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TRNX > SEC Filings for TRNX > Form 10-Q on 6-Nov-2013All Recent SEC Filings

Show all filings for TORNIER N.V.

Form 10-Q for TORNIER N.V.


6-Nov-2013

Quarterly Report


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

You should read the following discussion of our financial condition and results of operations together with the unaudited consolidated financial statements and the notes thereto included elsewhere in this report, and other financial information included in this report. The following discussion may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties, including those discussed under "Special Note Regarding Forward-Looking Statements", "Part II. Other Information - Item 1A. Risk Factors" and elsewhere in this report. These risks could cause our actual results to differ materially from any future performance suggested below.

Business Overview

We are a global medical device company focused on surgeons that treat musculoskeletal injuries and disorders of the shoulder, elbow, wrist, hand, ankle and foot. We refer to these surgeons as extremity specialists. We sell to this extremity specialist customer base a broad line of joint replacement, trauma, sports medicine and biologic products to treat extremity joints. Our motto of "specialists serving specialists" encompasses this focus. In certain international markets, we also offer joint replacement products for the hip and knee. We currently sell approximately 100 product lines in approximately 40 countries.

We believe we are differentiated by our full portfolio of upper and lower extremity products, our extremity-focused sales organization and our strategic focus on extremities. We further believe that we are well positioned to benefit from opportunities in the extremity products marketplace, primarily in the shoulder and ankle joint replacement markets and also the foot and ankle trauma market with our October 2012 acquisition of OrthoHelix Surgical Designs, Inc. (OrthoHelix). We believe that the recent launch of our Aequalis Ascend Flex pressed-fit reversed shoulder has further strengthened our market-leading shoulder product portfolio and has expanded our addressable market by filling what we believe was a previous gap in this portfolio. Our principal products are organized in four major categories: upper extremity joints and trauma, lower extremity joints and trauma, sports medicine and biologics, and large joints and other. Our upper extremity joints and trauma products include joint replacement and bone fixation devices for the shoulder, hand, wrist and elbow. Our lower extremity joints and trauma products, which include our OrthoHelix portfolio, include joint replacement and bone fixation devices for the foot and ankle. Our sports medicine and biologics product category includes products used across several anatomic sites to mechanically repair tissue-to-tissue or tissue-to-bone injuries, in the case of sports medicine, or to support or induce remodeling and regeneration of tendons and ligaments, in the case of biologics. Our large joints and other products include hip and knee joint replacement implants and ancillary products. In the United States, we market and sell products from all of our product categories, except large joints. Although we do not actively market hip or knee replacement joints in the United States, we have U.S. Food and Drug Administration (FDA) clearance to sell selected large joint products. Internationally, we sell our full product portfolio in the markets that we serve, including large joints, in select international markets. In addition, as we have received the required regulatory approvals, we have selectively introduced the OrthoHelix product portfolio into certain international markets, including France and Germany, which resulted in the first international sales of these products in the second quarter of 2013.

In the United States, which is the largest orthopaedic market, we believe that our "specialists serving specialists" market approach is strategically aligned with what we believe is an ongoing trend in orthopaedics for surgeons to specialize in certain parts of the anatomy or certain types of procedures. While we market our products to these extremity specialists, our revenue is generated primarily from sales to healthcare institutions. We historically have had a single sales channel in the United States that consisted of a network of independent commission-based sales agencies, along with direct sales representation in certain territories. Since our acquisition of OrthoHelix, we have been in the process of executing our integration strategy to establish separate U.S. sales channels that are individually focused on the upper extremity specialist and the lower extremity specialist as we believe that this increased focus will allow us to increase the product proficiency of our sales representatives and increase our selling opportunities by improving our overall procedure coverage, leveraging our entire product portfolio, and accessing new specialists and accounts. To create these separate upper and lower extremity sales channels, we have terminated relationships with certain independent sales agencies and transitioned these territories to new agencies or established direct sales representation; acquired certain sales agencies and established direct sales representation; or transitioned an upper or lower extremity product portfolio between agencies or from an agency to a new direct sales team. During the third quarter of 2013, we made a strategic decision to accelerate these transitions. As a result of these transitions, approximately one-third of our U.S. revenue is now represented by direct sales teams and we expect this to increase to approximately one-half upon completion of this strategic initiative. While we believe that this strategy will make Tornier more competitive, we believe these transitions have resulted in disruption in our U.S. sales channel that adversely affected our revenues during 2012 and the first nine months ended September 29, 2013, and will likely result in further disruption during the remainder of 2013 and into the first half of 2014 as we continue to execute this transition and educate and train the resulting sales teams. As of the end of September 2013, we had completed transitions for dedicated upper and dedicated lower extremities sales coverage in territories representing 61% of our U.S. revenue and anticipate that the transition of the remaining territories will occur in the fourth quarter of 2013. We believe this metric is a key indicator of our U.S. sales channel stability and future U.S. revenue growth potential.


