UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, DC 20549FORM 10-K(Mark(Mark One)[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31,2005 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 19342006
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period fromtoCOMMISSION FILE NO. 0-26224INTEGRA LIFESCIENCES HOLDINGS CORPORATION(EXACT(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)DELAWARE 51-0317849 - ------------------------------- --------------------- (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 311 ENTERPRISE DRIVE PLAINSBORO, NEW JERSEY 08536 - ------------------------------- --------------------- (ADDRESS OF PRINCIPAL (ZIP CODE) EXECUTIVE OFFICES) REGISTRANT'S
DELAWARE
(STATE OR OTHER JURISDICTION OF
INCORPORATION OR ORGANIZATION)51-0317849
(I.R.S. EMPLOYER IDENTIFICATION NO.)311 ENTERPRISE DRIVE
PLAINSBORO, NEW JERSEY
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)08536
(ZIP CODE)REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE:(609) 275-0500SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:NONE
Title of Each Class Name of Exchange on Which Registered Common Stock, Par Value $.01 Per Share The Nasdaq Stock Market LLC SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:COMMON STOCK, PAR VALUE $.01 PER SHARENONEIndicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.Yes[ ]þ No[X]oIndicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act.Yes[ ]o No[X]þIndicate 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]þ No[ ]oIndicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best ofregistrant'sregistrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.[X]oIndicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of large accelerated filer and accelerated filer in Rule 12b-2 of the ExchangeAct). Large accelerated filer Yes [ ] No [X] Accelerated filer Yes [X] No [ ] Non-accelerated filer Yes [ ] No [X]Act.
Large accelerated filer Yesþ Noo Accelerated filer Yeso Noþ Non-accelerated filer Yeso Noþ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes[ ]o No[X]þAs of June 30,2005,2006, the aggregate market value of theregistrant'sregistrant’s common stock held by non-affiliates was approximately$590.0$778.8 million based upon the closing sales price of theregistrant'sregistrant’s common stock on TheNASDAQ NationalNasdaq Global Market on such date.The number of shares of theregistrant'sregistrant’s Common Stock outstanding as ofMarch 10, 2006February 23, 2007 was28,435,001.27,327,292.DOCUMENTS INCORPORATED BY REFERENCECertain portions of theregistrant'sregistrant’s definitive proxy statement relating to its scheduled May 17,20062007 Annual Meeting of Stockholders are incorporated by reference in Part III of this report.PART I
ITEM 1. BUSINESS
OVERVIEW
The terms
"we," "our," "us," "Company"“we,” “our,” “us,” “Company” and"Integra"“Integra” refer to Integra LifeSciences Holdings Corporation, a Delaware corporation, and its subsidiaries unless the context suggests otherwise.Integra, a world leader in regenerative medicine, is
a market leading, innovative medical device company focused on helping the medical professional enhance the standard of care for patients. Integra provides customers with clinically relevant, innovative and cost-effective products that improvededicated to improving the quality of life forpatients. We focus on cranialpatients through the development, manufacturing andspinal procedures, peripheral nerve repair, small bonemarketing of cost-effective surgical implants andjoint injuries,medical instruments. Our products, used primarily in neurosurgery, extremity reconstruction, orthopedics andthe repair and reconstructiongeneral surgery, are used to treat millions ofsoft tissue. Integra was founded in 1989 and since then has leveraged its expertise in regenerative technologiespatients every year. Revenues from these products grew todevelop numerous products based on its Ultra Pure Collagen(TM) technology. Early in Integra's history, these regenerative products were sold through a number of private label arrangements with other large medical device companies. In 1999, we entered the neurosurgery market through an acquisition and the launch of our DuraGen(R) Dural Graft Matrix product for the repair of the dura mater. Since our entry into the neurosurgery field in 1999, we have entered the surgical instruments and reconstructive surgery businesses. We have increased our consolidated revenues from $42.9$419.3 million in1999 to2006, an increase of 51% from $277.9 million in2005,2005.Founded in 1989, Integra has grown to be a
compound annual growth rateleader in applying the principles of37%,biotechnology to medical devices, particularly for neurosurgery and extremity reconstruction, and is one of the largest surgical instrument companies in the United States. In the United States, Integra sells its products for neurosurgery and extremity reconstruction directly to customers and its surgical instruments through manufacturers’ representatives and stocking distributors. Outside the United States, Integra sells its products directly in major European markets and through stocking distributors elsewhere.In 2006, we
have broadened our product offeringsadded approximately 75 new field-based representatives toinclude more than 15,300 products. We have achieved this growth in our business by developing and introducing new products, expandingour sales anddistribution channelsmarketing organizations in the United States andacquiring new businesses10 in Europe. We now have approximately 400 sales andproduct lines. Financial information aboutmarketing employees, who sell ourgeographical areas is set forthproducts inour financial statements under "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - International Product Revenues and Operations" and Note 15 "Segment and Geographic Information" to our Consolidated Financial Statements.120 countries.STRATEGY
Our goal is to become
athe global leader in the development, manufacturing and marketing of medical devices, implantsbiomaterialsand instruments intheneurosurgeryreconstructive surgeryandgeneral surgeryextremity reconstruction markets. Key elements of our strategyinclude the following: oinclude:Marketing innovative medical devices
toin underserved marketso.We develop innovative medical devices for neurosurgery and reconstructive surgery. These are niche markets that larger medical device companies tend not to emphasize as their primary focus.Investing in sales distribution channels to increase market penetration
o.We have built a large neurosurgical sales team of approximately 150 sales professionals in the United States who sell products to operating rooms and intensive care units. We have also built the largest direct extremity reconstruction sales force of approximately 75 sales professionals in the United States. Our European sales force consists of approximately 35 professionals.Developing innovative products based on core technologies
o Acquiring businesses that fit existing sales channels or build out new sales channels Marketing innovative medical devices to underserved markets..Wehave developed a number of innovative medical devices for neurosurgery and reconstructive surgery. Reconstructive surgery includes treatment of burns and wounds (chronic and trauma-related), peripheral nerve repair, and small bone and joint fixation procedures. Traditionally these markets have been underserved by the largest medical device manufacturers. Investing in sales distribution channels to increase market penetration. We have a mix of direct and indirect sales distribution channels. We created our first direct sales force in 1999 with the creation of our Integra NeuroSciences sales force. Since then, the number of sales representatives (whom we call neurospecialists) in that sales force has grown to over 100. In 2003, we created our reconstructive surgery sales force, and this group now has over 50 sales representatives. Between these two sales forces, we reach neurosurgeons, plastic and reconstructive surgeons, orthopedic surgeons and podiatrists. Developing innovative products based on core technologies. We have becomeare a leader in regenerative technology.Our Ultra Pure Collagen(TM) technology is the basis forWe sell a number of regenerative productsthat we sellthrough both our own sales network andthroughalliances with other companies inprivate labelprivate-label arrangements.ThisOur proprietary highly purified collagen scaffold technologyhas been deployed inis the foundation of our productsrelating tofor duraplasty, dermal regeneration, nerve and tendon repair, and collagen matrices used forboneregeneration in the orthopedic implant market. We are a leading marketer of neurologicalregeneration.Acquiring products
used in the diagnosis, monitoring and treatment of chronic diseases and acute injuries, and we are a leading provider of surgical instruments. Acquiring businessesthat fit existing sales channels orbuild outestablish new saleschannels.channels.We acquire new products and businesses to increase the efficiency and size of our sales force, stimulate the development of new products, and extend the commercial lives of existing products. We have completed 11 acquisitions since the beginning of 2004, have demonstrated that we can quickly and profitably integrateacquisitions into our existing distribution channelsnew products anddrive revenue growth. Since 1999, webusinesses, and havecompletedan active program to evaluate morethan 20 acquisitions focused primarily on our neurosurgical product lines, reconstructive surgery, surgical instrumentation and orthopedic surgery. We regularly evaluate potential acquisition candidates in these markets and in other specialty medical technology markets characterized by high margins, fragmented competition and focused target customers. We believe that executing the abovesuch opportunities.Our strategy
will enableallows us to expand our presence in hospitals and other health care facilities, to integrate acquired productsand businesses efficiently andeffectively, to createnewstrong sales platforms and to drivebothshort- and long-termand short-termrevenue and earnings growth.PRODUCTS GROUPS, MARKETING1
SALES AND
SALES We have four distribution channels that sell four groups of products.DISTRIBUTIONOur distribution channels include two direct sales organizations (Integra NeuroSciences and Integra
Reconstructive Surgery)Extremity Reconstruction), a network of dealers managed bya directour instrument salesorganization (JARIT(R) Surgical Instruments)organizations (Miltex and Jarit), and strategic alliances.Our product groups include Instruments, Implants, Monitoring Products, and Private Label Products. We sell the products in our four product groups through our various distribution channels, as follows: ---------------------------------------------------------------- DISTRIBUTION CHANNELS --------------------------------------------------------------- - --------------- ---------------- ---------------- ---------------- ------------- PRODUCT GROUPS Integra Integra JARIT Surgical Strategic NeuroSciences Reconstructive Instruments Alliances - --------------- ---------------- ---------------- ---------------- ------------- - --------------- ---------------- ---------------- ---------------- ------------- Instruments X X X - --------------- ---------------- ---------------- ---------------- ------------- - --------------- ---------------- ---------------- ---------------- ------------- Implants X X - --------------- ---------------- ---------------- ---------------- ------------- - --------------- ---------------- ---------------- ---------------- ------------- Monitoring X - --------------- ---------------- ---------------- ---------------- ------------- - --------------- ---------------- ---------------- ---------------- ------------- Private Label X - --------------- ---------------- ---------------- ---------------- ------------- Distribution Channels At the heart of our business strategy is creation of and investment in our distribution channels. Direct Sales Forces. Our direct sales forces include the following: o Integra NeuroSciences(R). Integra NeuroSciences'
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• PRODUCTS – OVERVIEW
Integra is a fully integrated medical device company with thousands of products for the medical specialties that we target. Our objective is to develop or otherwise provide any product that will improve our service to our customers. These products include both implants for neurosurgery, spinal surgery, and reconstructive surgery, and medical surgical equipment, which includes hand-held instruments, powered instruments, image-guided surgery systems, and monitors that measure brain parameters. We distinguish ourselves, however, by emphasizing the importance of the relatively new field of regenerative medicine.
In 2006, approximately 25% of our revenues came from surgical implants derived from our proprietary collagen matrix technology. While these products vary in composition and structure, they operate under similar principles. We build our matrix products from collagen, which is the basic structural protein that binds cells together in the body. Our matrices (whether for the dura mater, dermis, peripheral nerves, tendon or bone) provide a scaffold to support the infiltration of the patient’s own cells and the growth of blood vessels. Eventually, those infiltrating cells consume the collagen of the implanted matrix and lay down new native “extracellular matrix.” In their interaction with the patient’s body, our collagen matrices inhibit the formation of scar tissue, so in the end the implant disappears and healthy native tissue has taken its place. Because we can apply the basic technology to many different procedures, we sell regenerative medicine products through both our Integra NeuroSciences and Extremity Reconstruction organizations.
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NEUROSURGICAL PRODUCT PORTFOLIO
Implants For Neurosurgery And Spine
We offer a wide array of implants for neurosurgery and spine surgery, including a complete set of duraplasty products and biomaterials for spine surgery.
Duraplasty Products.In the United States,
and Europe currently involves more than 150 professionals, including direct sales representatives (called neurospecialists in the United States), sales management, marketing managers and clinical educators who educate and train both our salespeople and customers in the use of our products. Neurospecialists call primarily on neurosurgeons, intensivists, other physicians, nurses, hospitals and surgery centers. Our Integra NeuroSciences sales and marketing team effectively reaches its hospital customers in the United States and those portions of Europe where we sell directly to customers. In certain international markets, we sell through distributors. We plan to create a separate team of 20 intensive care unit specialists in 2006 to provide a greater focus on our neuro-monitoring products. 2o Reconstructive Surgery. Our reconstructive surgery sales and marketing organization in the United States and Europe consists of approximately 65 professionals, including direct salespeople, sales management, clinical educators and marketing managers. This sales and marketing organization sells medical devices to orthopedic surgeons, podiatric surgeons, trauma and reconstructive surgeons, burn surgeons, hospitals, surgery centers and other physicians. o JARIT Surgical Instruments. Our JARIT organization in the United States employs 25 professionals, including sales management, instrument specialists and marketing managers. These individuals work withover100 manufacturers' representatives. The JARIT organization sells the JARIT line of general and specialty instruments for open and endoscopic surgery and a line of specialty instruments for spinal surgery, neurosurgery and plastic surgery. Our JARIT organization sells its products to more than 6,000 hospitals and surgery centers worldwide. We have direct sales forces in France, Germany, the United Kingdom and the Benelux (Belgium, Netherlands, Luxembourg) region. Independent distributors market and sell our products in those countries where we do not have a direct sales force. These distributors225,000 craniotomy procedures aremanaged by our nine distributor sales managers. Strategic Alliances. We market our private label products through strategic partners or original equipment manufacturer customers. Our private label products address large, diverse markets, and we believe that we can develop and promote these products more cost-effectively through leveraging the product development and distribution systems of our strategic partners than through developing the products ourselves or selling them through our own direct sales infrastructure. We have partnered with market leaders, such as Johnson & Johnson, Medtronic Sofamor Danek, Inc., Wyeth BioPharma and Zimmer Holdings, Inc., for the development and marketing efforts related to manyperformed each year. Most of theseproducts. Integra NeuroSciences Product Portfolio Instruments Ultrasonic Surgery Systems for Tissue Ablation. More than 145,000 primary and metastatic brain tumors are diagnosed annuallysurgeries result inthe United States alone. Our ultrasonic surgery systems address surgeons' needs for the surgical fragmentation and removal of malignant and non-malignant tumors and other tissue. Our acquisitiona breach of theRadionics business has increased our product offerings in this area. We offer certaindura mater – the tough membrane that surrounds the brain and spinal chord -– which breach must be repaired by suturing or the application ofour ultrasonic surgery products only outsidea dural graft. Since theUnited States. Our ultrasonic surgery systems use very high frequency sound waves to ablate cancer tumors and allow the surgeon to remove the damaged tumor tissue by aspiration. Unlike other surgical techniques, ultrasonic surgery selectively dissects and fragments soft tissue leaving fibrous tissues, such as nerves and blood vessels, intact. Ultrasonic aspiration facilitates the removal of unwanted tissue adjacent or attached to vital structures. Integra Radionics. The Integra Radionics business, which we acquired in March 2006, is a leader in the design, manufacture and sale of advanced minimally-invasive medical instruments in the fields of neurosurgery and radiation therapy. Radionics' products include the CRW(R) stereotactic system, the XKnife(TM) stereotactic radiosurgery system and the OmniSight(R) EXcel image guided surgery system. The Radionics products are primarily utilized by neurosurgeons in the diagnosis and treatment of cancer and in the treatment of movement disorders. These products are sold in over 75 countries, with approximately 50 percent of sales occurring outsideintroduction of theUnited States. The Radionics business includes the CUSA EXcel(TM) ultrasonic surgical aspirator, whichDuraGen® Dural Graft Matrix in 1999, wewill continue to sell along with our existing ultrasonic aspirator systems. Among other benefits, the acquisition of Radionics increases our global neurosurgery product offerings, positions us to offer new stereotactic surgery products, secures entry into new business, adds to our manufacturing and research and development expertise and enhances the efficiency of our global infrastructure and distribution network. 3Cranial Stabilization and Brain Retraction Systems. The MAYFIELD(R) Headrest System ishave become the market leader incranial stabilization equipment. We work closely with surgeons and other health care providers throughout the world to develop unique cranial stabilization products. Neurosurgical and Spinal Instrumentation. We provide neurosurgeons and spine surgeons with a full line of specialty hand-held spinal and neurosurgical instruments. We sell instruments under the R&B Redmond(TM) name primarily for spinal procedures (including neuro-spine) and under the Ruggles(TM) brand name primarily for cranial surgery. Implants Duraplasty Solutions. We provideduralgrafts that are indicated for the repair of the dura mater surrounding the brain and spine, which is often penetrated during brain surgery and often damaged during spine surgery.grafts. These productsserve as an alternativeare alternatives tousing a graft ofautologous tissue grafts taken from elsewhere in thepatient'spatient’s body.WeBiomaterials for Spine.Over 300,000 patients undergo lumbar surgery in the United States each year, and adhesions – a painful condition that occurs when internal scar tissue causes nerves, organs and other structures to adhere to each other – are
committeda frequent complication of the procedure. Our collagen matrix technology inhibits the formation of scar tissue, so we believe it is well-suited toproviding surgeons with a full compliment of products that provide solutions for a wide variety of possible procedures. We estimateaddress this problem. Outside theworldwide market for dural repair, including cranial and spinal applications, to be $120 million. Our line of duraplasty products includes the DuraGen(R) Dural Graft Matrix,United States, we sell the DuraGenPlus(R) Dural Regeneration Matrix and the Suturable DuraGen(TM) Dural Regeneration Matrix. Clinical trials have shown our duraplasty products to be an effective means for closing the dura mater without the need for suturing. This allows the neurosurgeon to conclude the operation more efficiently. In addition, because the human body ultimately absorbs our duraplasty products and replaces them with new natural tissues, the patient avoids some of the risks associated with a permanent implant inside the cranium or spinal cavity. Our Suturable DuraGenTM Dural Regeneration Matrix grafts have the added benefit of being able to anchor to the patient's dura with sutures. To complement these resorbable products, we also provide the Endura(TM) No-React(R) Dural Substitute, a permanent suture-only graft, which is optimal for more challenging procedures that require a stronger and more permanent graft.Plus® Adhesion Barrierfor the Spine. The DuraGen Plus(TM) Adhesion BarrierMatrixis an absorbable collagen product, which is CE marked in the European Unionas a barrier against the formation of adhesions following spine surgery and for the repair and restoration of the dura mater following spinal and cranial surgery. In the fourth quarter of 2006, the U.S. Food and Drug Administration (FDA) approved our Investigational Device Exemption (IDE) application to conduct a pivotal multi-center clinical trial designed to evaluate the safety and effectiveness of DuraGen Plus® Adhesion Barrier Matrix for use in spinal surgery in the United States as a barrier against the formation of adhesions following such surgery. We enrolled the first patient in the trial in November 2006. If the trial is completed on schedule and achieves results acceptable to the FDA (of which there can be no assurance), we expect to launch the DuraGen Plus® Adhesion Barrier Matrix in the United States in 2010.If the FDA approves the DuraGen Plus® matrix as an adhesion barrier, the commercial success of the product will hinge upon our ability to sell the product to orthopedic spine surgeons and neurosurgeons who perform spine procedures. To
obtain approval to market this productprepare for the launch of the adhesion barrier matrix in the United States, we areinitiatingdeveloping other regenerative medicine products for the spine and recruiting apivotal randomized prospective clinical trial undersales organization that will specialize in selling them. The first of our new products is the Integra Mozaik™ Osteoconductive Scaffold, which we launched in February 2007. The Integra Mozaik™ scaffold is composed of highly purified type-I collagen and high purity tri-calcium phosphate. Together, these components, when mixed with bone marrow aspirate, form anInvestigational Device Exemption fromenvironment conducive to theFoodformation of bone. The Integra Mozaik™ scaffold will be available as a compression resistant strip andDrug Administration (FDA). The trial is anticipated to begin during the third quarteras putty, making it useful in a variety of2006, with the first patient expected to be enrolled by the fourth quarter of 2006.spinal fusion procedures. We estimate that theworldwideglobal market fortreatmentbone graft substitutes, excluding bone morphogenetic proteins, exceeds $350 million.Medical Surgical Equipment For Neurosurgery
Integra NeuroSciences sells a full line of
spinal adhesions exceeds $300 million. Hydrocephalus Management.instruments and other equipment for neurosurgery. Wesell a wide varietyhave products for each step ofdevices, known as shunts,cranial procedure and in the care of the patient after the operation. Integra’s Medical Surgical Equipment includes equipment used in thetreatmentneurosurgery operating room (OR) and neurosurgery intensive care unit (ICU).At the beginning of
hydrocephalus. Hydrocephalusa craniotomy procedure, neurosurgeons deploy the market-leading MAYFIELD® line of cranial stabilization equipment to position and secure the patient’s head, an essential precondition to any cranial surgery. Once a patient isan incurable condition resulting from an imbalance betweenpositioned properly, theamount of cerebrospinal fluid producedsurgeon then opens the skull, perhaps assisted bythe brain and the rate at which the body absorbs cerebrospinal fluid. Hydrocephalus is most commonly treated by inserting a shunt into the ventricular system of the brain to divert the flow of cerebrospinal fluid out of the brain and using a pressure valve to maintain a normal level of cerebrospinal fluid within the ventricles. We estimate the total United States market for shunts used in hydrocephalus management to be $200 million. In 2004, we introduced the NPH(TM) Low Flow Hydrocephalus Valve that regulates the flow of cerebrospinal fluid out of the brain. Designed specifically to meet the needs of patients with normal pressure hydrocephalus (NPH), the NPH(TM) Low Flow Hydrocephalus Valve controls cerebrospinal fluid flow at a lower rate than our other flow-control valves. While many surgeons view shunting as the preferred treatment method for patients diagnosed with NPH, only approximately 5% of those with NPH are currently treated with a surgically implanted shunt. Based on these current treatment statistics, we estimate the current market for shunt systems designed to treat NPH to be approximately $35 million. Certain reports estimate that approximately 20% of total cerebrospinal fluid shunt sales address normal pressure hydrocephalus. Based on the NPH population as a whole, we estimate that the potential market opportunity exceeds $500 million. In 2005, we acquired the intellectual property estate of Eunoe, Inc., including the innovative COGNIShunt(R) system, which was being evaluated under an Investigational Device Exemption for the treatment of Alzheimer's disease 4patients. The COGNIShunt(R) system is designed to increase the flow of cerebral spinal fluid (CSF) and improve clearance of potential neurotoxins, which are believed to contribute to the progression of Alzheimer's disease. The COGNIShunt(R) system has not received FDA clearance or approval for sale. Monitoring Products Monitoring Of Brain Parameters. Neurosurgeons use intracranial monitors to diagnose and treat cases of severe head trauma and other diseases. There are approximately 500,000 cases of head trauma each year in the United States. We estimate the market for monitoring and intervention to be $110 million. We sell intracranial monitoring systems under the Camino(R), Ventrix(R) and LICOX(R) names. Currently more than 3,000one of ourintracranial monitors are installed and in use worldwide Cranial Access And External Ventricular Drainage. Neurosurgeons usedisposable cranial access kits, andexternal drainage systemscuts through the dura mater. The surgeon might then use our specialty neurosurgery instruments togain accessexpose the tumor, perhaps guided to the precise location by a Radionics OmniSight® EXcel image-guided surgery system.3
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Having located the tumor, the surgeon might then remove it with a CUSA Excel™ ultrasonic surgical aspirator, a powered instrument that selectively dissects tissue according to its density. The surgeon might reduce the bleeding at the point of removal with one of our collagen hemostatic agents. After removing the tumor, the surgeon can repair the dura mater with one of our duraplasty products and can fix the skull flap with our line of cranial
cavityplates andto drainscrews.Following a craniotomy, the neurosurgery ICU monitors a patient’s post-operative condition. We offer the leading products for the monitoring of intracranial pressure (the Camino® ICP monitor) and metabolic activity (LICOX® metabolic monitoring system) and equipment for the drainage of excess cerebrospinal fluid
from(CSF) (the AccuDrain™ and Hermetic™ External Ventricular Drainage Systems). Our Mobius™ Multi Modality Monitoring System serves as an integrated hub for existing Integra monitoring systems such as theventricles of the brain into an external container. We manufactureCamino® andmarketLICOX® systems.EXTREMITY RECONSTRUCTION PRODUCT PORTFOLIO
Extremity reconstruction is a
broad line of cranial access kits and ventricular and lumbar external drainage systems. Epilepsy Electrodes. We sell epilepsy electrodes that neurosurgeons use for the intra-operative monitoring of seizures to determine if surgical options can be used in the treatment of epilepsy. We estimate the worldwide market for intra-operative epilepsy electrodes to be $10 million. Reconstructive Product Portfolio Implants Small Bone And Joint Fixation Devices and Instruments. The Newdeal foot and ankle surgery devices address the reconstructive and fracture repair portiongrowing segment of the orthopedic market.The Newdeal lineTraditionally, larger orthopedic medical device companies have not focused primarily on this niche market, thus making it attractive to us. We define extremity reconstruction to mean the repair ofimplants include a wide range of products for the forefoot, the mid-footsoft tissue and thehindorthopedic reconstruction of bone in the foot,includingankle and leg below theBold(R) Screw, the Uniclip(R) Compression Staple, the Hallu-Fix(R) plate systemknee and theHINTEGRA(R) total ankle prosthesis. These implantshand, wrist, arm andthe instruments used to implant them are specifically designed for foot and ankle surgery. We estimate that the current Newdeal products address an approximately $500 million worldwide market. The HINTEGRA(R) total ankle prosthesis has been approved for sale only outside the United States.shoulder.Dermal Regeneration and Engineered Wound
Dressings.Dressings.Ourskin replacementdermal repair and regeneration productsaddress the market need created by severe burns, reconstructive surgery, trauma and chronic wounds. We estimate that the worldwide market now addressable by our skin replacement products exceeds $1.0 billion. The INTEGRA(R) Dermal Regeneration Template is designed to enable the human body to regenerate functional dermal tissue. We sell this product under a Premarket Approval (PMA) issued by the Food and Drug Administration for the post-excisional treatment of life-threatening deep or full-thickness dermal injury where sufficient autograft is not available at the time of excision or is not desirable due to the physiological condition of the patient and for the repair of scar contractures in patients who have already recovered from their initial wound. The INTEGRA(R)(Integra™ Bilayer Matrix Wound Dressing,and INTEGRA(TM)Integra™ Matrix Wound Dressing, and Integra® Dermal Regeneration Template) areadvancedused to treat the chronic wounds that can form on the foot, ankle and lower leg, severe burns and scar contractures.Integra’s matrix wound
care devicesdressings are indicated for the management ofsoft tissuewoundsincluding:including partial and full-thickness wounds, pressure ulcers, venous ulcers, diabetic ulcers, chronic vascular ulcers, tunneled/undermined wounds, surgical wounds (donor sites/grafts,post-Moh'sPost-Moh’s surgery, post-laser surgery, podiatric,andwound dehiscence), trauma wounds (abrasions, lacerations, second-degree burns, and skin tears) and draining wounds. Weexpectestimate that therapid growthmarket opportunity for products used to treat trauma and chronic wounds is approximately $400 million.Nerve and Tendon.Surgeons who specialize in foot or hand orthopedic surgery often have to repair nerves and tendon. We therefore offer the NeuraGen® Nerve Guide and the NeuraWrap™ Nerve Protector for peripheral nerve repair and protection and the TenoGlide™ Tendon Protector Sheet, all of which are based on our
reconstructive surgery sales forceregenerative medicine technology platform.The NeuraGen® Nerve Guide has been used in many procedures, including procedures to
drive sales growth of this important product line. Repair and Protection of Peripheral Nerves. Peripheralrepair peripheral nervesmay become severed or damaged through traumatic accidents or surgical injuries, often resultingin thepermanent loss of motorupper andsensory function. Although severed peripherallower extremities and cranial and facial nerves,regenerate spontaneously, they do not establish functional connections unless the nerve stumps are surgically reconnected.as well as procedures for brachial plexus reconstruction. We estimate that the worldwide market for the repair of severedand damagedperipheral nervesto be $110is approximately $40 million.5OurThe NeuraWrap™ Nerve Protector, a collagen nerve repair
products are absorbable collagen implantsconduit designed for therepair and protectiontreatment ofsevered andinjured,peripheral nerves. The NeuraGen(R) Nerve Guide is a collagen conduit designed to provide an environment for the repair and regeneration of severed nerves. The NeuraWrap(TM) Nerve Protectorcompressed or scarred nerves, provides a protective environment for nerve healing, serving as an interface between damaged nerves and surrounding tissue. We estimate that thehealingworldwide market for the repair of injured, compressedorand scarrednerves. Bothperipheral nerves is approximately $70 million.The TenoGlide™ Tendon Protector Sheet is used to protect the repair of a tendon. Pre-clinical studies suggest that it may reduce the formation of scar tissue between the tendon and surrounding tissue and may preserve the gliding plane of the tendon. The TenoGlide™ Tendon Protector Sheet can be used in numerous procedures, such as the repair of the flexor and extensor tendons of the hand and the repair of the peronus brevis tendon of the foot.
Bone and Joint Fixation Devices and Instruments.We offer the extremity reconstruction surgeon with a complete set of bone and joint fixation devices for upper and lower extremity reconstruction.
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Through our
Integra NeuroSciencesNewdeal line, we have become a leading developer andIntegra Reconstructive sales forces sell thesemanufacturer of specialty implants and instruments specifically designed for foot and ankle surgery. Newdeal productsto our hospital-based customers. Instruments Dermatomes and Meshers. We sellinclude a wide range ofmanualproducts for the forefoot, the midfoot andpowered dermatomesthe hindfoot, including the Bold® Screw, Hallu®-Fix plate system andrelated disposablesthe HINTEGRA™ total ankle prosthesis. Customers forharvesting skin grafts underNewdeal products include orthopedic surgeons specializing in injuries of thePadgett Instruments(TM) name.foot, ankle and extremities, as well as podiatric surgeons, of which there are 3,200 and 2,400, respectively, in the United States. The current products address an approximately $500 million worldwide market.In
2003,2006, welaunchedacquired Kinetikos Medical, Inc. (KMI), a developer of specialty implants primarily for the hand and wrist. The acquisition made it much more efficient for ournew Padgett Dermatome-S,sales representatives to call on hand surgeons, who we expect will be a large market for our NeuraGen® and NeuraWrap™ products, and it strengthened our position as a developer and manufacturer of orthopedic implants and surgical devices for small bone and joint procedures involving the foot, ankle, hand, wrist and elbow. We now have products that address both the trauma and reconstructive segments of the extremities market.These products include the Universal 2™ Total Wrist System, which is
lighter, more ergonomicrecognized as the premier implant for wrist replacement, a procedure that restores the function of the arthritic wrist. The Subtarlar MBA® Implant System (Maxwell-Brancheau Arthroereisis System) is the market leading product that provides a simple andmore powerful thaneffective means of correcting debilitating flatfoot for both pediatric and adult patients.In the
other dermatomes inreconstruction of lower extremities, ourline. Our variable skin mesher is designed to expand skin grafts prior to implantation to provide for greater coverage. JARIT(R) Surgical Instruments For more than 30 years, JARIT has marketed a wide variety of high quality, reusable surgical instruments to virtually all surgical disciplines. With more than 5,000 instrument patterns,leading brands include Newdeal®, ICOS™, theJARIT brand has a strong reputation for high-quality surgical instruments and customer service. Our Jarit Surgical Instrument channel sells directly to central supply and purchasing at hospitals. This channel has expanded beyondBold® Cannulated Compression Screw, theJARIT(R) product line to sell products under the Padgett Instruments(TM) and R&B Redmond(TM) product lines. More than 25 sales and marketing professionals supervise a group of over 100 manufacturers' representatives. Strategic Alliances Orthopedic Biomaterials. Since 1994, we have supplied Wyeth BioPharma with Absorbable Collagen Sponges for use in developing bone regeneration implants, including use with Wyeth BioPharma's recombinant human bone morphogenetic protein-2 (rhBMP-2). Wyeth BioPharma sells Absorbable Collagen Sponges to Medtronic Sofamor Danek. The FDA has approved Medtronic Sofamor Danek's InFUSE(TM) Bone Graft used with the LT-CAGE(TM) Lumbar Tapered Fusion Device for use in spinal fusion proceduresUni-Clip®, Hallu®-Fix System and theInFUSE(TM) Bone Graft forPANTA® Nail. For upper extremity reconstruction, we offer thetreatment of open, acute tibial shaft fractures. The InFUSE(TM) Bone Graft eliminates the need for a secondary, painful procedure to harvest pieces of bone from the patient's own hip (known as an autograft). More recently, we developed a compression resistant collagen ceramic matrix for Medtronic Sofamor Danek. The device, the MasterGraftTM Matrix, is a 3-dimensional, osteoconductive, porousUniversal 2™, Katalyst, Spider, Safeguard and Kompressor implantthat allows for bony ingrowth across the graft site while resorbing at a rate consistent with bone healing. Guided Tissue Regeneration In Periodontal Surgery. Our BioMend(R) Absorbable Collagen Membrane and BioMend(R) Extend Absorbable Collagen Membrane are sold through Zimmer Holdings, Inc. They are used for guided tissue regeneration in periodontal surgery. The body absorbs the BioMend(R) products, avoiding the requirement for additional surgical procedures to remove a non-absorbable membrane. Other Private Label Products. Our current private label products also include the VitaCuff(R) catheter access infection control device and the BioPatch(R) anti-microbial wound dressing.products.RESEARCH AND DEVELOPMENT STRATEGY
Integra'sOur research and development activities focus on identifying and evaluating unmet surgical needs and product improvement opportunities to drive the development of innovative solutions and products. We apply our technological and developmental core competencies to develop regenerative products for neurosurgical and reconstructive applications, neuro-monitoring and CSF management, cranial stabilization and closure, tissue ablation, surgical instruments and extremity small bone and joint fixation. Our activities include both internal product development initiatives and the acquisition of proprietary rights to strategic technological platforms.
6Because implants represent a fast-growing, high-margin segment for us, a large portion of our research and development expenditure is allocated to the development of these products. Our regenerative product development portfolio
is focusedfocuses on applying our expertise in biomaterials and collagen matrices to support the development of innovative products targeted at neurosurgical, orthopedic and spinal surgery applications, as well as dermal regeneration, nerve repair, and wound dressing applications. Our focus on technological advancement, product segmentation and differentiation activities will continue to drive our activities in each of these areas.ResearchWe are committed to investing in, and proving the safety and efficacy of, our regenerative products. Our initiation of the DuraGen Plus® Adhesion Barrier Matrix pivotal multi-center clinical trial in the United States reflects this commitment.With the acquisition of Newdeal and KMI, we have quickly built a product development team focused on the development of fixation devices for extremity reconstruction. We have structured a robust new product development program that will advance our product offerings to both United States and European markets. This program includes the development of devices for both the upper and lower extremities.
Our research and development efforts in the medical surgical equipment arena primarily focus on neuro-monitoring applications and surgical systems. Our efforts in neuro-monitoring
applications remains focusedremain concentrated on the improvement of our existing advanced neuromonitors and the evaluation of new and innovative technologies thataffordoffer significant advancements in monitoring ability. The development of multimodality monitoring systems, such as the Mobius™ Multi Modality Monitoring System, facilitates the use of neuro-monitoring data and helps to drive utilization of our products in our neuron-monitoring product line. For CSF management, we are exploring opportunities for the improvement of long-standing product applications, and we arebeing explored andupdating existing productsare being updatedto meet evolving needs. Ourindustry leadingindustry-leading cranial stabilization product expertiseis focusedfocuses on the advancement of mechanical stabilization techniques and the application of new materials to further the state-of-the-art of cranial stabilization. For tissue ablation, we will couple our existing development resourceswill be coupledwith those gained through the acquisition of Radionics to drive multi-technology based tissue ablation modalities to offer a broad array of products. Finally, we have anon-goingongoing program of identifying, developing and commercializing powered and hand-held surgical instruments.As our expansion into the orthopedic reconstructive market continues, ourDevelopment of new hand-held instruments, however, does not result in significant research and developmentactivities have targeted extremity small bone and joint fixation. Leveraging the development expertise from our acquisition of Newdeal Technologies, we are developing a robust new product development program that will advance our product offering to both United States and European markets.expenditures.5
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We spent
$12.8 million,$14.1 million,and$12.0 million and $26.0 million in2003,2004, 2005 and2005,2006, respectively, on research and development activities.The 2003 amount includes $400,000 of acquired in-process research and development charge recorded in connection with acquisitions.The 2004 amount includes a $1.4 million milestone payment relating to the completion of certain development activities for an advanced neuro-monitoring system and a $0.5 million licensing fee paid for the development of a data acquisition system to support the integration of our advanced monitoring products. The 2005 amount includes a $0.5 million in-process research and developmentchargescharge recorded in connection with an acquisition. The 2006 amount includes a $5.9 million in-process research and development charge recorded in connection with the KMI acquisition. Increases in research and development expenditures will accelerate the development of new devices for neurosurgery and extremity reconstruction. In addition to internal research and development activities, we may continue to acquire businesses that include research and development programs, which could result in additional in-process research and development charges in the future.COMPETITION
Our largest competitors in the neurosurgery markets are the Medtronic Neurosurgery division of Medtronic, Inc., the Codman division of Johnson & Johnson, the Stryker Craniomaxillofacial division of Stryker Corporation and the Aesculap division of B. Braun. In addition, many of our neurosurgery product lines compete with smaller specialized companies or larger companies that do not otherwise focus on neurosurgery.
Our competition in
reconstructive surgery can be divided into two areas that correspond to our main reconstructive product categories. Our skin and advanced wound healing products compete with those of LifeCell Corporation, Organogenesis Inc. and Wright Medical Group, Inc. Our orthopedic products compete with those ofextremity reconstruction includes the DePuy division of Johnson & Johnson, Synthes, Inc. and Stryker Corporation, as well as other major orthopedic companies that carry a full line of reconstructive surgery products. We also compete with Wright Medical Group in the orthopedic category.We believe that we are the second largest
re-usablereusable surgical instrument company in the United States. We compete with the largestre-usablereusable instrument company, V. Mueller, a division of Cardinal Healthcare, as well as the Aesculap division of B. Braun. In addition, we compete with the Codman division of Johnson & Johnson and many smaller instrument companiescompete with both re-usablein the reusable and disposable specialtyinstruments.instruments markets. We rely on the depth and breadth of our sales and marketing organization and our procurement operation to maintain our competitive position in surgical instruments.Our
private labelprivate-label products face diverse and broad competition, depending on the market addressed by the product.Finally, in certain cases our products compete primarily against medical practices that treat a condition without using a medical device
rather thanor any particularproduct.product, such as medical practices that use autograft tissue instead of our dermal regeneration products, duraplasty products and nerve repair products. Depending on the product line, we compete on the basis of7our products'products’ features, strength of our sales force or marketing partner, sophistication of our technology and cost effectiveness of our solution to thecustomer'scustomer’s medical requirements.GOVERNMENT REGULATION
As a manufacturer and marketer of medical devices, we are subject to extensive regulation by the FDA and other federal governmental agencies and, in some jurisdictions, by state and foreign governmental authorities. These regulations govern the introduction of new medical devices, the observance of certain standards with respect to the design, manufacture, testing, labeling, promotion and
promotionsales of the devices, the maintenance of certain records, the ability to track devices, the reporting of potential product defects, the import and export of devices and other matters. We believe that we are in substantial compliance with these governmental regulations.The regulatory process of obtaining product approvals and clearances can be onerous and costly. The
Food and Drug AdministrationFDA requires, as a conditionofto marketing a medical device in the United States, that we secure a Premarket Notification clearance pursuant to Section 510(k) of the Federal Food, Drug and Cosmetic Act, an approved Premarket Approval (PMA) application (or supplemental PMA application) or an approved Product Development Protocol. Obtaining these approvals and clearances can take up to several years and involve preclinical studies and clinical testing. To perform clinical testing in the United States on an unapproved product, we are required to obtain an Investigational Device Exemption from the FDA. FDA rules may also require a filingandfor FDA approval prior to marketing products that are modifications of existing products or new indications for existing products. Moreover, after clearance is given, if the product is shown to be hazardous or defective, the FDA and foreign regulatory agencies have the power to withdraw the clearance or require us to change the device, its manufacturing process or its labeling, to supply additional proof of its safety and effectiveness or to recall, repair, replace or refund the cost of the medical device. Because we currently export medical devices manufactured in the United States that have not been approved by the FDA for distribution in the United States, we are required to provide notices to the FDA,tomaintain certain records relating to exports and make these records available to the FDA for inspection, if required.6
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We are also required to register with the FDA as a device manufacturer. As such, we are subject to periodic inspection by the FDA for compliance with the
FDA'sFDA’s Quality System Regulations. These regulations require that we manufacture our products and maintain our documents in a prescribed manner with respect to design, manufacturing, testing and control activities. Further, we are required to comply with various FDA requirements and other legal requirements for labeling and promotion. The Medical Device Reporting regulations require that we provide information to the FDA whenever there is evidence to reasonably suggest that one of our devicesmaycould have caused or contributed to a death or serious injury or, if a malfunction were to recur, could cause or contribute to a death or serious injury. Under FDA regulations, we are required to submit reports of certain voluntary recalls and corrections to the FDA. If the FDA believes that a company is not in compliance with applicable regulations, itcanmay institute proceedings to detain or seize products, issue a warning letter, issue a recall order, impose operating restrictions, enjoin future violations and assess civil penalties against that company, its officers or its employees andcanmay recommend criminal prosecution to the Department of Justice.Medical device regulations also are in effect in many of the countries outside the United States in which we do business. These laws range from comprehensive device approval and quality system requirements for some or all of our medical device products to simpler requests for product data or certifications. The number and scope of these requirements are increasing. Under the European Union Medical Device Directive, all medical devices must meet the Medical Device Directive standards and receive CE Mark
certification.Certification. CE MarkcertificationCertification requires a comprehensive Quality System program,and submission ofcomprehensive technical documentation, data on the product, which aproduct to a "Notified Body"“Notified Body” inEurope.Europe reviews. The Medical Device Directive, ISO 9000 series and ISO 13485 are recognized international quality standards that are designed to ensure that we develop and manufacture quality medical devices. A recognized Notified Body (an organization designated by the national governments of the European Union member states to make independent judgments about whether or not a product complies with the protection requirements established by each CE marking directive) audits our facilities annually to verify our compliance with these standards. As a result of an amendment to Japan’s Pharmaceutical Affairs Law that went into effect on April 1, 2005, new regulations and requirements exist for obtaining approval of medical devices, including new requirements governing the conduct of clinical trials, the manufacturing of products and the distribution of products in Japan.Certain countries, as well as the European Union, have issued regulations that govern products that contain materials derived from animal sources. Regulatory authorities are particularly concerned with materials infected with the agent that causes bovine spongiform encephalopathy, otherwise known as BSE or mad cow disease. These regulations affect our dermal regeneration products, duraplasty products, biomaterial products for the spine, nerve and tendon repair products and certain other products, all of which contain material derived from bovine tissue. Although we take great care to provide that our products are safe and free of agents that can cause disease, products that contain materials derived from animals, including our products, may become subject to additional regulation, or even be banned in certain countries, because of concern over the potential for prion transmission. Significant new regulation, or a ban of our products, could have a material adverse effect on our current business or our ability to expand our business. See “Item 1A. Risk Factors – Certain Of Our Products Contain Materials Derived From Animal Sources And May Become Subject To Additional Regulation.”
