UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF
THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2004

 

 

Commission file number 1-9741

 

 

INAMED CORPORATION

 

Delaware		59-0920629
(State of Incorporation)		(I.R.S. Employer Identification No.)

 

5540 Ekwill Street
Santa Barbara, California  93111-2936

 

Telephone Number:  (805) 683-6761

 

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  ý    No  o

 

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes  ý    No  o

 

On August 4, 2004, there were 35,584,017 shares of the Registrant’s common stock outstanding.

 

 

INAMED CORPORATION AND SUBSIDIARIES

 

Quarterly Report on Form 10-Q

For the Quarter Ended June 30, 2004

 

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Stockholders’ Equity and Comprehensive Income
Consolidated Statements of Cash Flows
Notes to the Consolidated Financial Statements
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES

 

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

 

In this document, the words ‘‘we,’’ ‘‘our,’’ ‘‘ours,’’ ‘‘us,’’ “Company” and ‘‘Inamed’’ refer only to Inamed Corporation and its subsidiaries, not any other person or entity.

 

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PART I – FINANCIAL INFORMATION

 

ITEM 1.           Financial Statements

 

INAMED CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(millions, except par value)

 

		June 30, 2004			December 31, 2003
Assets
Current assets:
Cash and cash equivalents		$	77.7		$	80.5
Short-term investments		9.9			—
Trade accounts receivable, net of allowances of $20.4 and $19.7 in 2004 and 2003, respectively		65.2			63.7
Inventories, net		53.7			47.0
Prepaid expenses and other current assets		9.6			10.6
Deferred income taxes		7.8			10.3
Total current assets		223.9			212.1
Property and equipment, net		56.3			51.2
Goodwill		151.1			151.2
Other intangible assets, net		52.2			44.5
Deferred income taxes		31.8			32.9
Other assets		5.3			9.1
Total assets		$	520.6		$	501.0
Liabilities and Stockholders’ Equity
Current liabilities:
Current portion of long-term debt		$	10.0		$	10.0
Accounts payable		27.3			23.5
Income taxes payable		6.3			10.3
Accrued liabilities and other (note 10)		36.3			36.4
Total current liabilities		79.9			80.2
Long-term debt, net of current portion		17.5			22.5
Other long-term liabilities (note 10)		38.9			46.8
Commitments and contingencies (note 14)
Stockholders’ equity:
Common stock, $0.01 par value; authorized 100.0 and 50.0 shares; issued and outstanding 35.5 and 35.3 shares for 2004 and 2003, respectively		0.4			0.4
Additional paid-in capital		229.7			223.3
Deferred compensation		(5.8		)	(6.9		)
Retained earnings		156.2			128.9
Accumulated other comprehensive income		3.8			5.8
Total stockholders’ equity		384.3			351.5
Total liabilities and stockholders’ equity		$	520.6		$	501.0

 

See accompanying notes to unaudited consolidated financial statements.

 

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INAMED CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(millions, except per share data)

 

		Three Months Ended June 30, 2004			Three Months Ended June 30, 2003
Net sales		$	99.7		$	85.8
Cost of goods sold		25.1			24.1
Gross profit		74.6			61.7
Operating expenses:
Selling, general and administrative (note 15)		59.0			35.8
Research and development		6.6			5.2
Amortization of intangible assets		1.3			1.0
Total operating expenses		66.9			42.0
Operating income		7.7			19.7
Other income (expense):
Net interest income (expense) and debt costs		(0.1		)	(5.1		)
Foreign currency transaction gains/(losses)		(0.4		)	0.4
Royalty income and other		1.3			1.1
Total other income (expense), net		0.8			(3.6		)
Income before income tax expense		8.5			16.1
Income tax (benefit) expense		(1.3		)	3.3
Net income		$	9.8		$	12.8
Net income per share of common stock:
Basic		$	0.28		$	0.38
Diluted		$	0.27		$	0.37
Weighted average shares outstanding:
Basic		35.5			33.8
Diluted		36.0			34.4

 

See accompanying notes to unaudited consolidated financial statements.

 

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INAMED CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(millions, except per share data)

 

		Six Months Ended June 30, 2004			Six Months Ended June 30, 2003
Net sales		$	190.5		$	161.3
Cost of goods sold		48.4			45.5
Gross profit		142.1			115.8
Operating expenses:
Selling, general and administrative (note 15)		98.0			67.0
Research and development		11.9			10.8
Amortization of intangible assets		2.4			2.0
Total operating expenses		112.3			79.8
Operating income		29.8			36.0
Other income (expense):
Net interest income (expense) and debt costs		0.3			(6.9		)
Foreign currency transaction gains/(losses)		(0.2		)	0.6
Royalty income and other		2.3			2.1
Total other income (expense), net		2.4			(4.2		)
Income before income tax expense		32.2			31.8
Income tax expense		4.9			7.1
Net income		$	27.3		$	24.7
Net income per share of common stock:
Basic		$	0.77		$	0.74
Diluted		$	0.76		$	0.72
Weighted average shares outstanding:
Basic		35.4			33.5
Diluted		35.9			34.1

 

See accompanying notes to unaudited consolidated financial statements.

 

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INAMED CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

(Unaudited)

(millions)

 

							Additional Paid-in Capital			Retained Earnings			Deferred Compensation			Accumulated Other Comprehensive Income			Total Stockholders’ Equity
		Common Stock (Issued)
		Shares		Amount
Balance, December 31, 2003		35.3		$	0.4		$	223.3		$	128.9		$	(6.9	)	$	5.8		$	351.5
Comprehensive income:
Net income										27.3									27.3
Translation adjustment																(2.0		)	(2.0		)
Total comprehensive income																			25.3
Employee stock purchase plan							1.8												1.8
Amortization of deferred compensation													1.1						1.1
Exercise of stock options		0.2					2.8												2.8
Tax benefit of option exercises							1.8												1.8
Balance, June 30, 2004		35.5		$	0.4		$	229.7		$	156.2		$	(5.8	)	$	3.8		$	384.3

 

See accompanying notes to unaudited consolidated financial statements.

