UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
(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, 2004
[ ] 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 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. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]
As of June 30, 2004, the aggregate market value of the registrant's common stock
held by non-affiliates was approximately $632,254,000, based upon the closing
sales price of the registrant's common stock on NASDAQ on such date. For
purposes of this calculation only, all directors, executive officers and holders
of more than 10% of the registrant's outstanding common stock as of such date
were deemed to be "affiliates" of the registrant.
The number of shares of the registrant's Common Stock outstanding as of March
11, 2005 was 29,311,367.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's definitive proxy statement relating to its
scheduled May 17, 2005 Annual Meeting of Stockholders are incorporated by
reference in Part III of this report.
PART I
ITEM 1. BUSINESS
The terms "we," "our," "us," "Company" and "Integra" refer to Integra
LifeSciences Holdings Corporation and its subsidiaries unless the context
suggests otherwise.
Integra develops, manufactures and markets medical devices for use in
neuro-trauma, neurosurgery, reconstructive surgery and general surgery. Integra
was founded in 1989 and over the next decade developed technologies and products
directed toward tissue regeneration. 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 1999, we have increased our
revenues from $42.9 million to $229.8 million, a compound annual growth rate of
40%, and we have broadened our product offerings to include more than 15,000
products. We have achieved this growth in our overall business through the
development and introduction of new products, the development of our
distribution channels and acquisitions.
Our product lines include innovative tissue repair products that incorporate our
proprietary absorbable implant technology, such as the DuraGen(R) Dural Graft
Matrix, the DuraGen Plus(TM) Dural Regeneration Matrix, the DuraGen Plus(TM)
Adhesion Barrier Matrix, the NeuraGen(TM) Nerve Guide, the NeuraWrap(TM) Nerve
Protector, the INTEGRA(R) Dermal Regeneration Template, and the INTEGRA(TM)
Bilayer Matrix and INTEGRA(TM) Matrix Wound Dressings. In addition, we offer a
full range of medical devices that include monitoring and drainage systems,
surgical instruments and fixation systems.
Financial information about our geographical areas is set forth in our financial
statements under Notes to Consolidated Financial Statements, Note 14- Segment
and Geographic Information.
STRATEGY
Our goal is to become a global leader in the development, manufacturing and
marketing of medical devices, implants and biomaterials in the neurosurgery,
reconstructive surgery and general surgery markets. Key elements of our strategy
include the following:
EXPAND OUR PRESENCE IN HOSPITALS AND OTHER HEALTH CARE FACILITIES. Through
acquisitions and internal growth, we have become a leading provider of products
used in the diagnosis, monitoring and treatment of chronic diseases and acute
injuries and have become a leading provider of surgical instruments. We focus on
cranial, spinal, peripheral nervous system and small bone and joint injuries, as
well as the repair and reconstruction of soft tissue, such as dermis. We believe
that additional growth potential exists through the following:
o expanding our product portfolio and market reach through additional
acquisitions;
o increasing the penetration of our existing products into closely
related markets, such as the ear, nose, throat (ENT), maxillofacial,
extremities and spine markets;
o continuing the development and promotion of innovative new products,
such as our Dura Gen dural repair and anti-adhesion products, the
NeuraGen(TM) Nerve Guide, the NeuraWrap(TM) Nerve Protector, the
NeuroSensor(R) Cerebral Blood Flow Monitoring System and the LICOX(R)
Brain Tissue Oxygen Monitoring System; and
o expanding our sales force and product offerings focused on orthopedic
foot and ankle, podiatric and reconstructive surgeons.
ADDITIONAL STRATEGIC ACQUISITIONS. Since 1999 we have completed more than twenty
acquisitions focused primarily on our neurosurgical product lines,
reconstructive surgery, surgical instrumentation and orthopedic surgery. We
regularly evaluate potential acquisition candidates in this market and in other
specialty medical technology markets characterized by high margins, fragmented
competition and focused target customers.
CONTINUE TO DEVELOP NEW AND INNOVATIVE MEDICAL PRODUCTS. We have built a leading
proprietary absorbable implant franchise through our development of the
INTEGRA(R) Dermal Regeneration Template, the INTEGRA(TM) Bilayer Matrix and
INTEGRA(TM) Matrix Wound Dressings, the DuraGen(R) Dural Graft Matrix, the
DuraGen Plus(TM) Dural Regeneration Matrix, the DuraGen Plus(TM) Adhesion
Barrier Matrix, the NeuraGen(TM) Nerve Guide, the NeuraWrap(TM) Nerve Protector,
Biomend(R) and Biomend(R) Extend Absorbable Collagen Membranes and biomaterials
for the orthopedic implant market. We currently are developing a variety of
innovative neurosurgical and other medical products and are seeking expanded
applications for our existing products.
PRODUCT GROUPS, MARKETING AND SALES
Our business is organized into product groups and distribution channels. Our
product groups include Monitoring Products, Implants, Instruments and Private
Label Products. Our distribution channels include two direct sales organizations
(Integra NeuroSciences and Integra Reconstructive Surgery), one distributor
network managed by a direct sales organization (JARIT) and strategic alliances.
We sell the products from our four product groups through our various
distribution channels, as follows:
<Table>
<Caption>
PRODUCT GROUPS
-----------------------------------------------------------------------------------
MONITORING IMPLANTS INSTRUMENTS PRIVATE LABEL
- -------- --------------------- -------------------- -------------------- -------------------- --------------------
D INTEGRA
I NEUROSCIENCES X X X
S
T
R INTEGRA X X
I RECONSTRUCTIVE
B
U
T JARIT X
I
O ALLIANCES X
N
</Table>
The following table summarizes the most important products in each of our
product groups, which we discuss in more detail in the text following the table:
<Table>
<Caption>
PRODUCT LINES APPLICATIONS
- ----------------------------------------------------------------------------------------------------------------
MONITORING PRODUCTS
Camino(R) and Ventrix(R) Intracranial Pressure (ICP) Continuous monitoring of intracranial pressure,
Monitoring Systems and NeuroSensor(R) Cerebral Blood temperature and cerebral blood flow following injury or
Flow and ICP System neurosurgical procedures
LICOX(R) Oxygen Monitoring Systems Continuous monitoring of intracranial oxygen following
injury or neurosurgical procedures
Integra Systems of Cranial Access and CSF
Drainage Access to the cranial cavity and drainage of excess
cerebrospinal fluid from the brain
Integra Epilepsy Monitoring Electrodes Specialty electrodes for the intraoperative monitoring
of epileptic seizures
EEG, EP and EMG electrodes, disposables and other The diagnosis and monitoring of neurological, ENT and
supplies pulmonary disorders
IMPLANTS
DuraGen(R) Dural Graft and DuraGen Plus(TM) Dural Onlay collagen matrix to repair dura mater
Regeneration Matrices
DuraGen Plus(TM) Adhesion Barrier Matrix(1) Onlay collagen matrix to provide an adhesion barrier
following spinal and cranial surgery and for restoration
of the dura mater
</Table>
2
<Table>
<Caption>
PRODUCT LINES APPLICATIONS
- ----------------------------------------------------------------------------------------------------------------
EnDura(TM) No-React(R)(2) Dural Substitute Bovine pericardium suturable product for repair of dura
mater
NeuraGen(TM) Nerve Guide and NeuraWrap(TM) Nerve Repair and protection of peripheral nerves
Protector
Hydrocephalus shunts, including the new Integra Specifically designed for the management of
NPH(TM) Valve hydrocephalus, a chronic condition involving excess
cerebrospinal fluid in the brain
INTEGRA(R) Dermal Regeneration Template, INTEGRA(TM) Regenerate dermis, repair skin defects and wound
Bilayer Matrix Wound Dressing, INTEGRA(TM) Matrix dressings
Wound Dressing
Newdeal products, including the Bold(R) Screw, Full line of specialty implants and instruments
Uniclip(R) Compression Staple, Hallu-Fix(R) plate specifically designed for foot and ankle surgery
system and the HINTEGRA(R) total ankle
prosthesis(1)
Sundt(TM) and other carotid shunts For shunting blood during carotid endarterectomy
INSTRUMENTS
Selector(R) Integra Ultrasonic Aspirator; Electronic surgical systems that use ultrasonic energy
Dissectron(R) Ultrasonic Aspirator(1) to selectively dissect and ablate tissue
JARIT Surgical Instruments General and specialty instruments for open and
endoscopic surgery
MAYFIELD(R)(3) Cranial Stabilization and Intraoperative cranial stabilization and retraction
Positioning Systems and the BUDDE(R) Halo instruments for use during neurosurgical procedures
Retractor System
Elektrotom(R) electrosurgery generators(1) Electrosurgery system used to cut and coagulate selected
tissue
Ruggles(TM) Neurosurgical and Spinal Instruments Specialized surgical instruments for use in cranial
and R&B Redmond(TM) Spinal Instruments and/or spinal surgery
Padgett Instruments Instruments used in reconstructive and plastic surgery
Padgett Dermatomes and Meshers Devices for harvesting and conditioning skin grafts
Spinal Specialties Custom spinal, epidural, discogram and nerve block kits
and products for chronic pain management
PRIVATE LABEL PRODUCTS
Absorbable Collagen Sponge and other matrices for Fracture management / enabling spinal fusion
use with bone morphogenetic protein (rhBMP-2) (manufactured for Wyeth BioPharma; Medtronic Sofamor
Danek)
BioMend(R) and BioMend(R) Extend Absorbable Used in guided tissue regeneration in periodontal
Collagen Membranes, CollaCote(R), CollaTape(R) and surgery and to control bleeding in dental surgery
CollaPlug(R) Absorbable Wound Dressings (manufactured for Zimmer)
</Table>
3
<Table>
<Caption>
PRODUCT LINES APPLICATIONS
- ----------------------------------------------------------------------------------------------------------------
VitaCuff(R) Percutaneous Infection Control Device Provide protection against infection arising from
and BioPatch(R)(4) Antimicrobial Wound Dressing long-term catheters and in wounds (manufactured for
various medical device companies)
</Table>
(1) Not available for sale in the United States
(2) No-React is a registered trademark of Shelhigh, Inc.
(3) Mayfield is a registered trademark of SM USA, Inc., a wholly owned
subsidiary of Schaerer Mayfield USA, Inc.
(4) BioPatch is a registered trademark of Johnson & Johnson
MONITORING PRODUCTS
THE 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, and
the market for monitoring and intervention is estimated to approximate $110
million.
We sell the Camino(R) and Ventrix(R) lines of intracranial pressure and
temperature monitoring systems and the LICOX(R) Brain Tissue Oxygen Monitoring
System. Currently more than 3,000 of our intracranial monitors are installed and
in use worldwide. The Camino(R) and Ventrix(R) systems measure the intracranial
pressure and temperature in the brain and ventricles, and the LICOX(R) system
allows for continuous qualitative regional monitoring of dissolved oxygen in
cerebral tissues.
We expect to introduce the NeuroSensor(R) Cerebral Blood Flow Monitoring System
in the first half of 2005. This monitoring system measures both intracranial
pressure and cerebral blood flow using a single combined probe and an electronic
monitor for data display. Cerebral blood flow is considered to be an important
parameter for monitoring cerebral auto-regulation and, when combined with the
measurement of intracranial pressure, is expected to facilitate improved patient
care and clinical management with applications in neuro-trauma, cerebrovascular
disease and post-operative neurosurgical treatment.
Core technologies underlying the brain parameter monitoring product line include
the design and manufacture of the disposable catheters used in the monitoring
systems, pressure transducer technology, optical detection/fiber optic
transmission technology, sensor characterization and calibration technology and
monitor design.
CRANIAL ACCESS AND EXTERNAL 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 under the Integra CSF Drainage
and Cranial Access Systems brand names.
EPILEPSY ELECTRODES AND NEUROLOGICAL SUPPLIES. Neurosurgeons use electrodes for
the intraoperative monitoring of epileptic seizures to determine if surgical
options can be used in the treatment of epilepsy. Seizures vary from a momentary
disruption of the senses to short periods of unconsciousness or convulsions.
Seizures are caused by the sudden change in how the cells of the brain send
electrical signals to each other. The neurosurgeon uses the electrodes in
conjunction with an electroencephalography video monitor to determine if a
patient is a viable candidate for surgery, which involves the removal of the
damaged portion of brain tissue. The worldwide market for intraoperative
epilepsy electrodes is estimated to be $10 million. We sell these products in
the United States through our Integra NeuroSciences sales force.
We distribute a wide variety of disposables and supplies, including surface
electrodes, needle electrodes, recording transducers and stimulators, and
respiratory sensors, that are used in the diagnosis and monitoring of
neurological disorders. These products are designed to monitor and perform tests
of the nervous system and brain, including electromyography (EMG), evoked
potential (EP) and electroencephalography (EEG) tests, and to evaluate sleep
disorders.
We sell these products under the Integra Supplies(TM) name primarily through
catalogs and telemarketing to more than 6,000 neurologists, hospitals, sleep
clinics and other physicians. Neurologists are the referring physicians for
Integra's existing neurosurgeon customers and participate in the decision to use
our line of epilepsy monitoring electrodes.
4
IMPLANTS
REPAIR OF THE DURA MATER. The dura mater is the thick membrane that contains the
cerebrospinal fluid within the brain and the spine. The dura mater often must be
penetrated during brain surgery and is often damaged during spinal surgery. In
either case, surgeons may close or repair the dura mater with a graft. The graft
may consist of tissue taken from elsewhere in the patient's body, or it may be
one of the dural substitute products currently on the market, which are made of
collagen, synthetic materials, processed human cadaver or bovine pericardium.
The DuraGen(R) Dural Graft and DuraGen Plus(TM) Dural Regeneration Matrices are
absorbable collagen products indicated for the repair of the dura mater
surrounding the brain and spine. The worldwide market for dural repair,
including cranial and spinal applications, is estimated to be $120 million.
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
following spinal and cranial surgery and for restoration of the dura mater. We
estimate that the total worldwide market for treatment of spinal adhesions
exceeds $300 million. The DuraGen Plus(TM) Adhesion Barrier Matrix is not
approved for sale in the United States.
We believe that the DuraGen(R) Dural Graft and DuraGen Plus(TM) Dural
Regeneration Matrices, as well as the DuraGen Plus(TM) Adhesion Barrier Matrix,
address the shortcomings of other methods for repairing the dura mater. Clinical
trials have shown our DuraGen(R) and DuraGen Plus(TM) products to be an
effective means for closing the dura mater without the need for suturing, which
allows the neurosurgeon to conclude the operation more efficiently. In addition,
because the human body ultimately absorbs the DuraGen(R) and DuraGen Plus(TM)
Matrices 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.
EnDura(TM) No-React(R) Dural Substitute is a bovine pericardium suturable
product for the repair of the dura mater. It is treated with the proprietary
No-React(R) process, which reduces the body's inflammatory response to the
implant, prolongs the product's durability and eliminates the need for rinsing
prior to implantation. Through the EnDura product, we address the approximately
15% of dural repair procedures that, due to pressure existing at the dural
breach location, require a suturable graft.
SKIN REPLACEMENT AND ENGINEERED WOUND DRESSINGS. Our skin replacement products
address the market need created by severe burns, reconstructive surgery, trauma
and chronic wounds.
The INTEGRA(R) Dermal Regeneration Template is designed to enable the human body
to regenerate functional dermal tissue. The Food and Drug Administration (FDA)
initially approved the product under a Premarket Approval application (PMA) 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.
In 2002, we received FDA approval to market our skin replacement products for
use in certain procedures in which cadaver skin or an autograft would typically
be used. The FDA approved a PMA supplement to permit the marketing of the
INTEGRA(R) Dermal Regeneration Template for the repair of scar contractures in
patients who have already recovered from their initial wound. The FDA also
granted a Section 510(k) clearance for the sale of a related product,
INTEGRA(TM) Bilayer Matrix Wound Dressing, for the dressing of wounds, including
chronic wounds. We estimate that the worldwide market now addressable by our
skin replacement products exceeds $1.0 billion.
Between 1999 and 2003, the ETHICON division of Johnson & Johnson was the
exclusive seller of the INTEGRA(R) Dermal Regeneration Template and the
INTEGRA(TM) Bilayer Matrix Wound Dressing worldwide, except in Japan where
Century Medical, Inc. has rights to distribute the INTEGRA(R) Dermal
Regeneration Template. Effective December 31, 2003, we terminated our agreement
with ETHICON and again assumed the sales and marketing responsibility for both
products. We now distribute the INTEGRA(R) Dermal Regeneration Template and the
INTEGRA(TM) Bilayer Matrix Wound Dressing through our Reconstructive surgery
sales organization in the United States and parts of Western Europe and through
a network of distributors elsewhere.
In 2004, we received FDA approval and introduced the INTEGRA(R) Dermal
Regeneration Template - Terminally Sterilized (IDRT-TS). We also introduced the
INTEGRA(TM) Matrix Wound Dressing. IDRT-TS is a terminally sterilized version of
the INTEGRA(R) Dermal Regeneration Template. Although functionally the same as
the INTEGRA(R) Dermal Regeneration Template, IDRT-TS does not require
refrigeration and is not stored in alcohol,
5
which simplifies considerably the preparation and handling of the INTEGRA
product in the operating room. The INTEGRA(TM) Matrix Wound Dressing is a single
layer version of our advanced wound care product line, which is indicated for
the management of partial and full-thickness soft tissue wounds.
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.
The NeuraGen(TM) Nerve Guide and the NeuraWrap(TM) Nerve Protector are
absorbable collagen implants for the repair and protection of severed and
injured peripheral nerves. The NeuraGen(TM) product, used in the repair of
severed peripheral nerves, is a collagen tube designed to provide an environment
for the regenerating nerve and to provide a conduit through which regenerating
nerves can bridge the gap caused by the injury. The NeuraGen(TM) Nerve Guide
offers a rapid method for rejoining severed peripheral nerves. The NeuraWrap(TM)
product, designed for the treatment of injured, compressed or scarred nerves,
provides a protective environment for nerve healing, serving as an interface
between damaged nerves and surrounding tissue.
HYDROCEPHALUS MANAGEMENT. 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. This condition causes
the ventricles of the brain to enlarge and the pressure inside the head to
increase. Hydrocephalus often is present at birth, but may also result from
other causes, including head trauma, spina bifida, intraventricular hemorrhage,
intracranial tumors and cysts. 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.
According to the Hydrocephalus Association, hydrocephalus affects approximately
one in 500 children born in the United States. We estimate that greater than 50%
of total cerebrospinal fluid shunt sales address birth-related hydrocephalus,
while the remainder address surgical procedures involving excess cerebrospinal
fluid due to head trauma and adult onset normal pressure hydrocephalus. Based on
industry sources, we believe that the total United States market for
hydrocephalus management, including monitoring, shunting and drainage, is
approximately $150 million. Of that amount, it is estimated that a little more
than half consists of sales of monitoring products, and the balance consists of
sales of shunts and drains for the management of hydrocephalus.
In recent years, neurosurgeons have increased their use of programmable valves,
which allow the neurosurgeon to adjust the pressure settings of the shunt while
it is implanted in the patient. Shunts that do not incorporate programmable
valve technology must be removed from the patient for subsequent pressure
adjustments, a process that requires an additional surgical procedure. We do not
market hydrocephalus management shunts with programmable valves and believe that
the increasing use of programmable valves has negatively affected, and may
continue to negatively affect, the sales of our shunt products.
In 2004, we introduced the NPH(TM) Low Flow Hydrocephalus Valve that regulates
the flow of cerebrospinal fluid out of the brain, rather than the pressure
created by cerebrospinal fluid inside the head. Designed specifically to meet
the needs of patients with normal pressure hydrocephalus (NPH), the NPH(TM)
Valve controls cerebrospinal fluid flow at a lower rate than Integra's other
flow-control valves. Normal pressure hydrocephalus is a syndrome that occurs in
both adults who have previously experienced birth-related hydrocephalus and
those who have not. It is characterized by dementia, gait disturbance and
urinary incontinence in patients that are typically over 65 years of age. As
many as 10% of all patients with symptoms of dementia have NPH. While the
symptoms associated with NPH can intensify over time if the condition is left
untreated, the dementia associated with NPH can be reversed if treated properly.
While shunting is 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 that the market opportunity for shunt systems designed to treat NPH is
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, the potential market opportunity exceeds
$500 million.
SMALL BONE AND JOINT FIXATION DEVICES AND INSTRUMENTS. Our line of 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
6
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.
HEMODYNAMIC SHUNTS. Our Sundt(TM) and other carotid shunts are used to divert
blood to vital organs, such as the brain, during surgical procedures involving
blood vessels.
