UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
COMMISSION FILE NO. 0-26224
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 51-0317849
- ------------------------------- ---------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
311 ENTERPRISE DRIVE
PLAINSBORO, NEW JERSEY 08536
- ------------------------------- ---------------------
(ADDRESS OF PRINCIPAL (ZIP CODE)
EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (609) 275-0500
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]
The number of shares of the registrant's Common Stock, $.01 par value,
outstanding as of August 4, 2005 was 29,492,822.
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
INDEX
Page Number
-----------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Operations for the three
and six months ended June 30, 2005 and 2004 (Unaudited) 2
Condensed Consolidated Balance Sheets as of June 30, 2005
and December 31, 2004 (Unaudited) 3
Condensed Consolidated Statements of Cash Flows for the six months ended
June 30, 2005 and 2004 (Unaudited) 4
Notes to Unaudited Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 14
Factors that may affect our future performance 24
Item 3. Quantitative and Qualitative Disclosures About Market Risk 32
Item 4. Controls and Procedures 33
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 34
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 35
Item 4. Submission of Matters to a Vote of Security Holders 35
Item 6. Exhibits 36
SIGNATURES 37
EXHIBITS 38
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands, except per share amounts)
Three Months Ended June 30, Six Months Ended June 30,
---------------------------- --------------------------
2005 2004 2005 2004
---- ---- ---- ----
TOTAL REVENUE ........................ $69,778 $56,441 $135,617 $108,885
COSTS AND EXPENSES
Cost of product revenues (exclusive
of amortization related to the
manufacturing process) ............ 27,139 21,665 51,271 41,666
Research and development ............. 2,787 2,639 6,146 5,462
Selling, general and administrative .. 26,041 19,488 49,957 36,496
Amortization ......................... 1,668 1,049 3,143 1,932
------- ------- ------- -------
Total costs and expenses .......... 57,635 44,841 110,517 85,556
Operating income ..................... 12,143 11,600 25,100 23,329
Interest income ...................... 907 983 1,861 1,911
Interest expense ..................... (822) (823) (1,749) (1,694)
Other income (expense), net .......... (541) 135 (634) 118
------- ------- ------- -------
Income before income taxes ........... 11,687 11,895 24,578 23,664
Income tax expense ................... 4,032 4,377 8,480 8,708
------- ------- ------- -------
Net income............................ $ 7,655 $ 7,518 $16,098 $14,956
======= ======= ======= =======
Basic net income per share ........... $ 0.25 $ 0.25 $ 0.53 $ 0.50
Diluted net income per share ......... $ 0.23 $ 0.23 $ 0.49 $ 0.46
Weighted average common
shares outstanding:
Basic .......................... 30,401 29,854 30,481 29,779
Diluted ........................ 34,739 34,479 34,941 34,426
The accompanying notes are an integral part of these condensed consolidated financial statements
2
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In thousands, except per share amounts)
June 30, December 31,
2005 2004
------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents ............................... $ 29,020 $ 69,855
Short-term investments .................................. 69,434 30,955
Accounts receivable, net of allowances of
$2,922 and $2,749 ..................................... 46,275 46,765
Inventories ............................................. 69,206 55,947
Prepaid expenses and other current assets ............... 11,237 12,716
--------- ---------
Total current assets ................................ 225,172 216,238
Non-current investments ................................... 49,394 95,172
Property, plant, and equipment, net ....................... 27,691 25,461
Deferred income taxes, net ................................ 7,250 15,787
Identifiable intangible assets, net ....................... 67,739 59,817
Goodwill................................................... 69,817 39,237
Other assets .............................................. 4,623 5,001
--------- ---------
Total assets .............................................. $ 451,686 $ 456,713
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable, trade ................................. 12,788 10,160
Income taxes payable .................................... -- 1,022
Accrued compensation .................................... 9,313 4,212
Other accrued expenses and current liabilities .......... 10,162 8,840
--------- ---------
Total current liabilities ........................... 32,263 24,234
Long-term debt ............................................ 119,159 118,900
Deferred revenue .......................................... 264 310
Other liabilities ......................................... 5,304 5,446
--------- ---------
Total liabilities ......................................... 156,990 148,890
Commitments and contingencies
Stockholders' Equity:
Common stock; $0.01 par value; 60,000 authorized shares;
29,467 and 29,202 issued at June 30, 2005 and
December 31, 2004, respectively ....................... 295 292
Additional paid-in capital .............................. 325,916 320,602
Treasury stock, at cost; 1,468 and 718 shares at
June 30, 2005 and December 31, 2004, respectively ..... (44,124) (19,474)
Accumulated other comprehensive income (loss):
Unrealized loss on available-for-sale securities ..... (963) (818)
Foreign currency translation adjustment .............. (545) 9,266
Minimum pension liability adjustment ................. (1,716) (1,780)
Retained earnings/(Accumulated deficit) ................. 15,833 (265)
--------- ---------
Total stockholders' equity ............................ 294,696 307,823
--------- ---------
Total liabilities and stockholders' equity ............... $ 451,686 $ 456,713
========= =========
The accompanying notes are an integral part of these condensed consolidated financial statements
3
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
Six Months Ended June 30,
2005 2004
---- ----
OPERATING ACTIVITIES:
Net income ...................................................... $ 16,098 $ 14,956
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ................................... 5,751 4,032
Deferred income tax provision ................................... 6,304 6,750
Amortization of discount and premium on investments ............. 1,064 1,203
Other, net ...................................................... 241 391
Changes in assets and liabilities, net of business acquisitions:
Accounts receivable .......................................... 3,596 (2,997)
Inventories .................................................. (11,085) (5,976)
Prepaid expenses and other current assets .................... 1,610 (780)
Non-current assets ........................................... 104 (24)
Accounts payable ............................................. 2,488 (372)
Income taxes payable ......................................... (1,149) 1,361
Accrued compensation ......................................... 4,882 1,031
Other accrued expenses and current liabilities ............... (414) 1,300
-------- --------
Net cash provided by operating activities ....................... 29,490 20,875
-------- --------
INVESTING ACTIVITIES:
Proceeds from sales/maturities of available-for-sale investments. 21,077 142,863
Purchases of available-for-sale investments ..................... (15,000) (138,156)
Cash used in business acquisition, net of cash acquired ......... (50,099) (28,953)
Purchases of property and equipment ............................. (4,825) (4,813)
-------- --------
Net cash used in investing activities ........................... (48,847) (29,059)
-------- --------
FINANCING ACTIVITIES:
Proceeds from exercised stock options and warrants .............. 3,878 3,502
Purchases of treasury stock ..................................... (24,650) --
Repayment of bank loans ......................................... (49) --
-------- --------
Net cash (used in)/provided by financing activities ............. (20,821) 3,502
-------- --------
Effect of exchange rate changes on cash ......................... (657) 43
Net decrease in cash and cash equivalents ....................... (40,835) (4,639)
Cash and cash equivalents at beginning of period ................ 69,855 26,054
-------- --------
Cash and cash equivalents at end of period ...................... $ 29,020 $ 21,415
======== ========
Supplemental cash flow information:
- -----------------------------------
At June 30, 2005 and 2004, the Company had $3.4 million and $2.9 million,
respectively, of cash pledged as collateral in connection with its interest rate
swap agreement.
The accompanying notes are an integral part of these condensed consolidated
financial statements
4
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
General
In the opinion of management, the June 30, 2005 unaudited condensed consolidated
financial statements contain all adjustments (consisting only of normal
recurring adjustments) necessary for a fair statement of the financial position,
results of operations and cash flows of the Company. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted in accordance with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. These unaudited condensed consolidated financial statements
should be read in conjunction with the Company's consolidated financial
statements for the year ended December 31, 2004 included in the Company's Annual
Report on Form 10-K. Operating results for the three- and six-month periods
ended June 30, 2005 are not necessarily indicative of the results to be expected
for the entire year.
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amount of
assets and liabilities, the disclosure of contingent liabilities, and the
reported amounts of revenues and expenses. Significant estimates affecting
amounts reported or disclosed in the consolidated financial statements include
allowances for doubtful accounts receivable and sales returns, net realizable
value of inventories, estimates of future cash flows associated with long-lived
asset valuations, depreciation and amortization periods for long-lived assets,
valuation allowances recorded against deferred tax assets, estimates of amounts
to be paid to employees and other exit costs to be incurred in connection with
the restructuring of our European operations and loss contingencies. These
estimates are based on historical experience and on various other assumptions
that are believed to be reasonable under the current circumstances. Actual
results could differ from these estimates.
In 2004, the Company determined that its investments in auction rate securities
should be classified as short term investments. Auction rate securities are
reset to current interest rates periodically, but no later than every 90 days.
These securities were previously recorded in cash and cash equivalents due to
the liquidity provided by their short-term pricing reset features and the
Company's ability to liquidate them in monthly auctions. Prior period cash flow
information has been revised to conform to the current year presentation.
Accordingly, cash flows from investing activities increased by $31.8 million for
the six months ended June 30, 2004. There was no impact on the Company's net
income or cash flows from operations or financing activities as a result of this
revision. The Company does not have any debt covenants that are affected by
reported cash balances.
Certain other prior year amounts have been reclassified to conform to the
current year's presentation.
New Accounting Policy
Employee Termination Benefits and Other Exit-Related Costs
The Company does not have a written severance plan, nor does it offer similar
termination benefits to affected employees in all restructuring initiatives.
Accordingly, in situations where minimum statutory termination benefits must be
paid to the affected employees, the Company records employee severance costs
associated with these restructuring activities in accordance with SFAS No. 112,
"Employer's Accounting for Postemployment Benefits." Charges associated with
these activities are recorded when the payment of benefits is probable and can
be reasonably estimated. In all other situations where the Company pays out
termination benefits, including supplemental benefits paid in excess of
statutory minimum amounts and benefits offered to affected employees based on
management's discretion, the Company records these termination costs in
accordance with SFAS No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities."
The timing of the recognition of charges for employee severance costs depends on
whether the affected employees are required to render service beyond their legal
notification period in order to receive the benefits. If affected employees are
required to render service beyond their legal notification period, charges are
recognized ratably over the future service period. Otherwise, charges are
recognized when a specific plan has been confirmed by management and required
employee communication requirements have been met.
5
For leased facilities and equipment that have been abandoned, the Company
records estimated lease losses based on the fair value of the lease liability,
as measured by the present value of future lease payments subsequent to
abandonment, less the present value of any estimated sublease income. For owned
facilities and equipment that will be disposed of, the Company records
impairment losses based on fair value less costs to sell. The Company also
reviews the remaining useful life of long-lived assets following a decision to
exit a facility and may accelerate depreciation or amortization of these
assets, as appropriate.
Recently Issued Accounting Standards and Other Matters
In May 2005, the Financial Accounting Standards Board (FASB) issued Statement
No. 154, "Accounting Changes and Error Corrections, a replacement of APB Opinion
No. 20 and FASB Statement No. 3". SFAS 154 requires retrospective application to
prior periods' financial statements of a voluntary change in accounting
principle. Previously, voluntary changes in accounting principles were accounted
for by including a one-time cumulative effect in the period of change. This
statement is effective January 1, 2006. We anticipate that this standard will
have no impact on our financial statements.
In November 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 151, "Inventory Costs-an amendment of ARB No. 43, Chapter 4"
(Statement 151), which is effective beginning January 1, 2006. Statement 151
requires that abnormal amounts of idle facility expense, freight, handling costs
and wasted material be recognized as current period charges. Statement 151 also
requires that the allocation of fixed production overhead be based on the normal
capacity of the production facilities. Management does not expect that Statement
151 will have a material impact on our financial position or results of
operations.
In March 2004, the FASB Emerging Issue Task Force (EITF) reached a consensus on
Issue 03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application
to Certain Investments". Issue 03-01 provides guidance regarding recognition and
measurement of unrealized losses on available-for-sale debt and equity
securities accounted for under Statement of Financial Accounting Standard No.
115, "Accounting for Certain Investments in Debt and Equity Securities". The
application of certain paragraphs covering the measurement provisions of Issue
03-01 have been deferred pending the issuance of a final FASB Staff Position
providing implementation guidance on Issue 03-01. The disclosures were effective
in annual financial statements for fiscal years ending after December 15, 2003.
Management is currently assessing the impact that the recognition and
measurement provisions of Issue 03-01 could have on our financial statements.
The American Jobs Creation Act of 2004 (the "Act") was signed into law in
October 2004 and has several provisions that may affect the Company's income
taxes in the future, including the repeal of the extraterritorial income
exclusion and a deduction related to qualified production activities taxable
income. The FASB proposed that the qualified production activities deduction is
a special deduction and will have no impact on deferred taxes existing at the
enactment date. Rather, the impact of this deduction will be reported in the
period in which the deduction is claimed on the Company's tax return. Management
is currently evaluating the impact of the FASB guidance related to qualified
production activities on the Company's effective tax rate in future periods.
In December 2004, the FASB issued Statement No. 123 (revised 2004), "Share-Based
Payment," which is a revision of Statement No. 123, "Accounting for Stock-Based
Compensation." Statement 123(R) replaces APB Opinion No. 25, "Accounting for
Stock Issued to Employees," and amends Statement No. 95, "Statement of Cash
Flows." Statement 123(R) requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the financial
statements based on their fair value. Pro forma footnote disclosure will no
longer be an alternative to financial statement recognition.
Statement 123(R) must be adopted no later than January 1, 2006. Statement 123(R)
permits companies to adopt its requirements using either the "modified
prospective" method or the "modified retrospective" method. Management is
currently evaluating the potential impact of Statement 123(R) on our
consolidated financial position and results of operations and the alternative
adoption methods.
Equity-Based Compensation
The Company recognizes employee stock based compensation using the intrinsic
value method prescribed by APB Opinion No. 25 "Accounting for Stock Issued to
Employees" and FASB Interpretation No. 44 "Accounting for Certain Transactions
Involving Stock Compensation - an interpretation of APB Opinion No. 25".
