INTEGRA LIFESCIENCES HOLDINGS CORPORATION The following discussion and analysis of our financial condition and results of operations should be read together with the selected consolidated financial data and our financial statements and the related notes appearing elsewhere in this report. The comparison of fiscal 2019 to 2018 has been omitted from this Form 10-K, but can be referenced in our Form 10-K for the fiscal year endedDecember 31, 2019 -"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" filed onFebruary 21, 2020 . We have made statements in this report which constitute 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 (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 Company's ability to obtain accurate procedure volume in the midst of the COVID-19 pandemic; the risk that the COVID-19 pandemic could lead to further material delays and cancellations of, or reduced demand for, procedures; curtailed or delayed capital spending by the Company's customers; disruption to the Company's supply chain; closures of 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 or its variants disrupt 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." 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, advanced wound care, and orthopedic hardware through a combination of several global acquisitions and development of products internally to further meet the needs of its customers and impact patient care. Integra now manufactures and sells our products in two reportable business segments: Codman Specialty Surgical and Orthopedics and Tissue Technologies. Our Codman Specialty Surgical products comprise of specialty surgical implants and instrumentation for a broad range of specialties. This segment includes products and solutions for dural access and repair, precision tools and instruments, advanced energy, cerebral spinal fluid ("CSF") management and neuro monitoring including market leading product portfolios used in neurosurgery operation suites and critical care units. Codman Specialty Surgical products are sold through a combination of directly employed sales representatives, distributors and wholesalers, depending on the customer call point. Our Orthopedics and Tissue Technologies product portfolios consist of differentiated regenerative technology products for soft tissue repair and tissue regeneration products, and surgical reconstruction. This business also includes private label sales of a broad set of our regenerative and wound care medicine technologies. Orthopedics and Tissue Technologies products are sold through directly employed sales representatives and distributors focused on their respective surgical specialties, and strategic partners. InJanuary 2021 , we completed the sale of our Extremity Orthopedics business toSmith & Nephew USD Limited for approximately$240 million in cash. This transaction enables us to increase our investments in our business which will strengthen our existing leadership positions in both areas, fund pipeline opportunities to drive future growth and expand our addressable markets. See Note 18, Subsequent Events, for details. 31 -------------------------------------------------------------------------------- We have key manufacturing and research facilities located inCalifornia ,Massachusetts ,New Jersey ,Ohio ,Tennessee ,Canada ,France ,Germany ,Ireland ,Puerto Rico andSwitzerland . We also source most of our handheld surgical instruments, specialty metal and pyrocarbon implants, 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) building an execution-focused culture, 2) achieving relevant scale, 3) improving agility and innovation, 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. InDecember 2020 , Integra entered into a merger agreement to acquireACell, Inc. , an innovative regenerative medicine company. This acquisition, which closed onJanuary 20, 2021 , expands our product offering of regenerative technology and is complementary to Integra's existing tissue technologies portfolio. The acquisition also supports our long-term growth and profitability strategy with a financial profile similar to Integra's tissue products. In 2020, we continued to invest in our two most recent acquisitions from 2019,Arkis Biosciences, Inc. andRebound Therapeutics Corporation , both of which are developing innovative technologies for neurosurgery. 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. InFebruary 2020 , we launched the AmnioExcel® Plus Placental Allograft Membrane, the next generation wound care offering to support soft tissue repair. Throughout 2020, we continue to reap the benefits of many of our ten new products launches from 2019. 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. We continue to identify ways of optimizing our portfolio including identifying low-growth, low-margin products and product franchises for discontinuation. InJanuary 2021 , we completed the sale of our Extremity Orthopedics business toSmith & Nephew USD Limited for approximately$240 million in cash. This transaction enables us to increase our investments in our core Neurosurgery and Tissue Technology businesses which will strengthen our existing leadership positions in both areas, fund pipeline opportunities to drive future growth and expand our addressable markets. See Note 3, Assets and Liabilities Held for Sale, for details. Commercial Channel Investments. With acquisitions, new product introductions and a broader portfolio of products, 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. Internationally, we have increased our commercial resources significantly in many markets and are making investments to support our sales organization and maximize our commercial opportunities. We now have