UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 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 August
4, 2006 was 28,362,001.
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 and six months ended June 30, 2006 and 2005 (Unaudited) 2
Condensed Consolidated Balance Sheets as of June 30, 2006
and December 31, 2005 (Unaudited) 3
Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 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 28
Item 4. Controls and Procedures 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 30
Item 1A. Risk Factors 31
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 34
Item 4. Submission of Matters to a Vote of Security Holders 35
Item 6. Exhibits 36
SIGNATURES 37
EXHIBITS 38
1
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands, except per share amounts)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ------------------
2006 2005 2006 2005
---- ---- ---- ----
TOTAL REVENUE ........................ $100,121 $69,778 $177,256 $135,617
COSTS AND EXPENSES
Cost of product revenues ............. 41,373 27,518 69,310 52,029
Research and development ............. 6,354 2,787 9,527 6,146
Selling, general and administrative .. 37,219 26,041 68,339 49,957
Intangible asset amortization ........ 2,017 1,289 3,298 2,385
-------- -------- -------- --------
Total costs and expenses .......... 86,963 57,635 150,474 110,517
Operating income ..................... 13,158 12,143 26,782 25,100
Interest income ...................... 594 907 1,618 1,861
Interest expense ..................... (2,073) (822) (3,755) (1,749)
Other income (expense), net .......... (99) (541) (67) (634)
-------- -------- -------- --------
Income before income taxes ........... 11,580 11,687 24,578 24,578
Income tax expense ................... 3,603 4,032 7,896 8,480
-------- -------- -------- --------
Net income ........................... $ 7,977 $ 7,655 $ 16,682 $ 16,098
======== ======== ======== ========
Basic net income per share ........... $ 0.27 $ 0.25 $ 0.56 $ 0.53
Diluted net income per share ......... $ 0.26 $ 0.23 $ 0.54 $ 0.49
Weighted average common shares outstanding:
Basic .......................... 29,592 30,401 29,589 30,481
Diluted ........................ 33,804 34,739 33,816 34,941
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In thousands, except per share amounts)
June 30, December 31,
2006 2005
------------ ------------
ASSETS
Current Assets:
Cash and cash equivalents ............................... $ 27,533 $ 46,889
Short-term investments .................................. 6,417 80,327
Accounts receivable, net of allowances of
$4,577 and $3,508.................................... 74,135 49,007
Inventories, net ........................................ 92,981 67,476
Deferred tax assets ..................................... 12,793 10,842
Prepaid expenses and other current assets ............... 12,604 11,411
--------- ---------
Total current assets ................................ 226,463 265,952
Non-current investments ................................... 9,693 16,168
Property, plant, and equipment, net ....................... 35,791 27,451
Identifiable intangible assets, net ....................... 140,552 64,569
Goodwill................................................... 147,316 68,364
Other assets .............................................. 6,404 5,928
--------- ---------
Total assets .............................................. $ 566,219 $ 448,432
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Borrowings under senior credit facility ................. $ 64,000 $ --
Accounts payable, trade ................................. 16,192 8,978
Income taxes payable .................................... -- 715
Deferred revenue ........................................ 8,280 88
Accrued expenses and other current liabilities .......... 25,147 21,506
--------- ---------
Total current liabilities ........................... 113,619 31,287
Long-term debt ............................................ 118,112 118,378
Deferred tax liabilities .................................. 14,905 2,520
Other liabilities ......................................... 7,537 6,429
--------- ---------
Total liabilities ......................................... 254,173 158,614
Commitments and contingencies (see Footnote 11) -- --
Stockholders' Equity:
Common stock; $0.01 par value; 60,000 authorized shares;
31,066 and 29,823 issued at June 30, 2006 and
December 31, 2005, respectively ....................... 311 298
Additional paid-in capital .............................. 347,479 333,179
Treasury stock, at cost; 2,769 and 2,368 shares at
June 30, 2006 and December 31, 2005, respectively...... (91,002) (75,815)
Accumulated other comprehensive income (loss):
Unrealized loss on available-for-sale securities,
net of tax ....................................... (285) (801)
Foreign currency translation adjustment .............. 3,698 (2,300)
Minimum pension liability adjustment, net of tax ..... (1,766) (1,672)
Retained earnings ....................................... 53,611 36,929
--------- ---------
Total stockholders' equity ............................ 312,046 289,818
--------- ---------
Total liabilities and stockholders' equity ............... $ 566,219 $ 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)
Six Months Ended June 30,
2006 2005
---- ----
OPERATING ACTIVITIES:
Net income ...................................................... $ 16,682 $16,098
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ................................ 7,727 5,751
Deferred income tax provision ................................ 1,015 6,304
Amortization of discount/premium on investments .............. 358 1,064
Loss on sale of investments .................................. 390 24
Impairment of fixed assets.................................... 352 --
Share-based compensation ..................................... 6,473 39
Excess tax benefits from stock-based compensation arrangements (665) --
Other, net ................................................... 686 178
Changes in assets and liabilities, net of business acquisitions:
Accounts receivable ........................................ (18,578) 3,596
Inventories ................................................ 1,078 (11,085)
Prepaid expenses and other current assets .................. (892) 1,610
Other non-current assets ................................... (507) 104
Accounts payable, accrued expenses and other liabilities.... 6,022 7,011
Income taxes payable........................................ (250) (1,149)
Deferred revenue ........................................... 6,436 (55)
-------- --------
Net cash provided by operating activities ....................... 26,327 29,490
-------- --------
INVESTING ACTIVITIES:
Cash used in business acquisitions, net of cash acquired ........ (179,568) (50,099)
Proceeds from the sales/maturities of investments ............... 93,505 21,077
Purchases of available-for-sale investments ..................... (13,075) (15,000)
Purchases of property and equipment ............................. (3,619) (4,825)
-------- --------
Net cash used in investing activities ........................... (102,757) (48,847)
-------- --------
FINANCING ACTIVITIES:
Borrowings under senior credit facility ......................... 90,000 --
Repayment of loans .............................................. (26,037) (49)
Proceeds from exercised stock options ........................... 7,064 3,878
Excess tax benefits from stock-based compensation arrangements .. 665 --
Purchases of treasury stock ..................................... (15,187) (24,650)
-------- --------
Net cash provided by (used in) financing activities ............. 56,505 (20,821)
-------- --------
Effect of exchange rate changes on cash and cash equivalents..... 569 (657)
Net decrease in cash and cash equivalents ....................... (19,356) (40,835)
Cash and cash equivalents at beginning of period ................ 46,889 69,855
-------- --------
Cash and cash equivalents at end of period ...................... $ 27,533 $ 29,020
======== ========
Supplemental cash flow information:
- -----------------------------------
At June 30, 2006 and 2005, the Company had $3.5 million and $3.4 million,
respectively, of cash pledged as collateral in connection with its interest rate
swap agreement.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
General
In the opinion of management, the June 30, 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 six-month period ended June 30, 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 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 $379,000 and $758,000 for the three and six-month periods
ended June 30, 2005, respectively.
Recently Adopted Accounting Standard
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 six months ended June 30, 2006 were $6.5 million and $4.4 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.
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
5
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, the Company's net income and basic and diluted net income
per share for the three and six months ended June 30, 2005 would have been as
follows (in thousands, except per share amounts):
Three Months Ended Six Months Ended
June 30, 2005 June 30, 2005
------------------ ----------------
Net income, as reported ............................... $7,655 $16,098
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 ..................... (1,733) (3,463)
-------- --------
Pro forma ......................................... $ 5,922 $12,635
Net income per share:
Basic:
As reported ....................................... $ 0.25 $ 0.53
Pro forma ......................................... $ 0.19 $ 0.41
Diluted:
As reported ....................................... $ 0.23 $ 0.49
Pro forma ......................................... $ 0.19 $ 0.39
Statement 123(R) did not change the accounting for stock-based awards granted to
non-employees.
Recently Issued Accounting Standards and Other Matters
In July 2006, the FASB issued FASB Interpretation 48, "Accounting for
Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109" (FIN
48). FIN 48 clarifies the accounting for uncertainty in income taxes recognition
in a company's financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes, by defining the criterion that an individual tax
position must meet in order to be recognized in the financial statements. FIN 48
requires that the tax effects of a position be recognized only if it is
"more-likely-than-not" to be sustained based solely on the technical merits as
of the reporting date. FIN 48 further requires that interest that the tax law
requires to be paid on the underpayment of taxes should be accrued on the
difference between the amount claimed or expected to be claimed on the return
and the tax benefit recognized in the financial statements. FIN 48 also requires
additional disclosures of unrecognized tax benefits, including a reconciliation
of the beginning and ending balance. The provisions of FIN 48 are effective
January 1, 2007. The Company is currently assessing the impact that the adoption
of FIN 48 will have on its results of operations and financial position.