Had the compensation cost for the Company's stock option plans been determined
based on the fair value at the date of grant consistent with the provisions of
SFAS No. 123, the Company's net income and basic and diluted net income per
share would have been as follows:
6
Three Months Ended June 30, Six Months Ended June 30,
2005 2004 2005 2004
-------- -------- -------- --------
(in thousands, except per share amounts)
Net income:
As reported ................................ $ 7,655 $ 7,518 $16,098 $14,956
Less: Total stock-based employee
compensation expense determined under
the fair value-based method for all
awards, net of related tax effects ... (1,733) (1,667) (3,463) (3,137)
-------- -------- -------- --------
Pro forma ............................... $ 5,922 $ 5,851 $12,635 $11,819
Net income per share:
Basic:
As reported ............................. $ 0.25 $ 0.25 $ 0.53 $ 0.50
Pro forma ............................... $ 0.19 $ 0.20 $ 0.41 $ 0.40
Diluted:
As reported ............................. $ 0.23 $ 0.23 $ 0.49 $ 0.46
Pro forma ............................... $ 0.19 $ 0.19 $ 0.39 $ 0.38
As options vest over a varying number of years and awards are generally made
each year, the pro forma impacts shown above may not be representative of future
pro forma expense amounts. The pro forma additional compensation expense related
to all options granted prior to October 1, 2004 was calculated based on the fair
value of each option grant using the Black-Scholes model, while the pro forma
additional compensation expense related to all options granted on or after
October 1, 2004 was calculated based on the fair value of each option grant
using the binomial distribution model. Management believes that the binomial
distribution model is better than the Black-Scholes model because the binomial
distribution model is a more flexible model that considers the impact of
non-transferability, vesting and forfeiture provisions in the valuation of
employee stock options.
2. BUSINESS ACQUISITIONS
On January 3, 2005, the Company acquired all of the outstanding capital stock of
Newdeal Technologies SA for 38.3 million euros ($51.9 million) in cash, subject
to a working capital adjustment, and $0.8 million of acquisition related
expenses. Additionally, the Company has agreed to pay the sellers up to an
additional 1,250,000 euros if each of the sellers continues his employment with
Integra through January 3, 2006. This additional 1,250,000 euro payment is being
accrued to selling, general and administrative expense on a straight-line basis
over the one year employment requirement period.
Based in Lyon, France, Newdeal is a leading developer and marketer of specialty
implants and instruments specifically designed for foot and ankle surgery.
Newdeal's products include a wide range of products for the forefoot, the
mid-foot and the hind foot, including the Bold(R) Screw, Hallu-Fix(R) plate
system and the HINTEGRA(R) total ankle prosthesis. At the time of the
acquisition, Newdeal sold its products through a direct sales force in France,
Belgium and the Netherlands, and through distributors in more than 30 countries,
including the United States and Canada. Newdeal's target physicians include
orthopedic surgeons specializing in injuries of the foot, ankle and extremities,
as well as podiatric surgeons. The goodwill recorded in connection with this
acquisition is based on the benefits the Company expects to generate from the
synergy between Newdeal's reconstructive foot and ankle fixation products and
Integra's regenerative products that are used in the treatment of chronic and
traumatic wounds of the foot and ankle.
The following summarizes the fair value of the assets acquired and liabilities
assumed:
(All amounts in thousands)
Cash ................................. $ 2,520
Other current assets ................. 8,477
Property, plant and equipment ........ 1,120 Wtd. Avg. Life
Intangible assets: --------------
Tradename ......................... 2,926 37 years
Customer relationships ............ 6,032 10 years
Technology ........................ 3,387 10 years
Non-competition agreement ......... 745 5 years
Goodwill ............................. 35,576
Other assets ......................... 43
-------
Total assets acquired ............. 60,826
Liabilities assumed, excluding debt .. 7,640
Debt assumed ......................... 529
-------
Net assets acquired .................. $52,657
The fair value of assets acquired was determined with the assistance of a
third-party valuation firm.
7
The acquired intangible assets are being amortized over lives ranging from 5 to
40 years.
In May 2004, the Company acquired the MAYFIELD(R) Cranial Stabilization and
Positioning Systems and the BUDDE(R) Halo Retractor System business from
Schaerer Mayfield USA, Inc. (formerly Ohio Medical Instrument Company) for $20.0
million in cash paid at closing, a $0.3 million working capital adjustment, and
$0.3 million of acquisition related expenses. The MAYFIELD and BUDDE lines
include skull clamps, headrests, reusable and disposable skull pins, blades,
retractor systems, and spinal implants. MAYFIELD systems are the market leader
in the United States and have been used by neurosurgeons for over thirty years.
The products are sold in the United States through the Integra NeuroSciences
direct sales organization and in international markets through distributors.
In May 2004, the Company acquired all of the capital stock of Berchtold
Medizin-Elektronik GmbH, now named Integra ME, from Berchtold Holding GmbH for
$5.0 million in cash. Integra ME manufactures and markets the ELEKTROTOM(R) line
of electrosurgery generators and the SONOTOM(R) ultrasonic surgical aspirator,
as well as a broad line of related handpieces, instruments and disposables used
in many surgical procedures, including neurosurgery. Integra ME markets and
sells its products to hospitals and physicians primarily through a network of
distributors.
In January 2004, the Company acquired the R&B instrument business from R&B
Surgical Solutions, LLC for $2.0 million in cash. The R&B instrument line is a
complete line of high-quality handheld surgical instruments used in neuro- and
spinal surgery. The Company markets these products through its JARIT sales
organization.
In January 2004, the Company acquired the Sparta disposable critical care
devices and surgical instruments business from Fleetwood Medical, Inc. for $1.6
million in cash. The Sparta product line includes products used in plastic and
reconstructive, ear, nose and throat (ENT), neuro, ophthalmic and general
surgery. The Company sells the Sparta products through a direct marketing
organization and an existing distributor network.
The goodwill acquired in the MAYFIELD/BUDDE, R&B, and Sparta acquisitions is
expected to be deductible for tax purposes.
The following unaudited pro forma financial information summarizes the results
of operations for the six months ended June 30, 2004 as if the acquisitions
consummated in 2005 and 2004 had been completed as of the beginning of that
period. The pro forma results are based upon certain assumptions and estimates
and they give effect to actual operating results prior to the acquisitions and
adjustments to reflect increased depreciation expense, increased intangible
asset amortization, and increased income taxes at a rate consistent with
Integra's marginal rate in each year. No effect has been given to cost
reductions or operating synergies. As a result, these pro forma results do not
necessarily represent results that would have occurred if the acquisition had
taken place on the basis assumed above, nor are they indicative of the results
of future combined operations.
For the Six Months
Ended June 30, 2004
-----------
Total revenue .................................... $122,938
Net income ....................................... 16,167
Net income per share:
Basic ......................................... $ 0.54
Diluted........................................ $ 0.50
Because the Newdeal acquisition was consummated on January 3, 2005, the
Company's results of operations for the six months ended June 30, 2005 would not
have been materially different from those presented herein.
3. INVENTORIES
Inventories consisted of the following:
June 30, December 31,
2005 2004
---- ----
(in thousands)
Raw materials.............................. $13,393 $11,961
Work-in process............................ 10,601 7,496
Finished goods............................. 45,212 36,490
------- -------
$69,206 $55,947
======= =======
8
4. GOODWILL AND OTHER INTANGIBLE ASSETS
Changes in the carrying amount of goodwill for the three months ended June 30,
2005, were as follows:
Balance at December 31, 2004 ..................................... $ 39,237
Newdeal acquisition .............................................. 35,576
Other ............................................................ 69
Foreign currency translation ..................................... (5,065)
--------
Balance at June 30, 2005 ......................................... $ 69,817
========
The components of the Company's identifiable intangible assets were as follows:
June 30, 2005 December 31, 2004
Weighted ---------------------- ----------------------
Average Accumulated Accumulated
Life Cost Amortization Cost Amortization
-------- -------- ------------ -------- ------------
(in thousands)
Completed technology ....... 14 years $ 19,265 $ (5,068) $ 17,108 $ (4,505)
Customer relationships ..... 18 years 22,673 (4,024) 17,417 (3,214)
Trademarks/brand names ..... 36 years 31,232 (2,372) 28,689 (1,862)
Noncompetition agreements... 5 years 6,964 (1,895) 6,352 (1,198)
All other .................. 11 years 2,233 (1,269) 2,233 (1,203)
-------- ------------ -------- ------------
$ 82,367 $(14,628) $ 71,799 $(11,982)
Accumulated amortization .. (14,628) (11,982)
-------- --------
$ 67,739 $ 59,817
======== ========
During the quarter ended June 30, 2005, the Company discontinued a product line.
As a result, the Company recorded a $215,000 charge to amortization expense
related to the impairment of a technology-based intangible asset associated with
this discontinued product line.
Annual amortization expense is expected to approximate $6.0 million in 2005,
$5.7 million in 2006, $5.4 million in 2007, $5.1 million in 2008, and $4.4
million in 2009. Identifiable intangible assets are initially recorded at fair
market value at the time of acquisition generally using an income or cost
approach.
5. RESTRUCTURING ACTIVITIES
During the quarter ended June 30, 2005, management announced plans to
restructure the Company's European operations. The restructuring plan includes
closing the Company's Integra ME production facility in Tuttlingen, Germany and
reducing various positions in the Company's production facility located in
Biot, France by the end of 2005. The Company plans to transition the
manufacturing operations of Integra ME to its production facility in Andover,UK.
In June 2005, the Company reached an agreement with local representatives of
the Integra ME workforce regarding the amount of benefits that those employees
will receive in connection with the closure of that facility. The Company is
currently negotiating with representatives of the Biot, France workforce
regarding the amount of benefits the affected employees will receive in excess
of the minimum amounts required by local labor laws.
During the quarter ended June 30, 2005, the Company also eliminated some
duplicative sales and marketing positions, primarily in Europe.
In connection with these restructuring activities, the Company recorded a $2.1
million charge in the quarter ended June 30, 2005, consisting of the following:
Research Selling
Cost of and General and
Sales Development Administrative Total
------- ------- ------- -------
(in thousands)
Employee termination costs ...... $ 1,298 $ 24 $ 752 $ 2,074
9
Below is a reconciliation of the restructuring accrual activity recorded during
2005:
Employee
Termination
Costs Total
------- -------
Balance at December 31, 2004 ........................ $ -- $ --
Additions ........................................... 2,074 2,074
Payments ............................................ (85) (85)
Adjustments ......................................... -- --
------- -------
Balance at June 30, 2005 ............................ $ 1,989 $ 1,989
Approximately 74 individuals have been identified for termination under the
current restructuring plan. As of June 30, 2005, the Company has terminated six
of these individuals.
The Company expects to record up to an additional $1.8 million of restructuring
charges during the remainder of 2005 related to additional employee termination
costs and costs associated with exiting the Integra ME facility. These amounts
have not yet been recorded by the Company because either the employees are
required to render service beyond their legal notification period in order to
receive the benefits or the benefits have not been communicated to the affected
employees.
6. RETIREMENT BENEFIT PLANS
The Company maintains defined benefit pension plans that cover employees in its
manufacturing plants located in Andover, United Kingdom and Tuttlingen, Germany.
Net periodic benefit costs for the Company's defined benefit pension plans
included the following amounts:
Three Months Ended Six Months Ended
June 30
2005 2004 2005 2004
------ ------ ------ ------
(in thousands)
Service cost .......................... $ 63 $ 26 $ 124 $ 48
Interest cost ......................... 107 73 210 139
Expected return on plan assets ........ (89) (57) (175) (113)
Recognized net actuarial loss ......... 36 28 71 54
------ ------ ------ ------
Net periodic benefit cost .......... $ 117 $ 70 $ 230 $ 128
For the six months ended June 30, 2005, the Company made $105,000 of
contributions to its defined benefit pension plans.
7. COMPREHENSIVE INCOME
Comprehensive income was as follows:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- --------------------
2005 2004 2005 2004
-------- -------- ------ ------
(in thousands)
Net income ........................................ $ 7,655 $ 7,518 $ 16,098 $ 14,956
Foreign currency translation adjustment ........... (5,490) (237) (9,746) 16
Unrealized holding gains (losses) on
available-for-sale securities................. 292 (1,578) (163) (1,255)
Less: reclassification adjustment for losses
included in net income ................. 18 -- 18 --
-------- -------- -------- ---------
Comprehensive income .............................. $ 2,475 $ 5,703 $ 6,207 $ 13,717
======== ======== ======== =========
A significant portion of the foreign currency translation adjustment recorded
for the three- and six-month periods ended June 30, 2005 was related to the
appreciation of the U.S. dollar against the euro following the Company's
acquisition of Newdeal Technologies, whose functional currency is the euro, on
January 3, 2005.
10
8. NET INCOME PER SHARE
Basic and diluted net income per share was as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
2005 2004 2005 2004
------ ------ ------ ------
(In thousands, except
per share amounts)
Basic net income per share:
- ---------------------------
Net income ......................................... $ 7,655 $ 7,518 $ 16,098 $ 14,956
Weighted average common shares outstanding ......... 30,401 29,854 30,481 29,779
Basic net income per share ......................... $ 0.25 $ 0.25 $ 0.53 $ 0.50
Diluted net income per share:
- -----------------------------
Net income ......................................... $ 7,655 $ 7,518 $ 16,098 $ 14,956
Add back: Interest expense and other income/(expense)
related to convertible notes payable, net
of tax ................................. 488 496 1,032 1,016
-------- -------- -------- --------
Net income available to common stock ............. $ 8,143 $ 8,014 $ 17,130 $ 15,972
Weighted average common shares outstanding - Basic 30,401 29,854 30,481 29,779
Effect of dilutive securities:
Stock options .................................. 824 1,111 946 1,133
Shares issuable upon conversion of notes payable 3,514 3,514 3,514 3,514
-------- -------- -------- --------
Weighted average common shares for diluted earnings
per share....................................... 34,739 34,479 34,941 34,426
Diluted net income per share ................... $ 0.23 $ 0.23 $ 0.49 $ 0.46
Options outstanding at June 30, 2005 and 2004, respectively, to purchase
approximately 909,000 and 29,000 shares of common stock were excluded from the
computation of diluted net income per share for the three-month periods ended
June 30, 2005 and 2004 because their exercise price exceeded the average market
price of the Company's common stock during the period.
