UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Date of Report (date of earliest event reported): June 27, 2003
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 0-26224 51-0317849
(State or other jurisdiction of (Commission File Number) (I.R.S. Employer
incorporation or organization) Identification No.)
311 Enterprise Drive
Plainsboro, NJ 08536
(Address of principal executive offices) (Zip Code)
(609)-275-0500
(Registrant's telephone number, including area code)
Not Applicable
(Former name or former address, if changed since last report)
ITEM 5. OTHER EVENTS
As previously reported in our report on Form 10-Q for the quarter ended March
31, 2003, Integra changed its reportable segments in March 2003. This Current
Report on Form 8-K updates the following information contained in our Annual
Report on Form 10-K for the year ended December 31, 2002 to reflect this new
basis of segment reporting and to remove certain non-GAAP disclosures:
- Part I, Item 1. Business
- Part II, Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
- Part IV, Item 15. Financial Statements
Update to 2002 Annual Report on Form 10-K, 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
neurosurgery, plastic and reconstructive surgery, general surgery and soft
tissue repair. Integra was founded in 1989 and over the next decade developed
technologies and a product portfolio 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 $117.8 million,
an average annual growth rate of 40%, and we have broadened our product
offerings to include more than 10,000 products. We have achieved this growth in
our overall business through 12 acquisitions, the development and introduction
of new products, and the expansion of our direct sales force.
We have historically managed our business and reviewed our financial results
under two separate operating segments: Integra NeuroSciences(TM) and Integra
LifeSciences(TM). In 2003, following the integration of several recently
acquired, diverse businesses, we began to manage the business and review
financial results on an aggregate basis, instead of through these two operating
segments. Accordingly, we will report our 2003 financial results and now present
our 2002 financial results for a single operating segment - the development,
manufacturing and distribution of medical devices.
The Company's product lines include traditional medical devices, such as
monitoring and drainage systems, surgical instruments and fixation systems, as
well as innovative tissue repair products, such as the DuraGen(R) Dural Graft
Matrix, the NeuraGen(TM) Nerve Guide, and the INTEGRA(R) Dermal Regeneration
Template, that incorporate the Company's proprietary absorbable implant
technology.
Financial information about our geographical areas is set forth in our financial
statements under Notes to Consolidated Financial Statements, Note 13 - 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 markets in which
we compete. Key elements of our strategy include the following:
Expand our presence in the hospital and other health care facilities. Through
acquisitions and internal growth, we have rapidly become a leading provider of
products used in the diagnosis, monitoring and treatment of chronic diseases and
acute injuries involving the brain, spine and nervous system. We believe that
additional growth potential exists through
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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 ENT, neurology, and spine markets;
o continuing the development and promotion of innovative new products,
such as the NeuraGen(TM)Nerve Guide and the LICOX(R)Brain Tissue Oxygen
Monitoring System; and
o expanding our sales force and product offerings focused on plastic and
reconstructive surgeons.
Additional Strategic Acquisitions. Since 1999 we have completed twelve
acquisitions focused primarily on our neurosurgical product lines. 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 Form Strategic Alliances For Our Private Label Products. We have
collaborated with well-known medical device companies to develop and market the
majority of our non-neurosurgical product lines. Significant ongoing strategic
alliances include those with the Ethicon division of Johnson & Johnson to market
our INTEGRA(R) Dermal Regeneration Template and Wyeth BioPharma and Medtronic
Sofamor Danek to develop products for use in orthopedics. We intend to pursue
additional strategic alliances selectively.
Continue To Develop New And Innovative Medical Products. As evidenced by our
development of the INTEGRA(R) Dermal Regeneration Template, biomaterials for the
orthopedic implant market, Biomend(R) and Biomend(R) Extend Absorbable Collagen
Membrane, DuraGen(R) Dural Graft Matrix and the NeuraGen(TM) Nerve Guide, we
have a leading proprietary absorbable implant franchise. We currently are
developing a variety of innovative neurosurgical and other medical products and
are seeking expanded applications for our existing products.
MARKETING AND PRODUCTS
We offer one of the most comprehensive product lines serving the neuro intensive
care unit and operating room. We have established market positions in
intracranial monitoring, dural repair, tumor ablation, neurosurgical shunting,
surgical instrumentation, carotid shunting, peripheral nerve repair and central
nervous system diagnostic and monitoring supplies.
We sell our products directly through various sales forces and through a variety
of other distribution channels. Our direct sales forces include the following:
o Integra NeuroSciences(TM): Our Integra NeuroSciences(TM)sales force
provides implants, devices, instruments, and systems used in
neurosurgery, neuromonitoring, neurotrauma, and related
critical care to neurosurgeons and critical care units. These
products are used primarily by neurosurgeons and nurses in the
intensive care unit and the operating room and by neurologists in
hospital and outpatient settings. We believe that we can access
this focused group of hospital-based practitioners cost effectively
through our direct sales and marketing infrastructure in the
United States and Europe and our distribution network elsewhere.
Integra NeuroSciences' direct marketing effort in the United States and
Europe currently involves more than 100 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.
A national sales manager and seven regional managers lead the
United States sales force. We increased the number of our domestic
sales territories from 44 to 63 in 2002. We believe our expanded sales
force allows for smaller, more focused territories, better coverage
of our customers, greater participation in trade shows and more
extensive marketing efforts.
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o Our Integra Padgett Instruments sales force markets a wide variety of
high quality, reusable surgical instruments and implants to plastic and
reconstructive surgeons, burn surgeons, ENT surgeons, hospitals,
surgery centers, and other physicians. Padgett markets these products
primarily through an eight-person sales force in the United States.
Outside the United States, Padgett sells these products through a
network of distributors.
o Integra NeuroSupplies(TM) distributes disposables and supplies used in
the diagnosis and monitoring of neurological disorders. These products
are marketed primarily through a catalog, which is mailed once a year,
and are used by neurologists, hospitals, sleep clinics, and other
physicians in the United States.
We market our private label products through strategic partners or original
equipment manufacturer customers. Our private label products address large,
diverse markets, and we believe that we can develop and promote these products
more cost-effectively through leveraging the product development and
distribution systems of our strategic partners than through developing the
products ourselves or selling them through our own direct sales infrastructure.
We have partnered with market leaders, such as Johnson & Johnson, Medtronic,
Wyeth, and Centerpulse, 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.
Our products can be segregated into the following categories:
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PRODUCT LINES APPLICATION
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NEUROMONITORING PRODUCTS
Camino(R) and Ventrix(R) fiber optic-based intracranial Access, drainage and
continuous Monitoring systems, LICOX(R) oxygen monitoring monitoring of
intracranial pressure, Systems, Integra Systems of CSF Drainage and oxygen and
temperature following injury Cranial Access or neurosurgical procedures
Integra
NeuroSupplies(TM)
Disposables
and supplies
used in the
diagnosis
and
monitoring
of
neurological,
ENT and
pulmonary
disorders
Integra epilepsy monitoring electrodes Electrodes for the
intraoperative
monitoring of epileptic seizures
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OPERATING ROOM PRODUCTS
DuraGen(R)Dural Graft Matrix Graft to close brain and spine membrane
NeuraGen(TM)Nerve Guide Repair of peripheral nerves
Neurosurgical shunts, including the Specifically
designed for the management of Orbis-Sigma II(R),
and the H-V Lumbar, hydrocephalus, a chronic condition
involving Novus and Equi-Flow(R) Valves excess
cerebrospinal fluid in the brain
Sundt(TM)and other carotid shunts For shunting blood during surgical procedures
involving blood vessels
Helistat(R)and Helitene(R)Absorbable For control of bleeding
Collagen Hemostats
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PRODUCT LINES APPLICATION
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INSTRUMENTS
Selector(R)Integra Ultrasonic Aspirator; Surgical systems that use ultrasonic energy to
Dissectron(R)Ultrasonic Aspirator ablate tissue
Redmond(TM)-Ruggles(TM)neurosurgical Specialized surgical instruments for use in
and spinal instruments brain or spinal surgery
Padgett Instruments Devices and instruments used in burn,
reconstructive and plastic surgery
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PRIVATE LABEL PRODUCTS
INTEGRA(R)Dermal Regeneration Template Regenerate dermis and repair skin defects
(manufactured for Ethicon, Inc., a division of Johnson & Johnson, and Century Medical, Inc. in
Japan)
BioMend(R)and BioMend(R)Extend Absorbable Used in guided tissue regeneration in
periodontal Collagen Membrane surgery (manufactured for Centerpulse)
CollaCote(R), CollaTape(R)and CollaPlug(R) Used to control bleeding in dental surgery
Absorbable wound dressings (manufactured for Centerpulse)
Absorbable Collagen Sponge and other Fracture management / enabling spinal
fusion Matrices for use with bone morphogenetic (manufactured for Wyeth
BioPharma; Medtronic Protein (rhBMP-2) Sofamor Danek)
VitaCuff(R) catheter access infection control Provides protection against infection
arising from long-term catheters
(manufactured for Arrow International,
Bard Access Systems, Inc., Tyco HealthCare)
BioPatch(R)(1) Antimicrobial Wound Dressing Antimicrobial wound dressing (manufactured
for Ethicon, Inc.
Spembly Medical cryosurgery products Allows surgeon to use low temperature to more
easily extract diseased tissue (manufactured
for various distributors)
Cranial fixation devices; customer cranial plates Allows neurosurgeon to repair injuries to the
cranium (manufactured for Medtronic)
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(1) BioPatch is a registered trademark of Johnson & Johnson
Neuromonitoring 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 400,000 cases of head trauma each year in the United States, and
the market for monitoring and intervention is estimated to be approximately $40
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
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System. Currently there are more than 3,000 of our intracranial monitors
installed 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. 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.
External Drainage And Cranial Access. Neurosurgeons use external drainage
systems and cranial access kits 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.
Neurological Supplies. 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 test sleep
disorders.
We sell these products under the Integra NeuroSupplies(TM) name primarily
through a catalog 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.
Epilepsy Electrodes. We sell a line of electrodes for the intraoperative
monitoring of epileptic seizures. We acquired these products and other assets in
December 2002 from Radionics, a division of the Tyco Healthcare Group, and are
transferring the manufacture of these products to our facility in Biot, France.
Operating Room Products
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
synthetic materials, processed human cadaver, or bovine pericardium. The
worldwide market for dural repair, including cranial and spinal applications, is
estimated to be $80 million.
The DuraGen(R) Dural Graft Matrix is an absorbable collagen matrix indicated for
the repair of the dura mater surrounding the brain and spine. We believe that
the DuraGen(R) Dural Graft Matrix addresses the shortcomings of other methods
for repairing the dura mater. Clinical trials have shown our DuraGen(R) product
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) product and replaces it with new natural tissues, the patient avoids
some of the risks associated with a permanent implant inside the cranium or
spinal cavity.
Repair Of Peripheral Nerves. Peripheral nerves may become severed 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 market for the repair of
severed peripheral nerves to be $40 million.
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The NeuraGen(TM) Nerve Guide is an absorbable implant for the repair of severed
peripheral nerves. The NeuraGen(TM) product is a collagen tube designed to
provide a protective 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. In addition to targeting the neurosurgical operating room, we
are also marketing the NeuraGen(TM) product to the non-hospital and private
practice-based neurologists that purchase our Integra NeuroSupplies' products
and to the Integra Padgett Instruments' customer base of hand and reconstructive
surgeons.
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 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 approximately
80% of total cerebrospinal fluid shunt sales address birth-related
hydrocephalus, and the remaining 20% address surgical procedures involving
excess cerebrospinal fluid due to head trauma. Based on industry sources, we
believe that the total United States market for hydrocephalus management,
including monitoring, shunting and drainage, is approximately $70 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 2002 we strengthened our offering of hydrocephalus management products
through our acquisition of the neurosciences division of NMT Medical, Inc. and
certain assets of the Radionics business, a division of Tyco Healthcare Group.
Those acquisitions added a range of leading pressure valves, including the
Orbis-Sigma(R), Integra Hakim(R) horizontal-vertical ("H-V"), Equiflow(R) and
Contour Flex(R) valves to our existing line of hydrocephalus management shunting
products. We have sold the Heyer-Schulte(R), Novus(R), LPV(R) and Pudenz(TM)
shunts, ventricular, peritoneal and cardiac catheters, physician-specified
hydrocephalus management shunt kits, and Spetzler(R) lumbar and
syringo-peritoneal shunts since our acquisition of the NeuroCare group of
companies in 1999.
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 may negatively affect the future sales
of our shunt products.
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. The Integra NeuroSciences sales force sells these products
directly in the United States for use by vascular surgeons and neurosurgeons.
Instruments
Neurosurgical Systems For Tissue Ablation. More than 145,000 primary and
metastatic brain tumors are diagnosed annually in the United States. Our
Selector(R) Integra Ultrasonic Aspirator and Dissectron(R) Ultrasonic Surgical
Aspirator systems address the market for the surgical destruction and removal of
malignant and non-malignant tumors and other tissue.
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The Selector(R) Integra Ultrasonic Aspirator and Dissectron(R) Ultrasonic
Surgical Aspirator use very high frequency sound waves to pulverize 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. In September 2002, we received FDA
510(k) clearance to market the Selector(R) product for use in general,
gynecological, urological, plastic and reconstructive, orthopedic, thoracic and
thorascopic surgery procedures. We offer the Dissectron(R) product only outside
the United States.
Neurosurgical And Spinal Instrumentation. We provide neurosurgeons and spine
surgeons with a full line of specialty hand-held spinal and neurosurgical
instruments sold under the Redmond(TM) and Ruggles(TM) brand names and a line of
disposable neuroendoscopy products sold under the Neuro Navigational(R) brand
name.
The Redmond(TM)-Ruggles(TM) products include retractors, kerrisons, dissectors,
and curettes. Major product lines include spinal instruments, microsurgical
neuro instruments, and customized products sold through other companies and
distributors. Specialty surgical steel fabricators in Germany manufacture most
of the Redmond(TM) and Ruggles(TM) products to our specifications. The Neuro
Navigational(R) product line consists of fiber optic instruments used to
facilitate minimally invasive neurosurgery, including third ventriculostomies,
which are increasingly substituted for shunt placement for patients who meet the
criteria.
Padgett Instruments. We market a wide variety of high quality, reusable
surgical instruments to plastic and reconstructive surgeons, burn surgeons, ENT
surgeons, hospitals, surgery centers, and other physicians. We sell these
products in the United States through our Integra Padgett Instruments
eight-person direct sales force and through certain distributors and original
equipment manufacturer accounts. We sell these products internationally through
distributors.
Private Label Products
Skin Replacement. Our skin replacement products address the market need
created by severe burns, reconstructive surgery, and chronic wounds.
INTEGRA(R) Dermal Regeneration Template is designed to enable the human body to
regenerate functional dermal tissue. The 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 not desirable due to the
physiological condition of the patient. In 2002, 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. In 2002, we also received FDA 510(k)
clearance to sell a related product, Integra(TM) Bilayer Matrix Wound Dressing
and Integra(TM) Matrix Wound Dressing, for the dressing of wounds, including
chronic wounds.
The Ethicon division of Johnson & Johnson is the exclusive seller of the
INTEGRA(R) Dermal Regeneration Template and the Integra(TM) BiLayer Wound Matrix
worldwide, except in Japan where Century Medical, Inc. has rights to distribute
the INTEGRA(R) Dermal Regeneration Template.
In 2002, we sold $4.2 million of INTEGRA(R) Dermal Regeneration Template to
Ethicon and received $2.0 million in research payments and $1.0 million in
clinical and regulatory event payments that were recorded in other revenue.
