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IART > SEC Filings for IART > Form 10-Q on 2-May-2013All Recent SEC Filings

Show all filings for INTEGRA LIFESCIENCES HOLDINGS CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for INTEGRA LIFESCIENCES HOLDINGS CORP


2-May-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the related notes thereto appearing elsewhere in this report and our consolidated financial statements for the year ended December 31, 2012 included in our Annual Report on Form 10-K.
We have made statements in this report which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"). These forward-looking statements are subject to a number of risks, uncertainties and assumptions about the Company. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those set forth above under the heading "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2012 and under the heading "Risk Factors" in this Report. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
You can identify these forward-looking statements by forward-looking words such as "believe," "may," "could," "will," "estimate," "continue," "anticipate," "intend," "seek," "plan," "expect," "should," "would" and similar expressions in this report.

GENERAL
Integra is a world leader in medical devices focused on limiting uncertainty for surgeons so they can concentrate on providing the best patient care. Integra provides customers with clinically relevant, innovative and cost-effective products that improve the quality of life for patients. We focus on cranial and spinal procedures, small bone and joint injuries, the repair and reconstruction of soft tissue, and instruments for surgery.
We manage our business through a combination of product groups and geography, and accordingly, we report our financial results under five reportable segments
- U.S. Instruments, U.S. Neurosurgery, U.S. Extremities, U.S. Spine and Other (which consists of our U.S. Spine and Private Label businesses) and International. We present revenues in the following three product categories: Orthopedics, Neurosurgery and Instruments. Our orthopedics product group includes specialty metal implants for surgery of the extremities, shoulder and spine, orthobiologics products for repair and grafting of bone, dermal regeneration products and tissue-engineered wound dressings and nerve and tendon repair products. Our neurosurgery product group includes, among other things, dural grafts that are indicated for the repair of the dura mater, ultrasonic surgery systems for tissue ablation, cranial stabilization and brain retraction systems, systems for measurement of various brain parameters and devices used to gain access to the cranial cavity and to drain excess cerebrospinal fluid from the ventricles of the brain. Our instruments product group includes a wide range of specialty and general surgical and dental instruments and surgical lighting for sale to hospitals, outpatient surgery centers, and physician, veterinarian and dental practices. We manufacture many of our products in plants located in the United States, Puerto Rico, France, Germany, Ireland, the United Kingdom and Mexico. We also source most of our handheld surgical instruments and specialty metal and pyrocarbon implants through specialized third-party vendors. In the United States, we have several sales channels. We sell orthopedics products through a large direct sales organization and through specialty distributors focused on their respective surgical specialties. Neurosurgery products are sold through directly employed sales representatives. Instruments products are sold through two sales channels, both directly and through distributors and wholesalers, depending on the customer call point. We sell in the international markets through a combination of a direct sales organization and distributors. We also market certain products through strategic partners in the United States. Our objective is to become a multi-billion dollar diversified global medical technology company that (i) helps patients by limiting uncertainty for medical professionals and (ii) is a high-quality investment for shareholders. We will achieve these goals by delivering on our Brand Promises to our customers worldwide and by becoming a top player in all markets in which we compete. Our strategy includes the following key elements: geographic expansion, disciplined focus and execution, global quality assurance and acquiring or in-licensing products that fit existing sales channels, margin expansion and leveraging platform synergies. We aim to achieve growth in our revenues while maintaining strong financial results. While we pay attention to any meaningful trend in our financial results, we pay particular attention to measurements that are indicative of long-term profitable growth. These measurements include (1) revenue growth (including internal growth and by acquisitions), (2) gross margins on total


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revenues, (3) operating margins (which we aim to expand as we leverage our existing infrastructure), (4) earnings before interest, taxes, depreciation, and amortization, and (5) earnings per diluted share of common stock. We believe that we are particularly effective in the following aspects of our business:
• Regenerative Medicine Platform. We have developed numerous product lines through our proprietary collagen matrix and demineralized bone matrix technologies that are sold through every one of our sales channels.

