Interpore International 10-Q 2003 Q3 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2003

or

¨ 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. 0-22958

INTERPORE INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

Delaware	95-3043318
(State or other jurisdiction of incorporation or organization)	(I.R.S. employer identification number)

181 Technology Drive, Irvine, California	92618-2402
(Address of Principal Executive Offices)	(Zip Code)

Registrant’s telephone number, including area code: (949) 453-3200

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

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 proceeding 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. Yesx No¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yesx No¨

As of November 7, 2003, there were 17,872,379 shares of the registrant’s common stock issued and outstanding.

Interpore International, Inc.

Index

		Page(s)
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of December 31, 2002 and September 30, 2003 (unaudited)	3
	Condensed Consolidated Statements of Income (unaudited) for the three month and nine month periods ended September 30, 2002 and September 30, 2003	4
	Condensed Consolidated Statements of Cash Flows (unaudited) for the nine month periods ended September 30, 2002 and September 30, 2003	5
	Notes to Condensed Consolidated Financial Statements (unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	21
Item 4.	Controls and Procedures	22
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	23
Item 6.	Exhibits and Reports on Form 8-K	24
Signatures		25

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Interpore International, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except share data)

	December 31, 2002			September 30, 2003
				(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	1,810		$	5,227
Short-term investments		—			7,678
Accounts receivable, less allowance for doubtful accounts of $797 and $651 in 2002 and 2003, respectively		12,632			12,291
Inventories		31,995			33,670
Prepaid expenses		1,484			2,500
Deferred income taxes		2,154			2,154
Total current assets		50,075			63,520
Property, plant and equipment, net		3,410			3,021
Deferred income taxes		799			799
Goodwill		20,201			20,324
Other intangible assets, net		2,548			2,566
Other assets		209			789
Total assets	$	77,242		$	91,019
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	2,932		$	1,981
Accrued compensation and related expenses		1,803			2,104
Accrued royalties		530			518
Income taxes payable		—			2,078
Other accrued liabilities		943			1,396
Total current liabilities		6,208			8,077
Long-term debt		5,818			—
Commitments and contingencies
Stockholders’ equity:
Preferred stock, par value $.01 per share: Authorized shares – 5,000,000; issued and outstanding shares – none		—			—
Common stock, par value $.01 per share: Authorized shares – 50,000,000; issued and outstanding shares – 17,932,464 at December 31, 2002 and 18,477,379 at September 30, 2003		179			184
Additional paid-in-capital		64,855			68,492
Retained earnings		3,291			17,375
		68,325			86,051
Less treasury stock, at cost - 605,000 shares at December 31, 2002 and September 30, 2003		(3,109	)		(3,109	)
Total stockholders’ equity		65,216			82,942
Total liabilities and stockholders’ equity	$	77,242		$	91,019

See accompanying notes.

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Interpore International, Inc.

Condensed Consolidated Statements of Income

(in thousands, except per share data)

(unaudited)

	Three months ended September 30,						Nine months ended September 30,
	2002			2003			2002			2003
Net product sales	$	14,724		$	16,981		$	43,173		$	50,106
Royalty income		—			1,525			—			2,589
Total revenues		14,724			18,506			43,173			52,695
Cost of goods sold		4,277			5,170			12,114			14,844
Gross profit		10,447			13,336			31,059			37,851
Operating expenses:
Research and development		1,855			1,808			5,834			6,169
Selling and marketing		6,366			7,285			17,675			20,168
General and administrative		1,845			1,904			5,376			5,288
Total operating expenses		10,066			10,997			28,885			31,625
Income from operations		381			2,339			2,174			6,226
Interest income		1			39			40			104
Interest expense		(11	)		(5	)		(21	)		(23	)
Legal settlement		—			—			—			15,000
Other income		202			253			487			699
Total interest and other income, net		192			287			506			15,780
Income before taxes		573			2,626			2,680			22,006
Income tax provision (benefit)		(811	)		945			—			7,922
Net income	$	1,384		$	1,681		$	2,680		$	14,084
Net income per share:
Basic	$	.08		$	.09		$	.16		$	.80
Diluted	$	.08		$	.09		$	.15		$	.76
Weighted average shares:
Basic		17,282			17,823			17,219			17,555
Diluted		17,724			19,393			18,059			18,646

See accompanying notes.

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Interpore International, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

	Nine months ended September 30,
	2002			2003
Cash flows from operating activities
Net income	$	2,680		$	14,084
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation		847			924
Amortization		218			239
Stock-based compensation expense		199			318
Changes in operating assets and liabilities:
Accounts receivable		(136	)		341
Inventories		(11,740	)		(1,675	)
Prepaid expenses		(1,204	)		(774	)
Other assets		28			64
Accounts payable and accrued liabilities		1,871			1,907
Net cash provided by (used in) operating activities		(7,237	)		15,428
Cash flows from investing activities
Net cash paid for American OsteoMedix Corporation		(66	)		(161	)
Capital expenditures		(1,643	)		(535	)
Expenditures for patent rights		(688	)		(257	)
Sale of short-term investments		—			2,495
Purchase of short-term investments		—			(10,173	)
Net cash used in investing activities		(2,397	)		(8,631	)
Cash flows from financing activities
Proceeds from (repayment of) long-term debt		3,332			(5,818	)
Proceeds from exercise of stock options		1,008			2,343
Proceeds from employee stock purchase plan		60			95
Net cash provided by (used in) financing activities		4,400			(3,380	)
Net increase (decrease) in cash and cash equivalents		(5,234	)		3,417
Cash and cash equivalents at beginning of period		6,538			1,810
Cash and cash equivalents at end of period	$	1,304		$	5,227

See accompanying notes.

5

Interpore International, Inc.

Notes to Condensed Consolidated Financial Statements

September 30, 2003

(unaudited)

1. Organization and Description of Business

Interpore International, Inc. (“Interpore”), together with its subsidiaries unless the context implies otherwise, operates in one business segment: the design, manufacture and marketing of medical devices for the orthopedic marketplace. Interpore’s products are distributed in the United States and internationally.

2. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to Securities and Exchange Commission regulations. In the opinion of management, the accompanying condensed consolidated financial statements include all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the consolidated financial position at September 30, 2003 and the consolidated results of operations and cash flows for the periods ended September 30, 2002 and 2003.

The accompanying condensed consolidated financial statements include the accounts of Interpore and its subsidiaries after elimination of all significant intercompany transactions.

