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 March 31, 2006
[ ] 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 a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of large
accelerated filer and accelerated filer in Rule 12b-2 of the Exchange Act).
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The number of shares of the registrant's Common Stock outstanding as of May 05,
2006 was 28,575,410.
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
INDEX
Page Number
-----------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Operations for the three
months ended March 31, 2006 and 2005 (Unaudited) 2
Condensed Consolidated Balance Sheets as of March 31, 2006
and December 31, 2005 (Unaudited) 3
Condensed Consolidated Statements of Cash Flows for the three months ended
March 31, 2006 and 2005 (Unaudited) 4
Notes to Unaudited Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
Item 4. Controls and Procedures 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 1A. Risk Factors 29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 30
Item 6. Exhibits 30
SIGNATURES 31
EXHIBITS 32
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
March 31,
----------------------
2006 2005
---- ----
TOTAL REVENUE ........................ $77,135 $65,839
COSTS AND EXPENSES
Cost of product revenues ............. 27,937 24,496
Research and development ............. 3,173 3,359
Selling, general and administrative .. 31,120 23,916
Intangible asset amortization ........ 1,281 1,112
------- -------
Total costs and expenses .......... 63,511 52,883
Operating income ..................... 13,624 12,956
Interest income ...................... 1,024 954
Interest expense ..................... (1,682) (927)
Other income (expense), net .......... 32 (93)
------- -------
Income before income taxes ........... 12,998 12,890
Income tax expense ................... 4,293 4,447
------- -------
Net income ........................... $ 8,705 $8,443
======= =======
Basic net income per share ........... $ 0.29 $ 0.28
Diluted net income per share ......... $ 0.28 $ 0.26
Weighted average common shares outstanding:
Basic .......................... 29,585 30,561
Diluted ........................ 33,828 35,144
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)
March 31, December 31,
2006 2005
------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents ............................... $ 22,393 $ 46,889
Short-term investments .................................. 63,787 80,327
Accounts receivable, net of allowances of
$3,743 and $3,508 ..................................... 56,607 49,007
Inventories, net ........................................ 77,153 67,476
Deferred tax assets ..................................... 11,728 10,842
Prepaid expenses and other current assets ............... 11,158 11,411
--------- ---------
Total current assets ................................ 242,826 265,952
Non-current investments ................................... 11,683 16,168
Property, plant, and equipment, net ....................... 29,079 27,451
Identifiable intangible assets, net ....................... 108,069 64,569
Goodwill................................................... 94,075 68,364
Other non-current assets .................................. 5,899 5,928
--------- ---------
Total assets .............................................. $ 491,631 $ 448,432
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Borrowings under senior credit facility ................. 16,000 --
Accounts payable, trade ................................. 10,054 8,978
Income taxes payable .................................... 476 715
Deferred revenue ........................................ 5,792 88
Accrued expenses and other current liabilities .......... 21,446 21,506
--------- ---------
Total current liabilities ........................... 53,768 31,287
Long-term debt ............................................ 118,169 118,378
Deferred tax liabilities .................................. 3,946 2,520
Other non-current liabilities ............................. 6,700 6,429
--------- ---------
Total liabilities ......................................... 182,583 158,614
Commitments and contingencies
Stockholders' Equity:
Common stock; $0.01 par value; 60,000 authorized shares;
30,903 and 29,823 issued at March 31, 2006 and
December 31, 2005, respectively ....................... 310 298
Additional paid-in capital .............................. 341,829 333,179
Treasury stock, at cost; 2,368 shares at
March 31, 2006 and December 31, 2005................... (75,815) (75,815)
Accumulated other comprehensive income (loss):
Unrealized loss on available-for-sale securities ..... (576) (801)
Foreign currency translation adjustment .............. (642) (2,300)
Minimum pension liability adjustment ................. (1,692) (1,672)
Retained earnings ....................................... 45,634 36,929
--------- ---------
Total stockholders' equity ............................ 309,048 289,818
--------- ---------
Total liabilities and stockholders' equity ............... $ 491,631 $ 448,432
========= =========
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)
Three Months Ended March 31,
2006 2005
---- ----
OPERATING ACTIVITIES:
Net income ...................................................... $ 8,705 $8,443
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ................................... 3,191 2,722
Deferred income tax provision ................................... 622 3,106
Amortization of discount and premium on investments ............. 232 541
Amortization of bond issuance cost .............................. 273 203
Derivative loss (gain) .......................................... 192 (54)
Stock based compensation expense ................................ 3,035 --
Excess tax benefits from stock based compensation arrangements .. (27) --
Other, net ...................................................... 110 25
Changes in assets and liabilities, net of business acquisitions:
Accounts receivable .......................................... (7,490) (746)
Inventories .................................................. (1,031) (6,011)
Prepaid expenses and other current assets .................... (1,052) 686
Other non-current assets ..................................... (177) 221
Accounts payable, accrued expenses and other liabilities...... 224 4,124
Deferred revenue ............................................. 4,064 (27)
-------- --------
Net cash provided by operating activities ....................... 10,871 13,233
-------- --------
INVESTING ACTIVITIES:
Cash used in business acquisition, net of cash acquired ......... (75,840) (49,348)
Purchases of property and equipment ............................. (1,689) (2,781)
Sales/maturities of available-for-sale investments .............. 27,622 4,150
Purchases of available-for-sale investments ..................... (6,575) (4,350)
-------- --------
Net cash used in investing activities ........................... (56,482) (52,329)
-------- --------
FINANCING ACTIVITIES:
Proceeds from exercised stock options ........................... 5,024 2,285
Borrowings under senior credit facility ......................... 16,000 --
Excess tax benefits from stock based compensation arrangements .. 27 --
Repayment of loans .............................................. (37) (5)
-------- --------
Net cash provided by financing activities ....................... 21,014 2,280
-------- --------
Effect of exchange rate changes on cash ......................... 101 (276)
Net decrease in cash and cash equivalents ....................... (24,496) (37,092)
Cash and cash equivalents at beginning of period ................ 46,889 69,855
-------- --------
Cash and cash equivalents at end of period ...................... $ 22,393 $ 32,763
======== ========
Supplemental cash flow information:
- -----------------------------------
At March 31, 2006 and 2005, the Company had $3.5 million and $3.3 million,
respectively, of cash pledged as collateral in connection with its interest rate
swap agreement.
At March 31, 2006, the Company had $2.1 million of accrued capitalized expenses
associated with the Radionics acquisition.
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 March 31, 2006 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, 2005 included in the
Company's Annual Report on Form 10-K. The December 31, 2005 condensed
consolidated balance sheet was derived from audited financial statements but
does not include all disclosures required by accounting principles generally
accepted in the United States. Operating results for the three-month period
ended March 31, 2006 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 and allowances,
net realizable value of inventories, estimates of future cash flows associated
with long-lived asset valuations, depreciation and amortization periods for
long-lived assets, fair value estimates of stock based compensation awards,
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.
We revised our presentation of cost of product revenues in 2006 to include
amortization of product technology-based intangible assets. Previously, this
amortization was included in intangible asset amortization in the condensed
consolidated statement of operations. We have revised prior period amounts to
conform to the current year's presentation. This revision increased cost of
product revenues by $364,000 for the three month period ended March 31, 2005.
New Accounting Policy
Stock Based Compensation
The Company adopted Statement of Financial Accounting Standards No. 123(R)
"Share-Based Payment" on January 1, 2006 using the modified prospective method
which requires companies (1) to record the unvested portion of previously issued
awards that remain outstanding at the initial date of adoption and (2) to record
compensation expense for any awards issued, modified or settled after the
effective date of the statement. As a result of the adoption of Statement
123(R), the Company began expensing stock options in the 2006 first quarter
using the fair value method prescribed by Statement 123(R). Stock based
compensation cost is measured at the grant date based on the fair value of an
award and is recognized on a straight-line basis as an expense over the
requisite service period, which is the vesting period. Certain of these costs
are capitalized into inventory and will be recognized as an expense when the
related inventory is sold. The Company's income before income taxes and net
income for the three months ended March 31, 2006 were $3.0 million and $2.1
million lower, respectively, than if it had continued to account for share-based
compensation under APB No. 25.
The Company recognizes stock based compensation expense in the consolidated
statement of operations based on the awards that are expected to vest.
Accordingly, the Company's recognized stock based compensation expense is net of
the impact of estimated forfeitures. Statement 123(R) requires forfeitures to be
estimated at the time of grant and revised, if necessary, in subsequent periods
if actual forfeitures differ from those estimates. The Company estimates
forfeitures based on historical experience.