 

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INAMED CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(millions)

 

		Six Months Ended June 30, 2004			Six Months Ended June 30, 2003
Cash flows from operating activities:
Net income		$	27.3		$	24.7
Non-cash elements included in net income:
Depreciation and amortization		6.7			7.5
Tax benefit from stock option exercises		1.8			5.6
Deferred income taxes		3.5			8.1
Non-cash compensation		1.1			—
Realization of loss on interest rate swap		—			3.5
Provision for doubtful accounts		2.2			1.1
Amortization of deferred loan costs		0.1			0.4
Changes in assets and liabilities:
Trade accounts receivable		(5.1		)	(8.4		)
Inventories		(7.3		)	(0.2		)
Prepaid expenses and other current assets		1.0			1.4
Other assets		3.8			3.8
Accounts payable		3.9			(4.8		)
Income taxes payable		(3.7		)	(10.1		)
Accruals and other long-term liabilities		(7.8		)	5.6
Net cash provided by operating activities		27.5			38.2
Cash flows from investing activities:
Purchase of property and equipment		(9.9		)	(4.1		)
Purchase of investments		(9.9		)	—
Purchase of intangibles		(10.2		)	(2.0		)
Net cash used in investing activities		(30.0		)	(6.1		)
Cash flows from financing activities:
Principal repayment of long-term debt		(5.0		)	(0.4		)
Issuance of common stock		4.6			12.6
Net cash (used in) provided by financing activities		(0.4		)	12.2
Effect of exchange rate changes on cash		0.1			1.4
Change in cash and cash equivalents:
Net change in cash and cash equivalents		(2.8		)	45.7
Cash and cash equivalents at beginning of period		80.5			39.3
Cash and cash equivalents at end of period		$	77.7		$	85.0
Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest		$	0.7		$	3.3
Income taxes		$	2.9		$	5.0

 

See accompanying notes to unaudited consolidated financial statements.

 

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INAMED CORPORATION AND SUBSIDIARIES

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2004

(millions)

 

NOTE 1    – INTERIM FINANCIAL STATEMENTS

 

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

 

Certain information and note disclosures normally included in financial statements, prepared in accordance with accounting principles generally accepted in the United States of America, have been condensed or omitted as allowed by Form 10-Q.  The accompanying unaudited consolidated financial statements should be read in conjunction with Inamed Corporation’s (“Inamed” or the “Company”) consolidated financial statements for the year ended December 31, 2003 as filed with the Securities and Exchange Commission on Form 10-K.

 

NOTE 2    – DESCRIPTION OF BUSINESS

 

The Company

 

Inamed Corporation, a Delaware corporation, is a global health care company that develops, manufactures, and markets a diverse line of products that enhance the quality of people’s lives.  We have three principal product lines (which, for financial reporting purposes, are considered to be one segment): breast aesthetics (consisting primarily of breast implants and tissue expanders for use in plastic and reconstructive surgery); facial aesthetics (consisting primarily of collagen and hyaluronic acid-based dermal fillers for use in facial rejuvenation); and obesity intervention (consisting of products for use in treating severe and morbid obesity).  Our manufacturing locations are in California, Costa Rica, and Ireland, and our administrative support functions are principally in California and Ireland.  We sell our products through our staff of sales representatives in the U.S. and in our wholly owned foreign subsidiaries and, in certain countries, through independent distributors.

 

Common Stock Split

 

On October 30, 2003, the Board approved a three for two stock split of the Company’s Common Stock in the form of a 50 percent stock dividend. The stock split was effected on December 15, 2003 for stockholders of record at the close of business on December 1, 2003. A total of 11,727,612 shares of common stock were issued in connection with the stock split.  The par value of the shares was not changed from $0.01.  All references in the Quarterly Report on Form 10-Q to shares, per share amounts, stock option data and market prices of the Company’s stock have been restated to reflect the stock split.

 

NOTE 3    – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Principles of Consolidation

 

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

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires Inamed to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates and judgments, including those related to revenue recognition, inventories, adequacy of allowances for doubtful accounts, valuation of long-lived assets and goodwill, income taxes, litigation and warranties.  Inamed bases its estimates on historical and anticipated results and trends and on various other assumptions that it believes are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not

 

8

 

readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may differ from those estimates.

 

Cash and Cash Equivalents

 

Cash and cash equivalents consist principally of cash in banks and highly liquid debt and equity instruments purchased with original maturities of three months or less.  Inamed maintains balances in high-quality financial institutions.  In the U.S., these balances at times are in excess of federally insured limits.

 

Short-term Investments

 

In accordance with Statement of Financial Accounting Standards (SFAS) No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” the Company classifies its securities as held-to-maturity and reports them at cost without recognizing any unrealized gains or losses.  Because of the Company’s cash position and the short-term nature of the maturities, the Company has the positive intent and ability to hold these securities to their maturity dates.  Securities that mature in three months or less are classified as cash equivalents.  Those that mature over three months but within one year are classified as short-term investments.  The Company is currently investing in high quality corporate debt securities and the cost of securities sold will be based on the specific identification method.

 

Fair Value of Financial Instruments

 

The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, short-term investments, accounts receivable, accounts payable, and accrued expenses approximate fair value due to their short-term maturities.  The amounts presented for long-term debt approximate fair value because the interest rate adjusts periodically based on current market rates.

 

Allowance for Doubtful Accounts

 

Inamed maintains allowances for doubtful accounts for estimated losses resulting from the inability of some of its customers to make required payments.  The allowances for doubtful accounts are based on analysis of historical bad debts, customer credit-worthiness, past transaction history with the customer, current economic trends, deterioration of the accounts-receivable aging, and changes in customer payment terms.  If the financial condition of Inamed’s customers was to deteriorate, adversely affecting their ability to make payments, additional allowances may be required.

 

Inventories

 

Inventories are stated at the lower of cost or market using the first-in, first-out (FIFO) method.  The Company provides valuation reserves for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions.

 

Current Vulnerability Due to Certain Concentrations

 

Inamed has sole or limited sources of supply for certain raw materials and finished goods that are significant.  A change in suppliers could cause a delay in manufacturing and a possible loss of sales, which would adversely affect operating results.

 

Property and Equipment

 

Property and equipment are carried at cost less accumulated depreciation and amortization.  Depreciation is recorded on the straight-line method over the estimated useful lives of the assets, which range from three to ten years.  Amortization of leasehold improvements is based upon the estimated useful lives of the assets or the term of the lease, whichever is shorter.  Maintenance and repairs are charged to operations as incurred, while significant improvements are capitalized.  Asset retirements and dispositions are accounted for in accordance with SFAS No. 144 as described below.