2. BUSINESS ACQUISITIONS
Radionics
On March 3, 2006, the Company 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 $2.7 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.
6
The following summarizes the allocation of the Radionics purchase price based on
the fair value of the assets acquired and liabilities assumed (in thousands):
Inventory ............................ $ 8,201
Property, plant and equipment ........ 1,365 Wtd. Avg. Life
Intangible assets: --------------
Tradename ......................... 18,100 Indefinite
Customer relationships ............ 20,900 7 years
Technology ........................ 10,000 10 years
Goodwill ............................. 20,604
Other assets ......................... 72
-------
Total assets acquired ............. 79,242
Accrued expenses and other current
liabilities ....................... 425
Deferred revenue ..................... 1,605
Total liabilities assumed ......... 2,030
-------
Net assets acquired .................. $77,212
=======
The fair value of assets acquired was determined by management with the
assistance of a third-party valuation firm. Certain adjustments were finalized
in the second quarter of 2006 relating to the Radionics valuation, which
primarily resulted in an increase to intangible assets and a reduction in
goodwill of $4 million. The adjustment was related to the finalization of
certain assumptions in the valuation of identifiable intangible assets. 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.
Miltex
On May 12, 2006, the Company acquired all of the outstanding capital stock of
Miltex Holdings, Inc. ("Miltex") for $102.7 million in cash paid at closing,
subject to certain adjustments, and $0.2 million of transaction-related costs.
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. Miltex sells products
under the Miltex(R), Meisterhand(R), Vantage(R), Moyco(R), Union Broach(R), and
Thompson(R) trade names in over 65 countries, using a network of independent
distributors. Miltex operates a manufacturing and distribution facility in York,
Pennsylvania and also operates a leased facility in Tuttlingen, Germany, where
Miltex's staff coordinates design, production and delivery of instruments.
The following summarizes the preliminary allocation of the purchase price based
on the fair value of the assets acquired and liabilities assumed (in thousands):
Inventory ................................. $ 17,135
Property, plant and equipment ............. 6,717
Other current assets ...................... 9,707
Wtd. Avg. Life
Intangible assets: --------------
Customer relationships ................. 15,000 15 years
Tradename (Miltex)...................... 13,500 Indefinite
Tradename (Moyco, Union Branch, Thompson) 300 4 years
Tradename (other product lines) ........ 600 15 years
Technology.............................. 1,100 10 years
Goodwill .................................. 54,275
Other assets .............................. 295
--------
Total assets acquired .................. 118,629
Accrued expenses and other current
liabilities ............................ 4,884
Deferred tax liabilities .................. 10,858
--------
Total liabilities assumed .............. 15,742
--------
Net assets acquired ....................... $102,887
========
The preliminary 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
7
generate from Miltex's future cash flows. Certain elements of the purchase price
allocation are considered preliminary, particularly as they relate to the final
valuation of certain identifiable intangible assets. Additional changes could be
significant as the allocations are finalized.
The results of operations of the acquired businesses have been included in the
condensed consolidated financial statements since their respective dates of
acquisition.
Newdeal Technologies SAS
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 were to
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.
The following unaudited pro forma financial information summarizes the results
of operations for the six months ended June 30, 2006 and 2005 as if the
acquisitions consummated in 2006 had been completed as of the beginning of 2005.
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 interest expense, depreciation expense,
intangible asset amortization, and income taxes at a rate consistent with the
Company's statutory 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.
Three Months Ended Six Months Ended
June 30, June 30,
(in thousands, except per share amounts) 2006 2005 2006 2005
-------- -------- -------- --------
Total revenue ............................. $107,175 $103,913 $210,481 $192,811
Net income ................................ 5,922 9,323 15,611 18,288
Net income per share:
Basic .................................. $ 0.20 $ 0.31 $ 0.53 $ 0.60
Diluted................................. $ 0.20 $ 0.28 $ 0.51 $ 0.55
3. INVENTORIES
Inventories, net consisted of the following (in thousands):
June 30, December 31,
2006 2005
---- ----
Raw materials.............................. $15,211 $13,175
Work-in process............................ 14,459 9,801
Finished goods............................. 63,311 44,500
------- -------
$92,981 $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.
In June 2006, the Company recorded a $1.2 million charge to research and
development related to pre-approval inventory associated with a project to
develop an ultrasonic aspirator system. This project was discontinued in June
2006 following management's review of the Company's existing technology and the
ultrasonic aspirator technology acquired in the Radionics acquisition.
Management determined that there was no future, alternative use for the
pre-approval inventory in any other development project.
8
4. GOODWILL AND OTHER INTANGIBLE ASSETS
Changes in the carrying amount of goodwill for the six months ended June 30,
2006, were as follows (in thousands):
Balance at December 31, 2005 ..................................... $ 68,364
Radionics acquisition ............................................ 20,604
Miltex acquisition (based on preliminary allocation).............. 54,275
Newdeal working capital adjustment ............................... 694
Foreign currency translation ..................................... 3,379
--------
Balance at June 30, 2006 ......................................... $147,316
========
The components of the Company's identifiable intangible assets were as follows
(in thousands):
June 30, 2006 December 31, 2005
Weighted ---------------------- ----------------------
Average Accumulated Accumulated
Life Cost Amortization Cost Amortization
-------- -------- ------------ -------- ------------
Completed technology ....... 12 years $ 30,590 $ (6,926) $ 18,921 $ (5,691)
Customer relationships ..... 13 years 58,822 (6,923) 22,550 (4,823)
Trademarks/brand names ..... Indefinite 31,600 -- -- --
Trademarks/brand names ..... 35 years 32,256 (3,367) 31,175 (2,802)
Noncompetition agreements... 5 years 7,006 (3,343) 6,943 (2,607)
All other .................. 15 years 1,620 (783) 2,233 (1,330)
-------- ------------ -------- ------------
$161,894 $(21,342) $ 81,822 $(17,253)
Accumulated amortization .. (21,342) (17,253)
-------- --------
$140,552 $ 64,569
======== ========
Annual amortization expense is expected to approximate $9.8 million in 2006,
$10.6 million in 2007, $10.3 million in 2008, $9.6 million in 2009, and $8.9
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. The Company terminated 68 individuals under the European
restructuring plan.
During the six months ended June 30, 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 may terminate approximately ten additional employees over the next
nine to twelve months in connection with this transfer; however no final
decision has been made.
In connection with these restructuring activities, the Company has recorded the
following charges during the three and six months ended June 30, 2006 (in
thousands):
Research Selling
Cost of and General and
Sales Development Administrative Total
------- ------- ------- -------
Involuntary employee termination costs:
Three months ended June 30, 2006 ......... $ 127 $ -- $ -- $ 127
Six months ended June 30, 2006............ $ 228 $ 22 $ -- $ 250
9
Below is a reconciliation of the restructuring accrual activity recorded during
2006 (in thousands):
Employee Facility
Termination Exit
Costs Costs Total
------- ------- -------
Balance at December 31, 2005 ........................ $ 2,420 $ 124 $ 2,544
Additions ........................................... 268 -- 268
Change in estimate................................... (18) -- (18)
Payments ............................................ (1,991) (115) (2,106)
Effects of foreign exchange ......................... 108 5 113
------- ------- -------
Balance at June 30, 2006 ............................ $ 787 $ 14 $ 801
======= ======= =======
The Company expects to pay all of the remaining costs by the end of 2006.
6. STOCK-BASED COMPENSATION
As of June 30, 2006, the Company had stock options, restricted stock awards,
performance stock awards, contract 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 awards 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 six months ended June 30, 2006,
have been classified as financing cash flows.
At June 30, 2006, there were 6,697,371 shares authorized for issuance under the
Plans, with 1,561,299 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 Six Months Ended
June 30, 2006 June 30, 2006
------------------ ----------------
Research and development expense .................. $ 139 $ 284
Selling, general and administrative ............... 3,193 6,084
Amortization of amounts previously capitalized
to inventory ................................... 105 105
------ ------
Total employee stock-based compensation expense ... 3,437 6,473
Tax benefit related to employee stock-based
compensation expense ........................... (1,089) (2,040)
------ ------
Net effect on net income .......................... $ 2,348 $ 4,433
Effect on earnings per share:
Basic ........................................ $ .08 $ 0.15
Diluted ...................................... $ .06 $ 0.13
For the six months ended June 30, 2006, the Company also capitalized $116,000 of
stock-based compensation costs in inventory based on the underlying employees
receiving the awards.
