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 March 31, 1999 Commission File Number: 1-9741
INAMED CORPORATION
State of Incorporation: Delaware
I.R.S. Employer Identification No.: 59-0920629
700 Ward Drive, Santa Barbara, California 93111-2919
Telephone Number: (805) 692-5400
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 May 14, 1999 there were 17,120,437 Shares of the Registrant's Common Stock
Outstanding.
This document contains 23 pages.
INAMED CORPORATION AND SUBSIDIARIES
Form 10-Q
Quarter Ended March 31, 1999
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 6
Notes to the Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
PART II - OTHER INFORMATION 22
PART I. FINANCIAL INFORMATION
ITEM 1.
INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in 000's)
Unaudited Audited
March 31, 1999 December 31, 1998
Assets
Current assets:
Cash and cash equivalents $ 12,855 $ 11,873
Trade accounts receivable, net of
allowance for doubtful accounts
and returns and allowances of $7,323
and $6,15 24,198 23,169
Inventories 16,257 17,855
Prepaid expenses and other current assets 2,288 1,337
Income tax refund receivable 713 726
Deferred income taxes 8,511 8,000
________ ________
Total current assets 64,822 62,960
________ ________
Property and equipment, at cost:
Machinery and equipment 14,274 14,170
Furniture and fixtures 3,336 3,418
Leasehold improvements 11,950 11,986
________ ________
29,560 29,574
Less accumulated depreciation
and amortization (17,129) (16,751)
________ ________
Net property and equipment 12,431 12,823
________ ________
Notes receivable, net of allowance of $467 2,834 2,769
Intangible assets, net 982 1,015
Other assets, at cost 784 1,140
________ ________
Total assets $ 81,853 $ 80,707
========= =========
(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
March 31, 1999 December 31, 1998
Liabilities and Stockholders' Deficiency
Current liabilities:
Current installments of long-term debt $ 37 $ 51
Notes payable to bank 1,034 1,186
Accounts payable 10,548 12,226
Accrued liabilities:
Salaries, wages, and payroll taxes 2,641 2,681
Interest 1,019 2,032
Self-insurance 4,107 3,649
Other 5,913 4,523
Royalties payable 4,393 5,061
Income taxes payable 1,559 1,318
Accrued litigation settlement 1,806 5,721
Note payable, escrow agent 25,500 25,500
________ ________
Total current liabilities 58,557 63,948
________ ________
Convertible and other long-term debt,
excluding current installments 27,713 27,767
Deferred grant income 1,103 1,235
Deferred income taxes 310 382
Commitments and contingencies
Redeemable common stock, $.01 par value
426,323 shares issued and outstanding
stated at redemption value $7.04 per share 3,000 3,000
Stockholders' deficiency:
Common stock, $0.01 par value.
Authorized 20,000,000 shares; issued
and outstanding 11,245,991 and 11,010,290 110 110
Additional paid-in capital 37,907 37,605
Cumulative translation adjustment (737) 269
Accumulated deficit (46,110) (53,609)
________ ________
Stockholders' deficiency (8,830) (15,625)
________ ________
Total liabilities and stockholders'
deficiency $ 81,853 $ 80,707
========= =========
The Notes to Financial Statements are an integral part of this statement.
INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
(Unaudited)
(in 000's)
Three Months Three Months
Ended Ended
March 31, 1999 March 31, 1998
Net sales $ 37,588 $ 30,052
Cost of goods sold 11,900 12,292
_________ _________
Gross profit 25,688 17,760
_________ _________
Operating expenses:
Marketing 7,834 8,351
General and administrative 7,482 6,598
Research and development 2,027 2,040
_________ _________
Total operating expenses 17,343 16,989
_________ _________
Operating income 8,345 771
_________ _________
Other income (expense):
Foreign currency transaction gains (losses) 106 (1,027)
Miscellaneous income (loss) (313) 73
_________ _________
Net other expense (207) (954)
_________ _________
Income (loss) before interest and taxes 8,138 (183)
Interest expense, net 640 1,001
Income (loss) before income tax expense 7,498 (1,184)
Income tax expense --- 101
_________ _________
Net income (loss) $ 7,498 $ (1,285)
========= =========
Net income (loss) per share of common stock
Basic $ 0.66 $ (0.14)
========= =========
Diluted $ 0.47 $ (0.14)
========= =========
Weighted average common shares outstanding
basic 11,440,899 9,142,435
========== =========
Weighted average common shares outstanding
diluted 15,995,983 9,142,435
========== =========
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)
Three Months ended March 31, 1999 and 1998
Increase (Decrease) in Cash and Cash Equivalents
1999 1998
Cash flows from operating activities:
Net income (loss) $ 7,498 $ (1,285)
_________ __________
Adjustments to reconcile net income (loss)
to net cash provided by (used in) operating
activities:
Depreciation and amortization 686 729
Deferred income taxes (153) 206
Provision for doubtful accounts, notes &
returns 1,165 --
Provision for obsolescence of inventory 559 --
Provision for asset impairment 400 --
Non-cash compensation to directors & officers -- 230
Deferred tax benefit (204) --
Changes in assets and liabilities:
Trade accounts receivable (2,194) (5,083)
Notes receivable -- (22)
Inventories 1,039 1,965
Prepaid expenses and other current assets (950) (455)
Income tax refund receivable 12 108
Other assets (33) (1,116)
Accounts payable, accrued and other
liabilities (816) 1,653
Royalties payable (669) 323
Income taxes payable 323 (642)
Accrued litigation settlement (3,915) --
_________ _________
Total adjustments (4,750) (2,104)
_________ _________
Net cash provided by (used in) operating
activities 2,748 (3,389)
_________ _________
Cash flows from investing activities:
Purchases of property and equipment, net (608) (712)
_________ _________
Net cash used in investing activities (608) (712)
_________ _________
(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)
Three Months ended March 31, 1999 and 1998
Increase (Decrease) in Cash and Cash Equivalents
1999 1998
Cash flows from financing activities:
Increases in notes payable and long-term debt $ -- $ 364
Principal repayment of notes payable
and long-term debt (286) (3)
(Increase) decrease in related party receivables (65) 125
Increase (decrease) in related party payables -- 1,068
Proceeds from exercise of stock options 302 --
Increase (decrease) in deferred grants (103) --
_________ _________
Net cash (used in) provided by financing
activities (152) 1,554
_________ ________
Effect of exchange rate changes on cash (1,006) 1,456
_________ ________
Net increase (decrease) in cash
and cash equivalents 982 (1,091)
Cash and cash equivalents at beginning of period 11,873 1,946
_________ ________
Cash and cash equivalents at end of period $ 12,855 $ 855
_________ ________
Supplemental disclosure of cash flow information:
Cash paid during the quarter for:
Interest $ 784 $ 648
========= ========
Income taxes $ 11 $ 89
========= ========
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
MARCH 31, 1999
(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, 1998 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 International Corp. and each of its wholly owned subsidiaries (the
"Company"). Intercompany transactions are eliminated in consolidation.
The Company
INAMED Corporation's subsidiaries are organized into three business units:
United States Plastic and Reconstructive Surgery (consisting primarily of
McGhan Medical Corporation, Flowmatrix Corporation and CUI Corporation,
which develop, manufacture and sell medical devices and components);
BioEnterics Corporation, which develops, manufactures and sells medical
devices and associated instrumentation to the bariatric and general
surgery fields; and International (consisting of INAMED International Corp.
and its subsidiaries which are engaged in manufacturing and distribution
through McGhan Limited (based in Ireland) and sales subsidiaries in various
countries, including Holland, Germany, Italy, United Kingdom, France, Spain
and Mexico, which sell products for both the plastic and bariatric surgery
fields).
Note 2 - Basis of Presentation and Summary of Significant Accounting
Policies (continued)
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
and warrants. The assumed exercise of certain warrants and options would
have been anti-dilutive and, therefore, was not considered in the computation
of diluted earnings per share for March 31, 1998. As required by this
Statement, all periods presented have been restated to comply with the
provisions of SFAS No. 128.
Comprehensive Income
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income," ("SFAS No. 130") established standards for reporting and display of
comprehensive income, its components and accumulated balances. Comprehensive
income is defined to include all changes in equity except those resulting
from investments by owners and distributions to owners. Among other
disclosures, SFAS No. 130 requires that all items that are required to be
recognized under current accounting standards as components of comprehensive
income be reported in a financial statement that is displayed with the same
prominence as other financial statements. The Company has adopted SFAS Nos.
