SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934:
For the fiscal year ended December 31, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-9741
INAMED CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 59-0920629
(State or other (I.R.S.
jurisdiction Employer
of incorporation or Identification
organization) No.)
5540 Ekwill Street, 93111
Suite D (Zip
Santa Barbara, Code)
California
(Address of principal
executive offices)
Registrant's telephone number, including area code: (805) 692-
5400
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Name of Exchange on
Which Registered
Common Stock, par value
$.01 per share
NASDAQ National Market
Securities registered pursuant to Section 12(g) of the Act:
None
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 ____
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of registrant's
knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of voting stock held by non-
affiliates as of March 20, 2000 was $625,597,561.
On March 20, 2000, there were 20,410,508 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
The information required by Part III is incorporated by
reference to a definitive proxy statement to be filed by the
Registrant not later than April 30, 2000 pursuant to Regulation
14A.
This document contains 60 pages.
Exhibit index located on pages 25-26.
INAMED CORPORATION
Annual Report on Form 10-K
For the Fiscal Year Ended December 31, 1999
TABLE OF CONTENTS
Page
PART I
Item 1 Business 3
Item 2 Properties 14
Item 3 Legal Proceedings 14
Item 4 Submission of Matters to a Vote
Of Security Holders 17
PART II
Item 5 Market for the Company's Common
Stock and Related Stockholder
Matters 17
Item 6 Selected Financial Data 18
Item 7 Management's Discussion and
Analysis of Financial
Condition and Results of
Operations 19
Item 7a Quantitative and Qualitative
Disclosures about Market Risk 24
Item 8 Financial Statements and
Supplementary Data 24
Item 9 Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure 24
PART III
Item 10 Directors and Officers of the
Company 24
Item 11 Executive Compensation 24
Item 12 Security Ownership of Certain
Beneficial Owners and
Management 24
Item 13 Certain Relationships and
Related Transactions 24
PART IV
Item 14 Exhibits, Financial Statement
Schedules, and Current
Reports on Form 8-K 25
Signatures 27
Financial Statements F1 to F-33
This Annual Report on Form 10-K includes certain forward-looking
information 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, that involve risk and
uncertainty, including certain assumptions regarding the future
performance of the Company. Actual results and trends may differ
materially depending upon a variety of factors, including,
without limitation, market demand for the Company's services,
pricing trends in the markets in which the Company operates, the
Company's ability to successfully execute its internal
performance plans, the cyclical nature of the Company's business
and the impact of any government regulation. Further, customer
commitments under their contracts with the Company are based on
customers' estimates of their future requirements.
PART I
Item 1. Business
Inamed Corporation (the "Company") is a global surgical and
medical device company primarily engaged in the development,
manufacturing and marketing of medical devices for the plastic
and reconstructive surgery and aesthetic medicine markets. The
Company sells a variety of lifestyle products used to make
people look younger and more attractive, including breast
implants for cosmetic augmentation and collagen-based facial
implants to correct facial wrinkles and scars and to enhance lip
definition. The Company also sells products to address women's
health issues, including breast implants for reconstructive
surgery following a mastectomy, and devices to treat severe
obesity.
The Company manufactures its products in Santa Barbara,
Carpinteria and Fremont, California and in Arklow, County
Wicklow, Ireland, and owns or has exclusive licenses for more
than 90 patents in the United States and overseas. The Company
believes, with greater than 50% of the United States breast
implant market, approximately 40% of the worldwide breast
implant market and approximately 90% of the United States
collagen-based facial implant market, that it is the leading
company in both the breast implant and facial implant markets.
The following table contains summary financial information
which highlights the continued growth and progress of the
Company:
<TABLE>
<S> <C> <C> <C>
1998 1999 % Change
(Dollars, in millions)
Income statement data:
Net sales 131.6 189.3 43.8%
Gross profit 83.6 131.7 57.5%
Gross Margin 63.5% 69.6%
Marketing expense 33.4 43.1 29.0%
As a % of sales 25.4% 22.8%
G&A expense 27.8 32.9 18.3%
As a % of sales 21.% 17.4%
R&D expense 9.4 10.3 9.6%
As a % of sales 7.1% 5.4%
Restructuring expense 4.2 0 -100.0%
As a % of sales 3.2% 0.0%
Amortization of intangible
assets 0.4 1.7 325.0%
As a % of sales 0.3% 0.9%
Total operating expenses 75.1 88.0 17.2%
As a % of sales 57.1% 46.5%
Operating income (loss) 8.5 43.7 414.1%
Operating margin 6.5% 23.1%
Other income 0.6 1.6 166.75%
As a % of sales 0.5% 0.8%
Income before interest and
taxes 9.1 45.4 398.8%
As a % of sales 6.9% 24.0%
Balance sheet data:
Cash and equivalents 11.9 17.5 47.1%
Accounts receivable 23.2 44.4 91.4%
Inventory 17.9 25.3 41.3%
Total long-term debt 27.8 77.2 177.7%
Stockholders' (deficiency)
equity (15.6) 134.1 959.6%
</TABLE>
The Company operates through the following three business
units:
The U.S. Plastic Surgery and Aesthetic Medicine Group
operates through McGhan Medical Corporation, a California
corporation. This business unit develops, manufactures and
sells plastic and reconstructive surgery products (primarily
saline breast implants and tissue expanders), as well as facial
aesthetic products (primarily collagen facial implants). This
business unit sells to plastic surgeons, dermatologists,
cosmetic surgeons and other medical practitioners in the United
States and Canada through a sales force consisting of
approximately 80 company-employed representatives and managers.
In 1998 and early 1999, the Company sold or discontinued a
number of smaller business lines which were related to the
activities of its U.S. plastic surgery business; it also
consolidated the separate activities of CUI Corporation and
Flowmatrix Corporation into the business and operations of
McGhan Medical. These changes were undertaken to improve
manufacturing efficiencies, centralize management and reduce
duplicate administrative expenses. By the end of the fourth
quarter of 1999, the Company also completed the integration of
Collagen Aesthetics, Inc.'s U.S. and Canadian business and
operations into McGhan Medical. This integration included
terminating the lease covering the pre-acquisition headquarters
of Collagen Aesthetics in Palo Alto, California, consolidating
all of Collagen Aesthetics' billing, management information and
other computer systems into McGhan Medical's, and eliminating
redundant support functions. Pending the completion of an in-
process regulatory review, the Company has not yet dissolved the
Collagen Aesthetics legal entities. McGhan Medical now does
business in Canada through McGhan Medical Canada, Ltd.,
previously known as Collagen Aesthetics Canada Ltd. The Company
did not previously have a Canadian subsidiary.
Inamed International Corp., a Delaware corporation, was
formed in December 1998 to hold all of the Company's
international manufacturing and sales subsidiaries and to direct
the activities of the Company's network of distributors outside
North America. This business unit develops, manufactures and
sells plastic and reconstructive surgery products (primarily
silicone gel-filled breast implants and tissue expanders), as
well as facial aesthetic products (primarily collagen facial
implants) to plastic surgeons; it also sells the obesity
products manufactured by the Company's BioEnterics Corporation
subsidiary. This business unit sells to plastic surgeons,
dermatologists, cosmetic surgeons, gastric and obesity surgeons,
and other medical practitioners through a sales force consisting
of approximately 41 company-employed representatives in the
largest developed countries in Europe, as well as Japan and
Australia, plus a network of distributors in approximately 60
countries in Europe, the Middle East, Central and South America
and the Asia/Pacific region. Its subsidiaries include McGhan
Limited, an Irish corporation, which is engaged in
manufacturing, as well as direct sales organizations in England,
France, Germany, the Netherlands, Italy, Spain and Mexico.
During 1998 and 1999, the Company discontinued the active
operations of its subsidiaries or representative offices in
Belgium, Brazil, Mexico, Hong Kong, Singapore and Russia, as
well as silicone raw materials manufacturing (which had been
conducted through Chamfield Ltd.) and the European sales
headquarters based in Holland. These changes were undertaken to
reduce costs and instill greater management control and
coordination among the disparate international subsidiaries and
distributors. In 1999 and early 2000, the Company also
completed the integration of certain of Collagen Aesthetics'
non-U.S. subsidiaries, including those operating in the United
Kingdom, France, Germany and Spain, into Inamed International
subsidiaries that were already operating in those markets. The
Company is continuing to operate certain other non-U.S. Collagen
Aesthetics subsidiaries in countries where the Company did not
previously have active subsidiaries, namely Japan and Australia.
The Company is currently completing its review of all non-U.S.
companies, and will cause the dissolution of the non-U.S.
subsidiaries as required, in accordance with all applicable
business, legal and regulatory considerations.
BioEnterics Corporation is the Company's third business
unit. It is engaged in the development, production and
marketing of proprietary implantable devices for the bariatric,
general and laparoscopic surgery markets for the treatment of
serious obesity and gastrointestinal disorders, and to minimize
risks associated with surgery. BioEnterics' primary product is
the LAP-BAND Adjustable Gastric Banding System.
RECENT DEVELOPMENTS
Collagen Acquisition
On September 1, 1999, the Company acquired Collagen
Aesthetics, Inc., a designer, developer, manufacturer and
marketer of products that primarily treat aging or defective
human tissue. The principal acquired product lines, Zydermr and
Zyplastr collagen-based facial implants, are used in aesthetic
applications for the correction of scars and facial wrinkles due
to aging. Collagen's products are used by plastic surgeons,
dermatologists and other physicians for elective surgical and
non-surgical therapies to remedy aging and defective facial
tissue.
The aggregate purchase price for the Collagen acquisition
was approximately $159 million, including the cancellation of
employee stock options and expenses. The Company funded the
acquisition with a bridge loan facility of $155 million plus
cash on hand. At the same time, the Company retired
approximately $17 million of pre-existing debt.
In November 1999, Inamed completed a public offering of
2,950,000 primary shares of its common stock, plus 500,000
secondary shares for selling stockholders, at $29 per share.
The net proceeds received by the Company on this offering, $78.3
million, were used to retire an equivalent amount of the bridge
loan.
New Credit Facility
On February 1, 2000, the Company entered into a $107.5
million senior secured credit facility. The credit facility
includes (a) term loans in the amount of $82.5 million (the
"Term Loans"), which was used to retire the balance of the
bridge loan incurred in connection with the Collagen
acquisition, (b) a revolving credit facility under which the
Company may from time to time borrow up to $25 million, and (c)
subfacilities for letters of credit and swing line loans (See
Item 7 - Capital Resources).
Status of PMA Applications
In February 2000, the Company completed its application to
the United States Food and Drug Administration (FDA) for pre-
market approval (PMA) of its LAP-BAND Adjustable Gastric Banding
System. In March 2000, this PMA was accepted for filing by the
FDA. An FDA advisory panel meeting is scheduled for June 2000.
On March 2, 2000, an FDA advisory panel unanimously
recommended that the FDA approve (with conditions) the Company's
application for PMA of its saline-filled breast implants. Of
the two other manufacturers whose applications for PMA were
accepted for filing by the FDA, only one was recommended for
approval by the device panel.
PRODUCTS
Breast Implants and Related Products
The Company is a leading worldwide manufacturer and
marketer of breast implants, with a diverse product line
consisting of a variety of fills, shapes, sizes and textures.
The Company's breast implants consist of a silicone elastomer, a
rubber-like shell filled with either saline solution or silicone
gel. The shape of the breast implants can be either round or
anatomical. Round breast implants generally give a woman a
round curve in the upper part of her breasts, while anatomical
breast implants are designed to give the woman a gentle slope
which is shaped more like a natural breast. The actual results
obtained from a given implant shape depend on a variety of
factors, many of which are within the control and discretion of
the surgeon, including placement of the implant and fill volume.
The Company's breast implant products are available in an
aggregate of over 200 sizes to meet the Company's customers'
preferences and needs. The outside shell of the breast implants
can consist of either a smooth or textured surface, which
generally is chosen by the surgeon. Textured implants were
developed by the Company primarily in response to concerns about
capsular contraction, the formation of reactive and constrictive
tissue around the implant, and are sold at a higher average
selling price than smooth implants. The Company markets its
breast implants under the tradename McGhanr and the trademarks
BioCellr and MicroCellr. The Company's net sales for breast
implant products were $118 million for the year ended December
31, 1999, representing approximately 62% net sales.
Saline-filled breast implants. The Company markets and
distributes saline-filled breast implants in the U.S. and abroad
primarily for use in breast augmentation for cosmetic reasons.
The Company's saline-filled breast implants are currently
distributed in the U.S. pursuant to a 510(k) clearance.
However, pursuant to FDA action in the second half of 1999, the
FDA required any manufacturer wishing to continue to market
saline-filled implants in the U.S. to file an application for
pre-market approval (PMA) of such products by November 17, 1999.
Any manufacturer that failed to have a PMA application accepted
for filing by that date lost its 510(k) clearance and, as of
that date, had to cease distributing saline-filled breast
implants in the U.S. McGhan Medical was among the three
manufacturers of saline-filled breast implants whose PMA
applications were accepted for filing and, in accordance with
FDA rules, each of the three applications was referred to an FDA
advisory panel on general and plastic surgery. The advisory
panel met in open session on March 1-3, 2000 to consider the
applications and ultimately recommended FDA approval of two of
them, including the Company's application for PMA of its saline-
filled breast implants. Under applicable requirements, the
Company expects the FDA to act on these recommendations by May,
2000. The Company currently has the CE Mark for marketing its
saline-filled products in the European Community. For the year
ended December 31, 1999, net sales for saline-filled breast
implants represented approximately 41% of the Company's total
breast implant net sales.
Silicone gel-filled breast implants. The Company markets
and distributes silicone gel-filled breast implants primarily in
Europe and Australia. In the U.S., the Company sells silicone
gel-filled breast implants for certain revision surgeries and
for reconstructive surgeries following a mastectomy. The
Company's U.S. sales are based on its participation in an
adjunct clinical study for reconstructive and revision surgery
approved by the FDA. The Company currently has the CE Mark for
marketing its silicone gel-filled products in the European
Community. In the year ended December 31, 1999, net sales for
silicone gel-filled breast implants represented approximately
21% of the Company's total breast implant net sales for that
period.
Breast implants are placed under either a woman's breast
tissue or pectoral muscle. If the implant is saline-filled, it
is usually inserted empty and then filled and positioned. An
advantage to this type of implant is that it can usually be
placed through a small incision. Silicone gel-filled implants
are inserted pre-filled and require a slightly larger incision.
The incision generally is made as inconspicuously as possible in
either the fold of the breast, around the nipple or under the
arm. Breast implant surgery is performed in an operating room,
either in the surgeon's office or at a hospital. If done for
augmentation purposes, the surgery is typically performed on an
outpatient basis and usually lasts less than one hour. General
anesthesia is most commonly used, although local anesthesia may
be an option. Reconstructive surgery generally occurs in a
hospital, lasts one to six hours depending on the surgical
technique employed, and in substantially all cases requires more
than one operation over a period of several months.
In addition to breast implants, the Company develops,
manufactures and markets an extensive line of breast and non-
breast tissue expanders. The tissue expander is surgically
implanted under the skin at a site where new tissue is desired
and is filled over several weeks or months with saline solution.
The increased pressure under the skin results in tissue growth
to generate an increase in skin surface. The tissue expanders
are most commonly used in the first stage of two-stage breast
reconstruction to create additional tissue at the mastectomy
site. In addition, the Company makes and sells a complete line
of tissue expanders that are used for purposes other than breast
implant surgery, including as an alternative to skin grafting to
cover burn scars and to correct birth defects. In the year
ended December 31, 1999, net sales for all tissue expanders
represented approximately 38% of the Company's total breast
implant net sales for that period.
Facial Enhancement Products
The Company offers a full line of facial enhancement
products designed to improve facial appearance by smoothing
wrinkles, scars and enhancing the definition of the lip border.
The Company's primary products in this area are the Zydermr and
Zyplastr collagen-based facial implants. The Company also
distributes products manufactured by third parties, including
Hylaform gel and SoftForm implant.
Zyderm and Zyplast Implants. Zyderm and Zyplast are
injectable formulations of bovine collagen sourced from the
Company's exclusive domestic closed-herd of cows. Zyderm
implants were formulated especially for people with fine lines
or superficial contour defects. These implants are particularly
effective in smoothing delicate frown and smile lines and fine
creases that develop at the corners of the eyes and above and
below the lips, and can also help correct some kinds of shallow
scars. Zyplast implants are designed to treat deeper
depressions and can be used for more pronounced contour
problems, such as deeper scars, lines and furrows, and for areas
upon which more force is exerted, such as the corners of the
mouth. Zyderm and Zyplast implants may be used alone or in
conjunction with one another. Following injection, they produce
an immediate visible difference in the appearance of a patient's
skin. Zyderm and Zyplast implants are dispersed in a saline
solution containing a small amount of lidocaine, a local
anesthetic, and injected with a fine gauge needle into depressed
layers of skin to elevate the area to the level of the
surrounding skin surface. As a result, the Zyderm and Zyplast
implants replenish the skin's natural collagen support layer.
The implants take on the texture and appearance of human tissue
and are subject to similar stresses and aging processes.
Consequently, supplemental treatments are necessary after
initial treatment, depending on the location and original cause
of the skin deformity. On average, patients require two to four
treatments per year to maintain the desired result. Because the
products are derived from a non-human source, a skin test must
be performed with a requisite 30-day period to observe the
possibility of allergic reaction in the recipient. Zyderm and
Zyplast received their CE Marks in June 1995, allowing for
marketing in the European Community. The FDA granted PMA
applications for Zyderm in July 1981 and for Zyplast in June
1985, allowing for marketing in the U.S. The Company's Zyderm
and Zyplast line of collagen-based products are the only facial
injectable products currently marketed that have been approved
for marketing in the U.S. by the FDA. In the year ended
December 31, 1999, net sales for Zyderm and Zyplast implants
represented approximately 9.4% of the Company's total net sales
for that period.
Hylaform Gel. Hylaform gel is an injectable product for
same-day treatment of facial wrinkles and scars, which can be
used without a skin sensitivity test. The Company obtained
exclusive marketing and distribution rights to Hylaform gel from
BioMatrix, Inc. in selected international markets and has the
option to acquire the U.S. distribution rights in the future.
Hylaform gel received a CE Mark in December 1995 allowing
marketing in the European community, but is not approved for
marketing in the U.S.
SoftForm Implant. SoftForm implant is a non-resorbable,
long-lasting facial implant for the treatment of deep facial
furrows and creases such as deep frown lines, creases between
the nose and corners of the mouth, and definition of the lip
border. The Company obtained exclusive worldwide marketing and
distribution rights to SoftForm from TissueTechnologies, Inc.
SoftForm received a CE Mark in September 1997, allowing
marketing in the European community and FDA clearance in
September 1998 for marketing in the U.S.
Obesity and Other Products
The Company develops, manufactures and markets devices for
the treatment of obesity through its BioEnterics Corporation
subsidiary. Through Collagen, the Company also develops,
manufactures and markets products to treat urinary incontinence,
the involuntary loss of urine from the bladder due to intrinsic
sphincter deficiency.
The Company's LAP-BAND Adjustable Gastric Banding System is
designed to provide long-term treatment of severe obesity that
is minimally invasive and is used as an alternative to full
gastric bypass surgery or stomach stapling. The LAP-BAND System
consists of an adjustable silicone elastomer band which is
laparoscopically placed around the upper part of the stomach
through a small incision, making part of the stomach a small
pouch. This slows down the passage of food and makes the
patient feel fuller sooner. The LAP-BAND System procedure is
reversible. The LAP-BAND System has begun to achieve acceptance
in Europe and Australia, with approximately 40,000 units sold
since 1993. In February 2000, the Company completed its
application to the FDA for PMA of its LAP-BAND Adjustable
Gastric Banding System. The application includes the results of
the first phase of the Company's clinical trials, enrollment for
which opened in June 1995 and closed in the second quarter of
1998. In March 2000, this PMA was accepted for filing by the
FDA. An FDA advisory panel meeting is scheduled for June 2000.
The Company's net sales of the LAP-BAND System in the year ended
December 31, 1999 were $16 million, representing 8% of net
sales.
Contigen, the Company's collagen product used to treat
urinary incontinence, is injected into the tissues of and
adjacent to the urethra and/or bladder neck. This increases
tissue bulk and subsequently joins the urethral lumen to
alleviate urinary incontinence. The Contigen treatment cycle
may require multiple injections at the start of treatment and
may require supplementary injections over time. The Company
obtained approval from the FDA to market Contigen in September
1993 for the treatment of urinary incontinence. The Company has
granted C.R. Bard exclusive worldwide marketing and distribution
rights to Contigen, which is currently marketed in the U.S. C.R.
Bard has received reimbursement codes for Contigen and is
expected to commence marketing in several European nations,
Latin America, Japan, Australia and Canada. The Company's
revenues, including royalties, for the Contigen product in the
year ended December 31, 1999 were $3 million, representing less
than 2% of net sales.
The Company's BioEnterics Intragastric Balloon System (BIB)
is a short-term therapy, designed for patients who must reduce
weight either in preparation for surgery or for moderately obese
patients in conjunction with a diet and behavior modification
program. The BIB System is a silicone elastomer balloon which
is filled with saline after insertion into the patient.
Placement in the stomach is non-surgical, usually requires only
20 to 30 minutes, and is performed on an out-patient basis by an
endoscopist, using local anesthesia. The BIB contains a self-
sealing valve which allows for personalized adjustment of the
volume from 400 ml to 700 ml (the size of a large grapefruit),
at the time of placement. When the BIB System is deflated, it
can easily be removed endoscopically. The Company expects to
begin clinical trials for the BIB System in the United States in
2000.
SALES AND MARKETING
Physician Marketing Efforts
U.S. Sales Organization. In the U.S., the Company sells
its products to plastic and reconstructive surgeons, cosmetic
surgeons, facial and oral surgeons, dermatologists, out-patient
surgery centers and hospitals through the Company's staff of
direct sales people. The Company estimates that currently there
are approximately 4,600 plastic surgeons, 1,100 cosmetic
surgeons and 8,400 dermatologists in the U.S. As of December
31, 1999, the Company had approximately 73 direct sales
representatives in the U.S.
International Sales Organization. Internationally, the
Company sells its products directly and through independent
distributors in more than 60 countries worldwide, including
countries in Europe, Central and South America, Australia and
Asia. These sales are managed through regional sales and
marketing employees and, in some countries, through a direct
sales force. As of December 31, 1999, the Company's
international direct sales force consisted of approximately 41
direct sales representatives.
The Company reinforces its sales and marketing program with
telemarketing, which is designed to increase sales through
follow-up on leads and the distribution of product information
to potential customers. The Company supplements its marketing
efforts with appearances at trade shows and advertisements in
trade journals, sales brochures, national print media, radio and
television. In addition, the Company sponsors symposiums and
educational programs to teach surgeons the leading techniques
and methods of using its products.
Patient Education and Services
Because many of the Company's products involve elective
procedures, the costs of which are borne directly by the
patients, the Company strives to educate patients about its
products and provide services to make the products easier to
understand and access. The Company accomplishes this in part
through the formation in the U.S. of aesthetic marketing
alliances.
The Company directs potential patients accessing its
website or calling the toll-free numbers in the Company's
advertisements who want information about aesthetic products and
procedures to physicians in the aesthetic marketing alliance's.
This helps patients to better understand aesthetic medicine
options while allowing physicians to increase the visibility and
breadth of their practice. Physicians enrolled in the aesthetic
marketing alliances can also offer their patients an option to
finance cosmetic procedures from a third-party finance company.
