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WMGI > SEC Filings for WMGI > Form 10-Q on 6-Aug-2013All Recent SEC Filings

Show all filings for WRIGHT MEDICAL GROUP INC

Form 10-Q for WRIGHT MEDICAL GROUP INC


6-Aug-2013

Quarterly Report


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

General
The following management's discussion and analysis of financial condition and results of operations describes the principal factors affecting the results of our operations, financial condition, and changes in financial condition for the three and six month periods ended June 30, 2013. This discussion should be read in conjunction with the accompanying unaudited financial statements, our Annual Report on Form 10-K for the year ended December 31, 2012, which includes additional information about our critical accounting policies and practices and risk factors, and Note 1 of Part I of this Quarterly Report and Part II, Item 1A of this Quarterly Report.
On June 19, 2013, we entered into a definitive agreement with MicroPort Scientific Corporation (MicroPort) under which we will sell our OrthoRecon business. The OrthoRecon business consists of hip and knee implant products. We determined that this agreement meets the criteria for classification as discontinued operations. As such, the financial results of our OrthoRecon business have been reflected within discontinued operations for all periods presented and the discussion below is on a continuing operations basis. Executive Overview
Company Description. We are a global orthopaedic company that provides solutions that enable clinicians to alleviate pain and restore their patients' lifestyles. We are a recognized leader of surgical solutions for the foot and ankle market and market our products in over 60 countries worldwide. Our products are used primarily in foot and ankle repair, upper extremity products, and biologics products, which are used to replace damaged or diseased bone, to stimulate bone growth and to provide other biological solutions for surgeons and their patients. Extremity hardware includes implants and other devices to replace or reconstruct injured or diseased joints and bones of the foot, ankle, hand, wrist, elbow and shoulder, which we generally refer to as either foot and ankle or upper extremity products. Our extensive foot and ankle product portfolio, our approximately 200 specialized foot and ankle sales representatives, and our increasing level of training of foot and ankle surgeons has resulted in us being a recognized leader in the foot and ankle market.


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Biologics are used to repair or replace damaged or diseased bone, to stimulate bone growth and to provide other biological solutions for surgeons and their patients.
Our corporate headquarters and U.S. operations are located in Arlington, Tennessee, where we conduct research and development, sales and marketing administration, manufacturing, warehousing and administrative activities. Outside the U.S., we have distribution and administrative facilities in Amsterdam, the Netherlands, and sales and distribution offices in Canada, Japan and throughout Europe.
Principal Products. We specialize in extremity and biologic products used by extremity focused surgeon specialists for the reconstruction, trauma, and arthroscopy markets. Our biologics sales encompass a broad portfolio of products designed to stimulate and augment the natural regenerative capabilities of the human body.
Significant Quarterly Business Developments. On June 19, 2013, we entered into a definitive agreement with MicroPort under which MicroPort Medical B.V., a subsidiary of MicroPort, will acquire our OrthoRecon business. The purchase price is $290 million, subject to a net working capital adjustment, and is payable in cash at closing, which is expected to occur by the end of the third quarter or early in the fourth quarter of 2013. The transaction is subject to customary closing conditions, including MicroPort shareholder approval and receipt of regulatory clearances.
Our OrthoRecon business consists of hip and knee implant products and generated global revenue of approximately $269 million in 2012. The OrthoRecon business has established hip and knee franchise brands including DYNASTY® and CONSERVE® hips, PROFEMUR® modular stems, SUPERPATH™ minimally invasive hip surgical instrumentation, and ADVANCE® and EVOLUTION® medial-pivot knee implants. We have accounted for the OrthoRecon business as a discontinued operation in our financial statements.
Net sales from our continuing operations increased 17% in the quarter ended June 30, 2013 (second quarter) to $60.6 million, compared to net sales of $52.0 million in the quarter ended June 30, 2012, driven primarily by a 29% increase in global foot and ankle sales. In the second quarter of 2013, we recorded a net loss from continuing operations of $15.5 million, compared to a net loss of $1.4 million for the second quarter of 2012.
Items favorably impacting net loss in the second quarter of 2013 as compared to the second quarter of 2012 included:
• an unrealized gain of $1.0 million ($0.6 million net of taxes) associated with the mark-to-market adjustment on our derivative assets and liabilities; and

• a $0.3 million ($0.2 million net of taxes) decrease in restructuring charges.

