IART-2013.06.30-10Q/A
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q/A
(Mark One)
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x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2013
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o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
COMMISSION FILE NO. 0-26224
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE | | 51-0317849 |
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) | | (I.R.S. EMPLOYER IDENTIFICATION NO.) |
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311 ENTERPRISE DRIVE PLAINSBORO, NEW JERSEY | | 08536 |
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) | | (ZIP CODE) |
REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE: (609) 275-0500
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer | x | Accelerated filer | o |
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Non-accelerated filer | o (Do not check if a smaller reporting company) | Smaller reporting company | o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
The number of shares of the registrant’s Common Stock, $0.01 par value, outstanding as of July 29, 2013 was 28,093,915.
Explanatory Note
This Amendment No. 1 to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 is being filed to correct the number of shares outstanding of our Common Stock, $0.01 par value as of July 29, 2013 on the Form 10-Q cover page. No other information in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 is hereby amended.
We have also updated the signature page, the certifications of our Chief Executive Officer and Chief Financial Officer in Exhibits 31.1, 31.2, 32.1 and 32.2 and the financial statements formatted in Extensible Business Reporting Language (XBRL) in Exhibits 101. No other sections were affected, but for the convenience of the reader, this report on Form 10-Q/A restates in its entirety, as amended, our original Quarterly Report on Form 10-Q filed on August 1, 2013. This report on Form 10-Q/A is presented as of the filing date of the original Form 10-Q and does not reflect events occurring after that date, or modify or update disclosures in any way other than as required to reflect the correction described above.
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
INDEX
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Condensed Consolidated Statements of Operations and Comprehensive Income for the three and six months ended June 30, 2013 and 2012 (Unaudited) | |
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Condensed Consolidated Balance Sheets as of June 30, 2013 and December 31, 2012 (Unaudited) | |
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Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2013 and 2012 (Unaudited) | |
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Item 5. Other Information | |
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Exhibit 4.1 | |
Exhibit 10.1 | |
Exhibit 31.1 | |
Exhibit 31.2 | |
Exhibit 32.1 | |
Exhibit 32.2 | |
EX-101 INSTANCE DOCUMENT | |
EX-101 SCHEMA DOCUMENT | |
EX-101 CALCULATION LINKBASE DOCUMENT | |
EX-101 DEFINITION LINKBASE DOCUMENT | |
EX-101 LABELS LINKBASE DOCUMENT | |
EX-101 PRESENTATION LINKBASE DOCUMENT | |
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME
(UNAUDITED)
(In thousands, except per share amounts)
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| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2013 | | 2012 | | 2013 | | 2012 |
Total revenue, net | $ | 205,547 |
| | $ | 210,170 |
| | $ | 402,199 |
| | $ | 406,355 |
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Costs and Expenses: | | | | | | | |
Cost of goods sold | 83,068 |
| | 78,274 |
| | 163,336 |
| | 152,949 |
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Research and development | 11,809 |
| | 13,131 |
| | 24,525 |
| | 25,043 |
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Selling, general and administrative | 99,619 |
| | 96,097 |
| | 199,780 |
| | 183,508 |
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Intangible asset amortization | 3,073 |
| | 4,647 |
| | 6,624 |
| | 9,367 |
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Total costs and expenses | 197,569 |
| | 192,149 |
| | 394,265 |
| | 370,867 |
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Operating income | 7,978 |
| | 18,021 |
| | 7,934 |
| | 35,488 |
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Interest income | 289 |
| | 415 |
| | 352 |
| | 793 |
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Interest expense | (4,965 | ) | | (7,103 | ) | | (9,765 | ) | | (15,032 | ) |
Other income (expense), net | (307 | ) | | 236 |
| | (1,281 | ) | | (87 | ) |
Income (loss) before income taxes | 2,995 |
| | 11,569 |
| | (2,760 | ) | | 21,162 |
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Income tax (benefit) expense | (445 | ) | | 3,055 |
| | (2,150 | ) | | 5,955 |
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Net income (loss) | $ | 3,440 |
| | $ | 8,514 |
| | $ | (610 | ) | | $ | 15,207 |
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Basic net income per common share | $ | 0.12 |
| | $ | 0.30 |
| | $ | (0.02 | ) | | $ | 0.54 |
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Diluted net income per common share | $ | 0.12 |
| | $ | 0.30 |
| | $ | (0.02 | ) | | $ | 0.53 |
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Weighted average common shares outstanding (See Note 11): | | | | | | | |
Basic | 27,873 |
| | 28,419 |
| | 27,834 |
| | 28,382 |
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Diluted | 28,118 |
| | 28,609 |
| | 27,834 |
| | 28,549 |
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Comprehensive income (loss) (See Note 12) | $ | 5,317 |
| | $ | (2,730 | ) | | $ | (5,217 | ) | | $ | 10,911 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In thousands)
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| June 30, 2013 | | December 31, 2012 |
ASSETS | | | |
Current Assets: | | | |
Cash and cash equivalents | $ | 98,636 |
| | $ | 96,938 |
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Trade accounts receivable, net of allowances of $9,637 and $7,221 | 114,749 |
| | 114,916 |
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Inventories, net | 195,457 |
| | 171,806 |
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Deferred tax assets | 38,120 |
| | 39,100 |
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Prepaid expenses and other current assets | 30,774 |
| | 30,291 |
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Total current assets | 477,736 |
| | 453,051 |
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Property, plant and equipment, net | 184,537 |
| | 177,898 |
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Intangible assets, net | 206,884 |
| | 212,267 |
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Goodwill | 292,881 |
| | 294,067 |
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Deferred tax assets | 14,988 |
| | 15,957 |
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Other assets | 10,475 |
| | 10,359 |
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Total assets | $ | 1,187,501 |
| | $ | 1,163,599 |
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LIABILITIES AND STOCKHOLDERS’ EQUITY | | | |
Current Liabilities: | | | |
Accounts payable, trade | $ | 44,767 |
| | $ | 36,742 |
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Deferred revenue | 3,748 |
| | 3,505 |
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Accrued compensation | 27,822 |
| | 34,914 |
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Accrued expenses and other current liabilities | 33,002 |
| | 31,768 |
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Total current liabilities | 109,339 |
| | 106,929 |
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Long-term borrowings under senior credit facility | 341,875 |
| | 321,875 |
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Long-term convertible securities | 201,375 |
| | 197,672 |
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Deferred tax liabilities | 5,396 |
| | 5,393 |
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Other liabilities | 12,927 |
| | 13,955 |
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Total liabilities | $ | 670,912 |
| | $ | 645,824 |
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Commitments and contingencies |
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Stockholders’ Equity: | | | |
Preferred Stock; no par value; 15,000 authorized shares; none outstanding |
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Common stock; $0.01 par value; 60,000 authorized shares; 36,969 and 36,852 issued at June 30, 2013 and December 31, 2012, respectively | 370 |
| | 369 |
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Additional paid-in capital | 591,331 |
| | 587,301 |
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Treasury stock, at cost; 8,903 shares at June 30, 2013 and December 31, 2012 | (367,121 | ) | | (367,121 | ) |
Accumulated other comprehensive (loss) | (9,404 | ) | | (4,797 | ) |
Retained earnings | 301,413 |
| | 302,023 |
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Total stockholders’ equity | $ | 516,589 |
| | $ | 517,775 |
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Total liabilities and stockholders’ equity | $ | 1,187,501 |
| | $ | 1,163,599 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands)
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| Six Months Ended June 30, |
| 2013 | | 2012 |
OPERATING ACTIVITIES: | | | |
Net income (loss) | $ | (610 | ) | | $ | 15,207 |
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Adjustments to reconcile net income (loss) to net cash provided by operating activities: | | | |
Depreciation and amortization | 24,025 |
| | 25,808 |
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Deferred income tax (benefit) provision | (400 | ) | | (2,554 | ) |
Amortization of debt issuance costs | 1,094 |
| | 1,480 |
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Non-cash interest expense | 3,232 |
| | 6,496 |
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Payment of accreted interest | — |
| | (30,617 | ) |
Loss on disposal of property and equipment | 1,831 |
| | 431 |
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Share-based compensation | 4,764 |
| | 4,355 |
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Excess tax benefits from stock-based compensation arrangements | (102 | ) | | (418 | ) |
Changes in assets and liabilities, net of business acquisitions: | | | |
Accounts receivable | (745 | ) | | 2,252 |
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Inventories | (23,966 | ) | | (2,155 | ) |
Prepaid expenses and other current assets | (624 | ) | | 7,664 |
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Other non-current assets | (368 | ) | | (876 | ) |
Accounts payable, accrued expenses and other current liabilities | 2,893 |
| | 7,378 |
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Deferred revenue | 278 |
| | (289 | ) |
Other non-current liabilities | (538 | ) | | 432 |
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Net cash provided by operating activities | $ | 10,764 |
| | $ | 34,594 |
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INVESTING ACTIVITIES: | | | |
Purchases of property and equipment | (24,475 | ) | | (24,642 | ) |
Sales of property and equipment | 530 |
| | — |
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Cash used in business acquisition, net of cash acquired | (2,830 | ) | | (2,867 | ) |
Purchases of short-term investments | — |
| | (67,907 | ) |
Maturities of short-term investments | — |
| | 26,058 |
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Net cash used in investing activities | $ | (26,775 | ) | | $ | (69,358 | ) |
FINANCING ACTIVITIES: | | | |
Borrowings under senior credit facility | 20,000 |
| | 155,000 |
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Repayments under senior credit facility | — |
| | (12,812 | ) |
Payment of liability component of convertible notes | — |
| | (134,383 | ) |
Payment of debt issuance costs | (1,013 | ) | | — |
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Proceeds from exercised stock options | 234 |
| | 250 |
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Excess tax benefits from stock-based compensation arrangements | 102 |
| | 418 |
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Net cash provided by (used in) financing activities | $ | 19,323 |
| | $ | 8,473 |
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Effect of exchange rate changes on cash and cash equivalents | (1,614 | ) | | 953 |
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Net change in cash and cash equivalents | 1,698 |
| | (25,338 | ) |
Cash and cash equivalents at beginning of period | 96,938 |
| | 100,808 |
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Cash and cash equivalents at end of period | $ | 98,636 |
| | $ | 75,470 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
General
The terms “we,” “our,” “us,” “Company” and “Integra” refer to Integra LifeSciences Holdings Corporation, a Delaware corporation, and its subsidiaries unless the context suggests otherwise.
In the opinion of management, the June 30, 2013 unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary for a fair statement of the financial position, results of operations and cash flows of the Company. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements for the year ended December 31, 2012 included in the Company’s Annual Report on Form 10-K. The December 31, 2012 consolidated balance sheet was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States. Operating results for the three and six-month periods ended June 30, 2013 are not necessarily indicative of the results to be expected for the entire year.
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, the disclosure of contingent liabilities, and the reported amounts of revenues and expenses. Significant estimates affecting amounts reported or disclosed in the consolidated financial statements include allowances for doubtful accounts receivable and sales returns and allowances, net realizable value of inventories, valuation of intangible assets including in-process research and development, amortization periods for acquired intangible assets, discount rates and estimated projected cash flows used to value and test impairments of long-lived assets and goodwill, estimates of projected cash flows and depreciation and amortization periods for long-lived assets, computation of taxes, valuation allowances recorded against deferred tax assets, the valuation of stock-based compensation, valuation of pension assets and liabilities, valuation of derivative instruments, valuation of the equity component of convertible debt instruments, valuation of contingent liabilities, the fair value of debt instruments and loss contingencies. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the current circumstances. Actual results could differ from these estimates.
Certain amounts from the prior year’s financial statements have been reclassified in order to conform to the current year’s presentation.
Recently Issued Accounting Standards
There have been no recently issued accounting standards that have an impact on the Company's financial statements.
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
2. BUSINESS ACQUISITIONS
Tarsus Medical, Inc.
On January 24, 2013, the Company acquired all outstanding preferred and common stock of Tarsus Medical, Inc. for a total of $4.7 million consisting of $2.8 million in cash (less cash acquired) and contingent consideration with an estimated acquisition date fair value of approximately $1.6 million. The potential maximum undiscounted contingent consideration consists of the first milestone payment of up to $1.5 million and the second payment of up to $11.5 million. These payments are based on reaching certain sales of acquired products. Tarsus Medical, Inc. is a podiatry device company addressing clinical needs associated with diseases and injuries of the foot and ankle.