 

Accounting for Long-Lived Assets

 

Inamed accounts for long-lived assets, other than goodwill, in accordance with the provisions of SFAS No. 144, “Accounting for the Impairment and Disposal of Long Lived Assets,” which superseded SFAS No. 121 and certain sections of APB Opinion No. 30 specific to discontinued operations. SFAS No. 144 classifies long-lived assets as either (1) to be held and used, (2) to be disposed of by other than sale, or (3) to be disposed of by sale. This standard introduces a probability-weighted cash flow estimation approach to address situations where alternative courses of

 

9

 

action to recover the carrying amount of a long-lived asset are under consideration or a range is estimated for the amount of possible future cash flows. SFAS No. 144 requires, among other things, that an entity review its long-lived assets and certain related intangibles for impairment whenever changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable.  Factors the Company considers important that could trigger an impairment review include substantial operating losses, significant negative industry trends and significant changes in how it uses an asset.  Upon the determination that an impairment review is required the Company would compare the carrying amounts of the long-lived asset to its fair value, which is determined using a discounted cash flow model.  This model requires estimates of future revenues, profits, capital expenditures, working capital and other relevant factors.  These amounts are estimated by evaluating historical trends, current budgets, operating plans, and other industry data.  If the assets are considered to be impaired, the impairment charge is the amount by which the asset’s carrying value exceeds its fair value.  As with all cash flow models there is an inherent subjectivity.  The assumptions listed above could be different from actual results which would in turn create a different valuation.  If these assumptions change in the future, the Company may be required to record impairment charges for those assets.  With the exception of the manufacturing consolidation that commenced in 2002 (see Note 4), Inamed does not believe that any such changes have taken place.  The Company will continue to monitor its long lived asset balances and conduct formal tests when impairment indicators are present.

 

Goodwill and Other Intangible Assets

 

Goodwill represents the excess of cost over the fair value of identifiable net assets of businesses acquired. Other intangible assets consist primarily of purchased technology and patents. The Company adopted SFAS No. 142 “Goodwill and Other Intangible Assets,” on January 1, 2002. As a result, goodwill is no longer amortized, but was subjected to a transitional impairment analysis and is tested for impairment on an annual basis in October, or more frequently as impairment indicators arise. The test for impairment involves the use of estimates related to the fair values of the business operations with which goodwill is associated.  In accordance with SFAS 142 the Company evaluates the fair value of the reporting unit in relation to the carrying value of goodwill.  As long as the fair value of the reporting unit exceeds the carrying value of the reporting unit’s goodwill and no specific circumstances indicate a loss in value for goodwill, no impairment charge will be recognized.  If the fair value of the reporting unit is less than the carrying value of goodwill, the Company will measure the amount of the impairment loss and record an impairment charge based on a discounted cash flow model.  Other intangible assets are amortized using the straight-line method over their estimated useful lives and are evaluated for impairment under SFAS No. 144.

 

License and distribution rights – In the normal course of business, the Company enters into collaborative license and distribution contracts.  These collaborative agreements usually require the Company to pay up-front fees and milestone payments, some of which are significant.  When the Company pays an up-front or milestone payment for these license and distribution rights, management evaluates the stage of the acquired technology’s development to determine the appropriate accounting treatment.  Payments for these rights made in advance of regulatory approval are evaluated for capitalization based upon certain factors including: the contract, the expected launch date of the product, the market acceptance of the product in other countries, competitive product information (including products using the same compounds, similar compounds, or products used for the same application), level of development, alternative future uses, clinical experience and regulatory information.  Payments made to third parties subsequent to regulatory approval are capitalized.  Capitalized rights are stated at cost, less accumulated amortization, and are amortized using the straight-line method over their estimated useful lives of five to twenty-one years.  Significant changes to any of the factors above may result in a reduction in the useful life of the license and an acceleration of related amortization expense.  License rights are assessed periodically for impairment.

 

Product Warranties

 

The Company has an accrual for warranty programs for breast implant sales in the United States, Europe, and certain other countries.  Management estimates the amount of potential future claims from these warranty programs based on actuarial analyses.  Expected future obligations are determined based on the history of product shipments and claims and are discounted to a current value.  The liability is included in both the current and long-term liabilities in the balance sheet.  The U.S. plan in most cases provides product replacement and one thousand two hundred to two thousand four hundred dollars of financial assistance for surgical procedures within ten years of implantation.  The warranty programs in non-U.S. markets have similar terms and conditions to the U.S. plan.  The Company does not currently offer a warranty on its facial or health products and therefore no amount is included in the liability for those products.  The Company does not warrant any level of aesthetic result and, as

 

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required by government regulation, makes extensive disclosures concerning the risks of the use of its products and implantation surgery.  Changes to actual claims and interest rates could have a material impact on the actuarial analysis which could materially impact Inamed’s reported expenses and results of operations.  Substantially all of the product warranty liability arises from the U.S. warranty program. 

 

 

 

Revenue Recognition

 

The Company’s revenue is generated from the sale of its products to doctors, hospitals, clinics and distributors.  The Company sells its products through a direct sales force in the U.S. and through a direct sales force and distributors internationally.

 

Inamed recognizes product revenue, net of sales discounts, returns and allowances, in accordance with Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition” and SFAS No. 48 “Revenue Recognition When Right of Return Exists.”  Revenue is recognized when all four of the following criteria are met:  (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred and all significant contractual obligations have been satisfied; (iii) the fee is fixed or determinable; and (iv) collection is considered probable.  Appropriate reserves are established for anticipated returns and allowances based on product history.  The Company recognizes revenue when title to the goods and risk of loss transfer to customers provided there are no remaining performance obligations required of the Company or any matters requiring customer acceptance.

 

The Company allows for the return of product from doctors, hospitals, and clinics within a specified time frame, and records estimated sales returns as a reduction of sales in the same period revenue is recognized.  Inamed calculates these sales provisions based upon historical experience with actual returns.

 

A portion of the Company’s revenue is generated from consigned inventory maintained at doctors, hospitals, and clinic locations. The customer is contractually obligated to maintain a specific level of inventory and to notify Inamed upon use.  For these products, revenue is recognized at the time the Company is notified by the customer that the product has been implanted.

 

Our sales to distributors are conducted under the same revenue recognition criteria as sales via our direct sales force.  Distributors do not have explicit or implicit rights to return product and do not maintain consignment inventory.

 

Research and Development (R&D)

 

Inamed conducts its R&D internally as well as through contracts with other companies in the research and development of new products and processes.  R&D expenses are comprised of the following types of costs incurred in performing research and development activities: salaries and benefits, allocated overhead, clinical trial and related clinical manufacturing costs, regulatory costs, contract services, and other outside costs.  In accordance with SFAS No. 2, “Accounting for Research and Development Costs,” all R&D costs are expensed as incurred.

