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UTMD > SEC Filings for UTMD > Form 10-Q on 8-May-2013All Recent SEC Filings

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Quarterly Report

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

UTMD manufactures and markets a well-established range of specialty medical devices. The Company's Form 10-K Annual Report for the year ended December 31, 2012 provides a detailed description of products, technologies, markets, regulatory issues, business initiatives, resources and business risks, among other details, and should be read in conjunction with this report. Because of the relatively short span of time, results for any given three month period in comparison with a previous three month period may not be indicative of comparative results for the year as a whole. Currency amounts in the report are in thousands, except per-share amounts or where otherwise noted.

Analysis of Results of Operations
a) Overview In the first calendar quarter (1Q) of 2013, profit margins improved in all income statement categories compared to the same quarter in the prior year, as follows:

                                                            1Q 2013       1Q 2012
    Gross Profit Margin (gross profits/ sales):                60.5 %        60.1 %
    Operating Profit Margin (operating profits/ sales):        37.5 %        36.7 %
    EBT Margin (profits before income taxes/ sales):           36.5 %        35.1 %
    Net Profit Margin (profit after taxes/ sales):             26.4 %        24.9 %

UTMD's operating profit margin (OPM) improved despite the new Medical Device Excise Tax (MDET), imposed as a component of the Patient Protection and Affordable Care Act (Obamacare). Without the tax, levied as 2.3% of domestic sales of medical devices, UTMD's consolidated 1Q 2013 OPM would have been 38.2%.

In 1Q of the prior year 2012, a couple of UTMD's largest OEM/international distributor customers purchased substantially more than their prior or subsequent quarterly averages. As a result, revenues and profits were lower in 1Q 2013 compared to 1Q 2012, as follows:

                                       1Q 2013       1Q 2012      change
                Net Sales            $  10,374     $  11,206        (7.4 %)
                Gross Profit             6,281         6,738        (6.8 %)
                Operating Income         3,889         4,115        (5.5 %)
                Income Before Tax        3,787         3,937        (3.8 %)
                Net Income               2,735         2,789        (1.9 %)
                Earnings per Share        .728          .759        (4.1 %)

As noted in previous reports, following the addition of Femcare, UTMD has a greater proportion of its total sales each quarter going to distributors which purchase in larger order quantities, and/or at less frequent intervals, than end-users do. This can result in more choppy revenues quarter-to-quarter.

As an alternative comparison, the following table compares 1Q 2013 performance with the average quarterly performance during 2012:

                                               Quarterly Average
                                  1Q 2013            2012             change
           Net Sales            $  10,374     $            10,388        (0.1 %)
           Gross Profit             6,281                   6,327        (0.7 %)
           Operating Income         3,889                   3,799        +2.4 %
           Income Before Tax        3,787                   3,634        +4.2 %
           Net Income               2,735                   2,542        +7.6 %
           Earnings Per Share        .728                    .685        +6.3 %

Operating expenses were $2,392 (23.1% of sales) in 1Q 2013 compared to $2,623 (23.4% of sales) in 1Q 2012. Average quarterly operating expenses were $2,528 (24.3% of sales) in the full year of 2012.

Income before taxes (EBT) was $3,787 (36.5% of sales) in 1Q 2013 compared to $3,937 (35.1% of sales) in 1Q 2012. Average quarterly EBT was $3,634 (35.0% of sales) in the full year of 2012. In addition to the improvement in OPM, 1Q 2013 EBT benefited from lower interest expense on lower loan principal balances which were obtained to help finance the acquisition of Femcare in 2011.

Net Income (NP) was $2,735 (26.4% of sales) in 1Q 2013 compared to $2,789 (24.9% of sales) in 1Q 2012. Average quarterly NP was $2,542 (24.5% of sales) in the full year of 2012. The improvement in UTMD's EBT margin was further leveraged by a lower consolidated income tax provision.