We are subject to laws and regulations pertaining to healthcare fraud and abuse, including anti-kickback laws and physician self-referral laws, that regulate the means by which companies in the health care industry may market their products to hospitals and health care professionals and may compete by discounting the prices of their
8products. This requiresThe delivery of our products is subject to regulation regarding reimbursement, and federal healthcare laws apply when a customer submits a claim for a product that is reimbursed under a federally-funded healthcare program. These rules require that we exercise care in structuring our sales and marketing practices and customer discount arrangements.Our international operations subject us to laws regarding sanctioned countries, entities and persons, customs, import-export and other laws regarding transactions in foreign countries. Among other things, these laws restrict, and in some cases prohibit, United States companies from directly or indirectly selling goods, technology or services to people or entities in certain countries. In addition, these laws require that we exercise care in structuring our sales and marketing practices in foreign
counties.countries.7
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Our research, development and manufacturing processes involve the controlled use of certain hazardous materials. We are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of these materials and certain waste products. Although we believe that our safety procedures for handling and disposing of these materials comply with the standards prescribed by the controlling laws and regulations, the risk of accidental contamination or injury from these materials cannot be eliminated. In the event of this type of
anaccident, we could be held liable for any damages that may result and any liability could exceed our resources. Although we believe that we are in compliance in all material respects with applicable environmental laws and regulations, we could incur significant costs to comply with environmental laws and regulations in the future, and our operations, business or assets could be materially adversely affected by current or future environmental laws or regulations.In addition to the above regulations, we are and may be subject to regulation under federal and state laws, including, but not limited to, requirements regarding occupational health and safety, laboratory practices and the maintenance of personal health information. As a public company, we are subject to the securities laws and regulations, including the Sarbanes-Oxley Act of 2002. We
mayalsobeare subject to other present, and could be subject to possible future, local, state, federal and foreign regulations.PATENTS AND INTELLECTUAL PROPERTY
We seek patent protection of our key technology, products and product improvements, both in the United States and in selected foreign countries. When determined appropriate, we have enforced and plan to continue to enforce and defend our patent rights. In general, however, we do not rely on our patent estate to provide us with any significant competitive advantages as it relates to our existing product lines. We rely upon trade secrets and continuing technological innovations to develop and maintain our competitive position. In an effort to protect our trade secrets, we have a policy of requiring our employees, consultants and advisors to execute proprietary information and invention assignment agreements upon commencement of employment or consulting relationships with us. These agreements provide that all confidential information developed or made known to the individual during the course of their relationship with us must be kept confidential, except in specified circumstances.
ACCU-DISC(TM)AccuDrain™,
BioMend(R)Bold®,Bold(R)Camino®,BUDDE(R)CRW®,CALCANEA(R), Camino(R), COGNIShunt(R), CollaPlug(R), CollaStat(TM), CollaTape(R), CRW(R), CUSA(R)CUSA®, CUSAEXcel(TM)Excel™,Dissectron(R)Dissectron®,DuraGen(R)DuraGen®, DuraGenPlus(R)Plus®,Elektrotom(R)Hallu®-Fix, HINTEGRA™,EquiFlow(R)ICOS™,Eunoe, Inc.(R)Integra®,Hallu-Fix(R), Helistat(R), Helitene(R), Heyer-Schulte(R), HINTEGRA(R), INTEGRA(R), INTEGRA(TM) Bilayer Matrix Wound Dressing(R), INTEGRA(R)Integra Dermal RegenerationTemplate,Template®, Integra LifeSciencesCorporation(R)Corporation®, IntegraNeuroSciences(R)Mozaik™, IntegraNeuroSupplies(TM)NeuroSciences®,Integra Supplies(TM)Jarit®,JARIT(R)LICOX®,LICOX(R)Miltex®,LPV(R)Mobius™,Moni-Torr(TM)NeuraGen®,NeuraGen(R)NeuraWrap™,NeuraWrap(TM)NewDeal®,Neurosensor(R)OmniSight®,OmniSight(R)Radionics®,Orbis-Sigma(R)Selector®,Osteoject(R)Sublartar MBA®,Padgett Instruments, Inc(R)TenoGlide™,Pudenz(TM), Radionics(R), Redmond(TM), Ruggles(TM), Selector(R), Sonotom(R), Spetzler(R), Spin(R), Spinal Specialties(TM), Sundt(TM), Suturable DuraGenTM, Ultra Pure Collagen(TM), Uniclip(R), Ventrix(R), VitaCuff(R)Uniclip® andXKnife(TM)XKnife™ are some of the material trademarks of Integra LifeSciences Corporation and its subsidiaries.All other brand names, trademarks and service marks appearing in this report are the property of their respective holders, including MAYFIELD(R), whichMAYFIELD® is a registered trademark of SM USA, Inc., a wholly owned subsidiary of Schaerer Mayfield USA, Inc., and is used by Integra under a license.EMPLOYEES
At December 31,
2005,2006, we had approximately1,000 full-time employees and 180 temporary1,750 employees engaged in production and production support (including warehouse, engineering and facilities personnel), quality assurance/quality9control, research and development, regulatory and clinical affairs, sales, marketing, administration and finance. Except for certain employees at our facilities in France, none of our employees areis subject to a collective bargaining agreement.ManyFINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS
Financial information about our geographical areas is set forth in our financial statements under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – International Revenues and Operations” and Note 15 “Segment and Geographic Information” to our Consolidated Financial Statements.
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SOURCES OF RAW MATERIALS
In general, raw materials essential to our businesses are readily available from multiple sources. For reasons of quality assurance, sole source availability, or cost effectiveness, certain components and raw materials are available only from a sole supplier. Our policy is to maintain sufficient inventory of components so that our production will not be significantly disrupted even if a particular component or material is not available for a period of time.
Certain of our
employees,products, includingthose holding senior positions inourregulatory, operations, researchdermal regeneration products, duraplasty products, biomaterial products for the spine, nerve anddevelopment,tendon repair products andsales and marketing departments, have prior experience working for large pharmaceutical or medical technology companies. Our sales representatives and regional sales managers attend in-depth product training meetings throughout the year, and our clinical development team consists of medical professionals who specialize in specific therapeutic areascertain other products, contain material derived from bovine tissue. We take great care to provide that our productsserve.are safe and free of agents that can cause disease. In particular, the collagen used in the products that Integra manufactures is derived only from the deep flexor tendon of cattle less than 24 months old from New Zealand, a country that has never had a case of bovine spongiform encephalopathy, or from the United States. The collagen used in a product that we sell, but do not manufacture, is derived from bovine pericardium. Webelieveare also qualifying sources of collagen from other countries that are considered BSE-free. The World Health Organization classifies different types of cattle tissue for relative risk of BSE transmission. Deep flexor tendon and bovine pericardium are in the lowest-risk categories for BSE transmission (the same category as milk, for example), and are therefore considered to have a negligible risk of containing the agent that causes BSE.SEASONALITY
Revenues during our
clinical development team differentiates us fromsecond and fourth quarters tend to be stronger than the first and third quarters. This is because many hospitals increase their purchases of ourcompetition, asproducts during the second and fourth quarters, which coincides with the end of theirknowledge and experience as medical professionals allows them to more effectively educate and train both our sales force and the customers who use our products. This team is especially valuable in communicating the clinical benefits of new products.budget cycle.AVAILABLE INFORMATION
We are subject to the informational requirements of the Securities Exchange Act of 1934. In accordance with the Exchange Act, we file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission. You may view our financial information, including the information contained in this report, and other reports we file with the Securities and Exchange Commission, on the Internet, without charge as soon as reasonably practicable after we file them with the Securities and Exchange Commission, in the
"SEC Filings"“SEC Filings” page of the Investor Relations section of our website atwww.Integra-LS.com.www.Integra-LS.com. You may also obtain a copy of any of these reports, without charge, from our investor relations department, 311 Enterprise Drive, Plainsboro, NJ 08536. Alternatively, you may view or obtain reports filed with the Securities and Exchange Commission at the SEC Public Reference Room at 100 F Street, N.E. in Washington, D.C. 20549, or at theSEC'sSecurities and Exchange Commission’s Internet site atwww.sec.gov.www.sec.gov. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the operation of the public reference facilities.SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
We have made statements in this report, including statements under
"Management's“Business” and “Management’s Discussion and Analysis of Financial Condition and Results ofOperations" and "Business,"Operations” that constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of1934.1934, as amended. These forward-looking statements are subject to a number of risks, uncertainties and assumptions about us including, among other things:ogeneral economic and business conditions, both nationally and in our international markets;oour expectations and estimates concerning future financial performance, financing plans and the impact of competition;oanticipated trends in our business;oexisting and future regulations affecting our business;oour ability to obtain additional debt and equity financing to fund capital expenditures and working capital requirements and acquisitions;o physicians'9
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physicians’ willingness to adopt our recently launched and planned products, third-partypayors'payors’ willingness to provide reimbursement for these products and our ability to secure regulatory approval for products in development;oinitiatives launched by our competitors;our ability to protect our intellectual property, including trade secrets;oour ability to complete acquisitions, integrate operations post-acquisition and maintain relationships with customers of acquired entities;owork stoppages at our facilities; andoother risk factors described in the section entitled"Factors That May Affect Our Future Performance"“Risk Factors” in this report.You can identify these forward-looking statements by forward-looking words such as
believe, may, could, will, estimate, continue, anticipate, intend, seek, plan, expect, should, would“believe,” “may,” “could,” “might,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “seek,” “plan,” “expect,” “should,” “would” and similar expressions in this report.10We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks and uncertainties, the forward-looking events and circumstances discussed in this report may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements. ITEM 1A. RISK FACTORS
Our Operating Results May Fluctuate.
Our operating results, including components of operating results, such as gross margin
oncost 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:othe impact of acquisitions;othe impact of our restructuring activities;the timing of significant customer orders;omarket acceptance of our existing products, as well as products in development;othe timing of regulatory approvals;ochanges in theraterates of exchange between the U.S. dollar and other currencies of foreign countries in which we do business, such as the euro and the British pound;oexpenses incurred and business lost in connection with product field corrections or recalls;oincreases in the cost of raw materials, including energy and steel;oour ability to manufacture our products efficiently; andothe timing of our research and development expenditures.The Industry And Market Segments in Which We Operate Are Highly Competitive, And We May Be Unable To Compete Effectively With Other Companies.
In general, there is intense competition among medical device companies. We compete with established medical technology
and pharmaceuticalcompanies in many of our product areas. Competition also comes fromearly stageearly-stage companies that have alternative technological solutions for our primary clinical targets, as well as universities, research institutions and other non-profit entities. Many of our competitors have access to greater financial, technical, research and development, marketing, manufacturing, sales, distribution services and other resources than we do. Our competitors may be more effective at implementing their technologies to develop commercial products. Our competitors may be able to gain market share by offering lower-costproducts.products or by offering products that enjoy better reimbursement methodologies from third-party payors, such as Medicare.10
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Our competitive position will depend on our ability to achieve market acceptance for our products, develop new products, implement production and marketing plans, secure regulatory approval for products under development, obtain reimbursement under Medicare, Medicaid and private healthcare insurers and obtain patent protection. We may need to develop new applications for our products to remain competitive. Technological advances by one or more of our current or future competitors could render our present or future products obsolete or uneconomical. Our future success will depend upon our ability to compete effectively against current technology as well as to respond effectively to technological advances. Competitive pressures could adversely affect our profitability. For example, two of our largest competitors introduced an onlay dural graft matrix during 2004, another large company introduced a duraplasty product in 2006 and
other companies have introduced andothers may be preparing to introduce similar products. Competitors have also been developing products to compete with our extremity reconstruction implants. The introduction and market acceptance of such products could reduce the sales, growth in sales and profitability of our duraplasty products.Our largest competitors in the neurosurgery markets are the Medtronic Neurosurgery division of Medtronic, Inc., the Codman division of Johnson & Johnson, the Stryker Craniomaxillofacial division of Stryker Corporation and the Aesculap division of B. Braun Medical Inc.
and the Valleylab division of Tyco International Ltd.In addition, many of our neurosurgery product lines compete with smaller specialized companies or larger companies that do not otherwise focus on neurosurgery. Our competitors inreconstructive surgeryextremity reconstruction includeLifeCell Corporation, Organogenesis Inc., Wright Medical Group, Inc.,the DePuy division of Johnson & Johnson, Synthes, Inc. and StrykerCorporation. Some of these areCorporation, as well as other major orthopedic companies that carry a full line of reconstructive products. We also compete with Wright Medical Group, Inc. in the orthopedic category. In surgical instruments, we compete with V. Mueller, a division of Cardinal Healthcare, as well as the Aesculap division of B. Braun. In addition, we compete with the Codman division of Johnson & Johnson and many smaller instrument companies in the reusable and disposable specialty instruments markets. Ourprivate labelprivate-label products face diverse and broad competition, depending on the marketthat an individual product addresses. 11addressed by the product. Finally, in certain cases our products compete primarily against medical practices that treat a condition without using a device rather thanor any particular product, such as the medical practices that use autograft tissueas an alternative forinstead of our dermal regeneration products,ourduraplasty products andournerve repair products.Our Current Strategy Involves Growth Through Acquisitions, Which Requires Us To Incur Substantial Costs And Potential Liabilities For Which We May Never Realize The Anticipated Benefits.
In addition to internal growth, our current strategy involves growth through acquisitions. Since
1999,the beginning of 2004, we have acquired2211 businesses or product lines at a total cost of approximately$289$315 million.We may be unable to continue to implement our growth strategy, and our strategy ultimately may be unsuccessful. A significant portion of our growth in revenues has resulted from, and is expected to continue to result from, the acquisition of businesses complementary to our own. We engage in evaluations of potential acquisitions and are in various stages of discussion regarding possible acquisitions, certain of which, if consummated, could be significant to us. Any
potential acquisitions maynew acquisition can result in material transaction expenses, increased interest and amortization expense, increased depreciation expense and increased operating expense, any of which could have a material adverse effect on our operating results. Certain businesses that we acquire may not have adequate financial, regulatory or quality controls at the time we acquire them. As we grow byacquisitions,acquisition, we mustintegratemanage andmanageintegrate the new businesses to bring them into our systems for financial, regulatory and quality control, realize economies of scale, and control costs. In addition, acquisitions involve other risks, including diversion of management resources otherwise available for ongoing development of our business and risks associated with entering new marketswithin which our marketing and sales force has limited experience or where experienced distribution alliances are not available. Our future profitability will depend in part upon our ability to develop further our resources to adapt to these new products or business areas and to identify and enter into satisfactory distribution networks. We may not be able to identify suitable acquisition candidates in the future, obtain acceptable financing or consummate any future acquisitions. If we cannot integrate acquired operations, manage the cost of providing our products or price our products appropriately, our profitability could suffer. In addition, as a result of our acquisitions of other healthcare businesses, we may be subject to the risk of unanticipated business uncertainties, regulatory matters or legal liabilities relating to those acquired businesses for which the sellers of the acquired businesses may not indemnifyus.us or for which the indemnification may not be sufficient to cover the ultimate liabilities.11
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To Market Our Products Under Development We Will First Need To Obtain Regulatory Approval. Further, If We Fail To Comply With The Extensive Governmental Regulations That Affect Our Business, We Could Be Subject To Penalties And Could Be Precluded From Marketing Our Products.
Our researchAs a manufacturer and
development activities and the manufacturing, labeling, distribution and marketingmarketer ofour existing and future productsmedical devices, we are subject to extensive regulation bynumerousthe FDA and other federal governmental agenciesin the United Statesand, in some jurisdictions, by state and foreign governmental authorities. These regulations govern the introduction of new medical devices, the observance of certain standards with respect to the design, manufacture, testing, labeling, promotion and sales of the devices, the maintenance of certain records, the ability to track devices, the reporting of potential product defects, the import and export of devices and othercountries. The Food and Drug Administration (FDA) and comparable agencies in other countries impose mandatory procedures and standards for the conduct of clinical trials and the production and marketing of products for diagnostic and human therapeutic use.matters.Our products under development are subject to FDA approval or clearance prior to marketing for commercial use. The process of obtaining necessary FDA approvals or clearances can take years and is expensive and
full of uncertainties.uncertain. Our inability to obtain required regulatory approval on a timely or acceptable basis could harm our business. Further, approval or clearance may place substantial restrictions on the indications for which the product may be marketed or to whom it may be marketed,thewarnings that may be required to accompany the product or additional restrictions placed on the sale and/or use of the product. Further studies, including clinical trials and FDA approvals, may be required to gain approval for the use of a product for clinical indications other than those for which the product was initially approved or cleared or for significant changes to the product. These studies could take years to complete and could be expensive, and there is no guarantee that the results will convince the FDA to approve or clear the additional indication. In addition, for products with an approved Pre-Marketing Approval (PMA), the FDA requires annual reports and may require post-approval surveillance programs to monitor theproducts'products’ safety and effectiveness. Results of post-approval programs may limit or expand the further marketing of the product.Another risk of application to the FDA relates to the regulatory classification of new products or proposed new uses for existing products. In the filing of each application, we make a
legaljudgment about the appropriate form and content of the application. If the FDA disagrees with our judgment in any particular case and, for example, requires us to file a PMA application rather than allowing us to market for approved uses while we seek broader approvals or requires extensive additional clinical data, the time and expense required to obtain the required approval might be significantly increased or approval might not be granted.12Approved products are subject to continuing FDA requirements relating to quality control and quality assurance, maintenance of records, reporting of adverse events and product recalls, documentation, and labeling and promotion of medical devices.
The FDA and foreign regulatory authorities require that our products be manufactured according to rigorous standards. These regulatory requirements
maycould significantly increase our production or purchasing costs andmaycould even prevent us from making or obtaining our products in amounts sufficient to meet market demand. If we or a third-party manufacturer change our approved manufacturing process, the FDA may require a new approval before that process may be used. Failure to develop our manufacturing capabilitymaycould mean that even if we were to develop promising new products, wemaymight not be able to produce them profitably, as a result of delays and additional capital investment costs. Manufacturing facilities, both international and domestic, are also subject to inspections by or under the authority of the FDA. In addition, failure to comply with applicable regulatory requirements could subject us to enforcement action, including product seizures, recalls, withdrawal of clearances or approvals, restrictions on or injunctions against marketing our product or products based on our technology, cessation of operations and civil and criminal penalties.We are also subject to the regulatory requirements of countries outside
ofthe United States where we do business. For example,Japan isunder the European Union Medical Device Directive, all medical devices must meet the Medical Device Directive standards and receive CE Mark Certification. CE Mark Certification requires a comprehensive Quality System program, comprehensive technical documentation and data on the product, which a “Notified Body” inthe processEurope reviews. As a result ofreforming its medical device regulations. A recentan amendment toJapan'sJapan’s Pharmaceutical Affairs Law that went into effect on April 1,2005. New2005, new regulations and requirements exist for obtaining approval of medical devices, including new requirements governing the conduct of clinical trials, the manufacturing of products and the distribution of products in Japan. Significant resourcesalsomay be needed to comply with the extensive auditing of and requests for documentation relating to all manufacturing facilities of our company and our vendors by the Pharmaceutical Medical Device Agency and the Ministry of Health, Labor and Welfare in Japan to comply with the amendment to the Pharmaceutical Affairs Law. These new regulations may affect our ability to obtain approvals of new products for sale in Japan.12
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Certain Of Our Products Contain Materials Derived From Animal Sources And May Become Subject To Additional Regulation.
Certain of our products, including our dermal regeneration products,
ourduraplasty products, biomaterial products for the spine, nerve andour nervetendon repair products and certain other products, contain material derived from bovine tissue. Products that contain materials derived from animal sources, including food,as well aspharmaceuticals and medical devices, are increasingly subject to scrutiny in thepressmedia and by regulatory authorities. Regulatory authorities are concerned about the potential for the transmission of disease from animals to humans via those materials. This public scrutiny has been particularly acute in Japan and Western Europe with respect to products derived from animal sources, because of concern that materials infected with the agent that causes bovine spongiform encephalopathy, otherwise known as BSE or mad cow disease, may, if ingested or implanted, cause a variant of the human Creutzfeldt-Jakob Disease, an ultimately fatal disease with no known cure.Recent casesCases of BSE in cattle discovered in Canada and the United States have increased awareness of the issue in North America.We take great care to provide that our products are safe and free of agents that can cause disease. In particular, the collagen used in the products that
Integra manufactureswe manufacture is derived only from the deep flexor tendon of cattle less than 24 months old from New Zealand, a country that has never had a case of BSE, or from the United States. The collagen used in a product that we sell, but do not manufacture, is derived from bovine pericardium. We are also qualifying sources of collagen from other countries that are considered BSE-free. The World Health Organization classifies different types of cattle tissue for relative risk of BSE transmission. Deep flexor tendon and bovine pericardium are in thelowest risklowest-risk categories for BSE transmission (the same category as milk, for example), and are therefore considered to have a negligible risk of containing the agent that causes BSE (an improperly folded protein known as a prion). Nevertheless, products that contain materials derived from animals, including our products, may become subject to additional regulation, or even be banned in certain countries, because of concern over the potential for prion transmission. Significant new regulation, or a ban of our products, could have a material adverse effect on our current business or our ability to expand our business.Certain countries, such as China, Taiwan and Argentina, have issued regulations that require our collagen products be processed from bovine tendon sourced from countries where no cases of BSE have occurred, and the European Union has requested that our dural replacement products be sourced from bovine tendon sourced from a country where no cases of BSE have occurred. In addition,
we have been notified thatJapan has issued new regulations regarding medical devices that contain tissue of animal origin. Among other regulations, Japanmay requirerequires that the tendon used in the manufacture of medical devices sold in Japan originate in a country that has never had a case13of BSE. Currently, we purchase our tendon from the United States and New Zealand. We received approval in Japan for the use of New Zealand-sourced tendon in the manufacturing of our products sold in Japan. If we cannot continue to use or qualify a source of tendon from New Zealand or another country that has never had a case of BSE, we will not be permitted to sell our collagen hemostatic agents and products for oral surgery in Japan. We do not currently sell our dural or skindermal repair products in Japan.Lack Of Market Acceptance For Our Products Or Market Preference For Technologies That Compete With Our Products Could Reduce Our Revenues And Profitability.
We cannot be certain that our current products or any other products that we may develop or market will achieve or maintain market acceptance. Certain of the medical indications that can be treated by our devices can also be treated by other medical devices or by medical practices that do not include a device. The medical community widely accepts many alternative treatments, and certain of these other treatments have a long history of use. For example, the use of autograft tissue is a well-established means for repairing the dermis, and it competes for acceptance in the market with the
INTEGRA(R)Integra® Dermal Regeneration Template.In addition, the acceptance of our Newdeal products, which previously were distributed by third parties, faces similar competition.We cannot be certain that our devices and procedures will be able to replace those established treatments or that either physicians or the medical community in general will accept and utilize our devices or any other medical products that we may develop.
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In addition, our future success depends, in part, on our ability to develop additional products. Even if we determine that a product candidate has medical benefits, the cost of commercializing that product candidate
maycould be too high to justify development. Competitorsmaycould develop products that are more effective, achieve more favorable reimbursement status from third-party payors, cost less or are ready for commercial introduction before our products. If we are unable to develop additional commercially viable products, our future prospects could be adversely affected.Market acceptance of our products depends on many factors, including our ability to convince prospective collaborators and customers that our technology is an attractive alternative to other technologies, to manufacture products in sufficient quantities and at acceptable costs, and to supply and service sufficient quantities of our products directly or through our distribution alliances. In addition, unfavorable reimbursement methodologies, or adverse determinations of third-party payors against our products or third-party determinations that favor a competitor’s product over ours, could harm acceptance or continued use of our products. The industry is subject to rapid and continuous change arising from, among other things, consolidation and technological improvements. One or more of these factors may vary unpredictably,
whichand such variations could have a material adverse effect on our competitive position. We may not be able to adjust our contemplated plan of development to meet changing market demands.Our Intellectual Property Rights May Not Provide Meaningful Commercial Protection For Our Products,
Which Could EnablePotentially Enabling Third Parties To Use Our Technology Or Very Similar Technology And Could Reduce Our Ability To Compete In The Market.Our ability toTo compete effectively,
dependswe depend in part, on our ability to maintain the proprietary nature of our technologies and manufacturing processes, which includes the ability to obtain, protect and enforce patents on our technology and to protect our trade secrets. We own or have licensed patents that cover aspects of some of our product lines. However,you should not rely onour patentstomay not provide us with any significant competitive advantage. Others may challenge our patents and, as a result, our patents could be narrowed, invalidated or rendered unenforceable. Competitors may develop products similar to ours that our patents do not cover. In addition, our current and future patent applications may not result in the issuance of patents in the United States or foreign countries. Further, there is a substantial backlog of patent applications at the U.S. Patent and Trademark Office, and the approval or rejection of patent applications usually takes approximately two and a half years.Our Competitive Position Depends, In Part, Upon Unpatented Trade Secrets Which We May Be Unable To Protect.
Our competitive position also depends upon unpatented trade
secrets. Tradesecrets, which are difficult to protect. We cannot assure you that others will not independently develop substantially equivalent proprietary information and14techniques or otherwise gain access to our trade secrets, that our trade secrets will not be disclosed or that we can effectively protect our rights to unpatented trade secrets. In an effort to protect our trade secrets, we require our employees, consultants and advisors to execute proprietary information and invention assignment agreements upon commencement of employment or consulting relationships with us. These agreements provide that, except in specified circumstances, all confidential information developed or made known to the individual during the course of their relationship with us must be kept confidential. We cannot assure you, however, that these agreements will provide meaningful protection for our trade secrets or other proprietary information in the event of the unauthorized use or disclosure of confidential information.
Our Success Will Depend Partly On Our Ability To Operate Without Infringing Or Misappropriating The Proprietary Rights Of Others.
We may be sued for infringing the intellectual property rights of others. In addition, we may find it necessary, if threatened, to initiate a lawsuit seeking a declaration from a court that we do not infringe the proprietary rights of others or that their rights are invalid or unenforceable. If we do not prevail in any litigation, in addition to any damages we might have to pay, we would be required to stop the infringing activity or obtain a license for the proprietary rights involved. Any required license may be unavailable to us on acceptable terms, or at all. In addition, some licenses may be nonexclusive and allow our competitors to access the same technology we license.
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If we fail to obtain a required license or are unable to design our product so as not to infringe on the proprietary rights of others, we may be unable to sell some of our products,
whichand this potential inability could have a material adverse effect on our revenues and profitability.We May Be Involved In Lawsuits Relating To Our Intellectual Property Rights And Promotional Practices, Which May Be Expensive.
To protect or enforce our intellectual property rights, we may have to initiate or defend legal proceedings, such as infringement suits or interference proceedings, against or by third parties. For example, Codman & Shurtleff, Inc., a division of Johnson & Johnson, commenced an action in
December 2005May 2006 seeking declaratory relief that its DURAFORM™ product does not infringe ourNewdeal subsidiary sued Wright Medical Group, Inc.patent covering our duraplasty products andWright Medical's French subsidiary allegingthatcertain products within Wright Medical's "Charlotte System" of footour patent is invalid andankle products infringe upon Newdeal's foot-and-ankle system.unenforceable. In addition, we may have to institute proceedings regarding ourcompetitors'competitors’ promotional practices or defend proceedings regarding our promotional practices. Litigation is costly, and, even if we prevail, the cost of that litigation could affect our profitability. In addition, litigation is time consuming and could divert management attention and resources away from our business. We may also provoke these third parties to assert claims against us.It May Be Difficult To Replace Some Of Our Suppliers.
Outside vendors, some of whom are sole-source suppliers, provide key components and raw materials used in the manufacture of our products. Although we believe that alternative sources for many of these components and raw materials are available, any supply interruption in a limited or sole source component or raw material could harm our ability to manufacture our products until a new or alternative source of supply is identified and qualified. In addition, an uncorrected defect or
supplier'ssupplier’s variation in a component or raw material, either unknown to us or incompatible with our manufacturing process, could harm our ability to manufacture products. We may not be able to find a sufficient alternative supplier in a reasonable time period, or on commercially reasonable terms, if at all, and our ability to produce and supply our products could be impaired. We believe that these factors are most likely to affect the following products that we manufacture:oour collagen-based products, such as theINTEGRA(R)Integra® Dermal Regeneration Template and wound dressing products, theDuraGen(R)DuraGen® family of products, and our Absorbable Collagen Sponges;oour products made from silicone, such as our neurosurgical shunts and drainage systems and hemodynamic shunts; andoproducts which use many different electronic parts from numerous suppliers, such as our intracranial monitors and catheters.If we were suddenly unable to purchase products from one or more of these companies, we would need a significant period of time to qualify a replacement, and the production of any affected products could be disrupted. While it is our policy to maintain sufficient inventory of components so that our production
15will not be significantly disrupted even if a particular component or material is not available for a period of time, we remain at risk that we will not be able to qualify new components or materials quickly enough to prevent a disruption if one or more of our suppliers ceases production of important components or materials. If Any Of Our Manufacturing Facilities Were Damaged And/Or Our Manufacturing Or Business Processes Interrupted, We Could Experience Lost Revenues And Our Business Could Be Seriously Harmed.
We manufacture our products in a limited number of facilities. Damage to our manufacturing, development or research facilities due to fire, natural disaster, power loss, communications failure, unauthorized entry or other events could cause us to cease development and manufacturing of some or all of our products. In particular, our San Diego, California facility
that manufactures our Camino(R), Ventrix(R) and LICOX(R) catheter product linesisassusceptible to earthquake damage, wildfire damage and power losses from electrical shortages as are other businesses in the Southern California area. Our Anasco, Puerto Rico plant, where we manufacture collagen, silicone and ourprivate labelprivate-label products, is vulnerable to hurricane, storm and wind damage. Although we maintain property damage and business interruption insurance coverage on these facilities, our insurance might not cover all losses under such circumstances and we may not be able to renew or obtain such insurance in the future on acceptable terms with adequate coverage or at reasonable costs.15
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In addition, we began implementing an enterprise business system in 2004, which we intend to use in
all ofour facilities. This system, the hosting and maintenance of which we outsource, replaces several systems on which we previously relied and will be implemented in several stages. We have outsourced our product distribution function in the United States and inthe fourth quarter of 2005 began to outsource our European product distribution function.Europe. A delay or other problem with the enterprise business system problems orinwith ourimplementation schedule for any of these initiativesoutsourced distribution functions could have a material adverse effect on our operations.We Are Exposed To A Variety Of Risks Relating To Our International Sales And Operations, Including Fluctuations In Exchange Rates, Local Economic Conditions And Delays In Collection Of Accounts Receivable.
We generate significant revenues outside the United States in euros, British pounds and in U.S. dollar-denominated transactions conducted with customers who generate revenue in currencies other than the U.S. dollar. For those foreign customers who purchase our products in U.S. dollars, currency fluctuations between the U.S. dollar and the currencies in which those customers do business may have an impact on the demand for our products in foreign countries where the U.S. dollar has increased in value compared to the local currency.
Because we have operations based in Europe and we generate revenues and incur operating expenses in euros and British pounds, we experience currency exchange risk with respect to those foreign currency-denominated revenues and expenses.
In 2004 and 2005,We also experience currency exchange risk with respect to thecost of products we manufactured in our European facilities or purchased in foreign currencies exceeded our foreign currency-denominated revenues. We expect this imbalance to continue. Accordingly, a weakening of the dollar against the euro and British pound could negatively affect future gross margins and operating margins.yen.Currently, we do not use derivative financial instruments to manage operating foreign currency risk. As the volume of our business transacted in foreign currencies increases, we expect to continue to assess the potential effects that changes in foreign currency exchange rates could have on our business. If we believe that this potential impact presents a significant risk to our business, we may enter into derivative financial instruments to mitigate this risk.
In general, we cannot predict the consolidated effects of exchange rate fluctuations upon our future operating results because of the number of currencies involved, the variability of currency exposure and the potential volatility of currency exchange rates.
Our international operations subject us to customs, import-export, sanctioned country and
import-exportforeign corrupt practices laws. These laws restrict, and in some cases prohibit, United States companies from directly or indirectly selling goods, technology or services to people or entities in certain countries. These laws also prohibit transactions with certain designated persons.Our sales to foreign markets also may be affected by localLocal economic conditions, legal, regulatory or political considerations, the effectiveness of our sales representatives and distributors, local competition and changes in local medical
16practice.practice could also affect our sales to foreign markets. Relationships with customers and effective terms of sale frequently vary by country, often with longer-term receivables than are typical in the United States.Changes In The
Health CareHealthcare Industry May Require Us To Decrease The Selling Price For Our Products Or May Reduce The Size Of The Market For Our Products, Either Of Which Could Have A Negative Impact On Our Financial Performance.Trends toward managed care,
health carehealthcare cost containment and other changes in government and private sector initiatives in the United States and other countries in which we do business are placing increased emphasis on the delivery of more cost-effective medical therapies that could adversely affect the sale and/or the prices of our products. For example:omajor third-party payors of hospital services and hospital outpatient services, including Medicare, Medicaid and privatehealth carehealthcare insurers, annually revise their payment methodologies, which can result in stricter standards for reimbursement of hospital charges for certain medical procedures;oMedicare, Medicaid and privatehealth carehealthcare insurer cutbacks could create downward price pressure on our products;o16
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recently effected local Medicare coverage determinations will eliminate reimbursement for certain of our matrix wound dressing products in certain regions, negatively affecting our market for these products, and future determinations could eliminate reimbursement for certain of our products;potential legislative proposals have been considered that would result in major reforms in the U.S.health carehealthcare system that could have an adverse effect on our business;othere has been a consolidation amonghealth carehealthcare facilities and purchasers of medical devices in the United States who prefer to limit the number of suppliers from whom they purchase medical products, and these entities may decide to stop purchasing our products or demand discounts on our prices;owe are party to contracts with group purchasing organizations, which negotiate pricing for many member hospitals, that require us to discount our prices for certain of our products and limit our ability to raise prices for certain of our products, particularly surgical instruments;othere is economic pressure to containhealth carehealthcare costs in domestic and international markets;othere are proposed and existing laws, regulations and industry policies in domestic and international markets regulating the sales and marketing practices and the pricing and profitability of companies in thehealth carehealthcare industry;oproposed laws or regulations that will permit hospitals to provide financial incentives to doctors for reducing hospital costs (known as gainsharing) and to award physician efficiency (known as physician profiling) could reduce prices; andothere have been initiatives by third-party payors to challenge the prices charged for medical products that could affect our ability to sell products on a competitive basis.Both the pressures to reduce prices for our products in response to these trends and the decrease in the size of the market as a result of these trends could adversely affect our levels of revenues and profitability of sales.
Regulatory Oversight Of The Medical Device Industry Might Affect The Manner In Which We May Sell Medical
DevicesDevices.There are laws and regulations that
regulategovern the means by which companies in thehealth carehealthcare industry may market their products tohealth carehealthcare professionals and may compete by discounting the prices of their products. Although we exercise care in structuring our sales and marketing practices and customer discount arrangements to comply with those laws and regulations, we cannot assure you that:ogovernment officials charged with responsibility for enforcing those laws will not assert that our sales and marketing practices or customer discount arrangements are in violation of those laws or regulations; orogovernment regulators or courts will interpret those laws or regulations in a manner consistent with our interpretation.In January 2004, ADVAMED, the principal U.S. trade association for the medical device industry, put in place a model
"code“code ofconduct"conduct” that sets forth standards by which its members should abide in the promotion of their products. We have in place policies and procedures for compliance that we believe are at17least as stringent as those set forth in the ADVAMED Code, and we provide routine training to our sales and marketing personnel on our policies regarding sales and marketing practices. Nevertheless, the sales and marketing practices of our industry hashave been the subject of increased scrutiny from government agencies, and we believe that this trend will continue.Our
Private LabelPrivate-Label Business Depends Significantly On Key Relationships With Third Parties, Which WeMayCould Be Unable To Establish And Maintain.Our
private labelprivate-label business depends in part on our entering into and maintaining collaborative or alliance agreements with third parties concerning product marketing, as well as research and development programs. Our most important alliance is our agreement with the Wyeth BioPharma division of Wyeth for the development of collagen matrices to be used in conjunction with WyethBioPharma'sBioPharma’s recombinant bone protein, a protein that stimulates the growth of bone in humans. The third parties with whom we have entered into agreements might terminate these agreements for a variety of reasons, including developing other sources for the productsupplied by us.that we supply. Termination of any of our alliances would require us to develop other means to distribute the affected products and could adversely affect our expectations for the growth ofprivate labelprivate-label products.17
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We May Have Significant Product Liability Exposure And Our Insurance May Not Cover All Potential Claims.
We are exposed to product liability and other claims in the event that our technologies or products are alleged to have caused harm. We may not be able to obtain insurance for the potential liability on acceptable terms with adequate coverage or at reasonable costs. Any potential product liability claims could exceed the amount of our insurance coverage or may be excluded from coverage under the terms of the policy. Our insurance may not be renewed at a cost and level of coverage comparable to that then in effect.
We Are Subject To Regulatory Requirements Relating To The Use Of Hazardous Substances Which May Impose Significant Compliance Costs On Us.
Our research, development and manufacturing processes involve the controlled use of certain hazardous materials. We are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of these materials and certain waste products. Although we believe that our safety procedures for handling and disposing of those materials comply with the standards prescribed by the applicable laws and regulations, the risk of accidental contamination or injury from these materials cannot be eliminated. In the event of such an accident, we could be held liable for any damages that result and any related liability could exceed the limits or fall outside the coverage of our insurance and could exceed our resources. We may not be able to maintain insurance on acceptable terms or at all.
The Loss Of Key Personnel Could Harm Our Business.
We believe our success depends on the contributions of a number of our key personnel, including Stuart M. Essig, our President and Chief Executive Officer. If we lose the services of key personnel, those losses could materially harm our business. We maintain key person life insurance on Mr. Essig and two other members of management.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Our principal executive offices are located in Plainsboro, New Jersey. Principal manufacturing and research facilities are located in New Jersey, Massachusetts, Ohio, California, Pennsylvania, Puerto Rico, England, Ireland and France. Our instrument procurement operations are located in Germany. Our primary distribution centers are located in Nevada, New York,
England, FrancePennsylvania and Belgium. In addition, we lease several smaller facilities to support additional administrative, assembly, and distribution operations.The Sparkes,Third parties own and operate the facilities in Nevada andGhent, Belgium facilities are owned and operated by third parties.Belgium. We lease all of our facilities other than our facilities in Pennsylvania, England, and Biot, France, which we own.18All of our manufacturing facilities (other than one outside of the United States) are registered with the FDA. Our facilities are subject to FDA inspection to assure compliance with Quality System Regulations. We believe that our manufacturing facilities are in substantial compliance with Quality System Regulations, suitable for their intended purposes and have capacities adequate for current and projected needs for existing products. Some capacity of the plants is being converted, with any needed modification, to meet the current and projected requirements of existing and future products.
ITEM 3. LEGAL PROCEEDINGS
Various lawsuits, claims and proceedings are pending or have been settled by us. The most significant of those are described below.
In
July 1996, we filedMay 2006, Codman & Shurtleff, Inc., apatent infringement lawsuitdivision of Johnson & Johnson, commenced an action in the United States District Court for theSouthernDistrict ofCaliforniaNew Jersey for declaratory judgment against Integra LifeSciences Corporation with respect to United States Patent No. 5,997,895 (the"Trial Court"“‘895 Patent”) held by Integra. Integra’s patent covers dural repair technology related to Integra’s DuraGen® family of duraplasty products.18
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The action seeks declaratory relief that Codman’s DURAFORM™ product does not infringe Integra’s patent and that Integra’s patent is invalid and unenforceable. Codman does not seek either damages from Integra or injunctive relief to prevent Integra from selling the DuraGen® Dural Graft Matrix. Integra has filed a counterclaim against Codman, alleging that Codman’s DURAFORM™ product infringes the ‘895 Patent, seeking injunctive relief preventing the sale and use of DURAFORM™, and seeking damages, including treble damages, for past infringement.