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Internationally, the specialization of surgeons is not as prevalent as it is in the U.S.; and thus, we currently utilize several distribution approaches to serve surgeons and their healthcare institutions depending on individual market needs and requirements. Our international distribution system currently consists of 13 direct sales offices and a network of approximately 25 distributors that sell our products into approximately 40 countries. As part of our strategy to grow internationally, we expanded our distribution and sales efforts into Mexico, Israel, Argentina and Singapore in 2012 and are planning on expanding into Taiwan, Vietnam and the Czech Republic in 2013. In addition, we have selectively transitioned from distributor representation to direct sales representation in certain countries, including the United Kingdom, Denmark, Belgium, Luxembourg, Japan, Canada and Australia, and we have selectively converted from direct sales representation to distributor representation in certain countries, including Spain, during the past few years. We believe that this strategy of international expansion, in combination with the tailoring of our international distribution approach to the needs and requirements of each individual market, could result in additional sales coverage transitions in the future, but that this is necessary to drive the future growth of our business.

In the nine months ended September 29, 2013, we generated revenue of $227.6 million, of which 59% was in the United States and 41% was international.

Foreign Currency Exchange Rates

A substantial portion of our business is located outside the United States, and as a result, we generate revenue and incur expenses denominated in currencies other than the U.S. dollar. The majority of our operations denominated in currencies other than the U.S. dollar are denominated in Euros. In the nine months ended September 29, 2013 and September 30, 2012, approximately 41% and 44% respectively, of our revenue was denominated in foreign currencies. As a result, our revenue can be significantly impacted by fluctuations in foreign currency exchange rates. We expect that foreign currencies will continue to represent a similarly significant percentage of our revenue in the future. Selling, marketing and administrative costs related to these sales are largely denominated in the same foreign currencies, thereby limiting our foreign currency transaction risk exposure. In addition, we also have significant levels of other selling, general and administrative expenses and research and development expenses denominated in foreign currencies. We, therefore, believe that the risk of a significant impact on our earnings from foreign currency fluctuations is mitigated to some extent.

A substantial portion of the products we sell in the United States are manufactured in countries where costs are incurred in Euros. Fluctuations in the Euro to U.S. dollar exchange rate will have an impact on the cost of the products we manufacture in those countries, but we would not likely be able to change our U.S. dollar selling prices of those same products in the United States in response to those cost fluctuations. As a result, fluctuations in the Euro to U.S. dollar exchange rates could have a significant impact on our gross profit in future periods in which that inventory is sold. Fluctuations in the value of foreign currencies relative to the U.S. dollar impact our operating results. Impacts associated with fluctuations in foreign currency exchange rates are discussed in more detail under "Item 3 - Quantitative and Qualitative Disclosures about Market Risk." In countries with functional currencies other than the U.S. dollar, assets and liabilities are translated into U.S. dollars using end-of-period exchange rates; and revenues, expenses and cash flows are translated using average rates of exchange.