Earnings per share (EPS) were $.728 in 1Q 2013 compared to $.759 in 1Q 2012, and $.685 per quarter on the average for the full year of 2012. Diluted shares used to calculate EPS increased to 3,756,900 in 1Q 2013 from 3,674,900 in 1Q 2012 due to the exercise of employee options and the higher dilution factor applied to unexercised options as a result of a much higher average market price of UTMD stock. The number of shares added as a dilution factor in 1Q 2013 was 45,500 compared to 25,900 in 1Q 2012.

The changes in UTMD's Balance Sheet at March 31, 2013 from December 31, 2012 resulted primarily from continued excellent cash generation from operations, reduction in debt, a stronger U.S. Dollar (USD) which resulted in lower USD value of foreign subsidiary assets, a delay in payment of estimated income taxes until April (the following quarter) in contrast to other quarters in which estimated income tax payments are made within the same quarter, and the early payment of the 4Q 2012 cash dividend to shareholders in December 2012 instead of January 2013, in contrast to other quarters in which the dividend is paid in the following quarter.

b) Revenues The Company believes that revenue should be recognized at the time of shipment as title generally passes to the customer at the time of shipment, or completion of services performed under contract. Revenue recognized by UTMD is based upon documented arrangements and fixed contracts in which the selling price is fixed prior to acceptance and completion of an order. Revenue from product or service sales is generally recognized at the time the product is shipped or service completed and invoiced, and collectibility is reasonably assured. There are no post-shipment obligations which have been or are expected to be material to financial results.

There are circumstances under which revenue may be recognized when product is not shipped, which meet the criteria of SAB 104: the Company provides engineering services, for example, design and production of manufacturing tooling that may be used in subsequent UTMD manufacturing of custom components for other companies. This revenue is recognized when UTMD's service has been completed according to a fixed contractual agreement.

Terms of sale are established in advance of UTMD's acceptance of customer orders. In the U.S., Ireland, UK and Australia, UTMD generally accepts orders directly from and ships directly to end user clinical facilities, as well as third party med/surg distributors, under UTMD's Standard Terms and Conditions (T&C) of Sale. About 15% of UTMD's domestic end user sales go through third party med/surg distributors which contract separately with clinical facilities to provide purchasing, storage and scheduled delivery functions for the applicable facility. UTMD's T&C of Sale are substantially the same in the U.S., Ireland, UK and Australia.

UTMD may have separate discounted pricing agreements with a clinical facility or group of affiliated facilities based on volume of purchases. Pricing agreements with clinical facilities, or groups of affiliated facilities, if applicable, are established in advance of orders accepted or shipments made. For existing customers, past actual shipment volumes determine the fixed price by part number for the next agreement period of one or two years. For new customers, the customer's best estimate of volume is accepted by UTMD for determining the ensuing fixed prices for the agreement period. New customers typically have one-year agreements. Prices are not adjusted after an order is accepted. For the sake of clarity, the separate pricing agreements with clinical facilities based on volume of purchases disclosure is not inconsistent with UTMD's disclosure above that the selling price is fixed prior to the acceptance of a specific customer order.

Total 1Q 2013 sales were $832 (7%) lower than in 1Q 2012. Domestic sales, excluding UTMD's Femcare UK subsidiary sales to Cooper Surgical (COO) in the U.S., were 1% higher than in 1Q 2012. Total 1Q 2013 domestic sales (including Femcare UK sales to COO) were $619 (11%) lower than in 1Q 2012 because sales to COO were $656 (37%) lower.

International sales were $213 (4%) lower than in 1Q 2012. About 25% of the decline was due to a stronger USD. UTMD's Ireland subsidiary blood pressure monitoring device sales to its China distributor, which also overstocked in 1Q 2012, were $296 lower. In USD terms, international sales were 52% of total consolidated 1Q 2013 sales compared to 50% in 1Q 2012.

UTMD's Ireland subsidiary's 1Q 2013 trade shipments (excluding intercompany sales) - all in the "international sales" category - were 6% higher in USD terms and 8% higher in EURO terms compared to 1Q 2012.

UTMD's Femcare UK subsidiary's 1Q 2013 trade shipments (excluding intercompany sales) - some in the "domestic sales" category, predominantly COO, and some in the "international sales" category - were 20% lower in USD terms and 19% lower in Great Britain Pounds (GBP) terms compared to 1Q 2012.