In July 1996, Integra sued Merck KGaA, a German corporation,
Scripps Research Institute, a California nonprofit corporation, and David A. Cheresh, Ph.D., a research scientist with Scripps,seeking damagesand injunctive relief.for patent infringement. Thecomplaint charged, among other things, that the defendant Merck KGaA willfully and deliberately induced, and continues willfully and deliberately to induce, defendants Scripps Research Institute and Dr. Cheresh to infringe certain of our patents. Thesepatents in question are part of a group of patents granted to The Burnham Institute and licensed byusIntegra that are based on the interaction between a family of cell surface proteins called integrins and the arginine-glycine-aspartic acid("RGD"(“RGD”) peptide sequence found in many extracellular matrix proteins.The
defendants filed a countersuit asking for an award of defendants' reasonable attorney fees. In March 2000, a jurycase has been tried, appealed and returneda unanimous verdict in our favor and awarded us $15.0 million in damages, finding that Merck KGaA had willfully infringed and induced the infringement of our patents. The Trial Court dismissed Scripps and Dr. Cheresh from the case. In October 2000, the Trial Court entered judgment in our favor and against Merck KGaA in the case. In entering the judgment, the Trial Court also granted to us pre-judgment interest of $1.4 million, bringing the total award to $16.4 million, plus post-judgment interest. Merck KGaA filed various post-trial motions requesting a judgment as a matter of law notwithstanding the verdict or a new trial, in each case regarding infringement, invalidity and damages. In September 2001, the Trial Court entered orders in favor of us and against Merck KGaA on the final post-judgment motions in the case, and denied Merck KGaA's motions for judgment as a matter of law and for a new trial. Merck KGaA and we each appealed various decisions of the Trial Courtto theUnited States Court of Appeals for the Federal Circuit (the "Circuit Court"). In June 2003, the Circuit Court affirmed the Trial Court's finding that Merck KGaA had infringed our patents. The Circuit Court also held that the basis of the jury's calculation of damages was not clear from thetrialrecord, and remanded the case to the Trial Court for further factual development and a new calculation of damages consistent with the Circuit Court's decision.court. In September 2004, theTrial Courttrial court ordered MerckKgaAKGaA to payusIntegra $6.4 million indamages following the Circuit Court's order.damages. MerckKgaAKGaA filed a petition for a writforof certiorari with the United States Supreme Court seeking review of the CircuitCourt'sCourt’s decision, and the Supreme Court granted the writ in January 2005.On June 13, 2005, the Supreme Court vacated the June 2003 judgment of the Circuit Court. The Supreme Court held that the Circuit Court applied an erroneous interpretation of 35 U.S.C.
ss.271(e)§271(e)(1) when it rejected the challenge of Merck KGaA to thejury'sjury’s finding that Merck KGaA failed to show that its activities were exempt from claims of patent infringement under that statute. On remand, the Circuit Courtwill reviewwas to have reviewed the evidence under a reasonableness test that does not provide categorical exclusions of certain types of activities. The hearing before the Circuit Court occurred in June 2006, and a ruling is expected in 2007. Further enforcement of theTrial Court'strial court’s order has been stayed. We have not recorded any gain in connection with this matter, pending final resolution and completion of the appeals process.Three of our French subsidiaries that were acquired from the neurosciences division of NMT Medical, Inc. received a tax reassessment notice from the French tax authorities seeking in excess of 1.7 million euros in back taxes, interest and penalties. NMT Medical, the former owner of these entities, has agreed to indemnify us against direct damages and liability arising from misrepresentations in connection with these tax claims. In April 2005, NMT Medical, Inc. negotiated a settlement agreement with the French authorities that 19satisfied the outstanding tax assessments. In connection with this settlement, we recognized net operating loss carryforwards in France and recorded this benefit as a $0.5 million tax benefit in 2005.In addition to these matters, we are subject to various claims, lawsuits and proceedings in the ordinary course of our business, including claims by current or former employees, distributors and competitors and with respect to our products. In the opinion of management, such claims are either adequately covered by insurance or otherwise indemnified, or are not expected, individually or in the aggregate, to result in a material adverse effect on our financial condition. However, it is possible that our results of operations, financial position and cash flows in a particular period could be materially affected by these
contingencies.contingencies or the costs related thereto.ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.
ADDITIONAL
INFORMATION:INFORMATIONThe following information is furnished in this Part I pursuant to Instruction 3 to Item 401(b) of Regulation S-K.
Executive Officers of the Company
Our executive officers are appointed annually and serve at the discretion
of the Board of Directors. The only family relationship between any of our executive officers and directors is that Mr. Holtz is the nephew of Richard E. Caruso, Ph.D., the Chairmanof the Board of Directors. The following information indicates the position and age of our executive officers as of the date of this report and their previous business experience.19
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NAME AGE POSITION Stuart M. Essig ................... 4445 President, Chief Executive Officer and Director Maureen B. Bellantoni ............. 5657 Executive Vice President and Chief Financial Officer Gerard S. Carlozzi ................ 5051 Executive Vice President and Chief Operating Officer John B. Henneman, III ............. 4445 Executive Vice President and Chief Administrative Officer and Secretary David B. Holtz .................... 39 Senior Vice President, Finance Deborah A. Leonetti ............... 50 Senior Vice President, Global Marketing Donald R. Nociolo ................. 43 Senior Vice President, OperationsJudith E. O'Grady ................. 55O’Grady56 Senior Vice President, Regulatory, Quality Assurance and Clinical Affairs Robert D. Paltridge ............... 48 SeniorJerry E. Corbin 47 Vice President Global Salesand Corporate ControllerStuart M. Essig
has served asis Integra’s President and Chief Executive Officer and adirector ofdirector. He joined Integrasincein December 1997. Before joining Integra, Mr. Essig supervised the medical technology practice at Goldman, Sachs & Co. as a managing director. Mr. Essig had ten years of broad health care experience at Goldman Sachs serving as a senior merger and acquisitions advisor to a broad range of domestic and international medical technology, pharmaceutical and biotechnology clients. Mr. Essig also serves on the Board of Directors of St. Jude Medical20Corporation, Zimmer Holdings, Inc. and ADVAMED, the Advanced Medical Technology Association. Mr. Essig received an A.B. degree from the Woodrow Wilson School of Public and International Affairs at Princeton University and an M.B.A. and a Ph.D. degree in Financial Economics from the University of Chicago, Graduate School of Business. Maureen B. Bellantoniis
Integra'sIntegra’s Executive Vice President and Chief Financial Officer, and is responsible for thecompany'scompany’s finance department, including the corporate controller, financial reporting, budgeting, internal audit, tax, logistics, customer service and treasury functions of thecompany.Company. Ms. Bellantoni joined Integra in January 2006. Ms. Bellantoni served as Senior Vice President and Chief Financial Officer of CP Kelco, a global leader in the hydrocolloids market from 2003 through its sale to J.M. Huber in October 2004. From 2000 to 2002, Ms. Bellantoni served as Chief Financial Officer North America and Senior Vice President of Finance of Burger King. During 1999 to 2000, she served as Executive Vice President Finance, for Rohn Industries Inc. a publicly traded telecommunications company. From 1993 to 1998, she served at Sara Lee Corporation as President and Chief Operating Officer for their Bil Mar Foods division, Vice President, Finance and Chief Financial Officer for Sara Lee Meats, and Vice President, Finance and Chief Financial Officer for PYA/Monarch, Inc. From 1985 to 1993, Ms. Bellantoni was with Emerson Electric Company, as Vice President, Finance and Chief Financial Officer for their Automatic Switch Division and Vice President, Far East and Vice President, Finance and Chief Financial Officer for the Branson Ultrasonics Corporation. Ms. Bellantoni received a B.S. degreein financefrom the University of Bridgeport and an M.B.A. from the University of Connecticut.Gerard S. Carlozziis
Integra'sIntegra’s Executive Vice President and Chief Operating Officer, and is responsible for thecompany'sCompany’s marketing, sales, manufacturing,distributioninformation technology and research and development functions. Mr. Carlozzi joined Integra in September 2003, after serving as a consultant to the Company from March 2003 to September 2003. Prior to joining Integra, Mr. Carlozzi had spent over 25 years in the medical device industry. From 1999 to 2003, he was President, Chief Executive Officer and a director of Bionx Implants, a company focused on the development of novel biomaterial devices for various surgical specialties. Prior to 1999, he held various management positions with Synthes USA, Acufex microsurgical and Infusaid Corporation. Mr. Carlozzi also serves on the Board of Directors of Cascade Medical Corporation and Scandius Biomedical, Inc., privately held companies. Mr. Carlozzi received a B.S. degreein engineeringand an M.B.A. from Northeastern University.20
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John B. Henneman, IIIis
Integra'sIntegra’s Executive Vice President and Chief Administrative Officer, andSecretary, andis responsible forthe law department,regulatory affairs, corporate quality systems, clinical affairs, clinical education, business development, human resources,information managementthe law department, investor relations andinvestor relations.Miltex. Mr. Henneman was our General Counsel from September 1998 until September 2000 and our Senior Vice President, Chief Administrative Officer and Secretary from September 2000 until February 2003. Prior to joining Integra in August 1998, Mr. Henneman served Neuromedical Systems, Inc., a public company developer and manufacturer of in vitro diagnostic equipment, in various capacities for more than four years. Mr. Henneman received an A.B. degree from Princeton University and a J.D. from the University of Michigan Law School.David B. Holtz joined Integra as Controller in 1993, served as Vice President, Finance and Treasurer from March 1997 to January 2001, was promoted to Senior Vice President, Finance and Treasurer in February 2001 and served as Treasurer until 2004. From August 2002 through October 2003, Mr. Holtz was given responsibility for managing Integra's European operations to support the transition of our acquisitions in Europe. His current responsibilities include managing all financial reporting and accounting functions. Before joining Integra, Mr. Holtz was an associate with Coopers & Lybrand, L.L.P. in Philadelphia and Cono Leasing Corporation, a private leasing company. Mr. Holtz received a B.S. degree in Business Administration from Susquehanna University and has been certified as a public accountant. Deborah A. Leonetti joined Integra in May of 1997 as Director of Marketing, was promoted to Vice President, Global Marketing in April 1999 and to Senior Vice President, Global Marketing in May 2004. Her responsibilities include worldwide strategic marketing for all Integra products. From September 1989 through May 1997, Ms. Leonetti worked for Cabot Medical, which was later acquired by Circon Corporation, and held positions in sales, sales training, and marketing. Prior to her experience at Cabot-Circon, Ms. Leonetti completed fifteen years of clinical practice as a registered nurse at St. Christopher's Hospital for Children in Philadelphia. Ms. Leonetti received a nursing degree from St. Joseph's Hospital School of Nursing and La Salle University. Donald R. Nociolo joined Integra as Director of Manufacturing in 1994, and was promoted to Vice President, Operations in March 1997 and to Senior Vice President, Operations in May 2000. He is responsible for managing Integra's 21worldwide manufacturing operations. Mr. Nociolo has approximately 20 years experience working in engineering and manufacturing management in the medical device industry. Six of those years were spent working at ETHICON, Inc., a division of Johnson & Johnson. Mr. Nociolo received a B.S. degree in Industrial Engineering from Rutgers University and an M.B.A. in Industrial Management from Fairleigh Dickinson University.Judith E.
O'Grady joined Integra asO’Gradyis Integra’s Senior Vice President of Regulatory Affairs, Quality Assurance and ClinicalAffairsAffairs. Ms. O’Grady joined Integra in 1985. Ms.O'GradyO’Grady has worked in the areas of medical devices and collagen technology for over 20 years. Prior to joining Integra, Ms.O'GradyO’Grady worked for Colla-Tec, Inc., a Marion Merrell Dow Company. During her career she has held positions with Surgikos, a Johnson & Johnson Company, and was on the faculty of Boston University College of Nursing and Medical School. Ms.O'GradyO’Grady led the team that obtained the FDA approval forINTEGRA(R)Integra® Dermal Regeneration Template, the first regenerative product approved by the FDA, and has led teams responsible for approvals of theCompany'sCompany’s other regenerative product lines as well as more than 500 FDA and international submissions. Ms.O'GradyO’Grady received a B.S. degree from Marquette University and M.S.N. in Nursing from Boston University.Robert D. PaltridgeJerry E. Corbinis Integra’s Vice President and Corporate Controller. Mr. Corbin joined Integra
as National Sales DirectorinFebruary 1995 and was appointed Vice President, North American SalesJune 2006. Prior to joining Integra, Mr. Corbin held key finance positions inSeptember 1997. He was promoted to Vice President, Global Sales in October 2002 and Senior Vice President, Global Sales in January 2003. His responsibilities include managing the worldwide sales activities of Integra's three sales organizations and third-party distributors. Mr. Paltridge has over 20 years ofcorporate accounting, sales andsalesmarketing and, most recently, research and development for sanofi-aventis and its predecessors from 1989 to 2006. Prior to that, he held managementexperience in the medical device industry. Before joining Integra, he was National Sales Manager at Strato Medical, a division of Pfizer, Inc. Hepositions with Sigma-Aldrich Corporation and Edward D. Jones & Company. Mr. Corbin received a B.S. degreein Business AdministrationfromRutgers University. 22Illinois State University and is a certified public accountant. 21
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PART II
ITEM 5. MARKET FOR
REGISTRANT'SREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIESMarket Information, Holders and Dividends
Our common stock trades on The
NASDAQ NationalNasdaq Global Market under the symbol"IART".“IART.” The following table lists the high and low sales prices for our common stock for each quarter for the last two years:
HIGH LOW HIGH LOW 2005 2004 ------------------ ------------------Fourth Quarter $ 38.89 $ 32.00 $ 37.36 $ 29.41 Third Quarter $ 38.26 $ 28.74 $ 35.79 $ 27.14 Second Quarter $ 37.31 $ 28.69 $ 36.00 $ 29.76 First Quarter $ 39.87 $ 34.75 $ 33.86 $ 28.74
HIGH LOW HIGH LOW 2006 2005 Fourth Quarter $ 43.57 $ 36.36 $ 38.89 $ 32.00 Third Quarter $ 39.51 $ 34.56 $ 38.26 $ 28.74 Second Quarter $ 42.90 $ 36.27 $ 37.31 $ 28.69 First Quarter $ 41.72 $ 35.00 $ 39.87 $ 34.75 We have not paid any cash dividends on our common stock since our formation. Our credit facility limits the amount of dividends that we may pay. See
"Item“Item 7.Management'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations-– Liquidity and Capital Resources-– Requirements and Capital Resources."” Any future determinations to pay cash dividends on the common stock will be at the discretion of our Board of Directors and will depend upon our results of operations and financial condition and other factors deemed relevant by the Board of Directors.The number of stockholders of record as of
March 11, 2006February 23, 2007 was approximately530,850, which includes stockholders whose shares were held in nominee name.Issuer Purchases of Equity Securities
In May 2005, our Board of Directors authorized us to repurchase shares of our common stock for an aggregate purchase price not to exceed $40 million through December 31, 2006. We were authorized to repurchase no more than 1.5 million shares under this program. During the quarter ended June 30, 2005, we repurchased 750,000 shares of our common stock for $24.7 million under the May 2005 repurchase program. In October 2005, our Board of Directors terminated the May 2005 repurchase program and adopted a new program that authorized us to repurchase shares of our common stock for an aggregate purchase price not to exceed $50 million through December 31, 2006. During the quarter ended December 31, 2005, we repurchased 900,000 shares of our common stock for $31.7 million under the October 2005 repurchase program.In February 2006, our Board of Directors
terminated the October 2005adopted a stock repurchase programand adopted a new programthatauthorizesauthorized us to repurchase shares of our common stock for an aggregate purchase price not to exceed $50 million through December 31, 2006. Shares may be purchased either in the open market or in privately negotiated transactions. We purchased 456,750 and 400,900 shares of our common stock for a total purchase price of approximately $16.7 million and $15.1 million during the three months ended September 30, 2006 and June 30, 2006, respectively under this repurchase program. No purchases were made under this program during the first quarter of 2006.In October 2006, our Board of Directors terminated the repurchase program approved in February 2006 and adopted a new program that authorized us to repurchase shares of our common stock for an aggregate purchase price not to exceed $75 million through December 31, 2007. Shares may be repurchased either in the open market or in privately negotiated transactions.
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The following table summarizes our repurchases of our common stock during the quarter ended December 31,
20052006 under the October20052006 repurchase program:
Approximate Dollar Total Number of Value of Shares Shares Purchased as that May Yet be Total Number of Average Price Paid Part of Publicly Purchased Under the Shares Purchased per Share Announced Program Program October 1, 2006 – October 31, 2006 — — — $ 75,000,000 November 1, 2006 – November 30, 2006 460,855 $ 40.88 460,855 56,161,030 December 1, 2006 – December 31, 2006 461,771 (1) 42.10 459,750 36,807,629 Total 922,626 $ 41.49 920,605 $ 36,807,629
Shares Dollar Value(1) Includes 2,021 shares withheld by us from an employee to satisfy tax withholding obligations upon the vesting of Purchased as Shares that May Total Number Average Part of Publicly Yet be Purchased of Shares Price Paid Announced Underrestricted stock issued to thePeriod Purchased per Share Program Program - --------------------- ------------ ----------- ---------------- --------------October 1, 2005 - October 31, 2005 37,000 34.14 37,000 $48,736,713 November 1, 2005 - November 30, 2005 798,107 35.15 798,107 20,682,146 December 1, 2005 - December 31, 2005 64,893 36.56 64,893 18,309,396 - --------------------- ------------ ---------- ---------------- -------------- Total 900,000 $ 35.21 900,000 $18,309,396employee.23ITEM 6. SELECTED FINANCIAL DATA
The information set forth below should be read in conjunction with
"Item“Item 7.Management'sManagement’s Discussion and Analysis of Financial Condition and Results ofOperations"Operations” and our consolidated financial statements and related notes included elsewhere in this report. We have acquired numerous businesses and product lines during the previous five years. As a result of these acquisitions, the consolidated financial results and balance sheet data for certain of the periods presented below may not be directly comparable.
Years Ended December 31, 2006 2005 2004 2003 2002 (in thousands, except per share data) Operating Results: Total revenues, net (1) $ 419,297 $ 277,935 $ 229,825 $ 185,599 $ 117,822 Costs and expenses (2) 360,553 221,830 205,046 145,952 98,635 Operating income 58,744 56,105 24,779 39,647 19,187 Interest income (expense), net (8,426 ) (265 ) 555 471 3,535 Other income (expense), net (3) (2,010 ) (739 ) 2,674 3,071 3 Income before income taxes 48,308 55,101 28,008 43,189 22,725 Provision for income taxes (4) 18,901 17,907 10,811 16,328 (12,552 ) Net income $ 29,407 $ 37,194 $ 17,197 $ 26,861 $ 35,277 Diluted net income per share $ 0.97 $ 1.15 $ 0.55 $ 0.86 $ 1.14 Weighted average shares outstanding 32,747 34,565 31,102 33,104 30,720 23
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December 31, 2006 2005 2004 2003 2002 (in thousands) Financial Position: Cash, cash equivalents, and marketable securities (5) $ 22,697 $ 143,384 $ 195,982 $ 206,743 $ 132,311 Total assets 613,618 448,432 456,713 412,526 274,668 Long-term debt (5) 508 118,378 118,900 119,427 — Retained earnings / (accumulated deficit) 66,336 36,929 (265 ) (17,462 ) (44,323 ) Stockholders’ equity 296,162 289,818 307,823 268,530 247,597
Years Ended(1) In 2003, we recorded $11.0 million of other revenue related to the acceleration of the recognition of unused minimum purchase payments and deferred license fee revenue from ETHICON, Inc., a division of Johnson & Johnson, following the termination of the supply distribution and collaboration agreement with ETHICON in December 31,2003.
(2) In 2004, we recorded $23.9 million in share-based compensation charges incurred in connection with the extension of the employment agreement of our President and Chief Executive Officer.
(3) In 2004, we recorded a $1.4 million gain in other income related to an unrealized gain on a foreign currency collar which was used to reduce our exposure to fluctuations in the exchange rate between the euro and the US dollar as a result of our commitment to acquire Newdeal Technologies SAS for 38.5 million euros. The collar contract expired on January 3, 2005, 2004concurrent with our acquisition of Newdeal Technologies. In 2003,2002 2001 ------ ------ ------ ------ ------ (in thousands, except per share data)Operating Results: Total revenues (1) ..................................... $277,935 $229,825 $185,599 $117,822 $ 93,442 Total operating costs and expenses (2) ................. 221,830 205,046 145,952 98,635 79,156 ------- ------ ------ ------ ------ Operating income ....................................... 56,105 24,779 39,647 19,187 14,286 Interestwe recorded a $2.0 million gain in other income (expense),associated with a termination payment received from ETHICON.
(4) In 2002, we recognized a deferred income tax benefit of $20.4 million primarily related to the reduction of a portion of the valuation allowance recorded against our deferred tax assets.
(5) In 2003, we issued $120.0 million of 2.5% contingent convertible subordinated notes due 2008. The net ......................... (265) 555 471 3,535 1,393 Other income (expense), net (3) ........................ (739) 2,674 3,071 3 (392) ------ ------ ------ ------ ------ Income before income taxes ............................. 55,101 28,008 43,189 22,725 15,287 Income tax expense (benefit) (4) ....................... 17,907 10,811 16,328 (12,552) (10,876) ------ ------ ------ ------ ------ Net income ............................................. $37,194 $17,197 $26,861 $35,277 $ 26,163 ====== ====== ====== ====== ====== Diluted net income per share ........................... $ 1.15 $ 0.55 $ 0.86 $ 1.14 $ 0.92 Weighted averageproceeds generated by the notes, after expenses, were $115.9 million. The notes that remain outstanding are convertible into approximately 3.5 million sharesoutstanding .................... 34,565 31,102 33,104 30,720 27,196 December 31, 2005 2004 2003 2002 2001 ------ ------ ------ ------ ------ (in thousands) Financial Position: Cash, cash equivalents, andof our common stock. In 2006, we exchanged $119.5 million of these notes for the equivalent amount of new notes. Because the closing price of our stock at the issuance date was higher than the market price trigger of the new notes, the new notes were classified as a current liability. In 2006, all marketable securities(5) .. $143,384 $195,982 $206,743 $132,311 $131,036 Total assets ........................................... 448,432 456,713 412,526 274,668 227,588 Long-term debt (5) ..................................... 118,378 118,900 119,427 -- -- Retained earnings/(accumulated deficit) ................ 36,929 (265) (17,462) (44,323) (79,600) Stockholders' equity ................................... 289,818 307,823 268,530 247,597 204,056were liquidated.(1) In 2003, we recorded $11.0 million of other revenue related to the acceleration of the recognition of unused minimum purchase payments and deferred license fee revenue from ETHICON, Inc., a division of Johnson & Johnson, following the termination of the supply distribution and collaboration agreement with ETHICON in December 2003. (2) In 2004, we recorded $23.9 million in share-based compensation charges incurred in connection with the extension of the employment agreement of our President and Chief Executive Officer. (3) In 2004, we recorded a $1.4 million gain in other income related to an unrealized gain on a foreign currency collar which was used to reduce our exposure to fluctuations in the exchange rate between the euro and the US dollar as a result of our commitment to acquire Newdeal Technologies SAS for 38.5 million euros. The collar contract expired on January 3, 2005, concurrent with our acquisition of Newdeal Technologies. In 2003, we recorded a $2.0 million gain in other income (expense) associated with a termination payment received from ETHICON. (4) In 2002 and 2001, we recognized a deferred income tax benefit of $20.4 million and $11.5 million, respectively, primarily related to the reduction of a portion of the valuation allowance recorded against our deferred tax assets. (5) In 2003, we issued $120.0 million of 2.5% contingent convertible subordinated notes due 2008. The net proceeds generated by the notes, after expenses, were $115.9 million. The notes are convertible into approximately 3.5 million shares of our common stock. 24ITEM 7.
MANAGEMENT'SMANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSThe following discussion and analysis of our financial condition and results of operations should be read together with the selected consolidated financial data and our financial statements and the related notes appearing elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those under the heading
"Factors That May Affect Our Future Performance."“Risk Factors.”Regulation G,
"Conditions“Conditions for Use of Non-GAAP Financial Measures,"” and other provisions of the Securities Exchange Act of 1934, as amended, define and prescribe the conditions for the use of certain non-GAAP financial information. InManagement'sManagement’s Discussion and Analysis of Financial Condition and Results of Operations, we provide information regarding growth inproductrevenues excluding recently acquired product lines, which is a non-GAAP financial measure. A reconciliation of this non-GAAP financial measure to the most comparable GAAP measure is provided in this annual report.24
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This non-GAAP financial measure should not be relied upon to the exclusion of GAAP financial measures. Management believes that this non-GAAP financial measure constitutes important supplemental information to investors which reflects an additional way of viewing aspects of our operations that, when viewed with our GAAP results and the accompanying reconciliations, provides a more complete understanding of factors and trends affecting our ongoing business and operations. Management strongly encourages investors to review our financial statements and publicly filed reports in their
entirelyentirety and to not rely on any single financial measure. Because non-GAAP financial measures are not standardized, it may not be possible to compare these financial measures with othercompanies'companies’ non-GAAP financial measures having the same or similar names.GENERAL
Integra, a world leader in regenerative medicine, is
a market-leading, innovative medical device company focused on helping the medical professional enhance the standard of care for patients. Integra provides customers with clinically relevant, innovative and cost-effective products that improvededicated to improving the quality of life forpatients. We focus on cranialpatients through the development, manufacturing andspinal procedures, peripheral nerve repair, small bonemarketing of cost-effective surgical implants andjoint injuries,medical instruments. Our products, used primarily in neurosurgery, extremity reconstruction, orthopedics andthe repair and reconstructiongeneral surgery, are used to treat millions ofsoft tissue.patients every year.Our distribution channels include two direct sales organizations (Integra NeuroSciences and Integra Reconstructive Surgery),
onea networkof manufacturer's representativesmanaged by a direct sales organization(JARIT(Jarit/Miltex Surgical Instruments) and strategicalliances with market leaders such as Johnson & Johnson, Medtronic, Inc., Wyeth and Zimmer Holdings, Inc.alliances. We have direct sales forces in the UnitedStates, Germany,States. Outside of the UnitedKingdom, the Benelux (Belgium, Netherlands, Luxembourg) region and France. Elsewhere throughout the world,States, we sell our productsare distributeddirectly througha number of independent distributors.sales representatives in major European markets and through stocking distributors elsewhere. We invest substantial resources and management effort to develop our sales organizations, and we believe that we compete very effectively in this aspect of our business.In 2006, we revised the manner in which we present our revenues. This change better aligns our product categories by functional product characteristic and intended use. We now present revenues in two categories: Neurosurgical and Orthopedic Implants and Medical Surgical Equipment. Our
product groups include Instruments,Neurosurgical and Orthopedic ImplantsMonitoring Products, and Private Label Products. Our Instrumentsproduct group includesultrasonic surgery systems for tissue ablation, cranial stabilization and brain retraction systems, and instrumentation used in general, neurosurgical, spinal and plastic and reconstructive surgery. Our Implants product group includesthe following: dural grafts that are indicated for the repair of thedura mater,dural matter; dermal regeneration and engineered wounddressings, anddressings; implants used in small bone and joint fixation, repair of peripheralnerves,nerves; hydrocephalus management; andhydrocephalus management.implants used in bone regeneration and in guided tissue regeneration in periodontal surgery. OurMonitoring ProductsMedical Surgical Equipment product group includes the following: ultrasonic surgery systems for tissue ablation; cranial stabilization and brain retraction systems; instrumentation used in general, neurosurgical, spinal, plastic and reconstructive surgery and dental procedures; systems for the measurement of various brainparametersparameters; and devices used to gain access to the cranial cavity and to drain excess cerebrospinal fluid from theventriclesventricle of the brain.Our Private LabelWe manage these product
group includes implants used in bone regenerationgroups andin guided tissue regeneration in periodontal surgery.distribution channels on a centralized basis. Accordingly, we report our financial results under a single operating segment – the development, manufacture and distribution of medical devices.We manufacture many of our
implant, monitoring and private labelproducts in various plants located in the United States, Puerto Rico, France, Germany, Ireland and the UnitedKingdom and Germany.Kingdom. We alsomanufacture the ultrasonic surgical instruments andsource most of our hand-held surgical instruments through specialized third-party vendors.We believe that we have a particular advantage in the development, manufacture and sale of specialty tissue repair products derived from bovine collagen.
We 25developProducts that contain materials derived from animal sources, including food, pharmaceuticals andmanufacture thesemedical devices, are increasingly subject to scrutiny from the media and regulatory authorities. These productsprimarily in our facility in Plainsboro, New Jersey. Taken together, these products accounted for approximately 31%comprised 25%, 31% and27%31% ofproductrevenues in the years ended December 31, 2006, 2005 and 2004, respectively. Accordingly, widespread public controversy concerning collagen products, new regulations, or a ban of our products containing material derived from bovine tissue, could have a material adverse effect on our current business and2003, respectively. We manage these multiple product groups and distribution channels on a centralized basis. Accordingly, we reportourfinancial results under a single operating segment - the development, manufacturing and distribution of medical devices.ability to expand.Our objective is to continue to build a customer-focused and profitable medical device company by developing or acquiring innovative medical devices and other products to sell through our sales channels. Our strategy therefore entails substantial growth in
productrevenues through boththroughinternal means-– through launching new and innovative products and selling existing products more intensively-– and by acquiring existing businesses or already successful product lines.25
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We aim to achieve this growth in revenues while maintaining strong financial results. While we pay attention to any meaningful trend in our financial results, we pay particular attention to measurements that
tend to support the view that our profitability can grow for a periodare indicative ofyears.long-term profitable growth. These measurements include revenue growthderived(derived through acquisitions and products developedinternally,internally), gross margins onproductstotal revenues,which we aim to increase to more than 65% over a period of several years,operating marginswhich(which we aim to continually expand on as we leverage our existinginfrastructure,infrastructure) and earnings per fully diluted share of common stock.ACQUISITIONS
Our strategy for growing our business includes the acquisition of complementary product lines and companies. Our recent acquisitions of businesses, assets and product lines may make our financial results for the year ended December 31,
20052006 not directly comparable to those of the corresponding prior year periods.SinceSee Note 3 to thebeginning of 2003,financial statements for a further discussion. From January 2004 through December 2006, we have acquired the following businesses, assets and product lines:On July 31, 2006 we acquired all of the outstanding shares of Kinetikos Medical, Inc. (“KMI”) for $39.5 million in cash, subject to certain adjustments. There are additional contingent future payments totaling up to $20 million based on the performance of the KMI business after the acquisition. KMI, based in Carlsbad, California, was a leading developer and manufacturer of innovative orthopedic implants and surgical devices for small bone and joint procedures involving the foot, ankle, hand, wrist and elbow. KMI marketed products that addressed both the trauma and reconstructive segments of the extremities market. KMI’s reconstructive products are largely focused on treating deformities and arthritis in small joints of the upper and lower extremity, while its trauma products are focused on the treatment of fractures of small bones most commonly found in the extremities. KMI is considered a strategic fit for the growing extremity business and should strengthen our presence in the orthopedic hand market. We have integrated the KMI product line into our U.S. Extremity Reconstruction sales force and plan to increase sales of KMI product internationally through our well-established Newdeal infrastructure.
On July 6, 2006, we acquired a direct sales force in Canada through the acquisition of our longstanding distributor, Canada Microsurgical Ltd. (“Canada Microsurgical”). Canada Microsurgical has eight sales representatives who cover all of the provinces in Canada. The sales and distribution operations are expected to enhance our expanding Canadian business. We paid $5.8 million (6.4 million Canadian dollars) for Canada Microsurgical at closing and $0.1 million of transaction related costs. In addition, we may pay additional contingent future payments up to an additional $1.9 million (2.1 million Canadian dollars) over the next three years, depending on the performance of the business.
On May 12, 2006, we acquired all of the outstanding capital stock of Miltex Holdings, Inc. (“Miltex”) for $102.7 million in cash paid at closing, subject to certain adjustments, and $0.6 million of transaction related costs. Miltex, based in York, Pennsylvania, is a leading provider of surgical and dental hand instruments to alternate site facilities, which includes physician and dental offices and ambulatory surgery care sectors. Miltex sells products under the Miltex®, Meisterhand®, Vantage®, Moyco®, Union Borach® and Thompson™ trademarks in over 65 countries, using a network of independent distributors. Miltex operates a manufacturing and distribution facility in York, Pennsylvania and also operates a leased facility in Tuttlingen, Germany, where Miltex’s staff coordinates design, production and delivery of instruments. Miltex is considered a strategic fit for our instrument business. Miltex also provides a broader platform to grow the business as it participates in the dental and veterinary markets.
On March 3, 2006,
Integrawe acquired the assets of the Radionics Division of Tyco Healthcare Group, L.P. for approximately$76$74.5 million in cash, subject to certainadjustments.adjustments, and $3.2 million of acquisition related expenses in a transaction treated as a business combination. Radionics, based in Burlington, Massachusetts, is a leader in the design, manufacture and sale of advanced minimally invasive medical instruments in the fields of neurosurgery and radiation therapy.Radionics'Radionics’ products include the CUSAEXcel(R)Excel™ ultrasonic surgical aspiration system, theCRW(R)CRW® stereotactic system, theXKnife(R)XKnife™ stereotactic radiosurgery system, and theOmniSight(R)OmniSight® EXcel image guided surgery system.Tyco Healthcare soldThis acquisition increases our global neurosurgery product offering, positions us to offer new stereotactic surgery products, and secures our entry into theRadionics products in over 75 countries, using a network of independent distributors in the United Statesradiosurgery/radiotherapy andboth independent distributors and Tyco Healthcare affiliates internationally. We are likely to use distributors in many of the markets in which Tyco Healthcare sold direct. As a result, we expect that revenue and pre-tax income attributable to the acquired product lines will be reduced from the 2005 reported levels. In addition, because the CUSA Excel ultrasonic aspiration system competes with our existing line of ultrasonicimage-guided surgerysystems, our sales force may, in some situations, sell the CUSA system in lieu of our existing ultrasonic aspirator products. Overall, the acquired business has been growing at rates below our corporate growth rate targets.device business.26
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In September 2005, we acquired the intellectual property estate of Eunoe, Inc. for $0.5 million in cash. Prior to ceasing operations, Eunoe, Inc. was engaged in the development of its innovative
COGNIShunt(R)COGNIShunt® system for the treatment ofAlzheimer'sAlzheimer’s disease patients. The acquired intellectual property has not been developed into a product that has been approved or cleared by the FDA and has no future alternative use other than in clinical applications involving the regulation of cerebrospinal fluid. Accordingly, we recorded the entire acquisition price as an in-process research and development charge in 2005.In January 2005, we acquired all of the outstanding capital stock of Newdeal Technologies SAS. We paid $51.9 million (38.3 million euros) in cash at closing, a $0.7 million working capital adjustment paid in January 2006 and $0.8 million of acquisition related expenses. Additionally, we paid the sellers an additional $1.6 million (1.3 million euros) in January 2006 as a result of their continued employment with us through January 3, 2006. This additional payment was accrued to selling, general and administrative expense on a straight-line basis in 2005 over the one-year employment requirement period.
Newdeal is a leading developer and marketer of specialty implants and instruments specifically designed for foot and ankle surgery.
Newdeal'sNewdeal’s products include a wide range of products for the forefoot, themid-footmidfoot and thehind 26foot,hindfoot, including theBold(R)Bold® Screw,Hallu-Fix(R)Hallu®-Fix plate system and theHINTEGRA(R)HINTEGRA™ total ankle prosthesis.At the time of the acquisition, Newdeal sold its products through a direct sales force in France, Belgium and the Netherlands, and through distributors in more than 30 countries, including the United States and Canada. During 2005, we began to market the Newdeal products directly in the United States through our Integra Reconstructive Surgery sales force. Newdeal'sNewdeal’s target physicians include orthopedic surgeons specializing in injuries of the foot, ankle and extremities, as well as podiatric surgeons.In May 2004, we acquired the
MAYFIELD(R)MAYFIELD® Cranial Stabilization and Positioning Systems and theBUDDE(R)BUDDE® Halo Retractor System business from Schaerer Mayfield USA, Inc. (formerly Ohio Medical Instrument Company) for $20.0 million in cash paid at closing, a $0.3 million working capital adjustment and $0.3 million of acquisition related expenses. TheMAYFIELD(R)MAYFIELD® andBUDDE(R)BUDDE® lines include skull clamps, headrests, reusable and disposable skull pins, blades, retractor systems and spinal implants.MAYFIELDMAYFIELD® systems are the market leader in the United States, and neurosurgeons havebeenusedby neurosurgeonsthem for over thirty years. The products are sold in the United States through our IntegraNeuroSciences(TM)NeuroSciences direct sales organization and in international markets through distributors.In May 2004, we acquired all of the capital stock of Berchtold Medizin-Elektronik GmbH, now named Integra ME GmbH, from Berchtold Holding GmbH for $5.0 million in cash. Integra ME
manufacturesmanufactured andmarketssold theELEKTROTOM(R)ELEKTROTOM® line of electrosurgery generators and theSONOTOM(R)SONOTOM™ ultrasonic surgical aspirator, as well as a broad line of related handpieces, instruments and disposables used in many surgical procedures, including neurosurgery. We closed the Integra ME production facility at the end of 2005 and integrated the manufacturing and distribution of the products into other Integra operations.In January 2004, we acquired two small instruments businesses: the R&B instrument business
fromof R&B Surgical Solutions, LLC for $2.0 million in cash and the Sparta disposable critical care devices and surgical instruments business from Fleetwood Medical, Inc. for $1.6 million in cash. The R&B instrument line is a complete line of high-quality handheld surgical instruments used in neuro- and spinal surgery. The Sparta product line includes products used in plastic and reconstructive, ear, nose and throat (ENT), neuro, ophthalmic and general surgery.In December 2003, we acquired the assets of Reconstructive Technologies, Inc. for $0.4 million in cash and an agreement to make future payments based on product sales. Reconstructive Technologies was the developer of the Automated Cyclic Expansion System (ACE System(TM)), a tissue expansion device. As the ACE system was not yet approved for sale, we recorded a $0.4 million in-process research and development charge in connection with this acquisition. We are evaluating the regulatory, engineering, and clinical efforts necessary to develop and launch the ACE System.RESTRUCTURING ACTIVITIES
During the second quarter ofIn June 2005, we announced plans to restructure certain of our European operations. The restructuring plan included closing our Integra ME production facility in Tuttlingen, Germany and reducing
the manufacturing overhead workforcevarious positions in our production facility located in Biot, France, both of which were substantially completed in December 2005. We transitioned the manufacturing operations of Integra ME to our production facility in Andover,England. During the second quarter of 2005, weUnited Kingdom. We also eliminated some duplicative sales and marketing positions, primarily in Europe.ApproximatelyWe terminated 68individuals were identified for terminationemployees under the European restructuring plan.As of December 31, 2005, we terminated 65 of these individuals.In 2005, we also completed the transfer of the Spinal Specialties assembly operations from our San Antonio, Texas plant to our San Diego, California plant and we continue to transfer certain assembly, processing and packaging operations to our San Diego and Puerto Rico facilities. During the year ended December 31, 2006, we terminated four employees in connection with the transfer of certain manufacturing packaging operations from our plant in Plainsboro, New Jersey to our plant in Anasco, Puerto Rico.
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In October 2006, we announced plans to further restructure our French sales and marketing organization. One plan includes the elimination of nine positions at our Biot, France facility. Another plan includes the closing of our facility in Nantes, France and the elimination of three positions. These activities will be transferred to the sales and marketing headquarters in Lyon, France and should be completed in 2007.
In connection with these restructuring activities, we recorded employee termination costs of $1.0 and $4.0 million
of chargesin 2006 and 2005, respectively, for the estimated costs of employee termination benefits to be provided to the affected employees and related facility exit costs.While we expect a positive impact
offrom the restructuring and integration activities, such results remain uncertain. Weexpect to reinvesthave reinvested most of the savings from these restructuring and integration activities in further expanding our European sales, marketing and distribution organization andaddingintegrating the Radionics, KMI and Newdealgroup's business tobusinesses into our existing sales and distributionnetwork. 27networks. RESULTS OF OPERATIONS
Net income in
20052006 was $29.4 million, or $0.97 per diluted share, as compared to net income of $37.2 million, or $1.15 per diluted share,as compared toin 2005 and net income of $17.2 million, or $0.55 per diluted share, in2004 and net income of $26.9 million, or $0.86 per diluted share, in 2003.2004. These amounts include the following pre-tax charges:
(in thousands) 2005 2004 2003 ------ ------ ------CHARGES: - -------- Involuntary employee termination costs ........... $ 3,861 $ -- $ 120 Facility consolidation, acquisition integration and related costs ................ 2,340 -- 987 Acquired in-process research and development ..... 500 -- 400 Costs associated with discontinued products lines ............................... 478 -- -- Inventory fair market value purchase accounting adjustments .................................. 466 270 1,261 Cash donation to the Integra Foundation .......... 250 -- 2,000 Acquired technology licensing and milestone payments ........................... -- 1,855 -- Tax charge incurred in connection with the reorganization of certain European operations. -- 1,300 -- ------ ------ ------ Total ......................................... $ 7,895 $ 3,425 $ 4,768
2006 2005 2004 (in thousands) CHARGES Involuntary employee termination costs $ 1,034 $ 3,861 $ — Facility consolidation, acquisition integration, manufacturing transfer, enterprise business system integration and related costs 1,299 2,340 — Acquired in-process research and development 5,875 500 — Impairment of inventory and fixed assets related to discontinued product lines 1,578 478 — Inventory fair market value purchase accounting adjustments 4,640 466 270 Charges associated with convertible debt exchange offer 1,879 — — Charges associated with termination of interest rate swap 1,425 — — Cash donation to the Integra Foundation 1,000 250 — Acquired technology licensing and milestone payments — — 1,855 Tax charge incurred in connection with the reorganization of certain European operations — — 1,300 Total $ 18,730 $ 7,895 $ 3,425 Of these amounts, $10.9 million, $2.9 million and $0.3 million were charged to cost of product revenues for the years ended December 31, 2006, 2005 and 2004 respectively and $8.8 million, $1.0 million and $0 million were charged to research and development for the same periods. The remaining amounts were primarily charged to selling, general and administrative expenses.
In 2004, we recognized $1.4 million of other income related to an unrealized gain on a foreign currency collar, which was used to reduce our exposure to fluctuations in the exchange rate between the euro and the US dollar as a result of our commitment to acquire Newdeal Technologies for 38.5 million euros. The foreign currency collar expired in January 2005, concurrent with our acquisition of Newdeal Technologies.
We believe that, given our ongoing, active strategy of seeking acquisitions, our current focus on rationalizing our existing manufacturing and distribution infrastructure and our recent review of various product lines in relation to our current business strategy,
thecertain charges and amounts recorded to other income discussed above could recur with similar materiality in the future. We believe that the delineation of these costs provides useful information to measure the comparative performance of our business operations.28
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Net income also includes the following amounts:
In 2006, the adoption of SFAS 123R – “Share-Based Payment” resulted in $9.6 million, net of tax, of stock based compensation expense.
