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TGX > SEC Filings for TGX > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for THERAGENICS CORP

Form 10-Q for THERAGENICS CORP


13-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

Theragenics Corporation is a medical device company serving the surgical products and cancer treatment markets, operating in two business segments. The terms "Company", "we", "us", or "our" mean Theragenics Corporation and all entities included in our consolidated financial statements.

Our surgical products business consists of wound closure, vascular access, and specialty needle products. Wound closure includes sutures, needles and other surgical products. Vascular access includes introducers, guidewires, and related products. Specialty needles include coaxial, biopsy, spinal and disposable veress needles, access trocars, radiofrequency devices, implanters, introducer products, and other needle based products. This segment serves a number of markets and applications, including among other areas, interventional cardiology, interventional radiology, vascular surgery, orthopedics, plastic surgery, dental surgery, urology, veterinary medicine, pain management, endoscopy, and spinal surgery. Our surgical products business sells our devices and components primarily to original equipment manufacturers ("OEMs") and to a network of distributors.

Our brachytherapy business manufactures, markets and distributes "seeds" used primarily in the minimally invasive treatment of localized prostate cancer. Our brachytherapy product line includes our palladium-103 based TheraSeed® device, our iodine-125 based AgX100™ device, and other related products and services. Physicians, hospitals and other healthcare providers, primarily located in the United States, utilize our devices. The majority of TheraSeed® sales are channeled through third-party distributors. We also maintain an in-house sales force that sells TheraSeed® and AgX100™ directly to physicians. We manufacture the TheraSeed® and the AgX100™ devices.

Acquisition of Core Oncology's Prostate Brachytherapy Customer Base

On February 17, 2012, we acquired Core Oncology's prostate brachytherapy customer base. This transaction has substantially increased our share of the iodine-125 segment of the prostate brachytherapy market. In addition to the customer base, we also acquired certain packaging technologies, equipment related to the packaging technologies, and certain existing component inventory. We did not acquire Core's facilities, manufacturing equipment or processes, or Core's employees. We accounted for this transaction as an asset acquisition.

The total purchase price for the acquired assets is equal to one times the actual revenue generated from the acquired customers over the twelve-month period from September 2012 to August 2013 (the "Earn-Out Period"), in excess of a $2.5 million Threshold Amount. Through September 30, 2012 we have paid $5.2 million in cash for this transaction, primarily consisting of prepayment of a portion of the earn out at closing in February plus subsequent earn-out payments. We have four quarterly earn-out payments remaining through September 2013. Each quarterly earn-out payment is based upon that quarter's revenue from the acquired customers, reduced by a portion of the Threshold Amount and by a portion of the prepayment made at closing. The final earn-out payment is calculated as one times the revenue actually recognized from the acquired customer base over the twelve-month period from September 2012 to August 2013 in excess of the total Threshold Amount, reduced by the prepayment and the cumulative amount of all previous earn-out payments made. Based on our current estimates, we expect to make additional payments of $250,000 for this earn-out based acquisition, representing a total purchase price of $5.5 million, including transaction costs. However, remaining earn-out payments could be materially higher depending upon the actual amount of revenue generated from the acquired customers during the Earn-Out Period.

Modified Dutch Auction Tender Offer

On June 12, 2012, we announced a modified "Dutch Auction" tender offer to repurchase up to $10.0 million of our common stock. The offer period expired on July 11, 2012. On July 17, 2012 we repurchased 4,761,904 shares of our common stock for a total cost of $10.0 million, or $2.10 per share, excluding transaction costs. The purchase price was funded from cash on hand, and the shares repurchased represented approximately 14% of our issued and outstanding common stock at that time. We did not acquire any stated or unstated rights or privileges in connection with the repurchase of this common stock and, accordingly, the entire purchase price of $10.4 million, including transaction costs, was accounted for as treasury stock.

Medical Device Tax

Significant reforms to the healthcare system were adopted in the form of the Patient Protection and Affordable Care Act (the "PPACA"). See our discussion below under "Other Regulatory Developments". The PPACA includes provisions that, among other things, require the medical device industry to subidize healthcare reform in the form of a 2.3% excise tax on the U.S. sales of most medical devices beginning in 2013. While we continue to evaluate the impact of this tax on our overall business, if this tax was applicable to all of our product sales, this would have equated to an excise tax of approximately $2 million in 2011 and $1.4 million in the first nine months of 2012. This revenue-based tax will have a material impact on our consolidated results of operations, cash flows, and financial condition. See "Other Regulatory Developments" below.