10
Stock Options
The following is a summary of stock option activity for the six-month period
ended June 30, 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 ............................... 60 35.87
Exercised ............................. 350 39.30
Cancelled ............................. 59 33.45
--------- -------
Outstanding, June 30, 2006 ........... 3,652 $ 28.20 4.5 $38.8 million
Options exercisable at June 30, 2006. 2,039 $ 24.58 3.5 $29.0 million
The intrinsic value of options exercised during the six-month periods ended June
30, 2006 and 2005 was $6.5 million and $5.8 million, respectively. The
weighted-average per share fair value of stock options granted during the six
months ended June 30, 2006 and 2005 was $15.27 and $15.07, respectively.
As of June 30, 2006, there was approximately $20.6 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 2.5 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 Six Months Ended
June 30, June 30, June 30, June 30,
2006 2005 2006 2005
-------- --------- --------- ---------
Dividend yield .................................. 0% 0% 0% 0%
Expected volatility ............................. 43% 43% 43% 43%
Risk free interest rate ......................... 4.3% 4.3% 4.3% 3.4%
Expected life of option from grant date ......... 5.4 years 5.4 years 5.4 years 5.4 years
The Company received proceeds of $7.1 million and $3.9 million from stock option
exercises for the six months ended June 30, 2006 and 2005, respectively.
Awards of Restricted Stock, Performance Stock and Contract Stock
The following is a summary of awards of restricted stock, performance stock and
contract stock for the six-month period ended June 30, 2006 (shares in
thousands):
Restricted Stock Performance Stock and
Awards Contract Stock Awards
---------------------- ----------------------
Wtd. Avg. Wtd. Avg.
Fair Value Fair Value
Shares Per Share Shares Per Share
-------- ------------ -------- ------------
Unvested, December 31, 2005 ........ 19 $ 35.08 -- --
Grants ............................. 128 38.52 216 $35.40
Vested ............................. -- -- -- --
Cancellations ...................... (4) 36.86 -- --
-------- ------------ -------- ------------
Unvested, June 30, 2006 ........... 143 $ 38.11 216 $35.40
11
Performance stock awards have performance features associated with them.
Performance stock, restricted stock and contract stock awards generally have
requisite service periods of three years. The fair value of these awards is
being expensed on a straight-line basis over the vesting period. As of June 30,
2006, there was approximately $11.1 million of total unrecognized compensation
costs related to unvested awards. These costs are expected to be recognized over
a weighted-average period of approximately 2.9 years. The Company granted 2,496
restricted stock awards with a weighted average fair value of $32.04 during the
six months ended June 30, 2005.
The Company has no formal policy related to the repurchase of shares for the
purpose of satisfying stock-based compensation obligations. Independent of these
programs, the Company does have a practice of repurchasing shares, from time to
time, in the open market.
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 (in
thousands):
Three Months Ended Six Months Ended
June 30 June 30
2006 2005 2006 2005
------ ------ ------ ------
Service cost .......................... $ 58 $ 63 $ 104 $ 124
Interest cost ....................... 157 107 282 210
Expected return on plan assets ...... (137) (89) (246) (175)
Recognized net actuarial loss ....... 60 36 108 71
------ ------ ------ ------
Net periodic benefit cost......... $ 138 $ 117 $ 248 $ 230
The Company made $126,000 and $105,000 of contributions to its defined benefit
pension plans for the six months ended June 30, 2006 and 2005, respectively.
8. COMPREHENSIVE INCOME
Comprehensive income was as follows (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
----------------- -----------------
2006 2005 2006 2005
------- ------- ------- -------
Net income ........................................ $ 7,977 $ 7,655 $ 16,682 $16,098
Foreign currency translation adjustment ........... 4,265 (5,490) 5,902 (9,746)
Unrealized holding gains (losses) on
available-for-sale securities, net of tax .... 97 292 263 (163)
Reclassification adjustment for losses included
in net income, net of tax .................... 194 18 254 18
------- ------- -------- -------
Comprehensive income .............................. $12,533 $ 2,475 $ 23,101 $ 6,207
======= ======= ======== =======
12
9. NET INCOME PER SHARE
Basic and diluted net income per share was as follows (in thousands, except per
share amounts):
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
2006 2005 2006 2005
-------- -------- -------- --------
Basic net income per share:
- ----------------------------
Net income ....................................... $ 7,977 $ 7,655 $ 16,682 $ 16,098
Weighted average common shares outstanding ....... 29,592 30,401 29,589 30,481
Basic net income per share ....................... $ 0.27 $ 0.25 $ 0.56 $ 0.53
Diluted net income per share:
- -----------------------------
Net income ....................................... $ 7,977 $ 7,655 $ 16,682 $ 16,098
Add back: Interest expense and other
income/(expense) related to convertible
notes payable, net of tax .............. 684 488 1,497 1,032
------- -------- ------- -------
Net income available to common stock .............. $ 8,661 $ 8,143 $ 18,179 $ 17,130
Weighted average common shares outstanding - Basic 29,592 30,401 29,589 30,481
Effect of dilutive securities:
Stock options and restricted stock ............ 698 824 713 946
Shares issuable upon conversion of notes payable 3,514 3,514 3,514 3,514
------- -------- ------- --------
Weighted average common shares for diluted
earnings per share ............................ 33,804 34,739 33,816 34,941
Diluted net income per share ..................... $ 0.26 $ 0.23 $ 0.54 $ 0.49
Options outstanding at June 30, 2006 and 2005 to acquire approximately 1.8
million shares and 909,000 shares of common stock, respectively, were excluded
from the computation of diluted net income per share for the three months ended
June 30, 2006 and 2005, respectively, because their effects would be
anti-dilutive. Options outstanding at June 30, 2006 and 2005 to acquire
approximately 1.9 million shares and 475,000 shares of common stock,
respectively, were excluded from the computation of diluted net income per share
for the six months ended June 30, 2006 and 2005, respectively, 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 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. The Company's
revenues were as follows (in thousands):
Three Months Six Months
Ended June 30, Ended June 30,
2006 2005 2006 2005
-------- -------- -------- --------
Revenue:
Neuro/Ortho Implants ...... $ 38,896 $ 34,319 $ 75,642 $ 65,703
MedSurg Equipment ......... 61,225 35,459 101,614 69,914
-------- -------- -------- --------
Total Revenue ............. $100,121 $ 69,778 $177,256 $135,617
Certain of the Company's products, including the DuraGen(R) and NeuraGen(TM)
product families and the INTEGRA(R) Dermal Regeneration Template and
wound-dressing products, contain material derived from bovine tissue. Products
that contain materials derived from animal sources, including food as well as
pharmaceuticals and medical devices, are increasingly subject to scrutiny from
13
the press and regulatory authorities. These products constituted 25% and 32% of
total revenues in each of the three-month periods ended June 30, 2006 and 2005,
respectively, and 27% and 31% of total revenues in each of the six-month periods
ending June 30, 2006 and 2005, respectively. 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 (in thousands):
United Asia Other
States Europe Pacific Foreign Total
-------- ------- -------- ------- --------
Three months ended June 30, 2006 .... $ 74,415 $19,615 $3,198 $2,893 $100,121
Three months ended June 30, 2005 .... 51,752 12,982 2,733 2,311 69,778
Six months ended June 30, 2006 ...... $131,653 $33,990 $5,994 $5,619 $177,256
Six months ended June 30, 2005 ...... 99,119 25,744 5,781 4,973 135,617
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 sued Merck KGaA, a German corporation, seeking damages
for patent infringement. The patents in question 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 case has been tried, appealed and returned to the trial court. Most
recently, in September 2004, the trial court ordered Merck KgaA to pay Integra
$6.4 million in damages. Merck KGaA filed a petition for 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 was to have reviewed the evidence under a
reasonableness test that does not provide categorical exclusions of certain
types of activities. The hearing before the Circuit Court occurred in June 2006,
and a ruling is expected this year. 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 May 2006, Codman & Shurtleff, Inc. ("Codman"), a division of Johnson &
Johnson, commenced an action in the United States District Court for the
District of New Jersey for declaratory judgment against Integra LifeSciences
Corporation with respect to United States Patent No. 5,997,895 (the "'895
Patent") held by Integra. Integra's patent covers dural repair technology
related to Integra's Duragen(R) family of duraplasty products.
The action seeks declaratory relief that Codman's DURAFORM(TM) product does not
infringe Integra's patent and that Integra's patent is invalid and
unenforceable. Codman does not seek either damages from Integra or injunctive
relief to prevent Integra from selling the Duragen(R) Dural Graft Matrix.
Integra has filed a counterclaim against Codman, alleging that Codman's
DURAFORM(TM) product infringes the '895 Patent, seeking injunctive relief
preventing the sale and use of DURAFORM(TM), and seeking damages, including
treble damages, for past infringement.
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.
