United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter ended September 30, 1998
Commission File Number: 1-9741
INAMED CORPORATION
State of Incorporation:Florida I.R.S. Employer Identification No.: 59-0920629
3800 Howard Hughes Parkway, Suite #900, Las Vegas, Nevada 89109
Telephone Number: (702) 791-3388
Indicate by check mark whether the Registrant (1) has
filed all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No_____
On November 11,1998 there were 11,420,363 Shares of the
Registrant's Common Stock Outstanding.
This document contains 24 pages.
INAMED CORPORATION AND SUBSIDIARIES
Form 10-Q
Quarter Ended September 30, 1998
TABLE OF CONTENTS
Page
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
Unaudited Consolidated Income Statements 5
Unaudited Consolidated Statements
of Cash Flows 7
Notes to the Consolidated
Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
PART II - OTHER INFORMATION 23
PART I. FINANCIAL INFORMATION
ITEM 1.
INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in 000's)
Unaudited Audited
September 30, 1998 December 31, 1997
Assets
Current assets:
Cash and cash equivalents $ 6,543 $ 1,946
Trade accounts receivable, net of
allowance for doubtful accounts
and returns and allowances of
$5,118 at 9/30/98 and $5,221 at
12/31/97 22,573 13,979
Related party notes receivable -- 129
Inventories 19,141 23,117
Prepaid expenses and other
current assets 1,902 1,413
Income tax refund receivable 99 472
-------- --------
Total current assets 50,258 41,056
-------- --------
Property and equipment, at cost:
Machinery and equipment 13,973 12,585
Furniture and fixtures 5,361 4,541
Leasehold improvements 10,752 10,996
-------- --------
30,086 28,122
Less accumulated depreciation
and amortization (17,476) (14,639)
-------- --------
Net property and equipment 12,610 13,483
-------- --------
Notes receivable, net of
allowance of $467 2,769 2,799
Intangible assets, net 984 1,164
Other assets, at cost 419 340
-------- --------
Total assets $ 67,040 $ 58,842
======== ========
(continued)
The Notes to Financial Statements are an integral part of this
statement.
INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in 000's)
Unaudited Audited
September 30, 1998 December 31, 1997
Liabilities and Stockholders' Deficiency
Current liabilities:
Current installments of
long-term debt $ 59 $ 30
Notes payable to bank 870 659
Accounts payable 11,858 14,759
Accrued liabilities:
Salaries, wages, and
payroll taxes 4,738 2,683
Interest 1,994 3,146
Self-insurance 3,841 3,602
Other 5,653 2,667
Royalties payable 4,039 4,156
Income taxes payable 2,186 2,894
-------- --------
Total current liabilities 35,238 34,596
-------- --------
Convertible and other long-term debt,
excluding current installments 19,837 23,574
Subordinated notes payable,
related party -- 8,813
Deferred grant income and other 1,901 1,213
Accrued litigation settlement 37,307 37,335
Commitments and contingencies
Stockholders' deficiency:
Common stock, $0.01 par value.
Authorized 20,000,000 shares; issued
and outstanding 10,994,040
and 8,885,076 110 89
Additional paid-in capital 35,354 19,027
Cumulative translation adjustment 848 (223)
Accumulated deficit (63,555) (65,582)
-------- --------
Stockholders' deficiency (27,243) (46,689)
-------- --------
Total liabilities and
stockholders' deficiency $ 67,040 $ 58,842
======== ========
The Notes to Financial Statements are an integral part of this
statement.
INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
(Unaudited)
(in 000's except share and per share data)
Nine Months Nine Months
Ended Ended
September 30, 1998 September 30, 1997
Net sales $ 99,109 $ 80,309
Cost of goods sold 35,219 26,446
-------- --------
Gross profit 63,890 53,863
Operating expenses:
Marketing 26,894 21,216
General and administrative 21,201 21,983
Research and development 7,053 6,694
-------- --------
Total operating expenses 55,148 49,893
-------- --------
Operating income 8,742 3,970
-------- --------
Other income (expense):
Interest income 283 678
Interest expense (3,029) (4,258)
Royalty Income 108 211
Foreign currency transaction losses (961) (1,272)
Miscellaneous income (expense) 326 (259)
Restructuring expense (3,305) --
-------- --------
Net other expense (6,578) (4,900)
-------- --------
Income (loss) before income
tax expense 2,164 (930)
Income tax expense (benefit) 137 (14)
-------- --------
Net income (loss) $ 2,027 $ (916)
======== ========
Net income (loss) per share of common stock
Basic earnings (loss) per share $ 0.20 $ (0.11)
======== ========
Diluted earnings (loss) per share $ 0.20 $ (0.11)
======== ========
Weighted average common shares
outstanding 10,129,766 8,296,157
========== =========
The Notes to Financial Statements are an integral part of this statement.
INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
(Unaudited)
(in 000's except share and per share data)
Three Months Three Months
Ended Ended
September 30, 1998 September 30, 1997
Net sales $ 32,130 $ 24,205
Cost of goods sold 11,926 7,985
-------- --------
Gross profit 20,204 16,220
-------- --------
Operating expenses:
Marketing 8,598 6,298
General and administrative 5,549 7,697
Research and development 2,943 2,310
-------- --------
Total operating expenses 17,090 16,305
-------- --------
Operating income (loss) 3,114 (85)
-------- --------
Other income (expense):
Interest income 53 142
Interest expense (944) (1,345)
Royalty Income 108 211
Foreign currency transaction gains 106 81
Miscellaneous income (expense) 440 (303)
Restructuring expenses (3,305) --
-------- --------
Net other expense (3,542) (1,214)
Loss before income taxes (428) (1,299)
Income tax expense (benefit) 33 (391)
-------- --------
Net loss $ (461) $ (908)
======== ========
Net Loss per share of common stock
Basic loss per share $ (0.04) $ (0.11)
======== ========
Diluted loss per share $ (0.04) $ (0.11)
======== ========
Weighted average common shares
outstanding 10,924,108 8,477,455
========== =========
The Notes to Financial Statements are an integral part of this statement.
INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in 000's)
Nine Months ended September 30, 1998 and 1997
Increase (Decrease) in Cash and Cash Equivalents
1998 1997
---- ----
Cash flows from operating activities:
Net income (loss) $ 2,027 $ (916)
-------- --------
Adjustments to reconcile net income
(loss) to net cash used in operating
activities:
Non-cash operating activities 4,312 2,334
Changes in assets and liabilities:
Trade accounts and notes
receivable (8,223) (5,506)
Inventories 4,320 (4,631)
Prepaid expenses and other assets (248) (333)
Accounts payable, accrued and
other liabilities 1,919 209
-------- --------
Total adjustments 2,080 (7,927)
-------- --------
Net cash provided by (used in)
operating activities 4,107 (8,843)
-------- --------
Cash flows used in investing activities:
Disposal of fixed assets (670) --
Purchases of property and equipment (935) (3,688)
-------- --------
Net cash used in investing
activities (1,605) (3,688)
-------- --------
(continued)
The Notes to Financial Statements are an integral part of this statement.
INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in 000's)
Nine Months ended September 30, 1998 and 1997
Increase (Decrease) in Cash and Cash Equivalents
1998 1997
---- ----
Cash flows from financing activities:
Restricted cash in escrow for
litigation settlement $ -- $ 14,796
Increases in notes payable and
long-term debt 410 5,648
Principal repayment of notes payable
and long-term debt -- (15,048)
Decrease in related party receivables 128 219
Increase in related party payables 1,038 6,258
Grant income 298 --
Issuance and repurchases of
common stock 80 (6)
-------- --------
Net cash provided by
financing activities 1,954 11,867
-------- --------
Effect of exchange rate changes
on cash 141 2,399
-------- --------
Net increase in cash
and cash equivalents 4,597 1,735
Cash and cash equivalents at beginning
of period 1,946 923
Cash and cash equivalents at end
of period $ 6,543 $ 2,658
-------- --------
Supplemental disclosure of cash flow information:
Cash paid during the nine months for:
Interest $ 2,424 $ 3,198
======== ========
Income taxes $ 97 $ 371
======== ========
Disclosure of accounting policy:
For purposes of the consolidated statement of cash flows,
the Company considers all highly liquid debt instruments
purchased with a maturity of three months or less to be cash
equivalents.
The Notes to Financial Statements are an integral part of this statement.
INAMED CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1998
(in 000's)
Note 1 - Interim Financial Statements
The accompanying unaudited consolidated financial statements
include all adjustments (consisting only of normal recurring
accruals) which are, in the opinion of management, necessary for
fair presentation of the results of operations for the periods
presented. Interim results are not necessarily indicative of the
results to be expected for a full year.
Certain information and footnote disclosures normally included in
financial statements, prepared in accordance with generally
accepted accounting principles, have been condensed or omitted as
allowed by Form 10-Q. The accompanying unaudited consolidated
financial statements should be read in conjunction with the
Company's consolidated financial statements for the year ended
December 31, 1997 as filed with the Securities and Exchange
Commission on Form 10-K.
Note 2 - Basis of Presentation and Summary of Significant
Accounting Policies
The accompanying consolidated financial statements include the
accounts of INAMED Corporation and each of its wholly-owned
subsidiaries (the "Company"). Intercompany transactions are
eliminated in consolidation.
The Financial Statements do not include any adjustments relating
to the recoverability and classification of the recorded asset
and liability amounts that might be necessary should the Company
be unable to continue as a going concern.
The Company's continuation as a going concern is dependent upon
its ability to obtain financing for the non-opt-out settlement
agreement (see Note 7).
The Company
INAMED Corporation's subsidiaries are organized into three
business units: United States Plastic and Reconstructive Surgery
(consisting primarily of McGhan Medical Corporation, Flowmatrix
Corporation and CUI Corporation, which develop, manufacture and
sell medical devices and components); BioEnterics Corporation,
which develops, manufactures and sells medical devices and
associated instrumentation to the bariatric and general surgery
fields; and International (consisting primarily of two
manufacturing companies based in Ireland--McGhan Limited and
Chamfield Ltd.-and sales subsidiaries in various countries,
including Holland, Germany, Italy, United Kingdom, France, Spain,
Hong Kong and Mexico, which sell products for both the plastic
and bariatric surgery fields).
Note 2 - Basis of Presentation and Summary of Significant
Accounting Policies (continued)
Earnings Per Share
During 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings
per Share", ("SFAS No. 128") which provides for the calculation
of "basic" and "diluted" earnings per share. SFAS No. 128 is
effective for financial statements issued for periods ending
after December 15, 1997. Basic earnings per share includes no
dilution and is computed by dividing income available to common
shareholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per share reflects,
in periods in which they have a dilutive effect, the effect of
common shares issuable upon exercise of stock options. The
assumed exercise of various warrants and options would have been
anti-dilutive and, therefore, was not considered in the
computation of diluted earnings per share for September 30, 1998
and 1997. As required by this Statement, all periods presented
have been restated to comply with the provisions of SFAS No. 128.
