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TRNX > SEC Filings for TRNX > Form 10-K on 21-Feb-2014All Recent SEC Filings

Show all filings for TORNIER N.V.

Form 10-K for TORNIER N.V.


21-Feb-2014

Annual Report


ITEM 7. 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 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 1- 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.

Overview

We are a global medical device company focused on providing solutions to surgeons that treat musculoskeletal injuries and disorders of the shoulder, elbow, wrist, hand, ankle and foot, which we refer to as "extremity joints." We sell to this surgeon base a broad line of joint replacement, trauma, sports medicine and biologic products to treat extremity joints. In certain international markets, we also offer joint replacement products for the hip and knee.

We have had a tradition of innovation, intense focus on science and education and a commitment to the advancement of orthopaedics in the pursuit of improved clinical outcomes for patients since our founding over 70 years ago in France by Renι Tornier. Our history includes the introduction of the porous orthopaedic hip implant, the application of the Morse taper, which is a reliable means of joining modular orthopaedic implants, and, more recently, the introduction of the stemless shoulder both in Europe and in a U.S. clinical trial. This track record of innovation based on science and education stems from our close collaboration with leading orthopaedic surgeons and thought leaders throughout the world.

We believe we are differentiated in the marketplace by our strategic focus on extremities, our full portfolio of upper and lower extremity products, and our extremity-focused sales organization. We offer a broad product portfolio of over 95 extremities products that are designed to provide solutions to our surgeon customers with the goal of improving clinical outcomes for their patients. We believe a more active and aging patient population with higher expectations regarding "quality of life," an increasing global awareness of extremities solutions, improved clinical outcomes as a result of the use of extremities products and technological advances resulting in specific designs for extremities products that simplify procedures and address unmet needs for early interventions and the growing need for revisions and revision related solutions will drive the market for extremities products.

We manage our business in one reportable segment that includes the design, manufacture, marketing and sales of orthopaedic products. 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 a broad offering of products, including products for upper extremity joints and trauma, lower extremity joints and trauma, and sports medicine and biologics. We do not actively market products for the hip or knee, which we refer to as "large joints," in the United States, although we have clearance from the FDA to sell certain large joint products. We are in the process of completing our strategic initiative to transition our U.S. sales organization from a network of independent sales agencies that sold our full product portfolio to a combination of direct sales teams and independent sales agencies that are individually focused on selling either upper extremity products or lower extremity products across the territories that they serve. This transition caused disruption in our U.S. business in 2013 and this disruption is expected to continue throughout 2014 as we continue to transition our sales representatives to focus on either upper or lower extremities products, optimize our territory structures, hire additional sales representatives to fill territories and educate and train our sales teams. We ultimately believe that this strategy will position us to leverage our sales force and broad product portfolio toward our goal of achieving above market extremities revenue growth and margin expansion over the long term by allowing us to increase the product proficiency of our sales representatives to better serve our surgeon customers and to increase and optimize our selling opportunities by improving our overall procedure coverage and providing access to new specialists, general surgeons and accounts.

In international markets, we sell our full product portfolio, including large joints, and we utilize several distribution approaches that are tailored to the needs and requirements of each individual market. Our international sales and distribution system currently consists of 13 direct sales offices and approximately 25 distributors that sell our products in approximately 45 countries.


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2013 Executive Summary

During 2013, we believe we made significant progress toward our three main strategic initiatives:

• The transition of our U.S. sales organization. We spent most of 2013 transitioning our U.S. sales organization from a network of independent sales agencies that sold our full product portfolio to a combination of direct sales teams and independent sales agencies that are individually focused on selling either upper extremity products or lower extremity products across the territories that they serve. Over 85% of our U.S. revenues is now under a new agreement or transitioned to a direct sales model and over 55% of our U.S. revenues are served by direct sales teams. As we move into 2014, we expect to continue and complete the transition of our sales representatives to focus on either upper or lower extremities products, optimize our territory structures, hire additional sales representatives to fill territories and educate and train our sales teams. We believe that the transition of our U.S. sales organization will position us to leverage our sales force and broad product portfolio toward our goal of achieving above market extremities revenue growth and margin expansion over the long term.

• The integration of OrthoHelix. We acquired OrthoHelix in the fourth quarter of 2012 to strengthen our product portfolio of lower extremity products and gain access to a dedicated lower extremities sales force that would allow a move to dedicated upper and lower extremities sales representation. The 2013 transition of our U.S. sales organization was closely connected to the integration of many of the historical OrthoHelix distributors into our overall U.S. lower extremities sales organization. During 2013, we received CE Mark approval to sell the majority of our OrthoHelix products internationally and have since begun to selectively launch these products in certain markets, including France, Germany and the United Kingdom. In addition, we completed the integration of the OrthoHelix sales, marketing, and research and development activities into our global teams.