5
Statement 123(R) supercedes the Company's previous accounting under Accounting
Principals Boards Opinion No. 25 "Accounting for Stock Issued to Employees" for
periods subsequent to December 31, 2005. In March 2005, the Securities and
Exchange Commission issued Staff Accounting Bulletin No. 107, which provides
interpretive guidance in applying the provisions of Statement 123(R). The
Company has applied the provisions of SAB 107 in its adoption of Statement
123(R). Had compensation cost for the Company's stock option plans been
determined based on the fair value of the award at the grant date consistent
with Statement 123(R), the Company's net income and basic and diluted net income
per share for the three months ended March 31, 2005 would have been as follows
(in thousands, except per share amounts):
Net income, as reported ............................... $8,443
Add back: Total stock based employee compensation
expense determined under the intrinsic
value-based method for all awards, net
of related tax effects ..................... --
Less: Total stock based employee compensation
expense determined under the fair
value-based method for all awards, net
of related tax effects ..................... (1,729)
--------
Pro forma ......................................... $ 6,714
Net income per share:
Basic:
As reported ....................................... $ 0.28
Pro forma ......................................... $ 0.22
Diluted:
As reported ....................................... $ 0.26
Pro forma ......................................... $ 0.21
Statement 123(R) did not change the accounting for stock based awards granted to
non-employees.
Recently Issued Accounting Standards and Other Matters
In November 2005, the Financial Accounting Standards Board (FASB) issued FSP FAS
115-1, which nullifies the guidance in paragraphs 10-18 of Emerging Issues Task
Force Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments" and references existing other than temporary
impairment guidance. FSP FAS 115-1 clarifies that an investor should recognize
an impairment loss no later than when the impairment is deemed
other-than-temporary, even if a decision to sell the security has not been made,
and also provides guidance on the subsequent accounting for an impaired debt
security. The Company adopted FSP FAS 115-1 on January 1, 2006. The adoption of
FSP FAS 115-1 did not a material impact on the Company's financial statements.
In May 2005, the 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. The Company adopted Statement 154 on January 1,
2006. The adoption of Statement 154 did not have a material impact on the
Company's financial statements.
In November 2004, the FASB issued Statement No. 151, "Inventory Costs-an
amendment of ARB No. 43, Chapter 4" (Statement 151), which the Company adopted
on 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. The adoption of Statement 151 did not have a material impact on our
financial statements.
The American Jobs Creation Act of 2004 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 new
deduction related to qualified production activities income. The FASB determined
that the qualified production activities income 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.
6
2. BUSINESS ACQUISITIONS
On March 3, 2006, Integra acquired the assets of the Radionics Division of Tyco
Healthcare Group, L.P. for approximately $74.5 million in cash paid at closing,
subject to certain adjustments, and $2.1 million of acquisition related expenses
in a transaction treated as a business combination. Radionics, based in
Burlington, Massachusetts, is a leader in the design, manufacture and sale of
advanced minimally invasive medical instruments in the fields of neurosurgery
and radiation therapy. Radionics' products include the CUSA EXcel(R) ultrasonic
surgical aspiration system, the CRW(R) stereotactic system, the XKnife(R)
stereotactic radiosurgery system, and the OmniSight(R) EXcel image guided
surgery system.
The following summarizes the preliminary allocation of the purchase price based
on the fair value of the assets acquired and liabilities assumed:
(All amounts in thousands)
Inventory ............................ $ 8,225
Property, plant and equipment ........ 1,365 Wtd. Avg. Life
Intangible assets: --------------
Tradename ......................... 16,100 Indefinite
Customer relationships ............ 19,900 7 years
Technology ........................ 9,000 10 years
Goodwill ............................. 24,009
Other assets ......................... 162
-------
Total assets acquired ............. 78,761
Accrued expenses and other current
liabilities ....................... 554
Deferred revenue ..................... 1,605
-------
Total liabilities assumed ......... 2,159
-------
Net assets acquired .................. $76,602
The fair value of assets acquired was determined by management with the
assistance of a third-party valuation firm. The goodwill recorded in connection
with this acquisition is based on the benefits the Company expects to generate
from the synergy between Radionics' ultrasonic aspirator product line and
Integra's ultrasonic aspirator product lines. The goodwill acquired in the
Radionics acquisition is expected to be deductible for tax purposes. Certain
elements of the purchase price allocation are considered preliminary,
particularly as it relates to the final valuation of certain identifiable
intangible assets.
In January 2005, the Company acquired all of the outstanding capital stock of
Newdeal Technologies SAS ("Newdeal Technologies") for $51.9 million in cash paid
at closing, a $0.7 million working capital adjustment paid in January 2006, and
$0.8 million of acquisition related expenses. Additionally, the Company agreed
to pay the sellers up to an additional 1.3 million euros if the sellers continue
their employment with the Company through January 3, 2006. This additional
payment was accrued to selling, general and administrative expense on a
straight-line basis in 2005 over the one-year employment requirement period and
was paid in January 2006.
7
The following unaudited pro forma financial information summarizes the results
of operations for the three months ended March 31, 2006 and 2005 as if the
acquisitions consummated in 2006 and 2005 had been completed as of the beginning
of these periods. 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 the Company's effective 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
acquisitions had taken place on the basis assumed above, nor are they indicative
of the results of future combined operations.
For the Three
Months Ended
March 31,
2006 2005
------ ------
(in thousands)
Total revenue ............................. $87,683 $82,701
Net income ................................ 9,629 11,274
Net income per share:
Basic .................................. $ 0.32 $ 0.37
Diluted................................. $ 0.31 $ 0.34
3. INVENTORIES
Inventories, net consisted of the following:
March 31, December 31,
2006 2005
---- ----
(in thousands)
Raw materials.............................. $15,400 $13,175
Work-in process............................ 11,048 9,801
Finished goods............................. 50,705 44,500
------- -------
$77,153 $67,476
======= =======
The Company capitalizes inventory costs associated with certain products prior
to regulatory approval, based on management's judgment of probable future
commercialization. The Company could be required to expense previously
capitalized costs related to pre-approval inventory upon a change in such
judgment, due to, among other potential factors, a denial or delay of
approval by necessary regulatory bodies or a decision by management to
discontinue the related development program. At March 31, 2006 and December
31, 2005, respectively, we capitalized approximately $0.9 million of pre-
approval inventory.
4. GOODWILL AND OTHER INTANGIBLE ASSETS
Changes in the carrying amount of goodwill for the three months ended March 31,
2006, were as follows:
(in thousands)
Balance at December 31, 2005 ..................................... $ 68,364
Radionics acquisition ............................................ 24,009
Newdeal working capital adjustment ............................... 694
Foreign currency translation ..................................... 1,008
--------
Balance at March 31, 2006 ........................................ $ 94,075
========
8
The components of the Company's identifiable intangible assets were as follows:
March 31, 2006 December 31, 2005
Weighted ---------------------- ----------------------
Average Accumulated Accumulated
Life Cost Amortization Cost Amortization
-------- -------- ------------ -------- ------------
(in thousands)
Completed technology ....... 12 years $ 28,070 $ (6,165) $ 18,921 $ (5,691)
Customer relationships ..... 13 years 42,571 (5,521) 22,550 (4,823)
Trademarks/brand names ..... Indefinite 16,100 -- -- --
Trademarks/brand names ..... 36 years 31,234 (3,080) 31,175 (2,802)
Noncompetition agreements... 5 years 6,963 (2,974) 6,943 (2,607)
All other .................. 15 years 1,620 (749) 2,233 (1,330)
-------- ------------ -------- ------------
$126,558 $(18,489) $ 81,822 $(17,253)
Accumulated amortization .. (18,489) (17,253)
-------- --------
$108,069 $ 64,569
======== ========
Annual amortization expense is expected to approximate $8.8 million in 2006,
$9.1 million in 2007, $8.8 million in 2008, $8.1 million in 2009, and $7.4
million in 2010. 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
In June 2005, management announced plans to restructure the Company's European
operations. The restructuring plan included 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, both of which were
substantially completed in December 2005. The Company transitioned the
manufacturing operations of Integra ME to its production facility in Andover,
UK. The Company also eliminated some duplicative sales and marketing positions,
primarily in Europe. Approximately 69 individuals were identified for
termination under the European restructuring plan. As of March 31, 2006, the
Company had terminated 67 of these individuals.