COMPETITION
Breast Implant Products
The Company's sole significant competitor in the U.S.
breast implant market is Mentor Corporation. All other
manufacturers discontinued production of breast implants in the
U.S. by 1993, largely as a result of regulatory action by the
FDA and the ensuing wave of litigation by women alleging injury
from their breast implants. Internationally, the Company
competes with several other manufacturers, including Mentor
Corporation, Poly Implant Prostheses (PIP), Nagor, Silimed and
Laboratories Sebbin. Several of these manufacturers received
510(k) clearance from the FDA to market saline-filled breast
implants in the U.S. In August 1999, the FDA called for PMA
applications on saline-filled breast implants to be filed within
90 days. Any manufacturer that failed to have a PMA application
accepted for filing by November 17, 1999 lost its 510(k)
clearance and, as of that date, had to cease distributing
saline-filled breast implants in the U.S. McGhan Medical was
among the three manufacturers of saline-filled breast implants
whose PMA applications were accepted for filing and, in
accordance with FDA regulations, each of the three applications
was referred to an FDA advisory panel on general and plastic
surgery. The advisory panel met in open session on March 1-3,
2000 to consider the applications and ultimately recommended FDA
approval (with conditions) of the Company's and Mentor's
applications for PMA of saline-filled breast implants, and
recommended FDA disapproval of the third application filed by
PIP. Under applicable requirements the Company expects the FDA
to act on these recommendations by May, 2000. While the FDA
usually follows its advisory panels' recommendations, such
recommendations are not binding on the FDA.
The Company believes that the principal factors permitting
its products to compete effectively with its competitors are the
Company's high-quality product consistency, its variety of
product designs, management's knowledge of and sensitivity to
market demands, plastic surgeons' familiarity with its products
and their respective brand names, and its ability to identify,
develop and, if appropriate, license, patented products
embodying new technologies.
Facial Enhancement Products
Several companies and institutions compete directly with
the Company in the facial aesthetic applications business. Some
of these companies and institutions are developing human
collagen-based products which, when and if commercially
introduced, may have actual and perceived advantages over the
Company's bovine collagen-based products. Some of these
companies and institutions may have substantially greater
capital resources, research and development staffs and
facilities, and experience in conducting clinical trials,
obtaining regulatory approvals, and manufacturing and marketing
products similar to the Company's. These companies and
institutions may represent significant long-term competition for
the Company. The Company's competitors may succeed in
developing technologies and products that are more effective
than the Company's, which may render the Company's technology
and products obsolete or non-competitive.
The Company's injectable products also compete in the
dermatology and plastic surgery markets with substantially
different treatments, such as laser treatments, chemical peels,
fat injections, gelatin- or cadaver-based collagen products,
dermabrasion, botulinum toxin injections and face lifts. In
addition, several companies are engaged in research and
development activities examining the use of collagen and other
biomaterials for the correction of soft tissue defects.
Obesity and Other Products
The LAP-BAND System competes with the Swedish Adjustable
Gastric Band in Europe and Australia. This band is manufactured
by Obtech Medical A.G., a privately-held Swiss company. This
product is not currently available in the U.S. Contigen
competes with comparable bulking agents and some surgical
procedures, including sling procedures, bladder neck suspension
and insertion of bone anchors.
PRODUCT DEVELOPMENT
The Company has a qualified staff of over 50 doctorates,
scientists, engineers and technicians working on material
technology and product design as part of the Company's research
and development efforts. In addition, the Company is directing
its research and development toward new and improved products
based on scientific advances in technology and medical
knowledge, together with qualified input from the surgical
profession. For the year ended December 31, 1999, the Company
had research and development expenses of $10.3 million,
representing approximately 6% of net sales for the year.
PATENTS AND LICENSE AGREEMENTS
The Company currently owns or has exclusive licenses
covering more than 90 patents and patent applications throughout
the world. Certain of the Company's patents pertaining to the
Company's facial aesthetic application products are licensed to
it under an agreement with Cohesion Technologies, Inc., which
was spun off from Collagen Corporation in August 1998. In
connection with the spin-off, Collagen Corporation changed its
name to Collagen Aesthetics, Inc. In the spin-off, Collagen
Corporation assigned substantially all its patents and patent
applications to Cohesion. Cohesion in turn granted Collagen
Aesthetics, Inc. an exclusive, worldwide, perpetual, fully paid-
up license to the assigned patents and patent applications in
the fields of human aesthetic products, technologies and
treatments.
The Company's policy is to actively seek patent protection
for its products and manufacturing processes when appropriate.
The Company manufactures and markets its products both under its
own patents and under its license agreements with other parties.
The Company also has license agreements allowing other companies
to manufacture products using some of the Company's technology
in exchange for royalties and other compensation or benefits.
The Company also has patents relating to its breast implant
products, tissue expanders, injection ports and valve systems,
and obesity and general surgery products.
In 1998, the Company reviewed its portfolio of patents and
licenses and determined in several situations that the licensed
patents had expired, were invalid, were unenforceable, were not
being utilized or that the licensor had breached its obligations
to us. Accordingly, the Company ceased paying several million
dollars in annual royalties under some of the license
agreements. The Company is currently engaged in legal
proceedings with several former licensors over the Company's
obligations and whether the Company is entitled to recover past
royalties that were paid. In the proceedings, the former
licensors are seeking payment of the royalties the Company
determined were not owed, as well as additional damages and
royalties for the Company's ongoing sales of formerly royalty-
bearing products. One such proceeding is subject to an
attorneys' stipulation of settlement. The Company has also
brought suit against two manufacturers that the Company believes
have been infringing on its intellectual property. The
proceedings involving some of these patents and licenses are
discussed more fully in "Management's Discussion and Analysis of
Financial Condition and Results of Operations, Legal
Proceedings, Patent and License Litigation".
Although the Company believes its patents are valuable, its
knowledge and experience, creative product development and
marketing staff and its trade secret information with respect to
manufacturing processes, materials and product design, have been
equally important in maintaining the Company's proprietary
product lines. As a condition of employment, the Company
requires all employees to execute a confidentiality agreement
relating to proprietary information and patent rights.
While the Company makes efforts to protect its trade secret
information, others may independently develop or otherwise
acquire substantially equivalent proprietary information or
techniques, or gain access to its proprietary technology or
disclose this technology. Any of these factors could adversely
impact the value of the Company's proprietary trade secret
information and harm the Company's business.
MANUFACTURING
Breast Implants and Related Products
The Company's breast implant and related tissue expander
products are manufactured by the Company's subsidiaries, McGhan
Medical Corporation in the Company's Santa Barbara and
Carpinteria, California facilities and McGhan Limited in the
Company's Arklow, Ireland facility. The Company plans to begin
manufacturing some of its breast implant products in Costa Rica
in late 2000. The Company has no material backlog for these
products. The Company manufactures its devices and products in a
controlled environment utilizing specialized equipment for
precision measurement, quality control, packaging and
sterilization. The Company's quality control procedures begin
with the Company's suppliers meeting the Company's standards of
compliance. The Company's in-house quality control procedures
begin upon the receipt of raw components and materials and
continue throughout production, sterilization and final
packaging. The Company maintains quality control and production
records of each product manufactured and encourages the return
of any defective units for analysis.
All of the Company's domestic manufacturing activities are
subject to FDA regulations and guidelines, and the Company's
products and manufacturing procedures are continually monitored
or reviewed by the FDA. In 1999, the FDA conducted a review of
the Company's main U.S. manufacturing facilities.
Since the 1992 moratorium by the FDA on silicone gel-filled
breast implants and the ensuing litigation, traditional major
commercial suppliers of silicone raw materials have ceased to
supply implant or medical grade materials to medical device
manufacturers, including the Company. Under guidelines
established by the FDA, the Company has been successful in using
other companies to meet its silicone raw material needs, but at
higher prices. Prior to 1999, the Company also devoted
resources to develop a raw materials manufacturing capability
through a subsidiary in Arklow, Ireland.
In late 1998, the Company entered into a strategic alliance
with a privately-held specialty chemical company, whereby that
company has become the Company's exclusive supplier of silicone
raw materials and has taken over the operation of the Company's
Irish raw materials facility. This alliance includes favorable
long-term pricing, reduction of the overhead previously
associated with the in-house manufacturing, and closer technical
support for initiatives like the Company's just-in-time
inventory and new product development. The Company may
experience periodic disruptions in its source of supply or the
quantities needed due to regulatory or other factors, including
production problems at suppliers' facilities.
Facial Enhancement Products
Zyderm and Zyplast, the Company's primary collagen-based
injectable products, are manufactured at the Company's Fremont,
California facility. The Company uses a patented viral
inactivation process for its collagen-based products to promote
both safety and quality. The production processes use readily
available chemicals and enzymes and bovine dermis sourced from
cows as the source of collagen. Since 1987, the hides have been
sourced from a domestic closed herd, in an effort to prevent
contamination of the Company's collagen-based products. The
Company believes that the supply of raw materials and processing
materials for its manufacturing operations can be purchased from
other sources. The collagen-based products have refrigerated
shelf lives of 36 months. The Company typically ships products
to physicians as orders are received on an express delivery
basis and has no material backlog.
The Company's manufacturing facility for collagen-based
products is subject to regulatory requirements and periodic
inspection by regulatory authorities, such as the FDA in the
U.S. A periodic surveillance audit of the Company's quality
system was performed in March 1998, and the Company's quality
systems were recertified to permit the Company to sell products
in the European Community.
Hylaform gel and the SoftForm implant are manufactured by
third parties. Therefore, the Company is dependent on these
third parties to manufacture and supply these products to us as
required.
Obesity and Other Products
The Company's obesity treatment products are manufactured
by its subsidiary, BioEnterics Corporation at its facility in
Carpinteria, California. In 1999, the FDA reviewed BioEnterics'
manufacturing facilities. Contigen is manufactured by the
Company at the Company's Fremont, California facility -- the
same facility where Zyderm and Zyplast are produced.
GOVERNMENT REGULATIONS
United States
Application and Clearance Procedures
The FDA and corresponding state and foreign agencies
regulate the clinical testing, manufacture and sale of medical
devices, including labeling, advertising and record keeping.
Most of the Company's products manufactured or sold in the U.S.
are classified as medical devices subject to regulation by the
FDA.
Unless an exemption applies, each medical device that the
Company wishes to market in the U.S. must receive either a
510(k) clearance or a PMA from the FDA under the Federal Food,
Drug, and Cosmetic Act. The FDA's 510(k) clearance process
usually takes three to nine months but can last longer. The
FDA's PMA process generally requires from one to three years or
more. The Company may not be able to obtain 510(k) clearance or
a PMA for products it proposes to market.
The FDA decides whether a device must undergo either the
510(k) clearance or a PMA process based upon statutory criteria.
These criteria include the level of risk that the FDA perceives
is associated with the device and a determination of whether the
product is within a type that is similar to devices that are
already legally marketed. Those devices deemed to pose
relatively less risk are placed in either Class I or Class II.
Class II devices generally require the manufacturer to submit a
premarket notification requesting 510(k) clearance unless an
exemption applies. Some Class I devices may also require 510(k)
clearance.
A 510(k) clearance will be granted if the submitted
information establishes that the proposed device is
"substantially equivalent" to a "predicate device," a legally
marketed Class I or Class II medical device, or a preamendment
Class III medical device that was in commercial distribution
before May 28, 1976 for which the FDA has not called for PMAs.
The FDA may determine that the proposed device is not
substantially equivalent to a predicate device, or that
additional information is needed before it is deemed
substantially equivalent to a predicate device or that
additional information is needed before a substantial
equivalence determination can be made.
Devices deemed by the FDA to pose greater risk, or to be
novel devices lacking a legally marketed predicate, are placed
in Class III and are required to undergo the PMA process. A PMA
application must contain the results of clinical trials, the
results of all relevant bench tests, laboratory and animal
studies, a complete description of the device and its
components, and a detailed description of the methods,
facilities and controls used to manufacture the device. The
FDA's review time is often significantly extended by FDA
requests for additional information or clarification of
information already provided in the submission. Modifications
to a device that is the subject of an approved PMA, its labeling
or its manufacturing site or process may require approval by the
FDA of PMA supplements or new PMAs. The PMA process can be
expensive, uncertain and lengthy, and a number of devices for
which FDA approval has been sought by other companies have never
been approved for marketing.
If human clinical trials of a device are required in order
to obtain adequate safety, performance and/or efficacy data, and
the device presents a "significant risk" to the patient, the
sponsor of the trial, usually the manufacturer or the
distributor of the device, will have to file an Investigational
Device Exemption (IDE) application prior to commencing the human
clinical trials necessary to complete a PMA application. The
IDE application must be supported by data, typically including
the results of animal and laboratory testing. If the IDE
application is approved by the FDA and the study protocol is
approved by one or more appropriate Institutional Review Boards,
human clinical trials may begin at a specific number of
investigational sites with a specific number of patients, as
approved by the FDA. If the device presents a "nonsignificant
risk" to the patient, a sponsor may begin the clinical trial
after obtaining approval for the study by one or more
appropriate Institutional Review Boards without the need for FDA
approval. Sponsors of U.S. clinical trials are permitted to
charge for investigational devices distributed in the course of
the study provided that compensation does not exceed recovery of
the costs of manufacture, research, development and handling.
An IDE supplement must be submitted and approved by the FDA and
appropriate Institutional Review Boards before a sponsor or
investigator may make a change to the investigational plan that
may affect its scientific soundness or the rights, safety or
welfare of human subjects. The FDA can disapprove an IDE or
withdraw an IDE approval if there is reason to believe that the
risks to subjects are not outweighed by the anticipated
benefits, or if the sponsor fails to comply with applicable
requirements or conditions of approval.
The continuing trend of more stringent FDA oversight in
product clearance and enforcement activities has caused medical
device manufacturers to experience longer approval cycles, more
uncertainty, greater risk and higher expenses. Failure to
obtain, or delays in obtaining, the required regulatory
approvals for new products could hurt the Company's business, as
could product recalls. In addition, the Company may not receive
FDA approval to market its current products for broader or
different applications or to market separate products that
represent extensions of the Company's basic technology. In
addition, it is possible that the FDA will promulgate additional
regulations restricting the sale of the Company's present or
proposed products.
A majority of the Company's products are classified as
Class III devices, including all of the injectable bovine
collagen-based products, breast implant products and obesity
treatment products. All of the products described in
"Management's Discussion and Analysis of Financial Condition and
Results of Operations, Products", other than Hylaform gel, the
LAP-BAND System and the Company's silicone gel-filled breast
implants, have been approved or cleared for commercial sale in
the U.S.
In the ongoing process of compliance with applicable laws
and regulations, the Company has incurred, and will continue to
incur, substantial costs that relate to laboratory and clinical
testing of new products, data preparation and filing of
documents in the proper outline or format required by the FDA.
However, pursuant to FDA action in the second half of 1999, the
FDA required any manufacturer wishing to continue to market
saline-filled implants in the U.S. to file an application for
pre-market approval of such products by November 17, 1999. Any
manufacturer that failed to have a PMA application accepted for
filing by November 17, 1999 lost its 510(k) clearance and, as of
that date, had to cease distributing saline-filled breast
implants in the U.S. McGhan Medical was among the three
manufacturers of saline-filled breast implants whose PMA
applications were accepted for filing and, in accordance with
FDA regulations, each of the three applications was referred to
an FDA advisory panel on general and plastic surgery. The
advisory panel met in open session on March 1-3, 2000 to
consider the applications and ultimately recommended FDA
approval of two of them, including the Company's application for
PMA of its saline-filled breast implants, and recommended FDA
disapproval of the third application filed by PIP. Under
applicable requirements the Company expects the FDA to act on
these recommendations by May, 2000. While the FDA usually
follows its advisory panels' recommendations, such
recommendations are not binding on the FDA. A decision by the
FDA that the Company's application is not approvable would have
a material adverse effect on the Company's operations and
financial position.
In February 2000, the Company completed its PMA application
for the LAP-BANDr System, based on a clinical study of the
product under an IDE granted by the FDA in April 1995. The
application included the results of the first phase of the
Company's clinical trials, enrollment for which opened in June
1995 and closed in the second quarter of 1998 with approximately
300 participants. A second phase study, known as a continued
access trial, is continuing. Such a study involves less
stringent follow-up. The Company expects to receive a timetable
for FDA device panel and staff review of the PMA filing shortly.
Pursuant to an IDE granted by the FDA, the Company is also
in the process of conducting a clinical trial in preparation for
a potential PMA filing on its silicone gel-filled implants for
augmentation, reconstruction and revision uses. This trial
began in January 1999. In addition, in 1994, the FDA granted
LipoMatrix, Inc., a former subsidiary of Collagen, an IDE on the
Trilucent breast implant. LipoMatrix began a pilot study for
this product in December 1994 and a pivotal study in September
1996. Enrollment in the pivotal study was stopped in June 1997,
owing to planned changes in the product which would result in
the need for a new pivotal study. The Company continues to
follow up on the women who received this product in the U.S. and
Canada as per protocol. The Trilucent product was never marketed
commercially in the U.S. or Canada. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations, Legal Proceedings, Trilucent Implant Matters".
Manufacturing Regulations and Reporting Requirements
In addition to the foregoing application and clearance
procedures, the Company must comply with the current Quality
Systems Regulation in order to receive FDA approval to market
new products and to continue to market current products.
Manufacturers of medical devices for marketing in the U.S. are
required to adhere to detailed Quality Systems Regulation
requirements, which include testing, control and documentation.
Manufacturers must also comply with Medical Device Reporting
requirements that a company report to the FDA any incident in
which its product may have caused or contributed to a death or
serious injury. If a malfunction does not result in death or
serious injury, a manufacturer must report whether a recurring
malfunction would be likely to cause or contribute to death or
serious injury. Labeling and promotional activities are subject
to scrutiny by the FDA and state regulatory agencies and, in
some circumstances, by the Federal Trade Commission. FDA
enforcement policy prohibits the marketing of approved medical
devices for unapproved ("off label") uses. Manufacturers of
medical devices must also report to the FDA any notices of
corrections or removals of marketed products, and submit
periodic reports for PMA products. Investigational products are
also subject to reporting requirements, such as reporting of
deaths or serious injuries, periodic reporting, and special
reports as may be required by the FDA.
The Company is registered with the FDA as a manufacturer of
medical devices. The Company is subject to routine inspection
by the FDA and state agencies for compliance with Quality
Systems Regulation requirements, Medical Device Reporting
requirements and other applicable regulations. The Company's
facilities and manufacturing processes also have been inspected
periodically by the State of California and other agencies, and
remain subject to audit from time to time. The Company believes
that it is in substantial compliance with all applicable federal
and state regulations. Nevertheless, the FDA or a state agency
may not agree with the Company or the Company's Quality Systems
Regulation compliance may be challenged at some subsequent point
in time. Enforcement of Quality Systems Regulation has
increased significantly in the last several years, and the FDA
has stated publicly that compliance will be scrutinized more
strictly. In the event that the Company is deemed to be in
noncompliance with FDA regulations, to the extent that the
Company is unable to convince the FDA or state agency of the
adequacy of the Company's compliance, the FDA or state agency
has the power to assert penalties or remedies, including
injunction or temporary suspension of shipment until compliance
is achieved. Noncompliance may also lead to a recall of a
product. These penalties or remedies could have a materially
adverse effect on the Company's business, financial condition
and results of operations.
International
Medical device laws and regulations similar to those in the
U.S. are also in effect in many of the countries to which the
Company exports or sells its products. These range from
comprehensive device approval requirements for some or all of
the Company's medical device products to requests for product
data or certifications.
Some countries have historically permitted human studies
earlier in the product development cycle than U.S. regulations
permit. Other countries, such as Japan, have requirements
similar to those of the U.S. Disparities in the regulation of
medical devices may result in more rapid product clearance in
some countries than in others.
The primary regulatory environment in Europe is that of the
European Community which consists of 15 countries encompassing
most of the major countries in Europe. Other countries, such as
Switzerland, have voluntarily adopted laws and regulations that
mirror those of the European Community with respect to medical
devices. The European Community has adopted numerous directives
and standards regulating the design, manufacture, clinical
trial, labeling, and adverse event reporting for medical
devices. The principal rules pertaining to medical devices in
the European Community are found in the European Medical Devices
Directive, 93/42/EC.
Devices that comply with requirements of a relevant
directive will be entitled to bear CE conformity marking,
indicating that the device conforms with the essential
requirements of the applicable directive and, accordingly, can
be commercially distributed throughout the European Community.
The method of assessing conformity varies depending on the class
of the product, but normally involves a combination of self-
assessment by the manufacturer and a third-party assessment by a
notified body. This third-party assessment may consist of an
audit of the manufacturer's quality system, review of a
technical file or specific testing of the manufacturer's
products. An assessment by a notified body in one country
within the European Community is required in order for a
manufacturer to commercially distribute the product throughout
the European Community. The Company may not be successful in
meeting the European quality standards or other certification
requirements. The Company currently has the CE Mark for its
saline-filled and silicone gel-filled breast implants. Zyderm
and Zyplast received CE Mark on June 23, 1995, Contigen received
CE Mark on October 26, 1995, Hylaform received CE Mark on
November 2, 1995 and SoftForm received CE Mark on September 22,
1997.
While no additional pre-market approvals for individual
European Community countries are required prior to the marketing
of a device bearing CE Mark in most European Community
countries, practical complications with respect to market
introduction may occur. For example, differences among
countries have arisen with regard to labeling requirements. In
addition, advertising and promotion of medical devices are
governed primarily by national laws, subject to certain general
European Community directives on advertising. Some countries
also maintain registries or other special systems for particular
types of devices, including breast implants.
Unapproved devices subject to 510(k) clearance or PMA
requirements intended solely for export may be exported legally
without FDA approval provided certain requirements are met.
However, the Company must, among other things, notify the FDA
and meet the importing country's requirements. The Company may
not receive FDA export approval when this approval is necessary
and countries to which the devices are to be exported may not
approve the devices for import. Failure to receive import
approval from other countries, or to obtain Certificates of
Exportability when required, or to meet the FDA's export
requirements or to obtain FDA export approval when required to
do so, could have a material adverse effect on the Company's
business, financial condition and results of operations.
THIRD PARTY REIMBURSEMENT
In the U.S., healthcare providers that purchase medical
devices such as Contigenr generally rely on third-party payors,
principally federal Medicare, state Medicaid and private health
insurance plans to reimburse all or part of the cost of the
procedure in which the device is used. This reimbursement is
typically made at a fixed rate. In October 1998, a federal law
was signed that mandates nationwide insurance coverage of
reconstructive surgery following a mastectomy. Historically,
not all insurance providers covered this procedure.
Reimbursement is becoming increasingly available outside the
U.S., for example in Europe and Australia, where the purchaser
of medical devices such as the LAP-BANDr System may be
reimbursed.
LIMITED WARRANTIES
The Company makes every effort to conduct its product
development, manufacturing, marketing, and service and support
activities with careful regard for the consequences to patients.
As with any medical device manufacturer, the Company
occasionally receives communications from surgeons or patients
with respect to various products claiming the products were
defective and have resulted in injury to the patient. The
Company provides a limited warranty to the effect that any
breast implant, tissue expander or obesity treatment product
that proves defective will be replaced with a new product of
comparable type without charge. In the case of the Company's
breast implant products sold and implanted in the U.S., the
Company's ConfidencePlusT program provides product replacement
and some financial assistance for certain surgical procedures
required within ten years of implantation.
GEOGRAPHIC SEGMENT DATA
A description of the Company's net sales, operating income
(loss) and identifiable assets within the United States and
internationally, is detailed in Note 10 of the notes to the
consolidated financial statements, attached as Exhibit (a)(1).
EMPLOYEES
As of December 31, 1999, the Company had approximately
1,065 employees in active service, of which approximately 778
were in the U.S. and approximately 287 were at international
operations. Except for employees at the Company's manufacturing
facility in Arklow, Ireland, none of the Company's employees are
represented by a labor union. The Company offers its employees
competitive benefits and wages comparable with employees for the
type of business and the location/country in which the
employment occurs. The Company considers its employee relations
to be good throughout operations.