Ethicon has not been successful in selling the minimum amounts of INTEGRA(R)
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Dermal Regeneration Template specified in its agreement with us. In addition, we
have notified Ethicon that certain clinical and regulatory events have been
achieved under the agreement and that payments for the achievement of those
events are due to us. Ethicon has informed us that it disagrees that the
clinical and regulatory events in question have been achieved, and that it does
not intend to make the payments we have demanded. In addition, Ethicon has
informed us that if we do not agree to substantial amendments to its agreement
with us, it will consider alternatives that may include exercising its right to
terminate the agreement.
The agreement requires Ethicon to give us notice one year in advance of a
termination of the agreement, during which time Ethicon is required to continue
to comply with the terms of the contract. At the end of that period, Ethicon may
be required to pay additional amounts based on the termination provisions of the
agreement and is required to cooperate in the transfer of the business back to
Integra. Additionally, Ethicon may apply the value of any minimum payments in
excess of actual product purchases against future purchases of products for sale
on a non-exclusive basis for a specified period of time.
If Ethicon does terminate the agreement or if we determine that Ethicon is in
breach of the agreement and we terminate the agreement, there is no assurance
that we will be able to recover the money that we believe Ethicon is obligated
to pay us under the agreement. If Ethicon does give us notice that it will
terminate the agreement, it is possible that Ethicon will diminish its sales and
marketing efforts for the product during the one-year notice period and that its
sales will decline as a result. In addition, we may not be successful in
sustaining or restoring the sales of the INTEGRA(R) Dermal Regeneration Template
at current levels after the termination date. Finally, if Ethicon terminates the
agreement it is possible that we may become involved in litigation with Ethicon,
which could also impair our ability to sell products under our other agreements
with Ethicon, including the BioPatch(R) and Instat(R) products.
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 Centerpulse.
Orthopedic Biomaterials. We supply Wyeth BioPharma with Absorbable Collagen
Sponges for use in developing bone regeneration implants. Since 1994, we have
supplied Absorbable Collagen Sponges for use with Wyeth BioPharma's recombinant
human bone morphogenetic protein-2 (rhBMP-2), a manufactured version of human
protein naturally present in very small quantities in the body. Wyeth BioPharma
is developing rhBMP-2 for clinical evaluation in several areas of bone repair
and augmentation, including orthopedic, oral and maxillofacial surgery
applications.
We are selling Absorbable Collagen Sponges for spinal applications through a
related collaboration with Medtronic Sofamor Danek in North America. In July
2002, the FDA approved Medtronic Sofamor Danek's InFUSE(TM) Bone Graft used with
the LT-CAGE(TM) Lumbar Tapered Fusion Device for use in spinal fusion
procedures. 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 Lumbar Tapered Fusion Device, the InFUSE Bone Graft is indicated to
treat certain types of spinal degenerative disc disease, a common cause of low
back pain.
Wyeth BioPharma has filed a PMA application with the FDA seeking approval for
the use of InductOs(TM), rhBMP-2 used in conjunction with our Absorbable
Collagen Sponge, for use in the treatment of acute long-bone fractures requiring
open surgical management. In November 2002, the Orthopedic and Rehabilitation
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Panel of the FDA Medical Devices Advisory Committee recommended that the FDA
approve, with conditions, Wyeth BioPharma's PMA application.
We receive development funding and other payments from Medtronic Sofamor Danek
and Wyeth BioPharma related to the development of additional matrices for
various applications. Although the agreement provides for no milestone or other
contingent payments, Wyeth BioPharma pays us to assist with regulatory affairs
and research.
In addition, we are continuing to develop additional biomaterial technologies,
such as a new class of absorbable polycarbonates created through the
polymerization of tyrosine, that enhance the rate and quality of healing and
tissue regeneration with synthetic biodegradable scaffolds that support cell
attachment and growth. No medical device containing these materials has yet been
approved for sale.
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, a wide range of absorbable collagen products for
hemostasis for use in dental surgery sold under the names CollaCote(R),
CollaTape(R) and CollaPlug(R), the Instat(R) Absorbable Collagen Hemostat, and
cranial fixation devices for use in craniomaxillofacial surgery. Our Spembly
Medical cryosurgery products allow surgeons to use low temperatures to more
easily extract diseased tissue in ophthalmic, general, gynecological, urological
and cardiac applications.
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. Contract development revenues from strategic alliance partners and
government grants fund a portion of our research and development activities. We
spent approximately $10.6 million, $8.0 million, and $7.5 million in 2002, 2001,
and 2000, respectively, on research and development activities. The 2002 amount
includes $2.3 million of acquired in-process research and development charges
recorded in connection with acquisitions. Research and development activities
funded by contract development and government grant revenues amounted to $3.5
million, $3.9 million, and $2.8 million in 2002, 2001, and 2000, respectively.
We have either acquired or secured the proprietary rights to several important
technological and scientific platforms, including collagen matrix, peptide,
biomaterials, and intracranial monitoring technologies. These technologies
provide support for our critical applications in neurosciences and tissue
regeneration and 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 neuroscience applications. These
efforts have led to the successful development of new products, such as the
NeuraGen(TM) Nerve Guide and DuraGen(R) Dural Graft Matrix.
We regularly review our research and development programs to ensure that they
remain consistent with and supportive of our growth strategies. To that end, in
2002 we expanded our product development staff to increase the focus on our
neurosurgical product development efforts and to seek additional strategic
alliances and applications for our other products and technologies.
GOVERNMENT REGULATION
As a manufacturer of medical devices, we are subject to extensive regulation by
the Food and Drug Administration (FDA) and, in some jurisdictions, by state and
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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 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 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, and certain supplemental PMA applications. 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.
However, the changes could have a material impact on our business.
We have received or acquired more than 190 Premarket Notification 510(k)
clearances, five approved PMA applications and 54 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
11
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, ISO 13485 and EN46001 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 each of
our facilities annually to verify our compliance with these standards. In 2002,
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 do not currently export medical devices manufactured
in the United States that have not been approved by the FDA, although we have in
the past.
OTHER UNITED STATES REGULATORY REQUIREMENTS
In addition to the regulatory framework for product approvals, we are and may be
subject to regulation under federal and state laws, including requirements
regarding occupational health and safety; laboratory practices; the maintenance
of personal health information; sales and marketing practices, including product
discounting practices; 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
12
We pursue a policy of seeking patent protection of our 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.
BioMend(R), Camino(R), CollaCote(R), CollaPlug(R), CollaStat(TM), CollaTape(R),
Dissectron(R), DuraGen(R), EquiFlow(R), Helistat(R), Helitene(R),
Heyer-Schulte(R), INTEGRA(R) Dermal Regeneration Template, Integra
NeuroSciences(TM), Integra NeuroSupplies(TM), JARIT(R), LICOX(R), NeuraGen(TM),
NeuroNavigational(R), Novus(R), LPV(R), Ommaya(R), Orbis-Sigma(R), Padgett
Instruments, Inc(R), Pudenz(TM), Redmond(TM), Ruggles(TM), Selector(R),
Spetzler(R), Sundt(TM), 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, various of our neurosurgery product lines
compete with smaller specialized companies or larger companies that do not
otherwise focus on neurosurgery. 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 INTEGRA(R) Dermal
Regeneration Template). Depending on the product line, we compete on the basis
of our products' features, strength of our sales force or marketing partner,
sophistication of our technology, and cost effectiveness of our solution to the
customer's medical requirements.
EMPLOYEES
At December 31, 2002, we had approximately 760 regular 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 Biot, France facility, 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.
13
AVAILABLE INFORMATION
Integra is 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 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.
RECENT DEVELOPMENT
On March 17, 2003, we acquired JARIT(R) Surgical Instruments, Inc. ("JARIT") for
$44.5 million in cash, subject to a working capital adjustment and other
adjustments with respect to certain income tax elections. For more than 30
years, JARIT has marketed a wide variety of high quality, reusable surgical
instruments to virtually all surgical disciplines. JARIT sells its products to
more than 5,200 hospitals and surgery centers worldwide. In the United States,
JARIT sells through a 20 person sales management force that works with over 100
distributor sales representatives.
With more than 5,000 instrument patterns and a 98% order fill rate, JARIT has
developed a strong reputation as a leading provider of high-quality surgical
instruments. JARIT manages its vendor relationships and purchases, packages and
labels its products directly from instrument manufacturers through its facility
in Tuttlingen, Germany.
The acquisition of JARIT broadens Integra's existing customer base and surgical
instrument product offering and provides an opportunity to achieve operating
costs savings, including the procurement of Integra's Redmond(TM)-Ruggles(TM)
and Padgett Instruments Inc.(R) products directly from the instrument
manufacturers.
The acquired business generated approximately $30.9 million in revenues and $7.8
million in income before income taxes for the year ended December 31, 2002.
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", which constitute forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. These forward-looking statements are subject to a number
of risks, uncertainties and assumptions about Integra, 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;
14
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 our ability to complete acquisitions and integrate operations
post-acquisition; and o other risk factors described in the section
entitled "Risk Factors" 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.
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.
15
Update to 2002 Annual Report on Form 10-K, Part II, Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of
operations should be read together with the selected consolidated financial data
and our financial statements and the related notes appearing elsewhere in this
report. This discussion and analysis contains forward-looking statements that
involve risks, uncertainties and assumptions. Our actual results may differ
materially from those anticipated in these forward-looking statements as a
result of many factors, including but not limited to those under the heading
"Risk Factors".
General
Integra develops, manufactures, and markets medical devices for use in
neurosurgery, plastic and reconstructive surgery, general surgery and soft
tissue repair.
We have historically managed our business and reviewed our financial results
under two separate operating segments: Integra NeuroSciences(TM) and Integra
LifeSciences(TM). In 2003, following the integration of several recently
acquired, diverse businesses, we began to manage the business and review
financial results on an aggregate basis, instead of through these two operating
segments. Accordingly, we will report our 2003 financial results and now present
our 2002 financial results for a single operating segment - the development,
manufacturing and distribution of medical devices.
We offer one of the most comprehensive product lines serving the needs of the
neuro intensive care unit and operating room. We have established market
positions in intracranial monitoring, dural repair, tumor ablation,
neurosurgical shunting, surgical instrumentation, carotid shunting, peripheral
nerve repair and central nervous system diagnostic and monitoring supplies. We
sell our products directly through various sales forces and through a variety
of other distribution channels.
Acquisitions
Our recent growth in product revenues reflect increased sales of existing
products, sales of newly launched products and sales of acquired businesses and
product lines. We have acquired ten businesses and product lines since January
1, 2000, and those acquisitions have contributed significantly to our growth.
16
Reported product revenues for 2002 and 2001 included the following amounts in
sales of acquired product lines:
2002 Revenues 2001 Revenues
------------- -------------
(in thousands)
Neuromonitoring
Products acquired during 2002 ................ $ 1,626 $ --
Products acquired during 2001 ................ 6,460 990
All other product revenues ................... 29,098 27,168
------ ------
Total Neuromonitoring product revenues ....... 37,184 28,158
Operating Room
Products acquired during 2002 ................ $ 3,460 $ --
Products acquired during 2001 ................ 1,921 1,054
All other product revenues ................... 32,945 26,186
------ ------
Total Operating Room product revenues ........ 38,326 27,240
Instruments
Products acquired during 2002 ................ $ 1,110 $ --
Products acquired during 2001 ................ -- --
All other product revenues ................... 15,692 14,972
------ ------
Total Instruments product revenues ........... 16,802 14,972
Private Label
Products acquired during 2002 ................ $ 1,419 $ --
Products acquired during 2001 ................ -- --
All other product revenues ................... 18,894 17,538
------ ------
Total Private Label product revenues ......... 20,313 17,538
Consolidated
Products acquired during 2002 ................ $ 7,615 $ --
Products acquired during 2001 ................ 8,381 2,044
All other product revenues ................... 96,629 85,864
------ ------
Total product revenues ....................... $112,625 $ 87,908
(1) Excludes sales of the LICOX(R) product in those territories where Integra
had exclusive distribution rights to the product prior to our acquisition
of GMSmbH.
Since the beginning of 2000, we have acquired the following businesses and
product lines:
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 are moving the manufacturing of the acquired lines to our facility in
Biot, France and are selling the acquired products through our Integra
NeuroSciences sales force.
In October 2002, we acquired Padgett Instruments, Inc.(R), 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 expect to
complete the consolidation of Padgett's operations into our distribution center
located in Cranbury, New Jersey in March 2003.
In September 2002, we acquired certain assets, including the NeuroSensor(TM)
monitor and rights to certain intellectual property, from Novus Monitoring
Limited of the United Kingdom ("Novus") and entered into a related development
agreement pursuant to which Novus will, at its own cost, conduct certain
clinical studies, continue development of an additional neuromonitoring product,
17
and design and transfer to us a validated manufacturing process for these
products. We paid Novus $3.5 million in cash at closing and agreed to pay an
additional $1.5 million upon Novus' achievement of a development milestone and
up to an additional $2.5 million based upon revenues from Novus' products. The
NeuroSensor(TM) monitor received 510(k) clearance from the FDA in February 2002
but has not been launched, pending the results of clinical trials and other
factors. We expect the Novus products to complement our existing line of brain
parameter monitoring products.
In connection with the Novus acquisition, we recorded a $1.1 million in-process
research and development charge for the value associated with the development of
a next generation neuromonitoring system. The design and functionality of this
next generation neuromonitoring system is based, in part, on certain technology
employed in the NeuroSensor(TM) system that has been modified specifically for
this project and which has no alternative use in the modified state. Early
prototypes of this next generation neuromonitoring system have been designed and
manufactured based on this modified core technology. Novus remains responsible
for the costs to complete development and obtain regulatory clearance for this
project, the value of which we have recorded as prepaid research and
development. We estimated the value of the in-process research and development
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.
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 include a facility
located in Biot, France that manufactures, packages and distributes shunting,
catheter and drainage products, and a distribution facility located in Atlanta,
Georgia. We completed the consolidation of the Atlanta operations into our
Cranbury, New Jersey distribution center as of September 30, 2002.
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. Signature Technologies currently manufactures cranial fixation
systems for sale primarily under a single contract manufacturing agreement that
expires in June 2004.
In connection with this acquisition, we recorded a $1.2 million in-process
research and development charge 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.
Signature Technologies has manufactured prototypes of this enhanced cranial
fixation system and we do not expect to incur significant costs to complete
development and obtain regulatory clearance to market the product. We estimated
the value of the in-process research and development charge 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.
18
In December 2001, we acquired NeuroSupplies, Inc., a specialty distributor of
disposables and supplies for neurologists, pulmonologists and other physicians,
for $4.1 million. The purchase price consisted of $0.2 million in cash, a $3.6
million note paid in January 2002, and 10,000 shares of Integra Common Stock.
Integra NeuroSupplies markets a wide variety of supplies to neurologists,
hospitals, sleep clinics, and other physicians in the United States as well as
to original equipment manufacturers and distributors.
In April 2001, we acquired Satelec Medical, a subsidiary of the Satelec-Pierre
Rolland group, for $3.9 million in cash. Satelec Medical, based in France,
manufactures and markets the Dissectron(R) ultrasonic surgical aspirator console
and a line of related handpieces. We completed the consolidation of the Satelec
manufacturing operations into our Andover, England and Biot, France facilities
in 2002.
In April 2001, we acquired GMSmbH, the German manufacturer of the LICOX(R)
product, for $3.2 million. The purchase price consisted of $2.6 million in cash,
the forgiveness of $0.2 million in notes receivable from GMSmbH, and $0.4
million of future minimum royalty payments to the seller. Prior to the
acquisition, we had exclusive marketing rights to the LICOX(R) products in the
United States and certain other markets.
In April 2000, we purchased the Selector(R) Ultrasonic Aspirator, Ruggles(TM)
hand-held neurosurgical instruments and Spembly Medical cryosurgery product
lines from NMT Medical, Inc. for $11.6 million in cash.