14
12. SUBSEQUENT EVENTS
The Company announced on July 11, 2006 that it is launching a direct sales force
in Canada through the acquisition of its longstanding distributor, Canada
Microsurgical Ltd. Canada Microsurgical has eight sales representatives covering
each province in Canada. The Company paid $5.8 million (6.4 million Canadian
dollars) for Canada Microsurgical at closing. In addition, the Company will pay
up to an additional 2.1 million Canadian dollars over the next three years,
depending on the performance of the business. The determination of the fair
value of the assets acquired and liabilities assumed is in progress.
The Company announced on July 17, 2006 that it has commenced an offer to
exchange up to $120 million principal amount of new notes with a "net share
settlement" mechanism for its currently outstanding 2 1/2% Contingent
Convertible Subordinated Notes due 2008. Holders who exchange their existing
notes will receive new notes with the net share settlement feature and otherwise
substantially similar terms to the existing notes plus an exchange fee of $2.50
per $1,000 principal amount of their existing notes validly tendered and
accepted for exchange. The Company expects to pay $300,000 of exchange fees to
tendering holders of the existing notes plus estimated expenses, which may be in
excess of $225,000, in connection with the offer. In addition, approximately
$1.5 million of unamortized debt issuance costs may need to be expensed
immediately if the conversion criteria are met as the debt would be considered
demand debt. The offer is contingent upon the tender or exchange of 50% of the
principal amount of the existing notes and upon the satisfaction of certain
otherconditions. The exchange offer will expire on August 14, 2006, unless
extendedor earlier terminated by the Company.
The Company announced that on July 31, 2006 it has acquired the shares of
Kinetikos Medical, Inc. ("KMI") for approximately $40 million in cash, subject
to certain adjustments, including future payments based on the performance of
the KMI business after the acquisition. KMI, based in Carlsbad, California, is a
leading developer and manufacturer of innovative orthopedic implants and
surgical devices for small bone and joint procedures involving the foot, ankle,
hand, wrist and elbow. KMI currently markets products that address both the
trauma and reconstructive segments of the extremities market. KMI's
reconstructive products are largely focused on treating deformities and
arthritis in small joints of the upper and lower extremity, while its trauma
products are focused on the treatment of fractures of small bones most commonly
found in the extremities. KMI currently sells its products through approximately
45 independent sales agencies in the United States and through 17 independent
distributors internationally. The Company plans to expand the sale of KMI
products internationally through its well-established Newdeal infrastructure.
The determination of the fair value of the assets acquired and liabilities
assumed is in progress. The Company expects to record an in-process research and
development charge in the range of approximately $4 million to $8 million in the
third quarter of 2006 in connection with this acquisition.
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" in our
Annual Report on Form 10-K for the year ended December 31, 2005 and in
subsequent Quarterly Reports on Form 10-Q.
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.
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), two networks of
manufacturer's representatives managed by a direct sales organization (JARIT
Surgical Instruments and Miltex) 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, Canada, 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.
For the six months ended June 30, 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
and dental procedures, 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 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.
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
some of our 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 facilities in
Plainsboro, New Jersey and Puerto Rico. 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 27% and 31% of total revenues in each of
the six-month periods ended June 30, 2006 and 2005, respectively. 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.
16
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 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 six months ended June 30,
2006 not directly comparable to those of the corresponding prior-year period.
Since the beginning of 2005, we have acquired the following businesses:
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
$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 were to 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.
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 $2.7 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 directly to customers. As a
result, we expect that revenue and pre-tax income attributable to the acquired
product lines will be less than 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.
On May 12, 2006, we acquired all of the outstanding capital stock of Miltex
Holdings, Inc. ("Miltex") for $102.7 million in cash paid at closing, subject to
certain adjustments, and $0.2 million of transaction related costs. 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. Miltex sells products under the
Miltex(R), Meisterhand(R), Vantage(R), Moyco(R), Union Broach(R), and
Thompson(R) trade names in over 65 countries, using a network of independent
distributors. Miltex operates a manufacturing and distribution facility in York,
Pennsylvania and also operates a leased facility in Tuttlingen, Germany, where
Miltex's staff coordinates design, production and delivery of instruments.
We announced on July 11, 2006 that we are launching a direct sales force in
Canada through the acquisition of our longstanding distributor, Canada
Microsurgical Ltd. Canada Microsurgical has eight sales representatives covering
17
each province in Canada. The Company paid $5.8 million (6.4 million Canadian
dollars) for Canada Microsurgical at closing. In addition, the Company will pay
up to an additional 2.1 million Canadian dollars over the next three years,
depending on the performance of the business.
We announced that on July 31, 2006 we acquired the shares of Kinetikos Medical,
Inc. ("KMI") for approximately $40 million in cash, subject to certain
adjustments, including future payments based on the performance of the KMI
business after the acquisition. KMI, based in Carlsbad, California, is a leading
developer and manufacturer of innovative orthopedic implants and surgical
devices for small bone and joint procedures involving the foot, ankle, hand,
wrist and elbow. KMI currently markets products that address both the trauma and
reconstructive segments of the extremities market. KMI's reconstructive products
are largely focused on treating deformities and arthritis in small joints of the
upper and lower extremity, while its trauma products are focused on the
treatment of fractures of small bones most commonly found in the extremities.
KMI currently sells its products through approximately 45 independent sales
agencies in the United States and through 17 independent distributors
internationally. The Company plans to expand the sale of KMI products
internationally through its well-established Newdeal infrastructure.
IMPACT OF RESTRUCTURING ACTIVITIES
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. The Company terminated 68
individuals under the European restructuring plan.
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 six months
ended June 30, 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 may
terminate approximately ten additional employees over the next nine to twelve
months in connection with this transfer; however no final decision has been
made.
In connection with these restructuring activities, we recorded employee
termination costs of $127,000 and $251,000, respectively, during the three and
six months ended June 30, 2006.
While we expect to achieve a positive impact from the restructuring and
integration activities, such results remain uncertain. We have reinvested most
of the savings from these restructuring and integration activities into further
expanding our European sales, marketing and distribution organization, and
integrating the Radionics business into our existing sales and distribution
network.
RESULTS OF OPERATIONS
Net income for the three months ended June 30, 2006 was $8.0 million, or $0.26
per diluted share, as compared to net income of $7.7 million, or $0.23 per
diluted share, for the three months ended June 30, 2005.
Net income for the six months ended June 30, 2006 was $16.7 million, or $0.54
per diluted share, as compared to a net income of $16.1 million, or $0.49 per
diluted share, for the three months ended June 30, 2005.
These amounts include the following charges (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2006 2005 2006 2005
------ ------ ------ ------
Employee termination and related costs ........... $ 208 $2,074 $ 421 $2,074
Inventory fair market value purchase accounting
adjustments .................................. 2,149 197 2,613 466
Facility consolidation, acquisition integration,
manufacturing transfer, enterprise business
system integration, and related costs ........ 199 783 717 1,300
Impairment of inventory and fixed assets related
to discontinued development project........... 1,578 -- 1,578 --
Net share settlement transaction costs............ 87 -- 87 --
------ ------ ------ ------
Total $4,221 $3,054 $5,416 $3,840
18
Of these amounts, $3.6 million and $ 466,000 were charged to cost of product
revenues in the six-month periods ended June 30, 2006 and 2005, respectively,
and $1.6 million was charged to research and development in the three and six
months ended June 30, 2006. 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
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 recently acquired businesses and
additional systems integrations, along with additional fair market value
purchase accounting inventory costs, will be approximately $11.4 million in the
aggregate in 2006.
Net income for the three and six months ended June 30, 2006 also includes
approximately $4.4 million and $2.3 million, respectively, 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
Our revenues and gross margin on product revenues were as follows (in
thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2006 2005 2006 2005
-------- ------- ------- -------
Neuro/Ortho Implants ............................ $ 38,896 $ 34,319 $ 75,642 $ 65,703
MedSurg Equipment ............................... 61,225 35,459 101,614 69,914
------- -------- ------- -------
Total revenue ................................... $100,121 69,778 177,256 $135,617
Cost of product revenues ........................ 41,373 27,518 69,310 52,029
Gross margin on total revenues .................. 58,748 42,260 107,946 83,588
Gross margin as a percentage of total revenues... 59% 61% 61% 62%
THREE MONTHS ENDED JUNE 30, 2006 AS COMPARED TO THE THREE MONTHS ENDED JUNE 30,
2005
Revenues and Gross Margin
For the quarter ended June 30, 2006, total revenues increased 43% over the
prior-year period to $100.1 million. Domestic revenues increased $22.6 million
to $74.4 million, or 74% of total revenues, as compared to 74% of revenues in
the three months ended June 30, 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 30%
over the second quarter of 2005, nerve repair product revenues increased by 34%,
and our Newdeal foot and ankle products increased approximately 35%.
