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RTIX > SEC Filings for RTIX > Form 10-Q on 7-Aug-2013All Recent SEC Filings

Show all filings for RTI SURGICAL, INC.

Form 10-Q for RTI SURGICAL, INC.


7-Aug-2013

Quarterly Report


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

Cautionary Statement Relating to Forward Looking Statements

Certain information included in this filing contains "forward-looking statements" which can be identified by the use of forward-looking terminology such as "believes," "expects," "may," "will," "should," "anticipates" or comparable terminology, or by discussions of strategy. There can be no assurance that the future results covered by these forward-looking statements will be achieved. Some of the matters described in the "Risk Factors" section of our Form 10-K constitute cautionary statements which identify factors regarding these forward-looking statements, including certain risks and uncertainties, that could cause actual results to vary materially from the future results indicated in these forward-looking statements. Other factors could also cause actual results to vary materially from the future results indicated in such forward-looking statements.

Management Overview

RTI Surgical, Inc., together with its subsidiaries, produces orthopedic and other surgical implants that repair and promote the natural healing of human bone and other human tissues. We process donated human musculoskeletal and other tissues, including bone, cartilage, tendon, ligament, fascia lata, pericardium, sclera, and dermal tissues, as well as bovine animal tissues to produce allograft and xenograft implants by utilizing our proprietary BIOCLEANSE ®, TUTOPLAST® and CANCELLE™ SP sterilization processes. We process and distribute human and bovine animal tissues for use in the fields of sports medicine, spine, surgical specialties, bone graft substitutes, and general orthopedic and dental. We market our implants through a direct distribution organization, as well as through a network of independent distributors to hospitals and surgeons in the United States and internationally. We were founded in 1997 and are headquartered in Alachua, Florida.

Domestic distributions and services accounted for 89% of total revenues in the first six months of 2013. Most of our implants are distributed directly to doctors, hospitals and other healthcare facilities through a direct distribution force and through various strategic relationships.

International distributions and services accounted for 11% of total revenues in the first six months of 2013. Our implants are distributed in over 30 countries through a direct distribution force in Germany and through stocking distributors in the rest of the world outside of Germany and the U.S.

Our business is generally not seasonal in nature; however, the number of orthopedic implant surgeries and elective procedures generally declines during the summer months.

Our principal goals are to honor the gift of donated tissue, donor families, and patients while building our competitive strength in the marketplace to increase revenues, profitability and cash flow as we focus on improved operational efficiency, productivity and asset management. We are making investments in new implant and product development and our U.S. direct distribution network to promote growth in 2013 and beyond.

We continue to maintain our commitment to research and development and the introduction of new strategically targeted allograft and xenograft implants as well as focused clinical efforts to support their acceptance in the marketplace. In addition, we consider strategic acquisitions for new implants and technologies intended to augment our existing implant offerings.

Acquisition of Pioneer Surgical Technology, Inc.

We completed our acquisition of Pioneer Surgical Technology, Inc., a Michigan corporation ("Pioneer"), on July 16, 2013. Under the terms of the merger agreement dated June 12, 2013, we acquired Pioneer for $126.4 million in cash. The transaction was funded through a combination of cash on hand, a new credit facility and a concurrent private placement of convertible preferred equity. We obtained from TD Bank, N.A., TD Securities "USA" LLC and Regions Bank, a 5 year, $80.0 million senior secured facility, which includes a $60.0 million term loan and a $20.0 million revolving credit facility, that matures on July 16, 2018 with a variable interest rate between


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100 and 175 basis points in excess of the one month LIBOR rate. The $20.0 million revolving credit facility replaced our existing $15.0 million U.S. credit facility. Additionally, we received $50.0 million in proceeds from a private placement of convertible preferred equity to Water Street Healthcare Partners, a leading healthcare-focused private equity firm. The convertible preferred stock will be convertible into shares of our common stock, subject to the satisfaction of certain conditions. The convertible preferred stock will also accrue dividends at a rate of 6 percent per year, subject to adjustment under specified conditions. In the third quarter of 2013, we recorded $1.8 million in financing costs and expensed $3.5 million in investment banker fees at the time of closing of the acquisition.

We believe that the acquisition of Pioneer offers the potential for substantial strategic and financial benefits. The transaction will enhance our existing core competency in biologics processing with the addition of Pioneer's core competency in metals and synthetics. We believe the acquisition will enhance stockholder value through, among other things, enabling us to capitalize on the following strategic advantages and opportunities:

• Diversification of our implant portfolio.