INSTRUMENTS
NEUROSURGICAL SYSTEMS FOR TISSUE ABLATION. More than 145,000 primary and
metastatic brain tumors are diagnosed annually in the United States alone. Our
Selector(R) Integra Ultrasonic Aspirator, Dissectron(R) Ultrasonic Surgical
Aspirator and Sonotom(R) Ultrasonic Surgical Aspirator systems address surgeons'
needs for the surgical fragmentation and removal of malignant and non-malignant
tumors and other tissue on a worldwide basis.
The Selector(R) Integra Ultrasonic Aspirator, Dissectron(R) Ultrasonic Surgical
Aspirator and Sonotom(R) Ultrasonic Surgical Aspirator 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. The Selector(R) product is indicated for use in general,
gynecological, urological, plastic and reconstructive, orthopedic, thoracic and
thorascopic surgery procedures. We offer the Dissectron(R) and Sonotom(R)
products only outside the United States.
The Elektrotom(R), offered only outside the United States, is an electrosurgery
system used to cut and coagulate selected tissue, automatically regulating and
adapting the power required for the target tissue. The system is available with
both monopolar and bipolar handpieces and accessories.
CRANIAL STABILIZATION AND BRAIN RETRACTION SYSTEMS. The MAYFIELD(R) Headrest
System is a 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.
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 and a 98% order fill rate,
the JARIT brand has a strong reputation for high-quality surgical instruments
and customer service.
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 instruments under the Ruggles(TM)
brand name primarily for cranial surgery.
PLASTIC AND RECONSTRUCTIVE INSTRUMENTS. We market a wide variety of high
quality, reusable surgical instruments under the Padgett Instruments(TM) brand
to plastic and reconstructive surgeons, burn surgeons, ENT surgeons, hospitals,
surgery centers and other physicians.
DERMATOMES AND MESHERS. We sell a range of manual, air- and electric-powered
dermatomes and related disposables for harvesting skin grafts. 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.
SPINAL SPECIALTIES. Spinal Specialties' products include the OsteoJect(TM) Bone
Cement Delivery System and the ACCU-DISC(TM) Pressure Monitoring System.
Physicians use these products in a variety of spinal, orthopedic and pain
management procedures. The OsteoJect product allows precise delivery of bone
cement to a surgical site under active fluoroscopy by a surgeon whose hands
remain outside the fluoroscopy field. The ACCU-DISC, which is used to interpret
discography results, offers the accurate delivery of fluids to the body and the
ability to monitor the fluids in discography interpretation.
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PRIVATE LABEL PRODUCTS
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), which Wyeth BioPharma is developing for clinical evaluation
in several areas of bone repair and augmentation, including orthopedic, oral and
maxillofacial surgery applications. We sell Absorbable Collagen Sponges for
spinal applications through a related collaboration with Medtronic Sofamor Danek
in North America. The FDA has approved Medtronic Sofamor Danek's InFUSE(TM) Bone
Graft used with the LT-CAGE(TM) Lumbar Tapered Fusion Device and the INTER FIX
and INTER FIX Threaded Fusion Devices for use in spinal fusion procedures. The
InFUSE Bone Graft uses rhBMP-2 applied to our Absorbable Collagen Sponge in
place of a painful secondary procedure to harvest small pieces of bone from the
patient's own hip (autograft). When used with the LT-CAGE(TM) Lumbar Tapered
Fusion Device and the INTER FIX and INTER FIX Threaded Fusion Devices, the
InFUSE(TM) Bone Graft is indicated to treat certain types of spinal degenerative
disc disease, a common cause of low back pain. InFUSE received a new PMA
Approval from the FDA in 2004 for the treatment of open, acute tibial shaft
fractures.
GUIDED TISSUE REGENERATION IN PERIODONTAL SURGERY. Our BioMend(R) Absorbable
Collagen Membrane is used for guided tissue regeneration in periodontal surgery.
The BioMend(R) membrane is inserted between the gum and the tooth after surgical
treatment of periodontal disease, preventing the gum tissue from interfering
with the regeneration of the periodontal ligament that holds the tooth in place.
The body absorbs the BioMend(R) product after approximately four to seven weeks,
avoiding the requirement for additional surgical procedures to remove a
non-absorbable membrane. The BioMend(R) Extend product has the same indication
for use as the BioMend(R) product, except that it absorbs in approximately 16
weeks. The BioMend(R) and BioMend(R) Extend Absorbable Collagen Membranes are
sold through Zimmer Holdings, Inc.
OTHER PRIVATE LABEL PRODUCTS. Our current private label products also include
the VitaCuff(R) catheter access infection control device, the BioPatch(R)
anti-microbial wound dressing and a wide range of absorbable collagen products
for hemostasis.
DISTRIBUTION CHANNELS
We sell our products through various direct sales forces and a variety of other
distribution channels. Our direct sales forces include the following:
INTEGRA NEUROSCIENCES(TM). Integra NeuroSciences' direct marketing effort in the
United States and Europe currently involves more than 130 professionals,
including direct salespeople (called neurospecialists in the United States),
sales management, and clinical educators who educate and train both our
salespeople and customers in the use of our products. Our Integra
NeuroSciences(TM) sales force sells our monitoring products (including Camino,
LICOX, Ventrix and Neurosensor monitoring lines, cranial access kits, external
ventricular and lumbar monitoring and drainage products and epilepsy
electrodes), our neurosurgical operating room products (including the
DuraGen(R), DuraGen Plus(TM), EnDura(TM) and NeuraGen(TM) products, the NPH(TM)
Low Flow Hydrocephalus Valve and the Selector Integra Ultrasonic Aspirator) and
the Ruggles line of neurosurgical instruments. These salespeople call primarily
on neurosurgeons and intensive care units that are capable of managing
neuro-trauma cases. We believe that we effectively address this focused group of
hospital-based practitioners through our direct Integra NeuroSciences(TM) sales
and marketing infrastructure in the United States and in parts of Europe and our
distribution network elsewhere.
RECONSTRUCTIVE SURGERY. Our reconstructive surgery sales and marketing
organization in the United States and Europe consists of approximately 50
professionals, including direct salespeople, sales management, clinical
educators and marketing managers. This sales and marketing organization sells
the Newdeal line of orthopedic implants, devices and instruments, the INTEGRA(R)
Dermal Regeneration Template, the INTEGRA(TM) Bilayer Matrix Wound Dressing, the
NeuraGen(TM) Nerve Guide, the NeuraWrap(TM) Nerve Protector, Padgett dermatomes
and meshers, and a wide variety of high quality surgical instruments and
implants to orthopedic surgeons, podiatric surgeons, trauma and reconstructive
surgeons, burn surgeons, hospitals, surgery centers and other physicians.
JARIT SURGICAL INSTRUMENTS. Our JARIT organization sells its products to more
than 5,200 hospitals and surgery centers worldwide. In the United States, JARIT
employs a 20-person sales management force that works with over 100 distributor
sales 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 and neurosurgery.
PRIVATE LABEL. 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
8
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, Wyeth and Zimmer, for the development and marketing efforts
related to many of these products.
We have established a reputation as a value-added and dependable development and
manufacturing partner. Many of our current private label products are built on
our expertise in absorbable collagen products. In addition, we have expertise in
the development, manufacture and supply of a variety of absorbable materials and
can provide experienced personnel to support product quality and regulatory
review efforts.
RESEARCH AND DEVELOPMENT STRATEGY
Our research and development programs focus on developing new products based on
our materials and collagen engineering technologies and our expertise in fiber
optics, ultrasonic technology and surgical fixation. We spent $14.1 million,
$12.8 million and $11.5 million in 2004, 2003 and 2002, respectively, on
research and development activities. The 2004 amount includes a $1.4 million
milestone payment relating to the completion of certain development activities
for an advanced neuromonitoring system and a $0.5 licensing fee paid for the
development of a data acquisition system to support the integration of our
advanced monitoring products. The 2003 and 2002 amounts include $400,000 and
$2.3 million, respectively, of acquired in-process research and development
charges recorded in connection with acquisitions. In addition to internal
research and development activities, we may continue to use our capital
resources to acquire businesses that include research and development programs,
which could result in additional in-process research and development charges in
the future. We also receive contract development revenues and government grant
funding which support a portion of our research and development activities.
Research and development activities funded by contract development and
government grant revenues amounted to $4.5 million and $3.5 million in 2003 and
2002, respectively.
We have either acquired or secured the proprietary rights to several important
technological and scientific platforms, including collagen matrix, intracranial
monitoring, ultrasonic tissue ablation and implantable fixation technologies.
These technologies provide support for our critical applications in neurosurgery
and tissue regeneration with additional opportunities for generating near-term
and long-term revenues from medical applications. We have been able to identify
and bring together critical platform technology components from which we work to
develop products for both tissue regeneration and neurosurgical applications.
These efforts have led to the successful development of new products, such as
the NeuraGen(TM) Nerve Guide, the NeuraWrap(TM) Nerve Protector, the DuraGen
Plus(TM) Dural Regeneration Matrix, the DuraGen Plus(TM) Adhesion Barrier Matrix
(CE Approved), the INTEGRA(R) Dermal Regeneration Template - TS and the
INTEGRA(TM) Matrix Wound Dressing.
We regularly review our research and development programs to ensure that they
remain consistent with and supportive of our growth strategies.
GOVERNMENT REGULATION
As a manufacturer 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.
From time to time, we have recalled certain of our products. We have recalled
defective components or devices supplied by other vendors, kits assembled by us
that included incorrect combinations of products and defective devices
manufactured by us. None of these recalls resulted in a material direct expense
to us or a long-term disruption of an important customer or supplier
relationship. However, a future voluntary or involuntary recall of one of our
major products, particularly if it involved a potential or actual risk to
patients, could have an adverse financial impact on us as a result both of
direct expenses and disrupted customer relationships.
The FDA 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 PMA application
or a supplemental PMA application. Alternatively, we may seek United States
market clearance through a Product Development Protocol approved by the FDA.
Establishing and completing a Product Development Protocol, or obtaining a PMA
application or supplemental PMA application, can take up to several years and
can
9
involve preclinical studies and clinical testing. To perform clinical
testing in the United States on an unapproved product, we are also required to
obtain an Investigational Device Exemption from the FDA. In addition to
requiring clearance for new products, FDA rules may require a filing and FDA
approval, usually through a PMA application supplement or a 510(k) Premarket
Notification clearance, prior to marketing products that are modifications of
existing products or new indications for existing products. The FDA Medical
Device User Fee and Modernization Act of 2002 (MDUFMA) imposes user fees payable
to FDA for submission of Premarket Notifications, PMA applications, Product
Development Protocols, certain supplemental PMA applications and other types of
FDA submissions. The regulatory process of obtaining product
approvals/clearances can be onerous and costly.
We may not receive the necessary regulatory approvals, including approval for
product improvements and new products, on a timely basis, if at all. Delays in
receipt of, or failure to receive, regulatory approvals could have a material
adverse effect on our business. 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. In addition, federal, state and foreign regulations
regarding the manufacture and sale of medical devices are subject to future
changes. We cannot predict what impact, if any, these changes might have. These
changes, however, could have a material impact on our business.
We have received or acquired more than 245 Premarket Notification 510(k)
clearances, five approved PMA applications and 57 supplemental PMA applications.
We expect to file new applications during the next year to cover new products
and variations on existing products.
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 Systems 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 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. In
addition, the FDA prohibits us from promoting a medical device before marketing
clearance has been received or promoting an approved device for unapproved
indications. Under FDA regulations, we are required to submit reports of certain
voluntary recalls and corrections to 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. These actions could have a material
impact on our business. Other regulatory agencies may have similar powers.
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. In June 1998, the
European Union Medical Device Directive became effective, and 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 the 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. In 2004, each
of our certified facilities was audited, and we have maintained our
certification to these standards.
In addition, we are required to notify the FDA if we export specified medical
devices manufactured in the United States that have not been approved by the FDA
for distribution in the United States. We are also required to maintain certain
records relating to exports and make the records available to the FDA for
inspection, if required. We currently export medical devices manufactured in the
United States that have not been approved by the FDA.
OTHER UNITED STATES REGULATORY REQUIREMENTS
In addition to the regulatory framework for product approvals, we are and may be
subject to regulation under federal
10
and state laws, including requirements regarding occupational health and safety;
laboratory practices; the maintenance of personal health information; sales and
marketing practices, including product discounting practices; and the use,
handling and disposal of toxic or hazardous substances. We may also be subject
to other present and possible future local, state, federal and foreign
regulations.
Our research, development and manufacturing processes involve the controlled use
of certain hazardous materials. 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.
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),
CollaCote(R), CollaPlug(R), CollaStat(TM), CollaTape(R), Dissectron(R),
DuraGen(R), DuraGen Plus(TM), Elektrotom(R), EquiFlow(R), Hallu-Fix(R),
Helistat(R), Helitene(R), Heyer-Schulte(R), HINTEGRA(R), INTEGRA(TM),
INTEGRA(TM) Bilayer Matrix Wound Dressing, INTEGRA(R) Dermal Regeneration
Template, Integra NeuroSciences(TM), Integra NeuroSupplies(TM), Integra
Supplies(TM), JARIT(R), LICOX(R), LPV(R), Moni-Torr(R), NeuraGen(TM),
NeuraWrap(TM), Neurosensor(R), Orbis-Sigma(R), Osteoject(R), Padgett
Instruments, Inc(R), Pudenz(TM), Redmond(TM), Ruggles(TM), Selector(R),
Sonotom(R), Spetzler(R), Spin(R), Spinal Specialties(R), Sundt(TM), Uniclip(R),
Ventrix(R), VitaCuff(R) 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.
COMPETITION
Our largest competitors in the neurosurgery markets are the Medtronic
Neurotechnologies division of Medtronic, Inc., the Codman division of Johnson &
Johnson, the Aesculap division of B. Braun and the Valleylab division of Tyco
International Ltd. In addition, many of our neurosurgery product lines compete
with smaller specialized companies or larger companies that do not otherwise
focus on neurosurgery.
Our largest competitors in reconstructive surgery are Smith and Nephew plc,
LifeCell Corporation, Organogenesis Inc., Wright Medical Group, Inc., the DePuy
division of Johnson & Johnson and Synthes, Inc.
We believe that we are the second largest re-usable surgical instrument company
in the United States. The largest re-usable instrument company is V. Mueller, a
division of Cardinal Healthcare. 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 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 (such as autograft tissue as a substitute for the INTEGRA(R)
Dermal Regeneration Template, our duraplasty products, the NeuraGen(TM) Nerve
Guide and NeuraWrap(TM) Nerve Protector). Depending on the product line, we
compete on the basis of our products' features, strength of our sales
11
force or marketing partner, sophistication of our technology and cost
effectiveness of our solution to the customer's medical requirements.
EMPLOYEES
At December 31, 2004, we had approximately 922 full-time employees and 214
temporary employees engaged in production and production support (including
warehouse, engineering and facilities personnel), quality assurance/quality
control, research and development, regulatory and clinical affairs, sales,
marketing, administration and finance. Except for certain employees at our
facilities in Belgium, France and Germany, none of our current 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, were recruited from 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, as amended, which we refer to as the "Exchange Act". 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 450
Fifth Street, N.W. 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 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.
12
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.
FACTORS THAT MAY AFFECT OUR FUTURE PERFORMANCE
OUR OPERATING RESULTS MAY FLUCTUATE.
Our operating results, including components of operating results, such as gross
margin on product sales, may fluctuate from time to time, which 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 the timing of payments received and the recognition of those payments
as revenue under collaborative arrangements and other alliances;
o changes in the rate of exchange between the U.S. dollar, the euro and
the British pound;
o expenses incurred and business lost in connection with product field
corrections or recalls;
o our ability to manufacture our products efficiently; and
o the timing of our research and development expenditures.
NON-CASH COMPENSATION CHARGES MAY AFFECT OUR FUTURE EARNINGS.
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". 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.
Statement 123(R) must be adopted no later than July 1, 2005, and we expect to
adopt Statement 123(R) on July 1, 2005. For purposes of disclosing pro forma
financial results in our financial statements as if compensation cost for our
stock option plans had been determined based on the fair value at the grant
consistent with the provisions of Statement No. 123, we historically estimated
the fair value of stock options granted prior to October 1, 2004 using the
Black-Scholes valuation model. However, we estimated the pro forma additional
compensation expense related to all options granted on or after October 1, 2004
using a binomial distribution model. Management believes that the binomial
distribution model is preferable to 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. Because Statement 123(R) prohibits pro forma footnote
disclosure as an alternative to financial statement recognition, management is
currently evaluating the potential impact that Statement 123(R) will have on our
future results of operations. Previous estimates of option values using the
Black-Scholes method may not be indicative of results from applying the binomial
distribution model for valuing future option grants.
THE INDUSTRY AND MARKET SEGMENTS IN WHICH WE OPERATE ARE HIGHLY COMPETITIVE, AND
WE MAY BE UNABLE TO COMPETE EFFECTIVELY WITH OTHER COMPANIES.
In general, the medical technology industry is characterized by intense
competition. We compete with established medical technology and pharmaceutical
companies. Competition also comes from early stage companies that have
alternative technological solutions for our primary clinical targets, as well as
universities, research institutions and other non-profit entities. Many of our
competitors have access to greater financial, technical, research and
development, marketing, manufacturing, sales, distribution services and other
resources than we do. Our competitors may be more effective at implementing
their technologies to develop commercial products.
Our 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
13
and obtain patent protection. We may need to develop new applications for our
products to remain competitive. Technological advances by one or more of our
current or future competitors could render our present or future products
obsolete or uneconomical. Our future success will depend upon our ability to
compete effectively against current technology as well as to respond effectively
to technological advances. Competitive pressures could adversely affect our
profitability. For example, two of our largest competitors have recently
introduced an onlay dural graft matrix, and other companies may be preparing to
introduce similar products. The introduction of such products could reduce the
sales, growth in sales and profitability of our duraplasty products, including
our DuraGen(R), DuraGen Plus(TM) and EnDura(TM) product lines, which are among
our largest and fastest growing products.
Our largest competitors in the neurosurgery markets are the Medtronic
Neurotechnologies division of Medtronic, Inc., the Codman division of Johnson &
Johnson, the Aesculap division of B. Braun and the Valleylab division of Tyco
International Ltd. In addition, many of our product lines compete with smaller
specialized companies or larger companies that do not otherwise focus on
neurosurgery. Our reconstructive surgery business is small compared to its
principal competitors, which include major medical device and wound care
companies such as Smith and Nephew plc, LifeCell Corporation and Organogenesis
Inc., as well as companies focused on foot and ankle surgeons including Wright
Medical Group, Inc., the DePuy division of Johnson & Johnson and Synthes, Inc.
Our private label products face diverse and broad competition, depending on the
market addressed by the product. Finally, in certain cases our products compete
primarily against medical practices that treat a condition without using a
device, rather than any particular product, such as autograft tissue as an
alternative for the INTEGRA(R) Dermal Regeneration Template, our duraplasty
products and the NeuraGen(TM) Nerve Guide.
OUR CURRENT STRATEGY INVOLVES GROWTH THROUGH ACQUISITIONS, WHICH REQUIRES US TO
INCUR SUBSTANTIAL COSTS AND POTENTIAL LIABILITIES FOR WHICH WE MAY NEVER REALIZE
THE ANTICIPATED BENEFITS.
In addition to internal growth, our current strategy involves growth through
acquisitions. Since 1999, we have acquired 20 businesses or product lines at a
total cost of approximately $213 million.
We may be unable to continue to implement our growth strategy, and our strategy
ultimately may be unsuccessful. A significant portion of our growth in revenues
has resulted from, and is expected to continue to result from, the acquisition
of businesses complementary to our own. We engage in evaluations of potential
acquisitions and are in various stages of discussion regarding possible
acquisitions, certain of which, if consummated, could be significant to us. Any
potential acquisitions may result in material transaction expenses, increased
interest and amortization expense, increased depreciation expense and increased
operating expense, any of which could have a material adverse effect on our
operating results. As we grow by acquisitions, we must integrate and manage the
new businesses to realize economies of scale and control costs. In addition,
acquisitions involve other risks, including diversion of management resources
otherwise available for ongoing development of our business and risks associated
with entering new markets with which our marketing and sales force has limited
experience or where experienced distribution alliances are not available. Our
future profitability will depend in part upon our ability to develop further our
resources to adapt to these new products or business areas and to identify and
enter into satisfactory distribution networks. We may not be able to identify
suitable acquisition candidates in the future, obtain acceptable financing or
consummate any future acquisitions. If we cannot integrate acquired operations,
manage the cost of providing our products or price our products appropriately,
our profitability could suffer. In addition, as a result of our acquisitions of
other healthcare businesses, we may be subject to the risk of unanticipated
business uncertainties, regulatory matters or legal liabilities relating to
those acquired businesses for which the sellers of the acquired businesses may
not indemnify us. Future acquisitions may also result in potentially dilutive
issuances of securities.