• Diversification and Platform Synergies. Each of our three selling platforms contributes a different strength to our core business. Orthopedics enables us to grow our top line and increase gross margins. Neurosurgery provides stable growth as a market with few elective procedures. The Instruments business has a strong capacity to generate cash flows. We have unique synergies among these platforms, such as our regenerative medicine technology, instrument sourcing capabilities, and Group Purchasing Organization ("GPO") contract management.

• Unique Sales Footprint. Our sales footprint provides us with a unique set of customer call-points and synergies. Each of our sales channels can benefit from the GPO and Integrated Delivery Network ("IDN") relationships that our Instruments group manages. We have market-leading products for neurosurgeons, many of whom also perform spine surgeries, and we have yet to fully leverage those relationships to sell our spine products. We also have clinical expertise across all of our channels in the United States, and have an opportunity to expand and leverage this expertise in markets worldwide.

• Ability to Change and Adapt. Our corporate culture is truly what enables us to adapt and reinvent ourselves. We have demonstrated that we can quickly and profitably integrate new products and businesses. This core strength has made it possible for us to grow over the years, and is key to our ability to grow into a multi-billion dollar company.

ACQUISITIONS
On January 24, 2013, the Company acquired all outstanding preferred and common stock of Tarsus Medical, Inc. for total of $4.7 million, consisting of $2.8 million in cash (less cash acquired) and contingent consideration with an estimated acquisition date fair value of approximately$1.6 million. The potential maximum undiscounted contingent consideration payment consists of first milestone payment of up to $1.5 million and the second payment of up to $11.5 million. These payments are based on reaching certain sales of acquired products. We believe that Tarsus Medical's technology will allow us to enter the syndesmosis repair market.

RESULTS OF OPERATIONS
Executive Summary
Net loss for the three months ended March 31, 2013, was $4.1 million, or $0.15 per diluted share as compared with net income of $6.7 million or $0.23 per diluted share for the three months ended March 31, 2012.
The results of operations for the three months ended March 31, 2013 were impacted by a voluntary recall of certain products manufactured in our Añasco, Puerto Rico facility. The net income decrease for the three months ended March 31, 2013 over the same period last year directly resulted from increases in the sales returns reserve and product shortages caused by the recall that led to revenue reductions. We also incurred incremental expenses during the first quarter related to the recall, including scrap of finished good products that were not released to customers and work in process, legal and consulting costs, and expenses for remediation of our quality systems. The effects of the recall noted above were offset by a decrease in our interest expense as a result of the June 2012 repayment of our 2012 Notes and capitalization of a portion of our interest expense into the cost of our capital projects.


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Income before taxes includes the following special charges:

                                                             Three Months Ended March 31,
                                                                 2013              2012
                                                                    (In thousands)
Manufacturing facility remediation costs                   $         2,125     $    1,635
Certain expenses associated with product recalls                     1,279              -
Global ERP implementation charges                                    6,149          3,669
Facility optimization charges                                        3,408          1,636
Certain employee termination charges                                     -            501
Discontinued product lines charges                                       -            835
Acquisition-related charges                                            388            702
Impairment charges                                                       -            141
Convertible debt non-cash interest                                   1,610          3,528
Total                                                      $        14,959     $   12,647

The items reported above are reflected in the condensed consolidated statements of operations as follows:

                                          Three Months Ended March 31,
                                                2013                  2012
                                                 (In thousands)
Cost of goods sold                  $         4,501                 $  4,544
Selling, general and administrative           8,848                    4,575
Interest expense                              1,610                    3,528
Total                               $        14,959                 $ 12,647