• The launch of our Aequalis Ascend Flex. We completed the limited user release and commercial launch of the Aequalis Ascend Flex convertible shoulder system during 2013. We believe that the Aequalis Ascend Flex has further strengthened our market-leading shoulder product portfolio by providing surgeons with a convertible pressed-fit reversed solution, while also expanding our addressable market for shoulder products by filling what we believe was a previous gap in this portfolio. We completed the training and education of over 150 surgeons on the Aequalis Ascend Flex during 2013 and plan to increase the number of instrument sets available to the field during 2014, both in the United States and internationally, and continue to train surgeons to further increase market acceptance.

Although we believe we made great strides in our business and strategic initiatives during 2013, our financial performance was below our expectations set at the beginning of 2013, primarily as a result of the disruption experienced in our U.S. business driven by the transition of our U.S. sales organization. The following are a few highlights of our 2013 financial and operating performance:

• Our revenue grew by $33.4 million, or 12.0%, to $311.0 million in 2013 from $277.5 million in 2012 primarily as a result of our acquisition of OrthoHelix, and to a lesser extent, an increase in upper extremity joints and trauma revenue primarily as a result of the continued increase in sales of our Aequalis Ascend shoulder products, including the Aequalis Ascend Flex that was launched in the third quarter of 2013. Our 2013 revenue, however, 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 selling either upper extremity products or lower extremity products across the territories that they serve.

• Our gross margins improved to 72.3% in 2013 compared to 70.5% in 2012. Our 2013 gross margin results improved due to product cost improvements, production efficiencies and the insourcing of certain products. Additionally, our gross margin included $5.9 million of inventory fair value adjustments as a result of our acquisition of OrthoHelix and other smaller acquisitions, while our 2012 gross margin results included $2.0 million of fair value adjustments related to acquired inventory and $3.0 million product rationalization charges primarily due to product overlap with the products acquired from OrthoHelix.

• Although we incurred a net loss of $36.4 million for 2013 compared to a net loss of $21.7 million for 2012, our operating loss decreased to $24.1 million for 2013 from $28.3 million for 2012 driven by higher revenues and improved gross margins, partially offset by higher selling, general and administrative expenses primarily due to our U.S. sales organization transition, higher intangible amortization related to our recent acquisitions and the negative impact of the medical device excise tax.


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• We completed the acquisitions of certain stocking distributors in Canada, Australia and the United Kingdom and certain U.S. distributors and independent sales agencies during 2013 for an aggregate purchase price of $9.9 million, plus an additional $2.5 million in contingent consideration to be paid over the next two years.

• We completed an underwritten public offering in May 2013 pursuant to which we sold 5.2 million ordinary shares and certain shareholders sold 2.9 million ordinary shares at a public offering price of $16.15 per share, resulting in net proceeds to us of $78.7 million, after the underwriters' discount and commissions and offering expenses.

• We used $50.5 million of the net proceeds from our May 2013 public offering to pay off our $40.0 million Euro denominated term loan and a portion of our U.S. dollar denominated term loan.

• We recorded $3.7 million in special charges in 2013, which were primarily comprised of $7.1 million of integration and distributor transition costs and $1.2 million of legal settlements in the United States, partially offset by a $5.1 million reversal of a contingent consideration liability related to our OrthoHelix acquisition due to the under-performance of our legacy lower extremity products versus established revenue targets. We expect to record special charges in 2014 between $3.9 and $5.6 million primarily related to our ongoing integration of OrthoHelix, expected completion of our U.S. sales transitions and OrthoHelix restructuring efforts.

• We began and made significant progress on the implementation of an enterprise resource planning (ERP) system and our efforts will continue through 2014 and into 2015.

Results of Operations

Fiscal Year Comparisons

The following table sets forth, for the periods indicated, certain items from
our consolidated statements of operations and the percentage of revenue that
such items represent for the periods shown.