In January 2000, we purchased the business of Clinical Neuro Systems, Inc. for
$6.8 million. The purchase price consisted of $4.0 million in cash and a $2.8
million promissory note issued to the seller, which we repaid in full in 2001.
The acquired business designed and manufactured neurosurgical external
ventricular drainage systems, catheters, drainage bags, and cranial access kits.
We have accounted for these acquisitions using the purchase method of accounting
and have included the results of operations of each of the acquired businesses
in our consolidated financial statements since its date of acquisition. The
following table provides a comparison of pro forma product revenues for the
years 2002 and 2001 as if all acquisitions completed after January 1, 2001 had
occurred as of the beginning of that year. This pro forma product revenues data
is based upon estimates of product revenues generated by the acquired businesses
during the period prior to which Integra acquired them and does not necessarily
represent results that would have occurred if the acquisitions had taken place
on the basis assumed above.
2002 2001 Growth Over Prior Year
Reported Pro Forma Reported Pro Forma Reported Pro Forma
-------- --------- -------- --------- -------- ---------
($ in thousands)
Total product revenues ................. 112,625 128,909 87,908 118,498 28.1% 8.8%
Other revenue .......................... 5,197 5,197 5,534 5,534 (0.6%) (0.6%)
-------- --------- -------- --------- -------- ---------
Total revenue .......................... $117,822 $ 134,106 $ 93,442 $ 124,032 26.1% 8.1%
On March 17, 2003, we acquired JARIT Surgical Instruments, Inc. ("JARIT") for
$44.5 million in cash, subject to a working capital adjustment and other
adjustments with respect to certain income tax elections. For more than 30
years, JARIT has marketed a wide variety of high quality, reusable surgical
instruments to virtually all surgical disciplines. JARIT sells its products to
more than 5,200 hospitals and surgery centers worldwide. In the United States,
JARIT sells through a 20 person sales management force that works with over 100
19
distributor sales representatives.
With more than 5,000 instrument patterns and a 98% order fill rate, JARIT has
developed a strong reputation as a leading provider of high-quality surgical
instruments. JARIT manages its vendor relationships and purchases, packages and
labels its products directly from instrument manufacturers through its facility
in Tuttlingen, Germany.
The acquisition of JARIT broadens Integra's existing customer base and surgical
instrument product offering and provides an opportunity to achieve operating
costs savings, including the procurement of Integra's Redmond(TM)-Ruggles(TM)
and Padgett Instruments Inc.(R) products directly from the instrument
manufacturers.
The acquired business generated approximately $30.9 million in revenues and $7.8
million in income before income taxes for the year ended December 31, 2002.
Results of Operations
As a result of our recent acquisitions, the following financial results may not
be directly comparable.
(in thousands, except per share data) 2002 2001 2000
-------- -------- --------
Neuromonitoring products ............................ $ 37,184 $ 28,158 $ 23,532
Operating room products ............................. 38,326 27,240 18,988
Instruments ......................................... 16,802 14,972 8,647
Private label products .............................. 20,313 17,538 14,193
-------- -------- --------
Total product revenues ................................. 112,625 87,908 65,360
Other revenue .......................................... 5,197 5,534 6,289
-------- -------- --------
Total revenue .......................................... 117,822 93,442 71,649
Cost of product revenues ............................... 45,772 36,014 29,511
Gross margin on product revenues ....................... 66,853 51,894 35,849
Gross margin as a percentage of product revenues ....... 59% 59% 55%
Research and development expenses ...................... 8,304 7,992 7,524
Acquired in-process research and development ........... 2,328 -- --
Sales and marketing expenses ........................... 25,118 20,322 15,371
General and administrative expenses .................... 15,469 12,044 28,483
Amortization ........................................... 1,644 2,784 2,481
-------- -------- --------
Total other operating costs and expenses ............... 52,863 43,142 53,859
-------- -------- --------
Operating income (loss) ................................ 19,187 14,286 (11,721)
Interest income (expense), net ......................... 3,535 1,393 (473)
Gain on disposition of product line .................... -- -- 1,146
Other income (expense), net ............................ 3 (136) 201
-------- -------- --------
Income (loss) before income taxes ...................... 22,725 15,543 (10,847)
Income tax expense (benefit) ........................... (12,552) (10,863) 108
-------- -------- --------
Net income (loss) before extraordinary item and
accounting change ................................... 35,277 26,406 (10,955)
Extraordinary loss / accounting change ................. -- (243) (470)
-------- -------- --------
Net income (loss) ...................................... $ 35,277 $ 26,163 $(11,425)
======== ======== ========
Diluted net income (loss) per share .................... $ 1.14 $ 0.94 $ (0.97)
Weighted average shares outstanding .................... 30,895 27,796 17,553
20
Net income in 2002 was $35.3 million, or $1.14 per diluted share, as compared to
net income of $26.2 million in 2001, or $0.94 per diluted share, and a net loss
of $11.4 million in 2000, or $(0.97) per diluted share. Included in these
amounts are certain 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 charges and gains that meet this criteria promotes
comparability of reported financial results. The following charges and gains
were included in net income (loss) and net income (loss) per share:
Recorded in 2002
- 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; and
- acquired in-process research and development charges of $2.3 million
recorded in connection with acquisitions.
Recorded in 2001
- A $11.5 million deferred income tax benefit from the reduction of a
portion of the valuation allowance recorded against our deferred tax
assets associated with net operating loss carryforwards; and
- An extraordinary loss of $243,000, net of tax, from the early
retirement of debt;
Recorded in 2000
- A $13.5 million non-cash, stock-based compensation charge related to the
extension of the Chief Executive Officer's employment agreement recorded
in operating expenses;
- A $1.1 million gain on the sale of product lines;
- A $470,000 charge recorded as the cumulative effect of an accounting
change associated with the adoption of a new accounting policy for
revenue recognition; and
- A $4.2 million non-recurring, non-cash dividend related to the beneficial
conversion feature of our Series C Convertible Preferred Stock when it
was issued in March 2000 that did not affect the reported net loss for
2000 but was reflected in the calculation of net loss per share for 2000;
PRODUCT AND OTHER REVENUES and GROSS MARGINS ON PRODUCT REVENUES
In 2002, total revenues increased 26% over 2001 to $117.8 million, led by a 28%
increase in product revenues to $112.6 million. Domestic product revenues
increased $21.8 million in 2002 to $90.4 million, or 80% of total product
revenues, as compared to 78% of product revenues in 2001 and 79% of product
revenues in 2000. Growth in product revenues in 2002 was led primarily by sales
of neuromonitoring and operating room products, which reported a 32% and 41%
increase, respectively, in sales over 2001.
In 2001, total revenues increased 30% over 2000 to $93.4 million, led by a 35%
increase in product revenues to $87.9 million. Domestic product revenues
increased $16.9 million in 2001 to $68.6 million, or 78% of total product
revenues, as compared to 79% of product revenues in 2000. Growth in product
revenues in 2001 was led primarily by sales of operating room products and
instruments, which reported a 43% and 73% increase, respectively, in sales over
2000.
21
Increased sales of our DuraGen(R) Dural Graft Matrix and sales of recently
acquired product lines accounted for most of our growth in 2002 and 2001.
Revenue from sales of neurosurgical shunt product lines acquired in 2002, offset
in part by a decline in sales from our existing shunt lines, and increased sales
of the DuraGen(R) product and the NeuraGen(TM) Nerve Guide contributed to the
growth in our 2002 operating room product revenue. In 2001, increased sales of
the DuraGen(R) product led the growth in operating room products revenues.
Revenue from sales of drainage product lines acquired in 2002 and the Integra
NeuroSupplies(TM) products acquired in December 2001 and increased sales of our
intracranial monitoring systems and existing drainage systems all contributed
significantly to the growth in our neuromonitoring product revenues in 2002. In
2001, the launch of the LICOX(R) product in the United States and increased
sales of our existing neuromonitoring and drainage and cranial access systems
led growth in neuromonitoring product revenues.
Revenue from sales of the Padgett Instruments product line acquired in 2002 and
a full year of sales of the Dissectron(R) Ultrasonic Aspirator product line
acquired in April 2001 contributed to the growth in instruments product revenues
in 2002. In 2001, sales of the Dissectron product and a full year of sales of
the Selector(R) Ultrasonic Aspirator product line acquired in April 2000
contributed to the growth in instrument product revenues.
Effective January 2003, our Integra NeuroSciences sales force began to sell our
neurosurgical products to certain hospitals through a group purchasing
organization. Group purchasing organizations use the leverage of large,
organized buying groups 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. We expect that our participation
in group purchasing organizations will improve our ability to sell our products
to those participating hospitals that have not historically purchased from us.
Growth in sales of private label products in 2002 was generated primarily by
increased revenues from the Absorbable Collagen Sponge component of Medtronic's
recently approved InFUSE(TM) Bone Graft product and $1.4 million in sales of
product lines acquired in 2002. The increase in private label product revenues
in 2001 was generated primarily by increased sales of our INTEGRA(R) Dermal
Regeneration Template product and the Absorbable Collagen Sponge and a $600,000
increase in revenues from the cryosurgery product line acquired in the second
quarter of 2000.
In 2002, the FDA approved a Premarket Approval ("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. In
2002 we also received FDA 510(k) clearance to sell related products, Integra(TM)
Bilayer Matrix Wound Dressing and Integra(TM) Matrix Wound Dressing, for the
dressing of wounds, including chronic wounds. We are continuing to work with
Ethicon to obtain additional marketing indications for the INTEGRA(R) product.
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
22
acquire businesses that complement our existing businesses and products.
Gross margin as a percentage of product revenues was 59%, 59% and 55%, in 2002,
2001 and 2000, respectively. Cost of product revenues included $447,000,
$203,000, and $429,000 in fair value inventory purchase accounting adjustments
recorded in connection with acquisitions in 2002, 2001, and 2000, respectively.
The positive effect on gross margins of an increasing percentage of overall
product revenues generated from higher margin operating room products and of
increased direct sales to hospitals in Europe in 2002 and 2001 offset the
negative impact of certain unfavorable manufacturing overhead variances
incurred in the production of our private label products in 2002 and of fair
value inventory purchase accounting adjustments. We expect our future gross
margins to benefit as sales of the higher margin operating room products
continue to grow faster than other products. We also have developed or are
developing plans to improve gross margins by consolidating our manufacturing
facilities and increasing the efficiency of various manufacturing sites.
Other revenue consists 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. Other
revenue decreased by $337,000 in 2002 as a decline in government grant funding
and the expiration of a technology royalty agreement were slightly offset by the
receipt in 2002 of $1.0 million in event related payments. The $756,000 decline
in other revenue in 2001 was primarily the result of $1.5 million of
event-related revenues received in 2000, as compared to none in 2001, partially
offset by higher research and development funding received in 2001. Other
revenue includes $2.0 million per year in research and development funding
related to our strategic alliance with Ethicon. The Ethicon Agreement provides
us with research funding of $2.0 million per year through the year 2004. After
2004, funding amounts are based on a percentage of net revenues of the
INTEGRA(R) Dermal Regeneration Template.
Although the research, development and distribution agreements with our
strategic partners provide us with funding when certain events occur, such as
advances in research programs, critical publications or product approvals, the
timing of these event payments is uncertain and difficult to predict.
In 2002, we sold $4.2 million of INTEGRA(R) Dermal Regeneration Template to
Ethicon and received $2.0 million in research payments and $1.0 million in
clinical and regulatory event payments that were recorded in other revenue.
Ethicon has not been successful in selling the minimum amounts of INTEGRA(R)
Dermal Regeneration Template specified in its agreement with us. In addition, we
have notified Ethicon that certain clinical and regulatory events have been
achieved under the agreement and that payments for the achievement of those
events is due to us. Ethicon has informed us that it disagrees that the clinical
and regulatory events in question have been achieved, and that it does not
intend to make the payments we have demanded. In addition, Ethicon has informed
us that if we do not agree to substantial amendments to its agreement with us,
it will consider alternatives that may include exercising its right to terminate
the agreement.
The agreement requires Ethicon to give us notice one year in advance of a
termination of the agreement, during which time Ethicon is required to continue
to comply with the terms of the contract. At the end of that period, Ethicon may
be required to pay additional amounts based on the termination provisions of the
23
agreement and is required to cooperate in the transfer of the business back to
Integra. Additionally, Ethicon may apply the value of any minimum payments in
excess of actual product purchases against future purchases of products for sale
on a non-exclusive basis for a specified period of time.
If Ethicon does terminate the agreement or if we determine that Ethicon is in
breach of the agreement and we terminate the agreement, there is no assurance
that we will be able to recover the money that we believe Ethicon is obligated
to pay us under the agreement. If Ethicon does give us notice that it will
terminate the agreement, it is possible that Ethicon will diminish its sales and
marketing efforts for the product during the one-year notice period and that its
sales will decline as a result. In addition, we may not be successful in
sustaining or restoring the sales of the INTEGRA(R) Dermal Regeneration Template
at current levels after the termination date. Finally, if Ethicon terminates the
agreement it is possible that we may become involved in litigation with Ethicon,
which could also impair our ability to sell products under our other agreements
with Ethicon, including the BioPatch(R) and Instat(R) products.
OTHER OPERATING EXPENSES
In 2002, we recorded $2.3 million of in-process research and development charges
in connection with our acquisitions of Signature Technologies, Inc. and certain
assets of Novus Monitoring Limited. Other research and development expenses
increased in 2002 as a result of increased headcount and spending on product
development focused on our neurosurgical product lines, offset by reduced
development spending on INTEGRA(R) Dermal Regeneration Template and a $0.5
million decrease in government grants for research. Research and development
expenses increased in 2001 primarily due to the development of a collagen
hemostatic device for use in neurosurgical procedures and development costs for
the NeuraGen(TM) Nerve Guide product, offset by decreased spending from the
termination of a program with a partner to develop a product to regenerate
articular cartilage.
We expect to continue to increase our efforts and focus on product development
in the future.
Sales and marketing expenses have increased significantly since 2000, consistent
with the expansion of our domestic and international sales and marketing
infrastructure and increased trade show activities. Sales and marketing expenses
represented 22%, 23%, and 24% of total product revenues in 2002, 2001 and 2000,
respectively.
Since the end of 1999, we have more than doubled the size of our domestic
Integra NeuroSciences(TM) sales force to more than 80 professionals, including
neurospecialists, regional managers and clinical educators. With the
acquisitions of GMSmbH and Satelec Medical in April 2001 and the neurosciences
division of NMT Medical in July 2002, we have a direct neurosurgical sales and
marketing presence in the key markets of western Europe. Through the acquisition
of Padgett Instruments in 2002 we have an eight person direct sales force in the
United States that sells to plastic and reconstructive surgeons, burn surgeons,
hand surgeons, ENT surgeons and other physicians. Through the acquisition of
JARIT Surgical Instruments in March 2003, we have a 20 person sales management
force in the United States that works with over 100 distributor sales
representatives selling to virtually all surgical disciplines.
24
General and administrative expenses increased $3.4 million in 2002, $1.9 million
of which were operating costs associated with recently acquired businesses that
were not reflected in our results for the full year in 2001. The remaining
increase in general and administrative expenses in 2002 consisted primarily of
increased facility rent at our expanded corporate headquarters and higher
insurance and legal costs.
General and administrative expenses decreased $16.4 million in 2001 as compared
to 2000. General and administrative expenses in 2000 included a $13.5 million
non-cash, stock-based compensation charge related to the extension of the Chief
Executive Officer's employment agreement. The remaining decrease in general and
administrative expenses in 2001 resulted primarily from a decrease in legal
expenses related to the conclusion of the jury trial in the patent infringement
lawsuit against Merck KGaA in the first quarter of 2000 as well as a reduction
in other litigation matters outstanding in 2001 and because of the write-off in
2000 of a large distributor account receivable.
