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EXAC > SEC Filings for EXAC > Form 10-Q on 30-Oct-2013All Recent SEC Filings

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Form 10-Q for EXACTECH INC


30-Oct-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 and Nine Months Ended September 30, 2013 During the quarter ended September 30, 2013, sales increased 9% to $55.7 million from $51.3 million in the quarter ended September 30, 2012, as a result of 11% growth in our domestic sales, as well as 4% growth in our international sales. Gross margins increased to 71% in the third quarter of 2013 from 70% for the same quarter in 2012. Operating expenses increased 11% when compared to the quarter ended September 30, 2012, and, as a percentage of sales, operating expenses increased to 62% during the third quarter of 2013 as compared to 61% for the same quarter in 2012. This increase, as a percentage of sales, was primarily due to our increased variable selling costs and research and development spending. Net income for the quarter ended September 30, 2013 increased 25%, and diluted earnings per share were $0.23 as compared to $0.19 in the same quarter last year, which was primarily a result of sales growth and our cost reduction efforts.
During the nine months ended September 30, 2013, sales increased 6% to $175.5 million from $165.1 million in the nine months ended September 30, 2012, as a result of our domestic sales growth. Gross margins remained flat at 69%. Operating expenses increased 5% from the nine months ended September 30, 2012, and, as a percentage of sales, operating expenses decreased to 59.6% during the first nine months of 2013 as compared to 60.3% for the same period in 2012. This decrease, as a percentage of sales, was primarily due to our continued efforts to manage operating costs. Net income for the nine months ended September 30, 2013 increased 22%, and diluted earnings per share were $0.79 as compared to $0.67 for the first nine months of 2012, which was primarily a result of sales growth and our cost of goods sold reduction efforts.
During the nine months ended September 30, 2013, we acquired $12.5 million in property and equipment, including new production equipment and surgical instrumentation. Net cash flow from operations was $7.1 million for the nine months ended September 30, 2013, as compared to a net cash flow from operations of $14.6 million during the nine months ended September 30, 2012. The decrease was primarily due to the increase in inventory and accounts receivable.


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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 and nine month periods ended September 30, 2013 and September 30, 2012:

                                                Sales by Product Line
                                                    ($ in 000's)

                                         Three Months Ended                                   Inc (decr)
                           September 30, 2013           September 30, 2012         2013- 2012      Constant Currency
Knee                   $     18,607        33.4 %   $     18,220        35.6 %         2.1  %              3.6  %
Hip                           9,802        17.6            9,245        18.0           6.0                 7.9
Biologics and Spine           6,005        10.8            5,943        11.6           1.0                 0.1
Extremity                    15,122        27.2           12,215        23.8          23.8                23.5
Other                         6,114        11.0            5,647        11.0           8.3                 8.1
Total                  $     55,650       100.0 %   $     51,270       100.0 %         8.5  %              9.2  %

                                          Nine Months Ended                                   Inc (decr)
                           September 30, 2013           September 30, 2012         2013- 2012      Constant Currency
Knee                   $     60,154        34.3 %   $     60,678        36.8 %        (0.9 )%              0.4  %
Hip                          30,824        17.6           30,465        18.5           1.2                 3.0
Biologics and Spine          18,855        10.7           18,031        10.9           4.6                 4.2
Extremity                    47,087        26.8           37,188        22.5          26.6                26.5
Other                        18,590        10.6           18,721        11.3          (0.7 )              (0.4 )
Total                  $    175,510       100.0 %   $    165,083       100.0 %         6.3  %              7.1  %

