UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2005
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
COMMISSION FILE NO. 0-26224
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 51-0317849
- ------------------------------- ---------------------
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
311 ENTERPRISE DRIVE
PLAINSBORO, NEW JERSEY 08536
- ------------------------------- ---------------------
(ADDRESS OF PRINCIPAL (ZIP CODE)
EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (609) 275-0500
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The number of shares of the registrant's Common Stock, $.01 par value,
outstanding as of November 4, 2005 was 28,050,652. This amount does not include
1,579,718 shares held as treasury stock.
-1-
<table>
<caption>
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
INDEX
Page Number
-----------
<s> <c>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Operations for the three
and nine months ended September 30, 2005 and 2004 (Unaudited) 3
Condensed Consolidated Balance Sheets as of September 30, 2005
and December 31, 2004 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 2005 and 2004 (Unaudited) 5
Notes to Unaudited Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 17
Factors that may affect our future performance 29
Item 3. Quantitative and Qualitative Disclosures About Market Risk 37
Item 4. Controls and Procedures 37
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 39
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 40
Item 6. Exhibits 40
SIGNATURES 41
EXHIBITS 42
</table>
-2-
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<table>
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands, except per share amounts)
<caption>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- --------------------
2005 2004 2005 2004
---- ---- ---- ----
<s> <c> <c> <c> <c>
TOTAL REVENUE ........................ $69,333 $59,130 $204,951 $168,014
COSTS AND EXPENSES
Cost of product revenues (exclusive
of amortization related to acquired
intangible assets) ................ 26,013 22,412 77,284 64,078
Research and development ............. 3,110 5,103 9,256 10,565
Selling, general and administrative .. 22,653 42,600 72,610 79,096
Amortization ......................... 1,466 1,195 4,609 3,127
------- ------- ------- -------
Total costs and expenses .......... 53,242 71,310 163,759 156,866
Operating income (loss) .............. 16,091 (12,180) 41,192 11,148
Interest income ...................... 952 1,027 2,813 2,938
Interest expense ..................... (1,345) (784) (3,094) (2,478)
Other income (expense), net .......... (4) 306 (638) 424
------- ------- ------- -------
Income (loss) before income taxes .... 15,694 (11,631) 40,273 12,032
Income tax expense (benefit) ......... 5,213 (4,034) 13,693 4,674
------- ------- ------- -------
Net income (loss) .................... $10,481 $(7,597) $26,580 $ 7,358
======= ======= ======= =======
Basic net income (loss) per share .... $ 0.35 $ (0.25) $ 0.88 $ 0.25
Diluted net income per share ......... $ 0.33 $ (0.25) $ 0.82 $ 0.24
Weighted average common shares outstanding:
Basic .......................... 30,039 30,326 30,334 29,961
Diluted ........................ 34,297 30,326 34,727 31,026
The accompanying notes are an integral part of these condensed consolidated financial statements
</table>
-3-
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<table>
(In thousands, except per share amounts)
<caption>
September 30, December 31,
2005 2004
------------ ------------
<s> <c> <c>
ASSETS
Current Assets:
Cash and cash equivalents ............................... $ 37,352 $ 69,855
Short-term investments .................................. 98,430 30,955
Accounts receivable, net of allowances of
$2,990 and $2,749 ..................................... 46,786 46,765
Inventories ............................................. 69,014 55,947
Prepaid expenses and other current assets ............... 18,077 12,716
--------- ---------
Total current assets ................................ 269,659 216,238
Non-current investments ................................... 23,251 95,172
Property, plant, and equipment, net ....................... 27,511 25,461
Deferred income taxes, net ................................ 4,182 15,787
Identifiable intangible assets, net ....................... 66,183 59,817
Goodwill................................................... 69,737 39,237
Other non-current assets .................................. 5,358 5,001
--------- ---------
Total assets .............................................. $ 465,881 $ 456,713
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable, trade ................................. 9,118 10,160
Income taxes payable .................................... 268 1,022
Accrued compensation .................................... 8,449 4,212
Other accrued expenses and current liabilities .......... 15,701 8,840
--------- ---------
Total current liabilities ........................... 33,536 24,234
Long-term debt ............................................ 118,468 118,900
Other non-current liabilities ............................. 6,275 5,756
--------- ---------
Total liabilities ......................................... 158,279 148,890
Commitments and contingencies
Stockholders' Equity:
Common stock; $0.01 par value; 60,000 authorized shares;
29,603 and 29,202 issued at September 30, 2005 and
December 31, 2004, respectively ....................... 296 292
Additional paid-in capital .............................. 328,572 320,602
Treasury stock, at cost; 1,468 and 718 shares at
September 30, 2005 and December 31, 2004, respectively. (44,124) (19,474)
Accumulated other comprehensive income (loss):
Unrealized loss on available-for-sale securities ..... (963) (818)
Foreign currency translation adjustment .............. (864) 9,266
Minimum pension liability adjustment ................. (1,629) (1,780)
Retained earnings/(Accumulated deficit) ................. 26,314 (265)
--------- ---------
Total stockholders' equity ............................ 307,602 307,823
--------- ---------
Total liabilities and stockholders' equity ............... $ 465,881 $ 456,713
========= =========
The accompanying notes are an integral part of these condensed consolidated financial statements
</table>
-4-
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<table>
<caption>
(In thousands)
Nine Months Ended September 30,
2005 2004
---- ----
<s> <c> <c>
OPERATING ACTIVITIES:
Net income ...................................................... $ 26,580 $ 7,358
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization ................................... 8,488 6,486
Deferred income tax provision ................................... 10,004 3,379
Amortization of discount and premium on investments ............. 1,543 1,854
Share-based compensation ...... ................................. 77 23,535
Acquired-in process research and development .................... 500 --
Other, net ...................................................... 651 440
Changes in assets and liabilities, net of business acquisitions:
Accounts receivable .......................................... 2,975 (5,209)
Inventories .................................................. (11,505) (7,694)
Prepaid expenses and other current assets .................... (5,139) (386)
Non-current assets ........................................... 144 (326)
Accounts payable ............................................. (1,337) (1,023)
Income taxes payable ......................................... (869) 1,186
Accrued compensation ......................................... 3,837 1,234
Other accrued expenses and current liabilities ............... 5,938 1,149
-------- --------
Net cash provided by operating activities ....................... 41,887 31,983
-------- --------
INVESTING ACTIVITIES:
Proceeds from sales/maturities of available-for-sale investments. 39,477 169,510
Purchases of available-for-sale investments ..................... (36,724) (158,795)
Cash used in business acquisition, net of cash acquired ......... (50,527) (29,244)
Purchases of property and equipment ............................. (6,632) (5,697)
-------- --------
Net cash used in investing activities ........................... (54,406) (24,226)
-------- --------
FINANCING ACTIVITIES:
Proceeds from exercised stock options and warrants .............. 5,368 4,194
Purchases of treasury stock ..................................... (24,650) (14,238)
Repayment of bank loans ......................................... (270) --
-------- --------
Net cash used in financing activities ........................... (19,552) (10,044)
-------- --------
Effect of exchange rate changes on cash ......................... (432) 70
Net decrease in cash and cash equivalents ....................... (32,503) (2,217)
Cash and cash equivalents at beginning of period ................ 69,855 26,053
-------- --------
Cash and cash equivalents at end of period ...................... $ 37,352 $ 23,836
======== ========
<FN>
<F1>
Supplemental cash flow information:
- -----------------------------------
At September 30, 2005 and 2004, the Company had $3.4 million and $2.9 million,
respectively, of cash pledged as collateral in connection with its interest rate
swap agreement.
The accompanying notes are an integral part of these condensed consolidated financial statements
</FN>
</table>
-5-
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
General
In the opinion of management, the September 30, 2005 unaudited condensed
consolidated financial statements contain all adjustments (consisting only of
normal recurring adjustments) necessary for a fair statement of the financial
position, results of operations and cash flows of the Company. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted in accordance with the instructions to Form 10-Q and Rule
10-01 of Regulation S-X. These unaudited condensed consolidated financial
statements should be read in conjunction with the Company's consolidated
financial statements for the year ended December 31, 2004 included in the
Company's Annual Report on Form 10-K. The December 31, 2004 condensed
consolidated balance sheet was derived from audited financial statements but
does not include all disclosures required by accounting principles generally
accepted in the United States. Operating results for the three- and nine-month
periods ended September 30, 2005 are not necessarily indicative of the results
to be expected for the entire year.
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amount of
assets and liabilities, the disclosure of contingent liabilities, and the
reported amounts of revenues and expenses. Significant estimates affecting
amounts reported or disclosed in the consolidated financial statements include
allowances for doubtful accounts receivable and sales returns, net realizable
value of inventories, estimates of future cash flows associated with long-lived
asset valuations, depreciation and amortization periods for long-lived assets,
valuation allowances recorded against deferred tax assets, estimates of amounts
to be paid to employees and other exit costs to be incurred in connection with
the restructuring of our European operations and loss contingencies. These
estimates are based on historical experience and on various other assumptions
that are believed to be reasonable under the current circumstances. Actual
results could differ from these estimates.
In 2004, the Company determined that its investments in auction rate securities
should be classified as short-term investments. Auction rate securities are
reset to current interest rates periodically, but no later than every 90 days.
These securities were previously recorded in cash and cash equivalents due to
the liquidity that their short-term pricing reset features and the Company's
ability to liquidate them in monthly auctions provide. We have revised prior
period cash flow information to conform to the current-year presentation.
Accordingly, cash flows from investing activities increased by $41.9 million
from that previously reported for the nine months ended September 30, 2004. This
revision had no impact on the Company's net income or cash flows from operations
or financing activities. These reported cash balances do not affect any debt
covenants of the Company.
We have reclassified certain other prior year amounts to conform to the current
year's presentation.
Employee Termination Benefits and Other Exit-Related Costs
The Company does not have a written severance plan, and it does not offer
similar termination benefits to affected employees in all restructuring
initiatives. Accordingly, in situations where minimum statutory termination
benefits must be paid to the affected employees, the Company records employee
severance costs associated with these restructuring activities in accordance
with SFAS No. 112, "Employer's Accounting for Postemployment Benefits." Charges
associated with these activities are recorded when the payment of benefits is
probable and can be reasonably estimated. In all other situations where the
Company pays out termination benefits, including supplemental benefits paid in
excess of statutory minimum amounts and benefits offered to affected employees
based on management's discretion, the Company records these termination costs in
accordance with SFAS No. 146, "Accounting for Costs Associated with Exit or
Disposal Activities."
-6-
The timing of the recognition of charges for employee severance costs depends on
whether the affected employees are required to render service beyond their legal
notification period in order to receive the benefits. If affected employees are
required to render service beyond their legal notification period, charges are
recognized ratably over the future service period. Otherwise, charges are
recognized when management has approved a specific plan and required employee
communication requirements have been met.
For leased facilities and equipment that have been abandoned, the Company
records estimated lease losses based on the fair value of the lease liability,
as measured by the present value of future lease payments subsequent to
abandonment, less the present value of any estimated sublease income. For owned
facilities and equipment that will be disposed of, the Company records
impairment losses based on fair value less costs to sell. The Company also
reviews the remaining useful life of long-lived assets following a decision to
exit a facility and may accelerate depreciation or amortization of these assets,
as appropriate.
Recently Issued Accounting Standards and Other Matters
In November 2005, the Financial Accounting Standards Board (FASB) issued FSP FAS
115-1, which nullifies the guidance in paragraphs 10-18 of Emerging Issues Task
Force Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments" and references existing other than temporary
impairment guidance. FSP FAS 115-1 clarifies that an investor should recognize
an impairment loss no later than when the impairment is deemed
other-than-temporary, even if a decision to sell the security has not been made,
and also provides guidance on the subsequent accounting for an impaired debt
security. FSP FAS 115-1 is effective for reporting periods beginning after
December 15, 2005. Management does not expect that the adoption of FSP FAS 115-1
will have a material impact on the Company's financial statements.
In May 2005, the FASB issued Statement No. 154, "Accounting Changes and Error
Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3." SFAS
154 requires retrospective application to prior periods' financial statements of
a voluntary change in accounting principle. Previously, voluntary changes in
accounting principles were accounted for by including a one-time cumulative
effect in the period of change. This statement is effective January 1, 2006.
Management anticipates that this standard will have no impact on our financial
statements.
In November 2004, the FASB issued Statement No. 151, "Inventory Costs-an
amendment of ARB No. 43, Chapter 4" (Statement 151), which is effective
beginning January 1, 2006. Statement 151 requires that abnormal amounts of idle
facility expense, freight, handling costs and wasted material be recognized as
current-period charges. Statement 151 also requires that the allocation of fixed
production overhead be based on the normal capacity of the production
facilities. Management does not expect that Statement 151 will have a material
impact on our financial position or results of operations.
The American Jobs Creation Act of 2004 was signed into law in October 2004 and
has several provisions that may affect the Company's income taxes in the future,
including the repeal of the extraterritorial income exclusion and a new
deduction related to qualified production activities income. The FASB proposed
that the qualified production activities income deduction is a special deduction
and will have no impact on deferred taxes existing at the enactment date.
Rather, the impact of this deduction will be reported in the period in which the
deduction is claimed on the Company's tax return. Pursuant to United States
Department of Treasury Regulations issued in October 2005, management believes
that a tax benefit on qualified production activities income will be realized
once the Company has completely utilized its unrestricted net operating losses,
which is expected to occur in late 2006. Management is unable to determine the
favorable impact on the effective tax rate in future periods at this time.
In December 2004, the FASB issued Statement No. 123 (revised 2004), "Share-Based
Payment," which is a revision of Statement No. 123, "Accounting for Stock-Based
Compensation." Statement 123(R) replaces APB Opinion No. 25, "Accounting for
Stock Issued to Employees," and amends Statement No. 95, "Statement of Cash
Flows." Statement 123(R) requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the financial
statements based on their fair value. Pro forma footnote disclosure will no
longer be an alternative to financial statement recognition.
Statement 123(R) must be adopted no later than January 1, 2006. Statement 123(R)
permits companies to adopt its requirements using either the "modified
-7-
prospective" method or the "modified retrospective" method. Management is
currently evaluating the potential impact of Statement 123(R) on our
consolidated financial position and results of operations and the alternative
adoption methods.
Equity-Based Compensation
The Company recognizes employee stock based compensation using the intrinsic
value method prescribed by APB Opinion No. 25 "Accounting for Stock Issued to
Employees" and FASB Interpretation No. 44 "Accounting for Certain Transactions
Involving Stock Compensation - an interpretation of APB Opinion No. 25."