In 2005, we recognized an additional $1.3 million of royalty revenue related to a change in the manner we use to estimate royalties earned based on
Medtronic'sMedtronic’s sales of itsINFUSE(TM)INFUSE® bone graft product. Prior to 2005, we recognized this royalty revenue whenWyethpaidus royalties becauseas Wyeth did not provide information for us tous about the royalty amount earned each quarter prior to us reporting our quarterly financial results and we did not havedevelop a reliable basis forotherwiseestimating and recording royalty revenue in the same quarter it was earned. However, we now receive timely quarterly royalty revenue information,from Wyeth more quickly, wehave sufficient historical information available to help us estimate and the volatility in the royalty earned each quarter has decreased significantly. Accordingly, in 2005 we started recognizing this royalty on an accrual basis in the quarter earned.In 2004, we recognized a $23.9 million non-cash compensation charge related to the renewal of our President and Chief Executive
Officer'sOfficer’s employment agreement.In 2003, we recorded $11.0 million of other revenue related to the acceleration of the recognition of unused minimum purchase payments and unamortized license fee revenue from ETHICON following the termination of the Supply, Distribution and Collaboration agreement in December 2003. We also received a $2.0 million payment from ETHICON from the termination of our agreement with them, which is included in other income.These amounts represent revenues, gains and charges resulting from facts and circumstances that, based on our recent history and future expectations, are not expected to recur with similar materiality or
impacteffect on continuingoperations. 28operations with the exception of compensation expense under SFAS 123R. SFAS 123R was noted because of the lack of comparability with 2005 and 2004. We believe that the identification of these revenues, charges and gains that meet these criteria promotes comparability of reported financial results for the periods presented. Total Revenues and Gross Margin
on Product Revenues (Exclusive
2006 2005 2004 (in thousands, except per share data) Neurosurgical and Orthopedic Implants $ 166,432 $ 134,598 $ 101,791 Medical Surgical Equipment and other 252,865 143,337 128,034 Total revenues 419,297 277,935 229,825 Cost of product revenues 168,314 107,052 88,496 Gross margin 250,983 170,883 141,329 Gross margin as a percentage of revenues 60 % 61 % 61 % In 2006, total revenues increased 51% over 2005 to $419.3 million. Sales of
Amortization Related to Acquired Intangible Assets)instruments and implant products, which reported a 111% and 21% increase, respectively, in sales over 2005, led our growth in revenues in 2006.
(in thousands, except per share data) 2005 2004 2003 -------- -------- --------Monitoring products ................................. $ 48,940 $ 48,217 $ 44,229 Implant products ......... .......................... 108,156 78,418 53,301 Instruments ......................................... 91,918 77,667 47,168 Private label products .............................. 28,757 24,188 21,997 -------- -------- -------- Total product revenues ................................. 277,771 228,490 166,695 Other revenue .......................................... 164 1,335 18,904 -------- -------- -------- Total revenues.......................................... 277,935 229,825 185,599 Cost of product revenues (exclusive of amortization related to acquired intangible assets) ............. 105,536 87,299 70,597 Gross margin on product revenues ....................... 172,235 141,191 96,098 Gross margin as a percentage of product revenues ....... 62% 62% 58%In 2005, total revenues increased 21% over 2004 to $277.9
million, led by a $49.3 million, or 22%, increase in product revenues to $277.8million.Domestic product revenues increased $26.4 million in 2005 to $207.2 million, or 75% of total product revenues, as compared to 79% and 80% of product revenues in 2004 and 2003, respectively.Sales of instruments and implant products, which reported a 38% and 18% increase, respectively, in sales over 2004, led our growth inproductrevenues in 2005.In 2004, total revenues increased 24% over 2003 to $229.8 million, led by a $61.8 million, or 37%, increase in product revenues to $228.5 million. Domestic product revenues increased $48.1 million in 2004 to $180.9 million. Sales of instruments and implant products, which reported a 65% and 47% increase, respectively, in sales over 2003, led our growth in product revenues in 2004.Reported
productrevenues for20052006 and20042005 included the following amounts in revenues from acquired product lines:
2005 Revenues 2004 Revenues % change --------------- --------------- ---------- (in thousands)Total Product Revenues Products acquired during 2005 ........... $ 17,033 $ -- N/M Products acquired during 2004 ........... 9,343 2,770 N/M All other product revenues .............. 251,395 225,720 11% --------- -------- Total product revenues .................. 277,771 228,490 22%
2006 2005 Revenues Revenues % Change (in thousands) Total Revenues Products acquired during 2006 $ 98,110 $ 0 N/M Products acquired during 2005 23,050 17,033 35 % All other revenues 298,137 260,902 14 % Total revenues 419,297 277,935 51 % All of the products acquired in 2006 were added to the Medical Surgical equipment group, while all of the products acquired in 2005 were added to the
implants product group, while all of the products acquired in 2004 were added to the instrument productNeurosurgical and Orthopedic Implants group.Product revenuesRevenues excluding
20052006 and20042005 acquisitions grew at11% for the year ended December 31, 200514.3% in 2006 as compared to2004.2005. Increased sales of the following products accounted for a significant portion of this growth: our implant products used for skin replacement and wounddressings,dressings; dural repair and repair and protection of peripheralnerves,nerves; our surgical instrumentation and ultrasonic surgery systems for tissueablation,ablation; andrevenues fromour Absorbable Collagen Sponge product sold toWyeth accounted for a significant portion of this growth.Wyeth. Changes in foreign currency exchange ratesdid not havehad asignificant$0.6 million favorable effect on the year-over-year increase inproductrevenues.29
Product revenues29
Revenues in 2005 and 2004
and 2003,included$53.5$17 million and$24.5$3 million, respectively, in sales of products acquired in either20032004 or2004.2003. Increased sales of our implant products used for skin replacement and wound dressings and dural repair and increased revenues from our Absorbable Collagen Sponge product sold to Wyeth drove this revenue growth. Changes in foreign currency exchange rates in20042005 had a$2.8$0.9 millionfavorableunfavorable effect on the year-over-year increase inproductrevenues.We have developed a new targeted account sales and marketing strategy for products in the monitoring category and expect that it will contribute to improvements in the performance of our monitoring products in future periods.We have generated our
productrevenue growth through acquisitions, new product launches and increased direct sales and marketing efforts both domestically and in Europe. We expect that our expanded domestic salesforce,forces, therecent2005 conversion ofJARITJarit domestic sales from a distributor billing model to a direct billing model, the continued implementation of our direct sales strategy in Europe and sales of internally developed and acquired products will drive our future revenue growth. We also intend to continue to acquire businesses that complement our existing businesses and products.Overall, we expect our revenues to continue to grow in the range of 20% to 30% per annum. We expect organic revenue growth in excess of 15% per annum.Gross margin
as a percentage of product revenues (exclusive of amortization related to acquired intangible assets)was62%60% in 2006, 61% in 200562%and 61% in2004 and 58% in 2003.2004. Cost of product revenues included $4.6 million, $0.5 million,$0.3 million,and$1.3$0.3 million in fair value inventory purchase accounting adjustments recorded in connection with acquisitions in 2006, 20052004and2003,2004, respectively. Our gross margin in 2005 was also negatively affected by $2.6 million of termination costs incurred in connection with our European restructuring activities, $0.9 million of charges associated with facility consolidations and $0.3 million of charges associated with a discontinued product line. Continued growth in sales of higher-margin products, including our skin replacement and wound dressing implants, dural repair implants, cranial stabilization systems, andrecently acquiredfoot and ankle implant products offset the impact of the charges recorded in 2005.In
2006,2007, we expect our consolidated gross margin to increase. We expect that sales of our higher gross margin products will continue to increase as a proportion of totalproductrevenues.Also, we have begun to bill hospital customers directly for sales of JARIT instruments to them, rather than distributors. We expect that this will result in increased product revenues, a higher gross margin, and increased selling expenses.We anticipate that the relatively lower gross margin generated from sales of Radionics and Miltex products will offset some of these benefits.Gross margins in 2004 improved as compared to 2003 as a result of increased sales of higher margin products, including our skin replacement and wound dressing implants and dural repair implants and the cranial stabilization systems acquired in 2004, and from the negative impact of the $1.3 million in fair value inventory purchase accounting adjustments recorded in 2003.Other Operating Expenses
The following is a summary of other operating expenses as a percent of total revenues:
2005 2004 2003 -------- -------- --------Research and development ............................... 4% 6% 7% Selling, general and administrative .................... 35% 43% 32%We reported
2006 2005 2004 Research and development 6 % 4 % 6 % Selling, general and administrative 38 % 35 % 43 % Intangible asset amortization 2 % 2 % 2 % The increase in the above expenses is partially related to a $5.9 million in-process research and development
chargescharge related to the acquisition of KMI, $14 million stock-based compensation expense associated with the adoption of SFAS 123R (the majority of which is included in selling, general and administrative expense) and higher commission expense associated with the Jarit direct bill initiative. Expenses also increased because of the continued expansion of our direct sales and marketing organizations in our direct selling platforms and increased corporate staff to support the recent growth in our business to integrate acquired businesses. The Radionics, Miltex, KMI and Canada Microsurgical businesses contributed approximately $30.6 million in other operating expenses in 2006.Research and development expenses in 2006 increased by $14 million compared to 2005, to $26 million. Included in research and development costs during 2006 were a $5.9 million in-process research and development charge related to the KMI acquisition, a $0.5 million charge related to an up-front payment pursuant to a new product development alliance and
$0.4$0.6 million of stock-based compensation expense associated with the adoption of SFAS 123R. In addition to these charges, research and development expenses increased by $3.0 million in 2006 as a result of the acquisitions of Radionics and KMI. We recognized a $1.6 million impairment of inventory and fixed assets associated with a discontinued project for the development of an ultrasonic aspirator system. This project was discontinued in June 2006 following our review of our existing technology and the ultrasonic aspirator technology acquired in the Radionics acquisition. We determined there was no future, alternative use for the inventory or fixed assets in any other development project. There was also an overall increase of $4.2 million associated with product development initiatives compared to the prior-year period.30
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In 2005,
and 2003, respectively. Thewe had a $0.5 million in-process research and development chargein 2005related to intellectual property acquired from Eunoe,Inc in September 2005.Inc. Prior to ceasing operations, Eunoe, Inc. was engaged in the development ofits innovative COGNIShunt(R)the COGNIShunt® system for the treatment ofAlzheimer'sAlzheimer’s disease patients.The acquisition of the Eunoe intellectual property estate and clinical trial data extends Integra's technology to regulate the flow of cerebrospinal fluid within the brain.The acquired intellectual property has not been developed into a product that has been approved or cleared by the FDA and has no future alternative use other than in clinical applications involving the regulation of cerebrospinal fluid.30Research and development costs have continued to decline as a percentage of total revenue as we continue to restructure our research and development activities. The percentage declines are also the result of significant increases in hand-held instrument sales, which by their nature require less research and development expenditures compared to our other product lines.In
2005, our research and development expenses decreased $2.2 million to $12.0 million because of decreased development efforts related to our next generation ultrasonic aspirator and from the impact of the $1.4 million milestone payment related to the completion of certain development activities for an advanced neuro-monitoring system made in 2004. Our 2004 research and development expenses increased $1.3 million to $14.1 million and included the $1.4 million milestone payment and a $0.5 million licensing fee paid for the development of a data acquisition system to support the integration of our advanced monitoring products. In 2003, we incurred $1.1 million of expenses related to the consolidation of our San Diego research center with our other facilities. In 2006,2007, we expect our research and development expenses as a percentage of total revenues to increase slightly as we increase expenditures on research and clinical activities. These activities will be directed toward expanding the indications for use of our absorbable implant technology products, including a multi-center clinical trial suitable to support an application to the FDA for approval of the DuraGenPlus(TM)Plus® Adhesion Barrier Matrix product in the United States. Therecentlyacquired Radionics business alsospends proportionately more onadds to our research anddevelopment. We capitalize inventory costsdevelopment spending.In 2006, selling, general and administrative expenses increased $59.4 million, or 60% as compared to the prior-year period, to $157.7 million. This increase includes $13.1 million of stock-based compensation expense associated with
certain products priorthe adoption of SFAS 123R and higher commission expenses associated with the Jarit direct bill initiative. Selling, general and administrative costs also increased in 2006 in connection with the recently acquired Radionics, Miltex, KMI and Canada Microsurgical businesses. We also continue toregulatory approval, based on management's judgmentexpand our direct sales and marketing organizations in our direct selling platforms and increased corporate staff to support the recent growth in our business and to integrate acquired businesses. Additionally, we have incurred higher operating costs in connection with our recent investments in our infrastructure, including the continued implementation ofprobable future commercialization.an enterprise business system and the relocation and expansion of our domestic and international distribution capabilities through third-party service providers. Wecould be requiredexpect toexpense previously capitalizedincur costs related topre-approval inventory upon a changethese activities insuch judgment, due to, among other potential factors, a denial or delay of approval by necessary regulatory bodies or a decision by management to discontinue the related development program. At December 31, 2005,2007 as wecapitalized approximately $0.9 million of pre-approval inventory.complete these on-going activities.In 2004, our selling, general and administrative expenses included a $23.9 million share-based compensation charge related to the renewal of our President and Chief Executive
Officer'sOfficer’s employment agreement. Excluding the impact of this charge, selling, general and administrative expenses increased in 2005 because of the continued expansion of our direct sales and marketing organizationsaround all threein our direct selling platforms, increased corporate staff to support therecentgrowth in our business and costs associated with our restructuring, acquisition integration and systems implementation activities. Since 2004, we have been investing resources in the continued implementation of a new global enterprise business system. In 2004 and 2005, we relocated and expanded most of our domestic and international distribution capabilities through third-party service providers.In 2005, we recorded $1.1 million of employee termination costs and $1.4 million of charges associated with facility consolidations, acquisition integrations and related costs incurred in connection with our restructuring activities in selling, general and administrative expenses.
We do not expect that theIn 2006, we recorded $1.0 million of employee termination coststo complete these activities in 2006 will be as significant, although there may be additional significant costs incurred to integrate the Radionics business.associated with further restructuring of our European sales and marketing operations.In 2005, we also recorded $8.3 million of selling, general and administrative expenses associated with the
recentlyNewdeal business acquiredNewdeal businesses.in January 2005. These costs included a $1.4 million compensation charge related to thesellers'sellers’ obligation to continue their employment withIntegraNewdeal through the end of 2005.In 2006, we expect our selling, general and administrative costs as a percentage of revenue to increase as compared to 2005 as a result of the impact of expensing all share-based compensation following the adoption of SFAS No. 123(R) and from higher commissions associated with the conversion of JARIT domestic sales from a distributor billing model to a direct billing model.Amortization expense increased to
$6.1$11.6 million in20052006 because of amortization on intangible assets acquired through our business acquisitions. Including the impact of intangible assets acquired in the Radionics,acquisition,Miltex, KMI and Canada Microsurgical acquisitions, we expect annual amortization expense to be approximately$8.1 million in 2006, $8.3$14.3 million in 2007,$8.0$13.9 million in 2008,$7.3$12.5 million in 2009,and $6.7$10.8 million in2010. 312010 and $10.6 million in 2011. Non-Operating Income and Expenses
Interest expense primarily relates to the $120 million of 21/2% contingent convertible subordinated notes that we have outstanding, a related interest rate swap agreement, which was terminated on September 27, 2006, and interest and fees relating to our senior secured credit facility. The increase in interest expense for the year ended December 31, 2006 is primarily related to the write-off of unamortized debt issuance costs related to the old notes discussed below and interest associated with our credit facility. In 2006, we made net additional borrowings of $100 million under our credit facility.
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On September 27 and October 20, 2006, we exchanged $119.5 million (out of a total of $120.0 million) of our old contingent convertible notes for the equivalent amount of new notes. See Note 5 to the financial statements for a further discussion. In connection with the exchange of our convertible notes, we recorded a $1.2 million write-off of the unamortized debt issuance costs and $0.3 million of fees associated with the old contingent convertible notes that were exchanged. Our reported interest expense for the years ended December 31, 2006, 2005, and 2004 included $0.6 million, $0.8 million, and $0.8 million, respectively, of non-cash amortization of debt issuance costs.
In 2003, we received approximately $115.9 million of net proceeds from the sale of $120.0 million of our 21/
2%2% contingent convertible subordinated notes due in March 2008. In 2006, 2005,2004,and2003,2004 we recorded interest expense of$3.9$3.0 million,$3.5$3.0 million, and$2.7$3.0 million, respectively, in connection with thesenotes, which was offset by $3.9 million, $4.0 million, and $3.2 million, respectively, ofnotes. In addition, we recorded interest income on our invested cash and marketable debtsecurities.securities of $1.3 million, $3.9 million and $4.0 million in 2006, 2005 and 2004, respectively.We will pay additional interest
("(“contingentinterest"interest”) on our convertible notes if, at thirty days prior to maturity, our common stock price is greater than $37.56 per share. We recorded a $0.4 million liability related to the estimated fair value of the contingent interest obligation at the time the notes were issued. The contingent interest obligation, which remains unchanged by the exchange, is marked to its fair value at each balance sheet date, with changes in the fair value recorded to interest expense. At December 31,2005,2006, the estimated fair value of the contingent interest obligation was$0.7$1.1 million. In 2006, we recorded $0.4 million of interest expense associated with changes in the estimated fair value of the contingent interest obligation. In 2005, interest expense associated with changes in the estimated fair value of the contingent interest obligation was not significant. In 2004,and 2003, respectively,we recorded $0.3million and $0.1million of interest expense associated with changes in the estimated fair value of the contingent interest obligation.In August 2003, we entered into an interest rate swap agreement with a $50.0 million notional amount to hedge the risk of changes in fair value attributable to interest rate risk with respect to a portion of our
fixed ratefixed-rate convertible notes. Wereceivereceived a 21/2%2% fixed rate from the counterparty, payable on a semi-annual basis, andpaypaid to the counterparty a floating rate based on 3-month LIBOR minus 35 basis points, payable on a quarterly basis. The interest rate swap agreementterminateswas scheduled to terminate in March 2008, subject to early termination upon the occurrence of certain events, including redemption or conversion of the convertible notes. On September 27, 2006, we terminated this interest rate swap agreement in connection with the exchange of our convertible notes. The interest rate swap agreementqualifiesqualified as a fair value hedge under SFAS No. 133, as amended"Accounting“Accounting for Derivative Instruments and Hedging Activities."” The net amount to be paid or received under the interest rate swap agreementiswas recorded as a component of interest expense.In 2005, we recorded an additional $0.2We paid the counterparty approximately $2.2 million in connection with the termination of the swap, consisting of a $0.6 million payment of accrued interest
expense associated withand a $1.6 million payment representing the fair market value of the interest rate swapwhile we recorded a $0.7 million and $0.3 million reductionon the termination date. We had already accrued the termination payment. Historically, the net difference between changes ininterest expense in 2004 and 2003, respectively. The netthe fair value of the interest rate swapat December 31, 2005and the contingent convertible notes represented the ineffective portion of the hedging relationship, and this amount was$2.0 million.recorded in other income / (expense) net.We recorded the following changes in the net fair values of the interest rate swap and the hedged portion of the contingent convertible
notes:
2005 2004 2003 -------- -------- -------- (in thousands)Interest rate swap ............................... $ 690 $ 287 $ 305 Contingent convertible notes ..................... (821) (430) (433) -------- -------- -------- Net increase (decrease) in liabilities ........... $ (131) $ (143) $ (128)The net decrease in liabilities represents the ineffective portion of the hedging relationship, and thesenotes (2006 amountsare recorded in other income (expense), net.were incurred prior to termination):
2006 2005 2004 (in thousands) Interest rate swap $ (690 ) $ 690 $ 287 Contingent convertible notes 343 (821 ) (430 ) Net increase (decrease) in liabilities $ (347 ) $ (131 ) $ (143 ) Our net other income (expense)
declinedincreased in20052006 by$3.4$1.2 million to$0.7$2.0 million of expense. In 2006, we recognized $1.4 million in other expense related to the interest rate swap unwind. See Note 6 – Derivative Instruments for a further discussion. In 2004, we recorded a $1.4 million unrealized gain associated with a 38.5 million euro foreign currency collar contract that expired on January 3,2005.2005, concurrent with our acquisition of Newdeal. We entered into this contract to reduce our exposure to fluctuations in the exchange rate between the euro and the dollar as a result of our commitment to acquire Newdeal in January 2005 foreuro38.5million.million euros. The collar contract did not qualify as a hedge under SFAS No. 133. Accordingly, the collar contract was recorded at fair value and changes in fair value were recorded in other income (expense), net.The foreign currency collar expired in January 2005, concurrent with our acquisition of Newdeal Technologies.32
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Income Taxes
In
2005,2006, our effective income tax rate was32.5%39.1% of income before income taxes, compared to 32.5% in 2005 and 38.6% in20042004. The 2006 rate includes a $2.1 million tax charge for the write-off of in-process research and37.8%development related to the acquisition of KMI, which is nondeductible for tax purposes and a $0.7 million charge related to the newly adopted accounting treatment for incentive stock options under SFAS 123R. The increase in2003.our effective tax rate from 2005 to 2006 was primarily related to the impact of these charges, as well as, the changes in the geographical mix of taxable income attributable to recently acquired businesses. Our 2004 rate includes a $1.3 million tax charge related to the transfer of intangible assets. The reduction in our effective tax rate from 2004 to 2005 was primarily related to the impact of this charge on our 2004 effective rate and the favorable impact of various planning and reorganization initiatives that werecently implemented. 32implemented in 2005. Our effective tax rate
maycould vary from year to year depending on, among other factors, the geographic and business mix of taxable earnings and losses. We consider these factors and others, including our history of generating taxable earnings, in assessing our ability to realize deferred tax assets.The net decrease in our tax asset valuation allowance was $3.5 million, $0.2 million,
$0,and$2.3$0 million in 2006, 2005 and 2004,and 2003,respectively. The change in 2006 was recorded against the gross amount of the related deferred tax asset.A valuation allowance of
$5.1$1.6 million is recorded against the remaining$27.3$24.0 million of net deferred tax assets recorded at December 31,2005.2006. This valuation allowance relates to deferred tax assets for certain expenses which will be deductible for tax purposes in very limited circumstances and for which we believe it is unlikely that we will recognize the associated tax benefit. We do not anticipate additional income tax benefits through future reductions in the valuation allowance. However, if we determine that we would be able to realize more or less than the recorded amount of net deferred tax assets, we will record an adjustment to the deferred tax asset valuation allowance in the period such a determination is made.At December 31,
2005,2006, we had net operating loss carryforwards of$15.8$11.0 million for federal income tax purposes and$0.4$2.3 million for foreign income tax purposes to offset future taxable income. The federal net operating loss carryforwards expire through20242010, and the foreign net operating loss carryforwards have no expiration. Weexpect to useused all of our remaining unrestricted net operating loss carryforwards in 2006.At December 31,
2005, several2006, certain of our subsidiaries had unused net operating loss carryforwards and tax credit carryforwards arising from periods prior to our ownership which expire through 2010. The Internal Revenue Code limits the timing and manner in which we may use any acquired net operating losses or tax credits.We do not provide income taxes on undistributed earnings of non-U.S. subsidiaries because such earnings are expected to be permanently reinvested. Undistributed earnings of foreign subsidiaries totaled $20.3 million, $8.5 million and $2.6 million, at December 31, 2006, 2005 and 2004, respectively.
The American Jobs Creation Act of 2004 was signed into law in October 2004 and has several provisions that may impact our income taxes in the future, including the repeal of the extraterritorial income exclusion and a deduction related to qualified production activities income. The qualified production activities deduction is a special deduction and will have no impact on deferred taxes existing at the enactment date. Rather, the impact of this deduction will be reported in the period in which the deduction is claimed on our tax return. Pursuant to United States Department of Treasury Regulations issued in October 2005, we
believe that we will realizehave realized a tax benefit on qualified production activities incomeonce we have completely utilized our unrestricted net operating losses, which is expected to occurof $0.3 million in 2006.33
33
INTERNATIONAL
PRODUCTREVENUES AND OPERATIONSProduct revenuesRevenues by major geographic area are summarized below:
United Asia Other States Europe Pacific Foreign Consolidated -------- -------- --------- --------- -------------- (in thousands)2005 ..................... $207,245 $ 48,645 $ 11,403 $ 10,478 $277,771 2004 ..................... 180,887 30,941 8,535 8,127 228,490 2003 ..................... 132,805 21,433 5,828 6,629 166,695
United States Europe Asia Pacific Other Foreign Consolidated (in thousands) 2006 $ 317,503 $ 77,100 $ 12,315 $ 12,379 $ 419,297 2005 207,409 48,645 11,403 10,478 277,935 2004 182,168 30,994 8,535 8,128 229,825 In 2006, revenues from customers outside the United States totaled $101.9 million or 24% of consolidated revenues, of which approximately 76% were sales to European customers. Revenues from customers outside the United States included $57.6 million of revenues generated in foreign currencies.
In 2005,
productrevenues from customers outside the United States totaled $70.5 million, or 25% of consolidatedproductrevenues, of which approximately 69% were sales to European customers. Revenues from customers outside the United States included $55.2 million of revenues generated in foreign currencies.In 2004,
productrevenues from customers outside the United States totaled $47.6 million, or 21% of consolidatedproductrevenues, of which approximately 65%33were sales to European customers. Revenues from customers outside the United States included $33.6 million of revenues generated in foreign currencies. In 2003, product revenues from customers outside the United States totaled $33.9 million, or 20% of consolidated product revenues, of which approximately 63% were to European customers. Revenues from customers outside the United States included $21.3 million of revenues generated in foreign currencies.Because we have operations based in Europe and we generate revenues and incur operating expenses in euros and British pounds, we will experience currency exchange risk with respect to those foreign currency denominated revenues or expenses.
In 2005, 2004 and 2003,We also experience currency exchange risk with respect to thecost of products we manufactured in our European facilities or purchased in foreign currencies exceeded our foreign currency-denominated revenues. We expect this imbalance to continue into 2006.yen.We currently do not hedge our exposure to operating foreign currency risk. Accordingly, a weakening of the dollar against the
euroEuro and British pound could negatively affect future gross margins and operating margins. We will continue to assess the potential effects that changes in foreign currency exchange rates could have on our business. If we believe this potential impact presents a significant risk to our business, we may enter into derivative financial instruments to mitigate this risk.Additionally, we generate significant revenues outside the United States, a portion of which are U.S. dollar-denominated transactions conducted with customers who generate revenue in currencies other than the U.S. dollar. As a result, currency fluctuations between the U.S. dollar and the currencies in which those customers do business may have an impact on the demand for our products in foreign countries.
Local economic conditions, regulatory or political considerations, the effectiveness of our sales representatives and distributors, local competition and changes in local medical practice all
maycould combine to affect our sales into markets outside the United States.Relationships with customers and effective terms of sale frequently vary by country, often with longer-term receivables than are typical in the United States.
LIQUIDITY AND CAPITAL RESOURCES
Cash and Marketable Securities
At December 31,
2005,2006, we had cash, cash equivalents and marketable securities totaling$143.4$22.6 million. Investments consist almost entirely of highly liquid, interest bearing debt securities. In the third quarter of 2006, we liquidated our portfolio of marketable securities.34
34
Cash Flows
We generated positive operating cash flows of $71.7 million, $57.0 million, and $39.0 million in 2006, 2005 and
$34.8 million in 2005,2004,and 2003,respectively. Operating cash flows continued to improve primarily as a result of higher pre-tax income, improved working capital management, and the benefits from the continued utilization of our net operating loss carryforwards and tax deductions generated by employee stock option exercises. In 2006, 2005 and 2004, changes in working capital items reduced operating cash flows by $4.5 million, $4.7 million and $20.2 million, respectively. In 2004, we experienced delays in customer collections related to enterprise business systems transitions. The improvement in working capital in 2005 relates to an improvement in the collection cycle for accounts receivable.Our principal uses of funds for the year ended December 31, 2006 was $228.7 million for acquisition consideration, $70 million paid for the purchase of 1.8 million shares for our common stock and $11.5 million in capital expenditures. We received $109.9 million in cash from sales and maturities of available for sale securities, net of purchases. In
2006, we are targeting a decreaseaddition to the $71.7 million indays on hand in inventory to further improve operating cash flows. We expect to use all of our remaining unrestricted net operating loss carryforwards in 2006. Accordingly, we do not expect to realize the same level of benefits to ouroperating cash flowsinfor the year ended December 31, 2006,as compared to prior years.we received $15.9 million from the issuance of common stock through the exercise of stock options during the period and $100 million from borrowings under our credit facility.In 2005, we used $56.3 million to repurchase 1.7 million shares of our common stock, which was partially offset by $9.4 million in cash flows generated from the issuance of common stock under employee benefit plans. Other principal uses of funds in 2005 were $50.6 million for acquisitions and $8.1 million for capital expenditures. In 2005, we generated $27.8 million of cash flows from the net sales and maturities of our investments in marketable debt securities.
34In 2004, we generated $6.1 million from the issuance of common stock under employee benefit plans. We used $29.3 million of cash for acquisitions, $50.6 million for the net purchases of marketable debt securities, $14.2 million for the repurchase of 500,000 shares of our common stock and $8.5 million for capital expenditures.
In 2003, we generated $14.2 million from the issuance of common stock under employee benefit plans and $115.9 million of net proceeds from the sale of $120.0 million of our contingent convertible subordinated notes. We used $50.4 million of cash for acquisitions, $72.9 million for the net purchases of marketable debt securities, $35.4 million for the repurchase of 1.5 million shares our common stock and $3.8 million for capital expenditures. The significant repurchase of our common stock in 2003 was made simultaneously with the issuance of our convertible notes.Working Capital
At December 31,
20052006 and2004,2005, working capital was$234.7$(52.4) million and$192.0$234.7 million, respectively. Theincreasedecrease in working capital in20052006 was primarilyduerelated toincreases in short-term investments asthe use of $228.7 million for acquisitions. Also contributing to the decrease was the reclassification of $119.5 million of contingent convertible notes to current liabilities. Such classification was made because the closing price of ournon-current investment portfolio came closerstock on the issuance date of the new convertible notes was higher than the market price trigger of the new convertible notes. The noteholders have the option tomaturity in 2005.convert new convertible notes into cash and, if applicable, shares of our common stock.Convertible Debt and Related Hedging Activities
We pay interest on our contingent convertible subordinated notes at an annual rate of 21/
2%2% each September15th15 and March15th.15. We will also pay contingent interest on the notes if, at thirty days prior to maturity, our common stock price is greater than $37.56. The contingent interest will be payable at maturity for each of the last three years the notes remain outstanding in an amount equal to the greater of (1) 0.50% of the face amount of the notes and (2) the amount of regular cash dividends paid during each such year on the number of shares of common stock into which each note is convertible. Holders of the notes may convert the notesinto shares of our common stockunder certain circumstances, including when the market price of our common stock on the previous trading day is more than $37.56 per share, based on an initial conversion price of $34.15 per share.The notes are general, unsecured obligations of Integra and will be subordinate to any future senior indebtedness. We cannot redeem the notes prior to their maturity, and the
notes' holdersnoteholders may compel us to repurchase the notes upon a change of control. There are no financial covenants associated with the convertible notes.35
35
On September 27, 2006, we concluded an offer to exchange up to $120 million principal amount of new notes with a “net share settlement” mechanism for our then outstanding contingent convertible subordinated notes. As of that date, an aggregate principal amount of $115.2 million of old notes was tendered. The terms of the new notes are substantially similar to those of the old notes, except that the new notes have a net share settlement feature and include “takeover protections,” whereby we will pay a premium to holders who convert their notes upon the occurrence of designated events, including a change in control. The net share settlement feature of the new notes requires that, upon conversion of the new notes, we will pay holders in cash for up to the principal amount of the converted new notes, with any amount in excess of the cash amount settled, at our election, in cash or shares of our common stock. Holders who exchanged their old notes in the exchange offer received an exchange fee of $2.50 per $1,000 principal amount of their old notes. We
entered intopaid approximately $288,000 of exchange fees to tendering holders of the existing notes plus expenses totaling approximately $332,000 in connection with the offer.On October 20, 2006 an additional $4.3 million of old notes were tendered, bringing the total amount of exchanges to $119.5 million, or 99.6% of the original $120 million principal amount. We paid approximately $11,000 of exchange fees to tendering holders of these notes in connection with this exchange.
On September 27, 2006, we terminated our interest rate swap agreement with a $50 million notional amount to hedge the risk of changes in fair value attributable to interest rate risk with respect to a portion of the notes. See
"- Results“Results ofOperations -Operation — Non-Operating Income and Expenses." We receive a 2 1/2% fixed rate from the counterparty and pay to the counterparty a floating rate based on 3-month LIBOR minus 35 basis points. Our effective interest rate on the hedged portion of the notes was 3.7% as of December 31, 2005.”Share Repurchase Plans
During 2006, 2005,
2004and2003,2004, we repurchased 1.8 million, 1.7 million,0.5 million,and1.50.5 million shares, respectively, of our common stock under authorized share repurchase programs. We hold repurchased shares as treasury shares and may use them for general corporate purposes, including acquisitions and for issuance upon exercise of outstanding stock options.In May 2005, our Board of Directors authorized us to repurchase shares of our common stock for an aggregate purchase price not to exceed $40 million through December 31, 2006. We were authorized to repurchase no more than 1.5 million shares under this program. In October 2005, our Board of Directors terminated the May 2005 repurchase program and adopted a new program that authorized us to repurchase shares of our common stock for an aggregate purchase price not to exceed $50 million through December 31, 2006. During 2005, we repurchased approximately 1.7 million shares of our common stock for $56.3 million under the May 2005 and October 2005 repurchase programs.
In February 2006, our Board of Directors
terminated the October 2005 repurchase program and adopted a new program that authorizesauthorized us to repurchase shares of our common stock for an aggregate purchase price not to exceed $50 millionthroughthough December 31,2006.2006 and terminated our prior repurchase program.In October 2006, our Board of Directors terminated the repurchase program approved in February 2006 and adopted a new program that authorizes us to repurchase shares or our common stock for an aggregate purchase price not to exceed $75 million though December 31, 2007. Shares may be purchased either in the open market or in privately negotiated transactions.
35Dividend Policy
We have not paid any cash dividends on our common stock since our formation. Our credit facility limits the amount of dividends that we may pay. 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 bythat the Board ofDirectors.Directors deems relevant.Requirements and Capital Resources
We believe that our cash and marketable securities are sufficient to finance our operations and capital expenditures in the near term.
In March 2006, we used approximately $76.0 million in cash to complete the acquisition of the Radionics Division of Tyco Healthcare Group, L.P. and pay related transaction expenses. Given the significant level of liquid assets and our objective to grow by acquisition and alliances, our financial position could change significantly if we were to complete another business acquisition by utilizing a significant portion of our liquid assets.36
36
In December 2005, we established a $200 million, five-year, senior secured revolving credit facility.
The credit facility currently allows for revolving credit borrowings in a principal amount of up to $200 million, which can be increased to $250 million should additional financing be required in the future.We plan to utilize the credit facility for working capital, capital expenditures, share repurchases, acquisitions and other general corporate purposes. We did not draw any amounts against this credit facility in 2005. We made borrowings in 2006 for acquisition-related purposes. As of December 31, 2006, we had $100 million of outstanding borrowings under our credit facility at a weighted average interest rate of 6.5% per annum. We amended the credit facility in February 2007 to increase the size of the credit facility to $300 million, which can be increased to $400 million should additional financing be required in the future. We make regular borrowings and payments each month against the credit facility and consider the outstanding amounts to be short-term in nature.The indebtedness under the credit facility is guaranteed by
the Company'sall but one of our domestic subsidiaries. TheCompany'sCompany’s obligations under the credit facility and the guarantees of the guarantors are secured by a first-priority security interest in all present and future capital stock of (or other ownership or profit interest in) each guarantor and substantially all of theCompany'sCompany’s and theguarantors'guarantors’ other assets, other than real estate, intellectual property and capital stock of foreign subsidiaries.Borrowings under the credit facility bear interest, at our option, at a rate equal to (i) the Eurodollar Rate in effect from time to time plus an applicable rate (ranging from
0.75%0.375% to1.5%1.25%) or (ii) the higher of (x) the weighted average overnight Federal funds rate, as published by the Federal Reserve Bank of New York, plus 0.5%, and (y) the prime commercial lending rate of Bank of America, N.A. plus an applicable rate (ranging from 0% to0.5%0.25%). The applicable rates are based on a financial ratio at the time of the applicable borrowing.We will also pay an annual commitment fee (ranging from
0.15%0.10% to0.25%0.20%) on the daily amount by which the commitments under the credit facility exceed the outstanding loans and letters of credit under the credit facility.The credit facility requires us to maintain various financial covenants, including leverage ratios, a minimum fixed charge coverage ratio and a minimum liquidity ratio. The credit facility also contains customary affirmative and negative covenants, including those that limit the
Company'sCompany’s and itssubsidiaries'subsidiaries’ ability to incur additional debt, incur liens, make investments, enter into mergers and acquisitions, liquidate or dissolve, sell or dispose of assets, repurchase stock and pay dividends, engage in transactions with affiliates, engage in certain lines of business and enter into sale and leaseback transactions.In March 2006, we borrowed $16.0 million under the credit facilityThe Company was inconnectioncompliance withthe acquisition of Radionics.such covenants at each balance sheet date.Contractual Obligations and Commitments
As of December 31,
2005,2006, we were obligated to pay the following amounts under various agreements:
Less than More than Total 1 year 1-3 Years 3-5 Years 5 years ------- ----------- ----------- ----------- ----------- (in millions)Long Term Debt............... $120.0 $ -- $120.0 $ -- $ -- Interest on Long Term Debt... 7.5 3.0 4.5 -- -- Operating Leases............. 12.3 2.4 2.3 1.1 6.5 Purchase Obligations......... 2.8 2.8 -- -- -- Pension Contributions ....... 0.3 0.3 -- -- -- -------- ------- ------- -------- ------ Total........................ $142.9 $ 8.5 $126.8 $ 1.1 $ 6.536
Less than 1-3 3-5 More than Total 1 year Years Years 5 years (in millions) Convertible Securities — Short Term $ 119.5 $ 119.5 $ — $ — $ — Convertible Securities — Long Term 0.5 — 0.5 — — Interest on Convertible Securities 4.5 3.0 1.5 — — Employment Agreements 5.5 3.1 2.4 — — Operating Leases 18.4 4.1 5.2 1.9 7.2 Purchase Obligations 1.0 1.0 — — — Warranty Obligations 1.3 1.1 0.2 — — Pension Contributions 0.3 0.3 — — — Total $ 151.0 $ 132.1 $ 9.8 $ 1.9 $ 7.2 In addition, under other agreements we are required to make payments based on sales levels of certain products.
The above table does not include contingent interest that we may be obligated to pay on our contingent convertible subordinated notes due in March 2008. See
"-“– Results of Operations- --Non-Operating– Non-Operating Income and Expenses." OFF-BALANCE SHEET ARRANGEMENTS The $120.0 million of outstanding contingent convertible subordinated notes we have outstanding at December 31, 2005 are convertible into approximately 3.5 million shares of our common stock. If all these notes were converted, our stockholders could experience significant dilution. We would not receive any additional cash proceeds upon the conversion of the notes.”37
37
CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES
Our discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities, and the reported amounts of revenues and expenses. Significant estimates affecting amounts reported or disclosed in the consolidated financial statements include allowances for doubtful accounts receivable and sales returns and allowances, net realizable value of inventories, amortization periods for acquired intangible assets, goodwill, discount rates used to value and test impairments of long-lived assets, computation of taxes, valuation allowances recorded against deferred tax assets, the valuation of stock-based compensation, estimates of projected cash flows and depreciation and amortization periods for long-lived assets, in-process research and development charges and loss contingencies. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the current circumstances. Actual results could differ from these estimates.
We believe the following accounting policies, which form the basis for developing these estimates, are those that are most critical to the presentation of our financial statements and require the most difficult, subjective and complex judgments:
Goodwill and Other Intangible Assets
We review goodwill and purchased intangible assets with indefinite lives for impairment annually and whenever events or changes indicate that the carrying value of an asset may not be recoverable in accordance with the Financial Accounting Standards Board, or FASB, Statement of Financial Accounting Standards, or SFAS, No. 142 –Goodwill and Other Intangible Assets. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of significant assets or products. Application of the goodwill impairment test requires significant judgments, including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, the useful life over which cash flow will occur and determination of our weight-average cost of capital. Changes in these estimates and assumptions could materially affect the determination of fair value and/or goodwill impairment.
Allowances For Doubtful Accounts
AndReceivable and Sales Returns and AllowancesWe evaluate the collectibility of accounts receivable based on a combination of factors. In circumstances where a specific customer is unable to meet its financial obligations to us, we record an allowance against amounts due to reduce the net recognized receivable to the amount that we reasonably expect to collect. For all other customers, we record allowances for doubtful accounts based on the length of time the receivables are past due, the current business environment and our historical experience. If the financial condition of customers or the length of time that receivables are past due were to change, we may change the recorded amount of allowances for doubtful accounts in the future through charges or reductions to selling, general and administrative expense.
We record a provision for estimated sales returns and allowances on
productrevenues in the same period as the related revenues are recorded. We base these estimates on historical sales returns and allowances and other known factors. If actual returns or allowances are different from our estimates and the related provisions for sales returns and allowances, we may change the sales returns and allowances provision in the future through an increase or decrease inproductrevenues.Inventories
Inventories, consisting of purchased materials, direct labor and manufacturing overhead, are stated at the lower of cost (determined by the first-in, first-out method) or market. At each balance sheet date, we evaluate ending inventories for excess quantities, obsolescence or
shelf lifeshelf-life expiration. Our evaluation includes an analysis of historical sales levels by product, projections of future demand by product, the risk of technological or competitive obsolescence for our products, general market conditions, a review of theshelf lifeshelf-life expiration dates for our products, and the feasibility of reworking or using excess or obsolete products or components in the38
38
production or assembly of other
37products that are not obsolete or for which we do not have excess quantities in inventory. To the extent that we determine there are excess or obsolete quantities or quantities with a shelf life that is too near its expiration for us to reasonably expect that we can sell those products prior to their expiration, we record valuation reserves against all or a portion of the value of the related products to adjust their carrying value to estimated net realizable value. If future demand or market conditions are different from our projections, or if we are unable to rework excess or obsolete quantities into other products, we may change the recorded amount of inventory valuation reserves through a charge or reduction in cost of product revenues in the period the revision is made. We capitalize inventory costs associated with certain products prior to regulatory approval, based on
management'smanagement’s judgment of probable future commercialization. We could be required to expense previously capitalized costs related to pre-approval inventory upon a change in such judgment, due to, among other potential factors, a denial or delay of approval by necessary regulatory bodies or a decision by management to discontinue the related development program. At December 31,2005,2006, we had no capitalizedapproximately $0.9 million ofpre-approval inventory. If management decides to discontinue the related development program or we are not able togetobtain the required approvals from regulatory bodies to market these products, we would expense the value of the capitalized pre-approval inventory to research and development expense.Amortization Periods
We provide for amortization using the straight-line method over the estimated useful lives of acquired intangible assets. We base the determination of these useful lives on the period over which we expect the related assets to contribute to our cash flows or a shorter period such that recognition of the amortization better corresponds with the distribution of expected revenues. If our assessment of the useful lives of intangible assets changes, we may change future amortization expense.