We evaluate our results of operations on both an as reported and a constant currency basis. The constant currency presentation is a non-GAAP financial measure, which excludes the impact of fluctuations in foreign currency exchange rates. Constant currency growth rates used in the following discussion of results of operations eliminate the impact of period-over-period foreign currency fluctuations. We believe providing constant currency information provides valuable supplemental information regarding our results of operations, consistent with how we evaluate our performance. We calculate constant currency percentages by converting our current-period local currency financial results using the prior-period foreign currency exchange rates and comparing these adjusted amounts to our prior-period reported results. This calculation may differ from similarly-titled measures used by others; and, accordingly, the constant currency presentation is not meant to be a substitution for recorded amounts presented in conformity with GAAP nor should such amounts be considered in isolation.


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Results of Operations

The nine months ended September 29, 2013 and September 30, 2012 each consisted
of 13 weeks, respectively. The following table sets forth, for the periods
indicated, our results of operations as a percentage of revenue:



                                                     Three months ended                                    Nine months ended
                                          September 29,             September 30,              September 29,              September 30,
                                              2013                       2012                       2013                       2012
                                                       (in thousands)                                       (in thousands)
Statements of Operations Data:
Revenue                                $ 66,747        100 %     $  58,015        100 %     $ 227,567        100 %     $ 198,487        100 %
Cost of goods sold                       18,972         28 %        15,730         27 %        64,905         29 %        54.944         28 %

Gross profit                             47,775         72 %        42,285         73 %       162,662         71 %       143,543         72 %
Selling, general and administrative      46,797         70 %        38,524         66 %       150,400         66 %       124,157         63 %
Research and development                  4,665          7 %         5,260          9 %        16,390          7 %        16,329          8 %
Amortization of intangible assets         3,976          6 %         2,730          5 %        11,597          5 %         8,013          4 %
Special charges (income)                 (3,918 )       (6 %)        6,503         11 %         1,009          0 %         9,413          5 %

Operating loss                           (3,745 )       (6 %)      (10,732 )      (18 %)      (16,734 )       (7 )%      (14,369 )       (7 )%
Interest income                              85          0 %            70          0 %           181          0 %           304          0 %
Interest expense                         (1,499 )       (2 %)         (481 )       (1 %)       (5,754 )       (3 %)       (1,430 )       (1 %)
Foreign currency transaction loss          (285 )       (0 %)         (326 )       (1 %)       (1,071 )       (0 %)         (195 )       (0 %)
Loss on extinguishment of debt               -           *              -           *          (1,127 )       (0 %)           -           *
Other non-operating income                   95          0 %            56          0 %           183          0 %            54          0 %

Loss before income taxes                 (5,349 )       (8 %)      (11,413 )      (20 %)      (24,322 )      (11 %)      (15,636 )       (8 %)
Income tax expense                         (943 )       (1 %)         (268 )       (0 %)       (1,405 )       (1 %)       (1,305 )       (1 %)

Consolidated net loss                  $ (6,292 )       (9 %)    $ (11,681 )      (20 %)    $ (25,727 )      (11 %)    $ (16,941 )       (9 %)

The following tables set forth, for the periods indicated, our revenue by product category and geography expressed as dollar amounts and the changes in revenue between the specified periods expressed as percentages:

                                                   Three months ended                                                                  Nine months ended
                                          September 29,          September 30,          Percent            Percent            September 29,          September 30,          Percent              Percent
Revenue by Product Category                   2013                   2012                change             change                2013                   2012                change              change
                                                    ($ in thousands)                      (as             (constant                     ($ in thousands)                      (as               (constant
                                                                                       reported)          currency)                                                        reported)            currency)
Upper extremity joints and trauma        $        40,293        $        39,429                 2 %                1 %       $       136,258        $       129,434                 5 %                   5 %
Lower extremity joints and trauma                 13,530                  5,815               133                133                  42,514                 19,333               120                   120
Sports medicine and biologics                      3,117                  3,487               (11 )              (12 )                11,051                 11,363                (3 )                  (3 )

Total extremities                                 56,940                 48,731                17                 16                 189,823                160,130                19                    18
Large joints and other                             9,807                  9,284                 6                 (1 )                37,744                 38,357                (2 )                  (4 )

Total                                    $        66,747        $        58,015                15 %               13 %       $       227,567        $       198,487                15 %                  14 %