Item 2. Properties
The Company leases all of its office, manufacturing and
distribution facilities as follows (including approximate square
footage): Carpinteria, California (41,000 square feet), Fremont,
California (61,000 square feet), Santa Barbara, California
(187,000 square feet), New York, New York (3,100 square feet)
and Arklow, County Wicklow, Ireland (53,000 square feet).
The Company leases office and warehouse space ranging from
1,500 square feet to 4,000 square feet for international sales
offices, located in Australia, France, Germany, Italy, Japan,
The Netherlands, Spain and the United Kingdom. The Company
believes its facilities are generally suitable and adequate to
accommodate its current operations.
Item 3. Legal Proceedings
Breast Implant Litigation
Final Settlement on Litigation. Prior to the final
settlement order issued by federal Judge Sam C. Pointer, Jr. of
the U.S. District Court for the Northern District of Alabama,
Southern Division on February 1, 1999, the Company was a
defendant in tens of thousands of state and federal court
lawsuits involving breast implants. As part of that final
order, all of those cases arising from breast implant products
(both silicone gel-filled and saline-filled) that were implanted
before June 1, 1993 were consolidated into a mandatory class
action settlement and dismissed. The settlement order became
final and non-appealable on March 3, 1999. In May 1999, the
Company made the final payment in connection with the class
action litigation using proceeds from its $31.1 million equity
issuance. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations, Liquidity and
Capital Resources".
Current Product Liability Exposure. Currently, other than
the Trilucent matters discussed below, the Company's product
liability litigation relates largely to saline-filled products
that were implanted after the 1992 FDA moratorium on silicone
gel-filled implants went into effect. These cases are being
handled in the ordinary course of business and are not expected
to have a material financial impact on the Company.
Outside the U.S., where the Company has been selling
silicone gel-filled implants without interruption, and where the
local tort systems do not encourage or allow contingency fee
arrangements, the Company had only a minimal number of product
liability lawsuits and no material financial exposure.
Resolution of 3M Contractual Indemnity Claim. In
connection with the breast implant litigation, 3M asserted
against the Company 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. To resolve these claims, on April 16, 1998, the
Company entered into a provisional agreement with 3M under which
the Company agreed to seek to obtain releases of claims asserted
against 3M in lawsuits involving breast implants manufactured by
the Company's McGhan Medical subsidiary. The 3M agreement
provides for release of 3M's indemnity claim upon achievement of
an agreed minimum number of conditional releases for 3M.
Under the terms of the 3M agreement, as later amended in
January 1999, the Company paid $3 million to 3M in February
1999. Also under the terms of the 3M agreement, the Company will
assume limited indemnification obligations to 3M beginning in
the year 2000, subject to a cap of $1 million annually and $3 to
4.5 million in total, depending on the resolution of other cases
which were not settled prior to the issuance of the final order.
Ongoing Litigation Risks. Although the Company expects the
breast implant litigation settlement to end as a practical
matter the Company's involvement in the current mass product
liability litigation in the U.S. over breast implants, there
remain a number of ongoing litigation risks, including:
? Collateral Attack. As in all class actions, the Company
may be called upon to defend individual lawsuits
collaterally attacking the settlement even though it is
now non-appealable. However, the typically permissible
grounds for those attacks, in general, lack of
jurisdiction or constitutionally inadequate class notice
or representation, are significantly narrower than the
grounds available on direct appeal.
? 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 U.S. has, to date,
been minimal, and the court has, with minor exceptions, rejected
efforts by foreign plaintiffs to file suit in the U.S.
Trilucent Implant Matters. On November 6, 1998, Collagen
announced the sale of its LipoMatrix, Inc. subsidiary,
manufacturer of the Trilucent breast implant, to Sierra Medical
Technologies. Collagen accounted for LipoMatrix as a
discontinued operation in its 1998 fiscal year. On March 8,
1999, the United Kingdom Medical Devices Agency (MDA) announced
the voluntary suspension of marketing and voluntary withdrawal
of the Trilucent implant in the United Kingdom. The MDA stated
that its actions were taken as a precautionary measure and did
not identify any immediate hazard associated with the use of the
product. The MDA further stated that it sought the withdrawal
because it had received "reports of local complications in a
small number of women" who have received those implants,
involving localized swelling. The same notice stated that there
"has been no evidence of permanent injury or harm to general
health" as a result of these implants. Subsequently,
Lipomatrix's notified body in Europe suspended the product's CE
Mark pending further assessment of the long-term safety of the
product. Sierra Medical has since stopped sales of the product.
Collagen retained certain liabilities for Trilucent
implants sold prior to November 6, 1998. Collagen also agreed
with the United Kingdom National Health Service that, for a
period of time, it would perform certain product surveillance
with respect to United Kingdom patients implanted with the
Trilucent implant and pay for explants for any United Kingdom
women with confirmed Trilucent implant ruptures. Subsequent to
acquiring Collagen, the Company elected to continue this
voluntary program. Any swelling or inflammation relating to the
Trilucent implants appears to resolve upon explantation. At June
30, 1999, Collagen increased by $11.5 million its provision for
LipoMatrix as a discontinued operation in the U.K. The Company
is a party to several lawsuits outside the United States brought
by patients claiming damages from the Trilucent breast implant
product, some of which have recently been settled. In the
U.S., a total of 165 women received Trilucent breast implants in
two clinical studies; enrollment in both studies ended by June
1997. No lawsuit has been filed and the Company has not received
any notice of legal claim as a result of the implantation of any
Trilucent breast implants in the U.S. Based on the acquisition
related accruals and available insurance policies, the Company
does not believe that it faces a material risk to operations
from Trilucent.
Patent and License Litigation
In February 1999, the Company and certain of its
subsidiaries were named as respondents in an arbitration
commenced by Dr. Lubomyr I. Kuzmak at the American Arbitration
Association. Dr. Kuzmak alleges that, as of the date of filing
of the arbitration, he was owed approximately $400,000 in unpaid
royalties under a license agreement covering the Company's U.S.
patents in the field of gastric banding naming Dr. Kuzmak as an
inventor. In the past, the Company worked with Dr. Kuzmak,
through the Company's subsidiary BioEnterics, in the development
and improvement of gastric banding technology. The Company has
denied all of the material allegations raised by Dr. Kuzmak and
has asserted affirmative defenses and counterclaims, including
noninfringement, invalidity and unenforceability for inequitable
conduct before the U.S. Patent and Trademark Office.
In addition, in February 1999, the Company filed an action
in the U.S. District Court for the Central District of
California against Dr. Kuzmak seeking a declaratory judgment of
invalidity, unenforceability and non-infringement of the patents
to which Dr. Kuzmak claims ownership. In February 2000, that
action was dismissed for lack of personal jurisdiction. In
January 2000, the parties entered into an agreement in principle
to settle and resolve all matters with Dr. Kuzmak and adjourned
the arbitral hearing without a new date.
In January 1999, Medical Products Development Inc.("MPDI")
instituted an action against the Company's subsidiary McGhan
Medical Corporation in the U.S. District Court for the Central
District of California. MPDI alleges that McGhan Medical has
infringed on some of its U.S. patents and has breached an
agreement between McGhan Medical and MPDI that exclusively
licensed those patents to McGhan Medical. Those patents pertain
to the textured surface of the silicone shell used in the
Company's breast implants and the methods of making those
textured shells. Until 1998, McGhan Medical was the exclusive
licensee under these patents and paid royalties to MPDI on sales
in the U.S. of its textured implant products. In 1997, the last
full year for which McGhan Medical paid royalties under the
license, McGhan Medical paid MPDI approximately $2.5 million in
royalties. In 1994, McGhan Medical and MPDI entered into a
consent judgment in settlement of a dispute which stipulated
that the patent claims were valid in certain respects. The
consent judgment did not address McGhan Medical's present non-
infringement defense nor its unenforceability defense. MPDI is
seeking unpaid royalties up until the date of termination of the
license, unspecified damages, including enhanced damages for
alleged willful infringement, and an injunction. The unpaid
royalties allegedly due when the lawsuit was commenced were
approximately $1 million. McGhan Medical filed an answer
denying all of the material allegations of MPDI's complaint and
raising affirmative defenses and counterclaims of non-
infringement, invalidity on grounds not precluded by the consent
judgment, unenforceability of the patents and breach of
contract. McGhan Medical believes that its textured breast
implant products are made using significantly different
processes than that claimed in the patents, and that the alleged
inventor of the patents engaged in inequitable conduct before
the U.S. Patent and Trademark Office during prosecution of the
patents. In August 1999, the court granted MPDI's motion to
dismiss some of the counterclaims, and on its own motion
dismissed the remaining counterclaims. In September 1999, MPDI
filed a motion for leave to amend its complaint to add another
cause of action for breach of contract. In November 1999, the
Company moved for summary judgment on grounds of
unenforceability owing to inequitable conduct and of non-
infringement. That motion, and MPDI's cross-motion for a
judgment of infringement, are pending. The Company believes its
affirmative defenses have considerable merit, but resolution of
the action may result in the payment of damages and past
royalties. The Company does not believe that a negative outcome
in this action would limit its ability to sell textured breast
implants because it has recently become the licensee of other
patents for texturing breast implants and is capable of altering
its manufacturing process to utilize that technology.
In May 1998, Societe Anonyme de Development des
Utilisations du Collagene (SADUC) commenced an arbitration under
the rules of the International Chamber of Commerce against
Collagen Corporation under a technology license and human
collagen supply agreement between the parties. Following the
spin-off of Cohesion Technologies, Inc., Collagen Corporation
changed its name to Collagen Aesthetics, Inc. SADUC is
ultimately owned by Rhone-Poulenc. SADUC seeks recovery for
alleged lost profits and royalties for Collagen Corporation's
allegedly wrongful termination of the agreement as well as
compensation for confidential information allegedly
misappropriated by Collagen Corporation, including the
assignment to SADUC of certain Collagen Corporation patents
allegedly disclosing and claiming processes allegedly developed
by SADUC. SADUC seeks approximately $4.5 million in termination
damages and $2.1 million as losses for breach of the contractual
confidentiality obligations, plus ongoing royalties. Collagen
Corporation has denied all material allegations, as it is
Collagen Corporation's belief that SADUC breached the agreement
by being unable and unwilling to supply the specified product at
the contract price. In addition, Collagen Corporation has
stated that its patents do not disclose or claim any of SADUC's
allegedly confidential information, and that SADUC's allegedly
confidential information was neither novel nor useful.
Accordingly, Collagen Corporation seeks rescission of the
agreement and restitution to it of all amounts paid and the
costs incurred by it in attempting to perform under the
agreement. Collagen Corporation's position is believed to have
considerable merit, but resolution of this arbitration may
require the Company to pay damages or require these patents to
be assigned to SADUC. An evidentiary hearing on the liability
issues raised in this case began in March 2000.
Other Litigation
The Company is also party to a lawsuit filed in 1998 in the
Superior Court of the State of California, County of Los Angeles
known as Chieftain LLC, et al. vs. Medical Device Alliance, Inc.
(Case No. BC199819). The currently operative complaint contains
16 causes of action, three of which are alleged against the
Company and McGhan Medical. Other co-defendants include the
former chairman of Inamed, Donald K. McGhan, his wife and three
children, entities with which Mr. McGhan remains affiliated
including International Integrated Industries, LLC
("Industries") and Wedbush Morgan Securities, Inc., a securities
firm at which Mr. McGhan allegedly holds margin accounts. The
operative complaint purports to allege direct and derivative
claims on behalf of shareholders of Medical Device Alliance,
Inc. ("MDA") for unspecified damages. In February 2000, the
Company and McGhan Medical filed a demurrer to the currently
operative complaint. In March 2000, the Court granted that
motion in part. The operative complaint purports to allege that
prior to his February 1998 resignation as an officer and
director of the Company, Donald K. McGhan improperly diverted
$9.9 million of MDA funds to the Company, and that after his
resignation, Mr. McGhan and the Company conspired to defraud MDA
when these funds were repaid. The Company believes that the
operative complaint is bereft of support, both factually and
legally. Both the Company and McGhan Medical intend to
vigorously oppose the action.
The Company is involved in various legal actions arising in
the ordinary course of business, the majority of which involve
product liability claims alleging personal injuries and economic
harm as a result of ruptures in breast implants. In the
Company's experience, claimants typically do not allege that the
release of saline solution causes any chronic condition or
systemic disease. While the outcome of these matters is
currently not determinable, the Company believes that these
matters, individually or in the aggregate, will not have a
material adverse effect on the Company's business, results of
operations or financial condition.
Item 4. Submission of Matters to a vote of Security Holders.
On June 3, 1999, the Company held its annual stockholders'
meeting (the "Meeting"), whereby the stockholders (i) elected
eight directors and (ii) ratified the appointment of BDO
Seidman, LLP as the Company's independent accountants for fiscal
year 1999. The vote on such matters was as follows:
1. Election of Directors
<TABLE>
Total Vote For Total Vote Withheld
Each Nominee From Each Nominee
<S> <C> <C>
Richard G. Babbitt 10,357,741 2,925
James E. Bolin 10,357,741 2,925
Malcolm R. Currie, Ph.D. 10,357,741 2,925
John F. Doyle 10,357,741 2,925
Ilan K. Reich 10,357,741 2,925
Mitchell S. Rosenthal, M.D. 10,357,741 2,925
David A. Tepper 10,357,741 2,925
John E. Williams, M.D. 10,355,507 5,159
2. The appointment of BDO Seidman, LLP as the Company's
independent accountants for fiscal year 1999.
For 10,358,241
Against 2,425
Abstaining 0
Broker Non-Votes 0
</TABLE>
PART II
Item 5. Market for the Company's Common Stock and Related
Stockholder Matters.
The Company's common stock has been trading on the Nasdaq
National Market under the symbol IMDC since September 30, 1999.
Between January 1, 1997 and June 10, 1997, the Company's common
stock was listed on the Nasdaq SmallCap Market. However,
effective June 11, 1997, the Company's common stock was delisted
from the Nasdaq SmallCap Market. From June 11, 1997 to
September 29, 1999, the Company's common stock was traded on the
OTC Bulletin Board. On March 20, 2000, the Company had 622
stockholders of record. The Company's common stock price at the
close of business of March 20, 2000 was $43 per share.
The table below sets forth the high and low bid prices of
the Company's common stock for the periods indicated.
Quotations reflect prices between dealers, do not reflect retail
markups, markdowns or commissions, and may not necessarily
represent actual transactions. No cash dividends have been paid
by the Company during such periods.
High Low
1998
1st Quarter $ 5-5/8 $ 3-1/8
2nd Quarter $ 9-1/4 $ 5
3rd Quarter $ 8-1/2 $ 5
4th Quarter $ 10-1/8 $ 4-1/2
1999
1st Quarter $15 $9-5/8
2nd Quarter $17-1/8 $12
3rd Quarter $29-1/2 $14-5/8
4th Quarter $46-3/4 $24-1/16
The Company has never paid a cash dividend. It is the
current policy of the Company to retain earnings to finance the
growth and development of its business. Therefore, the Company
does not anticipate paying cash dividends on its common stock in
the foreseeable future. In addition, the Company's ability to
pay cash dividends is restricted by the Company's credit
facility. Any future determination to pay cash dividends will be
at the discretion of the Company's board of directors and will
be dependent upon the Company's financial condition, operating
results, capital requirements and other factors as the board of
directors deems relevant.
Item 6. Selected Financial Data.
The following financial information is qualified by
reference to, and should be read in conjunction with, the
Company's Consolidated Financial Statements and Notes thereto
and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" contained elsewhere in this report.
The selected consolidated financial information presented below
is derived from the Company's audited Consolidated Financial
Statements for each of the five years in the period ended
December 31, 1999. The Company completed its acquisition of
Collagen on September 1, 1999. The results of operations of
Collagen are included in the Company's operating results from
the date of acquisition.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Year Ended December 31,
1999(1) 1998 1997 1996 1995
(In thousands except per share data)
Statement of operations data:
Net sales $ 189,295 $ 131,566 $ 106,381 $ 93,372 $ 81,626
Cost of goods sold 57,553 47,954 37,643 35,295 30,156
Gross profit 131,742 83,612 68,738 58,077 51,470
Operating expenses:
Marketing 43,119 33,364 30,002 25,088 23,434
General and administrative 32,890 27,839 33,210 31,252 32,834
Research and development 10,324 9,366 8,863 5,693 4,392
Restructuring expense -- 4,202 -- -- --
Amortization of intangible
Assets 1,661 374 240 -- --
Total operating expenses 87,994 75,145 72,315 62,033 60,660
Operating income (loss) 43,748 8,467(2) (3,577) (3,956) (9,190)
Litigation settlement -- -- (28,150) -- --
Other Income (Expense) 1,626 686 (1,796) 68 677
Income (loss) before
interest and taxes 45,374 9,153 (33,523) (3,888) (8,513)
Net interest and other
Financing expense 13,080 3,812 6,173 4,277 63
Income (loss) before income
tax expense (benefit) and
extraordinary charges 32,294 5,341 (39,696) (8,165) (8,576)
Income tax (benefit)
expense (6,460)(3) (8,432)(4) 1,881(5) 3,214(6) (1,683)
Net income (loss) before
extraordinary charges 38,754 13,773 (41,577) (11,379) (6,893)
Extraordinary charges -- (1,800) -- -- --
Net income (loss) $ 38,754 $11,973 $(41,577) $(11,379) $(6,893)
Net income (loss) per
share of common stock:
Basic $ 2.51 $ 1.15 $ (4.97) $ (1.46) $ (0.91)
Diluted $ 2.03 $ 0.92 $ (4.97) $ (1.46) $ (0.91)
Weighted average common
Shares outstanding (basic) 15,466 10,387 8,371 7,811 7,544
Weighted average common shares
outstanding (diluted) 19,058 14,185 8,371 7,811 7,544
</TABLE>
<TABLE>
<S> <C> <C> <C> <C> <C>
December 31,
1999 1998 1997 1996 1995
(In thousands)
Balance sheet data:
Working capital (deficiency) $ 37,472 $ (988) $ 6,460 $ 4,511 $ (6,042)
Total assets 309,479 80,707 58,842 65,912 50,385
Term loans 77,035 -- -- -- --
Convertible and other long-
term debt, net of current
installments -- 27,767 23,574 34,607 89
Subordinated long-term debt,
related party -- -- 8,813 -- --
Stockholders' equity (deficiency) 134,121 (15,625) (46,689) (9,908) (1,704)
(1) The consolidated financial statements include the operations of Collagen
Aesthetics, Inc. from September 1, 1999 to December 31, 1999.
(2) Includes restructuring expense of $4,202.
(3) Includes reversal of $15,478 allowance on the deferred tax asset.
(4) Reflects the recognition of an $8,000 deferred tax asset based on future
short-term income projections.
(5) Includes a provision of $1,000 for the conversion of foreign intercompany
accounts to equity.
(6) Includes the recording of a $2,006 valuation allowance on domestic
deferred tax assets.
</TABLE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Results of Operations
In early 1998, the Company appointed a new senior management team
and focused on two primary objectives: settling the breast implant
litigation and making the Company consistently profitable on par with other
medical device companies.
On February 1, 1999, the court responsible for the Company's breast
implant class-action litigation entered a final, non-appealable order
approving the Company's settlement with the plaintiffs' class counsel and
3M. On March 3, 1999, the statutory period for filing appeals expired. On
May 10, 1999, the Company announced the completion of a $31.1 million
equity financing and a final payment of monies owed to the escrow agent on
behalf of the plaintiff class in the breast implant litigation.
In the third quarter of 1998 the Company initiated a cost reduction
program that included reducing overhead through an approximate 10%
worldwide reduction in work force; eliminating underutilized corporate
offices and the Company's European sales headquarters; entering into a
strategic alliance with the Company's supplier of silicone raw materials;
moving the Company's corporate headquarters from Las Vegas to Santa
Barbara; and terminating or selling unprofitable business lines.
During the third and fourth quarters of 1998, the Company expensed
a total of $4.2 million as a restructuring charge to recognize various
costs associated with implementing that plan. By the end of 1998, the
Company accomplished its transition from a history of unprofitable
operations to profitable operations. That progress continued throughout
1999, as the Company was able to increase sales, improve gross margins and
reduce operating expenses (as a percentage of sales), thereby markedly
improving its overall profitability.
In the third quarter of 1999, the Company completed the acquisition
of Collagen for an aggregate purchase price of approximately $159 million,
including expenses. The Company accounted for the Collagen acquisition
using the purchase method of accounting. Under the purchase method,
Collagen's financial data is consolidated with the Company's financial
results from the effective date of the acquisition, September 1, 1999. This
acquisition makes the Company a global leader in plastic surgery and
aesthetic medicine. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations, Business, Recent Developments,
Collagen Acquisition".
Set forth below is a table which shows the individual components of
the Company's actual results of operations as a percent of net sales for
each of the periods indicated.
<TABLE>
Year Ended
December 31,
<S> <C> <C> <C>
1999 1998 1997
Net Sales 100% 100% 100%
Gross profit 70 64 65
Marketing expenses 23 25 28
General and administrative
Expenses 18 21 31
Research and development
Expenses 5 7 8
Total Operating expenses
(excluding restructuring
expense) 46 54 68
Operating income (loss)
(excluding restructuring
expenses) 23 10 (3)
Net interest and other
Financing expense 7 3 6
Income (loss) before income
Taxes and extraordinary
Charges 17 4 (37)
Net income 20% 9% (39)%
</TABLE>
Comparison of Years Ended December 31, 1999 and 1998
Net Sales. Net sales for 1999 were $189.3 million, reflecting an
increase of $57.7 million or 44% over net sales for the same period in
1998. This increase is attributable to 19% growth in base business sales
plus the inclusion of four months of Collagen net sales, totaling $33
million. The Company expects to report substantially larger
period-over-period sales for the first three quarters of 2000 because of
the inclusion of Collagen product sales.
Net sales in the U.S. accounted for 67% of total net sales for 1999
as compared to 65% for 1998. International net sales accounted for 33% of
total net sales for 1999 as compared to 35% of total net sales for 1998.
Cost of Goods Sold. Cost of goods sold, as a percentage of net
sales, decreased to 30% for 1999 as compared to 36% for 1998. This decrease
reflects improved capacity utilization due to increased sales, improvements
in product mix, and a focus on cost reduction measures at all production
facilities.
Gross Profit. Gross profit for 1999 was $131.7 million, reflecting
an increase of $48.1 million or 58% over 1998. For 1999, gross profit as a
percentage of net sales improved by six percentage points, reaching 70% of
net sales compared to 64% in the prior year. Margins increased primarily
due to increased production efficiencies and increased volume in all
business units, along with increased sales volumes of higher margin gel
products for reconstructive surgery markets.
Marketing Expenses. Marketing expenses for 1999 were $43.1 million,
compared to $33.4 million in 1998. As a percentage of sales, marketing
expenses were 23% for 1999 as compared to 25% for 1998. Management's goals
of growing sales and reducing costs, which included the restructuring of
the entire company during 1998 and a strong cost containment focus, have
resulted in a controlled growth in marketing expenditures in 1999.
Marketing expenditures in future periods will depend on a variety of
factors, including the Company's level of operations, advertising spending
and the number of new markets the Company enters.