UTMD's Femcare Australia subsidiary's 1Q 2013 trade shipments - all in the "international sales" category - were 16% lower in USD terms and 14% lower in Australia Dollar (AUD) terms compared to 1Q 2012.

The following table provides USD sales amounts divided into general product categories for total sales and the subset of international sales:

Global revenues by product category:

                                                  1Q 2013       %         1Q 2012       %
   Obstetrics                                   $   1,213        12     $   1,283        12
   Gynecology/ Electrosurgery/ Urology              5,876        56         6,655        59
   Neonatal                                         1,543        15         1,602        14
   Blood Pressure Monitoring and Accessories*       1,742        17         1,666        15

Total: $ 10,374 100 $ 11,206 100

*includes molded components sold to OEM customers.

International revenues by product category:

                                                  1Q 2013       %         1Q 2012       %
   Obstetrics                                   $     130         3     $     166         3
   Gynecology/ Electrosurgery/ Urology              3,705        69         3,929        70
   Neonatal                                           382         7           270         5
   Blood Pressure Monitoring and Accessories*       1,142        21         1,211        22

Total: $ 5,363 100 $ 5,576 100

*includes molded components sold to OEM customers.

c) Gross Profit Gross profits (GP) result from subtracting the cost of manufacturing products (direct materials, direct labor and manufacturing overhead), or the purchase price of finished products which are resold, from revenues. UTMD's gross profit margin (GPM) is gross profits as a percentage of revenues. In 1Q 2013, GP were $6,281 (60.5% GPM) compared to $6,738 (60.1% GPM) in 1Q 2012. The better GPM in 1Q 2013 was due essentially to product mix. Sales of lower margin BPM devices to UTMD's China distributor were substantially lower than in 1Q 2012.

d) Operating Income Operating income is the profit remaining after subtracting operating expenses from GP. UTMD's operating profit margin (OPM) is its operating income divided by revenues. Operating income in 1Q 2013 was $3,889 (37.5% OPM) compared to $4,115 (36.7% OPM) in 1Q 2012. A higher OPM with lower sales in 1Q 2013 represents strong operational performance. Consolidated operating expenses were $232 lower in 1Q 2013 compared to 1Q 2012, despite $75 added to 1Q 2013 operating expenses for the Obamacare MDET that weren't part of 2012 operating expenses. A stronger USD helped reduce operating expenses by about $25 when consolidating the operating expenses of foreign subsidiaries into USD terms.

Operating expenses include sales and marketing (S&M) expenses, product development (R&D) expenses and general and administrative (G&A) expenses:

Consolidated S&M expenses in 1Q 2013 were $669 (6.4% of sales) compared to $651 (5.8% of sales) in 1Q 2012. 1Q 2013 S&M expenses included the MDET. In financial projections for 2013 included in UTMD's 2012 SEC Form 10-K, management included the MDET in non-operating expenses. The change in classification from non-operating to operating expenses, more specifically S&M expenses, was the result of a recommendation by UTMD's independent accounting firm. The $75 in MDET paid in 1Q 2013 was consistent with UTMD's expectation. S&M expenses include all customer support costs including training. In general, training is not required for UTMD's products since they are well-established and have been clinically widely used. Written "Instructions For Use" are packaged with all finished devices. Although UTMD does not have any explicit contracts with customers to provide training, it does have third party group purchasing organization agreements in the U.S. and UK under which it agrees to provide hospital members inservice and clinical training as required and reasonably requested.

UTMD promises prospective customers that it will provide, at no charge in reasonable quantities, copies of videotapes and other instruction materials developed for the use of its products. UTMD provides customer support from offices in the U.S., UK, Ireland and Australia by telephone, and employed representatives on a geographically dispersed basis, to answer user questions and help troubleshoot any user issues. Occasionally, on a case-by-case basis, UTMD may utilize the services of an independent practitioner to provide educational assistance to clinicians. All inservice and training expenses are routinely expensed as they occur. Except for the consulting services of independent practitioners, all of these services are allocated from fixed S&M overhead costs included in Operating Expenses. Historically, marginal consulting costs have been immaterial to financial results.