Comprehensive Income
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income," ("SFAS No. 130") established standards for
reporting and display of comprehensive income, its components and
accumulated balances. Comprehensive income is defined to include
all changes in equity except those resulting from investments by
owners and distributions to owners. Among other disclosures,
SFAS No. 130 requires that all items that are required to be
recognized under current accounting standards as components of
comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements.
The Company has adopted SFAS Nos. 130 and it has had no material
effect on the Company's financial position, results of operations
or financial statement disclosures.
Segment Reporting
In June 1997, the Financial Accounting Standards Board issued
SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information", ("SFAS No. 131") which supersedes SFAS No.
14, Financial Reporting for Segments of a Business Enterprise.
SFAS No. 131 establishes standards for the way public companies
report information about operating segments in annual financial
statements and requires reporting of selected information about
operating segments in interim financial statements issued to the
public. It also establishes standards for disclosures regarding
products and services, geographic areas and major customers.
SFAS No. 131 defines operating segments as components of a
company about which separate financial information is available
that is evaluated regularly by the chief operating decision maker
in deciding how to allocate resources and in assessing
performance. The Company has adopted SFAS Nos. 131 and it has had
no material effect on the Company's financial position, results
of operations or financial statement disclosures.
Reclassification
Certain reclassifications were made to the 1997 consolidated
financial statements to conform to the 1998 presentation.
Note 3 - Accounts and Notes Receivable
Accounts and notes receivable consist of the following:
September 30, 1998 December 31, 1997
------------------ -----------------
Accounts receivable $ 27,691 $ 19,200
Allowance for doubtful
accounts (1,062) (865)
Allowance for returns
and credits (4,056) (4,356)
_________ _________
Net accounts receivable $ 22,573 $ 13,979
========= =========
Notes receivable $ 3,236 $ 3,266
Allowance for doubtful notes(467) (467)
_________ _________
Net notes receivable $ 2,769 $ 2,799
========= =========
Note 4 - Inventories
Inventories are summarized as follows:
September 30, 1998 December 31, 1997
------------------- ------------------
Raw materials $ 4,472 $ 4,671
Work in process 4,217 3,799
Finished goods 11,816 16,161
--------- ---------
20,505 24,631
Less allowance for
obsolescence (1,364) (1,514)
--------- ---------
$ 19,141 $ 23,117
========= =========
Note 5 - Long Term Debt
The Company's long-term debt as of September 30, 1998 consists
primarily of $19,600 senior secured convertible notes which were
originally issued in January 1996. These notes mature on March
31, 1999 and were convertible at $5.50 per share. During
November, 1998 these notes were exchanged for new notes (see Note
6).
In July 1998, the Company converted $10,800 of subordinated
indebtedness, (consisting of principal and accrued interest),
with an entity controlled by the Company's former Chairman and
then 13% stockholder into 860,000 shares of common stock. A four-
year warrant to purchase 260,000 shares at $12.40 per share was
also issued in connection with this transaction.
Note 6 - Subsequent Events
During the fourth quarter, the Company completed the following
transactions related to long-term debt:
(a) $8,000 of senior secured notes, at an interest rate of 10%.
These notes mature on March 31, 1999 but are extendable under
certain conditions until September 1, 2000. The proceeds were
received by the Company on October 2, 1998. In connection with
this financing the Company issued 590,000 four-year warrants to
purchase common stock at $6.50 per share. $3,000 of the proceeds
of this financing were deposited in a court-supervised escrow as
part of the consideration for the litigation settlement (see Note
7); the balance is available for use by the Company in specific
capital improvement projects and working capital uses.
(b) $19,600 of junior secured notes, at an interest rate of 11%.
These notes were issued in an exchange offer completed in
November 1998 for senior secured convertible notes which were
originally issued in January 1996. These notes mature on March
31, 1999 but are extendable under certain conditions until
September 1, 2000. The $5.50 per share conversion feature of the
original notes was replaced with an equivalent number of new,
four-year warrants to purchase common stock at $5.50 per share,
and the holders of the original notes received 500,000 four-year
warrants to purchase common stock at $7.50 per share in
settlement of an anti-dilution adjustment. In the event the
settlement agreement becomes final and non-appealable (see note
7), under certain circumstances the Company can call the exercise
of the $5.50 per share warrants and the proceeds could be applied
either to redeem these notes without penalty or to pay for the
litigation settlement.
An income statement charge of approximately $408 will be
recorded in the fourth quarter of 1998 in relation to the
issuance of the warrants for the above transactions.
Note 7 - Commitments and Contingencies
INAMED and its McGhan Medical and CUI subsidiaries are defendants
in numerous state and federal court lawsuits involving breast
implants. The alleged factual basis for typical lawsuits
includes allegations that the plaintiffs' silicone gel-filled
breast implants caused specified ailments including, among
others, auto-immune disease, lupus, scleroderma, systemic
disorders, joint swelling and chronic fatigue. The Company has
opposed plaintiffs' claims in these lawsuits and other similar
actions and continues to deny any wrongdoing or liability of any
kind. In addition, the Company believes that a substantial body
of medical evidence exists which indicates that silicone gel-
filled implants are not causally related to any of the above
ailments. Numerous studies in the past few years by medical
researchers in North America and Europe have failed to show a
definitive connection between breast implants and disease (some
critics, however, have assailed the methodologies of these
studies). Nevertheless, plaintiffs continue to contest the
findings of these studies, and more than 15,000 lawsuits and
claims alleging such ailments are pending against the Company and
its subsidiaries. The volume of lawsuits has created substantial
ongoing litigation and settlement expense, in addition to the
inherent risk of adverse jury verdicts in cases not resolved by
dismissal or settlement.
