INTEGRA LIFESCIENCES HOLDINGS CORPORATION The following discussion and analysis provides information management believes to be relevant to understanding our financial condition and results of operations. For a full understanding of financial condition and results of operations, it should be read together with the selected consolidated financial data and our financial statements with the related notes appearing elsewhere in this report. The discussion focuses on our financial results for the year endedDecember 31, 2021 and 2020. The comparison of fiscal 2020 to 2019 has been omitted from this Form 10-K, but can be referenced in our Form 10-K for the fiscal year endedDecember 31, 2020 -"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" filed onFebruary 23, 2021 . We have made statements in this report which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934 (the "Exchange Act"). These forward-looking statements are subject to a number of risks, uncertainties and assumptions about the Company and other matters. These forward-looking statements include, but are not limited to, statements related to the Company's expectations regarding the potential impacts of the COVID-19 pandemic on our business, financial condition, and results of operations. These statements should, therefore, be considered in light of various important factors, including, but not limited to, the following: the risk that the COVID-19 pandemic could lead to further material delays and cancellations of, or reduced demand for, procedures; delayed capital spending by the Company's customers; disruption and/or higher costs to the Company's supply chain; staffing shortages in hospitals; labor impacts in our facilities; delays in gathering clinical evidence; diversion of management and other resources to respond to the COVID-19 outbreak; the impact of global and regional economic and credit market conditions on healthcare spending; the risk that the COVID-19 virus disrupts local economies and causes economies in our key markets to enter prolonged recessions. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those set forth under the heading "Risk Factors." 30 --------------------------------------------------------------------------------
GENERAL
Integra, headquartered inPrinceton, New Jersey , is a world leader in medical technology. The Company was founded in 1989 with the acquisition of an engineered collagen technology platform used to repair and regenerate tissue. Since then, Integra has developed numerous product lines from this technology for applications ranging from burn and deep tissue wounds to the repair of dura mater in the brain, as well as nerves and tendons. The Company has expanded its base regenerative technology business to include surgical instruments, neurosurgical products and advanced wound care through a combination of several global acquisitions and product development to meet the needs of its customers and impact patient care. Integra manufactures and sells medical technologies and products in two reportable business segments: Codman Specialty Surgical ("CSS") and Tissue Technologies ("TT"). The CSS segment, which represents two-thirds of our total revenue, consists of market-leading technologies and instrumentation used for a wide range of specialties, such as neurosurgery, neurocritical care and otolaryngology. We are the world leader in neurosurgery and one of the top three providers in instruments used in precision, specialty, and general surgical procedures. Our TT segment generates about one-third of our overall revenue and focuses on three main areas: complex wound surgery, surgical reconstruction, and peripheral nerve repair. We have key manufacturing and research facilities located inCalifornia ,Indiana ,Maryland ,Massachusetts ,New Jersey ,Ohio ,Puerto Rico ,Tennessee ,Utah ,Canada ,China ,France ,Germany ,Ireland andSwitzerland . We also source most of our handheld surgical instruments and dural sealant products through specialized third-party vendors. Integra is committed to delivering high quality products that positively impact the lives of millions of patients and their families. We focus on four key pillars of our strategy: 1) enabling an execution-focused culture, 2) optimizing relevant scale, 3) advancing innovation and agility, and 4) leading in customer experience. We believe that by sharpening our focus on these areas through improved planning and communication, optimization of our infrastructure, and strategically aligned tuck-in acquisitions, we can build scale, increase competitiveness and achieve our long-term goals.
To this end, the executive leadership team has established the following key priorities aligned to the following areas of focus:
Strategic Acquisitions. An important part of the Company's strategy is pursuing strategic transactions and licensing agreements that increase relevant scale in the clinical areas in which Integra competes. During 2021, the Company acquiredACell Inc. ("ACell"), an innovative regenerative medicine company specializing in the manufacturing of porcine urinary bladder extracellular matrices. This acquisition not only expanded the Company's product offering of regenerative technologies, but it also supported the Company's long-term growth and profitability strategy as this product line has a financial profile similar to Integra's other regenerative tissue products. All critical components ofACell have been integrated into the Company's TT segment. See Note 4, Acquisitions and Divestitures, to the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for additional details. In 2021, we continued to advance the development of pioneering neurosurgical technologies from our 2019 acquisitions,Arkis Biosciences, Inc. andRebound Therapeutics Corporation . Portfolio Optimization and New Product Introductions. We are investing in innovative product development to drive a multi-generational pipeline for our key product franchises. Our product development efforts span across our key global franchises focused on potential for significant returns on investment. In addition to new product development, we are funding studies to gather clinical evidence to support launches, ensure market access and improve reimbursement for existing products. In addition to acquisitions and organic reinvestment, we continually look to optimize our portfolio towards higher growth and higher margin businesses. As such, we may opportunistically divest businesses or discontinue products where we see limited runway for future value creation in line with our aspirations due in part to changes in the market, business fundamentals or the regulatory environment. InJanuary 2021 , we completed the sale of our Extremity Orthopedics business toSmith & Nephew USD Limited ("Smith & Nephew"), a subsidiary of Smith & Nephew plc, for approximately$240 million in cash. This transaction enables us to increase our investments in our core neurosurgery and tissue technologies businesses and fund pipeline opportunities to expand our addressable markets to strengthen our existing leadership positions in these segments and drive future growth. See Note 4, Acquisitions and Divestitures, to the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for details. Commercial Channel Investments. Investing in our sales channels is a core part of our strategy to create specialization and greater focus on reaching new and existing customers and addressing their needs. To support our commercial efforts in Tissue Technologies, we expanded our two-tier specialist model to increase our presence in focused segments by creating a virtual selling organization to help serve the evolving needs of our customers. In addition, we continue to build upon our leadership brands across our product franchises in both CSS and TT to engage customers through enterprise-wide contracts with leading hospitals, integrated delivery networks and global purchasing organizations inthe United States . Internationally, we have increased our commercial resources significantly in key emerging markets and are making investments to support our sales organization and maximize our commercial opportunities. These investments in our international sales channel position us well for expansion and long-term growth. 31 -------------------------------------------------------------------------------- Customer Experience. We aspire to be ranked as a best-in-class provider and are committed to strengthen our relationships with all customers. We continue to invest in technologies, systems and processes to enhance the customer experience. Additionally, we launched digital tools and programs, resources and virtual product training to drive continued customer familiarity with our growing portfolio of medical technologies globally.
