INAMED CORP - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

Commission file number 1-9741

INAMED CORPORATION
(Exact name of registrant as specified in its charter)

Delaware (State of Incorporation)		59-0920629 (I.R.S. Employer Identification No.)
5540 Ekwill Street Santa Barbara, California 93111-2936 (Address of principal executive offices)
(805) 683-6761 (Registrant's telephone number, including area code)

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 ý No o

On November 12, 2002, there were 21,875,147 shares of the Registrant's common stock outstanding.

INAMED CORPORATION AND SUBSIDIARIES

Quarterly Report on Form 10-Q
For the Quarter Ended September 30, 2002

TABLE OF CONTENTS

			Page
*PART I—FINANCIAL INFORMATION*
	Item 1.	Financial Statements
		Consolidated Balance Sheets	3
		Consolidated Statements of Income	4
		Consolidated Statements of Stockholders' Equity and Comprehensive Income	6
		Consolidated Statements of Cash Flows	7
		Notes to the Unaudited Consolidated Financial Statements	8
	Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	15
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28
	Item 4.	Controls and Procedures	29
*PART II—OTHER INFORMATION*
	Item 1.	Legal Proceedings	30
	Item 2.	Changes in Securities and Use of Proceeds	32
	Item 3.	Defaults Upon Senior Securities	32
	Item 4.	Submission of Matters to a Vote of Security Holders	32
	Item 5.	Other Information	32
	Item 6.	Exhibits and Reports on Form 8-K	32
*SIGNATURES*			38
*CERTIFICATIONS*			39

This report contains trademarks and trade names that are the property of Inamed Corporation and its subsidiaries, and of other companies, as indicated.

PART I—FINANCIAL INFORMATION

ITEM 1. Financial Statements

INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(millions, except par value)
(Unaudited)

			September 30, 2002			December 31, 2001
Assets
Current assets:
	Cash and cash equivalents		$	57.9		$	34.8
	Trade accounts receivable, net of allowances of $11.7 and $11.3 in 2002 and 2001, respectively			41.7			35.6
	Inventories (Note 6)			44.2			44.1
	Prepaid expenses and other current assets			11.3			6.9
	Deferred income taxes			14.7			14.7

		Total current assets		169.8			136.1

Property and equipment, net				44.1			39.4
Goodwill (Note 9)				149.8			149.4
Other intangible assets, net (Note 9)				41.6			44.0
Deferred income taxes				22.9			21.8
Investments (Note 4)				—			5.7
Other assets				3.1			3.8

		Total assets	$	431.3		$	400.2

Liabilities and Stockholders' Equity
Current liabilities:
	Current portion of long-term debt and capital leases		$	6.6		$	12.4
	Accounts payable			18.1			20.1
	Income taxes payable			9.6			9.7
	Accrued liabilities and other			33.7			30.6

		Total current liabilities		68.0			72.8

Long-term debt and capital leases, net of current portion				107.6			108.6
Other long-term liabilities				35.9			44.4
Commitments and contingencies (Note 10)
Stockholders' equity:
	Common stock, $0.01 par value; authorized, 50.0 and 50.0 shares; issued, 21.9 and 21.2 shares; outstanding, 21.9 and 20.2 shares for 2002 and 2001, respectively			0.2			0.2
	Additional paid-in capital			164.8			170.0
	Treasury stock, at cost, 0.0 and 1.0 shares in 2002 and 2001, respectively			—			(24.0	)
	Retained earnings			67.4			43.2
	Accumulated other comprehensive loss			(12.6	)		(15.0	)

		Stockholders' equity		219.8			174.4

		Total liabilities and stockholders' equity	$	431.3		$	400.2

See accompanying notes to unaudited consolidated financial statements.

INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(millions, except per share data)

		Three Months Ended September 30, 2002			Three Months Ended September 30, 2001
Net sales		$	66.9		$	56.8
Cost of goods sold			18.9			16.5

	Gross profit		48.0			40.3

Operating expenses:
	Selling, general, and administrative		30.3			23.4
	Research and development		2.1			3.3
	Restructuring charges (Note 3)		—			2.5
	Special charges (Note 4)		2.7			—
	Amortization of intangible assets and non-cash compensation		1.3			3.0

	Total operating expenses		36.4			32.2
	Operating income		11.6			8.1
Other income (expense):
	Net interest expense and debt costs		(2.3	)		(2.8	)
	Foreign currency transaction losses		(0.5	)		(1.1	)
	Royalty income and other		1.2			1.0

	Total other expense		(1.6	)		(2.9	)

Income before income tax expense			10.0			5.2
Income tax expense			2.4			1.8

Net income		$	7.6		$	3.4

Net income per share of common stock:
	Basic	$	0.36		$	0.17

	Diluted	$	0.35		$	0.16

Weighted average shares outstanding:
	Basic		21.2			20.0

	Diluted		21.8			21.4

See accompanying notes to unaudited consolidated financial statements.

INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(millions, except per share data)

		Nine Months Ended September 30, 2002			Nine Months Ended September 30, 2001
Net sales		$	201.8		$	177.2
Cost of goods sold			57.0			48.2

	Gross profit		144.8			129.0

Operating expenses:
	Selling, general, and administrative		88.6			72.6
	Research and development		8.9			9.0
	Restructuring charges (Note 3)		—			10.9
	Special charges (Note 4)		8.4			—
	Amortization of intangible assets and non-cash compensation		4.0			8.2

	Total operating expenses		109.9			100.7
	Operating income		34.9			28.3
Other income (expense):
	Net interest expense and debt costs		(7.1	)		(8.3	)
	Foreign currency transaction gains (losses)		0.4			(0.7	)
	Royalty income and other		3.8			4.0

	Total other expense		(2.9	)		(5.0	)

Income before income tax expense			32.0			23.3
Income tax expense			7.8			8.6

Net income		$	24.2		$	14.7

Net income per share of common stock:
	Basic	$	1.16		$	0.73

	Diluted	$	1.11		$	0.68

Weighted average shares outstanding:
	Basic		20.8			20.2

	Diluted		21.8			21.7

See accompanying notes to unaudited consolidated financial statements.

INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(Unaudited)
(millions)

		Common Stock												Accumulated Other Comprehensive Loss
		Common Stock				Additional Paid-in Capital			Treasury Stock			Retained Earnings					Total Stockholders' Equity
		Shares		Amount		Additional Paid-in Capital			Treasury Stock			Retained Earnings					Total Stockholders' Equity
Balance, December 31, 2001		21.2		$	0.2	$	170.0		$	(24.0	)	$	43.2	$	(15.0	)	$	174.4
Comprehensive income:
	Net income												24.2					24.2
	Translation adjustment														3.8			3.8
	Unrealized loss on interest rate swap agreements														(1.4	)		(1.4	)

	Total comprehensive income																	26.6
Cancellation of treasury stock		(1.0	)				(24.0	)		24.0								—
Non-cash compensation expense on options							0.9											0.9
Employee stock purchase plan							0.4											0.4
Exercise of stock options and warrants		1.7					13.7											13.7
Tax benefit of option exercises							3.8											3.8

Balance, September 30, 2002		21.9		$	0.2	$	164.8		$	—		$	67.4	$	(12.6	)	$	219.8

See accompanying notes to unaudited consolidated financial statements.

INAMED CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(millions)

			Nine Months Ended September 30, 2002			Nine Months Ended September 30, 2001
Cash flows from operating activities:
	Net income		$	24.2		$	14.7
	Non-cash elements included in net income:
		Depreciation and amortization		8.9			10.9
		Tax benefit from stock option exercises		3.8			—
		Deferred income taxes		(1.1	)		2.8
		Non-cash compensation		0.9			0.8
		Loss on disposition of property and equipment		0.2			—
		Provision for doubtful accounts, notes, and returns		0.4			0.9
		Amortization of deferred loan costs		0.8			—
		Special charges		5.7			—
	Changes in assets and liabilities:
		Trade accounts receivable		(6.5	)		(2.3	)
		Inventories		(0.1	)		(6.8	)
		Prepaid expenses and other assets		(4.6	)		2.8
		Accounts payable		(2.0	)		(1.3	)
		Income taxes payable		—			0.5
		Accruals and other long-term liabilities		(9.8	)		(4.7	)

	Net cash provided by operating activities			20.8			18.3

Cash flows used in investing activities:
		Purchase of property and equipment		(7.5	)		(16.8	)
		Other		(0.7	)		—

	Net cash used in investing activities			(8.2	)		(16.8	)

Cash flows provided by (used in) by financing activities:
		Issuance of long-term debt		—			25.0
		Principal repayment of notes payable and long-term debt		(5.8	)		(15.9	)
		Issuance of common stock and warrants		14.1			2.8
		Acquisition of treasury shares		—			(16.3	)

	Net cash provided by (used in) financing activities			8.3			(4.4	)

Effect of exchange rate changes on cash				2.2			(1.4	)
Change in cash and cash equivalents:
	Net change in cash and cash equivalents			23.1			(4.3	)
	Cash and cash equivalents at beginning of period			34.8			22.3

	Cash and cash equivalents at end of period		$	57.9		$	18.0

Supplemental disclosure of cash flow information:
	Cash paid during the year for:
		Interest	$	8.6		$	7.1

		Income taxes	$	4.1		$	5.0

See accompanying notes to unaudited consolidated financial statements.