During the three months ended March 31, 2006, the Company terminated four
employees in connection with the transfer of certain manufacturing packaging
operations from its plant in Plainsboro, New Jersey to its plant in Anasco,
Puerto Rico. The Company expects to terminate approximately ten additional
employees in 2006 in connection with this transfer.
In connection with these restructuring activities, the Company has recorded the
following charges during the quarter ended March 31, 2006:
Research Selling
Cost of and General and
Sales Development Administrative Total
------- ------- ------- -------
(in thousands)
Involuntary employee termination costs ... $ 101 $ 23 $ -- $ 124
Below is a reconciliation of the restructuring accrual activity recorded during
2006:
Employee Facility
Termination Exit
Costs Costs Total
------- ------- -------
(in thousands)
Balance at December 31, 2005 ........................ $ 2,420 $ 124 $ 2,544
Additions ........................................... 124 -- 124
Change in estimate................................... (17) -- (17)
Payments ............................................ (1,661) (19) (1,680)
Effects of foreign exchange ......................... 41 2 43
------- ------- -------
Balance at March 31, 2006 ........................... $ 907 $ 107 $ 1,014
The Company expects to pay all of the remaining costs by the end of the second
quarter of 2006.
9
6. STOCK BASED COMPENSATION
As of March 31, 2006, the Company had stock options, restricted stock awards,
and restricted stock unit awards outstanding under seven plans, the 1993
Incentive Stock Option and Non-Qualified Stock Option Plan (the 1993 Plan), the
1996 Incentive Stock Option and Non-Qualified Stock Option Plan (the 1996 Plan),
the 1998 Stock Option Plan (the 1998 Plan), the 1999 Stock Option Plan (the 1999
Plan), the 2000 Equity Incentive Plan (the 2000 Plan), the 2001 Equity Incentive
Plan (the 2001 Plan), and the 2003 Equity Incentive Plan (the 2003 Plan, and
collectively, the Plans). No new options may be granted under the 1993 Plan or
the 1996 Plan.
Stock options issued under the Plans become exercisable over specified periods,
generally within four years from the date of grant for officers, employees and
consultants, and generally expire six years from the grant date. The transfer
and non-forfeiture provisions of restricted stock issued under the Plans lapse
over specified periods, generally at three years after the date of grant.
Prior to the adoption of Statement 123(R), the Company presented all tax
benefits resulting from the exercise of stock options as operating cash flows
(reflected in accrued taxes). Statement 123(R) requires the cash flows resulting
from excess tax benefits (tax deductions realized in excess of the compensation
costs recognized for the options exercised) from the date of adoption of
Statement 123(R) to be classified as financing cash flows. Therefore, as of
January 1, 2006, excess tax benefits for the three months ended March 31, 2006,
have been classified as financing cash flows.
At March 31, 2006, there were 6,852,870 shares authorized for issuance under the
Plans, with 1,614,155 shares available for grant under the Plans.
Employee stock based compensation expense recognized under FAS 123(R) was as
follows (in thousands, except for per share data):
Three Months Ended
March 31, 2006
------------------
Research and development expense .................. $ 145
Selling, general and administrative ............... 2,890
Amortization of amounts previously capitalized
to inventory ................................... --
------
Total employee stock based compensation expense ... 3,035
Tax benefit related to employee stock based
compensation expense ........................... (951)
------
Net effect on net income .......................... $2,084
Effect on earnings per share:
Basic ........................................ $ 0.07
Diluted ...................................... $ 0.06
For the three months ended March 31, 2006, the Company also capitalized $105,000
of stock based compensation costs in inventory based on the underlying employees
receiving the awards.
Stock Options
The following is a summary of stock option activity for the three month period
ended March 31, 2006 (shares in thousands):
Wtd. Avg.
Wtd. Remaining
Avg. Contractual Aggregate
Stock Ex. Term Intrinsic
Options Price Years Value
--------- ------- ------- -------
Outstanding, December 31, 2005 ........ 4,001 $ 27.50
Granted ............................... 46 35.31
Exercised ............................. (251) 20.80
Cancelled ............................. (23) 32.10
--------- -------
Outstanding, March 31, 2006 ........... 3,773 $ 28.01 4.6 $48.9 million
Options exercisable at March 31, 2006.. 1,989 $ 23.98 3.6 $33.8 million
10
The intrinsic value of options exercised during the three month periods ended
March 31, 2006 and 2005 was $4.5 million and $3.3 million, respectively. The
weighted-average per share fair value of stock options granted during the three
months ended March 31, 2006 and 2005 was $15.04 and $15.43, respectively.
As of March 31, 2006, there was approximately $23.5 million of total
unrecognized compensation costs related to unvested stock options. These costs
are expected to be recognized over a weighted-average period of approximately
2.8 years.
The fair value of options granted prior to October 1, 2004 was calculated using
the Black-Scholes model, while the fair value of options granted on or after
October 1, 2004 was calculated using the binomial distribution model. Expected
volatilities are based on historical volatility of the Company's stock price
with forward looking assumptions. The expected life of stock options is
estimated based on historical data on exercises of stock options, post vesting
forfeitures and other factors to estimate the expected term of the stock options
granted. The risk-free interest rates are derived from the U.S. Treasury yield
curve in effect on the date of grant for instruments with a remaining term
similar to the expected life of the options. In addition, the Company applies an
expected forfeiture rate when amortizing stock-based compensation expenses. The
estimate of the forfeiture rate is based primarily upon historical experience of
employee turnover. As individual grant awards become fully vested, stock-based
compensation expense is adjusted to recognize actual forfeitures. The Company
used the following weighted-average assumptions to calculate the fair value for
stock options granted during the following periods:
Three Months Ended
March 31, March 31,
2006 2005
--------- ---------
Dividend yield .................................. 0% 0%
Expected volatility ............................. 43% 43%
Risk free interest rate ......................... 4.3% 3.5%
Expected life of option from grant date ......... 5.4 years 5.1 years
The Company received $5.0 million and $2.3 million from stock option exercises
for the three months ended March 31, 2006 and 2005, respectively.
Restricted Stock Awards and Restricted Stock Unit Awards
The following is a summary of restricted stock awards and restricted stock unit
awards activity for the three month period ended March 31, 2006 (shares in
thousands):
Restricted Stock Restricted Stock
Awards Unit Awards
---------------------- ----------------------
Wtd. Avg. Wtd. Avg.
Fair Value Fair Value
Shares Per Share Shares Per Share
-------- ------------ -------- ------------
Unvested, December 31, 2005 ........ 19 $ 35.08 -- --
Grants ............................. 58 36.16 216 $ 35.40
Vested ............................. -- -- -- --
Cancellations ...................... -- -- -- --
-------- ------------ -------- ------------
Unvested, March 31, 2006 ........... 77 $ 35.89 216 $ 35.40
Certain restricted stock unit awards have performance features associated with
them. Subsequent to meeting applicable performance criteria, restricted stock
unit awards generally have requisite service periods of three years. The fair
value of restricted stock and restricted stock unit awards is being expensed on
a straight-line basis over the vesting period. As of March 31, 2006, there was
approximately $9.5 million of total unrecognized compensation costs related to
unvested restricted stock and restricted stock unit awards. These costs are
expected to be recognized over a weighted-average period of approximately 2.9
years. The Company did not grant any restricted stock awards or restricted stock
unit awards during the three months ended March 31, 2005.
The Company has no formal policy related to the repurchase of shares for the
purpose of satisfying stock based compensation obligations. However, the Company
has a practice of repurchasing shares, from time to time, in the open market to
satisfy such obligations.
11
The Company also maintains an Employee Stock Purchase Plan (the ESPP), which
provides eligible employees of the Company with the opportunity to acquire
shares of common stock at periodic intervals by means of accumulated payroll
deductions. The ESPP was amended in 2005 to eliminate the look-back option and
to reduce the discount available to participants to five percent. Accordingly,
the ESPP is a non-compensatory plan under Statement 123(R).
7. RETIREMENT BENEFIT PLANS
The Company maintains defined benefit pension plans that cover employees in its
manufacturing plant located in Andover, United Kingdom and its former
manufacturing plant in Tuttlingen, Germany. Net periodic benefit costs for the
Company's defined benefit pension plans included the following amounts:
Three Months Ended
March 31
2006 2005
------ ------
(in thousands)
Service cost .......................... $ 46 $ 61
Interest cost ......................... 125 103
Expected return on plan assets ........ (109) (86)
Recognized net actuarial loss ......... 48 35
------ ------
Net periodic benefit cost .......... $ 110 $ 113
The Company made $60,000 and $41,000 of contributions to its defined benefit
pension plans for the three months ended March 31, 2006 and 2005, respectively.