Clinical and Product Development Activities
We continue to invest in collecting clinical evidence to support the Company's existing products and new product launches, and to ensure that we obtain market access for broader and more cost-effective solutions. In each area, we continue to benefit from products launched over the past several years, including our new electrosurgery generator and irrigator system, an innovative customer-centric toolkit for our Certas Plus Programmable Valve along with additional shunt configurations. InJapan , we are experiencing strong growth as a result of the successful launch of DuraGen in mid-2019, which is the first and only collagen xenograft approved for use as a dural substitute in the country. We are focused on the development of core clinical applications in our electromechanical technologies portfolio. Also, we continue to update our CUSA Clarity platform by incorporating new ultrasonic handpiece, surgical tips and integrated electrosurgical capabilities. We continue to work with several instrument partners to bring new surgical instrument platforms to the market. In the third quarter of 2021, our CereLink ICP Monitor System was launched in theU.S. andEurope . CereLink provides enhanced accuracy, usability and advanced data presentation that provides clinicians with uncompromised, advanced continuous ICP monitoring that until now, has not been available when treating patients with traumatic brain injuries. We continued to advance the early-stage technology platforms we acquired in 2019. Through the acquisition of Arkis Biosciences, we added a platform technology, CerebroFlo® external ventricular drainage ("EVD"), catheter with Endexo® technology, a permanent additive designed to reduce the potential for catheter obstruction due to thrombus formation. The CerebroFlo EVD Catheter has demonstrated an average of 99% less thrombus accumulation onto its surface, in vitro, compared to a market leading EVD catheter. In 2019, we also acquired Rebound Therapeutics, a Company that specialized in a single-use medical device, known as Aurora Surgiscope, which is the only tubular retractor system designed for cranial surgery with an integrated access channel, camera and lighting. In the third quarter of 2021, we conducted a limited clinical launch of the Aurora Surgiscope for use in minimally invasive neurosurgery as well as initiated a registry called MIRROR to collect data on early surgical intervention using this same technology platform for the treatment of ICH. Within our TT segment, during 2020, we announced positive clinical and economic data on Integra® Bilayer Wound Matrix ("IBWM") in complex lower extremity reconstruction based on two retrospective studies recently published in Plastic and Reconstructive Surgery, the official journal of theAmerican Society of Plastic Surgeons . As surgeons look for ways to efficiently and effectively repair and close wounds,IBWM helps address the efficiency needed in operating rooms by reducing both the operating time and costs to hospitals and patients. In 2021, we completed one of the largest diabetic foot ulcers ("DFU"), randomized controlled trials of the PriMatrix® Dermal Repair Scaffold for the management of DFU. This multi-center study enrolled more than 225 patients with chronic DFU's over the course of 12-week treatments and 4-week follow-up phases. The results of this study, which was published in theJournal of Wound Care , demonstrated that PriMatrix plus standard of care ("SOC") consisting of sharp debridement, infection elimination, use of dressings and offloading was significantly more likely to achieve complete wound closure compared with SOC alone, with a median number of one application of the product.
COVID-19 Pandemic
During this global crisis, the Company's focus remained on supporting patients,
providing customers with life-saving products, and protecting the well-being of
our employees. The global COVID-19 pandemic, together with the preventative and
precautionary measures taken by businesses, communities and governments, has
resulted in an unprecedented challenge to the global healthcare industry. In
response to the pandemic, we acted swiftly by implementing protocols to ensure
continuity of our manufacturing and distribution sites around the world and to
provide for the safety of our employees.
The COVID-19 pandemic continues to have widespread and unpredictable impacts and
the Company has continued to manage the risks in this uncertain environment. We
remain confident that the underlying markets in which the Company competes
remain attractive. We also remain focused on managing the business for the
long-term. The Company's adaptability and resiliency in the face of this
unprecedented crisis is made possible in part by prior investments in technology
infrastructure and operations, as well as our talented and committed global
workforce.
32
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Capital markets and worldwide economies have also been significantly impacted by
the COVID-19 pandemic, and it is possible that it could cause a local and/or
global economic recession. Any such economic recession could have a material
adverse effect on the Company's long-term business as hospitals curtail and
reduce capital as well as overall spending. The COVID-19 pandemic and local
actions, such as "shelter-in-place" orders and restrictions on travel and access
to our customers or temporary closures of our facilities or the facilities of
our suppliers and their contract manufacturers, disruption and/or higher costs
to the Company's supply chain, staffing shortages in hospitals and labor
constraints in our facilities, could further impact our sales and our ability to
ship our products and supply our customers. Any of these events could negatively
impact the number of surgical and medical intervention procedures performed and
have a material adverse effect on our business, financial condition, results of
operations, or cash flows.
FDA Matters
We manufacture and distribute products derived from human tissue for which FDA
has specific regulations governing human cells, tissues and cellular and
tissue-based products ("HCT/Ps"). An HCT/P is a product containing or consisting
of human cells or tissue intended for transplantation into a human patient.
Refer to Item 1. Business and Item 1A. Risk Factors for further details around
these FDA regulations and their potential effect on the Company's portfolio of
morselized amniotic material-based products as well as the impact on
consolidated revenues.
On March 7, 2019 , TEI Biosciences, Inc. ("TEI") a wholly-owned subsidiary of the
Company received a Warning Letter (the "Warning Letter"), dated March 6, 2019 ,
from the FDA. The warning letter related to quality systems issues at TEI's
manufacturing facility located in Boston, Massachusetts . The letter resulted
from an inspection held at that facility in October and November 2018 and did
not identify any new observations that were not already provided in the Form 483
that followed the inspection. The Company submitted its initial response to the
FDA Warning Letter on March 28, 2019 and provides regular progress reports to
the FDA as to its corrective actions and, since the conclusion of the
inspection, has undertaken significant efforts to remediate the observations and
continues to do so. On October 28, 2021 FDA initiated an inspection of the
facility and at the conclusion of the inspection issued a Form 483 on November
12, 2021 (the "2021 Form 483"). The Company provided an initial response to the
inspectional observations and will continue to provide responses to FDA. The
Warning Letter and the 2021 Form 483 do not restrict the Company's ability to
manufacture or ship products or require the recall of any products, nor do they
restrict our ability to seek FDA 510(k) clearance of products. The Warning
Letter states that requests for Certificates to Foreign Governments would not be
granted. However, due to our monthly progress reports, the FDA agreed to issue
Certificates to Foreign Governments for the products manufactured at TEI due to
substantial progress and the length of time it takes to resolve the Warning
Letter. Additionally, premarket approval applications for Class III devices to
which the Quality System regulation violations are reasonably related will not
be approved until the violations have been corrected. The TEI Boston facility
manufactures extracellular bovine matrix products. We cannot give any assurances
that the FDA will be satisfied with our response to the Warning Letter or as to
the expected date of the resolution of the matters included in the letter. Until
the issues cited in the letter are resolved to the FDA's satisfaction, the FDA
may initiate additional regulatory action without further notice. Any adverse
regulatory action, depending on its magnitude, may restrict us from effectively
manufacturing, marketing and selling our products and could have a material
adverse effect on our business, financial condition and results of operations.
Revenues of products manufactured in the TEI Boston facility for the year ended
ACQUISITIONS & DIVESTITURES
Divestiture
OnJanuary 4, 2021 , the Company completed its sale of its Extremity Orthopedics business to Smith & Nephew. The transaction included the sale of the Company's upper and lower Extremity Orthopedics product portfolio, including ankle and shoulder arthroplasty and hand and wrist product lines. The Company received an aggregate purchase price of$240.0 million from Smith & Nephew and concurrently paid$41.5 million to theConsortium of Focused Orthopedists , LLC ("CFO"), effectively terminating the licensing agreement between Integra and CFO relating to the development of shoulder arthroplasty products. The Company recognized a gain of$41.8 million in connection with the sale that is presented in "Gain from the sale of business" in the consolidated statement of operations for the year ended December, 31, 2021. See Note 4, Acquisitions and Divestitures of the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for details. Acquisitions Our growth strategy includes the acquisition of businesses, assets or products lines to increase the breadth of our offerings and the reach of our product portfolios and drive relevant scale to our customers. As a result of several acquisitions from 2019 through 2021, our financial results for the year endedDecember 31, 2021 may not be directly comparable to those of the corresponding prior-year periods. See Note 4, Acquisitions and Divestitures of the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for a further discussion. 33 --------------------------------------------------------------------------------
OnJanuary 20, 2021 , the Company acquiredACell, Inc. for an acquisition purchase price of$306.9 million plus contingent consideration obligations of up to$100 million , that may be payable upon achieving certain revenue-based performance milestones in 2022, 2023 and 2025.ACell was a privately-held company that offered a portfolio of regenerative products for complex wound management, including developing and commercializing products based on MatriStem Urinary Bladder Matrix ("UBM"), a technology platform derived from porcine urinary bladder extracellular matrix. See Note 4, Acquisitions and Divestitures of the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for details.Arkis BioSciences Inc. OnJuly 29, 2019 , the Company acquiredArkis BioSciences Inc. ("Arkis") for an acquisition purchase price of$30.6 million (the "Arkis Acquisition") plus contingent consideration of up to$25.5 million , that may be payable based on the successful completion of certain development and commercial milestones. The Company estimated the fair value of the contingent consideration to be$13.1 million at the acquisition date. The Company estimated fair value of the contingent consideration as ofDecember 31, 2021 to be$15.1 million . The Company recorded$3.7 million in accrued expenses and other current liabilities and$11.4 million in other liabilities atDecember 31, 2021 in the consolidated balance sheets of the Company. Arkis was a privately-held company that marketed the CerebroFlo external ventricular drainage ("EVD") catheter with Endexo technology, a permanent additive designed to reduce the potential for catheter obstruction due to clotting. See Note 4, Acquisitions and Divestitures of the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for details.