a strong international sales channel that will deliver our current portfolio as well as position us for expansion. In addition, we continue to build upon our leadership brands across our product franchises to enable us to engage customers through enterprise-wide contracts. Customer Experience. We aspire to be ranked as a best-in-class provider and are committed to strengthen our relationships with all customers. We strive to consistently deliver outstanding customer service and continue to invest in technologies, systems and processes to improve the way our customers do business with us. Additionally, we expect to build on the success of our professional education programs 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 two years. Within our Codman Specialty Surgical segment, the Company received FDA clearance inJuly 2020 to treat malignant and benign tumors, but not limited to meningiomas and gliomas, for its CUSA® Clarity Ultrasonic Surgical Aspirator System, the first and only ultrasonic tissue ablation system with this specific indication. The FDA clearance is based on a wealth of peer-reviewed clinical publications and 40 years of surgical cases involving resection of brain and spinal tumors. Additionally, the Company continued to reap the benefits of our product launches from the prior year from the Codman Specialty Surgical segment, 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® last year, 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 32 -------------------------------------------------------------------------------- electromechanical technologies portfolio. Also, we updated our CUSA Clarity platform to incorporate a 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. This enables us to add new instruments with minimal expense and invest in ongoing development, such as our next generation of LED technology with our DUO LED Surgical Headlight System. Throughout the year, we also continued to advance the early-stage technology platforms we acquired in 2019. Through the Arkis Biosciences acquisition, 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. We also acquired a company, Rebound Therapeutics, that specialized in single-use medical devices that enable minimally invasive access with enhanced lighting and visualization to the neurosurgery suite. Importantly, these new platforms provide us with the opportunity to expand into new, faster growth therapeutic areas, such as intracerebral hemorrhage and minimally invasive neurosurgery. Within our Orthopedics and Tissue Technologies segment, inFebruary 2020 , we launched AmnioExcel® Plus Placental Allograft Membrane, a human placental tissue product for treatment of wounds. We also launched a small post baseplate in our reverse shoulder system that accommodates smaller patients. In addition, we initiated the limited market release of enhancements to our Salto Talaris® Total Ankle System. InMay 2020 , the Company 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 looks for ways to efficiently and effectively repair and close wounds during these challenging times,IBWM helps address the efficiency needed in operating rooms by reducing both the operating time and costs to hospitals and patients. COVID-19 Pandemic During this global crisis, the Company's focus remains on supporting patients, providing customers with life-saving products, and protecting the well-being of our employees. The rapid and evolving spread of the virus has resulted in an unprecedented challenge to the global healthcare industry, as medical resources were reallocated to fight COVID-19. During the first half of 2020, 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. We continued to invest in our key research, development and clinical programs but also implemented cost-savings measures, which included the following: •Reduced executive management compensation throughJuly 2020 and director compensation; •Reduced cash compensation for all other employees through reduced commissions, reduction in hours throughJuly 2020 and/or furloughs; •Hiring freeze, elimination of overtime, reduction in certain employee benefit costs, cessation of third-party services and temporary contractor relationships; and •Significant reduction in capital expenditures and discretionary spending including travel, events and marketing programs. As the recovery began to take hold, we saw the benefit of our balanced pandemic response. In the second half of 2020, while continuing to methodically manage expenses, the Company restored employee wages, hired key positions and allocated additional funds toward growth and productivity projects. We remain confident that the underlying markets in which the Company competes remain attractive over the long term. We also remain focused on managing the business for the long-term, including preserving full time jobs needed to support the rebound in surgical procedure volumes. 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. 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, could further significantly 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. Information pertaining to additional risk factors as it relates to the COVID-19 pandemic can be found in Item 1A. Risk Factors. 