INAMED CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2002
(millions)

NOTE 1 —INTERIM FINANCIAL STATEMENTS

The accompanying unaudited consolidated financial statements include all adjustments which are, in our opinion, necessary for the fair presentation of the results of operations for the periods presented. Interim results are not necessarily indicative of the results to be expected for a full year.

Certain information and note disclosures normally included in financial statements, prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted as allowed by Form 10-Q. Certain reclassifications have been made to the prior period's financial statements to conform to the current period's presentation. The accompanying unaudited consolidated financial statements should be read in conjunction with Inamed Corporation's ("Inamed" or the "Company") consolidated financial statements for the year ended December 31, 2001 as filed with the Securities and Exchange Commission on Form 10-K.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with U.S. generally accepted accounting requires Inamed to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates and judgments, including those related to revenue recognition, inventories, adequacy of allowances for doubtful accounts, valuation of intangible assets and investments, income taxes, litigation and warranties. Inamed bases its estimates on historical and anticipated results and trends and on various other assumptions that it believes are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may differ from those estimates.

Revenue Recognition

Inamed recognizes product revenue, net of sales discounts, returns and allowances, in accordance with Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements" and SFAS No. 48 "Revenue Recognition When Right of Return Exists." These statements establish that revenue can be recognized when persuasive evidence of an arrangement exists, delivery has occurred and all significant contractual obligations have been satisfied, the fee is fixed or determinable, and collection is considered probable. Appropriate reserves are established for anticipated returns and allowances based on product return history.

Inventories

Inventories are stated at the lower of cost or market using the first-in, first-out (FIFO) method. Inamed capitalizes inventory costs associated with certain product candidates prior to regulatory approval, based on management's judgment of probable future commercialization. Inamed could be required to expense previously capitalized costs related to pre-approval inventory upon a change in such judgment, due to, among other factors, a decision denying approval of the product candidate by the necessary regulatory bodies.

Allowance for Doubtful Accounts

Inamed maintains allowances for doubtful accounts for estimated losses resulting from the inability of some of its customers to make required payments. The allowances for doubtful accounts are based

on the analysis of historical bad debts, customer credit-worthiness, past transaction history with the customer, current economic trends, and changes in customer payment terms. If the financial condition of Inamed's customers were to deteriorate, adversely affecting their ability to make payments, additional allowances may be required.

Litigation

Inamed is involved in various litigation matters as a claimant and as a defendant. The Company records any amounts recovered in these matters when collection is certain. The Company records liabilities for claims against it when the losses are probable and can be reasonably estimated. Amounts recorded are based on reviews by outside counsel, in-house counsel, and management.

Product Warranties

The provision for product warranty primarily relates to Inamed's "Confidence Plus" program. The amount of the provision is calculated and recorded based on actuarial amounts. Expected future obligations are determined based on the history of product shipments and claims and are discounted to a current value.

NOTE 2—DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

THE COMPANY

Inamed Corporation, a Delaware corporation, and its subsidiaries, or Inamed, is a global medical device company that develops, manufactures, and markets a diverse line of products that enhance the quality of people's lives. Inamed has three principal product lines (which, for financial reporting purposes, are considered to be one segment): breast aesthetics (consisting primarily of breast implants and tissue expanders sold largely for use in plastic and reconstructive surgery), facial aesthetics (consisting primarily of collagen and other dermal fillers sold largely to dermatologists and plastic surgeons), and health (consisting of products for use in treating severe and morbid obesity). Inamed's manufacturing locations are in California, Costa Rica, and Ireland; and its administrative support functions are in California and Ireland. Inamed sells through distributors and, in certain countries including the U.S., through its own staff of sales representatives.

PRESENTATION

The consolidated financial statements include the accounts of Inamed and its subsidiaries after elimination of all significant intercompany accounts and transactions.

RECENT PRONOUNCEMENTS

On August 16, 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations". The statement requires entities to record the fair value of a liability for legal obligations associated with the retirement obligations of tangible long-lived assets in the period in which it is incurred. When the liability is initially recorded, the entity increases the carrying amount of the related long-lived asset. Over time, accretion of the liability is recognized each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The standard is effective for fiscal years beginning after June 15, 2002, with earlier application encouraged. The Company does not expect that the adoption of SFAS No. 143 will have a material impact on the Company's results from operations.