Loss Contingencies
We are subject to claims and lawsuits in the ordinary course of our business, including claims by employees or former employees, with respect to our products and involving commercial disputes. We accrue for loss contingencies in accordance with SFAS 5; that is, 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. We consistently accrue legal fees expected to be incurred in connection with loss contingencies as those fees are incurred by outside counsel as a period cost, as permitted by EITF Topic D-77. Our financial statements do not reflect any material amounts related to possible unfavorable outcomes of claims and lawsuits to which we are currently a party because we currently believe that such claims and lawsuits are
either adequately covered by insurance or otherwise indemnified, or arenot expected, individually or in the aggregate, to result in a material adverse effect on our financial condition. However, it is possible that these contingencies could materially affect our results of operations, financial position and cash flows in a particular period if we change our assessment of the likely outcome of these matters.OTHER MATTERS Recently Issued Accounting Standards In December 2004,Income Taxes
Deferred income taxes reflect the
Financial Accounting Standards Board issued Statement No. 123 (revised 2004), "Share-Based Payment," which is a revisionnet tax effects ofStatement No. 123, "Accountingtemporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and their basis for income tax purposes and the tax effects of capital loss, net operating loss and tax credit carryforwards. We record valuation allowances to reduce deferred tax assets to the amounts that are more likely than not to be realized. We could recognize no benefit from our deferred tax assets or we could recognize some or all of the future benefit depending on the amount and timing of taxable income we generate in the future.Stock-Based
Compensation." Statement 123(R) replaces APB Opinion No. 25, "AccountingCompensation ExpensePrior to the adoption of SFAS 123R, employee stock-based compensation was recognized using the intrinsic value method. The Company did not include compensation expense for
Stock Issued to Employees," and amends Statement No. 95, "Statement of Cash Flows." Statement 123(R) requires all share-based payments to employees, including grants ofemployee stock options in net income because stock options were granted with an exercise price equal tobe recognized inthefinancial statements basedfair market value ontheir fair value. Pro forma footnote disclosure will no longer be an alternative to financial statement recognition. We adopted Statement 123(R) onthe date of grant.39
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Effective January 1, 2006,
usingwe account for stock-based compensation costs in accordance with SFAS 123R, which requires the"modified prospective" method. We expect to record $14 millionmeasurement and recognition ofshare-basedcompensation expensein 2006 as a resultfor all stock-based payment awards made to our employees and directors. Under the fair value recognition provision of SFAS 123R, stock-based compensation is measured at the grant date based on the value of theadoptionaward and is recognized as expense over the vesting period. Determining the fair value ofFAS 123R. However, our estimate of future share-based compensation expensestock-based awards at the grant date requires considerable judgment, including estimated expected volatility, expected term and risk-free rate. Our expected volatility isaffected by our stock price, the number of share-based awards that we may grant in 2006, as well as a number of complex and subjective valuation assumptions and the related tax effects. These valuation assumptions include, but are not limited to, thebased on historical volatility of our stock price with forward-looking assumptions. The expected life of the stock options is estimated based on historical data on exercise of stock options. The risk-free interest rate is based on the yield at the time of grant of a U.S. treasury security with an equivalent remaining term. If factors change andemployee stock option exercise behavior. Information aboutwe employ differ assumptions, stock-based compensation expense may differ significantly from what we have recorded in thehistoricalpast.OTHER MATTERS
Recently Issued Accounting Standards
In July 2006, the FASB issued FIN 48, which clarifies the accounting for uncertainty in tax positions. This interpretation requires an entity to recognize the impact of
Statement 123a tax position in its financial statements if that position is more likely than not to be sustained on audit based on the technical merits of the position. The provisions of FIN 48 are effective for us as of January 2007. Any cumulative effect of the change in accounting principle will be recorded as an adjustment to the opening retained earnings. We are evaluating the potential effect of implementing FIN 48 on ourreportedfinancialinformation cancondition and results of operation.In September 2006, the FASB issued statement No. 157 –Fair Value Measurements, or SFAS 157. SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosure about fair value measurements. SFAS 157 is in effect for us as of the beginning of fiscal year 2008. Any cumulative effect will be
found in Note 2recorded as an adjustment to theConsolidatedopening retained earnings. We are evaluating the potential effects of implementing this Statement on our financial condition and results of operation.In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108 –Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,
whichor SAB 108. SAB 108 was issued in order to reduce the diversity in practice in how public companies quantify misstatements of financial statements, including misstatements that were not material to prior years’ financial statements. SAB 108 is effective for fiscal year 2006. The implementation of SAB 108 did not have a material impact on the Company’s financial position or results of operations.In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159 –The Fair Value Option for Financial Assets and Financial Liabilities, or SFAS 159. The Statement provides companies an option to report certain financial assets and liabilities at fair value. The intent of SFAS 159 is to reduce the complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. SFAS 159 is effective for financial statements issued for fiscal years after November 15, 2007. We are
included herein under Item 8. We expect thatevaluating themost 38significantimpact this new standard will have on its financial position and results ofthe adoption of Statement 123(R) in 2006 will be to our selling, general and administrative expenses. Information about other recently issued accounting standards is included in Note 2 to the Consolidated Financial Statements.operations.ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to various market risks, including changes in foreign currency exchange rates and interest rates that could adversely affect our results of operations and financial condition. To manage the volatility relating to these typical business exposures, we may enter into various derivative transactions when appropriate. We do not hold or issue derivative instruments for trading or other speculative purposes.
Foreign Currency Exchange Rate Risk
Because we have operations based in Europe and we generate revenues and incur operating expenses in euros and British pounds, we will experience currency exchange risk with respect to those foreign currency denominated revenues or expenses.
In 2005, the total cost of products we manufacture in or purchase in foreign currencies and other operating expenses that we incur in foreign currencies exceeded our total foreign currency-denominated revenues. We expect this imbalance to continue into 2006.A weakening of the dollar against the euro and British pound could positively affect future revenues and negatively affect future gross margins and operating margins, while strengthening of the dollar against the euro and the British pound could negatively affect future revenues and positively affect future gross margins and operating margins.40
40
In November 2004, we entered into a collar contract that expired on January 3, 2005 for 38.5 million euros to reduce our exposure to fluctuations in the exchange rate between the euro and the US dollar as a result of our commitment to acquire Newdeal in January 2005 for 38.5 million euros. The collar contract did not qualify as a hedge under SFAS No. 133. Accordingly, the collar contract was recorded at fair value and changes in fair value were recorded in other income (expense), net. In 2004, we recorded a $1.4 million unrealized gain related to the change in the fair value of the collar contract as of December 31, 2004. The foreign currency collar expired in January 2005, concurrent with our acquisition of
Newdeal Technologies.Newdeal.Other than this foreign currency collar, we have not used derivative financial instruments to manage foreign currency risk. As the volume of our business transacted in foreign currencies increases, we will continue to assess the potential effects that changes in foreign currency exchange rates could have on our business. If we believe this potential impact presents a significant risk to our business, we may enter into additional derivative financial instruments to mitigate this risk.
Interest Rate Risk
-– Marketable Debt SecuritiesWe are exposed to the risk of interest rate fluctuations on the fair value and interest income earned on our cash and cash equivalents and investments in available-for-sale marketable debt securities. A hypothetical 100 basis point movement in interest rates applicable to our cash and cash equivalents and investments in marketable debt securities outstanding at December 31,
20052006 would increase or decrease interest income by approximately$1.4$0.2 million on an annual basis. We are not subject to material foreign currency exchange risk with respect to these investments.Interest Rate Risk
-– Long-Term Debt and Related Hedging InstrumentsWe are exposed to the risk of interest rate fluctuations on the net interest received or paid under the terms of an interest rate swap. At December 31, 2005,On September 27, 2006, we
had outstanding aterminated our $50.0 million notional amount interest rate swap used to hedge the risk of changes in fair value attributable to interest rate risk with respect to a portion of our $120.0 million principal amountfixed ratefixed-rate 21/2%2% contingent convertible subordinated notes due March 2008. Wereceivereceived a 21/2%2% fixed rate from the counterparty, payable on a semi-annual basis, andpaypaid to the counterparty a floating rate based on 3-month LIBOR minus 35 basis points, payable on a quarterly basis. The floating rateresetsreset each quarter.The interest rate swap agreement terminates on March 15, 2008, subject to early termination upon the occurrence of certain events, including redemption or conversion of our contingent convertible notes. Our effective interest rate payable on the floating rate portion of the swap was 3.7% as of December 31, 2005. 39Our interest rate swap agreement qualifies as a fair value hedge under SFAS No. 133, as amended, "Accounting for Derivative Instruments and Hedging Activities." At December 31, 2005, the net fair value of the interest rate swap approximated $2.0 million and is included in other liabilities. The net fair value of the interest rate swap represents the estimated receipts or payments that would be made to terminate the agreement. A hypothetical 100 basis point movement in interest rates applicable to the interest rate swap would increase or decrease interest expense by $0.5 million on an annual basis.ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial statements and the financial statement schedules specified by this Item, together with the reports thereon of PricewaterhouseCoopers LLP, are presented following Item 15 of this report.
Information on quarterly results of operations is set forth in our financial statements under Note 16
"Selected“Selected Quarterly Information- Unaudited"– Unaudited” to the Consolidated Financial Statements.ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange
Commission'sCommission’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow for timely decisions regarding required disclosure. Disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Management has designed our disclosure controls and procedures to provide reasonable assurance of achieving the desired control objectives.41
41
As required by Exchange Act Rule 13a-15(b), we have carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31,
2005.2006. Based on the foregoing, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.Management'sManagement’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework inInternal Control
-–Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework inInternal Control-— Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31,2005.2006. Ourmanagement'smanagement’s assessment of the effectiveness of our internal control over financial reporting as of December 31,20052006 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included herein.In conducting our evaluation of the effectiveness of our internal control over financial reporting, we have excluded the
acquisitionacquisitions ofNewdeal Technologies SAS,Miltex, Canada Microsurgical and KMI, whichwaswere completed onJanuary 3, 2005.May 12, 2006, July 6, 2006 and July 31, 2006, respectively. The total assets and total revenues40associated with these transactions and balances accounted for under Newdeal Technologies'these companies’ internal controls over financial reporting represent13%30% and6%11%, respectively, of therelatedconsolidated financialstatement amountsstatements as of and for the year ended December 31,2005.2006.Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because of such limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, this risk.
Changes in Internal Control Over Financial Reporting
No changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the quarter ended December 31,
2005,2006, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.ITEM 9B. OTHER INFORMATION
Not applicable.
42
42
PART III
INCORPORATED BY REFERENCE
The information called for by Item 10. Directors and Executive Officers of the Registrant (other than the information concerning executive officers set forth after Item 4 of Part I herein), Item 11. Executive Compensation, Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, Item 13. Certain Relationships and Related Transactions, and Director Independence and Item 14. Principal Accountant Fees and Services is incorporated herein by reference to the
Company'sCompany’s definitive proxy statement for its Annual Meeting of Stockholders scheduled to be held on May 17,2006,2007, which definitive proxy statement is expected to be filed with the Commission not later than 120 days after the end of the fiscal year to which this report relates.43
43
PART IVITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES(a) Documents filed as a part of this report.1. Financial Statements.The following financial statements and financial statement schedules are filed as a part of this report. Report of Independent Registered Public Accounting Firm ................... F-1 Consolidated Statements of Operations for the years ended December 31, 2005, 2004 and 2003 ...................................................... F-3 Consolidated Balance Sheets as of December 31, 2005 and 2004 ............... F-4 Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003 .............................................................. F-5 Consolidated Statements of Changes in Stockholders' Equity For the years ended December 31, 2005, 2004 and 2003 .................... F-6 Notes to Consolidated Financial Statements ..................................F-7 2. Financial Statement Schedules. 41
The following financial statements and financial statement schedules are filed as a part of this report: F-1 F-3 F-4 F-5 F-6 F-7 2. Financial Statement Schedules. F-40 All other schedules not listed above have been omitted, because they are not applicable or are not required, or because the required information is included in the consolidated financial statements or notes thereto.3. Exhibits required to be filed by Item 601 of Regulation S-K.
3. Exhibits required to be filed by Item 601 of Regulation S-K.3.1(a) Amended and Restated Certificate of Incorporation of the Company (Incorporated by reference to Exhibit 3.1(a) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005) 3.1(b) Certificate of Amendment to Amended and Restated Certificate of Incorporation dated May 22, 1998 (Incorporated by reference to Exhibit 3.1(b) to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31, 1998)3.1(c) Certificate of Amendment to Amended and Restated Certificate of Incorporation dated May 17, 1999 (Incorporated by reference to Exhibit 3.1(c) to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31, 2004)3.2 Amended and Restated By-laws of the Company (Incorporated by reference to Exhibit 3.1 to the Company'sCompany’s Current Report on Form 8-K filed onFebruary 24, 2005)November 3, 2006)4.1 Indenture, dated as of March 31, 2003, between the Company and Wells Fargo Bank Minnesota, National Association (Incorporated by reference to Exhibit 4.1 to the Company'sCompany’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2003)44
4.2 Registration Rights Agreement, dated as of March 31, 2003, between the Company and Credit Suisse First Boston, LLC, Banc of America Securities LLC and U.S. Bancorp Piper Jaffray Inc. (Incorporated by reference to Exhibit 4.3 to the Company'sCompany’s Registration Statement on Form S-3 filed on June 30, 2003 (File No. 333-106625))4.3(a) Credit Agreement, dated as of December 22, 2005, among Integra LifeSciences Holdings Corporation, the lenders party thereto, Bank of America, N.A., as Administrative Agent, Swing Line Lender and L/C Issuer, Citibank FSB and SunTrust Bank, as Co-Syndication Agents, and Royal Bank of Canada and Wachovia Bank, National Association, as Co-Documentation Agents (Incorporated by reference to Exhibit 10.1 to the Company'sCompany’s Current Report on Form 8-K filed on December 29, 2005)4.3(b) First Amendment, dated as of February 15, 2006, among Integra LifeSciences Holdings Corporation, the lenders party thereto, Bank of America, N.A., as Administrative Agent, Swing Line Lender and L/C Issuer, Citibank FSB and SunTrust Bank, as Co-Syndication Agents, and Royal Bank of Canada and Wachovia Bank, National Association, as Co-Documentation Agents (Incorporated by reference to Exhibit 4.3(b) to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005) 4.3(c) Second Amendment, dated as of February 23, 2007, among Integra LifeSciences Holdings Corporation, the lenders party thereto, Bank of America, N.A., as Administrative Agent, Swing Line Lender and L/C Issuer, Citibank FSB and SunTrust Bank, as Co-Syndication Agents, and Royal Bank of Canada and Wachovia Bank, National Association, as Co-Documentation Agents (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on February 27, 2007) 4.4 Security Agreement, dated as of December 22, 2005, among Integra LifeSciences Holdings Corporation and the additional grantors party thereto in favor of Bank of America, N.A., as administrative and collateral agent (Incorporated by reference to Exhibit 4.4 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005) 4.5 Pledge Agreement, dated as of December 22, 2005, among Integra LifeSciences Holdings Corporation and the additional grantors party thereto in favor of Bank of America, N.A., as administrative and collateral agent (Incorporated by reference to Exhibit 4.5 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005) 4.6 Subsidiary Guaranty Agreement, dated as of December 22, 2005, among the guarantors party thereto and individually as a "Guarantor"“Guarantor”), in favor of Bank of America, N.A., as administrative and collateral agent42(Incorporated by reference to Exhibit 4.6 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005) 4.7 Indenture, dated as of September 29, 2006, between the Company and Wells Fargo Bank, N.A. (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on October 5, 2006) 10.1(a) Lease between Plainsboro Associates and American Biomaterials Corporation dated as of April 16, 1985, as assigned to Colla-Tec, Inc. on October 24, 1989 and as amended through November 1, 1992 (Incorporated by reference to Exhibit 10.30 to the Company'sCompany’s Registration Statement on Form 10/A (File No. 0-26224) which became effective on August 8, 1995)10.1(b) Lease Modification #2 entered into as of the 28th day of October, 2005, by and between Plainsboro Associates and Integra LifeSciences Corporation (Incorporated by reference to Exhibit 10.1 to the Company'sCompany’s Current Report on Form 8-K filed on November 2, 2005)45
10.2 Equipment Lease Agreement between Medicus Corporation and the Company, dated as of June 1, 2000 (Incorporated by reference to Exhibit 10.1 to the Company'sCompany’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2000)10.3 Form of Indemnification Agreement between the Company and [ ] dated August 16, 1995, including a schedule identifying the individuals that are a party to such Indemnification Agreements (Incorporated by reference to Exhibit 10.37 to the Company'sCompany’s Registration Statement on Form S-1 (File No. 33-98698) which became effective on January 24, 1996)*10.4 1993 Incentive Stock Option and Non-Qualified Stock Option Plan (Incorporated by reference to Exhibit 10.32 to the Company'sCompany’s Registration Statement on Form 10/A (File No. 0-26224) which became effective on August 8, 1995)*10.5 1996 Incentive Stock Option and Non-Qualified Stock Option Plan (as amended through December 27, 1997) (Incorporated by reference to Exhibit 10.4 to the Company'sCompany’s Current Report on Form 8-K filed on February 3, 1998)*10.6 1998 Stock Option Plan (amended and restated as of July 26, 2005) (Incorporated(Incorporated by reference to Exhibit 10.3 to theCompany'sCompany’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005)*10.7 1999 Stock Option Plan (amended and restated as of July 26, 2005) (Incorporated by reference to Exhibit 10.4 to the Company'sCompany’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005)*10.8(a) Employee Stock Purchase Plan (as amended on May 17, 2004) (Incorporated by reference to Exhibit 4.1 to the Company'sCompany’s Registration Statement on Form S-8 (Registration No. 333-127488) filed on August 12, 2005)*10.8(b) First Amendment to the Company'sCompany’s Employee Stock Purchase Plan, dated October 26, 2005 (Incorporated by reference to Exhibit 10.1 to theCompany'sCompany’s Current Report on Form 8-K filed on November 1, 2005) *10.9 Deferred Compensation Plan (Incorporated by reference to Exhibit 10.15 to the Company's Annual Report on Form 10-K for the year ended December 31, 1999) 10.102000 Equity Incentive Plan (amended and restated as of July 26, 2005) (Incorporated(Incorporated by reference to Exhibit 10.5 to theCompany'sCompany’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005)10.11*10.10 2001 Equity Incentive Plan (amended and restated as of July 26, 2005) (Incorporated(Incorporated by reference to Exhibit 10.6 to theCompany'sCompany’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005)4310.12*10.11 2003 Equity Incentive Plan (amended and restated as of July 26, 2005) (Incorporated(Incorporated by reference to Exhibit 10.7 to theCompany'sCompany’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2005)10.13*10.12(a) Second Amended and Restated Employment Agreement dated July 27, 2004 between the Company and Stuart M. Essig (Incorporated by reference to Exhibit 10.1 to the Company'sCompany’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004)10.14*10.12(b) Amendment 2006-1, dated as of December 19, 2006, to the Second Amended and Restated Employment Agreement, between the Company and Stuart M. Essig (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on December 22, 2006)* 46
10.13 Indemnity letter agreement dated December 27, 1997 from the Company to Stuart M. Essig (Incorporated by reference to Exhibit 10.5 to the Company'sCompany’s Current Report on Form 8-K filed on February 3, 1998)10.15(a)*10.14(a) Registration Rights Provisions for Stuart M. Essig (Incorporated by reference to Exhibit B of Exhibit 10.1 to the Company'sCompany’s Current Report on Form 8-K filed on February 3, 1998)10.15(b)*10.14(b) Registration Rights Provisions for Stuart M. Essig (Incorporated by reference to Exhibit 10.2 to the Company'sCompany’s Current Report on Form 8-K filed on January 8, 2001)10.15(c)*10.14(c) Registration Rights Provisions for Stuart M. Essig (Incorporated by reference to Exhibit B of Exhibit 10.1 to the Company'sCompany’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004)10.16*10.15 Amended and Restated 2005 Employment Agreement between John B. Henneman, III and the Company dated December 19, 2005 10.17(Incorporated by reference to Exhibit 10.16 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005)*10.16 Amended and Restated 2005 Employment Agreement between Gerard S. Carlozzi and the Company dated December 19, 2005 10.18 Employment Agreement between Judith O'Grady and the Company dated February 20, 2003(Incorporated by reference to Exhibit 10.17 to theCompany'sCompany’s Annual Report on Form 10-K for the year ended December 31,2002) 10.192005)*10.17 Severance Agreement between Judith O’Grady and the Company dated January 1, 2007* 10.18 Amended and Restated 2005 Employment Agreement between David B. Holtz and the Company dated December 19, 2005 10.20 Employment Agreement between Donald Nociolo and the Company dated February 20, 2003(Incorporated by reference to Exhibit10.2010.19 to theCompany's Report on Form 10-K for the year ended December 31, 2003) 10.21 Retention Agreement between Robert Paltridge and the Company dated February 20, 2003 (Incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2003) 10.22 Severance Agreement between Deborah Leonetti and the Company dated February 20, 2003 (Incorporated by reference to Exhibit 10.22 to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31,2004) 10.23(a) Lease Contract dated June 30, 1994 between the Puerto Rico Industrial Development Company and Heyer-Schulte NeuroCare, Inc. (Incorporated by reference to Exhibit 10.32 to the Company's Annual Report on Form 10-K for the year ended December 31, 1999) 10.23(b) Construction and2005)*10.19 Lease Contract, dated April 11, 20031, 2005, between the Puerto Rico Industrial Development Company and IntegraNeuroSciences P.R.,CI, Inc. (executed on September 15, 2006) (Incorporated by reference to Exhibit10.23(b)10.3 to theCompany's AnnualCompany’s Quarterly Report on Form10-K10-Q for theyearquarter endedDecember 31, 2004) 10.23(c) Supplement and Amendment to Lease Contract, dated October 24, 2005, to the Construction and Lease Contract dated April 11, 2003 between Integra NeuroSciences PR, Inc. and the Puerto Rico Industrial Development Company (Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed on November 22, 2005) 10.24(a)September 30, 2006)10.20(a) Industrial Real Estate Triple Net Sublease dated July 1, 2001 between Sorrento Montana, L.P. and Camino NeuroCare, Inc. (Incorporated by reference to Exhibit 10.24(a) to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31, 2004)4410.24(b)10.20(b) First Amendment to Sublease dated as of July 1, 2003 by and between Sorrento Montana, L.P. and Camino NeuroCare, Inc. (Incorporated by reference to Exhibit 10.24(b) to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31, 2004)10.24(c)10.20(c) Second Amendment to Sublease dated as of June 1, 2004 by and between Sorrento Montana, L.P. and Camino NeuroCare, Inc. (Incorporated by reference to Exhibit 10.24(c) to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31, 2004)10.24(d)10.20(d) Third Amendment to Sublease dated as of June 15, 2004 by and between Sorrento Montana, L.P. and Integra LifeSciences Corporation (Incorporated by reference to Exhibit 10.24(d) to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31, 2004)10.2510.21(e) Fourth Amendment to Sublease, dated as of August 15, 2006, by and between Sorrento Montana, L.P. and Integra LifeSciences Corporation (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 17, 2006) 10.22 Restricted Units Agreement dated December 27, 1997 between the Company and Stuart M. Essig (Incorporated by reference to Exhibit 10.3 to the Company'sCompany’s Current Report on Form 8-K filed on February 3, 1998)10.26*47
10.23 Stock Option Grant and Agreement dated December 22, 2000 between the Company and Stuart M. Essig (Incorporated by reference to Exhibit 4.1 to the Company'sCompany’s Current Report on Form 8-K filed on January 8, 2001)10.27*10.24 Stock Option Grant and Agreement dated December 22, 2000 between the Company and Stuart M. Essig (Incorporated by reference to Exhibit 4.2 to the Company'sCompany’s Current Report on Form 8-K filed on January 8, 2001)10.28*10.25(a) Restricted Units Agreement dated December 22, 2000 Between the Company and Stuart M. Essig (Incorporated by reference to Exhibit 4.3 to the Company'sCompany’s Current Report on Form 8-K filed on January 8, 2001)10.29*10.25(b) Amendment 2006-1, dated as of October 30, 2006, to the Stuart M. Essig Restricted Units Agreement dated as of December 22, 2000 (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on November 3, 2006)* 10.26 Stock Option Grant and Agreement dated July 27, 2004 between the Company and Stuart M. Essig (Incorporated by reference to Exhibit 10.30 to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31, 2004)10.30*10.27(a) Contract Stock/Restricted Units Agreement dated July 27, 2004 between the Company and Stuart M. Essig (Incorporated by reference to Exhibit 10.31 to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31, 2004)10.31*10.27(b) Amendment 2006-1, dated as of October 30, 2006, to the Stuart M. Essig Contract Stock/Restricted Units Agreement dated as of July 27, 2004 (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on November 3, 2006)* 10.28 Form of Stock Option Grant and Agreement between the Company and Stuart M. Essig (Incorporated by reference to Exhibit 10.32 to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31, 2004)10.32 Share Purchase Agreement dated November 10, 2004 between Integra LifeSciences Corporation and Eric Fourcault, Theo Knevels, Jean-Christophe Giet and Bertrand Gauneau (Incorporated by reference to Exhibit 10.33 to the Company's Annual Report on Form 10-K for the year ended December 31, 2004) 10.33*10.29 Form of Notice of Grant of Stock Option and Stock Option Agreement*Agreement (Incorporated by reference to Exhibit 10.1 to theCompany'sCompany’s Current Report on Form 8-K filed on July 29, 2005)10.34*10.30 Form of Non-Qualified Stock Option Agreement (Non-Directors) (Incorporated by reference to Exhibit 10.35 to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31, 2004)4510.35*10.31 Form of Incentive Stock Option Agreement (Incorporated by reference to Exhibit 10.36 to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31, 2004)10.36*10.32 Form of Non-Qualified Stock Option Agreement (Directors) (Incorporated by reference to Exhibit 10.37 to the Company'sCompany’s Annual Report on Form 10-K for the year ended December 31, 2004)10.37*10.33 Compensation of Directors of the Company (Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed on February 28, 2006) 10.38Company*10.34 Form of Restricted Stock Agreement for Non-Employee Directors under the Integra LifeSciences Holdings Corporation 2003 Equity Incentive Plan (Incorporated by reference to Exhibit 10.2 to the Company'sCompany’s Current Report on Form 8-K filed on May 17, 2005)10.39*10.35 Form of Restricted Stock Agreement for Executive Officers (Incorporated by reference to Exhibit 10.1 to the Company'sCompany’s Current Report on Form 8-K filed on January 9, 2006)10.40*48
10.36 Asset Purchase Agreement, dated as of September 7, 2005, by and between Tyco Healthcare Group LP and Sherwood Services, AG and Integra LifeSciences Corporation and Integra LifeSciences (Ireland) Limited (Incorporated by reference to Exhibit 10.1 to the Company'sCompany’s Current Report on Form 8-K filed on September 13, 2005)10.4110.37 Restricted Stock Agreement by and between David B. Holtz and the Company dated December 19, 2005 10.42(Incorporated by reference to Exhibit 10.41 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005)*10.38 Performance Stock Agreement by and between John B. Henneman, III and the Company dated January 3, 2006 10.43(Incorporated by reference to Exhibit 10.42 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005)*10.39 Performance Stock Agreement by and between Gerard S. Carlozzi and the Company dated January 3, 2006 10.44(Incorporated by reference to Exhibit 10.43 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005)*10.40 Employment Agreement by and between Maureen B. Bellantoni and the Company dated January 10, 2006 10.45(Incorporated by reference to Exhibit 10.44 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005)*10.41 Performance Stock Agreement by and between Maureen B. Bellantoni and the Company dated January 10, 2006 (Incorporated by reference to Exhibit 10.45 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005)* 10.42 Stock Purchase Agreement, dated as of April 19, 2006, by and between ASP/Miltex LLC and Integra LifeSciences Corporation (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on April 25, 2006) 10.43 Stock Agreement and Plan of Merger, dated as of June 30, 2006, by and between Integra LifeSciences Corporation, Integra California, Inc., Kinetikos Medical, Inc., Telegraph Hill Partners Management LLC, as Shareholders Representative, and the Shareholders party thereto (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 7, 2006) 10.44 Integra LifeSciences Holdings Corporation Management Incentive Compensation Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2006)* 10.45 Form of Restricted Stock Agreement for Gerard S. Carlozzi and John B. Henneman, III (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on February 27, 2007)* 21 Subsidiaries of the Company 23 Consent of PricewaterhouseCoopers LLP 31.1 Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
* Indicates a management contract or compensatory plan or arrangement. TheCompany'sCompany’s Commission File Number for Reports on Form 10-K, Form 10-Q and Form 8-K is 0-26224.4649
SIGNATURESPursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.INTEGRA LIFESCIENCES HOLDINGS CORPORATION Date: March 15, 2006 By: /s/ Stuart M. Essig -------------------------------------
INTEGRA LIFESCIENCES HOLDINGS CORPORATION Date: March 2, 2007 By: /s/ Stuart M. Essig Stuart M. Essig President and Chief Executive Officer
Signature Title Date ------------ ------ ------/s//s/ Stuart M. EssigStuart M. Essig President, Chief Executive Officer and March 15, 2006 - ----------------------------Director (Principal Executive Officer)Stuart M. Essig /s/March 2, 2007 /s/ Maureen B. BellantoniMaureen B. Bellantoni Executive Vice President and Chief March 15, 2006 - ----------------------------Financial Officer (Principal FinancialMaureen B. BellantoniOfficer)/s/ David B. Holtz SeniorMarch 2, 2007 /s/ Jerry E. CorbinJerry E. Corbin Vice President Finance March 15, 2006 - ----------------------------and Corporate Controller (Principal Accounting Officer)David B. Holtz /s/March 2, 2007 /s/ Richard E. Caruso, Ph.D.Richard E. Caruso, Ph.D. Chairman of the Board March 15, 2006 - ---------------------------- Richard E. Caruso, Ph.D. /s/ David Auth Director March 15, 2006 - ---------------------------- David Auth /s/2, 2007/s/ Keith Bradley, Ph.D. Director March 15, 2006 - ----------------------------Keith Bradley, Ph.D./s/Director March 2, 2007 /s/ Neal MoszkowskiNeal Moszkowski Director March 2, 2007 /s/ Christian SchadeChristian Schade Director March 2, 2007 /s/ James M. Sullivan Director March 15, 2006 - ----------------------------James M. Sullivan/s/Director March 2, 2007 /s/ Anne M. VanLent Director March 15, 2006 - ----------------------------Anne M. VanLentDirector March 2, 2007 4750
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo Board of Directors and Stockholders of Integra LifeSciences Holdings Corporation and Subsidiaries:We have completed integrated audits of Integra LifeSciences HoldingsCorporation's 2005 and 2004Corporation’s consolidated financial statements and of its internal control over financial reporting as of December 31,2005, and an audit of its 2003 consolidated financial statements2006, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.Consolidated financial statements and financial statement scheduleIn our opinion, the consolidated financial statements listed in the accompanying indexappearing under Item 15(a)(1) "Exhibits and Financial Statement Schedules"present fairly, in all material respects, the financial position of Integra LifeSciences Holdings Corporation and its subsidiaries(the "Company")at December 31,20052006 andDecember 31, 2004,2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31,20052006 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying indexappearing under Item 15(a)(2)presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of theCompany'sCompany’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for share-based compensation and defined benefit pension and other postretirement obligations in 2006.Internal control over financial reportingAlso, in our opinion,management'smanagement’s assessment, included inManagement's“Management’s Report on Internal Control Over Financial Reporting,” appearinginunder Item9A "Controls and Procedures",8, that the Company maintained effective internal control over financial reporting as of December 31,20052006 based on criteria established in Internal Control-— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31,2005,2006, based on criteria established in Internal Control-— Integrated Framework issued by the COSO. TheCompany'sCompany’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions onmanagement'smanagement’s assessment and on the effectiveness of theCompany'sCompany’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluatingmanagement'smanagement’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.F-1
Acompany'scompany’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Acompany'scompany’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally acceptedF-1accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company'scompany’s assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.As described inManagement'sManagement’s Reportonof Internal Control Over Financial Reporting,appearing in Item 9A "Controls and Procedures",management has excludedNewdeal Technologies SAS ("Newdeal")Miltex, Kinetikos Medical, Inc. and Canada Microsurgical, Ltd. from itsassessmentassessments of internal control over financial reporting as of December 31,20052006 becauseit wasthey were acquired by the Company inapurchase businesscombinationcombinations during2005.2006. We have also excludedNewdealMiltex, Kinetikos Medical, Inc. and Canada Microsurgical, Ltd. from our audit of internal control over financial reporting.New Deal is a wholly-owned subsidiaryMiltex, Kinetikos Medical, Inc. and Canada Microsurgical, Ltd. are wholly owned subsidiaries of the Company whose total assets and totalrevenuesrevenue represent13%approximately 30% and6%11%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31,2005. /s/2006./s/ PricewaterhouseCoopers LLP
Florham Park, New Jersey
March15, 20061, 2007F-2
INTEGRA LIFESCIENCES HOLDINGS CORPORATIONCONSOLIDATED STATEMENTS OF OPERATIONS
In thousands, except per share amountsYears Ended December 31, -------------------------------- 2005 2004 2003 -------- -------- --------Total revenues .................................. $277,935 $229,825 $185,599 COSTS AND EXPENSES Cost of product revenues (exclusive of amortization related to acquired intangible assets) ...................................... 105,536 87,299 70,597 Research and development ........................ 11,960 14,121 12,814 Selling, general and administrative ............. 98,273 99,360 59,461 Amortization .................................... 6,061 4,266 3,080 -------- -------- -------- Total costs and expenses .................... 221,830 205,046 145,952 Operating income ................................ 56,105 24,779 39,647 Interest income ................................. 3,900 4,030 3,195 Interest expense ................................ (4,165) (3,475) (2,724) Other income (expense), net ..................... (739) 2,674 3,071 -------- -------- -------- Income before income taxes ...................... 55,101 28,008 43,189 Provision for income taxes ...................... 17,907 10,811 16,328 -------- -------- -------- Net income ...................................... $ 37,194 $ 17,197 $ 26,861 ======== ======== ======== Basic net income per share ................... $ 1.23 $ 0.57 $ 0.92 Diluted net income per share ................. $ 1.15 $ 0.55 $ 0.86 Weighted average common shares outstanding: Basic ........................................ 30,195 30,064 29,071 Diluted ...................................... 34,565 31,102 33,104In thousands, except per share amounts
Year Ended December 31, 2006 2005 2004 Total revenue, net $ 419,297 $ 277,935 $ 229,825 COSTS AND EXPENSES Cost of product revenues 168,314 107,052 88,496 Research and development 25,732 11,960 14,121 Selling, general and administrative 157,706 98,273 99,360 Intangible asset amortization 8,801 4,545 3,069 Total costs and expenses 360,553 221,830 205,046 Operating income 58,744 56,105 24,779 Interest income 2,194 3,900 4,030 Interest expense (10,620 ) (4,165 ) (3,475 ) Other income (expense), net (2,010 ) (739 ) 2,674 Income before income taxes 48,308 55,101 28,008 Provision for income taxes 18,901 17,907 10,811 Net income $ 29,407 $ 37,194 $ 17,197 Basic net income per share $ 1.00 $ 1.23 $ 0.57 Diluted net income per share $ .97 $ 1.15 $ 0.55 Weighted average common shares outstanding: Basic 29,300 30,195 30,064 Diluted 32,747 34,565 31,102 F-3
INTEGRA LIFESCIENCES HOLDINGS CORPORATIONCONSOLIDATED BALANCE SHEETS
In thousands, except per share amountsDecember 31, ----------------------- ASSETS 2005 2004 --------- ---------Current Assets: Cash and cash equivalents ...................................... $ 46,889 $ 69,855 Short-term investments ......................................... 80,327 30,955 Trade accounts receivable, net of allowances of $3,508 and $2,749 ....................................... 49,007 46,765 Inventories .... ............................................... 67,476 55,947 Deferred tax assets ............................................ 10,842 3,966 Prepaid expenses and other current assets ...................... 11,411 8,750 --------- --------- Total current assets ....................................... 265,952 216,238 Non-current investments ......................................... 16,168 95,172 Property, plant, and equipment, net ............................. 27,451 25,461 Deferred tax assets ............................................. -- 15,787 Intangible assets, net .......................................... 64,569 59,817 Goodwill ........................................................ 68,364 39,237 Other assets .................................................... 5,928 5,001 --------- --------- Total assets ..................................................... $ 448,432 $ 456,713 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Accounts payable, trade ........................................ $ 8,978 $ 10,160 Income taxes payable ........................................ .. 715 1,022 Accrued compensation ........................................... 8,761 4,212 Accrued expenses and other current liabilities ................. 12,833 8,840 --------- --------- Total current liabilities .................................. 31,287 24,234 Long term debt .................................................. 118,378 118,900 Deferred tax liabilities ........................................ 2,520 -- Other liabilities ............................................... 6,429 5,756 --------- --------- Total liabilities ................................................ 158,614 148,890 Commitments and contingencies Stockholders' Equity: Common stock; $.01 par value; 60,000 authorized shares; 29,823 and 29,202 issued ........................................... 298 292 Additional paid-in capital ..................................... 333,179 320,602 Treasury stock, at cost; 2,368 and 718 shares .................. (75,815) (19,474) Accumulated other comprehensive income (loss): Unrealized gain (loss) on available-for-sale securities, net of tax ............................................. (801) (818) Foreign currency translation adjustment ..................... (2,300) 9,266 Minimum pension liability adjustment, net of tax ............ (1,672) (1,780) Retained earnings/(accumulated deficit) ........................ 36,929 (265) --------- --------- Total stockholders' equity ................................... 289,818 307,823 --------- --------- Total liabilities and stockholders' equity ...................... $ 448,432 $ 456,713 ========= =========In thousands
Year Ended December 31, 2006 2005 ASSETS Current Assets: Cash and cash equivalents $ 22,697 $ 46,889 Investments in marketable securities — 80,327 Trade accounts receivable, net of allowances of $4,114 and $3,508 85,018 49,007 Inventories, net 94,387 67,476 Deferred tax assets 10,010 10,842 Prepaid expenses and other current assets 9,649 11,411 Total current assets 221,761 265,952 Investments in marketable securities, non-current — 16,168 Property, plant, and equipment, net 42,559 27,451 Intangible assets, net 179,716 64,569 Goodwill 162,414 68,364 Other assets 7,168 5,928 Total assets $ 613,618 $ 448,432 LIABILITIES AND STOCKHOLDERS’ EQUITY Current Liabilities: Borrowings under senior credit facility $ 100,000 $ — Convertible securities 119,542 — Accounts payable, trade 20,329 8,978 Income taxes payable — 715 Deferred revenue 4,319 88 Accrued compensation 12,454 8,761 Accrued expenses and other current liabilities 17,373 12,745 Total current liabilities 274,017 31,287 Long-term convertible securities 508 118,378 Deferred tax liabilities 31,356 2,520 Other liabilities 11,575 6,429 Total liabilities 317,456 158,614 Commitments and contingencies Stockholders’ Equity: Preferred Stock; no par value; 15,000,000 authorized shares; none outstanding — — Common stock; $.01 par value; 60,000 authorized shares; 31,464 and 29,823 issued 315 298 Additional paid-in capital 367,277 333,179 Treasury stock, at cost; 4,147 and 2,368 shares (145,846 ) (75,815 ) Accumulated other comprehensive income (loss): Unrealized gain (loss) on available-for-sale securities, net of tax — (801 ) Foreign currency translation adjustment 10,045 (2,300 ) Pension liability adjustment, net of tax (1,965 ) (1,672 ) Retained earnings 66,336 36,929 Total stockholders’ equity 296,162 289,818 Total liabilities and stockholders’ equity $ 613,618 $ 448,432 F-4