Sales of Reconstructive Surgery products continued their fast growth, while our
DuraGen(R) family of duraplasty products continued to grow modestly. 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 and sales of the recently acquired Radionics and Miltex
products provided the year-over-year growth in equipment product revenues for
the second quarter. Sales of Radionics and Miltex products contributed $23.6
million in the quarter.
19
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. Many of our recent acquisitions
involve businesses or product lines that overlap in some way with our existing
products. Our sales and marketing departments are integrating these
acquisitions, and there has been, and we expect there will continue to be, some
cannibalization of sales of our existing products that will affect our internal
growth. Overall, we target our revenues to continue to grow internally and
through acquisitions in the range of 20% to 30% per year.
In 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 $379,000 for the three-month period ended June 30, 2005.
Gross margin on total revenues in the second quarter of 2006 was 58.7%. Although
we had strong sales growth in many higher gross margin products, we recognized
$2.1 million in inventory fair value purchase accounting adjustments from the
Radionics and Miltex acquisitions as the products were sold and $346,000 in
restructuring and manufacturing transfer and systems integration costs. These
charges reduced our gross margin by approximately 2%. We recognized the impact
of $196,000 of inventory fair value purchase accounting adjustments in the
second quarter of 2005.
Sales of the relatively lower-margin Radionics and Miltex products reduced our
gross margin in the second quarter of 2006. Additionally, we recorded a $1.2
million impairment charge to cost of product revenues against a range of
electrosurgical generators and accessories sold exclusively in Europe following
a review of on-hand inventory quantities of those products in relation to
expected demand for that product line.
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, and also increased selling
expenses from commissions paid to distributors. We anticipate that the
relatively lower gross margin generated from sales of Radionics and Miltex
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 (in thousands):
Three Months Ended
June 30,
2006 2005
----- ------
Research and development ............................... 6% 4%
Selling, general and administrative .................... 38% 37%
Intangible asset amortization .......................... 2% 2%
Total other operating expenses ......................... 46% 43%
Total other operating expenses, which consist of research and development
expense, selling, general and administrative expense and amortization expense,
increased $15.5 million, or 51%, to $45.6 million in the second quarter of 2006,
compared to $30.1 million in the second quarter of 2005. The increase is
partially related to a $3.3 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) and higher commission expenses
associated with the JARIT direct bill initiative. Expenses also increased due to
the continued expansion of our direct sales and marketing organizations around
our direct selling platforms and increased corporate staff to support the recent
growth in our business and integrate acquired businesses. The recently acquired
Radionics and Miltex businesses contributed approximately $5 million in other
operating expenses in the second quarter 2006.
Research and development expenses in the second quarter of 2006 increased by
$3.6 million compared to the prior-year period. Included in research and
development costs was $140,000 of stock-based compensation expenses associated
with the adoption of Statement 123(R). In connection with our acquisition of
Radionics, research and development expenses increased by $1.0 million in the
second quarter June 30, 2006. We recognized a $1.6 million impairment of
inventory and fixed assets associated with a discontinued project for the
20
development of an ultrasonic aspirator system. This project was discontinued in
June 2006 following our review of our existing technology and the ultrasonic
aspirator technology acquired in the Radionics acquisition. We determined there
was no future, alternative use for the inventory or fixed assets in any other
development project. There was also an overall increase of $1.0 million
associated with product development initiatives compared to the prior-year
period. 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 $ 11.2 million, or 43%,
as compared to the prior-year period to $37.2 million. The increase in selling,
general and administrative expenses includes $3.2 million of stock-based
compensation expense associated with the adoption of Statement 123(R) and higher
commission expenses associated with the JARIT direct bill initiative. Selling,
general and administrative costs also increased in the second quarter of 2006 in
connection with the recently acquired Radionics and Miltex businesses. We also
continued to expand our direct sales and marketing organizations around our
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 an 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 second quarter of 2006 as a result of
amortization of intangible assets from the Radionics and Miltex acquisitions.
Non-Operating Income and Expenses
Interest expense primarily relates 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 second quarter of 2006 is primarily related
to the interest associated with the credit facility that was established in
December 2005. In the second quarter of 2006, we made net additional borrowings
of $48 million under our credit facility.
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 second quarter of 2006, the change in the
estimated fair value of the contingent interest obligation decreased interest
expense by $66,000. In the second quarter of 2005, the fair value decreased by
$180,000.
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 June 30, 2006 was $273,000. Interest
expense for the three months ended June 30, 2005 included an insignificant
amount associated with the interest rate swap.
For the three-month period ended June 30, 2006, the net fair value of the
interest rate swap increased $61,000 to $2.2 million, and the fair value amount
is included in other liabilities. In connection with this fair value hedge
transaction, during the second quarter of 2006 we recorded a $82,000 decrease in
the carrying value of our convertible notes. During the three months ended June
30, 2005, the net fair value of the interest rate swap decreased $619,000 to
$1.5 million, and the carrying value of our convertible notes increased by
$584,000. The net difference between changes in the fair value of the interest
rate swap and the contingent convertible notes represents the ineffective
portion of the hedging relationship, and this amount is recorded in other
income/(expense), net.
Our reported interest expense for the three-month periods ended June 30, 2006
and 2005 includes $273,000 and $204,000, respectively, 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.
21
Our income tax expense was $3.6 million and $4.0 million for the three-month
periods ended June 30, 2006 and 2005, respectively. The overall effective tax
rate for the three months ended June 30, 2006 and 2005 was 31.1% 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 have used substantially all of our remaining unrestricted and
current year allowable acquired net operating loss carryforwards to offset 2006
taxable income. At June 30, 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.
SIX MONTHS ENDED JUNE 30, 2006 AS COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2005
Revenues and Gross Margin
For the six months ended June 30, 2006, total revenues increased 31% over the
prior-year period to $177.3 million. Domestic revenues increased $32.5 million
to $131.7 million, or 74% of total revenues, as compared to 73% of revenues in
the six months ended June 30, 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 34%
over the six months of 2005, nerve repair product revenues increased by 38%, and
our Newdeal foot and ankle products increased approximately 29%.
Sales of Reconstructive Surgery products continued their fast growth, while our
DuraGen(R) family of duraplasty products continued to grow modestly. 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 and sales of the recently acquired Radionics and Miltex
products provided the year-over-year growth in equipment product revenues for
the six months. Sales of Radionics and Miltex products contributed $27.0 million
in the six months ended June 2006.
In 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 $758,000 for the six-month period ended June 30, 2005.
Gross margin on total revenues in the six months of 2006 was 61%. Although we
had strong sales growth in many higher gross margin products, we recognized $2.6
million in inventory fair value purchase accounting adjustments from the
Radionics and Miltex acquisitions as the products were sold and $936,000 in
restructuring and manufacturing transfer and systems integration costs. These
charges reduced our gross margin by approximately 2%. We recognized the impact
of $465,000 of inventory fair value purchase accounting adjustments in the six
months of 2005. Additionally, we recorded a $1.2 million impairment charge to
cost of product revenues against a range of electrosurgical generators and
accessories sold exclusively in Europe following a review of on-hand inventory
quantities of those products in relation to expected demand for that product
line.
Other Operating Expenses
The following is a summary of other operating expenses as a percent of total
revenues (in thousands):
Six Months Ended
June 30,
2006 2005
------ ------
Research and development ............................... 5% 5%
Selling, general and administrative .................... 39% 36%
Intangible asset amortization .......................... 2% 2%
Total other operating expenses ......................... 46% 43%
22
Total other operating expenses, which consists of research and development
expense, selling, general and administrative expense and amortization expense,
increased $22.6 million, or 39%, to $81.1 million in the six months of 2006,
compared to $58.5 million in the six months of 2005. The increase includes $6.4
million of stock-based compensation expense associated with the adoption of
Statement 123(R) (the majority of which is included in selling, general and
administrative expense). Our recently acquired Radionics and Miltex businesses
contributed approximately $5.5 million of other operating expenses for the
six-month period ended June 30, 2006. Higher commission expenses associated with
the JARIT distributor network, the continued expansion of our direct sales and
marketing organizations around our direct selling platforms and increased
corporate staff to support the recent growth in our business and integrate
acquired businesses also contributed to the increase.
Research and development expenses increased $3.4 million in the six months of
2006 and included $284,000 of stock-based compensation expenses associated with
the adoption of Statement 123(R), $1.2 million of research and development
activities from the recently acquired Radionics business and the $1.6 million
charge related to the discontinued ultrasonic aspirator development project.