In October 1999, a license and distribution agreement between
ArthroCare Corporation and Collagen Aesthetics, Inc., was amended. The
Company has worldwide rights to market ArthroCare's CoblationT Cosmetic
Surgery System and related products using ArthroCare's patented radio
frequency ("RF") technology. Pursuant to the agreement, the Company now has
exclusive rights to sell such technology, among others, to all physicians
in the fields of dermatology, cosmetic and aesthetic surgery to the extent
permitted by the FDA. ArthroCare retains responsibility for manufacturing
and product development. Pursuant to the parties' agreements, the Company
has to date paid ArthroCare $2 million in licensing fees and must make
certain minimum purchases and must pay certain minimum royalties in the
annual periods following FDA approval of a licensed product for general
dermatological use for skin resurfacing and wrinkle reduction. In addition,
in the future, the Company would owe ArthroCare $500,000 on completion of a
satisfactory disposable wand, $2 million on FDA approval of a licensed
product for general dermatological use for skin resurfacing and wrinkle
reduction, and a running royalty on the sale of the disposable wands. Such
FDA approval was received in March 2000. Under the agreement, ArthroCare is
also to supply a microdermabrasion product and an RF liposuction product,
FDA approval of which increases the above minimum purchase and royalty
requirements.
In May 1999, the Company entered into a strategic alliance with
Advanced Tissue Sciences, Inc. ("ATS") under which the Company licenses for
development, marketing and sales five of ATS's human-based,
tissue-engineered products for surgical applications. As of December 31,
1999, the Company's total investment in the ATS strategic alliance was $10
million. Of this amount, $7.2 million was paid for licensing rights and the
remainder was paid for an aggregate of 1.3 million shares of common stock,
and warrants to purchase common stock, of ATS at a blended purchase and
exercise price of $8.90 per share. The Company is also obligated to pay ATS
an additional $2 million milestone payment for each of the marketed
products that receives FDA approval, up to $10 million in total for all of
the products. Finally, ATS is entitled to royalties from the Company on a
sliding scale based on overall product sales. The Company has agreed to
hold any investment in ATS common stock until at least October 2002.
The license payments made to date to ArthroCare and Advanced Tissue
are being amortized over the estimated lives of the license agreements. All
royalty payments under these arrangements will be expensed as marketing
costs.
General and Administrative Expenses. General and administrative
expenses for 1999 were $32.9 million, up $5.1 million or 18% from 1998. The
acquisition of Collagen Aesthetics Inc., and incremental administrative
expenses derived from this acquisition, account for approximately $3.5
million of this increase. The additional $1.6 million increase came
primarily from staffing upgrades. As a percentage of sales, general and
administrative expenses decreased by three percentage points, due primarily
to the increased operating leverage arising from higher sales.
Research and Development Expenses. Research and development
expenses were $10.3 million for 1999, up by $0.9 million or 10% from 1998.
Research and development expenses consist of ongoing research and
development expenses for new product development in all business units, as
well as necessary regulatory and clinical costs associated with testing and
approving new product introductions in the U.S. and throughout the world.
Operating Income. The Company's operating income for 1999 totaled
$43.7 million, an increase of $35.3 million or 417% over 1998. This
increase reflects the successful implementation of the restructuring
program initiated by the Company's senior management in 1998 and the
continuing strength of the Company's core product lines.
Interest Expense. Net interest and other financing expense totaled
$13.1 million in 1999, reflecting an increase of $9.3 million or 243% from
1998. This increase is primarily attributable to the financing of the
Collagen acquisition. Interest expenses for 1999 include $5.2 million to
amortize the fees and interest paid in connection with the bridge loan for
the Collagen acquisition and a one-time financing charge of $2 million
incurred in connection with the exercise of warrants to fund the litigation
settlement. Without these charges, net interest and other financing
expenses would have been $5.9 million for 1999.
Foreign Currency Exchange Gains and Losses. During the second
quarter of 1999, the Company converted current non-U.S. intercompany debts
among the Company's subsidiaries to the capital of the respective
subsidiaries. This minimized the Companies exposure to foreign currency
transaction gains and losses. For 1999, the Company's foreign exchange
translation resulted in a marginal gain of $255 as compared to a $686 gain
for 1998.
Income Taxes and Earnings Per Share. The Company reduced the
valuation allowance on the deferred tax asset based on pre-tax earnings in
1999. In order to provide investors with a perspective on its earnings per
share on a normalized basis, assuming the Company accrued taxes at a 33%
effective rate, and excluding $5.2 million of interest expense in 1999
arising from the financing fees associated with the Collagen acquisition,
the Company's earnings for 1999 would have been $1.62 per basic share and
$1.30 per diluted share.
Comparison of Years Ended December 31, 1998 and 1997
Net Sales. Net sales for 1998 were $131 million, reflecting an
increase of $25.2 million or 24% over 1997 net sales. Net sales in the U.S.
accounted for 65% of total net sales in 1998 and 63% of total net sales in
1997. International net sales accounted for 35% of total net sales in 1998
and 37% of total sales in 1997. The accelerated growth in 1998 in U.S.
sales was due primarily to the introduction of silicone gel-filled implants
for reconstructive and revision surgery, which improved the Company's
overall sales mix, as well as increased sales of the Company's anatomical
and smooth-round breast implants.
Cost of Goods Sold. Cost of goods sold for 1998 were $48 million,
reflecting a 28% increase over 1997. Cost of goods sold, as a percentage of
net sales, were 36% in 1998 as compared to 35% in 1997. The largest factor
in the variation from year to year in cost of goods sold as a percentage of
net sales are the cost of raw material and the yield of finished goods from
the Company's manufacturing facilities. Both factors were fairly stable in
1998 and 1997. In late 1998, the Company entered into a long-term strategic
alliance with its largest supplier of raw materials, which should result in
improved cost savings in the coming years.
Gross Profit. Gross profit for 1998 was $83.6 million, reflecting
an increase of $14.9 million or 22% over 1997. For 1998, gross profit as a
percentage of net sales decreased slightly to 64% down from 65% for 1997.
Marketing Expenses. Marketing expenses for 1998 were $33.4 million,
an increase of $3.4 million or 11% from 1997. 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. Marketing expenses are also affected by
the overhead associated with supporting various sales marketing functions,
and by participation in trade conventions and shows. In 1998, the Company
began efforts to reevaluate and, where appropriate, reduce these expenses
through budgeting and planning. As a result, marketing expenses declined as
a percentage of sales to 25% in 1998 from 28% in 1997.
General and Administrative Expenses. General and administrative
expenses for 1998 were $27.8 million, a decrease of $5.4 .million or 16%
from 1997. The Company's general and administrative expenses are affected
by overall headcount in various administrative functions and the legal,
accounting and other outside services which were necessary to defend the
breast implant litigation and negotiate a settlement. Also, in 1997,
general and administrative expenses were affected by the legal and
accounting costs necessary to complete the audits for 1996 and 1997. The
number and cost for employees engaged in general and administrative
positions increased in 1997 and early 1998, at a rate greater than the
increase in gross profit dollars. However, beginning with the
implementation of new management's restructuring plan in mid-1998, these
were reduced; thereby resulting in the significant decline in general and
administrative expenses for 1998 as compared to 1997. As a result, general
and administrative expenses declined as a percentage of sales to 21% in
1998 from 31% in 1997.
Research and Development Expenses. Research and development
expenses increased slightly for 1998 as compared to 1997; while as a
percentage of sales, research and development expenses were 7% in 1998 as
compared to 8% in 1997. The Company invested $3.5 million in 1998 and $2.4
million in 1997 at the Company's BioEnterics subsidiary in connection with
the development of obesity products.
Operating Income (Loss). The Company's operating loss for 1997
reflected the significant selling, general and administrative expenses
which the Company bore under prior management. Beginning in 1998, the
Company's new senior management team undertook a restructuring program
which was designed to reverse the Company's poor operating performance and
significantly improve the Company's operating margin. The positive results
of that program are reflected in the $12.7 million of operating profit
(excluding restructuring expense) for 1998.
Interest Expense. Net interest expense and other financing expense
was $3.8 million in 1998, reflecting a decline of $2.4 million from 1997.
This decrease is due to lower overall debt and reduced penalty charges. Net
interest expense of approximately $6.2 million in 1997 included penalty
charges totaling $1.6 million due to the prior management's' failure to
provide an effective registration statement to the holders of the Company's
4% convertible debentures issued earlier that year, offset by a reduction
in interest expense due to the retirement of $15 million of the Company's
11% senior secured convertible notes with the proceeds that had been held
in an escrow account. Additionally, in 1997, under prior management the
Company accrued (but did not pay) interest on approximately $9.9 million of
10.5% subordinated notes which were incurred primarily in the later half of
the year to fund the Company's working capital needs. In July 1998, the
Company converted all of those 10.5% subordinated notes into common stock;
and as of April 1998 all of the 4% debentures were converted into common
stock. In September 1998, the Company refinanced $19.6 million of senior
debt to extend the maturity from March 1999 to September 2000, and also
borrowed $8 million, at 10% interest rate, until the same date.
Foreign Currency Exchange Loss. Historically, the Company's
subsidiaries have incurred significant intercompany debts (totaling more
than $29 million for non-U.S. subsidiaries), which are eliminated in the
Company's consolidated financial statements. However, those intercompany
debts, which are denominated in various foreign currencies, give rise to
exchange adjustments. In 1998, the new management team evaluated various
alternatives for reducing the Company's foreign currency transaction
exposure, and concluded to convert substantially all of the non-U.S.
intercompany debts (particularly in countries with volatile local
currencies) to the capital of the respective subsidiaries. The fourth
quarter of 1997 included a provision of $1 million for expenses arising
from those debt conversions. Beginning in 1999, virtually all of the
Company's sales will be denominated in either dollars or euros.
Income Tax Expense (Benefit). The Company's tax expense in 1997
pertained primarily to foreign operations. In 1998 the Company had an
income tax benefit of $8.4 million which primarily pertained to the
recognition of an $8 million deferred tax asset based on an estimate of
short-term future forecasted taxable income. The Company's remaining
deferred tax asset of approximately $15.5 million has a 100% valuation
allowance.
Liquidity and Capital Resources
The Company has funded its cash needs since 1997 through a series
of debt and equity transactions and through cash from operations.
Liquidity. During 1998, the Company's senior management team
focused on reversing the significant negative cash flow of the prior two
years. Based on the operating profit and net income for 1998 and improved
inventory turns, net cash provided by operating activities totaled $2.7
million for 1998, as compared to net cash used in operating activities of
$13.9 million for 1997. This improvement is due to the Company's efforts to
reduce costs and inventory and thereby improve cash flow. As further
improvements in cost of goods, general and administrative expenses and
research and development expenses continue to take effect, together with
the reduction of redundant expenses attributable to the Company's
acquisition of Collagen, the Company believes that cash flow from
operations will continue to improve.
During 1999, net cash provided by operations was $29.3 million
compared to $2.7 million provided by operations in 1998. Positive cash from
operations was offset by $154.1 million used in investing activities of
which $138 million, net of cash received, was used for the purchase of
Collagen, $6.1 million was used for fixed asset purchases and $10 million
was used to fund strategic alliances in 1999. During the year, cash
provided by net financing activities of $134.7 million primarily related to
the Company's $155 million debt financing which was partially offset by the
breast implant litigation settlement and debt payments.
Capital Resources. In May 1999, the Company completed a $31.1
million equity financing, in which 5.4 million new shares of common stock
were issued to various holders of the Company's $5.50 and $7.50 litigation
warrants in exchange for the payment of $20.4 million of cash and the
surrender of $10.7 million of 11% junior notes. In July 1998, all of the
Company's 10.5% subordinated notes, including accrued interest, were
converted into 860,000 shares of common stock and a warrant to purchase
260,000 shares at $12.40 per share. At the time, the Company's common stock
was trading at approximately $7.50 per share.
On May 10, 1999, the Company announced that it made its final
payment of all monies owed to the court-appointed escrow agent on behalf of
the plaintiff class in the mandatory class action settlement of the breast
implant litigation. The payment was $29.9 million in cash, and consisted of
$25.5 million as full payment of the 6% promissory note the Company issued
in June 1998, $1.4 million in accrued interest on the note, and $3 million
to repurchase 426,323 shares of common stock which were also issued in June
1998 to the escrow agent. As a result of this payment, approximately $30
million of liabilities relating to the breast implant litigation that was
recorded on the Company's balance sheet as of the end of 1998 and the first
quarter of 1999 has now been eliminated.
On September 1, 1999, the Company borrowed $155 million under a
secured bridge loan facility and used $24 million of cash to finance the
Collagen acquisition and to repay $17 million of debt. This bridge facility
was refinanced in two parts. Approximately $78 million was retired in
November 1999 using the proceeds of a 2,950,000 share equity offering. The
remaining approximately $77 million was retired using the proceeds of a
credit facility placed in February 2000. The credit facility is comprised
of a five-year term loan of $82.5 million and a revolving credit line of
$25 million.
The term loans, advances under the revolving facility and the other
loans will bear interest at the rate of either (i) the one, two, three or
six-month London Interbank Offered Rate (LIBOR) plus an applicable margin
of 3.75% or (ii) prime rate plus an applicable margin of 2.75%. The
applicable margin is subject to change based on the Company's consolidated
leverage ratio. The term of the loan agreement is five years and the term
loans, revolving loans and other loans are guaranteed on a senior basis by
all of the Company's material U.S. subsidiaries and secured by a lien on
substantially all of the assets of the Company and its material U.S.
subsidiaries.
The Company anticipates that cash generated from its internal
operations, and borrowings under the revolving credit facility, will enable
it to meet liquidity, working capital and capital expenditure needs for the
next two years.
Capital Expenditures. Expenditures on property and equipment
approximated $6.1 million in 1999, compared to $3.7 million in 1998 and
$5.1 million in 1997. The majority of the expenditures in each period were
for building improvements, computer equipment and production equipment to
increase capacity and efficiency. During 2000 to 2001, the Company expects
to spend an aggregate of approximately $20 million above the Company's
normal annual capital expenditure level of approximately $6 million. This
new incremental spending will be used primarily to build new manufacturing
facilities.
Significant Fourth Quarter Adjustments, 1999
During the fourth quarter of the year ended December 31, 1999, the
Company released the remaining $7.2 million allowance on its deferred tax
asset.
Significant Fourth Quarter Adjustments, 1998
During the fourth quarter of the Company's 1998 fiscal year, the
Company recorded significant adjustments which increased net income by $6.2
million. The adjustments were to recognize an extraordinary charge of $1.8
million for the issuance of warrants in the restructuring of the Company's
11% notes which occurred in the fourth quarter. In addition, an income tax
benefit of $8 million was established to recognize a portion of the benefit
expected to be received from the Company's substantial net operating loss
carryforward.
Impact of Inflation
Management believes that inflation has had a negligible effect on
operations. The Company believes that it can offset inflationary increases
in the cost of materials and labor by increasing sales prices and improving
operating efficiencies.
Impact of Year 2000
To date, the Company has not experienced any negative impact
resulting from the date change to the year 2000 and the Company believes
this issue will not have a material impact on the Company's business,
results of operations or financial condition.
New Accounting Standards
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS No. 133"), which
requires entities to recognize all derivatives as either assets or
liabilities in the statement of financial position and measure these
instruments at fair value. SFAS No. 133 is effective for all fiscal years,
beginning after June 15, 2000. The adoption of SFAS No. 133 is not expected
to have a material impact on the Company's business, results of operations,
financial position or cash flows.
Risk and Uncertainties
The following risks and uncertainties should be considered in
evaluating our business, operating results, financial results and future
prospects. Our future profitability depends on the success of our principal
products
Sales of our breast implant, tissue expander and collagen-based
facial implant products account for a substantial majority of our net
sales. We expect our revenues to continue to be based primarily on sales of
these principal products. Adverse rulings by regulatory authorities,
product liability lawsuits, introduction of competitive products by third
parties, the loss of market acceptance or other adverse publicity for these
principal products may significantly and adversely affect our sales of
these products and, as a result, would adversely affect our business,
financial condition and results of operations.
OUR RECENT ACQUISITION OF COLLAGEN MAKES EVALUATING OUR OPERATING RESULTS
DIFFICULT
Our historical results of operations in this report give effect to
the Collagen acquisition from September 1, 1999 but otherwise do not give
effect to the operations of Collagen. The pro forma statements of
operations in this report are based primarily on the separate
pre-acquisition financial reports of Inamed and Collagen. Consequently, our
historical results of operations and pro forma financial information may
not give you an accurate indication of how we, together with Collagen, will
perform in the future.
WE HAVE BEEN PARTY TO SIGNIFICANT BREAST IMPLANT LITIGATION IN THE PAST AND
MAYBE PARTY TO THIS
TYPE OF LITIGATION IN THE FUTURE
We face an inherent business risk of exposure to product liability
claims alleging that the use of our technology or products has resulted in
adverse health effects. The risks of litigation exist even with respect to
products that have received or in the future may receive regulatory
approval for commercial sale. If we are unable to avoid significant product
liability claims, our business could be materially harmed. In particular,
the manufacture and sale of breast implant products entails significant
risk of product liability claims due to potential allegations of possible
disease transmission and other health factors, rupture or other product
failure and product recalls. The manufacture and sale of collagen-based
implant products also entails risks of product liability claims. In the
past, we were party to and settled claims related to our breast implant
products. In February 1999, we received final judicial approval of a
mandatory non-opt-out settlement relating to a class action lawsuit arising
from our silicone gel-filled and saline- filled breast implant products
that were implanted before June 1, 1993. Under the settlement, we paid an
aggregate amount of $31.5 million to a court appointed escrow agent on
behalf of the plaintiff class and $3.0 million to resolve a significant
indemnity claim by Minnesota Mining and Manufacturing Company (3M). This
settlement does not apply to our breast implant products, predominantly
saline-filled implants, that were implanted after June 1, 1993 or to
silicone gel- filled and saline-filled breast implants sold outside the
U.S. Although the time to take an appeal from the judicial order approving
the settlement has passed, we cannot assure you that this settlement will
not be collaterally attacked in state court for lack of jurisdiction or
constitutionally inadequate class notice or representation. We are not
aware of any pending or threatened collateral attacks to the settlement on
any grounds.
We also are currently engaged in ongoing breast implant litigation,
which we are defending in the normal course. As a result of our acquisition
of Collagen, we face exposure to claims regarding Trilucent breast implant
products which were distributed in Europe between January 1996 and March
1999, and which subsequently have been discontinued. Although we reserved a
total of $11.5 million as part of our discontinuation of the Trilucent
breast implant product in 1999 and recently purchased a medical expense
reimbursement policy to cover certain liabilities specifically relating to
the Trilucent breast implant product, this reserve and insurance policy may
be inadequate to cover all potential related liabilities.
OUR PRODUCTS EXPOSE US TO LIABILITIES THAT MAY NOT BE ADEQUATELY COVERED BY
INSURANCE AND OUR FINANCIAL RESULTS MAY SUFFER
In addition to the risks we face from product liability claims, we
are subject to the inherent risk that a government authority or third party
may require us to recall one or more of our products. We have liability
insurance that would cover a claim relating to the use or recall of our
products under a limited number of circumstances. In addition, a product
liability claim against us could exceed our insurance coverage. In the
event liability insurance would not sufficiently cover a product liability
claim or recall, these events could have a material adverse effect on our
business, financial condition and results of operations. Adequate product
liability insurance may not continue to be available, either at existing or
increased levels of coverage, on commercially reasonable terms or at all.
Even if a claim is covered by insurance, the costs of defending a product
liability, negligence or other action, and the assessment of damages in
excess of insurance coverage, could entail significant expense and damage
our reputation. We cannot assure you that our insurance will be broad
enough to protect us against all future claims, which could have a material
adverse effect on our business, financial condition and results of
operations. Further, liability claims relating to the use of our products
or a product recall could hurt our ability to obtain or maintain regulatory
approvals for our products.
CONCERNS ABOUT THE SAFETY AND EFFICACY OF OUR PRODUCTS AND ANY NEGATIVE
PUBLICITY COULD HARM OUR FINANCIAL RESULTS
Physicians and potential patients may have a number of concerns
about the safety and efficacy of our products, primarily our breast implant
products. The responses of potential patients, physicians, the news media,
legislative and regulatory investigatory bodies and others to information
about possible complications or alleged complications from our products
could result in negative publicity and could materially reduce market
acceptance of our products. These responses or investigations, and
potential resulting negative publicity, may have a material adverse effect
on our business, financial condition, results of operations or the market
price of our stock. In addition, significant negative publicity could
result in an increased number of product liability claims against us.
OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO SUBSTANTIAL FLUCTUATIONS AND
YOU SHOULD NOT RELY ON THEM AS AN INDICATION OF OUR FUTURE RESULTS
Our quarterly operating results may vary significantly due to a
combination of factors, many of which are beyond our control. These factors
include:
- - demand for our products, which historically has been the highest in the
second quarter;
- - our ability to meet the demand for our products;
- - increased competition;
- - the number, timing and significance of new products and product
introductions and enhancements by us and our competitors;
- - our ability to develop, introduce and market new and enhanced
versions of our products on a timely basis;
- - changes in pricing policies by us and our competitors;
- - the timing of significant orders and shipments; and
- - general economic factors.
Our recent acquisition of Collagen may make it more difficult for
us to evaluate and predict our future operating performance and we cannot
assure you that our operating performance will continue to improve. Our
expense levels are based, in part, on our expectations of future revenue
levels. If revenue levels are below expectations, operating results are
likely to be materially adversely affected. In particular, because only a
small portion of our expenses varies with revenue in the short term, net
income may be disproportionately affected by a reduction in revenue. Due to
the foregoing factors, quarterly revenue and operating results have been
and will continue to be difficult to forecast.
Based upon all of the foregoing, we believe that quarterly revenues
and operating results may vary significantly in the future and that
period-to-period comparisons of our results of operations are not
necessarily meaningful and should not be relied upon as indications of
future performance. We cannot assure you that our revenue will increase or
be sustained in future periods or that we will be profitable in any future
period. Any shortfall in revenue or earnings from levels expected by
securities or industry analysts could have an immediate and significant
adverse effect on the trading price of our common stock in any given
period.
CHANGES IN THE ECONOMY AND CONSUMER SPENDING COULD ADVERSELY AFFECT OUR
ABILITY TO SELL OUR PRODUCTS
Breast augmentations and collagen-based implants and injections are
elective procedures and are expensive. Other than U.S. federally mandated
insurance reimbursement for post-mastectomy reconstructive surgery, breast
augmentations and other cosmetic procedures are not typically covered by
insurance. A significant adverse change in the economy may cause consumers
to reassess their spending choices and reduce the demand for cosmetic
surgery. This shift could have an adverse effect on our ability to sell our
products and could materially harm our business.
IF WE ARE UNABLE TO CONTINUE TO DEVELOP AND MARKET NEW PRODUCTS AND
TECHNOLOGIES, WE MAY EXPERIENCE
A DECREASE IN DEMAND FOR OUR PRODUCTS OR OUR PRODUCTS COULD BECOME OBSOLETE,
AND OUR BUSINESS WOULD SUFFER
We believe that a crucial factor in the success of a new product is
obtaining the applicable regulatory approvals and marketing the new product
quickly to respond to new user needs or advances in medical technologies,
without compromising product quality. We are continually engaged in product
development and improvement programs. We cannot assure you that we will be
successful in enhancing existing products or developing new products or
technologies that will timely achieve regulatory approval or receive market
acceptance. To the extent that any of our competitors' products are
perceived to be superior to our products or are marketed sooner than ours,
demand for our products could decrease or our products could be rendered
obsolete. If one or more competing products or technologies achieve broader
market acceptance or render our products obsolete, we may lose customers
and revenues which could have a material adverse effect on our business,
financial condition and results of operations.
WE MAY NOT BE ABLE TO MEET UNANTICIPATED DEMAND FOR OUR PRODUCTS, WHICH COULD
CAUSE US TO LOSE REVENUES AND CUSTOMERS
Since the manufacturing processes for many of our products involve
long lead times, specialized production equipment and a significant degree
of human labor, if demand for our products increases in excess of our
capacity, we may not be able to meet this demand. If we cannot meet the
demand for our products, we may lose revenues and customers, which could
have a material adverse effect on our business, financial condition and
results of operations.