• Expansion of our direct distribution and marketing organizations.

• Enhancement of our current international business.

• Improvement of our margin profile and revenue growth opportunities.

We will account for the acquisition of Pioneer under ASC ("Accounting Standards Codification") 805, Business Combinations. Pioneer's results of operations will be included in the consolidated financial statements for periods ending after July 16, 2013, the acquisition date. Given the date of the acquisition, we have not completed the valuation of assets acquired and liabilities assumed which is in process. We anticipate providing a preliminary purchase price allocation, qualitative description of factors that make up goodwill to be recognized, and supplemental pro forma financial information for the third quarter ended September 30, 2013 to be filed on or before November 9, 2013. Acquisition expenses of $1.5 million were incurred in the three and six months ended June 30, 2013 and are reflected separately in the accompanying Condensed Consolidated Statements of Comprehensive (Loss) Income.

Additionally, on July16, 2013, we changed our name from RTI Biologics, Inc. to RTI Surgical, Inc.

Three and Six Months Ended June 30, 2013 Compared with Three and Six Months
Ended June 30, 2012



                                           Three Months Ended          Six Months Ended
                                                June 30,                   June 30,
                                            2013          2012         2013         2012
                                                          (In Thousands)
    Revenues from tissue distribution:
    Sports medicine                      $   11,657     $ 13,337     $ 22,168     $ 26,762
    Spine                                    11,221        9,785       21,320       18,345
    Surgical specialties                      6,875        8,459       13,829       16,256
    BGS and general orthopedic                6,050        7,016       11,401       14,031
    Dental                                    5,006        5,114        9,179       10,438
    Other revenues                            1,500        1,486        4,834        3,108

    Total revenues                       $   42,309     $ 45,197     $ 82,731     $ 88,940

    Domestic revenues                        37,413       39,191       73,527       77,064
    International revenues                    4,896        6,006        9,204       11,876

    Total revenues                       $   42,309     $ 45,197     $ 82,731     $ 88,940


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Three Months Ended June 30, 2013 Compared With Three Months Ended June 30, 2012

Revenues. Our total revenues decreased by $2.9 million, or 6.4%, to $42.3 million for the three months ended June 30, 2013 compared to $45.2 million for the three months ended June 30, 2012. Our revenues were negatively impacted in the three months ended June 30, 2013 as a result of continued customer reaction to a U.S. Food and Drug Administration warning letter received in the fourth quarter of 2012.

Sports Medicine-Revenues from sports medicine allografts decreased $1.7 million, or 12.6%, to $11.7 million for the three months ended June 30, 2013 compared to $13.3 million for the three months ended June 30, 2012. Sports medicine revenues decreased primarily as a result of lower unit volumes of 15.7% partially offset by higher average revenue per unit of 3.6%, primarily due to changes in distribution mix.

Spine-Revenues from spinal allografts increased $1.4 million, or 14.7%, to $11.2 million for the three months ended June 30, 2013 compared to $9.8 million for the three months ended June 30, 2012. Spine revenues increased primarily as a result of higher unit volumes of 10.7% and higher average revenue per unit of 3.6%, primarily due to changes in distribution mix.

Surgical Specialties-Revenues from surgical specialty allografts decreased $1.6 million, or 18.7%, to $6.9 million for the three months ended June 30, 2013 compared to $8.5 million for the three months ended June 30, 2012. Surgical specialties revenues decreased as a result of lower unit volumes of 14.4% and lower average revenue per unit of 5.5%.

Bone Graft Substitutes (BGS) and General Orthopedic-Revenues from BGS and general orthopedic allografts decreased $966,000, or 13.8%, to $6.1 million for the three months ended June 30, 2013 compared to $7.0 million for the three months ended June 30, 2012. BGS and general orthopedic revenues decreased primarily as a result of lower average revenue per unit of 17.3%, primarily due to changes in distribution mix, partially offset by an increase in unit volumes of 3.8%.

Dental-Revenues from dental allografts decreased $108,000, or 2.1%, to $5.0 million for the three months ended June 30, 2013 compared to $5.1 million for the three months ended June 30, 2012. Dental revenues decreased primarily as a result of lower average revenue per unit of 1.4%, primarily due to changes in product mix, as well as a decrease in unit volumes of 1.2%.