R&D expenses in 1Q 2013 were $123 (1.2% of sales) compared to $146 (1.3% of sales) in 1Q 2012. The decrease was due to normal period to period fluctuation in project costs.

Consolidated G&A expenses in 1Q 2013 were $1,600 (15.4% of sales) compared to $1,827 (16.3% of sales) in 1Q 2012. The G&A expenses in 1Q 2013 included $625 (6.0% of sales) of non-cash expense from the amortization of identifiable intangible assets resulting from the Femcare acquisition, which were $635 (5.7% of sales) in 1Q 2012. In addition to the reduction in foreign operating expense due to a stronger USD, lower G&A expenses were primarily the result of 1) $100 lower litigation expense in the U.S.; 2) $48 lower UK expense from lower leases and rents compared to the prior year, and a foreign currency exchange gain on UK accounts receivable; and 3) $18 in lower variable expenses in Australia related to lower sales activity, and a reclassification of $22 Australia freight expense included in G&A in 2012 to S&M expense in 2013.

In addition to litigation costs, G&A expenses include the cost of outside financial auditors and corporate governance activities relating to the implementation of SEC rules resulting from the Sarbanes-Oxley Act of 2002, as well as estimated stock-based compensation cost, a noncash expense. Option compensation expense included in G&A expenses was $7 in 1Q 2013 compared to $20 in 1Q 2012.

Summary comparison of consolidated operating expenses:

                                               1Q 2013       1Q 2012
                 S&M Expense                 $     669     $     651
                 R&D Expense                       123           146
                 G&A Expense                     1,600         1,827
                 Total Operating Expenses:   $   2,392     $   2,623

e) Non-operating income/ expense Non-operating income (NOI) includes income from rent of underutilized property, investment income and royalties received from licensing the Company's technology. Non-operating expense (NOE) includes loan interest and bank fees. UTMD's reported NOE is the net of its NOE and NOI. The net is a NOE because the amount of interest that UTMD has been paying on bank loans since the 2011 Femcare acquisition substantially exceeds the sum of all of its non-operating income. (Net) NOE in 1Q 2013 was $102 compared to $178 in 1Q 2012. The decrease was primarily due to $67 lower interest expense on bank loans. In the absence of helping fund additional acquisitions of assets that improve shareholder value with debt, NOE will continue to decline as UTMD repays its current bank loans.

f) Income Before Income Taxes Income before taxes (EBT) results from subtracting NOE from operating income. EBT Margin (EBTM) is EBT divided by revenues. 1Q 2013 consolidated EBT was $3,787 (36.5% EBTM) compared to $3,937 (35.1% EBTM) in 1Q 2012. The EBT of UTMD Ltd. (Ireland) was 227 (24.5% EBTM) in 1Q 2013 compared to 122 (14.3% EBTM) in 1Q 2012. The EBT of Femcare (Femcare-Nikomed, Ltd., UK and Femcare Australia) was 1,030 (36.7% EBTM) in 1Q 2013 compared to 1,277 (37.5% EBTM) in 1Q 2012.

Excluding the noncash effects of depreciation, amortization of intangible assets, write-off of impaired assets and stock option expense, 1Q 2013 and last twelve months consolidated EBT plus interest expense were $4,710 and $18,447, respectively.

g) Net Income Net income divided by revenues is UTMD's net income margin (NPM). UTMD's consolidated net income was $2,735 (26.4% NPM) in 1Q 2013 compared to $2,789 (24.9% of sales) in 1Q 2012. The improvement in 1Q 2013 NPM compared to 1Q 2012 was due to the improvement in OPM and EBTM described above, plus a greater portion of total EBT achieved in Ireland, the lowest taxed sovereignty, and a lower corporate income tax rate in the UK. The average consolidated income tax provisions (as a % of EBT) in 1Q 2013 and 1Q 2012 were 27.8% and 29.2%, respectively.