33 -------------------------------------------------------------------------------- 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, or 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. OnMarch 7, 2019 ,TEI Biosciences, Inc. a subsidiary of the Company received a Warning Letter (the "Warning Letter"), datedMarch 6, 2019 , from the FDA. The warning letter relates to quality systems issues at our manufacturing facility located inBoston, Massachusetts . The letter resulted from an inspection held at that facility in October andNovember 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 onMarch 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. The warning letter does not restrict the Company's ability to manufacture or ship products or require the recall of any products. Nor does it restrict our ability to seek FDA 510(k) clearance of products. The letter states that requests for Certificates to Foreign Governments would not be granted. However, due to our progress reports, the FDA agreed to resume issuing Certificates to Foreign Governments to 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 (EBM) products. The Company does not expect to incur material incremental expense for remediation activities. We cannot, however, 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 theFDA'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 endedDecember 31, 2020 were approximately 4.5% of consolidated revenues. ACQUISITIONS & DIVESTITURES Divestiture OnJanuary 4, 2021 , upon the terms and conditions set forth in the Divestiture agreement (see Note 3, Assets and Liabilities Held for Sale), the Company completed its previously announced sale of its Extremity Orthopedics business toSmith & Nephew USD Limited . The Company received an aggregate purchase price of$240.0 million from Smith and Nephew and concurrently paid$41.5 million to CFO effectively terminating our licensing agreement (see Note 5, Acquisitions). 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. 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 throughout 2019, our financial results for the year endedDecember 31, 2020 may not be directly comparable to those of the corresponding prior-year periods. See Note 5 - Acquisitions and Note 18- Subsequent Events, to our consolidated financial statements for a further discussion.ACell Inc. OnJanuary 20, 2021 , the Company acquiredACell Inc. for an acquisition purchase price of$300 million . Under the terms of the definitive merger agreement, the Company paid the consideration for the merger as an upfront cash payment subject to a customary post-closing adjustment for certain working capital. The Company is also required to pay the former shareholders ofACell Inc. up to$100 million based upon achieving certain revenue-based performance milestones in 2022, 2023 and 2025.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 estimated fair value as ofDecember 31, 2020 was$15.1 million . The Company recorded$3.4 million in accrued expenses and other current liabilities and$11.7 million in other liabilities atDecember 31, 2020 in the consolidated balance sheets of the Company. Arkis was a privately-held company that marketed the 34 -------------------------------------------------------------------------------- CerebroFlo® external ventricular drainage (EVD) catheter with Endexo® technology, a permanent additive designed to reduce the potential for catheter obstruction due to clotting.Rebound Therapeutics Corporation 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. During the fourth quarter of 2019, the Company achieved the first developmental milestone which triggered a$5.0 million obligation to be paid to former shareholders of Rebound. The Company recorded$5.0 million as IPR&D expense in the consolidated statements of operations during the year endedDecember 31, 2019 . The obligation was included in accrued liabilities atDecember 31, 2019 in the consolidated balance sheets. The milestone was paid during the first quarter of 2020. During the fourth quarter of 2020, the Company achieved another developmental milestone which triggered a$20.0 million obligation to be paid to the former shareholders of Rebound. The milestone was paid during the fourth quarter of 2020.Integrated Shoulder Collaboration, Inc. OnJanuary 4, 2019 , the Company entered into a licensing agreement withIntegrated Shoulder Collaboration, Inc ("ISC"). Under the terms of the agreement, the Company paid ISC$1.7 million for the exclusive, worldwide license to commercialize its short stem and stemless shoulder system. A patent related to short stem and stemless shoulder systems was issued to ISC during the first quarter of 2019. ISC is eligible to receive royalties on sales of the short stem and stemless shoulder system. The Company has the option to acquire ISC at a date four years subsequent to the first commercial sale, which becomes mandatory upon the achievement of a certain sales threshold of the short stem and stemless shoulder system, for an amount not to exceed$80.0 million . The transaction was accounted for as an asset acquisition as the Company concluded that it acquired primarily one asset. During the quarter endedMarch 31, 2019 , the total upfront payment of$1.7 million was expensed as a component of research and development expense and the future milestone and option payments will be recorded if the corresponding events become probable. In connection with the divestiture of the Extremity Orthopedics business, the Company paid$41.5 million to theConsortium of Focused Orthopedists , LLC ("CFO") concurrently pursuant to the terms of certain agreements between Integra and CFO relating to the development of shoulder arthroplasty products effectively terminating our licensing agreement with ISC. 