130 and it has had no material effect on the Company's financial position,
results of operations or financial statement disclosures.
Segment Reporting
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information", ("SFAS
No. 131") which supersedes SFAS No. 14, Financial Reporting for Segments of a
Business Enterprise. SFAS No. 131 establishes standards for the way public
companies report information about operating segments in annual financial
statements and requires reporting of selected information about operating
segments in interim financial statements issued to the public. It also
establishes standards for disclosures regarding products and services,
geographic areas and major customers. SFAS No. 131 defines operating
segments as components of a company about which separate financial
information is available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and in assessing
performance. The Company has adopted SFAS Nos. 131 and it has had no material
effect on the Company's financial position, results of operations or financial
statement disclosures.
New Accounting Standards
In June 1998 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"), which requires entities to recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure these instruments at fair value. SFAS No. 133 is
effective for all fiscal years beginning after June 15, 1999. The Company
is currently reviewing SFAS No. 133 and has of yet been unable to fully
evaluate the impact, if any, it may have on future operating results or
financial statement disclosures.
Reclassification
Certain reclassifications were made to the 1998 consolidated financial
statements to conform to the 1999 presentation.
Note 3 - Accounts and Notes Receivable
Accounts and notes receivable consist of the following:
March 31, 1999 December 31, 1998
Accounts receivable $ 31,521 $ 29,327
Allowance for doubtful accounts (1,996) (1,402)
Allowance for returns and credits (5,327) (4,756)
__________ _________
Net accounts receivable $ 24,198 $ 23,169
========= =========
Notes receivable $ 3,301 $ 3,236
Allowance for doubtful notes (467) (467)
_________ _________
Net notes receivable $ 2,834 $ 2,769
========= =========
Note 4 - Inventories
Inventories are summarized as follows:
March 31, 1999 December 31, 1998
Raw materials $ 4,085 $ 3,764
Work in process 4,102 3,931
Finished goods 9,798 11,329
_________ _________
17,985 19,024
Less allowance for
obsolescence (1,728) (1,169)
_________ _________
$ 16,257 $ 17,855
========= =========
Note 5 - Long Term Debt
The following is a summary of the Company's significant long-term debt:
(a) $8,000 of senior secured notes, at an interest rate of 10%. These notes
mature on September 1, 2000. The proceeds were received by the Company on
October 2, 1998. In connection with this financing the Company issued
590,000 four-year warrants to purchase common stock at $6.50 per share.
$3,000 of the proceeds of this financing were deposited in a court-supervised
escrow as part of the consideration for the litigation settlement (see Notes
6 and 7); the balance is available for use by the Company in specific capital
improvement projects and working capital uses.
(b) $19,600 of junior secured notes, at an interest rate of 11%. These notes
were issued in an exchange offer completed in November 1998 for a similar
amount of senior secured convertible notes that were originally issued in
January 1996. These notes mature on September 1, 2000. The $5.50 per share
conversion feature of the original notes was replaced with an equivalent
number of new, four-year warrants to purchase common stock at $5.50 per
share, and the holders of the original notes received 500,000 four-year
warrants to purchase common stock at $7.50 per share in settlement of an
anti-dilution adjustment. In the event the settlement agreement becomes
final and non-appealable (see Notes 6 and 7), under certain circumstances
the Company can call the exercise of the $5.50 warrants and the proceeds
could be applied either to redeem these notes without penalty or to pay for
the litigation settlement.
Note 6 - Subsequent Events
Equity financing:
During the second quarter of 1999, the Company completed a $31.1 million equity
financing, in which 5.4 million new shares of common stock were issued to
various holders of $5.50 and $7.50 warrants in exchange for the payment of
$20.4 million of cash and the surrender of $10.7 million of 11% junior
secured notes. Virtually all of the holders of warrants who were eligible
to exercise at this time participated in the transaction. The Company also
received $3 million of cash from its noteholders, which was used to purchase
on their behalf the 426,323 shares of common stock held by the court-appointed
escrow agent. All of those 5.8 million shares of common stock contain a legend
that restricts transferability absent an exemption under Rule 144 (after the
one-year holding period) or an effective registration statement.
