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EXAC > SEC Filings for EXAC > Form 10-Q on 6-May-2013All Recent SEC Filings

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Form 10-Q for EXACTECH INC


6-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes appearing elsewhere in this report.
Overview of the Company
We develop, manufacture, market and sell orthopaedic implant devices, related surgical instrumentation, supplies and biologic materials to hospitals and physicians in the United States and internationally. Our revenues are principally derived from sales of knee, hip, and extremity joint replacement systems and spinal fusion products. Our continuing research and development projects will enable us to continue the introduction of new, advanced biologic materials, joint replacement product line extensions and other products and services.
Our operating expenses consist of sales and marketing expenses, general and administrative expenses, research and development expenses, and depreciation expenses. The largest component of operating expenses, sales and marketing expenses, primarily consists of payments made to independent sales representatives for their services to hospitals and surgical facilities on our behalf. These expenses tend to be variable in nature and related to sales growth. Research and development expenses primarily consist of expenditures on projects concerning knee, extremities, spine and hip implant product lines and biologic materials and services.
In marketing our products, we use a combination of traditional targeted media marketing together with our primary marketing focus, direct customer contact and service to orthopaedic surgeons. Because surgeons are important decision makers when it comes to the choice of products and services that best meet the needs of their patients, our marketing strategy is focused on meeting the needs of the orthopaedic surgeon community. In addition to surgeon's preference, hospitals and buying groups, as the economic customers, are actively participating with physicians in the choice of implants and services. Overview of the Three Months Ended March 31, 2013 During the quarter ended March 31, 2013, sales increased 1% to $59.3 million from $58.6 million in the comparable quarter ended March 31, 2012, as a result of a 6% growth in our domestic sales, partially offset by a reduction in our international sales. Gross margins remained flat at 69%. Operating expenses decreased 2% from the quarter ended March 31, 2012, and as a percentage of sales, operating expenses decreased to 58% during the first quarter of 2013 as compared to 60% for the same quarter in 2012. This decrease, as a percentage of sales, was primarily due to our continued efforts to manage operating costs. Net income for the quarter ended March 31, 2013 increased 17%, and diluted earnings per share were $0.29 as compared to $0.25 last year, which was primarily a result of our cost reduction efforts.
During the three months ended March 31, 2013, we acquired $5.2 million in property and equipment, including new production equipment and surgical instrumentation. Net cash flow from operations was $2.6 million for the three months ended March 31, 2013 as compared to a net cash flow from operations of $1.1 million during the three months ended March 31, 2012.


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The following table includes the net sales and percentage of net sales, as well as a comparison of net sales change to net sales change calculated on a constant currency basis, for each of our product lines for the three month periods ended March 31, 2013 and March 31, 2012:

                                      Sales by Product Line
                                           ($ in 000's)

                               Three Months Ended                           Inc (decr)
                      March 31, 2013        March 31, 2012       2013- 2012     Constant Currency
Knee                $ 20,502     34.6 %   $ 21,456     36.6 %      (4.4 )%             (3.5 )%
Hip                   10,440     17.6       10,954     18.7        (4.7 )              (3.1 )
Biologics and Spine    6,057     10.2        6,161     10.5        (1.7 )              (1.8 )
Extremity             15,683     26.4       12,977     22.1        20.9                20.8
Other                  6,619     11.2        7,080     12.1        (6.5 )              (6.2 )
Total               $ 59,301    100.0 %   $ 58,628    100.0 %       1.1  %              1.8  %

The following table includes items from the unaudited Condensed Consolidated Statements of Income for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012, the dollar and percentage change from period to period and the percentage relationship to net sales (dollars in thousands):

                                           Comparative Statement of Income Data

                                 Three Months Ended March 31,         2013 - 2012 Inc (decr)             % of Sales
                                    2013               2012              $              %            2013          2012
Net sales                     $      59,301       $      58,628          673              1.1        100.0  %      100.0  %
Cost of goods sold                   18,590              18,096          494              2.7         31.3          30.9
Gross profit                         40,711              40,532          179              0.4         68.7          69.1
Operating expenses:
Sales and marketing                  21,524              21,820         (296 )           (1.4 )       36.3          37.2
General and administrative            5,096               5,648         (552 )           (9.8 )        8.6           9.6
Research and development              3,850               4,104         (254 )           (6.2 )        6.5           7.0
Depreciation and amortization         4,175               3,792          383             10.1          7.1           6.5
Total operating expenses             34,645              35,364         (719 )           (2.0 )       58.5          60.3
Income from operations                6,066               5,168          898             17.4         10.2           8.8
Other income (expense), net            (715 )              (212 )       (503 )          237.3         (1.2 )        (0.4 )
Income before taxes                   5,351               4,956          395              8.0          9.0           8.4
Provision for income taxes            1,494               1,671         (177 )          (10.6 )        2.5           2.8
Net income                    $       3,857       $       3,285          572             17.4          6.5           5.6

Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012 Sales
For the quarter ended March 31, 2013, sales increased 1% to $59.3 million from $58.6 million in the quarter ended March 31, 2012, as a result of domestic sales growth that was partially offset by currency deterioration and pricing pressures internationally. Sales of knee implant products decreased 4% to $20.5 million for the quarter ended March 31, 2013 compared to $21.5 million for the quarter ended March 31, 2012, as we experienced a slowdown of international sales from Latin America, as well as government mandated price reductions in Japan. Sales of our extremity products were up 21% to $15.7 million as compared to $13.0 million for the same period in 2012, as we see continued interest in our Equinoxe® reverse shoulder system. Hip implant sales of $10.4 million during the quarter ended March 31, 2013 decreased 5% from the $11.0 million in sales during the quarter ended March 31, 2012, as a result of the price reductions in Japan and other international markets as well as a flat U.S. market. Sales from biologics and spine decreased 2% during the quarter ended March 31, 2013 to $6.1 million, from $6.2 million in the comparable quarter in 2012, primarily as a result of pricing pressure in our biologics revenues. Sales of all other products decreased to $6.6 million as compared to $7.1 million in the same quarter last year, primarily as a result of reduced instrumentation sales to


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international stocking distributors. Domestically, sales increased 6% to $39.0 million, or 66% of total sales, during the quarter ended March 31, 2013, up from $36.8 million, which represented 63% of total sales, in the comparable quarter last year. Internationally, sales decreased 7% to $20.3 million, representing 34% of total sales, for the quarter ended March 31, 2013, as compared to $21.9 million, which was 37% of total sales, for the same quarter in 2012. On a constant currency basis, international sales decreased approximately 5% during the quarter ended March 31, 2013, compared to the same quarter in 2012. Gross Profit
Gross profit increased to $40.7 million in the quarter ended March 31, 2013 from $40.5 million in the quarter ended March 31, 2012. As a percentage of sales, gross profit remained flat at 69% during each of the quarters ended March 31, 2013 and 2012, as a result of our domestic sales growth, which generally carries higher margins, offset by our lower international sales. Looking forward to the remainder of the fiscal year, we expect gross profit, as a percentage of sales, to be lower by 1.0 to 1.5% compared to prior year quarters on a comparative quarter basis due to the impact of the medical device tax enacted as part of the health care legislation signed into law in 2010 and pricing pressure. Operating Expenses
Total operating expenses decreased 2% to $34.6 million in the quarter ended March 31, 2013 from $35.4 million in the quarter ended March 31, 2012, due to a reduction in overall operating expenses. As a percentage of sales, total operating expenses decreased to 58% for the quarter ended March 31, 2013, as compared to 60% for the quarter ended March 31, 2012. The decrease in operating expenses, as a percentage of sales, is primarily due to our continued efforts to reduce costs.
Sales and marketing expenses, the largest component of total operating expenses, decreased 1% for the quarter ended March 31, 2013 to $21.5 million from $21.8 million in the same quarter last year. The decrease was primarily related to reduced variable selling costs as a result of our focus on cost management, and from our lower sales growth. Sales and marketing expenses, as a percentage of sales decreased to 36% for the quarter ended March 31, 2013, from 37% for the quarter ended March 31, 2012. Looking forward, sales and marketing expenditures, as a percentage of sales, are expected to be in the range of 36% to 37% for the remainder of 2013.
General and administrative expenses decreased to $5.1 million in the quarter ended March 31, 2013 from $5.6 million in the same quarter in 2012, as we reduced compliance expenses related to the expiration of the DPA from $0.6 million in the first quarter of 2012 to $0.4 million in the first quarter of 2013. As a percentage of sales, general and administrative expenses decreased to 9% for the quarter ended March 31, 2013, as compared to 10% in the quarter ended March 31, 2012. General and administrative expenses for the balance of the year ending December 31, 2013 are expected to be in the range of 9% to 10% of sales. Research and development expenses decreased 6% for the quarter ended March 31, 2013 to $3.9 million from $4.1 million in the same quarter last year. As a percentage of sales, research and development expenses decreased to 6% for the quarter ended March 31, 2013 from 7% for the comparable quarter last year. The decrease was due primarily to lower clinical studies activities during the quarter. We anticipate growth in research and development expenditures, as a percent of sales, to outpace sales growth for the balance of 2013 as increases in product development activities, with total research and development expenses ranging from 7% to 8% of sales.
Depreciation and amortization increased 10% to $4.2 million for the quarter ended March 31, 2013 from $3.8 million during the same quarter in 2012. As a percentage of sales, depreciation and amortization increased to 7% during the quarter ended March 31, 2013 from 6% during the quarter ended March 31, 2012. We placed $4.2 million of surgical instrumentation in service and spent approximately $0.3 million for product licenses and designs during the first three months of 2013.
Income from Operations
Our income from operations increased 17% to $6.1 million, or 10% of sales in the quarter ended March 31, 2013 from $5.2 million, or 9% of sales in the quarter ended March 31, 2012. The increase in our income from operations was a result of our continued efforts to reduce our overall expenses and leverage our existing cost structures. Looking forward, we expect operating expenses for the year to increase slower than sales growth and, therefore, we anticipate income from operations to be in the range of 8% to 10% of sales for the remainder of 2013.