The results of operations and cash flows for the periods ended September 30, 2003 are not necessarily indicative of results to be expected for future quarters or the full year.

These consolidated financial statements should be read in conjunction with the financial statements included in Interpore’s Annual Report on Form 10-K for the year ended December 31, 2002, as filed with the Securities and Exchange Commission.

3. Revenue Recognition

Revenue from sales of product where the customer immediately accepts title is recorded at the time of shipment. Revenue from sales of consigned inventory is recorded upon receipt of written acknowledgement from sales agents or customers that the product has been used in a surgical procedure. Provision is made currently for estimated product returns based on historical experience and other known factors.

Royalty income is recorded upon receipt of royalty payments from third parties to which Interpore has granted licenses to certain of its spinal implant patents. These licenses provide for royalties calculated at a negotiated percentage of sales of specified spinal implant products by the third parties.

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4. Earnings Per Share

Basic earnings per share (EPS) is calculated by dividing net earnings by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the assumed conversion of all dilutive securities, consisting of employee stock options and warrants. The following table presents the computation of net income per share (in thousands, except per share data):

	Three months ended September 30,				Nine months ended September 30,
	2002		2003		2002		2003
Net income	$	1,384	$	1,681	$	2,680	$	14,084
Shares used in computing net income per share - basic:
Weighted average common shares outstanding		17,282		17,823		17,219		17,555
Effect of dilutive securities:
Common share equivalents outstanding		442		1,570		840		1,091
Shares used in computing net income per share - diluted		17,724		19,393		18,059		18,646
Basic earnings per share	$	.08	$	.09	$	.16	$	.80
Diluted earnings per share	$	.08	$	.09	$	.15	$	.76
Stock option shares excluded from the diluted earnings per share calculation because their assumed conversion would have been anti-dilutive		1,196		9		124		19

5. Inventories

Inventories are stated at the lower of first-in, first-out average cost or market. Inventories are comprised of the following (in thousands):

	December 31, 2002		September 30, 2003
Raw materials	$	4,655	$	3,394
Work-in-process		874		1,268
Finished goods		26,466		29,008
	$	31,995	$	33,670

6. Stock Option Plans

Interpore accounts for stock compensation to employees using the intrinsic value method provided for by Accounting Principles Board Opinion No. 25 (APB 25),Accounting for Stock Issued to Employees and related interpretations. Interpore applies APB 25 and related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under Statement of Financial Accounting Standards No. 123 (SFAS 123),Accounting for Stock-Based Compensation, requires use of option valuation models that were not developed for use in valuing employee stock options.

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Pro forma information regarding net income and earnings per share is required by SFAS 123, and has been determined as if Interpore had accounted for employee stock options under the fair value method of SFAS 123. The fair value for these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: a risk-free interest rate of 3% in 2002 and 2003, a volatility factor of the expected market price of Interpore common stock of .73 in 2002 and 2003, a weighted-average expected life of the options of six years, and no dividend yield.

The following table illustrates the effect on net income per share, had compensation expense for the employee stock-based plans been recorded based on the fair value method under SFAS 123 (in thousands, except per share data):

	Three months ended September 30,				Nine months ended September 30,
	2002		2003		2002		2003
Net income, as reported	$	1,384	$	1,681	$	2,680	$	14,084
Deduct: total stock based employee compensation expense determined under fair value based method, net of related tax effects		392		360		1,175		1,064
Net income, as adjusted	$	992	$	1,321	$	1,505	$	13,020
Basic net income per share:
As reported	$	.08	$	.09	$	.16	$	.80
As adjusted	$	.06	$	.07	$	.09	$	.74
Diluted net income per share:
As reported	$	.08	$	.09	$	.15	$	.76
As adjusted	$	.06	$	.07	$	.08	$	.70

7. Income Taxes

The effective tax rate for the third quarter of 2003 was 36%. During the third quarter of 2002, Interpore revised its estimate of the expected effective tax rate for 2002 to 0%, and applied this revised rate to year-to-date pre-tax income resulting in a tax benefit being recorded in the quarter. The effective tax rates for the nine months ended September 30, 2002 and 2003 were 0% and 36%, respectively.

8. Goodwill

In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,Business Combinations and No. 142,Goodwill and Other Intangible Assets. SFAS 141 addresses financial accounting and reporting for business combinations and requires all business combinations to be accounted for using the purchase method. SFAS 142 addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. Goodwill and other intangible assets with indefinite lives are no longer amortized, but instead subject to impairment tests at least annually. The impairment test is comprised of two parts. The first step compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount exceeds the fair value of a reporting unit, the second step of the goodwill impairment test must be performed. The second step compares the implied fair value of the reporting unit’s goodwill with the respective carrying amount in order to determine the amount of impairment loss, if any. In July 2001, upon the acquisition of American OsteoMedix Corporation (“AOM”), Interpore early adopted SFAS 141 and SFAS 142. In connection with the acquisition, approximately $20 million of the purchase price was allocated to goodwill. Prior to July 2001, Interpore had no goodwill or other intangible assets with indefinite lives. In accordance with SFAS 142. Interpore performed the first part of the two-step goodwill impairment test. For Interpore’s subsidiary, AOM, for which goodwill was recorded, Interpore determined that the fair value exceeded the carrying amount as of January 1, 2002. As a result, the second step of the impairment test was not required. Interpore performed the annual impairment test during the quarter ended

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September 30, 2003 and determined that there was no impairment of goodwill. Interpore intends to perform its annual impairment test of goodwill during the respective third quarter of subsequent years.

9. Recent Accounting Pronouncements

In January 2003 the Financial Accounting Standards Board issued Interpretation No. 46,Consolidation of Variable Interest Entities (“FIN 46”). FIN 46 requires the primary beneficiary of a variable interest entity (“VIE”) to consolidate the entity and also requires majority and significant variable interest investors to provide certain disclosures. For arrangements entered into with VIEs created prior to January 31, 2003, the provisions of FIN 46 are required to be adopted at the end of periods ending after December 15, 2003. Interpore is currently reviewing its investments and other arrangements to determine whether any of its investee companies are VIEs. Interpore does not expect to identify any significant VIEs that would be consolidated, but may be required to make additional disclosures. The provisions of FIN 46 are effective immediately for all arrangements entered into with new VIEs created after January 31, 2003. Interpore has not invested in any new VIEs created after January 31, 2003.