Items unfavorably impacting net loss in the second quarter of 2013 included:
• an unrealized loss of $5.8 million ($5.8 million net of taxes) associated with the mark-to-market adjustment on the contingent value rights (CVRs) issued in connection with the acquisition of BioMimetic;

• $2.6 million ($1.6 million net of taxes) of transition costs associated with the sale of our OrthoRecon business;

• non-cash interest expense of $2.2 million ($1.3 million net of taxes) associated with the our 2017 Convertible Notes;

• charges of $1.4 million ($0.9 million net of taxes) for transition costs associated with our acquisition of BioMimetic that closed during the first quarter of 2013;

• a $0.5 million ($0.3 million net of taxes) increase in charges associated with transitioning a major portion of our U.S. independent distributor foot and ankle territories to direct employee sales representation; and

• decreased profitability primarily driven by investments in our direct U.S. foot and ankle sales force and operating losses associated with the acquired BioMimetic business.

Geographically, our second quarter of 2013 domestic sales increased 5%, as a 15% increase in foot and ankle sales and a 1% increase in upper extremity sales was partially offset by a 16% decline in biologics sales.
Our international sales increased 59% to $17.9 million in the second quarter of 2013, compared to $11.2 million in the second quarter of 2012, primarily due to a 29% increase in Europe and the impact of certain stocking orders in Asia. In addition, we incurred a $0.3 million unfavorable impact from currency exchange rates.
Opportunities and Challenges. Following the closing of the transaction with MicroPort, we expect to be well positioned and committed to accelerating growth in our foot and ankle business and increasing U.S. foot and ankle sales productivity. We have made changes to attempt to realize these opportunities, including aggressively converting a portion of our U.S. independent distributor foot and ankle territories to direct employee sales representation, and substantially increasing our investment in foot and ankle medical education to drive market adoption of new products and technologies. With the acquisition of BioMimetic, we have an opportunity to transform our biologics business and further accelerate our growth. These transformational changes for our business have required significant investment; however, we believe these investments will improve the performance of our business in the longer term.


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Significant Industry Factors. Our industry is affected by numerous competitive, regulatory, and other significant factors. The growth of our business relies on our ability to continue to develop new products and innovative technologies, obtain regulatory clearance and compliance for our products, protect the proprietary technology of our products and our manufacturing processes, manufacture our products cost-effectively, respond to competitive pressures specific to each of our geographic markets, including our ability to enforce non-compete agreements, and successfully market and distribute our products in a profitable manner. We, and the entire industry, are subject to extensive governmental regulation, primarily by the FDA. Failure to comply with regulatory requirements could have a material adverse effect on our business.

Results of Operations
On June 19, 2013, we entered into a definitive agreement with MicroPort under which we will sell our OrthoRecon business. The OrthoRecon business consists of hip and knee implant products. We determined that this agreement meets the criteria for classification as discontinued operations. As such, the financial results of our OrthoRecon business have been reflected within discontinued operations for all periods presented and the discussion below is on a continuing operations basis.
Comparison of three months ended June 30, 2013 to three months ended June 30, 2012
The following table sets forth, for the periods indicated, our results of operations expressed as dollar amounts (in thousands) and as percentages of net sales:

                                                       Three Months Ended June 30,
                                                    2013                        2012
                                            Amount      % of Sales      Amount      % of Sales
Net sales                                 $  60,572        100.0 %    $  51,964        100.0 %
Cost of sales 1                              14,564         24.0 %       11,779         22.7 %
Gross profit                                 46,008         76.0 %       40,185         77.3 %
Operating expenses:
Selling, general and administrative 1        50,543         83.4 %       35,885         69.1 %
Research and development 1                    5,868          9.7 %        3,490          6.7 %
Amortization of intangible assets             2,778          4.6 %          982          1.9 %
Restructuring charges                             -            - %          254          0.5 %
Total operating expenses                     59,189         97.7 %       40,611         78.2 %
Operating loss                              (13,181 )      (21.8 %)        (426 )       (0.8 %)
Interest expense, net                         3,990          6.6 %        1,887          3.6 %
Other expense (income), net                   4,577          7.6 %         (321 )       (0.6 %)
Loss from continuing operations before
income taxes                                (21,748 )      (35.9 %)      (1,992 )       (3.8 %)
Benefit for income taxes                     (6,209 )      (10.3 %)        (625 )       (1.2 %)
Net loss from continuing operations         (15,539 )      (25.7 %)      (1,367 )       (2.6 %)
(Loss) income from discontinued
operations, net of tax (1)                   (1,792 )                     2,077
Net (loss) income                         $ (17,331 )                 $     710