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
14
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. 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
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.
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, 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 goes into effect on April 1, 2005. New regulations
and requirements will exist for obtaining approval of medical devices, including
new requirements governing the conduct of clinical trials, the manufacturing of
products and the distribution of products in Japan. Significant resources also
may be needed to comply with the extensive auditing of all manufacturing
facilities of our company and our vendors by the Ministry of Health, Labor and
Welfare in Japan to comply with the amendment to the Pharmaceutical Affairs Law.
These new regulations may affect our ability to obtain approvals of new products
as well as maintain the certain businesses in Japan. Sales in Japan accounted
for approximately $3.1 million of our revenues in 2004.
CERTAIN OF OUR PRODUCTS CONTAIN MATERIALS DERIVED FROM ANIMAL SOURCES AND MAY
BECOME SUBJECT TO ADDITIONAL REGULATION.
Certain of our products, including the DuraGen(R) Dural Graft Matrix, DuraGen
Plus(TM) Dural Regeneration Matrix and DuraGen Plus(TM) Adhesion Barrier Matrix
products, the NeuraGen(TM) Nerve Guide, the NeuraWrap(TM) Nerve Protector, the
INTEGRA(R) Dermal Regeneration Template, the INTEGRA(TM) Bilayer Matrix and
INTEGRA(TM) Matrix Wound Dressing, the Helistat(R)/Helitene(R) Absorbable
Collagen Hemostatic Agents, our Absorbable Collagen Sponges, the CollaCote(R),
CollaTape(R) and CollaPlug(R) Absorbable Wound Dressings and the BioMend(R) and
BioMend(R) Extend Absorbable Collagen Membranes, contain material derived from
bovine tissue. Products that contain materials derived from animal sources,
including food as well as pharmaceuticals and medical devices, are increasingly
subject to scrutiny in the press and by regulatory authorities. Regulatory
authorities are concerned about the potential for the transmission of disease
from animals to humans via those materials. This public scrutiny has been
particularly acute in Japan and Western Europe with respect to products derived
from cattle, because of concern that materials infected with the agent that
causes bovine spongiform encephalopathy, otherwise known as BSE or mad cow
disease, may, if ingested or implanted, cause a variant of the human
Creutzfeldt-Jakob Disease, an ultimately fatal disease with no known cure.
Recent cases of BSE in cattle discovered in Canada and the United States have
increased awareness of the issue in North America.
We take great care to provide that our products are safe and free of agents that
can cause disease. In particular, the collagen used in the manufacture of our
products is derived only from the deep flexor tendon of cattle from the
15
United States that are less than 24 months old. The World Health Organization
classifies different types of cattle tissue for relative risk of BSE
transmission. Deep flexor tendon, the sole source of our collagen, is in the
lowest risk category for BSE transmission (the same category as milk, for
example), and is therefore considered to have a negligible risk of containing
the agent that causes BSE (an improperly folded protein known as a prion).
Nevertheless, products that contain materials derived from animals, including
our products, may become subject to additional regulation, or even be banned in
certain countries, because of concern over the potential for prion transmission.
Significant new regulation, or a ban of our products, could have a material
adverse effect on our current business or our ability to expand our business.
In addition, we have been notified that Japan has issued new regulations
regarding medical devices that contain tissue of animal origin. Among other
regulations, Japan may require that the tendon used in the manufacture of
medical devices sold in Japan originate in a country that has never had a case
of BSE. Currently, we purchase our tendon from the United States and have
qualified a source of tendon from New Zealand, a country which has never had a
case of BSE. If we cannot continue to 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.
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. For example, we cannot be certain that the medical
community will accept the NeuraGen(TM) Nerve Guide over conventional
microsurgical techniques for connecting severed peripheral nerves.
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,
cost less or are ready for commercial introduction before our products. For
example, our sales of shunt products could decline if neurosurgeons increase
their use of programmable valves and we fail to introduce a competitive product,
or our sales of certain catheters may be adversely affected by the recent
introduction by other companies of catheters that contain anti-microbial agents
intended to reduce the incidence of infection after implantation. If we are
unable to develop additional commercially viable products, our future prospects
could be adversely affected.
Market acceptance of our products depends on many factors, including our ability
to convince prospective collaborators and customers that our technology is an
attractive alternative to other technologies, to manufacture products in
sufficient quantities and at acceptable costs, and to supply and service
sufficient quantities of our products directly or through our distribution
alliances. In addition, limited funding available for product and technology
acquisitions by our customers, as well as internal obstacles to customer
approvals of purchases of our products, could harm acceptance of our products.
The industry is subject to rapid and continuous change arising from, among other
things, consolidation and technological improvements. One or more of these
factors may vary unpredictably, which could materially adversely affect our
competitive position. We may not be able to adjust our contemplated plan of
development to meet changing market demands.
OUR INTELLECTUAL PROPERTY RIGHTS MAY NOT PROVIDE MEANINGFUL COMMERCIAL
PROTECTION FOR OUR PRODUCTS, WHICH COULD ENABLE THIRD PARTIES TO USE OUR
TECHNOLOGY OR VERY SIMILAR TECHNOLOGY AND COULD REDUCE OUR ABILITY TO COMPETE IN
THE MARKET.
Our ability to compete effectively depends in part, on our ability to maintain
the proprietary nature of our technologies and manufacturing processes, which
includes the ability to obtain, protect and enforce patents on our technology
and to protect our trade secrets. We own or have licensed patents that cover
aspects of certain of our product lines. However, you should not rely on our
patents to provide us with any significant competitive advantage. Others may
challenge our patents and, as a result, our patents could be narrowed,
invalidated or rendered
16
unenforceable. Competitors may develop products similar to ours that our patents
do not cover. In addition, our current and future patent applications may not
result in the issuance of patents in the United States or foreign countries.
Further, there is a substantial backlog of patent applications at the U.S.
Patent and Trademark Office, and the approval or rejection of patent
applications usually takes from 18 to 24 months.
OUR COMPETITIVE POSITION DEPENDS, IN PART, UPON UNPATENTED TRADE SECRETS WHICH
WE MAY BE UNABLE TO PROTECT.
Our competitive position also depends upon unpatented trade secrets. Trade
secrets are difficult to protect. We cannot assure you that others will not
independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to our trade secrets, that our trade secrets
will not be disclosed or that we can effectively protect our rights to
unpatented trade secrets.
In an effort to protect our trade secrets, we require our employees, consultants
and advisors to execute proprietary information and invention assignment
agreements upon commencement of employment or consulting relationships with us.
These agreements provide that, except in specified circumstances, all
confidential information developed or made known to the individual during the
course of their relationship with us must be kept confidential. We cannot assure
you, however, that these agreements will provide meaningful protection for our
trade secrets or other proprietary information in the event of the unauthorized
use or disclosure of confidential information.
OUR SUCCESS WILL DEPEND PARTLY ON OUR ABILITY TO OPERATE WITHOUT INFRINGING OR
MISAPPROPRIATING THE PROPRIETARY RIGHTS OF OTHERS.
We may be sued for infringing the intellectual property rights of others. In
addition, we may find it necessary, if threatened, to initiate a lawsuit seeking
a declaration from a court that we do not infringe the proprietary rights of
others or that their rights are invalid or unenforceable. If we do not prevail
in any litigation, in addition to any damages we might have to pay, we would be
required to stop the infringing activity or obtain a license for the proprietary
rights involved. Any required license may be unavailable to us on acceptable
terms, or at all. In addition, some licenses may be nonexclusive and allow our
competitors to access the same technology we license. If we fail to obtain a
required license or are unable to design our product so as not to infringe on
the proprietary rights of others, we may be unable to sell some of our products,
which could have a material adverse effect on our revenues and profitability.
IT MAY BE DIFFICULT TO REPLACE SOME OF OUR SUPPLIERS.
Outside vendors, some of whom are sole-source suppliers, provide key components
and raw materials used in the manufacture of our products. Although we believe
that alternative sources for many of these components and raw materials are
available, any supply interruption in a limited or sole source component or raw
material could harm our ability to manufacture our products until a new source
of supply is identified and qualified. In addition, an uncorrected defect or
supplier's variation in a component or raw material, either unknown to us or
incompatible with our manufacturing process, could harm our ability to
manufacture products. We may not be able to find a sufficient alternative
supplier in a reasonable time period, or on commercially reasonable terms, if at
all, and our ability to produce and supply our products could be impaired. We
believe that these factors are most likely to affect the following products that
we manufacture:
o our collagen-based products, such as INTEGRA(R) Dermal Regeneration
Template, DuraGen(R) Dural Graft Matrix and DuraGen Plus(TM) Dural
Regeneration 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 Camino(R), Ventrix(R) and NeuroSensor(TM) lines
of intracranial monitors and catheters.
If we were suddenly unable to purchase products from one or more of these
companies, we could need a significant period of time to qualify a replacement,
and the production of any affected products could be disrupted. While it is our
policy to maintain sufficient inventory of components so that our production
will not be significantly disrupted even if a particular component or material
is not available for a period of time, we remain at risk that we will not be
able to qualify new components or materials quickly enough to prevent a
disruption if one or more of our suppliers ceases production of important
components or materials.
17
IF ANY OF OUR MANUFACTURING FACILITIES WERE DAMAGED AND/OR OUR MANUFACTURING OR
BUSINESS PROCESSES INTERRUPTED, WE COULD EXPERIENCE LOST REVENUES AND OUR
BUSINESS COULD BE SERIOUSLY HARMED.
We manufacture our products in a limited number of facilities. Damage to our
manufacturing, development or research facilities due to fire, natural disaster,
power loss, communications failure, unauthorized entry or other events could
cause us to cease development and manufacturing of some or all of our products.
In particular, our San Diego, California facility that manufactures our
Camino(R) and Ventrix(R) product line is as susceptible to earthquake damage,
wildfire damage and power losses from electrical shortages as are other
businesses in the Southern California area. Our silicone manufacturing plant in
Anasco, Puerto Rico is vulnerable to hurricane damage. Although we maintain
property damage and business interruption insurance coverage on these
facilities, we may not be able to renew or obtain such insurance in the future
on acceptable terms with adequate coverage or at reasonable costs.
In addition, we are implementing in several stages over several years an
enterprise business system for use in all of our facilities. This system will
replace several systems on which we now rely. We have outsourced our product
distribution function in the United States and are also planning to outsource
our European product distribution function. A delay or other problem with the
system or in our implementation schedule for either of these initiatives could
have a material adverse effect on our operations.
WE MAY BE INVOLVED IN LAWSUITS TO PROTECT OR ENFORCE OUR INTELLECTUAL PROPERTY
RIGHTS, 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. Intellectual property litigation is costly, and, even if
we prevail, the cost of that litigation could affect our profitability. In
addition, litigation is time consuming and could divert management attention and
resources away from our business. We may also provoke these third parties to
assert claims against us.
WE ARE EXPOSED TO A VARIETY OF RISKS RELATING TO OUR INTERNATIONAL SALES AND
OPERATIONS, INCLUDING FLUCTUATIONS IN EXCHANGE RATES, LOCAL ECONOMIC CONDITIONS
AND DELAYS IN COLLECTION OF ACCOUNTS RECEIVABLE.
We generate significant revenues outside the United States in euros, British
pounds and in U.S. dollar-denominated transactions conducted with customers who
generate revenue in currencies other than the U.S. dollar. For those foreign
customers who purchase our products in U.S. dollars, currency fluctuations
between the U.S. dollar and the currencies in which those customers do business
may have an impact on the demand for our products in foreign countries where the
U.S. dollar has increased in value compared to the local currency.
Because we have operations based in Europe and we generate revenues and incur
operating expenses in euros and British pounds, we experience currency exchange
risk with respect to those foreign currency-denominated revenues and expenses.
In 2003 and 2004, the cost of products we manufactured in our European
facilities or purchased in foreign currencies exceeded our foreign
currency-denominated revenues. We expect this imbalance to continue.
Accordingly, a further weakening of the dollar against the euro and British
pound could negatively affect future gross margins and operating margins.
Currently, we do not use derivative financial instruments to manage operating
foreign currency risk. As the volume of our business transacted in foreign
currencies increases, we will continue to assess the potential effects that
changes in foreign currency exchange rates could have on our business. If we
believe that this potential impact presents a significant risk to our business,
we may enter into derivative financial instruments to mitigate this risk.
In general, we cannot predict the consolidated effects of exchange rate
fluctuations upon our future operating results because of the number of
currencies involved, the variability of currency exposure and the potential
volatility of currency exchange rates.
Our sales to foreign markets also may be affected by local economic conditions,
legal, regulatory or political considerations, the effectiveness of our sales
representatives and distributors, local competition and changes in local medical
practice. Relationships with customers and effective terms of sale frequently
vary by country, often with longer-term receivables than are typical in the
United States.
18
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, have substantially revised their payment methodologies, which
has resulted 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 numerous 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 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
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; 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
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, we believe that the sales and
marketing practices of our industry will be subject to increased scrutiny from
government agencies.
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
19
bone in humans. Termination of any of our alliances would require us to develop
other means to distribute the affected products and could adversely affect our
expectations for the growth of private label products.
WE MAY HAVE SIGNIFICANT PRODUCT LIABILITY EXPOSURE AND OUR INSURANCE MAY NOT
COVER ALL POTENTIAL CLAIMS.
We are exposed to product liability and other claims in the event that our
technologies or products are alleged to have caused harm. We may not be able to
obtain insurance for the potential liability on acceptable terms with adequate
coverage or at reasonable costs. Any potential product liability claims could
exceed the amount of our insurance coverage or may be excluded from coverage
under the terms of the policy. Our insurance may not be renewed at a cost and
level of coverage comparable to that then in effect.
WE ARE SUBJECT TO OTHER REGULATORY REQUIREMENTS RELATING TO OCCUPATIONAL HEALTH
AND SAFETY AND THE USE OF HAZARDOUS SUBSTANCES WHICH MAY IMPOSE SIGNIFICANT
COMPLIANCE COSTS ON US.
We are subject to regulation under federal and state laws regarding occupational
health and safety, laboratory practices and the use, handling and disposal of
toxic or hazardous substances. Our research, development and manufacturing
processes involve the controlled use of certain hazardous materials. Although we
believe that our safety procedures for handling and disposing of those materials
comply with the standards prescribed by the applicable laws and regulations, the
risk of accidental contamination or injury from these materials cannot be
eliminated. In the event of such an accident, we could be held liable for any
damages that result and any related liability could exceed the limits or fall
outside the coverage of our insurance and could exceed our resources. We may not
be able to maintain insurance on acceptable terms or at all. We may incur
significant costs to comply with environmental laws and regulations in the
future. We may also be subject to other present and possible future local,
state, federal and foreign regulations.
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.
ITEM 2. PROPERTIES
Our principal executive offices are located in Plainsboro, New Jersey. Principal
manufacturing and research facilities are located in Plainsboro, New Jersey,
Cincinnati, Ohio, San Diego, California, Anasco, Puerto Rico, Andover, England,
Biot, France, Lyon, France, Mielkendorf, Germany and Tuttlingen, Germany. Our
primary distribution centers are located in Sparkes, Nevada, Hawthorne, New
York, Andover, England, Biot, France, Vilvoorde, Belgium and Lyon, France. In
addition, we lease several smaller facilities to support additional
administrative, assembly, and distribution operations. We lease all of our
facilities other than our facilities in Andover, England, Biot, France and
Tuttlingen, Germany, which we own.
All of our manufacturing and distribution facilities 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.
20
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 approximately $1.4 million, bringing the total award to
approximately $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. 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. Oral arguments are scheduled for April 2005, and we expect the
Supreme Court to render a decision before the end of the current term.
In September 2004, the Trial Court ordered Merck KgaA to pay us $6.4 million in
damages following the Circuit Court's order. Further enforcement of the Trial
Court's order has been stayed pending the decision of the Supreme Court.
We have not recorded any gain in connection with this matter, pending final
resolution and completion of the appeals process.
In addition to the Merck KGaA matter, we are subject to various claims, lawsuits
and proceedings in the ordinary course of our business, including claims by
current or former employees and distributors 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.
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. Following objection from NMT Medical, the amount claimed by the
authorities was reduced to 930,367 euros, and negotiations and other procedures
are under way, which may lead to a further reduction of the amount owed. 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 addition, NMT Medical, Inc. has agreed to provide the
French tax authorities with payment of the tax liabilities on behalf of each of
these subsidiaries.
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 elected 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.
21
<Table>
<Caption>
NAME AGE POSITION
Stuart M. Essig ................... 43 President, Chief Executive Officer and Director
Gerard S. Carlozzi................. 49 Executive Vice President, Chief Operating
Officer
John B. Henneman, III.............. 43 Executive Vice President, Chief Administrative
Officer and Secretary
David B. Holtz..................... 38 Senior Vice President, Finance and Treasurer
Deborah A. Leonetti ............... 49 Senior Vice President, Marketing
Donald R. Nociolo ................. 42 Senior Vice President, Operations
Judith E. O'Grady.................. 54 Senior Vice President, Regulatory, Quality
Assurance and Clinical Affairs
Robert D. Paltridge ............... 47 Senior Vice President, Global Sales
</Table>
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 received an A.B. degree from the Woodrow Wilson School of
Public and International Affairs at Princeton University and an MBA and a Ph.D.
degree in Financial Economics from the University of Chicago, Graduate School of
Business. Mr. Essig also serves on the Board of Directors of St. Jude Medical
Corporation and ADVAMED, the Advanced Medical Technology Association.
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, a privately held company. He received
a BS degree in engineering and an MBA 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 his A.B. from Princeton University and
his 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, and was promoted to
Senior Vice President, Finance and Treasurer in February 2001. 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. He received a BS 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, 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. She received her nursing degree from St. Joseph's
Hospital School of Nursing and La Salle University.
22
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 of Operations in May 2000. He is responsible for managing Integra's
worldwide manufacturing and distribution operations. Mr. Nociolo has over
sixteen 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 BS degree in
Industrial Engineering from Rutgers University and an MBA in Industrial
Management from Fairleigh Dickinson University.
Judith E. O'Grady has served as Senior Vice President of Regulatory Affairs,
Quality Assurance and Clinical Affairs, since 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 more than 500 FDA and
international submissions. She received her BS degree from Marquette University
and MSN 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 21 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 BS degree in Business Administration from Rutgers University.
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:
<Table>
<Caption>
HIGH LOW
2004
Fourth Quarter $ 37.36 $ 29.41
Third Quarter $ 35.79 $ 27.14
Second Quarter $ 36.00 $ 29.76
First Quarter $ 33.86 $ 28.74
2003
Fourth Quarter $ 34.99 $ 27.23
Third Quarter $ 30.65 $ 23.39
Second Quarter $ 29.94 $ 21.75
First Quarter $ 23.72 $ 15.66
</Table>
For purposes of calculating the aggregate market value of the shares of our
voting stock held by non-affiliates, as shown on the cover page of this report,
we have assumed that all outstanding shares not held by our directors and
executive officers and stockholders owning 10% or more of outstanding shares
were held by non-affiliates. However, this should not be deemed to constitute an
admission that any such persons are, in fact, affiliates of ours. Further
information concerning ownership of our voting stock by executive officers,
directors and principal stockholders will be included in our definitive proxy
statement for our upcoming Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission.
We have not paid any cash dividends on our common stock since our formation. 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.
23
The number of stockholders of record as of March 11, 2005 was approximately 480,
which includes stockholders whose shares were held in nominee name.
ISSUER PURCHASES OF EQUITY SECURITIES
We did not purchase any shares of our common stock during the quarter ended
December 31, 2004.
In March 2004, our Board of Directors authorized us to repurchase up to 1.5
million shares of our common stock for an aggregate purchase price not to exceed
$40 million. We were authorized to repurchase shares under this program through
December 31, 2004 either in the open market or in privately negotiated
transactions. We purchased 500,000 shares for $14.2 million under this program
ITEM 6. SELECTED FINANCIAL DATA
The information set forth below should be read in conjunction with "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.
