UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
311 ENTERPRISE DRIVE
PLAINSBORO, NEW JERSEY 08536
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(ADDRESS OF PRINCIPAL (ZIP CODE)
EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (609) 275-0500
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or 15(d) of the Securities Exchange Act. Yes [ ] No [X]
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of large
accelerated filer and accelerated filer in Rule 12b-2 of the Exchange Act).
Large accelerated filer Yes [ ] No [X] Accelerated filer Yes [X] No [ ]
Non-accelerated filer Yes [ ] No [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
As of June 30, 2005, the aggregate market value of the registrant's common stock
held by non-affiliates was approximately $590.0 million based upon the closing
sales price of the registrant's common stock on The NASDAQ National Market on
such date.
The number of shares of the registrant's Common Stock outstanding as of March
10, 2006 was 28,435,001.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's definitive proxy statement relating to its
scheduled May 17, 2006 Annual Meeting of Stockholders are incorporated by
reference in Part III of this report.
PART I
ITEM 1. BUSINESS
OVERVIEW
The terms "we," "our," "us," "Company" and "Integra" refer to Integra
LifeSciences Holdings Corporation, a Delaware corporation, and its subsidiaries
unless the context suggests otherwise.
Integra is a market leading, innovative medical device company focused on
helping the medical professional enhance the standard of care for patients.
Integra provides customers with clinically relevant, innovative and
cost-effective products that improve the quality of life for patients. We focus
on cranial and spinal procedures, peripheral nerve repair, small bone and joint
injuries, and the repair and reconstruction of soft tissue.
Integra was founded in 1989 and since then has leveraged its expertise in
regenerative technologies to develop numerous products based on its Ultra Pure
Collagen(TM) technology. Early in Integra's history, these regenerative products
were sold through a number of private label arrangements with other large
medical device companies. In 1999, we entered the neurosurgery market through an
acquisition and the launch of our DuraGen(R) Dural Graft Matrix product for the
repair of the dura mater. Since our entry into the neurosurgery field in 1999,
we have entered the surgical instruments and reconstructive surgery businesses.
We have increased our consolidated revenues from $42.9 million in 1999 to $277.9
million in 2005, a compound annual growth rate of 37%, and we have broadened our
product offerings to include more than 15,300 products. We have achieved this
growth in our business by developing and introducing new products, expanding our
sales and distribution channels and acquiring new businesses and product lines.
Financial information about our geographical areas is set forth in our financial
statements under "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations - International Product Revenues and
Operations" and Note 15 "Segment and Geographic Information" to our Consolidated
Financial Statements.
STRATEGY
Our goal is to become a global leader in the development, manufacturing and
marketing of medical devices, implants, biomaterials and instruments in the
neurosurgery, reconstructive surgery and general surgery markets. Key elements
of our strategy include the following:
o Marketing innovative medical devices to underserved markets
o Investing in sales distribution channels to increase market penetration
o Developing innovative products based on core technologies
o Acquiring businesses that fit existing sales channels or build out new
sales channels
Marketing innovative medical devices to underserved markets. We have developed a
number of innovative medical devices for neurosurgery and reconstructive
surgery. Reconstructive surgery includes treatment of burns and wounds (chronic
and trauma-related), peripheral nerve repair, and small bone and joint fixation
procedures. Traditionally these markets have been underserved by the largest
medical device manufacturers.
Investing in sales distribution channels to increase market penetration. We have
a mix of direct and indirect sales distribution channels. We created our first
direct sales force in 1999 with the creation of our Integra NeuroSciences sales
force. Since then, the number of sales representatives (whom we call
neurospecialists) in that sales force has grown to over 100. In 2003, we created
our reconstructive surgery sales force, and this group now has over 50 sales
representatives. Between these two sales forces, we reach neurosurgeons, plastic
and reconstructive surgeons, orthopedic surgeons and podiatrists.
Developing innovative products based on core technologies. We have become a
leader in regenerative technology. Our Ultra Pure Collagen(TM) technology is the
basis for a number of regenerative products that we sell through both our own
sales network and through alliances with other companies in private label
arrangements. This technology has been deployed in our products relating to
duraplasty, dermal regeneration, nerve repair and collagen matrices used for
bone regeneration in the orthopedic implant market. We are a leading marketer of
neurological products used in the diagnosis, monitoring and treatment of chronic
diseases and acute injuries, and we are a leading provider of surgical
instruments.
Acquiring businesses that fit existing sales channels or build out new sales
channels. We have demonstrated that we can quickly integrate acquisitions into
our existing distribution channels and drive revenue growth. Since 1999, we have
completed more than 20 acquisitions focused primarily on our neurosurgical
product lines, reconstructive surgery, surgical instrumentation and orthopedic
surgery. We regularly evaluate potential acquisition candidates in these markets
and in other specialty medical technology markets characterized by high margins,
fragmented competition and focused target customers.
We believe that executing the above strategy will enable us to expand our
presence in hospitals and other health care facilities, to integrate acquired
products and businesses efficiently and effectively, to create new sales
platforms and to drive both long-term and short-term revenue and earnings
growth.
PRODUCTS GROUPS, MARKETING AND SALES
We have four distribution channels that sell four groups of products. Our
distribution channels include two direct sales organizations (Integra
NeuroSciences and Integra Reconstructive Surgery), a network managed by a direct
sales organization (JARIT(R) Surgical Instruments) and strategic alliances. Our
product groups include Instruments, Implants, Monitoring Products, and Private
Label Products. We sell the products in our four product groups through our
various distribution channels, as follows:
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DISTRIBUTION CHANNELS
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PRODUCT GROUPS Integra Integra JARIT Surgical Strategic
NeuroSciences Reconstructive Instruments Alliances
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Instruments X X X
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Implants X X
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Monitoring X
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Private Label X
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Distribution Channels
At the heart of our business strategy is creation of and investment in our
distribution channels.
Direct Sales Forces. Our direct sales forces include the following:
o Integra NeuroSciences(R). Integra NeuroSciences' direct sales effort in
the United States and Europe currently involves more than 150
professionals, including direct sales representatives (called
neurospecialists in the United States), sales management, marketing
managers and clinical educators who educate and train both our
salespeople and customers in the use of our products. Neurospecialists
call primarily on neurosurgeons, intensivists, other physicians,
nurses, hospitals and surgery centers. Our Integra NeuroSciences sales
and marketing team effectively reaches its hospital customers in the
United States and those portions of Europe where we sell directly to
customers. In certain international markets, we sell through
distributors. We plan to create a separate team of 20 intensive care
unit specialists in 2006 to provide a greater focus on our
neuro-monitoring products.
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o Reconstructive Surgery. Our reconstructive surgery sales and marketing
organization in the United States and Europe consists of approximately
65 professionals, including direct salespeople, sales management,
clinical educators and marketing managers. This sales and marketing
organization sells medical devices to orthopedic surgeons, podiatric
surgeons, trauma and reconstructive surgeons, burn surgeons, hospitals,
surgery centers and other physicians.
o JARIT Surgical Instruments. Our JARIT organization in the United States
employs 25 professionals, including sales management, instrument
specialists and marketing managers. These individuals work with over
100 manufacturers' representatives. The JARIT organization sells the
JARIT line of general and specialty instruments for open and endoscopic
surgery and a line of specialty instruments for spinal surgery,
neurosurgery and plastic surgery. Our JARIT organization sells its
products to more than 6,000 hospitals and surgery centers worldwide.
We have direct sales forces in France, Germany, the United Kingdom and the
Benelux (Belgium, Netherlands, Luxembourg) region. Independent distributors
market and sell our products in those countries where we do not have a direct
sales force. These distributors are managed by our nine distributor sales
managers.
Strategic Alliances. We market our private label products through strategic
partners or original equipment manufacturer customers. Our private label
products address large, diverse markets, and we believe that we can develop and
promote these products more cost-effectively through leveraging the product
development and distribution systems of our strategic partners than through
developing the products ourselves or selling them through our own direct sales
infrastructure. We have partnered with market leaders, such as Johnson &
Johnson, Medtronic Sofamor Danek, Inc., Wyeth BioPharma and Zimmer Holdings,
Inc., for the development and marketing efforts related to many of these
products.
Integra NeuroSciences Product Portfolio
Instruments
Ultrasonic Surgery Systems for Tissue Ablation. More than 145,000 primary and
metastatic brain tumors are diagnosed annually in the United States alone. Our
ultrasonic surgery systems address surgeons' needs for the surgical
fragmentation and removal of malignant and non-malignant tumors and other
tissue. Our acquisition of the Radionics business has increased our product
offerings in this area. We offer certain of our ultrasonic surgery products only
outside the United States.
Our ultrasonic surgery systems use very high frequency sound waves to ablate
cancer tumors and allow the surgeon to remove the damaged tumor tissue by
aspiration. Unlike other surgical techniques, ultrasonic surgery selectively
dissects and fragments soft tissue leaving fibrous tissues, such as nerves and
blood vessels, intact. Ultrasonic aspiration facilitates the removal of unwanted
tissue adjacent or attached to vital structures.
Integra Radionics. The Integra Radionics business, which we acquired in March
2006, is a leader in the design, manufacture and sale of advanced
minimally-invasive medical instruments in the fields of neurosurgery and
radiation therapy. Radionics' products include the CRW(R) stereotactic system,
the XKnife(TM) stereotactic radiosurgery system and the OmniSight(R) EXcel image
guided surgery system.
The Radionics products are primarily utilized by neurosurgeons in the diagnosis
and treatment of cancer and in the treatment of movement disorders. These
products are sold in over 75 countries, with approximately 50 percent of sales
occurring outside of the United States.
The Radionics business includes the CUSA EXcel(TM) ultrasonic surgical
aspirator, which we will continue to sell along with our existing ultrasonic
aspirator systems.
Among other benefits, the acquisition of Radionics increases our global
neurosurgery product offerings, positions us to offer new stereotactic surgery
products, secures entry into new business, adds to our manufacturing and
research and development expertise and enhances the efficiency of our global
infrastructure and distribution network.
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Cranial Stabilization and Brain Retraction Systems. The MAYFIELD(R) Headrest
System is the market leader in cranial stabilization equipment. We work closely
with surgeons and other health care providers throughout the world to develop
unique cranial stabilization products.
Neurosurgical and Spinal Instrumentation. We provide neurosurgeons and spine
surgeons with a full line of specialty hand-held spinal and neurosurgical
instruments. We sell instruments under the R&B Redmond(TM) name primarily for
spinal procedures (including neuro-spine) and under the Ruggles(TM) brand name
primarily for cranial surgery.
Implants
Duraplasty Solutions. We provide dural grafts that are indicated for the repair
of the dura mater surrounding the brain and spine, which is often penetrated
during brain surgery and often damaged during spine surgery. These products
serve as an alternative to using a graft of tissue taken from elsewhere in the
patient's body. We are committed to providing surgeons with a full compliment of
products that provide solutions for a wide variety of possible procedures. We
estimate the worldwide market for dural repair, including cranial and spinal
applications, to be $120 million.
Our line of duraplasty products includes the DuraGen(R) Dural Graft Matrix, the
DuraGen Plus(R) Dural Regeneration Matrix and the Suturable DuraGen(TM) Dural
Regeneration Matrix. Clinical trials have shown our duraplasty products to be an
effective means for closing the dura mater without the need for suturing. This
allows the neurosurgeon to conclude the operation more efficiently. In addition,
because the human body ultimately absorbs our duraplasty products and replaces
them with new natural tissues, the patient avoids some of the risks associated
with a permanent implant inside the cranium or spinal cavity. Our Suturable
DuraGenTM Dural Regeneration Matrix grafts have the added benefit of being able
to anchor to the patient's dura with sutures. To complement these resorbable
products, we also provide the Endura(TM) No-React(R) Dural Substitute, a
permanent suture-only graft, which is optimal for more challenging procedures
that require a stronger and more permanent graft.
Adhesion Barrier for the Spine. The DuraGen Plus(TM) Adhesion Barrier Matrix is
an absorbable collagen product, which is CE marked in the European Union as a
barrier against adhesions and for repair and restoration of the dura mater
following spinal and cranial surgery. To obtain approval to market this product
in the United States, we are initiating a pivotal randomized prospective
clinical trial under an Investigational Device Exemption from the Food and Drug
Administration (FDA). The trial is anticipated to begin during the third quarter
of 2006, with the first patient expected to be enrolled by the fourth quarter of
2006. We estimate that the worldwide market for treatment of spinal adhesions
exceeds $300 million.
Hydrocephalus Management. We sell a wide variety of devices, known as shunts,
used in the treatment of hydrocephalus. Hydrocephalus is an incurable condition
resulting from an imbalance between the amount of cerebrospinal fluid produced
by the brain and the rate at which the body absorbs cerebrospinal fluid.
Hydrocephalus is most commonly treated by inserting a shunt into the ventricular
system of the brain to divert the flow of cerebrospinal fluid out of the brain
and using a pressure valve to maintain a normal level of cerebrospinal fluid
within the ventricles. We estimate the total United States market for shunts
used in hydrocephalus management to be $200 million.
In 2004, we introduced the NPH(TM) Low Flow Hydrocephalus Valve that regulates
the flow of cerebrospinal fluid out of the brain. Designed specifically to meet
the needs of patients with normal pressure hydrocephalus (NPH), the NPH(TM) Low
Flow Hydrocephalus Valve controls cerebrospinal fluid flow at a lower rate than
our other flow-control valves. While many surgeons view shunting as the
preferred treatment method for patients diagnosed with NPH, only approximately
5% of those with NPH are currently treated with a surgically implanted shunt.
Based on these current treatment statistics, we estimate the current market for
shunt systems designed to treat NPH to be approximately $35 million. Certain
reports estimate that approximately 20% of total cerebrospinal fluid shunt sales
address normal pressure hydrocephalus. Based on the NPH population as a whole,
we estimate that the potential market opportunity exceeds $500 million.
In 2005, we acquired the intellectual property estate of Eunoe, Inc., including
the innovative COGNIShunt(R) system, which was being evaluated under an
Investigational Device Exemption for the treatment of Alzheimer's disease
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patients. The COGNIShunt(R) system is designed to increase the flow of cerebral
spinal fluid (CSF) and improve clearance of potential neurotoxins, which are
believed to contribute to the progression of Alzheimer's disease. The
COGNIShunt(R) system has not received FDA clearance or approval for sale.
Monitoring Products
Monitoring Of Brain Parameters. Neurosurgeons use intracranial monitors to
diagnose and treat cases of severe head trauma and other diseases. There are
approximately 500,000 cases of head trauma each year in the United States. We
estimate the market for monitoring and intervention to be $110 million.
We sell intracranial monitoring systems under the Camino(R), Ventrix(R) and
LICOX(R) names. Currently more than 3,000 of our intracranial monitors are
installed and in use worldwide
Cranial Access And External Ventricular Drainage. Neurosurgeons use cranial
access kits and external drainage systems to gain access to the cranial cavity
and to drain excess cerebrospinal fluid from the ventricles of the brain into an
external container. We manufacture and market a broad line of cranial access
kits and ventricular and lumbar external drainage systems.
Epilepsy Electrodes. We sell epilepsy electrodes that neurosurgeons use for the
intra-operative monitoring of seizures to determine if surgical options can be
used in the treatment of epilepsy. We estimate the worldwide market for
intra-operative epilepsy electrodes to be $10 million.
Reconstructive Product Portfolio
Implants
Small Bone And Joint Fixation Devices and Instruments. The Newdeal foot and
ankle surgery devices address the reconstructive and fracture repair portion of
the orthopedic market. The Newdeal line of implants include a wide range of
products for the forefoot, the mid-foot and the hind foot, including the Bold(R)
Screw, the Uniclip(R) Compression Staple, the Hallu-Fix(R) plate system and the
HINTEGRA(R) total ankle prosthesis. These implants and the instruments used to
implant them are specifically designed for foot and ankle surgery. We estimate
that the current Newdeal products address an approximately $500 million
worldwide market. The HINTEGRA(R) total ankle prosthesis has been approved for
sale only outside the United States.
Dermal Regeneration and Engineered Wound Dressings. Our skin replacement
products address the market need created by severe burns, reconstructive
surgery, trauma and chronic wounds. We estimate that the worldwide market now
addressable by our skin replacement products exceeds $1.0 billion.
The INTEGRA(R) Dermal Regeneration Template is designed to enable the human body
to regenerate functional dermal tissue. We sell this product under a Premarket
Approval (PMA) issued by the Food and Drug Administration for the
post-excisional treatment of life-threatening deep or full-thickness dermal
injury where sufficient autograft is not available at the time of excision or is
not desirable due to the physiological condition of the patient and for the
repair of scar contractures in patients who have already recovered from their
initial wound.
The INTEGRA(R) Bilayer Matrix Wound Dressing and INTEGRA(TM) Matrix Wound
Dressing are advanced wound care devices indicated for the management of soft
tissue wounds including: partial and full-thickness wounds, pressure ulcers,
venous ulcers, diabetic ulcers, chronic vascular ulcers, surgical wounds (donor
sites/grafts, post-Moh's surgery, post-laser surgery, podiatric and wound
dehiscence), trauma wounds (abrasions, lacerations, second-degree burns and skin
tears) and draining wounds. We expect the rapid growth of our reconstructive
surgery sales force to drive sales growth of this important product line.
Repair and Protection of Peripheral Nerves. Peripheral nerves may become severed
or damaged through traumatic accidents or surgical injuries, often resulting in
the permanent loss of motor and sensory function. Although severed peripheral
nerves regenerate spontaneously, they do not establish functional connections
unless the nerve stumps are surgically reconnected. We estimate the worldwide
market for the repair of severed and damaged peripheral nerves to be $110
million.
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Our nerve repair products are absorbable collagen implants for the repair and
protection of severed and injured peripheral nerves. The NeuraGen(R) Nerve Guide
is a collagen conduit designed to provide an environment for the repair and
regeneration of severed nerves. The NeuraWrap(TM) Nerve Protector provides a
protective environment for the healing of injured, compressed or scarred nerves.
Both our Integra NeuroSciences and Integra Reconstructive sales forces sell
these products to our hospital-based customers.
Instruments
Dermatomes and Meshers. We sell a range of manual and powered dermatomes and
related disposables for harvesting skin grafts under the Padgett Instruments(TM)
name. In 2003, we launched our new Padgett Dermatome-S, which is lighter, more
ergonomic and more powerful than the other dermatomes in our line. Our variable
skin mesher is designed to expand skin grafts prior to implantation to provide
for greater coverage.
JARIT(R) Surgical Instruments
For more than 30 years, JARIT has marketed a wide variety of high quality,
reusable surgical instruments to virtually all surgical disciplines. With more
than 5,000 instrument patterns, the JARIT brand has a strong reputation for
high-quality surgical instruments and customer service.
Our Jarit Surgical Instrument channel sells directly to central supply and
purchasing at hospitals. This channel has expanded beyond the JARIT(R) product
line to sell products under the Padgett Instruments(TM) and R&B Redmond(TM)
product lines. More than 25 sales and marketing professionals supervise a group
of over 100 manufacturers' representatives.
Strategic Alliances
Orthopedic Biomaterials. Since 1994, we have supplied Wyeth BioPharma with
Absorbable Collagen Sponges for use in developing bone regeneration implants,
including use with Wyeth BioPharma's recombinant human bone morphogenetic
protein-2 (rhBMP-2). Wyeth BioPharma sells Absorbable Collagen Sponges to
Medtronic Sofamor Danek. The FDA has approved Medtronic Sofamor Danek's
InFUSE(TM) Bone Graft used with the LT-CAGE(TM) Lumbar Tapered Fusion Device for
use in spinal fusion procedures and the InFUSE(TM) Bone Graft for the treatment
of open, acute tibial shaft fractures. The InFUSE(TM) Bone Graft eliminates the
need for a secondary, painful procedure to harvest pieces of bone from the
patient's own hip (known as an autograft).
More recently, we developed a compression resistant collagen ceramic matrix for
Medtronic Sofamor Danek. The device, the MasterGraftTM Matrix, is a
3-dimensional, osteoconductive, porous implant that allows for bony ingrowth
across the graft site while resorbing at a rate consistent with bone healing.
Guided Tissue Regeneration In Periodontal Surgery. Our BioMend(R) Absorbable
Collagen Membrane and BioMend(R) Extend Absorbable Collagen Membrane are sold
through Zimmer Holdings, Inc. They are used for guided tissue regeneration in
periodontal surgery. The body absorbs the BioMend(R) products, avoiding the
requirement for additional surgical procedures to remove a non-absorbable
membrane.
Other Private Label Products. Our current private label products also include
the VitaCuff(R) catheter access infection control device and the BioPatch(R)
anti-microbial wound dressing.
RESEARCH AND DEVELOPMENT STRATEGY
Integra's research and development activities focus on identifying and
evaluating unmet surgical needs and product improvement opportunities to drive
the development of innovative solutions and products. We apply our technological
and developmental core competencies to develop regenerative products for
neurosurgical and reconstructive applications, neuro-monitoring and CSF
management, cranial stabilization and closure, tissue ablation, surgical
instruments and extremity small bone and joint fixation. Our activities include
both internal product development initiatives and the acquisition of proprietary
rights to strategic technological platforms.
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Our regenerative product development portfolio is focused on applying our
expertise in biomaterials and collagen matrices to support the development of
innovative products targeted at neurosurgical, orthopedic and spinal surgery
applications, as well as dermal regeneration, nerve repair, and wound dressing
applications. Our focus on technological advancement, product segmentation and
differentiation activities will continue to drive our activities in each of
these areas.
Research and development in neuro-monitoring applications remains focused on the
improvement of our existing advanced neuromonitors and the evaluation of new and
innovative technologies that afford significant advancements in monitoring
ability. For CSF management, opportunities for the improvement of long-standing
product applications are being explored and existing products are being updated
to meet evolving needs. Our industry leading cranial stabilization product
expertise is focused on the advancement of mechanical stabilization techniques
and the application of new materials to further the state-of-the-art of cranial
stabilization. For tissue ablation, our existing development resources will be
coupled with those gained through the acquisition of Radionics to drive
multi-technology based tissue ablation modalities to offer a broad array of
products. Finally, we have an on-going program of identifying, developing and
commercializing powered and hand-held surgical instruments.
As our expansion into the orthopedic reconstructive market continues, our
research and development activities have targeted extremity small bone and joint
fixation. Leveraging the development expertise from our acquisition of Newdeal
Technologies, we are developing a robust new product development program that
will advance our product offering to both United States and European markets.
We spent $12.8 million, $14.1 million, and $12.0 million in 2003, 2004 and 2005,
respectively, on research and development activities. The 2003 amount includes
$400,000 of acquired in-process research and development charge recorded in
connection with acquisitions. The 2004 amount includes a $1.4 million milestone
payment relating to the completion of certain development activities for an
advanced neuro-monitoring system and a $0.5 million licensing fee paid for the
development of a data acquisition system to support the integration of our
advanced monitoring products. The 2005 amount includes a $0.5 million in-process
research and development charges recorded in connection with an acquisition. In
addition to internal research and development activities, we may continue to
acquire businesses that include research and development programs, which could
result in additional in-process research and development charges in the future.
COMPETITION
Our largest competitors in the neurosurgery markets are the Medtronic
Neurosurgery division of Medtronic, Inc., the Codman division of Johnson &
Johnson and the Aesculap division of B. Braun. In addition, many of our
neurosurgery product lines compete with smaller specialized companies or larger
companies that do not otherwise focus on neurosurgery.
Our competition in reconstructive surgery can be divided into two areas that
correspond to our main reconstructive product categories. Our skin and advanced
wound healing products compete with those of LifeCell Corporation, Organogenesis
Inc. and Wright Medical Group, Inc. Our orthopedic products compete with those
of the DePuy division of Johnson & Johnson, Synthes, Inc. and Stryker
Corporation, as well as other major orthopedic companies that carry a full line
of reconstructive surgery products. We also compete with Wright Medical Group in
the orthopedic category.
We believe that we are the second largest re-usable surgical instrument company
in the United States. We compete with the largest re-usable instrument company,
V. Mueller, a division of Cardinal Healthcare, as well as the Aesculap division
of B. Braun. In addition, the Codman division of Johnson & Johnson and many
smaller instrument companies compete with both re-usable and disposable
specialty instruments. We rely on the depth and breadth of our sales and
marketing organization and our procurement operation to maintain our competitive
position in surgical instruments.