Results of Operations

Revenue

Following is a summary of revenue by segment (in thousands):
                                   Three Months Ended                           Nine Months Ended
                                     September 30,                                September 30,
                          2012          2011         Change ($)        2012          2011        Change ($)
Revenues by segment:
  Surgical products
   Product sales        $  14,230     $  15,259     $     (1,029 )   $  45,598     $  45,088     $       510
   License and fee
income                         16            21               (5 )          64            54              10
     Total surgical
products                   14,246        15,280           (1,034 )      45,662        45,142             520

  Brachytherapy seed
   Product sales            5,227         5,512             (285 )      16,663        16,693             (30 )
   License and fee
income                        614           541               73         1,813         1,591             222
     Total
brachytherapy seed          5,841         6,053             (212 )      18,476        18,284             192

Intersegment
eliminations                 (171 )        (271 )            100          (683 )        (575 )          (108 )

  Consolidated
   Product sales           19,286        20,500           (1,214 )      61,578        61,206             372
   License and fee
income                        630           562               68         1,877         1,645             232
     Total
consolidated            $  19,916     $  21,062     $     (1,146 )   $  63,455     $  62,851     $       604

Surgical Products Segment

Revenue in our surgical products business decreased 7% in the quarter ended September 30, 2012 compared to the quarter ended September 30, 2011. For the year to date period, revenue increased 1% in the nine months ended September 30, 2012 from the comparable 2011 period. Our customers' ordering patterns continue to be variable and unpredictable, especially on a quarter-to-quarter basis. Customer behavior and ordering patterns also continue to be erratic due to significant macroeconomic uncertainties, such as the federal deficit, impending healthcare reform and the medical device tax, changing tax policies and other concerns. We expect this variability and unpredictable customer behavior to continue in the fourth quarter and into 2013. Sluggish demand and unpredictable behavior have a direct effect on our revenue and results.

Open orders in our surgical products segment were $13.5 million on September 30, 2012 compared to $13.9 million at December 31, 2011. Open orders represent firm orders from customers for future delivery. Open orders are not guaranteed shipments, and they are subject to cancellation or delay. Backlog in our surgical products business was $588,000 at September 30, 2012 and $379,000 at December 31, 2011. Backlog represents orders included in open orders on which we have missed promised shipment dates. We expect our open orders and backlog to continue to vary based on changes in ordering patterns of our larger customers and changes in customer behavior.

Recently we announced the launch of three new vascular access products. We launched our Galt Microslide™ Pediatric Introducer line ("Galt Microslide") in the first quarter of 2012; our Galt VTI™ Valved Tearaway Introducer ("Galt VTI") in the third quarter of 2012; and our Galt Centeze™ centesis drainage catheter in October. While sales of these new products have not been material in 2012, each of these new products is expected to provide our surgical products business with access to new markets and new customers. These new products are also expected to carry a higher gross profit margin than we are currently realizing in our surgical products business.

A significant portion of the products in our surgical business continue to be sold to OEMs and a network of distributors. Ordering patterns and behaviors of these customers vary and are difficult to predict. Accordingly, surgical products revenue continues to be subject to fluctuation, especially on a quarter-to-quarter basis. In addition, revenue has been and will continue to be affected by our customers' and potential customers' efforts to manage their supply chains and reduce costs. All of these factors may cause the fluctuations in our results to be even more volatile from period to period.

Brachytherapy Seed Segment

We sell our TheraSeed® palladium-103 device directly to healthcare providers and to third-party distributors. We also sell our AgX100TM iodine-125 based device, and other brachytherapy related products, directly to healthcare providers.

Our brachytherapy product sales decreased 5% for the quarter ended September 30, 2012 and were flat for the nine months ended September 30, 2012 from the comparable 2011 periods. Incremental revenues from the acquisition of the Core Oncology customer base totaled $1.0 million and $2.8 million for the three and nine months ended September 30, 2012, respectively. See "Acquisition of Core Oncology's Prostate Brachytherapy Customer Base" above. Excluding the incremental sales to the acquired customers, brachytherapy product revenue, primarily from our TheraSeed® product, declined 24% and 17% for the three and nine months ended September 30, 2012, respectively.