 

Stock-Based Compensation

 

Inamed has adopted the provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.”  In accordance with SFAS No. 123, Inamed has elected the disclosure-only provisions related to employee stock options and follows the  intrinsic value method in Accounting Principles Board Opinion (APB) No. 25 in accounting for stock options issued to employees.  Under APB No. 25, compensation expense, if any, is recognized as the difference between the exercise price and the fair value of the common stock on the measurement date, which is typically the date of grant, and is recognized over the service period, which is typically the vesting period.

 

Inamed accounts for options and warrant grants to non-employees using the guidance prescribed by SFAS No. 123, Financial Accounting Standards Board (FASB) Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation, and interpretation of APB No. 25,” and Emerging Issue Task Force No. 96-18, “Accounting for Equity Instruments that Are Issued to Other Than Employees for Acquiring, or In Conjunction with

 

11

 

Selling, Goods, or Services,” whereby the fair value of such option and warrant grants are measured using the fair value at the earlier of the date at which the non-employee’s performance is completed or a performance commitment is reached.

 

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure.”  SFAS No. 148 amends SFAS No. 123 and provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure requirements of SFAS No. 123 to require more prominent and frequent disclosures in financial statements about the effects of stock-based compensation. Inamed adopted the disclosure requirements of SFAS No. 148 in the fourth quarter of 2002 and will adopt, upon the completion of the final FASB rules, the fair value based method of accounting for stock-based employee compensation.

 

Pro Forma Disclosures of the Effect of Stock-based Compensation

 

Pro forma information regarding results of operations and net income per share is required by SFAS No. 123, which also requires that the information be determined as if Inamed had accounted for its employee stock options under the fair value method of SFAS No. 123.  The fair value for these options was estimated at the date of grant using a Black-Scholes option valuation model with the following weighted-average assumption used for grants:

 

 

The option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected life of the option.  Because Inamed’s employee stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not provide a reliable single measure of the fair value of its employee stock options.

 

Had compensation costs for Inamed’s stock-based compensation plan been determined using the fair value at the grant dates for awards under the plan calculated using the Black-Scholes option valuation model, Inamed’s net income would have been decreased to the pro forma amounts indicated below:

 

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		Three Months Ended June 30, 2004			Three Months Ended June 30, 2003			Six Months Ended June 30, 2004			Six Months Ended June 30, 2003
Net income as reported		$	9.8		$	12.8		$	27.3		$	24.7
Add: Stock-based compensation expense
included in reported net income, net of related
tax effects		0.3			—			0.6			—
Deduct: Total stock-based compensation expense
determined under the fair value method for all
awards, net of tax effects		(2.6		)	(0.9		)	(4.8		)	(1.8		)
Pro forma net income		$	7.5		$	11.9		$	23.1		$	22.9
Earnings Per Share
Basic as reported		$	0.28		$	0.38		$	0.77		$	0.74
Basic pro-forma		$	0.21		$	0.35		$	0.65		$	0.68
Diluted as reported		$	0.27		$	0.37		$	0.76		$	0.72
Diluted pro-forma		$	0.21		$	0.34		$	0.65		$	0.67

 

Foreign Currency Translation

 

Assets and liabilities of foreign subsidiaries with functional currencies other than the U.S. dollar are translated into U.S. dollars using the exchange rates in effect at the balance sheet date.  Results of their operations are translated using the average exchange rates during the period.  The resulting foreign currency translation adjustment is included in stockholders’ equity as a component of accumulated other comprehensive income.  Transaction gains and losses are recorded in the consolidated statements of income.  Accumulated foreign currency gains were $3.8 and $0.2, at June 30, 2004 and 2003, respectively.

 

Income Taxes

 

Deferred income tax assets or liabilities are computed based on the temporary differences between the financial statement and income tax bases of assets and liabilities using the statutory marginal income tax rate in effect for the years in which the differences are expected to reverse.  Deferred income tax expenses or credits are based on the changes in the deferred income tax assets or liabilities from period to period.  A valuation allowance against deferred tax assets is required if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.  The valuation allowance should be sufficient to reduce the deferred tax asset to the amount that is more likely than not to be realized.

 

Income taxes are determined using an estimated annual effective tax rate, which is generally less than the U.S. Federal statutory rate, primarily because of lower tax rates in certain non-U.S. jurisdictions and research and development tax credits available in the United States.  In accordance with FIN 18, “Accounting for Income Taxes in Interim Periods,” discrete items are included in the period affected rather than being reflected in the annual effective tax rate.  Included in the provision for income taxes for the three and six months ended June 30, 2004 is an estimated $6.9 income tax benefit for a legal settlement and related second quarter fees.

 

Interest Rate Swaps

 

On January 1, 2001, the Company adopted SFAS No. 133, “Accounting for Derivative Instruments and Certain Hedging Activities” and SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activity, an Amendment of SFAS No. 133”, as amended by SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS Nos. 133 and 138 require that all derivative instruments be recorded on the balance sheet at their respective fair values.  If the hedging criteria in SFAS No. 133 are met, the resulting valuation adjustments are included in stockholders’ equity as a component of accumulated other comprehensive income (loss), net of tax when no ineffectiveness exists.  Amounts in accumulated other comprehensive income (loss) shall be reclassified into earnings in the same period during which the hedged forecasted transaction affects earnings or when a cash flow hedge is discontinued because it is probable that the original forecasted transaction will not occur.  (See Note 8 for a further discussion on the interest rate swap.)

 

13

 

 

Recent Pronouncements

 

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an interpretation of ARB No. 51,” which was originally effective on July 1, 2003.  In December 2003, the FASB deferred the effective date for applying the provision of FIN 46 to March 31, 2004 for interests held by public companies in variable interest entities or potential variable interest entities created prior to February 1, 2003.  The adoption of FIN 46 did not have a material impact on our financial position or results from operations.

 

On March 31, 2004, the FASB issued an exposure draft, “Share-Based Payment, an Amendment of SFAS No. 123 and 95.”  The exposure draft proposes to expense the fair value of share-based payments to employees beginning in 2005.  The Company is currently evaluating the impact of this proposed standard on its financial statements.