Had the compensation cost for the Company's stock option plans been determined
based on the fair value at the date of grant consistent with the provisions of
SFAS No. 123, the Company's net income (loss) and basic and diluted net income
(loss) per share would have been as follows:
<table>
<caption>
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2004 2005 2004
-------- -------- -------- --------
(in thousands, except per share amounts)
<s> <c> <c> <c> <c>
Net income (loss):
As reported ................................ $10,481 $(7,597) $26,580 $ 7,358
Add back: Total stock-based employee
compensation expense determined
under the intrinsic value-based
method for all awards, net
of related tax effects ........... 30 15,372 53 15,372
Less: Total stock-based employee
compensation expense determined under
the fair value-based method for all
awards, net of related tax effects ... (1,897) (16,991) (5,383) (19,899)
-------- -------- -------- --------
Pro forma ............................... $ 8,614 $ (9,216) $21,250 $ 2,831
Net income (loss) per share:
Basic:
As reported ............................. $ 0.35 $ (0.25) $ 0.88 $ 0.25
Pro forma ............................... $ 0.29 $ (0.30) $ 0.70 $ 0.09
Diluted:
As reported ............................. $ 0.33 $ (0.25) $ 0.82 $ 0.24
Pro forma ............................... $ 0.28 $ (0.30) $ 0.67 $ 0.09
</table>
As options vest over a varying number of years and awards are generally made
each year, the pro forma impacts shown above may not be representative of future
pro forma expense amounts. The pro forma additional compensation expense related
to all options granted prior to October 1, 2004 was calculated based on the fair
value of each option grant using the Black-Scholes model, while the pro forma
additional compensation expense related to all options granted on or after
October 1, 2004 was calculated based on the fair value of each option grant
using the binomial distribution model. Management believes that the binomial
distribution model is more appropriate than the Black-Scholes model because the
binomial distribution model is a more flexible model that considers the impact
of non-transferability, vesting and forfeiture provisions in the valuation of
employee stock options.
2. BUSINESS ACQUISITIONS
On September 7, 2005, the Company announced the signing of a definitive
agreement to acquire the assets of the Radionics Division of Tyco Healthcare
Group, L.P. for $80 million in cash, subject to certain adjustments. Radionics,
based in Burlington, Massachusetts, is a leader in the design, manufacture and
sale of advanced minimally-invasive medical instruments and systems for
radiation therapy. Radionics' products include the CRW(TM) stereotactic system,
the XKnife(TM) stereotactic radiosurgery system, the OmniSight(TM) EXcel image
guided surgery system, and the CUSA EXcel(TM) ultrasonic surgical aspiration
system. Completion of the transaction is subject to customary closing
conditions, a fiscal year-end financial audit, regulatory approvals and
expiration of the requisite waiting period under the Hart-Scott-Rodino Antitrust
Improvements Act, as amended. We do not expect the transaction to close before
the end of 2005.
On September 13, 2005, the Company acquired the intellectual property estate of
Eunoe, Inc. for $500,000 in cash. Prior to ceasing operations, Eunoe, Inc. was
engaged in the development of its innovative COGNIShunt(R) system for the
-8-
treatment of Alzheimer's disease patients. The acquisition of the Eunoe
intellectual property estate and clinical trial data extends the Company's
technology base relevant to the management of conditions that require regulation
of cerebrospinal fluid flow within the brain. The traditional application of
this technology is for the treatment of hydrocephalus, a market in which Integra
currently competes. The acquired intellectual property has not been developed
into a product that has been approved by the FDA and has no future alternative
use other than in clinical applications involving the regulation of
cerebrospinal fluid. Accordingly, the Company recorded the entire acquisition
price as an in-process research and development charge in the three-month period
ended September 30, 2005. This transaction was accounted for as an asset
purchase because the acquired assets did not constitute a business under FASB
Statement No 141 "Business Combinations".
On January 3, 2005, the Company acquired all of the outstanding capital stock of
Newdeal Technologies SA for $51.9 million (38.3 million euros) in cash, subject
to a working capital adjustment, and $0.8 million of acquisition related
expenses. Additionally, the Company has agreed to pay the sellers up to an
additional 1,250,000 euros if the sellers continue their employment with the
Company through January 3, 2006. This additional 1,250,000 euro payment is being
accrued to selling, general and administrative expense on a straight-line basis
over the one-year employment requirement period.
Based in Lyon, France, Newdeal is a leading developer and marketer of specialty
implants and instruments specifically designed for foot and ankle surgery.
Newdeal's products include a wide range of products for the forefoot, the
mid-foot and the hind foot, including the Bold(R) Screw, Hallu-Fix(R) plate
system and the HINTEGRA(R) total ankle prosthesis. At the time of the
acquisition, Newdeal sold its products through a direct sales force in France,
Belgium and the Netherlands, and through distributors in more than 30 countries,
including the United States and Canada. Newdeal's target physicians include
orthopedic surgeons specializing in injuries of the foot, ankle and extremities,
as well as podiatric surgeons. The goodwill recorded in connection with this
acquisition is based on the benefits the Company expects to generate from the
synergy between Newdeal's reconstructive foot and ankle fixation products and
the Company's regenerative products that are used in the treatment of chronic
and traumatic wounds of the foot and ankle.
The following summarizes the fair value of the assets acquired and liabilities
assumed:
<table>
<caption>
(All amounts in thousands)
<s> <c> <c>
Cash ................................. $ 2,520
Other current assets ................. 8,477
Property, plant and equipment ........ 1,120 Wtd. Avg. Life
Intangible assets: --------------
Tradename ......................... 2,926 37 years
Customer relationships ............ 6,032 10 years
Technology ........................ 3,387 10 years
Non-competition agreement ......... 745 5 years
Goodwill ............................. 35,576
Other assets ......................... 43
-------
Total assets acquired ............. 60,826
Liabilities assumed, excluding debt .. 7,640
Debt assumed ......................... 529
-------
Net assets acquired .................. $52,657
</table>
The fair value of assets acquired was determined with the assistance of a
third-party valuation firm.
The acquired intangible assets are being amortized over lives ranging from 5 to
40 years.
In May 2004, the Company acquired the MAYFIELD(R) Cranial Stabilization and
Positioning Systems and the BUDDE(R) Halo Retractor System business from
Schaerer Mayfield USA, Inc. (formerly Ohio Medical Instrument Company) for $20.0
million in cash paid at closing, a $0.3 million working capital adjustment, and
$0.3 million of acquisition related expenses. The MAYFIELD and BUDDE lines
include skull clamps, headrests, reusable and disposable skull pins, blades,
retractor systems, and spinal implants. MAYFIELD systems are the market leader
in the United States, and neurosurgeons have used them for over thirty years.
The products are sold in the United States through the Integra NeuroSciences
direct sales organization and in international markets through distributors.
In May 2004, the Company acquired all of the capital stock of Berchtold
Medizin-Elektronik GmbH, now named Integra ME, from Berchtold Holding GmbH for
-9-
$5.0 million in cash. Integra ME manufactures and markets the ELEKTROTOM(R) line
of electrosurgery generators and the SONOTOM(R) ultrasonic surgical aspirator,
as well as a broad line of related handpieces, instruments and disposables used
in many surgical procedures, including neurosurgery. Integra ME markets and
sells its products to hospitals and physicians primarily through a network of
distributors.
In January 2004, the Company acquired the R&B instrument business from R&B
Surgical Solutions, LLC for $2.0 million in cash. The R&B instrument line is a
complete line of high-quality handheld surgical instruments used in neuro- and
spinal surgery. The Company markets these products through its JARIT(R) sales
organization.
In January 2004, the Company acquired the Sparta disposable critical care
devices and surgical instruments business from Fleetwood Medical, Inc. for $1.6
million in cash. The Sparta product line includes products used in plastic and
reconstructive, ear, nose and throat (ENT), neuro, ophthalmic and general
surgery. The Company sells the Sparta products through a direct marketing
organization and an existing distributor network.
The goodwill acquired in the MAYFIELD/BUDDE, R&B, and Sparta acquisitions are
deductible for tax purposes.
The following unaudited pro forma financial information summarizes the results
of operations for the nine months ended September 30, 2004 as if the
acquisitions consummated in 2005 and 2004 had been completed as of the beginning
of that period. The pro forma results are based upon certain assumptions and
estimates and they give effect to actual operating results prior to the
acquisitions and adjustments to reflect increased depreciation expense,
increased intangible asset amortization, and increased income taxes at a rate
consistent with the Company's marginal rate in each year. No effect has been
given to cost reductions or operating synergies. As a result, these pro forma
results do not necessarily represent results that would have occurred if the
acquisition had taken place on the basis assumed above, nor are they indicative
of the results of future combined operations.
<table>
<caption>
For the Nine
Months Ended
September 30, 2004
------------------
(in thousands)
<s> <c>
Total revenue .................................... $184,699
Net income ....................................... 7,891
Net income per share:
Basic ......................................... $ 0.26
Diluted........................................ $ 0.25
</table>
Because the Newdeal acquisition was consummated on January 3, 2005, the
Company's results of operations for the nine months ended September 30, 2005
would not have been materially different from those presented herein.
3. INVENTORIES
Inventories consisted of the following:
<table>
<caption>
September 30, December 31,
2005 2004
---- ----
(in thousands)
<s> <c> <c>
Raw materials.............................. $14,237 $11,961
Work-in process............................ 10,058 7,496
Finished goods............................. 44,719 36,490
------- -------
$69,014 $55,947
======= =======
</table>
-10-
4. GOODWILL AND OTHER INTANGIBLE ASSETS
Changes in the carrying amount of goodwill for the nine months ended September
30, 2005, were as follows:
<table>
<caption>
(in thousands)
<s> <c>
Balance at December 31, 2004 ..................................... $ 39,237
Newdeal acquisition .............................................. 35,576
Other ............................................................ 69
Foreign currency translation ..................................... (5,145)
--------
Balance at September 30, 2005 .................................... $ 69,737
========
</table>
The components of the Company's identifiable intangible assets were as follows:
<table>
<caption>
September 30, 2005 December 31, 2004
Weighted ---------------------- ----------------------
Average Accumulated Accumulated
Life Cost Amortization Cost Amortization
-------- -------- ------------ -------- ------------
(in thousands)
<s> <c> <c> <c> <c> <c>
Completed technology ....... 14 years $ 19,129 $ (5,397) $ 17,108 $ (4,505)
Customer relationships ..... 18 years 22,659 (4,443) 17,417 (3,214)
Trademarks/brand names ..... 36 years 31,227 (2,629) 28,689 (1,862)
Noncompetition agreements... 5 years 6,961 (2,255) 6,352 (1,198)
All other .................. 11 years 2,233 (1,302) 2,233 (1,203)
-------- ------------ -------- ------------
$ 82,209 $(16,026) $ 71,799 $(11,982)
Accumulated amortization .. (16,026) (11,982)
-------- --------
$ 66,183 $ 59,817
======== ========
</table>
The Company discontinued a product line in June 2005. As a result, the Company
recorded a $215,000 charge to amortization expense related to the impairment of
a technology-based intangible asset associated with this discontinued product
line.
Annual amortization expense is expected to approximate $5.9 million in 2005,
$5.6 million in 2006, $5.3 million in 2007, $5.1 million in 2008, and $4.4
million in 2009. Identifiable intangible assets are initially recorded at fair
market value at the time of acquisition generally using an income or cost
approach.
5. RESTRUCTURING ACTIVITIES
In June 2005, management announced plans to restructure the Company's European
operations. The restructuring plan includes closing the Company's Integra ME
production facility in Tuttlingen, Germany and reducing various positions in
the Company's production facility located in Biot, France by the end of 2005.
The Company plans to transition the manufacturing operations of Integra ME to
its production facility in Andover, UK.
In June 2005, the Company reached an agreement with local representatives of
the Integra ME workforce regarding the amount of benefits that those employees
will receive in connection with the closure of that facility. The Company is
currently negotiating with representatives of the Biot, France workforce
regarding the amount of benefits the affected employees will receive in excess
of the minimum amounts required by local labor laws.
In June 2005, the Company also eliminated some duplicative sales and marketing
positions, primarily in Europe.
In connection with these restructuring activities, the Company has recorded the
following charges during 2005:
<table>
<caption>
Involuntary employee termination costs
--------------------------------------
Research Selling
Cost of and General and
Sales Development Administrative Total
------- ------- ------- -------
(in thousands)
<s> <c> <c> <c> <c>
Three months ended September 30, 2005.. $ 536 $ 60 $ 70 $ 666
Nine months ended September 30, 2005... 1,834 $ 84 $ 822 $ 2,740
</table>
-11-
Below is a reconciliation of the restructuring accrual activity recorded during
2005:
<table>
<caption>
Employee
Termination
Costs Total
------- -------
(in thousands)
<s> <c> <c>
Balance at December 31, 2004 ........................ $ -- $ --
Additions ........................................... 2,740 2,740
Payments ............................................ (558) (558)
Adjustments ......................................... -- --
------- -------
Balance at September 30, 2005 ....................... $ 2,182 $ 2,182
</table>
Approximately 74 individuals have been identified for termination under the
current restructuring plan. As of September 30, 2005, the Company has terminated
14 of these individuals.
The Company expects to record up to an additional $1.6 million of restructuring
charges during the remainder of 2005 related to additional employee termination
costs and costs associated with exiting the Integra ME facility. The Company
has not yet recorded these amounts because either the employees are required to
render service beyond their legal notification period in order to receive the
benefits or the benefits have not been communicated to the affected employees.
6. SHARE-BASED COMPENSATION CHARGE
In July 2004, the Company's President and Chief Executive Officer (Executive)
renewed his employment agreement with the Company through December 31, 2009. In
connection with the renewal of the agreement, the Executive received a grant of
fair market value options to acquire up to 250,000 shares of Integra common
stock and a fully vested contract stock unit award providing for the payment of
750,000 shares of Integra common stock which shall generally be delivered to the
Executive following his termination of employment or retirement but not before
December 31, 2009, or later under certain circumstances. In connection with the
fully vested contract stock award, the Company recorded a share-based
compensation charge of $23.9 million, including payroll taxes, in the three
months ended September 30, 2004 for the compensation expense related to the
fully-vested contract stock unit grant.
7. RETIREMENT BENEFIT PLANS
The Company maintains defined benefit pension plans that cover employees in its
manufacturing plants located in Andover, United Kingdom and Tuttlingen, Germany.
Net periodic benefit costs for the Company's defined benefit pension plans
included the following amounts:
<table>
<caption>
Three Months Ended Nine Months Ended
September 30 September 30
2005 2004 2005 2004
------ ------ ------ ------
(in thousands)
<s> <c> <c> <c> <c>
Service cost .......................... $ 61 $ 26 $ 185 $ 74
Interest cost ......................... 103 73 313 213
Expected return on plan assets ........ (85) (58) (260) (172)
Recognized net actuarial loss ......... 34 28 106 81
------ ------ ------ ------
Net periodic benefit cost .......... $ 113 $ 69 $ 344 $ 196
</table>
For the nine months ended September 30, 2005, the Company made $167,000 of
contributions to its defined benefit pension plans.