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 medical device, rather than any
particular product. Depending on the product line, we compete on the basis of
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our products' features, strength of our sales force or marketing partner,
sophistication of our technology and cost effectiveness of our solution to the
customer's medical requirements.
GOVERNMENT REGULATION
As a manufacturer and marketer of medical devices, we are subject to extensive
regulation by the FDA and, in some jurisdictions, by state and foreign
governmental authorities. These regulations govern the introduction of new
medical devices, the observance of certain standards with respect to the design,
manufacture, testing, labeling and promotion of the devices, the maintenance of
certain records, the ability to track devices, the reporting of potential
product defects, the export of devices and other matters. We believe that we are
in substantial compliance with these governmental regulations.
The regulatory process of obtaining product approvals and clearances can be
onerous and costly. The Food and Drug Administration requires, as a condition of
marketing a medical device in the United States, that we secure a Premarket
Notification clearance pursuant to Section 510(k) of the Federal Food, Drug and
Cosmetic Act, an approved Premarket Approval (PMA) application (or supplemental
PMA application) or an approved Product Development Protocol. Obtaining these
approvals and clearances can take up to several years and involve preclinical
studies and clinical testing. To perform clinical testing in the United States
on an unapproved product, we are required to obtain an Investigational Device
Exemption from the FDA. FDA rules may also require a filing and FDA approval
prior to marketing products that are modifications of existing products or new
indications for existing products. Moreover, after clearance is given, if the
product is shown to be hazardous or defective, the FDA and foreign regulatory
agencies have the power to withdraw the clearance or require us to change the
device, its manufacturing process or its labeling, to supply additional proof of
its safety and effectiveness or to recall, repair, replace or refund the cost of
the medical device. Because we currently export medical devices manufactured in
the United States that have not been approved by the FDA for distribution in the
United States, we are required to provide notices to the FDA, to maintain
certain records relating to exports and make these records available to the FDA
for inspection, if required.
We are also required to register with the FDA as a device manufacturer. As such,
we are subject to periodic inspection by the FDA for compliance with the FDA's
Quality System Regulations. These regulations require that we manufacture our
products and maintain our documents in a prescribed manner with respect to
design, manufacturing, testing and control activities. Further, we are required
to comply with various FDA requirements and other legal requirements for
labeling and promotion. The Medical Device Reporting regulations require that we
provide information to the FDA whenever there is evidence to reasonably suggest
that one of our devices may have caused or contributed to a death or serious
injury or, if a malfunction were to recur, could cause or contribute to a death
or serious injury. Under FDA regulations, we are required to submit reports of
certain voluntary recalls and corrections to the FDA. If the FDA believes that a
company is not in compliance with applicable regulations, it can institute
proceedings to detain or seize products, issue a warning letter, issue a recall
order, impose operating restrictions, enjoin future violations and assess civil
penalties against that company, its officers or its employees and can recommend
criminal prosecution to the Department of Justice.
Medical device regulations also are in effect in many of the countries outside
the United States in which we do business. These laws range from comprehensive
device approval and quality system requirements for some or all of our medical
device products to simpler requests for product data or certifications. The
number and scope of these requirements are increasing. Under the European Union
Medical Device Directive, all medical devices must meet the Medical Device
Directive standards and receive CE Mark certification. CE Mark certification
requires a comprehensive Quality System program and submission of data on a
product to a "Notified Body" in Europe. The Medical Device Directive, ISO 9000
series and ISO 13485 are recognized international quality standards that are
designed to ensure that we develop and manufacture quality medical devices. A
recognized Notified Body (an organization designated by the national governments
of the European Union member states to make independent judgments about whether
or not a product complies with the protection requirements established by each
CE marking directive) audits our facilities annually to verify our compliance
with these standards.
We are subject to laws and regulations that regulate the means by which
companies in the health care industry may market their products to hospitals and
health care professionals and may compete by discounting the prices of their
8
products. This requires that we exercise care in structuring our sales and
marketing practices and customer discount arrangements.
Our international operations subject us to laws regarding sanctioned countries,
entities and persons, customs, import-export and other laws regarding
transactions in foreign countries. Among other things, these laws restrict, and
in some cases prohibit, United States companies from directly or indirectly
selling goods, technology or services to people or entities in certain
countries. In addition, these laws require that we exercise care in structuring
our sales and marketing practices in foreign counties.
Our research, development and manufacturing processes involve the controlled use
of certain hazardous materials. We are subject to federal, state and local laws
and regulations governing the use, manufacture, storage, handling and disposal
of these materials and certain waste products. Although we believe that our
safety procedures for handling and disposing of these materials comply with the
standards prescribed by the controlling laws and regulations, the risk of
accidental contamination or injury from these materials cannot be eliminated. In
the event of this type of an accident, we could be held liable for any damages
that result and any liability could exceed our resources. Although we believe
that we are in compliance in all material respects with applicable environmental
laws and regulations, we could incur significant costs to comply with
environmental laws and regulations in the future, and our operations, business
or assets could be materially adversely affected by current or future
environmental laws or regulations.
In addition to the above regulations, we are and may be subject to regulation
under federal and state laws, including, but not limited to, requirements
regarding occupational health and safety, laboratory practices and the
maintenance of personal health information. As a public company, we are subject
to the securities laws and regulations, including the Sarbanes-Oxley Act of
2002. We may also be subject to other present and possible future local, state,
federal and foreign regulations.
PATENTS AND INTELLECTUAL PROPERTY
We seek patent protection of our key technology, products and product
improvements, both in the United States and in selected foreign countries. When
determined appropriate, we have enforced and plan to continue to enforce and
defend our patent rights. In general, however, we do not rely on our patent
estate to provide us with any significant competitive advantages as it relates
to our existing product lines. We rely upon trade secrets and continuing
technological innovations to develop and maintain our competitive position. In
an effort to protect our trade secrets, we have a policy of requiring 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 all confidential
information developed or made known to the individual during the course of their
relationship with us must be kept confidential, except in specified
circumstances.
ACCU-DISC(TM), BioMend(R), Bold(R), BUDDE(R), CALCANEA(R), Camino(R),
COGNIShunt(R), CollaPlug(R), CollaStat(TM), CollaTape(R), CRW(R), CUSA(R), CUSA
EXcel(TM), Dissectron(R), DuraGen(R), DuraGen Plus(R), Elektrotom(R),
EquiFlow(R), Eunoe, Inc.(R), Hallu-Fix(R), Helistat(R), Helitene(R),
Heyer-Schulte(R), HINTEGRA(R), INTEGRA(R), INTEGRA(TM) Bilayer Matrix Wound
Dressing(R), INTEGRA(R) Dermal Regeneration Template, Integra LifeSciences
Corporation(R), Integra NeuroSciences(R), Integra NeuroSupplies(TM), Integra
Supplies(TM), JARIT(R), LICOX(R), LPV(R), Moni-Torr(TM), NeuraGen(R),
NeuraWrap(TM), Neurosensor(R), OmniSight(R), Orbis-Sigma(R), Osteoject(R),
Padgett Instruments, Inc(R), Pudenz(TM), Radionics(R), Redmond(TM), Ruggles(TM),
Selector(R), Sonotom(R), Spetzler(R), Spin(R), Spinal Specialties(TM),
Sundt(TM), Suturable DuraGenTM, Ultra Pure Collagen(TM), Uniclip(R), Ventrix(R),
VitaCuff(R) and XKnife(TM) are some of the trademarks of Integra and its
subsidiaries. All other brand names, trademarks and service marks appearing in
this report are the property of their respective holders, including MAYFIELD(R),
which is a registered trademark of SM USA, Inc., a wholly owned subsidiary of
Schaerer Mayfield USA, Inc.
EMPLOYEES
At December 31, 2005, we had approximately 1,000 full-time employees and 180
temporary employees engaged in production and production support (including
warehouse, engineering and facilities personnel), quality assurance/quality
9
control, research and development, regulatory and clinical affairs, sales,
marketing, administration and finance. Except for certain employees at our
facilities in France, none of our employees are subject to a collective
bargaining agreement.
Many of our employees, including those holding senior positions in our
regulatory, operations, research and development, and sales and marketing
departments, have prior experience working for large pharmaceutical or medical
technology companies. Our sales representatives and regional sales managers
attend in-depth product training meetings throughout the year, and our clinical
development team consists of medical professionals who specialize in specific
therapeutic areas that our products serve. We believe that our clinical
development team differentiates us from our competition, as their knowledge and
experience as medical professionals allows them to more effectively educate and
train both our sales force and the customers who use our products. This team is
especially valuable in communicating the clinical benefits of new products.
AVAILABLE INFORMATION
We are subject to the informational requirements of the Securities Exchange Act
of 1934. In accordance with the Exchange Act, we file annual, quarterly and
special reports, proxy statements and other information with the Securities and
Exchange Commission. You may view our financial information, including the
information contained in this report, and other reports we file with the
Securities and Exchange Commission, on the Internet, without charge as soon as
reasonably practicable after we file them with the Securities and Exchange
Commission, in the "SEC Filings" page of the Investor Relations section of our
website at www.Integra-LS.com. You may also obtain a copy of any of these
reports, without charge, from our investor relations department, 311 Enterprise
Drive, Plainsboro, NJ 08536. Alternatively, you may view or obtain reports filed
with the Securities and Exchange Commission at the SEC Public Reference Room at
100 F Street, N.E. in Washington, D.C. 20549, or at the SEC's Internet site at
www.sec.gov. Please call the Securities and Exchange Commission at
1-800-SEC-0330 for further information on the operation of the public reference
facilities.
SPECIAL NOTE REGARDING 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" and
"Business," that 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 us including, among other things:
o general economic and business conditions, both nationally and in our
international markets;
o our expectations and estimates concerning future financial performance,
financing plans and the impact of competition;
o anticipated trends in our business;
o existing and future regulations affecting our business;
o our ability to obtain additional debt and equity financing to fund
capital expenditures and working capital requirements and acquisitions;
o physicians' willingness to adopt our recently launched and planned
products, third-party payors' willingness to provide reimbursement for
these products and our ability to secure regulatory approval for
products in development;
o our ability to protect our intellectual property, including trade
secrets;
o our ability to complete acquisitions, integrate operations
post-acquisition and maintain relationships with customers of acquired
entities;
o work stoppages at our facilities; and
o other risk factors described in the section entitled "Factors That May
Affect Our Future Performance" in this report.
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.
10
We undertake no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
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.
ITEM 1A. RISK FACTORS
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:
o the impact of acquisitions;
o the timing of significant customer orders;
o market acceptance of our existing products, as well as products in
development;
o the timing of regulatory approvals;
o changes in the rate of exchange between the U.S. dollar and other
currencies of foreign countries in which we do business, such as the
euro and the British pound;
o expenses incurred and business lost in connection with product field
corrections or recalls;
o increases in the cost of energy and steel;
o our ability to manufacture our products efficiently; and
o 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, there is intense competition among medical device companies. We
compete with established medical technology and pharmaceutical companies in many
of our product areas. 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 introduced an onlay dural graft matrix during 2004, and other
companies have introduced and 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.
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 competitors in reconstructive surgery
include LifeCell Corporation, Organogenesis Inc., Wright Medical Group, Inc.,
the DePuy division of Johnson & Johnson, Synthes, Inc. and Stryker Corporation.
Some of these are major orthopedic companies that carry a full line of
reconstructive products. Our private label products face diverse and broad
competition, depending on the market that an individual product addresses.
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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 our dermal
regeneration products, our duraplasty products and our nerve repair products.
Our Current Strategy Involves Growth Through Acquisitions, Which Requires Us To
Incur Substantial Costs And Potential Liabilities For Which We May Never
Realize The Anticipated Benefits.
In addition to internal growth, our current strategy involves growth through
acquisitions. Since 1999, we have acquired 22 businesses or product lines at a
total cost of approximately $289 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.
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 and requests for
documentation relating to 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 for sale in Japan.
Certain Of Our Products Contain Materials Derived From Animal Sources And May
Become Subject To Additional Regulation.
Certain of our products, including our dermal regeneration products, our
duraplasty products and our nerve repair 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 animal sources, 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 products that Integra
manufactures is derived only from the deep flexor tendon of cattle less than 24
months old from New Zealand, a country that has never had a case of BSE, or the
United States. The collagen used in a product that we sell, but do not
manufacture, is derived from bovine pericardium. 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 and bovine pericardium are in the lowest
risk categories for BSE transmission (the same category as milk, for example),
and are 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
medical devices sold in Japan originate in a country that has never had a case
13
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. 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, 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 have a material adverse effect on 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 some 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 approximately two years.
Our Competitive Position Depends, In Part, Upon Unpatented Trade Secrets Which
We May Be Unable To Protect.
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
14
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.
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. For example, in December 2005 our Newdeal subsidiary sued
Wright Medical Group, Inc. and Wright Medical's French subsidiary alleging that
certain products within Wright Medical's "Charlotte System" of foot and ankle
products infringe upon Newdeal's foot-and-ankle system. 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.
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:
o 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;
o our products made from silicone, such as our neurosurgical shunts and
drainage systems and hemodynamic shunts; and
o products which use many different electronic parts from numerous
suppliers, such as our 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
15
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), Ventrix(R) and LICOX(R) catheter product lines is as susceptible to
earthquake damage, wildfire damage and power losses from electrical shortages as
are other businesses in the Southern California area. Our Anasco, Puerto Rico
plant, where we manufacture collagen, silicone and our private label products,
is vulnerable to hurricane, storm and wind damage. Although we maintain property
damage and business interruption insurance coverage on these facilities, our
insurance might not cover all losses under such circumstances and we may not be
able to renew or obtain such insurance in the future on acceptable terms with
adequate coverage or at reasonable costs.
In addition, we began implementing an enterprise business system in 2004, which
we intend to use in all of our facilities. This system, the hosting and
maintenance of which we outsource, replaces several systems on which we
previously relied and will be implemented in several stages. We have outsourced
our product distribution function in the United States and in the fourth quarter
of 2005 began to outsource our European product distribution function. A delay
or other problem with the system or in our implementation schedule for any of
these initiatives could have a material adverse effect on our operations.
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 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 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 expect to 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 international operations subject us to customs and import-export laws. These
laws restrict, and in some cases prohibit, United States companies from directly
or indirectly selling goods, technology or services to people or entities in
certain countries. These laws also prohibit transactions with certain designated
persons.
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
16
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.
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:
o major third-party payors of hospital services and hospital outpatient
services, including Medicare, Medicaid and private health care
insurers, annually revise their payment methodologies, which can result
in stricter standards for reimbursement of hospital charges for certain
medical procedures;
o Medicare, Medicaid and private health care insurer cutbacks could
create downward price pressure on our products;
o potential legislative proposals have been considered that would result
in major reforms in the U.S. health care system that could have an
adverse effect on our business;
o there has been a consolidation among health care facilities and
purchasers of medical devices in the United States who prefer to limit
the number of suppliers from whom they purchase medical products, and
these entities may decide to stop purchasing our products or demand
discounts on our prices;
o we are party to contracts with group purchasing organizations, which
negotiate pricing for many member hospitals, that require us to
discount our prices for certain of our products and limit our ability
to raise prices for certain of our products, particularly surgical
instruments;
o there is economic pressure to contain health care costs in domestic and
international markets;
o there are proposed and existing laws, regulations and industry policies
in domestic and international markets regulating the sales and
marketing practices and the pricing and profitability of companies in
the health care industry;
o proposed laws or regulations that will permit hospitals to provide
financial incentives to doctors for reducing hospital costs (known as
gainsharing) and to award physician efficiency (known as physician
profiling) could reduce prices; and
o there have been initiatives by third-party payors to challenge the
prices charged for medical products that could affect our ability to
sell products on a competitive basis.
Both the pressures to reduce prices for our products in response to these trends
and the decrease in the size of the market as a result of these trends could
adversely affect our levels of revenues and profitability of sales.
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:
o 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
o 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
17
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
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 Regulatory Requirements Relating To The Use Of Hazardous
Substances Which May Impose Significant Compliance Costs On Us.
Our research, development and manufacturing processes involve the controlled use
of certain hazardous materials. We are subject to federal, state and local laws
and regulations governing the use, manufacture, storage, handling and disposal
of these materials and certain waste products. 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.
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 and two other
members of management.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our principal executive offices are located in Plainsboro, New Jersey. Principal
manufacturing and research facilities are located in New Jersey, Massachusetts,
Ohio, California, Puerto Rico, England and France. Our instrument procurement
operations are located in Germany. Our primary distribution centers are located
in Nevada, New York, England, France and Belgium. In addition, we lease several
smaller facilities to support additional administrative, assembly, and
distribution operations. The Sparkes, Nevada and Ghent, Belgium facilities are
owned and operated by third parties. We lease all of our facilities other than
our facilities in England, and Biot, France, which we own.
18
All of our manufacturing facilities (other than one outside of the United
States) are registered with the FDA. Our facilities are subject to FDA
inspection to assure compliance with Quality System Regulations. We believe that
our manufacturing facilities are in substantial compliance with Quality System
Regulations, suitable for their intended purposes and have capacities adequate
for current and projected needs for existing products. Some capacity of the
plants is being converted, with any needed modification, to meet the current and
projected requirements of existing and future products.
ITEM 3. LEGAL PROCEEDINGS
In July 1996, we 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 our
patents. These patents are part of a group of patents granted to The Burnham
Institute and licensed by us 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 our favor and awarded us
$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 our favor and against Merck
KGaA in the case. In entering the judgment, the Trial Court also granted to us
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 us 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 we 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 us $6.4 million in
damages following the Circuit Court's order. Merck KgaA filed a writ for
certiorari with the United States Supreme Court seeking review of the Circuit
Court's decision, and the Supreme Court granted the writ in January 2005.
On June 13, 2005, the Supreme Court vacated the June 2003 judgment of the
Circuit Court. The Supreme Court held that the Circuit Court applied an
erroneous interpretation of 35 U.S.C. ss.271(e)(1) when it rejected the
challenge of Merck KGaA to the jury's finding that Merck KGaA failed to show
that its activities were exempt from claims of patent infringement under that
statute. On remand, the Circuit Court 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. We have not
recorded any gain in connection with this matter, pending final resolution and
completion of the appeals process.
Three of our 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 us 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
19
satisfied the outstanding tax assessments. In connection with this settlement,
we recognized net operating loss carryforwards in France and recorded this
benefit as a $0.5 million tax benefit in 2005.
In addition to these matters, we are subject to various claims, lawsuits and
proceedings in the ordinary course of our business, including claims by current
or former employees, distributors and competitors and with respect to our
products. In the opinion of management, such claims are either adequately
covered by insurance or otherwise indemnified, or are not expected, individually
or in the aggregate, to result in a material adverse effect on our financial
condition. However, it is possible that our results of operations, financial
position and cash flows in a particular period could be materially affected by
these contingencies.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
ADDITIONAL INFORMATION:
The following information is furnished in this Part I pursuant to Instruction 3
to Item 401(b) of Regulation S-K.
Executive Officers of the Company
Our executive officers are appointed annually and serve at the discretion of the
Board of Directors. The only family relationship between any of our executive
officers and directors is that Mr. Holtz is the nephew of Richard E. Caruso,
Ph.D., the Chairman of the Board of Directors. The following information
indicates the position and age of our executive officers as of the date of this
report and their previous business experience.
NAME AGE POSITION
<s> <c> <c>
Stuart M. Essig ................... 44 President, Chief Executive Officer and Director
Maureen B. Bellantoni ............. 56 Executive Vice President and Chief Financial Officer
Gerard S. Carlozzi ................ 50 Executive Vice President and Chief Operating Officer
John B. Henneman, III ............. 44 Executive Vice President, Chief Administrative Officer and
Secretary
David B. Holtz .................... 39 Senior Vice President, Finance
Deborah A. Leonetti ............... 50 Senior Vice President, Global Marketing
Donald R. Nociolo ................. 43 Senior Vice President, Operations
Judith E. O'Grady ................. 55 Senior Vice President, Regulatory, Quality Assurance and
Clinical Affairs
Robert D. Paltridge ............... 48 Senior Vice President, Global Sales
Stuart M. Essig has served as President and Chief Executive Officer and a
director of Integra since December 1997. Before joining Integra, Mr. Essig
supervised the medical technology practice at Goldman, Sachs & Co. as a managing
director. Mr. Essig had ten years of broad health care experience at Goldman
Sachs serving as a senior merger and acquisitions advisor to a broad range of
domestic and international medical technology, pharmaceutical and biotechnology
clients. Mr. Essig also serves on the Board of Directors of St. Jude Medical
20
Corporation, Zimmer Holdings, Inc. and ADVAMED, the Advanced Medical Technology
Association. Mr. Essig received an A.B. degree from the Woodrow Wilson School of
Public and International Affairs at Princeton University and an M.B.A. and a
Ph.D. degree in Financial Economics from the University of Chicago, Graduate
School of Business.
Maureen B. Bellantoni is Integra's Executive Vice President and Chief Financial
Officer, and is responsible for the company's finance department, including the
corporate controller, financial reporting, internal audit, tax, and treasury
functions of the company. Ms. Bellantoni joined Integra in January 2006. Ms.
Bellantoni served as Senior Vice President and Chief Financial Officer of CP
Kelco, a global leader in the hydrocolloids market from 2003 through its sale to
J.M. Huber in October 2004. From 2000 to 2002, Ms. Bellantoni served as Chief
Financial Officer North America and Senior Vice President of Finance of Burger
King. During 1999 to 2000, she served as Executive Vice President Finance, for
Rohn Industries Inc. a publicly traded telecommunications company. From 1993 to
1998, she served at Sara Lee Corporation as President and Chief Operating
Officer for their Bil Mar Foods division, Vice President, Finance and Chief
Financial Officer for Sara Lee Meats, and Vice President, Finance and Chief
Financial Officer for PYA/Monarch, Inc. From 1985 to 1993, Ms. Bellantoni was
with Emerson Electric Company, as Vice President, Finance and Chief Financial
Officer for their Automatic Switch Division and Vice President, Far East and
Vice President, Finance and Chief Financial Officer for the Branson Ultrasonics
Corporation. Ms. Bellantoni received a B.S. degree in finance from the
University of Bridgeport and an M.B.A. from the University of Connecticut.
Gerard S. Carlozzi is Integra's Executive Vice President and Chief Operating
Officer, and is responsible for the company's marketing, sales, manufacturing,
distribution and research and development functions. Mr. Carlozzi joined Integra
in September 2003, after serving as a consultant to the Company from March 2003
to September 2003. Prior to joining Integra, Mr. Carlozzi had spent over 25
years in the medical device industry. From 1999 to 2003, he was President, Chief
Executive Officer and a director of Bionx Implants, a company focused on the
development of novel biomaterial devices for various surgical specialties. Prior
to 1999, he held various management positions with Synthes USA, Acufex
microsurgical and Infusaid Corporation. Mr. Carlozzi also serves on the Board of
Directors of Cascade Medical Corporation and Scandius Biomedical, Inc.,
privately held companies. Mr. Carlozzi received a B.S. degree in engineering and
an M.B.A. from Northeastern University.
John B. Henneman, III is Integra's Executive Vice President, Chief
Administrative Officer and Secretary, and is responsible for the law department,
regulatory affairs, corporate quality systems, clinical affairs, business
development, human resources, information management and investor relations. Mr.
Henneman was our General Counsel from September 1998 until September 2000 and
our Senior Vice President, Chief Administrative Officer and Secretary from
September 2000 until February 2003. Prior to joining Integra in August 1998, Mr.
Henneman served Neuromedical Systems, Inc., a public company developer and
manufacturer of in vitro diagnostic equipment, in various capacities for more
than four years. Mr. Henneman received an A.B. degree from Princeton University
and a J.D. from the University of Michigan Law School.
David B. Holtz joined Integra as Controller in 1993, served as Vice President,
Finance and Treasurer from March 1997 to January 2001, was promoted to Senior
Vice President, Finance and Treasurer in February 2001 and served as Treasurer
until 2004. From August 2002 through October 2003, Mr. Holtz was given
responsibility for managing Integra's European operations to support the
transition of our acquisitions in Europe. His current responsibilities include
managing all financial reporting and accounting functions. Before joining
Integra, Mr. Holtz was an associate with Coopers & Lybrand, L.L.P. in
Philadelphia and Cono Leasing Corporation, a private leasing company. Mr. Holtz
received a B.S. degree in Business Administration from Susquehanna University
and has been certified as a public accountant.