In October 2004, the EITF reached a consensus on Issue 04-08 "The Effect of
Contingently Convertible Instruments on Diluted Earnings per Share" that
requires issuers of contingent convertible securities to account for these
securities on an "if-converted" basis pursuant to Statement of Financial
Accounting Standards No. 128 "Earnings Per Share", in computing their diluted
earnings per share whether or not the issuer's stock is above the contingent
conversion price. The provisions of Issue 04-08 were applied on a retroactive
basis, and this reduced previously reported diluted earnings per share by $0.01
to $0.23 for the three months ended June 30, 2004 and by $0.02 to $0.46 for the
six months ended June 30, 2004. The impact of Issue 04-08 reduced previously
reported pro forma diluted earnings per share by $0.01 to $0.19 for the three
months ended June 30, 2004 and by $0.01 to $0.38 for the six months ended June
30, 2004 (see Note 1).
9. SEGMENT AND GEOGRAPHIC INFORMATION
Integra management reviews financial results and manages the business on an
aggregate basis. Therefore, financial results are reported in a single operating
segment, the development, manufacture and marketing of medical devices for use
in neuro-trauma, neurosurgery, reconstructive surgery and general surgery.
Revenues consisted of the following:
Three Months Ended Six Months Ended
June 30, June 30,
(in thousands) 2005 2004 2005 2004
------ ------ ------- -------
Implant products ................................$ 27,120 $19,412 $ 53,008 $ 37,744
Instruments ...................................... 22,785 19,006 45,313 35,049
Monitoring products .............................. 12,025 11,813 23,399 23,011
Private label products ........................... 7,832 6,205 13,841 12,067
------ ------ ------- -------
Total product revenues ........................... 69,762 56,436 135,561 107,871
Other revenues ................................... 16 5 56 1,014
------ ------ ------- -------
Total revenues ...................................$69,778 $56,441 $ 135,617 108,885
11
Certain of the Company's products, including the DuraGen(R) and NeuraGen(TM)
product families and the INTEGRA(R) Dermal Regeneration Template and wound
dressing products contain material derived from bovine tissue. Products that
contain materials derived from animal sources, including food as well as
pharmaceuticals and medical devices, are increasingly subject to scrutiny from
the press and regulatory authorities. These products comprised 32% of total
revenues in each of the three-month periods ended June 30, 2005 and 2004 and 31%
of total revenues in each of the six-month periods ended June 30, 2005 and 2004.
Accordingly, widespread public controversy concerning collagen products, new
regulation, or a ban of the Company's products containing material derived from
bovine tissue, could have a material adverse effect on the Company's current
business or its ability to expand its business.
Total revenues by major geographic area are summarized below:
United Asia Other
States Europe Pacific Foreign Total
-------- -------- -------- -------- --------
(in thousands)
Three months ended June 30, 2005.... $ 51,752 $ 12,982 $ 2,733 $ 2,311 $ 69,778
Three months ended June 30, 2004.... 44,984 7,561 2,069 1,827 56,441
Six months ended June 30, 2005...... $ 99,119 $ 25,744 $ 5,781 $ 4,973 $135,617
Six months ended June 30, 2004...... 86,379 14,809 3,898 3,799 108,885
10. COMMITMENTS AND CONTINGENCIES
Various lawsuits, claims and proceedings are pending or have been settled by the
Company. The most significant of those are described below.
In July 1996, the Company filed a patent infringement lawsuit in the United
States District Court for the Southern District of California (the "Trial
Court") against Merck KGaA, a German corporation, Scripps Research Institute, a
California nonprofit corporation, and David A. Cheresh, Ph.D., a research
scientist with Scripps, seeking damages and injunctive relief. The complaint
charged, among other things, that the defendant Merck KGaA willfully and
deliberately induced, and continues willfully and deliberately to induce,
defendants Scripps Research Institute and Dr. Cheresh to infringe certain of the
Company's patents. These patents are part of a group of patents granted to The
Burnham Institute and licensed by Integra that are based on the interaction
between a family of cell surface proteins called integrins and the
arginine-glycine-aspartic acid ("RGD") peptide sequence found in many
extracellular matrix proteins. The defendants filed a countersuit asking for an
award of defendants' reasonable attorney fees.
In March 2000, a jury returned a unanimous verdict in the Company's favor and
awarded Integra $15.0 million in damages, finding that Merck KGaA had willfully
infringed and induced the infringement of our patents. The Trial Court dismissed
Scripps and Dr. Cheresh from the case.
In October 2000, the Trial Court entered judgment in Integra's favor and against
Merck KGaA in the case. In entering the judgment, the Trial Court also granted
to the Company pre-judgment interest of $1.4 million, bringing the total award
to $16.4 million, plus post-judgment interest. Merck KGaA filed various
post-trial motions requesting a judgment as a matter of law notwithstanding the
verdict or a new trial, in each case regarding infringement, invalidity and
damages. In September 2001, the Trial Court entered orders in favor of Integra
and against Merck KGaA on the final post-judgment motions in the case, and
denied Merck KGaA's motions for judgment as a matter of law and for a new trial.
Merck KGaA and Integra each appealed various decisions of the Trial Court to the
United States Court of Appeals for the Federal Circuit (the "Circuit Court"). In
June 2003, the Circuit Court affirmed the Trial Court's finding that Merck KGaA
had infringed our patents. The Circuit Court also held that the basis of the
jury's calculation of damages was not clear from the trial record, and remanded
the case to the Trial Court for further factual development and a new
calculation of damages consistent with the Circuit Court's decision. In
September 2004, the Trial Court ordered Merck KgaA to pay Integra $6.4 million
in damages following the Circuit Court's order. Merck KGaA filed a petition for
a writ of certiorari with the United States Supreme Court (the "Supreme Court")
seeking review of the Circuit Court's decision, and the Supreme Court granted
the writ in January 2005. Oral arguments before the United States Supreme Court
were held in April 2005.
On June 13, 2005, the Supreme Court vacated the June 2003 judgment of the
Circuit Court. The Supreme Court held that the Circuit Court applied an
erroneous interpretation of 35 U.S.C. ss.271(e)(1) when it rejected the
challenge of Merck KGaA to the jury's finding that Merck KGaA failed to show
that its activities were exempt from claims of patent infringement under that
statute. On remand, the Circuit Court will review the evidence under a
reasonableness test that does not provide categorical exclusions of certain
types of activities.
12
Further enforcement of the Trial Court's order has been stayed pending the
decision of the Supreme Court.
The Company has not recorded any gain in connection with this matter, pending
final resolution and completion of the appeals process.
Three of the Company's French subsidiaries that were acquired from the
neurosciences division of NMT Medical, Inc. received a tax reassessment notice
from the French tax authorities seeking in excess of 1.7 million euros in back
taxes, interest and penalties. NMT Medical, the former owner of these entities,
has agreed to indemnify Integra against direct damages and liability arising
from misrepresentations in connection with these tax claims. In April 2005, NMT
Medical, Inc. negotiated a settlement agreement with the French authorities that
will satisfy the outstanding tax assessments. This settlement will not have any
impact on the Company's financial statements.
In addition to these matters, the Company is subject to various claims, lawsuits
and proceedings in the ordinary course of its business, including claims by
current or former employees, distributors and competitors and with respect to
our products. In the opinion of management, such claims are either adequately
covered by insurance or otherwise indemnified, or are not expected, individually
or in the aggregate, to result in a material adverse effect on the Company's
financial condition. However, it is possible that our results of operations,
financial position and cash flows in a particular period could be materially
affected by these contingencies.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our condensed consolidated
financial statements and the related notes thereto appearing elsewhere in this
report and our consolidated financial statements for the year ended December 31,
2004 included in our Annual Report on Form 10-K.
This discussion and analysis contains forward-looking statements that involve
risks, uncertainties and assumptions. Our actual results may differ materially
from those anticipated in these forward-looking statements as a result of many
factors, including but not limited to those set forth below under the heading
"Factors That May Affect Our Future Performance."
GENERAL
Integra develops, manufactures and markets medical devices for use in
neuro-trauma, neurosurgery, reconstructive surgery and general surgery. Our
business is organized into product groups and distribution channels. Our product
groups include implants and other devices for use in surgical procedures,
monitoring systems for the measurement of various parameters in tissue (such as
pressure, temperature and oxygen), hand-held and ultrasonic surgical
instruments, and private label products that we manufacture for other medical
device companies.
Our distribution channels include three sales organizations in the United
States: one that we employ to call on neurosurgeons known as our Integra
NeuroSciences(TM) sales organization, another employed to call on reconstructive
surgeons and a third group that utilizes a network of third-party distributors.
Internationally, we combine resources across different sales channels in some
cases with direct sales organizations in France, Germany, the United Kingdom and
the Benelux region. Outside of these areas, we operate through a number of
distributors that sell our products in over 90 countries. We invest substantial
resources and management effort to develop our sales organizations, and we
believe that we compete very effectively in this aspect of our business. We
distribute private label products through strategic alliances.
We manufacture most of the implant, monitoring and private label products that
we sell in various plants located in the United States, Puerto Rico, France, the
United Kingdom and Germany. We also manufacture the ultrasonic surgical
instruments and source most of our hand-held surgical instruments through
specialized third-party vendors.
We believe that we have a particular advantage in the development, manufacture
and sale of specialty tissue repair products derived from bovine collagen. We
develop and build these products in our manufacturing facility in Plainsboro,
New Jersey. Taken together, these products accounted for approximately 31% of
total revenues in the six months ended June 30, 2005 and 2004.
We manage these multiple product groups and distribution channels on a
centralized basis. Accordingly, we report our financial results under a single
operating segment - the development, manufacturing and distribution of medical
devices.
Our objective is to build a customer-focused and profitable medical device
company by developing or acquiring innovative medical devices and other products
to sell through our sales channels. Our strategy therefore entails substantial
growth in product revenues both through internal means - through launching new
and innovative products and selling existing products more intensively - and by
acquiring existing businesses or already successful product lines.
We aim to achieve this growth in revenues while maintaining strong financial
results. While we pay attention to any meaningful trend in our financial
results, we pay particular attention to measurements that tend to support the
view that our profitability can grow for a period of years. These measurements
include revenue growth, derived through acquisitions and products developed
internally, gross margins on products revenues, which we hope to increase to
more than 65% over a period of several years, operating margins, which we hope
to continually expand on as we leverage our existing infrastructure, and
earnings per fully diluted share of common stock.
14
RESULTS OF OPERATIONS
Our strategy for growing our business includes the acquisition of complementary
product lines and companies. Recent acquisitions (as discussed in Note 2 to our
unaudited condensed consolidated financial statements) and restructuring
activities may make our financial results for the three- and six-month periods
ended June 30, 2005 not directly comparable to those of the corresponding prior
year period.
During the second quarter ended June 30, 2005, we announced plans to
restructure certain of our European operations. The restructuring plan includes
closing our Integra ME production facility in Tuttlingen, Germany and reducing
the manufacturing overhead workforce in our production facility located in
Biot, France by the end of 2005. We plan to transition the manufacturing
operations of Integra ME to our production facility in Andover, UK.
In June 2005, we reached an agreement with local representatives of the Integra
ME workforce regarding the amount of benefits that those employees will receive
in connection with the closure of that facility. We are currently negotiating
with representatives of the Biot, France workforce regarding the amount of
benefits the affected employees will receive in excess of the minimum amounts
required by local labor laws.
During the second quarter ended June 30, 2005, we also eliminated some
duplicative sales and marketing positions, primarily in Europe.
Approximately 74 individuals have been identified for termination under the
current restructuring plan. As of June 30, 2005, we have terminated 6 of these
individuals. In connection with this restructuring plan, we recorded a $2.1
million charge in the quarter ended June 30, 2005, for the estimated costs of
employee termination benefits to be provided to the affected employees.
Net income for the three months ended June 30, 2005 was $7.7 million, or $0.23
per diluted share, as compared to net income of $7.5 million, or $0.23 per
diluted share, for the three months ended June 30, 2004.
Net income for the six months ended June 30, 2005 was $16.1 million, or $0.49
per diluted share, as compared to net income of $15.0 million, or $0.46 per
diluted share, for the six months ended June 30, 2004.
These amounts include the following costs associated with inventory fair value
purchase accounting, employee terminations and other costs incurred in
connection with post-acquisition integration activities and the consolidation of
various manufacturing and distribution facilities, and costs related to product
lines that have been discontinued:
Three Months Ended Six Months Ended
June 30, June 30,
(in thousands) 2005 2004 2005 2004
------ ------ ------ ------
Inventory fair market value purchase accounting
adjustments .................................. $ 197 $ 69 $ 466 $ 69
Employee termination costs ....................... 2,074 -- 2,074 --
Facility consolidation, acquisition
integration and related costs ................ 305 -- 822 --
Costs associated with discontinued
products lines ............................... 478 -- 478 --
------ ------ ------ ------
Total $3,054 $ 69 $3,840 $ 69
We believe that, given our on-going, active strategy of seeking acquisitions,
our current focus on rationalizing our existing manufacturing and distribution
infrastructure, and our recent review of various product lines in relation to
our current business strategy, identifying these costs provides useful
information to measure the comparative performance of our business operations.