As a result of this equity financing, as of May 14, 1999 the Company has
approximately 17.1 million shares outstanding and approximately 20.2 million
shares on a fully diluted basis. In addition, as of May 14, 1999 the Company's
debt has decreased from approximately $27.7 million to $17.0 million, and the
Company's tangible net worth is approximately $22 million, as compared to the
significant deficit position of the past few years. Also, due to an incentive
fee that was paid as part of the equity financing, the Company expects to
record a non-operating charge of approximately $1.9 million in the second
quarter of 1999.
Final payment to plaintiffs in the mandatory class action settlement of the
breast implant litigation:
Subsequent to the end of the first quarter of 1999, the Company also completed
the final payment of all of the monies owed to the court-appointed escrow agent
on behalf of the plaintiffs in the mandatory class action settlement of the
breast implant litigation. The payment was $29.9 million in cash, and included
$25.5 million as full payment of the 6% promissory note which was issued in June
1998 at the time the settlement received preliminary approval, $1.4 million of
accrued interest on that note, and $3 million to repurchase the 426,323 shares
of common stock which were also issued in June 1998 to the escrow agent. As a
result of this payment, approximately $27.3 million of liabilities relating to
the breast implant litigation that was recorded on the Company's balance sheet
as of the end of the first quarter of 1999 has now been eliminated.
Pro Forma Financial Statements
In (000's except share and per share data)
Proforma Unaudited
Unaudited Adjustments Proforma
March 31, 1999 (Note A) March 31, 1999
Current assets $ 64,822 $ (6,500) $ 58,322
Net property and equipment 12,431 12,431
Other assets 4,600 4,600
_________ _________
Total assets 81,853 75,353
========= =========
Current liabilities 58,557 (23,900) 34,657
Convertible and other long-term debt 27,713 (10,700) 17,013
Other liabilities 1,413 1,413
Redeemable common stock 3,000 (3,000) ---
Stockholders' (deficiency) equity (8,830) 31,100 22,270
_________ ________
Total liabilities and
stockholders' (deficiency)
equity $ 81,853 $ 75,353
========= ========
Note A - The Proforma adjustments reflect the equity financing and final
payment of the class action settlement as described above as if the
transactions had taken place on March 31, 1999.
Note 7 - Commitments and Contingencies
Breast Implant Litigation:
Final Order of Settlement. Prior to the final settlement order issued by
federal Judge Sam C. Pointer, Jr. on February 1, 1999, INAMED and its McGhan
Medical and CUI subsidiaries were defendants in tens of thousands of state
and federal court lawsuits involving breast implants. As part of that final
order, all of those cases arising from breast implant products (both silicone
gel-filled and saline) which were implanted before June 1, 1993 were
consolidated into a mandatory class action settlement and dismissed.
On March 3, 1999 the statutory 30-day period for filing appeals expired, with
no notices of appeal being filed with the Federal District Court within that
period. As a result, by June 2, 1999 the Company will be required to fund the
$25.5 million promissory note that was previously issued to the court-supervised
escrow agent on behalf of the plaintiff class. An additional $3 million of
funding will be needed by June 2, 1999 to purchase the 426,323 shares of
common stock which were issued last year to the court-supervised escrow agent
as part of the consideration for the settlement. Those funds will be provided
directly by the Company's senior noteholders. The Company had assigned its
right to purchase that stock to its senior noteholders in April 1998, at the
time the settlement agreement was signed.
In May 1999, the Company completed the final payment of all of the monies owed
under the Settlement Agreement (see Note 6 for subsequent events).
Current Product Liability Exposure. Currently, the Company's product liability
litigation relates almost entirely to saline products which were implanted after
the 1992 FDA moratorium on silicone gel-filled implants went into effect. These
cases are being handled in the ordinary course of business and will not have a
material financial impact on the Company.
History of the Litigation Settlement. Beginning in 1992 with the FDA
moratorium on silicone gel-filled implants, a torrent of litigation was
filed against the manufacturers. The alleged factual basis for typical
lawsuits included 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 opposed plaintiffs' claims in these lawsuits and other similar
actions and has continually denied any wrongdoing or liability. 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). Most recently in December 1998,
a science panel of independent experts appointed by Judge Pointer reached the
same conclusion. Nevertheless, the immense volume of lawsuits created a
substantial burden on the Company, both in terms of ongoing litigation costs and
the expenses of settlement, in addition to the inherent risk of adverse jury
verdicts in cases that could not be resolved by dismissal or settlement.