The following table includes items from the unaudited condensed consolidated statements of income for the three and nine months ended September 30, 2013 as compared to the three and nine months ended September 30, 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
                                   September 30,           2013 - 2012 Inc (decr)             % of Sales
                                 2013          2012           $               %           2013         2012
Net sales                     $  55,650     $ 51,270         4,380             8.5        100.0 %      100.0  %
Cost of goods sold               16,126       15,392           734             4.8         29.0         30.0
Gross profit                     39,524       35,878         3,646            10.2         71.0         70.0
Operating expenses:
Sales and marketing              20,274       18,713         1,561             8.3         36.4         36.5
General and administrative        5,384        4,564           820            18.0          9.7          8.9
Research and development          5,068        4,366           702            16.1          9.1          8.5
Depreciation and amortization     3,963        3,722           241             6.5          7.1          7.3
Total operating expenses         34,689       31,365         3,324            10.6         62.3         61.2
Income from operations            4,835        4,513           322             7.1          8.7          8.8
Other income (expense), net          10         (240 )         250           104.2            -         (0.5 )
Income before taxes               4,845        4,273           572            13.4          8.7          8.3
Provision for income taxes        1,653        1,720           (67 )          (3.9 )        3.0          3.3
Net income                    $   3,192     $  2,553           639            25.0          5.7          5.0


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                                  Nine Months Ended September 30,         2013 - 2012 Inc (decr)            % of Sales
                                     2013                 2012                $               %          2013         2012
Net sales                     $       175,510       $       165,083          10,427             6.3     100.0  %     100.0  %
Cost of goods sold                     53,791                50,688           3,103             6.1      30.6         30.7
Gross profit                          121,719               114,395           7,324             6.4      69.4         69.3
Operating expenses:
Sales and marketing                    63,281                60,501           2,780             4.6      36.1         36.6
General and administrative             15,801                14,947             854             5.7       9.0          9.1
Research and development               13,523                12,630             893             7.1       7.7          7.7
Depreciation and amortization          11,992                11,327             665             5.9       6.8          6.9
Total operating expenses              104,597                99,405           5,192             5.2      59.6         60.3
Income from operations                 17,122                14,990           2,132            14.2       9.8          9.0
Other income (expense), net            (1,090 )                (897 )          (193 )          21.5      (0.7 )       (0.5 )
Income before taxes                    16,032                14,093           1,939            13.8       9.1          8.5
Provision for income taxes              5,255                 5,232              23             0.4       3.0          3.1
Net income                    $        10,777       $         8,861           1,916            21.6       6.1          5.4

Three and Nine Months Ended September 30, 2013 Compared to Three and Nine Months Ended September 30, 2012
Sales
For the quarter ended September 30, 2013, sales increased 9% to $55.7 million from $51.3 million in the quarter ended September 30, 2012, principally as a result of a strong 11% domestic sales growth and a 4% increase in international sales, which was partially due to the continued rebounding of the Latin American markets. Sales of knee implant products increased 2% to $18.6 million for the quarter ended September 30, 2013 from $18.2 million for the same quarter in 2012, as our domestic knee sales improved. Sales of our extremity products were up 24% to $15.1 million as compared to $12.2 million for the same period in 2012, as we continued to gain market share with our Equinoxe® reverse shoulder system. Hip implant sales of $9.8 million during the quarter ended September 30, 2013 increased 6% from the $9.2 million in sales during the quarter ended September 30, 2012, as a result of improvements in international markets. Sales from biologics and spine increased 1% during the quarter ended September 30, 2013 to $6.0 million, from $5.9 million in the comparable quarter in 2012, primarily as a result of new spinal product launches. Sales of all other products increased to $6.1 million as compared to $5.6 million in the same quarter last year, primarily as a result of increased sales of our cement products. Domestically, sales increased 11% to $39.1 million, or 70% of total sales, during the quarter ended September 30, 2013, up from $35.3 million, which represented 69% of total sales, in the comparable quarter last year. Internationally, sales increased 4% to $16.6 million, representing 30% of total sales, for the quarter ended September 30, 2013, as compared to $16.0 million, which was 31% of total sales, for the same quarter in 2012. On a constant currency basis, international sales increased approximately 6% during the quarter ended September 30, 2013, compared to the same quarter in 2012. For the nine months ended September 30, 2013, sales increased 6% to $175.5 million from $165.1 million in the nine months ended September 30, 2012, as a result of domestic sales growth that was partially offset by pricing pressures internationally. Sales of knee implant products decreased 1% to $60.2 million for the nine months ended September 30, 2013 compared to $60.7 million for the nine months ended September 30, 2012, as we experienced a slowdown of international sales from Latin America in the first quarter, as well as relatively weaker currency in Japan. Sales of our extremity products were up 27% to $47.1 million as compared to $37.2 million for the first nine months of 2012, due to the success of our Equinoxe® reverse shoulder system. Hip implant sales of $30.8 million during the nine months ended September 30, 2013 increased 1% from the $30.5 million in sales during the nine months ended September 30, 2012, as a result of improved international sales, offset partially by the Japanese government mandated price reductions during the second quarter of 2012, and relatively weaker currency in Japan. Sales from biologics and spine increased 5% during the nine months ended September 30, 2013 to $18.9 million, from $18.0 million in the comparable period in 2012, primarily as a result of our spine product expansion, offset partially by pricing pressure in our biologics revenues. Sales of all other products decreased slightly to $18.6 million as compared to $18.7 million in the same nine month period last year. Domestically, sales increased 10% to $117.9 million, or 67% of total sales, during the nine months ended September 30, 2013, up from $107.3 million, which represented 65% of total sales, in the comparable nine