Selling, general and administrative expenses increased $18.4 million, or 37%,
as compared to the prior-year period to $68.3 million. This increase is
primarily related to a $6.1 million stock-based compensation expense associated
with the adoption of Statement 123(R) and operating costs associated with the
recently acquired Radionics and Miltex businesses. Additionally, we have
incurred higher operating costs in connection with our recent investments in our
infrastructure, including the continued implementation of an 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 by approximately $0.9 million in the six months
of 2006 as a result of amortization of intangible assets from the Radionics and
Miltex acquisitions.
Non-Operating Income and Expenses
The increase in interest expense in the six months 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. In the six months
ended June 30, 2006, we made net borrowings of $64 million under our credit
facility.
In the six months of 2006, the changes in the estimated fair value of the
contingent interest obligation increased interest expense by $167,000. In the
six months of 2005, the valuation decreased by $202,000.
Interest expense associated with the interest rate swap for the six months ended
June 30, 2006 was $483,000. Interest expense for the six months ended June 30,
2005 included an insignificant benefit associated with the interest rate swap.
For the six-month period ended June 30, 2006, the net fair value of the interest
rate swap increased $215,000 to $2.2 million, and the fair value amount is
included in other liabilities. In connection with this fair value hedge
transaction, during the six months of 2006 we recorded a $277,000 decrease in
the carrying value of our convertible notes. During the six months ended June
30, 2005, the net fair value of the interest rate swap increased $136,000 to
$1.5 million, and the carrying value of our convertible notes decreased by
$203,000. The net difference between changes in the fair value of the interest
rate swap and the contingent convertible notes represents the ineffective
portion of the hedging relationship, and this amount is recorded in other income
(expense), net.
Our reported interest expense for the six-month periods ended June 30, 2006 and
2005 includes $545,000 and $406,000, respectively, 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 $7.9 million and $8.5 million for the six-month
periods ended June 30, 2006 and 2005, respectively. The overall effective tax
rate for the six months ended June 30, 2006 and 2005 was 32.1% 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.
23
INTERNATIONAL PRODUCT REVENUES AND OPERATIONS
Product revenues by major geographic area are summarized below (in thousands):
United Asia Other
States Europe Pacific Foreign Total
-------- -------- -------- -------- --------
Three months ended June 30, 2006 .... $ 74,415 $ 19,615 $ 3,198 $ 2,893 $100,121
Three months ended June 30, 2005 .... 51,752 12,982 2,733 2,311 69,778
Six months ended June 30, 2006 ...... 131,653 33,990 5,994 5,619 177,256
Six months ended June 30, 2005 ...... 99,119 25,744 5,781 4,973 135,617
For the three months ended June 30, 2006, revenues from customers outside the
United States totaled $25.7 million, or 26% of total revenues, of which
approximately 76% were to European customers. Revenues from customers outside
the United States included $15.9 million of revenues generated in foreign
currencies.
In the three months ending June 30, 2005, revenues from customers outside the
United States totaled $18.0 million, or 26% of total revenues, of which
approximately 72% were from European customers. Revenues from customers outside
the United States included $14.6 million of revenues generated in foreign
currencies.
For the six months ended June 30, 2006, revenues from customers outside the
United States totaled $45.7 million, or 26% of total revenues, of which
approximately 74% were to European customers. Revenues from customers outside
the United States included $30.6 million of revenues generated in foreign
currencies.
In the six months ending June 30, 2005, revenues from customers outside the
United States totaled $36.5 million, or 27% of total revenues, of which
approximately 71% were from European customers. Revenues from customers outside
the United States included $29.0 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 experience currency
exchange risk with respect to those foreign currency denominated revenues or
expenses.
In the six months 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.
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 June 30, 2006, we had cash, cash equivalents and current and non-current
investments totaling approximately $43.6 million. Our investments consist almost
entirely of highly liquid, interest bearing-debt securities.
At June 30, 2006, we had $3.5 million of cash pledged as collateral in
connection with our interest rate swap agreement.
24
In July 2006, we used $5.5 million of cash on hand and we borrowed an additional
$40 million under our credit facility to finance the acquisitions of Canada
Microsurgical Ltd. and Kinetikos Medical, Inc.
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 $26.3 million for the six
months ended June 30, 2006. Operating cash flows for the six months ended June
30, 2005 were $29.5 million. Overall, operating cash flows in the six months
ended of 2006 were negatively affected by subsequent investments in working
capital made in connection with the Radionics acquisition.
Our principal uses of funds during the six-month period ended June 30, 2006 were
$179.6 million for acquisition consideration, $15.2 million paid for the
purchase of 401,000 shares of our common stock and $3.6 million in capital
expenditures. We received $80.4 million in cash from sales and maturities of
available for sale securities, net of purchases. In addition to the $26.3
million in operating cash flows for the six months ended June 30, 2006, we
received $7.1 million from the issuance of common stock through the exercise of
stock options during the period and $64.0 million from borrowings under our
credit facility.
Working Capital
At June 30, 2006 and December 31, 2005, working capital was $112.8 million and
$234.7 million, respectively. The decrease in working capital is primarily
related to the use of $179.6 million for acquisition consideration in the first
six months of 2006. Working capital does not include the $9.7 million and $16.2
million of marketable securities classified as non-current at June 30, 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 15 and March 15. 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 June 30, 2006, our stock price
exceeded $37.56 and no convertible notes have been converted to 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.
On July 17, 2006, we commenced an offer to exchange up to $120 million principal
amount of new notes with a "net share settlement" mechanism for our currently
outstanding contingent convertible subordinated notes. Holders who exchange
their existing notes will receive new notes with the net share settlement
feature and otherwise substantially similar terms to the existing notes plus an
exchange fee of $2.50 per $1,000 principal amount of their existing notes
validly tendered and accepted for exchange. The Company expects to pay $300,000
of exchange fees to tendering holders of the existing notes plus estimated
expenses, which may be in excess of $225,000, in connection with the offer. In
addition, approximately $1.5 million of unamortized debt issuance costs may need
to be expensed immediately if the conversion criteria are met as the debt would
be considered demand debt. The offer is contingent upon the tender or exchange
of 50% of the principal amount of the existing notes and upon satisfaction of
certain conditions. The exchange offer will expire on August 14, 2006, unless
extended or earlier terminated by us.
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
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 4.6% as of June 30, 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.
25
The Company purchased 400,900 shares of our common stock for a total purchase
price of approximately $15.2 million during the three months ended June 30, 2006
under this repurchase program. No purchases were made under this program during
the first quarter of 2006.
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 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 have borrowed against this credit facility in 2006 for acquisition
related purposes. As of June 30, 2006, we had $64 million of outstanding
borrowings under our credit facility, and the weighted average interest rate per
annum for this borrowing was 6.30% per annum.
The indebtedness under the credit facility is guaranteed by all but one of our
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 of June 30, 2006, we were in compliance with all of
our debt covenants.
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 our 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
26
effective date of the statement. As a result of the adoption of Statement
123(R), we began expensing stock options in the first quarter of 2006 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 six months ended
June 30, 2006 were $6.5 million and $4.4 million lower, respectively, than if we
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 six months ended June
30, 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 pro forma 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 six months ended June 30, 2006 or pro forma amounts reported
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.
27
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 June 30, 2006 would
increase or decrease interest income by approximately $436,000 on an annual
basis. We are not subject to material foreign currency exchange risk with
respect to these investments.
Interest Rate Risk - Long Term Debt and Related Hedging Instruments
We are exposed to the risk of interest rate fluctuations on the net interest
received or paid under the terms of an interest rate swap. At June 30, 2006, we
had outstanding a $50 million notional amount interest rate swap used to hedge
the risk of changes in fair value attributable to interest rate risk with
respect to a portion of our $120.0 million principal amount fixed rate 2 1/2%
contingent convertible subordinated notes due March 2008.
Our interest rate swap agreement qualifies as a fair value hedge under SFAS No.
133, as amended, "Accounting for Derivative Instruments and Hedging Activities."
At June 30, 2006, the net fair value of the interest rate swap approximated $2.3
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.
Interest Rate Risk - Senior Secured Credit Facility
We are exposed to the risk of interest rate fluctuations on the interest paid
under the terms of our senior secured credit facility. A hypothetical 100 basis
point movement in interest rates applicable to this credit facility would
increase or decrease interest expense by approximately $640,000 on an annual
basis.
28
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 June 30, 2006, that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
On March 3, 2006 and May 12, 2006 the Company completed the purchases of
Radionics and Miltex, respectively, and is in the process of integrating the
operations and related controls of both businesses within the Company. See Note
2, "Business Acquisitions", to the unaudited interim condensed consolidated
financial statements included in this Quarterly Report on Form 10-Q for a
discussion of the acquisitions and related financial data.
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.