OnSeptember 9, 2019 , the Company acquiredRebound Therapeutics Corporation ("Rebound"), developers of a single-use medical device known as the Aurora which enables minimally invasive access, using optics and illumination, for visualization, diagnostic and therapeutic use in neurosurgery (the "Rebound transaction"). Under the terms of the Rebound transaction, the Company made an upfront payment of$67.1 million and committed to pay up to$35.0 million of contingent development milestones upon achievement of certain regulatory milestones. The acquisition of Rebound was primarily concentrated in one single identifiable asset and thus, for accounting purposes, the Company concluded that the acquired assets did not meet the accounting definition of a business. The initial payment was allocated primarily to Aurora, resulting in a$59.9 million in-process research and development ("IPR&D") expense. The balance of approximately$7.2 million , which included$2.1 million of cash and cash equivalents and a net deferred tax asset of$4.2 million , was allocated to the remaining net assets acquired. The deferred tax asset primarily resulted from a federal net operating loss carryforward. See Note 4, Acquisitions and Divestitures of the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for details.
OPTIMIZATION AND INTEGRATION ACTIVITIES
As a result of our ongoing acquisition strategy and significant growth in recent years, we have undertaken cost-saving initiatives to consolidate manufacturing operations, distribution facilities and transfer activities, implement a common ERP system, eliminate duplicative positions, realign various sales and marketing activities, and expand and upgrade production capacity for our regenerative technology products. These efforts are expected to continue and while we expect a positive impact from ongoing restructuring, integration, and manufacturing transfer and expansion activities, such results remain uncertain.
RESULTS OF OPERATIONS
Executive Summary
Net income for the year endedDecember 31, 2021 was$169.1 million , or$1.98 per diluted share, compared to$133.9 million , or$1.57 per diluted share for the year endedDecember 31, 2020 . The increase in net income for the year endedDecember 31, 2021 , was primarily driven by higher revenues across most franchises driven by continued recovery in surgical procedure volumes from prior year COVID-19 pandemic levels. This was partially offset by higher operating expenses as costs continued to normalize after 2020 cost reduction actions. Within non-operating income and expense, the Company benefited from lower interest expense, higher other income and a gain of$41.8 million as a result of the sale of its Extremity Orthopedics business to Smith & Nephew. The Company also had a net tax benefit in 2020 due to the impact of the intra-entity transfer of certain intellectual property which resulted in the recognition of a deferred tax benefit in the amount of$59.2 million . 34 --------------------------------------------------------------------------------
Special Charges
Income before taxes includes the following special charges:
Years Ended December 31,
Dollars in thousands 2021 2020
Acquisition, divestiture and integration-related charges (1) $ (11,712) $ 32,906
Structural optimization charges 20,385 15,363
EU medical device regulation 24,375 9,372
Discontinued product lines charges 377 6,342
Expenses related to debt refinancing - 6,168
COVID-19 pandemic related charges (2) - 3,482
Convertible debt non-cash interest expense - 15,415
Total 33,425 89,048
(1) The Company completed its sale of its Extremity Orthopedics business and
recognized a gain of $41.8 million for the year ended December 31, 2021 which
was partially offset by other acquisition, divestiture and integration-related
charges. See Note 4, Acquisitions and Divestitures of the Notes to Consolidated
Financial Statements (Part II, Item 8 of this Form 10-K) for details.
(2) Charges relate to business interruptions and costs associated with the COVID-19 pandemic which impacted the Company's operations globally, partially offset by Coronavirus government relief programs.
The items reported above are reflected in the consolidated statements of
operations as follows:
Years Ended December 31,
Dollars in thousands 2021 2020
Cost of goods sold $ 32,334 $ 34,557
Research and development 17,487 3,163
Selling, general and administrative 31,013 29,745
Interest expense (1) - 21,583
Gain from the sale of business (41,798) -
Other (income) expense (5,611) -
Total 33,425 89,048
(1) Upon adoption of ASU No. 2020-06, the Company will no longer incur non-cash
interest expense for the amortization of debt discount. See Note 1, Basis of
Presentation of the Notes to Consolidated Financial Statements (Part II, Item 8
of this Form 10-K), for details.
We typically define special charges as items for which the amounts and/or timing
of such expenses may vary significantly from period to period, depending upon
our acquisition, divestiture, integration and restructuring activities, and for
which the amounts are non-cash in nature, or for which the amounts are not
expected to recur at the same magnitude. We believe that given our ongoing
strategy of seeking acquisitions, our continuing focus on rationalizing our
existing manufacturing and distribution infrastructure and our continuing review
of various product lines in relation to our current business strategy, some of
the special charges discussed above could recur with similar materiality in the
future.
We believe that the separate identification of these special charges provides
important supplemental information to investors regarding financial and business
trends relating to our financial condition and results of operations. Investors
may find this information useful in assessing comparability of our operating
performance from period to period, against the business model objectives that
management has established, and against other companies in our industry. We
provide this information to investors so that they can analyze our operating
results in the same way that management does and to use this information in
their assessment of our core business and valuation of Integra.
35
--------------------------------------------------------------------------------Revenues and Gross Margin
Our revenues and gross margin on product revenues were as follows:
Years Ended December 31,
Dollars in thousands 2021 2020
Segment Net Sales
Codman Specialty Surgical $ 1,025,232 $
894,831
Tissue Technologies 517,216 477,037
Total revenues 1,542,448 1,371,868
Cost of goods sold 597,808 520,834
Gross margin on total revenues $ 944,640 $ 851,034
Gross margin as a percentage of total revenues 61.2 % 62.0 % Revenues For the year endedDecember 31, 2021 , total revenues increased by$170.6 million , or 12.4%, to$1,542.4 million from$1,371.9 million during the prior year. Domestic revenues increased by$117.6 million , or 12.1%, to$1,089.5 million and were 70.6% of total revenues for the year endedDecember 31, 2021 . International revenues increased by$53.0 million or 13.3% to$452.9 million , compared to$399.9 million during 2020. The increase in revenues was primarily driven by recovery experienced from the COVID-19 pandemic across most franchises compared to the prior year. Foreign exchange fluctuations had a favorable impact of$9.8 million on revenues for the year. In the CSS segment, revenues were$1,025.2 million which was an increase of$130.4 million , or 14.6% as compared to the prior-year period as a result of the continued recovery experienced from the COVID-19 pandemic, and the launch of our new CereLink™ ICP monitoring system in the third quarter inU.S. and European markets. The Company saw growth within our Neurosurgery portfolio increasing low double digits primarily due to sales in neuromonitoring, advanced energy and dural access and repair. Sales in our instruments portfolio increased low double digits as compared to the same period in the prior year driven by order recovery. In the TT segment, revenues were$517.2 million , which was an increase of$40.2 million , or 8.4% as compared to the prior-year period. Within TT, our Extremity Orthopedics business was divested onJanuary 4, 2021 and the acquisition ofACell was completed onJanuary 20, 2021 . Sales in our Wound Reconstruction business, excluding the impact of the divestiture and acquisition, increased low double digits. Sales in our Private Label business increased low double digits as a result of continued recovery experienced from the COVID-19 pandemic. As we look forward to 2022 and beyond, we continue to closely monitor local, regional, and global COVID-19 surges as well as recent variants of the virus for an impact on procedures. The reallocation of hospital resources to treat COVID-19 and staffing shortages may continue to cause a financial strain on healthcare systems and reduce procedural volumes.