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, 2020 was$133.9 million , or$1.57 per diluted share, compared to$50.2 million , or$0.58 per diluted share for the year endedDecember 31, 2019 . The increase in net income for the year endedDecember 31, 2020 as compared toDecember 31, 2019 was primarily driven by two main components. The first was due to 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 . The second component of the increase in net income in 2020 compared to 2019 resulted from a$64.9 million IPR&D expense attributed to the Rebound transaction which occurred during the third quarter of 2019. Excluding these components, net income for the year endedDecember 31, 2020 declined by$40.4 million compared to the prior year 2019. This decrease was attributable to the impact of the COVID-19 pandemic which resulted in lower revenues, and was partially offset by a decrease in the level of operating expenses due to cost-savings measures implemented by the Company during 2020. The Company demonstrated recovery in both of our reporting segments in the second half of 2020 as compared to the first half of 2020. The revenue results 35 -------------------------------------------------------------------------------- in the second half of 2020 along with expense management by the Company contributed to overall profitability and strong operating cash flows during a year in which the Company was severely affected by a global crisis. For the year endedDecember 31, 2020 , total revenues were$1,371.9 million , representing a decline of 9.6% from prior year revenues due to COVID-19 related surgical procedure delays and capital spending deferrals. Given the variability throughout 2020, we have presented our results below including Revenue for the first and second half of 2020 as compared to the first and second half of 2019. First Half Second Half (amounts in thousands) 2020 2019 2020 2019 Codman Special Surgical$ 401,218 $ 483,826 $ 493,613 $ 512,380 Orthopedics and Tissue Technologies$ 211,771 $ 259,509 $ 265,266 $ 261,842 Total Revenue$ 612,989 $ 743,335 $ 758,879 $ 774,222 During the first half of 2020, total revenues declined$130.3 million , representing a decline of 18%, compared to the first half of 2019 and reflected the impact of the COVID-19 pandemic on the Company frommid-March 2020 throughJune 30, 2020 . The Company experienced the largest impact of COVID-19 during the second quarter of 2020 when revenues declined 32.6% compared to the same period in 2019. As a result of the speed and severity of the spread of COVID-19, the Company saw rapid and significant decline in surgical and medical intervention procedures as healthcare providers deferred non-urgent medical procedures in order to address the increasing demands caused by the COVID-19 pandemic. Despite the revenue decline experienced, the Company does not believe its underlying markets in neurosurgery and regenerative medicine have fundamentally changed, rather the revenue declines were driven by COVID-19 procedural delays. During the second half of 2020, total revenues declined$15.3 million , representing a decline of 2% compared to the second half of 2019. In the second half of 2020, we experienced strong sequential revenue improvements across all franchises, representing an increase of 24% compared to the first of half of 2020. The Company's performance varied across regions and product lines based on the severity of the pandemic but in general, the Company saw broad based recovery across its portfolio when compared to the first half of 2020, as surgical procedures recovered and shelter in place restrictions were lifted. In the Codman Specialty Surgical ("CSS") segment, revenues for the second half of 2020 increased 23.0% as compared to the first half of 2020. Both the Neurosurgery and Instruments portfolio showed significant sequential improvement compared to the first half of 2020. During the second half of 2020, CSS revenues declined 3.7% as compared to the second half of 2019. Sales in our neuro monitoring products increased high single digits and CSF management products increased mid single digits in the second half of 2020 compared to the second half of 2019. Despite showing low double digits sequential improvement as compared to the first half of 2020, sales in capital equipment products, declined low double digits in the second half of 2020 compared to the same period in the prior year as hospitals and healthcare institutions continued to allocate capital budgets to manage the increase in costs associated with the COVID pandemic. The Company continues to have a strong pipeline of new capital opportunities and believes the reallocation of capital budgets is only temporary. Sales from our Instruments portfolio decreased low double digits excluding discontinued products as compared to the second half of 2019, due to a decrease experienced in surgical procedures as a result of COVID-19. In the Orthopedics and Tissue Technologies ("OTT") segment, revenues for the second half of 2020 increased 25.3% as compared to the first half of 2020. Sales in our Wound Reconstruction, Extremity Orthopedics and Private Label portfolios all showed sequential improvement in revenues as compared to the first half of 2020. During the second half of 2020, OTT revenues increased 1.3% as compared to the second half of 2019. Sales in our Private label portfolio increased high-single digits over the prior year. Sales of our Wound Reconstruction and Extremity Orthopedics portfolio remained flat as compared to the second half of 2019 led by growth in sales of Integra skin, nerve and Primatrix products. We continue to closely monitor local, regional, and global COVID-19 surges as well as new variants of the virus for an impact on procedures during Q1 2021 and beyond. The reallocation of hospital resources to treat COVID-19 may continue to cause a financial strain on healthcare systems and reduce procedural volumes. Additionally, the Company does not expect all markets and product lines to improve at the same rate based on the level of recurrence of COVID-19 and its associated impact on the pace of procedure recovery and economic normalization. 