-12-
8. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) was as follows:
<table>
<caption>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- --------------------
2005 2004 2005 2004
-------- -------- ------ ------
(in thousands)
<s> <c> <c> <c> <c>
Net income (loss) ................................. $10,481 $(7,597) $26,580 $ 7,358
Foreign currency translation adjustment ........... (232) 532 (9,978) 108
Minimum pension liability adjustment, net of tax .. -- 4 -- 444
Unrealized holding gains (losses) on
available-for-sale securities, net of tax .... -- 678 (163) (577)
Less: Reclassification adjustment for losses
included in net income (loss), net of tax ... -- -- 18 --
-------- -------- -------- ---------
Comprehensive income (loss) ....................... $10,249 $(6,383) $ 16,457 $ 7,333
======== ======== ======== =========
</table>
A significant portion of the foreign currency translation adjustment recorded
for the nine-month periods ended September 30, 2005 was related to the
appreciation of the U.S. dollar against the euro following the Company's
acquisition of Newdeal Technologies, whose functional currency is the euro, on
January 3, 2005.
9. NET INCOME (LOSS) PER SHARE
Basic and diluted net income per share was as follows:
<table>
<caption>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2005 2004 2005 2004
-------- -------- -------- --------
(In thousands, except
per share amounts)
<s> <c> <c> <c> <c>
Basic net income (loss) per share:
- ----------------------------------
Net income (loss) ................................. $ 10,481 $ (7,597) $ 26,580 $ 7,358
Weighted average common shares outstanding ........ 30,039 30,326 30,334 29,961
Basic net income (loss) per share ................. $ 0.35 $ (0.25) $ 0.88 $ 0.25
Diluted net income (loss) per share:
- ------------------------------------
Net income (loss) ................................ $ 10,481 $ (7,597) $ 26,580 $ 7,358
Add back: Interest expense and other
income/(expense) related to convertible
notes payable, net of tax ............... 800 -- 1,832 --
-------- -------- -------- --------
Net income (loss) available to common stock ....... $ 11,281 $ (7,597) $ 28,412 $ 7,358
Weighted average common shares outstanding - Basic 30,039 30,326 30,334 29,961
Effect of dilutive securities:
Stock options and restricted stock ............. 744 -- 879 1,065
Shares issuable upon conversion of notes payable 3,514 -- 3,514 --
-------- -------- -------- --------
Weighted average common shares for diluted
earnings (loss) per share ...................... 34,297 30,326 34,727 31,026
Diluted net income (loss) per share ............... $ 0.33 $ (0.25) $ 0.82 $ 0.24
</table>
Options outstanding at September 30, 2005 to purchase approximately 921,000
shares of common stock were excluded from the computation of diluted net income
per share for the three-month period ended September 30, 2005 because their
exercise price exceeded the average market price of the Company's common stock
during the period. Options outstanding at September 30, 2004 to purchase
approximately 3,315,000 shares of common stock and approximately 3,514,000
shares of common stock issuable upon the conversion of notes payable were
excluded from the computation of diluted net loss per share for the three-month
period ended September 30, 2004 because their impact would be anti-dilutive.
-13-
In October 2004, the EITF reached a consensus on Issue 04-08 "The Effect of
Contingently Convertible Instruments on Diluted Earnings per Share" that
requires issuers of contingent convertible securities to account for these
securities on an "if-converted" basis pursuant to Statement of Financial
Accounting Standards No. 128 "Earnings Per Share", in computing their diluted
earnings per share whether or not the issuer's stock is above the contingent
conversion price. The provisions of Issue 04-08 were applied on a retroactive
basis, but they had no impact on the previously reported diluted loss per share
for the three month period ended September 30, 2004 or previously reported
diluted net income per share for the nine-month period ended September 30, 2004.
10. SEGMENT AND GEOGRAPHIC INFORMATION
Integra management reviews financial results and manages the business on an
aggregate basis. Therefore, financial results are reported in a single operating
segment, the development, manufacture and marketing of medical devices for use
in neurosurgery, reconstructive surgery and general surgery.
Revenues consisted of the following:
<table>
<caption>
Three Months Ended Nine Months Ended
September 30, September 30,
(in thousands) 2005 2004 2005 2004
------ ------ ------- -------
<s> <c> <c> <c> <c>
Implant products .............................. $ 26,769 $20,823 $ 79,777 $ 58,566
Instruments .................................... 22,597 19,933 67,909 54,982
Monitoring products ............................ 12,509 12,689 35,908 35,700
Private label products and other ............... 7,458 5,685 21,357 18,766
------ ------ ------- -------
Total revenue .................................. $ 69,333 $59,130 $204,951 $168,014
</table>
Certain of the Company's products, including the DuraGen(R) and NeuraGen(TM)
product families and the INTEGRA(R) Dermal Regeneration Template and wound
dressing products, contain material derived from bovine tissue. Products that
contain materials derived from animal sources, including food as well as
pharmaceuticals and medical devices, are increasingly subject to scrutiny from
the press and regulatory authorities. These products comprised 31% of total
revenues in each of the three-month periods ended September 30, 2005 and 2004
and 31% of total revenues in each of the nine-month periods ended September 30,
2005 and 2004. Accordingly, widespread public controversy concerning collagen
products, new regulation, or a ban of the Company's products containing material
derived from bovine tissue, could have a material adverse effect on the
Company's current business or its ability to expand its business.
Total revenues by major geographic area are summarized below:
<table>
<caption>
United Asia Other
States Europe Pacific Foreign Total
-------- -------- -------- -------- --------
(in thousands)
<s> <c> <c> <c> <c> <c>
Three months ended Sept 30, 2005 ... $ 53,504 $ 10,443 $ 2,662 $ 2,724 $ 69,333
Three months ended Sept 30, 2004 ... 46,960 7,603 2,592 1,975 59,130
Nine months ended Sept 30, 2005 .... $152,623 $ 36,187 $ 8,443 $ 7,698 $204,951
Nine months ended Sept 30, 2004 .... 133,338 22,412 6,490 5,774 168,014
</table>
11. COMMITMENTS AND CONTINGENCIES
Various lawsuits, claims and proceedings are pending or have been settled by the
Company. The most significant of those are described below.
In July 1996, the Company filed a patent infringement lawsuit in the United
States District Court for the Southern District of California (the "Trial
Court") against Merck KGaA, a German corporation, Scripps Research Institute, a
California nonprofit corporation, and David A. Cheresh, Ph.D., a research
scientist with Scripps, seeking damages and injunctive relief. The complaint
charged, among other things, that the defendant Merck KGaA willfully and
deliberately induced, and continues willfully and deliberately to induce,
defendants Scripps Research Institute and Dr. Cheresh to infringe certain of the
Company's patents. These patents are part of a group of patents granted to The
-14-
Burnham Institute and licensed by Integra that are based on the interaction
between a family of cell surface proteins called integrins and the
arginine-glycine-aspartic acid ("RGD") peptide sequence found in many
extracellular matrix proteins. The defendants filed a countersuit asking for an
award of defendants' reasonable attorney fees.
In March 2000, a jury returned a unanimous verdict in the Company's favor and
awarded Integra $15.0 million in damages, finding that Merck KGaA had willfully
infringed and induced the infringement of our patents. The Trial Court dismissed
Scripps and Dr. Cheresh from the case.
In October 2000, the Trial Court entered judgment in Integra's favor and against
Merck KGaA in the case. In entering the judgment, the Trial Court also granted
to the Company pre-judgment interest of $1.4 million, bringing the total award
to $16.4 million, plus post-judgment interest. Merck KGaA filed various
post-trial motions requesting a judgment as a matter of law notwithstanding the
verdict or a new trial, in each case regarding infringement, invalidity and
damages. In September 2001, the Trial Court entered orders in favor of Integra
and against Merck KGaA on the final post-judgment motions in the case, and
denied Merck KGaA's motions for judgment as a matter of law and for a new trial.
Merck KGaA and Integra each appealed various decisions of the Trial Court to the
United States Court of Appeals for the Federal Circuit (the "Circuit Court"). In
June 2003, the Circuit Court affirmed the Trial Court's finding that Merck KGaA
had infringed our patents. The Circuit Court also held that the basis of the
jury's calculation of damages was not clear from the trial record, and remanded
the case to the Trial Court for further factual development and a new
calculation of damages consistent with the Circuit Court's decision. In
September 2004, the Trial Court ordered Merck KgaA to pay Integra $6.4 million
in damages following the Circuit Court's order. Merck KGaA filed a petition for
a writ of certiorari with the United States Supreme Court (the "Supreme Court")
seeking review of the Circuit Court's decision, and the Supreme Court granted
the writ in January 2005. Oral arguments before the United States Supreme Court
were held in April 2005.
On June 13, 2005, the Supreme Court vacated the June 2003 judgment of the
Circuit Court. The Supreme Court held that the Circuit Court applied an
erroneous interpretation of 35 U.S.C. ss.271(e)(1) when it rejected the
challenge of Merck KGaA to the jury's finding that Merck KGaA failed to show
that its activities were exempt from claims of patent infringement under that
statute. On remand, the Circuit Court will review the evidence under a
reasonableness test that does not provide categorical exclusions of certain
types of activities.
Further enforcement of the Trial Court's order has been stayed pending the
decision of the Supreme Court.
The Company has not recorded any gain in connection with this matter, pending
final resolution and completion of the appeals process.
Three of the Company's French subsidiaries that were acquired from the
neurosciences division of NMT Medical, Inc. received a tax reassessment notice
from the French tax authorities seeking in excess of 1.7 million euros in back
taxes, interest and penalties. NMT Medical, the former owner of these entities,
has agreed to indemnify Integra against direct damages and liability arising
from misrepresentations in connection with these tax claims. In April 2005, NMT
Medical, Inc. negotiated a settlement agreement with the French authorities that
satisfied the outstanding tax assessments. This settlement did not have any
impact on the Company's financial statements.
In addition to these matters, the Company is subject to various claims, lawsuits
and proceedings in the ordinary course of its business, including claims by
current or former employees, distributors and competitors and with respect to
our products. In the opinion of management, such claims are either adequately
covered by insurance or otherwise indemnified, or are not expected, individually
or in the aggregate, to result in a material adverse effect on the Company's
financial condition. However, it is possible that our results of operations,
financial position and cash flows in a particular period could be materially
affected by these contingencies.
12. SUBSEQUENT EVENT
Related Party Lease
On October 28, 2005, the Company entered into a lease modification agreement
with Plainsboro Associates relating to its manufacturing facility in Plainsboro,
New Jersey. Plainsboro Associates is a New Jersey general partnership. Ocirne,
Inc., a subsidiary of Provco Industries ("Provco"), owns a 50% interest in
Plainsboro Associates. Provco's stockholders are trusts whose beneficiaries
include the children of Dr. Richard Caruso, the Chairman and a principal
stockholder of the Company. Dr. Caruso is the President of Provco.
-15-
The lease modification agreement provides for extension of the term of the lease
from October 31, 2012 for an additional five year period through October 31,
2017 at an annual rate of approximately $272,000 per year. The lease
modification agreement also provides a ten year option for the Company to extend
the lease from November 1, 2017 through October 31, 2027 at an annual rate of
approximately $296,000 per year.
-16-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our condensed consolidated
financial statements and the related notes thereto appearing elsewhere in this
report and our consolidated financial statements for the year ended December 31,
2004 included in our Annual Report on Form 10-K.
This discussion and analysis contains forward-looking statements that involve
risks, uncertainties and assumptions. Our actual results may differ materially
from those anticipated in these forward-looking statements as a result of many
factors, including but not limited to those set forth below under the heading
"Factors That May Affect Our Future Performance."
GENERAL
Integra develops, manufactures and markets medical devices for use in
neurosurgery, reconstructive surgery and general surgery. Our business is
organized into product groups and distribution channels. Our product groups
include implants and other devices for use in surgical procedures, monitoring
systems for the measurement of various parameters in tissue (such as pressure,
temperature and oxygen), hand-held and ultrasonic surgical instruments, and
private label products that we manufacture for other medical device companies.
Our distribution channels include three sales organizations in the United
States: one that we employ to call on neurosurgeons known as our Integra
NeuroSciences(TM) sales organization, another employed to call on reconstructive
surgeons and a third group that utilizes a network of third-party distributors.
Internationally, we combine resources across different sales channels in some
cases with direct sales organizations in France, Germany, the United Kingdom and
the Benelux region. Outside of these areas, we operate through a number of
distributors that sell our products in over 90 countries. We invest substantial
resources and management effort to develop our sales organizations, and we
believe that we compete very effectively in this aspect of our business. We
distribute private-label products through strategic alliances.
We manufacture most of the implant, monitoring and private-label products that
we sell in various plants located in the United States, Puerto Rico, France, the
United Kingdom and Germany. We also source most of our hand-held surgical
instruments through specialized third-party vendors.
We believe that we have an advantage in the development, manufacture and sale of
specialty tissue repair products derived from bovine collagen. We develop and
manufacture these products in our manufacturing facility in Plainsboro, New
Jersey. Taken together, these products accounted for approximately 31% of total
revenues in the nine-month periods ended September 30, 2005 and 2004.
We manage these multiple product groups and distribution channels on a
centralized basis. Accordingly, we report our financial results under a single
operating segment - the development, manufacturing and distribution of medical
devices.
Our objective is to build a customer-focused and profitable medical device
company by developing or acquiring innovative medical devices and other products
to sell through our sales channels. Our strategy therefore entails substantial
growth in product revenues both through internal means - through launching new
and innovative products and selling existing products more intensively - and by
acquiring existing businesses or product lines.
We aim to achieve this growth in revenues while maintaining strong financial
results. While we pay attention to any meaningful trend in our financial
results, we pay particular attention to measurements that tend to support the
view that our profitability can grow for a period of years. These measurements
include revenue growth, derived through acquisitions and products developed
internally, gross margins on revenue, which we hope to increase to more than 65%
in the near term, operating margins, which we hope to continually expand on as
we leverage our existing infrastructure, and earnings per fully diluted share of
common stock.
-17-
RESULTS OF OPERATIONS
Our strategy for growing our business includes the acquisition of complementary
product lines and companies. Recent acquisitions (as discussed in Note 2 to our
unaudited condensed consolidated financial statements), restructuring
activities, and non-cash compensation charges may make our financial results for
the three- and nine-month periods ended September 30, 2005 not directly
comparable to those of the corresponding prior year periods.
