United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended June 30, 1998
Commission File Number: 1-9741
INAMED CORPORATION
State of Incorporation: Florida I.R.S. Employer Identification No.:59-0920629
3800 Howard Hughes Parkway, Suite #900, Las Vegas, Nevada 89109
Telephone Number: (702) 791-3388
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_____
On August 14, 1998 there were 10,990,290 Shares of the
Registrant's Common Stock Outstanding.
This document contains 25 pages.
INAMED CORPORATION AND SUBSIDIARIES
Form 10-Q
Quarter Ended June 30, 1998
TABLE OF CONTENTS
Page
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
Unaudited Consolidated Income Statements 5
Unaudited Consolidated Statements
of Cash Flows 7
Notes to the Consolidated
Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
PART II - OTHER INFORMATION 24
PART I. FINANCIAL INFORMATION
ITEM 1.
INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in 000's)
Unaudited Audited
June 30, 1998 December 31, 1997
Assets
Current assets:
Cash and cash equivalents $ 3,184 $ 1,946
Trade accounts receivable, net of
allowance for doubtful accounts
and returns and allowances of
$5,192 and $5,221 22,089 13,979
Related party notes receivable -- 129
Inventories 20,200 23,117
Prepaid expenses
and other current assets 1,842 1,413
Income tax refund receivable 511 472
-------- --------
Total current assets 47,826 41,056
-------- --------
Property and equipment, at cost:
Machinery and equipment 12,826 12,585
Furniture and fixtures 5,152 4,541
Leasehold improvements 11,101 10,996
-------- --------
29,079 28,122
Less accumulated depreciation
and amortization (16,170) (14,639)
-------- --------
Net property and equipment 12,909 13,483
-------- --------
Notes receivable, net of
allowance of $467 2,928 2,799
Intangible assets, net 1,018 1,164
Other assets, at cost 1,532 340
-------- --------
Total assets $ 66,213 $ 58,842
======== ========
(continued)
The Notes to Financial Statements are an integral part of this
statement.
INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in 000's)
Unaudited Audited
June 30, 1998 December 31,1997
Liabilities and Stockholders' Deficiency
Current liabilities:
Current installments of
long-term debt $ 18 $ 30
Notes payable to bank 1,233 659
Accounts payable 11,000 14,759
Accrued liabilities:
Salaries, wages, and
payroll taxes 3,654 2,683
Interest 2,955 3,146
Self-insurance 3,847 3,602
Other 5,559 2,667
Royalties payable 5,497 4,156
Income taxes payable 2,550 2,894
-------- --------
Total current liabilities 36,313 34,596
-------- --------
Convertible and other long-term debt,
excluding current installments 19,628 23,574
Subordinated notes payable,
related party 9,851 8,813
Deferred grant income 1,214 993
Deferred income taxes 203 220
Accrued litigation settlement 37,300 37,335
Commitments and contingencies
Stockholders' deficiency:
Common stock, $0.01 par value.
Authorized 20,000,000 shares;
issued and outstanding 10,120,290
and 8,885,076 101 89
Additional paid-in capital 24,241 19,027
Cumulative translation adjustment 456 (223)
Accumulated deficit (63,094) (65,582)
-------- --------
Stockholders' deficiency (38,296) (46,689)
-------- --------
Total liabilities and stockholders'
deficiency $ 66,213 $ 58,842
======== ========
The Notes to Financial Statements are an integral part of this
statement.
INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
(Unaudited)
(in 000's except share and per share data)
Six Months Six Months
Ended Ended
June 30, 1998 June 30, 1997
Net sales $ 66,980 $ 56,104
Cost of goods sold 23,294 18,461
-------- --------
Gross profit 43,686 37,643
-------- --------
Operating expenses:
Marketing 18,296 14,918
General and administrative 15,653 14,286
Research and development 4,110 4,384
-------- --------
Total operating expenses 38,059 33,588
-------- --------
Operating income 5,627 4,055
-------- --------
Other income (expense):
Interest income 230 536
Interest expense (2,084) (2,913)
Foreign currency transaction losses (1,068) (1,353)
Miscellaneous income/(expense) (113) 44
-------- --------
Net other expense (3,035) (3,686)
-------- --------
Income before income tax expense 2,592 369
Income tax expense 104 377
-------- --------
Net income (loss) $ 2,488 $ (8)
======== ========
Net Income per share of common stock
Basic $ 0.26 $ 0.00
======== ========
Diluted $ 0.26 $ 0.00
======== ========
Weighted average common
shares outstanding 9,726,013 8,204,004
========= =========
The Notes to Financial Statements are an integral part of this statement.
INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
(Unaudited)
(in 000's except share and per share data)
Three Months Three Months
Ended Ended
June 30, 1998 June 30, 1997
Net sales $ 36,928 $ 29,687
Cost of goods sold 11,002 9,183
-------- --------
Gross profit 25,926 20,504
-------- --------
Operating expenses:
Marketing 9,945 7,819
General and administrative 9,055 7,852
Research and development 2,070 2,334
-------- --------
Total operating expenses 21,070 18,005
-------- --------
Operating income 4,856 2,499
-------- --------
Other income (expense):
Interest income 121 275
Interest expense (974) (1,676)
Foreign currency transaction losses (41) (475)
Miscellaneous income (186) 30
-------- --------
Net other expense (1,080) (1,846)
-------- --------
Income before income taxes 3,776 653
Income taxes 3 384
-------- --------
Net income $ 3,773 $ 269
======== ========
Net income per share of common stock
Basic $ 0.38 $ 0.03
======== ========
Diluted $ 0.38 $ 0.03
======== ========
Weighted average common
shares outstanding 9,987,705 8,212,009
========= =========
The Notes to Financial Statements are an integral part of this statement.
INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in 000's)
Six Months ended June 30, 1998 and 1997
Increase (Decrease) in Cash and Cash Equivalents
1998 1997
Cash flows from operating activities:
Net income (loss) $ 2,488 $ (8)
-------- --------
Adjustments to reconcile net income
(loss) to net cash used in operating
activities:
Depreciation of property
and equipment 1,475 828
Amortization of intangible assets 139 154
Amortization of deferred grant income (47) (53)
Amortization of debenture discount 223 135
Amortization of private offering costs 24 24
Deferred income taxes 205 180
Non-cash compensation to directors
& officers 230 --
Changes in assets and liabilities:
Trade accounts receivable (8,243) (5,288)
Notes receivable (126) (351)
Inventories 2,603 (1,613)
Prepaid expenses and other
current assets (485) 293
Income tax refund receivable (57) (86)
Other assets (1,224) (66)
Accounts payable (3,697) (1,897)
Accrued salaries, wages and
payroll taxes 1,003 (2,323)
Accrued interest 78 777
Accrued self-insurance 245 1,114
Accrued litigation settlement (33) --
Other accrued liabilities 2,904 422
Royalties payable 1,841 (545)
Income taxes payable (436) (343)
-------- --------
Total adjustments (3,378) (8,638)
-------- --------
Net cash used in operating
activities (890) (8,646)
-------- --------
Cash flows used in investing activities:
Purchases of property and equipment (1,143) (1,891)
-------- --------
(continued)
The Notes to Financial Statements are an integral part of this
statement.
INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in 000's)
Six Months ended June 30, 1998 and 1997
Increase (Decrease) in Cash and Cash Equivalents
1998 1997
Cash flows from financing activities:
Restricted cash in escrow for
litigation settlement $ -- $ (329)
Increases in notes payable
and long-term debt 579 --
Increases in convertible notes payable
and debentures payable -- 5,648
Principal repayment of notes payable
and long-term debt (15) (255)
Decrease in related party receivables 129 25
Increase in related party payables 1,038 3,601
Grant income 290 --
Proceeds from the exercise of stock
options 4 1
Issuance of common stock 56 --
-------- --------
Net cash provided by
financing activities 2,081 8,691
-------- --------
Effect of exchange rate changes
on cash 1,190 2,177
-------- --------
Net increase in cash
and cash equivalents 1,238 331
Cash and cash equivalents at
beginning of period 1,946 923
-------- --------
Cash and cash equivalents at
end of period $ 3,184 $ 1,254
-------- --------
Supplemental disclosure of cash flow information:
Cash paid during the six months for:
Interest $ 1,736 $ 2,116
======== ========
Income taxes $ 97 $ 366
======== ========
Disclosure of accounting policy:
For purposes of the consolidated statement of cash flows,
the Company considers all highly liquid debt instruments
purchased with a maturity of three months or less to be cash
equivalents.
The Notes to Financial Statements are an integral part of
this statement.
INAMED CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 1998
(in 000's)
Note 1 - Interim Financial Statements
The accompanying unaudited consolidated financial statements
include all adjustments (consisting only of normal recurring
accruals) which are, in the opinion of management, necessary for
fair presentation of the results of operations for the periods
presented. Interim results are not necessarily indicative of the
results to be expected for a full year.
Certain information and footnote disclosures normally included in
financial statements, prepared in accordance with generally
accepted accounting principles, have been condensed or omitted as
allowed by Form 10-Q. The accompanying unaudited consolidated
financial statements should be read in conjunction with the
Company's consolidated financial statements for the year ended
December 31, 1997 as filed with the Securities and Exchange
Commission on Form 10-K.
Note 2 - Basis of Presentation and Summary of Significant
Accounting Policies
The accompanying consolidated financial statements include the
accounts of INAMED Corporation and each of its wholly-owned
subsidiaries (the "Company"). Intercompany transactions are
eliminated in consolidation.
The Financial Statements do not include any adjustments relating
to the recoverability and classification of the recorded asset
and liability amounts that might be necessary should the Company
be unable to continue as a going concern.
The Company's continuation as a going concern is dependent upon
its ability to obtain financing for the non-opt-out settlement
agreement (see Note 6) and its ability to generate sufficient
cash flows to meet its obligations on a timely basis. The
Company is actively seeking financing and anticipates undertaking
restructuring which the Company believes will ultimately enable
it to attain profitability.
The Company
INAMED Corporation's subsidiaries are McGhan Medical Corporation
and CUI Corporation, which develop, manufacture and sell medical
devices principally for the plastic and general surgery fields;
BioEnterics Corporation which develops, manufactures and sells
medical devices and associated instrumentation to the bariatric
and general surgery fields; Biodermis Corporation which develops,
produces and distributes premium products for dermatology, wound
care and burn treatment; Bioplexus Corporation which develops,
produces and distributes specialty medical products for use by
the general surgery profession; Flowmatrix Corporation which
manufactures high quality silicone components and devices for
INAMED's wholly-owned subsidiaries and distributes an
international line of proprietary silicone products; Medisyn
Technologies Corporation which focuses on the development and
promotion of the merits of the use of silicone chemistry in the
fields of medical devices, pharmaceuticals and biotechnology;
INAMED Development Company, which is engaged in the research and
development of new medical devices using silicone-based
technology; McGhan Limited, an Irish corporation which
manufactures medical devices principally for the plastic and
general surgery fields; Medisyn Technologies, Ltd. and Chamfield
Ltd., Irish corporations which specialize in the development of
silicone materials for use by INAMED's wholly-owned subsidiaries;
and McGhan Medical B.V., a Netherlands corporation, McGhan
Medical B.V.B.A., a Belgium corporation, McGhan Medical GmbH, a
German corporation,
Note 2 - Basis of Presentation and Summary of Significant
Accounting Policies (continued)
The Company (continued)
McGhan Medical S.R.L., an Italian corporation, McGhan Medical
Ltd., a United Kingdom corporation, McGhan Medical S.A.R.L., a
French corporation, McGhan Medical S.A., a Spanish corporation,
INAMED do Brasil, a Brazilian corporation, INAMED Medical Group,
a Japanese corporation, McGhan Medical Asia Pacific, a Hong Kong
corporation, McGhan Medical Mexico, S.A. de C.V., a Mexican
corporation, and Bioenterics Latin America, S.A. de C.V., a
Mexican corporation, which all sell medical devices on a direct
sales basis in the various countries in which they are located.