__________________________


(1) These line items include the following amounts of non-cash, stock-based compensation expense for the periods indicated:

                                                         Three Months Ended June 30,
                                              2013        % of Sales        2012        % of Sales
Cost of sales                             $      143          0.2 %     $      177          0.3 %
Selling, general and administrative            2,502          4.1 %          2,098          4.0 %
Research and development                         247          0.4 %            124          0.2 %
(Loss) income from discontinued
operations, net of tax                         1,011          n/a              990          n/a


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The following table sets forth our net sales by product line for the periods indicated (in thousands) and the percentage of year-over-year change:

Three Months Ended June 30,
                      2013            2012      % Change
Foot and Ankle  $    37,316         $ 28,880      29.2 %
Upper Extremity       6,087            6,349      (4.1 %)
Biologics            15,091           15,454      (2.3 %)
Other                 2,078            1,281      62.2 %
Total Sales     $    60,572         $ 51,964      16.6 %

The following table presents net sales by geographic area (in thousands):

Three Months Ended June 30,
                       2013            2012      % Change
Geographic
Domestic        $    42,640          $ 40,721        4.7 %
International        17,932            11,243       59.5 %
Total net sales $    60,572          $ 51,964       16.6 %

Net Sales
Net sales totaled $60.6 million in the second quarter of 2013, as compared to $52.0 million in the second quarter of 2012. The 17% increase was driven by 29% growth in our foot and ankle business, offset by a 2% decline in our biologics business and a 4% decline in upper extremities.
Our foot and ankle net sales increased to $37.3 million in the second quarter of 2013, representing growth of 29% over the second quarter of 2012. Domestically, foot and ankle product sales increased 15% over the second quarter of 2012, due to the continued success of our ORTHOLOC® 3Di Reconstruction Plating System launched in the second quarter of 2012, as well as continued growth of our INBONE® Total Ankle Arthroplasty products. Our international foot and ankle sales grew 92% to $10.4 million as a result of $0.8 million of increased sales in Europe due to the acquisition of a foot and ankle business in the quarter ended March 31, 2013 and $2.1 million of certain stocking orders in Asia as the result of the addition of a new distribution partner in China. The remaining growth is a result of increased focus on our foot and ankle business across all international geographies.
Upper extremity net sales decreased to $6.1 million in the second quarter of 2013, representing a decline of 4% over the second quarter of 2012, driven primarily by unfavorable currency exchange rates.
Net sales of our biologics products totaled $15.1 million in the second quarter of 2013, representing a 2% decrease from the second quarter of 2012. In the U.S., our biologics sales decreased 16% in 2013, due to lower sales volume. Cost of Sales
Our cost of sales as a percentage of net sales increased to 24.0% in the second quarter of 2013, as compared to 22.7% in the second quarter of 2012, primarily due to unfavorable geographic mix, partially offset by favorable provisions for excess and obsolete inventory. Our cost of sales and corresponding gross profit percentages can be expected to fluctuate in future periods depending upon changes in our product sales mix and prices, distribution channels and geographies, manufacturing yields, period expenses, levels of production volume, cost of raw materials, and currency exchange rates. Selling, General and Administrative
Our selling, general and administrative expenses as a percentage of net sales totaled 83.4% in the second quarter of 2013, compared to 69.1% in the second quarter of 2012. Selling, general and administrative expense for the second quarter of 2013 included $2.6 million of transition costs associated with the sale of our OrthoRecon business (4.3% of net sales), $1.4 million of transition costs related to our acquisition of BioMimetic (2.4% of net sales), and $0.3 million of cost related to distributor transition agreements (0.6% of net sales). Selling, general and administrative expense for the second quarter of 2012 included $0.2 million of cost related to distributor transition agreements (0.4% of net sales). The remaining increase is the result of $2.7 million of expenses associated with the acquired BioMimetic business (4.5% of net sales), $0.8 million of taxes related to the enacted 2.3% excise tax on U.S. sales of medical devices (1.3% of net sales), and increased sales and marketing costs as a result of our initiative to convert a substantial portion of our U.S. foot and ankle sales force to direct employees.