The following summarizes the final allocation of the purchase price based on fair value of the assets acquired and liabilities assumed:
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| Final Purchase Price Allocation | | |
| (Dollars in thousands) | | |
Cash | $ | 85 |
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Prepaid expenses | 13 |
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Intangible assets | | | Wtd. Avg. Life: |
Technology | 5,040 |
| | 10 - 14 years |
In-process research and development | 340 |
| | Indefinite |
Deferred tax asset - long term | 1,334 |
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Goodwill | 116 |
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Total assets acquired | 6,928 |
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Accounts payable and other liabilities | 111 |
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Deferred tax liability | 2,152 |
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Net assets acquired | $ | 4,665 |
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Management determined the preliminary fair value of net assets acquired during the first quarter of 2013 and finalized the working capital adjustment in the second quarter of 2013. The Company accounts for the contingent consideration by recording its fair value as a liability on the date of the acquisition. The contingent consideration is remeasured to fair value at each reporting date until the contingency is resolved. Changes in fair value of contingent consideration are recognized in earnings. Accordingly, on January 24, 2013 the Company recorded $1.6 million representing the initial fair value estimate of the contingent consideration that will be earned through December 31, 2015. At June 30, 2013 there was no change in the fair value of the contingent consideration. The fair value of this liability is based on future sales projections of the Tarsus Medical product under various potential scenarios and weighting the probability of these outcomes for the period ended December 31, 2015. At the date of the acquisition, the first milestone cash flow projection was discounted using a rate of 4.3% based on an estimated after tax cost of debt; the second milestone cash flow projection was discounted using a weighted average cost of capital of 16.5%. These fair value measurements were based on significant inputs not observed in the market and thus represented a Level 3 measurement.
The goodwill recorded in connection with this acquisition is based on (i) expected cost savings, operating synergies and other benefits expected to result from the combined operations, (ii) the value of the going-concern element of Tarsus’ existing business (that is, the higher rate of return on the assembled net assets versus if the Company had acquired all of the net assets separately), and (iii) intangible assets that do not qualify for separate recognition such as Tarsus’ assembled workforce. The goodwill acquired will not be deductible for tax purposes.
The impact of the Tarsus acquisition is not material to the consolidated operating results of the Company; therefore, the pro-forma impact of the acquisition has not been presented.
3. INVENTORIES
Inventories, net consisted of the following:
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| June 30, 2013 | | December 31, 2012 |
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Finished goods | $ | 118,464 |
| | $ | 102,401 |
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Work-in process | 44,771 |
| | 39,944 |
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Raw materials | 32,222 |
| | 29,461 |
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| $ | 195,457 |
| | $ | 171,806 |
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The finished goods inventory includes $4.6 million of capitalized medical device excise tax at June 30, 2013.
4. GOODWILL AND OTHER INTANGIBLE ASSETS
The excess of the cost over the fair value of net assets of acquired businesses is recorded as goodwill. Goodwill is not subject to amortization, but is reviewed for impairment at the reporting unit level annually, or more frequently if impairment indicators arise. The Company's assessment of the recoverability of goodwill is based upon a comparison of the carrying value of goodwill with its estimated fair value. This assessment is performed annually during the third quarter and was performed most recently on July 31, 2012 resulting in no impairment. However, if future results do not meet or exceed the Company's forecasts, or if unfavorable changes occur in the weighted-average cost of capital, growth assumptions for future revenue, terminal value growth rate and/or forecasted cash flows utilized in the discounted cash flow analysis, the Company may record an impairment of this goodwill at a future date.
The Company has experienced a decline in sales relative to the previous forecasts, partially with respect to its U.S. Spine and Private Label reporting units which has recorded goodwill of $46.8 million and $8.9 million, respectively. This decline is in part attributable to the recall, as well as lower sales to customers. The Company currently believes this impact is temporary. However, in the event that sales and operating results of the U.S. Spine and Private Label reporting units in the second half of the year continue to deteriorate, or in the event that management revises its forecasts, an impairment of goodwill may be recognized.
Changes in the carrying amount of goodwill for the six months ended June 30, 2013 were as follows:
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| U.S. Neurosurgery | | U.S. Instruments | | U.S. Extremities | | U.S. Spine and Other | | International | | Total |
| (In thousands) |
Goodwill, gross | $ | 94,312 |
| | $ | 57,514 |
| | $ | 60,353 |
| | $ | 56,219 |
| | $ | 25,669 |
| | $ | 294,067 |
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Accumulated impairment losses |
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Goodwill at December 31, 2012 | 94,312 |
| | 57,514 |
| | 60,353 |
| | 56,219 |
| | 25,669 |
| | 294,067 |
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Tarsus Medical, Inc. acquisition |
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| | 116 |
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| | 116 |
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Foreign currency translation | (417 | ) | | (255 | ) | | (267 | ) | | (249 | ) | | (114 | ) | | (1,302 | ) |
Balance at June 30, 2013 | $ | 93,895 |
| | $ | 57,259 |
| | $ | 60,202 |
| | $ | 55,970 |
| | $ | 25,555 |
| | $ | 292,881 |
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INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
The components of the Company’s identifiable intangible assets were as follows:
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| Weighted Average Life | June 30, 2013 | | Weighted Average Life | December 31, 2012 |
| Cost | | Accumulated Amortization | | Net | | Cost | | Accumulated Amortization | | Net |
| (Dollars in thousands) |
Completed technology | 12 years | $ | 80,456 |
| | $ | (41,496 | ) | | $ | 38,960 |
| | 12 years | $ | 75,692 |
| | $ | (38,402 | ) | | $ | 37,290 |
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Customer relationships | 12 years | 146,333 |
| | (74,633 | ) | | 71,700 |
| | 12 years | 147,690 |
| | (70,005 | ) | | 77,685 |
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Trademarks/brand names | 31 years | 33,578 |
| | (15,164 | ) | | 18,414 |
| | 31 years | 33,807 |
| | (15,034 | ) | | 18,773 |
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Trademarks/brand names | Indefinite | 48,484 |
| | — |
| | 48,484 |
| | Indefinite | 48,484 |
| | — |
| | 48,484 |
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Supplier relationships | 27 years | 34,721 |
| | (8,561 | ) | | 26,160 |
| | 27 years | 34,721 |
| | (7,817 | ) | | 26,904 |
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All other (1) | 4 years | 4,830 |
| | (1,664 | ) | | 3,166 |
| | 4 years | 4,519 |
| | (1,388 | ) | | 3,131 |
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| | $ | 348,402 |
| | $ | (141,518 | ) | | $ | 206,884 |
| | | $ | 344,913 |
| | $ | (132,646 | ) | | $ | 212,267 |
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(1) | At June 30, 2013 and December 31, 2012, all other included in-process research and development of $2.1 million and $1.7 million, respectively, which was indefinite-lived. |
Based on quarter-end exchange rates, annual amortization expense is expected to approximate $19.4 million in 2013, $18.4 million in 2014, $16.6 million in 2015, $14.3 million in 2016 and $12.5 million in 2017. Identifiable intangible assets are initially recorded at fair market value at the time of acquisition using an income or cost approach.
5. DEBT
Amended and Restated Senior Credit Agreement
On August 10, 2010, the Company entered into an amended and restated credit agreement with a syndicate of lending banks (the “Senior Credit Facility”). The Company amended the Senior Credit Facility on June 8, 2011, and further amended it on May 11, 2012 and June 21, 2013.
The June 8, 2011 amendment:
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i. | increased the revolving credit component from $450 million to $600 million and eliminated the $150 million term loan component that existed under the original amended and restated credit agreement; |
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ii. | allows the Company to further increase the size of the revolving credit component by an aggregate of $200 million with additional commitments; |
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iii. | provides the Company with decreased borrowing rates and annual commitment fees, and provides more favorable financial covenants; and |
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iv. | extended the maturity date from August 10, 2015 to June 8, 2016. |
On May 11, 2012, the Company entered into another amendment to the Senior Credit Facility (the “2012 Amendment”). The 2012 Amendment modified certain financial and negative covenants. The 2012 Amendment provides that the Company’s Maximum Consolidated Total Leverage Ratio (a measure of net debt to consolidated EBITDA, in each case as defined in the Senior Credit Facility, as amended) during any consecutive four quarter period should not be greater than 3.75 to 1.00 during any such period ending on December 31, 2013 (instead of March 31, 2012). In addition, when calculating consolidated EBITDA for any period, the 2012 Amendment permits the addition of certain costs and expenses in the calculation of consolidated net income for such period, to the extent deducted in the calculation of consolidated net income.
On June 21, 2013, the Company entered into a second amendment to the Senior Credit Facility (the “2013 Amendment”). The 2013 Amendment modified certain financial and negative covenants and increased the Company’s Maximum Consolidated Total Leverage Ratio (a measure of net debt to consolidated EBITDA, in each case as defined in the Senior Credit Facility, as amended) to 4.25 through June 30, 2014, with a step-down to 4.00 through March 31, 2015, and then with another step-down to 3.75 thereafter. In addition, when calculating consolidated EBITDA for any period, the 2013 Amendment permits the addition
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
of certain costs and expenses in the calculation of consolidated net income for such period, to the extent deducted in the calculation of consolidated net income. The effect of the 2013 Amendment is to increase the ability of the Company to borrow under the Senior Credit Facility during the affected periods. The Company capitalized $1.0 million of incremental financing costs in connection with the 2013 Amendment, which will be amortized through the maturity date of the Senior Credit Facility.
The Senior Credit Facility is collateralized by substantially all of the assets of the Company’s U.S. subsidiaries, excluding intangible assets. The Senior Credit Facility is subject to various financial and negative covenants and at June 30, 2013, the Company was in compliance with all such covenants.
Borrowings under the Senior Credit Facility currently bear interest, at the Company’s option, at a rate equal to (i) the Eurodollar Rate (as defined in the Senior Credit Facility, which definition has not changed) in effect from time to time plus the applicable rate (ranging from 1.00% to 1.75%) or (ii) the highest of (x) the weighted average overnight Federal funds rate, as published by the Federal Reserve Bank of New York, plus 0.5%, (y) the prime lending rate of Bank of America, N.A. or (z) the one-month Eurodollar Rate plus 1.0%. The applicable rates are based on the Company’s consolidated total leverage ratio (defined as the ratio of (a) consolidated funded indebtedness less cash in excess of $40 million that is not subject to any restriction of the use or investment thereof to (b) consolidated EBITDA) at the time of the applicable borrowing.
The Company also pays an annual commitment fee (ranging from 0.15% to 0.30%, based on the Company’s consolidated total leverage ratio) on the daily amount by which the revolving credit facility exceeds the outstanding loans and letters of credit under the credit facility.
At June 30, 2013 and December 31, 2012, there was $341.9 million and $321.9 million outstanding under the Senior Credit Facility at a weighted average interest rate of 2.0% and 1.8%, respectively. At June 30, 2013, there was approximately $258.1 million available for borrowing under the Senior Credit Facility. The fair value of outstanding borrowings under the Senior Credit Facility at June 30, 2013 was approximately $335.9 million. The fair value of the Senior Credit Facility was determined by using a discounted cash flow model based on current market interest rates available to the Company. These inputs are corroborated by observable market data for similar liabilities and therefore classified within Level 2 of the fair value hierarchy. Level 2 inputs represent inputs that are observable for the asset or liability, either directly or indirectly and are other than active market observable inputs that reflect unadjusted quoted prices for identical assets or liabilities. The Company considers the balance to be long term in nature based on its current intent and ability to repay the borrowing outside of the next twelve-month period.
2016 Convertible Senior Notes
On June 15, 2011, the Company issued $230.0 million aggregate principal amount of its 1.625% Convertible Senior Notes due in 2016 (the “2016 Notes”). The 2016 Notes mature on December 15, 2016, and bear interest at a rate of 1.625% per annum payable semi-annually in arrears on December 15 and June 15 of each year. The portion of the debt proceeds that was classified as equity at the time of the offering was $43.2 million, an equivalent of that amount is being amortized to interest expense using the effective interest method through December 2016. The effective interest rate implicit in the liability component is 5.6%.
At June 30, 2013, the carrying amount of the liability component was $201.4 million, the remaining unamortized discount was $28.6 million, and the principal amount outstanding was $230.0 million. The fair value of the 2016 Notes at June 30, 2013 was approximately $230.1 million. At December 31, 2012, the carrying amount of the liability component was $197.7 million, the remaining unamortized discount was $32.3 million and the principal amount outstanding was $230.0 million. The fair value of the liability of the 2016 Notes was determined using a discounted cash flow model based on current market interest rates available to the Company. These inputs are corroborated by observable market data for similar liabilities and therefore classified within Level 2.
The 2016 Notes are senior, unsecured obligations of the Company, and are convertible into cash and, if applicable, shares of its common stock based on an initial conversion rate, subject to adjustment of 17.4092 shares per $1,000 principal amount of 2016 Notes (which represents an initial conversion price of approximately $57.44 per share). The Company will satisfy any conversion of the 2016 Notes with cash up to the principal amount of the 2016 Notes pursuant to the net share settlement mechanism set forth in the indenture and, with respect to any excess conversion value, with shares of the Company’s common stock. The 2016 Notes are convertible only in the following circumstances: (1) if the closing sale price of the Company’s common stock exceeds 150% of the conversion price during a period as defined in the indenture; (2) if the average trading price per $1,000 principal amount of the 2016 Notes is less than or equal to 98% of the average conversion value of the 2016 Notes during a period as defined in the indenture; (3) at any time on or after June 15, 2016; or (4) if specified corporate transactions occur. The issue price of the 2016 Notes was equal to their face amount, which is also the amount holders are entitled to receive at maturity if the 2016 Notes are not converted. As of June 30, 2013, none of these conditions existed with respect to the 2016 Notes and as a result, the 2016 Notes are classified as long term.
