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IART > SEC Filings for IART > Form 10-Q on 1-Aug-2013All Recent SEC Filings




Quarterly Report

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.

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

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the quality of life for patients. We focus on cranial and spinal procedures, small bone and joint injuries, the repair and reconstruction of soft tissue, and instruments for surgery.
We manage our business through a combination of product groups and geography, and accordingly, we report our financial results under five reportable segments
- U.S. Instruments, U.S. Neurosurgery, U.S. Extremities, U.S. Spine and Other (which consists of our U.S. Spine and Private Label businesses) and International. We present revenues in the following three product categories: Orthopedics, Neurosurgery and Instruments. Our orthopedics product group includes specialty metal implants for surgery of the extremities, shoulder and spine, orthobiologics products for repair and grafting of bone, dermal regeneration products and tissue-engineered wound dressings and nerve and tendon repair products. Our neurosurgery product group includes, among other things, dural grafts that are indicated for the repair of the dura mater, ultrasonic surgery systems for tissue ablation, cranial stabilization and brain retraction systems, systems for measurement of various brain parameters and devices used to gain access to the cranial cavity and to drain excess cerebrospinal fluid from the ventricles of the brain. Our instruments product group includes a wide range of specialty and general surgical and dental instruments and surgical lighting for sale to hospitals, outpatient surgery centers, and physician, veterinarian and dental practices. We manufacture many of our products in plants located in the United States, Puerto Rico, France, Germany, Ireland, the United Kingdom and Mexico. We also source most of our handheld surgical instruments and specialty metal and pyrocarbon implants through specialized third-party vendors. In the United States, we have several sales channels. We sell orthopedics products through a large direct sales organization and through specialty distributors focused on their respective surgical specialties. Neurosurgery products are sold through directly employed sales representatives. Instruments products are sold through two sales channels, both directly and through distributors and wholesalers, depending on the customer call point. We sell in the international markets through a combination of a direct sales organization and distributors. We also market certain products through strategic partners in the United States. Our objective is to become a multi-billion dollar diversified global medical technology company that (i) helps patients by limiting uncertainty for medical professionals and (ii) is a high-quality investment for shareholders. We will achieve these goals by delivering on our Brand Promises to our customers worldwide and by becoming a top player in all markets in which we compete. Our strategy includes the following key elements: geographic expansion, disciplined focus and execution, global quality assurance and acquiring or in-licensing products that fit existing sales channels, margin expansion and leveraging platform synergies. We aim to achieve growth in our revenues while maintaining strong financial results. While we pay attention to any meaningful trend in our financial results, we pay particular attention to measurements that are indicative of long-term profitable growth. These measurements include (1) revenue growth (including internal growth and by acquisitions), (2) gross margins on total revenues, (3) operating margins (which we aim to expand as we leverage our existing infrastructure and improve our quality systems), (4) earnings before interest, taxes, depreciation, and amortization, and (5) earnings per diluted share of common stock. We believe that we are particularly effective in the following aspects of our business:
• Regenerative Medicine Platform. We have developed numerous product lines through our proprietary collagen matrix and demineralized bone matrix technologies that are sold through every one of our sales channels.

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

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

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• 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.

We did not complete any acquisitions during the second quarter of 2013.
Executive Summary
Net income for the three months ended June 30, 2013, was $3.4 million, or $0.12 per diluted share as compared with net income of $8.5 million or $0.30 per diluted share for the three months ended June 30, 2012.
Net loss for the six months ended June 30, 2013 was $0.6 million, or $0.02 per diluted share as compared with net income of $15.2 million or $0.53 per diluted share for the six months ended June 30, 2012.
The results of operations for the three and six months ended June 30, 2013 were adversely affected by a voluntary recall of certain collagen-based products manufactured in our Añasco, Puerto Rico facility. Increases in the sales returns reserve and product shortages caused by the recall led to revenue and margin reductions. We also incurred incremental expenses related to the recall, including scrap of finished good products that were not released to customers and work in process, legal and consulting costs, and expenses for remediation of our quality systems. Additionally, our expenses were impacted by higher selling, general and administration headcount, increased consulting fees and expenses incurred in connection with the implementation of our global ERP system. The effects of the recall noted above were offset by a decrease in our interest expense as a result of the June 2012 repayment of our 2012 Notes and capitalization of a portion of our interest expense into the cost of our capital projects.
Income before taxes includes the following special charges:

                                       Three Months Ended June 30,       Six Months Ended June 30,
                                           2013             2012            2013             2012
                                             (In thousands)                    (In thousands)
Global ERP implementation charges    $        7,616     $    3,607     $      13,765     $    7,276
Facility optimization charges                 2,262          2,984             5,670          4,620
Manufacturing facility remediation
costs                                         2,963          1,770             5,088          3,405
Certain expenses associated with
product recalls                                 165              -             1,444              -
Certain employee termination charges              -              -                 -            501
Discontinued product lines charges                -              -                 -            835
Acquisition-related charges                     286          1,019               674          1,721
Impairment charges                                -              -                 -            141
Convertible debt non-cash interest            1,622          2,969             3,232          6,497
Total                                $       14,914     $   12,349     $      29,873     $   24,996

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

                                       Three Months Ended June 30,       Six Months Ended June 30,
                                           2013             2012            2013             2012
                                             (In thousands)                    (In thousands)
Cost of goods sold                   $        4,371     $    3,685     $       8,872     $    8,229
Selling, general and administrative           8,921          5,695            17,769         10,270
Interest expense                              1,622          2,969             3,232          6,497
Total                                $       14,914     $   12,349     $      29,873     $   24,996

We typically define special charges as items for which the amounts and/or timing of such expenses may vary significantly from period to period, depending upon our acquisition, integration and restructuring activities, and for which the amounts are non-

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cash in nature, or for which the amounts are not expected to recur at the same magnitude as we implement certain tax planning strategies. We believe that given our ongoing strategy of seeking acquisitions, our continuing focus on rationalizing our existing manufacturing and distribution infrastructure and our continuing review of various product lines in relation to our current business strategy, certain of the special charges discussed above could recur with similar materiality in the future. In 2010 we began investing significant resources in the global implementation of a single enterprise resource planning system. We began capitalizing certain costs for the project starting in 2011. We believe that the separate identification of these special charges provides important supplemental information to investors regarding financial and business trends relating to our financial condition and results of operations. Investors may find this information useful in assessing comparability of our operating performance from period to period, the business model objectives that management has established, and other companies in our industry. We provide this information to investors so that they can analyze our operating results in the same way that management does and to use this information in their assessment of our core business and valuation of Integra. Update on Remediation Activities
Remediation activities in our regenerative medicine facility in Plainsboro, New Jersey affected revenues and gross margin in the first and second quarters of 2013. We received a warning letter from the FDA in December 2011, related to quality systems and compliance issues at that plant. The letter resulted from an inspection held at that facility in August 2011, and did not identify any new observations that were not provided in the Form 483 that followed the inspection. The warning letter did not restrict our ability to manufacture or ship products, nor did it require the recall of any product. In June and July 2012, the FDA again inspected the regenerative medicine facility. The second inspection closed out on July 30, 2012 and a FDA Form 483 Inspectional Observations was issued. We have been addressing the Form 483 observations, warning letter citations and communicating with the FDA on a monthly basis. Our efforts with respect to closing out the warning letter are well along. On July 16, 2013, the FDA began an inspection of the Plainsboro facility. At this point, the inspection remains in progress.

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

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

On April 10, 2013, we initiated a voluntary recall of certain products manufactured in our Añasco facility between December 2010 and May 2011 and between November 2012 and March 2013. Specific lots of these products, as described below, have been recalled because we identified that there may have been deviations from required processes in their production. We identified through an internal quality assurance review that we may have deviated from a production process during the manufacture of specific lots of collagen products during the periods described. The product lots in question passed all product finished goods testing including endotoxin testing, are sterile, and were tested and accepted for release. However, due to the process deviation, they may have been released with higher levels of endotoxins than permitted by the product specifications. Higher levels of endotoxins may result in a fever in the immediate postoperative period. There have been no reports of patient injuries or other adverse events attributable to the products subject to the recall. We continue to manufacture all such products in our Añasco facility.