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Our selling, general and administrative expenses in continuing operations will increase after the sale of our OrthoRecon business is complete, due to anticipated dis-synergies in certain corporate and international expenses that have been recorded in discontinued operations in our condensed consolidated financial statements. These dis-synergies include expenses associated with our information technology support, a new corporate headquarters, and international employees and facilities.
Research and Development
Our investment in research and development activities represented approximately 9.7% of net sales in the second quarter of 2013, as compared to 6.7% of net sales in the second quarter of 2012. Our research and development expenses include $0.2 million (0.4% of net sales) of non-cash, stock-based compensation expense in the second quarter of 2013 and $0.1 million (0.2% of net sales) of non-cash, stock-based compensation expense in the second quarter of 2012. The increase in research and development costs as a percentage of net sales is attributable to spending associated with the acquired BioMimetic business. Our research and development expenses in continuing operations will increase after the sale of our OrthoRecon business is complete, due to anticipated dis-synergies in certain employee-related expenses that have been recorded in discontinued operations in our condensed consolidated financial statements. Amortization of Intangible Assets
Charges associated with the amortization of intangible assets totaled $2.8 million (4.6% of net sales) in the second quarter of 2013, as compared to $1.0 million (1.9% of net sales) in the second quarter of 2012. This increase is primarily attributable to approximately $1.0 million of impairment charges associated with certain intangible assets acquired in prior periods and a $0.3 million increase in amortization expense associated with distributor non-compete agreements entered into during the second and third quarters of 2012. The remaining increase is due to amortization of intangible assets of the acquired BioMimetic and WG Healthcare businesses. Based on the intangible assets held as of June 30, 2013, excluding amortization associated with Augment® Bone Graft, which remains subject to FDA approval, we expect to recognize amortization expense of approximately $6.3 million for the full year of 2013, $4.5 million in 2014, $2.8 million in 2015, $2.0 million in 2016, and $1.8 million in 2017. Based upon our preliminary value of IPR&D, we anticipate an increase in amortization expense of approximately $4 million to $5 million per year, if and when, Augment® Bone Graft is approved by the FDA. Our amortization expense will also be impacted when other IPR&D projects reach technological feasibility. Interest Expense, Net
Interest expense, net, consists of interest expense of $4.1 million during the second quarter of 2013 and $2.0 million during the second quarter of 2012, offset by interest income of $0.1 million during the second quarter of 2013 and 2012. Our interest expense during the second quarter of 2013 relates primarily to $1.5 million of interest expense on our 2017 Notes and $2.2 million of non-cash interest expense associated with the amortization of the discount on our 2017 Notes. Our interest income is generated by our invested cash balances and investments in marketable securities. The amounts of interest income we expect to realize in 2013 and beyond are subject to variability, dependent upon both the rate of invested returns we realize and the amount of excess cash balances on hand.
Other (Income) Expense, Net
Other (income) expense, net was $4.6 million in the second quarter of 2013, compared to ($0.3 million) in the second quarter of 2012. For the second quarter of 2013, other (income) expense, net includes an unrealized loss of $5.8 million on CVRs issued in connection with the acquisition of BioMimetic, partially offset by an unrealized gain of $1.0 million for mark-to-market adjustments on our derivative asset and liability.
Provision for Income Taxes
We recorded an income tax benefit of $6.2 million in the second quarter of 2013, compared to $0.6 million in the second quarter of 2012. During the second quarter of 2013, our effective tax rate was approximately 28.5% as compared to 31.4% in the second quarter of 2012. The decrease in the effective tax rate is primarily related to the impact of the non-deductible mark-to-market adjustment on CVRs issued in connection with the acquisition of BioMimetic on our taxable income.
Discontinued Operations, net of Tax
Discontinued operations, net of tax, consists of our OrthoRecon business for which we have entered into a definitive agreement to sell to MicroPort. In addition, costs associated with corporate employees and infrastructure being transferred as a part of the sale have been included in discontinued operations. Net sales of our OrthoRecon business totaled $60.2 million in the second quarter of 2013, as compared to $71.3 million in the second quarter of 2012, a 16% decline, driven by an 18% decrease in hip sales and a 12% decrease in knee sales.
Our hip product net sales totaled $32.7 million during the second quarter of 2013, down from $40.1 million in the second quarter of 2012. Our domestic hip sales decreased 12% over prior year, primarily due to a 9% decrease in volume as the result of customer


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losses during 2012. International hip sales declined 22% from the prior year primarily due to the conversion of our Belgium subsidiary to a stocking distributor late in the second quarter of 2012, as well as the negative impact of $1.8 million of unfavorable currency exchange rates.