Amortization expense decreased in 2002 because of the adoption of Statement of
Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets",
which requires that goodwill no longer be amortized. Excluding the effect of the
recently acquired Jarit Instruments business, annual amortization expense is
expected to approximate $2.1 million in both 2003 and 2004, $1.8 million in both
2005 and 2006, and $1.6 million in 2007.
NON-OPERATING INCOME AND EXPENSES
In August 2001, we raised $113.4 million from a follow-on public offering of 4.7
million shares of common stock, of which $9.3 million was subsequently used to
repay all outstanding indebtedness. Accordingly, net interest income in 2002
increased to $3.5 million, as compared to net interest income of $1.4 million in
2001 and net interest expense of $473,000 in 2000.
We recorded a $1.1 million pre-tax gain on the disposition of two product lines
in 2000.
INCOME TAXES
Since 1999, we have generated positive taxable income on a cumulative basis. In
light of this trend, our current projections for future taxable earnings, and
the expected timing of the reversal of deductible temporary differences, we
concluded in the fourth quarter of 2001 that we no longer needed to maintain a
portion of the valuation allowance recorded against federal and state net
operating loss carryforwards and certain other temporary differences. We reduced
the valuation allowance by $12.0 million in 2001 because we believed that it was
more likely than not that we would realize the benefit of that portion of the
deferred tax assets recorded at December 31, 2001. The $12.0 million reduction
in the valuation allowance consisted of an $11.5 million deferred income tax
benefit and a $450,000 credit to additional paid-in capital related to net
operating loss carryforwards generated through the exercise of stock options.
In the fourth quarter of 2002, we reduced the remaining valuation allowance
recorded against net operating loss carryforwards by $23.4 million, which
reflected our estimate of additional tax benefits that we expect to realize in
the future. The $23.4 million reduction in the valuation allowance consisted of
a $20.4 million deferred income tax benefit and a $3.0 million credit to
additional paid-in capital related to net operating loss carryforwards generated
25
through the exercise of stock options. A valuation allowance of $7.7 million is
recorded against the remaining $32.9 million of net deferred tax assets recorded
at December 31, 2002. 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, in the event that
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.
The net change in the Company's valuation allowance was $(26.7) million, $(10.4)
million, and $3.3 million, in 2002, 2001, and 2000, respectively. Included in
the 2002 reduction was the write off of the valuation allowance associated with
$3.3 million of deferred tax assets which the Company wrote off because they are
no longer expected to be utilizable.
At December 31, 2002, we had net operating loss carryforwards of approximately
$74.4 million and $19.8 million for federal and state income tax purposes,
respectively, to offset future taxable income. The federal and state net
operating loss carryforwards expire through 2013 and 2010, respectively. New
Jersey has imposed a moratorium on the ability of corporations to use their net
operating loss carryforwards to reduce their New Jersey state tax obligations.
In 2000, we recognized a tax benefit of $467,000 from the sale of certain state
net operating loss carryforwards through a special program offered by the State
of New Jersey.
At December 31, 2002, several of our subsidiaries had unused net operating loss
carryforwards and tax credit carryforwards arising from periods prior to our
ownership which expire through 2010. The Internal Revenue Code limits the timing
and manner in which we may use any acquired net operating losses or tax credits.
International Product Revenues and Operations
Because we have operations based in Europe and we generate certain revenues and
incur certain operating expenses in British Pounds and the Euro, we will
experience currency exchange risk with respect to those foreign currency
denominated revenues or expenses.
Currently, we do not use derivative financial instruments to manage foreign
currency risk. As the volume of our business transacted in foreign currencies
increases, we will continue to assess the potential effects that changes in
foreign currency exchange rates could have on our business. If this potential
impact is believed to present a significant risk to our business, we may enter
into derivative financial instruments, including forward contracts to purchase
or sell foreign currencies, 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 where the U.S. dollar has increased compared to
the local currency.
Our sales to foreign markets may be affected by local economic conditions.
26
Relationships with customers and effective terms of sale frequently vary by
country, often with longer-term receivables than are typical in the United
States.
Product revenues by major geographic area are summarized below:
United Asia Other
States Europe Pacific Foreign Consolidated
---------- ---------- ---------- ---------- ------------
(in thousands)
Product revenues:
2002 ................. $ 90,422 $ 14,737 $ 4,062 $ 3,404 $ 112,625
2001 ................. 68,612 10,577 4,838 3,881 87,908
2000 ................. 51,752 6,759 4,628 2,221 65,360
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. Of this amount, $13.4 million of these revenues were
generated in foreign currencies from our foreign-based subsidiaries in the
United Kingdom, Germany and France. We expect revenues from customers outside
the United States and expenses and revenues denominated in foreign currencies to
increase in absolute terms, but not as a proportion of our total revenues, in
2003 as our acquisition of a significant facility in France in July 2002 and our
continued expansion of our European sales force offset the effect of our recent
acquisitions of entities that sell solely in the United States.
In 2001, revenues from customers outside the United States totaled $19.3
million, or 22% of consolidated product revenues, of which approximately 55%
were to European customers. Of this amount, $7.2 million of these revenues were
generated in foreign currencies from our foreign subsidiaries in the United
Kingdom, Germany and France.
In 2000, revenues from customers outside the United States totaled $13.6
million, or 21% of consolidated product revenues, of which approximately 50%
were to European customers. Of this amount, $3.2 million of these revenues were
generated in foreign currencies from our subsidiary based in the United Kingdom,
which was acquired in April 2000.
Liquidity And Capital Resources
Historically, we have funded our operations primarily through private and public
offerings of equity securities, product revenues, research and collaboration
funding, borrowings under a revolving credit line and cash acquired in
connection with business acquisitions and dispositions. Since 1999, we have
substantially reduced our net use of cash from operations and, in 2002 and 2001,
we generated positive operating cash flows of $32.0 million and $15.7 million,
respectively. Operating cash flows improved in 2002 as a result of higher net
income and improved working capital management.
Our principal uses of funds in 2002 were $25.0 million for business
acquisitions, the repayment of a $3.6 million note given to a seller as
consideration for the acquisition of NeuroSupplies, Inc. and $2.3 million for
purchases of property and equipment. Principal sources of funds were
approximately $3.3 million from the issuance of common stock and $32.0 million
of positive operating cash flow.
On August 13, 2001, we issued 4.7 million shares of common stock in a public
offering at $25.50 per share. The net proceeds generated by the offering, after
expenses, were $113.4 million. With the proceeds from the public offering of
common stock, we repaid all outstanding debt, including $7.9 million of bank
27
loans and $1.4 million payable under the terms of a promissory note, in the
third quarter of 2001. Additionally, a related term loan and revolving credit
facility was terminated in August 2001. We had no debt outstanding at December
31, 2002.
At December 31, 2002, we had cash, cash equivalents and marketable securities
totaling $132.3 million. Investments consist almost entirely of highly liquid,
interest bearing debt securities. We believe that our cash and marketable
securities are sufficient to finance our operations in the short term. However,
given the significant level of liquid assets and our objective to grow by
acquisition and alliances, our financial position and future financial results
could change significantly if we were to complete a business acquisition by
utilizing a significant portion of our liquid assets. On March 17, 2003, we used
$44.5 million to acquire the business of Jarit Instruments.
Excluding the effect of the acquisition of JARIT Surgical Instruments in March
2003, we are obligated to pay approximately $2.5 million and $2.2 million in
2003 and 2004, respectively, under the terms of operating lease agreements for
our facilities. Thereafter, through 2012, we are contractually obligated to pay
an aggregate of $6.1 million in total lease costs. We may be obligated to pay
Novus an additional $1.5 million upon Novus' achievement of a development
milestone and up to an additional $2.5 million based upon revenues from Novus'
products. Additionally, we are obligated to pay royalties based on sales of
certain of our products, including $0.3 million in future guaranteed minimum
royalty payments to the seller of the GMSmbH business. We have no other
significant future contractual obligations.
In February 2003, our Board of Directors authorized us to repurchase up to one
million shares of our common stock for an aggregate cost not to exceed $15.0
million. We may repurchase shares under this program through February 2004
either in the open market or in privately negotiated transactions. During 2002,
we repurchased 100,000 shares of our stock for an aggregate purchase price of
$1.8 million under a previously authorized share repurchase program.
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 long-lived asset
valuations and acquired in-process research and development charges,
depreciation and amortization periods for long-lived assets, valuation
allowances recorded against deferred tax assets, loss contingencies, and
estimates of costs to complete performance obligations associated with research,
licensing, and distribution arrangements for which revenue is accounted for
using percentage of completion accounting. 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.
28
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, determined on 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.
Long-Lived Assets. We review long-lived assets to be held and used, including
property, plant, and equipment and intangible assets, for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. We evaluate the recoverability of long-lived assets to
be held and used by comparing its carrying value with the projected undiscounted
net cash flows applicable to the long-lived assets. If an impairment exists, we
calculate the amount of such impairment based on the estimated fair value of the
asset. We record impairments to long-lived assets to be disposed of based upon
the fair value of the applicable assets. If future events that would trigger an
impairment review occur or we change our estimates of projected future
undiscounted net cash flows related to long-lived assets to be held and used, we
may need to record an impairment charge.
Goodwill. Upon the adoption of Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets" in January 2002, our assessment of
the recoverability of goodwill changed to a method based upon a comparison of
the carrying value of the reporting units to which goodwill is assigned with its
respective fair value. We completed our initial impairment review for goodwill
as of June 30, 2002 and determined that our reporting unit goodwill was not
impaired. If future events that would trigger an impairment review occur or we
change our estimates of the fair value of our reporting units, we may need to
record an impairment charge.
29
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.
Depreciation And Amortization Periods. We provide for depreciation and
amortization using the straight-line method over the estimated useful lives of
property, plant and equipment and other 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. If our assessment of the useful
lives of these long-lived assets changes, we may change future depreciation and
amortization expense.
Income Taxes. We recognize deferred tax assets and liabilities 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. We record a valuation allowance to reduce our deferred tax
assets to the amount that is more likely than not to be realized. We have
considered our projections for future taxable earnings and the expected timing
of the reversal of deductible temporary differences in determining the need for
a valuation allowance. In 2002, this analysis resulted in our reducing the
recorded valuation allowance by $23.4 million. In the event that we determine
that we would be able to realize more or less than the recorded amount of net
deferred tax assets, we would record an adjustment to the deferred tax asset
valuation allowance in the period we make such a determination. We would record
the adjustment in the earnings of such period or, to the extent the valuation
allowance relates to tax benefits from the exercise of stock options, as a
credit to additional paid-in capital.
Revenue Recognition. We recognize product sales when delivery has occurred and
title has passed to the customer, there is a fixed or determinable sales price,
and collectibility of that sales price is reasonably assured. We recognize
research grant revenue when the related expenses are incurred. Under the terms
of existing research grants, we are reimbursed for allowable direct and indirect
research expenses. We recognize royalty revenue over the period our customers
sell the royalty products and the amount earned by Integra is fixed and
determinable. We recognize non-refundable fees received under research,
licensing and distribution arrangements as revenue when received if we have no
continuing obligations to the other party. For those arrangements where we have
continuing performance obligations, we recognize revenue using the lesser of the
amount of non-refundable cash received or the result achieved using percentage
of completion accounting based upon our estimated cost to complete these
obligations. If our estimates of the costs to complete these obligations change,
we may change the amount of revenue we recognized for fees received under
research, licensing and distribution arrangements where we have continuing
performance obligations.
Loss Contingencies. We are subject to claims and lawsuits in the ordinary course
of our business, including claims by employees or former employees and with
respect to our products. Our financial statements do not reflect any material
30
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,
and 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.
31
Update to 2002 Annual Report on Form 10-K, Part IV, Item 15. Financial
Statements
1. Financial Statements. The following financial statements and financial
statement schedule are filed as a part of this report.
Report of Independent Accountants ....................................... F-1
Consolidated Statements of Operations for the years ended
December 31, 2002, 2001, and 2000 ...................................... F-2
Consolidated Balance Sheets as of December 31, 2002 and 2001 ............ F-3
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001, and 2000 ...................................... F-4
Consolidated Statements of Changes in Stockholders' Equity
for the years ended December 31, 2002, 2001, and 2000 .................. F-5
Notes to Consolidated Financial Statements .............................. F-6
Report of Independent Accountants on Financial Statement Schedule ....... F-30
Financial Statement Schedule ............................................ F-31
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Integra LifeSciences
Holdings Corporation and Subsidiaries:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity and cash flows
present fairly, in all material respects, the financial position of Integra
LifeSciences Holdings Corporation and Subsidiaries (the Company) at December 31,
2002 and 2001 and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 2002, in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
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.
As discussed more fully in Note 2 to the consolidated financial statements, in
2000 the Company changed its method of accounting for nonrefundable fees
received under its various research, license and distribution agreements.
As discussed in Note 2 to the consolidated financial statements, the Company has
adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets", effective January 1, 2002.
/s/ PricewaterhouseCoopers LLP
Florham Park, New Jersey
February 21, 2003, except Note 15
for which the date is March 17, 2003
and Notes 1 and 13 for which the
date is June 26, 2003.