Gross Margin
Gross margin was$944.6 million for the year endedDecember 31, 2021 , an increase of$93.6 million from$851.0 million for the same period last year. Gross margin as a percentage of revenues was 61.2% in 2021 and 62.0% in 2020. The decrease in gross margin percentage was due to increased amortization associated with technology-based intangible assets and inventory step-up amortization in connection with the acquisition ofACell .
Operating Expenses
The following is a summary of operating expenses as a percent of total
revenues:
Years Ended December 31,
2021 2020
Research and development 6.0 % 5.6 %
Selling, general and administrative 41.3 % 43.3 %
Intangible asset amortization 1.1 % 2.0 %
Total operating expenses 48.4 % 50.9 %
36
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Total operating expenses, which consist of research and development, selling,
general and administrative, and intangible asset amortization expenses,
increased by $47.7 million or 6.8% to $747.4 million in 2021, compared to $699.7
million in the prior year. The increase in operating expenses compared to the
prior year reflects costs associated with higher employee related costs,
increased research and development as well as increased outside spending as
revenue recovered. We also benefited from reduced operating expenses from the
sale of the Extremity Orthopedics business and cost synergies as a result of the
acquisition of ACell .
The Company continues to manage and prioritize its operating costs to increase
organic investments that will drive long-term growth including the support of
new product development and introductions, clinical studies, geographic
expansion and targeted U.S. sales channel expansion.
Research and Development
Research and development expenses for the year endedDecember 31, 2021 increased by$15.7 million as compared to the prior year. This increase in spending resulted from additional spending on new product development, clinical studies and spending related to European Union Medical Device Regulation compliance activities.
Selling, General and Administrative
Selling, general and administrative expenses for the year endedDecember 31, 2021 increased by$42.9 million as compared to the prior year driven primarily due to higher employee related costs, higher incentive and stock-based compensation, as well as increased outside spending as revenue recovered.
Intangible Asset Amortization
Amortization expense (excluding amounts reported in cost of product revenues for technology-based intangible assets) in 2021 was$16.9 million compared to$27.8 million in 2020 primarily due to a reduction in amortization expense associated with intangible assets sold in conjunction with the sale of the Extremity Orthopedics business during the current year as well as accelerated amortization expense associated with an intangible asset which was recorded in the prior year. We may discontinue certain products in the future as we continue to assess the profitability of our product lines. As our profitability assessment evolves, we may make further decisions about our trade names and incur additional impairment charges or accelerated amortization. We expect total annual amortization expense to be approximately$79.1 million in 2022,$78.4 million in 2023,$77.7 million in 2024,$77.7 million in 2025,$77.6 million in 2026 and$585.8 million thereafter.
Non-Operating Income and Expenses
The following is a summary of non-operating income and expenses:
Years Ended December 31,
Dollars in thousands 2021 2020
Interest income $ 6,737 $ 9,297
Interest expense (50,395) (71,581)
Gain from sale of business 41,798 -
Other income, net 19,307 4,434
Total non-operating income and expense $ 17,447 $(57,850) Interest Income
Interest income for the year ended
Interest Expense
Interest expense for the year endedDecember 31, 2021 decreased by$21.2 million as compared to the same period last year primarily due to the elimination of the non-cash interest expense as the result of the adoption ASU 2020-06 and the expenses associated with Amended and Restated Senior Credit Agreement which occurred in the prior period. See Note 2, Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for details in relation to the adoption of ASU 2020-06.
Gain from the sale of business
On
37
--------------------------------------------------------------------------------Other Income, Net
Other income, net for the year ended
Income Taxes
Our effective income tax rate was 21.2% and (43.2)% of income before income taxes in 2021 and 2020, respectively. See Note 13, Income Taxes, in our consolidated financial statements for a reconciliation ofthe United States federal statutory rate to our effective tax rate. Our effective tax rate could vary from year to year depending on, among other factors, tax law changes, the geographic and business mix and taxable earnings and losses. We consider these factors and others, including our history of generating taxable earnings, in assessing our ability to realize deferred tax assets. InDecember 2020 , the Company completed an intra-entity transfer of certain intellectual property rights to one of its subsidiaries inSwitzerland . While the transfer did not result in a taxable gain; the Company's Swiss subsidiary received a step-up in tax basis based on the fair value of the transferred intellectual property rights. The Company determined the fair value using a discounted cash flow model based on expectations of revenue growth rates, royalty rates, discount rates, and useful lives of the intellectual property. The Company recorded a$59.2 million deferred tax benefit inSwitzerland related to the amortizable tax basis in the transferred intellectual property. Our effective tax rate could vary from year to year depending on, among other factors, tax law changes, the geographic and business mix and taxable earnings and losses. We consider these factors and others, including our history of generating taxable earnings, in assessing our ability to realize deferred tax assets. We estimate our worldwide effective income tax rate for 2022 to be approximately 18.4%. AtDecember 31, 2021 , the Company had$9.8 million of valuation allowance against the remaining$190.7 million of gross deferred tax assets recorded atDecember 31, 2021 . Our deferred tax asset valuation allowance decreased by$0.1 million in 2021 and remained substantially unchanged in 2020. This valuation allowance relates to deferred tax assets for which the Company does not believe it has satisfied the more likely than not threshold for realization. AtDecember 31, 2021 , we had net operating loss carryforwards of$71.7 million for federal income tax purposes,$26.6 million for foreign income tax purposes and$39.0 million for state income tax purposes to offset future taxable income. The federal net operating loss carryforwards decreased during 2021 due to the use of net operating losses. Of the total federal net operating loss carryforwards,$67.5 million expire through 2037 and$4.1 million have an indefinite carryforward period. Regarding the foreign net operating loss carryforwards,$26.6 million have an indefinite carryforward period. The state net operating loss carryforwards expire in 2036. As ofDecember 31, 2021 , the Company has not provided deferred income taxes on unrepatriated earnings from foreign subsidiaries as they are deemed to be indefinitely reinvested. Such taxes would primarily be attributable to foreign withholding taxes and local income taxes when such earnings are distributed. As such, the Company has determined the tax impact of repatriating these earnings would not be material as ofDecember 31, 2021 . 38 --------------------------------------------------------------------------------
GEOGRAPHIC PRODUCT REVENUES AND OPERATIONS
The Company attributes revenues to geographic areas based on the location of the
customer. Total revenue by major geographic area consisted of the following:
Years Ended December 31,
Dollars in thousands 2021 2020
United States $ 1,089,526 $ 971,975
Europe 191,327 172,689
Asia Pacific 182,034 157,174
Rest of World 79,561 70,030
Total Revenues $ 1,542,448 $ 1,371,868
The Company generates significant revenues outside the U.S. , a portion of which
are U.S. dollar-denominated transactions conducted with customers that generate
revenue in currencies other than the U.S. dollar. As a result, currency
fluctuations between the U.S. dollar and the currencies in which those customers
do business could have an impact on the demand for the Company's products in
foreign countries. Local economic conditions, regulatory compliance or political
considerations, the effectiveness of our sales representatives and distributors,
local competition and changes in local medical practice all may combine to
affect our sales into markets outside the U.S.