Our knee product net sales totaled $26.6 million during the second quarter of 2013, down from $30.2 million in the second quarter of 2012. Our domestic knee sales decreased 16% over prior year, primarily due to a 16% decrease in volume as the result of customer losses during 2012. International knee sales declined 8% from the prior year primarily due to the negative impact of $0.5 million of unfavorable currency exchange rates.

Loss from discontinued operations, net of tax, was $1.8 million in the second quarter of 2013, as compared to income from discontinued operations, net of tax of $2.1 million in the second quarter of 2012. The decrease in net income was primarily driven by the decrease in sales year over year, the after tax impact of $2.8 million of legal and professional fees associated with the MicroPort transaction, and $0.5 million of taxes related to the enacted 2.3% excise tax on U.S. sales of medical devices, partially offset by the after tax impact of a $1.4 million decrease in expenses associated with the deferred prosecution agreement and U.S. governmental inquiries.

Comparison of six months ended June 30, 2013 to six months ended June 30, 2012 The following table sets forth, for the periods indicated, our results of operations expressed as dollar amounts (in thousands) and as percentages of net sales:

                                                        Six Months Ended June 30,
                                                    2013                        2012
                                            Amount      % of Sales      Amount      % of Sales
Net sales                                 $ 116,865        100.0 %    $ 104,837        100.0 %
Cost of sales 1                              28,261         24.2 %       23,213         22.1 %
Gross profit                                 88,604         75.8 %       81,624         77.9 %
Operating expenses:
Selling, general and administrative 1       101,252         86.6 %       70,409         67.2 %
Research and development 1                    9,375          8.0 %        6,851          6.5 %
Amortization of intangible assets             4,384          3.8 %        1,637          1.6 %
Restructuring charges                             -            - %          431          0.4 %
Total operating expenses                    115,011         98.4 %       79,328         75.7 %
Operating (loss) income                     (26,407 )      (22.6 %)       2,296          2.2 %
Interest expense, net                         7,935          6.8 %        3,694          3.5 %
Other income, net                            (1,272 )       (1.1 %)        (334 )       (0.3 %)
Loss from continuing operations before
income taxes                                (33,070 )      (28.3 %)      (1,064 )       (1.0 %)
Benefit for income taxes                    (12,613 )      (10.8 %)        (121 )       (0.1 %)
Net loss from continuing operations         (20,457 )      (17.5 %)        (943 )       (0.9 %)
Income from discontinued operations, net
of tax 1                                     11,561                       6,214
Net (loss) income                         $  (8,896 )                 $   5,271


__________________________


1 These line items include the following amounts of non-cash, stock-based compensation expense for the periods indicated:

                                                            Six Months Ended June 30,
                                                2013           % of Sales        2012        % of Sales
Cost of sales                             $      290               0.2 %     $      355          0.3 %
Selling, general and administrative            6,147               5.3 %          3,463          3.3 %
Research and development                         368               0.3 %            200          0.2 %
Income from discontinued operations, net
of tax                                         1,716               n/a            1,754          n/a


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The following table sets forth our net sales by product line for the periods indicated (in thousands) and the percentage of year-over-year change:

Six Months Ended June 30,
                   2013          2012      % Change
Foot and Ankle  $   72,393    $  58,507      23.7 %
Upper Extremity     12,149       12,894      (5.8 %)
Biologics           28,748       30,641      (6.2 %)
Other                3,575        2,795      27.9 %
Total Sales     $  116,865    $ 104,837      11.5 %

The following table presents net sales by geographic area (in thousands):

Three Months Ended June 30,
                      2013             2012      % Change
Geographic
Domestic        $     85,401        $  81,642        4.6 %
International         31,464           23,195       35.6 %
Total net sales $    116,865        $ 104,837       11.5 %

Net Sales
Net sales totaled $116.9 million during the first six months of 2013, as compared to $104.8 million in the first six months of 2012. The 11% increase was driven by 24% growth in our foot and ankle business, offset by a 6% decline in our biologics business and a 6% decline in upper extremities.
Our foot and ankle net sales increased to $72.4 million in the first six months of 2013, representing growth of 24% over the first six months of 2012. . . .

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