8. COMPREHENSIVE INCOME
Comprehensive income was as follows:
Three Months Ended
March 31,
---------------------
2006 2005
-------- --------
(in thousands)
Net income ........................................ $ 8,705 $ 8,443
Foreign currency translation adjustment ........... 1,637 (4,256)
Minimum pension liability adjustment, net of tax .. -- --
Realized losses on available-for-sale
investments, net of tax ...................... 60 --
Unrealized holding gains (losses) on
available-for-sale securities, net of tax .... 166 (455)
-------- --------
Comprehensive income .............................. $10,568 $ 3,732
======== ========
A significant portion of the foreign currency translation adjustment recorded
for the three months ended March 31, 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.
12
9. NET INCOME PER SHARE
Basic and diluted net income per share was as follows:
Three Months Ended
March 31,
--------------------
2006 2005
-------- --------
(In thousands, except
per share amounts)
Basic net income per share:
- ----------------------------
Net income ........................................ $ 8,705 $ 8,443
Weighted average common shares outstanding ........ 29,585 30,561
Basic net income per share ........................ $ 0.29 $ 0.28
Diluted net income per share:
- -----------------------------
Net income ........................................ $ 8,705 $ 8,443
Add back: Interest expense and other
income/(expense) related to convertible
notes payable, net of tax ............... 813 544
-------- --------
Net income available to common stock .............. $ 9,518 $ 8,987
Weighted average common shares outstanding - Basic 29,585 30,561
Effect of dilutive securities:
Stock options and restricted stock ............. 729 1,069
Shares issuable upon conversion of notes payable 3,514 3,514
-------- --------
Weighted average common shares for diluted
earnings per share ............................. 33,828 35,144
Diluted net income per share ...................... $ 0.28 $ 0.26
Options outstanding at March 31, 2006 and 2005 to purchase approximately 1.9
million shares and 42,000 shares of common stock, respectively, were excluded
from the computation of diluted net income per share for the three months ended
March 31, 2006 and 2005 because their effects would be anti-dilutive.
10. 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 neurosurgery, reconstructive surgery and general surgery.
In the first quarter ended March 31, 2006, the Company revised the manner in
which it presents its revenues. The Company now presents its revenues in two
categories: Neurosurgical/Orthopedic Implants and Medical/Surgical Equipment.
This change better aligns our product categories by functional product
characteristic and intended use. Our revenues were as follows:
Three Months
Ended March 31,
2006 2005
------ ------
($ in thousands)
Revenue:
Neuro/Ortho Implants ...... $36,746 $31,384
MedSurg Equipment ......... 40,389 34,455
------ ------
Total Revenue ............. $77,135 $65,839
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
13
pharmaceuticals and medical devices, are increasingly subject to scrutiny from
the press and regulatory authorities. These products comprised 30% of total
revenues in each of the three-month periods ended March 31, 2006 and 2005.
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 Mar 31, 2006 .... $ 57,238 $ 14,375 $ 2,796 $ 2,726 $ 77,135
Three months ended Mar 31, 2005 .... 47,367 12,762 3,048 2,662 65,839
11. COMMITMENTS AND CONTINGENCIES
As consideration for certain technology, manufacturing, distribution and selling
rights and licenses granted to the Company, the Company has agreed to pay
royalties on the sales of products that are commercialized relative to the
granted rights and licenses. Royalty payments under these agreements by the
Company were not significant for any of the periods presented.
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.
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
14
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. The hearing before the Circuit Court is scheduled for June
2006.
Further enforcement of the Trail Court's order has been stayed. The Company has
not recorded any gain in connection with this matter, pending final resolution
and completion of the appeals process.
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 the Company's results of
operations, financial position and cash flows in a particular period could be
materially affected by these contingencies.
12. SUBSEQUENT EVENT
In April, 2006, the Company signed a definitive agreement to acquire the shares
of Miltex Holdings, Inc. ("Miltex") for approximately $101 million in cash,
subject to certain adjustments. Miltex, based in York, Pennsylvania, is a
leading provider of surgical and dental hand instruments to alternate site
facilities, which includes physician and dental offices and ambulatory surgery
care sectors. Its distribution network and service management team is recognized
for providing the industry's highest levels of customer service. Miltex
generated revenues of $62 million for the year ending December 31, 2005.
Miltex sells the Miltex(R), Meisterhand, Vantage, Moyco, Union Broach, and
Thompson products in over 65 countries, using a network of independent
distributors. Integra will acquire Miltex's manufacturing and distribution
facility in York, Pennsylvania, which employs approximately 200 employees.
Miltex also operates a leased facility in Tuttlingen, Germany, where Miltex's
staff coordinates design, production and delivery of instruments. After closing,
Miltex will continue to manufacture and ship its products from York,
Pennsylvania.
Completion of the transaction is subject to customary closing conditions,
regulatory approvals and expiration of the requisite waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act, as amended.
15
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,
2005 included in our Annual Report on Form 10-K.
We have made statements in this report 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. 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 above under the heading "Risk Factors".
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.
Regulation G, "Conditions for Use of Non-GAAP Financial Measures," and other
provisions of the Securities Exchange Act of 1934, as amended, define and
prescribe the conditions for the use of certain non-GAAP financial information.
In Management's Discussion and Analysis of Financial Condition and Results of
Operations, we provide information regarding growth in product revenues
excluding recently acquired product lines and changes in foreign currency
exchange rates, which is a non-GAAP financial measure. A reconciliation of this
non-GAAP financial measure to the most comparable GAAP measure is provided in
this quarterly report on Form 10-Q.
This non-GAAP financial measure should not be relied upon to the exclusion of
GAAP financial measures. Management believes that this non-GAAP financial
measure constitutes important supplemental information to investors which
reflects an additional way of viewing aspects of our operations that, when
viewed with our GAAP results and the accompanying reconciliations, provides a
more complete understanding of factors and trends affecting our ongoing business
and operations. Management strongly encourages investors to review our financial
statements and publicly filed reports in their entirely and to not rely on any
single financial measure. Because non-GAAP financial measures are not
standardized, it may not be possible to compare these financial measures with
other companies' non-GAAP financial measures having the same or similar names.
GENERAL
Integra is a market-leading, innovative medical device company focused on
helping the medical professional enhance the standard of care for patients.
Integra provides customers with clinically relevant, innovative and
cost-effective products that improve the quality of life for patients. We focus
on cranial and spinal procedures, peripheral nerve repair, small bone and joint
injuries, and the repair and reconstruction of soft tissue.
Our distribution channels include two direct sales organizations (Integra
NeuroSciences and Integra Reconstructive Surgery), one network of manufacturer's
representatives managed by a direct sales organization (JARIT Surgical
Instruments) and strategic alliances with market leaders such as Johnson &
Johnson, Medtronic, Inc., Wyeth and Zimmer Holdings, Inc. We have direct sales
forces in the United States, Germany, the United Kingdom, the Benelux (Belgium,
Netherlands, Luxembourg) region and France. Elsewhere throughout the world, our
products are distributed through a number of independent distributors. 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.
In the first quarter ended March 31, 2006, we revised the manner in which we
present our revenues. This change better aligns our product categories by
functional product characteristic and intended use. We now present revenues in
two categories: Neurosurgical/Orthopedic Implants and Medical/Surgical
Equipment. Our Neuro/Ortho Implants product group includes dural grafts that are
indicated for the repair of the dura mater, dermal regeneration and engineered
wound dressings, implants used in small bone and joint fixation, repair of
peripheral nerves, and hydrocephalus management, and implants used in bone
regeneration and in guided tissue regeneration in periodontal surgery. Our
MedSurg Equipment product group includes ultrasonic surgery systems for tissue
ablation, cranial stabilization and brain retraction systems, instrumentation
used in general, neurosurgical, spinal and plastic and reconstructive surgery,
16
systems for the measurement of various brain parameters, and devices used to
gain access to the cranial cavity and to drain excess cerebrospinal fluid from
the ventricles of the brain.
We manufacture many of our products 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 manufacture these products primarily in our facility in Plainsboro,
New Jersey. 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 30% of total revenues in each of the three-month periods ended March
31, 2006 and 2005. 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.