<Table>
<Caption>
Years Ended December 31,
2004 2003 2002 2001 2000
--------- --------- --------- --------- ---------
(in thousands, except per share data)
Operating Results:
Total revenues (1) ......................... $ 229,825 $ 185,599 $ 117,822 $ 93,442 $ 71,649
Total operating costs and expenses (2) ..... 205,046 145,952 98,635 79,156 83,370
--------- --------- --------- --------- ---------
Operating income (loss) .................... 24,779 39,647 19,187 14,286 (11,721)
Interest income (expense), net ............. 555 471 3,535 1,393 (473)
Gain on disposition of product line ........ -- -- -- -- 1,146
Other income (expense), net (1) ............ 2,674 3,071 3 (392) 201
--------- --------- --------- --------- ---------
Income (loss) before income taxes .......... 28,008 43,189 22,725 (15,287) (10,847)
Income tax expense (benefit) (3) ........... 10,811 16,328 (12,552) (10,876) 108
--------- --------- --------- --------- ---------
Net income (loss) before cumulative
effect of accounting change ............. 17,197 26,861 35,277 26,163 (10,955)
Cumulative effect of accounting change(5) .. -- -- -- -- (470)
--------- --------- --------- --------- ---------
Net income (loss) .......................... $ 17,197 $ 26,861 $ 35,277 $ 26,163 $ (11,425)
========= ========= ========= ========= =========
Diluted net income (loss) per share (6) .... $ 0.55 $ 0.86 $ 1.14 $ 0.92 $ (0.97)
Weighted average shares outstanding ........ 31,102 33,104 30,720 27,196 17,553
</Table>
<Table>
<Caption>
December 31,
2004 2003 2002 2001 2000
--------- --------- --------- --------- ----------
(in thousands)
Financial Position:
Cash, cash equivalents, and marketable securities (4,7) ... $ 195,982 $ 206,743 $ 132,311 $ 131,036 $ 15,138
Total assets ............................................... 456,713 412,526 274,668 227,588 86,514
Long-term debt (7) ......................................... 118,900 119,257 -- -- 4,758
Accumulated deficit ........................................ (265) (17,462) (44,323) (79,600) (105,729)
Stockholders' equity ....................................... 307,823 268,530 247,597 204,056 53,781
</Table>
(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 following the termination of
the supply distribution and collaboration agreement in December 2003.
We also recorded a $2.0 million gain in other income associated with a
related termination payment received from ETHICON.
(2) We recorded the following significant items in operating expenses:
$23.9 million and $13.5 million in stock-based compensation charges
incurred in connection with the extensions of the employment agreement
of our President and Chief Executive Officer in 2004 and 2000,
respectively; $0.4 million and $2.3 million of acquired in-process
research and development charges recorded in connection with
acquisitions in 2003 and 2002, respectively; $1.1 million of expenses
related to the closing of our San Diego research center and a $2.0
million donation to the Integra Foundation in 2003.
(3) In 2002 and 2001, respectively, we recognized a $20.4 million and $11.5
million deferred income tax benefit primarily related to the reduction
of a portion of the valuation allowance recorded against our deferred
tax assets.
(4) In August 2001, we issued 4,747,500 shares of common stock at $25.50
per share in a follow-on public
24
offering. The net proceeds generated by the offering, after expenses,
were $113.4 million. We subsequently used a portion of these proceeds
to repay outstanding indebtedness totaling $9.3 million, for which we
recorded a $256,000 loss on the early retirement of debt.
(5) As the result of the adoption of SEC Staff Accounting Bulletin No. 101
"Revenue Recognition" (SAB 101), we recorded a $470,000 cumulative
effect of an accounting change to defer a portion of a nonrefundable,
up-front fee received and recorded in other revenue in 1998. The
cumulative effect of this accounting change was measured as of January
1, 2000. As a result of this accounting change, other revenue in 2003,
2002, 2001 and 2000 includes $112,000 of amortization of the amount
deferred as of January 1, 2000.
(6) Diluted net income per share for 2003 was restated for the adoption of
EITF Issue 04-08 "The Effect of Contingently Convertible Instruments on
Diluted Earnings per Share". Issue 04-08 requires issuers of contingent
convertible securities to account for these securities on an
"if-converted" basis pursuant to Statement of Financial Accounting
Standards No. 128 "Earnings Per Share" in computing diluted earnings
per share whether or not the issuer's stock is above the contingent
conversion price. The provisions of Issue 04-08 are effective for all
periods ending after December 15, 2004 and have been applied on a
retroactive basis. Previously disclosed 2003 diluted net income per
share was reduced by $0.02 to $0.86.
(7) 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.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS 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 develops, manufactures and markets medical devices for use in
neuro-trauma, neurosurgery, reconstructive surgery and general surgery. Our
business is organized into product groups and distribution channels. Our product
groups include implants and other devices for use in surgical procedures,
monitoring systems for the measurement of various parameters in tissue (such as
pressure, temperature and oxygen), hand-held and ultrasonic surgical
instruments, and private label products that we manufacture for other medical
device companies.
Our distribution channels include three sales organizations in the United
States: one that we employ to call on neurosurgeons known as our Integra
NeuroSciences(TM) sales organization, another employed to call on reconstructive
surgeons and a third group that utilizes a network of third-party distributors.
Internationally, we combine resources across different sales channels in some
cases with direct sales organizations in France, Germany, the United Kingdom and
the Benelux region. Outside of these areas, we operate through a number of
distributors that sell our products in over 90 countries. We invest substantial
resources and management effort to develop our sales organizations, and we
believe that we compete very effectively in this aspect of our business. We
distribute private label products through strategic alliances.
25
We manufacture most of the implant, monitoring and private label products that
we sell in various plants located in the United States, Puerto Rico, France, the
United Kingdom and Germany. We also 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
develop and build these products in our manufacturing facility in Plainsboro,
New Jersey. Taken together, these products accounted for approximately 31%, 27%
and 32% of product revenues in the years ended December 31, 2004, 2003 and 2002,
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 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 hope to increase to
more than 65% over a period of several years, operating margins, which we hope
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,
2004 not directly comparable to those of the corresponding prior year periods.
Since the beginning of 2002, we have acquired the following businesses, assets
and product lines:
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 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. 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. Integra ME
markets and sells its products to hospitals and physicians primarily through a
network of distributors in markets outside the United States.
In January 2004, we acquired two small instruments businesses: the R&B
instrument business from R&B Surgical Solutions, LLC for approximately $2.0
million in cash and the Sparta disposable critical care devices and surgical
instruments business from Fleetwood Medical, Inc. for approximately $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. We market these products
through our JARIT sales organization. The Sparta product line includes products
used in plastic and reconstructive, ear, nose and throat (ENT), neuro,
ophthalmic and general surgery. We sell the Sparta products through a direct
marketing organization and an existing distributor network.
In December 2003, we acquired the assets of Reconstructive Technologies, Inc.
for $400,000 in cash and an agreement to make future payments based on product
sales. Reconstructive Technologies is the developer of the Automated Cyclic
Expansion System (ACE System(TM)), a tissue expansion device. As the ACE system
is not yet
26
approved, we recorded an in-process research and development charge in
connection with this acquisition. Once approved, we plan to market the system
through our reconstructive sales organization.
In November 2003, we acquired all of the outstanding capital stock of Spinal
Specialties, Inc. from I-Flow Corporation for $6.4 million in cash, including
expenditures associated with the acquisition and a working capital adjustment.
Spinal Specialties assembles and sells custom kits and products for chronic pain
management, including the OsteoJect(TM) Bone Cement Delivery System and the
ACCU-DISC(TM) Pressure Monitoring System. Spinal Specialties markets its
products to anesthesiologists and interventional radiologists through an
in-house telemarketing team and a network of distributors. We report sales of
Spinal Specialties products as instrument revenues.
In August 2003, we acquired the assets of Tissue Technologies, Inc., the
manufacturer and distributor of the UltraSoft(TM) line of facial implants for
soft tissue augmentation of the facial area, for $0.6 million in cash and up to
an additional $1.5 million based on future sales of the acquired products. We
market the UltraSoft(TM) products directly to cosmetic and reconstructive
surgeons through our reconstructive surgery sales organization
In March 2003, we acquired all of the outstanding capital stock of J. Jamner
Surgical Instruments, Inc. (doing business as JARIT(R) Surgical Instruments) for
$45.6 million in cash. JARIT sells its products to more than 5,200 hospitals and
surgery centers worldwide. JARIT generates its domestic product sales primarily
through sales to hospitals that are members of group purchasing organizations.
Group purchasing organizations use the combined leverage of their member
hospitals to obtain better prices for medical products for the participating
hospitals and other health care providers than might otherwise be available to
these institutions individually. The acquisition of JARIT broadened our customer
base and surgical instrument product offering and facilitated the procurement of
our Ruggles(TM) and Padgett instrument products directly from the instrument
manufacturers.
In December 2002, we acquired the epilepsy monitoring and neurosurgical shunt
business of the Radionics division of Tyco Healthcare Group for $3.7 million in
cash. We moved the manufacturing of the acquired lines to our facility in Biot,
France and are selling the acquired products through our Integra
NeuroSciences(TM) sales force.
In October 2002, we acquired Padgett Instruments, Inc., a marketer of
instruments used in reconstructive and plastic surgery, for $9.6 million in
cash. Our acquisition of Padgett Instruments broadened our existing surgical
customer base and allowed us to expand into new market segments. We consolidated
Padgett's operations into our then existing distribution center located in
Cranbury, New Jersey in March 2003.
In August 2002, we acquired certain assets, including the NeuroSensor(R) monitor
and rights to certain intellectual property, from Novus Monitoring Limited of
the United Kingdom and entered into a related development agreement pursuant to
which Novus agreed to provide, at its own cost, certain development activities
related to the acquired products and technology. We paid Novus $3.5 million in
cash at closing and a $1.4 million milestone payment related to the development
of a next-generation, advanced neuromonitoring system in September 2004. We are
required to pay up to an additional $2.5 million based upon revenues from Novus'
products. We expect the Novus products to complement our existing line of brain
parameter monitoring products. We expect to introduce the NeuroSensor(R)
Cerebral Blood Flow Monitoring System in the first half of 2005. The
NeuroSensor(R) Cerebral Blood Flow Monitoring System measures both intracranial
pressure and cerebral blood flow using a single combined probe and an electronic
monitor for data display.
In August 2002, we acquired the neurosciences division of NMT Medical, Inc. for
$5.7 million in cash. Through this acquisition, we added a range of leading
differential pressure valves, including the Orbis-Sigma(R), Integra Hakim(R) and
horizontal-vertical lumbar valves, and external ventricular drainage products to
our neurosurgical product line. The acquired operations included a facility
located in Biot, France that manufactures, packages and distributes shunting,
catheter and drainage products.
In July 2002, we acquired the assets of Signature Technologies, Inc., a
specialty manufacturer of titanium and stainless steel implants for the
neurosurgical and spinal markets, and certain other intellectual property
assets. The purchase price consisted of $2.9 million in cash, $0.5 million of
deferred consideration and royalties on future sales of products to be
developed. Our acquisition of Signature Technologies gave us the capability of
developing and manufacturing metal implants for our strategic partners and for
our direct sale organizations. Through June 2004, Signature Technologies
manufactured cranial fixation systems for sale primarily under a single contract
manufacturing agreement. In December 2004, we consolidated the Signature
manufacturing operation into our Cincinnati, Ohio facility.
27
In November 2004, we agreed to acquire all of the outstanding capital stock of
Newdeal Technologies for 38.5 million euros in cash, subject to certain
adjustments. The acquisition closed on January 3, 2005. Based in Lyon, France,
Newdeal is a leading developer and marketer of specialty implants and
instruments specifically designed for foot and ankle surgery. The company sells
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.
RESULTS OF OPERATIONS
Net income in 2004 was $17.2 million, or $0.55 per diluted share, as compared to
net income of $26.9 million, or $0.86 per diluted share, in 2003 and net income
of $35.3 million, or $1.14 per diluted share, in 2002. Included in these amounts
are certain revenues, charges or gains resulting from facts and circumstances
that, based on our recent history and future expectations, may not recur with
similar materiality or impact on continuing operations. We believe that the
identification of all revenues, charges and gains that meet these criteria
promotes comparability of reported financial results. The following revenues,
charges and gains were included in net income and net income per diluted share:
In 2004
- - We recorded a $1.4 million charge in connection with the milestone
payment related to the completion of certain development activities
related to the NeuroSenor(R) Cerebral Blood Flow 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.
- - We recorded a $23.9 million share-based compensation charge associated
with the renewal of our President and Chief Executive Officer's
employment agreement.
- - We recorded a $1.3 million tax charge incurred in connection with the
reorganization of certain European operations.
- - 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 Newdeal Technologies acquisition was
completed in January 2005.
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 incurred $1.1 million of expenses related to the closing of our San
Diego research center, consolidation of the research activities into
our other facilities and the discontinuation of certain research
programs.
- - We recorded an acquired in-process research and development charge of
$400,000 in connection with an acquisition.
- - We made a $2.0 million donation to the Integra Foundation, which is
included in general and administrative expenses.
- - We received a $2.0 million payment from ETHICON from the termination of
our agreement with them, which is included in other income.
In 2002
- - We recorded a $20.4 million deferred income tax benefit primarily from
the reduction of the valuation allowance recorded against our deferred
tax assets associated with net operating loss carryforwards.
- - We recorded acquired in-process research and development charges of
$2.3 million in connection with acquisitions.
TOTAL REVENUES AND GROSS MARGIN ON PRODUCT REVENUES
<Table>
<Caption>
(in thousands, except per share data) 2004 2003 2002
-------- -------- --------
Monitoring products ................................. $ 48,217 $ 44,229 $ 37,184
Implant products ......... .......................... 78,418 53,301 38,326
Instruments ......................................... 77,667 47,168 16,802
Private label products .............................. 24,188 21,997 20,313
-------- -------- --------
</Table>
28
<Table>
Total product revenues ................................. 228,490 166,695 112,625
Other revenue .......................................... 1,335 18,904 5,197
-------- -------- --------
Total revenues.......................................... 229,825 185,599 117,822
Cost of product revenues ............................... 87,299 70,597 45,772
Gross margin on product revenues ....................... 141,191 96,098 66,853
Gross margin as a percentage of product revenues ....... 62% 58% 59%
</Table>
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, or 79% of
total product revenues, as compared to 80% of product revenues in 2003 and 2002.
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.
In 2003, total revenues increased 58% over 2002 to $185.6 million, led by a 48%
increase in product revenues to $166.7 million. Domestic product revenues
increased $42.4 million in 2003 to $132.8 million. Sales of instruments and
implant products, which reported a 181% and 39% increase, respectively, in sales
over 2002, led our growth in product revenues in 2003.
Reported product revenues for 2004 and 2003 included the following amounts in
revenues from acquired product lines:
<Table>
<Caption>
2004 Revenues 2003 Revenues % change
------------- ------------- --------
(in thousands)
Total Product Revenues
Products acquired during 2004 ... $ 13,632 $ -- N/A
Products acquired during 2003 ... 39,898 24,476 63%
All other product revenues ...... 174,960 142,219 23%
-------- --------
Total product revenues .......... 228,490 166,695 37%
</Table>
Product revenues excluding 2004 and 2003 acquisitions grew at 23% for the year
ended December 31, 2004 as compared to 2003. Increased sales of our DuraGen(R)
Dural Graft Matrix and INTEGRA(R) Dermal Regeneration Template product families
as well as an increase in our Absorbable Collagen Sponge product sold to Wyeth
BioPharma accounted for a significant portion of this growth. Our revenue growth
in 2003 over 2002, excluding acquisitions, was driven by our DuraGen(R) Dural
Graft Matrix, NeuraGen(TM) Nerve Guide, intracranial monitoring and drainage
systems, and neurosurgical systems products. All of the products acquired in
2004 and 2003 were added to the instrument product group.
In 2004, we launched several new products under the DuraGen(R) Dural Graft
Matrix and INTEGRA(R) Dermal Regeneration Template product families. However, we
expect growing competition in the area of absorbable implant technology
products, which could affect growth in our product lines. We continue to broaden
our product offerings using our proprietary absorbable implant technology by
developing products that meet the additional needs of surgeons within the
markets we serve. Our acquisition in January 2005 of the Newdeal foot and angle
implant product lines gives us additional opportunities to expand the use of our
absorbable implant products into additional areas within the surgical
reconstructive market.
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 future growth will derive from our expanded
domestic sales force, the continued implementation of our direct sales strategy
in Europe and from internally developed and acquired products. We also intend to
continue to acquire businesses that complement our existing businesses and
products.
Gross margin as a percentage of product revenues was 62% in 2004, 58% in 2003
and 59% in 2002. Cost of product revenues included $270,000, $1,261,000 and
$447,000 in fair value inventory purchase accounting adjustments recorded in
connection with acquisitions in 2004, 2003 and 2002, respectively. Product gross
margins improved in 2004 as a result of increased sales of higher margin
products, including the effect of selling our INTEGRA(R) Dermal Regeneration
products directly, as well as the contribution of the MAYFIELD product line we
acquired in 2004. During 2003, the gross margin was negatively affected by fair
value inventory purchase accounting adjustments and from the acquisition of
lower margin products. The impact of foreign exchange rates on the cost of
products that we manufacture or purchase in Europe negatively affected gross
margins in 2004 and 2003. We expect our future gross
29
margins to continue to benefit as our higher margin products continue to grow
faster than other products and as we continue to increase sales of our products
in foreign currencies.
We currently do not hedge our exposure to operating foreign currency risk. In
2004 and 2003, the cost of products we manufacture or purchase in Europe
exceeded our foreign currency-denominated revenues. We expect this imbalance to
continue into 2005. A further weakening of the dollar against the euro and
British pound could negatively affect future gross margins.
Other revenue has historically consisted of research and development funding
from strategic partners and government grants, and license, distribution, and
other event-related revenues from strategic partners and other third parties. In
2003, our other revenue included $16.3 million of revenues derived from an
agreement with ETHICON that was terminated in December 2003. We do not expect to
generate significant revenues in the future from these types of arrangements.
OTHER OPERATING EXPENSES
The following is a summary of other operating expenses as a percent of total
revenues:
<Table>
<Caption>
2004 2003 2002
-------- -------- --------
Research and development ............................... 6% 7% 10%
Selling, general and administrative .................... 43% 32% 34%
</Table>
Research and development costs have continued to decline as 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. Our 2004 research
and development expenses increased $1.3 million to $14.1 million and included a
$1.4 million milestone payment related to the completion of certain development
activities for an advanced neuromonitoring 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. In 2003 we incurred $950,000 of
expenses related to the consolidation of our San Diego research center with our
other facilities. We also reported in-process research and development charges
of $400,000 and $2.3 million in 2003 and 2002, respectively. In 2005, we expect
our research and development expenses as a percentage of total revenues to
remain consistent with 2004 as we increase expenditures on research and clinical
activities directed towards expanding the indications for use of our absorbable
implant technology products, including a multi-center clinical trial suitable to
support an application to the FDA for approval of the DuraGen Plus(TM) Adhesion
Barrier Matrix product in the United States.
Selling, general and administrative expenses increased significantly in 2004 and
included a stock-based compensation charge of $23.9 million related to the
renewal of our President and Chief Executive Officer's employment agreement.
This stock-based compensation charge represented 10% of total revenues. We
reported significant increases in sales and marketing expenditures as we
continue to build our direct sales and marketing organizations around all three
direct selling platforms. Sales and marketing increases included additional
personnel costs, additional trade show activities as well as costs related to
acquired product lines. We made significant investments in our infrastructure
with the implementation of a new enterprise business system and the relocation
and expansion of our distribution capabilities through a third-party service
provider. We also incurred a significant increase in professional fees
associated with compliance with new internal controls compliance and reporting.
In 2003, increases in spending included sales support for JARIT instrument sales
and the expansion of the reconstructive sales force in anticipation of the
termination of the ETHICON agreement. We also hired more experienced marketing
professionals and spent more on advertising. In addition, in 2003 we donated
$2.0 million to the Integra Foundation and incurred additional costs to
consolidate several facilities. In 2005, we expect our selling, general and
administrative costs as a percentage of revenue will return to the 2003 and 2002
range.
Amortization expense increased to $4.3 million in 2004 because of amortization
on intangible assets acquired through our business acquisitions. Including the
expected impact of intangible assets acquired in the acquisition of Newdeal in
January 2005, we expect annual amortization expense to be approximately $6.1
million in 2005, $6.0 million in 2006, $5.7 million in 2007, $5.4 million in
2008 and $4.7 million in 2009.
NON-OPERATING INCOME AND EXPENSES
In March and April 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 2004 and 2003, we recorded interest
30
expense of $3.5 million and $2.7 million, respectively, in connection with these
notes, which was offset by $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 $365,000 liability related to the estimated fair
value of the Contingent Interest obligation at the time the notes were issued.
The fair value of this Contingent Interest obligation is marked to its fair
value at each balance sheet date, with changes in the fair value recorded to
interest expense. At December 31, 2004 and 2003, the estimated fair value of the
Contingent Interest obligation was $710,000 and $460,000, respectively.
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. Interest expense for the years
ended December 31, 2004 and 2003, respectively, reflects a $686,000 and $330,000
reduction associated with the interest rate swap.