10. Commitments and Contingencies

Cross Medical Products v. Medtronic Sofamor Danek

On May 1, 2003, Cross filed an amended complaint in the United States District Court for the Central District of California against Medtronic Sofamor Danek, Inc. and Medtronic Sofamor Danek USA, Inc. (collectively, “Medtronic”), which complaint alleges that Medtronic has infringed and continues to infringe Cross’ U.S. Patent Nos. 5,466,237, 5,474,555 and 5,624,442. These patents relate to technology embodied in certain components of the SYNERGY Spinal System. The complaint seeks damages for willful past and continuing infringement of the patents. The complaint also seeks a declaratory judgment against Medtronic that Cross is not infringing U.S. Patent Nos. 5,591,165, 4,641,636, 4,815,453 and 5,005,562. On June 23, 2003, Medtronic filed counterclaims for a declaratory judgment that it does not infringe Cross’ patents, and that the patents are invalid and unenforceable.

On October 10, 2003, Medtronic filed a motion to amend its answer and counterclaims to add certain affirmative defenses and causes of action against Cross on behalf of Medtronic and SDGI Holdings, Inc. (“SDGI”) for past and continued infringement of U.S. Patent Nos. 6,152,927 and 6,533,786 based on Cross’ C-TEK anterior cervical plate system. That motion was set for hearing on November 3, 2003.

On October 22, 2003, the Court, at the request of Cross, dismissed Cross’ claims for declaratory judgment that Cross is not infringing U.S. Patent Nos. 5,591,165, 4,641,636, 4,815,453 and 5,005,562.

On November 3, 2003, the Court granted Medtronic’s motion to amend its answer and counterclaims to allege causes of action against Cross on behalf of Medtronic and SDGI for past and continued infringement of U.S. Patent Nos. 6,152,927 and 6,533,786 based on Cross’ C-TEK anterior cervical plate system.

On October 22, 2003, Cross, Interpore Cross, and Interpore Orthopaedics, Inc. (“Interpore Orthopaedics”) filed an amended complaint in the United States District Court for the Central District of California against Medtronic and SDGI, which complaint alleges that Medtronic has infringed and continues to infringe Cross’ U.S. Patent No. 6,224,602. That patent relates to technology embodied in certain components of the C-TEK anterior cervical plate system. The complaint seeks damages for willful past and continuing infringement of the patent. The complaint also seeks a declaratory judgment against Medtronic and SDGI that Interpore Cross and Interpore Orthopaedics are not infringing U.S. Patent Nos. 6,152,927 and 6,533,786.

Interpore is unable at this time to predict the outcome of these litigations.

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Aside from these matters, the nature of Interpore’s business subjects it to product liability and various other legal proceedings from time to time. Interpore is currently involved in legal proceedings incidental to the normal conduct of our business. Interpore does not believe that any liabilities relating to the legal proceedings to which it is a party are likely to be, individually or in the aggregate, material to Interpore’s consolidated financial condition or results of operations.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Our revenues are generated from the sale of medical device products and from the receipt of royalty payments from third parties to which we have granted licenses to certain of our spinal implant patents. Our medical device products fall into three principal categories—spinal implant products, orthobiologic products and minimally invasive surgery, or M.I.S., products. Our spinal implant products consist of titanium or stainless steel hooks, rods, plates, spacers and screws and related instruments required for the surgeon to assemble a construct which restores the natural anatomy of the spine, keeping it immobilized while a bone graft eventually fuses the vertebrae. Our orthobiologic products consist of bone graft substitute materials and products used to derive Autologous Growth Factors^®, or AGF^®. AGF fibrinogen-rich extract is used to provide faster, more complete bone growth and enhance the performance of our bone graft products. Our M.I.S. products consist of instruments and devices used to deliver biocompatible materials into bony structures in a minimally invasive procedure.

All of our operations are located in the United States; however, we sell our products to customers both within and outside the United States. Within the United States, we distribute our products through independent agencies and direct sales representatives. The independent agencies and our direct sales representatives provide delivery and consultative services to our surgeon and hospital customers and receive commissions based on sales in their territories. The commissions are reflected in our income statement within selling and marketing expense.

For our spinal implant products and M.I.S. products, we invoice hospitals directly following a surgical procedure in which our products are used. These products are made available to hospitals from consignment inventories maintained by our independent agencies and direct sales representatives, or from loaner implant sets that we ship from our facility. For our orthobiologic products, we generally ship directly to hospitals from our facility, and we invoice hospitals upon shipment. Our AGF and ACCESS processors are usually placed on consignment at hospitals; the hospitals are invoiced for AGF and ACCESS^® disposables.

Outside the United States, we sell our products directly to distributors who maintain an inventory of our products. We record revenue at the time of shipment to the distributor at prices reflecting a discount from our U.S. list prices. The distributors provide service to the surgeons and hospitals, deliver products and invoice hospitals directly at prices determined by the distributors.

Because our revenues from U.S. hospitals are primarily at list price, and our revenues from international distributors are at a discount to U.S. list prices, our overall gross margin is subject to fluctuation based on our domestic versus international sales mix, with domestic gross margins being somewhat higher than international gross margins.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an on-going basis, we evaluate our estimates including those related to product returns, bad debts, inventories, intangible assets, income taxes and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements:

• Revenue from sales of product where the customer immediately accepts title is recorded at the time of shipment. Revenue from sales of consigned inventory is recorded upon receipt of written acknowledgement from independent agencies, direct sales representatives or customers that the product has been used in a surgical procedure. Provision is made currently for estimated product returns based on historical experience and other known factors.

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• Royalty income is recorded upon receipt of royalty payments from third parties to which we have granted licenses to certain of our spinal implant patents. These licenses provide for royalties calculated at a negotiated percentage of sales of specified spinal implant products by the third parties.

• We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances would be required.

• We provide an inventory reserve for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs would be required.

• We have significant intangible assets, including goodwill. The determination of related estimated useful lives and whether or not these assets are impaired involves significant judgments. Changes in strategy or market conditions could significantly impact these judgments and require adjustments to recorded asset balances.

• We currently have deferred tax assets, which are subject to periodic recoverability assessments. Realization of our deferred tax assets is principally dependent upon our achievement of projected future taxable income. We evaluate the realizability of the deferred tax assets annually.