Other Revenues-Revenues from other sources consisting of tissue recovery fees, biomedical laboratory fees, recognition of previously deferred revenues, shipping fees, distribution of reproductions of our allografts to distributors for demonstration purposes and restocking fees were comparable for the three months ended June 30, 2013 as compared to the three months ended June 30, 2012.

International revenues-International revenues include distributions from our foreign affiliates as well as domestic export revenues. International revenues decreased $1.1 million, or 18.5%, to $4.9 million for the three months ended June 30, 2013 compared to $6.0 million for the three months ended June 30, 2012. On a constant currency basis, international revenues decreased $1.2 million, or 19.6%.

Costs of Processing and Distribution. Costs of processing and distribution decreased $453,000, or 1.9%, to $23.1 million for the three months ended June 30, 2013 compared to $23.5 million for the three months ended June 30, 2012.

Costs of processing and distribution increased as a percentage of revenues from 52.1% for the three months ended June 30, 2012 to 54.5% for the three months ended June 30, 2013. The increase was primarily the result of lower production levels and operating efficiencies for the three months ended June 30, 2013 as compared to the prior year period.


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Marketing, General and Administrative Expenses. Marketing, general and administrative expenses increased $1.4 million, or 9.8%, to $15.7 million for the three months ended June 30, 2013 from $14.3 million for the three months ended June 30, 2012. Marketing, general and administrative expenses increased as a percentage of revenues from 31.6% for the three months ended June 30, 2012 to 37.1% for the three months ended June 30, 2013. The increase in expenses was primarily due to increases in marketing related expenses of $1.4 million primarily due to the build-out of our surgical specialties direct distribution force.

Research and Development Expenses. Research and development expenses for the three months ended June 30, 2013 were comparable to the three months ended June 30, 2012. As a percentage of revenues, research and development expenses increased from 7.4% for the three months ended June 30, 2012 to 7.9% for the three months ended June 30, 2013.

Asset Abandonments. There were no asset abandonments for the three months ended June 30, 2013 compared to $2,000 for the three months ended June 30, 2012.

Litigation settlement. As of June 30, 2013, there are 39 lawsuits pending against us related to the misconduct of Biomedical Tissue Services, Ltd. ("BTS") and BTS's owner, the late, Michael Mastromarino, as well as several funeral homes and their owners with which BTS conducted its affairs. Subsequent to June 30, 2013, an agreement has been reached to settle 37 of these lawsuits, and the parties are preparing documentation to effect such agreement. Pursuant to the proposed settlement of these lawsuits, we have recorded a litigation settlement charge of $3.0 million for the three months ended June 30, 2013.

Acquisition expenses. Acquisition expenses related to acquisition of Pioneer Surgical Technology, Inc., a Michigan corporation ("Pioneer") were $1.5 million for the three months ended June 30, 2013.

Net Other Income. Net other income was $3,000 for the three months ended June 30, 2013, compared to $51,000 net other income for the three months ended June 30, 2012. The decrease in net other income is primarily attributable to lower interest income.

Income Tax Benefit (Provision). Income tax benefit for the three months ended June 30, 2013 was $1.3 million compared to an income tax provision of $412,000 for the three months ended June 30, 2012. Our effective tax rate for the three months ended June 30, 2013 and 2012 was 30.1% and 23.8% respectively.

Six Months Ended June 30, 2013 Compared With Six Months Ended June 30, 2012

Revenues. Our total revenues decreased by $6.2 million, or 7.0%, to $82.7 million for the six months ended June 30, 2013 compared to $88.9 million for the six months ended June 30, 2012. Our revenues were negatively impacted in the six months ended June 30, 2013 as a result of continued customer reaction to a U.S. Food and Drug Administration warning letter received in the fourth quarter of 2012.

Sports Medicine-Revenues from sports medicine allografts decreased $4.6 million, or 17.2%, to $22.2 million for the six months ended June 30, 2013 compared to $26.8 million for the six months ended June 30, 2012. Sports medicine revenues decreased primarily as a result of lower unit volumes of 18.6%, partially offset by higher average revenue per unit of 1.8% primary due to changes in distribution mix.

Spine-Revenues from spinal allografts increased $3.0 million, or 16.2%, to $21.3 million for the six months ended June 30, 2013 compared to $18.3 million for the six months ended June 30, 2012. Spine revenues increased primarily as a result of higher unit volumes of 16.1%.

Surgical Specialties-Revenues from surgical specialty allografts decreased $2.4 million, or 14.9%, to $13.8 million for the six months ended June 30, 2013 compared to $16.3 million for the six months ended June 30, 2012. Surgical specialties revenues decreased as a result of lower unit volumes of 17.2% partially offset by higher average revenue per unit of 2.3%.