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months last year. Internationally, sales decreased to $57.6 million, representing 33% of total sales, for the nine months ended September 30, 2013, as compared to $57.8 million, which was 35% of total sales, for the same nine months in 2012. On a constant currency basis, international sales increased approximately 2% during the nine months ended September 30, 2013, compared to the same period in 2012.
Gross Profit
Gross profit increased to $39.5 million in the quarter ended September 30, 2013 from $35.9 million in the quarter ended September 30, 2012. As a percentage of sales, gross profit increased to 71% during the quarter ended September 30, 2013 from 70% for the quarter ended September 30, 2012. Gross profit increased to $121.7 million in the nine months ended September 30, 2013 from $114.4 million in the nine months ended September 30, 2012. As a percentage of sales, gross profit remained flat at 69% during each of the nine month periods ended September 30, 2013 and 2012, as a result of higher domestic sales growth, which generally carries higher margins, offset by the impact of the implementation of the medical device excise tax enacted as part of the health care legislation signed into law in 2010. Looking forward to the fourth quarter, we expect gross profit, as a percentage of sales, to be lower by 0.5 to 1.0% compared to prior year quarters on a comparative quarter basis due to the impact of the medical device excise tax, and pricing pressure. Operating Expenses
Total operating expenses increased 11% to $34.7 million in the quarter ended September 30, 2013 from $31.4 million in the quarter ended September 30, 2012, primarily due to increased variable costs associated with our increase in domestic sales, as well as increased research and development spending. As a percentage of sales, total operating expenses increased to 62% for the quarter ended September 30, 2013, as compared to 61% for the quarter ended September 30, 2012. Total operating expenses increased 5% to $104.6 million in the nine months ended September 30, 2013 from $99.4 million in the nine months ended September 30, 2012, primarily due to increased variable selling costs and research and development expenses. As a percentage of sales, total operating expenses decreased to 59.6% for the nine months ended September 30, 2013, as compared to 60.3% for the nine months ended September 30, 2012.
Sales and marketing expenses, the largest component of total operating expenses, increased 8% for the quarter ended September 30, 2013 to $20.3 million from $18.7 million in the same quarter last year. The increase was primarily related to additional variable selling costs as a result of our sales growth, as well as product launch activities for Exactech Guided Personalized Surgery system, or GPS®. Sales and marketing expenses, as a percentage of sales was 36% for each of the quarters ended September 30, 2013 and 2012. Sales and marketing expenses increased 5% for the nine months ended September 30, 2013 to $63.3 million from $60.5 million in the same period last year. The increase was primarily related to variable selling costs as a result of our sales growth, partially offset by our focus on cost management. Sales and marketing expenses, as a percentage of sales decreased to 36% for the nine month period ended September 30, 2013, compared to 37% for the same period in 2012. Looking forward, sales and marketing expenditures, as a percentage of sales, are expected to be in the range of 34% to 35% for the fourth quarter of 2013.
General and administrative expenses increased to $5.4 million in the quarter ended September 30, 2013 from $4.6 million in the same quarter in 2012, primarily due to additional regulatory and compliance expenditures. As a percentage of sales, general and administrative expenses increased to 10% for the quarter ended September 30, 2013 from 9% for the same quarter in 2012. General and administrative expenses increased to $15.8 million in the nine months ended September 30, 2013 from $14.9 million for the same quarter in 2012. As a percentage of sales, general and administrative expenses remained at 9% for each of the nine months ended September 30, 2013, and 2012. General and administrative expenses for the fourth quarter of 2013 are expected to be in the range of 8.5% to 9.5% of sales.
Research and development expenses increased 16% for the quarter ended September 30, 2013 to $5.1 million from $4.4 million in the same quarter last year, as we incurred increased testing and product development expenses. As a percentage of sales, research and development expenses remained flat at 9% for each of the quarters ended September 30, 2013 and 2012. Research and development expenses increased 7% for the nine months ended September 30, 2013 to $13.5 million from $12.6 million in the same period last year. As a percentage of sales, research and development expenses remained at 8% for each of the nine months ended September 30, 2013 and 2012. We anticipate growth in research and development expenditures, as a percentage of sales, to outpace sales growth for the fourth quarter of 2013, with total research and development expenses ranging from 7.5% to 8.5% of sales.
Depreciation and amortization increased 6% to $4.0 million for the quarter ended September 30, 2013 from $3.7 million during the same quarter in 2012. As a percentage of sales, depreciation and amortization remained flat at 7% during each of the quarters ended September 30, 2013 and 2012. Depreciation and amortization increased 6% to $12.0