F1
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
In thousands, except per share amounts
Years Ended December 31,
--------------------------------
2002 2001 2000
-------- -------- --------
REVENUES
Product revenue ................................. $112,625 $ 87,908 $ 65,360
Other revenue ................................... 5,197 5,534 6,289
-------- -------- --------
Total revenue ............................... 117,822 93,442 71,649
COSTS AND EXPENSES
Cost of product revenue ......................... 45,772 36,014 29,511
Research and development ........................ 8,304 7,992 7,524
Acquired in-process research and development .... 2,328 -- --
Selling and marketing ........................... 25,118 20,322 15,371
General and administrative ...................... 15,469 12,044 28,483
Amortization .................................... 1,644 2,784 2,481
-------- -------- --------
Total costs and expenses .................... 98,635 79,156 83,370
Operating income (loss) ......................... 19,187 14,286 (11,721)
Interest income (expense), net .................. 3,535 1,393 (473)
Gain on dispositions of product lines ........... -- -- 1,146
Other income (expense), net ..................... 3 (136) 201
-------- -------- --------
Income (loss) before income taxes ............... 22,725 15,543 (10,847)
Income tax expense (benefit) .................... (12,552) (10,863) 108
-------- -------- --------
Income (loss) before extraordinary loss and
cumulative effect of accounting change ....... 35,277 26,406 (10,955)
Extraordinary loss on early retirement of debt,
net of income tax benefit .................... -- (243) --
Cumulative effect of accounting change .......... -- -- (470)
-------- -------- --------
Net income (loss) ............................... $ 35,277 $ 26,163 $(11,425)
======== ======== ========
Basic net income (loss) per share before
extraordinary loss and cumulative effect
of accounting change ....................... $ 1.21 $ 1.09 $ (0.95)
Basic net income (loss) per share ............ $ 1.21 $ 1.08 $ (0.97)
Diluted net income (loss) per share before
extraordinary loss and cumulative effect
of accounting change ....................... $ 1.14 $ 0.95 $ (0.95)
Diluted net income (loss) per share .......... $ 1.14 $ 0.94 $ (0.97)
Weighted average common shares outstanding:
Basic ........................................ 29,021 23,353 17,553
Diluted ...................................... 30,895 27,796 17,553
The accompanying notes are an integral part of these consolidated financial statements
F2
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONSOLIDATED BALANCE SHEETS
In thousands, except per share amounts
December 31,
-----------------------
ASSETS 2002 2001
--------- ---------
Current Assets:
Cash and cash equivalents ...................................... $ 43,583 $ 44,518
Short-term investments ......................................... 55,278 22,183
Trade accounts receivable, net of allowances
of $1,387 and $1,403 ....................................... 19,412 14,024
Inventories .................................................... 28,502 24,329
Prepaid expenses and other current assets ...................... 5,498 2,898
--------- ---------
Total current assets ....................................... 152,273 107,952
Noncurrent investments .......................................... 33,450 64,335
Property, plant, and equipment, net ............................. 16,556 11,662
Deferred income taxes, net ...................................... 25,218 10,243
Goodwill, net ................................................... 22,073 14,627
Intangible assets, net .......................................... 23,091 16,898
Other assets .................................................... 2,007 1,871
--------- ---------
Total assets ..................................................... $ 274,668 $ 227,588
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Short-term debt ................................................ $ -- $ 3,576
Accounts payable, trade ........................................ 3,764 2,924
Income taxes payable ........................................... -- 1,481
Customer advances and deposits ................................. 7,908 4,843
Deferred revenue ............................................... 816 772
Accrued expenses and other current liabilities ................. 9,433 5,550
--------- ---------
Total current liabilities .................................. 21,921 19,146
Deferred revenue ................................................ 3,263 3,949
Other liabilities ............................................... 1,887 437
--------- ---------
Total liabilities ................................................ 27,071 23,532
Commitments and contingencies
Stockholders' Equity:
Preferred stock; $0.01 par value; 15,000 authorized shares; 0
and 54 Series C Convertible shares issued and outstanding ... -- 1
Common stock; $.01 par value; 60,000 authorized shares; 27,204
and 26,129 issued and outstanding ........................... 272 261
Additional paid-in capital ..................................... 292,007 284,021
Treasury stock, at cost; 106 and 6 shares ...................... (1,812) (51)
Other .......................................................... (15) (37)
Accumulated other comprehensive income (loss):
Unrealized gain on available-for-sale securities ............ 861 237
Foreign currency translation adjustment ..................... 1,618 (776)
Minimum pension liability adjustment ........................ (1,011) --
Accumulated deficit ............................................ (44,323) (79,600)
--------- ---------
Total stockholders' equity ................................... 247,597 204,056
--------- ---------
Total liabilities and stockholders' equity ...................... $ 274,668 $ 227,588
========= =========
The accompanying notes are an integral part of these consolidated financial statements
F3
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
In thousands
Years Ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
OPERATING ACTIVITIES:
Net income (loss) ......................................... $ 35,277 $ 26,163 $(11,425)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization ............................ 5,020 5,959 5,357
Loss (gain) on sale of product line and other assets ..... 28 -- (1,316)
In process research and development charge ............... 2,328 -- --
Loss on early retirement of debt ......................... -- 256 --
Deferred tax benefit ..................................... (13,401) (12,085) --
Amortization of discount and premium on investments ...... 2,142 298 (181)
Stock based compensation ................................. 31 29 13,587
Other, net ............................................... 129 158 43
Changes in assets and liabilities, net of business
acquisitions:
Accounts receivable .................................... (2,109) 98 (3,475)
Inventories ............................................ 1,153 (6,987) (3,061)
Prepaid expenses and other current assets .............. (1,131) (1,443) (571)
Non-current assets ..................................... 185 1,858 (3,565)
Accounts payable, accrued expenses and other
liabilities ................................. (90) (941) 2,831
Customer advances and deposits ......................... 2,565 4,020 (3,078)
Deferred revenue ....................................... (142) (1,682) (106)
-------- -------- --------
Net cash provided by (used in) operating activities ...... $ 31,985 15,701 (4,960)
-------- -------- --------
INVESTING ACTIVITIES:
Proceeds from sale of product line and other assets ....... -- -- 1,600
Proceeds from the maturities of investments ............... 35,402 3,000 16,981
Purchases of available for sale investments ............... (39,113) (88,533) (13,391)
Purchases of property and equipment ....................... (2,254) (2,860) (3,268)
Cash used in business acquisitions, net of cash acquired .. (25,015) (6,348) (16,187)
Loans made ................................................ -- -- (238)
-------- -------- --------
Net cash used in investing activities .................... $(30,980) (94,741) (14,503)
-------- -------- --------
FINANCING ACTIVITIES:
Net proceeds (repayments) from revolving credit facility .. -- (3,147) 3,143
Repayments of term loan ................................... (3,600) (7,705) (2,250)
Repayment of note payable ................................. -- (2,800) --
Proceeds from sales of preferred stock and warrants ....... -- -- 5,375
Proceeds from the issuance of common stock ................ -- 113,433 5,000
Proceeds from exercise of common stock purchase warrants .. -- 3,616 50
Proceeds from stock issued under employee benefit plans ... 3,323 6,060 3,156
Purchases of treasury stock ............................... (1,761) -- (170)
Collection of related party note receivable ............... -- -- 35
Preferred stock dividends paid ............................ -- -- (67)
-------- -------- --------
Net cash (used in) provided by financing activities ...... $ (2,038) 109,457 14,272
Effect of exchange rate changes on cash and cash equivalents .. 98 15 (24)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents .......... $ (935) 30,432 (5,215)
Cash and cash equivalents at beginning of period .............. 44,518 14,086 19,301
-------- -------- --------
Cash and cash equivalents at end of period .................... $ 43,583 $ 44,518 $ 14,086
======== ======== ========
Cash paid during the year for interest ........................ $ 20 $ 778 $ 922
Cash paid during the year for income taxes .................... 1,435 928 508
The accompanying notes are an integral part of these consolidated financial statements
F4
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
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, 1999 .................. $ 6 $ 161 $ (7) $ 132,340 $ (143) $ (64) $ (94,304) $ 37,989
Net loss .................................... (11,425) (11,425)
Unrealized losses on investments ............ (32) (32)
Foreign currency translation ................ (457) (457)
---------
Total comprehensive loss ............. $(11,914)
=========
Issuance of 54 shares of Series C Preferred
Stock and warrants ....................... 1 5,374 5,375
Conversion of 500 shares of Series
Preferred Stock into 250 shares of
common stock ............................. (5) 3 2 --
Private placement of 333 shares of common
stock .................................... 3 4,997 5,000
Issuance of 564 shares of common stock
through employee benefit plans ............ 6 3,201 3,207
Warrants exercised for cash ................. 50 50
Issuance of 45 shares of common stock in
settlement of obligation .................. 641 641
Amortization of unearned compensation ....... 72 72
Tax benefit related to stock option
exercises ................................ 51 51
Issuance of 1,250 Restricted Units .......... 13,515 13,515
Unearned compensation related to
Non-employee stock options ................ 30 (30) --
Dividends paid on Series A Preferred Stock .. (67) (67)
Repurchase 19 shares of common stock ........ (173) (173)
Collection of related party note ............ 35 35
Balance, December 31, 2000 .................. 2 173 (180) 160,134 (66) (553) (105,729) 53,781
========= ========= ========= ========== ========= ============= =========== ========
Net income .................................. 26,163 26,163
Unrealized gains on investments (1) ......... 333 333
Foreign currency translation ................ (319) (319)
---------
Total comprehensive income............ $ 26,177
=========
Conversion of 100 shares of Series B
Preferred Stock into 2,618 shares of
common stock ............................. (1) 26 (25) --
Public offering of 4,748 shares of
common stock .............................. 48 113,385 113,433
Issuance of 879 shares of common stock
through employee benefit plans ............ 9 129 5,998 (34) 6,102
Warrants exercised for cash ................. 5 3,611 3,616
Issuance of 10 shares of common stock in
acquisition ............................... 276 276
Amortization of unearned compensation ....... 29 29
Tax benefit related to stock option
exercises ................................ 642 642
Balance, December 31, 2001 .................. 1 261 (51) 284,021 (37) (539) (79,600) $ 204,056
========= ========= ========= ========= ========= ============= =========== ==========
Net income .................................. 35,277 35,277
Unrealized gains on investments ............ 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
Amortization of unearned 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
========= ========= ========= ========== ========= ============= =========== =========
(1) Includes $95 reclassification adjustment for other than temporary impairment
of available for sale securities
The accompanying notes are an integral part of these consolidated financial statements
F5
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 neurosurgery, plastic and
reconstructive surgery, general surgery and soft tissue repair. The Company's
product lines include traditional medical devices, such as monitoring and
drainage systems, surgical instruments, and fixation systems, as well as
innovative tissue repair products, such as the DuraGen(R) Dural Graft Matrix,
the NeuraGen(TM) Nerve Guide, and the INTEGRA(R) Dermal Regeneration Template,
that incorporate the Company's proprietary absorbable implant technology.
The Company sells its products directly through various sales forces and through
a variety of other distribution channels. The global manufacturing, sales,
marketing and administrative functions for each of the organizations through
which the Company sells its products are managed on a centralized basis.
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.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with 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.
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 was 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, 2002 and 2001 were as follows:
Unrealized Fair
Cost Gains Losses Value Maturity
------- ------- ------- ------- ----------
(in thousands)
2002:
-----
Marketable debt securities, current..... $54,695 $ 504 $ (1) $55,198 less than 1 year
Marketable equity securities ........... 60 21 (1) 80
Marketable debt securities, non-current. 33,112 347 (9) 33,450 less than 40 months
------- ------- ------- -------
$87,867 $ 872 $ (11) $88,728
2001:
-----
Marketable debt securities, current..... $22,092 $ 53 $ (35) $22,110 less than 1 year
Marketable equity securities ........... 78 3 (8) 73
Marketable debt securities, non-current. 64,111 357 (133) 64,335 less than 30
months
------- ------- ------- -------
$86,281 $ 413 $ (176) $86,518
The carrying values of all other financial instruments were not materially
different from their estimated fair values.
F6
ALLOWANCES FOR DOUBTFUL ACCOUNTS RECEIVABLE AND SALES RETURNS
The Company evaluates the collectibility of accounts receivable based on a
combination of factors. In circumstances where a specific customer is unable to
meet its financial obligations to us, an allowance 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, allowances for doubtful
accounts are recorded based on the length of time the receivables are past due,
the current business environment and our historical experience.
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.
INVENTORIES
Inventories, consisting of purchased materials, direct labor and manufacturing
overhead, are stated at the lower of cost, determined on the first-in, first-out
method, or market. Inventories consisted of the following:
December 31,
2002 2001
---------- ----------
(in thousands)
Finished goods .......................... $ 19,198 $ 13,277
Work in process ......................... 3,019 3,493
Raw materials ........................... 6,285 7,559
---------- ----------
$ 28,502 $ 24,329
At each balance sheet date, the Company evaluates ending inventories for excess
quantities, obsolescence or shelf-life expiration. This evaluation includes an
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:
December 31,
2002 2001 Lives
---------- ---------- ---------------
(in thousands)
Land ............................................ $ 511 $ --
Buildings and leasehold improvements ............ 11,877 10,095 2 to 40 years
Machinery and equipment ......................... 16,492 13,320 3 - 15 years
Furniture and fixtures .......................... 3,561 1,657 5 - 7 years
Construction in progress ........................ 500 310
---------- ----------
32,941 25,382
Less: Accumulated depreciation .................. (16,385) (13,720)
---------- ----------
$ 16,556 $ 11,662
Depreciation expense associated with property, plant and equipment was $3.4
million, $3.2 million, and $2.9 million, in 2002, 2001, and 2000 respectively.
F7
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 acquired prior to July 1, 2001 was amortized
on a straight line basis over a period of 15 years through December 31, 2001.
Goodwill acquired after July 1, 2001 was not subject to amortization. Effective
January 1, 2002, goodwill was no longer amortized but is instead subject to
annual impairment reviews.
Upon the adoption of Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets" in January 2002, our assessment of the
recoverability of goodwill has changed to a method based upon a comparison of
the carrying value of goodwill with its estimated fair value. The Company
completed its initial impairment review for goodwill as of June 30, 2002 and
determined that its goodwill was not impaired.
Changes in the carrying amount of reporting unit goodwill in 2002 were as
follows:
Integra Integra
NeuroSciences LifeSciences Total
------------- ------------- -------------
(in thousands)
Goodwill, net of accumulated amortization
at December 31, 2001 .................... $ 13,815 $ 812 $ 14,627
Reclassification of assembled workforce
intangible, net of amortization ......... 1,245 30 1,275
Acquisitions ................................ 5,775 -- 5,775
Adjustments to previously recorded
pre-acquisition income tax contingencies.. (484) -- (484)
Other, net ................................. 64 -- 64
Foreign currency translation ................ 814 2 816
-------- -------- --------
Goodwill at December 31, 2002 ............... $ 21,229 $ 844 $ 22,073
======== ======== ========
The components of the Company's identifiable intangible assets were as follows:
December 31, 2002 December 31, 2001
Weighted ---------------------- ----------------------
Average Accumulated Accumulated
Life Cost Amortization Cost Amortization
-------- -------- ------------ -------- ------------
(in thousands)
Completed technology ........... 15 years $ 13,165 $ (2,380) $ 11,255 $ (1,516)
Customer relationships ......... 10 years 4,661 (1,085) 3,575 (674)
Trademarks / brand names ....... 34 years 7,151 (445) 1,715 (305)
Assembled work force ........... -- -- 1,581 (306)
All other ...................... 10 years 2,601 (577) 1,824 (251)
-------- ------------ -------- ------------
$ 27,578 $ (4,487) $ 19,950 $ (3,052)
Accumulated amortization .................... (4,487) (3,052)
-------- --------
$ 23,091 $ 16,898
======== ========
F8
Excluding the effect of the recently acquired JARIT Surgical Instruments
business (Note 15), annual amortization expense is expected to approximate $2.1
million in both 2003 and 2004, $1.8 million in both 2005 and 2006, and $1.6
million in 2007. 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.
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). 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.
REVENUE RECOGNITION
Product revenues include both product sales and royalties earned on sales by
strategic alliance partners of the Company's products or of products
incorporating one or more of the Company's products. 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
products are sold by our customers and the amount earned by Integra is fixed and
determinable.
Other revenues include research grants, fees received under research, licensing,
and distribution arrangements, and technology-related royalties. Research grant
revenue is recognized when the related expenses are incurred. Under the terms of
existing research grants, the Company is reimbursed for allowable direct and
indirect research expenses. 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 percentage of
completion accounting based upon the estimated cost to complete these
obligations.
In December 1999 (as amended in March 2000 and June 2000) the staff of the
Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin 101,
"Revenue Recognition" (SAB 101). As the result of the adoption of SAB 101, the
Company recorded a $470,000 cumulative effect of an accounting change in 2000 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 for
each of the years ended December 31, 2002, 2001 and 2000 includes $112,000 of
amortization of the amount deferred as of January 1, 2000.
SHIPPING AND HANDLING FEES AND COSTS
Amounts billed to customers for shipping and handling are included in products
revenues. The related shipping and handling fees and costs incurred by the
Company are included in cost of product revenues.
F9
PRODUCT WARRANTIES
Certain of the Company's medical devices, including monitoring systems and
ablation systems, are reusable and are designed to operate over long periods of
time. These products are sold with warranties extending for up to two years from
date of purchase. The Company accrues estimated product warranty costs at the
time of sale based on historical experience. Any additional amounts are recorded
when such costs are probable and can be reasonably estimated. Accrued warranty
expense consisted of the following:
December 31,
2002 2001
-------- --------
(in thousands)
Beginning balance .................. $ 226 $ 124
Charged to expense ................. 257 347
Deductions ......................... (267) (245)
-------- --------
Ending balance ..................... $ 216 $ 226
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.
STOCK BASED COMPENSATION
Employee stock based compensation is recognized using the intrinsic value method
prescribed by Accounting Principles Board Opinion No. 25 "Accounting for Stock
Issued to Employees" and Financial Accounting Standards Board Interpretation No.
44 "Accounting for Certain Transactions Involving Stock Compensation an
interpretation of APB Opinion No. 25".
