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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:
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%
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
Total Vote For Total Vote Withheld
Each Nominee From Each Nominee
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
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.
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
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.
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.
Year Ended
December 31,
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)%
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 m