WE DEPEND ON A SINGLE SUPPLIER FOR OUR SILICONE RAW MATERIALS AND THE LOSS OF
THIS SUPPLIER COULD ADVERSELY AFFECT OUR ABILITY TO MANUFACTURE MANY OF OUR
PRODUCTS
We currently rely on a single supplier for silicone raw materials
used in many of our products. Although we have an agreement with this
supplier to transfer the necessary formulations to us in the event that
this supplier cannot meet our requirements, we cannot assure you that we
will be able to timely produce a sufficient amount of quality silicone raw
materials, if at all. In the event of a disruption, we currently anticipate
that we could require a period of approximately two months before our
silicone production facility could become operational. In addition, we may
not be able to quickly establish additional or replacement suppliers to
meet these needs. If we cannot produce or find replacement suppliers for
these materials, our ability to produce our products could be impaired and
we could lose customers and market share. Accordingly, the loss of this
supplier could have a material adverse effect on our business, financial
condition and results of operations.
OUR ABILITY TO SELL BOVINE COLLAGEN-BASED PRODUCTS COULD BE ADVERSELY AFFECTED
IF WE EXPERIENCE
PROBLEMS WITH THE CLOSED HERD OF DOMESTIC CATTLE FROM WHICH WE DERIVE THESE
PRODUCTS
We rely on a closed herd of domestic cattle that is kept apart from
all other cattle for the production of our bovine collagen-based products.
In the event of any material diminution in the size of our herd for any
reason, including accident or disease, we would have a limited ability to
quickly increase the supply of acceptable cattle and our bovine-based
products from a similarly segregated source. Further, any stray cattle that
enter our herd could infect our cattle and could affect the purity of our
cattle through mating. The diminution in size or infection of our cattle
could have a material adverse effect on our ability to sell bovine
collagen- based products and, as a result, a material adverse effect on our
business, financial condition and results of operations.
COMPETITION MAY ERODE OUR MARKET SHARE AND REDUCE OUR PROFITABILITY
The markets for many of our products are competitive. In addition,
some of our competitors may be larger or may have greater resources to
devote to new product development, clinical trials, selling and marketing.
Customers may perceive these new products to be more effective,
technologically advanced, clinically safer or otherwise more appealing,
which may cause our products to be rendered noncompetitive or obsolete. In
addition, our competitors may succeed in obtaining regulatory approvals for
competing products faster than us. This would permit our competitors to
introduce their competing products to the market before us and as a result
we may lose market share and experience reduced margins. If we do not
effectively compete with our competitors, our profitability may be
materially affected. We cannot assure you that we will be able to
effectively compete in the future.
OUR INTERNATIONAL BUSINESS EXPOSES US TO A NUMBER OF RISKS
More than one-third of our net sales are derived from international
operations. Accordingly, any material decrease in foreign sales may have a
material adverse effect on our business, financial condition and results of
operations. Most of our international sales are denominated in U.S.
dollars, euros or yen. Depreciation or devaluation of the local currencies
of countries where we sell our products may result in our products becoming
more expensive in local currency terms, thus reducing demand. We
manufacture some of our breast implant products in Ireland and plan to
begin manufacturing some breast implant products in Costa Rica this year.
Therefore, some of our operating expenses are denominated in currencies
other than the U.S. dollar. We cannot assure you that we will not
experience unfavorable currency fluctuation effects in future periods,
which could have an adverse effect on our operating results. Our operations
and financial results also may be significantly affected by other
international factors, including: - the imposition of additional foreign
government controls or regulations on medical devices; - new export license
requirements; - political instability, inflation or negative economic
growth in our target markets; - trade restrictions; - changes in tariffs;
and - difficulties in managing international operations.
WE ARE SUBJECT TO SUBSTANTIAL GOVERNMENT REGULATION, WHICH COULD MATERIALLY
ADVERSELY AFFECT OUR BUSINESS
The production and marketing of our products and our ongoing
research and development, preclinical testing and clinical trial activities
are subject to extensive regulation and review by numerous governmental
authorities both in the U.S. and abroad. Most of the medical devices we
develop must undergo rigorous preclinical and clinical testing and an
extensive regulatory approval process administered by the Food and Drug
Administration under the Food, Drug, and Cosmetic Act and comparable
foreign authorities before they can be marketed. Unless an exemption
applies, each medical device that we wish to market in the U.S. must
receive either a "510(k)" clearance or a premarket approval (PMA) from the
FDA. In order to be commercially distributed throughout the European
Community, a medical device must bear a CE conformity marking, indicating
that it conforms with the essential requirements of the applicable European
Medical Devices Directive. These regulations govern the testing, marketing
and registration of new medical devices, in addition to regulating
manufacturing practices, labeling and record keeping procedures. This
process makes it longer, harder and more costly to bring our products to
market, and we cannot assure you that any of our products will be approved.
If we do not comply with applicable regulatory requirements it can result
in warning letters, non-approval, suspensions of regulatory approvals,
civil penalties and criminal fines, product seizures and recalls, operating
restrictions, injunctions and criminal prosecution.
Delays in or rejection of FDA approval of our products may be
encountered due to, among other reasons, regulatory review of each new
device application or product license application we submit, as well as
changes in regulatory policy during the period of product development both
in the U.S. and abroad. Even if regulatory approval of a product is
granted, this approval may entail limitations on uses for which the product
may be labeled and promoted. Further, for a marketed product, its
manufacturer and the facilities in which the product is manufactured are
subject to continual review and inspection. Later discovery of previously
unknown problems with a product, manufacturer or facility may result in
restrictions on the product, manufacturer or facility, including withdrawal
of the product from the market or other enforcement actions.
WE MAY FAIL TO MAINTAIN THE REGULATORY APPROVAL NECESSARY TO CONTINUE LEGALLY
MARKETING OUR SALINE-FILLED BREAST IMPLANT PRODUCT
Our saline-filled breast implant products are being marketed in the
U.S. based upon substantial equivalence to other saline-filled breast
implant products that were in commercial distribution before May 28, 1976.
In mid-August 1999, the FDA issued regulations that eliminated this
"grandfather" status and require all manufacturers of saline-filled breast
implant products to obtain PMA approval in order to enter or remain in the
market.
Pursuant to the PMA action, any manufacturer wishing to continue
marketing a saline-filled implant in the U.S. had to file an application
for PMA of such product by November 17, 1999. Any manufacturer that failed
to have a PMA application accepted for filing by that date lost its 510(k)
clearance and, as of that date, had to cease distributing such products in
the U.S. We were among the three manufacturers whose PMA applications for a
saline-filled implant were accepted. In accordance with FDA rules, each of
these applications was referred to an FDA advisory panel on general and
plastic surgery. The advisory panel met in open session on March 1-3, 2000
to consider the applications. The advisory panel recommended FDA approval
of two of them, including our application. Under FDA regulations, we expect
the FDA to act on these recommendations in May, 2000. The FDA could accept
or reject the advisory panel's recommendation. If the FDA declines to
accept our PMA application, the FDA could require us to cease marketing our
saline- filled breast implant product pending further FDA review. In
addition, the FDA ultimately could find our PMA application not approvable,
which would preclude us from commercial distribution of this product in the
U.S. Our failure to obtain approval of our PMA application would have a
material adverse effect on our business, financial condition and results of
operations.
FUTURE LEGISLATION OR REGULATIONS RELATING TO US OR OUR PRODUCTS COULD
MATERIALLY ADVERSELY AFFECT OUR BUSINESS
If any national healthcare reform or other legislation or
regulations are passed that impose limits on the number or type of medical
procedures that may be performed or that have the effect of restricting a
physician's ability to select specific products for use in his or her
procedures, it could have a material adverse effect on the demand for our
products. In the U.S., there have been, and we expect that there will
continue to be, a number of federal and state legislative proposals and
regulations to implement greater governmental control on the healthcare
industry. These proposals create uncertainty as to the future of our
industry and may have a material adverse effect on our ability to raise
capital or to form collaborations, and the enactment of these reforms could
have a material adverse effect on our business, financial condition and
results of operations. In a number of foreign markets, the pricing and
profitability of healthcare products are subject to governmental influence
or control. In addition, legislation or regulations that impose
restrictions on the price that may be charged for healthcare products or
medical devices may adversely affect our business, financial condition and
results of operations. From time to time, legislation or regulatory
proposals are introduced and discussed which could alter the review and
approval process relating to medical device products.
IF WE ARE UNABLE TO HIRE AND RETAIN KEY PERSONNEL, OUR BUSINESS AND GROWTH
WILL SUFFER
We are dependent on a limited number of key management, technical
and sales personnel, the loss of any one of which could have a material
adverse effect on our business, financial condition and results of
operations. Our future success will depend in part upon our ability to
attract and retain highly qualified personnel. We compete for these
personnel with other companies, academic institutions, government entities
and other organizations. We cannot assure you that we will be successful in
hiring or retaining qualified personnel. Our inability to attract and
retain key employees could have a material adverse effect on our business,
financial condition and results of operations.
WE USE PRODUCTS IN THE MANUFACTURING PROCESS WHICH MAY BE HAZARDOUS TO THE
ENVIRONMENT IF NOT HANDLED PROPERLY, WHICH EXPOSES US TO ADDITIONAL LIABILITY
We are subject to foreign and domestic laws and regulations
relating to the protection of the environment. Our business involves the
handling, storage and disposal of materials that are classified as
hazardous. Although our safety procedures for handling, storage and
disposal of these materials are designed to comply with the standards
prescribed by applicable laws and regulations, we cannot assure you that we
will not be held liable for any damages that result, and any related
liability could have a material adverse effect on our business, financial
condition and results of operations. Further, we cannot assure you that the
cost of complying with these laws and regulations will not increase
materially in the future.
WE ARE UNCERTAIN ABOUT THE STATUS OF SOME OF OUR PATENTS AND PROPRIETARY
TECHNOLOGY AND ARE INVOLVED IN PATENT LITIGATION WHICH, IF DETERMINED ADVERSELY
TO US, COULD HARM OUR RESULTS OF OPERATIONS
Our success will depend, in part, on our ability and our licensors'
ability to obtain, assert and defend our patents, protect our trade secrets
and operate without infringing the proprietary rights of others. We protect
our proprietary technology through a combination of confidentiality
agreements and patents. We cannot assure you that our owned and licensed
patents, products and technology will prove to be enforceable or that our
products and technology do not infringe the patents or proprietary rights
of others. We could also incur substantial costs in seeking enforcement of
our proprietary rights against infringement or in defending ourselves
against claims of infringement by others. Since much of our technology
consists of trade secrets and unpatented know-how, we are exposed to the
risk that others will independently develop similar or superior products or
technologies or that our trade secrets or know-how will become known to
others.
We license some of our products and technology under patents owned
by others. In 1998, we reviewed our portfolio of patents and licenses and
determined in several situations that licensed patents either were invalid,
were unenforceable, were not being utilized or that the licensor had
breached its obligations to us. Accordingly, we ceased paying several
million dollars in annual royalties under several license agreements. We
are currently engaged in litigation with several former licensors over the
recovery of past royalties that were paid and our potential future
obligations. One of these litigation matters subject to an executed
agreement among counsel to settle on terms that will not have a material
adverse impact on us. If these proceedings are determined against us, we
may be liable for a significant amount of past unpaid and potential future
royalty or other contract payments, which could include a significant
amount of damages, interest and enhanced damages if we are found to have
willfully infringed the patents after ceasing royalty payments, and
ultimately may be prohibited from using the patented technology.
HISTORICALLY, OUR STOCK PRICE HAS BEEN VOLATILE AND OUR TRADING VOLUME
HAS BEEN LOW
The market prices for securities of medical device companies have
historically been highly volatile. Broad market fluctuations may have a
material adverse effect on the market price of our common stock. The
trading price of our common stock has been, and may be, subject to wide
fluctuations in response to a number of factors, many of which are beyond
our control. These factors include:
- - quarter-to-quarter variations in our operating results;
- - the results of testing, technological innovations or new
commercial products by us or our competitors;
- - governmental regulations, rules and orders;
- - general conditions in the healthcare, medical device or
plastic surgery industries;
- - changes in our earnings estimates by securities analysts;
- - developments concerning patents or other proprietary rights; and
- - litigation or public concern about the safety of our products.
Historically, the daily trading volume of our common stock was
relatively low. On September 30, 1999, our common stock began trading on
the Nasdaq National Market. Since that time, the average trading volume of
our common stock has increased. We cannot assure you that an active public
market for our common stock will be sustained or that the average trading
volume will remain at present levels or increase.
AS A RESULT OF THEIR OWNERSHIP OF OUR COMMON STOCK, OUR EXECUTIVE OFFICERS,
DIRECTORS AND AFFILIATES MAY EXERCISE SIGNIFICANT INFLUENCE OVER OUR CORPORATE
DECISIONS CONTRARY TO THE INTERESTS OF OTHER STOCKHOLDERS
Following our November 1999 public equity offering, our executive
officers, directors and affiliates beneficially owned approximately 33% of
our common stock. Accordingly, these stockholders have significant
influence with respect to any corporate transaction or other matter
submitted to the stockholders for approval, including mergers,
consolidations and the sale of all or substantially all of our assets.
Third parties may be discouraged from making a bid or tender offer to
acquire us because of this concentration of ownership.
OUR CERTIFICATE OF INCORPORATION, BY-LAWS, RIGHTS PLAN AND DELAWARE LAW MAKE IT
DIFFICULT FOR A THIRD PARTY TO ACQUIRE US, DESPITE THE POSSIBLE BENEFIT TO OUR
STOCKHOLDERS
Our certificate of incorporation, bylaws and Delaware law include
provisions that may have the effect of discouraging a third party from
pursuing a non-negotiated takeover of our company and preventing specific
changes of control. In addition, our board of directors has adopted a
stockholders' rights plan providing for discount purchase rights to some of
our stockholders upon some acquisitions of our common stock. The exercise
of these rights is intended to inhibit specific changes of control of
Inamed. In addition, we have entered into agreements with our senior
executive officers under which they could receive substantial payments in
connection with a change of control of our company.
SHARES ELIGIBLE FOR FUTURE SALE BY OUR CURRENT STOCKHOLDERS OR EMPLOYEES MAY
ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK
At March 20, 2000, there were 20,410,500 shares of our common stock
outstanding and 4,139,889 shares of our common stock issuable upon the
exercise of outstanding options and warrants. Once vested, the options and
warrants generally may be exercised at any time. On February 14, 2000, we
entered into a Letter Agreement with several affiliates of Appaloosa
Management L.P. which own shares of our common stock and warrants to
purchase shares of our common stock. Pursuant to the Letter Agreement, we
agreed, following March 17, 2000 (the effective date of the registration
statement we filed on February 14, 2000 with respect to 2,000,000 shares of
our common stock owned by the several affiliates of Appaloosa Management)
to file one or more additional registration statements, and to use our best
efforts to cause those registration statements to be declared effective
under the Securities Act, with respect to the remaining shares of common
stock beneficially owned by those affiliates of Appaloosa Management. These
filings may be made over a maximum of four subsequent periods of
approximately 45 days each, and in any event no later than December 31,
2000. Certain of our outstanding warrants or warrant agreements provide for
anti-dilution adjustment upon the occurrence of certain events, including
certain issuances by us of shares of common stock, or warrants to purchase
shares of our common stock or other rights to purchase common stock, for
consideration or at an exercise price which is less than the current market
price of our common stock (defined in these warrants as the daily volume
weighted average sale price per share of our common stock for the 20
business days ending five days before the date of determination). The
issuance or sale of a significant number of shares of our capital stock,
whether in connection with the exercise of a significant number of
outstanding options or warrants, the possible operation of these
anti-dilution provisions in some of our warrants or otherwise, could dilute
the percentage interest of our other stockholders now or in the future or
adversely affect the market price of our common stock.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Company conducts operations and/or business in various foreign
countries throughout the world. Global and regional economic factors and
potential changes in laws and regulations affecting the Company's business,
including without limitation, currency fluctuations, changes in monetary
policy and tariffs, and federal, state and internationals laws, could
impact the Company's financial condition or future results of operations.
The Company does not currently conduct any hedging activities.
Item 8. Financial Statements and Supplementary Data.
The Financial Statements appear at pages F-1 to F-33.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
Item 10. Directors and Officers of the Company.
The information required in this item is incorporated herein by
reference to portions of the Proxy Statement for Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission within
120 days of the close of the fiscal year ended December 31, 1999.
Item 11. Executive Compensation.
The information required in this item is incorporated herein by
reference to portions of the Proxy Statement for Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission within
120 days of the close of the fiscal year ended December 31, 1999.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required in this item is incorporated herein by
reference to portions of the Proxy Statement for Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission within
120 days of the close of the fiscal year ended December 31, 1999.
Item 13. Certain Relationships and Related Transactions.
The information required in this item is incorporated herein by
reference to portions of the Proxy Statement for Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission within
120 days of the close of the fiscal year ended December 31, 1999.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Current
Reports on Form 8-K.
(a)(1) Financial Statements
(a)(1) Consolidated Financial Statements:
Report of Independent Accountants F-1
Consolidated Balance Sheets as of December 31, 1999 and 1998 F-2
Consolidated Statements of Operations for the years ended
December 31, 1999, 1998 and 1997 F-4
Consolidated Statements of Stockholders' Equity (Deficiency)
for the years ended December 31, 1999, 1998 and 1997 F-6
Consolidated Statements of Cash Flows for the years ended
December 31, 1999, 1998 and 1997 F-7
Notes to Consolidated Financial Statements F-9
a)(2) Consolidated Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts F-33
All other schedules are omitted because the required information is not
present or is not required.
(a)(3) Exhibits
The following exhibits are filed as part of this Annual Report
on Form 10-K:
Exhibit
No. Description
2.1 Agreement and Plan of Merger dated as of December
22, 1998 by and between Inamed Corporation and
Inamed Corporation (Delaware). (Incorporated herein
by reference to Exhibit 2.1 of the Registrant's
Current Report on Form 8-K filed with the
Commission on December 30, 1998.)
2.2 Agreement and Plan of Merger, dated as of July 31,
1999, by and among Inamed Corporation, Inamed
Acquisition Corporation and Collagen Aesthetics,
Inc. (Incorporated herein by reference to Exhibit
(c)(1) to Schedule 14D-1 filed by Inamed
Corporation and Inamed Acquisition Corporation with
the Commission on August 4, 1999.)
3.1 Registrant's Restated Certificate of Incorporation,
as amended December 22, 1998. [Incorporated herein
by reference to Exhibit 3.1 of the Registrant's
Annual Report on Form 10- K for the year ended
December 31, 1998 (Commission File No. 1-9741).]
3.2 Registrant's By-Laws, as amended December 22, 1998
[Incorporated herein by reference to Exhibit 3.2 of
the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1998 (Commission File No.
1-9741).]
4.1 Specimen Stock Certificate for Inamed Corporation
Common Stock, par value $0.01 per share.
[Incorporated herein by reference to Exhibit 3.3 of
the Company's Annual Report on Form 10-K for the
year ended December 31, 1995 (Commission File No.
0-7101).]
4.2 Form of Registration Rights Agreement.
(Incorporated herein by reference to Exhibit 10.6
of the Company's Financial Report on Form 10-K for
the year ended December 31, 1997.)
4.3 Registration Rights Agreement, dated as of
September 30, 1998. (Incorporated herein by
reference to Exhibit 99.10 of the Company's Current
Report on Form 8-K filed with the Commission on
October 15, 1998.)
4.4 Registration Rights Agreement by and between Inamed
Corporation and Santa Barbara Bank and Trust, as
trustee, dated as of November 5, 1998.
(Incorporated herein by reference to Exhibit 99.9
of the Company's Current Report on Form 8-K filed
with the Commission on November 19, 1998.)
4.5 Amended and Restated Rights Agreement, dated as of
November 16, 1999, by and between Inamed
Corporation and U.S. Stock Transfer Corporation, as
Rights Agent. (Incorporated herein by reference to
Exhibit 4.1 of the Registrant's Current Report on
Form 8-K filed with the Commission on November 19,
1999.)
4.6 Form of Amendment No. 1 to Amended and Restated
Rights Agreement, dated as of December 22, 1999, by
and among Inamed Corporation, Appaloosa Management
L.P. and U.S. Stock Transfer Corporation, as Rights
Agent. (Incorporated by reference to Exhibit 4.1 of
the Registrant's Current Report on Form 8-K filed
with the Commission on December 30, 1999.)
10.1 Form of Inamed Corporation 4% Convertible
Debenture. (Incorporated herein by reference to
Exhibit 10.5 of the Company's Financial Report on
Form 10-K for the year ended December 31, 1996.)
10.2 Form of Convertible Debenture Agreement.
(Incorporated herein by reference to Exhibit 10.7
of the Company's Financial Report on Form 10-K for
the year ended December 31, 1996.)
10.3 Loan Agreement, dated as of September 1, 1999,
by and among Inamed Corporation and Inamed
Acquisition Corporation, as Borrowers, the Initial
Lenders named therein, as Initial Lenders, and
Ableco Finance LLC, as Administrative Agent.
(Incorporated herein by reference to Exhibit 4.1 of
the Registrant's Current Report on Form 8-K filed
with the Commission on September 15, 1999.)
10.4 Employment Agreement, dated January 23, 1998, by
and between Richard G. Babbitt and Inamed
Corporation and other related agreements.
(Incorporated herein by reference to Exhibit 10.1
of the Registrant's Current Report on Form 8-K
filed with the Commission on November 19, 1999.)
10.5 Employment Agreement, dated January 22, 1998, by
and between Ilan K. Reich and Inamed Corporation
and other related agreements. (Incorporated by
reference to Exhibit 10.2 of the Registrant's
Current Report on Form 8-K filed with the
Commission on November 19, 1999.)
10.6 Form of Warrant for Senior Executive Officers.
(Incorporated by reference to Exhibit 10.3 of the
Registrant's Current Report on Form 8-K filed with
the Commission on November 19, 1999).
21 Registrant's Subsidiaries.
23.2 Consent of BDO Seidman, LLP.
23.3 Consent of Ernst & Young LLP, independent auditors.
24 Power of Attorney.
27 Financial Data Schedule.
99.1 Order and Final Judgment Certifying Inamed
Settlement Class, Approving Class Settlement, and
Dismissing Claims against Inamed and Released
Parties dated February 1, 1999. [Incorporated
herein by reference to Exhibit 99.1 of the
Company's Financial Report on Form 10-K for the
year ended December 31, 1998 (Commission File No.
1-9741).]
99.2 Order Instituting Proceedings Pursuant to Section
21C of the Securities Exchange Act of 1934, Making
Findings and Imposing a Cease-and-Desist Order
dated August 17, 1999 (Administrative Proceeding
File No. 3-9976).
99.3 Offer of Settlement of Inamed Corporation dated
July 21, 1999.
(b) Current Reports on Form 8-K
Form 8-K dated February 1, 1999
Form 8-K dated March 4, 1999
Form 8-K dated March 19, 1999
Form 8-K dated April 2, 1999
Form 8-K dated May 10, 1999
Form 8-K dated September 15, 1999
Form 8-K dated November 19, 1999
Form 8-K dated December 30, 1999
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, on March 30, 2000.
INAMED CORPORATION
By: /s/ Richard G. Babbitt
-----------------------------
Richard G. Babbitt,
Chairman of the Board
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities indicated
and on the date indicated.