Deborah A. Leonetti joined Integra in May of 1997 as Director of Marketing, was
promoted to Vice President, Global Marketing in April 1999 and to Senior Vice
President, Global Marketing in May 2004. Her responsibilities include worldwide
strategic marketing for all Integra products. From September 1989 through May
1997, Ms. Leonetti worked for Cabot Medical, which was later acquired by Circon
Corporation, and held positions in sales, sales training, and marketing. Prior
to her experience at Cabot-Circon, Ms. Leonetti completed fifteen years of
clinical practice as a registered nurse at St. Christopher's Hospital for
Children in Philadelphia. Ms. Leonetti received a nursing degree from St.
Joseph's Hospital School of Nursing and La Salle University.
Donald R. Nociolo joined Integra as Director of Manufacturing in 1994, and was
promoted to Vice President, Operations in March 1997 and to Senior Vice
President, Operations in May 2000. He is responsible for managing Integra's
21
worldwide manufacturing operations. Mr. Nociolo has approximately 20 years
experience working in engineering and manufacturing management in the medical
device industry. Six of those years were spent working at ETHICON, Inc., a
division of Johnson & Johnson. Mr. Nociolo received a B.S. degree in Industrial
Engineering from Rutgers University and an M.B.A. in Industrial Management from
Fairleigh Dickinson University.
Judith E. O'Grady joined Integra as Senior Vice President of Regulatory Affairs,
Quality Assurance and Clinical Affairs in 1985. Ms. O'Grady has worked in the
areas of medical devices and collagen technology for over 20 years. Prior to
joining Integra, Ms. O'Grady worked for Colla-Tec, Inc., a Marion Merrell Dow
Company. During her career she has held positions with Surgikos, a Johnson &
Johnson Company, and was on the faculty of Boston University College of Nursing
and Medical School. Ms. O'Grady led the team that obtained the FDA approval for
INTEGRA(R) Dermal Regeneration Template, the first regenerative product approved
by the FDA, and has led teams responsible for approvals of the Company's other
regenerative product lines as well as more than 500 FDA and international
submissions. Ms. O'Grady received a B.S. degree from Marquette University and
M.S.N. in Nursing from Boston University.
Robert D. Paltridge joined Integra as National Sales Director in February 1995
and was appointed Vice President, North American Sales in September 1997. He was
promoted to Vice President, Global Sales in October 2002 and Senior Vice
President, Global Sales in January 2003. His responsibilities include managing
the worldwide sales activities of Integra's three sales organizations and
third-party distributors. Mr. Paltridge has over 20 years of sales and sales
management experience in the medical device industry. Before joining Integra, he
was National Sales Manager at Strato Medical, a division of Pfizer, Inc. He
received a B.S. degree in Business Administration from Rutgers University.
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Market Information, Holders and Dividends
Our common stock trades on The NASDAQ National Market under the symbol "IART".
The following table lists the high and low sales prices for our common stock for
each quarter for the last two years:
HIGH LOW HIGH LOW
2005 2004
------------------ ------------------
<s> <c> <c> <c> <c>
Fourth Quarter $ 38.89 $ 32.00 $ 37.36 $ 29.41
Third Quarter $ 38.26 $ 28.74 $ 35.79 $ 27.14
Second Quarter $ 37.31 $ 28.69 $ 36.00 $ 29.76
First Quarter $ 39.87 $ 34.75 $ 33.86 $ 28.74
We have not paid any cash dividends on our common stock since our formation. Our
credit facility limits the amount of dividends that we may pay. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources - Requirements and Capital
Resources." Any future determinations to pay cash dividends on the common stock
will be at the discretion of our Board of Directors and will depend upon our
results of operations and financial condition and other factors deemed relevant
by the Board of Directors.
The number of stockholders of record as of March 11, 2006 was approximately 530,
which includes stockholders whose shares were held in nominee name.
Issuer Purchases of Equity Securities
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. During the quarter ended June 30, 2005, we
repurchased 750,000 shares of our common stock for $24.7 million under the May
2005 repurchase program. In October 2005, our Board of Directors terminated the
May 2005 repurchase program and adopted a new program that authorized us to
repurchase shares of our common stock for an aggregate purchase price not to
exceed $50 million through December 31, 2006. During the quarter ended December
31, 2005, we repurchased 900,000 shares of our common stock for $31.7 million
under the October 2005 repurchase program. In February 2006, our Board of
Directors terminated the October 2005 repurchase program 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.
The following table summarizes our repurchases of our common stock during the
quarter ended December 31, 2005 under the October 2005 repurchase program:
Shares Dollar Value of
Purchased as Shares that May
Total Number Average Part of Publicly Yet be Purchased
of Shares Price Paid Announced Under the
Period Purchased per Share Program Program
- --------------------- ------------ ----------- ---------------- --------------
<s> <c> <c> <c> <c>
October 1, 2005 -
October 31, 2005 37,000 34.14 37,000 $48,736,713
November 1, 2005 -
November 30, 2005 798,107 35.15 798,107 20,682,146
December 1, 2005 -
December 31, 2005 64,893 36.56 64,893 18,309,396
- --------------------- ------------ ---------- ---------------- --------------
Total 900,000 $ 35.21 900,000 $18,309,396
23
ITEM 6. SELECTED FINANCIAL DATA
The information set forth below should be read in conjunction with "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our consolidated financial statements and related notes included
elsewhere in this report. We have acquired numerous businesses and product lines
during the previous five years. As a result of these acquisitions, the
consolidated financial results and balance sheet data for certain of the periods
presented below may not be directly comparable.
Years Ended December 31,
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
(in thousands, except per share data)
<s> <c> <c> <c> <c> <c>
Operating Results:
Total revenues (1) ..................................... $277,935 $229,825 $185,599 $117,822 $ 93,442
Total operating costs and expenses (2) ................. 221,830 205,046 145,952 98,635 79,156
------- ------ ------ ------ ------
Operating income ....................................... 56,105 24,779 39,647 19,187 14,286
Interest income (expense), net ......................... (265) 555 471 3,535 1,393
Other income (expense), net (3) ........................ (739) 2,674 3,071 3 (392)
------ ------ ------ ------ ------
Income before income taxes ............................. 55,101 28,008 43,189 22,725 15,287
Income tax expense (benefit) (4) ....................... 17,907 10,811 16,328 (12,552) (10,876)
------ ------ ------ ------ ------
Net income ............................................. $37,194 $17,197 $26,861 $35,277 $ 26,163
====== ====== ====== ====== ======
Diluted net income per share ........................... $ 1.15 $ 0.55 $ 0.86 $ 1.14 $ 0.92
Weighted average shares outstanding .................... 34,565 31,102 33,104 30,720 27,196
December 31,
2005 2004 2003 2002 2001
------ ------ ------ ------ ------
(in thousands)
Financial Position:
Cash, cash equivalents, and marketable securities (5) .. $143,384 $195,982 $206,743 $132,311 $131,036
Total assets ........................................... 448,432 456,713 412,526 274,668 227,588
Long-term debt (5) ..................................... 118,378 118,900 119,427 -- --
Retained earnings/(accumulated deficit) ................ 36,929 (265) (17,462) (44,323) (79,600)
Stockholders' equity ................................... 289,818 307,823 268,530 247,597 204,056
(1) In 2003, we recorded $11.0 million of other revenue related to the
acceleration of the recognition of unused minimum purchase payments and
deferred license fee revenue from ETHICON, Inc., a division of Johnson &
Johnson, following the termination of the supply distribution and
collaboration agreement with ETHICON in December 2003.
(2) In 2004, we recorded $23.9 million in share-based compensation charges
incurred in connection with the extension of the employment agreement of
our President and Chief Executive Officer.
(3) In 2004, we recorded a $1.4 million gain in other income related to an
unrealized gain on a foreign currency collar which was used to reduce our
exposure to fluctuations in the exchange rate between the euro and the US
dollar as a result of our commitment to acquire Newdeal Technologies SAS
for 38.5 million euros. The collar contract expired on January 3, 2005,
concurrent with our acquisition of Newdeal Technologies. In 2003, we
recorded a $2.0 million gain in other income (expense) associated with a
termination payment received from ETHICON.
(4) In 2002 and 2001, we recognized a deferred income tax benefit of $20.4
million and $11.5 million, respectively, primarily related to the reduction
of a portion of the valuation allowance recorded against our deferred tax
assets.
(5) In 2003, we issued $120.0 million of 2.5% contingent convertible
subordinated notes due 2008. The net proceeds generated by the notes, after
expenses, were $115.9 million. The notes are convertible into approximately
3.5 million shares of our common stock.
24
ITEM 7. 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 together with the selected consolidated financial data
and our financial statements and the related notes appearing elsewhere in this
report. 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 under the heading
"Factors That May Affect Our Future Performance."
Regulation G, "Conditions for Use of Non-GAAP Financial Measures," and other
provisions of the Securities Exchange Act of 1934, as amended, define and
prescribe the conditions for the use of certain non-GAAP financial information.
In Management's Discussion and Analysis of Financial Condition and Results of
Operations, we provide information regarding growth in product revenues
excluding recently acquired product lines, which is a non-GAAP financial
measure. A reconciliation of this non-GAAP financial measure to the most
comparable GAAP measure is provided in this annual report.
This non-GAAP financial measure should not be relied upon to the exclusion of
GAAP financial measures. Management believes that this non-GAAP financial
measure constitutes important supplemental information to investors which
reflects an additional way of viewing aspects of our operations that, when
viewed with our GAAP results and the accompanying reconciliations, provides a
more complete understanding of factors and trends affecting our ongoing business
and operations. Management strongly encourages investors to review our financial
statements and publicly filed reports in their entirely and to not rely on any
single financial measure. Because non-GAAP financial measures are not
standardized, it may not be possible to compare these financial measures with
other companies' non-GAAP financial measures having the same or similar names.
GENERAL
Integra is a market-leading, innovative medical device company focused on
helping the medical professional enhance the standard of care for patients.
Integra provides customers with clinically relevant, innovative and
cost-effective products that improve the quality of life for patients. We focus
on cranial and spinal procedures, peripheral nerve repair, small bone and joint
injuries, and the repair and reconstruction of soft tissue.
Our distribution channels include two direct sales organizations (Integra
NeuroSciences and Integra Reconstructive Surgery), one network of manufacturer's
representatives managed by a direct sales organization (JARIT Surgical
Instruments) and strategic alliances with market leaders such as Johnson &
Johnson, Medtronic, Inc., Wyeth and Zimmer Holdings, Inc. We have direct sales
forces in the United States, Germany, the United Kingdom, the Benelux (Belgium,
Netherlands, Luxembourg) region and France. Elsewhere throughout the world, our
products are distributed through a number of independent distributors. We invest
substantial resources and management effort to develop our sales organizations,
and we believe that we compete very effectively in this aspect of our business.
Our product groups include Instruments, Implants, Monitoring Products, and
Private Label Products. Our Instruments product group includes ultrasonic
surgery systems for tissue ablation, cranial stabilization and brain retraction
systems, and instrumentation used in general, neurosurgical, spinal and plastic
and reconstructive surgery. Our Implants product group includes dural grafts
that are indicated for the repair of the dura mater, dermal regeneration and
engineered wound dressings, and implants used in small bone and joint fixation,
repair of peripheral nerves, and hydrocephalus management. Our Monitoring
Products group includes systems for the measurement of various brain parameters
and devices used to gain access to the cranial cavity and to drain excess
cerebrospinal fluid from the ventricles of the brain. Our Private Label product
group includes implants used in bone regeneration and in guided tissue
regeneration in periodontal surgery.
We manufacture many of our implant, monitoring and private label products in
various plants located in the United States, Puerto Rico, France, the United
Kingdom and Germany. We also manufacture the ultrasonic surgical instruments and
source most of our hand-held surgical instruments through specialized
third-party vendors.
We believe that we have a particular advantage in the development, manufacture
and sale of specialty tissue repair products derived from bovine collagen. We
25
develop and manufacture these products primarily in our facility in Plainsboro,
New Jersey. Taken together, these products accounted for approximately 31%, 31%
and 27% of product revenues in the years ended December 31, 2005, 2004 and 2003,
respectively.
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 continue to build a customer-focused and profitable medical
device company by developing or acquiring innovative medical devices and other
products to sell through our sales channels. Our strategy therefore entails
substantial growth in product revenues both through internal means - through
launching new and innovative products and selling existing products more
intensively - and by acquiring existing businesses or already successful product
lines.
We aim to achieve this growth in revenues while maintaining strong financial
results. While we pay attention to any meaningful trend in our financial
results, we pay particular attention to measurements that 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 products revenues, which we aim to increase to more
than 65% over a period of several years, operating margins, which we aim to
continually expand on as we leverage our existing infrastructure, and earnings
per fully diluted share of common stock.
ACQUISITIONS
Our strategy for growing our business includes the acquisition of complementary
product lines and companies. Our recent acquisitions of businesses, assets and
product lines may make our financial results for the year ended December 31,
2005 not directly comparable to those of the corresponding prior year periods.
Since the beginning of 2003, we have acquired the following businesses, assets
and product lines:
In March 2006, Integra acquired the assets of the Radionics Division of Tyco
Healthcare Group, L.P. for approximately $76 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
in the fields of neurosurgery and radiation therapy. Radionics' products include
the CUSA EXcel(R) ultrasonic surgical aspiration system, the CRW(R) stereotactic
system, the XKnife(R) stereotactic radiosurgery system, and the OmniSight(R)
EXcel image guided surgery system.
Tyco Healthcare sold 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. We are likely to
use distributors in many of the markets in which Tyco Healthcare sold direct. As
a result, we expect that revenue and pre-tax income attributable to the acquired
product lines will be reduced from the 2005 reported levels. In addition,
because the CUSA Excel ultrasonic aspiration system competes with our existing
line of ultrasonic surgery systems, our sales force may, in some situations,
sell the CUSA system in lieu of our existing ultrasonic aspirator products.
Overall, the acquired business has been growing at rates below our corporate
growth rate targets.
In September 2005, we acquired the intellectual property estate of Eunoe, Inc.
for $0.5 million in cash. 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 acquired intellectual property has not been
developed into a product that has been approved or cleared by the FDA and has no
future alternative use other than in clinical applications involving the
regulation of cerebrospinal fluid. Accordingly, we recorded the entire
acquisition price as an in-process research and development charge in 2005.
In January 2005, we acquired all of the outstanding capital stock of Newdeal
Technologies SAS. We paid $51.9 million (38.3 million euros) in cash at closing,
a $0.7 million working capital adjustment paid in January 2006, and $0.8 million
of acquisition related expenses.
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
26
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. During 2005, we began to market the Newdeal products directly in the
United States through our Integra Reconstructive Surgery sales force. Newdeal's
target physicians include orthopedic surgeons specializing in injuries of the
foot, ankle and extremities, as well as podiatric surgeons.
In May 2004, we 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(R) and BUDDE(R) 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 have been used by neurosurgeons for over thirty years. The products are sold
in the United States through our Integra NeuroSciences(TM) direct sales
organization and in international markets through distributors.
In May 2004, we acquired all of the capital stock of Berchtold
Medizin-Elektronik GmbH, now named Integra ME GmbH, from Berchtold Holding GmbH
for $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.
In January 2004, we acquired two small instruments businesses: the R&B
instrument business from R&B Surgical Solutions, LLC for $2.0 million in cash
and the Sparta disposable critical care devices and surgical instruments
business from Fleetwood Medical, Inc. for $1.6 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 Sparta product line includes products
used in plastic and reconstructive, ear, nose and throat (ENT), neuro,
ophthalmic and general surgery.
In December 2003, we acquired the assets of Reconstructive Technologies, Inc.
for $0.4 million in cash and an agreement to make future payments based on
product sales. Reconstructive Technologies was the developer of the Automated
Cyclic Expansion System (ACE System(TM)), a tissue expansion device. As the ACE
system was not yet approved for sale, we recorded a $0.4 million in-process
research and development charge in connection with this acquisition. We are
evaluating the regulatory, engineering, and clinical efforts necessary to
develop and launch the ACE System.
RESTRUCTURING ACTIVITIES
During the second quarter of 2005, we announced plans to restructure certain of
our European operations. The restructuring plan included closing our Integra ME
production facility in Tuttlingen, Germany and reducing the manufacturing
overhead workforce in our production facility located in Biot, France, both of
which were completed in December 2005. We transitioned the manufacturing
operations of Integra ME to our production facility in Andover, England. During
the second quarter of 2005, we also eliminated some duplicative sales and
marketing positions, primarily in Europe. Approximately 68 individuals were
identified for termination under the European restructuring plan. As of December
31, 2005, we terminated 65 of these individuals.
In 2005, we also completed the transfer of the Spinal Specialties assembly
operations from our San Antonio, Texas plant to our San Diego, California plant
and we continue to transfer certain assembly, processing and packaging
operations to our San Diego and Puerto Rico facilities.
In connection with these restructuring activities, we recorded $4.0 million of
charges in 2005 for the estimated costs of employee termination benefits to be
provided to the affected employees and related facility exit costs.
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 expanding
our European sales, marketing and distribution organization, and adding the
Newdeal group's business to our existing sales and distribution network.
27
RESULTS OF OPERATIONS
Net income in 2005 was $37.2 million, or $1.15 per diluted share, as compared to
net income of $17.2 million, or $0.55 per diluted share, in 2004 and net income
of $26.9 million, or $0.86 per diluted share, in 2003. These amounts include the
following charges:
(in thousands) 2005 2004 2003
------ ------ ------
CHARGES:
- --------
Involuntary employee termination costs ........... $ 3,861 $ -- $ 120
Facility consolidation, acquisition
integration and related costs ................ 2,340 -- 987
Acquired in-process research and development ..... 500 -- 400
Costs associated with discontinued
products lines ............................... 478 -- --
Inventory fair market value purchase accounting
adjustments .................................. 466 270 1,261
Cash donation to the Integra Foundation .......... 250 -- 2,000
Acquired technology licensing and
milestone payments ........................... -- 1,855 --
Tax charge incurred in connection with the
reorganization of certain European operations. -- 1,300 --
------ ------ ------
Total ......................................... $ 7,895 $ 3,425 $ 4,768
In 2004, we recognized $1.4 million of other income related to an unrealized
gain on a foreign currency collar, which was used to reduce our exposure to
fluctuations in the exchange rate between the euro and the US dollar as a result
of our commitment to acquire Newdeal Technologies for 38.5 million euros. The
foreign currency collar expired in January 2005, concurrent with our acquisition
of Newdeal Technologies.
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 charges and amounts recorded to other income
discussed above could recur with similar materiality in the future. We believe
that the delineation of these costs provides useful information to measure the
comparative performance of our business operations.
Net income also includes the following amounts:
In 2005, we recognized an additional $1.3 million of royalty revenue related to
a change in the manner we use to estimate royalties earned based on Medtronic's
sales of its INFUSE(TM) bone graft product. Prior to 2005, we recognized this
royalty revenue when Wyeth paid us royalties because Wyeth did not provide
information to us about the royalty amount earned each quarter prior to us
reporting our quarterly financial results and we did not have a reliable basis
for otherwise estimating and recording royalty revenue in the same quarter it
was earned. However, we now receive quarterly royalty revenue information from
Wyeth more quickly, we have sufficient historical information available to help
us estimate, and the volatility in the royalty earned each quarter has decreased
significantly. Accordingly, we started recognizing this royalty on an accrual
basis in the quarter earned.
In 2004, we recognized a $23.9 million non-cash compensation charge related to
the renewal of our Chief Executive Officer's employment agreement.
In 2003, we recorded $11.0 million of other revenue related to the acceleration
of the recognition of unused minimum purchase payments and unamortized license
fee revenue from ETHICON following the termination of the Supply, Distribution
and Collaboration agreement in December 2003. We also received a $2.0 million
payment from ETHICON from the termination of our agreement with them, which is
included in other income.
These amounts represent revenues, gains, and charges resulting from facts and
circumstances that, based on our recent history and future expectations, are not
expected to recur with similar materiality or impact on continuing operations.
28
We believe that the identification of these revenues, charges and gains that
meet these criteria promotes comparability of reported financial results for the
periods presented.
Total Revenues and Gross Margin on Product Revenues (Exclusive of Amortization
Related to Acquired Intangible Assets)
(in thousands, except per share data) 2005 2004 2003
-------- -------- --------
<s> <c> <c> <c>
Monitoring products ................................. $ 48,940 $ 48,217 $ 44,229
Implant products ......... .......................... 108,156 78,418 53,301
Instruments ......................................... 91,918 77,667 47,168
Private label products .............................. 28,757 24,188 21,997
-------- -------- --------
Total product revenues ................................. 277,771 228,490 166,695
Other revenue .......................................... 164 1,335 18,904
-------- -------- --------
Total revenues.......................................... 277,935 229,825 185,599
Cost of product revenues (exclusive of amortization
related to acquired intangible assets) ............. 105,536 87,299 70,597
Gross margin on product revenues ....................... 172,235 141,191 96,098
Gross margin as a percentage of product revenues ....... 62% 62% 58%
In 2005, total revenues increased 21% over 2004 to $277.9 million, led by a
$49.3 million, or 22%, increase in product revenues to $277.8 million. Domestic
product revenues increased $26.4 million in 2005 to $207.2 million, or 75% of
total product revenues, as compared to 79% and 80% of product revenues in 2004
and 2003, respectively. Sales of instruments and implant products, which
reported a 38% and 18% increase, respectively, in sales over 2004, led our
growth in product revenues in 2005.
In 2004, total revenues increased 24% over 2003 to $229.8 million, led by a
$61.8 million, or 37%, increase in product revenues to $228.5 million. Domestic
product revenues increased $48.1 million in 2004 to $180.9 million. Sales of
instruments and implant products, which reported a 65% and 47% increase,
respectively, in sales over 2003, led our growth in product revenues in 2004.
Reported product revenues for 2005 and 2004 included the following amounts in
revenues from acquired product lines:
2005 Revenues 2004 Revenues % change
--------------- --------------- ----------
(in thousands)
<s> <c> <c> <c>
Total Product Revenues
Products acquired during 2005 ........... $ 17,033 $ -- N/M
Products acquired during 2004 ........... 9,343 2,770 N/M
All other product revenues .............. 251,395 225,720 11%
--------- --------
Total product revenues .................. 277,771 228,490 22%
All of the products acquired in 2005 were added to the implants product group,
while all of the products acquired in 2004 were added to the instrument product
group.
Product revenues excluding 2005 and 2004 acquisitions grew at 11% for the year
ended December 31, 2005 as compared to 2004. Increased sales of our implant
products used for skin replacement and wound dressings, dural repair, and repair
and protection of peripheral nerves, our surgical instrumentation and ultrasonic
surgery systems for tissue ablation, and revenues from our Absorbable Collagen
Sponge product sold to Wyeth accounted for a significant portion of this growth.
Changes in foreign currency exchange rates did not have a significant effect on
the year-over-year increase in product revenues.
29
Product revenues in 2004 and 2003, included $53.5 million and $24.5 million,
respectively, in sales of products acquired in either 2003 or 2004. Increased
sales of our implant products used for skin replacement and wound dressings and
dural repair and increased revenues from our Absorbable Collagen Sponge product
sold to Wyeth drove this revenue growth. Changes in foreign currency exchange
rates in 2004 had a $2.8 million favorable effect on the year-over-year increase
in product revenues.
We have developed a new targeted account sales and marketing strategy for
products in the monitoring category and expect that it will contribute to
improvements in the performance of our monitoring products in future periods.
We have generated our product revenue growth through acquisitions, new product
launches and increased direct sales and marketing efforts both domestically and
in Europe. We expect that our expanded domestic sales force, the recent
conversion of JARIT domestic sales from a distributor billing model to a direct
billing model, the continued implementation of our direct sales strategy in
Europe and sales of internally developed and acquired products will drive our
future revenue growth. We also intend to continue to acquire businesses that
complement our existing businesses and products. Overall, we expect our revenues
to continue to grow in the range of 20% to 30% per annum. We expect organic
revenue growth in excess of 15% per annum.
