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WMGI > SEC Filings for WMGI > Form 10-Q on 5-Nov-2013All Recent SEC Filings

Show all filings for WRIGHT MEDICAL GROUP INC

Form 10-Q for WRIGHT MEDICAL GROUP INC


5-Nov-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 nine month periods ended September 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 business includes products that 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.
Our corporate headquarters and U.S. operations are currently located in Arlington, Tennessee, where we conduct research and development, sales and marketing administration, manufacturing, warehousing and administrative activities. Following the closing of the sale of our OrthoRecon business, we intend to move our corporate headquarters to Memphis, Tennessee. 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 August 7, 2013, we received a not approvable letter from the Food & Drug Administration (FDA) in response to our Pre-Market Approval (PMA) application for Augment® Bone Graft for use as an alternative to autograft in hindfoot and ankle fusion procedures. We have filed an appeal with the FDA regarding its decision. On October 31, 2013 the FDA notified us it has elected to convene a Dispute Resolution Panel to consider the scientific issues in dispute before making a decision on our appeal. While we believe our appeal has strong merits, we were required to evaluate assets associated with the BioMimetic acquisition for impairment. As a result, we recorded charges totaling $207.2 million of impairment and other charges related to assets acquired from BioMimetic, including $1.0 million of charges recorded within Cost of Sales to write down inventory to its estimated net realizable value. In addition, due to the significant decline in market value of the Contingent Value Rights (CVRs) issued as contingent consideration for the acquired business, we have recognized an unrealized gain of $66.1 million from the decreased value of the CVRs that are recorded as a liability. See Note 1, Note 9 and Note 12 to our condensed consolidated financial statements for further discussion of these charges.
On October 16, 2013, we entered into a definitive agreement to acquire Biotech International (Biotech), a leading privately held French orthopaedic extremities company. The transaction will significantly expand our direct sales channel in France and international distribution network, and add Biotech's complementary extremity product portfolio to further accelerate global growth opportunities in our Extremities business. We will acquire 100% of Biotech's outstanding equity on a fully diluted basis at a total offer price of up to $80 million, comprised of upfront payments of approximately $55 million in cash, subject to certain adjustment set forth in the definitive agreement, and the issuance of common stock having a value of $20 million, and up to an additional $5 million in cash contingent upon the achievement of certain revenue milestones in 2014 and 2015. We expect the transaction to close in the fourth quarter of 2013.


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Net sales from our continuing operations increased 13% in the quarter ended September 30, 2013 (third quarter) to $57.6 million, compared to net sales of $50.9 million in the quarter ended September 30, 2012, driven primarily by a 21% increase in global foot and ankle sales.
Geographically, our third quarter of 2013 domestic sales increased 8%, as a 17% increase in foot and ankle sales was partially offset by a 6% decline in biologics sales and a 1% decrease in upper extremity sales.
Our international sales increased 32% to $14.6 million in the third quarter of 2013, compared to $11.1 million in the third quarter of 2012, primarily due to a 50% increase in Europe primarily due to the acquisition of a foot and ankle business in the quarter ended March 31, 2013, a 27% increase in Asia as the result of the addition of new distribution partner in China during the quarter ended June 30, 2013, partially offset by a $0.5 million unfavorable impact from currency exchange rates.
In the third quarter of 2013, we recorded a net loss from continuing operations of $124.5 million, compared to a net loss of $4.1 million for the third quarter of 2012. Items unfavorably impacting net loss in the third quarter of 2013 included:
• $207.2 million ($171.3 million net of taxes) of impairment and other charges related to assets acquired from BioMimetic, including $1.0 million of charges recorded within Cost of Sales to write down inventory to its estimated net realizable value (see Note 9 to our condensed consolidated financial statements for discussion of these charges), partially offset by an unrealized gain of $66.1 million ($66.1 million net of taxes) associated with the mark-to-market adjustment on the contingent value rights payable as contingent consideration for the BioMimetic acquisition;

• $11.2 million ($6.9 million net of taxes) of transition costs associated with the pending sale of our OrthoRecon business;

• a $4.3 million ($2.6 million net of taxes) decrease in net unrealized gains/losses associated with the mark-to-market adjustments on our derivative assets and liabilities;

• a $1.5 million ($0.9 million net of taxes) increase in non-cash interest expense associated with the our 2017 Convertible Notes;

• $1.7 million ($1.2 million net of taxes) of due diligence, transition and transaction costs associated with our acquisitions of BioMimetic and Biotech; 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.