INTEGRA LIFESCIENCES HOLDINGS CORPORATIONCONSOLIDATED STATEMENTS OF CASH FLOWS
In thousandsYears Ended December 31, ------------------------------ 2005 2004 2003 -------- -------- --------OPERATING ACTIVITIES: Net income ............................................... $ 37,194 $ 17,197 $ 26,861 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ........................... 11,313 9,087 7,030 In process research and development charge .............. 500 -- 400 Deferred income tax provision ........................... 9,895 6,101 12,357 Amortization of discount/premium on investments ......... 1,908 2,505 2,013 Share-based compensation ................................ 146 23,572 26 Other, net .............................................. 779 696 776 Changes in assets and liabilities, net of business acquisitions: Accounts receivable ................................... 491 (13,287) (4,819) Inventories ........................................... (9,984) (9,738) (1,829) Prepaid expenses and other current assets ............. 30 (1,949) (505) Non-current assets .................................... (66) (169) 480 Accounts payable, accrued expenses and other liabilities ........................................ 4,800 6,029 2,537 Customer advances and deposits ........................ -- (959) (6,431) Deferred revenue ...................................... (158) (110) (4,070) -------- -------- -------- Net cash provided by operating activities ................ $ 56,848 $ 38,975 $ 34,826 -------- -------- -------- INVESTING ACTIVITIES: Proceeds from the sales/maturities of investments ......... 93,315 241,440 287,558 Purchases of available for sale investments ............... (65,499) (190,888) (360,470) Purchases of property and equipment ....................... (8,053) (8,508) (3,843) Payment of product license fee ............................ -- -- (1,500) Cash used in acquisitions, net of cash acquired ........... (50,602) (29,302) (50,405) -------- -------- -------- Net cash provided by (used in) investing activities ...... $(30,839) $ 12,742 $(128,660) -------- -------- -------- FINANCING ACTIVITIES: Fees paid in connection with bank line of credit .......... (1,132) -- -- Repayment of bank loans ................................... (245) -- -- Proceeds from exercised stock options and warrants ........ 9,382 6,123 14,152 Purchases of treasury stock ............................... (56,341) (14,238) (35,402) Proceeds from issuance of convertible notes, net........... -- -- 115,923 -------- -------- -------- Net cash provided by (used in) financing activities ...... $(48,336) $ (8,115) $ 94,673 Effect of exchange rate changes on cash and cash equivalents .. (639) 199 232 -------- -------- -------- Net increase (decrease) in cash and cash equivalents .......... $(22,966) 43,801 1,071 Cash and cash equivalents at beginning of period .............. 69,855 26,054 24,983 -------- -------- -------- Cash and cash equivalents at end of period .................... $ 46,889 $ 69,855 $ 26,054 ======== ======== ======== Cash paid during the year for interest ........................ $ 3,275 $ 2,331 $ 1,476 Cash paid during the year for income taxes .................... 7,721 1,789 1,309 Supplemental non-cash disclosure: Acquisition fees included in liabilities ...................... $ 1,123 -- -- Property and equipment purchases included in liabilities ...... 199 969 2,000In thousands
Year Ended December 31, 2006 2005 2004 OPERATING ACTIVITIES: Net income $ 29,407 $ 37,194 $ 17,197 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 19,018 11,313 9,087 In-process research and development 5,875 500 — Loss on sale of assets/investments 755 — (55 ) Amortization of bond issuance costs 2,096 820 821 Excess tax benefits from stock-based compensation arrangements (1,335 ) — — Deferred income tax provision 3,235 9,895 6,101 Amortization of discount/premium on investments 364 1,908 2,505 Share-based compensation 14,115 146 23,572 Other, net 336 (41 ) (70 ) Changes in assets and liabilities, net of business acquisitions: Accounts receivable (26,131 ) 491 (13,287 ) Inventories 3,461 (9,984 ) (9,738 ) Prepaid expenses and other current assets (2,465 ) 30 (1,949 ) Other non-current assets (799 ) (66 ) (169 ) Accounts payable, accrued expenses and other liabilities 14,011 (1,494 ) 2,118 Income taxes payable 7,496 6,294 3,911 Deferred revenue 2,409 (158 ) (110 ) Other liabilities (146 ) — (959 ) Net cash provided by operating activities 71,702 56,848 38,975 INVESTING ACTIVITIES: Proceeds from the sales of investments 109,872 93,315 241,440 Proceeds from sales of property and equipment 689 — — Purchases of available for sale investments (13,074 ) (65,499 ) (190,888 ) Purchases of property and equipment (11,520 ) (8,053 ) (8,508 ) Cash used in acquisitions, net of cash acquired (228,662 ) (50,602 ) (29,302 ) Net cash (used in)/provided by investing activities (142,695 ) (30,839 ) 12,742 FINANCING ACTIVITIES: Borrowings under senior credit facility 162,000 — — Fees paid in connection with bank line of credit — (1,132 ) — Repayment of bank loans (63,530 ) (245 ) — Proceeds from exercised stock options and warrants 15,867 9,382 6,123 Purchases of treasury stock (70,031 ) (56,341 ) (14,238 ) Excess tax benefits from stock-based compensation arrangements 1,335 — — Net cash provided by (used in) financing activities 45,641 (48,336 ) (8,115 ) Effect of exchange rate changes on cash and cash equivalents 1,160 (639 ) 199 Net (decrease) increase in cash and cash equivalents (24,192 ) (22,966 ) 43,801 Cash and cash equivalents at beginning of period 46,889 69,855 26,054 Cash and cash equivalents at end of period $ 22,697 $ 46,889 $ 69,855 Cash paid during the year for interest $ 8,060 $ 3,275 $ 2,331 Cash paid during the year for income taxes 16,395 7,721 1,789 Supplemental non-cash disclosure: Acquisition fees included in liabilities $ — $ 1,123 $ — Property and equipment purchases included in liabilities 765 199 969 F-5
INTEGRA LIFESCIENCES HOLDINGS CORPORATIONCONSOLIDATED STATEMENTS OFSTOCKHOLDERS'STOCKHOLDERS’ EQUITY
In thousandsAccumulated Retained Additional Other Earnings/ Preferred Common Treasury Paid-In Comprehensive (Accumulated Total Stock Stock Stock Capital Other Income (Loss) Deficit) Equity --------- -------- --------- ---------- --------- ------------- ----------- ---------- Balance, December 31, 2002 ............... -- 272 (1,812) 292,007 (15) 1,468 (44,323) $ 247,597 ========= ======== ========= ========== ========= ============= =========== ==========Net income ............................... 26,861 26,861 Realized gains on investments............. (210) (210) Unrealized losses on investments, net of tax .............................. (588) (588) Foreign currency translation ............. 3,673 3,673 Minimum pension liability adjustment, net of tax .......................... (112) (112) --------- Total comprehensive income ........ $ 29,624 ========= Issuance of 1,788 shares of common stock through employee benefit plans ......... 4 31,978 (17,880) 14,102 Warrants exercised for cash ......... .... 50 50 Conversion of 1,000 Restricted Units into 1,000 shares of common stock........... 10 (10) -- Share-based compensation ................. 16 10 26 Tax benefit related to stock option exercises ............................. 12,533 12,533 Repurchase 1,503 shares of common stock... (35,402) (35,402) Balance, December 31, 2003 ............... $ -- $ 286 $(5,236) $ 286,716 $ (5) $ 4,231 $ (17,462) $ 268,530 ========= ========= ========= ========== ========= ============ =========== ========== Net income................................ 17,197 17,197 Realized gains on investments............. 88 88 Unrealized losses on investments, net of tax .............................. (969) (969) Foreign currency translation.............. 3,683 3,683 Minimum pension liability adjustment, net of tax .......................... (365) (365) --------- Total comprehensive income......... $ 19,634 ========= Issuance of 592 shares of common stock through employee benefit plans.......... 6 6,492 6,498 Issuance of contract stock unit award for 750 shares of common stock .......... 23,535 23,535 Other share-based compensation ........... 30 5 35 Tax benefit related to stock option exercises.............................. 3,829 3,829 Repurchase 500 shares of common stock..... (14,238) (14,238) Balance, December 31, 2004............... $ -- $ 292 $(19,474) $ 320,602 $ -- $ 6,668 $ (265) $ 307,823 ========= ========= ========= ========== ========= ============ =========== ========== Net income................................ 37,194 37,194 Realized gains on investments............. 18 18 Unrealized losses on investments, net of tax .............................. (1) (1) Foreign currency translation.............. (11,375) (11,375) Minimum pension liability adjustment, net of tax .......................... (83) (83) --------- Total comprehensive income......... $ 25,753 ========= Issuance of 621 shares of common stock through employee benefit plans.......... 6 9,170 9,176 Share-based compensation ................. 146 146 Tax benefit related to stock option exercises.............................. 3,261 3,261 Repurchase 1,650 shares of common stock .. (56,341) (56,341) Balance, December 31, 2005............... $ -- $ 298 $(75,815) $ 333,179 $ -- $ (4,773) $ 36,929 $ 289,818 ========= ========= ========= ========== ========= ============ =========== ==========In thousands
Accumu- lated Retained Other Earnings / Additional Compre- (Accumu- Preferred Common Treasury Paid-In hensive lated Total Stock Stock Stock Capital Other Income (Loss) Deficit) Equity Balance, December 31, 2003 $ — $ 286 $ (5,236 ) $ 286,716 $ (5 ) $ 4,231 $ (17,462 ) $ 268,530 Net income 17,197 17,197 Realized gains on investments 88 88 Unrealized losses on investments, net of tax (969 ) (969 ) Foreign currency translation 3,683 3,683 Minimum pension liability adjustment, net of tax (365 ) (365 ) Total comprehensive income $ 19,634 Issuance of 592 shares of common stock through employee benefit plans 6 6,492 6,498 Issuance of contract stock unit award for 750 shares of common stock 23,535 23,535 Other share-based compensation 30 5 35 Tax benefit related to stock option exercises 3,829 3,829 Repurchase 500 shares of common stock (14,238 ) (14,238 ) Balance, December 31, 2004 $ — $ 292 $ (19,474 ) $ 320,602 $ — $ 6,668 $ (265 ) $ 307,823 Net income 37,194 37,194 Realized gains on investments 18 18 Unrealized losses on investments, net of tax (1 ) (1 ) Foreign currency translation (11,375 ) (11,375 ) Minimum pension liability adjustment, net of tax (83 ) (83 ) Total comprehensive income $ 25,753 Issuance of 621 shares of common stock through employee benefit plans 6 9,170 9,176 Share-based compensation 146 146 Tax benefit related to stock option exercises 3,261 3,261 Repurchase 1,650 shares of common stock (56,341 ) (56,341 ) Balance, December 31, 2005 $ — $ 298 $ (75,815 ) $ 333,179 $ — $ (4,773 ) $ 36,929 $ 289,818 Net income 29,407 29,407 Realized gains on investments 254 254 Reversal of unrealized losses on investments, net of tax 547 547 Foreign currency translation 12,345 12,345 Pension liability adjustment, net of tax (293 ) (293 ) Total comprehensive income $ 42,260 Issuance of 1,649 shares of common stock through employee benefit plans 17 15,888 15,905 Tax benefit related to stock option exercises 3,237 3,237 Share-based compensation 14,973 14,973 Repurchase 1,779 shares of common stock (70,031 ) (70,031 ) Balance, December 31, 2006 $ — $ 315 $ (145,846 ) $ 367,277 $ — $ 8,080 $ 66,336 $ 296,162 Company'sCompany’s acquisition of Newdeal Technologies, whose functional currency is the euro, on January 3, 2005.The accompanying notes are an integral part of these consolidated financial statementsF-6
INTEGRA LIFESCIENCES HOLDINGS CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. BUSINESSIntegra LifeSciences Holdings Corporation (the"Company"“Company”) incorporated in Delaware in 1989. The Company, a world leader in regenerative medicine, isa market-leading, innovative medical device company focused on helping the medical professional enhance the standard of care for patients. Integra provides customers with clinically relevant, innovative and cost-effective products that improvededicated to improving the quality of life forpatients. The Company focuses on cranialpatients through the development, manufacturing, andspinal procedures, peripheral nerve repair, small bonemarketing of cost-effective surgical implants andjoint injuries,medical instruments. Its products are used primarily in neurosurgery, extremity reconstruction, orthopedics andthe repair and reconstruction of soft tissue.general surgery.The Company sells its products directly through various sales forces and through a variety of other distribution channels.2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESBASIS OF PRESENTATIONThese financial statements and the accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America and conform to Regulation S-X under the Securities Exchange Act of 1934, as amended. The Company has made all necessary adjustments so that the financial statements are presented fairly and all such adjustments are of a normal recurring nature.The Company revised its presentation of cost of product revenues in 2006 to include amortization of product technology-based intangible assets. Previously, this amortization was included in intangible asset amortization in the consolidated statement of operations. The Company revised prior period amounts to conform to the current year’s presentation. This revision increased cost of product revenues by $1.5 million and $1.2 million for the years ended December 31, 2005 and 2004, respectively.PRINCIPLES OF CONSOLIDATIONThe consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. All significant intercompany accounts and transactions are eliminated in consolidation. See Note 3. Acquisitions for details of new subsidiaries included in the consolidation.USE OF ESTIMATESThe 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, amortization periods for acquired intangible assets, goodwill, discount rates used to value and test impairments of long-lived assets and goodwill, computation of taxes, valuation allowances recorded against deferred tax assets, the valuation of stock-based compensation, estimates of projected cash flows and depreciation and amortization periods for long-lived assets, valuation of intangible assets and in-process research and development, 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.CASH AND CASH EQUIVALENTSThe Company considers all short term, highly liquid investments purchased with original maturities of three months or less to be cash equivalents.F-7
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIALINSTRUMENTSSTATEMENTSINVESTMENTSIn 2006, the Company liquidated its portfolio of marketable securities. Proceeds from the sales totaled $109.9 million. As the amounts were previously classified as available for sale securities based on the guidance of SFAS 115 —Accounting for Certain Investments inmarketableDebt and Equity Securities, the unrealized losses of $0.8 million were reclassified from accumulated other comprehensive income into net income upon sale.As of December 31, 2005, investments were comprised of available-for-sale debt and equity securitiesare classifiedas defined in SFAS No. 115 —Accounting for Certain Investments in Debt andaccounted for as available-for-sale securities and areEquity Securities, or SFAS 115. Securities were carried at fair value, whichiswas based on quoted market prices.UnrealizedIncreases and decreases in fair value were recorded as unrealized gains and lossesare reported as a component of accumulatedin other comprehensiveincome (loss).income. Realized gains and losses are determined on the specific identification cost basis and reported in other income (expense), net. Investment balances as of December 31, 2005and 2004were as follows:
Unrealized Fair Cost Gains Losses Value ------- ------- ------- ------- (in thousands)2005 - ----- Marketable Securities, current Corporate Debt Securities with continuous unrealized losses greater than 1 year ....... $ 37,248 $ -- $ (372) $ 36,876 Auction Rate Securities ............................ 2,650 -- -- 2,650 U.S. Government Debt Securities with continuous unrealized losses greater than 1 year ....... 39,201 -- (427) 38,774 Other Securities with continuous unrealized losses greater than 1 year ....... 2,054 -- (27) 2,027 ------- ------- ------- ------- Total marketable securities, current ............ $ 81,153 $ -- $ (826) $ 80,327 Marketable Securities, non-current Corporate Debt Securities with continuous unrealized losses greater than 1 year ....... $ 10,330 $ -- $ (277) 10,053 U.S. Government Debt Securities with continuous unrealized losses greater than 1 year ....... 6,252 -- (137) 6,115 ------- ------- ------- ------- Total marketable securities, non-current ........ $ 16,582 $ -- $ (414) $ 16,168 2004: - ----- Marketable securities, current ..................... $31,191 $ -- $ (236) $ 30,955 Marketable securities, non-current ................. 96,278 30 (1,136) 95,172 ------- ------- -------- -------- $ 127,469 $ 30 $(1,372) $126,127F-7INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unrealized Cost Gains Losses Fair Value (in thousands) 2005 Marketable Securities, current Corporate Debt Securities $ 37,248 $ — $ (372 ) $ 36,876 Auction Rate Securities 2,650 — — 2,650 U.S. Government Debt Securities 39,201 — (427 ) 38,774 Other Securities 2,054 — (27 ) 2,027 Total marketable securities, current $ 81,153 $ — $ (826 ) $ 80,327 Marketable Securities, non-current Corporate Debt Securities $ 10,330 $ — $ (277 ) $ 10,053 U.S. Government Debt Securities 6,252 — (137 ) 6,115 Total marketable securities, non-current $ 16,582 $ — $ (414 ) $ 16,168 Company'sCompany’s marketable debt securitiesarewere primarily related to the increase in interest rates since the Company acquired these investments. Managementdoesevaluated certain available-for-sale investments for other-than-temporary impairment when the fair value of the investment was lower than its book value. Factors that were considered when evaluating for other-than-temporary impairment included: the length of time and the extent to which market value has been less than cost; the financial condition and near-term prospects of the issuer; interest rates, credit risk, the value of any underlying portfolios or investments; and the Company’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in the market. Management did not believe that the unrealized losses onthese marketable securities arethe investments were other than temporary because of its intent and ability to hold these investments for a sufficiently long period of time such that recovery ofthesethe unrealized losses is expected as the investmentsgetgot closer to their maturity. The maturity dates or interest rate reset periods for marketable debt securities classified as currentarewere less than one year. The maturity dates for marketable debt securities classified as non-currentarewere less than 31months and less than 45months as of December 31,2005 and 2004, respectively.2005.The fair value of theCompany'sCompany’s $120.0 million principal amount 21/2%1/2% contingent convertible subordinated notes outstanding at December 31,2005 and 20042006 was $114.3million and $115.5 million, respectively.million.The carrying values of all other financial instruments were not materially different from their estimated fair values.F-8
TRADE ACCOUNTS RECEIVABLE, ALLOWANCES FOR DOUBTFUL ACCOUNTS RECEIVABLE AND SALES RETURNSTrade accounts receivable are recorded at the invoiced amount and do not bear interest. The Company grants credit to customers in the normal course of business, but generally does not require collateral or any other security to support its receivables.The Company evaluates the collectibility of accounts receivable based on a combination of factors. In circumstances where a specific customer is unable to meet its financial obligations to the Company, a provision to the allowances for doubtful accounts is recorded against amounts due to reduce the net recognized receivable to the amount that is reasonably expected to be collected. For all other customers, a provision to the allowances for doubtful accounts is recorded based on the length of time the receivables are past due, the current business environment and theCompany'sCompany’s historical experience. Provisions to the allowances for doubtful accounts are recorded to selling, general and administrative expenses. Account balances are charged off against the allowance when the Company feels it is probable that the receivable will not be recovered.The Company records a provision for estimated returns and allowances on product revenues in the same period as the related revenues are recorded. These estimates are based on historical sales returns and discounts and other known factors. The provisions are recorded as a reduction to revenues.INVENTORIESInventories, consisting of purchased materials, direct labor and manufacturing overhead, are stated at the lower of cost, the value determined by the first-in, first-out method, or market. Inventories consisted of the following:
December 31, 2005 2004 ---------- ---------- (in thousands)Finished goods .......................... $ 44,500 $ 36,490 Work in process ......................... 9,801 7,496 Raw materials ........................... 13,175 11,961 ---------- ---------- $ 67,476 $ 55,947
December 31, 2006 2005 (in thousands) Finished goods $ 74,324 $ 51,970 Work in process 14,416 9,895 Raw materials 20,433 15,379 Less: reserves (14,786 ) (9,768 ) Total inventories, net $ 94,387 $ 67,476 andas well as the feasibility of reworking or using excess or obsolete products or componentsF-8INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTSin the production or assembly of other products that are not obsolete or for which there are not excess quantities in inventory. To the extent that management determines there are excess or obsoleteor expiredinventoryquantitiesor quantities with a shelf life that is too near its expiration for the Company to reasonably expect that it can sell those products prior to their expiration, valuation reserves are recorded against all or a portion of the value of the related products to adjust their carrying value to estimated net realizable value.The Company capitalizes inventory costs associated with certain products prior to regulatory approval, based onmanagement'smanagement’s judgment of probable future commercialization. The Company could be required to expense previously capitalized costs related to pre-approval inventory upon a change in such judgment, due to, among other potential factors, a denial or delay of approval by necessary regulatory bodies or a decision by management to discontinue the related development program. At December 31, 2005,wethe Company capitalized approximately $0.9 million of pre-approval inventory. In June 2006, the Company recorded a $1.2 million charge to research and development related to pre-approval inventory including amounts capitalized in the first half of 2006 associated with a project to develop an ultrasonic aspirator system. The Company discontinued this project in June 2006 following management’s review of the Company’s existing technology and the ultrasonic aspirator technology acquired in the Radionics acquisition. Management determined that there was no future alternative use for the pre-approval inventory in any other development project. No such amounts are capitalized at December 31, 2006.F-9
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSPROPERTY, PLANT AND EQUIPMENTProperty, plant and equipment are stated at cost. The Company provides for depreciation using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the lesser of the lease term or the useful life. The cost of major additions and improvements is capitalized, while maintenance and repair costs that do not improve or extend the lives of the respective assets are charged to operations as incurred.Property, plant and equipment balances and corresponding lives were as follows:
December 31, 2005 2004 Lives ---------- ---------- --------------- (in thousands)Land ............................................ $ 890 $ 941 Buildings and leasehold improvements ............ 15,208 12,886 2 - 40 years Machinery and equipment ......................... 20,732 19,369 3 - 15 years Furniture ,fixtures and information systems .... 15,310 11,569 5 - 7 years Construction in progress ........................ 2,007 3,252 ---------- ---------- 54,147 48,017 Less: Accumulated depreciation .................. (26,696) (22,556) ---------- ---------- $ 27,451 $ 25,461
December 31 2006 2005 Lives (in thousands) Land $ 1,405 $ 890 Buildings 3,762 3,433 30-40 years Leasehold improvements 18,364 11,775 2-22 years Machinery and equipment 26,108 20,732 2-15 years Furniture, fixtures and information systems 25,279 15,310 3-10 years Construction in progress 5,818 2,007 Total 80,736 54,147 Less: Accumulated depreciation (38,177 ) (26,696 ) $ 42,559 $ 27,451 $3.9 million, in 2005,2004and 2003respectively.GOODWILL AND OTHER INTANGIBLE ASSETSThe 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. TheCompany'sCompany’s assessment of the recoverability of goodwill is based upon a comparison of the carrying value of goodwill with its estimated fairvalue. The Company conducted its annualvalue, determined using a discounted cash flow methodology. No impairmentreview forof goodwillashas been identified during any ofJune 30, 2005 and determined that its goodwill was not impaired. F-9INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTSthe periods presented.Changes in the carrying amount of goodwill in20052006 and20042005 were as follows:
2005 2004 ---------- --------- (in thousands)Goodwill, beginning of year ....................................... $ 39,237 $ 26,683 Acquisitions ...................................................... 35,668 11,596 Foreign currency translation and other............................. (6,541) 958 ---------- --------- Goodwill, end of year ............................................. $ 68,364 $ 39,237 ========== =========
2006 2005 (in thousands) Goodwill, beginning of year $ 68,364 $ 39,237 Radionics acquisition 21,054 — Newdeal working capital adjustment 694 — Miltex acquisition 43,018 — Kinetikos Medical acquisition 23,089 — Newdeal acquisition — 35,668 Foreign currency translation and other 6,195 (6,541 ) Goodwill, end of year $ 162,414 $ 68,364 F-10
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSThe components of theCompany'sCompany’s identifiable intangible assets were as follows:
December 31, 2005 December 31, 2004 Weighted ---------------------- ---------------------- Average Accumulated Accumulated Life Cost Amortization Cost Amortization -------- -------- ------------ -------- ------------ (in thousands)Completed technology ........... 14 years $ 18,921 $ (5,691) $ 17,108 $ (4,505) Customer relationships ......... 18 years 22,550 (4,823) 17,417 (3,214) Trademarks / brand names ....... 36 years 31,175 (2,802) 28,689 (1,862) Noncompetetion agreements ...... 5 years 6,943 (2,607) 6,352 (1,198) All other ...................... 11 years 2,233 (1,330) 2,233 (1,203) -------- ------------ -------- ------------ $ 81,822 $(17,253) $ 71,799 $(11,982) Accumulated amortization .................... (17,253) (11,982) -------- -------- $ 64,569 $ 59,817 ======== ========The Company does not have any indefinite life intangible assets.
Weighted December 31, 2006 December 31, 2005 Average Accumulated Accumulated Life Cost Amortization Net Cost Amortization Net Completed technology 13 years $ 35,632 $ (8,573 ) $ 27,059 $ 18,921 $ (5,691 ) $ 13,230 Customer relationships 12 years 67,872 (10,671 ) 57,201 22,550 (4,823 ) 17,727 Trademarks/brand names 34 years 35,350 (4,029 ) 31,321 31,175 (2,802 ) 28,373 Trademarks/brand names Indefinite 31,600 — 31,600 — — — Noncompetition agreement 5 years 7,151 (4,079 ) 3,072 6,943 (2,607 ) 4,336 Supplier relationships 30 years 29,300 (620 ) 28,680 All other 15 years 1,620 (837 ) 783 2,233 (1,330 ) 903 $ 208,525 $ (28,809 ) $ 179,716 $ 81,822 $ (17,253 ) $ 64,569 ExcludingAmortization expense for theimpact of intangible assets acquired in the Radionics acquisition discussed in Note 17, annualyears ended December 31, 2006, 2005, and 2004 was $11.7 million, $6.1 million and $4.2 million, respectively. Annual amortization expense is expected to approximate$5.6 million in 2006, $5.3$14.6 million in 2007,$5.0$14.4 million in 2008,$4.3$12.9 million in 2009,and $3.7$11.1 million in2010.2010, $11.0 million in 2011 and $84.1 million thereafter. Identifiable intangible assets are initially recorded at fair market value at the time of acquisition generally using an income or cost approach.LONG-LIVED ASSETSLong-lived assets held and used by the Company, including property, plant and equipment and intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. For purposes of evaluating the recoverability of long-lived assets to be held and used, a recoverability test is performed using projected undiscounted net cash flows applicable to the long-lived assets. If an impairment exists, the amount of such impairment is calculated based on the estimated fair value of the asset. Impairments to long-lived assets to be disposed of are recorded based upon the fair value of the applicable assets.INTEGRA FOUNDATIONThe Company may periodicallyat the discretion of its Board of Directors,make a contribution to the Integra Foundation, Inc. The Integra Foundation was incorporated in 2002 exclusively for charitable, educational, and scientific purposes and qualifies under IRC 501(c)(3) as an exempt private foundation. Under its charter, the Integra Foundation engages in activities that promote health, the diagnosis and treatment of disease, and the development of medical science through grants, contributions and other appropriate means. The Integra Foundation is a separate legal entity and is not a subsidiary of the Company.F-10INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTSTherefore, its results are not included in these consolidated financial statements. The Company contributed$0.3$1.0 million and$2.0$0.3 million to the Integra Foundation in20052006 and2003,2005, respectively. These contributions were recorded in selling, general, and administrative expense.DERIVATIVESThe Company reports all derivatives at their estimated fair value and records changes in fair value in current earnings or defers these changes until a related hedged item is recognized in earnings, depending on the nature and effectiveness of the hedging relationship. The designation of a derivative as a hedge is made on the date the derivative contract is executed. On an ongoing basis, the Company assesses whether each derivative continues to be highly effective in offsetting changes in the fair value or cash flows of hedged items. If and when a derivative is no longer expected to be highly effective, the Company discontinues hedge accounting. All hedge ineffectiveness is included in current period earnings inotherOther income (expense), net.F-11
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSThe Company documents all relationships between hedged items and derivatives. TheCompany'sCompany’s overall risk management strategy describes the circumstances under which it may undertake hedge transactions and enter into derivatives. The objective of theCompany'sCompany’s current risk management strategy is to hedge the risk of changes in fair value attributable to interest rate risk with respect to a portion offixed ratefixed-rate debt.The determination of fair value of derivatives is based on valuation models that use observable market quotes or projected cash flows and theCompany'sCompany’s view of the creditworthiness of the derivative counterparty.FOREIGN CURRENCYAll assets and liabilities of foreign subsidiaries are translated at the rate of exchange at year-end, while elements of the income statement are translated at the average exchange rates in effect during the year. The net effect of these translation adjustments is shown as a component of accumulated other comprehensive income (loss). These currency translation adjustments are not currently adjusted for income taxes as they relate to permanent investments in non-U.S. subsidiaries. Foreign currency transaction gains and losses are reported inotherOther income (expense), net.INCOME TAXESIncome taxes are accounted for in accordance with Statement of Financial Accounting Standards No. 109 —Accounting for Income Taxes, or SFAS 109, which requires the use of the liability method in accounting for income taxes. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period when the change is enacted.REVENUE RECOGNITIONTotal revenues, net include product sales,andproduct royalties and otheroperatingrevenues, such as fees received under research, licensing, and distribution arrangements, research grants, and technology-related royalties.Total revenues for 2005, 2004 and 2003 consisted of the following:
2005 2004 2003 ---------- ---------- ----------Product sales and product royalties ............ $ 277,771 $ 228,490 $ 166,695 Other operating revenues ....................... 164 1,335 18,904 ---------- ---------- ---------- Total revenues ................................. $ 277,935 $ 229,825 $ 185,599Product sales are recognized when delivery has occurred and title and risk of loss has passed to the customer, there is a fixed or determinable sales price, and collectibility of that sales price is reasonably assured.F-11INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTSThe Company records a provision for estimated returns and allowances on revenues in the same period as the related revenues are recorded. These estimates are based on historical sales returns and discounts and other known factors. The provisions are recorded as a reduction to revenues.Product royalties are estimated and recognized in the same period that the royalty products are sold by our customers. The Company estimates and recognizes royalty revenue based upon communication with licensees, historical information and expected sales trends. Differences between actual revenues and estimated royalty revenues are adjustedforin the period in which they become known, which is typically the following quarter. Historically, such adjustments have not been significant.F-12
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSIn thefourthquarter ended December 31, 2005, the Company recognized an additional $1.3 million of royalty revenue related to a change in the manner used to estimate royalties earned based onMedtronic'sMedtronic’s sales of itsINFUSE(TM)INFUSE® bone graft product. Prior to the quarter ended December 31, 2005, the Company recognized this royalty revenue when paid by Wyeth because Wyeth did not provide information to the Company about the royalty amount earned each quarter prior to the Company reporting its quarterly financial results, and the Company did not have a reliable basis for otherwise estimating and recording royalty revenue in the same quarter it was earned.However,Because the Company now receives quarterly royalty revenue information from Wyeth in a morequickly,timely fashion, has sufficient historical informationisavailable to help the Company estimate and the volatility in the royalty earned each quarter has decreasedsignificantly. Accordingly,significantly, the Company started recognizing this royalty on an accrual basis in the quarter earned starting in the quarter ended December 31, 2005.Other operating revenues include fees received under research, licensing, and distribution arrangements, technology-related royalties, and research grants. Non-refundable fees received under research, licensing and distribution arrangements or for the licensing of technology are recognized as revenue when received if the Company has no continuing obligations to the other party. For those arrangements where the Company has continuing performance obligations, revenue is recognized using the lesser of the amount of non-refundable cash received or the result achieved using the proportional performance method of accounting based upon the estimated cost to complete these obligations. Research grant revenue is recognized when the related expenses are incurred.SHIPPING AND HANDLING FEES AND COSTSAmounts billed to customers for shipping and handling are included inproductrevenues. The related shipping and freight charges incurred by the Company are included in cost of product revenues. Distribution and handling costs of $6.1 million, $5.9 million and $3.8 millionand $2.6 million arewere recorded in selling, general and administrative expense during 2006, 2005, and 2004,and 2003,respectively.PRODUCT WARRANTIESCertain of theCompany'sCompany’s medical devices, including monitoring systems and neurosurgical systems, are reusable and are designed to operate over long periods of time. These products are sold with warranties generally extending for up to two years from date of purchase. The Company accrues estimated product warranty costs at the time of sale based on historical experience. Any additional amounts are recorded when such costs are probable and can be reasonably estimated.Accrued warranty expense consisted of the following:
December 31, 2005 2004 -------- -------- (in thousands)Beginning balance .................. $ 748 $ 403 Liability acquired through acquisition -- 255 Charged to expense ................. 191 258 Deductions ......................... (243) (168) -------- -------- Ending balance ..................... $ 696 $ 748
December 31, 2006 2005 (in thousands) Beginning balance $ 696 $ 748 Liability acquired through acquisition 358 — Charged to expense 300 191 Deductions (29 ) (243 ) $ 1,325 $ 696 F-12INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTSIn-process research and development charges recorded in connection with acquisitions represent the value assigned to acquired assets to be used in research and development activities and for which there is no alternative use. Value is generally assigned to these assets based on the net present value of the projected cash flows expected to be generated by those assets.F-13
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSIn 2006, the Company recorded a $5.9 million in-process research and development charge related to the KMI acquisition and a $0.5 million charge related to an upfront payment pursuant to a new product development alliance. In 2005, the Company recorded a $0.5 million in-process research and development charge from its acquisition of intellectual property and clinical trial data related to technology that can be used in the management of cerebrospinal fluid flow within the brain. In 2004, the Company recordedtoa research and development expenseaof $1.4 millionchargefor a milestone payment related to the completion of certain development activities for an advanced neuro-monitoring system and a $0.5 million charge for a licensing fee paid for the development of a data acquisition system to support the integration of theCompany'sCompany’s advanced monitoring products.The Company recorded $0.4 million of in-process research and development charges in connection with acquisitions during 2003.EMPLOYEE TERMINATION BENEFITS AND OTHER EXIT-RELATED COSTSThe Company does not have a written severance plan, and it does not offer similar termination benefits to affected employees in all restructuring initiatives. Accordingly, in situations where minimum statutory termination benefits must be paid to the affected employees, the Company records employee severance costs associated with these restructuring activities in accordance with SFAS No. 112,"Employer'sEmployer’s Accounting for PostemploymentBenefits."Benefits. Charges associated with these activities are recorded when the payment of benefits is probable and can be reasonably estimated. In all other situations where the Company pays out termination benefits, including supplemental benefits paid in excess of statutory minimum amounts and benefits offered to affected employees based onmanagement'smanagement’s discretion, the Company records these termination costs in accordance with SFAS No. 146,"AccountingAccounting for Costs Associated with Exit or DisposalActivities."Activities.The timing of the recognition of charges for employee severance costs depends on whether the affected employees are required to render service beyond their legal notification period in order to receive the benefits. If affected employees are required to render service beyond their legal notification period, charges are recognized ratably over the future service period. Otherwise, charges are recognized when management has approved a specific plan andrequiredemployee communication requirements have been met.For leased facilities and equipment that have been abandoned, the Company records estimated lease losses based on the fair value of the lease liability, as measured by the present value of future lease payments subsequent to abandonment, less the present value of any estimated sublease income. For owned facilities and equipment that will be disposed of, the Company records impairment losses based on fair value less costs to sell. The Company also reviews the remaining useful life of long-lived assets following a decision to exit a facility and may accelerate depreciation or amortization of these assets, as appropriate.STOCK BASEDSTOCK-BASED COMPENSATIONOn January 1, 2006, the Company adopted the provisions of FASB Statement No. 123R —Share-Based Payment, a Revision of FASB Statement No. 123 — Accounting for Stock-Based Compensation, or SFAS 123R. This standard requires companies to recognize the expense related to the fair value of their stock-based compensation awards. The Company elected to use the modified prospective approach to transition to SFAS 123R, as allowed under the statement. Under this approach, financial results need not be restated for prior periods. Under the transition method, stock-based compensation expense for the year ended December 31, 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of December 31, 2006, based on the fair value on the grant date estimated in accordance with original provision of SFAS 123 as amended by SFAS No. 148 —Accounting for Stock Based Compensation — Transition and Disclosure. Since the adoption of SFAS 123R, there have been no changes to the Company’s stock compensation plans or modifications to outstanding stock-based awards which would change the value of any awards outstanding. Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 was based on the fair value on the grant date, estimated in accordance with the provisions of SFAS 123R using the binomial distribution model. The Company recognized compensation expense for stock option awards on a ratable basis over the requisite service period of the award. The long form method was used in the determination of the windfall tax benefit in accordance with SFAS 123R.F-14
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSEmployeestockstock-based compensation expense recognized under SFAS 123R was as follows:
Year ended December 31, 2006 (in thousands, except per share amounts) Research and development expense $ 639 Selling, general and administrative 13,161 Amortization of amounts previously capitalized to inventory 315 Total employee stock-based compensation expense 14,115 Tax benefit related to employee stock-based compensation expense 4,550 Net effect on net income $ 9,565 Effect on earnings per share: Basic $ 0.33 Diluted $ 0.29 iswas recognized using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25"Accounting“Accounting for Stock Issued toEmployees"Employees” and Financial Accounting Standards Board Interpretation No. 44,"AccountingAccounting for Certain Transactions Involving Stock Compensation-an interpretation. Prior to the adoption ofAPB Opinion No. 25". F-13INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTSSFAS 123R, the Company did not include compensation expense for employee stock options in net income (loss), since all stock options granted under those plans had an exercise price equal to the market value of the common stock on the date of the grant. Had the compensation cost for theCompany'sCompany’s stock option plans been determined based on the fair value at the grant consistent with the provisions of Statement of Financial Accounting Standards No. 123,"AccountingAccounting for Stock-BasedCompensation"Compensation, theCompany'sCompany’s net income and basic and diluted net income per share would have been as follows:
2005 2004 2003 -------- -------- --------< (in thousands, except per share amounts)Net income: As reported ...................................... $ 37,194 $ 17,197 $ 26,861 Add back: Total share-based employee compensation expense determined under the intrinsic value-based method for all awards, net of related tax effects ............ 103 15,372 -- Less: Total share-based employee compensation expense determined under the fair value-based method for all awards, net of related tax effects ................ (7,264) (21,799) (5,537) -------- -------- -------- Pro forma ........................................ $ 30,033 $ 10,770 $ 21,324 Net income per share: Basic As reported ...................................... $ 1.23 $ 0.57 $ 0.92 Pro forma ........................................ $ 0.99 $ 0.36 $ 0.73 Diluted As reported ...................................... $ 1.15 $ 0.55 $ 0.86 Pro forma ........................................ $ 0.94 $ 0.35 $ 0.70As options vest over a varying number of years and awards are generally made each year, the pro forma impacts shown above may not be representative of future pro forma expense amounts.