We believe that most of the recalled product lots manufactured between December 2010 and May 2011 have already been consumed, and that therefore, the recall of those lots will not have a material financial impact. However, the return of products, manufactured between November 2012 and March 2013, which were substantially sold in the first three months ended March 31, 2013, directly reduced revenues in the six months ended June 30, 2013 by $3.1 million. As we anticipated, we were not able to produce all the affected products quickly enough to meet the demand from customers in the three months ended June 30, 2013. Such supply shortages resulted in lower revenues in the first six months of 2013 and will result in lower revenues for

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the third quarter of 2013 than previously forecasted. As expected, the recall and supply shortages had a significant impact on the U.S. Neurosurgery, U.S. Spine and Other, and International segments during the first six months of 2013.

The recall applies to limited and specific lots of DuraGen® Dural Graft Matrix, DuraGen® Plus Dural Regeneration Matrix, DuraGen® Suturable Dural Regeneration Matrix, DuraGen XS™ Dural Regeneration Matrix, Layershield® Adhesion Barrier Matrix, NeuraWrap™ Nerve Protector, NeuraGen® Nerve Guide, BioMend® Absorbable Collagen Membrane, OraMem® Absorbable Collagen Membrane, BioMend® Extend Absorbable Collagen Membrane, CollaCote® Absorbable Collagen Wound Dressing for Dental Surgery, CollaTape® Absorbable Collagen Wound Dressing for Dental Surgery, CollaPlug® Absorbable Collagen Wound Dressing for Dental Surgery, HeliTape® Absorbable Collagen Wound Dressing for Dental Surgery, HeliPlug® Absorbable Collagen Wound Dressing for Dental Surgery, OraTape® Absorbable Collagen Wound Dressing for Dental Surgery, OraPlug® Absorbable Collagen Wound Dressing for Dental Surgery, Instat® Microfibrillar Collagen Hemostat, Helistat® Absorbable Collagen Hemostatic Sponge (ACS/Helistat), and Helitene® Absorbable Collagen Hemostatic Agent. The Absorbable Collagen Sponge (ACS) is not a final product, but a component of a product assembled by another company.

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

We have undertaken significant efforts to remediate the observations that the FDA has made and have been working on improving and revising our quality systems. During the three and six months ended June 30, 2013, we incurred $3.0 million and $5.1 million in remediation activities expenses, respectively, consisting of consulting expenses and other work activities required to complete our remediation activities. For the full year 2013, we expect to spend approximately $7.0 million on our quality systems and expect to have these activities completed in the second half of 2013. We will provide periodic status reports to the FDA and work cooperatively with the agency to resolve any outstanding issues.
Revenues and Gross Margin on Product Revenues Our revenues and gross margin on product revenues were as follows:

                                         Three Months Ended June 30,          Six Months Ended June 30,
                                           2013               2012               2013              2012
Segment Net Sales                              (In thousands)                       (In thousands)
U.S. Neurosurgery                    $      41,767       $      42,324     $      80,763       $   82,507
U.S. Instruments                            39,991              41,269            76,939           79,263
U.S. Extremities                            33,538              32,048            64,899           58,635
U.S. Spine and Other                        42,962              48,823            86,510           93,633
International *                             47,289              45,706            93,088           92,317
Total revenue                              205,547             210,170           402,199          406,355
Cost of goods sold                          83,068              78,274           163,336          152,949
Gross margin on total revenues       $     122,479       $     131,896     $     238,863       $  253,406
Gross margin as a percentage of
total revenues                                59.6 %              62.8 %            59.4 %           62.4 %

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

Three Months Ended June 30, 2013 as Compared to Three Months Ended June 30, 2012 Revenues and Gross Margin
For the three months ended June 30, 2013, total revenues decreased by $4.7 million to $205.5 million from $210.2 million for the same period in 2012.