Gross margin as a percentage of product revenues (exclusive of amortization
related to acquired intangible assets) was 62% in 2005, 62% in 2004 and 58% in
2003. Cost of product revenues included $0.5 million, $0.3 million, and $1.3
million in fair value inventory purchase accounting adjustments recorded in
connection with acquisitions in 2005, 2004 and 2003, respectively. Our gross
margin in 2005 was also negatively affected by $2.6 million of termination costs
incurred in connection with our European restructuring activities, $0.9 million
of charges associated with facility consolidations and $0.3 million of charges
associated with a discontinued product line. Continued growth in sales of
higher-margin products, including our skin replacement and wound dressing
implants, dural repair implants, cranial stabilization systems, and recently
acquired foot and ankle implant products offset the impact of the charges
recorded in 2005.
In 2006, we expect our consolidated gross margin to increase. We expect that
sales of our higher gross margin products will continue to increase as a
proportion of total product revenues. Also, we have begun to bill hospital
customers directly for sales of JARIT instruments to them, rather than
distributors. We expect that this will result in increased product revenues, a
higher gross margin, and increased selling expenses. We anticipate that the
relatively lower gross margin generated from sales of Radionics products will
offset some of these benefits.
Gross margins in 2004 improved as compared to 2003 as a result of increased
sales of higher margin products, including our skin replacement and wound
dressing implants and dural repair implants and the cranial stabilization
systems acquired in 2004, and from the negative impact of the $1.3 million in
fair value inventory purchase accounting adjustments recorded in 2003.
Other Operating Expenses
The following is a summary of other operating expenses as a percent of total
revenues:
2005 2004 2003
-------- -------- --------
<s> <c> <c> <c>
Research and development ............................... 4% 6% 7%
Selling, general and administrative .................... 35% 43% 32%
We reported in-process research and development charges of $0.5 million and $0.4
million in 2005 and 2003, respectively. The $0.5 million in-process research and
development charge in 2005 related to intellectual property acquired from Eunoe,
Inc in September 2005. 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 to regulate the flow
of cerebrospinal fluid within the brain. The acquired intellectual property has
not been developed into a product that has been approved or cleared by the FDA
and has no future alternative use other than in clinical applications involving
the regulation of cerebrospinal fluid.
30
Research and development costs have continued to decline as a percentage of
total revenue as we continue to restructure our research and development
activities. The percentage declines are also the result of significant increases
in hand-held instrument sales, which by their nature require less research and
development expenditures compared to our other product lines. In 2005, our
research and development expenses decreased $2.2 million to $12.0 million
because of decreased development efforts related to our next generation
ultrasonic aspirator and from the impact of the $1.4 million milestone payment
related to the completion of certain development activities for an advanced
neuro-monitoring system made in 2004. Our 2004 research and development expenses
increased $1.3 million to $14.1 million and included the $1.4 million milestone
payment and a $0.5 million licensing fee paid for the development of a data
acquisition system to support the integration of our advanced monitoring
products. In 2003, we incurred $1.1 million of expenses related to the
consolidation of our San Diego research center with our other facilities.
In 2006, we expect our research and development expenses as a percentage of
total revenues to increase slightly as we increase expenditures on research and
clinical activities directed toward 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 in the United States. The recently
acquired Radionics business also spends proportionately more on research and
development.
We capitalize inventory costs associated with certain products prior to
regulatory approval, based on management's judgment of probable future
commercialization. We could be required to expense previously capitalized costs
related to pre-approval inventory upon a change in such judgment, due to, among
other potential factors, a denial or delay of approval by necessary regulatory
bodies or a decision by management to discontinue the related development
program. At December 31, 2005, we capitalized approximately $0.9 million of
pre-approval inventory.
In 2004, our selling, general and administrative expenses included a $23.9
million share-based compensation charge related to the renewal of our President
and Chief Executive Officer's employment agreement. Excluding the impact of this
charge, selling, general and administrative expenses increased in 2005 because
of the continued expansion 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 costs associated with our restructuring,
acquisition integration and systems implementation activities. Since 2004, we
have been investing resources in the implementation of a new global enterprise
business system. In 2004 and 2005, we relocated and expanded most of our
domestic and international distribution capabilities through third-party service
providers.
In 2005, we recorded $1.1 million of employee termination costs and $1.4 million
of charges associated with facility consolidations, acquisition integrations and
related costs incurred in connection with our restructuring activities in
selling, general and administrative expenses. We do not expect that the costs to
complete these activities in 2006 will be as significant, although there may be
additional significant costs incurred to integrate the Radionics business.
In 2005, we also recorded $8.3 million of selling, general and administrative
expenses associated with the recently acquired Newdeal businesses. These costs
included a $1.4 million compensation charge related to the sellers' obligation
to continue their employment with Integra through the end of 2005.
In 2006, we expect our selling, general and administrative costs as a percentage
of revenue to increase as compared to 2005 as a result of the impact of
expensing all share-based compensation following the adoption of SFAS No. 123(R)
and from higher commissions associated with the conversion of JARIT domestic
sales from a distributor billing model to a direct billing model.
Amortization expense increased to $6.1 million in 2005 because of amortization
on intangible assets acquired through our business acquisitions. Including the
impact of intangible assets acquired in the Radionics acquisition, we expect
annual amortization expense to be approximately $8.1 million in 2006, $8.3
million in 2007, $8.0 million in 2008, $7.3 million in 2009 and $6.7 million in
2010.
31
Non-Operating Income and Expenses
In 2003, we received approximately $115.9 million of net proceeds from the sale
of $120.0 million of our 2 1/2% contingent convertible subordinated notes due in
March 2008. In 2005, 2004, and 2003, we recorded interest expense of $3.9
million, $3.5 million, and $2.7 million, respectively, in connection with these
notes, which was offset by $3.9 million, $4.0 million, and $3.2 million,
respectively, of interest income on our invested cash and marketable debt
securities.
We will pay additional interest ("contingent interest") on our convertible notes
if, at thirty days prior to maturity, our common stock price is greater than
$37.56 per share. We recorded a $0.4 million liability related to the estimated
fair value of the contingent interest obligation at the time the notes were
issued. The contingent interest obligation is marked to its fair value at each
balance sheet date, with changes in the fair value recorded to interest expense.
At December 31, 2005, the estimated fair value of the contingent interest
obligation was $0.7 million. In 2005, interest expense associated with changes
in the estimated fair value of the contingent interest obligation was not
significant. In 2004, and 2003, respectively, we recorded $0.3 million and $0.1
million of interest expense associated with changes in the estimated fair value
of the contingent interest obligation.
In August 2003, we entered into 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. 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 in March 2008, subject to early termination upon the
occurrence of certain events, including redemption or conversion of the
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. In 2005, we recorded an additional
$0.2 million of interest expense associated with the interest rate swap, while
we recorded a $0.7 million and $0.3 million reduction in interest expense in
2004 and 2003, respectively.
The net fair value of the interest rate swap at December 31, 2005 was $2.0
million. We recorded the following changes in the net fair values of the
interest rate swap and the hedged portion of the contingent convertible notes:
2005 2004 2003
-------- -------- --------
(in thousands)
<s> <c> <c> <c>
Interest rate swap ............................... $ 690 $ 287 $ 305
Contingent convertible notes ..................... (821) (430) (433)
-------- -------- --------
Net increase (decrease) in liabilities ........... $ (131) $ (143) $ (128)
The net decrease in liabilities represents the ineffective portion of the
hedging relationship, and these amounts are recorded in other income (expense),
net.
Our net other income (expense) declined in 2005 by $3.4 million to $0.7 million
of expense. In 2004, we recorded a $1.4 million unrealized gain associated with
a 38.5 million euro foreign currency collar contract that expired on January 3,
2005. We entered into this contract to reduce our exposure to fluctuations in
the exchange rate between the euro and the dollar as a result of our commitment
to acquire Newdeal in January 2005 for euro 38.5 million. The collar contract
did not qualify as a hedge under SFAS No. 133. Accordingly, the collar contract
was recorded at fair value and changes in fair value were recorded in other
income (expense), net. The foreign currency collar expired in January 2005,
concurrent with our acquisition of Newdeal Technologies.
Income Taxes
In 2005, our effective income tax rate was 32.5% of income before income taxes,
compared to 38.6% in 2004 and 37.8% in 2003. Our 2004 rate includes a $1.3
million tax charge related to the transfer of intangible assets. The reduction
in our effective tax rate from 2004 to 2005 was primarily related to the impact
of this charge on our 2004 effective rate and the favorable impact of various
planning and reorganization initiatives that we recently implemented.
32
Our effective tax rate may vary from year to year depending on, among other
factors, the geographic and business mix of taxable earnings and losses. We
consider these factors and others, including our history of generating taxable
earnings, in assessing our ability to realize deferred tax assets.
The net decrease in our tax asset valuation allowance was $0.2 million, $0, and
$2.3 million in 2005, 2004 and 2003, respectively.
A valuation allowance of $5.1 million is recorded against the remaining $27.3
million of net deferred tax assets recorded at December 31, 2005. This valuation
allowance relates to deferred tax assets for certain expenses which will be
deductible for tax purposes in very limited circumstances and for which we
believe it is unlikely that we will recognize the associated tax benefit. We do
not anticipate additional income tax benefits through future reductions in the
valuation allowance. However, if we determine that we would be able to realize
more or less than the recorded amount of net deferred tax assets, we will record
an adjustment to the deferred tax asset valuation allowance in the period such a
determination is made.
At December 31, 2005, we had net operating loss carryforwards of $15.8 million
for federal income tax purposes and $0.4 million for foreign income tax purposes
to offset future taxable income. The federal net operating loss carryforwards
expire through 2024 and the foreign net operating loss carryforwards have no
expiration. We expect to use all of our remaining unrestricted net operating
loss carryforwards in 2006.
At December 31, 2005, several of our subsidiaries had unused net operating loss
carryforwards and tax credit carryforwards arising from periods prior to our
ownership which expire through 2010. The Internal Revenue Code limits the timing
and manner in which we may use any acquired net operating losses or tax credits.
We do not provide income taxes on undistributed earnings of non-U.S.
subsidiaries because such earnings are expected to be permanently reinvested.
Undistributed earnings of foreign subsidiaries totaled $8.5 million and $2.6
million, at December 31, 2005 and 2004, respectively.
The American Jobs Creation Act of 2004 was signed into law in October 2004 and
has several provisions that may impact our income taxes in the future, including
the repeal of the extraterritorial income exclusion and a deduction related to
qualified production activities income. The qualified production activities
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 our tax return.
Pursuant to United States Department of Treasury Regulations issued in October
2005, we believe that we will realize a tax benefit on qualified production
activities income once we have completely utilized our unrestricted net
operating losses, which is expected to occur in 2006.
INTERNATIONAL PRODUCT REVENUES AND OPERATIONS
Product revenues by major geographic area are summarized below:
United Asia Other
States Europe Pacific Foreign Consolidated
-------- -------- --------- --------- --------------
(in thousands)
<s> <c> <c> <c> <c> <c>
2005 ..................... $207,245 $ 48,645 $ 11,403 $ 10,478 $277,771
2004 ..................... 180,887 30,941 8,535 8,127 228,490
2003 ..................... 132,805 21,433 5,828 6,629 166,695
In 2005, product revenues from customers outside the United States totaled $70.5
million, or 25% of consolidated product revenues, of which approximately 69%
were to European customers. Revenues from customers outside the United States
included $55.2 million of revenues generated in foreign currencies.
In 2004, product revenues from customers outside the United States totaled $47.6
million, or 21% of consolidated product revenues, of which approximately 65%
33
were to European customers. Revenues from customers outside the United States
included $33.6 million of revenues generated in foreign currencies.
In 2003, product revenues from customers outside the United States totaled $33.9
million, or 20% of consolidated product revenues, of which approximately 63%
were to European customers. Revenues from customers outside the United States
included $21.3 million of revenues generated in foreign currencies.
Because we have operations based in Europe and we generate revenues and incur
operating expenses in euros and British pounds, we will experience currency
exchange risk with respect to those foreign currency denominated revenues or
expenses.
In 2005, 2004 and 2003, 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 into 2006.
We currently do not hedge our exposure to operating foreign currency risk.
Accordingly, a weakening of the dollar against the euro and British pound could
negatively affect future gross margins and operating margins. We will continue
to assess the potential effects that changes in foreign currency exchange rates
could have on our business. If we believe this potential impact presents a
significant risk to our business, we may enter into derivative financial
instruments to mitigate this risk.
Additionally, we generate significant revenues outside the United States, a
portion of which are U.S. dollar-denominated transactions conducted with
customers who generate revenue in currencies other than the U.S. dollar. As a
result, currency fluctuations between the U.S. dollar and the currencies in
which those customers do business may have an impact on the demand for our
products in foreign countries.
Local economic conditions, regulatory or political considerations, the
effectiveness of our sales representatives and distributors, local competition
and changes in local medical practice all may combine to affect our sales into
markets outside the United States.
Relationships with customers and effective terms of sale frequently vary by
country, often with longer-term receivables than are typical in the United
States.
LIQUIDITY AND CAPITAL RESOURCES
Cash and Marketable Securities
At December 31, 2005, we had cash, cash equivalents and marketable securities
totaling $143.4 million. Investments consist almost entirely of highly liquid,
interest bearing debt securities.
Cash Flows
We generated positive operating cash flows of $57.0 million, $39.0 million and
$34.8 million in 2005, 2004 and 2003, respectively. Operating cash flows
continued to improve primarily as a result of higher pre-tax income, improved
working capital management, and the benefits from the continued utilization of
our net operating loss carryforwards and tax deductions generated by employee
stock option exercises. In 2005 and 2004, changes in working capital items
reduced operating cash flows by $4.7 million and $20.2 million, respectively. In
2004, we experienced delays in customer collections related to business systems
transitions. The improvement in working capital in 2005 relates to an
improvement in the collection cycle for accounts receivable. In 2006, we are
targeting a decrease in days on hand in inventory to further improve operating
cash flows. We expect to use all of our remaining unrestricted net operating
loss carryforwards in 2006. Accordingly, we do not expect to realize the same
level of benefits to our operating cash flows in 2006 as compared to prior
years.
In 2005, we used $56.3 million to repurchase 1.7 million shares of our common
stock, which was partially offset by $9.4 million in cash flows generated from
the issuance of common stock under employee benefit plans. Other principal uses
of funds in 2005 were $50.6 million for acquisitions and $8.1 million for
capital expenditures. In 2005, we generated $27.8 million of cash flows from the
net sales and maturities of our investments in marketable debt securities.
34
In 2004, we generated $6.1 million from the issuance of common stock under
employee benefit plans. We used $29.3 million of cash for acquisitions, $50.6
million for the net purchases of marketable debt securities, $14.2 million for
the repurchase of 500,000 shares of our common stock and $8.5 million for
capital expenditures.
In 2003, we generated $14.2 million from the issuance of common stock under
employee benefit plans and $115.9 million of net proceeds from the sale of
$120.0 million of our contingent convertible subordinated notes. We used $50.4
million of cash for acquisitions, $72.9 million for the net purchases of
marketable debt securities, $35.4 million for the repurchase of 1.5 million
shares our common stock and $3.8 million for capital expenditures. The
significant repurchase of our common stock in 2003 was made simultaneously with
the issuance of our convertible notes.
Working Capital
At December 31, 2005 and 2004, working capital was $234.7 million and $192.0
million, respectively. The increase in working capital in 2005 was primarily due
to increases in short-term investments as our non-current investment portfolio
came closer to maturity in 2005.
Convertible Debt and Related Hedging Activities
We pay interest on our contingent convertible subordinated notes at an annual
rate of 2 1/2% each September 15th and March 15th. We will also pay contingent
interest on the notes if, at thirty days prior to maturity, our common stock
price is greater than $37.56. The contingent interest will be payable at
maturity for each of the last three years the notes remain outstanding in an
amount equal to the greater of (1) 0.50% of the face amount of the notes and (2)
the amount of regular cash dividends paid during each such year on the number of
shares of common stock into which each note is convertible. Holders of the notes
may convert the notes into shares of our common stock under certain
circumstances, including when the market price of our common stock on the
previous trading day is more than $37.56 per share, based on an initial
conversion price of $34.15 per share.
The notes are general, unsecured obligations of Integra and will be subordinate
to any future senior indebtedness. We cannot redeem the notes prior to their
maturity, and the notes' holders may compel us to repurchase the notes upon a
change of control. There are no financial covenants associated with the
convertible notes.
We entered into an interest rate swap agreement with a $50 million notional
amount to hedge the risk of changes in fair value attributable to interest rate
risk with respect to a portion of the notes. See "- Results of Operations -
Non-Operating Income and Expenses." We receive a 2 1/2% fixed rate from the
counterparty and pay to the counterparty a floating rate based on 3-month LIBOR
minus 35 basis points. Our effective interest rate on the hedged portion of the
notes was 3.7% as of December 31, 2005.
Share Repurchase Plans
During 2005, 2004 and 2003, we repurchased 1.7 million, 0.5 million, and 1.5
million shares, respectively, of our common stock under authorized share
repurchase programs.
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. In October 2005, our Board of Directors terminated
the May 2005 repurchase program and adopted a new program that authorized us to
repurchase shares of our common stock for an aggregate purchase price not to
exceed $50 million through December 31, 2006. During 2005, we repurchased
approximately 1.7 million shares of our common stock for $56.3 million under the
May 2005 and October 2005 repurchase programs. In February 2006, our Board of
Directors terminated the October 2005 repurchase program 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.
35
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.
In March 2006, we used approximately $76.0 million in cash to complete the
acquisition of the Radionics Division of Tyco Healthcare Group, L.P. and pay
related transaction expenses. 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 another business acquisition by
utilizing a significant portion of our liquid assets.
In December 2005, we established a $200 million, five-year, senior secured
revolving credit facility. The credit facility currently allows for revolving
credit borrowings in a principal amount of up to $200 million, which can be
increased to $250 million should additional financing be required in the future.
We plan to utilize the credit facility for working capital, capital
expenditures, share repurchases, acquisitions and other general corporate
purposes. We did not draw any amounts against this credit facility in 2005.
The indebtedness under the credit facility is guaranteed by the Company's
domestic subsidiaries. The Company's obligations under the credit facility and
the guarantees of the guarantors are secured by a first-priority security
interest in all present and future capital stock of (or other ownership or
profit interest in) each guarantor and substantially all of the Company's and
the guarantors' other assets, other than real estate, intellectual property and
capital stock of foreign subsidiaries.
Borrowings under the credit facility bear interest, at our option, at a rate
equal to (i) the Eurodollar Rate in effect from time to time plus an applicable
rate (ranging from 0.75% to 1.5%) or (ii) the higher of (x) the weighted average
overnight Federal funds rate, as published by the Federal Reserve Bank of New
York, plus 0.5%, and (y) the prime commercial lending rate of Bank of America,
N.A. plus an applicable rate (ranging from 0% to 0.5%). The applicable rates are
based on a financial ratio at the time of the applicable borrowing.
We will also pay an annual commitment fee (ranging from 0.15% to 0.25%) on the
daily amount by which the commitments under the credit facility exceed the
outstanding loans and letters of credit under the credit facility.
The credit facility requires us to maintain various financial covenants,
including leverage ratios, a minimum fixed charge coverage ratio and a minimum
liquidity ratio. The credit facility also contains customary affirmative and
negative covenants, including those that limit the Company's and its
subsidiaries' ability to incur additional debt, incur liens, make investments,
enter into mergers and acquisitions, liquidate or dissolve, sell or dispose of
assets, repurchase stock and pay dividends, engage in transactions with
affiliates, engage in certain lines of business and enter into sale and
leaseback transactions.
In March 2006, we borrowed $16.0 million under the credit facility in connection
with the acquisition of Radionics.
Contractual Obligations and Commitments
As of December 31, 2005, we were obligated to pay the following amounts under
various agreements:
Less than More than
Total 1 year 1-3 Years 3-5 Years 5 years
------- ----------- ----------- ----------- -----------
(in millions)
<s> <c> <c> <c> <c> <c>
Long Term Debt............... $120.0 $ -- $120.0 $ -- $ --
Interest on Long Term Debt... 7.5 3.0 4.5 -- --
Operating Leases............. 12.3 2.4 2.3 1.1 6.5
Purchase Obligations......... 2.8 2.8 -- -- --
Pension Contributions ....... 0.3 0.3 -- -- --
-------- ------- ------- -------- ------
Total........................ $142.9 $ 8.5 $126.8 $ 1.1 $ 6.5
36
In addition, under other agreements we are required to make payments based on
sales levels of certain products.
The above table does not include contingent interest that we may be obligated to
pay on our contingent convertible subordinated notes due in March 2008. See "-
Results of Operations - --Non-Operating Income and Expenses."
OFF-BALANCE SHEET ARRANGEMENTS
The $120.0 million of outstanding contingent convertible subordinated notes we
have outstanding at December 31, 2005 are convertible into approximately 3.5
million shares of our common stock. If all these notes were converted, our
stockholders could experience significant dilution. We would not receive any
additional cash proceeds upon the conversion of the notes.
CRITICAL ACCOUNTING ESTIMATES
Our discussion and analysis of financial condition and results of operations is
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent liabilities, and the reported amounts
of revenues and expenses. Significant estimates affecting amounts reported or
disclosed in the consolidated financial statements include allowances for
doubtful accounts receivable and sales returns and allowances, net realizable
value of inventories, amortization periods for acquired intangible assets, and
loss contingencies. These estimates are based on historical experience and on
various other assumptions that are believed to be reasonable under the current
circumstances. Actual results could differ from these estimates.
We believe the following accounting policies, which form the basis for
developing these estimates, are those that are most critical to the presentation
of our financial statements and require the most difficult, subjective and
complex judgments:
Allowances For Doubtful Accounts And Sales Returns and Allowances
We evaluate the collectibility of accounts receivable based on a combination of
factors. In circumstances where a specific customer is unable to meet its
financial obligations to us, we record an allowance against amounts due to
reduce the net recognized receivable to the amount that we reasonably expect to
collect. For all other customers, we record allowances for doubtful accounts
based on the length of time the receivables are past due, the current business
environment and our historical experience. If the financial condition of
customers or the length of time that receivables are past due were to change, we
may change the recorded amount of allowances for doubtful accounts in the future
through charges or reductions to selling, general and administrative expense.
We record a provision for estimated sales returns and allowances on product
revenues in the same period as the related revenues are recorded. We base these
estimates on historical sales returns and allowances and other known factors. If
actual returns or allowances are different from our estimates and the related
provisions for sales returns and allowances, we may change the sales returns and
allowances provision in the future through an increase or decrease in product
revenues.
Inventories
Inventories, consisting of purchased materials, direct labor and manufacturing
overhead, are stated at the lower of cost (determined by the first-in, first-out
method) or market. At each balance sheet date, we evaluate ending inventories
for excess quantities, obsolescence or shelf life expiration. Our evaluation
includes an analysis of historical sales levels by product, projections of
future demand by product, the risk of technological or competitive obsolescence
for our products, general market conditions, a review of the shelf life
expiration dates for our products, and the feasibility of reworking or using
excess or obsolete products or components in the production or assembly of other
37
products that are not obsolete or for which we do not have excess quantities in
inventory. To the extent that we determine there are excess or obsolete
quantities or quantities with a shelf life that is too near its expiration for
us to reasonably expect that we can sell those products prior to their
expiration, we record valuation reserves against all or a portion of the value
of the related products to adjust their carrying value to estimated net
realizable value. If future demand or market conditions are different from our
projections, or if we are unable to rework excess or obsolete quantities into
other products, we may change the recorded amount of inventory valuation
reserves through a charge or reduction in cost of product revenues in the period
the revision is made.
We capitalize inventory costs associated with certain products prior to
regulatory approval, based on management's judgment of probable future
commercialization. We could be required to expense previously capitalized costs
related to pre-approval inventory upon a change in such judgment, due to, among
other potential factors, a denial or delay of approval by necessary regulatory
bodies or a decision by management to discontinue the related development
program. At December 31, 2005, we capitalized approximately $0.9 million of
pre-approval inventory. If management decides to discontinue the related
development program or we are not able to get the required approvals from
regulatory bodies to market these products, we would expense the value of the
capitalized pre-approval inventory to research and development expense.
Amortization Periods
We provide for amortization using the straight-line method over the estimated
useful lives of acquired intangible assets. We base the determination of these
useful lives on the period over which we expect the related assets to contribute
to our cash flows or a shorter period such that recognition of the amortization
better corresponds with the distribution of expected revenues. If our assessment
of the useful lives of intangible assets changes, we may change future
amortization expense.
