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EXAC > SEC Filings for EXAC > Form 10-K on 6-Mar-2014All Recent SEC Filings

Show all filings for EXACTECH INC

Form 10-K for EXACTECH INC


6-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the 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 and other products and services. Revenue from sales of other products, including surgical instrumentation, Cemex® bone cement, the InterSpace™ pre-formed, antibiotic cement hip, knee and shoulder spacers have contributed to revenue growth and are expected to continue to be an important part of our anticipated future revenue growth.
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 the primary decision maker 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 customer, are actively participating with physicians in the choice of implants and services. Overview of 2013
During the twelve months ended December 31, 2013, sales increased 6% to $237.1 million from $224.3 million in the comparable twelve months ended December 31, 2012, due to domestic growth. Domestic sales for the year ended December 31, 2013 increased 10%, to $159.6 million from $145.6 million for the same period for 2012, as a percentage of sales domestic sales increased to 67% from 65% for the year ended December 31, 2012. Gross margins remained constant at 69%. Operating expenses during 2013 increased 4% from 2012, and, as a percentage of sales, operating expenses decreased to 59% during 2013 as compared to 60% 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 twelve months ended December 31, 2013 increased 21% to $15.4 million, and diluted earnings per share were $1.12 as compared to $0.96 during 2012. At the end of 2013, working capital increased 14% to $112.0 million from $98.7 million as of December 31, 2012. The increase in working capital was primarily a result of increased receivables. During the twelve months ended December 31, 2013, we acquired $16.1 million in property and equipment, including new production equipment and surgical instrumentation. Net cash flow from operations was $16.7 million for the year ended December 31, 2013 as compared to net cash flow from operations of $27.5 million during the year ended December 31, 2012. The decrease in operating cash flow was primarily a result of increased accounts receivable balances at the end of 2013, primarily due to the longer payment terms of international sales, as well as the delay in payments from government hospitals in Spain.


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The following table includes: (i) items from the Statements of Income for the year ended December 31, 2013 as compared to 2012, and the dollar and percentage change from year to year and the percentage relationship to net sales, and (ii) items from the Statements of Income for the year ended December 31, 2012 as compared to 2011, and the dollar and percentage change from year to year and the percentage relationship to net sales:

  (dollars in                                                     2013 - 2012         2012 - 2011
thousands)                  Years Ended December 31,              Inc (decr)           Inc (decr)                 % of Sales
                        2013          2012          2011          $         %         $          %        2013       2012       2011
Net sales            $ 237,088     $ 224,337     $ 205,397     12,751      5.7     18,940       9.2     100.0  %   100.0  %   100.0  %
Cost of goods sold      73,019        68,731        64,847      4,288      6.2      3,884       6.0      30.8       30.6       31.6
Gross profit           164,069       155,606       140,550      8,463      5.4     15,056      10.7      69.2       69.4       68.4
Operating expenses:
Sales and marketing     84,999        81,979        77,243      3,020      3.7      4,736       6.1      35.9       36.5       37.6
General and
administrative          21,149        20,139        21,969      1,010      5.0     (1,830 )    (8.3 )     8.9        9.0       10.7
Research and
development             17,802        16,803        13,059        999      5.9      3,744      28.7       7.5        7.5        6.4
Depreciation and
amortization            16,190        15,343        14,455        847      5.5        888       6.1       6.8        6.8        7.0
Total operating
expenses               140,140       134,264       126,726      5,876      4.4      7,538       5.9      59.1       59.8       61.7
Income from
operations              23,929        21,342        13,824      2,587     12.1      7,518      54.4      10.1        9.5        6.7
Other income
(expense), net          (1,521 )      (1,448 )        (514 )      (73 )    5.0       (934 )   181.7      (0.6 )     (0.6 )     (0.2 )
Income before taxes     22,408        19,894        13,310      2,514     12.6      6,584      49.5       9.5        8.9        6.5
Provision for income
taxes                    7,036         7,153         4,484       (117 )   (1.6 )    2,669      59.5       3.0        3.2        2.2
Net income           $  15,372     $  12,741     $   8,826      2,631     20.6      3,915      44.4       6.5        5.7        4.3