36 -------------------------------------------------------------------------------- Special Charges Income before taxes includes the following special charges: Years Ended December 31, 2020 2019 (In thousands) Acquisition, divestiture and integration-related charges (2)$ 32,906 $ 124,665 Convertible debt non-cash interest expense 15,415 - Structural optimization charges 15,363 17,582 EU medical device regulation 9,372 6,221 Discontinued product lines charges 6,342 9,168 Expenses related to debt refinancing 6,168 - COVID-19 pandemic related charges (1) 3,482 - Impairment charges - 5,764 Litigation matters - 96 Total 89,048 163,496 (1) 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. (2) The Company included$64.9 million of IPR&D expense within acquisition, divestiture and integration-related charges as a result of the Rebound transaction in the prior year. The items reported above are reflected in the consolidated statements of operations as follows: Years Ended December 31, 2020 2019 (In thousands) Cost of goods sold (1)$ 34,557 $ 25,266 Research and development 3,163 2,786 IPR&D expense - 64,916 Selling, general and administrative 29,745 67,265 Intangible asset amortization (2) - 5,764 Interest expense 21,583 - Other (income) expense - (2,501) Total$ 89,048 $ 163,496 (1) Amortization and impairment charges related to technology based intangible assets is included in cost of goods sold. (2) Impairment charges related to non-technology based intangible assets such as customer relationships are included in Intangible asset amortization. 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. 37 -------------------------------------------------------------------------------- Revenues and Gross Margin Our revenues and gross margin on product revenues were as follows: Years Ended December 31, 2020 2019 Segment Net Sales (In thousands) Codman Specialty Surgical$ 894,831 $ 996,206 Orthopedics and Tissue Technologies 477,037 521,351 Total revenues 1,371,868 1,517,557 Cost of goods sold 520,834 564,681 Gross margin on total revenues$ 851,034 $
952,876
Gross margin as a percentage of total revenues 62.0 %
62.8 %
Revenues
For the year endedDecember 31, 2020 , total revenues decreased by$145.7 million , or 9.6%, to$1,371.9 million from$1,517.6 million during the prior year. Domestic revenues decreased by$105.4 million , or 9.8%, to$972.0 million and were 70.9% of total revenues for the year endedDecember 31, 2020 . International revenues decreased by$40.3 million or 9.2% to$399.9 million , compared to$440.2 million during 2019. The net decrease of$145.7 million was a result of decline in both segments due to disruption from the COVID-19 pandemic,$22.7 million due to discontinued and divested products, and$4.7 million due to favorable impact of foreign exchange. Codman Specialty Surgical revenues were$894.8 million , a decrease of 10.2% from the prior year primarily due to disruption caused by the COVID-19 pandemic and impact of discontinued products. Orthopedics and Tissue Technologies revenues were$477.0 million , a decrease of 8.5% from the prior year primarily due to disruption caused by the COVID-19 pandemic. With our global reach, we generate revenues in multiple foreign currencies. Accordingly, we will experience currency exchange risk with respect to those foreign currency denominated revenues. Gross Margin Gross margin as a percentage of revenues was 62.0% in 2020 and 62.8% in 2019. The decrease in gross margin percentage from 2019 to 2020 was primarily due to the disruption caused by the COVID-19 pandemic, an increase related to the manufacturing transition of certain CSS products to ourMansfield, MA facility, partially offset by favorable product mix. Operating Expenses The following is a summary of operating expenses as a percent of total revenues: Years Ended December 31, 2020 2019 Research and development 5.6 % 5.2 % IPR&D expense - % 4.3 % Selling, general and administrative 43.3 % 45.3 % Intangible asset amortization 2.0 % 1.8 % Total operating expenses 50.9 % 56.6 % Total operating expenses, which consist of research and development, IPR&D, selling, general and administrative, and amortization expenses, decreased by$159.5 million or 18.6% to$699.7 million in 2020, compared to$859.1 million in the prior year. Operating costs were managed lower in 2020 due to on-going cost reduction efforts to offset the impact of lower revenues driven by the COVID-19 pandemic. These cost reduction actions included temporary reduced compensation and work hours, hiring freezes, reduction in certain employee benefit costs, cessation of third party services and contractors, and reductions in discretionary spending, including travel, events and marketing programs for a period of time. Research and Development Research and development expenses for the year endedDecember 31, 2020 largely remained flat year over year with only a slight decrease of$2.2 million compared to the prior year. The Company continues to invest in R&D programs with spending in-line with prior year levels despite the challenges from the COVID-19 pandemic. 38