Loss Contingencies
We are subject to claims and lawsuits in the ordinary course of our business,
including claims by employees or former employees, with respect to our products
and involving commercial disputes. Our financial statements do not reflect any
material amounts related to possible unfavorable outcomes of claims and lawsuits
to which we are currently a party because we currently believe that such claims
and lawsuits are either adequately covered by insurance or otherwise
indemnified, or are not expected, individually or in the aggregate, to result in
a material adverse effect on our financial condition. However, it is possible
these contingencies could materially affect our results of operations, financial
position and cash flows in a particular period if we change our assessment of
the likely outcome of these matters.
OTHER MATTERS
Recently Issued Accounting Standards
In December 2004, the Financial Accounting Standards Board 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. We adopted Statement 123(R) on January 1, 2006 using the "modified
prospective" method. We expect to record $14 million of share-based compensation
expense in 2006 as a result of the adoption of FAS 123R. However, our estimate
of future share-based compensation expense is affected by our stock price, the
number of share-based awards that we may grant in 2006, as well as a number of
complex and subjective valuation assumptions and the related tax effects. These
valuation assumptions include, but are not limited to, the volatility of our
stock price and employee stock option exercise behavior.
Information about the historical impact of Statement 123 on our reported
financial information can be found in Note 2 to the Consolidated Financial
Statements, which are included herein under Item 8. We expect that the most
38
significant impact of the adoption of Statement 123(R) in 2006 will be to our
selling, general and administrative expenses.
Information about other recently issued accounting standards is included in Note
2 to the Consolidated Financial Statements.
ITEM 7A. 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 affect 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
Because we have operations based in Europe and we generate revenues and incur
operating expenses in euros and British pounds, we will experience currency
exchange risk with respect to those foreign currency denominated revenues or
expenses. In 2005, the total cost of products we manufacture in or purchase in
foreign currencies and other operating expenses that we incur in foreign
currencies exceeded our total foreign currency-denominated revenues. We expect
this imbalance to continue into 2006. A weakening of the dollar against the euro
and British pound could positively affect future revenues and negatively affect
future gross margins and operating margins, while strengthening of the dollar
against the euro and the British pound could negatively affect future revenues
and positively affect future gross margins and operating margins.
In November 2004, we entered into a collar contract that expired on January 3,
2005 for 38.5 million euros to reduce our exposure to fluctuations in the
exchange rate between the euro and the US dollar as a result of our commitment
to acquire Newdeal in January 2005 for 38.5 million euros. The collar contract
did not qualify as a hedge under SFAS No. 133. Accordingly, the collar contract
was recorded at fair value and changes in fair value were recorded in other
income (expense), net. In 2004, we recorded a $1.4 million unrealized gain
related to the change in the fair value of the collar contract as of December
31, 2004. The foreign currency collar expired in January 2005, concurrent with
our acquisition of Newdeal Technologies.
Other than this foreign currency collar, we have not used derivative financial
instruments to manage 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 this potential impact presents a significant risk to
our business, we may enter into additional derivative financial instruments to
mitigate this risk.
Interest Rate Risk - Marketable Debt 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 December 31, 2005 would
increase or decrease interest income by approximately $1.4 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 December 31, 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. 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 floating rate resets each quarter. 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 our contingent convertible notes. Our effective interest rate
payable on the floating rate portion of the swap was 3.7% as of December 31,
2005.
39
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 December 31, 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 $0.5 million on an annual basis.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial statements and the financial statement schedules specified by this
Item, together with the reports thereon of PricewaterhouseCoopers LLP, are
presented following Item 15 of this report.
Information on quarterly results of operations is set forth in our financial
statements under Note 16 "Selected Quarterly Information - Unaudited" to the
Consolidated Financial Statements.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. 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 Exchange Act Rule 13a-15(b), 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 December 31, 2005. 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.
Management's Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rule
13a-15(f). Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
conducted an evaluation of the effectiveness of our internal control over
financial reporting based on the framework in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on our evaluation under the framework in Internal Control -
Integrated Framework, our management concluded that our internal control over
financial reporting was effective as of December 31, 2005. Our management's
assessment of the effectiveness of our internal control over financial reporting
as of December 31, 2005 has been audited by PricewaterhouseCoopers LLP, an
independent registered public accounting firm, as stated in their report which
is included herein.
In conducting our evaluation of the effectiveness of our internal control over
financial reporting, we have excluded the acquisition of Newdeal Technologies
SAS, which was completed on January 3, 2005. The total assets and total revenues
40
associated with transactions and balances accounted for under Newdeal
Technologies' internal controls over financial reporting represent 13% and 6%,
respectively, of the related consolidated financial statement amounts as of and
for the year ended December 31, 2005.
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.
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 December 31, 2005, that have materially affected, or are reasonably likely
to materially affect, our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
Not applicable.
PART III
INCORPORATED BY REFERENCE
The information called for by Item 10. Directors and Executive Officers of the
Registrant (other than the information concerning executive officers set forth
after Item 4 of Part I herein), Item 11. Executive Compensation, Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters, Item 13. Certain Relationships and Related Transactions and
Item 14. Principal Accountant Fees and Services is incorporated herein by
reference to the Company's definitive proxy statement for its Annual Meeting of
Stockholders scheduled to be held on May 17, 2006, which definitive proxy
statement is expected to be filed with the Commission not later than 120 days
after the end of the fiscal year to which this report relates.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Documents filed as a part of this report.
1. Financial Statements.
The following financial statements and financial statement schedules are filed
as a part of this report.
Report of Independent Registered Public Accounting Firm ................... F-1
Consolidated Statements of Operations for the years ended December 31, 2005,
2004 and 2003 ...................................................... F-3
Consolidated Balance Sheets as of December 31, 2005 and 2004 ............... F-4
Consolidated Statements of Cash Flows for the years ended December 31, 2005,
2004 and 2003 .............................................................. F-5
Consolidated Statements of Changes in Stockholders' Equity
For the years ended December 31, 2005, 2004 and 2003 .................... F-6
Notes to Consolidated Financial Statements ..................................F-7
2. Financial Statement Schedules.
41
All other schedules not listed above have been omitted, because they are not
applicable or are not required, or because the required information is included
in the consolidated financial statements or notes thereto.
3. Exhibits required to be filed by Item 601 of Regulation S-K.
<s> <c>
3.1(a) Amended and Restated Certificate of Incorporation of the
Company
3.1(b) Certificate of Amendment to Amended and Restated Certificate
of Incorporation dated May 22, 1998 (Incorporated by reference
to Exhibit 3.1(b) to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998)
3.1(c) Certificate of Amendment to Amended and Restated Certificate
of Incorporation dated May 17, 1999 (Incorporated by reference
to Exhibit 3.1(c) to the Company's Annual Report on Form 10-K
for the year ended December 31, 2004)
3.2 Amended and Restated By-laws of the Company (Incorporated by
reference to Exhibit 3.1 to the Company's Current Report on
Form 8-K filed on February 24, 2005)
4.1 Indenture, dated as of March 31, 2003, between the Company and
Wells Fargo Bank Minnesota, National Association (Incorporated
by reference to Exhibit 4.1 to the Company's Quarterly Report
on Form 10-Q for the quarter ended March 31, 2003)
4.2 Registration Rights Agreement, dated as of March 31, 2003,
between the Company and Credit Suisse First Boston, LLC, Banc
of America Securities LLC and U.S. Bancorp Piper Jaffray Inc.
(Incorporated by reference to Exhibit 4.3 to the Company's
Registration Statement on Form S-3 filed on June 30, 2003
(File No. 333-106625))
4.3(a) Credit Agreement, dated as of December 22, 2005, among Integra
LifeSciences Holdings Corporation, the lenders party thereto,
Bank of America, N.A., as Administrative Agent, Swing Line
Lender and L/C Issuer, Citibank FSB and SunTrust Bank, as
Co-Syndication Agents, and Royal Bank of Canada and Wachovia
Bank, National Association, as Co-Documentation Agents
(Incorporated by reference to Exhibit 10.1 to the Company's
Current Report on Form 8-K filed on December 29, 2005)
4.3(b) First Amendment, dated as of February 15, 2006, among Integra
LifeSciences Holdings Corporation, the lenders party thereto,
Bank of America, N.A., as Administrative Agent, Swing Line
Lender and L/C Issuer, Citibank FSB and SunTrust Bank, as
Co-Syndication Agents, and Royal Bank of Canada and Wachovia
Bank, National Association, as Co-Documentation Agents
4.4 Security Agreement, dated as of December 22, 2005, among
Integra LifeSciences Holdings Corporation and the additional
grantors party thereto in favor of Bank of America, N.A., as
administrative and collateral agent
4.5 Pledge Agreement, dated as of December 22, 2005, among Integra
LifeSciences Holdings Corporation and the additional grantors
party thereto in favor of Bank of America, N.A., as
administrative and collateral agent
4.6 Subsidiary Guaranty Agreement, dated as of December 22, 2005,
among the guarantors party thereto and individually as a
"Guarantor"), in favor of Bank of America, N.A., as
administrative and collateral agent
42
10.1(a) Lease between Plainsboro Associates and American Biomaterials
Corporation dated as of April 16, 1985, as assigned to
Colla-Tec, Inc. on October 24, 1989 and as amended through
November 1, 1992 (Incorporated by reference to Exhibit 10.30
to the Company's Registration Statement on Form 10/A (File No.
0-26224) which became effective on August 8, 1995)
10.1(b) Lease Modification #2 entered into as of the 28th day of
October, 2005, by and between Plainsboro Associates and
Integra LifeSciences Corporation (Incorporated by reference to
Exhibit 10.1 to the Company's Current Report on Form 8-K filed
on November 2, 2005)
10.2 Equipment Lease Agreement between Medicus Corporation and the
Company, dated as of June 1, 2000 (Incorporated by reference
to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 2000)
10.3 Form of Indemnification Agreement between the Company and [ ]
dated August 16, 1995, including a schedule identifying the
individuals that are a party to such Indemnification
Agreements (Incorporated by reference to Exhibit 10.37 to the
Company's Registration Statement on Form S-1 (File No.
33-98698) which became effective on January 24, 1996)
10.4 1993 Incentive Stock Option and Non-Qualified Stock Option
Plan (Incorporated by reference to Exhibit 10.32 to the
Company's Registration Statement on Form 10/A (File No.
0-26224) which became effective on August 8, 1995)
10.5 1996 Incentive Stock Option and Non-Qualified Stock Option
Plan (as amended through December 27, 1997) (Incorporated by
reference to Exhibit 10.4 to the Company's Current Report on
Form 8-K filed on February 3, 1998)
10.6 1998 Stock Option Plan (amended and restated as of July 26,
2005)(Incorporated by reference to Exhibit 10.3 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2005)
10.7 1999 Stock Option Plan (amended and restated as of July 26,
2005) (Incorporated by reference to Exhibit 10.4 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2005)
10.8(a) Employee Stock Purchase Plan (as amended on May 17, 2004)
(Incorporated by reference to Exhibit 4.1 to the Company's
Registration Statement on Form S-8 (Registration No.
333-127488) filed on August 12, 2005)
10.8(b) First Amendment to the Company's Employee Stock Purchase Plan,
dated October 26, 2005 (Incorporated by reference to Exhibit
10.1 to the Company's Current Report on Form 8-K filed on
November 1, 2005)
10.9 Deferred Compensation Plan (Incorporated by reference to
Exhibit 10.15 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1999)
10.10 2000 Equity Incentive Plan (amended and restated as of July
26, 2005)(Incorporated by reference to Exhibit 10.5 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2005)
10.11 2001 Equity Incentive Plan (amended and restated as of July
26, 2005)(Incorporated by reference to Exhibit 10.6 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2005)
43
10.12 2003 Equity Incentive Plan (amended and restated as of July
26, 2005)(Incorporated by reference to Exhibit 10.7 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2005)
10.13 Second Amended and Restated Employment Agreement dated July
27, 2004 between the Company and Stuart M. Essig (Incorporated
by reference to Exhibit 10.1 to the Company's Quarterly Report
on Form 10-Q for the quarter ended September 30, 2004)
10.14 Indemnity letter agreement dated December 27, 1997 from the
Company to Stuart M. Essig (Incorporated by reference to
Exhibit 10.5 to the Company's Current Report on Form 8-K filed
on February 3, 1998)
10.15(a) Registration Rights Provisions for Stuart Essig (Incorporated
by reference to Exhibit B of Exhibit 10.1 to the Company's
Current Report on Form 8-K filed on February 3, 1998)
10.15(b) Registration Rights Provisions for Stuart Essig (Incorporated
by reference to Exhibit 10.2 to the Company's Current Report
on Form 8-K filed on January 8, 2001)
10.15(c) Registration Rights Provisions for Stuart Essig (Incorporated
by reference to Exhibit B of Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended September
30, 2004)
10.16 Amended and Restated 2005 Employment Agreement between John B.
Henneman, III and the Company dated December 19, 2005
10.17 Amended and Restated 2005 Employment Agreement between Gerard
S. Carlozzi and the Company dated December 19, 2005
10.18 Employment Agreement between Judith O'Grady and the Company
dated February 20, 2003 (Incorporated by reference to Exhibit
10.17 to the Company's Report on Form 10-K for the year ended
December 31, 2002)
10.19 Amended and Restated 2005 Employment Agreement between David
B. Holtz and the Company dated December 19, 2005
10.20 Employment Agreement between Donald Nociolo and the Company
dated February 20, 2003 (Incorporated by reference to Exhibit
10.20 to the Company's Report on Form 10-K for the year ended
December 31, 2003)
10.21 Retention Agreement between Robert Paltridge and the Company
dated February 20, 2003 (Incorporated by reference to Exhibit
10.1 to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2003)
10.22 Severance Agreement between Deborah Leonetti and the Company
dated February 20, 2003 (Incorporated by reference to Exhibit
10.22 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2004)
10.23(a) Lease Contract dated June 30, 1994 between the Puerto Rico
Industrial Development Company and Heyer-Schulte NeuroCare,
Inc. (Incorporated by reference to Exhibit 10.32 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1999)
10.23(b) Construction and Lease Contract dated April 11, 2003 between
the Puerto Rico Industrial Development Company and Integra
NeuroSciences P.R., Inc. (Incorporated by reference to Exhibit
10.23(b) to the Company's Annual Report on Form 10-K for the
year ended December 31, 2004)
10.23(c) Supplement and Amendment to Lease Contract, dated October 24,
2005, to the Construction and Lease Contract dated April 11,
2003 between Integra NeuroSciences PR, Inc. and the Puerto
Rico Industrial Development Company (Incorporated by reference
to Exhibit 10.1 to the Company's Current Report on Form 8-K
filed on November 22, 2005)
10.24(a) Industrial Real Estate Triple Net Sublease dated July 1, 2001
between Sorrento Montana, L.P. and Camino NeuroCare, Inc.
(Incorporated by reference to Exhibit 10.24(a) to the
Company's Annual Report on Form 10-K for the year ended
December 31, 2004)
44
10.24(b) First Amendment to Sublease dated as of July 1, 2003 by and
between Sorrento Montana, L.P. and Camino NeuroCare, Inc.
(Incorporated by reference to Exhibit 10.24(b) to the
Company's Annual Report on Form 10-K for the year ended
December 31, 2004)
10.24(c) Second Amendment to Sublease dated as of June 1, 2004 by and
between Sorrento Montana, L.P. and Camino NeuroCare, Inc.
(Incorporated by reference to Exhibit 10.24(c) to the
Company's Annual Report on Form 10-K for the year ended
December 31, 2004)
10.24(d) Third Amendment to Sublease dated as of June 15, 2004 by and
between Sorrento Montana, L.P. and Integra LifeSciences
Corporation (Incorporated by reference to Exhibit 10.24(d) to
the Company's Annual Report on Form 10-K for the year ended
December 31, 2004)
10.25 Restricted Units Agreement dated December 27, 1997 between the
Company and Stuart M. Essig (Incorporated by reference to
Exhibit 10.3 to the Company's Current Report on Form 8-K filed
on February 3, 1998)
10.26 Stock Option Grant and Agreement dated December 22, 2000
between the Company and Stuart M. Essig (Incorporated by
reference to Exhibit 4.1 to the Company's Current Report on
Form 8-K filed on January 8, 2001)
10.27 Stock Option Grant and Agreement dated December 22, 2000
between the Company and Stuart M. Essig (Incorporated by
reference to Exhibit 4.2 to the Company's Current Report on
Form 8-K filed on January 8, 2001)
10.28 Restricted Units Agreement dated December 22, 2000 Between the
Company and Stuart M. Essig (Incorporated by reference to
Exhibit 4.3 to the Company's Current Report on Form 8-K filed
on January 8, 2001)
10.29 Stock Option Grant and Agreement dated July 27, 2004 between
the Company and Stuart M. Essig (Incorporated by reference to
Exhibit 10.30 to the Company's Annual Report on Form 10-K for
the year ended December 31, 2004)
10.30 Contract Stock/Restricted Units Agreement dated July 27, 2004
between the Company and Stuart M. Essig (Incorporated by
reference to Exhibit 10.31 to the Company's Annual Report on
Form 10-K for the year ended December 31, 2004)
10.31 Form of Stock Option Grant and Agreement between the Company
and Stuart M. Essig (Incorporated by reference to Exhibit
10.32 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2004)
10.32 Share Purchase Agreement dated November 10, 2004 between
Integra LifeSciences Corporation and Eric Fourcault, Theo
Knevels, Jean-Christophe Giet and Bertrand Gauneau
(Incorporated by reference to Exhibit 10.33 to the Company's
Annual Report on Form 10-K for the year ended December 31,
2004)
10.33 Form of Notice of Grant of Stock Option and Stock Option
Agreement* (Incorporated by reference to Exhibit 10.1 to the
Company's Current Report on Form 8-K filed on July 29, 2005)
10.34 Form of Non-Qualified Stock Option Agreement (Non-Directors)
(Incorporated by reference to Exhibit 10.35 to the Company's
Annual Report on Form 10-K for the year ended December 31,
2004)
45
10.35 Form of Incentive Stock Option Agreement (Incorporated by
reference to Exhibit 10.36 to the Company's Annual Report on
Form 10-K for the year ended December 31, 2004)
10.36 Form of Non-Qualified Stock Option Agreement (Directors)
(Incorporated by reference to Exhibit 10.37 to the Company's
Annual Report on Form 10-K for the year ended December 31,
2004)
10.37 Compensation of Directors of the Company (Incorporated by
reference to Exhibit 10.1 to the Company's Current Report on
Form 8-K filed on February 28, 2006)
10.38 Form of Restricted Stock Agreement for Non-Employee Directors
under the Integra LifeSciences Holdings Corporation 2003
Equity Incentive Plan (Incorporated by reference to Exhibit
10.2 to the Company's Current Report on Form 8-K filed on May
17, 2005)
10.39 Form of Restricted Stock Agreement for Executive Officers
(Incorporated by reference to Exhibit 10.1 to the Company's
Current Report on Form 8-K filed on January 9, 2006)
10.40 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)
10.41 Restricted Stock Agreement by and between David B. Holtz and
the Company dated December 19, 2005
10.42 Performance Stock Agreement by and between John B. Henneman,
III and the Company dated January 3, 2006
10.43 Performance Stock Agreement by and between Gerard S. Carlozzi
and the Company dated January 3, 2006
10.44 Employment Agreement by and between Maureen Bellantoni and the
Company dated January 10, 2006
10.45 Performance Stock Agreement by and between Maureen Bellantoni
and the Company dated January 10, 2006
21 Subsidiaries of the Company
23 Consent of PricewaterhouseCoopers LLP
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
The Company's Commission File Number for Reports on Form 10-K, Form 10-Q and
Form 8-K is 0-26224.
46
SIGNATURES
Pursuant to the requirements of Section 13 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: March 15, 2006 By: /s/ Stuart M. Essig
-------------------------------------
Stuart M. Essig
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons, on behalf of the registrant in
the capacities indicated.
Signature Title Date
------------ ------ ------
<s> <c> <c>
/s/ Stuart M. Essig President, Chief Executive Officer and March 15, 2006
- ---------------------------- Director (Principal Executive Officer)
Stuart M. Essig
/s/ Maureen B. Bellantoni Executive Vice President and Chief March 15, 2006
- ---------------------------- Financial Officer (Principal Financial
Maureen B. Bellantoni Officer)
/s/ David B. Holtz Senior Vice President, Finance March 15, 2006
- ---------------------------- (Principal Accounting Officer)
David B. Holtz
/s/ Richard E. Caruso, Ph.D. Chairman of the Board March 15, 2006
- ----------------------------
Richard E. Caruso, Ph.D.
/s/ David Auth Director March 15, 2006
- ----------------------------
David Auth
/s/ Keith Bradley, Ph.D. Director March 15, 2006
- ----------------------------
Keith Bradley, Ph.D.
/s/ James M. Sullivan Director March 15, 2006
- ----------------------------
James M. Sullivan
/s/ Anne M. VanLent Director March 15, 2006
- ----------------------------
Anne M. VanLent
47
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To Board of Directors and Stockholders of Integra LifeSciences Holdings
Corporation and Subsidiaries:
We have completed integrated audits of Integra LifeSciences Holdings
Corporation's 2005 and 2004 consolidated financial statements and of its
internal control over financial reporting as of December 31, 2005, and an audit
of its 2003 consolidated financial statements in accordance with the standards
of the Public Company Accounting Oversight Board (United States). Our opinions,
based on our audits, are presented below.
Consolidated financial statements and financial statement schedule
In our opinion, the consolidated financial statements listed in the accompanying
index appearing under Item 15(a)(1) "Exhibits and Financial Statement Schedules"
present fairly, in all material respects, the financial position of Integra
LifeSciences and its subsidiaries (the "Company") at December 31, 2005 and
December 31, 2004, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2005 in conformity with
accounting principles generally accepted in the United States of America. In
addition, in our opinion, the financial statement schedule listed in the index
appearing under Item 15(a)(2) presents fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit of financial statements
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
Internal control over financial reporting
Also, in our opinion, management's assessment, included in Management's Report
on Internal Control Over Financial Reporting appearing in Item 9A "Controls and
Procedures", that the Company maintained effective internal control over
financial reporting as of December 31, 2005 based on criteria established in
Internal Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), is fairly stated, in all
material respects, based on those criteria. Furthermore, in our opinion, the
Company maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2005, based on criteria established in
Internal Control - Integrated Framework issued by the COSO. The Company's
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express opinions on
management's assessment and on the effectiveness of the Company's internal
control over financial reporting based on our audit. We conducted our audit of
internal control over financial reporting in accordance with the standards of
the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether effective internal control over financial reporting was maintained in
all material respects. An audit of internal control over financial reporting
includes obtaining an understanding of internal control over financial
reporting, evaluating management's assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing such other
procedures as we consider necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
F-1
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
As described in Management's Report on Internal Control Over Financial Reporting
appearing in Item 9A "Controls and Procedures", management has excluded Newdeal
Technologies SAS ("Newdeal") from its assessment of internal control over
financial reporting as of December 31, 2005 because it was acquired by the
Company in a purchase business combination during 2005. We have also excluded
Newdeal from our audit of internal control over financial reporting. New Deal is
a wholly-owned subsidiary whose total assets and total revenues represent 13%
and 6%, respectively, of the related consolidated financial statement amounts as
of and for the year ended December 31, 2005.