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million for the nine months ended September 30, 2013 from $11.3 million during the same period in 2012. As a percentage of sales, depreciation and amortization remained at 7% during each of the nine months ended September 30, 2013 and 2012. We placed $10.4 million of surgical instrumentation in service, $2.0 million for equipment , and spent approximately $0.4 million for product licenses and designs during the first nine months of 2013. Income from Operations
Our income from operations increased 7% to $4.8 million, or 9% of sales in the quarter ended September 30, 2013 from $4.5 million, or 9% of sales in the quarter ended September 30, 2012. Our income from operations increased 14% to $17.1 million, or 10% of sales in the nine months ended September 30, 2013 from $15.0 million, or 9% of sales in the nine months ended September 30, 2012. The increase in our income from operations for both the quarter and the nine months year to date was a result of our sales growth, and continued efforts to reduce our overall expenses and leverage our existing cost structures. Looking forward, we expect operating expenses for the fourth quarter to increase more slowly than sales growth, therefore anticipating income from operations to be in the range of 9% to 10% of sales for the fourth quarter of 2013. Other Income and Expenses
We had other income, net of other expenses, of $10,000 during the quarter ended September 30, 2013, compared to other expenses, net of other income of $0.2 million in the quarter ended September 30, 2012. Included in other expenses are foreign currency transaction gains of $0.3 million, compared to foreign currency gains of $0.1 million for the same quarter of 2012. Currency gains were partially offset by net interest expense of $0.3 million for each of the quarters ended September 30, 2013 and 2012. We had other expenses, net of other income, of $1.1 million during the nine months ended September 30, 2013, as compared to other expenses, net of other income, of $0.9 million in the nine months ended September 30, 2012, due to foreign currency transaction losses of $0.3 million, compared to foreign currency gains of $0.2 million for the same nine months of 2012. Currency losses were partially offset by a decrease in net interest expense to $0.8 million for the nine months ended September 30, 2013 compared to $1.1 million for the nine months ended September 30, 2012. Taxes and Net Income
Income before provision for income taxes increased 13% to $4.8 million in the quarter ended September 30, 2013 from $4.3 million in the quarter ended September 30, 2012. The effective tax rate, as a percentage of income before taxes, was 34% for the quarter ended September 30, 2013 as compared to 40% for the quarter ended September 30, 2012. The decrease in the effective tax rate for the third quarter of 2013 was due to the renewal of the credit for research and development activities in 2013 that had expired in the comparable period in 2012, as well as lower non-deductible international losses. As a result of the foregoing, we realized net income of $3.2 million in the quarter ended September 30, 2013, an increase of 25% from $2.6 million in the quarter ended September 30, 2012. As a percentage of sales, net income increased to 6% for the quarter ended September 30, 2013 from 5% for the quarter ended September 30, 2012. Earnings per share, on a diluted basis, increased to $0.23 for the quarter ended September 30, 2013, from $0.19 for the quarter ended September 30, 2012. Income before provision for income taxes increased 14% to $16.0 million in the nine months ended September 30, 2013 from $14.1 million in the nine months ended September 30, 2012. The effective tax rate, as a percentage of income before taxes, was 33% for the nine months ended September 30, 2013 as compared to 37% for the nine months ended September 30, 2012. The decrease in the effective tax rate for the first nine months 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 $10.8 million in the nine months ended September 30, 2013, an increase of 22% from $8.9 million in the nine months ended September 30, 2012. As a percentage of sales, net income increased to 6% for the nine months ended September 30, 2013 from 5% for the nine months ended September 30, 2012. Earnings per share, on a diluted basis, increased to $0.79 for the nine months ended September 30, 2013, from $0.67 for the nine months ended September 30, 2012. We expect our effective tax rates to range from 33% to 35% for the fourth quarter 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 September 30, 2013, we had working capital of $111.9 million, an increase of 13% from $98.7 million at the end of 2012. Working capital in 2013 increased primarily as a result of an increase in our accounts