Sales
Comparison of the years ended December 31, 2013 and 2012
For the year ended December 31, 2013, sales increased 6% to $237.1 million from
$224.3 million in the comparable twelve months ended December 31, 2012. The
following table includes the net sales for each of our product lines, which are
also our reportable segments, along with the percentage of net sales, as well as
a comparison of net sales change to net sales change calculated on a constant
currency basis for the years ended December 31, 2013 and 2012:
                                                                            Constant Currency
                         Years Ended December 31,              % Change         % Change
 (in thousands)         2013                   2012           2013-2012         2013-2012
Knee            $  80,532     34.0 %   $  81,387     36.3 %       (1.1 )              0.2
Extremity          65,528     27.6        52,061     23.2         25.9               25.7
Hip                40,958     17.3        40,826     18.2          0.3                2.3
Biologics/Spine    25,486     10.7        24,463     10.9          4.2                3.7
Other              24,584     10.4        25,600     11.4         (4.0 )             (3.6 )
Total           $ 237,088    100.0 %   $ 224,337    100.0 %        5.7                6.4

The decrease in sales of knee implant products was related to the slowdown of international sales to Latin America in the first quarter of 2013, as well as relatively weaker currency in Japan. Sales of our extremity products increased significantly as we continued the success of our Equinoxe reverse shoulder system. Hip implant sales remained relatively flat as we continued to experience international growth with our Novation Element hip system, offset by the weaker currency in Japan and Europe. Our biologics and spine sales increase resulted from our spine product expansion, offset partially by pricing pressure in our biologics revenues. The decrease in the sales of all other products was related to the expiration of two third party distribution agreements and a reduction in sales of our surgical instrumentation sold outside the United States. Domestically, sales increased 10% to $159.6 million, or 67% of total


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sales, during the year ended December 31, 2013, up from $145.6 million, which represented 65% of total sales during 2012. Internationally, sales decreased 2% to $77.4 million, representing 33% of total sales, for the year ended December 31, 2013, as compared to $78.7 million, which represented 35% of total sales during 2012. On a constant currency basis, international sales increased approximately 1% during the year ended December 31, 2013, compared to the same period in 2012.
Comparison of the years ended December 31, 2012 and 2011 For the year ended December 31, 2012, sales increased 9% to $224.3 million from $205.4 million in the comparable twelve months ended December 31, 2011. The following table includes the net sales for each of our product lines, which are also our reportable segments, along with the percentage of net sales, as well as a comparison of net sales change to net sales change calculated on a constant currency basis for the years ended December 31, 2012 and 2011:

                                                                                Constant Currency
                                  Years Ended                      % Change         % Change
 (in thousands)   December 31, 2012        December 31, 2011      2012-2011         2012-2011
Knee            $    81,387     36.3 %   $    80,088     39.0 %        1.6                3.1
Hip                  40,826     18.2          33,688     16.4         21.2               22.1
Biologics/Spine      24,463     10.9          24,341     11.9          0.5                1.6
Extremity            52,061     23.2          39,923     19.4         30.4               31.3
Other                25,600     11.4          27,357     13.3         (6.4 )             (4.5 )
Total           $   224,337    100.0 %   $   205,397    100.0 %        9.2               10.5