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Other Income and Expenses
We had other expenses, net of other income, of $0.7 million during the quarter ended March 31, 2013, as compared to other expenses, net of other income, of $0.2 million in the quarter ended March 31, 2012, due to foreign currency transaction losses of $0.5 million, compared to foreign currency transaction gains of $0.2 million for the same quarter of 2012. Currency losses were partially offset by a decrease in net interest expense to $0.3 million for the quarter ended March 31, 2013 compared to $0.5 million for the quarter ended March 31, 2012.
Taxes and Net Income
Income before provision for income taxes increased 8% to $5.4 million in the quarter ended March 31, 2013 from $5.0 million in the quarter ended March 31, 2012. The effective tax rate, as a percentage of income before taxes, was 28% for the quarter ended March 31, 2013 as compared to 34% for the quarter ended March 31, 2012. The decrease in the effective tax rate for the first quarter of 2013 was primarily due to the retroactive renewal of the 2012 research and development tax credit that was enacted on January 2, 2013, and as such, the entire credit of $0.6 million was recognized in the first quarter of 2013. As a result of the foregoing, we realized net income of $3.9 million in the quarter ended March 31, 2013, an increase of 17% from $3.3 million in the quarter ended March 31, 2012. As a percentage of sales, net income increased to 7% for the quarter ended March 31, 2013 from 6% for the quarter ended March 31, 2012. Earnings per share, on a diluted basis, increased to $0.29 for quarter ended March 31, 2013, from $0.25 for the quarter ended March 31, 2012. We expect our effective tax rates to range from 32% to 34% for the remainder of 2013. Liquidity and Capital Resources
We have financed our operations primarily through a combination of commercial debt financing and cash flows from our operating activities. At March 31, 2013, we had working capital of $99.7 million, an increase of 1% from $98.7 million at the end of 2012. Working capital in 2013 increased primarily as a result of an increase in our accounts receivable and current inventory balance, and was partially offset by increases in our accounts payable. Inventory and surgical instrumentation increases were impacted by the $0.4 million paid for the medical device excise tax. We project that cash flows from operating activities, borrowing under our line of credit, and the issuance of equity securities, in connection with both stock purchases under the 2009 ESPP and stock option exercises will be sufficient to meet our commitments and cash requirements in the next twelve months. If not, we will seek additional funding options with any number of possible combinations of additional debt, additional issuance of equity or convertible debt.
Operating Activities - Operating activities provided net cash of $2.6 million in the three months ended March 31, 2013, as compared to net cash from operations of $1.1 million during the three months ended March 31, 2012. A primary contributor to this change related to the reduction in accounts receivable increases, which used cash of $3.5 million for the three months ended March 31, 2013, in contrast to using net cash $7.8 million for the three months ended March 31, 2012. A major contributor to the collection effort is our sales distribution office in Spain, which experienced an improvement in collections of accounts receivable aged six months or older. Our allowance for doubtful accounts and sales returns increased to $1.1 million at March 31, 2013 from $1.0 million at December 31, 2012, principally as a result of the slow aging increase of the accounts receivable at our sales distribution office in Spain. The total days sales outstanding (DSO) ratio, based on average accounts receivable balances, was 74 for the three months ended March 31, 2013, down from a ratio of 78 for the three months ended March 31, 2012. As we continue to expand our operations internationally, our DSO ratio could increase, due to the fact that credit terms outside the U.S. tend to be relatively longer than those in the U.S. Inventory increased by $4.8 million during the first three months ended March 31, 2013, compared to an increase of $2.2 million during the same period ended March 31, 2012, as a result of our product line and market expansions. Investing Activities - Investing activities were relatively flat, and used net cash of $4.8 million in the three months ended March 31, 2013, as compared to $4.9 million in the three months ended March 31, 2012. Our cash outlays for surgical instrumentation and manufacturing equipment were $4.5 million, and $0.3 million for purchases of product licenses during the three month period ended March 31, 2013, as compared to cash outlays of $4.5 million for purchases of surgical instrumentation and manufacturing equipment, and $0.4 million for purchases of product licenses during the same period of 2012. License technology
Our Taiwanese subsidiary, Exactech Taiwan, has entered into a license agreement with the Industrial Technology Research Institute (ITRI) and the National Taiwan University Hospital (NTUH) for the rights to technology and patents related to the repair of cartilage lesions. As of March 31, 2013, we had paid approximately $2.1 million for the licenses, patents, equipment related to this license agreement, and prepaid expenses, and we will make royalty payments when the technology becomes marketable. Using the technology, we plan to launch a cartilage repair program that will