29
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, the Company sued Merck KGaA, a German corporation, seeking damages
for patent infringement. The patents in question 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 case has been tried, appealed and returned to the trial court. Most
recently, in September 2004, the trial court ordered Merck KgaA to pay Integra
$6.4 million in damages. Merck KGaA filed a petition for 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 was to have reviewed the evidence under a
reasonableness test that does not provide categorical exclusions of certain
types of activities. The hearing before the Circuit Court occurred in June 2006,
and a ruling is expected this year. 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 May 2006, Codman & Shurtleff, Inc., a division of Johnson & Johnson,
commenced an action in the United States District Court for the District of New
Jersey for declaratory judgment against Integra LifeSciences Corporation with
respect to United States Patent No. 5,997,895 (the "'895 Patent") held by
Integra. Integra's patent covers dural repair technology related to Integra's
Duragen(R) family of duraplasty products.
The action seeks declaratory relief that Codman's DURAFORM(TM) product does not
infringe Integra's patent and that Integra's patent is invalid and
unenforceable. Codman does not seek either damages from Integra or injunctive
relief to prevent Integra from selling the Duragen(R) Dural Graft Matrix.
Integra has filed a counterclaim against Codman, alleging that Codman's
DURAFORM(TM) product infringes the '895 Patent, seeking injunctive relief
preventing the sale and use of DURAFORM(TM), and seeking damages, including
treble damages, for past infringement.
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.
30
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 (as modified by the subsequent Quarterly
Report on Form 10-Q) have not materially changed other than the modifications to
the risks factors as set forth below.
Our Current Strategy Involves Growth Through Acquisitions, Which Requires
Us To Incur Substantial Costs And Potential Liabilities For Which We May Never
Realize The Anticipated Benefits.
In addition to internal growth, our current strategy involves growth through
acquisitions. Since 1999, we have acquired 25 businesses or product lines at a
total cost of approximately $438 million.
A significant portion of our growth in revenues has resulted from, and is
expected to continue to result from, the acquisition of businesses complementary
to our own. We evaluate potential acquisitions and are in various stages of
discussion regarding possible acquisitions, certain of which, if consummated,
could be significant to us. Any potential acquisitions may result in material
transaction expenses, increased interest and amortization expense, increased
depreciation expense and increased operating expense, any of which could have a
material adverse effect on our operating results. As we grow by acquisitions, we
must integrate and manage the new businesses to realize economies of scale and
control costs. In addition, acquisitions involve other risks, including
diversion of management resources otherwise available for ongoing development of
our business and risks associated with entering new markets with which our
marketing department and sales force has limited experience or where experienced
distribution alliances are not available. Our future profitability will depend
in part upon our ability to develop further our resources to adapt to these new
products or business areas and to identify and enter into satisfactory
distribution networks. We may not be able to identify suitable acquisition
candidates in the future, obtain acceptable financing or consummate any future
acquisitions. If we cannot integrate acquired operations, manage the cost of
providing our products or price our products appropriately, our profitability
could suffer. In addition, as a result of our acquisitions of other healthcare
businesses, we may be subject to the risk of unanticipated business
uncertainties, regulatory matters or legal liabilities relating to those
acquired businesses for which the sellers of the acquired businesses may not
indemnify us.
To Market Our Products Under Development We Will First Need To Obtain Regulatory
Approval. Further, If We Fail To Comply With The Extensive Governmental
Regulations That Affect Our Business, We Could Be Subject To Penalties And Could
Be Precluded From Marketing Our Products.
Our research and development activities and the manufacturing, labeling,
distribution and marketing of our existing and future products are subject to
regulation by numerous governmental agencies in the United States and in other
countries. The United States Food and Drug Administration (FDA) and comparable
agencies in other countries impose mandatory procedures and standards for the
conduct of clinical trials and the production and marketing of products for
diagnostic and human therapeutic use.
Our products under development are subject to FDA approval or clearance prior to
marketing for commercial use. The process of obtaining necessary FDA approvals
or clearances can take years and is expensive and full of uncertainties. Our
inability to obtain required regulatory approval on a timely or acceptable basis
could harm our business. Further, approval or clearance may place substantial
restrictions on the indications for which the product may be marketed or to whom
it may be marketed, the warnings that may be required to accompany the product
or additional restrictions placed on the sale and/or use of the product. Further
studies, including clinical trials and FDA approvals, may be required to gain
approval for the use of a product for clinical indications other than those for
which the product was initially approved or cleared or for significant changes
to the product. In addition, for products with an approved Pre-Marketing
Approval (PMA), the FDA requires annual reports and may require post-approval
surveillance programs to monitor the products' safety and effectiveness. Results
of post-approval programs may limit or expand the further marketing of the
product.
Another risk of application to the FDA relates to the regulatory classification
of new products or proposed new uses for existing products. In the filing of
each application, we make a judgment about the appropriate form and content of
the application. If the FDA disagrees with our judgment in any particular case
and, for example, requires us to file a PMA application rather than allowing us
to market for approved uses while we seek broader approvals or requires
extensive additional clinical data, the time and expense required to obtain the
required approval might be significantly increased or approval might not be
granted.
Approved products are subject to continuing FDA requirements relating to quality
control and quality assurance, maintenance of records, reporting of adverse
events and product recalls, documentation, and labeling and promotion of medical
devices.
31
The FDA and foreign regulatory authorities require that our products be
manufactured according to rigorous standards. These regulatory requirements may
significantly increase our production or purchasing costs and may even prevent
us from making or obtaining our products in amounts sufficient to meet market
demand. If we or a third-party manufacturer change our approved manufacturing
process, the FDA may require a new approval before that process may be used.
Failure to develop our manufacturing capability may mean that even if we develop
promising new products, we may not be able to produce them profitably, as a
result of delays and additional capital investment costs. Manufacturing
facilities, both international and domestic, are also subject to inspections by
or under the authority of the FDA. In addition, failure to comply with
applicable regulatory requirements could subject us to enforcement action,
including product seizures, recalls, withdrawal of clearances or approvals,
restrictions on or injunctions against marketing our product or products based
on our technology, cessation of operations and civil and criminal penalties.
We are also subject to the regulatory requirements of countries outside of the
United States where we do business. For example, Japan has issued an amendment
to its Pharmaceutical Affairs Law which went into effect on April 1, 2005. New
regulations and requirements exist for obtaining approval of medical devices,
including new requirements governing the conduct of clinical trials, the
manufacturing of products and the distribution of products in Japan. Significant
resources may be needed to comply with the extensive auditing of and requests
for documentation relating to all manufacturing facilities of our company and
our vendors by the Pharmaceutical Medical Device Agency (PMDA) and the Ministry
of Health, Labor and Welfare (MHLW) in Japan to comply with the amendment to the
Pharmaceutical Affairs Law. These new regulations may affect our ability to
obtain approvals of new products for sale in Japan.
We May Be Involved In Lawsuits Relating To Our Intellectual Property Rights And
Promotional Practices, Which May Be Expensive.
To protect or enforce our intellectual property rights, we may have to initiate
or defend legal proceedings, such as infringement suits or interference
proceedings, against or by third parties. For example, Codman & Shurtleff, Inc.,
a division of Johnson & Johnson, commenced an action in May 2006 seeking
declaratory relief that its DURAFORM(TM) product does not infringe our patent
covering our duraplasty products and that our patent is invalid and
unenforceable. In addition, we may have to institute proceedings regarding our
competitors' promotional practices or defend proceedings regarding our
promotional practices. Litigation is costly, and, even if we prevail, the cost
of that litigation could affect our profitability. In addition, litigation is
time consuming and could divert management attention and resources away from our
business. We may also provoke these third parties to assert claims against us.
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 is 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 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.
Changes In The Health Care Industry May Require Us To Decrease The Selling Price
For Our Products Or May Reduce The Size Of The Market For Our Products, Either
Of Which Could Have A Negative Impact On Our Financial Performance.