UTMD's combined state and federal income tax rate in the U.S. after all allowable deductions was 33.1% in 1Q 2013 compared to 34.6% in 1Q 2012. The corporate income tax rate in the UK was 24% in 1Q 2013 compared to 26% in 1Q 2012. As of April 1, 2013, the UK corporate tax rate was reduced again, from 24% to 23%, which will further benefit UTMD's NPM during the remainder of 2013. The income tax rate in Australia has been and remains 30%. UTMD Ltd (Ireland) tax provision rate was 13.2% in 1Q 2013.

h) Earnings Per Share Earnings per share (EPS) are net income divided by the number of shares of stock outstanding (diluted to take into consideration stock option awards which are "in the money," i.e., have exercise prices below the applicable period's weighted average market value). Diluted EPS were $0.728 in 1Q 2013 compared to $0.759 in 1Q 2012. Average quarterly EPS for the full year of 2012 were $.685. EPS for the most recent twelve months were $2.71.

1Q 2013 weighted average number of diluted common shares (the number used to calculate diluted EPS) were 3,756,900 compared to 3,674,900 shares in 1Q 2012. Employees exercised options for 32,008 shares in 1Q 2013. Options outstanding at March 31, 2013 were 116,300 shares at an average exercise price of $27.04 per share, including shares awarded but not vested. This compares to 202,000 unexercised option shares outstanding at March 31, 2012.

Increases and decreases in UTMD's stock price impact EPS as a result of the dilution calculation for unexercised options with exercise prices below the average stock market value during each period. The dilution calculation added 45,500 shares to actual weighted average shares outstanding in 1Q 2013 compared to 25,900 in 1Q 2012. Actual outstanding common shares as of the end of 1Q 2013 were 3,722,100 compared to 3,668,200 at the end of 1Q 2012. The Company did not repurchase any of its shares in the open market in 1Q 2013 or in 1Q 2012. UTMD retains its program for repurchasing shares when they seem undervalued.

i) Return on Equity Return on equity (ROE) is the portion of net income retained by UTMD to internally finance its growth, divided by the average accumulated stockholder equity for the applicable time period. Annualized ROE in 1Q 2013 was 22% compared to 26% in 1Q 2012. Both periods did not include a dividend payment. The dividend that normally would have been paid in early January was paid in late December of both prior years. The lower ROE in 1Q 2013 was due primarily to higher average stockholders' equity.

Liquidity and Capital Resources

j) Cash flows Net cash provided by operating activities, including adjustments for depreciation and amortization and other non-cash expenses along with changes in working capital, totaled $2,719 in 1Q 2013 compared to $3,434 in 1Q 2012. The most significant differences in the two periods were use of cash of $493 from a smaller increase in accrued expenses and $311 from increased inventories, offset by a $270 benefit to cash from a smaller increase in accounts receivable in 1Q 2013.

The Company's use of cash to pay down its bank loan principal balances was the most significant use of cash in either period. UTMD repaid $969 on its notes during 1Q 2013, compared to $2,464 during 1Q 2012. All of UTMD's notes are scheduled to be repaid by April, 2016. UTMD did not make cash dividend payments during either 1Q 2013 or 1Q 2012, as the dividends which would normally be paid in January were paid in December of the prior applicable year.

Capital expenditures for property and equipment (PP&E) were $52 in 1Q 2013 compared to $61 in 1Q 2012. In contrast, depreciation of PP&E was $155 in 1Q 2013 and $169 in 1Q 2012. Planned capital expenditures during 2013 are expected to be less than depreciation of PP&E. The Company will continue to keep facilities, equipment and tooling in good working order.

In 1Q 2013, UTMD received $340 and issued 19,268 shares of its stock upon the exercise of employee stock options, net of 12,740 shares retired upon employees trading those shares in payment of the stock option exercise price and related taxes. Option exercises in 1Q 2013 were at an average price of $25.23 per share. In comparison, in 1Q 2012, the Company received $585 from issuing 28,172 shares of stock on the exercise of employee and director stock options, net of 2,969 shares retired upon employees trading those shares in payment of the stock option exercise price. UTMD did not repurchase any of its own shares of stock in the open market during either 1Q 2013 or 1Q 2012.