We estimate that the costs of these restructuring activities and charges
associated with other acquisition and integration related activities in 2005
will not exceed $8 million in the aggregate. We have not yet recorded
additional amounts for employee termination benefits because either the
employees are required to render service beyond their legal notification period
in order to receive the benefits or the benefits have not been communicated to
the affected employees. We will record charges for other acquisitions and
integration charges when the related expenses are incurred.
While we expect a positive impact of the restructuring and integration
activities with projected cost savings of approximately $3 million per year for
2006 and beyond, such results remain uncertain. We expect to reinvest most of
the savings from these restructuring and integration activities in further
building out our European sales, marketing and distribution organization, and
integrating the Newdeal group's business with our existing sales and
distribution network.
15
Revenues and Gross Margin on Product Revenues
Three Months Ended Six Months Ended
June 30, June 30,
(in thousands) 2005 2004 2005 2004
------ ------ ------ ------
Implant products .............................$27,120 $19,412 $ 53,008 $ 37,744
Instruments ...................................22,785 19,006 45,313 35,049
Monitoring products ...........................12,025 11,813 23,399 23,011
Private label products and other revenue....... 7,848 6,210 13,897 13,081
------ ------ -------- --------
Total revenues ...............................$69,778 $56,441 $135,617 $108,885
Cost of total revenues ....................... 27,139 21,665 51,271 41,666
Gross margin on total revenues ............... 42,639 34,776 84,346 67,218
Gross margin as a percentage of total revenues 61% 62% 62% 62%
THREE MONTHS ENDED JUNE 30, 2005 AS COMPARED TO THE THREE MONTHS ENDED JUNE 30,
2004
For the quarter ended June 30, 2005, total revenues increased 24% over the prior
year to $69.8 million. Domestic revenues increased $6.8 million in 2005 to $51.8
million, or 74% of total revenues, as compared to 80% of revenues in the quarter
ended June 30, 2004.
Sales of implant products and instruments, which reported a 40% and 20%
increase, respectively, in sales over 2004, led our growth in revenues in 2005.
Rapid growth in the NeuraGen(TM) Nerve Guide, the INTEGRA(R) Dermal Regeneration
Template and the INTEGRA(TM) Bilayer Matrix Wound Dressing products, and sales
of the recently acquired Newdeal products for the foot and ankle accounted for
most of the increase in implant product revenues. Sales of our NeuraGen(TM) and
NeuraWrap(TM) products increased 69% over the prior-year period. Sales of our
INTEGRA(R) family of dermal repair products increased 47% over the second
quarter of 2004. Newdeal product revenues were $4.1 million. Sales of the
NPH(TM) Low Flow Hydrocephalus Valve that we introduced in late 2004 also
contributed to the growth in implant product revenues for the quarter. Our
DuraGen(R) family of duraplasty products achieved record revenues in the
quarter, although it grew at slower rates than in recent years.
Increased sales of our JARIT(R) surgical instrument and Selector(R) Ultrasonic
Aspirator product lines provided most of the internal growth in instrument
product revenues. The Mayfield(R) product line acquired during the second
quarter of 2004 also continues to provide strong results.
Year-over-year growth in monitoring product revenues continued to be affected by
slower-than-expected acceptance of our LICOX(R) Brain Oxygen Monitoring System
in the United States and slower growth in external drainage systems. We expect
that our NeuroSensor(R) cerebral blood flow monitoring system and Accudrain(R)
external drainage system will contribute to improvements in the performance of
this category in future periods.
Increased revenues of the Absorbable Collagen Sponge that we supply for use in
Medtronic's INFUSE(TM) bone graft product and revenues of the Biopatch(R)
product that we manufacture for Johnson & Johnson, more than offset the removal
of the Signature Technologies revenues from our private label products category.
In the second quarter of 2005, we received a one-time royalty payment of $0.5
million based on additional patent claims associated with the Biopatch(R)
product license.
Revenues from product lines acquired since the beginning of the second quarter
of 2004 accounted for $5.9 million of the $13.3 million increase in total
revenues over the prior-year period. Changes in foreign currency exchange rates
also accounted for $0.4 million of the increase in product revenues. We continue
to expect organic revenue growth to accelerate in the second half of 2005. Our
long-term organic growth rate expectation for revenues is in the range of 15% to
20% per annum.
Our gross margin (exclusive of amortization related to manufacturing processes)
on total revenues in the second quarter of 2005 was 61% versus 62% in second
quarter of 2004. Our gross margin in 2005 was negatively affected by $1.3
million of termination costs incurred in connection with our announced European
restructuring plans, $196,000 of fair value purchase accounting adjustments, and
$354,000 of inventory write-offs and other charges associated with a
discontinued product line and facility consolidations. We recorded $69,000 of
inventory fair value purchase accounting adjustments in the second quarter of
2004.
We have generated our recent product revenue growth through acquisitions, new
product launches and increased direct sales and marketing efforts both
domestically and in Europe. We expect that our future revenue growth will be
driven by our expanded domestic sales force, the continued implementation of our
direct sales strategy in Europe and from internally developed and acquired
products. We also intend to continue to acquire businesses that complement our
existing businesses and products.
16
Other Operating Expenses:
The following is a summary of other operating expenses as a percent of total
revenues:
Three Months Ended
June 30,
(in thousands) 2005 2004
------ ------
Research and development ............................... 4% 5%
Selling, general and administrative .................... 37% 35%
Total other operating expenses, which consists of research and development
expense, selling, general and administrative expense and amortization expense,
increased 32% to $30.5 million in the second quarter of 2005, compared to $23.2
million in the second quarter of 2004.
Research and development expenses increased $148,000 to $2.8 million in the
second quarter of 2005. Expenses increased due to higher spending on research
and clinical activities related to our absorbable implant technology products.
In 2005, we expect our research and development expenses as a percentage of
total revenues to remain consistent with 2004 as we increase expenditures on
research and clinical activities directed towards expanding the indications for
use of our absorbable implant technology products, including a multi-center
clinical trial suitable to support an application to the FDA for approval of the
DuraGen Plus(TM) Adhesion Barrier Matrix product in the United States that was
initiated in the first quarter of 2005.
Sales, general, and administrative expenses increased 34% over the prior year
period to $26.0 million. In 2005, we continue to build our direct sales and
marketing organizations around all three direct selling platforms and have
increased corporate staff to support the recent growth in our business and
integrate acquired businesses.
Additionally, we have recently made significant investments in our
infrastructure with the implementation of a new enterprise business system and
the relocation and expansion of our domestic distribution capabilities through a
third-party service provider. We expect that we will continue to incur costs
related to these activities during the remainder of 2005 and 2006 as we complete
these activities.
Approximately $2.4 million of the $6.5 million increase in sales, general, and
administrative expenses in the second quarter of 2005 represents operating costs
associated with the recently acquired Newdeal acquisition. Included in these
costs is a $0.4 million compensation charge related to the sellers' obligation
to continue their employment with Integra through the end of 2005.
In 2005, we recorded in selling, general, and administrative expense $752,000 of
costs associated with employee termination benefits from our European
restructuring plan and $213,000 of other costs incurred in connection with the
consolidation of various manufacturing and distribution facilities.
Amortization expense increased in the first quarter of 2005 as a result of
amortization of intangible assets from recent acquisitions and a $215,000
impairment charge recorded against a technology-based intangible asset in
connection with the discontinuation of a product line.
From time to time, we review our existing product lines in terms of
profitability and compatibility with our current business strategy and customer
call points. We also review the market effectiveness of our existing brand names
and tradenames. If we determine that a product line does not meet our current
minimum profitability expectations in light of the costs to sell that product,
or if a particular product is not on point with our current customer call point,
we may decide to discontinue that product line. Additionally, if a particular
tradename or brand name is no longer effective, we may discontinue the use of
that tradename or brand name. These decisions could result in future impairment
charges recorded against the related inventories and intangible assets.
Non-Operating Income and Expenses
Interest expense is related to the $120 million of 2 1/2% contingent convertible
subordinated notes we have outstanding and a related interest rate swap
agreement. Our reported interest expense includes $0.2 million of non-cash
amortization of debt issuance costs in both 2005 and 2004. Debt issuance costs
totaled $4.0 million and are being amortized using the straight-line method over
the five-year term of the notes.
We will pay additional interest ("Contingent Interest") on our convertible notes
under certain conditions. The fair value of this Contingent Interest obligation
is marked to its fair value at each balance sheet date, with changes in the fair
value recorded to interest expense. In the second quarter of 2005, the changes
in the estimated fair value of the Contingent Interest obligation decreased
interest expense by $180,000. In the second quarter of 2004, the change
increased interest expense by $61,000.
17
We have an interest rate swap agreement with a $50.0 million notional amount to
hedge the risk of changes in fair value attributable to interest rate risk with
respect to a portion of our fixed rate convertible notes. The interest rate swap
agreement qualifies as a fair value hedge under SFAS No. 133, as amended
"Accounting for Derivative Instruments and Hedging Activities". The net amount
to be paid or received under the interest rate swap agreement is recorded as a
component of interest expense. Interest expense associated with the interest
rate swap for the three months ended June 30, 2005 was not significant. Interest
expense for the three months ended June 30, 2004 included a $216,000 benefit
associated with the interest rate swap.
For the three month period ended June 30, 2005, the net fair value of the
interest rate swap decreased $619,000 to $1.5 million and the fair value amount
is included in other liabilities. In connection with this fair value hedge
transaction, during the second quarter of 2005, we recorded a $584,000 increase
in the carrying value of our convertible notes. During the three months ended
June 30, 2004, the net fair value of the interest rate swap increased $1.4
million to $2.0 million, and the carrying value of our convertible notes
decreased by $1.4 million. The net difference between changes in the fair value
of the interest rate swap and the contingent convertible notes represents the
ineffective portion of the hedging relationship, and this amount is recorded in
other income/(expense), net.
Our net other income/expense decreased by $676,000 from $135,000 of income in
the second quarter of 2004 to $541,000 of expense in the second quarter of 2005.
This decrease was primarily related to $522,000 of losses in 2005 from foreign
currency transactions attributable the appreciation of the US dollar relative to
the euro and the British pound.
Income tax expense was approximately 34.5% and 36.8% of income before income
taxes for the second quarters of 2005 and 2004, respectively. Income tax expense
for the second quarters of 2005 and 2004 included a deferred income tax
provision of $3.2 million and $3.6 million, respectively. The decrease in the
effective income tax rate in 2005 resulted primarily from the benefits received
from business planning initiatives undertaken in 2004 to reorganize our European
assets.
SIX MONTHS ENDED JUNE 30, 2005 AS COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2004
For the six months ended June 30, 2005, total revenues increased by $26.7
million, or 25%, over the six months ended June 30, 2004 to $135.6 million.
Revenues from products acquired since the second quarter of 2004 accounted for
$15.3 million of the $26.7 million increase in total revenues over the prior
year period. Changes in foreign currency exchange rates contributed $0.8 million
to the increase in total revenues. Domestic revenues increased $12.7 million
compared to the six months ended June 30, 2004 to $99.1 million, or 73% of
product revenues, compared to 79% reported for the six months ended June 30,
2004.
Our implant product line revenues increased over the prior year period by $15.3
million, or 40%, and includes $8.7 million of sales from our recently acquired
Newdeal implant product line. The remaining increase was the result of growth in
the NeuraGen(TM) Nerve Guide, the INTEGRA(R) family of dermal repair products
and as well as the ongoing launch of the NPH(TM) Low Flow Hydrocephalus Valve.
Revenues from our instrument product lines increased by $10.3 million, or 29%,
over the prior-year period. This increase resulted from the impact of recently
acquired product lines and strong sales growth in each of our existing
instrument product lines. Revenues from our monitoring product lines increased
$0.4 million, or 2%.
Our private label product revenue and other revenue increased by $816,000, or
6%, over the prior-year period, as increases in revenues of the Absorbable
Collagen Sponge that we supply for use in Medtronic's INFUSE(TM) bone graft
product and revenues of the Biopatch(R) product more than offset the removal of
the Signature Technologies revenues from our private label products category.
Our gross margin (exclusive of amortization related to manufacturing processes)
on product revenues for the six months ended June 30, 2005 and 2004 was 62%. Our
gross margin for the six months ended June 30, 2005 was negatively affected by
$1.3 million of termination costs incurred in connection with our announced
European restructuring plans, $465,000 of fair value purchase accounting
adjustments, and $354,000 of inventory write-offs and other charges associated
with a discontinued product line and facility consolidations. Offsetting the
impact of these amounts was the continued growth in higher gross margin
products. We recorded $69,000 of inventory fair value purchase accounting
adjustments in the six month period ended 2004.
18
Other Operating Expenses:
The following is a summary of other operating expenses as a percent of total
revenues:
Six Months Ended
June 30,
(in thousands) 2005 2004
------ ------
Research and development ............................... 5 % 5 %
Selling, general and administrative .................... 37 % 34 %
Total other operating expenses, consists of research and development expense,
selling, general and administrative expense and amortization expense, increased
35% to $59.2 million in the six months ended June 30, 2005, compared to $43.9
million in the prior-year period.
Research and development expenses increased $0.7 to $6.1 million in the six
months ended June 30, 2005. Expenses increased because of higher spending on
research and clinical activities related to our absorbable implant technology
products and the addition of development personnel. These increases were offset
by a decrease in external development projects costs.
Selling, general, and administrative expenses increased 37% over the prior year
period to $50.0 million. In 2005, we continue to build our direct sales and
marketing organizations around all three direct selling platforms and have
increased corporate staff to support the recent growth in our business and
integrate acquired businesses.
Approximately $4.6 million of the $13.5 million increase in sales, general, and
administrative expenses in the six months ended June 30, 2005 represents
operating costs derived from the recently acquired Newdeal acquisition. Included
in these costs is a $0.8 million compensation charge related to the sellers'
obligation to continue their employment with Integra through the end of 2005.
Amortization expense increased $1.2 to $3.1 million in 2005 as a result of
amortization of intangible assets from recent acquisitions and a $215,000
impairment recorded in connection with the discontinuation of a product line.