/s/ PricewaterhouseCoopers LLP
Florham Park, New Jersey
March 15, 2006
F-2
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
In thousands, except per share amounts
Years Ended December 31,
--------------------------------
2005 2004 2003
-------- -------- --------
<s> <c> <c> <c>
Total revenues .................................. $277,935 $229,825 $185,599
COSTS AND EXPENSES
Cost of product revenues (exclusive of
amortization related to acquired intangible
assets) ...................................... 105,536 87,299 70,597
Research and development ........................ 11,960 14,121 12,814
Selling, general and administrative ............. 98,273 99,360 59,461
Amortization .................................... 6,061 4,266 3,080
-------- -------- --------
Total costs and expenses .................... 221,830 205,046 145,952
Operating income ................................ 56,105 24,779 39,647
Interest income ................................. 3,900 4,030 3,195
Interest expense ................................ (4,165) (3,475) (2,724)
Other income (expense), net ..................... (739) 2,674 3,071
-------- -------- --------
Income before income taxes ...................... 55,101 28,008 43,189
Provision for income taxes ...................... 17,907 10,811 16,328
-------- -------- --------
Net income ...................................... $ 37,194 $ 17,197 $ 26,861
======== ======== ========
Basic net income per share ................... $ 1.23 $ 0.57 $ 0.92
Diluted net income per share ................. $ 1.15 $ 0.55 $ 0.86
Weighted average common shares outstanding:
Basic ........................................ 30,195 30,064 29,071
Diluted ...................................... 34,565 31,102 33,104
The accompanying notes are an integral part of these consolidated financial
statements
F-3
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONSOLIDATED BALANCE SHEETS
In thousands, except per share amounts
December 31,
-----------------------
ASSETS 2005 2004
--------- ---------
<s> <c> <c>
Current Assets:
Cash and cash equivalents ...................................... $ 46,889 $ 69,855
Short-term investments ......................................... 80,327 30,955
Trade accounts receivable, net of allowances
of $3,508 and $2,749 ....................................... 49,007 46,765
Inventories .... ............................................... 67,476 55,947
Deferred tax assets ............................................ 10,842 3,966
Prepaid expenses and other current assets ...................... 11,411 8,750
--------- ---------
Total current assets ....................................... 265,952 216,238
Non-current investments ......................................... 16,168 95,172
Property, plant, and equipment, net ............................. 27,451 25,461
Deferred tax assets ............................................. -- 15,787
Intangible assets, net .......................................... 64,569 59,817
Goodwill ........................................................ 68,364 39,237
Other assets .................................................... 5,928 5,001
--------- ---------
Total assets ..................................................... $ 448,432 $ 456,713
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable, trade ........................................ $ 8,978 $ 10,160
Income taxes payable ........................................ .. 715 1,022
Accrued compensation ........................................... 8,761 4,212
Accrued expenses and other current liabilities ................. 12,833 8,840
--------- ---------
Total current liabilities .................................. 31,287 24,234
Long term debt .................................................. 118,378 118,900
Deferred tax liabilities ........................................ 2,520 --
Other liabilities ............................................... 6,429 5,756
--------- ---------
Total liabilities ................................................ 158,614 148,890
Commitments and contingencies
Stockholders' Equity:
Common stock; $.01 par value; 60,000 authorized shares; 29,823
and 29,202 issued ........................................... 298 292
Additional paid-in capital ..................................... 333,179 320,602
Treasury stock, at cost; 2,368 and 718 shares .................. (75,815) (19,474)
Accumulated other comprehensive income (loss):
Unrealized gain (loss) on available-for-sale securities,
net of tax ............................................. (801) (818)
Foreign currency translation adjustment ..................... (2,300) 9,266
Minimum pension liability adjustment, net of tax ............ (1,672) (1,780)
Retained earnings/(accumulated deficit) ........................ 36,929 (265)
--------- ---------
Total stockholders' equity ................................... 289,818 307,823
--------- ---------
Total liabilities and stockholders' equity ...................... $ 448,432 $ 456,713
========= =========
The accompanying notes are an integral part of these consolidated financial
statements
F-4
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
In thousands
Years Ended December 31,
------------------------------
2005 2004 2003
-------- -------- --------
<s> <c> <c> <c>
OPERATING ACTIVITIES:
Net income ............................................... $ 37,194 $ 17,197 $ 26,861
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ........................... 11,313 9,087 7,030
In process research and development charge .............. 500 -- 400
Deferred income tax provision ........................... 9,895 6,101 12,357
Amortization of discount/premium on investments ......... 1,908 2,505 2,013
Share-based compensation ................................ 146 23,572 26
Other, net .............................................. 779 696 776
Changes in assets and liabilities, net of business
acquisitions:
Accounts receivable ................................... 491 (13,287) (4,819)
Inventories ........................................... (9,984) (9,738) (1,829)
Prepaid expenses and other current assets ............. 30 (1,949) (505)
Non-current assets .................................... (66) (169) 480
Accounts payable, accrued expenses and other
liabilities ........................................ 4,800 6,029 2,537
Customer advances and deposits ........................ -- (959) (6,431)
Deferred revenue ...................................... (158) (110) (4,070)
-------- -------- --------
Net cash provided by operating activities ................ $ 56,848 $ 38,975 $ 34,826
-------- -------- --------
INVESTING ACTIVITIES:
Proceeds from the sales/maturities of investments ......... 93,315 241,440 287,558
Purchases of available for sale investments ............... (65,499) (190,888) (360,470)
Purchases of property and equipment ....................... (8,053) (8,508) (3,843)
Payment of product license fee ............................ -- -- (1,500)
Cash used in acquisitions, net of cash acquired ........... (50,602) (29,302) (50,405)
-------- -------- --------
Net cash provided by (used in) investing activities ...... $(30,839) $ 12,742 $(128,660)
-------- -------- --------
FINANCING ACTIVITIES:
Fees paid in connection with bank line of credit .......... (1,132) -- --
Repayment of bank loans ................................... (245) -- --
Proceeds from exercised stock options and warrants ........ 9,382 6,123 14,152
Purchases of treasury stock ............................... (56,341) (14,238) (35,402)
Proceeds from issuance of convertible notes, net........... -- -- 115,923
-------- -------- --------
Net cash provided by (used in) financing activities ...... $(48,336) $ (8,115) $ 94,673
Effect of exchange rate changes on cash and cash equivalents .. (639) 199 232
-------- -------- --------
Net increase (decrease) in cash and cash equivalents .......... $(22,966) 43,801 1,071
Cash and cash equivalents at beginning of period .............. 69,855 26,054 24,983
-------- -------- --------
Cash and cash equivalents at end of period .................... $ 46,889 $ 69,855 $ 26,054
======== ======== ========
Cash paid during the year for interest ........................ $ 3,275 $ 2,331 $ 1,476
Cash paid during the year for income taxes .................... 7,721 1,789 1,309
Supplemental non-cash disclosure:
Acquisition fees included in liabilities ...................... $ 1,123 -- --
Property and equipment purchases included in liabilities ...... 199 969 2,000
The accompanying notes are an integral part of these consolidated financial
statements
F-5
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
In thousands
Accumulated Retained
Additional Other Earnings/
Preferred Common Treasury Paid-In Comprehensive (Accumulated Total
Stock Stock Stock Capital Other Income (Loss) Deficit) Equity
--------- -------- --------- ---------- --------- ------------- ----------- ----------
Balance, December 31, 2002 ............... -- 272 (1,812) 292,007 (15) 1,468 (44,323) $ 247,597
========= ======== ========= ========== ========= ============= =========== ==========
<s> <c> <c> <c> <c> <c> <c> <c> <c>
Net income ............................... 26,861 26,861
Realized gains on investments............. (210) (210)
Unrealized losses on investments, net
of tax .............................. (588) (588)
Foreign currency translation ............. 3,673 3,673
Minimum pension liability adjustment,
net of tax .......................... (112) (112)
---------
Total comprehensive income ........ $ 29,624
=========
Issuance of 1,788 shares of common stock
through employee benefit plans ......... 4 31,978 (17,880) 14,102
Warrants exercised for cash ......... .... 50 50
Conversion of 1,000 Restricted Units into
1,000 shares of common stock........... 10 (10) --
Share-based compensation ................. 16 10 26
Tax benefit related to stock option
exercises ............................. 12,533 12,533
Repurchase 1,503 shares of common stock... (35,402) (35,402)
Balance, December 31, 2003 ............... $ -- $ 286 $(5,236) $ 286,716 $ (5) $ 4,231 $ (17,462) $ 268,530
========= ========= ========= ========== ========= ============ =========== ==========
Net income................................ 17,197 17,197
Realized gains on investments............. 88 88
Unrealized losses on investments, net
of tax .............................. (969) (969)
Foreign currency translation.............. 3,683 3,683
Minimum pension liability adjustment,
net of tax .......................... (365) (365)
---------
Total comprehensive income......... $ 19,634
=========
Issuance of 592 shares of common stock
through employee benefit plans.......... 6 6,492 6,498
Issuance of contract stock unit award for
750 shares of common stock .......... 23,535 23,535
Other share-based compensation ........... 30 5 35
Tax benefit related to stock option
exercises.............................. 3,829 3,829
Repurchase 500 shares of common stock..... (14,238) (14,238)
Balance, December 31, 2004............... $ -- $ 292 $(19,474) $ 320,602 $ -- $ 6,668 $ (265) $ 307,823
========= ========= ========= ========== ========= ============ =========== ==========
Net income................................ 37,194 37,194
Realized gains on investments............. 18 18
Unrealized losses on investments, net
of tax .............................. (1) (1)
Foreign currency translation.............. (11,375) (11,375)
Minimum pension liability adjustment,
net of tax .......................... (83) (83)
---------
Total comprehensive income......... $ 25,753
=========
Issuance of 621 shares of common stock
through employee benefit plans.......... 6 9,170 9,176
Share-based compensation ................. 146 146
Tax benefit related to stock option
exercises.............................. 3,261 3,261
Repurchase 1,650 shares of common stock .. (56,341) (56,341)
Balance, December 31, 2005............... $ -- $ 298 $(75,815) $ 333,179 $ -- $ (4,773) $ 36,929 $ 289,818
========= ========= ========= ========== ========= ============ =========== ==========
A significant portion of the foreign currency translation adjustment recorded in
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.
The accompanying notes are an integral part of these consolidated financial
statements
F-6
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS
Integra LifeSciences Holdings Corporation (the "Company") is a market-leading,
innovative medical device company focused on helping the medical professional
enhance the standard of care for patients. Integra provides customers with
clinically relevant, innovative and cost-effective products that improve the
quality of life for patients. The Company focuses on cranial and spinal
procedures, peripheral nerve repair, small bone and joint injuries, and the
repair and reconstruction of soft tissue.
The Company sells its products directly through various sales forces and through
a variety of other distribution channels.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its subsidiaries, all of which are wholly owned. All intercompany accounts and
transactions are eliminated in consolidation.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents.
FINANCIAL INSTRUMENTS
Investments in marketable debt and equity securities are classified and
accounted for as available-for-sale securities and are carried at fair value,
which is based on quoted market prices. Unrealized gains and losses are reported
as a component of accumulated other comprehensive income (loss). Realized gains
and losses are determined on the specific identification cost basis and reported
in other income (expense), net. Investment balances as of December 31, 2005 and
2004 were as follows:
Unrealized Fair
Cost Gains Losses Value
------- ------- ------- -------
(in thousands)
<s> <c> <c> <c> <c>
2005
- -----
Marketable Securities, current
Corporate Debt Securities with continuous
unrealized losses greater than 1 year ....... $ 37,248 $ -- $ (372) $ 36,876
Auction Rate Securities ............................ 2,650 -- -- 2,650
U.S. Government Debt Securities with continuous
unrealized losses greater than 1 year ....... 39,201 -- (427) 38,774
Other Securities with continuous
unrealized losses greater than 1 year ....... 2,054 -- (27) 2,027
------- ------- ------- -------
Total marketable securities, current ............ $ 81,153 $ -- $ (826) $ 80,327
Marketable Securities, non-current
Corporate Debt Securities with continuous
unrealized losses greater than 1 year ....... $ 10,330 $ -- $ (277) 10,053
U.S. Government Debt Securities with continuous
unrealized losses greater than 1 year ....... 6,252 -- (137) 6,115
------- ------- ------- -------
Total marketable securities, non-current ........ $ 16,582 $ -- $ (414) $ 16,168
2004:
- -----
Marketable securities, current ..................... $31,191 $ -- $ (236) $ 30,955
Marketable securities, non-current ................. 96,278 30 (1,136) 95,172
------- ------- -------- --------
$ 127,469 $ 30 $(1,372) $126,127
F-7
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The unrealized losses on the Company's marketable debt securities are primarily
related to the increase in interest rates since the Company acquired these
investments. Management does not believe that the unrealized losses on these
marketable securities are other than temporary because of its intent and ability
to hold these investments for a sufficiently long period of time such that
recovery of these unrealized losses is expected as the investments get closer to
their maturity. The maturity dates or interest rate reset periods for marketable
debt securities classified as current are less than one year. The maturity dates
for marketable debt securities classified as non-current are less than 31 months
and less than 45 months as of December 31, 2005 and 2004, respectively.
The fair value of the Company's $120.0 million principal amount 2 1/2%
contingent convertible subordinated notes outstanding at December 31, 2005 and
2004 was $114.3 million and $115.5 million, respectively.
The carrying values of all other financial instruments were not materially
different from their estimated fair values.
TRADE ACCOUNTS RECEIVABLE, ALLOWANCES FOR DOUBTFUL ACCOUNTS RECEIVABLE AND SALES
RETURNS
Trade accounts receivable are recorded at the invoiced amount and do not bear
interest. The Company grants credit to customers in the normal course of
business, but generally does not require collateral or any other security to
support its receivables.
The Company evaluates the collectibility of accounts receivable based on a
combination of factors. In circumstances where a specific customer is unable to
meet its financial obligations to the Company, a provision to the allowances for
doubtful accounts is recorded against amounts due to reduce the net recognized
receivable to the amount that is reasonably expected to be collected. For all
other customers, a provision to the allowances for doubtful accounts is recorded
based on the length of time the receivables are past due, the current business
environment and the Company's historical experience. Provisions to the
allowances for doubtful accounts are recorded to selling, general and
administrative expenses. Account balances are charged off against the allowance
when the Company feels it is probable the receivable will not be recovered.
The Company records a provision for estimated returns and allowances on product
revenues in the same period as the related revenues are recorded. These
estimates are based on historical sales returns and discounts and other known
factors. The provisions are recorded as a reduction to revenues.
INVENTORIES
Inventories, consisting of purchased materials, direct labor and manufacturing
overhead, are stated at the lower of cost, the value determined by the first-in,
first-out method, or market. Inventories consisted of the following:
December 31,
2005 2004
---------- ----------
(in thousands)
<s> <c> <c>
Finished goods .......................... $ 44,500 $ 36,490
Work in process ......................... 9,801 7,496
Raw materials ........................... 13,175 11,961
---------- ----------
$ 67,476 $ 55,947
At each balance sheet date, the Company evaluates ending inventories for excess
quantities, obsolescence or shelf-life expiration. This evaluation includes
analyses of historical sales levels by product, projections of future demand,
the risk of technological or competitive obsolescence for products, general
market conditions, a review of the shelf life expiration dates for products, and
the feasibility of reworking or using excess or obsolete products or components
F-8
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
in the production or assembly of other products that are not obsolete or for
which there are not excess quantities in inventory. To the extent that
management determines there are excess or obsolete or expired inventory
quantities or quantities with a shelf life that is too near its expiration for
the Company to reasonably expect that it can sell those products prior to their
expiration, valuation reserves are recorded against all or a portion of the
value of the related products to adjust their carrying value to estimated net
realizable value.
The Company capitalizes inventory costs associated with certain products prior
to regulatory approval, based on management's judgment of probable future
commercialization. The Company could be required to expense previously
capitalized costs related to pre-approval inventory upon a change in such
judgment, due to, among other potential factors, a denial or delay of approval
by necessary regulatory bodies or a decision by management to discontinue the
related development program. At December 31, 2005, we capitalized approximately
$0.9 million of pre-approval inventory.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are stated at cost. The Company provides for
depreciation using the straight-line method over the estimated useful lives of
the assets. Leasehold improvements are amortized over the lesser of the lease
term or the useful life. The cost of major additions and improvements is
capitalized, while maintenance and repair costs that do not improve or extend
the lives of the respective assets are charged to operations as incurred.
Property, plant and equipment balances and corresponding lives were as follows:
December 31,
2005 2004 Lives
---------- ---------- ---------------
(in thousands)
<s> <c> <c> <c>
Land ............................................ $ 890 $ 941
Buildings and leasehold improvements ............ 15,208 12,886 2 - 40 years
Machinery and equipment ......................... 20,732 19,369 3 - 15 years
Furniture ,fixtures and information systems .... 15,310 11,569 5 - 7 years
Construction in progress ........................ 2,007 3,252
---------- ----------
54,147 48,017
Less: Accumulated depreciation .................. (26,696) (22,556)
---------- ----------
$ 27,451 $ 25,461
Depreciation expense associated with property, plant and equipment was $5.3
million, $4.8 million, and $3.9 million, in 2005, 2004, and 2003 respectively.
GOODWILL AND OTHER INTANGIBLE ASSETS
The excess of the cost over the fair value of net assets of acquired businesses
is recorded as goodwill. Goodwill is not subject to amortization, but is
reviewed for impairment at the reporting unit level annually, or more frequently
if impairment indicators arise. The Company's assessment of the recoverability
of goodwill is based upon a comparison of the carrying value of goodwill with
its estimated fair value. The Company conducted its annual impairment review for
goodwill as of June 30, 2005 and determined that its goodwill was not impaired.
F-9
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Changes in the carrying amount of goodwill in 2005 and 2004 were as follows:
2005 2004
---------- ---------
(in thousands)
<s> <c> <c>
Goodwill, beginning of year ....................................... $ 39,237 $ 26,683
Acquisitions ...................................................... 35,668 11,596
Foreign currency translation and other............................. (6,541) 958
---------- ---------
Goodwill, end of year ............................................. $ 68,364 $ 39,237
========== =========
The components of the Company's identifiable intangible assets were as follows:
December 31, 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 $ 18,921 $ (5,691) $ 17,108 $ (4,505)
Customer relationships ......... 18 years 22,550 (4,823) 17,417 (3,214)
Trademarks / brand names ....... 36 years 31,175 (2,802) 28,689 (1,862)
Noncompetetion agreements ...... 5 years 6,943 (2,607) 6,352 (1,198)
All other ...................... 11 years 2,233 (1,330) 2,233 (1,203)
-------- ------------ -------- ------------
$ 81,822 $(17,253) $ 71,799 $(11,982)
Accumulated amortization .................... (17,253) (11,982)
-------- --------
$ 64,569 $ 59,817
======== ========
The Company does not have any indefinite life intangible assets.
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.
Excluding the impact of intangible assets acquired in the Radionics acquisition
discussed in Note 17, annual amortization expense is expected to approximate
$5.6 million in 2006, $5.3 million in 2007, $5.0 million in 2008, $4.3 million
in 2009, and $3.7 million in 2010. Identifiable intangible assets are initially
recorded at fair market value at the time of acquisition generally using an
income or cost approach.
LONG-LIVED ASSETS
Long-lived assets held and used by the Company, including property, plant and
equipment and intangible assets, are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. For purposes of evaluating the recoverability of long-lived
assets to be held and used, a recoverability test is performed using projected
undiscounted net cash flows applicable to the long-lived assets. If an
impairment exists, the amount of such impairment is calculated based on the
estimated fair value of the asset. Impairments to long-lived assets to be
disposed of are recorded based upon the fair value of the applicable assets.
INTEGRA FOUNDATION
The Company may periodically, at the discretion of its Board of Directors, make
a contribution to the Integra Foundation, Inc. The Integra Foundation was
incorporated in 2002 exclusively for charitable, educational, and scientific
purposes and qualifies under IRC 501(c)(3) as an exempt private foundation.
Under its charter, the Integra Foundation engages in activities that promote
health, the diagnosis and treatment of disease, and the development of medical
science through grants, contributions and other appropriate means. The Integra
Foundation is a separate legal entity and is not a subsidiary of the Company.
F-10
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Therefore, its results are not included in these consolidated financial
statements. The Company contributed $0.3 million and $2.0 million to the Integra
Foundation in 2005 and 2003, respectively. These contributions were recorded in
selling, general, and administrative expense.
DERIVATIVES
The Company reports all derivatives at their estimated fair value and records
changes in fair value in current earnings or defers these changes until a
related hedged item is recognized in earnings, depending on the nature and
effectiveness of the hedging relationship. The designation of a derivative as a
hedge is made on the date the derivative contract is executed. On an ongoing
basis, the Company assesses whether each derivative continues to be highly
effective in offsetting changes in the fair value or cash flows of hedged items.
If and when a derivative is no longer expected to be highly effective, the
Company discontinues hedge accounting. All hedge ineffectiveness is included in
current period earnings in other income (expense), net.
The Company documents all relationships between hedged items and derivatives.
The Company's overall risk management strategy describes the circumstances under
which it may undertake hedge transactions and enter into derivatives. The
objective of the Company's current risk management strategy is to hedge the risk
of changes in fair value attributable to interest rate risk with respect to a
portion of fixed rate debt.
The determination of fair value of derivatives is based on valuation models that
use observable market quotes or projected cash flows and the Company's view of
the creditworthiness of the derivative counterparty.
FOREIGN CURRENCY
All assets and liabilities of foreign subsidiaries are translated at the rate of
exchange at year-end, while elements of the income statement are translated at
the average exchange rates in effect during the year. The net effect of these
translation adjustments is shown as a component of accumulated other
comprehensive income (loss). These currency translation adjustments are not
currently adjusted for income taxes as they relate to permanent investments in
non-U.S. subsidiaries. Foreign currency transaction gains and losses are
reported in other income (expense), net.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. A valuation allowance is provided when it is more likely than not that
some portion or all of the deferred tax assets will not be realized. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period when the change is enacted.
REVENUE RECOGNITION
Total revenues include product sales and product royalties and other operating
revenues, such as fees received under research, licensing, and distribution
arrangements, research grants, and technology-related royalties. Total revenues
for 2005, 2004 and 2003 consisted of the following:
2005 2004 2003
---------- ---------- ----------
<s> <c> <c> <c>
Product sales and product royalties ............ $ 277,771 $ 228,490 $ 166,695
Other operating revenues ....................... 164 1,335 18,904
---------- ---------- ----------
Total revenues ................................. $ 277,935 $ 229,825 $ 185,599
Product sales are recognized when delivery has occurred and title and risk of
loss has passed to the customer, there is a fixed or determinable sales price,
and collectibility of that sales price is reasonably assured.
F-11
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Product royalties are estimated and recognized in the same period that the
royalty products are sold by our customers. The Company estimates and recognizes
royalty revenue based upon communication with licensees, historical information,
and expected sales trends. Differences between actual revenues and estimated
royalty revenues are adjusted for in the period in which they become known,
which is typically the following quarter. Historically, such adjustments have
not been significant.
In the fourth quarter ended December 31, 2005, the Company recognized an
additional $1.3 million of royalty revenue related to a change in the manner
used to estimate royalties earned based on Medtronic's sales of its INFUSE(TM)
bone graft product. Prior to the quarter ended December 31, 2005, the Company
recognized this royalty revenue when paid by Wyeth because Wyeth did not provide
information to the Company about the royalty amount earned each quarter prior to
the Company reporting its quarterly financial results and the Company did not
have a reliable basis for otherwise estimating and recording royalty revenue in
the same quarter it was earned. However, the Company now receives quarterly
royalty revenue information from Wyeth more quickly, sufficient historical
information is available to help the Company estimate, and the volatility in the
royalty earned each quarter has decreased significantly. Accordingly, the
Company started recognizing this royalty on an accrual basis in the quarter
earned starting in the quarter ended December 31, 2005.
Other operating revenues include fees received under research, licensing, and
distribution arrangements, technology-related royalties, and research grants.
Non-refundable fees received under research, licensing and distribution
arrangements or for the licensing of technology are recognized as revenue when
received if the Company has no continuing obligations to the other party. For
those arrangements where the Company has continuing performance obligations,
revenue is recognized using the lesser of the amount of non-refundable cash
received or the result achieved using the proportional performance method of
accounting based upon the estimated cost to complete these obligations. Research
grant revenue is recognized when the related expenses are incurred.
SHIPPING AND HANDLING FEES AND COSTS
Amounts billed to customers for shipping and handling are included in product
revenues. The related shipping and freight charges incurred by the Company are
included in cost of product revenues. Distribution and handling costs of $5.9
million, $3.8 million, and $2.6 million are recorded in selling, general and
administrative expense during 2005, 2004, and 2003, respectively.
PRODUCT WARRANTIES
Certain of the Company's medical devices, including monitoring systems and
neurosurgical systems, are reusable and are designed to operate over long
periods of time. These products are sold with warranties generally extending for
up to two years from date of purchase. The Company accrues estimated product
warranty costs at the time of sale based on historical experience. Any
additional amounts are recorded when such costs are probable and can be
reasonably estimated.