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 (loss) and basic and diluted net income
(loss) per share would have been as follows:
2002 2001 2000
-------- -------- --------
(in thousands, except per share amounts)
Net income (loss):
As reported ...................................... $ 35,277 $ 26,163 $(11,425)
Less: Total stock-based employee compensation
expense determined under the fair
value-based method for all awards, net
of related tax effects ..................... (4,774) (5,911) (3,436)
-------- -------- --------
Pro forma ........................................ $ 30,503 $ 20,252 $(14,861)
Net income (loss) per share:
Basic
As reported ...................................... $ 1.21 $ 1.08 $ (0.97)
Pro forma ........................................ $ 1.05 $ 0.82 $ (1.17)
Diluted
As reported ...................................... $ 1.14 $ 0.94 $ (0.97)
Pro forma ........................................ $ 1.03 $ 0.75 $ (1.17)
F10
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 was
calculated based on the fair value of each option grant using the Black-Scholes
model with the following weighted-average assumptions:
2002 2001 2000
---------- ---------- ----------
Dividend yield ....................... 0% 0% 0%
Expected volatility .................. 65% 80% 90%
Risk free interest rate .............. 3.00% 4.50% 6.50%
Expected option lives ................ 4.5 years 4.5 years 4.5 years
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,
in-process research and development charges, and estimates of costs to complete
performance obligations associated with research, licensing, and distribution
arrangements for which revenue is accounted for using percentage of completion
accounting. These estimates are based on historical experience and on various
other assumptions that are believed to be reasonable under the current
circumstances. Actual results could differ from these estimates.
RECENTLY ISSUED ACCOUNTING STANDARDS
In November 2002, the FASB issued Interpretation No. 45 (FIN 45), "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others". Among other things, FIN 45 requires
guarantors to recognize, at fair value, their obligations to stand ready to
perform under certain guarantees. FIN 45 is effective for guarantees issued or
modified on or after January 1, 2003. FIN 45 is not expected to have any impact
on the Company's financial statements.
In July 2002, the FASB issued Statement of Financial Accounting Standards No.
146, "Accounting for Costs Associated with Exit or Disposal Activities"
(Statement 146). Statement 146 requires that a liability for a cost associated
with an exit or disposal activity be recognized when the liability is incurred.
Statement 146 nullifies Emerging Issues Task Force Issue 94-3 "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)," which required
that an entity recognize a liability for an exit cost at the date it commits to
an exit plan. The provisions of this Statement are effective for exit or
disposal activities initiated after December 31, 2002. The adoption of Statement
146 is not expected to have a material impact on the Company's financial
statements.
In October 2001, the FASB issued Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (Statement
144). Statement 144 supercedes Statement of Financial Accounting Standards No
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
F11
Assets to Be Disposed Of." Statement 144 applies to all long-lived assets,
including discontinued operations, and consequently amends Accounting Principles
Board Opinion No. 30, "Reporting Results of Operations-- Reporting the Effects
of Disposal of a Segment of a Business." The Company adopted Statement 144 on
January 1, 2002. The adoption of Statement 144 had no impact on the Company's
financial statements.
In July 2001, the FASB issued Statements of Financial Accounting Standards No.
141, "Business Combinations" (Statement 141), and No. 142, "Goodwill and Other
Intangible Assets" (Statement 142).
Statement 141 requires that all business combinations initiated after June 30,
2001 be accounted for using the purchase method of accounting and further
clarifies the criteria to recognize intangible assets separately from goodwill.
The Company determined that its assembled workforce intangible asset does not
meet the criteria for recognition as a separate identifiable intangible asset
and thus, effective January 1, 2002, reclassified the net book value of its
assembled workforce intangible asset into goodwill.
Under Statement 142, goodwill and indefinite-lived intangible assets are no
longer amortized, but are reviewed for impairment at the reporting unit level
annually, or more frequently if impairment indicators arise. Separable
intangible assets that are not deemed to have an indefinite life will continue
to be amortized over their useful lives. Upon adoption of Statement 142, the
Company reassessed the useful lives of its existing identifiable intangible
assets and determined that they continue to be appropriate. As required by
Statement 142, the Company amortized through December 31, 2001 all goodwill
acquired prior to July 1, 2001. Effective January 1, 2002, the Company stopped
amortizing all goodwill.
If the Company had applied the non-amortization provisions of Statement 142 for
all of 2001 and 2000, net income (loss) would have been as follows:
2001 2000
-------- --------
(in thousands)
Net income (loss), as reported ............................ $ 26,163 $(11,425)
Effect of goodwill and assembled workforce amortization ... 858 611
-------- --------
Net income (loss), as adjusted ............................ $ 27,021 $(10,814)
Basic net income (loss) per share, as reported ............ $ 1.08 $ (0.97)
Effect of goodwill and assembled workforce amortization ... .03 .03
-------- --------
Basic net income (loss) per share, as adjusted............ $ 1.11 $ (0.94)
Diluted net income (loss) per share, as reported .......... $ 0.94 $ (0.97)
Effect of goodwill and assembled workforce amortization ... .03 .03
-------- --------
Basic net income (loss) per share, as adjusted............ $ 0.97 $ (0.94)
3. ACQUISITIONS
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 expenses associated with the acquisition. The
manufacturing of the acquired product lines is being transferred to Integra's
manufacturing facility located in Biot, France. This acquisition broadened
Integra's neurosurgical product line offering and customer base and is expected
to increase 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 expenses
associated with the acquisition. For more than 40 years, Padgett has been
providing high quality instruments to meet the needs of the plastic and
F12
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.
Integra is consolidating the distribution operations of Padgett into the
Company's distribution center located in Cranbury, New Jersey, which is expected
to result in future operating cost savings. This acquisition also broadened
Integra's direct sales and marketing infrastructure in the United States and its
existing surgical customer base, which represents an additional call point to
market certain of Integra's existing products.
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
expenses associated with the acquisition. Through this acquisition, the Company
added a range of leading differential pressure valves and external ventricular
drainage products to its neurosurgical product line. The acquired operations
included a facility located in Biot, France that manufactures, packages and
distributes shunting, catheter and drainage products, and a distribution
facility located in Atlanta, Georgia that was consolidated into Integra's
Cranbury, New Jersey distribution center in September 2002. The $4.2 million
fair value assigned to the land, building and equipment in Biot was determined
based on a third party appraisal.
This acquisition broadened Integra's neurosurgical product line offering and
provided a more technologically advanced neurosurgical shunting product line
than was previously sold by the Company. Additionally, the acquired Biot
facility and European-based direct sales organization are expected to become an
important part of Integra's continental European operating activities.
In connection with this acquisition, the Company terminated all of NMT's
independent neurosciences sales agents based in the United States and exited the
Atlanta, Georgia distribution facility. The estimated costs to terminate the
independent sales agents, all rent payments made after the shutdown of the
facility, and the costs paid to terminate the Atlanta facility lease were
accrued as part of the purchase price because they provided no future benefit to
the Company's operations. The amounts recorded are summarized below:
Initial Change in Balance
Balance Estimate Utilized 12/31/02
--------- --------- -------- --------
(in thousands)
Termination of sales agents ........ $ 211 $ -- $ (62) $ 149
Lease obligations .................. 175 (96) (79) --
Severance costs totaling $130,000 were paid to employees of the Atlanta facility
as a condition for their continued employment until operations at the facility
ceased. These costs were expensed over the period in which the related services
were performed.
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 expenses associated with the acquisition), $0.5 million of deferred
consideration that is included in accrued liabilities at December 31, 2002, and
royalties on future sales of products to be developed. Signature Technologies
currently manufactures cranial fixation systems primarily for sale under a
single contract manufacturing agreement that expires in June 2004.
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. Signature Technologies has manufactured prototypes of
F13
this enhanced cranial fixation system and we do not expect to incur significant
costs to complete development and obtain regulatory clearance to market the
product. 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.
In December 2001, the Company acquired all of the capital stock of
NeuroSupplies, Inc., a specialty distributor of disposables and supplies for
neurologists, pulmonologists and other physicians, for $4.1 million. The
purchase price consisted of $0.2 million in cash (including expenses associated
with the acquisition), a $3.6 million note that was repaid in 2002, and 10,000
shares of Integra common stock. This acquisition extended Integra's reach to the
neurologist and allied fields and further into products used for the diagnosis
and monitoring of neurological disorders.
In April 2001, the Company acquired all of the outstanding capital stock of
Satelec Medical, a subsidiary of the Satelec-Pierre Rolland group, for $3.9
million in cash, including expenses associated with the acquisition. Satelec
Medical, based in France, manufactures and markets the Dissectron(R) ultrasonic
surgical aspirator console and a line of related handpieces. The Company
completed the consolidation of the Satelec manufacturing operations into its
Andover, England and Biot, France facilities in 2002. This acquisition broadened
Integra's neurosurgical product line offering and its direct sales and marketing
presence in Europe.
In April 2001, the Company acquired all of the outstanding capital stock of
GMSmbH, the German manufacturer of the LICOX(R) Brain Tissue Oxygen Monitoring
System, for $3.2 million. The purchase price consisted of $2.6 million in cash
(including expenses associated with the acquisition), the forgiveness of $0.2
million in notes receivable from GMSmbH, and $0.4 million of future minimum
royalty payments to the seller. Prior to the acquisition, the Company had
exclusive marketing rights to the LICOX(R) products in the United States and
certain other markets. This acquisition provided Integra with full rights to the
LICOX(R) product technology.
In April 2000, the Company purchased the Selector(R) Ultrasonic Aspirator,
Ruggles(TM) hand-held neurosurgical instruments and Spembly Medical cryosurgery
product lines from NMT Medical, Inc. for $11.6 million in cash. This acquisition
broadened Integra's neurosurgical product line offering and provided Integra
with its first direct sales and marketing presence in Europe.
In January 2000, the Company purchased the business of Clinical Neuro Systems,
Inc. for $6.8 million. The purchase price consisted of $4.0 million in cash and
a 5% $2.8 million promissory note issued to the seller, which was repaid in
2001. The acquired business designed and manufactured neurosurgical external
ventricular drainage systems, including catheters and drainage bags, as well as
cranial access kits.
All of these acquisitions have been accounted for using the purchase method of
accounting, and the results of operations of the acquired businesses have been
included in the consolidated financial statements since their respective dates
of acquisition.
F14
The following table summarizes the fair value of the assets acquired and
liabilities assumed as a result of these acquisitions:
(All amounts in thousands)
2002 Acquisitions Radionics Padgett NMT Neuro Signature
----------------- --------- --------- --------- ---------
Current assets ....................... $ 1,049 $ 2,164 $ 5,605 $ 490
Property, plant and equipment ........ 75 65 4,510 1,165
Intangible assets .................... 391 6,437 -- 626
Goodwill ............................. 2,152 3,389 -- --
In-process research and development .. -- -- -- 1,177
Other non-current assets ............. 18 281 -- --
--------- --------- --------- ---------
Total assets acquired ............. 3,685 12,336 $10,115 3,458
Current liabilities .................. -- 200 3,789 76
Deferred tax liabilities ............. -- 2,524 665 --
--------- --------- --------- ---------
Total liabilities assumed ......... -- 2,724 4,454 76
Net assets acquired .................. $ 3,685 $ 9,612 $ 5,661 $ 3,382
2001 Acquisitions NeuroSupplies Satelec GMS
----------------- ------------- ----------- -----------
Current assets ....................... $ 931 $ 999 $ 484
Property, plant and equipment ........ 74 55 336
Intangible assets .................... 470 1,064 613
Goodwill ............................. 3,044 2,210 2,383
Other non-current assets ............. -- 75 --
------------- ----------- -----------
Total assets acquired ............. 4,519 4,403 3,816
Current liabilities .................. 255 9 339
Deferred tax liabilities ............. 179 448 272
------------- ----------- -----------
Total liabilities assumed ......... 434 457 611
Net assets acquired .................. $ 4,085 $ 3,946 $ 3,205
The goodwill acquired in the Radionics acquisition 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 operations for the periods indicated as if the acquisitions consummated in
2002 and 2001 had been completed as of January 1, 2001. 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 decreased
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.
2002 2001
-------- --------
(in thousands)
Total revenue ......................................... $134,106 $124,032
Income before extraordinary loss ...................... 36,253 27,760
Net income ............................................ 36,253 27,517
Basic income per share before extraordinary loss ...... $ 1.25 $ 1.19
Diluted income per share before extraordinary loss .... $ 1.25 $ 1.00
Basic net income per share ............................ $ 1.17 $ 1.18
Diluted net income per share .......................... $ 1.17 $ 0.99
F15
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 expenses associated with the acquisition), an additional $1.5 million
to be paid upon Novus' achievement of a product development milestone, and up to
an additional $2.5 million payable based upon revenues from Novus' products. The
NeuroSensor(TM) system, which has received 510(k) clearance from the United
States Food and Drug Administration but has not yet been launched pending the
results of clinical trials and other factors, measures both intracranial
pressure and cerebral blood flow using a single combined probe and an electronic
monitor for data display. As part of the consideration paid, Novus has also
agreed to conduct certain clinical studies on the NeuroSensor(TM) system,
continue development of a next generation, advanced neuromonitoring product, and
design and transfer to Integra a validated manufacturing process for these
products. The Company expects Novus' products to complement our existing line of
brain parameter monitoring products.
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):
Prepaid research and development expense ......... $ 771
Other assets ..................................... 151
Intangible assets ................................ 1,663
In-process research and development .............. 1,151
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 design and functionality of this
next generation neuromonitoring system is based, in part, on certain technology
employed in the NeuroSensor(TM) system that has been modified specifically for
this project and which has no alternative use in the modified state. Early
prototypes of this next generation neuromonitoring system have been designed and
manufactured based on this modified core technology. Novus remains responsible
for the costs to complete development and obtain regulatory clearance for this
project, the value of which was recorded as prepaid research and development.
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.
4. DEBT
In connection with the acquisition of NeuroSupplies in December 2001, the
Company issued a one month, interest-free $3.6 million promissory note to the
seller that was repaid in January 2002.
In connection with the prepayment of all outstanding bank loans and a $2.8
million note payable issued in connection with an acquisition, the Company
recorded in 2001 an extraordinary loss on the early retirement of debt of
$243,000, net of a $13,000 tax benefit.
F16
5. 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 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 Series C Preferred was issued with a beneficial conversion feature that
resulted in a nonrecurring, non-cash dividend of $4.2 million, which has been
reflected in the net loss per share in 2000. The beneficial conversion dividend
was based upon the excess of the price of the underlying common stock as
compared to the fixed conversion price of the Series C Preferred, after taking
into account the value assigned to the common stock warrants. The warrants
issued with the Series C Preferred were exercised in December 2001 for proceeds
of $2.7 million.
In connection with the NeuroCare acquisition, the Company issued 100,000 shares
of Series B Convertible Preferred Stock (Series B Preferred) and warrants to
purchase 240,000 shares of common stock at $3.82 per share to SPEP for $9.9
million, net of issuance costs. In June 2001, SPEP converted the Series B
Preferred into 2,617,800 shares of common stock. The Series B Preferred had a
10% cumulative annual dividend yield payable only upon liquidation. The warrants
issued with the Series B Preferred were exercised in March 2001 for proceeds of
$916,800.
SPEP is entitled to certain registration rights for shares of common stock
obtained through conversion of the Series B Preferred or Series C Preferred or
the exercise of the related warrants.
During the second quarter of 1998, the Company sold 500,000 shares of Series A
Convertible Preferred Stock (Series A Preferred) for $4.0 million to Century
Medical, Inc. (CMI). CMI converted the Series A Preferred into 250,000 shares of
common stock in October 2000. The Series A Preferred paid an annual dividend of
$0.16 per share.
COMMON STOCK TRANSACTIONS
In August 2001, the Company issued 4,747,500 shares of common stock at $25.50
per share in a follow-on public offering. The net proceeds generated by the
offering, after expenses, were $113.4 million.