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include a device and method for the treatment and repair of cartilage in the knee joint. It is expected that the project will require us to complete human clinical trials under the guidance of the Food & Drug Administration in order to obtain pre-market approval for the device in the United States. The agreement terms include a license fee based on the achievement of specific, regulatory milestones and a royalty arrangement based on sales once regulatory clearances are established.
Financing Activities - Financing activities provided net cash of $0.9 million in the three months ended March 31, 2013, as compared to $2.6 million in net cash provided for the three months ended March 31, 2012. In the first three months of 2013, we had net debt repayments of $0.2 million as compared to net borrowings of $2.9 million in the first three months of 2012. Proceeds from the exercise of stock options provided cash of $1.2 million in the three months ended March 31, 2013, as compared to $0.2 million in the three months ended March 31, 2012, with the proceeds used to fund general working capital. Long-term Debt
On February 24, 2012, we entered into a revolving credit and term loan agreement for a maximum aggregate principal amount of $100 million, referred to as the Credit Agreement, with SunTrust Bank, as Administrative Agent, issuing bank and swingline lender, and a syndicate of other lenders. The Credit Agreement is composed of a $30 million term loan facility and revolving credit line in an aggregate principal amount of up to $70 million, of which, a portion is a swingline note for $5 million. The swingline note is used for short-term cash management needs, and excess bank account cash balances are swept into the swingline to reduce any outstanding balance. Additionally, the Credit Agreement provides for the issuance of letters of credit in an aggregate face amount of up to $5 million. Proceeds from the Credit Agreement were used to pay all amounts outstanding under our previous line of credit and other loan balances outstanding as of the closing date.
Interest on loans outstanding under the Credit Agreement is based, at our election, on a base rate, a Eurodollar Rate or an index rate, in each case plus an applicable margin. The base rate is the highest of (i) the rate which the Administrative Agent announces from time to time as its prime lending rate,
(ii) the Federal Funds rate, as in effect from time to time, plus one-half of one percent (1/2%) per annum and (iii) the Eurodollar Rate determined on a daily basis for an Interest Period of one (1) month, plus one percent (1.00%) per annum. The Eurodollar Rate is the London interbank offered rate for deposits in U.S. Dollars for approximately a term comparable to the applicable interest period (one, two, three or six months, at our election), subject to adjustment for any applicable reserve percentages. The index rate is the rate equal to the offered rate for deposits in U.S. Dollars for a one (1) month interest period, as appears on the Bloomberg reporting service, or such similar service as determined by the Administrative Agent that displays British Bankers' Association interest settlement rates for deposits in Dollars, subject to adjustment for any applicable reserve percentages. The applicable margin is based upon our leverage ratio, as defined in the Credit Agreement, and ranges from 0.50% to 1.25% in the case of base rate loans and 1.50% to 2.25% in the case of index rate loans and Eurodollar loans. We must also pay a commitment fee to the Administrative Agent for the account of each lender, which, based on our leverage ratio, accrues at a rate of 0.20% or 0.25% per annum on the daily amount of the unused portion of the revolving loan. The Credit Agreement has a five year term expiring on February 24, 2017. The $30 million term loan is subject to amortization and is payable in quarterly principal installments of $375,000 during the first year of the five-year term and quarterly principal installments of $750,000 during the remaining years of the term, with any outstanding unpaid principal balance, together with accrued and unpaid interest, due at the expiration of the term. The Credit Agreement requires that, within one-year after entering into the Credit Agreement (or such later date as agreed to by the Administrative Agent), we fix or limit our interest exposure to at least fifty percent (50%) of the term loan pursuant to one or more hedging arrangements reasonably satisfactory to the Administrative Agent. On May 15, 2012, pursuant to the terms of the Credit Agreement we entered into an interest rate swap agreement with the Administrative Agent as a cash flow hedge. The swap is effective beginning on September 30, 2013 and matures February 28, 2017, and fixes the variable interest rate at 1.465% of $27 million the term loan that will be outstanding on the effective date. All long-term debt instruments outstanding, including our previous line of credit, our commercial construction loan and commercial real estate loan, have been repaid and terminated using proceeds from the Credit Agreement. The obligations under the Credit Agreement have been guaranteed by all of our domestic subsidiaries and are secured by substantially all of our and our domestic subsidiaries' assets (other than real property), together with a pledge of 100% of the equity in our domestic subsidiaries and 65% of the equity in certain of our non-U.S. subsidiaries. The outstanding balance under the Credit Agreement may be prepaid at any time without premium or penalty. The Credit Agreement contains customary events of default and remedies upon an event of default, including the acceleration of repayment of outstanding amounts and other remedies with respect to the collateral securing the Credit Agreement obligations. The Credit Agreement includes covenants and terms that place certain restrictions on our ability to incur