Trends toward managed care, health care cost containment and other changes in
government and private sector initiatives in the United States and other
32
countries in which we do business are placing increased emphasis on the delivery
of more cost-effective medical therapies that could adversely affect the sale
and/or the prices of our products. For example:
o major third-party payors of hospital services and hospital outpatient
services, including Medicare, Medicaid and private health care
insurers, annually revise their payment methodologies, which can result
in stricter standards for reimbursement of hospital charges for certain
medical procedures;
o Medicare, Medicaid and private health care insurer cutbacks could
create downward price pressure on our products;
o recent drafts of local Medicare coverage determinations, if effected,
would eliminate reimbursement for certain of our dermal regeneration
products, potentially negatively affecting our market for these
products;
o potential legislative proposals have been considered that would result
in major reforms in the U.S. health care system that could have an
adverse effect on our business;
o there has been a consolidation among health care facilities and
purchasers of medical devices in the United States who prefer to limit
the number of suppliers from whom they purchase medical products, and
these entities may decide to stop purchasing our products or demand
discounts on our prices;
o we are party to contracts with group purchasing organizations, which
negotiate pricing for many member hospitals, that require us to
discount our prices for certain of our products and limit our ability
to raise prices for certain of our products, particularly surgical
instruments;
o there is economic pressure to contain health care costs in domestic and
international markets;
o there are proposed and existing laws, regulations and industry policies
in domestic and international markets regulating the sales and
marketing practices and the pricing and profitability of companies in
the health care industry;
o proposed laws or regulations that will permit hospitals to provide
financial incentives to doctors for reducing hospital costs (known as
gainsharing) and to award physician efficiency (known as physician
profiling) could reduce prices; and
o there have been initiatives by third-party payors to challenge the
prices charged for medical products that could affect our ability to
sell products on a competitive basis.
Both the pressures to reduce prices for our products in response to these trends
and the decrease in the size of the market as a result of these trends could
adversely affect our levels of revenues and profitability of sales.
33
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. Shares may be purchased either in the open market or
in privately negotiated transactions.
The following table summarizes our repurchases of our common stock during the
quarter ended June 30, 2006 under this program:
Total Number Approximate
of Shares Dollar Value of
Purchased as Shares that May
Total Number Average Part of Publicly Yet be Purchased
of Shares Price Paid Announced Under the
Period Purchased per Share Program Program
- --------------------- ------------ ----------- ---------------- --------------
April 1, 2006 -
April 30, 2006 -- $ -- -- $50,000,000
May 1, 2006 -
May 31, 2006 400,900 37.88 400,900 34,813,278
June 1, 2006 -
June 30, 2006 -- -- -- 34,813,278
- --------------------- ------------ ---------- ---------------- --------------
Total 400,900 $ 37.88 400,900 $34,813,278
34
ITEM 4. SUBMISSION OF MATTTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on May 17, 2006 and in
connection therewith, management solicited proxies pursuant to Regulation 14A
under the Securities Exchange Act of 1934, as amended. An aggregate of
27,183,686 shares of the Company's common stock was outstanding and entitled to
a vote at the meeting. At the meeting the following matters (not including
ordinary procedural matters) were submitted to a vote of the holders of the
common stock, with the results indicated below:
1. Election of directors to serve until the 2007 Annual Meeting. The following
persons were elected. All were management's nominees for election, and all,
except Mr. Schade, were serving as directors. There was no solicitation in
opposition to such nominees. The tabulation of votes was as follows:
Nominee For Withheld
---------------------- ---------- ----------
Keith Bradley 26,552,806 630,610
Richard E. Caruso 18,530,760 8,652,926
Stuart M. Essig 26,961,041 221,645
Christian S. Schade 27,015,524 168,162
James M. Sullivan 26,973,882 209,804
Anne M. VanLent 26,605,034 578,652
2. Ratification of independent registered public accounting firm. The
appointment of PricewaterhouseCoopers LLP as the Company's independent
registered public accounting firm for the current fiscal year was ratified. The
tabulation of votes was as follows:
For Against Abstentions
---------- --------- ------------
26,718,535 162,852 2,293
35
ITEM 6. EXHIBITS
10.1 Severance Agreement, dated as of March 1, 2006, by and between Integra
LifeSciences Holdings Corporation and Deborah A. Leonetti.
(Incorporated by reference to Exhibit 10.1 to the Company's Current
Report on Form 8-K filed on April 13, 2006).
10.2 Severance Agreement, dated as of March 1, 2006, by and between Integra
LifeSciences Holdings Corporation and Robert D. Paltridge.
(Incorporated by reference to Exhibit 10.2 to the Company's Current
Report on Form 8-K filed on April 13, 2006).
10.3 Stock Purchase Agreement, dated as of April 19, 2006, by and between
ASP/Miltex LLC and Integra LifeSciences Corporation (Incorporated by
reference to Exhibit 10.1 to the Company's Current Report on Form 8-K
filed on April 25, 2006)
10.4 Agreement and Plan of Merger, dated as of June 30, 2006, by and between
Integra LifeSciences Corporation, Integra California, Inc., Kinetikos
Medical, Inc., Telegraph Hill Partners Management LLC, as Shareholders
Representative, and the Shareholders party thereto (Incorporated by
reference to Exhibit 10.1 to the Company's Current Report on Form 8-K
filed on July 7, 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
36
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
Date: August 9, 2006 /s/ Stuart M. Essig
-------------------
Stuart M. Essig
President and Chief Executive Officer
Date: August 9, 2006 /s/ Maureen B. Bellantoni
-------------------
Maureen B. Bellantoni
Executive Vice President and Chief
Financial Officer
37
EXHIBITS
10.1 Severance Agreement, dated as of March 1, 2006, by and between Integra
LifeSciences Holdings Corporation and Deborah A. Leonetti.
(Incorporated by reference to Exhibit 10.1 to the Company's Current
Report on Form 8-K filed on April 13, 2006).
10.2 Severance Agreement, dated as of March 1, 2006, by and between Integra
LifeSciences Holdings Corporation and Robert D. Paltridge.
(Incorporated by reference to Exhibit 10.2 to the Company's Current
Report on Form 8-K filed on April 13, 2006).
10.3 Stock Purchase Agreement, dated as of April 19, 2006, by and between
ASP/Miltex LLC and Integra LifeSciences Corporation (Incorporated by
reference to Exhibit 10.1 to the Company's Current Report on Form 8-K
filed on April 25, 2006)
10.4 Agreement and Plan of Merger, dated as of June 30, 2006, by and between
Integra LifeSciences Corporation, Integra California, Inc., Kinetikos
Medical, Inc., Telegraph Hill Partners Management LLC, as Shareholders
Representative, and the Shareholders party thereto (Incorporated by
reference to Exhibit 10.1 to the Company's Current Report on Form 8-K
filed on July 7, 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
38
Certification of Principal Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Stuart M. Essig, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Integra
LifeSciences Holdings Corporation;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present
in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for,
the periods presented in this report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and we have:
(a) designed such disclosure controls and procedures, or
caused such disclosure controls and procedures to be
designed under our supervision, to ensure that
material information relating to the registrant,
including its consolidated subsidiaries, is made
known to us by others within those entities,
particularly during the period in which this report
is being prepared;
(b) designed such internal control over financial
reporting, or caused such internal control over
financial reporting to be designed under our
supervision, to provide reasonable assurance
regarding the reliability of financial reporting and
the preparation of financial statements for external
purposes in accordance with generally accepted
accounting principles;
(c) evaluated the effectiveness of the registrant's
disclosure controls and procedures and presented in
this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the
end of the period covered by this report based on
such evaluation; and
(d) disclosed in this report any change in the
registrant's internal control over financial
reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal
quarter in the case of an annual report) that has
materially affected, or is reasonably likely to
materially affect, the registrant's internal control
over financial reporting; and
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
(a) all significant deficiencies and material weaknesses
in the design or operation of internal control over
financial reporting which are reasonably likely to
adversely affect the registrant's ability to record,
process, summarize and report financial information;
and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal control over
financial reporting.
Date: August 9, 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-Q of Integra
LifeSciences Holdings Corporation;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other
financial information included in this report, fairly present
in all material respects the financial condition, results of
operations and cash flows of the registrant as of, and for,
the periods presented in this report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and we have:
(a) designed such disclosure controls and procedures, or
caused such disclosure controls and procedures to be
designed under our supervision, to ensure that
material information relating to the registrant,
including its consolidated subsidiaries, is made
known to us by others within those entities,
particularly during the period in which this report
is being prepared;
(b) designed such internal control over financial
reporting, or caused such internal control over
financial reporting to be designed under our
supervision, to provide reasonable assurance
regarding the reliability of financial reporting and
the preparation of financial statements for external
purposes in accordance with generally accepted
accounting principles;
(c) evaluated the effectiveness of the registrant's
disclosure controls and procedures and presented in
this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the
end of the period covered by this report based on
such evaluation; and
(d) disclosed in this report any change in the
registrant's internal control over financial
reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal
quarter in the case of an annual report) that has
materially affected, or is reasonably likely to
materially affect, the registrant's internal control
over financial reporting; and
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
(a) all significant deficiencies and material weaknesses
in the design or operation of internal control over
financial reporting which are reasonably likely to
adversely affect the registrant's ability to record,
process, summarize and report financial information;
and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal control over
financial reporting.
Date: August 9, 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
June 30, 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: August 9, 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
June 30, 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: August 9, 2006 /s/ Maureen B Bellantoni
-------------------------------
Maureen B. Bellantoni
Executive Vice President and Chief Financial
Officer