Additionally, future financial results may be impacted by the pending
acquisition of the Radionics Division of Tyco Healthcare Group, L.P. On
September 7, 2005, Integra announced the signing of a definitive agreement to
acquire the assets of the Radionics Division of Tyco Healthcare Group, L.P. for
$80 million in cash, subject to certain adjustments. Radionics, based in
Burlington, Massachusetts, is a leader in the design, manufacture and sale of
advanced minimally invasive medical instruments and systems for radiation
therapy. Radionics' products include the CRW(TM) stereotactic system, the
XKnife(TM) stereotactic radiosurgery system, the OmniSight(TM) EXcel image
guided surgery system, and the CUSA EXcel(TM) ultrasonic surgical aspiration
system. Completion of the transaction is subject to customary closing
conditions, a fiscal year-end financial audit, regulatory approvals and
expiration of the requisite waiting period under the Hart-Scott-Rodino Antitrust
Improvements Act, as amended. We do not expect the transaction to close before
the end of 2005.
The Radionics business generated revenues of $62.2 million and pre-tax income of
$13.4 million for the year ending September 30, 2004, the most recent audited
period. Integra will acquire the Radionics facility in Burlington Massachusetts,
which employs approximately 135 people and enter into transitional supply and
distribution agreements with Tyco Healthcare for products currently manufactured
at Tyco facilities not included in the transaction. The transaction offers a
number of strategic benefits to us:
|X| Increases our global neurosurgery product offering with the addition of
an ultrasonic surgical aspirator product line, including handpiece,
tip, and energy delivery designs utilizing magnetostrictive technology.
|X| Positions us to offer new stereotactic surgery products by combining
our existing Mayfield(R) and Budde head-holding and retraction products
with Radionic's CRW stereotactic head frame.
|X| Secures entry into the radiosurgery/radiotherapy and image-guided
surgery device business.
|X| Adds to our manufacturing and R&D expertise in electronics,
ultrasonics, and software.
|X| Enhances the efficiencies of our global infrastructure and distribution
network through economies of scale and cost synergies.
Tyco Healthcare sells the Radionics products in over 75 countries, using a
network of independent distributors in the United States and both independent
distributors and Tyco Healthcare affiliates internationally. Although Radionics
currently sells directly through many Tyco affiliates internationally, after
closing Integra is likely to use distributors in many of these markets. As a
result, after Integra takes over the Radionics business, we expect that revenue
and pre-tax income attributable to the acquired product lines will be reduced by
approximately 20% from the 2004 reported levels, prior to any impact associated
with purchase accounting related to the transaction. Overall, the acquired
business has been growing at rates below our corporate growth rate targets.
During the second quarter of 2005, we announced plans to restructure certain of
our European operations. The restructuring plan includes closing our Integra ME
production facility in Tuttlingen, Germany and reducing the manufacturing
overhead workforce in our production facility located in Biot, France by the
end of 2005. We are in the process of transitioning the manufacturing
operations of Integra ME to our production facility in Andover, UK.
In June 2005, we reached an agreement with local representatives of the Integra
ME workforce regarding the amount of benefits that those employees will receive
in connection with the closure of that facility. We are currently negotiating
with representatives of the Biot, France workforce regarding the amount of
benefits the affected employees will receive in excess of the minimum amounts
required by local labor laws.
During the second quarter of 2005, we also eliminated some duplicative sales
and marketing positions, primarily in Europe.
Approximately 74 individuals have been identified for termination under the
current restructuring plan. As of September 30, 2005, we have terminated 14 of
these individuals. In connection with this restructuring plan, we recorded a
$2.7 million charge in the nine-month period ended September 30, 2005 (of which
$0.7 million was recorded in the third quarter of 2005) for the estimated costs
of employee termination benefits to be provided to the affected employees.
-18-
During the third quarter of 2005, the Company completed the transfer of the
Spinal Specialties assembly operations from its San Antonio, Texas plant to the
Company's San Diego, California plant.
Net income for the three months ended September 30, 2005 was $10.5 million, or
$0.33 per diluted share, as compared to a net loss of $7.6 million, or $0.25 per
diluted share, for the three months ended September 30, 2004.
Net income for the nine months ended September 30, 2005 was $26.6 million, or
$0.82 per diluted share, as compared to net income of $7.4 million, or $0.24 per
diluted share, for the nine months ended September 30, 2004.
These amounts include the following charges:
<table>
<caption>
Three Months Ended Nine Months Ended
September 30, September 30,
(in thousands) 2005 2004 2005 2004
------ ------ ------ ------
<s> <c> <c> <c> <c>
Involuntary employee termination costs ........... $ 666 $ -- $ 2,740 $ --
Inventory fair market value purchase accounting
adjustments .................................. -- 134 466 203
Facility consolidation, acquisition
integration and related costs ................ 492 -- 1,314 --
Acquired technology licensing and
milestone payments ........................... -- 1,855 -- 1,855
Acquired in-process research and development ..... 500 -- 500 --
Non-cash compensation charge related to the
renewal of Chief Executive Officer's
employment agreement ......................... -- 23,876 -- 23,876
Costs associated with discontinued
products lines ............................... -- -- 478 --
------ ------ ------ ------
Total $ 1,658 $25,865 $ 5,498 $25,934
</table>
We believe that, given our ongoing, active strategy of seeking acquisitions, our
current focus on rationalizing our existing manufacturing and distribution
infrastructure and our recent review of various product lines in relation to our
current business strategy, the delineation of these costs provides useful
information to measure the comparative performance of our business operations.
We estimate that the costs of these restructuring activities and charges
associated with other acquisition and integration-related activities in 2005
will not exceed $8 million in the aggregate. We have not yet recorded
additional expense for employee termination benefits because either the
employees are required to render service beyond their legal notification period
in order to receive the benefits or the benefits have not been communicated to
the affected employees. We will record charges for other acquisition and
integration charges when the related expenses are incurred.
While we expect a positive impact of the restructuring and integration
activities, such results remain uncertain. We expect to reinvest most of the
savings from these restructuring and integration activities in further building
out our European sales, marketing and distribution organization, and integrating
the Newdeal group's business with our existing sales and distribution network.
Revenues and Gross Margin on Product Revenues
<table>
<caption>
Three Months Ended Nine Months Ended
September 30, September 30,
(in thousands) 2005 2004 2005 2004
------ ------ ------- -------
<s> <c> <c> <c> <c>
Implant products .............................. $ 26,769 $20,823 $ 79,777 $ 58,566
Instruments .................................... 22,597 19,933 67,909 54,982
Monitoring products ............................ 12,509 12,689 35,908 35,700
Private label products and other ............... 7,458 5,685 21,357 18,766
------ ------ ------- -------
Total revenue .................................. $ 69,333 $59,130 $204,951 $168,014
Cost of product revenues ....................... 26,013 22,412 77,284 64,078
-19-
Gross margin on total revenues (exclusive
of amortization related to acquired
intangible assets) .......................... 43,320 36,718 127,667 103,936
Gross margin (exclusive of amortization
related to acquired intangible assets) as
a percentage of total revenues .............. 62% 62% 62% 62%
</table>
THREE MONTHS ENDED SEPTEMBER 30, 2005 AS COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2004
For the quarter ended September 30, 2005, total revenues increased 17% over the
prior year period to $69.3 million. Domestic revenues increased $6.5 million to
$53.5 million, or 77% of total revenues, as compared to 79% of revenues in the
quarter ended September 30, 2004.
Sales of implant products and instruments, which reported a 29% and 13%
increase, respectively, in sales over the quarter ended September 30, 2004, led
our growth in revenues for the quarter ended September 30, 2005.
Rapid growth in the NeuraGen(TM) Nerve Guide, the INTEGRA(R) Dermal Regeneration
Template and the INTEGRA(TM) Bilayer Matrix Wound Dressing products and sales of
Newdeal products for the foot and ankle accounted for most of the increase in
implant product revenues. Sales of the NPH(TM) Low Flow Hydrocephalus Valve also
contributed to the growth in implant product revenues for the quarter. Our
DuraGen(R) family of duraplasty products continued to grow, although it grew at
slower rates than in recent years. Sales of the DuraGen Plus(TM) and Suturable
DuraGen(TM) Dural Regeneration Matricies led the sales growth in this group of
products. Sales of our Reconstructive Surgery products grew particularly well.
INTEGRA(R) dermal repair product revenues increased approximately 42% over the
third quarter of 2004.
Increased sales of our JARIT(R) surgical instrument, reconstructive surgical
instrument, Selector(R) Ultrasonic Aspirator and Mayfield(R) product lines
provided most of the growth in instrument product revenues.
Lower than expected sales of our Camino(R) Intracranial Pressure Monitors and
external drainage systems affected our monitoring product revenues negatively.
Sales of our LICOX(R) Brain Oxygen Monitoring System product line, which
increased approximately 12% over the prior-year period, partially offset the
negative impact of the Camino and external drainage systems' sales. We have
developed a new targeted account sales and marketing strategy for products in
this category, and we expect that it will contribute to improvements in the
performance of our monitoring products in future periods.
Increased revenues of the Absorbable Collagen Sponge that we supply for use in
Medtronic Inc.'s INFUSE(TM) bone graft product, BioPatch(R), a product that we
manufacture for Johnson & Johnson, and BioMend(R), a product that we manufacture
for Zimmer Holdings, Inc., led the growth in revenues from our private label
products category.
Revenues from product lines acquired since the beginning of the third quarter of
2004 accounted for $3.5 million of the $10.2 million increase in total revenues
over the prior-year period. Changes in foreign currency exchange rates did not
have a significant effect on the year-over-year increase in product revenues. We
expect long-term organic growth in the range of 15% to 20% per annum.
Our gross margin (exclusive of amortization related to acquired intangible
assets) on total revenues in the third quarter of 2005 was 62%, consistent with
the third quarter of 2004. Our gross margin in 2005 was negatively affected by
$0.5 million of termination costs incurred in connection with our announced
European restructuring plans and $0.3 million of charges associated with
facility consolidations. Offsetting the impact of these amounts was continued
growth in higher gross margin products. We recorded $0.1 million of inventory
fair value purchase accounting adjustments in the third quarter of 2004. The
recent significant increase in energy and freight costs has negatively affected
our cost of product revenues.
We have generated our recent product revenue growth through acquisitions, new
product launches and increased direct sales and marketing efforts both
domestically and in Europe. We expect that our expanded domestic sales force,
the ongoing conversion of JARIT domestic sales from a distributor billing model
to a direct billing model, the continued implementation of our direct sales
strategy in Europe and from internally developed and acquired products will
drive our future revenue growth. We also intend to continue to acquire
businesses that complement our existing businesses and products.
-20-
Other Operating Expenses:
The following is a summary of other operating expenses as a percent of total
revenues:
<table>
<caption>
Three Months Ended
September 30,
(in thousands) 2005 2004
------ ------
<s> <c> <c>
Research and development ............................... 4% 9%
Selling, general and administrative .................... 33% 72%
</table>
Total other operating expenses, which consists of research and development
expense, selling, general and administrative expense and amortization expense,
decreased 44% to $27.2 million in the third quarter of 2005, compared to $48.9
million in the third quarter of 2004. The decrease is primarily related to a
$23.9 million share-based compensation charge recorded in the third quarter of
2004 associated with the renewal of our Chief Executive Officer's employment
agreement. The compensation charge resulted from the award of a fully vested
contract stock unit award providing for the payment of 750,000 shares of Integra
common stock.
Research and development expenses decreased $2.0 million to $3.1 million in the
third quarter of 2005. Research and development expenses in the third quarter of
2005 included a $0.5 million in-process research and development charge related
to intellectual property acquired from Eunoe, Inc. Prior to ceasing operations,
Eunoe, Inc. was engaged in the development of its innovative COGNIShunt(R)
system for the treatment of Alzheimer's disease patients. The acquisition of the
Eunoe intellectual property estate and clinical trial data extends Integra's
technology base relevant to the management of conditions that require regulation
of cerebrospinal fluid flow within the brain. The acquired intellectual property
has not been developed into a product that has been approved by the FDA and has
no future alternative use other than in clinical applications involving the
regulation of cerebrospinal fluid.
Research and development expenses in the third quarter of 2004 included a $1.4
million product development milestone payment and a $0.5 million technology
licensing fee. The subject technologies underlying the milestone payment and the
licensing fee arrangement had not been commercialized into a product for which
regulatory clearance has been obtained. Accordingly, we recorded these payments
as research and development expenses.
In 2006, we expect to increase expenditures on research and clinical activities
directed towards expanding the indications for use of our absorbable implant
technology products, including a multi-center clinical trial suitable to support
an application to the FDA for approval of the DuraGen Plus(TM) Adhesion Barrier
Matrix product. During 2005, we have incurred costs associated with the planning
and technical review of protocols in preparation for beginning the study in
2006.
Selling, general, and administrative expenses decreased $19.9 million, or 47%,
as compared to the prior year period to $22.7 million, primarily as a result of
the $23.9 million share-based compensation charge recorded in the third quarter
of 2004. Offsetting the share-based payment in 2005 were costs associated with
the continued build out of our direct sales and marketing organizations around
all three direct selling platforms and increased corporate staff to support the
recent growth in our business and integrate acquired businesses. Additionally,
we have incurred higher operating costs in connection with our recent
investments in our infrastructure with the implementation of a new enterprise
business system and the relocation and expansion of our domestic distribution
capabilities through a third-party service provider. We expect that we will
continue to incur costs related to these activities during the remainder of 2005
and 2006 as we complete these ongoing activities and complete the relocation of
our European distribution capabilities to a third-party service provider.
Selling, general, and administrative expenses in the third quarter of 2005
includes $1.8 million of operating costs associated with the recently acquired
Newdeal acquisition. Included in these costs is a $0.4 million compensation
charge related to the sellers' obligation to continue their employment with
Integra through the end of 2005.
In the third quarter of 2005, we recorded in selling, general, and
administrative expense $0.1 million of costs associated with employee
termination benefits from our European restructuring plan and $0.1 million of
other costs incurred in connection with the consolidation of various
manufacturing and distribution facilities.
Amortization expense increased in the third quarter of 2005 as a result of
amortization of intangible assets from the Newdeal acquisition.
-21-
From time to time, we review our existing product lines in terms of
profitability and compatibility with our current business strategy and customer
call points. We also review the market effectiveness of our existing brand names
and tradenames. If we determine that a product line does not meet our current
minimum profitability expectations in light of the costs to sell that product,
or if a particular product is not on point with our current customer call point,
we may decide to discontinue that product line. Additionally, if a particular
tradename or brand name is no longer effective, we may discontinue the use of
that tradename or brand name. These decisions could result in future impairment
charges recorded against the related inventories and intangible assets.
Non-Operating Income and Expenses
Interest expense is related to the $120 million of 2 1/2% contingent convertible
subordinated notes that we have outstanding and a related interest rate swap
agreement. Our reported interest expense includes $0.2 million of non-cash
amortization of debt issuance costs in both the third quarter of 2005 and 2004.
Debt issuance costs totaled $4.0 million and are being amortized using the
straight-line method over the five-year term of the notes.