Domestic revenues increased by $117.6 million for the year ended December 31,
2021 compared to the same period last year. European sales increased by $18.6
million for the year ended December 31, 2021 compared to the same period last
year. Sales to customers in Asia Pacific increased by $24.9 million for the year
ended December 31, 2021 compared to the same period last year. The Rest of the
World for the year ended December 31, 2021 increased by $9.5 million compared to
the same period last year. The increase in revenues globally was primarily
driven by the continued recovery experienced from the COVID-19 pandemic across
all franchises compared to the prior year due to rebound in surgical procedure
volumes. Sales in China , Japan Canada, Europe and our indirect markets continue
to drive international growth. The Company also benefited from the launch of the
CereLink ICP Monitor which occurred during the second half of the 2021.
LIQUIDITY AND CAPITAL RESOURCES
Working Capital
AtDecember 31, 2021 andDecember 31, 2020 , working capital was$813.7 million and$836.2 million , respectively. Working capital consists of total current assets less total current liabilities as presented in the consolidated balance sheets.
The Company had cash and cash equivalents totaling approximately$513.4 million and$470.2 million atDecember 31, 2021 and 2020, respectively, which are valued based on Level 1 measurements in the fair value hierarchy. AtDecember 31, 2021 , our non-U.S. subsidiaries held approximately$245.2 million of cash and cash equivalents that are available for use outside theU.S. The Company asserts that it has the ability and intends to indefinitely reinvest the undistributed earnings from its foreign operations unless there is no material tax cost to remit the earnings into theU.S. 39 --------------------------------------------------------------------------------
Cash Flows
Year Ended December 31,
Dollars in thousands 2021 2020
Net cash provided by operating activities $ 312,427 $ 203,832
Net cash used in investing activities (161,443) (68,073)
Net cash used (provided) by financing activities (98,226)
121,625
Effect of exchange rate fluctuations on cash (9,476)
13,871
Net increase (decrease) in cash and cash equivalents
Cash Flows Provided by Operating Activities
Operating cash flows for the year endedDecember 31, 2021 increased by$108.6 million compared to the same period in 2020. Net income after removing the impact of the gain on sale of business and non-cash adjustments increased for the year endedDecember 31, 2021 , by approximately$49.1 million as compared to the same period in 2020 primarily due to the continuing revenue recovery in the current year as compared to the height of the COVID-19 pandemic in the prior year. The changes in assets and liabilities, net of business acquisitions, increased cash flows from operating activities in the current year by$18.2 million compared to the decrease of$41.3 million for the same period in 2020. The improvement in 2021 working capital is attributable to a decrease in inventory of$5.4 million due to investments in building safety stock made in the prior year where inventory increased by$48.3 million as well as improved sales in 2021. Operating cash flows for the year endedDecember 31, 2020 decreased compared to the same period in 2019. Net income after non-cash adjustments increased by approximately$0.8 million to$245.1 million from$245.9 million . The changes in assets and liabilities, net of business acquisitions, decreased cash flows from operating activities by$41.3 million in the year endedDecember 31, 2020 compared to a decrease of$14.5 million for the same period in 2019. The decrease in 2020 is attributable to an increase in inventory to improve safety stock of select products. In addition, decreases were also driven by reduced payables offset by decreases in accounts receivable due to lower revenues and continued collection efforts.
Cash Flows Used in Investing Activities
During the year endedDecember 31, 2021 , we paid a net cash amount of$303.9 million in relation to the acquisition ofACell and received net proceeds of$190.5 million for the sale of the Extremity Orthopedics business. The Company also paid for$48.0 million capital expenditures to support operations improvement initiatives at a number of our manufacturing facilities and other information technology investments.
During the year ended
Cash Flows (Used in) Provided by Financing Activities
Uses of cash from financing activities for the year endedDecember 31, 2021 were repayments of$125.5 million on the revolving portion of our Senior Credit Facility and Securitization Facility. In addition, the Company had$4.8 million in cash taxes paid in net equity settlements. These uses were offset by$6.8 million proceeds from the exercise of stock options and$25.5 million borrowings under our Senior Credit Facility and Securitization Facility. Our principal sources of cash from financing activities for the year endedDecember 31, 2020 were$515.3 million in proceeds from the issuance of Convertible Senior Notes including the call and warrant transactions and$171.5 million borrowing under our Senior Credit Facility and Securitization Facility. These were offset by repayments of$441.0 million on the revolving portion of our Senior Credit Facility and Securitization Facility,$24.3 million in debt issuance costs related to the Amended and Restated Senior Credit Agreement and the issuance of Convertible Senior Notes and$100.0 million in purchases of treasury stock.
Amended and Restated Senior Credit Agreement, Convertible Senior Notes, Securitization and Related Hedging Activities
See Note 5, Debt, to the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for a discussion of our Amended and Restated Senior Credit Agreement, the 2025 Notes and Securitization Facility and Note 6, Derivative Instruments to the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for discussion of our hedging activities. We are forecasting that sales and earnings for the next twelve months will be sufficient to remain in compliance with our financial covenants under the terms of theFebruary 2020 Amendment andJuly 2020 Amendment to the Senior Credit Facility. 40 --------------------------------------------------------------------------------
Share Repurchase Plan
OnDecember 7, 2020 , the Board of Directors authorized the Company to repurchase up to$225 million of the Company's common stock. The program allows the Company to repurchase its shares opportunistically from time to time. The repurchase authorization expires inDecember 2022 . This stock repurchase authorization replaces the previous$225 million stock repurchase authorization, of which$125 million remained authorized at the time of its replacement, and which was otherwise set to expire onDecember 31, 2021 .
For the year ended
OnJanuary 12, 2022 , the Company entered into a$125.0 million accelerated share repurchase ("2022 ASR") and received 1.5 million shares of the Company common stock at inception of the 2022 ASR, which represented approximately 80% of the expected total shares under the 2022 ASR. The remaining 20% of the expected total shares is expected to settle in the first half of 2022, upon which additional shares of common stock may be delivered to the Company or, under certain circumstances, the Company may be required to make a cash payment or may elect to deliver shares of our common stock to the 2022 ASR counterparty in each case pursuant to the terms of the 2022 ASR agreement between the Company and the 2022 ASR counterparty. The total number of shares to be delivered or the amount of such payment, as well as the final average price per share, will be based on the volume-weighted average price, less a discount, of the Company's common stock during the term of the transaction. As a result of this transaction,$100.0 million remains available under the$225.0 million stock repurchase authorization. During the twelve months endedDecember 31, 2020 , the Company repurchased 2.1 million shares of Integra's common stock as part of the previous share repurchase authorization. The Company utilized$100.0 million of net proceeds from the offering of convertible notes to execute the share repurchase transactions. This included$7.6 million from certain purchasers of the convertible notes in conjunction with the closing of the offering. OnFebruary 5, 2020 , the Company entered into a$92.4 million accelerated share repurchase ("2020 ASR") to complete the remaining$100.0 million of share repurchase. The Company received 1.3 million shares at inception of the 2020 ASR, which represented approximately 80% of the expected total shares. Upon settlement of the 2020 ASR inJune 2020 , the Company received an additional 0.6 million shares determined using the volume-weighted average price of the Company's common stock during the term of the transaction.