Accrued warranty expense consisted of the following:
December 31,
2005 2004
-------- --------
(in thousands)
<s> <c> <c>
Beginning balance .................. $ 748 $ 403
Liability acquired through acquisition -- 255
Charged to expense ................. 191 258
Deductions ......................... (243) (168)
-------- --------
Ending balance ..................... $ 696 $ 748
RESEARCH AND DEVELOPMENT
Research and development costs, including salaries, depreciation, consultant and
other external fees, and facility costs directly attributable to research and
development activities, are expensed in the period in which they are incurred.
F-12
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In-process research and development charges recorded in connection with
acquisitions represent the value assigned to acquired assets to be used in
research and development activities and for which there is no alternative use.
Value is generally assigned to these assets based on the net present value of
the projected cash flows expected to be generated by those assets.
In 2005, the Company recorded a $0.5 million in-process research and development
charge from its acquisition of intellectual property and clinical trial data
related to technology that can be used in the management of cerebrospinal fluid
flow within the brain. In 2004, the Company recorded to research and development
expense a $1.4 million charge for a milestone payment related to the completion
of certain development activities for an advanced neuro-monitoring system and a
$0.5 million charge for a licensing fee paid for the development of a data
acquisition system to support the integration of the Company's advanced
monitoring products. The Company recorded $0.4 million of in-process research
and development charges in connection with acquisitions during 2003.
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."
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.
STOCK BASED COMPENSATION
Employee stock based compensation is recognized using the intrinsic value method
prescribed by Accounting Principles Board Opinion No. 25 "Accounting for Stock
Issued to Employees" and Financial Accounting Standards Board Interpretation No.
44 "Accounting for Certain Transactions Involving Stock Compensation -an
interpretation of APB Opinion No. 25".
F-13
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Had the compensation cost for the Company's stock option plans been determined
based on the fair value at the grant consistent with the provisions of Statement
of Financial Accounting Standards No. 123 "Accounting for Stock-Based
Compensation", the Company's net income and basic and diluted net income per
share would have been as follows:
2005 2004 2003
-------- -------- --------
< (in thousands, except per share amounts)
<s> <c> <c> <c>
Net income:
As reported ...................................... $ 37,194 $ 17,197 $ 26,861
Add back: Total share-based employee
compensation expense determined
under the intrinsic value-based
method for all awards, net
of related tax effects ............ 103 15,372 --
Less: Total share-based employee compensation
expense determined under the fair
value-based method for all awards, net
of related tax effects ................ (7,264) (21,799) (5,537)
-------- -------- --------
Pro forma ........................................ $ 30,033 $ 10,770 $ 21,324
Net income per share:
Basic
As reported ...................................... $ 1.23 $ 0.57 $ 0.92
Pro forma ........................................ $ 0.99 $ 0.36 $ 0.73
Diluted
As reported ...................................... $ 1.15 $ 0.55 $ 0.86
Pro forma ........................................ $ 0.94 $ 0.35 $ 0.70
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. The following weighted-average
assumptions were used in the calculation of fair value:
2005 2004 2003
---------- ---------- ----------
<s> <c> <c> <c>
Dividend yield ....................... 0% 0% 0%
Expected volatility .................. 43% 48% 61%
Risk free interest rate .............. 3.8% 3.2% 2.9%
Expected life of option from
grant date ......................... 5.4 years 4.7 years 4.5 years
The effect of the change in estimate related to the use of the bionomial
distribution model has been accounted for on a prospective basis. The Company
will value all future stock option grants using the binomial distribution model.
Management believes that the binomial distribution model is better than the
Black-Scholes model because the binomial distribution model is a more flexible
model that considers the impact of non-transferability, vesting and forfeiture
provisions in the valuation of employee stock options.
In December 2004, the Financial Accounting Standards Board 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. The Company adopted Statement 123(R) on January 1, 2006 using the
"modified prospective" method. The Company expects to record $14 million of
share-based compensation expense in 2006 in connection with the adoption of FAS
123R. However, this estimate of future share-based compensation expense is
affected by the Company's stock price, the number of share-based awards that the
F-14
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company may grant in 2006, as well as a number of complex and subjective
valuation assumptions and the related tax effects. These valuation assumptions
include, but are not limited to, the volatility of the Company's stock price and
employee stock option exercise behavior.
CONCENTRATION OF CREDIT RISK
Financial instruments, which potentially subject the Company to concentrations
of credit risk, consist principally of cash and cash equivalents, which are held
at major financial institutions, investment-grade marketable debt securities and
trade receivables. The Company's products are sold on an uncollateralized basis
and on credit terms based upon a credit risk assessment of each customer.
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amount of assets and liabilities, the
disclosure of contingent liabilities, and the reported amounts of revenues and
expenses. Significant estimates affecting amounts reported or disclosed in the
consolidated financial statements include allowances for doubtful accounts
receivable and sales returns and allowances, net realizable value of
inventories, estimates of projected cash flows and discount rates used to value
and test impairments of long-lived assets, depreciation and amortization periods
for long-lived assets, valuation allowances recorded against deferred tax
assets, loss contingencies, and in-process research and development charges.
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.
RECENTLY ISSUED ACCOUNTING STANDARDS
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 qualified
production activities income deduction is a special deduction and will have no
F-15
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 the Company will
realize a tax benefit on qualified production activities income once the Company
has completely utilized its unrestricted net operating losses, which is expected
to occur in 2006.
3. ACQUISITIONS
BUSINESS COMBINATIONS
In January 2005, the Company acquired all of the outstanding capital stock of
Newdeal Technologies SAS ("Newdeal Technologies") for $51.9 million (38.3
million euros) in cash paid at closing, a $0.7 million working capital
adjustment paid in January 2006, and $0.8 million of acquisition related
expenses. Additionally, the Company agreed to pay the sellers up to an
additional 1.3 million euros if the sellers continue their employment with the
Company through January 3, 2006. This additional payment was accrued to selling,
general and administrative expense on a straight-line basis in 2005 over the
one-year employment requirement period.
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. During 2005, Integra began to market the
Newdeal products directly in the United States through its Integra
Reconstructive Surgery sales force. Newdeal's target physicians include
orthopedic surgeons specializing in injuries of the foot, ankle and extremities,
as well as podiatric surgeons.
In connection with this acquisition, the Company recorded $35.7 million of
goodwill and $13.1 million of intangible assets, consisting primarily of trade
name, customer relationships, and technology, which are being amortized on a
straight-line basis over lives ranging from 5 to 40 years. 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 fair value
of assets acquired was determined with the assistance of a third-party valuation
firm.
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 have been used by neurosurgeons for over thirty years.
F-16
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The products are sold in the United States through the Integra NeuroSciences
direct sales organization and in international markets through distributors. In
connection with this acquisition, the Company recorded $8.4 million of goodwill
and $8.1 million of intangible assets, consisting of a non-compete agreement,
trade name, and technology, which are being amortized on a straight-line basis
over lives ranging from 5 to 30 years. The fair value of assets acquired was
determined with the assistance of a third-party valuation firm.
In May 2004, the Company acquired all of the capital stock of Berchtold
Medizin-Elektronik GmbH, now named Integra ME GmbH, from Berchtold Holding GmbH
for $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. This acquisition provided Integra with additional
devices for the European and international markets and an existing
infrastructure through which it can sell certain of its other products directly
into Germany. In connection with this acquisition, the Company recorded $1.7
million of goodwill and $1.3 million of intangible assets, consisting primarily
of trade name, technology, and customer relationships, which are being amortized
on a straight-line basis over lives ranging from 3 to 10 years.
The acquired business included a facility located in Tuttlingen, Germany that
manufactured, packaged and distributed the ELEKTROTOM and SONOTOM products. The
Company closed the Tuttlingen facility in December 2005 and transferred all of
the Tuttlingen operations to its facility located in Andover, England.
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 sales
organization. In connection with this acquisition, the Company recorded $1.5
million of intangible assets and goodwill. The acquired intangible assets are
being amortized on a straight-line basis over lives ranging from 5 to 20 years.
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. In connection with this
acquisition, the Company recorded $1.6 million of intangible assets and
goodwill. The acquired intangible assets are being amortized on a straight-line
basis over 5 years.
The results of operations of the acquired businesses have been included in the
consolidated financial statements since their respective dates of acquisition.
The following table summarizes the fair value of the assets acquired and
liabilities assumed as a result of 2005 and 2004 acquisitions:
(All amounts in thousands)
2005 Acquisitions Newdeal
- ----------------- -------------
<s> <c> <c>
Current assets ....................... $10,925
Property, plant and equipment ........ 1,026 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 ............................. 35,668
Other assets ......................... 38
-------------
Total assets acquired ............. 60,747
Liabilities assumed, excluding debt .. 7,560
Debt assumed ......................... 530
-------------
Net assets acquired .................. $52,657
F-17
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAYFIELD/
2004 Acquisitions BUDDE Integra ME R&B/Sparta
- ----------------- ------------- ----------- -----------
<s> <c> <c> <c>
Current assets ....................... $ 3,489 $ 3,151 $ 817
Property, plant and equipment ........ 1,400 78 10
Intangible assets .................... 8,030 1,320 1,639
Goodwill ............................. 8,397 1,775 1,478
------------- ----------- -----------
Total assets acquired ............. 21,316 6,324 3,944
Current liabilities .................. 768 837 340
Deferred tax liabilities ............. -- 240 --
Other non-current liabilities ........ -- 265 --
------------- ----------- -----------
Total liabilities assumed ......... 768 1,342 340
Net assets acquired .................. $20,548 $ 4,982 $ 3,604
The goodwill acquired in the MAYFIELD/BUDDE, R&B, and Sparta acquisitions is
expected to be deductible for tax purposes.
The following unaudited pro forma financial information summarizes the results
of operations for the year ended December 31, 2004 as if the acquisitions
consummated in 2005 and 2004 had been completed as of the beginning of 2004. 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 Integra'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.
2004
--------
(in thousands)
<s> <c>
Total revenue ......................................... $250,191
Net income ............................................ 17,922
Basic net income per share ............................ $ 0.60
Diluted net income per share .......................... $ 0.58
Pro forma financial information for the year ended December 31, 2005 would not
be materially different from actual reported amounts because the Newdeal
acquisition was consummated on January 3, 2005.
ASSET ACQUISITIONS
In September 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
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 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".
In December 2003, the Company acquired the assets of Reconstructive
Technologies, Inc.("RTI") for $400,000 in cash and agreed to make certain future
F-18
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
performance-based payments for the RTI assets. Any future contingent
consideration paid to the seller is expected to be recorded as a
technology-based intangible asset. RTI is the developer of the Automated Cyclic
Expansion System (ACE System(TM)), a tissue expansion device. Because the ACE
System was not approved by the FDA for sale and the Company did not acquire any
assets other than technology and intellectual property underlying the ACE
System, the Company recorded the entire acquisition price as an in-process
research and development charge in 2003. This transaction was accounted for as
an asset purchase because the acquired assets did not constitute a business
under Statement 141.
4. RESTRUCTURING ACTIVITIES
In June 2005, management announced plans to restructure the Company's European
operations. The restructuring plan included closing the Company's Integra ME
production facility in Tuttlingen, Germany and reducing various positions in the
Company's production facility located in Biot, France, both of which were
completed in December 2005. The Company closed the Integra ME production
facility and transitioned the manufacturing operations of Integra ME to its
production facility in Andover, UK.
In June 2005, the Company also eliminated some duplicative sales and marketing
positions, primarily in Europe.
Approximately 68 individuals were identified for termination under the European
restructuring plan. As of December 31, 2005, the Company terminated 65 of these
individuals.
In 2005, the Company also completed the transfer of the Spinal Specialties
assembly operations from the Company's San Antonio, Texas plant to its San
Diego, California plant.
In connection with these restructuring activities, the Company recorded $4.0
million of charges in 2005 for the estimated costs of employee termination
benefits to be provided to the affected employees and related facility exit
costs.
In connection with these restructuring activities, the Company has recorded the
following charges during 2005:
Research Selling
Cost of and General and
Sales Development Administrative Total
------- ------- ------- -------
(in thousands)
<s> <c> <c> <c> <c>
Involuntary employee termination costs ... $ 2,596 $ 183 $ 1,082 $ 3,861
Facility exit costs ...................... -- -- 155 $ 155
Below is a reconciliation of the restructuring accrual activity recorded during
2005:
Employee Facility
Termination Exit
Costs Costs Total
------- ------- -------
(in thousands)
<s> <c> <c> <c>
Balance at December 31, 2004 ........................ $ -- $ -- $ --
Additions ........................................... 4,010 155 4,165
Reversal of prior accruals .......................... (149) -- (149)
Payments ............................................ (1,398) (31) (1,429)
Effects of foreign exchange ......................... (43) -- (43)
------- ------- -------
Balance at December 31, 2005 ........................ $ 2,420 $ 124 $ 2,544
We expect to pay the all of the remaining costs in early 2006.
In December 2003, the Company recorded a $1.1 million charge in connection with
closing of its San Diego research center, the termination of certain research
F-19
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
programs conducted there, and the consolidation of the remaining research
activities into its other facilities. The charge consisted of the following (in
thousands):
<s> <c>
Facility lease termination fee .................. $ 379
Research program termination costs .............. 216
Property and equipment impairment ............... 183
Inventory write-off ............................. 157
Employee severance .............................. 120
Other ........................................... 52
------
Total $1,107
The inventory write-off was recorded to cost of product revenues. All other
amounts were recorded to research and development expense. All amounts were paid
in 2003, except for the employee severance amounts, which were included in
accrued expenses and other current liabilities at December 31, 2003 and
subsequently paid in 2004.
5. DEBT
In 2003, the Company completed a $120.0 million private placement of contingent
convertible subordinated notes due 2008.
The notes bear interest at 2.5 percent per annum, payable semiannually. The
Company will pay additional interest ("Contingent Interest") if, at thirty days
prior to maturity, Integra's common stock price is greater than $37.56 per
share. The Contingent Interest will be payable for each of the last three years
the notes remain outstanding in an amount equal to the greater of (i) 0.50% of
the face amount of the notes and (ii) the amount of regular cash dividends paid
during each such year on the number of shares of common stock into which each
note is convertible. The Company recorded a $0.4 million liability related to
the estimated fair value of the Contingent Interest obligation at the time the
notes were issued. The fair value of the Contingent Interest obligation is
marked to its fair value at each balance sheet date, with changes in the fair
value recorded to interest expense. At December 31, 2005 and 2004, the estimated
fair value of the Contingent Interest Obligation was $0.7 million and $0.7
million, respectively. In 2005, interest expense associated with changes in the
estimated fair value of the Contingent Interest Obligation was not significant.
In 2004, and 2003, the Company recorded $0.3 million and $0.1 million,
respectively, of interest expense associated with changes in the estimated fair
value of the Contingent Interest Obligation.
Debt issuance costs totaled $4.1 million and are being amortized using the
straight-line method over the five-year term of the notes.
Holders may convert their notes into shares of Integra common stock at an
initial conversion price of $34.15 per share, upon the occurrence of certain
conditions, including when the market price of Integra's common stock on the
previous trading day is more than 110% of the conversion price.
The notes are general, unsecured obligations of the Company and will be
subordinate to any future senior indebtedness of the Company. The Company cannot
redeem the notes prior to their maturity. Holders of the notes may require the
Company to repurchase the notes upon a change in control.
Concurrent with the issuance of the notes, the Company used $35.3 million of the
proceeds to purchase 1.5 million shares of its common stock.
In December 2005, the Company established a $200 million, five-year, senior
secured revolving credit facility. The credit facility currently allows for
revolving credit borrowings in a principal amount of up to $200 million, which
can be increased to $250 million should additional financing be required in the
future. The Company did not draw any amounts against this credit facility in
2005.
The indebtedness under the credit facility is guaranteed by the Company's
domestic subsidiaries. The Company's obligations under the credit facility and
F-20
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the guarantees of the guarantors are secured by a first-priority security
interest in all present and future capital stock of (or other ownership or
profit interest in) each guarantor and substantially all of the Company's and
the guarantors' other assets, other than real estate, intellectual property and
capital stock of foreign subsidiaries.
Borrowings under the credit facility bear interest, at the Company's option, at
a rate equal to (i) the Eurodollar Rate in effect from time to time plus an
applicable rate (ranging from 0.75% to 1.5%) or (ii) the higher of (x) the
weighted average overnight Federal funds rate, as published by the Federal
Reserve Bank of New York, plus 0.5%, and (y) the prime commercial lending rate
of Bank of America, N.A. plus an applicable rate (ranging from 0% to 0.5%). The
applicable rates are based on a financial ratio at the time of the applicable
borrowing.
The Company will also pay an annual commitment fee (ranging from 0.15% to 0.25%)
on the daily amount by which the commitments under the credit facility exceed
the outstanding loans and letters of credit under the credit facility.
In 2005, the Company paid approximately $1.1 million of fees in connection with
establishing the credit facility. The company capitalized these fees and is
amortizing them to interest expense over the five-year term of the credit
facility.
The credit facility requires the Company to maintain various financial
covenants, including leverage ratios, a minimum fixed charge coverage ratio, and
a minimum liquidity ratio. The credit facility also contains customary
affirmative and negative covenants, including those that limit the Company's and
its subsidiaries' ability to incur additional debt, incur liens, make
investments, enter into mergers and acquisitions, liquidate or dissolve, sell or
dispose of assets, repurchase stock and pay dividends, engage in transactions
with affiliates, engage in certain lines of business and enter into sale and
leaseback transactions.
6. DERIVATIVE INSTRUMENTS
In August 2003, the Company entered into an interest rate swap agreement with a
$50 million notional amount to hedge the risk of changes in fair value
attributable to interest rate risk with respect to a portion of its fixed rate
contingent convertible subordinated notes. The Company receives a 2 1/2% fixed
rate from the counterparty, payable on a semi-annual basis, and pays to the
counterparty a floating rate based on 3-month LIBOR minus 35 basis points,
payable on a quarterly basis. The floating rate resets each quarter. 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.
The net amount to be paid or received under the interest rate swap agreement is
recorded as a component of interest expense. In 2005, the Company recorded an
additional $0.2 million of interest expense associated with the interest rate
swap. In 2004 and 2003, the Company recorded a reduction in interest expense of
$0.7 million and $0.3 million, respectively. Our effective interest rate on the
hedged portion of the notes was 3.7% as of December 31, 2005.
The interest rate swap agreement qualifies as a fair value hedge under SFAS No.
133, as amended, "Accounting for Derivative Instruments and Hedging Activities".
Accordingly, the interest rate swap is recorded at fair value and changes in
fair value are recorded in other income (expense), net.
The net fair value of the interest rate swap at December 31, 2005 was $2.0
million. The Company recorded the following changes in the net fair values of
the interest rate swap and the hedged portion of the contingent convertible
notes:
2005 2004 2003
-------- -------- --------
(in thousands)
<s> <c> <c> <c>
Interest rate swap ............................... $ 690 $ 287 $ 305
Contingent convertible notes ..................... (821) (430) (433)
-------- -------- --------
Net increase (decrease) in liabilities ........... $ (131) $ (143) $ (128)
F-21
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The net increase (decrease) in liabilities represents the ineffective portion of
the hedging relationship, and these amounts are recorded in other income
(expense), net.
At December 31, 2005 and 2004, the Company had $3.4 million and $2.9 million of
cash pledged as collateral in connection with the interest rate swap agreement.
In November 2004, the Company entered into a collar contract for euro 38.5
million to reduce its exposure to fluctuations in the exchange rate between the
euro and the US dollar as a result of its commitment to acquire Newdeal
Technologies in January 2005 for euro 38.5 million. The collar contract did not
qualify as a hedge under SFAS No. 133. Accordingly, the collar contract was
recorded at fair value and changes in fair value were recorded in other income
(expense), net. In 2004, the Company recorded a $1.4 million gain related to the
change in the fair value of the collar contract. The foreign currency collar
expired in January 2005, concurrent with the Company's acquisition of Newdeal
Technologies.
7. COMMON AND PREFERRED STOCK
PREFERRED STOCK TRANSACTIONS
The Company is authorized to issue up to 15,000,000 shares of preferred stock in
one or more series, of which 2,000,000 shares have been designated as Series A,
120,000 shares have been designated as Series B, and 54,000 shares have been
designated as Series C. There was no preferred stock outstanding at either
December 31, 2005 or 2004.
COMMON STOCK TRANSACTIONS
The Company repurchased 1.7 million, 0.5 million, and 1.5 million shares of its
common stock in 2005, 2004 and 2003, respectively, for $56.3 million, $14.2
million and $35.4 million, respectively.
8. STOCK PURCHASE AND AWARD PLANS
EMPLOYEE STOCK PURCHASE PLAN
The purpose of the Employee Stock Purchase Plan (the ESPP) is to provide
eligible employees of the Company with the opportunity to acquire shares of
common stock at periodic intervals by means of accumulated payroll deductions.
Under the ESPP, a total of 1.5 million shares of common stock are reserved for
issuance. These shares will be made available either from the Company's
authorized but unissued shares of common stock or from shares of common stock
reacquired by the Company as treasury shares. At December 31, 2005, 1.1 million
shares remain available for purchase under the ESPP.
The ESPP was amended in 2005 to eliminate the lookback option and to reduce the
discount available to participants to five percent. Accordingly, the ESPP will
be a non-compensatory plan under Statement 123(R).
EQUITY AWARD PLANS
As of December 31, 2005 the Company had stock options, restricted stock awards,
and contract stock outstanding under seven plans, the 1993 Incentive Stock
Option and Non-Qualified Stock Option Plan (the 1993 Plan), the 1996 Incentive
Stock Option and Non-Qualified Stock Option Plan (the 1996 Plan), the 1998 Stock
Option Plan (the 1998 Plan), the 1999 Stock Option Plan (the 1999 Plan), the
2000 Equity Incentive Plan (the 2000 Plan), the 2001 Equity Incentive Plan (the
2001 Plan), and the 2003 Equity Incentive Plan (the 2003 Plan, and collectively,
the Plans). No new options may be granted under the 1993 Plan.
F-22
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company has reserved 750,000 shares of common stock for issuance under both
the 1993 Plan and 1996 Plan, 1,000,000 shares under the 1998 Plan, 2,000,000
shares under each of the 1999 Plan, the 2000 Plan and the 2001 Plan, and
4,000,000 shares under the 2003 Plan. The 1993 Plan, 1996 Plan, 1998 Plan, and
the 1999 Plan permit the Company to grant both incentive and non-qualified stock
options to designated directors, officers, employees and associates of the
Company. The 2000 Plan, 2001 Plan, and 2003 Plan permit the Company to grant
incentive and non-qualified stock options, stock appreciation rights, restricted
stock, contract stock, performance stock, or dividend equivalent rights to
designated directors, officers, employees and associates of the Company. Stock
options issued under the Plans become exercisable over specified periods,
generally within four years from the date of grant for officers, employees and
consultants, and generally expire six years from the grant date. The transfer
and non-forfeiture provisions of restricted stock issued under the Plans lapse
over specified periods, generally at three years after the date of grant.
Stock Options
- -------------
Stock option activity for all the Plans was as follows:
2005 2004 2003
--------------------- --------------------- ---------------------
Wtd. Avg. Wtd. Avg. Wtd. Avg.
Options Ex. Price Options Ex. Price Options Ex. Price
-----------------------------------------------------------------------
(shares in thousands)
<s> <c> <c> <c> <c> <c> <c>
Options outstanding at
January 1, ........... 3,683 $23.42 2,884 $16.19 4,295 $12.15
Granted ................. 1,089 $34.53 1,473 $31.81 430 $24.81
Exercised ............... (576) $13.83 (547) $ 9.80 (1,726) $ 7.70
Cancelled ............... (195) $30.28 (127) $21.97 (115) $17.40
Options outstanding at
December 31, ......... 4,001 $27.50 3,683 $23.42 2,884 $16.19
Options exercisable at
December 31, .......... 2,023 $22.74 1,641 $17.61 1,495 $ 13.65
The following table summarizes information about stock options outstanding as of
December 31, 2005:
Options Outstanding Options Exercisable
---------------------------------------------- -----------------------
As of Wtd. Avg. Wtd. Avg. As of Wtd. Avg.