We will pay additional interest on our convertible notes under certain
conditions. The fair value of this contingent interest obligation is marked to
its fair value at each balance sheet date, with changes in the fair value
recorded to interest expense. In the third quarter of 2005, the changes in the
estimated fair value of the contingent interest obligation increased interest
expense by $0.3 million. In the third quarter of 2004, the change was minimal.
We have an interest rate swap agreement with a $50.0 million notional amount to
hedge the risk of changes in fair value attributable to interest rate risk with
respect to a portion of our fixed rate convertible notes. The interest rate swap
agreement qualifies as a fair value hedge under SFAS No. 133, as amended
"Accounting for Derivative Instruments and Hedging Activities". The net amount
to be paid or received under the interest rate swap agreement is recorded as a
component of interest expense. Interest expense associated with the interest
rate swap for the three months ended September 30, 2005 was approximately $0.1
million. Interest expense for the three months ended September 30, 2004 included
a $0.2 million benefit associated with the interest rate swap.
For the three-month period ended September 30, 2005, the net fair value of the
interest rate swap increased $0.5 million to $2.0 million, and the fair value
amount is included in other liabilities. In connection with this fair value
hedge transaction, during the third quarter of 2005 we recorded a $0.4 million
decrease in the carrying value of our convertible notes. During the three months
ended September 30, 2004, the net fair value of the interest rate swap decreased
$0.9 million to $1.0 million, and the carrying value of our convertible notes
increased by $0.9 million. The net difference between changes in the fair value
of the interest rate swap and the contingent convertible notes represents the
ineffective portion of the hedging relationship, and this amount is recorded in
other income/(expense), net.
Our net other income/(expense) decreased by $0.3 million as compared to the
third quarter of 2004. This decrease was primarily related to foreign currency
transaction losses recorded in the third quarter of 2005 attributable to the
appreciation of the US dollar relative to the euro and the British pound.
Income tax expense was 33.2% of income before income taxes for the third quarter
of 2005, as compared to an income tax benefit of 34.7% of loss before income
taxes for the third quarter of 2004. Income tax expense for the third quarter of
2005 included a deferred income tax provision of $3.7 million. Income tax
benefit for the third quarter of 2004 included a deferred income tax benefit of
$3.4 million. The decrease in the effective income tax rate in 2005 resulted
primarily from the benefits received from business planning initiatives
undertaken in 2004 to reorganize our European assets, including a reorganization
of certain European operations undertaken in the third quarter of 2004, for
which we recorded a $0.8 million tax charge.
NINE MONTHS ENDED SEPTEMBER 30, 2005 AS COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2004
For the nine months ended September 30, 2005, total revenues increased by $36.9
million, or 22%, over the nine months ended September 30, 2004 to $205.0
million. Revenues from products acquired since the beginning of 2004 accounted
for $19.8 million of the $36.9 million increase in total revenues over the prior
year period. Changes in foreign currency exchange rates contributed $0.7 million
to the increase in total revenues. Domestic revenues increased $19.3 million
compared to the nine months ended September 30, 2004 to $152.6 million, or 74%
of product revenues, compared to 79% reported for the nine months ended
September 30, 2004.
-22-
Our implant product line revenues increased over the prior year period by $21.1
million, or 36%, and the increase includes $12.2 million of sales from our
recently acquired Newdeal implant product line. The remaining increase was the
result of growth in our DuraGen(R) family of duraplasty products, NeuraGen(TM)
Nerve Guide, the INTEGRA(R) family of dermal repair products and as well as the
ongoing launch of the NPH(TM) Low Flow Hydrocephalus Valve.
Revenues from our instrument product lines increased by $12.9 million, or 24%,
over the prior-year period. This increase resulted from the impact of recently
acquired product lines and strong sales growth in each of our existing
instrument product lines. Revenues from our monitoring product lines increased
$0.2 million, or 1%.
Our private label product revenue and other revenue increased by $2.6 million,
or 14%, over the prior-year period, as increased revenues from the Absorbable
Collagen Sponge that we supply for use in Medtronic's INFUSE(TM) bone graft
product and revenues of the Biopatch and BioMend products more than offset the
removal of the Signature Technologies revenues from our private label products
category.
Our gross margin (exclusive of amortization related to acquired intangible
assets) on product revenues for the nine months ended September 30, 2005 and
2004 was 62%. Our gross margin for the nine months ended September 30, 2005 was
negatively affected by $1.8 million of termination costs incurred in connection
with our announced European restructuring plans, $0.5 million of fair value
purchase accounting adjustments, and $0.6 million of inventory write-offs and
other charges associated with a discontinued product line and facility
consolidations. Offsetting the impact of these amounts was the continued growth
in higher gross margin products. We recorded $0.2 million of inventory fair
value purchase accounting adjustments in the nine month period ended September
30, 2004.
Other Operating Expenses:
The following is a summary of other operating expenses as a percent of total
revenues:
<table>
<caption>
Nine Months Ended
September 30,
(in thousands) 2005 2004
------ ------
<s> <c> <c>
Research and development ............................... 5 % 6 %
Selling, general and administrative .................... 35 % 47 %
</table>
Total other operating expenses, consisting of research and development expense,
selling, general and administrative expense and amortization expense, decreased
7% to $86.5 million in the nine months ended September 30, 2005, compared to
$92.8 million in the prior-year period.
Research and development expenses decreased $1.3 million to $9.3 million in the
nine months ended September 30, 2005. The $0.5 million in-process research and
development charge recorded in the nine months ended September 30, 2005 was more
than offset by the $1.4 million product development milestone payment and $0.5
million technology licensing fee recorded to expense in the nine months ended
September 30, 2004.
Selling, general, and administrative expenses decreased $6.5 million, or 8%, as
compared to the prior year period to $72.6 million. The $23.9 million
share-based compensation charge recorded in the third quarter of 2004 was offset
by increased expenses recorded in 2005 related to the continued build out of our
direct sales and marketing organizations around all three direct selling
platforms, increased corporate staff to support the recent growth in our
business and integrate acquired businesses, and approximately $6.4 million of
sales, general, and administrative expenses associated with the recently
acquired Newdeal acquisition. Included in these costs is a $1.1 million
compensation charge related to the sellers' obligation to continue their
employment with Integra through the end of 2005.
Amortization expense increased $1.5 to $4.6 million in 2005 as a result of
amortization of intangible assets from recent acquisitions and a $215,000
impairment charge recorded in 2005 in connection with the discontinuation of a
product line.
-23-
Non-Operating Income and Expenses
Our reported interest expense in 2005 and 2004 includes $0.6 million of
amortization of debt issuance costs. The change in the estimated fair value of
the Contingent Interest obligation increased interest expense by $0.1 million in
2005 and 2004. Interest expense associated with the interest rate swap for the
nine months ended September 30, 2005 was $0.1 million. Interest expense for the
nine months ended September 30, 2004 included a $0.6 million benefit associated
with the interest rate swap.
During the nine months ended September 30, 2005, the net fair value of the
interest rate swap increased $0.6 million to $2.0 million, and this amount is
included in other liabilities. In connection with this fair value hedge
transaction, during the nine months ended September 30, 2005, we recorded a $0.5
million decrease in the carrying value of our convertible notes. During the nine
months ended September 30, 2004, the net fair value of the interest rate swap
decreased less than $0.1 million to $1.0 million, and the carrying value of our
convertible notes increased by $0.1 million. The net difference between changes
in the fair value of the interest rate swap and the contingent convertible notes
represents the ineffective portion of the hedging relationship, and this amount
is recorded in other income (expense), net.
Our net other income/(expense) decreased by $1.0 million from $0.4 million of
income in 2004 to $0.6 million of expense in 2005. In 2005, we recorded $0.9
million of losses from foreign currency transactions attributable the
appreciation of the US dollar relative to the euro and the British pound.
Income tax expense was approximately 34.0% and 38.8% of income before income
taxes for 2005 and 2004, respectively. Income tax expense in 2005 and 2004
includes a deferred income tax provision of $10.0 million and $3.4 million,
respectively. The decrease in the effective income tax rate in 2005 resulted
primarily from the benefits received from business planning initiatives
undertaken in 2004 to reorganize our European assets, for which we recorded a
$0.8 million tax charge in 2004.
INTERNATIONAL OPERATIONS
Because we have operations based in Europe and we generate revenues and incur
operating expenses in euros and British pounds, we have currency exchange risk
with respect to those foreign currency denominated revenues or expenses.
In the third quarter of 2005, the cost of products we manufactured in our
European facilities or purchased in foreign currencies exceeded our foreign
currency-denominated revenues. We expect this imbalance to continue. We
currently do not hedge our exposure to foreign currency risk. Accordingly, a
weakening of the dollar against the euro and British pound could negatively
affect future gross margins and operating margins. We will continue to assess
the potential effects that changes in foreign currency exchange rates could have
on our business. If we believe this potential impact presents a significant risk
to our business, we may enter into derivative financial instruments to mitigate
this risk.
Additionally, we generate significant revenues outside the United States, a
portion of which are U.S. dollar-denominated transactions conducted with
customers who generate revenue in currencies other than the U.S. dollar. As a
result, currency fluctuations between the U.S. dollar and the currencies in
which those customers do business may have an impact on the demand for our
products in foreign countries.
Local economic conditions, regulatory or political considerations, the
effectiveness of our sales representatives and distributors, local competition,
and changes in local medical practice could affect our sales to foreign markets.
Relationships with customers and effective terms of sale frequently vary by
country, often with longer-term receivables than are typical in the United
States.
-24-
Total revenues by major geographic area are summarized below:
<table>
<caption>
United Asia Other
States Europe Pacific Foreign Total
-------- -------- -------- -------- --------
(in thousands)
<s> <c> <c> <c> <c> <c>
Three months ended Sept 30, 2005 ... $ 53,504 $ 10,443 $ 2,662 $ 2,724 $ 69,333
Three months ended Sept 30, 2004 ... 46,960 7,603 2,592 1,975 59,130
Nine months ended Sept 30, 2005 .... $152,623 $ 36,187 $ 8,443 $ 7,698 $204,951
Nine months ended Sept 30, 2004 .... 133,338 22,412 6,490 5,774 168,014
</table>
For the nine months ended September 30, 2005, revenues from customers outside
the United States totaled $52.3 million, or 26% of total revenues, of which
approximately 69% were to European customers. Of this amount, $41.0 million was
generated in foreign currencies primarily by our subsidiaries in Europe.
In the nine months ending September 30, 2004, product revenues from customers
outside the United States totaled $34.7 million, or 21% of total revenues, of
which approximately 65% were from European customers. Of this amount, $24.6
million was generated in foreign currencies.
LIQUIDITY AND CAPITAL RESOURCES
Cash and Marketable Securities
At September 30, 2005, we had cash, cash equivalents and current and non-current
investments totaling approximately $159.0 million. Our investments consist
almost entirely of highly liquid, interest bearing-debt securities.
At September 30, 2005, we had $3.4 million of cash pledged as collateral in
connection with our interest rate swap agreement.
Cash Flows
Cash provided by operations has recently been and is expected to continue to be
our primary means of funding existing operations and capital expenditures. We
have generated positive operating cash flows on an annual basis, including $34.8
million in 2003, $39.0 million in 2004, and $41.9 million of operating cash
flows in the nine months ending September 30, 2005. Operating cash flows for the
nine months ending September 30, 2004, were $32.0 million.
Our principal uses of funds during the nine-month period ended September 30,
2005 were $50.5 million for acquisition consideration, net of cash acquired,
$6.6 million for purchases of property and equipment, and $24.7 million for the
repurchase of 750,000 shares of our common stock. We received $2.8 million in
cash from sales and maturities of investments, net of purchases. In addition to
the $41.9 million in operating cash flows for the nine months ended September
30, 2005, we received $5.4 million from the issuance of common stock through the
exercise of stock options during the period.
During the nine-month period ended September 30, 2005, we paid $5.3 million for
income taxes and $3.0 million for interest on our convertible notes. During the
nine-month period ended September 30, 2004, we paid $0 for income taxes and $3.0
million for interest on our convertible notes.
Based on our current unused net operating loss carryforward position and various
other future potential tax deductions, we expect our operating cash flows to
continue to benefit from actual cash tax payments being lower than our effective
book income tax rate through 2006.
Working Capital
At September 30, 2005 and December 31, 2004, working capital was $236.1 million
and $192.0 million, respectively. Working capital does not include the $23.3
million and $95.2 million of marketable securities classified as non-current at
September 30, 2005 and December 31, 2004, respectively.
-25-
Accounts receivable days sales outstanding improved from approximately 69 days
at December 31, 2004 to approximately 62 days at September 30, 2005 as a result
of increased collection efforts during 2005. We expect our days sales
outstanding to remain consistent with current levels.
Inventory days on hand increased from approximately 217 days at December 31,
2004 to approximately 246 days at September 30, 2005, primarily from higher
levels of Newdeal products and instrument inventory. We expect our days on hand
in inventory to decrease in 2006.
Accrued compensation increased $4.2 million during the nine month period ended
September 30, 2005 primarily as a result of increased headcount and the timing
of payroll in 2005, the $2.0 million of accrued employee termination benefits
associated with our European restructuring activities, and a $1.1 million
accrued compensation charge related to the Newdeal sellers' obligation to
continue their employment with Integra through the end of 2005.
Debt
We have outstanding $120.0 million of 2 1/2% contingent convertible subordinated
notes due 2008. We are obligated to pay $3.0 million of interest per year on the
notes and to repay their principal amount on March 15, 2008, if the notes are
not converted into common stock before that date. We will also pay contingent
interest on the notes if, at thirty days prior to maturity, Integra's common
stock price is greater than $37.56, subject to certain conditions.
We also have outstanding an interest rate swap agreement with a $50 million
notional amount to hedge the risk of changes in fair value attributable to
interest rate risk with respect to a portion of the convertible notes. We
receive a 2 1/2% fixed rate from the counterparty, payable on a semi-annual
basis, and pay to the counterparty a floating rate based on 3 month LIBOR minus
35 basis points, payable on a quarterly basis. The interest rate swap agreement
terminates on March 15, 2008, subject to early termination upon the occurrence
of certain events, including redemption or conversion of the contingent
convertible notes.
We also have outstanding long-term indebtedness totaling $0.2 million related to
the recently acquired Newdeal business.
Share Repurchase Plan
In May 2005, our Board of Directors authorized us to repurchase shares of our
common stock for an aggregate purchase price not to exceed $40 million through
December 31, 2006. We were authorized to repurchase no more than 1.5 million
shares under this program. Through September 30, 2005, we repurchased 750,000
shares for $24.7 million.
In October 2005, our Board of Directors terminated the repurchase program
adopted in May 2005 and adopted a new program that authorizes us to repurchase
shares of our common stock for an aggregate purchase price not to exceed $50
million through December 31, 2006. Shares may be purchased either in the open
market or in privately negotiated transactions.