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
In connection with the issuance of the 2016 Notes, the Company entered into call transactions and warrant transactions, primarily with affiliates of the initial purchasers of such notes (the “hedge participants”). The initial strike price of the call transaction is approximately $57.44 per share, subject to customary anti-dilution adjustments. The initial strike price of the warrant transaction is approximately $70.05 per share, subject to customary anti-dilution adjustments.
Convertible Note Interest
The interest expense components of the Company’s convertible notes are as follows:
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2013 | | 2012 | | 2013 | | 2012 |
| (In thousands) |
2016 Notes: | | | | | | | |
Amortization of the discount on the liability component | $ | 1,622 |
| | $ | 1,763 |
| | $ | 3,232 |
| | $ | 3,502 |
|
Cash interest related to the contractual interest coupon | 813 |
| | 934 |
| | 1,631 |
| | 1,869 |
|
Total | $ | 2,435 |
| | $ | 2,697 |
| | $ | 4,863 |
| | $ | 5,371 |
|
2012 Notes: | | | | | | | |
Amortization of the discount on the liability component | $ | — |
| | $ | 1,206 |
| | $ | — |
| | $ | 2,995 |
|
Cash interest related to the contractual interest coupon | — |
| | 653 |
| | — |
| | 1,633 |
|
Total | $ | — |
| | $ | 1,859 |
| | $ | — |
| | $ | 4,628 |
|
6. DERIVATIVE INSTRUMENTS
Interest Rate Hedging
The Company’s interest rate risk relates to U.S. dollar denominated variable LIBOR interest rate borrowings. The Company uses an interest rate swap derivative instrument entered into on August 10, 2010 with an effective date of December 31, 2010 to manage its earnings and cash flow exposure to changes in interest rates by converting a portion of its floating-rate debt into fixed-rate debt beginning on December 31, 2010. This interest rate swap expires on August 10, 2015.
The Company designates this derivative instrument as a cash flow hedge. The Company records the effective portion of any change in the fair value of a derivative instrument designated as a cash flow hedge as unrealized gains or losses in accumulated other comprehensive income (“AOCI”), net of tax, until the hedged item affects earnings, at which point the effective portion of any gain or loss will be reclassified to earnings. If the hedged cash flow does not occur, or if it becomes probable that it will not occur, the Company will reclassify the amount of any gain or loss on the related cash flow hedge to interest expense at that time.
The Company expects that approximately $1.7 million of pre-tax losses recorded as net in AOCI related to the interest rate hedge could be reclassified to earnings within the next twelve months.
Foreign Currency Hedging
From time to time the Company enters into foreign currency hedge contracts intended to protect the U.S. dollar value of certain forecasted foreign currency denominated transactions. The Company records the effective portion of any change in the fair value of foreign currency cash flow hedges in AOCI, net of tax, until the hedged item affects earnings. Once the related hedged item affects earnings, the Company reclassifies the effective portion of any related unrealized gain or loss on the foreign currency cash flow hedge to earnings. If the hedged forecasted transaction does not occur, or if it becomes probable that it will not occur, the Company will reclassify the amount of any gain or loss on the related cash flow hedge to earnings at that time.
The success of the Company’s hedging program depends, in part, on forecasts of certain activity denominated in euros. The Company may experience unanticipated currency exchange gains or losses to the extent that there are differences between forecasted and actual activity during periods of currency volatility. In addition, changes in currency exchange rates related to any unhedged transactions may affect its earnings and cash flows.
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Counterparty Credit Risk
The Company manages its concentration of counterparty credit risk on its derivative instruments by limiting acceptable counterparties to a group of major financial institutions with investment grade credit ratings, and by actively monitoring their credit ratings and outstanding positions on an ongoing basis. Therefore, the Company considers the credit risk of the counterparties to be low. Furthermore, none of the Company’s derivative transactions are subject to collateral or other security arrangements, and none contain provisions that depend upon the Company’s credit ratings from any credit rating agency.
Fair Value of Derivative Instruments
The Company has classified all of its derivative instruments within Level 2 of the fair value hierarchy because observable inputs are available for substantially the full term of the derivative instruments. The fair value of the foreign currency forward exchange contracts related to inventory purchases is determined by comparing the forward rate as of the period end and the settlement rate specified in each contract. The fair value of the interest rate swaps was developed using a market approach based on publicly available market yield curves and the terms of the related swap. The Company performs ongoing assessments of counterparty credit risk.
The following table summarizes the fair value and presentation in the condensed consolidated balance sheets for derivatives designated as hedging instruments as of June 30, 2013 and December 31, 2012:
|
| | | | | | | | | | | | | |
| Fair Value as of | | Notional Amount as of |
Location on Balance Sheet (1): | June 30, 2013 | | December 31, 2012 | | June 30, 2013 | | December 31, 2012 |
| (In thousands) |
Derivatives designated as hedges — Assets: | | | | | | | |
Foreign currency forward contracts — Other current assets | $ | (27 | ) | | — |
| | $ | 1,392 |
| | |
Derivatives designated as hedges — Liabilities: | | | | | | | |
Interest rate swap — Accrued expenses and other current liabilities (2) | 1,748 |
| | 1,888 |
| | | | |
Interest rate swap — Other liabilities (2) | 1,282 |
| | 2,238 |
| | | | |
Total Derivatives designated as hedges — Liabilities | $ | 3,030 |
| | $ | 4,126 |
| | | | |
| |
(1) | The Company classifies derivative assets and liabilities as current based on the cash flows expected to be incurred within the following 12 months. |
| |
(2) | At June 30, 2013 and December 31, 2012, the notional amount related to the Company’s sole interest rate swap was $120.0 million and $127.5 million, respectively. In the next twelve months, the Company expects to reduce the notional amount by $15.0 million. |
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
The following presents the effect of derivative instruments designated as cash flow hedges on the accompanying consolidated statements of operations during the three and six months ended June 30, 2013 and 2012:
|
| | | | | | | | | | | | | | | | | |
| Balance in AOCI Beginning of Quarter | | Amount of Gain (Loss) Recognized in AOCI- Effective Portion | | Amount of Gain (Loss) Reclassified from AOCI into Earnings-Effective Portion | | Balance in AOCI End of Quarter | | Location in Statements of Operations |
| (In thousands) |
Three Months Ended June 30, 2013 | | | | | | | | | |
Forward currency forward contracts | $ | — |
| | $ | 162 |
| | $ | — |
| | $ | 162 |
| | Costs of goods sold |
Interest rate swap | (3,644 | ) | | 108 |
| | (506 | ) | | (3,030 | ) | | Interest (expense) |
| $ | (3,644 | ) | | $ | 270 |
| | $ | (506 | ) | | $ | (2,868 | ) | | |
Three Months Ended June 30, 2012 | | | | | | | | | |
Forward currency forward contracts | $ | (9 | ) | | $ | (338 | ) | | $ | (171 | ) | | $ | (176 | ) | | Costs of goods sold |
Interest rate swap | (4,092 | ) | | (759 | ) | | (477 | ) | | (4,374 | ) | | Interest (expense) |
| $ | (4,101 | ) | | $ | (1,097 | ) | | $ | (648 | ) | | $ | (4,550 | ) | | |
| | | | | | | | | |
| Balance in AOCI Beginning of Year | | Amount of Gain (Loss) Recognized in AOCI- Effective Portion | | Amount of Gain (Loss) Reclassified from AOCI into Earnings-Effective Portion | | Balance in AOCI End of Quarter | | Location in Statements of Operations |
| (In thousands) |
Six Months Ended June 30, 2013 | | | | | | | | | |
Forward currency forward contracts | $ | (34 | ) | | $ | 162 |
| | $ | (34 | ) | | $ | 162 |
| | Cost of goods sold |
Interest rate swap | (4,125 | ) | | 99 |
| | (996 | ) | | (3,030 | ) | | Interest (expense) |
| $ | (4,159 | ) | | $ | 261 |
| | $ | (1,030 | ) | | $ | (2,868 | ) | | |
Six Months Ended June 30, 2012 | | | | | | | | | |
Forward currency forward contracts | $ | (216 | ) | | $ | (131 | ) | | $ | (171 | ) | | $ | (176 | ) | | Cost of goods sold |
Interest rate swap | (4,092 | ) | | (1,208 | ) | | (926 | ) | | (4,374 | ) | | Interest (expense) |
| $ | (4,308 | ) | | $ | (1,339 | ) | | $ | (1,097 | ) | | $ | (4,550 | ) | | |
The Company recognized no gains or losses resulting from ineffectiveness of cash flow hedges during the three and six months ended June 30, 2013 and 2012.
7. STOCK-BASED COMPENSATION
As of June 30, 2013, the Company had stock options, restricted stock awards, performance stock awards, contract stock awards and restricted stock unit awards outstanding under three plans, the 2000 Equity Incentive Plan (the “2000 Plan”), the 2001 Equity Incentive Plan (the “2001 Plan”), and the 2003 Equity Incentive Plan (the “2003 Plan,” and collectively, the “Plans”).
Stock options issued under the Plans become exercisable over specified periods, generally within four years from the date of grant for officers and directors, and generally expire from six to ten years for directors and certain executive officers. Restricted stock issued under the Plans vests over specified periods, generally three years after the date of grant. Performance stock vesting, issued under the Plans, is subject to service and performance conditions.
Stock Options
There were 32,468 stock options granted during the six months ended June 30, 2013. As of June 30, 2013, there were approximately $1.8 million of total unrecognized compensation costs related to unvested stock options. These costs are expected to be recognized over a weighted-average period of approximately one year.
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Awards of Restricted Stock, Performance Stock and Contract Stock
Performance stock, restricted stock and contract stock awards generally have requisite service periods of three years. Performance stock awards are subject to graded vesting conditions and the Company expenses their fair value over the requisite service period. The Company expenses the fair value of restricted stock and contract stock awards on a straight-line basis over the vesting period or requisite service period, whichever is shorter. The Company granted approximately 174,000 restricted stock awards/stock units and 55,000 performance shares during the six months ended June 30, 2013. As of June 30, 2013, there were approximately $16.2 million of total unrecognized compensation costs related to these unvested awards. The Company expects to recognize these costs over a weighted-average period of approximately two years.
The Company has no formal policy related to the repurchase of shares for the purpose of satisfying stock-based compensation obligations.
The Company also maintains an Employee Stock Purchase Plan (the “ESPP”), which provides eligible employees with the opportunity to acquire shares of common stock at periodic intervals by means of accumulated payroll deductions. The ESPP is a non-compensatory plan based on its terms.
8. TREASURY STOCK
On October 23, 2012, the Company's Board of Directors authorized a repurchase of up to $75.0 million of its outstanding common stock through December 2014. The Company has not repurchased any of its outstanding shares of common stock during the three and six month periods ended June 30, 2013 and 2012.
As of June 30, 2013, there remained $75.0 million available for repurchases under this authorization.
9. RETIREMENT BENEFIT PLANS
The Company maintains defined benefit pension plans that cover employees in its manufacturing plants located in Andover, United Kingdom (the “UK Plan”) and Tuttlingen, Germany (the “Germany Plan”). The Company closed the Tuttlingen, Germany plant in December 2005. The Company did not terminate the Germany Plan, and the Company remains obligated for the accrued pension benefits related to this plan. Effective March 31, 2011, the Company froze the benefits due to the participants of the UK Plan in their entirety; this curtailment resulted in a $0.3 million reduction in the projected benefit obligations which the Company recorded on that date. The plans cover certain current and former employees.
Net periodic benefit costs for the Company’s defined benefit pension plans included the following amounts:
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2013 | | 2012 | | 2013 | | 2012 |
| (In thousands) |
Service cost | $ | — |
| | $ | 6 |
| | $ | — |
| | $ | 12 |
|
Interest cost | 136 |
| | 161 |
| | 273 |
| | 321 |
|
Return on plan assets | (100 | ) | | (145 | ) | | (200 | ) | | (289 | ) |
Net period benefit cost | $ | 36 |
| | $ | 22 |
| | $ | 73 |
| | $ | 44 |
|
The Company made $0.4 million of contributions to its defined benefit pension plans during the six months ended June 30, 2013 and 2012.
10. INCOME TAXES
The following table provides a summary of the Company’s effective tax rate:
|
| | | | | |
| Three Months Ended June 30, |
| 2013 | | 2012 |
Reported tax rate | (14.9 | )% | | 26.4 | % |
| Six Months Ended June 30, |
| 2013 | | 2012 |
Reported tax rate | 77.9 | % | | 28.1 | % |
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
The Company’s effective income tax rates for the three months ended June 30, 2013 and 2012 were (14.9)% and 26.4%, respectively. For the three months ended June 30, 2013, the reduction in the income tax rate compared to the same period in 2012 was primarily the result of a change in the jurisdictional mix of year-to-date worldwide pretax income and the establishment of the Irish research and development credit. During the quarter, the Company was granted an Irish research and development credit for 2011 and 2012, which resulted in a benefit of $0.5 million. The Company also recorded a benefit of $0.8 million for the release of uncertain tax positions due to the expiration of the statute of limitation in certain state jurisdictions, which is offset by an expense of $0.3 million due to additional non-U.S. tax contingency reserves.