Non-Operating Income and Expenses
Our reported interest expense in 2005 and 2004, respectively, includes $404,000
and $410,000 of amortization of debt issuance costs. The change in the estimated
fair value of the Contingent Interest obligation decreased interest expense by
$202,000 in 2005 and increase interest expense by $163,000 in 2004. Interest
expense associated with the interest rate swap for the six months ended June 30,
2005 was not significant. Interest expense for the six months ended June 30,
2004 included a $426,000 benefit associated with the interest rate swap.
During the six months ended June 30, 2005, the net fair value of the interest
rate swap increased $136,000 to $1.5 million, and this amount is included in
other liabilities. In connection with this fair value hedge transaction, during
the six months ended June 30, 2005, we recorded a $203,000 decrease in the
carrying value of our convertible notes. During the six months ended June 30,
2004, the net fair value of the interest rate swap increased $882,000 to $2.0
million, and the carrying value of our convertible notes decreased by $957,000.
The net difference between changes in the fair value of the interest rate swap
and the contingent convertible notes represents the ineffective portion of the
hedging relationship, and this amount is recorded in other income (expense),
net.
Our net other income/expense decreased by $752,000 from $118,000 of income in
2004 to $634,000 of expense in 2005. In 2005, we recorded $714,000 of losses
from foreign currency transactions attributable the appreciation of the US
dollar relative to the euro and the British pound.
Income tax expense was approximately 34.5% and 36.8% of income before income
taxes for 2005 and 2004, respectively. Income tax expense in 2005 and 2004
includes a deferred income tax provision of $6.3 million and $6.7 million,
respectively. The decrease in the effective income tax rate in 2005 resulted
primarily from the benefits received from the recent reorganization of our
European assets.
19
International Operations
Because we have operations based in Europe and we generate revenues and incur
operating expenses in euros and British pounds, we have currency exchange risk
with respect to those foreign currency denominated revenues or expenses.
In the second quarter of 2005, the cost of products we manufactured in our
European facilities or purchased in foreign currencies exceeded our foreign
currency-denominated revenues. We expect this imbalance to continue. We
currently do not hedge our exposure to foreign currency risk. Accordingly, a
weakening of the dollar against the euro and British pound could negatively
affect future gross margins and operating margins. We will continue to assess
the potential effects that changes in foreign currency exchange rates could have
on our business. If we believe this potential impact presents a significant risk
to our business, we may enter into derivative financial instruments to mitigate
this risk.
Additionally, we generate significant revenues outside the United States, a
portion of which are U.S. dollar-denominated transactions conducted with
customers who generate revenue in currencies other than the U.S. dollar. As a
result, currency fluctuations between the U.S. dollar and the currencies in
which those customers do business may have an impact on the demand for our
products in foreign countries.
Our sales to foreign markets may be affected by local economic conditions,
regulatory or political considerations, the effectiveness of our sales
representatives and distributors, local competition, and changes in local
medical practice.
Relationships with customers and effective terms of sale frequently vary by
country, often with longer-term receivables than are typical in the United
States.
20
Total revenues by major geographic area are summarized below:
United Asia Other
States Europe Pacific Foreign Total
-------- -------- -------- -------- --------
(in thousands)
Three months ended June 30, 2005.... $ 51,752 $ 12,982 $ 2,733 $ 2,311 $ 69,778
Three months ended June 30, 2004.... 44,984 7,561 2,069 1,827 56,441
Six months ended June 30, 2005...... $ 99,119 $ 25,744 $ 5,781 $ 4,973 $135,617
Six months ended June 30, 2004...... 86,379 14,809 3,898 3,799 108,885
For the six months ended June 30, 2005, revenues from customers outside the
United States totaled $36.5 million, or 27% of total revenues, of which
approximately 71% were to European customers. Of this amount, $29.0 million was
generated in foreign currencies primarily by our subsidiaries in Europe.
In the six months ending June 30, 2004, product revenues from customers outside
the United States totaled $22.5 million, or 21% of consolidated product
revenues, of which approximately 66% were to European customers. Of this amount,
$16.5 million was generated in foreign currencies.
LIQUIDITY AND CAPITAL RESOURCES
Cash and Marketable Securities
At June 30, 2005, we had cash, cash equivalents and current and non-current
investments totaling approximately $147.8 million. Our investments consist
almost entirely of highly liquid, interest bearing debt securities.
At June 30, 2005, we had $3.4 million of cash pledged as collateral in
connection with our interest rate swap agreement.
Cash Flows
Cash provided by operations has recently been and is expected to continue to be
our primary means of funding existing operations and capital expenditures. We
have generated positive operating cash flows on an annual basis, including $34.8
million in 2003, $39.0 million in 2004, and $29.5 million of operating cash
flows in the six months ending June, 2005. Operating cash flows for the six
months ending June 30, 2004, were $20.9 million.
Our principal uses of funds during the six month period ended June 30, 2005 were
$50.1 million for acquisition consideration, net of cash acquired, and $4.8
million for purchases of property and equipment, and $24.7 million for the
repurchase of 750,000 shares of our common stock. We received $6.1 million in
cash from sales and maturities of investments, net of purchases. In addition to
the $29.5 million in operating cash flows for the six months ended June 30,
2005, we received $3.9 million from the issuance of common stock through the
exercise of stock options during the period.
During the six month period ended June 30, 2005, we paid $4.2 million for income
taxes and $1.5 million for interest.
Based on our current unused net operating loss carryforward position and various
other future potential tax deductions, we expect our operating cash flows to
continue to benefit from actual cash tax payments being lower than our effective
book income tax rate through 2006.
Working Capital
At June 30, 2005 and December 31, 2004, working capital was $192.9 million and
$192.0 million, respectively. Working capital does not include the $49.4 million
and $95.2 million of marketable securities classified as non-current at June 30,
2005 and December 31, 2004, respectively.
Accounts receivable days sales outstanding improved from approximately 69 days
at December 31, 2004 to approximately 61 days at June 30, 2005 as a result of
increased collection efforts during 2005. We expect our days sales outstanding
to remain consistent with current levels.
Inventory days on hand increased from approximately 217 days at December 31,
2004 to approximately 246 days at June 30, 2005, primarily from higher levels of
Newdeal products and instrument inventory. We expect our days on hand in
inventory to decrease during the second half of 2005.
21
Accrued compensation increased $5.1 million during the six month period ended
June 30, 2005 primarily as a result of increased headcount and the timing of
payroll in 2005, the $2.0 million of accrued employee termination benefits
associated with our European restructuring activities, and a $0.8 million
accrued compensation charge related to the Newdeal sellers' obligation to
continue their employment with Integra through the end of 2005.
Debt
We have outstanding $120.0 million of 2 1/2% contingent convertible subordinated
notes due 2008. We are obligated to pay $3.0 million of interest per year on the
notes and to repay their principal amount on March 15, 2008, if the notes are
not converted into common stock before that date. We will also pay contingent
interest on the notes if, at thirty days prior to maturity, Integra's common
stock price is greater than $37.56, subject to certain conditions.
We also have outstanding an interest rate swap agreement with a $50 million
notional amount to hedge the risk of changes in fair value attributable to
interest rate risk with respect to a portion of the convertible notes. We
receive a 2 1/2% fixed rate from the counterparty, payable on a semi-annual
basis, and pay to the counterparty a floating rate based on 3 month LIBOR minus
35 basis points, payable on a quarterly basis. The interest rate swap agreement
terminates on March 15, 2008, subject to early termination upon the occurrence
of certain events, including redemption or conversion of the contingent
convertible notes.
We also have outstanding long-term indebtedness totaling $0.4 million related to
the recently acquired Newdeal business.
Share Repurchase Plan
In May 2005, our Board of Directors authorized us to repurchase shares of our
common stock for an aggregate purchase price not to exceed $40 million through
December 31, 2006. We may repurchase no more than 1.5 million shares under this
program. Shares may be purchased either in the open market or in privately
negotiated transactions. Through June 30, 2005, we repurchased 750,000 shares
for $24.7 million.
Dividend Policy
We have not paid any cash dividends on our common stock since our formation. Any
future determinations to pay cash dividends on our common stock will be at the
discretion of our Board of Directors and will depend upon our financial
condition, results of operations, cash flows, and other factors deemed relevant
by the Board of Directors.
Requirements and Capital Resources
We believe that our cash and marketable securities are sufficient to finance our
operations and capital expenditures in the near term. We expect to invest
approximately $3.5 million in 2005 associated with the continued worldwide
implementation of our new enterprise business software. Additionally, we have
agreed to pay the sellers of Newdeal Technologies SA up to an additional
1,250,000 euros if each of the sellers continues his employment with Integra
through January 3, 2006. We also expect to pay up to $1.7 million in 2005 to
those employees who are affected by our European restructuring plans.
Given the significant level of liquid assets and our objective to grow by
acquisition and alliances, our financial position could change significantly if
we were to complete a business acquisition by utilizing a significant portion of
our liquid assets.
Currently, we do not have any existing borrowing capacity or other credit
facilities in place to raise significant amounts of capital if such a need
arises.
Contractual Obligations and Commitments
Under certain agreements, we are required to make royalty payments based on
sales levels of certain products.
22
OTHER MATTERS
RECENTLY ISSUED ACCOUNTING STANDARDS AND OTHER MATTERS
Recently Issued Accounting Standards and Other Matters
In May 2005, the Financial Accounting Standards Board (FASB) issued Statement
No. 154, "Accounting Changes and Error Corrections, a replacement of APB Opinion
No. 20 and FASB Statement No. 3". SFAS 154 requires retrospective application to
prior periods' financial statements of a voluntary change in accounting
principle. Previously, voluntary changes in accounting principle were accounted
for by including a one-time cumulative effect in the period of change. This
statement is effective January 1, 2006. This standard has no impact on our
financial statements.
In November 2004, the Financial Accounting Standards Board (FASB) issued
Statement No. 151, "Inventory Costs-an amendment of ARB No. 43, Chapter 4"
(Statement 151), which is effective beginning January 1, 2006. Statement 151
requires that abnormal amounts of idle facility expense, freight, handling costs
and wasted material be recognized as current period charges. Statement 151 also
requires that the allocation of fixed production overhead be based on the normal
capacity of the production facilities. Management does not expect that Statement
151 will have a material impact on our financial position or results of
operations.
In March 2004, the FASB Emerging Issue Task Force (EITF) reached a consensus on
Issue 03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application
to Certain Investments". Issue 03-01 provides guidance regarding recognition and
measurement of unrealized losses on available-for-sale debt and equity
securities accounted for under Statement of Financial Accounting Standard No.
115, "Accounting for Certain Investments in Debt and Equity Securities". The
application of certain paragraphs covering the measurement provisions of Issue
03-01 have been deferred pending the issuance of a final FASB Staff Position
providing implementation guidance on Issue 03-01. The disclosures were effective
in annual financial statements for fiscal years ending after December 15, 2003.
Management is currently assessing the impact that the recognition and
measurement provisions of Issue 03-01 could have on our financial statements.
The American Jobs Creation Act of 2004 (the "Act") was signed into law in
October 2004 and has several provisions that may impact the Company's income
taxes in the future, including the repeal of the extraterritorial income
exclusion and a deduction related to qualified production activities taxable
income. The FASB proposed that the qualified production activities deduction is
a special deduction and will have no impact on deferred taxes existing at the
enactment date. Rather, the impact of this deduction will be reported in the
period in which the deduction is claimed on the Company's tax return. Management
is currently evaluating the impact of the FASB guidance related to qualified
production activities on the Company's effective tax rate in future periods.
In December 2004, the FASB issued Statement No. 123 (revised 2004), "Share-Based
Payment," which is a revision of Statement No. 123, "Accounting for Stock-Based
Compensation." Statement 123(R) replaces APB Opinion No. 25, "Accounting for
Stock Issued to Employees," and amends Statement No. 95, "Statement of Cash
Flows." Statement 123(R) requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the financial
statements based on their fair value. Pro forma footnote disclosure will no
longer be an alternative to financial statement recognition.
Statement 123(R) must be adopted no later than January 1, 2006. Statement 123(R)
permits companies to adopt its requirements using either the "modified
prospective" method or the "modified retrospective" method. Management is
currently evaluating the potential impact of Statement 123(R) on our
consolidated financial position and results of operations and the alternative
adoption methods.
23
FACTORS THAT MAY AFFECT OUR FUTURE PERFORMANCE
Our Operating Results May Fluctuate.
Our operating results, including components of operating results, such as gross
margin on product sales, may fluctuate from time to time, and such fluctuations
could affect our stock price. Our operating results have fluctuated in the past
and can be expected to fluctuate from time to time in the future. Some of the
factors that may cause these fluctuations include:
- - the impact of acquisitions;
- - the timing of significant customer orders;
- - market acceptance of our existing products, as well as products in
development;
- - the timing of regulatory approvals;
- - changes in the rate of exchange between the U.S. dollar, the euro and the
British pound;
- - expenses incurred and business lost in connection with product field
corrections or recalls;
- - our ability to manufacture our products efficiently; and
- - the timing of our research and development expenditures.
The Industry And Market Segments in Which We Operate Are Highly Competitive,
And We May Be Unable To Compete Effectively With Other Companies.
In general, the medical technology industry is characterized by intense
competition. We compete with established medical technology and pharmaceutical
companies. Competition also comes from early stage companies that have
alternative technological solutions for our primary clinical targets, as well as
universities, research institutions and other non-profit entities. Many of our
competitors have access to greater financial, technical, research and
development, marketing, manufacturing, sales, distribution services and other
resources than we do. Our competitors may be more effective at implementing
their technologies to develop commercial products.