Earnings Per Share
During 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings
per Share", ("SFAS No. 128") which provides for the calculation
of "basic" and "diluted" earnings per share. SFAS No. 128 is
effective for financial statements issued for periods ending
after December 15, 1997. Basic earnings per share includes no
dilution and is computed by dividing income available to common
shareholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per share reflects,
in periods in which they have a dilutive effect, the effect of
common shares issuable upon exercise of stock options. The
assumed conversion of the notes payable and exercise of the
warrants and options would have been anti-dilutive and,
therefore, were not considered in the computation of diluted
earnings per share for June 30, 1998 and 1997. As required by
this Statement, all periods presented have been restated to
comply with the provisions of SFAS No. 128.
Reclassification
Certain reclassifications were made to the 1997 consolidated
financial statements to conform to the 1998 presentation.
Note 3 - Accounts and Notes Receivable
Accounts and notes receivable consist of the following:
June 30, 1998 December 31, 1997
Accounts receivable $ 27,281 $ 19,200
Allowance for doubtful
accounts (836) (865)
Allowance for returns
and credits (4,356) (4,356)
_________ _________
Net accounts receivable $ 22,089 $ 13,979
========= =========
Notes receivable $ 3,395 $ 3,266
Allowance for doubtful
notes (467) (467)
_________ _________
Net notes receivable $ 2,928 $ 2,799
========= =========
Note 4 - Inventories
Inventories are summarized as follows:
June 30, 1998 December 31, 1997
Raw materials $ 4,082 $ 4,671
Work in process 3,978 3,799
Finished goods 13,607 16,161
-------- --------
21,667 24,631
Less allowance for -------- --------
obsolescence (1,467) (1,514)
-------- --------
$ 20,200 $ 23,117
======== ========
Note 5 - Long Term Debt
The following is a summary of the Company's significant long-term
debt:
(a) During January 1996, $35,000 of proceeds were received upon
the issuance of 11% senior secured convertible notes, due March
31, 1999, in a private placement transaction. Of that amount,
$14,800 was placed in an escrow account to be released within one
year, following court approval of a mandatory non-opt-out class
settlement of the breast implant litigation. Inasmuch as that
condition was not met, in July 1997 the Company returned those
escrowed funds to the senior Noteholders, in exchange for
warrants to purchase $13,900 of common stock at $8.00 per share
(subsequently adjusted to $7.50 per share), resulting in a charge
of $864 to debt costs for 1997. The conversion price of the 11%
senior secured convertible notes was originally $10 per share.
In July 1997 the Company and the senior Noteholders agreed to
change the conversion price to $5.50 per share at 103% of
principal balance as part of an overall restructuring plan which
included the waiver of past defaults. The conversion price of
$5.50 per share was above market value. At July 31, 1998,
$19,600 of the 11% senior notes were outstanding. In 1996 the
Company offered an incentive to convert the senior secured
convertible notes. The incentive increased the number of shares
received upon conversion by 10%.
(b) During January 1997, $5,700 of proceeds were received upon
the issuance of $6,200 principal amount of 4% convertible
debentures, due January 30, 2000. These debentures were
convertible at 85% of the market price of the common stock. On
March 31, 1997 the Company was in default of certain covenants.
The default required the Company to reduce the conversion price
by 6%. In addition, the Company incurred 3% liquidated damages
per month on the outstanding principal balance. These
transactions resulted in $396 and $1,267 of debt and interest
expenses in 1997. In April 1998, the remaining debentures were
converted into an aggregate of 1,108,059 shares of common stock.
All of the convertible debentures were converted into shares of
common stock at prices ranging from $2.60 to $4.60 per share.
In addition, commencing during April 1997 and continuing through
January 1998, an entity controlled by the Company's former
Chairman and 13% stockholder loaned $9,900 to the Company to
provide it with working capital to fund its operations. The loan
agreement discussed in (a) above precludes the payment of
interest and principal on this 10.5% subordinated note without
the consent of the senior Noteholders. In
Note 5 -Long-Term Debt (continued)
July 1998, the Company converted into 860,000 shares of common
stock all of the $10,800 of indebtedness, principal and interest,
which was owed to that entity. A four-year warrant to purchase
260,000 shares at $12.40 per share was also issued in connection
with this agreement.
Note 6 - Commitments and Contingencies
INAMED and its McGhan Medical and CUI subsidiaries are defendants
in numerous state and federal court lawsuits involving breast
implants. The alleged factual basis for typical lawsuits
includes allegations that the plaintiffs' silicone gel-filled
breast implants caused specified ailments including, among
others, auto-immune disease, lupus, scleroderma, systemic
disorders, joint swelling and chronic fatigue. The Company has
opposed plaintiffs' claims in these lawsuits and other similar
actions and continues to deny any wrongdoing or liability of any
kind. In addition, the Company believes that a substantial body
of medical evidence exists which indicates that silicone gel-
filled implants are not causally related to any of the above
ailments. Numerous studies in the past few years by medical
researchers in North America and Europe have failed to show a
definitive connection between breast implants and disease (some
critics, however, have assailed the methodologies of these
studies). Nevertheless, plaintiffs continue to contest the
findings of these studies, and more than 15,000 lawsuits and
claims alleging such ailments are pending against the Company and
its subsidiaries. The volume of lawsuits has created substantial
ongoing litigation and settlement expense, in addition to the
inherent risk of adverse jury verdicts in cases not resolved by
dismissal or settlement.