The Company's effective income tax rates for the six months ended June 30, 2013 and 2012 were 77.9% and 28.1%, respectively. For the six months ended June 30, 2013, the increase in the income tax rate compared to the same period in 2012 primarily resulted from a change in the jurisdictional mix of year-to-date worldwide pretax income, a reinstatement of the Federal research and development credit of, which resulted in a benefit $0.9 million and the establishment of the Irish research and development credit.
The Company expects its effective income tax rate for the full year to be approximately 4.5% resulting in part from foreign earnings taxed at lower tax rates, the expected release of tax contingency reserves, and the benefit from the Federal research credit. This estimate could be revised in the future as additional information is presented to the Company.
11. NET INCOME PER SHARE
Basic and diluted net income per share was as follows:
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2013 | | 2012 | | 2013 | | 2012 |
| (In thousands, except per share amounts) |
Basic net income per share: | | | | | | | |
Net income (loss) | $ | 3,440 |
| | $ | 8,514 |
| | $ | (610 | ) | | $ | 15,207 |
|
Weighted average common shares outstanding | 27,873 |
| | 28,419 |
| | 27,834 |
| | 28,382 |
|
Basic net income per common share | $ | 0.12 |
| | $ | 0.30 |
| | $ | (0.02 | ) | | $ | 0.54 |
|
Diluted net income per share: | | | | | | | |
Net income (loss) | $ | 3,440 |
| | $ | 8,514 |
| | $ | (610 | ) | | $ | 15,207 |
|
Weighted average common shares outstanding — Basic | 27,873 |
| | 28,419 |
| | 27,834 |
| | 28,382 |
|
Effect of dilutive securities: | | | | | | | |
Stock options and restricted stock | 245 |
| | 190 |
| | — |
| | 167 |
|
Weighted average common shares for diluted earnings per share | 28,118 |
| | 28,609 |
| | 27,834 |
| | 28,549 |
|
Diluted net income per common share | $ | 0.12 |
| | $ | 0.30 |
| | $ | (0.02 | ) | | $ | 0.53 |
|
At June 30, 2013 and 2012, the Company had 1.7 million of outstanding stock options. The Company also has warrants outstanding relating to its 2016 Notes at June 30, 2013 and 2012. Stock options, restricted stock and warrants are included in the diluted earnings per share calculation using the treasury stock method, unless the effect of including the stock options would be anti-dilutive. For the three months ended June 30, 2013 and 2012, 1.0 million and 1.2 million of anti-dilutive stock options, respectively, were excluded from the diluted earnings per share calculation. As the strike price of the warrants exceeded the Company’s average stock price for the period, the warrants are anti-dilutive and the entire number of warrants was also excluded from the diluted earnings per share calculation. For the six months ended June 30, 2013, all stock options, restricted stock and warrants are excluded in the diluted earnings per share calculation using the treasury stock method because of their anti-dilutive effect.
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
12. COMPREHENSIVE (LOSS) INCOME
Comprehensive (loss) income was as follows:
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2013 | | 2012 | | 2013 | | 2012 |
| (In thousands) |
Net (loss) income | $ | 3,440 |
| | $ | 8,514 |
| | $ | (610 | ) | | $ | 15,207 |
|
Foreign currency translation adjustment | 1,357 |
| | (11,005 | ) | | (5,423 | ) | | (4,158 | ) |
Change in unrealized gain on derivatives, net of tax | 451 |
| | (241 | ) | | 747 |
| | (136 | ) |
Pension liability adjustment, net of tax | 69 |
| | 2 |
| | 69 |
| | (2 | ) |
Comprehensive (loss) income | $ | 5,317 |
| | $ | (2,730 | ) | | $ | (5,217 | ) | | $ | 10,911 |
|
Changes in Accumulated Other Comprehensive Income by component between December 31, 2012 and June 30, 2013 are presented in the table below, net of tax: |
| | | | | | | | | | | | | | | | |
| | Gains and Losses on Cash Flow Hedges | | Defined Benefit Pension Items | | Foreign Currency Items | | Total |
| | (In thousands) |
Beginning balance | | $ | (2,373 | ) | | $ | (1,154 | ) | | $ | (1,270 | ) | | $ | (4,797 | ) |
Other comprehensive income before reclassifications | | 160 |
| | 69 |
| | (5,423 | ) | | (5,194 | ) |
Amounts reclassified from accumulated other comprehensive income | | (587 | ) | | — |
| | — |
| | (587) |
Net current-period other comprehensive income (loss) | | 747 |
| | 69 |
| | (5,423 | ) | | (4,607 | ) |
Ending balance | | $ | (1,626 | ) | | $ | (1,085 | ) | | $ | (6,693 | ) | | $ | (9,404 | ) |
The reclassification adjustments out of Accumulated Other Comprehensive (Loss) Income during the three and six months ended June 30, 2013 were as follows:
|
| | | | | | |
Three Months Ended June 30, 2013 |
Details about Accumulated Other Comprehensive Income Components | | Amount Reclassified from Accumulated Other Comprehensive Income | | Affected Line Item in the Statement where Net Income (loss) is Presented |
| | (In thousands) | | |
Gains and losses on cash flow hedges | | | | |
Interest rate swap | | $ | (506 | ) | | Interest (expense) |
Foreign currency forwards | | — |
| | Cost of goods sold |
| | (506 | ) | | Total before tax |
| | 218 |
| | Tax (expense) or benefit |
| | $ | (288 | ) | | Net of tax |
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
|
| | | | | | |
Six Months Ended June 30, 2013 |
Details about Accumulated Other Comprehensive Income Components | | Amount Reclassified from Accumulated Other Comprehensive Income | | Affected Line Item in the Statement where Net Income (loss) is Presented |
| | (In thousands) | | |
Gains and losses on cash flow hedges | | | | |
Interest rate swap | | $ | (996 | ) | | Interest (expense) |
Foreign currency forwards | | (34 | ) | | Cost of goods sold |
| | (1,030 | ) | | Total before tax |
| | 443 |
| | Tax (expense) or benefit |
| | $ | (587 | ) | | Net of tax |
13. SEGMENT AND GEOGRAPHIC INFORMATION
The Company internally manages and reports the results of its businesses to its chief operating decision maker through five reportable segments. The five reportable segments are U.S. Neurosurgery, U.S. Instruments, U.S. Extremities, U.S. Spine and Other, and International. The U.S. Neurosurgery segment sells a full line of products specifically for neurosurgery and critical care such as tissue ablation equipment, dural repair products, cerebral spinal fluid management devices, intracranial monitoring equipment, and cranial stabilization equipment. The U.S. Instruments business sells more than 60,000 instrument patterns and surgical and lighting products to hospitals, surgery centers, and dental, podiatry, and veterinary offices. The U.S. Extremities segment includes the U.S. Extremity reconstruction business, which includes such offerings as skin and wound repair, bone and joint fixation, implants in the upper and lower extremities, bone grafts and nerve and tendon repair. The U.S. Spine and Other segment includes (i) the U.S. Spine business, which focuses on spinal fusion, spinal implants, and deformity correction, together with bone graft substitutes and other related medical devices that are used to enhance the repair and regeneration of bone in various types of orthopedic surgical procedures, and (ii) the Private Label business, which sells the Company’s regenerative medicine and other products to strategic partners. The International segment sells similar products to those discussed above, but are managed through the following geographies: (i) Europe, Middle East and Africa, and (ii) Central/South America, Asia-Pacific and Canada. The Corporate and other category includes (i) various legal, finance, executive, and human resource functions, (ii) brand management, (iii) share-based compensation costs, and (iv) costs related to procurement, manufacturing operations and logistics for the Company’s entire organization.
The operating results of the various reportable segments as presented are not comparable to one another because (i) certain operating segments are more dependent than others on corporate functions for unallocated general and administrative and/or operational manufacturing functions, and (ii) the Company does not allocate certain manufacturing costs and general and administrative costs to the operating segment results.
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Net sales and profit by reportable segment for the three and six months ended June 30, 2013 and 2012 and three months ended March 31, 2013 and 2012 are as follows:
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | | Three Months Ended June 30, | | Six Months Ended June 30, |
| | 2013 | | 2012 | | 2013 | | 2012 | | 2013 | | 2012 |
| | (In thousands) |
Segment Net Sales | | | | | | | | | | | | |
U.S. Neurosurgery | | $ | 38,996 |
| | $ | 40,183 |
| | $ | 41,767 |
| | $ | 42,324 |
| | $ | 80,763 |
| | $ | 82,507 |
|
U.S. Instruments | | 36,948 |
| | 37,994 |
| | 39,991 |
| | 41,269 |
| | 76,939 |
| | 79,263 |
|
U.S. Extremities | | 31,361 |
| | 26,587 |
| | 33,538 |
| | 32,048 |
| | 64,899 |
| | 58,635 |
|
U.S. Spine and Other | | 43,548 |
| | 44,810 |
| | 42,962 |
| | 48,823 |
| | 86,510 |
| | 93,633 |
|
International | | 45,799 |
| | 46,611 |
| | 47,289 |
| | 45,706 |
| | 93,088 |
| | 92,317 |
|
Total revenues | | $ | 196,652 |
| | $ | 196,185 |
| | $ | 205,547 |
| | $ | 210,170 |
| | $ | 402,199 |
| | $ | 406,355 |
|
Segment Profit | | | | | | | | | | | | |
U.S. Neurosurgery | | $ | 16,904 |
| | $ | 21,156 |
| | $ | 19,786 |
| | $ | 21,890 |
| | $ | 36,690 |
| | $ | 43,046 |
|
U.S. Instruments | | 9,312 |
| | 10,067 |
| | 11,206 |
| | 11,982 |
| | 20,518 |
| | 22,049 |
|
U.S. Extremities | | 10,734 |
| | 9,183 |
| | 13,225 |
| | 13,305 |
| | 23,959 |
| | 22,488 |
|
U.S. Spine and Other | | 13,183 |
| | 13,533 |
| | 12,284 |
| | 13,862 |
| | 25,467 |
| | 27,395 |
|
International | | 12,654 |
| | 17,465 |
| | 14,350 |
| | 13,441 |
| | 27,004 |
| | 30,906 |
|
Segment profit | | 62,787 |
| | 71,404 |
| | 70,851 |
| | 74,480 |
| | 133,638 |
| | 145,884 |
|
Amortization | | (3,551 | ) | | (4,720 | ) | | (3,073 | ) | | (4,647) |
| | (6,624) |
| | (9,367) |
|
Corporate and other | | (59,280 | ) | | (49,217 | ) | | (59,800 | ) | | (51,812 | ) | | (119,080 | ) | | (101,029 | ) |
Operating (loss) income | | $ | (44 | ) | | $ | 17,467 |
| | $ | 7,978 |
| | $ | 18,021 |
| | $ | 7,934 |
| | $ | 35,488 |
|
The segment profits for the U.S. Instruments and U.S. Extremities segments, and Corporate and Other for the three and six months ended June 30, 2012 have been revised. The segment profits for the U.S. Instruments and U.S. Extremities segments for the three months ended March 31, 2013 and 2012 have been also revised.
Revenue by major product category consisted of the following:
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2013 | | 2012 | | 2013 | | 2012 |
| (In thousands) |
Orthopedics | $ | 91,434 |
| | $ | 95,695 |
| | $ | 181,694 |
| | $ | 181,847 |
|
Neurosurgery | 68,459 |
| | 67,775 |
| | 131,644 |
| | 133,832 |
|
Instruments | 45,654 |
| | 46,700 |
| | 88,861 |
| | 90,676 |
|
Total Revenues | $ | 205,547 |
| | $ | 210,170 |
| | $ | 402,199 |
| | $ | 406,355 |
|
The Company attributes revenues to geographic areas based on the location of the customer. There are certain revenues that the various U.S. segments manage that are generated from non-U.S. customers and therefore are included in Europe and the Rest of World revenues below. Total revenue by major geographic area consisted of the following:
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2013 | | 2012 | | 2013 | | 2012 |
| (In thousands) |
United States | $ | 157,166 |
| | $ | 163,483 |
| | $ | 307,185 |
| | $ | 312,157 |
|
Europe | 23,776 |
| | 22,884 |
| | 47,393 |
| | 46,552 |
|
Rest of World | 24,605 |
| | 23,803 |
| | 47,621 |
| | 47,646 |
|
Total Revenues | $ | 205,547 |
| | $ | 210,170 |
| | $ | 402,199 |
| | $ | 406,355 |
|
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
14. COMMITMENTS AND CONTINGENCIES
In consideration for certain technology, manufacturing, distribution, and selling rights and licenses granted to the Company, the Company has agreed to pay royalties on sales of certain products that we sell. The royalty payments that the Company made under these agreements were not significant for any of the periods presented.
The Company is subject to various claims, lawsuits and proceedings in the ordinary course of the Company's business, including claims by current or former employees, distributors and competitors and with respect to its products and product liability claims, lawsuits and proceedings, some of which have been settled by the Company. 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 the Company's results of operations, financial position and cash flows in a particular period could be materially affected by these contingencies.
On June 6, 2012, the Company was contacted by the United States Attorney's Office for the District of New Jersey regarding the activities of sales representatives in a single region within our Extremities Reconstruction division. The U.S. Attorney's Office is investigating the activities of three sales representatives, one of whom was a supervisor until terminated by the Company for failure to cooperate with this investigation. The activities at issue pertain to alleged improper billing of products for extremities indications. The Company is cooperating with the United States Attorney's Office on a voluntary basis and is not a subject or target of an investigation at this time.