Beginning in 1994 the Company sought to resolve breast implant litigation by
participating in a proposed industry-wide class action settlement (the "Global
Settlement") of domestic breast implant litigation. At that time, the Company
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 plaintiffs'
negotiating committee 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.
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. The Settlement Agreement was
preliminarily approved by the Court on June 2, 1998. 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 that these lawsuits had placed on the Company.
Terms and Conditions of the Settlement Agreement. Under the Settlement
Agreement, $31.5 million of consideration, consisting of $3 million of cash,
$3 million of common stock and $25.5 million principal amount of a 6%
subordinated note were deposited in a court supervised escrow account in
September 1998.
In the first quarter of 1999, the Court granted final approval of the Settlement
and that final order became non-appealable. In the second quarter of 1999, the
Company completed its funding obligations, and all of the consideration held in
the escrow account was released to the court-appointed settlement office for
distribution to the plaintiff class in accordance with an allocation plan to
be determined by the Court in proceedings to be held in mid-1999.
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.
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. In
connection with a fairness hearing held on January 11, 1999 the Company and the
plaintiffs submitted additional materials to support questions posed by the
Court and to answer various objections which had been made.
Resolution of 3M Contractual Indemnity Claims. The Settlement was 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 (as later amended in January 1999), the
Company paid $3 million to 3M in February 1999, shortly after the Court
granted final approval of the Settlement. Also under the terms of the 3M
Agreement the Company will assume certain limited indemnification obligations
to 3M beginning in the year 2000, subject to a cap of $1 million annually and
$3 million to $6 million in total, depending on the resolution of certain
cases which were not settled prior to the issuance of the final order.
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.
Ongoing Litigation Risks. Although the Company expects the Settlement 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. Collateral Attack. As in all class actions, the Company may be called upon
to defend individual lawsuits collaterally attacking the Settlement even after
it becomes non-appealable. 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.
2. Non-Covered Claims. The Settlement does not include several categories of
breast implants that 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.
Accounting Treatment. In 1993, the Company recorded a $9.2 million reserve for
litigation. For the year ended December 31, 1997, the Company booked an
additional reserve of $28.2 million. As of March 31, 1999, the reserves
relating to the litigation settlement included $1.8 million for accrued
legal costs and the cost of other settlements and $25.5 million for the note
payable to the escrow agent. In the second quarter of 1999, the Company
completed the final payment of all of the monies owed to the court-appointed
escrow agent, and all of those $27.3 million of liabilities relating to the
breast implant litigation were eliminated (see Note 6 for subsequent events).
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 prior to 1998 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.
Recent developments. In January 1998 a new management team was selected, and in
April 1998 a settlement agreement providing for a mandatory, non-opt-out class
action settlement of the breast implant litigation was announced. Consequently,
the Company took a $32 million charge to the 1997 results of operations (of
which $28.2 million is directly related to the cost of the litigation
settlement), and an additional charge of approximately $3.3 million was
incurred in the third quarter of 1998 to reflect the costs of a restructuring
plan. During the fourth quarter, the Company restructured its existing debt,
obtained financing alternatives to raise the $31.5 million of consideration
required under the terms of the settlement agreement and obtained additional
$8 million in financing for the settlement, working capital and ongoing
projects (see Note 6 for subsequent events).
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 March 31, 1999 and 1998.
March 31, 1999 March 31, 1998
(in 000's) %Inc.
Sales 37,588 25% 30,052
Cost of Goods Sold 11,900 (3%) 12,292
Gross Profit 25,688 45% 17,760
As a % of sales 68% 59%
Marketing 7,834 (6%) 8,351
As a % of sales 21% 28%
G&A 7,482 13% 6,598
As a % of sales 20% 22%
R&D 2,027 --% 2,040
As a % of sales 5% 7%
Operating expenses 17,343 2% 16,989
As a % of sales 46% 57%
Operating income 8,345 771
Sales:
Sales for the three months ended March 31, 1999 totaled $37.6 million, an
increase of $7.5 million or 25% over sales for the same period in 1998 that
totaled $30.0 million. Increased sales from all business units and primarily
increased demand for saline and gel implants in the U.S. and International
Plastic and Reconstructive Surgery markets contributed to the increase in
sales volume.