Proposed Class Action Settlement
As a result of the burdens imposed by the litigation on the
Company's management and operations, the substantial ongoing
litigation and settlement expense, the continuing litigation
risks, and the adverse perception held by the financial community
arising out of the litigation, the Company is seeking approval of
a mandatory ("non-opt-out") class action settlement (the
"Settlement") under Federal Rule of Civil
Note 7 - Commitments and Contingencies (continued)
Procedure 23(b)(1)(B). As described below, the Company is
seeking through this settlement to resolve all claims arising
from McGhan Medical and CUI breast implants implanted before June
1, 1993, a cutoff date which encompasses substantially all
domestically-implanted silicone gel-filled implants.
Background of Class Settlement Negotiations
The Settlement has its genesis in negotiations begun in 1994 with
the Plaintiffs' Negotiation Committee ("PNC"), a committee of the
national Plaintiffs' Steering Committee ("PSC") appointed by
Judge Sam C. Pointer, Jr. of the United States District Court for
the Northern District of Alabama (the "Court") to represent the
interests of plaintiffs in multi-district breast implant
litigation transferred to the Court for pretrial proceedings
under the federal multi-district transfer statute. At that time
the Company entered into an agreement to participate in a
proposed industry-wide class action settlement (the "Global
Settlement") of domestic breast implant litigation and petitioned
the Court to certify the Company's portion of the Global
Settlement as a mandatory class under Federal Rule of Civil
Procedure 23(b)(1)(B), meaning that claimants could not elect to
"opt out" from the class in order to pursue individual lawsuits
against the Company. Negotiations with the PNC over mandatory
class treatment were tabled, however (and the Company's petition
consequently not ruled upon), when an unexpectedly high
projection of current disease claims and the subsequent election
of Dow Corning Corporation to file for protection under federal
bankruptcy laws necessitated a substantial restructuring of the
Global Settlement.
In late 1995, the Company agreed to participate in a scaled-back
Revised Settlement Program ("RSP") providing for settlement, on a
non-mandatory basis, of claims by domestic claimants who were
implanted before January 1, 1992 with silicone gel-filled
implants manufactured by the Company's McGhan Medical subsidiary,
and who met specified disease and other criteria. Under the
terms of the RSP, 80% of the settlement costs relating to the
Company's McGhan Medical implants were to be paid by 3M and Union
Carbide Corporation, with the remaining 20% to be paid by the
Company. However, because the RSP did not provide a vehicle for
settling claims other than by persons who elected to participate,
and because of continuing uncertainty about the Company's ability
to fund its obligations under the RSP in the absence of a broader
settlement also resolving breast implant lawsuits against the
Company and its CUI subsidiary which would not be covered by the
RSP, the Company continued through 1996 and 1997 to negotiate
with
the PNC in an effort to reach a broader resolution through a
mandatory class. The PNC was advised in these negotiations by
its consultant, Ernst & Young LLP, which at the PNC's request
conducted reviews of the Company's finances and operations in
1994 and again in 1996 and 1997.
On April 2, 1998, the Company and the Settlement Class Counsel
executed a formal settlement agreement (the "Settlement
Agreement"), resolving, on a mandatory, non-opt-out basis, all
claims arising from McGhan Medical and CUI breast implants
implanted before June 1, 1993. On June 2, 1998 the Court issued
a preliminary order approving the Settlement. The Court also
issued an injunction staying all pending breast implant
litigation against the Company (and its subsidiaries) in federal
and state courts. The Company believes that this stay will
alleviate a significant financial and managerial burden which
these lawsuits had placed on the Company.
Terms and Conditions of the Settlement Agreement
Pursuant to the terms of the Settlement Agreement, on October 2,
1998 the Company deposited into a court-supervised escrow account
$31,500 of consideration, consisting of $3,000 of cash, 426,323
shares of common stock and $25,500 principal amount of a 6%
subordinated note. Also at that time, Judge
Note 7 - Commitments and Contingencies (continued)
Pointer authorized the mailing of a notice of the fairness
hearing to the class members, and established December 11, 1998
as the date for class members to file written objections, and
January 11, 1999 as the date for a fairness hearing to consider
final approval.
In the event the Court grants final approval of the Settlement,
and the Court's final order becomes non-appealable, the
consideration held in the escrow account will then be released to
the court-appointed settlement office for distribution to the
plaintiff class, and the $25,500 subordinated note will mature
and become payable in cash. However, this payment will not
become due before April 30, 1999 or 90 days after the Court's
final order becomes non-appealable, whichever is later. In the
event the subordinated note is still outstanding on September 1,
1999, the interest rate will increase to 11%.
The Settlement Agreement covers all domestic claims against the
Company and its subsidiaries by persons who were implanted with
McGhan Medical or CUI silicone gel-filled or saline implants
before June
1, 1993, including claims for injuries not yet known and claims
by other persons asserting derivative recovery rights by reason
of personal, contractual or legal relationships with such
implantees. The Settlement is structured as a mandatory, non-opt-
out class settlement pursuant to Federal Rule of Civil Procedure
23(b)(1)(B), and is modeled on similarly-structured mandatory
class settlements approved in the 1993 Mentor Corporation breast
implant litigation, and more recently in the 1997 Acromed
Corporation pedicle screw litigation.