The Company accrues for loss contingencies when it is deemed probable that a loss has been incurred and that loss is estimable. The amounts accrued are based on the full amount of the estimated loss before considering insurance proceeds, and do not include an estimate for legal fees expected to be incurred in connection with the loss contingency. The Company consistently accrues legal fees expected to be incurred in connection with loss contingencies as those fees are incurred by outside counsel as a period cost.
15. SUBSEQUENT EVENTS
On July 1, 2013, the Company entered into a Lease Agreement with 109 Morgan Lane, LLC (the "Landlord") (the "Lease"). The Lease terminates and replaces the prior lease between the Company and the Landlord dated May 15, 2008, as amended. The Company is leasing approximately 58,011 square feet located at 109 Morgan Lane, Plainsboro, New Jersey (the "Premises") for general office, labs (research & development and/or product development), manufacturing and warehouse purposes. The term of the Lease is 20 years from July 1, 2013 to June 30, 2033 with a 5 year renewal option. The rent for the Premises is $585.9 thousand per year, with monthly rent payments of $48.8 thousand. Additional payments are also required to be made by the Company to the Landlord consisting of $290.1 thousand per year, with monthly payments of $24.2 thousand for taxes and operating expenses as well as other charges. In addition, pursuant to the Lease, the Landlord agreed to pay the Company (i) $40.0 thousand of the total cost to replace the existing roof on the building and (ii) $100.0 thousand of the total cost to replace all of the existing windows in the building.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the related notes thereto appearing elsewhere in this report and our consolidated financial statements for the year ended December 31, 2012 included in our Annual Report on Form 10-K.
We have made statements in this report 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 (the “Exchange Act”). These forward-looking statements are subject to a number of risks, uncertainties and assumptions about the Company. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those set forth above under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2012 and under the heading "Risk Factors" 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.
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.
GENERAL
Integra is a world leader in medical devices focused on limiting uncertainty for surgeons so they can concentrate on providing the best patient care. Integra provides customers with clinically relevant, innovative and cost-effective products that improve
the quality of life for patients. We focus on cranial and spinal procedures, small bone and joint injuries, the repair and reconstruction of soft tissue, and instruments for surgery.
We manage our business through a combination of product groups and geography, and accordingly, we report our financial results under five reportable segments - U.S. Instruments, U.S. Neurosurgery, U.S. Extremities, U.S. Spine and Other (which consists of our U.S. Spine and Private Label businesses) and International.
We present revenues in the following three product categories: Orthopedics, Neurosurgery and Instruments. Our orthopedics product group includes specialty metal implants for surgery of the extremities, shoulder and spine, orthobiologics products for repair and grafting of bone, dermal regeneration products and tissue-engineered wound dressings and nerve and tendon repair products. Our neurosurgery product group includes, among other things, dural grafts that are indicated for the repair of the dura mater, ultrasonic surgery systems for tissue ablation, cranial stabilization and brain retraction systems, systems for measurement of various brain parameters and devices used to gain access to the cranial cavity and to drain excess cerebrospinal fluid from the ventricles of the brain. Our instruments product group includes a wide range of specialty and general surgical and dental instruments and surgical lighting for sale to hospitals, outpatient surgery centers, and physician, veterinarian and dental practices.
We manufacture many of our products in plants located in the United States, Puerto Rico, France, Germany, Ireland, the United Kingdom and Mexico. We also source most of our handheld surgical instruments and specialty metal and pyrocarbon implants through specialized third-party vendors.
In the United States, we have several sales channels. We sell orthopedics products through a large direct sales organization and through specialty distributors focused on their respective surgical specialties. Neurosurgery products are sold through directly employed sales representatives. Instruments products are sold through two sales channels, both directly and through distributors and wholesalers, depending on the customer call point. We sell in the international markets through a combination of a direct sales organization and distributors.
We also market certain products through strategic partners in the United States.
Our objective is to become a multi-billion dollar diversified global medical technology company that (i) helps patients by limiting uncertainty for medical professionals and (ii) is a high-quality investment for shareholders. We will achieve these goals by delivering on our Brand Promises to our customers worldwide and by becoming a top player in all markets in which we compete. Our strategy includes the following key elements: geographic expansion, disciplined focus and execution, global quality assurance and acquiring or in-licensing products that fit existing sales channels, margin expansion and leveraging platform synergies.
We aim to achieve growth in our revenues while maintaining strong financial results. While we pay attention to any meaningful trend in our financial results, we pay particular attention to measurements that are indicative of long-term profitable growth. These measurements include (1) revenue growth (including internal growth and by acquisitions), (2) gross margins on total revenues, (3) operating margins (which we aim to expand as we leverage our existing infrastructure and improve our quality systems), (4) earnings before interest, taxes, depreciation, and amortization, and (5) earnings per diluted share of common stock.
We believe that we are particularly effective in the following aspects of our business:
| |
• | Regenerative Medicine Platform. We have developed numerous product lines through our proprietary collagen matrix and demineralized bone matrix technologies that are sold through every one of our sales channels. |
| |
• | Diversification and Platform Synergies. Each of our three selling platforms contributes a different strength to our core business. Orthopedics enables us to grow our top line and increase gross margins. Neurosurgery provides stable growth as a market with few elective procedures. The Instruments business has a strong capacity to generate cash flows. We have unique synergies among these platforms, such as our regenerative medicine technology, instrument sourcing capabilities, and Group Purchasing Organization (“GPO”) contract management. |
| |
• | Unique Sales Footprint. Our sales footprint provides us with a unique set of customer call-points and synergies. Each of our sales channels can benefit from the GPO and Integrated Delivery Network (“IDN”) relationships that our Instruments group manages. We have market-leading products for neurosurgeons, many of whom also perform spine surgeries, and we have yet to fully leverage those relationships to sell our spine products. We also have clinical expertise across all of our channels in the United States, and have an opportunity to expand and leverage this expertise in markets worldwide. |
| |
• | Ability to Change and Adapt. Our corporate culture is truly what enables us to adapt and reinvent ourselves. We have demonstrated that we can quickly and profitably integrate new products and businesses. This core strength has made it possible for us to grow over the years, and is key to our ability to grow into a multi-billion dollar company. |
ACQUISITIONS
We did not complete any acquisitions during the second quarter of 2013.
RESULTS OF OPERATIONS
Executive Summary
Net income for the three months ended June 30, 2013, was $3.4 million, or $0.12 per diluted share as compared with net income of $8.5 million or $0.30 per diluted share for the three months ended June 30, 2012.
Net loss for the six months ended June 30, 2013 was $0.6 million, or $0.02 per diluted share as compared with net income of $15.2 million or $0.53 per diluted share for the six months ended June 30, 2012.
The results of operations for the three and six months ended June 30, 2013 were adversely affected by a voluntary recall of certain collagen-based products manufactured in our Añasco, Puerto Rico facility. Increases in the sales returns reserve and product shortages caused by the recall led to revenue and margin reductions. We also incurred incremental expenses related to the recall, including scrap of finished good products that were not released to customers and work in process, legal and consulting costs, and expenses for remediation of our quality systems. Additionally, our expenses were impacted by higher selling, general and administration headcount, increased consulting fees and expenses incurred in connection with the implementation of our global ERP system.
The effects of the recall noted above were offset by a decrease in our interest expense as a result of the June 2012 repayment of our 2012 Notes and capitalization of a portion of our interest expense into the cost of our capital projects.
Income before taxes includes the following special charges:
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2013 | | 2012 | | 2013 | | 2012 |
| (In thousands) | | (In thousands) |
Global ERP implementation charges | $ | 7,616 |
| | $ | 3,607 |
| | $ | 13,765 |
| | $ | 7,276 |
|
Facility optimization charges | 2,262 |
| | 2,984 |
| | 5,670 |
| | 4,620 |
|
Manufacturing facility remediation costs | 2,963 |
| | 1,770 |
| | 5,088 |
| | 3,405 |
|
Certain expenses associated with product recalls | 165 |
| | — |
| | 1,444 |
| | — |
|
Certain employee termination charges | — |
| | — |
| | — |
| | 501 |
|
Discontinued product lines charges | — |
| | — |
| | — |
| | 835 |
|
Acquisition-related charges | 286 |
| | 1,019 |
| | 674 |
| | 1,721 |
|
Impairment charges | — |
| | — |
| | — |
| | 141 |
|
Convertible debt non-cash interest | 1,622 |
| | 2,969 |
| | 3,232 |
| | 6,497 |
|
Total | $ | 14,914 |
| | $ | 12,349 |
| | $ | 29,873 |
| | $ | 24,996 |
|
The items reported above are reflected in the condensed consolidated statements of operations as follows:
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2013 | | 2012 | | 2013 | | 2012 |
| (In thousands) | | (In thousands) |
Cost of goods sold | $ | 4,371 |
| | $ | 3,685 |
| | $ | 8,872 |
| | $ | 8,229 |
|
Selling, general and administrative | 8,921 |
| | 5,695 |
| | 17,769 |
| | 10,270 |
|
Interest expense | 1,622 |
| | 2,969 |
| | 3,232 |
| | 6,497 |
|
Total | $ | 14,914 |
| | $ | 12,349 |
| | $ | 29,873 |
| | $ | 24,996 |
|
We typically define special charges as items for which the amounts and/or timing of such expenses may vary significantly from period to period, depending upon our acquisition, integration and restructuring activities, and for which the amounts are non-
cash in nature, or for which the amounts are not expected to recur at the same magnitude as we implement certain tax planning strategies. We believe that given our ongoing strategy of seeking acquisitions, our continuing focus on rationalizing our existing manufacturing and distribution infrastructure and our continuing review of various product lines in relation to our current business strategy, certain of the special charges discussed above could recur with similar materiality in the future. In 2010 we began investing significant resources in the global implementation of a single enterprise resource planning system. We began capitalizing certain costs for the project starting in 2011.
We believe that the separate identification of these special charges provides important supplemental information to investors regarding financial and business trends relating to our financial condition and results of operations. Investors may find this information useful in assessing comparability of our operating performance from period to period, the business model objectives that management has established, and other companies in our industry. We provide this information to investors so that they can analyze our operating results in the same way that management does and to use this information in their assessment of our core business and valuation of Integra.
Update on Remediation Activities
Remediation activities in our regenerative medicine facility in Plainsboro, New Jersey affected revenues and gross margin in the first and second quarters of 2013. We received a warning letter from the FDA in December 2011, related to quality systems and compliance issues at that plant. The letter resulted from an inspection held at that facility in August 2011, and did not identify any new observations that were not provided in the Form 483 that followed the inspection. The warning letter did not restrict our ability to manufacture or ship products, nor did it require the recall of any product. In June and July 2012, the FDA again inspected the regenerative medicine facility. The second inspection closed out on July 30, 2012 and a FDA Form 483 Inspectional Observations was issued. We have been addressing the Form 483 observations, warning letter citations and communicating with the FDA on a monthly basis. Our efforts with respect to closing out the warning letter are well along. On July 16, 2013, the FDA began an inspection of the Plainsboro facility. At this point, the inspection remains in progress.
The FDA inspected our neurosurgery manufacturing facility in Andover, England in June 2012. Subsequently, on November 5, 2012, we received a warning letter from the FDA dated November 1, 2012 related to quality systems issues at the Andover manufacturing facility. The warning letter identified violations related to corrective and preventative actions, process validations, internal quality audits, and internal review of the suitability and effectiveness of the quality system at defined intervals. We filed the FDA warning letter as an exhibit to a Current Report on Form 8-K on November 13, 2012. Since the conclusion of the FDA inspection in June 2012, we have undertaken significant efforts to remediate the observations that the FDA has made and continue to do so. We are providing the FDA with monthly status reports and working cooperatively with the FDA to resolve any outstanding issues.
On February 14, 2013, we received a warning letter from the FDA relating to quality systems issues at our manufacturing facility located in Añasco, Puerto Rico. The letter resulted from an inspection conducted at that facility during October and November 2012. On February 15, 2013 we stopped distribution of our collagen products manufactured in the Añasco facility in order to confirm that we had successfully validated all such products and engaged a third-party consultant having appropriate quality system regulations expertise to confirm such validations. On February 22, 2013 the third-party consultant certified the completeness of such validations and we resumed distribution of collagen products from the Añasco facility.
On April 10, 2013, we initiated a voluntary recall of certain products manufactured in our Añasco facility between December 2010 and May 2011 and between November 2012 and March 2013. Specific lots of these products, as described below, have been recalled because we identified that there may have been deviations from required processes in their production. We identified through an internal quality assurance review that we may have deviated from a production process during the manufacture of specific lots of collagen products during the periods described. The product lots in question passed all product finished goods testing including endotoxin testing, are sterile, and were tested and accepted for release. However, due to the process deviation, they may have been released with higher levels of endotoxins than permitted by the product specifications. Higher levels of endotoxins may result in a fever in the immediate postoperative period. There have been no reports of patient injuries or other adverse events attributable to the products subject to the recall. We continue to manufacture all such products in our Añasco facility.