Dividend Policy
We have not paid any cash dividends on our common stock since our formation. Any
future determinations to pay cash dividends on our common stock will be at the
discretion of our Board of Directors and will depend upon our financial
condition, results of operations, cash flows, and other factors deemed relevant
by the Board of Directors.
Requirements and Capital Resources
We believe that our cash and marketable securities are sufficient to finance our
operations and capital expenditures in the near term. We expect to make
additional investments of approximately $2.5 million through 2006 associated
with the continued worldwide implementation of our new enterprise business
software. Additionally, we have agreed to pay the sellers of Newdeal
Technologies SA up to an additional 1,250,000 euros if the sellers continue
their employment with Integra through January 3, 2006. We also expect to pay up
to $4.0 million in the fourth quarter of 2005 to those employees who are
affected by our European restructuring plans.
-26-
Given the significant level of liquid assets and our objective to grow by
acquisition and alliances, our financial position could change significantly if
we were to complete a business acquisition by utilizing a significant portion of
our liquid assets.
On September 7, 2005, we announced the signing of a definitive agreement to
acquire the assets of the Radionics Division of Tyco Healthcare Group, L.P. for
$80 million in cash, subject to certain adjustments.
Currently, we do not have any existing borrowing capacity or other credit
facilities in place to raise significant amounts of capital if such a need
arises.
Contractual Obligations and Commitments
Under certain agreements, we are required to make royalty payments based on
sales levels of certain products.
OTHER MATTERS
Recently Issued Accounting Standards and Other Matters
In November 2005, the Financial Accounting Standards Board (FASB) issued FSP FAS
115-1, which nullifies the guidance in paragraphs 10-18 of Emerging Issues Task
Force Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments" and references existing other than temporary
impairment guidance. FSP FAS 115-1 clarifies that an investor should recognize
an impairment loss no later than when the impairment is deemed
other-than-temporary, even if a decision to sell the security has not been made,
and also provides guidance on the subsequent accounting for an impaired debt
security. FSP FAS 115-1 is effective for reporting periods beginning after
December 15, 2005. We do not expect that the adoption of FSP FAS 115-1 will have
a material impact on our financial statements.
In May 2005, the FASB issued Statement No. 154, "Accounting Changes and Error
Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3." SFAS
154 requires retrospective application to prior periods' financial statements of
a voluntary change in accounting principle. Previously, voluntary changes in
accounting principles were accounted for by including a one-time cumulative
effect in the period of change. This statement is effective January 1, 2006. We
anticipate that this standard will have no impact on our financial statements.
In November 2004, the FASB issued Statement No. 151, "Inventory Costs-an
amendment of ARB No. 43, Chapter 4" (Statement 151), which is effective
beginning January 1, 2006. Statement 151 requires that abnormal amounts of idle
facility expense, freight, handling costs and wasted material be recognized as
current-period charges. Statement 151 also requires that the allocation of fixed
production overhead be based on the normal capacity of the production
facilities. Management does not expect that Statement 151 will have a material
impact on our financial position or results of operations.
In March 2004, the FASB Emerging Issue Task Force (EITF) reached a consensus on
Issue 03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application
to Certain Investments." Issue 03-01 provides guidance regarding recognition and
measurement of unrealized losses on available-for-sale debt and equity
securities accounted for under Statement of Financial Accounting Standard No.
115, "Accounting for Certain Investments in Debt and Equity Securities". The
application of certain paragraphs covering the measurement provisions of Issue
03-01 have been deferred pending the FASB's issuance of a final Staff Position
providing implementation guidance on Issue 03-01. The disclosures were effective
in annual financial statements for fiscal years ending after December 15, 2003.
Management is currently assessing the impact that the recognition and
measurement provisions of Issue 03-01 could have on our financial statements.
The American Jobs Creation Act of 2004 was signed into law in October 2004 and
has several provisions that may affect the Company's income taxes in the future,
including the repeal of the extraterritorial income exclusion and a new
deduction related to qualified production activities income. The FASB proposed
that the qualified production activities income deduction is a special deduction
and will have no impact on deferred taxes existing at the enactment date.
-27-
Rather, the impact of this deduction will be reported in the period in which the
deduction is claimed on the Company's tax return. Pursuant to United States
Department of Treasury Regulations issued in October 2005, management believes
that a tax benefit on qualified production activities income will be realized
once the Company has completely utilized its unrestricted net operating losses,
which is expected to occur in late 2006. We are unable to determine the
favorable impact on the effective tax rate in future periods at this time.
In December 2004, the FASB issued Statement No. 123 (revised 2004), "Share-Based
Payment," which is a revision of Statement No. 123, "Accounting for Stock-Based
Compensation." Statement 123(R) replaces APB Opinion No. 25, "Accounting for
Stock Issued to Employees," and amends Statement No. 95, "Statement of Cash
Flows." Statement 123(R) requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the financial
statements based on their fair value. Pro forma footnote disclosure will no
longer be an alternative to financial statement recognition.
Statement 123(R) must be adopted no later than January 1, 2006. Statement 123(R)
permits companies to adopt its requirements using either the "modified
prospective" method or the "modified retrospective" method. Management is
currently evaluating the potential impact of Statement 123(R) on our
consolidated financial position and results of operations and the alternative
adoption methods.
In October 2005, our Board of Directors approved an amendment to our Employee
Stock Purchase Plan, effective January 1, 2006, that reduces the purchase price
discount for Integra common stock purchased under the plan from 15% to 5% and
eliminates the "look-back" provision for calculating the purchase price of
common stock. As a result, our Employee Stock Purchase Plan will no longer be
considered compensatory under Statement 123(R).
-28-
FACTORS THAT MAY AFFECT OUR FUTURE PERFORMANCE
Our Operating Results May Fluctuate.
Our operating results, including components of operating results, such as gross
margin on product sales, may fluctuate from time to time, and such fluctuations
could affect our stock price. Our operating results have fluctuated in the past
and can be expected to fluctuate from time to time in the future. Some of the
factors that may cause these fluctuations include:
- the impact of acquisitions;
- the timing of significant customer orders;
- market acceptance of our existing products, as well as products in
development;
- the timing of regulatory approvals; - changes in the rate of exchange
between the U.S. dollar, the euro and the British pound;
- expenses incurred and business lost in connection with product field
corrections or recalls;
- increases in the cost of energy and steel;
- our ability to manufacture our products efficiently; and
- the timing of our research and development expenditures.
The Industry And Market Segments in Which We Operate Are Highly Competitive,
And We May Be Unable To Compete Effectively With Other Companies.
In general, the medical technology industry is characterized by intense
competition. We compete with established medical technology and pharmaceutical
companies. Competition also comes from early stage companies that have
alternative technological solutions for our primary clinical targets, as well as
universities, research institutions and other non-profit entities. Many of our
competitors have access to greater financial, technical, research and
development, marketing, manufacturing, sales, distribution services and other
resources than we do. Our competitors may be more effective at implementing
their technologies to develop commercial products. Our competitors may be able
to gain market share by offering lower-cost products.
Our competitive position will depend on our ability to achieve market acceptance
for our products, develop new products, implement production and marketing
plans, secure regulatory approval for products under development, obtain
reimbursement under Medicare and obtain patent protection. We may need to
develop new applications for our products to remain competitive. Technological
advances by one or more of our current or future competitors could render our
present or future products obsolete or uneconomical. Our future success will
depend upon our ability to compete effectively against current technology as
well as to respond effectively to technological advances. Competitive pressures
could adversely affect our profitability. For example, two of our largest
competitors have introduced an onlay dural graft matrix within the past year,
and other companies may be preparing to introduce similar products. The
introduction of such products could reduce the sales, growth in sales and
profitability of our duraplasty products, including our DuraGen(R), DuraGen
Plus(TM), Suturable DuraGen(TM) and EnDura(TM) product lines, which are among
our largest and fastest growing products.
Our largest competitors in the neurosurgery markets are the Medtronic
Neurosurgery division of Medtronic, Inc., the Codman division of Johnson &
Johnson, the Aesculap division of B. Braun Medical Inc. and the Valleylab
division of Tyco International Ltd. In addition, many of our product lines
compete with smaller specialized companies or larger companies that do not
otherwise focus on neurosurgery. Our reconstructive surgery business is small
compared to its principal competitors, which include major medical device and
wound care companies such as Smith and Nephew plc, LifeCell Corporation and
Organogenesis Inc., as well as companies focused on foot and ankle surgeons
including Wright Medical Group, Inc., the DePuy division of Johnson & Johnson,
Synthes, Inc. and a number of smaller companies. Our private label products face
diverse and broad competition, depending on the market addressed by the product.
Finally, in certain cases our products compete primarily against medical
practices that treat a condition without using a device, rather than any
particular product, such as autograft tissue as an alternative for the
INTEGRA(R) Dermal Regeneration Template, our DuraGen(R) line of duraplasty
products and the NeuraGen(TM) Nerve Guide.
Our Current Strategy Involves Growth Through Acquisitions, Which Requires Us To
Incur Substantial Costs And Potential Liabilities For Which We May Never Realize
The Anticipated Benefits.
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In addition to internal growth, our current strategy involves growth through
acquisitions. Since 1999, we have acquired 21 businesses or product lines at a
total cost of approximately $214 million.
We may be unable to continue to implement our growth strategy, and our strategy
ultimately may be unsuccessful. A significant portion of our growth in revenues
has resulted from, and is expected to continue to result from, the acquisition
of businesses complementary to our own. We engage in evaluations of potential
acquisitions and are in various stages of discussion regarding possible
acquisitions, certain of which, if consummated, could be significant to us. Any
potential acquisitions may result in material transaction expenses, increased
interest and amortization expense, increased depreciation expense and increased
operating expense, any of which could have a material adverse effect on our
operating results. As we grow by acquisitions, we must integrate and manage the
new businesses to realize economies of scale and control costs. In addition,
acquisitions involve other risks, including diversion of management resources
otherwise available for ongoing development of our business and risks associated
with entering new markets with which our marketing and sales force has limited
experience or where experienced distribution alliances are not available. Our
future profitability will depend in part upon our ability to develop further our
resources to adapt to these new products or business areas and to identify and
enter into satisfactory distribution networks. We may not be able to identify
suitable acquisition candidates in the future, obtain acceptable financing or
consummate any future acquisitions. If we cannot integrate acquired operations,
manage the cost of providing our products or price our products appropriately,
our profitability could suffer. In addition, as a result of our acquisitions of
other healthcare businesses, we may be subject to the risk of unanticipated
business uncertainties, regulatory matters or legal liabilities relating to
those acquired businesses for which the sellers of the acquired businesses may
not indemnify us. Future acquisitions may also result in potentially dilutive
issuances of securities.
The Benefits From The Restructuring Of Our European Operations May Not
Materialize.
We may incur significant costs in connection with employee severance, legal and
other items related to restructuring and integration activities, largely in
Europe, as well as due to the pending Radionics acquisition. While we expect a
positive impact of the restructuring and integration activities as well as from
the acquisition, such results remain uncertain. Through the nine months ended
September 30, 2005 we have incurred $5.5 million of these charges. We currently
expect additional charges of $2.5 million to occur in the fourth quarter of
2005.
To Market Our Products Under Development We Will First Need To Obtain Regulatory
Approval. Further, If We Fail To Comply With The Extensive Governmental
Regulations That Affect Our Business, We Could Be Subject To Penalties And Could
Be Precluded From Marketing Our Products.
Our research and development activities and the manufacturing, labeling,
distribution and marketing of our existing and future products are subject to
regulation by numerous governmental agencies in the United States and in other
countries. The Food and Drug Administration (FDA) and comparable agencies in
other countries impose mandatory procedures and standards for the conduct of
clinical trials and the production and marketing of products for diagnostic and
human therapeutic use.
Our products under development are subject to FDA approval or clearance prior to
marketing for commercial use. The process of obtaining necessary FDA approvals
or clearances can take years and is expensive and full of uncertainties. Our
inability to obtain required regulatory approval on a timely or acceptable basis
could harm our business. Further, approval or clearance may place substantial
restrictions on the indications for which the product may be marketed or to whom
it may be marketed, the warnings that may be required to accompany the product
or additional restrictions placed on the sale and/or use of the product. Further
studies, including clinical trials and FDA approvals, may be required to gain
approval for the use of a product for clinical indications other than those for
which the product was initially approved or cleared or for significant changes
to the product. In addition, for products with an approved Pre-Marketing
Approval (PMA), the FDA requires annual reports and may require post-approval
surveillance programs to monitor the products' safety and effectiveness. Results
of post-approval programs may limit or expand the further marketing of the
product.
Another risk of application to the FDA relates to the regulatory classification
of new products or proposed new uses for existing products. In the filing of
each application, we make a legal judgment about the appropriate form and
content of the application. If the FDA disagrees with our judgment in any
particular case and, for example, requires us to file a PMA application rather
than allowing us to market for approved uses while we seek broader approvals or
requires extensive additional clinical data, the time and expense required to
obtain the required approval might be significantly increased or approval might
not be granted.
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Approved products are subject to continuing FDA requirements relating to quality
control and quality assurance, maintenance of records, reporting of adverse
events and product recalls, documentation, and labeling and promotion of medical
devices.
The FDA and foreign regulatory authorities require that our products be
manufactured according to rigorous standards. These regulatory requirements may
significantly increase our production or purchasing costs and may even prevent
us from making or obtaining our products in amounts sufficient to meet market
demand. If we or a third-party manufacturer change our approved manufacturing
process, the FDA may require a new approval before that process may be used.
Failure to develop our manufacturing capability may mean that even if we develop
promising new products, we may not be able to produce them profitably, as a
result of delays and additional capital investment costs. Manufacturing
facilities, both international and domestic, are also subject to inspections by
or under the authority of the FDA. In addition, failure to comply with
applicable regulatory requirements could subject us to enforcement action,
including product seizures, recalls, withdrawal of clearances or approvals,
restrictions on or injunctions against marketing our product or products based
on our technology, cessation of operations and civil and criminal penalties.
We are also subject to the regulatory requirements of countries outside of the
United States where we do business. For example, Japan is in the process of
reforming its medical device regulations. A recent amendment to Japan's
Pharmaceutical Affairs Law went into effect on April 1, 2005. New regulations
and requirements exist for obtaining approval of medical devices, including new
requirements governing the conduct of clinical trials, the manufacturing of
products and the distribution of products in Japan. Significant resources also
may be needed to comply with the extensive auditing of all manufacturing
facilities of our company and our vendors by the Ministry of Health, Labor and
Welfare in Japan to comply with the amendment to the Pharmaceutical Affairs Law.
These new regulations may affect our ability to obtain approvals of new products
as well as maintain the certain businesses in Japan. Sales in Japan accounted
for approximately $3.1 million of our revenues in 2004 and $3.0 million in the
nine month period ended September 30, 2005.