Proposed Class Action Settlement
As a result of the burdens imposed by the litigation on the
Company's management and operations, the substantial ongoing
litigation and settlement expense, the continuing litigation
risks, and the adverse perception held by the financial community
arising out of the litigation, the Company is seeking approval of
a mandatory ("non-opt-out") class action settlement (the
"Settlement") under Federal Rule of Civil Procedure 23(b)(1)(B).
As described below, the Company is seeking through this
settlement to resolve all claims arising from McGhan Medical and
CUI breast implants implanted before June 1, 1993, a cutoff date
which encompasses substantially all domestically-implanted
silicone gel-filled implants.
Background of Class Settlement Negotiations
The Settlement has its genesis in negotiations begun in 1994 with
the Plaintiffs' Negotiation Committee ("PNC"), a committee of the
national Plaintiffs' Steering Committee ("PSC") appointed by
Judge Sam C. Pointer, Jr. of the United States District Court for
the Northern District of Alabama (the "Court") to represent the
interests of plaintiffs in multi-district breast implant
litigation transferred to the Court for pretrial proceedings
under the federal multi-district transfer statute. At that time
the Company entered into an agreement to participate in a
proposed industry-wide class action settlement (the "Global
Settlement") of domestic breast implant litigation and petitioned
the Court to certify the Company's portion of the Global
Settlement as a mandatory class under Federal Rule of Civil
Procedure 23(b)(1)(B), meaning that claimants could not elect to
"opt out" from the class in order to pursue individual lawsuits
against the Company. Negotiations with the PNC over mandatory
class treatment were tabled, however (and the Company's petition
consequently not ruled upon), when an unexpectedly high
projection of current disease claims and the subsequent election
of Dow Corning Corporation to file for protection under federal
bankruptcy laws necessitated a substantial restructuring of the
Global Settlement.
Note 6 - Commitments and Contingencies (continued)
In late 1995, the Company agreed to participate in a scaled-back
Revised Settlement Program ("RSP") providing for settlement, on a
non-mandatory basis, of claims by domestic claimants who were
implanted before January 1, 1992 with silicone gel-filled
implants manufactured by the Company's McGhan Medical subsidiary,
and who met specified disease and other criteria. Under the
terms of the RSP, 80% of the settlement costs relating to the
Company's McGhan Medical implants were to be paid by 3M and Union
Carbide Corporation, with the remaining 20% to be paid by the
Company. However, because the RSP did not provide a vehicle for
settling claims other than by persons who elected to participate,
and because of continuing uncertainty about the Company's ability
to fund its obligations under the RSP in the absence of a broader
settlement also resolving breast implant lawsuits against the
Company and its CUI subsidiary which would not be covered by the
RSP, the Company continued through 1996 and 1997 to negotiate
with the PNC in an effort to reach a broader resolution through a
mandatory class. The PNC was advised in these negotiations by
its consultant, Ernst & Young LLP, which at the PNC's request
conducted reviews of the Company's finances and operations in
1994 and again in 1996 and 1997.
On April 2, 1998, the Company and the Settlement Class Counsel
executed a formal settlement agreement (the "Settlement
Agreement"), resolving, on a mandatory, non-opt-out basis, all
claims arising from McGhan Medical and CUI breast implants
implanted before June 1, 1993.
Terms and Conditions of the Settlement Agreement
Under the Settlement Agreement, $31,500 of consideration,
consisting of $3,000 of cash, 426,323 shares of common stock and
$25,500 principal amount of a 6% subordinated note will be
deposited in a court supervised escrow account approximately 90
days after preliminary approval by the Court. The parties will
then request the Court to authorize the mailing of a notice of
the proposed Settlement to all class members and schedule a
fairness hearing, which would probably be held in the fourth
quarter of 1998.
In the event the Court grants final approval of the Settlement,
the consideration held in the escrow account will then be
released, once the Court's final order becomes non-appealable, to
the court-appointed settlement office for distribution to the
plaintiff class, and the $25,500 subordinated note will mature
and become payable in cash. However, this payment will not
become due before April 30, 1999 or 90 days after the Court's
final order becomes non-appealable, whichever is later. In the
event the subordinated note is still outstanding on September 1,
1999, the interest rate will increase to 11%.
The Settlement Agreement covers all domestic claims against the
Company and its subsidiaries by persons who were implanted with
McGhan Medical or CUI silicone gel-filled or saline implants
before June 1, 1993, including claims for injuries not yet known
and claims by other persons asserting derivative recovery rights
by reason of personal, contractual or legal relationships with
such implantees. The Settlement is structured as a mandatory,
non-opt-out class settlement pursuant to Federal Rule of Civil
Procedure 23(b)(1)(B), and is modeled on similarly-structured
mandatory class settlements approved in the 1993 Mentor
Corporation breast implant litigation, and more recently in the
1997 Acromed Corporation pedicle screw litigation.
On June 2, 1998 the Court issued a preliminary order approving
the Settlement. The Court also issued an injunction staying all
pending breast implant litigation against the Company (and its
subsidiaries) in federal and state courts. The Company believes
that this stay will alleviate a significant financial and
managerial burden which these lawsuits had placed on the Company.
Note 6 - Commitments and Contingencies(continued)
The application for preliminary approval included evidentiary
submissions by both the Company and the plaintiffs addressing
requisite elements for certification and approval, including the
existence, absent settlement, of a "limited fund" insufficient to
respond to the volume of individual claims, and the fairness,
reasonableness and adequacy of the Settlement.
The Settlement is subject to a number of conditions, including:
1. Extinguishment of the Company's Obligations under the RSP.
The Settlement is conditioned on the entry by the Court of an
order, pursuant to the default provisions of the RSP,
extinguishing the Company's obligations under the RSP and
restoring RSP participants' previously existing rights in the
litigation system against the Company and its subsidiaries. On
May 19, 1998, the Court issued such an order.