                                                                            Year ended
                                                December 29,               December 30,                January 1,
                                                    2013                       2012                       2012
                                                                         ($ in thousands)
Statements of Operations Data:
Revenue                                     $ 310,959        100 %     $ 277,520        100 %     $ 261,191        100 %
Cost of goods sold                             86,172         28          81,918         30          74,882         29

Gross profit                                  224,787         72         195,602         70         186,309         71
Selling, general and administrative           206,851         67         170,447         61         161,448         62
Research and development                       22,387          7          22,524          8          19,839          8
Amortization of intangible assets              15,885          5          11,721          4          11,282          4
Special charges                                 3,738          1          19,244          7             892          0

Operating loss                                (24,074 )       (8 )       (28,334 )      (10 )        (7,152 )       (3 )
Interest income                                   245          0             338          0             550          0
Interest expense                               (7,256 )       (2 )        (3,733 )       (1 )        (4,326 )       (2 )
Foreign currency transaction (loss) gain       (1,820 )       (1 )          (473 )       (0 )           193          0
Loss on extinguishment of debt                 (1,127 )       (0 )          (593 )       (0 )       (29,475 )      (11 )
Other non-operating (expense) income, net         (45 )       (0 )           116          0           1,330          1

Loss before income taxes                      (34,077 )      (11 )       (32,679 )      (12 )       (38,880 )      (15 )
Income tax (expense) benefit                   (2,349 )       (1 )        10,935          4           8,424          3

Consolidated net loss                       $ (36,426 )      (12 )%    $ (21,744 )       (8 )%    $ (30,456 )      (12 )%


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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:

Revenue by Product Category



                                                          Year ended                                         Percent change
                                       December 29,       December 30,       January 1,       2013/        2012/        2013/        2012/
                                           2013               2012              2012          2012         2011         2012         2011
                                                       ($ in thousands)                          (as stated)                (constant
                                                                                                                            currency)*
Upper extremity joints and trauma     $      184,457     $      175,242     $    164,064           5 %          7 %          5 %          9 %
Lower extremity joints and trauma             58,747             34,109           26,033          72           31           72           33
Sports medicine and biologics                 14,752             15,526           14,779          (5 )          5           (5 )          7

Total extremities                            257,956            224,877          204,876          15           10           14           12
Large joints and other                        53,003             52,643           56,315           1           (7 )         (2 )          1

Total                                 $      310,959     $      277,520     $    261,191          12 %          6 %         11 %          9 %

Revenue by Geography



                                    Year ended                                         Percent change
                 December 29,       December 30,       January 1,       2013/        2012/        2013/        2012/
                     2013               2012              2012          2012         2011         2012         2011
                                 ($ in thousands)                          (as stated)                (constant
                                                                                                     currency) *
United States   $      182,104     $      156,750     $    141,496          16 %         11 %         16 %         11 %
International          128,855            120,770          119,695           7            1            5            8

Total           $      310,959     $      277,520     $    261,191          12 %          6 %         11 %          9 %

* -Constant currency is a non-GAAP financial measure. 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.

Year Ended December 29, 2013 (2013) Compared to Year Ended December 30, 2012
(2012)

Revenue. Revenue increased by 12% to $311.0 million in 2013 from $277.5 million in 2012, primarily as a result of our acquisition and integration of OrthoHelix and growth in upper extremity joints and trauma. Foreign currency exchange rate fluctuations had a positive impact of $2.1 million in 2013. Excluding the positive impact of foreign currency exchange rate fluctuations, our revenue grew by 11% on a constant currency basis. We believe revenue in 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 upper extremity products and lower extremity products.

Revenue by product category. Revenue in upper extremity joints and trauma increased by 5% to $184.5 million in 2013 from $175.2 million in 2012, primarily as a result of the continued increase in sales of our Aequalis Ascend shoulder products, including the Aequalis Ascend Flex convertible shoulder that was launched in the third quarter of 2013, and Aequalis reversed shoulder products and the Latitude EV elbow. We believe the increase in sales of our Aequalis Ascend shoulder products was due to continued market share gains and the launch of the Aequalis Ascend Flex, while the increased sales of our Aequalis reversed shoulder products resulted from continued market movement toward reversed shoulder replacement procedures. This increase was partially offset by decreased revenue from our mature shoulder products and disruption in our U.S. sales channel. Foreign currency exchange rate fluctuations had a positive impact of $0.5 million on the upper extremity joints and trauma revenue growth during 2013. Excluding the positive impact of foreign currency exchange rate fluctuations, our upper extremity joints and trauma revenue grew by 5% on a constant currency basis. We anticipate that revenue from upper extremity joints and trauma will be favorably impacted in future periods as a result of the launch of our Aequalis Ascend Flex, although we expect a certain level of cannibalization of our other mature shoulder products as a result of the launch.