We typically define special charges as items for which the amounts and/or timing of such expenses may vary significantly from period to period, depending upon our acquisition, integration and restructuring activities, and for which the amounts are non-cash in nature, or for which the amounts are not expected to recur at the same magnitude as we implement certain tax planning strategies. We believe that given our ongoing strategy of seeking acquisitions, our continuing focus on rationalizing our existing manufacturing and distribution infrastructure and our continuing review of various product lines in relation to our current business strategy, certain of the special charges discussed above could recur with similar materiality in the future. In 2010 we began investing significant resources in the global implementation of a single enterprise resource planning system. We began capitalizing certain costs for the project starting in 2011, and as other aspects of the project reach the application development stage, we will capitalize those expenditures as well. We believe that the separate identification of these special charges provides important supplemental information to investors regarding financial and business trends relating to our financial condition and results of operations. Investors may find this information useful in assessing comparability of our operating performance from period to period, the business model objectives that management has established, and other companies in our industry. We provide this information to investors so that they can analyze our operating results in the same way that management does and to use this information in their assessment of our core business and valuation of Integra. Update on Remediation Activities
Remediation activities in our regenerative medicine facility in Plainsboro, New Jersey affected revenues and gross margin in the first quarter of 2013. We received a warning letter from the FDA in December 2011, related to quality systems and compliance issues at that plant. The letter resulted from an inspection held at that facility in August 2011, and did not identify any new observations that were not provided in the Form 483 that followed the inspection. The warning letter did not restrict our ability to manufacture or ship products, nor did it require the recall of any product. In June and July 2012, the FDA again inspected the regenerative medicine facility. The second inspection closed out on July 30, 2012 and a FDA Form 483 Inspectional Observations was issued. We have been addressing the Form 483 observations, warning letter citations and communicating with the FDA on a monthly basis. Our efforts with respect to closing out the warning letter are well along, and we expect the FDA to return for another inspection at this facility later in 2013.


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Since August 2011, we have undertaken significant efforts to remediate the observations that the FDA has made and continue to do so, including both capital investment for new equipment, leasehold improvements and incremental spending to improve or revise quality systems. We have recorded expenses totaling approximately $15.2 million since August 2011 through the end of the quarter ended March 31, 2013, of which $6.8 million was associated with remediation activities and $8.4 million for unplanned idle time and underutilization. The capital expenditures directed to the remediation of our regenerative medicine facility over the same period were $7.5 million.
In the first quarter of 2013 and 2012, we expensed approximately $1.5 million and $1.6 million, respectively. For the full year 2013, we expect to spend approximately $2.8 million on our remediation activities and we expect to have them completed by the end of the second quarter.

The FDA inspected our neurosurgery manufacturing facility in Andover, England in June 2012. Subsequently, on November 5, 2012, we received a warning letter from the FDA dated November 1, 2012 related to quality systems issues at the Andover manufacturing facility. The warning letter identified violations related to corrective and preventative actions, process validations, internal quality audits, and internal review of the suitability and effectiveness of the quality system at defined intervals. We filed the FDA warning letter as an exhibit to a Current Report on Form 8-K on November 13, 2012. Since the conclusion of the FDA inspection in June 2012, we have undertaken significant efforts to remediate the observations that the FDA has made and continue to do so. We are providing the FDA with monthly status reports and working cooperatively with the FDA to resolve any outstanding issues.

On February 14, 2013, we received a warning letter from the FDA relating to quality systems issues at our manufacturing facility located in Añasco, Puerto Rico. The letter resulted from an inspection conducted at that facility during October and November 2012. On February 15, 2013 we stopped distribution of our collagen products manufactured in the Añasco facility in order to confirm that we had successfully validated all such products and engaged a third-party consultant having appropriate quality system regulations expertise to confirm such validations. On February 22, 2013 the third-party consultant certified the completeness of such validations and we resumed distribution of collagen products from the Añasco facility.

On April 10, 2013, we initiated a voluntary recall of certain products manufactured in our Añasco, Puerto Rico facility between December 2010 and May 2011 and between November 2012 and March 2013. Specific lots of these products, as described below, have been recalled because we identified that there may have been deviations from required processes in their production. We identified through an internal quality assurance review that we may have deviated from a production process during the manufacture of specific lots of collagen products during the periods described in the preceding paragraph. The product lots in question passed all product finished goods testing including endotoxin testing, are sterile, and were tested and accepted for release. However, due to the process deviation, they may have been released with higher levels of endotoxins than permitted by the product specifications. Higher levels of endotoxins may result in a fever in the immediate postoperative period.