In May 2012 the U.S. Preventive Services Task Force recommended against routine PSA screenings for healthy men without symptoms. We believe this recommendation may be leading to a decline in PSA screening. In addition, we believe there has been an increase in "active surveillance", a practice where no immediate medical treatment is provided; but the physician and patient closely monitor the patient's cancer for signs that the cancer is growing. We believe that declines in PSA screenings would lead to a decline in the number of men diagnosed with prostate cancer. Both a decline in the number of PSA screenings and an increase in the proportion of men diagnosed with prostate cancer but not seeking immediate medical treatment would in turn lead to a decline in the number of procedures to treat prostate cancer, including brachytherapy procedures.

The prostate brachytherapy industry in the United States continues to experience pressure from newer forms of treatment. Some newer forms of treatment have increased their market share, especially those with Medicare reimbursement levels that are higher than reimbursement levels for brachytherapy. These newer forms of alternative treatments include Intensity Modulated Radiation Therapy ("IMRT") and robotic surgery. In addition to treatment options that enjoy favorable reimbursement rates, we believe brachytherapy seed volume and revenue are also affected by disruptive pricing from other brachytherapy providers and uncertainties surrounding reimbursement.

We have non-exclusive distribution agreements in place for the distribution of our TheraSeed® device. Under our third party distribution agreements, we are the exclusive palladium-103 seed supplier for the treatment of prostate cancer for each distributor, and each distributor has the non-exclusive right to sell TheraSeed® in the U.S. and Canada. Certain agreements also provide distributors with the right to distribute TheraSeed® for the treatment of solid localized tumors other than in the prostate and with rights to distribute to certain locations outside of North America. Such applications (non-prostate and outside of North America) have not been material and are not expected to become material in the near future. Our principal non-exclusive distribution agreement is with C.R. Bard ("Bard"). Our agreement with Bard provides for automatic one year extensions of the term, unless either party gives notice of its intent not to renew at least twelve months prior to the end of the current term. The current term expires December 31, 2013 and will be automatically extended for one additional year unless either party gives notice of its intent not to extend by December 31, 2012. Sales to Bard under the agreement with Bard represented approximately 23% and 25% of total brachytherapy seed segment revenue for the three and nine months ended September 30, 2012, respectively, and 26% and 28% of total brachytherapy seed segment revenue for the three and nine months ended September 30, 2011, respectively.

We also currently have other non-exclusive distribution agreements in place for TheraSeed®. Other than Bard, one distributor represented 10% of our brachytherapy seed segment revenues for both the three and nine months ended September 30, 2012. No other distributors represented 10% or more of brachytherapy seed segment revenues in 2011. We may pursue additional distribution agreements for both palladium-103 and iodine-125 products in an effort to increase market share. We may also have opportunities to enter certain markets outside of the United States with an iodine-125 device.

Core became an additional non-exclusive distributor of TheraSeed® in January 2010. In February 2011, we terminated our agreement with Core due to Core's failure to satisfy its financial obligation to us in accordance with the contractual terms of the agreement. Core had been attempting to become current with amounts due to us. However, litigation filed against Core by a third party in January 2011 created what we viewed as an unacceptable level of uncertainty surrounding Core's ability to satisfy their financial obligations to us for both current and ongoing sales. Subsequent to termination of the agreement, we continued to supply TheraSeed® to Core on a prepaid basis. In the latter half of 2011, certain customers who previously purchased TheraSeed® through Core began purchasing either from us on a direct basis or through one of our other TheraSeed® distributors. In February 2012, we acquired Core's prostate brachytherapy customer base. See above under "Acquisition of Core Oncology's Prostate Brachytherapy Customer Base". Sales to Core in our brachytherapy segment totaled approximately 11% and 12% of total brachytherapy seed segment revenue for the three and nine months ended September 30, 2011, respectively.

We believe that Medicare reimbursement policies have affected the brachytherapy market and will continue to affect the brachytherapy market. See "Medicare Developments" below.

License fees in our brachytherapy segment increased 13% and 14% for the three and nine months ended September 30, 2012, respectively, over the comparable 2011 periods. License fees include fees from the licensing of our TheraSphere® product, a medical device used for the treatment of liver cancer. License fees also include fees related to the licensing of certain intellectual property related to an expandable brachytherapy delivery system that we developed. This agreement, which was executed in May 2008, provides for a minimal non-refundable initial license fee and non-refundable, continuing royalties based upon sales and subject to certain minimums.