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Bone Graft Substitutes (BGS) and General Orthopedic-Revenues from BGS and general orthopedic allografts decreased $2.6 million, or 18.7%, to $11.4 million for the six months ended June 30, 2013 compared to $14.0 million for the six months ended June 30, 2012. BGS and general orthopedic revenues decreased primarily as a result of lower average revenue per unit of 10.9%, primarily due to changes in product mix, and lower unit volumes of 9.2%.

Dental-Revenues from dental allografts decreased $1.3 million, or 12.1%, to $9.2 million for the six months ended June 30, 2013 compared to $10.4 million for the six months ended June 30, 2012. Dental revenues decreased primarily as a result of lower unit volumes of 11.5% and a decrease in average revenue per unit of 1.2%.

Other Revenues-Revenues from other sources consisting of tissue recovery fees, biomedical laboratory fees, recognition of previously deferred revenues, shipping fees, distribution of reproductions of our allografts to distributors for demonstration purposes and restocking fees increased by $1.7 million to $4.8 million for the six months ended June 30, 2013 compared to $3.1 million for the six months ended June 30, 2012. The increase was primarily due to the acceleration of deferred revenue recognition relating to Davol relinquishing their exclusive distribution rights in the hernia market in the first quarter of 2013.

International revenues-International revenues include distributions from our foreign affiliates as well as domestic export revenues. International revenues decreased $2.7 million, or 22.5%, to $9.2 million for the six months ended June 30, 2013 compared to $11.9 million for the six months ended June 30, 2012. On a constant currency basis, international revenues decreased $2.8 million, or 23.3%.

Costs of Processing and Distribution. Costs of processing and distribution decreased $2.9 million, or 6.1%, to $44.3 million for the six months ended June 30, 2013 compared to $47.2 million for the six months ended June 30, 2012.

Costs of processing and distribution increased as a percentage of revenues from 53.0% for the six months ended June 30, 2012 to 53.5% for the six months ended June 30, 2013. The increase was primarily due to lower production levels and operating efficiencies for the six months ended June 30, 2013 as compared to the prior year period, partially offset by the recognition of $1.7 million of additional deferred revenue in the other revenues category due to the acceleration of deferred revenue recognition with no associated costs of processing and distribution relating to Davol relinquishing their exclusive distribution rights in the hernia market in the first quarter of 2013.

Marketing, General and Administrative Expenses. Marketing, general and administrative expenses increased $2.1 million, or 7.2%, to $30.7 million for the six months ended June 30, 2013 from $28.7 million for the six months ended June 30, 2012. Marketing, general and administrative expenses increased as a percentage of revenues from 32.2% for the six months ended June 30, 2012 to 37.1% for the six months ended June 30, 2013. The increase in expenses was primarily due to increases in marketing related expenses of $2.1 million primarily due to the build-out of our surgical specialties direct distribution force.

Research and Development Expenses. Research and development expenses increased by $282,000, or 4.6%, to $6.5 million for the six months ended June 30, 2013 from $6.2 million for the six months ended June 30, 2012. As a percentage of revenues, research and development expenses increased from 6.9% for the six months ended June 30, 2012 to 7.8% for the six months ended June 30, 2013. The increase was primarily due to development related expenses related to launches of surgical specialties related products.

Asset Abandonments. There were no asset abandonments for the six months ended June 30, 2013 compared to $18,000 for the six months ended June 30, 2012.

Litigation settlement. As of June 30, 2013, there are 39 lawsuits pending against us related to the misconduct of BTS and BTS's owner, the late, Michael Mastromarino, as well as several funeral homes and their owners with which BTS conducted its affairs. Subsequent to June 30, 2013, an agreement has been reached to settle 37 of these lawsuits, and the parties are preparing documentation to effect such agreement. Pursuant to the proposed settlement of these lawsuits, we have recorded a litigation settlement charge of $3.0 million for the six months ended June 30, 2013.


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Acquisition expenses. Acquisition expenses related to acquisition of Pioneer were $1.5 million for the six months ended June 30, 2013.

Net Other Income. There was $3,000 net other income for the six months ended June 30, 2013 compared to $106,000 for the six months ended June 30, 2012. The decrease in net other income is primarily attributable to lower interest income and unfavorable foreign currency exchange changes due to fluctuations in the value of the U.S. dollar versus the Euro and the timing of payments on foreign currency liabilities.