Our competitive position will depend on our ability to achieve market acceptance
for our products, develop new products, implement production and marketing
plans, secure regulatory approval for products under development and obtain
patent protection. We may need to develop new applications for our products to
remain competitive. Technological advances by one or more of our current or
future competitors could render our present or future products obsolete or
uneconomical. Our future success will depend upon our ability to compete
effectively against current technology as well as to respond effectively to
technological advances. Competitive pressures could adversely affect our
profitability. For example, two of our largest competitors have introduced an
onlay dural graft matrix within the past year, and other companies may be
preparing to introduce similar products. The introduction of such products could
reduce the sales, growth in sales and profitability of our duraplasty products,
including our DuraGen(R), DuraGen Plus(TM), Suturable DuraGen(TM) and EnDura(TM)
product lines, which are among our largest and fastest growing products.
Our largest competitors in the neurosurgery markets are the Medtronic
Neurotechnologies division of Medtronic, Inc., the Codman division of Johnson &
Johnson, the Aesculap division of B. Braun and the Valleylab division of Tyco
International Ltd. In addition, many of our product lines compete with smaller
specialized companies or larger companies that do not otherwise focus on
neurosurgery. Our reconstructive surgery business is small compared to its
principal competitors, which include major medical device and wound care
companies such as Smith and Nephew plc, LifeCell Corporation and Organogenesis
Inc., as well as companies focused on foot and ankle surgeons including Wright
Medical Group, Inc., the DePuy division of Johnson & Johnson, Synthes, Inc. and
a number of smaller companies. Our private label products face diverse and broad
competition, depending on the market addressed by the product. Finally, in
certain cases our products compete primarily against medical practices that
treat a condition without using a device, rather than any particular product,
such as autograft tissue as an alternative for the INTEGRA(R) Dermal
Regeneration Template, our duraplasty products and the NeuraGen(TM) Nerve Guide.
24
Our Current Strategy Involves Growth Through Acquisitions, Which Requires Us To
Incur Substantial Costs And Potential Liabilities For Which We May Never Realize
The Anticipated Benefits.
In addition to internal growth, our current strategy involves growth through
acquisitions. Since 1999, we have acquired 20 businesses or product lines at a
total cost of approximately $213 million.
We may be unable to continue to implement our growth strategy, and our strategy
ultimately may be unsuccessful. A significant portion of our growth in revenues
has resulted from, and is expected to continue to result from, the acquisition
of businesses complementary to our own. We engage in evaluations of potential
acquisitions and are in various stages of discussion regarding possible
acquisitions, certain of which, if consummated, could be significant to us. Any
potential acquisitions may result in material transaction expenses, increased
interest and amortization expense, increased depreciation expense and increased
operating expense, any of which could have a material adverse effect on our
operating results. As we grow by acquisitions, we must integrate and manage the
new businesses to realize economies of scale and control costs. In addition,
acquisitions involve other risks, including diversion of management resources
otherwise available for ongoing development of our business and risks associated
with entering new markets with which our marketing and sales force has limited
experience or where experienced distribution alliances are not available. Our
future profitability will depend in part upon our ability to develop further our
resources to adapt to these new products or business areas and to identify and
enter into satisfactory distribution networks. We may not be able to identify
suitable acquisition candidates in the future, obtain acceptable financing or
consummate any future acquisitions. If we cannot integrate acquired operations,
manage the cost of providing our products or price our products appropriately,
our profitability could suffer. In addition, as a result of our acquisitions of
other healthcare businesses, we may be subject to the risk of unanticipated
business uncertainties, regulatory matters or legal liabilities relating to
those acquired businesses for which the sellers of the acquired businesses may
not indemnify us. Future acquisitions may also result in potentially dilutive
issuances of securities.
The Benefits From The Restructuring Of Our European Operations May Not
Materialize.
We may incur significant costs in connection with employee severance, legal and
other items related to restructuring and integration activities, largely in
Europe. We estimate that the costs of our restructuring and integration
activities (including the costs already incurred) will not exceed $8 million in
the aggregate. While we expect a positive impact of the restructuring and
integration activities with projected cost savings of approximately $3 million
per year for 2006 and beyond, such results remain uncertain.
To Market Our Products Under Development We Will First Need To Obtain Regulatory
Approval. Further, If We Fail To Comply With The Extensive Governmental
Regulations That Affect Our Business, We Could Be Subject To Penalties And Could
Be Precluded From Marketing Our Products.
Our research and development activities and the manufacturing, labeling,
distribution and marketing of our existing and future products are subject to
regulation by numerous governmental agencies in the United States and in other
countries. The Food and Drug Administration (FDA) and comparable agencies in
other countries impose mandatory procedures and standards for the conduct of
clinical trials and the production and marketing of products for diagnostic and
human therapeutic use.
Our products under development are subject to FDA approval or clearance prior to
marketing for commercial use. The process of obtaining necessary FDA approvals
or clearances can take years and is expensive and full of uncertainties. Our
inability to obtain required regulatory approval on a timely or acceptable basis
could harm our business. Further, approval or clearance may place substantial
restrictions on the indications for which the product may be marketed or to whom
it may be marketed. Further studies, including clinical trials and FDA
approvals, may be required to gain approval for the use of a product for
clinical indications other than those for which the product was initially
approved or cleared or for significant changes to the product. In addition, for
products with an approved Pre-Marketing Approval, the FDA requires annual
25
reports and may require post-approval surveillance programs to monitor the
products' safety and effectiveness. Results of post-approval programs may limit
or expand the further marketing of the product.
Another risk of application to the FDA relates to the regulatory classification
of new products or proposed new uses for existing products. In the filing of
each application, we make a legal judgment about the appropriate form and
content of the application. If the FDA disagrees with our judgment in any
particular case and, for example, requires us to file a PMA application rather
than allowing us to market for approved uses while we seek broader approvals or
requires extensive additional clinical data, the time and expense required to
obtain the required approval might be significantly increased or approval might
not be granted.
Approved products are subject to continuing FDA requirements relating to quality
control and quality assurance, maintenance of records, reporting of adverse
events and product recalls, documentation, and labeling and promotion of medical
devices.
The FDA and foreign regulatory authorities require that our products be
manufactured according to rigorous standards. These regulatory requirements may
significantly increase our production or purchasing costs and may even prevent
us from making or obtaining our products in amounts sufficient to meet market
demand. If we or a third-party manufacturer change our approved manufacturing
process, the FDA may require a new approval before that process may be used.
Failure to develop our manufacturing capability may mean that even if we develop
promising new products, we may not be able to produce them profitably, as a
result of delays and additional capital investment costs. Manufacturing
facilities, both international and domestic, are also subject to inspections by
or under the authority of the FDA. In addition, failure to comply with
applicable regulatory requirements could subject us to enforcement action,
including product seizures, recalls, withdrawal of clearances or approvals,
restrictions on or injunctions against marketing our product or products based
on our technology, and civil and criminal penalties.
We are also subject to the regulatory requirements of countries outside of the
United States where we do business. For example, Japan is in the process of
reforming its medical device regulations. A recent amendment to Japan's
Pharmaceutical Affairs Law went into effect on April 1, 2005. New regulations
and requirements exist for obtaining approval of medical devices, including new
requirements governing the conduct of clinical trials, the manufacturing of
products and the distribution of products in Japan. Significant resources also
may be needed to comply with the extensive auditing of all manufacturing
facilities of our company and our vendors by the Ministry of Health, Labor and
Welfare in Japan to comply with the amendment to the Pharmaceutical Affairs Law.
These new regulations may affect our ability to obtain approvals of new products
as well as maintain the certain businesses in Japan. Sales in Japan accounted
for approximately $3.1 million of our revenues in 2004 and $2.0 million in the
six month period ended June 30, 2005.
Certain Of Our Products Contain Materials Derived From Animal Sources And May
Become Subject To Additional Regulation.
Certain of our products, including the DuraGen(R) and NeuraGen(TM) product
families and the INTEGRA(R) Dermal Regeneration Template and wound dressing
products, contain material derived from bovine tissue. Products that contain
materials derived from animal sources, including food as well as pharmaceuticals
and medical devices, are increasingly subject to scrutiny in the press and by
regulatory authorities. Regulatory authorities are concerned about the potential
for the transmission of disease from animals to humans via those materials. This
public scrutiny has been particularly acute in Japan and Western Europe with
respect to products derived from cattle, because of concern that materials
infected with the agent that causes bovine spongiform encephalopathy, otherwise
known as BSE or mad cow disease, may, if ingested or implanted, cause a variant
of the human Creutzfeldt-Jakob Disease, an ultimately fatal disease with no
known cure. Recent cases of BSE in cattle discovered in Canada and the United
States have increased awareness of the issue in North America.
We take great care to provide that our products are safe and free of agents that
can cause disease. In particular, the collagen used in the manufacture of our
products is derived only from the deep flexor tendon of cattle from the United
States that are less than 24 months old. The World Health Organization
classifies different types of cattle tissue for relative risk of BSE
transmission. Deep flexor tendon, the sole source of our collagen, is in the
lowest risk category for BSE transmission (the same category as milk, for
example), and is therefore considered to have a negligible risk of containing
the agent that causes BSE (an improperly folded protein known as a prion).
Nevertheless, products that contain materials derived from animals, including
our products, may become subject to additional regulation, or even be banned in
certain countries, because of concern over the potential for prion transmission.
Significant new regulation, or a ban of our products, could have a material
adverse effect on our current business or our ability to expand our business.
26
In addition, we have been notified that Japan has issued new regulations
regarding medical devices that contain tissue of animal origin. Among other
regulations, Japan may require that the tendon used in the manufacture of
medical devices sold in Japan originate in a country that has never had a case
of BSE. Currently, we purchase our tendon from the United States and have
qualified a source of tendon from New Zealand, a country which has never had a
case of BSE. If we cannot continue to qualify a source of tendon from New
Zealand or another country that has never had a case of BSE, we will not be
permitted to sell our collagen hemostatic agents and products for oral surgery
in Japan. We do not currently sell our dural or skin repair products in Japan.
Lack Of Market Acceptance For Our Products Or Market Preference For Technologies
That Compete With Our Products Could Reduce Our Revenues And Profitability.
We cannot be certain that our current products or any other products that we may
develop or market will achieve or maintain market acceptance. Certain of the
medical indications that can be treated by our devices can also be treated by
other medical devices or by medical practices that do not include a device. The
medical community widely accepts many alternative treatments, and certain of
these other treatments have a long history of use. For example, the use of
autograft tissue is a well-established means for repairing the dermis, and it
competes for acceptance in the market with the INTEGRA(R) Dermal Regeneration
Template.
We cannot be certain that our devices and procedures will be able to replace
those established treatments or that either physicians or the medical community
in general will accept and utilize our devices or any other medical products
that we may develop.
In addition, our future success depends, in part, on our ability to develop
additional products. Even if we determine that a product candidate has medical
benefits, the cost of commercializing that product candidate may be too high to
justify development. Competitors may develop products that are more effective,
achieve more favorable reimbursement status from third-party payors, cost less
or are ready for commercial introduction before our products. For example, our
sales of shunt products could decline if neurosurgeons increase their use of
programmable valves and we fail to introduce a competitive product, or our sales
of certain catheters may be adversely affected by the recent introduction by
other companies of catheters that contain anti-microbial agents intended to
reduce the incidence of infection after implantation. If we are unable to
develop additional commercially viable products, our future prospects could be
adversely affected.
Market acceptance of our products depends on many factors, including our ability
to convince prospective collaborators and customers that our technology is an
attractive alternative to other technologies, to manufacture products in
sufficient quantities and at acceptable costs, and to supply and service
sufficient quantities of our products directly or through our distribution
alliances. In addition, limited funding available for product and technology
acquisitions by our customers, as well as internal obstacles to customer
approvals of purchases of our products and unfavorable reimbursement
methodologies of third-party payors could harm acceptance of our products. The
industry is subject to rapid and continuous change arising from, among other
things, consolidation and technological improvements. One or more of these
factors may vary unpredictably, which could materially adversely affect our
competitive position. We may not be able to adjust our contemplated plan of
development to meet changing market demands.
Our Intellectual Property Rights May Not Provide Meaningful Commercial
Protection For Our Products, Which Could Enable Third Parties To Use Our
Technology Or Very Similar Technology And Could Reduce Our Ability To Compete In
The Market.
Our ability to compete effectively depends in part, on our ability to maintain
the proprietary nature of our technologies and manufacturing processes, which
includes the ability to obtain, protect and enforce patents on our technology
and to protect our trade secrets. We own or have licensed patents that cover
aspects of certain of our product lines. However, you should not rely on our
patents to provide us with any significant competitive advantage. Others may
challenge our patents and, as a result, our patents could be narrowed,
invalidated or rendered unenforceable. Competitors may develop products similar
to ours that our patents do not cover. In addition, our current and future
patent applications may not result in the issuance of patents in the United
States or foreign countries. Further, there is a substantial backlog of patent
applications at the U.S. Patent and Trademark Office, and the approval or
rejection of patent applications usually takes from 18 to 24 months.
Our Competitive Position Depends, In Part, Upon Unpatented Trade Secrets Which
We May Be Unable To Protect.
Our competitive position also depends upon unpatented trade secrets. Trade
secrets are difficult to protect. We cannot assure you that others will not
independently develop substantially equivalent proprietary information and
27
techniques or otherwise gain access to our trade secrets, that our trade secrets
will not be disclosed or that we can effectively protect our rights to
unpatented trade secrets.
In an effort to protect our trade secrets, we require our employees, consultants
and advisors to execute proprietary information and invention assignment
agreements upon commencement of employment or consulting relationships with us.
These agreements provide that, except in specified circumstances, all
confidential information developed or made known to the individual during the
course of their relationship with us must be kept confidential. We cannot assure
you, however, that these agreements will provide meaningful protection for our
trade secrets or other proprietary information in the event of the unauthorized
use or disclosure of confidential information.
Our Success Will Depend Partly On Our Ability To Operate Without Infringing Or
Misappropriating The Proprietary Rights Of Others.