2. Certification of Settlement Class. The Settlement is
conditioned on the Court's certification of a new settlement
class pursuant to Federal Rule of Civil Procedure 23(b)(1)(B).
The parties are requesting such certification under the same
theory applied in the Mentor Corporation and Acromed Corporation
settlements, namely that the Company is a "limited fund" whose
resources, absent a mandatory class settlement, are insufficient
to respond to the volume of claims pending against it.
3. Court Approval of Settlement. The Settlement is subject to
judicial approval of its terms and conditions as fair, reasonable
and adequate under Federal Rule of Civil Procedure 23(e), a
determination which takes into account such factors as the nature
of the claims, the arms' length negotiation process, the
recommendation of approval by experienced class counsel, and the
defendant's ability to pay.
4. Resolution of 3M Contractual Indemnity Claims. The
settlement is conditioned on resolution of claims asserted by 3M
under a contractual indemnity provision which was part of the
August 1984 transaction in which the Company's McGhan Medical
subsidiary purchased 3M's plastic surgery business. To resolve
these claims, on April 16, 1998 the Company and 3M entered into a
provisional agreement (the "3M Agreement") pursuant to which the
Company will seek to obtain releases, conditional on judicial
approval of the Company's settlement and favorable resolution of
any appeals, of claims asserted against 3M in lawsuits involving
breast implants manufactured by the Company's McGhan subsidiary.
The 3M Agreement provides for release of 3M's indemnity claim,
again conditional on judicial approval of the Settlement and
favorable resolution of any appeals, upon achievement of an
agreed minimum number of conditional releases for 3M. The 3M
Agreement requires that this condition be met or waived before
notice of the Settlement is given to the class.
Under the terms of the 3M Agreement, the Company will pay $3,000
to 3M once the Court grants final approval of the Settlement;
except that no payment will become due any sooner than (x) April
30, 1999 or (y) 90 days after the Court's final order on the
Settlement becomes non-appealable, whichever is later.
Under the terms of the 3M Agreement, after the indemnity to 3M is
released, the Company will assume certain limited indemnification
obligations to 3M beginning in the year 2000, subject to a cap of
$1,000 annually and $3,000 in total.
5. State Law Contribution and Indemnity Claims. The Settlement
is conditioned on entry by the Court of an order finding the
Settlement to have been made in good faith and barring joint
tortfeasor claims for contribution and indemnity arising under
state law (e.g., claims against the Company by other
Note 6 - Commitments and Contingencies (continued)
manufacturers, suppliers or physicians also sued by a settling
class member). As additional protection against such claims in
states whose laws do not provide for a bar of contribution and
indemnity claims upon determination of good faith settlement, the
Settlement also requires class members to reduce any judgments
they may obtain against such third parties by the amount
necessary to eliminate such parties' contribution or indemnity
claims against the Company under state law.
6. U.S. Government and Private Carrier Claims. The United
States government and private insurance carriers are seeking
reimbursement of medical services provided to class members. The
Company is presently in discussions with these parties concerning
the terms of such settlement. While the Settlement is not
conditioned on resolution of these claims, the Company
anticipates that it, together with Settlement Class Counsel and
the Court, if appropriate, will be able to resolve the issues
raised by the U.S. government and the private insurance carriers
before the mailing date of the class notice.
7. Favorable Resolution of Appeals. The Settlement is
conditioned on favorable resolution of any appeals which may be
taken from the final judgment approving the Settlement or from an
interim stay order. In the event the Settlement is disapproved
on appeal, all of the escrowed settlement funds, plus accrued
interest, will be returned to the Company, and the litigation
will be restored to the status which existed prior to any class
settlements.
8. Allocation and Distribution of Settlement Proceeds.
Following the procedures adopted in the Mentor Corporation and
Acromed Corporation mandatory class settlements, the Settlement
leaves allocation and distribution of the proceeds to class
members to later proceedings to be conducted by the Court, and
contemplates that the Court may appoint subclasses or adopt other
procedures in order to ensure that all relevant interests are
adequately represented in the allocation and distribution
process.
Class Settlement Approval Process and Timetable
Following the issuance by the Court of a preliminary order on
June 2, 1998, the settlement approval process is anticipated to
proceed in several stages, as follows:
1. Satisfaction of the Condition under the 3M Agreement.
Within 60 days after the date of the preliminary order
(extendable to 90 days at the Company's option), the Company
needs to obtain an agreed minimum number of conditional releases
for 3M pursuant to the terms of the 3M Agreement. At 3M's
option, that condition can be modified or waived. The Company
anticipates satisfying that condition in August 1998.
2. Notice to the Class. Following conditional class
certification and preliminary approval of the Settlement, as well
as satisfaction (or waiver) of the condition in the 3M Agreement,
the parties will give notice to class members advising class
members of the Court's preliminary order and advising them of
their opportunity to be heard in support of or opposition to
final certification and approval. The parties expect that class
notice will be given approximately 30 days after satisfaction of
the condition in the 3M Agreement. Prior to the distribution of
the class notice, the Company must deposit in a court supervised
escrow account $31,500 of consideration, consisting of $3,000 of
cash, 426,323 shares of common stock, and $25,500 principal
amount of a 6% subordinated note. The Company anticipates that
this deposit will occur prior to September 30, 1998.
Note 6 - Commitments and Contingencies (continued)
The parties' proposed form of notice provides a 60-day deadline
for class members to submit comments, objections, or requests to
intervene and be heard, with a final settlement hearing scheduled
approximately 20 days thereafter. Assuming the Court adopts this
schedule, the final settlement hearing would occur in the latter
part of the fourth quarter of 1998, barring further unanticipated
delays.
3. Hearing on Final Certification and Approval. At the hearing
on final certification and approval, the Court will consider any
comments and objections received from class members as well as
any further evidence and legal argument submitted by the parties
or interveners concerning issues relevant to certification and
approval, including the Company's status as a "limited fund" and
fairness, reasonableness and adequacy of the Settlement.