/s/ Richard G. Babbitt Chairman of the Board of March 30, 2000
Directors and Chief Executive
Officer (Principal Executive
Officer)
/s/ James E. Bolin Director March 30, 2000
/s/ John F. Doyle Director March 30, 2000
/s/ Malcolm R. Currie, PhD Director March 30, 2000
/s/ Ilan K. Reich Director, President and March 30, 2000
Co-Chief Executive Officer
/s/ Mitchell S Rosenthal, MD Director March 30, 2000
/s/ David A. Tepper Director March 30, 2000
/s/ Michael J. Doty Senior Vice President March 30, 2000
and Chief Financial
Officer (Principal
Financial and
Accounting Officer)
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Stockholders and Board of Directors
Inamed Corporation and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Inamed
Corporation and Subsidiaries as of December 31, 1999 and 1998, and the
related consolidated statements of operations, stockholders' equity
(deficiency) and cash flows for each of the three years in the period ended
December 31, 1999. We have also audited the schedule listed in the
accompanying index for the same periods. These financial statements and
schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and
schedule are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
financial statements and schedule. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall presentation of the financial statements and
schedule. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Inamed
Corporation and Subsidiaries at December 31, 1999 and 1998, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1999, in conformity with generally accepted
accounting principles. Also, in our opinion, the schedule presents fairly,
in all material respects, the information set forth therein for each of the
three years in the period ended December 31, 1999.
BDO Seidman, LLP
New York, New York
January 21, 2000, except
with respect to Note 5(c),
which is as of February 1, 2000
<TABLE>
<CAPTION>
INAMED CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31,
<S> <C> <C>
Assets 1999 1998
Current Assets:
Cash and cash equivalents $17,519 $11,873
Trade accounts receivable, net of allowances for
doubtful accounts and returns of $6,425
and $6,158 44,379 23,169
Inventories 25,332 17,855
Prepaid expenses and other current assets 4,660 1,337
Tax refund receivable 220 726
Deferred income taxes 32,794 8,000
Total current assets 124,904 62,960
Property and equipment, at cost:
Machinery and equipment 21,568 14,170
Furniture and fixtures 6,377 3,418
Leasehold improvements 14,570 11,986
42,515 29,574
Less, accumulated depreciation and amortization (18,405) (16,751)
Net property and equipment 24,110 12,823
Notes receivable, net of allowances of $467 2,681 2,769
Intangible assets, net 142,335 1,015
Other assets 15,409 1,140
Total assets $309,439 $80,707
</TABLE>
See accompanying notes to consolidated financial statements.
<TABLE>
<CAPTION>
INAMED CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31,
<S> <C> <C>
1999 1998
Liabilities and Stockholders' Equity (Deficiency)
Current liabilities:
Current installments of long-term
debt and capital leases $ 54 $ 51
Notes payable to bank 1,079 1,186
Accounts payable 16,716 12,226
Accrued liabilities:
Salaries, wages, and payroll taxes 8,369 2,681
Interest 1,211 2,032
Self-insurance 5,102 3,649
Acquisition and integration costs 16,055 --
Other 5,130 4,523
Royalties payable 4,813 5,061
Acquired liabilities 7,724 --
Income taxes payable 18,729 1,318
Accrued litigation 2,450 5,721
Note payable, escrow agent -- 25,500
Total current liabilities 87,432 63,948
Long-term debt and capital leases 77,196 27,767
Acquired liabilities 5,448 --
Long-term acquisition and integration costs 1,745 --
Deferred grant income 2,019 1,235
Deferred income taxes 1,478 382
Redeemable common stock, $.01 par value
426,323 shares issued and outstanding
stated at redemption value $7.04 per share -- 3,000
Stockholders' equity (deficiency):
Common stock, $.01 par value. Authorized 25,000,000
shares; issued and outstanding 20,200,114
and 11,010,290 202 110
Additional paid-in capital 152,779 37,605
Accumulated other comprehensive adjustments (4,005) 269
Accumulated deficit (14,855) (53,609)
Stockholders' equity (deficiency) 134,121 (15,625)
Total liabilities and stockholders' equity $309,479 $ 80,707
</TABLE>
See accompanying notes to consolidated financial statements.
<TABLE>
INAMED CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 1999, 1998 and 1997
1999 1998 1997
<S> <C> <C> <C>
Net sales $ 189,295 $ 131,566 $ 106,381
Cost of goods sold 57,553 47,954 37,643
Gross profit 131,742 83,612 68,738
Operating expense:
Marketing 43,119 33,364 30,002
General and administrative 32,890 27,839 33,210
Research and development 10,324 9,366 8,863
Restructuring expense -- 4,202 --
Amortization of intangible
assets 1,661 374 240
---------- --------- ---------
Total operating expenses 87,994 75,145 72,315
Operating profit (loss) 43,748 8,467 (3,577)
Other income (expense):
Litigation settlement -- -- ( 28,150)
Net interest expense and
debt costs (13,080) (3,812) (6,173)
Foreign currency transactions
gains (losses) 255 686 (1,796)
Royalty income and other 1,371 -- --
Other expense (11,454) (3,126) (36,119)
Income (loss) before income tax
expense (benefit) and
extraordinary charges 32,294 5,341 (39,696)
Income tax (benefit) expense (6,460) (8,432) 1,881
Income (loss) before
extraordinary charges 38,754 13,773 (41,577)
Extraordinary charges -- (1,800) --
Net income (loss) $ 38,754 $ 11,973 $(41,577)
</TABLE>
See accompanying notes to consolidated financial statements.
<TABLE>
INAMED CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations, continued
1999 1998 1997
Income (loss) before extraordinary charges
per share of common stock
<S> <C> <C> <C>
Basic $ 2.51 $ 1.33 $ (4.97)
Diluted $ 2.03 $ 1.05 $ (4.97)
Loss from extraordinary charges
per share of common stock
Basic $ (0.00) $ (0.18) $ (0.00)
Diluted $ (0.00) $ (0.13) $ (0.00)
Net income (loss) per share of common stock
Basic $ 2.51 $ 1.15 $ (4.97)
Diluted $ 2.03 $ 0.92 $ (4.97)
Weighted average shares outstanding:
Basic 15,466,232 10,387,163 8,371,399
Diluted 19,058,287 14,185,244 8,371,399
</TABLE>
See accompanying notes to consolidated financial statements.
<TABLE>
Accumulated Total
Additional Other Shareholders'
Common Stock Paid In Comprehensive Accumulated Equity
Shares Amount Capital Adjustments Deficit (Deficiency)
<S> <C> <C> <C> <C> <C> <C>
January 1, 1997 8,037 80 13,586 431 (24,005) (9,908)
Comprehensive income:
Net income -- -- -- -- (41,577) (41,577)
Transition adjustment -- -- -- (654) -- (654)
Total comprehensive
Income -- -- -- -- -- (42,231)
Repurchases and
Retirement of
Common Stock (11) -- (55) -- -- (55)
Issuance of common stock
(exercise of stock options) 71 1 102 -- -- 103
Issuance of common stock
(conversions of debt to
equity) 616 6 2,261 -- -- 2,267
Issuance of common stock
(waiver of covenant
defaults) 172 2 1,415 -- -- 1,417
Issuance of warrants &
Options -- -- 1,718 -- -- 1,718
Balance, December 31,
1997 8,885 89 19,027 (223) (65,582) (46,689)
Comprehensive income
(loss):
Net income -- -- -- -- 11,973 11,973
Translation adjustment -- -- -- 492 -- 492
Total comprehensive
Income -- -- -- -- -- 12,645
Issuance of common stock
(Exercise of stock
Options) 33 -- 47 -- -- 47
Issuance of common stock
(conversions of debt
to equity) 1,990 20 15,188 -- -- 15,208
Issuance of common stock 102 1 555 -- -- 556
Issuance of Warrants &
Options -- -- 2,788 -- -- 2,788
Balance, December 31,
1998 11,010 110 37,605 269 (53,609) (15,625)
Comprehensive income
(loss): -- -- -- -- 38,754 38,754
Translation adjustment -- -- -- (4,274) -- (4,274)
Total comprehensive
Income -- -- -- -- -- 34,480
Repurchase and retirement
Of stock (1) -- -- -- -- --
Issuance of common
stock
(exercise of
stock options
and warrants) 375 4 10 -- -- 14
Issuance of common
stock
(conversions of debt
to equity) 1,717 17 10,683 -- -- 10,700
Issuance of common
stock
(exercise of
warrants) 3,723 37 23,203 -- -- 23,240
Issuance of common
stock
(equity offering) 2,950 30 78,282 -- -- 78,312
Issuance of common
stock
(settlement of
litigation) 426 4 2,996 -- -- 3,000
Balance, December 31,
1999 20,200 $ 202 $ 152,779 $(4,005) $(14,855) $134,121
</TABLE>
See accompanying notes to consolidated financial statements
INAMED CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 1999, 1998 and 1997
<TABLE>
1999 1998 1997
Cash flows from operating activities:
<S> <C> <C> <C>
Net income (loss) $ 38,754 $ 11,973 $(41,577)
Net cash provided by (used for)
operating activities:
Depreciation and amortization 7,477 3,769 2,379
Non-cash debt costs 1,977 2,538 1,487
Non-cash compensation 160 250 231
Provision (credits) for doubtful accounts,
notes and returns (81) 936 (785)
Provision for obsolescence of inventory 1,142 156 264
Deferred income taxes (8,147) (8,104) (35)
Changes in current assets and liabilities:
Trade accounts receivable (8,361) (9,471) (3,265)
Notes receivable 88 (150) (101)
Inventories 1,407 5,659 (4,491)
Prepaid expenses and other
current assets (2,785) (174) (294)
Other assets (568) (636) (105)
Accounts payable, accrued and other
liabilities (2,336) 633 3,116
Income taxes payable 3,801 (1,612) 1,091
Accrued litigation settlement (3,271) (3,114) 28,183
_________ _________ _________
Net cash provided by (used
for) operating activities 29,257 2,653 (13,902)
_________ _________ _________
Cash flows from investing activities:
Disposal of fixed assets -- 1,621 --
Purchase of Collagen, net of cash
acquired (137,969) -- --
Investment in ATS (10,000) -- --
Purchase of property and equipment (6,106) (3,678) (5,106)
_________ _________ _________
Net cash used in
investing activities (154,075) (2,057) (5,106)
_________ _________ _________
</TABLE>
Continued
INAMED CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows (continued)
<TABLE>
1999 1998 1997
<S> <C> <C> <C>
Cash flows from financing activities:
Restricted cash in escrow for litigation
settlement $ -- $ -- $ 14,796
Increases in notes payable and long-
term debt 155,000 638 --
Increases in convertible notes payable
and debentures payable -- 8,000 5,648
Principal repayment of notes payable
and long-term debt (120,475) -- (13,816)
Decrease in related party receivables -- 128 105
Increase in related party payables -- 1,038 8,813
Grants received, gross 784 308 --
Issuance of common stock 102,429 104 48
Redemption of common stock (3,000) -- --
Net cash provided by financing activities 134,738 10,216 15,594
Effect of exchange rate changes on cash (4,274) (885) 4,437
Net increase in cash
and cash equivalents 5,646 9,927 1,023
Cash and cash equivalents at beginning of
year 11,873 1,946 923
Cash and cash equivalents at end of year $ 17,519 $ 11,873 $ 1,946
Supplemental disclosure of cash flow
information:
Cash paid during the year for:
Interest $ 12,653 $ 4,562 $ 3,745
Income taxes $ 1,653 $ 1,138 $ 988
</TABLE>
See accompanying notes to consolidated financial statements.
(1) 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 Company
Inamed Corporation's subsidiaries are organized into three business
units (for financial reporting purposes all business units are considered
to be one segment): U.S. Plastic Surgery and Aesthetic Medicine (consisting
primarily of McGhan Medical Corporation, which develops, manufactures and
sells medical devices and components for breast implants and facial
aesthetics); BioEnterics Corporation, which develops, manufactures and
sells medical devices and associated instrumentation to the bariatric and
general surgery fields; and International (consisting primarily of a
manufacturing company based in Ireland - McGhan Limited - and sales
subsidiaries in various countries, including The Netherlands, Germany,
Italy, United Kingdom, France, Spain, Australia and Japan, which sell
products for both the plastic, aesthetics and bariatric surgery fields).
Revenue Recognition
The Company recognizes revenue in accordance with Statement of
Financial Accounting Standards No. 48, "Revenue Recognition When Right of
Return Exists" ("SFAS No. 48"). Revenues are recorded net of estimated
returns and allowances when product is shipped. The Company ships product
with the right of return and has provided an estimate of the allowance for
returns based on historical returns. Because management can reasonably
estimate future returns, the product prices are substantially fixed and the
Company recognizes net sales when the product is shipped. The estimated
allowance for returns is based on the historical trend of returns and
year-to-date sales.
Inventories
Inventories are stated at the lower of cost or market using the
first-in, first-out (FIFO) convention. The Company provides a provision for
obsolescence based upon historical experience.
Current Vulnerability Due to Certain Concentrations
The Company has limited sources of supply for certain raw materials,
which are significant to its manufacturing process. A change in suppliers
could cause a delay in manufacturing and a possible loss of sales, which
would adversely affect operating results.
Property and Equipment
Property and equipment are stated at cost less accumulated
depreciation and amortization. Significant improvements are capitalized
while maintenance and repairs are charged to operations as incurred.
Depreciation of property and equipment is computed using the
straight-line method based on estimated useful lives ranging from five to
ten years. Leasehold improvements are amortized on the straight-line basis
over their estimated economic useful lives or the lives of the leases,
whichever is shorter
Intangible and Long-Term Assets
Intangible and long-term assets are stated at cost less accumulated
amortization, and are being amortized on a straight-line basis over their
estimated useful lives ranging from 5 to 30 years.
The Company classifies as goodwill the cost in excess of fair value of
the net assets acquired in purchase transactions. The Company periodically
evaluates the realizability of long-lived assets and goodwill in accordance
with Statement of Financial Account Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of" ("SFAS No. 121"). This statement requires that long-lived assets and
certain identifiable intangible assets to be held and used be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of such assets may not be recoverable. The carrying value
of long-term assets is periodically reviewed by management, and impairment
losses, if any, are recognized when the expected non- discounted future
operating cash flows derived from such assets are less than their carrying
value. Impairment of long-lived assets is measured by the difference
between the non- discounted future cash flows expected to be generated from
the long-lived asset against the carrying value of the long-lived asset.
Based upon its most recent analysis, no impairment of long-lived assets
exists at December 31, 1999.
Research and Development
Research and development costs are expensed when incurred.
Advertising costs
Advertising costs are charged to operations in the year incurred and totaled
approximately $2,839, $677 and $426 in 1999, 1998 and 1997, respectively.
Income Taxes
The Company accounts for its income taxes using the liability method,
under which deferred taxes are determined based on the differences between
the financial reporting and tax bases of assets and liabilities, using
enacted tax rates in effect for the years in which the differences are
expected to reverse. Valuation allowances are established when necessary to
reduce deferred tax assets to the amount expected to be realized.
Use of Estimates
In preparing financial statements in conformity with generally
accepted accounting principles, the Company is required to make estimates
and assumptions that affect the reported amounts of assets and liabilities
and the disclosure of contingent assets and liabilities at the date of the
financial statements and revenues and expenses during the reporting period.
Actual results could differ from those estimates.
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 became 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 reflect, in periods in which
they have a dilutive effect, the effect of common shares issuable upon
exercise of common stock equivalents.
<TABLE>
Computation of Per Share Earnings
Year Ended December 31,
1999 1998
Diluted:
<S> <C> <C>
Net income $38,754 $11,973
Interest and convertible debt
assuming conversion at
beginning of the year -- 1,112
_________ _________
Net income for diluted
calculation $38,754 $ 13,085
========= =========
Weighted average shares
outstanding 15,466 10,387
Shares outstanding assuming
conversion at the beginning
of the year:
Convertible debt -- 3,317
Stock options 1,187( ) 192
Warrants 4,299 1,723(1)
Less assumed repurchase of
Shares (1,894) (1,434)
Shares outstanding 19,058 14,185
========= =========
Per share amount
Basic $2.51 $1.15
Diluted $2.03 $0.92
</TABLE>
Foreign Currency
The functional currencies of the Company's foreign subsidiaries are
their local currencies, and accordingly, the assets and liabilities of
these foreign subsidiaries are translated at the rate of exchange at the
balance sheet date. Revenues and expenses have been translated at the
average rate of exchange in effect during the periods. For the year ended
December 31, 1999, the foreign subsidiaries have incurred significant
intercompany debts, which are denominated in various foreign currencies.
The translation of the intercompany debts resulted in foreign currency
exchange gains (losses) of $255, $686 and ($1,796) in 1999, 1998 and 1997,
respectively. Unrealized translation adjustments are included in the
accumulated other comprehensive adjustments account as a component of
stockholders' equity (deficiency), while transaction gains and losses are
reflected in the consolidated statement of operations. To date, the Company
has not entered into hedging transactions to protect against changes in
foreign currency exchange rates.
Stock-Based Compensation
The Company has adopted the disclosure-only option under Statement of
Financial Accounting Standards No. 123, "Accounting for Stock Based
Compensation" ("SFAS No. 123"), as of December 31, 1996. Pro-forma
information regarding net income and earnings per share using the fair
value method is required by SFAS No. 123.
Statement of Cash Flows
For purposes of the statement of cash flows, the Company considers all
highly liquid debt instruments and other short-term investments with an
initial maturity of three months or less to be cash equivalents. At
December 31, 1999, a total of $10,700 was invested in short-term deposits
maturing in thirty days or less.
Concentrations of Credit Risk
The Company places its short-term cash investments with high credit
quality financial institutions and, by policy, limits the amount of credit
exposure to any one financial institution. Concentrations of credit risk
with respect to trade receivables are limited due to a large customer base
and its dispersion across different types of healthcare professionals and
geographic areas. The Company maintains an allowance for losses based on
the expected collectability of all receivables.
Financial Instruments
The fair value of cash and cash equivalents and receivables
approximate their carrying value due to their short-term maturities. The
fair value of long-term debt instruments, including the current portion,
approximates the carrying value and is estimated based on the current rates
offered to the Company for debt of similar maturities.
Accounting for Derivative Instruments and Hedging Activities
The Company has not engaged in any material hedging activity. Thus the
effect of implementing SFAS No. 133 has been determined to be immaterial.
(2) Accounts and Notes Receivable
Accounts and notes receivable consist of the following:
<TABLE>
December 31,
1999 1998
<S> <C> <C>
Accounts receivable $ 50,804 $ 29,327
Allowance for doubtful accounts (1,805) (1,402)
Allowance for returns and credits (4,620) (4,756)
_________ _________
Net accounts receivable $ 44,379 $ 23,169
Notes receivable $ 3,148 $ 3,236
Allowance for doubtful notes (467) (467)
_________ _________
Net notes receivable $ 2,681 $ 2,769
</TABLE>
(3) Inventories
Inventories are summarized as follows:
<TABLE>
December 31,
1999 1998
<S> <C> <C>
Raw materials $ 7,409 $ 3,764
Work in progress 7,179 3,931
Finished goods 13,545 11,329
_________ _________
28,133 19,024
Less allowance for
obsolescence (2,801) (1,169)
_________ _________
$ 25,332 $ 17,855
</TABLE>
(4) Intangible Assets
<TABLE>
December 31, December 31,
1999 1998
<S> <C> <C>
Goodwill $137,323 $ 1,785
Patents, trademarks 11,315 2,640
Other 735 697
149,373 5,122
Less accumulated depreciation (7,038) (4,107)
$142,335 $ 1,015
</TABLE>
Goodwill represents the excess of the purchase price of the Collagen
acquisition over the fair value of identifiable net assets acquired.
(5) Long Term Debt and Capital Leases
Long-term debt is summarized as follows:
<TABLE>
December 31,
1999 1998
10% Senior Secured Note
payable, maturing September,
2000, interest payable
quarterly, December 31,
March 31, June 30, and
<S> <C> <C>
September 30 (a) $ -- $ 7,948
11% Senior Secured Convertible
Note payable, maturing
September, 2000, interest payable
quarterly, January 1, April 1,
July 1, and October 1 (b) -- 57
11% Junior Secured Note payable,
maturing September, 2000,
interest payable quarterly,
January 1, April 1, July 1,
and October 1 (b) -- 19,549
12% Bridge Notes payable,
maturing May 2000 interest
payable monthly (c) 77,035 --
Capital lease obligations,
collateralized by related
equipment 215 264
77,250 27,818
Less, current installments (54) (51)
_______ ________
$77,196 $27,767
</TABLE>
(a) In September 1998, $8 million of proceeds were received from the
issuance of the Company's 10% senior secured notes. Under the terms of that
loan, $3 million was placed in a court- supervised escrow account which was
used to satisfy the Company's deposit obligation under the settlement
agreement for the breast implant litigation, and the balance was reserved
for allocation to specific working capital and capital expenditure
projects. Along with the debt, the Company issued 590,000 warrants which
resulted in a $52 charge to debt costs. The Company redeemed all 10%
percent senior notes on September 1, 1999.
(b) In January 1996, $35,000 of proceeds were received upon the
issuance of 11% senior secured convertible notes, due March 31, 1999, in a
private placement transaction. Of that amount, $14,800 was placed in an
escrow account to be released within one year, following court approval of
a mandatory, non-opt-out class settlement of the breast implant litigation.
Inasmuch as that condition was not met, in July 1997 the Company returned
those escrowed funds to the senior Noteholders, in exchange for warrants to
purchase $13,900 of common stock at $8.00 per share (subsequently adjusted
to $7.50 per share), resulting in a charge of $864 to debt costs for 1997.
In September 1998, the Company and the senior Noteholders agreed to extend
the maturity of this debt from March 31, 1999 to September 30, 2000 and to
exchange 100% of this debt for non- convertible 11% junior secured debt and
warrants to purchase common stock at $5.50 per share. The Company recorded
an extraordinary charge of $1,800 net of taxes of $1,200 related to the
exchange of the 11% senior secured convertible notes for non-convertible
junior secured debt and warrants. At December 31, 1998, $19.5 million of
the 11% junior notes were outstanding. All 11% junior notes that remained
outstanding as of September 1, 1999 were redeemed on that date.
(c) In September, 1999 the Company issued senior secured bridge notes
in an aggregate principal amount of $155.0 million. The proceeds, in
addition to $23.8 million of cash on hand, were used to acquire Collagen
Aesthetics, Inc. (See Note 18) and repay $16.9 million of Company debt.
The bridge notes were secured by perfected first priority liens on,
and security interests in, substantially all of the assets of the Company,
substantially all of the stock and assets of the Company's domestic
subsidiaries, including the stock and assets of Collagen and its domestic
subsidiaries, and 65% of the outstanding capital stock of the Company's
foreign subsidiaries. They were guaranteed on a senior basis by all of the
Company's material U.S. subsidiaries, including Collagen and its material
U.S. subsidiaries.
The bridge notes bore interest initially at a margin of 600 basis
points over the 30-day London Interbank Offered Rate (LIBOR). Under the
applicable loan agreements, the margin increased 100 basis points on the
three-month anniversary of the issuance.
In connection with the bridge loan facility, the Company paid
financing fees of $5,425 (3-1/2 points on principal), which were amortized
as the bridge notes were paid down. Under the terms of the facility, the
Company was permitted to prepay the bridge notes, at par plus accrued
interest plus $1,550 (an additional point on principal). The Company has
accrued this additional point and is amortizing it as the bridge notes are
paid down. As of December 31, 1999 the Company has unamortized financing
costs of $1,962 recorded in prepaid expensesand other current assets and
has expensed $5,049, which is recorded in net interest expense and debt
cost.
In November 1999, the Company completed a public offering of 2.95
million primary shares of common stock and 500,000 secondary shares on
behalf of selling shareholders, at $29 per share. The net proceeds to the
Company of $78 million were used to retire a comparable amount of the
bridge loan.
In February 2000, the Company obtained a $107.5 million five-year
credit facility and repaid the remaining $77 million bridge loan balance.
