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EXAC > SEC Filings for EXAC > Form 10-Q on 30-Apr-2014All Recent SEC Filings

Show all filings for EXACTECH INC

Form 10-Q for EXACTECH INC


30-Apr-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes appearing elsewhere in this report.
Overview of the Company
We develop, manufacture, market and sell orthopaedic implant devices, related surgical instrumentation, supplies and biologic materials to hospitals and physicians in the United States and internationally. Our revenues are principally derived from sales of knee, hip, and extremity joint replacement systems and spinal fusion products. Our continuing research and development projects will enable us to continue the introduction of new, advanced biologic materials, joint replacement product line extensions and other products and services.
Our operating expenses consist of sales and marketing expenses, general and administrative expenses, research and development expenses, and depreciation expenses. The largest component of operating expenses, sales and marketing expenses, primarily consists of payments made to independent sales representatives for their services to hospitals and surgical facilities on our behalf. These expenses tend to vary and generally relate to our sales growth. Research and development expenses primarily consist of expenditures on projects concerning knee, extremities, spine and hip implant product lines and biologic materials and services.
In marketing our products, we use a combination of traditional targeted media marketing together with our primary marketing focus, direct customer contact and service to orthopaedic surgeons. Because surgeons are important decision makers when it comes to the choice of products and services that best meet the needs of their patients, we focus our marketing strategy on meeting the needs of the orthopaedic surgeon community. In addition to surgeon's preference, hospitals and buying groups, as the economic customers, actively participate with physicians in the choice of implants and services. Overview of the Three Months Ended March 31, 2014 During the quarter ended March 31, 2014, sales increased 7% to $63.3 million from $59.3 million in the quarter ended March 31, 2013, as a result of 7% growth in our domestic sales, and 6% growth in our international sales. Gross margins increased to 71% in the first quarter of 2014 from 69% for the same quarter in 2013, primarily due to growth in the higher margin U.S. Extremity segment. Operating expenses increased 10% when compared to the quarter ended March 31, 2013, and, as a percentage of sales, operating expenses increased to 60% during the first quarter of 2014 as compared to 58% for the same quarter in 2013. This increase, as a percentage of sales, was primarily due to our increased global compliance costs. Net income for the quarter ended March 31, 2014 increased 9%, and diluted earnings per share was $0.30 as compared to $0.29 in the same quarter last year, which was a result of sales growth and improvements in gross margins.
During the three months ended March 31, 2014, we acquired $3.7 million in property and equipment, including new production equipment and surgical instrumentation. Net cash flow from operations was $19.0 million for the three months ended March 31, 2014, as compared to net cash flow from operations of $2.6 million during the three months ended March 31, 2013. The increase was primarily due to the reduction in accounts receivable and lower inventory increases.


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The following table includes the net sales and percentage of net sales, as well as a comparison of net sales change to net sales change calculated on a constant currency basis, for each of our product lines, which are also our reportable segments, for the three month periods ended March 31, 2014 and March 31, 2013:

                                            Sales by Product Line
                                                ($ in 000's)

                                     Three Months Ended                               Inc (decr)
                           March 31, 2014           March 31, 2013        2014 - 2013      Constant Currency
Knee                   $ 20,567        32.5 %   $ 20,502        34.6 %         0.3  %              0.8  %
Extremity                19,671        31.1       15,683        26.4          25.4                24.9
Hip                      10,804        17.1       10,440        17.6           3.5                 4.9
Biologics and Spine       5,822         9.2        6,057        10.2          (3.9 )              (4.6 )
Other                     6,394        10.1        6,619        11.2          (3.4 )              (3.6 )
Total                  $ 63,258       100.0 %   $ 59,301       100.0 %         6.7  %              6.9  %

The following table includes items from the unaudited condensed consolidated statements of income for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013, the dollar and percentage change from period to period and the percentage relationship to net sales (dollars in thousands):