In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment and Disposal of Long Lived Assets," which supercedes SFAS No. 121 and certain sections of APB Opinion No. 30.

SFAS No. 144 classifies long-lived assets as either (1) to be held and used, (2) to be disposed of by other than sale, or (3) to be disposed of by sale. This standard introduces a probability-weighted cash flow estimation approach to deal with situations in which alternative courses of action to recover the carrying amount of a long-lived asset are under consideration or a range is estimated for the amount of possible future cash flows. Inamed has adopted this statement, which has not had a material impact on its financial position or results of operations.

In April 2002, the FASB issued SFAS No. 145, "Recission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections," which among other things provides guidance in reporting gains and losses from extinguishments of debt and accounting for leases. Inamed will adopt this statement in 2003 and is currently reviewing this statement to determine its impact. However, Inamed does not expect the adoption of this standard to have a material impact on its financial position or its results of operations.

On July 30, 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS 146 nullifies EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." It requires that a liability be recognized for those costs only when the liability is incurred, that is, when it meets the definition of a liability in the FASB's conceptual framework. SFAS No. 146 also establishes fair value as the objective for initial measurement of liabilities related to exit or disposal activities. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002, with earlier adoption encouraged. Inamed will adopt this statement in 2003 and does not expect that its adoption of SFAS 146 will have a material impact on its financial position or results from operations.

NOTE 3—RESTRUCTURING COSTS

Inamed recorded $12.0 of restructuring costs in 2001. $10.9 was recorded in the nine months ended September 30, 2001. This restructuring was a series of events to change senior management and consolidate facilities. At December 31, 2001, the accrual was $4.6. During the current quarter, Inamed paid $0.9 in restructuring costs. As of September 30, 2002, the remaining accrual for restructuring charges was $1.9 comprised of $1.7 for severance-related expenditures and $0.2 for expenditures to exit leased facilities. We expect $1.1 of payments to be made in the next year.

NOTE 4—SPECIAL CHARGES

In 1999, the Company made an investment in the common stock of Advanced Tissue Sciences, Inc. (ATS) a supplier of bioengineered human-derived collagen to the Company. In October of 2002, ATS announced that it had voluntarily filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code, and subsequently announced in November 2002 that it decided to undertake an orderly liquidation of its assets. ATS's common stock has been delisted by NASDAQ. As a result, the Company determined that the investment was permanently impaired and a write-off of the entire investment of approximately $2.7 was recorded in the quarter ended September 30, 2002.

In 2000, Inamed entered into an agreement with Reconstructive Technologies, Inc. (RTI) under which the Company acquired exclusive rights to develop a novel method of tissue expansion for breast reconstruction. RTI performed research and development work for the Company in the areas of autologous tissue generation. In conjunction with the agreement, Inamed invested $3.0 in the capital stock of RTI. During the three-month period ended June 30, 2002, Inamed decided not to pursue this research any further and determined that the investment was permanently impaired. As a result, a write-off of approximately $3.0 was recorded in the quarter ended June 30, 2002. The Company concluded that this investment was permanently impaired based on a review of RTI's financial condition, cash flow projections, operating performance; and lack of any other strategic partner.

In 1999, the Company entered into an agreement with ArthroCare Corporation to distribute ArthroCare's Coblation products in the cosmetic surgery field. During the three-month period ended June 30, 2002, the Company recorded a charge of approximately $0.3 pursuant to a settlement agreement between the Company and ArthroCare Corporation.

During the quarter ended June 30, 2002, Inamed conducted an intensive analysis of its potential sales tax liabilities. Based on the results of this analysis, the Company accrued an additional liability of $1.3.

In the quarter ended March 31, 2002, the Company recorded a $1.1 million charge relating to a legal settlement with Mr. Thomas Pilholski, an officer of Inamed from 1997 to 1998.

NOTE 5—EARNINGS PER SHARE RECONCILIATION (Per share data shown as actual, not millions)

Basic net income per share is calculated by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income per share is calculated by dividing income available to common stockholders by the weighted-average number of common and dilutive common equivalent shares outstanding during the period. Computations of per share earnings for the three and nine months ended September 30, 2002 and 2001 are as follows:

			Three Months Ended September 30, 2002			Three Months Ended September 30, 2001			Nine Months Ended September 30, 2002			Nine Months Ended September 30, 2001
Net Income—Basic and Diluted			$	7.6		$