There have been no reports of patient injuries or other adverse events attributable to the products subject to the recall. We continue to manufacture all such products in our Añasco facility.

We believe that most of the recalled product lots manufactured between December 2010 and May 2011 have already been consumed, and that therefore, the recall of those lots will not have a material financial impact. However, the return of products, manufactured between November 2012 and March 2013, which were substantially sold in the first three months ended March 31, 2013, directly reduced revenues in the first quarter of 2013 by $2.9 million. In addition, we anticipate that we will not be able to produce all the affected products quickly enough to meet the demand from customers for at least several months. Such supply shortages resulted in lower revenues in the first quarter of 2013 and will result in lower revenues for the second and third quarters of 2013 than previously forecasted. We expect that the recall and expected supply shortages will have the greatest impact on the U.S. Neurosurgery, U.S. Spine and Other, and International Segments during the first and second quarters.

We met with the Office of Compliance at the Center for Devices and Radiological Health on March 26, 2013. We presented our plans for both immediate remediation and our corporate plan for the development and implementation of one Quality System. We have engaged former FDA professionals as third party consultants to work with us on our remediation plans. We also met with the Office of Compliance at the FDA San Juan, Puerto Rico office to discuss the remediation plans at the Añasco facility. We have prioritized senior level quality and regulatory staff to address the quality system improvement plans at all of our facilities.

The recall applies to limited and specific lots of DuraGen® Dural Graft Matrix, DuraGen® Plus Dural Regeneration Matrix, DuraGen® Suturable Dural Regeneration Matrix, DuraGen XS™ Dural Regeneration Matrix, Layershield® Adhesion Barrier


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Matrix, NeuraWrap™ Nerve Protector, NeuraGen® Nerve Guide, BioMend® Absorbable Collagen Membrane, OraMem® Absorbable Collagen Membrane, BioMend® Extend Absorbable Collagen Membrane, CollaCote® Absorbable Collagen Wound Dressing for Dental Surgery, CollaTape® Absorbable Collagen Wound Dressing for Dental Surgery, CollaPlug® Absorbable Collagen Wound Dressing for Dental Surgery, HeliTape® Absorbable Collagen Wound Dressing for Dental Surgery, HeliPlug® Absorbable Collagen Wound Dressing for Dental Surgery, OraTape® Absorbable Collagen Wound Dressing for Dental Surgery, OraPlug® Absorbable Collagen Wound Dressing for Dental Surgery, Instat® Microfibrillar Collagen Hemostat, Helistat® Absorbable Collagen Hemostatic Sponge (ACS/Helistat), and Helitene® Absorbable Collagen Hemostatic Agent. The Absorbable Collagen Sponge (ACS) is not a final product, but a component of a product assembled by another company.

We have undertaken significant efforts to remediate the observations that the FDA has made and have been working on improving and revising our quality systems. During the three months ended March 31, 2013, we incurred $0.6 million in remediation activities expenses consisting of consulting expenses and other work activities required to complete our remediation activities. For the full year 2013, we expect to spend approximately $4.0 million on our quality systems activities and expect to have these activities completed in the second half of 2013. We will provide periodic status reports and work cooperatively with the FDA to resolve any outstanding issues.
Revenues and Gross Margin on Product Revenues Our revenues and gross margin on product revenues were as follows:

                                                   Three Months Ended March 31,
                                                     2013                 2012
Segment Net Sales                                         (In thousands)
U.S. Neurosurgery                              $       38,996       $       40,183
U.S. Instruments                                       36,948               37,994
U.S. Extremities                                       31,361               26,587
U.S. Spine and Other                                   43,548               44,810
International *                                        45,799               46,611
Total revenue                                         196,652              196,185
Cost of goods sold                                     80,268               74,675
Gross margin on total revenues                 $      116,384       $      121,510
Gross margin as a percentage of total revenues           59.2 %               61.9 %

* The Company attributes revenue to geographic areas based on the location of the customer. There are certain revenues managed by the various U.S. segments above that are generated from non-U.S. customers and therefore included in Europe and the Rest of World revenues.