Results of Operations

The following table presents our results of operations as percentages:

	Three months ended September 30,						Nine months ended September 30,
	Percentage of total revenues				Percentage change		Percentage of total revenues				Percentage change
	2002		2003		2003 vs. 2002		2002		2003		2003 vs. 2002
Total revenues	100.0	%	100.0	%	25.7	%	100.0	%	100.0	%	22.1	%
Cost of goods sold	29.0	%	27.9	%	20.9	%	28.1	%	28.2	%	22.5	%
Gross profit	71.0	%	72.1	%	27.7	%	71.9	%	71.8	%	21.9	%
Operating expense:
Research and development	12.6	%	9.8	%	(2.5	%)	13.5	%	11.7	%	5.7	%
Selling and marketing	43.3	%	39.4	%	14.4	%	40.9	%	38.3	%	14.1	%
General and administrative	12.5	%	10.3	%	3.2	%	12.5	%	10.0	%	(1.6	%)
Total operating expenses	68.4	%	59.5	%	9.2	%	66.9	%	60.0	%	9.5	%
Income from operations	2.6	%	12.6	%	513.9	%	5.0	%	11.8	%	186.4	%

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Three months ended September 30, 2002 and 2003

For the quarter ended September 30, 2003, total revenues of $18.5 million were $3.8 million, or 25.7%, higher than total revenues of $14.7 million for the same period of 2002. Net product sales for the quarter ended September 30, 2003 of $17.0 million were $2.3 million, or 15.3%, higher than net product sales of $14.7 million for the quarter ended September 30, 2002. The following table presents total revenues by category (in thousands):

	Three months ended September 30,				Change
	2002		2003		Amount		%
Spinal implant product sales	$	9,569	$	11,450	$	1,881	19.7	%
Orthobiologic product sales		4,200		4,512		312	7.4	%
M.I.S. product sales		955		1,019		64	6.7	%
Net product sales		14,724		16,981		2,257	15.3	%
Royalty income		—		1,525		1,525	n/a
Total revenues	$	14,724	$	18,506	$	3,782	25.7	%

Sales of spinal implant products for the quarter ended September 30, 2003 increased by $1.9 million, or 19.7%, to $11.5 million, compared to $9.6 million for the quarter ended September 30, 2002. The increase is primarily attributable to growth in sales of C-TEK® and GEO STRUCTURE™ products as well as sales of our recently released ALTIUS™ and TPS™-TL products.

Sales of orthobiologic products increased by $312,000, or 7.4%, to $4.5 million for the quarter ended September 30, 2003, compared to $4.2 million for the quarter ended September 30, 2002. During 2002, we experienced a decline in year-over-year orthobiologic products sales, which we attribute primarily to increased competition for platelet-based growth factor products and to the focus of our independent sales agencies on the spinal implant market. To combat the decline in sales of our orthobiologic products, our strategy has been to introduce new orthobiologic products and expand the direct sales force specifically responsible for sales of these products. The third quarter sales growth resulted primarily from sales of our INTERGRO™ allograft putty products, which were introduced in 2002 and 2003. We anticipate that these strategic efforts may result in the continuation of the improved sales trend in our orthobiologic products; however, we cannot assure you that INTERGRO will achieve additional market acceptance; that we will be able to successfully introduce ACCESS, our improved AGF processing system; or that our efforts in hiring domestic direct sales representatives to focus on our orthobiologic products will be successful.

Sales of M.I.S. products increased by $64,000, or 6.7%, to $1.0 million for the quarter ended September 30, 2003, compared to $955,000 for the quarter ended September 30, 2002. In the fourth quarter of 2002, we initiated significant organization changes in our M.I.S business, beginning with the closing of the M.I.S. related facility in Leesburg, Virginia. In early 2003 we hired two domestic sales division managers for our M.I.S. products and began to expand the direct sales force which is exclusively focused on selling our M.I.S. products. Second quarter 2003 domestic sales of M.I.S. products increased by 16% when compared to the first quarter of 2003; however, third quarter 2003 domestic sales decreased by 8% when compared to the second quarter of 2003. The length of time it takes for a newly-hired direct sales representative to achieve a satisfactory level of monthly sales is greater than we had anticipated. Nonetheless, we believe that these efforts are necessary to help generate continued growth in sales in this product category. However, we cannot assure you that our efforts will ultimately result in the sales growth we expect in M.I.S. products.

Domestic sales of all product categories increased $2.2 million, or 18.1%, to $14.2 million for the quarter ended September 30, 2003, compared to $12.0 million for the same period of 2002. International sales for the quarter ended September 30, 2003 increased by $83,000 or 3.1%, to $2.8 million from $2.7 million for the quarter ended September 30, 2002.

During the quarter ended September 30, 2003, we received royalty payments totaling $1.5 million from third parties to which we have granted licenses to certain of our spinal implant patents. This royalty payment stream began in the second quarter of 2003.

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For the quarter ended September 30, 2003, gross profit was 72.1% of total revenues compared to 71.0% of total revenues for the quarter ended September 30, 2002. However, before accounting for the effect of the royalty income, the gross profit as a percentage of net sales declined from 71.0% in the quarter ended September 30, 2002 to 70.0% in the quarter ended September 30, 2003. This decline reflects the comparatively lower gross margin on sales of certain recently released products, primarily INTERGRO allograft products and ACCESS processors.

Total operating expenses for the quarter ended September 30, 2003 increased by $931,000, or 9.2%, to $11.0 million, compared to $10.1 million for the same quarter of 2002. However, as a percentage of total revenue, total operating expenses decreased from 68.4% in the third quarter of 2002 to 59.5% in the third quarter of 2003. Research and development expenses decreased by $47,000, or 2.5%, compared to the third quarter of 2002. Selling and marketing expenses increased $919,000, or 14.4%, compared to the third quarter of 2002, primarily due to our investment in additional direct sales personnel for our orthobiologic and M.I.S. products. General and administrative expenses increased $59,000, or 3.2%, compared to the third quarter of 2002.

Total interest and other income increased to $287,000 for the quarter ended September 30, 2003, compared to $192,000 during the same period of 2002. The increase is primarily the result of higher non-core product royalty income and interest income on higher average cash and short-term investment balances.

The effective tax rate for the third quarter of 2003 was 36%. Tax savings projects undertaken during the third quarter ended September 30, 2002 generated a significant tax benefit in that quarter, resulting in the reversal of the $811,000 tax provision that had been recorded for the first six months of 2002.