These unfavorable impacts were partially offset by $4.5 million ($2.8 million net of taxes) of charges in 2012 related to the write-off of deferred financing costs associated with the termination of our Senior Credit Facility and 2014 Convertible Notes and the termination of an associated interest rate swap. 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.
Business continuity and a seamless customer experience are top priorities, and we are highly focused on ensuring that no business momentum is lost during the transition period. As such, we will have inefficiencies immediately post the transaction but will have an excellent opportunity to improve efficiency and leverage fixed costs in the business going forward. Additionally, there will be expense dis-synergies as a result of the transaction, and we do expect some short-term revenue dis-synergies as we work through the separation of some of the remaining full-line distribution both in the U.S. and outside the U.S. 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.


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Comparison of three months ended September 30, 2013 to three months ended September 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 September 30,
                                                     2013                        2012
                                             Amount      % of Sales      Amount      % of Sales
Net sales                                 $   57,641        100.0 %    $  50,888        100.0 %
Cost of sales 1                               14,037         24.4 %       11,704         23.0 %
Gross profit                                  43,604         75.6 %       39,184         77.0 %
Operating expenses:
Selling, general and administrative 1         63,054        109.4 %       36,730         72.2 %
Research and development 1                     5,518          9.6 %        3,428          6.7 %
Amortization of intangible assets              1,342          2.3 %        1,289          2.5 %
BioMimetic impairment charges                206,249        357.8 %            -            - %
Total operating expenses                     276,163        479.1 %       41,447         81.4 %
Operating loss                              (232,559 )     (403.5 %)      (2,263 )       (4.4 %)
Interest expense, net                          4,044          7.0 %        2,509          4.9 %
Other (income) expense, net                  (64,019 )     (111.1 %)       1,895          3.7 %
Loss from continuing operations before
income taxes                                (172,584 )     (299.4 %)      (6,667 )      (13.1 %)
Benefit from income taxes                    (48,084 )      (83.4 %)      (2,579 )       (5.1 %)
Net loss from continuing operations         (124,500 )     (216.0 %)      (4,088 )       (8.0 %)
Loss from discontinued operations, net of
tax 1                                         (5,520 )                    (1,251 )
Net loss                                  $ (130,020 )                 $  (5,339 )


__________________________


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

                                                          Three Months Ended September 30,
                                                  2013        % of Sales        2012        % of Sales
Cost of sales                                 $      100          0.2 %     $      193          0.4 %
Selling, general and administrative                2,357          4.1 %          1,696          3.3 %
Research and development                             215          0.4 %             87          0.2 %
Loss from discontinued operations, net of tax        837          n/a              718          n/a

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 September 30,
                         2013               2012      % Change
Foot and Ankle  $     35,233              $ 29,030      21.4 %
Upper Extremity        5,933                 6,207      (4.4 %)
Biologics             15,184                14,614       3.9 %
Other                  1,291                 1,037      24.5 %
Total Sales     $     57,641              $ 50,888      13.3 %

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

Three Months Ended September 30,
                          2013                2012      % Change

Domestic        $      42,998               $ 39,808        8.0 %
International          14,643                 11,080       32.2 %
Total net sales $      57,641               $ 50,888       13.3 %