See Note 8, Treasury Stock of the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for further details.
Dividend Policy
We have not paid any cash dividends on our common stock since our formation. Our Senior Credit Facility limits the amount of dividends that we may pay. Any future determinations to pay cash dividends on our common stock will be at the discretion of the Board and will depend upon our financial condition, results of operations, cash flows and other factors deemed relevant by the Board.
Capital Resources
We believe that our cash and available borrowings under the Senior Credit Facility are sufficient to finance our operations and capital expenditures for the foreseeable future. Our future capital requirements will depend on many factors, including the growth of our business, the timing and introduction of new products and investments, strategic plans and acquisitions, among others. Additional sources of liquidity available to us include short term borrowings and the issuance of long term debt and equity securities.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet financing arrangements during the
year-ended
41
--------------------------------------------------------------------------------Contractual Obligations and Commitments
We will continue to have cash requirements to support seasonal working capital needs and capital expenditures, to pay interest, to service debt, and to fund acquisitions. As part of our ongoing operations, we enter into contractual arrangements that obligate us to make future cash payments. Our primary obligations include principal and interest payments on revolving portion and Term Loan component of the Senior Credit Facility,Securitization Facility and Convertible Securities . See Note 5, Debt, to the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for details. The Company also leases some of our manufacturing facilities and office buildings which have future minimum lease payments associated. See Note 11, Leases and Related Party Leases to the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for a schedule of our future minimum lease payments. Amounts related to the Company's other obligations, including employment agreements and purchase obligations were not material. The Company has contingent consideration obligation related to prior and current year acquisitions and future pension contribution obligations. See Note 10, Retirement Benefit Plans and Note 15, Commitments and Contingencies to the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for details. The associated obligations are not fixed. The Company also has a liability for uncertain tax benefits including interest and penalties. See Note 12, Income Taxes to the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for details. The Company cannot make a reliable estimate of the period in which the uncertain tax benefits may be realized.
Employee Termination Benefits
The Company incurred restructuring costs of$3.4 million and$4.9 million in cost of goods sold,$0.5 million and$1.2 million in selling, general and administrative and$0.3 million and$0.3 million in research and development related to employee terminations associated with a future plant closure in the consolidated statement of operations for the years endedDecember 31, 2021 and 2020, respectively. Restructuring costs of$10.2 million were included in accrued expenses and other current liabilities and$6.4 million were included in other liabilities in the consolidated balance sheet for the year endedDecember 31, 2021 and 2020, respectively. See Note 2, Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for further details.
CRITICAL ACCOUNTING POLICIES AND THE USE OF ESTIMATES
Our discussion and analysis of financial conditions and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted inthe United States of America ("GAAP"). The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent liabilities, and the reported amounts of revenues and expenses. Significant estimates affecting amounts reported or disclosed in the consolidated financial statements include allowances for doubtful accounts receivable and sales returns and allowances, net realizable value of inventories, valuation of intangible assets including amortization periods for acquired intangible assets, discount rates and estimated projected cash flows used to value and test impairments of long-lived assets and goodwill, estimates of projected cash flows and depreciation and amortization periods for long-lived assets, computation of taxes, valuation allowances recorded against deferred tax assets, the valuation of stock-based compensation, valuation of derivative instruments, valuation of contingent liabilities, the fair value of debt instruments and loss contingencies. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the current circumstances.
As we continue to navigate the COVID-19 pandemic and recent variants of the virus, as well as the adverse impacts to global economic conditions, supply chain and our operations, there may be impact to future estimates including, but not limited to, inventory valuations, fair value measurements, goodwill and long-lived asset impairments, the effectiveness of the Company's hedging instruments, deferred tax valuation allowances, and allowances for doubtful accounts receivable.
We believe that the following accounting policies, which form the basis for
developing these estimates, are those that are most critical to the presentation
of our consolidated financial statements and require the more difficult
subjective and complex judgments, often because of the need to make estimates
about the effect of matters that are inherently uncertain. Because of this
uncertainty, actual results could differ from these estimates.
42
--------------------------------------------------------------------------------Allowances for Doubtful Accounts Receivable and Sales Returns and Allowances
We evaluate the collectability of accounts receivable based on a combination of factors. The Company recognizes a provision for doubtful accounts that reflects the Company's estimate of expected credit losses for trade accounts receivable. In circumstances where a specific customer is unable to meet its financial obligations to us, we record an allowance against amounts due to reduce the net recognized receivable to the amount that we reasonably expect to collect. For all other customers, the Company evaluates measurement of all expected credit losses for trade receivables held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. If the financial condition of customers or the length of time that receivables are past due were to change, we may change the recorded amount of allowances for doubtful accounts in the future through charges or reductions to selling, general and administrative expense. We record a provision for estimated sales returns and allowances on revenues in the same period as the related revenues are recorded. We base these estimates on historical sales returns and allowances and other known factors. If actual returns or allowances differ from our estimates and the related provisions for sales returns and allowances, we may change the provision in the future through an increase or decrease in revenues. InJune 2016 , the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. We adopted this guidance onJanuary 1, 2020 using a modified retrospective transition method which requires a cumulative-effect adjustment to the opening balance of retained earnings to be recognized on the date of adoption with no change to financial results reported in prior periods. The cumulative-effect adjustment recorded onJanuary 1, 2020 was not material. The adoption of this ASU did not have a significant impact on our consolidated financial statements and related disclosures. Our exposure to credit losses may increase if its customers are adversely affected by changes in healthcare laws, coverage, and reimbursement, economic pressures or uncertainty associated with local or global economic recessions, disruption associated with the COVID-19 pandemic and recent variants of the virus, and other customer-specific factors. Although we have historically not experienced significant credit losses, it is possible that there could be an adverse impact due to customer and governmental responses to the COVID-19 pandemic.
Inventories
Inventories, consisting of purchased materials, direct labor and manufacturing overhead, are stated at the lower of cost (determined by the first-in, first-out method) or net realizable value. At each balance sheet date, we evaluate ending inventories for excess quantities, obsolescence or shelf-life expiration. Our evaluation includes an analysis of historical sales levels by product, projections of future demand by product, the risk of technological or competitive obsolescence for our products, general market conditions, a review of the shelf-life expiration dates for our products, and the feasibility of reworking or using excess or obsolete products or components in the production or assembly of other products that are not obsolete or for which we do not have excess quantities in inventory. To the extent that we determine there are excess or obsolete quantities or quantities with a shelf life that is too near its expiration for us to reasonably expect that we can sell those products prior to their expiration, we adjust their carrying value to estimated net realizable value. If future demand or market conditions are lower than our projections, or if we are unable to rework excess or obsolete quantities into other products, we may record further adjustments to the carrying value of inventory through a charge to cost of product revenues in the period the revision is made. The Company capitalizes inventory costs associated with certain products prior to regulatory approval, based on management's judgment of probable economic benefit. The Company could be required to expense previously capitalized costs related to pre-approval inventory upon a change in such judgment, due to, among other potential factors, a denial or delay of approval by necessary regulatory bodies or a decision by management to discontinue the related development program.