Nine months ended September 30, 2002 and 2003

For the nine months ended September 30, 2003, total revenues of $52.7 million were $9.5 million, or 22.1%, higher than total revenues of $43.2 million for the same period of 2002. Net product sales for the nine months ended September 30, 2003 of $50.1 million were $6.9 million, or 16.1%, higher than net product sales of $43.2 million for the nine months ended September 30, 2002. The following table presents total revenues by category (in thousands):

	Nine months ended September 30,				Change
	2002		2003		Amount		%
Spinal implant product sales	$	26,742	$	32,889	$	6,147	23.0	%
Orthobiologic product sales		13,359		14,112		753	5.6	%
M.I.S. product sales		3,072		3,105		33	1.1	%
Net product sales		43,173		50,106		6,933	16.1	%
Royalty income		—		2,589		2,589	n/a
Total revenues	$	43,173	$	52,695	$	9,522	22.1	%

Sales of spinal implant products for the nine months ended September 30, 2003 increased by $6.1 million, or 23.0%, to $32.9 million, compared to $26.7 million for the nine months ended September 30, 2002. The increase is primarily attributable to growth in sales of SYNERGY™, C-TEK and GEO STRUCTURE products as well as sales of our recently released ALTIUS and TPS-TL products.

Sales of orthobiologic products increased by $753,000, or 5.6%, to $14.1 million for the nine months ended September 30, 2003, compared to $13.4 million for the nine months ended September 30, 2002. The increase resulted primarily from sales of our INTERGRO allograft putty products.

Sales of M.I.S. products were approximately $3.1 million in both nine month periods ended September 30, 2003 and September 30, 2002.

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Domestic sales for all product categories increased $4.9 million, or 13.8%, to $40.3 million for the nine months ended September 30, 2003, compared to $35.4 million for the same period of 2002. International sales of $9.8 million for the nine months ended September 30, 2003 were $2.0 million, or 26.5%, higher than sales of $7.7 million for the same period of 2002.

During the nine month period ended September 30, 2003, we received royalty payments totaling $2.6 million from third parties to which we have granted licenses to certain of our spinal implant patents. This royalty payment stream began in the second quarter of 2003.

For the nine months ended September 30, 2003, the gross margin was 71.8% of total revenues, compared to 71.9% of total revenues for the nine months ended September 30, 2002. However, before accounting for the effect of the royalty income, the gross profit as a percentage of net sales declined from 71.9% in the nine months ended September 30, 2002 to 70.4% in the nine months ended September 30, 2003. This decline reflects the comparatively lower gross margin on sales of certain recently released products, primarily INTERGRO allograft products and ACCESS processors.

Total operating expenses for the nine months ended September 30, 2003 increased by $2.7 million, or 9.5%, to $31.6 million, compared to $28.9 million for the same period of 2002. As a percentage of total revenues, total operating expenses decreased from 66.9% in the nine months ended September 30, 2002 to 60.0% in the same period of 2003. Research and development expenses increased for the nine months ended September 30, 2003 by $335,000, or 5.7%, as compared to the same period in 2002 due primarily to efforts related to the development of potential new products. Selling and marketing expenses for the nine months ended September 30, 2003 increased by $2.5 million, or 14.1%, compared to the nine months ended September 30, 2002, primarily due to our investment in additional direct sales personnel for our orthobiologic and M.I.S. products. General and administrative expenses decreased by $88,000, or 1.6%, compared to the nine months ended September 30, 2002.

Total interest and other income increased to $15.8 million for the nine months ended September 30, 2003, compared to $506,000 during the same period of 2002. Other income in 2003 includes a $15 million payment from DePuy Spine, received in January 2003, in settlement of patent litigation.

The effective tax rate for the nine months ended September 30, 2003 was 36.0%. Because of the significant tax benefit in 2002 resulting from tax savings projects undertaken during the third quarter ended September 30, 2002, we recorded no income tax provision for the nine months ended September 30, 2002.

Liquidity and Capital Resources

At September 30, 2003, cash, cash equivalents and short-term investments totaled $12.9 million, an increase of $11.1 million from $1.8 million at December 31, 2002. We have a $10.0 million secured revolving bank line of credit which expires in June 2005. At December 31, 2002, we had borrowed approximately $5.8 million under this facility to fund our 2002 working capital needs, which were driven primarily by significant investments in inventories to support new product launches. On January 27, 2003, we received the $15 million payment from DePuy Spine in settlement of patent litigation, some of which was used to pay off the outstanding balance on our line of credit. We currently have no outstanding borrowings under our line of credit.

We plan to continue making significant investments in initial inventory levels for new products. We also intend to continue to invest in the development of our business. We believe we currently possess sufficient resources, including our revolving bank line of credit, to meet the cash requirements of our operations for at least the next year. In addition, we have used and may continue to use our cash, our common stock, or a combination of both to pay for purchased technologies, product lines, mergers and acquisitions. Some of these activities may require resources in excess of those which we currently possess, and we cannot assure you that we will be able to raise additional capital on satisfactory terms, if at all.

At September 30, 2003, we had no material commitments for capital expenditures.

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Cautionary Note Regarding Forward-Looking Statements

Investors are cautioned that certain statements contained in or incorporated by reference into this Quarterly Report on Form 10-Q, or which are otherwise made by us or on our behalf are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements that are predictive in nature, which depend upon or refer to future events or conditions, which include words such as “believes,” “plans,” “anticipates,” “estimates,” “expects” or similar expressions. In addition, any statements concerning future financial performance, ongoing business strategies or prospects, and possible future actions, which may be provided by our management, are also forward-looking statements. Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties, and assumptions about our company, economic and market factors and the industry in which we do business, among other things. These statements are not guaranties of future performance and we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

Actual events and results may differ materially from those expressed or forecasted in forward-looking statements due to a number of factors. Factors that could cause our actual performance and future events and actions to differ materially from such forward-looking statements, include, but are not limited to those discussed below and elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2002.

We are dependent on a few products which may be rendered obsolete.

A majority of our revenue currently comes from sales of our SYNERGY, C-TEK and PRO OSTEON® products. We cannot assure you that we will continue to market these products successfully or that we will be able to increase sales of these products in the future. Any significant diminished sales of our SYNERGY, C-TEK or PRO OSTEON products would adversely affect our business and results of operations.

If we fail to compete successfully against existing or potential competitors, our operating results may be adversely affected.