                                          Comparative Statement of Income Data

                                 Three Months Ended March 31,        2014 - 2013 Inc (decr)           % of Sales
                                    2014               2013               $            %          2014          2013
Net sales                     $      63,258       $      59,301           3,957          6.7      100.0  %      100.0  %
Cost of goods sold                   18,634              18,590              44          0.2       29.5          31.3
Gross profit                         44,624              40,711           3,913          9.6       70.5          68.7
Operating expenses:
Sales and marketing                  23,713              21,524           2,189         10.2       37.5          36.3
General and administrative            5,785               5,096             689         13.5        9.2           8.6
Research and development              4,193               3,850             343          8.9        6.6           6.5
Depreciation and amortization         4,322               4,175             147          3.5        6.8           7.1
Total operating expenses             38,013              34,645           3,368          9.7       60.1          58.4
Income from operations                6,611               6,066             545          9.0       10.4          10.2
Other income (expense), net              (7 )              (715 )           708         99.0          -          (1.2 )
Income before taxes                   6,604               5,351           1,253         23.4       10.4           9.0
Provision for income taxes            2,406               1,494             912         61.0        3.8           2.5
Net income                    $       4,198       $       3,857             341          8.8        6.6           6.5

Three Months Ended March 31, 2014 Compared to Three Months Ended March 31, 2013 Sales
For the quarter ended March 31, 2014, sales increased 7% to $63.3 million from $59.3 million in the quarter ended March 31, 2013, principally as a result of a 7% domestic sales growth and 6% increase in international sales, which was partially due to an improved European market, as well as strength in Latin American markets. Sales of knee implant products remained relatively flat at $20.6 million for the quarter ended March 31, 2014 as compared to $20.5 million for the same quarter in 2013. Sales of our extremity products were up 25% to $19.7 million as compared to $15.7 million for the same period in 2013, as we continued to gain global market share with our Equinoxe® reverse shoulder system. Hip implant sales of $10.8 million during the quarter ended March 31, 2014 increased 3% from the $10.4 million in sales during the quarter ended March 31, 2013, as a result of improvements both domestically and internationally. Sales from biologics and spine decreased 4% during the quarter ended March 31, 2014 to $5.8 million, from $6.1 million in the comparable quarter in 2013, primarily as a result of pricing pressures in the domestic biologics market due to competition. Sales of all other products decreased to $6.4 million as compared to $6.6 million in the same quarter last year. Domestically, sales increased 7% to $41.6 million, or 66% of total sales, during the quarter


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ended March 31, 2014, up from $39.0 million, which also represented 66% of total sales, in the comparable quarter last year. Internationally, sales increased 6% to $21.7 million, representing 34% of total sales, for the quarter ended March 31, 2014, as compared to $20.3 million, which was also 34% of total sales, for the same quarter in 2013. On a constant currency basis, international sales increased approximately 7% during the quarter ended March 31, 2014, compared to the same quarter in 2013.
Gross Profit
Gross profit increased to $44.6 million in the quarter ended March 31, 2014 from $40.7 million in the quarter ended March 31, 2013. As a percentage of sales, gross profit increased to 71% during the quarter ended March 31, 2014 from 69% for the quarter ended March 31, 2013, primarily as a result of growth in the higher margin U.S. Extremities segment. Looking forward to the remainder of the year, we expect gross profit, as a percentage of sales, to be 0.50% to 0.75% higher as compared to prior year quarters due to continued strength in the Extremities segment and manufacturing cost reductions. Operating Expenses
Total operating expenses increased 10% to $38.0 million in the quarter ended March 31, 2014 from $34.6 million in the quarter ended March 31, 2013, primarily due to increased compliance expenses related to an extensive review of our global compliance programs, as well as increased research and development spending. As a percentage of sales, total operating expenses increased to 60% for the quarter ended March 31, 2014, as compared to 58% for the quarter ended March 31, 2013.
Sales and marketing expenses, the largest component of total operating expenses, increased 10% for the quarter ended March 31, 2014 to $23.7 million from $21.5 million in the same quarter last year. The increase was primarily related to the global compliance expenditures, as well as additional variable selling costs as a result of our sales growth. Sales and marketing expenses, as a percentage of sales were 37% for the quarter ended March 31, 2014 and 36% for the quarter ended March 31, 2013. Looking forward, sales and marketing expenditures, as a percentage of sales, are expected to be in the range of 36% to 37% for the remainder of 2014.
General and administrative expenses increased to $5.8 million in the quarter ended March 31, 2014 from $5.1 million in the same quarter in 2013, primarily due to additional regulatory and compliance expenditures. As a percentage of sales, general and administrative expenses remained at 9% for each of the quarters ended March 31, 2014 and 2013. General and administrative expenses for the remainder of 2014 are expected to be in the range of 8.5% to 9.5% of sales. Research and development expenses increased 9% for the quarter ended March 31, 2014 to $4.2 million from $3.9 million in the same quarter last year, as we incurred increased testing and product development expenses. As a percentage of sales, research and development expenses increased to 7% for the quarter ended March 31, 2014 from 6% for the same quarter in 2013. As a number of product development projects reach prototype and testing phases, we anticipate growth in research and development expenditures, as a percentage of sales, to outpace sales growth for the remainder of 2014, with total research and development expenses ranging from 7% to 8% of sales.
Depreciation and amortization increased 4% to $4.3 million for the quarter ended March 31, 2014 from $4.2 million during the same quarter in 2013. As a percentage of sales, depreciation and amortization remained flat at 7% during each of the quarters ended March 31, 2014 and 2013. We placed $3.3 million of surgical instrumentation in service, and $0.1 million of equipment in service during the first three months of 2014.
Income from Operations
Our income from operations increased 9% to $6.6 million, or 10% of sales in the quarter ended March 31, 2014 from $6.1 million, or 10% of sales in the quarter ended March 31, 2013. The increase in our income from operations for the quarter was a result of our sales growth, coupled with expanding gross margins. Looking forward, we expect operating expenses for the remainder of the year to increase more slowly than sales growth, therefore we anticipate income from operations, as a percentage of sales, to increase by 0.25% to 0.50% for the remainder of 2014.