The increase in sales of knee implant products was related to the market acceptance of our Optetrak Logic system. Sales of our extremity products increased significantly as we continued to penetrate market share with our Equinoxe reverse shoulder system. Hip implant sales increased as we continued to experience market penetration with our Novation Element hip system. Our biologics and spine sales increase was a result of increased spinal revenues worldwide. The decrease in the sales of all other products was related to a reduction in sales of our surgical instrumentation sold outside the United States. Domestically, sales increased 9% to $145.6 million, or 65% of total sales, during 2012, up from $133.0 million, which also represented 65% of total sales during 2011. Internationally, sales increased 9% to $78.7 million, representing 35% of total sales during 2012, as compared to $72.4 million, which was also 35% of total sales during 2011. The international sales increase was primarily attributable to growth in our direct sales operations. Gross Profit
Gross profit increased 5% to $164.1 million for the year ended December 31, 2013 from $155.6 million for the year ended December 31, 2012. As a percentage of sales, gross profit remained constant at 69% during each of the years ended December 31, 2013 and 2012, as a result of domestic sales growth, which generally carries higher margins than sales in international markets, however, this was 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. Gross profit increased 11% to $155.6 million for the year ended December 31, 2012 from $140.6 million for the year ended December 31, 2011. As a percentage of sales, gross profit increased to 69% during the year ended December 31, 2012 as compared to 68% in the same twelve month period in 2011, as a result of continued cost reductions in our internally manufactured products. Operating Expenses
Total operating expenses increased 4% to $140.1 million in the year ended December 31, 2013 from $134.3 million in the year ended December 31, 2012. As a percentage of sales, total operating expenses decreased to 59% for the twelve months ended December 31, 2013, as compared to 60% for the same period in 2012. The decrease, as a percentage of sales, was primarily due to sales growth outpacing increases in variable selling costs. During 2012, total operating expenses increased 6% to $134.3 million from $126.7 million in the year ended December 31, 2011. As a percentage of sales, total operating expenses decreased to 60% for the twelve months ended December 31, 2012, as compared to 62% for the same period in 2011. The decrease as a percentage of sales was a result of lower compliance costs as well as our focus on reducing operating expenses.


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Sales and marketing expenses, the largest component of total operating expenses, increased 4% for the year ended December 31, 2013 to $85.0 million from $82.0 million in the comparable period of December 31, 2012. Sales and marketing expenses, as a percentage of sales, decreased slightly to 36% for the year ended December 31, 2013, from 37% for the year ended December 31, 2012. During 2012, sales and marketing expenses increased 6% to $82.0 million from $77.2 million in the comparable period of December 31, 2011. Sales and marketing expenses, as a percentage of sales, decreased slightly to 37% for the year ended December 31, 2012, from 38% for the year ended December 31, 2011. Looking forward, sales and marketing expenditures, as a percentage of sales, are expected to be in the range of 36% to 37% for 2014.
General and administrative expenses increased 5% to $21.1 million in the twelve months ended December 31, 2013 from $20.1 million in the twelve months ended December 31, 2012, which included $2.3 million in compliance expenses for each of the twelve month periods. As a percentage of sales, general and administrative expenses remained at 9% for each of the twelve months ended December 31, 2013 and 2012. General and administrative expenses decreased 8% to $20.1 million in the twelve months ended December 31, 2012 from $22.0 million in the twelve months ended December 31, 2011, which included the $2.3 million and $4.5 million in compliance expenses for each of the periods, respectively. As a percentage of sales, general and administrative expenses decreased to 9% for the twelve months ended December 31, 2012, as compared to 11% in the year ended December 31, 2011. General and administrative expenses for 2014 are expected to be in the range of 8.5% to 9.5% of sales.
Research and development expenses increased 6% for the year ended December 31, 2013 to $17.8 million from $16.8 million for 2012. As a percentage of sales, research and development expenses increased to 8% for the twelve months ended December 31, 2013 from 7% for the comparable period last year. The increase was primarily due to increased testing and product development expenses related to our Exactech GPS, advanced surgical technology. Research and development expenses increased 29% for the year ended December 31, 2012 to $16.8 million from $13.1 million for 2011. As a percentage of sales, research and development expenses increased to 7% during 2012 from 6% for 2011. The 2012 increase was due primarily to increased design and development activities, including our cartilage repair development project. We anticipate research and development expenditures, as a percentage of sales, to range from 7% to 8% of sales during 2014.
Depreciation and amortization increased 6% to $16.2 million during the year ended December 31, 2013 from $15.3 million in the twelve months ended December 31, 2012, as a result of our continued investment in surgical instrumentation. As a percentage of sales, depreciation and amortization remained flat at 7% for the years ended December 31, 2013 and 2012. Total capital expenditure investment for 2013 was $16.5 million, which included $11.8 million of surgical instrumentation placed in service and approximately $0.4 million spent for product licenses, patents and trademarks during the twelve months of 2013. During 2012, depreciation and amortization increased 6% to $15.3 million from $14.5 million in 2011. As a percentage of sales, depreciation and amortization remained flat at 7% for the years ended December 31, 2012 and 2011. Total capital expenditure investment for 2012 was $22.4 million, which included $17.9 million of surgical instrumentation placed in service and approximately $1.4 million spent for patents and trademarks. Income from Operations
Our income from operations increased 12% to $23.9 million, or 10% of sales in the year ended December 31, 2013 from $21.3 million, or 10% of sales in the twelve month period ended December 31, 2012. The increase in our income from operations was a result of our sales growth, and continued efforts to leverage our existing cost structures. During 2012, our income from operations increased 54% to $21.3 million, or 10% of sales from $13.8 million, or 7% of sales in 2011. Looking forward, we expect operating expenses to increase slightly slower than sales growth, and we anticipate income from operations to expand to the range of 10.5% to 11.5% for 2014.
Other Income and Expenses
We had other expenses, net of other income, of $1.5 million during the year ended December 31, 2013, as compared to other expenses, net of other income of $1.4 million in the twelve months ended December 31, 2012. The increase to net other expenses was primarily due to the foreign currency loss of $0.4 million for 2013 from a net foreign currency loss of $0.1 million for 2012. Partially offsetting the increase was net interest expense, which decreased for the twelve months ended December 31, 2013 to $1.2 million from $1.4 million during the twelve months ended December 31, 2012, due to decreased full year average borrowing under our line of credit facility. During 2012, we incurred other expenses, net of other income, of $1.4 million, as compared to other expenses, net of other income of $0.5 million during 2011. The 2012 increase to net other expenses was due to the net foreign currency loss of $0.1 million for 2012 compared to a foreign currency gain of $0.5 million for 2011, as well as a net interest expense increase to $1.4