Assuming a favorable outcome, the Court will thereafter issue a
final order and judgment certifying the class as a mandatory
class under Federal Rule of Civil Procedure 23(b)(1)(B),
approving the settlement, enjoining class members from litigation
of settled claims, and barring contribution and indemnity claims
to the extent permitted under state law.
Ongoing Litigation Risks
Although the Company expects the Settlement, if approved, to end
as a practical matter its involvement in the current mass product
liability litigation in the United States over breast implants,
there remain a number of ongoing litigation risks, including:
1. Non-Approval of Settlement. The Settlement Agreement
requires all parties to use their best efforts to obtain approval
of the Settlement by the Court and on appeal. However, there can
be no assurance that the Court will approve the Settlement or
that a decision approving it will be affirmed on appeal. The
approval decision turns on factual issues which may be contested
by class members opposing the Settlement, and additionally
implicates a number of legal issues that neither the United
States Supreme Court nor the federal appellate courts have
definitely ruled upon. While courts have approved similarly
structured mandatory class settlements in the Mentor Corporation
and Acromed Corporation cases, neither of those decisions was
subjected to appellate review. The Company cannot predict the
ultimate outcome of the approval process or the appeals process
in the event any appeals of the Settlement are filed in a timely
manner.
2. Collateral Attack. As in all class actions, the Company may
be called upon to defend individual lawsuits collaterally
attacking the Settlement even if approved and affirmed on appeal.
However, the typically permissible grounds for such attacks (in
general, lack of jurisdiction or constitutionally inadequate
class notice or representation) are significantly narrower than
the grounds available on direct appeal.
3. Non-Covered Claims. The Settlement does not include several
categories of breast implants which the Company will be left to
defend in the ordinary course through the tort system. These
include lawsuits relating to breast implants implanted on or
after June 1, 1993, and lawsuits in foreign jurisdictions. The
Company regards lawsuits involving post-June 1993 implants
(predominantly saline-filled implants) as routine litigation
manageable in the ordinary course of business. Breast implant
litigation outside of the United States has to date been minimal,
and the Court has with minor exceptions rejected efforts by
foreign plaintiffs to file suit in the United States.
The Company does not currently have any product liability
insurance. Depending on the availability and cost of such
insurance, the Company may in the future seek to obtain product
liability insurance.
Note 6 - Commitments and Contingencies (continued)
The Company plans to obtain the cash needed to fund the proposed
settlement from a combination of new senior secured debt and the
proceeds to be received upon the exercise of $13,900 of warrants
to purchase common stock (which were issued to the senior
Noteholders in July 1997 in anticipation of this event). The
Company has discussed its financing plans with Appaloosa
Management, L.P. and its affiliates, who are jointly the largest
holders of the 11% senior secured convertible notes. Those
entities have indicated their willingness to provide the new
financing, subject to negotiation of satisfactory terms,
covenants and legal documentation, including amendments to the
existing indenture and a new maturity date for the existing
senior debt. Such new financing may entail the issuance of
warrants or convertible securities which could be dilutive to
existing holders of the Company's common stock.
Accounting Treatment
In 1993, the Company recorded a $9,152 reserve for litigation.
For the year ended December 31, 1997, the Company recorded an
additional reserve of $28,150. The litigation reserve as of June
30, 1998 of $37,300 includes the cost of the non-opt-out
settlement agreement of $31,500, other settlements of $4,845 and
legal fees and other related expenses of $955.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This Quarterly Report contains certain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933,
as amended, and Section 21E of the Securities Exchange Act of
1934, as amended, which are intended to be covered by the safe
harbors created thereby. Investors are cautioned that all
forward-looking statements involve risks and uncertainty,
including without limitation, the ability of the Company to
continue its expansion strategy, changes in costs of raw
materials, labor, and employee benefits, as well as general
market conditions, competition and pricing. Although the Company
believes that the assumptions underlying the forward-looking
statements contained herein are reasonable, any of the
assumptions could be inaccurate, and therefore, there can be no
assurance that the forward-looking statements included in this
Quarterly Report will prove to be accurate. In light of the
significant uncertainties inherent in the forward-looking
statements including herein, the inclusion of such information
should not be regarded as a representation by the Company or any
other person that the objectives and plans of the Company will be
achieved.
Results of Operations
The Company's financial performance in recent years was
strongly and adversely impacted by: 1) the costs of improving
manufacturing practices and policies in accordance with FDA
regulations; 2) the costs of addressing the breast implant
litigation; 3) investments made in international markets to
increase the Company's sales and marketing presence; and 4) the
cost of investing in research and development, particularly in
new products and technologies. Based on these factors, although
sales have grown during those periods, expenses have grown at a
significantly higher rate. Consequently, the Company's
financial performance has deteriorated in recent years through
the first quarter of 1998.
Since its appointment in early 1998, the Company's new senior
management team has concentrated the Company on increasing sales,
improving manufacturing efficiencies and reducing various
expenses. As a result of these efforts, the Company achieved net
income of $3.8 million in the second quarter of 1998, and net
income of $2.5 million for the first six months of 1998 (as
compared to $269,000 and $(8,000) for the comparable periods last
year). The new management team has also undertaken a strategic
review of the Company's operations and businesses, and based on
that effort a restructuring plan is now being implemented. This
plan includes an approximately 15% worldwide reduction in
headcount, the conversion of the Company's European sales force
to distributors and the exiting or discontinuance of certain
smaller unprofitable product lines. These activities were
undertaken after the end of the second quarter of 1998 and, as a
result, the Company anticipates incurring approximately $4 million
in charges in the third quarter to reflect the costs of the
restructuring plan. Management believes that the restructuring
plan is an important and essential step towards marking the
Company a long-term, viable enterprise once the breast implant
settlement is completed; without the steps contemplated by the
restructuring plan, management believes that the Company could
not obtain the financing necessary to ensure the success and
completion of that settlement.