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Our total revenues were negatively affected by our voluntary recall of certain products manufactured in our Añasco, Puerto Rico facility, including DuraGen® Dural Graft Matrix products. Although we continue to manufacture all the affected products in, and distribute from, our Añasco facility, the recall caused significant supply disruptions resulting in a decrease in our worldwide revenue and a larger than usual total backorder at the end of the current quarter. The Company expects to resolve most of these disruptions by the end of 2013, but there can be no assurance the Company will not lose some customers or that backorder levels will return to normal by the end of the year. U.S. Neurosurgery revenues were $41.8 million, a decrease of 1% from the prior-year period. The decrease continues to be directly related to our collagen product shortages caused by the recall. Tissue ablation sales also decreased on a strong comparison from the prior year period, but strong growth in neuro critical care, cranial stabilization and sterotaxy partly offset these decreases. Overall sales of neuro capital products were relatively flat. U.S. Instruments revenues were $40.0 million, a decrease of 3% from the prior-year period. In the quarter, we saw mid-single digit growth in our acute care sales channel as a result of several large orders for hospital starts. We continued to experience sustained growth in sales of our LED surgical headlamp, which was offset by lower sales of our legacy xenon lighting products. In addition, we experienced softness in our alternate site sales resulting from pricing pressures and discontinuation of some of our lower margin products. U.S. Extremities revenues were $33.5 million, an increase of 5% from the prior-year period. This increase resulted primarily from mid-single digit growth in sales of our regenerative products compared to the prior year period when sales of such products were unusually high following the elimination of a significant backorder. We also saw low single digit growth in both our upper and lower extremities businesses, driven by new product introductions, including pyrocarbon implants.
U.S. Spine and Other revenues, which include our spine hardware, orthobiologics and private label products, were $43.0 million, a 12% decrease from the prior-year period. In addition to general market softness and pricing pressure, our spine hardware product sales declined more than the market because of poor execution in the business and some distributor turnover. We have identified the issues impacting our performance and have plans in place to return to market performance by the end of the year. Orthobiologics sales were flat because of backorders in collagen ceramic bone void fillers. Sales growth in the rest of the portfolio offset much of this decrease, and demand for the overall orthobiologics line remains strong. Sales of our private label products were down significantly from the prior-year period due to the recall-related supply shortage and declining sales of absorbable collagen sponges to our important customers.
International segment revenues were $47.3 million, an increase of 4% from the prior-year period. Our sales around the world were affected by the recall of our collagen products and backorders on these recalled products. We saw double digit growth in our spine implants and mid-single digit growth in neurosurgery products. Foreign currency had a negligible impact on our sales in the current quarter.
Gross margin decreased 7% to $122.5 million for the three-month period ended June 30, 2013 from $131.9 million for the same period last year. Gross margin as a percentage of total revenue decreased to 59.6% for the second quarter of 2013 from 62.8% for the same period last year. The decrease in gross margin percentage resulted primarily from product mix, increased validation and remediation costs related to improving quality systems at our manufacturing facilities and the impact of the 2.3% manufacturer's excise tax that we capitalize in our inventory and subsequently record in cost of goods sold as these products are sold to third-party customers.
We expect our consolidated gross margin percentage for the full year 2013 to be between 60% and 61%, down compared to 2012. Costs related to the expansion of our regenerative medicine activities, continued downward pressure on our private-label and spine hardware product sales volumes, and the inclusion of the medical device tax will negatively affect our consolidated gross margin. Operating Expenses
The following is a summary of operating expenses as a percent of total revenues:

                                          Three Months Ended June 30,
                                         2013                          2012
Research and development                    5.7 %                      6.2 %
Selling, general and administrative        48.5 %                     45.7 %
Intangible asset amortization               1.5 %                      2.2 %
Total operating expenses                   55.7 %                     54.1 %

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Total operating expenses, which consist of research and development expenses, selling, general and administrative expenses, and amortization expense, increased $0.6 million, or 1%, to $114.5 million in the three months ended June 30, 2013, compared to $113.9 million in the same period last year.

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