The application for preliminary approval of the Settlement
included evidentiary submissions by both the Company and the
plaintiffs addressing requisite elements for certification and
approval, including the existence, absent settlement, of a
"limited fund" insufficient to respond to the volume of
individual claims, and the fairness, reasonableness and adequacy
of the Settlement.
The Settlement is subject to a number of conditions, including:
1. Extinguishment of the Company's Obligations under the RSP.
The Settlement is conditioned on the entry by the Court of an
order, pursuant to the default provisions of the RSP,
extinguishing the Company's obligations under the RSP and
restoring RSP participants' previously existing rights in the
litigation system against the Company and its subsidiaries. On
May 19, 1998, the Court issued such an order.
2. Certification of Settlement Class. The Settlement is
conditioned on the Court's certification of a new settlement
class pursuant to Federal Rule of Civil Procedure 23(b)(1)(B).
The parties are requesting such certification under the same
theory applied in the Mentor Corporation and Acromed Corporation
settlements, namely that the Company is a "limited fund" whose
resources, absent a mandatory class settlement, are insufficient
to respond to the volume of claims pending against it.
3. Court Approval of Settlement. The Settlement is subject to
judicial approval of its terms and conditions as fair, reasonable
and adequate under Federal Rule of Civil Procedure 23(e), a
determination which takes into account such factors as the nature
of the claims, the arms' length negotiation process, the
recommendation of approval by experienced class counsel, and the
defendant's ability to pay.
4. Resolution of 3M Contractual Indemnity Claims. The
settlement is conditioned on resolution of claims asserted by 3M
under a contractual indemnity provision which was part of the
August 1984 transaction in which the Company's McGhan Medical
subsidiary purchased 3M's plastic surgery business.
Note 7 - Commitments and Contingencies (continued)
To resolve these claims, on April 16, 1998 the Company and 3M
entered into a provisional agreement (the "3M Agreement")
pursuant to which the Company will seek to obtain releases,
conditional on judicial approval of the Company's settlement and
favorable resolution of any appeals, of claims asserted against
3M in lawsuits involving breast implants manufactured by the
Company's McGhan subsidiary. The 3M Agreement provides for
release of 3M's indemnity claim, again conditional on judicial
approval of the Settlement and favorable resolution of any
appeals, upon achievement of an agreed minimum number of
conditional releases for 3M.
Under the terms of the 3M Agreement, the Company will pay $3,000
to 3M once the Court grants final approval of the Settlement;
except that no payment will become due any sooner than (x) April
30, 1999 or (y) 90 days after the Court's final order on the
Settlement becomes non-appealable, whichever is later.
Under the terms of the 3M Agreement, after the indemnity to 3M is
released, the Company will assume certain limited indemnification
obligations to 3M beginning in the year 2000, subject to a cap of
$1,000 annually and $3,000 in total.
5. State Law Contribution and Indemnity Claims. The Settlement
is conditioned on entry by the Court of an order finding the
Settlement to have been made in good faith and barring joint
tortfeasor claims for contribution and indemnity arising under
state law (e.g., claims against the Company by other
manufacturers, suppliers or physicians also sued by a settling
class member). As additional protection against such claims in
states whose laws do not provide for a bar of contribution and
indemnity claims upon determination of good faith settlement, the
Settlement also requires class members to reduce any judgments
they may obtain against such third parties by the amount
necessary to eliminate such parties' contribution or indemnity
claims against the Company under state law.
6. U.S. Government and Private Carrier Claims. The United
States government and private insurance carriers are seeking
reimbursement of medical services provided to class members. The
Company has tentatively agreed with these parties on the terms of
a settlement of their claims. While the Settlement is not
conditioned on resolution of these claims, the Company
anticipates that it will be able to conclude the issues raised by
the U.S. government and the private insurance carriers by
December 31,
1998 without the incurrence of any additional charges to the
litigation reserve established in the 1997 financial statements.
7. Favorable Resolution of Appeals. The Settlement is
conditioned on favorable resolution of any appeals which may be
taken from the final judgment approving the Settlement or from an
interim stay order. In the event the Settlement is disapproved
on appeal, all of the escrowed settlement funds, plus accrued
interest, will be returned to the Company's lenders, and the
litigation will be restored to the status which existed prior to
any class settlements.
8. Allocation and Distribution of Settlement Proceeds.
Following the procedures adopted in the Mentor Corporation and
Acromed Corporation mandatory class settlements, the Settlement
leaves allocation and distribution of the proceeds to class
members to later proceedings to be conducted by the Court, and
contemplates that the Court may appoint subclasses or adopt other
procedures in order to ensure that all relevant interests are
adequately represented in the allocation and distribution
process.
Note 7 - Commitments and Contingencies (continued)
Class Settlement Approval Process and Timetable
Following the issuance by the Court of a preliminary order on
June 2, 1998, the settlement approval process is anticipated to
proceed in several stages, as follows:
1. Satisfaction of the Condition under the 3M Agreement. The
Company needs to obtain an agreed minimum number of conditional
releases for 3M pursuant to the terms of the 3M Agreement. At
3M's option, that condition can be modified or waived. The
anticipated satisfaction of that condition has been extended
until December 31, 1998
2. Notice to the Class. Following conditional class
certification and preliminary approval of the Settlement, the
parties are required to give notice to class members, advising
class members of the Court's preliminary order and advising them
of their opportunity to be heard in support of or opposition to
final certification and approval. The notice was mailed to the
members of the class beginning on October 12, 1998 following the
Company's deposit on October 2, 1998 of $3,000 of cash, 426,323
shares of common stock, and $25,500 principal amount of a 6%
subordinated note in a court supervised escrow account.