We manage these 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 continue 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 are indicative of
long-term profitable growth. These measurements include revenue growth, derived
through acquisitions and products developed internally, gross margins on total
revenues, which we aim to increase to more than 65% over a period of several
years, operating margins, which we aim to continually expand on as we leverage
our existing infrastructure, and earnings per fully diluted share of common
stock.
ACQUISITIONS
Our strategy for growing our business includes the acquisition of complementary
product lines and companies. Our recent acquisitions of businesses, assets and
product lines may make our financial results for the three months ended March
31, 2006 not directly comparable to those of the corresponding prior year
period. Since the beginning of 2005, we have acquired the following businesses:
On March 3, 2006, Integra acquired certain assets of the Radionics Division of
Tyco Healthcare Group, L.P. for approximately $74.5 million in cash paid at
closing, subject to certain adjustments, and $2.1 million of acquisition related
expenses in a transaction treated as a business combination. Radionics, based in
Burlington, Massachusetts, is a leader in the design, manufacture and sale of
advanced minimally invasive medical instruments in the fields of neurosurgery
and radiation therapy. Radionics' products include the CUSA EXcel(R) ultrasonic
surgical aspiration system, the CRW(R) stereotactic system, the XKnife(R)
stereotactic radiosurgery system, and the OmniSight(R) EXcel image guided
surgery system.
Tyco Healthcare sold Radionics products in over 75 countries, using a network of
independent distributors in the United States and both independent distributors
and Tyco Healthcare affiliates internationally. We are using distributors in
many of the markets in which Tyco Healthcare sold direct. As a result, we expect
that revenue and pre-tax income attributable to the acquired product lines will
be reduced from the 2005 levels recognized by Tyco. In addition, because the
CUSA Excel ultrasonic aspiration system competes with our existing line of
ultrasonic surgery systems, our sales force may, in some situations, sell the
CUSA system in lieu of our existing ultrasonic aspirator products. Overall, the
acquired business has been growing at rates below our corporate growth rate
targets.
In January 2005, we acquired all of the outstanding capital stock of Newdeal
Technologies SAS ("Newdeal Technologies") for $51.9 million in cash paid at
closing, a $0.7 million working capital adjustment paid in January 2006, and
17
$0.8 million of acquisition related expenses. Additionally, we agreed to pay the
sellers up to an additional 1.3 million euros if the sellers continue their
employment with us through January 3, 2006. This additional payment was accrued
to selling, general and administrative expense on a straight-line basis in 2005
over the one-year employment requirement period and was paid in January 2006.
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. Newdeal's target physicians include orthopedic surgeons
specializing in injuries of the foot, ankle and extremities, as well as
podiatric surgeons.
RESULTS OF OPERATIONS
In June 2005, we announced plans to restructure our European operations. The
restructuring plan included closing our Integra ME production facility in
Tuttlingen, Germany and reducing various positions in our production facility
located in Biot, France, both of which were substantially completed in December
2005. We transitioned the manufacturing operations of Integra ME to our
production facility in Andover, UK. We also eliminated some duplicative sales
and marketing positions, primarily in Europe. Approximately 69 individuals were
identified for termination under the European restructuring plan. As of March
31, 2006, we terminated 67 of these individuals.
In 2005, we also completed the transfer of the Spinal Specialties assembly
operations from our San Antonio, Texas plant to our San Diego, California plant
and we continue to transfer certain assembly, processing and packaging
operations to our San Diego and Puerto Rico facilities. During the three months
ended March 31, 2006, the Company terminated four employees in connection with
the transfer of certain manufacturing packaging operations from its plant in
Plainsboro, New Jersey to its plant in Anasco, Puerto Rico. The Company expects
to terminate approximately ten additional employees in 2006 in connection with
this transfer.
In connection with these restructuring activities, we recorded employee
termination costs of $124,000 during the quarter ended March 31, 2006.
While we expect a positive impact of the restructuring and integration
activities, such results remain uncertain. We expect to reinvest most of the
savings from these restructuring and integration activities in further expanding
our European sales, marketing and distribution organization, and adding the
Radionics business to our existing sales and distribution network.
Net income for the three months ended March 31, 2006 was $8.7 million, or $0.28
per diluted share, as compared to a net income of $8.4 million, or $0.26 per
diluted share, for the three months ended March 31, 2005.
These amounts include the following charges:
Three Months Ended
March 31,
(in thousands) 2006 2005
------ ------
Employee termination and related costs ........... $ 213 $ --
Inventory fair market value purchase accounting
adjustments .................................. 464 269
Facility consolidation, acquisition integration,
manufacturing transfer, enterprise business
system integration, and related costs ...... 518 517
------ ------
Total $ 1,195 $ 786
Of these amounts, $1.1 million and $269,000 was charged to cost of product
revenues in the three month periods ended March 31, 2006 and 2005, respectively.
The remaining amounts were primarily charged to selling, general and
administrative expenses.
We believe that, given our ongoing, active strategy of seeking new acquisitions
and integrating recent acquisitions, our current focus on rationalizing our
existing manufacturing and distribution infrastructure, our recent review of
various product lines in relation to our current business strategy, and a
18
renewed focus on enterprise business systems integrations, charges similar to
those discussed above could recur with similar materiality in the future. We
believe that the delineation of these costs provides useful information to
measure the comparative performance of our business operations.
We estimate that the costs of completing these ongoing and other restructuring
activities, including the integration of the recently acquired Radionics
business and additional systems integrations, along with additional fair market
value purchase accounting inventory costs will be approximately $5.0 million in
the aggregate in 2006.
Net income for the three months ended March 31, 2006 also includes approximately
$2.1 million, net of tax, of stock based compensation expense recorded in
connection with the adoption of Statement of Financial Accounting Standards No
123(R) "Shared Based Payment".
Revenues and Gross Margin on Product Revenues
Three Months Ended
March 31,
(in thousands) 2006 2005
-------- --------
Neuro/Ortho Implants ............................ $ 36,746 $ 31,384
MedSurg Equipment ............................... 40,389 34,455
-------- --------
Total revenue ................................... $ 77,135 $ 65,839
Cost of product revenues ........................ 27,937 24,496
Gross margin on total revenues .................. 49,198 41,343
Gross margin as a percentage of total revenues .. 64% 63%
For the quarter ended March 31, 2006, total revenues increased 17% over the
prior year period to $77.1 million. Domestic revenues increased $9.9 million to
$57.2 million, or 74% of total revenues, as compared to 72% of revenues in the
quarter ended March 31, 2005.
In the Neuro/Ortho Implants category, sales of our Reconstructive Surgery
implant products grew particularly well. Strong growth in the NeuraGen(TM) Nerve
Guide, the INTEGRA(TM) dermal repair products and sales of Newdeal products for
the foot and ankle accounted for much of the increase in implant product
revenues. INTEGRA(TM) dermal repair product revenues increased approximately 39%
over the first quarter of 2005, nerve repair product revenues increased by 42%,
and our Newdeal foot and ankle products increased approximately 24%.
Our DuraGen(R) family of duraplasty products continued to grow modestly, which
partially offset the fast growth in Reconstructive Surgery. Sales of the DuraGen
Plus(TM) and Suturable DuraGen(TM) Dural Regeneration products led the growth in
sales of this group of products. Increased revenues of the Absorbable Collagen
Sponge that we supply for use in Medtronic's INFUSE(TM) bone graft product and
of the dental products we supply to Zimmer, also contributed to the growth in
implant revenues.
In the MedSurg Equipment category, increased sales of our JARIT(R) surgical
instrument lines, our Selector(R) and Dissectron(R) Ultrasonic Aspirator
products and sales of the recently acquired Radionics products provided the
year-over-year growth in equipment product revenues for the first quarter. Sales
of Radionics products contributed $3.4 million in the quarter.
19
Excluding the recently acquired Radionics product lines and changes in foreign
currency exchange rates, first quarter 2006 revenues increased by $9.1 million,
or 14%, over the prior-year period, as set forth below. Changes in foreign
currency exchange rates had a negative impact of $1.3 million on our quarterly
year-over-year revenue growth.