Sales in the United States accounted for 67% and 66% of total net sales for the
periods ended March 31, 1999 and 1998. International sales accounted for 33% and
34% of total net sales for the periods ended March 31, 1999 and 1998.
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
and the yield of finished goods from the Company's manufacturing facilities.
Given the limited number of suppliers of medical-grade silicone raw materials
and components, the Company's ability to control raw materials cost is
often limited. While the Company seeks to manufacture its finished goods as
efficiently as possible, its products are subject to stringent quality and
control standards (including those agreed upon with the FDA), which can
periodically have a significant impact on the yield of finished goods.
The new management team has set targets to improve the gross profit margin.
Gross profit for the three months ended March 31, 1999 totaled $25.7 million,
an increase of $7.9 million or 45% over the same period in 1998. As a
percentage of revenues, gross profit increased 9% to 68% for the first
quarter of 1999 from 59% in 1998. Increased production efficiencies
resulting in higher yields and increased through-put in all three business
units, along with increased sales volumes of higher margin gel products for
reconstructive surgery, and cost reduction measures contributed to the
increase margins and overall reduction of cost of goods sold for the first
quarter of 1999. Cost of sales in 1998 were negatively impacted by pending FDA
audits and manufacturing inefficiencies caused by idle time at both U.S. and
International Plastic and Reconstructive Surgery operations.
Marketing expenses. In the past the largest factor in the variation from year
to year in marketing expenses had been 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.
Additional costs of Marketing associated with the increased sales generally
relate to sales commissions to sales representatives and other payments to
third parties with sales-based payment arrangements. Management is reviewing
those payments and implementing cost reduction plans for all marketing
and related expenses.
Marketing expenses as a percentage of sales were 21% and 28% for the first three
months of 1999 and 1998 respectively. Marketing expenses decreased in absolute
dollars from $8.3 million in 1998 down to $7.8 million in 1999. New
management's goals of growing the sales and reducing costs which included the
restructuring of the entire company during 1998 and strong cost containment
procedures have helped to dramatically reduce the company's marketing expenses
in 1999 from 1998 levels. The Company currently anticipates that marketing
expenses will increase in future quarters but may decrease as a percentage of
sales. The actual amount spent will depend on a variety of factors, including
the Company's level of operations, and the number of new markets the Company
attempts to enter, either geographically or through joint ventures or
strategic alliances for new products.
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 has reduced the staff levels in both the domestic
and international subsidiaries. In addition, management has also set targets
to control and reduce other general and administrative expenses throughout the
Company.
General and administrative expenses decreased as a percentage of sales from 22%
in 1998 down to 20% in 1999. General and administrative expenses increased in
absolute dollars from $6.5 million in the first quarter of 1998 up to $7.4
million over the same period in 1999.
Research and development expenses. R&D expenses primarily consist of ongoing
research and development expenses for new product development in all business
units. Expenses also include necessary regulatory and clinical costs
associated with testing and approving new product introductions in the United
States and throughout the world.
Research and development expenses as a percentage of sales decreased 2% down
from 7% in 1998 to 5% for the first quarter of 1999. Research and development
costs of $2.0 million remained constant in absolute dollars for the first
three months of 1999 and 1998, respectively. The Company currently anticipates
that research and development expenses will increase in future quarters and may
increase as a percentage of sales. The actual amount spent will depend on a
variety of factors, including the Company's level of operations, and the
number of product development projects that it embarks upon, including
through strategic alliances for new products.
Interest expense. Net interest expense of $640,000 for the three months
ended March 31, 1999 decreased $361,000, down from $1.001 million for the
three months ended March 31, 1998. The 1998 expense was primarily due to:
(1) the net carrying costs on the 11% secured convertible notes issued in
January 1996; (2) interest of $510,000 on $9.9 million of 10.5% subordinated
notes which were incurred primarily in the later half of 1997 to fund the
working capital needs; (3) non-cash, finance expense of $330,000 related to
the issuance of warrants in conjunction with the conversion of the 10.5%
subordinated notes to equity, and (4) 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 $31 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 decided to convert the non-U.S.
intercompany debts to the capital of the respective subsidiaries. This
conversion will take place in the second quarter of 1999.