The net fair value of the interest rate swap at inception was $767,000. In 2004
and 2003, the net fair value of the interest rate swap increased $287,000 to
$1.4 million and $305,000 to $1.1 million, respectively. In connection with this
fair value hedge, we recorded in 2004 and 2003 a $430,000 and $433,000,
respectively, net decrease in the carrying value of our contingent convertible
notes. The $143,000 and $128,000 net difference between changes in the fair
value of the interest rate swap and the contingent convertible notes represents
the ineffective portion of the hedging relationship, and these amounts are
recorded in other income (expense), net.
Our net other income/expense declined in 2004 by $400,000 to $2.7 million as a
result of an increase in foreign currency transaction gains, including a $1.4
million unrealized gain associated with the foreign currency collar in 2004,
offset by the decline of $2.0 million from the termination payment received from
ETHICON in 2003.
INCOME TAXES
Since 1999, we have generated positive taxable income on a cumulative basis. In
light of this trend, our projections for future taxable earnings and the
expected timing of the reversal of deductible temporary differences, in 2002, we
reduced the remaining valuation allowance recorded against our net operating
loss carryforwards by $23.4 million, which reflected our estimate of additional
tax benefits that we expected to realize in the future. A valuation allowance of
$5.4 million is recorded against the remaining $31.5 million of net deferred tax
assets recorded at December 31, 2004. 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.
In 2004, our effective income tax rate was 38.6% of income before income taxes
compared to 37.8% in 2003. Our 2004 rate includes a $1.3 million tax charge
related to the transfer of certain intangible assets. We recorded a net income
tax benefit in 2002 related to the reduction of deferred tax asset valuation
allowances previously recorded.
The net decrease in our tax asset valuation allowance was $2.3 million and $26.7
million in 2003 and 2002, respectively.
At December 31, 2004, we had net operating loss carryforwards of approximately
$46.8 million and $0.6 million for federal and state income tax purposes,
respectively, to offset future taxable income. The federal and state net
operating loss carryforwards expire through 2018 and 2005, respectively.
At December 31, 2004, several of our subsidiaries had unused net operating loss
carryforwards and tax credit carryforwards arising from periods prior to our
ownership which expire through 2005. The Internal Revenue Code limits the timing
and manner in which we may use any acquired net operating losses or tax credits.
31
The American Jobs Creation Act of 2004 (the "Act") 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 taxable income. The
Financial Accounting Standards Board ("FASB") proposed that 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. We are currently evaluating the impact of the FASB guidance
related to qualified production activities on our effective tax rate in future
periods.
INTERNATIONAL PRODUCT REVENUES AND OPERATIONS
Product revenues by major geographic area are summarized below:
<Table>
<Caption>
United Asia Other
States Europe Pacific Foreign Consolidated
-------- -------- --------- --------- --------------
(in thousands)
2004 ..................... $180,887 $ 30,941 $ 8,535 $ 8,127 $228,490
2003 ..................... 132,805 21,433 5,828 6,629 166,695
2002 ..................... 90,422 14,737 4,062 3,404 112,625
</Table>
In 2004, revenues from customers outside the United States totaled $47.6
million, or 21% of consolidated product revenues, of which approximately 65%
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.
In 2002, product revenues from customers outside the United States totaled $22.2
million, or 20% of consolidated product revenues, of which approximately 66%
were to European customers. Revenues from customers outside the United States
included $13.4 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 2004, 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 2005. We currently do not
hedge our exposure to operating foreign currency risk. Accordingly, a further
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.
Our sales to foreign markets may be affected by local economic conditions,
regulatory or political considerations, the effectiveness of our sales
representatives and distributors, local competition and changes in local medical
practice.
Relationships with customers and effective terms of sale frequently vary by
country, often with longer-term receivables than are typical in the United
States.
LIQUIDITY AND CAPITAL RESOURCES
CASH AND MARKETABLE SECURITIES
32
At December 31, 2004, we had cash, cash equivalents and marketable securities
totaling $196 million. Investments consist almost entirely of highly liquid,
interest bearing debt securities.
CASH FLOWS
We generated positive operating cash flows of $39.0 million, $34.8 million and
$32.0 million in 2004, 2003 and 2002, respectively. Operating cash flows
continued to improve primarily as a result of higher pre-tax income adjusted for
the add back of non-cash items and the benefits from the continued utilization
of our net operating loss carryforwards and tax deductions generated by employee
stock option exercises. Included in the 2004 operating cash flow was a $20.2
million use of cash related to changes in working capital items. A significant
increase in accounts receivable and inventory was primarily due to the overall
growth in the business and delays in customer collections related to business
systems transitions. We expect our days on hand in accounts receivable and
inventory to return to historic trend levels during 2005. Based on our current
unused net operating loss carryforward position and various other future
potential tax deductions, we expect our operating cash flows to continue to
benefit from actual cash tax payments being lower than our effective book income
tax rate for at least the next two years.
In 2004, we used $14.2 million to repurchase 500,000 shares of our common stock,
which was partially offset by $6.1 million in cash flows generated from the
issuance of common stock under employee benefit plans. Other principal uses of
funds in 2004 were $29.3 million for acquisitions and $8.5 million in purchases
in property and equipment. The $4.7 million increase in purchases of property
and equipment in 2004 was primarily related to our procurement and
implementation of our new enterprise business software. We had positive cash
flows of $50.6 million from the net sales and maturities of marketable debt
securities.
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 had uses of
funds of $50.4 million for acquisitions, $72.9 million for the net purchases of
marketable debt securities, $35.4 million for the repurchase of approximately
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.
In 2002, our principal sources of funds were $32.0 million of operating cash
flow and $3.3 million from the issuance of common stock under employee benefit
plans. In 2002, our principal uses of funds were $25.0 million for acquisitions,
the repayment of a $3.6 million note and $2.3 million for capital expenditures.
WORKING CAPITAL
At December 31, 2004 and 2003, working capital was $192.0 million and $171.0
million, respectively. The increase in working capital in 2004 was primarily due
to increases in inventory to support our growth in product revenues, higher
accounts receivable balances related to increased sales and delays in customer
collections. Both items were also affected by our transition to our new
enterprise business system in the second half of the year. We expect our days on
hand in accounts receivable and inventory to return to historic trend levels
during 2005. The December 31, 2004 amount includes the funds subsequently used
on January 3, 2005 to purchase Newdeal Technologies, as discussed below.
CONVERTIBLE DEBT AND RELATED HEDGING ACTIVITIES
In 2003, we generated $115.9 million of net proceeds from the sale of $120.0
million of our contingent convertible subordinated notes due in March 2008. We
pay interest on the convertible 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 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.
33
In August 2003, 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. 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 contingent convertible
notes. Our effective interest rate on the hedged portion of the notes was 1.6%
as of December 31, 2004.
SHARE REPURCHASE PLANS
During 2004, 2003 and 2002, we repurchased approximately 500,000, 1.5 million
and 100,000 shares, respectively, of our common stock under authorized share
repurchase programs.
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 January 2005, we used
$50.9 million in cash to complete the acquisition of Newdeal Technologies. We
also expect to invest approximately $3.5 million in 2005 associated with the
continued worldwide implementation of our new enterprise business software.
Given the significant level of liquid assets and our objective to grow by
acquisition and alliances, our financial position could change significantly if
we were to complete a business acquisition by utilizing a significant portion of
our liquid assets.
Currently, we do not have any existing borrowing capacity or other credit
facilities in place to raise significant amounts of capital if such a need
arises.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
As of December 31, 2004, we were obligated to pay the following amounts under
various agreements:
<Table>
<Caption>
Less than More than
Total 1 year 1-3 Years 3-5 Years 5 years
------- ----------- ----------- ----------- -----------
(in millions)
Long Term Debt ................ $120.0 $ -- $ -- $120.0 $ --
Interest on Long Term Debt .... 10.5 3.0 6.0 1.5 --
Operating Leases .............. 8.6 2.6 3.3 0.9 1.8
Purchase Obligations .......... 6.3 6.3 -- -- --
Pension Contributions ......... 0.2 0.2 -- -- --
Other Long Term Liabilities ... 0.4 -- 0.1 0.1 0.2
------ ------ ------ ------ ------
Total ......................... $146.0 $ 12.1 $ 9.4 $122.5 $ 2.0
</Table>
In addition, under other agreements we are required to make payments based on
sales levels of certain products or if specific development milestones are
achieved.
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
"--Non-Operating Income and Expenses."
In November 2004, we agreed to acquire all of the outstanding capital stock of
Newdeal Technologies for 38.5 million euros in cash, subject to certain
adjustments. The acquisition closed on January 3, 2005. The above table does not
include the amount we paid at the closing of this transaction on January 3, 2005
and does not include the obligation to pay up to 1.25 million euros plus a
working capital adjustment that we may be obligated to pay under the Newdeal
acquisition agreement on January 3, 2006 as a post-closing payment.
34
USE OF ESTIMATES AND CRITICAL ACCOUNTING POLICIES
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, net realizable value of
inventories, estimates of future cash flows associated with acquired in-process
research and development charges, fair market value of derivative instruments,
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
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. 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 other known factors. Actual
returns could be different from our estimates and the related provisions for
sales returns and allowances, resulting in future changes to the sales returns
and allowances provision.
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. 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 and
projections of future demand. To the extent that we determine there are excess,
obsolete or expired inventory quantities, we record valuation reserves against
all or a portion of the value of the related products. If future demand or
market conditions are different than our projections, a change in recorded
inventory valuation reserves may be required and would be reflected in cost of
revenues in the period the revision is made.
DERIVATIVES
We report all derivatives at their estimated fair value and record changes in
fair value in current earnings or defer 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, we assess 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, we discontinue hedge accounting. All hedge
ineffectiveness is included in current period earnings in other income
(expense), net.
We document all relationships between hedged items and derivatives. Our overall
risk management strategy describes the circumstances under which we may
undertake hedge transactions and enter into derivatives. The objective of our
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 our 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 our view of the
creditworthiness of the derivative counterparty. If a derivative is no longer
35
deemed to qualify as an effective hedge, changes in the fair value of that
derivative could significantly affect our non-operating income or expense.
ACQUIRED IN-PROCESS RESEARCH AND DEVELOPMENT CHARGES
In-process research and development charges are recorded in connection with
acquisitions and represent the value assigned to acquired assets which have not
yet reached technological feasibility and for which there is no alternative use.
Fair 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.
Significant assumptions underlying these cash flows include our assessment of
the timing and our ability to successfully complete the in-process research and
development project, projected cash flows associated with the successful
completion of the project, and interest rates used to discount these cash flows
to their present value.
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
that our results of operations, financial position and cash flows in a
particular period could be materially affected by these contingencies 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 (FASB) issued
Statement No. 123 (revised 2004), "Share-Based Payment," which is a revision of
Statement No. 123, "Accounting for Stock-Based Compensation." Statement 123(R)
replaces APB Opinion No. 25, "Accounting for Stock Issued to Employees," and
amends Statement No. 95, "Statement of Cash Flows." Statement 123(R) requires
all share-based payments to employees, including grants of employee stock
options, to be recognized in the financial statements based on their fair value.
Pro forma footnote disclosure will no longer be an alternative to financial
statement recognition.
Statement 123(R) must be adopted no later than July 1, 2005. We expect to adopt
Statement 123(R) on July 1, 2005. Statement 123(R) permits companies to adopt
its requirements using either the "modified prospective" method or the "modified
retrospective" method. Management is currently evaluating the potential impact
of Statement 123(R) on our consolidated financial position and results of
operations and the alternative adoption methods.
In 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. We are currently assessing the potential effect that Statement 151
could have on the our financial position or results of operations.
In October 2004, the FASB Emerging Issue Task Force (EITF) reached a consensus
on Issue 04-08 "The Effect of Contingently Convertible Instruments on Diluted
Earnings per Share" that requires issuers of contingent convertible securities
to account for these securities on an "if-converted" basis pursuant to Statement
of Financial Accounting Standards No. 128 "Earnings Per Share", in computing
their diluted earnings per share whether or not the issuer's stock is above the
contingent conversion price. The provisions of Issue 04-08 are effective for all
periods ending
36
after December 15, 2004 and we have applied them on a retroactive basis. We have
restated all earnings per share amounts to reflect the impact of Issue 04-08. We
reduced previously disclosed 2003 diluted net income per share by $0.02 to
$0.86. We present restated quarterly diluted net income per share for 2004 and
2003 in Note 15 to our consolidated financial statements.
In March 2004, the EITF reached a consensus on Issue 03-01, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments".
Issue 03-01 provides guidance regarding recognition and measurement of
unrealized losses on available-for-sale debt and equity securities accounted for
under Statement of Financial Accounting Standard No. 115, "Accounting for
Certain Investments in Debt and Equity Securities". The application of certain
paragraphs covering the measurement provisions of Issue 03-01 have been deferred
pending the issuance of a final FASB Staff Position providing implementation
guidance on Issue 03-01. The disclosures are effective in annual financial
statements for fiscal years ending after December 15, 2003. Management is
currently assessing the impact that the recognition and measurement provisions
of Issue 03-01 could have on our financial statements.
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 impact our results of
operations and financial condition. To manage the volatility relating to these
typical business exposures, we may enter into various derivative transactions
when appropriate. We do not hold or issue derivative instruments for trading or
other speculative purposes.
FOREIGN CURRENCY EXCHANGE RATE RISK
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 2004, 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 2005. A further weakening of the dollar against
the euro and British pound could negatively affect future gross margins and
operating margins.
In November 2004, we entered into a collar contract for 38.5 million euros
expiring in January 2005 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 (see Note 16 to the financial
statements). The collar contract did not qualify as a hedge under SFAS No. 133.
Accordingly, the collar contract is recorded at fair value and changes in fair
value are recorded in other income (expense), net. In 2004, we recorded a $1.4
million gain related to the change in the fair value of the collar contract.
Other than this foreign currency collar, we do not use derivative financial
instruments to manage operating foreign currency risk. As the volume of our
business transacted in foreign currencies increases, we will continue to assess
the potential effects that changes in foreign currency exchange rates could have
on our business. If we believe 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, 2004 would
increase or decrease interest income by approximately $2.0 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, 2004,
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
37
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 1.6% as of December 31, 2004.
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, 2004, the net fair value of the interest rate swap approximated
$1.4 million and is included in other liabilities. The net fair value of the
interest rate swap represents the estimated receipts or payments that would be
made to terminate the agreement. A hypothetical 100 basis point movement in
interest rates applicable to the interest rate swap would increase or decrease
interest expense by approximately $500,000 on an annual basis.
ITEM 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 Notes to Consolidated Financial Statements, Note 15 - Selected
Quarterly Information - unaudited.
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 the end of the quarter covered by this report. Based on the
foregoing, our principal executive officer and principal financial officer
concluded that our disclosure controls and procedures were effective at the
reasonable assurance level.
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, 2004. Our management's
assessment of the effectiveness of our internal control over financial reporting
as of December 31, 2004 has been audited by PricewaterhouseCoopers LLP, an
independent registered public accounting firm, as stated in their report which
is included herein.
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.
38
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
In August 2004, we implemented in our main business units a new enterprise
business system, which included the following modules: order management,
procurement and payables, general ledger (including receivables, inventory and
fixed assets), manufacturing and human resources. As of August 15, 2004, all of
our business units subject to this implementation began using the new system.
The implementation has involved changes in systems that included internal
control over financial reporting, and accordingly, these changes have required
changes to our system of internal control over financial reporting. We have
reviewed each system as it is being implemented and the internal control over
financial reporting affected by the implementation of the new systems and made
appropriate changes to affected internal control over financial reporting as we
implemented the new systems.
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, 2005, 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.
<Table>
<Caption>
Report of Independent Registered Public Accounting Firm ................. F-1
Consolidated Statements of Operations for the years ended
December 31, 2004, 2003 and 2002 ...................................... F-3
Consolidated Balance Sheets as of December 31, 2004 and 2003 ............ F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 2004, 2003 and 2002 ...................................... F-5
Consolidated Statements of Changes in Stockholders' Equity
For the years ended December 31, 2004, 2003 and 2002 .................. F-6
Notes to Consolidated Financial Statements .............................. F-7
</Table>
2. Financial Statement Schedules.
<Table>
<Caption>
Financial Statement Schedule ............................................ F-33
</Table>
39
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.
<Table>
<Caption>
Exhibit in
Incorporated Filing
-------------------
3.1(a) Amended and Restated Certificate of Incorporation of
the Company (2) (Exh. 3.1)
3.1(b) Certificate of Amendment to Amended and Restated
Certificate of Incorporation dated May 22, 1998 (3) (Exh. 3.1(b))
3.1(c) Certificate of Amendment to Amended and Restated
Certificate of Incorporation dated May 17, 1999 (1)
3.2 Amended and Restated By-laws of the Company (23) (Exh. 3.1)
4.1 Indenture, dated as of March 31, 2003, between
the Company and Wells Fargo Bank
Minnesota, National Association (17) (Exh. 4.1)
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. (18) (Exh. 4.3)
10.1 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 (2) (Exh. 10.30)
10.2 Equipment Lease Agreement between Medicus Corporation
and the Company, dated as of June 1, 2000 (9) (Exh. 10.1)
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 (4) (Exh. 10.37)
10.4 1993 Incentive Stock Option and Non-Qualified Stock
Option Plan* (2) (Exh. 10.32)
10.5(a) 1996 Incentive Stock Option and Non-Qualified Stock
Option Plan* (5) (Exh. 4.3)
10.5(b) Amendment to 1996 Incentive Stock Option and
Non-Qualified Stock Option Plan* (7) (Exh. 10.4)
10.6 1998 Stock Option Plan* (6) (Exh. 4.1)
10.7 1999 Stock Option Plan* (8) (Exh. 10.13)
10.8 Employee Stock Purchase Plan* (21) (App. B)
10.9 Deferred Compensation Plan* (8) (Exh. 10.15)
10.10 2000 Equity Incentive Plan* (11) (Exh. 10.17)
10.11 2001 Equity Incentive Plan* (12) (Exh. 4)
10.12 2003 Equity Incentive Plan* (16) (App. A)
10.13 Second Amended and Restated Employment Agreement
dated July 27, 2004 between the Company and
Stuart M. Essig* (22) (Exh. 10.1)
10.14 Indemnity letter agreement dated December 27, 1997
from the Company to Stuart M. Essig* (7) (Exh. 10.5)
10.15(a) Registration Rights Provisions for Stuart Essig* (7) (Exh. 10.1, Exh. B)
10.15(b) Registration Rights Provisions for Stuart Essig* (10) (Exh. 10.2)
10.15(c) Registration Rights Provisions for Stuart Essig* (22) (Exh. 10.1, Exh. B)
10.16 Amended and Restated Employment Agreement between
John B. Henneman, III and the Company
dated October 31, 2003* (19) (Exh. 10.2)
</Table>
40
<Table>
10.17 Employment Agreement between Gerard Carlozzi and the
Company dated September 25, 2003* (19) (Exh. 10.1)
10.18 Employment Agreement between Judith O'Grady and the
Company dated February 20, 2003* (14) (Exh. 10.17)
10.19 Employment Agreement between David B. Holtz and the
Company dated September 10, 2002* (13) (Exh. 10.38)
10.20 Employment Agreement between Donald R. Nociolo and
the Company dated February 20, 2003* (20) (Exh. 10.20)
10.21 Retention Agreement between Robert Paltridge and the
Company dated February 20, 2003* (17) (Exh. 10.1)
10.22 Severance Agreement between Deborah Leonetti and the
Company dated February 20, 2003* (1)
10.23(a) Lease Contract dated June 30, 1994 between the Puerto
Rico Industrial Development Company and Heyer-Schulte
NeuroCare, Inc. (8) (Exh. 10.32)
10.23(b) Construction and Lease Contract dated June 30, 1994
between the Puerto Rico Industrial Development Company
and Integra NeuroSciences P.R., Inc. (1)
10.24(a) Industrial Real Estate Triple Net Sublease dated
July 1, 2001 between Sorrento Montana, L.P. and
Camino NeuroCare, Inc. (1)
10.24(b) First Amendment to Sublease dated as of July 1, 2003
by and between Sorrento Montana, L.P. and Camino
NeuroCare, Inc. (1)
10.24(c) Second Amendment to Sublease dated as of June 1, 2004
by and between Sorrento Montana, L.P. and Camino
NeuroCare, Inc. (1)
10.24(d) Third Amendment to Sublease dated as of June 15, 2004
by and between Sorrento Montana, L.P. and Integra
LifeSciences Corporation (1)
10.25 Stock Purchase Agreement, dated as of March 17,2003,
among Integra LifeSciences Corporation and Howard Jamner
and other individual stockholders of J. Jamner Surgical
Instruments, Inc. (15) (Exh. 2.1)
10.26 Restricted Units Agreement dated December 27, 1997
between the Company and Stuart M. Essig* (7) (Exh. 10.3)
10.27 Stock Option Grant and Agreement dated December 22,
2000 between the Company and Stuart M. Essig* (10) (Exh. 4.1)
10.28 Stock Option Grant and Agreement dated December 22,
2000 between the Company and Stuart M. Essig* (10) (Exh. 4.2)
10.29 Restricted Units Agreement dated December 22, 2000
Between the Company and Stuart M. Essig* (10) (Exh. 4.3)
10.30 Stock Option Grant and Agreement dated July 27,
2004 between the Company and Stuart M. Essig* (1)
10.31 Contract Stock/Restricted Units Agreement dated July 27,
2004 between the Company and Stuart M. Essig* (1)
10.32 Form of Stock Option Grant and Agreement between
the Company and Stuart M. Essig* (1)
10.33 Share Purchase Agreement dated November 10, 2004 between
Integra LifeSciences Corporation and Eric Fourcault,
Theo Knevels, Jean-Christophe Giet and Bertrand Gauneau (1)
10.34 Form of Notice of Grant of Stock Option and
Stock Option Agreement* (1)
10.35 Form of Non-Qualified Stock Option Agreement
(Non-Directors)* (1)
10.36 Form of Incentive Stock Option Agreement* (1)
10.37 Form of Non-Qualified Stock Option Agreement
(Directors)* (1)
</Table>
41
<Table>
10.38 Compensation of Directors of the Company* (1)
21 Subsidiaries of the Company (1)
23 Consent of PricewaterhouseCoopers LLP (1)
31.1 Certification of Principal Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 (1)
31.2 Certification of Principal Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 (1)
32.1 Certification of Principal Executive Officer
Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 (1)
32.2 Certification of Principal Financial Officer
Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 (1)
</Table>
* Indicates a management contract or compensatory plan or arrangement.