The parties' form of notice provides a December 11, 1998 deadline
for class members to submit comments, objections, or requests to
intervene and be heard, with a final settlement hearing scheduled
on January 11, 1999.
3. Hearing on Final Certification and Approval. At the hearing
on final certification and approval, the Court will consider any
comments and objections received from class members as well as
any further evidence and legal argument submitted by the parties
or interveners concerning issues relevant to certification and
approval, including the Company's status as a "limited fund" and
fairness, reasonableness and adequacy of the Settlement.
Assuming a favorable outcome, the Court will thereafter issue a
final order and judgment certifying the class as a mandatory
class under Federal Rule of Civil Procedure 23(b)(1)(B),
approving the settlement, enjoining class members from litigation
of settled claims, and barring contribution and indemnity claims
to the extent permitted under state law.
Ongoing Litigation Risks
Although the Company expects the Settlement, if approved, to end
as a practical matter its involvement in the current mass product
liability litigation in the United States over breast implants,
there remain a number of ongoing litigation risks, including:
1. Non-Approval of Settlement. The Settlement Agreement
requires all parties to use their best efforts to obtain approval
of the Settlement by the Court and on appeal. However, there can
be no assurance that the Court will approve the Settlement or
that a decision approving it will be affirmed on appeal. The
approval decision turns on factual issues which may be contested
by class members opposing the Settlement, and additionally
implicates a number of legal issues that neither the United
States Supreme Court nor the federal appellate courts have
definitely ruled upon. While courts have approved similarly
structured mandatory class settlements in the Mentor Corporation
and Acromed Corporation cases, neither of those decisions was
subjected to appellate review. The Company cannot predict the
ultimate outcome of the approval process or the appeals process
in the event any appeals of the Settlement are filed in a timely
manner. The U.S. Supreme Court is scheduled to hear arguments on
Note 7 - Commitments and Contingencies(continued)
December 8, 1998 in a case involving a limited fund settlement of
an asbestos company's liabilities. The Company cannot predict
whether that case will have an adverse impact on the Settlement.
2. Collateral Attack. As in all class actions, the Company may
be called upon to defend individual lawsuits collaterally
attacking the Settlement even if approved and affirmed on appeal.
However, the typically permissible grounds for such attacks (in
general, lack of jurisdiction or constitutionally inadequate
class notice or representation) are significantly narrower than
the grounds available on direct appeal.
3. Non-Covered Claims. The Settlement does not include several
categories of breast implants which the Company will be left to
defend in the ordinary course through the tort system. These
include lawsuits relating to breast implants implanted on or
after June 1, 1993, and lawsuits in foreign jurisdictions. The
Company regards lawsuits involving post-June 1993 implants
(predominantly saline-filled implants) as routine litigation
manageable in the ordinary course of business. Breast implant
litigation outside of the United States has to date been minimal,
and the Court has with minor exceptions rejected efforts by
foreign plaintiffs to file suit in the United States.
The Company plans to obtain the cash needed to fund the
Settlement from the $35.5 million of proceeds to be received upon
the exercise of an aggregate of 5.6 million warrants at a blended
price of $6.20 per share issued in July 1997 and October 1998 to
the various holders of the Company's senior and junior secured
debt. In the event the stock market price for the Company's
shares has not increased by the time such funding is needed to at
least $10 per share, the Company may seek to obtain other debt
and/or equity financing, or may adjust the exercise price of
those warrants. In either such event, the Company cannot predict
the extent of additional dilution to existing shareholders.
Accounting Treatment
In 1993, the Company recorded a $9,152 reserve for litigation.
For the year ended December 31, 1997, the Company recorded an
additional reserve of $28,150. The litigation reserve as of
September 30, 1998 of $37,303 includes the cost of the non-opt-
out settlement agreement of $31,500, other settlements of $4,845
and legal fees and other related expenses of $958.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This Quarterly Report contains certain 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 of
1934, as amended, which are intended to be covered by the safe
harbors created thereby. Investors are cautioned that all
forward-looking statements involve risks and uncertainty,
including without limitation, the ability of the Company to
continue its expansion strategy, changes in costs of raw
materials, labor, and employee benefits, as well as general
market conditions, competition and pricing. Although the Company
believes that the assumptions underlying the forward-looking
statements contained herein are reasonable, any of the
assumptions could be inaccurate, and therefore, there can be no
assurance that the forward-looking statements included in this
Quarterly Report will prove to be accurate. In light of the
significant uncertainties inherent in the forward-looking
statements including herein, the inclusion of such information
should not be regarded as a representation by the Company or any
other person that the objectives and plans of the Company will be
achieved.
Results of Operations
The Company's financial performance in recent years was
strongly and adversely impacted by: 1) the costs of improving
manufacturing practices and policies in accordance with FDA
regulations; 2) the costs of addressing the breast implant
litigation; 3) investments made in international markets to
increase the Company's sales and marketing presence; and 4) the
cost of investing in research and development, particularly in
new products and technologies. Based on these factors, although
sales have grown during those periods, expenses have grown at a
significantly higher rate. Consequently, the Company's
financial performance has deteriorated in recent years through
the first quarter of 1998.