 

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NOTE 4 – RESTRUCTURING COSTS

 

Inamed recorded $5.1 of restructuring costs in the fourth quarter of 2002.  This restructuring was undertaken to consolidate manufacturing facilities.  The annual savings from the manufacturing consolidation is estimated to be a reduction in U.S. payroll and support costs of $10.0, with a corresponding increase in costs in Ireland of $4.3 and Costa Rica of $0.4, with a net savings of $5.3 per year.  The savings are from the relocation to lower-cost manufacturing locations.  The savings will be reflected in cost of goods sold on the income statement.  The consolidation of operations was completed in the first quarter of 2004 and involved transitioning Santa Barbara-based manufacturing to the Company’s facilities in Costa Rica and Ireland.  Through June 30, 2004, the Company eliminated approximately 140 manufacturing positions in Santa Barbara and will eliminate approximately 10 more through the end of 2004.  Approximately 80 of these positions were added in Ireland and Costa Rica through March 31, 2004.  The majority of the costs relate to severance which has been and will be paid from the beginning of 2003 through 2005.  Inamed has accounted for the restructuring in accordance with EITF 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring).” As part of the manufacturing consolidation the Company accelerated the depreciation on certain assets with shortened useful lives.  For the three and six months ended June 30, 2004, Inamed included $0.0 and $0.4, respectively, of accelerated depreciation charges in cost of goods sold.  For the three and six months ended June 30, 2003, Inamed included $0.9 and $1.9, respectively, of accelerated depreciation charges in cost of goods sold. These assets were fully depreciated as of March 31, 2004.  The Company does not expect any further material costs related to the 2002 restructuring.  Through the six months ended June 30, 2004 a major contributor in the increase of the gross margin year over year was the savings generated as a result of the manufacturing consolidation.  The savings generated were primarily the result of reduced payroll costs.

 

Inamed recorded $12.0 of restructuring costs in the first quarter of 2001.  This restructuring was a series of events to reorganize senior management and to consolidate facilities and administrative functions.  The Santa Barbara reduction was facilitated by certain manufacturing operations having moved to Inamed’s new facility in Costa Rica and the move of Santa Barbara’s remaining manufacturing to a local facility.  These costs were primarily employee severance costs which will be paid through 2005.  Inamed does not expect any further material costs related to the 2001 restructuring.

 

A summary of activity related to the restructuring charges is as follows:

 

		Employee Termination Benefits
2001 restructuring accrual:
Balance at December 31, 2003		$	0.7
Cash paid through June 30, 2004		(0.3		)
Accrual balance at June 30, 2004		0.4
2002 restructuring accrual:
Balance at December 31, 2003		$	3.2
Cash paid through June 30, 2004		(1.0		)
Accrual balance at June 30, 2004		$	2.2
Total accrual balance at June 30, 2004		$	2.6

 

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NOTE 5 – NET INCOME PER SHARE RECONCILIATION  (Per share data shown as actual, not millions)

 

Basic net income per share is calculated by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period.  Diluted net income per share is calculated by dividing income available to common stockholders by the weighted-average number of common and dilutive common equivalent shares outstanding during the period.  Computations of per share earnings for the three and six months ended June 30, 2004 and 2003 are as follows:

 

		Three Months Ended June 30, 2004			Three Months Ended June 30, 2003			Six Months Ended June 30, 2004			Six Months Ended June 30, 2003
Net Income - Basic and Diluted		$	9.8		$	12.8		$	27.3		$	24.7
Weighted average shares outstanding - Basic		35.5			33.8			35.4			33.5
Dilutive effect of stock options		0.5		(1)	0.6		(1)	0.5		(1)	0.6		(1)
Weighted average shares outstanding - Diluted		36.0			34.4			35.9			34.1
Per share amount
Basic		$	0.28		$	0.38		$	0.77		$	0.74
Diluted		$	0.27		$	0.37		$	0.76		$	0.72

 

(1) The calculation excludes 0.4 options that are anti-dilutive for the six months ended June 30, 2003.

 

NOTE 6 – INVENTORIES

 

Inventories are summarized as follows:

 

		June 30, 2004			December 31, 2003
Raw materials		$	11.6		$	11.7
Work in process		11.0			7.1
Finished goods, net		31.1			28.2
		$	53.7		$	47.0

 

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NOTE 7 – SALES BY PRODUCT LINE/GEOGRAPHICALLY

 

Sales by product line were as follows:

 

		Three Months Ended June 30, 2004			Three Months Ended June 30, 2003			Six Months Ended June 30, 2004			Six Months Ended June 30, 2003
Breast Aesthetics		$	57.3		$	47.5		$	110.2		$	89.9
Facial Aesthetics		20.5			22.2			37.9			40.0
Health		21.1			15.2			40.3			29.2
Other*		0.8			0.9			2.1			2.2
Total Sales		$	99.7		$	85.8		$	190.5		$	161.3

 

*  Other products consist of collagen sales to other medical manufacturers.

 

Sales in the U.S. and all other countries (according to the location of the customer) were as follows:

 

		Three Months Ended June 30, 2004			Three Months Ended June 30, 2003			Six Months Ended June 30, 2004			Six Months Ended June 30, 2003
United States		$	59.9		$	55.8		$	115.1		$	102.2
All other countries*		39.8			30.0			75.4			59.1
Total Sales		$	99.7		$	85.8		$	190.5		$	161.3

 

*  No other country’s sales comprise more than 10% of net sales for any of the periods presented.

 

NOTE 8 – INTEREST RATE SWAP

 

As of June 30, 2004, the Company no longer had an interest rate swap agreement.  At June 30, 2003 Inamed had an interest rate swap agreement with a financial institution.  The purpose of this agreement was to establish a hedge against interest rate fluctuations associated with Inamed’s variable interest rate debt outstanding at that time.  Inamed had designated this derivative as a cash flow hedge and recorded the existing liability and unrecognized losses.  The swap agreement fixed the interest rates at 9.815% on a $39.8 notional value. The swap required monthly interest payments to settle the differences in its fixed rates compared to one month LIBOR plus 3.0%.  Inamed included these payments in interest expense.

 

As of June 30, 2003, the Company determined that it was probable that Inamed’s variable interest rate debt described above for which the hedge was utilized would be refinanced.  Consequently, pursuant to SFAS No. 133 as amended, unrealized losses of $3.5 that had been previously included in accumulated other comprehensive income (loss) were recorded as interest expense in the Company’s income statement.  In July 2003, the Company terminated the interest rate swap agreement in connection with the termination of the variable interest rate debt.

 

NOTE 9 – INTEREST INCOME AND INTEREST EXPENSE

 

Interest income and interest expense for the three and six month periods ended June 30, 2004 and 2003 were as follows:

 

		Three Months Ended June 30, 2004		Three Months Ended June 30, 2003		Six Months Ended June 30, 2004		Six Months Ended June 30, 2003
Interest income		0.2		0.3		1.0		0.4
Interest expense		(0.3	)	(5.4	)	(0.7	)	(7.3	)
Interest income (expense)		(0.1	)	(5.1	)	0.3		(6.9	)

 

Included in interest expense in the three and six months ended June 30, 2003 is $3.5 of realized losses on the Company's interest rate swap.