Summary financial table. Set forth below is a table which
shows the individual components of the Company's results of
operations, both in dollars (in thousands) and as a percent of
net sales; and including the percentage increase (decrease) for
the periods ended June 30, 1998 and 1997.
Six Months Ended
June 30, 1998 June 30,1997
------------- ------------
(in 000's) %Inc.
----
Sales 66,980 19% 56,104
Cost of Goods Sold 23,294 26% 18,461
Gross Profit 43,686 16% 37,643
As a % of sales 65% 67%
Marketing 18,296 23% 14,918
As a % of sales 27% 27%
G&A 15,653 10% 14,286
As a % of sales 23% 25%
R&D 4,110 (1%) 4,384
As a % of sales 6% 8%
Operating expenses 38,059 13% 33,588
As a % of sales 57% 60%
Operating income 5,627 39% 4,055
Sales. While the Company's revenues are subject to
adjustments due to changes in price or volume of units sold,
revenue increases from the first six months of 1997 compared to
the first six months of 1998 were primarily a result of increased
volume. Based on publicly available information, the Company
believes that the markets for its products are growing, and that
it is increasing its market share in relation to competitors.
Sales in the United States accounted for 65% and 63% of total
net sales for the periods ended June 30, 1998 and 1997.
International sales accounted for 35% and 37% of total net sales
for the periods ended June 30, 1998 and 1997.
Cost of goods sold. The largest factors in the variation from
year to year in cost of goods sold as a percentage of net sales
is the cost of raw materials, the yield of finished goods from
the Company's manufacturing facilities, and the load factor at
the Company's manufacturing facilities. The first two factors
were stable for the first six months of 1998. However, in the
first quarter of 1998 there was significant downtime at the
Company's manufacturing facilities, due to an FDA audit and
excess inventory, which adversely affected the load factor and
manufacturing efficiencies. In the second quarter of 1998 the
Company's manufacturing facilities returned to a normal operating
rate and, consequently, the gross margin returned to its
historical level.
Marketing expenses. The largest factor in the variation from
year to year in marketing expenses is the success of the
Company's start-up businesses in various foreign countries.
Depending on the country and the potential market demand for the
Company's products, the Company may choose to begin operations in
a new territory through either a third party medical products
distribution partner or through its own sales force. In either
situation, extra financial support may be necessary for several
years while the Company establishes itself in a new market and
generates sufficient sales to earn a profit in that new
territory. However, in the future the new management team plans
to control the introduction of new products and the entry into
new markets so as to minimize negative impacts on results of
operations.
General and administrative expenses. G&A expenses are
affected by overall headcount in various administrative
functions, and the legal, accounting and other outside services
which were necessary to defend the Company in the breast implant
litigation and negotiate a settlement. In order to reduce these
expenses the Company is in the process of reducing staff levels
in both the domestic and international subsidiaries. In
addition, management has also set other targets to control and
reduce other general and administrative expenses throughout the
Company. The legal and administrative costs relating to the
breast implant litigation were $1.7 million and $2.3 million for
the first six months ended June 30, 1998. and 1997, respectively.
Research and development expenses. R&D expenditures have
decreased slightly for the six month period ended June 30, 1998
as compared to the six month period ended June 30, 1997. As a
percentage of sales, research and development costs for the six
months have decreased by approximately 2% in 1998 as compared to
1997. The Company invested $1.4 million and $1.1 million for the
periods ended June 30, 1998 and 1997 at the Company's BioEnterics
subsidiary in connection with the development of obesity
products. In 1998 the new management team began considering
various options to sell a portion of its interest in this
business.
Interest expense. Net interest expense of approximately $2.1
million for the six month period ended June 30, 1998 (as compared
to $2.9 million for the six month period ended June 30, 1997) was
primarily due to: (1) the net carrying costs on the 11% senior
secured convertible notes issued in January 1996; (2) accrued
(but unpaid) interest of $509,880 on approximately $9.9 million
of 10.5% subordinated notes which were incurred primarily in the
later half of 1997 to fund its working capital needs; and (3) a
penalty charge of $253,000 due to the Company's failure to
provide an effective registration statement to the holders of the
4% convertible debentures issued in January of 1997. As of July
1998 all of the 10.5% subordinated notes (including accrued
interest) were converted into common stock; and as of April 1998
all of the 4% debentures were converted into common stock and the
Company is no longer incurring such penalty charges.
Foreign currency translation loss. Historically the Company's
subsidiaries have incurred significant intercompany debts
(totaling more than $43 million for non-U.S. subsidiaries), which
are eliminated in the consolidated financial statements.
However, those intercompany debts, which are denominated in
various foreign currencies, give rise to translation adjustments.
In 1998 the new management team evaluated various alternatives
for reducing the Company's foreign currency exposure, and
concluded to convert the non-U.S. intercompany debts to the
capital of the respective subsidiaries during the later half of
1998. This should yield a significant reduction in foreign
currency translation losses.
Operating Income. As noted above, beginning in 1998 the new
management team has undertaken a restructuring program which is
designed to reverse the Company's poor operating performance and
significantly improve the Company's operating margin. Included
in this program is a reduction in headcount, discontinuance or
sale of certain smaller unprofitable product lines, improved
asset management (especially receivables and inventory), and
reduced general and administrative expenses. There is no
assurance that the Company will be successful in these efforts.
Financial Condition
Liquidity. The Company's liquidity has deteriorated
significantly in the last few years resulting in substantial
doubt about the Company's ability to continue as a going concern.
During the first six months of 1998, however, the new management
team focused on reversing the significant negative cash flow of
the past three years. Based on net income of $2.5 million for
the first six months of 1998 and improved inventory turns, net
cash used for operating activities totaled $0.9 million for the
first six months ended June 30, 1998 as compared to $8.6 million
for the six months ended June 30, 1997. As further reductions in
cost of goods, G&A and R&D outlined above begin to take effect,
the Company believes it can improve its cash flow from
operations, and thereby be able to generate sufficient cash flow
to fund the anticipated financing cost of the pending breast
implant settlement.