In September 2000, the Company completed a $5.0 million private placement of
333,334 shares of common stock.
In 2002 and 2000, respectively, the Company repurchased 100,000 and 19,000
shares of its common stock for $1.8 million and $173,000. In February 2003, the
Company received authorization from its Board of Directors to repurchase up to
one million shares of its common stock for an aggregate cost not to exceed $15.0
million.
F17
6. 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 have been reserved for issuance. These shares
will be made available either from the Company's authorized but unissued shares
of common stock or from shares of common stock reacquired by the Company as
treasury shares. At December 31, 2002, approximately 248,000 shares remain
available for purchase under the ESPP.
STOCK OPTION PLANS
As of December 31, 2002, the Company had stock options outstanding under six
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), and
the 2001 Equity Incentive Plan (the 2001 Plan and collectively, the Plans).
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, and 2,000,000
shares each under the 1999 Plan, the 2000 Plan and the 2001 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 and 2001 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:
2002 2001 2000
--------------------- --------------------- ---------------------
Wtd. Avg. Wtd. Avg. Wtd. Avg.
Options Ex. Price Options Ex. Price Options Ex. Price
-----------------------------------------------------------------------
(shares in thousands)
Options outstanding at
January 1, ........... 4,261 $10.79 4,519 $ 7.74 3,791 $ 5.82
Granted ................. 618 $17.73 748 $24.61 1,548 $11.62
Exercised ............... (425) $ 6.15 (836) $ 6.49 (493) $ 5.68
Cancelled ............... (159) $13.39 (170) $11.88 (327) $ 6.90
Options outstanding at
December 31, ......... 4,295 $12.15 4,261 $10.79 4,519 $ 7.74
Options exercisable at
December 31, .......... 2,380 $ 8.75 1,986 $ 6.89 1,759 $ 6.27
At December 31, 2002, there were 1,270,000 shares available for grant under the
Plans.
F18
The following table summarizes information about stock options outstanding as of
December 31, 2002:
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 2002 Price Contractual Life 2002 Price
----------------- ---------- ------------ -------------------- ---------- -----------
(shares in thousands)
$ 3.375 - $ 4.375 567 $ 3.73 2.0 years 548 $ 3.73
$ 4.438 - $ 5.875 1,014 $ 5.81 3.9 years 882 $ 5.81
$ 5.906 - $12.563 885 $ 10.03 5.8 years 401 $ 9.31
$12.625 - $17.650 1,106 $ 15.35 4.8 years 342 $ 14.16
$17.680 - $32.420 723 $ 25.36 5.0 years 207 $ 24.52
------- -------- ----------- ------- --------
4,295 $ 12.15 4.5 years 2,380 $ 8.75
The weighted average fair market value of options granted in 2002, 2001 and 2000
was $9.57, $16.14, and $8.20 per share, respectively.
RESTRICTED UNITS
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 Company's
President and Chief Executive Officer (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. In connection with the
issuance of the Restricted Units, the Company incurred a non-cash compensation
charge of $13.5 million in the fourth quarter of 2000, which is included in
general and administrative expenses. The Executive also 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. The Executive has demand
registration rights under the Restricted Units issued in December 1997 and
December 2000.
No other stock-based awards are outstanding under any of the Plans.
7. RETIREMENT BENEFIT PLANS
DEFINED BENEFIT PLAN
The Company maintains a defined benefit pension plan in the United Kingdom
covering certain current and former employees. This plan is no longer open to
new participants. Net periodic benefit costs for this defined benefit pension
plan included the following amounts:
2002 2001 2000
-------- -------- --------
(in thousands)
Service cost ..................................... $ 122 $ 115 $ 76
Interest cost .................................... 355 332 228
Expected return on plan assets ................... (331) (356) (256)
Recognized net actuarial loss .................... 85 7 --
-------- -------- --------
Net periodic benefit cost ..................... $ 231 $ 98 $ 48
The following weighted average assumptions were used to develop net periodic
benefit cost and the actuarial present value of projected benefit obligations:
2002 2001 2000
-------- -------- --------
Discount rate .................................... 5.5% 5.9% 6.0%
Expected return on plan assets ................... 6.5% 6.5% 6.5%
Rate of compensation increase .................... 3.8% 4.1% 4.1%
F19
The following sets forth the change in benefit obligations and change in plan
assets at December 31, 2002 and 2001 and the prepaid (accrued) benefit cost:
December 31,
2002 2001
-------- --------
(in thousands)
CHANGE IN BENEFIT OBLIGATION
Benefit obligation, beginning of year .......................... $ 5,733 $ 5,841
Service cost ................................................... 123 115
Interest cost .................................................. 356 332
Participant contributions ...................................... 33 33
Actuarial (gain) loss .......................................... 30 (323)
Benefits paid .................................................. (105) (101)
Effect of foreign currency exchange rates ...................... 633 (164)
-------- --------
Benefit obligation, end of year ................................ $ 6,803 $ 5,733
CHANGE IN PLAN ASSETS
Plan assets at fair value, beginning of year ................... $ 5,153 $ 5,683
Actual return on plan assets ................................... (669) (427)
Employer contributions ......................................... 153 127
Benefits paid .................................................. (105) (101)
Participant contributions ...................................... 33 33
Effect of foreign currency exchange rates ...................... 503 (162)
-------- --------
Plan assets at fair value, end of year ......................... $ 5,068 $ 5,153
RECONCILIATION OF FUNDED STATUS
Funded status, Benefit obligation in excess of plan assets ........ $(1,735) $ (580)
Unrecognized net actuarial loss ................................... 2,001 1,036
Adjustment to recognize minimum liability ......................... (1,444) --
-------- --------
Prepaid (accrued) benefit cost .................................... $(1,178) $ 456
The accrued benefit liability recorded at December 31, 2002 is included in other
liabilities. The prepaid benefit asset recorded at December 31, 2001 is included
in other assets.
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
plan were $575,000, $411,000 and $310,000 in 2002, 2001 and 2000, respectively.
8. 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 beneficiaries 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 rent escalations of 8.5% in 2007 and expires in October 2012.
The lease agreement related to the Company's research facility in San Diego
provides for annual escalations.
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 both 2002 and 2001.
F20
Future minimum lease payments under operating leases at December 31, 2002 were
as follows:
Related Third
Parties Parties Total
--------- --------- ---------
(in thousands)
2003 ............................ 321 2,160 2,481
2004 ............................ 321 1,925 2,246
2005 ............................ 321 1,110 1,431
2006 ............................ 321 781 1,102
2007 ............................ 324 777 1,101
Thereafter ...................... 1,340 1,135 2,475
--------- --------- ---------
Total minimum lease payments..... 2,948 7,888 10,836
========= ========= =========
Total rental expense in 2002, 2001, and 2000 was $2.0 million, $1.9 million, and
$1.4 million, respectively, and included $321,000, $306,000, and $255,000, in
related party expense, respectively.
9. INCOME TAXES
The income tax expense (benefit) consisted of the following:
2002 2001 2000
-------- -------- --------
(in thousands)
Current:
Federal .............................. $ -- $ 221 $ 100
State ................................ 1,276 446 (131)
Foreign .............................. (427) 555 139
-------- -------- --------
Total current .......................... 849 1,222 108
Deferred:
Federal .............................. $(13,671) $(10,774) $ --
State ................................ 373 (739) --
Foreign .............................. (103) (572) --
-------- -------- --------
Total deferred ......................... (13,401) (12,085) --
Income tax expense (benefit) ........... $(12,552) $(10,863) $ 108
======== ======== ========
The temporary differences which give rise to deferred tax assets are presented
below:
December 31
2002 2001
-------- --------
(in thousands)
Net operating loss and tax credit carryforwards ........... $ 23,749 $ 32,765
Inventory reserves and capitalization ..................... 2,722 2,616
Other ..................................................... 2,102 1,403
Deferred compensation ..................................... 7,692 7,756
Deferred revenue .......................................... 2,167 2,403
-------- --------
Total deferred tax assets before valuation allowance .... 38,432 46,943
Valuation allowance ....................................... (7,692) (34,356)
Depreciation and amortization ............................. (5,130) (1,952)
Other ..................................................... (392) (392)
-------- --------
Net deferred tax assets ................................... $ 25,218 $ 10,243
======== ========
Since 1999, the Company has generated positive taxable income on a cumulative
basis. In light of this recent trend, current projections for future taxable
earnings, and the expected timing of the reversal of deductible temporary
differences, management concluded in the fourth quarter of 2001 that a portion
F21
of the valuation allowance recorded against federal and state net operating loss
carryforwards and certain other temporary differences was no longer necessary.
The valuation allowance was reduced by $12.0 million in 2001 because management
believed that it was more likely than not that the Company will realize the
benefit of that portion of the deferred tax assets recorded at December 31,
2001. The $12.0 million reduction in the valuation allowance consisted of an
$11.5 million deferred income tax benefit and a $450,000 credit to additional
paid-in capital related to net operating loss carryforwards generated through
the exercise of stock options.
In the fourth quarter of 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
expects to realize in the future. The $23.4 million reduction in the valuation
allowance consisted of a $20.4 million deferred income tax benefit and a $3.0
million credit to additional paid-in capital related to net operating loss
carryforwards generated through the exercise of stock options. A valuation
allowance of $7.7 million is recorded against the remaining $32.9 million of net
deferred tax assets recorded at December 31, 2002. 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 the Company believes it
is unlikely that it will recognize the associated tax benefit. The Company does
not anticipate additional income tax benefits through future reductions in the
valuation allowance. However, in the event that the Company determines that it
would be able to realize more or less than the recorded amount of net deferred
tax assets, an adjustment to the deferred tax asset valuation allowance would be
recorded in the period such a determination is made.
The net change in the Company's valuation allowance was $(26.7) million, $(10.4)
million, and $3.3 million, in 2002, 2001, and 2000, respectively. Included in
the 2002 reduction was the write off of the valuation allowance associated with
$3.3 million of deferred tax assets which the Company wrote off because they are
no longer expected to be utilizable.
A reconciliation of the United States Federal statutory rate to the Company's
effective tax rate for the years ended December 31, 2002, 2001, and 2000 is as
follows:
2002 2001 2000
------ ------ ------
Federal statutory rate ..................................... 35.0% 34.0% (34.0%)
Increase (reduction) in income taxes resulting from:
State income taxes - before deferred benefit ............. 3.7% 1.9% 3.1%
Benefit from sale of state net operating loss
carryforwards, net of federal effect .................. -- -- (4.3%)
Foreign taxes booked at different rates .................. (2.5%) (1.3%) (0.5%)
Alternative minimum tax, net of state benefit ............ -- 1.4% 0.9%
Nondeductible items ...................................... (0.5%) 1.1% 2.1%
Other .................................................... (1.0%) 1.9% 2.9%
Change in valuation allowance ............................ (89.9%) (108.9%) 30.8%
------ ------ ------
Effective tax rate ......................................... (55.2%) (69.9%) 1.0%
====== ====== ======
At December 31, 2002, the Company had net operating loss carryforwards of
approximately $74.4 million and $19.8 million for federal and state income tax
purposes, respectively, to offset future taxable income. The federal and state
net operating loss carryforwards expire through 2013 and 2010, respectively. In
2000, the Company recognized a tax benefit of $467,000 from the sale of certain
state net operating loss carryforwards through a special program offered by the
State of New Jersey.
At December 31, 2002, several of the Company's subsidiaries had unused net
operating loss carryforwards and tax credit carryforwards arising from periods
prior to the Company's ownership which expire through 2010. The timing and
manner in which any acquired net operating losses or tax credits may be utilized
in any year by the Company are limited by the Internal Revenue Code of 1986, as
amended, Section 382 and other provisions of the Internal Revenue Code and its
applicable regulations.
F22
Income taxes are not provided on undistributed earnings of non-U.S. subsidiaries
because such earnings are expected to be permanently reinvested.
10. NET INCOME (LOSS) PER SHARE
Amounts used in the calculation of basic and diluted net income (loss) per share
were as follows:
2002 2001 2000
-------- -------- --------
(in thousands, except per share amounts)
Basic:
------
Income (loss) before extraordinary item and accounting change.. $ 35,277 $ 26,406 $(10,955)
Dividends on preferred stock .................................. (159) (1,026) (5,642)
-------- -------- --------
Income (loss) before extraordinary item and accounting
change applicable to common stock .......................... $ 35,118 $ 25,380 $(16,597)
Basic income (loss) per share before extraordinary
item and accounting change ................................. $ 1.21 $ 1.09 $ (0.95)
======== ======== ========
Net income (loss) ............................................. $ 35,277 $ 26,163 $(11,425)
Dividends on preferred stock .................................. (159) (1,026) (5,642)
-------- -------- --------
Net income (loss) applicable to common stock .................. $ 35,118 $ 25,137 $(17,067)
Basic net income (loss) per share ............................. $ 1.21 $ 1.08 $ (0.97)
======== ======== ========
Weighted average common shares outstanding - Basic ............ 29,021 23,353 17,553
======== ======== ========
Diluted:
--------
Income (loss) before extraordinary item and accounting change.. $ 35,277 $ 26,406 $(10,955)
Dividends on preferred stock .................................. -- -- (5,642)
-------- -------- --------
Income (loss) before extraordinary item and accounting
change applicable to common stock .......................... $ 35,277 $ 26,406 $(16,597)
Diluted income (loss) per share before extraordinary
item and accounting change ................................. $ 1.14 $ 0.95 $ (0.95)
======== ======== ========
Net income (loss) ............................................. $ 35,277 $ 26,163 $(11,425)
Dividends on preferred stock .................................. -- -- (5,642)
-------- -------- --------
Net income (loss) applicable to common stock .................. $ 35,277 $ 26,163 $(17,067)
Diluted net income (loss) per share ........................... $ 1.14 $ 0.94 $ (0.97)
======== ======== ========
Weighted average common shares outstanding - Basic ............ 29,021 23,353 17,553
Effect of dilutive securities:
Assumed conversion of Preferred Stock ...................... 175 1,873 --
Stock options and warrants ................................. 1,699 2,570
--
-------- -------- --------
Weighted average common shares outstanding .................... 30,895 27,796 17,553
======== ======== ========
Dividends on preferred stock in 2000 include a $4,170,000 beneficial conversion
feature on preferred stock issuance.
The $243,000 extraordinary loss on the early retirement of debt reduced basic
and diluted earnings per share by $0.01 in 2001. The $470,000 cumulative effect
of the accounting change for SAB 101 reduced basic and diluted earnings per
share by $0.02 in 2000.
F23
Shares of common stock issuable through exercise or conversion of the following
dilutive securities were not included in the computation of diluted net income
(loss) per share for each period because their effect would have been
antidilutive:
2002 2001 2000
-------- -------- --------
(in thousands)
Convertible Preferred Stock ........................ -- -- 3,218
Stock options and warrants ......................... 1,104 65 5,068
Restricted Units issued by the Company (see Note 7) that entitle the holder to
2,250,000 shares of common stock 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.
11. DEVELOPMENT, DISTRIBUTION, AND LICENSE AGREEMENTS AND GOVERNMENT GRANTS
The Company has various development, distribution, and license agreements under
which it receives payments. Significant agreements and grant awards include the
following:
- In 1999, the Company and Ethicon, Inc., a division of Johnson & Johnson,
signed an agreement (the Ethicon Agreement) providing Ethicon with exclusive
marketing and distribution rights to INTEGRA(R) Dermal Regeneration Template
worldwide, excluding Japan. Under the Ethicon Agreement, the Company will
continue to manufacture INTEGRA(R) Dermal Regeneration Template and will
collaborate with Ethicon to conduct research and development and clinical
research aimed at expanding indications and developing future products in the
field of skin repair and regeneration. Upon signing the Ethicon Agreement,
the Company received a nonrefundable payment from Ethicon of $5.3 million for
the exclusive use of the Company's trademarks and regulatory filings related
to INTEGRA(R) Dermal Regeneration Template and certain other rights. This
amount was initially recorded as deferred revenue and is being recognized as
revenue in accordance with the Company's revenue recognition policy for
nonrefundable, up-front fees received. The unamortized balance of $3.3
million at December 31, 2002 is recorded in deferred revenue, of which
$528,000 is classified as short-term. Additionally, the Ethicon Agreement
requires Ethicon to make nonrefundable payments to the Company each year
based upon minimum purchases of INTEGRA(R) Dermal Regeneration Template.