--------------------------------------------------------------------------------In-Process Research and Development IPR&D expense for the year endedDecember 31, 2020 decreased$64.9 million from the same period last year as a result of IPR&D expense attributed to the Rebound transaction which occurred during the third quarter of 2019. Selling, General and Administrative Selling, general and administrative expenses for the year endedDecember 31, 2020 decreased by$93.1 million as compared to the prior year resulting from less acquisition, divestiture and integration related charges, lower commissions and selling costs resulting from lower revenue during the year and overall cost reduction actions resulting from cost-savings measures taken by the Company as a result of the impact of the COVID-19 pandemic. Intangible Asset Amortization Amortization expense (excluding amounts reported in cost of product revenues for technology-based intangible assets) in 2020 was$27.8 million compared to$27.0 million in 2019. 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 (including amounts reported in cost of product revenues, but excluding any possible future amortization associated with acquired IPR&D and recent acquisition ofACell Inc. completed onJanuary 20, 2021 ) to be approximately$63.8 million in 2021,$61.4 million in 2022,$60.7 million in 2023,$60.2 million in 2024,$60.2 million in 2025 and$512.3 million thereafter. Non-Operating Income and Expenses The following is a summary of non-operating income and expenses: Years Ended December 31, 2020 2019 (In thousands) Interest income$ 9,297 $ 10,779 Interest expense (71,581) (53,957) Other income, net 4,434 9,522 Total non-operating income and expense$ (57,850) $ (33,656) Interest Income Interest income for the year endedDecember 31, 2020 decreased by$1.5 million as compared to the same period last year primarily due to the termination of cross-currency swaps designated as net investment hedges in Q4 2019. Interest Expense Interest expense for the year endedDecember 31, 2020 increased by$17.6 million as compared to the same period last year primarily due to an increase in non-cash interest expense due to the issuance of the Convertible Senior Notes and expenses associated with our Amended and Restated Senior Credit Agreement. Other Income, Net Other income, net for the year endedDecember 31, 2020 decreased by$5.1 million as compared to the same period last year primarily due to the unfavorable impact of foreign exchange and a$3.0 million gain from a legal settlement received during the prior year. Income Taxes Our effective income tax rate was (43.2)% and 16.5% of income before income taxes in 2020 and 2019, 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. 39 -------------------------------------------------------------------------------- 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 2021 to be approximately 20.0%. AtDecember 31, 2020 , the Company had$9.9 million of valuation allowance against the remaining$173.3 million of gross deferred tax assets recorded atDecember 31, 2020 . Our deferred tax asset valuation allowance remained substantially unchanged in 2020 and increased by$2.9 million in 2019. 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. The increase in valuation allowance in 2019 primarily resulted from certain assets from the Rebound and Arkis acquisitions. AtDecember 31, 2020 , we had net operating loss carryforwards of$90.2 million for federal income tax purposes,$36.7 million for foreign income tax purposes and$41.6 million for state income tax purposes to offset future taxable income. The federal net operating loss carryforwards decreased during 2020 due to the use of net operating losses. Of the total federal net operating loss carryforwards,$78.4 million expire through 2037 and$11.8 million have an indefinite carryforward period. Regarding the foreign net operating loss carryforwards,$0.3 million expire through 2025, and the remaining$36.4 million have an indefinite carryforward period. The state net operating loss carryforwards expire in 2036. As ofDecember 31, 2020 , the Company has not provided deferred income taxes on unrepatriated earnings from foreign subsidiaries as they are deemed to be indefinitely reinvested. Such taxes would primarily be attributable to foreign withholding taxes and local income taxes when such earnings are distributed. As such, the Company has determined the tax impact of repatriating these earnings would not be material as ofDecember 31, 2020 . GEOGRAPHIC PRODUCT REVENUES AND OPERATIONS The Company attributes revenues to geographic areas based on the location of the customer. Total revenue by major geographic area consisted of the following: Years Ended December 31, 2020 2019 (In thousands) United States$ 971,975 $ 1,077,379 Europe 172,689 197,468 Asia Pacific 157,174 157,391 Rest of World 70,030 85,319 Total Revenues$ 1,371,868 $ 1,517,557 The Company generates significant revenues outside theU.S. , a portion of which areU.S. dollar-denominated transactions conducted with customers that generate revenue in currencies other than theU.S. dollar. As a result, currency fluctuations between theU.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 theU.S. Domestic revenues decreased by$105.4 million for the year endedDecember 31, 2020 compared to the same period last year. European sales decreased by$24.8 million for the year endedDecember 31, 2020 compared to the same period last year. Sales to customers inAsia Pacific decreased by only$0.2 million for the year endedDecember 31, 2020 compared to the same period last year driven by accelerated recovery in both theJapan andChina markets in relation to otherwise negative COVID-19 impacts. The Rest of the World for the year endedDecember 31, 2020 decreased by$15.3 million compared to the same period last year. The decrease in revenues globally was primarily due to adverse effects of the COVID-19 pandemic across all franchises. LIQUIDITY AND CAPITAL RESOURCES Working Capital AtDecember 31, 2020 andDecember 31, 2019 , working capital was$836.2 million and$526.9 million , respectively. Working capital consists of total current assets less total current liabilities as presented in the consolidated balance sheets.Cash and Marketable Securities The Company had cash and cash