Income Tax Benefit (Provision). Income tax benefit for the six months ended June 30, 2013 was $1.7 million compared to an income tax provision of $1.4 million for the six months ended June 30, 2012. Our effective tax rate for the six months ended June 30, 2013 and 2012 was 52.4% and 29.0% respectively. During the six months ended June 30, 2013, we recognized the entire 2012 research tax credit plus a portion of the 2013 research tax credit with no comparable credit in the prior period. On January 2, 2013 the American Taxpayer Relief Act of 2012 ("ATRA") was signed into law. The ATRA retroactively extended the research tax credit to the beginning of 2012 through 2013. Under ASC 740, Accounting for Income Taxes, the effects of the tax legislation are recognized upon enactment. Therefore, we recognized the tax benefit during the first quarter of 2013.

Liquidity and Capital Resources

Our working capital at June 30, 2013 decreased $2.8 million to $126.3 million from $129.1 million at December 31, 2012. The decrease in working capital was primarily due to a decrease in cash and cash equivalents partially offset by increases in inventories and prepaid and other current assets during the current period. At June 30, 2013, we had 47 days of revenues outstanding in trade accounts receivable, an increase of 3 days compared to December 31, 2012. The increase was due to lower cash receipts from customers than shipments and corresponding billings to customers during the first six months of 2013. At June 30, 2013 we had 323 days of inventory on hand, an increase of 21 days compared to December 31, 2012. The increase was primarily as a result of higher tissue procurements and lower product distributions. We believe that our inventory levels will be adequate to support our on-going operations for the next twelve months. We had $39.4 million of cash and cash equivalents at June 30, 2013. The decrease in cash was primarily due to strong tissue procurements, lower product distributions, the investment in our direct distribution force and the timing of tax payments in the six months ended June 30, 2013.

Our long term obligations at June 30, 2013 decreased $93,000 to $27,000 from $120,000 at December 31, 2012. The decrease in long term obligations was primarily due to paying down our capital lease obligations. At June 30, 2013, we have $16.6 million of borrowing capacity available under our revolving credit facilities.

As of June 30, 2013, we believe that our working capital, together with our borrowing ability under our revolving credit facilities, will be adequate to fund our on-going operations for the next twelve months.

On July 16, 2013, we completed our acquisition of Pioneer. Under the terms of the merger agreement dated June 12, 2013, we acquired Pioneer for $126.4 million in cash. The transaction was funded through a combination of cash on hand, a new credit facility and a concurrent private placement of convertible preferred equity. We obtained from TD Bank, N.A., TD Securities "USA" LLC and Regions Bank, a 5 year, $80.0 million senior secured facility, which includes a $60.0 million term loan and a $20.0 million revolving credit facility. The $20.0 million revolving credit facility replaced our existing $15.0 million U.S. credit facility. Additionally, we received $50.0 million in proceeds from a private placement of convertible preferred equity to Water Street Healthcare Partners, a leading healthcare-focused private equity firm. The convertible preferred stock will be convertible into shares of our common stock, subject to the satisfaction of certain conditions. The convertible preferred stock will also accrue dividends at a rate of 6 percent per year, subject to adjustment under specified conditions. In the third quarter of 2013, we recorded $1.8 million in financing costs and expensed $3.5 million in investment banker fees at the time of the closing of the acquisition.


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Certain Commitments.

The Company's short-term and long-term debt obligations and availability of
credit as of June 30, 2013 are as follows:



                                          Outstanding       Available
                                            Balance          Credit
                                                (In thousands)
               Short-term obligations:
               Credit facilities         $          -      $    16,632
               Capital leases                       27              -

The following table provides a summary of our debt obligations, operating lease obligations, and other significant obligations as of June 30, 2013.

                                                           Contractual Obligations Due by Period
                                              Total       2013       2014      2015      2016       After 2016
                                                                       (In thousands)
Debt obligations                             $    27     $    19     $   8     $  -      $  -      $         -
Operating leases                               2,547         747       916       526       223              135
Other significant obligations (1)              2,699       2,699        -         -         -                -
Unrecognized tax benefits                      1,037         716        -         -        321               -

Total                                        $ 6,310     $ 4,181     $ 924     $ 526     $ 544     $        135

(1) These amounts consist of contractual obligations for tissue recovery development grants and licensing fees.

The Company was in compliance with all covenants related to its revolving credit facilities as of June 30, 2013.


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