(1) Filed herewith.
(2) Incorporated by reference to the indicated exhibit to the Company's
Registration Statement on Form 10/A (File No. 0-26224) which became
effective on August 8, 1995.
(3) Incorporated by reference to the indicated exhibit to the Company's
Annual Report on Form 10-K for the year ended December 31, 1998.
(4) Incorporated by reference to the indicated exhibit to the Company's
Registration Statement on Form S-1 (File No. 33-98698) which became
effective on January 24, 1996.
(5) Incorporated by reference to the indicated exhibit to the Company's
Registration Statement on Form S-8 (File No. 333-06577) filed on June
21, 1996.
(6) Incorporated by reference to the indicated exhibit to the Company's
Registration Statement on Form S-8 (File No. 333-58235) filed on June
30, 1998.
(7) Incorporated by reference to the indicated exhibit to the Company's
Report on Form 8-K filed on February 3, 1998.
(8) Incorporated by reference to the indicated exhibit to the Company's
Annual Report on Form 10-K for the year ended December 31, 1999.
(9) Incorporated by reference to the indicated exhibit to the Company's
Report on Form 10-Q for the quarter ended June 30, 2000.
(10) Incorporated by reference to the indicated exhibit to the Company's
Report on Form 8-K filed on January 8, 2001.
(11) Incorporated by reference to the indicated exhibit to the Company's
Annual Report on Form 10-K for the year ended December 31, 2000 as
filed on April 2, 2001.
(12) Incorporated by reference to the indicated exhibit to the Company's
Registration Statement on Form S-8 (File No. 333-73512) filed on
November 16, 2001.
(13) Incorporated by reference to the indicated exhibit to the Company's
Report on Form 10-Q for the quarter ended September 30, 2002.
(14) Incorporated by reference to the indicated exhibit to the Company's
Report on Form 10-K for the year ended December 31, 2002.
(15) Incorporated by reference to the indicated exhibit to the Company's
Report on Form 8-K filed on March 25, 2003.
(16) Incorporated by reference to the indicated exhibit to the Company's
Definitive Proxy Statement on Form 14A filed on April 17, 2003.
(17) Incorporated by reference to the indicated exhibit to the Company's
Report on Form 10-Q for the quarter ended March 31, 2003.
(18) Incorporated by reference to the indicated exhibit to the Company's
Registration Statement on Form S-3 filed on June 30, 2003 (File No.
333-106625).
(19) Incorporated by reference to the indicated exhibit to the Company's
Report on Form 10-Q for the quarter ended September 30, 2003.
(20) Incorporated by reference to the indicated exhibit to the Company's
Report on Form 10-K for the year ended December 31, 2003.
(21) Incorporated by reference to the indicated exhibit to the Company's
Definitive Proxy Statement on Form 14A filed on April 12, 2004.
(22) Incorporated by reference to the indicated exhibit to the Company's
Report on Form 10-Q for the quarter ended September 30, 2004.
(23) Incorporated by reference to the indicated exhibit to the Company's
Report on Form 8-K filed on February 24, 2005.
42
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 16, 2005 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.
<Table>
<Caption>
Signature Title Date
----------- ------- ------
/s/ Stuart M. Essig President, Chief March 16, 2005
- ------------------------------ Executive Officer and
Stuart M. Essig Director (Principal
Executive Officer)
/s/ David B. Holtz Senior Vice President, March 16, 2005
- ------------------------------ Finance and Treasurer
David B. Holtz (Principal Financial and
Accounting Officer)
/s/ Richard E. Caruso Chairman of the Board March 16, 2005
- ------------------------------
Richard E. Caruso, Ph.D.
/s/ Keith Bradley Director March 16, 2005
- ------------------------------
Keith Bradley, Ph.D.
/s/ David Auth Director March 16, 2005
- ------------------------------
David Auth
/s/ Neal Moszkowski Director March 16, 2005
- ------------------------------
Neal Moszkowski
/s/ James M. Sullivan Director March 16, 2005
- ------------------------------
James M. Sullivan
/s/ Anne M. VanLent Director March 16, 2005
- ------------------------------
Anne M. VanLent
</Table>
43
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Integra LifeSciences Holdings Corporation and Subsidiaries
We have completed an integrated audit of Integra LifeSciences Holdings
Corporation's 2004 consolidated financial statements and of its internal control
over financial reporting as of December 31, 2004 and audits of its 2003 and 2002
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 index
appearing under Item 15(a)(1) "Exhibits and Financial Statement Schedules"
present fairly, in all material respects, the financial position of Integra
LifeSciences Holdings Corporation and its Subsidiaries (the Company) at December
31, 2004 and 2003, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2004 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, 2004 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, 2004, 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.
F-1
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
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.
/s/ PricewaterhouseCoopers LLP
Florham Park, New Jersey
March 15, 2005
F-2
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
In thousands, except per share amounts
<Table>
<Caption>
Years Ended December 31,
--------------------------------
2004 2003 2002
-------- -------- --------
Total revenues .................................. $229,825 $185,599 $117,822
COSTS AND EXPENSES
Cost of product revenue ......................... 87,299 70,597 45,772
Research and development ........................ 14,121 12,814 11,517
Selling, general and administrative ............. 99,360 59,461 39,702
Amortization .................................... 4,266 3,080 1,644
-------- -------- --------
Total costs and expenses .................... 205,046 145,952 98,635
Operating income ................................ 24,779 39,647 19,187
Interest income ................................. 4,030 3,195 3,575
Interest expense ................................ (3,475) (2,724) (40)
Other income (expense), net ..................... 2,674 3,071 3
-------- -------- --------
Income before income taxes ...................... 28,008 43,189 22,725
Income tax expense (benefit) .................... 10,811 16,328 (12,552)
-------- -------- --------
Net income....................................... $ 17,197 $ 26,861 $ 35,277
======== ======== ========
Basic net income per share ................... $ 0.57 $ 0.92 $ 1.21
Diluted net income per share ................. $ 0.55 $ 0.86 $ 1.14
Weighted average common shares outstanding:
Basic ........................................ 30,064 29,071 29,021
Diluted ...................................... 31,102 33,104 30,720
</Table>
The accompanying notes are an integral part of these consolidated financial
statements
F-3
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
In thousands, except per share amounts
December 31,
-----------------------
ASSETS 2004 2003
--------- ---------
Current Assets:
Cash and cash equivalents ...................................... $ 69,855 $ 26,054
Short-term investments ......................................... 30,955 82,492
Trade accounts receivable, net of allowances
of $2,749 and $2,025 ....................................... 46,765 28,936
Inventories .................................................... 55,947 41,046
Prepaid expenses and other current assets ...................... 12,716 13,093
--------- ---------
Total current assets ....................................... 216,238 191,621
Noncurrent investments .......................................... 95,172 98,197
Property, plant, and equipment, net ............................. 25,461 20,072
Deferred income taxes, net ...................................... 15,787 17,641
Goodwill ........................................................ 39,237 26,683
Intangible assets, net .......................................... 59,817 52,435
Other assets .................................................... 5,001 5,877
--------- ---------
Total assets ..................................................... $ 456,713 $ 412,526
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable, trade ........................................ $ 10,160 $ 7,947
Income taxes payable ........................................ .. 1,022 774
Accrued compensation ........................................... 4,212 3,726
Accrued expenses and other current liabilities ................. 8,840 8,171
--------- ---------
Total current liabilities .................................. 24,234 20,618
Long term debt .................................................. 118,900 119,257
Deferred revenue ................................................ 310 418
Other liabilities ............................................... 5,446 3,703
--------- ---------
Total liabilities ................................................ 148,890 143,996
Commitments and contingencies
Stockholders' Equity:
Common stock; $.01 par value; 60,000 authorized shares; 29,202
and 28,611 issued ........................................... 292 286
Additional paid-in capital ..................................... 320,602 286,716
Treasury stock, at cost; 718 and 218 shares .................... (19,474) (5,236)
Other .......................................................... -- (5)
Accumulated other comprehensive income (loss):
Unrealized gain (loss) on available-for-sale securities,
net of tax ............................................. (818) 63
Foreign currency translation adjustment ..................... 9,266 5,400
Minimum pension liability adjustment, net of tax ............ (1,780) (1,232)
Accumulated deficit ............................................ (265) (17,462)
--------- ---------
Total stockholders' equity ................................... 307,823 268,530
--------- ---------
Total liabilities and stockholders' equity ...................... $ 456,713 $ 412,526
========= =========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements
F-4
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
In thousands
Years Ended December 31,
---------------------------------------
2004 2003 2002
--------- --------- ---------
OPERATING ACTIVITIES:
Net income .................................................... $ 17,197 $ 26,861 $ 35,277
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ................................ 9,087 7,030 5,020
In process research and development charge ................... -- 400 2,328
Deferred tax provision (benefit) ............................. 6,101 12,357 (13,401)
Amortization of discount and premium on investments .......... 2,505 2,013 2,142
Stock-based compensation ..................................... 23,572 26 31
Other, net ................................................... 696 776 157
Changes in assets and liabilities, net of business
acquisitions:
Accounts receivable ........................................ (13,287) (4,819) (2,109)
Inventories ................................................ (9,738) (1,829) 1,153
Prepaid expenses and other current assets .................. (1,949) (505) (1,131)
Non-current assets ......................................... (169) 480 185
Accounts payable, accrued expenses and other
liabilities ............................................. 6,029 2,537 (90)
Customer advances and deposits ............................. (959) (6,431) 2,565
Deferred revenue ........................................... (110) (4,070) (142)
--------- --------- ---------
Net cash provided by operating activities .................... $ 38,975 $ 34,826 $ 31,985
--------- --------- ---------
INVESTING ACTIVITIES:
Proceeds from the sales/maturities of investments ............. 241,440 287,558 35,402
Purchases of available for sale investments ................... (190,888) (360,470) (57,713)
Purchases of property and equipment ........................... (8,508) (3,843) (2,254)
Payment of product license fee ................................ -- (1,500) --
Cash used in business acquisitions, net of cash acquired ...... (29,302) (50,405) (25,015)
--------- --------- ---------
Net cash provided by (used in) investing activities .......... $ 12,742 $(128,660) $ (49,580)
--------- --------- ---------
FINANCING ACTIVITIES:
Repayment of note payable and bank loans ...................... -- -- (3,600)
Proceeds from exercised stock options and warrants ............ 6,123 14,152 3,323
Purchases of treasury stock ................................... (14,238) (35,402) (1,761)
Proceeds from issuance of convertible notes, net .............. -- 115,923 --
--------- --------- ---------
Net cash provided by (used in) financing activities .......... $ (8,115) $ 94,673 $ (2,038)
Effect of exchange rate changes on cash and cash equivalents ...... 199 232 98
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents .............. $ 43,801 1,071 (19,535)
Cash and cash equivalents at beginning of period .................. 26,054 24,983 44,518
--------- --------- ---------
Cash and cash equivalents at end of period ........................ $ 69,855 $ 26,054 $ 24,983
========= ========= =========
Cash paid during the year for interest ............................ $ 2,331 $ 1,476 $ 20
Cash paid during the year for income taxes ........................ 1,789 1,309 1,435
Supplemental non-cash disclosure:
Property and equipment purchases included in liabilities .......... $ 969 2,000 --
</Table>
The accompanying notes are an integral part of these consolidated financial
statements
F-5
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<Table>
<Caption>
In thousands Accumulated
Additional Other
Preferred Common Treasury Paid-In Comprehensive Accumulated Total
Stock Stock Stock Capital Other Income (Loss) Deficit Equity
--------- ------- -------- ---------- ------ ------------- ----------- ----------
Balance, December 31, 2001 ............ 1 261 (51) 284,021 (37) (539) (79,600) $ 204,056
========= ======= ======== ========== ====== ============= =========== =========
Net income ............................ 35,277 35,277
Unrealized losses on investments,
net of tax ......................... 624 624
Foreign currency translation .......... 2,394 2,394
Minimum pension liability adjustment,
net of tax ......................... (1,011) (1,011)
--------
Total comprehensive income ..... $ 37,284
========
Conversion of 54 shares of Series C
Preferred Stock into 600 shares
of common stock .................... (1) 6 (5) --
Issuance of 475 shares of common
stock through employee benefit
plans .............................. 5 3,288 3,293
Stock-based compensation .............. 9 22 31
Tax benefit related to stock option
exercises .......................... 4,694 4,694
Repurchase 100 shares of common
stock .............................. (1,761) (1,761)
Balance, December 31, 2002 ............ $ -- $ 272 $ (1,812) $ 292,007 $ (15) $ 1,468 $ (44,323) $247,597
========= ========= ========= ========== ========= ============= ========== ========
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) --
Stock-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........... 3,833
3,833
Minimum pension liability adjustment,
net of tax ....................... (548) (548)
--------
Total comprehensive income...... $ 19,601
========
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 stock-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 $ -- $ 6,635 $ (265) $307,790
========= ========= ========= ========== ========= ============= =========== ========
</Table>
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") develops,
manufactures, and markets medical devices for use in neuro-trauma, neurosurgery,
reconstructive surgery, and general surgery. The Company's product lines include
innovative tissue repair products that incorporate the Company's proprietary
absorbable implant technology, such as the DuraGen(R) Dural Graft Matrix, the
DuraGen Plus(TM) Dural Regeneration Matrix, the NeuraGen(TM) Nerve Guide and
NeuraWrap(TM) Nerve Protector, the INTEGRA(R) Dermal Regeneration Template, and
the INTEGRA(TM) Bilayer Matrix and INTEGRA(TM) Matrix Wound Dressing. In
addition, we offer a full range of medical devices to include monitoring and
drainage systems, surgical instruments and fixation systems.
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.
REVISION
In 2004, we determined that our investments in auction rate securities should be
classified as short term investments. Auction rate securities are reset to
current interest rates periodically, but no later than every 90 days. These
securities were previously recorded in cash and cash equivalents due to the
liquidity provided by their short-term pricing reset features and the Company's
ability to liquidate them in monthly auctions. Prior period balance sheet and
cash flow information has been revised to conform to the current year
presentation. Short term investments at December 31, 2004 and 2003, include $0
and $52.9 million, respectively, of auction rate securities. Cash flows from
investing activities decreased by $34.3 million and $18.6 million in 2003 and
2002, respectively, and in 2004 included $52.9 million in cash provided by the
sale of these securities. There was no impact on the Company's net income or
cash flows from operations or financing activities as a result of this revision.
The Company does not have any debt covenants that are affected by reported cash
balances.
Certain other prior year amounts have been reclassified to conform to the
current year presentation.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents.
F-7
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, 2004 and
2003 were as follows:
<Table>
<Caption>
Unrealized Fair
Cost Gains Losses Value
-------- ------- ------- -------
(in thousands)
2004
- -----
Marketable Securities, current
Corporate Debt Securities with continuous
unrealized losses less than 1 year .......... $ 16,273 $ 0 $ (122) $ 16,151
Corporate Debt Securities with continuous
unrealized losses greater than 1 year ....... 7,919 0 (66) 7,853
U.S. Government Debt Securities with continuous
unrealized losses less than 1 year .......... 6,999 0 (48) 6,951
-------- ------- ------- --------
Total marketable securities, current ............ $ 31,191 $ 0 $ (236) $ 30,955
Marketable Securities, non-current
Corporate Debt Securities with continuous
unrealized losses less than 1 year .......... $ 29,510 $ 0 $ (374) $ 29,136
Corporate Debt Securities with continuous
unrealized losses greater than 1 year ....... 15,198 0 (167) 15,031
Corporate Debt Securities with unrealized gains .... 4,069 30 0 4,099
U.S. Government Debt Securities with continuous
unrealized losses less than 1 year .......... 45,456 0 (557) 44,899
Other Securities with continuous
unrealized losses less than 1 year .......... 2,045 0 (38) 2,007
------- ------- ------- -------
Total marketable securities, non-current ........ $ 96,278 $ 30 $(1,136) $ 95,172
2003:
- -----
Marketable securities, current ..................... $82,471 $ 22 $ (1) $ 82,492
Marketable securities, non-current ................. 98,152 156 (111) 98,197
------- ------- -------- --------
$ 180,623 $ 178 $ (112) $180,689
</Table>
The primary reason for the unrealized losses on the Company's marketable debt
securities is the recent 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 45 months and less than 60 months as of December 31, 2004 and 2003,
respectively.
The fair value of the Company's $120.0 million principal amount 2 1/2%
contingent convertible subordinated notes outstanding at December 31, 2004 and
2003 was $115.5 million and $116.7 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
F-8
of factors. In circumstances where a specific customer is unable to
meet its financial obligations to us, 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 our 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 we feel it is
probable the receivable will not be recovered.
The Company records a provision for estimated returns and allowances on product
sales in the same period as the related revenues are recorded. These estimates
are based on historical sales returns 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:
<Table>
<Caption>
December 31,
2004 2003
---------- ----------
(in thousands)
Finished goods .......................... $ 36,490 $ 26,239
Work in process ......................... 7,496 5,069
Raw materials ........................... 11,961 9,738
---------- ----------
$ 55,947 $ 41,046
</Table>
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 and projections of future demand.
To the extent that management determines there are excess, obsolete or expired
inventory quantities, valuation reserves are recorded against all or a portion
of the value of the related products.
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:
<Table>
<Caption>
December 31,
2004 2003 Lives
-------- -------- ------------
(in thousands)
Land ...................................... $ 941 $ 892
Buildings and leasehold improvements ...... 12,886 12,082 2 - 40 years
Machinery and equipment ................... 19,369 19,498 3 - 15 years
Furniture ,fixtures and information systems 11,569 3,277 5 - 7 years
Construction in progress .................. 3,252 2,316
-------- --------
48,017 38,065
Less: Accumulated depreciation ............ (22,556) (17,993)
-------- ---------
$ 25,461 $ 20,072
</Table>
Depreciation expense associated with property, plant and equipment was $4.8
million, $3.9 million, and $3.4 million, in 2004, 2003, and 2002 respectively.
F-9
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, 2004 and determined that its goodwill was not impaired.
Changes in the carrying amount of goodwill in 2004 and 2003 were as follows:
<Table>
<Caption>
2004 2003
------- -------
(in thousands)
Goodwill, net of accumulated amortization beginning of year ... $26,683 $22,073
Acquisitions .................................................. 11,596 3,321
Foreign currency translation .................................. 958 1,318
------- -------
Goodwill, end of year ......................................... $39,237 $26,683
======= =======
</Table>
The components of the Company's identifiable intangible assets were as follows:
<Table>
<Caption>
December 31, 2004 December 31, 2003
Weighted ---------------------- ----------------------
Average Accumulated Accumulated
Life Cost Amortization Cost Amortization
-------- -------- ------------ -------- ------------
(in thousands)
Completed technology ........... 14 years $17,108 $ (4,505) $ 15,062 $ (3,337)
Customer relationships ......... 20 years 17,417 (3,214) 16,755 (2,053)
Trademarks / brand names ....... 36 years 28,689 (1,862) 25,235 (1,017)
Noncompetetion agreements ...... 5 years 6,352 (1,198) 765 (265)
All other ...................... 11 years 2,233 (1,203) 2,144 (854)
------- -------- -------- --------
$71,799 $(11,982) $ 59,961 $ (7,526)
Accumulated amortization .................... (11,982) (7,526)
------- --------
$59,817 $ 52,435
======= ========
</Table>
The Company does not have any indefinite life intangible assets.