 

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NOTE 10  –  ACCRUED LIABILITIES AND OTHER; OTHER LONG-TERM LIABILITIES

 

Accrued liabilities and other is summarized as follows:

 

		June 30, 2004			December 31, 2003
Salaries, wages, and payroll taxes		$	10.3		$	14.7
Acquisition and restructuring costs		1.7			2.4
Royalties payable		2.0			2.6
Trilucent liability, current		4.5			3.5
Accrued legal and settlement expense		1.7			0.7
Sales tax liability		4.2			5.0
Warranty provision, current		2.9			2.7
Other		9.0			4.8
Total accrued liabilities and other		$	36.3		$	36.4

 

Other long-term liabilities consist of the following:

 

		June 30, 2004			December 31, 2003
Warranty provision		$	8.0		$	7.8
Trilucent liability		9.9			18.2
Deferred income tax liability		14.6			14.6
Other liabilities		6.4			6.2
Total other long-term liabilities		$	38.9		$	46.8

 

NOTE 11  –  LONG-TERM DEBT

 

Long-term debt is summarized as follows:

 

		June 30, 2004			December 31, 2003
Variable 1-month LIBOR plus 2.0% note, final maturity in July 2008		$	27.5		$	32.5
Less: current maturities		(10.0		)	(10.0		)
Long-term debt		$	17.5		$	22.5

 

As of June 30, 2004, the Company had long-term debt of $27.5 including $10.0 of current liabilities.  In addition, the Company had a $35.0 five-year revolving credit facility of which $14.8 of the revolver capacity was utilized by having letters of credit issued to collateralize certain insurance programs. The remaining $20.2 of revolver capacity was unused as of June 30, 2004.  The borrowings under the current credit facilities bear interest at the London Interbank Offered Rate or LIBOR plus 2.0%.  Remaining principal payments of $5.0, $12.5, and $10.0 are due in 2004, 2005 and 2006, respectively.

 

NOTE 12  –  GOODWILL AND OTHER INTANGIBLE ASSETS

 

Inamed has adopted SFAS No. 142, “Goodwill and Other Intangible Assets.”  In accordance with SFAS No. 142, Inamed discontinued amortizing goodwill and other intangible assets with indefinite lives.  Inamed performed its annual impairment test of goodwill using a market value approach during the fourth quarter of 2003 and determined that there was no impairment of goodwill and intangible assets.  No events have occurred to trigger an impairment evaluation since the fourth quarter of 2003.

 

Goodwill was $151.1 and $151.2 as of June 30, 2004 and December 31, 2003, respectively.

 

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Net other intangible assets subject to amortization were $48.1 and $40.4 as of June 30, 2004 and December 31, 2003, respectively.  These assets will continue to be amortized over their expected useful lives, which range from three to twenty one years. Other intangible assets not subject to amortization (trade names) were $4.1 at June 30, 2004 and December 31, 2003.   Total other intangible assets are as follows:

 

				June 30, 2004									December 31, 2003
		Weighted Average Life		Gross			Accumulated Amortization			Net			Gross			Accumulated Amortization			Net
Licenses		13.2		$	61.2		$	(17.1	)	$	44.1		$	51.1		$	(14.9	)	$	36.2
Patents		15.5		5.7			(1.7		)	4.0			5.7			(1.5		)	4.2
Other		5.0		2.4			(2.4		)	—			2.4			(2.4		)	—
Total intangibles subject to amortization				$	69.3		$	(21.2	)	$	48.1		$	59.2		$	(18.8	)	$	40.4
Other intangibles not subject to amortization				4.1			—			4.1			4.1			—			4.1
Total other intangibles				$	73.4		$	(21.2	)	$	52.2		$	63.3		$	(18.8	)	$	44.5

 

Aggregate amortization expense for intangible assets was $1.3 and $2.4 for the three and six months ended June 30, 2004, respectively. For the years 2004 through 2007, amortization expense for intangible assets is expected to be approximately $5.2, $5.2, $5.2, and $5.0 million.

 

NOTE 13  –  STOCKHOLDERS’ EQUITY (Share quantity and per share data shown as actual, not millions)

 

Stock Options

 

The following table represents share information for all the option plans for Inamed at June 30, 2004:

 

		Authorized shares		Number of securities to be issued upon the exercise of outstanding options		Weighted average exercise price of outstanding options			Number of options remaining available for future issuance
The 1993 Plan		225,000		37,500		$	19.20		—
The 1998 Plan		675,000		7,400		$	4.33		107,499
The 1999 Program		1,350,000		231,249		$	44.30		231,416
The 2000 Option Plan		2,287,500		1,362,803		$	34.75		95,246
The 2003 Outside Director Plan		225,000		60,000		$	45.74		165,000
The 2004 Plan		500,000		—		$	—		500,000
Equity compensation plans  approved by Stockholders		5,262,500		1,698,952		$	35.96		1,099,161
Stand Alone Options, not  approved by Stockholders		2,426,250		200,001		$	15.34		—
Total		7,688,750		1,898,953		$	33.79		1,099,161

 

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Summary

 

Activity under these plans for the periods ended June 30, 2004 and 2003 was as follows (shares in millions):

 

		For the three months ended					For the three months ended					For the six months ended					For the six months ended
		June 30, 2004					June 30, 2003					June 30, 2004					June 30, 2003
		Shares Under Option		Weighted Average Exercise Price			Shares Under Option		Weighted Average Exercise Price			Shares Under Option		Weighted Average Exercise Price			Shares Under Option		Weighted Average Exercise Price
Options outstanding at
the beginning of the period		2.0		$	33.54		2.7		$	16.18		2.1		$	32.55		3.4		$	15.20
Granted		—		$	57.96		—		$	—		0.1		$	51.18		—		$	21.86
Cancelled		(0.1	)	$	49.16		—		$	24.43		(0.1	)	$	42.87		(0.1	)	$	21.40
Exercised		(0.1	)	$	17.51		(0.5	)	$	11.57		(0.2	)	$	18.34		(1.1	)	$	10.74
Options outstanding at the end of the period		1.9		$	33.79		2.2		$	16.18		1.9		$	33.79		2.2		$	17.20
Options exercisable at the end of the period		0.2		$	20.17		1.0		$	19.08		0.2		$	20.17		1.0		$	19.08
Weighted average fair value of options granted during the period				$	18.22				$	—				$	21.46				$	8.21

 

The following table summarizes information about stock options outstanding at June 30, 2004 (shares in millions):

 