Acquisitions
Results of operations of acquired companies are included in the Company's
results of operations as of the respective acquisition dates. The Company
accounts for the acquisition of a business in accordance with ASC 805, Business
Combinations (ASC 805). Amounts paid to acquire a business are allocated to the
assets acquired and liabilities assumed based on the fair values at the date of
acquisition. Any excess of the purchase price over the fair value of the net
assets acquired in recorded as goodwill. Transaction costs and costs to
restructure the acquired company are expensed as incurred.
43
--------------------------------------------------------------------------------
Contingent consideration is recorded at fair value as measured on the date of
acquisition. The value recorded is based on estimates of future financial
projections under various potential scenarios using either a Monte Carlo
simulation or the probability-weighted income approach derived from revenue
estimates and probability assessment with respect to the likelihood of achieving
contingent obligations. Contingent payments related to acquisitions consist of
development, regulatory, and commercial milestone payments, in addition to
sales-based payments, and are valued using discounted cash flow techniques. Each
quarter until such contingent amounts are earned, the fair value of the
liability is remeasured at each reporting period and adjusted as a component of
operating expenses based on changes to the underlying assumptions. The change in
the fair value of sales-based payments is based upon future revenue estimates
and increases or decreases as revenue estimates or expectation of timing of
payment charges. The estimates used to determine the fair value of the
contingent consideration liability are subject to significant judgment and
actual results are likely to differ from the amounts originally recorded.
The Company determines the fair value of acquired intangible assets based on
detailed valuations that use certain information and assumptions provided by
management. The Company allocates any excess purchase price over the fair value
of the net tangible and intangible assets acquired to goodwill. Determining the
fair value of these intangible assets, acquired as part of a business
combination requires the Company to make significant estimates. These estimates
include the amount and timing of projected future cash flows, the discount rate
used to discount those cash flows to present value, the assessment of the
asset's life cycle, and the consideration of legal, technical, regulatory,
economic, and competitive risks. The fair value assigned to other intangible
assets is determined by estimating the future cash flows of each project or
technology and discounting the net cash flows back to their present values. The
discount rate used is determined at the time of measurement in accordance with
accepted valuation methodologies.
Acquired IPR&D is recognized at fair value and initially characterized as an
indefinite-lived intangible asset, irrespective of whether the acquired IPR&D
has an alternative future use. The Company uses the income approach to determine
the fair value of developed technology and IPR&D acquired in a business
combination. This approach determines fair value by estimating the after-tax
cash flows attributable to the respective asset over its useful life and then
discounting these after-tax cash flows back to a present value. Some of the more
significant assumptions inherent in the development of those asset valuations
include the estimated net cash flows for each year for each product including
net revenues, cost of sales, R&D costs, selling and marketing costs, the
appropriate discount rate to select in order to measure the risk inherent in
each future cash flow stream, the assessment of each asset's life cycle, and
competitive trends impacting the asset and each cash flow stream. The Company
also uses the income approach, as described above, to determine the estimated
fair value of certain other identifiable intangible assets including customer
relationships, trade names and business licenses. Customer relationships
represent established relationships with customers, which provide a ready
channel for the sale of additional products and services. Trade names represent
acquired company and product names.
IPR&D acquired in a business combination is capitalized as an indefinite-lived
intangible asset. Development costs incurred after the acquisition are expensed
as incurred. Upon receipt of regulatory approval, the indefinite-lived
intangible asset is then accounted for as a finite-lived intangible asset and
amortized on a straight-line basis or accelerated basis, as appropriate, over
its estimated useful life. If the research and development project is
subsequently abandoned, the indefinite-lived intangible asset is charged to
expense. IPR&D acquired outside of a business combination is expensed
immediately.
Due to the uncertainty associated with research and development projects, there
is risk that actual results will differ materially from the original cash flow
projections and that the research and development project will result in a
successful commercial product. The risks associated with achieving
commercialization include, but are not limited to, delay or failure to obtain
regulatory approvals to conduct clinical trials, delay or failure to obtain
required market clearances, delays or issues with patent
issuance, or validity and litigation.
If the acquired net assets do not constitute a business under the acquisition
method of accounting, the transaction is accounted for as an asset acquisition
and no goodwill is recognized. In an asset acquisition, the amount allocated to
acquired IPR&D with no alternative future use is charged to expense at the
acquisition date. Payments that would be recognized as contingent consideration
in a business combination are expensed when probable in an asset acquisition.
Refer to Note 4, Acquisitions and Divestitures to the Notes to Consolidated
Financial Statements (Part II, Item 8 of this Form 10-K) for details.
Valuation of
The excess of the cost over the fair value of net assets of acquired businesses is recorded as goodwill.Goodwill is not subject to amortization but is reviewed for impairment at the reporting unit level annually, or more frequently if impairment indicators arise. The Company's assessment of the recoverability of goodwill is based upon a comparison of the carrying value of goodwill with its estimated fair value. The Company reviews goodwill for impairment in the third quarter every year in accordance with ASC Topic 350 and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. Refer to Note 7,Goodwill and Other Intangibles of the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K) for more information. 44 --------------------------------------------------------------------------------
Valuation of Identifiable Intangible Assets
The Company tests intangible assets with indefinite lives for impairment annually in the third quarter in accordance with ASC Topic 350. Additionally, the Company may perform interim tests if an event occurs or circumstances change that could potentially reduce the fair value of a indefinite lived intangible asset below its carrying amount. The Company tests for impairment by either performing a qualitative evaluation or a quantitative test. The qualitative evaluation is an assessment of factors, including specific operating results as well as industry, market and general economic conditions, to determine whether it is more likely than not that the fair values of the intangible asset is less than its carrying amount. The Company may elect to bypass this qualitative evaluation and perform a quantitative test. Product rights and other definite-lived intangible assets are tested periodically for impairment in accordance with ASC Topic 360 when events or changes in circumstances indicate that an asset's carrying value may not be recoverable. The impairment test involves comparing the carrying amount of the asset or asset group to the forecasted undiscounted future cash flows. In the event the carrying value of the asset exceeds the undiscounted future cash flows, the carrying value is considered not recoverable and impairment exists. An impairment loss is measured as the excess of the asset's carrying value over its fair value, calculated using discounted future cash flows. The computed impairment loss is recognized in the period that the impairment occurs.
Derivatives
We develop, manufacture, and sell medical devices globally. Our earnings and cash flows are exposed to market risk from changes in interest rates and currency exchange rates. We address these risks through a risk management program that includes the use of derivative financial instruments and operate the program pursuant to documented corporate risk management policies. All derivative financial instruments are recognized in the financial statements at fair value in accordance with the authoritative guidance. Under the guidance, for those instruments that are designated and qualify as hedging instruments, the hedging instrument must be designated as a fair value hedge, cash flow hedge, or a hedge of a net investment in a foreign operation, based on the exposure being hedged. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, further, on the type of hedging relationship. Our derivative instruments do not subject our earnings or cash flows to material risk, and gains and losses on these derivatives generally offset losses and gains on the item being hedged. We have not entered into derivative transactions for speculative purposes. From time to time, we may enter into derivatives that are not designated as hedging instruments in order to protect the Company from currency volatility due to intercompany balances. All derivative instruments are recognized at their fair values as either assets or liabilities on the balance sheet. We determine the fair value of our derivative instruments, by considering the estimated amount we would receive to sell or transfer these instruments at the reporting date and by taking into account expected forward interest rates, currency exchange rates, the creditworthiness of the counterparty for assets, and our creditworthiness for liabilities. In certain instances, we may utilize a discounted cash flow model to measure fair value. Generally, we use inputs that include quoted prices for similar assets or liabilities in active markets, other observable inputs for the asset or liability, and inputs that are derived principally from, or corroborated by, observable market data by correlation or other means.