Certain Of Our Products Contain Materials Derived From Animal Sources And May
Become Subject To Additional Regulation.
Certain of our products, including the DuraGen(R) and NeuraGen(TM) product
families and the INTEGRA(R) Dermal Regeneration Template and wound dressing
products, contain material derived from bovine tissue. Products that contain
materials derived from animal sources, including food as well as pharmaceuticals
and medical devices, are increasingly subject to scrutiny in the press and by
regulatory authorities. Regulatory authorities are concerned about the potential
for the transmission of disease from animals to humans via those materials. This
public scrutiny has been particularly acute in Japan and Western Europe with
respect to products derived from cattle, because of concern that materials
infected with the agent that causes bovine spongiform encephalopathy, otherwise
known as BSE or mad cow disease, may, if ingested or implanted, cause a variant
of the human Creutzfeldt-Jakob Disease, an ultimately fatal disease with no
known cure. Recent cases of BSE in cattle discovered in Canada and the United
States have increased awareness of the issue in North America.
We take great care to provide that our products are safe and free of agents that
can cause disease. In particular, the collagen used in the manufacture of our
products is derived only from the deep flexor tendon of cattle from the United
States or New Zealand, a country that has never had a case of BSE, that are less
than 24 months old. We are also qualifying sources of collagen from other
countries that are considered BSE-free. The World Health Organization classifies
different types of cattle tissue for relative risk of BSE transmission. Deep
flexor tendon, the sole source of our collagen, is in the lowest risk category
for BSE transmission (the same category as milk, for example), and is therefore
considered to have a negligible risk of containing the agent that causes BSE (an
improperly folded protein known as a prion). Nevertheless, products that contain
materials derived from animals, including our products, may become subject to
additional regulation, or even be banned in certain countries, because of
concern over the potential for prion transmission. Significant new regulation,
or a ban of our products, could have a material adverse effect on our current
business or our ability to expand our business.
In addition, we have been notified that Japan has issued new regulations
regarding medical devices that contain tissue of animal origin. Among other
regulations, Japan may require that the tendon used in the manufacture of
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medical devices sold in Japan originate in a country that has never had a case
of BSE. Currently, we purchase our tendon from the United States and New
Zealand. If we cannot continue to use or qualify a source of tendon from New
Zealand or another country that has never had a case of BSE, we will not be
permitted to sell our collagen hemostatic agents and products for oral surgery
in Japan. We do not currently sell our dural or skin repair products in Japan.
Lack Of Market Acceptance For Our Products Or Market Preference For Technologies
That Compete With Our Products Could Reduce Our Revenues And Profitability.
We cannot be certain that our current products or any other products that we may
develop or market will achieve or maintain market acceptance. Certain of the
medical indications that can be treated by our devices can also be treated by
other medical devices or by medical practices that do not include a device. The
medical community widely accepts many alternative treatments, and certain of
these other treatments have a long history of use. For example, the use of
autograft tissue is a well-established means for repairing the dermis, and it
competes for acceptance in the market with the INTEGRA(R) Dermal Regeneration
Template. In addition, the acceptance of our Newdeal products, which previously
were distributed by third parties, faces similar competition.
We cannot be certain that our devices and procedures will be able to replace
those established treatments or that either physicians or the medical community
in general will accept and utilize our devices or any other medical products
that we may develop.
In addition, our future success depends, in part, on our ability to develop
additional products. Even if we determine that a product candidate has medical
benefits, the cost of commercializing that product candidate may be too high to
justify development. Competitors may develop products that are more effective,
achieve more favorable reimbursement status from third-party payors, cost less
or are ready for commercial introduction before our products. For example, our
sales of shunt products could decline if neurosurgeons increase their use of
programmable valves and we fail to introduce a competitive product, or our sales
of certain catheters may be adversely affected by the recent introduction by
other companies of catheters that contain anti-microbial agents intended to
reduce the incidence of infection after implantation. If we are unable to
develop additional commercially viable products, our future prospects could be
adversely affected.
Market acceptance of our products depends on many factors, including our ability
to convince prospective collaborators and customers that our technology is an
attractive alternative to other technologies, to manufacture products in
sufficient quantities and at acceptable costs, and to supply and service
sufficient quantities of our products directly or through our distribution
alliances. In addition, limited funding available for product and technology
acquisitions by our customers, as well as internal obstacles to customer
approvals of purchases of our products and unfavorable reimbursement
methodologies of third-party payors could harm acceptance of our products. The
industry is subject to rapid and continuous change arising from, among other
things, consolidation and technological improvements. One or more of these
factors may vary unpredictably, which could materially adversely affect our
competitive position. We may not be able to adjust our contemplated plan of
development to meet changing market demands.
Our Intellectual Property Rights May Not Provide Meaningful Commercial
Protection For Our Products, Which Could Enable Third Parties To Use Our
Technology Or Very Similar Technology And Could Reduce Our Ability To Compete In
The Market.
Our ability to compete effectively depends in part, on our ability to maintain
the proprietary nature of our technologies and manufacturing processes, which
includes the ability to obtain, protect and enforce patents on our technology
and to protect our trade secrets. We own or have licensed patents that cover
aspects of certain of our product lines. However, you should not rely on our
patents to provide us with any significant competitive advantage. Others may
challenge our patents and, as a result, our patents could be narrowed,
invalidated or rendered unenforceable. Competitors may develop products similar
to ours that our patents do not cover. In addition, our current and future
patent applications may not result in the issuance of patents in the United
States or foreign countries. Further, there is a substantial backlog of patent
applications at the U.S. Patent and Trademark Office, and the approval or
rejection of patent applications usually takes from 18 to 24 months.
Our Competitive Position Depends, In Part, Upon Unpatented Trade Secrets Which
We May Be Unable To Protect.
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Our competitive position also depends upon unpatented trade secrets. Trade
secrets are difficult to protect. We cannot assure you that others will not
independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to our trade secrets, that our trade secrets
will not be disclosed or that we can effectively protect our rights to
unpatented trade secrets.
In an effort to protect our trade secrets, we require our employees, consultants
and advisors to execute proprietary information and invention assignment
agreements upon commencement of employment or consulting relationships with us.
These agreements provide that, except in specified circumstances, all
confidential information developed or made known to the individual during the
course of their relationship with us must be kept confidential. We cannot assure
you, however, that these agreements will provide meaningful protection for our
trade secrets or other proprietary information in the event of the unauthorized
use or disclosure of confidential information.
Our Success Will Depend Partly On Our Ability To Operate Without Infringing Or
Misappropriating The Proprietary Rights Of Others.
We may be sued for infringing the intellectual property rights of others. In
addition, we may find it necessary, if threatened, to initiate a lawsuit seeking
a declaration from a court that we do not infringe the proprietary rights of
others or that their rights are invalid or unenforceable. If we do not prevail
in any litigation, in addition to any damages we might have to pay, we would be
required to stop the infringing activity or obtain a license for the proprietary
rights involved. Any required license may be unavailable to us on acceptable
terms, or at all. In addition, some licenses may be nonexclusive and allow our
competitors to access the same technology we license. If we fail to obtain a
required license or are unable to design our product so as not to infringe on
the proprietary rights of others, we may be unable to sell some of our products,
which could have a material adverse effect on our revenues and profitability.
It May Be Difficult To Replace Some Of Our Suppliers.
Outside vendors, some of whom are sole-source suppliers, provide key components
and raw materials used in the manufacture of our products. Although we believe
that alternative sources for many of these components and raw materials are
available, any supply interruption in a limited or sole source component or raw
material could harm our ability to manufacture our products until a new source
of supply is identified and qualified. In addition, an uncorrected defect or
supplier's variation in a component or raw material, either unknown to us or
incompatible with our manufacturing process, could harm our ability to
manufacture products. We may not be able to find a sufficient alternative
supplier in a reasonable time period, or on commercially reasonable terms, if at
all, and our ability to produce and supply our products could be impaired. We
believe that these factors are most likely to affect the following products that
we manufacture:
- our collagen-based products, such as the INTEGRA(R) Dermal Regeneration
Template and wound dressing products, the DuraGen(R) family of products,
and our Absorbable Collagen Sponges;
- our products made from silicone, such as our neurosurgical shunts and
drainage systems and hemodynamic shunts; and
- products which use many different electronic parts from numerous
suppliers, such as our Camino(R), Ventrix(R) and NeuroSensor(TM) lines
of intracranial monitors and catheters.
If we were suddenly unable to purchase products from one or more of these
companies, we would need a significant period of time to qualify a replacement,
and the production of any affected products could be disrupted. While it is our
policy to maintain sufficient inventory of components so that our production
will not be significantly disrupted even if a particular component or material
is not available for a period of time, we remain at risk that we will not be
able to qualify new components or materials quickly enough to prevent a
disruption if one or more of our suppliers ceases production of important
components or materials.
If Any Of Our Manufacturing Facilities Were Damaged And/Or Our Manufacturing Or
Business Processes Interrupted, We Could Experience Lost Revenues And Our
Business Could Be Seriously Harmed.
We manufacture our products in a limited number of facilities. Damage to our
manufacturing, development or research facilities due to fire, natural disaster,
power loss, communications failure, unauthorized entry or other events could
cause us to cease development and manufacturing of some or all of our products.
In particular, our San Diego, California facility that manufactures our
Camino(R) and Ventrix(R) product line is as susceptible to earthquake damage,
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wildfire damage and power losses from electrical shortages as are other
businesses in the Southern California area. Our silicone manufacturing plant in
Anasco, Puerto Rico is vulnerable to hurricane, storm and wind damage. Although
we maintain property damage and business interruption insurance coverage on
these facilities, our insurance might not cover all losses under such
circumstances and we may not be able to renew or obtain such insurance in the
future on acceptable terms with adequate coverage or at reasonable costs.
In addition, we are implementing in several stages over several years an
enterprise business system for use in all of our facilities. This system will
replace several systems on which we now rely. We have outsourced our product
distribution function in the United States and in the fourth quarter of 2005
signed a contract to begin to outsource our European product distribution
function. A delay or other problem with the system or in our implementation
schedule for either of these initiatives could have a material adverse effect on
our operations.
We May Be Involved In Lawsuits Relating To Our Intellectual Property Rights And
Promotional Practices, Which May Be Expensive.
To protect or enforce our intellectual property rights, we may have to initiate
legal proceedings, such as infringement suits or interference proceedings,
against third parties. In addition, we may have to institute proceedings
regarding our competitors' promotional practices. Litigation is costly, and,
even if we prevail, the cost of that litigation could affect our profitability.
In addition, litigation is time consuming and could divert management attention
and resources away from our business. We may also provoke these third parties to
assert claims against us.
We Are Exposed To A Variety Of Risks Relating To Our International Sales And
Operations, Including Fluctuations In Exchange Rates, Local Economic Conditions
And Delays In Collection Of Accounts Receivable.
We generate significant revenues outside the United States in euros, British
pounds and in U.S. dollar-denominated transactions conducted with customers who
generate revenue in currencies other than the U.S. dollar. For those foreign
customers who purchase our products in U.S. dollars, currency fluctuations
between the U.S. dollar and the currencies in which those customers do business
may have an impact on the demand for our products in foreign countries where the
U.S. dollar has increased in value compared to the local currency.
Because we have operations based in Europe and we generate revenues and incur
operating expenses in euros and British pounds, we experience currency exchange
risk with respect to those foreign currency-denominated revenues and expenses.
In 2004 and the first nine months of 2005, the cost of products we manufactured
in our European facilities or purchased in foreign currencies exceeded our
foreign currency-denominated revenues. We expect this imbalance to continue.
Accordingly, a further weakening of the dollar against the euro and British
pound could negatively affect future gross margins and operating margins.
Currently, we do not use derivative financial instruments to manage operating
foreign currency risk. As the volume of our business transacted in foreign
currencies increases, we will continue to assess the potential effects that
changes in foreign currency exchange rates could have on our business. If we
believe that this potential impact presents a significant risk to our business,
we may enter into derivative financial instruments to mitigate this risk.
In general, we cannot predict the consolidated effects of exchange rate
fluctuations upon our future operating results because of the number of
currencies involved, the variability of currency exposure and the potential
volatility of currency exchange rates.
Our sales to foreign markets also may be affected by local economic conditions,
legal, regulatory or political considerations, the effectiveness of our sales
representatives and distributors, local competition and changes in local medical
practice. Relationships with customers and effective terms of sale frequently
vary by country, often with longer-term receivables than are typical in the
United States.
Changes In The Health Care Industry May Require Us To Decrease The Selling Price
For Our Products Or May Reduce The Size Of The Market For Our Products, Either
Of Which Could Have A Negative Impact On Our Financial Performance.
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Trends toward managed care, health care cost containment and other changes in
government and private sector initiatives in the United States and other
countries in which we do business are placing increased emphasis on the delivery
of more cost-effective medical therapies that could adversely affect the sale
and/or the prices of our products. For example:
- major third-party payors of hospital services and hospital outpatient
services, including Medicare, Medicaid and private health care insurers,
have substantially revised their payment methodologies, which has
resulted in stricter standards for reimbursement of hospital charges fo
certain medical procedures;
- Medicare, Medicaid and private health care insurer cutbacks could create
downward price pressure on our products;
- umerous legislative proposals have been considered that would result in
major reforms in the U.S. health care system that could have an adverse
effect on our business;
- there has been a consolidation among health care facilities and
purchasers of medical devices in the United States who prefer to limit
the number of suppliers from whom they purchase medical products, and
these entities may decide to stop purchasing our products or demand
discounts on our prices;
- we are party to contracts with group purchasing organizations, which
negotiate pricing for many member hospitals, that require us to discount
our prices for certain of our products and limit our ability to raise
prices for certain of our products, particularly surgical instruments;
- there is economic pressure to contain health care costs in international
markets;
- there are proposed and existing laws, regulations and industry policies
in domestic and international markets regulating the sales and marketing
practices and the pricing and profitability of companies in the health
care industry; and
- proposed laws or regulations that will permit hospitals to provide
financial incentives to doctors for reducing hospital costs (know as
gainsharing) and to award physician efficiency (known as physician
profiling) could reduce prices; and
- there have been initiatives by third-party payors to challenge the
prices charged for medical products that could affect our ability to
sell products on a competitive basis.
Both the pressures to reduce prices for our products in response to these trends
and the decrease in the size of the market as a result of these trends could
adversely affect our levels of revenues and profitability of sales.
Regulatory Oversight Of The Medical Device Industry Might Affect The Manner In
Which We May Sell Medical Devices
There are laws and regulations that regulate the means by which companies in the
health care industry may market their products to health care professionals and
may compete by discounting the prices of their products. Although we exercise
care in structuring our sales and marketing practices and customer discount
arrangements to comply with those laws and regulations, we cannot assure you
that:
- government officials charged with responsibility for enforcing those laws
will not assert that our sales and marketing practices or customer
discount arrangements are in violation of those laws or regulations; or
- government regulators or courts will interpret those laws or regulations
in a manner consistent with our interpretation.