We believe that most of the recalled product lots manufactured between December 2010 and May 2011 have already been consumed, and that therefore, the recall of those lots will not have a material financial impact. However, the return of products, manufactured between November 2012 and March 2013, which were substantially sold in the first three months ended March 31, 2013, directly reduced revenues in the six months ended June 30, 2013 by $3.1 million. As we anticipated, we were not able to produce all the affected products quickly enough to meet the demand from customers in the three months ended June 30, 2013. Such supply shortages resulted in lower revenues in the first six months of 2013 and will result in lower revenues for
the third quarter of 2013 than previously forecasted. As expected, the recall and supply shortages had a significant impact on the U.S. Neurosurgery, U.S. Spine and Other, and International segments during the first six months of 2013.
The recall applies to limited and specific lots of DuraGen® Dural Graft Matrix, DuraGen® Plus Dural Regeneration Matrix, DuraGen® Suturable Dural Regeneration Matrix, DuraGen XS™ Dural Regeneration Matrix, Layershield® Adhesion Barrier Matrix, NeuraWrap™ Nerve Protector, NeuraGen® Nerve Guide, BioMend® Absorbable Collagen Membrane, OraMem® Absorbable Collagen Membrane, BioMend® Extend Absorbable Collagen Membrane, CollaCote® Absorbable Collagen Wound Dressing for Dental Surgery, CollaTape® Absorbable Collagen Wound Dressing for Dental Surgery, CollaPlug® Absorbable Collagen Wound Dressing for Dental Surgery, HeliTape® Absorbable Collagen Wound Dressing for Dental Surgery, HeliPlug® Absorbable Collagen Wound Dressing for Dental Surgery, OraTape® Absorbable Collagen Wound Dressing for Dental Surgery, OraPlug® Absorbable Collagen Wound Dressing for Dental Surgery, Instat® Microfibrillar Collagen Hemostat, Helistat® Absorbable Collagen Hemostatic Sponge (ACS/Helistat), and Helitene® Absorbable Collagen Hemostatic Agent. The Absorbable Collagen Sponge (ACS) is not a final product, but a component of a product assembled by another company.
We met with the Office of Compliance at the Center for Devices and Radiological Health on March 26, 2013. We presented our plans for both immediate remediation and our corporate plan for the development and implementation of a single Quality System for the entire Company. We have engaged former FDA professionals as third party consultants to work with us on our remediation plans. We also met with the Office of Compliance at the FDA San Juan, Puerto Rico office to discuss the remediation plans at the Añasco facility. We have prioritized senior level quality and regulatory staff to address the quality system improvement plans at all of our facilities.
We have undertaken significant efforts to remediate the observations that the FDA has made and have been working on improving and revising our quality systems. During the three and six months ended June 30, 2013, we incurred $3.0 million and $5.1 million in remediation activities expenses, respectively, consisting of consulting expenses and other work activities required to complete our remediation activities. For the full year 2013, we expect to spend approximately $7.0 million on our quality systems and expect to have these activities completed in the second half of 2013. We will provide periodic status reports to the FDA and work cooperatively with the agency to resolve any outstanding issues.
Revenues and Gross Margin on Product Revenues
Our revenues and gross margin on product revenues were as follows:
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2013 | | 2012 | | 2013 | | 2012 |
Segment Net Sales | (In thousands) | | (In thousands) |
U.S. Neurosurgery | $ | 41,767 |
| | $ | 42,324 |
| | $ | 80,763 |
| | $ | 82,507 |
|
U.S. Instruments | 39,991 |
| | 41,269 |
| | 76,939 |
| | 79,263 |
|
U.S. Extremities | 33,538 |
| | 32,048 |
| | 64,899 |
| | 58,635 |
|
U.S. Spine and Other | 42,962 |
| | 48,823 |
| | 86,510 |
| | 93,633 |
|
International * | 47,289 |
| | 45,706 |
| | 93,088 |
| | 92,317 |
|
Total revenue | 205,547 |
| | 210,170 |
| | 402,199 |
| | 406,355 |
|
Cost of goods sold | 83,068 |
| | 78,274 |
| | 163,336 |
| | 152,949 |
|
Gross margin on total revenues | $ | 122,479 |
| | $ | 131,896 |
| | $ | 238,863 |
| | $ | 253,406 |
|
Gross margin as a percentage of total revenues | 59.6 | % | | 62.8 | % | | 59.4 | % | | 62.4 | % |
* The Company attributes revenue to geographic areas based on the location of the customer. There are certain revenues managed by the various U.S. segments above that are generated from non-U.S. customers and therefore included in Europe and the Rest of World revenues.
Three Months Ended June 30, 2013 as Compared to Three Months Ended June 30, 2012
Revenues and Gross Margin
For the three months ended June 30, 2013, total revenues decreased by $4.7 million to $205.5 million from $210.2 million for the same period in 2012.
Our total revenues were negatively affected by our voluntary recall of certain products manufactured in our Añasco, Puerto Rico facility, including DuraGen® Dural Graft Matrix products. Although we continue to manufacture all the affected products in, and distribute from, our Añasco facility, the recall caused significant supply disruptions resulting in a decrease in our worldwide revenue and a larger than usual total backorder at the end of the current quarter. The Company expects to resolve most of these disruptions by the end of 2013, but there can be no assurance the Company will not lose some customers or that backorder levels will return to normal by the end of the year.
U.S. Neurosurgery revenues were $41.8 million, a decrease of 1% from the prior-year period. The decrease continues to be directly related to our collagen product shortages caused by the recall. Tissue ablation sales also decreased on a strong comparison from the prior year period, but strong growth in neuro critical care, cranial stabilization and sterotaxy partly offset these decreases. Overall sales of neuro capital products were relatively flat.
U.S. Instruments revenues were $40.0 million, a decrease of 3% from the prior-year period. In the quarter, we saw mid-single digit growth in our acute care sales channel as a result of several large orders for hospital starts. We continued to experience sustained growth in sales of our LED surgical headlamp, which was offset by lower sales of our legacy xenon lighting products. In addition, we experienced softness in our alternate site sales resulting from pricing pressures and discontinuation of some of our lower margin products.
U.S. Extremities revenues were $33.5 million, an increase of 5% from the prior-year period. This increase resulted primarily from mid-single digit growth in sales of our regenerative products compared to the prior year period when sales of such products were unusually high following the elimination of a significant backorder. We also saw low single digit growth in both our upper and lower extremities businesses, driven by new product introductions, including pyrocarbon implants.
U.S. Spine and Other revenues, which include our spine hardware, orthobiologics and private label products, were $43.0 million, a 12% decrease from the prior-year period. In addition to general market softness and pricing pressure, our spine hardware product sales declined more than the market because of poor execution in the business and some distributor turnover. We have identified the issues impacting our performance and have plans in place to return to market performance by the end of the year. Orthobiologics sales were flat because of backorders in collagen ceramic bone void fillers. Sales growth in the rest of the portfolio offset much of this decrease, and demand for the overall orthobiologics line remains strong. Sales of our private label products were down significantly from the prior-year period due to the recall-related supply shortage and declining sales of absorbable collagen sponges to our important customers.
International segment revenues were $47.3 million, an increase of 4% from the prior-year period. Our sales around the world were affected by the recall of our collagen products and backorders on these recalled products. We saw double digit growth in our spine implants and mid-single digit growth in neurosurgery products. Foreign currency had a negligible impact on our sales in the current quarter.
Gross margin decreased 7% to $122.5 million for the three-month period ended June 30, 2013 from $131.9 million for the same period last year. Gross margin as a percentage of total revenue decreased to 59.6% for the second quarter of 2013 from 62.8% for the same period last year. The decrease in gross margin percentage resulted primarily from product mix, increased validation and remediation costs related to improving quality systems at our manufacturing facilities and the impact of the 2.3% manufacturer's excise tax that we capitalize in our inventory and subsequently record in cost of goods sold as these products are sold to third-party customers.
We expect our consolidated gross margin percentage for the full year 2013 to be between 60% and 61%, down compared to 2012. Costs related to the expansion of our regenerative medicine activities, continued downward pressure on our private-label and spine hardware product sales volumes, and the inclusion of the medical device tax will negatively affect our consolidated gross margin.
Operating Expenses
The following is a summary of operating expenses as a percent of total revenues:
|
| | | | | |
| Three Months Ended June 30, |
| 2013 |
| 2012 |
Research and development | 5.7 | % |
| 6.2 | % |
Selling, general and administrative | 48.5 | % |
| 45.7 | % |
Intangible asset amortization | 1.5 | % |
| 2.2 | % |
Total operating expenses | 55.7 | % |
| 54.1 | % |
Total operating expenses, which consist of research and development expenses, selling, general and administrative expenses, and amortization expense, increased $0.6 million, or 1%, to $114.5 million in the three months ended June 30, 2013, compared to $113.9 million in the same period last year.
Research and development expenses in the second quarter of 2013 decreased $1.3 million compared to the same period last year due to lower product development spending. We target full-year 2013 spending on research and development to be approximately 6.0% of total revenues.
Selling, general and administrative expenses in the second quarter of 2013 increased by $3.5 million to $99.6 million compared to $96.1 million in the same period last year. Selling and marketing expenses increased by $1.3 million, primarily resulting from a higher headcount of our sales force in Europe and marketing and logistic groups in the United States. General and administrative costs were up $2.2 million, primarily because of higher expenses incurred in connection with the implementation of our global ERP system and consulting costs to support various strategic projects. Our prior year general and administrative expenses included $1.1 million of expenses to terminate an exclusive product distribution agreement with a former distributor in China.
Amortization expense in the second quarter of 2013 was $3.1 million compared to $4.6 million in the same period last year. The decrease is primarily due to certain intangible assets becoming fully amortized in 2013.
Non-Operating Income and Expenses
The following is a summary of non-operating income and expenses:
|
| | | | | | | |
| Three Months Ended June 30, |
| 2013 | | 2012 |
| (In thousands) |
Interest income | $ | 289 |
| | $ | 415 |
|
Interest expense | (4,965 | ) | | (7,103 | ) |
Other income (expense) | (307 | ) | | 236 |
|
Interest Income and Interest Expense
Interest income decreased in the three months ended June 30, 2013, because the Company no longer holds any short-term investments in time deposit accounts held outside the United States as it did in the prior-year period.
Interest expense in the three months ended June 30, 2013 decreased by $2.1 million primarily as a result of the June 2012 repayment of our 2012 Senior Convertible Notes, which decreased our interest expense by $1.9 million. In addition, we also capitalized $0.7 million of interest expense on our qualified construction in progress balances. This amount was offset by an additional $0.5 million of higher interest because of increased borrowing on our revolving line of credit. Our reported interest expense for the three-month periods ended June 30, 2013 and 2012 includes non-cash interest related to the accounting for convertible securities of $1.6 million and $3.0 million, respectively.
Other Income (Expense)
Other expense for the second quarter of 2013 was primarily attributable to foreign exchange losses on intercompany balances.
Income Taxes
|
| | | | | | | |
| Three Months Ended June 30, |
| 2013 | | 2012 |
| (In thousands) |
Income before income taxes | $ | 2,995 |
| | $ | 11,569 |
|
Income tax (benefit) expense | (445 | ) | | 3,055 |
|
Effective tax rate | (14.9 | )% | | 26.4 | % |
Our effective income tax rates for the three months ended June 30, 2013 and 2012 were (14.9)% and 26.4%, respectively. For the three months ended June 30, 2013, the reduction in the income tax rate compared to the same period in 2012 was primarily
the result of a change in the jurisdictional mix of worldwide pretax income and the establishment of the Irish research and development credit. During the quarter, we were granted an Irish research and development credit for 2011 and 2012 that resulted in a benefit of $0.5 million. Also, in the current quarter, we recorded a benefit of $0.8 million for the release of uncertain tax positions due to the expiration of the statute of limitations in certain state jurisdictions, which is offset by an expense of $0.3 million for the establishment of additional non-U.S. tax contingency reserves.
We expect our effective income tax rate for the full year to be approximately 4.5% due, in part, to foreign earnings taxed at lower tax rates, the release of a tax contingency reserve, and the benefit from the Federal research credit. This estimate could be revised in the future as additional information is presented to us.
The effective tax rate may vary from period to period depending on, among other factors, the geographic and business mix of taxable earnings and losses, tax planning and settlements with the various taxing authorities. We consider these factors and others, including our history of generating taxable earnings, in assessing our ability to realize deferred tax assets on a quarterly basis.
While it is often difficult to predict the final outcome or the timing of resolution of any particular matter with the various Federal, state and foreign tax authorities, we believe that our reserves reflect the most probable outcome of known tax contingencies. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual effective tax rate in the year of resolution. The tax reserves are presented in the balance sheet within other liabilities, except for amounts relating to items we expect to pay in the coming year which are classified as current income taxes payable.
Six Months Ended June 30, 2013 as Compared to Six Months Ended June 30, 2012
Revenues and Gross Margin
For the six-month period ended June 30, 2013, total revenues decreased by $4.2 million or 1%, to $402.2 million from $406.4 million during the prior-year period.
Our total revenues for the six-month period ended June 30, 2013, were negatively affected by our voluntary recall of certain products manufactured in our Añasco, Puerto Rico facility, including DuraGen® Dural Graft Matrix products.