Quarter Ended Increase
March 31, (Decrease)
2006 2005 $ %
-------- -------- ------- -----
($ in thousands)
Total revenues, as reported ............. $ 77,135 $ 65,839 $11,296 17%
Less: Revenues of product lines acquired
since the beginning of the
first quarter of 2006 ........ 3,415 -- 3,415 N/M
Plus: Impact of changes in foreign
currency exchange rates ...... 1,260 -- 1,260 N/M
-------- -------- ------- -----
Revenues excluding recently acquired
product lines and changes
in foreign currency
exchange rates ............... $ 74,980 $ 65,839 $ 9,141 14%
We have generated our product revenue growth through acquisitions, new product
launches and increased direct sales and marketing efforts both domestically and
in Europe. We expect that our expanded domestic sales force, the recent
conversion of JARIT domestic sales from a distributor billing model to a direct
billing model, the continued implementation of our direct sales strategy in
Europe and sales of internally developed and acquired products will drive our
future revenue growth. We also intend to continue to acquire businesses that
complement our existing businesses and products. Overall, we expect our revenues
to continue to grow in the range of 20% to 30% per annum. We expect organic
revenue growth in excess of 15% per annum.
In the first quarter of 2006, we revised our presentation of cost of product
revenues to include amortization of product technology-based intangible assets.
Previously, this amortization was included in intangible asset amortization in
the condensed consolidated statement of operations. We have revised prior period
amounts to conform to the current year's presentation. This revision increased
cost of product revenues by $364,000 for the three month period ended March 31,
2005.
Gross margin on total revenues in the first quarter of 2006 was 64%. Although we
had strong sales growth in higher gross margin products, we recognized $464,000
in inventory fair value purchase accounting adjustments from the Radionics
acquisition as the products were sold and $590,000 in restructuring and
manufacturing transfer and systems integration costs. These charges negatively
affected our gross margin by approximately 1%. We recognized the impact of
$269,000 of inventory fair value purchase accounting adjustments in the first
quarter of 2005.
We expect that sales of our higher gross margin products will continue to
increase as a proportion of total product revenues. Also, we now invoice
hospital customers directly for sales of JARIT instruments rather than
distributors. This has resulted in increased product revenues as a result of
higher selling prices, a higher gross margin, but also increased selling
expenses from commissions paid to distributors. We anticipate that the
relatively lower gross margin generated from sales of Radionics products will
offset some of these benefits.
Other Operating Expenses:
The following is a summary of other operating expenses as a percent of total
revenues:
Three Months Ended
March 31,
(in thousands) 2006 2005
------ ------
Research and development ............................... 4% 5%
Selling, general and administrative .................... 40% 36%
Total other operating expenses ......................... 46% 43%
20
Total other operating expenses, which consists of research and development
expense, selling, general and administrative expense and amortization expense,
increased $7.2 million, or 25%, to $35.6 million in the first quarter of 2006,
compared to $28.4 million in the first quarter of 2005. The increase is
primarily related to a $3.0 million stock based compensation expense associated
with the adoption of Statement 123(R) (the majority of which is included in
selling, general and administrative expense), higher commission expenses
associated with the JARIT distributor network, and the continued build out of
our direct sales and marketing organizations around all three direct selling
platforms and increased corporate staff to support the recent growth in our
business and integrate acquired businesses.
Research and development expenses in the first quarter of 2006 included $145,000
of stock based compensation expenses associated with the adoption of Statement
123(R). Our research and development efforts in 2006 are expected to be focused
on 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, and development of a next-generation
ultrasonic aspirator system.
Selling, general, and administrative expenses increased $7.2 million, or 30%, as
compared to the prior year period to $31.1 million. This increase is primarily
related to a $2.9 million stock based compensation expense associated with the
adoption of Statement 123(R) and higher commission expenses associated with the
JARIT direct bill initiative. We also continued to build out our direct sales
and marketing organizations around all three direct selling platforms and
increased corporate staff to support the recent growth in our business and
integrate acquired businesses. Additionally, we have incurred higher operating
costs in connection with our recent investments in our infrastructure, including
the continued implementation of a new enterprise business system and the
relocation and expansion of our domestic and international distribution
capabilities through third-party service providers. We expect that we will
continue to incur costs related to these activities during the remainder of 2006
and 2007 as we complete these ongoing activities.
Amortization expense increased in the first quarter of 2006 as a result of
amortization of intangible assets from the Radionics acquisition.
Non-Operating Income and Expenses
Interest expense is related to the $120 million of 2 1/2% contingent convertible
subordinated notes that we have outstanding and a related interest rate swap
agreement and interest on the used and unused portion of the $200 million senior
secured credit facility that we established in December 2005. The increase in
interest expense in the first quarter of 2006 is primarily related to an
increase in the variable rate that we pay on our $50 million interest rate swap,
an increase in the valuation of the contingent interest obligation associated
with our contingent convertible notes, and interest associated with the credit
facility that was established in December 2005.
We will pay additional 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 first quarter of 2006, the changes in the
estimated fair value of the contingent interest obligation increased interest
expense by $233,000. In the first quarter of 2005, the change was minimal.
We have 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 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 March 31, 2006 was $210,000. Interest
expense for the three months ended March 31, 2005 included an insignificant
benefit associated with the interest rate swap.
For the three-month period ended March 31, 2006, the net fair value of the
interest rate swap increased $154,000 to $2.2 million, and the fair value amount
is included in other liabilities. In connection with this fair value hedge
transaction, during the first quarter of 2006 we recorded a $195,000 decrease in
the carrying value of our convertible notes. During the three months ended March
31, 2005, the net fair value of the interest rate swap increased $755,000 to
$2.1 million, and the carrying value of our convertible notes increased by
$787,000. The net difference between changes in the fair value of the interest
21
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 reported interest expense for the three month periods ended March 31, 2006
and 2005, respectively, includes $259,000 and $202,000 of non-cash amortization
of debt issuance costs. Debt issuance costs totaled $5.2 million and are being
amortized using the straight-line method over the five-year term of the notes
and credit facility.
Our income tax expense was $4.3 million and $4.4 million for the three month
periods ended March 31, 2006 and 2005, respectively. The overall effective tax
rate for the three months ended March 31, 2006 and 2005 was 33.0% and 34.5%,
respectively. The decrease in the effective income tax rate in 2006 was
primarily due to a continued favorable impact of various planning and
reorganization initiatives, a change in the geographic mix of earnings and
losses and our realization of additional deductions related to qualified
production activities income provided for under the American Jobs Creation Act
of 2004.
In 2006, we expect to use all of our remaining unrestricted and current year
allowable acquired net operating loss carryforwards to offset 2006 taxable
income. At March 31, 2006, several of our subsidiaries had unused net operating
loss carryforwards arising from periods prior to our ownership which expire
through 2010. The Internal Revenue Code limits the timing and manner in which we
may use any acquired net operating losses.
Our effective tax rate may vary from period to period depending on, among other
factors, the geographic and business mix of taxable earnings and losses. We
consider these factors and others, including our history of generating taxable
earnings, in assessing our ability to realized deferred tax assets.
INTERNATIONAL PRODUCT REVENUES AND OPERATIONS
Product revenues by major geographic area are summarized below:
United Asia Other
States Europe Pacific Foreign Total
-------- -------- -------- -------- --------
(in thousands)
Three months ended Mar 31, 2006 .... $ 57,238 $ 14,375 $ 2,796 $ 2,726 $ 77,135
Three months ended Mar 31, 2005 .... 47,367 12,762 3,048 2,662 65,839
For the three months ended March 31, 2006, revenues from customers outside the
United States totaled $19.9 million, or 26% of total revenues, of which
approximately 72% were to European customers. Revenues from customers outside
the United States included $14.7 million of revenues generated in foreign
currencies.
In the three months ending March 31, 2005, revenues from customers outside the
United States totaled $18.5 million, or 28% of total revenues, of which
approximately 69% were from European customers. Revenues from customers outside
the United States included $14.3 million of revenues generated in foreign
currencies.
Because we have operations based in Europe and we generate revenues and incur
operating expenses in euros and British pounds, we will experience currency
exchange risk with respect to those foreign currency denominated revenues or
expenses.
In the first quarter of 2006, 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.
22
Local economic conditions, regulatory or political considerations, the
effectiveness of our sales representatives and distributors, local competition
and changes in local medical practice all may combine to affect our sales into
markets outside the United States.
Relationships with customers and effective terms of sale frequently vary by
country, often with longer-term receivables than are typical in the United
States.
LIQUIDITY AND CAPITAL RESOURCES
Cash and Marketable Securities
At March 31, 2006, we had cash, cash equivalents and current and non-current
investments totaling approximately $97.9 million. Our investments consist almost
entirely of highly liquid, interest bearing-debt securities.
At March 31, 2006 , we had $3.5 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 $56.8
million for the year ended December 31, 2005 and $10.9 million for the three
months ended March 31, 2006. Operating cash flows for the three months ended
March 31, 2005 were $13.2 million. Cash flows in the first quarter of 2006 were
negatively affected by investments in working capital made in connection with
the Radionics acquisition.