The Ethicon Agreement also provides for annual research funding of $2.0
million through 2004, after which such funding amounts will be determined
based on a percentage of net sales of the INTEGRA(R) product, as defined.
Additional funding will be received upon the occurrence of certain clinical
and regulatory events and for funding certain expansions of the Company's
INTEGRA(R) Dermal Regeneration Template production capacity. In 2002 and
2000, the Company received $1.0 million and $750,000, respectively, of
event-related payments from Ethicon which were recorded in other revenue in
accordance with the Company's revenue recognition policy.
Ethicon has not been successful in selling the minimum amounts of INTEGRA(R)
Dermal Regeneration Template specified in the Ethicon Agreement. In addition,
Integra has notified Ethicon that certain clinical and regulatory events have
been achieved under the Ethicon Agreement and that payments for the
achievement of those events is due to the Company. Ethicon has informed
Integra that it disagrees that the clinical and regulatory events in question
have been achieved, and that it does not intend to make the payments the
Company has demanded. In addition, Ethicon has informed Integra that if the
Company does not agree to substantial amendments to the Ethicon Agreement, it
will consider alternatives that may include exercising its right to terminate
the agreement.
F24
The Ethicon Agreement requires Ethicon to give the Company notice one year in
advance of a termination of the agreement, during which time Ethicon is
required to continue to comply with the terms of the contract. At the end of
that period, Ethicon may be required to pay additional amounts based on the
termination provisions of the contract and is required to cooperate in the
transfer of the business back to Integra. Additionally, Ethicon may apply the
value of any minimum payments in excess of actual product purchases against
future purchases of products for sale on a non-exclusive basis for a
specified period of time.
- The Company has an agreement with Wyeth and Medtronic Sofamor Danek 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 2004, but may be extended for successive five
year terms at the option of Wyeth. 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 $1.2 million, $1.1
million, and $0.3 million of research and development revenues under the
agreement in 2002, 2001, and 2000, respectively.
12. 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 "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 to willfully and deliberately 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 the Company 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.
This case went to trial in February 2000, and in March, 2000, a jury returned a
unanimous verdict for the Company, finding that Merck KGaA had willfully
infringed and induced the infringement of the Company's patents, and awarded
$15,000,000 in damages. The Court dismissed Scripps and Dr. Cheresh from the
case.
In October, 2000, the Court entered judgment in the Company's favor and against
Merck KGaA in the case. In entering the judgment, the Court also granted the
Company pre-judgment interest of approximately $1,350,000, bringing the total
amount to approximately $16,350,000, 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 Court entered orders in favor of
the Company 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.
F25
Merck KGaA and Integra have each appealed various decisions of the Court. The
court of appeals heard arguments in the appeal in November 2002, and we expect
the court to issue its opinion in 2003. Integra has not recorded any gain in
connection with this matter.
Bruce D. Butler, Ph.D., Bruce A. McKinley, Ph.D., and C. Lee Parmley (the Optex
Claimants), each parties to a Letter Agreement (the Letter Agreement) with a
wholly-owned subsidiary of the Company (Subsidiary), dated as of December 18,
1996, alleged that Subsidiary breached the terms of the Letter Agreement prior
to the Company's acquisition of the NeuroCare Group (Subsidiary's prior parent
company). In August, 2000, the Company and the Optex Claimants reached an
agreement whereby the Company paid the Optex Claimants $250,000 cash and issued
45,000 shares of the Company's common stock, valued at $641,250, in settlement
of all claims under the Letter Agreement. Subsequent to the settlement of this
matter, the Company received $350,000 from the seller of the NeuroCare Group
through assertion of the Company's right of indemnification. The Company did not
record any provision for this matter, as liabilities recorded at the time of the
Company's acquisition of the NeuroCare Group and the $350,000 indemnification
payment were adequate to cover this liability.
The Company is also 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.
In September, 2001, three subsidiaries of the recently acquired neurosciences
division of NMT Medical, Inc. received a tax reassessment notice from the French
tax authorities seeking in excess $1.5 million in back taxes, interest and
penalties. NMT Medical, Inc., the former owner of these entities, has agreed to
specifically indemnify Integra against any liability 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.
F26
13. SEGMENT AND GEOGRAPHIC INFORMATION
The Company develops, manufactures, and markets medical devices for use in
neurosurgery, plastic and reconstructive surgery, general surgery and soft
tissue repair. The Company's product lines include traditional medical devices,
such as monitoring and drainage systems, surgical instruments, and fixation
systems, as well as innovative tissue repair products, such as the DuraGen(R)
Dural Graft Matrix, the NeuraGen(TM) Nerve Guide, and the INTEGRA(R) Dermal
Regeneration Template, that incorporate the Company's proprietary absorbable
implant technology.
The Company sells its products directly through various sales forces and through
a variety of other distribution channels. The global manufacturing, sales,
marketing and administrative functions for each of the organizations through
which the Company sells its products are managed on a centralized basis.
Historically, the Company managed its business and reviewed financial results
under two separate operating segments: Integra NeuroSciences(TM) and Integra
LifeSciences(TM). In 2003, following the integration of several recently
acquired, diverse businesses, Integra's began to manage the business and review
financial results on an aggregate basis, instead of through these two operating
segments. Accordingly, all prior period financial results provided below have
been revised to reflect the retroactive application of this change to a single
operating segment.
Product revenues consisted of the following:
2002 2001 2000
-------- -------- --------
(in thousands)
Neuromonitoring products .............................. $ 37,184 $ 28,158 $ 23,532
Operating room products ............................... 38,326 27,240 18,988
Instruments ........................................... 16,802 14,972 8,647
Private label products ................................ 20,313 17,538 14,193
-------- -------- --------
Consolidated product revenues ......................... $112,625 $ 87,908 $ 65,360
======== ======== ========
Products, including food as well as pharmaceuticals and medical devices, that
contain materials derived from animal sources are increasingly subject to
scrutiny in the press and by regulatory authorities. Certain of the Company's
products, including DuraGen(R) Dural Graft Matrix, NeuraGen(TM) Nerve Guide,
Integra(R) Dermal Regeneration Template, and Biomend(R) Absorbable Collagen
Membrane, contain material derived from bovine tissue. These products comprised
approximately 32%, 32% and 28% of product revenues in 2002, 2001 and 2000,
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 significant adverse effect on the
Company's current business or its ability to expand its business.
Product revenue and long-lived assets (excluding financial instruments and
deferred tax assets) by major geographic area are summarized below:
United Asia Other
States Europe Pacific Foreign Consolidated
---------- ---------- ---------- ---------- ------------
(in thousands)
Product revenue:
2002 ................... $ 90,422 $ 14,737 $ 4,062 $ 3,404 $112,625
2001 ................... 68,612 10,577 4,838 3,881 87,908
2000 ................... 51,752 6,759 4,628 2,221 65,360
Long-lived assets:
December 31, 2002 ...... $ 45,319 $ 18,408 $ -- $ -- $ 63,727
December 31, 2001 ...... 33,001 12,057 -- -- 45,058
December 31, 2000 ...... 33,428 6,869 -- -- 40,297
F27
14. SELECTED QUARTERLY INFORMATION -- UNAUDITED
Fourth Third Second First
Quarter Quarter Quarter Quarter
-------- --------- --------- ----------
(in thousands, except per share data)
2002:
-----
Total revenue ................... $ 35,261 $ 30,204 $ 26,441 $ 25,916
Cost of product revenues ........ 14,168 12,611 9,465 9,528
Total other operating expenses .. 14,313 16,001 11,486 11,063
Operating income ................ 6,780 1,592 5,490 5,325
Interest income, net ............ 727 822 993 993
Other income (expense), net ..... (18) (11) 55 (23)
Income before income taxes ...... 7,489 2,403 6,538 6,295
Income tax expense (benefit) .... (17,885) 840 2,289 2,204
Net income ...................... $ 25,374 $ 1,563 $ 4,249 $ 4,091
Basic net income per share ...... 0.87 0.05 0.15 0.14
Diluted net income per share .... 0.83 0.05 0.14 0.13
2001:
-----
Total revenue .......................... $ 25,088 $ 23,750 $ 22,920 $ 21,684
Cost of product revenues ............... 9,957 9,153 8,310 8,594
Total other operating expenses ......... 10,419 10,861 11,154 10,708
Operating income ....................... 4,712 3,736 3,456 2,382
Interest income (expense), net ......... 1,029 556 (114) (78)
Other income (expense), net ............ (19) 96 (151) (62)
Income before income taxes ............. 5,722 4,388 3,191 2,242
Income tax expense (benefit) ........... (11,903) 365 429 246
Income before extraordinary loss ....... 17,625 4,023 2,762 1,996
Extraordinary loss on early retirement
of debt, net of income tax benefit .. -- (243) -- --
Net income ............................. $ 17,625 $ 3,780 $ 2,762 $ 1,996
Basic income per share before
extraordinary loss .................. $ 0.63 $ 0.15 $ 0.12 $ 0.08
Basic net income per share ............. 0.63 0.14 0.12 0.08
Diluted income per share before
extraordinary loss ................... $ 0.56 $ 0.14 $ 0.10 $ 0.07
Diluted net income per share ........... 0.56 0.13 0.10 0.07
F28
15. SUBSEQUENT EVENT
On March 17, 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 $44.5 million in cash, subject to a working capital
adjustment and other adjustments with respect to certain income tax elections.
For more than 30 years, JARIT has marketed a wide variety of high quality,
reusable surgical instruments to virtually all surgical disciplines. JARIT sells
its products to more than 5,200 hospitals and surgery centers worldwide. In the
United States, JARIT sells through a 20 person sales management force that works
with over 100 distributor sales representatives.
With more than 5,000 instrument patterns and a 98% order fill rate, JARIT has
developed a strong reputation as a leading provider of high-quality surgical
instruments. JARIT manages its vendor relationships and purchases, packages and
labels its products directly from instrument manufacturers through its facility
in Germany.
The acquisition of JARIT broadens Integra's existing customer base and surgical
instrument product offering and provides an opportunity to achieve operating
costs savings, including the procurement of Integra's Redmond(TM)-Ruggles(TM)
and Padgett Instruments Inc.(R) products directly from the instrument
manufacturers.
The acquired business generated approximately $30.9 million in revenues and $7.8
million in income before income taxes for the year ended December 31, 2002.
The determination of the fair value of the assets acquired and liabilities
assumed as a result of this acquisition is in progress. The Company expects to
record in excess of $30.0 million of intangible assets, consisting primarily of
customer relationships and tradename.
F29
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and
Stockholders of Integra LifeSciences
Holdings Corporation and Subsidiaries:
Our audits of the consolidated financial statements referred to in our report
dated February 21, 2003, except Note 15, for which the date is March 17, 2003,
and Notes 1 and 13, for which the date is June 26, 2003, appearing in the
Current Report on Form 8-K dated June 26, 2003 of Integra LifeSciences Holdings
Corporation and Subsidiaries also included an audit of the financial statement
schedule included in this Form 8-K. In our opinion, this financial
statement schedule presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements.
/s/ PricewaterhouseCoopers LLP
Florham Park, New Jersey
February 21, 2003
F30
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
SCHEDULE II
Balance at Charged to Charged Balance at
Beginning Costs and to Other End of
Description Of Period Expenses Accounts(1) Deductions(2) Period
--------------------------------------------------------------------------------------------------------------------
(in thousands)
Year ended December 31, 2002
----------------------------
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
Year ended December 31, 2001
----------------------------
Allowance for doubtful accounts
and Sales Returns .......... $ 1,253 $ 2,142 $ 4 $ (1,996) $ 1,403
Inventory reserves ...................... 3,420 3,734 -- (1,342) 5,812
Deferred tax asset valuation allowance .. 44,776 (9,970) -- (450) 34,356
Year ended December 31, 2000
----------------------------
Allowance for doubtful accounts
and Sales Returns .......... $ 944 $ 935 $ 30 $ (656) $ 1,253
Inventory reserves ...................... 3,137 892 903 (1,512) 3,420
Deferred tax asset valuation allowance .. 41,434 3,342 -- -- 44,776
(1) All amounts shown were recorded to goodwill in connection with acquisitions
except for the $3.3 million reduction in the deferred tax asset valuation
allowance in 2002 which was written off against the gross deferred tax
asset.
(2) The $3.0 million and $450,000 reductions of the deferred tax asset
valuation allowance in 2002 and 2001, respectively, were recorded to
additional paid-in capital.
F31
ITEM 7. Financial Statements, Pro Forma Financial Information and Exhibits.
(a) Not applicable
(b) Not applicable
(c) Exhibits.
Exhibit
Number Description of Exhibit
------- ----------------------
99.1 Consent of Independent Accountants
99.2 Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
Fi
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, as of the 27th day of June, 2003.
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
By: /s/ Stuart M. Essig
-----------------------------
Stuart M. Essig
President and Chief Executive Officer
Fii
Exhibit Index
-------------
Exhibit
Number Description of Exhibit
------- ----------------------
99.1 Consent of Independent Accountants
99.2 Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002(1)
(1) The certifications are furnished to, and not filed with, the Securities and
Exchange Commission and are not incorporated by reference into any registration
statement filed under the Securities Act of 1933, as amended.
Fiii
Exhibit 99.1.
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (File Nos. 333-46024, 333-82233, 333-58235, 333-06577,
and 333-73512) of Integra LifeSciences Holdings Corporation and Subsidiaries of
our report dated February 21, 2003, except Note 15, for which the date is March
17, 2003, and Notes 1 and 13, for which the date is June 26, 2003, relating to
the consolidated financial statements and our report dated February 21, 2003
related to the financial statement schedule, which appear in this Form 8-K.
PricewaterhouseCoopers LLP
Florham Park, New Jersey
June 26, 2003
Exhibit 99.2
Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Certification of Chief Executive Officer
Pursuant to Section 906 of the
Sarbanes - Oxley Act of 2002
I, Stuart M. Essig, Chief Executive Officer and Director of
Integra LifeSciences Holdings Corporation (the "Company"), hereby certify
that, to my knowledge:
1. The Annual Report on Form 10-K of the Company for the year ended
December 31, 2002 (updated by this Current Report on Form 8-K, the
"Report") fully complies with the requirement of Section 13(a) or
Section 15(d), as applicable, of the Securities Exchange Act of 1934,
as amended; and
2. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of
operations of the Company.
Date: June 27, 2003 By: /s/ Stuart M. Essig
--------------------
Stuart M. Essig
Chief Executive Officer
Certification of Chief Financial Officer
Pursuant to Section 906 of the
Sarbanes - Oxley Act of 2002
I, David B. Holtz, Senior Vice President, Finance and Treasurer of Integra
LifeSciences Holdings Corporation (the "Company"), hereby certify that, to my
knowledge:
3. The Annual Report on Form 10-K of the Company for the year ended
December 31, 2002 (updated by this Current Report on Form 8-K, the
"Report") fully complies with the requirement of Section 13(a) or
Section 15(d), as applicable, of the Securities Exchange Act of 1934,
as amended; and
4. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of
operations of the Company.
Date: June 27, 2003 By: /s/ David B. Holtz
-------------------
David B. Holtz
Sr. Vice President, Finance and
Treasurer