The term loans, advances under the revolving facility and the other
loans will bear interest at the rate of either (i) the one, two, three or
six-month LIBOR plus an applicable margin of 3.75% or (ii) prime rate plus
an applicable margin of 2.l75%. The applicable margin is subject to change
based on the Company's consolidated leverage ratio. The term of the loan
agreement is five years and the term loans, revolving loans and other loans
are guaranteed on a senior basis by all of the Company's material U.S.
subsidiaries and secured by a lien on substantially all of the assets of
the Company and its material U.S. subsidiaries.
The aggregate installments of long-term debt and capital leases as of
December 31, 1999 are as
follows:
<TABLE>
Year ending December 31:
<C> <C>
2000 $ 54
2001 60
2002 57
2003 27
2004 77,035
$ 77,233
</TABLE>
(6) Deferred Grant Income
Deferred grant income represents grants received from the Irish
Industrial Development Authority (IDA) for the purchase of capital
equipment and is being amortized to income over the life of the related
assets. Amortization for the years ended December 31, 1999, 1998 and 1997
was approximately $110, $110 and $454, respectively.
IDA grants are subject to revocation upon a change of ownership or
liquidation of McGhan Limited. If the grant were revoked, the Company would
be liable on demand from the IDA for all sums received and deemed to have
been received by the Company in respect to the grant. In the event of
revocation of the grant, the Company could be liable for the amount of
approximately $958 at December 31, 1999.
(7) Income Taxes
The following summarizes the provision for income taxes:
Year ended December 31,1999
Current
Federal $ 0
State and local 0
Foreign 2,441
(2,441)
Deferred
Federal $(7,565)
State and local (1,336)
Foreign 0
(8,901)
Provision for income taxes $(6,460)
Income tax benefit for 1998 of $8,432 primarily pertains to a $12,664
reduction of the valuation allowance on deferred tax assets.
Income tax expense for 1997 pertains primarily to foreign operations.
The Company recorded a provision in 1997 for foreign taxes of $1,000
related to the planned capitalization of intercompany balances with foreign
subsidiaries.
The domestic and foreign components of income before provision for
income taxes were as follows:
Year ended December 31,1999
United States $14,593
Foreign 17,701
$32,294
The provision for income taxes on adjusted historical income differs
from the amounts computed by applying the applicable Federal statutory
rates due to the following:
Year ended December 31,1999
Provision for Federal income taxes
at the statutory rate $10,980
State and local income taxes, net
of federal benefit 1,938
Amortization of Goodwill 662
Benefit of lower foreign tax brackets (4,640)
Other items, net 78
Change in deferred tax valuation
allowance (15,478)
Provision for income taxes $(6,460)
The 1998 tax benefit differs from the amount computed using the
Federal statutory income tax rate due to the utilization of NOL's to offset
current years taxable income and the recording of a $8,000 deferred tax
asset.
The 1997 tax benefit differs from the amount computed using the
Federal statutory income tax rate due to unprofitable operations and a 100%
valuation allowance on deferred tax assets.
Provision has not been made for U.S. or additional foreign taxes on
undistributed earnings of foreign subsidiaries. Those earnings have been
and will continue to be permanently reinvested. These earnings could become
subject to additional tax if they were remitted as dividends, if foreign
earnings were loaned to the Company or a U.S. affiliate, or if the Company
should sell its stock in the foreign subsidiaries. It is not practicable to
determine the amount of additional tax, if any, that might be payable on
the foreign earnings. The cumulative amount of reinvested earnings was
approximately $23,387 at December 31, 1999.
The Company currently has a net operating loss (NOL) for Federal Income Tax
reporting purposes of approximately $26,495 expiring in 2019.
The Company has federal tax credit carryforwards of approximately
$1,959 and state net operation loss ("NOL") and credit carryforwards of
approximately $6,686 and $798, respectively. The federal credit
carryforward amounts will expire in various years beginning in 2008. If the
Company has a change in ownership as defined by Internal Revenue Code
Section 382, use of these carryforward amounts could be limited.
The primary components of temporary differences which compose the
Company's net deferred tax assets and liabilities as of December 31, 1999
and 1998 are as follows:
<TABLE>
<CAPTION>
December 31, December 31,
1999 1998
Current deferred tax assets (liability):
<S> <C> <C>
Allowance for returns $ 2,062 $ 1,618
Allowance for doubtful
accounts 671 103
Allowance for inventory
obsolescence 704 402
Accrued liabilities 3,862 2,097
Allowance for doubtful notes 187 187
Litigation reserve -- 13,781
Net operating losses and
credits 13,911 2,996
Debt costs (71) 1,646
Acquisition and integration
costs 7,093 --
Deferred costs 432 --
Accrued disposal costs 3,294 --
Uniform capitalization
adjustments 649 648
Deferred tax assets 32,794 23,478
Valuation allowance -- (15,478)
Deferred tax assets $ 32,794 $ 8,000
Non-current deferred tax liability:
Depreciation $344 --
Other 1,134 $ 382
Deferred tax liabilities $ 1,478 $ 382
</TABLE>
The Company has released the $15,478 allowance on the deferred tax
assets at December 31, 1999 based on future short-term income projections
and profitable operations.
(8) Royalties
The Company has obtained the right to produce, use and sell patented
technology through various license agreements. The Company pays royalties
ranging from 5% to 10% of the related net sales, depending upon sales
levels. Royalty expense under these agreements was approximately $5,318,
$6,626 and $5,689 for the years ended December 31, 1999, 1998 and 1997,
respectively, and is included in marketing expense. The license agreements
expire at the expiration of the related patents.
(9) Stockholders' Equity
The Company has adopted several stock option plans. At December 31,
1999, under the terms of all director, officer and employee plans,
1,509,450 shares of common stock were reserved for issuance.
Activity under these plans for the years ended December 31, 1999, 1998
and 1997:
<TABLE>
<CAPTION>
1999 1998 1997
Wgtd.Avg. Wgtd.Avg. Wgtd. Avg.
Shares Exer.Price Shares Exer.Price Shares Exer.Price
Options outstanding
<S> <C> <C> <C> <C> <C> <C>
at beginning of year 510,000 $ 5.95 71,500 $ 2.46 115,000 $1.46
Granted 920,000 19.16 470,000 6.18 30,000 3.81
Exercised (70,550) 6.00 (30,000) 1.45 (73,500) 1.45
Expired (24,166) 6.50 (1,500) 2.49 -- --
-------- ----- -------- ------ ------- -----
Options outstanding
at end of year 1,335,284 15.07 510,000 5.95 71,500 2.46
Options exercisable
at end of year 144,450 5.75 60,000 2.63 71,500 2.46
</TABLE>
The following table summarizes information about stock options
outstanding at December 31, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
Weighted
<C> <C> <C> <C> <C>
Range of Average Weighted Weighted
Exercise Number Remaining Average Number Average
Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
$1.45 30,000 5.39 $1.45 22,500 $1.45
3.75 to 3.875 10,000 7.47 3.81 10,000 3.81
6.50 385,284 8.80 6.50 106,950 6.50
13 to 24.75 910,000 9.69 19.16 5,000 13.00
1,335,284 9.33 $15.07 144,450 $5.75
</TABLE>
The Company applies Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25")
and related interpretations in accounting for its employee
stock options.
Under the accounting provisions of FASB Statement 123, the
Company's net income and earnings per share would have been
reduced to the following pro forma amounts for 1999 and
1998. The effect on proforma net income and earnings per
share for 1997 is immaterial.
1999 1998
Net income $36,151 $10,618
Net income per common share
Basic $2.34 $1.02
Diluted $1.90 $0.75
The Company estimates the fair value of each stock option
and warrant at the grant date by using the Black-Scholes
option-pricing model with the following weighted-average
assumptions used for grants in 1999: no dividends paid for
all years; expected volatility of 34.4%; risk-free interest
rates ranging from 5.82% to 4.9%; and expected lives
ranging from 2 years to 10 years. For 1998: no dividends
paid for all years; expected volatility of 34.8%; risk-free
interest rates ranging from 5.71% to 4.06%; and expected
lives ranging from 0.58 years to 9 years. For 1997: no
dividends paid for all years; expected volatility of 34.8%;
risk-free interest rates ranging from 6.17% to 5.87%; and
expected lives ranging from 2.6 years to 6.7 years.
In 1999, the Company issued 47,500 warrants to officers of
the Company.
In 1998, the Company issued 4,750,916 warrants in
connection with the restructuring of the 11% junior secured
notes and the issuance of the 10% senior secured notes. In
addition, the Company issued 260,000 warrants in connection
with the conversion of its 10.5% subordinated note into
equity. Compensatory warrants totaling 995,000 were issued
during 1998; 845,000 to executive officers and 150,000 to
non-employee directors.
In 1997, the Company issued 1,846,071 warrants in
connection with the restructuring of the $35,000
convertible debt and 500,000 warrants in connection with
the issuance of the $6,200 convertible debenture.
Compensatory warrants totaling 175,000 were also issued to
non-employee directors.
In 1999, 1998 and 1997, the Company has recorded $0, $2,538
and $1,487, respectively, as interest and other debt costs
and $0, $250 and $231, respectively, as compensation
expense for warrants issued to executives.
Shares Exercise Price Expiration Date Fair Market Value
on Grant Date
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
1999
Warrants granted in 1999 25,000 $13.00 May 2, 2009 $ 60,695
Warrants granted in 1999 22,500 12.50 May 31, 2009 84,743
1998
Warrants granted in 1998 400,000 $ 3.95 January 22, 2008 $ 769,000
Warrants granted in 1998 400,000 3.525 January 31, 2008 726,000
Warrants granted in 1998 150,000 5.51 March 4, 2005 211,000
Warrants granted in 1998 25,000 5.51 March 15, 2005 60,000
Warrants granted in 1998 20,000 5.51 July 29, 20008 40,000
Warrants granted in 1998 260,000 12.40 July 8, 2002 330,000
Warrants granted in 1998 500,001 7.50 September 1, 2000 356,000
Warrants granted in 1998 590,000 6.50 September 1, 2002 52,000
Warrants granted in 1998 3,660,915 5.50 Septemer 1, 2002 3,000,000
1997
Warrants granted in 1997 1,846,071 $ 7.50 March 30, 2000 864,000
Warrants granted in 1997 500,000 9.81 January 15, 2000 623,000
Warrants granted in 1997 175,000- 5.51 April 1, 2004 180,000
</TABLE>
The exercise price of all options outstanding under the
stock option plans range from $1.45 to $24.75 per share.
All options exercised in 1999, 1998 and 1997 were exercised
at a price range from $1.45 to $13.25. At December 31,
1999, there were 128,066 shares available for future grant
under these plans. In certain instances, the Company has
granted options at strike prices which were, below the fair
market value of the common stock at the date of grant. In
each such case, the Company recorded compensation expense
for the difference between the fair market value and the
exercise price of the related outstanding options.
In 1993, the Company adopted a Non-Employee Director Stock
Option Plan (the "1993 Plan") which authorized the Company
to issue up to 150,000 shares of common stock to directors
who are not employees of or consultants to the Company and
who are thus not eligible to receive stock option grants
under the Company's stock option plans. Pursuant to the
1993 Plan, each non-employee director is automatically
granted an option to purchase 5,000 shares of common stock
on the date of his or her initial appointment or election
as a director, and an option to purchase an additional
5,000 shares of common stock on each anniversary of his or
her initial grant date providing he or she is still serving
as a director. The exercise price per share is the fair
market value per share on the date of grant. The options
are exercisable for ten (10) years after the option grant
date and vest in full one year from grant date. A total of
30,000 options to purchase shares were issued during 1997
under this plan and the Company recorded stock compensation
expense of $51.0 for this issuance. No options were issued
in 1998. In 1999, options to purchase 30,000 shares were
issued under the 1993 Plan. At December 31, 1999, there
were 85,000 options available for future grant under the
1993 Plan.
In 1998, the Company adopted a non-qualified stock option
plan (the "1998 Plan"). Under the terms of the 1998 Plan,
450,000 shares of common stock were reserved for issuance
to key employees. In 1998, 440,000 options to purchase
shares were granted to approximately 70 employees under the
1998 Plan at $6.50 per share. The current market price of
the Company's common stock at that time was $5.8125. The
options are exercisable for ten (10) years after the option
grant date and vest ratably over three (3) years. No
options were granted in 1999 under the 1998 Plan. At
December 31, 1999, there were 29,166 options available for
future grant under the 1998 Plan.
In 1999, the Company adopted a non-qualified stock option
program (the "1999 Program"). Under the terms of the 1999
Program, 900,000 shares of common stock have been reserved
for issuance to key employees. In 1999, options to
purchase 900,000 shares were granted to 21 officers of the
Company and its subsidiaries and a $160 compensation charge
was recorded. The majority of the 900,000 options were
issued out of money at exercise prices of $15.50 (382,832
shares), $20.00 (283,334 shares) and $24.75 (233,834
shares). The options are exercisable for ten (10) years
after the option grant date and vest ratably over three (3)
years.
In 1999, the Company adopted a Director Stock Election Plan
(the "Stock Election Plan"). Under the terms of the Stock
Election Plan, non-employee directors are allowed the
opportunity to receive shares of common stock in lieu of
cash compensation owed to them as a result of their service
on the Company's Board of Directors. Under the terms of
the Stock Election Plan, 50,000 shares of common stock have
been reserved for issuance to non-employee directors. In
1999, no shares were issued under the Stock Election Plan.
In 1997, the Company was in default of certain covenants of
the 4% Convertible Debentures due January 30, 2000, which
required the Company to reduce the conversion price by 6%.
In addition, the Company incurred 3% liquidated damages per
month on the outstanding principal balance. These
transactions resulted in $396 and $1,202 of debt and
interest expenses in 1997. As of April 6, 1998, all of these
debentures had been converted into an aggregate of 1,724,017
shares of common stock at prices ranging from $2.60 to $4.44
per share.
In April 1997 and continuing through January 1998, an entity
controlled by the Company's former Chairman loaned $9,900 to
the Company to provide it with working capital to fund its
operations. In July 1998, the Company and its former
chairman agreed to convert all of this debt (including
accrued interest computed at 10.5% per annum) into 860,000
shares of the Company's common stock and a warrant to
purchase 260,000 shares of the Company's common stock at
$12.40 per share. At the time, the Company's common stock
was trading at approximately $7.50 per share.
During the second quarter of 1999, the Company completed a
$31.1 million equity financing, in which 5,440,000 new
shares of common stock were issued to various holders of
$5.50 and $7.50 warrants in exchange for the payment of
$20.4 million of cash and the surrender of $10.7 million of
11% junior secured notes. Virtually all of the holders of
warrants who were eligible to exercise at this time
participated in the transaction. The Company also received
$3 million of cash from its noteholders, which was used to
purchase on their behalf the 426,000 shares of common stock
held by the court-appointed escrow agent. All of those 5.8
million shares of common stock contain a legend that
restricts transferability absent compliance with or an
exemption under Rule 144 (after the one-year holding period
) or an effective registration statement. In addition, the
Company incurred a one-time $1,977 finance charge against
earnings in connection with the exercise of warrants to
fund the litigation settlement.
(10) Geographic Segment Data
<TABLE>
<CAPTION>
U.S. International Elimination Consolidated
Year ended December 31, 1999
<S> <C> <C> <C> <C>
Net sales to unaffiliated
customers $126,461 $ 62,834 -- $189,295
Intersegment sales 11,267 2,892 $(14,159) ---
Total net sales $137,728 $ 65,726 $(14,159) $189,295
Operating profit $ 44,016 $ 18,511 --- $62,527
General corporate expenses (9,676) -- (9,676) ---
Depreciation and amortization (6,375) (1,102) -- (7,477)
Net interest expense -- -- -- (13,080)
Profit (loss) before income
taxes and extraordinary
charges $ 14,885 $ 17,409 -- $32,294
Total Long-Lived Assets $158,907 $ 7,538 -- $166,445
Year ended December 31, 1998
Net sales to unaffiliated
customers $ 85,889 $ 45,677 -- $131,566
Intersegment sales 9,204 29,020 $(38,224) --
Total net sales $ 95,093 $ 74,697 $(38,224) $131,566
Operating profit $ 20,071 $ 3,845 -- $23,916
General corporate expenses (6,792) -- -- (6,792)
Restructuring expense -- -- (4,202)
Depreciation and amortization (2,832) (937) -- (3,769)
Net interest expense -- -- -- (3,812)
Profit (loss) before income
taxes and extraordinary
charges $ 6,057 $ (716) -- $5,341
Total Long-Lived Assets $ 8,184 $ 5,654 -- $13,838
Year ended December 31, 1997
Net sales to unaffiliated
Customers $66,778 $39,603 -- $106,381
Intersegment sales 7,857 33,785 $(41,642) --
Total net sales $74,635 $73,388 $(41,642) $106,381
Operating profit $ 1,101 $ 3,349 -- $4,450
General corporate expenses (7,444) -- -- (7,444)
Litigation settlement expense -- -- -- (28,150)
Depreciation and amortization (2,025) (354) -- (2,379)
Net interest expense -- -- -- (6,173)
(Loss) profit before income
taxes $(42,246) $ 2,550 -- $(39,696)
Total Long-Lived Assets $ 9,912 $ 4,735 -- $14,647
</TABLE>
The international classification above includes The Netherlands,
United Kingdom, Italy, France, Germany, Ireland, Spain, Japan and
Australia. The individual operations were not material and are therefore
included in the international classification.
(11) Related Party Transactions
From April 1997 until January 1998, International Integrated
Industries, LLC ("Industries"), an entity affiliated with Mr. Donald K.
McGhan, lent the Company an aggregate of $9.9 million, of which $8.8
million was included in liabilities at December 31, 1997. Prior to February
1998, Mr. McGhan was Chairman and Chief Executive Officer of the Company.
After Industries began to lend those monies to the Company, Mr. McGhan
represented to the Board of Directors that those funds were derived from
personal financial resources. In early 1998, however, in connection with
Mr. McGhan's unsuccessful efforts to negotiate a payment schedule for the
interest and principal of the loan, Mr. McGhan for the first time advised
other directors that approximately two-thirds of the monies lent by
Industries to the Company were in fact derived from loans made to
Industries by Medical Device Alliance, Inc. ("MDA"). MDA is a company
formed by Mr. McGhan in 1995 primarily to develop and market various
products for use in ultrasonic liposuction; the Company believes that Mr.
McGhan raised at least $20 million for MDA from various outside investors
through private placement transactions. The Company does not believe those
outside investors were apprised of the loans from MDA to Industries;
however, Mr. McGhan has asserted that the investment of those funds in a
medical device company such as the Company was within the permitted scope
of the proposed use of the funds when those investors made their
investment. The Company's Board of Directors has been advised by legal
counsel: (a) that the Company has no responsibility whatsoever to the
outside investors in MDA for the monies which Mr. McGhan arranged to loan
Industries, which in turn were loaned by Industries to the Company, and (b)
that Mr. McGhan, as the controlling person of both MDA and Industries at
the times those loans were made, is solely responsible to the outside
investors in MDA for his actions with respect to those monies. Interest
expense with respect to this note totaled $535 and $86 in 1998 and 1997.
In July 1998, the Company and Mr. McGhan agreed to convert, and
converted, all of the $9.9 million lent by Industries (including accrued
interest computed at 10.5% per annum) into 860,000 shares of the common
stock of the Company (the "Restricted Shares") and a warrant to purchase
260,000 shares at $12.40 per share (the "Warrant"). At the time, the
Company's Common Stock was trading at approximately $7.50 per share. In
addition, Mr. McGhan (on behalf of himself and his affiliates) agreed to a
five-year standstill and voting agreement which restricts their ability to
vote, sell or acquire their shares of Common Stock. Among other things the
July 1998 agreement was intended to redress, and redressed, Mr. McGhan's
breaches of fiduciary duty to the Company, committed in 1996-97.
In 1997, the Company entered into an agreement to sublease from MDA on
a month-to-month basis approximately 5,000 square feet of office space in
Las Vegas for $10 per month. Donald K. McGhan was the Chairman of MDA. In
July 1998 the Company vacated that office space. While it continues as a
named party under the lease, in July 1998, Mr. McGhan placed 200,000 shares
of Common Stock in escrow with the Company until such time as the Company
is no longer liable under the terms of the lease. At the current market
price for the Company's Common Stock, the value of the 200,000 shares
substantially exceeds the Company's obligations under the lease.
In 1996 and 1997, the Company performed administrative services for
MDA and other related parties. The Company believes the value of these
services is approximately $150. The reimbursement for these services was
recognized as part of the July 1998 debt restructuring with Industries (See
Note 9).
In 1997, the Company signed a distribution agreement with LySonix
Inc., a subsidiary of MDA, to sell ultrasonic surgery equipment in the
European and Latin American regions. Special incentive discounts were
offered to the Company for the introduction of the product in 1997. Net
sales in 1998 and 1999 were approximately $606 and $300. In 1998, the terms
of the original agreement were revised so that the Company would obtain the
goods on a consignment basis and not have an obligation with LySonix until
the products were sold. The Company stopped selling LySonix machines in
mid-1999.
Included in general and administrative expense on the income statement
in 1997 is $1,600 in aircraft rental expenses paid to Executive Flite
Management, Inc., a company that is controlled by the family of Mr. Donald
K. McGhan. No signed contract exists and the Company was billed based on
its usage. In 1998, the Company discontinued the use of such corporate
aircraft. The Company incurred $140 during 1997 for flight related services
with McGhan Management Corporation. Mr. Donald K. McGhan and his wife are
the majority shareholders of McGhan Management Corporation.
The Company believes it obtained full reimbursement for the foregoing
aircraft rental and flight related services expenses through the July 1998
debt restructuring with Industries.
(12) Employee Benefit Plans
Effective January 1, 1990, the Company adopted a 401(k) Defined
Contribution Plan (the "Plan") for all U.S. employees. Participants may
contribute to the Plan and the Company may, at its discretion, match a
percentage of the participant's contribution as specified in the Plan's
provisions. Participants direct their own investments.
Effective February 1, 1990, McGhan Limited (Ireland) adopted a Defined
Contribution Plan for all non-production employees. Upon commencement of
service, these employees become eligible to participate in the plan and
contribute to the plan up to 5% of their compensation. The Company's
matching contribution is equal to 10% of the participant's compensation.
The employee is immediately and fully vested in the Company's contribution.
The Company's contributions to the plan approximated $237, $292 and $303
for the years ended December 31, 1999, 1998 and 1997, respectively.
Certain other foreign subsidiaries sponsor defined benefit or defined
contribution plans. The remaining plans, covering approximately 80 non-U.S.
employees, were instituted at various times during 1991 through 1997 and
the accumulated assets and obligations are immaterial. These plans are
funded annually according to plan provisions with aggregate contributions
of $339, $189 and $125 for the years ended December 31, 1999, 1998 and
1997, respectively.
(13) Litigation
Breast Implant Litigation
Final Settlement on Litigation. Prior to the final settlement order
issued by federal Judge Sam C. Pointer, Jr. of the U.S. District Court for
the Northern District of Alabama, Southern Division, on February 1, 1999,
the Company was a defendant in tens of thousands of state and federal court
lawsuits involving breast implants. As part of that final order, all of
those cases arising from breast implant products (both silicone gel-filled
and saline-filled) that were implanted before June 1, 1993 were
consolidated into a mandatory class action settlement and dismissed. The
settlement order became final and non-appealable on March 3, 1999. In May
1999, the Company made the final payment in connection with the class
action litigation using proceeds from its $31.1 million equity issuance.
Current Product Liability Exposure. Currently, other than the
Trilucent matters discussed below, the Company's product liability
litigation relates largely to saline- filled products that were implanted
after the 1992 FDA moratorium on silicone gel-filled implants went into
effect. These cases are being handled in the ordinary course of business
and are not expected to have a material financial impact on the Company.