Our principal use of funds during the three month period ended March 31, 2006
was $75.8 million for acquisition consideration. We received $21.0 million in
cash from sales and maturities of available for sale securities, net of
purchases. In addition to the $10.9 million in operating cash flows for the
three months ended March 31, 2006, we received $5.0 million from the issuance of
common stock through the exercise of stock options during the period and $16.0
million from borrowings under our credit facility.
Working Capital
At March 31, 2006 and December 31, 2005, working capital was $189.1 million and
$234.7 million, respectively. The decrease in working capital is primarily
related to the use of $75.8 million for acquisition consideration in the first
quarter of 2006. Working capital does not include the $11.7 million and $16.2
million of marketable securities classified as non-current at March 31, 2006 and
December 31, 2005, respectively.
Convertible Debt and Related Hedging Activities
We pay interest on our contingent convertible subordinated notes at an annual
rate of 2 1/2% each September 15th and March 15th. We will also pay contingent
interest on the notes if, at thirty days prior to maturity, our common stock
price is greater than $37.56. The contingent interest will be payable at
maturity for each of the last three years the notes remain outstanding in an
amount equal to the greater of (1) 0.50% of the face amount of the notes and (2)
the amount of regular cash dividends paid during each such year on the number of
shares of common stock into which each note is convertible. Holders of the notes
may convert the notes into shares of our common stock under certain
circumstances, including when the market price of our common stock on the
previous trading day is more than $37.56 per share, based on an initial
conversion price of $34.15 per share. As of March 31, 2006, our stock price
exceeded $37.56 and no convertible notes have been converted in common stock.
The notes are general, unsecured obligations of Integra and are subordinate to
any senior indebtedness. We cannot redeem the notes prior to their maturity, and
the notes' holders may compel us to repurchase the notes upon a change of
control. There are no financial covenants associated with the convertible notes.
We entered into 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 notes. See "- Results of Operations -
Non-Operating Income and Expenses." We receive a 2 1/2% fixed rate from the
23
counterparty and pay to the counterparty a floating rate based on 3-month LIBOR
minus 35 basis points. Our effective interest rate on the hedged portion of the
notes was 4.2% as of March 31, 2006.
Share Repurchase Plan
In February 2006, our Board of Directors authorized us to repurchase shares of
our common stock for an aggregate purchase price not to exceed $50 million
through December 31, 2006 and terminated our prior repurchase program. Shares
may be purchased either in the open market or in privately negotiated
transactions.
No repurchase of our common stock was made during the quarter ended March 31,
2006 under this program nor our prior repurchase program.
Dividend Policy
We have not paid any cash dividends on our common stock since our formation. Our
credit facility limits the amount of dividends that we may pay. 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
In April 2006, we signed a definitive agreement to acquire the shares of Miltex
Holdings, Inc. for approximately $101 million in cash, subject to certain
adjustments. Given our current levels of cash and marketable securities on hand,
we expect to finance a portion of this acquisition using the credit facility
that we established in December 2005.
In December 2005, we established a $200 million, five-year, senior secured
revolving credit facility. The credit facility currently allows for revolving
credit borrowings in a principal amount of up to $200 million, which can be
increased to $250 million should additional financing be required in the future.
We plan to utilize the credit facility for working capital, capital
expenditures, share repurchases, acquisitions and other general corporate
purposes. We did not draw any amounts against this credit facility in 2005.
The indebtedness under the credit facility is guaranteed by all but one of the
Company's domestic subsidiaries. The Company's obligations under the credit
facility and the guarantees of the guarantors are secured by a first-priority
security interest in all present and future capital stock of (or other ownership
or profit interest in) each guarantor and substantially all of the Company's and
the guarantors' other assets, other than real estate, intellectual property and
capital stock of foreign subsidiaries.
Borrowings under the credit facility bear interest, at our option, at a rate
equal to (i) the Eurodollar Rate in effect from time to time plus an applicable
rate (ranging from 0.75% to 1.5%) or (ii) the higher of (x) the weighted average
overnight Federal funds rate, as published by the Federal Reserve Bank of New
York, plus 0.5%, and (y) the prime commercial lending rate of Bank of America,
N.A. plus an applicable rate (ranging from 0% to 0.5%). The applicable rates are
based on a financial ratio at the time of the applicable borrowing.
We will also pay an annual commitment fee (ranging from 0.15% to 0.25%) on the
daily amount by which the commitments under the credit facility exceed the
outstanding loans and letters of credit under the credit facility.
The credit facility requires us to maintain various financial covenants,
including leverage ratios, a minimum fixed charge coverage ratio and a minimum
liquidity ratio. The credit facility also contains customary affirmative and
negative covenants, including those that limit the Company's and its
subsidiaries' ability to incur additional debt, incur liens, make investments,
enter into mergers and acquisitions, liquidate or dissolve, sell or dispose of
assets, repurchase stock and pay dividends, engage in transactions with
affiliates, engage in certain lines of business and enter into sale and
leaseback transactions. As March 31, 2006, we were in compliance with our
financial covenants.
In March 2006, we borrowed $16.0 million under the credit facility in connection
with the acquisition of Radionics under a 30 day borrowing of 5.89% per annum.
24
Contractual Obligations and Commitments
Under certain agreements, we are required to make payments based on sales levels
of certain products or if specific development milestones are achieved.
OTHER MATTERS
Critical Accounting Estimates
The critical accounting estimates included in the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 2005 have not materially
changed other than as set forth below.
Accounting for Stock Based Compensation Arrangements
We adopted Statement of Financial Accounting Standards No. 123(R) "Share-Based
Payment" on January 1, 2006 using the modified prospective method which requires
companies (1) to record the unvested portion of previously issued awards that
remain outstanding at the initial date of adoption and (2) to record
compensation expense for any awards issued, modified or settled after the
effective date of the statement. As a result of the adoption of Statement
123(R), the Company began expensing stock options in the 2006 first quarter
using the fair value method prescribed by Statement 123(R). Stock based
compensation cost is measured at the grant date based on the fair value of an
award and is recognized on a straight-line basis as an expense over the
requisite service period, which is the vesting period. Certain of these costs
are capitalized into inventory and will be recognized as an expense when the
related inventory is sold. Our income before income taxes and net income for the
three months ended March 31, 2006 were $3.0 million and $2.1 million lower,
respectively, than if it had continued to account for share-based compensation
under APB No. 25.
We recognize stock based compensation expense in the consolidated statement of
operations based on the awards that are expected to vest. Accordingly, we have
adjusted stock based compensation expense to reflect estimated forfeitures.
Statement 123(R) requires forfeitures to be estimated at the time of grant and
revised, if necessary, in subsequent periods if actual forfeitures differ from
those estimates. We estimate forfeitures based on historical experience.
Statement 123(R) supercedes our previous accounting under Accounting Principals
Boards Opinion No. 25 "Accounting for Stock Issued to Employees" for periods
subsequent to December 31, 2005. In March 2005, the Securities and Exchange
Commission issued Staff Accounting Bulletin No. 107, which provides interpretive
guidance in applying the provisions of Statement 123(R). We have applied the
provisions of SAB 107 in our adoption of Statement 123(R).
Our condensed consolidated statement of operations for the three months ended
March 31, 2006, includes compensation expense related to (i) stock based awards
granted prior to, but not fully vested as of, January 1, 2006, based on grant
date fair values estimated in accordance with the proforma provisions of
Statement of Financial Accounting Standards Statement No 123 "Accounting for
Stock Based Compensation", and (ii) stock based awards granted in 2006, based on
grant-date fair values estimated in accordance with Statement 123(R).
We calculate the fair value of our restricted stock awards and restricted stock
unit awards based on the closing market price of our common stock on the date of
the grant. We calculated the fair value of options granted prior to October 1,
2004 using the Black-Scholes model, while we calculate the fair value of options
granted on or after October 1, 2004 using the binomial distribution model. These
models include assumptions regarding the expected term of our option awards,
expected future volatility in the market price of our common stock, future
risk-free interest rates, and future dividends, if any, on our common stock. We
believe 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.
The assumptions used in calculating the fair value of stock based compensation
awards involve inherent uncertainties and the application of management
judgment. If factors were to change, and we used different assumptions,
depending on the level of our future stock based awards, our stock based
compensation expense in the future could be materially different from that
reported for the three months ended March 31, 2006 or proforma amounts reported
25
for periods prior to January 1, 2006. In addition, if our actual forfeiture rate
varies significantly from our current estimate, the amount of stock based
compensation expense recognized in future periods will be affected.