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additional debt, incur additional liens, make investments, effect mergers, declare or pay dividends, sell assets, engage in transactions with affiliates, effect sale and leaseback transactions, enter into hedging agreements or make capital expenditures. Certain of the foregoing restrictions limit our ability to fund our foreign subsidiaries in excess of certain limits. Additionally, the Credit Agreement contains financial covenants requiring that we maintain a leverage ratio of not greater than 2.50 to 1.00 and a fixed charge coverage ratio (as defined in the Credit Agreement) of not less than 2.00 to 1.00. We were in compliance with such covenants at March 31, 2013. Other Commitments and Contingencies
At March 31, 2013, we had outstanding commitments for the purchase of inventory, raw materials and supplies of $14.9 million and outstanding commitments for the purchase of capital equipment of $8.7 million. Purchases under our distribution agreements were $2.1 million during the three months ended March 31, 2013.


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CAUTIONARY STATEMENT RELATING TO FORWARD LOOKING STATEMENTS This report contains various "forward looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent the Company's expectations or beliefs concerning future events, including, but not limited to, statements regarding growth in sales of the Company's products, profit margins and the sufficiency of the Company's cash flow for its future liquidity and capital resource needs. When used in this report, the terms "anticipate," "believe," "estimate," "expect" and "intend" and words or phrases of similar import, as they relate to the Company or its subsidiaries or its management, are intended to identify forward-looking statements. These forward-looking statements are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements. These factors include, without limitation, the effect of competitive pricing, the Company's dependence on the ability of its third-party suppliers to produce components on a cost-effective basis to the Company, significant expenditures of resources to maintain high levels of inventory, market acceptance of the Company's products, the impact of the medical device excise tax, the outcome of litigation, the effects of governmental regulation, potential product liability risks and risks of securing adequate levels of product liability insurance coverage, and the availability of reimbursement to patients from health care payers for procedures in which the Company's products are used. Results actually achieved may differ materially from expected results included in these statements as a result of these or other factors, including those factors discussed under "Risk Factors" in our 2012 annual report on Form 10-K and each quarterly report on Form 10-Q we have filed after this annual report. Exactech undertakes no obligation to update, and the Company does not have a policy of updating or revising, these forward-looking statements. Except where the context otherwise requires, the terms, "we", "us", "our", "the Company," or "Exactech" . . .

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