		Options Outstanding							Options Exercisable
Range of exercise prices		Number Outstanding		Wgtd. Avg. Remaining Contractual Life (Years)		Wgtd. Avg. Exercise Price			Number Exercisable		Wgtd. Avg. Exercise Price
$4.33 - $12.80		0.22		7.34		$	11.39		0.03		$	10.00
$14.69 - $16.50		0.19		7.61		$	14.99		0.03		$	16.25
$16.68 - $18.17		0.32		5.99		$	17.40		0.03		$	17.65
$20.88 - $43.84		0.19		6.66		$	26.67		0.11		$	24.45
$44.58 - $48.68		0.14		9.18		$	47.47		—			—
$48.99		0.77		9.25		$	48.99		—			—
$49.19		0.04		9.69		$	49.19		—			—
$49.70		0.01		6.24		$	49.70		—			—
$51.08		0.02		9.23		$	51.08		—			—
$57.96		0.02		6.93		$	57.96		—			—
$ 4.33 - $57.96		1.90		8.04		$	33.79		0.20		$	20.17

 

Restricted Stock Plan

 

In 2003 Inamed adopted the 2003 Restricted Stock Plan, which authorizes Inamed to issue shares to any employee, officer, consultant, or non-employee director.  In the second quarter of 2004, the stockholders approved an increase in the number of authorized shares by 150,000 shares to 300,000 shares.  Restricted Stock Awards may be granted by the Board subject to vesting and any other restrictions (including a period during which vested shares may not be sold) as determined by the Board and stated in the Award Agreement.  Restricted stock may not be sold or otherwise transferred or pledged until the restrictions lapse or are terminated.

 

		Authorized shares		Number of shares issued		Available for Issuance
The 2003 Restricted Stock Plan		300,000		142,500		157,500

 

The following table summarizes the restricted stock-based compensation charges that have been included in the following captions of the income statement, for each of the periods presented (in thousands):

 

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		Three months ended June 30,					Six months ended June 30,
		2004			2003		2004			2003
Cost of goods sold		$	83.2		—		$	166.4		—
Selling, general and administrative		$	443.5		—		$	887.0		—
		$	526.7		—		$	1,053.4		—

 

NOTE 14 – COMMITMENTS AND CONTINGENCIES

 

The Company is involved in various litigation matters as a claimant and as a defendant.  Inamed records any amounts recovered in these matters when collection is realized.  Inamed records liabilities for claims against the Company when the losses are probable and can be reasonably estimated.  Amounts recorded are based on reviews by outside counsel, in-house counsel, and management.  Actual results could differ from estimates. See “Legal Proceedings. ”

 

NOTE 15 – LITIGATION

 

Effective June 21, 2004, the Company resolved its patent infringement lawsuit with Ethicon Endo-Surgery, Inc. (“Ethicon”) and entered into a settlement agreement regarding various patents related to gastric banding.  Under the terms of the settlement agreement, Inamed paid Ethicon $17.2 in the second quarter of 2004, and, pursuant to a license arrangement included in the settlement agreement, will pay royalties to Ethicon on future United States sales of the LAP-BAND® System, initially at 7.5%. Prior to this settlement, Inamed accrued a royalty on U.S. sales at 1.2%.  The 7.5% royalty will be reduced to 5.5% if Ethicon is able to obtain approval from the U.S. Food and Drug Administration for the marketing of an adjustable gastric band sometime in the future. Inamed will also pay Ethicon 3.5% on all future foreign sales of the LAP-BAND® System.  The U.S. and international royalties payable will decrease to 2% after June 20, 2011, and all Inamed royalty obligations will expire no later than May 12, 2013.   Inamed’s license is to Ethicon’s family of gastric banding patents which were at issue during the litigation.

 

The Company recorded a charge in the amount of $17.2 for the three months ended June 30, 2004, to reflect the settlement payment to Ethicon and related second quarter litigation costs and expenses.  This charge is net of the previously accrued amounts and is included in selling, general and administrative expenses.

 

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ITEM 2.           Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Forward-Looking Statements

 

Certain statements contained in this Quarterly Report on Form 10-Q, and other written and oral statements made from time to time by us, do not relate strictly to historical facts. These statements are considered “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “forecast,” “intend,” “may,” “plan,” “possible,” “project,” and “should,” or similar words or expressions, are intended to identify forward looking statements. This forward looking information involves important risks and uncertainties that could materially alter results in the future from those expressed in any forward looking statements made by, or on behalf of, us. We caution you that such forward-looking statements are only predictions and that actual events or results may differ materially. In evaluating such statements, you should specifically consider the various factors that could cause actual events or results to differ materially, including those factors described below. It is not possible to foresee or identify all factors affecting our forward-looking statements and you should not consider any list of such factors to be exhaustive. We are under no duty to update any forward-looking statements.

 

Although forward-looking statements in this report on Form 10-Q reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Factors that could cause or contribute to such differences in results and outcomes include without limitation those discussed under the heading ‘‘Risks and Uncertainties’’ below, as well as those discussed elsewhere in this report on Form 10-Q. Readers are referred to the report on Form 10-K for the year ended December 31, 2003 and other documents as filed by Inamed Corporation with the Securities and Exchange Commission, which identify important risk factors that could cause actual results to differ from those contained in the forward-looking statements.  Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this report on Form 10-Q.  The information contained in this Form 10-Q is a statement of our present intention, belief, or expectation and is based upon, among other things, the existing regulatory environment, industry conditions, market conditions and prices, the economy in general, and our assumptions.  We may change our intention, belief, or expectation at any time and without notice, based upon any changes in such factors, in our assumptions or otherwise.  We undertake no obligation to review or confirm analysts’ expectations or estimates or to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this report on Form 10-Q  and we expressly disclaim any duty to update the information contained in this Form 10-Q. Readers are urged to carefully review and consider the various disclosures made in this report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations and prospects.

 

By including any information in this Form 10-Q, we do not necessarily acknowledge that disclosure of such information is required by applicable law or that the information is material.

 

The following Management’s Discussion and Analysis (MD&A) is intended to help the reader to better understand the financial condition and results of operations of Inamed Corporation.  MD&A is provided as a supplement to, and should be read in conjunction with, our financial statements and the accompanying notes included herein and our audited financial statements and accompanying notes included in our annual report on Form 10-K.  The following provides a brief description of each section of our MD&A:

 

•                  Company and Industry Overview – provides a general description of our business, our market place and the basis for most of our revenues and expenses;

 

•                  Liquidity and Capital Resources – provides our historical sources and uses of cash, existence and timing of cash commitments, and a prospective look into where future cash will be provided and used;

 

•                  Results of Operations – provides a consolidated analysis of the results of operations for the two periods presented in our financial statements, including prospective information;

 

22

 

•                  Application of Critical Accounting Policies and Estimates – provides a discussion on our accounting policies that require critical judgments and estimates.

