of our Aequalis Ascend shoulder products which continued to gain share in the shoulder replacement market. Offsetting this increase was the negative impact of foreign currency exchange rate fluctuations of $1.2 million. Revenue in our lower extremity joints and trauma decreased by 2% to $5.8 million for the third quarter of 2012 from $5.9 million for the third quarter of 2011, primarily due to fluctuations in exchange rates and a decrease in total ankle procedures in certain parts of Europe, partially offset by growth in such procedures in the U.S. Revenue in sports medicine and biologics increased by 5% to $3.5 million for the third quarter of 2012 from $3.3 million for the third quarter of 2011. This increase was attributable to increased sales of our anchor products internationally, partially offset by a decrease in sales of our biologics products. Revenue from large joints and other decreased by 12% to $9.3 million for the third quarter of 2012 from $10.6 million for the third quarter of 2011 related primarily to negative foreign currency exchange rate fluctuations of $1.2 million. Excluding the impact of foreign currency fluctuations, our large joints and other product category decreased by 1% in the third quarter of 2012 compared to the third quarter of 2011 primarily as a result of a decrease in the sales of our knee products due to continued economic pressures in our southern European geographies.

Revenue by geography. Revenue in the United States increased by 5% to $34.4 million for the third quarter of 2012 from $32.8 million for the third quarter of 2011, primarily driven by the continued increase in sales of upper extremities joints and trauma products, partially offset by the negative impact on sales as a result of certain distribution channel changes made during 2012. International revenue decreased by 5% to $23.6 million for the third quarter of 2012 from $24.8 million for the third quarter of 2011 related primarily to negative foreign currency exchange rate fluctuations of $2.7 million. Excluding the impact of foreign currency exchange rate fluctuations, our international revenue increased by 6%. This increase was primarily due to increased revenue in Australia and the establishment of a direct sales office in Belgium, which also serves Luxembourg, through the acquisition of our previous exclusive distributor in these territories, partially offset by a negative impact on sales in certain Western European countries due to austerity measures and lower procedure volumes.

Cost of goods sold. Our cost of goods sold decreased to $15.7 million for the third quarter of 2012 from $16.7 million for the third quarter of 2011. As a percentage of revenue, cost of goods sold decreased from 29% for the third quarter of 2011 to 27% for the third quarter of 2012, primarily due to a lower level of excess and obsolete inventory charges in the third quarter of 2012 and lower internal manufacturing costs. Our cost of goods sold and corresponding gross profit as a percentage of revenue can be expected to fluctuate in future periods depending upon certain factors, including, among others, changes in our product sales mix and prices, distribution channels and geographies, manufacturing yields, plans for insourcing some previously outsourced production activities, inventory reserves required, levels of production volume and fluctuating inventory costs due to changes in foreign currency exchange rates since the period they were manufactured.

Selling, general and administrative. Our selling, general and administrative expenses increased by 2% to $38.5 million for the third quarter of 2012 from $37.9 million for the third quarter of 2011. As a percentage of revenue, selling, general and administrative expenses were 66% for both the three months ended September 30, 2012 and the three months ended October 2, 2011. Our variable selling costs as a percentage of revenue were slightly higher during the third quarter of 2012 when compared to the third quarter of 2011. The increase in total selling, general and administrative expense was primarily a result of additional variable sales expenses and non-variable sales expenses including strategic investments in our US sales organization, training and education, expansion into Japan and conversion to a direct distribution channel in Belgium. Partially offsetting this increase is a decrease in share based compensation, legal fees and expenses related to certain management incentives. Also affecting selling, general and administrative expenses was the favorable impact of foreign currency exchange rate fluctuations of $2.4 million.


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Research and development. Research and development expenses increased by 22% to $5.3 million for the third quarter of 2012 from $4.3 million for the third quarter of 2011. As a percentage of revenue, research and development expenses grew 2% to 9% for the three months ended September 30, 2012 from 7% for the three months ended October 2, 2011. The increase in total research and development expense was primarily due to increased clinical study related expenses, an increased level of expenses on certain shoulder and biologic related product development projects and increased personnel related expenses. These items were partially offset by the favorable impact of foreign currency exchange rate fluctuations of $0.3 million. We believe that continued investment in research and development is an important part of sustaining our growth strategy through new product development and anticipate that in the near future, research and development expenses as a percentage of revenue will remain consistent with past levels.

Amortization of intangible assets. Amortization of intangible assets remained flat at $2.7 million for both the third quarter of 2012 and the third quarter of 2011.

Special charges. Special charges were $6.5 million for the three months ended September 30, 2012 compared to $0.1 million for the three months ended October 2, 2011. Special charges included approximately $2.8 million of expense for the three months ended September 30, 2012 related to our facilities . . .

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