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Other Income and Expenses
We had other expenses, net of other income, of $7,000 during the quarter ended March 31, 2014, compared to other expenses, net of other income of $0.7 million in the quarter ended March 31, 2013. Included in other expenses were foreign currency transaction gains of $0.3 million, compared to foreign currency transaction losses of $0.5 million for the same quarter of 2013. The impact of currency transaction gains and losses was partially offset by net interest expense of $0.3 million for each of the quarters ended March 31, 2014 and 2013. Taxes and Net Income
Income before provision for income taxes increased 23% to $6.6 million in the quarter ended March 31, 2014 from $5.4 million in the quarter ended March 31, 2013. The effective tax rate, as a percentage of income before taxes, was 36% for the quarter ended March 31, 2014 as compared to 28% for the quarter ended March 31, 2013. The increase in the effective tax rate for the first quarter of 2014 was due primarily to the expiration in 2014 of the credit for research and development activities that reduced the comparative 2013 effective tax rate. As a result of the foregoing, we realized net income of $4.2 million in the quarter ended March 31, 2014, an increase of 9% from $3.9 million in the quarter ended March 31, 2013. As a percentage of sales, net income remained at 7% for each of the quarters ended March 31, 2014 and 2013. Earnings per share, on a diluted basis, increased to $0.30 for the quarter ended March 31, 2014, from $0.29 for the quarter ended March 31, 2013.
Liquidity and Capital Resources
We have financed our operations primarily through a combination of commercial debt financing and cash flows from our operating activities. At March 31, 2014, we had working capital of $106.3 million, a decrease of 5% from $112.0 million at the end of 2013. Working capital in 2014 decreased primarily as a result of the reduction in our accounts receivable balance, which was partially offset by an increase in our cash balance. Inventory and capitalized surgical instrumentation increases were impacted by the $0.6 million paid for the medical device excise tax in the first three months of 2014.
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 the exercise of stock option awards under the 2009 Plan will be sufficient to meet our commitments and cash requirements in the next twelve months. If not, we will seek additional funding through any number of possible combinations of additional debt, additional issuance of equity or convertible debt.
Operating Activities - Operating activities provided net cash of $19.0 million in the three months ended March 31, 2014, as compared to net cash from operations of $2.6 million during the three months ended March 31, 2013. A primary contributor to this increase related to the decrease in accounts receivable experienced in the first three months of 2014, which provided cash of $11.4 million for the three months ended March 31, 2014, in contrast to an increase in accounts receivable using net cash of $3.5 million for the three months ended March 31, 2013. A major contributor to the decrease in total accounts receivable was the payment of government receivables to our distribution operation in Spain, aggregating approximately €9.4 million, or approximately $12.9 million at a 1.37 exchange rate. Our allowance for doubtful accounts and sales returns decreased to $0.9 million at March 31, 2014 from $1.0 million at December 31, 2013. The total days sales outstanding (DSO) ratio, based on average accounts receivable balances, was 76 for the three months ended March 31, 2014, up from a ratio of 74 for the three months ended March 31, 2013. 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. Inventory increased by $1.3 million during the first three months ended March 31, 2014, compared to an increase of $4.8 million during the same period ended March 31, 2013, as a result of our continued supply chain efficiency efforts.
Investing Activities - Investing activities used net cash of $3.5 million in the three months ended March 31, 2014, as compared to $4.8 million in the three months ended March 31, 2013. Our cash outlays for surgical instrumentation and manufacturing equipment were $3.2 million during the three month period ended March 31, 2014, as compared to cash outlays of $4.5 million for purchases of surgical instrumentation and manufacturing equipment during the same period of 2013.
License technology
Our Taiwanese subsidiary, Exactech Taiwan, 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 March 31, 2014, we had paid approximately $2.1 million for the licenses, patents, and equipment related to this license agreement, as well as prepaid expenses, and we will make royalty payments