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Net Sales
Net sales totaled $57.6 million in the third quarter of 2013, as compared to $50.9 million in the third quarter of 2012. The 13% increase was driven by 21% growth in our foot and ankle business and a 4% increase in our biologics business, partially offset by a 4% decline in upper extremities.
Our foot and ankle net sales increased to $35.2 million in the third quarter of 2013, representing growth of 21% over the third quarter of 2012. Domestically, foot and ankle product sales increased 17% over the third quarter of 2012, due to the continued success of our ORTHOLOC® 3Di Reconstruction Plating System, as well as continued growth of our INBONE® Total Ankle Arthroplasty products. Our international foot and ankle sales grew 42% to $7.6 million as a result of $0.9 million of sales in Europe due to the foot and ankle products acquired from the WG Healthcare acquisition and a 47% increase in Asia as the result of the addition of a new distribution partner in China in the first half of 2013. 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 $5.9 million in the third quarter of 2013, representing a decline of 4% over the third quarter of 2012, driven primarily by unfavorable currency exchange rates, as volumes were relatively flat in all major geographies.
Net sales of our biologics products totaled $15.2 million in the third quarter of 2013, representing a 4% increase from the third quarter of 2012. Internationally, our sales increased 38% as the result of $1.2 million of increased sales in Australia, primarily related to sales of Augment® Bone Graft acquired from the BioMimetic acquisition in the first quarter of 2013. This increase was partially offset by a 6% decrease in U.S. sales due to lower sales volume.
Cost of Sales
Our cost of sales as a percentage of net sales increased to 24.4% in the third quarter of 2013, as compared to 23.0% in the third quarter of 2012. Cost of sales for the third quarter of 2013 included $1.0 million (1.7% of net sales) of charges to write down inventory acquired from BioMimetic to its estimated net realizable value. The remaining cost of sales decreased as a percentage of net sales, primarily due to favorable manufacturing expenses that were partially offset by provisions for excess and obsolete inventory and unfavorable geographic mix. 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 109.4% in the third quarter of 2013, compared to 72.2% in the third quarter of 2012. Selling, general and administrative expense for the third quarter of 2013 included $11.2 million of transition costs associated with the sale of our OrthoRecon business (19.5% of net sales), $1.2 million and $0.5 million of due diligence, transition and transaction costs related to our acquisitions of BioMimetic and Biotech, respectively (totaling 3.0% of net sales), and $0.1 million of cost related to distributor transition agreements (0.2% of net sales). Selling, general and administrative expense for the third quarter of 2012 included $0.4 million of cost related to distributor transition agreements (0.8% of net sales). The remaining increase is primarily driven by $2.9 million of expenses associated with the ongoing operations of the acquired BioMimetic business (5.0% of net sales), $0.7 million of taxes related to the enacted 2.3% excise tax on U.S. sales of medical devices (1.2% of net sales), 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, increased spending on international growth initiatives, increased non-cash stock-based compensation expense, and legal and other spending on our appeal of the not approvable letter from the FDA.
We anticipate that 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. These increases will be offset by anticipated decreased spending on transition costs associated with the sale of the OrthoRecon business.
Research and Development
Our investment in research and development activities represented approximately 9.6% of net sales in the third quarter of 2013, as compared to 6.7% of net sales in the third 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.
We anticipate that 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.