The Company has funded its cash needs through a series of debt
and equity transactions, including:
$35 million of proceeds received upon the issuance of
11% senior secured convertible notes, due March 31, 1999, in
a private placement transaction in January 1996. Of that
amount, $14.8 million was placed in an escrow account to be
released within one year, following court approval of a
mandatory non-opt-out class settlement of the breast implant
litigation. Inasmuch as that condition was not met, in July
1997 the Company returned those escrowed funds to the senior
Noteholders, in exchange for warrants to purchase $13.9
million of common stock at $8.00 per share (subsequently
adjusted to $7.50 per share). The conversion price of the
11% senior secured convertible notes was originally $10 per
share. In July 1997 the Company and the senior Noteholders
agreed to change the conversion price to $5.50 per share at
103% of the principal balance as part of an overall
restructuring plan which included the waiver of past
defaults. At July 31, 1998, $19.6 million of the 11% senior
notes was outstanding.
$5.7 million of proceeds received in January 1997
upon the issuance of $6.2 million principal amount of 4%
convertible debentures, due January 30, 2000. These
debentures were convertible at 85% of the market price of
the common stock less an additional discount of 6%. As of
April 6, 1998, all of such debentures had been converted
into an aggregate of 1,724,017 shares of common stock at
prices ranging from $2.60 to $4.44 per share. No debentures
are currently outstanding.
$9.9 million of proceeds received periodically
from April 1997 until January 1998 from an entity affiliated
with the Company's former chairman. That indebtedness is
denoted as the Company's 10.5% subordinated notes. By the
terms of the 11% senior secured convertible notes, the 10.5%
subordinated notes are junior in right of payment and
liquidation and, accordingly, no interest or principal
payments can be made with respect thereto without the
consent of the senior Noteholders. In July 1998, the Company
converted into 860,000 shares of common stock all of the
$10.8 million of indebtedness, principal and interest, which
was owed to such entity (at an effective conversion price of
$12.40 per share). A four-year warrant to purchase 260,000
shares at $12.40 per share was also issued in connection
with this agreement.
The Company is seeking to establish a domestic line of
credit; under the terms of the 11% senior secured convertible
notes, the Company has leeway for up to $5 million of such
financing. The Company currently maintains an international line
of credit with a major Dutch bank. The current line is
approximately $700,000 and is collateralized by the accounts
receivable, inventories and certain other assets of McGhan
Medical B.V. As of June 30, 1998, approximately $475,000 had
been drawn on the line of credit. The interest rate on the line
of credit is 7% per annum. In July 1998, the line of credit was
paid down to zero.
Breast Implant Settlement. Under the terms of the proposed
settlement of the breast implant litigation, the Company will be
obligated to pay an aggregate of $34.5 million to the plaintiffs
and 3M at the later of (x) April 30, 1999 or (y) 90 days after
the Court's final order becomes non-appealable. That payment
will consist of $31.5 million of cash (which will be used to
retire the $25.5 million note to the plaintiffs which will be
placed in escrow prior to the mailing of notice of the proposed
settlement) and 426,323 shares of common stock.
The Company plans to obtain the cash needed to fund the
proposed settlement from a combination of new senior secured debt
and the proceeds to be received upon the exercise of $13.9
million of warrants to purchase common stock (which were issued
to the senior Noteholders in July 1997 in anticipation of this
event). The Company has discussed its financing plans with
Appaloosa Management, L.P. and its affiliates, who are jointly
the largest holders of the 11% senior secured convertible notes.
Those entities have indicated their willingness to provide the
new financing, subject to negotiation of satisfactory terms,
covenants and legal documentation, including amendments to the
existing indenture and a new maturity date for the existing
senior debt. Such new financing may entail the issuance of
warrants or convertible securities which could be dilutive to
existing holders of the Company's common stock.
The costs of defending the breast implant litigation-both
past and future-vastly exceed the Company's financial resources.
Absent the successful completion of the settlement of this
litigation through the vehicle of a mandatory non-opt-out class,
management believes that the Company would not be able to
continue as a going concern. Although the Company is optimistic
that the proposed settlement agreement can be completed on the
terms and within the timetable negotiated and announced in April
1998, there can be no assurance in this regard.
The Company's continuation as a going concern is dependent
upon its ability to obtain financing for the non-opt-out
settlement agreement and its ability to generate sufficient cash
flows to meet its obligations on a timely basis. The Company is
actively seeking financing and has begun to implement a
restructuring plan which the Company believes will ultimately
enable it to attain consistent profitability.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is a defendant in breast implant litigation
as discussed in Note 6 to the unaudited consolidated
financial statements.
The Company has been advised by the Securities and
Exchange Commission that it has begun a formal
investigation of the matters disclosed in the Form 8K
dated March 6, 1998 relating to the resignation of
Coopers & Lybrand LLP as the Company's independent
accountant. The Company is cooperating fully in this
investigation. Furthermore, the Company believes that
all of the procedural and substantive issues raised in
that filing have been addressed through a variety of
steps, including the appointment of a new senior
management team, the continual oversight by an audit
committee, and the conversion into equity of the $10.8
million of indebtedness (including accrued interest)
owed to an entity controlled by the former Chairman at
a significant discount which more than adequately
reflects the dollar value of any questionable related
party transactions. The Company does not believe that
this investigation will give rise to any material
costs, and is seeking to pursue a prompt resolution of
this matter so that it can focus its efforts on
returning the Company to long-term profitability and
resolving the breast implant litigation.
ITEMS 2. THROUGH 5.
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Not applicable
INAMED CORPORATION
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, Registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto
duly authorized.
INAMED CORPORATION
August 14, 1998 By: /s/ Richard G. Babbitt
Richard G. Babbitt,
Chairman of the Board,
Chief Executive Officer and President