Fiscal year ended December 31, 2005 2004 (in thousands, except per share amounts) Net income: As reported $ 37,194 $ 17,197 Add back: Total share-based employee compensation expense determined under the intrinsic value-based method for all awards, net of related tax effects 103 15,372 Less: Total share-based employee compensation expense determined under the fair value-based method for all awards, net of related tax effects (7,264 ) (21,799 ) Pro forma $ 30,033 $ 10,770 Net income per share: Basic As reported $ 1.23 $ 0.57 Pro forma $ 0.99 $ 0.36 Diluted As reported $ 1.15 $ 0.55 Pro forma $ 0.94 $ 0.35 F-15
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSThe pro forma additional compensation expense related to all options granted prior to October 1, 2004 was calculated based on the fair value of each option grant using the Black-Scholes model, while the pro forma additional compensation expense related to all options granted on or after October 1, 2004 was calculated based on the fair value of each option grant using the binomial distribution model. The Company has never paid cash dividends and does not currently intend to pay cash dividends, and thus has assumed a 0% dividend yield. Expected volatilities are based on historical volatility of the Company’s stock price with forward-looking assumptions. The expected life of stock options is estimated based on historical data on exercise of stock options, post-vesting forfeitures and other factors to estimate the expected term of the stock options granted. The risk-free interest rates are derived from the U.S. Treasury yield curve in effect on the date of grant for instruments with a remaining term similar to the expected life of the options. In addition, the Company applies an expected forfeiture rate when amortizing stock-based compensation expenses. The estimate of the forfeiture rates is based primarily upon historical experience of employee turnover. As individual grant awards become fully vested, stock-based compensation expense is adjusted to recognize actual forfeitures. The following weighted-average assumptions were used in the calculation of fair value:
2006 2005 2004 Dividend yield 0 % 0 % 0 % Expected volatility 39 %(1) 43 % 48 % Risk free interest rate 4.3 to 5.1 %(2) 3.8 % 3.2 % Expected life of option from grant date 6.1 years 5.4 years 4.7 years
2005 2004 2003 ---------- ---------- ----------Dividend yield ....................... 0% 0% 0% Expected(1) A volatility .................. 43% 48% 61%rate of 39% in 2006 that decreases 1% in each subsequent year for the length of the term was used.(2) Risk free interest rate .............. 3.8% 3.2% 2.9% Expected liferates ranged based on the duration ofoption from grant date ......................... 5.4 years 4.7 years 4.5 yearsthe grant.The effect of the change in estimate related to the use of thebionomialbinomial distribution model has been accounted for on a prospective basis. The Company will value all future stock option grants using the binomial distribution model. Management believes that the binomial distribution model is better than the Black-Scholes model because the binomial distribution model is a more flexible model that considers the impact of non-transferability, vesting and forfeiture provisions in the valuation of employee stock options.In December 2004, the Financial Accounting Standards Board issued Statement No. 123 (revised 2004), "Share-Based Payment," which is a revisionPENSION BENEFITSPension plans cover certain former U.S. employees ofStatement No. 123, "Accounting for Stock-Based Compensation." Statement 123(R) replaces APB Opinion No. 25, "Accounting for Stock Issued to Employees," and amends Statement No. 95, "Statement of Cash Flows." Statement 123(R) requires all share-based payments toMiltex, as well as certain employeesincluding grants of employee stock options, to be recognizedin thefinancial statements based on their fair value. Pro forma footnote disclosure will no longer be an alternative to financial statement recognition. The Company adopted Statement 123(R) on January 1, 2006 usingUK and former employees in Germany. Various factors are considered in determining the"modified prospective" method. The Company expects to record $14 million of share-based compensation expense in 2006 in connection with the adoption of FAS 123R. However, this estimate of future share-based compensation expense is affected by the Company's stock price,pension liability, including the number ofshare-based awardsemployees expected to be paid, their salary levels and years of service, the expected return on plan assets, the discount rate used to determine the benefit obligations, the timing of benefit payments and other actuarial assumptions. If the actual results and events for the pension plans differ from current assumptions, the benefit obligation may be over or under valued.Retirement benefit plan assumptions are reassessed on an annual basis or more frequently if changes in circumstances indicate a re-evaluation of assumptions are required. The key benefit plan assumptions are the discount rate and expected rate of return on plan assets. The discount rate is based on average rates on bonds that matched theF-14expected cash outflows of the benefit plans. The expected rate of return is based on historical and expected returns on the various categories of plan assets. F-16
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSCompany may grant in 2006, as well as a number of complexPension contributions are expected to be consistent over the next few years since the Miltex andsubjective valuation assumptionsGermany plans are frozen and therelated tax effects. These valuation assumptions include, but are not limitedUK plan is closed to new participants. Contributions to thevolatility of the Company's stock priceplans for 2006 andemployee stock option exercise behavior.2005 were $0.3 million and $0.3 million, respectively.CONCENTRATION OF CREDIT RISKFinancial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash and cash equivalents, which are held at major financial institutions, investment-grade marketable debt securities and trade receivables. TheCompany'sCompany’s products are sold on an uncollateralized basis and on credit terms based upon a credit risk assessment of each customer.USE OF ESTIMATESRECENTLY ISSUED ACCOUNTING STANDARDSIn February 2007, the FASB issued Statement of Financial Accounting Standards No. 159 —Thepreparation of consolidatedFair Value Option for Financial Assets and Financial Liabilities(SFAS 159). The Statement provides companies an option to report certain financialstatements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount ofassets and liabilities at fair value. The intent of SFAS 159 is to reduce thedisclosure of contingent liabilities,complexity in accounting for financial instruments and thereported amounts of revenuesvolatility in earnings caused by measuring related assets andexpenses. Significant estimates affecting amounts reported or disclosed in the consolidated financial statements include allowances for doubtful accounts receivable and sales returns and allowances, net realizable value of inventories, estimates of projected cash flows and discount rates used to value and test impairments of long-lived assets, depreciation and amortization periods for long-lived assets, valuation allowances recorded against deferred tax assets, loss contingencies, and in-process research and development charges. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the current circumstances. Actual results could differ from these estimates. RECENTLY ISSUED ACCOUNTING STANDARDS In November 2005, the Financial Accounting Standards Board (FASB) issued FSP FAS 115-1, which nullifies the guidance in paragraphs 10-18 of Emerging Issues Task Force Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" and references existing other than temporary impairment guidance. FSP FAS 115-1 clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell the security has not been made, and also provides guidance on the subsequent accounting for an impaired debt security. FSP FAS 115-1liabilities differently. SFAS 159 is effective forreporting periods beginningfinancial statements issued for fiscal years after November 15, 2007. The Company is evaluating the impact this new standard will have on its financial position and results of operations.In September 2006, the SEC issued Staff Accounting Bulletin No. 108 —Considering the effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements(SAB 108), to address diversity in practice in quantifying financial statement misstatements. SAB 108 requires the quantification of misstatements based on their impact to both the balance sheet and the income statements to determine materiality. The guidance provides for a one-time cumulative effect adjustment to correct for misstatements for errors that were not deemed material under a company’s prior approach but are material under the SAB 108 approach. SAB 108 is effective for the fiscal year ended December15, 2005. Management does31, 2006. The implementation of this provision did notexpect that the adoption of FSP FAS 115-1 willhave a material impact on theCompany'sCompany’s financialstatements.position or results of operations.In July 2006, the FASB issued FASB Interpretation No. 48 —Accounting for Uncertainty in Income Taxes(FIN 48). FIN 48 prescribes detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in the Company’s financial statements in accordance with FASB Statement No. 109,Accounting for Income Taxes. Tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized upon the adoption of FIN 48 and in subsequent periods. The Company will adopt the provisions of FIN 48 for all tax positions on January 1, 2007, the date of adoption. The cumulative effect of applying the provisions of the FIN 48 will be reported as an adjustment to the opening balance of retained earnings upon adoption. The Company is currently evaluating the impact of adopting this Interpretation on its financial position and results of operations.In September 2006, FASB issued Statement of Financial Accounting Standards No. 157—Fair Value Measurements, or SFAS 157. This standard establishes a framework for measuring fair value and expands disclosures about fair value measurement of a company’s assets and liabilities. This standard also requires that the fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and, generally, must be applied prospectively. The Company expects to adopt this standard beginning in January 2008. Currently, management is evaluating the impact that this new standard will have on its financial position and results of operations.In May 2005, the FASB issued Statement No. 154,"AccountingAccounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No.3."3. SFAS 154 requires retrospective application to priorperiods'periods’ financial statements of a voluntary change in accounting principle. Previously, voluntary changes in accounting principles were accounted for by including a one-time cumulative effect in the period of change. This statement is effective January 1, 2006.Management anticipates that thisThis standardwilldid not havenoan impact onourthe Company’s financial statements.F-17
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSIn November 2004, the FASB issued Statement No. 151,"Inventory Costs-anInventory Costs—an amendment of ARB No. 43, Chapter4" (Statement4(Statement 151), which is effective beginning January 1, 2006. Statement 151 requires that abnormal amounts of idle facility expense, freight, handling costs and wasted material be recognized as current-period charges. Statement 151 also requires that the allocation of fixed production overhead be based on the normal capacity of the production facilities.Management doesThis Statement did notexpect that Statement 151 willhave a material impact onourthe financial position or results of operations.The American Jobs Creation Act3. ACQUISITIONSBUSINESS COMBINATIONSRadionicsOn March 3, 2006, the Company acquired the assets of2004 was signed into lawthe Radionics Division of Tyco Healthcare Group, L.P. for approximately $74.5 million inOctober 2004cash paid at closing, subject to certain adjustments, andhas several provisions that may affect the Company's income taxes$3.2 million of acquisition-related expenses in a transaction treated as a business combination. Radionics, based in Burlington, Massachusetts, is a leader in thefuture, includingdesign, manufacture and sale of advance minimally invasive medical instruments in therepealfields of neurosurgery and radiation therapy. Radionics’ products include the CUSA Excel™ ultrasonic surgical aspiration system, the CRW® stereotactic system, the XKnife™ stereotactic radiosurgery system, the OmniSight® stereotactic radiosurgery system, and the OmniSight® EXcel image-guide surgery system. The consolidated financial statements include the results of operations for Radionics from the date of acquisition.The following summarized the fair value of theextraterritorial income exclusionassets acquired and liabilities assumed (in thousands):
Inventory $ 8,201 Property, plant and equipment 1,365 Wtd. Avg. Life Intangible Assets: Tradename 18,100 Indefinite Customer relationships 20,900 7 years Technology 10,000 10 years Goodwill 21,054 �� Other Assets 72 Total assets acquired 79,692 Accrued expenses and other current liabilities 425 Deferred revenue 1,605 Total liabilities assumed 2,030 Net assets acquired $ 77,662 new deductionreduction in goodwill of $3 million. The adjustment was related toqualified production activities income.the finalization of certain assumptions in the valuation of identifiable intangible assets. Additional direct costs of approximately $450,000 were paid in the third quarter and have been added to goodwill. Thequalified production activities income deductiongoodwill recorded in connection with this acquisition isa special deductionbased on the benefit the Company expects to generate from the synergy between Radionics’ ultrasonic aspirator product line andwill have no F-15the Company’s ultrasonic aspirator product lines. The goodwill acquired in the Radionics acquisition is expected to be deductible for tax purposes. F-18
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSimpactMiltexOn May 12, 2006, the Company acquired all of the outstanding capital stock of Miltex Holdings, Inc. (“Miltex”) for $102.7 million in cash paid at closing, subject to certain adjustments, and $0.6 million of transaction-related costs. Miltex, based in York, Pennsylvania, is a leading provider of surgical and dental offices and ambulatory surgery care sectors. Miltex sells products under the Miltex®, Meisterhand®, Vantage®, Moyco®, Union Broach®, and Thompson™ trademarks in over 65 countries, using a network of independent distributors. Miltex operates a manufacturing and distribution facility in York, Pennsylvania and also operates a leased facility in Tuttlingen, Germany where Miltex’s staff coordinates designs, production and delivery of instruments. The consolidated financial statements include the results of operations for Miltex from the date of acquisition.The following summarizes the allocation of the purchase price based ondeferred taxes existing attheenactment date. Rather,fair value of theimpactassets acquired and liabilities assumed (in thousands):
Inventory $ 16,775 Other current assets 8,049 Property, plan and equipment 7,699 Wtd. Avg. Life Intangible Assets: Customer relationships 13,100 15 years Tradename (Miltex) 13,500 Indefinite Tradename (Moyco, Union Broach, Thompson) 300 4 years Tradename (other product lines) 600 15 years Technology 1,100 10 years Supplier relationships 29,300 30 years Goodwill 43,018 Other Assets 219 Total assets acquired 133,660 Accrued expenses and other current liabilities 3,988 Deferred tax liabilities 20,674 Other non-current liabilities 5,667 Total liabilities assumed 30,329 Net assets acquired $ 103,331 this deduction will be reportedassets acquired with the assistance of a third-party valuation firm. Certain adjustments were made in theperiodthird quarter of 2006 relating to the Miltex valuation, the most significant of which resulted inwhichthededuction is claimed onrecognition of a $29.3 million supplier relationship intangible asset, a decrease of $1.9 million in theCompany'scustomer relationship intangible asset, a decrease in goodwill of $13.8 million and an increase in deferred taxreturn. Pursuant to United States Departmentliabilities ofTreasury Regulations issued$11.7 million. A portion of the goodwill acquired inOctober 2005, management believes thattheCompany will realize a tax benefit on qualified production activities income once the Company has completely utilized its unrestricted net operating losses, whichMiltex acquisition is expected tooccurbe deductible for tax purposes. The purchase price allocation was finalized in2006. 3. ACQUISITIONS BUSINESS COMBINATIONSthe fourth quarter with an increase of $5.0 million to goodwill and an increase of $5.0 million to other non-current liabilities as the Company finalized its assessment of pre-acquisition tax contingencies.Canada Microsurgical, Ltd.On July 6, 2006, the Company acquired all of the outstanding capital stock of Canada Microsurgical, Ltd. (“CML”) for $5.8 million in cash paid at closing, subject to certain adjustments, $0.1 million working capital adjustment and $0.2 million of transaction-related costs. In addition, the Company may pay up to an additional $1.9 million (2.1 million Canadian dollars) over the next three years, depending on the performance of the business. If and when such amounts are paid, then those payments will be added to goodwill. CML, a long-standing distributor for the company, has eight sales representatives who cover all of the provinces in Canada. The consolidated financial statements include the results of operations for CML from the date of acquisition.F-19
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSThe following summarizes the allocation of the purchase price based on the fair value of the assets acquired and liabilities assumed (in thousands):
Inventory $ 1,576 Other current Assets 1,121 Wtd. Avg. Life Intangible Assets: Customer relationships 4,722 10 years Tradename 2,756 15 years Non-compete 90 5 years Goodwill — Other Assets 21 Total assets acquired 10,286 Accrued expenses and other current liabilities 730 Deferred liabilities 671 Deferred tax liabilities 2,737 Total liabilities assumed 4,138 Net assets acquired $ 6,148 F-20
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSThe following summarized the allocation of the purchase price based on the fair value of the assets acquired and liabilities assumed (in thousands):
Inventory $ 2,208 Other current Assets 2,801 Property, plant and equipment 1,646 Wtd. Avg. Life Intangible Assets: Customer relationships 6,100 3.5 years Tradename (MBA, UNI2) 300 5 years Developed technology patents 4,350 15 years In-process research and development 5,875 Expensed immediately Goodwill 23,089 Other Assets 1,260 Total assets acquired 47,629 Accrued expenses and other current liabilities 1,933 Deferred tax liabilities 3,953 Total liabilities assumed 5,886 Net assets acquired $ 41,743 ("Newdeal Technologies"(“Newdeal”) for $51.9 million (38.3 million euros) in cash paid at closing, a $0.7 million working capital adjustment paid in January 2006, and $0.8 million of acquisition related expenses. Additionally, the Company agreed to pay the sellers up to an additional 1.3 million euros if the sellers continue their employment with the Company through January 3, 2006. This additional payment was accrued to selling, general and administrative expense on a straight-line basis in 2005 over the one-year employment requirementperiod.period and was paid in January 2006.Based in Lyon, France, Newdeal is a leading developer and marketer of specialty implants and instruments specifically designed for foot and ankle surgery.Newdeal'sNewdeal’s products include a wide range of products for the forefoot, themid-footmidfoot and thehind foot,hindfoot, including theBold(R)Bold® Screw,Hallu-Fix(R)Hallu®-Fix plate system and theHINTEGRA(R)HINTEGRA™ total ankle prosthesis. At the time of the acquisition, Newdeal sold its products through a direct sales force in France, Belgium and the Netherlands and through distributors in more than 30 countries, including the United States and Canada. During 2005, Integra began to market the Newdeal products directly in the United States through its Integra Reconstructive Surgery sales force.Newdeal'sNewdeal’s target physicians include orthopedic surgeons specializing in injuries of the foot, ankle and extremities as well as podiatric surgeons.F-21
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSIn connection with this acquisition, the Company recorded $35.7 million of goodwill and $13.1 million of intangible assetsconsisting(consisting primarily oftrade name,tradename, customer relationships, andtechnology,technology) which are being amortized on a straight-line basis over lives ranging from 5 to 40 years. The goodwill recorded in connection with this acquisition is based on the benefits the Company expects to generate from the synergy betweenNewdeal'sNewdeal’s reconstructive foot and ankle fixation products and theCompany'sCompany’s regenerative products that are used in the treatment of chronic and traumatic wounds of the foot and ankle. The fair value of assets acquired was determined with the assistance of a third-party valuation firm.In May 2004, the Company acquired theMAYFIELD(R)MAYFIELD® Cranial Stabilization and Positioning Systems and theBUDDE(R)BUDDE® Halo Retractor System business from Schaerer Mayfield USA, Inc. (formerly Ohio Medical Instrument Company) for $20.0 million in cash paid at closing, a $0.3 million working capital adjustment and $0.3 million of acquisition related expenses. The MAYFIELD® and BUDDE® lines include skull clamps, headrests, reusable and disposable skull pins, blades, retractor systems, and spinal implants. MAYFIELD® systems are the market leader in the United States and have been used by neurosurgeons for over thirty years.F-16INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTSThe products are sold in the United States through the Integra NeuroSciences direct sales organization and in international markets through distributors. In connection with this acquisition, the Company recorded $8.4 million of goodwill and $8.1 million of intangible assets, consisting of a non-compete agreement,trade name,tradename, and technology, which are being amortized on a straight-line basis over lives ranging from 5 to 30 years. The fair value of assets acquired was determined with the assistance of a third-party valuation firm.In May 2004, the Company acquired all of the capital stock of Berchtold Medizin-Elektronik GmbH, now named Integra ME GmbH, from Berchtold Holding GmbH for $5.0 million in cash. Integra ME manufactures and markets theELEKTROTOM(R)ELEKTROTOM® line of electrosurgery generators and theSONOTOM(R)SONOTOM™ ultrasonic surgical aspirator, as well as a broad line of related handpieces, instruments and disposables used in many surgical procedures, including neurosurgery. Integra ME markets and sells its products to hospitals and physicians primarily through a network of distributors. This acquisition provided Integra with additional devices for the European and international markets and an existing infrastructure through which it can sell certain of its other products directlyintoin Germany. In connection with this acquisition, the Company recorded $1.7 million of goodwill and $1.3 million of intangible assets, consisting primarily of trade name, technology, and customer relationships, which are being amortized on a straight-line basis over lives ranging from 3 to 10 years.The acquired business included a facility located in Tuttlingen, Germany that manufactured, packaged and distributed the ELEKTROTOM® andSONOTOMSONOTOM™ products. The Company closed the Tuttlingen facility in December 2005 and transferred all of the Tuttlingen operations to its facility located in Andover,England.United Kingdom.In January 2004, the Company acquired the R&B instrument businessfromof R&B Surgical Solutions, LLC for $2.0 million in cash. The R&B instrument line is a complete line of high-quality handheld surgical instruments used in neuro- and spinal surgery. The Company markets these products through itsJARITJarit sales organization. In connection with this acquisition, the Company recorded $1.5 million of intangible assets and goodwill. The acquired intangible assets are being amortized on a straight-line basis over lives ranging from 5 to 20 years.In January 2004, the Company acquired the Sparta disposable critical care devices and surgical instruments business from Fleetwood Medical, Inc. for $1.6 million in cash. The Sparta product line includes products used in plastic and reconstructive, ear, nose and throat (ENT), neuro, ophthalmic and general surgery. The Company sells the Sparta products through a direct marketing organization and an existing distributor network. In connection with this acquisition, the Company recorded $1.6 million of intangible assets and goodwill. The acquired intangible assets are being amortized on a straight-line basis over 5 years.The results of operations of the acquired businesses have been included in the consolidated financial statements since their respective dates of acquisition.F-22
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSThe following table summarizes the fair value of the assets acquired and liabilities assumed as a result of the 2005 and 2004 acquisitions:
(All amounts in thousands)2005 Acquisitions Newdeal - ----------------- -------------Current assets ....................... $10,925 Property, plant and equipment ........ 1,026 Wtd. Avg. Life Intangible assets: -------------- Tradename ......................... 2,926 37 years Customer relationships ............ 6,032 10 years Technology ........................ 3,387 10 years Non-competition agreement ......... 745 5 years Goodwill ............................. 35,668 Other assets ......................... 38 ------------- Total assets acquired ............. 60,747 Liabilities assumed, excluding debt .. 7,560 Debt assumed ......................... 530 ------------- Net assets acquired .................. $52,657F-17INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MAYFIELD/ 2004 Acquisitions BUDDE Integra ME R&B/Sparta - ----------------- ------------- ----------- -----------Current assets ....................... $ 3,489 $ 3,151 $ 817 Property, plant and equipment ........ 1,400 78 10 Intangible assets .................... 8,030 1,320 1,639 Goodwill ............................. 8,397 1,775 1,478 ------------- ----------- ----------- Total assets acquired ............. 21,316 6,324 3,944 Current liabilities .................. 768 837 340 Deferred tax liabilities ............. -- 240 -- Other non-current liabilities ........ -- 265 -- ------------- ----------- ----------- Total liabilities assumed ......... 768 1,342 340 Net assets acquired .................. $20,548 $ 4,982 $ 3,604
Newdeal (All amounts in thousands) 2005 Acquisitions Current assets $ 10,925 Property, plant and equipment 1,026 Intangible assets 13,090 Goodwill 35,668 Other assets 38 Total assets acquired 60,747 Liabilities assumed, excluding debt 7,560 Debt assumed 530 Net assets acquired $ 52,657
Amount Estimated useful life Tradename $ 2,926 37 years Customer relationships 6,032 10 years Technology 3,387 10 years Non-competition agreement 745 5 years
MAYFIELD /
BUDDEIntegra ME R&B / Sparta 2004 Acquisitions Current assets $ 3,489 $ 3,151 $ 817 Property, plant and equipment 1,400 78 10 Intangible assets 8,030 1,320 1,639 Goodwill 8,397 1,775 1,478 Total assets acquired 21,316 6,324 3,944 Current liabilities 768 837 340 Deferred tax liabilities — 240 — Other non-current liabilities — 265 — Total liabilities assumed 768 1,342 340 Net assets acquired $ 20,548 $ 4,982 $ 3,604 yearyears ended December 31,20042006 and 2005 as if the acquisitions consummated in20052006 and20042005 had been completed as of the beginning of2004.2005. The pro forma results are based upon certain assumptions and estimates and they give effect to actual operating results prior to the acquisitions and adjustments to reflect increased depreciation expense, increased intangible asset amortization, and increased income taxes at a rate consistent withIntegra'sIntegra’s marginal rate in each year. No effect has been given to cost reductions or operating synergies. As a result, these pro forma results do not necessarily represent results that would have occurred if the acquisition had taken place on the basis assumed above, nor are they indicative of the results of future combined operations.
2004 -------- (in thousands)Total revenue ......................................... $250,191 Net income ............................................ 17,922 Basic net income per share ............................ $ 0.60 Diluted net income per share .......................... $ 0.58Pro forma financial information for the year ended December 31, 2005 would not be materially different from actual reported amounts because the Newdeal acquisition was consummated on January 3, 2005.F-23
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2006 2005 (in thousands, except per share amounts) Total revenue, net $ 462,593 $ 414,785 Net income 32,903 35,312 Basic net income per share $ 1.12 $ 1.17 Diluted net income per share $ 1.07 $ 1.09 its innovative COGNIShunt(R)the COGNIShunt® system for the treatment ofAlzheimer'sAlzheimer’s disease patients. The acquisition of the Eunoe intellectual property estate and clinical trial data extends theCompany'sCompany’s technology base relevant to the management of conditions that require regulation of cerebrospinal fluid flow within the brain. The traditional application of this technology is for the treatment of hydrocephalus, a market in which Integra currently competes. The acquired intellectual property has not been developed into a product that has been approved by the FDA and has no future alternative use other than in clinical applications involving the regulation of cerebrospinal fluid. Accordingly, the Company recorded the entire acquisition price as an in-process research and development charge in 2005. This transaction was accounted for as an asset purchase because the acquired assets did not constitute a business under FASB StatementNoNo. 141"Business Combinations"“Business Combinations”.In December 2003, the Company acquired the assets of Reconstructive Technologies, Inc.("RTI") for $400,000 in cash and agreed to make certain future F-18INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS performance-based payments for the RTI assets. Any future contingent consideration paid to the seller is expected to be recorded as a technology-based intangible asset. RTI is the developer of the Automated Cyclic Expansion System (ACE System(TM)), a tissue expansion device. Because the ACE System was not approved by the FDA for sale and the Company did not acquire any assets other than technology and intellectual property underlying the ACE System, the Company recorded the entire acquisition price as an in-process research and development charge in 2003. This transaction was accounted for as an asset purchase because the acquired assets did not constitute a business under Statement 141.4. RESTRUCTURING ACTIVITIESIn June 2005, management announced plans to restructure theCompany'sCompany’s European operations. The restructuring plan included closing theCompany'sCompany’s Integra ME production facility in Tuttlingen, Germany and reducing various positions in theCompany'sCompany’s production facility located in Biot, France, both of which were completed in December 2005. The Company closed the Integra ME production facility and transitioned the manufacturing operations of Integra ME to its production facility in Andover,UK. In June 2005, theUnited Kingdom. The Company also eliminated some duplicative sales and marketing positions, primarily in Europe.ApproximatelyThe Company terminated 68 individualswere identified for terminationunder the European restructuring plan.As of December 31, 2005, the Company terminated 65 of these individuals.In 2005, the Company also completed the transfer of the Spinal Specialties assembly operations from theCompany'sCompany’s San Antonio, Texas plant to its San Diego, California plant.In connection with these restructuring activities, the Company recorded $4.0 million of charges in 2005 for the estimated costs of employee termination benefits to be provided to the affected employees and related facility exit costs.During the year ended December 31, 2006, the Company terminated 10 employees in connection with the transfer of certain manufacturing packaging operations from its plant in Plainsboro, New Jersey to its plant in Anasco, Puerto Rico.F-24
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSIn connection with these restructuring activities, the Company has recorded the following charges during2005:2006 and 2005 (there were no restructuring activities in 2004):
Research Selling Cost of and General and Sales Development Administrative Total ------- ------- ------- ------- (in thousands)Involuntary employee termination costs ... $ 2,596 $ 183 $ 1,082 $ 3,861 Facility exit costs ...................... -- -- 155 $ 155
Research and Selling, General Cost of Sales Development and Administrative Total (in thousands) 2006 Involuntary employee termination costs $ 290 $ — $ 745 $ 1,035 Facility exit costs — — — — 2005 Involuntary employee termination costs $ 2,596 $ 183 $ 1,082 $ 3,861 Facility exit costs — — 155 155 2005:2006:
Employee Facility Termination Exit Costs Costs Total ------- ------- ------- (in thousands)Balance at December 31, 2004 ........................ $ -- $ -- $ -- Additions ........................................... 4,010 155 4,165 Reversal of prior accruals .......................... (149) -- (149) Payments ............................................ (1,398) (31) (1,429) Effects of foreign exchange ......................... (43) -- (43) ------- ------- ------- Balance at December 31, 2005 ........................ $ 2,420 $ 124 $ 2,544
Employee Termination Facility Exit Costs Costs Total (in thousands) Balance at December 31, 2005 $ — $ — $ — Additions 4,010 155 4,165 Reversal of prior accruals (149 ) — (149 ) Payments (1,398 ) (31 ) (1,429 ) Effects of foreign exchange (43 ) — (43 ) Balance at December 31, 2005 2,420 124 2,544 Additions 1,035 — 1,035 Acquired through acquisition 220 155 375 Reversal of prior accruals (116 ) — (116 ) Payments (2,107 ) (118 ) (2,225 ) Effects of foreign exchange 104 9 113 Balance at December 31, 2006 $ 1,556 $ 170 $ 1,726 theall of the remaining costs in early2006. In December 2003, the Company recorded a $1.1 million charge in connection with closing of its San Diego research center, the termination of certain research F-19INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS programs conducted there, and the consolidation of the remaining research activities into its other facilities. The charge consisted of the following (in thousands):
Facility lease termination fee .................. $ 379 Research program termination costs .............. 216 Property and equipment impairment ............... 183 Inventory write-off ............................. 157 Employee severance .............................. 120 Other ........................................... 52 ------ Total $1,107The inventory write-off was recorded to cost of product revenues. All other amounts were recorded to research and development expense. All amounts were paid in 2003, except for the employee severance amounts, which were included in accrued expenses and other current liabilities at December 31, 2003 and subsequently paid in 2004.2007.5. DEBTIn 2003, the Company completed a $120.0 million private placement of contingent convertible subordinated notes due 2008.The notes bear interest at2.5 percent2.5% per annum, payable semiannually. The Company will pay additional interest("(“ContingentInterest"Interest”) if, at thirty days prior to maturity,Integra'sIntegra’s common stock price is greater than $37.56 per share. The Contingent Interest will be payable for each of the last three years the notes remain outstanding in an amount equal to the greater of (i) 0.50% of the face amount of the notes and (ii) the amount of regular cash dividends paid during each such year on the number of shares of common stock into which each note is convertible. The Company recorded a $0.4 million liability related to the estimated fair value of the Contingent Interest obligation at the time the notes were issued. Thefair valueCompany used $35.3 million of the proceeds from the issuance of the old notes to purchase 1.5 million shares of its common stock.F-25
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSOn September 27, 2006, the Company exchanged $115.2 million (out of a total of a $120.0 million) of its 21/2% ContingentInterest obligation is markedConvertible Subordinated Notes due 2008 (the “old notes”) for the equivalent amount of 21/2% Contingent Convertible Subordinated Notes due 2008 (the “new notes”). The terms of the new notes are substantially similar to those of the old notes, except that the new notes have a net share settlement feature and include “takeover protection,” whereby the Company will pay a premium to holders who convert their notes upon the occurrence of designated events, including a change in control. The net share settlement feature requires that, upon conversion of the new notes, the Company will pay holders in cash for up to the principal amount of the converted new notes with any amounts in excess of this cash amount settled, at the election of the Company, in cash or shares of itsfair value at each balance sheet date, with changescommon stock. Holders who exchange their old notes in thefair value recordedexchange offer received an exchange fee of $2.50 per $1,000 principal amount of their old notes. We paid approximately $288,000 of exchange fees tointerest expense. At December 31, 2005 and 2004, the estimated fair valuetendering holders of theContingent Interest Obligationexisting notes plus expenses totaling approximately $332,000 in connection with the offer.In addition, because the closing price of the Company’s stock on the issuance date of the new notes was$0.7higher than the market price trigger of the new notes, the holders have the option to convert their notes into cash, and if applicable, shares of its common stock at any time. As a result, $115.2 million of contingent convertible notes have been classified as current liability on the balance sheet. The Company recorded a $1.2 million write-off of the unamortized debt issuance costs and$0.7$0.3 millionrespectively. In 2005, interest expenseof fees associated withchanges intheestimated fair valueexchange of theContingent Interest Obligation was not significant. In 2004, and 2003,old notes.On October 20, 2006 an additional $4.3 million of old notes were tendered, bringing theCompany recorded $0.3total amount of exchanges to $119.5 million,and $0.1 million, respectively, of interest expense associated with changes in the estimated fair valueor 99.6% of theContingent Interest Obligation. Debt issuance costs totaled $4.1original $120 millionand are being amortized using the straight-line method over the five-year termprincipal amount. The Company paid approximately $11,000 ofthe notes.exchange fees to tendering holders of these notes in connection with this exchange.Holders may convert their notesinto shares of Integra common stockat an initial conversion price of $34.15 per share, upon the occurrence of certain conditions, including when the market price ofIntegra'sIntegra’s common stock on the previous trading day is more than 110% of the conversion price.The notes are general, unsecured obligations of the Company and will be subordinate to any future senior indebtedness of the Company. The Company cannot redeem the notes prior to their maturity. Holders of the notes may require the Company to repurchase the notes upon a change in control.ConcurrentThe fair value of the Company’s $120.0 million principle amount 21/2% contingent convertible subordinated notes outstanding at December 31, 2006 was $114.3 million.In August 2003, the Company entered into an interest rate swap agreement with a $50.0 million notional amount to hedge the risk of changes in fair value attributable to interest rate risk with respect to a portion of our fixed-rate convertible notes. The Company received a 21/2% fixed rate from the counterparty, payable on a semi-annual basis, and paid to the counterparty a floating rate based on 3-month LIBOR minus 35 basis points, payable on a quarterly basis. The interest rate swap agreement was scheduled to terminate in March 2008, subject to early termination upon the occurrence of certain events, including redemption or conversion of the convertible notes. On September 27, 2006, the Company terminated this interest rate swap agreement in connection with theissuanceexchange of the convertible notes. The interest rate swap agreement qualified as a fair value hedge under SFAS No. 133, as amended “Accounting for Derivative Instruments and Hedging Activities.” The net amount to be paid or received under the interest rate swap agreement was recorded as a component of interest expense.The fair value of the Contingent Interest obligation, which is the same under the old and new notes has been marked to its fair value at each balance sheet date, with changes in the fair value recorded to interest expense. At December 31, 2006 and 2005, the estimated fair value of the Contingent Interest Obligation was $1.1 million and $0.7 million, respectively. In 2006, the Companyused $35.3recorded $0.4 million of interest expense associated with changes in theproceeds to purchase 1.5estimated fair value of the Contingent Interest Obligation. In 2005, interest expense associated with changes in the estimated fair value of the Contingent Interest Obligation was not significant. In 2004, the Company recorded $0.3 millionsharesofits common stock.interest expense associated with changes in the estimated fair value of the Contingent Interest ObligationF-26
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSIn December 2005, the Company established a $200 million, five-year, senior secured revolving creditfacility.facility The Company plans to utilize the credit facilitycurrently allowsforrevolvingworking capital, capital expenditures, share repurchases, acquisitions and other general corporate purposes. The Company borrowed against this credit facility in 2006 for acquisition related purposes. The Company makes regular borrowings and payments each month against the credit facility and considers the outstanding amounts to be short-term in nature. As of December 31, 2006, the Company had $100 million of outstanding borrowings under the credit facility at aprincipal amountweighted average interest rate ofup to $200 million, which can be increased to $250 million should additional financing be required in the future.6.58% per annum. The Company did not draw any amounts against this credit facility in 2005.The indebtedness under the credit facility is guaranteed by theCompany'sCompany’s domestic subsidiaries. TheCompany'sCompany’s obligations under the credit facility andF-20INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTSthe guarantees of the guarantors are secured by a first-priority security interest in all present and future capital stock of (or other ownership or profit interest in) each guarantor and substantially all of theCompany'sCompany’s and theguarantors'guarantors’ other assets, other than real estate, intellectual property and capital stock of foreign subsidiaries.Borrowings under the credit facility bear interest, at theCompany'sCompany’s option, at a rate equal to (i) the Eurodollar Rate in effect from time to time plus an applicable rate (ranging from0.75%0.375% to1.5%1.25%) or (ii) the higher of (x) the weighted average overnight Federal funds rate, as published by the Federal Reserve Bank of New York, plus 0.5%, and (y) the prime commercial lending rate of Bank of America, N.A. plus an applicable rate (ranging from 0% to0.5%0.25%). The applicable rates are based on a financial ratio at the time of the applicable borrowing.The Company will also pay an annual commitment fee (ranging from0.15%0.10% to0.25%0.20%) on the daily amount by which the commitments under the credit facility exceed the outstanding loans and letters of credit under the credit facility.In 2005, the Company paid approximately $1.1 million of fees in connection with establishing the credit facility. The company capitalized these fees and is amortizing them to interest expense over the five-year term of the credit facility.The credit facility requires the Company to maintain various financial covenants, including leverage ratios, a minimum fixed charge coverage ratio, and a minimum liquidity ratio. The credit facility also contains customary affirmative and negative covenants, including those that limit theCompany'sCompany’s and itssubsidiaries'subsidiaries’ ability to incur additional debt, incur liens, make investments, enter into mergers and acquisitions, liquidate or dissolve, sell or dispose of assets, repurchase stock and pay dividends, engage in transactions with affiliates, engage in certain lines of business and enter into sale and leaseback transactions.6. DERIVATIVE INSTRUMENTSIn August 2003, the Company entered into an interest rate swap agreement with a $50 million notional amount to hedge the risk of changes in fair value attributable to interest rate risk with respect to a portion of itsfixed ratefixed-rate contingent convertible subordinated notes. The Companyreceivesreceived a 21/2%1/2% fixed rate from the counterparty, payable on a semi-annual basis, andpayspaid to the counterparty a floating rate based on 3-month LIBOR minus 35 basis points, payable on a quarterly basis. The floatingrate resetsrates reset each quarter. The interest rate swap agreementterminateswas scheduled to terminate on March 15, 2008, subject to early termination upon the occurrence of certain events, including redemption or conversion of the contingent convertible notes.The net amount to be paid or received under the interest rate swap agreement is recorded as a component of interest expense. In 2005, the Company recorded an additional $0.2 million of interest expense associated with the interest rate swap. In 2004 and 2003, the Company recorded a reduction in interest expense of $0.7 million and $0.3 million, respectively. Our effective interest rate on the hedged portion of the notes was 3.7% as of December 31, 2005.The interest rate swap agreementqualifiesqualified as a fair value hedge under SFAS No. 133, as amended,"Accounting“Accounting for Derivative Instruments and HedgingActivities".Activities.” Accordingly, until it was terminated, the interest rate swapishas been recorded at fair value and changes in fair value are recorded inotherOther income (expense), net.The net fair value of the interest rate swap at December 31, 2005 was $2.0 million. The Company recorded the following changes in the net fair values of the interest rate swap and the hedged portion of the contingent convertible notes:
2005 2004 2003 -------- -------- -------- (in thousands)Interest rate swap ............................... $ 690 $ 287 $ 305 Contingent convertible notes ..................... (821) (430) (433) -------- -------- -------- Net increase (decrease) in liabilities ........... $ (131) $ (143) $ (128)F-21INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The net increase (decrease) in liabilities represents the ineffective portion of the hedging relationship, and these amounts are recorded in other income (expense), net. At December 31, 2005 and 2004, the Company had $3.4 million and $2.9 million of cash pledged as collateral in connection with the interest rate swap agreement.In November 2004, the Company entered into a collar contract for euro 38.5 million to reduce its exposure to fluctuations in the exchange rate between the euro and the US dollar as a result of its commitment to acquire Newdeal Technologies in January 2005 for euro 38.5 million. The collar contract did not qualify as a hedge under SFAS No. 133. Accordingly, the collar contract was recorded at fair value and changes in fair value were recorded inotherOther income (expense), net. In 2004, the Company recorded a $1.4 million gain related to the change in the fair value of the collar contract. The foreign currency collar expired in January 2005, concurrent with theCompany'sCompany’s acquisition of Newdeal Technologies.7. COMMON AND PREFERRED STOCK PREFERRED STOCK TRANSACTIONSF-27
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSThe Companyisrecorded the following changes in the net fair values of the interest rate swap and the hedged portion of the contingent convertible notes:
2006 2005 2004 (in thousands) Interest rate swap $ (690 ) $ 690 $ 287 Contingent convertible notes 343 (821 ) (430 ) Net increase (decrease) in liabilities 347 $ (131 ) $ (143 ) to issue up to 15,000,000the repurchase of shares ofpreferredits common stockin one or more series, of which 2,000,000 shares have been designated as Series A, 120,000 shares have been designated as Series B, and 54,000 shares have been designated as Series C. There was no preferred stock outstanding at eitherfor an aggregate purchase price not to exceed $50 million through December 31,20052006, and terminated the prior repurchase program. Shares may be purchased either in the open market or2004. COMMON STOCK TRANSACTIONSin privately negotiated transactions.The Company repurchased1.7 million, 0.51.8 million and1.51.7 million shares of its common stock in2005, 20042006 and2003,2005, respectively, for $70.0 million and $56.3 million,$14.2respectively.In October 2006, the Board of Directors terminated the repurchase program approved in February 2006 and adopted a new program that authorizes the Company to repurchase shares of its common stock for an aggregate purchase price not to exceed $75 millionand $35.4 million, respectively.through December 31, 2007. Shares may be repurchased either in the open market or in privately negotiated transactions.8. STOCK PURCHASE AND AWARD PLANSEMPLOYEE STOCK PURCHASE PLANThe purpose of the Employee Stock Purchase Plan (theESPP)“ESPP”) is to provide eligible employees of the Company with the opportunity to acquire shares of common stock at periodic intervals by means of accumulated payroll deductions. Under the ESPP, a total of 1.5 million shares of common stock are reserved for issuance. These shares will be made available either from theCompany'sCompany’s authorized but unissued shares of common stock or from shares of common stock reacquired by the Company as treasury shares. At December 31,2005,2006, 1.1 million shares remain available for purchase under the ESPP. During the years ended December 31, 2006 and 2005, the Company issued 38,577 and 8,826 shares under the ESPP for $1.2 million and $0.4 million, respectively.The ESPP was amended in 2005to eliminate the lookback option andto reduce the discount available to participants to fivepercent.percent and to fix the price against which such discount would be applied. Accordingly, the ESPPwill beis a non-compensatory plan underStatement 123(R).SFAS 123R.EQUITY AWARD PLANSAs of December 31,20052006 the Company had stock options, restricted stock awards, and contract stock outstanding under seven plans, the 1993 Incentive Stock Option and Non-Qualified Stock Option Plan (the1993 Plan)“1993 Plan”), the 1996 Incentive Stock Option and Non-Qualified Stock Option Plan (the1996 Plan)“1996 Plan”), the 1998 Stock Option Plan (the1998 Plan)“1998 Plan”), the 1999 Stock Option Plan (the1999 Plan)“1999 Plan”), the 2000 Equity Incentive Plan (the2000 Plan)“2000 Plan”), the 2001 Equity Incentive Plan (the2001 Plan)“2001 Plan”), and the 2003 Equity Incentive Plan (the2003 Plan,“2003 Plan”, and collectively, thePlans)“Plans”). No newoptionsawards may be granted under the 1993 Plan and the 1996 Plan.F-22F-28