Three Months Ended March 31, 2013 as Compared to Three Months Ended March 31, 2012
Revenues and Gross Margin
For the three months ended March 31, 2013, total revenues increased slightly by $0.5 million to $196.7 million from $196.2 million for the same period in 2012. Our total revenues were negatively affected by our voluntary recall of certain products manufactured in our Anasco, Puerto Rico facility, including DuraGen® Dural Graft Matrix products. Although we continue to manufacture all the affected products in, and distribute from, our Anasco facility, the recall caused significant supply disruptions resulting in a decrease in our worldwide revenue and a larger than usual total backorder at the end of the quarter. The Company expects to resolve most of these disruptions by the end of 2013, but there can be no assurance the Company will not lose some customers or that backorder levels will return to normal by the end of the year. U.S. Neurosurgery revenues were $39.0 million, a decrease of 3% from the prior-year period. The decrease was directly related to our collagen product shortages caused by the recall. Capital sales were up as we saw mid-single digit growth in our critical care, tissue ablation and cranial stabilization lines.


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U.S. Instruments revenues were $36.9 million, a decrease of 3% from the prior-year period. In the quarter, we saw lower sales of our legacy lighting products. These declines were somewhat offset by growth in our retractor sales and sales of instruments to hospitals. We continued to experience sustained growth in sales of our LED surgical headlamp.
U.S. Extremities revenues were $31.4 million, an increase of 18% from the prior-year period. This growth resulted primarily from significant increases in sales of our dermal and wound care products. We saw strong double digit growth in both our upper and lower extremities businesses, driven by new products, including pyrocarbon implants. The favorable comparison can also be attributed to prior-year backorders in our nerve and tendon products, which did not clear until April 2012.
U.S. Spine and Other revenues, which include our spine hardware, orthobiologics and private label products, were $43.5 million, a 3% decrease from the prior-year period. Our spine hardware product sales were down as we saw continued pricing pressure, reimbursement delays and increased time to get product approvals to sell in hospitals. We saw continued growth in our orthobiologics products, led by a strong demand for our EVO3™ products which was partially offset by lower sales of our Integra Mozaik™ products due to supply issues. Sales of our private label products were down from the prior-year period.
International segment revenues were $45.8 million, a decrease of 2% from the prior-year period. Our sales around the world were affected by the recall of our collagen products and backorders on these recalled products. Foreign currency unfavorably impacted our sales and accounted for $0.2 million. We saw growth in our spine implants and dermal and wound businesses with several new products and increasing coverage in direct and indirect channels.
Gross margin decreased 4% to $116.4 million for the three-month period ended March 31, 2013 from $121.5 million for the same period last year. Gross margin as a percentage of total revenue decreased to 59.2% for the first quarter of 2013 from 61.9% for the same period last year. The decrease in gross margin percentage resulted primarily from increases in reserves related to inventory associated with the recall and increased spending and remediation costs related to improving quality systems at our manufacturing facilities. The Health Care and Education Reconciliation Act of 2010 imposed a manufacturer's excise tax equal to 2.3% of the manufacturer's price of applicable medical devices by a medical device manufacturer, producer or importer of such device. In January, we began paying the tax deductible manufacturer's excise tax imposed on the first sale of certain medical devices in the United States. We elected to capitalize the excise tax in our inventory and subsequently record it in cost of goods sold as these products are sold to third-party customers.
We expect our consolidated gross margin percentage for the full year 2013 to be between 60% and 61%, down when compared to 2012. We expect to complete the remediation work at our Plainsboro, New Jersey regenerative medicine manufacturing facility in the second quarter of 2013 and accordingly, expect to return to normal levels of production at that time. That said, costs related to the expansion of our regenerative medicine activities, and continued downward pressure on our private-label and spine hardware product sales volumes and the inclusion of the medical device tax will negatively affect our consolidated gross margin.
Operating Expenses
The following is a summary of operating expenses as a percent of total revenues:

                                           Three Months Ended March 31,
                                          2013                           2012
Research and development                     6.5 %                       6.1 %
Selling, general and administrative         50.9 %                      44.6 %
. . .
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