Revenue in lower extremity joints and trauma increased by 72% to $58.7 million in 2013 from $34.1 million in 2012, primarily as a result of our acquisition and integration of OrthoHelix. This growth was partially offset by decreased revenue of legacy Tornier foot and ankle fixation products driven by disruption in our U.S. sales channel due to our strategic initiative to establish separate sales channels that are individually focused on upper extremity products and lower extremity products.

Revenue in sports medicine and biologics decreased 5% to $14.8 million in 2013 from $15.5 million in 2012 as growth in our suture and BioFiber products was more than offset by decreases in certain anchor products and our Conexa product. Our sports medicine and biologics products are sold by both our upper and lower extremities sales forces and were also partially impacted by the disruption in our U.S. sales channel.


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Revenue from large joints and other increased by 1% to $53.0 million in 2013 from $52.6 million in 2012 related primarily to growth in sales of our hip products and the positive impact of foreign currency exchange rate fluctuations, partially offset by declines in sales of our mature knee products as we transition to next generation technologies. Revenue from our large joints and other category is primarily generated in certain western European geographies which continued to experience economic pressures, negatively impacting our revenue in this category. Foreign currency exchange rate fluctuations had a positive impact of $1.5 million on our large joints and other revenue during 2013. Excluding the positive impact of foreign currency exchange rate fluctuations, our large joints and other revenue decreased by 2% on a constant currency basis.

Revenue by geography. Revenue in the United States increased by 16% to $182.1 million in 2013 from $156.8 million in 2012, primarily due to our acquisition and integration of OrthoHelix. Excluding the impact from OrthoHelix, our 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 upper extremity products and lower extremity products. While we believe this transition will increase our ability to meet our customers' needs in the future, it had a negative impact on our U.S. revenue growth and likely will continue to negatively impact U.S. revenue growth during 2014 until the initiative is complete.

International revenue increased by 7% to $128.9 million in 2013 from $120.8 million in 2012. International revenue increased due to revenue growth in France from increased demand and 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. Our international revenue growth was partially offset by decreases in revenue in certain western European countries due to continued austerity measures and lower procedure volumes and lower sales volumes to certain stocking distributors. Foreign currency exchange rate fluctuations had a positive impact of $2.1 million on international revenue during 2013. Excluding the positive impact of foreign currency exchange rate fluctuations, our international revenue increased by 5% on a constant currency basis.

Cost of goods sold. Cost of goods sold increased to $86.2 million in 2013 from $81.9 million in 2012. As a percentage of revenue, cost of goods sold decreased to 28% in 2013 from 30% in 2012, primarily due to product cost improvements, production efficiencies and the insourcing of certain products. This decrease was partially offset by a higher level of excess and obsolete inventory charges and the negative impact of our geographical revenue mix. Also included in cost of goods sold in 2013 is approximately $5.9 million in fair value adjustments related to inventory acquired in our acquisition of OrthoHelix compared to $2.0 million in fair value adjustments related to acquired inventory and $3.0 million related to product rationalization charges in 2012 as a result of our acquisition of OrthoHelix. We intend to continue to focus on improving our cost of goods sold as a percentage of revenue through a combination of manufacturing efficiencies, additional in-sourcing activities and improved product mix. However, 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. The fair value adjustment charges recorded as cost of goods sold from the sell through of inventory acquired from business acquisitions is expected to decline in future periods from the levels experienced in 2013 as all fair value adjustment charges related to the OrthoHelix acquired inventory have been fully recognized.

Selling, general and administrative. Our selling, general and administrative expenses increased by 21% to $206.9 million in 2013 from $170.4 million in 2012 primarily as a result of our acquisition of OrthoHelix. As a percentage of revenue, selling, general and administrative expenses were 67% and 61% in 2013 and 2012, respectively. The increase in selling, general and administrative expense as a percentage of revenue was primarily a result of higher variable sales expenses and non-variable sales expenses related to the establishment of direct sales channels in the United States and several countries internationally, higher investments in sales training and education, an increase in expense related to information technology infrastructure and $3.2 million of expense related to the medical device excise tax which became effective in 2013. 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 U.S. sales 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 slightly to $22.4 million in 2013 from $22.5 million in 2012. As a percentage of revenue, research and development expenses decreased 1% to 7% in 2013 from 8% in 2012. The decrease in total research and development expense of $0.1 million was primarily due to lower spending due to the timing of certain development projects, partially offset by our acquisition of OrthoHelix.


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Amortization of intangible assets. Amortization of intangible assets increased $4.2 million to $15.9 million in 2013 from $11.7 million in 2012. The increase in amortization expense was primarily attributable to an increase in intangible assets due to our acquisition of OrthoHelix.

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