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million from $1.1 million during 2011. Net foreign currency activities during the twelve months ended December 31, 2012 consisted of $0.2 million in foreign currency transaction gains, offset by the realized loss of $0.3 million from our forward currency option hedge.
Taxes and Net Income
Income before provision for income taxes increased 13% to $22.4 million in the year ended December 31, 2013 from $19.9 million in the same period in 2012. The effective tax rate, as a percentage of income before taxes, was 31% for the twelve months ended December 31, 2013 and 36% for the same twelve month periods in 2012. The decrease in the effective tax rate for the year ended December 31, 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. During the full year 2014, we anticipate an effective tax rate of 33 to 34% as the research and development tax credit has expired. As a result of the foregoing, we realized net income of $15.4 million in the year ended December 31, 2013, an increase of 21% from $12.7 million in the twelve months ended December 31, 2012. As a percentage of sales, net income increased to 6.5% from 5.7% during the year ended December 31, 2012. Earnings per share, on a diluted basis, increased to $1.12 for the twelve months ended December 31, 2013, from $0.96 for the twelve months ended December 31, 2012. Income before provision for income taxes increased 49% to $19.9 million in the year ended December 31, 2012 from $13.3 million in the same period in 2011. The effective tax rate, as a percentage of income before taxes, was 36% for the twelve months ended December 31, 2012 and 34% for the same twelve month periods in 2011. The increase in the effective tax rate for 2012 was primarily due to the tax impact of the research and development tax credit that was effective for 2011 as opposed to having expired during 2012, and the change in estimate of the non-deductible portion of the 2010 DOJ settlement. Formerly, we anticipated that $0.6 million of the settlement was non-deductible and, as a result of IRS discussions with the DOJ in the second quarter of 2012, pursuant to an IRS audit being conducted for tax years 2009 through 2011, it was clarified that $1.3 million of this settlement was non-deductible resulting in $0.3 million of additional tax liability. As a result of the foregoing, we realized net income of $12.7 million in the year ended December 31, 2012, an increase of 44% from $8.8 million in the twelve months ended December 31, 2011. As a percentage of sales, 2012 net income increased to 6% from 4% during the year ended December 31, 2011. Earnings per share, on a diluted basis, increased to $0.96 for the twelve months ended December 31, 2012, from $0.67 for the twelve months ended December 31, 2011.
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 December 31, 2013, we had working capital of $112.0 million, an increase of 14% from $98.7 million at the end of 2012. Working capital in 2013 increased primarily as a result of an increase in our current receivables balance. Inventory and surgical instrumentation increases were impacted by the $1.8 million incurred for the medical device excise tax during December 31, 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 options with any number of possible combinations of additional debt, additional equity or convertible debt.
Operating Activities - Operating activities provided net cash of $16.7 million in the twelve months ended December 31, 2013, as compared to net cash from operations of $27.5 million during the twelve months ended December 31, 2012. A primary contributor to this change related to the increase in accounts receivable of $11.1 million during the year ended December 31, 2013, compared to an increase of $2.3 million during the same period ended December 31, 2012, as a result of our distribution operation in Spain, which continued 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 confirmed receivables and notified us that payments of those confirmed receivables would begin during the first quarter of 2014. During February 2014 we received approximately €9.4 million from the confirmed government hospitals. Our allowance for doubtful accounts and sales returns remained relatively flat at $1.0 million at both December 31, 2013 and 2012, The total days sales outstanding (DSO) ratio, based on average accounts receivable balances, was 81 for the twelve months ended December 31, 2013, which increased from a ratio of 75 for the year ended December 31, 2012, primarily as a result of the delayed payments in Spain. As we continue to expand our operations internationally, our DSO ratio could continue to increase, due to the fact that credit terms outside the U.S. tend to be relatively longer than those in the U.S. During 2013, the increase in inventory used net cash of $9.7 million as compared to $8.0 million during 2012, as a result of our continued product line expansion and continued growth within existing markets.