Range Of Dec. 31, Exercise Remaining Dec. 31 Exercise
Exercise Prices 2005 Price Contractual Life 2005 Price
----------------- ---------- ------------ -------------------- ---------- -----------
(shares in thousands)
<s> <c> <c> <c> <c> <c>
$ 6.56 - $17.65 827 $ 13.79 3.0 years 745 $ 13.42
$17.68 - $27.89 800 $ 25.20 2.5 years 700 $ 25.38
$27.94 - $31.38 939 $ 29.94 5.6 years 336 $ 29.76
$31.89 - $35.52 829 $ 34.16 6.0 years 242 $ 34.03
$35.57 - $38.72 606 $ 36.33 6.7 years -- $ 0.00
------- -------- ----------- ------- --------
4,001 $ 27.50 4.7 years 2,023 $ 22.74
The weighted average fair market value of stock options granted in 2005, 2004
and 2003 was $14.88, $13.48, and $13.01 per share, respectively.
Restricted Stock
- ----------------
In 2005, the Company issued 21,246 shares of restricted stock. These awards are
expensed over their vesting period, ranging from six months to three years. The
Company recognized $0.1 million of expense in 2005 related to these awards. The
Company did not issue any shares of restricted stock prior to 2005.
F-23
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Contract Stock and Restricted Units Awards
- ------------------------------------------
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, or earlier if he is
terminated without cause, if he leaves his position for good reason or upon a
change of control or certain tax related events. The options and contract stock
award were granted under the 2003 Plan. 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 2004 for the compensation expense
related to the fully-vested contract stock unit grant. The Executive has demand
registration rights under the Restricted Units issued.
In December 2000, the Company issued 1,250,000 restricted units (Restricted
Units) under the 2000 Plan as a fully vested equity based bonus to the Executive
in connection with the extension of his employment agreement. Each Restricted
Unit represents the right to receive one share of the Company's common stock.
The Executive has demand registration rights under the Restricted Units issued.
In January 2006, the Company issued 750,000 shares of the Company's common stock
to the Executive pursuant to the obligations with respect to 750,000 of these
Restricted Units.
The Executive received 1,000,000 Restricted Units in December 1997, each of
which entitles him to receive one share of the Company's common stock. The
Restricted Units issued in December 1997 were not issued under any of the Plans.
In November 2003, the Company issued 1,000,000 shares of the Company's common
stock to the Executive pursuant to the obligations under these Restricted Units.
No other share-based awards are outstanding under any of the Plans. At December
31, 2005, there were 1,812,904 shares available for grant under the Plans.
9. RETIREMENT BENEFIT PLANS
DEFINED BENEFIT PLAN
The Company maintains defined benefit pension plans that cover employees in its
manufacturing plants located in Andover, United Kingdom (the "UK Plan") and
Tuttlingen, Germany (the "Germany Plan"). The Company closed the Tuttlingen,
Germany plant in December 2005. However, the Germany Plan was not terminated and
the Company remains obligated for the accrued pension benefits related to this
plan. The plans cover certain current and former employees. Both plans are no
longer open to new participants. The Company uses a December 31 measurement date
for both of its pension plans.
Net periodic benefit costs for these defined benefit pension plans included the
following amounts:
2005 2004 2003
-------- -------- --------
(in thousands)
<s> <c> <c> <c>
Service cost ..................................... $ 178 $ 179 $ 88
Interest cost .................................... 567 522 397
Expected return on plan assets ................... (464) (434) (330)
Recognized net actuarial loss .................... 215 203 116
-------- -------- --------
Net periodic benefit cost ..................... $ 496 $ 470 $ 271
F-24
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following weighted average assumptions were used to develop net periodic
benefit cost and the actuarial present value of projected benefit obligations:
2005 2004 2003
-------- -------- --------
<s> <c> <c> <c>
Discount rate .................................... 4.7% 5.2% 5.4%
Expected return on plan assets ................... 4.9% 5.8% 6.2%
Rate of compensation increase .................... 3.5% 3.3% 3.3%
The expected return on plan assets represents the average rate of return
expected to be earned on plan assets over the period the benefits included in
the benefit obligation are to be paid. In developing the expected rate of
return, the Company considers long-term compound annualized returns of
historical market data as well as actual returns on the plan assets and applies
adjustments that reflect more recent capital market experience. Using this
reference information, the long-term return expectations for each asset category
is developed, according to the allocation among those investment categories.
The following sets forth the change in benefit obligations and change in plan
assets at December 31, 2005 and 2004 and the accrued benefit cost:
December 31,
2005 2004
-------- --------
(in thousands)
<s> <c> <c>
CHANGE IN PROJECTED BENEFIT OBLIGATION
Projected benefit obligation, beginning of year ................ $11,367 $ 8,832
Service cost ................................................... 178 179
Interest cost .................................................. 567 522
Participant contributions ...................................... 36 42
Benefits paid .................................................. (317) (183)
Actuarial (gain) loss .......................................... 1,133 656
Acquisitions ................................................... -- 474
Effect of foreign currency exchange rates ...................... (1,315) 845
-------- --------
Projected benefit obligation, end of year ...................... $11,649 $11,367
CHANGE IN PLAN ASSETS
Plan assets at fair value, beginning of year ................... $ 8,379 $ 6,646
Actual return on plan assets ................................... 1,277 816
Employer contributions ......................................... 264 238
Participant contributions ...................................... 36 37
Benefits paid .................................................. (315) (183)
Other .......................................................... -- 46
Acquisitions ................................................... -- 162
Effect of foreign currency exchange rates ...................... (968) 617
-------- --------
Plan assets at fair value, end of year ......................... $ 8,673 $ 8,379
RECONCILIATION OF FUNDED STATUS
Funded status, projected benefit obligation in excess
of plan assets ............................................. $(2,976) $(2,988)
Unrecognized net actuarial loss ................................... 2,504 2,759
Adjustment to recognize minimum liability ......................... (2,390) (2,543)
-------- --------
Accrued benefit cost .............................................. $(2,862) $(2,772)
The accrued benefit liability recorded at December 31, 2005 and 2004 is included
in other liabilities.
The combined accumulated benefit obligation for the defined benefit plans was
$11.5 million and $11.2 million as of December 31, 2005 and 2004, respectively.
The accumulated benefit obligation for each plan exceeded that plan's assets for
all periods presented.
F-25
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The weighted-average allocation of plan assets by asset category is as follows:
December 31,
2005 2004
-------- --------
<s> <c> <c>
Equity securities .......................................... 47% 52%
Corporate bonds ............................................ 26% 19%
Government bonds ........................................... 20% 22%
Insurance contracts ........................................ 2% 2%
Cash ....................................................... 5% 5%
-------- --------
100% 100%
The investment strategy for the Company's defined benefit plans is both to meet
the liabilities of the plans as they fall due and to maximize the return on
invested assets within appropriate risk tolerances. The assets of the Germany
Plan consist entirely of insurance contracts.
The Company anticipates contributing approximately $250,000 to its defined
benefit plans in 2006. The Company expects to pay the following estimated future
benefit payments in the years indicated:
2006 ............. 269,000
2007 ............. 286,000
2008 ............. 312,000
2009 ............. 338,000
2010 ............. 400,000
2011-2015 ........ 2,679,000
DEFINED CONTRIBUTION PLAN
The Company also has various defined contribution savings plans that cover
substantially all employees in the United States, the United Kingdom, and Puerto
Rico. The Company matches a certain percentage of each employee's contributions
as per the provisions of the plans. Total contributions by the Company to the
plans were $627,000, $622,000, and $483,000 in 2005, 2004, and 2003,
respectively.
10. LEASES
The Company leases administrative, manufacturing, research and distribution
facilities and various manufacturing, office and transportation equipment
through operating lease agreements.
In November 1992, a corporation whose shareholders are trusts, whose
beneficiaries include family members of the Company's Chairman, acquired from
independent third parties a 50% interest in the general partnership from which
the Company leases its manufacturing facility in Plainsboro, New Jersey. In
October 2005, the Company entered into a lease modification agreement relating
this facility. 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.
In June 2000, the Company signed a ten-year agreement to lease certain
production equipment from a corporation whose sole stockholder is a general
partnership, for which the Company's Chairman is a partner and the President.
Under the terms of the lease agreement, the Company paid $90,000 to the related
party lessor in 2005, 2004, and 2003.
F-26
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Future minimum lease payments under operating leases at December 31, 2005 were
as follows:
Related Third
Parties Parties Total
--------- --------- ---------
(in thousands)
<s> <c> <c> <c>
2006 ............................ $ 321 $ 2,095 $ 2,416
2007 ............................ 324 1,337 1,661
2008 ............................ 341 342 683
2009 ............................ 341 204 545
2010 ............................ 341 176 517
Thereafter ...................... 4,732 1,764 6,496
--------- --------- ---------
Total minimum lease payments..... $ 6,400 $ 5,918 $12,318
========= ========= =========
Total rental expense in 2005, 2004, and 2003 was $3.2 million, $2.3 million, and
$2.9 million, respectively, and included $321,000, $321,000, and $321,000, in
related party expense, respectively.
11. INCOME TAXES
The provision for income taxes consisted of the following:
2005 2004 2003
-------- -------- --------
(in thousands)
<s> <c> <c> <c>
Current:
Federal .............................. $ 2,547 $ 1,899 $ 972
State ................................ 2,038 1,670 2,470
Foreign .............................. 3,427 1,141 529
--------- --------- ---------
Total current ......................... 8,012 4,710 3,971
Deferred:
Federal .............................. $13,706 $ 5,802 $ 12,800
State ................................ (409) 53 83
Foreign .............................. (3,402) 246 (526)
--------- --------- ---------
Total deferred ......................... 9,895 6,101 12,357
Provision for income taxes ............. $ 17,907 $ 10,811 $ 16,328
========= ========= =========
Income before income taxes consisted of the following:
2005 2004 2003
-------- -------- --------
(in thousands)
<s> <c> <c> <c>
United States operations ............. $ 46,111 $ 17,074 $ 40,883
Foreign operations ................... 8,990 10,934 2,306
--------- --------- ---------
Total .................................. $ 55,101 $ 28,008 $ 43,189
========= ========= =========
F-27
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The temporary differences that give rise to deferred tax assets and liabilities are presented below:
December 31
2005 2004
-------- --------
(in thousands)
<s> <c> <c>
Net operating loss and tax credit carryforwards ........... $ 4,622 $ 13,405
Inventory reserves and capitalization ..................... 4,781 2,145
Deferred compensation ..................................... 14,053 14,164
Deferred income ........................................... 3,831 1,821
-------- --------
Total deferred tax assets before valuation allowance .... 27,287 31,535
Valuation allowance ....................................... (5,126) (5,360)
Depreciation and amortization ............................. (9,694) (5,327)
Other ..................................................... (4,148) (1,095)
-------- --------
Net deferred tax assets ................................... $ 8,319 $ 19,753
======== ========
A valuation allowance of $5.1 million is recorded against the remaining $27.3
million of deferred tax assets recorded at December 31, 2005. This valuation
allowance relates to deferred tax assets for certain expenses that will be
deductible for tax purposes in very limited circumstances and for which the
Company believes it is unlikely that it will recognize the associated tax
benefit. The Company does not anticipate additional income tax benefits through
future reductions in the valuation allowance. However, in the event that the
Company determines that it would be able to realize more or less than the
recorded amount of net deferred tax assets, an adjustment to the deferred tax
asset valuation allowance would be recorded in the period such a determination
is made.
The Company's valuation allowance decreased by $0.2 million in 2005 as a result
of a change in the Company's marginal state effective income tax rates.
A reconciliation of the United States Federal statutory rate to the Company's
effective tax rate for the years ended December 31, 2005, 2004, and 2003 is as
follows:
2005 2004 2003
------ ------ ------
<s> <c> <c> <c>
Federal statutory rate ..................................... 35.0% 35.0% 35.0%
Increase (reduction) in income taxes resulting from:
State income taxes, net of federal tax benefit ........... 2.0% 4.0% 3.9%
Foreign taxes booked at different rates .................. (3.7%) (4.2%) (1.0%)
Foreign losses for which no benefit was previously taken.. (0.9%) -- --
Tax on asset transfer .................................... -- 4.5% --
Other .................................................... 0.1% (0.7%) (0.1%)
------ ------ ------
Effective tax rate ......................................... 32.5% 38.6% 37.8%
====== ====== ======
At December 31, 2005, the Company had net operating loss carryforwards of $15.8
million for federal income tax purposes and $0.4 million for foreign tax
purposes to offset future taxable income. The federal net operating loss
carryforwards expire through 2024 and the foreign net operating loss
carryforwards have no expiration.
At December 31, 2005, several of the Company's subsidiaries had unused net
operating loss carryforwards and tax credit carryforwards arising from periods
prior to the Company's ownership which expire through 2010. The Internal Revenue
Code limits the timing and manner in which we may use any acquired net operating
losses or tax credits.
Income taxes are not provided on undistributed earnings of non-U.S. subsidiaries
because such earnings are expected to be permanently reinvested. Undistributed
earnings of foreign subsidiaries totaled $8.5 million and $2.6 million at
December 31, 2005 and 2004, respectively.
F-28
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. NET INCOME PER SHARE
Amounts used in the calculation of basic and diluted net income per share were as follows:
2005 2004 2003
-------- -------- --------
(in thousands, except per share amounts)
<s> <c> <c> <c>
Basic:
- ------
Net income..................................................... $ 37,194 $ 17,197 $ 26,861
Basic net income per share .................................... $ 1.23 $ 0.57 $ 0.92
======== ======== ========
Weighted average common shares outstanding - Basic ............ 30,195 30,064 29,071
======== ======== ========
Diluted:
- --------
Net income..................................................... $ 37,194 $ 17,197 $ 26,861
Add back: Interest expense and other income/(expense) related
to convertible notes payable, net of tax ......... 2,440 -- 1,608
-------- -------- --------
Net income applicable to common stock ......................... $ 39,634 $ 17,197 $ 28,469
Diluted net income per share .................................. $ 1.15 $ 0.55 $ 0.86
======== ======== ========
Weighted average common shares outstanding - Basic ............ 30,195 30,064 29,071
Effect of dilutive securities:
Restricted stock and stock options ......................... 856 1,038 1,397
Shares issuable upon conversion of notes payable ........... 3,514 -- 2,636
-------- -------- --------
Weighted average common shares outstanding .................... 34,565 31,102 33,104
======== ======== ========
Shares of common stock issuable through exercise or conversion of the following dilutive securities were not included in the
computation of diluted net income per share for each period because their effect would have been antidilutive:
2005 2004 2003
-------- -------- --------
(in thousands)
<s> <c> <c> <c>
Stock options and restricted stock ................. 570 155 424
Shares issuable upon conversion of notes payable ... -- 3,514 --
-------- -------- --------
Total .............................................. 570 3,669 424
A contract stock unit award that entitles the holder to 750,000 shares of common
stock and Restricted Units that entitle the holder to 1,250,000 shares of common
stock (see Note 8) are included in the basic and diluted weighted average shares
outstanding calculation from their date of issuance because no further
consideration is due related to the issuance of the underlying common shares.
13. DEVELOPMENT, DISTRIBUTION, AND LICENSE AGREEMENTS
The Company has various development, distribution, and license agreements under
which it receives payments. Significant agreements include the following:
From 1999 through 2003, ETHICON, Inc., a division of Johnson & Johnson, marketed
and distributed the Company's INTEGRA(R) Dermal Regeneration Template under the
terms of a ten year distribution agreement (the "ETHICON Agreement"). Upon
signing the ETHICON Agreement, the Company received a nonrefundable payment from
ETHICON of $5.3 million for the exclusive use of the Company for trademarks and
regulatory filings related to the INTEGRA(R) Dermal Regeneration Template and
certain other rights. This amount was initially recorded as deferred revenue and
was recognized as revenue in accordance with the Company's revenue recognition
policy for nonrefundable, up-front fees received. Additionally, the ETHICON
F-29
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Agreement required ETHICON to make nonrefundable payments to the Company each
year based upon minimum purchases of INTEGRA(R) Dermal Regeneration Template.
Upon early termination of the ETHICON Agreement in December 2003, ETHICON paid
Integra $2.0 million, which the Company recorded as other income. The Company
also recorded $11.0 million of other revenue in the fourth quarter of 2003
related to the acceleration of the recognition of unused minimum purchase
payments and unamortized license fee revenue.
In 2003, the Company received $2.8 million of event-related payments from
ETHICON and $2.0 million of research funding. Both the event-related payments
and the research funding were recorded in other operating revenue in accordance
with the Company's revenue recognition policy.
The Company has an agreement with Wyeth for the development of collagen and
other absorbable matrices to be used in conjunction with Wyeth's recombinant
human bone morphogenetic protein-2 (rhBMP-2) in a variety of bone regeneration
applications. The agreement with Wyeth requires Integra to supply Absorbable
Collagen Sponges to Wyeth (including those that Wyeth sells to Medtronic Sofamor
Danek with rhBMP-2 for use in Medtronic Sofamor Danek's InFUSE(TM) product) at
specified prices. In addition, the Company receives a royalty equal to a
percentage of Wyeth's sales of surgical kits combining rhBMP-2 and the
Absorbable Collagen Sponges. The agreement terminates in 2007, but may be
extended at the option of the parties. The agreement does not provide for
milestones or other contingent payments, but Wyeth pays the Company to assist
with regulatory affairs and research. The Company received $2.2 million of
research and development revenues under the agreement in 2003.
14. COMMITMENTS AND CONTINGENCIES
As consideration for certain technology, manufacturing, distribution and selling
rights and licenses granted to the Company, the Company has agreed to pay
royalties on the sales of products that are commercialized relative to the
granted rights and licenses. Royalty payments under these agreements by the
Company were not significant for any of the periods presented.
Various lawsuits, claims and proceedings are pending or have been settled by the
Company. The most significant of those are described below.
In July 1996, the Company 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.
F-30
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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. In connection with this settlement,
the Company recognized net operating loss carryforwards in France and recorded
this benefit as a $0.5 million tax benefit in 2005.
In addition to these matters, the Company is subject to various claims, lawsuits
and proceedings in the ordinary course of its business, including claims by
current or former employees, distributors and competitors and with respect to
our products. In the opinion of management, such claims are either adequately
covered by insurance or otherwise indemnified, or are not expected, individually
or in the aggregate, to result in a material adverse effect on the Company's
financial condition. However, it is possible that the Company's results of
operations, financial position and cash flows in a particular period could be
materially affected by these contingencies.
F-31
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. 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 cranial and spinal procedures, peripheral nerve repair, small bone and joint
injuries, and the repair and reconstruction of soft tissue.
Product revenues consisted of the following:
2005 2004 2003
-------- -------- --------
(in thousands)
<s> <c> <c> <c>
Monitoring products ................................... $ 48,940 $ 48,217 $ 44,229
Implant products ...................................... 108,156 78,418 53,301
Instruments ........................................... 91,918 77,667 47,168
Private label products ................................ 28,757 24,188 21,997
-------- -------- --------
Consolidated product revenues ......................... $277,771 $228,490 $166,695
======== ======== ========
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%, 31%, and 27%
of product revenues in 2005, 2004, and 2003, respectively. Accordingly,
widespread public controversy concerning collagen products, new regulation, or a
ban of the Company's products containing material derived from bovine tissue,
could have a material adverse effect on the Company's current business or its
ability to expand its business.
Product revenue and long-lived assets (excluding intangible assets, financial
instruments and deferred tax assets) by major geographic area are summarized
below:
United Asia Other
States Europe Pacific Foreign Consolidated
---------- ---------- ---------- ---------- ------------
(in thousands)
<s> <c> <c> <c> <c> <c>
Product revenue:
2005 ................... $207,245 $ 48,645 $ 11,403 $ 10,478 $277,771
2004 ................... 180,887 30,941 8,535 8,127 228,490
2003 ................... 132,805 21,433 5,828 6,629 166,695
Long-lived assets:
December 31, 2005 ...... $ 23,938 $ 9,441 $ -- $ -- $ 33,379
December 31, 2004 ...... 21,287 9,175 -- -- 30,462
F-32
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. SELECTED QUARTERLY INFORMATION -- UNAUDITED
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(in thousands, except per share data)
<s> <c> <c> <c> <c>
2005:
- -----
Total revenue:
2005 ........................... $ 72,985 $ 69,333 $ 69,778 $ 65,839
2004 ........................... 61,811 59,130 56,441 52,443
Gross margin (exclusive of
amortization related to acquired
intangible assets):
2005 ........................... 44,733 43,320 42,639 41,707
2004 ........................... 38,590 36,718 34,776 32,442
Net income (loss):
2005 ........................... 10,615 10,481 7,655 8,443
2004 ........................... 9,839 (7,597) 7,518 7,437
Basic net income (loss) per share:
2005 ........................... $ 0.36 $ 0.35 $ 0.25 $ 0.28
2004 ........................... $ 0.32 $ (0.25) $ 0.25 $ 0.25
Diluted net income (loss) per share:
2005 ........................... $ 0.33 $ 0.33 $ 0.23 $ 0.26
2004 ........................... $ 0.30 $ (0.25) $ 0.23 $ 0.23
In 2005, the Company recorded the following charges in connection with its restructuring activities:
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(in thousands)
<s> <c> <c> <c> <c>
Involuntary employee termination
costs .......................... $ 1,120 $ 667 $ 2,074 $ --
Facility exit costs .............. 155 -- -- --
In the third quarter of 2004, the Company recorded the following:
- - a $1.4 million charge in connection with a milestone payment related to the
completion of certain development activities related to an advanced
neuro-monitoring system;
- - a $23.9 million share-based compensation charge associated with the renewal
of the Company's President and Chief Executive Officer's employment
agreement; and
- - a $1.3 million tax charge incurred in connection with the reorganization of
certain European operations.
In the fourth quarter of 2004, the Company recognized $1.4 million of other
income related to an unrealized gain on a foreign currency collar, which was
used to reduce the exposure to fluctuations in the exchange rate between the
euro and the US dollar as a result of the Company's commitment to acquire
Newdeal Technologies for 38.5 million euros. The foreign currency collar expired
in January 2005, concurrent with the Company's acquisition of Newdeal
Technologies.
17. SUBSEQUENT EVENT
In September 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 approximately $76 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(R)
stereotactic system, the XKnife(TM) stereotactic radiosurgery system, the
OmniSight(R)EXcel image guided surgery system, and the CUSA EXcel(TM)
ultrasonic surgical aspiration system. The acquisition closed on March 3, 2006.
F-33
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The determination of the fair value of the assets acquired and liabilities
assumed as a result of this acquisition is in progress. Based on a preliminary
valuation, the following summarizes the fair value of the assets acquired and
liabilities assumed:
(All amounts in thousands)
<s> <c>
Current assets ....................... $ 8,440
Property, plant and equipment ........ 1,350
Intangible assets and goodwill ....... 67,090
-------
Total assets acquired ............. 76,880
Liabilities assumed .................. 2,380
-------
Net assets acquired .................. $74,500
The acquired intangible assets consist primarily of developed technology, trade
name, and customer relationships. The final fair value of assets acquired will
be determined with the assistance of a third-party valuation firm.
In March 2006, the Company borrowed $16.0 million under its credit facility in
connection with the acquisition of Radionics.
F-34
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
SCHEDULE II
Balance at Charged to Charged Balance at
Beginning Costs and to Other End of
Description Of Period Expenses Accounts(1) Deductions Period
- --------------------------------------------------------------------------------------------------------------------
(in thousands)
<s> <c> <c> <c> <c> <c>
Year ended December 31, 2005
- ----------------------------
Allowance for doubtful accounts and
sales returns and allowances ........ $ 2,749 $ 1,279 $ 34 $ (554) $ 3,508
Inventory reserves ...................... 7,600 2,191 247 (270) 9,768
Deferred tax asset valuation allowance .. 5,360 -- -- (234) 5,126
Year ended December 31, 2004
- ----------------------------
Allowance for doubtful accounts and
sales returns and allowances ........ $ 2,025 $ 802 $ 297 $ (327) $ 2,749
Inventory reserves ...................... 6,204 1,210 1,056 (870) 7,600
Deferred tax asset valuation allowance .. 5,360 -- -- -- 5,360
Year ended December 31, 2003
- ----------------------------
Allowance for doubtful accounts and
sales returns and allowances ........ $ 1,387 541 497 (400) $ 2,025
Inventory reserves ...................... 9,573 3,193 894 (7,456) 6,204
Deferred tax asset valuation allowance .. 7,692 -- (2,332) -- 5,360
(1) All amounts shown were recorded to goodwill in connection with acquisitions
except for the $2.3 million reduction in the deferred tax asset valuation
allowance in 2003, which was written off against the gross deferred tax
asset.
F-35