In January 2004, ADVAMED, the principal U.S. trade association for the medical
device industry, put in place a model "code of conduct" that sets forth
standards by which its members should abide in the promotion of their products.
We have in place policies and procedures for compliance that we believe are at
least as stringent as those set forth in the ADVAMED Code, and we provide
routine training to our sales and marketing personnel on our policies regarding
sales and marketing practices. Nevertheless, the sales and marketing practices
of our industry has been the subject of increased scrutiny from government
agencies, and we believe that this trend will continue.
Our Private Label Business Depends Significantly On Key Relationships With Third
Parties, Which We May Be Unable To Establish And Maintain.
Our private label business depends in part on our entering into and maintaining
collaborative or alliance agreements with third parties concerning product
marketing, as well as research and development programs. Our most important
alliance is our agreement with the Wyeth BioPharma division of Wyeth for the
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development of collagen matrices to be used in conjunction with Wyeth
BioPharma's recombinant bone protein, a protein that stimulates the growth of
bone in humans. The third parties with whom we have entered into agreements
might terminate these agreements for a variety of reasons, including developing
other sources for the product supplied by us. Termination of any of our
alliances would require us to develop other means to distribute the affected
products and could adversely affect our expectations for the growth of private
label products.
We May Have Significant Product Liability Exposure And Our Insurance May Not
Cover All Potential Claims.
We are exposed to product liability and other claims in the event that our
technologies or products are alleged to have caused harm. We may not be able to
obtain insurance for the potential liability on acceptable terms with adequate
coverage or at reasonable costs. Any potential product liability claims could
exceed the amount of our insurance coverage or may be excluded from coverage
under the terms of the policy. Our insurance may not be renewed at a cost and
level of coverage comparable to that then in effect.
We Are Subject To Other Regulatory Requirements Relating To Occupational Health
And Safety And The Use Of Hazardous Substances Which May Impose Significant
Compliance Costs On Us.
We are and may be subject to regulation under federal and state laws, including
requirements regarding occupational health and safety, laboratory practices, the
maintenance of personal health information, sales and marketing practices
(including product discounting practices) customs and import-export practices
and the use, handling and disposal of toxic or hazardous substances. We may also
be subject to other present and possible future local, state, federal and
foreign regulations.
Our research, development and manufacturing processes involve the controlled use
of certain hazardous materials. Although we believe that our safety procedures
for handling and disposing of those materials comply with the standards
prescribed by the applicable laws and regulations, the risk of accidental
contamination or injury from these materials cannot be eliminated. In the event
of such an accident, we could be held liable for any damages that result and any
related liability could exceed the limits or fall outside the coverage of our
insurance and could exceed our resources. We may not be able to maintain
insurance on acceptable terms or at all. We may incur significant costs to
comply with environmental laws and regulations in the future, as well as laws
and regulations in other areas.
The Loss Of Key Personnel Could Harm Our Business.
We believe our success depends on the contributions of a number of our key
personnel, including Stuart M. Essig, our President and Chief Executive Officer.
If we lose the services of key personnel, those losses could materially harm our
business. We maintain key person life insurance on Mr. Essig.
FORWARD-LOOKING STATEMENTS
We have made statements in this report, including statements under "Management's
Discussion and Analysis of Financial Condition and Results of Operations" which
constitute forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
These forward-looking statements are subject to a number of risks, uncertainties
and assumptions about the Company, including those described under "Factors that
May Affect Our Future Performance" in the Company's Annual Report on Form 10-K
for the year ended December 31, 2004 filed with the Securities and Exchange
Commission and those set forth under the heading "Factors That May Affect our
Future Performance" in this report. In light of these risks and uncertainties,
the forward-looking events and circumstances discussed in this report may not
occur and actual results could differ materially from those anticipated or
implied in the forward-looking statements.
You can identify these forward-looking statements by forward-looking words such
as "believe," "may," "could," "will," "estimate," "continue," "anticipate,"
"intend," "seek," "plan," "expect," "should," "would" and similar expressions in
this report.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to various market risks, including changes in foreign currency
exchange rates and interest rates that could adversely impact our results of
operations and financial condition. To manage the volatility relating to these
typical business exposures, we may enter into various derivative transactions
when appropriate. We do not hold or issue derivative instruments for trading or
other speculative purposes.
Foreign Currency Exchange Rate Risk
A discussion of foreign currency exchange risks is provided under the caption
"International Operations" under "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Interest Rate Risk - Marketable Securities
We are exposed to the risk of interest rate fluctuations on the fair value and
interest income earned on our cash and cash equivalents and investments in
available-for-sale marketable debt securities. A hypothetical 100 basis point
movement in interest rates applicable to our cash and cash equivalents and
investments in marketable debt securities outstanding at September 30, 2005
would increase or decrease interest income by approximately $1.6 million on an
annual basis. We are not subject to material foreign currency exchange risk with
respect to these investments.
Interest Rate Risk - Long Term Debt and Related Hedging Instruments
We are exposed to the risk of interest rate fluctuations on the net interest
received or paid under the terms of an interest rate swap. At September 30,
2005, we had outstanding a $50.0 million notional amount interest rate swap used
to hedge the risk of changes in fair value attributable to interest rate risk
with respect to a portion of our $120.0 million principal amount fixed rate 2
1/2% contingent convertible subordinated notes due March 2008.
Our interest rate swap agreement qualifies as a fair value hedge under SFAS No.
133, as amended, "Accounting for Derivative Instruments and Hedging Activities."
At September 30, 2005, the net fair value of the interest rate swap approximated
$2.0 million and is included in other liabilities. The net fair value of the
interest rate swap represents the estimated receipts or payments that would be
made to terminate the agreement. A hypothetical 100 basis point movement in
interest rates applicable to the interest rate swap would increase or decrease
interest expense by approximately $500,000 on an annual basis.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our Exchange Act reports is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms and that such information
is accumulated and communicated to our management, including our principal
executive officer and principal financial officer, as appropriate, to allow for
timely decisions regarding required disclosure. Disclosure controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management
is required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures. Management has designed our disclosure
controls and procedures to provide reasonable assurance of achieving the desired
control objectives.
As required by Rule 13a-15(b) under the Exchange Act, we have carried out an
evaluation, under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, of
the effectiveness of the design and operation of our disclosure controls and
procedures as of the end of the quarter covered by this report. Based on the
foregoing, our principal executive officer and principal financial officer
concluded that our disclosure controls and procedures were effective at the
reasonable assurance level.
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Changes in Internal Control Over Financial Reporting
No changes in our internal control over financial reporting (as defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the quarter
ended September 30, 2005, that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
Internal control over financial reporting cannot provide absolute assurance of
achieving financial reporting objectives because of its inherent limitations.
Internal control over financial reporting is a process that involves human
diligence and compliance and is subject to lapses in judgment and breakdowns
resulting from human failures. Internal control over financial reporting also
can be circumvented by collusion or improper management override. Because of
such limitations, there is a risk that material misstatements may not be
prevented or detected on a timely basis by internal control over financial
reporting. However, these inherent limitations are known features of the
financial reporting process. Therefore, it is possible to design into the
process safeguards to reduce, though not eliminate, this risk.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEDINGS
In July 1996, the Company filed a patent infringement lawsuit in the United
States District Court for the Southern District of California (the "Trial
Court") against Merck KGaA, a German corporation, Scripps Research Institute, a
California nonprofit corporation, and David A. Cheresh, Ph.D., a research
scientist with Scripps, seeking damages and injunctive relief. The complaint
charged, among other things, that the defendant Merck KGaA willfully and
deliberately induced, and continues willfully and deliberately to induce,
defendants Scripps Research Institute and Dr. Cheresh to infringe certain of the
Company's patents. These patents are part of a group of patents granted to The
Burnham Institute and licensed by Integra that are based on the interaction
between a family of cell surface proteins called integrins and the
arginine-glycine-aspartic acid ("RGD") peptide sequence found in many
extracellular matrix proteins. The defendants filed a countersuit asking for an
award of defendants' reasonable attorney fees.
In March 2000, a jury returned a unanimous verdict in the Company's favor and
awarded Integra $15.0 million in damages, finding that Merck KGaA had willfully
infringed and induced the infringement of our patents. The Trial Court dismissed
Scripps and Dr. Cheresh from the case.
In October 2000, the Trial Court entered judgment in Integra's favor and against
Merck KGaA in the case. In entering the judgment, the Trial Court also granted
to the Company pre-judgment interest of $1.4 million, bringing the total award
to $16.4 million, plus post-judgment interest. Merck KGaA filed various
post-trial motions requesting a judgment as a matter of law notwithstanding the
verdict or a new trial, in each case regarding infringement, invalidity and
damages. In September 2001, the Trial Court entered orders in favor of Integra
and against Merck KGaA on the final post-judgment motions in the case, and
denied Merck KGaA's motions for judgment as a matter of law and for a new trial.
Merck KGaA and Integra each appealed various decisions of the Trial Court to the
United States Court of Appeals for the Federal Circuit (the "Circuit Court"). In
June 2003, the Circuit Court affirmed the Trial Court's finding that Merck KGaA
had infringed our patents. The Circuit Court also held that the basis of the
jury's calculation of damages was not clear from the trial record, and remanded
the case to the Trial Court for further factual development and a new
calculation of damages consistent with the Circuit Court's decision. In
September 2004, the Trial Court ordered Merck KgaA to pay Integra $6.4 million
in damages following the Circuit Court's order. Merck KGaA filed a petition for
a writ of certiorari with the United States Supreme Court (the "Supreme Court")
seeking review of the Circuit Court's decision, and the Supreme Court granted
the writ in January 2005. Oral arguments before the United States Supreme Court
were held in April 2005.
On June 13, 2005, the Supreme Court vacated the June 2003 judgment of the
Circuit Court. The Supreme Court held that the Circuit Court applied an
erroneous interpretation of 35 U.S.C. ss.271(e)(1) when it rejected the
challenge of Merck KGaA to the jury's finding that Merck KGaA failed to show
that its activities were exempt from claims of patent infringement under that
statute. On remand, the Circuit Court will review the evidence under a
reasonableness test that does not provide categorical exclusions of certain
types of activities.
Further enforcement of the Trial Court's order has been stayed pending the
decision of the Supreme Court.
The Company has not recorded any gain in connection with this matter, pending
final resolution and completion of the appeals process.
Three of the Company's French subsidiaries that were acquired from the
neurosciences division of NMT Medical, Inc. received a tax reassessment notice
from the French tax authorities seeking in excess of 1.7 million euros in back
taxes, interest and penalties. NMT Medical, the former owner of these entities,
has agreed to indemnify Integra against direct damages and liability arising
from misrepresentations in connection with these tax claims. In April 2005, NMT
Medical, Inc. negotiated a settlement agreement with the French authorities that
satisfied the outstanding tax assessments. This settlement did not have any
impact on our financial statements.
In addition to the these matters, the Company is subject to various claims,
lawsuits and proceedings in the ordinary course of its business, including
claims by current or former employees, distributors and competitors and with
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respect to our products. In the opinion of management, such claims are either
adequately covered by insurance or otherwise indemnified, or are not expected,
individually or in the aggregate, to result in a material adverse effect on the
Company's financial condition. However, it is possible that our results of
operations, financial position and cash flows in a particular period could be
materially affected by these contingencies.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In May 2005, our Board of Directors authorized us to repurchase shares of our
common stock for an aggregate purchase price not to exceed $40 million through
December 31, 2006. We were authorized to repurchase no more than 1.5 million
shares under this program. No repurchases of our common stock was made during
the quarter ended September 30, 2005 under this program, and there remained
$15.3 million of repurchases available under the program as of September 30,
2005.
In October 2005, our Board of Directors terminated the repurchase program
approved in May 2005 and adopted a new program that authorizes us to repurchase
shares of our common stock for an aggregate purchase price not to exceed $50
million through December 31, 2006. Shares may be purchased either in the open
market or in privately negotiated transactions.
ITEM 6. EXHIBITS
10.1 Form of Notice of Grant of Stock Options and Option Agreement
(Incorporated by reference to Exhibit 10.1 to the Company's Current
Report on Form 8-K filed on July 29, 2005)
10.2 Asset Purchase Agreement, dated as of September 7, 2005, by and
between Tyco Healthcare Group LP and Sherwood Services, AG and Integra
LifeSciences Corporation and Integra LifeSciences (Ireland) Limited
(Incorporated by reference to Exhibit 10.1 to the Company's Current
Report on Form 8-K filed on September 13, 2005)
10.3 Integra LifeSciences Holdings Corporation 1998 Stock Option Plan
(amended and restated as of July 26, 2005)
10.4 Integra LifeSciences Holdings Corporation 1999 Stock Option Plan
(amended and restated as of July 26, 2005)
10.5 Integra LifeSciences Holdings Corporation 2000 Equity Incentive Plan
(amended and restated as of July 26, 2005)
10.6 Integra LifeSciences Holdings Corporation 2001 Equity Incentive Plan
(amended and restated as of July 26, 2005)
10.7 Integra LifeSciences Holdings Corporation 2003 Equity Incentive Plan
(amended and restated as of July 26, 2005)
31.1 Certification of Principal Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Certification of Principal Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32.1 Certification of Principal Executive Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
32.2 Certification of Principal Financial Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
Date: November 9, 2005 /s/ Stuart M. Essig
-------------------
Stuart M. Essig
President and Chief Executive Officer
Date: November 9, 2005 /s/ David B. Holtz
-------------------
David B. Holtz
Senior Vice President, Finance
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Exhibits
10.1 Form of Notice of Grant of Stock Options and Option Agreement
(Incorporated by reference to Exhibit 10.1 to the Company's Current
Report on Form 8-K filed on July 29, 2005)
10.2 Asset Purchase Agreement, dated as of September 7, 2005, by and
between Tyco Healthcare Group LP and Sherwood Services, AG and Integra
LifeSciences Corporation and Integra LifeSciences (Ireland) Limited
(Incorporated by reference to Exhibit 10.1 to the Company's Current
Report on Form 8-K filed on September 13, 2005)
10.3 Integra LifeSciences Holdings Corporation 1998 Stock Option Plan
(as amended and restated)
10.4 Integra LifeSciences Holdings Corporation 1999 Stock Option Plan
(as amended and restated)
10.5 Integra LifeSciences Holdings Corporation 2000 Equity Incentive Plan
(as amended and restated)
10.6 Integra LifeSciences Holdings Corporation 2001 Equity Incentive Plan
(as amended and restated)
10.7 Integra LifeSciences Holdings Corporation 2003 Equity Incentive Plan
(as amended and restated)
31.1 Certification of Principal Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
31.2 Certification of Principal Financial Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002
32.1 Certification of Principal Executive Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
32.2 Certification of Principal Financial Officer Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
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