Since its appointment in early 1998, the Company's new senior
management team has concentrated the Company on increasing sales,
improving manufacturing efficiencies and reducing various
expenses. The new management team has undertaken a strategic
review of the Company's operations and businesses, and based on
that effort a restructuring plan was implemented. This plan
included an approximate 10% worldwide reduction in headcount, the
closing of administration offices and the exiting or
discontinuance of certain smaller unprofitable product lines.
These activities were undertaken beginning in the third quarter
of 1998.
During the third quarter of 1998, a total of $2.8 million, net
of an income tax refund, was expensed to recognize various
restructuring charges associated with management's plan.
Approximately $3.3 million was classified as restructuring
charges of which $2.1 million relates directly to the closing of
an administration office in the Netherlands, $0.6 million
recognizes the termination costs of employees at both the Ireland
and U.S. subsidiaries and $0.6 million in assets was disposed of
in the United States as part of the restructuring plan and is
included in miscellaneous expenses. In the Netherlands, a tax
benefit of $0.5 million was also recorded as a result of the
restructuring charges incurred in that subsidiary.
Net income prior to the restructuring charge of $2.8 million
totaled $4.8 million year to date and $2.3 million for the third
quarter of 1998, as compared to a loss of $0.9 million and $0.9
million for the same periods in 1997. Net income per share, both
basic and diluted, prior to the restructuring charges was $0.48
per share year to date and $0.22 for the third quarter of 1998 as
compared to a net loss of $0.11 and a net loss of $0.11 for the
same periods in 1997. Taking the restructuring charges into
account, the Company had a net income of $2.0 million year to
date and a net loss of $0.5 million for the quarter as compared
to a net loss of $0.9 million for both the year to date and third
quarter of 1997. Net income per share, basic and diluted, was
$0.20 year to date and net loss for the third quarter of 1998 was
$0.04. For the same periods in 1997 the results yielded a net
loss per share, basic and diluted, of $0.11 for both periods.
Management believes that the restructuring plan is an
important and essential step toward making the Company a long-
term, viable enterprise once the breast implant settlement is
completed; without the steps included in the restructuring plan,
management believes that the Company could not obtain the
financing necessary to ensure the success and completion of that
settlement.
Summary financial table. Set forth below is a table which
shows the individual components of the Company's results of
operations, both in dollars (in thousands) and as a percent of
net sales; and including the percentage increase (decrease) for
the periods ended September 30, 1998 and 1997.
Nine Months Ended
September 30, September 30,
1998 1997
(in 000's)
%Inc.
(Dec.)
Sales 99,109 23% 80,309
Cost of Goods Sold 35,219 33% 26,446
Gross Profit 63,890 19% 53,863
As a % of sales 64% 67%
Marketing 26,894 27% 21,216
As a % of sales 27% 26%
G&A 21,201 (4%) 21,983
As a % of sales 21% 27%
R&D 7,053 5% 6,694
As a % of sales 7% 8%
Operating expenses 55,148 11% 49,893
As a % of sales 56% 62%
Operating income 8,742 120% 3,970
As a % of sales 9% 5%
Sales. While the Company's revenues are subject to
adjustments due to changes in price or volume of units sold,
revenue increases from the first nine months of 1997 compared to
the first nine months of 1998 were primarily a result of
increased volume. Based on publicly available information, the
Company believes that the markets for its products are growing,
and that it is increasing its market share in relation to
competitors.
Sales in the United States accounted for 65% and 63% of total
net sales for the periods ended September 30, 1998 and 1997,
respectively. International sales accounted for 35% and 37% of
total net sales for the periods ended September 30, 1998 and
1997, respectively.
Cost of goods sold. The largest factors in the variation from
year to year in cost of goods sold as a percentage of net sales
is the cost of raw materials, the yield of finished goods from
the Company's manufacturing facilities, and the load factor at
the Company's manufacturing facilities. The first two factors
were stable for the first nine months of 1998. However, in the
first quarter of 1998 there was significant downtime at the
Company's manufacturing facilities, due to an FDA audit and
excess inventory, which adversely affected the load factor and
manufacturing efficiencies. On an annual basis, the Company was
also adversely affected by a write-off of certain raw materials
which did not meet Company specifications and by a devaluation of
inventory based on a periodic adjustment in the standard cost of
certain products.
Marketing expenses. The increase in marketing expenses is
generally correlated to increased sales, based on commissions to
sales representatives and other payments to third parties with
sales-based payment arrangements. Management is reviewing those
other payments and expects to implement a reduction in the coming
months. Marketing expenses are also affected by the overhead
associated with supporting various sales and marketing functions,
and by participation in trade conventions and shows. Management
is reviewing these expenses as well, and expects to reduce them
without adversely impacting sales growth.
General and administrative expenses. G&A expenses are
affected by overall headcount in various administrative
functions, and the legal, accounting and other outside services
which were necessary to defend the Company in the breast implant
litigation and negotiate a settlement. In order to reduce these
expenses, the Company has reduced the staff levels in both the
domestic and international subsidiaries. In addition, management
has also set targets to control and reduce other general and
administrative expenses throughout the Company.
Research and development expenses. R&D expenditures increased
slightly for the nine month period ended September 30, 1998 as
compared to the nine month period ended September 30, 1997. As
a percentage of sales, research and development costs for the
nine months have decreased by approximately 1% in 1998 as
compared to 1997. The Company invested $2.2 million and $1.7
million for the periods ended September 30, 1998 and 1997,
respectively at the Company's BioEnterics subsidiary in
connection with the development of obesity products. In 1998 the
new management team began considering various options to sell a
portion of its interest in this business or to seek a joint
venture partner.