Management believes that income from operations and effective management of working capital will provide the liquidity needed to finance its internal growth plans. In addition, the Company may use cash for marketing or product manufacturing rights to broaden the Company's product offerings; for continued share repurchases when the price of the stock is undervalued; and if available for a reasonable price, an acquisition that might strategically fit UTMD's business and be accretive to performance.

k) Assets and Liabilities March 31, 2013 total assets decreased $574 from December 31, 2012, essentially due to a strengthening of the USD compared to the GBP and EURO. UTMD's Ireland subsidiary assets were translated into USD at a rate 2.8% lower than the EURO to USD conversion rate at the end 2012. UTMD's Femcare UK subsidiary assets were translated into USD at a rate 6.5% lower than the GBP to USD conversion rate at the end 2012. Femcare's March 31, 2013 intangible assets were $2,746 lower than they would have been at the December 31, 2012 GBP/USD exchange rate. Cash increased $1,999 during the quarter. Accounts and other receivables increased $1,022. Inventories increased $53, and other current assets decreased $18 during 1Q 2013. Inventory and receivables balances were within management's productivity targets.

Working capital (current assets minus current liabilities) was $12,573 at March 31, 2013, compared to $10,712 at December 31, 2012. Current liabilities increased $1,201, including a $1,229 increase in accrued expenses. The accrued expenses increase was due to 1) the 1Q 2013 quarterly dividend payment to shareholders of $911 accrued but not paid until after March 31, whereas the 4Q 2012 dividend payment was paid before the end of December 2012, and 2) the 1Q 2013 estimated income tax payment was not due to be paid until April 15, whereas the estimated taxes in 4Q 2012 were paid by December 15. UTMD believes that its working capital remains sufficient to meet normal operating needs, debt service requirements and cash dividend payments to shareholders.

Intangible assets (Goodwill plus Other intangible assets) decreased $3,410. As noted above, the decrease was due to a stronger USD relative to GBP at March 31, 2013 compared to December 31, 2012. Amortization of identifiable intangible assets was $625 in 1Q 2013. At March 31, 2013, net intangible assets including goodwill were 61% of total assets compared to 65% at year-end 2012.

Net property and equipment decreased $225 in 1Q 2013. Depreciation of $155 exceeded capital expenditures of $52.

UTMD's principal balance of bank debt at March 31, 2013 was 1) $4,200 to Chase in the U.S., of which $2,800 is long term debt, and 2) $7,294 (4,800) to JP Morgan Chase in the U.K., of which $4,863 (3,200) is long term debt. The loan principal balances at March 31, 2013 declined $350 in the U.S. and 400 in the UK from the end of 2012. The deferred tax liability balance for Femcare identifiable intangible assets ($9,084 on the date of the acquisition), was $7,733 at March 31, 2013. Reduction of the deferred tax liability occurs as the book/tax difference of amortization is eliminated over the remaining useful life of the identifiable intangible assets. UTMD's total debt ratio (total liabilities/ total assets) as of March 31, 2013 was 34%, the same as on December 31, 2012. UTMD's total debt ratio on March 31, 2012 was 44%.

l) Management's Outlook. As outlined in its December 31, 2012 10-K report, UTMD's plan for 2013 is to
1) continue to exploit distribution and manufacturing synergies by further integrating capabilities and resources in its multinational operations;
2) introduce additional gynecology products helpful to clinicians through internal new product development;
3) continue achieving excellent overall financial operating performance;
4) utilize positive cash generation to pay down debt, continue cash dividends to shareholders and continue open market share repurchases if/when the UTMD share price seems undervalued; and
5) be vigilant for accretive acquisition opportunities which may be increasingly brought about by difficult burdens on small, innovative companies, including especially the MDET.

Management believes it remains on track after 1Q 2013 to accomplish its previously stated objectives for 2013.

m) Accounting Policy Changes. None.

Forward-Looking Information. This report contains certain forward-looking . . .

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