The market for our products is intensely competitive, subject to change and significantly affected by new product introductions and other market activities of industry participants. Our principal global competitors with respect to our spinal implant product line are Medtronic Sofamor Danek, Inc., DePuy Spine, Inc., a Johnson & Johnson company, and Synthes-Stratec, Inc. Our principal global competitors with respect to our orthobiologic products include DePuy Spine, Inc., Medtronic Sofamor Danek, Inc., Osteotech, Inc., Orthovita, IsoTis OrthoBiologics, Regeneration Technologies and Wright Medical Technology. Our principal competitor with respect to our minimally invasive surgery products is Kyphon Inc. We compete in all of our markets primarily on the basis of product performance and price, as well as customer loyalty and service. Many of our competitors have greater resources for product development, sales and marketing and patent litigation than we do. Accordingly, they could substantially increase the resources they devote to the development and marketing of products that are competitive with ours. Many of our potential customers have existing relationships with our competitors that could make it difficult for us to continue to penetrate the markets for our products. Additionally, several of our competitors have broader product lines that we do. Moreover, our competitors may develop and successfully commercialize medical devices that directly or indirectly accomplish what our products are designed to accomplish in a superior and less expensive manner. If our competitors’ products prove to be more successful than ours, our products could be rendered obsolete. If we fail to compete successfully against our existing or potential competitors, our operating results may be adversely affected.

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We may not be able to develop new products that will be accepted by the market.

Our future growth will be dependent on our ability to develop and introduce new products, including enhancements to our existing products. We cannot assure you that we will be able to successfully develop or market new products or that any of our future products will be accepted by our customers. If we do not develop new products in time to meet market demand or if there is insufficient demand for these products, our revenues and profitability may be adversely affected. The success of any new product offerings or enhancements to existing product offerings will depend on several factors, including our ability to:

• properly identify and anticipate customer needs;

• commercialize new products or enhancements in a timely manner;

• develop an effective marketing and distribution network for new products or product enhancements;

• manufacture and deliver products in sufficient volumes on time;

• differentiate our offerings from competitors’ offerings;

• achieve positive clinical outcomes for new products or product enhancements;

• satisfy the increased demands of healthcare payors, providers and patients for lower-cost procedures;

• innovate and develop new materials, product designs and surgical techniques;

• obtain the necessary regulatory approvals for new products or product enhancements; and

• provide adequate medical and/or consumer education relating to new products and product enhancements and attract key surgeons to advocate these new products and product enhancements.

In addition, we have spent and expect to continue to spend significant cash on the development, product launch and continued marketing of new products, and if there is insufficient demand for these new products, our cash flow could suffer and our liquidity would be adversely affected.

Our ability to increase the market penetration of AGF, via the introduction of our new ACCESS processing system, is uncertain.

Our AGF related products were commercially launched in 1999 and were the first products available that could concentrate a patient’s platelet-derived growth factors to levels shown in studies that would enhance bone growth in grafts. Since that time, several competitors have introduced competitive products that, while unable to achieve comparable growth factor concentrations, are simpler to use than our original AGF processing system and can produce smaller quantities at a lower cost. As a result, sales of our AGF related products have declined.

We have designed our new ACCESS system, soon to be commercially launched, to address these competitive issues. We are also in late stages of building a direct sales force for our orthobiologic products, and this direct sales force will be a critical component in our domestic introduction of ACCESS. However, our competitors have greater financial resources and distribution than us, and we cannot assure you that our efforts to increase sales of AGF related products via the ACCESS launch will be successful.

Additionally, published data regarding the efficacy of AGF are limited. If long-term studies or clinical experience indicate that procedures involving AGF do not provide patients with improved clinical outcomes, anticipated sales of our AGF related products and ACCESS technology may never materialize. Our success in selling our AGF related products will depend, in large part, on the medical community’s acceptance of AGF. The medical community’s acceptance of AGF will depend upon our ability to demonstrate the efficacy of AGF and its advantages, favorable clinical performance and cost-effectiveness. We cannot predict whether the medical community will accept AGF or ACCESS or, if accepted, the extent of the medical community’s use of these products. If long-term studies or clinical experience indicate that AGF causes negative effects, we could be subject to significant liability.

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Our minimally invasive surgery products business may not achieve the growth we expect and our results of operations and financial condition could be adversely affected.

To date, our M.I.S. revenues have been below our expectations. To address this, we are investing significantly in the hiring and training of a group of direct sales representatives that will be dedicated primarily to the sale of our M.I.S. products. We believe that these efforts may allow us to achieve the expected growth in M.I.S. revenues. However, we cannot assure you that our efforts will be successful. The creation of a direct sales force is very expensive, and if this sales force does not achieve the expected growth in M.I.S. revenues, our results of operations and financial condition could be materially and adversely affected.

We face risks related to the maintenance, upgrading and expansion of our domestic distribution network.

In domestic markets, we primarily use independent sales agents for the distribution of our spinal implant products and orthobiologic products. However, because of the agents’ focus on selling only to spinal surgeons, our orthobiologic products sales have suffered. Therefore, we have created an initial direct sales force to distribute our orthobiologic products in certain underperforming territories, and we plan to significantly increase this sales force in the future. However, we cannot assure you that we will be successful in our efforts to identify and hire qualified candidates for these positions, or that such candidates, upon their hiring, will be successful in distributing our orthobiologic products. Additionally, this effort requires a substantial investment and our profitability could be adversely affected as a result.

We expect to continue to rely primarily on independent agencies for the domestic distribution of our spinal implant products. Independent commissioned sales agencies may represent other medical devices for a variety of manufacturers and may not dedicate enough time or attention to selling our products. Furthermore, we expend significant resources to train and educate new independent agencies about our products and our marketing programs. Our ability to recruit independent sales agencies has been aided by some of our competitors’ replacement of independent agencies with direct sales representatives. However, our competitors may not continue to utilize direct sales representatives and we cannot assure you that we will continue to be able to attract new or retain our current independent sales agencies. We also cannot assure you that we will be able to develop an effective distribution network or that our independent agencies will be able to continue to increase sales or maintain current sales levels of our products.

We may face challenges to our patents and proprietary rights.