Interest expense. Net interest expense of approximately $3.0
million for the nine month period ended September 30, 1998 (as
compared to $4.3 million for the nine month period ended
September 30, 1997) was primarily due to: (1) the net carrying
costs on the 11% secured convertible notes issued in January
1996; (2) interest of $510,000 on $9.9 million of 10.5%
subordinated notes which were incurred primarily in the later
half of 1997 to fund the working capital needs; (3) non-cash,
finance expense of $330,000 related to the issuance of warrants
in conjunction with the conversion of the 10.5% subordinated
notes to equity, and (4) a penalty charge of $253,000 due to the
Company's failure to provide an effective registration statement
to the holders of the 4% convertible debentures issued in January
of 1997. As of July 1998 all of the 10.5% subordinated notes
(including accrued interest) were converted into common stock;
and as of April 1998 all of the 4% debentures were converted into
common stock and the Company is no longer incurring such penalty
charges.
Foreign currency translation loss. Historically the Company's
subsidiaries have incurred significant intercompany debts
(totaling more than $31 million for non-U.S. subsidiaries), which
are eliminated in the consolidated financial statements.
However, those intercompany debts, which are denominated in
various foreign currencies, give rise to translation adjustments.
In 1998 the new management team evaluated various alternatives
for reducing the Company's foreign currency exposure, and decided
to convert the non-U.S. intercompany debts to the capital of the
respective subsidiaries during the later part of 1998.
Operating Income. As noted above, beginning in 1998 the new
management team has undertaken a restructuring program which is
designed to reverse the Company's poor operating performance and
significantly improve the Company's operating margin. Included
in this program is a reduction in headcount, discontinuance or
sale of certain smaller unprofitable product lines, improved
asset management (especially receivables and inventory), and
reduced general and administrative expenses. There is no
assurance that the Company will be successful in these efforts.
Financial Condition
Liquidity. During the first nine months of 1998, the new
management team focused on reversing the significant negative
cash flow of the past three years. Based on net income of $2.0
million for the first nine months of 1998 and improved inventory
turns, net cash provided by operating activities totaled $4.1
million for the first nine months ended September 30, 1998 as
compared to net cash used in operating activities of $8.8 million
for the nine months ended September 30, 1997. The swing from
using cash in operating activities to providing cash in operating
activities, totaling approximately $12.9 million, is the result
of the efforts which were undertaken to reduce costs and
inventory and thereby improve cash flow. As further reductions
in cost of goods, G&A and R&D outlined above begin to take
effect, the Company believes cash flow from operations will
continue to improve.
Breast Implant Settlement. Under the terms of the proposed
settlement of the breast implant litigation, the Company will be
obligated to pay an aggregate of $34.5 million to the plaintiffs
and 3M at the later of (x) April 30, 1999 or (y) 90 days after
the Court's final order becomes non-appealable. That payment
will consist of $31.5 million of cash (which will be used to
retire the $25.5 million note to the plaintiffs which was placed
in escrow prior to the mailing of notice of the proposed
settlement) and 426,323 shares of common stock.
The Company plans to obtain the cash needed to fund the
Settlement from the $35.5 million of proceeds to be received upon
the exercise of an aggregate of 5.6 million warrants at a blended
price of $6.20 per share issued in July 1997 and October 1998 to
the various holders of the Company's senior and junior secured
debt. In the event the stock market price for the Company's
shares has not increased by the time such funding is needed to at
least $10 per share, the Company may seek to obtain other debt
and/or equity financing, or may adjust the exercise price of
those warrants. In either such event, the Company cannot predict
the extent of additional dilution to existing shareholders.
The costs of defending the breast implant litigation-both
past and future-vastly exceed the Company's financial resources.
Absent the successful completion of the settlement of this
litigation through the vehicle of a mandatory non-opt-out class,
management believes that the Company would not be able to
continue as a going concern. Although the Company is optimistic
that the proposed settlement agreement can be completed on the
terms and within the timetable negotiated and announced in April
1998, there can be no assurance in this regard.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is a defendant in breast implant litigation
as discussed in Note 7 to the unaudited consolidated
financial statements.
The Company has been advised by the Securities and
Exchange Commission that it has begun a formal
investigation of the matters disclosed in the Current
Report on Form 8K dated March 6, 1998 relating to the
resignation of Coopers & Lybrand LLP as the Company's
independent accountant. The Company is cooperating
fully in this investigation. Furthermore, the Company
believes that all of the procedural and substantive
issues raised in that filing have been addressed
through a variety of steps, including the appointment
of a new senior management team, the continual
oversight by an audit committee, and the conversion
into equity of the $10.8 million of indebtedness
(including accrued interest) owed to an entity
controlled by the former Chairman at a significant
discount, which more than adequately reflects the
dollar value of any questionable related party
transactions. The Company does not believe that this
investigation will give rise to any material costs, and
is seeking to pursue a prompt resolution of this matter
so that it can focus its efforts on returning the
Company to long-term profitability and resolving the
breast implant litigation.
ITEMS 2. THROUGH 5.
Not applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Form 8-K dated October 2, 1998
INAMED CORPORATION
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, Registrant has duly caused this
report to be signed on its behalf by the undersigned, thereunto
duly authorized.
INAMED CORPORATION
November 12, 1998 By: /s/ Richard G. Babbitt
Richard G. Babbitt,
Chairman of the Board,
Chief Executive Officer and President
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