Operating income and costs and expenses

Following is a summary of operating income by segment (in thousands):

                                       Three Months Ended                           Nine Months Ended
                                          September 30,                               September 30,
                               2012          2011        Change ($)        2012          2011        Change ($)

 Surgical products           $     243     $     780     $      (537 )   $   1,030     $   1,087     $       (57 )
 Brachytherapy seed                906         1,243            (337 )       3,033         3,838            (805 )
 Intersegment eliminations          11            15              (4 )         (12 )           2             (14 )

 Consolidated                $   1,160     $   2,038     $      (878 )   $   4,051     $   4,927     $      (876 )

Surgical Products Segment

In the third quarter of 2012, operating income in our surgical products segment was $243,000 compared to $780,000 in the third quarter of 2011. For the first nine months of 2012, operating income was $1.0 million compared to $1.1 million in the first nine months of 2011. Our gross profit margins on sales were 34% in the quarter ended September 30, 2012 compared to 37% in the quarter ended September 30, 2011. In the year to date period, our gross profit margin on sales was 34% for the nine months ended September 30, 2012 compared to 36% for the nine months ended September 30, 2011. Gross margins continue to be affected by our sales channel mix. We sell our surgical products primarily to OEM's and to a network of distributors. Sales to OEM's, which typically carry a lower gross profit margin than sales to dealers, have increased relative to total sales over the past several years from 84% in 2009 to 89% in 2012. We also experienced higher rework costs on some newer customer programs during 2012. Over time, we plan to increase margins by integrating manufacturing processes, improving efficiencies and introducing newer and higher margin products, such as the Galt VTI, Galt Microslide and Galt Centeze discussed above.

Selling, general and administrative ("SG&A") costs were 25% of revenue for each of the quarters ended September 30, 2012 and 2011 and 26% of revenue for each of the nine month periods ended September 30, 2012 and 2011. The first nine months of 2011 included $218,000 of expenses related to responding to an unsolicited acquisition proposal while the 2012 periods included higher bad debt expense.

Research and development ("R&D") expenses decreased $99,000 and $488,000 for the quarter and nine months ended September 30, 2012, respectively, from the comparable 2011 periods. Our R&D program is intended to focus on product extensions, next generation products, and new products that are complementary to our current product lines and that support our customers' product lines. Our R&D program is directed toward 510(k) products that have an established market and not on products that require lengthy and expensive clinical trials. Looking forward, our quarterly results are expected to be affected by the timing of these investments. We recently introduced three new vascular access products. See our discussion under "Revenue - Surgical Products Segment" above.

Recently there have been worldwide shortages of certain animal-based materials utilized in some of our wound closure products. To date these shortages have not had a materially adverse effect on our operations or results. Currently we believe such shortages are being addressed by suppliers and will be short-term in nature. However, if such shortages worsen or endure for an extended period of time, we may experience increased costs for raw materials or delays in production, which could have a material adverse effect on our results of operations.

Looking forward, we expect a number of items to continue to affect the profitability in our surgical products business including, among other things:
· ordering patterns of our larger OEM and distributor customers,

· costs created by unpredictability of customer ordering patterns,

· continued investments in infrastructure, R&D, products, and companies as we make investments to support anticipated future growth and to develop products to address growth opportunities,

· changes in product mix and sales channels, with sales through OEM channels generally carrying a relatively lower gross profit margin and sales through distributor channels generally carrying a somewhat higher gross profit margin,

· continued pricing pressure from customers,

· availability and pricing of raw material supplies,

· the utilization costs and benefits from our new, corporate-wide ERP systems,

· any changes in the demand for medical devices,

· the increasing scale of our surgical products business, and

· the 2.3% excise tax on medical devices under the PPACA.