We rely on a combination of patents, trade secrets and nondisclosure agreements to protect our proprietary intellectual property. Our patent positions and those of other medical device companies are uncertain and involve complex and evolving legal and factual questions. We cannot assure you that pending patent applications will result in issued patents, that patents issued to or licensed by us will not be challenged or circumvented by competitors or that such patents will be found to be valid or sufficiently broad to protect our technology or to provide us with any competitive advantage. Third parties could also obtain patents that may require licensing for the conduct of our business, and there can be no assurance that the required licenses would be available. We also rely on nondisclosure agreements with certain employees, consultants and other parties to protect, in part, trade secrets and other proprietary technology. We cannot assure you that these agreements will not be breached, that we will have adequate remedies for any breach, that others will not independently develop substantially equivalent proprietary information or that third parties will not otherwise gain access to our trade secrets and proprietary knowledge. If our intellectual property is not adequately protected, our competitors could use the intellectual property that we have developed to enhance their products and compete more directly with us, which could result in a decrease in our market share and profits.

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We are from time to time involved in litigation to protect or enforce our patents and proprietary rights, or to defend against claims brought by others, which could be expensive and time consuming.

The medical product industry is characterized by frequent and substantial intellectual property litigation and competitors may resort to intellectual property litigation as a means of competition. Intellectual property litigation is complex and expensive, and the outcome of such litigation is difficult to predict. We cannot assure you that we will be successful in defending against these claims. This and any future litigation, regardless of the outcome, could result in substantial expense and significant diversion of the efforts of our technical and management personnel. Additionally, an adverse determination in any such proceeding could subject us to significant liabilities to third parties, or require us to seek licenses from third parties or pay royalties that may be substantial. Accordingly, an adverse determination in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from manufacturing or selling certain of our products which in turn would have a material adverse effect on our business, financial condition and results of operations. Litigation may also be necessary to enforce our patents and license agreements, to protect our trade secrets or know-how or to determine the enforceability, scope and validity of the proprietary rights of others. We recently filed suit against another medical device manufacturer claiming that certain of its products infringe several of our spinal implant patents and seeking a declaratory judgment that our products do not infringe its patents. This and any future litigation to protect or enforce our proprietary rights could result in substantial expense and significant diversion of management’s attention from our business.

Product introductions or modifications may be delayed or canceled as a result of the FDA regulatory process, which could cause our sales to decline.

The medical devices we manufacture and market are subject to rigorous regulation by the FDA and numerous other federal, state and foreign governmental authorities. Our failure to comply with such regulations could lead to the imposition of injunctions, suspensions or loss of regulatory approvals, product recalls, termination of distribution or product seizures. In the most egregious cases, criminal sanctions or closure of our manufacturing facilities are possible. The process of obtaining regulatory approvals to market a medical device, particularly from the FDA, can be costly and time-consuming, and we cannot assure you that such approvals will be granted on a timely basis, if at all. The regulatory process may delay the marketing of new products for lengthy periods and impose substantial additional costs or it may prevent the introduction of new products altogether. In particular, the FDA permits commercial distribution of a new medical device only after the FDA has cleared a 510(k) premarket notification or has approved a Premarket Approval application, or PMA, for such device. The FDA will clear marketing of a medical device through the 510(k) process if it is demonstrated that the new product is substantially equivalent to other 510(k)-cleared products. The PMA approval process is more costly, lengthy and uncertain than the 510(k) premarket notification process. We cannot assure you that any new products we develop will be subject to the shorter 510(k) clearance process and therefore significant delays in the introduction of any new products that we develop may occur. We anticipate that most of our products that are in final development will be eligible for the 510(k) premarket notification process. If the FDA does not clear marketing of our products in final development through the 510(k) clearance process, we will be forced to comply with the PMA approval process in order to obtain FDA approval for these products. If we choose to go through the PMA approval process, there will be significant costs and delays in the introduction of our new products, if they are approved at all. Moreover, foreign governmental authorities have become increasingly stringent and we may be subject to more rigorous regulation by foreign governmental authorities in the future. Any inability or failure of our foreign independent distributors to comply with the varying regulations or the imposition of new regulations could restrict such distributors’ ability to sell our products internationally and thereby adversely affect our business. All products and manufacturing facilities are subject to continual review and periodic inspection by the FDA. The discovery of previously unknown problems with our company or our products or facilities may result in product labeling restrictions, recall or withdrawal of the products from the market. In addition, the FDA actively enforces regulations prohibiting the promotion of medical devices for unapproved indications. If the FDA determines that we have marketed our products for off-label use, we could be subject to fines, injunctions or other penalties.

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We may be subject to product liability claims and our limited product liability insurance may not be sufficient to cover the claims, or we may be required to recall our products.

We manufacture medical devices that are used on patients in surgical procedures, and we may be subject to product liability claims and product recalls. The spinal implant industry has been historically litigious and we face an inherent business risk of financial exposure to product liability claims. Since most of our products are implanted in the human body, manufacturing errors or design defects could result in injury or death to the patient, and could result in a recall of our products and substantial monetary damages. Any product liability claim brought against us, with or without merit, could result in an increase to our product liability insurance premiums or our inability to secure coverage in the future. We would also have to pay any amount awarded by a court in excess of our policy limits. In addition, any recall of our products, whether initiated by us or by a regulatory agency, may result in adverse publicity for us that could have a material adverse effect on our business, financial condition and results of operations. Our product liability insurance policies have various exclusions, and we may be subject to a product liability claim or recall for which we have no insurance coverage, in which case we may have to pay the entire amount of the award or costs of the recall. Finally, product liability insurance is expensive and may not be available in the future on acceptable terms, or at all.

Possible denial of third-party reimbursement could have a material adverse effect on our future business, results of operations and financial condition.

In the United States, our products are purchased by hospitals that are reimbursed for the devices provided to their patients by third-party payors, such as governmental programs (e.g., Medicare and Medicaid), private insurance plans and managed care programs. These third-party payors may deny reimbursement if they determine that a device used in a procedure was not used in accordance with cost-effective treatment methods, as determined by the third-party payor, or was used for an unapproved indication. Also, third-party payors are increasingly challenging the prices charged for medical products and services. In addition, we believe the increasing emphasis on managed care in the United States may put pressure on the prices and usage of our products, which may adversely affect product sales. In international markets, reimbursement and healthcare payment systems vary significantly by country and many countries have instituted price ceilings on specific product lines. We cannot assure you that our products will be considered cost-effective by third-party payors, that reimbursement will be available or, if available, that the third-party payors’ reimbursement policies will not adversely affect our ability to sell our products profitably.

We are dependent on our suppliers and the loss of any of them could adversely affect our business.