We may be sued for infringing the intellectual property rights of others. In
addition, we may find it necessary, if threatened, to initiate a lawsuit seeking
a declaration from a court that we do not infringe the proprietary rights of
others or that their rights are invalid or unenforceable. If we do not prevail
in any litigation, in addition to any damages we might have to pay, we would be
required to stop the infringing activity or obtain a license for the proprietary
rights involved. Any required license may be unavailable to us on acceptable
terms, or at all. In addition, some licenses may be nonexclusive and allow our
competitors to access the same technology we license. If we fail to obtain a
required license or are unable to design our product so as not to infringe on
the proprietary rights of others, we may be unable to sell some of our products,
which could have a material adverse effect on our revenues and profitability.
It May Be Difficult To Replace Some Of Our Suppliers.
Outside vendors, some of whom are sole-source suppliers, provide key components
and raw materials used in the manufacture of our products. Although we believe
that alternative sources for many of these components and raw materials are
available, any supply interruption in a limited or sole source component or raw
material could harm our ability to manufacture our products until a new source
of supply is identified and qualified. In addition, an uncorrected defect or
supplier's variation in a component or raw material, either unknown to us or
incompatible with our manufacturing process, could harm our ability to
manufacture products. We may not be able to find a sufficient alternative
supplier in a reasonable time period, or on commercially reasonable terms, if at
all, and our ability to produce and supply our products could be impaired. We
believe that these factors are most likely to affect the following products that
we manufacture:
- - our collagen-based products, such as the INTEGRA(R) Dermal Regeneration
Template and wound dressing products, the DuraGen(R) family of products, and
our Absorbable Collagen Sponges;
- - our products made from silicone, such as our neurosurgical shunts and
drainage systems and hemodynamic shunts; and
- - products which use many different electronic parts from numerous suppliers,
such as our Camino(R), Ventrix(R) and NeuroSensor(TM) lines of intracranial
monitors and catheters.
If we were suddenly unable to purchase products from one or more of these
companies, we could need a significant period of time to qualify a replacement,
and the production of any affected products could be disrupted. While it is our
policy to maintain sufficient inventory of components so that our production
will not be significantly disrupted even if a particular component or material
is not available for a period of time, we remain at risk that we will not be
able to qualify new components or materials quickly enough to prevent a
disruption if one or more of our suppliers ceases production of important
components or materials.
If Any Of Our Manufacturing Facilities Were Damaged And/Or Our Manufacturing Or
Business Processes Interrupted, We Could Experience Lost Revenues And Our
Business Could Be Seriously Harmed.
We manufacture our products in a limited number of facilities. Damage to our
manufacturing, development or research facilities due to fire, natural disaster,
power loss, communications failure, unauthorized entry or other events could
cause us to cease development and manufacturing of some or all of our products.
In particular, our San Diego, California facility that manufactures our
Camino(R) and Ventrix(R) product line is as susceptible to earthquake damage,
wildfire damage and power losses from electrical shortages as are other
businesses in the Southern California area. Our silicone manufacturing plant in
Anasco, Puerto Rico is vulnerable to hurricane damage. Although we maintain
property damage and business interruption insurance coverage on these
facilities, we may not be able to renew or obtain such insurance in the future
on acceptable terms with adequate coverage or at reasonable costs.
28
In addition, we are implementing in several stages over several years an
enterprise business system for use in all of our facilities. This system will
replace several systems on which we now rely. We have outsourced our product
distribution function in the United States and are also planning to outsource
our European product distribution function. A delay or other problem with the
system or in our implementation schedule for either of these initiatives could
have a material adverse effect on our operations.
We May Be Involved In Lawsuits Relating To Our Intellectual Property Rights And
Promotional Practices, Which May Be Expensive.
To protect or enforce our intellectual property rights, we may have to initiate
legal proceedings, such as infringement suits or interference proceedings,
against third parties. In addition, we may have to institute proceedings
regarding our competitors' promotional practices. Litigation is costly, and,
even if we prevail, the cost of that litigation could affect our profitability.
In addition, litigation is time consuming and could divert management attention
and esources away from our business. We may also provoke these third parties to
assert claims against us.
We Are Exposed To A Variety Of Risks Relating To Our International Sales And
Operations, Including Fluctuations In Exchange Rates, Local Economic Conditions
And Delays In Collection Of Accounts Receivable.
We generate significant revenues outside the United States in euros, British
pounds and in U.S. dollar-denominated transactions conducted with customers who
generate revenue in currencies other than the U.S. dollar. For those foreign
customers who purchase our products in U.S. dollars, currency fluctuations
between the U.S. dollar and the currencies in which those customers do business
may have an impact on the demand for our products in foreign countries where the
U.S. dollar has increased in value compared to the local currency.
Because we have operations based in Europe and we generate revenues and incur
operating expenses in euros and British pounds, we experience currency exchange
risk with respect to those foreign currency-denominated revenues and expenses.
In 2005 and 2004, the cost of products we manufactured in our European
facilities or purchased in foreign currencies exceeded our foreign
currency-denominated revenues. We expect this imbalance to continue.
Accordingly, a further weakening of the dollar against the euro and British
pound could negatively affect future gross margins and operating margins.
Currently, we do not use derivative financial instruments to manage operating
foreign currency risk. As the volume of our business transacted in foreign
currencies increases, we will continue to assess the potential effects that
changes in foreign currency exchange rates could have on our business. If we
believe that this potential impact presents a significant risk to our business,
we may enter into derivative financial instruments to mitigate this risk.
In general, we cannot predict the consolidated effects of exchange rate
fluctuations upon our future operating results because of the number of
currencies involved, the variability of currency exposure and the potential
volatility of currency exchange rates.
Our sales to foreign markets also may be affected by local economic conditions,
legal, regulatory or political considerations, the effectiveness of our sales
representatives and distributors, local competition and changes in local medical
practice. Relationships with customers and effective terms of sale frequently
vary by country, often with longer-term receivables than are typical in the
United States.
Changes In The Health Care Industry May Require Us To Decrease The Selling Price
For Our Products Or May Reduce The Size Of The Market For Our Products, Either
Of Which Could Have A Negative Impact On Our Financial Performance.
Trends toward managed care, health care cost containment and other changes in
government and private sector initiatives in the United States and other
countries in which we do business are placing increased emphasis on the delivery
of more cost-effective medical therapies that could adversely affect the sale
and/or the prices of our products. For example:
- - major third-party payors of hospital services and hospital outpatient
services, including Medicare, Medicaid and private health care insurers, have
substantially revised their payment methodologies, which has resulted in
stricter standards for reimbursement of hospital charges for certain medical
procedures;
- - Medicare, Medicaid and private health care insurer cutbacks could create
downward price pressure on our products;
29
- - numerous legislative proposals have been considered that would result in
major reforms in the U.S. health care system that could have an adverse
effect on our business;
- - there has been a consolidation among health care facilities and purchasers
of medical devices in the United States who prefer to limit the number of
suppliers from whom they purchase medical products, and these entities may
decide to stop purchasing our products or demand discounts on our prices;
- - we are party to contracts with group purchasing organizations, which
negotiate pricing for many member hospitals, that require us to discount our
prices for certain of our products and limit our ability to raise prices for
certain of our products, particularly surgical instruments;
- - there is economic pressure to contain health care costs in international
markets;
- - there are proposed and existing laws, regulations and industry policies in
domestic and international markets regulating the sales and marketing
practices and the pricing and profitability of companies in the health care
industry; and
- - proposed laws or regulations that will permit hospitals to provide financial
incentives to doctors for reducing hospital costs (know as gainsharing) and
to award physician efficiency (known as physician profiling) could reduce
prices; and
- - there have been initiatives by third-party payors to challenge the prices
charged for medical products that could affect our ability to sell products
on a competitive basis.
Both the pressures to reduce prices for our products in response to these trends
and the decrease in the size of the market as a result of these trends could
adversely affect our levels of revenues and profitability of sales.
Regulatory Oversight Of The Medical Device Industry Might Affect The Manner In
Which We May Sell Medical Devices
There are laws and regulations that regulate the means by which companies in the
health care industry may market their products to health care professionals and
may compete by discounting the prices of their products. Although we exercise
care in structuring our sales and marketing practices and customer discount
arrangements to comply with those laws and regulations, we cannot assure you
that:
- - government officials charged with responsibility for enforcing those laws
will not assert that our sales and marketing practices or customer discount
arrangements are in violation of those laws or regulations; or
- - government regulators or courts will interpret those laws or regulations in
a manner consistent with our interpretation.
In January 2004, ADVAMED, the principal U.S. trade association for the medical
device industry, put in place a model "code of conduct" that sets forth
standards by which its members should abide in the promotion of their products.
We have in place policies and procedures for compliance that we believe are at
least as stringent as those set forth in the ADVAMED Code, and we provide
routine training to our sales and marketing personnel on our policies regarding
sales and marketing practices. Nevertheless, we believe that the sales and
marketing practices of our industry will be subject to increased scrutiny from
government agencies.
Our Private Label Business Depends Significantly On Key Relationships With
Third Parties, Which We May Be Unable To Establish And Maintain.
Our private label business depends in part on our entering into and maintaining
collaborative or alliance agreements with third parties concerning product
marketing, as well as research and development programs. Our most important
alliance is our agreement with the Wyeth BioPharma division of Wyeth for the
development of collagen matrices to be used in conjunction with Wyeth
BioPharma's recombinant bone protein, a protein that stimulates the growth of
bone in humans. Termination of any of our alliances would require us to develop
other means to distribute the affected products and could adversely affect our
expectations for the growth of private label products.
We May Have Significant Product Liability Exposure And Our Insurance May Not
Cover All Potential Claims.
We are exposed to product liability and other claims in the event that our
technologies or products are alleged to have caused harm. We may not be able to
obtain insurance for the potential liability on acceptable terms with adequate
coverage or at reasonable costs. Any potential product liability claims could
exceed the amount of our insurance coverage or may be excluded from coverage
under the terms of the policy. Our insurance may not be renewed at a cost and
level of coverage comparable to that then in effect.
30
We Are Subject To Other Regulatory Requirements Relating To Occupational Health
And Safety And The Use Of Hazardous Substances Which May Impose Significant
Compliance Costs On Us.
We are and may be subject to regulation under federal and state laws, including
requirements regarding occupational health and safety, laboratory practices, the
maintenance of personal health information, sales and marketing practices
(including product discounting practices) import-export practices and the use,
handling and disposal of toxic or hazardous substances. We may also be subject
to other present and possible future local, state, federal and foreign
regulations.
Our research, development and manufacturing processes involve the controlled use
of certain hazardous materials. Although we believe that our safety procedures
for handling and disposing of those materials comply with the standards
prescribed by the applicable laws and regulations, the risk of accidental
contamination or injury from these materials cannot be eliminated. In the event
of such an accident, we could be held liable for any damages that result and any
related liability could exceed the limits or fall outside the coverage of our
insurance and could exceed our resources. We may not be able to maintain
insurance on acceptable terms or at all. We may incur significant costs to
comply with environmental laws and regulations in the future.
The Loss Of Key Personnel Could Harm Our Business.
We believe our success depends on the contributions of a number of our key
personnel, including Stuart M. Essig, our President and Chief Executive Officer.
If we lose the services of key personnel, those losses could materially harm
our business. We maintain key person life insurance on Mr. Essig.
FORWARD-LOOKING STATEMENTS
We have made statements in this report, including statements under "Management's
Discussion and Analysis of Financial Condition and Results of Operations" which
constitute forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
These forward-looking statements are subject to a number of risks, uncertainties
and assumptions about the Company, including those described under "Factors that
May Affect Our Future Performance" in the Company's Annual Report on Form 10-K
for the year ended December 31, 2004 filed with the Securities and Exchange
Commission and those set forth under the heading "Factors That May Affect our
Future Performance" in this report. In light of these risks and uncertainties,
the forward-looking events and circumstances discussed in this report may not
occur and actual results could differ materially from those anticipated or
implied in the forward-looking statements.
You can identify these forward-looking statements by forward-looking words such
as "believe," "may," "could," "will," "estimate," "continue," "anticipate,"
"intend," "seek," "plan," "expect," "should," "would" and similar expressions in
this report.
31
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to various market risks, including changes in foreign currency
exchange rates and interest rates that could adversely impact our results of
operations and financial condition. To manage the volatility relating to these
typical business exposures, we may enter into various derivative transactions
when appropriate. We do not hold or issue derivative instruments for trading or
other speculative purposes.
Foreign Currency Exchange Rate Risk
A discussion of foreign currency exchange risks is provided under the caption
"International Operations" under "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
Interest Rate Risk - Marketable Securities
We are exposed to the risk of interest rate fluctuations on the fair value and
interest income earned on our cash and cash equivalents and investments in
available-for-sale marketable debt securities. A hypothetical 100 basis point
movement in interest rates applicable to our cash and cash equivalents and
investments in marketable debt securities outstanding at June 30, 2005 would
increase or decrease interest income by approximately $1.5 million on an annual
basis. We are not subject to material foreign currency exchange risk with
respect to these investments.
Interest Rate Risk - Long Term Debt and Related Hedging Instruments
We are exposed to the risk of interest rate fluctuations on the net interest
received or paid under the terms of an interest rate swap. At June 30, 2005, we
had outstanding a $50.0 million notional amount interest rate swap used to hedge
the risk of changes in fair value attributable to interest rate risk with
respect to a portion of our $120.0 million principal amount fixed rate 2 1/2%
contingent convertible subordinated notes due March 2008.
Our interest rate swap agreement qualifies as a fair value hedge under SFAS No.
133, as amended, "Accounting for Derivative Instruments and Hedging Activities".
At June 30, 2005, the net fair value of the interest rate swap approximated $1.5
million and is included in other liabilities. The net fair value of the interest
rate swap represents the estimated receipts or payments that would be made to
terminate the agreement. A hypothetical 100 basis point movement in interest
rates applicable to the interest rate swap would increase or decrease interest
expense by approximately $500,000 on an annual basis.