Brachytherapy Seed Segment

Operating income in our brachytherapy business was $906,000 in the third quarter of 2012 compared to $1.2 million in the third quarter of 2011. For the nine month period, operating income was $3.0 million in 2012 and $3.8 million in 2011. Sales of TheraSeed® decreased $1.1 and $2.3 million for the three and nine months ended September 30, 2012, respectively, from the comparable 2011 periods. Manufacturing expenses related to our TheraSeed® palladium-103 based device tend to be fixed in nature and, accordingly, these declines in revenue had a significant effect on operating income in the 2012 periods. Operating income in our brachytherapy seed business is expected to continue to be highly dependent on TheraSeed® sales levels due to the high fixed cost component of our manufacturing operations. Revenue from the acquired Core customers partially offset the decline in Theraseed® sales and contributed to operating income in 2012, though margins on iodine-125 based devices are lower than our TheraSeed® devices. Initially, we supplied the acquired customer base with iodine-125 based devices under a temporary supply agreement with Core as we transitioned the new customers. Effective July 1, 2012, we began to supply these acquired customers with our internally produced AgX100TM device, which lowered our cost of sales for these customers. The improved profitability from our internally produced AgX100 TM partially offset the decline in operating income resulting from our lower Theraseed® sales.

The first nine months of 2011 included $215,000 of bad debt expense related to amounts due under our prior distribution agreement with Core that were considered uncollectible. No such bad debt expense was incurred in the 2012 periods.

Other income/expense

A summary of our interest expense is as follows (in thousands):

                                        Three Months Ended               Nine Months Ended
                                           September 30,                   September 30,
                                       2012             2011           2012             2011
Interest paid or accrued,
including loan fees                 $      166       $      213     $      559       $      658
Fair value adjustment                        -              (38 )          (57 )            (98 )
Interest capitalized                        (3 )            ( 9 )          (20 )            (31 )
Total interest expense              $      163       $      166     $      482       $      529

Interest expense paid or accrued, including loan fees, is related to our effective interest rates and the level of our outstanding borrowings under our credit facility. Fair value adjustments are related to our interest rate swaps we previously held. Such fair value adjustments are unrealized gains or losses and reflect the period-to-period changes in the estimated fair value of our swaps. Interest capitalized relates to the development of our ERP system, which was completed in August 2012. Our weighted average effective interest rate was 2.5% at September 30, 2012.

We managed our interest rate risk using interest rate swaps associated with outstanding borrowings under our credit agreement since our interest rates are floating rates based on LIBOR. We no longer hold any derivative financial instruments since our interest rate swaps matured in June 2012. Changes in the fair value of our interest rate swaps were recognized as interest expense.

Income tax expense

Our effective income tax rate, which include federal and state income taxes, for both the quarter and nine months ended September 30, 2012, was approximately 33% compared to 40% and 38% for the quarter and nine months ended September 30, 2011, respectively. Our 2012 tax rates were lower than taxes computed at the statutory rates primarily due to the domestic production deduction for income tax purposes.

Critical Accounting Policies and Estimates

The preparation of financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The SEC defines "critical accounting policies" as those that require application of our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Our significant accounting policies are more fully described in the notes to our consolidated financial statements included in our Form 10-K for the year ended December 31, 2011. Certain accounting policies, as more fully described under "Critical Accounting Policies and Estimates" included in the Management's Discussion and Analysis of our 2011 Form 10-K, are those which we believe are most critical in fully understanding and evaluating our reported financial results, and are areas in which our judgment in selecting an available alternative might produce a materially different result. There have been no significant changes to our critical accounting policies since December 31, 2011, other than described as follows:

Estimates related to the acquisition of Core Oncology Customer Base. On February 17, 2012, we acquired Core Oncology's prostate brachytherapy customer base. This transaction substantially increased our share of the iodine-125 segment of the prostate brachytherapy market. In addition to the customer base, we also acquired certain packaging technologies, equipment related to the packaging technologies, and certain existing component inventory. We did not acquire Core's facilities, manufacturing equipment or processes, or Core's employees.

The total purchase price for the acquired assets is equal to one times the actual revenue generated from the acquired customers over the twelve-month period from September 2012 to August 2013 (the "Earn-Out Period"), in excess of a $2.5 million Threshold Amount. Through September 30, 2012 we have paid $5.2 million in cash for this transaction, primarily consisting of prepayment of a portion of the earn out at closing in February and subsequent earn-out payments. We have four quarterly earn-out payments remaining through September 2013. Each quarterly earn-out payment is based upon that quarter's revenue from the acquired customers, reduced by a portion of the Threshold Amount and by a portion of the prepayment made at closing. The final earn-out payment is calculated as one times the revenue actually recognized from the acquired customer base over the twelve-month period from September 2012 to August 2013 in excess of the total Threshold Amount, reduced by the prepayment and the . . .

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