We do not manufacture the components for our spinal implants or instruments or minimally invasive surgery products; rather, we are dependent upon several suppliers for the manufacturing of such components. Also, the specialized filter material contained in our UltraConcentrator was sole-sourced from a vendor that no longer supplies the material. Although we have not identified any alternate vendors of the filter material, we have a several year supply of the material in inventory and we believe there are suppliers that could supply alternate materials which may have equivalent function. In the event that a re-engineering of the product were necessary due to a conversion to an alternate material, delays in product availability could occur and significant costs could be incurred, either of which could have a material adverse effect on our operations.

The harvesting of coral is subject to regulation which could affect our ability to obtain sufficient quantities of coral in the future.

The harvesting and import of the coral used for our coral-based orthobiologic products must comply with the requirements of the Convention on International Trade of Endangered Species of Wild Fauna and Flora. As a result, we must register and obtain licensure from the U.S. Department of Fish and Wildlife for both the import of raw coral and the export of finished product. In the future, regulations could make the import or export of coral or coral-derived products prohibitive and could interrupt our ability to supply product. We cannot assure you that our supply of raw coral is sufficient, that we will be able to obtain sufficient quantities of coral in the future or that future regulations will not prohibit its use altogether.

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Our business could be materially adversely impacted by risks inherent in international markets.

For the nine months ended September 30, 2003, approximately 20% of our net product sales were generated outside the United States. We expect that such sales will continue to account for a significant portion of our revenue in the future. Our international sales subject us to other inherent risks, including the following:

• fluctuations in currency exchange rates;

• regulatory, product approval and reimbursement requirements;

• tariffs and other trade barriers;

• greater difficulty in accounts receivable collection and longer collection periods;

• difficulties and costs of managing foreign distributors;

• reduced protection for intellectual property rights in some countries;

• burdens of complying with a wide variety of foreign laws;

• the impact of recessions in economies outside the United States;

• political and economic instability; and

• seasonal reductions in business activity during the summer months in Europe and other parts of the world.

If we fail to successfully market and sell our products in international markets, our business, financial condition, results of operations, and cash flows could be materially and adversely affected.

The information contained in this report is as of September 30, 2003, unless expressly stated as of another date. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. We also may make additional disclosures in our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K that we may file from time to time with the Securities and Exchange Commission. Please also note that we provide a cautionary discussion of risks and uncertainties under the section entitled “Certain Business Considerations” in our Annual Report on Form 10-K for the year ended December 31, 2002. These are factors that we think could cause our actual results to differ materially from expected results. Other factors besides those listed here could also adversely affect us. This discussion is provided as permitted by the Private Securities Litigation Reform Act of 1995.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risk for changes in interest rates related primarily to our cash and cash equivalent balances and marketable securities. However, as all of our investments are in short-term instruments, we believe that we have no material market risk exposure. All of our international sales are denominated in U.S. dollars, and accordingly, we believe we have no material foreign currency exchange rate risk.

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Item 4. 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 SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

There has been no change in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

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PART II - OTHER INFORMATION

Item 1. Legal Proceedings

Cross Medical Products v. Medtronic Sofamor Danek

On May 1, 2003, Cross filed an amended complaint in the United States District Court for the Central District of California against Medtronic Sofamor Danek, Inc. and Medtronic Sofamor Danek USA, Inc. (collectively, “Medtronic”), which complaint alleges that Medtronic has infringed and continues to infringe Cross’ U.S. Patent Nos. 5,466,237, 5,474,555 and 5,624,442. These patents relate to technology embodied in certain components of the SYNERGY Spinal System. The complaint seeks damages for willful past and continuing infringement of the patents. The complaint also seeks a declaratory judgment against Medtronic that Cross is not infringing U.S. Patent Nos. 5,591,165, 4,641,636, 4,815,453 and 5,005,562. On June 23, 2003, Medtronic filed counterclaims for a declaratory judgment that it does not infringe Cross’ patents, and that the patents are invalid and unenforceable.

On October 10, 2003, Medtronic filed a motion to amend its answer and counterclaims to add certain affirmative defenses and causes of action against Cross on behalf of Medtronic and SDGI Holdings, Inc. (“SDGI”) for past and continued infringement of U.S. Patent Nos. 6,152,927 and 6,533,786 based on Cross’ C-TEK anterior cervical plate system. That motion was set for hearing on November 3, 2003.

On October 22, 2003, the Court, at the request of Cross, dismissed Cross’ claims for declaratory judgment that Cross is not infringing U.S. Patent Nos. 5,591,165, 4,641,636, 4,815,453 and 5,005,562.

On November 3, 2003, the Court granted Medtronic’s motion to amend its answer and counterclaims to allege causes of action against Cross on behalf of Medtronic and SDGI for past and continued infringement of U.S. Patent Nos. 6,152,927 and 6,533,786 based on Cross’ C-TEK anterior cervical plate system.

On October 22, 2003, Cross, Interpore Cross, and Interpore Orthopaedics, Inc. (“Interpore Orthopaedics”) filed an amended complaint in the United States District Court for the Central District of California against Medtronic and SDGI, which complaint alleges that Medtronic has infringed and continues to infringe Cross’ U.S. Patent No. 6,224,602. That patent relates to technology embodied in certain components of the C-TEK anterior cervical plate system. The complaint seeks damages for willful past and continuing infringement of the patent. The complaint also seeks a declaratory judgment against Medtronic and SDGI that Interpore Cross and Interpore Orthopaedics are not infringing U.S. Patent Nos. 6,152,927 and 6,533,786.

Interpore is unable at this time to predict the outcome of these litigations.

Aside from these matters, the nature of Interpore’s business subjects it to product liability and various other legal proceedings from time to time. Interpore is currently involved in legal proceedings incidental to the normal conduct of our business. Interpore does not believe that any liabilities relating to the legal proceedings to which it is a party are likely to be, individually or in the aggregate, material to Interpore’s consolidated financial condition or results of operations.

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Item 6. Exhibits and Reports on Form 8-K

a. Exhibits.

31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

b. Reports on Form 8-K.

None.

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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.

DATE: November 12, 2003	INTERPORE INTERNATIONAL, INC.
	(Registrant)
	By:	/s/ David C. Mercer
		David C. Mercer, Chairman and Chief Executive Officer
	By:	/s/ Richard L. Harrison
		Richard L. Harrison Sr. Vice President and Chief Financial Officer

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