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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. It is expected that the project will require us to complete human clinical trials under the guidance of the Food & Drug Administration in order to obtain pre-market approval for the device in the United States. 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.
Financing Activities - Financing activities used net cash of $10.3 million in the three months ended March 31, 2014, as compared to $0.9 million in net cash provided for the three months ended March 31, 2013. In the first three months of 2014, we had net debt repayments of $11.5 million, due to the repayment of our line of credit balance, as compared to net repayments of $0.2 million in the first three months of 2013. Proceeds from the exercise of stock options provided cash of $1.2 million during each of the three month periods ended March 31, 2014 and 2013, with the proceeds used to fund general working capital. 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 $5.0 million swingline facility. Interest on loans outstanding under the Credit Agreement is based, at our election, on a base rate, a Eurodollar Rate or an index rate, in each case plus an applicable margin. The Credit Agreement expires on February 24, 2017. Additionally, the Credit Agreement contains financial covenants requiring that we maintain a leverage ratio of not greater than 2.50 to 1.00 and a fixed charge coverage ratio (as defined in the Credit Agreement) of not less than 2.00 to 1.00. As of March 31, 2014, we were in compliance with all financial covenants. For additional information regarding the Credit Agreement, please see note 6 - Debt to our audited consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2013.
Other Commitments and Contingencies
At March 31, 2014, we had outstanding commitments for the purchase of inventory, raw materials and supplies of $16.2 million and outstanding commitments for the purchase of capital equipment of $7.4 million. Purchases under our distribution agreements were $1.4 million during the three months ended March 31, 2014.


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CAUTIONARY STATEMENT RELATING TO FORWARD LOOKING STATEMENTS This report contains various "forward looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent the Company's expectations or beliefs concerning future events, including, but not limited to, statements regarding growth in sales of the Company's products, profit margins and the sufficiency of the Company's cash flow for its future liquidity and capital resource needs. When used in this report, the terms "anticipate," "believe," "estimate," "expect" and "intend" and words or phrases of similar import, as they relate to the Company or its subsidiaries or its management, are intended to identify forward-looking statements. These forward-looking statements are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statements. These factors include, without limitation, the effect of competitive pricing, the Company's dependence on the ability of its third-party suppliers to produce components on a cost-effective basis to the Company, significant expenditures of resources to maintain high levels of inventory, market acceptance of the Company's products, the impact of the medical device excise tax, the outcome of litigation, the effects of governmental regulation, potential product liability risks and risks of securing adequate levels of product liability insurance coverage, and the availability of reimbursement to patients from health care payers for procedures in which the Company's products are used. Results actually achieved may differ materially from expected results included in these statements as a result of these or other factors, including those factors discussed under "Risk Factors" in our annual report on Form 10-K for the year ended December 31, 2013 and each quarterly report on Form 10-Q we filed after this annual report. Exactech undertakes no obligation to update, and the Company does not have a policy of updating or revising, these forward-looking statements. Except where the context otherwise requires, the terms, "we", "us", "our", "the Company," or "Exactech" refer to the business of Exactech, Inc. and its consolidated subsidiaries.


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