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Amortization of Intangible Assets
Charges associated with the amortization of intangible assets were relatively flat at $1.3 million in both the third quarter of 2013 and the third quarter of 2012.
Based on the intangible assets held as of September 30, 2013, we expect to recognize amortization expense of approximately $6.1 million for the full year of 2013, $4 million in 2014, $2.8 million in 2015, $2.0 million in 2016, and $1.8 million in 2017. These amounts do not include the potential amortization of the portion of the IPRD Technology asset that would begin being amortized, if and when, Augment® Bone Graft is approved by the FDA, which we estimate would generate approximately $0.3 million of amortization expense annually. BioMimetic Impairment Charges
During the third quarter of 2013, we recorded charges of approximately $206.2 million associated with the BioMimetic business acquired in the first quarter of 2013. On August 7, 2013, we received a not approvable letter from the FDA in response to our Pre-PMA application for Augment® Bone Graft for use as an alternative to autograft in hindfoot and ankle fusion procedures. We have filed an appeal with the FDA regarding its decision. On October 31, 2013 the FDA notified us it has elected to convene a Dispute Resolution Panel to consider the scientific issues in dispute before making a decision on our appeal. While we believe our appeal has strong merits, we were required to evaluate assets associated with the BioMimetic acquisition for impairment. As a result of this evaluation, we recorded an intangible impairment charge of approximately $88.1 million and a goodwill impairment charge of $115.0 million, as well as the recognition of a $3.2 million charge for noncancelable inventory commitments for the raw materials used in the manufacture of Augment® Bone Graft, which we have estimated will expire unused. See Note 9 to our condensed consolidated financial statements for further discussion of these impairment charges. Interest Expense, Net
Interest expense, net, consists of interest expense of $4.2 million during the third quarter of 2013 and $2.6 million during the third quarter of 2012, offset by interest income of $0.1 million during the third quarter of 2013 and 2012. Our interest expense during the third 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 $(64.0) million in the third quarter of 2013, compared to $1.9 million in the third quarter of 2012. For the third quarter of 2013, other (income) expense, net includes an unrealized gain of $66.1 million on CVRs issued in connection with the acquisition of BioMimetic, partially offset by an unrealized loss of $2.0 million for mark-to-market adjustments on our derivative asset and liability.
Benefit from Income Taxes
We recorded an income tax benefit of $48.1 million in the third quarter of 2013, compared to $2.6 million in the third quarter of 2012. During the third quarter of 2013, our effective tax benefit rate was approximately 27.9% as compared to 38.7% in the third quarter of 2012. The decrease in the effective tax rate is primarily related to the impact of the non-deductible goodwill impairment charges and mark-to-market adjustment on CVRs issued in connection with the acquisition of BioMimetic on our taxable income (net unfavorable impact of 11.0% to effective tax benefit rate).
Loss from Discontinued Operations, Net of Tax Loss from 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 $49.0 million in the third quarter of 2013, as compared to $59.5 million in the third quarter of 2012, an 18% decline, driven by a 21% decrease in hip sales and a 14% decrease in knee sales. Our hip product net sales totaled $26.2 million during the third quarter of 2013, down from $33.0 million in the third quarter of 2012. Our domestic hip sales decreased 14% over prior year, primarily due to a 15% decrease in volume as the result of customer losses during the latter portion of 2012. International hip sales declined 25% from the prior year due to declines in every significant geographic region due primarily to the impact of the transition activities, as well as the negative impact of $1.6 million of unfavorable currency exchange rates.
Our knee product net sales totaled $22.1 million during the third quarter of 2013, down from $25.7 million in the third quarter of 2012. Our domestic knee sales decreased 12% over prior year, primarily due to a 12% decrease in volume as the result of customer


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losses during the latter portion of 2012. International knee sales declined 16% from the prior year, as a 25% increase in sales in Japan were more than offset by declines in sales to stocking distributors, due primarily to the impact of the transition activities, as well as the negative impact of $0.5 million of unfavorable currency exchange rates.
Loss from discontinued operations, net of tax, was $5.5 million in the third quarter of 2013, as compared to a loss from discontinued operations, net of tax of $1.3 million in the third quarter of 2012. The increase in net loss was primarily driven by the decrease in sales year over year, the after tax impact of $5.2 million of legal and professional fees associated with the MicroPort transaction, and $0.4 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 $1.2 million decrease in expenses associated with the deferred prosecution agreement and U.S. governmental inquiries.

Comparison of nine months ended September 30, 2013 to nine months ended September 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:

                                                     Nine Months Ended September 30,
                                                     2013                        2012
                                             Amount      % of Sales      Amount      % of Sales
Net sales                                 $  174,506        100.0 %    $ 155,725        100.0 %
Cost of sales 1                               42,298         24.2 %       34,917         22.4 %
Gross profit                                 132,208         75.8 %      120,808         77.6 %
Operating expenses:
. . .
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