Including the expected impact of intangible assets acquired in the acquisition
of Newdeal Technologies SA in January 2005 (see Note 16), annual amortization
expense is expected to approximate $6.1 million in 2005, $6.0 million in 2006,
$5.7 million in 2007, $5.4 million in 2008, and $4.7 million in 2009.
Identifiable intangible assets are initially recorded at fair market value at
the time of acquisition generally using an income or cost approach.
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
F-10
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. Therefore, its results are
not included in these consolidated financial statements. The Company contributed
$2.0 million to the Integra Foundation in 2003, which was 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 2004, 2003 and 2002 consisted of the following:
<Table>
<Caption>
2004 2003 2002
---------- ---------- ---------
Product sales and product royalties ............ $ 228,490 $ 166,695 $ 112,625
Other operating revenues ....................... 1,335 18,904 5,197
--------- --------- ---------
Total revenues ................................. $ 229,825 $ 185,599 $ 117,822
</Table>
Product sales are recognized when delivery has occurred and title has passed to
the customer, there is a fixed or determinable sales price, and collectability
of that sales price is reasonably assured. Product royalties are recognized as
the royalty
F-11
products are sold by our customers and the amount earned by Integra is fixed and
determinable.
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 $3.8
million, $2.6 million, and $1.5 million are recorded in selling, general and
administrative expense during 2004, 2003, and 2002, 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:
<Table>
<Caption>
December 31,
2004 2003
-------- --------
(in thousands)
Beginning balance .................. $ 403 $ 216
Liability acquired through acquisition 255 95
Charged to expense ................. 258 243
Deductions ......................... (168) (151)
------- -------
Ending balance ..................... $ 748 $ 403
</Table>
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.
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 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 neuromonitoring system and a $500,000 charge for a
licensing fee paid for the development of a data acquisition system to support
the integration of our advanced monitoring products. The Company recorded
$400,000 and $2.3 million of in-process research and development in connection
with acquisitions during 2003 and 2002, respectively.
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
F-12
"Accounting for Certain Transactions Involving Stock Compensation -an
interpretation of APB Opinion No. 25".
Had the compensation cost for the Company's stock option plans been determined
based on the fair value at the 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:
<Table>
<Caption>
2004 2003 2002
-------- -------- --------
(in thousands, except per share amounts)
Net income:
As reported ...................................... $ 17,197 $ 26,861 $ 35,277
Add back: Total stock-based employee
compensation expense determined
under the intrinsic value-based
method for all awards, net
of related tax effects ............ 15,372 -- --
Less: Total stock-based employee compensation
expense determined under the fair
value-based method for all awards, net
of related tax effects ................ (21,799) (5,537) (4,774)
-------- -------- --------
Pro forma ........................................ $ 10,770 $ 21,324 $ 30,503
Net income per share:
Basic
As reported ...................................... $ 0.57 $ 0.92 $ 1.21
Pro forma ........................................ $ 0.36 $ 0.73 $ 1.04
Diluted
As reported ...................................... $ 0.55 $ 0.86 $ 1.14
Pro forma ........................................ $ 0.35 $ 0.70 $ 1.02
</Table>
As options vest over a varying number of years and awards are generally made
each year, the pro forma impacts shown above may not be representative of future
pro forma expense amounts. The pro forma additional compensation expense related
to all options granted prior to October 1, 2004 was calculated based on the fair
value of each option grant using the Black-Scholes model, while the pro forma
additional compensation expense related to all options granted on or after
October 1, 2004 was calculated based on the fair value of each option grant
using the binomial distribution model. The following weighted-average
assumptions:
<Table>
<Caption>
2004 2003 2002
---------- ---------- ----------
Dividend yield ....................... 0% 0% 0%
Expected volatility .................. 48% 61% 65%
Risk free interest rate .............. 3.2% 2.9% 3.0%
Expected life of option from
grant date ......................... 4.7 years 4.5 years 4.5 years
</Table>
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.
Statement 123(R) must be adopted no later than July 1, 2005. The Company expects
to adopt Statement 123(R) on July 1, 2005. Statement 123(R) permits companies to
adopt
F-13
its requirements using either the "modified prospective" method or the "modified
retrospective" method. Management is currently evaluating the potential impact
of Statement 123(R) on the Company's consolidated financial position and results
of operations and the alternative adoption methods.
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, 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 AND ADOPTED ACCOUNTING STANDARDS
In November 2004, the Financial Accounting Standards Board (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. The effect of Statement 151 on the
Company's financial position or results of operations has not yet been
determined.
In October 2004, the FASB Emerging Issue Task Force (EITF) reached a consensus
on Issue 04-08 "The Effect of Contingently Convertible Instruments on Diluted
Earnings per Share" that requires issuers of contingent convertible securities
to account for these securities on an "if-converted" basis pursuant to Statement
of Financial Accounting Standards No. 128 "Earnings Per Share", in computing
their diluted earnings per share whether or not the issuer's stock is above the
contingent conversion price. The provisions of Issue 04-08 are effective for all
periods ending after December 15, 2004 and have been applied on a retroactive
basis. All earnings per share amounts have been restated to reflect the impact
of Issue 04-08. Previously disclosed 2003 diluted net income per share was
reduced by $0.02 to $0.86. Restated quarterly diluted net income per share for
2004 and 2003 is presented in Note 15.
In March 2004, the EITF reached a consensus on Issue 03-01, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments".
Issue 03-01 provides guidance regarding recognition and measurement of
unrealized losses on available-for-sale debt and equity securities accounted for
under Statement of Financial Accounting Standard No. 115, "Accounting for
Certain Investments in Debt and Equity Securities". The application of certain
paragraphs covering the measurement provisions of Issue 03-01 have been deferred
pending the issuance of a final FASB Staff Position providing implementation
guidance on Issue 03-01. The disclosures are effective in annual financial
statements for fiscal years ending after December 15, 2003. Management is
currently assessing the impact that the recognition and measurement provisions
of Issue 03-01 could have on the Company's financial statements.
In March 2004, the EITF reached a consensus on Issue 03-6, "Participating
Securities and the Two-Class Method Under FASB Statement No. 128". Issue 03-6
expanded the
F-14
notion of participation rights in calculating earnings per share from previous
practice. Issue 03-6 defines participation rights based solely on whether the
holder would be entitled to receive any dividends declared during the period,
even if the company would not declare any dividends during the period due to
economic or practical concerns or legal or contractual limitations on the
company's ability to pay dividends. The adoption of Issue 03-06 in 2004 did not
change the previously reported basic or diluted earnings per share for any
period during the three years ended December 31, 2004. Previously disclosed pro
forma basic and diluted net income per share for 2002, adjusted to reflect
compensation cost for the Company's stock option plans as if it had been
determined based on the fair value at the grant consistent with the provisions
of Statement 123, was reduced as follows:
- 2002 pro forma basic net income per share was reduced by $0.01 to $1.04
- 2002 pro forma diluted net income per share was reduced by $0.01 to $1.02
3. ACQUISITIONS
BUSINESS COMBINATIONS
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.
The products are sold in the United States through the Integra NeuroSciences
direct sales organization and in international markets through distributors.
The acquired business includes a facility located in Cincinnati, Ohio that
manufactures, packages and distributes MAYFIELD and BUDDE stabilization
products, as well as a broad line of related instruments and disposables used in
many neurosurgical and spinal procedures. In addition, as part of the
acquisition, Integra entered into a long-term license with SM USA, Inc., a
wholly owned subsidiary of Schaerer Mayfield USA, Inc., for the use of the
MAYFIELD name in connection with the acquired business.
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.
In May 2004, the Company acquired all of the capital stock of Berchtold
Medizin-Elektronik GmbH, now named Integra ME, from Berchtold Holding GmbH for
$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.
The acquired business includes a facility located in Tuttlingen, Germany that
manufactures, packages and distributes the ELEKTROTOM and SONOTOM products. 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.
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
F-15
over lives ranging from 5 to 20 years. If the Company had consummated this
acquisition as of the beginning of 2003, its operating results would not have
been materially different from those presented herein.
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. If the Company had consummated this acquisition as of the
beginning of 2003, its operating results would not have been materially
different from those presented herein.
In November 2003, the Company acquired all of the outstanding capital stock of
Spinal Specialties, Inc. for $6.4 million in cash, including expenditures
associated with the acquisition and a working capital adjustment. In connection
with this acquisition, the Company recorded $5.4 million of goodwill and
intangible assets. The acquired intangible assets consisted primarily of trade
name, technology and customer relationships and are being amortized on a
straight-line basis over lives ranging from 3 to 15 years. Spinal Specialties
markets its products primarily to anesthesiologists and interventional
radiologists through an in-house telemarketing team and a network of
distributors. Spinal Specialties' products include the OsteoJect(TM) Bone Cement
Delivery System and the ACCU-DISC(TM) Pressure Monitoring System.
In August 2003, the Company acquired substantially all of the assets of Tissue
Technologies, Inc., the manufacturer and distributor of the UltraSoft(TM) line
of implants for soft tissue augmentation of the facial area. The Company paid
$0.6 million in cash and is obligated to pay the seller up to an additional $1.5
million in contingent consideration based upon a multiple of the Company's sales
of the UltraSoft product in the third year following the acquisition. Any future
contingent consideration paid to the seller is expected be recorded as
additional goodwill.
In March 2003, the Company acquired all of the outstanding capital stock of J.
Jamner Surgical Instruments, Inc. (doing business as JARIT(R) Surgical
Instruments) ("JARIT") for $43.5 million in cash, including expenditures
associated with the acquisition and net of $2.1 million of cash acquired. JARIT
markets a wide variety of high quality, reusable surgical instruments to
virtually all surgical disciplines. The acquisition of JARIT has broadened
Integra's existing customer base and surgical instrument product offering and
has provided Integra with operating costs savings from the procurement of
Integra's Ruggles(TM) and Padgett(TM) instruments products directly from the
instrument manufacturers.
In connection with this acquisition, the Company recorded $29.1 million of
intangible assets, consisting primarily of trade name and customer
relationships, which are being amortized on a straight-line basis over lives
ranging from 5 to 40 years.
In December 2002, the Company acquired the neurosurgical shunt and epilepsy
monitoring business of the Radionics division of Tyco Healthcare Group for $3.7
million in cash, including expenditures associated with the acquisition. This
acquisition broadened Integra's neurosurgical product line offering and customer
base and increased capacity utilization at the Company's Biot facility.
In October 2002, the Company acquired all of the outstanding capital stock of
Padgett Instruments, Inc., an established marketer of instruments used in
reconstructive and plastic surgery, for $9.6 million in cash, including
expenditures associated with the acquisition. For more than 40 years, Padgett
has been providing high quality instruments to meet the needs of the plastic and
reconstructive surgeon and, as a result, has become one of the most recognized
names in the plastic and reconstructive surgery market. Approximately $5.4
million of the purchase price was allocated to the trademarks and trade name of
the acquired business, which are being amortized on a straight-line basis over
40 years.
In August 2002, the Company acquired all of the capital stock of the
neurosciences division of NMT Medical, Inc. for $5.7 million in cash, including
expenditures associated with the acquisition. Through this acquisition, the
Company added a range
F-16
of leading differential pressure valves and external ventricular drainage
products to its neurosurgical product line. The acquired operations included a
manufacturing facility located in Biot, France. The $4.2 million fair value
assigned to the land, building and equipment in Biot was determined based on a
third party appraisal.
In July 2002, the Company acquired the assets of Signature Technologies, Inc., a
specialty manufacturer of titanium and stainless steel implants for the
neurosurgical and spinal markets, and certain other intellectual property
assets. The Company acquired Signature Technologies to gain the capability of
developing and manufacturing metal implants for strategic partners and for
direct sale by Integra. The purchase price consisted of $2.9 million in cash
(including expenditures associated with the acquisition), $0.5 million of
deferred consideration that was paid in 2003, and royalties on future sales of
products to be developed.
In connection with this acquisition, the Company recorded a $1.2 million
in-process research and development charge of for the value associated with a
project for the development of an enhanced cranial fixation system using
patented technology for improved identification and delivery of certain
components of the system. The value of the in-process research and development
charge was estimated with the assistance of a third party appraiser using
probability weighted cash flow projections with factors for successful
development ranging from 10% to 35% and a 15% discount rate.
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 2004 and 2003 acquisitions:
<Table>
<Caption>
(All amounts in thousands)
MAYFIELD/
2004 Acquisitions BUDDE Integra ME R&B/Sparta
- ----------------- ------------- ----------- -----------
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
</Table>
<Table>
<Caption>
Spinal Jarit Tissue
2003 Acquisitions Specialties Instruments Technologies
- ----------------- ------------- ----------- ------------
Current assets ....................... $ 1,944 $ 17,498 $ 81
Property, plant and equipment ........ 307 1,285 88
Intangible assets .................... 2,300 29,091 281
Goodwill ............................. 3,070 -- 251
Other non-current assets ............. -- 104 --
------------- ----------- -----------
Total assets acquired ............. 7,621 47,978 701
Current liabilities .................. 358 2,357 76
Deferred tax liabilities ............. 836 -- --
------------- ----------- -----------
Total liabilities assumed ......... 1,194 2,357 76
Net assets acquired .................. $ 6,427 $ 45,621 $ 625
</Table>
The goodwill acquired in the MAYFIELD/BUDDE, R&B, Sparta, Tissue Technologies
and Radionics acquisitions is expected to be deductible for tax purposes. The
acquired intangible assets are being amortized on a straight-line basis over
lives ranging from 2 to 40 years.
The following unaudited pro forma financial information summarizes the results
of
F-17
operations for the periods indicated as if the acquisitions consummated in 2004
and 2003 had been completed as of the beginning of each period. The pro forma
results are based upon certain assumptions and estimates and they give effect to
actual operating results prior to the acquisitions and adjustments to reflect
increased depreciation expense, increased intangible asset amortization, and
increased income taxes at a rate consistent with Integra's effective rate in
each year. No effect has been given to cost reductions or operating synergies.
As a result, these pro forma results do not necessarily represent results that
would have occurred if the acquisition had taken place on the basis assumed
above, nor are they indicative of the results of future combined operations.
<Table>
<Caption>
2004 2003
-------- --------
(in thousands)
Total revenue ......................................... $236,031 $212,372
Net income ............................................ 17,872 27,937
Basic net income per share ............................ $ 0.59 $ 0.96
Diluted net income per share .......................... $ 0.57 $ 0.89
</Table>
ASSET ACQUISITIONS
In December 2003, the Company acquired the assets of Reconstructive
Technologies, Inc.("RTI") for $400,000 in cash and agreed to make certain future
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 the fourth quarter of 2003. This transaction
was accounted for as an asset purchase because the acquired assets did not
constitute a business under Statement 141.
In September 2002, the Company acquired certain assets, including the
NeuroSensor(TM) monitoring system and rights to certain intellectual property,
from Novus Monitoring Limited of the United Kingdom for $3.7 million in cash
(including expenditures associated with the acquisition), a $1.4 million
milestone payment related to the development of a next-generation, advanced
neuromonitoring system that was paid in September 2004, and up to an additional
$2.5 million payable based upon revenues from Novus' products. As part of the
consideration paid, Novus agreed to perform certain product development efforts
on Integra's and those efforts were completed in 2004.
The assets acquired from Novus were accounted for as an asset purchase because
the acquired assets did not constitute a business under Statement 141. The
initial $3.7 million purchase price was allocated as follows (in thousands):
<Table>
Prepaid research and development expense ......... $ 771
Other assets ..................................... 151
Intangible assets ................................ 1,663
In-process research and development .............. 1,151
</Table>
The acquired intangibles assets consisted primarily of technology-related
intangible assets, which are being amortized on a straight-line basis over lives
ranging from 3 to 15 years. The prepaid research and development expense
represents the estimated fair value of future services to be provided by Novus
under the development agreement. The $1.2 million in-process research and
development charge represents the value associated with the development of a
next generation neuromonitoring system. The value of the in-process research and
development was estimated with the assistance of a third party appraiser using
probability weighted cash flow projections with factors for successful
development ranging from 15% to 20% and a 15% discount rate.
The $1.4 million product development milestone was recorded as research and
development expense in 2004, as the underlying product technology was not
approved by the FDA for sale.
F-18
4. DEBT
In March and April 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 $365,000 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, 2004 and 2003, the estimated fair
value of the Contingent Interest obligation was $710,000 and $460,000,
respectively.
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.
5. 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 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 amount to be
paid or received under the interest rate swap agreement is recorded as a
component of interest expense. Interest expense for the years ended December 31,
2004 and 2003, respectively, reflects a $686,000 and a $330,000 reduction
associated with the interest rate swap. Our effective interest rate on the
hedged portion of the notes was 1.6% as of December 31, 2004.
The net fair value of the interest rate swap at inception was $767,000. In 2004
and 2003, respectively, the net fair value of the interest rate swap increased
$287,000 to $1.4 million and $305,000 to $1.1 million. In connection with this
fair value hedge, the Company recorded in 2004 and 2003, respectively, a
$430,000 and $433,000 net decrease in the carrying value of its contingent
convertible notes. The $143,000 and $128,000 net difference between changes in
the fair value of the interest rate swap and the contingent convertible notes
represents the ineffective portion of the hedging relationship, and these
amounts are recorded in other income (expense), net.
At December 31, 2004 and 2003, the Company had $2.9 million and $2.2 million of
cash pledged as collateral in connection with the interest rate swap agreement.
F-19
In November 2004, the Company entered into a collar contract for euro 38.5
million expiring in January 2005 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 in January 2005 for euro 38.5 million (see Note 16). The
collar contract did not qualify as a hedge under SFAS No. 133. Accordingly, the
collar contract is recorded at fair value and changes in fair value are 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.
6. 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.
On March 29, 2000, the Company issued 54,000 shares of Series C Convertible
Preferred Stock (Series C Preferred) and warrants to purchase 300,000 shares of
common stock at $9.00 per share to affiliates of Soros Private Equity Partners
LLC (SPEP) for $5.4 million, net of issuance costs. The Series C Preferred
ranked on a parity with the Company's then existing Series B Convertible
Preferred Stock, was senior to the Company's common stock and all other
preferred stock of the Company, and had a 10% cumulative annual dividend yield
payable only upon liquidation. The Series C Preferred was converted into 600,000
shares of common stock in April 2002. The warrants issued with the Series C
Preferred were exercised in December 2001 for proceeds of $2.7 million.
SPEP is entitled to certain registration rights for shares of common stock
obtained through conversion of its preferred stock or the exercise of the
related warrants.
COMMON STOCK TRANSACTIONS
In 2004 and 2003, respectively, the Company repurchased 500,000 and 1.5 million
shares of its common stock for $14.2 million and $35.4 million.
7. STOCK PURCHASE AND AWARD PLANS
EMPLOYEE STOCK PURCHASE PLAN
The Company received stockholder approval for its Employee Stock Purchase Plan
(ESPP) in May 1998. The purpose of 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
500,000 shares of common stock were originally reserved for issuance. In May
2004, stockholders of the Company approved an amendment to the ESPP that
increased the number of shares available for issuance under the Plan by 1.0
million to 1.5 million shares. 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, 2004,
1.1 million shares remain available for purchase under the amended ESPP.
STOCK OPTION PLANS
As of December 31, 2004 the Company had stock options 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.
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
2,500,000 shares under the
F-20
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, performance stock,
or dividend equivalent rights to designated directors, officers, employees and
associates of the Company. Options issued under the Plans become exercisable
over specified periods, generally within four years from the date of grant, and
generally expire six years from the grant date.
Option activity for all the Plans was as follows:
<Table>
<Caption>
2004 2003 2002
------------------- ------------------- -------------------
Wtd. Avg. Wtd. Avg. Wtd. Avg.