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 Product Revenues and 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 March 31, 2006 would
increase or decrease interest income by approximately $1.0 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 March 31, 2006, 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 March 31, 2006, the net fair value of the interest rate swap approximated
$2.2 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.
26
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 period 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 March 31, 2006, 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.
27
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEDINGS
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, we 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 our
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 our 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 our favor and against Merck
KGaA in the case. In entering the judgment, the Trial Court also granted to us
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 we 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 writ of
certiorari with the United States Supreme Court seeking review of the Circuit
Court's decision, and the Supreme Court granted the writ in January 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. The hearing before the Circuit Court is scheduled for June
2006.
Further enforcement of the Trial Court's order has been stayed. We have not
recorded any gain in connection with this matter, pending final resolution and
completion of the appeals process.
In addition to these matters, we are 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 our 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.
28
ITEM 1A. RISK FACTORS
The Risk Factors included in the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2005 have not materially changed other than the
modifications to two risks factors as set forth below.
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, there is intense competition among medical device companies. We
compete with established medical technology and pharmaceutical companies in many
of our product areas. 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 competitors may be able
to gain market share by offering lower-cost 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, obtain
reimbursement under Medicare 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 introduced an onlay dural graft matrix during 2004, and other
companies have introduced and 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.
Our largest competitors in the neurosurgery markets are the Medtronic
Neurosurgery division of Medtronic, Inc., the Codman division of Johnson &
Johnson, the Aesculap division of B. Braun Medical Inc. and Stryker Corporation.
In addition, many of our product lines compete with smaller specialized
companies or larger companies that do not otherwise focus on neurosurgery. Our
competitors in reconstructive surgery include LifeCell Corporation,
Organogenesis Inc., Wright Medical Group, Inc., the DePuy division of Johnson &
Johnson, Synthes, Inc. and Stryker Corporation. Some of these are major
orthopedic companies that carry a full line of reconstructive products. Our
private label products face diverse and broad competition, depending on the
market that an individual product addresses. 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 our dermal regeneration products, our duraplasty
products and our nerve repair products.
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) catheter product lines is as susceptible to earthquake
damage, wildfire damage and power losses from electrical shortages as are other
businesses in the Southern California area. Our Anasco, Puerto Rico plant, where
we manufacture collagen, silicone and our private label products, is vulnerable
to hurricane, storm and wind damage. Although we maintain property damage and
business interruption insurance coverage on these facilities, our insurance
might not cover all losses under such circumstances and we may not be able to
renew or obtain such insurance in the future on acceptable terms with adequate
coverage or at reasonable costs.
In addition, we began implementing an enterprise business system in 2004, which
we intend to use in all of our facilities. This system, the hosting and
maintenance of which we outsource, replaces several systems on which we
previously relied and will be implemented in several stages. We have outsourced
our product distribution function in the United States and in the fourth quarter
of 2005 began to outsource our European product distribution function. A delay
or other problem with the system or in our implementation schedule for any of
these initiatives could have a material adverse effect on our operations.
29
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In February 2006, our Board of Directors authorized us to repurchase shares of
our common stock for an aggregate purchase price not to exceed $50 million
through December 31, 2006 and terminated our prior repurchase program. Shares
may be purchased either in the open market or in privately negotiated
transactions.
No repurchase of our common stock was made during the quarter ended March 31,
2006 under this program nor our prior repurchase program.
ITEM 6. EXHIBITS
4.1 First Amendment, dated as of February 15, 2006, among Integra
LifeSciences Holdings Corporation, the lenders party thereto,
Bank of America, N.A., as Administrative Agent, Swing Line
Lender and L/C Issuer, Citibank FSB and SunTrust Bank, as
Co-Syndication Agents, and Royal Bank of Canada and Wachovia
Bank, National Association, as Co-Documentation Agents
(Incorporated by reference to Exhibit 4.3 to the Company's
Annual Report on Form 10-K for the year ended December 31,
2005)
10.1 Performance Stock Agreement by and between John B. Henneman,
III and the Company dated January 3, 2006 (Incorporated by
reference to Exhibit 10.43 to the Company's Annual Report on
Form 10-K for the year ended December 31, 2005)
10.2 Performance Stock Agreement by and between Gerard S. Carlozzi
and the Company dated January 3, 2006 (Incorporated by
reference to Exhibit 10.43 to the Company's Annual Report on
Form 10-K for the year ended December 31, 2005)
10.3 Employment Agreement by and between Maureen Bellantoni and
the Company dated January 10, 2006 (Incorporated by
reference to Exhibit 10.44 to the Company's Annual Report on
Form 10-K for the year ended December 31, 2005)
10.4 Performance Stock Agreement by and between Maureen Bellantoni
and the Company dated January 10, 2006 (Incorporated by
reference to Exhibit 10.45 to the Company's Annual Report on
Form 10-K for the year ended December 31, 2005)
10.5 Compensation of Directors of the Company (Incorporated by
reference to Exhibit 10.1 to the Company's Current Report on
Form 8-K filed on February 28, 2006)
10.6 Form of Restricted Stock Agreement for Executive Officers
(Incorporated by reference to Exhibit 10.1 to the Company's
Current Report on Form 8-K filed on January 9, 2006)
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
30
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: May 10, 2006 /s/ Stuart M. Essig
-------------------
Stuart M. Essig
President and Chief Executive Officer
Date: May 10, 2006 /s/ Maureen B. Bellantoni
-------------------
Maureen B. Bellantoni
Executive Vice President and Chief
Financial Officer
31
EXHIBITS
4.1 First Amendment, dated as of February 15, 2006, among Integra
LifeSciences Holdings Corporation, the lenders party thereto,
Bank of America, N.A., as Administrative Agent, Swing Line
Lender and L/C Issuer, Citibank FSB and SunTrust Bank, as
Co-Syndication Agents, and Royal Bank of Canada and Wachovia
Bank, National Association, as Co-Documentation Agents
(Incorporated by reference to Exhibit 4.3 to the Company's
Annual Report on Form 10-K for the year ended December 31,
2005)
10.1 Performance Stock Agreement by and between John B. Henneman,
III and the Company dated January 3, 2006 (Incorporated by
reference to Exhibit 10.43 to the Company's Annual Report on
Form 10-K for the year ended December 31, 2005)
10.2 Performance Stock Agreement by and between Gerard S. Carlozzi
and the Company dated January 3, 2006 (Incorporated by
reference to Exhibit 10.43 to the Company's Annual Report on
Form 10-K for the year ended December 31, 2005)
10.3 Employment Agreement by and between Maureen Bellantoni and the
Company dated January 10, 2006 (Incorporated by reference to
Exhibit 10.44 to the Company's Annual Report on Form 10-K for
the year ended December 31, 2005)
10.4 Performance Stock Agreement by and between Maureen Bellantoni
and the Company dated January 10, 2006 (Incorporated by
reference to Exhibit 10.45 to the Company's Annual Report on
Form 10-K for the year ended December 31, 2005)
10.5 Compensation of Directors of the Company (Incorporated by
reference to Exhibit 10.1 to the Company's Current Report on
Form 8-K filed on February 28, 2006)
10.6 Form of Restricted Stock Agreement for Executive Officers
(Incorporated by reference to Exhibit 10.1 to the Company's
Current Report on Form 8-K filed on January 9, 2006)
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
32
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-K 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: May 10, 2006
/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, Maureen B. Bellantoni, certify that:
1. I have reviewed this quarterly report on Form 10-K 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: May 10, 2006
/s/ Maureen B. Bellantoni
----------------------------
Maureen B. Bellantoni
Executive Vice President and
Chief Financial Officer
Certification of Principal Executive Officer
Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
I, Stuart M. Essig, President and Chief Executive Officer 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
March 31, 2006 (the "Report") fully complies with the requirements 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: May 10, 2006 /s/ Stuart M. Essig
-------------------------------------
Stuart M. Essig
President and Chief Executive Officer
Certification of Principal Financial Officer
Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
I, Maureen B. Bellantoni, Executive Vice President and Chief Financial Officer
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
March 31, 2006 (the "Report") fully complies with the requirements 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: May 10, 2006 /s/ Maureen B. Bellantoni
----------------------------
Maureen B. Bellantoni
Executive Vice President and
Chief Financial Officer