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Investing Activities - Investing activities used net cash of $15.7 million for the year ended December 31, 2013, as compared to $22.2 million for the year ended December 31, 2012. The decrease was due to a reduction of purchases of property and equipment. Our cash outlays for surgical instrumentation, manufacturing equipment and facility expansion was $14.9 million, and $0.4 million for purchases of patents, trademarks and product licenses during the year ended December 31, 2013, as compared to $20.7 million for purchases of surgical instrumentation, manufacturing equipment and facility expansion, and $1.4 million for purchases of patents, trademarks and product licenses during the same period of 2012.
During 2013, we invested $1.4 million in ongoing license, milestone and research payments to Blue Ortho related to the Guided Personalized Surgery knee technology.
License technology
Our Taiwanese subsidiary, Exactech Taiwan, has entered into a license agreement with the Industrial Technology Research Institute (ITRI) and the National Taiwan University Hospital (NTUH) for the rights to technology and patents related to the repair of cartilage lesions. As of December 31, 2013, we had paid approximately $2.1 million for the licenses, patents, equipment related to this license agreement, and prepaid expenses, and we will make royalty payments when the technology becomes marketable. Using the technology, we plan to launch a cartilage repair program that will include a device and method for the treatment and repair of cartilage in the knee joint. The agreement terms include a license fee based on the achievement of specific, regulatory milestones and a royalty arrangement based on sales once regulatory clearances are established. We are currently evaluating regulatory approval pathways for this technology. Financing Activities - Financing activities used net cash of $0.8 million for the year ended December 31, 2013, as compared to using net cash of $4.3 million for the year ended December 31, 2012, primarily due to cash proceeds from issuance of stock offsetting the reduction in total outstanding debt. In 2013, we had net debt repayments of $4.1 million as compared to net repayments of $5.5 million in 2012. Proceeds from the exercise of stock options provided cash of $3.4 million for the year ended December 31, 2013, as compared to $1.9 million for the year ended December 31, 2012, with the proceeds used to reduce the outstanding balance under our line of credit. Long-term Debt
On February 24, 2012, we entered into a revolving credit and term loan agreement for a maximum aggregate principal amount of $100.0 million, referred to as the Credit Agreement, with SunTrust Bank, as Administrative Agent, issuing bank and swingline lender, and a syndicate of other lenders. The Credit Agreement is composed of a $30.0 million term loan facility and revolving credit line in an aggregate principal amount of up to $70.0 million, of which, a portion is a swingline note for $5.0 million. The swingline note is used for short-term cash management needs, and excess bank account cash balances are swept into the . . .

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