32
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our Exchange Act reports is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms and that such information
is accumulated and communicated to our management, including our principal
executive officer and principal financial officer, as appropriate, to allow for
timely decisions regarding required disclosure. Disclosure controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management
is required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures. Management has designed our disclosure
controls and procedures to provide reasonable assurance of achieving the desired
control objectives.
As required by Rule 13a-15(b) under the Exchange Act, we have carried out an
evaluation, under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, of
the effectiveness of the design and operation of our disclosure controls and
procedures as of the end of the quarter covered by this report. Based on the
foregoing, our principal executive officer and principal financial officer
concluded that our disclosure controls and procedures were effective at the
reasonable assurance level.
Changes in Internal Control Over Financial Reporting
No changes in our internal control over financial reporting (as defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the quarter
ended June 30, 2005, that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
Internal control over financial reporting cannot provide absolute assurance of
achieving financial reporting objectives because of its inherent limitations.
Internal control over financial reporting is a process that involves human
diligence and compliance and is subject to lapses in judgment and breakdowns
resulting from human failures. Internal control over financial reporting also
can be circumvented by collusion or improper management override. Because of
such limitations, there is a risk that material misstatements may not be
prevented or detected on a timely basis by internal control over financial
reporting. However, these inherent limitations are known features of the
financial reporting process. Therefore, it is possible to design into the
process safeguards to reduce, though not eliminate, this risk.
33
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEDINGS
In July 1996, the Company filed a patent infringement lawsuit in the United
States District Court for the Southern District of California (the "Trial
Court") against Merck KGaA, a German corporation, Scripps Research Institute, a
California nonprofit corporation, and David A. Cheresh, Ph.D., a research
scientist with Scripps, seeking damages and injunctive relief. The complaint
charged, among other things, that the defendant Merck KGaA willfully and
deliberately induced, and continues willfully and deliberately to induce,
defendants Scripps Research Institute and Dr. Cheresh to infringe certain of the
Company's patents. These patents are part of a group of patents granted to The
Burnham Institute and licensed by Integra that are based on the interaction
between a family of cell surface proteins called integrins and the
arginine-glycine-aspartic acid ("RGD") peptide sequence found in many
extracellular matrix proteins. The defendants filed a countersuit asking for an
award of defendants' reasonable attorney fees.
In March 2000, a jury returned a unanimous verdict in the Company's favor and
awarded Integra $15.0 million in damages, finding that Merck KGaA had willfully
infringed and induced the infringement of our patents. The Trial Court dismissed
Scripps and Dr. Cheresh from the case.
In October 2000, the Trial Court entered judgment in Integra's favor and against
Merck KGaA in the case. In entering the judgment, the Trial Court also granted
to the Company pre-judgment interest of $1.4 million, bringing the total award
to $16.4 million, plus post-judgment interest. Merck KGaA filed various
post-trial motions requesting a judgment as a matter of law notwithstanding the
verdict or a new trial, in each case regarding infringement, invalidity and
damages. In September 2001, the Trial Court entered orders in favor of Integra
and against Merck KGaA on the final post-judgment motions in the case, and
denied Merck KGaA's motions for judgment as a matter of law and for a new trial.
Merck KGaA and Integra each appealed various decisions of the Trial Court to the
United States Court of Appeals for the Federal Circuit (the "Circuit Court"). In
June 2003, the Circuit Court affirmed the Trial Court's finding that Merck KGaA
had infringed our patents. The Circuit Court also held that the basis of the
jury's calculation of damages was not clear from the trial record, and remanded
the case to the Trial Court for further factual development and a new
calculation of damages consistent with the Circuit Court's decision. In
September 2004, the Trial Court ordered Merck KgaA to pay Integra $6.4 million
in damages following the Circuit Court's order. Merck KGaA filed a petition for
a writ of certiorari with the United States Supreme Court (the "Supreme Court")
seeking review of the Circuit Court's decision, and the Supreme Court granted
the writ in January 2005. Oral arguments before the United States Supreme Court
were held in April 2005.
On June 13, 2005, the Supreme Court vacated the June 2003 judgment of the
Circuit Court. The Supreme Court held that the Circuit Court applied an
erroneous interpretation of 35 U.S.C. ss.271(e)(1) when it rejected the
challenge of Merck KGaA to the jury's finding that Merck KGaA failed to show
that its activities were exempt from claims of patent infringement under that
statute. On remand, the Circuit Court will review the evidence under a
reasonableness test that does not provide categorical exclusions of certain
types of activities.
Further enforcement of the Trial Court's order has been stayed pending the
decision of the Supreme Court.
The Company has not recorded any gain in connection with this matter, pending
final resolution and completion of the appeals process.
Three of the Company's French subsidiaries that were acquired from the
neurosciences division of NMT Medical, Inc. received a tax reassessment notice
from the French tax authorities seeking in excess of 1.7 million euros in back
taxes, interest and penalties. NMT Medical, the former owner of these entities,
has agreed to indemnify Integra against direct damages and liability arising
from misrepresentations in connection with these tax claims. In April 2005, NMT
Medical, Inc. negotiated a settlement agreement with the French authorities that
will satisfy the outstanding tax assessments. This settlement will not have any
impact on the Company's financial statements.
In addition to the these matters, the Company is subject to various claims,
lawsuits and proceedings in the ordinary course of its business, including
claims by current or former employees, distributors and competitors and with
respect to our products. In the opinion of management, such claims are either
adequately covered by insurance or otherwise indemnified, or are not expected,
individually or in the aggregate, to result in a material adverse effect on the
Company's financial condition. However, it is possible that our results of
operations, financial position and cash flows in a particular period could be
materially affected by these contingencies.
34
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In May 2005, our Board of Directors authorized us to repurchase shares of our
common stock for an aggregate purchase price not to exceed $40 million through
December 31, 2006. We may repurchase no more than 1.5 million shares under this
program. Shares may be purchased either in the open market or in privately
negotiated transactions. The following table summarizes our repurchases of our
common stock during the quarter ended June 30, 2005 under this program:
Total Number Approximate
of Shares Dollar Value of
Purchased as Shares that May
Total Number Average Part of Publicly Yet be Purchased
of Shares Price Paid Announced Under the
Period Purchased per Share Program Program
- ---------------- ------------ ----------- ---------------- --------------
April 1, 2005 -
April 30, 2005 -- -- -- $40,000,000
May 1, 2005 -
May 31, 2005 360,200 33.38 360,200 27,976,266
June 1, 2005 -
June 30, 2005 389,800 32.39 389,800 15,349,626
- ----------------- ------------ ---------- ---------------- --------------
Total 750,000 $ 32.87 750,000 $15,349,626
ITEM 4. SUBMISSION OF MATTTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on May 17, 2005 and in
connection therewith, management solicited proxies pursuant to Regulation 14A
under the Securities Exchange Act of 1934, as amended. An aggregate of
28,613,891 shares of the Company's common stock was outstanding and entitled to
a vote at the meeting. At the meeting the following matters (not including
ordinary procedural matters) were submitted to a vote of the holders of the
common stock, with the results indicated below:
1. Election of directors to serve until the 2005 Annual Meeting. The following
persons, all of whom were serving as directors and were management's nominees
for election, were elected. There was no solicitation in opposition to such
nominees. The tabulation of votes was as follows:
Nominee For Withheld
---------------------- ---------- ----------
David C. Auth 24,203,154 750,559
Keith Bradley 24,099,832 853,881
Richard E. Caruso 19,410,510 5,543,203
Stuart M. Essig 24,565,634 388,079
James M. Sullivan 24,560,769 392,944
Anne M. VanLent 24,667,570 286,143
On May 13, 2005, Mr. Neal Moszkowski, a director of the Company, notified the
Board of Directors that he would not stand for re-election as a director at the
annual meeting. As result, the Company's Board of Directors reduced the number
of members of the Board of Directors from seven to six prior to the meeting.
2. Approval of Amendment to the Company's 2003 Equity Incentive Plan. The
Amendment to the Company's 2003 Equity Incentive Plan was approved. The
tabulation of votes was as follows:
For Against Abstentions Broker Non-Votes
---------- --------- -------------- ------------------
13,514,375 8,774,787 21,310 2,643,241
3. Ratification of independent registered public accounting firm. The
appointment of PricewaterhouseCoopers LLP as the Company's independent
registered public accounting firm for the current fiscal year was ratified. The
tabulation of votes was as follows:
For Against Abstentions
---------- --------- --------------
24,808,668 138,387 6,658
35
ITEM 6. EXHIBITS
10.1 First Amendment to the Integra LifeSciences Holdings Corporation 2003
Equity Incentive Plan (Incorporated by reference to Exhibit 10.1 to
the Company's Current Report on Form 8-K filed on May 17, 2005)
10.2 Form of Restricted Stock Agreement for non-employee directors under
the Integra LifeSciences Holdings Corporation 2003 Equity Incentive
Plan (Incorporated by reference to Exhibit 10.2 to the Company's
Current Report on Form 8-K filed on May 17, 2005)
31.1 Certification of Principal Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Certification of Principal Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32.1 Certification of Principal Executive Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
32.2 Certification of Principal Financial Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
36
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
Date: August 9, 2005 /s/ Stuart M. Essig
-------------------
Stuart M. Essig
President and Chief Executive Officer
Date: August 9, 2005 /s/ David B. Holtz
-------------------
David B. Holtz
Senior Vice President, Finance
37
Exhibits
10.1 First Amendment to the Integra LifeSciences Holdings Corporation 2003
Equity Incentive Plan (Incorporated by reference to Exhibit 10.1 to
the Company's Current Report on Form 8-K filed on May 17, 2005)
10.2 Form of Restricted Stock Agreement for non-employee directors under
the Integra LifeSciences Holdings Corporation 2003 Equity Incentive
Plan (Incorporated by reference to Exhibit 10.2 to the Company's
Current Report on Form 8-K filed on May 17, 2005)
31.1 Certification of Principal Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Certification of Principal Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32.1 Certification of Principal Executive Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
32.2 Certification of Principal Financial Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
38
Certification of Principal Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Stuart M. Essig, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Integra
LifeSciences Holdings Corporation;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present
in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for,
the periods presented in this report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and we have:
(a) designed such disclosure controls and procedures, or
caused such disclosure controls and procedures to be
designed under our supervision, to ensure that
material information relating to the registrant,
including its consolidated subsidiaries, is made
known to us by others within those entities,
particularly during the period in which this report
is being prepared;
(b) designed such internal control over financial
reporting, or caused such internal control over
financial reporting to be designed under our
supervision, to provide reasonable assurance
regarding the reliability of financial reporting and
the preparation of financial statements for external
purposes in accordance with generally accepted
accounting principles;
(c) evaluated the effectiveness of the registrant's
disclosure controls and procedures and presented in
this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the
end of the period covered by this report based on
such evaluation; and
(d) disclosed in this report any change in the
registrant's internal control over financial
reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal
quarter in the case of an annual report) that has
materially affected, or is reasonably likely to
materially affect, the registrant's internal control
over financial reporting; and
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
(a) all significant deficiencies and material weaknesses
in the design or operation of internal control over
financial reporting which are reasonably likely to
adversely affect the registrant's ability to record,
process, summarize and report financial information;
and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal control over
financial reporting.
Date: August 9, 2005
/s/ Stuart M. Essig
--------------------
Stuart M. Essig
President and Chief Executive Officer
Certification of Principal Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, David B. Holtz, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Integra
LifeSciences Holdings Corporation;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present
in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for,
the periods presented in this report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and we have:
(a) designed such disclosure controls and procedures, or
caused such disclosure controls and procedures to be
designed under our supervision, to ensure that
material information relating to the registrant,
including its consolidated subsidiaries, is made
known to us by others within those entities,
particularly during the period in which this report
is being prepared;
(b) designed such internal control over financial
reporting, or caused such internal control over
financial reporting to be designed under our
supervision, to provide reasonable assurance
regarding the reliability of financial reporting and
the preparation of financial statements for external
purposes in accordance with generally accepted
accounting principles;
(c) evaluated the effectiveness of the registrant's
disclosure controls and procedures and presented in
this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the
end of the period covered by this report based on
such evaluation; and
(d) disclosed in this report any change in the
registrant's internal control over financial
reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal
quarter in the case of an annual report) that has
materially affected, or is reasonably likely to
materially affect, the registrant's internal control
over financial reporting; and
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
(a) all significant deficiencies and material weaknesses
in the design or operation of internal control over
financial reporting which are reasonably likely to
adversely affect the registrant's ability to record,
process, summarize and report financial information;
and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal control over
financial reporting.
Date: August 9, 2005
/s/ David B. Holtz
------------------
David B. Holtz
Senior Vice President, Finance
Certification of Chief Executive Officer
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
I, Stuart M. Essig, Chief Executive Officer and Director of Integra LifeSciences
Holdings Corporation (the "Company"), hereby certify that, to my knowledge:
1. The Quarterly Report on Form 10-Q of the Company for the quarter ended
June 30, 2005 (the "Report") fully complies with the requirement of
Section 13(a) or Section 15(d), as applicable, of the Securities
Exchange Act of 1934, as amended; and
2. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of
the Company.
Date: August 9, 2005 /s/ Stuart M. Essig
-------------------
Stuart M. Essig
President and Chief Executive Officer
Certification of Chief Financial Officer
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
I, David B. Holtz, Senior Vice President, Finance of Integra LifeSciences
Holdings Corporation (the "Company"), hereby certify that, to my knowledge:
1. The Quarterly Report on Form 10-Q of the Company for the quarter ended
June 30, 2005 (the "Report") fully complies with the requirement of
Section 13(a) or Section 15(d), as applicable, of the Securities
Exchange Act of 1934, as amended; and
2. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of
the Company.
Date: August 9, 2005 /s/ David B. Holtz
-------------------
David B. Holtz
Senior Vice President, Finance