Options Ex. Price Options Ex. Price Options Ex. Price
------- --------- ------- --------- ------- ---------
(shares in thousands)
Options outstanding at
January 1, ........... 2,884 $16.19 4,295 $12.15 4,261 $10.79
Granted ................. 1,473 $31.81 430 $24.81 618 $17.73
Exercised ............... (547) $ 9.80 (1,726) $ 7.70 (425) $ 6.15
Cancelled ............... (127) $21.97 (115) $17.40 (159) $13.39
Options outstanding at
December 31, ......... 3,683 $23.42 2,884 $16.19 4,295 $12.15
Options exercisable at
December 31, .......... 1,641 $17.61 1,495 $13.65 2,380 $ 8.75
</Table>
At December 31, 2004, there were 1,330,072 shares available for grant under the
Plans.
The following table summarizes information about stock options outstanding as of
December 31, 2004:
<Table>
<Caption>
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 2004 Price Contractual Life 2004 Price
- ----------------- ---------- ------------ -------------------- ---------- -----------
(shares in thousands)
$ 3.50 - $13.63 838 $ 10.05 2.9 years 712 $ 9.87
$13.75 - $26.34 918 $ 20.26 3.6 years 544 $ 20.52
$26.45 - $28.78 897 $ 27.95 4.3 years 306 $ 27.10
$28.80 - $34.49 761 $ 32.39 6.7 years 80 $ 30.40
$34.62 - $35.52 269 $ 35.43 5.9 years -- $ 0.00
----- -------- --------- ----- -------
3,683 $ 23.42 4.4 years 1,641 $ 17.61
</Table>
The weighted average fair market value of options granted in 2004, 2003 and 2002
was $13.48, $13.01, and $9.57 per share, respectively.
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.
F-21
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.
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 1997 restricted units were converted into 1,000,000 shares
of the Company's common stock.
No other stock-based awards are outstanding under any of the Plans.
8. 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 plans cover certain current and
former employees. The UK Plan is 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:
<Table>
<Caption>
2004 2003 2002
------- -------- -------
(in thousands)
Service cost ..................................... $ 179 $ 88 $ 122
Interest cost .................................... 522 397 355
Expected return on plan assets ................... (434) (330) (331)
Recognized net actuarial loss .................... 203 116 85
------ -------- -------
Net periodic benefit cost ..................... $ 470 $ 271 $ 231
</Table>
The following weighted average assumptions were used to develop net periodic
benefit cost and the actuarial present value of projected benefit obligations:
<Table>
<Caption>
2004 2003 2002
---- ---- ----
Discount rate .................................... 5.2% 5.4% 5.5%
Expected return on plan assets ................... 5.8% 6.2% 6.5%
Rate of compensation increase .................... 3.3% 3.3% 3.8%
</Table>
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, 2003 and 2002 and the accrued benefit cost:
<Table>
<Caption>
December 31,
2004 2003
-------- --------
(in thousands)
CHANGE IN PROJECTED BENEFIT OBLIGATION
Projected benefit obligation, beginning of year ................ $ 8,832 $ 6,803
Service cost ................................................... 179 88
Interest cost .................................................. 522 397
Participant contributions ...................................... 42 36
Benefits paid .................................................. (183) (151)
Actuarial (gain) loss .......................................... 656 857
Acquisitions ................................................... 474 --
Effect of foreign currency exchange rates ...................... 845 802
------- -------
Projected benefit obligation, end of year ...................... $11,367 $ 8,832
</Table>
F-22
<Table>
CHANGE IN PLAN ASSETS
Plan assets at fair value, beginning of year ................... $ 6,646 $ 5,068
Actual return on plan assets ................................... 816 881
Employer contributions ......................................... 238 211
Participant contributions ...................................... 37 36
Benefits paid .................................................. (183) (151)
Other .......................................................... 46 --
Acquisitions ................................................... 162
Effect of foreign currency exchange rates ...................... 617 601
------- -------
Plan assets at fair value, end of year ......................... $ 8,379 $ 6,646
RECONCILIATION OF FUNDED STATUS
Funded status, projected benefit obligation in excess
of plan assets ............................................. $(2,988) $(2,186)
Unrecognized net actuarial loss ................................... 2,759 2,416
Adjustment to recognize minimum liability ......................... (2,543) (1,804)
------- -------
Accrued benefit cost .............................................. $(2,772) $(1,574)
</Table>
The accrued benefit liability recorded at December 31, 2004 and 2003 is included
in other liabilities.
The combined accumulated benefit obligation for the defined benefit plans was
$11.2 million and $8.2 million as of December 31, 2004 and 2003, respectively.
The accumulated benefit obligation for each plan exceeded that plan's assets for
all periods presented.
The weighted-average allocation of plan assets by asset category is as follows:
<Table>
<Caption>
December 31,
2004 2003
---- ----
Equity securities ..... 52% 54%
Corporate bonds ....... 19% 19%
Government bonds ...... 22% 22%
Insurance contracts ... 2% 0%
Cash .................. 5% 5%
--- ---
100% 100%
</Table>
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. In 2002, the UK Plan began
shifting its portfolio from primarily equity securities to a portfolio more
weighted towards corporate bonds. The assets of the Germany Plan consist
entirely of insurance contracts.
The Company anticipates contributing approximately $250,000 to its defined
benefit plans in 2005. The Company expects to pay the following estimated future
benefit payments in the years indicated:
<Table>
2005 .......... $ 218,000
2006 .......... 248,000
2007 .......... 264,000
2008 .......... 293,000
2009 .......... 337,000
2010-2014 ..... 2,384,000
</Table>
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 $622,000, $483,000 and $575,000 in 2004, 2003 and 2002, respectively.
F-23
9. 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. The
lease provides for a rent escalation of 8.5% in 2007 and expires in October
2012.
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 2004, 2003 and 2002.
Future minimum lease payments under operating leases at December 31, 2004 were
as follows:
<Table>
<Caption>
Related Third
Parties Parties Total
--------- --------- ---------
(in thousands)
2005 ............................ $ 321 $ 2,317 $ 2,638
2006 ............................ 321 1,719 2,040
2007 ............................ 324 936 1,260
2008 ............................ 341 119 460
2009............................ 341 119 460
Thereafter ...................... 755 991 1,746
------- ------- -------
Total minimum lease payments..... $ 2,403 $ 6,201 $ 8,604
======= ======= =======
</Table>
Total rental expense in 2004, 2003, and 2002 was $2.3 million, $2.9 million, and
$2.0 million, respectively, and included $321,000, $321,000, and $321,000, in
related party expense, respectively.
10. INCOME TAXES
The income tax expense (benefit) consisted of the following:
<Table>
<Caption>
2004 2003 2002
-------- -------- --------
(in thousands)
Current:
Federal ...................... $ 1,899 $ 972 $ --
State ........................ 1,670 2,470 1,276
Foreign ...................... 1,141 529 (427)
-------- -------- --------
Total current .................. 4,710 3,971 849
Deferred:
Federal ...................... $ 5,802 $ 12,800 $(13,671)
State ........................ 53 83 373
Foreign ...................... 246 (526) (103)
-------- -------- --------
Total deferred ................. 6,101 12,357 (13,401)
Income tax expense (benefit) ... $ 10,811 $ 16,328 $(12,552)
======== ======== ========
</Table>
F-24
The temporary differences that give rise to deferred tax assets are presented
below:
<Table>
<Caption>
December 31
2004 2003
-------- --------
(in thousands)
Net operating loss and tax credit carryforwards .......... $ 13,405 $ 22,695
Inventory reserves and capitalization .................... 2,145 2,294
Other .................................................... -- 1,758
Deferred compensation .................................... 14,164 5,361
Deferred income .......................................... 1,821 1,434
-------- --------
Total deferred tax assets before valuation allowance ... 31,535 33,542
Valuation allowance ...................................... (5,360) (5,360)
Depreciation and amortization ............................ (5,327) (6,421)
Other .................................................... (1,095) (392)
-------- --------
Net deferred tax assets .................................. $ 19,753 $ 21,369
======== ========
</Table>
At December 31, 2004 and 2003, respectively, $4.0 million and $3.7 million of
the net deferred tax asset is included in prepaid expenses and other current
assets.
Since 1999, the Company has generated positive taxable income on a cumulative
basis. In light of this trend, current projections for future taxable earnings,
and the expected timing of the reversal of deductible temporary differences, in
2002, the Company reduced the remaining valuation allowance recorded against net
operating loss carryforwards by $23.4 million, which reflected the Company's
estimate of additional tax benefits that it expected to realize in the future. A
valuation allowance of $5.4 million is recorded against the remaining $31.5
million of deferred tax assets recorded at December 31, 2004. 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.
In 2004, our effective income tax rate was 38.6% of income before income taxes
compared to 37.8% in 2003. Our 2004 rate includes a $1.3 million tax charge
related to the transfer of certain intangible assets. We recorded a net income
tax benefit in 2002 related to the reduction of the deferred tax asset valuation
allowance.
The net change in the Company's valuation allowance was $(2.3) million and
$(26.7) million, in 2003 and 2002, respectively.
A reconciliation of the United States Federal statutory rate to the Company's
effective tax rate for the years ended December 31, 2004, 2003, and 2002 is as
follows:
<Table>
<Caption>
2004 2003 2002
------ ----- -----
Federal statutory rate ................................. 35.0% 35.0% 35.0%
Increase (reduction) in income taxes resulting from:
State income taxes, net of federal tax benefit ....... 4.0% 3.9% 3.7%
Foreign taxes booked at different rates .............. (4.2%) (1.0%) (2.5%)
Tax on asset transfer ................................ 4.5% -- --
Other ................................................ (0.7%) (0.1%) (1.5%)
Change in valuation allowance ........................ -- -- (89.9%)
---- ---- -----
Effective tax rate ..................................... 38.6% 37.8% (55.2%)
==== ==== =====
</Table>
At December 31, 2004, the Company had net operating loss carryforwards of $46.8
million and $0.6 million for federal and state income tax purposes,
respectively, to offset future taxable income. The federal and state net
operating loss carryforwards expire through 2018 and 2005, respectively.
F-25
At December 31, 2004, 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 2005. 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 $2.6 million at December 31, 2004.
The American Jobs Creation Act of 2004 (the "Act") was signed into law in
October 2004 and has several provisions that may impact the Company's income
taxes in the future, including the repeal of the extraterritorial income
exclusion and a deduction related to qualified production activities taxable
income. The Financial Accounting Standards Board ("FASB") proposed that 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 the Company's tax return. Management is currently evaluating the
impact of the FASB guidance related to qualified production activities on the
Company's effective tax rate in future periods.
11. NET INCOME PER SHARE
Amounts used in the calculation of basic and diluted net income per share were
as follows:
<Table>
<Caption>
2004 2003 2002
-------- -------- --------
(in thousands, except per share amounts)
Basic:
- --------
Net income ...................................................... $ 17,197 $ 26,861 $ 35,277
Less: Dividends on Series C Preferred Stock ..................... -- -- (159)
Net income allocable to dilutive participating
Series C Preferred Stock ............................... -- -- (96)
-------- -------- --------
Net income applicable to common stock ........................... $ 17,197 $ 26,861 $ 35,022
Basic net income per share ...................................... $ 0.57 $ 0.92 $ 1.21
======== ======== ========
Weighted average common shares outstanding - Basic .............. 30,064 29,071 29,021
======== ======== ========
Diluted:
- --------
Net income ...................................................... $ 17,197 $ 26,861 $ 35,277
Add back: Interest expense and other income/(expense) related
to convertible notes payable, net of tax ........... -- 1,608 --
Less: Dividends on Series C Preferred Stock ..................... -- -- (159)
Net income allocable to dilutive participating
Series C Preferred Stock ............................... -- -- (96)
-------- -------- --------
Net income applicable to common stock ........................... $ 17,197 $ 28,469 $ 35,022
Diluted net income per share .................................... $ 0.55 $ 0.86 $ 1.14
======== ======== ========
Weighted average common shares outstanding - Basic .............. 30,064 29,071 29,021
Effect of dilutive securities:
Stock options and warrants ................................... 1,038 1,397 1,699
Shares issuable upon conversion of notes payable ............. -- 2,636 --
-------- -------- --------
Weighted average common shares outstanding ...................... 31,102 33,104 30,720
======== ======== ========
</Table>
F-26
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:
<Table>
<Caption>
2004 2003 2002
----- ----- -----
(in thousands)
Stock options ...................................... 155 424 1,104
Shares issuable upon conversion of notes payable ... 3,514 -- --
----- ----- -----
Total .............................................. 3,669 424 1,104
</Table>
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 7) are included in the 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.
12. DEVELOPMENT, DISTRIBUTION, AND LICENSE AGREEMENTS AND GOVERNMENT GRANTS
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
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, and 2002, the Company received $2.8 million and $1.0 million,
respectively, 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 and $1.2
million of research and development revenues under the agreement in 2003 and
2002, respectively.
F-27
13. 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.
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. 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 argument is scheduled for
April 2005, and we expect the Supreme Court to render a decision before the end
of its current term.
In September 2004, the Trial Court ordered Merck KgaA to pay Integra $6.4
million in damages. following the Circuit Court's order. Further enforcement of
the Trial Court's order has been stayed pending the decision of the Supreme
Court.
The Company has not recorded any gain in connection with this matter, pending
final resolution and completion of the appeals process.
In addition to the Merck KGaA matter, the Company is subject to various claims,
lawsuits and proceedings in the ordinary course of its business, including
claims by current or former employees, distributors and competitors and with
respect to our products. In the opinion of management, such claims are either
adequately covered by insurance or otherwise indemnified, or are not expected,
individually or in the aggregate, to result in a material adverse effect on the
Company's financial condition. However, it is possible that our results of
operations, financial position and cash flows in a particular period could be
materially affected by these contingencies.
F-28
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. Following objection from NMT Medical, the amount
claimed by the authorities was reduced to 930,367 euros, and negotiations and
other procedures are under way, which may lead to a further reduction of the
amount owed. 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 addition, NMT
Medical, Inc. has agreed to provide the French tax authorities with payment of
the tax liabilities on behalf of each of these subsidiaries.
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
programs conducted there, and the consolidation of the remaining research
activities into its other facilities. The charge consisted of the following (in
thousands):
<Table>
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
</Table>
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.
14. 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 neuro-trauma, neurosurgery, reconstructive surgery and general surgery.
Product revenues consisted of the following:
<Table>
<Caption>
2004 2003 2002
-------- -------- --------
(in thousands)
Monitoring products ............. $ 48,217 $ 44,229 $ 37,184
Implant products ................ 78,418 53,301 38,326
Instruments ..................... 77,667 47,168 16,802
Private label products .......... 24,188 21,997 20,313
-------- -------- --------
Consolidated product revenues ... $228,490 $166,695 $112,625
======== ======== ========
</Table>
Certain of the Company's products, including the DuraGen(R) Dural Graft
products, NeuraGen(TM) Nerve Guide, INTEGRA(R) Dermal Regeneration Template,
INTEGRA(TM) Bi-Layer Matrix Wound Dressing, and BioMend(R) Absorbable Collagen
Membrane, 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%, 27% and 32% of product
revenues in 2004, 2003 and 2002, 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.
F-29
Product revenue and long-lived assets (excluding financial instruments and
deferred tax assets) by major geographic area are summarized below:
<Table>
<Caption>
United Asia Other
States Europe Pacific Foreign Consolidated
---------- ---------- ---------- ---------- ------------
(in thousands)
Product revenue:
2004 ................... $180,887 $ 30,941 $ 8,535 $ 8,127 $228,490
2003 ................... 132,805 21,433 5,828 6,629 166,695
2002 ................... 90,422 14,737 4,062 3,404 112,625
Long-lived assets:
December 31, 2004 ...... $ 83,235 $ 46,282 $ -- $ -- $129,517
December 31, 2003 ...... 81,182 21,082 -- -- 102,264
December 31, 2002 ...... 45,319 18,408 -- -- 63,727
</Table>
15. SELECTED QUARTERLY INFORMATION -- UNAUDITED
<Table>
<Caption>
Fourth Third Second First
Quarter Quarter Quarter Quarter
-------- --------- --------- ----------
(in thousands, except per share data)
2004:
- -----
Total revenue ................... $ 61,811 $ 59,130 $ 56,441 $ 52,443
Cost of product revenues ........ 23,221 22,412 21,665 20,001
Total other operating expenses .. 24,959 48,898 23,176 20,714
Operating income (loss) ......... 13,631 (12,180) 11,600 11,728
Interest income (expense), net .. 95 243 160 57
Other income (expense), net ..... 2,250 306 135 (17)
Income (loss) before
income taxes ............... 15,977 (11,631) 11,895 11,768
Income tax expense (benefit) .... 6,137 (4,034) 4,377 4,331
Net income (loss) ............... $ 9,839 $ (7,597) $ 7,518 $ 7,437
Basic net income per share....... $ 0.32 $ (0.25) $ 0.25 $ 0.25
Diluted net income per share .... $ 0.30 $ (0.25) $ 0.23 $ 0.23
</Table>
The retroactive application of EITF Issue 04-08 reduced previously reported
diluted earnings per share by $0.01 in both the first and second quarters of
2004.
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
neuromonitoring 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 Newdeal Technologies
acquisition was completed in January 2005.
F-30
<Table>
2003:
- -----
Total revenue ................... $ 59,025 $ 47,058 $ 42,736 $ 36,780
Cost of product revenues ........ 20,935 18,869 17,090 13,703
Total other operating expenses .. 25,095 17,266 17,357 15,637
Operating income ................ 12,995 10,923 8,289 7,440
Interest income (expense), net .. 81 (188) (198) 776
Other income (expense), net ..... 1,962 309 451 349
Income before income taxes ...... 15,038 11,044 8,542 8,565
Income tax expense .............. 5,867 4,210 3,124 3,127
Net income ...................... $ 9,171 $ 6,834 $ 5,418 $ 5,438
Basic net income per share....... $ 0.31 $ 0.24 $ 0.19 $ 0.18
Diluted net income per share .... $ 0.28 $ 0.22 $ 0.18 $ 0.18
</Table>
In the fourth quarter of 2003, the Company recorded the following:
- - $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;
- - a $2.0 million payment from ETHICON from the termination of the
agreement with them, which is included in other income;
- - $1.1 million of expenses related to the closing of the Company's San
Diego research center, consolidation of the research activities into
other facilities and the discontinuation of certain research programs;
- - a $400,000 acquired in-process research and development charge in
connection with an acquisition; and
- - a $2.0 million donation to the Integra Foundation, which is included in
selling, general and administrative expenses.
The retroactive application of EITF Issue 04-08 reduced previously reported
diluted earnings per share by $0.01 and $0.02, respectively, in the second and
third quarters of 2003.
16. SUBSEQUENT EVENT
In November 2004, the Company agreed to acquire all of the outstanding capital
stock of Newdeal Technologies SA ("Newdeal") for euro 38.5 million in cash,
subject to certain adjustments. The acquisition closed on January 3, 2005.
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. The company sells its
products through a direct sales force in France, Belgium and the Netherlands,
and through distributors in more than 30 countries, including the United States
and Canada. Newdeal's target physicians include orthopedic surgeons specializing
in injuries of the foot, ankle and extremities, as well as podiatric surgeons.
The Company expects to benefit from the synergy between Newdeal's reconstructive
foot and ankle fixation products and Integra's regenerative products that are
used in the treatment of chronic and traumatic wounds of the foot and ankle.
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:
<Table>
(All amounts in thousands)
Current assets ....................... $12,616
Property, plant and equipment ........ 1,078
Intangible assets .................... 14,900
Goodwill ............................. 27,614
-------
Total assets acquired ............. 56,208
Liabilities assumed .................. 4,341
-------
Net assets acquired .................. $51,867
</Table>
F-31
The acquired intangible assets consist primarily of developed technology, trade
name, and customer relationships and are expected to be amortized over lives
ranging from 5 to 30 years.
F-32
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
SCHEDULE II
<Table>
<Caption>
Balance at Charged to Charged Balance at
Beginning Costs and to Other End of
Description Of Period Expenses Accounts(1) Deductions(2) Period
- --------------------------------------------------------------------------------------------------------------------
(in thousands)
Year ended December 31, 2004
- ----------------------------
Allowance for doubtful accounts
and Sales Returns .............. $ 2,025 $ 802 $ 249 $ (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 .............. $ 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
Year ended December 31, 2002
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Allowance for doubtful accounts
and Sales Returns .............. $ 1,403 1,961 559 (2,537) $ 1,387
Inventory reserves .......................... 5,812 4,152 787 (1,178) 9,573
Deferred tax asset valuation allowance ...... 34,356 (20,389) (3,260) (3,015) 7,692
</Table>
(1) All amounts shown were recorded to goodwill in connection with acquisitions
except for the $2.3 million and $3.3 million reduction in the deferred tax
asset valuation allowance in 2003 and 2002, respectively, which were
written off against the gross deferred tax asset.
(2) The $3.0 million reduction of the deferred tax asset valuation allowance in
2002 was recorded to additional paid-in capital.
F-33