Income Taxes
Since we conduct operations on a global basis, our effective tax rate has and
will depend upon the geographic distribution of our pre-tax earnings among
locations with varying tax rates. Changes in the tax rates of the various
jurisdictions in which we operate affect our profits. In addition, we maintain a
reserve for uncertain tax benefits, changes to which could impact our effective
tax rate in the period such changes are made. The effective tax rate can also be
impacted by changes in valuation allowances of deferred tax assets, and tax law
changes.
Our provision for income taxes may change period-to-period based on specific
events, such as the settlement of income tax audits and changes in tax laws, as
well as general factors, including the geographic mix of income before taxes,
state and local taxes and the effects of the Company's global income tax
strategies. We maintain strategic management and operational activities in
overseas subsidiaries. See Note 12, Income Taxes of the Notes to Consolidated
Financial Statements (Part II, Item 8 of this Form 10-K), in our consolidated
financial statements for disclosures related to foreign and domestic pretax
income, foreign and domestic income tax expense (benefit) and the effect foreign
taxes have on our overall effective tax rate.
We recognize a tax benefit from an uncertain tax position only if it is more
likely than not to be sustained upon examination based on the technical merits
of the position. The amount of the accrual for which an exposure exists is
measured by determining the amount that has a greater than 50 percent likelihood
of being realized upon ultimate settlement of the position. Components of the
reserve are classified as a long-term liability in the consolidated balance
sheets. We record interest and penalties accrued in relation to uncertain tax
benefits as a component of income tax expense.
45
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We believe that we have identified all reasonably identifiable exposures and
that the reserve we have established for identifiable exposures is appropriate
under the circumstances; however, it is possible that additional exposures exist
and that exposures will be settled at amounts different from the amounts
reserved. It is also possible that changes in facts and circumstances could
cause us to either materially increase or reduce the carrying amount of our tax
reserves.
Our deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and their basis for income tax purposes, and the temporary differences
created by the tax effects of capital loss, net operating loss and tax credit
carryforwards. We record valuation allowances when it is more likely than not
that some portion or all of the deferred tax assets will not be realized. We
could recognize no benefit from our deferred tax assets or we could recognize
some or all of the future benefit depending on the amount and timing of taxable
income we generate in the future.
We intend to indefinitely reinvest substantially all of our foreign earnings in
our foreign subsidiaries unless there is a tax-free manner under which to remit
the earnings. The current analysis indicates that we have sufficient U.S.
liquidity, including borrowing capacity, to fund foreseeable U.S. cash needs
without requiring the repatriation of foreign cash. One time or unusual items
that may impact our ability or intent to keep the foreign earnings and cash
indefinitely reinvested include significant U.S. acquisitions, loans from a
foreign subsidiary, and changes in tax laws.
As of December 31, 2021 , the Company has not provided deferred income taxes on
unrepatriated earnings from foreign subsidiaries as they are deemed to be
indefinitely reinvested. Such taxes would primarily be attributable to foreign
withholding taxes and local income taxes when such earnings are distributed. As
such, the Company has determined the tax impact of repatriating these earnings
would not be material as of December 31, 2021 .
Loss Contingencies
We are subject to claims and lawsuits in the ordinary course of our business, including claims by employees or former employees, and claims with respect to our products and involving commercial disputes. We accrue for loss contingencies when it is deemed probable that a loss has been incurred and that loss is estimable. The amounts accrued are based on the full amount of the estimated loss before considering insurance proceeds, if applicable, and do not include an estimate for legal fees expected to be incurred in connection with the loss contingency. We consistently accrue legal fees expected to be incurred in connection with loss contingencies as those fees are incurred by outside counsel as a period cost. Our financial statements do not reflect any material amounts related to possible unfavorable outcomes of claims and lawsuits to which we are currently a party because we currently believe that such claims and lawsuits are not expected, individually or in the aggregate, to result in a material, adverse effect on our financial condition. However, it is possible that these contingencies could materially affect our results of operations, financial position and cash flows in a particular period if we change our assessment of the likely outcome of these matters.
Pension Benefits
The Company maintains defined benefit pension plans that cover certain employees inFrance ,Japan ,Germany andSwitzerland . Various factors are considered in determining the pension liability, including the number of employees expected to be paid their salary levels and years of service, the expected return on plan assets, the discount rate used to determine the benefit obligations, the timing of benefit payments and other actuarial assumptions. If the actual results and events for the pension plans differ from current assumptions, the benefit obligation may be over or under valued. We recognize the underfunded status of the defined benefit pension plans as an asset or a liability in the balance sheet, with changes in the funded status recorded through other comprehensive income in the year in which those changes occur. The Company's discount rates are determined by considering current yield curves representing high quality, long-term fixed income instruments. The resulting discount rates are consistent with the duration of plan liabilities. In 2021, the discount rate was prescribed as the current yield on corporate bonds with an average rating of AA orAAA of equivalent currency and term to the liabilities. The expected return on plan assets represents the average rate of return expected to be earned on plan assets over the period the benefits included in the benefit obligation are to be paid. In developing the expected rate of return, the Company considers returns of historical market data as well as actual returns on the plan assets. Using this reference information, the long-term return expectations for each asset category are developed according to the allocation among those investment categories. The net plan assets of the pension plans are invested in common trusts as ofDecember 31, 2021 . Common trusts are classified as Level 2 in fair value hierarchy. The fair value of common trusts are valued at net asset value based on the fair values of the underlying investments of the trusts as determined by the sponsor of the trusts. 46 -------------------------------------------------------------------------------- The following weighted average assumptions were used to develop net periodic pension benefit cost and the actuarial present value of projected pension benefit obligations for the year endedDecember 31, 2021 and 2020, respectively: As of December 31, 2021 2020 Discount rate 0.37 % 0.34 %
Expected return on plan assets 3.59 % 2.04 %
Rate of compensation increase 2.10 % 2.14 %
Interest crediting rate for cash balance plans 1.0 % 1.0 %
A change of plus (minus) 25 basis points on expected rate of return on plan
assets, with other assumptions held constant, would have an estimated
We use the corridor approach in the valuation of defined benefit pension benefit plans. The corridor approach defers all actuarial gains and losses resulting from variances between actual results and actuarial assumptions. Those unrecognized gains and losses are amortized when the net gains and losses exceed 10% of the greater of the market-related value of plan assets or the projected benefit obligation at the beginning of the year. The amount in excess of the corridor is amortized over the average remaining service period to retirement date of active plan participants.
Stock-based Compensation
We apply the authoritative guidance for stock-based compensation. This guidance requires companies to recognize the expense related to the fair value of their stock-based compensation awards. Stock-based compensation expense for stock option awards is based on the grant date fair value on using the binomial distribution model. The Company recognizes compensation expense for stock option awards, restricted stock awards, performance stock awards and contract stock awards on a ratable basis over the requisite service period of the award. All excess tax benefits and taxes and tax deficiencies from stock-based compensation are included in the provision for income taxes in the consolidated statement of operations.
Recently Issued and Adopted Accounting Standards
Refer to Note 2, Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements (Part II, Item 8 of this Form 10-K), to the consolidated financial statements for recently adopted accounting pronouncements.
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