Outside the U.S., where the Company has been selling silicone
gel-filled implants without interruption, and where the local tort systems
do not encourage or allow contingency fee arrangements, the Company had
only a minimal number of product liability lawsuits and no material
financial exposure.
Resolution of 3M Contractual Indemnity Claim. In connection with the
breast implant litigation, 3M asserted against the Company 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. To resolve these claims, on April 16, 1998, the Company entered
into a provisional agreement with 3M under which the Company agreed to seek
to obtain releases of claims asserted against 3M in lawsuits involving
breast implants manufactured by the Company's McGhan Medical subsidiary.
The 3M agreement provides for release of 3M's indemnity claim upon
achievement of an agreed minimum number of conditional releases for 3M.
Under the terms of the 3M agreement, as later amended in January 1999,
the Company paid $3.0 million to 3M in February 1999. Also under the terms
of the 3M agreement, the Company will assume limited indemnification
obligations to 3M beginning in the year 2000, subject to a cap of $1.0
million annually and $3 to 4.5 million in total, depending on the
resolution of other cases which were not settled prior to the issuance of
the final order.
Ongoing Litigation Risks. Although the Company expects the breast
implant litigation settlement to end as a practical matter the Company's
involvement in the current mass product liability litigation in the U.S.
over breast implants, there remain a number of ongoing litigation risks,
including:
Collateral Attack. As in all class actions, the Company may be called
upon to defend individual lawsuits collaterally attacking the settlement
even though it is now non- appealable. However, the typically permissible
grounds for those attacks, in general, lack of jurisdiction or
constitutionally inadequate class notice or representation, are
significantly narrower than the grounds available on direct appeal.
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 U.S. has, to date, been
minimal, and the court has, with minor exceptions, rejected efforts by
foreign plaintiffs to file suit in the U.S.
Trilucent Implant Matters. On November 6, 1998, Collagen announced the
sale of its LipoMatrix, Inc. subsidiary, manufacturer of the Trilucent
breast implant, to Sierra Medical Technologies. Collagen accounted for
LipoMatrix as a discontinued operation in its 1998 fiscal year. On March 8,
1999, the United Kingdom Medical Devices Agency (MDA) announced the
voluntary suspension of marketing and voluntary withdrawal of the Trilucent
implant in the United Kingdom. The MDA stated that its actions were taken
as a precautionary measure and did not identify any immediate hazard
associated with the use of the product. The MDA further stated that it
sought the withdrawal because it had received "reports of local
complications in a small number of women" who have received those implants,
involving localized swelling. The same notice stated that there "has been
no evidence of permanent injury or harm to general health" as a result of
these implants. Subsequently, Lipomatrix's notified body in Europe
suspended the product's CE Mark pending further assessment of the long-term
safety of the product. Sierra Medical has since stopped sales of the
product.
Collagen retained certain liabilities for Trilucent implants sold
prior to November 6, 1998. Collagen also agreed with the United Kingdom
National Health Service that, for a period of time, it would perform
certain product surveillance with respect to United Kingdom patients
implanted with the Trilucent implant and pay for explants for any United
Kingdom women with confirmed Trilucent implant ruptures. Subsequent to
acquiring Collagen, the Company elected to continue this voluntary program.
Any swelling or inflammation relating to the Trilucent implants appears to
resolve upon explantation. At June 30, 1999, Collagen increased by $11.5
million its provision for LipoMatrix as a discontinued operation in the
U.K. The Company is a party to several lawsuits outside the United States
brought by patients claiming damages from the Trilucent breast implant
product, some of which have recently been settled. In the U.S., a total of
165 women received Trilucent breast implants in two clinical studies;
enrollment in both studies ended by June 1997. No lawsuit has been filed
and the Company has not received any notice of legal claim as a result of
the implantation of any Trilucent breast implants in the U.S. Based on the
acquisition related accruals and available insurance policies, the Company
does not believe that it faces a material risk to operations from
Trilucent.
Patent and License Litigation
In February 1999, the Company and certain of its subsidiaries were
named as respondents in an arbitration commenced by Dr. Lubomyr I. Kuzmak
at the American Arbitration Association. Dr. Kuzmak alleges that, as of the
date of filing of the arbitration, he was owed approximately $400,000 in
unpaid royalties under a license agreement covering the Company's U.S.
patents in the field of gastric banding naming Dr. Kuzmak as an inventor.
In the past, the Company worked with Dr. Kuzmak, through the Company's
subsidiary BioEnterics, in the development and improvement of gastric
banding technology.
The Company has denied all of the material allegations raised by Dr.
Kuzmak and has asserted affirmative defenses and counterclaims, including
noninfringement, invalidity and unenforceability for inequitable conduct
before the U.S. Patent and Trademark Office.
In addition, in February 1999, the Company filed an action in the U.S.
District Court for the Central District of California against Dr. Kuzmak
seeking a declaratory judgment of invalidity, unenforceability and
non-infringement of the patents to which Dr. Kuzmak claims ownership. In
February 2000, that action was dismissed for lack of personal jurisdiction.
In January 2000, the parties entered into an agreement in principle to
settle and resolve all matters with Dr. Kuzmak and adjourned the arbitral
hearing without date.
In January 1999, Medical Products Development Inc. ("MPDI") instituted
an action against the Company's subsidiary McGhan Medical Corporation in
the U.S. District Court for the Central District of California. MPDI
alleges that McGhan Medical has infringed on some of its U.S. patents and
has breached an agreement between McGhan Medical and MPDI that exclusively
licensed those patents to McGhan Medical. Those patents pertain to the
textured surface of the silicone shell used in the Company's breast
implants and the methods of making those textured shells. Until 1998,
McGhan Medical was the exclusive licensee under these patents and paid
royalties to MPDI on sales in the U.S. of its textured implant products. In
1997, the last full year for which McGhan Medical paid royalties under the
license, McGhan Medical paid MPDI approximately $2.5 million in royalties.
In 1994, McGhan Medical and MPDI entered into a consent judgment in
settlement of a dispute which stipulated that the patent claims were valid
in certain respects. The consent judgment did not address McGhan Medical's
present non-infringement defense nor its unenforceability defense. MPDI is
seeking unpaid royalties up until the date of termination of the license,
unspecified damages, including enhanced damages for alleged willful
infringement, and an injunction. The unpaid royalties allegedly due when
the lawsuit was commenced were approximately $1.0 million. McGhan Medical
filed an answer denying all of the material allegations of MPDI's complaint
and raising affirmative defenses and counterclaims of non-infringement,
invalidity on grounds not precluded by the consent judgment,
unenforceability of the patents and breach of contract. McGhan Medical
believes that its textured breast implant products are made using
significantly different processes than that claimed in the patents, and
that the alleged inventor of the patents engaged in inequitable conduct
before the U.S. Patent and Trademark Office during prosecution of the
patents. In August 1999, the court granted MPDI's motion to dismiss some of
the counterclaims, and on its own motion dismissed the remaining
counterclaims. In September 1999, MPDI filed a motion for leave to amend
its complaint to add another cause of action for breach of contract. In
November 1999, the Company moved for summary judgment on grounds of
unenforceability owing to inequitable conduct and non-infringement. That
motion, and MPDI's cross-motion for a judgment of infringement, are
pending. The Company believes its affirmative defenses have considerable
merit, but resolution of the action may result in the payment of damages
and past royalties. The Company does not believe that a negative outcome in
this action would limit its ability to sell textured breast implants
because it has recently become the licensee of other patents for texturing
breast implants and is capable of altering its manufacturing process to
utilize that technology.
In May 1998, Societe Anonyme de Development des Utilisations du
Collagene (SADUC) commenced an arbitration under the rules of the
International Chamber of Commerce against Collagen Corporation under a
technology license and human collagen supply agreement between the parties.
Following the spin-off of Cohesion Technologies, Inc., Collagen Corporation
changed its name to Collagen Aesthetics, Inc. SADUC is ultimately owned by
Rhone-Poulenc. SADUC seeks recovery for alleged lost profits and royalties
for Collagen Corporation's allegedly wrongful termination of the agreement
as well as compensation for confidential information allegedly
misappropriated by Collagen Corporation, including the assignment to SADUC
of certain Collagen Corporation patents allegedly disclosing and claiming
processes allegedly developed by SADUC. SADUC seeks approximately $4.5
million in termination damages and $2.1 million as losses for breach of the
contractual confidentiality obligations, plus ongoing royalties. Collagen
Corporation has denied all material allegations, as it is Collagen
Corporation's belief that SADUC breached the agreement by being unable and
unwilling to supply the specified product at the contract price. In
addition, Collagen Corporation has stated that its patents do not disclose
or claim any of SADUC's allegedly confidential information, and that
SADUC's allegedly confidential information was neither novel nor useful.
Accordingly, Collagen Corporation seeks rescission of the agreement and
restitution to it of all amounts paid and the costs incurred by it in
attempting to perform under the agreement. Collagen Corporation's position
is believed to have considerable merit, but resolution of this arbitration
may require the Company to pay damages or require these patents to be
assigned to SADUC. An evidentiary hearing on the liability issues raised in
this case began in March 2000.
Other Litigation
The Company is also party to a lawsuit filed in the Superior Court of
the State of California, County of Los Angeles, known as Chieftain LLC, et
al. vs. Medical Device Alliance, Inc. (Case No. BC199819). The currently
operative complaint contains 16 causes of action, three of which are
alleged against the Company and McGhan Medical. Other co-defendants include
the former chairman of Inamed, Donald K. McGhan, his wife and three
children, entities with which Mr. McGhan remains affiliated including
International Integrated Industries, LLC ("Industries") and Wedbush Morgan
Securities, Inc., a securities firm at which Mr. McGhan allegedly holds
margin accounts. The operative complaint purports to allege direct and
derivative claims on behalf of shareholders of Medical Device Alliance,
Inc. ("MDA") for unspecified damages. The operative complaint purports to
allege that prior to his February 1998 resignation as an officer and
director of the Company, Donald K. McGhan improperly diverted $9.9 million
of MDA funds to the Company, and that after his resignation, Mr. McGhan and
the Company conspired to defraud MDA when these funds were repaid. The
Company believes that the operative complaint is bereft of support, both
factually and legally. Both the Company and McGhan Medical intend to
vigorously oppose the action.
The Company is involved in various legal actions arising in the
ordinary course of business, the majority of which involve product
liability claims alleging personal injuries and economic harm as a result
of ruptures in breast implants. In the Company's experience, claimants
typically do not allege that the release of saline solution causes any
chronic condition or systemic disease. While the outcome of these matters
is currently not determinable, the Company believes that these matters,
individually or in the aggregate, will not have a material adverse effect
on the Company's business, results of operations or financial condition.
(14) Commitments and Contingencies
In October 1999, a license and distribution agreement between
ArthroCare Corporation and Collagen Aesthetics, Inc., was amended. The
Company has worldwide rights to market ArthroCare's CoblationT Cosmetic
Surgery System and related products using ArthroCare's patented radio
frequency ("RF") technology. Pursuant to the agreement, the Company now has
exclusive rights to sell such technology, among others, to all physicians
in the fields of dermatology, cosmetic and aesthetic surgery to the extent
permitted by the FDA. ArthroCare retains responsibility for manufacturing
and product development. Pursuant to the parties' agreements, Collagen has
to date paid ArthroCare $2.0 million in licensing fees and must make
certain minimum purchases and must pay certain minimum royalties in the
annual periods following FDA approval of a licensed product for general
dermatological use for skin resurfacing and wrinkle reduction. In addition,
in the future, the Company would owe ArthroCare $500,000 on completion of a
satisfactory disposable wand, $2.0 million on FDA approval of a licensed
product for general dermatological use for skin resurfacing and wrinkle
reduction, and a running royalty on the sale of the disposable wands. Such
FDA approval was received in March 2000. Under the agreement, ArthroCare is
also to supply a microdermabrasion product and an RF liposuction product,
FDA approval of which increases the above minimum purchase and royalty
requirements.
In May 1999, the Company entered into a strategic alliance with
Advanced Tissue Sciences, Inc. ("ATS") under which the Company licenses for
development, marketing and sales five of ATS's human-based,
tissue-engineered products for surgical applications. As of December 31,
1999, the Company's total investment in the ATS strategic alliance was $10
million and is included in other assets. Of this amount, $7.2 million was
paid for licensing rights and the remainder was paid for an aggregate of
1.3 million shares of common stock, and warrants to purchase common stock,
of ATS at a blended purchase and exercise price of $8.90 per share. The
Company is also obligated to pay ATS an additional $2.0 million milestone
payment for each of the marketed products that receives FDA approval, up to
$10.0 million in total for all of the products. Finally, ATS is entitled to
royalties from the Company on a sliding scale based on overall product
sales. The Company has agreed to hold any investment in ATS common stock
until at least October 2002. The adjustment of ATS stock to market at
December 31, 1999 is not material.
The license payments made to date to ArthroCare and Advanced Tissue
are being amortized over the estimated lives of the license agreements. All
royalty payments under these arrangements will be expensed as marketing
costs.
The Company leases facilities under operating leases. The leases are
generally on an all-net basis, whereby the Company pays taxes, maintenance
and insurance. Leases that expire are expected to be renewed or replaced by
leases on other properties. Rent expense aggregated $6,657, $4,589 and
$4,664 for the years ended December 31, 1999, 1998 and 1997, respectively.
Minimum lease commitments under all noncancelable leases at December 31, 1999
are as follows:
Year ending December 31:
2000 $ 6,991
2001 7,069
2002 6,221
2003 5,445
2004 4,729
Thereafter 22,600
$53,055
(15) Sale of Subsidiary
In 1993, the Company sold its wholly-owned subsidiary, Specialty
Silicone Fabricators, Inc. (SSF), a manufacturer of silicone components for
the medical device industry, for $10.8 million. The consideration consisted
of $2.7 million in cash, the forgiveness of $2.2 million in intercompany
notes due to SSF, and $5.9 million in structured notes. The receivable
included a note in the amount of $2,425 due February 1995 and a note in the
amount of $3,466 due on August 31, 2003, accruing interest quarterly at a
rate of prime, not to exceed 11%. The notes have been reflected on the
balance sheet net of an allowance of $467. The notes are collateralized by
all of the assets of the merger. The Company has filed a UCC-1 and its
position is subordinated only to that of the primary lender.
(16) Supplemental Schedule of Non-Cash Investing and Financing Activities
Year ended December 31, 1999:
The Company issued 1,717 shares of common stock and recorded a
corresponding $10,700 reduction of junior secured notes.
Details of acquisition:
Fair value of assets acquired $198,633
Liabilities assumed (60,664)
Net Cash Paid for Acquisition 137,969
Cash acquired in acquisition 22,521
Cash paid for acquisition $160,490
Year ended December 31, 1998:
The Company issued 1,112,173 shares of common stock and recorded a
corresponding $4,080 reduction of convertible debt in connection with the
4% Convertible Debentures converted to equity.
The Company issued 66,117 shares of common stock as payment of $261 of
accrued debt costs related to the 1997 default of certain financial
covenants related to the $6,200 convertible debenture.
The Company issued 16,052 shares of common stock and recorded a
corresponding $86 reduction of convertible notes payable in connection with
the 11% Convertible Notes converted to equity.
The Company issued 90,744 shares of common stock and recorded a
corresponding $500 reduction of royalties payable.
The Company issued $25,500 of notes payable and 426,323 shares of
redeemable common stock at an aggregate stated value of $3,000 and recorded
a corresponding $28,500 reduction in the accrued litigation settlement.
Year ended December 31, 1997:
The Company issued 615,958 shares of common stock and recorded a
corresponding $2,267 reduction of convertible debt in connection with the
4% Convertible Debentures converted to equity.
The Company accrued debt costs of $396 related to the default of
certain financial covenants related to the $6,200 convertible debenture.
During 1997, the Company issued 36,711 shares of common stock as payment of
$135 of the accrued debt costs.
(17) Quarterly Summary of Operations (Unaudited)
The following is a summary of selected quarterly financial data for 1999 and
1998:
<TABLE>
<CAPTION>
Quarter
First Second Third Fourth
Net Sales
<S> <C> <C> <C> <C>
1999 $37,588 $42,165 $43,969 $65,573
1998 30,052 36,928 32,130 32,456
Gross Profit
1999 25,688 30,145 31,292 44,617
1998 17,760 25,926 20,204 19,722
Net Income (loss)
1999 7,498 9,066 8,526 13,644
1998 (1,285) 3,773 (461) 9,946
Net Income (loss) per share
1999 Basic 0.65 0.62 0.50 0.74
1998 Diluted 0.57 0.54 0.44 0.64
======= ======== ======== =======
1999 Basic (0.14) 0.38 (0.04) 0.87
1998 Diluted (0.14) 0.30 (0.04) 0.72
======= ======= ======== =======
</TABLE>
Significant Fourth Quarter Adjustments, 1999
During the fourth quarter of the year ended December 31,
1999, the Company released the remaining $7,178 allowance
on its deferred tax asset.
Significant Fourth Quarter Adjustments, 1998
During the fourth quarter of the year ended December 31,
1998, the Company recorded significant adjustments which
increased net income by $6,200. The adjustments were as
follows:
Extraordinary charge for issuance of
Warrants $ (1,800)
Income Tax Benefit 8,000
The Company incurred the extraordinary charge in relation
to the restructuring of the Company's 11% junior
subordinated notes, which occurred in the fourth quarter of
1998.
An income tax benefit was established to recognize a
portion of the benefit expected to be received from the
Company's substantial net operating loss carryforward.
Significant Fourth Quarter Adjustments, 1997
During the fourth quarter of the year ended December 31,
1997, the Company recorded significant adjustments which
decreased income by $29,700. The adjustments were as
follows:
Litigation related expenses $ 28,200
General & administrative expenses
Related to litigation 500
Income Tax Expense 1,000
The Company's litigation settlement expense was adjusted to
recognize the latest developments in the breast implant
litigation.
(18) Collagen Acquisition
On September 1, 1999, the Company acquired Collagen
Aesthetics, Inc., a designer, developer, manufacturer and
marketer of products that treat defective, diseased,
traumatized or aging human tissue. The principal acquired
products, Zydermr and Zyplastr collagen-based facial
implants, are used in aesthetic applications for the
correction of scars and facial wrinkles due to aging.
Collagen's products are used by plastic surgeons,
dermatologists and other physicians for elective surgical
and non-surgical therapies to remedy aging and defective
facial tissue.
The Collagen acquisition has been accounted for by the
purchase method of accounting and accordingly, the results
of operations of Collagen for the period from September 1,
1999 to December 31, 1999 have been included the
consolidated financial statements.
The aggregate purchase price for the Collagen acquisition
was approximately $159 million, including the cancellation
of employee stock options and expenses. The Company funded
the acquisition with a bridge loan facility of $155 million
plus cash on hand. At the same time, cash on hand was used
to retire $17 million of pre-existing debt.
The acquired goodwill will be amortized on a straight-line
basis over 30 years.
The summarized unaudited pro forma results of operations
set forth below for the years ended December 31, 1999 and
1998 assume the acquisition occurred as of the beginning of
the year.
1998 1999
Net sales 213,694 247,493
Net Income before
extraordinary items (3,304) --
Net (Loss) Income (5,104) 29,882
Net income per share
of common stock:
Basic (0.40) 1.76
Diluted (0.31) 1.45
Pro forma adjusted net income per common share may not be
indicative of actual results, primarily because the pro
forma earnings include historical results of Collagen and
do not reflect any cost savings or potential sales erosion
that may result from the Company's integration efforts.
Acquisition and Integration Costs
In connection with the acquisition of Collagen, the Company
assessed and formulated preliminary plans to restructure
certain operations. These plans involved the closure of
manufacturing facilities, certain offices, and foreign
subsidiaries. The objectives of the plans were to
eliminate unprofitable or marginally profitable lines of
business and reduce overhead expenses. The accrual of
these costs and liabilities was recorded as an increase to
goodwill and include:
<TABLE>
<CAPTION>
Balance at Reductions and Balance at
September 1, 1999 Payments December 31, 1999
<S> <C> <C> <C>
Severance and other employee
Costs (approximately 100
employees) $ 14,855 $ 12,390 $ 2,465
Lease commitments 3,119 395 2,724
Professional fees 8,882 5,935 2,924
Insurance 3,058 22 3,080
Other 5,200 338 4,862
$ 35,114 $ 19,059 $16,055
</TABLE>
The Company plans have not been finalized in all areas, and additional
restructuring costs may result as the Company continues to evaluate and
assess the impact of duplicate responsibilities and international
operations. Any additional costs relating to Collagen incurred before
September 1, 2000 will be recorded as additional goodwill; after that date,
additional costs will be charged to operations in the period in which they
occur.
Acquired Liabilities
The aggregate $13,172 of long and short-term acquired liabilities at
December 31, 1999 is the remaining provision for Collagen's discontinued
operation of the LipoMatrix breast implant business. The provision
represents management's best estimate based on current information of the
mostly likely costs and provides for additional current and future losses
related to ongoing clinical follow-up for multi-year studies in the U.S.
and Europe, the withdrawal of the Trilucent implant from the European and
U.K. markets, safety studies and a patient surveillance program in the
U.K., as well as a $5,000 accrual of an insurance policy premium which
provides the Company with liability coverage for the Trilucent implants.
The LipoMatrix operations have been discontinued since June 30, 1998.
<TABLE>
<CAPTION>
Schedule II
INAMED CORPORATION AND SUBSIDIARIES
Valuation and Qualifying Accounts
Years ended December 31, 1999, 1998 and 1997
Beginning of End of Period
Description period balance Additions Deductions balance
Year ended December 31,
1999
<S> <C> <C> <C> <C>
Allowance for returns $ 4,756 -- $ 136 $ 4,620
Allowance for doubtful
Accounts 1,402 $ 403 -- 1,805
Allowance for
Obsolescence 1,169 1,632 -- 2,801
Valuation allowance for
Deferred tax assets 15,478 -- 15,478 --
Self-insurance accrual 3,649 1,453 -- 5,102
Allowance for doubtful
Notes 467 -- -- 467
Litigation reserve 5,721 -- 5,721 --
Year ended December 31,
1998
Allowance for returns $ 4,356 $ 406 -- $ 4,756
Allowance for doubtful
Accounts 865 537 -- 1,402
Allowance for
Obsolescence 1,514 -- $ 345 1,169
Valuation allowance for
Deferred tax assets 28,142 -- 12,664 15,478
Self-insurance accrual 3,602 47 -- 3,649
Allowance for doubtful
Notes 467 -- -- 467
Litigation reserve 37,335 -- 31,614 5,721
Year ended December 31,
1997
Allowance for returns $ 4,697 -- 341 $ 4,356
Allowance for doubtful
Accounts 714 $ 151 -- 865
Allowance for
Obsolescence 1,326 188 $ -- 1,514
Valuation allowance for
Deferred tax assets 12,026 16,116 -- 28,142
Self-insurance accrual 1,373 2,229 -- 3,602
Allowance for doubtful
Notes 1,067 -- 600 467
Litigation reserve 9,152 28,183 -- 37,335
</TABLE>
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Inamed Corporation and Subsidiaries
New York, New York
We hereby consent to the incorporation by reference in the
Prospectus constituting a part of the Registration Statements on
Form S-8 filed October 6, 1999 and March 10,2000 and Form S-3
filed on February 14, 2000 and March 29, 2000 of our reports
dated January 21, 1000, except with respect to Note 5 (c) which
is as of Febreuary 1, 2000 relating to the consolidated
financial statements and schedule of Inamed Corporation and
Subsidiaries appearing in the Company's Annual Report on Form
10-K for the year ended December 31, 1999.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
New York, New York
March 16, 2000
(1) The calculation excludes 234 options and 2,701 warrants that are anti-
dilutive.
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