U.S. Neurosurgery revenues were $80.8 million, a decrease of 2% from the prior year. The decrease was directly related to our collagen product shortages caused by the recall. Capital sales were up mid to high single digits as we saw growth in our critical care, cranial stabilization and stereotaxy lines. This growth was partly offset by a decrease in tissue ablation sales on a strong comparison from the prior period. Our disposable product sales grew to mid-single digits.
U.S. Instruments revenues were $76.9 million, a decrease of 3% from the prior year. We saw lower sales of our legacy lighting products due to some product discontinuation and conversion of the legacy xenon lighting products to LED lighting. We saw growth in our acute care sales channel as a result of several large orders for hospital starts. These increases were offset by softness in our alternate sites sales due to pricing pressures and product discontinuation of some of our lower margin products.
U.S. Extremities revenues were $64.9 million, an increase of 11% from the prior year. This low-double digit growth resulted primarily from significant increases in sales of our dermal and wound care products. We also saw low-double digit growth in both our upper and lower extremities businesses, driven by new product introductions, including pyrocarbon implants.
U.S. Spine and Other revenues, which include our spine hardware, orthobiologics and private label products, were $86.5 million, a decrease of 8% from the prior year. In addition to general market softness and pricing pressure, our spine hardware product sales declined more than the market because of poor execution in the business and some distributor turnover. We have identified the issues impacting our performance and have plans in place to return to market performance by the end of the year. Orthobiologics sales were flat because of backorders in collagen ceramic bone void fillers. We expect supply to return to normal levels by the end of the third quarter. Sales growth in the rest of the portfolio offset much of this decrease, and demand for the overall orthobiologics line remains strong. Sales of our private label products were down significantly from the prior-year period due to the recall-related supply shortage.
International segment revenues were $93.1 million, an increase of 1% from prior year. Our sales around the world were affected by the recall of our collagen products and backorders on these recalled products. We saw growth in our spine implants and dermal and wound businesses with several new product introductions and increasing product coverage in direct and indirect channels. We experienced growth in Asia-Pacific and Latin America markets for our duraplasty products not affected by the recall. Foreign currency unfavorably impacted our sales by $0.4 million.
Gross margin decreased 6% to $238.9 million for the six-month period ended June 30, 2013 from $253.4 million for the same period last year. Gross margin as a percentage of total revenue decreased to 59.4% for the first six months of 2013 from 62.4% for the same period last year. The decrease in gross margin percentage resulted primarily from increases in reserves related to inventory associated with the recall and increased spending and remediation costs related to improving quality systems and validation processes at our manufacturing facilities. Finally, in January, we began paying the manufacturer's excise tax imposed on the first sale of certain medical devices in the United States. We elected to capitalize the excise tax in inventory and subsequently record in cost of goods sold as these products are sold to third-party customers, which had the impact of decreasing our gross margin by 0.5%.
Operating Expenses
The following is a summary of operating expenses as a percent of total revenues:
|
| | | | | |
| Six Months Ended June 30, |
| 2013 | | 2012 |
Research and development | 6.1 | % | | 6.2 | % |
Selling, general and administrative | 49.7 | % | | 45.2 | % |
Intangible asset amortization | 1.6 | % | | 2.3 | % |
Total operating expenses | 57.4 | % | | 53.7 | % |
Total operating expenses, which consist of research and development expenses, selling, general and administrative expenses and amortization expense, increased $13.0 million, or 6%, to $230.9 million in the six months of 2013, compared to $217.9 million in the same period last year.
Research and development expenses in the six months of 2013 decreased slightly compared to the same period last year due to lower spending on product development.
Selling, general and administrative expenses in the six months of 2013 increased by $16.3 million to $199.8 million compared to $183.5 million in the same period last year. Selling and marketing expenses increased by $8.4 million primarily resulting from higher headcount. Additionally, U.S. Extremities' commission costs were higher as a result of increases in revenue. General and administrative costs were up $7.9 million primarily because of higher headcount, increased expenses incurred in connection with the implementation of our global ERP system, and consulting costs to support various strategic projects.
Amortization expense in the first six months of 2013 decreased by $2.8 million to $6.6 million, compared to $9.4 million in the same period last year. The decrease is primarily due to certain intangible assets becoming fully amortized in the first half of 2013.
Non-Operating Income and Expenses
The following is a summary of non-operating income and expenses:
|
| | | | | | | |
| Six Months Ended June 30, |
| 2013 | | 2012 |
| (In thousands) |
Interest income | $ | 352 |
| | $ | 793 |
|
Interest expense | (9,765 | ) | | (15,032 | ) |
Other income (expense) | (1,281 | ) | | (87 | ) |
Interest Income and Interest Expense
Interest income decreased in the six-month period ended June 30, 2013, because the Company no longer holds any short-term investments in time deposit accounts held outside the United States as it did in the prior year period.
Interest expense in the six-month period ended June 30, 2013 decreased by $5.3 million primarily as a result of the June 2012 repayment of our 2012 Senior Convertible Notes, which decreased our interest expense by $4.9 million. In addition, we capitalized $1.4 million of interest expense on our qualified construction in progress balances. This amount was offset by an
additional $1.0 million of higher interest because of increased borrowing on our revolving line of credit. Furthermore, the amount of our 2016 Notes discount amortization increased by $0.2 million as expected when using the effective interest method for its amortization in the six month period ended June 30, 2012. Our reported interest expense for the six-month periods ended June 30, 2013 and 2012 includes non-cash interest related to the accounting for convertible securities of $3.2 million and $6.5 million, respectively.
Other Income (Expense)
Other expenses of $1.3 million in 2013 were primarily attributable to a write off of $1.5 million for a capital expenditure project not placed into service and by foreign exchange losses on intercompany balances.
Income Taxes
|
| | | | | | | |
| Six Months Ended June 30, |
| 2013 | | 2012 |
| (In thousands) |
(Loss) income before income taxes | $ | (2,760 | ) | | $ | 21,162 |
|
Income tax (benefit) expense | (2,150 | ) | | 5,955 |
|
Effective tax rate | 77.9 | % | | 28.1 | % |
The Company's effective income tax rates for the six months ended June 30, 2013 and 2012 were77.9% and 28.1%, respectively. The change in year-to-date effective tax rates is attributable to the change in the mix in year-to-date worldwide pretax income, as well as a reduction in the estimated domestic manufacturing deduction caused by a change in U.S. taxable income for 2013. The year-to-date tax increase is offset by a benefit of $1.2 million for the release of tax contingency reserves and a benefit of $0.9 million for the extension of the Federal research credit and the establishment of the Irish research and development credit.
The effective tax rate may vary from period to period depending on, among other factors, the geographic and business mix of taxable earnings and losses, tax planning and settlements with the various taxing authorities. We consider these factors and others, including our history of generating taxable earnings, in assessing our ability to realize deferred tax assets on a quarterly basis.
While it is often difficult to predict the final outcome or the timing of resolution of any particular matter with the various Federal, state and foreign tax authorities, we believe that our reserves reflect the most probable outcome of known tax contingencies. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual effective tax rate in the year of resolution. The tax reserves are presented in the balance sheet within other liabilities, except for amounts relating to items it expects to pay in the coming year which are classified as current income taxes payable.
We expect our effective income tax rate for the full year to be approximately 4.5%.
GEOGRAPHIC PRODUCT REVENUES AND OPERATIONS
We attribute revenues to geographic areas based on the location of the customer. There are certain revenues that the various U.S. segments manage that are generated from non-U.S. customers and therefore included in Europe and the Rest of World revenues below – these revenues are not significant. Total revenue by major geographic area consisted of the following:
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2013 | | 2012 | | 2013 | | 2012 |
| (In thousands) | | (In thousands) |
United States | $ | 157,166 |
| | $ | 163,483 |
| | $ | 307,185 |
| | $ | 312,157 |
|
Europe | 23,776 |
| | 22,884 |
| | 47,393 |
| | 46,552 |
|
Rest of World | 24,605 |
| | 23,803 |
| | 47,621 |
| | 47,646 |
|
Total Revenues | $ | 205,547 |
| | $ | 210,170 |
| | $ | 402,199 |
| | $ | 406,355 |
|
Domestic revenues decreased 4% to $157.2 million, or 76% of total revenues, for the three months ended June 30, 2013 from $163.5 million, or 78% of total revenues, for the three months ended June 30, 2012. International revenues increased to $48.4 million from $46.7 million in the prior-year period, an increase of 4%. Foreign exchange rate fluctuations accounted for a $0.1 million decrease in revenues during the second quarter of 2013 as compared to the same period last year.
Domestic revenues decreased by 2% to $307.2 million, and were 76% of the total revenues, for the six months ended June 30, 2013 from $312.2 million, or 77% of total revenues, for the six months ended 2012. International revenues increased by 1% to $95.0 million. Foreign exchange rate fluctuations accounted for a $0.4 million decrease in revenues during the six-month period ended June 30, 2013 as compared to the same period last year.
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 could have an impact on the demand for our products in foreign countries.
Local economic conditions, regulatory compliance or political considerations, the effectiveness of our sales representatives and distributors, local competition and changes in local medical practice all may combine to affect our sales into markets outside the United States.
LIQUIDITY AND CAPITAL RESOURCES
Cash and Marketable Securities
We had cash and cash equivalents totaling approximately $98.6 million and $96.9 million at June 30, 2013 and December 31, 2012, respectively. At June 30, 2013, our non-U.S. subsidiaries held approximately $82.4 million of cash and cash equivalents that are available for use by our operations outside of the United States. If these funds were repatriated to the United States, or used for United States operations, certain amounts could be subject to tax in the United States for the incremental amount in excess of the foreign tax paid.
Cash Flows
|
| | | | | | | |
| Six Months Ended June 30, |
| 2013 | | 2012 |
| (In thousands) |
Net cash provided by operating activities | $ | 10,764 |
| | $ | 34,594 |
|
Net cash used in investing activities | (26,775 | ) | | (69,358 | ) |
Net cash provided by (used in) financing activities | 19,323 |
| | 8,473 |
|
Effect of exchange rate fluctuations on cash | (1,614 | ) | | 953 |
|
Net increase (decrease) in cash and cash equivalents | $ | 1,698 |
| | $ | (25,338 | ) |
In 2013, we anticipate that our principal uses of cash will include payments of the new medical device excise tax in a range of $9 -$12 million. We also plan to spend between $55.0 million and $65.0 million on capital expenditures primarily for our
continued expansion of regenerative medicine manufacturing capacity, support maintenance in our existing plants, our enterprise resource planning system implementation, and additions to our instrument kits used in sales of orthopedic products.
Cash Flows Provided by Operating Activities
We generated operating cash flows of $10.8 million and $34.6 million for the six months ended June 30, 2013 and 2012, respectively.
Operating cash flow was lower than the same period in 2012 largely because net income decreased by $15.8 million for the six months ended June 30, 2013. Changes in working capital decreased cash flows by approximately $22.2 million. Among the changes in working capital, accounts receivable used $0.7 million of cash, inventory used $24.0 million of cash, prepaid expenses and other current assets used $0.6 million of cash, and accounts payable, accrued expenses and other current liabilities provided $2.9 million of cash.
Net income for the six months ended June 30, 2012 plus non-cash items included in those earnings amounted to approximately $50.8 million. The operating cash flows were largely impacted by the repayment of our convertible 2012 Notes of $165 million, of which $31.0 million was classified as an operating use of cash for the repayment of accreted interest.
Cash Flows Used in Investing Activities
During the six months ended June 30, 2013, we paid $24.5 million in cash for capital expenditures, most of which was directed to the expansion of our regenerative medicine production capacity and global enterprise system implementation. We also paid $2.8 million for the acquisition of Tarsus Medical, Inc.
During the six months ended June 30, 2012, we paid $24.6 million in cash for capital expenditures, most of which was directed to the expansion of our regenerative medicine production capacity and global enterprise system implementation. We had net purchases of $41.8 million in short-term time deposit accounts, which are held outside of the United States.
Cash Flows Provided by Financing Activities
Our principal sources of cash for financing activities in the six months ended June 30, 2013 were $20.0 million of borrowings under our Senior Credit Facility offset by amendment costs of $1.0 million.
Our principal uses of cash for financing activities in the six months ended June 30, 2012 were $155.0 million of borrowings under our Senior Credit Facility offset by the repayment of the liability component of our convertible 2012 Notes of $134.4 million and $12.8 million of repayments under our Senior Credit Facility.
Working Capital
At June 30, 2013 and December 31, 2012, working capital was $368.4 million and $346.1 million, respectively.
Amended and Restated Senior Credit Agreement
On August 10, 2010, the Company entered into an amended and restated credit agreement (the “Senior Credit Facility") with a syndicate of lending banks and further amended the Senior Credit Facility on June 8, 2011 (the “2011 Amendment”). The 2011 Amendment increased the revolving credit component from $450.0 million to $600.0 million and eliminated the $150.0 million term loan component that previously existed under the Senior Credit Facility, allows the Company to further increase the size of the revolving credit component by an aggregate of $200.0 million with additional commitments, provides the Company with decreased borrowing rates and annual commitment fees, and provides more favorable financial covenants. The 2011 Amendment extended the Senior Credit Facility’s maturity date from August 10, 2015 to June 8, 2016.