equivalents totaling approximately$470.2 million and$198.9 million atDecember 31, 2020 and 2019, respectively, which are valued based on Level 1 measurements in the fair value hierarchy. AtDecember 31, 2020 , 40 -------------------------------------------------------------------------------- our non-U.S. subsidiaries held approximately$234.0 million of cash and cash equivalents that are available for use outside theU.S. The Company asserts that it has the ability and intends to indefinitely reinvest the undistributed earnings from its foreign operations unless there is no material tax cost to remit the earnings into theU.S. The Company does not anticipate the need to repatriate earnings from foreign subsidiaries as a result of the impact of the COVID-19 pandemic. Cash Flows Year Ended December 31, 2020 2019 (In thousands) Net cash provided by operating activities$ 203,832 $ 231,433 Net cash used in investing activities (68,073)
(162,668)
Net cash used (provided) by financing activities 121,625
(8,766)
Effect of exchange rate fluctuations on cash 13,871
74
Net increase (decrease) in cash and cash equivalents
Cash Flows Provided by Operating Activities 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, 2020 , we paid$38.9 million for capital expenditures, most of which were directed to our facilities located inMansfield, MA ;Boston, MA ;Memphis, TN ; andPrinceton, NJ and$25.0 million associated with achieving developmental milestones paid to the former shareholders of Rebound. During the year endedDecember 31, 2019 , we paid$69.5 million for capital expenditures, most of which were directed to our newMansfield, Massachusetts facility,Princeton, New Jersey facility and commercial expansion. Further we paid$95.5 million for the Arkis and Rebound transactions, net of cash acquired. Cash Flows Provided by (Used in) Financing Activities 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. Our principal sources of cash from financing activities for the year endedDecember 31, 2019 were$236.9 million in borrowings under our Senior Credit Facility and Securitization Facility. These were offset by repayments of$246.1 million on borrowings under our Senior Credit Facility and Securitization Facility. Amended and Restated Senior Credit Agreement, Convertible Senior Notes, Securitization and Related Hedging Activities See Note 6, Debt to the current period's consolidated financial statements for a discussion of our Amended and Restated Senior Credit Agreement, Convertible Senior Notes and Securitization Facility and Note 7, Derivative Instruments for a discussion of our hedging activities. We are forecasting that for the next twelve months, sales and earnings 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. The Company entered into theJuly 2020 amendment to increase financial flexibility in light of the unprecedented impact and uncertainty of the COVID-19 pandemic on the global economy. 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, 2020 . 41 -------------------------------------------------------------------------------- During the year endedDecember 31, 2020 , the Company repurchased 2.1 million shares of Integra's common stock as a part of our previous share repurchase authorization. The Company utilized$100.0 million of net proceeds from the offering of the Convertible Senior 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 ("ASR") to complete the remaining$100.0 million of share repurchases. The Company received 1.3 million shares through the ASR, which represented approximately 80% of the expected total shares. Upon settlement of the ASR inJune 2020 , the Company received an additional 0.6 million shares, which was determined using the volume weighted average price of the Company's common stock during the term of the ASR. Dividend Policy The Company has 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. Further, as part of our actions to manage the impacts of the COVID-19 pandemic on our business, the Company significantly reduced capital expenditures in 2020 by approximately$30.6 million as compared to the prior year. Off-Balance Sheet Arrangements We do not have any off-balance sheet financing arrangements during the year-endedDecember 31, 2020 that have or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our interests. Contractual Obligations and Commitments As ofDecember 31, 2020 , we were obligated to pay the following amounts under the following agreements: Payments Due by Calendar Year Total 2021 2022-2023 2024-2025 Thereafter (In millions) Revolving Credit Facility (1)$ 97.5 $ - $ - $ -$ 97.5 Term Loan$ 877.5 $ 33.8 $ 45.0 $ 129.4 $ 669.4 Securitization Facility (1)$ 112.5 $ 112.5 $ - $ - $ - Convertible Securities(4)$ 575.0 $ - $ - $ -$ 575.0 Interest (2)$ 48.5 $ 13.1 $ 12.4 $ 22.1 $ 1.0 Employment Agreements (3)$ 1.0 $ 1.0 $ - $ - Operating Leases$ 138.8 $ 13.8 $ 14.3 $ 21.9 $ 88.9 Purchase Obligations$ 6.0 $ 2.7 $ 2.1 $ 1.2 $ - Others$ 4.2 $ 1.1 $ 0.4 $ 1.6 $ 1.1 Total$ 1,861.1 $ 178.0 $ 74.2 $ 176.1 $ 1,432.8
(1) The Company may borrow and make payments against the revolving credit portion of its
Senior Credit Facility and Securitization Facility from time to time and considers all
of the outstanding amounts to be long term based on its current intent and ability to
repay the borrowing outside of the next twelve-month period. (2) Interest is calculated on the term loan portion of the Senior Credit Facility based on
current interest rates paid by the Company. As the revolving credit facility and
Securitization Facility can be repaid at any time, no interest has been included in the
calculation.
(3) Amounts shown under Employment Agreements do not include compensation resulting from a
change in control.