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receivable and current inventory balance. Inventory and surgical instrumentation increases were impacted by the $1.3 million paid for the medical device excise tax in the first nine months of 2013.
We expect that cash flows from operating activities, borrowings 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 through any number of possible combinations of additional debt, additional issuance of equity or convertible debt.
Operating Activities - Operating activities provided net cash of $7.1 million in the nine months ended September 30, 2013, as compared to net cash from operations of $14.6 million during the nine months ended September 30, 2012. A primary contributor to this decrease related to the increase in accounts receivable experienced in the first nine months of 2013, which used cash of $8.3 million for the nine months ended September 30, 2013, in contrast to a reduction in accounts receivable providing net cash $2.6 million for the nine months ended September 30, 2012. A major contributor to the increase in total accounts receivable is due to our distribution operation in Spain, which continues to experience increases in total accounts receivable due to government payment levels. Delayed accounts receivable payments in Spain also occurred in 2011 and 2012, and similar to 2012, the government has initiated the process to confirm receivables and determine when payments of those confirmed receivables will begin. As such, we expect a large payment within the next six months. Our allowance for doubtful accounts and sales returns increased to $1.2 million at September 30, 2013 from $1.0 million at December 31, 2012, principally as a result of the slow aging increase of the accounts receivable at our distribution operation in Spain. The total days sales outstanding (DSO) ratio, based on average accounts receivable balances, was 80 for the nine months ended September 30, 2013, up from a ratio of 74 for the nine months ended September 30, 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 $9.3 million during the first nine months ended September 30, 2013, compared to an increase of $13.2 million during the same period ended September 30, 2012, as a result of our continued product line expansion and continued growth within existing markets.
Investing Activities - Investing activities used net cash of $12.7 million in the nine months ended September 30, 2013, as compared to $14.7 million in the nine months ended September 30, 2012. Our cash outlays for surgical instrumentation and manufacturing equipment were $12.2 million, and $0.4 million . . .

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