The Senior Credit Facility is collateralized by substantially all of the assets of the Company’s U.S. subsidiaries, excluding intangible assets. The Senior Credit Facility is subject to various financial and negative covenants and at June 30, 2013, the Company was in compliance with all such covenants.
On May 11, 2012, the Company entered into another amendment to the Senior Credit Facility. The amendment modified certain financial and negative covenants as disclosed in Note 5 to the Financial Statements, the effect of which was to increase the Company’s capacity to borrow.
On June 21, 2013, the Company entered into a second amendment to the Senior Credit Facility. The amendment provides for an increase to the Company's Maximum Consolidated Total Leverage Ratio and permits the addition of certain costs and expenses in the calculation of the consolidated EBIDTA as disclosed in Note 5 to the Financial Statements. There were no other changes as a result of the second amendment. In connection with the June 21, 2013 amendment, the Company capitalized $1.0 million in incremental financing costs.
Borrowings under the Senior Credit Facility currently bear interest, at the Company’s option, at a rate equal to (i) the Eurodollar Rate (as defined in the Senior Credit Facility, which definition has not changed) in effect from time to time plus the applicable rate (ranging from 1.00% to 1.75%) or (ii) the highest of (x) the weighted average overnight Federal funds rate, as published by the Federal Reserve Bank of New York, plus 0.5%, (y) the prime lending rate of Bank of America, N.A. or (z) the one-month Eurodollar Rate plus 1.0%. The applicable rates are based on the Company’s Consolidated Total Leverage Ratio (defined as the ratio of (a) consolidated funded indebtedness less cash in excess of $40 million that is not subject to any restriction of the use or investment thereof ("net debt") to (b) consolidated EBITDA) at the time of the applicable borrowing. The Company will also pay an annual commitment fee (ranging from 0.15% to 0.30%, based on the Company’s consolidated total leverage ratio) on the daily amount by which the revolving credit facility exceeds the outstanding loans and letters of credit under the credit facility.
We plan to utilize the Senior Credit Facility for working capital, capital expenditures, share repurchases, acquisitions, debt repayments and other general corporate purposes. At June 30, 2013 and December 31, 2012, there was $341.9 million and $321.9 million, respectively, outstanding under the Senior Credit Facility at a weighted average interest rate of 2.0% and 1.8%, respectively. The Company considers the balance to be long-term in nature based on its current intent and ability to repay the borrowing outside of the next twelve-month period.
At June 30, 2013, there was approximately $258.1 million available, subject to certain limitations, for borrowing under the Senior Credit Facility.
Convertible Debt and Related Hedging Activities
We pay interest each June 15 and December 15 on our $230.0 million senior convertible notes due December 2016 (“2016 Notes”) at an annual interest rate of 1.625%.
The 2016 Notes are senior, unsecured obligations of Integra, and are convertible into cash and, if applicable, shares of our common stock based on an initial conversion rate, subject to adjustment, of 17.4092 shares per $1,000 principal amount of 2016 Notes (which represents an initial conversion price of approximately $57.44 per share). We expect to satisfy any conversion of the 2016 Notes with cash up to the principal amount pursuant to the net share settlement mechanism set forth in the respective indenture and, with respect to any excess conversion value, with shares of our common stock. The 2016 Notes are convertible only in the following circumstances: (1) if the closing sale price of our common stock exceeds 150% of the conversion price during a period as defined in the applicable indenture; (2) if the average trading price per $1,000 principal amount of the 2016 Notes is less than or equal to 98% of the average conversion value of the 2016 Notes during a period as defined in the applicable indenture; (3) at any time on or after June 15, 2016; or (4) if specified corporate transactions occur. The issue price of the 2016 Notes was equal to their face amounts, which is also the amount holders are entitled to receive at maturity if the 2016 Notes are not converted. None of these conditions existed with respect to the 2016 Notes; therefore the 2016 Notes are classified as long-term.
In connection with the issuance of the 2016 Notes, we entered into call transactions and warrant transactions, primarily with affiliates of the initial purchasers of the 2016 Notes (the “hedge participants”). The cost of the call transactions to us was approximately $42.9 million for the 2016 Notes. We received approximately $28.5 million of proceeds from the warrant transactions for the 2016 Notes. The call transactions involved our purchasing call options from the hedge participants, and the warrant transactions involved us selling call options to the hedge participants with a higher strike price than the purchased call options. The initial strike price of the call transactions is approximately $57.44 for the 2016 Notes, subject to anti-dilution adjustments. The initial strike price of the warrant transactions is approximately $70.05 for the 2016 Notes, in each case subject to customary anti-dilution adjustments.
We may from time to time seek to retire or purchase a portion of our outstanding 2016 Notes through cash purchases and/or exchanges for equity securities, in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. Under certain circumstances, the call options associated with any repurchased 2016 Notes may terminate early, but only with respect to the number of 2016 Notes that cease to be outstanding. The amounts involved may be material.
Share Repurchase Plan
On October 23, 2012, our Board of Directors authorized a repurchase of up to $75.0 million of outstanding common stock through December 2014. Shares may be repurchased either in the open market or in privately negotiated transactions. We repurchased no shares under this program during the first six months of 2013 and $75.0 million remains available under the authorization.
Dividend Policy
We have not paid any cash dividends on our common stock since our formation. Our Senior Credit Facility limits the amount of dividends that we may pay. Any future determinations to pay cash dividends on our common stock will be at the discretion of our Board of Directors and will depend upon our financial condition, results of operations, cash flows and other factors deemed relevant by the Board of Directors.
Capital Resources
We believe that our cash and available borrowings under the Senior Credit Facility are sufficient to finance our operations and capital expenditures. The Company considers all such outstanding amounts to be long-term in nature based on its current intent and ability to repay the borrowings outside of the next twelve month period.
Off-Balance Sheet Arrangements
There were no off-balance sheet arrangements during the six months ended June 30, 2013 that have or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to our interests.
OTHER MATTERS
Critical Accounting Estimates
The critical accounting estimates included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 have not materially changed.
Recently Issued Accounting Standards
There have been no recently issued accounting standards that have an impact on our financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to various market risks, including changes in foreign currency exchange rates and interest rates that could adversely affect our results of operations and financial condition. To manage the volatility relating to these typical business exposures, we may enter into various derivative transactions when appropriate. We do not hold or issue derivative instruments for trading or other speculative purposes.
Foreign Currency Exchange and Other Rate Risks
We operate on a global basis and are exposed to the risk that changes in foreign currency exchange rates could adversely affect our financial condition, results of operations and cash flows. We are primarily exposed to foreign currency exchange rate risk with respect to transactions and net assets denominated in euros, Swiss francs, British pounds, Canadian dollars, Australian dollars and Japanese yen. We manage the foreign currency exposure centrally, on a combined basis, which allows us to net exposures and to take advantage of any natural offsets. To mitigate the impact of currency fluctuations on transactions denominated in nonfunctional currencies, we periodically enter into derivative financial instruments in the form of foreign currency exchange forward contracts with major financial institutions. We temporarily record realized and unrealized gains and losses on these contracts that qualify as cash flow hedges in other comprehensive income, and then recognize them in other income or expense when the hedged item affects net earnings.
From time to time, we enter into foreign currency forward exchange contracts with terms of up to 12 months to manage currency exposures for transactions denominated in a currency other than an entity’s functional currency. As a result, the impact of foreign currency gains/losses recognized in earnings are partially offset by gains/losses on the related foreign currency forward exchange contracts in the same reporting period.
We maintain written policies and procedures governing our risk management activities. With respect to cash flow hedges, changes in cash flows attributable to hedged transactions are generally expected to be completely offset by changes in the fair value of hedge instruments. Consequently, foreign currency exchange contracts would not subject us to material risk due to exchange rate movements, because gains and losses on these contracts offset gains and losses on the assets, liabilities or transactions being hedged.
The results of operations discussed herein have not been materially affected by inflation.
Interest Rate Risk
Cash and Cash Equivalents - We are exposed to the risk of interest rate fluctuations on the interest income earned on our cash and cash equivalents. A hypothetical 100 basis point movement in interest rates applicable to our cash and cash equivalents outstanding at June 30, 2013 would increase interest income by approximately $1.0 million on an annual basis. No significant decrease in interest income would be expected as our cash balances are earning interest at rates close to zero. We are subject to foreign currency exchange risk with respect to cash balances maintained in foreign currencies.
Senior Credit Facility - Our interest rate risk relates primarily to U.S. dollar LIBOR-indexed borrowings. We have used an interest rate derivative instrument to manage our earnings and cash flow exposure to changes in interest rates by utilizing a forward-starting interest rate swap that began to offset a portion of our interest payments in the first quarter of 2011. This interest rate derivative instrument fixed the interest rate on a portion of our expected LIBOR-indexed floating-rate borrowings beginning on December 31, 2010. The interest rate swap had a notional amount of $120.0 million outstanding as of June 30, 2013. We recognized $0.5 million of additional interest expense related to this derivative during the three months ended June 30, 2013. The fair value of our interest rate derivative instrument was a net liability of $3.0 million at June 30, 2013.
Based on our outstanding borrowings at June 30, 2013, a one-percentage point change in interest rates would have impacted interest expense on the unhedged portion of the debt by $2.2 million on an annualized basis.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in our Exchange Act report is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. Disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Management has designed our disclosure controls and procedures to provide reasonable assurance of achieving the desired control objectives.
As required by Exchange Act Rule 13a-15(b), we have carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2013. Based upon this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of June 30, 2013 to provide such reasonable assurance.
As previously disclosed, the Company is in the process of a multi-year implementation of a global enterprise resource planning (“ERP”) system. In the second quarter of 2013, the Company began deploying its first ERP module within certain U.S. operations. In addition, in response to business integration activities, the Company has and will continue to further align and streamline the design and operation of the financial control environment to be responsive to the changing business model.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the quarter ended June 30, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Various lawsuits, claims and proceedings are pending or have been settled by us; the most significant of which are described below.
The Company is subject to various claims, lawsuits and proceedings in the ordinary course of the Company's business, including claims by current or former employees, distributors and competitors and with respect to its products and product liability claims, lawsuits and proceedings, some of which have been settled by the Company. 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 the Company's results of operations, financial position and cash flows in a particular period could be materially affected by these contingencies.
On June 6, 2012, the Company was contacted by the United States Attorney's Office for the District of New Jersey regarding the activities of sales representatives in a single region within our Extremities Reconstruction division. The U.S. Attorney's Office is investigating the activities of three sales representatives, one of whom was a supervisor until terminated by the Company for failure to cooperate with this investigation. The activities at issue pertain to alleged improper billing of products for extremities indications. The Company is cooperating with the United States Attorney's Office on a voluntary basis and is not a subject or target of an investigation at this time.
The Company accrues for loss contingencies when it is deemed probable that a loss has been incurred and that loss is estimable. The amounts accrued are based on the full amount of the estimated loss before considering insurance proceeds, and do not include an estimate for legal fees expected to be incurred in connection with the loss contingency. The Company consistently accrues legal fees expected to be incurred in connection with loss contingencies as those fees are incurred by outside counsel as a period cost.
ITEM 1A. RISK FACTORS
The Risk Factors included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, as modified by the subsequent Quarterly Report on Form 10-Q for the period ended March 31, 2013, have not materially changed other than the modifications to the risk factors as set forth below.
Risks Related to Our Business
Our operating results may fluctuate.
Our operating results, including components of operating results such as gross margin and cost of product sales, may fluctuate from time to time, and such fluctuations could affect our stock price. Our operating results have fluctuated in the past and can be expected to fluctuate from time to time in the future. Some of the factors that may cause these fluctuations include:
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• | economic conditions in the United States or abroad, especially in Europe, which could affect the ability of hospitals and other customers to purchase our products and could result in a reduction in elective and non-reimbursed operative procedures; |
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• | the impact of acquisitions; |
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• | the impact of our restructuring activities; |
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• | the timing of significant customer orders, which tend to increase in the fourth quarter to coincide with the end of budget cycles for many hospitals; |
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• | market acceptance of our existing products, as well as products in development; |
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• | the timing of regulatory approvals; |
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• | changes in the rates of exchange between the U.S. dollar and other currencies of foreign countries in which we do business, such as the euro, the British pound and the Japanese yen; |
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• | expenses incurred and business lost in connection with product field correction actions or recalls; |
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• | potential backorders and lost sales resulting from stoppages in production relating to product recalls or field corrective actions; |
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• | changes in the cost or decreases in the supply of raw materials, including energy and steel; |
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• | our ability to manufacture and ship our products efficiently or in sufficient quantities to meet sales demands; |
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• | the timing of our research and development expenditures; |
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• | reimbursement for our products by third-party payors such as Medicare, Medicaid, private and public health insurers and foreign governmental health systems; |
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• | inspections of our manufacturing facilities for compliance with Quality System Regulations (Good Manufacturing Practices) which could result in Form 483 observations, warning letters, injunctions or other adverse findings from the FDA or from equivalent regulatory bodies, and corrective actions, procedural changes and other actions |