(4) On
its of 0.5% Convertible Senior Notes due 2025 (the "2025 Notes"). The 2025 Notes will
mature on
semi-annually in arrears, unless earlier converted, repurchased or redeemed in
accordance with the terms of the Notes. See Note 6, Debt, for the details on the 2025
Notes.
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The Company has excluded its contingent consideration obligation related to
prior and current year acquisitions from the contractual obligations table
above; this liability had a total estimated fair value of $15.4
million at December 31, 2020 . This liability has been excluded because the
amount to be paid and the potential payment date is not fixed.
In connection with the sale of the Company's Extremity Orthopedic business, the
Company will pay $41.5 million to Consortium of Focused Orthopedists , LLC
("CFO") pursuant to the terms of certain agreements between Integra and CFO
relating to the development of shoulder arthroplasty products. As a result, the
Company has excluded its former option to acquire Integrated Shoulder
Collaboration Inc. , which becomes mandatory upon achievement of a certain sales
threshold, for an amount not to exceed $80.0 million , as the option is no longer
available to the Company following the transaction with CFO. See Note 3, Assets
and Liabilities Held for Sale and Note 18, Subsequent Events, for further
details of the transaction.
The Company has excluded its future pension contribution obligations from the
table above. This has been excluded because the future amounts to be paid and
the potential payment dates are not fixed.
The Company has excluded the liability for uncertain tax benefits from the
contractual obligations table above, including interest and penalties, totaling
$0.9 million at December 31, 2020 . This liability for uncertain tax benefits has
been excluded because we cannot make a reliable estimate of the period in which
the uncertain tax benefits may be realized.
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 in the United States of
America . 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, in-process research and development ("IPR&D"), 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
the equity component of convertible debt 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. Actual
results could differ from these estimates. The COVID-19 pandemic and the
resulting adverse impacts to global economic conditions, as well as our
operations, may impact 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:
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.
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
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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.
Acquisitions
Results of operations of acquired companies are included in the Company's
results of operations as of the respective acquisition dates. Net assets
acquired are recorded at fair value at the date of the acquisition. Any purchase
price in excess of these net assets is recorded as goodwill. The fair values of
net assets acquired may be subject to revision based on the final determination
of fair values during the measurement period, which may be up to one year from
the acquisition date.
Contingent consideration is recognized at the estimated fair value on the
acquisition date for a business combination and recorded when probable for an
asset acquisition. Subsequent changes to the fair value of contingent payments
are recognized in earnings. 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. The
fair value of development, regulatory, and commercial milestone payments
reflects management's expectations of the probability of payment and increases
or decreases as the probability of payment or expectation of timing of payments
changes. The fair value of sales-based payments is based upon
probability-weighted future revenue estimates and increases or decreases as
revenue estimates or expectation of timing of payments changes.
Valuation of Goodwill
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. Our assessment of the recoverability of goodwill
is based upon a comparison of the carrying value of goodwill with its estimated
fair value. We review goodwill for impairment annually as of July 31 and
whenever events or changes in circumstances indicate the carrying value of
goodwill may not be recoverable. Refer to Note 8 - Goodwill and Other Intangible
Assets for more information on reportable segments.
Valuation of Identifiable Intangible Assets
Other intangible assets include patents, trademarks, purchased technology, and
supplier and customer relationships. Identifiable intangible assets are
initially recorded at fair market value at the time of acquisition generally
using an income or cost approach. The Company capitalizes costs incurred to
renew or extend the term of recognized intangible assets and amortizes those
costs over their expected useful lives.
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 and 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, using the framework prescribed by the authoritative
guidance, 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.
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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 13, Income Taxes, 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.
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. The 2017 Tax Act imposed a
Toll Tax on a deemed repatriation of undistributed earnings of foreign
subsidiaries. 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, 2020 , 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, 2020 . The Company does not anticipate
the need to repatriate earnings from foreign subsidiaries as a result of the
impact of the COVID-19 pandemic.
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.
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Pension Benefits
The Company maintains defined benefit pension plans that cover certain employees
in France , Japan , Germany and Switzerland . 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 2020,
the discount rate was prescribed as the current yield on corporate bonds with an
average rating of AA or AAA 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 of
December 31, 2020 . 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.
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 ended December 31, 2020 and 2019, respectively:
As of December 31,
2020 2019
Discount rate 0.34 % 0.40 %
Expected return on plan assets 2.04 % 3.33 %
Rate of compensation increase 2.14 % 2.25 %
Interest crediting rate for cash balance plans 1.0 % 0.9 %
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$0.1 million favorable (unfavorable) impact on pension plan costs. As ofDecember 31, 2020 , contributions expected to be paid to the plan in 2021 are$2.3 million . 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, to the consolidated financial statements for recently adopted accounting pronouncements.
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