                                                   Three months ended                                                                  Nine months ended
                                          September 29,          September 30,          Percent            Percent            September 29,          September 30,          Percent              Percent
Revenue by Geography                          2013                   2012                change             change                2013                   2012                change              change
                                                    ($ in thousands)                      (as             (constant                     ($ in thousands)                      (as             (at constant
                                                                                       reported)          currency)                      (as reported)                     reported)            currency)
United States                            $        40,678        $        34,377                18 %               18 %       $       134,244        $       110,647                21 %                  21 %
International                                     26,069                 23,638                10                  6                  93,323                 87,840                 6                     5

Total                                    $        66,747        $        58,015                15 %               13 %       $       227,567        $       198,487                15 %                  14 %

Comparison of three months ended September 29, 2013 to three months ended September 30, 2012

Revenue. Revenue increased by 15% to $66.7 million for the three months ended September 29, 2013 from $58.0 million for the three months ended September 30, 2012, primarily as a result of our acquisition and integration of OrthoHelix and growth in upper


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extremity joints and trauma. Foreign currency exchange rate fluctuations had a positive impact of $0.9 million in the third quarter of 2013 as compared to the same quarter of last year. We believe revenue for the three months ended September 29, 2013 was negatively impacted by disruption in our U.S. sales channel due to our strategic initiative to establish separate sales channels that are individually focused on the upper extremity specialist and the lower extremity specialist.

Revenue by product category. Revenue in upper extremity joints and trauma increased by 2% to $40.3 million for the third quarter of 2013 from $39.4 million for the third quarter of 2012, primarily as a result of the continued increase in revenue from our Aequalis reversed and Aequalis Ascend shoulder product line in our international markets as well as our Latitude elbow product lines, both of which have been widely accepted in the market place. Additionally, revenue for the third quarter of 2013 had a positive impact from foreign currency exchange rates of $0.3 million. We believe that the disruption in our U.S. sales channel negatively impacted upper extremity joints and trauma revenue in the third quarter of 2013, offsetting the growth experienced internationally. This was especially true in certain U.S. territories where our legacy distributor partner relationships were changed. We believe this initiative could continue to negatively impact our revenue for the remainder of 2013 and into 2014 until it is completed. However, we anticipate that revenue from upper extremities will be favorably impacted in future periods as a result of the third quarter of 2013 launch of our Aequalis Ascend Flex shoulder. Revenue in lower extremity joints and trauma increased by 133% to $13.5 million for the third quarter of 2013 from $5.8 million for the third quarter of 2012, primarily as a result of our acquisition and integration of OrthoHelix in the fourth quarter of 2012. This growth was partially offset by decreased revenue of legacy Tornier joint replacement and fixation products due to disruption in our U.S. sales channel. Revenue in sports medicine and biologics decreased 11% to $3.1 million during the third quarter of 2013 compared to $3.5 million in the third quarter of 2012 as growth in our international suture and biologic products was offset by decreases in U.S. sales of Conexa and certain anchor product lines. Revenue from large joints and other increased by 6% to $9.8 million for the third quarter of 2013 from $9.3 million for the third quarter of 2012 primarily from a positive impact from foreign currency exchange rates of $0.6 million. Also impacting revenue from large joints was growth in our core hip product portfolio offset by declines in our sales of our knee products and instrumentation. Revenue from our large joints and other category is primarily generated in certain western European geographies which continued to experience economic pressures, thereby adversely affecting our large joints and other revenue.

Revenue by geography. Revenue in the United States increased by 18% to $40.7 million for the third quarter of 2013 from $34.4 million for the third quarter of 2012, primarily due to revenue from our acquisition and integration of OrthoHelix. Excluding the impact from OrthoHelix, we believe our remaining revenues in the United States decreased as a result of disruption in our U.S. sales channel due to our strategic initiative to establish separate sales channels that are individually focused on the upper extremity specialist and the lower extremity specialist. While we believe this transition will increase our ability to meet our customers' needs in the future, it had a negative impact on our United States revenue during the third quarter of 2013 and likely will continue to negatively impact revenue into 2014 until this initiative is complete. International revenue increased by 10% to $26.1 million for the third quarter of 2013 from $23.6 million for the third quarter of 2012. Foreign currency exchange rate fluctuations had a positive $0.9 million impact on international revenue during the third quarter of 2013. International revenue increased due primarily to growth in sales in France and from certain geographic expansion activities in which we increased the number of products sold through direct sales channels in countries where we historically utilized local independent distributor representation. This growth was partially offset by decreases in revenue in certain western European countries due to continued austerity measures and lower procedure volumes and a decrease in revenue in Australia due to the impact of our then pending acquisition of our lower extremity stocking distributor in that country.