 

Company and Industry Overview

 

Inamed is a global health care company that develops, manufactures and markets a diverse line of products that enhance the quality of peoples’ lives. These products include breast implants and tissue expanders for use in plastic and reconstructive surgery, a range of dermal products to correct facial wrinkles and the LAP-BANDÒ System and BIBÒ Systems used to treat severe and morbid obesity.  We generate approximately 36% of our revenues outside the U.S./Canada.

 

Our primary markets are very competitive and subject to substantial government regulation. Pricing and market share pressures vary by product line and geographic market. In general, inflationary trends result in increases in our labor and material costs. In addition, there are foreign currency fluctuations and other risks associated with operating on a global basis, such as price and currency-exchange controls, import restrictions, and changing economic, social and political conditions in foreign countries. We expect these trends and risks to continue. We will continue to manage these issues by capitalizing on our market presence, developing innovative products, investing in human resources, leveraging our cost structure, and possibly entering into alliances and other arrangements.

 

We derive all of our revenues from product sales. We sell our breast aesthetics, facial aesthetics and obesity intervention products in the U.S. to hospitals, clinics and doctors through a direct sales force. Internationally, our products are sold either through direct sales forces in countries where we have our own subsidiaries or through third party distributors.

 

We manufacture our products in California, Costa Rica and Ireland.  We also purchase finished products and certain raw material components from third party manufacturers and suppliers.  The cost of goods sold represents raw materials, labor and overhead, and the cost of third party finished products. Gross margins may fluctuate from period to period due to changes in the selling prices of our products, the mix of products sold, changes in the cost of third party finished products, raw materials, labor and overhead and manufacturing efficiencies or inefficiencies.  For the six months ended June 30, 2004 and June 30, 2003, the cost of goods sold also includes accelerated depreciation charges related to the manufacturing consolidation.  (See Note 4 of the notes to the consolidated financial statements.)

 

Our selling, general and administrative expense incorporates the expenses of our sales and marketing organization and the general and administrative expenses necessary to support the global corporation. Our sales and marketing expenses consist primarily of salaries, commissions, and marketing program costs. General and administrative expenses incorporate the costs of finance, human resources, information services, legal and insurance costs.

 

Our research and development expenses are comprised of the following types of costs incurred in performing clinical development and research and development activities: salaries and benefits, allocated overhead, clinical trial and related clinical manufacturing costs, regulatory costs, contract services, and other outside costs.  We also conduct research on materials technology, product design and product improvement.

 

Liquidity and Capital Resources

 

We had cash and cash equivalents of $77.7 million and short-term investments of $9.9 million at June 30, 2004, an aggregate increase of $7.1 million from $80.5 million of cash and cash equivalents and no short-term investments at December 31, 2003. The increase was primarily the result of cash provided by operations of $27.5 million and cash from the issuance of common stock of $4.6 million, offset primarily by the purchases of plant and equipment of $9.9 million, intangible assets of $10.2 million, and principal repayments of long-term debt of $5.0 million.  Cash provided by operating activities has been, and is expected to continue to be, our primary source of funds.  We invest a portion of our cash and cash equivalents in short-term investments with maturities of less than one year.

 

Cash provided by operations was $27.5 million for the six months ending June 30, 2004 compared to $38.2 million for the six months ended June 30, 2003.  The decrease was primarily the result of a cash payment for our Ethicon Endo-Surgery, Inc. (“Ethicon”) legal settlement of $17.2 million (see Part II, Item 1.  Legal Proceedings, Patents and

 

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License Litigation, Kuzmak Matter for a further discussion of this settlement agreement).  Pursuant to the terms of this settlement agreement, we will commence accrual of the royalties in the third quarter of 2004 and payment of such royalties to Ethicon in the fourth quarter of 2004.  Royalty amounts will vary based on the sales of these products.  Accounts receivable increased $5.1 million due to increased sales.  Inventories increased $7.3 million mainly in our facial product inventory in the U.S.  Accounts payable increased $3.9 million in line with our increased inventory purchases.  Income taxes payable decreased $3.7 million as a result of our lower tax rate in 2003 and utilization of net operating losses and tax credits.  Accruals and other long-term liabilities decreased $7.8 million primarily due to payments on our Trilucent liability (see Part II, Item 1.  Legal Proceedings, Breast Implant Litigation, Trilucent Breast Implant Matters).  We expect cash from operations to increase for the full year as a result of increased sales and net income.

 

Cash used in investing activities of $30.0 million for the six months ended June 30, 2004 consists of $9.9 million for the purchase of short-term investments, $10.2 million for the purchase of intangibles, primarily the purchase of license and distribution agreements, and $9.9 million in capital expenditures, primarily for our plant expansions and our global Enterprise Resource Planning or ERP system.  Cash used in investing activities of $6.1 million for the six months ended June 30, 2003 consisted of the purchase of intangibles of $2.0 million and capital expenditures of $4.1 million, primarily for our global ERP system.

 

Cash used in financing activities for the six months ended June 30, 2004 of $0.4 million reflects proceeds of $4.6 million from the issuance of common stock upon the exercise of outstanding employee stock options and issuances pursuant to the employee stock purchase plan, offset by long-term debt principal payments of $5.0 million.  Cash provided by financing activities for the six months ended June 30, 2003 of $12.2 million reflected proceeds of $12.6 million from the issuance of common stock upon the exercise of outstanding employee stock options and issuances pursuant to the employee stock purchase plan, partially offset by principal payments of $0.4 million on our long-term debt.

 

As of June 30, 2004, we had long-term debt of $27.5 million including $10.0 million of current liabilities.  In addition, we had a $35.0 million five-year revolving credit facility. We had utilized $14.8 million of the revolver capacity by having letters of credit issued to collateralize certain insurance programs. The remaining $20.2 million of revolver capacity was unused as of June 30, 2004. The borrowings under the current credit facilities bear interest at the London Interbank Offered Rate or LIBOR plus 2.0%.  Remaining principal payments of $5.0, $12.5, and $10.0 million are due in 2004, 2005 and 2006, respectively.

 

The primary objectives of our investment policy are, in order of priority, preservation of principal, liquidity, and attaining a high rate of return.  Consequently, our investments are generally of short duration and high credit quality. We believe that existing funds, cash generated from operations, and existing debt financing are adequate to satisfy our working capital and capital expenditure requirements for the foreseeable future. Further, we believe that our operating cash flow will be in an amount sufficient to repay the existing term loan. However, we may raise additional capital from time to time.

 

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