Operating Income. As noted above, beginning in 1998 and continuing into 1999
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 marketing, general and administrative expenses.
There is no assurance that the Company will be continually successful in
these efforts, although the results for the first quarter of 1999 show strong,
positive improvements in operating income and operating margin.
Financial Condition
Liquidity. During the first three months of 1999, net cash provided by
operations was $2.7 million compared to $3.3 million used in operations
for the same time period in 1998. Cash used in financing activities of
$152,000 primarily related to debt payments also offset positive operating
cash. The positive cash from operations resulted from the Company's
continued effort to improve manufacturing efficiencies, reduce inventory
and cost reduction efforts instituted by the new management in all areas
of operation. As further cost reductions measures in all areas are
implemented, the Company believes cash flow from operations will continue
to improve.
Breast Implant Settlement. Under the terms of the proposed settlement of the
breast implant litigation, the Company was obligated to pay an aggregate of
$34.5 million to the plaintiffs and 3M by June 2, 1999. That payment
consists of $31.5 million of cash (which will be used to retire the $25.5
million note to the plaintiffs that was placed in escrow prior to the
mailing of notice of the proposed settlement) and 426,323 shares of common
stock (see Note 6 for subsequent events).
Equity financing:
During the second quarter of 1999, the Company completed a $31.1 million
equity financing, in which 5.4 million new shares of common stock were issued
to various holders of $5.50 and $7.50 warrants in exchange for the payment of
$20.4 million of cash and the surrender of $10.7 million of 11% junior
secured notes. Virtually all of the holders of warrants who were eligible to
exercise at this time participated in the transaction. The Company also
received $3 million of cash from its noteholders, which was used to purchase
on their behalf the 426,323 shares of common stock held by the court-appointed
escrow agent. All of those 5.8 million shares of common stock contain a
legend that restricts transferability absent an exemption under Rule
144 (after the one-year holding period) or an effective registration
statement.
As a result of this equity financing, as of May 14, 1999 the Company now has
approximately 17.1 million shares outstanding and approximately 20.2 million
shares on a fully diluted basis. In addition, as of May 14, 1999 the
Company's debt has decreased from approximately $27.7 million to $17.0
million, and the Company's tangible net worth is approximately $22 million,
as compared to the significant deficit position of the past few years. Also,
due to an incentive fee that was paid as part of the equity financing, the
Company expects to record a non-operating charge of approximately $1.9
million in the second quarter of 1999.
Final payment to plaintiffs in the mandatory class action settlement of the
breast implant litigation:
Subsequent to the end of the first quarter of 1999, the Company also
completed the final payment of all of the monies owed to the court-appointed
escrow agent on behalf of the plaintiffs in the mandatory class action
settlement of the breast implant litigation. The payment was $29.9 million
in cash, and included $25.5 million as full payment of the 6% promissory note
which was issued in June 1998 at the time the settlement received preliminary
approval, $1.4 million of accrued interest on that note, and $3 million to
repurchase the 426,323 shares of common stock which were also issued in June
1998 to the escrow agent. As a result of this payment, approximately $27.3
million of liabilities relating to the breast implant litigation that
was recorded on the Company's balance sheet as of the end of the first
quarter of 1999 has now been eliminated.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company has been advised by the Securities and Exchange Commission
that it has begun a formal investigation of the matters disclosed in the
Current Report on 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.
ITEMS 2. THROUGH 5.
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Form 8-K dated February 1, 1999 (incorporated herein by reference
to the Company's filing with the Commission on February 4, 1999)
Form 8-K dated March 4, 1999 (incorporated herein by reference to
the Comany's filing with the Commission on March 5, 1999)
Form 8-K dated March 19, 1999 (incorporated herein by reference to
the Company's filing with the Commission on March 23, 1999)
Form 8-K dated April 2, 1999 (incorporated herein by reference to
the Company's filing with the Commission on April 9, 1999)
Form 8-K dated May 10, 1999 (incorporated herein by reference to
the Company's filing with the Commission on May 12, 1999)
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
May 14, 1999 By: /s/ Richard G. Babbitt
Richard G. Babbitt, Chairman of the Board
and Chief Executive Officer
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