Cost of goods sold. Cost of goods sold increased to $19.0 million for the third quarter of 2013 from $15.7 million for the third quarter of 2012. As a percentage of revenue, cost of goods sold increased from 27% for the third quarter of 2012 to 28% for the third quarter of 2013, primarily due to approximately $1.8 million in fair value adjustments related to inventory acquired in our acquisition of OrthoHelix and our acquisition of our stocking distributor in Canada. Excluding the inventory fair value adjustment items, our cost of goods sold as a percentage of revenue decreased due to product cost improvements, production efficiencies and the insourcing of certain products, partially offset by negative impacts of geographical mix. Our cost of goods sold and corresponding gross profit as a percentage of revenue can be expected to fluctuate in future periods depending upon certain factors, including, among others, changes in our product sales mix and prices, distribution channels and geographies, manufacturing yields, plans for insourcing some previously outsourced production activities, inventory reserves required, levels of production volume and fluctuating inventory costs due to changes in foreign currency exchange rates since the period they were manufactured. In addition, the fair value adjustment charges recorded as cost of goods sold from the sell through of inventory acquired from business acquisitions should decline in future periods from the levels experienced in the fourth quarter of 2012 and the first three quarters of 2013 as all fair value adjustment charges related to the OrthoHelix acquired inventory had been recognized as of September 29, 2013.

Selling, general and administrative. Our selling, general and administrative expenses increased by 21% to $46.8 million for the third quarter of 2013 from $38.5 million for the third quarter of 2012. As a percentage of revenue, selling, general and administrative expenses were 70% and 66% for the third quarter of 2013 and the third quarter of 2012, respectively. Included in selling, general and administrative expenses for the third quarter of 2013 is $4.7 million of expense relating to OrthoHelix. Excluding this amount, the increase in total selling, general and administrative expense as a percentage of revenue on a comparable basis quarter over quarter was


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primarily a result of higher non-variable sales expenses due to the establishment of direct sales channels in certain areas of the U.S. and several countries internationally and $0.7 million of expense related to the medical device excise tax in the U.S. We expect selling, general and administrative expenses as a percentage of revenue to be higher than historical levels in the near term until we experience the anticipated revenue benefits of our distribution channel transitions, integration initiatives, investments in sales resources, training and education, and new product launches, including the Aequalis Ascend Flex.

Research and development. Research and development expenses decreased by 11% to $4.7 million for the third quarter of 2013 from $5.3 million for the third quarter of 2012. As a percentage of revenue, research and development expenses decreased 2% to 7% for the third quarter of 2013 from 9% for the third quarter of 2012. The decrease in total research and development expense of $0.6 million was primarily due to the timing of spending on certain projects, partially offset by increases in spending due to our acquisition of OrthoHelix.

Amortization of intangible assets. Amortization of intangible assets increased $1.2 million to $4.0 million for the third quarter of 2013 from $2.7 million for the third quarter of 2012. The increase in amortization expense was primarily attributable to an increase in intangible assets due to our acquisition of OrthoHelix.

Special charges (income). We recorded $(3.9) million in special charges for the third quarter of 2013 compared to $6.5 million for the third quarter of 2012. The $(3.9) million is primarily comprised of a $4.9 million reversal of a contingent consideration liability related to the OrthoHelix acquisition due to the underperformance of legacy Tornier lower extremity products versus established revenue targets offset by $1.1 million of integration costs and distributor transition costs. The $6.5 million of special charges for the quarter ended September 30, 2012 was comprised of approximately $2.7 million of costs incurred in relation to our facilities consolidation initiative, $2.0 . . .

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