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSThe Company has reserved 750,000 shares of common stock for issuance under both the 1993 Plan and 1996 Plan, 1,000,000 shares under the 1998 Plan, 2,000,000 shares under each of the 1999 Plan, the 2000 Plan and the 2001 Plan, and 4,000,000 shares under the 2003 Plan. The 1993 Plan, 1996 Plan, 1998 Plan, and the 1999 Plan permit the Company to grant both incentive and non-qualified stock options to designated directors, officers, employees and associates of the Company. The 2000 Plan, 2001 Plan, and 2003 Plan permit the Company to grant incentive and non-qualified stock options, stock appreciation rights, restricted stock, contract stock, performance stock, or dividend equivalent rights to designated directors, officers, employees and associates of the Company. Stock options issued under the Plans become exercisable over specified periods, generally within four years from the date of grant for officers, employees and consultants, and generally expire six years from the grant date. The transfer and non-forfeiture provisions of restricted stock issued under the Plans lapse over specified periods, generally at three years after the date of grant.Stock Options- ------------- StockThe following table summarizes the Company’s stock option activityfor all the Plans was as follows:
2005 2004 2003 --------------------- --------------------- --------------------- Wtd. Avg. Wtd. Avg. Wtd. Avg. Options Ex. Price Options Ex. Price Options Ex. Price ----------------------------------------------------------------------- (shares in thousands)Options outstanding at January 1, ........... 3,683 $23.42 2,884 $16.19 4,295 $12.15 Granted ................. 1,089 $34.53 1,473 $31.81 430 $24.81 Exercised ............... (576) $13.83 (547) $ 9.80 (1,726) $ 7.70 Cancelled ............... (195) $30.28 (127) $21.97 (115) $17.40 Options outstanding at December 31, ......... 4,001 $27.50 3,683 $23.42 2,884 $16.19 Options exercisable at December 31, .......... 2,023 $22.74 1,641 $17.61 1,495 $ 13.65
Shares Weighted Average Stock Options (in thousands) Exercise Price Outstanding at December 31, 2003 2,884 $ 16.19 Granted 1,473 31.81 Exercised (547 ) 9.80 Forfeited or Expired (127 ) 21.97 Outstanding at December 31, 2004 3,683 23.42 Granted 1,089 34.53 Exercised (576 ) 13.83 Forfeited or Expired (195 ) 30.28 Outstanding at December 31, 2005 4,001 27.50 Granted 273 40.75 Exercised (705 ) 22.20 Forfeited or Expired (131 ) 33.27 Outstanding at December 31, 2006 3,438 $ 29.41 F-29
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSThe following table summarizes information about stock options outstanding:
Options Outstanding Weighted Avg. Options Exercisable Shares (in Weighted Avg. Remaining Shares (in Weighted Avg. Range of Exercise Prices thousands) Exercise Price Contractual Life thousands) Exercise Price $11.00 to $16.07 348 $ 11.81 3.43 348 $ 11.81 $16.13 to $22.95 346 18.90 1.98 337 18.83 $23.80 to $27.32 349 26.58 1.11 329 26.54 $27.47 to $29.24 363 28.65 2.95 261 28.58 $29.32 to $31.38 481 30.86 5.98 226 31.03 $31.89 to $34.49 497 33.57 5.73 260 33.52 $34.62 to $35.57 492 35.48 6.01 190 35.46 $35.76 to $38.20 347 36.65 4.25 150 36.63 $38.72 to $42.53 216 42.25 9.54 7 38.72 Amounts as of December 31, 2006 3,438 $ 29.41 2,108 $ 26.04 Amounts as of December 31, 2005 4,001 $ 27.50 2,023 $ 22.74 Amounts as of December 31, 2004 3,683 $ 23.42 1,641 $ 17.61 2005:
Options Outstanding Options Exercisable ---------------------------------------------- -----------------------2006 and 2005, respectively. Cash received from option exercises was $15.9 million, $9.3 million, and $6.1 million for fiscal 2006, 2005, and 2004, respectively.As of December 31, 2006, there was approximately $18.8 million of total unrecognized compensation costs related to unvested stock options. These costs are expected to be recognized over a weighted-average period of approximately 2.5 years.Awards ofWtd. Avg. Wtd. Avg. As of Wtd. Avg. Range Of Dec. 31, Exercise Remaining Dec. 31 Exercise Exercise Prices 2005 Price Contractual Life 2005 Price ----------------- ---------- ------------ -------------------- ---------- ----------- (shares in thousands)$ 6.56 - $17.65 827 $ 13.79 3.0 years 745 $ 13.42 $17.68 - $27.89 800 $ 25.20 2.5 years 700 $ 25.38 $27.94 - $31.38 939 $ 29.94 5.6 years 336 $ 29.76 $31.89 - $35.52 829 $ 34.16 6.0 years 242 $ 34.03 $35.57 - $38.72 606 $ 36.33 6.7 years -- $ 0.00 ------- -------- ----------- ------- -------- 4,001 $ 27.50 4.7 years 2,023 $ 22.74The weighted average fair market value of stock options granted in 2005, 2004 and 2003 was $14.88, $13.48, and $13.01 per share, respectively.Restricted Stock,- ---------------- In 2005, the Company issued 21,246 sharesPerformance Stock and Contract StockThe following is a summary of awards of restrictedstock. These awards are expensed over their vesting period, ranging from six months to three years.stock, performance stock and contract stock for the year ended December 31, 2006 (shares in thousands):
Performance Stock and Contract Restricted Stock Awards Stock Awards Wtd. Avg. Fair Wtd. Avg. Fair Shares Value Per Share Shares Value Per Share Unvested, December 31, 2005 19 $ 35.08 — $ — Granted 194 38.38 218 35.41 Cancellations (11 ) 38.18 — — Unvested, December 31, 2006 202 $ 38.08 218 $ 35.41 ofin expensein 2005related tothese awards.awards granted in 2006 and 2005, respectively. The Company did not issue any shares of restricted stock prior to 2005.F-23Performance stock awards have performance features associated with them. Performance stock, restricted stock and contract stock awards generally have requisite service periods of three years. The fair value of these awards is being expensed on a straight-line basis over the vesting period. As of December 31, 2006, there was approximately $10.6 million of total unrecognized compensation costs related to unvested awards. These costs are expected to be recognized over a weighted-average period of approximately 2.7 years. The company granted 194,498 restricted stock awards with a weighted average fair value of $38.38 during the year ended December 31, 2006.F-30
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSContract Stock and Restricted Units Awards - ------------------------------------------In July 2004, theCompany'sCompany’s President and Chief Executive Officer(Executive)(the “Executive”) renewed his employment agreement with the Company through December 31, 2009. In connection with the renewal of the agreement, the Executive received a grant of fair market value options to acquire up to 250,000 shares of Integra common stock and a fully vested contract stock unit award providing for the payment of 750,000 shares of Integra common stock which shall generally be delivered to the Executive following his termination of employment or retirement but not before December 31, 2009, or later under certain circumstances, or earlier if he is terminated without cause, if he leaves his position for good reason or upon a change of control or certain tax related events. The options and contract stock award were granted under the 2003 Plan. In connection with the fully vested contract stock award, the Company recorded a share-based compensation charge of $23.9 million, including payroll taxes, in 2004 for the compensation expense related to the fully-vested contract stock unit grant. The Executive has demand registration rights under the Restricted Units issued.In December 2000, the Company issued 1,250,000 restricted units(Restricted Units)(“Restricted Units”) under the 2000 Plan as a fully vested equity based bonus to the Executive in connection with the extension of his employment agreement. Each Restricted Unit represents the right to receive one share of theCompany'sCompany’s common stock. The Executive has demand registration rights under the Restricted Units issued. In January 2006, the Company issued 750,000 shares of theCompany'sCompany’s common stock to the Executive pursuant to the obligations with respect to 750,000 of these Restricted Units.The Executive received 1,000,000 Restricted Units in December 1997, each of which entitles him to receive one share of the Company's common stock. The Restricted Units issued in December 1997 were not issued under any of the Plans. In November 2003, the Company issued 1,000,000 shares of the Company's common stock to the Executive pursuant to the obligations under these Restricted Units.No other share-based awards are outstanding under any of the Plans. At December 31,2005,2006, there were1,812,9041,354,299 shares available for grant under the Plans.9. RETIREMENT BENEFIT PLANSIn September 2006, the Financials Accounting Standards Board issued Statement No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Post-retirement Plans” which is an amendment of FASB Statements No. 87, 88, 106, and 123R. This Statement requires the Company to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur though comprehensive income. The Company currently recognizes the unfunded liability for each of its plans. Therefore, this statement had no effect on the financial statements as of December 31, 2006.DEFINED BENEFIT PLANThe Company maintains defined benefit pension plans that cover employees in its manufacturing plants located in York, Pennsylvania (the “Miltex Plan”), Andover, United Kingdom (the"UK Plan"“UK Plan”) and Tuttlingen, Germany (the"Germany Plan"“Germany Plan”). The Miltex Plan is frozen and all future benefits were curtailed prior to the acquisition of Miltex by the Company. The Company closed the Tuttlingen, Germany plant in December 2005. However, the Germany Plan was not terminated and the Company remains obligated for the accrued pension benefits related to this plan. The plans cover certain current and former employees.BothThe plans are no longer open to new participants. The Company uses a December 31 measurement date forbothall of its pension plans.Net periodic benefit costs for these defined benefit pension plans included the following amounts:
2005 2004 2003 -------- -------- -------- (in thousands)Service cost ..................................... $ 178 $ 179 $ 88 Interest cost .................................... 567 522 397 Expected return on plan assets ................... (464) (434) (330) Recognized net actuarial loss .................... 215 203 116 -------- -------- -------- Net periodic benefit cost ..................... $ 496 $ 470 $ 271F-24
2006 2005 2004 (in thousands) Non-U.S. Non-U.S. Non-U.S. U.S. Plan Plans Plans Plans Service cost $ — $ 182 $ 178 $ 179 Interest cost 25 585 567 522 Expected return on plan assets (24 ) (483 ) (464 ) (434 ) Recognized net actuarial loss 28 337 215 203 Net periodic benefit cost, before settlement expenses 29 621 496 470 Settlement expense 53 — — — Net periodic benefit cost $ 82 $ 621 $ 496 $ 470 F-31
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSThe following weighted average assumptions were used to develop net periodic benefit cost and the actuarial present value of projected benefit obligations:
2005 2004 2003 -------- -------- --------Discount rate .................................... 4.7% 5.2% 5.4% Expected return on plan assets ................... 4.9% 5.8% 6.2% Rate of compensation increase .................... 3.5% 3.3% 3.3%
2006 2005 2004 U.S. Plan Non-U.S. Plans Non-U.S. Plans Non-U.S. Plans Discount rate 5.5 % 5.2 % 4.7 % 5.2 % Expected return on plan assets 7.0 % 5.7 % 4.9 % 5.8 % Rate of compensation increase N/A 3.1 % 3.5 % 3.3 % The expected return on plan assets represents the average rate of return expected to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. In developing the expected rate of return, the Company considers long-term compound annualized returns of historical market data as well as actual returns on the plan assets and applies adjustments that reflect more recent capital market experience. Using this reference information, the long-term return expectations for each asset categoryisare developed according to the allocation among those investment categories. The discount rate is prescribed as the current yield on corporate bonds with an average rating of AA of equivalent currency and term to the liabilities.The following sets forth the change in benefit obligations and change in plan assets at December 31,20052006 and20042005 and the accrued benefit cost:
December 31, 2005 2004 -------- -------- (in thousands)CHANGE IN PROJECTED BENEFIT OBLIGATION Projected benefit obligation, beginning of year ................ $11,367 $ 8,832 Service cost ................................................... 178 179 Interest cost .................................................. 567 522 Participant contributions ...................................... 36 42 Benefits paid .................................................. (317) (183) Actuarial (gain) loss .......................................... 1,133 656 Acquisitions ................................................... -- 474 Effect of foreign currency exchange rates ...................... (1,315) 845 -------- -------- Projected benefit obligation, end of year ...................... $11,649 $11,367 CHANGE IN PLAN ASSETS Plan assets at fair value, beginning of year ................... $ 8,379 $ 6,646 Actual return on plan assets ................................... 1,277 816 Employer contributions ......................................... 264 238 Participant contributions ...................................... 36 37 Benefits paid .................................................. (315) (183) Other .......................................................... -- 46 Acquisitions ................................................... -- 162 Effect of foreign currency exchange rates ...................... (968) 617 -------- -------- Plan assets at fair value, end of year ......................... $ 8,673 $ 8,379 RECONCILIATION OF FUNDED STATUS Funded status, projected benefit obligation in excess of plan assets ............................................. $(2,976) $(2,988) Unrecognized net actuarial loss ................................... 2,504 2,759 Adjustment to recognize minimum liability ......................... (2,390) (2,543) -------- -------- Accrued benefit cost .............................................. $(2,862) $(2,772)
December 31, 2006 2005 U.S. Plan Non-U.S. Plans Non-U.S. Plans (in thousands) CHANGE IN PROJECTED BENEFIT OBLIGATION Projected benefit obligation, beginning of year $ — $ 11,647 $ 11,367 Service cost 182 178 Interest cost 25 585 567 Participant contributions 33 36 Benefits paid (425 ) (317 ) Actuarial (gain) loss 13 211 1,133 Settlements (104 ) — — Acquisitions 503 — — Effect of foreign currency exchange rates — 1,637 (1,315 ) Projected benefit obligation, end of year $ 437 $ 13,870 $ 11,649 F-32
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006 2005 U.S. Plan Non-U.S. Plans Non-U.S. Plans (in thousands) CHANGE IN PLAN ASSETS Plan assets at fair value, beginning of year $ — $ 8,673 $ 8,379 Actual return on plan assets 24 440 1,277 Employer contributions 57 278 264 Participant contributions — 33 36 Benefits paid (104 ) (333 ) (315 ) Acquisitions 363 — — Effect of foreign currency exchange rates — 1,224 (968 ) Plan assets at fair value, end of year $ 340 $ 10,315 $ 8,673 RECONCILIATION OF FUNDED STATUS Funded status, projected benefit obligation in excess of plan assets $ (97 ) $ (3,555 ) $ (2,976 ) Unrecognized net actuarial loss 223 2,584 2,504 Additional minimum liability — — (2,390 ) Accumulated other comprehensive income under FAS 158 (223 ) (2,584 ) — Accrued benefit cost $ (97 ) $ (3,555 ) $ (2,862 ) 20052006 and20042005 is included in otherliabilities.liabilities and the current portion is included in accrued expenses.The combined accumulated benefit obligation for the defined benefit plans was$11.5$14.3 million and$11.2$11.6 million as of December 31,20052006 and2004,2005, respectively. The accumulated benefit obligation for each plan exceeded thatplan'splan’s assets for all periods presented.F-25INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTSThe Miltex and UK Plans invest in pooled funds which provide a diversification that supports the overall investment objectives. The assets of the Germany Plan consist entirely of insurance contracts. Based on the assets which comprise each of the funds, the weighted-average allocation of plan assets by asset category is as follows:
December 31, 2005 2004 -------- --------Equity securities .......................................... 47% 52% Corporate bonds ............................................ 26% 19% Government bonds ........................................... 20% 22% Insurance contracts ........................................ 2% 2% Cash ....................................................... 5% 5% -------- -------- 100% 100%
December 31, 2006 2005 U.S. Plan Non-U.S. Plans Non-U.S. Plans Equity securities 61 % 46 % 47 % Corporate bonds — 32 % 26 % Government bonds 36 % 18 % 20 % Insurance contracts — 3 % 2 % Cash 3 % 1 % 5 % 100 % 100 % 100 % Company'sCompany’s defined benefit plans is both to meet the liabilities of the plans as they fall due and to maximize the return on invested assets within appropriate risk tolerances.The assets of the Germany Plan consist entirely of insurance contracts.The Company anticipates contributing approximately$250,000$352,000 to its defined benefit plans in2006.2007. The Company expects to pay the following estimated future benefit payments in the years indicated:2006 ............. 269,000 2007 ............. 286,000 2008 ............. 312,000 2009 ............. 338,000 2010 ............. 400,000 2011-2015 ........ 2,679,000
2007 $ 506,000 2008 529,000 2009 553,000 2010 629,000 2011 677,000 2012-2016 $ 4,223,000 F-33
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSIncluded in Accumulated Other Comprehensive Income is $2.8 million of unrecognized net actuarial loss, $0.4 million of which is expected to be recognized as a component of net periodic benefit cost in 2007.DEFINED CONTRIBUTION PLANThe Company also has various defined contribution savings plans that cover substantially all employees in the United States, the United Kingdom and Puerto Rico. The Company matches a certain percentage of eachemployee'semployee’s contributions as per the provisions of the plans. Total contributions by the Company to the plans were $962,000, $627,000, and $622,000 in 2006, 2005, and$483,000 in 2005,2004,and 2003,respectively.10. LEASESThe Company leases administrative, manufacturing, research and distribution facilities and various manufacturing, office and transportation equipment through operating lease agreements.In November 1992, a corporation whose shareholders are trusts, whose beneficiaries include family members of theCompany'sCompany’s Chairman, acquired from independent third parties a 50% interest in the general partnership from which the Company leases its manufacturing facility in Plainsboro, New Jersey. In October 2005, the Company entered into a lease modification agreement relating to this facility. The lease modification agreement provides for extension of the term of the lease from October 31, 2012 for an additionalfive yearfive-year period through October 31, 2017 at an annual rate of approximately $272,000 per year. The lease modification agreement also provides aten yearten-year option for the Company to extend the lease from November 1, 2017 through October 31, 2027 at an annual rate of approximately $296,000 per year.In June 2000, the Company signed a ten-year agreement to lease certain production equipment from a corporation whose sole stockholder is a general partnership, for which theCompany'sCompany’s Chairman is a partner and the President. Under the terms of the lease agreement, the Company paid $90,000 to the related party lessor in each of 2006, 20052004,and2003. F-26INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS2004.Future minimum lease payments under operating leases at December 31,20052006 were as follows:
Related Third Parties Parties Total --------- --------- --------- (in thousands)2006 ............................ $ 321 $ 2,095 $ 2,416 2007 ............................ 324 1,337 1,661 2008 ............................ 341 342 683 2009 ............................ 341 204 545 2010 ............................ 341 176 517 Thereafter ...................... 4,732 1,764 6,496 --------- --------- --------- Total minimum lease payments..... $ 6,400 $ 5,918 $12,318 ========= ========= =========
Related Parties Third Parties Total (in thousands) 2007 $ 324 $ 3,772 $ 4,096 2008 341 2,654 2,995 2009 341 1,896 2,237 2010 296 729 1,025 2011 251 621 872 Thereafter 4,525 2,664 7,189 Total minimum lease payments $ 6,078 $ 12,336 $ 18,414 and 2003was $3.4 million, $3.2 million,$2.3 million,and$2.9$2.3 million, respectively, and included $321,000, $321,000, and $321,000, in related party expense, respectively.F-34
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS11. INCOME TAXESThe provision for income taxes consisted of the following:
2005 2004 2003 -------- -------- -------- (in thousands)Current: Federal .............................. $ 2,547 $ 1,899 $ 972 State ................................ 2,038 1,670 2,470 Foreign .............................. 3,427 1,141 529 --------- --------- --------- Total current ......................... 8,012 4,710 3,971 Deferred: Federal .............................. $13,706 $ 5,802 $ 12,800 State ................................ (409) 53 83 Foreign .............................. (3,402) 246 (526) --------- --------- --------- Total deferred ......................... 9,895 6,101 12,357 Provision for income taxes ............. $ 17,907 $ 10,811 $ 16,328 ========= ========= =========
2006 2005 2004 (in thousands) Current: Federal $ 7,454 $ 2,547 $ 1,899 State 1,332 2,038 1,670 Foreign 6,880 3,427 1,141 Total current 15,666 8,012 4,710 Deferred: Federal $ 2,049 $ 13,706 $ 5,802 State (256 ) (409 ) 53 Foreign 1,442 (3,402 ) 246 Total deferred 3,235 9,895 6,101 Provision for income taxes $ 18,901 $ 17,907 $ 10,811
2005 2004 2003 -------- -------- -------- (in thousands)United States operations ............. $ 46,111 $ 17,074 $ 40,883 Foreign operations ................... 8,990 10,934 2,306 --------- --------- --------- Total .................................. $ 55,101 $ 28,008 $ 43,189 ========= ========= =========F-27INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The temporary differences that give rise to deferred tax assets and liabilities are presented below:December 31 2005 2004 -------- -------- (in thousands)Net operating loss and tax credit carryforwards ........... $ 4,622 $ 13,405 Inventory reserves and capitalization ..................... 4,781 2,145 Deferred compensation ..................................... 14,053 14,164 Deferred income ........................................... 3,831 1,821 -------- -------- Total deferred tax assets before valuation allowance .... 27,287 31,535 Valuation allowance ....................................... (5,126) (5,360) Depreciation and amortization ............................. (9,694) (5,327) Other ..................................................... (4,148) (1,095) -------- -------- Net deferred tax assets ................................... $ 8,319 $ 19,753 ======== ========
2006 2005 2004 (in thousands) United States operations $ 20,000 $ 46,111 $ 17,074 Foreign operations 28,308 8,990 10,934 Total $ 48,308 $ 55,101 $ 28,008
December 31, 2006 2005 (in thousands) Net operating loss and tax credit carryforwards $ 1,258 $ 4,622 Inventory reserves and capitalization 7,242 4,781 Deferred compensation 14,582 14,053 Deferred income 961 3,831 Total deferred tax assets before valuation allowance 24,043 27,287 Valuation allowance (1,632 ) (5,126 ) Depreciation and amortization (35,506 ) (9,694 ) Other (8,251 ) (4,145 ) Net deferred tax assets (liability) $ (21,346 ) $ 8,322 $5.1$1.6 million is recorded against the remaining$27.3$24.0 million of deferred tax assets recorded at December 31,2005.2006. This valuation allowance relates to deferred tax assets for certain expenses that will be deductible for tax purposes in very limited circumstances and for which the Company believes it is unlikely that it will recognize the associated tax benefit. The Company does not anticipate additional income tax benefits through future reductions in the valuation allowance. However, in the event that the Company determines that it would be able to realize more or less than the recorded amount of net deferred tax assets, an adjustment to the deferred tax asset valuation allowance would be recorded in the period such a determination is made.TheCompany'sCompany’s valuation allowance decreased by$0.2$3.5 million in20052006 as a result of achangedecrease in deferred tax assets relating to stock-based compensation, which exceeded Internal Revenue Service deductible limits. Accordingly, no tax benefit was recorded for amounts exceeding theCompany's marginal state effective income tax rates.statutory limitations.F-35
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSA reconciliation of the United States Federal statutory rate to theCompany'sCompany’s effective tax rate for the years ended December 31, 2006, 2005,2004,and20032004 is as follows:
2005 2004 2003 ------ ------ ------Federal statutory rate ..................................... 35.0% 35.0% 35.0% Increase (reduction) in income taxes resulting from: State income taxes, net of federal tax benefit ........... 2.0% 4.0% 3.9% Foreign taxes booked at different rates .................. (3.7%) (4.2%) (1.0%) Foreign losses for which no benefit was previously taken.. (0.9%) -- -- Tax on asset transfer .................................... -- 4.5% -- Other .................................................... 0.1% (0.7%) (0.1%) ------ ------ ------ Effective tax rate ......................................... 32.5% 38.6% 37.8% ====== ====== ======
2006 2005 2004 Federal statutory rate 35.0 % 35.0 % 35.0 % Increase (reduction) in income taxes resulting from: State income taxes, net of federal tax benefit 1.9 % 2.0 % 4.0 % Foreign taxes booked at different rates (1.6 %) (3.7 %) (4.2 %) Foreign losses — (0.9 %) — Tax on asset transfer — — 4.5 % In-process research and development 4.3 % — — Incentive Stock Option expense 1.4 % — — Adjustments to net operating losses (1.8 %) — — Compensation in excess of IRS deductible limits 2.5 % — — Decrease in valuation allowances (2.5 %) — — Other (0.1 %) 0.1 % (0.7 %) Effective tax rate 39.1 % 32.5 % 38.6 % 2005,2006, the Company had net operating loss carryforwards of$15.8$11.0 million for federal income tax purposes and$0.4$2.3 million for foreign tax purposes to offset future taxable income. The federal net operating loss carryforwards expire through20242010 and the foreign net operating loss carryforwards have no expiration.At December 31,2005,2006, several of theCompany'sCompany’s subsidiaries had unused net operating loss carryforwards and tax credit carryforwards arising from periods prior to theCompany's ownershipCompany’s ownerships which expire through 2010. The Internal Revenue Code limits the timing and manner in whichwethe Company may use any acquired net operating losses or tax credits.Income taxes are not provided on undistributed earnings of non-U.S. subsidiaries because such earnings are expected to be permanently reinvested. Undistributed earnings of foreign subsidiaries totaled$8.5$21.9 million and$2.6$8.5 million at December 31, 2006 and 2005, respectively.The American Jobs Creation Act of 2004 was signed into law in October 2004 and2004, respectively. F-28has several provisions that may impact the Company’s income taxes in the future, including the repeal of the extraterritorial income exclusion and a deduction related to qualified production activities income. The qualified production activities deduction is a special deduction and will have no impact on deferred taxes existing at the enactment date. Rather, the impact of this deduction will be reported in the period in which the deduction is claimed on the Company’s tax return. Pursuant to United States Department of Treasury Regulations issued in October 2005, the Company has realized a tax benefit on qualified production activities income of $0.3 million in 2006. F-36
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS12. NET INCOME PER SHARE
Amounts used in the calculation of basic and diluted net income per share were as follows:2005 2004 2003 -------- -------- -------- (in thousands, except per share amounts)Basic: - ------ Net income..................................................... $ 37,194 $ 17,197 $ 26,861 Basic net income per share .................................... $ 1.23 $ 0.57 $ 0.92 ======== ======== ======== Weighted average common shares outstanding - Basic ............ 30,195 30,064 29,071 ======== ======== ======== Diluted: - -------- Net income..................................................... $ 37,194 $ 17,197 $ 26,861 Add back: Interest expense and other income/(expense) related to convertible notes payable, net of tax ......... 2,440 -- 1,608 -------- -------- -------- Net income applicable to common stock ......................... $ 39,634 $ 17,197 $ 28,469 Diluted net income per share .................................. $ 1.15 $ 0.55 $ 0.86 ======== ======== ======== Weighted average common shares outstanding - Basic ............ 30,195 30,064 29,071 Effect of dilutive securities: Restricted stock and stock options ......................... 856 1,038 1,397 Shares issuable upon conversion of notes payable ........... 3,514 -- 2,636 -------- -------- -------- Weighted average common shares outstanding .................... 34,565 31,102 33,104 ======== ======== ========
Shares of common stock issuable through exercise or conversion of the following dilutive securities were not included in the computation of diluted net income per share for each period because their effect would have been antidilutive:2005 2004 2003 -------- -------- -------- (in thousands)Stock options and restricted stock ................. 570 155 424 Shares issuable upon conversion of notes payable ... -- 3,514 -- -------- -------- -------- Total .............................................. 570 3,669 424Amounts used in the calculation of basic and diluted net income per share were as follows:
2006 2005 2004 (in thousands, except per share amounts) Basic: Net income $ 29,407 $ 37,194 $ 17,197 Basic net income per share $ 1.00 $ 1.23 $ 0.57 Weighted average common shares outstanding — Basic 29,300 30,195 30,064 Diluted: Net income $ 29,407 $ 37,194 $ 17,197 Add back: Interest expense and other income related to convertible notes payable, net of tax 2,254 2,440 — Net income applicable to common stock $ 31,661 $ 39,634 $ 17,197 Diluted net income per share $ 0.97 $ 1.15 $ 0.55 Weighted average common shares outstanding — Basic 29,300 30,195 30,064 Effect of dilutive securities: Restricted stock and stock options 710 856 1,038 Shares issuable upon conversion of notes payable 2,737 3,514 — Weighted average common shares outstanding 32,747 34,565 31,102
2006 2005 2004 (in thousands) Stock options and restricted stock 1,551 570 155 Shares issuable upon conversion of notes payable — — 3,514 Total 1,551 570 3,669 From 1999 through 2003, ETHICON, Inc., a division of Johnson & Johnson, marketed and distributed the Company's INTEGRA(R) Dermal Regeneration Template under the terms of a ten year distribution agreement (the "ETHICON Agreement"). Upon signing the ETHICON Agreement, the Company received a nonrefundable payment from ETHICON of $5.3 million for the exclusive use of the Company for trademarks and regulatory filings related to the INTEGRA(R) Dermal Regeneration Template and certain other rights. This amount was initially recorded as deferred revenue and was recognized as revenue in accordance with the Company's revenue recognition policy for nonrefundable, up-front fees received. Additionally, the ETHICON F-29INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Agreement required ETHICON to make nonrefundable payments to the Company each year based upon minimum purchases of INTEGRA(R) Dermal Regeneration Template. Upon early termination of the ETHICON Agreement in December 2003, ETHICON paid Integra $2.0 million, which the Company recorded as other income. The Company also recorded $11.0 million of other revenue in the fourth quarter of 2003 related to the acceleration of the recognition of unused minimum purchase payments and unamortized license fee revenue. In 2003, the Company received $2.8 million of event-related payments from ETHICON and $2.0 million of research funding. Both the event-related payments and the research funding were recorded in other operating revenue in accordance with the Company's revenue recognition policy.The Company has an agreement with Wyeth for the development of collagen and other absorbable matrices to be used in conjunction withWyeth'sWyeth’s recombinant human bone morphogenetic protein-2 (rhBMP-2) in a variety of bone regeneration applications. The agreement with Wyeth requires Integra to supply Absorbable Collagen Sponges to Wyeth (including those that Wyeth sells to Medtronic Sofamor Danek with rhBMP-2 for use in Medtronic SofamorDanek's InFUSE(TM)Danek’s INFUSE® product) at specified prices. In addition, the Company receives a royalty equal to a percentage ofWyeth'sWyeth’s sales of surgical kits combining rhBMP-2 and the Absorbable Collagen Sponges. The agreement terminates in2007,2012, but may be extended at the option of the parties. The agreement does not provide for milestones or other contingent payments, but Wyeth pays the Company to assist with regulatory affairs and research.The Company received $2.2 million of research and development revenues under the agreement in 2003.14. COMMITMENTS AND CONTINGENCIESAsIn consideration for certain technology, manufacturing, distribution and selling rights and licenses granted to the Company, the Company has agreed to pay royalties on the sales of products that are commercialized relative to the granted rights and licenses. Royalty payments under these agreements by the Company were not significant for any of the periods presented.F-37
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSVarious lawsuits, claims and proceedings are pending or have been settled by the Company. The most significant of those are described below.InJuly 1996, the Company filedMay 2006, Codman & Shurtleff, Inc. (“Codman”), apatent infringement lawsuitdivision of Johnson & Johnson, commenced an action in the United States District Court for theSouthernDistrict ofCaliforniaNew Jersey for declaratory judgment against Integra LifeSciences Corporation with respect to United States Patent No. 5,997,895 (the"Trial Court"“‘895 Patent”) held by Integra. Integra’s patent covers dural repair technology related to Integra’s DuraGen® family of duraplasty products.The action seeks declaratory relief that Codman’s DURAFORM™ product does not infringe Integra’s patent and that Integra’s patent is invalid and unenforceable. Codman does not seek either damages from Integra or injunctive relief for selling the DuraGen® Dural Graft Matrix. Integra has filed a counterclaim against Codman, alleging that Codman’s DURAFORM™ product infringes the ‘895 Patent, seeking injunctive relief preventing the sale and use of DURAFORM™, and seeking damages, including treble damages, for past infringement.In July 1996, the Company sued Merck KGaA, a German corporation,Scripps Research Institute, a California nonprofit corporation, and David A. Cheresh, Ph.D., a research scientist with Scripps,seeking damagesand injunctive relief.for patent infringement. Thecomplaint charged, among other things, that the defendant Merck KGaA willfully and deliberately induced, and continues willfully and deliberately to induce, defendants Scripps Research Institute and Dr. Cheresh to infringe certain of the Company's patents. Thesepatents in question are part of a group of patents granted to The Burnham Institute andlicensedLicensed by Integra that are based on the interaction between a family of cell surface proteins called integrins and the arginine-glycine-aspartic acid("RGD"(“RCG”) peptide sequence found in manyextracellularextra cellular matrix proteins.Thedefendants filed a countersuit asking for an award of defendants' reasonable attorney fees. In March 2000, a jurycase has been tried, appealed and returneda unanimous verdict in the Company's favor and awarded Integra $15.0 million in damages, finding that Merck KGaA had willfully infringed and induced the infringement of our patents. The Trial Court dismissed Scripps and Dr. Cheresh from the case. In October 2000, the Trial Court entered judgment in Integra's favor and against Merck KGaA in the case. In entering the judgment, the Trial Court also grantedto theCompany pre-judgment interest of $1.4 million, bringing the total award to $16.4 million, plus post-judgment interest. Merck KGaA filed various post-trial motions requesting a judgment as a matter of law notwithstanding the verdict or a newtrialin each case regarding infringement, invalidity and damages. In September 2001, the Trial Court entered orders in favor of Integra and against Merck KGaA on the final post-judgment motions in the case, and denied Merck KGaA's motions for judgment as a matter of law and for a new trial. F-30INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Merck KGaA and Integra each appealed various decisions of the Trial Court to the United States Court of Appeals for the Federal Circuit (the "Circuit Court"). In June 2003, the Circuit Court affirmed the Trial Court's finding that Merck KGaA had infringed our patents. The Circuit Court also held that the basis of the jury's calculation of damages was not clear from the trial record, and remanded the case to the Trial Court for further factual development and a new calculation of damages consistent with the Circuit Court's decision.court. In September 2004, theTrial Courttrial court ordered MerckKgaAKGaA to pay Integra $6.4 million indamages following the Circuit Court's order.damages. Merck KGaA filed a petition for a writ of certiorari with the United States Supreme Court(the "Supreme Court")seeking review of the CircuitCourt'sCourt’s decision, and the Supreme Court granted the writ in January 2005.Oral arguments before the United States Supreme Court were held in April 2005.On June 13, 2005, the Supreme Court vacated the June 2003 judgment of the Circuit Court. The Supreme Court held that the Circuit Court applied an erroneous interpretation of 35 U.S.C.ss.271(e)§271(e)(1) when it rejected the challenge of Merck KGaA to thejury'sjury’s finding that Merck KGaA failed to show that its activities were exempt from claims of patent infringement under that statute. On remand, the Circuit Court will review the evidence under a reasonableness test that does not provide categorical exclusions of certain types of activities. Further enforcement of the trial court’s order has been stayed. The Company has not recorded any gain in connection with this matter, pending final resolution and completion of the appeals process.Three of the Company's French subsidiaries that were acquired from the neurosciences division of NMT Medical, Inc. received a tax reassessment notice from the French tax authorities seeking in excess of 1.7 million euros in back taxes, interest and penalties. NMT Medical, the former owner of these entities, has agreed to indemnify Integra against direct damages and liability arising from misrepresentations in connection with these tax claims. In April 2005, NMT Medical, Inc. negotiated a settlement agreement with the French authorities that satisfied the outstanding tax assessments. In connection with this settlement, the Company recognized net operating loss carryforwards in France and recorded this benefit as a $0.5 million tax benefit in 2005.In addition to these matters, the Company is subject to various claims, lawsuits and proceedings in the ordinary course of its business, including claims by current or former employees, distributors and competitors and with respect toourits products. In the opinion of management, such claims are either adequately covered by insurance or otherwise indemnified, or are not expected, individually or in the aggregate, to result in a material adverse effect on theCompany'sCompany’s financial condition. However, it is possible that theCompany'sCompany’s results of operations, financial position and cash flows in a particular period could be materially affected by thesecontingencies. F-31INTEGRA LIFESCIENCES HOLDINGS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTScontingencies or the costs related thereto.The Company accrues for loss contingencies in accordance with SFAS 5; that is, 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, as permitted by EITF Topic D-77.15. SEGMENT AND GEOGRAPHIC INFORMATIONIntegraThe Company’s management reviews financial results and manages the business on an aggregate basis. Therefore, financial results are reported in a single operating segment, the development, manufacture and marketing of medical devices for use in cranial and spinal procedures, peripheral nerve repair, small bone and joint injuries, and the repair and reconstruction of soft tissue.
Product revenues consisted of the following:2005 2004 2003 -------- -------- -------- (in thousands)Monitoring products ................................... $ 48,940 $ 48,217 $ 44,229 Implant products ...................................... 108,156 78,418 53,301 Instruments ........................................... 91,918 77,667 47,168 Private label products ................................ 28,757 24,188 21,997 -------- -------- -------- Consolidated product revenues ......................... $277,771 $228,490 $166,695 ======== ======== ========In 2006, the Company revised the manner in which it presents its revenues. The Company now presents its revenues in two categories: Neurosurgical/Orthopedic Implants and Medical/Surgical Equipment. This change better aligns the Company’s product categories by functional product characteristic and intended use.F-38
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSRevenue consisted of the following:
2006 2005 2004 (in thousands) Neurosurgical and Orthopedic Implants $ 166,432 $ 134,598 $ 101,791 Medical/Surgical Equipment 252,865 143,337 128,034 Total revenue, net $ 419,297 $ 277,935 $ 229,825 Company'sCompany’s products, including theDuraGen(R)DuraGen® andNeuraGen(TM)NeuraGen® product families and theINTEGRA(R)Integra® Dermal Regeneration Template and wound dressing products, contain material derived from bovine tissue. Products that contain materials derived from animal sources, including food as well as pharmaceuticals and medical devices, are increasingly subject to scrutiny from the press and regulatory authorities. These products comprised31%25%, 31%, and27%31% ofproductrevenues in 2006, 2005,2004,and2003,2004, respectively. Accordingly, widespread public controversy concerning collagen products, new regulation, or a ban of theCompany'sCompany’s products containing material derived from bovine tissue, could have a material adverse effect on theCompany'sCompany’s current business or its ability to expand its business.ProductTotal revenue, net and long-lived assets (excluding intangible assets, financial instruments and deferred tax assets) by major geographic area are summarized below:
United Asia Other States Europe Pacific Foreign Consolidated ---------- ---------- ---------- ---------- ------------ (in thousands)Product revenue: 2005 ................... $207,245 $ 48,645 $ 11,403 $ 10,478 $277,771 2004 ................... 180,887 30,941 8,535 8,127 228,490 2003 ................... 132,805 21,433 5,828 6,629 166,695 Long-lived assets: December 31, 2005 ...... $ 23,938 $ 9,441 $ -- $ -- $ 33,379 December 31, 2004 ...... 21,287 9,175 -- -- 30,462F-32
United States Europe Asia Pacific Other Foreign Consolidated (in thousands) Total revenue, net: 2006 $ 317,503 $ 77,100 $ 12,315 $ 12,379 $ 419,297 2005 207,409 48,645 11,403 10,478 277,935 2004 182,168 30,994 8,535 8,128 229,825 Long-lived assets: December 31, 2006 33,646 16,081 — — 49,727 December 31, 2005 $ 23,938 $ 9,441 $ — $ — $ 33,379
Fourth Third Second First Quarter Quarter Quarter Quarter (in thousands, except per share data) 2006: Total revenue, net: 2006 $ 125,394 $ 116,647 $ 100,121 $ 77,135 2005 $ 72,985 $ 69,333 $ 69,778 $ 65,839 Gross margin: 2006 73,949 69,088 58,748 49,198 2005 44,355 42,940 42,260 41,328 Net income: 2006 10,131 2,594 7,977 8,705 2005 10,615 10,481 7,655 8,443 Basic net income per share: 2006 $ 0.35 $ 0.09 $ 0.27 $ 0.29 2005 $ 0.36 $ 0.35 $ 0.25 $ 0.28 Diluted net income per share: 2006 $ 0.34 $ 0.09 $ 0.26 $ 0.28 2005 $ 0.33 $ 0.33 $ 0.23 $ 0.26 F-39
INTEGRA LIFESCIENCES HOLDINGS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS16. SELECTED QUARTERLY INFORMATION -- UNAUDITED
Fourth Third Second First Quarter Quarter Quarter Quarter ------- ------- ------- ------- (in thousands, except per share data)2005: - ----- Total revenue: 2005 ........................... $ 72,985 $ 69,333 $ 69,778 $ 65,839 2004 ........................... 61,811 59,130 56,441 52,443 Gross margin (exclusive of amortization related to acquired intangible assets): 2005 ........................... 44,733 43,320 42,639 41,707 2004 ........................... 38,590 36,718 34,776 32,442 Net income (loss): 2005 ........................... 10,615 10,481 7,655 8,443 2004 ........................... 9,839 (7,597) 7,518 7,437 Basic net income (loss) per share: 2005 ........................... $ 0.36 $ 0.35 $ 0.25 $ 0.28 2004 ........................... $ 0.32 $ (0.25) $ 0.25 $ 0.25 Diluted net income (loss) per share: 2005 ........................... $ 0.33 $ 0.33 $ 0.23 $ 0.26 2004 ........................... $ 0.30 $ (0.25) $ 0.23 $ 0.23
In 2005, the Company recorded the following charges in connection with its restructuring activities:Fourth Third Second First Quarter Quarter Quarter Quarter ------- ------- ------- ------- (in thousands)Involuntary employee termination costs .......................... $ 1,120 $ 667 $ 2,074 $ -- Facility exit costs .............. 155 -- -- --Inthe third quarter of 2004,2006, the Company recorded thefollowing: - - a $1.4 million chargefollowing charges in connection witha milestone payment related to the completion of certain development activities related to an advanced neuro-monitoring system; - - a $23.9 million share-based compensation charge associated with the renewal of the Company's President and Chief Executive Officer's employment agreement; and - - a $1.3 million tax charge incurred in connection with the reorganization of certain European operations. In the fourth quarter of 2004, the Company recognized $1.4 million of other income related to an unrealized gain on a foreign currency collar, which was used to reduce the exposure to fluctuations in the exchange rate between the euro and the US dollar as a result of the Company's commitment to acquire Newdeal Technologies for 38.5 million euros. The foreign currency collar expired in January 2005, concurrent with the Company's acquisition of Newdeal Technologies.its restructuring activities:
Fourth Third Second First Quarter Quarter Quarter Quarter (in thousands) Involuntary employee termination costs 2006 $ 693 $ 63 $ 199 $ 80 2005 1,120 667 2,074 — Facility exit costs 2006 — — — — 2005 155 — — — In September 2005,On January 3, 2007, the Company announcedthe signing of a definitive agreement to acquirethat its Miltex Dental business had acquired the assets of theRadionics DivisionDenLite illuminated mirror product from Welch Allyn, Inc.On February 23, 2007, the Company entered into a second amendment to its credit agreement with a syndicate ofTyco Healthcare Group, L.P.lending banks. The amendment increased the size of the Company’s revolving credit facility from $200 million to $300 million and allows the Company to further increase the size to $400 million. The amendment extended the credit facility’s maturity date from December 22, 2010 to December 22, 2011 and reduced the applicable rates used forapproximately $76 million in cash, subject to certain adjustments. Radionics, based in Burlington, Massachusetts, is a leader in the design, manufacture and sale of advanced minimally-invasive medical instruments and systems for radiation therapy. Radionics' products include the CRW(R) stereotactic system, the XKnife(TM) stereotactic radiosurgery system, the OmniSight(R)EXcel image guided surgery system,borrowings and theCUSA EXcel(TM) ultrasonic surgical aspiration system.annual commitment fee. Theacquisition closedamendment also modified certain financial and negative covenants. As a condition to the effectiveness of the amendment, the Company must pay any outstanding loans made by lenders who, after giving effect to the amendment, will no longer be lenders under the credit facility and must prepay any other outstanding loans to the extent necessary to keep the outstanding loans ratable, based onMarch 3, 2006. F-33the new commitments of the lenders. The Company satisfied the conditions to effectiveness on February 28, 2007. F-40
INTEGRA LIFESCIENCES HOLDINGS CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS The determination of the fair value of the assets acquired and liabilities assumed as a result of this acquisition is in progress. Based on a preliminary valuation, the following summarizes the fair value of the assets acquired and liabilities assumed:
(All amounts in thousands)Current assets ....................... $ 8,440 Property, plant and equipment ........ 1,350 Intangible assets and goodwill ....... 67,090 ------- Total assets acquired ............. 76,880 Liabilities assumed .................. 2,380 ------- Net assets acquired .................. $74,500The acquired intangible assets consist primarily of developed technology, trade name, and customer relationships. The final fair value of assets acquired will be determined with the assistance of a third-party valuation firm. In March 2006, the Company borrowed $16.0 million under its credit facility in connection with the acquisition of Radionics. F-34INTEGRA LIFESCIENCES HOLDINGS CORPORATION
VALUATION AND QUALIFYING ACCOUNTSSCHEDULE II
Balance at Charged to Charged to Balance at Beginning of Costs and Other End of Description Period Expenses Accounts(1) Deductions Period (in thousands) Year ended December 31, 2006: Allowance for doubtful accounts and sales returns and allowances $ 3,508 $ 650 $ 350 $ (394 ) $ 4,114 Inventory reserves 9,768 4,706 2,862 (2,550 ) 14,786 Deferred tax asset valuation allowance 5,126 — (3,494 ) — 1,632 Year ended December 31, 2005: Allowance for doubtful accounts and sales returns and allowances $ 2,749 $ 1,279 $ 34 $ (554 ) $ 3,508 Inventory reserves 7,600 2,191 247 (270 ) 9,768 Deferred tax asset valuation allowance 5,360 — — (234 ) 5,126 Year ended December 31, 2004: Allowance for doubtful accounts and sales returns and allowances $ 2,025 $ 802 $ 249 $ (327 ) $ 2,749 Inventory reserves 6,204 1,210 1,056 (870 ) 7,600 Deferred tax asset valuation allowance 5,360 — — — 5,360
Balance at Charged(1) All amounts shown were recorded to Charged Balance at Beginning Costs and to Other End of Description Of Period Expenses Accounts(1) Deductions Period - -------------------------------------------------------------------------------------------------------------------- (in thousands)Year ended December 31, 2005 - ---------------------------- Allowancegoodwill in connection with acquisitions except fordoubtful accounts and sales returns and allowances ........ $ 2,749 $ 1,279 $ 34 $ (554) $ 3,508 Inventory reserves ...................... 7,600 2,191 247 (270) 9,768 Deferredthe $3.5 million reduction in the deferred tax asset valuation allowance.. 5,360 -- -- (234) 5,126 Year ended December 31, 2004 - ---------------------------- Allowance for doubtful accountsin 2006, which was written off against the gross deferred tax asset.F-41
EXHIBIT INDEX
Exhibit Number Description 10.17 Severance Agreement between Judith O’Grady and sales returns and allowances ........ $ 2,025 $ 802 $ 297 $ (327) $ 2,749 Inventory reserves ...................... 6,204 1,210 1,056 (870) 7,600 Deferred tax asset valuation allowance .. 5,360 -- -- -- 5,360 Year ended December 31, 2003 - ---------------------------- Allowance for doubtful accounts and sales returns and allowances ........ $ 1,387 541 497 (400) $ 2,025 Inventory reserves ...................... 9,573 3,193 894 (7,456) 6,204 Deferred tax asset valuation allowance .. 7,692 -- (2,332) -- 5,360the Company dated January 1, 2007*10.33 Compensation of Directors of the Company* 21 Subsidiaries of the Company 23 Consent of PricewaterhouseCoopers LLP 31.1 Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1) All amounts shown were recorded to goodwill in connection with acquisitions except for the $2.3 million reduction in the deferred tax asset valuation allowance in 2003, which was written off against the gross deferred tax asset. F-35
* Indicates a management contract or compensatory plan or arrangement.